Episode 3: The Empire Strikes Back

In August 2005, readers of MOS was introduced to a company which distributes fast moving consumer goods to Russia, its fellow ex Soviet bloc republics, Central Asia and Indochina. Then, we were salivating over its "big footprint" in these countries and were "positive about MacCoffee sales". In an update given a year later, we said that the company "has been able to capitalise on the rising Russian tide". So this post represents the third update.

This play on the emerging markets - FEH SP - i.e., Food Empire Holdings Ltd (SIN:F03), has continued to defy gravity in its astonishing rise late last week. It appears that in recent days, the market has latched onto the counter due to its cheap valuations, commanding market share and quality management.

Without including its bumper yields about 4-5% p.a., FEH has rewarded shareholders with a total return of 106% over the holding period. This works out to an approximate annualized return of 78%, or IRR of 72%. Whichever way you choose to look at it, this baby is screamer!

With the recent additional analyst coverage, it is likely that the exuberant party has just gotten started for FEH. Hence, by momentum standards (totally unlike MOS' tenets), there could be money still to be made. But are current investors picking up nickels on the highway?

As regular readers would expect, the more bullish the market is about the prospects of our holdings, the less sanguine we become. Despite being considered "contrarian" by some quarters, we consider it almost as a reflex defensive measure to protect our capital. In fact, we would like to remind fellow investors of Cinderella's plight when the clock strikes twelve midnight during her ball. Whilst we remain very positive (the superlative is not used lightly) about FEH's prospects, investors today have to ask whether the market price quoted is right for capital protection.

MOS congratulates early shareholders to this ball for bagging this baby. It was certainly rewarding in our bid to build our financial empire.

Crouching Tiger, Hidden Assets

The coat of arms of Malaysia consists of a shield guarded by two tenacious tigers. And Keck Seng (M) Bhd (KS MK) (KUL:KSG) (RM3.50) is a company domiciled there which is engaged in the diverse businesses of oil palm cultivation, milling and refining, property development and ownership.

Over the years, the company has accumulated several crown jewels. It has a cash horde of RM320 million, a portfolio of marketable securities, little debt and several property assets in the form of an office tower in central Kuala Lumpur and three hotels in Toronto, Quebec and Honolulu.

Much of the value of these assets is obfuscated from the casual eye. For example, the marketable securities portfolio has not been marked to market while its property holdings are held at prices which are nearly 20 years old. On a conservative RNAV basis, it is trading at 0.65x book, and P/S of 1x. Furthermore, as KS is required to comply with revised accounting rules that require it to mark to market the securities portfolio which it is currently carrying at cost, it is likely to report a sharp jump in EPS; leading to a low forward PER of 2x (1.3x on a PER (ex cash) basis) if any tax effects are ignored.

In June 2006, KS announced its intentions to set up a REIT in the next two to three years. Assets that KS may inject include Menara Keck Seng – a office building located in Kuala Lumpur’s prime GT, Regency Tower and Tanjong Puteri Golf Resort. But MOS is of the view that the formation of the REIT is unlikely to occur in the foreseeable future. As evident from the foregoing list, the bunch of buildings is a diverse current group with no coherent theme as yet. So KS may need time to acquire or construct other buildings before sponsoring a REIT.

Two developments are likely to give its property development arm a boost and eradicate the rumored oversupply situation in Johor. First, the Malaysian government recently announced measures to allow foreign ownership of properties. The “Malaysia, My Second Home Programme” is a government initiative allowing foreigners to live in the country on a social visit pass with a multiple entry visa. They can now own or invest in houses costing more than RM250,000 each without having to secure Foreign Investment Committee’s approval. In this regard, there is reportedly interest from the oil rich Middle Easterners to invest in Malaysia, a fellow Muslim country. Johor, being the state closest to developed Singapore, should figure high on a potential property investor’s list. Second, KS’ land bank which is largely in Johor may benefit from the positive sentiment arising from the Iskandar Development Region (formerly known as the South Johor Economic Region) – an ambitious blueprint unveiled in the 9th Malaysia Plan to develop the state into a hub for leisure and business in Peninsular Malaysia. It is expected that some 800,000 jobs will be expected over the next 20 years at the IDR. With the migration of people from other states to Johor in search for jobs, residential demand should be boosted.

Finally, there is growing interest to use palm oil as a biodiesel to serve as an alternative to petrol. This may further catalyse investor interest in KS as it holds several such plantations.

In a nutshell, we estimate that there may be up to 40% upside [to its RNAV value] when the market takes note of the above factors.

Priced to Perfection

As we usher in the new year, financial magazines, TV programmes, and brokers are all falling over each other to share their top (ten) picks for this calendar year. However, the mood at Margin of Safety (MOS) is considerably more somber as we are folks who are very much focused on the downside risk of every trade. Hence, the first security featured this year is one which we feel investors should exercise caution with.

CapitaRetail China Trust (CRCT) is a Singapore-domiciled REIT established with the aim of investing into a diversified portfolio of income-producing real estate used for retail purposes that are located primarily in China, Hong Kong and Macau. CRCT's initial portfolio of seven retail malls - Jinyu Mall, Zhengzhou Mall, Anzhen Mall, Jiulong Mall, Wanjing Mall, Xinwu Mall and Qibao Mall, are located in five major cities across China.

CrCT was initially offered at S$1.13 and started trading on 8 Dec 06. It closed on the first trading day at S$1.80 and has since run up to over S$2.00. Investors piling up into CrCT are buying into the growth story of China consumerism and the familiar, but what we crudely consider to be the balderdash of Chinese over-hype. Of course, CrCT is backed by a strong sponsor in CapitaLand Limited (SIN:C31) who has promised to inject properties into the REIT from its incubator funds. Capitaland is a seasoned operator with a stellar track record of managing REITs in Singapore and lately, in Malaysia in the form of Quill Capita Trust. Readers will also recall that in early 2005, CapitaLand had entered into an agreement with state-owned Shenzhen International Trust & Investment Co Ltd to build 21 shopping centres in China with an option for a further 14. These malls will be anchored by US retail giant WalMart Stores Inc.

But at its current price of S$2.10, we like to point out that CrCT is yielding a paltry 2.91%. Paltry because one can receive a yield of more than 3% by purchasing risk free "AAA" Singapore government sovereign gilts (albeit its unglamorous factor). So accumulators at this price have to ask themselves whether they are being sufficiently compensated for assuming the risk of investing into an emerging economy like China? Or risks that competing malls may mushroom adjacent to CrCT's current one in the vast country, changes in legislation, or even a slowdown in Chinese demand?

To compensate for the low yield, investors are probably expecting strong rental growth or an increase in capital value in the years ahead. So exactly how much growth in NAV are we looking at for it to catch up with prevailing prices? It is specifically a 114% increase for its NAV of $0.98 to narrow the gap for CrCT is trading at 2.14x of NAV.

For illustration purposes, we assume that a fair yield for Chinese mall exposure is 6%. A 6% yield at S$2.10 implies CrCT has to make a distribution per unit (DPU) of $0.105. This is approximately a 70% increase over the current DPU from future rental step-ups and asset enhancements. If its DPU were to grow at 10% per year, CrCT will then take about 6 years to grow its DPU to the requisite level. So today's investors have to decide whether they want to pay up for this possibility 6 years in advance!

Another quick way to look at it is that any cent above the NAV backing of $0.98 which one forks out is essentially for the hope of growth. Or for, if you are to excuse our "un-investment bank like" plain speak - Chinese air (which quality may not be the best around if recent reports are to be believed) until the growth materialises.

As a rule of thumb, prices of stocks in a market can gyrate between three states: (a) underpriced, (b) fairly priced, (c) overpriced. Category (b) is for upholders of the efficient market theory. If you fall in this group, it suggests that no mortal can beat the market and hence, one should be better off investing into an index fund (and spending time with your kids) and not CrCT. MOS folks do not fall in this camp. It is stocks in category (a) that we relish and would back up the truck for. At current prices, we are of the view that CrCT is more likely to fall in (c) where the probability of sustaining a loss far exceeds that of making a gain. We tend to stay clear of such a situation where capital impairment is a distinct possibility.

Obviously, one man's poison is another's caviar. So if there is a takeaway in this opening post of 2007, it is that one should tread carefully in the stock market minefield, especially when considering a buy of CrCT at current prices.