• 2019 First Quarter Review
    April 2019

    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 13th year of history-making performance. This means that the Fund now has more than a decade of solid track record and has delivered 12 full years of great returns to our investors and shareholders. The Fund has outperformed the market and delivered great net return since inception. More remarkably, the Fund achieved the good performance without adding volatility.

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    Trade War Update
    Since our last quarterly update in January, the trade war between China and the US has abated further since the US extended the truce deadline (1st March 2019) to host a prolonged negotiation with China. As reported by the press, the discussion has mostly been focused on the US demands for a system to ensure that China abides by its promises, including purchasing more US produced goods and moving towards a more market-based economy. Mr. Mnuchin, US Treasury Secretary, already said that “enforcement offices” would be set up in the US and China to monitor the enforcement of the agreement. In spite of multiple rounds of talks and claims of significant progress by the negotiators, the trade deal still hasn’t been finalized and an agreement may be reached in May or even June at the earliest.

    Stabilization of Chinese Economy
    Chinese economy started to weaken since the China-US trade dispute began in late-March 2018. The industrial manufacturing activities and consumption sentiment in China had been negatively impacted by the decrease of export orders, declining stock market, fear of being isolated by other developed countries, tightened monetary liquidity, and technology boycott by the US. However, as the trade dispute has abated and the Chinese government has supplied additional monetary and fiscal supports to the economy through medium-term lending facility (MLF) and tax cuts, the economy seems to have reached its bottom in March 2019. Also, the recovering A-share stock market should result a wealth effect that supports stronger consumption sentiment. Nevertheless, investors should beware that Chinese government may pull out some of its stimulus policies if the economic prospect improves after the two government reach a trade deal.

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    Holdings Review
    Our investment team has been busy attending meetings or conference calls with company management (most companies report results in March, with one month of blackout period prior to that). Here are some photos of the busy March:

    Let’s recap the companies we mentioned in previous issues of the Fund quarterly review:

    Kweichow Moutai (600519 SH) operational performance in 1Q2019 was better than its previous 14% revenue growth guidance for 2019. Revenue and net profit were estimated to increase by 21% and 31% respectively in the first quarter. 3 factors contributed to the outstanding performance: 1) strong retail sales growth of Feitian Moutai in Chinese New Year; 2) high popularity of the Zodiac Series helped increase the ASP; 3) elimination of loss-making non-core brands. On the other hand, Moutai eliminated 400-600 distributors in the past year and that has freed up a meaningful amount of product supply for Moutai’s self-operated stores. Since the retail price of a bottle of Feitian Moutai is about 55% higher than its wholesale price, a higher direct sales exposure will drive Moutai’s revenue growth.

    During the preceding 3 months to March 2019, we also added 4 interesting stocks to the portfolio, namely Jushi, Zhongsheng, Ping An Insurance, and Country Garden.

    Jushi (600176 SH) is the world's largest fiberglass manufacturer in the world. In spite of the relatively high entry barrier, the fiberglass price was weak in 2018 because 1) most of the industry’s new capacity were started at the end of 2018 and 2) weak business activities in China caused a slowdown of demand. The net profit growth rate hence turned negative in 4Q2018. However, the slowdown of capacity growth and an economic recovery in 2019 should accelerate the company’s profit growth in the near future. Higher demand for wind power generator turbines, 5G equipment, and lighter automobile will further drive the demand for the mid-high-end fiberglass products of the company. When we initiated the position, the stock was selling at 12x 2019 PE, 1 standard deviation below the historical average, and we believed the valuation was attractive.

    Zhongsheng (881 HK) is one of the largest luxury car auto dealership companies in China. Nearly half of its profit comes from luxury car sales and the other half comes from after-sales services. Due to the economic slowdown in China, the new car sales margin declined and that caused the company’s net profit growth to slow down substantially in 2018. Looking forward, as the Chinese economy and the stock market have stabilized, demand for luxury cars and new car sales margins should rebound to a stronger level in 2019. When we initiated the position, the stock was selling at 9x 2019 PE, slightly below the historical average, and we believed the valuation was attractive.

    Ping An Insurance (2318 HK) is one of the most well-run financial conglomerates in China and its core operations include insurance, banking, asset management, fintech, and healthcare businesses. Ping An’s insurance business almost always performs well, but its financial performances in 2018 were disrupted by the bearish equity market as investment income is an important part of its business. The earnings volatility hence depressed the valuation of the company. However, as asset returns have rebounded since the global financial liquidity situation started to improve at the beginning of 2019 and Ping An also announced an aggressive buyback plan in March, we believe the valuation of the stock should be re-rated. When we initiated the position, the stock was selling at 10x 2019 PE, below its historical average, and we believed the valuation was attractive.

    Country Garden (2007 HK) is the largest residential real estate operator in China. By tightly controlling costs and fiercely pushing for faster construction time, the company has grown from the industry number 7 in 2015 to the number 1 today in terms of sales area. As the industry continues to consolidate, operators with strong cash flow management and financing capability like Country Garden will outperform the industry meaningfully in the foreseeable future. The valuation was depressed by the bearish economy and slowing home sales figures in 2018. However, as the consumption sentiment in China has stabilized, we believe Country Garden’s net profit and cash flow will see substantial improvements. When we initiated the position, the stock was selling at 4.5x 2019 PE and we believed the valuation was attractive.

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    Final Words
    Hang Seng Index has rebounded in 2019 but it is still trading at 1 standard deviation below its 25-year historical average price-to-book valuation level. Though the global economy is entering the synchronized slowdown phase and the Chinese economy is facing some challenges, the situation may have stabilized already. We believe the risk of a global economic hard landing is relatively low. Owning a portfolio of well-selected businesses that can both withstand the headwinds and gain market share at the same time now will definitely bear fruit in the mid to long term as the global economy gains steam again.

    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.

    Research Team, Foundation Asset Management (HK) Limited
    April 2019 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.