Love-hate relationships – Airlines

I have a love-hate relationship with my local airline, Cathay Pacific. I used to be a big fan but my loyalty has waned. I still want to support my local airline but I don’t like how they changed the frequent flyer programme and how we are now all packed in likes sardines. As a traveller, that’s how I feel but if I were a shareholder, would my hate turn to love as the cost cutting effort start to pay off? With CX’s market cap at only a fraction that of its global peers, how much of the challenges from budget airlines, fuel costs are already factored into the price?

I have a love-hate relationship with my local airline. In the past, I was a big fan of Cathay Pacific. They were slightly more expensive but the service and amenities were much better than the competition.

But over the past few years, the relationship has changed. Firstly, they changed their loyalty programme, making it much harder to achieve any frequent flyer status unless you are a corporate traveller willing to pay full fare economy/business. Secondly, even when I have flown with them, I find that they have pared back their services so much that I wonder if they are worth it. Now, I am packed in like the sardines above and the food offering leaves a lot to be desired. It reminds me a lot of when I used to fly on US domestic flights. The flights were always full and people brought their own food on board.

But here is where the love-hate part comes in. Just because I don’t like the service, does it mean I should also dislike the stock? After all, if the airline is now cutting costs and becoming more efficient, is that not good for shareholders? It is a fine line because if consumers have other choices, then top line revenue may fall faster than cost savings.

How the greats have fallen – CX market cap

If one were to look at how far the likes of Cathay Pacific and Singapore Airlines have fallen you only have to consider their market caps. At US$6bn, Cathay Pacific’s market capitalisation is now less than a quarter that of the three big American airlines. Its market cap is also less than half of the three Chinese airlines, 30% smaller than Singapore Airlines and 25% smaller than Qantas.

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Challenges – Competition, fuel and small markets

Now, there are real challenges facing CX which help to explain why it has fallen so far behind its peers. There is the rising competition from the budget airlines. There is the fuel hedge that has gone horribly wrong and there is also the fact that it serves a much smaller market.

Fleet size and average age – CX at 9.0, SQ and CA at 6.4 yrs old

One stat where this shows up is fleet size. At the end of 2016, CX had a fleet size of 189 airplanes. SQ is slightly smaller at 178 planes but just to CX’s North, the three Chinese airlines have an average of 640 planes. The three US airlines is more than double that at 1,356 planes.

What’s interesting is the average age of the fleet. I kind of guessed that SQ’s fleet would be very young at 6.4 years old. With China’s strong growth and acquisitive nature, it was also not a surprised that their fleet was only 6.1 years old. But I was quite surprised to see that Cathay’s fleet is now 9.0 years old. By comparison, although the American airlines have much larger fleets, they are much older with an average age between 10.3 and 17.0 years.

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As consumers, we would of course prefer the newer plane. From a business perspective, although the newer planes offer better fuel efficiency, they cost money, lots of money.

Here I would suggest that one reason why the US airlines have higher market cap and higher valuation is partly due to their older fleets. First, the lower depreciation charge help to boost operating margins. Second, on a cash flow level, the more conservative replacement strategy has meant that Operating Cash Flows tended to exceeded capital expenditure. In other words, they are earning more cash than they are spending on new planes. Notably, Air China and China Southern, despite building up a very young fleet have also managed to keep Operating CF above capex.

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On the flipside, we see that SQ and CX have operating CF that are 0.64x and 0.41x that of capex. As we alluded to earlier, part of CX’s problem is due to a fuel hedge gone wrong. This cost CX approximately HK$8.5bn in 2016 and if one were to exclude this loss, CX’s operating CF to capex ratio would be around 0.98x but still below 1.0x.

What about competition from budget airlines?

Relative to the US, budget airlines have had a much shorter history in Asia. So, in order to gauge their potential impact, we look to the US to see how they may have affected revenue growth and margin.

At a glance, we can see that in 2016, the three US airlines saw revenues declining by 2.68% on average. While revenues declined, the US airlines enjoyed the highest operating margin of 14.2%. This is even higher than the Chinese airline’s average operating margin of 13.0%. So while competition from budget airlines could lead to an overall decline in top line revenue, this suggest that profitability could still be maintained with greater efficiency.

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Load factors and costs management

In order to dissect the efficiency issue further, we consider load factors. Is CX’s problem tied to too many empty seats or is it because its running costs are too high?

Load factor not the problem, CX packing them in like sardines

As the following chart shows, CX actually fills their flight as tightly as the US airlines do. In 2016, CX’s load factor (kind of like an occupancy rate) of 84.5% is only a little bit below Delta’s 84.6%. It is in fact higher than AA’s 81.7%, UA’s 82.9% and much higher than the Chinese airline’s 80.8% load factor.

chart (3)

If CX’s problem is not too many empty seats, are the budget airlines causing it to sell its seats too cheaply? This might be the case. When we divide total revenues by total passengers kilometres flown, we see that CX earned an average of 9.7 US cents per kilometre. Interestingly, despite the competition from budget airlines, the US airlines commanded an average of 11.2 cents per kilometre. The Chinese airlines are clearly competing on lower price with an average charge of 8.8 cents per kilometre. But if we were to compare CX to Air China, the price differential is not that big now at 9.7 cents to 9.2 cents, so the worst may already be behind it.

chart (6)

Operating costs are the key culprit

Where CX has lots of work to do is in cost cutting. If one were to look at operating expense per available seat kilometres flown, CX has got the second highest costs at 8.2 cents (SQ highest at 8.9 cents). Even if we were to exclude the HK$8.5bn fuel hedging loss in 2016, CX’s operating expense per kilometre flown would still be around 7.5 cents. This is lower than the US airlines but still much higher than the Chinese airline’s average operating costs of 6.2 cents.

You might not love it as a consumer…

Granted the Chinese airlines’ lower cost may be due to cheaper labour or landing fees but if CX is to compete against them as well as the budget airlines, they will have to continue to focus on reducing costs.

Unfortunately for the consumer, this means the cheap pastry meals are here to stay and may even be extended beyond the short haul flights. My guess is that CX will increasingly resemble an US airline. There will be more more ancilliary charges, limited inflight entertainment and older planes. Considering that the average fleet age for American, United and Delta is between 10 and 17 years old, beyond the planes currently on order, the average age for CX’s fleet appears likely to rise.

For employees, this is also bad news. Staff costs represents 21% of CX’s revenues and if the company is to try to restore profitability this is the one area that it can control. There is nothing that CX can do about its fuel hedge. Short term capex commitments are also already set. For CX to boost cash flow, it must turn to wages.

…but shareholders may hate it less

The only good news will be to shareholders. After suffering through a 50% correction in share price over the past two years, if CX is successful in restoring its profitability, its valuation gap should narrow with those of its peers.

As a CX frequent flyer, I don’t like the the changes that are coming my way. But as the saying goes, if you can’t beat them, you might as well join them.







From 50/50 to 59/41 – Return of the animal spirits

The Hang Seng Index has risen 25% in 2017 and is now within 3.7% of the 2015 peak. The market had been strong but how much of an outlier is it? When we look at daily performance, we find the HSI had risen 59% of the time with an average gain/loss ratio of 1.29x, putting it in similar outlier territory as 2015 and 2007.

Until very recently, Hong Kong’s 2017 stock market rally had been one of the most stealthy bull market in recent memory. As of  1 August, the Hang Seng Index had risen 25% and at 27,540, the HSI is only 3.7% below the 2015 peak of 28,588 and 13.8% below the all-time high of 31,958 that was reached on 30 October 2007.

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3.7% away from 2015 peak, will the good times last?

As we approach the 2015 大時代 peak, we get the inevitable question about bubbles and whether we are due for a correction.

From a historical perspective, we can certainly appreciate where the concern is coming. In 2015, the Hang Seng Index had a blazing start, rising 21% by 28 April. Had the pace continued for the full year, it would have annualised to 63%. But the good times did not last. After peaking on April 28, the market corrected 23% the rest of the year and reversed the previous gains to a full year loss of 7.4%. Ouch.

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So, what are we to make of this year’s (2017) strong performance? Is it a repeat of 2015’s roller coaster ride or is the current rally likely to prove more sustainable?

Until today, my gut feel was that it may have more room to run. Why? First, I think the market’s animal spirits feeds on recent peaks. Until 2015’s 28,588 peak is surpassed, I suspect Mr. and Mrs Wong are still sceptical. From a behavioural perspective, others have commented that one sign of bubble is when taxi drivers start to give out stock tips and people quit their day jobs to day-trade.

I read somewhere that in the US market, the number of days that the market goes up and the times that the market goes down is roughly 50/50. Although the odds are roughly even, the reason why the markets have tended to go up is because average gains have outweigh average losses and the compound effect leads to long-term cumulative gains.

3,922 up days and 3,633 down days since 1986

I wanted to see if the same held true for the local stock market. Looking at the Hang Seng Index’s performance since 1986, although the market had risen 9.7x, the number of up days versus the number of down days is almost 50/50. Specifically, there were 3,922 up days and 3,633 down days. This is a ratio of 51.9%/48.1%. If one were to consider the average daily movements, the average up day gain was 1.09% while the average down day loss was 1.08%, so again very  close to 50/50.

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2017 has been an outlier – 59.4% Up Days and Gain/Loss ratio of 1.29

What about 2017? Well, in the 143 trading days this year, there has been 85 up days and 58 down days. This is a ratio of 59.4/40.6. Furthermore, when we consider the average daily movement, although the average gain on up days is only 0.57%, when this is compared against an average loss of 0.44% on down days, the gain/loss ratio of 1.29 is much higher the past five year’s average of 1.01.

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Current rally as much of an outlier as 2015 and 2007

Clearly, the 2017 rally had been strong but how does it compare to the previous “bubbles”. In the more recent memory, there was the 2015 大時代 rally. Through the first 78 trading days of 2015, the index rose 21%. Over those 78 trading days, there were 49 up days and only 29 down days. While 2015’s up days ratio of 63% is 4pp higher than 2017’s 59%, the average gain/loss ratio was milder at 1.19x (0.77% average gain versus -0.64% average loss).

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If one were to look further back, we saw an even more euphoric rally in 2007. Driven by hopes of a “through-train’ of China domestic investments, the Hang Seng Index had rallied by 60.7% through 30 October 2007 and reached an all-time intra-day high of 31,958. During this period, over the 204 trading days, the Hang Seng Index rose on 115 days and fell on 89 days. The Up days to Down days ratio was 56/44. Although this was milder than 2015’s 63/37 up/down days ratio, the longer duration of the cycle couple with an average gain/loss ratio of 1.20x helped to push the market up by 60%.

2017 less hot than 2005 and 2007

So if one were to consider the current market condition, we can see that 2017’s up days ratio of 59.4% is higher than 2007’s 56% but lower than 2015’s 63%. But from a daily percentage change ratio, 2017’s 1.29x ratio is higher than 2015’s 1.19x ad 2007’s 1.20x.

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In the long run, reversion to the mean is likely but timing is anyone’s guess

In the long run, a reversion to the man is probably inevitable and the up day to down day ratio should probably trend back towards 50/50. But as one can see in the table above, that up days ratio remained elevated in 2006 (59%) and 2007 (56%) and only reverted back to 47% in 2008.

Be that as it may, given the combination of higher than expect win streak and higher than normal win ratio, it might be better to simply ride the current wave than to initiate new buy positions at this stage. Caveat emptor.




Mass Consumption Part 4 – Whassssup? Watching the game, having a beer

Whassup? During the summer, when it is scorching outside, there are few things better than an ice-cold beer. In Part 4 of our Mass Consumption series we review the state of the beer industry. But unlike the previous post, the Chinese beer industry outlook is not “whassup”. In fact, after peaking in 2013, Chinese beer consumption has fallen for three straight years and operating margins are less than half of global peers.



For those unfamiliar with the term, Whassup was an iconic beer commercial from the late 1990s. The commercial was so successful that for quite a while, everyone went around saying “Whassup?”. To truly appreciate the fad at the time, you have to go back and watch the commercial. (Youtube link here). It may appear silly now, but admit it, you said your fair share of “Whassup” back then.

As promised from my “Fried Chicken and Coffee” post, I was planning to do some work on the Beer industry but I did some initial reading, I I really did not feel a sense of urgency, hence the lateness of this post. To put it simply, the beer industry is not “Whassup?”

China beer production peaked in 2013

chart (9)

According to data from the National Bureau of Statistics, in 2016, China’s beer production was 450.6mn hectolitres. Beer production had peaked in 2013 at 506.2mn hl and has now fallen for three straight years and are now down 11% from the peak. This is very different from the other mass consumption themes that we had been talking about (i.e. ageing population, travel and fast food).

Volumes down across most major breweries

Looking into the numbers, this is not just a China phenomenon. Across the major international breweries, Heineken was the only one to report a growth in beer sales in 2016 (up 6.3%). The largest brewery, AB InBev (owner of Budweiser, Stella Artois and Corona) saw sales volume drop by 0.4% in 2016. Carlsberg’s sales volume fell by 2.8% while Tsing Tao’s declined by 6.6%.

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Craft beers and premium-ization

With overall beer consumption flat, in order to grow revenues, breweries have turned to craft and premium beers to try to boost overall ASPs. Next time when you order a Leffe or Camden Town, you are in fact ordering a cousin of Budweiser (so to speak). Here’s a table of the family of beers.

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For instance, did you know that Budweiser, Corona, Hoegarden, Boddington’s and Pure Blond are from the same family. Similarly, the Carlsberg family of beers include Grimbergen and Brooklyn Lager. And in the Heineken family, this includes Moretti, Sol, Anchor and Tiger.

Alcohol-Free and Ciders

In addition to premium craft  beers, another focus area for the breweries is the “low and no-alcohol” beer segment. AB InBev has set a goal to have low-and-no alcohol beers represent 20% of its global beer volumes by 2025. For Carlsberg, although Craft and Non-alcoholic beer only represent 5% of its beer volume, they make up 10% of net revenues. As for Heineken, the low-and no-alcohol segment represented 12mn hectolitres in 2016.

Margins are all over the place

While the beer industry’s growth profile is very different from the other mass consumption industries that we have reviewed, there is one aspect that is similar: Low China margins.

At 29%, AB InBev has the highest EBIT margin among the breweries. Heineken and Carlsberg are at 17% and 13% respectively. By comparison, the two Chinese breweries’ operating profit margin of 6% is less than half of their international peers.

chart (13)

Looking at the international breweries’ segmental results, China’s lower margin is not obvious. For AB InBev, although its Asia Pacific profit margin of 16% is well below those of Latin America, North America and EMEA, it is still more than double that of Tsingtao and CR Beer.

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Interestingly, for Heineken and Carlsberg, their Asian operating margins are actually higher than those of Europe and the America. Of the three, Heineken’s 32% operating margin in Asia is the highest among our comparison group.

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Need to diet before I have a pint

Although overall volume growth has been anaemic, the sector has not done too poorly over the past 12 months. On a blended basis, the five beer stocks above are up 27% against their 52 weeks lows. But with current price only 8% below their 52 week highs, I feel that similar to my own situation, the stocks may need to go on a diet before they become attractive again.

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Mass Consumption Part 3 – Coffee and Fried Chicken

I love coffee and I love fried chicken. Normally, I wouldn’t mix these two together but in Part 3 of our mass consumption series, we look at the economics of feeding China’s 1.3bn mouths.

I know, I know, coffee and fried chicken don’t go well together. I wish the title could have been Beer and Fried Chicken but I have yet to do work on the beer industry so for this week, we will have to focus on the two strange bed fellows of Coffee and Fried Chicken.

I love coffee and I love fried chicken. Every morning, regardless of whether it is a weekday, weekend, rain or shine, I always start my day with a Grande Black Coffee. If one were to talk about an industry with a defensive moat where consumer stickiness is very high, coffee is it for me. If my local Starbucks were to raise prices, I’m stuck.

On the other hand, although I love fried chicken, I eat it sparingly. When I was a teenager, I could devour a whole bucket of KFC by myself but nowadays, I try to limit myself to splurging once every 6-12 months. It taste good but I feel very guilty afterwards and the indulgence shows up immediately on the scales.

What do they have in common? Making money in China

But what do Coffee and Fried Chicken have in common? They are two of the food companies that have been able to make money in China. Yes, I’m talking about Starbucks and KFC.

In part 3 of our Mass Consumption series, we turn to the largest consumption category. At Rmb1,535, food and tobacco make up 32% of the average spending of the Chinese consumer. Although its growth rate of 4.6% is the second slowest among the various categories, it is still growing nonetheless.

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A Starbucks around every corner?

Although it may seem like there is a Starbucks around every corner, the actual penetration is still limited, especially in overseas market. At the end of September 2016, including both company operated and licensed stores, there were 15,607 in the Americas. China and Asia Pacific is one of the fastest growing regions but the 6,443 stores is still only 41% that of the Americas. In percentage terms, the America’s have 62% of total stores, China/Asia Pacific 26% and EMEA 11%.


(Source: Company data for all charts)

In terms of revenue, the skew is even higher. The Americas contributed US$14.8bn or 69% of total revenues. China and Asia Pacific grossed US$2.9bn of revenue or 13% of the total while EMEA made US$1.1bn revenue or 5.3%. Although it may not seem obvious from the below chart, China and Asia Pacific had the fastest revenue growth in FY2016 at 22%, nearly double the 11% growth rate experienced in the Americas.

chart (1)

By product, beverages make up 58.1% of total revenues. Food make up 16.4% and packaged and single-serve coffees and teas made up 13.4%. From a growth rate perspective, in FY2016, food sales grew 13% y/y, slightly faster than the 11% beverage sales growth.

chart (2)

The trick is in growing profitably

As we have written previously (see here and here), China’s allure has always been its massive 1.3bn population. But the big pitfall for many companies is how to grow in a profitable manner especially when it is faced with hyper competition.

Starbucks profitability in Americas and China / AsiaPac

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In this regards, Starbucks appears to be successfully juggling between growth and profitability. In absolute terms, Starbucks made US$632mn from the China and Asia Pacific region. This represented a margin of 21.5%, roughly 4pp below the 25.3% operating margin that it makes in the Americas. Even if one were to exclude the 5.1pp by way of income from equity investees, the operating margin of 16.4% is still pretty respectable.

Looking at the cost breakdown, the obvious areas of variance between the Americas and China/Asia Pacific would be in the (i) cost of sales including occupancy costs and (ii) store operating expenses. While the store operating expenses in China / Asia Pacific is much lower than the Americas (26.5% Vs. 33.2%), this is more than offset by the higher occupancy costs (35.6% Vs. 44.1%).

chart (3)

Last but not least, while China and Asia Pacific’s 22% revenue growth is obviously important, don’t count out the Americas. If we were to consider same-store-sales growth, The Americas are actually doing better at +6% versus China / Asia Pacific at +3%. Notably, the key distinction is in the change in ticket size. In FY2016, the average ticket in the Americas increased by 5% while the average ticket in China / Asia Pacific only rose by 2%. In both cases, the number of transactions within the stores only rose by 1% but that is understandable as more stores are being added around every corner.

Finger licking good

If we are talking about tapping into China’s mass consumption wave, Starbucks was actually pretty late. It opened its first store in 1999 at the China World Trade Building in Beijing. McDonald’s opened its first store in Shenzhen in 1990. The first global brand to go into China was in fact Kentucky Fried Chicken. Yes, Colonel Sanders was the first one to “make a run for the border”  when he opened the first KFC in Beijing back in 1987 (Note: two points if you can tell me where the quoted slogan is from).

Including sister restaurants like Pizza Hut, Taco Bell and Little Sheep, Yum China now operates 7,562 restaurants in China. This is 14% more than Starbuck’s 6,443 stores in the China / Asia Pacific region.

Over the past five years, the number of KFC and Pizza Huts have increased by 32%. Company operated restaurants make up nearly 80% of restaurants with franchisees and unconsolidated affiliates making up the other 20%.

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Between fried chicken and pizza, KFC is more popular. At the end of 2016, there were 5,224 KFCs, nearly 3x the number of Pizza Huts. Incidentally, both KFC and Pizza Hut have added about 400 stores over the past two years.

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While the number of KFCs outnumber Pizza Hut 3:1, at the top line revenue level, KFC’s US$4,696mn revenue is only 2.6x that of Pizza Hut’s US$1,774mn. Perhaps due to some food scare issue, KFC’s revenues have actually fallen slightly from US$ 4,893mn to US$4,696mn while Pizza Hut’s revenues have increased by 4.5% from US$1,696mn to US$1,774mn.

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What KFC appears to have done much better over the past two years is in boosting its profitability. According to the segmental data, restaurant margins at KFC has increased from 11.4% in 2014 to 15.9% in 2016. By comparison, Pizza Hut’s margins have oscillated from 14.3% in 2014 to 12.3% in 2015 before rebounding to 14.0% in 2016.

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Similar to Starbucks, occupancy costs and other operating expenses are the biggest cost items, eating up around 33.5% of revenues. Interestingly, “Food and paper” is the second largest cost item, accounting for around 28.4% of revenues. I suppose fried chicken is quite greasy and you do need lots of napkins to clean your hands afterwards.

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So what will it be? Chicken or Coffee?

Hmm, that’s a hard one. In nominal terms, although Yum China’s revenue is more than double that of Starbuck’s China / Asia Pacific revenues (US$6,752mn Vs. US$2,939mn), as Starbuck’s China / Asia Pac 21.5% operating margin is double that of Yum China’s 9.5%, their nominal operating profits are actually very comparable. For the fiscal year 2016, Yum China had operating profit of US$640mn while Starbuck’s China / Asia Pac segment earned US$632mn.

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While Starbuck’s US$87bn market cap is much higher than Yum China’s US$15bn, from a valuation perspective, the two are in fact quite similar. Starbuck is currently trading at 30x trailing twelve months PE. Yum China is at 28x. Although both company’s PE may appear high, one must decide if China’s 1.3 billions mouths to feed are worth it.

Decisions, decisions….

Mass Consumption Part 2 – The best travel deals around

There are Chinese tourists everywhere. Whether you are in Sydney, Hong Kong, London or LA, I think that statement holds some relevance. Well, the fact is that in 2016, Chinese outbound tourists numbered 135mn and with only 4% of its population holding a passport, that number is likely to rise further. In this second part of our mass consumption series, we look into the economics of the online travel agency business and see where the best travels deals are.

China is big. It’s 1.3bn population makes any kind of consumption trend a potential huge opportunity. However, as we illustrated last week in Part 1 of our Mass Consumption series, the winners might not be the obvious candidates.

In this second instalment, we look into the economics of the travel business, specifically, the online travel business. I’m not sure whether travel falls into the (i) education and recreation services or (ii) transport and communications but these are the second and third fastest growing spending categories for the typical Chinese consumer.

Average spending by Chinese population

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(Source: National Bureau of Statistics)

While China does have a rapidly ageing population, those between the age of 14-64 had been one of the fastest growing segment that currently number nearly 1bn persons or 73% of the overall population.

Chinese population between 14-64

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(Source: World Bank)

4% of Chinese hold a passport vs. 37% of Americans

According to the United Nations World Tourism Organization, Chinese tourists spent US$261bn overseas in 2016, up 12% y/y, while the number of outbound tourists rose 6% y/y to 135mn. Although those numbers are big, they could get even bigger since the percentage of Chinese that hold a passport is only 4%, compared to 37% for Americans (source: China Daily).

The spending by Chinese tourists on things like cosmetics and luxury goods have been well documented but what about the very act of travel itself?


Say what you will about commercial jingles but I think they are effective. To this date, when I think about online travel portals, I usually think of trivago or Expedia.

Travel agencies were among the first industries to be disrupted by the internet. Nowadays, for anyone planning a holiday getaway, their first port of call must be to comparison shop with an online travel agency (OTA). While most of these sites come with some sort of price match guarantee, exactly how good are their deals? And how do they make money?

Travel – a US$1.3trn market with 50% online presence

As I read up on the OTA industry, I came across a couple of interesting findings.

First, let’s check out the current OTA landscape. According to a presentation from Expedia, the total travel market is estimated at US$1.3trn in 2017. Of this EMEA (Europe, Middle East and Africa) is the largest market at US$456bn, followed by Asia Pacific at US$392bn and the US and Canada at US$383bn.

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(Source: Expedia presentation)

But if one were to consider the online penetration, the US is the most advanced at 67%, followed by Europe at 50%. Asia Pacific and Latin America are at 37% and 34% respectively. For the overall market, online penetration is at 50%.

Multiple brands, different niches

The second detail that I found interesting was how the brands are affiliated. I don’t know whether it was because of historical mergers and acquisitions but many of the big travel websites are owned by the same parent.

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(Source: Company data)

In the case of some of the Priceline websites, the company actually does a good job of explaining how each company fits into the different geographic niches. For instance, Priceline is a leading site in the US, whereas agoda caters primarily to consumers in Asia Pacific.

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(Source: Company data)

From a market cap perspective, Priceline is the largest one by far. But despite having a market cap that is 3x that of Ctrip, its price-to-earnings ratio is the lowest at 42x (still quite punchy by non-internet standards. Note: No PE for Ctrip as it made a loss in 2016).

How much commission do they charge?

In terms of amount of business, Expedia is currently the leader with about US$72.4bn of gross booking done in 2016. Over the past three years, Expedia and Priceline have actually been very close while Ctrip has begun to catch up with 2016 GMV at around US$63.2bn. For Ctrip, it targets total GMV to surpass US$150bn by 2020 or even a year or two earlier. If this is met by 2020, this would suggest a CAGR of 24%. If this is met by 2018, then the CAGR would rise to 54%.

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(Source: Company data)

Perhaps due to their different business and geographic mix, the three companies’ commission rate (i.e. gross revenue divided by  gross booking) vary quite a bit. At first glance, Priceline appear to have the highest take at around 15.1% of gross bookings. Expedia is around 12% but Ctrip is very low at only around 4.6%. Since some of the overall gross booking numbers are not broken down by segments, this could be a case of a higher transport-to-hotel mix for Ctrip dragging on the overall gross commissions rate.

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(Source: Company data)

I won’t go into the full details but the companies do report on their revenues slightly differently depending on whether they run a merchant or agency model. In the case of Priceline, there is little difference between its gross profit and its gross revenue whereas for Expedia and Ctrip, their gross profit margin range from 67-82%.

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(Source: Company data)

Advertising and marketing eat up 30-50% of overall revenues

As the OTA are a service based business, there is hardly any significant costs of goods sold. Instead, the key costs are those related to advertising, sales and marketing which help to differentiate these very similar product offerings.

Of the three, Expedia spends the most on advertising and marketing at around 50% of overall revenues. Priceline is also high at around 40% of overall revenues. Perhaps due to less competition within China’s on-line travel market, Ctrip only spends about 30% of revenues on marketing and advertising (Note: Ctrip also spends about 30-40% of revenues on Product Development).

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(Source: Company data)

With advertising eating up nearly 30-50% of revenues, it is little wonder that those travel deals keep popping up on the banner ads on various websites.

Net margins explain reason behind Priceline’s high valuation

Net of all the other personnel, depreciation and miscellaneous expenses, Priceline’s operating margins stands heads and shoulders above the other two. For 2016, Priceline had written off US$941mn in goodwill. Excluding this amount, Priceline’ operating margin would have been around 37%.

Screen Shot 2017-05-31 at 3.59.40 pm(Source: Company data)

A bird in hand or two in the bush

So, where are we going on this? I think the bottom line is what is the better deal?

If one were to simply consider the profitability issue, there is no comparison between Priceline and the other two operators. It’s operating margin of 37% is just that much higher. And if we assume that top line revenue growth can be translated into profits, Priceline should be in the best position. That said, we are also confronted with the reality that over the past three years’, Priceline’s fully diluted EPS had been fairly stable, fluctuating between $45.67 to $49.45 to $42.65. The other two operators also do not seem to have fared much better. Clearly, somewhere along the line, the very strong top-line growth in bookings and revenues have not translated to bottom line earnings.

Screen Shot 2017-05-31 at 4.32.48 pm

(Source: Company data)

On the other hand, if we were to take a more forward-looking perspective, one could argue that Ctrip may have greater potential. The Asia Pacific market is already the second largest travel market after EMEA, yet it has the third lowest online penetration at 37%. Furthermore, with Ctrip’s commission rate of only 4.6% versus Priceline and Expedia’s 15% and 12%, there is the potential for this to converge with the other two operators.

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Now for the end user. If you are still  planning your summer or Christmas holidays, you better try to lock in the lower rates before Ctrip starts raising its commission levels from the current 4.6% and you wind up paying more.

Mass consumption Part 1 – Ageing population

Imagine selling a billion pairs of sneakers and a billion frapuccinos. China’s massive population has always been the holy grail for consumption plays. With a rapidly ageing population where those above aged 65 already number more than 131mn, we look into the economics of assisted nursing care.

A billion pair of sneakers and a billion frappuccinos

For as long as I can remember, China’s 1 billion plus population has always made for a compelling investment case. This is especially the case, when you hear about China’s rising middle class and the growing affluence of its consumers. As the following chart shows, in the six years between 2009 and 2015, China’s per capita GDP has more than doubled from US$3,838 to US$8,069.

Screen Shot 2017-05-24 at 1.26.23 pm

(Source: World Bank)

But first some caveats…

While the Chinese population is definitely richer and consuming more, the winners (from a stock perspective) are far from intuitive. Consider the case of the life insurance companies. The logic was supposed to be that as China’s middle class became more affluent, they would buy more insurance products, benefiting the likes of China Life. Well, since October 2010 (note that this is already after the bursting of the 2007 China bubble and also the 2008 Credit Crisis), China’s Life share price has declined by 30%. In sharp contrast, another life insurance company, AIA, has seen its share price rise more than 130% over the same period.

Insurance – China Life versus AIA
Screen Shot 2017-05-24 at 1.26.47 pm

(Source: Yahoo Finance)

Similarly, the rise of mobile penetration has also not translated into higher share prices for the incumbent operators. Since October 2010, China Mobile’s share price has remained largely unchanged while Verizon in the US has seen its share price rise by 37%.

Telecom – China Mobile versus Verizon

Screen Shot 2017-05-24 at 1.26.56 pm

(Source: Yahoo Finance)

Now, if this were the case of traditional retailers losing market share to the internet, I can totally understand that. But even in the irreplaceable bricks and mortar play of home builders, share prices have greatly lagged behind the rise in consumption. Over the past five years, one of China’s largest developers, China Overseas Land, has grown its top line revenue nearly three fold from HK$57bn in 2011 to HK$164bn in 2016. Yet its share price is only up by 48% and has in essence been stuck in a range since 2013.

Property – China Overseas Land – Share price versus EPSScreen Shot 2017-05-24 at 1.53.27 pm

(Source: Yahoo Finance, Company data)

There are many possible explanations behind this apparent decoupling between trend growth and share price growth but I think it is safe to say that in many cases one has to be very careful in selecting the right stocks that can “profitably” benefit from this trend.

How are the masses spending their money?

Be that as it may, the long-term rise of the Chinese consumer is still compelling enough that we should do more research around it.

In the latest data release from the National Bureau of Statistics, it showed that (1) Food and tobacco and (2) Residence are the two largest spending categories for Chinese consumers, accounting for 32% and 20% of total spend. However, if one were to consider the rate of growth, the fastest rising spending categories are (a) Healthcare and (b) Education and Recreation Services at 15.8% and 13.5% y/y growth.

Average spending per head

Screen Shot 2017-05-24 at 2.12.57 pm

(Source: National Bureau of Statistics)

131mn people above age 65

In this first instalment, we start by looking into healthcare. Although China’s 1.3bn population usually grabs the headlines, there is another very significant aspect to China’s population. It is ageing rapidly. Over the past 10 years, the percentage of the population above age 65 have risen from 7.5% to 9.6%. At the same time, those below age 14 have dropped from 20.1% to 17.2%.

China population – Those above 65 and those below 14

Screen Shot 2017-05-24 at 2.44.47 pm

(Source: World Bank)

In absolute terms, the number of seniors have increased from 97.7mn in 2005 to 131mn as of 2015. By comparison, those below the age of 14 have dropped from 261.9mn in 2005 to 236.3mn in 2015.

Part 1A – Nursing care

Although I like the healthcare concept, there are two practical issues to overcome. The first is the absence of a sector leader. Among the 50 Hang Seng constituent stocks, there are no healthcare stocks. Within the Hang Seng Healthcare Index, the largest constituent, only has a market cap of US$8.9bn and most of them are pharmaceutical companies. The second problem is that Pharma is a highly specialized industry. For the average layman, it is near impossible to see which medicine has better efficacy and predict which drug may be the next blockbuster.

Instead, we turn to the hospital and healthcare providers. We still have the problem of a lack of sizeable comparables but let’s do some homework anyway. Below, we look into the economics of nursing care in Hong Kong.

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(Source: Census and Statistics Department)

In 2016, 16% of Hong Kong’s population is aged 65 or above. According to the Census and Statistics Department, this ratio will rise to nearly 23% by 2026 and 29% by the year 2036.

Screen Shot 2017-05-24 at 4.00.37 pm

(Source: Company data)

As those with older family members can attest, regardless of how well we try to live and how much we exercise, our bodies eventually break down. Even though today’s medicine has greatly reduced the invasiveness of certain procedures and shorten recovery periods, there are times when assisted nursing care is necessary. According to a study done back in 2014, the gross fees from healthcare staffing solutions was HK$290.6mn back in 2013. This was projected to grow to HK$437.1mn by 2019, a CAGR of 7.0%.

Screen Shot 2017-05-25 at 11.45.38 am(Source: Company data)

In terms of service hours, personal care workers (PCW) make up nearly 53% of total demand. They are followed by health worker and healthcare assistants (HCA/HW) at 23.6%. Registered and Enrolled Nurses (RN and EN) make up 9.8% and 8.2% of service hours.

Screen Shot 2017-05-25 at 11.47.30 am(Source: Company data)

Based on data from June 2016, the average hourly charge out rate for RN and EN was HK$270/hr and HK$226/hr respectively, roughly double the rate charged by the HCA and PCWs.

In organising and matching the supply and demand for healthcare and nursing providers, the platform take a cut around 20-25% of the gross fee charged.

Screen Shot 2017-05-24 at 4.19.24 pm

(Source: Company data)

As the service is mainly one of matching supply and demand, overhead and PPE is minimal, with the resultant operating and net margin generally around 60% and 50%. Even though the margins appear very favourable, the main barriers of entry is just word of mouth and the availability of the nursing database.

Screen Shot 2017-05-24 at 4.20.03 pm

(Source: Company data)

With the right “app”, one could easily see the matchmaker being dis-intermediated from the process. If one were to look ahead, this matchmaker ought to take advantage of its strong database and uber-ize its service before someone else does it for them.


Golf is a hard game

Golf is a hard game. In the US, only 31% of players get down to single handicap. But you know what’s even harder? The golf equipment business where net margins are only 5-6% for two of the biggest players out there. That said, with Nike and Adidas exiting the equipment business, is there an opportunity for a niche player to grab more market share.

Golf is a hard game. I have been playing for a long time and I am still bad at it. According to the USGA Handicap Index, only 31% of the players manage to get down to single handicap. Since these are players who chose to submit their statistics in order to get an official handicap, my guess is that the actual percentage of players who manage to get down to single handicap is probably even lower.

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(Source: USGA)

Making golf equipment is even harder…

But you know what’s even harder than shooting bogey golf (i.e. you average one shot more than par on each hole), the golf equipment business. Did you know that two of the biggest golf clubs and golf ball makers only have market capitalisation of US$1.572bn and US$871mn. That is roughly 0.9%-1.8% the size of Nike and 2.1-4.3% that of Adidas. Notably, both sports apparel giants have decided to exit the golf equipment business.  Continue reading “Golf is a hard game”