While emerging markets stocks have been mostly going sideways, there are always opportunities to find stocks on the upswing or high quality companies that have pulled back but present “catch up” potential.
Our new recommendation is from the latter group and is a name most members will know well.
Cabot Emerging Markets Investor 684
[premium_html_toc post_id="176488"]
Cabot Emerging Markets Timer
The Emerging Markets Timer is our disciplined method for staying on the right side of the emerging markets. The Timer is bullish when the index is above the lower of its two moving averages and that moving average is trending up.
The Emerging Markets Timer remains positive, but the next few days could be interesting. You can see in the chart that the iShares EM Fund (EEM) continues to trade above its lower (50-day) moving average, which is enough to keep the intermediate-term trend pointed up. Hence we remain heavily invested.
However, we’re watching things closely. EEM has retreated recently and isn’t far above its 50-day line. A decisive break could cause us to raise a little cash, but we always go with the evidence in front of us—and today, that remains bullish, so the odds favor higher prices ahead.
The Google of China is on Sale
Our Emerging Markets Timer is still bullish but, to be fair, it’s also mostly mixed; EEM is hovering around key support near its 50-day line, so the next few days will be key for the intermediate-term trend.
This reflects how EEM has traded so far in 2019. After a very strong start in January, EEM (a basket of 800 stocks across emerging markets) has been choppy, with its current price about where it was in early February.
The rally in Chinese stocks lasted a few weeks later into late February before stalling and going sideways despite some positive news regarding consumer spending and economic growth in China and other Asian and emerging markets.
I expect that this choppy phase is really a base-building effort that will lead to the next leg upward, so I still advise investing in compelling opportunities. The key piece that’s missing for an enduring EM bull market is a weaker U.S. dollar.
We’ll take what the markets give us but need to stay alert, be selective in new ideas, and be ready to change our exposure (more cash or, if things reaccelerate, a more aggressive stance) as conditions warrant.
While not hitting stocks in our portfolio, some regulatory issues are coming up that brought out the sellers in some Chinese stocks pretty hard this week. Momo Inc (MOMO) was one that came under the gun.
For example, thousands of video game titles that were in the queue for government approval will have to provide additional material before re-applying for approval. The new requirements include provisions of a video demonstrating that the games include an “anti-addiction mechanism,” publisher profile information and copyright documents.
Finally, please note that in the portfolio update section later in today’s issue, I have formed a separate category for speculative recommendations, a change that further highlights these names as ones I like, but also with a higher risk/reward profile, giving you more of an idea what to expect. Large, relatively well-traded issues will still be the core of our portfolio, but more speculative ideas (like Largo) will pop up from time to time to add some more spice to the mix.
Featured Stock
New Recommendation: Baidu (BIDU)
Many of you are quite familiar of Baidu, which is commonly referred to as the “Google of China,” so I won’t dive into the minutiae of the story.
Founded in 2000, Baidu enjoys an impressive 70% share of China’s Internet search market—a market that continues to grow along with the online population of that country.
The reason to buy Baidu right now is that the stock has been out of favor and on the bench since July of 2018 when it traded at 270 a share. Today, Baidu now trades at 165 (down 40%) despite the robust recovery in Chinese markets so far in 2019.
What’s going on?
Analysts don’t seem to have one compelling answer, citing higher spending, more competition, U.S.-China trade tensions, Beijing’s “crackdown” on Internet content and slower growth in earnings due to slower growth in China.
My hunch is that investors have been ignoring Baidu because the sharp pullback presented the market with dozens of higher growth opportunities. But the strengths of Baidu can’t be ignored, especially given its dominant search engine position.
Moreover, when buying Baidu, an investor gets commanding exposure to the Chinese internet via search, but so much more including social media and entertainment, a 58% position in iQiyi (IQ) (which many call the Netflix of China and is worth about $10 billion), a 19% stake in online travel king Ctrip (market cap $24 billion), food delivery services, apps, maps, payment services and Baidu cloud services.
In addition, Baidu is making a strong move into artificial intelligence, which will likely be a strategically important growth area. And the company also has a nice war chest with more than $13 billion of cash on its balance sheet.
On the valuation side, even taking into account the possibility of weaker profits in 2019, Baidu’s stock now trades at a multiple of forward earnings in line with the average S&P 500 stock.
The IQ Kicker
I’ll keep a close eye on IQ as well.
IQ, after a nice uptrend in the first quarter of 2019 has been a bit bumpy in the past month going from 27 in March back to around 22. I’m sure much of this is profit taking as, even with this sharp pullback, IQ has surged over 50% since the start of the year.
IQ’s second convertible bond offering was not well received by investors who fear dilution and feel that the company did not need to raise any cash at this time. Keep in mind that while IQ is posting some great growth numbers (revenues up 46%, 35% and 38% over the past three quarters), it is not expected to be profitable until 2022.
Even so, the story looks gigantic.
Historically, people in China were not used to paying for video, but iQiyi is changing that, as it began offering those services when they were fully owned by Baidu. They put up a paywall, they put in some premium content and they began marketing to subscribers to move over to the subscription service. And now they have both an ad-supported service similar to Hulu, and a subscription-based service similar to Netflix.
In total, IQ now has 88 million paying users (Netflix has 56 million in U.S.) and in the last quarter, subscription revenue rose 55% while ad revenue only grew 9%. The firm’s other business segments such as online games, merchandising, comics, social media services posted 105% growth in 2018 and 129% year-over-year growth in the fourth quarter.
Offsetting this revenue growth is content costs, which are rising sharply and reached $943 million in 2018.
By itself, IQ is an intriguing prospect, though I’m not ready to dive in there yet. We like that story as an added kicker to owning Baidu, though, and we’ll be adding a position in that stock to our portfolio. BUY.
Baidu (BIDU)
Baidu Campus
No 10, Shangdi
10th Street Haidian District
Beijing 100085
China
http://www.baidu.com
Model Portfolio
Prices as of 2:30pm
Updates
Alibaba (BABA) breached 190 yesterday, a high that was last seen in July of 2018, and despite the market-induced pullback today, options traders appear to be betting on more upside in the short term.
Fundamentally, BABA was highlighted by Estee Lauder (EL) in comments that its recent earnings were boosted due to strong sales from Alibaba’s Tmall marketplace. These Estee Lauder comments support the notion that the Tmall website operated by Alibaba has attracted brands including Valentino, Bottega Veneta and Burberry. Even as the luxury brands have snubbed Amazon, they seem to be embracing Alibaba as a platform to grow their businesses in the high potential Asian markets.
Of course, the key to the stock is earnings growth and I wish the firm would invest more in core E-commerce and the Cloud and a lot less on start ups in new markets that will only produce earnings years down the line. Still, I believe that BABA remains a great core China holding. Earnings are due out May 15. BUY A HALF.
Baozun (BZUN) outperformed with a 12% gain during the week, while the broader Chinese market was soft amid concerns the Chinese government would scale back on its stimulus efforts following signs of stabilization. Our patience with Baozun has paid off as the stock is demonstrating clear relative strength.
If you have yet to buy in, I think you can buy here or on dips—the company expects $1 billion in revenue for 2019 yet has a market value of only $2.2 billion. BUY A HALF.
Daimler’s (DDAIF) was up marginally this week despite reporting a first-quarter operating profit that declined 16% and Mercedes-Benz sales in China, the world’s largest car market, that were down 3% year over year.
This is a high-quality, conservative play on emerging consumer markets, and it’s performed beyond my expectations since being added to the portfolio last month. As a bonus, it offers a juicy 7.5% dividend yield.
Daimler reiterated that it expects slight growth in 2019 sales and earnings as cost-cutting measures are implemented. If you haven’t taken a position yet, and are looking for a high quality, income-producing idea, I encourage you to invest in this emerging market play. BUY A HALF.
LexinFintech (LX) has done well but ended this week about where it started. Last week LX launched Le Card, an APP that offers young people lifestyle benefits and privileges, ranging from KFC coupons to 20%-off movie tickets. It will also increase the types of services available on Fenqile, its e-commerce-driven platform, as young people are consuming more services, such as flight tickets and training services, than ever before.
LX’s target market is the 149 million-strong Generation Z (those born after 1995). This group is increasingly the driving force behind China’s consumer market, accounting for a quarter of e-commerce users in China, according to market research company iResearch.
This high-growth fintech idea is currently trading at a very reasonable valuation and, if you don’t own any, you can grab a half-sized position here. BUY A HALF.
Sea Limited (SE) has been facing some resistance after a very strong first quarter. It benefits greatly from its partnership with Tencent but needs to cut costs and cash burn in order to show investors it’s on track to profitability.
Tiger Global, a hedge fund, announced it was increasing its stake in Sea and is now its largest shareholder at around 4%. Sea is expected to report earnings on May 21st.
If you bought on our recommendation, you may want to take some profits off the table right now. If you have not yet invested in SE, I’d recommend waiting for the moment. HOLD A HALF.
Tencent (TCEHY) has built a deep ecosystem that ties together gaming with social media. Tougher regulation in 2018 hurt Tencent’s competitors more than Tencent and already this year it has received eight mobile game approvals from Chinese regulators.
Included among those is Perfect World Mobile, which was launched in early March and is a multiplayer online role-playing game. It became the world’s top-grossing mobile game last month with sales estimated to already exceed $160 million!
Looking at the full year, analysts are expecting earnings of $1.47 per share and revenue of $59.78 billion, which translates into 26% growth for both metrics. BUY.
ZTO Express (ZTO) demonstrated some strength this week, breaching the 20 level. ZTO is building an enormous, scalable platform that will further increase efficiencies and lower costs. Yet despite its impressive growth, ZTO Express still trades near its IPO price from two and a half years ago. If you are not yet on board, I encourage you to buy a half position right here. The next earnings report is expected May 15. BUY A HALF.
Speculative Portfolio Recommendation
Largo Resources (LGORF) drifted lower this week on light volume, falling about 10 cents per share, in line with the move in vanadium prices. I’m monitoring the price of vanadium, which has come off sharply from last November highs.
We will likely upgrade the stock as I see an uptrend develop. This idea is a very aggressive, speculative idea – it might not be for some investors but I see good potential. BUY A SMALL POSITION.
Watch List
NIO (NIO) seems to be facing some resistance around 5. There’s been no news this week other than some analysts believe NIO needs more capital fairly soon. I think it needs a strong partner.
[premium_html_footer]
Send questions or comments to paul@cabotwealth.com.
Cabot Emerging Markets Investor • 176 North Street, Salem, MA 01970 • www.cabotwealth.com
All Cabot Emerging Markets Investor buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special alerts via email. To calculate the performance of the hypothetical portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.
THE NEXT CABOT EMERGING MARKETS INVESTOR ISSUE IS SCHEDULED FOR May 16, 2019
We appreciate your feedback on this issue. Follow the link below to complete our subscriber satisfaction survey: Go to: www.surveymonkey.com/chinasurvey
Cabot Emerging Markets Investor is published by Cabot Wealth Network, an independent publisher of investment advice since 1970. Neither Cabot Wealth Network, nor our employees, are compensated in any way by the companies whose stocks we recommend. Sources of information are believed to be reliable, but they are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. © Cabot Wealth Network 2019. Copying and/or electronic transmission of this report is a violation of the copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, visit www.cabotwealth.com, write to support@cabotwealth.com or call 978-745-5532.
[/premium_html_footer]