Asian Equity: Treasure Island

The confluence of the portfolio being overweight both Information Technology and Taiwan is no accident.

Taiwan has been in the news recently with ill-founded speculation that China, Russia’s ally, might invade the island.  Joe Biden’s recent gaffe implying that the US would defend the Taiwan militarily if attacked was unhelpful.  Following the United States' recognition of the People's Republic of China, Congress passed the Taiwan Relations Act in 1979.  While some of the prior Sino-American Mutual Defence Treaty's content (effective 1955-1980) survived in the Act, it falls short of promising Taiwan direct military assistance in the face of an invasion.  Taiwan has a population of 23.6mn, just 1.7% of the estimated Chinese population of 1.4bn.  In my opinion a military invasion of Taiwan by China is inconceivable.

The EPIC Oriental Focus Fund has almost 30% of its assets invested in Taiwan compared to an index weight just shy of 20%.  The Fund also has some 37% invested in the information technology index, again a significant overweight compared to the near 25% index weight.  The portfolio is built with a ‘bottom up’ stock selection process.  We focus on identifying high quality, well managed companies with strong growth prospects.  The confluence of the portfolio being overweight both Information Technology and Taiwan is no accident.

Four of our six Taiwanese holdings are information technology concerns accounting for 23% of the 30% exposure to Taiwan.  The following three charts track their return on equity (ROE), return on assets (ROA) and return on invested capital (ROIC) over the past decade.

Source:  Bloomberg, MSCI

Source:  Bloomberg, MSCI

Source:  Bloomberg, MSCI

TSMC

This preeminent global foundry needs no introduction.  TSMC recently introduced a 6% price increase which takes effect from January 2023.  Tier2 foundries such as UMC are following suit while Samsung Electronics is reportedly raising mature nodes pricing by 20% and that for advanced nodes processes by 15% in the second year of this year.  TSMC’s capex is running at circa $40bn per annum and this will, as it always has done, drive revenues higher in the years ahead.  Revenues in the first four months of 2022 rose 40.1% y-o-y.  Over the past decade ROE, ROA and ROIC have averaged 25.5%, 18.3% and 20.6% respectively.  After a 20% share price decline from recent highs, TSMC trades on 16x 2022 earnings and yields over 2%.  The company remains the largest position in the portfolio with a weighting of 9.2%.

eMemory

eMemory Technology develops and provides logic non-volatile memory (LogicNVM) technology. The company licenses its intellectual property to semiconductor foundries, integrated devices manufacturers (IDMs), and fabless design houses around the world.  In short, their IP makes semiconductors smarter and more secure.  In their last quarterly report the company noted that “8-inch royalties will continue their momentum due to the demand and content increase from the mass production for PMIC, MCU, Fingerprint, and Sensor-related in 5G, Automotive, and IoT-related applications.  12-inch royalties will have strong growth with increasing penetration rate in in OLED, ISP, DTV, STB, WiFi 6/6E, Network-related, DRAM and others. In addition, royalties for 12/16nm and 7nm FinFET continue to contribute in the first-quarter and are expected to be the next growth driver after 28nm”.  Revenues in the first four months of 2022 rose 30.3% y-o-y.  Over the past decade ROE, ROA and ROIC have averaged 28.9%, 24.7% and 27.0% respectively.  As the charts above illustrate, eMemory is comprehensively the most profitable of our four Taiwanese IT holdings.  After a 40% share price decline from recent highs, this debt free company trades on an admittedly rich 68x 2022 earnings.  However, with earnings growth likely to compound at 30% plus for the foreseeable future we believe this multiple is justified.  The company remains a significant position in the portfolio with a weighting of 6.6%.

Parade Technologies

Parade Technologies, Ltd. is a fabless semiconductor company. The Company offers high-speed interface and display systems used in computers, consumer electronics, and display panels. A frontrunner in high-speed interface IC design, Parade’s product line up spans TCON ICs, high-speed interface ICs, SIPI source ICs, and TrueTouch chips used in NBs, tablets, and LCD TVs. The company serves clients like Apple, Google, Huawei, and Samsung Electronics.  Revenues in the first four months of 2022 rose 31.1% y-o-y.  Over the past decade ROE, ROA and ROIC have averaged 38.6%, 29.4% and 37.3% respectively.  After a 30% share price decline from recent highs, this debt free company trades on 17x 2022 earnings and offers a 2% yield.  The company remains a significant position in the portfolio with a weighting of 5.1%.

Yageo

We purchased Yageo in January this year.  The company manufactures resistors and related equipment.  The Company also produces thick-film resistors which are used in downstream electronics products, and high power thin-film resistors and chip resistors which are used in aerospace, automobile, and precision electronics industries.  In June 2021 Yageo completed its cash acquisition of KEMET and in January 2022 Yageo completed its share swap financed acquisition of Chilisin.  The upgrading of existing business lines and these two acquisitions have seen Yageo take a commanding market share in Chip Resistors (#1 player with 34% market share), Tantalum Capacitors (#1 player with 43% market share), Multilayer Ceramic Capacitors (#3 player with 15% market share) and Inductors (#3 player with 13% market share).  The investment thesis for Yageo rests on its aspirations to move away from commodity like products with minimal pricing power to higher value-added products where it has established a market leading position.  Revenues in the first four months of 2022 rose 22.7% y-o-y.  Over the past decade ROE, ROA and ROIC have averaged a mediocre 21.6%, 9.8% and 11.6% respectively, our expectation is that these returns will improve markedly over the next few years.  After a 35% share price decline from recent highs, Yageo trades on 8x 2022 earnings and offers a 2.5% yield.  The company is a modest holding in the portfolio with a weight of 2.1%.  Evidence that our investment thesis is playing out correctly will allow us to increase this position.

Henry Thornton
Fund Manager, EPIC Oriental Focus Fund