Tuesday, May 29, 2007

A Look at the Glasses Companies

A while ago I found the glass companies all quite promising as the over capacity problem seemed to be nearing an end. But the prices jumped too quickly, as it had always had ahead of the relevant facts, so only the brave or informed were rewarded, handsomely, excluding me.

I then found some consolation in the glasses companies, which I think are still very reasonably priced in spite of their recent rises and should provide another opportunity to ride on the turnaround story. They are Arts Optical (1120), Sun Hing (125), and Elegance (907).

A few myth to rebut.

(1) Glasses, like shoes, have evolved from a necessity item into a fashion item. Take a look in a shop and you'd tempted to buy a pair yourself even you don't need one. Count the brands, Gucci, Prada, BV, D&G, Valentino, then count all the different style, shape, and colors and it's like you're in a mini department store. It's not unusual people nowadays have multiple pairs to match their clothes. What this brings is ample replacement demand, season in season out.

(2) RMB appreciating by 5%-7% a year is a lot but only against USD that is. If you look at how much more the Pound, Euro, and every other major currencies (except for the sorry yen) has appreciated against the USD, then you'd realize RMB has actually depreciated during this time. This made the China export very attractively priced (since it's priced in USD) and it's no coincidence that all three glasses companies had 2/3 of turnover from Europe. This also means more outsourcing opportunities though the major brands won't admit directly their glasses are made in China.

(3) Increasing production cost - this is really no concern if you look at the margin of the glasses makers, averaging over 10% in net margin. Remember glasses are now a fashion item and so follows the cardinal rule 'the more expensive the better'. A small rise in retail prices will more than take care of the costs. And I don't see the glasses makers being squeezed when its customers, i.e. importers and retailers, are having a good time.

I have slight preference for Arts Optical as it's the biggest and with the most active trading, but if you're buying for a longer term and in smaller quantities then either Sun Hing or Elegance is equally good. I remember Sun Hing outperformed quite a bit in the last up cycle while Elegance is now backed up a major European glassmaker and is a little cheaper too. Only Elegance has negligible debt while the other two have nil.

DISCLOSURE: I hold 1120 at time of writing. I don't hold 125 or 907 at time of writing.

Tuesday, May 22, 2007

Dongfang Electric (1072): a Faithful Buy

This was a company I came to know in late 2005 when Vincent and his team recommended it on Quam, largely because of the cheap valuation (maybe 5x prospective p/e) and the huge order book on hand. I wasn't such a macro guy and couldn't see very far ahead, figuring the good prospect couldn't sustain, so I made a pass on it. And what a miss it turned out. Now I'm looking at it again 18 months later at over $37, and it was less than $10 back then!

Fellow bloggers especially Wing hing have covered DE pretty extensively and you can check out the links to the right for their work. I'll only supplement my thoughts after reading the annual reports and the latest acquisition circular.

Good points
(1) DE has a good clientele serving the power companies. Foremost there's no need to worry about not getting paid. And 2nd in case you're not aware the power industry is constantly under complain for paying out too high a salary to its supposedly civil servants. What's that to do with DE? Well I think you all know it's a lot easier doing business with the rich than the average. How easy? So easy that DE doesn't need working capital.
(2) All 3 DE units have negligible debt. Over the last 3 years, all its working capital requirement was supported by customers and suppliers. If you add up the figures you'll find DE units have what Warren Buffet calls 'float', unbelievable for a construction type company. On the balance sheet the items 'receipt in advance' and 'amount due to customers for contracts' even exceeded the total of a/r and inventory. The trend looked like that DE received huge deposits from customers in 2004 (which maybe the beginning of an order), so much that it had to place it in fixed deposits, for its cash need throughout the order up to 2006.
(3) Why's that? My guess is DE really dictated the terms with the power companies back then. This may be due to its market position and superior engineering capability. Speaking of which, it also means that unlike the heavy industry, DE has relatively little capital requirement. There's no much to reinvest and since working capital is taken care of too, DE is always stuffed with cash.
(4) With the continual growth in power industry, where older equipment is being replaced, and in alternative energies like hydro, wind, and nuclear. The future looks very bright for DE.

Bad points
(5) Are the power companies as generous with new orders? For orders placed in 2004, or even earlier in 2003, the power companies were having a field day (902 and 991 were over $8 and $7 respectively). There was no coal price hike, no restricted tariff increase, and no utilization hour to worry about. Now is a very different climate and the 'float' may go away.
(6) Contrary to popular belief, hydro projects (62% less vs coal-fired) and higher MW coal-fired projects (33% less gross margin YOY vs 2005 for DE boiler) carry substantially lower margin than older less efficient coal-fired projects. Management only cited price competition and did not explain in details. The reason could be there's more foreign competition in these advanced projects, as domestic competition is unlikely. Or (5) could be the reason. But the fact does suggest newer projects have lower margin.
(7) Steel price also was a concern highlighted by the management though it wasn't a contributing factor in the 2006 results. But my speculation is special steel price will more likely rise than fall.
(8) Expect overall margin to decrease over time. In fact management has predicted only increased earnings for the turbine business, flat earnings for DE itself, and decreased earnings for boiler business. As we're nearly midway into 2007 these projections do carry weight. Plus there's no incentive for them to downplay the prospect when seeking approval for a major merger.

For reference the profit forecast is $2.91 a share, or $2.62 to adjust for increased profit tax under reform. I like the business and especially the 'float', but at current price ($36.1) and with a downtrend in margin, it requires faith to think it'll continue to deliver extraordinary return on assets (and to the stock price too). It's a reasonable investment but not spectacular opportunity.

I have more confidence in performance of special steel companies which supply to DE and other equipment manufacturers. Any idea?

DISCLOSURE: I don't hold 1072 at time of writing.

Friday, May 11, 2007

Belle (1880) & the 3-star Chef who'd make Cooking Mama Proud

Warning: This post is based on a causal and incomplete read of the prospectus without any elaborate work done on the company nor its industry, which I think won't be necessary anyway.

Belle the dragon head retail play is creating sensation in the market. It's gonna become the biggest among all China retail and consumer product plays, surpassing even Mengniu and Li Ning. It's so profitable and the business is so good that Chairman Tang has claimed that every new store can be profit making one month after opening, even there's over 3,800 stores already. Other retailers have much to learn from Belle.

Track record was nothing short of breathtaking. Revenue for the last 3 years was $870m, $1,732m, $6,239m, and profits were $75m, $235m, $977m. I don't know about you but I couldn't stop but wondered what happened in 2006 that magically transpired Belle into a mighty dragon. It turned out the credit should go to the 3-star chef Chairman Tang and the professional cooking crew from Morgan Stanley.

Let's take a look at the main ingredients and steps:

(1) Belle started out as a small shoe maker in SZ in 1991 with its own brands and retail shops in HK. In China, it engaged a group of distributors, who were mostly Chef Tang's relatives and friends, to sell its shoes. Shops in China grew to over 600 in 2002. There's no mentioning of the profitability of either Belle nor the distributors during this time.

(2) When China opened up the retail market to foreigners in 2004, Belle wanted to a piece of it and by some unknown mechanism ousted all distributors and took up all their existing shops and personnel in 2005, at no compensation. Or more specifically, an unknown HK individual showed up and bought out all the distributors, then handed everything over to Belle. That's all there is about this episode in the prospectus.

(3) Profits of Belle were respectable up to that point, earning $75m as a pure manufacturer in 2004, and tripling that amount to $235m after assuming the retail operation from sept 2005. Annualized earning from the retail side in 2005 may be $480m. Again, how Belle managed to take back this much earning from the distributors without paying is unknown.

(4) Then came the Morgan Stanley cooking team. Between sept 2005 and june 2006, MS private equity fund and another fund bought Belle shares in three occasions for a total of $544m. And you should probably know the average cost per share is only $1.50, 76% discount to the top IPO price of $6.20. But the curious thing is that only $24m was for new shares while $520m was for old shares bought mostly from Chef Tang. Maybe he really needed the money to take care of things.

(5) Chef Tang wasn't taking all money away, yet. Also in sept 2005, he and a group of others (funny enough some ex-distributors' names showed up here) subscribed for new Belle shares for $448m. With this money, Belle started its massive expansion and doubled its size to over 3,800 stores in a little more than one year (including acquiring sportswear stores below).

(6) Chef Tang had another secret ingredient, sportswear retail, which was part of the original distributors' business but wasn't taken up by Belle as it had wanted to focus on shoe retail only. This was back in the end of 2005 and Chef Tang took over the sportswear retail (maybe some 500 shops and staff), in similar unexplained fashion, from the distributors at no cost. Only a few months later, Belle decided it was now time to expand beyond shoe retail, and it acquired Chef Tang's sportswear retail operation. The purchase was done in june 2006 via issue of new Belle shares and the price was $831m!

By now, if you are a normal person like me, you should feel dizzy enough about all these oddball transactions which had nothing to do with shoes nor sportswear. So I did some simple math for everyone.

(1) Belle received $472m from Chef Tang and the funds and paid out $588m in dividends.

(2) Chef Tang and others put in $448m, got back $520m from selling shares to the funds, $416m in dividends, and $492m from selling shares in IPO, netting $980m profit. And Chef Tang and others still hold $30.5b worth of shares after IPO.

(3) The funds put in $544m, got back $68m in dividends and $964m from selling shares in IPO, netting $488m profit. And they still hold $4.1b worth of shares after IPO.

(4) You and I will need to put in $6.2 a share + 1.25% brokerage + 6% margin interest. We'll probably get back less than 5% allotment and make a profit when our shares rise for more than 10%.

There you have it, the recipe to grow a shoe maker from $300m to over $50b, 166x in 2 & 1/2 years!

Finally, a dummy profit forecast. Belle earned $1b last year on $2.6b of net assets. Now with $7b raised from the IPO, earnings should skyrocket to more than $3b for a full year! And market capitalization may even reach $100b 2008!

DISCLOSURE: I wish I had 1880 at $1.5 but I don't hold any at time of writing.

Thursday, May 10, 2007

There's NO Insider Trading in HK!

Everyone knows it's a damn lie! But this is the message behind the HKEX's response when asked about the Dow Jones incident, yet another typical head-in-the-sand approach to problems, or is there a head at all?

(This post is not about and won't comment the individuals involved in the U.S. SEC investigations, who are only being accused at the moment.)

Maybe the HKEX finds this a good PR opportunity to promote HK as an even-better-than-the-real-thing financial centre, just the way Donald likes it. "Hey, it's a cleaner market here! We won't allow that kind of things." But they seem to forget the persons under investigations are also active in the HK market.

The incident also comes timely as the HKEX has been taking a beating from the the Shanghai market for pretty much all this year.

Let me repeat what the masterminds in the HKEX have come up in response:

"There's enough laws and regulations in Hong Kong to deter insider trading from happening here." Well, I'm sure the U.S. regulations are really deficient in this regard even with truckload of lawyers over there.

"HK has a stellar record in prosecuting against insider trading." Yeah, there's been no new prosecutions since 2003 when it was made a criminal offense under the SFO. How can you have a bad record when there's no record? Or just like the HKEX suggests either it's a cleaner market here or the laws are really perfect.

Peter Lynch says 'invest in companies with a franchise so strong that even dummies can run it'. HKEX is a case in mind.

DISCLOSURE: I don't hold 388 at time of writing.

Wednesday, May 09, 2007

Something Else

Coke Zero

Many of my friends love this new invention for it gives the real coke taste but none the guilt of sugar, natural or substitute. I'm not much of a coke lover and in fact found the coke light taste satisfying enough. But I'm really curious about this substance that can taste like sugar but is not sugar or substitute sugar? What's really inside that drink?

It's kind of creepy when you think more about it, isn't it? It's like ordering a medium done hamburger in a restaurant and the waiter goes, "Don't worry! It's not beef but it ain't vegetarian either, but cholesterol free nonetheless!"









Ask Doctor Eason

Over a month ago there's this really outrageous scandal* about GlaxoSmithKline (GSK) being fined for misleading ads about the vitamin C content of its Ribena. Yes, the same one brought to you here by 'Dr. Eason'. What he didn't bring to you is that there's actually ZERO vitamin C in Ribena ready-to-drink form and only a trace more than zero in concentrate form. What's scandalous is that two teenage girls already reported their lab findings back in 2004 but GSK chose to do nothing until when it's found guilty as charged. And I guess GSK probably has known this for ages.

What's more puzzling is that the same misleading ad is still shown daily here in HK? Of course it's 100% factually correct to quote 'grapes has 4x the vitamin C than oranges', but the untold fact is you shouldn't count on Ribena for your vitamin needs.

I guess the GSK PR people, in typical denial fashion, can argue the ad isn't misrepresenting, just like no one would believe "Dr. Eason" is really a doctor even he dresses like one in the ad. It's just an ad, lighten up people! Hong Kong is a business friendly town.

* see http://www.google.com/search?hl=en&client=safari&rls=en&sa=X&oi=spell&resnum=0&ct=result&cd=1&q=new+zealand+vitamin+c+scandal&spell=1 for full story


Hong Kong Style

Finally, a good book to share. With the debacle of the Queen's Pier demolition reaching a climax today, and the topic of conserving our history and culture is gaining momentum, this book serves as a good introduction. It's written by a HK architect and express his many views and feelings toward the rapid changes and developments in Hong Kong. He may be overly critical or extreme in making some of his points, but you won't doubt his passion for his hometown and his courage to take on the authority and the developers (note he's an architect). It's a very easy read with lots of photographs, so you can probably read it during commercial breaks when watching the Abalone family.

Monday, May 07, 2007

Talking People Out of Getting Rich is a Hideous Crime!

Of course I'm not about to commit one. There's nothing which hurts more than seeing a sold stock go up further, which causes at least double the pain than of keeping a losing stock. It's because a losing stock can always come back while a sold stock is gone forever. Of course one could make use of the proceed and earn just as much with a subsequent purchase, but somehow our cognitive mind won't recognize that but forever stuck in the dollar that was meant to be.

I'm writing this post as I'm experiencing this pain 1st hand. While I was trimming down some of my positions (note 'trimming' and 'some' only as I knew liquidating would create unbearable pain and probably regret too), I found myself heavily divided in the classic greed vs fear struggle, so much so like a mental patient with an unstable mind.

On one moment I'm totally pleased with my return this year that I'm happy to go away for a long vacation and come back next year. On another moment I long for staying for the magic moment to arrive, something like a countdown and fireworks in a new year's eve party. This state of mind is a new experience to me and I think the market is having heavy influence on my otherwise rational self.

The market is in a twilight zone now. Indexes are up everywhere and almost everyday. Bears are either squeezed into extinction or become converted bulls. There's no negative news, or no news can be perceived negatively. The press is all upbeat, even the traditional bearish Mr. Cho of HKEJ has kept quiet for a while (for he has been mostly wrong in market direction since the middle of last year). I find it extremely difficult to find a contrasting view. The market has becoming highly uniform in opinion.

Why worry when the A-shares are trading twice as expensive and still not falling?

On the street level, twice each on a taxi and a minivan at night time recently (total 4 occasions) did I find the radio was tuned to the Metro financial channel. My weight trainer nearly tripled his money from his 1st purchase even having sold in the March correction. In my stock search while there's a lot of good companies to write about, there's not a lot of recommendations which can be made. On the other hand I found more bargains on ebay so I'm spending increasing time there, hence lesser output here.

While everyone knows the ageless wisdom "cut the losers and let the winners run", make sure what you hold are really long term winners, not just pricewise.

DISCLOSURE: I still hold shares.

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