margin of safety

A Sound Investment (so far)

2011-04-15T00:21:00.003+08:00

Soundwill Holdings, which was flagged out in June 2007 at HK4.40 per share, continues to scale the price chart as management unveils more value accretive initiatives. It closed today at HK13.60, which implies a gain of approximately 210% over the 3.8 years holding period, or about 50% per annum. To some extent, this pick has highlighted the importance of investing in companies with growing NAV per share.

The flagship property Soundwill Plaza remains nearly fully let in the prime Causeway Bay district. There was also positive rental growth of 9% yoy, bringing net income from the asset to HK$200 million. As we had flagged out earlier, Soundwill is developing another commercial building behind Soundwill Plaza at Tang Lung street. When completed in FY2013, rental income would likely be boosted by an additional HK$72 million. Including its property assembly / development business, Soundwill's fair value could be about HK$20.00.

When viewed in the context of the horrible global financial crisis which happened during our holding period, Soundwill has proven to be a performing and rewarding bet thus far.

On a rising tide

2011-04-08T14:40:00.001+08:00

Jaya Holdings (S$0.63) was the subject of a takeover bid recently. We are of the view that it was a technical bid by the new controlling shareholder Cathay because it had to satisfy the rules of the Takeover Panel. As expected, the independent financial advisor Kim Eng had recommended minorities not to accept Cathay's offer. The takeover has since lapsed. As this poor sentiment dissipates, we expect the price of Jaya shares to quickly breach its book value of S$0.68 and next settle at least in the S$0.70s range. Following its restructuring, we have no issue with the fundamental prospects of the company and estimate its fair value to be substantially higher given the buoyant prospects of the oil and gas industry as well as the new builds in progress. Street estimates its RNAV to be north of S$1.00.

Show Me the Money

2011-04-07T22:38:00.002+08:00

Asia Enterprise Holdings hit an intra day high of S$0.375 as excitement returned to the oil and gas sector. Despite its cash laden balance sheet, the stock closed at S$0.34, below its NAV. Our other recent name Selangor Properties also advanced to RM4.36 from RM4.20 as regional investors take note of the steep discount to NAV of RM5.11. Looking at how the counter is stirring, more upside could be in store.

Innotek which was flagged out a year ago at S$0.50 surged too. It closed at S$0.615. Note that management has consistently doled out a 5 cent per share dividend annually. Hence, it represents a capital gain of 23%. Given its 10% yield on cost, the total return over this 1 year holding period is approximately 33%. If Innotek maintains its cash horde and does not deploy into acquisitions, the current 8% yield is sustainable. Even at S$0.615 per share, it trades at a steep 28% discount to NAV (S$0.85). The upcoming annual general meeting would be held on 28 Apr 2011, where the dividend is likely to be ratified for a pay out in late May 2011. Expect shareholder approval for this sizable payout to bring about further interest in the name.

On the Right Track

2011-04-03T11:53:00.004+08:00

Malaysians will readily tell you that one of the most prime plots of real estate in KL is in Damansara locality. The area has also received a further boost with the government's plans to put up a MRT line through the locality.

One of the prime beneficiaries of the above developments is Selangor Properties (SP), a sleepy KLSE listed company (current price of RM4.20) with a substantial land bank in Damasara.

SP owns about 20 acres of land adjacent to the proposed MRT Blue Line Pusat Bandar Damansara station. Future projects is likely to be integrated with the station, thereby increasing attractiveness and consequently, its selling price.

SP also has a strong balance sheet with a net cash position of about RM200 million (RM0.58 per share). This is because it has a strong recurring cash flows from being a landlord of assets such as the 25 storey Menara Millenium. The capital values of these assets (including Wisma Help, Kompleks Pejabat Damansara) should also increase in future when the MRT stations are completed. These assets are located in close proximity to the Pusat Bandar Damansara and Sematan stations.

SP had been able to consistently grow its book value per share in the last five years. Its last report BV per share is RM5.11. A broker has issued a report on SP in March 2011 titled "Sitting on a Gold Mine". The analyst's estimated RNAV per share is RM7.31 per share.

The group also intends to launch its high end Batai project in the second half of 2011. Strong pre-sales could be a catalyst for price to move closer to BV of RM5.11 per share. Its major shareholder Kayin Holdings obviously sees value as it raised its stake from 61% to 66% recently. A take out by Kayin cannot be ruled out due to the past failed privatization attempts on the group.

Hence, with the numerous catalysts above, this sleepy company may well have its day in the sun soon!

Nerves of Steel

2011-04-03T11:27:00.000+08:00

Asia Enterprise Holdings (AEH) continued to perform credibly in FY2010. The group registered EPS of 3.52 cents, extending its track record of profitability to 38 straight years.

With over 50% of its inventory gearing towards supplying the shipping industry, AEH is likely to benefit from the boom in the marine and offshore sector in 2011. In fact, the Group reiterated its bullishness by indicating that the Group "stands to benefit from rising steel prices".

AEH continues to maintain a strong balance sheet with 38% of its NAV being a net cash position of 14 cents.

Valuations wise, the Group remains compelling. At the market price of 34 cents, it trades at a 14% discount to its NAV of 38 cents. On a PER basis, it trades at 9.6x earnings. Excluding its cash horde, the PER dips to only 5.4%.

Hence, valuations does not look overstretched even though it has run up over 20% from our call on 21 December 2010 (when stock was trading at S$0.27 per share).

A Year Older, but None the Wiser?

2010-12-21T21:18:00.004+08:00

What a year it has been! Liquidity remains abound and asset prices, particularly that for real assets, have continued to remain resilient.

It is also looking like a bifurcated world; in terms of growth prospects and asset prices for the developed and emerging economies. That said, never forget that the entry price is vital in determining investment return regardless of how rosy economic prospects can be. If it is already in the price, the return is likely to be mediocre.

Despite these peculiar market conditions, MOS feels value investing remains the way to go although having an idea of the macro picture is tantamount to avoid big mistakes.

Several of the stocks profiled have continued to perform. Whilst its investment into a REIT remains questionable, Innotek remains above the March 2010 price. It also appears on track to pay out another 5 cent dividend.

We all like companies which we can hold through cycles. But by and large, we are not "buy and hold investors" because very few firms possess the competitive advantage to merit investors holding them through market cycles.

For firms in cyclical industries, it is paramount to know when to exit before things go pear shaped. We continue to like Innotek because it yields 10% at our entry price and remains under NTA. That is not to say that we would not hesitate to trim/exit the position when the price-NAV gap shrinks. Likewise with Asia Enterprise Holdings. Trading at S$0.27 on the Singapore Exchange, it has grown its NAV and has a very long track record of profitability. Mindful of the fact that it operates in a cyclical industry where demand can vaporize quickly, management has prudently maintained a strong balance sheet. Trading under NTA, it offers a good 4-5% yield at current price. MOS also see a potential catalyst in the coming year. Investors have placed bets on Keppel and Sembcorp Marine on potential large contracts from Petrobras. Placing money in Asia Enterprise which derives a significant chunk of its revenue from the local marine industry is a bet on both horses. Seems to be a two in one proposition which we could live with. Unfortunately we cannot delve into details for more portfolio holdings or provide more update for this is meant to be a strategy piece.

The high yield of Innotek brings us to the next characteristic which exemplifies our portfolio - importance of dividends. To go to the upcoming Christmas cocktail party and tell people that you are into dividends instead of the next solar stock may not make for exciting conversation. However, for excitement and attention, we recommend you put on a loud red, green and pink garish outfit and stick to picking out high yield names. In markets with increased volatility, MOS feels that going for yield will make a significant difference in the long run.

Besides the obvious reasons where it is usually companies with good strong business models or excess free cash flow which can afford dividends, it is not usually highlighted that dividend income makes up approximately 30% of total return in many global studies over extended periods of time. So with reports suggesting that the recent whipsaws in markets are unprecedented, having high yield as a cushion is a strategy which MOS is pursuing. Not rocket science, not the most sexy but one which being a hare could far outstrip the rabbit if the return on capital is sensibly compounded.

The market volatility also brings into spotlight arbitrage techniques. Capital structure arbitrages, TDR/cross listing trades, spin-offs are event driven techniques which are independent of market direction. Hence, their contribution to the overall portfolio return is important if market is directionless. So investors should actively seek opportunities like Lion Asiapac where the return is more dependent on corporate events rather than broad market movement or sentiment.

Another year has flashed by but the market prognosis remains challenging. The future will always remain inherently uncertain. The fundamental concepts of value investing may be simple but no one would say that applying them is easy.

Lion Asiapac declares a 15 cents special dividend.

2010-03-30T17:47:00.002+08:00

“First they ignore you, then they laugh at you, then they fight you, then you win.”

Mahatma Gandhi

Perhaps MOS was premature in expecting a payout as early as Feb 2008. Even though we are value investors accustomed to the long journey, this has been a particularly interesting one. We also offered several updates in Sep 2009 and Dec 2009. But ultimately, we are just glad that that the minorities are having their day in the sun.

Never Ask a Barber if you need a Haircut

2010-03-27T09:52:00.002+08:00

MOS almost fell off the chair laughing after reading comments made by leaders on the Asian property space.

One director from a prominent HK developer argued that bubbles are good for the market. Another appeared to suggest that the non release of sites at low prices to developers in government auctions has contributed to the exuberance today.

These remarks remind us of Chuck Prince's 2007 comment. Prince, the former chairman and chief executive of Citigroup said in July 2007 that "as long as the music is playing, you’ve got to get up and dance. We’re still dancing.".

We always like to say that it is never wise to ask a barber if you need a haircut. Or the fruit seller if his oranges are sweet. The wider implication to all this is that it is tantamount to establish one's interest or agenda behind each pitch.

For so long as interest rates are low and the apparent recovery is taking root, demand for apartment units will continue to move quickly. Developers who are in the business of selling units will, understandably, launch units to feed the frenzy.

So investors/individuals have to be discerning. Shrewd property investing requires one to have a very long time horizon and a through analysis of demand and supply conditions; and not just buying shoe box size units because they are affordable at today's low rates. Examining "what ifs" are necessary too: What if the unit cannot be rented out? What if rates go up? etc etc.

Whilst we are at it, we would like to draw attention to the first line of Prince's complete quote which is less often run: “When the music stops, in terms of liquidity, things will be complicated."

How far out do you look?

2010-03-23T13:31:00.002+08:00

Investing, by definition, means forgoing present consumption for future returns. It is worrying how far we, as a market, has strayed from this definition. The average holding period of securities listed on NYSE has, from memory, been falling over time. The recent holding period for a stock could be as short as six months.

This plays into the hands of value investors who truly are able to cast their return expectations further out into the future. The telling statistic also suggests that true blue value investors will continue to hold their own, when their performance is measured over an entire market cycle.

We are strong proponents of time arbitrage. In January 2007, MOS highlighted the gross undervaluation of Malaysia listed Keck Seng. As pointed out then, the failure of the market to recognise its hidden value of its assets which, as we wrote then "is obfuscated from the casual eye.". These assets include:

not marking to market its securities portfolio;
holding its property assets at cost which goes back nearly 20 years old.

Then, it was speculated that the catalyst to unlocking the value would be a REIT although we had surmised that "the REIT is unlikely to occur in the foreseeable future". For those who have a longer time horizon, the development of the Iskandar Development Region would play into the hands of Keck Seng as it holds several plantation plots in Southern Johor, albeit away from the "action" currently.

Besides the tax credits which has to be used by 2013, the more immediate catalyst driving the stock up today is the need for the company to comply with revised accounting rules that require it to mark to market its securities portfolio.

Under FRS139 which has been effective since Jan 2010, listed companies are required to fair value their equity investments and reflect unrealized gains/losses in their quarterly statements. This will make the earnings more volatile if the securities portfolio, when classified as trading securities, is large compared to the core business.

In the case of Keck Seng, examining the notes to its financials show that the market value of its securities portfolio is RM672 million. This translates to an uplift to book value of about RM1.80 per share. This implies a RNAV of about RM6.80.

As you would imagine, this takes into account only the revaluation of the marketable securities portfolio. The bulk of the revised value lies, however, in the property portfolio. In 2005, Keck Seng sold 180 acres of plantation land in Ulu Tiram to the government at RM251,000 per acre. If its entire land bank in Ulu Tiram, Bandar Baru Kangkar Pulai, Pasir Gudang and Tanjong Langsat (carried at 1980 prices) is simply revalued to those 2005 prices, Keck Seng's NTA would increase by another RM9 per share!

Its commercial properties are also grossly understated on the books. Menara Keck Seng at the prime Bukit Bintang stretch is likely to be carried only half of current market values. We can probably say the same for its properties in Singapore (last valued in 80s), and hospitality assets in Canada and Hawaii. The hotels were last revalued in 1997 and 2000.

Standing at 2007, reflecting our conservative self, we wrote that there may be "up to 40% upside" from RM3.50. The current market price of Keck Seng has way surpassed our estimates. In fact, from the above analysis, it does suggest that the RNAV seem wide - from a range of RM6.80 to even a whopping RM16 if the property portfolio is completely revalued. What intrinsic value that will eventually be crystallised perhaps lies in the investor's time horizon.

Run Keck Seng Run

2010-03-22T22:08:00.003+08:00

Bursa Malaysia listed Keck Seng, whose core businesses include managing oil palm plantations and property development, has been surging of late. Market watchers are anticipating the conglomerate to dole out more dividends soon. At end 2009, the firm had cash of RM332.6 million and is debt-free. It reportedly also has high unutilised tax credit of RM427.6 million to be franked as dividends before end-2013.

Welcome to the "World of Innovation"

2010-03-21T16:45:00.003+08:00

Innotek specializes in precision component manufacturer. The SGX listed firm produce small tiny metal components which are building blocks for numerous devices which we use daily.

The group was known as Magnecomp previously. It has restructured heavily in recent years. One of the moves was to acquire the remaining 17% in Mansfield Manufacturing in April 2008. Following this acquisition, Innotek, through Mansfield owns ten modern manufacturing facilities, including eight in China, one in Netherlands and one in the Czech Republic.

Currently, Innotek serves customers in the consumer electronics, office automation and automotive industries. It recently reported full year results for 2009. For the full year, Innotek reported a 14% decline in revenue to S$361 million.

What analysts, however were looking out for was confirmation of a bottom line turnaround. Innotek delivered. Net profit surged sharply into the black to S$9 million compared to a loss of S$6 million in 2009. This follows from the return to profitability of Mansfield. With EPS at 3.24 cents per share, its PER is 15x. Whilst this multiple appears high, note that further compression will occur as the business improves out of the trough. So paying what appears to be peak multiples for trough earnings and on a before ex-cash basis appear reasonable.

With stock price only at S$0.50 and NTA at S$0.86, Innotek is trading under book at less than 0.6x. Management appears determined to correct this.

For the second year in a row, shareholders are rewarded with a 5 cent dividend. With the stock at 50 cents, this translates to an astounding 10% yield! This is paid out of its huge cash pile of approximately S$0.28 per share. Whilst this may drop as the group seeks acquisition targets, management is likely to retain sufficient cash for working capital requirements as well as for future payouts.

Second, management has also embarked on a share buyback program. The completion of the program is likely to drive the NTA per share to over S$0.90 share, thereby steepening its discount further.

Analysts are also increasingly engaged as management seek to correct the steep discount. For example, it was recently shared that Innotek intends to pursue opportunities in the automotive and medical related sectors which offer higher margins.

In a nod to Innotek's tagline "World of Innovation", buyers now are, by virtue of its fat dividend, paid to wait for the sharp discount to close. As value investors, we find that certainly most inventive!

Will the Lion Roar?

2009-12-18T00:14:00.003+08:00

MOS last wrote about Lion Asiapac (LAP) in late Septembe r. Following the disposal of its entire stake in the Chinese automaker, LAP had attempted to takeover an Australian listed mining firm Polaris Resources. The bid has since fallen through after a competing bid was deemed to be more attractive by Polaris shareholders.

The failed bid raises the possibility that LAP may return more cash to shareholders in the coming year. Besides embarking on a share buyback program, shareholders are likely to demand more than the usual 1 cent per share dividend if the cash continues to sit on the LAP's balance sheet.

We estimate that the net cash per share to be approximately S$0.47. As a result of the cash laden balance sheet, buying interest has returned to the stock, leading it to close at S$0.36 today, near its 52 week high of S$0.37. LAP has doled out special dividends before. Of note was in 2006 where a payout of 5 cents was paid that financial year. Assuming a total payout of 5 cents at the current market price of S$0.36, LAP would have a dividend yield of 13.8%. Hence, expect LAP to trade substantially higher if there is more certainly of a special pay day.

Christopher Browne passes on

2009-12-15T14:55:00.002+08:00

Legendary value investor and principal of value investing firm Tweedy Browne, Christoper Browne, has passed away. Barton Biggs of Traxis Partners once called him "one of the best value investors in the world". He was in his 60s when he passed away on Sunday.

In the early days, Tweedy Browne had brokered trades for Benjamin Graham and helped Warren Buffett acquire Berkshire Hathaway. Although the firm currently manages only about US$10 billion in assets, Christopher is better known as the genteel portfolio manager who brought down media baron Conrad Black. He started questioning the accounting of Black's Hollinger International in 2001. Subsequently, it was revealed that Hollinger's shareholders were bankrolling Black's lavish lifestyle including his Rolls Royce's refurbishment to the tips doled out by his wife on shopping trips.

Christopher has also authored "The Little Book of Value Investing", a book which MOS consistently recommends as an excellent introductory primer to this craft.

Our heart goes out to Christopher's family. The value investing community has lost a scion.

Running on Empty

2009-11-01T11:19:00.002+08:00

This post is at least a week late. Various committments had conspired and led to what should have been a late October post to turn into a 1 Nov one.

About ten to eleven months ago, we asked whether "we can have a last flutter?". Many readers were astounded and questioned our sanity. Fortunately, equity markets have heeded our request and delivered one of the most stunning recoveries since the Great Depression. The recovery in price performance is so strong that it seems detached from the underlying economic and market fundamentals. So it is worthwhile to check back to ascertain whether this is inherently sustainable.

First, it is important to understand why we wrote that in Dec 08 that we "cannot rule out the possibility of the largest ever January effect taking place". Our call was made on the back of the direct consequence of the monetary easing and fiscal expansion; actions coordinated by all global economies. Hence, the strong subsequent surge in equities was due to the flood of liquidity or easy money in the system, not an actual recovery in fundamentals.

Fast forward nearly a year. Things are indeed looking up but it would be foolhardy to think that we are out of the woods yet. A debt deleveraging crisis is inherently debilitating and countries like the US still have a ton of debt, including that in commercial property space that remains yet to be tackled. However, a lot of emergency stimulus measures put in place last October at the height of the crisis expired in end October this year. Whilst the market does not require some of these measures such as those designed to restart money markets, due to the inherent recoveries, liquidity in the system cannot be said to be as abundance as before.

Likewise, in China, whilst Premier Wen may be asserting that headline monetary policy stance remains loose, folks on the ground are reporting otherwise. Bank lending in 4Q09 are not as easy as that of the record RMB 7 trillion extended in the first nine months.

Also, certain governments such as that in Australia are mindful of inflation, and have started hiking rates.

We write this with the STI closed at 2651 and S&P 500 at 1036. At these levels, we feel that the downside risk outweights the upside potential because (a) liquidity conditions are not as strong as before, (b) fundamental recovery has not taken root to support current equity valuations. In plain English, MOS expects markets to correct in the months ahead.

Despite the bold assertion in the preceding paragraph, we have to stress that we do not possess any magic crystal balls. It is just an outcome we believe should happen given our analysis of fund flows and market dynamics. If we are right, MOS will be in a much better position to capitalise on the resulting carnage. As net buyers in the long run, we welcome any correction in the market as we plough through company after company in search for fundamental value. This is also not a recommendation to short markets as they can stay irrational for longer than one can stay solvent. It however should represent an opportunity for an investor to trim or unload any fundamentally weak positions into this period of strength, given that we expect rougher waters ahead.

We had a good time last night, indulging in the various "Trick or Treat" festivities that characterize Halloween. But without future government intervention, we leave the month of October with a niggling suspicion that the haunting and spooking of markets could linger on for much further, into the weeks and months ahead.

The Wayward Son?

2009-09-26T09:18:00.004+08:00

In February last year, Margin of Safety pointed out the special situations opportunity in Lion Asiapac Limited (LAP). LAP was trading at S$0.265 then. The value proposition was that if LAP were to dispose of its stake in Shanghai listed Anhui Jianghuai Automobile (AJA), the NET CASH on its balance sheet will swell to S$0.44 per share, a whopping S$0.17 above the then market price.

The ensuing financial crisis meant that LAP failed to dispose of the AJA shares above the price floor of RMB7.50. However, the recent recovery in global, in particular, Chinese equity markets have given LAP much cause for cheer. AJA has traded back up above the floor price, thereby allowing LAP to partially dispose of its stake.

As on 15 Sept, LAP has disposed approximately 2% of its 6.16% stake in AJA. The sales netted total consideration of Rmb189.46 million.

By our updated estimates, the net cash per share on the balance sheet increases to S$0.21 per share (assuming the 2% were all conservatively sold at S$0.21). Completing the entire disposal program means net cash per share of at least S$0.41, still way above today's market price for LAP at S$0.32 a share.

Enthused by the recent strong property sales in Chinese market, LAP had proposed to go into property development in China. The mandate, however, was wisely (in our opinion) thrown out by minority shareholders at an EGM yesterday. This effectively leaves the possibility of LAP being a company trading under net cash when the remaining stake in AJA are progressively disposed in the days ahead. Whilst management do not have a track record of doling out special dividends, there is little reason for a company to trade under its net cash value when it is not under any particular duress.

In recent meetings, minority shareholders have increasingly made their presence felt and views ahead. Besides vetoing the mandate to do property development, many have also loudly articulated the need for a special dividend. We expect increasing media focus on this tussle in the days ahead as the small investor turns up the heat on management for a special dividend from a company which will soon trade under its net cash value. Perhaps if you are convinced about the merits of our argument, you may wish to pick up several lots of LAP and make your voice heard too.

A Return to the Gold Standard

2009-09-24T22:19:00.005+08:00

October beckons and what an amazing twelve months it has been. Vindicating our golden call since July to go into S-REITs, we note that S-REITs as a basket are up about 17% in the past month, 36% in the past 3 months, outperforming both the property developers (+3% and +14% respectively) and STI index (+6% and +21% respectively). In July, we had lamented that "it is surprising that the S-REITs have not re-rated more strongly." In early August, we maintained our similarly bullish stance saying that S-REITs, "despite the run-up, still offer a very healthy spread to the risk free rate." and REITs are, "by and large, still very cheap".

The performance in last month was indeed robust as S-REITs are benefiting from a chase for yields. If fixed deposits are yielding a paltry 1% tops, perhaps CMT at 4.5% yield is still attractive. So there can still be upside remaining but we don't like to bet when the odds are only marginally in our favor. So choose judiciously if you still want to play this game because going forward, rates can only go up from here.

We continue to be bullish about high yielding equities in the near term. US rates are likely to remain on the floor as the authorities attempt to revive employment. Consequently, this results in a lot of cheap and easy money in the global system seeking returns. The run up in asset prices in HK is a case in point. A rich businessman has reportedly paid HKD40,000 psf for a one bedroom unit in Kowloon (not HK island!). The monetary policy mismatch brought about by the HK dollar peg is certainly fuelling a bubble in HK. Easy money from China is also flowing into HK. The situation is certainly worrying the local authorities who have warned the HK banks to tighten their lending standards. We suspect the pleads will continue to fall on deaf ears. So, in the next few months, residential prices will continue to rise in HK, Singapore and key gateway Asian countries, despite the currently half hearted efforts by the authorities to rein it in. Looking ahead, we wonder whether the HK property bubble would result in a de-pegging of the HKD to the USD? After all, both economics are structurally different today as night and day. No inflation will ensue in the US because they are still battling deflationary monsters. But in Asian countries like HK and China, it is inflation worries that is keeping us awake at night.

North of HK is of course China, the country touted as the new locomotive of the world. It is such a misnomer to label them a communist country when their citizens are probably amongst the most capitalistic and enterpreneurial in the world. It is also here in China where we find the comment made by the CIC chairman Lou Jiwei in late August most fascinating: “It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose."

Certainly reminds us of the title of one of our past posts - Forever Blowing Bubbles, isn't it? Judging from CIC's recent investments into Noble Group, Poly HK, etc, his view also ties in to the lament in our last post: "Yes, the market is irrational. It may not really matter if we don't have understand why it is irrational. We just want to be able to profit from it."

So in the paper currency system, it is plain obvious that it is possible to monetize our way of problems. But will everyone raise their hands up and say they have had enough with the USD and Euro in the longer term? If the Yuan is still not ready to step up to the plate, perhaps what's in store for the world is a return to the Gold Standard. So perhaps it may be wiser to persuade your loved one that gold jewellery would make a better gift with the cash made from your S-REITs investments.

We will all laugh at Gilded butterflies

2009-08-02T12:10:00.001+08:00

Come, let's away to prison:
We too alone will sing like birds I' the cage;
When thou dost ask me blessing I'll kneel down
And ask of thee forgiveness; so we'll live,
And pray, and sing, and tell old tales, and laugh
At gilded butterflies...

-- King Lear to daughter Cordelia, King Lear, Act V, Scene 3

Following our positive call on S-REITs on 20 Jul 09, the sector has continued to re-rate strongly. It is our belief that we are now in a bull leg of a bear market. It is not hard to figure it out why equities are the default asset class for investors today. Are we convinced that there will not be a double dip? No, but alternatives to equities are yielding close to nothing. Cash returns close to zero. Ten year Treasuries give a pathetic two per cent and one bears the risk of capital loss if yields move outwards under inflationary pressures. So, its our view that equities will continue with its sizzling run.

As our title posits, we may all laugh at gilded butterflies. But we still cannot help and admire their beauty nor resist touching them. So for investors who missed out on the strong surge which we pointed out could happen as early as Dec 08, the small and mid cap space should be where opportunities remain. As usual, the strategy would be to buy value and move nimbly.

Also, REITs are, by and large, still very cheap. M-REITs are trading around 9 per cent yield and S-REITs, despite the run-up, still offer a very healthy spread to the risk free rate. Likewise, the property funds in Thailand still offer double digit yields. We continue to be positive on them.

Prim and Proper Property

2009-07-20T22:57:00.003+08:00

If two investments are similar and one is trading at a higher yield, what is likely to happen to the one with the higher yield? Price compression is likely to ensue. With the direct property market burning red hot, it is surprising that the S-REITs have not re-rated more strongly.

Investors are chasing condo projects in the residential market at yields of apparently 3%. Note the word apparently because rentals are likely to come under pressure due to the supply of 20,000 units coming on stream in the next two years. A Singapore minister alluded to the same per annum supply figure recently. S-REITs on the other hand, are yielding at least 6%. Their yield spread to the risk free rate is probably the largest on record ever. Take A-REIT for example. If you think its quarterly DPU can be annualized, one is looking at an investment which is liquid and tradable and yielding 8%. The indicative yield on a 10 year SGS is about 2.3%. So that's over 6% yield spread. Of course, you are taking on equity risk premium and yes, some REITs are pricing in blue skies scenario and investors have ignored balance sheet/credit risk. But that is not to say that there are good REITs going for a song in the market today. Another benchmark was when CMT first went to the market in 2003. Then, the first incarnation of CMT failed. A revised offer, from memory, of a 7% yield helped get investors attention and thus, planted the seed for our S-REIT industry. With yields where we are at today, are we back at the same spot in the 6-7 year cycle? We are vested and do not want to offer names. But any serious yield investor who ignores this segment of the market, we believe, would be missing out on an opportunity to get yield with upside potential.

At this juncture, we also would like to clarify our comments on the Singapore residential market. Whilst we will not participate in the queues, it is not to say that the rise in prices and buying activity will abate anytime soon. So is this a bubble? Maybe so. But there could be rational reasons underlying the frenzy.

If one were to take a step back to examine the Singapore household balance sheets, you may come to a similar conclusion. Do not quote us on this but the cash and housing investable savings are about 140% of our GDP and our medium household income is approximately S$7000 per month. Unlike the US and UK counterparts, Singapore households have no deleveraging issue and are not net in debt. So to put a downpayment for a S$1 million property and service its monthly interest is comfortable for many households. Loan servicing may only become a challenge if jobs are lost. But lo and behold, isn't the papers reporting that banks are hiring back investment bankers and private wealth managers again - the same segment of the market who are likely to buy these units? So although the huge supply in the coming months ahead should put a dampener on capital values and rental prospects, the price may find support at a level that may not represent fire-sale prices. If you need to buy, buy into unique projects with good location. Its amazing how the 2 room or studio units get sold so quickly these days. Yes, the absolute ticket size is small but I really wonder how many occupants want to live in such small confined places? An expat family wants a sizable unit, not a tiny 60 sqm compound which sees Junior running into the family's domestic help at every turn.

Yes, the market is irrational. It may not really matter if we don't have understand why it is irrational. We just want to be able to profit from it.

Nobody is thinking in the Herd

2009-06-27T11:02:00.003+08:00

We write this 100th MOS post in late June when the Asian property markets are on the verge of boiling over. Today, showrooms are crowded and property viewing is weekend sport. Queues have also started to form overnight, and agents are working in overdrive again.

Whilst the economic fundamentals in many Asian countries such as Singapore and China are better than that in the US, the recent rush back into the residential property market suggests too much misplaced optimism.

The inventory in markets such as Shanghai are low, but the same cannot be said for cities like Singapore and Malaysia where, in the case of the former, close to 10,000 new units could well be made available in the next two years. And in certain Malaysian states like Johor, the supply overhang has been a historical challenge.

Indeed, the low savings rate and rock bottom mortgage rates (such as sub 2% for the latter in HK) brought about by the easy monetary conditions globally has unleashed money into alternative asset classes such as residential properties. But these investors search for yield without paying sufficient regard to the possibility that rentals could fall in oversupplied cities. Also, the other oft-cited argument that physical property is an inflation hedge is only partially true. One usually forgets that the effectiveness of the hedge actually depends on the lease structures in place and inflation actually pushes out the nominal discount rate. Furthermore, the terrible recession today has caused an output gap of 7% and prices are unlikely to run away until this gaping gap is closed out possibly, at the earliest, at the start of the next decade.

So, we find it apt to leave readers with a quote from English economist and logician, William Stanley Jevons (1835 - 1882) - "As a general rule, it is foolish to do just what other people are doing, because there are almost sure to be too many people doing the same thing."

Life in Hamelin

2009-05-10T11:54:00.009+08:00

It was only a few months back in December when we wrote the piece titled Death by a Thousand Cuts (But can we have a last flutter?). In that post, we stuck our neck out with a prediction. And with economic predictions, one will inevitably get it wrong:

"If we succeed in getting the credit creation process going again (probably more likely than not), another rally in equities would be inevitable. This is not totally tongue in cheek but I cannot rule out the possibility of the largest ever January effect taking place next month! "

Well, we were partially right, save for the timing. The "inevitable rally" has occurred since the March 09 low. And boy has it been a strong one. One of the strongest post crash rallies ever. This has left everyone split and debating whether this is the birth of a bull or a suckers' rally?

As we take in the plaudits, we also take time to compile a list of FAQs which we have been asked and heard discussed regularly in the last few weeks. And we offer our best guesses to each of them.

(1) Birth of bull or suckers' rally?

Call it a suckers' rally, a dead cat bounce, a codicil or a last flutter at the casino. Call it whatever you like but the fact is that the market took off on a tear. We somehow saw it coming in 2009 because of the unconventional and the "do it at all cost" will of the measures undertaken by authorities. That resulted in truck loads of cash sitting at the sidelines and, when sentiment improved a little, led to them being pored into equities again. After all, near money supply growth, M1 and M2 measures are very good leading indicators of subsequent stock market performance.

Also, let us not lose sight for a single moment that we are in the business of buying cheap stocks. And a lot of equities were very cheap in March. They were really oversold. Some were trading at sustainable double digit dividend and free cash flow yields. These should have gone into your shopping basket. So, a rally from those levels is also inevitable.

(2) What to make out of the green shoots?

We think the low lying fruits have been plucked. The economic data is less ugly than before is because the US economy cannot contract at the same negative six percent every quarter. There is also a limit to the savings a corporate can generate through cost cutting. What happens to the next quarter's numbers when there are nearly 9% unemployment rate out there? Will these workers spend? And what in turn happens to corporate earnings then? Economists of a better ilk call it the paradox of thrift; in that, more savings is not necessary good for the wider economy. Paul Krugman had weighed in similar words recently too.

(3) Is the deflationary beast slayed and we are back on track?
It was a massive, do it at all cost boost given by the US authorities. Unlike Japan which used quant easing after the economy sanked into the pits, USA is using it before it really went into the quagmire. So, herein lies the crucial difference. The massive quant easing after Oct 2008 may well have plastered a lot of band aid over the sputtering machine to keep Pied the Piper going for a while more.

Its true that a lot of the quant easing programs have a short time span to it, ie, they will expire in the next 12 months or so. But we could totally see the authorities extending it again if it was necessary to prop things up.

(4) So what's next for the world?

We all knew the eventual destination of the rats in the town of Hamelin. We may be able to avoid hyper inflation. But higher inflation also seems like another inevitable too. So net net, the world could be a low growth and higher inflation place. Until maybe China changes its economic structure. So whilst focusing on cheap stocks, it will not hurt if you prepare for this next inevitable of higher inflation in the medium term because all the quant easing measures to fight deflation may well bring about higher inflationary pressures in the medium term.

In a few years out, asset inflation may also be inevitable then with real rates possibly being negatively currently. Shrewd investors may wish to consider how to hedge or position oneself to profit from this inevitability.

(5) Last Words, MOS?

If you have taken a monster coaster, you will know that the best way to go about it is to either look far out into the horizon or have your hands firmed gripped around the handle bars or do both.

Markets unfortunately are going to be very volatile from this point onwards. Participants in the market will find that they are almost like riding a monster coaster. To get over the fear of it, you should look out into the horizon - at the medium and the long run of the business. And by holding onto your handle bars or seats, the parallel would be having a strong grasp of fundamental valuations of your investee companies. That's has been and is the only way to "survive the ride".

Feel free to drop comments with your opinions.

Laughter is the Best Medicine

2009-03-31T18:33:00.004+08:00

We like this mordant joke cracked by Nobel economist Paul Krugman recently on US' trade with China: "They give us poisoned products, we give them worthless paper".

DDD: Deflationary Death Decline

2009-03-31T18:23:00.002+08:00

In the last market drop in 2001-2002 after the bursting of the tech bubble, the financial press had a field day suggesting that deflation could be near. Even a certain Ben Bernanke then offered his few cents worth when he made his famous remarks on the helicopter drop of money to reflate the US economy. That then was but a scare. Today, the deflationary threat is more real than ever. Case in point are the recent CPI figures for many countries around the world: from US, to China, Japan and even Singapore, the CPI is either flat or registered a yoy decrease. In Singapore, a deflationary trend seems to have been established with four consecutive months of decline?

But you ask: what's wrong with things getting cheaper? It should be great for consumers except that deflation brings about major challenges for businesses and is a heady and toxic mix with high debt levels. Deflation leads to the necessary deleveraging in order for businesses to right size their heavily geared balance sheets. Fire sales would occur in today's market where sellers outnumber buyers. This in turn leads to a sharp marking down of capital values of assets. And businesses scramble to maintain banking covenants in yet another round of asset sales or equity raising. I think you will see where this is leading to: a self reinforcing death spiral. Well, we weren't the geniuses that came up with this sequences of events for the deflationary death decline. It was first introduced by Irving Fisher in his seminal paper "The Debt Deflation theory of Great Depressions. Fisher had published it in Econometrica during the depths of the Great Depression in 1933.

In a nutshell, Fisher postulates that over indebtedness acts in conjunction with deflation to produce a contracting economy. This in turn causes bankruptcies, rising unemployment and falling profits. Given that inflation has been kept somewhat low due to the ability to rely of cheap Chinese produce, the strong growth in corporate and consumer debt has brought back the relevance of Fisher's theory and is triggering fears of a debt-deflation induced depression.

The possibility of such a scenario manifesting is not lost on the IMF. In a recent report, the IMF reckoned the following: "Considering this, risks for sustained deflation are appreciably greater than in 2002-2003, particularly in several G7 (Group of Seven) economies" due to anemic global demand and falling asset prices.

With the threat of deflation hovering, investing is difficult. Whilst brokers are peddling statistics that show that equities are cheap or at least fair valued these days, the whole game will be thrown out of the window if the deflationary seeds take root. So, buy only if you think it is really cheap or if you have established a more than adequate margin of safety. That is the only way to protect your individual investments from this ugly beast. Otherwise if you are not confident, our suggestion on what to invest in this year remains: love, kinship and friendship.

All that Glitters may not be Gold

2009-02-01T11:12:00.006+08:00

The trailing yields of the REITs, shipping trusts and several infrastructure stocks trading on SGX are at all time highs. It is not unusual to find REITs trading in the 10-20% dividend yield range. Like their American listed counterparts, the three shipping trusts listed in Singapore are purportedly yielding more than 30%.

To the yield starved investor, these should be like honey attracting the bees. But the key here is that those sky high yields are derived based on historical dividend payouts figures. If historical payouts are sustainable, then the Babcock and Brown Global Investments must surely be the best thing since sliced bread because the current market price implies a yield of over 120%. Simply too good to be true!

The simple fact is focusing purely on the trailing yields of many such vehicles are misleading.

In today's turbulent market conditions, many vehicles need to preserve cash. Macquarie International Infrastructure Trust has also come out in Nov 08 to say that cash will be diverted to paying down corporate level debt. Following the revelation, its unit price has dipped by about 30%. A scrip dividend schedule was also introduced last year to conserve cash.

For the three shipping trusts, FSL Trust has announced on Jan 20th that it has to reduce its distribution payout ratio to as little as 75% of cash flow. That's a hefty 25% reduction from their usual 100% payout. This comes on the heel of an earlier announcement that its bankers are upping the interest on their debt due to extraordinary circumstances. Pacific Shipping Trust has also cut its payout ratio from 100% to 90% last year.

Clearly, future payouts of some of these vehicles are not sustainable and are subject to future cuts. Putting financing risk aside, business risk are also abound. The income stream from shipping trusts come from long leases inked with shippers. Spot freight rates have dropped and to our knowledge, two liners have gone bust last year. So, what's keeping liners from renegotiating leases with the shipping trusts?

As for REITs, based on the need to have a prudent capital structure, there is no doubt that many may have to reduce their payouts or may face refinancing stresses in future. Many saw the refinancing by smallish Cambridge Industrial Trust as a thumbs up for the ENTIRE sector. Please don't kid yourself. Note that the quantum involved for Cambridge was small. Do also count the number of banks involved for the S$390 mil and take note that the resulting interest cost of 6.6% was not the most attractive ever, thereby leading to a DPU cut. When the refinancing of a larger lump sum say involving S$750 mil and above comes about arising from an expiring CMBS facility, an entirely different story could play out.

REITs with no roll over access would have to do a cheap rights issue, thereby crushing its DPU. It is no secret that investment bankers have approached the S-REITs with respect to doing rights issuances. Saizen and A-REIT have been the first to bite the bullet with new equity issuances. Will more S-REITs follow? The debt maturity profile of some suggest that the likelihood is high.

There's an irony towards doing rights. As a corporate, you want the market price to be high in order to raise more equity. However, if the market gets a whiff that a rights could be on the cards, a mad selloff usually ensues. So, a corporate which really needs the cash usually ends up engaging in a more dilutive exercise to the detriment of the remaining holders. Further pussy footing may even cause the company to go belly up if it gets caught in a vicious downward spiral making a rights issue impossible. General Growth Properties in the US and several Aussie REITs appear to be victims in this respect.

So, it can be upsetting for an investor examining the DPU figure - either the numerator (dividend) drops due to higher interest expense, lower income or the denominator (number of units) increases following a rights exercise!

REITs may need to conserve cash to stay afloat. Bloomberg has estimated that an estimated 70 % of the American REITs are likely to pay out its dividends in scrip instead of cash this year. For example, New York based Vornado Realty Trust, America's third largest REIT, has announced that it would pay up to 60% of its next quarter dividend with scrip.

The regulators of S-REITs stipulate a minimum payout in order for these structures to enjoy a tax break and also to give holders certainty of income. But stubbornly maintaining the rule in these volatile times could well hasten the demise of these vehicles.

These are extraordinary times which calls for extraordinary measures. The rules on gearing have been re-looked to avoid technical breaches. The fact that REITs themselves are lobbying to allow for a cut in the payout ratio (to only 50%) suggests that the management thinks preserving cash is the way to go in this uncertain environment. Should the high payouts continue at the expense of the vehicles' future viability as a going concern? We argue that a cut in the REITs payout ratio should be allowed in today's circumstances until credit conditions normalise. So the stipulated payout ratio should be suspended if management deems fit.

We have applied our judgment and obviously have complied a list of "stay aways". But we do not profess to be superior beings and so cannot be here to tell you which of these business models or trusts are at high risk. After all, we may be dead wrong ourselves. Furthermore, it is also unfair to tar all these vehicles with the same brush. So examine the business model to satisfy yourself of its viability. But if you have not done your homework and are simply lured in by the astronomical historical yield, we advice you to stay away. Merely keeping your fingers crossed in hope of sustainable future payouts may not pan out well and will instead lead to another annus horribilis for your portfolio.

Hence, we wish to take this chance to remind you that: all that glitters may not be gold. During their course of duty, medical professionals are sometimes confounded with the need to make tough calls: - Do you severe the limb to preserve the life (ie, keep the business going by cutting DPU) or let the rot fester in at the risk of one's life later (ie, maintain DPU but face refinancing and counterparty issues down the road at the risk of destroying the entire entity)? As an investor without management influence, you may wish to hang on like a deer in the spotlight to see if the DPU gets crushed or take action now and bail out before the dividend payouts get axed and see your capital impaired.

The choice of individuals differ. But the choice is in your hand.

No Bull in the China Shop

2009-01-31T02:36:00.003+08:00

Madam Ren owns a tailoring shop minutes from the Bund in Puxi, Shanghai. Relocated over from a previous location about a year ago because the authorities were cleaning up the city ahead of the World Expo 2010, she estimates that business has dropped by 30% since the financial crisis struck hard in the third quarter of 2008. Operating out of a spartan shop in a textile complex, she specializes in making office wear such as jackets and long sleeves shirts for professionals. Business was brisk in the last few years and she concentrated on producing as fast as she could to satisfy her rapidly growing list of customers. She didn't even bother to sew on her own brand onto her creations. Foreigners, including Americans, Europeans and Singaporeans make up her client base as they find that forking up about RMB 100 per shirt is good value in their foreign currencies. These days, she finds that her regulars are coming back less often as the reality of the bearish global economy has hurt consumers' wallets.

Indeed, it is hard to be bullish about China's near term prospects these days. GDP growth in 2008 was 9%, down by the usual 12% experienced in previous years. Clearly the high octane growth engine has sputtered and economists are falling over themselves in dropping the 2009 estimate to the 6%-7% range. The number may still seem large for developed countries but for emerging China, growth in that range will signal a hard fall, not a soft landing for it is a floor figure to maintain social stability.

Well, we all have heard suggestions from watercooler talk that their official GDP numbers should be taken with a pinch of salt. Even putting that aside, the Chinese way of measuring GDP growth is strictly not comparable with other developed countries. China's quarterly GDP figure is derived on a yoy basis. In contrast, the US figure is determined on a qoq annualized basis. So whilst the headline 4Q08 figure of 6.8% may be decently comforting, converting this yoy figure to the qoq figure actually reveals a number that is zero or negative! So, China could technically be in a recession.

Skeptics of official figures point to other data which confirm our suspicion - the sharp fall in electricity production and the Purchasing Managers' Index which has remained below 50% for over five instances in 2008. Analysts expect the PMI to remain under 50% - firmly in contraction territory - for 1H09.

The severity and speed of the downturn has caught many by surprise and exposed the weakness in the structure of the Chinese economy. Dependent primarily on export growth and the property market, the retrenchment of demand from the US and Europe has hit China hard. As a result, manufacturers located in Pearl River delta such as Guangdong and Shenzhen as badly affected. This is news which have been flogged to death in major publications. What is less reported is that the malaise has also affected other coastal cities in the Yangtze River delta. In fact, container volume growth at Shanghai's port (China's busiest) was in negative territory for the first time ever in Dec 08. Hence, factories catered to producing goods for exporting have closed and plenty of migrant workers have returned to inner China way before the Spring Festival this year.

With key industries experiencing a sharp downturn, the problem is exacerbated by the fact that another six million new graduates are set to enter the workforce in 2009. The large number of graduates churned out annually has led to stagnating pay for new hires, about RMB2000-3000 per month for graduates from top varsities. With pay packages at financial institutions frozen and small businesses folding, the employer of choice is now the government sector. But such coveted positions are hard to come by and the government is mindful of possible unrest which may ensue if the restless and unemployed intellensia take to the streets. 20 years has passed since the Tiananmen incident but the memories remain fresh.

So, while the graduates are requested to seek employment further inland, it is unsure how the skillsets acquired through their education would be put to use in these largely agrarian cities. But the granting of loans to graduates to start their own business should help.

Unemployment and the structural composition of the economy are tough issues with no quick fixes. But there are many grounds for future optimism in the Middle Kingdom. The re-balancing of the economy towards domestic consumption will take time but China's has a strong balance sheet which it can tap to make the adjustments. It has an enviable FX reserves of US$1.9 trillion. Debt levels for households and the government is also very low by global standards.

The first RMB 4 trillion targeted primarily at infrastructure and construction spending was unveiled in October last year. Policies towards the property sector has also eased sharply through the course of the year by local governments. The latest to follow the Chongqing easing measures in mid January is Beijing. If the situation deteriorates further, the Chinese central government can and will do more. Why not do more to boost consumption directly via a second national stimulus package? The Chinese policymakers have been on the ball in recent months and we expect them to continue to be vigilant in the days ahead.

But investors should not expect instant results. The outcomes will not come overnight. Whilst the country's medium term prospects remain bright, more hard work is in store for China and entrepreneurs like Mdm Ren in the near term. She now works all through the week from 8.30am till 6pm. To boost sales, she may well have extend her operating hours, move up the value chain by creating her own brand or consider exporting her creations as well in order to benefit from the reduced value added tax under the stimulus package. For otherwise, she may well have to make do with much reduced sales for the immediate foreseeable future.

I'm Forever Blowing Bubbles

2009-01-04T12:28:00.002+08:00

I'm forever blowing bubbles,
Pretty bubbles in the air,
They fly so high, nearly reach the sky,
Then like my dreams they fade and die.
Fortune's always hiding,
I've looked everywhere,
I'm forever blowing bubbles,
Pretty bubbles in the air.

I'm dreaming dreams, I'm scheming schemes,
I'm building castles high.
They're born anew, their days are few,
Just like a sweet butterfly.
And as the daylight is dawning,
They come again in the morning!

I'm forever blowing bubbles,
Pretty bubbles in the air,
They fly so high, nearly reach the sky,
Then like my dreams they fade and die.
Fortune's always hiding,
I've looked everywhere,
I'm forever blowing bubbles,
Pretty bubbles in the air.

When shadows creep, when I'm asleep,
To lands of hope I stray!
Then at daybreak, when I awake,
My bluebird flutters away.
Happiness, you seem so near me,
Happiness, come forth and cheer me!

I'm forever blowing bubbles,
Pretty bubbles in the air,
They fly so high, nearly reach the sky,
Then like my dreams they fade and die.
Fortune's always hiding,
I've looked everywhere,
I'm forever blowing bubbles,
Pretty bubbles in the air.

(Lyrics of I'm Forever Blowing Bubbles by Cockney Rejects;
Original Lyrics written circa 1918)

Death by a Thousand Cuts (But can we have a last flutter?)

2008-12-23T22:38:00.003+08:00

In the past post, MOS ruled out the prospect of a quick recovery for global markets but are we at the bottom yet? I admit to being a bear, a six foot one. But I cannot help being so in recent times especially in seeing how ailing the US and by extrapolation, the global economy is or has become.

These days, I feel out of sorts and uneasy. There appears to be many other shoes waiting to drop; particularly in emerging/Eastern Europe where certain governments may be behind the curve in terms of policy moves. It is apparent from asset prices that capital markets are discounting bad news aplenty. Prior to the relief rally in the recent past month, global equities have tanked by approximately 40 - 50%. We all know that no one can catch the market trough; well, maybe except for Mister Liar. But that has not stopped many from trying to do so.

Elisabeth Kubler Ross introduced the world to the five stages of grief in her 1969 book "On Death and Dying". The stages are:
1. Denial
2. Anger
3. Bargaining
4. Depression
5. Acceptance

Doctor Ross is a psychiatrist and the Kulber-Ross model she developed was a process which people subconsciously use to deal with tragedy and grief, especially when diagnosed with a terminal condition. Over time it is apparent that these stages can apply to any form of catastrophic personal loss, from love (out of love to divorce) to even jobs (unemployment or income loss).

Given that financial markets are also driven by the manic emotions of humans (say hi to Mister Market!), wouldn't the Kulber-Ross model apply to market cycles and consequently asset prices too? Recall the famous "Death of Equities" magazine cover in 1981. It is at the "acceptance stage" of capitulation where a bottom in equities may be found. It is only at such extreme depths when the seed of the next super bull market is planted. In which stage do you think we are at for equities?

With regulators sleeping at the switch and sold out on the story of self regulation, the US maneuvered itself into a big tangle of having high leverage and deflation. Household wealth has shrunk with collapsing housing prices. Debt levels, unfortunately, remain somewhat unchanged. The resulting fire sale of assets will set off a reverse spiral in asset prices and trigger off more margin calls. Truth be told, this evil spiral has started and the US Federal Reserve is throwing the kitchen sink at it to stop the rot.

To fight the deflationary beast, the Fed has wielded the big axe by dropping policy rates next to nothing. If you think about it, zero rates implies free money! Its tantamount to Governor Ben going up to his helicopter and throwing down cash. Unfortunately, since no one has decided to pay another when the latter borrows, zero is as low as rates can go in setting monetary policy stimulus. In its breach comes the unconventional tools of "quantitative easing" through the use of the central bank's balance sheet.

Given that markets are so sickly, my mind cannot help but to conjure up another medical analogy. To fight cancer, there is front line conventional medicine and then, there are experimental drugs for the seriously ill. The fact that such unconventional tools of quantitative easing are being employed to resuscitate the economy indicates how bad the situation is and how desperate we have become. Are we all grasping at straws? No wonder bond futures are discounting in approximately five years of deflation!

We are all in unchartered waters today. Sadly like all test drugs, the efficacy is unclear. The same can be said with quantitative easing based on the limited empirical evidence available. Hence, the US and by virtue of our close interconnectivity today, global economies are a huge trial in Governor Ben's petri dish. Roll out the printing press! Crank up the bubble machine! I am no economist but short of the liquidationist policies which bordered on Darwinian style economic cleansing (ie, the weak must fall for the strong to rise again), what other choices do we effectively have when we cannot stomach the pain of bank collapses to purge the system's excesses? I, for one, will not be able to tolerate the systemic failures because I want to remain in finance and not go into farming just yet.

Compared to mainstream medicine, experimental treatments usually bring side effects which may not be tolerable. Will the global economy face a death by a thousand cuts? As this will probably go down as the most morbid post, allow us to explain the phase. It refers to slow slicing - a form of torture and execution originating from Imperial China where many cuts were gradually applied to keep the victim on the edge of death. Our economy had many recent near death experiences. The last was in 2002 in the aftermath of the tech bubble wreck. Today, besides the Fed, central banks all over the world from the Reserve Bank of Australia to Bank of England have all fallen over themselves to cut interest rates. Like a floored individual, the policy makers are hoping that timely cardiac cardioversion can jot the collapsing economy back to life.

If we succeed in getting the credit creation process going again (probably more likely than not), another rally in equities would be inevitable. This is not totally tongue in cheek but I cannot rule out the possibility of the largest ever January effect taking place next month!

That said, the direst consequence of this massive pump priming is hyper-inflation if the easing stimulus is not withdrawn in time. We are footing the bill today in 2008 because of the party we started in 2003. It is widely acknowledged that policy rates were held overly low for too long a period of time and it resulted in the housing bubble. So how confident are we in the authorities to pull back the life support this time as we tread the thin line between deflation and inflation? Weren't Mr Bernanke already on the Board of Governors of the Federal Reserve System in 2003?

Let's not for a moment forget the situation in Harare, Zimbabwe where the annual inflation rate is an astounding 231 million (no typo here, its over a two hundred million) percent. We agree that figure sounds pretty bleak and too much of a stretch but if it helps to put things in perspective and raise an early warning, it would have served its purpose.

I recognise that Christmas is upon us. It is this time of the year when we, as kids, would write to Santa to have our wishes fulfilled. But with time and age, we soon realize that Mister Claus is very much, sadly, only make believe, a figment of adults' fertile imagination. As things stand, it does also appear that our goal of having a Goldilocks economy of sustainable moderate economic growth with low inflation will also remain a fairy tale.

Under the Mattress or A New Mat?

2008-12-07T12:02:00.004+08:00

What a year it has been! 2008 will go down into financial history as the worst collapse after the 1929-1932 crash.

About a year to six months coming into this, we at MOS have been forewarning of what is to come, with posts last May like Canaries in the Chinese Coal Mine, etc and This Time It is Different. In the latter, I almost shudder at how prescient we were in calling then that "every conceivable asset class that we know of, from real estate to infrastructure to commodities to junk bonds, are trading at steep valuations." This time is, indeed, very different; in that, there is no hiding place!

As this is no self praise exercise, we must confess that the extent of the deleveraging that followed had totally escaped us. Perhaps many investors would have wanted to take heed at our advice in February 2007 to pack up for a getaway to Phuket to enjoy the Andaman Sea breeze and sun instead. Whilst you would have missed the market roller coaster, your pocket will probably be lined with more cash these days.

And so the demi-god Warren Buffet was spot on again. The carnage left by what he famously labels as the "weapons of mass destruction", which took down one of the oldest bank on the Street, Lehman and left several other reeling for the count out, showed that many market participants were actually swimming naked as the tide washed out.

Daddy once warned us that it is liquor and leverage that destroys grown men. The banks have pulled the lines on businesses and individuals when credit was needed the most. No particular reference is intended but it is almost like the banker removing the umbrella when it starts to rain, isn't it? As a result, asset prices have tumbled. The CMBS and private real estate markets have frozen. The volatility index, VIX, is making new recent highs. Prices of several commodities like oil and copper have been trashed. Corporate bond yields have spiked out. US investment grade corporate debt have widened to record levels of more than 6% - spreads last seen during the Great Depression! (if the editor allows me to slip this in - these are levels which we find increasingly attractive).

In Singapore, you can find stocks trading at 2x historical earnings, while some trade way under book. A simple screen would indicate that the market is pricing them as being worth more dead than alive. By that I mean the shares are available for less than the net cash (net of total liabilities sometimes) on their balance sheet. So, such companies are better off being taken private and liquidated. Many of these are the much maligned S-Chips such as China Taisun who have fallen out of favour as liquidity was totally retrenched from the system. It is ironic that a lack of scrutiny of corporate balance sheets brought us to where we are. Investors had blindly piled into growth stocks. Debt was cheap then so we hailed firms with business models which promised growth and more. Alas, it turned out to be blind and misplaced faith. Yet today, this same investor is ignoring how cheap things have become - relative to what is available on the balance sheet.

REITs are yet another asset class which are offering some of the widest spreads I have witnessed in my investing career. Sure, some of them are trading on a cum rights basis and are factoring a downturn which necessitates the loss of tenants and rising vacancies, but a judicious investor can surely sieve out those unduly battered from the deserving.

Our regular readers, if there are any, know we spilled a fair amount of ink on these pages poking fun at those who bought into CapitaRetail China Trust in Jan 2007 when it traded at S$2.10. Today, the same REIT is available for about S$0.46. It is pretty much the same business except maybe without the visionary Pua who have gone on to bigger things. Granted that the land title system in China is not the most developed in the world (but it is inconceivable to me that things will not improve over time) and cap rates will increase, but the current price offers one nearly 50% to last appraised value. If you can get comfortable with its debt expiry profile, one is essentially enjoying a healthy yield with an option on rising Chinese middle class consumerism which these malls are aiming to tap. To us, that's almost like "Heads I win, tails I win too" - akin to holding a distorted call option with premium paid to us! This is certainly a proposition we much prefer over the put options which investment banks have insidiously made retail investors sell through structured notes so that Grandma can earn a paltry 1% spread in return for taking on the credit risk of hedge funds disguised as banks.

If we were to put all this witch hunting and crucifying aside and peer into our crystal ball, what do we see in the months ahead? In a market this volatile where writers can be made to look foolish almost within a day or two after publication, we can only venture our best guess.

Whilst we do not think the US will slip into the 1930s style depression, our base case still assumes that they pull out of their rut only gradually over the next few years. We have completely ruled out a V shaped global recovery. In fact, we think that there will be another few shoes to drop, particularly in Middle East. With oil prices back at around US$50 (which we think is undervalued!), the rapid rise of the Gulf States will surely be under tremendous pressure.

What worries us most is that the American policymakers are cornered. Rates cannot be lowered further without raising concerns of trapping the American economy in the Japanese style liquidity trap. But the swift and decisive steps to pump prime through fiscal policies - ie, printing greenbacks will surely help and sooth the frayed nerves. The fact that inflation will rear its ugly head when the dust settles appears to be besides the point now. Fortunately for the Americans, the world still lack options and the Chinese remain happy holding onto US IOUs even though a critical analysis of America's balance sheet leaves a lot to be desired. Perhaps the Chinese are trapped in a "chicken and egg" loop and they cannot afford for the American music to stop.

We are definitely sanguine about the long term prospects of China but unfortunately, the Middle Kingdom is but a nascent piece in the global economic jigsaw today. In a world where the American consumers are swiftly deleveraging - after spending a dollar fifty when they have only a buck in their pockets, there remains a fair bit of slack for the thrifty Chinese to pick up. After all, the Chinese like the Japanese have, in general, a habit of keeping money under the mattress rather than splurging on a fancy new mat. So, we see that the net effect on the global economy would be one of a gradual recovery.

We will write again when we have more to get off our chest or if we find some time to leave the candy store of value this market has presented to us. Until then, stay liquid but don't ignore the apparent values.

Spinning the Wheel

2008-04-26T09:43:00.002+08:00

"Never Say Never" - In investing, it is always important to keep an open mind. It helps one to assimilate new information and explore new areas. Many good investors are exceedingly humble and are always keen to learn more. In fact, given how rough markets are these days, an investor should drop his ego at the door before he steps into the trading room.

We are known in general for our aversion towards Singapore listed Chinese plays, popularly known as S-chips. Several corporate governance blow-ups in the last few years didn't help. Nevertheless, we are sure there is wheat amongst the chaff but because of distance and lack of track record, it is very difficult to do sufficient due diligence for us to get comfortable. Hence, we have steered clear and given them a wide berth.

Given that there are more than 100 S-chips, ignoring the entire sector essentially means limiting the fields where one can mine for value. Of course, one can argue that it is better to stick to the tried and tested and narrow one's circle of competence. But given the general market turbulence, the price of many S-chips have been hammered down to ridiciously low levels.

One of the recently battered S-chips is Li Heng which had the misfortune of being listed in the midst of the general market sell-off. It manufactures high end nylon yarn products in the PRC for the domestic market. The products are highly oriented yarn/partially oriented yarn, nylon fully drawn yarn and nylon drawn textured yarn. They sell them under its brand names Liyuan and Liheng. Purchases of the yarn use it to manufacture high end casual wear, sportswear, swimwear and even umbrellas and parachutes.

The industry is a competitive one. We are not here to spin a yarn to suggest that Li Heng possesses an imprenable edge. One can easily ratter off a long list of competitors - Yantai Chemical Fiber Nylon, Qingdao Zhongda Chemical Fiber, Guangdong Xinhui Meida Nylon, and China Sky Chemical Fiber (SGX listed). Other SGX listed companies like Sino tech fibre, CG Industrial manufacture chemical fibre too but they generally compete at the lower end of the quality spectrum.

Li Heng was listed in March at S$0.80. It quickly sunk under the IPO price amidst the sub prime hubris. It is baffling to think that subscribers of the IPO would dump the stock so quickly as the price slid southwards. After all, a fundamentally sound stock at S$0.60 would be more attractive than one at S$0.80, ceteris paribus; the good economists would append. This is especially so after it reported a good set of FY07 results in April.

Granted that its FY07 numbers benefited from a tax holiday, we still see earnings rocketing up going forward. Whilst the world is grappling with recessionary fears, the Chinese jugglenaut should continue rolling, hiccups notwithstanding. We expect Chinese consumerism to remain strong especially for basic necessities such as clothing. China is also a net importer of nylon as the local players do not produce enough to meet demand. Anecdotal evidence suggest that the total market demand is 1.4 mtons, of which 400,000 tonnes is imported. Hence, demand for Li Heng's products should remain robust going forward.

To meet the growing demand, management will be aggressively ramping up the production capacity, from 92,000 mtons in FY07 to 167,000 mtons in FY08. The internal target is to achieve 257,000 mtons by 3Q09. Note that its capacity in FY07 was nearly completely utilized.

To insulate itself and generate cost savings, it intends to use part of the IPO proceeds to build a polyamide plant. Polyamide is the raw material used to produce nylon. Vertically integration will enable Li Heng to shave off some cost and reduce its dependence on suppliers. Although the plant will only cover about 20% of its polyamide needs, this move will strengthen its bargaining power over suppliers of its raw materials. RMB appreciation does also allow it to offset increase in raw material prices. Despite these measures, operating expenses are expected to rise. The expansion of its sales network and wage inflation in the country will bite into its margins.

On its customers end, Li Heng possesses reasonably good bargaining power. It is not overly dependent on a single customer as it serves over 170 customers with none contributing to more than 5% of total sales. Given that Li Heng supplies as much as 20-50% of its customer's nylon, the firm does have some muscle to pass on costs.

There are no street coverage on the stock yet. But its market capitalization places it alongside China Sky as one of the largest S-Chips, warranting inclusion into major indices which track the performance of this sub-sector. Hence, it should pop up on the radars of analysts fairly soon. Until then, one needs to do his own maths. We did ours and think that Li Heng can, conservatively, achieve revenue of RMB 3800 million in FY08. This is on the back of 80% utilization of its enlarged capacity. However, given expense increases and the additional 12.5% taxation rate, net margins should fall from 32.8% (achieved in FY07). Management did guide that they think margins can remain above 30%. Our internal estimates peg their FY08 EPS to be between RMB 65 - 70 cents (about 18% yoy growth), or SGD 13 - 14 cents. At the current price of 80 cents, this translates to an FY08 PER of 5.7x - 6.2x. When analyst reports are issued, we expect the street to be more aggressive, factoring more optimism in their projections. They may be looking at a FY08 PER of 5x or less on the back of EPS of at least RMB 80 cents. Assigning a fair PER of 10x suggests that Li Heng's fair value is S$1.60, representing 100% upside from current prices.

We chose to look at things differently. For us, it is a decision on whether paying for Li Heng at an FY08 PER of 6.2x is good enough to rest easy at night. We rather leave room for more pleasant upside surprises!

Reality Bites

2008-02-08T11:08:00.000+08:00

In one of our recent presentations to a group, a line was emblazoned across the slides: "Price is what you pay, value is what you get".

Turn back the clock about one year to the time when the mass media were all dishing out their top stock picks for 2007, MOS, in our true contrarian fashion, played the party popper by picking a stock which we felt investors should exercise caution with. In a post titled "Priced to Perfection" on 2 Jan 2007, we warned investors about the valuations of CapitaRetail China Trust (CrCT). When we posted our piece, CrCT was trading at S$2.10.

We were made to look like conservative old farts with pies on our faces when CrCT soared to over S$3.00 several months later. In fact, it hit a high of S$3.34 in 1 Oct 07. Hence, an investor who acted in contrary to us would have pocketed a cool 60% if he had entered on 2 Jan 07 and exited at the high. This is of course analyzed with the benefit of hindsight [With 20/20 hindsight, I would have (i) bought several units of The Sail during its launch, (ii) dated and married the sweetest girl in class and achieved just that little bit more in my life]. Unfortunately, not everyone is blessed with such perfect foresight. An investor who did not exit on the high in October will soon be caught in a rapid downward slide as "Mr Market" shunned the stock in the subsequent months. It's ironic that CrCT closed exactly at S$2.10, exactly one year later on 3 Jan 08. If you had fast forward another month out, you would note that CrCT closed at S$1.55 on 6 Feb 08.

We ferret out this past post not to pat ourselves on the back and make others look foolish. In fact, we believe that the heart of value investing philosophy requires one to be humble and be critical of ourselves. Rather, we like to pull out and go through our past "hits and misses" so as to improve ourselves.

In this festive period, the traffic cops on this island are all out in force reminding that mixing booze and driving kills. In our case, overpaying "kills" too, or at least will burn a fat hole in the pocket. For this example, the perfect market timer would have exited with a 60% gain. On the other hand, a less savvy individual who bought at around the high of S$3.00 would be staring at a 50% loss on the eve of the Lunar New Year 08. For the latter to recover this loss, paper or otherwise, CrCT would have to deliver a whopping 100% (not 50%) return in the months ahead. It's a tall order, if you ask us. So, after several long winded paragraphs, this illustration highlights why it is crucial to know what you are stumping out for; particularly in the case of CrCT at 2x NAV, which meant that for every dollar paid, 50 cents went into what we then sarcastically termed to be purchasing "Chinese air until the growth materialises".

This exercise also shows how difficult it is to "invert" the value investing framework to short overpriced securities. As an institutional investor, shorting attracts financing cost and requires the payment of dividends to the lender. The other issue clearly is timing, where in the case of CrCT, prices continued to rise for several months after January 07. Hence, a short position would have entailed expensive covering before reality set in.

P.S. I Love You: Thank you to all who took the time to drop us a short line or two welcoming us back into the fray after the rocketing valuations in 2H07 forced us into a hiatus. We are delighted to receive these encouragement and yes, if you where the sweetest girls in town hang out, do let us know too. ;)

A Lunar New Year Angpow

2008-02-06T19:56:00.000+08:00

The Lunar New Year of the Rat is upon us. Whilst the Chinese associate a splash of the color red with an abundance of good fortune and luck, the recent spate of blood letting in the markets is something which we could do with less of.

In the coming year, we hope all investors have good health and wealth. We, here at MOS, thought it would be opportune to attempt to offer you a "red packet" by introducing a cash rich company which has the potential to offer shareholders a special dividend "angpow".

Lion Asiapac Limited (LAP) (Bloomberg: LAP SP, SIN:L08) is a holding company with diverse business lines. It has been listed on the SGX since 1981. It is now engaged in the manufacturing of electronics and automotive components and limestone processing. The bulk of its revenue comes from the electronics business, which as you would expect, isn't wildly profitable.

However, what distinguishes LAP from other companies is its strong balance sheet. The balance sheet is clean and has little liabilities. It presently has a net cash position of S$0.05 per share. In addition, LAP holds a 6.16% stake in Anhui Jianghuai Automobile (AJA). AJA is listed on the Shanghai Stock Exchange. In fact, the stake in AJA is worth more than the market capitalization of LAP! At this point, we believe value investing enthusiasts are starting to appreciate why we are getting excited.

In a move which may unlock its hidden value, the management of LAP has recently announced that they intend to dispose of their entire stake in AJA. AJA is trading in the market at about RMB8.21 today. But assuming the entire stake is disposed at the desired minimum price of RMB7.50 (about 30% below present market price), the net cash per share on LAP's books will swell to S$0.44 per share. This is S$0.17 above the current market price of LAP.

There are obviously risks in every investment. This trade is no exception. The first that comes to mind would be the inability to place out the AJA block given the poor market sentiment. Another would be that the cash is trapped in LAP and not returned to shareholders. To this end, it is noted that the circular explaining the disposal indicated that the proceeds would be used for working capital and deployed into money market instruments. Hence, LAP may not distribute the excess cash to shareholders in the form of an "angpow" or special dividend.

As with every new year, everyone has renewed hopes and aspirations. Should the disposal be successful, minority shareholders will all be hopeful that the management of LAP would offer some festive cheer by doling out a payback to supplement the historical 3.7% yield. Could this be the reason why LAP closed flat at S$0.265 when the STI plummeted over 100 points today?

A Reality Check

2008-01-22T23:57:00.000+08:00

Just when you thought we were dead and buried, we return. Our last post was in 1 July 2007. And we went almost six months without a single post. In the intervening months, global markets continued their uptrend, save for a hiccup or two in August/September. Despite the challenges, the STI was still up 17% in 2007. Fast forward in 2008, oh how the tide has turned! I believe the STI is down by almost the same percentage after 20 days into the year.

The words: recession, doom and gloom is hogging all the headlines today. As we write this, the doctors at the US Federal Reserve has just ordered a 75 basis point cut to the Fed funds rate in a bid to sooth the nerves of jumpy investors worldwide. We are not market timers but we had been advocating all to exercise caution during the mighty run up throughout 2007 [See the posts - A Time for Especial Caution, The Sun Always Shines (only on TV), This Time It's Different, Canaries in the Chinese Coal Mine]. The way several asset classes - equities, bonds, commodities and real estate unraveled recently makes the post in May 2007 (This Time It's Different) seems spot on. Whilst our heart goes out to those in negative equity, the splate of market weakness helps to inject some much needed normality into the system.

We see values being created in some sectors. In the days ahead, more opportunities should emerge. Investors who have established fair value for companies with strong management and little leverage should rub their hands in glee as prices sink below their fair value.

We close our first post of 2008 with a line from Mr Buffett: "Be fearful when others are greedy and greedy only when others are fearful."

Beauty is in the Eye of the Beholder

2007-07-01T11:01:00.000+08:00

Close followers of events in corporate Singapore were mostly fixated on the saga surrounding Yellow Pages (Singapore) Ltd (SIN:Y07) (YPG SP) last month. Yellow Pages' undemanding valuations were first pointed out in early Dec 06 to readers of MOS. It was trading at S$1.12 then and has since closed at ~S$1.40, chalking up a tidy 25% gain in 6 months. Besides MOS, there are several other prominent institutional investors who have taken a position in the counter. The largest being Third Avenue which holds about 16%. Others include Marathon Asset Management and Sleep, Zakaria & Co.

Much has been said about the attempt by Global Advisory's to install new independent directors that there is probably no need for us to weight in on the matter. Instead, we think that investors may instead be more interested in the worth of an asset whose value may not be immediately apparent. After all, Yellow Pages is the business of producing print directories, a product whose relevance in the digital age may be questionable. Whilst we beg to differ on this point as there may yet still be value which the firm may unlock by focusing on niche local directories, the focus of this post is not on its business model. Instead, MOS hopes to share why the counter appears cheap in terms of its private market value even at today's prices.

Directory services have repeatedly been the target of private equity firms as its stable cash flow generating ability allows the acquirer to gear up to increase the IRR. As recently as March 2007, Yellow Pages NZ was sold to a private equity consortium consisting of CCMP Capital Asia and Teacher's Private Equity, the special investment arm of Ontario Teacher's Pension Plan for NZ$2.24 bil. CCMP Capital Asia is formerly the private equity fund of JP Morgan. The transacted EV/EBITDA multiple was 13.6x for Yellow Pages NZ which had a EBITDA margin of 58%. In 2001, several equity firms also teamed up to buy out the Yell Group, the UK Yellow Pages at an EV/EBITDA of 9.7x, when the latter had an EBITDA margin of 27%. The venerable KKR had also teamed up with Ontario Teachers to gooble up Yellow Pages Canada in Sept 02 at an EV/EBITDA of 8.8x. In fact, the global average transaction multiple may be ~11.7x since 1999.

As for Yellow Pages Singapore, even though its EBITDA margin is falling, it still commands a respectable 44% in 2006. Pegging the take-over EV/EBITDA of 9.7x for Yell which had an inferior EBITDA margin of 27%, the fair value of Yellow Pages Singapore may be in the range of S$2.00. Hence, this clearly hints at a possible arbitrage at private and public market values. Whilst the public investors may not fancy owning such an "old economy business", private equity firms have been lapping them up with great enthusiasm. This is clearly a case of beauty being in the eye of the beholder.

Of course, the above simplistic analysis does not take into account the maturity of the markets and the potential for re-structuring for each firm. It is merely intended to invoke critical thinking and discussion.

Playing the Devil's Advocate

2007-06-13T23:36:00.001+08:00

In our last post a week ago, MOS pointed out Soundwill Holdings (878.HK) as trading at at least 60% to readily ascertained NAV. Despite pointing out the fundamental merits of the investment case, the write-up ended with a question on whether "such great bargains exist in the booming market today". MOS then went on to provide a short spiel about why the sharp discount to NAV may exist. As a result of playing the devil's advocate, we received several comments and emails questioning our apparently confusing position. Hence, we see this post as an opportune note to set the record straight.

An astute value investor may have noted that the factors listed were, by and large, macro-economic ones. As fundamental, bottom-up value investors, we pay scant attention to such economic factors. It's true that HIBOR has been and may trend further up. But to a fundamentalist, one can easily incorporate the sensitivity to interest rate changes when modeling the RNAV.

Regarding the factor on a possible market correction, it is unfortunate that our crystal ball isn't a nuclear powered one which will allow us to discern the future more clearly. Hence, our mantra generally is "as long as a clear bargain exists, anytime is a good time to buy". If time permits, we will expound on the foregoing with some data in future. But our general finding is that it is better to remain invested in the market to avoid missing out on the bull-runs. This statement is of course premised on one finding attractively priced securities to invest into.

So, the answer to last week's question is a resounding "Yes!" - such bargains can exist in the booming market today. In fact, we feel that a key to unlocking the value in Soundwill would be the rejuvenation of Tang Lung Street. But before you hit your broker's number on the speed dial, please note that this does not constitute any investment recommendation and investors should also do their own homework and know the risk factors. As Mr Munger always stresses - "Invert"; i.e., no security is perfect and know what can possibly go wrong.

Do you have a Sound Will?

2007-06-06T18:22:00.000+08:00

MOS last featured a HK stock in March 07. It was Wheelock (0020.HK) when it traded at HK$17. This property counter has since rallied 20% in the last two months. Today's post also features another property counter. It is Soundwill Holdings (878.HK). The company is a property developer and holding company specializing in HK real estate. The jewel in the company’s crown is Soundwill Plaza. Soundwill Plaza is located in Causeway Bay, opposite Time Square and within walking distance from Sogo. This Grade A commercial building is largely leased up, with well known beauty related products and services targeting the hip and trendy. A shopper can fulfill all her (and his, as there are many modern age men) body and beauty needs as the building’s tenants include Sasa, Marie France and City Spa.

A fair amount of the leases will be up for renewal this year. This turns out to be a great opportunity for the landlord to increase rents because a lot of these leases were stuck 2-3 years ago, when the HK property market were in doldrums. Recall the panic over HK when SARS gripped the territory in 2003?

Besides property leasing, the firm is also into urban redevelopment. In this line of business, Soundwill acquires old sites for redevelopment and future sale. They view the foregoing to be a great opportunity because several urban areas in HK are in need of rejuvenation. Closely related to this business is the Group’s activity in property development. It has two residential property development projects. The one in Sai Kung is due for sale in 2H07. In addition, they dabble in urban infrastructure development on the Mainland.

With the property leasing and residential market in HK faring well, the above sounds like a very decent story. So one may ask what valuations are looking like. The PER on historical earnings is only 2x. However, these earnings include two substantial contributions from the disposal of investment properties. To find the real PER, one would have to strip out these extraordinary items to arrive at the core earnings. We leave this exercise to the interested investor; but we can share that the resulting PER figure is a large one.

If the commercial rents for Soundwill Plaza rises as anticipated, the valuation of the building will increase further. As a result, the NAV could be as high as HK$11 per share by our back of envelope estimates, without even attributing any value to its other businesses. Based on today's closing price of HK$4.40, we are looking at about a discount of 60%.

Do such great bargains exist in the booming market today? Well, Mr Market may have thought that he apply a hefty discount because the Plaza is situated just in front of Tang Lung Street, a lane with old buildings and smallish eating outlets. After all, property is about - location, location and location. Or maybe he thinks the HIBOR will continue to rise further due to inflationary pressures and hence will adversely affect Soundwill because all their debt are floating rate issues (note that the firm has fairly high gearing). Perhaps Mr Market feels that the Chinese market will crash and drag stocks in HK down too. The truth is, we ain't sure what he is thinking about either. If you are a smart investor with a line to Mr Market, do let us know?

If you enjoyed reading this post & frequenting this site, please support by clicking on advertisements of interest on the left panel.

Horology Culture

2007-05-26T10:15:00.000+08:00

Sincere Watch (Hong Kong) Ltd (HKG:0444) reported its full year results for the period ending 31 March 2007 in the middle of this week. First, some pertinent numbers:

Revenue increased 26% from HK$373 mil to HK$470 mil.
Gross profit increased 40.2% from HK$108 mil to HK$151 mil.
Hence, the gross profit margin inched up from 29% to 32%.
The net profit, however, dropped from HK$49 mil to HK$43 mil. This was because last year's figures were boosted by an exchange rate gains. Net margin however, remain a respectable 9%.
Hence, if the exchange differences were excluded, the operating profit before tax would have increased from HK$37 mil to HK$71 mil.
The operating margin has also swelled to about 15% while ROA and ROE were 8% and 20% respectively.

The final EPS figure, as MOS had expected, was lesser than that of 2006's HK13.2 cents. However, it exceeded our full year forecast of HK10 cents by 0.7 cents. MOS singled out Sincere HK on 7 Nov 06 when it was trading at HK$0.56. We had wondered aloud whether it was "Time to Buy?". Then, we were of the view that the PER (even before adjusting for its cash horde) was trading at an attractive 5.6x forward earnings. Its management did not disappoint and also managed to swell NAV to HK$0.52 per share by FYE. Hence, we were able to initiate a position at utterly un-demanding valuations. Please thank Mr. Graham for introducing the term "margin of safety" to investing.

Sincere has also expanded its distributor-ships in the region by adding 7 retail outlets and 4 independent watch dealers. As at end Mar 07, the Group has 41 retail outlets and 23 independent watch dealers in North Asia. Sincere had also open a total of 3 Franck Muller outlets in the last FY - one on HK island, one on Kowloon's Ocean Terminal Mall and one in Macau's Landmark Hotel.

Next year's earnings are likely to be boosted by the Group’s first Franck Muller store in Beijing. It also plans to re-open the boutique in Shanghai's Plaza 66 Nanjing Xi Lu, the classy luxury mall in the booming city. Another outlet is likely to sprout out in the Venetian Macao in Aug 2007. These new shops make Sincere well positioned to capitalize on the growing affluence in Greater China. Furthermore, the up coming Beijing Olympics should translate to a tourism boom and possibly higher sales for the Group.

To reward shareholders for sticking out with management in a year when the stock price sank, a final dividend of HK$0.06 per share has been proposed. This is a cent less than last year's payout but it still represents a 10.7% yield on the price at our time of initial call.

The counter soared to around HK$0.92 cents after the results announcement. It, however, lost some ground to HK$0.87 amidst poor market sentiment. At the latter closing price, the return over the approximately half year holding period is about 55%.

For readers who may want more brain food, swing by to MOS' partner site to get your weekend dose of value investing news. The site features several new articles, including one describing how Bill Miller is lagging the S&P 500 returns in this calender year so far.

In Cruise Control

2007-05-24T08:52:00.000+08:00

Singapore Shipping Corporation has released its FY2007 results. MOS last discussed this security about a month ago (11 Apr 07) after noticing that its adjusted PER was actually less than 1x. Despite its net profits sinking by nearly 85% for the last financial year, management has declared a hefty net dividend payout of 12 cents. This far exceeds our expectations but it verifies what we discussed earlier - Mr Ow has a track record of rewarding shareholders.

Based on the 11 Apr 07 entry price of S$0.40, the payout translates to a bumper dividend yield of 30%.

Sincere dividends

2007-05-23T19:54:00.000+08:00

Sincere HK reported its full year results after the close of market yesterday. The results were very encouraging. In particular, we note that its top line growth increased by 26%. Investors who track this stock will note that the price of the counter surged today. One of the reason is because Sincere has recommended a dividend of HKD 6 cents per share.

MOS will be reviewing the results of Sincere HK with interest in the days ahead and may provide some thoughts. We may also share our views of the recent 3Q07 results of Micro Mechanics. Whilst the numbers were weak, we did not consider it to be unexpected given the poor state of affairs in the entire semiconductor industry in the last quarter.

In the meanwhile, readers may wish to visit our partner site to view an interview of Mr Warren Buffett.

Partner Site to MOS

2007-05-21T19:10:00.000+08:00

Dear readers, as the market soared to new highs, the number of readers of this blog has increased markedly as well. Some have also requested more frequent commentary and ideas. Unfortunately, we are not full time journalists. However, we are pleased to inform you of a partner site which serves as an aggregation tool for pertinent market news for the Asian value investor. As the site will be updated very frequently, do use it to get a pulse of Asian markets!

Canaries in the Chinese Coal Mine

2007-05-19T09:39:00.000+08:00

In MOS' last post, we spoke about the possibility of how this global exuberance may all come tumbling down when China's searing run stops. In today's column, MOS explains why we now net sellers of holdings after evaluating the Chinese environment.

Bubbles usually come to an end when the common man gets overly involved in the stock markets. In the local Chinese press, a cleaning lady was actually feted as a "Stock market Wizard" after managing to double her money in recent months (And we know that tomorrow's weekend papers in Singapore will carry an article about a gentleman who made S$100,000 in the last few months). Stories of rapid and large gains are abound in Asia today. As such, the public without trading accounts have rushed to open one, eager to partake in the strongest bull-run since 2000. Figures we have seen suggest that the number of A share accounts opened in Apr 2007 have more than doubled that of Feb 07.

"Liquidity" was certainly awash in the markets for the average Chinese household has one of the highest savings rates in the world. Hence, another milestone was brushed aside with ease last week. The turnover of the Chinese domestic markets hit US$50 bil, more than the rest of Asia combined. Its mind boggling for the latter pool includes the more established financial centers of Hong Kong and Singapore. The measure of trading mentality also shows that participants' trading horizon has also shortened considerably. The turnover velocity measured by the annualized daily market turnover as a percentage of free float market capitalization, has been rising steadily; underlining the extent of churning in the Chinese market.

Older investors blessed with elephant memories will recall how the Taiwanese stock market staged a similar rally in the early to mid 1980s. Tellingly, before the Taiwanese bubble cracked, everyone was dead certain that the "liquidity" will keep the party going. As a result, the turnover of a single Taiwanese market had also exceeded that of other Asian exchanges as everyone had to jump onto the back of the raging bull. We run the risk of performing "mental data mining" but doesn't this remind you of state of affairs in the mainland market today?

The Chinese stocks have come a long way since bottoming in the summer of 2005. In 2006, the Shanghai index was up 130%. We believe, from memory, that it has turned in another sterling 50% in this year to date. Simple valuation measures, if anyone is still looking at them, such as the PER indicates that over 1000 Shanghai A shares are trading at close to 50x last year's earnings. Simply put, a investor today will recoup his investment only in half a century’s time unless earnings surge by leaps and bounds. The typical retort when we raise the foregoing is that earnings growth can justify such valuations. But in a country where data availability can be slow and unreliable, it is difficult for us to conclusively put a finger on earnings momentum. It is also MOS' belief that if one searches hard enough, one would stumble upon a valuation yardstick which justifies today's price. If all else fails, try eyeballs or cash burn rate.

Since we are in this light hearted vein, it is worth pointing out the exercises which some undertake to support today's prices. The latest we have read is in a prominent Hong Kong newspaper. The author moved the Shanghai index back by almost two decades to illustrate its parallels with the Taipei bull-run in the 1980s. The result? The former potentially have room to quadruple (yes, quadruple isn’t a typo) in the next year. Despite proffering some economic similarities between the two markets, we cannot help but wonder if this is a case of data mining. However, it is to the author's credit that the article ended with an ominous warning - that the resultant crash in Taiwan was so hard that today's prices are barely half of the peak then.

The other must be the prevailing "market wisdom" about the Chinese market. That the Chinese government cannot let the euphoria vanish abruptly because the 17th Chinese Communist Party Congress meeting and the Beijing Olympics which will be held at the end of this year and in 2008 respectively. We have not been able to fathom the economic reasoning behind this but financial history is littered with examples of how "wisdom" came unstuck. Or how the "January calendar effect" disappeared after investors engaged in one-up-man-ship and started buying in the prior December.

The canaries in the coal mine have started chirping. In recent months, it has almost become an agenda item for Chinese officials to talk down the market. The latest to warn about this irrational exuberance was "Superman" Li Ka-shing, arguably Hong Kong's most shrewd businessman.

We are not full time journalists or bloggers. So thoughts for this piece were progressively jotted down since Thursday evening. But before this was fit for public consumption, we hear news of that the Chinese authorities have put in a "triple whammy" of measures to rein in the market. This includes widening the RMB's trading limits, upping the domestic interest rates and reserve requirements of banks. The latter two may cause a liquidity retrenchment and panicky retail investors who have not experienced a bad hair day may stampede for the doors.

We are also not fortune tellers with a crystal ball on markets. We are strictly "extreme value investors". Hence, we often have cakes in our faces when our macro calls go awfully wrong. But, to us, it’s better to be safe than sorry. Hence, we have raised substantially more cash than before by liquidating our non core positions. For we prefer to bypass the last few pennies on the financial highway rather than risk permanent capital impairment.

This Time It's Different

2007-05-13T17:25:00.000+08:00

Regular readers of MOS will know that we have turned bearish several months ago. The market may go up tomorrow and the day after but the probability of a huge crash simply increases. In fact, we have been issuing "warnings" about possibly how hyper-extended this market was. But, a complete correction never quite came. Yes, we were prescient in calling the February sell-off; but the massive bloodshed that would create enormous value on the Street never quite materialized.

So, is this time different? Absolutely. We are living in unprecedented times. Unprecedented to the extent that every conceivable asset class that we know of, from real estate to infrastructure to commodities to junk bonds, are trading at steep valuations. Look at the estimates in the list below. Simply put, there isn't any asset that is sufficiently cheap to entice loss averse guys like us.
Estimated cumulative performance of key asset classes (Mar 02 to Mar 07):
Equities -

S&P 500: 36%
Russell 2000: 68%
Energing Market equities: 221%

Bonds -

US government bonds: 28%
US junk bonds: 64%
Emerging markets debt: 87%

Many institutions still keep an eye on US numbers to serve as a barometer to the world economic growth. This is in line with the thoughts that "when Uncle Sam sneezes, the world/tiny Singapore catches a cold". But MOS thinks that this exercise is becoming increasingly meaningless. We should instead be looking to China. The rising superpower that is mopping up American debt. The "Joe Chink" that is working hard and lapping up assets of the "Stars and Stripes". It has kept the latter from imploding despite running a trillion dollar current account deficit. Indeed, one of the indicators investors buying into emerging countries watch is the current account deficit as a percentage of its GDP. 5% is usually the level institutional managers get nervous and when they would prepare to yank their monies out and sending its currency in a downward spiral. Is the US too big that it defys the laws of conventional macro-economics? Or will there be a time for payback?

Its true that Chinese companies are, likely to be at the behest of the government, making attempts to correct the deficit. PC maker, Lenovo, recently inked a deal to purchase operating systems from Microsoft. There will be more purchases to come. But we consider this to be just a signaling exercise which will not correct the root problem.

We are big fans of the Americans. A global policeman, friendly people, beautiful cities and of course, who can forget the American Dream. But unfortunately, trees do not grow to the sky. The Chinese have decided to set up a national agency to invest their assets into "solid"/hard assets. They will be cutting down on their purchases of American paper, to gradually stop funding the American debt. Isn't it almost like dishing out the cold turkey treatment?

Its almost like the leadership baton of this century will be passed from the Americans to the Chinese. Sure, the UK had its glory days, two centuries ago. The last one was America's time in the sun. This century, as it is increasingly suggesting, is going to be China's.

There is a huge construction boom, a housing boom, a stock market speculation fever. Folks on the Mainland are rushing to open security trading accounts. Admittedly the Chinese government has done a great job, in managing to keep affairs humming along. Selective curbs on infrastructure investment, small hikes to bank reserve requirements. Things have been kept on the slow boil. But there will surely be growing pains along the way. When? After the 2008 Beijing Summer Olympics did someone guess?

We do not know when and what will cause this bubble will pop. But the clock will strike twelve and turn much to mushy pumpkins, to many party goers' dismay. But if asked to venture a guess, we will put our money that this house of cards will start unraveling from China.

In the Pink of Health

2007-04-29T12:11:00.000+08:00

Recently, one of MOS' friends revealed that she was expecting her first bundle of joy in the latter half of the year. After a judicious selection process, the medical centre of choice for her gynecology care was Thomson Medical Centre (Public, SIN:5FV) ("TMC"). Followers of MOS will recall it was our top performer last year. TMC has continued on its soaring path to bridge the valuation gap between itself and other locally listed healthcare counters. Compared to the price of 29 cents when it appeared on MOS' radar screens in February 2006, TMC has since gained 129% (based on Friday's close of 66.5 cents)!

One of the reasons for the robust showing was the stellar report card which the obstetrics, gynecology and pediatric specialist turned in recently. For 1H results ending Feb 2007, its revenue and net profit grew by 8% and 35% respectively. In addition, TMC is expected to benefit from the local government's pro-creation policies. With a growing middle class in the country, the group is well poised to capture their fair share as the locals seek higher end medical care and facilities to take care of their first child.

Despite the above, TMC's moves suggest that their management acknowledges the saturating and competitive Singapore market dynamics. Hence, TMC has been making good inroads into overseas markets. The group's management contracts for three women and pediatric hospitals in Vietnam are expected to kick in over the next 2 to 3 years.

The progress of the above initiatives clearly indicates that MOS' top performer in 2006 remains very much in the pink of health.

Bring Frontline to Life

2007-04-18T18:44:00.000+08:00

"Wake me up inside, wake me up inside, call my name and save me from the dark", that's how the chorus of Evanescence hit single "Bring Me to Life" goes. The analogy to this song cannot be more apt for Frontline Technologies Corporation Ltd. (FT SP) (SIN:F02) ("Frontline"). This company was abruptly resurrected when it hogged the top volume charts of SGX today.

Frontline is a pan-Asian IT solutions company with operations in several Asian countries. It was featured on MOS in October 2006 when it traded at S$0.135. Then, MOS made a mockery of the closing price, suggesting that the market had been "distracted by the boom of the North Korean nuclear test". MOS was then attracted to Frontline as it received substantial cash proceeds from the listing of its Indian subsidiary, thereby swelling its NTA above its market price.

Six months down the road, the market are now excited by its undemanding valuations (relative to its peers), the possibility of a dividend payout which would exhaust its unused section 44 credits and its growth prospects.

Frontline closed at S$0.17 today. At this juncture, the price represents a handsome 26% gain for a half year holding period.

PER of less than 1x?

2007-04-11T09:23:00.000+08:00

Last month, Mr Market offered a "free" stake in Lane Crawford through Wheelock & Co. As we write today, Mr Market remains in generous mood. What's available for "free" today are ships, specifically three "ro-ro" vessels.

Singapore Shipping Corporation Ltd ("SSC") owns these three "ro-ro" vessels which are used to transport cars around Asia. They represent the only significant assets remaining after the firm made a series of divestments. Besides the vessels, the book of SSC comprises of cash and cash equivalents, with little liabilities. The net cash position of SSC is S$0.37. So purchasing SSC at a market price of S$0.40 suggests that one obtains the three vessels for "free" as its book value is marginally higher. On a PER basis, it is about 12.5x but if one were to strip out the cash, the real adjusted PER is actually less than 1!

The founder of SSC, Ow Chio Kiat continues to hold 37% of the shares. Hence, his interests will be aligned with that of minority shareholders. What is more impressive is that Ow has a track record of rewarding shareholders. Besides spinning off assets such as Cougar Logistics, Ow has also dished out sizable dividends in the last two financial years.

In FY05, SSC declared a total dividend payout of $0.04; comprising of a final dividend of $0.024 and a special dividend of $0.016. The cash windfall was repeated in FY06. Then, SSC declared a total dividend payout of $0.17; comprising of a final dividend of $0.03 and a special dividend of $0.14.

For our base case scenario, SSC is assumed to declare a dividend payout of 3 cents for FY07, the counter would have a net yield of 6.6%. This leaves room for yield compression to occur. If the yield compresses to 6%, the price of SSC would increase to 45 cents. A more generous payout of 4 cents would obviously lead to higher potential capital gains.

At the current price, we view the pay-off profile of SSC to be similar to a call option. Even in the unlikely scenario where SSC does not declare any dividends, it may potentially mean that the firm is close to making vessel or real estate acquisitions. The market is likely to welcome such purchases as it signifies that SSC has growth potential. Such a development is likely to lead to analyst upgrades, spurring price increase.

Tiger Roars on Good Friday

2007-04-06T10:56:00.000+08:00

The stock market in Singapore is closed today for the Good Friday holiday. Many have taken the chance to go overseas for a long weekend. The MOS crew was also anticipating a slow end to the hectic week which saw Asian markets claw back to match or surge past their mid February highs.

Bursa Malaysia was, however, open for trading. Hence, we were pleasantly surprised when KLSE listed Keck Seng (KS) took a big pop today. KS was last featured on our blog in 9 January 2007 in a post titled "Crouching Tiger, Hidden Assets". It was trading at RM3.50 then. Following the post, the counter took off on a steady run up but fizzled out subsequently. But KS jumped to RM5.60 on early trading today, chalking up a 60% gain over the holding period. The spike up today can largely be attributed to a local newspaper report which hyped up the revaluation of KS' assets. In particular, a lofty valuation was placed on its huge land bank in south Johor. In our post then, we had alluded to the positive sentiment that KS could benefit from following Malaysia's massive IDR plans. The market is similarly excited as other property counters with exposure to south Johor have soared to highs of late.

Wheeling & Dealing

2007-03-18T17:32:00.000+08:00

Fancy owning a slice of Times Square HK, Wheelock Place Singapore? And with the up market Lane Crawford thrown in for "free"? MOS tells you how...

Wheelock and Company Limited (0020.HK) (Public, HKG:0020) (Wheelock) is the holding company of Hong Kong tycoon Pao Yue-Kong. Its actual structure of the organization is undoubtedly complex and does not make for weekend reading. Essentially, Wheelock derives most of its earnings from Wheelock Properties Limited (0049.HK) (Public, HKG:0049)(74% subsidiary) (Wheelock Properties HK) and The Wharf (Holdings) Limited (0004.HK) (Public, HKG:0004) (49% associate). To complicate matters, Wheelock HK in turn holds a 76% stake in Wheelock Properties (Singapore) Ltd. (Public, SIN:M35) The latter is the developer of condominium projects in Singapore such as The Cosmopolitan, The Sea View and Ardmore II and Orchard View. It also owns Scotts Shopping Centre and The Ascott Singapore along Orchard Road which were 99% and 86% leased respectively (as of Sept 06). For Singapore readers, it may be noteworthy to learn that the familiar Orchard Road landmark will be demolished and redeveloped into a residential and commercial complex in the first half of 2007. Of course, Wheelock Singapore also owns Wheelock Place which was 93% leased up.

Let's turn our attention to Wheelock Properties HK. It is also a property development and holding company. One of its residential development in Homantin, Parc Palais (700 apartments) was 94% sold in September 2006. Two other property assets under its wing, Wheelock House and Fitfort also enjoyed good occupancies of 87% and 95% respectively.

As for Wharf, it wholly owns Harbour City - a retail, office and hospitality development in Tsim Sha Tsui. Harbour City has continued to perform strongly. Occupancy in the retail component is largely fully occupied (99%). Hence, Wharf was able to step up rents on new leases and renewal. The office component also remained strong, with average occupancy of 95% while the three hotels at Harbour City had a consolidated occupancy of 90%.

Wharf also owns Times Square. Both the retail and office components are robust - with occupancy of nearly 100% and 93% respectively. In addition, Wharf is performing asset enhancing works in Basement 2 to capture shopper traffic from the MTR.

Besides the above properties, Wharf also holds 68% of Modern Terminals which manages container ports in HK and China (Taicang, Shenzhen and Shekou) and a 73% stake of i-CABLE, a multimedia (pay TV and internet) operator.

Other than Wheelock Properties HK and Wharf, Wheelock also wholly owns Lane Crawford House and several development properties. For example, Bellagio is a development in Sham Tseng while Sorrento is a project in Kowloon. Virtually all units of the Sorrento have been sold by September 2006.

From the long description above, it is clear that Wheelock provides investors with exposure to numerous property assets in South Asia's two major financial hubs of Hong Kong and Singapore. While property prices in nearly all sectors have run up considerably in Singapore, MOS remain sanguine about prices in Hong Kong. For example, office landlords in Central, HK should have the upper hand in leasing negotiations as there is hardly any vacancy in the financial district. Granted that rising rents will eject certain companies into fringe areas such as Northpoint or even Kowloon where there is plenty of contiguous space coming up, we continue to see demand for Central office space from the finance, insurance and banking sector. We also expect HK and Singapore to the key beneficiaries of increasing tourist flows from the region, especially with the advent of budget air travel. While MOS is dim about retail prospects in Singapore, visitors from China should provide support to the retail and hospitality sectors in HK.

So what's valuation picture looking like? Wheelock's NAV on its 30 September 2006 books is HK$22.09. However, as Wharf is a 49% associate, adjustments are required to apportion Wheelock's share to reflect economic reality. This share is at least worth HK$5.00. Capitalizing the rentals of Lane Crawford at 6% suggests that this asset adds another HK$1.00. Hence, the adjusted NAV of Wheelock is at least approximately HK$28. So, the market price of HK$17 offers a 39% discount to adjusted NAV. Depending on how much "conglomerate discount" you want to apply (MOS sniggers at this), it appears that there is sufficient room for price appreciation to bridge the divergence between price and value.

No adjustment was made for debt because the group has sufficient cash balance to square out its loans. With its gearing pared down, proceeds from sales of the remaining units of Parc Palais and Bellagio (expected to be received in 31 Mar 07) will effectively accrue to its balance sheet. Its low gearing leaves Mr. Pao with flexibility to lever up when the opportunity arises. With this growing cash balance, it also means the group has the option to offer shareholders a fat dividend payout.

A vital catalyst to unlock the value of this group would be the injection of its assets into a REIT. Management had indeed indicated that it was studying this route in April 2006. Whilst we understand that several REITs are in the making in HK, sentiment in the capital market towards REITs remains lukewarm there. Hence, MOS rates this driver as a low probability event. But, interested investors ought to keep their ears on to the ground to ascertain this possibility.

Through its various portfolios, Third Avenue Management holds sizable chunks of Wheelock. As recently as the last reporting quarter, Third Avenue has increased its holdings through Third Avenue Value Fund and Third Avenue Real Estate Value Fund. As you would be aware, the funds are piloted by Martin Whitman and Michael Winer respectively.

It would not be right for MOS to sign off without clarifying how Lane Crawford, as touted in the first paragraph, can be obtained for "free". Well, by simply taking the apportioned shares of the market capitalizations of Wheelock Properties HK and Wharf, one will come up with a value of about HK$22 for each Wheelock share. With Wheelock trading below this, isn't Mr. Market offering a slice of the directly held asset, Lane Crawford, for "free"?

The Chinese Contagion

2007-02-28T22:24:00.000+08:00

Global markets were all roundly routed today after Chinese stocks sold off by 9% yesterday. Asian markets such as Japan, Korea, Malaysia, India and Singapore all tumbled more than 2% in its worst slide since the Sept 11 attacks in 2001. Markets further away in India, Canada and South America were not spared either.

Volatility returned to the market when the VIX spiked to 19 in early morning trade. The VIX was up almost 50% from the day before. MOS last described VIX in our last posting. As evident from recent posts, MOS has been preaching the theme of cautious investing of late. The choppiness of the market today underscores our warning.

The Sun Always Shines (only on TV)

2007-02-24T11:34:00.000+08:00

On Tuesday, MOS had alerted investors that we should exercise "especial caution" in the market. With the festive boozing getting to our cranium, we had inevitably failed to explain our case. That, as a result, drew several mails from irate readers who suggested that MOS is attempting to talk the market down.

Hence, we would like to take the opportunity to present our case today. We consider this to be a period of unprecedented bullishness across many asset classes. From memory, the current PER of the local market is about 19x, only a shade off the high of 22x registered in the technology bubble. This same sentiment is observed in international markets, may it be the US or emerging countries. The recent returns of the Dow, S&P 500, TSX are very strong. Emerging market equities such as Vietnam, China, India and Latin American countries are also trading at extremely extended levels too.

We also understand that junk bonds and highly leveraged debt instruments are abound in the market today and they continue to proliferate. In addition, REITs, which are a hybrid between equities and debt, are yielding less than their ten year government bond benchmarks.

For some reason unknown to us, fear has virtually vanished from the market. The VIX, aka the Fear Index of US, is languishing near record lows, ranging around 9 - 10 when highs of 20 - 30 were registered only as recently as 2002. Even the volatilities of major currencies, an asset class synonymous with volatility, are below normalized (ten year) levels.

These record setting highs are engineered by the substantial liquidity that has been sloshing around for over a year. The combination of petro-dollars and the wealth of the rising Chinese are plausible causes for this liquidity glut. But it will take only a quick and rude shock to the global financial system to bring about the withdrawal of the hot money.

The strains are starting to show. In January, the sub-prime mortgage market in the US tanked. The industry benchmark, the ABX, nosedived after several lenders reported higher loan losses, delinquencies and defaults. MOS does not think that issues in the housing market will be contained within the sector. The housing slowdown is likely to have knock-on effects on the broader US economy. And should the world's largest economy go into a tail spin, the other nations are unlikely to fare any better.

It is always difficult to play the party pooper. And it’s never going to be easy to convince Noah to build the ark when rain is not in evident in the horizon. But, the sun always shines, unfortunately, only on TV.

Credits: The title is a play on A-ha's smash hit from the 1985 album, "Hunting High and Low" - "The Sun Always Shines on TV".

A Time for Especial Caution

2007-02-20T17:36:00.000+08:00

Frequent readers of this site will know how averse the MOS folks are to capital loss. We see our first and foremost mission as capital preservation, not capital appreciation. A Mandarin proverb, loosely translated underscores our objective - "with the lush mountain intact, one should not be afraid that there will be insufficient wood for a fire".

Over the long weekend, the talk dominating cocktail parties here is "Singapore 4000". It is not a catchy phrase of a new government campaign. But it refers to the optimism that the benchmark Straits Times Index will hit a high of 4000 points and luxury apartment prices will reach S$4000 per square foot soon. And there would bound to be someone sharing how fast bucks were made flipping the numerous initial public offerings which trebled within days of their listing.

In fact, as this stellar run in the equity market and property prices continue, more and more cautious investors are throwing in the towel - "to heck with valuations" and succumbing to the temptation of hitching a ride on this "relentless" bull. For the last few holding out, let us suggest that it may be more worthwhile to pack up for a getaway to Phuket to enjoy the Andaman Sea breeze and sun instead. There, you are assured not be to bombarded with news of market highs if your Blackberry is left behind.

With prices escalating more than before, we argue that the danger now of sustaining a capital loss with an indiscriminate purchase is higher than ever. Indiscriminate to the extent that the business quality is actually poor, or possess cyclical earnings but is masked by the current buoyant economic conditions. The foregoing caution is not novel; but one that has been expounded by Mr Benjamin Graham. We end this post by quoting several paragraphs written by the superinvestor.

In the 1951 edition of "Security Analysis", Mr. Graham offered the following - "When the general market is high there are always a number of individual issues that appear definitely undervalued by objective standards, and consequently even more attractive in contrast to the inflated level of other stocks... But that is a time that calls for especial caution. Not only may the 'neglected security' continue neglected for the remainder of the bull market, but when the downturn comes it is likely to decline in price along with the general market and to fully as great an extent. In a word, beware of 'bargains' when most stocks seem very high."

Mr. Graham went on to elaborate on the above in "The Intelligent Investor" - "The risk of paying too high a price for good quality stocks - while a real one - is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to "earning power" and assume prosperity is synonymous with safety... It is then, also, that common stocks of obscure companies can be floated far above tangible investment, on the strength of two or three years of excellent growth." Mr. Graham continued, "These securities do not offer an adequate margin of safety in any admissible sense of the term... Thus it follows that most of the fair weather investments, acquired at fair weather prices, are destined to suffer disturbing price declines when the horizon clouds over - and often sooner than that".

Defying Gravity

2007-02-06T23:28:00.000+08:00

Gravity defying - that's been the path for which the share price of Micro-Mechanics (Holdings) Ltd (MMH SP) (SIN: 5DD) (MMH) has been taking in the last few months. Since MMH was last featured on Margin of Safety (MOS) on August 2006 (S$0.48), investors in the semiconductor consumables supplier would have pocketed a 70% gain. Whilst the run up may partly have been attributed to the buoyant market sentiment, its management led by Christopher Borch, has also continued to deliver the results and reward shareholders.

The latter was evident in the 1H FY07 results unveiled yesterday. MMH managed to grow its revenue by 15% (vs 1H06) to S$17.7 million despite the loss of a customer in Singapore. This was due to the group's increased penetration into Taiwan and Europe. More significantly, net profit margin increased further to 25%. MOS believes that the custom machining and assembly (CMA) business which MMH has diversified into may be the reason behind this margin expansion. The growth of the CMA business from an insignificant share to 7.3% of total revenue also serves to help MMH diversify beyond the semiconductor industry. With the increasing net profit margin and top line growth, its EPS grew by 21% to 3.2 cents per share.

To foster share ownership amongst its employees, MMH has also announced a unique share offer cum gift scheme. Employees (or a family member) who meet certain pre-requisites are allowed to purchase shares from Mr and Mrs Borch at a sharp discount to the reference price of S$0.78. MOS views this as a refreshing move by the management when they clearly could have sanctioned a share option scheme which may potentially be dilutive to current shareholders in future. Should these purchasers subsequently sell their entitlements on the open market, the available free float also increases for this relatively illiquid counter. Whilst liquidity isn't a factor for the patient folks at MMH, it may well put the counter on the radar of the bigger and more established fund houses; thereby spurring added activity on the counter.

To reward shareholders, MMH is also declaring an interim dividend of 1.5 cents per share. This puts it on track to equal or best the total dividend of 3.5 cents per share paid in FY2006. Furthermore, the balance sheet of MMH remains debt free and its ROE remains high at 25.2% on an annualized basis.

Going forward, it is unclear how the fortunes of the global semiconductor industry will pan out. In fact, research consultancy Gartner has forecasted that growth is likely to slow. However, MOS remains confident that MMH's management will take all measures to keep the company on even keel.

Episode 3: The Empire Strikes Back

2007-01-14T10:11:00.000+08:00

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

2007-01-09T09:05:00.000+08:00

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

2007-01-02T15:59:00.000+08:00

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.

Tis the Season to be Jolly!

2006-12-31T12:50:00.000+08:00

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.

Chinese Brothers

2006-12-24T11:46:00.000+08:00

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.

Mabuhay Value!

2006-12-07T22:33:00.000+08:00

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

Are we on the same (Yellow) Page?

2006-12-04T22:35:00.000+08:00

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.

For whom the bells toll

2006-11-30T21:08:00.000+08:00

Come 1st January 2007, the bells will toll for the pockets of motorists who use Malaysia highways frequently. This is because fares on five highways are set to rise from 1st January 2007. The Malaysian Works Minister was quoted in the local media as saying that the government will withdraw subsidies paid to concession holders running the highways. One of the affected highways is the Karak Highway operated by MTD InfraPerdana of the MTD Capital Berhad (KUL:9032).

MTD Capital was featured in April this year when we felt that the Singapore market featured few opportunities. MTD Capital was then trading at a steep discount to its three listed subsidaries. Over the space of the seven months, this discount has since narrowed as MTD Capital has rallied by about 14% from RM1.88 to RM2.14.

Sweet Symphony

2006-11-29T22:17:00.000+08:00

China Lifestyle Food And Beverages Group (SIN:E69) has entered into a share placement arrangement with broker-dealer UOB Kay Hian. The latter will help place up to 70 million shares at S$0.38 each on a best endeavours basis. This placement price is about 9% lower than the current market price of S$0.415. The placement is of a fairly large size; representing about 16% of its current share capital. As a result, the new share capital will be enlarged to 495 million shares (from 425 million).

The net proceeds raised, approximately S$25.8 mil, will be used for three purposes. They are for (a) developing a production facility in Tianjin, (b)purchasing new product lines and (c) working capital for their joint venture with Super Coffeemix.

With this placement, China Lifestyle hopes to embark on expansion plans to strengthen its market position. In view of this, investors can look forward to accelerated earnings growth in the near future. This may also bring sweet dividend payouts as China Lifestyle are committed to paying out 20% of its net profit as dividends from FY2006 to FY2008. Does this sound like sweet music to your ears?

Perfect Timing

2006-11-23T06:45:00.000+08:00

Sincere Watch (Hong Kong) Ltd (HKG:0444) ("Sincere HK") was first featured on Margin of Safety about two weeks ago on 7 November. This HKEx listed counter has since surged 21% from HKD 0.57 to HKD 0.69. The CFA Institute does not permit annualizing of performance numbers if the review period is less than a year. Given this sharp pop in a fortnight, we can understand why. For those who are curious, such a movement would actually be equivalent to an annualized rate of return in excess of 10,000%.

Don’t we deserve a pat for our immaculate timing? Sincere HK has since reported its 2Q07 earnings. As expected, its EPS showed a marked improvement compared to the 1Q07 numbers. Its EPS for the quarter was HKD0.032 vs. HKD0.0028 earlier.

Management has reported that consumer sentiment continue to be strong in Hong Kong and other North Asian economies. In this light, Sincere HK intends to step up its brand management activities for all its luxury brands, namely Franck MULLER, de Grisogono, European Watch Company, Pierre Kunz and Cvstos. Sincere HK will also be enlarging its flagship Franck MULLER boutique in Hong Kong island and a new one will be opened in Ocean Terminal Mall in Kowloon before year end. In addition, a Franck MULLER boutique has been established at the Landmark Hotel Macau to tap on the booming gaming and hospitality sector in Macau.

Looking further north, Sincere HK is stepping up its market presence in the PRC by relocating its Franck MULLER boutique in Shanghai and seeking new locations in Beijing.

Traditionally, Sincere HK's earnings exhibit a seasonality pattern. Hence, we expect its 3Q07 earnings to be even stronger, barring unrealized exchange rate losses. Earnings should also be given a shot in the arm when the expansion and market plans outlined above bear fruit. In view of the foregoing, our full year EPS target of HKD 0.10 remains on track.

BIL, don't you lose my number

2006-11-20T12:58:00.000+08:00

BIL International Limited (SIN:B16) has been in the news on both sides of the Causeway of late. Its KLSE listed holding company, Camerlin has surged following reports of a possible in specie distribution of BIL shares to Camerlin shareholders.

Over in Singapore, market sentiment is also warm towards BIL after a series of announcements regarding its foray into the UK gaming industry. In this connection, it has indicated that it wants to spend 31 million pounds to buy Rank Group’s Clermont Club. It has also applied for licenses to operate casinos within their Thistle hotels in UK. As a result, BIL's share price has chalked up a gain of 20% since we featured it in June 29.

Then, we had also alluded to the potential of the redevelopment of Molokai. Since then, news about this matter has been mixed. There are activists who resist development on what is known as Hawaii's last undeveloped island. In fact, in September, about 30 of them occupied La'au point on Southwestern Molokai at Shipwreck Cove to make their point that the island's development plans will have a negative impact on the island. However, Molokai Properties Limited, a fully owned subsidiary of BIL, proceeded to file a special management area permit to make a significant first step towards the re-opening of the abandoned 152 room Kaluakoi Hotel last week. The hotel is part of Kaluakoi Resort which Molokai Properties Limited purchased in 2001. The other part of the resort is a 18-hole course which has since been re-opened for play in 2004. The next step in the application process is for Maui County to review the application and seek comments from other stakeholders. More certainty on the outcome of the application should come through in the first quarter of 2007.

The title is a play on the Phil Collins top five smash hit, "Billy, Don't you lose my number". It was released in 1985 in the album, "No Jacket Required".

"Hotung baby!" shortlisted in Festival of Stocks

2006-11-16T11:07:00.000+08:00

Our post published on 6th November titled Hotung baby! on Hotung Investment Holdings Ltd has made the cut for the Festival of Stocks #10. The festival is currently hosted by Gannon on Investing, a value investing blog and podcast influenced by Mr Benjamin Graham, Mr Joel Greenblatt and Mr Warren Buffett's value investing model. Geoff Gannon, who runs the blog, has indicated that whilst the current festival lacks quantity, "it more than makes up for in quality". So immerse yourself in the festivities and may you enrich yourself in the process.

Sweet Tidings

2006-11-12T17:53:00.000+08:00

China Lifestyle Food And Beverages Group (SIN:E69) is a fast moving consumer goods company that holds the second largest market share for PRC jelly desserts retailing under its brand "LaBiXiaoXin". Margin of Safety first featured this company in March 2006 when it was trading at S$0.235. It closed for this weekend at S$0.425. Investors over this period who placed their faith in the counter will be licking up sweet returns in excess of 80% over the space of eight months.

China Lifestyle reported its financials for the first nine months of FY2006 over the weekend. Compared to the previous period for FY2005, its net profit soared 20% to RMB64 million, underpinned by robust top line growth of 32% to RMB404 million. Its net profit margin was roughly steady at 15%.

Going forward, China Lifestyle intends to build on its brand recognition further by airing a series of commercials on CCTV. It also intends to launch at least 10 new products, including the "Labixiaoxin" brand of potatos chips in FY2007. The potato chips is the first product introduced after the group's tieup with another SGX listed company, Super Coffeemix Manufacturing Ltd (SIN:S10) in August 2006.

Event Horizon

2006-11-11T09:54:00.000+08:00

Mr Warren Buffett is known as a value investor who attempts to purchase, when possible, an entire business at an attractive price. However, before Berkshire Hathaway (BRKa) was synoymous with this approach, Buffett had put on trades in a manner known today in the hedge fund industry as "merger arbitrage".

The blog features a present opportunity available in the Singapore market. Aircraft equipment and avionics specialist, A-Sonic Aerospace Limited (SIN:A53) (ASON SP) has launched a takeover bid for logistics firm, Airocean Group Limited (SIN:A21) (AIR SP). A-Sonic has proposed to swap one A-Sonic share for every 2.63 Airocean shares in their bid to delist the latter. At the time of this writing, Airocean exchanged hands at $0.090 a share. This implies that shareholders in Airocean who bought in at this price are, upon successful closing of the deal, effectively purchasing A-Sonic stock at $0.24 a share. Since A-Sonic is trading at $0.28, these investors are effectively getting exposure to A-Sonic at a 17% discount.

Obviously, the trade is not a risk free one. For example, the deal may not close if insufficient shareholders vote in its favor. This may lead to a divergence in the stock prices instead. Interested investors should also study the shareholding structures of both companies to ascertain which way substantial shareholders will vote on November 13th.

Time to Buy?

2006-11-07T22:45:00.000+08:00

Dear Reader,

Sincere Watch (Hong Kong) Ltd (HKG:0444) ("Sincere HK") is principally engaged in brand management and wholesale distribution of watches in Hong Kong, Macau and the PRC. The brands in Sincere HK's stable include Franck MULLER, de Grisogono, European Company Watch and Pierre Kunz.

As a result of largely unrealised FX losses affecting 1Q07 earnings, Sincere HK’s price has plummeted by nearly 50% in the past year from its IPO price of HK$1.08. The FX losses are due to the sharp appreciation of the CHF vs USD during the reporting period. However, we consider short term FX changes to be random and should cancel out in the longer run.

In terms of financial ratios, Sincere HK generally is able to command respectable net margins of 9% and an ROE in excess of 20%. Additionally, it must be emphasized that the ROE was achieved with no gearing.

With the FX movement squaring out over the longer term, full year earnings are expected to come in at around HKD 0.10 for FY2007. At the current market price of HKD 0.57, this imputes an inexpensive PER of 5.7.

Whilst there are risks such as its dependence on Groupe Franck Muller for the exclusive distributorship which aren’t expounded here, the current market price may merit more investigation than merely putting Sincere HK on your watch-list.

Yours Sincerely,
Mr Market

Hotung baby!

2006-11-06T22:20:00.000+08:00

Hotung Investment Holdings Ltd (HIH SP) (SIN: H34) is a Taiwanese venture capitalist listed on the Singapore Exchange which the blog first featured on November 2005. The price has since gained 50%. Is there any opportunities left? We re-visit and update our notes on its prospects in this post.

As of December 31, 2005, Hotung had invested in 228 companies. Hotung's fortunes are very much intertwined with the buoyancy of the Taiwanese stock market. As most of its investments are in technology related companies, it is no surprise that Hotung reported losses in the years following the deflating of the technology bubble.

Things are, however, looking up for Hotung. The net profit for the second quarter of this fiscal year was a record NT$275 million vs. a loss of NT$333 million in the same quarter last year. The results are a third consecutive quarter of profits. This consecutive string of black figures suggests that the company turning around.

Hotung's balance sheet remain rock solid. About 50% is cash and cash equivalent. While we do not expect Hotung to declare any sizeable dividends, its management has sensibly used its cash horde to engage in a stock buyback program.

The market is offering a slice of Hotung at about US$0.13. This represents about a 35% off its book value of US$0.20. Other than trading under book value, it has already chalked up net earnings of NT$440 million at the half year mark. Doing a conservative projection for its full year earnings, Hotung is expected to turn in an EPS of NT$0.55 (US$0.125). This translates to a reasonable P/E of 7.5.

It is noteworthy that Third Avenue Fund Management, led by the venerable Mr. Martin Whitman has increased their stake in Hotung. It now holds a 10.12% stake. The most recent purchase was in 31 October 2006; probably at around US$0.12-0.13. But this is a case of averaging up as Third Avenue has accumulated when the price was languishing at around US$0.08.

Oh yes, in case you are wondering about the significance of the title of this post, it is a play on U2's best selling and most critically acclaimed album, Achtung baby. Achtung Baby topped the Billboard 200 chart soon after its release in November 1991. Will our Hotung baby go on to the apex of the top gainers' chart anytime soon? Your guess is as good as mine.

Salute to the Deficient Market Hypothesis

2006-10-10T23:08:00.000+08:00

Margin of Safety is delighted to have a post featured in the Festival of Stocks (Edition #5). The current edition is hosted by the kind folks at Value Discipline, a blog which celebrates value thinking and is a salute the common sense and straightforward logic. Value Discipline is run by Rick, a portfolio manager of institutional portfolios for over 25 years. Rick considers our recent post on the Deficient Market Hypothesis as providing "terrific insight" into the mantra of value investors. We thank Rick for his kind words and trust that our regular readers will find Value Discipline and the other posts shortlisted in this edition of the Festival of Stocks as highly enjoyable reading.

IT Boom

2006-10-10T22:50:00.000+08:00

Frontline Technologies Corporation Ltd. (FT SP) (SIN:F02) is a provider of end-to-end IT services in Asia. It offers IT consulting, IT infrastructure and enterprise application solutions and systems integration. FT hires over 4000 professionals in eight Asian markets, such as Singapore, China, HK, India and Taiwan. The group is also rated in the top 10% of the Corporate Transparency Index in Singapore and its chairman, Steve Ting continues to hold a sizable 12% stake.

As one would expect, the IT space is a highly competitive and the environment is a "cut throat" one. This is evident in the thin profit margins of FT. Its net profit margin for FY2006 was 5.5%. Since any cash generated is utilized for capital expenditure or acquisitions, FT has not paid a dividend recently. Given these seemingly unattractive features, why would FT be featured?

The first reason is that it is trading at a low P/S of 0.66. The second, which is also the crux of this post, is that FT has a subsidiary that is listing soon. This Chennai based subsidiary, Accel Frontline Limited (Accel), is seeking a listing on the Bombay Stock Exchange. The IPO subscription period has just closed. This new issue was 2.44x over-subscribed. In particular, it is reported that retail investors had bid for 4 more times than the shares offered. As a result of Accel's listing, the net tangible assets of FT will swell to $0.14 per share. Curiously, trading for FT has been range bound between $0.13 to $0.135 per share. This price range is actually below its revised NTA! Perhaps the market is distracted by boom of the North Korean "nuclear" test? FT, which trades on the Singapore Exchange, closed at $0.135 today.

Deficient Market Hypothesis

2006-10-01T09:45:00.000+08:00

We need to be professional about this posting by starting with a health warning. Please do not read beyond this paragraph if you are schooled and strongly believe in the practical applications of the pillars of modern finance. In fact, reading on may be hazardous to your financial health.

In 1952, Harry Markowitz postulated that diversification reduces risk. It was proposed that assets should not be evaluated by their individual characteristics but by their effect on a portfolio. Hence, an optimal portfolio can be constructed to maximize return for a given standard deviation. Markowitz won the Nobel Price in Economics in 1990 for his work.

In 1964, William Sharpe unleashed the Capital Asset Pricing Model (CAPM) on an unsuspecting world. He defined risk as volatility relative to market in a concept known as beta. Arising from this, the expected return from a stock is positively correlated with the amount of risk. It soon dawned that the mindless price gyrations can be summarized by the succinct CAPM equation. Sharpe won the Nobel Prize in Economics in 1990.

In 1966, Eugene Fama developed the efficient market hypothesis (EMH). It asserts that market prices reflect values because information is accurately and rapidly imputed into prices. Hence, the implication is that it is not possible to capture returns in excess of market returns without taking levels of risk greater than that of the market. Consequently, investors would not be able to identify superior stocks using either technical or fundamental analysis.

The above works have become the bedrock of all fine finance education today. They are what we would refer to as "modern finance". However, the acid test question, to investors, has to be whether these theories can be applied in the practical context. We, obviously, question modern finance and their high priests. In the paragraphs that follow, we offer our take and our Deficient Market Hypothesis.

(1) Welcome Volatility

An integral component of CAPM is beta. Any finance student worth his salt would be able to expound on beta and what is measures. As a recap, beta is merely the measure of a stock's volatility in relation to the market. In this context, high beta stocks are supposed to be riskier but they provide potential for higher returns. The converse applies.
Whilst beta and its workings may appear great on paper, will it work in practice? We pour scorn on the idea of beta because it suggests that a security that has fallen greatly in price is more risky that it was before it fell. From a true investor perspective, a company should represent as a lower risk investment after it tanked. After all, investors can purchase the same company at a lower price despite an increase in the security's beta. Hence, volatility should actually be welcomed as it allows the investor to potentially purchase a stake at an attractive price relative to its intrinsic value.

(2) Markets are inefficient

Striking at the heart of EMH is our dagger thesis that markets are inherently inefficient. For example, we consider it impossible for every investor to receive information simultaneously, interpret it accurately and execute the correct trade. Instead we suggest that markets are in a constant state of flux because prices reflect both imputed company information and the psychological state of investors. As a result of the latter, markets cannot be efficient for the simple reason that humans are irrational creatures. This explains periods of financial markets history where there is irrational exuberance and manic depressions.

(3) Risk and return do not go hand in hand

When a market swings from one extreme to another, we suggest that the oft talked about positive relationship between risk and return breaks down. In fact, there will be instances where risk and return have an asymptotic relationship. For example, one would expect the expected return to outweigh the downside risk shouldered when a security whose price is way under its intrinsic value is purchased. Thus, the risk and return relationship is hunky dory only in the idealized state. Unfortunately, we feel markets deviate from this utopia.

(4) Doing nothing is a strategy

In today's electronic economy, we lead our lives in a fast paced pressure cooker. On this tack, the turnover ratios posted by certain mutual funds (some in excess of 100; i.e. entire portfolio flipped in the past reporting period) appear forgivable. But does doing so seem incongruent to what these guys preach to investors - buy and hold for the long term? To us, it amounts to having double standards if a fund manager wants his investors to buy and hold onto his fund for the long haul while he is actually furiously turning over the portfolio in search of returns.
Instead we suggest that in portfolio management, inactivity may actually qualify as the most appropriate strategy at certain junctures. Not many of us are blessed with the virtue of patience. But one who patiently awaits for the discrepancy between price and intrinsic value is likely to be handsomely rewarded. Just as with a leopard would lie in wait for its right prey to pass by in the African savannah. (Caveat: High turnover strategies do work for some quant shops. Kudos to folks like Steve Cohen of SAC.)

(5) Today may not be a good time to buy

The folks in the sales department will always suggest otherwise. We, of course, beg to differ. In the same vein as the arguments proposed above on market inefficiency, the optimal time to invest is when the market is oversold or when the price is substantially below its intrinsic value. Being able to wait for such opportunities will separate the super investor from the average one.

(6) Diversification is oversold

Diversification, unfortunately, has been used as a surrogate for knowledge and understanding your investments. Over diversification leads to mediocrity. Mediocrity means average results. An investor with excessive diversification should expect average results.
On the flipside, it may actually be worthwhile to concentrate one's portfolio holdings. At the very least, we suggest that an investor should concentrate his portfolio around securities which he possess adequate knowledge.

(7) Value = Growth, Growth = Value

To us, differentiation between value and growth is just the rich figment of a marketing man's imagination to move another mutual fund product. We believe that value and growth are two sides of a coin. Both are inseparable. Common media pigeon-hole value guys as those attempting to purchase a stake for less than what it is worth. Don't growth guys expect to do the same too? Have you ever wondered what a value pick would be worth if it had negative growth in earnings? No prizes for guessing that such a company will slip into abyss quickly. So value guys do seek some element of growth too. As a result, we argue that it is meaningless to categorize an individual as a value or growth investor. To our mind, the real distinction should really be between investors and speculators.

Final Words

In 1992, in what may amount to a U-turn on his earlier work, Fama collaborated with French to improve on CAPM. A three factor asset pricing model was developed with factors such as market, size and value to explain market return. Is this a tip of an iceberg which amounts to the unraveling of earlier theories?

The best thing about reading this piece is that you do not have to believe this whole lot of hogwash above. These ideas are admittedly too controversial for the mainstream media and a nightmare to the marketing folks. Investing, seen through the lens of the Deficient Market Hypothesis, would simply be too boring.

In science, we use classical Newton mechanics to explain the majority of the physics challenges encountered daily. But these wonderful laws, unfortunately, fail at the atomic level and set the stage for Einstein's quantum mechanics laws. Would the Deficient Market Hypothesis be reveled in such light one day? We honestly hope not because it may represent the day when we run out of opportunities.

Mixed Signals - Crystal Ball Analytics

2006-09-16T11:36:00.000+08:00

I was recently asked to comment on outlook of US financial markets, particulary on the prospect of the US economy slipping into a recession. As you would expect, to provide views on the big picture was tough for someone who spends his time nose deep in the sand hunting for undervalued companies. Nevertheless, the task was undertaken with gusto and I shall attempt to share the mis-mash of findings which I unearthed in my search for a crystal ball economic leading indicator.

Inverted Yield curve
Historically, the slope of the yield curve for US Treasuries has proven to be a reliable indicator for forecasting recessions, with a lead time of up to 6 months. In fact, the New York Fed has performed several studies investigating the reliability of this indicator. While examining historical spreads, I reached the following hypothesis. Specifically, the signals provided by the spread between the 10 year T yields and the 3 month Fed funds rate have been un-canningly accurate when: (a) the yield curve inverts more than 50 basis points and (b) for more than four quarters. When the foregoing two conditions are fulfilled, the US has, historically, experienced a recession. This is validated by data going back to 1965. As things stand currently, the US economic outlook certainly looks bleak, at least from the perspective of this indicator. So, it's likelihood of recession 1, no recession 0.

Dealer Doldrums indicator
Coincidentally, I chanced upon another leading indicator which attempts to make the call using the change in sales by new car dealers. It was unveiled by a New York Times columnist recently. According to the columnist, there is a correlation between the year on year change in sales by new car dealers on a trailing 12 month basis (adjusted for inflation) and a recession in the US. The correlation is positive when the sales figure is a negative 2% or greater. In more exact terms, if the figure is down 2% or more, a recession is either underway or set to begin within a few months. With data going back to 1968, this indicator has not warned of a recession which did not occur. According to data released by the Census Bureau, the sales figure has dropped to a negative 2.4%; so this dealer doldrums indicator suggests that a recession is either already under-way or will soon being. Its recession 2, no recession 0.

But before you reach for the mobile to call your broker to recession proof your portfolio, please read on.

Anxious Index
The Federal Bank of Philadelphia maintains the Anxious Index. This index refers to the probability of a decline in real GDP, as reported in the Survey of Professional Forecasters. In this survey, panelists are asked to estimate the probability that real GDP will decline in the quarter in which the survey is taken and in each of the following four quarters. Thus, the Anxious Index is the probability of a decline in real GDP in the quarter after a survey is taken. This Index tends to peak during recessions, then declines when a recovery seems near. For example, the Index fell to 14% in 2Q02 when economic indicators were turning brighter. Using data dating back to 1968, a recession always followed when the Index shot above 30%. In 3Q06, the Index painted a benign picture with the probability levels hovering at 10%, no where near the recession trigger of 30%. Now, the scoreboard reads - recession 2, no recession 1.

National Activity Index
Singing a similar tune is the National Activity Index maintained by the Chicago Fed (CFNAI). The monthly CFNAI is a weighted average of 85 indicators of national economic activity. The 85 economic indicators that are included in the CFNAI are drawn from four broad categories of data: (a) production and income, (b) employment, (c) personal consumption and housing, (d) sales, orders and inventories.

As month to month data in the CFNAI can be volatile, a three month moving average version is also published. This CFNAI-MA3 provides a more consistent picture of US economic growth. When the CFNAI-MA3 is below -0.70 after a period of economic expansion, there is increasing likelihood that a recession has begun. The CFNAI-MA3 reading for August stands at 0.2 - dispelling the worry hawks.

The next CFNAI will be released on the 21st of September at 10am Eastern Time. Visit the Chicago Fed's site if you are keen to track this. In the meantime, its recession 2, no recession 2.

Some one which I cannot quite recall once remarked - put two economists in a room and you will get four opinions. Does the opposing results confirm the foregoing? I am not sure but I know I should be better off sticking to burying my nose in the sand.

Small is indeed Beautiful

2006-09-11T07:06:00.000+08:00

"I don't want to sound like a used-car salesman, but this car is a real cream puff," Warren Buffett when he donated his Lincoln Town car for an eBay auction starting Sept 12 to raise money for Girls Inc.

We risk sounding like a used-car salesman by discussing about Micro Mechanics again. MMH, the semiconductor industry supplier, was featured last month. It supplies such consumables to more than 300 semiconductor companies including Intel, Amkor, Infineon and STATSChipPac.

MMH has reported its FY2006 results. As we expected, its report card was sterling. Of note, was its ability to expand its net profit margin from 20.5% to 24.4%. Its top line continued to register healthy growth of 19%. This stunning set of numbers was achieved with no gearing. There is probably no necessity for MMH to leverage up in the near future as it still maintains a healthy cash balance of S$12.9 million, representing about 19% of its market capitalization. With its coffers bulging with cash, management intends to reward shareholders with a larger dividend payout this financial year (dividend yield: 7%).

At current prices, MMH has a P/E of approximately 9, P/S of 2, and P/NAV of 2. We consider MMH a growth counter at value prices.

Small is Beautiful

2006-08-18T00:29:00.000+08:00

As the title of this post suggests, the counter being introduced is a small capitalisation company. In fact, its market capitalisation is about S$65 million. Interestingly, its name connotes a link to the sub-micron kingdom too.

Micro-Mechanics (MMH SP) designs and manufactures a wide range of precision tools, parts and consumable products which are used by semiconductor firms to assemble and test chips.

MMH's primary focus is on the die attach and wire bonding processes. It is currently extending its capabilities to include custom machining and assembly, and consumable products for the encapsulation process. In order to serve its wide international customer base (over 300), MMH has five manufacturing facilities located in Asia, namely, Singapore, Malaysia, China, Thailand and the Philippines.

Being a site associated with the value style of investing, it may come as a surprise to introduce a firm related to the cyclical semiconductor industry. Whilst statistics from the international industry association, Semiconductor Equipment and Materials International point to the industry holding up well, skeptics about MMH should examine its financials to see how resilient its earnings has been despite being in the volatile industry. Since listing in 2003, it has consistently maintained a gross profit margin in excess of 60%! In the same vein, its net profit margin is a healthy 20%. Eyeballing its balance sheet also reveals that it has no long term debt. In addition, MMH has been able to manage its capital expenditure with internally generated cash flow. In fact, its cash flows have remained healthy despite one major capital expenditure exercise in FY2005 to build a new plant in China and improve the Singapore and Malaysian factories. Its management has also been willing to fork out any excess cash to reward shareholders.

We also rank MMH’s management highly. Founder and President Chris Borsh has over 20 years in the industry and he communicates candidly to his shareholders. He also demonstrates alignment of his personal interest by continuing to hold over 30% of MMH's shares after listing.

Investors who stare at charts are likely to be deceived by its relatively flat price movement. In order to appreciate the full extent of its historical price, one needs to factor in its several capital structure changes. For example, it issued an extra one share for every four held last year. The willingness for a company to issue new shares (a move which will dilute per share measures such as EPS unless the earnings increase at a faster rate than the increase in number of shares) speaks volumes of the confidence that its management has in its prospects.

Going forward, MMH is seeking to diversify into the precision manufacturing business. Since starting its Custom Machining and Assembly division in 2005, it has received orders from customers from the medical, instrumentation and high tech equipment fields.

Indeed, MMH’s prospects are looking rosy in the near term too. We expect MMH to report record FY2006 earnings soon and register at least 25% YOY earnings growth. The current historical P/E is approximately 11x. Should our earnings forecast materialize and its P/E holds up, MMH's fair value is north of S$0.58.

MMH closed at S$0.48 today.

Embrace Capitalism

2006-08-06T19:06:00.000+08:00

Nearly a year ago, readers of this blog were introduced to FEH SP. FEH SP is a food and beverage company with a huge footprint in Russia and several other emerging markets. In Russia alone, their prospects are tremendous. Russia have rapidly embraced capitalism in the last 6 years and now has an economy that is humming along with a GDP just off a shade of a trillion dollars.

FEH SP has been able to capitalise on the rising Russian tide. Based on last Friday's close, the counter has chalked up in excess of 30% p.a. return and padded our pockets with consistent yields of 4-5%.

Three other counters were introduced to readers then. The stunning performance of Sarin was analysed recently but the counter has since fell from stratospheric heights. The chief causes are due to issuance of guidance that the diamond industry will slow down and the ongoing Lebanon conflict. This knife edge drop also reflects our dislike for companies which have been chased up by market punters. A year ago, the counter was a diamond in the rough. But after turning in good results, its growth prospects were overly touted, thereby leading to a rich P/E. As always, such a backdrop is a recipe for disaster when the growth potential does not materialise. We can only hope that readers have realised their gains.

On a brighter note, the two other counters featured a year ago have been taken private, underlining their under-valuation. The returns for both were good, in particular, that for TASH SP, aka Total Automation which rewarded shareholders with a handsome payout.

Blazing a trail in philanthropy

2006-07-05T19:07:00.000+08:00

All Buffett acolytes should probably have read by now that Mr Buffett has agreed to donate almost a jaw-dropping US$30 billion to the Gates Foundation last week.

Even at the age of 76, Mr Buffett continues to astound me with his actions, not only in the investment field but also in how he chooses to lead his life. With his large riches, he could have easily set up a foundation in his own name but chooses not to do so. Instead, he donates the bulk of it to a foundation without even asking for his name on its door. It is a move which is utterly low key, but probably expected given his trademark non descript demeanor.

To me, Mr Buffett is not only a symbol of success for American capitalism, it is also about remaining humble, being fair, just and approachable. Despite his success, he still stays in his same old house, remains devoted to his sweetheart (unfortunately, passed on) and still drives the same old car with the vanity license plate, Prudent. And interestingly, the greatness of Berkshire Hathaway was achieved from Omaha, away from the hustle and bustle of Wall Street. What is more astounding is that this wealth was accumulated in a manner almost antithesis of modern corporate America which to some extent celebrates big money and flashy cars.

As he heads towards the twilight of his life, Mr Buffett chooses to donate the bulk of his enormous wealth to a foundation dedicated to “reducing inequalities in the United States and around the world”. It appears to be almost like life coming a full circle for a great man who started with reportedly only US$10,000 almost 50 years ago.

We hope that he continues to illuminate the lives of many more through his actions and deeds.

Aloha: Owning a slice of Hawaii

2006-06-29T22:39:00.000+08:00

BIL International [SGX listed: S$1.35, 29 June 06]

The key investments of BIL International ("BILI") are the group of Thistle Hotels, Molokai Properties, Bass Strait Oil & Gas Royalty and Denarau Properties.

Thistle Hotels group represents BILI's primary investment. It owns, leases and manages 49 hotels in UK. It is the largest full service hotel operator in London. BILI has shown that it is willing to engage in sale and lease back structures to lighten its balance sheet. For example, 6 hotels were sold and leased back for 185 million pounds in April 2005. The sale proceeds were used to repay BILI's bank debt. It also allowed the group to book a profit of approximately US$50 million.

Molokai is one of the several Hawaiian islands. BILI has reached an agreement with Molokai community leaders to develop 65,000 acres of land, representing 40% of the Molokai island. This land includes 13 miles of coastal land and BILI intends to reopen a 152 room Kaluakoi hotel that it purchased in an abandoned state in 2001. BILI is currently seek an investor to develop the coastal land.
BILI owns 55.1% of the royalty granted by BHP/ESSO which gives the holder 2.5% of the gross value of all hydrocarbons, liquid or gass produced and recovered in certain areas within Australia's Bass Strait. This royalty is monetised for the next 10 yers through the ASX listing Bass Strait Oil Trust (BSOT), of which 20 mil is held by BILI.

Denarau is BILI's wholly owned property company in Fiji. It owns Fiji's largest resort (Denarau Island Resort in Western Viti Levu, 650 acre) and is currently working on a new five star resort and a commercial retail project.

Analysis: BILI is trading near its net book value. The bulk of its assets comprise of hotels in London situated on freehold and leasehold land which is likely to be valuable. It is likely that BILI will engage in more sale and lease back transactions following the successful sale of the 6 hotels in April 2005. Any profits from such transactions will likely accure to its earnings as much of its debt has been paid off.

There is a potential earnings catalyst in the units of BSOT. The 10 year monetization of BSOT will expire in 2007 and all subseqently cash flows of the royalty will revert to BIL. Hence, from 2007, the contribution to revenue of Bass Strait is likely to approximately double to 24 mil. This translates to an additional US$0.88 per share in earnings. BILI has also keen on securing a casino license to operate a gaming venue in one of their London hotels. Future casino operations can be a boost to its bottomline.

Another noteworthy aspect is that its controlling shareholder, Mr LC Quek has been snapping up more shares in the open market. This is suggestive of improved fortunes for the group ahead.

Diamonds are forever

2006-05-14T17:22:00.000+08:00

At this year's Berkshire Hathaway's AGM, Mr Buffett introduced shareholders to his first international acquisition. It was an 80% stake in Iscar Metalworking Companies. The stake in the metal cutting tool manufacturer costs a cool US$4 billion. The Wertheimer family will continue to retain a 20% stake and run the business.

We cannot claim to be close to the greatness of the Oracle of Omaha. But this blog, Margin of Safety, had also introduced faithful readers to an Israeli company. It was about a year ago, in August 2005. The company is Sarin Technologies and is the first Israeli company listed on the Singapore Exchange. We did not provide any description of the firm but curious readers would did their homework into the red letters "SARIN SP" at the end of the blog entry would be sitting on a handsome and oversized gain today of about 120%. That may be enough to get your mum a diamond for this Mother's Day for producing the genius in you!

Sarin is a manufacturer of 3-D laser modeling systems that help optimize the cutting of rough diamonds into high-value gem stones. It also makes instruments to measure the colour and cut of stones (two of the four key quality parameters of diamond grading; others being clarity and carat, of course!). Margin of Safety was attracted Sarin as it was a unique niche business with only apparently three other competitors in the world. And its competitive strengths ought to have been crystal clear to any casual reader of its financials which exhibited fat profitability margins and high ROE!

Featured in 13 August 2005: S$0.49
Close on 12 May 2006: S$1.08

Go North, life is peaceful there.

2006-04-20T00:19:00.000+08:00

The Singapore market barometer, the STI, hit an all time high today. Several key bourses around the region such as the Korean KOPSI also posted multi year highs. If the foregoing is not a sign of a crowded room, what is? It's hard to find quieter spaces these days in markets of such exuberance that our approach almost appear to be a damp [although some might say: damn because no oil counters were ever pitched] squid.

With the market going through the roof daily, it may be tough to mine for value in Singapore but it may simply mean the filters have to work harder. But for the first update in April, it may be most worthwhile to look up north to Malaysia where things are quieter. Unlike the Pet Shop Boys who suggested that folks go west, we head north instead from little Singapore across the borders. As we drive up on the roads into the bustling capital of Kuala Lumpur, the Kuala Lumpur Karak Highway will come into sight. The highway, known to locals as KLK, is a 60km artery road linking the Klang Valley to Karak Town.

You pause to check if you have surfed into a wrong site or examine whether Margin of Safety has lost its bearings and is now a travel site. No, the focus has not changed. KLK is one of the concessionary highways held by a listed Malaysian company named MTD Infrastructure. MTD Infrastructure is, in turn, owned by MTD Capital. There are two other listed companies in the MTD Capital umbrella - Metacorp and ACPI [Now it seems normalcy has resumed to the blog]. Hence, MTD Capital is effectively an investment holding company with interests in construction, civil engineering, property development and infrastructure operations. Using figures from the 2005 annual reports of these companies, a sum of parts valuation of MTD Capital was attempted.

Stakes in listed companies

MTD Infrastructure (75.7%, RM1.18) - RM991 mil

Metacorp (22%, RM0.225) - RM34 mil

ACPI (22%, RM1.10) - RM97 mil

MTD Capital also has RM190 mil of cash balances and non current liabilities of RM620 mil. Erring on the side of conservatism, no valuation is placed on its non current assets which, if you were to examine its annual report, are a hefty number! After adjusting for its outstanding warrants [due in May], one would arrive at a diluted revised NAV per share is approximately RM2.47.

The current market price of MTD is RM1.88. On this very strict back-of-the-envelope calculation, this translates to a discount of approximately 25%. Depending on your assumptions or imputation on the value of fixed assets, one could be looking at a diluted revised NAV per share of up to RM3.90! Finding steep discounts for holding companies reminds one of WBL, another conglomerate which was featured in Sept 05. At last count, the Singapore listed WBL has popped up a whopping 110% from our feature date.

It appears that the macro picture augers well for the MTD group. The government has recently announced the 9th Malaysia Plan that sees an equity infusion of over RM200 billion into projects all over the country. Analysts are estimating that infrastructure projects [construction of roads, highways, airports expansions and refurbishments, etc] will be allocated to the tune of RM37 bil. MTD Capital, being a major player on the construction scene is expected to benefit.

[For the record: MTD Capital: RM1.88, MTD Infrastructure: RM1.18, Metacorp: RM0.225, ACPI: RM1.10]

The Best Things in Life are Free

2006-03-30T17:55:00.000+08:00

Despite the pro bono nature of the ideas put up for discussion, the last four ideas have performed admirably. The foregoing explains the basis for the title of today's column.

The most fruitful discussion centered on Thomson Medical which has rocketed up over 25% since our posting on 23 Feb. The market seems to have vindicated our post which highlighted its cheap valuation, on a relative basis to other medical counters. It is trading around S$0.365 today compared to S$0.29 then.

The next best performer of the lot is China Lifestyle. In a tongue in cheek remark, we called their CEO the Chinese Willy Wonka in a column on 14 March. But its returns have not been a joke. It's up 12.9% (from S$0.235 to S$0.27).

Of the four, Magnecomp is the most recent counter put up for discussion. It was featured when it was trading at S$1.37 on 16 March. Compared to the meteoric rises of the above two counters, Magnecomp's 3.7% gain is a tad sluggish (today: S$1.42). It is nonetheless a move in the right direction. We shall see if sentiment towards it improves in the days ahead.

Finally, the last one on the list is Tong Ren Tang. The HKEx listed counter was considered fully valued at HK$17.00. It is interesting to note that it is trading at HK$16.20 today.

Well, that's all for the wrap-up. It's always good to give oneself a pat on the back occasionally so long as we do not get carried away!

Spinning the disc

2006-03-16T00:29:00.000+08:00

Magnecomp International is listed on the Singapore Exchange in 1998 [today's close: S$1.37]. Its business consists of two major divisions: (a) Magnecomp Precision Technology (MPT) and (b) Mansfield Manufacturing Company (MSF).

Interestingly, MPT - the hard disk division of Magnecomp, is also listed on the Stock Exchange of Thailand. It last traded at about THB4.70 per share. Hence, Magnecomp's 74% stake in MPT is valued by the market to be about S$302 million. As Magnecomp's own market capitalisation on the Singapore Exchange is S$312 million, Mr. Market effectively prices MSF at S$10 million.

The perculiar thing is that MSF, alone as a division, is profitable through its provision of metal stamping and tooling services. Given that MSF may generate net earnings of about S$10 million, this segment of Magnecomp is only priced at an attractive P/E of 1x. Is Mr. Market's pricing accurate or was he confused by his Thai counterpart?

Other vital ratios of Magnecomp [approximate historical ratios]:

P/E: 11
P/B: 1.5
ROE: 16
ROA: 9
Debt/Equity: 0.3

The Chinese Willy Wonka

2006-03-14T00:39:00.000+08:00

Anyone keen on having exposure to Chinese consumers who enjoy marshmallows, candy and jelly desserts? If you do, look no further than China Lifestyle. It is listed recently on the Singapore Exchange and it closed at S$0.235 today.

The company is based in Tianjin and Fujian where it manufactures products under its propriety brands "Labixiaoxin" and Sunshine City. It is noteworthy that China Lifestyle has been awarded the China Top Brand Certificate in 2005 in recognition for being the preferred choice amongst the discerning Chinese taste buds. In this connection, "Labixiaoxin" has the second largest market share in the Chinese jelly market.

Industry trends

Industry sources indicate that jelly desserts which China Lifestyle produce are one of the top three sweets in China, alongside more traditional chocolates and candies. The annual growth rate for jelly desserts is estimated to be 15-20%, far outstripping that for sweets which is expected to grow at 8%. In terms of world consumption of jelly, China ranks second.

The value proposition

China Lifestyle hopes to ride on the rising disposable income of the Chinese and their indulgence in sweet desserts. We understand that overseas demand for the company's products is rising from a small base of 4% of group sales, as can be seen by the growth in the number of foreign customers seeking OEM arrangements. Under existing arrangements, China Lifestyle already has exports to South East Asia, North America, Australia and Europe. Its OEM arrangements with Walmart and Tesco are also a step in right direction for more future collaborations.

In terms of distribution reach, China Lifestyle has sales network of over 300 distributors supplying its 1000 varieties of jelly products, 100 varieties of marshmallows and 100 varieties of candy products to over 13000 retail outlets. These outlets are in 30 provinces and cities throughout China and their products may be seen in supermarket chains such as Carrefour.

Investors concerned with the agency issue should be heartened that there is alignment of interest between management and investors. Alliance Holdings, controlled by the founding family still owns a large majority of China Lifestyle (72.4%). It is founded and continue to be run by three brothers (CEO Zheng Yu Long).

In sum, at the current price, China Lifestyle provides a cheap play for investors seeking long term exposure to the Chinese market. Its business model is scalable and the products scores well with Chinese consumers.

Buffett the Wordsmith

2006-03-10T22:35:00.000+08:00

Much has been written about the Berkshire Hathaway's 2005 shareholder's letter. Plenty of newsprint have been devoted to analysing the profiles of possible successors to Mr. Buffett's legacy after it was announced that the replacement has been agreed upon unanimously. Reports covering his comments on managerial compensation and risks of derivatives have made the business pages too. With so much already written, there probably isn't much left to write about.

Instead, we choose to take a light hearted look at the shareholder's letter to pick up interesting analogies which Mr. Buffett loves to pepper his message with. At the end of this short exercise, we can only conclude that Mr. Buffett has scored a home-run with his choice of examples and words.

To describe not being able to do two things simultaneously. [pg 4 of shareholder's letter]
"...elderly couple who had been romantically challenged for some time. As they finished dinner on their 50th anniversary, however, the wife – stimulated by soft music, wine and candlelight – felt a long-absent tickle and demurely suggested to her husband that they go upstairs and make love. He agonized for a moment and then replied, “I can do one or the other, but not both.”

To describe over optimism [pg 8]
"...behave like the fellow in a switchblade fight who, after his opponent has taken a mighty swipe at his throat, exclaimed, “You never touched me.” His adversary’s reply: “Just wait until you try to shake your head.”"

To describe the importance of attitude of managers [pg 14]
the young man who married a tycoon’s only child, a decidedly homely and dull lass. Relieved, the father called in his new son-in-law after the wedding and began to discuss the future:
“Son, you’re the boy I always wanted and never had. Here’s a stock certificate for 50% of the company. You’re my equal partner from now on.”
“Thanks, dad.”
“Now, what would you like to run? How about sales?”
“I’m afraid I couldn’t sell water to a man crawling in the Sahara.”
“Well then, how about heading human relations?”
“I really don’t care for people.”
“No problem, we have lots of other spots in the business. What would you like to do?”
“Actually, nothing appeals to me. Why don’t you just buy me out?”

From East to West

2006-02-23T19:16:00.000+08:00

Thomson Medical Centre [Thom SP, S$0.29]
The last post featured a traditional chinese medicine player in mainland China. Today, we traverse from East to West. Unlike Tong Ren Tang, Thomson Medical Centre ("TMC") is a niche hospital in Singapore that specialises in obstetrics & gynecology ("O&G") and paediatric services. It has only one medical centre located in Thomson which operates a 190 bed private hospital. TMC delivers about 600 babies a month. A milestone in its history was that its Fertility Clinic delivered Singapore's first surviving IVF triplets in 1988.

Let's look a summarized breakdown of TMC.

Pluses:
Niche positioning: With its fees and charges, it targets the "middle segment" of mothers to be who do not wish to pay high end private hospital rates nor stay in a government hospital.
Established brand name with mothers: Whilst it has only been listed for over a year, TMC has a fairly long operational history. From memory, it has at least been around for 25 years.
Possible boost to top and bottom line: Six new O&G specialists have set out practice in TMC in middle of 2005. TMC expects their full year contribution only in the coming FY.
More satellite clinics in housing estates: TMC is targeting to open 2 or 3 such clinics to add to its current seven. These clinics serve as an outreach of TMC into the population and allows it to refer mothers to be to TMC for inpatient or other diagnostic services.
Consultancy work: An MOU has been inked for TMC to provide its O&G expertise to a Vietnamese hospital in Binh Buong Province, near Ho Chi Minh City. TMC will provide hospital planning, design and project management, technical advisory and operational planning services. TMC is attempting to sign a 3 - 5 year contract to run the medical centre. If successful, this should provide another source of a recurring earnings.
Major stake by founder/chairman: Founder and executive chairman, Dr Cheng has retained more than a third of its shares after its IPO in Jan 05.
Pro active government perks for child birth: Singapore's child birth rate is below current population replacement levels. However, in recent years, the government has been doling out baby bonuses, in a bid to encourage procreation. The most recent package was introduced in August 2004. Recent statistics show that these measures have helped to reverse the declining birth rate. Unfortunately, based on studies in other developed European countries, such stimulus are unlikely to persist in the long term, suggesting that the child boom could be a short term phenomena unless steps are taken again. In this connection, it may be heartening to note that the government pays close attention to this issue.

Risks:
Limited growth: Other than the Vietnamese tie-up, organic growth of TMC is expected to be limited. As pointed out above, the managing the birth rate in Singapore is a severe challenge. TMC may have to venture abroad for growth but for a traditionally local player, its first forays overseas should be tough.
Management renewal: TMC is the result of chairman's Dr Cheng's life work. Whilst Dr Cheng is nearly 75 years old, he still runs its own clinic at TMC. Dr Cheng's son has assumed the role of deputy chairman of TMC too.

Valuation:
Even though, the contribution from the Vietnamese venture has not been factored in, TMC looks relatively cheap compared to its local hospital plays in Parkway and Raffles Medical. The latter two are trading at historical P/Es of about 30 and at a P/B of about 3. In contrast, TMC's historical P/E is approximately 19 while its current P/E is 13. As for P/B, it is at an inexpensive 1.1x as TMC owes the medical centre at Thomson Road. Its ROE of about 9 is comparable to both peers too and it is managed with a low debt to asset ratio of 12%.

Granted that TMC is the smaller of the three hospital plays and its growth prospects appear limited currently, the discount applied to TMC appears overly done. Over the long term, if its growth stagnates, TMC could also appear attractive as a yield play. Its current yield is 4.2% and with a quick ratio of 1.1, TMC could dip its hand into this kitty to fund future payouts.

Efficient traditional chinese medicine

2006-02-18T09:52:00.000+08:00

Tong Ren Tang Technologies ("TRT") [8069 HK] is a researcher, manufacturer and distributor of traditional Chinese medicine in mainland China. It was founded over 300 years ago. TRT was established during in the reign of the last Qing Dynasty in China. It is listed on the Hong Kong Stock Exchange and it closed at HK $17.00 per share today.

Its price recently look a hit when there was a 8.5% decline in its 3Q05 profit. There are also fears that as a result of the mature growth of its flagship drugs, TRT will experience slower earnings growth.

Key ratios:
P/E: 15.7
Div yield: 2.6%
P/B: 4
Current ratio: 1.9

A succinct breakdown of the merits and risks of TRT is set out below:

Pluses:
Strong brand name with experience history. Verified with Chinese counterparts that TRT has one of the strongest brand name in traditional Chinese medicine in China.
Experienced management that has delivered results.
Management is of the view that 3Q05 results were only a blip and full year target of double digit earnings growth is still on track. Hence, TRT may be undemanding on a PEG basis.
New plant in HK likely to be completed in middle of 2006 which will increase its overseas reach. Expect to penetrate Taiwan market.
Established distribution network.

Risks:
As a result of relatively poorer intellectual property rights in China, other manufacturers may replicate its mature products.
There is stiff competition from lower priced generics.
Continued expenditure in R&D to produce new drugs to replace older ones.

Valuation:
A variant of the discount cash flow was applied to the historical cash flows of TRT. It is noted that whilst income grew steadily along with top line growth over the last five years, TRT had periods of high capital expenditure too; particularly in 2002 and 2004 which led to a hit on its free cash flow. As a result, it is probably unreasonable to do a straight line projection growth of free cash flow. However, in an attempt to put a finger down on its intrinsic value, it is assumed that TRT's owner earnings for 2004 is able to grow at a growth rate of 3% for 10 years. A relatively growth rate of 3% was selected in an attempt to smooth out its historical fluctuations. No terminal growth rate was assigned.

The above assumptions lead to a fair price which is close to the current market price. There appear to be no margin of safety at current quoted prices. Well, considering that TRT is considered a "blue chip" garnering a large number of coverage by analysts, it should be no surprise if the market is efficient with this one!

Undervalued property & gas play?

2006-02-16T22:31:00.000+08:00

The last post rambled on the outlook for oil from the demand and supply angle. In today's post, a company which derives a substantial portion from providing engineering services to the oil & gas industries is featured.

G&W is traded on the Singapore Exchange. It is the holding company of Oakwell Engineering which also trades on the same stock exchange. [Last closing price: G&W: S$0.18, Oakwell: S$0.05] G&W has three core businesses - building materials, oil & gas and real estate, which contributes 49%, 39% and 12% respectively. Its building materials division provides concrete products such as precast and ready mix concrete to the local construction industry, parts of China (Beijing, Shenyang) and Indonesia. As for its real estate arm, it engages in property development in China. In particular, 70% of its phase 2 of its Sentosa Gardens project in Shenyang was sold. It is also exploring property management services as a means of providing a steady income stream to the group. The majority of its oil and gas division has been spun off as a separate listed entity Oakwell. It handles distributorships for oil and gas related equipment and products.

In its annual report for FY04, G&W reported a NAV per share of S$0.61. Does today's price of S$0.18 present an opportunity?

G&W holds over 57% of Oakwell. This stake translates to S$0.14 per share (Note, however, that Oakwell's NAV is only about S$0.06.). G&W is also cash rich. It has S$0.22 of cash and cash equivalents per share. The other substantial current assets of G&W are trade debtors and inventories. We are unsure whether: (a) sufficient provision has been made for allowances for bad debts, (b) inventories are realisable at recorded value. So, a discount of 20% is applied to their recorded value. This yields S$0.66 per share. G&W also owns a fair bit of plant, property and equipment. Part of the property/land lies on the Indonesian island of Batam. Due to potential geopolitical risks and short 30 year lease, the full value of such properties may not be realisable. In view of the foregoing, a generous discount of 40% is applied to the recorded value of PP&E. This yields S$0.17 per share.

It would be ideal if the valuation ended here. However, G&W has sizable amount of debt on its books. Its total liabilities amount to S$0.82 per share. The above yields a net valuation of S$0.37 per share. At the current market price of $0.18, it appears to offer a margin of safety of about 50%.

Show me the Oil!

2006-02-12T21:51:00.000+08:00

Are the days of cheap oil over? The question hogged the business headlines for much of 2005 and the issue was brought to the fore again with Matthew Simmons' new book. But Mr Simmons' hypothesis of a "peak oil" theory isn't novel. Geophysicist Marion King Hubbert was probably the first to voice similar concerns in 1956 when he controversially predicted that world oil production would peak in 2000.

To literally drill down to the root of the pricing equation, a systematic approach to examining the determinants of price, oil's demand and supply, is necessary.

The Demand
Let's start with demand. The North America region of USA and Canada is responsible for about 33% of the world's energy consumption. Currently, Asia is placed second; guzzling about 25%. But with Asia housing the world giants of China and India, it is expected that Asia will double its energy needs while demand in the US will increase by about 25% by 2020. Already, consumption in a rapidly industrializing China has rapidly outstripped its domestic production levels as the former increases exponentially. In fact, China became a net importer of oil in 1993. In India's case, it has already been a net importer for the past decade.

For years, engineers and scientists have touted the viability of alternative sources of energy which, when they come on stream, should reduce the demand for oil. However, it is not particularly clear that clean and safe alternatives such as solar, wind energies have proven to be commercially viable and may be produced on a mass scale. Even when they do, the question of time comes in for these technologies cannot be mass produced over night at a cheap price to penetrate and replace products which oil power. As with all products, the initial prices of such advances are expected to be high as firms need to recoup their R&D expenditures.

Instead, what I suspect has increased is the number of drivers who zip around with larger capacity cars (think SUVs which guzzle oil) and increased flights following the proliferation of cheap air travel. While budget air travel is common in Europe and USA, it is only starting to take root in certain parts of Asia. With increasing affluence levels, it is expected that Asians' appetite for automobiles and air travel will increase.

The Supply
What about supply then? Is it on the wane? The largest oil exporter is Saudi Arabia who churns out over 8 million barrels each day. The Saudis have claimed that there is a fair bit of reserves in their fields. As pointed out by several "peak oil" proponents, the numbers have not been independently audited, thereby raising questions on their authenticity. And because OPEC's current export quotas are pegged to the levels of members' reserves, there appears to be perverse incentive to artificially inflate the claims. Coupled by the fact that there are no great discoveries of oil fields for the last 35 years internationally, the nagging suggestion that oil is depleting simply cannot go away.

It is ironic that much of the oil exporters are located in the Middle East region where many states share a love-hate and yet symbiotic relationship with the West. From the religious angle, this geographical region embed potential flashpoints. The rise of certain pockets of Islamic extremists, whose views are certainly not representative of the larger Islamic community, is worrying for it threatens to polarize nations. As things stand, tension between the West and Islam probably sits on a tight balance and pushing the wrong buttons repeatedly won't do matters any good - think the current situation in Europe (Denmark).

Other than the Saudis, the Iranians (4th largest exporter) also chip in by exporting about 2.5 million barrels a day. But the Iranians have ruffled the feathers of some super-powers by insisting on pursuing nuclear enrichment work, arguably for energy purposes only. One wonders whether there will come a day when tensions between the Muslims and the West deteriorate to the point in that oil will be used as a weapon? Is there a risk of the oil tap being turned off as a form of retaliation? Risk has no religion but religion has risk.

In recent years, I have traveled to the Middle East. Skyscrapers are abound in Dubai. Qatar is rapidly modernizing and Bahrain has embarked on an ambitious billion dollar project to construct a US$2 billion financial harbor on largely reclaimed land. These ambitious projects are undoubtedly fuelled by their oil wealth and these states seem intent on developing an alternative pillar in their economies. The conspiracy theorist in me cannot help but wonder whether the increased urgency to devote increased attention to growing an alternative sector in financial services stems from knowledge that oil supplies may run out? Indeed, some quarters venture that Dubai's oil may dry out in as early as 2010. Recently, it got increasingly worrisome when the industry newsletter Petroleum Intelligence Weekly ran an expose suggesting that Kuwait had overestimated its oil reserves.

With limited domestic supplies, China has turned its sights overseas for more. As the old saying goes, "actions speak louder than words". China has gone out of its way to cultivate good relations with oil producers in their bid to secure their oil supply. Without the ideological baggage that besiege Western nations, Beijing has demonstrated that it is prepared to close deals with countries which the West may shun due to human rights or ethical reasons. Case in point: The Chinese has secured a multi billion stake in a Nigerian offshore oil field. It has also done a deal with Petro Kazakhstan and has secured rights to prospect and import in Algeria. Also, have we conveniently forgotten that CNOOC attempted to purchase a stake in a US oil corporation in 2005?

Whilst the supply picture for oil appears bleak, there have been suggestions that there may be substantial oil deposits under Canada. The reports could well be true but the issue here, from what I gather, is that extracting them will not be a piece of cake. Apparently, the oil deposits are fused with sand. Thus, extracting them will be a technological feat. Just as technology served up the diamond drill bit to enable deep sea drilling, it is likely that the day will come to allow the extraction from oil from difficult deposits or far flung corners. But the issue could well be that the world has to tolerate inflated oil prices before the day arrives.

Let's also not discount the supply chain bottleneck which could cause oil prices to spike. When was the last major oil refinery built in USA? I believe it was several years ago and no new capacity has come abroad on existing ones. Essentially a bottleneck situation could arise if any of the refineries should fail due to a terrorist attack or be affected by a natural disaster. Scenarios not entirely impossible with the heightened security concerns internationally and the increased frequency of hurricanes affecting USA (think Katrina).

The Positioning
The demand and supply scenarios are set out very starkly above. So what's the lowdown? Will there be inflationary pressures? The recent Fed statement, the last presided over by Mr Greenspan, suggested that core inflation remained manageable. But is core inflation, which exclude oil figures, truly reflective? Should the nightmarish scenarios for oil pan out, there could well be an oil led inflation. And history suggests that equities do not perform when prices of commodities such as oil surge [Link to previous post on market cycles].

A critical appraisal of the holdings in one's portfolio may be necessary. In particular, it may pay to be more cautious towards the raw materials used by the companies which one invests in. For example, plastic OEM manufacturers which have no pricing power may see their margins squeezed if oil prices spiral. Prices of oil by-products such as plastic resins could escalate and erode margins of manufacturers of plastic thin films too.

Many macroeconomic predictions have gone awry. The above demand and supply analysis could have been overly pessimistic and I am no petroleum expert. Despite the grave uncertainly in the oil picture, it is clear that to increase the probabilities of being successful in investing will require a sound grasp of one's circle of competence and purchasing only in attractively priced companies within it. Understanding your companies inside out and outside in, knowing how high prices of oil will affect it, could well make the difference between holding a sinker or a multi-bagger in one's portfolio.

Hotung - No longer as hot.

2006-02-09T13:20:00.001+08:00

What a coincidence in timing! When this blog highlighted the run up in Hotung yesterday, Third Avenue Management disclosed to the Singapore Exchange on the same evening that it was winding down its position in its counter. Third Avenue now holds 7.51%, down from 8.02%. Was yesterday's sell down by Third Avenue a prelude to further reductions?

Our original posting in Nov 05 asked whether "Will HIH prove to be another gem in the bag for Amit?" The current gross return appears to suggest so!

Hotung on the roll

2006-02-07T18:31:00.000+08:00

This blog first mentioned how attractively priced Hotung Investments was on Nov 05, 2005 in a post titled "Bargain Technology VC" [Link to post]

Then, the Taiwanese company was trading at US$0.09. In recent weeks, market sentiment towards the counter has improved significantly. It closed at US$0.14 today. This represents approximately a 55% gain over a space of 3 months!

As noted in the earlier post, Third Avenue holds a substantial stake in HIH and this must also represent a fruitful position for them too!

The Value of Technical Analysis

2006-01-23T18:04:00.000+08:00

Warren Buffett recently remarked that he does not wish to know the price of the stock prior to his analysis. He would rather do the work and estimate a value for the stock and then compare that to the current offering price. In particular, he opined that knowing the price in advance may influence his analysis. In short, Buffett values the company first before checking against its price to ascertain whether to buy into the company. What about technical analysis? It is using price as a starting point to determine if it is attractive to buy into the company. Hence, technical analysis turns Buffett's consideration on whether to purchase on its head.

Furthermore, does valuation of the company come into the picture of a chartist? Apparently not if you are looking purely at indicators such as moving averages, Japanese candlesticks, momentum etc to make your assessment. By extension, the next question to ask oneself is whether valuations matter?

Graham once famously remarked that the stock market is, if I may paraphrase, a weighting machine in the long run while it is a voting machine in the short run. His profound statement succinctly suggests that the true valuation of a company will shine through only in the longer time frame. It recognizes that the short term fluctuations are dependent on the whims and fancies of the herd who may base their decision on chart patterns or other such indicators. My sense about the value of technical analysis is that it should be looked at as a tool in the broader context of behavioral finance to understand prices in the short term if one wishes to ride its ups and downs.

Technical analysis relies on many assumptions which one may easily poke holes at. For one, it relies on the historical data to predict the future. It requires past prices to be a prologue to the future. In essence, it is driving forward while looking in the rearview mirror. Do you have a stomach for it?

China makes Soros' mouth water

2006-01-14T22:34:00.000+08:00

Soros addressed another packed audience comprising of academics and tertiary students at the Raffles City convention hall on 11 Jan 06. However, his talk was largely focused on his current pet cause of championing for an open society.

Even though Soros kicked off his 20 minute speech by saying that he was thankful for the publicity generated when certain governments attributed the Asian financial crises to him, the speech and the follow up discussion was largely a philosophical one and hence, is of no relevance to this blog. Instead, this blog whips up a mix of the nuggets of financial information he offered during this and Monday's talk.

Soros says today's opportunities in China is, literally, mouth-watering. The current situation reminds him of the under-developed financial markets which he used to do very well in. Generally speaking, he thinks that the current share prices do not reflect values of the Chinese companies. This difference arises because of the issue of corporate governance where the interest of management and shareholders may not be aligned. His point echos that of Charlie Munger who once remarked that the agency problem is an important question which investors in Chinese companies should ask, but often forget to do so.

To which, Soros continued that he is beginning to observe increased alignment of interests. When this agency problem is corrected, he expects big opportunities to present.

Soros considers the intervention of governments necessary because the authorities can prevent financial markets from swinging to extremes. In fact, he thought that the then Hong Kong treasury secretary was correct to use the reserves to shore up falling equity prices during the Asian financial crises and turn in profits subsequently.

When queried if markets were efficient, Soros opined that he was of the view that only 50% of the market is efficient while the other half is not. The answer should not come as a surprise for it is the existence of in-efficiency which allowed him to make his fortune and retire from active fund management at the age of 50.

The Alchemy of a Global Slowdown

2006-01-10T10:03:00.000+08:00

Soros: US recession in 2007

Billionaire investor and philanthropist George Soros has warned about a possible global slowdown in 2007 brought about by a recession in the US economy. Soros is in Singapore and his remarks were made at a talk organized by the Singapore Institute of International Affairs to a sold out audience at the auditorium of the Singapore Exchange during lunch. Soros served up plenty of food for thought by suggesting that the US economy could face a hard landing caused primarily by the bursting of the property bubble.

When the US economy slows down and interest rate hikes stop, the US dollar is likely to depreciate. In a bid to fend off inflationary pressures, he expects the US Fed funds rate to hit 4.75% before the central bank eases off. Soros suggests that the Fed is likely to overdo their rate hikes as they will not stop until the economy shows obvious signs of slowdown, during which it would be too late.

He does not believe that demand from Asia or a recovering Japan could counteract the slowdown caused by the US economy. This is because consumer spending in America has been greater than Asians who are traditionally savers. In response, Asian governments could reduce their export dependency by stimulating domestic demand. Red hot oil prices are also not expected quell soon as demand from a rising China will continue unabated while additional supply may only come on stream in a year or two.

The ominous warning by the chairman of Soros Fund Management came on a day when the DJIA breached the psychological 11,000 barrier for the first time in over four years and as the local press carried a headline offering bullish analyst forecasts for the Straits Times Index.

On Wednesday, Soros is scheduled to speak at another event organized by the Institute of South East Asian Studies. Exclusive notes of his dialogue will be made available.

The Big Picture - Yielding to a Recession

2005-12-29T20:18:00.000+08:00

The value investing technique is essentially a bottom-up method which focuses first on the fundamentals of a business. So, does the noises coming out of America about the inversion of the US bond yield curve fore-warning an impending recession to their economy matter?

Lowdown on the Yield Curve
First, the lowdown on the inverted yield curve. The inversion occurred post Christmas. The yield on the 10 year US Treasuries has remained in the range of 4.4% - 4.6% for much of December, reflecting the strong demand largely from Asian central banks for the long bond. It was, however, a different story for the 2 year note. Its yield has trended up on the expectation that the US Federal Reserve will raise the benchmark fed funds rate at least once (if not twice) to 4.75% by early 2006.

On Tuesday trading session, the yield on the 10 year Treasuries did indeed fall under that of 2 year notes, reflecting the market expectation of slower economic prospects in the months ahead. But some normalcy resumed when the 10 year yield inched higher to 4.36%, one basis point above the 2 yield subsequently.

Why the nervousness?
All of the six recessions which US experienced in the period of 1965 - 2005 were preceded by an inversion of the yield curve. But before you ring the alarm bell after reading the foregoing statement, let it be clear that there were two other instances of inversion, in mid 1966 and mid 1998, after which no recession ensued. A closer look at the extent of inversion was performed at the risk of data mining. The negative interest rate spread for this two time periods in question was noted to be minimal; only about 30 basis points.

This is in sharp contrast to the wider spreads seen in the other dips; particularly those which transpired prior to 1989. The earlier four recessions (of 1970, 1973, 1979, 1982) in the period under study were all foreshadowed by spreads of at least 100 basis points for at least a year. As for the two more recent recessions (1990 and 2001), the spread was narrower - only about 50 basis points but still wider than the two inversions which occurred in 1966 and 1998 when no recessions happened subsequently. Hence, the above observations from the historical data suggest that the yield curve has to invert by more than about 50 basis points before a recession materializes. Another noteworthy point is that the negative spreads which fore-warned the six recessions took place over a longer time period than the two dips in 1966 and 1998. As the extent of the recent inversion is relatively minimal, the jury is still out on whether it truly signals an impending recession.

With interest rates having a direct effect on the housing demand in US, the US Fed would do well to take a leaf out of the Bank of Japan's books. After spending nearly a decade in recession, Japan appears only to be coming out of the quagmire today. One of the causes of Japan's long recession was the collapse of the real estate market. To cool their housing bubble (and stock market) then, the Japanese benchmark rate was raised swiftly from 2.5% to 6% within a space of 15 months. The result was a sharp slow down in the demand in both markets leading to a hard landing for the entire economy. Hence, the US Fed will probably look to keep the rate hikes, if any, measured to gradually take the wind out of the housing bubble.

Value in a Recession
A market downturn will be a true test of an investor's financial and mental mettle. As Warren Buffett once famously remarked, "you don't know who is swimming naked till the tide goes out." Shares buoyed by strong growth expectations will come crashing back to earth when they are not underpinned by earnings growth as the economy slows. On the other hand, stocks correctly selected using the value investing technique, distinguished by its emphasis on margin of safety, should offer considerable downside protection.

A depressed market often offers an opportunity to a shrewd value investor to deploy any idle capital. In fact, sound businesses may be going for a song, ideal for picking by the value investor.

Should the macro picture gets more grim with other indicators such as falling consumption numbers, rocketing inflation (oil included) figures, defensive measures may be taken for the portfolio if one is of the view that a recession in the US is imminent. This may be achieved by placing a macro overlay over your stock selection - choose sound businesses that are less reliant on the state of the US economy. This may also entail diversifying out of a US only portfolio, leaving only core holdings, into international stocks to position one's portfolio for the headwinds. Accordingly, good businesses which will benefit from a resurgent China and, to a less extent, India or Asia, should merit a second look.

The future is always before us but it is never certain or clear. But, as before, we tread bravely on.

WBL climbs in recent weeks

2005-12-09T13:44:00.000+08:00

A counter listed on the Singapore Exchange held by Third Avenue has rocked up in recent weeks.

This blog last mentioned Third Avenue's substantial holding of WBL on 10 Oct (S$3.52). [Link to post]

This revelation follows our first post in 13 Sept 05 where we pointed out the severe undervaluation of WBL (at S$3.40). [Link to post]

WBL closed at S$4.38 yesterday. This represents approximately a 30% gain in a space of few months since the exchange reported Third Avenue's substantial shareholding.

Warren Buffett's Wealth

2005-11-13T16:38:00.000+08:00

Notes from Robert P. Miles presentation in October to an audience at the National University of Singapore

"Warren Buffett's Wealth: Principles and Practical Methods used by the World's Greatest Investor"

Robert Miles is a critically acclaimed author of three books on Warren Buffett. He has also spoken extensively on the billionaire to international audiences. Miles is currently working on his next book. It will yet again be on the man who transformed US$100 to US$100 billion. The book will be titled "E = mc2". The title is a play on what Miles believes are key tenets of Buffett's investments: (i) E is earnings (ii) m is management (iii) c is character raised to the power of 2 to signify its weightage.

He started by speaking about the importance of character - one's inner moral compass and reputation - it takes years to build a reputation but minutes to ruin it. These are attributes which he believes Buffett will cover when he talks to a young audience.

Miles says Buffett thinks of a share to represent an ownership of business. One must also make "Mr Market" your servant, not your master. He adds that intrinsic value of a business is the present value of future earnings discounted back to today.

He also reiterated two important aspects which Buffett says that a student of investment must know: (i) How to value a business; (ii) How to think about market prices.

Unlike conventional finance theory which defines the measure of risk as volatility of prices, Miles offered that risk is not knowing what one is doing. He stressed that it is pertinent to know what you own and ignore the madness of crowds.

Criteria supposedly important to Buffett:

Earnings;
ROE;
No debt;
Management;
Simple.

It was noted that Buffett's holding period is forever.

Miles also touched on the five investment principles of Lou Simpson. Lou is the chief investment officer at GEICO and is reportedly the heir apparent to the Berkshire's investment portfolio after Buffett. As disclosed in Berkshire's annual report, Lou's current track record tops even that of Buffett.
Principles of Lou Simpson:

Think independently;
Buy high return business run for the benefit of shareholders;
Pay a reasonable price even for an outstanding business;
Invest long term; and
Do not diversify excessively.

Bargain technology VC

2005-11-06T14:38:00.000+08:00

Hotung Investment [HIH SP, 1 Nov: US$0.09, listed on Singapore Exchange (SGX)]

HIH SP is a Taiwanese company involved in the business of venture capital investments, securites and fund management. The venture capital business is a high risk - high return model. The management of HIH had a very credible track record in the 1990s but its recent record has been patchy. With a market capitalisation of US$114 mil, it is a penny stock by any standards.

Even though HIH reported rather dismal results in 2Q05 in August [Losses in 1Q05: NT$163 mil and 2Q05: NT$333 mil.], it may be poised to make a number of divestments in the upcoming months. Some of the companies in its venture capital portfolio which it could divest include: (a) Nanya - a IC substrate supplier for Intel's central processing unit, (b) Genius Optical - one of the largest maker of lens for cameras fitted in mobile phones, (c) Himax - Taiwan's largest driver integrated circuit company. We expect value of HIH to be unlocked when a profitable divestment is made by listing one of these technology companies. This may take place when sentiment towards technology stocks in Taiwan improves.

According to filings with the exchange, US deep value house, Third Avenue Management LLC holds a substantial stake in HIH. The stake is likely to be purchased by Amit Wadhwaney who pulls the strings for Third Avenue's International Value Fund. Once dubbed by the media to be "one that shuns the crowds", Amit appeared to have quietly built up its stake in HIH from half a globe away. As an acolyte of value guru Martin Whitman, Amit's fund has racked up about 26% return in the 12 months ending April 2005. Since the fund's birth about 3.5 years ago, its annualised returns is a most encouraging 22.5%. Will HIH prove to be another gem in the bag for Amit?

Attractiveness: The P/BV ratio is 0.5x => NTA per share is US$0.18. HIH also has US$0.038 in cash.

Substantial shareholding reporting of Third Avenue to SGX
17 Aug: 5.53% to 6.12%
26 Aug: 6.12% to 6.44%
29 Sep: 6.44% to 6.81%
06 Oct: 6.81% to 7.06%
31 Oct: 7.06% to 7.98%

The Passing of a Superinvestor of Graham and Doddsville: Mr. William Ruane

2005-10-16T08:25:00.000+08:00

The founder of the Sequoia Fund, Mr William Ruane, passed away at the age of 79 on Oct 4. Even though Mr Ruane had a degree in electrical engineering, his life path changed after he attended Benjamin Graham's class at Columbia in 1950. He had attended Graham's class alongside Warren Buffett. When Buffett wound up the Buffett Parnership in 1969, he requested Mr Ruane to set up a fund to handle Buffett's partners. It is a testimony to Mr Ruane's ability as he was the only person Buffett recommended to his partners.

An investor who invested S$10,000 with Mr Ruane at his fund's inception in 1970 would be S$1.1 million richer today (dividends reinvested). As extracted from Buffett's speech, The Superinvestors of Graham and Doddsville, the annual gross investment return of the Sequoia Fund of 18.2% out-strips the 10.0% return of the S&P 500 index [for the period of 1970 - 1984].

At the 2005 Sequoia Fund shareholders' meeting, Mr Ruane reportedly offered two rules of investment, borrowed from his old friend Buffett: "Rule No. 1: Don't lose money. Rule No. 2: Don't forget Rule No. 1."

The value investing community mourns the passing of a great iconic figure.

See the official announcement at:
http://www.sequoiafund.com/

Update on WBL

2005-10-10T23:44:00.000+08:00

This blog last featured conglomerate WBL on 13 Sept 05 (at S$3.40) in a posting entitled "Sometimes they don't add up, do they?". In a filing with the exchange today, it was revealed that Third Avenue Management LLC is a substantial shareholder in WBL. According to the announcement, Third Avenue currently holds 5.06% of WBL on behalf of several portfolios. WBL closed today at S$3.52.

Is a bird in the hand worth two in the bush?

2005-10-06T22:50:00.000+08:00

Yield plays have been an investment theme for several months. In particular, hot money have chased up the price of high yielding counters like M1, Yellow Pages as investors focus on the importance of income. Some initial public offerings such as Courage Marine have also outlined a clear dividend payout policy in hope of enticing demand. In a market with no clear direction, the appeal of dividends lies in the reasonable certainty of an income stream over capital appreciation. Indeed, the proverbial bird in the hand appears to be worth more than two in the bush. Or is it not?

On my part, I am uncertain about the allure of dividends. While the dividend yield of stocks is higher than interest rates of deposit accounts or even the local ten year government gilt yield, one must be mindful of possible capital loss if the risk premium demand of stocks increase. In this vein, this column had earlier warned about foolishly rushing into REIT plays in a rising interest rate environment. Indeed, what good is there to receive a 5% yield if one suffers a much larger capital loss?

Dividends are very useful as they allow the analyst to perform a very quick valuation of the company using the dividend discount model. This allows the analyst to ascertain if the counter is over or undervalued. But the dividend discount model turns on the premise that the company is able to sustain its dividend payouts in future. In this regard, it would be worthwhile to check the steadiness in the firm's cash flow generation ability. A patchy record suggests that the dividend payment may not be sustainable. Another important metric is the dividend payout ratio. A high dividend payout ratio suggests that the firm is paying out nearly all its earnings without much retained as reserves. Wouldn't it be worrying when the time comes for the firm to make capital expenditures to replace old fittings or equipment? Would it then be able to upkeep its generous dividends payouts?

Another pertinent point to note is the tradeoff between dividends and retained earnings. With higher dividend payouts, less monies is retained by the company. The return on equity (ROE) is key for deciding whether it is appropriate of the company to retain the earnings. If its ROE is in excess of 20%, it means that the company is able to reinvest the retained earnings at a return of 20% had it not distributed it to shareholders. Should the shareholder be unable to reinvest the dividends at a rate of 20%, it suggests that the shareholder is better off with the firm retaining its earnings and "reinvesting" them on shareholders' behalf because it is able to uncover more compelling opportunities. Of course, we assume that the business acumen of the management has not deserted them as the earnings are plowed back into its profitable business or equally profitable ventures. Eventually in the longer run, this should lead to capital gains.

So the bottom-line for the investor would be an assessment to find out if he or she is better off with a dividend payout to enjoy returns today or "leaving" it with a high ROE company in order to savor returns in the long run.

The Dean of Wall Street

2005-09-25T13:27:00.000+08:00

Warren Buffett once remarked that he is a synthesis of "85% Graham and 15% Fisher". Fisher refers to Philip Fisher, the Californian money manager who advocated the importance of doing groundwork and speaking to people on the turf. He coined the term "scuttle-butt" to refer to his technique of relentless recee in his attempt to uncover investment gems.

Who is Graham then? Benjamin Graham is still fondly referred to and revered as the Dean of Wall Street. In the 1930s, he provided the investment community with the framework for security analysis when speculators were abound. Graham lectured Buffett at the University of Columbia and mentored Buffett in his early stages of his career when Buffett worked at his Graham-Newman investment partnership.

What is most interesting to me is that Buffett's superior return today was not the result of applying Graham's valuation techniques. Graham championed the "net-net" technique which calls for purchasing a company when its current assets exceed its total liabilities. Later in his career or life as both are intertwined for investing is a lifetime obsession, Graham also examined the merits of low P/E investing. However, a peek into the financials of Buffett's purchases over the years reveal otherwise. He is not into low P/E investing nor the "net-net" approach. This begets the question – where is Graham’s influence over Buffett?

The difference between investing and speculation
Graham made it clear that investing and speculation are different. He remarked that "almost by mathematical law, more speculators must lose than can profit." Speculators are playing the greater fool game - buying and selling the stock off to the greater fool - before the music stops. And history - whether it was the 1970s with the Nifty Fifties or 2000 with the dotcoms - has shown that the music will always stop. On the other hand, investing requires a through analysis of the company underlying the stock, understanding its strengths and weakness and its competitive environment.

The importance of the Independent Thought Process
While the investor must be respectful of the current market price or direction, Graham stressed that one must develop and retain his own independent thought and evaluation process. This means that the investor, through his own through research, should be able to form his own opinion on the attractiveness of the company and industry regardless of market sentiment. In the herd, one may feel the warmth but in investing, it is important to discern if the direction which the herd is headed is correct. The investor does not need affirmation from the crowd as to whether he is correct. In fact, it is usually costly if there is affirmation from the crowd. The investor is correct only because he has his facts and analysis right.

Mastering Market Psychology
"Mr Market" was a term coined by Graham to refer to the manic depressant which turned up every day (except on weekends) to provide a price quotation for a fractional share of the company ownership. Depending on his exuberance, "Mr Market" can offer sky high or depressed prices for a share. "Mr Market" is so ubiquitous today. He silently runs his quotes at the bottom of your television screen, provides updates on your favourite webpages and can even push prices to your handphones/pagers, almost begging you to transact with him.

Despite his pervasiveness, the choice to buy or not from "Mr Market" remains in the investor's hands. And the decision to buy comes only when the price quoted is more attractive relative to the investor's valuation of the company. This entails divorcing the market price from the true worth of the company. And true worth is established after the investor has completed his due diligence of the company and has done an appraisal of its prospects and established his valuation.

The Margin of Safety
The "margin of safety" is said to be the three most invaluable words in Graham's investment thesis. It means that the investor should only buy securities when the price quoted is substantially lower than what the investor thinks it is worth. The key lies in the word “substantial”. This concept is not unique to the field of investment. For example, in engineering, the electrical engineer would design a circuit that have the ability to carry, say 10 amperes of current, when it is envisaged that only a current of 5 amperes will flow through it. It would be foolhardy for the engineer to provide only for 5 amperes of current.

Hence, by insisting on a margin of safety, the investor provides himself with a cushion should his assumptions turn out to be overly optimistic or should unforeseen circumstances occur. This is especially essential because in investment, unlike engineering where the last decimal place may be pinned down, a lot of factors are qualitative projections and subjective assessments of the company, its industry and its management. This highlights the significance of performing a scenario analysis before a security purchase.

It is evident that the richness of Graham's works extends beyond his mathematical equations but to such intangibles which shaped the mindset of Buffett. I have not done justice to Graham's teachings and ideas by distilling them into this short note. Only direct reading of his pieces is adequate.

I was introduced to Graham at Borders bookstore when Regina informed me that Graham was the one who had largely shaped Buffett. I have offered myself to be shaped too as Graham's approach to investing is so compelling it provides a compass to navigate one through the vicissitudes that characterize irrational markets.

"I need to buy a REIT!"

2005-09-25T13:08:00.000+08:00

I had spent half an hour explaining the structure of a REIT and its source of income before learning that so-and-so did not actually have a securities custodian account. This meant that this particular individual could not apply for the latest REIT initial public offer. And I ran into another who said that he simply needed to go out there and buy a REIT because he was unsuccessful with the initial public offering. To me, if you hear about an investment (class) being talked about in lifts and covered till death in the local press, it means that we could well have a bubble waiting to be burst!

When REITs hit our shores about three years ago, not many gave them a second look. In fact, the first offer failed and the offeror had to go back to the drawing board. It restructured and came out offering a hefty 7 or 8% yield in a low interest rate environment. The capital gains of the early REITs which ensued was the result of yield compression as investors piled into them and grabbed them like hotcakes in recent years.

Today, the REITs trade at between yields of 4.2 - 5.3%. Investors are still enamored by them for they offer the prospect of relatively higher yields and a hope that they will repeat the stellar capital gains. I found it alarming that today's papers described such yields as attractive compared to fixed deposits rates offered by banks. Well, yes if you compare yields alone and forget about your capital. If one parks his hard earned dollars in a fixed deposit account, the returns may not be compelling but he enjoys the safety of capital return (assuming no default risk by bank). With REITs, I am not sure if capital return is assured in the current or projected environment. Interest rates clearly on the up-swing with the US Fed continuing to chalk up steady increases despite Hurricane Katrina's devastation. When interest rates inch up, yields of REITs are likely to need to increase. This would then translate to capital losses for the investor!

The foregoing is clearly my current humble view towards this asset class and you may differ. If you still need to invest in one, purchasing a REIT with a clear acquisition strategy helps. As the acquisitions tend to be yield accretive, it provides a defense for yield de-compression. However, bear in mind that the manager's task is made harder when the portfolio of properties increase.

The REIT play

2005-09-20T19:05:00.000+08:00

Initial public offers of REITs are snapped up like the proverbial hot cakes when they are offered. It's near to impossible to get one's hands on them these days. But are there other ways of benefiting from the REITs rush?

(1) Vendors
By divesting the property to the REIT, the vendor receives cash which it may invest in other more profitable projects or to pay down its debt. A good example of a property developer disposing some of its assets and on-investing them in Chinese projects is Capitaland. Other SGX listed companies have also sold properties to REIT. Freight Links have sold several warehouses. Armstrong, Osim and TT International also come to mind. But will the proceeds be used wisely?

(2) Would be vendors
Market talk is that other companies with property portfolios on their books may be interested to also hive off their assets into REITs. With an ex-CEO of a REIT on board, the moves of F&N cannot be more overt. Or what about Cheung Kong who may potentially spin off more assets on its books into REITs?

(3) "Spill over" effect
When Prime REIT goes to the market, it will provide a benchmark to revalue other assets along Orchard Road. Bonvests which holds Yishun Ten and Liat Towers, of which the latter is a stone's throw from Wisma Atria, saw trading activity pick up. It's still trading about 50% under NTA. Paragon is held by SPH but the valuation of SPH may have fully factored in the possible sale of the properties. Or look across the road from Wisma to see CK Tang?

What's illustrated in this short post today is that there are other means of benefiting from this "REIT rush". Of course, never forget to do one's due diligence.

Sometimes they don't add up, do they?

2005-09-13T14:04:00.000+08:00

WBL (13 Sept 05) S$3.40.

WBL is a conglomerate listed on SGX. It is closely held by the OCBC Group of companies - GE Holdings (20.7%), Straits Trading Co (11.0%) and OCBC Bank (6.1%). Recently, it was in the news in its failed bid to privatize Wearnes International. Other than Wearnes, it holds large stakes in two other technology companies, namely, Multi Fineline, a Nasdaq listed company and MFS Technology. The latter is listed on SGX.

We attempt to do a simple sum of the parts valuation to ascertain if WBL is trading at a fair price today.

(A) Stakes in companies which are listed
Entity -- WBL's stake -- Mkt Price -- Mkt Cap -- Value
Wearnes -- 85% -- S$1.27 -- S$250 mil -- S$212 mil
Multi F -- 57% -- S$43.00 -- S$1032 mil -- S$588 mil
MFS Tech -- 56% -- S$0.55 -- S$355 mil -- S$199 mil
TOTAL: S$999 mil

(B) Stakes in companies which are unlisted
WBL holds stakes in several other technology and biotechnology companies. It also holds investment properties. As it is difficult to value unlisted entities and properties without performing a revaluation, we shall conveniently assign zero value to WBL's portfolio of unlisted entities.

Shares outstanding: 172 mil.
Therefore, value per share = S$5.80.

At today's price of S$3.40, this represents approximately 40% discount to its value. When will the value be unlocked? It's anyone's guess.