In this issue of the Asian Idea Generator Weekly, I continue to look for the following categories of Asian companies: 1) Companies that are either currently owned by institutional investors or witness significant insider buying/share buybacks; 2) companies that pass stringent quantitative screens; and 3) companies that are proxies for secular investment themes.
Piggybacking: An Aviation Monopoly TravelSky Technology
In the prior second issue of the Asian Idea Generator Weekly, I introduced fund manager Terry Smith, and Fundsmith Emerging Equities Trust, for which he is the Chief Investment Officer. I also profiled Hong Kong-listed Vitasoy International (OTCPK:VTSYF) [345:HK], Fundsmith Emerging Equities Trust's largest position with an approximate 5% weighting as of May 2019.
Fundsmith Emerging Equities Trust also owns other Asian stocks, including TravelSky Technology Limited (OTCPK:TSYHY) (OTCPK:TSYHF) [696:HK], which was listed as the top five detractors for the month of May 2019. TravelSky Technology was among the top 10 positions for Fundsmith Emerging Equities Trust at the end of December 2018, but likely fell out of the top 10 holdings list in subsequent months as the company's share price declined as the Asian and Hong Kong stock markets corrected following the escalation of U.S.-China trade tensions.
TravelSky Technology is a Hong Kong-listed provider of information technology solutions such as airline reservation for China’s aviation and travel industry. The aviation information technology services, data network and other services, system integration services and accounting, settlement and clearing services business segments accounted for 55.7%, 23.8%, 12.7% and 7.8% of TravelSky Technology's FY2018 revenue respectively.
I will be focusing primarily on TravelSky Technology's aviation information technology services business segment for the purpose of this article, as this business segment is a monopoly and contributes over half of the company's revenue. The aviation information technology services business essentially distributes electronic air tickets and charges flat transaction fees for each electronic ticket it distributes.
Started in October 2000, TravelSky Technology became the first and only aviation information system services provider in China. Almost all domestic airlines use TravelSky Technology's electronic travel distribution services (including inventory control system services, computer reservation system services and airport passenger processing system), with the exception of a few such as Spring Airlines which has developed and used its own in-house aviation information system. In October 2012, The Civil Aviation Administration of China allowed foreign GDS (Global Distribution System) providers to operate in China, but note that only non-Chinese airlines are allowed to use foreign GDS. In other words, foreign GDS can provide booking systems and services to foreign airlines’ sales agents in China. Notably even with foreign GDS providers operating in China since late 2012, TravelSky still has over 350 foreign and regional commercial airlines (on top of the 41 Chinese commercial airline customers) as clients of its electronic travel distribution services.
Besides regulatory barriers to entry, TravelSky Technology commands a near-monopoly in the domestic aviation information system service market thanks to its shareholder base. TravelSky Technology's founding shareholders are China’s Civil Aviation Computer Information Center and selected domestic airlines. China's three major airlines, China Southern Airlines (OTCPK:CHKIF) (ZNH) [1055:HK], China Eastern Airlines (CEA) (OTC:CHEAF) [670:HK] and Air China (OTCPK:AIRYY) (OTCPK:AICAF) [753:HK], are the company's largest indirect shareholders (the airlines' respective controlling shareholders hold direct stakes in TravelSky) and also its top customers. China Southern Air Holding Company Limited, China Eastern Air Holding Company Limited and China National Aviation Holding Company Limited, own a 36.2% equity interest in TravelSky Technology as of end-2018; while TravelSky Technology's top five clients, which include the three major domestic airlines, contributed 44% of the company's FY2018 revenue. This implies that China Southern Airlines, China Eastern Airlines and Air China are more likely than not to continue doing business with TravelSky Technology in the foreseeable future. However, having shareholders as one's clients could be a double-edged sword in terms of the customers' bargaining power in terms of pricing, which I would discuss later.
Certain monopolies have limited growth prospects due to the maturity of the end-market. This is not the case with TravelSky Technology which has a long growth runway. It is a play on Chinese air traffic growth, as its aviation information technology services business charges clients on a per-transaction basis.
The International Air Transport Association forecasts China's air passenger volume to grow from 610 million in 2018 to 1.6 billion by 2037, and China to become the largest civil aviation market globally by 2024-2025. CNN also quotes estimates by Chinese government officials that 450 airports will be needed by 2035 versus 235 airports in the country now. The Chinese air travel growth potential is also reflected in the fact that under 10% of Chinese hold passports versus 40% for Americans and 95% for the British. That being said, there are near-term headwinds. The International Air Transport Association guided in early June 2019 that it expects the global airline industry to record its lowest profits in five years in 2019 on the back of higher fuel costs and with global trade tensions dampening travel demand.
TravelSky Technology fell to a three-year share price low of HK$14.90 on June 17, 2019, representing a 44% decline from its all-time share price high of HK$26.60 on March 16, 2018. Based on its share price of HK$16.04 on June 20, 2019, TravelSky Technology is trading at 15.7 times consensus FY2019 forward P/E and 13.7 times FY2020 forward P/E.
Apart from a potential slowdown in aviation traffic, there are other investor concerns that have contributed to TravelSky Technology's steep share price decline.
Firstly, although TravelSky Technology's aviation information technology services business is a monopoly (in terms of share of volume), it seems to have weaker pricing power. This is evidenced by the fact that the FY2018 YoY revenue growth of +7.3% for the aviation information technology services segment trails the +9.8% YoY growth in the amount of flight bookings on domestic and overseas commercial airlines it processed for the year.
At the FY2018 earnings call held on March 29, 2019, TravelSky Technology management commented on pricing for its aviation information technology services business (my emphasis):
I know that you are rather concerned and interested about our AIT (aviation information technology segment) ASP (average selling price), while all our competitors in this particular segment are listed companies. And so because of the market condition, we have felt quite a lot of pressure. In fact, we cannot really disclose the exact data. But for you to have a rough idea, in terms of our charges to foreign airlines, well, basically, it is rather stable, it remains quite flat and it is mainly denominated in foreign currencies. For domestic airlines, we offer volume discounts.
As mentioned above, TravelSky Technology's major domestic airline clients are its indirect shareholders. This suggests that TravelSky Technology could have weaker bargaining power with its customers, implying that it could find it difficult to raise prices. Furthermore, volume discounts for domestic airlines could also put a cap on future ASP growth to a certain extent, as Chinese aviation traffic continues to grow over time.
Do note that RMB depreciation relative to USD (revenue from foreign airlines denominated in USD) is also a contributing factor to the lower revenue growth relative to bookings growth. While foreign commercial airline bookings are a smaller proportion (versus domestic airline bookings) of total bookings, the bookings fees for foreign commercial airlines are much higher than that of domestic airlines.
Secondly, TravelSky Technology is spending more on promotions and commissions to fend off increased competition in other business segments where it is not as dominant.
TravelSky Technology management acknowledged the increased competition at its FY2018 earnings call (my emphasis):
We have a dominating position in the Greater China region, and so we will continue to make investment in this market. At the same time, we will also implement internationalization. So concerning foreign airline distribution and also the interface and connection with airlines overseas we will also do some work there. So in relation to promotion done overseas, because the distribution market overseas is a market with complete competition. So as a result, we need to increase our promotion expenses. In recent years, with the opening up of the China market, competition has actually increased. So it is very natural to see an increase in promotion expenses...Concerning the trend of our commission and promotion expenses, well, in fact, these expenses will go up following the increase in our overall business volume. So, for example, we pay rebates and also there are some commissions for third-party payment companies. There is usually an increase in the commission and promotion expenses when we earn more income from these businesses. And in some other situation, we also do more promotion and incur more promotion expenses in order to combat competition in the market. And whether or not this will generate a faster growth depends really on the competition in the market...First of all, I want to clarify that this rebate is not payable to the airlines. They are paid to the agents who are involved in the business and in providing the service. Besides, this rebate will depend on the total passenger volume and also market competition. So it is very difficult for me to forecast whether this amount of rebate will increase or decrease in the coming period.
Thirdly, TravelSky Technology is facing significant cost pressures. Its operating margin declined from 36.7% in FY2017 to 31.0% (which is still very healthy) in FY2018, partly due to increased commissions paid to travel agencies and higher promotional expenses highlighted above, and costs associated with moving into its new operating center comprising a data center and the headquarter office building in Beijing in end-2017.
TravelSky Technology also touched on the increased operating costs associated with the relocation to its new operating center in Beijing at its FY2018 earnings call (my emphasis):
In relation to our relocation expenses into the new area, we exercised strict control in costs in order to complete this work. In fact, when we moved in, there were really some one-time expenses which have increased. For example, when we arrived at the new zone, there were screening expenses, there was also cleansing and clearing expenses. So these are one-off expenses. In 2018, we had already completed the work, basically..Concerning our cost structure after moving into the new area. Well, actually, if you look carefully at our cost structure, you will understand more about the situation. When we arrive at the new area, the depreciation expenses, land amortization expenses, property tax and also daily operational expenses have all gone up. Well, so in other words, starting 2018, we have got a new cost model. And this new cost model will continue in the future.
In other words, while there are certain one-off expenses pertaining to the relocation to its new operating center in Beijing, there are also other costs such as depreciation, land amortization, property tax that would be permanent expense item on TravelSky Technology's income statement and depress its profit margins going forward. The good news is that these additional costs associated with the new operating center are fixed in nature, so TravelSky Technology can improve its margins benefiting from positive operating leverage if it continues to grow its top line.
The bear case for TravelSky Technology will see Chinese aviation traffic declining and continued margin pressure.
Screens: Dividend Contenders
With the Fed signaling of possible interest rate cuts this year, high-yielding stocks could be in favor as they become more attractive vis-a-vis fixed income alternatives. When it comes to yield stocks, investors need to choose companies with both the ability and willingness to pay out dividends. While it is not difficult to assess dividend paying ability by evaluating a company's profitability and balance sheet strength, a company's willingness to pay out dividends is harder to judge. If the company has no stated dividend policy, a long track record of dividend payment is the clearest sign that the company will continue to dish out dividends in future. This makes Dividend Contenders good investment candidates. Dividend Contenders are defined as companies which have raised their annual dividends for 10-24 consecutive years by The DRiP Investing Resource Center.
I screen for Asian dividend contenders with a minimum dividend yield of 3% and ranked them in descending order of dividend yield as follows:
|Stock||Trailing Dividend Yield||Years Of Consecutive Dividend Increase|
|Far East Consortium International Ltd (OTC:FRTCF) [35:HK]||6.4%||10|
|Cyberpower Systems Inc [3617:TW]||5.6%||11|
|Fairwood Holdings Ltd (OTC:FRWDF) [52:HK]||4.9%||11|
Tongda Group Holdings Ltd (OTC:TDGFF) [698:HK]
|Daito Trust Construction Co Ltd (OTCPK:DITTF) (OTCPK:DIFTY) [1878:JP]||4.4%||11|
|Mitsubishi UFJ Lease & Finance Co Ltd (OTCPK:MIUFY) [8593:JP]||4.3%||18|
|Bursa Malaysia Bhd (OTC:BSMAF) [BURSA:MK]||4.0%||10|
|CK Infrastructure Holdings Ltd (OTCPK:CKISY) (OTCPK:CKISF) [1038:HK]||3.8%||22|
|KDDI Corp (OTCPK:KDDIF) (OTCPK:KDDIY) [9433:JP]||3.8%||10|
|Hong Leong Industries Bhd [HLI:MK]||3.6%||10|
|Nippon Telegraph & Telephone Corp (OTCPK:NTTYY) (OTCPK:NPPXF) [9432:JP]||3.6%||16|
|China State Construction International (OTCPK:CCOHF) (OTCPK:CCOHY) Holdings Ltd [3311:HK]||3.3%||10|
|China Overseas Land & Investment Ltd (OTCPK:CAOVF) (OTCPK:CAOVY) [688:HK]||3.3%||16|
|Prudential PLC (PUK) (OTCPK:PUKPF) [2378:HK]||3.1%||14|
|Fuyo General Lease Co Ltd [8424:JP]||3.1%||14|
There are few points to note when one considers investing in a list of dividend contenders. Firstly, past performance is not indicative of future results. A consistent dividend payment history does not guarantee that the company will continue to pay dividends in future. Secondly, a high trailing dividend yield could be the combination of a very low share price and modest dividends. The market is implying that the company could either cut or even omit the current dividend. Thirdly, dividends might not represent the optimal form of capital allocation. The company could possibly be destroying shareholder value by not allocating excess capital to accretive acquisitions or share buybacks.
Thematics: Play On Autonomous Vehicles
Nexteer Automotive Group Limited (OTCPK:NTXVF) [1316:HK] is the world's third largest manufacturer of electric power steering, or EPS, systems globally. In terms of geographic markets, it is the largest steering systems supplier in the U.S. and ranked third and fourth in China and Europe respectively. It is a play on autonomous driving in the long run.
Nexteer's share price hit a new three-year historical low of HK$9.06 on June 6, 2019, which is less than half of its historical share price peak of HK$19.00 on January 12, 2018. Nexteer is trading at 9.0 times consensus FY2019 forward P/E and 7.8 times FY2020 forward P/E, based on its share price of HK$9.78 on June 20, 2019.
Nexteer's share price weakened in the past year due to poor auto sales in Asia/China and trade tariffs. Its Asia Pacific revenue declined -8.5% YoY (-10.1% YoY in constant currency terms) in FY2018. The company also highlighted at its FY2018 earnings call that "China OEM production fell year-on-year by almost 4%, with a significant deceleration in the second half of 2018 of almost 11% compared with 2017." Nexteer derived 67% of its FY2018 sales from North America, of which Mexico accounted for roughly one-third. Trump initially proposed to impose tariffs on Mexico imports into the U.S. in June, which was subsequently called off. In contrast, U.S.-China trade tensions have a limited impact as Nexteer does not have products manufactured in China and exported to the U.S.
The global steering systems market is an oligopoly, with a handful of players including Nexteer, dominating the market. The "Big Six" - JTEKT Corporation (OTCPK:JTEKF) (OTCPK:JTEKY) [6473:JP], ZF-TRW, Nexteer, Bosch (OTC:BSWQY), Showa Corporation [7274:JP] and NSK (OTCPK:NPSKF) (OTCPK:NPSKY) [6471:JP] - have over 90% share of the global steering systems market.
Nexteer's competitive strength is evidenced by a key metric, conquest bookings, which refers to business taken from its competitive peers. Nexteer is targeting half of its 2019 bookings to be conquests. This 50% target is reasonable considering that 47% of its $6.1 billion gross new bookings secured in 2018 were conquest bookings. More significantly, more than 80% of Nexteer's major launches were derived from conquests booked historically.
At Nexteer's 1Q2019 earnings call on April 15, 2019, the management explained why the company was able to take business away from its competitors (my emphasis):
I'll speak to the EPS wins. They were both Rack-assisted EPS on pickup truck and sports car, and so the award on truck and the sports car we went head-to-head with tough competitors, Europeans and Asian competitors. Obviously, price always comes into play, the commercial offer will have to be competitive. And we did it with the technology offering in our power pack area that is very well viewed in terms of size and weight reduction as well as reliability. We talked to you before about the term FIT, the failures in time with lower FIT numbers, higher reliability. So we offered them some of the state-of-the-art technology that narrowed the field down to a few - only a few of us that the customers would trust. And then in the end, it came down to relationship, and what really closes a deal for us a lot of times is our flexibility, customer intimacy, the ability to tailor applications as needed. We've talked before about how inflexible Bosch has been, and that allowed us to win on the truck. And Hitachi and Mando were the competition on sports car. And again, they were viewed as unfavorable, inflexible. In fact, the customer is pretty upset with one of those competitors. So we used that as an opportunity to maintain our position on that sports car.
Besides client trust, flexibility and the ability to tailor applications, it is also clear that Nexteer has a technological edge. The company spends approximately 3% of its sales on research & development historically, and that has clearly paid off.
In the near-term, Nexteer's growth will come primarily from Asia Pacific. While Asia Pacific accounted for only 19% of its FY2018 sales, the region accounted for 40% of new business bookings on average for the past three years.
At its FY2018 earnings call in March 2019, Nexteer referred to Asia Pacific as its "highest margin region," and EPS as its "highest margin product." Nexteer generated 65% of its FY2018 revenue from EPS systems, and EPS systems comprised 70% of its order backlog as of end-2018. In China, EPS penetration still has room to grow. A December 2018 sell-side broker report highlighted that "China's EPS penetration rate was 60% in 2017, reaching North America/Europe’s 2008/2006 levels." EPS has gained market share over hydraulic power steering, or HPS, due to a few reasons. Firstly, EPS boasts superior fuel economy, so it is preferred by automotive manufacturers who need to meet increasingly stricter emissions standards. Secondly, new energy vehicles can only utilize EPS as they don’t have internal combustion engines.
In the mid-to-long term, advanced driver-assistance systems, or ADAS, will propel Nexteer's future growth. Of the $25.2 billion order backlog as of end-2018, 70% or $17.6 billion was from EPS, and 21% or $4 billion of the EPS backlog came from ADAS-featured steering products.
Furthermore, Nexteer has already secured contracts with the leaders in the autonomous vehicle space such as Waymo and General Motors' (GM) Cruise. The company gave further details on the progress of its collaborations with Alphabet's (GOOG) (NASDAQ:GOOGL) Waymo and General Motors at the FY2018 earnings call (my emphasis):
Let me give you some examples. We're seeing higher levels of vehicle autonomy, Level 3 plus, on production time lines. In 2019, Waymo was continuing to accumulate significant miles in real world experience. Middle of '18, they announced 5 billion miles in simulations and 8 million real-world miles that they continue to accumulate at the rate of 25,000 miles a day. They also contracted another 62,000 Pacifica minivans. We are on every Pacifica minivan, no matter what the configuration, including Waymo. Every vehicle you see on the road being tested on the West Coast is our product and we're learning rapidly with Waymo. Continuing 2019 at GM, we're on the Autonomous Board for battery electric vehicle. This application is more advanced than Waymo. It is being built with and without steering wheels. And in '19, GM intends to have a captured fleet, shipping 30,000 units, 2,500 of them being Level 5 capable, again, without a steering wheel. We're on all of those.
Nevertheless, to put things in perspective, revenue contribution from ADAS-related products could take years to be significant for Nexteer. But Nexteer will build its track record over time with these key collaborations, positioning it for the future growth potential of autonomous driving. Steve Spicer, Product Line Executive for Global Electric Steering at Nexteer, touched on this point at the FY2018 earnings call (my emphasis):
The ADAS penetration of an overall program, a new business booking, is a small percent, but it really enables us to win the bigger fish, if you will. The new program, maybe 10% of it is the 10 FIT ADAS, 90% is the base. You can't win one without being a leader in the other. So being the ADAS leader positions us to win these big programs that have to carry the weight while preparing for the future of ADAS. And the ADAS programs, although they're low volume, they have obviously high impact, high visibility in the market. The -- one of the earlier first questions, I just wanted to reiterate, the ADAS peak volume, the Level 3, 4, 5 is probably not going to be until 2025 or later. Some of the forecasts I've seen could be as late as 2030, but you got to be relevant, you got to have the technology, you got to have it in production. Otherwise they don't want to talk to you about the other 90% of the volume on any given program that they're going to award. So they come to us for one-stop shopping for all product types, all under hood, column drive, and they also come to us one-stop shop because we can do any level of FIT or ADAS driving.
Key risk factors for Nexteer include lower-than-expected new vehicle sales, and trade tariffs, which were elaborated on earlier.
The two stocks, which I profiled, in this week of the Asian Idea Generator Weekly share quite a few common characteristics. Both are dominant in their market space, have long growth runways, but face near-term headwinds.
TravelSky Technology has a near-monopoly in the Chinese aviation information system services market and it is a proxy for Chinese air travel growth. But the market is concerned about the slowdown in aviation traffic and margin pressure from increased commissions, higher promotional expenses and costs associated with its new operating center.
Similarly, Nexteer is one of just six companies dominating the global steering systems market, and it is one of few companies building a track record of ADAS products to benefit from the rise of autonomous driving in the long run. However, investors are worried about lower-than-expected new vehicle sales and rising trade tensions between countries (which could lead to more tariffs).
In other words, both TravelSky Technology and Nexteer are classic cases of "short-term pain, long-term gain." Although there is near-term uncertainty for both companies, patient long-term investors are likely to achieve decent investment returns from them, once the short-term issues go away, and the market recognizes their long-term investment merits again.
Investors make money from stocks in two ways: capital appreciation and dividend income. Stock prices don't go up in every time period, so it makes sense to include high-yielding Dividend Contenders as part of the portfolio, so that positive dividend income can help to partially offset paper losses in declining markets. The list of 15 Asian stocks, which have raised their annual dividends for 10-24 consecutive years, I provided above could serve as a good starting point for further research.
Asia Value & Moat Stocks is a research service for value investors seeking value stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like "Magic Formula" stocks, high quality businesses, hidden champions and wide moat compounders)
Disclosure: I am/we are long NEXTEER (1316:HK). 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.