Asia Presents Unique Long-Term Investment Opportunities: HSBC

Despite near-term obstacles, Asia offers some very good and unique long-term investment opportunities that should not be ignored, argues HSBC Holdings plc (ADR) (NYSE:HSBC) (LON:HSBA). Herald van der Linde and Devendra Joshi of HSBC note in their July 29 research report titled: “The Flying Dutchman” that China’s continued reliance on debt and slower reform momentum continue to cloud equity markets.

Asia faces near-term obstacles

Linde and his colleague point out that there are quite a few factors hindering the near-term performance of equities across Asia. Some obstacles include: the gyrations in Chinese equities, the upcoming Fed rate hike, falling commodity prices, recent USD strength, and slowing reform momentum in some countries.

However, the HSBC analysts believe some of these factors have become less of a threat in the last few months. For instance, they argue that core yield curves have steepened already and that most of the USD strength is behind us. The analysts believe the USD is not expected to strengthen much further against most currencies and that the steepening of core bond curves has largely played out.

The HSBC analysts argue that there is no historical precedent for what happens when U.S. rates rise from the current near zero levels. Linde and his colleague point out that the best reference point for Asian equity markets is probably 2004, when the decline in PE levels exceeded EPS growth acceleration and markets declined:

Focusing on falling global commodity prices, especially oil, the analysts point out that lower oil prices should be helpful to Asian consumers’ disposable income. However, they also say that the fall in oil prices late last year didn’t provide the expected boost to consumption. The analysts added that, on the contrary, household spending across Asia has slowed further as credit and wage growth fizzled.

Asia presents long-term opportunities

Linde and Joshi highlight Asia’s long-term developments, such as a potential recovery in profit margins in Asia in the years ahead and growth of “financial inclusion” and assets across the region. The analysts argue that one of the key reasons for Asia’s underperformance in recent years has been poor ROE performance. They point out that in 2009, operating margins in Asia averaged 14%, though they have slid since then to touch about 11% now.

Linde and his colleague believe Asian margins have started to stabilize and are at a long-term bottom. They believe that if this is to continue, it could eventually lift Asian margins and ROE and underpin a future re-rating in Asian PEs. The HSBC analysts also point out that there are sectors across Asia that benefit from continued growth, irrespective of business cycle. They cite examples such as China’s wind industry and Macau gaming sector.

Revising their “Asia’s Best in Class,” a screen of stocks with qualities setting them apart from the crowd in terms of management, Linde and his colleague point out that the best in class companies are private sector companies that have the potential to generate high medium-term returns. Moreover, some of the companies fit into their long-term themes of ROE expansion, financial inclusion and structural growth.

The following table presents a snapshot of the companies the HSBC analysts think represent a “bargain,” offering over 20% upside potential to current prices: