When you think about banking in emerging markets, it may conjure images of long lines outside banks under the tropical sun. Surprisingly, it has been a rather short road from the long lines of yesterday to the super apps of today. For example, it’s not uncommon now to see street side hawkers in China and India accepting payments via apps as deftly as they handle their cast iron woks. Unburdened by the shackles of high cost legacy financial infrastructure, emerging markets have been faster, leaner, and more efficient in building the new age pipes that move money from point A to B.

There are three key reasons for this lightning pace of technology adoption.

• Firstly, in the absence of a traditional brick and mortar banking network, the pace of adoption has been exponential. EM consumers have leapfrogged credit cards and traditional bank-to-bank payments to mobile-based transactions.

• Secondly, emerging markets themselves have been open to collaborating with each other when it comes to sharing infrastructure and regulatory best practices via fintech bridges that connect fintech hubs like Dubai, Nairobi, and Singapore.

• Finally, emerging markets offer the size and scale of the population required to encourage fintech startups to innovate and roll out new products.

The result of this fintech innovation and rapid penetration of mobile internet has been the rise of digital payment platforms, such as Paytm in India, GoPay in Indonesia, and M-Pesa in Kenya. Similarly, we have seen the rise of digital banks, like WeBank in China, Next Bank in Taiwan, and Kakao Bank in South Korea. Another differentiating factor in emerging markets has been the proactive intervention of governments in building the infrastructure that makes payments low cost and frictionless. In Brazil for example, there is PIX, an instant payment and open banking infrastructure. In India, we have the Unified Payments Interface (UPI), which is a real time, identity-based payment infrastructure.

A great result of this blistering adoption of fintech is the tradition of gifting red packets or envelopes called “Hongbaos” during the Chinese New Year as a blessing of good luck.According to WeChat, in 2019, a staggering 820 million digital Hongbaos were exchanged during the New Year. At Global Alpha, we are both excited by and aware of the disruption that is being caused by fintech to traditional financial incumbents in banking, payment processing, insurance, and investments.

In identifying investment opportunities, it is particularly relevant for us to understand how traditional banking incumbents are adapting to competition in digital banking.³ Let us take emerging markets in the Asia Pacific as an example where the share of consumers using digital banking has risen from 54% in 2017 to 88% in 2021 according to a McKinsey report. That’s a growth of 1.4x over 5 years.

Similarly, while over 70% of consumers in these countries are interested in using digital channels to access banking services, only 20-30% of them have actually made a purchase via these channels. This is a huge untapped opportunity for traditional banks to reach consumers in the comfort of their homes while offering them their full suite of products and services.

In this rapidly shifting landscape, we evaluate how traditional banks are shifting to an omnichannel approach by leveraging digital channels for everything from transactions, customer acquisition and retention, and cross-selling to improve the productivity of existing branch infrastructure. On the other end of the spectrum, we also look at new digital-only banks and how they are leveraging technology to offer a different value proposition to consumers.

We ask the following questions while evaluating opportunities in this space:

• Do they have a unique proposition to make banking services more accessible and affordable? It’s not just about a sleeker interface and new branding. The rubber meets the road in seamless onboarding, friction-free purchasing experiences and high-quality customer service.
• Do they offer the full suite of products and services that traditional banks offer?
• Are they catering to underserved segments ignored by big banks? These segments offer the critical mass necessary for quick scalability.
• Do they have experienced leadership with a plan towards a clear path to profitability? An experienced team knows how to leverage data for accurate targeting and product pricing while still deploying a robust risk management framework.

Banco Regional (RA MM)

One of our holdings that is looking to leverage opportunities in this space is Banco Regional in Mexico. Banco Regional focuses on banking for the small and medium enterprises (SME) segment. Banco Regional made a successful foray into the consumer segment by targeting the high net worth segment and more recently, it has decided to target the mid/low-end consumer with a fully digital offering called Hey Bank. With over 500 programmers on their payroll, Hey Bank has built an offering that is easy to use and full of convenient functionalities. Their mobile app allows customers to open an account in just five minutes. We like the fact that Hey Bank pursues profitable clients and is expected to break even by 2022. At Global Alpha, we continue to look for opportunities at the intersection of finance and technology that tap into the growing financialization of emerging economies.

The Chinese economy has undergone major changes over the past year, aimed at stabilizing the long-term sustainability of its economy. We discussed many of these changes in our commentary, Navigating through current China uncertainties (and opportunities). Looking ahead, we will continue to carefully analyze the movement of Beijing’s policies, which provide key insights into the economy and financial markets this year.

Based on our analysis and interactions with companies, we anticipate a better second half of the year, and history has shown us similar behavior.

Regarding the property sector, in the first two months of 2022, sales in the top 30 cities declined 29% year-over-year (YoY), making it the second worst year since the start of the decade. Sales for 200 developers in lower tier cities dropped 43% YoY.[1] Falling property prices are often an indicator of a drop in land values, which directly affects local governments, as it is an important source of revenue. 

If we recall the last property down cycles in 2011-12 and 2014-15, they lasted around 9 months. As the current down cycle started in September-October, best case scenario would be improvements starting in the second half of 2022. During the first half, most indicators will continue to look very bad, and developers may face problems.

What can the government do then to improve sentiment?

Real estate and credit growth have always been key metrics for GDP expansion in China. Further, previous down cycles could guide government action. For example, the government could turn to a more easing mode, similar to actions taken in 2012 and 2015. As a result, we could see growth of new housing starts to bottom. That said, we don’t expect a massive easing in the property market, unless situation spreads very widely.

In the second half of 2012, Chinese policy makers released a set of stimulus measures. While each of these measures differ, it is similar to what’s been happening in 2022. In 2012 policy makers were reluctant to loosen measures and reiterated the idle land policy: a 20% penalty if idled for one year and forfeiture if idled for two years. The policy makers wanted to test the market and see results with gradual easing.

In March of 2015, minimum down payment was reduced to from 60% to 40% for second time home buyers who have still not paid the first mortgage. For first time buyers the down payment was reduced from 30% to 20%. State Council meeting was held on Dec 14^th and analyzed the urban planning for 2016. Key focus was to reduce real estate inventory deepening urbanization.

 In 2022, we think policy makers have the tools to do similar easing, although, considering last year’s common prosperity, the willingness to do so is likely a little more difficult.

Many cities are easing mortgage lending (e.g., Guangzhou), lowering down payment rates (e.g., Heze, a third-tier city in Shandong province), or relaxing home purchase restrictions (e.g., Zhengzhou). China will also make it easier for state-owned enterprises (SoE) to buy distressed assets for private peers in order to avoid a credit crunch in the sector. For example, SoEs acquiring distressed assets will not be majorly subject to the three red lines policies. Likewise, some developers are being allowed to issue bonds in onshore markets.

The last Politburo meeting in December had a clear message: policy makers would shift from regulatory tightening to supporting growth. We believe China will defend around 5.5% growth (announced last week in NPC meeting) and considering mounting growth pressures, the current property tightening mode should shift to a gradual easing, similar to 2012 and 2015. Top leaders have declared their intention to double the Chinese economy from 2020 to 2035, which implies a minimum 4.7% CAGR growth.

The main pillar of this relaxation cycle was understanding the change of policy makers from December 2020 (regulatory tightening) to 2021 (stability). What policy makers state at the beginning of the year is the most important message for understanding further actions. The latter meant that most probably regulation in many sectors has peaked. Chinese policy makers are extremely careful in making the best they can in order to fulfil their guidelines.

Together with property initial reactions, credit impulse is has also seemed bottoming up.  In January, credit figures came in better than expected. Total Social Financing was RMB 6.2 trillion (consensus 5.4 trillion) and credit growth expanded from 10.3% YoY) to 10.5% YoY.[2] This is part of the initiation of a more deep easing cycle.

Is it time to leverage the economy again?

It could be, if you consider the messages out of the yearly Politburo meetings. In 2019 it was all about deleveraging. Why? Because GDP growth was not an issue. In 2022, stability is the main concern, which implies that GDP growth is a target. Government bond issuance and short term corporate lending have picked up substantially (especially the latter) in January. 

In addition, on January 20^th, China lowered its benchmark loan rate, or Loan Prime Rate (LPR), from 3.8% to 3.7%. Meanwhile, the 5-year LPR was also lowered by 5bps to 4.6% in December (a small move but this rate is linked to the property sector). On Monday of the same week the one year Medium Lending Facility (MLF) rate was lowered 10 bps. Again, not a relevant move but the importance was the signal considering it was the first move since April 2020. The MLF cutting cycle is also the 5^th decrease since the global financing crisis. China will also enter in a divergence driven by its easing and the tightening on the FED. The latter could make some pressure over the Yuan over time which can eventually anticipate some further easing measures.

Another factor that can boost China’s economy this year is Infrastructure investment, which could accelerate in 2022, considering fiscal policy has ample room to turn from contraction to expansion. Fiscal deficit was solely 4.5% of GDP (vs 6.5% expected at the beginning of the year) rolling over more than 3 trillion for 2022 spending, although policymakers should lose the controls on local government debt.

Regarding consumption, the disposable income from Chinese families has been affected by current economy slowdown, however the greatest negative impact from consumption is Zero Covid policy. As long as this measure doesn’t change it will be very difficult for consumption metrics to improve. History has shown us that consumption growth has been quite stable in the past, with low volatility. This implies that any change in Zero Covid, can bump consumption in a great extent. Most likely it will be gradually changed to more targeted measures (not locking down entire cities), nevertheless we don’t expect the complete elimination of the policy until at least the National Congress of the Chinese Communist Party this fall.

China’s top scientist Zeng Guang recently declared that China and Covid could coexist.[3] This is an important signal for an eventual turning point of Beijing to open the door to more discussions in following periods.

Despite the sluggish current economy we are overweight in China our emerging markets (EM) Small Cap Portfolio. Our approach is to invest in companies/sectors that are subject to less regulation and more likely to benefit from the new trends that we see emerging in the future.

Zhou Hei Ya (1458 HK)

We have recently initiated a position in Zhou Hei Ya (ZHY) in our Global Alpha Emerging Markets Small Cap Strategy. Our global and international small cap strategy do not invest in this country. ZHY is a leading braised food company in China and their main products include packaged duck products, such as duck necks and wings.

The brand is originally from Wuhan and is particularly strong among many cities in the country. ZHY is the first company in China to introduce MAP, which makes it possible to store braised food for up to seven days in a chilled environment. In the past, braised food products had to be unpackaged and consumed within the same day, hence it could only serve dining demand. MAP technology makes it much easier for people to consume braised foods on a variety of occasions.

China’s casual braised food industry reached a market size of RMB 109 billion in retail sales as of 2020, growing at a 16% CAGR over 2015-20. According to Frost & Sullivan they should continue increasing at similar pace, reaching RMB 205 billion in 2025. The main reasons for this increase are: increasing repurchases, a recovery in traffic post Covid-19, growing all-day snacking demand, and a convergence of consumer behavior in low-tier cities vs. top-tier cities.

ZHY has a highly standardized and scalable operating model. In 2019 it installed a franchisee model that will very likely speed up growth. ZHY has superior store unit economics (self-operating and franchisee stores take two to three months to breakeven), distinctive brand positioning, high stickiness, and are popular among the younger population It has been severely affected by Covid, but store openings are intact. We see strong potential for store expansions throughout China, fostering earnings and margins growth. Post Covid-19, we believe consumers will prefer more quality, healthier products. ZHY’s packaged products are perceived as safe and cleaner products vs. unpackaged ones. In summary, after a very tough 2021 and a difficult first half of 2022, we are starting to see some light at the end of the tunnel. The messages from policy makers have been key to understanding the direction of the Chinese economy during the year. Although every year has its own particular characteristics, we see some historical patterns that are showing similar signals in 2021- 2022. As Mark Twain stated, History Doesn’t Repeat Itself but it often Rhymes. The current Russia/Ukraine conflict and its implications on the Chinese economy are risks we are closely monitoring.

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[1] Source : Macquaire

[2] Source: Bloomberg and Macquaire

[3] China Should Eventually « Co-Exist » With Covid, Says Top Scientist (ndtv.com)

On February 21^st, Australia finally reopened its border to international travellers after two years of being fully closed. One of the strictest travel bans of the COVID era, at one point more than 30,000 Australians were unable to access the country due to the limited amount of people allowed to return home every month.^[1] The Australian government was not afraid to make a public example out of a certain tennis player to show how no exceptions would be made. Nonetheless, it slowly started showing signs in 2022 that it would shift from its strict zero-COVID strategy and instead hinted that it would follow the steps taken by the UK and other western countries to figure out how to live with the virus.

One of the biggest casualties of its zero-COVID strategy will be the end of its streak as the longest period of economic growth in modern history. Australia was able to navigate the Asian financial crisis, the dot-com bubble, the great recession of 2008, and a once-in-a-generation mining boom that ended in 2014 without experiencing a recession. Even after 30 years of continued growth, it took an almost complete shutdown of international trade to pull the Australian economy back into a recession. For the record, it was still a less severe downturn than almost every single country in the world except China experienced.^[2]

Despite the end of this streak, Australia retains most of the growth drivers of the last 30 years. The strength of its consumers remains in solid shape thanks to government support, upward wage pressure due to a labour shortage, significant household savings, and the safety of the strong pension benefits. Australia’s geographic location places them in a unique position to benefit from the growth in Asian consumer spending power. Its abundant natural resources, especially its mining industry, are resilient and should benefit from an inflationary environment, and what many expect to be the start of a commodity super cycle.^[3]

People more pessimistic about the Australian economy will usually point to its dependence on China as a trading partner. The trade war between the two nations was escalated to the World Trade Organization (WTO) in 2021 over tariffs that China implemented in 2020 on Australian products such as barley, coal, cotton, logs, meat and wine. This was the result of Australia’s previous criticism of China’s human rights record and the decision to ban Huawei from the country, in addition to other grievances formulated toward the Chinese government. While it is true that China always represents a risk to the Australian economy, representing roughly 40% of their good exports, this misses the dependence China has on some Australian commodities. Unsurprisingly, their largest export, iron ore, was not part of the tariffs China imposed on Australia. The Chinese government knew very well how difficult it is to find other sources of the same scale as Australia. Furthermore, as China was facing a coal shortage in October, it resumed letting Australian coal ships access their port after being banned since December 2020.^[4] Although, strong political rhetoric between the two countries is expected to continue, it is unlikely that economic relations will get much worse in the short term.

It is also worth noting that the country’s reputation as being an economy dependent on natural resources is often exaggerated. Like Canada, Australia’s stock markets tend to move along with commodity prices. But the reality is that much like other developed markets, Australia’s economy is dominated by the service sector. Representing more than 70% of GDP, almost 80% of its labour force and 40% of its export earnings, its expertise range from energy and mining-related services to banking and fintech.^[5] Outside of the tourism industry, the impact of the travel ban and other COVID measures had a limited economic impact as evidenced by the unemployment rate increasing only 1.45% between 2019 and 2020.^[6]

Global Alpha enjoys the exposure to various names in the Australian services industry.

ALS Ltd (ALQ AU)

Based in Brisbane, ALS is one of the world’s largest testing providers of laboratory analysis services, offering assessment, inspection, certification and verification. They operate out of 350 sites across 65 countries and across three segments: life sciences, commodities and industrials. The new management is in the process of solving many business inefficiencies to improve margins and their growth profile to be more sustainable. ALS should be a clear winner from the exploding demand for commodities and the new project development that will result from it.

Bravura Solutions Ltd. (BVS AU)

Bravura Solutions provides web-based software products and SaaS to the wealth management and funds administration industries, primarily in the Asia-Pacific and European regions. With over 70 bluechip clients and $2.3t trillion in assets managed through its systems, it is a market leader with a sticky product that participates in an industry with increasing regulation and the need for outsourcing.

Smartgroup Corp Ltd. (SIQ AU)

Founded in 2001, Smartgroup is a leading provider of salary packaging, fleet management, share plan administration and payroll services based in Sydney. Quite popular in Australia, the concept of salary packaging involves an arrangement between employer and employees where certain items or benefits can be paid for out of your pre-tax salary, reducing taxable income and therefore tax payable. Their business model involves charging employers an admin fee for outsourcing this for an average of AUD$200 per employee every year. Their client base mostly includes entities that benefit from not having to manage this internally, such as not-for-profit, hospitals, governments, and universities.

Australia is a relatively small weight within our developed market benchmarks but a mix of its exposure to the Asian consumer, strong expected consumer and corporate demand, and a Federal election in May that could lead to more deficit expanding policies, should result in outsized growth in the years ahead. We are quite satisfied with the varied exposure we currently have there.

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[1] Australia is ending its zero-covid strategy | The Economist

[2] Just four countries fared better than Australia (afr.com)

[3] June 10^th 2021 GA commentary – Hot commodity

[4] China accepts stranded Australian coal as shortages bite, but unofficial ban on new orders remains (afr.com)

[5] The importance of services trade to Australia | Australian Government Department of Foreign Affairs and Trade (dfat.gov.au)

[6] Australia Unemployment Rate 1991-2022 | MacroTrends

Dear Clients and Colleagues:

As the world transitions to green energy over the next 30 years, China must find short-term alternatives to their coal thermal plant problem, which represents 18% of total global carbon dioxide (CO₂) emissions. ¹

While it may seem like a contrary solution, China sees gas-fired power as the most realistic transitory solution until greener and grid friendly alternatives take scale. Gas has lower emissions than coal (50% less, oil is 25% less) and gas is more flexible than solar, wind, and even pumped-storage hydropower. It seems that China wants to import natural gas as fast as pipeline and LNG infrastructure is built. China’s pipeline gas volume surged 154.2% in 2021, to 7.54 million metric tons (mt). Natural gas imports (LNG) from Russia rose 50.5% year-over-year in 2021.² Meanwhile, China LNG imports from the United States (U.S.) saw the biggest year-over-year jump, rising 187.4% to 9.21 million mt in 2021.³ 

According to GlobalData, LNG liquefaction capacity is expected to grow by 70% over the next four years.³ China will add as much as 21.5 million mt/year of LNG receiving capacity in 2022, this from more than the 14 million mt/year added in 2021 for a total import capacity of 127 mt/year in 2022.¹ Japan pioeneered LNG 60 years ago and recently fell in second place in terms of activity with 75 mt/year of LNG imports.⁴

Although the Chinese LNG import growth only absorbes world gas production by less than 1%, it is enough to pressure pricing upwards, especially since Europe and other regions try to curb thermal coal as well. Supply side dynamics are not helping either, as world rig counts are 45% lower than in 2015.⁵ Why so few? Oil and gas companies are shuffling with higher exploration costs, regulations and low labor availability.

Coming back to Japan, the country has low internal energy resources and imports 90% of its energy requirements. An important part of the country’s electrification is fuelled with LNG imports. Japan has the largest LNG capacity with 227 mt/year.⁴ As part of its CO₂ emission targets, the country is trending towards a hydrogen strategy fuelled by renewables while reducing its LNG imports and nuclear power.

Iwatani (8088:JT)

Global Alpha owns Iwatani, the largest provider of LPG liquified propane gas, from importing to stove tanks. Iwatani provides an essential service throughout Japan, a country with very low penetration of utility style gas piping to the house. Although Japan’s LNG imports for electrification will decline, LPG will continue to be a key part of Japanese culture for cooking and heating especially in rural settings. Iwatani is also Japan’s only fully integrated supplier of hydrogen, with a nationwide network, including manufacturing, transportation, storage, supply, and security. It had 53 hydrogen stations in Japan as of 2021. Plans are to add 270 by 2030.

With plans to start exports by 2025, the west coast of Canada is set to benefit from the Asian LNG expansion. The energy shipped from Canada over to Asia is expected to offset up to 90 million tonnes of CO₂ emissions in a single year. This is equivalent to shutting down 40 to 60 coal fired plants in China.⁷

ARC Resources (ARX:TSE)

Global Alpha owns ARC Resources, a Canadian energy company with operations focused in the Montney Resource Play in Alberta and northeast British Columbia. The company is best positioned with its gas assets to supply LNG requirements for Asian LNG exports. ARX is an industry leaders in terms of ESG with many initiatives regarding gas flaring and CO₂ carbon capture.

Clean Energy Fuels (CLNE:US)

North American natural gas usage is also expected to increase in renewable growth as it is mixed with captured methane producing negative CO₂ emission. For this Global Alpha owns Clean Energy Fuels, the largest network of retail natural gas distribution in the country.

China’s need for energy to fuel cars and electrify houses (and give them some benefit, to reduce thermal coal) has forced them to shut down many internally produced commodities that demand  high energy consumptions (as well as high CO₂ emission) notably aluminium and copper smelters. China still needs these commodities and has reverted to the global trade market. If we add the change in habits brought on by COVID-19 that supported a rush for hard goods during the pandemic, this is the consequence.

With a high energy production input, shipping aluminum is basically shipping energy. 

Alumina (AWC:AU)

Global Alpha owns Australia’s Alumina, which owns 40% of the world’s largest alumina business, Alcoa World Alumina and Chemicals (AWAC), the recognized industry leader. Precursor to aluminum, the metal powder alumina is refined from bauxite. AWC owns alumina refineries, bauxite mines and aluminum refineries globally with a good concentration in Australia. Close to China, AWC Australia large operations present the lowest cost import option for China. As well, AWC sources all of its energy requirements from natural gas. AWC also has important ESG initiatives such as Mechanical Vapor Recompression (MVR) which turns waste vapor into steam.

If we consider the energy transition to renewables as a secular event, the trend has certainly affected commodity prices in addition to more typical demand and supply forces.

Have a nice week.

The Global Alpha team

¹ https://www.statista.com/statistics/239093/co2-emissions-in-china/#:~:text=China%20released%2010.67%20billion%20metric,of%20countries%20where%20emissions%20increased

² https://www.spglobal.com/platts/en/market-insights/latest-news/lng/012022-china-data-total-natural-gas-imports-rose-20-in-2021-on-strong-energy-demand

³ https://store.globaldata.com/report/global-capacity-and-capital-expenditure-outlook-for-lng-liquefaction-terminals-to-2025-north-america-dominates-global-capacity-additions-and-capex-spending/

⁴ https://www.statista.com/statistics/1285639/japan-share-lng-in-energy-production/

⁵ https://rigcount.bakerhughes.com/intl-rig-count

⁶ https://world-nuclear.org/information-library/country-profiles/countries-g-n/japan-nuclear-power.aspx

⁷ https://biv.com/article/2022/01/lng-canada-project-construction-kicking-high-gear

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