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Fidelity China board introduces discount target after year of poor performance

Fidelity China board introduces discount target after year of poor performance – Fidelity China Special Situations has published results covering the year ended 31 March 2019. It wasn’t a great year for the trust, which saw an NAV total return of -5.3% as compared to a benchmark (MSCI China) return of 0.9%. The share price return was -0.3%, reflecting a narrowing of the discount. The dividend has been increased by 10% to 3.85p. The chairman lays the trust’s underperformance on small and medium sized companies lagging larger ones and stresses the company’s outperformance over five years.

Discount control mechanism

The board has decided to adopt a formal discount control policy whereby it will seek to maintain the discount in single digits in normal
market conditions and will, subject to market conditions, repurchase shares with the objective of stabilising the share price discount within a single digit range.

Extract from the Q&A with the manager

Underperformance over the year predominantly came in the six-month period from 30 April 2018 to 31 October 2018 when the market fell into bear market territory. Larger declines were in the consumer and technology related areas of the portfolio, which is disappointing given this remains the key thrust of the portfolio. Whilst execution by some companies has disappointed, I remain confident in the long-term outlook for the majority of names in the portfolio. Being geared in this environment also hurt performance. 

The portfolio saw strong returns from long-term holdings CITIC Telecom, Yihai International and China Meidong Auto. Macau telecom operator, CITIC Telecom, continued to report stable earnings and cash flow and an increase in its dividend payout was well received in the market. Hot pot condiment manufacturer Yihai rose more than 68% over the year as its restaurant partner, Haidilao, continues to roll out new restaurants successfully across China and had a highly successful IPO. Furthermore, Yihai grew third-party sales, especially in condiments used for home cooking. China Meidong Auto is a car dealership that has been held in the portfolio throughout my tenure as Portfolio Manager of the Company. Once again, it reported rising profits, despite a tough environment for auto sales, supported by ongoing growth in the margin-accretive after-sales care and servicing business.
The portfolio also saw a significant return from Aurora Mobile, a mobile data solution platform. This was an unlisted holding added to the portfolio in 2017 which listed in the US in July 2018. The holding’s value was increased ahead of its IPO, and while it had a very volatile start, the company has generated significant value for shareholders.
The three largest detractors from relative performance actually came from not owning large, relatively defensive and mostly State Owned Enterprises: China Mobile, CNOOC and Ping An Insurance.
Goodbaby, a baby product manufacturer, also declined over the review period. Its key US distributor, Toys R Us, went into administration and this has severely disrupted its US business, and we are yet to see the benefits of various restructuring efforts which have hurt earnings in the short-term. While admittedly we need to see better execution going forward, the potential for improvement in operations supported by strong brands combined with an attractive valuation, the risk-reward balance is positive for the company from here on. China Pacific Insurance, a larger bet in the portfolio, also underperformed. This has been driven by concerns over margins and investment returns which, I believe are overdone, and with the company near trough valuations, this remains a core holding.

FCSS : Fidelity China board introduces discount target


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