A tourist poses for a photo against the backdrop of the financial Central district and Victoria Harbour in Hong Kong, May 9, 2023.TYRONE SIU/Reuters
For the moment, one word can be used to link together Asia’s two largest economies, China and Japan, and that is “crisis.” With a surprisingly weak post-COVID economic recovery alongside heightening geopolitical tensions, China is likely to have just entered a crisis. Its neighbour, meanwhile, seems to have just gotten out of one, seeing decades-long clouds of deflation finally dissipating. Interestingly, (traditional) Chinese and Japanese use the same word, with the same two characters, for “crisis.” And those two characters have the same meanings – “danger” and “opportunity.”
Enterprising stock pickers including us are certainly not going to waste a crisis.
We travelled to the Far East earlier this year, where we visited companies of interest in Shanghai, Hong Kong, Tokyo, and Nagoya. The goal was to treasure hunt.
Our journey started in the Greater China region – which includes Hong Kong, Macau and Taiwan – where we had the chance to meet with a few entrepreneurs and corporate executives in Hong Kong. They operate their businesses mainly in Hong Kong, the world’s second-freest economy, generating one of the highest GDPs per capita on the planet. Our top picks are Plover Bay, Perfect Medical, and Kato. Coincidentally, all three are offering mouthwatering free-cash-flow yields at current share-price levels.
Plover Bay Technologies (PBTDF)
As an ultrarare global technology company originating in Hong Kong, Plover Bay found its niche opportunities to deliver attractive returns on capital in the domain of cost-effective, unbreakable, flexible, high-performance networking solutions. The company may still see its best days lying ahead, benefiting from multiple long-term tailwinds from the Internet of Things, 5G, AI and autonomous systems. Founder and chair Alex Chan has instilled a unique culture throughout the organization with an emphasis on efficiency, frugality, problem-solving, passion, and ownership. No wonder the company has consistently maintained industry-leading margins and growth over the years.
Perfect Medical Health Management
Perfect Medical is a unique player in the lucrative but crowded medical beauty space in Hong Kong thanks to its conservative practices, which are reflected in its founder’s mantra “don’t do stupid things.” The company has a laser focus on non-invasive cosmetic procedures, where it has captured the lion’s share of the market in Hong Kong. A prepayment, contract-based model enables the company to lock in near-term recurring revenues, which supports enviable cash generation, shorter payback periods of new locations, and operational stability. Over recent years, the management team has attempted a variety of expansion initiatives both vertically (into new treatment areas such as hair growth, men’s beauty, pain care) and horizontally (into new geographic markets such as the mainland, Singapore and Australia). They have, however, yet to produce a meaningful outcome for shareholders.
Kato (Hong Kong) Holdings
Kato is probably the most boring business we visited during our trip – it operates residential care homes for the elderly in Hong Kong. However, the company’s financial statement is nothing short of exciting. It produces superior margin, strong cash-flow, steady growth and high return on capital. In Hong Kong, which has the second-highest life expectancy worldwide, the elderly-care-home industry has been driven by a lack of supply, with applicants often on waiting lists for months (if not years) before securing a spot. According to our estimate, Kato is likely to own a top market share on the supply side, but still at a modest level of 2 per cent to 3 per cent, indicating room for further market consolidation. The industry is well known for being recession-proof and even countercyclical (e.g., more elderly people need more help during tough times), but not for its profitability, owing to shortages in labour and real estate. Nonetheless, the management at Kato puts great emphasis on cost savings, sometimes to the extreme. The company does not even have its own office – we met with the management team in the exercise room at one of their elderly-care homes.
Some final thoughts
Hong Kong is filled with many seemingly high-quality businesses but there are some pitfalls to watch out for, especially for Western investors:
1. Capital allocation: it’s rare to see a highly levered balance sheet among these companies, but the opposite – too much cash – can also be harmful to long-term shareholders. This is typically where “diworsification” gets started – when a company becomes distracted by diversifying beyond its core products and services, affecting the overall trajectory of its business.
2. Industry landscape: external environments may shift more rapidly than expected, and hence, so does the business strategy. We see it beneficial to keep in touch with management on a more frequent basis;
3. Corporate governance: a low degree of transparency is not uncommon, especially for those family-owned or founder-controlled companies. Therefore, after reading financial reports, be sure to book a meeting with the management team (preferably, face-to-face along with a site visit).
We will continue with our stories in the Far East with Japan in our next article. Stay tuned.
Jason Del Vicario, CFA, is portfolio manager at HillsideWealth | iA Private Wealth Inc. Steven Chen, MBA, is global analytics associate at the firm.