Asia-Pacific – a profit powerhouse
14 minute read
Home to three of the five largest economies in the world, the 40 or so countries which collectively comprise the Asia Pacific region, ex Japan, account for over 50% of the world’s population and yet, oddly, remain significantly under-represented in equity portfolios. They comprise of less than 15% of the MSCI All Country World index.1 One has to believe that the region's participation in global market indices can only rise further therefore, as will the opportunities for equity investors looking to the Far east. This paper looks at how profits and dividends in the Asia Pacific region held up in 2020 compared to the rest of the word and explores the structural trends driving the region’s growth. It then goes on to examine how Henderson Far East Income Limited, an investment company managed by Janus Henderson, is looking to capitalise on the opportunities presented by these fundamental macroeconomic trends.
In the late 1980s, we lived through the zenith of Japan's financial bubble and the volatility that accompanied it. Share price valuations averaged 60x earnings, with property prices similarly bloated. The Emperor’s palace in central Tokyo was deemed to be worth more than the whole of California, whilst countries like Australia, Argentina and Malaysia were rumoured to have sold off their Tokyo embassies to meaningfully reduce their budget deficit back home. Then began the country's long stock market decline in the ’90s and ‘noughties’ – widely referred to as the 'lost decades' – which coincided with the surfacing of other economies in the Asia Pacific region: first the south-east Asian 'tiger' economies of Malaysia and Thailand, and then the north Asian powerhouses such as South Korea and China.
After a historic year – witness the enormity and all-pervading nature of the COVID-19 coronavirus, global lockdowns, intense volatility in equity markets, unprecedented levels of monetary support, and the ongoing success, albeit uneven, of vaccine rollouts – regional and global economies find themselves largely on the mend. Amidst the worst economic crisis since the second world war, Asian earnings proved remarkably irrepressible relative to those in the rest of the world. Undeniably, the Asian recovery – led by China – continues to gather speed, the region having emerged from the shadows of the crisis stronger and with ever greater influence on the world stage, pulling the globe’s economic centre of gravity steadily towards the east.
Few would dispute the claim that, by virtue of the region's growth potential and better management of the pandemic, Asia Pacific represents a core asset with superior long-term growth characteristics. Two key observations bring the claim sharply into focus:
- Asian assets are attractively valued relative to more developed markets – based on forward earnings as at the end of September 2021, the MSCI All Company Asia Pacific ex Japan Index price/earnings (PE) ratio was less than 18; for the MSCI World Index, it was over 22;2
- as at October 2021, the International Monetary Fund's 2021 growth projections (World Economic Outlook Update, based on real GDP) for Emerging & Developing Asia, China and India were 7.2%, 8.0% and 9.5%, respectively, all significantly ahead of its forecast for the world as a whole of 6.0% (see the table below)3.
It's a view shared by Mike Kerley – Portfolio Manager of Henderson Far East Income Limited, a fund within the Janus Henderson range of investment trusts. The trust aims to provide a high dividend yield, together with capital appreciation, from a portfolio of investments traded across Asia Pacific in countries as diverse as Australia and Indonesia, but united by their common bond in driving the region's economic growth story. The narrative is expanded upon by Mike within the latest edition of the Henderson Far East Income Dividend Index.
Building on the last three editions of research tracking the trends in the earnings and dividend payouts of companies listed across Asia Pacific, the latest edition has enhanced its analysis with the inclusion of research on profits and dividends globally – highlighting how Asia is increasingly becoming a powerhouse. Looking at profit, cash balances, net debts or cash flow, the region’s companies are demonstrating that the fast-growing dividends they are paying are extremely well-supported by fundamentals, adding up to a compelling investment case for Asia Pacific ex Japan. The Far East Income Dividend Index sheds good light on the drivers behind the region's performance.
Asia vs the world
Global profits collapsed in 2020 as the pandemic took hold across the world. Pre-tax earnings fell over 23% to £2.2 trillion, with the UK the hardest hit: down by over 80% and to a level well below that seen during the global financial crisis, reflecting both the unfavourable sector mix and the impact of repeated lockdowns. Europe saw a significant decline, whilst the impact in the US and Canada was less acute. Profits in Japan were flat year-on-year but, in the rest of Asia Pacific, they fell by just 4%. Only four companies in 10 in the region delivered lower profits, compared to six in 10 elsewhere in the world. In China – responsible for over half the region's earnings – profits actually rose in 2020 (by 2.2%), as they did in South Korea and Taiwan.
Taking a longer-term perspective, earnings growth has been more rapid than in other regions too. Over the last one, three, five and 10 years, Asia Pacific ex-Japan has beaten the rest of the world in the profits race. Since 2010, pre-tax earnings have risen 80% compared to just 2% for the rest of the world, thereby driving a marked increase in the region's share of global profits. In 2020, profits from Asia delivered 36% of the global total, up from 23% a decade earlier. Even if we were to exclude 2020 earnings from the calculations, profits grew almost twice as fast as for the wider world.
Next, we must turn our attentions to the growth in dividend payouts, which were much less severely damaged by the pandemic in Asia Pacific than elsewhere. Again, the rate of growth has been significantly higher than the global average – up 139% over the last 10 years as opposed to 109% for the rest of the world. In 2020, Asian dividends fell just 5.6%, much less than the 9.3% fall in the rest of the world.4 Much of this deterioration can be attributed to HSBC, Australian banks, and mining groups – without those, year-on-year payouts would have been flat.
Balance sheets are stronger, and debt levels lower, in Asia Pacific than those prevalent elsewhere: Janus Henderson's Corporate Debt Index for 2020 showed that Asia's companies (excluding financials) owed just 6% of the world's corporate net debt, compared to their 18% share of the world's dividend payouts. Dividend cover levels are consequently much higher – at 2.4x rather than 1.6x – and free cash flow is strong, and so, from a financial perspective, one would have good reason for being optimistic, despite the peculiarity of recent times, about the region's prospects.
Countries and sectors
China was, as we've said the primary growth driver: by the end of 2020, its profits had climbed to a record £430bn, a rise of 141% since 2010, outpacing very other large nation and seven times faster than the global average. 4 Ignoring the events of 2020, profits in China had grown over three times faster than the global average. The country's investment boom has been good for its financial businesses, with over 40% of profits coming from the banks since 2010, with broader financial services players contributing another 23%. The fastest growth has been seen in the retail, media, household products and food sectors – globally renowned companies like Tencent and Alibaba – all evidence of the rising spending power of China's expanding middle class.
Hong Kong was the fourth largest contributor to world profits in 2020, behind the US, China and Japan, and ending the year almost 70% higher than 2010. Its large resort groups, such as Sands China, and banks, such as HSBC and Standard Chartered, understandably suffered. Taiwan and South Korea, both of which reacted to the advent of the pandemic with speed and skill, mirrored China in reporting higher earnings – record earnings in the case of the former, up almost 25% year-on-year. Semiconductors were the dominant force, especially Taiwan Semiconductor. The company alone accounted for almost a quarter of the country's profits last year. Across the electronics and semiconductor sectors, over 80% of companies saw a profit uplift over 2019. Driven by government support, a vast potential market and increasing R&D spending,
South Korea and Taiwan are now the two largest semiconductor players in Asia Pacific, and the region is the world's largest market for semiconductors, accounting for 60% of global sales. Samsung is the dominant player in South Korea, delivering 40% of total corporate profits, and is continuing its recovery from an arduous 2018.4
Australia is the region's laggard: profits were lower in 2020 by some 3.5% than in 2010, with two-thirds of businesses reporting a profit decline.4 In many ways, the country resembles its western peers but its heavy dependence on mining stocks (10% of GDP in 2019-2020 according to the Australian Bureau of Statistics), which are always at the mercy of the cycle, and its reliance on China and other Asian nations for exports give it some of the characteristics of an emerging market. Earnings performance has also not been helped by the size of its slow-growing but substantial banking sector.
Elsewhere in the region, Singapore, Indonesia, Malaysia and Thailand were all adversely impacted most heavily by the poor fortunes of the financial sector, and by the fall in oil profits in Thailand.
Examining the sector performance, widespread global themes in 2020 include the difficulties experienced by the banking and other financials, consumer discretionary, industrial and energy sectors – even the oil industry made a global loss. In Asia Pacific, however, almost every sector fared better, with only consumer discretionary stocks falling further than their global counterparts, largely because the large casino and resort operators were mothballed by the pandemic. Asia has undoubtedly benefitted from a business mix that is skewed towards manufacturing and finance, and where service industries vulnerable to a pandemic are less prevalent. Over the longer term, no industry grouping in the Asia Pacific region has seen slower growth than in the rest of the world.
Beijing's recent clampdown of its technology sector is difficult to ignore, however. The suspension of Ant Group's blockbuster IPO last year was followed by a record anti-trust fine imposed on Alibaba for supposedly abusing its market dominance, and the opening of a cybersecurity review into ride-hailing company Didi two days after the company went public in New York, sending the shares falling by 30%. Three weeks later, the government abruptly barred tutoring companies from making profits, a move which triggered a nearly $1 trillion global sell-off and sent shares of online private tutoring companies plummeting. More recently still, the casualties have included Tencent – Asia's largest stock by market value – after the Chinese state media described games as "spiritual opium" and "electronic drugs".
The measures undertaken are not a huge surprise considering the well-documented goals of the Chinese government. However, the new regulation aims to address the regulatory loopholes that some businesses have exploited, thereby promoting fairer competition, sustainable growth and ultimately level the playing field. To look at this as a 'crackdown' on private companies, some might say, is a misunderstanding of the government's plan. There is no doubt that the new regulations have got the market spooked. However, comments that China is now uninvestable appear very wide of the mark. Of course, there will be uncertainty in the short-to-medium term, but this will pass as people return to analysing companies and not government policy. Earnings revisions may well be weak in the coming months as margin expectations are adjusted, but the baseline is that revenue should continue to grow commensurate with an economy with high single-digit nominal GDP growth.
The future's bright
A host of factors have combined to push Asian markets to the top of the world's economic growth table, and it remains a region set for major disruption. The first, and arguably the most obvious, is its demographic advantages and structural reforms. The region's large and highly educated populations, a growing skills base, the relentless expansion of its middle-class cohorts and a plentiful supply of investment capital from its ever-thrifty households combine to provide a rapidly expanding market for goods and services. The exponential profit growth of relative newcomers such as the aforementioned Tencent and Alibaba attest to this. Export-led growth used to be the priority, but the region is no longer simply the producer of goods for the western consumer – with its own booming middle class fuelling strong domestic consumption – and, because incomes are rising from lower levels, this growing affluence is already resulting in less precautionary saving and a higher propensity to spend.
As a proportion of the global middle class, China and India will represent 45% by 2030; the Asian component as a whole is set to rise from 28% in 2009 to 66% by 2030 – 3.2 billion of a global total of 4.9 billion. In 2018, 2.1 billion – or 54% – of the world’s 3.9 billion internet users were in the Asia-Pacific region. By 2023, there are forecast to be 3.2 billion internet users in the Asia-Pacific region, a rise of over 50% and representing over 60% of the world's 5.3 billion internet users. Only 30% of Asian consumers currently own a smartphone, compared to almost 70% of residents of the USA.5
Accelerating urbanisation represents another key factor, on the basis that cities drive growth. Indeed, 85% of global GDP is generated in cities. It's widely predicted that 90% of global urban growth will take place in Asia and Africa, with 46% of Fortune 500 companies being headquartered in the emerging markets by 2025. Seven out of 10 of the world's largest cities will be in Asia by 2030.
The region is also among the most advanced in terms of themes such as e-commerce and fintech. In 2017, Chinese patent applications in the field of artificial intelligence exceeded those submitted by the US by a factor of over 6, with its companies investing more than many developed peers in research and development in order to drive future growth. Technology is benefitting from huge investment, for example, with China having bridged the gap with the US in terms of R&D spending (see chart below), a phenomenon that would have been unthinkable 10 years ago.6
China is set to grow by over 8% in 2021 as we've seen, Australia is riding a commodity boom, and other countries in the region will benefit both from resurgent Western demand and from growing domestic consumption. The electronics market is particularly strong for Taiwanese and South Korean producers, for example. Market expectations are for earnings per share to grow by a third in 2021, with profits rebounding to a new record.
Dividends will also rebound and are expected to jump by 12-14% in total value for 2021 – even at the lower end of that range, the region should deliver record payouts almost £270bn this year.4 Payout ratios have room to expand of course, and so dividends look well-supported, and a surge in one-off special dividends is also anticipated, especially from Australia's large miners. 10 years ago, income investors would have paid much less attention to the Asia Pacific region; not so now, with growing profits supporting rising dividends and fuelling higher share prices, based on the robust foundations of low corporate indebtedness and attractive valuations relative to developed markets.
Nevertheless, the ongoing upturn is likely to be uneven, with the divergence between faster and slower recovering countries and sectors representing an excellent opportunity for an actively managed vehicle like Henderson Far East Income.
Keeping the faith
Henderson Far East Income is a trust that 'does what it says on the tin', offering investors a high and growing yield from a relatively concentrated portfolio of quality companies – circa 46 currently – across the Asia Pacific region. The trust was designed to capture the change in dividend culture in Asia versus the rest of the world, which has gathered pace since its launch in 2006.
Total dividends have increased every year, growing at a compound annual rate of 3.7% over the five years to the end of the 2020 financial year on 31st August (FY20), and to date have always been fully covered by income, even in FY20 when COVID-19 provisions severely impacted payouts in many territories around the world.7 The third interim dividend of 5.9p, announced in June 2021, was a 1.7% increase on the previous two quarters.3 Although many of the dividends received during FY20 were based on FY19 (pre-pandemic) earnings, the income for the first half of FY21 was also ahead of the comparable period in FY20, despite a 5.6% decline in aggregate dividends for the Asia Pacific region in the calendar year 2020. The Trust also has a current dividend yield of 7.9%, which continues to look highly attractive compared with most other investments.8
Ten years ago, investors would have paid much less attention to the region, but Asia Pacific ex Japan is increasingly becoming a powerhouse. Whether we look at profit, cash balances, net debts, or cash flow, the region’s companies are showing that the fast-growing dividends they are paying are extremely well supported by fundamentals. In addition, the structural growth story remains intact, buoyed by the fast-growing middle class and adoption of technology across the region. This all adds up to a very compelling investment case for the Asia Pacific region.
|Discrete year performance % change (updated quarterly)||Share Price||Nav|
|30/09/2020 to 30/09/2021||4.4||7.6|
|30/09/2019 to 30/09/2020||-11.1||-11.1|
|28/09/2018 to 20/09/2019||7.2||6.2|
|29/09/2017 to 28/09/2018||6.5||6.5|
|30/09/2016 to 29/09/2017||12.6||11.1|
|All performance, cumulative growth and annual growth data is sourced from Morningstar|
1 Source: MSCI All Country World index, Factsheet, as at 30/09/2021
2 Source: MSCI All Company Asia Pacific ex Japan Index, Factsheet, as at 30/09/2021
3 Source: World Economic Outlook Update, published in October 2021
4 Source: Henderson Far East Income Limited, Asia Pacific Dividend Index Report, 2021
5 Source: Henderson Far East Income Limited, Asia Pacific Dividend Index Report, 2020
6 Source: Refinitiv Datastream, as at November 2020. *Purchasing power parity (PPP) is a formula used to compare different countries' currencies through the price of specific goods which are valued equally
7 Source: Henderson Far East Income Limited, Annual Report 2020
8 Source: Henderson Far East Income Limited factsheet, as at 30.09.21
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
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