A Contrarian’s Dream




New home prices in 70 major Chinese cities rose by 10.4% in May on a year ago on a weighted average basis. The year-on-year pace of growth has continued to decelerate from the 12.6% increase seen in November. On a month-on-month basis, average home prices rose by 0.7% in May with this unchanged from April. Average prices rose in 56 out of 70 cities in April, on a month-on-month basis, versus 69 in April.

Our largest holding in the Fat Prophets Global Contrarian Fund (ASX:FPC) and major holding in our Asian and Global Managed Accounts is Baidu, China’s biggest search engine. Baidu has badly underperformed Alibaba and Tencent over the past few years after growth stalled and the online advertising division was hit by an online scandal.

Prospects for the company could be about to turnaround with a number of potential catalysts. On July 10, Baidu will unveil its ‘driverless car software” and make this available to all the car manufacturers. China’s driverless car market is set to become the largest in the world.

There are other potential catalysts and a return to topline revenue growth in the online advertising division could also have a significant impact. Revenues have stabilized from the volatility seen over the last few years. A third catalyst could come from the recent tie up with iQiyi, Baidu’s leading online video platform, with 36% mobile time spent market share, which is well ahead of Tencent’s 25% and Youku Tudou’s 23%.

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A recent article in Barron’s highlighted that iQiyi could extend its lead after outlining future plans at its annual Technology and Entertainment World conference. Barron’s highlighted that the launch of Netflix content later this year with iQiyi could potentially be a game changer. Other catalysts include the release of drama sequel to “Candle in the Tomb” and “Nirvana in Fire” later this year as well as the expansion of the subscription model to appeal to more genres. iQiyi is projecting total revenue growth of c.70% with subscription revenue contributing as much as advertising in 2017.

Barron’s reported that “Paid subscriptions are expected to contribute a greater share of iQiyi’s top line. iQiyi will expand its paid subscription model beyond premium movie, drama and in-house content to more genres including animation, documentaries, etc.”

iQiyi’s ad revenue alone could grow at 25-30% in 2017 driven by the recent launch of there in-feed ad program. Stockbroker Jeffries endorsed their recommendation on Baidu emphasizing that “iQiyi’s revenue growth estimate of c.70% and expectations that subscription revenue will contribute as much as online advertising in 2017, compared to a 30/70 split in 2016.” Jeffries has a buy rating on Baidu with a $208 a share target price, which implies 20% upside from current levels.

Having cleared a converging triangle range, further upside should ensue for Baidu in my opinion with the company clearly being the cheapest in terms of valuation of the “Big 3” and with a number of powerful positive catalysts on the horizon.

We have stuck to our knitting to some degree in recent months, favouring the larger caps which are a play on rising interest rates, and higher rates of inflation. This has included the insurers, and particularly QBE which we cited as one of our top three conviction buys in Australia at the start of the year (the other two being Fairfax and Evolution Mining).

QBE hit a key inflection point last year, and has grinded upwards slowly this year, adding 8% in 2017, and up 1.2% yesterday. The stock remains highly correlated to the 10 year US T, and the real upward price action will come when the US yield curve begins to steepen. It is encouraging that following a recent flattening in the US yield curve, QBE has hit medium term highs. Part of this has been due to a buoyant ASX200, but I would also counter that fundamentally after significant restructuring, particularly in the problematic US division, QBE is at least getting back on track.

After a decade long base building formation, the breakout in QBE when it finally arrives should be explosive. I expect the catalysts will be an inevitable steepening of the US yield curve and an ongoing fundamental recovery in QBE’s underlying business.

Mantra Group on the other hand already looks to be recovering nicely, and rose 2.35% on Monday to $3.05. Heavy resistance has capped Mantra around the $3.10 level, but each successive pullback has been shorter in depth and duration, whilst volumes have been increasing. Mantra is not due to report FY results until August, but given the tourism inbound numbers have been robust and continue to grow rapidly, this is the obvious catalyst for a significant rerating. Recent broker presentations have pointed to this.

I think that the accommodation operator is a strong play on rising levels of tourism within Australia (as well as overseas, with last year’s acquisition in Hawaii being good one). The consistent quality of the company’s properties continues to provide a key point of difference in combatting the competitive threats from disruptors such as Airbnb, which have been more than adequately priced in. Mantra is one of our significant positions in the Fat Prophets Global Contrarian Fund and the Australian Managed accounts.

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A Contrarians dream – Adapt, Survive, & Thrive

Mitsubishi UFJ Group (MUFG), the biggest bank in Japan, is reportedly planning a major restructuring of its headcount, potentially laying off up to 10,000 employees over the next decade (although likely a shorter period). That would be the biggest shake-up at the Japanese banking giant since the Japanese banking crisis in the 1990’s. At that time, Japanese banks were reeling from the aftermath of the popping of the asset bubble in the late 1980s and faced a double whammy from the broader Asian Financial Crisis in 1997.

Today, the health of the Japanese banking system is fine, but the introduction of the negative interest rate policy by the Bank of Japan in early 2016 further squeezed already thin net interest rate margins in Japan.

Banks in Japan, like elsewhere, are also facing stiffer competition in several areas from non-banking financial institutions and the rise of ‘fintech’ companies. Another factor is the continued slow decline of the Japanese population, which is a drag on residential credit demand. To a large extent though, we believe this will be offset by increased corporate activity in Japan. Companies flush with cash after several years of bumper profits should ramp up investment activity over the next few years.

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Most of the intended reduction in headcount is expected to be at home in Japan and the group reportedly currently employs roughly 147,000 worldwide. A 10,000, or seven percent cut in the headcount is material, but improvements in technology are driving productivity at banks everywhere. MUFG is reported to be considering closing some branches at home and boosting investment in digital initiatives.

The move is likely an acceleration and expansion of the group’s “Re-imagining” strategy discussed in May 2017, when the company outlined plans to slice some ¥120 billion (US$1.1 billion) of costs from the income statement the medium term, while boosting gross profits by ¥180 billion to provide a ¥300 billion boost to net operating profits. That represents an approximate 20% plus 1,41increase from reported net operating profits of ¥1.42 trillion posted for the fiscal year ending March 2017.

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Mitsubishi UFJ Group

The company said it planned to enhance its payment platform, accelerate its asset management and wealth management businesses and invest in technology to improve customer convenience, re-engineer business processes and reform customer interface channels at home and abroad. The company also highlighted productivity initiatives, optimizing resource allocation at the group level and finally reorganizing its management structure.

Japan’s negative interest rate policy curbed profits for Japan’s banks in the fiscal year ending March 2017 compared to the prior year, which also impacted Mitsubishi UFJ. Net operating profits at MUFG declined 8.9% year-on-year to ¥1.42 trillion, but that result was better than most peers. MUFG has been the most aggressive of the Japanese megabanks at building out its overseas operations, which buffered the impact somewhat.

Mitsubishi UFJ snapped up a 23% cornerstone stake in Morgan Stanley during the GFC for a bargain. California-based Union Bank also became a wholly-owned subsidiary in 2008 and by the end of March 2016 its combined banking operations in the United States ranked 15th by deposit base. The group has its sights set on cracking the top 10 in the US over the medium term. Mitsubishi UFJ has also established a material footprint in Southeast Asia.

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Source: FDIC, MUFG

Mitsubishi UFJ is a core holding in our Global Opportunities and Asian Managed Account Portfolios. It is also a core holding in the Fat Prophets Global Contrarian Fund. We continue to view the investment case as compelling.

Should the Japanese economy continue trending positively, inflation is likely to pick up and provide the right backdrop for the Bank of Japan to remove its negative interest rate policy. If this occurs, it should result in a major positive rerating for the Japanese banks. We also hold positions in several other banks such as Mizuho and Sumitomo, along with regional player Bank of Kyoto.

Headwinds from NIRP are already factored into MUFG’s current earnings profile, with the stock trading on roughly 0.6 times book value.  The backdrop improved during the second half of the fiscal year, with a better performance from its overseas operations with higher margins from loans and higher fee income from the investment banking business helping.

Disclosure: The Fat Prophets Contrarian Fund declares a holding Mitsubishi UFJ, Bank of Kyoto, Mizuho Financial, Sumitomo Mitsui, Baidu, Mantra Group and QBE Insurance.

Carpe Diem!

CEO | Fat Prophets
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