Podcast interview with Vineet Mitera, the CIO of WFM Asia (previously Ward Ferry Management). He has been with the firm for ~20 years. WFM manages long-only equity funds with AUM of ~US$3bn, and focuses primarily on small and mid-cap companies across Asia Pacific. He discusses the firm’s approach to investment and portfolio construction as well as the firm’s outlook/positioning for China, Japan, India and the ASEAN region. Some of my notes are included below (these are for personal reference only and not meant as a comprehensive transcript; any mistakes are my own).
On WFM’s investment philosophy: their portfolio gets built by looking for companies with the following three characteristics: 1) large addressable markets, hopefully with tailwinds of growth; 2) businesses that are run with good, or at least improving, governance, transparency and alignment with minority shareholders; and 3) businesses that can be sustainably free cash flow positive over a period of time even if at the initial stages there is a considerable amount of investment involved.
Portfolio construction is very bottom up. They are looking to build a portfolio of 25-35 companies, where the top 10 companies are 50-60% of NAV. Generally, they are looking for companies in four buckets: financial services, technology and media, healthcare, and consumer/lifestyle. They want their companies to be able to do well despite / regardless of the macro environment around them. The whole idea is that if someone said to them you could not trade the portfolio for the next 3-5 years, he would say no problem because of the characteristics of their companies from a balance sheet standpoint, market position standpoint, growth etc.
Sourcing of ideas: There are ~12,000 listed companies in Asia, so it is a very large universe. They will typically exclude the state-owned companies, the commodity and resource companies, and the heavy capex and/or cyclical businesses. So they whittle down the list pretty quickly to 5-6,000 companies and then go down from there. The team has ~1,000 company touchpoints a year. They have four primary ways of sourcing ideas: 1) everything has to have those three characteristics he talked about earlier, 2) they have been doing this as a firm for over 20 years, with that comes a lot of institutional knowledge/insights, 3) as they build partnerships with their management teams, they often ask them about entrepreneurs they respect, where they have invested their own money etc. and that can sometimes lead to ideas, and 4) they have had a good experience with certain business models in some markets and will then look for similar ones in other countries. From time to time, they do run screens, which can be helpful, but it is not a big part of their idea generation process.
On how their process has evolved: they are more concentrated than they were 20 years ago. That comes down to being comfortable with what you don’t know – even if there is upside there, it is better to stay away from it, especially if there is a probability or chance for monetized losses to be greater than you are comfortable with. They stopped investing well over a decade ago in commodity and resource businesses and also moved away from cyclical businesses, as he found those were very short-term driven investments, whereas they are trying to capture the long-term value creation of businesses. One of the questions they ask themselves all the time is will this business compound its economic value by 15-25% a year over a 3-5 year time horizon, perhaps some moderation after that but what they don’t want is a cliff.
On the portfolio characteristics today: It has been a frustrating period as an investor in Asian small- and mid-caps, but they believe that fundamentals do matter and that over time the fundamentals will be recognized from a value-creation standpoint. If you are able to buy companies that are the #1s or #2s in their space, growing at 15-25% a year with multi-year track records, that have reached scale points of profitability, with valuations well below PEG of 1 over a 3 year perspective, that seems like an attractive proposition. Their portfolio currently trades on 23-24x forward earnings, the 3-year compound growth rate will be ~40% a year and will continue at ~25% a year in years 4, 5, 6 etc. The portfolio has an average OCF yield of 7% and a FCF yield of 5% with ROEs of just under 22%. Their companies also don’t need significant capital to generate that growth, ~85% of their NAV today is invested in net cash companies. Liquidity is also getting healthier and that is just a natural byproduct of the way these markets are evolving, with more scale and domestic support over time.
The state of corporate governance in Asia: governance quality has improved considerably over his ~20 years investing in Asian public markets. You can see that in terms of the level of disclosures, the quality of regulatory oversight etc. But you also see it as a generational change happens, which is where we are now with many Asian companies. The younger generation usually comes in with a different view about how to run things, based on their reference sets, educational backgrounds etc. They spend a lot of time with their portfolio companies guiding them on how to be a better public market company, how to improve their investor relations efforts, how to communicate what the long-term upside is from a value-creation standpoint etc.
On their outlook for China – they have ~15% of the fund invested in China today. He has not seen a combination of scale, fundamentals and valuation come together as they have in China today, so he does think it deserves some cautious interest from them. There are obviously still a number of issues that haven’t found resolution. But it does seem like the majority of the marginal selling is done. That was triggered by concerns about the economy, geopolitical risks, and that meaningful reform and stimulus was not going to happen. All of this means it could be a long recovery ahead and, for some investors, there are perhaps better things to do than invest in China.
The way they manage the risks are by keeping exposure at judicious levels, having a very high bar to put anything new in the portfolio, and making sure what they own can answer the following four questions positively: 1) if the company does well, will it be beneficial for SME growth?; 2) if the company does well, will that be broadly positive for employment?; 3) if the company does well, will it be broadly additive to fixed asset utilization? (China wants to move more and more towards a consumer-led economy and become less dependent on fixed asset investment); and 4) will it cause any regulatory anxiety, be viewed as profiteering? You need to ensure there are reasonable margins but also offer a good experience to customers.
One of their holdings is H World, the leading hotel business in China, which they have owned for over a decade. The company started out with budget hotels, expanded into the mid-segment and is now also moving into higher-end hotels. They see the business continuing to compound in the mid-teens while it is trading at a ~12x forward EBITDA multiple, with 15% of its market cap in cash and ~7.5% capital management yield (dividends + buybacks). Another business they own, for the lack of a better analogy, is the Uber of long-haul trucking. It has well over 80% market share but is just starting its monetization journey, which is why they are excited about the upside potential despite a tepid economic environment. As it does well, it benefits both sides of the platform – the supply side who are SMEs (truckers, sole proprietors) and the demand side (shippers have a better service experience). The business today has ~55% of its market cap in cash, has just started embarking on a buyback and is trading at 7x ex-cash P/E with well over 30% growth. Some of their other holdings in China are in the jobs (classifieds) space and a hot pot chain.
What is the inflection point for them to add to China? One of the things they are trying to answer is when will Chinese companies and entrepreneurs start increasing their investments in China – when will they start to buy companies or consolidate markets partly because the valuation and opportunity set is compelling, but also because they will be allowed to earn a good rate of return on it. That is the key data point they are looking for. It’s all good to get money back from companies and they are giving you an excuse to wait but what you really want to see is that they put the dividend in place, do the buybacks, but then go increase their capex plans because they have confidence in the next 3-5+ years.
On India – India has been a large part of their portfolio since the inception of the fund. He anticipates that will remain the case for the next many years. One of the things they have been attracted to is the quality of the entrepreneur in India and the ability for these companies to be built with a cost structure that allows them to generate significant margins, ROEs by selling goods and services that are well priced for the Indian consumer. That is not an easy thing to do.
India goes through periods of exuberance and and pessimism. Right now, we are in a period of let’s call it optimism, with pockets of exuberance. So you do need a discerning eye not to get caught up in the thematics, because the Indian market is trading at higher multiples than in the past, on an absolute and relative basis, as well as a GDP to market cap basis. The relative basis you can explain a little bit because part of that is driven by the ex-China trade. India has always had higher valuations because the ROE of the market has been higher than other markets.
They are still finding lots to do in India. They have been trimming companies that they think have gotten to elevated valuations where they can’t justify the medium/long-term upside they need to hold it in the portfolio at the scale it was. But they are adding to positions where it seems like domestic investors have lost relative interest, in areas such as financial services, consumer lending, life/health insurance, hospital chains etc. The other takeaway he had from his recent trip to India was there seemed to be an increased level-headedness by owner-operators about how they are going to manage their businesses from a funding and debt/equity funding perspective, making sure they have learnt from previous periods (e.g. the credit crisis in India in 2018).
In terms of ideas, they like Max Healthcare, a hospital chain which they think is going to compound its EBITDA by 25% a year for the next 5 years. It has 22 hospitals and 5,000+ beds. Trades at 30x forward EV/EBITDA, ROIC of 20%+, with a neutral balance sheet. Both the number of beds and number of hospitals will grow over the next 5 years. Indians don’t a health insurance safety net, which is now starting to build, so people are making choices to trade up from public to private hospitals. They also like Bajaj Finance, India’s leading consumer finance company. Over the last decade, revenue has grown at a ~31% CAGR, and profit by ~35%. Over the next 3-5 years, revenue growth will be in the 25-30% range and earnings growth will be similar. Trades at 20x forward earnings for that growth profile, with no need to raise capital and an ROE of ~20%.
Japan – you are seeing a structural change from a corporate governance perspective, attention to capital management, laziness of balance sheets, reducing cross-holdings etc. These changes are not new, started over a decade ago. But what perhaps needs to be tempered is the expectation about the rate of change. To expect large parts of the market to make these changes within 1-2 years is too optimistic, it will take time. The recent positioning you have seen is a result of people’s excitement and Japan has benefited more than India from the China-pivot.
The most interesting area of the market is the small/mid-caps, which is being ignored because of the current focus on the low P/B, advanced manufacturing companies etc. There are four areas they are focused on: 1) companies that are consolidating / innovating these large addressable markets, e.g. MonotaRO. Over the last 10 years, revenues and gross profit have grown by 20+% CAGR, PAT by 25%. 2) Japanese companies that have great businesses domestically but are taking those businesses overseas. 3) Opportunities due to demographic decline and digitalization (latter is being driven by the government + Covid-19 also led to an inflection point in the adoption of digital services). 4) Hidden value on the balance sheets. That is the area of least focus to them. The hidden value companies tend to be one-time rerating events.
ASEAN – it is a super interesting region because no one seems to care about it right now. On every indicator, the economies that they are focused on (primarily PH, ID, VN) have improved significantly over the last 10-15 years. Companies have also scaled meaningfully but valuations have derated. A considerable portion of the population is still under 35. One issue is that liquidity is quite challenged. They are trying to find the best domestic consumer opportunities in the region – a disproportionate % of the people coming into the middle class in Asia by 2030 will be from ASEAN (along with India). One of their holdings is SEA Limited. This has moved from a company that was focused on growth to a company that is delivering growth with profitability. Last few years, revenues has compounded at ~68% a year and GP at ~87% a year. Going forward, he thinks it will compound revenue at ~20-25% but profit at rates approaching ~100% given that it is coming from a very low base. P/E number is 15x earnings next year and 10x earnings the year after that. Still have the growth opportunity intact, but the business is now focused on monetization.