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June 3, 2016

A Shift From Momentum to Value in Asia?

by Sridharan Raman.

Looking back at equity market trends in 2015, we see that like much of the world, Asia (ex-Japan) saw momentum factors perform strongly relative to the market, while traditional valuation factors underperformed. Many stocks with high valuation ratios such as P/E, P/B, etc. outperformed their less expensive counterparts. However the trend seems to have changed in 2016, with value outperforming and momentum underperforming.

Quality, represented by the StarMine Earnings Quality (EQ) model, performed only in-line with the market in 2015 but is a stand-out so far this year. We seem to be witnessing a shift in investor sentiment to one where the stocks benefiting most are those with attractive valuations where the earnings underpinning those valuations are backed by persistent sources – such as strong cash flows.  Assuming these trends continue, we screened for Asian companies that might benefit.

                                                  2015 Performance

2015

                                               2016 Performance

2016

Source: StarMine

Searching for gems

The charts above show the performance of the StarMine valuation vs. momentum models in 2015 and the beginning of 2016. We looked at the performance of the top decile of the StarMine Relative Valuation (RV) model as a proxy for valuation, and the Analyst Revision Model (ARM) and Price Momentum (Price Mo) model as a proxy for momentum. We also include the performance of quality factors, represented by the StarMine Earnings Quality model. This model assigns high scores to companies whose earnings are derived from sustainable sources such as cash flows vs. those with high levels of accrued earnings and/or poor returns.

As the benchmark, we plotted the performance of an equally weighted portfolio of the largest 1,000 stocks in Asia, indexed to 100. As you can see, the ARM and Price Mo models were the best performers in 2015 while the RV model underperformed the market portfolio. In contrast, Price Mo and ARM have underperformed since the beginning of 2016, and after a poor January, RV has had three consecutive quarters of strong performance. Of these, the EQ model has been the best performing model in 2016.

In light of these recent performance results, we built a screen for Asian companies with the recent favorable characteristics of high quality and low valuation. To pass the screen below, a company was required to be in both the cheapest 10% of stocks (those ranked in the top decile by the RV model) and of high quality (those in the top quintile of the EQ model). Note that the StarMine models are using a 1-100 region-relative rank, where high numbers are favorable signals. We screened out companies with less than $1 billion market cap. Below are the select group of companies passing the screen.

 

asia3

Source: Eikon/StarMine

Who is the standout?

As an equity analyst looking for an unbiased source of new investment ideas on which to do additional fundamental analysis, any of these look like good candidates for a deeper dive. We chose Belle International Holdings ((1880.HK) since it is in the top decile of both the EQ and the RV model. It trades on the Hong Kong exchange and is in the textile, apparel and luxury goods industry. It distributes such first-tier sportswear brands as Nike and Adidas, and second-tier sportswear brands PUMA, Converse and Mizuno. Let’s dig a little further.

asia4

Source: Eikon/StarMine

Looking inside

Belle has seen strong cash flow from operations, which have steadily been increasing over the years. In each semi-annual period over the last four years, Belle has reported cash flow from operations that have exceeded net income. Earnings backed by strong cash flow tend to be more sustainable in the long term and are a sign of good earnings quality.

In another sign of good earnings quality, the company has brought inventory days below 150 days in the last two years. Considering that that level was 185 days just in 2012, it’s a sign that management has done a better job at inventory management, a critical factor for the apparel industry where trends change and inventory can quickly become obsolete. Net operating asset turnover has also improved over the last two years to 2.2. This is a measure of how efficiently the company is generating revenues from its asset base, and marks improved operating efficiency.

asia5

Source: Eikon/StarMine

Share price analysis

One thing to note is that the shares are trading down significantly over the past four years. But the Relative Valuation model does show that the company may be cheap. Belle shares are trading at a forward 12M P/E of 8.7. The five year median Is 14.1, so compared to that it appears cheap. The company also pays a strong dividend of almost 6%. Given the strong cash flow from operations, those dividends seem sustainable.

Some things to keep in mind is that the stock does have negative momentum, as analysts point to weaker footwear same store sales. However, the apparel division continues to perform strongly. If the end of winter was truly the reason for poor SSS for footwear, then there will likely be a turnaround in that. If that does happen, and if the trend towards value as opposed to momentum holds in the region, Belle may be in fashion.

The question for investors may be: have the negative trends in footwear been overly priced in or, conversely, has the strong performance in apparel been overlooked? Of course, it’s also possible that this seemingly undervalued stock is cheap for good reason (i.e. a value trap), but its high Earnings Quality score suggests otherwise. If you conclude that this company isn’t sufficiently misunderstood or overlooked, more candidates, using StarMine Models and the Eikon Screener app as a source of new idea generation, are readily available.

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