Scottish Oriental Smaller Companies (SST) has announced its annual results for the year ended 31 August 2022, during which it provided an NAV total return of 10.0% and a share price total return of 10.3%. In comparison, it says that these compare favourably to the MSCI AC Asia ex Japan Small Cap Index, MSCI AC Asia ex Japan Index, and the FTSE All-Share Index which returned -0.9%, -7.1% and +1.0% respectively. The largest contributors to performance were from holdings in India and Indonesia, while the biggest detractors were from holdings in South Korea and the Philippines.
Manager’s comments on the top five contributors
“Mitra Adiperkasa benefited from higher customer footfall across its retail and restaurant operations in Indonesia. During the Covid-19 led disruption, the company’s management took several initiatives to shut down unprofitable stores and reduce operating expenses. As growth in same store sales resumed, these measures led to a substantial improvement in the company’s profitability. The introduction of new brands such as Subway and Foot Locker should sustain the company’s growth momentum.
“Mahindra Lifespace rose after it reported a substantial increase in revenues and profit. The company’s management, led by a new Chief Executive Officer (CEO) appointed in 2020 has focused on faster land acquisition and increasing the number of project launches. The company has also been benefiting from the trend among Indian residential property buyers of moving rapidly away from local developers to larger companies such as Mahindra Lifespace. This is expected to continue to drive an acceleration in demand for its residential projects.
“Blue Star reported strong growth as the company continues to gain market share in the under-penetrated Indian air-conditioning industry. Its engineering, procurement and construction (EPC) projects business is also benefiting from increasing demand due to higher infrastructure and industrial investments. As the expectation is for the Indian air-conditioning industry to grow rapidly in the coming years, the company is making significant investments in its manufacturing, distribution and service capabilities to gain more market share.
“Kei Industries rose after it also reported strong growth in revenues across its cables and wires operations. The company has benefited from an acceleration of the growth in the sales of branded consumer cables, which has higher profitability and lower working capital needs compared to its unbranded power cables segment. As its valuations have become expensive after its strong performance, we have reduced the Trust’s holding.
“Oberoi Realty also benefited from strong demand for residential property and the increasing preference among consumers for projects developed by reputed developers with strong balance sheets. The company’s commercial and retail operations gained from higher mobility levels. New land acquisitions made in recent periods put Oberoi in a strong position to sustain its growth.”
Manager’s comments on the top five detractors
“Solara Active Pharma suffered from oversupply in a key product, due to which its sales declined sharply and the company also wrote down the value of its inventory. The management also cancelled its plan to merge with Aurore (announced last year), as Aurore did not meet its performance expectations. Demand for its key product is normalising gradually and the company is building new customer relationships. Their medium-term prospects remain strong as it launches new active pharmaceutical ingredient (API) products.
“Ace Hardware Indonesia declined after it reported slow improvement in same store sales growth. The company was impacted by rising competition from e-commerce platforms and new large format stores such as IKEA. Ace has launched initiatives such as WhatsApp based shopping to mitigate this risk. It is also experimenting with smaller format “Ace Express” stores to accelerate growth. The management expects a gradual improvement in demand over the coming periods.
“NHN KCP declined as the company’s profitability was impacted by weak growth in its business with overseas clients, which earn high levels of profitability, while it continued to make investments to support its growth in the coming periods. The company’s management has paused hiring to control costs. As the company’s new contracts with large overseas clients are finalised, profitability is expected to improve.
“JNBY Design was affected by movement restrictions across Chinese cities. Over this period, the company’s investments in digital channels helped to mitigate the decline in its offline retail operations. JNBY successfully dealt with the initial disruption of Covid-19 in 2020, which was followed by a strong rebound in profitability as movement restrictions reduced. We added to the Trust’s holding given the company’s attractive valuation and its track record of successfully dealing with such disruptions.
“Vitasoy International reported poor revenues and profitability as it was affected by lower sales of its beverage products due to movement restrictions in China as well as a temporary disruption to its fast growing business in the country. The company has increased investment in marketing and its revenues in China recovered significantly during the second half of the year. The company has also hired several experienced professionals, including a new CEO for its China operations, to support the growth of its business in the country.”
Manager’s comments on recent portfolio activity
New Holdings
During the year, seven new holdings were added to the portfolio.
“Autobio Diagnostics (‘Autobio’) is the leading in-vitro diagnostics (IVD) reagent and machine manufacturer in China. The immunological IVD market in China is large and has grown consistently, as the penetration of diagnostic services has risen. Multinational companies dominate the industry, however, domestic manufacturers have gained market share in recent years. Autobio has built a leading position by consistently improving the quality of its products, which are now comparable to leading multinationals in many areas. The company’s management is ambitious with a target of gaining market share in its existing categories, while also entering new segments.
“Computer Age Management (‘CAMS’) is India’s largest registrar and transfer agent of mutual funds with a dominant market share of 70%. CAMS’ outsourced back-office services allow its asset management clients to focus on their core business and reduce costs. The company has significant growth potential, as households increase their investments in financial assets from a low base currently. The management is also building new businesses such as Account Aggregation and an insurance repository that could increase in size in the coming years. This provides the company significant growth potential over the long-term, while its asset light business model leads to returns on capital employed (ROCE) in excess of 100%.
“Escorts Kubota (‘Kubota’) is a leading Indian tractor and construction equipment manufacturer. The company was founded by the Nanda family in India, which continues to lead its operations. In 2021, Kubota acquired a majority stake in the company. Escorts Kubota is expected to benefit from the technological and managerial expertise of the Japanese parent, which should help the company launch new products and improve operational efficiency. Kubota also plans to use the company’s low cost Indian manufacturing base to gain market share globally, which adds to the company’s growth prospects.
“Haitian International (‘Haitian’) is the leading plastic injection moulding machine (PIMM) manufacturer in China. Based on its scale advantages as the market leader, the company earns attractive levels of profitability and returns on capital employed across business cycles. In recent periods, its growth has been negatively affected by the cyclical downturn in China. Over this period, Haitian has gained market share and is shifting its product portfolio in favour of machines with higher clamping force, which earn higher levels of profitability. The strong growth in electric vehicles should lead to an improvement in the company’s growth prospects in the future. It is also expanding into markets outside China, using its strong, net cash balance sheet.
“Parade Technologies (‘Parade’) is an integrated circuit designer. Its products facilitate high-speed data transmission across electronic devices. It has built leading market shares in its key products such as high-speed interface integrated circuits and embedded display port timing controllers. The management has also built strong relationships with large customers such as Apple, with which Parade has maintained a monopoly position in certain products. Data transmission speeds have been increasing consistently across devices. Higher speeds require new products, which drive higher prices and better profitability for Parade. Data transmission speeds are likely to continue rising. Parade is also the first mover in building new products with applications in servers and automobiles. These can become large addressable markets for the company in the years ahead.
“Avia Avian (‘Avian’) is the market leader in Indonesia’s decorative paint industry. Avian’s extensive distribution network has helped it gain market share from its competitors who are dependent on third-party distributors. The company has also established dominant positions in niche areas such as waterproofing paints as well as wood & metal paints, which have historically not been areas of focus for multinationals. The Indonesian paint industry remains fragmented. We expect Avian to lead the industry’s consolidation in the coming years. Its vertical integration allows it to earn high margins and returns on capital employed. It also has a strong net – cash balance sheet that should support its growth.
“Sporton International (‘Sporton’) is the market leader in the electromagnetic testing and certification industry globally. As various electronic applications upgrade to new technology standards, the addressable market for the company’s testing and certification business should grow consistently. Following years of investments in research and development, Sporton has built a leading position in the niche electromagnetic testing category. The introduction of fifth generation broadband cellular technology (known as 5G) is leading to improved prospects for its revenue growth. Its high market share also allows Sporton to earn attractive levels of profitability.
Portfolio sales
Nine holdings were sold during the year. Of these nine, six were sold as their valuations became expensive following strong performance and share price appreciation. These were Thermax, Mr. DIY Group, CTOS Digital, Mphasis, Metropolis Healthcare and SKF India.
“Emami was sold due to increasing risks to its profitability following a sharp increase in raw material costs. Its management intends to focus on improving its growth prospects, due to which it may not be able to raise prices adequately to cover these cost increases. Its valuations had also become relatively expensive after appreciation in its share price.
“China Overseas Grand Oceans Group and Zhejiang Weixing New Building Materials were sold due to concerns related to a significant slowdown in the Chinese residential property industry. We expect this to impact the growth prospects as well as profitability of both companies.”
Purchased and subsequently sold
“We purchased a holding in OZ Minerals, a leading copper and gold miner in Australia. The company has a strong track record of developing high quality copper assets operating in the first quartile of the global cost curve. Its management has also achieved its growth while maintaining a net cash balance sheet. It has significant growth prospects as it develops a new mine in Australia, which is currently at early stages of exploration. Based on its attractive prospects, BHP Group announced a bid for the company at a substantial premium to the prevailing price. As its valuations became expensive following the bid, we sold our holding in the company.”