Asia’s resilience being tested


  • Business
  • Saturday, 26 Sep 2015

THESE are trying times for Asia.

With global growth appearing to be slowing, and while currency markets continue to gyrate and the US dollar continuing to gain strength, the region now faces intense pressure that is putting its potential to the test all over again.

Notwithstanding the risks, some markets in Asia will likely still see robust cash flow that will be able to tide them over during the period of weak economic activity, while a few others will likely be more vulnerable.

Notably, Malaysia, along with Singapore, Thailand, Vietnam and India, are the ones that could demonstrate cash-flow resilience to downside scenarios, while China and Indonesia have shown varying degrees of weakness, according to a recent stress test conducted by Maybank Kim Eng on Asian corporations.

With a focus on 2016, the analysis by the regional investment broking and securities group is based on a combination of stresses, including a 10% cut in revenue forecasts, a 10% cut in foreign exchange (forex) forecasts, and changes in domestic interest rates (a 100 basis points increase in Asean due to the potential for higher credit spreads; but a 100 basis points reduction in China and India based on their central banks’ action).

It finds China and India to be on the opposite ends – China is the most vulnerable, while India is the most resilient market of all.

Sector-wise, Maybank Kim Eng’s stress test on Asian corporations shows signs of vulnerability in consumer and real estate, while the more cyclical ones such as oil and gas appear to be more resilient.

This, the brokerage explains, is because the more cyclical companies have already started adjusting to a potentially slower economic environment much earlier on, while others have continued to expand.

In terms of valuations, while the price-to-book metrics for Asian markets appear more attractive now, Maybank Kim Eng argues that measures based on free cash flow and enterprise value (EV) to Ebitda (earnings before interest, tax, depreciation and amortisation) are less so.

In an exclusive interview with StarBizWeek, Maybank Kim Eng global investment strategist Dr Sadiq Currimbhoy says the objective of the stress test, which shows how resilient cash flows are, is to explore opportunities for investment in companies that can, even in a not so great environment, still generate a lot of cash, which will then benefit shareholders.

He shares his views on the stress-test finding as published in Maybank Kim Eng’s “Unmasking Asia” report and his broader outlook on the regional market. Below are excerpts of the interview:

StarBizWeek: What is the most surprising finding that has come out from the stress test?

Currimbhoy: That one market has turned out to be better than what macro observers have been talking about.

Bottom-up numbers indicate Malaysia’s cash-flow resilience, which is a surprise to us, as the country, together with China and Indonesia, have been the three markets on which macro forecasters have been particularly negative.

Our stress test on the resilience of company cash flows in the region find China to be the most vulnerable market, followed by Indonesia.

China’s vulnerability could perhaps be due to its excess capacity that has built up so much that a shock to the system could result in a company cash flow turning negative. This worries us a little bit because it indicates China’s sensitivity to the global environment. It appears that the external environment, for instance, a stronger US dollar, will put more pressure on China that what’s happening in the country’s domestic economy.

Our analysis also suggests that returns on capital in China are relatively low, which means it may be difficult for the market to attract capital. In a stress environment, some companies might resort to cutting capital expenditure (capex) to preserve cash flow. But if too many companies cut capex, the country will see significantly lower aggregate investments, which could in turn mean slower growth.

For Indonesia, we see very skewed distribution. While the system overall is relatively resilient, we see nearly half of the universe ending up with negative free cash flow in a stress environment, indicating pressure on smaller companies.

So now, while we remain cautious on China and Indonesia, our optimism has increased for Malaysia.

Have equity markets in the region hit their troughs?

We know they have not. Historical trough valuations on price-to-book for the region are around 1.2 times; we’re now hovering in between a multiple of 1.4 and 1.5 times.

So, there is potentially more downside for the region.

But, as the numbers have come down quite a bit in recent months, on a price-to-book basis, valuations for Asian equities have become more attractive.

What we’re seeing, however, is that valuations based on EV/Ebitda and free cash flow are not compelling as yet.

There are certainly pockets of value appearing (in some markets, following the recent selldown), but it is not at the point where we can go significantly overweight.

Is the worst over for Asian currencies?

We are concerned that the yuan (or sometimes called renminbi) will weaken further, considering the challenges facing China’s economy.

Historically, weakness in China’s currency will lead to weaker regional currencies.

Currencies are determined by relative returns on capital, and their movements at present are reflecting that global growth is slowing.

At this stage, we don’t see much economic recovery coming out of Europe and Japan. If global growth was a lot more balanced, then the US dollar wouldn’t be so attractive to capital.

We are a US dollar bull – we think the greenback is strong and will continue to stay strong.

What are the implications on the region’s markets?

We see two major forces that have been driving the markets here – one is the strong US dollar and another is the high level of currency volatilities.

Why that’s important for markets like Asia is because we tend to have a lot of exporters, and manufacturers who have low margins. Currency volatilities will increase overall costs, as hedging and transaction costs go up, and that will eat into their bottom lines.

Are we looking at another crisis?

When we construct this stress test, which show similar pressures on Asia today as those we saw in the 1997/98 Asian Financial Crisis, we observe material differences.

One of it is the presence of current account surpluses, in contrast to current account deficits, which implied the need for external funding, in the run up to the 1997/98 Asian Financial Crisis.

Many companies in the region are free-cash-flow positive, which essentially means there are more savings than investments, which in turn is a reflection of the current account surpluses.

I believe if the same a stress-test analysis were to be conducted during the 1997/98 Asian Financial Crisis, we would find many corporations in negative free cash flow position. Every cycle is different. Our hope is that policy mistakes in the past will not be repeated.

Which are the markets in the region that appeal to you now?

There are three markets on which we are more positive for the longer term.

One of them is India, where we see a lot of policy credibility. Despite its current account deficit, India’s policy credibility and declining inflation may allow lower interest rates, and hopefully, with continuing policy reforms, these factors will be able to drive higher returns for Indian corporations.

The other market that we like is the Philippines, where we are looking at the broadening out of growth from first-tier cities to second- and third-tier cities.

The third market that we quite like is Vietnam. Being a frontier market, Vietnam, from the growth perspective, looks a lot better than other more mature markets.

In general, our investment view under the present environment is to stay defensive. We have to face the uncertainties head on ... market volatility always creates opportunities.


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