Investing Daily

China’s Purchasing Managers Index (PMI) for April came in at 53.5, up from 52.4 in March. Chinese PMI is now well off the 38.8 all-time low registered for November 2008. Readings above 50 indicate economic expansion; clearly, the Chinese economy is reaccelerating.

More broadly, strong economic growth in China and other emerging economies has been the basic underpinning of the most profitable market trends in recent years, including the dramatic up-trends in energy and basic commodity prices.

My go-to expert when it comes to Asia is Yiannis Mostrous. I co-authored a book with Yiannis in which we analyzed the outlook for growth in Asia and some of the sectors and industry groups poised to benefit. The Silk Road to Riches: How You Can Profit by Investing in Asia’s Newfound Prosperity turned three years old in March, but the trends, stocks and sectors we highlighted are every bit as relevant today.

Yiannis is also the editor of two outstanding newsletters covering the Asian markets. The free weekly e-zine Emerging Markets Speculator offers a take on important economic and market trends and, the subscription-based Silk Road Investor is a must-read for anyone interested in the best ways to profit from Asia’s economic boom.

Earlier this week, I had a conversation with Yiannis about Asia’s current growth prospects. The discussion was so illuminating I decided to interview him and ask him for some specific ideas and recommendations.

Following are excerpts from our talk.

Elliott Gue: You’ve been covering Asia for nearly a decade and have remained bullish on the region’s long-term prospects throughout. What’s the rationale for your take, and why do investors need to maintain exposure to Asian markets?

Yiannis Mostrous: My bullishness on Asia is summed up in two simple words: economic change.

Global economic leadership changes over time, and the world has now entered a period where a shift is becoming more obvious. In coming years, Asia will emerge as the global economic growth leader, and the West will enter a more subdued cycle.

Time will test everybody’s theories, but history has shown that in the aftermath of calamitous economic/market bottoms, the world and its societies have profoundly changed.

I expect this to be the case this time around, too. I don’t subscribe to the theory that after all is said and done, things will go back to the status quo. Things never do, and won’t this time.

Elliott: Let’s talk a little shorter term. What’s the most exciting market in Asia right now?

Yiannis: As I wrote in Thursday’s EMS, it’s Taiwan. In fact, Taiwan could be the biggest out-of-consensus investment story around as the first decade of the 21st century comes to a close.

Taiwan isn’t in position to survive economically without China’s assistance. This reality is just now being recognized, and the political parties are expected to act accordingly. As in South Korea, economic development is taking precedent over extreme nationalistic policies.

An eventual understanding between Taiwan and the Mainland will help Taiwan's economic development. Increased foreign direct investment (FDI) will flow to the island, just as China did with Hong Kong 20 years ago.

And this change is imminent, as Beijing has indicated its willingness to talk to a responsible government.

Recently, a delegation from the China-based Association for Relations Across the Taiwan Straits (ARATS) held preliminary discussions in Taiwan, with the goal of establishing initial consensus on key issues on the official agenda of the upcoming formal meetings on the Mainland. The main subject of the meeting included tighter financial cooperation between the two, an outcome that would do a lot to revive Taiwan.

Today markets around the world are excited because Taiwan and Mainland China are a step closer to a more harmonious relationship. The government in Beijing gave its blessings for public health officials from Taiwan to attend, as observers, the 62nd World Health Assembly (WHA) meeting in Geneva, 18 to 27 May. Note that the WHA assembly is only open to “Member States,” a definition that has given China the ability to block Taiwanese participation for a long time.

It’s clear that the Chinese government has decided to reward the Taiwanese leader Ma Ying-jeou efforts to expand Taiwan’s presence in the international scene, in cooperation with the Mainland. Furthermore, both sides have begun implementing plans for greater economic integration.

The latter development will take Taiwan to the next level of economic growth. 

Yesterday, China Mobile (Hong Kong: , NYSE: CHL) announced it will acquire a 12 percent stake in Far EasTone Communications, Taiwan’s smallest mobile operator, at a 13 percent premium to the April 29 closing price. Although this is a small investment for China Mobile, the significance of the deal is huge.

As Taiwan and the Mainland continue to normalize their relationship, more investment capital will find its way to Taipei, boosting the domestic economy and putting Taiwan back at the forefront of global economic growth.

Elliott: Compelling; any picks?

Yiannis: The easiest way to participate in upside for Taiwan is through iShares MSCI Taiwan Index (NYSE: EWT), an exchange traded fund.

Most of the Taiwanese companies that trade as American Depository Receipts (ADR) on the US exchanges are focused on the export economy. These companies produce items such as semiconductors. Some of these firms are world leaders, but demand for their goods is ultimately dependent on global economic conditions.

Some of the biggest beneficiaries of growing integration between Taipei and Beijing will be Taiwanese firms that sell primarily to the domestic economy. Increased Chinese investment into Taiwan will power domestic demand and boost firms that sell goods and services mainly inside Taiwan or are involved in Chinese-Taiwanese trade. The Taiwan ETF provides exposure to these domestic-demand-driven firms.

Elliott: You’ve consistently forecast that the Chinese economy would grow around 7 to 8 percent in 2009, even while many pundits lowered their estimates to 5 or 6 percent at the end of last year.

Based on recent economic data it now appears your bullish take was absolutely correct. What’s your current outlook for China?

Yiannis: China is on track to deliver 7 to 8 percent GDP growth this year. First quarter growth of 6.1 percent is a good enough base to support such an outcome.

As I’ve noted repeatedly, anything above 6 percent should be viewed as a significant positive, particularly in light of the fact that China’s stimulus package will have greater impact later in the year. It’s likely that the first quarter will prove to be the bottom of this cycle.

This assessment is even more credible given the details of China’s recent first quarter GDP announcement. Industrial production in March rose by 8.3 percent on a year-over-year basis, rebounding from 3.8 percent in the first two months of the year, while fixed-asset investment also rose strongly, by 30.2 percent.

The property sector continues to improve because Chinese banks are in full lending mode and people are willing to borrow. The latter indicates that household balance sheets remain healthy and that Chinese have faith in the government’s efforts to cushion the downturn.

Maintain your exposure to Chinese stocks, though most market observers are still skeptical of China’s ability to deliver solid growth this year.

Elliott: Sounds like you’re still bullish on China. Any stocks to recommend?

Yiannis: Look at Dalian Port (Hong Kong: 2880, OTC: DLPTF). The Port of Dalian is one of China’s four strategic oil reserve bases and the largest oil/liquefied chemicals port in Northeast China.

For the first two months of 2009, Dalian Port reported flat container throughput growth, which, given the slowdown in the economy and the fact that the overall sector registered a decline of around 15 percent, is a positive.

The port’s sheer size--it has capacity of about 3 million cubic meters--means it’s critically important to China’s ability to fill its national strategic oil reserve. The launch of PetroChina’s (NYSE: PTR) commercial oil storage tanks (1.4 million cubic meters of capacity) will also contribute to the port’s profitability this year.

Profits for 2008 were up 27.5 percent. Both the oil handling and container handling/logistics businesses saw steady revenue and earnings growth on increased volume and tariffs.

In 2008, Dalian raised its container handling rate by an average of 7 percent, while total container volume at the port was up 18.1 percent year-over-year.

On the other hand, the company experienced a decline in oil storage earnings, was subject to a higher income tax rate, and suffered a bigger loss at the automobile terminal. In order to accommodate PetroChina’s construction of crude storage tanks, Dalian sold a piece of land, as well as a few storage tanks, to PetroChina. This, along with rising costs, led to a decline in oil storage earnings.

Its automobile terminal was severely hit by the demand slowdown; vehicle volume fell by 40.3 percent last year. But demand has perked up. Finally, due to the expiry of tax holidays, Dalian’s effective income tax rate increased to 20.3 percent in 2008, from 15.9 percent a year ago.

Dalian Port remains on track for a good fiscal 2009. Oil-related operations will be a key earnings driver. The company has 12 new crude oil storage tanks with a capacity of 1.2 million cubic meters, and all have been locked up with a three-year lease at a higher rental rate.

Dalian will continue to benefit from the nation’s strategic oil reserve, which will add another 3 million tons throughput, and PetroChina’s commercial oil reserve.

Containers should be the weak spot, but I expect the company to eke out a slightly positive growth number because a lot of the containers there carry domestic cargo and food and resources.

Elliott: Let’s move this discussion to frontier markets. Is there a smaller, more obscure Asian market that investors should consider?

Yiannis: Cambodia has been a long-time favorite for me.

Just over a decade ago, Cambodia was battling through a bloody political crisis reminiscent of the days after Phnom Penh fell to the Khmer Rouge in 1975. Since then, however, the country has achieved relative political stability compared to its past and has pursued pro-development policies as it integrates into the global economy. 

Tourism, which now accounts for roughly USD1 billion per year in revenue, is Cambodia’s fastest growing industry. The prime attraction is the temples at Angkor, one of the biggest religious complexes in the world. The temples spread out over some 40 miles around the village of Siem Reap, about 192 miles from the Cambodian capital, Phnom Penh. They were built between the eighth and 13th centuries and range from single towers made of bricks to vast stone temple complexes.

Tourist arrivals have been growing at double-digit rates. This has led to a rise in property prices, especially in Phnom Penh and Siem Reap.

The economy as a whole has been growing solidly; the government is running a tight fiscal policy, even while funds are made available through financial aid for infrastructure projects and foreign direct investment (FDI). Real GDP growth for the past three years has been in the double digits and should remain strong.

Cambodia is a true emerging market, and it will be some time before mass investing takes place. There are only a few ways an investor can gain exposure, aside from a couple private equity funds that cater to the upper echelons of the investing community.

The main reason is the lack of market structure and the resulting absence of liquidity. But the lack of liquidity can be a good thing for early birds because big money will eventually flow in once Cambodia enters the mainstream of the global economy. Think Vietnam seven years ago.

Cambodia and Laos have agreements in place with the Korea Stock Exchange to help set up their own stock markets, which are due to open later this year and in 2010, respectively. It may take longer than anticipated, but the government has been working toward this goal and has made much progress in establishing a legal framework for securities issuance and trading.

Only a few companies can be listed right now, but as the economy grows, more will emerge. One of the only pure plays on Cambodia’s growth and potential is a casino firm listed in Hong Kong that’s part of my model Portfolios in Silk. 

Elliott: One of your favorite sectors in the region longer term has been the telecoms. I know the group offers stable cash flows and high dividend yield potential. Give us your favorite play in the group.

Yiannis: PT Telkom Indonesia’s (NYSE: TLK) strong cash flow and solid dividend yield make it appealing in times when access to capital is difficult and expensive.

On the growth side, the company should be the key beneficiary of mobile growth in Indonesia. Its mobile unit, Telkomsel, has a dominant position. Because of its strong cash position and extended network, Telkomsel will be able to expand its dominance outside of Java, where it already enjoys a 70 percent market share.

This is the area where the next wave of growth should appear--mobile penetration remains low in the hinterlands at 25 to 30 percent, whereas mobile penetration nationwide currently stands at around 40 percent.

PT Telkom offers steady growth in a promising market and should be able to take advantage of opportunities as they appear. Its strong balance sheet and cash flow should allow it to maintain its capital expenditure budget, and the competition won’t be able to compete on this metric.

PT Telekom offers a superior network and similar tariffs to those of its competitors. The company has a share buyback in place of around 2 to 3 percent, and offers a 6 percent dividend yield.

Elliott: Thanks, Yiannis. I encourage all PF Weekly readers to check out Yiannis’ Silk Road Investor service. He has kindly arranged for you to receive 7 free reports if you sign up today.

Speaking Engagements

I’d like to extend a special invitation to PFW readers to join me and my colleagues Roger Conrad, Yiannis Mostrous, Benjamin Shepherd and GS Early May 30 at the historic Mayflower Hotel in Washington, DC for the 2009 KCI Wealth Summit.

You’ll have an opportunity to talk with me and my fellow editors as well as an exclusive group of investors about the challenges we face amid these volatile times.

Click here for more information. I look forward to seeing you.

And there are few better places to combine work and play than Sin City: Join Roger Conrad, editor of Utility Forecaster, Canadian Edge and New World 3.0, PF Executive Editor GS Early, and me for The Money Show Las Vegas, May 11-14, 2009, at The Mandalay Bay Resort & Casino.

I’ll provide significant insight into my approach to stock selection and portfolio management. Roger, a steady hand through many market events such as the one we’re dealing with now, will talk about his new service focused on exploiting the greatest spending boom in history, New World 3.0.

This is one trip to Vegas that won’t make a wreck out of you.

To attend as my guest, click here or call 800-970-4355 and refer to promotion code 012647.