Abaci's Common Sense Investing

Omaha 2010

2010-07-16T13:05:00.000+08:00

I went to the Berkshire shareholders' meeting this May and I'm glad I finally made the trip after putting it off for a few years for no apparent reason. It was a fruitful experience.

Buffett and Munger are really worth flying 12,000km to see in person. They made the meeting an intense yet fun wisdom sharing experience for anyone who wishes to learn. It's like being near a knowledge fountain on a fully open tap. You'd surprised at times they also taught you how to be a good person and lead a meaningful life. I hope I've become wiser after this meeting.

In the end, I'll leave two quotes from each of them.

"Most people do not have the temperament to be investing their own money."

"In my whole life, I've known no wise people who didn't read all the time - none, zero."

And this is the last post on this blog about investment.

p.s. you can google for the complete script of the shareholders' meeting. there may even be translated versions. the flash spot in the photo is where Buffett was at before the meeting began.

HSBC Rights Issue

2009-03-10T14:00:00.000+08:00

I hope this is useful reference for most who want to do some trades with their HSBC shares and rights during the rights period. If you decide to act now however, I have no advice for you. All I can say is the current HSBC share price is the subject of much speculation and arbitrage, and hence is a bad time for trade (for layman) as the market quote is highly distorted. Things should become clearer once the stock has gone ex-right and more so when the rights start trading on their own.

By now most should be familiar with what a rights issue entails so I'll skip to the core analysis.

(HSBC share price, ex-right price, price of each rights)

P P(ex) Rights*
46 40.7 12.7
45 40.0 12.0
44 39.3 11.3
43 38.6 10.6
42 37.9 9.9
41 37.2 9.2
40 36.5 8.5
39 35.8 7.8
38 35.1 7.1
37 34.4 6.4
36 33.6 5.6
35 32.9 4.9
34 32.2 4.2
33 31.5 3.5
32 30.8 2.8
31 30.1 2.1
30 29.4 1.4
29 28.7 0.7
28 28.0 0.0

* [P - P(ex)] x 12/5 or P(ex) - $28

For example, yesterday HSBC closed in HK at $33, so the theoretical ex-right share price of HSBC should be $31.5 (it's lower than market price because there's dilution from the rights shares issued at $28) and the implied market price of each right (to buy one share) is $3.5.

Note these calculation are only relevant BEFORE before the share goes ex-right after trading this Thursday, after which the rights price (theoretical and not traded until March 20) will simply be the difference between the then HSBC share price and $28.

Between this Friday and the following Friday, Mar 20, only the ex-right HSBC shares will be traded but not the rights. It may be interesting to compare the actual ex-right prices to the theoretical ones over the past week (it's roughly 0.9 of the share price if it's not adjusted automatically by your stock quote provider) but I don't know how one can profit from this, if at all, reliably.

Comes the following Friday, i.e. Mar 20, when the rights start trading, 3 possible scenarios can happen but you only need to pay attention to one.

(1) The share price trades more expensive than the rights price indicates, e.g. share price is $35 yet the rights trades less than $7, which means it'd be cheaper to buy the rights and then subscribe to the share than buying the ex-right share outright in the market. You need not worry about this scenario because I'm sure arbitrageurs would come out and equalize this difference in no time, by shorting HSBC shares and buying the rights. So there's nothing you can do to profit from this scenario as a layman.

(2) The share price trades on par with the rights price, i.e. rights price = difference between share price and $28. Again, nothing you can do as a layman. You many choose to participate in rights or buy new HSBC shares as you wish, or not.

(3) The share price trades cheaper than the rights price indicates, e.g. share price is $35 yet the rights trades more than $7, or in the extreme case where share price is below $28, yet the rights trades above zero value. If this happens and stays for a while, a few hours maybe, then there's something we layman can do about. I don't really know why it may happen but there's no need to understand fully either.

If you hold HSBC shares and have decided to participate the rights issue, DON'T! Instead sell your rights and buy the same number of shares (as you would via subscribing to the rights) in the open market. Rarely will you have the chance to do exactly what an arbitrageur would do, selling high and buying low of the same asset.

If you want to speculate and make a quick buck, buy some HSBC shares, as the higher-than-usual demand for the HSBC rights will soon translate into higher demand for the shares as well. But how the share will perform after this difference has been equalized is anybody's guess.

In summary, do nothing new if (1) or (2) happens, buy some HSBC shares in (3).

DISCLOSURE: I have no HSBC at time of writing.

Should You Invest in USD or Gold? cont'd

2009-02-23T12:09:00.000+08:00

There's really no way to predict how different currencies will act in this on going crisis, just as nobody could really see it coming or foresaw its magnitude (perhaps except Doctor Doom & the Black Swan). Therefore I can only list out the underlying forces at work. You are welcome to contribute what additional signs to watch out for.

(1) USD buying pressure to ease when de-leveraging is completed
This is easier said than observed. USD should drop when global de-leveraging is completed and most USD loans are reduced down to a safer level. But it's hard to say when. Even though most banks in US and Europe are re-capitalized and less leveraged, this is only relevant if value of assets they hold don't drop further. If we see higher grade debt instruments in US turn sour faster and deeper than expected, e.g. commercial real estate loans, credit card debt, municipal and state loan, etc, we know well this time it's not gonna be a localized problem in the US, as via securitization its effect will be broad reaching. And depending on whether the banks have learnt to hold more than enough USD for contingency, there's possibility for another USD rush when positions have to be closed. In addition, the on-going sell/scale down of foreign operations by US institutions will continue to support the USD as funds are repatriated back.

(2) USD borrowing to ease as interest rate is low everywhere
Companies are less likely to borrow in USD if they can get equally low rate in local currencies. In fact, a lot of existing USD debt will be refinanced with local currency debt. For example, in HK many companies are increasing their exposure to RMB debt to repay USD syndicated loan. This suggests lesser selling pressure for the USD. After witnessing the turmoil in the fx market last year, there aren't a lot of brave souls who would venture off-shore financing anytime soon.

(3) Spread of US treasury yield and corporate bond to narrow
It's happening and is a good sign that the bond market is breathing again, even only faintly. There are talks of quantitative easing everywhere, that the central banks will issue cheap debt and used the money to buy commercial loans/bond to push down the yield (i.e. borrowing cost). Whether that's gonna happen is not really important as investors have chosen to anticipate and act in advance, doing what the central banks want to do in advance and hoping to turn a quick buck when the central banks do move in. This seems neutral to the USD.

(4) US treasury buyer's stance, mostly Japan and China
Japan has no choice but to suppress the Yen, which is good for USD. Japan is an export economy and the US is its biggest customer. Its domestic market is too small to self sustain and it can no longer boast infrastructure spending. As most things Japan produces are human/physical capital intensive and it owns the brands, there's a lot of value adding so higher resources price in terms of a weaker yen is of lesser concern.

China on the other hand wouldn't mind a stronger RMB, for most of its exports are low value-adding and thus more sensitive to resources prices. A stronger RMB also brings cheaper imports (even for goods manufactured locally as resources are mostly imported) and boasts internal consumption, good prescription for the economy. However, China doesn't want to see a collapsed USD either as not only will the value of its USD assets largely deteriorate, Chinese suppliers will suffer badly too as they usually hold no brand, operating in fragmented industries, and have little bargaining power with US importers. A weaker USD will translate to lesser demand for goods and pressure for discount (i.e. Chinese side will need to absorb the loss from USD depreciation). If I were among the Chinese leaders I really wouldn't know which I prefer.

Another emerging trend is China is buying up natural resources everywhere in the world whenever opportunities arise. In time this may affect China's appetite for US treasury but at present there's not enough deals of magnitude big enough to cause such a swift. Moreover I note most deals, including the Russian oil deal and the Australian mine deal, are priced in USD (I suppose the reason being most commodities are priced and settled in USD), so China is only exchanging its USD reserve for something tangible, i.e. it doesn't involve buy/sell of new USD. And those selling countries/companies are in need of those USD to repay their USD debt as part of their de-leveraging. So this is really the other side of the same coin (i.e. factor (1)).

(5) Economic health of US and the others
This one is easier to spot - every economy is sick! And the common prescription is to borrow like crazy, either on the government level like in the US or much of Europe, or on business level via the easing of credit by banks like in China. If the borrowed amounts aren't enough to jump start the economies, there'll be a lot more money coming your way. In the end, it's the same for all currencies, i.e. a lot more money supply than before and nobody can be sure that the new money gets spent wisely. Therefore this factor is neutral as all currencies are not considered safe in this regard, i.e. low interest but no future.

But relatively, US is in a stronger position. If it is already hard enough for Obama to get things done quickly with just fellow democrats and the republicans, imagine how hard it is for Europe to agree on anything with all the different political ideologies. Moreover, the downfall of many smaller economies in Europe (including even Italy and Spain and of course the entire Eastern Europe) will drag down the Euro zone further. And the Russia position looks shaky and Europe as its neighbor is gonna feel the impact. If something drastic does happen in Russia, money will be flooding into the USD.

Summary
All the factors are mostly supportive of USD or neutral. The central theme seems to be if the US is bad, then everywhere else is just as bad and likely worse! Therefore I think the USD strength is logical and gonna sustain. WHEN and IF it does collapse, it won't be against other major currencies but rather against hard currencies, at present I think it's gold and oil (and there may be more). This is because the collapse is likely to be driven by the belief that most developed countries are close to bankrupt and thus paper currencies are no longer trusted. Monetary system takes a step backward and people will revert to holding hard currencies. So it's possible that a gold bubble is forming and maybe oil will follow steps too, and it doesn't require actual anticipated events to take place to support it, just imagination of it happening is enough to fuel it.

Should You Invest in USD or Gold?

2009-02-06T12:25:00.000+08:00

This isn't my favorite topic for obvious reason - one pays no interest and the other barely pays interest. But since most people can't be convinced to buy stocks perhaps it's good time for a change of topic

Have you ever noticed that American dollar is only currency that is called 'gold' in Chinese when it's not? You never hear (in Chinese) British Gold or Euro Gold. It seems the USD is the next best thing to gold.

The USD has started an uptrend, just like gold, since the collapse of Lehman last year, and it's stayed strong even when the US economy looked like it's heading into a tailspin, and amid the massive creation of money supply via everyday rescue and stimulus package's' and a close to zero federal rate.

The easy answer to this abnormality is that people flight for security in times of uncertainty. The US economy sucks and is shrinking but still it's the biggest economy in the world, and with the biggest army. The only other nations comparable are Russia and China, both communist and with currency control, hence it's not hard for most to make the choice. What about Euro? Well, as much as the high cost and unionized workforce is plaguing the US, the same hurts even more across Europe. And Europeans also fare generally less well than fellow Americans on creativity and technology front.

But this answer seems too easy and ignores something deeper in the working. I recently read an Economist article that provided better insights and together with my understanding here's a slight more difficult answer.

I'll start with the background. Globalization has lead to more emerging market countries, notably China and others in Asia, earning USD from selling exports. These USD ended up in various central banks' reserves and were not converted back, as most governments were still haunted by past trauma of the Asian financial crisis and the heavy foreign currency debt. So this time around they all loaded up USD as buffer for the bad times. Of course at the same time they also didn't want to their currency to rise too much and thus selling these USD was a big no no.

These USD then found their way naturally in the US treasury bond. As foreign trade increased and reserves soared, more treasury bonds were purchased which drove down the yield. During this time there was the bursting of the IT bubble and Alan Greenspan's monetary easing. I think everyone understood this well. So I'd just say both factors combined and the result was an extra low interest rate in the US, second to only Japan.

Out of cheap financing, a housing boom and a consumer spending boom was born. The housing boom was more devastating because it's also self-reinforcing, as higher prices led to more speculative buying.

Extra low interest also meant extra low return for lenders. American bankers then got creative and repackaged all kinds of loans into AAA securities and started selling overseas to those who had to buy USD but weren't satisfied with treasury return. Local US banks then eased its lending standard because lousy loans could always be sold. This part you now know very well too so I'll skip. I'd just add many US banks also provide USD financing to entice overseas buyers.

The low interest rate also helped grow the eurodollar / eurodollar bond market, i.e. borrowing dollar on non-US soil, mostly in Europe. As more companies/investors took advantage of the lower rate USD borrowing, this became self-reinforced as when borrowers converted the USD proceeds into local currencies to use, this drove down the USD and made borrowing USD more attractive as it's a currency that had low interest and was depreciating too!

So much for the long-winded background! Let's guess what's been happening since last year.

First the US banks got into trouble as the housing market deflated. But this was seen to be domestic only and hence USD fell even more as most people moved to other currencies with a higher interest rate when US was cutting rates. Then it became obvious that all the repackaged loans sold to Europe would go sour too, hence most European banks and investors would suffer as well, and probably as much too. These USD assets became illiquid or substantially worth-less. However much of these securities were financed by USD loan given by US banks at the 1st place (originally a nice hedge and leverage to enrich return). So Europeans suddenly found they were very short of USD. Of course it didn't help the US lenders were all in deeper trouble and needed that USD even more urgently.

Naturally the Eurodollar borrowing market ceased as the lenders, both US and European banks, or actually everyone, was short of USD! Normal commercial lending was affected at this point. So every asset class had to be sold to repay those USD loan, and hence USD had nowhere to go but up abruptly. The case was also worsened as borrowing was gradual over years but repayment was almost immediate. This was similar to the YEN unwinding every once in a while but of much broader scale, and with the difference that the original US lenders were also scrambling for the same USD like the borrowers. That's why we had a very high LIBOR vs US fed rate and the USD swap arrangement between the FED and ECB late last year. There's USD shortage everywhere.

What about all the monetary injection by central banks and the fiscal stimulus packages? I think evidence is the former is not enough to counter the size of the credit crunch, and the effect of the latter is not yet felt. Meaning - credit is still not enough so de-leveraging has to go on. This has been a rise or normalization of long term US treasury yield lately, which suggests maybe inflation or worst insolvency of US. But this is universal as I think credit spread for many European countries are rising as well, meaning everyone is having just as bad prospect.

What does these mean? The strong USD isn't going away soon! It's lucky we are in Hong Kong and most of us are automatically invested in USD via the peg. But I do think the tide will turn. I'll try organize my thoughts and tell you next time, and cover gold too.

Investment Ideas for 2009

2009-01-13T13:15:00.003+08:00

I remember it wasn't long ago, maybe in late November or early December, that the 3 month US T-bill yield hitted zero. This sounded absurd as why would anyone invest in something, mind you all investments entail risk, for no return. So now somebody rightfully dubs T-bill as the great 'return-free risk', as opposed to 'risk-free return'. I guess the only reason for this abnormality is that massive amount of capital has flown from everywhere into government bond class, and the bond managers have to do something to earn their fees, just like an equity fund manager who must buy when new fund is received. As longer tenure bond yields are also at historical lows, which implies there's much downside for prices to come down, 3 month bet is the safest option as it can always be held to maturity. And those who bought government bond funds don't know they'll be receiving zero return until after the news, since they don't directly participate in the T-bill auction. They probably bought it because they read the yesterday's news in the marketing materials, that government bond funds had little risk but outperformed equity funds by more than 50% last year. This is one layman's investment idea you can consider.

The 2nd idea is a derivative of the 1st, no, it's not a MBO or CDO kind of derivative, but is an origination of Warren Buffett. His rationale is that zero T-bill yield means lending money to the government is no different from putting money under your mattress, except that the government may default. So the next logical thing people will do is to buy as many mattresses as possible to store their wealth, hence all major mattress makers should see much increased sales. Because Buffett himself bought up a lot of household furniture stores last year, he thinks he's gonna make a killing out of it. This is one pro's investment idea you can consider.

Disclosure: I have one mattress (practically only half) and no government bond.

Final update on COSL (2883)

2008-12-01T17:20:00.004+08:00

Early last year I looked at COSL and found out it's less a service company but more an utility with old equipment. Subsequently to my amazement its price rocketed from $5 to over $20 in Oct 07, then it was sold all the way down to a little under $3 last month (i.e. one year later). Now the price is around $4.6. One peculiar thing was that share price this year pretty much moved against the rise in profits and the oil price until July, then it moved further down with the oil price and then entered a free fall zone like every other stock in Sept and Oct.

Meanwhile during this time COSL completed a huge acquisition of a Norwegian drilling company. The deal was announced in July and completed in Sept. So I think it's about time to have a second look of COSL.

The acquisition was huge at NOK 12.7b, which was about HK$20b at time of announcement and the same as COSL's own NAV. COSL's historical highest profit earned was a little more than HK$2 billion in last year.

The assets acquired were a fleet of 6 drilling rigs in operation and 7 rigs in shipyard under construction. These 13 rigs will eventually double the capacity of COSL which is 15 now. The Norwegian company was only set up in 2005 and was barely profitable until 2007 (as the rig was put into operation one by one). Given the lack of track record, this deal could be seen as an asset buy, for I don't believe there's much goodwill developed within the 2+ years of operation.

The deal also came with a lot of debt as those rigs were heavily geared. There was US$1.35b of debt against US$1.8b of fixed assets (including those under construction), making the rigs 75% bank financed. Overall gearing of the Norwegian driller was more than 260% and NAV was only US$515m. So HK$20b was spent to acquire HK$4b of net assets. It certainly looked quite expensive for asset purchase. One reason for the high cost maybe the long lead time (~2-3 years) required for manufacturing rigs, thus creating limited supply in the market. Another reason was of course the now-seen-overheated market for drilling equipment back then when everyone was searching for new oil.

This acquisition was ill timed as the deal was struck at beginning of July when the crude oil price was at its peak. Though luck may have it, the deal got to go through the lengthly approval process of the Chinese bureaucracy and wasn't completed until the last week of September, and during this time the NOK has dropped about 15% against the USD so making the cost slightly cheaper at HK$17b.

COSL intended to finance the acquisition with debt so it will have HK$27b debt to service for the new rigs acquired. Interest cost (say 5%) will be at least $1.35 billion a year. Revenue side is less certain now given the market environment has changed quite a bit, and half of the rigs are yet to be delivered and hence without having secured order. Rentals seem to fluctuate quite a bit and some rigs are only on contracts for a few months, subject to extension pending successful exploration which will then lead to multi-year contracts. I'm not really sure about exact dynamics, except the revenue side is much less stable than desired. Looking at the substantial increase in revenue of COSL over the last 5 years, when its fleet size only increased moderately, only confirmed the instability of the revenue stream.

The most COSL earned with its 15 rigs was $2 billion in last year, but it operated with almost no debt and inside Chinese waters, and paid a low 15% tax rate. How much the new rigs will contribute to the enlarged COSL group is really a question.

As said last time, the average useable life of COSL's existing fleet is only about 10 years (vs. 30 years of a new rig), so COSL will have to continue to upgrade its drillers in the future (think what it will do to dividends and debt level). This Norwegian acquisition alone already took up much more than all free cash flow of past 5 years combined! Future replacement cost may come down as the industry slows down and the raw material becomes cheaper. But having an extremely long capax cycle and great uncertainty in product pricing (which depends on oil price) making running a driller business not less difficult than an airline. Both require heavy and long term commitment upfront but profitability depends much on oil price movement.

The current price reflects a historical p/e of 8 times, which looks reasonable but is a result of last year's favorable industry conditions. This years' results should be even better (assume the newly acquired Norwegian driller can pay off the interest of acquisition debt at least), but it's difficult to work out a longer term sustainable earnings, as this entails a forecast of the oil price level. COSL needs both favorable oil price movement and good timed execution in capax to succeed in the long run.

My initial opinion about COSL hasn't changed. I'd modify it as an utility with unstable revenue stream and old equipment. It's mostly a speculation stock.

DISCLOSURE: I don't hold 2883 at time of writing.

More statistics to share (updated)

2008-11-21T20:45:00.002+08:00

Last month I was in an accounting standard update seminar and the speaker, who might have lost a lot of money and thus turned a complete cynic, kept making lame jokes every few minutes about mini-bonds, Citic Pacific, HSBC, and other names I've forgotten. But he repeated more than once, in a serious tone, of his gloomy prediction of HSI falling by 90% and reaching 3,200. His reason was two-fold: (1) this crisis is most severe since the great depression of 1920s, since there's no HK stock market at that time, he could only surmise the HSI fall will be at least as bad as in the 1973 bear market; (2) one of his manufacturing client in Foshan made the exact same gloomy estimate when they discussed the market condition.

Reason (1) is actually not his origination but a popular bear belief in the market, and I don't understand why reason (2) can be considered a reason at all, maybe his client is the unknown 'Foshan Buffett'.

Then I read from Tony Messar's daily column last week and he mentioned something about the 1973 bear market, when the index fell from 1,775 in Mar 1973 to 150 in Dec 1974.

"The 150 on the Hang Seng Index during 1974 was extraordinarily elusive. On that day it had fallen for less than 10 minutes, and 600 points was about its real bottom, and that was hardly attainable for more than a day or two."

This certainly sounded encouraging, but I wasn't satisfied. So I started my own research on the great 1973 bear market, and found out unfortunately Tony's memory was a bit too rosy, although I don't blame him especially given his age now why shouldn't he be keeping only pleasant memories.

There wasn't much on the internet about the crash, mostly anecdotes about how people went mad and then crazy (or the other way around) in the great bull/bear cycle in 1973/74. I have little confidence in the accuracy nor representativeness of those stories, given the tendency of the media to spice up things for attraction.

I did manage to find some data about the index. 1st, the real bottom wasn't 150 but much lower, but it's an intra-day low and probably happened in what Tony referred to as the 10-minute selling. But he's wrong in saying 600 was the real bottom. In fact, the index did fall by 90% in Dec 1974 and stayed there for quite a while before rising again, to 209 on Jan 27 1975, and then to 279 on Mar 27 1975.

Another useful bit of information was found about the super bull market before the crash, on Nov 13 1972, the index was 673, 3 months later on Feb 9 1973, it was 1,450, 1 month later on Mar 9 1973, it was 1,775. I don't really have a starting point for the bull run because of poor data collection. But if I use 673 as a base, then it was up 263% in only 4 months. It was indeed quite a gold rush! [Update: From less reliable source I got that HSI was 113 at beginning of 1969, so in 4 years and 3 months (until Mar 1973), it's risen by 15.7 times! The Economic Journal wasn't even published until sometime in late 1973 in the middle of the crash.]

Next I tried to compare this to the last bull run we had, I used 32,000 as the finish line and calculated backward, arriving at 12,167 in order to give the same 263% increase. It was a time around Aug 2003. The total time was 4 years and 4 months.

So it was 4 years+ vs 4 months!

You should realize the intensity of these two bull runs wasn't quite the same. If you believe that the extent of a bear market fall has some thing to do with the previous bull market run, then you should perhaps give some more thought before casually linking the two bear markets.

[Update: A quick summary

From 1/1969 to 3/1973 (51 months), HSI was up 1,570%
From 8/2003 to 11/2007 (52 months), HSI was up 263%

From 3/1973 to 12/1974 (20 months), HSI was down 92%
From 11/2007 to 10/2008 (12 months), HSI was down 66% (using 11,000 on 10/27 as floor)

For additional info, the bottom of 150 in 1974 was still 33% higher than the starting point of 113 in 1969, while the 11,000 bottom last month was 10% lower than the starting point of 12,167 in 2003.]

Anything can happen for the 1st time, the HSI may fall by 99.9%, or it may rise by 100 times. History is not a reliable predictor of the future, for you will continue to witness 'new' piece of history. (idea of Black Swan author Taleb)

p.s. one should also bear in mind the composition of HSI is very different now with the addition of Chinese companies. therefore to assume a HSI of 3,200 is similar to making an end-day prediction of the China economy. well, if that day does come then that accountant probably has a lot of other things to worry about than the HSI.

Some statistics to share

2008-11-19T12:49:00.003+08:00

This is taken out from quamnet after yesterday's trading, which was probably a typical falling day.

Best performing HSI members
#1 Sino Land 1.1% down
#10 HKE 3.2% down

Best performing midcap members
#1 Lifestyle 3.8% up
#10 Chinese Estates 1.5% down

Best performing smallcap members
#1 Samling 5.2% up
#10 K. Wah 4.3% down

So far so good, all HSI members were down and some mid/small caps went up, not too unsurprising. Below is the more interesting bit.

Worst performing HSI members
#1 Pingan 12% down
#10 HLP 6% down

Worst performing midcap members
#1 OOIL 10.8% down
#10 Shun Tak 5.3% down

Worst performing smallcap members
#1 Kowloon Development 10.2% down
#10 Polytec 3.6% down

In short the bigger the company the larger the fall. De-leveraging you may say, which can explain almost anything now. Because small caps have inherently lower credit quality in eyes of banks, their shares were less lent against in the 1st place and hence can't be de-leveraged as much now. Another explanation is we're near the end of the selling circle, when the best managed companies get sold too. But we can't use recession or depression as a reason, because in that case bigger companies should fare better and hence decline less. The market is indeed acting funny lately.

To conclude, larger companies are more defensive yet cheaper, favorable combination.

A look at some yield plays

2008-11-19T12:43:00.001+08:00

Below are a list of high yield plays I've looked at these few weeks. I think it's wise to hold a certain percentages of one's portfolio in this sector as these are fundamentally stable businesses with good distribution, a nice complement to the high flying chips that you plan to profit several times over cost in the eventual rebound (if there is). Fat dividends also keep one's mind sane in a protracted down market.

I won't bore you with the financial details. These are all reasonable buy for holding (read: not trading) with adequate yield and even considerable appreciation potential. In my view these are much better buys than bonds. However I have little confidence if these can outperform putting money under your mattress, over the next quarter or even next year.

Local consumption
GD Investment (270)
This should be the most resilient even in a recession because 80% (or more) of its profit is from selling water to the HK government. Extension terms have just been agreed with a 15% increase in tariff. GDI has some miscellaneous businesses heres and theres but none of them is interesting enough to warrant attention. GDI still has a lot of debt carried over from its last financial trouble and it'd be nice if management is more active in reducing those debt. However now that GDI has gotten in better financial shape, management seems more eager to do acquisitions to demonstrate their competency, but it is this area where GDI really has nothing to show for confidence. Profit should be comfortably above $2b and 09 prospective p/e should be around 7x or less. Yield is adequate but not as attractive though, which kind of reduce the attraction of buying in the 1st place.

TVB (511)
Champion of anti-IQ programming and broadcasting, surprising effective in capturing local viewers for more than 40 years. TVB has such dormant market position you all understand 1st hand. It is also a great business machine. It has little fixed outlay and almost no need for reinvestment (for future earnings). The only capax is the studio which is real estate and hence keeps value. 5 year average earnings are about 900m which suggests 10x p/e. Yield should be around 6/7%. Future generations may abandon TV altogether but I'm sure that'll be beyond my time. Future advertising revenue will contract certainly but share price is already at SARS level and not much above that at worst of Asian financial crisis, making any further fall rather limited.

Oriental Press (18)
Annual profit should be comfortably above $250m. The exceptional move to half the price of its 'Sun' newspaper which badly affected profits in FY06 and 07 probably won't repeat, as it didn't seem to achieve anything. Surprisingly, in the year of SARS OP actually had the most revenue and profit over the past 5 years. Maybe the internet and other new media is really having its effect slowly. This 1st half should have been tough as oil price (which seems to affect newsprint and ink cost) was high and advertising might have slowed. But it should see some relief in 2nd half when costs have come down. There's almost no debt and net cash is $1.75b after selling out its head office in Kowloon Bay. Do you know the market cap now is also $1.75b? Since the Ma family has been reluctant to distribute anything more than current year earnings, I guess overtime the market has basically written this 'cash holding' off. God knows how long you have to wait before you get to see this cash. And you need to pray daily that OP won't buy any of those funny financial products from its bankers. But even without this cash cushioning OP is still attractive at current price. It probably has the highest yield too.

REIT
GZI (405) and Champion (2778)
Both are commercial and retail REIT but at different locations. Main attraction of REIT is regulation, there's a cap of the amount of debt raised (45% on asset) and most importantly 90% of earnings have to be distributed. So you don't have to worry management getting too ambitious with your money. These two offer similar yield and face similar problems, possible falling rental. I'm not sure about the Guangzhou property market although I believe it may be more resilient than HK, but I don't know much about its property portfolio so I'll pass. Champion is more tempting with a 75% discount to NAV ($7), but I have great reservation about that figure because when new units were issued earlier this year, the issue price was only $3.6. Yet, the current price is only half of that at $1.7. The two buildings of Champion, ICBC Plaza and Langham Place are prime enough to me and both are in great locations. If I take 50% off current distribution as long term average (this implies no distribution in really bad years), the yield is about 7% over time of holding, not bad for grade A commercial properties. The return is also sort of inflation-protected too as rent should increase with inflation. However if you want deflation protection then you should probably stop reading from here and forget all stocks mentioned above.

Ports
Cosco Pacific (1199), Dalian Port (2880), China Merchants (144)
These seem interchangeable as they all have had the same dismal share price performance, even their earnings stream are quite different. CP is about 1/3 container terminal, 1/3 container leasing (mostly to parent company China Cosco), and 1/3 container manufacturing. DP is half crude oil terminal and half container terminal. Only CM is a pure container port play.

CP is most complicated in operation and in short too uncertain for a yield play. The container leasing and manufacturing look bleak at the moment, although I tend to believe share price discount is big enough. The worrying bit is actually the port side, where CP is increasing its investment in at least a dozen ports, along the coastline of China and overseas. I'm not really sure if the golden age of port operators has past and whether China can really support that many ports without oversupplying it, like it did in any other sector maybe except oil. CM is more focused and with less expansion, mostly because it started early. But it also has the highest valuation making its attraction average. I wouldn't count on the high earnings growth and 25x plus p/e ratio seen over the last 2 years to reappear in future. DP looks most attractive as half of its earnings is from the more profitable yet stable crude oil terminal business, which will actually benefit from the fallout in oil price. Its container port business targets the northeastern region trade which should be less developed and hence have more potential. I also like its lack of explosive earnings growth like CP and CM which means any adjustment should be slight. The only big negative is that DP invested in some funny interest rate swap in 2007, similar to those sold by Deutsche Bank and covered by David Webb already, I calculated the maximum downside to be about some $22m annually until 2015, which is not much compared to annual earnings of $600m. However in today's market if this is made known the punishment will probably be out of all proportion. That may become the opportune time to enter.

DISCLOSURE: I hold 511 at time of writing.

Something Else: this time last year

2008-11-07T14:28:00.004+08:00

Around this time last year there were plenty of stock market experts sprung out from everywhere in town. We all heard and read about how they picked the right stocks and made fortune out of it. They were maximum bullish and they put money where their mouth was. They were the stars of the time with huge followers.

This year we have a new group of stock market experts - those who made fortune (relatively) by literally putting money where their pillow was, i.e. under a mattress! Very soon they'll become superstars too. They'll hold investment talks and write books with titles like "Top 10 mattresses to keep your wealth in 2009" or better yet "How I made my fortune by just sleeping on my mattress".

Today's superstars despised stocks so much, just as much as yesterday's superstars despised cash.

Last year it was buy stocks and get rich, this year it is do nothing and get rich! I think both defy common sense, unless you believe the world is only in black and white.

Something Else: The Monopoly Game

2008-11-06T16:30:00.001+08:00

Watching all major central banks are busy printing money and lowering interest rate, injecting more and more money in the market, this reminds me like in a game of monopoly, when one player is about to go bust, he would usually suggest 'why don't we all get $500 each so I can continue the game and everyone is $500 richer?'

Except that this time the sum is a lot more than $500 and everyone is asking for it at the same time. Well the lucky break is unlike in Monopoly there's unlimited supply of $500 notes in central banks.

Yet I'm confused because in Monopoly you can't have all losers without a big winner? So I tried to imagine myself in a game of Monopoly.....................

In the beginning every player is buying properties with cash on hand and cashflow received each round, nothing fancy. After a few rounds someone with a bit of luck will have built up a connecting block of land. Houses and hotels are erected to increase rental but more importantly this block can be mortgaged to the banker or other players to get new loans to continue expansion. This is still within normal boundary of business, for players have to be careful about cash-flows received each round is enough to pay off the interest.

Then for some reason the banker lowers the official interest rate, perhaps a bit too low, and that alters the dynamics and risk appetite. Players begin taking up more loans for 'rents' collected from land can increase with development but interest cost has gone lower. So in theory one can gear up indefinitely to increase return, hence properties are bid to higher levels. Rent soon gets higher too for more properties become fully developed into hotels. At this stage there are happy buyers who look forward to continual appreciation and happy sellers who are willing to sell off and hold on to the profits.

Then comes another big event, suddenly there's whole bunch of late comers with a large pile of cash and desire to become monopolies too! The reason for their late arrival is not known but unimportant. They bring up the pace of buying and the property price. At about the same time all land and properties have been mortgaged to the banker and there isn't enough cashflow each round to support the buying. So all players figure they could invent a 2nd mortgage market at a higher interest, given prices have appreciated by much. So rules are changed and new rounds of refinancing are done to support new buying. And markets for 3rd and 4th mortgages are soon becoming the norm. Early sellers are buying back too because they reckon they'd out of the game soon, eaten alive because of the ever increasing rent. There isn't an exit mechanism, for monopoly is played until there's only one man left standing.

What about bankruptcy risk which are supposed to counter irresponsible financing? Some smart players who are holding more cash than properties figure he could make some extra income by insuring against the default of other players, so rulebook is changed again. Lending become more rampant because of the 'safety' of insurance. Very soon the amount insured is greater than the cash and assets the insurer has, and worse, those assets reserved for claims are properties too! But he reckons players can't go bust together so he's safe. A few other players get envy in this new business and start to insure others too, figuring this can increase income and reduce its own insurance cost. Very soon we have a situation where player A insures B, B Insures C, C insures D, and D insures back A, yet in essence they all insure against a fall in price of an asset which they all hold themselves.

Then one day one player wants to sell down, for no reason, perhaps he suddenly finds reducing debt is a good idea, and then he can't find one buyer in the market. Everyone has run out of cash and borrowing capacity. And during this time the banker has increased interest rate for various time already so all the properties have become cashflow negative. When price can't increase any further, down it goes. and it goes down hard.

Property price plunges and that forces more selling. Those holding on aren't faring better because cashflows are draining each round. Players suddenly find out properties prices are elusive while loan balance is rock solid! Before long all players are into negative equity territory. All 2nd, 3rd, 4th mortgages become worthless. Bankruptcy now is a real threat, but at this important juncture the 'insurer', finds the impossible happening, that all players are bankrupting and it backing assets are vanishing too. Counter insuring also becomes a joke as neither can pay off the claims of the other nor survive himself.

So in the end we have all players owing large sums to the banker (and to each other too), with collateral grossly insufficient in value and technically bankrupt. The banker in order to allow the game continuing then has to convert a large part of that debt into equity, hence becoming a player himself. Next is the cancelling or offsetting of all those inter-player debt and counter insurance contracts which are now proven useless and senseless (i.e. A releases B, B releases C, C releases D, D releases back A). In other words, eliminate all liabilities against losses. With sufficient time all players are largely back to a position where they begin. Meanwhile interest rate is lowered again to its beginning low level so properties become cashflow positive again to induce buying. Players will soon react because no matter how scared they have become, they are still in the game of monopoly, and their job is to win this game. In short, let's start another game ASAP!

I really wonder if this game creates wealth? If this is negative then perhaps the resultant loss of wealth is just one part of the game, for the thrills. And we're all part of this game.

Results Brief

2008-09-09T14:53:00.000+08:00

Chalco (2600)

I had expected Chalco to have an average year but 2008 turned out to be much uglier. Profits dropped from $6.6b in 1st half 2007 to $3.3b in 2nd half 2007 to only $2.4b in 1st half this year. This drop in profit contrasted sharply against the expansion last year as Chalco took on more aluminum plants and enlarged its alumina capacity. The culprits: falling selling prices and increased costs.

I can understand the higher bauxite price and the energy costs as that's universal, but I have trouble reasoning the weak pricing power of Chalco, as it's already the biggest producer of alumina and aluminum in China. The steel producers seem to have fared much better amid similar difficulties.

On latest production figures, Chalco's market share of alumina and aluminum is over 45% and 20% respectively, basically unchanged from one year ago. As Chalco has expanded quite a bit over last year, this means everyone else has done the same. Thought there's no figures to confirm, it appeared national supply had grown faster just when demand growth had softened a bit. Probably these extra capacities are eating into everyone's bottom line now. Chalco's alumina production was 8% below target and aluminum production was 16% below target. On aluminum, sales / production ratio fell below 1 at 0.89 and sales / budgeted production was lower at 0.75. Partial blame could be put on the snowstorm in January which had disrupted production and sales. It's also possible that the newly acquired plants are going through an adjusting period so in time results should improve. True picture should emerge when the 2nd half figures come out. In fact price protection is said to be the company's focus in the 2nd half.

I'm disappointed by the aluminum segment which Chalco actively developed because it did not provide the buffer effect as intended. It appeared to be just as volatile and the drop in upstream alunina price didn't appear to benefit the downstream aluminum business. It's also surprising to see oversupply again, when the industry only started to recover in 2006 from its last oversupply problem and price war. Increasing energy costs will also become a bigger problem as it seems clear China will change its energy policy. It will take some time for the industry to consolidate yet again before Chalco can really achieve market dominance.

On the good side, Chalco did vary its financing structure by issuing more bond to reduce bank loan and to make acquisitions (as opposed to issuing shares). Debt level has thus grown by still manageable at about 56% (net) of equity.

Market capitalisation now is about rmb74b. Against a NAV backing of 58b it looks comfortable. Considering it earned over 10b in each of the past 2 years in a size that's smaller than today, there is little reason to doubt Chalco cannot breach that mark again when better conditions come. After all, aluminium is still a key infrastructure material required everyday in China and there have to be decent profit opportunities to entice investments. A better entry time may come when there's bloodbath in the aluminum market later this year.

OOIL (316)

This one is simpler to analyze. Earnings appeared to have dropped a lot, even on a recurring basis after taking out the disposal gain last year, operating profit of USD175m was only 2/3 of last year. But further study would reveal the difference was caused by (i) reduced interest income as a large part of the disposal proceeds had been distributed and (ii) property revaluation loss from the Wall Street Plaza in NY. Core business container shipping actually earned slightly more than last year, albeit on much larger turnover (27% higher) meaning reduced margin, but that's still respectable considering the tough operating environment in the 1st half.

It seems quite clear the US and Europe are heading into hard times and that will impact the volume of trade and hence shipping demand. But global trade is bound to be here and stay, and it's hard to imagine either continent going back into manufacturing what they need. It's just impossible to find another country which can truly replace China's status as the world's supplier. In terms of labour population, infrastructure, the stability of government, and the potential domestic market opportunities, there's really no competitor. Routes could be different but goods would continue to be shipped from once place to the other. And container shipping remains the most efficient way of doing this.

Speaking of valuation, it's only HK$15b! It barely covers the amount of usable cash OOIL had (assuming vessels can be 70% financed by bank loans). This valuation is also 55% discount to NAV of HK$33.6b and mind you vessels can be sold, probably at a higher value than would the discount suggest. So OOIL is now trading in scrap value with zero value attached to the earning ability of the fleet. This is frustrating but I guess OOIL probably isn't the most extreme in this very depressed market.

Meadville (3313)

Both turnover and profit kept the momentum and soared over 30% (excluding interest income and share award expense). Meadville continues to benefit from the investment in the China telecom sector upgrade and the outsourcing trend in manufacturing advanced electronics in China. Margin was down slight from 22% to 20% but that was inevitable for all manufacturers and part of it could also be attributed to the pre-operating losses of some new facitities.

Financial position remains tight as the gearing remains unchanged at 80%, understandable as the company is in a quick expansion mode, which however requires some precision in execution to prevent troubles down the road. Recent conclusion of a syndicated loan of HK$1.3b should help lengthen the debt profile (total net debt: $2.5b) and ease the funding pressure for ongoing expansion. But one should keep a keen eye on this area.

With an annual earnings expected to be at least $500m and on a rising trend, Meadville continues to be a better bet on the telecom sector / electronics sector. But its relatively strong share price performance has reflected part of this and its 7x p/e is no longer a steal in today's market, where value stocks are in abundance.

RIMH (1997)

Similar to Meadville good performance was as expected. In fact RIMH is one of the rare breed to have increased turnover, profit, and margin. Dividend again was very generous but I'm afraid there's gonna be a slowdown in the 2nd half after the Olympics. I guess most of RIMH's customers have large exposure to the China market and after this wave of TV upgrade demand growth will slow, and the added production capacities of the industry will start to weigh down on everyone's earnings. Latest monthly turnover in Aug is reported to be down from last year and that's second month in a roll. RIMH also appeared to have slowed down its expansion as suggested by the larger dividend and yet-to-be-utilized proceeds more than 12 months after IPO. The effect from the resignation of CFO and INED earlier this year seem to have past.

With an annual earnings of I guess not less than $300m and a net cash position of $400m, the current market capitalization of $1.2b is low. Future appears less certain as the flat panel tv market may have a difficult time but that is countered by the excellent dividend yield. But since cheap choices are everywhere, RIMH probably isn't the most attractive one.

I hold all the above stocks at time of writing.

Something Else

2008-09-01T15:00:00.003+08:00

Recently I got some experience travelling in Europe with Finnair and Air France. Here are some interesting contrast to share with you. It tells you a bit about the airline and the people behind too.

Finnair - Scandinavians are very time conscious and efficient. When I arrive at the HK airport a little less than 90 minutes before take off time, there's no queue at the counter. I thought the flight must be pretty empty but in fact everyone had already checked in, and the ground staff was already waiting to close the counter!

The interior was tidy and quite new. Info system was top notch with very large and bright screen. Movie selection was quite international and even included choices from Japan, Korea and China. Meal serving was very fast and cleaning up was done even quicker, barely allowing enough time for any slow eater. Once the meal time was over all snacks and drink, save water, now costed extra, and there's only Pringle chips, sandwiches and soft drink. Services stopped and I had to get my own water at the back of the plane, even buying chips is no exception.

On the ground custom/immigration officers worked very fast as well, at speed comparable to officers here in Hong Kong.

Air France - French are in my mind too romantic and have too much time to burn. When I took my flight at the Paris airport at night, there's only 2 immigration counters working and a huge line up of people! And nothing was done about it as the queue continued to lengthen. I really couldn't believe this could happen in an international airport in an international city. When I get through the security procedures I only had 10 minutes left before boarding. The plane left on time though and there's no delay on arrival either.

Inside the plane everything was slightly older but only by a small degree. The info system though looked like an antique, very slow to respond and took forever to load the menu from French into English. The screen was much smaller and french movies took up considerable space. For meals it's nice one could get champagne (even at breakfast) and forks and knifes were from Phillipe Starck! And there's every snack and drink (save alcohol) you can grab for free at the back after meals. Service was comparable but Air French actually employed a Chinese translator who took up a passenger seat at the back and only did translation work. This was a novelty to me.

For speed and efficiency, choose Finnair (it actually flies to most European cities); for those who need to stopover and pick up a few bags on the way back, Air France is the only choice.

Thoughts on Auto Suppliers

2008-07-30T15:30:00.002+08:00

I've bought and sold some auto makers for a few times over the last few years without much success. I don't know the reason why but I was never quite able to catch the price movement. Since I never treated those as investment, I wasn't particularly concerned. My limited experience in Canada taught me that most, maybe except Toyota, auto makers do not seem to enjoy prolonged success as the industry is too cyclical and worse competitive. At one time Chrysler was the favorite as it invented the minivan, then it was Ford with the SUV, but now it was Toyota with the hybrid. Anyone guess who tomolo's winner is?

Having said this, the China growing middle class story continues to attract me and I wonder whether in China the auto market will be different. But there's are even more automakers there who share with me the same inspiration, and this pretty much balances the odd, i.e. greater competition in a greater market. So instead I opted for autopart suppliers who may present some value.

Minth (425)
A body part builder which supplies mostly to Japanese brand automakers in China. 85% of sales last year was local so it should be least affected by the slowdown in overseas market. As Japanese brands are usually more energy efficient and have better quality than competitors, Minth's order book should have more stability. Minth's products also seem to be of higher grade, judging from its ability to serve Japanese automakers and to obtain various grant from the local government to support it R&D (~3.5% of sales). However it's hard not to ignore the effect of the rising gasoline prices which will, if liberated eventually, dampen overall auto demand.

Profit has been growing nicely in over 30% over the last 3 years, in RMB which means even higher growth in HKD. Of course a large part of it was due to the growth in the China auto market and the aggressive expansion plan of automakers. Net margin was about 20% but the tax rate was very low at single digit, due to the preferential treatment which will phase out in a few years. ROE has been around 20%. Financial position is very good as Minth raised 1.5b from the market timely last July when the share price was over $12 (vs $5 now). NAV was 3b and net cash including FX products was 1.4b which was a lot!

Orders should be in RMB but somehow Minth had considerable exchange loss last year (50m compared to profit of 360m). It appeared Minth had been tempering too much with FX products. It had 600m invested in funny named instrument like range accrual and basket note that did not appear to be of much business value other than earning interest. Probably Minth didn't really have plans for the huge placement proceeds and felt compelled to do something about it. Distributing the extra cash makes better sense as dividend yield is absurdly low at 2.35% even at today's price.

At current price of $5 Minth appears fairly priced at a p/e of about 13x (if adjusted for a higher tax rate), for a bigger discount is needed to compensate for the uncertainty in the auto market and its treasury management. I quite liked Minth actually but since there's plenty of alternatives to choose from these days, the standard has to be set higher.

Norstar (2339)
It is the opposite of Minth which supplies brakes and suspension system to mostly overseas markets, biggest of which is US aftermarket. There's about 20% sales to Europe and local sales was only 15%. So it's safe to say it pretty much covers all major disaster zone. While secondary demand should sustain even in a downturn, afterall one can't really drive with faulty brakes, the US and Europe markets do look shaky at the moment. Norstar is trying hard to develop the China market but that will take some years before profit contribution becomes meaningful.

Norstar is already feeling the heat like other export-oriented industrials. Its margin and profit growth was eaten up by rising RMB and production costs. It also shares similar downside risk as Minth, too little tax paid but too much tempering with fx products. Norstar even has exposure to JPY/NZD rate which looks like a carried trade to me. In fact, much of earnings growth last year came from these structured products and year end invested sum could be as much as 1.1b. The company's huge pile of cash also looks a bit strange to me, and it had been holding over 1.4b net cash in the beginning of last year, yet it raised another 1b of syndicated loan during the year, but year end capital commitment was only 150m. Bear in mind NAV was 3.3b so about half was in cash (and possibly fx products). And it's hard to feel comfortable when Norstar didn't tell exactly how much it's invested in what. There's some description but in scant details and I'm not counting on the sensitivity analysis provided by management either. Norstar may turn out to be an excellent fx trader, but that's not why I was attracted to this company in the 1st place.

Even Norstar is traded very cheaply as the whole company is valued at only 1.7b, when last year's recurring earning was about 500m, there's probably good reason for this.

Looks like I'm not ready for the auto sector yet.

DISCLOSURE: I don't hold 425 nor 2339 at time of writing.

Something Else

2008-07-16T19:25:00.003+08:00

My new grown fondness of mathematicians.

I recently finished two books about math and mathematicians by William Poundstone. I don't know how to classify these books but I'd say it's not boring at all. It's like 'Freakonomics' in math and written in a more serious manner.

It covered topics like atomic bomb, world war strategy, game theory and moral dilemma, binary code, casinos, stock market, and private lives of mathematicians, the last bit which turned out to be most interesting and surprising.

One anecdote cited one math professor Edward Thorp was so much into thinking about winning the casino that he built a roulette predicting device with his colleague and tried it in Vegas, in disguise and with their wives trained too! (for the stunt required four person to pull off successfully)

His interest later transferred to blackjack and he wrote a paper on it, which got so much attention from outside the academic circle (for obvious reason) that the idea of card counting was later explained in the best seller "Beat the Dealer". As an experiment to prove his idea, he unknowingly teamed up with two big time gangsters from New York, who provided seed capital, and did a nation wide casino tour. He later found himself practically banned from all casinos. So he began studied the stock market and before long he co-founded a hedge fund which delivered a compound return of 15% over 19 years, only to be dissolved because his partner was associated with the then junk bond king Mike Milken and hence was under SEC investigation and later trial.

I sure wouldn't have guessed a mathematicians would lead a life like that. But the biggest discovery of the book was about another math professor John Kelly and his concept of the Kelly criterion, which became the cardinal rule in gambling but never appeared in modern day finance, just like the whole value investment school of thought by Graham and Dodd.

In mathematical term it means maximizing the geometric mean will maximize long term grow rate in a repeated gamble with a positive expected value. In my term it translates to "it's better be safe than sorry" in investment (or gamble). Being risk averse in making investments will generate the greatest long term wealth, whereas being risk neutral will lead to blow up in the long run in certainty. This is why it's common to witness strings of success followed by spectacular fallout in finance. BTW, the Graham and Dodd school of thought follows very a similar line of reasoning but without the mathematics, i.e. stress of capital preservation before appreciation.

I know this all sounds too philosophical but this has always been a mystery and dilemma to me, as my felt like playing safe but was taught to be risk neutral in making decisions. So thanks professor Kelly for providing the mathematical ground.

Results Brief: Shui On Construction (983) - part ii

2008-05-19T15:20:00.000+08:00

Part ii is about the relatively small but interesting cement business (45% owned JV with French Lafarge).

The JV is the largest cement producer in the central/southwest whose development has been the government's priority, irrespective of the earthquake. Cement is a very localized business and transportation costs make trans-province sales next to impossible. A favorable development is that the industry is undergoing consolidation because of excess competition (and expansion) in the past. Reinvestment has been kept low and old facilities which are environmentally unfriendly are plenty. It's good that government is enforcing stricter standard and so unfitted facilities are closing down quickly. This is reflected in the rise of the cement price across the nation.

It's worthy to note the JV's average selling price of cement last year was higher than Anhui Conch, the industry leader. So it seems the JV doesn't compete on price and there should be little doubt about quality of cement and the technological level of the plants. Capacity was 24m tons p.a. and the JV plans to double it to 50m tons by 2012. For comparison sales volume of Anhui Conch was 87m tons last year.

Profits are starting to climb. Before tax and impairment charges (on old facilities), SOC's share of earnings was $90 million last year and just $30 million the year before. Last year's share of turnover was $2b, the low profitability and high selling price seem to suggest there's much scope for improvement.

Like last time, it's very hard to put a value on a turnaround business. If I use the takeover of Chia Hsin Cement by TCC last year as a benchmark, then the value is 3x turnover (i.e. $6b in SOC's case). If I take the internal transfer price of SOC's guizhou cement plants to the Lagarge JV (which happened this year), then it's 1.5x book value (i.e. $4b for the all SOC's cement assets).

Both method give a very modest valuation if compared with Anhui Conch, which has 8x the capacity and generated 10x the turnover last year, had a market capitalization of $116 billion (@$74), more than 19x of even the higher value of $6b I just arrived. The Taiwanese Asia Cement which had similar turnover and size to SOC's stake in the Lafarge JV is currently listed at a capitalization of $7.2b. So it appears my ballpark figures should be close enough.

The combined valuation of SOC then becomes $10b (from part i) and $6b of cement assets minus $4.5b debt, which equals $11.5b. The current market capitalization (on enlarged basis after CB conversion) is only $7.6b, so it appears the current price is very safe and backed by ample value.

I must warn this share is not actively traded and there's great fluctuation in daily volume. And you may want to refer back to my analysis of SOC last year to complete the picture, for there were things that I won't repeat here.

DISCLOSURE: I hold 983 at time of writing.

Results Brief: Shui On Construction (983) - part i

2008-05-17T17:42:00.000+08:00

There's been a change in the business mix of SOC, as it has been selling down its Shui On Land (272) holdings. The SOL shares were part of the original attraction of buying SOC because SOL was itself undervalued in my view, and indirectly buying it via SOC gives an additional holding company discount.

But now SOL holdings is down from 17.5% to 9.5%, and further sales are likely for SOC to finance its other projects. So far SOC's has realised $2.8b proceeds and applied $1.8b in property projects, jointly invested with SOL and CCP (its 40% owned distressed property fund listed last year on AIM in London).

I found this perplexing. SOC sold downs SOL shares to co-invest with SOL? It's a similar case with CCP where the AIM listing proceeds were plough back into joint projects with CCP.

One guess is financing in China has gone really tight and therefore SOC had to put money back in. Or maybe those projects were so lucrative that SOC must lay its hands upon. I think the former is more likely though I don't doubt the viability of the projects. Business risk has risen as a property portfolio (via SOL/CCP) is replaced by individual investments.

With the above in mind. SOC now is a combination of China properties, cement, construction, and venture capital.

The property assets include 9.5% in SOL, 40% plus CB interest in CCP, and individual projects. As the SOL holdings are expendable, it's fair to use market price to value those shares. For interest in CCP and individual projects totalling $4b, 1.5x book value is about right given past completed projects of CCP were quite profitable, which should balance out the relatively unknown quality of SOC's new projects. If the property market does get from bad to worse, then CCP should get more buying opportunities (as it's a distressed property fund), which means it isn't totally bad for SOC.

There's a fund management component in the CCP business where SOC earns both management and performance fee out of the minority shareholders (~$3b invested). However I don't see much contribution yet as it only started out in the 2nd half of last year. As SOC are committed to these projects anyway, via CCP or co-investment, this is a nice side business with no incremental cost but upside. Last time I attached as much as over $1b for this part, maybe too aggressive as I overestimated the fund size, but $500m of capitalization should be attainable.

Construction business provided too little contribution although it's improving, and venture capital investments are just too remote for me (even profits are mostly accounting profit). So I won't spend more time here.

Up to now the combined value is about $10b.

DISCLOSURE: I hold 983 at time of writing.

Results Brief: Chalco (2600)

2008-05-07T11:07:00.000+08:00

Here's the long overdue review of the final results of Chalco, so late that it's even after the company's 08Q1 results. My apologies, as I had a conclusion quite some time ago but couldn't find the time to put it down. And my neck pain led to further delay.

So let me start with my conclusion 1st to save you reading time, Chalco is still a good investment but unlike when I recommended it in Jan last year, I don't think it can outperform the index (2828) this year. So if you have a fair share of money in the index already you need not bother adding Chalco.

Final results were far below expectation, or more precisely 2nd half results were quite bad considering Chalco had taken on a few aluminium smelters. I was looking for earnings of about $13b (a guess based on 1st half earnings of $6.6b) but in the end there's only $10.2b. If you work out the math you'd see 2nd half results were only half of the 1st half.

Segmental margins for alumina and aluminium were 27% and 19% in the 1st half but full year margins decreased to 23% and 14%, so 2nd half went pretty bad as Chalco was squeezed pretty hard at both end of the value chain. This wasn't something I had expected as a lower alumina price didn't seem to help the downstream aluminum business.

Management reported that alumina was still in shortage (though China will probably gain self-sufficiency in a year or two) and aluminum market was basically in balance. And looking at the use of metals, i.e. construction, transportation, electricity, and packaging, it's safe to say demand will hardly go away. Yet prices were falling for both alumina and aluminium. Management cited the fear of the US economy softening in the 2nd half drove London future prices down which in turn affected the domestic prices in China. This is probably true as Chalco has to compete with import as well and alumina/aluminum is a light metal to be transported around.

Another contributory factor, though smaller, was the newly acquired smelters which were likely to be run less efficiently (henceforth the reason for integration with Chalco), and it will take time for Chalco to turn them around and synergy to kick in.

Chalco is extremely financially sound, so much so that I think it should not issue any more new shares in future acquisitions. Gearing was only 30% (it's always been kept at such low level) and interest coverage was over 16x.

One can't go wrong putting money in the biggest alumina/aluminum producer in China which occupies over half of the market, for demand will continue to grow as long as China is in the building mode.

DISCLOSURE: I hold 2600 at time of writing.

Results Brief

2008-04-22T15:29:00.000+08:00

Tomson (258)

There was some progress in the selling of a smaller luxury housing project in Pudong. Proceeds were $1 billion or thereabout and delivery should happen in 2008. This should bring in some decent profit but overall valuation of Tomson still hinges on Tomson Riviera, which takes up at least 2/3 of the company valuation, with the remaining 1/3 composing of smaller developments, commercial buildings, and a golf club.

2 out of the 4 towers of TR have been labeled rental properties and that mark-to-market adjustment increased the company NAV to $7b, more than double of the market capitalization of $3.3b. The remaining 2 towers should push the NAV to over $9b.

The biggest risks remain to be the timing of sale, the application of the Land Appreciation Tax, and how the proceeds are to be used.

Treat it like holding the property itself should make one comfortable. I would rather invest in completed properties with discount to market price than in a landbank with massive premium to NAV, or 'adjusted' NAV which one can never be sure how those adjustments came about.

RIMH (1997)

Results were slightly ahead of my expectation, earning $312m with a net margin of 9.3%. Turnover and net profit was up 57% and 70% respectively. ROE was 25% and there was no debt. Whether this momentum can be sustained is to be seen, as this account was the 1st one post listing.

I hope any impact from the resignation of independent directors and accounting staff will be left behind after say the next interim report. But looking at the pay scale of RIMH I do think the last debacle might have to do with compensation.

On fundamentals, RIMH seems vulnerable as it's single product/process company. SMT processing is also a single step in the LCD display manufacturing process. Its good fortune relies to a large extent on its relationship with fellow Taiwanese LCD manufacturers. But at least RIMH is slightly better positioned than pure LCD display assemblers. The growth of flat TV market worldwide should continue.

However, I wouldn't count on RIMH getting a very high p/e ratio, perhaps a max of 8x is already very generous at today's market. Deducting from this, the current p/e of 4.6x puts RIMH as a speculation but not a very compelling one.

RIMH will be reporting its quarter results on the 28th and there was speculation of a special dividend. But I certainly won't want one if the reason is a slowdown in business.

Meadville (3313)

Results were expectedly good. Turnover went up by 43% to $4.5b and net profit (after adjusting for share award expense) went up by 61% to $700m. Net margin was 15%, also up slightly and ROE was 25%. Capital account i.e. fixed assets doubled up last year while net gearing increased to 80%.

The 1st report after listing is usually good for most companies so let's not get too carried away. But I do like Meadville focuses its PCB business on telecom infrastructure which makes it a beneficiary of the huge capax program of the telecom companies. These higher count PCBs and HDIs required also make Meadville more resilient to margin erosion. I also like it generates 2/3 of turnover within China making it less vulnerable than other export based manufacturers.

Another bright point is the acquisition of Aspocomp's shares and plants in China last year. The giving up of manufacturing capability by a Norwegian company in the business is good proof that higher-tech manufacturing outsourcing is continuing and that Meadville has reached a certain plateau to satisfy even the toughest customer.

Talking so much about tech, it's also good to know PCB manufacturing is a lot less technologically evolving than other sectors like for example LCD modules, where manufacturers seem always one generation behind the latest products on market.

Business is expanding fast but if the consumer electronics sector slows down then Meadville will be affected nonetheless. But the higher technological content of its products should provide ample cushion (for there's fewer competitors on that level). The telecom side of the business looks promising as well.

At p/e of about 5x Meadville is a more solid bet than RIMH.

DISCLOSURE: I hold 258, 1997, and 3313 at time of writing.

A Look at the Power Companies - final

2008-04-09T16:20:00.001+08:00

Things happened so fast during the last few weeks that I ended up holding some Datang before I looked at the final results, atypical for me but it wasn't a typical March either.

Huaneng's results came up slightly ahead of my estimate while Datang was slightly below, both by about 10%. So it seemed the coal factor had gotten bigger since the 4th quarter, for my estimate was based on 3 quarters of results.

SIZE

Datang vs Huaneng (YOY growth in bracket)
Asset size: $122b (34%) vs 124b (9%)
Power generated: 118b kwh (27%) vs 174b kwh (13%)
Revenue: $32.8b (32%) vs $49.8b (12%)
Commitment: not available yet

As noted before, Datang has been growing at a much faster pace and is now as big as Huaneng in terms of assets. One reader pointed out the apparently lower depreciation rate of Datang (which led to a higher margin), but I think there should be little scope for maneuver in this area as the generators used should be homogeneous. The lower rate is more likely due to the higher growth, i.e. more generators put in use each year which inflated the fixed assets account.

PROFITABILITY

Datang vs Huaneng
Recurring profit: $3.4b (up 22%) vs $5.6b (down 7.5%)
(2006 figure in bracket)
EBIT margin: 23.6% (24%) vs 15.9% (19.3%)
EBT margin: 17.8% (18.7%) vs 12.2%* (16%*)
ROE: 11.5% vs 12%
Gearing: 2x vs 1x

* excluding associates' contribution

Huaneng's margins really contracted and overall profit declined as well. This was surprising as Huaneng was better hedged for coal price, whose effect should be felt pretty evenly across the industry yet this difference in margins was too great to explain. I couldn't find any explanation or even mentioning of this by management.

The lower ROE of Datang was mostly the result of the A-share issue in 2006 (and to a lesses extent the higher MI payout). But its gearing is reaching the comfort limit of any reasonable investor.

COAL PRICE IMPACT

Datang
Tariff hike: $1.2b vs $2.4b*
Fuel cost hike*: $1.66b vs 2.26b

* according to my estimation as management of both were very elusive and didn't say much on this area. I hope more is disclosed in the final reports.

Again like last time, Huaneng seemed better at managing its fuel with it long term contracts. It generated almost 50% more power yet its incremental coal cost wasn't that much greater. The overall situation actually wasn't that dire for both last year and even Datang's net loss of $360m could be easily absorbed.

Going forward Huaneng gave indication of 18% increase in coal cost in 2008 whilst Datang's figure was 12%. I have no idea why Huaneng's figure is higher as it has contracts running until 2009 for 1/4 of its demand (based on 2006). Datang's figure was lower and some quoted management saying its coal mines will be meeting part of the demand this year. I'm really not sure about the accuracy of this.

Next I try to quantify the impact of further coal price increase.

Huaneng vs Datang
2007 generation: 173.7b kwh and 118.3b kwh
2008 growth*: 12% vs 25%
2007 avg fuel cost**: $0.16/kwh vs $0.129/kwh
2008 increase: 18% vs 12%

Incremental cost: $5.6b vs $2.3b (before tax and MI)

*very slightly lower than 2007
** fuel cost divided by total power generation

The result was dramatic to say the least. For reference last year earnings were $5.6b and $3.4b respectively. Although new capacities will bring in some contribution to partly offset the increases but risen interest cost (esp. for Datang) will be working in opposite direction.

If nothing happens between now and the end of the year, Datang will probably see a 1/2 to 2/3 decline in profit and Huaneng wlll be barely profitable. In fact, the news had it that the whole power generation industry had losses for the first 2 months of 2008; however I couldn't really reconcile the figures to that fact. But nevertheless the situation is bad like everyone knows.

CONCLUSION

How long will this tariff control remain in place is not a question I can answer. But there are believers in the market, like myself, as the prices of Datang and Huenang are far from distressed level. Huaneng is cheaper at 11x p/e vs Datang's 14x but with a higher yield of 5.6% vs 2.8%. I'd say the valuation is fair and there isn't bargain here. Calculating 2008 p/e is not meaningful as it won't be a normal year, and you don't need it to convince yourself not to buy anyway, i.e. if you are negative toward the power sector.

However if you believe the power industry should enjoy normal growth many years down the road, then I suggest you choose the higher grower.

DISCLOSURE: I hold 991 and no 902 at time of writing.

Something Else

2008-04-02T20:23:00.002+08:00

I know I've been late in updating the final results of many companies. I've looked at most of them roughly but haven't really done any analysis in depth. Progress has been very slow as I've been bothered by neck/shoulder pain a lot lately, this has forbid me from spending too much time at the desk. In fact, for all this time I have visited a doctor, an acupuncturist, a bone-setter, and a physiotherapist, with chinese massages in between treatments. After nearly a month of intense treatment I'm feeling much better now and ready to start this blog again.

After this episode, I strongly advise you to get a desktop if you can, as using a notebook really causes posture problem, which like my case can develop into a longer term one. This is especially relevant if you already use a laptop at your daytime job, at which you have no choice. (FYI, before the incident, I used a desktop at daytime and a notebook at nighttime)

An imac looks really nice and can run windows too, this is if you are a fashion slave. Otherwise get a decent sized monitor and an ergonomic chair, don't use your dining chair and definitely not your sofa. Try a trackball if you can as it reduces shoulder stress, and learn to use it with both hands.

Beware, this thing really doesn't go from 1 to 10, it's more like 1,2,3,4, and then 10. You feel some stiffness on and off and then one morning you just can't turn your head no more. And that's too late already.

DISCLOSURE: I have neck and shoulder pain at time of writing.

Searching among Rubble

2008-03-17T18:51:00.004+08:00

Everything is shattered so badly that it's getting difficult to tell a good company from a bad one if one only looks at the share price movement. Indiscriminate selling is everywhere as the yen carry trade continues to be unwound. I really feel sympathy for those who are going to Japan for the Easter holiday, like my brother. But I feel even more sympathy over my stock holdings, of which prices move more like mortgage backed securities now.

After the surge of Yen, I can safely declare RMB is now the 2nd cheapest currency after the USD, which I wouldn't hold. As the USD looks oversold and RMB looks undervalued, owning China stocks in HKD remains the best option. HKD is a funny currency as it's pegged to USD but economically tied to RMB. As interest rate is extremely low and will go even lower, I hope that'll eventually attract speculative money.

After today's decline both the HSI and HSCEI are up by only 6.5% from the end of 2006. Yes, it even underperformed holding yen in time deposit! Here are some stocks which I found are even trading below 2006 year-end prices. (please feel free to add to the list if you find more companies of similar caliber)

ICBC (1398) -3.7%
BofC (3988) -30.6%
BofComm (3328) -16.2%
China Life (2628) -3%
PetroChina (857) -16%
Sinopec (386) -15%
Datang (991) -10%
Huaneng (902) -33%
Mengniu (2319) -23%
Fuji (1175) -49%
Bank of EA (23) -18%
CoscoPac (1199) -30%
ND paper (2689) -52%

I don't know about you but this looks like a typical all-star team to me, and could've been a portfolio held by any given fund. But if you hold these stocks then you would've underperformed the index by a wide margin. Whether this serves a valid investment lesson is another day's topic. Today I'm more interested in finding broken jewels among the rubble, sort of like wild men finding ways to survive after a huge earthquake or nuclear disaster.

The reasons for the dismal share price performances could be that the market is now less enthusiastic about their prospect, or they have problems not identified before, or they happen to be heavily held by funds who need to liquidate positions, or a combination of the above and other factors. Therefore this is not an endorsed list but rather a to-do list.

It's a lot of work to be done in a bad mood but I think it'd be worth the effort in the end.

DISCLOSURE: I happen to hold 3328, 3988, 991, and 1199 at time of writing. This doesn't mean I prefer these holdings over the rest at all.

Results Brief: OOIL (316)

2008-03-06T16:07:00.001+08:00

The results surprised me in two ways.

1st, it was quite remarkable that the rising oil price did not seem to bother the operation too much. OOIL still managed to grow its profit by 29% (recurring and excluding property revaluation) last year. Gross profit was down a bit but operating margin stayed at around 9%, indicating high efficiency.

In fact, last year's profit of $4.3b was not far off from the all-time-high of $4.9b (excluding port operation) achieved in 2004. To say OOIL is well managed is an understatement.

But the negative surprise was the lack of a special dividend, which surely has upset the market including myself. So far only about half of the $17.3b proceed from selling the North America ports has been paid out, and management continues to be mute about the use of fund. I recall UBS was once hired to advise on this matter but if there was any result, it wasn't made known to the shareholders. The cashflow breakdown also confirmed my earlier belief that the shipping business can be self-financed, i.e. cashflow coming in was sufficient for capital expansion. So there's really no need to keep a large pile of cash at the head office.

Another omission was the lack of the outlook section in the results announcement. Maybe the outlook is really cloudy that the management don't want to commit to any view, or they want us to know as little as possible.

China property business had some progress but contribution won't come until 2010. NAV was $5b. Applying a 2x p/b to it and adding the valuation of Wall Street Plaza, the property business should be worth $11.5b. However, the market doesn't seem to attribute much value to OOIL's property business.

Idle cash is at least $8.5b, from disposal proceed alone, and could be as much as double.

For the fleet, I'd stick to my estimate of $24b, i.e. $3b x 8 times p/e.

The combined valuation would suggest an upside of at least 50% from today's price.

DISCLOSURE: I hold 316 at time of writing.

A look at the Power Companies - part ii

2008-02-28T15:50:00.002+08:00

COAL PRICE IMPACT

Datang
Tariff hike: $758m
Fuel cost hike: $1.1b

Huaneng
Tariff hike: $1.4b*
Fuel cost hike: $1b*
* not disclosed so I had to calculate myself which could be very wrong

Huaneng is better at managing its fuel, remember it generated 50% more power than Datang yet its incremental fuel cost (from price increase) was lower. On the other hand, Huaneng’s higher revenue from tariff hike was only the logical result of its larger scale.

Huaneng dealt with the coal problem by entering into long term contracts with miners to ensure supply and probably lock-in purchase price ahead too. The last annual report showed it had secured $5.5b of coal supply a year, about ¼ of 2006 requirement, up to 2009. So Huaneng should continue to have a cost advantage over Datang in the short run.

Datang is more ambitious and is prepared is spend $10b in developing coal mines in Inner Mongolia. Part of the output will also be used to generate natural gas of some sort (I’m no scientist).

Because of their expansion, Datang and Huaneng have so far hung out alright even past tariff hike lagged, both in time and dollar terms, behind the increase in coal price.

But now as further tariff hike is uncertain, I tried to estimate how much negative impact that will cause. To start I’d assume further fuel cost increase to be $1b for every 6 months, which is the same as 1st half of 2007, for Datang and Huaneng.

To put things in perspective $1b is about 1/3 of interim EBT for both Datang and Huaneng.

With an EBT margin of 19.3% and 13.3% respectively, it’d suggest a further $5.2b and $7.5b of turnover are needed to produce enough margin to offset the additional fuel charges of $1b. These mean a 6-month-growth rate of 30%+ for both, much higher than the full year growth of 42% for Datang and 21% for Huaneng. (Note: actually the EBT margin going forward should be lower because of higher fuel cost but I recken the new capacities will probably come with some tax concessions and the two will cancel out to a certain extent.)

CONCLUSION

The answer to the 1st question is no: neither can withstand a tariff freeze for very long without seeing a decline in profit. Datang however is slightly more resilient because (i) it has a higher turnover growth, and (ii) it pays higher taxes and MI which means the net effect to bottom line will be relatively smaller.

The bigger question is how long will this price control be in place? If it’s like the petroleum market then the outlook is indeed very dim. Sinopec has been running losses 3 years in a row but the price reform is still nowhere in sight. But the picture here is slightly more complicated as the total industry profit is shared between the power grids and the power plants, i.e. the power plants sell power to the grids who then resell it to end consumers. As the power grids are said to be very profitable, the government should have some space to maneuver if it so wishes. However, whether anything will be done when the grid companies are themselves preparing for listing is another question mark. If the grid companies are squeezed too tight then their ability to raise funds to build/revamp the power network is compromised.

Valuation wise it'd seem the market has assumed that price control will go away in the not too distant future. Datang at $5.6 has a capitalization of $65b and Huaneng at $6.6 had a capitalization of $80b. Both have a recurring p/e of 17x or thereabout according to my estimation, seems not justifiable if continuing results are seen to be flat or declining. (Note: the ongoing p/e will go lower as RMB appreciates)

Since the results are shortly due there's no need to guess. If the price cap does go away then profit of both should go in tandem with the pace of expansion, and Datang should have the upper hand. It's the preferred choice between the two.

DISCLOSURE: I don't hold 991 or 902 at time of writing.

A Look at the Power Companies - part i

2008-02-27T14:28:00.004+08:00

I've always had good impressions about power companies, especially those in China where demand seems to be growing with no end in sight. Selling power is an easy business, all is needed is a growing population and fair regulatory environment for it to prosper. Buying power companies is more like making a country bet. The higher growth is the country, the better return is for the power companies.

But the problem with China now is the government wants higher growth but without a rising electricity bill. Since it majority owns all the power assets in the country, it manages to ban all tariff hike at the moment. Power companies, faced with rising coal price (60+% of their operating cost) but unable to pass it on, can only pursue volume, i.e. to sell more electricity via expansion. They are also diversifying into alternative power but that's more a strategic move than an economical one, as this won't have material impact on the results until in the medium term.

The critical questions one needs to consider are:

(1) Can the expansion and increased turnover make up for the loss from the rising coal price?
(2) How long will the price control stay in place?

I've focused only on Datang (991) and Huaneng (902). This part will only deal with the 07 interim data and I will tackle the final results later. I'll try to answer the two questions as I go along.

SIZE

Datang
Asset size: $100b
Power generated: 56b kwh, up 35%
Revenue: $15.5b, up 42%
Commitment: $15b

Hueneng
Asset size: $110b
Power generated: 81b kwh, up 14%
Revenue: $23b, up 21%
Commitment: $10b

Hueneng appears more efficient as it generates close to 50% more power and revenue from the same asset base. But it's a distorted scene because of Datang's high growth in recent years (look at growth in power generated and revenue instead). Datang actually has doubled its asset base since 12/04 (I tracked 3-yr data) whereas Huaneng has only increased its assets by about 50% over the same period. Once those new capacities are up and running, Datang will probably produce just as much turnover or may even surpass Huaneng. Another point to note is Datang has 50% more capital commitment in new capacities than Huaneng, indicating strong growth prospect.

EARNINGS

Datang
Recurring profit: $1.8b, up 42%
EBIT margin: 25.3%
EBT margin: 19.3%
Net margin: 14.6%
Net margin after MI: 11.7%
2006 ROE: 14.6% (excluding A-share issue in Dec)
Gearing: 1.72x

Huaneng
Recurring profit: $2.3b, up 7%
EBIT margin: 15%
EBT margin: 13.3%
Net margin: 10.9%
Net margin after MI: 10%
2006 ROE: 13.9%
Gearing: 1.43x

On each dollar of revenue, Datang had much higher margin (25.3% vs 15%), even before leverage. This has been another consistent trend since 12/04. So Datang seems to have done something very right (which I don't know). After paying out financing costs which were twice as much in proportion to sales, since Datang was more heavily geared, the margin gap was still very wide (19.3% vs 13.3%).

Then two unusual items caught my attention - tax and MI. Somehow Huaneng paid profits tax at a much lower rate whereas Datang had a much higher MI payout ratio. Stange isn't it given the two are running the same business? The net effect is such that the net margin after tax and ROE of the two were very close, with slight edge went to Datang (whose figure was distorted by its faster expansion). I checked past figures and found this pretty much has been a consistent trend for the past 3 years.

I have some speculative reasons for these differences, like Huaneng's plants are younger, or some of Datang's lucrative deals had to be compensated by a bigger minority stake. But much time will need to be spent to gain a better insight.

For now, let's just say both are very well-oiled machines, with one running at a faster speed.

DISCLOSURE: I don't hold 991 or 902 at time of writing.

Xinhua Bookstore (811)

2008-02-14T16:52:00.000+08:00

I found Xinhua bookstore an interesting stock when it was listed last year, simply because I enjoy reading books and naturally I was attracted to buying a bookstore share. But the price took off far too early and by too much. It's only very recent that I found the price worthwhile to 'read' the prospectus.

The stock has quite some attractions. Xinhua is the largest bookstore chain in Sichuan and it distributes textbooks for all primary and secondary schools in the province. I don't know the details but I always hear complains about those HK bookstores distributing textbooks making too much profit, so I reckon it may be a good business too in China. And most Chinese parents are willing to mortgage anything if they can to finance education of their children. They never skim on education. In addition, Xinhua, if properly managed, may expand to become a nationwide bookstore chain like those in North America.

But the facts turn out a little different.

1st, the retail operation, i.e. its 190+ bookstores, makes up less than 20% of turnover and doesn't make profit. The management has put it nicely that it generates plenty of cash flow. This in fact is 100% true. The arrangement with book suppliers is that no settlement is made until the books are sold. And nearly all of the books purchased can be returned if not sold after a certain period. On the sales side of course it's COD. So no inventory risk, cash received upfront, and suppliers settled in months. Yet the business still barely breakevens. What's wrong?

I think the tough terms with suppliers are out of necessities, i.e. nobody is buying books, or more precisely, nobody is paying for books. Books are intellectual properties, which in chinese term means 'trash' and nobody cares. Like CDs and DVDs, I can imagine a huge supply of pirated books in the market driving down prices of all books. Worse, there's electronic books all over the internet and younger generations may never need to touch a book, let alone pay for one. Sharing is all wonderful, isn't it? Why pay for anything if it's free on internet?

One direction Xinhua can take to like go asset light but strong on logistics like Amazon. But I bet even Amazon will have a tough time in China with this level of piracy.

Nevermind, the bread and butter business of Xinhua is textbook distribution. This made up more than 80% of sales and all the profit for the IPO track record period. Segment profit was quite high at 20% given what Xinhua did was to pass the books from suppliers to schools and students. However, there's no competition because this area is heavily controlled by the central government (no surprise) and only selected bookstores are granted exclusive distribution right. Xinhua thus has been the sole distributor in Sichuan for decades. Monopoly leads to excess profit, although it's probably true that the bookstore network also functions as distribution points which are now cost-free to the distribution business, i.e. real margin should be lower.

Xinhua also has got another sweetener: it's not required to pay any VAT nor profits tax (from 2006), as the central government wants to encourage the good habit of reading to increase the quality of its citizens. So it has to be sure no bookstores will go belly up.

With all the help Xinhua's net margin grew from 10% in 2005 to 13.5% in 2006. Profit in 2006 was $300m with sales of $2.2b (marginally up from $2b in 2004).

So far so good even if Xinhua has to bear the unprofitable bookstore operation. But the government's policy is changing and it's trying to open up the distribution market for competition in all provinces. The distribution right will go through a tendering process like any government contract would. In fact, Sichuan was a trial province and Xinhua won the last tender which will last till spring term 2008, which is now.

Now comes the perplexing part. Will Xinhua win the next distribution right? It should since it has the most established infrastructure in place already. But what's the point of the reform if it's the same old Xinhua over and over again? Xinhua also states in its prospectus that it will try to bid for neighbouring province's distribution right. This is more interesting as other provinces' Xinhua (it's a common trademark shared nationally by all state owned or ex-state owned bookstores) will have no choice but to bid in Sichuan as well, just in case it loses in its home turf. And it helps neither of them if they end up winning the other's right, in which case they might just swap back the right!

So it doesn't look to me that this reform is going anywhere. One thing for sure though is that all these biddings will drive down the margin of all future right!

A more likely development is for Xinhua to expand by M&A, issuing shares and taking over neighbouring Xinhua one by one. If policy allows this seems a better expansion route. But the current low share price will be hard to appeal to others.

In fact the Xinhua management seemed to concur and found more creative use of its IPO proceeds (~1/8) in investing in Chengdu City Commercial Bank as a strategic investor. A bookstore can be a strategic investor of a bank? You bet. I remember even if one sells in the 1st month of IPO, he's still a strategic investor, and his sale is considered a strategic sale!

Because of all these confusions about Xinhua's future I won't bother even it's cheap. Plus I try to avoid any business that can prosper only because of status, privilige, or government protection.

DISCLOSURE: I don't hold 811 at time of writing.

p.s. i apologize for there may be a lot of typos as somehow the spellchecker isn't working.

Housekeeping: What to do with those losers? part iv

2008-01-30T16:15:00.000+08:00

RIMH (1997)

This series is running like a journal now. I must have been cursed!

I suggested this share last Aug at $2 but now it's down by half to $1. At one time it was as low as 80 cents only! It's the biggest money loser in this blog and among my personal holdings too.

What happened was one day out of the blue the CFO (also an executive director), the qualified accountant and company secretary (same person), and all independent non-executive directors walked away. You can't have a no-confidence vote stronger than that.

The official explanation was the CFO had some misunderstandings about his future in RIMH and the closing down of the HK office, the INEDs had some misunderstandings about the leaving of the CFO and the use of IPO proceeds, the qualified accountant/company secretary found no misunderstanding but a new job.

This sounded like a total mess and consequently the market awarded a valuation of the same.

BUT I think it may look messier than it actually is.

The most paramount concern is whether there's any indication of fraud involved. The ex-CFO is relatively young at 33 and only joined RIMH in 2006, mostly for the IPO I suspect. The ex-qualified accountant/company secretary was even younger at 29 and joined RIMH in 2007. I don't mean to discriminate either of them but it would seem to me that more (preparation) time and experience would be required to perpetuate any accounting fraud, especially with an IPO.

Looking at the business model of RIMH where substantially all business are conducted in China, the function of the HK accounting staff is likely only for liaison with the regulators, accountants, and lawyers. They probably get busy during the reporting season but otherwise should be pretty free. So it's not a surprise that the chairman/owner of RIMH would want to keep the HK overhead as low as possible, barely enough to satisfy the HKSE requirements.

So I think the story is as it's told. The chairman asked the CFO to be transferred to the international sales department. He didn't like it and quited. There may have been some disagreement about salary increment too but I'm only guessing. The replacement CFO is even younger at only 30.

The counter argument is that all accounting fraud is masterminded in the China offices and hence minimum competency is preferred for the accounting staff in HK. It's valid argument but I doubt whether the E&Y auditors can be held in the same regard.

The INEDs didn't really know what's going on, got scared, and quited together. There's mentioning about the actual usage of IPO proceeds being lesser than that written in the prospectus. But there may be legitimate reasons for the change, a slowdown of sales for example. One can't draw conclusion from this lone fact. I think the INEDs might also be upset by the special dividend paid in Q3, which I agree is unusual (but i've seen another new listed company did the same). The chairman of RIMH might want to cheer up the share price a bit but this act showed his lack of consideration and understanding of the HK capital market. I agree this is a question mark area which requires further explanation. My suggeston is RIMH should really retain some quality advisers if its wants to regain market confidence.

RIMH for its fundamentals was a good investment at $2. Now its status has been downgraded to a speculation, but a good one at $1.

DISCLOSURE: I hold 1997 at time of writing.

A Comparision Between 2 Headphone Makers - part ii

2008-01-28T16:38:00.000+08:00

Today I'll finish the series off with Fujikon (927).

1st difference of Fujikon from AAC is it makes earphones connected to a phone, not built-in, e.g. blue tooth hand-free ear pieces that cling to your ear, and audio-grade stereo head phones that can be used for music as well. Some has radio built in and some can be used to control a phone and an ipod simultaneously. These are lower value-added products and hence have a lower margin. But I suspect there's replacement demand since some people lose their headphones, some will keep one in their cars, some buy for improved audio quality when new model becomes available. Fujikon is also a supplier to Nokia for earphones and hence its business has been prospering while Motorola is losing market share.

Fujikon also makes premium audio-grade headphones for home audio and hand-held electronics. Other than the organic growth of the market helped by popularity of mp3 music, new headphones with wireless and noise-cancelling ability creates new demand and increases unit price. Fujikon actually has a much higher margin (20% vs. 8.5%) in its audio products than mobile phone products. In absolute term audio products also contribute more to the gross profit.

Besides Fujikon makes headphones for Microsoft's Xbox 360 consoles but that's not a lot of contribution by comparison. Audio and electronic parts, mostly volume business with low margin, make up the rest of the business.

Contribution wise, according to the latest interim report, the proportion is audio 44%, mobile 25%, Xbox 8%, and parts 23%. Historically there's some variation but still it's clear Fujikon is less reliant on the mobile phone sector for business. However because of its small size Fujikon does have its fate hinged on a few of its major customers (Nokia took up 1/3 of its turnover in 2006).

Fujikon is an efficiently run manufacturer with some technological content in its products to differentiate itself from its competitors. ROE has been close to or over 20% for the past 3 financial years with no use of debt. This was impressive as the past few years were bad years for manufacturing and especially exporters. Fujikon seemed to have its breakthrough in FY2006 after signing a few big accounts - Nokia, a U.S. audio brand (maybe Shure), and Microsoft. I hope this good trend will continue.

Profit was $160m in FY06 and it was about 1/3 of AAC's FY07 profit of $500m. Interim profit was up 48% so it's likely that full year profit will be higher than that of last year, 3rd year in a row. That closes the gap between Fujikon and AAC further.

Fujikon is now only trading at 5.4x FY06 p/e and has a capitalization of only 1/10 of AAC. I think there's a lot of scope for the price to catch up.

DISCLOSURE: I hold 927 and no 2018 at time of writing.

A Comparision Between 2 Headphone Makers

2008-01-25T14:55:00.000+08:00

Today I want to write down some comparison between AAC (2018) and Fujikon (927) which I did earlier this month. I won't repeat the basic investment theme as that's been unchanged, and readers can always go back to my previous post on industrials one year ago for that.

AAC manufactures mostly headphones 'inside' a mobile phone, in other words mini speakers. These mini speakers also find application in computers and appliances. I assume that's not generating a lot of turnover now (because no segmental breakdown is disclosed) but AAC is trying to diversify out of the mobile phones so future sales should increase.

Apparently AAC is very good at making these mini headphones as it has kept its net margin at over 30% for the last 4 years (03-06). 07 margin has come down to 26%, still very respectable for an industrial. This high margin reflects the strong growth in the mobile phone market and the higher technology content of AAC's product (i.e. fewer competitors), and of course the migration of manufacturing to the low-cost China (this last one has become such a cliche, although true, that I won't repeat in my future posts).

Profits have been growing nicely from $138m in 2003 to $570m in 2006. It's 4 times in 3 years! So AAC was trading between 15x-20x p/e for most of 2007 even the attention wasn't on export companies. There's a lawsuit about IP right which might have dampened the share price, but since that was settled last month I didn't look into the details.

The share price weakness was actually the result of weak 07 interim figures (AAC adopts quarterly reporting), in which profit declined by half in 1st half of 07. Q3 reporting showed substantial improvement but YOY profit was still down 25%. The slowdown was caused by weak order of its major customer Motorola. AAC may have foreseen this already for some time and it started shipping to Nokia in the Q3 (after the lengthy certification process). The business seems to be well run by its Singaporean management.

Judging from the strong Q3 turnaround, I expect full year result to be around $500m (assuming AAC makes similar profit in Q4 as in Q3), slightly down from $570m of 06. It could be lower if Motorola orders decreased further in Q4. 07 p/e is about 18-20x p/e, about fair but definitely not cheap.

The business is sizable. Financial position is healthy as AAC is in net cash position. Customer base has gotten stronger with Nokia, though I prefer AAC to be less reliant on the mobile phone market. The U.S. economy slowdown may continue to affect Motorola and hence AAC. AAC is trading at a 'growth' premium which one has to keep a keen eye on.

Why Sub-prime sucks but its Culprits don't?

2008-01-17T15:45:00.000+08:00

Imagine you are running a restaurant and you keep fouling up your business, your dishes taste awful and once in a while you get heavy fines from the health authority, you've run into heavy losses, about to go belly up, but yet people are lining up at your door, not for food but bringing cash to invest into your restaurant. Are we in Alice the Wonderland!

This wonderland now exists in U.S. financial sector.

You may wonder why the name of Buffett hasn't appeared on the buyer's list, for he is famous for buying great companies in distressed times. Aren't Citibank and Merrill great names to hold? In case you don't know Buffett has once bought a stake in Salomon Brothers, the then famous investment bank / bond traders and now part of Citigroup. So he already knew too well.

He invested at that time because he personally knew the then Chairman of Salomon, whom in his eyes was an honorable business person (but the business was corrupt). Well of course he also found the price attractive enough. The end result was bitter however and at one time when Salomon was investigated by the SEC and the government about it allegedly cornering the U.S. treasury bill market, Buffett had to step in as the interim chairman and got involved in day-to-day management in order to save the company (also his investment) from being banned from business. Along the way he discovered more about the inner workings of an investment bank which led to his decision to get out eventually.

Investment banking is really about reckless business management using OPM. During good times 50% of profit goes to the employees (in order to retain them), but in bad times, the employees go (because they shouldn't be retained) and owners have to bear 100% of the loss. It's not hard to imagine what the management would do under this payoff structure. This is plain stupid business proposition.

I'm not saying those funds buying now will lose money, they may win big too but only because this is a special situation play. Look at the losses of all the other shareholders. Investment bank as a category can never be classified as an investment.

Anniversary Look at the Shipping Companies - part ii

2008-01-17T00:45:00.000+08:00

COSCO (1919)

COSCO has transformed into a dry bulk shipper. Its old business of container shipping and port operation (via COSCO Pacific) now contributes maybe only 15% to the bottom line. A better benchmark for comparison is China Shipping Development (1138).

Business wise the two differ slightly. CSD has 2/3 of its turnover from shipping crude oil and 1/3 from dry bulk (mostly coal). Its routes are 60% domestic and 40% international. COSCO on the other hand ships mostly iron ore (40%), coal (30%), and grain (10%) from overseas to China. COSCO's parent operates an oil tanker fleet which has yet to be injected into COSCO.

Oil and dry bulk shipping is more defensive than container shipping as China demand for resources is much more robust than consumer demand of the US and Europe whose economies are slowing down. Specifically all the infrastructure China has to build in the next few years will require a lot of steel and hence iron ore. Coal is mother of all energy and China doesn't have enough either and has become a net importer. Grain shortage is fast becoming a problem as well and so demand should also grow strong. Oil requires no explanation and so much for the broad picture.

CSD is trading at 15x 07 earnings (25x 06 earnings). I've included 06 p/e as well because looking at the freight index it seems 07 is an extraordinary year and no one is quite sure performance like that can be repeated. The index has dropped by more than 30% since peaking last October. Actually if you look at the movement of the Baltic dry index over the last few years, then the recent rise and fall of HSI is really nothing in comparison.

COSCO is trading at a lower 9x 07 proforma earnings. Apparently the market perceives demand for oil tankers will be stable even under economic downturn, and that CSD's less international exposure is safer. But a large premium in share price has done away much of the attraction so I'll pass. I also remember CSD once (I think in 2005) was trading at only 5x historical p/e and many researchers (including Quam) were suggesting a sell. Of course they were then embarrassed but my point is market can be very wrong, far more than you can imagine and you may not survive the interim loss.

COSCO's dry bulk fleet had earnings of more or less $6-8b in 2004-06. Then 2007 interim earnings shot up by nearly 100% to $6b and management last estimated only 2 days ago full year proforma earnings to be well over $18b (incl. container shipping and port operation). I assume non-dry-bulk business to contributed about $3-4b and hence dry bulk business should earn about $14b or more last year, as it's hard say what "well over" really means and I don't know if there's any non-recurring items.

Looking forward, what earnings should I use? 7b or 14b or somewhere in between? This gives a total group earnings ranging from $10b to $18b, or p/e of 8.6-15.5x against a capitalization of ~$155b. If I cut it in the middle then p/e is about 12x, still considerably cheaper than CSD historical p/e of 15x.

One concern is the age of the fleet as I read from the acquisition that dry bulk fleet worldwide is quite old due to lack of investment in the past and many ships are near retirement age. These ships are only hanging there because demand is so strong. If you look at this positively, then if demand does slow down these ships can retire and won't drag down earnings of everyone as much. If you look at this negatively, then replacement ships will carry much higher current cost and depreciation charge.

For COSCO, it owns ships for 40% of its capacity while charters for the remaining 60%. It seems a safe position to me, neither too aggressive nor conservative. If things turn really bad COSCO can always charter fewer ships.

I think the current price is tempting for speculation but only fair for investment.

Note: On a more difficult note, since merger accounting was used to account for the dry bulk fleet acquisition, there's no mark up of asset value and depreciation going forward will definitely be understated. So the p/e should be adjusted higher.

DISCLOSURE: I hold 316 and no 1919 at time of writing.

Anniversary Look at the Shipping Companies

2008-01-16T17:03:00.000+08:00

It's been a little more than one year since I first covered the container shippers. Their prices started out slowly during the 1st half of last year, then skyrocketed until October, and since then have been dropping like a rocket running out of fuel. The price movement has been much wilder than I've anticipated (even though I've seen OOIL rising from $4 to $40 in 2004 I'm still surprised this time around), and I've taken profit much too soon. But I took comfort that I could've made a huge loss as well if I bought them at the wrong time of the year.

Cyclical stocks are all about timing which is very difficult to catch, even shipping companies can get grossly wrong when predicting customer demand. So the only safe entry is to buy at beaten down prices when the need for guessing is reduced to minimum. Like last time I've avoided the analysis of the shipping industry overall because that will be too darn imprecise that even I won't rely on myself. However you can refer to my previous post in Dec 06 for background info and my very basic look at the industry.

A better time to do this review should be April after the full year results have been announced. But since we have earnings forecast from both CSCL and COSCO, there should be reasonable accuracy. And the recent massive sell off should provide additional safety for compensation.

CSCL (2866)
Capitalisation is $37.3b. 07 interim earnings were $1.15b and management forecasted FY earnings to be $3.2b.

P/E is about 11.7x, nothing spectacular. It should've been adjusted lower as the A-share issue was completed toward the end of the year while its effect on earnings (from expansion with the use of the proceeds) will only be seen next year. Still it looks pretty pricey for a cyclical as 07 isn't an average year but a relatively good one. There continues to be a premium for possible injection by the parent company.

OOIL (316)
Capitalization is $28b. 07 interim earnings (recurring) were $1.6b. 07 earnings will probably be higher than $3b but I'd rather be conservative as interim dividend was cut back. So I'd stick to my previous estimate that OOIL should earn $3b in an average year.

The interim report showed OOIL had cash and bonds of $21.5b, with debt of about $16.7b. OOIL's common practice is to have its fleet 80% financed by loans and 20% by equity. The fleet had a book value (net of operational debt) of $23.4b, meaning the entire cash and bonds isn't tied up and could be distributed! Of course part of it would be needed for buying new ships and daily operation. I'd assume $15b is idle cash and distributable.

Properties in U.S. and China had a book value of $5.7b and my assessed value is unchanged at $10b.

Taking out the cash and properties, we have a fleet that's valued at only $3b. And it earns $3b a year! Even if I use book value for properties, the fleet is still insanely cheap at $7.3b! At this valuation, I won't be worried even if earnings drop all the way to $1b.

I think OOIL's share price is approaching liquidation value, except it's far from liquidation and in net cash position.

I'll continue with COSCO in my next post, separately, as its business has changed to largely dry bulk shipping.

Don't sell all you want and all you can!

2008-01-15T12:32:00.000+08:00

I think this week is probably the Armageddon as everyone is selling in anticipation of the worst possible results of the U.S. financials to be released, and its ramifications over the economy and everyone else. And as normally we tend to over-exaggerate bad things, the end of the tunnel should be near, share price wise.

I was going to suggest we start looking for bargains, but then I figured most of us (including myself) are probably out of cash and as convinced to be a long term investor as ever. So the next best course of action is to do nothing and wait for the storm to pass, which it certainly will, just as certain as it will come back one day. Like Warren Buffet once said people have this weird logic that they should shy away from the market when there's uncertainty or bad news, thinking however that once that's cleared the good times will last forever.

If you are a fund manager then you lose this option, as redemption demand can come anytime and you need to have the cash ready. Even if you have solid investor backing you will still need to sell down fast, because you know your weaker competitors are selling and that's driving down the prices of many over-valued shares which you all helped build up in the good times. Even selling below value isn't a concern as long as you sell faster, because relatively the fastest seller will still outperform in the end.

With large presence of indiscriminate sellers, that's why I believe good catches can still be made in difficult times.

Something Else

2008-01-10T12:06:00.000+08:00

The best thing our government has done for a long time. The anti-spam law was effective last Dec and now all we have to do is to call and register our fax/telephone/mobile # onto a registry. So there should be no more "computer repair" or "hello, have you done your medical check-up" kind of irritating stuff. But I've also heard spams from out of H.K. (including China) still roam free. Let's hope there's not a lot of those.

Instructions are in the file below. It's a bit cumbersome but well worth the effort. Just remember you need to make 2 calls, one to register and one to confirm, to complete the registration.

http://www.ofta.gov.hk/zh/uem/how_to_register.pdf

Report Card

2008-01-04T15:27:00.000+08:00

This is the 2nd report card of this blog, mostly for record of my workdone.

For 2007 there have been more than 30,000 individual visits, 2/3 of which are returning meaning regular visits. This is a small group of readers but has gotten bigger. I thank you for your support.

Summarized below are the companies which I've covered so far and their share price performance since. The proper way to do this is to include the financial performance as well but that's too much work for one person. I have also put down which companies I hold shares in for better disclosure.

Please note this is NOT a recommended buy list. For example I disliked COSL (2882) at $6.1 last March but it closed at $17.8 last year!

(for simplicity dividends are not included except stated)
(* means present holding)

Dec 18 06
China COSCO (1919)
up 554% from $3.887

OOIL (316)*
up 48% from $48.5 (dividends added back)

Dec 20 06
Tomson (258)*
up 46% from $2.05

Dec 27 06
WKK (532)*
up 12% from $1.12

Jan 2 07
Dickson (113)*
down 9% from $7.91

Jan 8 07
Man Yue (894)*
up 15% from $2.03

Fujikon (927)*
up 89% from $1.80

Arts Optical (1120)*
up 19% from $2.58

Yip's Chemicals (408)*
up 47% from $3.82

VSC (1001)*
down 13% from $0.98

Jan 9 07
Chalco (2600)*
up 232% from $6.95

Jan 16 2007
SH Petrochemicals (338)
up 18% from $4.07

Jan 24 07
Meadville (3313)*
down 4% from $2.25

Jan 29 07
Xinyi Glass (868)
up 204% from $3.71

Jan 31 07
ZJ Glass (739)
up 438% from $1.68 (my 'miss' of the year)

Feb 2 07
LSH (238)
up 264% from $3.40

Feb 13 07
PCCW (8)
down 1% from $4.67

Feb 16 07
HKCG (3)
up 37% from $17.48

Mar 22 07
Sinopec (386)
up 94% from $6.07

Mar 27 07
COSL (2883)
up 291% from $6.11

Mar 28 07
Hendersen Investment (97)
up 50% from $15.52 (surprise of the year) (dividends added back)

April 3 07
Proactive Technologies (8089)
up as much as 270%, in the end down 45% from $7.27 (roller coaster of the year and 'death bed' of many)

April 12 07
China Glass (3300)
up 18% from $3.40

Apr 16 07
Shui On Construction (983)*
up 64% from $17.40

May 11 07
Belle (1880)
up 43% from $8.40 (opening price not IPO price)

May 22 07
Dong Fang Electric (1072)
up 75% from $37.5

July 5 07
H-share index fund (2828)
up 30% from $125.1

Aug 21 07
RIMH (1997)
down 19% from $2

Nov 1 07
SOHO China (410)
down 19% from $9.98

Shui On Land (272)*
down 15% from $10.7

DISCLOSURE: I hold those shares with * at time of writing.

Housekeeping: What to do with those losers? part iii

2008-01-04T15:15:00.000+08:00

I hope this series won't turn into a regular feature of this blog!

(3) VSC - down 13% from $0.98 in Jan 07

I suggested 5 industrial stocks one year ago in Jan 2007 and labelled them as underdogs. VSC turned out to be the real dog of the dogs, as it's the only money loser!

I knew VSC was the most speculative among the dogs and its performance, both share price wise and earnings wise, unfortunately lived up to its reputation. It rose from under 98 cents last Jan to over $1.8 in June, but by the end of the year it's retreated back to 85 cents. Earnings in FY07 showed substantial improvement at $71m (inclusive of one-time gain from selling a 40% stake of its coil business to Ryerson), but in FY2008 interim earnings deteriorated by 50% to $21m.

VSC's coil business in China and construction steel business in HK was both hit by negative policy change in China. But I won't bore you with the details. VSC as a pure commodity processor and distributor with no size advantage, has an inherently unstable business model because it has no control over the volatitivity of upstream pricing nor influence over its product pricing. Its past 5 years' results (2003-2007) were clear indication of this instability: 60m, 81m, 36m, 23m, 71m.

But VSC's attraction lies not on its own but with its joint venture with Ryerson, the #1 U.S. company in steel processing and distribution with annual sales of US$5.8 billion. I had expected Ryerson would bring forth new businesses and technical know-how to help VSC grow into a much bigger player. The effect has not been apparent yet after one year of integration and logically market enthusiasm faded.

What I didn't know (what a shame to me!) was that during this period Ryerson management was in a big fight, with a hedge fund who criticized them for lack of performance and wanted to overhaul the whole board. The management eventually found their way out by selling Ryerson to another private equity fund in July last year while taking the golden parachute themselves (i.e. getting handsome compensation from the buyer). Now there's a new CEO and Ryerson, as in usual after a takeover, is loaded with debt and in cost cutting mode. The fate of its China venture with VSC is unknown.

It's time to get out of VSC, it's valuation is still cheap, or even cheaper than one year ago, but for good reasons. I'll sell on rebound unless there's positive development from Ryerson side.

DISCLOSURE: I hold 1001 at time of writing.

Housekeeping: What to do with those losers? part ii

2007-12-31T10:43:00.000+08:00

(2) WKK (up 12% from $1.12 in Jan 07)

This one is technically not a loser as it share price is above water, but its significant underperformance against the index made it so.

I had hoped for something to happen to this M&A prospect when I suggested it last year. And a second privatisation attempt did come by, at $1.68 in April which wasn't generous but still would have netted a 50% return if I sold it back then. Actually I had planned to sell part of my holdings just before the SGM as a hedge, as I knew Senta Wong and his parties would be buying all votes they could muster so there'd be no problem getting rid of my shares.

Then something unexpected happened as David Webb showed up and announced he had enough votes to block the deal. He obviously tried to force a better offer (he suggested $2.5) but failed as Senta Wong did nothing. In the end the share price retreated and we are back to square one. I don't blame Webb for raising the stake as shareholders' movement is sorely missing in HK and his work is good for everybody in the long run.

Things then took another downturn as WKK announced a worse than expected interim results (Jan - June 07) with turnover and profit both sharply down. This was confusing as Senta Wong should've known about this already and if he had waited until say Oct to put up his offer, he would have likely succeeded. From what I saw in the SGM, Senta Wong appeared a competent business man and I guess he should have known about this better than anyone.

So what really is his plan? Is the business really going downhill or is there unspotted value inside that's worth two privatisation attempt? This continues to be a mystery.

I begin to see a pattern in my bad calls. I tend to hang on too long with owners who are smart but sometimes too smart for us shareholders - a good lesson learnt for 2007.

Similar to Dickson, I'm thinking of unloading this share when there's more turnover. Another reason for doing so is to keep fewer shares that have little or no (margin) financing in the portfolio, which is another goal for me in 2008.

DISCLOSURE: I hold 532 at time of writing.

Housekeeping: What to do with those losers?

2007-12-28T15:39:00.000+08:00

This is a hard question. Because more often than not the share price of those losers would rise after I'd sold. At least I seem to believe it that way. But if I really did the math and included the total time I needed to hold the share and the extent of subsequent appreciation, then I'd also probably conclude that it wasn't worth the effort. The time is usually too long and unpredictable. It's for the same reason I now shy away from asset shares with little earnings stream, as I can never predict when the price will meet, if ever, the underlying asset value.

So this years' losers go to:

(1) Dickson Concept (down 9% from $7.91 in Dec 06)

I really thought this was one safe recommendation that I didn't have to worry much. Well looking back I've overlooked its owner Dickson Poon, whom I should've given more 'special' attention. I originally had hoped for a $300m earnings in FY2008, but now after reading the interim results which were flat, full year earnings are likely to be around $200m, at most $250m. That'd give a p/e of 10-13x.

Disclosure continues to be non-transparent and I don't really know what happened in each business line other than some qualitative description by management. There should be positive contribution from the TH stores acquired last year, better sales from Admiralty and Mongkok Seibu, offset by weaker than expected performance of TST Seibu and initial losses of China Seibu. As there's no breakdown this was the most information I could gather.

Dickson itself is still a good story waiting to happen. I guess my timing was wrong by one year as I tried to be clever. The new stores, especially China ones, really take time for their market to develop since they are not typical everyday department stores. HK and other Asian stores (save Taiwan) should also do great this year as everyone is feeling a little rich. Taiwan is never in my equation so I need not worry. $300m earnings a year should still be attainable, but one year later in FY2009.

The only thing which makes me wary though is its owner. I'm still unconvinced about the merit of the injection by Dickson Poon of the TH network in 2006 (I have no way to verify its post-acquisition performance since there's no separate disclosure) and especially over the fact that the entire consideration of $400m was settled in cash, when the issuance of shares could've been an option.

Subsequent development was more unsettling as the name of Dickson Poon was associated with many pre-IPOs placement (obviously making good use of that $400m) and then Dickson the company did a $460m placement in Oct, which caused the share price to drop like a stone from $8 to as low as $6 (since there's suddenly a whole bunch of placees making a quick buck). So it appeared Dickson the company needed the cash after all and one has to wonder why it passed it all to Dickson Poon one year earlier. Perhaps I shouldn't place too much hope on a company named after its owner. It's his concept that matters after all.

Dickson is a good company but with an owner who has questionable intent at times. I don't have a firm view yet but I incline to sell when there's more interest developed in this share. I shall make a note to review my decision again during the Chinese New Year holiday.

DISCLOSURE: I hold 113 at time of writing.

Something Else

2007-12-05T14:30:00.000+08:00

I just came back last weekend from Egypt and what a magnificant civilization there was. I said 'there was' because nothing notable has happened afterward for the next 2,000 years (up to now). Talk about an extended slump!

The historical sites are plenty and quite well maintained given their age. But you really have to be there to appreciate it. So today I only want to share with you one toilet tip, i.e. you do need a tip (1 Egyptian pound) to visit every toilet. There's a toilet man usually waiting at the entrance or he will sneak up from nowhere after you have 'unloaded' to collect his toll.

The tricky bit is how to get enough 1-pound bills to last your day, everyday, afterall Egypt is a hot country and a lot of water is consumed. The quick answer is 'you can't'! You could try get a change from the toilet man but 9 out of 10 times he'd say either he had no change or could only give you a lesser change becoz that's all he had (which of course is a lie). You could try your luck in the restaurants and shops but again 9 out of 10 times they'd have no change. What about if you buy something to get a change? Well you'd soon find out everything in store is priced at 'whole' prices like 5, 10, 20, etc. So you'd never get anything less than a 5-pound bill!

The toilet pound is like an underground secret currency, nowhere to be seen elsewhere, and worse, is only kept by those who run the toilets! And the bill's look and condition is also exactly as its name would suggest (gross), not unusual given all the moist in its surroundings.

Many US or European elders who don't 'hold up' well have given up hope and paid USD or EURO instead, which is at least 5 times more expensive than the Egyptian pound, and only if they have that many dollar bills.

Eventually after a few days of observation I founded a workable solution when I don't have the toilet pound. I'd just stand next to the toilet man and watch people come by and drop him the pounds. Once after 5 or 10 people had paid him, I'd say to him 'Hey I just saw you got 5/10 pounds for a change so don't fool around this time!'

And I just earned myself a few more tickets to the great Egyptian loo.

Something Else

2007-11-09T20:25:00.000+08:00

Those Annoying Faxes

You are extremely lucky if you haven't received one yet. I got at least one marketing fax everyday and sometimes several a day. I used to think only companies using commercial lines would suffer, but this is apparently not the case. My brother used to receive plenty so he eventually threw away his fax machine. Now he still gets the long 'beep' calls just as frenquently.

Taking his lesson, when I applied for my residential line, I didn't tell PCCW that this would be a fax line. I also specifically asked that the telephone number assigned not to be a recycled commercial number. They got me a new number but guess what, the damn fax still arrives at my door everyday.

I eventually got really pissed off and started my 'call-back' campaign, i.e. calling back each company and asking them to stop sending faxes to me , in a gentle manner of course.

This campaign started two months ago and here's the preliminary findings.

(1) I'm still receiving offers to have my computer/printer fixed.
(2) 99% of the telephone operators are female.
(3) 0% of them would identify the name of the company when answering the phone. I heard only 'wei' or 'hello' 100% of the time.
(4) Sometimes I heard multiple phone ringing in the background which suggested I might be talking to a 'call centre'.
(5) I suspect sometimes I talk to the same operator twice on the same day. And I suspect she might recognize me too.

I also have the burning desire to know why the faxes are all about fixing computer/printer but not refridgerators, microwave, or DVD players? If there's enough variety then I might eventually find one useful.

The campaign shall continue and I'll post another update again.

One Life, One Love, One Gift

You are happy your friend has finally found the 'one' and settled down. You happily pay your due to attend the banquet, wishing them happy for the rest of their lives. Yet afterward you find yourself stuck with their token gift for the rest of your life too, which you have least expected.

What am I talking about? I'm talking about those little gifts you receive that hold tremendous value to your hosts but little value to anyone else. Take for example a couple of cute ceremic bride and groom with names and the wedding date etched on it. Some were even made to look like the couple themselves! How am I gonna do with it afterward? Do I need to display it in home so that I won't forget to call during anniversary, or so I can remember this happy day too for the rest of my life? Gosh my long term memory will be really running short if I have to remember so many happy days, and in some of those days I might just be drunk and had no memory.

Other times it's a cute car, a cute box, or cute anything, but the common theme is there's no real use. And I can't even re-gift it because it's got names on it. So in the end I had to secretly discard it. It's a waste of money and natural resources, not to mention those gifts may contain excess lead in paint which can be harmful to small children!

If any of you is planning a banquet please seriously DROP the idea of token gift, or simply give out chocolate instead. You guests will appreciate it immensely.

DISCLOSURE: I'm married and have nothing against marriage, just the gifts.

SOHO China (410): Where's my money? final words

2007-11-08T13:00:00.000+08:00

In my previous posts, I've left out one very important factor from the calculation, i.e. the tax effect and especially that of the Land Appreciation Tax. Currently SOHO is providing 2-3% on sales as provision for LAT, said to be common practice in BJ, and auditors have no particular complain about it, so neither should I. But I figure if anyone buying SOHO is not buying simply assets or business but Pan, he should have confidence Pan will find a way out if tax becomes a problem, just as he has confidence Pan will find good land at good prices and erect magnificent buildings on it.

But my money isn't with SOHO or Pan. I did subscribe to the IPO but I don't hold any now. I don't have anything against SOHO or Pan strongly but just that I'm a cautious person and prefer a safer bet. In this case my preference is with Shui On Land (272), a company with a similar business, cheaper valuation, but more importantly better execution in my view.

SOL is also in the city redevelopment business and its owner Vincent Lo is also well connected in Shanghai. SOL also has good city center projects in Shanghai because of Lo and the 'Xintiandi' project is a success. Well the architecture for sure has a lower 'WOW' factor than that of SOHO, but 'Xintiandi' nonetheless has become a brand that can be leveraged.

But don't mistake 'wow' for margin, for SOL has an even higher gross margin of 70% (vs. 50% of SOHO). I don't believe this margin will sustain because land prices have gone up a lot, but SOL does have the advantage of having secured most of its land supply some time ago, for city redevelopment is by definition a long term project.

What I like better about SOL is that it has successfully reached out to other cities with the 'Xintiandi' brand, in at least Xihu, Wuhan, and Chongqing. In technical terms I'd say its business model of city redevelopment is proven scalable, thus lessening the need for connections to get good land. Bear in mind in redevelopment the land is usually prime. Not to mention this also means having a much larger landbank of 10 times the size. Earnings sustainability is therefore lesser a concern.

Another area which I think SOL did better was in the management of retail and commercial tranche of its projects, whereas SOHO has sold off everything and will only start keeping some in future projects. The rental from shops and offices provides continuous cashflow which helps smooth out the volatility of the residential market. Plus investment properties will also rise in value, slowly but steadily. This means less aggressive use of funds but is more comforting for a conservative investor looking for the long run.

SOL is where my money is at.

DISCLOSURE: I hold 272 and no 410 at time of writing.

SOHO China (410): Where's my money? part ii

2007-11-01T22:00:00.000+08:00

Before I start on Tiananmun South, the final piece of the valuation puzzle, let me add something about Sanlitum SOHO.

The site, vacant now, is valued at $7.9 billion at 30 Jun 2007. This I already told you yesterday. So here's something new for today. SOHO mentioned in the prospectus that it acquired this site via private negotiation in 2006 and nothing more. I had to look at the footnotes of the valuation report in the appendix to find out SOHO purchased it at only $2.15 billion six months ago in Dec 2006. The seller was BJ Tongying Property Development. If you happen to know more about this company please enlighten me.

During Jan to Jun 07, SOHO spent $1.1 billion on infrastructure of the land. Also during this time land price in BJ has surged so fast that there's an immediate windfall gain of $4.65 billion (i.e. $7.9 billion - $2.15 billion - $1.1 billion), or 143% on cost even before construction permit was issued! I can only say 'winner takes all' and feel apathy for the seller, for I have much experience to share.

The above brings out the nature of SOHO's profit which relies much on land appreciation than anything else, which makes it not so different from other land developers as Pan may claim. The other point is the 100% margin on future development cost I assumed in my calculation yesterday was probably too high, since SOHO had already made a killing on land price and past overall gross profit was only about 50%. But I'd leave the calculation as it is because in all likelihood the land will continue to appreciate, though by what extent I do not know.

Now I turn my attention to Tiananmun South.

It was city center redevelopment project similar to what we have here in Graham Street, Central, and Kwun Tong, except in bigger scale. There's a total of 44 parcels of land totaling 127,000 sqm of site area and 360,000 sqm of planned GFA. The site includes 12 heritage sites where extensive conservation work will be carried out. The project owner is a company named BJ Tianjie, wholly owned by the State Owned Asset Supervision and Administration Commission (SASAC) at the beginning. The role of BJ Tianjie functions sort of like the City Redevelopment Council we have in Hong Kong, i.e. to relocate and rebuild. Relocation started in 2004 and now all land has been cleared for development. A total of $3.6 billion was incurred in relocation and pre-development, which was financed by a combination of equity put up by SASAC and bank loans.

Pan owns 49% of BJ Tianjie (with SASAC owning 51%) which holds the right to develop 33 out of the 44 parcels of land in the project. Although the interest is a minority one, Pan will be entitled to 100% profits earned from the 33 parcels of land after repaying all bank loans of BJ Tianjie and capital put forth by SASAC (i.e. a total sum of $3.6 billion). For simplicity you can treat it like a wholly owned project. The remaining 11 parcels of land will be put out for tender early next year. Agreements have been reached whereby Pan's 49% interest in BJ Tianjie will be injected into SOHO, pending the necessary regulatory approval. In fact, the main reason of listing is to raise enough funding to develop this project.

How much is the land worth now? Well according to the valuer just the 33 parcels are worth $12.3 billion! If these parcels are sold today there'll be immediate gain of $8.7 billion ($12.3 billion - $3.6 billion) already. In addition, there's a further development profit of up to $4 billion, if I apply the same 100% profit margin on development cost.

If you wonder why or when Pan's name showed up in the picture all of a sudden? That's a good question to ask. But you won't get an easy answer unless you search deep into the footnotes of the accountant's report in the appendix. There you'd find Pan acquired his 49% interest in BJ Tianjie from SASAC at $144 million in Mar 07. Yes, only half an year ago in Mar 07 and for only $144 million. Pan subsequently put in $500m as shareholder's loan. In simple math Pan/SOHO put up $644 million and is ready to reap $8.7 billion home.

But why Pan? Why would SASAC spend 3 years clearing up the site, bargaining hard with the local residents, and then just pass the development right of this highly valuable downtown site to Pan at giveaway price, without any public auction?

I definitely smell Cyberport dejevu here! don't you?

The timing of events is more suspicious because SOHO was trying hard to get listed at that time and landbank wasn't big enough.

Now it becomes clear why the tycoons* are all so eager to buy into SOHO, for one should never challenge their collective wisdom. My guess is it's nothing but raw capitalism. Pan has excellent connections in BJ which can get him excellent land, and tycoons are buying those connections. In all fairness Pan and SOHO have done excellent marketing and worked hard enough in past projects to earn their special status now.

And we all know having a status can be very advantageous, even in a communist country.

To answer the very 1st question of where's my money, here's the breakdown.

Valuation of current projects: $17.5 billion
Less all liabilities net of cash and minority interest: aprox. ($6.5 billion)

Add Sanlitum profit: $3.55 billion on land + $1.1 billion on development
Add Tiananmun south profit: $8.9 billion on land + $4 billion on development

Add IPO proceeds: $11.4 billion

Total: $40 billion
Mkt value: $52 billion

Premium is now only 30%. Of course it's a lot fairer than those absurd valuation of other property counters. More importantly I dare not to underestimate Pan's continual ability to get good deals and the tycoon's trust in him.

So don't fancy the world renowned architects, beautiful buildings, Pan's charisma, or the SOHO brand, because those are just icings on the cake and you're missing the picture! You're buying not what's written in, but rather what's NOT written in the prospectus.

* BTW, I mistyped 'tycoon' effect as 'typhoon' effect in my last post. I'm sorry if I've confused you.

DISCLOSURE: I don't hold 410 at time of writing.

SOHO China (410): Where's my money?

2007-10-31T16:45:00.000+08:00

SOHO China has made itself a celebrity among Chinese developers. Pan and Zhang are legends in the eyes of many Chinese, for they invented a whole new category of housing in Beijing - SOHO living. One can't but admire the beauty of the architecture and planning of their projects which, I think, put nearly all HK developers in shame by comparison. The reward is celebrity valuation. Pan wants to achieve what Steve Jobs has done for the IT business - to continuously innovate and bring 'coolest' surprises to the market, but in hard property assets (and of course earn a lot of money as well). In other words, to 'intangiblize' the company and rid itself of the burden of having to carrying assets, land in this case.

Many already know and have talked about SOHO's lack of land. But how severe? I've extracted some figures from the prospectus, but after making some adjustments because in there you will find even a project completed in 2001 (!) included in the landbank calculation (although it won't affect the net result, it's misleading nonetheless).

Total Saleable GFA*: 0.9 million sqm
Less GFA presold: 0.23 million sqm
Useable landbank: 0.69 million sqm

*this already includes Tiananmen South project which SOHO said it would acquire (but not yet) from Pan, and two hotels.

I'm not sure if it can be called a bank when land is this little. There are actually only two projects on hand to be developed, i.e. Sanlitun SOHO and Tiananmen South, with the rest pretty much sold out already. Note there's nothing left from those finished projects so don't expect there'll be income stream from rental. But oddly enough, I've read from more than one places quoting Pan saying 'SOHO has enough land for development for the next 5 years'. Well, these two sites better be worth a lot more at time of sale, because the latest market value of SOHO has risen to $52 billion.

Next I'll try break down the valuation into pieces to get a better perspective.

NAV of SOHO: $1,368 million
Add 2007 profit: $1,624 million
Add IPO proceeds: $11,426 million

Total: 14,418 million or $14.4 billion
Mkt value: $52 billion

From 1st look, it appears SOHO has indeed invented a new way of valuing property companies. Market value is 3.6 times NAV post listing, yet 80% of the NAV is cash! Essentially people are willing to pay premium for cash held in Pan's hands, believing he can both find land and deliver exceptional return at the same time!

But wait! There's should be more profit beyond 2007 right? And projects on hand should be worth a lot more than NAV on books. So in all fairness I've tried this approach.

Valuation of SOHO's interest in all properties: $17.5 billion
Less all liabilities net of cash and minority interest: aprox. ($6.5 billion)
Add IPO proceeds: $11.4 billion

Total: $22.4 billion
Mkt value: $52 billion

I usually don't take property valuation in a selling document at face value, but it sure has a comforting effect when premium over adjusted NAV has come down from 260% to 132%. But now we've marked up the properties to market value, where does that remaining premium (i.e. $29.6 billion or 57% of market value) come from?

Well for one, the Sanlitun SOHO project is a vacant land now and hence its valuation ($7.6 billion) only reflects land appreciation, but not future development profit (on construction and finance cost and etc) and the SOHO premium, if there is one. Development cost is estimated to be about $2.1 billion. Say SOHO can make 100% profit out of this, which is possible since past gross profit was as high as 57% in 2006, and so the further adjusted NAV becomes $22.4 billion + $2.1 billion = $24.5 billion.

More than half of the market value is still missing? I suspect it's a product of Pan's charisma, the 'tycoon' effect, the nice PR work of the sponsors, and last but not least, the yet-to-be-acquired Tiananmen South project.

(to be continued)

Sell all you want and all you can?

2007-10-08T09:05:00.000+08:00

I don't have an answer of course, but my gut feeling is the 1st part may very well be the right thing to do.

It's not my principle to comment on daily movement or the general market. Because for those you get plenty from the press, Internet, and everywhere else, including but not limited to anybody on the street. Since nobody can foretell short term trend in a consistent manner, why bother giving out tips and forecasts which are at best 50% right?

But now is one of the rare moments I think worth being called a total fool by telling people to sell.

I'm not giving out hard facts and figures here because I don't need to prove the market is expensive, that is well acknowledged by the market. But I do observe there is an emerging belief or consensus that the market is infallible. And with this pace of rise continuing most people will not need a job soon. You can sense that from the way people work and talk.

Expensive stocks get more expensive by each day and cheap stocks, including HSBC, get nowhere. People are only interested in momentum stocks. For me, there's little need to find new performers when old performers aren't moving. On defense I did pick up this trend of polarization and recommended holding a H-share index fund back in July. And its performance has been more than respectable.

This may not be the top but it's getting close. If you have stocks you want to sell but are waiting for a good price, wait no more. On the other hand if selling hasn't come to your mind, because you are holding either cheap stocks or for really long term, then there's nothing to be worried about.

Results Brief

2007-09-14T15:15:00.000+08:00

Tomson (258)
There wasn't much activities during the period, save that Company managed to earn a few bucks from the stock market, decent but unreliable and not to be encouraged. Income from golf club, hotel, and commercial properties was stable but nothing spectacular. There are a few smaller scale property projects in Pudong being built mostly via its associated company Riviera. While these will provide income, they are only peanuts next to the 4 towers of Tomson Riviera. The way I see remains that this project alone should be worth more the entire Tomson's capitalization right now. And the other property assets of Tomson are worth of at least their book value.

WKK (532)
On the contrary, the results were really bad with both turnover and profits down substantially, by 24% and 42% respectively. This raised serious question on the timing of the privatization. If Senta Wong knew the business was going bad, he could've waited until now to make the offer, and his chance of success would've been much higher. Or more importantly, why would he want to make an offer at all? He's too smart to have missed that. I'm too dumb to understand him.

Maybe now he's failed in taking over WKK cheap, he wants to 'demonstrate' he was actually trying to do all shareholders a big favor, so we should send our apologies to him for misjudging his good intention.

There was no mentioning of the Chinese medicine and health product business which Senta Wong talked about during the privatization period (WKK had invested 10 million already). In fact there's almost nothing in the MD&A section and shareholders are pretty much left in the dark, as before. Let's hope darn isn't far away.

The funny thing is that the stock barely moved after this disastrous results. It seems that the holders are all very calm, at least up to now. I guess most stocks are now split between Senta Wong, his friends, supporters, and his enemies (like David Webb and other funds).

The soap opera continues.

DISCLOSURE: I hold 258 & 532 at time of writing.

Correction on Yesterday's Post

2007-09-05T16:05:00.000+08:00

After reading the paper and looking at the announcement again, I found I'd got it wrong at the 1st place. China COSCO is indeed buying the whole fleet (not part of it). And that made the consideration even more absurdly low, $34.6b for a fleet which earned $6b last year and $6b in 1st half of this year (likely earning over $10b for the whole year! I can't really find any rationale for a price this low except the average age of the fleet may be considered high and so one had to account for replacement cost in determining the overall consideration. Still, the price was dirt cheap and reminded me of the Angang asset injection last year, from which Angang also benefited immensely, and so did the H-share holders.

I reworked the figures and found the bulk fleet is trading at about 11x p/e, or 13x p/e if I apply a more realistic p/e to the container fleet. So the current price is mostly fair, maybe ahead a little bit since contribution from the bulk fleet probably won't come until next year when the deal is completed.

I think I can forgive myself for letting go the share too soon, for this kind of deal is really unpredictable. To compensate I can only thinking of buying more H-share index or fund, as for sure there'll be more injections for all state owned enterprises down the road but one can't be sure which one will come first.

p.s. to share my friend's blog which is quite enlightening: http://hk.myblog.yahoo.com/ohpalkof/

Latest on China COSCO (1919)

2007-09-04T11:00:00.000+08:00

Finally the mystery is over and I come to understand, again, that the market, or at least some part of the market, is more efficient than I. Last time I questioned about the market enthusiasm over the asset injection and suggested reduction. Subsequently I sold out my last position at around $12. Of course looking back now, when the share price is standing over $19, that sell call appears very premature or even questionable. But hey that's also the fun/pain and challenge of investing on your own.

The dry bulk fleet acquisition deal is at last inked and proposed, but I don't think it'll have any difficulty in seeking approval from shareholders, given the terms are so favorable. In fact it's hard to imagine why this type of deal can still exist - there's no better way to demonstrate that selling state assets cheap is still everyday life in China.

The fleet (over 400 of them though some will only be partly owned after completion) will be acquired at a total of $34.6b, $24b to be financed by shares and the rest in cash. And part of the consideration is even deferred, meaning China COSCO can take time to arrange financing or even pay from the cashflows of the acquired fleets!

Attributable earnings from the fleet were $2b for 2006 and judging at the doubled results of 2007 1st half, one can safely assume $4b annual earnings. So we are talking about a prospective p/e of 8.65x for a national dry bulk fleet! Its competitor China Overseas Shipping Development (COSD) which reported similar interim profit has a capitalisation 100%+ higher at $78.5b. With a discount this deep my valuation framework used last time was immediately rendered useless. Now I know a price of $12 is of course sustainable but how about $19?

Let's try again. The market capitalisation post completion is about $190b. Taking out value of COSCO Pacific ($25b) and container fleet ($55b, generously using CSCL as benchmark), we have $110b for the dry bulk fleet. This translates to a 07 p/e of 27.5x, or 40% higher than COSD. It seems even the big favor from the parent company can't mop up all the excitement and hype around the share. China analysts are suggesting a target price of $40! I'm beginning to like my Chinese counterpart more and more as they really do introduce new rules and bring a whole different ball game here.

From this episode I think I have overlooked two things: (1) the grand re-rating of all H-shares which is still pretty much continuing and (2) the much improved prospect of dry bulk shipping since my last analysis in June. Perhaps the biggest lession is as value investors we can often tolerate undervaluation for as long as we want, but when its comes to overvaluation we don't do as much as we need to.

Of course I don't recommed a buy at this price. This should go without saying.

DISCLOSURE: I don't hold 1919 at time of writing.

p.s. to share my friend's blog which is quite enlightening: http://hk.myblog.yahoo.com/ohpalkof/

Results Brief

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

(in no particular order)

OOIL (316)

There's little surprise, or one can say OOIL management is as reliable as ever. Latest interim results were more or less flat when compared to the 2nd half of 2006, although I'm sure it's still the best among its HK listed peers. Increasing fuel price and 3rd party logistics costs (port and ground transportation) are the culprit and may restrict further profit growth, but I have confidence that over the medium term these can be dealt with effectively. Shipping profit of HK$3b a year should be attainable. I'm however disappointed at the lack of news about new projects, or even an glimpse of where the management may consider spending its massive sales proceeds from the American ports (HK$10b after interim special dividend of HK$4b), despite having appointed UBS as the adviser for some time. Equally there's almost no progress made on the property side of which value is almost unchanged at about HK$10b, which may be excused by the lackluster Shanghai market.

The current price is about fair or slightly below value if benchmarked against its peers. Probably the lack of direction has stalled the share price movement somewhat. On more generous multiples or under better market sentiment a price of $85-95 can be justified. Any M&A opportunity is a bonus.

RIMH (1997)

This is a Taiwan company specialized in offering surface-mount technology (SMT) solutions to LCD makers, meaning soldering all electronic components onto PCBs. This is done automatically by machineries as PCBs have shrunk in size and gone multi-layer, so components used are now too small to be handled manually. RIMH is also responsible for the design, procurement and the logistics. Because SMT is such an integral part of the LCD production process RIMH has all its plants next to its customers'. And in many cases RIMH co-planned its expansion program including plant setup with its customers. I don't really understand why LCD makers can't handle SMT in-house and how SMT has come to become an independent business, but it appears the current mode is mutually beneficial and I'm too much of an outsider to question. But I'm quite certain that as more and more LCDs, LCDTVs, notebook computers, mobile phones are made in China, as opposed to Taiwan, Korea, and Japan, demand for SMT will grow naturally. So far RIMH is mainly serving fellow Taiwanese but over time I hope to see a more diversified clientele.

2006 profit was about HK$185m on HK$2.1b of turnover. 2007 interim saw turnover increased by more than 50% to HK$1.4b and net profit doubled to HK$137m. So we may be looking at an annualized profit growth of 50% to HK$270m. If this can be achieved, then the current capitalization of HK$2.1b definitely errs to the low side. RIMH has also planned for sizable capital expansion with its HK$400m IPO proceeds (NAV was HK$760m before IPO) and that's another indication of increased orders ahead, as RIMH has to expand with its customers together.

LCD market is known for high competition and low margin. RIMH although only a supplier is subject to similar pressure as its customers. But I hope RIMH's 'higher technology content' can help maintain its margin and competitiveness.

Meadville (3313)
Really impressive results! Profit was HK$300m last year and for 1st half this year profit already soared to HK$250m, on the back of a 42% increase in turnover to HK$2b. Management reported full utilization throughout (except for the Chinese new year holiday) and had to speed up the expansion plan to cope with all the demand. On the 3G front it's the biggest PCB supplier to both ZTE and Huawei and with extensive 3G testing underway in China orders are already flying. Consumer electronics side also performed satisfactorily as outsourcing of advanced electronics manufacturing continued. Laminate venture with Hitachi appears going well and that should cement Meadville's high end status in the industry. Some may be concerned about the share award charges, which will continue to drag down bottom line until 2011, but I can assure it has no effect on both equity and dilution, and can be safely ignored. (If you don't know what it's about, you can skip it altogether) Current capitalization of HK$3.6b is definitely too low, for an annualized profit of HK$500m can't be overlooked by the market for too long. Just think of why ZTE can have over 40x p/e while its biggest supplier can only demand 7x, this is too big a gap which will be narrowed.

Chalco (2600)
Definitely positive surprise as 2007 1st half profit was only marginally down 5% from that of 2006, when 2006 was an excellent year when alumina was at all time high. Downstream aluminum side now contributes about equally to the bottom line (vs 15% same period last year), making Chalco more resilient to market changes and an tremendous edge over competitors in both fields, on top of its huge size advantage already (50% and 23% of national output of alumina and aluminum). Alumina selling price was down but that's expected and the earnings gap has been filled up nicely by the downstream operation.

Proforma earnings was even higher at HK$7.2b and continual expansions could easily propel full year earnings to over HK$15b, against capitalization of about HK$200b (including shares for taking over Baotau Aluminum). Financial position is as strong as ever after A-share listing. Net gearing was only 11% and management should seriously consider offering fewer shares and more cash for future acquisitions, even though offering A-shares for exchange is still vastly beneficial to H-share holders.

Going forward Chalco will continue to benefit from the infrastructure and housing boom, and manufacturing to a lesser extent. And it's becoming more dominant in its field by each day. I wouldn't be surprised if Chalco can be traded at 20x p/e. Sifu Tony pointed out today rightfully that even Alcan of Canada was offered HK$250b by Alcoa of US. Comparatively speaking there should be plenty of upside for Chalco.

Note: Readers who wish to know more about the companies (except RIMH) can go to past posts for details.

DISCLOSURE: I hold 316, 1997, 3313, & 2600 at time of writing.

Buy all you want and all you can?

2007-08-16T12:51:00.000+08:00

Only 2 days ago I said the market had not reached the stage where one could 'buy all he wanted and all he could', well after today I'd say we're really close, if not there yet.

The recent fall is liquidity driven, or is it? All the central banks have pledged to provide as much capital as it could but the markets are still falling. Is it the sub-prime mortgage problem? But the U.S. market, which is supposedly to be most affected, has fallen by a much lesser extent than other markets. Have the fundamentals changed? It might if the markets continue to behave this way for a while, but right now at this part of the world China is still going too strong and stocks are still good hedge against inflation (caused by excess money supply).

So what's the real cause for the fall? No one quite knows and that's scary, and scare causes panic, and panic costs money.

If one can assure himself that this is a confidence issue, that he should have no problem convincing himself buying into this dip, because emotion is like weather and can change in no time; on the other hand we have failed to accurately predict the weather for as long as human history went back. So if you must fish at the absolute bottom then now is a good time to test your skills.

To me, many stocks at today's level have already provided enough safety for investment purpose. If you are not forced to sell because of margin calls, then you should have no problem weathering the storm and come up ahead.

Something Else

2007-08-14T12:20:00.000+08:00

Recently I got complains from my friends about the lack of output, asking whether I've given up writing and moved on to something else. Actually I've run out of good investment ideas: the ones I've mentioned I don't wanna repeat (for if people don't like it the 1st time they see they won't like it the 2nd time either), while those which are more speculative I don't wanna mention (for most people don't have problem generating speculative ideas on their own).

The sub-prime storm, as it's called, has created quite a stir in the market but not strong enough to make one declare "buy all you want and all you can". I've also told my views for months so there's nothing substantial to add. Hedge funds losing money is nothing new and only proves again the lesson "don't over borrow on stocks" is timeless.

Instead, I'd share with you two pieces of investment related news.

Last week Mattel and Fisher Price recalled a massive number of China made toys as there's too much lead in the paint. While exposure to lead may cause children health problems in the long run, before that happens we see one human life has paid for the price already. The owner of a Foshan toy factory hung himself in a warehouse after his factory had been identified as one of the toy suppliers and banned from all export by the Chinese government. The factory has been a long term supplier to Mattel and the critical mistake the owner made apparently was to trust the wrong paint supplier, whose owner was his long time friend, making this all more tragic. He was 50 years old and left 5,000 people unemployed.

On a light note, Wynn released latest quarter results last week. I'm never a follower of gambling stocks, on ethical grounds, so I only read the brief from the paper but management's explanation on the Macau operation caught my attention. Quarter revenue there was USD350m and 15% higher than the previous one. The reason quoted was 'winning rate of the VIP tables was 3.3% higher than expected', which was a polite way of saying Chinese gamblers suck! Most of us know the casino wins in the end but even they couldn't predict it'd be that easy.

I remember reading about the game of blackjack where professional gamblers and mathematicians (like those MIT whiz kids) came up with all kinds of methods to count cards so that the winning odd could be increased by 1-2% (to above 50%), and that's already huge advantage and money, so much so that casinos would 'invite' anyone spotted counting cards out of their casinos. Maybe the Chinese aren't really in it for the money. Or maybe there's something really funny going on under the table?

Revisit the 2007 Underdogs

2007-07-23T12:58:00.000+08:00

Time for a review of the underdogs, a.k.a. industrials, as the latest results have come out. Against common perceptions or wisdom the results were all outstanding, a fine achievement and it looks like the depreciating USD is really helping exporters.

Check out http://abaci-investing.blogspot.com/2007/01/every-dog-has-its-day-my-industrial.html for the basic story of each selection which remains sound today.

1st a summary of the basic parameters.

894 - sales up 12%, EPS up 15%, 9x p/e, 2.1% yield
927 - sales up 54%, EPS up 84%, 8.5x p/e, 4.3% yield
1120 - sales up 38%, EPS up 72%, 7.5x p/e, 3.3% yield
408 - sales up 18%, EPS up 31%, 12x p/e, 3.5% yield
1001 - sales up 6%, EPS up 209%, 8x p/e, 3.1% yield

Average - sales up 26%, EPS up 82%, 9x p/e, 3.3% yield

Since it's only been 6 months I don't have much to supplement. 408 appears more expensive but justifiable so given its 5-year growth record. And it definitely has re-rating potential as management and owners are restructuring the board and improving corporate governance to please the institutions. 894 and 927 will continue to benefit from the growth in consumer electronics and communications market, plus both are enlarging their capacities. 1120 will enjoy the rising EURO and fashion appetite. 1001 has just turned around and will need time to prove the value in its JV with Ryerson. In short I'm still positive on all five of them. Remember Peter Lynch's rule of 5 and these are meant to be purchased in a basket.

Next let's look at the market performance.

894 - $2.03, $2.54, up 25%
927 - $1.8, $3.67, up 104%
1120 - $$2.58, $3.28, up 27%
408 - $3.82, $5.7, up 40%
1001 - $0.98, $1.5, up 53%

Average - up 50%

50% in 6 months is outstanding and it's actually my annual target for small caps, though one could've done even better if just sticking to my other picks like Chalco, China Cosco, or even Tomson. But this is the cost for diversification and I already forewarned these were dogs. Comparing the price movement with the profit growth, I don't think the dogs are let out of the doghouse yet. That's why I think this sector continues to be a safe place, on relative terms, in today's market.

During this evaluation process I've looked at other potential dogs, as I know readers are always only interested in the 'next' pick, as if past picks were like retired hall-of-famer athletes on wheelchairs now. For which I can say after studying a dozen other dogs, I still can't find any that can really outshine the 'fab 5'. One exception is Meadville (3313) but beware it's the only flop of all my picks in the past! Though I still have good hope of the PCB market and its 3G potential. The other interesting bet is RMIH (1997) but since it's a new IPO and the price has already run away before this post, I'd not recommend it this time.

DISCLOSURE: I hold the 'fab 5' and 1997, no 3313 at time of writing.

Stop Loss on China Glass (3300)

2007-07-06T11:38:00.000+08:00

CG has announced a US$100m bond issue. This is a massive offer compared to its capitalization of HK$1.3b, after falling by more than 10% at one point this morning, and NAV of only some HK$400m. I may be over-reacting but I'm very allergic to any junk bond offering. Interest rate is over 9% p.a. and underwriting fee is 4%, plus I don't like its lead manager Standard Chartered either (no offense to the bank though, just the department). By taking this terms I can only guess CG has run out of funding options, and there's little demand for its shares nor loans. In fact I think the terms are even worse than what Zhejiang Glass got from the IFC when it was in deep trouble.

I guess with this big a warchest CG will continue to expand its presence actively in the glass market. But I doubt whatever good comes out of this will mostly go to the bondholders and shareholders are left in a very vulnerable position - head you win and tail I lose.

The last junk bond of Ocean Grand really turned into junk. I really don't have a good feeling for this one either.

DISCLOSURE: I don't hold 3300 at time of writing.

More Thoughts on H-share & Red Chips Index

2007-07-05T17:23:00.000+08:00

If you agree to what I wrote last time, then it's never too late to accumulate more China positions, for there should be many more good years ahead. This is a time which I think buying the marco concept will probably do just as well, if not better, as performing elaborate micro analysis. Bear in mind the H-share index has risen by 139% (excluding dividends) since 2006 up to today! Don't expect this kind of performance will repeat itself but equally don't underestimate the potential of China, nor the craziness of the market at times.

So unless you are a stock picking fanatic or have extreme confidence in your (proven) ability, think seriously about allocating part of your portfolio in a H-share index fund, or futures if you really know what you are doing. For red chips since there's no ETF readily available, pick a few that you like like China Mobile, CNOOC, or COSCO Pacific, and you are set. Just sit and wait for lady luck to pay you a visit. If you have itchy fingers that's hard to stand, try your luck on other sectors like blue chips or small caps, or do whatever you want that works, just don't get them burnt!

As for timing, I can't tell you but I do know right now some shares are extremely expensive but some are still reasonable. That's why on average I think buying an index should be relatively safe, for the downside may at most be 30%. I'd buy in stages, like I always do, it's best if it turns out I buy on the way down, but I'd be pleased too if I end up buying on the way up, since the alternative would be not holding a position in a rising market, which sucks even more!

Thoughts on H-share & Red Chips Index

2007-07-03T14:30:00.000+08:00

This is a continuation of yesterday's post.

One important distinction to make about red chips: I only mean those controlled by the government, e.g. China Mobile, not those owned by private country men, e.g. Citic Pacific. I don't mean the latter has less investment value (in fact I own Citic Pacific) but it's just outside the scope of today's discussions.

And I'll only use the term 'H-share' throughout even I mean red chips as well, just to save typing time. Make no mistake this post is definitely not about investing in 'A' shares.

Right now I see there are at least 4 favorable factors at work driving the H-shares.

(1) China growth story - no need to explain. The China story is more compelling than many others (notably Russia) because it's not resources dependent; on the contrary it's China's ability to grow despite the lack of it that'll make its growth sustainable. The theme will stay for at least another decade amid temporary setback from time to time. Keep in mind the old saying: when the tide comes all ships shall float. I'll add even if you've picked a sucker you're likely to be rescued some point in time.

(2) Industry consolidation - it's clear the government is leaning toward larger national enterprises in policy making and squeezing out smaller private competitors. This will save on the energy bill, environmental cost, increase competitiveness, etc, plus the government will benefit since they own those companies. By forcing the management to pay dividends there'll be funds to implement various social policies.

(3) QDII - though the actual fund flow will come in later and in stages, stock prices always move before facts. This is almost the exact duplicate of the 'freedom tourists' in 2003, save it's 'freedom money' buying cheaper stocks. Remember the last time the share price of many retailers never retreated until 2005! Don't doubt the immediate impact this time.

Looking from another angle, if the Chinese have that much money to create the expensive A-share market, they should have little trouble repeating that in HK whose market turnover is only a fraction.

(4) Asset injection - more national assets are getting listed by injection (or listing) and so far the price set is very reasonable, or you may say unreasonably reasonable. The official explanation is these assets belong to the people and it's only fair the people get to share the prosperity of their country. If there's a crash down the road, the government can also avoid being accused of selling at the top and reaping its own people off, a big no-no in a communist country. The management of these vendor companies are only civic servants so don't expect them to bargain for a good price for the government.

A favorable injection price will ensure favorable response, not only to those receiving the 'gift' but also to their peers, who like a spoiled child, will go to his father and ask for similar treatment. If the injection price is set at a discount to the A-share peers, A-share (of the subject company) will respond and H-share will follow suit (if not immediately, QDII and speculators will ensure it does). If the injection price is set at a discount to the H-share peers, H-share will respond but A-share will go wild, then H-share will go wild too.

The other catalyst to this dynamite is the means of financing and I'm seeing more and more A-shares being issued as consideration. This serves the legitimate purpose of increasing supply which fits in the government's cooling measures. To the company though, it's free capital! Since the management own near zero equity stake they'd care less about dilution than growing faster than its peers, as otherwise their companies would get taken over and they'd lose their helms. How will this affect the H-shares? Of course the effect is highly positive as issuing A-shares, even at a discount, will still be at a price vastly above the H-shares, which of course will jump in response.

The scary part is that these 4 factors are interrelated making this upward trend, in Soros's terminology, self-reinforcing. Discounted injection -> higher share price -> more M&A using shares -> reduced competition -> higher profit -> even higher price. This will likely continue until the rationalization is complete and every industry is dominated by a few big players.

To continue.

Asset Allocation Review

2007-07-02T15:42:00.000+08:00

Industrials: 29.3%
Resources: 15.2%
Property: 14.7%
Financial: 11.6%
Shipping/Port: 9.5%
Conglomerate: 6.9%
Utilities: 6.5%
Construction: 3.4%
Retail: 2.8%

The industrials have grown quite a bit and now stand out visibly from the rest. I didn't add much to my positions so the difference came mostly from reflection of earnings increase. I expect a few of them will get re-rated in the 2nd half so there's no immediate need for trimming down, plus the overall sector valuation is still very reasonable.

On the other hand, the shipping stocks look very richly valued despite their good earnings prospect. I'll continue to reduce and probably replace them with pure port plays for a more defensive position and to complement the utility plays, which could occupy a larger space in the portfolio.

Other sectors look fine but I'd like to add one or two Chinese financial plays, which are sorely lacking and performance hurting too. I also plan to buy more Chinese property companies as by now the housing market looks more sane and healthy than the A-share market. Same as last time, China retail is another near-empty space which I need to focus harder.

The 2007 results are very encouraging but I'm not gonna say much here as there's quite a number of stocks in my portfolio which aren't mentioned here. But trust me nearly all of the better choices are already here! As I won't update the Report Card until the end of the year so check out the April post for past recommendations.

More importantly, there's no much to brag about when the H-share index has grown by 130% (135% including dividends) since 2006. I failed to match that kind of return but managed to close the total gap substantially in 2007. The obvious reason is that I didn't have as many H-shares and therefore I still underperformed although my other selections perform satisfactorily (earnings and share price wise). You could say I've made a wrong macro call since 2006 and hence had to double or triple my effort just to keep up with the pace.

In the next post I'll lay out my thoughts on investment value of H-shares and red chips going forward.

Something Else

2007-07-01T13:00:00.000+08:00

Saw this movie 'Bridge to Terabathia' on the flight back from Canada. It's a PG-13 movie but was just as entertaining for adults. It brought back childhood memories and the theme was good - always open up your mind to possibilities and let imagination comes through, a typical Disney message brought by Disney.

This movie echoes what I felt strongly in this trip. Though I've lived in Canada before this time around, I've grown (literally too!) to appreciate the American value 'to dream and to pursuit' more. It's so entrenched in the culture you can find it everywhere. Maybe it's in the genes as America is a country founded by pioneers and enriched by emigrants in search of not benefits but a dream to get ahead. And this value is systematically passed on to each younger generation.

Take my 1st stop at the Disney magic kingdom as an example. Although the tomorrow land has ironically become the place that least lives up to its reputation with outdated attractions, I found time in the Disney gallery and read some literature about the rides. The monorail was actually the 1st one erected in North Amercia at the time (50s) and the 'submarine' (don't bother riding as the vessel doesn't even submerge) was the result of Walt Disney's effect to bring in the latest invention of the time to the park to show kids that everything was possible. The Disney visit was rounded up nicely with fireworks and of course the legendary song 'when you wish upon a star', the lyrics which I now wholeheartly believe. (http://www.niehs.nih.gov/kids/lyrics/wishstar.htm)

Next stop is Hollywood, the dream factory, and the Universal Studio is a fine place to instill that value into kids whilst also a fun experience itself. Even the Seaworld (Ocean Park of America) has the story of a young kid growing up dreaming to become a whale trainer, and of course he's succeed and is performing today. Whether this story is true or not is less important. Then there's the story of Las Vegas growing out of a desert.

I'm not even a half pro-america person but I acknowledge we do have much to learn from them in 'soft' education.

Finally, another good line spotted in America to share 'it costs nothing to dream but everything not to'.

Sights at the WKK EGM

2007-06-28T17:43:00.000+08:00

What an anti-climax! David Webb didn't show and there's very little sparkle throughout. And there's no much to eat either. But I did learn from a minority shareholder a couple of golden lines by the great late Chairman Mao, of the communist party of course.

(1) "Dishonestly always gets one in trouble" but
(2) "Honest people are often pushed around"

Nothing offensive to Chairman Wong. I hope the HKET will have good coverage as its journalist had a lengthy chat with that shareholder.

1st, Kudo to the HKEX for imposing the approval threshold of 75% (YES vote) and 10% (or less of NO vote) to the proposal thus making it harder to pass than usual. Otherwise WKK would simply need 50%+ independent votes to get the resolution through. But guess what - this wasn't necessary afterall as the NO votes outnumbered the YES votes! I think slight more than half of the independent shareholders showed a thumb down to Chairman Wong's offer.

Good news for the financial adviser Standard Chartered Bank and independent financial adviser DBS as they'll get a third chance to do the same work again, having collected their fees twice already.

There may never be a 3rd time, in which case WKK is still very cheaply priced now, but when the chance does come there may be a different structure again. Of course the best scenario as I said before would be for a fund to come in and buy out the PCB assets from WKK, at a much more reasonable price of course, and leave the listing status to Chairman Wong to play around with his latest medical venture, which may or may not by run by him for too long.

DISCLOSURE: I hold 532 at time of writing.

Results Brief: Dickson (113)

2007-06-28T17:29:00.000+08:00

The results were almost every bit as expected, spooky. So I really have nothing to add other than that Dickson could use more transparency in disclosure. The lack of segmental p&l is a case in point and there's no way to tell how much each market is contributing or improving by. Taiwan, which Dickson has quite a presence, is struggling still but that may change after the next presidential election if Ma wins. Other markets should grow at least steadily as the whole asia region is prospering right now so it's hard to imagine people not buying luxury goods.

Check out http://abaci-investing.blogspot.com/2007/01/end-of-era-of-chinese-tourists-in-hk_03.html for detailed analysis as I don't want to repeat myself here.

Looking good and maybe it's about time for the share to run.

DISCLOSURE: I hold 113 at time of writing.

Latest on Shui On Construction (983)

2007-06-16T15:32:00.000+08:00

Well I'm surprised to have time to keep track of developments in the HK market and to write while on vacation. Yes my holiday so far is really dull! However somehow I can't open any PDF file and hence much of the HKEX data is unavailable, so all figures used here are rough.

This post isn't really an update on SOC though it has listed its distressed property unit on the AIM in London. But because it's as expected there's nothing to add for now. Those who are unfamiliar can check my posts in April about SOC and my investment rationale. Rather, this post is prompted by announcement of the merger of TCC and Chiahsin Cement. I always keep a close watch at corporate activities as those are orginated by insiders who are more informed and thus whose actions and reasons are usually well thought out, thereby saving my time and energy!

I don't know much about either company other than they, together with the industry as a whole, seem to be turning around after some bad years. I don't expect one to vary significantly from the others as cement is a pretty homogenous product. The merger puts a value on CC at about $3b, against a turnover of $1b. For reference, the industry leader Anhui Cement is trading at $69b against a turnover of $15b, higher but understandable given the difference in size. P/E isn't used here as it's usually irrelevant in turnaround situations.

Using this latest acquisition price (3x turnover) as the benchmark for SOC's cement operation gives a value of $4.5b, double of my last conservative estimate. Apply the same method to value other parts of SOC: Shui On Land ($5.2b), construction ($0.4b), distressed property ($2.5b), less corporate debt ($3b), SOC in total should be worth $9.6b. Current capitalization (including convertible bond) is only $7b.

The current price is very attractive because you get exposure to both the housing and building materials market. Plus there's upside potential from 1st Shui On Land (which is also undervalued at current price), and 2nd SOC itself, a rare double double opportunity I'd say.

DISCLOSURE: I hold 983 at time of writing.

Summer Break

2007-06-08T15:44:00.000+08:00

I'll be away for 2 weeks and don't expect to post something new, unless I'm extremely bored in my trip (hope not!).

Next month is an exciting month as most small caps will be releasing annual results and I expect many of them will give pleasant surprises. This month has already seen many small caps flying off at great speed but it's hard to tell, from price movement alone, the great ones from the also-rans. One is forced to play catch up and has to choose between buying a good company at a much higher price post results and buying a potential lemon now.

If you don't hold any position in small caps, then I suggest you opt for the 1st route and wait until July, since you've already missed out the chunk of the movement and it's dangerous to join the ride now. By end of July the dust will be settled and it'll become clear which ones are the better investments.

'The Return of the Red Chips' should be another theme that's worth paying attention to for the 2nd half.

Latest on Tomson (258)

2007-06-07T10:09:00.000+08:00

There's rumor which has since been confirmed by the company that it's under investigation for price manipulation, creating a false market for its ultra expensive Tomson Rivieria. I'm bemused by this development because it's quite obvious to anyone that there's NO market for TR at the asking price. Only 3 units have been sold and so there's hardly any 'victim' to speak of. The local government may have gotten its priority wrong too if its aim is to protect those who can afford RMB130,000 per sqm apartment, a sector irrelevant to the daily life of 99% of the population. This makes me think the investigation is more of a gesture than anything. There may be a slap on the hand, fines in the end but I see no more harm done to Tomson.

DISCLOSURE: I hold 258 at time of writing.

Latest on WKK (532)

2007-06-06T11:04:00.000+08:00

What started out as a cheeky steal has turned into downtown robbery!

Check out my last post in April for background (if you're new) and you shouldn't miss today's announcement, because you're not gonna see something like this in a long time (at least I've not seen one before). Don't miss the headings too as they are catchy, e.g. Who's Mr. Webb?

http://main.ednews.hk/listedco/listconews/sehk/20070605/LTN20070605158.pdf

Sure Mr. Webb is trying to create the same independent shareholder activist movement taking place in the U.S. and Europe, and this is the second episode no long after the Mr. Lau vs TCI standoff in the Chinese Estates privatization, save that Mr. Lau opted for a graceful exit whilst Mr. Wong has chosen a showdown.

My guess is Mr. Webb does have enough votes as he's claimed and the proposal will be shot down at the SGM. And those more speculative or feeble are already exiting this morning in fear of the subsequent fall in share price. Mr. Wong has made the statement that he won't increase the offer price and if this fails won't make another privatization move in 12 months, maybe as a threat to all of us holding shares to surrender. But I remind you that this latest offer is not really a privatization offer governed by the SFC, where whatever said during the offer period is etched in stones and can't be overturned, but merely a purchase of assets under the HKSE rules. So Mr. Wong can change his mind anytime and technically won't be in breach of anything (he's not made any announcement under his name), other than personal reputation which I don't think matters the most to him right now.

Having said this I do admire Mr. Wong's courage to go the full distance knowing his chance of success is slim. His only chance of winning is Mr. Webb backing down at the last minute, slim. What Mr. Wong can do now is to grab as many shares as he can, knowing he can't buy up the whole company. What's next is anybody's guess? The best scenario is that Mr. Wong's planning to flip the company over to a private equity fund and the worst scenario is nothing will happen for a long while.

I'm gonna to attend the SGM and see how this eventually plays out.

DISCLOSURE: I hold 532 at time of writing.

It was a Good Show

2007-06-05T12:50:00.000+08:00

All good things have to come to an end. I can see my days with China COSCO is limited. In fact I've been reducing my exposure for some time.

Capitalization is now $67b, about 35% attributable to COSCO Pacific the port operator and 65% to the shipping division. COSCO's vessels are thus valued at $43.6b, or 54% more than that of COSL (2866), which despite a 100%+ rise this year still trails behind at $28.3b. There's no need to compare to OOIL (316) because the discrepancy will be even bigger. Bear in mind shipping profit last year was less than $1b and my best estimate for a normal year was $3b. Either way I look at it the price is steep.

The last time I wrote the cause of the premium was due to the potential injection of dry bulk fleet and A-share listing, the latter has become a reality. The capital will be enlarged by about 20% after listing, which to me is a relatively small scale offering. The proceed will be funding mostly expansion of container fleet. So any injection will come at a later stage. Let's just assume the new container fleet will generate the same rate of return as present so we need not worry about the dilution from A-shares for now.

With the A-share listing factor gone, the premium of $15.3b (over COSL) is based entirely on injection hope, which makes up 1/4 of the current capitalization. It's common ground that share price tend to precede facts and market consensus now seems that China COSCO will be dished $15.3b worth of favor in the coming asset injection.

How big is a favor of $15.3b? For benchmark I use China Shipping Development (1138) which is trading at 19x p/e. I calculate the market valuation for each $1b of dry bulk earnings injected, then how much discount is needed and the injection p/e in order to give $15.3b favor to China COSCO.

1b; 19b; 81%; 3.61x
2b; 38b; 40%; 11.4x
3b; 57b; 27%; 13.9x
4b; 76b; 20%; 15.2x
5b; 95b; 16%; 16x

I don't think the discount to market comparable can be too great so it'll have to be assets with more than $2b earnings at least. With China COSCO's capitalizaiton of $67b, unless the injection is of a grand scale (like that of Dongfang Electric (1072)) the market is likely to be disappointed.

It's not my principle to invest on hope nor ride on speculation too much. So to me it's time to reduce and watch the development.

DISCLOSURE: I hold 1919 at time of writing.

A Look at the Glasses Companies

2007-05-29T16:35:00.000+08:00

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.

Dongfang Electric (1072): a Faithful Buy

2007-05-22T11:57:00.000+08:00

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.

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

2007-05-11T01:20:00.000+08:00

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.

There's NO Insider Trading in HK!

2007-05-10T11:09:00.000+08:00

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.

Something Else

2007-05-09T13:40:00.000+08:00

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.

Talking People Out of Getting Rich is a Hideous Crime!

2007-05-07T23:45:00.000+08:00

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.

Results Brief: PCCW (8)

2007-04-30T13:55:00.000+08:00

This comes later than usual because I was waiting for the annual report of PCCW, not because I was expecting something groundbreaking to be said by Richard Li but rather a better breakdown of the segmental figures. However in the end I found there's none and the information there was just as convoluted.

(previous analysis at http://abaci-investing.blogspot.com/2007/02/pccw-8-now-is-time.html for the unfamiliar)

The item I was curious to know more was $600m of unallocated expenses, which was quite sizable considering its mysterious nature and that 2006 pre-tax profit was only $2.5b. The weird thing was that there was no such item in the interim report, i.e. somehow all unallocated expenses found its ways into the different business segments at interim, and then reappeared as unallocated in the annual report.

Earnings were down from $1.9b to $1.6b. Management's explanation was lower investment income and disposal gains. There was no elaboration and the slightest hints I picked up were the $100m derivative loss (vs. $300m gain last year) and $150m lesser disposal gain last year. I had no way to know which way these items will show up next year so I take it'll be same this year. Fixed line and internet business was flat or in nicer term consistent. NOW and PCCW mobile provided much of the bleeding. The consulting arm on the other hand was a surprise turnaround. Interest cost as expected did drop by $200m as higher cost debt were refinanced and interest income increased by $200m as well.

I'm not concerned about the prospect of NOW as I'm sure the EPL license will bring in sufficient subscribers to cover the costs. Many of us have had enough experience with Cable TV's lousy picture and customer service. I don't see there's any other killer programming to stop this migration. Knowing the habit of our fellow honkies, the switching should occur at the last minute and at the same time in September. I read that some equipment will be upgraded to broadcast matches in HD, if it's true it'll draw an even larger crowd. Just 350k new subscribers to the sports channels (less than half of Cable TV users) at $179 a month will bring in over $750m revenue a year, even though the license alone will cost some $500m a year.

I have lesser comfort in PCCW mobile, for mobile market is too crowded and no one is earning decent income. In fact the mobile division was the loss leader, increasing from $126m in 2005 to $700m last year, albeit $500m of it was depreciation, amortization and interests. My expectation of lower costs from consolidating Sunday and PCCW outlets and staff didn't happen yet in 2006, but I'm sure it'll take place this year as increasing revenue (vs. cost cutting) will be a more difficult task. I'll stick to my previous guess of $200m saving for this year.

Earnings excluding PCPD and amortization this year may be $1.6B-1.8b so recurring p/e is 16-18x, not attractive enough if you are an income collector. I hoped PCCW would go into a quiet debt reduction mode which would grow the company value internally. But looking at the recent developments it looks like big cash will always be spent and there will always be deals, buy or sell, to make the headlines to entice buyers for PCCW. So I've changed my view and labeled PCCW as a pure M&A play, meaning it isn't exciting and you won't know when it'll happen. The good thing is it'll hold its value against general market fall.

DISCLOSURE: I hold 8 at time of writing.

Results Brief: Tomson (258)

2007-04-23T17:19:00.000+08:00

This one is gonna be really brief as there's not much to talk about.

As far as I know only 3 units of Tomson Rivieria (TR) have been pre-sold and Tomson has collected $100m. I also read from the internet that a neighboring development in Pudong is planning to be sold at $60k-80k per sqm. This can be good news for a floor price is established for TR, or bad news as potential buyers may be drawn to the cheaper offer.

There are other developments in Pudong that Tomson is developing including villas around the Tomson golf course (75,000 sqm to be sold this year) and apartments in the Zhangjiang Hi-Tech Park (which have been sold out). These will provide interim earnings before the sale of TR and may actually turn in some impressive figures too given the low land costs. I have not accounted for these profits in my analysis so when it becomes due it'll be bonus.

The big question of LAT remain unresolved. Tomson has provided $246m but it's more likely not to have included provision for TR judging from the size of the provision. Management has made it clear that two blocks will be kept for rental purpose (whether it can be rented is another matter) so it may suggest sale of two blocks before early 2008 when the LAT is due. And how much LAT is gonna levied in the end is anybody's guess but I'm sure Tomson should have no problem borrowing against TR should the funding need arises, and in any case Tomson is in a net cash position so it can raise further debt too.

So the basic story remains intact - Shanghai financial district luxury property developer is trading at only 70% of unadjusted book value. I don't see the need to change view.

DISCLOSURE: I hold 258 at time of writing.

Report Card

2007-04-19T18:23:00.000+08:00

This is the 1st report card about this blog and the investment picks, mostly for my record.

Today is 4 months and 1 day since this blog was started back in December last year. Looking back I think it was a right decision because it really forced a lot of discipline into my life. I wanted to do a review earlier, probably at quarter end, but the hectic reporting season has precluded it until now. (Note: the other reason is I'm scared the market will turn and wipe out most of the gain)

Up to today there have been 6,600 visitors, working out to be around 55 visitors a day. This is quite a small group but the quality of the comments received suggests big thinkers. Say 'bravo' to yourself if you are reading and I thank you for your support.

Summarized below are the companies which I've covered so far and their share price performance since. The proper way to do this is to include the financial performance as well but that's too much work for one person. I have also put down which companies I hold shares in for better disclosure. While I have thought about whether I should only include those which I hold shares in or have suggested a buy, even as a speculation, in the end I've decided to list them all out since I figured I'd never spent time writing about a company if I wasn't interested in it at the 1st place. And I trust my readers to be competent enough to make their own decisions.

Please note this is NOT a recommended buy list.

(dividends are not added back except stated)
(* means present holding)

Dec 18 06
China COSCO (1919)*
up by 77% from $3.887 (adj. for bonus shares)

OOIL (316)*
up by 55% from $48.5 (adj. for dividends)

Dec 20 06
Tomson (258)*
up by 5% from $2.05

Dec 27 06
WKK (532)*
up by 40% from $1.12

Jan 2 07
Dickson (113)*
up by 17% from $7.91

Jan 8 07
Man Yue (894)*
up by 21% from $2.03

Fujikon (927)*
up by 2% from $1.80

Arts Optical (1120)*
up by 18% from $2.58

Yip's Chemicals (408)*
up by 11% from $3.82

VSC (1001)*
up by 20% from $0.98

Jan 9 07
Chalco (2600)*
up by 29% from $6.95

Jan 16 2007
SH Petrochemicals (338)*
up by 13% from $4.07

Jan 24 07
Meadville (3313)
down by 21% from $2.25

Jan 29 07
Xinyi Glass (868)
up by 21% from $3.71

Jan 31 07
ZJ Glass (739)
up by 180% from $1.68 (this'll likely be my 'miss' of the year)

Feb 2 07
LSH (238)
up by 3% from $3.40

Feb 13 07
PCCW (8)*
up by 3% from $4.67

Feb 16 07
HKCG (3)
up by 5% from $17.48

Mar 22 07
Sinopec (386)*
up by 10% from $6.07

Mar 27 07
COSL (2883)
up by 4% from $6.11

Mar 28 07
Hendersen Investment (97)*
up by 5% from $15.52

April 3 07
Proactive Technologies (8089)
up by 52% from $7.27

April 12 07
China Glass (3300)
up by 13% from $3.40

Apr 16 07
Shui On Construction (983)*
up by 1% from $17.40

Not a bad start with only one loser from Meadville, which was an IPO so there wasn't a lot of damage. The super bull market has helped a lot. Of course I'm also proud of my achievement of finding you an IPO loser which is next to impossible these days.

Hope the adjustment won't be too severe and we'll all have as much luck for the remainder of the year.

DISCLOSURE: I hold those shares with * at time of writing.

Ever Deeper Underdogs vs Ever Rising Superstars

2007-04-19T11:42:00.000+08:00

Can the underdogs go any deeper? Can the superstars get any more out of reach?

This is a market as divided as ever. If you happen to sell inside China, you're automatically treated like a Hollywood celebrity. If you happen to sell outside China, you're banished into the dog house.

Of course I'm crying out loud for my favorite industrial plays, which I've picked to outperform the market in 2007. (http://abaci-investing.blogspot.com/2007/01/every-dog-has-its-day-my-industrial.html)

So far they have delivered excellent results against all hostilities (RMB, oil price, wages, tax reform, blahblahblah) but the market is clearly turning a blind eye on it, while busy worshipping the latest batch of superstars (note they come in batches).

Just a look at the figures will tell you the whole story.

(2006 earnings; EPS growth; p/e; yield)

Stars
Minth (425) - $269m; 6.8%; 25x; 1.2%
Shandong Molong (568) - $139m; 59%; 25x; 0.66%
Enric (3899) - $97m; 0.2%; 23x; nil

Dogs
WKK (532) - $250m; 37.2%; 4.4x; 1%
Arts Optical (1120) - $166m; 72.1%; 6.7x; 4.8%
Man Yue (894) - $122m; 15%; 8.7x; 2.2%

Valuation gap this big has not been seen since the last IT craze when industrials, including Techtronic, were ignored and all eyes were fixed on China Mobile and PCCW. By the way, coincidentally HSBC is once again being ignored.

For those, including myself, who have missed out the rally last time, now is the chance to redeem. But one cautionary note, not all industrials are created equal and management quality really matters in tough times like now. Choose wisely.

DISCLOSURE: I hold all 3 dogs and none of the stars at time of writing.

Senta Wong has done it again!

2007-04-18T12:30:00.000+08:00

My salute to the tenacity of Senta Wong to rip us off!

For proper introduction and to put things back in perspective before we begin, check out http://abaci-investing.blogspot.com/2006/12/failed-privatization-follow-chairman.html.

WKK (532) was suspended on Mar 19 with a note that there'd be a substantial disposal. At first I thought some private equity funds were buying the PCB business and so it should be good news. But then not a single word came out since. Then I noticed the 2006 results were scheduled for release yesterday and realized probably the Stock Exchange had requested the two announcements to go hand in hand to the shareholders (this was one of the few things the HKEX had done correctly) given the closeness of the two event.

It turned out the buyer was interested in buying everything WKK had, and the buyer was no one other than Senta Wong himself. So this is yet another privatization in disguise and was done in a cheeky manner again. The last offer was timed right before the release of interim results and this time it was right before the final results. The purpose was all the same: to avoid having the latest results, which were excellent, included in the shareholder's circular and to shorten the decision time as much as possible (since there'll be probably be a delay in publishing the circular if the annual report is to be included).

This time the deal is structured as a sale of assets as opposed to a privatization offer, the difference being that the approval threshold is lowered from 90% to 75% of independent vote. And the deal can also fall outside the jurisdiction of the SFC. Since the deal was only marginally voted down last time, Senta Wong must feel pretty confident to succeed this time and hence offer a price ($1.65) only 20% higher than his last offer of $1.38. And to save interest further he even offers part of the consideration paid in promissory note to be settled in cash 3 months after completion (note: in normal takeover deals you would see a stand-by facility arranged by a bank ready at time of offer).

All these moves are really low class acts. If there's a financial or legal adviser behind, shame on them too!

Do I even need to mention the financial results? I guess not much since as you can see Senta Wong is so smart that I can really rely on his judgement.

EPS was up by 37% in 2006 and earnings were $250m. In this sense the offer hasn't really been improved but only reflected the increase in profit, or is it the opposite? The last offer was made at 5.3x p/e of 2005 earnings while the new offer is only made at 4.7x 2006 earnings! This offer is even worse than the last one.

In the results announcement the tone was as downbeat as it could be, citing all the difficulties facing the industry but contradicting all the underlying figures nonetheless. This shows symptom of a divided personality.

I strongly recommend everyone who holds WKK to vote and block this deal. There's no need to even consider any offer below $2 a share.

A side note, from this repeated exercise and that David Webb's buying into Sinotronics (1195), I'd say one shouldn't miss out the PCB industry. Other choices include Meadville (3313), Daishomicroline (567), Hannstar (667), or the upstream Kingboard twins (1888) and (148). Logical extension includes capacitor maker Man Yue (894). Pick wisely.

DISCLOSURE: I hold 532, 1195, & 894 at time of writing.

Shun On Construction (983): Becoming a Fund Manager? Part II

2007-04-17T11:28:00.000+08:00

Construction business
This is the old build and deliver construction business, which is unexciting and earns little profit. Profits for the last 2 years were more or less $50m. Most businesses are in HK and Macau but future opportunities will come from referral from SOL and the distressed property division in China. Since the scale now is really small I'll simply give it a 8x p/e valuation at $400m and move on.

Distressed property (or what Shui On calls DAD)
This is the newer and more interesting business as it's similar to what SOL does but on a micro level. DAD team will buy up abandoned or half-finished property sites from distressed owners or creditor banks and then complete it and sell for profit. Up to now there's 5 projects of similar nature being developed and 2 more projects will commence later this year (and there's 5 more on the pipeline being negotiated). Each deal is structured in form of a JV with different partners like JP Morgan and other institutional investors.

It certain looks like this DAD business is really promising that SOC is planning to spin it off on a stock exchange, maybe on the London AIM market since Deutsche Bank London branch will be the placing agent. This move is logical since SOC has the reputation and experience (it gained from SOL) to source enough deals but not the capital to secure it (SOC itself is pretty loaded with debt already). And it'd be time consuming to find partners and negotiate a separate JV agreement for every deal. Plus SOC gets to benefit from putting on a second hat as a fund manager and can earn additional fees.

According to preliminary information, property interests and shareholders loan valued at $2.3b (of which SOC portion is $1.1b) will be injected into the listco. DB London is expected to raise $4.3b cash from listing. SOC will subscribe some new shares too in cash subject to a cap of $1.2b and that it'll hold no more than 49% of the listco. I note that these properties cost SOC only $460m and thus it'll make 100%+ profit upon listing. I hope this will look impressive enough to the investors in London, where property prices are on a very high plateau already.

The listing is expected to close before the end of May. If everything runs smoothly the fund will have a NAV of $6.6b (note: I use 'fund' as the listco is like a closed-end fund). SOC will be both the fund manager and the chief contractor earning income from both sides. Management fee will be 2% on net equity (less 0.5% for expenses) and 20% performance fee on the portion of return above 10%. The all-in fee should be 2.5% p.a. assuming an average annual return of 15%, or $165m in dollar term. I don't know if or where taxes are to be paid so I'll simply discount it by 20% to get after tax earnings of $132m. Contractor fees will be 4% on each budget and some incentive fee from cost savings. This calculation is a bit tricky so I won't bother.

Remember SOC has injected $1.1b worth of assets into this fund too. After management fee, SOC will earn 12.5% (15% return less 2.5% fees) on investment, or $138m in dollar term.

The two add up to about $270m earnings a year. Note that SOC will earn just as much from the fund management side using OPM (other people's money) as from its own investment. I've not included any return from SOC's additional $1.2b subscription in the fund yet, which could be earning up to another $150m a year. No wonder SOC is very eager to market this DAD concept abroad. One should really have a close eye on the progress of the listing.

For valuation I'll put a sticker of $2.5b. It's a little below 10x p/e for a $270m earnings but I'm really guessing.

Summary

We have $4.9b for SOL, $2.25b for cement, $400m for construction, and $2.5b for DAD, which adds up to $10b. SOC has $3b of gross debt so the net value should be about $7b. At current price of $18, the capitalization (enlarged by CB conversion) is $6b. So there's some scope for appreciation (IF the spin-off goes through). Or you can see it as a cheaper way to buy into SOL with some freebie call options on DAD and cement.

DISCLOSURE: I hold both 272 and 983 at time of writing.

Shui On Construction (983): Becoming a Fund Manager?

2007-04-16T17:06:00.000+08:00

SOC runs 4 businesses, the biggest of which is property development which has been spun-off and become 18% holding in Shui On Land, next is some cement plants in southwestern China, then there's distressed property development, and finally the old school construction business. There's also some venture capital funds but since the profit contribution is small yet unpredictable, I'll skip here.

Shui On Land (272)
This is Tony Measor's favorite pick for 2007 which he expects has the most chance to double. But instead its price has dropped by 5% so far this year. I think the share was listed at $5.35 last year, making the gain up to now about 20%, very modest compared to other China property plays. One reason seems that people believe locals are more experienced and informed in their homeland and hence can better run the business. And Vincent Lo being a HK citizens is thus regarded as second grade at best, even the fact is he already invested in China as early as in the last property slump in the 90s, and I guess many of the new crop of local Chinese property developers didn't even exist back then. So much for the local is better myth for me.

Quite the contrary the 'foreigner' status of Shui On Land gives me more confidence, for Shui On group has a long listing history in HK (3 listed companies) and a reputation to rely upon. And its track record has been respectable and the Shanghai Xintiandi is a fine example. I'd rather buy into Vincent Lo than many new Chinese property tycoons whom I don't really know much about, especially those who seem to get too rich too quickly. I initially thought many foreign funds would follow this logic and found SOL a more reasonable and reliable investment than the Chinese counterparts. Again the market logic beats me and I don't have a clue.

There's no much to really look into SOL because it's not a simple business to understand. It's like the city redevelopment council here in HK except it's without government funding. Valuing this type of long term property projects which may run anywhere from 5-10 years or even longer is nearly impossible. But here one can count on the long term trend of the Chinese property market which is up, and the proven Shui On management quality. The long duration of the projects can also soothe out the impact of any interim fluctuation in the property market.

Lastly, the less precise value of the business can really give scope for imagination and fuel speculation.

Cement business
SOC runs the plants mostly via a 45% owned JV with the french cement company Lafarge. It aims at the upscale market with plants in Chongqing, Sichuan, Guizhou, and Beijing. Separately SOC runs plants in Guizhou and Nanjing under its own name. Last year's results were hampered by an one-off provision of old equipment of $170m. Discount that the JV would have been profit making already. The cement market has come around if you look at the latest results or share price of Anhui Cement. Business should prosper with much construction activities going on in central/western China and in Beijing for the Olympics (note SOC's plants are all nearly by).

Profit is not easy to predict for a turnaround play. So for valuation I'll arbitrarily but conservatively give it 1/20 of the capitalization of Anhui Cement, although SOC (cement division) had more than 1/10 of the turnover. This will give a value of $2.25b.

To continue...

DISCLOSURE: I hold both 272 & 983 at time of writing.

2nd Look at the Glass Companies

2007-04-12T17:29:00.000+08:00

I took another look at the glass makers as there's been quite some activities going on with these counters, which unfortunately mean higher prices too. More people are buying into the recovery story after 2 years of oversupply and price war, and demand should pick up strongly from growth in both the auto and the construction sector. Speaking of construction materials, the glass counters are also a lagger after others like steel, aluminum, copper, cement, which all have had their run.

Those who are reading about the glass companies for the 1st time should also look at my work done back in January on Xinyi and ZJ Glass.

Xinyi (868)
The 2006 results were a surprise as it showed very strong growth in construction glass in the 2nd half, which helped counter the slower growth in auto glass. And it finally put its upstream float glass plant in operation after some delay. Bottom line showed excellent 50% growth but EPS growth was more moderate at 40% because of dilution from new shares issued last June. One can't really pick on these results in any way but my only concern about its strange cash management practice remains. I thought cashflow was tight when Xinyi had to raise $180m from a placement to build a solar glass operation. But then Xinyi declared roughly the same amount as dividends. Maybe the management really has a distaste for debt or maybe the outlook was really blurry at the time of placement when they didn't expect things to turnaround that quickly. But the market isn't troubled by this and Xinyi is now trading at 19x p/e. This one looks like is becoming a growth share.

ZJ Glass (739)
Nothing new came out since my last look but price has climbed by 40% in 2 months' time, which was respectable but no longer spectacular these days. 2006 results will be published on the 27th but all eyes are apparently already on 2007 and beyond, since there's nothing to cheer about the past year. Capitalization is now $1.8b so if ZJ Class can really recover to its previous peak earning of about 200m a year in 2007 (note: it made a loss in $76m 2006 interim), the p/e will be 9x, not bad if this kind of growth can maintain. I'd say for now the price has got ahead of earnings a bit, but those early birds might really know something which I don't.

China Glass (3300)
This one is complicated and so far I've not been able to make much sense out of its reports. It started out as a small glass makers and was listed in 2005. Since beginning of last year it have had a series of M&A taking up 6 or 7 other glass makers. Now it claims itself to be the biggest glass maker in China!

It attracted me because of its relatively small capitalization of about $1.3b, comparing to Xinyi's $7.5b and ZJ Glass's $1.8b. And it had good backing too with Nippon Glass as a strategic partner holding 29.9% and IFC holding like 3% plus Casanove (a good name in this business) helped place some shares recently at $2.75 (too bad now the price is $3.6 already). So it seemed a good bet on the recovery story. But after going through the numbers I found myself lost completely, even as simple as to the size and earnings power of the enlarged China Glass group. Of course it didn't help much when Everbright Capital was the IFA advising the minority shareholders in these acquisitions (for their opinion provided no useful insight).

To me it seems China Glass has been swapping shares with others to enlarge itself as opposed to straight acquisition, and it doesn't have majority control over most of these newly acquired businesses. The plus side is little cash is required and the company appears larger than it is. But the minus side is that it's hard to manage so many operations and to get consensus with so many heads on top. China Glass Group should properly be called China Glass and the group of companies. If you look at the balance sheet you'll find minority interest to be just as big, if not bigger, as the owners' equity!

So there you have it, my view on the three glass counters. All have merits not without doubt. I have a slight preference for China Glass for now but that can go away easily with a swing in price. This is a sector which I think is promising and worth taking some risk.

DISCLOSURE: I don't hold 868, 739, 3300 at time of writing.

A Little Proactivity won't Hurt

2007-04-03T19:34:00.000+08:00

I've always read successful people are proactive in life and pursuit of everything, and they never wait for things to happen. So this may be one fine inspiring example, how about growing a company by 150 times in capitalization from $20m to $3b in less than 4 months?

Here is a company which used to be in the telecom software business. It was listed on GEM in 2002 and shares were held by management shareholders Tsang, Lam, and Lau. It even had attracted a fund, Pacific Technology Partners, as a strategic investor. But things apparently turned bad after listing as financial performance deteriorated in the next few years. Then at some point in time things became discouraging enough that the owners decided to sell their stakes, one by one.

First, Lau, the COO, exited and sold his shares at 9.2 cents in July 2005. But lucky was he there was a buyer (Century Dragon) for his minority interest and the deal was done off-market. 9 months later in April last year, Lam, the co-founder, exited and he was also lucky to find a buyer (Gorgeous Overseas) for his shares at 8.75 cents off-market. One month later in May last year, Pacific Technology Partners probably sensed trouble and wanted out, but be not desperate as it too found a buyer (Homerun Business) and sold out off-market at 6 cents. Finally in November last year, Tsang, the remaining co-founder, sold out his stake at 8 cents to, how hard could it be, yet another off-market buyer, Well Support. Well Support was indeed very well supported as the name Kingston Finance and Ms. Chu showed up in the SFO disclosure. My guess is they were the financier because their names were subsequently cleared off the shareholders' record in February this year.

Bear in mind the 4 buyers were unrelated and we must give praise to whoever the broker was because it was one hell of a job to clear those GEM stocks in 4 non-controlling blocks. In total, 139.7m shares (60%) were changed hands at an average price of 8.2 cents for $11.4m, more or less the price for a GEM shell.

Now the proactivity began, trading volume and price started to go up in the same month of November, with no apparent reason. By this time Gorgeous Overseas must be feeling gorgeous as it was selling down its stakes (from 40m shares to 23m shares) at 28 cents, making more than 3 times of cost or 200% profit. A placing was then done at 24 cents raising $46.4m. No names of the placees were disclosed.

Things continued to go wild after the placing and before anyone knew it, the price was up by 400% to over a dollar in the 2nd trading day into December. Remember proactive people don't wait for things to happen. An announcement then came out and mentioned talks were being held with some companies under the China Railway department about potential co-operation in logistics and transportation. It then settled down for a while, but for not long, before climbing by 400% again to $4 in this January! But it didn't stop there and continued to reach $7 this month! $7 was 87 times of the original investment cost of 8.2 cents! Early birds must be very full by now.

Full details about the co-operation and the agreements eventually came out on 12 March. The company will be injected a 49% effective interest in a JV with China Railway (HK), GD Railway, Pacific Telecom and Networks, and BJ Run Tong as partners on two shareholding levels. The business will be railway cargo transportation operator. I wrote 'will be' because the JV is not yet in operation and is still trying to obtain the necessary regulatory approval to operate. But that didn't apparently deter anyone. The consideration was $680m which will be 99% satisfied by issue of new shares at $7.11, yes, seven-eleven. And so another shareholder Cheung emerged. There are now 5 shareholders introduced into this company and they don't know each other! Maybe proactive people have a tendency to find one another.

Okay you might say it's just a rubbish for rubbish deal since there's little cash involved. But 7-11 is never a quiet place, under the same deal 55m new shares were also placed at $7.11 via China Construction Bank to a number of institutional investors including at least two investment funds, Indus Capital and Gandhara Master Fund. UBS's name showed up too but it's more likely to be a broker of either of the fund. So now there's real money backing this surreal railway venture.

Apparently you should know by now I'm not the proactive type since I only brought to you this company when its price is over $7. So don't expect me to tell you what'll happen next.

What's the purpose of this post? Of course I'm jealous of others getting immensely rich! I'm all red eye now.

And what's the name of this company? Proactive Technology Holdings (8089).

DISCLOSURE: I don't hold 8089 at time of writing.

China Oilfield Services (2883): Final Look

2007-03-30T15:41:00.000+08:00

The CNOOC 2006 results were out yesterday and there's no surprises. It was as good as people had expected under very favorable environment of last year. Management was also very upbeat about new oil finds, citing the replacement/production ratio reached 200% last year, and they expect the oil reserve will continue to grow and hence are investing heavily into E&P equipment. This sounds good to the driller.

I had a quick look at the 5-year operation summary in the 2005 annual report. There I found the r/p ratio has always been over 100% over the period, meaning more oil was found than produced. And at the end of 2005 the reserve life was 15.3 years, almost same as the 2006 figure, reflecting higher production level last year.

But one has to be careful that the excellent results of the past few years was a combination of rising product prices (rental) and increase in utilization rate, which steadily increased from 70% in 2002 to over 90% of capacity last year, as opposed to increase in capacity, ie. production from new oil wells. Utilization will become less of a growth factor in the future and as costs will definitely be going up due to the replacement of the fleet, whether future rental can be raised enough to compensate for it (so far the margin has been stable) is unknown and will be an internal matter between CNOOC and the driller. If the driller has to bear the cost then it might earn 20% less (see my last analysis).

Business for certain will continue to be robust but I'm just not so sure if earnings will be. At 22x p/e and less than 1% yield, I'd take a pass on the driller and rather look for real service companies that have less reinvestment burden and more distribution.

DISCLOSURE: I don't hold 2883 at time of writing.

Results Brief: China COSCO (1919)

2007-03-29T12:15:00.000+08:00

The last few posts were a little long and complicated which wasn't expected, nor was it my usual style. That's why I usually hate reading into too much details, because it only draws you to more calculation and guesswork but not necessarily accuracy. And it tends to masks you from seeing the big picture too. I'll try to go back to being brief and simple for the coming ones.

Below is breakdown of the two halves' figures of China COSCO.

Port 1H: $0.54b; 2H: $0.61b; Total: $1.15b
Shipping 1H: $0.44b; 2H: $0.44b; Total: $0.88b

The shipping side showed no improvement in the 2nd half despite cheaper fuel and supposedly higher freight. As OOIL management correctly put it earlier, too many lower-priced contracts locked in the 1st half when everyone was too eager to find business for the new vessels had a lingering effect on the 2nd half. Of course you won't find this mentioned by the COSCO management.

In my first analysis of the shipliners in Dec last year, my work was based on the principal assumption that all three shipliners with roughly equal-sized fleet and similar routes should demand similar valuation. That's how I came up with the pick on China COSCO and OOIL at that time. Three months later and with a bit of luck the valuation gap is now pretty much filled. But when I come to think of it again after seeing these results, I think execution skills should factor in and OOIL is clearly superior in this regard.

After deducting the market value of COSCO Pacific*, the shipping division is worth $23b, which is about what I gave to the OOIL shipping division, 8x p/e of a $3b earnings. I'd be really hesitate to give China COSCO the same valuation, when it only made 30% of OOIL's earnings last year. Maybe half of it is more appropriate and 2/3 will be very generous. So I'd say the current price is fair at best, you may add it's a little rich, but that's because all eyes are now on the injection of the parent company's dry bulk fleet, which is the largest in the world, and the A-share listing, and China COSCO is the only ticket to the show so this premium won't go away anytime soon. I hope it'll be a good show.

Don't buy at this price unless you are a speculator, a good one, but hold on to your shares if you have it.

DISCLOSURE: I hold 1919 at time of writing.

* i'm not not worried about the ports since its business nature is utility-like and defensive, and the current price isn't stretched and actually shows restraint compared to a lot of other china shares.

China Oilfield Services (2883): Supplementals

2007-03-28T16:45:00.000+08:00

Today I did some more digging into the equipment cost issue where I left off yesterday.

According to the prospectus the fixed assets were revalued twice, once in 1994 and once before listing in 2002, under the replacement cost method. Whatever that was the book cost shown should be reasonably current, which is comforting. The discomforting part is that while these revaluation surplus nicely showed up as reserves, there's no cash set aside for replacement. The driller will need to incur debt or sell shares to finance these replacement, which unlike capital expansion won't generate new earnings (but one can argue the new rigs should be more efficient and have lower operating costs). Either way is gonna negatively affect per share earnings by higher interest or dilution.

In 2002 there were $10.2b of fixed assets (cost basis) supporting operations of 12 rigs, or $8.5b per rig. In 2005 the book cost was $13.9b and there were 15 rigs, so the unit cost was increased to $9.3b per rig. The 2005 annual report showed just the rig alone to be delivered at the end of this year would cost $11.5b, another 24% increase. If all rigs are to be replaced then eventually depreciation should go up by similar proportion. My estimate shows this will cost 20% of future earnings, if these increases can't be passed on to customers.

Most importantly and before costs, are there enough oilfields to be drilled? What's the use of having new rigs if there are not enough discoveries? Almost all the rigs now are on sites that are just as old as the rigs itself. What's gonna happen after these wells are done with. I got from the prospectus that in terms of E&P activities, China off-shore seemed much less developed than the Mexico Gulf of the US. So that seemed to suggest the China off-shore oilfields would have a long life. Anyhow, this is such a fundamental issue but I only raise it in the end of my analysis! I guess this shows I still have a long way to go.

I'll try to make a conclusion after I read CNOOC's results tomorrow.

DISCLOSURE: I don't hold 2883 at time of writing.

Thoughts on Latest Henderson Asset Shuffle

2007-03-28T13:45:00.000+08:00

This morning on reflex I bought some shares in Henderson Investment (97), mainly as I saw it as a cheaper way to buy into Hong Kong and China Gas.

Having said this, this is not a new discovery as there's been two privatization attempts in the past for the same objective. But this time there's a new twist as HI's interest in HKCG is untouched whilst almost everything else inside HI will change hands. This will make holding HI no different from holding HKCG directly. Even dividends are said to be fully distributed dollar for dollar in the future, until and unless HI takes on other acquisitions (this is the tricky part and you'll have my guess later).

Quick math shows after two dividends (interim & special) HI will be worth 2/3 of its value or about 32b. The market value of its 38.5% interest in HKCG is worth 37b. So there's a 15% difference which one can pocket, or as I saw it an invitation to buy HKCG cheap. Of course my assumption is this time the deal will get the greenlight from the minority shareholders. I'm confident Mr. Lee after two hard lessons should have figured a way out already. So I'll let him worried about it and do his job.

Now the fun part of guessing what's behind all these and what'll happen next. But beforehand you should be warned that as I hold a position all these arguments won't be impartial and my wishful thinking will dominate.

(1) Privatization of HI
Many suggest this will be the eventual path and the current step is to clear the necessary hurdles for it to happen. This sounds very logical but doesn't make much sense. Unless Mr. Li has lost his sense this will mostly likely not happen. Privatization is only sensible when the assets can be bought cheap, which can be caused by market inefficiency or a divergence of view between the market and the owner on future prospect. But I see neither of this. After the shuffle, HI will hold nothing but HKCG's stocks. With this much of transparency, any future buyout will have to be made on market price (at least) to succeed. If this was what Mr. Li was willing to pay, this deal could have been bundled together this time, or would have been done long time ago.

(2) Future role of Panva Gas
Some say this reshuffle will cement and expedite Panva Gas's role as the flatship of HKCG's China business. It's a bit stretched on imagination to say the least how these two can be related. I'd just say I'm not sure if Mr. Lee would want to share the captain seat of his flatship with someone else. Nevertheless Panva Gas may get more assets down the road and let's watch the space.

(3) Future role of HI
This part draws my interest the most as I can't really figure out why HI is kept. There's got to be a purpose for its listing or a story to sell. The official reason is to have an more efficient operating structure for the Henderson group and to unlock the value inside HI. My logical guess is Mr. Lee and HI are thinking about selling new shares, otherwise why he would care about reflecting the real value of HI. Now if I tie in this to the part about HI paying out all dividends from HKCG until and unless there's new acquisitions, a picture starts to emerge - HI may have big acquisitions in the pipeline which will need equity financing. I'll look no further than those in HKCG.

HKCG has 4 pieces of assets: HK gas business, China gas business, China water business, and IFC interest. There's some HK development properties which will turn to cash so I'll ignore it here. The IFC interest looks a better fit to Henderson Land and I won't be surprised to see it go first. The HK gas business has nothing exciting so the candidates can only be the China gas and water business.

But why buy something one already owns? First, one need to distinguish the level of effective interest. Henderson Land owns 68% of HI but only 68% x 38.5% = 26% of HKCG. Wouldn't it be nice for Henderson to hold 68% of those China projects on the HI level than 28% on the HKCG level? Second, after the shuffle HI will only be 1/3 the market size of HKCG and hence its share price should respond faster to the growth in the China business. It'll be easier to raise capital too. HKCG also benefits from having a clear identity of a local utility play.

How soon will these happen? I'd say patience. HKCG won't be selling now as these assets are green and need funding (which it's got plenty from the HK gas business). Remember Mr. Lee has said he expected the China business to flourish anywhere between now and in 3 years' time. My guess is it'll happen when the assets start to mature but not overly ripe.

DISCLOSURE: I hold 97 at time of writing. I don't hold 3, 12, 1083 at time of writing.

China Oilfield Services (2883): Where's the Service?

2007-03-27T23:30:00.000+08:00

This is a nice detour from the tough job of reading the Sinopec financial statements.

COSL announced yet another pleasant results with 37% increase in 2006 earnings. And it doesn't appear the momentum is slowing down. COSL has plans for major capex and will be raising both debt and equity, but more on that later. Since listing at the end of 2002, COSL has had a EPS compound growth of 32%, or a triple over 4 years. Even taking out the effect of the tax break it's gotten since 2003, when its income tax rate was reduced from 33% to 15%, pre-tax earnings showed 29% compound growth. Making this record more impressive is that COSL has had no debt for most of this time until last year, even then debt level was still held at very manageable level (d/e: 23%).

COSL looked to me like a perfect beneficiary of the oil boom. Even real estates of Calgary and Edmonton, two oil cities in Canada, have gone skyrocketing again after many years of drought since the end of last oil boom in the 80s. With the US not having much success on international affairs and its influence fading, COSL with its Chinese background is looking more attractive in the eyes of lesser developed oil countries in the Middle East, Africa, and South America. Don't forget Russia is also China's long time buddy.

Moreover, COSL being a fee-based service company, as opposed to an oil producer, has the added advantage of not having to worry about the rise and fall of oil price too much. Just in case you don't know what COSL does, in simplest terms it does everything an oil company requires to find oil and to produce oil on sea. In more difficult terms it does geophyiscal services, drilling, well management, marine support and transportation.

At first I thought of COSL as a Li & Fung or HAECO type of service organization, those that require great skills but little hard assets to operate on. Afterall aren't we told it's getting harder and harder to find and produce oil? But one look at the historical financials suggests otherwise, rather something to the opposite. ROA for each of the past 5 years were surprisingly low at mid-to-high single digits and ROE weren't much better barely reaching 10%, except for last year when it was 13% with some debt in place. So it's a pretty darn capital intensive business. The question next came to my mind was why I'd want to pay over 3x p/b for assets that yield so little. What am I buying into if it's not great service?

Could this national franchise* to drill, as long as it's above water, be worth so much? I'll simply call COSL the driller from here. I think it's a carved out bit from the E&P unit of CNOOC (this explains the heavy capital requirement), who has been its biggest customer for over 60% of its business every year since listing. Clearly the driller can't survive on its own. But equally there's no ground to suggest CNOOC will ditch the driller, for it's detrimental to both its daily operation and 62% equity investment.

How's the fee to be determined between CNOOC and the driller? The official line is to charge no less than the current market rate. But whether that's entirely accurate is another issue when the two are intermingled and CNOOC takes up so much volume of the business. And I doubt cost difference, if any, will be apparent enough to an outsider given the the complexity and technicalities of the matter. However having observed how listed state-owned companies operate for some time, I'd say they are actually quite fair in their dealings. So I guess the fee would approximate a reasonable return on the assets employed, making the business model look like an utility, in particular that of a power company. Another similarity is that once a rig (drill tower) is in place and production starts, it'll probably stay there until the well has been depleted, which will be many years down the road.

Following this logic cost containment should be the focus since revenue is relatively stable. I want to find out if the driller, like other oil companies' E&P units, also faces the problem of increasing costs. But if it's on the receiving end, i.e. it can pass on the costs to CNOOC, then the current situation is actually conducive to its businesses.

Both the daily rate (price) and the utilization rate of the rigs have increased over the past 5 years. The pre-tax profit margins, however, were more or less 20% during these years (save for last year's higher margin of 22.8% due to the use of leverage), so operating costs had increased but it appeared to have been passed on to customers. Expansion provided further earnings growth as 3 rigs were added to the lineup which is now 15.

Unlike the power companies, the driller hasn't make good use of its balance sheet by borrowing as much as it can. Management has stated it's gonna increase its gearing from 23% to somewhere between 50-100%. This will probably lead to another 10-20% growth in earnings assuming the new assets won't yield less than the present ones.

Up to now the driller's p/e of 21x appears justifiable or even to the low side for a high growth utility.

This final bit is the spoiler. Don't read further if you are keen to buy now. Like Sinopec, capex has been multiples of depreciation for each of every year since listing. Rough calculation showed the remaining life of all productive fixed assets at the end of 2005 was only 7.3 years! This was already improvement from 6.8 years at the end of 2002 but still short by any measure. If you look at the lineup of the self-owned rigs you'd be impressed that only one belongs to the 90s and the second youngest has already 24 years in its service. So over the next few years the driller will have to replace its fleet, and at higher current costs too (read: higher depreciation and lower dividends). I tried but couldn't quantify the earnings effect. But if the driller could pass this cost too to CNOOC and other customers, then my worry is overdone. Now I'm undecided.

Don't let that name fool you, this aint' a service business but rather an utility with old equipment.

DISCLOSURE: I don't hold 2883 at time of writing.

* it's been the government's policy that CNOOC be responsible for all China offshore and overseas oil exploration and production activities, whilst Sinopec and PetroChina be restricted to that on land only. but this distinction could get blurry when everyone is fighting for oil now.

1st Look at Sinopec (386)

2007-03-22T13:30:00.000+08:00

This is the 1st part of an I-hope-not-too-long series on Sinopec, a business which is both huge and diverse. If this is not difficult enough, the rapid movement of oil price creates further headaches to those who try to analyze and properly value Sinopec. Nevertheless oil, like coal, is the mother of energy, but it's cleaner. Oil, like gold, serves as a hedge against war and instability of this world, but it has much greater industrial use. So my first impression is oil is a better investment than either coal or gold.

While there'll always be plenty of buyers for oil, the unanswerable question is price, which could be US$70 per barrel last year or only $25 per barrel 5 years ago post 911. And for this reason I'd prefer Sinopec over PetroChina and CNOOC for its downstream operations and stability, relatively speaking. Others though might prefer the other two when making a hedging bet in a portfolio.

Sinopec runs a fully vertically integrated operation from exploration to refinery to petrochemicals to distribution of oil products. Looking at the asset breakdown each division is roughly equally sized at $106-135 billion, which is a surprise as the exploration and production (E&P) unit is perceived to be biggest because of its earnings (contributing 3 quarters of total operating income). The refining unit made a loss and the rest made up the balance of the earnings.

E&P

Looking at the operational data from 2001-2005, I noted that both the production output and the proven reserves stayed pretty much the same, at about 270-280m barrels and 12 years of production. So far Sinopec has been able to replenish its reserves by finding new wells and squeezing extra mileages from existing wells using more advanced technologies, though it seems not much can be done to increase production level. This is consistent with my observation that for most oil producing countries production can't be rapidly raised to meet demand even under a higher oil price.

With oil prices hovering around high level it's said many old wells and untapped reserves previously deemed not commercially viable have become productive because oil companies can now afford using more expensive technologies in extraction. Explorations are probably getting more costly as well since new findings are few and far between. The case is probably similar for Sinopec so I expect to see increasing costs over time and I've tried to verify this in the following ways.

I extracted that the total operating cost of E&P per barrel of production output increased by 18%, 15%, and 12% over the last 3 years, an definite up-trend though the magnitude of increase was getting smaller.

5 years' average capex of $21b a year exceeded amortization (i.e. depreciation of fixed assets plus write-off of dry well cost) by 74%. This was against the background of no growth in either reserves nor production.

Indeed, the carrying value of E&P fixed assets kept growing by $10b a year for 3 out of past 4 years and has grown by 47% since end of 2001, but depreciation only grew by 35% over the same period. Maybe there's some giant infrastructure being built that's yet in operation, like say long distance pipes to bring oil/gas from Russia. But there's no figures or description in the annual report to give any useful insight.

Which way I choose look at it, it suggests reducing margin for E&P over time.

At the back of the report though, there's a supplemental disclosure prepared under US accounting standard which showed the discounted value of the oil and gas reserves at $360b (calculated based on 2005 year-end oil price of US$60 per barrel and a discount rate of 10%). Amortizing this over the reserve's production life of 12 years gives an annual expense of $30b a year, 3x of last year's depreciation. I then plugged in US$50 in the calculation, the amortization expense was a rough $22b a year still $12b more than last year's depreciation. All these are very imprecise estimate I must say. And I've not thought it through that whether it's necessary to take such amortization from an investor's point of view, in lieu of the company provided amortization.

Finally there's the new 'oil' tax put in place that weighs down earnings. But I'll wait until the release of the 2006 results for further analysis. I think what I have now is already complicated enough.

To sum up, costs are up, additional amortization might be needed, and taxes are higher, but all these won't matter if oil price is high enough. So it all comes down to oil price again, which no one can foretell. Here's a quick look at the E&P profits of the past 5 years and the average oil price.

2005; US$55; $46.9b
2004; US$38; $25.6b
2003; US$29; $19.2b
2002; US$25; $14.8b
2001; US$25; $23.4b

I'll come back to the valuation after I'm done with other parts of the Sinopec business.

DISCLOSURE: I hold 386 at time of writing.

Results Brief: HK & China Gas (3)

2007-03-20T12:00:00.000+08:00

The 2006 results came up last night and offered no surprises, market price though jumped up by more than 3% this morning, quite a movement for an utility. Maybe the market is really excited about the China unit's 60% jump in operating profit to about $400m, which was now over 10% of total earnings (excluding property). Gross investment in China, which includes gas and water projects, grew by some 40% to $10.5b, starting to catch up with that in HK of $12.6b.

Growth in China earnings apparently lacked behind the speed and scale of expansion (ROA at only 4%) but Chairman Lee offered no insights into when these investments are gonna give meaningful return other than that "these projects are projected to thrive within the next three years". Since Chairman Lee is known to be a very long term investor, it could be in 2009 when the thriving really happens.

The problem seems to stem from a lack of supply of natural gas as the giant west-to-east gas pipe can't cope with the rapid conversion from coal to natural gas taking place in many cities. This is because coal price has gone up whilst the natural gas price is still under strict government control to promote usage. Hence supply has run tight and HKCG is tackling this by establishing its own upstream projects. It remains to be seen how long will this situation resolve itself. I'll probably need to dig deep into the PetroChina and Sinopec reports to find out more.

Using the same valuation yardstick last time, the China part is worth 3x p/b at $30 billion. If we assume the supply situation can revert to normal, which will eventually, and the return on investment can reach 15% (with gearing), then the valuation will be about 20x p/e, certainly justifiable but in what year? $1.5b is about 5x of last year's China earnings after some adjusting for profits tax. It'll take more than 3 years if profit growth can be maintained at 50% annually. Alternatively if a 30x p/e can be accepted in light of the growth potential, then a mere $1b earnings can support the valuation. Either way Chairman Lee's words 'thriving within 3 years' comes to mind again. To be any more aggressive than this really requires imagination, which I never have much in disposal.

The performance of the HK gas business was as predicted lackluster. No detailed figures were given but earnings should be a little less than $3b. The partial switch to natural gas is said to create cost savings which will be passed on to customers. But I think it's equally likely and understandable that some savings will find its way to the bottom line. For now I'd stick to the same price tag of $48b.

HK properties including the IFC had a book value of about $10b, since the IFC has been marked to market and the Grand Promenade was largely sold, I'd say it's worth $12b which allows for one or two more years' profit. HKG also held some cash and investment worth about $3b on book.

The total valuation of HKCG is $93b, about the current capitalization. Downside risk at this price is little to none. Personally I'd prefer to wait for one or two reports to see if the China earnings can really take off, or wait for some market signal given by other gas companies. Since many brokerages have already issued buy calls with bullish forecasts, soon I may be left behind in dust regretting my inaction. However I'm not afraid to buy at a higher price if it becomes a sure bet.

DISCLOSURE: I don't hold 3 at time of writing.

Thoughts on US Sub-Prime Mortgage Market

2007-03-15T23:00:00.000+08:00

The subject has attracted so much attention and press coverage that I almost felt guilty not to write something about it. However I'd not repeat what you probably have heard but instead fill-in a few details which I hope will help you understand the situation better.

The mortgage market in the US is the most advanced in the world and it's long evolved from a pure lending market, where banks and homeowners are the participants, into a free-flowing capital market where everyone can be a part of it, be it commercial banks, investment banks, mutual funds, pension funds, wholesale and retail investors. For this day we have the US academics to thank, who came up with the exotic math to tackle all kinds of uncertainties in this world, and property market is only one area of application.

Anyone who'd want to know more about the inner-workings of the mortgage market, but not too much technical details, can read Liar's Poker by Michael Lewis. It's a hilarious story about the daily life of a group of greedy and over-aggressive mortgage bond traders. The fictional story took place in the 80s but I don't think things have changed much since, other than that there are now more exotic products.

Like HSBC management has explained, Household Finance was too eager to lend to sub-prime borrowers as, like everyone else, they thought they could always securitize and sell those mortgages to others. Nobody was expecting to hold the mortgage for long, in spite of its higher interest. They all aimed for making capital profit, i.e. lend/buy mortgages at say 10% and then securitize and sell for 8% (similar to what HK developers did with REIT to get rid of its rental properties). After the mortgages have been sold the process repeats itself, like a wholeseller selling and restocking. If they 'turnover' the mortgage book often enough they'd sure make big bucks in the end of the year. Mortgages have become a merchandise, a hot one indeed with the rising and buoyant housing market. The overall market grew by the day and that attracted more liquidity. Of course, the low interest cost environment throughout the world also added fuel to the campfire.

Once a big enough pool of mortgages is obtained, you can slice it anyway you want and start selling, as far as your imagination can go. It can be done by location, e.g. Westcoast, Silicon Valley, or even beachfront (my wild guess); by average maturity, e.g. 5 years, 10 years, 20 years; by timing of cashflow, e.g. interest only (IO) which a holder only receives interest throughout, and principal only (PO) which works like a zero coupon bond; by level of credit protection which works sort of like preferred and common shares (higher class bondholders have priority over lower class bondholders in receiving interest). Closer to present there's a new market for credit derivatives where insurers underwrite default risk for a fee and then, guess what, further securitize those policies, bringing in yet more investors. In nice words it's said mortgage securitization allows every John Dole to participate in the growth of the US housing market, and in investment opportunities that didn't exist before, and that all the different varieties merely reflect investors' needs and tastes. Most importantly, the originators should be rewarded for their ingenuity. Soon came the convenient disregard for the classic listing question: 'should' the issue be floated as opposed to 'can' the issue be floated.

With the mortgage market functioning much like a stock market, it's no surprise there will be extended bull and bear runs. Obviously now is a bear market where liquidity has dried up and sellers/lenders are fighting for the nearest exit. And probably some witty traders, if their hands are not burnt yet, are trying ways to further 'short' the market knowing most participants don't have the capital to defend their positions. This will cause an oversold market which don't reflect longer term fundamentals.

What are the fundamentals?

A property market dropping by say 15-20% can result in many negative equity homes and many more near worthless bonds, but these don't necessarily lead to massive default, just like a listed company can go by its business without minding its share price. The key factor remains repayment ability. How fragile are the sub-prime borrowers? Are there more property-flippers or those making lower but honest income? Is the job economy gonna be affected eventually? These are all important considerations, and there are many more, but my lack of timely knowledge of the state of US market has precluded me from writing further.

Results Brief: Chalco (2600)

2007-03-13T19:30:00.000+08:00

Chalco reported earnings of more than RMB11b on strong sales on alumina and recovery of the aluminum market. On the face of it p/e is now only 8x which suggests cheapness but can it be sustained?

For those not familiar with Chalco and its attraction to me can visit my past post. (http://abaci-investing.blogspot.com/2007/01/buy-china-buy-chalco.html) This post is more about the latest results.

I'll start off with the aluminum business because that's where Chalco has been expanding in order to lessen its reliance on the more volatile upstream alumina market. Aluminum is an essential construction and industrial material (in my view it's better than steel for its lighter weight and better strength) with uses in construction (think buildings), transportation (think cars and parts), packaging (think consumer goods), aviation, aerospace. These sectors will all grow with China even over the long run. I think these all you already know.

Figures wise, capacity was up 65% to 2.5m tonnes and production volume was up 84% to 1.93m tonnes (vs national output of 9.35m tonnes). National demand was slightly lower estimated at 8.67m tonnes but did show faster growth than supply. Management's 2007 target previously stated was 3.4m tonnes or 1/3 of the domestic aluminum market.

I'm not particularly worried about the supply/demand situation of the downstream market, for now, because last year was only the 1st year of recovery when everyone started making money again. Operating margin (before interest & tax) of Chalco was 13.5% vs 1.6% in 2005. And a 13.5% margin did not strike me as being excessive. I don't think a new round of price war will be near the top of the agenda for most smelters.

Figures wise, Chalco's smelters made operating profit of 4.5b, 20x better than in 2005 but still only 1/3 of the upstream alumina business.

I couldn't help but notice the downstream smelters were bought cheap, at only perhaps 4x p/e and discount to the fair value. These bargains might have come as the result of luck as Chalco happened to buy when the industry was at a bottom, or the result of government policy which forced smaller smelters to merge into bigger ones. Though these new businesses only contributed 5% of the net profit last year, it's a good start and I'd like to see this trend of 'cheap' acquisition to continue.

The alumina business contributed 3 quarters of the operating profit, or 13.3b. There isn't much to analyze about this market as so far no one can quite predict the pricing. There was a series of price cut in the 2nd half of last year but then a sudden 50% spike this year. This coupled with Chalco selling forward too making it even harder to understand. So I'd leave this task to the specialist and I offer you no comfort on the stability of the alumina price. But it's worthwhile to note the national supply, though grew by 61% and reached 13.7m tonnes (Chalco produced 8.8m tonnes), still fell behind of the national demand of 19m tonnes. Internal consumption ratio of alumina also grew to 40%, and increasing, which should provide more stable earnings stream.

On capax, Chalco spent 8.7b last year and 8.4b in 2005, proportion spent on downstream increased to 50% from 33%. Management mentioned 3 major alumina projects with combined capacity of 2.8m tonnes, and some expansion of smelters, nearly all located in central/southwest China (opportunities?). These would probably be financed by further bond issues as financially Chalco was very strong with net debt of 6b (against equity of 44b) and interest expense was insignificant at 800m.

Last year's result was exceptional and could be hard to repeat. In a normal year, I'd expect Chalco to earn maybe 8b a year, with equal contribution from upstream and downstream, and a potential to earn up to say 10b as downstream business further expanded. I wouldn't attach too much hope on the alumina business just to be conservative and to save myself from any future embarrassment (but I do assume selling price will not drop by more than 20% from 2006 average of 3,600 per ton). But I do believe it shouldn't be too risky when one is buying the largest vertically integrated production chain of aluminum in China, for China is far from done in building its dynasty.

In terms of valuation anywhere between 10-12x p/e would be fair, that translates to a price range between roughly HK$7-10, though one can never correctly gauge the appetite of the market at any one time, and judging from past observations large over-shooting in either way does seem to occur frequently.

DISCLOSURE: I hold 2600 at time of writing.

Results Brief: OOIL (316)

2007-03-10T19:30:00.000+08:00

The FY results were more or less in-line with expectations and that of the 1st half. Segmental profit of the shipping division in the 2nd half showed some 10% improvement, although I had hoped for a higher figure with the sharp drop in crude oil price.

Management cited the cause of the sluggishness was other ship-liners being far too eager to reduce freight in the 1st half to secure orders, for fear of over-capacity in the industry (which did not materialize), and hence OOIL was reluctantly dragged into this price war. And the damage done to the freight, which were contracted months ahead, will take time to recover. There may be some truth in the statement as both China COSCO and CSCL did so much worse in the interim (with shipping profit dropped by 75% and 99%!). So don't expect their full year results will bring much surprise. And salute to the OOIL management for riding out this very tough year.

Going forward management's tone is positive and expansion of fleet is still going strong with about all free cashflow (shipping) reinvested. There was mentioning of a drop in shipping volume of furniture and housing related goods due to the softening of the US housing market, but that was well compensated by increase in goods of other categories. This is pretty much what I have thought, as more of everything is now made in China and people just can't buy it elsewhere. For 2007 so far the freight has increased by an average of 10% though the crude oil price has also climbed back to the level of US$60 a barrel. My optimistic view is the shipping division will earn about HK$3b net each year and be worth HK$24b.

There wasn't much contained about the property division in the press release, other than the old news that property income will be kicking in starting 2008. The Wall Street Plaza though could be sold to provide further funding to the China property projects, as it's another piece of non-core asset.

The port business was classified as discontinued operation so maybe the California and Taiwan ports are now included in the shipping and logistics division.

The biggest disappointment came from the size of the special dividend (80 US cents), which was only a quarter of proceeds from the sale of the North American ports. The official reason was that completion will take place in 1st half of 2007, not 2nd half of 2006, and therefore there's still the possibility of further special dividends down the road. But I guess the real reason is management is either not willing to let go of the money yet, or they have something cooking in the kitchen. This will probably trigger some profit-taking when the trading resumes on Monday. But to me a dollar is still worth a dollar, in my hand or not, as I have confidence in OOIL's management and their execution ability.

So my rough estimate of the company's worth is HK$24b for the shipping business plus HK$18b cash plus say HK$10b on the properties, or HK$52b in total. This is about HK$82 a share. I'd say the current price while still has some attraction isn't the tremendous buy as it once was. I'd hang on to my holding but wouldn't add more.

DISCLOSURE: I hold 316 at time of writing.

Asset Allocation Review: Have you done lately?

2007-03-06T16:10:00.000+08:00

I usually update my portfolio status (i.e. gain/loss/%/etc) after each Friday's close. I reckon it's probably done too frequently but in return I do get a feel on the 'beta' or sensitivity of my portfolio and more importantly, I need to monitor the gearing as I do borrow against my holding. But after yesterday's fall I also did an asset allocation review, which on the other hand was something rarely done but should've deserved more of my attention.

Although I'm not a believer in the efficient market theory, I do by experience come to appreciate the virtue of some diversification, based on what's called academically the efficient frontier (which suggests within certain parameters diversification can actually both increase return and reduce risk!), unless you have superb sense to correctly pick the 'hot' industry year after year, in which case you are already immensely rich and I hope you are doing the society some good now.

I had to update my positions again yesterday even it's a Monday because I saw myself really 'stretched' after the fall (during which I bought some too). It turned out my gearing wasn't too bad and could absorb further shock. For self-record this is what my asset allocation looked like at yesterday's close.

Industrials 24.4%
Container Shipping / Port 18.4%
Banking / Insurance 13.4%
China Property 12.9%
Resources 12.9%
Utilities 6.6%
Construction 4.8%
China Retail 2.7%
Others 3.9%

There's so many good stocks to buy, with every one of them holding an equally credible story and promises. Sometimes it's easy to get distracted and lose focus. In my case while I believed I had done enough since last year to trim down my small cap positions, I was surprised I still held a bundle of them, especially the industrials though they are my sentimental favorite having brought my first success in stocks. Now it's clear I'll have to drop an existing holding if I happen to find yet another bargain in this sector, or this may be a proof that they are not really bargains and there's something wrong in my selection process. I don't wanna become a nail-hitting hammer only!

Other categories look fine though I'd prefer more exposure to the China power and retail plays. And maybe holding more resources as a strategic hedge isn't a bad idea too. I'll probably add some should this correction go deeper since the prices still weren't attractive enough and I only have one or two rounds of ammo left, so I'll wait for my chance and if possible until the release of last years' results. But who knows if the market will simply take off from here and never come back? But a 6-day correction, if it's over, will be one of the shortest in recent memory, even it managed to create as much damage as the last correction in May 2006 which lasted 6 weeks! I think this is too far off today's topic.

Another useful thing I did during a review is to count the number of stocks. I usually hold about 20-25 at any one time (excluding those IPO allotments which are too small to matter). I've tried hard enough to keep it under 25 but my target is 15-20, which should suit my portfolio size and risk appetite well. Reducing the number of stocks in a portfolio can really stress on one's stockpicking ability. That's why if you read an annual report of a typical mutual fund you'll find hundreds of holdings but little return! This is in sharp contrast to Tony's portfolio in the Next Magazine which holds like more or less a dozen stocks but has delivered 25% annual return since 1999! I guess the morale is: you can't hold too many good stocks because there aren't that many good stocks around!

Something Else

2007-02-27T16:00:00.000+08:00

South Africa isn't like Africa at all!

And I won't fault anyone for mistaking Cape Town for any U.S. or European coastal city. The scenery is breathtaking and the weather is excellent. Cities are highly developed and highways and airways are equally impressive. Dining, and especially wines, are surprisingly affordable. Meat is generally excellently done whilst seafood is only average and lacks variety, a surprise given the long coastline of South Africa. Caucasian girls there are real beauties too probably due to their European origin. If not for the high crime rate (I saw electric fences in some homes!) South Africa could really make an excellent vacation home for many.

Maybe I haven't joined a group tour for a long time, I found out at favorite tourist spots and restaurants that I was no longer surrounded by other HK groups but Chinese ones. Many merchants also spoke simple mandarin to us obviously not knowing the difference. Small chats with the Chinese revealed that the tour had cost them $18,000 each, which wasn't cheap even in HK standard, but many travelled with their parents or kids. And on my return flight I was further bemused by those Chinese ladies at the back of the plane who were buying so enthusiastically from the duty-free shop catalogue! The serving flight attendant ended up bringing a large bag of merchandise for them to pick from! My further grown respect for our country men!

Something Else

2007-02-17T12:18:00.000+08:00

This year is the 1st 'payback' year for me, after having received red packets for so long. I sure miss the days when I was part of the special task force in 'storming' every office and cubicle in the company! But giving out those packets this year really does give me a different kind of pleasure. And family reunion is another thing which one can only grow to appreciate.

I'll be away to South Africa for 10 days and so there'll probably be no new post until March. Have a happy holiday and hope everyone is charged up for next year's challenges!

HK & China Gas (3): Take a Wild Guess?

2007-02-16T17:00:00.000+08:00

Like PCCW, HK & China Gas, finally beginning to live up to its name serving China now, has a valuation that seems mind boggling, yet there has been a share repurchase programme, two privatization attempts (on Henderson Investment) and direct purchases by Mr. Lee, who's not known for buying high.

The business model of HKCG is about the simplest among all HK stocks, that of building pipelines and selling gas and equipment. It's a natural monopoly and there's no profit arrangement like the power companies, although it too faces political and public expectation to keep fees reasonable. As HK has become a mature city with limited population growth, it has diversified into property development and China, where major cities are moving toward using natural gas after PetroChina's west-to-east gas pipeline has commissioned operation.

HKCG has a market capitalization of about $97b, or $100b for simplicity. On average it made some $3b from selling gas in HK, fairly consistent. Future profits may become slightly higher after natural gas is increasingly used to replace coal (naphtha) in production of gas. Historical p/e before 2003 was between 15-18x (I chose pre-2003 as afterward property profit became part of recurring profit) and I'd arbitrarily give a 16x which is slightly higher than what I assigned to PCCW. This works out to be $48b or roughly half of HKCG's capitalization.

The question then becomes should the HK properties and China business worth as much as, or even more than, the HK gas business?

On the face of it the valuation is stretched as the HK operation has 140 years of history where HKCG only started investing in China since 2000. Segmental information in 2005 annual report showed China business took up a quarter of assets and contributed 3% of earnings before tax (increased to 7% in 2006 interim). Either way one looks at it it doesn't suggest a 50/50 split in valuation.

On the other hand the China market is huge as any China city, even 2nd-tier ones, can provide as big a market as HK. HKCG has laid pipelines in 34 cities, mostly in the Eastern region and Shandong, the receiving end of the giant gas pipeline. Once the supply issue is taken care of (it seems steady supply of gas is a problem now as demand is greater than anticipated) businesses should thrive, maybe exponentially.

However the China gas market is primitive both in terms of development and regulations. It's an open market and most cities would welcome anyone with the capital and skills to assume the responsibilities for laying and running the pipelines, in return for a share in the profit. So far a national operator with sufficient scale has yet to emerge but looking at the competitors so far, HKCG should have a higher chance mostly due to its reputation and financial capability.

Imagination can go very far, sometimes dangerously too far, so I try an educated guess as to how far we are now.

According to the 2005 annual report the China business had a NAV of $6.8b. Since earnings have yet to come one can only use p/b as a reference. After checking out Panva (I'll go into the Panva/HKGC deal later), Zhengzhou, Xinao, and China Gas, the p/b is from 2.3x to 3x. So at most HKCG can warrant a 3x p/b for its China business, although the ratio should actually be lower as HKCG can't grow as fast with the HK business dragging at its back (and so came the spin-off deal with Panva).

I worked out that the property interests had a book value of $6b (don't ask me how as it's a very rough guess too) Since these projects were either acquired at a low price (IFC centre and Grand Promenade) or self-owned site redevelopment (that in Ma Tau Kok), I'll give it a generous 2x p/b valuation so $12b in total.

Adding up the pieces I got $48b + $20.4b + $12b + $3b (securities investment on book) and $83.4b in total. This is 87% of the current market price. The 'imagination' premium is only 15% which is lower than I initially thought. And it may not even exist as the disclosure of HKGC is really inadequate and obscures any serious attempt of analysis. I wouldn't fault Mr. Lee for it though as he has been trying to buy up the company.

HKCG appears to be fairly priced now and is worth a second look when it 2006 results are out.

DISCLOSURE: I don't hold 3 at time of writing.

PCCW (8): Now is the Time?

2007-02-13T23:01:00.000+08:00

Now or i-Cable, PCCW Mobile or CSL, 0060 IDD or another carrier, there's a lot of reasons not to pick PCCW. Now is cumbersome to install, PCCW Mobile is Sunday in disguise, 0060 is costly. To many the time to buy PCCW is never. But there's also apparently sophisticated people foolish enough to chase for its assets, or even offer to buy shares at $6. So who's dumb and who's dumber? Now share price is back to around $4.6, a level where it's been stuck since 2003 when it was in much worse shape. I'm curious to know if there's something special inside PCCW which can only be seen by the 'gweilo'.

You may not like PCCW overpaying for the English Premier League broadcasting right, or Now and PCCW Mobile never making a profit, or IDD keep losing customers, I thought about these too. But they actully matter less in the bigger financial picture. A look at PCCW's turnover breakdown will help understand why PCCW isn't gonna screwed in any significant way.

(excluding PCPD)
Telephone & broadband & services $7.5b (IDD $1.1b) -> PCCW solutions $737m -> Mobile $585m -> Others $364m -> NOW $303m

No matter how PCCW pretends otherwise it is still the same old fixed line behemoth with a 68% market share in HK, reaching 2.6m household and businesses. And it's proven resilient against challengers in all fronts. It isn't growing but ain't going down either. Telecom revenue (excluding PCPD) is over $16b with an EBITDA of $6.5b and operating margin even showed improvement in 2006 1st half. This cash generating ability and market penetration is certainly attractive to an outside buyer.

You may ask 'what about all that haunting debt incurred from the takeover of HKT back at year 2000'? Good question, and to answer, net debt was halved from $41b in 2001 to $20b in 2006 interim (I'll stick to management's figure although I calculated $18b), but still overwhelming against net assets of only $3.1b (or only $750m if MI is taken out!). Normal capital expenditure in an year appears to be in the region of $2b, but PCCW is buying new assets too, recently spending ~$1.5b on EPL license and last year ~$1.6b on REACH undersea cable right. It is possible that ~$4b can be used to repaid debt each year and in 5 years all debt will be gone. As debt is progressively repaid PCCW's bond rating will improve and this will reduce future interest cost too. This scenario is however with the shaky belief that the management can keep their composure and confidence in check and won't try to pull another stunt to impress.

One peculiar feature about PCCW is its high profit tax rate, at ~37% of income over the last 2 years. And taxes were paid too during loss making years in 2002 and 2003. The explanation in the 2005 annual report was that certain expenses ($348m) were not deductible and some tax losses ($444m) were not allowed to offset profit. I guess it's the interest associated with the HKT acquisition debt that contributed to the bulk of the non-deductible expenses and that taxes losses were from Sunday, NOW, and other new ventures PCCW undertook in these few years. This can be a bad thing now but a good thing for the future, because future interest savings (from paying down acquisition debt) will translate 100% to bottomline improvement. Similarly, any turnaround of the new businesses will enjoy tax advantage.

Profit excluding PCPD should be roughly $1.25b. Add back amortization of $200m (which was mostly trademark) and optimistically assume* $200m interest saving and $200m savings from merging Sunday operation, we have 2007 profit of $1.85b. P/E works out to be ~15x excluding the market value of PCPD, which is about fair for a pseudo utility. Profits will grow marginally for the years afterward but if NOW and PCCW Mobile can trim their losses it'd be a major plus. On the contrary if there's no improvement these can be sold off so there's no further drain on resources.

A takeover is always a possibility, as it's in the blood of Richard Li, like father like son. Francis Leung's deal was at $6 and I gathered from press that the competitive bids worked out to be roughly the same** too. There may not be a lot of upside but I'm confident downside is really limited since PCCW today is a much stronger company than it was a few years ago, but its share price has only gone sideway. It may actually be a good defensive play in a correction with a 4% yield.

* $3b repayment x average yield of 6.5% / Sunday cost saving is more or less a guess
** market rumoured USD7.3b x 7.8 for telecom assets less $2b net debt plus market value of 62% interest in PCPD work out to be ~$6 a share

DISCLOSURE: I don't hold 8 at time of writing.

Something Else

2007-02-06T15:47:00.000+08:00

Most of you have heard about the funny notion in China now that your luck in stocks will improve if you eat more beef. Well thank god I'm a beef lover already. We can laugh it off but weird things do happen when the temperature of the market gets past a certain degree. I've got a few more funny anetotes, of international flavor and across history, from a book* about past financial bubbles to share.

Early 18th century France - "gold mania" during Mississippi Company Bubble

MC was set up and given trading privileges by the French Government to pursue gold deposits presumed to exist in Louisiana of America (when there was no evidence of the gold). Shares were offered to the public who went crazy for it. The proceeds however went not to the search for gold but to the government for repaying its debt!

"So determined were some women purchasers that, in an interesting modern touch, they offered themselves for the right to buy shares." [I wonder how redemption and interest payment work?]
"To restore confidence and assure noteholders and investors that a goodly supply of [gold] would be forthcoming, a battalion of Paris [street beggars] were recruited, and the members were equipped with shovels and marched through the streets of Paris as though on the way to mine the [gold] in Louisiana. It was thought distressing when, in the next weeks, many of them were seen [in town] back to their old [selves]"

Early 18th century Britain - "concept company" mania during South Sea Company bubble

SSC ran a very similar theme to MC so I'll spare introduction. But it was the imitators who had outdone SSC founders in promoting companies with pure creativity and imagination. Some noble themes included:

"a company to build and market a typewriter - a company considerably ahead of its time." [it wasn't until more than 100 years later at 1868 when typewriters were invented]
"a project for a subtle machine gun that could fire both round and square bullets, depending on whether the enemy was a Christian or a Turk."
"a company to erect houses or hospitals for taking in and maintaining illegitimate children" [would they take mistresses too?]
"a company for carrying on an undertaking of great advantage, but nobody to know what it is [yet]" [this one sure sounds like the 'I have a dream' IPO campaign of Tom.com]

Early 20th century America - during Florida real estate boom

"beachfront lots could, by a flexible approach to [measurement], be 10 or 15 miles from the water."
"a subdivision said to be near Jacksonville was approximately 65 miles away." [we all know these well as we're told new properties anywhere in Hong Kong are all only 20 minutes away from Central]

Late 20th century Japan - beginning of end of Tokyo stock market boom where index dropped by nearly a quarter

"a leading investment house concerned with Japan reported that there was talk of changing the accounting rules, so that an institution that loses money in stocks can keep that fact confidential".

Early 21st century China - beef = bull???

* John Kenneth Galbraith, "A Short History of Financial Euphoria"

Money can't buy Benz, nor its Dealer

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

I read from the 'Investor's Dairy' weeks ago that in China now, people have to wait 9 months for a Mercedes Benz. And it said the last time when we Hongkies needed to wait that long for a car, it was the pre-handover 1997. It was also the days of the 'big fly' when Mercedes Benz were frequent flyer.

What's surprising is that it may take you just as long to buy enough shares in the China Mercedes dealer Lei Shing Hong (238)!

The allure of the Mercedes brand needs no introduction. Hong Kong has the highest Mercedes 'density' in the world, but I think in time that'll pale compared to a major Chinese city like Shanghai or Beijing. And unlike a Rolex, a Mercedes can't be bought here in HK and carried across border (or more accurately not anymore) so it must be bought via dealers of LSH.

LSH hold a 49% interest in the Mercedes Benz distribution company in China/HK, Taiwan and Korea. It also runs Mercedes dealerships in the Northern and Eastern China, HK, Taiwan, Korea (where it distributes Porsche as well) and Vietman. LSH also distributes Caterpillar heavy equipment in Eastern China and Taiwan.

China/HK business contributed 77% of turnover while sales from automobiles (70%) and Caterpillar equipment (17%) contributed the bulk of turnover. LSH is a growth story of both luxury consumption and construction in China.

Automobile dealership can be a risky business with slow moving inventory tying up working capital, not the case with Mercedes Benz in China. And in worst case old stocks can be cleared with ease at a 10-15% discount, leaving LSH more or less unscratched.

Indeed, profit grew for 5 straight years, though mildly, and turnover only had a dip in 2004. 2006 interim reported 37% growth in turnover to $9b and 52% growth in profit to $170m. I expect 2006 profit to be a little more than $300m.

Maybe business was simply too easy, management found amusement in dangling stocks and foreign currencies and got burnt in 2005 losing close to $90m. LSH still made $252m that year.

LSH also spent some cash in building properties too. This one they had better luck and projects sold in the last 2 years made good profits. But I'd appreciate more if the management spent that cash to pay dividends or pay down its debt. At 2006 interim LSH held $1.6b cash and had $2.8b debt. Interest for half year was $95m. Dividends were unchanged for 5 years at only 3 cents.

With a market capitalization of $3.6b and NAV of $5.5b, LSH is a good bet on China premium auto. But liquidity of the shares is non-existent and it makes you wonder where the shares have gone. LSH is perhaps even harder to buy than a Mercedes.

DISCLOSURE: I don't hold 238 at time of writing.

A Couple of Glass Makers from Heaven and Hell Part II

2007-01-31T23:30:00.000+08:00

From hell - ZJ Glass (739)

JZG is almost the exact opposite of Xinyi, though it's only one step up in the value chain. It's the 4th largest float glass manufacturer in China but with a capitalization (domestic + H shares) of $1.25b or only 1/5 of Xinyi's.

First, it's been operating in a severely over-supplied domestic float glass market (since 2004), which at one point last year forced some firms to close production as the selling price was so low at $50 per weight case (JZG's unit cost was $64). All major players had to sit down and agreed on a joint price hike as the whole industry was losing money (which nevertheless could suggest a bottoming-out). The price stabilized at around $70 per weight case (JZG's avg. selling price was $66). The other contributing factor was the surge in heavy oil price (73% YOY for 2006 1st half), which might come down in 2nd half with the drop in crude oil prce (or not because of the price fixing mechanism).

JZG managed to lessen the impact by focusing on higher quality automotive grade glass and recently ultra-thin glass for electronics, but it still reported 66% decline in profit in 2005 and a net loss in 2006 interim (EBIT was close to breakeven though). The loss was a 1st since listing. Like Xinyi it also pursued vertical integration by building an upstream soda ash plant in Qinghai and breaking into the downstream processed glass market. But both fronts are not showing success so far.

Qinghai soda ash plant started production last year and contributed 18% to the 2006 interim turnover of $580m. 70% of output (in volume) was light ash for non-glass applications and 30% was dense ash for glass production, which was said to increase in the future. Segmental information showed 37% of output (in RMB) was consumed by JZG and the rest was sold to the market. The business reported a loss before interest and tax but management told things would improve when capacity is better utilized (2006 expected utilization: 66%). They also cited that the building of the Qinghai-Tibet railway had disrupted deliveries. However, it appears that JZG has simply moved from one over-supplied market to another! Even management quoted the national supply of soda ash would reach 15.5m tonnes in 2006, outgrowing the national demand of 13m tonnes. Selling price dropped by 28% to RMB1,350 per tonne in 2006 1st half compared to that of 2005, though the price didn't change much within the 6 months. The only bright spot is there's 5-year profit tax exemption followed by 50% reduction for the following 5 years. This may not last under profit tax reform though.

Processed glass business performed worse with production volume, selling price, and turnover all declined in 2006 1st half. Total sales was only 7% of turnover.

Unlike Xinyi's management who are wary of debt financing, ZJG loaded up the balance sheet with debt pretty hard, so hard that total debt was $3.3b at 2006 interim. NAV was only $1.3b. Current ratio was 0.4 and net gearing was 186%. In typical Chinese fashion 2/3 of the debt was short term and management claimed they would have no problem renewing it, which might have some grounds as ZJG still managed to borrow $125m more in 2006 1st half to finance the working capital of the soda ash plant! However I don't expect this can continue for long as capacity expansion is the prime target under austerity measures. Finance cost was a high $76m in 2006 1st half.

$1.6b was spent on the soda ash plant and there's planning for a second phase of it which will cost another $1.6b ($385m was spent already). In the interim account ZJG reported a total capital commitment of $7.3b, of which $6.3b is for more float glass production lines! This makes ZJG look more like a builder than a glass factory. Of course all these expansions were planned in 2004 and now everything is put on hold indefinitely.

For as demon as ZJG can be it has attracted funding from the IFC, who together with a fund put in $800m, $260m by equity (1/4 of the then capital) and $540m by loan. Proceeds would go into retiring short term debt and the new loan would be long term with semi-annual repayment starting July 2008. Proforma net gearing would come down to 124% and current ratio would improve to 0.52. I guess maybe the soda ash plant project fits into the IFC agenda of developing the rural China.

After injection Chairman Feng's stake would be diluted to 55% (400m shares out of 721m). This is another bright spot as ZJG has avoided equity financing until now. Corporate governance is supposed to improve gradually marked first by the step down of the Chairman's wife and daughter from the board replaced by two management staff. Chairman Feng has also provided personal guarantee and pledged 120m domestic shares as security for the loan.

With IFC's involvement ZJG becomes an interesting turnaround bet. For one I think ZJG is not heading into big troubles any time soon as bankers (not Chinese bankers) are conservative and should have done their math before lending. IFC was impartial and wasn't throwing good money after bad one. As the placing was completed after June 2006 they should've known better about the float glass and soda ash business. And second with IFC as the chief lender I think ZJG will focus on debt repayment over the next few years (read: no more senseless expansion). This will cut down interest expense as debts are repaid gradually, which will increase future profits.

Over the last 5 years (up to 2005), ZJG made about $200m in 3 years and $80m in 2 years. In 2005, it made $74m on an avg. price of $70 per weight case of float glass. Let's assume conservatively that with the soda ash plant 2007 profit is $100m. Depreciation is about $300m a year which together with profit will go into retiring debt. Interest savings (assume 6.5% on debt) after tax will be $17m a year, and $51m in 3 years. This will give a 15% annualized profit growth, which may be higher if ZJG has a break from the profit tax reform. Against a $1.26b capitalization, prospective p/e will become 10.8x, 9.4x, and 8.3x. There's also upside from the recovery of the float glass market and increase in efficiency of the soda plant. But equally things could get uglier than already is and IFC may not be the lender of last resort for the second time.

ZJG is a speculation, which means there's considerable upside but also real risk of losing one's capital. But what more can you expect from a company from hell.

DISCLOSURE: I don't hold 739 at time of writing.

A Couple of Glass Makers from Heaven and Hell

2007-01-29T19:08:00.000+08:00

From heaven - Xinyi Glass (868)

Xinyi was listed in Jan 2005 and is the largest exporter of auto glass in China. It sells mostly to the replacement market worldwide but is qualified to supply auto glass to all 3 major US carmakers, a proof of its product quality. Auto glass is not a flashy business but an essential one with consistent demand. You're not gonna change your windshield unless it's broken; and you're gonna have to change your windshield to stay on the road if it's broken. Auto glass took up 3/4 of the turnover and the remaining 1/4 is from construction glass, coated one which is said to be more environmental friendly and energy saving. Local and overseas sales mix is 60/40.

Xinyi fits into the growth story of both auto parts outsourcing and booming property market in China. The storyline is further enriched by the growing China automobile industry and the huge infrastructure spending under the eleventh-5-year plan. Xinyi's capitalization has doubled to about $6b in two years since the IPO. Profits were $260m in 2005 and $236m in 2004. 2006 interim profit was $140m. Turnover too grew from $1b in 2004 to $1.4b in 2005; 6-month turnover grew from $600m in 2005 to $700m in 2006.

Xinyi has production facilities in HK, Shenzhen, Donguan, and Wuhu. In the prospectus it said it'd spend $700m in installing two float glass production lines in its DG plant with maximum capacities of 269k tonnes and 157k tonnes. Float glass is the single largest cost component which takes up 1/2 of production cost. This backward integration is supposed to create substantial cost savings to Xinyi, first in terms of procurement and second in transportation. As I could tell this was the largest selling point of the IPO - no need to find customers to fill up this capacity and a 10% return on assets would produce $70m profit. However, no estimate of savings were made in the prospectus and it got few mentioning in the 2005 annual report. These float glass production lines were to begin commercial production in end of 2005 but according to the 2006 interim report, there's only trial production run and float glass sales was only 2% of turnover. I'd soon learnt about the over-supply problem in float glass from studying the glass company from hell, though some recent press reported that float glass price is finally rebounding. My concern is whether this delay is caused by teething problem, which will go away soon, or a larger quality issue (otherwise why not produce as much as possible since Xinyi needs float glass and has sunk in so much cost?). It remains to be seen how much benefit this $700m investment will yield.

Separately, Xinyi chose to expand into alternative energy (there's no previous mentioning in the prospectus) and announced in May last year it'd build a $290m solar glass plant in DG. Trial production would begin in 4Q 2007, sounds familiar? Two weeks later, Xinyi placed 220m shares via its sponsor Kingsway and raised $186m. Its ability and expertise in producing solar glass aside, Xinyi certainly seems to know how the keep the market's hope alive.

Xinyi's gearing has been decreasing and is now at <20%, which contrasts with the rapid expansion which saw it assets grew from $1.6b pre-IPO to $2.8b. Is it a lack of confidence in the expansion (therefore relying on OPM) or is the management just being conservative? Dividend policy is also puzzling. It paid out $190m dividends since the IPO but had to raise $186m from placing. It paid out 46% of earnings in 2005 but capax was 3x the earnings. Effective tax rate is unusually low at only ~5%.

Xinyi is run by Lee, a Fukienese, and family members - brothers, brothers-in-law, and sons. They hold some 50% shares in total. Market rumours had it that Kingboard bought some shares from the Lees who reported a sell down of 54m shares off the exchange in last November. This may add some credibillity to Xinyi but there's no way to confirm the news.

I like the auto glass business and the backward integration. I'm not sure about the solar glass part and hesitant about the management as they seem opportunistic and not very forefront in their presentation of the business. But it may just be my own suspicion. Say if Xinyi earned $300m in 2006 then the p/e would be 20x. Assuming $100m cost savings in 2007, the p/e will become more affordable though still not a bargain at 15x. The current price has probably taken into account of the savings from the float glass production as the existing plants are operating near full capacity and profit growth in 2005 already slowed down to 10%. But this area is also the biggest uncertainty.

I don't think Xinyi is my saving angel yet.

DISCLOSURE: I don't hold 868 at time of writing.

Investment Ideas for 2007 Invited

2007-01-25T13:00:00.000+08:00

Yesterday I went to an investment seminar held by Quam. It was a slight disappointment that it lasted only an hour or maybe less, while it took me 1 hour of commuting time back and forth and some 20 minutes of waiting. Having said this, just one good investment idea would make all these troubles worthwhile.

The four sectors they have picked for 2007 are banks, automobiles, infrastructure construction, and ports/shipping. Banks are no longer bargains though they may still be good long term investments. I've mentioned some shipping plays already and ports are more expensive though consistent. So today I'd focus on the automobiles and infrastructure construction sectors. I'm only starting on these sectors so if you have any good ideas as to where or what to look, let me know.

Everyone knows about the China automobiles growth story so there's no repeating here. It's another battlefield over-crowded with domestic and foreign producers all trying to get a bigger slice of this growing pie. I used to like Denway despite I could not understand its accounts at all. All important financial information is condensed in one line as 'investment in an associate', although I think this structure had nothing to do with the management but rather the government's policy that forbids foreign majority ownership. I like the chance of Honda in China because of its success in North America and here in HK. However Denway is only a manufacturer so there's a cap in profit potential. Then I found out Dongfeng also produces automobiles for Honda, hence making Denway's identity confusing. That of Dongfeng is even more confusing as it also produces cars for Nissans, Peugeot, and now there's talks with Volvo too. The market though seems to like this blurred identity and has rewarded it with a higher valuation. Brilliance should have a good future with its JV with BMW but that is offset by its problems with its own brand luxury sedans. I don't know much about Qingling nor Isuzu other than that its profit is on a declining trend. Other the other hand there are pure domestic brands like Geely and Greatwall but I'm doubtful of their cars' quality and low price strategy over the long run. 'When the tide comes all boats shall rise', it may be the case here but I'd rather be waiting on the shore at the moment.

Take a step step and look at some ancillary companies. I think there's a listed company running Benz dealerships in China and Hong Kong. It may be a good proxy bet after further study. Norstar makes car brakes and has proven itself in the US replacement market. It's starting to develop the domestic market too. But it seems to have too much dealings with its owners. IPE claims itself to be an autopart supplier but the numbers suggest it's at least one or two years away. Weichai makes heavy truck engines and is technologically advanced with its cooperation with German counterparts in developing Euro IV environmental standard compliant engines. But it's price has advanced too far ahead. There may be some good companies in making windshields, tires, electronics, die casting moulds, or other autoparts, lying out there waiting to be uncovered. I'll just have to keep looking.

Infrastructure construction sector is heavily favored as under the latest China 5-year plan the transportation/logistics network is the focus of development. We'll see more roads, railways, bridges, ports, airports get built over the next 5 years. However it's hard find any bargain here. For constructors we have China Communication Construction and for traders we have CNBM. Both seem fully priced in right now but the Quam team still prefers CCC for its irreplaceable leader status. CIMH the infrastructure machinery maker is just as richly priced. China State Construction sounds similar to CCC but actually derives most businesses from HK and the international market. PYI is more a landlord than constructor with heavy investments in the Yangtze River Delta. There are numerous HK construction plays but I doubt they can make it successfully into the China market. I like Shui On Construction for its cement plants are in around Sichuan and the southwest which should benefit from the development of the neighbour 2nd tier cities. Anhui on the other hand is a bit pricey which according to Quam has a prospective p/e of over 20x. Guangshen Railway, pricey, Zhuzhou CSR Times, crazy.

This post is not very organized and coherent, but it's intended as a brainstorming session to invite views from readers.

More Layers in my PCBs please, Mr. Financial Secretary

2007-01-24T12:16:00.000+08:00

Of course our Financial Secretary IQT (such named in a column of HKEJ) isn't moonlighting in a PCB factory. Rather it's his family's company Meadville, a PCB manufacturer, which is going through an IPO now. Upon initial read of the prospectus, it seems to be an interesting prospect.

More layers = higher technology = higher margin. This is the rule of thumb for PCBs I learnt from my past clients. But even multi layer PCBs are getting common in China and so we have HDI, high density interconnect, which squeezes in more 'electronic path' than a standard PCB. With denser and multi-layer PCBs, electronics can be made increasingly compact, as we have witnessed the rapid shrinking in weight and size of computers, phones, digital cameras and other electronics over the last few years. The next step is IC substrates which is even smaller in a micron state. As the trend of miniaturisation in consumer electronics isn't changing soon, demand for these high end PCBs is predicted to be much stronger than the overall market.

Manufacturing PCBs is a bloody competitive business and one way to come up ahead is to be the forerunners. In China where there's little proprietary technology this means being the first to adopt foreign technologies in local production. But for this to happen one needs to earn enough reputation and trust among customers before they are willing to transfer their technologies and outsource production. This appears to be the growth story of Meadville who has successfully collaborated with Hitachi and TNCsi, two Japanese firms with more advanced production technologies, and managed to stay in the top end of the market and avoided excessive price competition.

Looking at the breakdown of the latest turnover, about 2/3 was derived from higher-end PCBs (>8 layers), HDI, and IC subtrates. Conventional lower-end PCBs (<8 layers) constituted about 20% and has been on a decreasing trend (down from 48% in 2003). Meadville serves customers in communications equipment (Huawei, ZTE), computer and peripherals (ATI), consumer electronics (Pioneer), mobile phones, automotive, medical and industrial equipment. It's comforting to know many of its customers require 2 years before fully admitting any new supplier. Local/export ratio is about 70/30. Pricing is said to follow a cost-plus model meaning any rise in material cost can be passed on to customers - I'll wait and see.

Capital expenditure is gonna be substantial at $1.2b, $1b, and $650m over the next 3 years. Comparing to the pre-IPO net assets of $1.5b, we're talking about a super expansion phase here! Meadville is gonna be ~3 times as big as it is now. I certainly hope the management is right in their forecast. The IPO proceeds are only enough to cover the first year so I'd expect a lot more gearing or even fund raising in the future. And initial production expenses and depreciation is gonna hurt profit too. Debt is already running high at $1.1b and $700m was paid out as part of pre-IPO reorganization. Financial strength is one key concern, although I don't quite believe the Tangs will risk ruining its reputation with Meadville. (K.S. Lee on the other hand does this trick more and more often now)

I also don't quite grasp the accounting treatment on the giving out of shares by the controlling shareholder to the management and staff. This is supposed to be a transfer of existing shares but it'll nevertheless be expensed off by the company in the 2007 accounts. And the amount will be substantial at $250m.

Profit, as usual in any prospectus, is rising rapidly and Meadville is estimated to have earned $310m in 2006. Capitalization based on the top end price of $2.4 will be $4.8b or $5.0b with over allotment, giving a 2006 p/e of 15.5-16.1x. This is not cheap at all for an industrial and certainly the Tang family name is sold at a premium. P/B at IPO will be around 1.8x. Valuation is built upon success in future expansion and management quality. I'm gonna have a dip in this IPO (I won't receive a lot of shares anyway) and see my luck, just for excitement in this boring market when only China Mobile and a few are rising. Meadville is certainly worth another look at should its price becomes more affordable down the road.

Similar companies listed on market are Daisho Microline and Hannstar but they are not as diversified in customer base. DM is focused on mobile phones and Hannstar is on notebook computers. But they are selling at much cheaper valuation at maybe 6x and 10x respectively. Or WKK the PCB machinery trader is even cheaper. These may be more interesting bets.

DISCLOSURE: I have applied for 3313 and hold 532 at time of writing. I don't hold 567 or 667 at time of writing.

Land VAT and Tomson (258)

2007-01-21T20:00:00.000+08:00

Albert Tong was quoted saying that Tomson will not be affected by the land VAT at all as most of its projects have been completed and are for rental, and that it is a debt-free company. This reply shows his immaturity and maybe lack of in-depth understanding of the matter. But he's only 22/23 and I remember what I was like when at his age.

I don't see how his reasoning can lead to his conclusion (especially that rental properties are required to be taxed too). Tomson Riviera being such a focal point of the Shanghai property boom would surely attract attention from the public and may even become a precedent setting case of enforcement. This can be a good or bad thing. I wishfully think there may be some leeway as after all Tomson helped build Pudong from nothing years ago when no body else was interested. If I don't misread the guidelines Tomson should have about 2 years to cut a deal with the local tax bureau, assuming it'll not liquidate the units. It may require a cash call at that time to pay for the tax. I'll be more comfortable if units are sold progressively from now till then as there should still be money left on the table after tax.

The last interim report showed the book cost of properties under development, which I assumed to be Tomson Riviera, at ~$1.2b. Tomson hasn't made any provision for land VAT and gave an estimate of $150m as contingent liability in the last annual report. I think this figure probably has excluded Tomson Riviera in the calculation as it was under construction. I also found out from the company's circular that the land was acquired in year 2000 at $450m. I'm waiting to see how DTT the auditor will deal with this potential timebomb when the 2006 final results are due in April. But now I'll assume the worst.

The estimated market value of Tomson Riviera in my last analysis is $5.9b @5000 per sq.ft.. I don't think the local tax bureau will use the asking price of $10,000 per sq.ft. in the calculation as there is no turnover at that price and Tomson can simply hire a bunch of valuers to appeal. If the tax was levied today, the ball park exposure* would be ($5.9b x 95% - $1.2b) x 60% = $2.6b! And Tomson's gain would shrink to only $1.8b, and to $1.5b after a further 15% profit tax! In other words, a little more than 2/3 of the profits will be taken away for the society's good! If this does become reality I think all land developers will think twice before erecting another building! To continue, net proceeds from Tomson Riviera will be $5.9b x 95% - $2.6b - $0.3b = $2.7b. This is about the market capitalization of Tomson now so I'm still getting my money's worth, although not much more (indeed there's some $2.8b net assets but I'm not counting on them in my analysis).

Hope for the best but be prepared for the worst.

* readers interested in the exact calculation can go to http://www.ctaxnews.com.cn/sydjch/t20061219_1441042.html. thanks accountboy hing for providing the link. i did not apply it here as the cost of the project was so low that the end result wouldn't be much affected. btw, it's funny that the numeral example in the link was actually set up in a way to demonstrate developers could earn more by lowering the price(!), explaining there is a tax advantage (no VAT) for mass housing projects with a <20% gross margin. however whoever wrote this is probably clueless as to how market functions. i wonder how many commercial developers will be interested in earning 20% on a property which they have to buy, borrow, build, and sell and which will take at least 3 years' time, unless they can borrow like hell!

DISCLOSURE: I hold 258 at time of writing.