Investors watch the stock trading board at a securities exchange house. (Photographer: Qilai Shen/Bloomberg)

Cash-Flow King for Templeton Seeing More Riches in China Stocks

(Bloomberg) -- In the midst of last year’s Chinese stock sell-off and the deepening trade dispute with the U.S., Franklin Templeton took a long, hard look at its China strategy before reaching an inescapable conclusion: stay the course.

Twelve months later, that conviction is starting to pay off handsomely, with the Shanghai Composite Index of mainland stocks rebounding 28 percent this year to become the world’s best-performing equity index. And it’s a strategy the company isn’t ready to dispense with.

“We haven’t let the crisis of last year get in the way of our thinking,” said Manraj Sekhon, chief investment officer for Franklin Templeton Emerging Markets Equity. “We stayed very close to the companies. We took a look at what they’re doing. We have all these wonderful teams on the ground that give us an idea of the demand picture."

Sekhon’s optimism is partly a bet on a stable Chinese economy and partly a bet on a growing dynamic across emerging markets as a whole: an increase in free cash flows -- or cash left over after a company pays for its operating expenses and capital expenditures -- that’s likely to reward shareholders with more dividend payouts and stock buybacks.

Cash-Flow King for Templeton Seeing More Riches in China Stocks

In the face of a more dovish Federal Reserve, easing of trade tensions and growth concern in China, the MSCI Emerging Markets Index of stocks has rebounded more than 12 percent this year, after falling 17 percent in 2018. Similarly, the Shanghai index has rebounded following a 25 percent slump last year, the worst since 2008.

  • The MSCI EM index’s free cash flow per share could surge about 70 percent over the next three years from the end of 2018, according to Franklin Templeton, citing estimates from FactSet.
  • China is probably on a more “sustainable footing than it’s ever been for a while” with a better balance between domestic demand and exports, its banks behaving in a “much more rational way” and debt being controlled.
  • Chinese stocks comprise the biggest share in the $1 billion Templeton Emerging Markets Fund at 23 percent, based on the latest factsheet from the company. The fund had an annualized total return of 13.6 percent in the past three years through March, compared with 11.1 percent in the MSCI EM gauge, according to the firm.
  • Companies including those in South Korea, Taiwan and Russia like Samsung Electronics Co. and Lukoil PJSC are behaving more efficiently and rationally on how they treat shareholders.
  • Over the course of 2019, more companies in developing nations should upgrade their earnings as demand picks up by the second half. That should boost sectors such as consumer goods, technology hardware, semiconductors, and selective financial services in places like India, Indonesia and Brazil.
  • The MSCI EM index’s price-to-earnings ratio will probably rise to "mid-teens" by the second half. The gauge is currently trading at 12.4 times of its 1-year forward earnings estimate, according to Bloomberg data.

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