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UBS Investment Research
Asia Equity Strategy
Anomalies from the rise in commodities
Inflation still the principal concern
Inflation remains the core question in all our meetings at the moment. This note
takes a look at the theme behind the theme: the spike in commodities – how much
of an impact do they really have on Asian equities at the market and stock level?
Market level: limited absolute impact. Relative impact is higher
Over the last ten years, the correlation of commodities with Asian equities has
risen and is now positive. Asian equities go up along with commodity prices. But
the relative performance impact is more nuanced – unsurprisingly, Asia ex Japan
equities tend to lag the commodity equity markets (e.g. other EM) in times of
rising commodities.
Hunting for the anomalies – what stocks are moving the ‘wrong way’?
We look at 7 commodities and their impact on costs and pass-through for 480
stocks in Asia ex Japan with the help of our research colleagues. We have screened
for anomalies in this list: stocks that are impacted by commodities (negative or
positive) yet this does not appear to be reflected in recent share price moves,
margin forecasts or valuations.
Attractive: Shenhua, PetroChina; Vulnerable: EVA Air, Giordano, L&F
Shenhua - H is the only stock that shows up in all of our screens (price moves,
margins and valuation) as attractive. EVA Air and Giordano look vulnerable as
stocks that may be negatively affected by the higher commodity prices which seem
not to be reflected in the market – either in recent share price moves, margin
forecasts or valuation.
In virtually every meeting with clients since mid December, inflation has been
the central issue. This is something that we’ve been writing about extensively
(be it in the context of India/Indonesia, or markets in general) for a while now,
along with our economists. As a quick reminder, our economists think that
inflation is likely to moderate cyclically, which should reduce some of the
pressure for aggressive monetary tightening in Asia ex Japan. Structurally,
however, they believe that inflation will keep moving higher due to loose
monetary policy. This has been part of our monetary theme for the last two years,
which we see as being positive for real assets, consumption, and the credit cycle.
Positive, however, until the monetary brakes are slammed on. We still do not see
that as being a 2011 story.
While monetary fears are certainly fuelling the inflation debate, in practice much
of the current rise is down to the move in commodity prices. That’s the feature
of this note: the impact these have on a) Asian equities over time and b) looking
to where the risks (positive and negative) lie at the stock level, and specifically
trying to identify where these are and are not ‘priced-in’.
Our conclusions are that A) for sure, Asia in a relative sense tends to
underperform when commodity prices are rising. On the basis of our economist
and commodity strategy forecasts, we expect stabilisation in commodity prices,
which should take away some headwinds to Asian equity performance. B) A
few stocks appear to us to be anomalies from this exercise. Amongst the
beneficiaries of higher commodity prices, China Shenhua and PetroChina look
attractive. Amongst stocks that are negatively affected, EVA Air, Giordano and
Li & Fung look vulnerable.
Commodity Inflation – One big ‘correlated trade’
Over the recent weeks, rising commodity prices have once again become a focal
point of attention amongst Asia ex Japan investors. The CRB index, which
tracks the spot price for a basket of commodities, has risen past its previous peak
in 2008, and higher commodity prices have fed fears that this could add
inflationary pressure in Asia. Beyond this inflationary pressure, do rising
commodities hurt or help Asian equities?
Looking at a simple chart of the CRB index along with Asia ex Japan equities,
the relationship appears in recent years to be positive: higher commodities are
associated with better Asian equity markets.
This has not always been the case: indeed for most of the 1990s, the
performance of commodity markets and Asian equities was inversely correlated
as chart 2 shows. More generally the inverse relationship between commodities
and equities was one of the arguments that were made 10 years back for
investors to buy commodities in their own right. How times have changed.
Given the positive correlation that exists today, the prima facie evidence seems
to be that one rising is not bad for the other. Or, we shouldn’t worry too much
about rising commodity prices per se, it signifies growth, which is good for the
other.
This is absolute performance. The relative case for Asia is less appealing as a
commodity importer. Chart 3 shows the relative performance of Asia ex Japan
to EMEA and Latin America, along with the CRB index. The charts make clear
a relationship that most of us implicitly accept – that we as commodity
importers relatively suffer compared to producers (these indices are dominated
respectively by Russia and Brazil) when commodity prices are rising. Chart 4
shows the performance of Asia ex Japan relative to the developed world along
with the CRB index. Similar to the underperformance against EM, Asia tends to
underperform the rest of the world as well in periods with rising commodity
prices.
The bottom line is that rising commodity prices are not great for Asia ex Japan
in relative terms, and this has clearly compounded our underperformance in
recent weeks, both relative to other emerging markets, but also to the world
index. Both our economists and commodity experts expect upside in commodity
prices at least in the first half of the year and think that policy responses could
be critical to commodity and materials prospects in 2011. However, our analysts
expect oil price to be range bound in the $70-$90 range in 2011 which should
provide some relief to the recent headwinds, especially for food.
Moving beyond the macro and into the micro, what about the impact of certain
‘soaring’ commodity prices on individual stocks? After all, when we look at
costs in Asia, commodities figure significantly. Table 1 shows data that we
compiled around mid-2009, showing the cost breakdown where available for
companies in different countries. While labour is a significant cost in Hong
Kong and Singapore’s service economies (along with property costs) in others,
particularly the more manufacturing economies, input costs like commodities
figure more heavily.
For the rest of the note we take a detailed look, with the help of our colleagues
in research, to identify the potential gainers and sufferers from rising commodity
prices. What we are most interested in are anomalies: stocks that are positively
affected and yet have underperformed, or consensus forecast margins that have
yet to reflect higher costs.
This note is divided into three parts. First, we look at the price changes by
individual commodities and highlight some of the sectors and UBS-covered
stocks that are affected. Second, we run screens to look for outliers based on
share price moves, consensus forecast margins versus historical average margins,
and valuations. What we are most interested in are anomalies: stocks that are
positively affected and yet have underperformed, or consensus forecast margins
that have yet to reflect higher costs. Third, we present the detailed comments
we collected from our analysts on individual stocks in the Appendix
A few stocks stand out. Amongst the potential beneficiaries of higher
commodity prices, China Shenhua - H shows up as attractive in all three of our
screens. It is one of the worst performers amongst likely beneficiaries of higher
coal prices, its forecast margins are below the trough levels back in 2005-10,
and its market-relative PB is below its historical average. PetroChina also looks
to be attractive as an underperformer with low margins for the H shares.
Amongst the stocks that could be negatively affected by higher commodity
prices, there aren’t any stocks that show up as anomalies in all three screens but
a number of them show up in two screens. EVA Air and Giordano, to our minds,
look the most vulnerable. Both have performed well in the last 6 months. The
average consensus forecast margin for Giordano in 2011-12 is above the peak it
achieved in 2005-10; for EVA, above the peak during that period except 2010.
On a market-relative price-to-book basis, EVA is trading at more than 2x above
its historical average. Both stocks are rated Neutral by our analysts (Erica Poon
Werkun for Giordano and Eric Lin for EVA Air).
Top down, Li & Fung looks to be another candidate for potential disappointment.
As a sourcing agent, it is not directly affected by higher commodities price but
its customers and manufacturers are likely to face margin pressure. Some US
and European clothing and textiles retailers have warned that higher cotton
prices could lead to lower margins for that. We think it unlikely that Li & Fung
will be immune to the pressure. Spencer Leung, our analyst, has a high
conviction Sell call on the stock.
Stock impact by commodity
Oil
The oil price is arguably the most important commodity-related driver of the
CPI in Asia ex Japan, due to its direct impact on energy and fuel prices as well
as the knock-on impact on food. The impact is particularly pronounced for
lower-income countries: food, fuel and utilities together account for over 50% of
the CPI basket in the Philippines and India, and 40% in Indonesia and China.
Stronger economic data out of the US over the past 6 months has coincided with
an acceleration in the increase in the oil price, which is approaching levels that
were not seen before the spike in H1 2008. Jon Rigby, our global sector
strategist, believes that the oil price should average at around US$85 per barrel
in 2011E and 2012E, as it reflects the price at which the industry can make
sufficient economic return to develop the required capacity
The sectors that are the most positively affected by the oil price in Asia ex Japan
include the upstream oil producers and to a lesser degree the downstream
refineries and chemical producers. The product prices for the latter group are
correlated with the oil price though their margins depend on industry-specific
supply and demand. The key sectors that are considered negatively affected
include Utilities (if there is no pass-through) and Transpor
We list all the stocks under UBS coverage that are directly and indirectly
affected by the oil price, our analysts’ estimates of the impact, as well as their
company-specific comments in Table 5.
Oil companies as a group are beneficiaries but the company-specific impact is
dependent on the market in which the companies operate. According to Peter
Gastreich, our Head of Asia Oil & Gas Research, CNOOC’s EPS should go up
by 14%, and PetroChina’s by 10% for every US$10/barrel change in the oil
price. For the Indian oil companies, on the other hand, our analyst Prakash Joshi
believes that higher oil prices should have neutral and negative impact on most
companies, as they have downstream operations and the higher costs are
difficult to pass through.
John Chung, our analyst for the regional refining and chemicals companies,
believes that industry margin is near a bottom, and as the supply and demand
picture normalises the industry should gain pricing power. As a result, he
believes higher oil prices should positively affect his sector with higher product
prices.
A somewhat less direct beneficiary of the higher oil price are likely to be palm
oil producers in the region. Crude palm oil (CPO) prices historically trade in
line with the oil price, and the CPO plantation stocks have been amongst the
best performers in Asia recently. Whilst Alain Lai, our analyst, is bullish on the
plantation stocks due to structural constraints in finding more land for new
plantations, he has cautioned that CPO is now trading near the top end of its
range versus the oil price so there could be near-term risk of mean reversion.
Transport companies represent the biggest group that is negatively affected by
higher oil prices. For airlines and shipping companies, there is partial passthrough
and pricing power is dependent on demand, which also tends to
correlate with the oil price. At the moment, demand is strong so they should
have some abilities to pass through the cost increases, according to Richard Wei
and Eric Lin, our analysts. The Chinese rail companies are also affected, to a
lesser degree, although their tariffs are fixed by the government and hence there
is no pass-through to customers.
The other major group of stocks that are negatively affected are consumer
companies that use oil or oil-derived products as inputs, such as Li Ning and
Hengan. According to our analyst, Spencer Leung, oil and cotton together
account for around 20% of the input cost for the Chinese sportswear brands (Li
Ning, Anta, Xtep) and pulp and oil together account for 45% of the cost for
Hengan. Whilst there is some pass-through in these costs, higher commodity
prices look clear headwinds.
Coal
The coal price has been on an uptrend over the past 12 months but the recent
floods in Australia have led to a notable acceleration in the price increase. As
our commodities team believes the restoration of mining capacity is likely to
take months, if not longer, we forecast that the coal prices will stay elevated at
near current levels throughout 2011 and 2012.
Whilst coal has less widespread impact on the economy compared with oil, it is
the most important energy source for power generation for most Asian
economies as well as a key input for steel and cement production, which are
crucial materials for fixed asset investments.
Indonesia is considered a key beneficiary of higher coal prices as mining
companies form a significant part of the equity market. By extension, equipment
manufacturers and companies that are geared to the Indonesian economy are
indirect beneficiaries.
In terms of impact by individual stocks covered by UBS (Table 7), the earnings
sensitivity amongst coal miners are broadly between 2-3% for every 1%
increase in the coal price, according to our analysts. The major differences
between the Chinese and Indonesian producers lie mainly in the corporate
structure and degree of government control: amongst the Chinese miners,
greater government control implies greater risk of price controls (though in
some cases offset by the benefit of easier access to financing and mining assets);
for the Indonesian miners. Some of the Indonesian miners are part of a
conglomerate structure which entails exposure to non-coal mining assets.
The biggest group of stocks that are the most negatively impacted are utilities.
They have varying degrees of pricing power: Hong Kong Electric and CLP, for
instance, enjoy protection from explicit fuel pass-through mechanisms and
operate under a strong regulatory regime. KEPCO and the Chinese IPPs, on the
other hand, are often stuck with the negative impact from higher fuel cost due to
their inability to raise tariffs.
Steel companies represent another group that is negatively impacted as coking
coal and iron ore are their major costs. Yong Suk Son and Hubert Tang, our
steel analysts, believe that whilst coal prices are rising, steel prices are
increasing as well so steel companies should be able to offset some of the impact.
Cement companies in China have 40% of their raw materials costs in coal, yet
they are amongst the best performers in the last 6 months. Cement supply has
been disrupted by electricity shortages in China in H2 2010, and demand has
continued to be robust, thereby allowing the cement producers to pass on cost.
As the Chinese government is restricting construction of new capacity, Mick Mi,
our analyst, believes that pricing power is sustainable. CNBM is a UBS Key
Call.
Steel
The rise in steel prices has been relatively subdued in the recent months in part
due to concerns of slower demand in China as well as general industry
overcapacity. Our analysts, Yong Suk Son and Hubert Tang, are more optimistic
that steel mills should have better pricing power in Q1 with potential re-stocking
and some re-acceleration in demand. In general, higher commodity prices
should negatively affect steel mills as they do not have direct pass-through of
their coal and iron ore costs.
Higher steel prices benefit steel mills but negatively affect downstream users of
steel – mainly industrial companies. Auto makers and shipbuilding are amongst
the heaviest users of steel.
Amongst steel makers, our analysts believe they tend to be net losers from
higher coal and iron ore costs, although in the near-term pricing power should
improve. In China, Baosteel has the best pricing power, according to Hubert,
and Yong Suk believes that the share prices of the Korean steelmakers should
benefit from higher steel prices and some restocking in H1.
In general, our analysts appear to be sanguine about steel cost for stocks that are
negatively affected. Young Chang, our Korean auto analyst, believes that
margins should be relatively well-protected despite steel being 60% of the cost
of goods sold. Sonal Gupta, our Indian auto analyst, notes that companies have
hiked prices to offset cost increases, and seem confident this will continue.
The same is true for other sectors. Richard Wei, our China rail analyst, believes
that the Ministry of Rail will aim to protect the rolling stock companies’
profitability even though 80% of their input costs comprise of steel, aluminium
and copper, and pricing of their products are determined by their customer
(Ministry of Rail). For the Korean E&C companies, Yong Suk also believes in
decent abilities to pass through higher costs.
From a top-down perspective, we think this probably reflects the relatively
subdued price increases in steel over the past 6 months and hence the lack of
pressure on the supply chain. However, if steel mills were to be able to gain
some pricing power in H1, as Yong Suk and Hubert predict, higher steel cost
could become more topical over the next 6 months, which currently does not
seem to be a major concern per our analyst comments.
Copper
Copper production was affected in Chile and Mexico during 2010 which,
together with re-stocking in China, led to a sharp rise in the price. Our global
commodities team believes that copper prices will stay at relatively elevated
levels in 2011 (5% below the Q1 2010E level), albeit that there could be a 15-
20% decline from the current level in 2012E.
There are relatively few copper miners in Asia that benefits directly from higher
copper prices, whilst those that are negatively affected are mainly industrial
companies.
The listed copper producers under UBS coverage include Sterlite Industries and
Hindalco in India, as well as Jiangxi Copper in China. We estimate Jiangxi
Copper should see its 2011 and 12 profit going up by ~1.5% for every 1%
increase in the copper price, all else remaining equal.
Industrial equipment producers are vulnerable to copper price increases, though
they may or may not be able to pass through the cost increases depending on
supply and demand within their specific industries. Amongst the companies we
cover, copper, along with other industrial metals, often account for more than
60% of the input cost.
Aluminium
Our global commodities team expects aluminium prices to stay at near Q1 2011
level for 2011 and 2012, as demand growth outpaces supply growth. The main
demand drivers include developing markets economic growth and consumption,
as well as loose US monetary policy. Whilst inventories are relatively high, our
team believes that some of them are inaccessible
The listed aluminium producers are mainly in China and India, the two major
markets. Higher aluminium prices affect a host of industrial companies
including auto makers, auto part manufacturers as well as machinery
manufacturers. Typically, their input cost are affected by aluminium as well as
other industrial metals, and aluminium tend to be a smaller part of the input cost
compared with other metals such as copper and steel.
At the individual stock level, the railway rolling stock companies are amongst
the heaviest users of aluminium. Our China rail analyst, Richard Wei, is
convinced that they will be allowed to pass through cost increases by the
Ministry of Rail and hence the companies’ margins should be unaffected.
Amongst the Chinese aluminium producers, our analysts, Haoxiang Li and Ghee
Peh, note that the aluminium smelting is now in oversupply, and hence the
companies have limited pricing power. Electricity is a large input cost of
aluminium smelters and electricity prices are in turn affected by coal prices in
China. Whilst, at the moment, the government seems intent on controlling
inflation and therefore it seems unlikely it would let power prices rise,
aluminium producers could be adversely affected should this change.
Cotton
Cotton prices have almost doubled over the last 6 months, in part due to weather
disruptions. Our global commodities team does not forecast cotton prices
though, for agricultural commodities in general, we believe that prices should
start to stabilise assuming the weather normalises
Cotton impacts primarily the clothing and apparel retailers in Asia as well as the
exporters in the textile trade. Within the UBS coverage universe, the key stocks
that are impacted are mainly Chinese consumer companies, as well as exporters
such as Li & Fung and Esprit. For most of them, our analysts have indicated
that they expect the companies to have effective pass-through, which stems from
robust demand in China as well as their confidence in the brand’s pricing power.
From a top-down perspective, the risk is that pricing power could erode should
the economy slow, and given the generally high valuations of the Chinese
consumer companies the market could be caught off guard.
Agricultural commodities
Agricultural commodities are amongst those that have risen the most in the past
12 months due to major weather disruptions, ranging from droughts in Russia,
China and the US to storms in Asia, Indonesia and Australia. The magnitude of
the increases varies though most of Asia have seen double-digit increases in
food prices, as measured by the respective government agencies, some time in
2010. We show the price trends of a few benchmark commodities below.
Our economics team believes that food price increases – and the ensuing
pressure on the CPI in Asia – should moderate simply because of the higher base
and unlikely repeat (hopefully!) of the disruptive weather. However, structurally,
our economics team does expect inflation pressures to build in Asia ex Japan.
The biggest beneficiaries of higher agricultural commodity prices are expected
to be the producers - examples of them include the palm oil plantations and the
likes of Yurun in China. On the other hand, processed food manufacturers (food,
beverage and tobacco) and restaurants are likely to be negatively affected as
food commodities represent a key input cost.
Within the UBS coverage, the biggest beneficiaries of higher agricultural
commodity prices appear to be the palm oil plantation stocks. Whilst cyclically
crude palm oil prices have been pulled up by higher oil prices, Alain Lai, our
analyst, believes that there is a strong structural case for higher CPO prices as
well given robust demand driven by emerging market consumption, and
constrained incremental supply given increasing difficulties in securing land for
plantations. He has Buy ratings on the plantation stocks.
Amongst the companies that are likely to be negatively affected, most
companies have no or only partial abilities to pass through the cost increases.
The A-share listed breweries (Kweichow Moutai, Wuliangye Yibin, Luzhou
Laojiao) appear to have the strongest pricing power, according to our analysts.
The market appears to share the same assumptions as the cluster stands out as
the companies that have consensus forecast margins in 2011-12 above their
previous peak in 2005-10.
Screening for anomalies
Section 1 above gives us a ‘map’ of which Asian stocks are affected by the
individual commodities. What we are most interested in, however, is whether
these are already priced in. We look at this via three screens: on recent price
momentum, consensus margin forecasts and valuation. The stocks we want to
seek out are, for instances, commodity beneficiaries that have lagged the market,
for which the forecast margins are running below periods of comparable
commodity prices and are trading at reasonable valuations.
Screen 1: Price momentum
We start with a very simple screen of share price momentum. In Table 18, we
show the best and worst performing stocks in the past 6 months, grouped by
whether they are positively or negatively affected by price moves in a
commodity. We are interested in two types of anomalies: stock prices that have
moved the opposite way from how commodity prices should affect them; and
stocks with similar sensitivities to commodity prices that have divergent share
price moves.
A few groups stand out. Within the Oil category, the Indonesian E&P
companies (Medco Energi and Energi Mega Persada) have lagged their regional
peers despite being beneficiaries of higher prices. The Taiwan Transport stocks
have been top performers and have outperformed their sector peers, despite
being highly sensitive to the oil price and their relatively high price-to-book
valuations, compared with their own history.
Cement companies in China have 40% of their raw materials costs in coal, yet
they are amongst the best performers in the last 6 months. Cement supply has
been disrupted by electricity shortages in China in H2 2010, and demand has
continued to be robust, thereby allowing the cement producers to pass on cost.
As the Chinese government is restricting construction of new capacity, Mick Mi,
our analyst, believes that pricing power is sustainable. CNBM is a UBS Key
Call.
Amongst companies negatively impacted by steel, the Korean shipbuilders
(DSME and Hyundai Heavy Industries) have performed very well. Yong Suk,
our analyst, has highlighted in his comments that rising steel cost could pose
earnings risk to the sector.
The Chinese railway rolling stock manufacturers (CSR and CNR) seem to have
been barely affected by higher commodity prices, and their share prices have
appreciated by more than 50% over the past 6 months. Steel, aluminium and
copper together account for 80% of their costs, and they have limited pricing
power as their prices are effectively set by the Ministry of Rail (MOR) in China.
Richard Wei, our analyst, is sanguine about margin pressure as he believes that
the MOR is keen to develop the companies into global competitors and will try
to protect their profitability.
National Aluminium in India has lagged behind Hindalco and Sterlite, its listed
peers. The underperformance seems large even though both Hindalco and
Sterlite have exposure to copper, the price for which has gone up more sharply
than aluminium during the last 6 months.
The A-share listed Chinese breweries (Kweichow Moutai, Luzhou Laojiao and
Wuliangye) have been amongst the top performers within the Agriculture
category, though they are affected by grain prices. IOI Corporation is a laggard
amongst beneficiaries of higher crude palm oil prices, but Alain Lai, our analyst,
also highlights that its earnings are also the least sensitive to CPO prices
amongst Malaysian plantations.
Lastly, Shanghai Metersbonwe and Giordano, the Hong Kong and China
clothing retailers, stand out as significant outperformers of their respective
markets. They are not directly affected by higher cotton prices as retailers, not
manufacturers, though the high level of volatility around cotton prices (+75% in
the last six months) as well as its historic high level in absolute terms (more than
double its long-term average in 2000-10, see Chart 10) could imply some impact
in the next few months, as the cost increases work through the supply chain.
Screen 2: Profit margin
We also look at consensus forecast margins and see if they are realistic. What
we are interested in are anomalies: stocks which have forecast margins moving
in the opposite direction of how they are supposed to be affected by higher
commodity prices, according to our analysts. For instance, a stock that is
negatively affected by higher commodity prices should have lower forecast
margins than history. If the consensus forecasts indicate a higher margin, this
would imply that the company can pass on the cost increases or that consensus is
too optimistic.
Specifically, we look for these stocks by comparing their 2011-12 average EBIT
margins with what they had achieved in 2005-10. We exclude the margin data
during 2008 and 2009 because they are likely to be distorted by the
extraordinary swing in the inventory cycle. We include only stocks that have
margin data available going back to at least 2007.
Companies with pricing power / overly optimistic forecasts
In Table 19, we show the stocks that should in theory be adversely affected by
higher commodity prices; yet they have average forecast margins that are above
the peak achieved during 2005-10. We rank them by the gap between the 2011-
12 EBIT margin and the 2005-10 peak.
Consumer companies – in particular, Food, Beverage & Tobacco – stand out as
the biggest group from this screen. Five of them are breweries listed on the Ashare
market in China. As a group, they should be affected by higher grain and
other food commodities cost, though it appears that the market has assumed that
they could more than pass on the cost increases. The biggest concentration of
the consumer companies are in China, which suggests generally high confidence
in pricing power for the sector.
Outside of Consumer, another group for which the market appears to have
assumed strong pricing power is Cement. Coal is the biggest input cost for
cement, although cement pricing tends to be determined by local supply and
demand, and demand appears to be strong across the region, according to our
analysts. Still, for companies such as Lafarge Malaysia, Holcim Indonesia,
Tunggal Prakarsa and Taiwan Cement, consensus forecast margins are
substantially above the 2005-10 peak, which are themselves significantly above
the averages during the period. This would imply very strong pricing power.
Korean Auto is another group that features in the screen, although it appears to
be the result of substantial market share gains and stronger brands over the last
several years. Young Chang, our analyst, is confident that the market share
gains will continue, which should support the profit margins.
Companies with weak pricing power / overly pessimistic forecasts
In Table 20, we screen for the reverse of Table 19 above. We look for stocks
that should be beneficiaries of higher commodity prices, and yet have forecast
margins below their 2005-10 trough (excluding 2008 and 2009). We rank them
by the gap between their average forecast margin versus the historical trough.
This screen yields a much smaller group of companies: essentially the big stateowned
China resources stocks. The lower margin for CNOOC, an upstream oil
producer, is a function of rising production cost as well as the government
‘windfall’ tax, the rate for which increases with the oil price. Even as the per
barrel dollar margin for CNOOC increase with higher oil prices, its percentage
margin did not expanded due to the higher base numbers for both revenues and
cost.
For PetroChina and Shenhua, concerns over government efforts to keep coal and
oil product prices under control appear to be factors affecting the margin
forecasts. Nonetheless, the margins appear low.
Screen 3: Relative valuation
Our final screen looks for valuation anomalies: we are interested in stocks that
should be beneficiaries of higher commodity prices and are trading at low
multiples relative to history, and vice versa. As our valuation benchmark, we
compare the price-to-book ratios versus the market (MSCI Asia ex Japan index),
versus the historical average market-relative PB. We limit our universe to
stocks that have more than US$1 billion in free float market cap.
Table 20 shows the 10 most expensive stocks based on our metric that are
negatively affected by higher commodity prices.
The mix of stocks is very diverse, so are their absolute PB valuations. Chinese
Consumer stocks account for 3 of the 10 stocks (Tingyi, Tsingtao and Hengan),
though aside from Tsingtao there is no overlap with the stocks on the previous
screen that shows stocks with consensus forecast margins higher than their
historical average.
Dongfang Electric and SANY are valued at substantially higher market-relative
PB multiples than history, as well as high absolute PB multiples. SANY looks
less vulnerable as a coal mining equipment producer, as it should be benefit
indirectly from higher coal prices whilst negatively affected by higher steel cost.
Patrick Dai, our analyst, is optimistic on the heavy industrial equipment outlook
in China and has Buy ratings for both stocks.
Top-down, we are the most concerned about EVA Airways. It has very high
earnings sensitivity to the fuel prices and, whilst current demand is strong,
pricing power rarely stays with airlines. At historically high valuations relative
to market, the stock looks vulnerable
In Table 21 above, we show the reverse of Table 20: the 10 ‘cheapest’ stocks
that benefit from higher commodity prices.
The biggest group is coal companies in China. This is in sharp contrast with
2007-08, when rising coal prices drove up their valuations. It appears that the
market is concerned about the efforts by the Chinese government to control
inflation and by extension the coal price, notwithstanding the disruptions in coal
production in Australia.
PetroChina’s valuation seems to be held back by the same concerns, as the
vertically integrated nature of the company means it may not benefit from higher
oil prices unless oil product prices also rise in China.
Indofood looks like a potentially cheap beneficiary of higher oil prices. Its
profits are geared to crude palm oil (CPO) prices, which tend to be correlated
with the oil price (though lately CPO has been trading at the high end of its
historical range versus the oil price). Our analyst, Alain Lai, believes there are
structural constraints to new supply (suitable land for new plantations is
increasingly difficult to find) whilst demand should continue to be robust, driven
by higher spending on food globally. Valuation looks attractive in this light, in
our view.
Combining the three screens
Now that we have presented the stock screen from three different angles, our
final section combines the results of all three to see if there are stocks that show
up as anomalies in all of them. In other words, we are interested in commodity
beneficiaries that are bottom performers, have low forecast margins relative to
history and are valued at lower market-relative PB than their historical average.
Those could be interesting stocks to own. The same goes for stocks that are
negatively affected by higher commodity prices, under the reversed parameters.
We present our results in Tables 22-23. First, we show the likely beneficiaries
from higher commodity prices that are anomalies in two or more of our three
screens.
China Shenhua - H shows up as attractive in all three of our screens. It is one of
the worst performers amongst beneficiaries of higher coal prices, its forecast
margins are below the trough levels back in 2005-10, and its market-relative PB
is below its historical average. PetroChina also looks to be attractive as an
underperformer with low margins for the H shares, and low valuation for the A
shares.
Amongst the stocks that could be negatively affected by higher commodity
prices, there aren’t any stocks that show up as anomalies in all three screens but
a number of them show up in two screens. EVA Air and Giordano, to our minds,
look the most vulnerable. Both have performed well in the last 6 months. The
average consensus forecast margin for Giordano in 2011-12 is above the peak it
achieved in 2005-10; for EVA, above the peak during that period except 2010.
On a market-relative price-to-book basis, EVA is trading at more than 2x above
its historical average. Both stocks are rated Neutral by our analysts (Erica Poon
Werkun for Giordano and Eric Lin for EVA Air).
Top down, Li & Fung looks to be another candidate for potential disappointment.
As a sourcing agent, it is not directly affected by higher commodities price but
its customers and manufacturers will likely face margin pressure. Some US and
European clothing and textiles retailers have warned that higher cotton prices
could lead to lower margins for that. It seems unlikely that Li & Fung will be
immune to the pressure. Spencer Leung, our analyst, has a high conviction Sell
call on the stock.
A number of breweries in China appear on Table 19 – all of them have forecast
margins higher than their 2005-10 peaks despite being affected by higher grain
costs. Consensus seems to be confident in the companies’ pricing power, though
the high valuation – both absolute and relative – would make us think that this is
largely in the price.
CNBM is a UBS Key Call and appears on Table 23 as a stock that has both
outperformed in the last 6 months and has consensus forecast margins at a level
above its historical peak, thus vulnerable. However, there are structural factors
that support pricing power in the sector, namely the government ban for new
cement capacity to be built as well as the campaign to build affordable housing.
Our analyst, Mick Mi, is confident that cement price increases will more than
offset cost pressure from higher coal prices.
Strategy conclusion
In recent weeks, rising commodity prices have become an increasing concern for
investors, as many commodities climbed back to above or near their peak prices
in 2008. Historically, there has been no consistent relationship between
commodities and Asia ex Japan equities performance, and equities tend to
perform well with commodities when the economy is strong. We expect it to be
no different in the current market.
That said, the impact from higher commodity prices is expected to be felt
unevenly by different parts of the market. With the help of our equity research
colleagues, we try to identify the impact by commodity in this note. To take this
a step further, we look for anomalies where the impact from commodities may
not have reflected in the recent share price performances, consensus margin
forecasts and/or valuations.
A few stocks appear to us to be anomalies from this exercise. Amongst the
beneficiaries of higher commodity prices, China Shenhua and PetroChina look
attractive. Amongst stocks that are negatively affected, EVA Air, Giordano and
Li & Fung look vulnerable.
Summary of our Strategy View
We remain positive on Asia ex-Japan equities in 2011. Earnings growth
forecasts look achievable and valuations are attractive, especially relative to
other assets. With liquidity now becoming a tailwind, growth less of a concern
and the domestic credit cycle set to improve, we think Asia could re-rate from
its current discount to its historical average PE, and potentially even a premium.
We upgrade our 2011 year-end MSCI Asia ex-Japan index target to 670 from
650, based on 13.7x forward PE, in line with the long-term average.
Our key country picks are Singapore and China. We are neutral the G7 proxy
markets of Taiwan and Korea. Valuations have moved back toward neutral, and
leading indicators have already stabilized. There is less compensation, unless
convinced one way or other of external demand (which we are not) for taking an
aggressive view on these markets now. We are generally underweight the
expensive ASEAN markets. Of which Indonesia with low bond yields, rising
inflation and huge foreign ownership look the most vulnerable beyond
valuation. At the sector level, we are overweight financials, as the best proxy for
the liquidity theme and the credit cycle. We are underweight defensive sectors,
expecting them to underperform a rising market.
We believe there is an elevated risk that Asian markets could reach a ‘euphoric’
state, fuelled by inappropriately loose monetary policy. On the downside,
inflation, sharply higher US bond yields and government intervention are risks.
Key Calls
What are Key Calls?
Key Calls represent our highest conviction single stock research ideas across the
region. The list is designed to generate bottom-up ‘alpha’ and is not a portfolio
that we use to express our top-down view. The key selection criteria are analyst
conviction, liquidity (>US$10m average daily turnover for most stocks) and a
strategy overlay in terms of the macro outlook, market positioning and risk
management.
Company Rating Price
(LC) PT (LC) Upside /
Downside
Mkt Cap
(US$ bn)
EPS
Growth
11e
PE 11e P/BV
11E Comments
LG Display
Buy 37950 49000 29% 12.1 4% 9.54 1.09
The potential panel order from Sony in 2011 should
allow LG Display to outperform other LCD stocks. The
company is also a beneficiary of growing tablet PC
demand.
Bangkok Bank
Buy 164 189 15% 10.2 9% 11.58 1.28
Prime beneficiary of new credit cycle in Thailand.
Demand for credit from corporations (over 70% of
BBL’s loan book) is likely to be the key driver in the 18
months.
Cheung Kong Inf Buy 36.8 45.5 24% 10.7 43% 12.98 1.74
Well-positioned to acquire assets to improve ROE.
Cement business in HK an overlooked generator of
EBITDA.
China National
Building Material
Buy 18.92 30 59% 6.6 61% 8.93 2.08
Beneficiary of government policy to consolidate supply
and dampen property prices via increasing housing
supply. H-share placement has alleviated concerns
over gearing. EV/ton valuation at historical low.
OCBC
Buy 10 11.3 13% 25.9 4% 13.57 1.73
OCBC should benefit more from the strong liquidity in
Singapore via its Wealth Management Business.
Private banking has better growth and profitability and
thus should help command a valuation premium.
Shriram Transport
Finance
Buy 743.1 1000 35% 3.7 30% 11.18 2.88
SHTF Is the only established player in financing for
second-hand commercial vehicles in India. It has
around 20-25% market share in a market which is
expected to grow & and has high barriers to entry.
Lanco Infratech Buy 53.45 105 96% 2.8 105% 13.67 2.82
Strong execution track record in building power plants
underappreciated. New projects could offer Rp35
upside to the current share price
Sun Hung Kai P
Buy 136.1 225.9 66% 44.9 21% 17.61 1.33
A sector leader that command premium pricing
(superior profitability); income stream from commercial
properties holding underappreciated; large landbank
holder and a beneficiary of the credit upcycle in Hong
Kong
Industrial &
Commercial Bank Of
China-H
Buy 5.95 7.7 29% 255.3 11% 11.61 2.22
Strong capital position and provisioning buffer, rising
net interest margin and healthy, albeit sequentially
slower, loan growth.
Source: UBS (prices as of 20th January 2011)
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Asia Equity Strategy
Anomalies from the rise in commodities
Inflation still the principal concern
Inflation remains the core question in all our meetings at the moment. This note
takes a look at the theme behind the theme: the spike in commodities – how much
of an impact do they really have on Asian equities at the market and stock level?
Market level: limited absolute impact. Relative impact is higher
Over the last ten years, the correlation of commodities with Asian equities has
risen and is now positive. Asian equities go up along with commodity prices. But
the relative performance impact is more nuanced – unsurprisingly, Asia ex Japan
equities tend to lag the commodity equity markets (e.g. other EM) in times of
rising commodities.
Hunting for the anomalies – what stocks are moving the ‘wrong way’?
We look at 7 commodities and their impact on costs and pass-through for 480
stocks in Asia ex Japan with the help of our research colleagues. We have screened
for anomalies in this list: stocks that are impacted by commodities (negative or
positive) yet this does not appear to be reflected in recent share price moves,
margin forecasts or valuations.
Attractive: Shenhua, PetroChina; Vulnerable: EVA Air, Giordano, L&F
Shenhua - H is the only stock that shows up in all of our screens (price moves,
margins and valuation) as attractive. EVA Air and Giordano look vulnerable as
stocks that may be negatively affected by the higher commodity prices which seem
not to be reflected in the market – either in recent share price moves, margin
forecasts or valuation.
In virtually every meeting with clients since mid December, inflation has been
the central issue. This is something that we’ve been writing about extensively
(be it in the context of India/Indonesia, or markets in general) for a while now,
along with our economists. As a quick reminder, our economists think that
inflation is likely to moderate cyclically, which should reduce some of the
pressure for aggressive monetary tightening in Asia ex Japan. Structurally,
however, they believe that inflation will keep moving higher due to loose
monetary policy. This has been part of our monetary theme for the last two years,
which we see as being positive for real assets, consumption, and the credit cycle.
Positive, however, until the monetary brakes are slammed on. We still do not see
that as being a 2011 story.
While monetary fears are certainly fuelling the inflation debate, in practice much
of the current rise is down to the move in commodity prices. That’s the feature
of this note: the impact these have on a) Asian equities over time and b) looking
to where the risks (positive and negative) lie at the stock level, and specifically
trying to identify where these are and are not ‘priced-in’.
Our conclusions are that A) for sure, Asia in a relative sense tends to
underperform when commodity prices are rising. On the basis of our economist
and commodity strategy forecasts, we expect stabilisation in commodity prices,
which should take away some headwinds to Asian equity performance. B) A
few stocks appear to us to be anomalies from this exercise. Amongst the
beneficiaries of higher commodity prices, China Shenhua and PetroChina look
attractive. Amongst stocks that are negatively affected, EVA Air, Giordano and
Li & Fung look vulnerable.
Commodity Inflation – One big ‘correlated trade’
Over the recent weeks, rising commodity prices have once again become a focal
point of attention amongst Asia ex Japan investors. The CRB index, which
tracks the spot price for a basket of commodities, has risen past its previous peak
in 2008, and higher commodity prices have fed fears that this could add
inflationary pressure in Asia. Beyond this inflationary pressure, do rising
commodities hurt or help Asian equities?
Looking at a simple chart of the CRB index along with Asia ex Japan equities,
the relationship appears in recent years to be positive: higher commodities are
associated with better Asian equity markets.
This has not always been the case: indeed for most of the 1990s, the
performance of commodity markets and Asian equities was inversely correlated
as chart 2 shows. More generally the inverse relationship between commodities
and equities was one of the arguments that were made 10 years back for
investors to buy commodities in their own right. How times have changed.
Given the positive correlation that exists today, the prima facie evidence seems
to be that one rising is not bad for the other. Or, we shouldn’t worry too much
about rising commodity prices per se, it signifies growth, which is good for the
other.
This is absolute performance. The relative case for Asia is less appealing as a
commodity importer. Chart 3 shows the relative performance of Asia ex Japan
to EMEA and Latin America, along with the CRB index. The charts make clear
a relationship that most of us implicitly accept – that we as commodity
importers relatively suffer compared to producers (these indices are dominated
respectively by Russia and Brazil) when commodity prices are rising. Chart 4
shows the performance of Asia ex Japan relative to the developed world along
with the CRB index. Similar to the underperformance against EM, Asia tends to
underperform the rest of the world as well in periods with rising commodity
prices.
The bottom line is that rising commodity prices are not great for Asia ex Japan
in relative terms, and this has clearly compounded our underperformance in
recent weeks, both relative to other emerging markets, but also to the world
index. Both our economists and commodity experts expect upside in commodity
prices at least in the first half of the year and think that policy responses could
be critical to commodity and materials prospects in 2011. However, our analysts
expect oil price to be range bound in the $70-$90 range in 2011 which should
provide some relief to the recent headwinds, especially for food.
Moving beyond the macro and into the micro, what about the impact of certain
‘soaring’ commodity prices on individual stocks? After all, when we look at
costs in Asia, commodities figure significantly. Table 1 shows data that we
compiled around mid-2009, showing the cost breakdown where available for
companies in different countries. While labour is a significant cost in Hong
Kong and Singapore’s service economies (along with property costs) in others,
particularly the more manufacturing economies, input costs like commodities
figure more heavily.
For the rest of the note we take a detailed look, with the help of our colleagues
in research, to identify the potential gainers and sufferers from rising commodity
prices. What we are most interested in are anomalies: stocks that are positively
affected and yet have underperformed, or consensus forecast margins that have
yet to reflect higher costs.
This note is divided into three parts. First, we look at the price changes by
individual commodities and highlight some of the sectors and UBS-covered
stocks that are affected. Second, we run screens to look for outliers based on
share price moves, consensus forecast margins versus historical average margins,
and valuations. What we are most interested in are anomalies: stocks that are
positively affected and yet have underperformed, or consensus forecast margins
that have yet to reflect higher costs. Third, we present the detailed comments
we collected from our analysts on individual stocks in the Appendix
A few stocks stand out. Amongst the potential beneficiaries of higher
commodity prices, China Shenhua - H shows up as attractive in all three of our
screens. It is one of the worst performers amongst likely beneficiaries of higher
coal prices, its forecast margins are below the trough levels back in 2005-10,
and its market-relative PB is below its historical average. PetroChina also looks
to be attractive as an underperformer with low margins for the H shares.
Amongst the stocks that could be negatively affected by higher commodity
prices, there aren’t any stocks that show up as anomalies in all three screens but
a number of them show up in two screens. EVA Air and Giordano, to our minds,
look the most vulnerable. Both have performed well in the last 6 months. The
average consensus forecast margin for Giordano in 2011-12 is above the peak it
achieved in 2005-10; for EVA, above the peak during that period except 2010.
On a market-relative price-to-book basis, EVA is trading at more than 2x above
its historical average. Both stocks are rated Neutral by our analysts (Erica Poon
Werkun for Giordano and Eric Lin for EVA Air).
Top down, Li & Fung looks to be another candidate for potential disappointment.
As a sourcing agent, it is not directly affected by higher commodities price but
its customers and manufacturers are likely to face margin pressure. Some US
and European clothing and textiles retailers have warned that higher cotton
prices could lead to lower margins for that. We think it unlikely that Li & Fung
will be immune to the pressure. Spencer Leung, our analyst, has a high
conviction Sell call on the stock.
Stock impact by commodity
Oil
The oil price is arguably the most important commodity-related driver of the
CPI in Asia ex Japan, due to its direct impact on energy and fuel prices as well
as the knock-on impact on food. The impact is particularly pronounced for
lower-income countries: food, fuel and utilities together account for over 50% of
the CPI basket in the Philippines and India, and 40% in Indonesia and China.
Stronger economic data out of the US over the past 6 months has coincided with
an acceleration in the increase in the oil price, which is approaching levels that
were not seen before the spike in H1 2008. Jon Rigby, our global sector
strategist, believes that the oil price should average at around US$85 per barrel
in 2011E and 2012E, as it reflects the price at which the industry can make
sufficient economic return to develop the required capacity
The sectors that are the most positively affected by the oil price in Asia ex Japan
include the upstream oil producers and to a lesser degree the downstream
refineries and chemical producers. The product prices for the latter group are
correlated with the oil price though their margins depend on industry-specific
supply and demand. The key sectors that are considered negatively affected
include Utilities (if there is no pass-through) and Transpor
We list all the stocks under UBS coverage that are directly and indirectly
affected by the oil price, our analysts’ estimates of the impact, as well as their
company-specific comments in Table 5.
Oil companies as a group are beneficiaries but the company-specific impact is
dependent on the market in which the companies operate. According to Peter
Gastreich, our Head of Asia Oil & Gas Research, CNOOC’s EPS should go up
by 14%, and PetroChina’s by 10% for every US$10/barrel change in the oil
price. For the Indian oil companies, on the other hand, our analyst Prakash Joshi
believes that higher oil prices should have neutral and negative impact on most
companies, as they have downstream operations and the higher costs are
difficult to pass through.
John Chung, our analyst for the regional refining and chemicals companies,
believes that industry margin is near a bottom, and as the supply and demand
picture normalises the industry should gain pricing power. As a result, he
believes higher oil prices should positively affect his sector with higher product
prices.
A somewhat less direct beneficiary of the higher oil price are likely to be palm
oil producers in the region. Crude palm oil (CPO) prices historically trade in
line with the oil price, and the CPO plantation stocks have been amongst the
best performers in Asia recently. Whilst Alain Lai, our analyst, is bullish on the
plantation stocks due to structural constraints in finding more land for new
plantations, he has cautioned that CPO is now trading near the top end of its
range versus the oil price so there could be near-term risk of mean reversion.
Transport companies represent the biggest group that is negatively affected by
higher oil prices. For airlines and shipping companies, there is partial passthrough
and pricing power is dependent on demand, which also tends to
correlate with the oil price. At the moment, demand is strong so they should
have some abilities to pass through the cost increases, according to Richard Wei
and Eric Lin, our analysts. The Chinese rail companies are also affected, to a
lesser degree, although their tariffs are fixed by the government and hence there
is no pass-through to customers.
The other major group of stocks that are negatively affected are consumer
companies that use oil or oil-derived products as inputs, such as Li Ning and
Hengan. According to our analyst, Spencer Leung, oil and cotton together
account for around 20% of the input cost for the Chinese sportswear brands (Li
Ning, Anta, Xtep) and pulp and oil together account for 45% of the cost for
Hengan. Whilst there is some pass-through in these costs, higher commodity
prices look clear headwinds.
Coal
The coal price has been on an uptrend over the past 12 months but the recent
floods in Australia have led to a notable acceleration in the price increase. As
our commodities team believes the restoration of mining capacity is likely to
take months, if not longer, we forecast that the coal prices will stay elevated at
near current levels throughout 2011 and 2012.
Whilst coal has less widespread impact on the economy compared with oil, it is
the most important energy source for power generation for most Asian
economies as well as a key input for steel and cement production, which are
crucial materials for fixed asset investments.
Indonesia is considered a key beneficiary of higher coal prices as mining
companies form a significant part of the equity market. By extension, equipment
manufacturers and companies that are geared to the Indonesian economy are
indirect beneficiaries.
In terms of impact by individual stocks covered by UBS (Table 7), the earnings
sensitivity amongst coal miners are broadly between 2-3% for every 1%
increase in the coal price, according to our analysts. The major differences
between the Chinese and Indonesian producers lie mainly in the corporate
structure and degree of government control: amongst the Chinese miners,
greater government control implies greater risk of price controls (though in
some cases offset by the benefit of easier access to financing and mining assets);
for the Indonesian miners. Some of the Indonesian miners are part of a
conglomerate structure which entails exposure to non-coal mining assets.
The biggest group of stocks that are the most negatively impacted are utilities.
They have varying degrees of pricing power: Hong Kong Electric and CLP, for
instance, enjoy protection from explicit fuel pass-through mechanisms and
operate under a strong regulatory regime. KEPCO and the Chinese IPPs, on the
other hand, are often stuck with the negative impact from higher fuel cost due to
their inability to raise tariffs.
Steel companies represent another group that is negatively impacted as coking
coal and iron ore are their major costs. Yong Suk Son and Hubert Tang, our
steel analysts, believe that whilst coal prices are rising, steel prices are
increasing as well so steel companies should be able to offset some of the impact.
Cement companies in China have 40% of their raw materials costs in coal, yet
they are amongst the best performers in the last 6 months. Cement supply has
been disrupted by electricity shortages in China in H2 2010, and demand has
continued to be robust, thereby allowing the cement producers to pass on cost.
As the Chinese government is restricting construction of new capacity, Mick Mi,
our analyst, believes that pricing power is sustainable. CNBM is a UBS Key
Call.
Steel
The rise in steel prices has been relatively subdued in the recent months in part
due to concerns of slower demand in China as well as general industry
overcapacity. Our analysts, Yong Suk Son and Hubert Tang, are more optimistic
that steel mills should have better pricing power in Q1 with potential re-stocking
and some re-acceleration in demand. In general, higher commodity prices
should negatively affect steel mills as they do not have direct pass-through of
their coal and iron ore costs.
Higher steel prices benefit steel mills but negatively affect downstream users of
steel – mainly industrial companies. Auto makers and shipbuilding are amongst
the heaviest users of steel.
Amongst steel makers, our analysts believe they tend to be net losers from
higher coal and iron ore costs, although in the near-term pricing power should
improve. In China, Baosteel has the best pricing power, according to Hubert,
and Yong Suk believes that the share prices of the Korean steelmakers should
benefit from higher steel prices and some restocking in H1.
In general, our analysts appear to be sanguine about steel cost for stocks that are
negatively affected. Young Chang, our Korean auto analyst, believes that
margins should be relatively well-protected despite steel being 60% of the cost
of goods sold. Sonal Gupta, our Indian auto analyst, notes that companies have
hiked prices to offset cost increases, and seem confident this will continue.
The same is true for other sectors. Richard Wei, our China rail analyst, believes
that the Ministry of Rail will aim to protect the rolling stock companies’
profitability even though 80% of their input costs comprise of steel, aluminium
and copper, and pricing of their products are determined by their customer
(Ministry of Rail). For the Korean E&C companies, Yong Suk also believes in
decent abilities to pass through higher costs.
From a top-down perspective, we think this probably reflects the relatively
subdued price increases in steel over the past 6 months and hence the lack of
pressure on the supply chain. However, if steel mills were to be able to gain
some pricing power in H1, as Yong Suk and Hubert predict, higher steel cost
could become more topical over the next 6 months, which currently does not
seem to be a major concern per our analyst comments.
Copper
Copper production was affected in Chile and Mexico during 2010 which,
together with re-stocking in China, led to a sharp rise in the price. Our global
commodities team believes that copper prices will stay at relatively elevated
levels in 2011 (5% below the Q1 2010E level), albeit that there could be a 15-
20% decline from the current level in 2012E.
There are relatively few copper miners in Asia that benefits directly from higher
copper prices, whilst those that are negatively affected are mainly industrial
companies.
The listed copper producers under UBS coverage include Sterlite Industries and
Hindalco in India, as well as Jiangxi Copper in China. We estimate Jiangxi
Copper should see its 2011 and 12 profit going up by ~1.5% for every 1%
increase in the copper price, all else remaining equal.
Industrial equipment producers are vulnerable to copper price increases, though
they may or may not be able to pass through the cost increases depending on
supply and demand within their specific industries. Amongst the companies we
cover, copper, along with other industrial metals, often account for more than
60% of the input cost.
Aluminium
Our global commodities team expects aluminium prices to stay at near Q1 2011
level for 2011 and 2012, as demand growth outpaces supply growth. The main
demand drivers include developing markets economic growth and consumption,
as well as loose US monetary policy. Whilst inventories are relatively high, our
team believes that some of them are inaccessible
The listed aluminium producers are mainly in China and India, the two major
markets. Higher aluminium prices affect a host of industrial companies
including auto makers, auto part manufacturers as well as machinery
manufacturers. Typically, their input cost are affected by aluminium as well as
other industrial metals, and aluminium tend to be a smaller part of the input cost
compared with other metals such as copper and steel.
At the individual stock level, the railway rolling stock companies are amongst
the heaviest users of aluminium. Our China rail analyst, Richard Wei, is
convinced that they will be allowed to pass through cost increases by the
Ministry of Rail and hence the companies’ margins should be unaffected.
Amongst the Chinese aluminium producers, our analysts, Haoxiang Li and Ghee
Peh, note that the aluminium smelting is now in oversupply, and hence the
companies have limited pricing power. Electricity is a large input cost of
aluminium smelters and electricity prices are in turn affected by coal prices in
China. Whilst, at the moment, the government seems intent on controlling
inflation and therefore it seems unlikely it would let power prices rise,
aluminium producers could be adversely affected should this change.
Cotton
Cotton prices have almost doubled over the last 6 months, in part due to weather
disruptions. Our global commodities team does not forecast cotton prices
though, for agricultural commodities in general, we believe that prices should
start to stabilise assuming the weather normalises
Cotton impacts primarily the clothing and apparel retailers in Asia as well as the
exporters in the textile trade. Within the UBS coverage universe, the key stocks
that are impacted are mainly Chinese consumer companies, as well as exporters
such as Li & Fung and Esprit. For most of them, our analysts have indicated
that they expect the companies to have effective pass-through, which stems from
robust demand in China as well as their confidence in the brand’s pricing power.
From a top-down perspective, the risk is that pricing power could erode should
the economy slow, and given the generally high valuations of the Chinese
consumer companies the market could be caught off guard.
Agricultural commodities
Agricultural commodities are amongst those that have risen the most in the past
12 months due to major weather disruptions, ranging from droughts in Russia,
China and the US to storms in Asia, Indonesia and Australia. The magnitude of
the increases varies though most of Asia have seen double-digit increases in
food prices, as measured by the respective government agencies, some time in
2010. We show the price trends of a few benchmark commodities below.
Our economics team believes that food price increases – and the ensuing
pressure on the CPI in Asia – should moderate simply because of the higher base
and unlikely repeat (hopefully!) of the disruptive weather. However, structurally,
our economics team does expect inflation pressures to build in Asia ex Japan.
The biggest beneficiaries of higher agricultural commodity prices are expected
to be the producers - examples of them include the palm oil plantations and the
likes of Yurun in China. On the other hand, processed food manufacturers (food,
beverage and tobacco) and restaurants are likely to be negatively affected as
food commodities represent a key input cost.
Within the UBS coverage, the biggest beneficiaries of higher agricultural
commodity prices appear to be the palm oil plantation stocks. Whilst cyclically
crude palm oil prices have been pulled up by higher oil prices, Alain Lai, our
analyst, believes that there is a strong structural case for higher CPO prices as
well given robust demand driven by emerging market consumption, and
constrained incremental supply given increasing difficulties in securing land for
plantations. He has Buy ratings on the plantation stocks.
Amongst the companies that are likely to be negatively affected, most
companies have no or only partial abilities to pass through the cost increases.
The A-share listed breweries (Kweichow Moutai, Wuliangye Yibin, Luzhou
Laojiao) appear to have the strongest pricing power, according to our analysts.
The market appears to share the same assumptions as the cluster stands out as
the companies that have consensus forecast margins in 2011-12 above their
previous peak in 2005-10.
Screening for anomalies
Section 1 above gives us a ‘map’ of which Asian stocks are affected by the
individual commodities. What we are most interested in, however, is whether
these are already priced in. We look at this via three screens: on recent price
momentum, consensus margin forecasts and valuation. The stocks we want to
seek out are, for instances, commodity beneficiaries that have lagged the market,
for which the forecast margins are running below periods of comparable
commodity prices and are trading at reasonable valuations.
Screen 1: Price momentum
We start with a very simple screen of share price momentum. In Table 18, we
show the best and worst performing stocks in the past 6 months, grouped by
whether they are positively or negatively affected by price moves in a
commodity. We are interested in two types of anomalies: stock prices that have
moved the opposite way from how commodity prices should affect them; and
stocks with similar sensitivities to commodity prices that have divergent share
price moves.
A few groups stand out. Within the Oil category, the Indonesian E&P
companies (Medco Energi and Energi Mega Persada) have lagged their regional
peers despite being beneficiaries of higher prices. The Taiwan Transport stocks
have been top performers and have outperformed their sector peers, despite
being highly sensitive to the oil price and their relatively high price-to-book
valuations, compared with their own history.
Cement companies in China have 40% of their raw materials costs in coal, yet
they are amongst the best performers in the last 6 months. Cement supply has
been disrupted by electricity shortages in China in H2 2010, and demand has
continued to be robust, thereby allowing the cement producers to pass on cost.
As the Chinese government is restricting construction of new capacity, Mick Mi,
our analyst, believes that pricing power is sustainable. CNBM is a UBS Key
Call.
Amongst companies negatively impacted by steel, the Korean shipbuilders
(DSME and Hyundai Heavy Industries) have performed very well. Yong Suk,
our analyst, has highlighted in his comments that rising steel cost could pose
earnings risk to the sector.
The Chinese railway rolling stock manufacturers (CSR and CNR) seem to have
been barely affected by higher commodity prices, and their share prices have
appreciated by more than 50% over the past 6 months. Steel, aluminium and
copper together account for 80% of their costs, and they have limited pricing
power as their prices are effectively set by the Ministry of Rail (MOR) in China.
Richard Wei, our analyst, is sanguine about margin pressure as he believes that
the MOR is keen to develop the companies into global competitors and will try
to protect their profitability.
National Aluminium in India has lagged behind Hindalco and Sterlite, its listed
peers. The underperformance seems large even though both Hindalco and
Sterlite have exposure to copper, the price for which has gone up more sharply
than aluminium during the last 6 months.
The A-share listed Chinese breweries (Kweichow Moutai, Luzhou Laojiao and
Wuliangye) have been amongst the top performers within the Agriculture
category, though they are affected by grain prices. IOI Corporation is a laggard
amongst beneficiaries of higher crude palm oil prices, but Alain Lai, our analyst,
also highlights that its earnings are also the least sensitive to CPO prices
amongst Malaysian plantations.
Lastly, Shanghai Metersbonwe and Giordano, the Hong Kong and China
clothing retailers, stand out as significant outperformers of their respective
markets. They are not directly affected by higher cotton prices as retailers, not
manufacturers, though the high level of volatility around cotton prices (+75% in
the last six months) as well as its historic high level in absolute terms (more than
double its long-term average in 2000-10, see Chart 10) could imply some impact
in the next few months, as the cost increases work through the supply chain.
Screen 2: Profit margin
We also look at consensus forecast margins and see if they are realistic. What
we are interested in are anomalies: stocks which have forecast margins moving
in the opposite direction of how they are supposed to be affected by higher
commodity prices, according to our analysts. For instance, a stock that is
negatively affected by higher commodity prices should have lower forecast
margins than history. If the consensus forecasts indicate a higher margin, this
would imply that the company can pass on the cost increases or that consensus is
too optimistic.
Specifically, we look for these stocks by comparing their 2011-12 average EBIT
margins with what they had achieved in 2005-10. We exclude the margin data
during 2008 and 2009 because they are likely to be distorted by the
extraordinary swing in the inventory cycle. We include only stocks that have
margin data available going back to at least 2007.
Companies with pricing power / overly optimistic forecasts
In Table 19, we show the stocks that should in theory be adversely affected by
higher commodity prices; yet they have average forecast margins that are above
the peak achieved during 2005-10. We rank them by the gap between the 2011-
12 EBIT margin and the 2005-10 peak.
Consumer companies – in particular, Food, Beverage & Tobacco – stand out as
the biggest group from this screen. Five of them are breweries listed on the Ashare
market in China. As a group, they should be affected by higher grain and
other food commodities cost, though it appears that the market has assumed that
they could more than pass on the cost increases. The biggest concentration of
the consumer companies are in China, which suggests generally high confidence
in pricing power for the sector.
Outside of Consumer, another group for which the market appears to have
assumed strong pricing power is Cement. Coal is the biggest input cost for
cement, although cement pricing tends to be determined by local supply and
demand, and demand appears to be strong across the region, according to our
analysts. Still, for companies such as Lafarge Malaysia, Holcim Indonesia,
Tunggal Prakarsa and Taiwan Cement, consensus forecast margins are
substantially above the 2005-10 peak, which are themselves significantly above
the averages during the period. This would imply very strong pricing power.
Korean Auto is another group that features in the screen, although it appears to
be the result of substantial market share gains and stronger brands over the last
several years. Young Chang, our analyst, is confident that the market share
gains will continue, which should support the profit margins.
Companies with weak pricing power / overly pessimistic forecasts
In Table 20, we screen for the reverse of Table 19 above. We look for stocks
that should be beneficiaries of higher commodity prices, and yet have forecast
margins below their 2005-10 trough (excluding 2008 and 2009). We rank them
by the gap between their average forecast margin versus the historical trough.
This screen yields a much smaller group of companies: essentially the big stateowned
China resources stocks. The lower margin for CNOOC, an upstream oil
producer, is a function of rising production cost as well as the government
‘windfall’ tax, the rate for which increases with the oil price. Even as the per
barrel dollar margin for CNOOC increase with higher oil prices, its percentage
margin did not expanded due to the higher base numbers for both revenues and
cost.
For PetroChina and Shenhua, concerns over government efforts to keep coal and
oil product prices under control appear to be factors affecting the margin
forecasts. Nonetheless, the margins appear low.
Screen 3: Relative valuation
Our final screen looks for valuation anomalies: we are interested in stocks that
should be beneficiaries of higher commodity prices and are trading at low
multiples relative to history, and vice versa. As our valuation benchmark, we
compare the price-to-book ratios versus the market (MSCI Asia ex Japan index),
versus the historical average market-relative PB. We limit our universe to
stocks that have more than US$1 billion in free float market cap.
Table 20 shows the 10 most expensive stocks based on our metric that are
negatively affected by higher commodity prices.
The mix of stocks is very diverse, so are their absolute PB valuations. Chinese
Consumer stocks account for 3 of the 10 stocks (Tingyi, Tsingtao and Hengan),
though aside from Tsingtao there is no overlap with the stocks on the previous
screen that shows stocks with consensus forecast margins higher than their
historical average.
Dongfang Electric and SANY are valued at substantially higher market-relative
PB multiples than history, as well as high absolute PB multiples. SANY looks
less vulnerable as a coal mining equipment producer, as it should be benefit
indirectly from higher coal prices whilst negatively affected by higher steel cost.
Patrick Dai, our analyst, is optimistic on the heavy industrial equipment outlook
in China and has Buy ratings for both stocks.
Top-down, we are the most concerned about EVA Airways. It has very high
earnings sensitivity to the fuel prices and, whilst current demand is strong,
pricing power rarely stays with airlines. At historically high valuations relative
to market, the stock looks vulnerable
In Table 21 above, we show the reverse of Table 20: the 10 ‘cheapest’ stocks
that benefit from higher commodity prices.
The biggest group is coal companies in China. This is in sharp contrast with
2007-08, when rising coal prices drove up their valuations. It appears that the
market is concerned about the efforts by the Chinese government to control
inflation and by extension the coal price, notwithstanding the disruptions in coal
production in Australia.
PetroChina’s valuation seems to be held back by the same concerns, as the
vertically integrated nature of the company means it may not benefit from higher
oil prices unless oil product prices also rise in China.
Indofood looks like a potentially cheap beneficiary of higher oil prices. Its
profits are geared to crude palm oil (CPO) prices, which tend to be correlated
with the oil price (though lately CPO has been trading at the high end of its
historical range versus the oil price). Our analyst, Alain Lai, believes there are
structural constraints to new supply (suitable land for new plantations is
increasingly difficult to find) whilst demand should continue to be robust, driven
by higher spending on food globally. Valuation looks attractive in this light, in
our view.
Combining the three screens
Now that we have presented the stock screen from three different angles, our
final section combines the results of all three to see if there are stocks that show
up as anomalies in all of them. In other words, we are interested in commodity
beneficiaries that are bottom performers, have low forecast margins relative to
history and are valued at lower market-relative PB than their historical average.
Those could be interesting stocks to own. The same goes for stocks that are
negatively affected by higher commodity prices, under the reversed parameters.
We present our results in Tables 22-23. First, we show the likely beneficiaries
from higher commodity prices that are anomalies in two or more of our three
screens.
China Shenhua - H shows up as attractive in all three of our screens. It is one of
the worst performers amongst beneficiaries of higher coal prices, its forecast
margins are below the trough levels back in 2005-10, and its market-relative PB
is below its historical average. PetroChina also looks to be attractive as an
underperformer with low margins for the H shares, and low valuation for the A
shares.
Amongst the stocks that could be negatively affected by higher commodity
prices, there aren’t any stocks that show up as anomalies in all three screens but
a number of them show up in two screens. EVA Air and Giordano, to our minds,
look the most vulnerable. Both have performed well in the last 6 months. The
average consensus forecast margin for Giordano in 2011-12 is above the peak it
achieved in 2005-10; for EVA, above the peak during that period except 2010.
On a market-relative price-to-book basis, EVA is trading at more than 2x above
its historical average. Both stocks are rated Neutral by our analysts (Erica Poon
Werkun for Giordano and Eric Lin for EVA Air).
Top down, Li & Fung looks to be another candidate for potential disappointment.
As a sourcing agent, it is not directly affected by higher commodities price but
its customers and manufacturers will likely face margin pressure. Some US and
European clothing and textiles retailers have warned that higher cotton prices
could lead to lower margins for that. It seems unlikely that Li & Fung will be
immune to the pressure. Spencer Leung, our analyst, has a high conviction Sell
call on the stock.
A number of breweries in China appear on Table 19 – all of them have forecast
margins higher than their 2005-10 peaks despite being affected by higher grain
costs. Consensus seems to be confident in the companies’ pricing power, though
the high valuation – both absolute and relative – would make us think that this is
largely in the price.
CNBM is a UBS Key Call and appears on Table 23 as a stock that has both
outperformed in the last 6 months and has consensus forecast margins at a level
above its historical peak, thus vulnerable. However, there are structural factors
that support pricing power in the sector, namely the government ban for new
cement capacity to be built as well as the campaign to build affordable housing.
Our analyst, Mick Mi, is confident that cement price increases will more than
offset cost pressure from higher coal prices.
Strategy conclusion
In recent weeks, rising commodity prices have become an increasing concern for
investors, as many commodities climbed back to above or near their peak prices
in 2008. Historically, there has been no consistent relationship between
commodities and Asia ex Japan equities performance, and equities tend to
perform well with commodities when the economy is strong. We expect it to be
no different in the current market.
That said, the impact from higher commodity prices is expected to be felt
unevenly by different parts of the market. With the help of our equity research
colleagues, we try to identify the impact by commodity in this note. To take this
a step further, we look for anomalies where the impact from commodities may
not have reflected in the recent share price performances, consensus margin
forecasts and/or valuations.
A few stocks appear to us to be anomalies from this exercise. Amongst the
beneficiaries of higher commodity prices, China Shenhua and PetroChina look
attractive. Amongst stocks that are negatively affected, EVA Air, Giordano and
Li & Fung look vulnerable.
Summary of our Strategy View
We remain positive on Asia ex-Japan equities in 2011. Earnings growth
forecasts look achievable and valuations are attractive, especially relative to
other assets. With liquidity now becoming a tailwind, growth less of a concern
and the domestic credit cycle set to improve, we think Asia could re-rate from
its current discount to its historical average PE, and potentially even a premium.
We upgrade our 2011 year-end MSCI Asia ex-Japan index target to 670 from
650, based on 13.7x forward PE, in line with the long-term average.
Our key country picks are Singapore and China. We are neutral the G7 proxy
markets of Taiwan and Korea. Valuations have moved back toward neutral, and
leading indicators have already stabilized. There is less compensation, unless
convinced one way or other of external demand (which we are not) for taking an
aggressive view on these markets now. We are generally underweight the
expensive ASEAN markets. Of which Indonesia with low bond yields, rising
inflation and huge foreign ownership look the most vulnerable beyond
valuation. At the sector level, we are overweight financials, as the best proxy for
the liquidity theme and the credit cycle. We are underweight defensive sectors,
expecting them to underperform a rising market.
We believe there is an elevated risk that Asian markets could reach a ‘euphoric’
state, fuelled by inappropriately loose monetary policy. On the downside,
inflation, sharply higher US bond yields and government intervention are risks.
Key Calls
What are Key Calls?
Key Calls represent our highest conviction single stock research ideas across the
region. The list is designed to generate bottom-up ‘alpha’ and is not a portfolio
that we use to express our top-down view. The key selection criteria are analyst
conviction, liquidity (>US$10m average daily turnover for most stocks) and a
strategy overlay in terms of the macro outlook, market positioning and risk
management.
Company Rating Price
(LC) PT (LC) Upside /
Downside
Mkt Cap
(US$ bn)
EPS
Growth
11e
PE 11e P/BV
11E Comments
LG Display
Buy 37950 49000 29% 12.1 4% 9.54 1.09
The potential panel order from Sony in 2011 should
allow LG Display to outperform other LCD stocks. The
company is also a beneficiary of growing tablet PC
demand.
Bangkok Bank
Buy 164 189 15% 10.2 9% 11.58 1.28
Prime beneficiary of new credit cycle in Thailand.
Demand for credit from corporations (over 70% of
BBL’s loan book) is likely to be the key driver in the 18
months.
Cheung Kong Inf Buy 36.8 45.5 24% 10.7 43% 12.98 1.74
Well-positioned to acquire assets to improve ROE.
Cement business in HK an overlooked generator of
EBITDA.
China National
Building Material
Buy 18.92 30 59% 6.6 61% 8.93 2.08
Beneficiary of government policy to consolidate supply
and dampen property prices via increasing housing
supply. H-share placement has alleviated concerns
over gearing. EV/ton valuation at historical low.
OCBC
Buy 10 11.3 13% 25.9 4% 13.57 1.73
OCBC should benefit more from the strong liquidity in
Singapore via its Wealth Management Business.
Private banking has better growth and profitability and
thus should help command a valuation premium.
Shriram Transport
Finance
Buy 743.1 1000 35% 3.7 30% 11.18 2.88
SHTF Is the only established player in financing for
second-hand commercial vehicles in India. It has
around 20-25% market share in a market which is
expected to grow & and has high barriers to entry.
Lanco Infratech Buy 53.45 105 96% 2.8 105% 13.67 2.82
Strong execution track record in building power plants
underappreciated. New projects could offer Rp35
upside to the current share price
Sun Hung Kai P
Buy 136.1 225.9 66% 44.9 21% 17.61 1.33
A sector leader that command premium pricing
(superior profitability); income stream from commercial
properties holding underappreciated; large landbank
holder and a beneficiary of the credit upcycle in Hong
Kong
Industrial &
Commercial Bank Of
China-H
Buy 5.95 7.7 29% 255.3 11% 11.61 2.22
Strong capital position and provisioning buffer, rising
net interest margin and healthy, albeit sequentially
slower, loan growth.
Source: UBS (prices as of 20th January 2011)
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