Macro Outlook: Looking Further East
The conflict in Ukraine has taken the worst possible turn and resembles the invasion of Czechoslovakia by the USSR in 1968. If the history were to repeat itself, the invasion could lead to federalization of Ukraine, composed of Ukrainian-speaking West, Russian-speaking East and the newly formed DNR and LNR.
While the parallels with the 1968 invasion are striking, this time around a regime change will be much more difficult to implement, because in Ukraine there is no established security apparatus needed to enforce a pro-Russian stance.
Looking at the timeline, the invasion of Czechoslovakia was widely condemned, and it took more than three years for the US-USSR relationship to get somewhat better. Whatever happens to Ukraine, a transition to “normal” relations with Russia can take a very long time.
I think that the crisis in Ukraine will be inflationary (rerouting of the Russian trade will bring additional costs), and generally good for China. China has only limited restrictions on purchasing Russian commodities and will start getting them at a favorable price. China will benefit from helping Russia to deal with financial sanctions and import restrictions. China will use the situation to further popularize Chinese currency to the detriment if the USD.
There are reasons to start looking at Chinese or China-related stocks: the country is emerging from the Covid shut-downs, and the government will most likely cut rates and start to stimulate the economy. Chinese stocks were poor performers for a long time due to COVID and politically driven campaigns. Over the past two years Hang Seng Index underperformed S&P 500 by approximately 40% - there are some good bargains there.
A couple of China-related stocks
Standard Chartered (STAN LSE) is an international banking group operating in Asia, Africa, and the Middle East. Over 1/3 of the group’s income comes from Hong Kong and China. The stock is inexpensive, trading at approximately 0.4 Price/Book, and 7.0x forward P/E. The company is targeting to improve ROE from 6% this past year to 10% by 2024. If successful, valuation of shares should improve materially. The bank has been restructuring over the past few years under CEO Bill Winters (ex- JP Morgan) and continues to improve its operations by shedding unprofitable customers, closing unneeded branches, spending on digitalization (cheaper modes of operation), and focusing on growth opportunities in China. The bank’s profitability should be helped by internal actions, and an increase in interest rates: net interest income should be improving by approximately 20% for every 1% change in rates. The stock performed well over the past year, and I think it has more room to run.
Yum China (YUM NYSE) is a fast-food chain with 12K stores operating in China. The company is offering Chinese versions of menus under famous American brand names: KFC, Taco Bell, and Pizza Hut. Despite challenging environment and multiple waves of COVID in 2021 the company managed to grow the business and opened 1,800 new stores. Up to 1,200 new stores are planned for 2022. Management has a record of innovation and creativity in developing of popular menu items, digital offerings, and membership programs. The company remains profitable and generates substantial free cash flow. The stock performed poorly last year but began to move up very recently, on the prospects of COVID dissipating and same store sales growth improving sometime in 2H 2022. Further expansion into less-penetrated markets, increase in store density, and development of the coffee business in China are good growth opportunities.