Sunday, December 31, 2006

Tis the Season to be Jolly!

Tis really the Year to be Jolly! And what a year it has been for the Asian markets. The folks at Margin of Safety (MOS) principally feature ideas available on the (usually) sunny island of Singapore but frequently intersperse it with choice picks from the region as well.

With the inclement weather lashing down by the bucket load, we thought it would be interesting to start our own MOS Awards for the ideas featured on this calendar year. Initially, there were arguments against such a format of basing returns on a calendar year because value picks often take time to unlock. But, we hope our regular readers understand that this is really a tongue in cheek exercise on a damp afternoon.

And there is no better way to kick off the MOS Awards by examining the biggest red blot on the report/blog card...

#1: MOS Top Dog of 2006: Magnecomp: -44%
Featured in March, Magnecomp International Limited is a company engaged in manufacturing and sale of suspension assemblies, metal stamping and sub-assembly of stamped components, tooling and die making. It appeared cheap on a sum of parts basis and had indeed moved beyond the price on feature date subsequently. However, a profit warning issued in May/June sent the whole pack of cards crashing through the floor. What went wrong? On hindsight, at the price of S$1.37, Magnecomp may have incorporated growth expectations and thus lacked sufficient discount from intrinsic value. However, in recent months, things are brighter and an opportunity may surface at current prices.

#2: MOS Star of 2006: Thomson Medical Centre: +84%
A meteoric rise since being featured in February when it was trading at only $0.29. At the price then, the counter was trading marginally under book. It has nearly doubled since as investors zeroed in on its cheap valuations and exciting growth prospects in Vietnam.

#3: MOS Top Foreign Star: Sincere HK: +36%
We started featuring foreign listed securities after lamenting about the dearth of value plays on the local bourse. So, its apt to have a special category for them. Bagging the bragging rights is Sincere HK which staged a stunning reversal in fortunes after being featured in early November. Investors took to the counter overnight after seeing that Sincere HK is well poised to tap on the rising affluence in North Asia.

The entire list of ideas discussed this calendar year are set out below:

Date* --Security -- Price then -- Price now** -- Return to date
16-Feb --G&W -- 0.18 -- 0.295 -- 63.9%
23-Feb --Thomson Medical Centre -- 0.29 -- 0.535 -- 84.5%
14-Mar -- China Lifestyle -- 0.235 -- 0.42 -- 78.7%
16-Mar -- Magnecomp -- 1.37 -- 0.77 -- (43.8%)
20-Apr -- MTD -- 1.88 -- 2.01 -- 6.9%
29-Jun -- BIL -- 1.35 -- 1.68 -- 24.4%
18-Aug -- Micro-Mechanics -- 0.48 -- 0.69 -- 43.8%
10-Oct -- Frontline -- 0.135 -- 0.125 -- (7.4%)
6-Nov -- Hotung -- 0.13-- 0.135 -- 3.8%
7-Nov -- Sincere HK -- 0.57 -- 0.78 -- 36.8%
4-Dec -- Yellow Pages -- 1.12 --1.12 -- 0.0%
7-Dec -- Ayala -- 510 -- 540 -- 5.9%

* Date refers to date featured on blog.
**Price now refers to price on market close on 22 Dec.

It has been a great year for the Straits Times Index - returning nearly 24%. On the other hand, Margin of Safety's featured securities turned in only marginally higher returns - about 24.8%. Strictly speaking, the returns are not comparable for the latter return was derived by equal weighting the returns to date of all securities. But we thought it might demonstrate how difficult it is to beat the index. Some may consider the performance of MOS' picks laudable as none were index securities. However, others would question the effort in such arduous stock picking when index tracker funds are readily available.

Indeed, in a situation where the rising tide raises all boats, we also cannot conclusively attribute the returns purely to alpha generated by superior stock picking ability. The true test, may well be when the bad times strike. As the year comes to a close, we make merry and revel into the night. We consider it apt to leave you with a tidbit of wisdom from the venerable and respected Mr Warren Buffett who wrote in the shareholder's letter of Berkshire Hathaway in February 2002: "It's only when the tide goes out that you learn who's been swimming naked."

Until 2007, MOS is ghost.

Important note: This is not a sample or model portfolio. The author and his/her associates may not be holding onto any of the above named security. It is also not a recommendation to buy or to continue holding onto any security. The above is purely for illustrative purposes.


Sunday, December 24, 2006

Chinese Brothers

One of our picks earlier this year, Brothers Holdings Ltd. (SIN:G03), has rocketed to a 52 week high of S$0.365 after it announced a project to develop a township in Shenyang City. You may be having a second take but Brothers Holdings is actually the new name for G&W Group which was featured on 16 Feb 06. The name change took place in the middle of this year. From its Friday's close [S$0.295], it is up about 64% since Margin of Safety's post [close of S$0.18] in February. Then, we were of the view that the company "appears to offer a margin of safety of about 50%".

The township project, named Singapore City @ Shenyang will comprise of commercial (10%) and residential (90%) units. This S$1 billion township will also include schools and a country club. It will be located ten kilometres from Shenyang Inernational Airport and about five kilometres from Taiyuan Street Business Zone.

Development will commence in 2007 but is expected to take eight years. In order to fund this huge undertaking, Brothers has completed a private placement of nearly 25 million shares at about S$0.28. The proceeds will largely be channeled to this Shenyang project while the rest will be used as working capital. The placement is fairly substantial as it represents 20% of the existing issued share capital and 16% of the enlarged issued share capital.


Thursday, December 07, 2006

Mabuhay Value!

With the Singapore market index, STI, scaling fresh heights each day, counters which offer sufficient discount to their intrinsic values are far and few between. Hence, Margin of Safety features a company from slightly afar - headquartered across the South China Sea. Ayala Corporation (PSE:AC) is Philippines' largest investment holding company. As at Dec 05, it has total assets of over P$173 billion with stakes in real estate, banking and insurance, telecommunications, electronics, IT and infrastructure development businesses.

Ayala's main subsidiaries are dominant firms in their respectively fields. For example, Ayala Land, Inc (PSE: ALI) (AL) is the number one property developer in the Philippines. Bank of the Philippine Islands (PSE:BPI) (BOP) is the number two bank while Globe Telecom, Inc. (PSE:GLO) (GT) ranks second largest in terms of subscriber base in mobile telephony. Another listed company which Ayala has a stake in is Manila Water Company Inc (PSE:MWC) (MW). MW can be considered to have a moat in the form of a 25 year concession to provide water, sewerage and sanitation services to about five million people in the East Zone of the Philippines.

At Ayala's current trading price of P510, it offers an opportunity to partake in this diverse congloromate at about 10% discount to its underlying subsidaries businesses. This discount was arrived at without even attributing a single cent to its unlisted investments.

Listed --- Market Price --- Ayala's stake

AL --- P15 --- 59%

BOP --- P64 --- 34%

GT --- P1270 --- 35%

MW--- P9.40 --- 33%

less debt of P27 bil

Market NAV per share = P558


Monday, December 04, 2006

Are we on the same (Yellow) Page?

Yellow Pages (Singapore) Ltd (SIN:Y07) (YPG SP) is the market leader in providing telephone directories and classified directory advertising in Singapore. Recently, its share price dropped like a rock following a set of poor 2Q07 results. However, at this price, Margin of Safety sees real value emerging.

Let's being with a broad review of its financials. As one would expect, the industry that Yellow Pages operate in isn't the most exciting or glamourous. This is reflected by its falling revenue since FY1998. Its recent 2Q07 numbers paint a similarly troubled picture. Compared to the previous financial year, its revenue slipped nearly 8% and net profit dropped by 17%. The lower revenue was attributed to a delay in the production of directories which led to lower distribution. Its net profit took a hit because operating expenses increased by 5% due to higher wage cost, higher provision for doubtful debts and higher training cost for sales force. However, issues such as the distribution delay are considered one-off troubles which we expect Yellow Pages to be able to turn the page on.

The ace in the hand could be the company's internet platform - Internet Yellow Pages (IYP). Currently, IYP contributes only about 4% of revenue. But with its recent initiatives to beef up its hardware and software in order to enhance its search capabilities, IYP's future contribution is likely to increase. The IYP is essentially a search engine that seeks to carve out a niche in local content. It also seeks to feature more local small and medium size enterprises. Given that this business model pits IYP head on with the search engines titans of the world such as Google and Yahoo, it is difficult to put a finger down on its potential impact on Yellow Pages' bottomline. Hence, we chose to ignore IYP in our valuation.

Yellow Pages has a 100% dividend payout policy. In FY06, it paid out S$0.085. Due to reduced profitability, its payout this year is likely to be cut to S$0.075. Given its clear dividend payout policy, the dividend discount model (DDM) will be a natural candidate to apply to this company. The following assumptions were made:

  • Dividend per share will fall by 2.5% over the next ten years;
  • A terminal growth rate in dividend of 0% was used; and
  • A discount rate of 5%.
The discount rate is justifable given the stable perating characteristic of the company. DDM gives a fair value of S$1.26.

A cross check was done using the discounted cash flow methodology. Its core business generates copious amounts of free cash flow annually. Yellow Pages current free cash flow yield is about 9%. Its cash flow per share would have been higher if not for it being masked by relatively high non cash depreciation charges. This second valuation method returns a fair value of S$1.65 using similar assumptions.

We consider the current market price of S$1.12 to be very attractive as it provides a discount ranging from 11 - 32% from its intrinsic value. We also consider the 7% yield to be attractive given the possibility of a Fed Funds rate cut in the horizon.

As it is lonely to fight against the herd, it is comforting to know that we are on the same page as a superinvestor. In early November, Third Avenue Management LLC popped up as a substantial shareholder of Yellow Pages. The Third Avenue Global Value (Master) Fund L.P. is 5.21% of the company.