Daily China: Inventory Clearance and the Semiconductor Cycle and more

In this briefing:

1. Inventory Clearance and the Semiconductor Cycle
2. Hujiang Education (沪江教育) Pre-IPO – Spending More than It Earns
3. China Meidong (1268 HK): Standout Story in Gloomy Auto Dealership Sector; Luxury Brands Outperform
4. RIO & BHP:  Valuation Gap Gone; Closing Long-Rio/Short-BHP
5. RRG Global Macro Weekly – Dramatic Brexit Defeat A Positive for Markets? We Are Not So Sanguine

1. Inventory Clearance and the Semiconductor Cycle

A very normal part of the semiconductor cycle is inventory clearance.  DRAM makers are starting to discuss this in their earnings calls.  What they are NOT telling their investors is how significant this is to the onset of a price collapse, perhaps because they don’t understand it themselves.  This Insight will help readers to learn how and why an inventory clearance helps ratchet a budding oversupply into a full-blown glut.

2. Hujiang Education (沪江教育) Pre-IPO – Spending More than It Earns

Hujiang Education (1414698D CH) (HET) is planning to raise US$200m in its upcoming IPO.

HET has grown its revenue at an impressive 73% CAGR from 2015 to 2017 and has been accompanied by gross margin expansion. The strong growth was supported by improving operating metrics such as an increase in student enrollment and average spending. 

However, HET has been making losses and continues to spend more than its net billing. It is unclear whether HET had already achieved break even for its proprietary courses before expanding into its CCtalk platform. But from its high level of expenses, it seems unsustainable for HET to be relying heavily on the sales and marketing spending to get users to purchase online courses.

In this insight, we will look into the company’s financial and operating performance, regulatory risks regarding K12 courses, aggressive spending on sales and marketing, and the performance of other online education companies.

3. China Meidong (1268 HK): Standout Story in Gloomy Auto Dealership Sector; Luxury Brands Outperform

China Meidong Auto (1268 HK) has been on a rollercoaster ride in 2018. The stock price of Meidong started 2018 around 2.7 HKD and recently has been trading around 2.9 HKD.

Nice and steady ride? Not exactly, as it has swung from 4.3 HKD in June to 2.6 HKD in August. After analyzing how NPAT estimates evolved over the past year there should be no justifications for these wild swings. 

Meidong is likely to report solid FY18 results by late March vs industry peers which are expected to report a weak 2H18. While BMW dealers have been reportedly suffering in China during 2018, Meidong was fortunate to have other luxury brands pick up the slack.

FY19 should be another growth year for Meidong as 1) recently acquired BMW showrooms contribute their maiden results and 2) other luxury brands continue to perform despite overall doom and gloom in the Chinese auto market. Should the Chinese government launch car replacement stimulus measures this would be icing on the cake.

Fair Value lowered slightly from 4.7 HKD to 4.4 HKD (10x 2019E) on lower 2019 profit estimates, which leaves 52% upside excluding dividends.

4. RIO & BHP:  Valuation Gap Gone; Closing Long-Rio/Short-BHP

Investment Conclusion:
We recommend closing our long-Rio Tinto Ltd (RIO AU)/short-Bhp Billiton (BHP AU) following recent trading updates from both companies which helped to narrow the previous valuation gap we identified in our Aug-18 note: US$20bn in Lost Market Cap Looks Hard to Justify: Recommend Long Rio; Short BHP

5. RRG Global Macro Weekly – Dramatic Brexit Defeat A Positive for Markets? We Are Not So Sanguine

The dramatic defeat of PM May’s Brexit arrangement with the EU was seen by the markets as a positive development. Apparently the markets believe that this could result in Britain remaining in the EU.

While we agree this would be good news we consider it unlikely without many more months or years of uncertainty as another referendum is organized and implemented.

Romania: GDP in Q3 grew 4.4% y/y, up from 4.1% in Q2. The country’s economy is doing better than most EU countries.
Brazil: The CPI in Dec rose 3.7%, down from 4.05% in Nov. Lowest rate since May, as prices slowed for food and fuel.
India: The trade deficit in Dec narrowed to $13.1 bn. Exports rose a meager 0.3% and imports fell 2.44%. GDP growth of 7% is expected for this year and next..