• 2018 Third Quarter Review
    October 2018

    Dear Investors,

    We are pleased to report to you our investment results and recent developments at our firm and to share our latest thoughts and strategy. We hope you will find it both interesting and informative.

    Foundation China Opportunity Fund is now in its 12th year of history-making performance. This means that the Fund now has more than a decade of solid track record and has delivered 11 full years of great returns to our investors and shareholders. The Fund has outperformed the market and delivered great net returns since inception. More remarkably, the Fund achieved the good performance without adding volatility.

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    Trade War
    Since our last quarterly update in July, the trade war between China and US has escalated. After both countries have started to execute the first round of tariffs on USD 50 billion worth of each other's exports, US government started to implement the next round of tariffs on another USD 200 billion worth of exports from China on 18th Sept 2018. To retaliate, Chinese government has also charged tariffs on another USD 60 billion worth of exports from US. Both governments have kept the option to increase the tariff rate after 1st Jan 2019. In other words, if the two governments do not come to any new agreement before the year-end, the trade war will escalated in a few months.

    Social Security Fund Collection in China
    Chinese government will transfer the authority for collecting social security contributions from local social security bureaus to local tax authorities at the beginning of 2019, and this change will likely cause more cost burden to local private businesses. The collection has long been patchy and many smaller companies in labor-intensive industries have ignored the requirements. However, because of the ageing population, the financial pressure on Chinese government to distribute social security benefits to citizens is mounting. The situation has to change. As the local tax agencies usually have more information about companies' financial situations, the enforcement of social security fund collection will be much stronger than before.

    Most SOEs and foreign businesses have always abided by the rules and will see limited direct impacts. But many local private businesses without the ability to transfer the cost pressure to customers will see their margins going down because of this change. Depending on how labor intensive a business is, the negative impact on margin varies. But a labor intensive business can easily be halved because of this new development. Unless the Chinese government can introduce other remedies to alleviate the pressure on companies, Chinese companies will have a hard time in the near future. On the other hand, this will be another great opportunity for competitive companies to gain market share from weaker peers.

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    Holdings Review
    Let’s recap the companies we mentioned in previous issues of the Fund quarterly review:
    CR Beer (291 HK) business performance in 1H2018 was in-line with expectation and the recurring net profit increased by about 70% yoy. The product upgrade strategy has been executed well and the average selling price during the period increased by 13% yoy. As a result, the GPM increased from 33.5% in 1H2017 to 36.0% in 1H2018. On the other hand, peers like Tsingtao Beer (168 HK) saw its GPM declined from 33.2% to 30.7%. We believe CR Beer's superior execution capability will support its endeavor to improve margins in the coming years.

    CSPC (1093 HK) business performance in 1H2018 was in-line with expectation and the recurring profit increased by about 30% yoy. The GPM increased from 57.3% in 1H2017 to 63.9% in 1H2018 as the sales of innovative drugs grew by 65.3% yoy. In spite of the announcement from the Chinese government on its intention to keep drug price lower and healthcare more affordable in China, we believe a drug manufacturer like CSPC with leading market share in its respective segments, strong R&D and sales capability to push innovative drugs to the market, and reasonable profitability level compared to international peers, the company will be able to keep growing with the Chinese healthcare industry in the long-term.

    During the preceding 3 months to September 2018, we also added one interesting stock to the portfolio, namely BOCA.
    BOCA (2588 HK) acquires aircrafts in bulk and leases them to customers like multinational airliners so that the airliners do not have to bear the capital expenditure burden while expanding. By aggregating the purchases, BOCA is then able to structure financing in a more efficient way than any individual airliner can do it alone. With an outstanding credit rating, BOCA's debt cost is about 1.8-2.5%, lower than the other four major peers' 3.4-5.4% rate. In August, BOCA announced a better than expected 1H2018 results. Both recurring net profit and dividends grew by 24% yoy. The aircraft delivery backlog before 2021 is 163, of which 52 of them will be delivered by the end of 2018. This predictable delivery schedule and the longest contract duration period, 8.2 years, amongst peers will bring predictable growth to its net profit and dividends in the future. When we added the stock to our portfolio, the expected dividend yield in 2019 was more than 5% and the valuation was attractive.

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    Final Words
    Though the Hang Seng Index has been weak in 2018, it is now close to the floor of its 25-year historical average price-to-book valuation band. We think that after years of economy restructuring engineered by the Chinese government, China’s growth quality has become much healthier than it was a few years ago. On the other hand, the trade war between China and US may pose uncertainty on certain companies' earnings prospect. It therefore becomes necessary for investors to own a portfolio of well-selected businesses that can both withstand the headwinds and gain market share at the same time. In the past few years, certain Chinese companies were able to utilize the opportunity during the brief economy slowdown to make themselves more efficient and competitive. We believe these companies are fully equipped to deal with the trade war uncertainty and prosper when the Chinese economy recovers.

    Our CIO, Mr. Michael Liang, recently was interviewed by the three local leading financial publications to discuss about recent development of the stock market. As usual, Mr. Liang consistently reminded readers that the most important qualities any value investors should have are temperament, rationality, and independent thinking. While the mainstream media has been reporting how bad the economy and stock market are, he advised investors to stay rational and keep investing in superior companies to earn alpha.

    To extend the success of Foundation China Opportunity Fund, we are working with Chinese and Hong Kong institutions to launch a Hong Kong domiciled and SFC authorized version of our China Opportunity Fund, named Foundation China Equity Fund, because its strong 10+ years outstanding performance has caught much attention that it deserves.
    Yours faithfully,

    Research Team, Foundation Asset Management (HK) Limited
    October 2018 in Hong Kong 


  • Disclaimer

    The views expressed are the views of Foundation Asset Management (HK) Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Investors should note that investment involves risk. The price of units may go down as well as up and past performance is not indicative of future results. Investors should read the explanatory memorandum for details and risk factors in particular those associated with investment in emerging markets. This commentary has not been reviewed by the Securities and Futures Commission.