Caught In The Geopolitical Crossfire

by: Henry Miles

Three years ago, I wrote an article arguing that transnational companies are more reliable than countries; this is even more true today.

Still, there may be reversion-type investment opportunities in such companies temporarily caught in the crossfire between trade-warring nations.

I’m testing this hypothesis with investments in Alibaba and Baidu whose stocks have taken hits by bullets flying between the US and China.

A while back, I wrote an article for SA entitled, "Transnational Companies - More Reliable Than Countries Right Now". I led off that piece with three points: a) "Cooperative and open international systems are under attack from the left and right", b) "To deny globalization is to ignore longstanding economic and commercial realities" c) "Transnational companies offer promise and protection against political dysfunction"

Nationalism vs. Globalism

Indeed, I described the "call to turn inward" and used the term "nationalism" to label movements underway including, notably, in the UK and US. Subsequently, that tag was popularized by President Trump who views his/our country as a victim (as impossible as that is to believe). In calling on readers to reject nationalism, I noted that:

"Sealing oneself off, or drumming others into submission, just doesn't work very well financially/economically for very long because, again, global forces are beyond the ability of any country or alliance to control. International commerce will prevail; it is naïve to believe otherwise."

I went on to name some transnational companies that I felt were of the size and agility to maneuver through and around geopolitical economic dysfunction. Companies like Boeing (BA), Veolia (OTCPK:VEOEY), Siemens (OTCPK:SIEGY) to name one each from the US, France, and Germany. I encouraged investors to consider geopolitical risk diversification via companies headquartered in various developed countries.

That was Then

That article appeared before the 2016 election; no one could have predicted then how nuts things would become. The expression "trade war" has come into use and some, like Ray Dahlio, believe it even understates a tectonic schism opening between the United States and China. Economic relationships with Mexico are now also under threat and, most recently, India. Soybeans, automobiles, rare-earth metals, FedEx (NYSE:FDX), you name it - many supply chains are being jerked mightily with reverberations felt throughout economies right down to the global equity markets. Stock prices have plummeted; we investors are at serious risk.

Under the circumstances, I believe the arguments for investing in transnational companies are even more compelling today especially global oligopolists that serve fundamental (inelastic) demands and/or are positioned for strategic growth: renewable energy, commercial blockchain, crop-based agribusiness, cybersecurity, freshwater management, precious metals, robotics/AI, and 5G. It is in these areas that we are primarily invested.

Geopolitical Reversion Investing

At the same time, I wonder, whether amidst all the geopolitical dysfunction, there might be opportunity in something akin to reversion investing. Recall that as defined by Investopedia, the term refers to: "…a theory used in finance that suggests that asset prices and historical returns eventually will revert to the long-run mean or average…". The hypothesis being that price disruptions will eventually "self-correct". My best reversion trades were a few years back when per barrel oil prices sank into the $30's and I jumped into BP (BP), Royal Dutch Shell (RDS.A) (RDS.B), and Total (TOT). On top of healthy fundamentals and dividends, those trades worked out well and I continue to hold these positions.

Up until a few weeks ago, it had never occurred to me that the technique might also be applied to stock price disruptions resulting from international trade disputes. So, I decided to experiment by establishing a half position in Alibaba (BABA) and full position in Baidu (BIDU):

  • Alibaba - A Chinese multinational conglomerate holding company specializing in e-commerce, retail, Internet and technology. Founded 4 April 1999, the company provides consumer-to-consumer, business-to-consumer, and business-to-business sales services via web portals, as well as electronic payment services, shopping search engines and cloud computing services. It owns and operates a diverse array of businesses around the world in numerous sectors and is named as one of the world's most admired companies by Fortune. Somewhere in a past article or comment, I've mused that I consider Alibaba the "portal into China" even broader in scope and implications than Amazon (AMZN).
  • Baidu - A Chinese multinational technology company specializing in Internet-related services and products and artificial intelligence, headquartered in Beijing's Haidian District. It is one of the largest AI and internet companies in the world; often referred to as, "The Google (GOOG) (GOOGL) of China".

Dating back to the first rumblings of "trade war" over a year ago, the stocks in these two companies have been hit hard. Their prices reeled a few weeks ago when the US embargoed Huawei, a move that has the potential to affect many within their extensive supply and delivery chains.

Chart Data by YCharts

Putting this chart aside, one will discover that the financial fundamentals of Alibaba and Baidu are fine. Against a general caveat about Chinese accounting and reporting standards vis a vis a "managed" currency, we see evidence of good growth, solid margins, conservative leverage, and strong liquidity. Nothing particularly troubling here:

Don't Believe Me

Year-end Alibaba Baidu
Revenue $56.1B $14.9B
1-Year Growth 40.1% 14.1%
Net Income $13.1B $4.0B
1-Year Growth 28.4% 41.7%
Operating CF $22.5B $5.2B
1-Year Growth 19.7% 3.5%
Gross Margin 45.1% 46.3%
Operating Margin 15.5% 9.0%
Net Margin 21.1% 15.8%
Cash Flow Margin - 30.5%
Liabs. to Equity 0.9X 0.8x
Current Ratio 1.3x 2.8x
CF / Share $5.8 $13.9
Cash / Share $11.4 $59.7
Book / Share $27.9 $68.0
Price / Earnings 32.0x 13.6x
Price / Forecast 22.9x 21.5x

But don't believe me; take it from the professional financial analysts who live and breathe these stocks. As you can see, they are biased toward "buy" with median price targets approaching 10x their current prices. Divide by 2, divide by 4, and you will still the find the pros forecasting serious uplift in BABA and BIDU.

Sell Under- Perform Hold Over- Perform Buy Median Target Friday's Close Appre- ciation
BABA 0 0 0 6 42 $1,500 $149 907%
BIDU 0 0 16 3 19 $1,179 $110 972%

Beyond this variation of reversion investing, I'll close out this article by reminding readers again that I am a big believer in country / geopolitical diversification (especially via transnational companies that enjoy oligopoly status). To avoid flooding this piece with a long list of secondary ticker symbols, I will simply list our percentage exposure by country:

  • Canada - 5%
  • China - 5%
  • Denmark - 2%
  • France - 11%
  • Germany - 6%
  • Ireland - 3%
  • Japan - 6%
  • Netherlands - 4%
  • South Africa - 3%
  • Switzerland - 4%
  • United Kingdom - 3%
  • United States - 48%

In perhaps 6 - 12 months, I plan to report back on this China reversion strategy, hopefully with positive news. Whatever the case, I also plan to continue experimenting with this and other investment ideas in my continuing search for alpha.

Disclosure: I am/we are long BABA, BIDU, BA, BP, GOOGL, RDS.B, SIEGY, TOT, VEOEY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Always do your own due diligence in consultation with a licensed and competent financial adviser who understands your unique needs and puts your interests ahead of their own. Remember, there are added considerations in owning foreign securities including those associated with ADR sponsorship, buying and selling the pinks, foreign withholding taxes on dividends, and fees. (All my proceeds from contributing to SA go to charity.)