Emma Wall: Hello, and welcome to Morningstar. I am Emma Wall and here with me today is Charlie Awdry, Manager of the Henderson China Opportunities Fund. Hi, Charlie.
Charlie Awdry: Hi, Emma.
Wall: Here today to give three stock picks. What's your first company?
Awdry: Well, the first company really is a sector. One of the areas that we like in China is healthcare and we like it because the communist party can't really control the drivers. They have a very aging population, they have a population that's richer and those two combined together with quite a polluted environment means that healthcare bills are going up. So, any company who is driven by healthcare expenditure will see quite a good outlook. We've chosen a few, but a couple I'd highlight would be CSPC Pharma (01093) and also China Medical Systems; so one is a drug company and one is a distributor of drugs, and both are seeing accelerating sales and good cash flow.
Wall: For the uninitiated they would probably think of pharmaceuticals and think of those big global stocks. Is the Chinese market more dominated by domestic companies such as these?
Awdry: It is. Primarily because they have lower-priced products. However, if the products are particularly specialist then they tend to go to the multinationals. But what we are seeing is Chinese companies are buying brands and buying generics that they can then distribute more expansively through China on their own networks. So, really the market kind of splits in two, the expensive drugs where they have to go overseas and the lower cost ones where they tend to have domestically.
Wall: What's your second stock?
Awdry: So, the second stock is our largest portfolio holding. It's a company called Tencent (00700). I think a lot of people would have heard about Alibaba (BABA) in the last couple of weeks. Tencent is in a way a rival and Alibaba dominates e-commerce, it's kind of like Amazon, but Tencent dominates social media in China and has sort of amalgam of Facebook and WhatsApp and also has a lot of gaming as well.
So, the interesting thing about Tencent is they've been listed for a number of years with the same management. They have executed very well with new products and of course, being an Internet company we will be mindful that it generates profits and cash flow which it does. So, the first half of the year had net profits of $2 billion and interestingly and importantly, its operating cash flow was actually higher than that. So, it does convert this internet idea into cash flows for shareholders.
Wall: I think one of the things that people are wary of with social media is how you generate revenues. You look at Facebook’s share price from IPO and it's been all over the place just because people don’t understand that. Is it just advertising, how can you monetise those users? How is this company doing that?
Awdry: Well, there is a very unique Chinese feature with this company and that is actually they generate cash flows without really pushing advertising yet and they do it by selling basically online games, casual gaming between people and Chinese people, they love to share aspects of their life and they love to share music and photos and so on and actually they can monetise that themselves through the actual games. And really the next leg will be advertising and also pushing e-commerce through their systems. So, I would expect them over time to start to get more monetization actually because it's below the levels of Facebook.
Wall: And what's the third stock?
Awdry: So, the third stock is a beneficiary of reform. One of the things we think about China is, yes, the economy is growing nicely. But actually one of the big drivers is reform and things getting better. We think CITIC Securities is placed quite well for that. It's China's leading stock broker and its management has pushed itself really to the front of the industry by acquiring overseas. So, they've really got in position before this Hong Kong Shanghai Stock Connect. So, we expect them to make the most of the opportunities in terms of financial reform between Hong Kong and Shanghai and the opening up of those stock markets.
Wall: So, the opening up is for foreign investors. But how much do Chinese consumers invest in their own markets? I mean is this quite an under-mature market, isn't it, an immature market?
Awdry: It's very retail-driven market, which means it's very volatile and it tends to be less valuation driven. But liquidity is very high, so participation is high. But when you talk about the opening of the markets, it's actually two-way. So, foreign investors will be going into Shanghai, but actually local Mainland investors will be coming into Hong Kong as well. So, actually one sort of unintended consequence of that I think is you'll see more of that domestic liquidity driven investing in Hong Kong which might make small and midcaps even more volatile than they are now.
Wall: And how does that affect that stock?
Awdry: Well, I think it probably means that valuations in the midcap space in Hong Kong will probably be more extreme. So, they might get extremely pessimistic and drive valuations very low and very optimistic and drive valuations beyond what's reasonable. So, as an active stock picker myself with a bit of patience I should be able to buy low and sell high.
Wall: Charlie, thank you very much.
Awdry: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
