Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by Mark Asquith, Manager of the Somerset Emerging Market Small Cap Fund to give his three stock picks.
Hello Mark.
Mark Asquith: Hi Emma.
Wall: So, what's the first stock you'd like to highlight today.
Asquith: The first is Hering ( in Brazil. Who are well-loved clothing brand. Who mismanaged their franchises quite badly just at the time when the slowdown started to hit about four years ago. So, we bought them last year when they had fallen 80% in dollar terms from their peak. They were making credible efforts to turn around first their brand and then their franchises and the retail experience. Strong balance sheet, 15% free cash flow yield at that point meant that we were paying to wait effectively and we could see if there was any credibility to this.
So, we spoke to the CFO earlier this month after what he described as the toughest quarter in 20 years. And he came up with one of those great quotes we always like, signifies a bottom possibly, which is; we have a future, but we have no present. And this is similar to what one of our Indian banks said at the trough of their share price, which is the light is nowhere. When a businessman comes up with a quote like this you know it's been drawn out of a sense of real pain.
What he meant by that was that the supply side was in tremendous pain. There was no and there is no real pickup in demand although you see confidence indicators marginally improving in Brazil. There is not much sign of it in the stores. But their competitors are going bankrupt especially the small medium sized one. The 10% to 15% reduction you are seeing in sales area is a result of that. They are discounting heavily on the way down, but they will not simply go out and provide more competitive landscape.
Meanwhile Hering is down to a deep period of introspection which is only going to improve its business. And what we like about it most is how much everyone else hates it at the moment. There are 17 analysts covering Hering not a single one has a buy recommendation. This is for a stock which still has got a nice balance sheet and 5% dividend yield so there is a future. But we are going to have to wait still a bit for them.
Wall: And what's the second stock today.
Asquith: The second one is KVB which is an old Indian private sector bank. Concentrated mainly in the south of India. They are 90% deposit funded, nice steady funding. Got a very good traditional business lending to small and medium size enterprises. Where they went wrong was to start lending to big corporates just as the credit cycle turned again about 4 years ago. And the positive is they were quick to learn from their mistakes.
They are conservative in their accounting of NPLs, well-provisioned, lots of collateral behind the loans and they have got a very good record on recoveries. So, what you should get is a nice recovery cycle as they begin to bring back some of the collateral on those loans. And you've got good fundamental underlying growth in Southern Indian small and medium size enterprises. This 9% market cap to deposits is really very cheap bank and so we like that as another survivor.
Wall: And what's the third and final stock.
Asquith: The third one is Padini in Malaysia. Who are a Malaysian fashion retailer, less than a brand. They have probably been through most of their pain now. Their hallmark is adaptability. And over their 40-year lifespan they have been very good at repositioning themselves in the light of new circumstances and you have to do that if you are selling cloths and fashion.
They did this about 4 years ago when there was new foreign and local competitive threats coming in. They repositioned their prices lower and bought out a new retail format called Brands Outlet which is basically like Primark. And that’s been very successful and after a period of pain they have actually opened new avenues of growth outside the Kuala Lumpur Klang Valley area into less metropolitan, slightly poor, but underpenetrated markets. You've got this well-run family business at less 13 times earnings now after 80% earnings growth this year. They had a slight weak quarter just a couple of weeks ago. But that’s mainly on the cost from new store openings both gross and renewed company. So, that’s our third stock.
Wall: Mark, thank you very much.
Asquith: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
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