Aberdeen’s Hugh Young has warned that his Asian Smaller Companies Investment Trust is looking expensive in the face of slow earnings growth from the region.
Following a run of strong performance, the stocks in the trust appear more pricey on some valuation metrics than the broader market.
The trust currently has a price-to-earnings (p/e) ratio, based on 2014 earnings, of 17.8x, whereas the MSCI Asia Pacific ex Japan Small Cap index has a p/e ratio of 13.9x and the MSCI Asia Pacific ex Japan index is at 12.6x.
Mr Young said the valuation difference was unlikely to improve next year because the outlook for earnings growth in Asian smaller companies was weak compared with their history.
He said 2014 was shaping up to be a “quietish year of single-digit percentage earnings growth”, or approximately 7-8 per cent. He also forecast 2015 would see similar growth, in spite of Asian smaller companies historically seeing double-digit earnings growth.
Given the lack of earnings growth, the outlook for 2015 valuations looks to be even more unfavourable for the Aberdeen trust.
Aberdeen’s figures show the p/e ratio of the trust is set to fall to 16.2x based on forecasted 2015 earnings, but the Small Cap index’s valuation is set to decline even further to 11.9x.
Mr Young said the valuation of the stocks within the portfolio was the “main risk” on the trust.
He also pointed out that the level the shares trade below the net value of the trust’s assets – known as the discount – had fallen in the past couple of weeks to 4 per cent, but was not particularly low relative to the trust’s history.
However, Mr Young said, in spite of the high valuations of the stocks in the trust, the companies were “as good as they have ever been”.
He said the balance sheet strength of the stocks in the investment trust meant they were on an “extremely strong footing”.
The average net debt-to-equity position for the stocks with the trust is currently -4.6 per cent, which means the companies have more cash than debt.
The opposite is true for the average company in both the small cap and main Asian indices, which has significantly more debt than cash.
The MSCI Asia Pacific ex Japan Small Cap index has a debt-to-equity ratio of 18.7 per cent.
Mr Young also pointed out the companies within the trust have a much higher return on equity (Roe) than the index, at 18.3 per cent compared with 10.9 per cent.
Roe is a key measure of company profitability, generally calculated by dividing the net income of a company by the shareholder equity, with a higher figure seen as much more positive.
Mr Young said in spite of the relatively expensive valuations in the Aberdeen Asian Smaller Companies Investment Trust, he is not looking to sell out of any holdings, nor does he have any concerns about the value of the companies.
Aberdeen manager laments lack of ‘quality’ listed companies in China
Hugh Young, and Aberdeen’s Asian equity franchise in general, has long been a China bear.
The main gripe Mr Young has with the country is not about the levels of economic growth though, it is the fact that he cannot find any “quality” companies listed on the stockmarket.
In spite of tentative efforts at reform, which continued last month with the opening up of the Shanghai exchange to international investors, Mr Young says he is still not finding opportunities there.
The Aberdeen Asian Smaller Companies Investment Trust has a significantly underweight position in China compared with its benchmark – China stocks make up just 1.6 per cent of the trust.
By contrast, Mr Young is very positive on the outlook for both Indonesia and India, providing their new leaders are able to push through beneficial reforms.
The trust also has a much higher weighting in Thailand, at 13.2 per cent, compared with the benchmark, in
spite of the disruption brought about in the country following the military coup.
Mr Young said businesses were still “chugging along” in spite of the political troubles.
He said in the past decade Thailand as a country had been “a complete shambles”, but at the same time “the market has been one of the best in Asia”.
