HK Housing: Fear of Losing Out Part 2 – Money Supply

According to my high school economics teacher, the price of a product is set at where the supply and demand curves intersect. Theoretically, if some force were to act on the supply or demand curve and shift it inwards or outwards, this will result in a new equilibrium price. This is how things are supposed to work.

Source: Wikipedia


As we noted last week, Hong Kong’s housing supply has increased by 31% over the past three years. Whether this was due to higher prices causing developers to increase supply (i.e. moving up the supply curve) or a more proactive government supplying land (i.e. an outward shift in supply curve) is up to debate. What is clear is that supply has definitely increased.

Ironically, Housing Demand is Driven by Money Supply

This week, we turn to the demand side of the equation. Ironically, in order to gauge housing demand, we will be looking at “Money Supply”.

M1, M2 and M3. No, not BMW’s but Money Supply

Embed from Getty Images

Simply put, money supply is how much money there is in circulation or in existence in a country. Economist generally measures money supply using three terms – M1, M2 and M3.

  • M1 is the narrowest definition. In Hong Kong, it would include all of the physical notes and coins in the hands of the public as well as demand deposits in the bank. As of Oct 2017, Hong Kong’s M1 money supply stood at HK$2,997bn.
  • M2 includes all of M1 and adds all of the deposits with licensed banks (i.e. savings deposit, time deposit and negotiable certificate of deposit). As of Oct 2017, HK’s M2 money supply was HK$13,951bn, roughly 4.7x the size of M1.
  • M3 includes all of M1 and M2 and further adds deposits with restricted licence banks and deposit taking companies. In HK, M3 is only slightly larger than M2 at HK$14,003bn.

M3 has increased 27% over the past three years

Over the past three years, Hong Kong’s M3 money supply has increased by 27% from HK$11trn to HK$14trn. Narrow money supply, M1 (i.e. the notes and coins in circulation as well as demand deposits) increased by 71% from HK$1.75trn to HK$3trn.

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If one were to go back to the onset of the Global Financial Crisis back in October 2008, Hong Kong’s broad money supply, M3, has more than doubled, rising 131% from HK$6trn to HK$14trn.

Incidentally, home prices have risen 27% also

Incidentally, between October 2014 to October 2017, Hong Kong’s home price index has risen by 27%. And between October 2008 to October 2017, the Rating & Valuation Department’s home price index has increased by 196%.

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That’s the past, what about the next three years?

Looking back, we can reason that with a larger pool of cash shifting out the demand curve, asset prices have increased. Now, the questions is what will happen to Hong Kong’s money supply in the next three years?

The way that I see it, there are three factors at play.

  1. Potential in/outflow of global liquidity
  2. Will HK banks increase their loan-to-deposit ratios?
  3. Change in reserve ratio and discount rate

Central Bank balance sheet expected to shrink sometime in 2018

Hong Kong being a small open economy has and will be subjected to change in global liquidity conditions. Over the past 10 years, a big driver of its money supply has been the expansion of the various Central banks’ balance sheets. Looking ahead, with the US Fed starting to allow its holdings to roll off and the ECB expected to taper its asset buying program, Central bank balance sheets are expected to start to shrink sometime in 2018.

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Source: JPM AM via Business Insider

Will HK banks increase their loan-to-deposit ratios?

Assuming that global liquidity flows are unchanged, another way to increase money supply would be for the banks to increase lending by raising their loan-to-deposit ratios. As of October 2017, Hong Kong banks’ loan-to-deposit ratio is only around 71%. Although this has risen by more than 10pp since 2008, one could argue that there is still scope for this figure to head higher and banks to lend more.

Screen Shot 2017-12-04 at 4.11.54 PMHowever, if one were to consider the rise in household debt, I have my doubts on how keen the banks are to further increase their lending to households.

According to the HKMA’s Half-Yearly Monetary and Financial Stability Report, Hong Kong’s household debt-to-GDP ratio has climbed to 68.3% in 1H 2017. Two things shout out at me when I look at the chart below. Firstly, 68.3% is the highest household-debt-to-GDP that Hong Kong has seen since 2000 when the data started. Secondly, look at the breakdown of this debt. Mortgage and credit cards have remained broadly stable but “Loans for other private purpose” has driven almost the entire increase in household debt.

Screen Shot 2017-12-04 at 4.12.43 PMI’m not sure what this is but judging by the commercials on prime time television, it is probably people consolidating their credit card debt or taking out high interest loans to fund their down payments to fill the gap from residential mortgage LTVs have been capped.

For now, as long as liquidity is plentiful and asset prices are rising, this number may yet rise. But my guess is that when the tide goes out, this would be one of the charts that people point to and say we should have seen it coming.

Change in reserve ratio and discount rate

Just like the first two questions, the reserve ratio question is debatable. Some would argue that although the discount rate has risen from its low of 0.50% to 1.50%, it is still very low and Central banks would surely come to the rescue and cut reserve ratios and discount rates on any sign of trouble.

This could happen but unlike 2007 when the discount window was reduced from 6.75% to 0.5% within a span of 18 months, there is a lot less ammo this time around. Furthermore, with the HKD pegged to the USD, for our base rate to be cut, it would require a synchronised downturn with the US.

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Three key takeaways on demand

  • Hong Kong’s money supply has increased by 27% and 131% since October 2014 and October 2008. This is coincidentally close to the 27% and 196% increase in local home prices over the same period.
  • Will HK’s money supply continue to expand in the next three years? Well, we know that:
    • the G4 Central bank balance sheet is expected to start shrinking sometime around Q2/Q3 2018.
    • Although overall LDR at 71% is still low, HK’s household debt-to-GDP ratio at 68% is the highest that it’s ever been at. Furthermore, this increase has almost entirely been driven by “Loans for other private purpose”

For the die-hard property bulls, yes, it is possible that Central banks can put off shrinking their balance sheet and banks can increase their lending even more. But, with the Fed clearly spelling out their asset reduction program and household debt-to-GDP at the highest levels ever, to hope that Hong Kong’s monetary base will expand at the same pace would require one to turn a blind eye to some clear and present risks.




HK Housing: Fear of Losing Out? Part 1 – Supply Snapshot

If after ten minutes at the poker table you do not know who the patsy is—you are the patsy.      Poker Proverb

Hong Kong is one of the most expensive and most unaffordable housing markets in the world. This has been the case for years but 2017 has taken us to new heights. Year-to-date, home prices have soared another 11%. Through the first 10 months of 2017, home buyers have snapped up HK$199bn of new homes, up a staggering 36% over the same period last year.

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The fear of missing out

One of the biggest problems with buying a home is the emotional attachment. For most people, your home is the biggest investment you ever make. If you buy and the market falls, you risk a drop in your net worth. If you don’t buy and the market keeps going up, then you worry about the decline in your purchasing power. In a rising market, there is a huge fear of missing out.

Trust the process? Have the fundamentals change

With home prices having risen 28% over the past three years, my fear of losing out is starting to get the better part of me. Do you chase the market or do you trust the process? Have the fundamentals change to make this expensive market reasonable?

Taking a fresh look at HK housing supply

As a starting point, let’s take a look at Hong Kong’s housing supply picture. Although I’ve seen some of the headlines, I haven’t spent a lot of time with the detailed supply figures  for a few years. As I updated the various data points, I was struck by how much bigger the supply figures have become.

Primary supply up 31% since 2014

In December 2014, Hong Kong’s private primary housing supply (i.e. the amount of stock on the hands of the developers) was 74,000 units. As of September 2017, this figure has now reached 97,000 units, an increase of 31%.

chart (29)

Current supply equals 64 months of sales

Although housing sales (red line above) have also increased, supply (blue line above) has clearly outpaced demand. If one were to look at supply in terms of the number of months inventory (total supply divided by average monthly sales), the current supply pipeline is equal to 64 months of sales.

chart (28)

64 months is not particularly high in the historical context. In fact, since the data began in Q3 2004, the long run average months of supply has been 70 months. And when demand was particularly weak, the effective months of supply have been more than 150 months and as high as 208 months.

Composition of supply: Is it creating a false sense of shortage?

As I reviewed the supply picture, another key aspect that struck me was the composition of this supply. The Hong Kong government splits housing supply into (1) unsold units from completed projects, (2) unsold units from project under construction and (3) unsold units from disposed sites.

Since developers are allowed to pre-sell units within 20 months of completion, (1) and (2) [or the red and blue areas below] would represent the readily available supply that potential home buyers would see. However, as construction works begin on disposed sites, over time, the yellow part of the supply picture would transition to the red part, increasing the apparent supply to the market.

chart (30)

If one were to look the breakdown of housing supply, we can see that the percentage of supply where construction has not yet started (i.e. long dated supply) is now at 32%, near the highest that it has ever been at. On the flipside, the percentage from unsold units in already completed projects (i.e. leftover units) is at 9.3%.

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At this point, there is little incentive for developers to clear stock. However, if future demand should weaken and long-dated supply starts to turn into ready supply, the goldilocks environment that has driven price up 11% and primary sales up 36% may be difficult to replicate in 2018.

Three Key Supply Takeaways

Next week, we turn our attention to demand, specifically, how much money there is to chase after Hong Kong’s housing stock. In the meantime, our three supply takeaways are:

  • Private primary supply has increased 31% over the past three years to 97,000 units.
  • Although demand has been strong, supply has risen even faster At 97,000 units, this is equal to 64 months of supply (based on elevated demand).
  • The current supply mix has created a “false” sense of supply shortage. Of the 97,000 units, 32% are from recently disposed sites for which construction work has yet to start. As construction begins, ready-for-sale units will increase and potentially alleviate the perceived supply shortage.

How instant noodles reflect where you’re from?

When I say “Instant Noodles”, what’s the first image that comes to your mind?

Do you think of the cake of instant noodles that you cook in boiling water and add the packet of MSG? Or do you think of something more along the lines of “Cup noodles?”

Your choice of instant noodle says a lot about you

Before we go into how the type of instant noodle reflect who you are, let’s start by firstly reviewing the instant noodle market in Hong Kong and China.

Instant Noodle Market Growth is Anaemic in both HK & China

According to an industry report from Frost & Sullivan, Hong Kong’s instant noodle market was worth around HK$1.8bn. Over the past four years, growth has been anaemic with sales value only rising 0.5% p.a. while sales volumes have actually contracted by 1.3% p.a.

chart (14)

Although China’s instant noodle market is much bigger, it is also not growing much. The Rmb81bn of instant noodle sales in 2016 only represent a p.a. growth rate of 0.4% over the 2012-2016 period. Volume wise, the number of instant noodle serving has actually fallen by 3.9% p.a.

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Who eats more instant noodles?

In absolute terms, China’s 37.2bn serving of instant noodles is 90x larger than Hong Kong’s 415mn servings. However, if you consider that China’s 1.3bn population is actually 186x larger than Hong Kong’s 7 mn population, the data actually shows that Hong Kong people actually eat more instant noodle than their mainland cousins.

HK 59.2 servings Vs. China 28.6 servings

In 2016, Hong Kong people ate 59.2 servings of instant noodles, almost twice as much as the average 28.6 servings consumed by those in China.

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What do you eat? Cups, Bowls or Bags

When we examine the data further, we see another interesting distinction between Hong Kong and China’s instant noodle connoisseurs. In Hong Kong, bag-type instant noodles make up nearly two-thirds of the overall sales volume. In China, the mix is almost 50/50 with bags taking up 53% of sales.

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In this respect, if you associate instant noodle with those that come in a little plastic bag that you cook yourself, then you’re most likely from Hong Kong. Conversely, if you think about pouring water into a little cup/bowl then you’re most likely from China.

What brand do you prefer? 出前一丁 or 康師傅

If you go to a Cha Chan Teng in Hong Kong and order instant noodle for breakfast, you are usually given a choice of upgrading to 丁麵 (Demae Iccho) for a few extra bucks. But what you may not realise is that in Hong Kong, 出前一丁, 公仔麵, 福麵 and Cup Noodles are all carried by Nissin Foods.

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The multiple brand strategy has helped Nissin Group become a clear leader in the Hong Kong market with a market share of 65.3%. Nong Shim (maker of Shim Ramyun) and Sau Tao, are a very distant second and third and only have a 5.5% and 5.4% market share respectively.

In China, the names are very different. Taiwanese noodle makers like Tingyi (康師傅) and Uni-President dominate the instant noodle market and hold market shares of 46.5% and 17.8% respectively. Nissin Foods is much smaller and only holds a market share of 2.8%.

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So if you associate instant noodle with Cup Noodle and 出前一丁, you’re most likely from Hong Kong. On the other hand, if you think of 康師傅 or 來一客, then you are most likely from China.

These two distinction is even more stark when you consider the revenue breakdown of Nissin Foods in the two areas. In Hong Kong, the revenue split between Bag type instant noodles, cup/bowl type and frozen foods are almost even at 39/28/33. Whereas, in China, the revenue split for Nissin Foods is 85/13/2 .

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The Premium-isation of Instant Noodles

In a way, China’s instant noodle market is very unique. Unlike the other industries that we have looked at in our Mass Consumption series (travel, beer, coffee and fried chicken, online games), the instant noodle market is NOT growing. In fact, Frost and Sullivan forecast that the number of instant noodle servings will decline from 2016’s 37.2bn to 34.5bn in 2021E.

With volume in decline, the only way to make more money is to try to raise ASP through the premium-isation of instant noodles.

As the bowls get bigger…

Noodles - 1

…and fancier…


…so does the ASP. In China, over the past four years, the average selling price of instant noodles have risen by 4.4% p.a. since 2012 (faster than Hong Kong’s 1.75% ASP growth). chart (16)

However, with the “Big Cup” noodle now weighing in 80 grams, 450 calories and 1,600mg of sodium, I suspect this premium-isation trend could be hard to sustain. Furthermore, while the past few years’ increase in ASP appear to have helped with gross profit margins, the benefits do not appear to have flowed to the bottom line.

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I am Satay Flavour出前一丁

As for me, I’ve been told that I make the best instant noodles with the exact right balance of soup to noodle. If I had to choose one type of noodle to eat, it would be the satay flavour 出前一丁.

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Now what does that say about me?


P.S. In the first collage, there is one picture that does not belong, can you spot it.

Alibaba – The Internet Giant Vs. the Tale from Arabian Nights

What do you think of when you hear the word “Alibaba”?

The US$488bn Internet Giant

I reckon that most of you would be thinking of Jack Ma and the massive e-commerce giant behind TaoBao, T-Mall and the recent Singles Day which generated US$25.3bn online sales within 24 hours.

But Alibaba is really much more than just TaoBao and TMALL, the overall group (including the non-listed side) also includes a logistics network (Cainiao) and a financial services group (via Ant Financial and AliPay).

Alibaba’s vision statement is: “We aim to build the future infrastructure of commerce. We envision that our customers will meet, work and live at Alibaba, and that we will be a company that lasts at least 102 years.

But how you ever thought of “Why Alibaba?”. Is there any special meaning behind the name?

The Tale from Arabian Nights


This thought occurred to me when my daughter recently asked me to read her “The Tale of Ali Baba and the Forty Thieves”. Although I can recall some parts of the story like “Open Sesame”, I had forgotten much of the details and often confuse Ali Baba with Aladdin.

I’m not sure if the version I read is accurate to the original tale but some parts of the story struck me.

  • Ali Baba was the younger of two brothers. His elder brother Qasim was the one that had great skill in buying and selling and was one of the richest men in Baghdad. Ali Baba on the other hand was a humble woodcutter.
  • Ali Baba came upon his wealth when he stumbled upon the magical cave where the Forty Thieves stored their loot. This is where the phrase “Open Sesame” came from. He took three sacks of gold dinars out of the cavern and took it home on his donkey.
  • When Ali Baba’s wife and son asked him “where did you find such wealth?”, he said, “I may not tell you except to say that I broke no law, nor did I rob any honest man.”
  • When Qasim found out, he gave Ali Baba no peace until he revealed the secret of the cave.
  • But Qasim was greedy. He brought 12 mules to carry the loot away but unfortunately once he was inside the cave, he forgot the last word of the charm and was locked inside. The thieves came back, found him and killed him.
  • Ali Baba went to look for his brother and found him dead in the cave. He brought home Qasim’s body as well as the the coins and jewels that  his brother had tried to steal from the cave.
  • In order to evade the attention and deal with the forty thieves, Alibaba had a trusted helper, Marghana.
  • Since Qasim had no children, Ali Baba inherited his household and all his wealth, making him the richest man in Baghdad.
  • When the leader of the forty thieves came posing as a fine oil merchant, Ali Baba actually invited him into his household. The rest of the forty thieves hid in oil jars.
  • Once again, it fell on Marghana to discover and foil the evil plot of the forty thieves. She poured hot oil into the jars where the forty thieves hid and then she killed the leader of the forty thieves.

“Ali Baba’s wealth knew no bounds”

When I sat back and thought about this story, I wondered if these might be some interesting parallels.

  • Ali Baba came upon his wealth by accident. His older brother was actually more talented but Qasim had bad intentions.
  • When Ali Baba took the three sacks for gold dinar from the cave, he said “I broke no law, nor did I rob any honest man.” This made me think of a statement from Amazon’s founder who said “Your margin is my opportunity”. In a very similar way, Alibaba’s business is to reduce the friction of commerce, thereby reducing the high margins of the entrenched businesses (i.e. the Forty Thieves).
  • Marghana, his trusted helper, was essential to Ali Baba in helping him evade the Forty Thieves. I think in this case, Marghana is the Internet. Without the proliferation of the internet, it would not be possible to combat/disrupt the entrenched businesses.

Here’s the most interest part.

  • From that day on, Ali Baba’s wealth knew no bounds, for now that the forty thieves were dead, all the treasures of their cavern belonged to him.”

I guess that’s why he chose the name Alibaba.


MiFID II – What would you pay for content?

MiFID II? I reckon that except for those that work in the broking industry, most people have never heard of MiFID. This silly acronym actually stand for “Markets in Financial Instrument Directive”.

For those that work in the broking industry, the 3 January 2018 in force date for MiFid 2 represents a big sea change as it requires the unbundling of research from sales and trading commissions.

Fine line between investment research and the business pages

This means that investment funds can no longer say that research is included in the commission costs that it pays for trades, rather, it needs to write a separate cheque for the research services that it receives. While this may sound simple, it is not. Considering that the investment banks had been giving research away for free, how much do you now charge for a research report, for a phone call or for a face-to-face meeting?

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As a content creator, I have a vested interest. My wishful thinking is that “Content is King” but I am often reminded of an old lesson from my mentor – very little separates investment research from the business pages and considering that most newspapers sell for US$1-2, sell-side research must be a sunset industry.

To a large extent, he was right in his prediction. But I would also argue that “Content is still king”, the difference we are facing is just how we consume and how we pay for it.

So how much is content worth?

To try to address this question, we turn to the hottest IPO in 2017 – China Literature Limited.

Source: CNBC

China Literature Limited is China’s largest online publishing platform. When it IPOed earlier this year, it drew HK$520bn in investor capital. The retail portion was 691x oversubscribed and its share price has since surged 82%, giving it a market capitalisation of US$11.5bn. So what is there to learn from China Literature?

The good news – 333mn online readers and Rmb4.6bn market size

First the good news. According to the industry report from China Literature’s IPO, there were 333mn users in China’s online literature market. Value-wise, the online literature market generated Rmb4.6bn in 2016.

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…but only 6% pay for content

The bad news is that very few actually pay for content. For China Literature, of its 192mn monthly active users (MAU), there were only 11.5mn Monthly Paying Users (MPU). In other words, the paying ratio was only 6.0%. While the paying ratio might be low, one positive is that it has risen from 3.3% in 2015 to 6.0% in 1H 2017.

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Using China Literature’s experience as guide, we can guess that the paying ratio for MiFid 2 is going to be low as well. This is especially the case since investors have historically been used to getting content for free.

Average pay rate is only around Rmb20 per month

But what about price elasticity? Here it gets interesting. In 2015 and 2016, at the same time that the paying ratio increased from 3.3% to 4.9%, the average monthly online reading revenue per paying user also increased from Rmb17.1 to Rmb17.4. The coincidental increase of paying ratio and pay rate was even more obvious in the first half data. In 1H 2017, the paying ratio increased to 6.0% from 4.4% in 1H 2016. At the same time, the monthly average online reading revenue per paying user also increased from Rmb15.1 to Rmb20.5.

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This suggest that content does matter. Similar to how you or I would be willing to subscribe to HBO just to watch the latest season of Curb Your Enthusiasm or Game of Thrones, online readers are willing to pay, provided that the content is good.

Content Vs Platform – What do Cost of Revenues Say?

Before we get to the cost of content, take a look at China Literature’s revenue breakdown. In 1H 2017, 85% of overall revenues was generated from online reading. The second derivation of this content, in this case, intellectual property (i.e. making the stories into movies, TV shows, games) and physical books made up 8% and 5% of overall revenues.

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In order to acquire this “premium” content, which helps to attract paying readers, China Literature was willing to pay around 40-50% of the online reading revenues. According to the Frost & Sullivan industry report, in 2016, the average income of the Top 10 online literature writer was Rmb32.3mn.

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Although having the right content is important, the platform is key to its monetisation. As a percentage of overall revenues, selling and marketing expense took up 24% of the top line, general and administrative costs was 17% and the actual platform and distribution costs was 6.4%.

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Content is not dead, it’s just the banking platform that is failing

Bringing this back to the issue of MiFid 2, I don’t think investment research is dead. It’s just the medium that is changing. For me personally, in addition to forking out HK$10 everyday for my newspaper, I am also happy to pay US$299 per year for a monthly investment newsletter. But for the rest of my content consumption, it is likely to be driven by ads (whether sponsored or not).

Until the big investment banks recognise that investors actually want good content, any effort to try to collect while they simultaneous cut content costs is just an exercise in futility.

While they are at it, maybe Nokia can try to drive revenues by cutting production costs and try to sell the old 3310. Hang on, isn’t that what they are doing? Perhaps, the investment banks should talk to Nokia and find out how it’s going.

Nokia 3310
Photo from Karlis Dambrans via Flickr





Mass Consumption 8 – Cash, credit or QR code?

It used to be “Cash or credit”. Then it became “Visa or Master” and more recently “ApplePay or AndroidPay?”. In China and increasing in the West, it is becoming AliPay or WeChat Pay. In 2016, card based spending totalled US$20.6trn but compared to the total payment flow market, this is still just around 10%. Although the detailed business model may be complicated, at its essence, it is really just about capturing a sliver of the massive payment flows.

How do you consume? After coming back from China and seeing the proliferation of AliPay, I wanted to do some work on the rise of cashless payment methods. For most people, when we think of cashless payment, we think of the latest technology like ApplePay or P2P and we often forget that there is still the good old credit card.

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US$26trn of spending was done on plastic

According to data from the Nilson Report, in 2016 there were 257.2bn transactions in the global credit and debit card market. These credit and debit cards recorded total spending of US$26trn, up 6.4% YoY. (comprising of US$20.6trn in purchases and US$5.4trn in cash).

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Visa account for 54% but UnionPay is growing the fastest

While Visa dominates the payment scene and accounts for 54% of global purchases, Union Pay is the fastest growing payment brand. Transactions handled by Union Pay rose 32% YoY in 2016 and it now accounts for 38% of purchases by transaction volume.

Four Party, three party network, two-sided proprietary platform? What?

So far, so good. Where it starts to get confusing is trying to understand how these companies make money. You’ve got the likes of Visa and MasterCard who operate a four party network comprising of (1) cardholder, (2) merchant, (3) issuer and (4) acquirer. Then you’ve got three-party networks like Amex where they operate as both both issuer and acquirer (acquirer is essentially who pays the merchant). When we think about the 1.5% -2.5% fee that the merchant has to pay for credit card transactions or the interest on overdue amount, this is where the issuer and acquirer comes in. From this perspective, it is easier to understand Amex’s business model.

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But if Visa and Mastercard’s role is really just to process the transactions then how does it make money? And where does the likes of PayPal come in as you can also choose to pay via Visa or Mastercard on PayPal?

Revenue and net profit snapshot

We start by taking a snapshot of the financials. The first point of interest is how Amex’s top-line compares to Visa and Mastercard. By payment volume, Amex only process one-seventh the amount that Visa does and only one-fifth what Mastercard processes (Amex US$1,037bn, Visa US$7,336bn, Mastercard US$4,828bn). However, by capturing the payment discount (i.e the fee charged to the merchant) Amex’s revenue at US$26bn is much larger than Visa and also Mastercard.

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But this is not quite the right comparison as they do operate different business model. This difference can be seen in their net profit margins. Visa and Mastercard both have net profit margins around 36%, Amex’s margin is only around 20% and PayPal is at only 13%.

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Another aspect that sets Amex apart is its sizeable net interest income. Since Amex also takes on the role of Issuer and Acquirer, it earns interest on overdue charge amounts. In 2016, Amex generated net interest income of US$5.7bn, this account for 71% of its pretax income of US$8.1bn. For Visa, Mastercard and PayPal, net interest income were insignificant.

For Mastercard and Visa, when we consider their revenue segments, we see descriptors like “domestic assessment/service revenues”, “cross-border volume/international transaction revenues” and “transaction processing/data processing”.

It’s all about capturing the flow

Although it all sounds terribly confusing, at its core, I think it is all about capturing the overall payment flow.

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Source: Mastercard Investment Community presentation

According to Mastercard, the global personal consumption market is about US$45trn. Of this, roughly 50% is done via credit/debit cards. While US$45trn is a huge number, it is still much smaller than the US$120trn B2B market and the US$60trn in P2P/B2C market. Since both of those are largely untapped by cards, in the grand scheme of things, the US$22trn payment flow currently captured by credit and debit cards only represent 10% of the overall payment flow market.

What about the likes of PayPal?

But what about the newer payment technologies like PayPal, ApplePay, Android Pay that are linked to credit cards? Using PayPal as a guide, we see the following:

  • Total Payment Volume of US$419bn in the previous 12 months. This is roughly one-tenth the size of Mastercard but growing at twice the rate.


  • On average, each payment is around US$56-60, slightly lower than the US$65-86 average transaction size that is processed by Visa and Mastercard.

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The interesting part is the average transaction take rate (which is basically how much is charged per transactions). For PayPal, over the past six quarters, this has trended down from 2.69% to 2.49%. This was partly attributed to the rise of P2P transfers like Venmo. On the expense side, transaction expense accounted for around 94bp-100bps while transaction and loan loss was another 30-32bps.

chart (1)

With volume based expenses making up some 40-45% of revenues, if these payment companies can increase flow and keep non-variable expenses in check, there can be much to gain from greater payment flows. Furthermore, since much of the variable expense is payment to the card companies, this is probably why many of the new operators are encouraging payments via their own wallets.

Who drinks best from the firehose?

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How well do you know luxury goods? Hermes Edition

How well do you know your luxury goods? After looking at LVMH’s 3Q results, in part 2, we turn to the highly sought after Hermes. Do you know which region generates the most sales, which one is growing the fastest and what are the key similarities and differences between Hermes and LVMH? Find out.

LVMH is one of the largest luxury brands in the world with a market cap around €129bn but it is not the most sought after. I think the honour goes to Hermes (market cap €47bn).

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Its iconic Birkin and Kelly handbags are so sought after that strategy books have been written on how to obtain one. Similar to our earlier post “How well do you know luxury goods?”, today, we test your knowledge on “How well do you know Hermes?”

The answers are posted after the various photos. Don’t peak.

1. Which region contributes the most to Hermes revenues through the first nine months of 2017?

  • A) Asia,
  • B) Europe,
  • C) US,
  • D) Others

2. Which region had the strongest revenue growth rate in 3Q 2017?

  • A) Asia ex Japan,
  • B) Japan,
  • C) Europe,
  • D) US

3. Rank the revenue contribution by product segment from largest to smallest?

  • A) Leather goods,
  • B) Fashion and accessories,
  • C) Silk and textiles,
  • D) Other Hermes sector (i.e. Jewellery and home products)
  • E) Perfumes
  • F) Watches
  • G) Other products (i.e. production activities for non-group brands)

4. Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

  • A) Leather goods
  • B) Fashion and accessories,
  • C) Silk and textiles,
  • D) Jewellery and home products
  • E) Perfumes
  • F) Watches
  • G) Other products
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Which region contributes the most to Hermes revenues through the first nine months of 2017?

  • The answer is Asia. Combining Asia ex-Japan (36%) and Japan (13%), Asia contributed 49% to Hermes’ overall revenues in 9M 2017. (Recall that for LVMH, Asia was 36%). Europe was the second largest region with 32% of sales (LVMH was 27% exposed to Europe). the Americas was third at 17.5%

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Which region had the strongest revenue growth rate in 3Q 2017?

  • Not counting the “Others” region, the strongest growth came out of Europe ex-France which rose 14% YoY in 3Q 2017. Notably, while Japan showed very strong growth for LVMH in 3Q 2017, for Hermes, 3Q growth in Japan was only 7%. For the full 9M 2017, Asia Pacific was the fastest growing region with sales rising 14% YoY in local currency terms.

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Rank the revenue contribution by product segment from largest to smallest?

  • This was another obvious one. Leather goods was the clear leader and accounted for 50.8% of overall sales. Fashion and accessories contributed around 21.8% in 9M 2017. In the third to fifth place, the gap is quite small with Silk & Textiles at 8.9%, Jewellery and home at 6.3% and Perfumes at 5.4%.

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Among the various product segments, which one recorded the strongest revenue growth in 9M 2017?

This is another area where we saw some departure from LVMH’s results. For LVMH, its largest segment were also its fastest growing segment (Fashion and Leather Goods at 35.5% of sales and rising 14% YoY). But for Hermes, it was the smaller categories. Perfumes (5.4% of sales) grew the fastest at 13% YoY. This was then followed by steady growth of 11% across Leather goods, Fashion and accessories and jewellery and homes. Notably, for 3Q 2017, Silk and Textiles sales surged by 17% YoY.

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Key Takeaways – Very strong Asia performance, watch Japan in 4Q and affordable luxury

When we compare and contrast the 3Q results from LVMH and Hermes, there are two key takeaway messages.

1) The divergent performance between LVMH and Hermes out of Japan. In 3Q, Japan sales rose by 21% for LVMH and only up 7% for Hermes. In comparison, Asia Pacific ex Japan sales were strong for both LVMH and Hermes (up 21% and 14%). This would seem to validate that luxury consumption growth is more broad-based in Asia ex-Japan and points to a bullish story for China. For Japan, given the higher price points of its products, it would be interesting to see if the continued rally of the Nikkei will help Hermes sales growth to surge in 4Q 17.

2) On the other hand, a key similarity is the strong performance out of the smaller ticket item of perfume. For Hermes, Perfume and Silk and Textiles showed the strongest growth in 3Q (up by 23% and 17%). At LVMH, perfume and cosmetics was also the strongest growth category in 3Q, up 17%. This reinforces our belief that consumers love the luxury brands. In the case of Hermes, where supply cannot rise to meet demand, consumers will go after the affordable luxury items like perfumes, scarfs and pashmina.

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