MSCI iShares Taiwan 23 Jan 14

Fat Prophets take profits

We have held a long established exposure to Taiwan, gained through our recommendation of the MSCI Taiwan iShares (LSE, ITWN) back in FAT-UK-122. At the time the country’s stock-market had stagnated for more than decade, and we believed that it was on the cusp of a re-rating.

Rapid growth and a successful export industry had helped Taiwan become a creditor nation, with the world's third largest stock of foreign reserves and solid economic growth of around 4 percent. Our investment thesis was also based on an expected expected thawing of relations with neighbouring powerhouse China that would provide a further fillip to the tech heavy market. The market’s valuation also appealed, trading on 13 times earnings and offering a 4 percent yield.

A re-rating did ensue although this was interrupted somewhat severely by the GFC. And whilst the market has recovered since, we are somewhat conscious that the ‘Taiwanese story’ is not as compelling as it once was.

Firstly the country’s growth rates have become sluggish on the back of weaker Chinese demand. And added to this is that other neighbouring countries also appear to be stealing a march on the relationship with the Asian dragon. A reluctance to engage in competitive currency devaluations is also seeing the country lose out to other rivals.

Meanwhile the valuation of the Taiwanese stock market is not as compelling as it once was with a forward earnings multiple for 2014 of 15.4 times and a dividend yield of  2.7%.

We are therefore advising Members to bank profits and sell their shares in MSCI Taiwan iShares.


From a technical point of view ITWN has been trading in an uptrend channel since end 2011. Although after failing to break above 2350p , prices have moved lower recently. The near term technical outlook is somewhat challenged in our opinion, and it would take a break out of this continuation pattern for the long-term uptrend to resume.

Growth Softens

Taiwan’s GDP growth has been hampered for much of the past two years by weaker Chinese growth, as the Asian dragon is Taiwan’s largest trading partner. The extent of the decline was also somewhat of a surprise to the government with initial projections of achieving 3 percent growth for 2013 downgraded to 1.74 percent.

The global economic revival is likely to see this performance improve measurably this year, with medium forecasts for GDP growth coming in at around 4 percent. This would of course be satisfactory but what concerns us is that these estimates may miss by a wide mark.

One issue for the country is that, despite low inflation, the Chinese central bank is refusing to engage in currency devaluations to improve regional competitiveness for Chinese companies. This is the subject of much debate in Taiwan with many companies, including Taiwan Semiconductor (the largest constituent in the index and iShare) arguing that the New Taiwanese dollar is overvalued versus regional currencies. The government however looks likely to buckle on this though.

A second issue is China which as Taiwan’s largest trading partner is essential to economic well-being. Taiwan has made great progress in recent years in thawing historically frosty relations and opening up trade with China, and should be ideally placed to piggy back the revival of economic momentum on the Mainland.

However there have been delays in ratifying a trade pact which was agreed with China last year to ‘open up service sectors’. This should be a no-brainer but the deal has not cleared legislature with concerns over the impact on local industry and the job market.

Delays over the pact are now causing doubts among Taiwan’s trading other trading partners over the need to sign free trade agreements. And arguably the delay is also creating an opportunity for the likes of South Korea which is currently negotiating its own free trade agreement with China. South Korea is also a tech savvy nation and some would argue with better technology than Taiwan. Therefore the longer the delays drag on, the more Taiwan could be marginalised, further dampening any rebound in growth.

And this is perhaps being recognised by investors. Approved foreign and overseas Chinese investment in Taiwan totalled US$4.9 billion in 2013, down 11.25% year-on-year, according to Taiwan's Investment Commission of the Ministry of Economic Affairs.

 

Impact on ITWN

The MSCI Taiwan iShares is a proxy for the Taiwanese market and therefore the current headwinds that the economy may face over the next year or two will have a direct impact.

As the below graphic shows the index has a tech and export heavy base with 53.35% of constituents in IT. Clearly the prospect of Taiwanese firms continuing to cede further ground to regional competitors due to a higher currency and a drag in a free trade agreement with China will have a negative impact on earnings and valuations. 

Source: iShares MSCI Taiwan Index Fund ETF webpage

We also note there are also specific headwinds facing the largest holding in the portfolio, Taiwan Semiconductor which makes up almost 20% of the ETF.

Source: iShares MSCI Taiwan Index Fund ETF webpage

Dr Morris Chang the founding chairman of Taiwan Semiconductor is about to step away from the CEO role. It is fair to say he is widely considered the father of Taiwan’s chip industry and his voluntary departure in the next few months may have knock on impacts to sentiment, and potentially strategic direction.

Taiwan Semi is also facing increasing competitive pressures. Although the company is unequivocally the leading independent foundry, the competition is always fierce and is currently mounting in the 28-nanometer node. Taiwan Semiconductor has built a lead in this area, which has been a resounding success for the company and helped drive margins for the chipmaker. 

Recent indications are that other foundries have made solid progress on the quality of their 28-nanometer technologies. Although we expect Taiwan Semiconductor to retain its lead in terms of overall market share, growing competition is likely to mean more pricing pressure for the company kin an area which accounts for 30 percent of sales. .

 

Therefore with a change of CEO about to occur, intensifying competition in the 28-nanometer node and some technology risk to come from next-node production, we believe the ETF’s largest holding could come possibly under specific selling pressure this year. This would also of course have knock on effects to the market’s and ETF’s performance.

Source: ITWN factsheet

Summary

Whilst we remain positive on the tech story that the Taiwan market represents we also acknowledge that the valuation of the market is not as cheap as once was.

And with Taiwanese companies facing a number of headwinds versus regional competitors we believe now is the time to exit.

Consequently, we recommend Members sell the MSCI Taiwan iShares. The holding will be removed from the Fat Prophets Portfolio.

 

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