Opportunity Amidst Chaos
The first quarter is not yet over, and already we have had a busy 2020. Many questions are still unanswered regarding the impact Coronavirus will have on both Chinese and global supply & demand; However, the investor response has been clear- bid up U.S. equities, and sell off Chinese equities.
Risk aversion is likely the core factor driving those YTD return differentials between the U.S. and China. At the end of January, the VIX saw a large spike that persisted into the beginning of February, this coincided with a rally in both Gold and its speculative virtual brother, Bitcoin. Simultaneously, Brent, Crude and Natural Gas have all fallen over 13% YTD as global growth forecasts continue to be revised down in response to the potentially global health crisis.
The IMF issued an update to their annual global forecast on January 9th that saw 2020 global growth around 3.3% and saw Chinese growth at 6%.1 That Chinese growth estimate seems particularly optimistic in the wake of the news out of China regarding business closures and the continuing climb in both infected cases and deaths from the Coronavirus. As of writing (2/17/2020) there were over 71,000 cases and 1,700 deaths reported from the virus, with many doubting the accuracy of the data coming out of China.2
However, this isn’t meant to be a scare piece. I have held, and continue to hold, a substantial amount of Chinese ADRs in my person portfolio. As of the market close 2/14/2020 I held about 18% of my trading portfolio in {BABA, JD, LNVGY & MOMO}. I see the Chinese growth story as highly investable and am quite attracted to some of the fundamental valuations of the firms just mentioned. Given my long-term investment time horizon, I see the potential impact of a virus on global trade as a short-term threat to markets. In fact, several economists have predicted the same – a Reuters article surveyed 40 economists and found that, if the virus is contained, the consensus – is that Chinese GDP growth in the first quarter will take a negative hit (to a median forecast of +4.5% YoY), but in the second quarter China will see a turnaround in part due to built-up demand (to a median forecast of +5.7% YoY).3 Keep in mind, however, forecasts are much less rosy in a situation where the virus is not contained.
In the weeks ahead there will likely be some very bad headlines coming out from both public firms and in the general economic gauges regarding January and February data. I suspect investing opportunities will present themselves as the market reacts, and possibly overreacts, to the data. One position, I recently added to in January, and will be watching to build the position further, is the PC market leader – Lenovo.
On January 13th, IDC reported the 2019 worldwide PC market (including desktops, notebooks and workstations) grew 2.7% from 2018, shipping 267M units in total.4 Lenovo led that industry climb with an 8.2% YoY increase from 2018 to 2019, shipping 65M units and taking 24.3% of the market.
That positive 2019 industry growth has been largely attributed to Microsoft ending support for their Windows 7 operating system, which drove consumers to new devices to run the more advanced Windows 10 operating system. However, at a firm level, Lenovo has been growing steadily in market share for years and their current market price does not appear to be reflective of that fact. According to data from Statista, in the first quarter of 2011 Lenovo had market share of 10.4% and by the fourth quarter of 2019 their market share rose to 24.8%.5 Meanwhile, from 3/31/2011 to 2/14/2020 Lenovo ADR shares have only rose from an adjusted price of $7.71 to $13.60 (a rise of 76%), while the SP500TR, a proxy for the S&P 500 total return index, rose from $2,239.44 to $6,872.68 (a rise of 207%).
Financially Lenovo has had mixed results, perhaps helping to explain the disconnect between the firm’s market share dominance and their stock performance. From 2015 to 2019 (their fiscal year ends in March) revenue rose from $46B to $51B (annualized growth of 2.5%). While profits have oscillated between positive and negative, in three out of the last five years the firm has reported positive net income, with the positive years significantly outweighing the years of losses. Furthermore, cash flow from operations has been positive in four out of the last five years. Lenovo has low margins compared to peers, but I believe that to be a characteristic of the strategic business strategy the firm is pursuing (high value at a low cost to attract and retain customers). Nonetheless, the latest quarterly report, 2019Q2 ending 9/30/2019, showcased a gross profit margin of 16.1% (up 2.7% YoY) and a profit margin of 1.5% (up 0.25% YoY), showcasing improved expense management on both the cost of goods sold and operating line items.
The graphic below was customized using Schwab to compare Lenovo to selected peers based on several fundamental metrics. One particularly favorable aspect of Lenovo shares is their relatively high dividend yield. Dividend data from Lenovo’s website depicts a reliable and investor focused firm.8 Lenovo currently yields over 5% while competitors – HP & Apple payout 3.3% and 1% respectively.6
In addition to the positively trending financial performance, continuing market share dominance and bountiful dividend yield, Lenovo may also have an overlooked piece of news further boosting their prospects. In December news surfaced of a new directive from the Chinese Communist party. The directive is said to order “all government offices and public institutions to remove foreign computer equipment and software within three years.”7 This initiative has been nicknamed the 3-5-2 policy because it aims to take place over three years at a pace of 30% in 2020, 50% in 2021 and then 20% in 2022. This new regulation could be a catalyst for Lenovo expansion at the cost of U.S. competitors like Dell, HP, & Apple. Although I don’t foresee overly robust growth ahead for Lenovo, I do see shares as reasonably priced, and believe the strong yield is worth portfolio consideration – especially if market weakness presents itself.
- https://www.imf.org/en/Publications/WEO/Issues/2020/01/20/weo-update-january2020
- https://www.worldometers.info/coronavirus/
- https://www.nytimes.com/reuters/2020/02/13/business/13reuters-china-health-economy-poll.html
- https://www.idc.com/getdoc.jsp?containerId=prUS45865620
- https://www.statista.com/statistics/269703/global-market-share-held-by-pc-vendors-since-the-1st-quarter-2009/
- https://www.schwab.com/public/schwab/client_home
- https://www.ft.com/content/b55fc6ee-1787-11ea-8d73-6303645ac406
- https://investor.lenovo.com/en/ir/historical.php
