Hi, I’m Stephen, one of the senior analysts here at Clime and I look after the Mid cap portion of the Clime portfolio, this being ASX200 excluding those companies in the ASX50.
In my last video back in September I highlighted the downside risks to valuation multiples, particularly mid cap businesses focusing on growth. Since then, bond yields have continued to increase resulting in a de-rate in earnings multiples as expected.
Given this, our attention now turns to those businesses with exposure to offshore growth that have been de-rated recently.
In doing so, we focus our attention on businesses looking to grow
· in regions experiencing above average growth; and
· understand the additional risk of operating in a particular region
Figure 1. Forecast output growth, by country/region
In terms of the regions of interest, it’s no surprise we are interested in those businesses looking to grow in Asia with current economic growth outlook of ~6% rather than regions growing at levels below Australia e.g. Western, Eastern Europe & Russia.
Having identified the region, which is the easy part, it’s then important to consider the additional risks the businesses is exposed too in achieving this growth.
All too often, sell side analysts will not adjust their discount rates to reflect the risks of expanding offshore leading to valuations reflecting upside potential without considering the downside risks, some of these risks include:
· Political and social climate
· Economic growth and financial position
· Tax and regulatory environment
· Infrastructure and cultural compatibility
In assisting our understanding of risks, we can look to country risks premium studies which are based on relative pricing in bonds and/or credit default swaps.
Figure 2. Country Risk Premium
In this chart, we can see the additional risks over and above those associated with operating a businesses in Australia. The stand out region here is Eastern Europe & Russia with a premium of ~60% and the region of most interest being Asia at ~20%.
Based on this analysis, on a risk vs return basis, Asia looks to be best positioned and add to this Australia proximity to the region, further adds to the attractiveness of the region.
We now turn our attention to what we are looking for in businesses expanding in Asia
Most would, when contemplating expanding into the Asian region would automatically focus on China given the size of the population and the growth associated with urbanisation.
Figure 3. Population – Asian Countries
However, in recent times we have seen an increase in the level of policy or regulatory changes in China driven largely by the economic concerns over the shift in the growth of the economy from Government expenditure on infrastructure to that of a consumption, some of these changes include:
· Increasing capital controls including a limit on capital outflows
· Introduction of Coal import regulations
· Tightening up unregulated import channels affecting certain products e.g. infant formula
The impact of these changes have in some cases, negatively impacted earnings of Australian businesses, often without warning or consultation.
As a consequence, we prefer to have exposure to businesses that are not wholly reliant on growth from China, rather spreading the risk of offshore expansion across multiple countries within the Asian region.
What does this mean for our portfolio, specific to investing in mid cap stocks
The recent de-rating in earnings multiples is now resulting in attractive entry prices into businesses currently exploring growth in the Asian region taking a diversified approach.
I hope you’re found this short video useful and should you require further information, please contact us via our website