April 2022 Portfolio Update

S&P 500 Index Fund: -11.04% -> -4.32%

Hong Kong Tracker Fund: -19.99% -> -5.53%

Straits Times Index Fund: 3.06% -> 8.26%

My portfolio: -15.38% -> -4.22%

The onslaught to the Hong Kong market recovered unexpectedly with comments by Vice Premier Liu He, promising to support the market among other things. Markets rallied incredibly, but with some hindsight, levels are still depressed when compared to 6 months back.

Hang Seng Tech ETF 3067

The Hong Kong Tracker Fund

I have no love for Hong Kong tech as I felt that they are excessively valued, despite their long term promise. It was a clear example of what happens when you are a buyer of something when is too popular. How do you know if it is too popular?

5 years ago, you have to depend on the news to tell you so. Now, we have:

-Youtubers 

-creation of "sector" ETF (created solely by financial institute to capture the interest through fees from assets under management) to "cater to the needs of investors"

-daily chatter, as observed from chat groups.

Mainland tech firms not only have to contend with regulation and growth in mainland itself, but deal with the narrative of having to expand out of China one day. That could be way more difficult than their present ordeals. From my layman valuation techniques, and that generally people around me are still very hopeful of these companies (a good gauge of market sentiment), I would avoid increasing my position in Alibaba unless valuation declines.

Notable Transactions

-Purchase of Embecta, a spin off from Becton, Dickinson and Co.

Fell from 40.x to almost 27 at one point.

The basic reasons why spin-offs sold down in the initial phase usually follows this narrative:

a) A huge company, ideally an index constituent, decided to spin off a much smaller division/branch of its business.

b) For Embecta's case, existing share holders of BDX gets 1 share of Embecta for every 5 shares it owns.

c) Embecta gets sold off "indiscriminately" by share holders for the following reasons:

-Embecta runs a business that could be perceived by BDX share holders as unexciting (an opinion), of low growth (certainly). 

-Stock gets sold because of disinterest. After all, they might be seen as "dividend" from the parent.

-Embecta is not a member of the index and is under 2B market cap (contrasting BDX's market cap of 78B presently). For e.g. a fund manager might be forced by mandate to only hold stock of market cap x and above.

-The spun-off entity could be transferred undesirable assets, such as debt, or legal issues.

The basic reasons why it is a good idea to buy a spin-off:

a) existing management is incentivized to do well since they now hold stock options, and have clearer and more public standards to live up to (stock price, targets to meet to receive additional remuneration, etc)

b) The sell-off could bring prices to conservative levels (main reason for buying Embecta).

At my purchase price of Embecta at 30.8 USD per share, the company's market cap is 1.7B.

It bears a debt of about 1.6B

The last three years of profit is about 300-400m.

If one were to disregard debt, which is convenient enough when credit is cheap, the company is worth only 5x PE at worst. Since one should never disregard debt and value a company like a private owner, Embecta actually cost 3.3B (1.7B market cap + 1.6B of debt).

That isn't a bad price by itself since you are paying 10x earnings. 

Unfortunately, my position in Embecta is very modest. Last evening, perhaps the market had realised its folly, and the stock went up 10%, 14 at one point. It is just the problem with the way I inject capital-- very small amounts. I only buy more when the stock plunges 10%-15%.

-The significant amount of Alibaba purchase did not actually materialised last month. How I wish it had! I simply wrote a put contract at strike price of 87.5 HKD, right before the selldown begins. Alibaba went from 100+ to 71 HKD, and the contract spiked up to 800% in value.

(my bad luck with option contracts continues after the Didi Global episode, where I failed to cover my put by 1 or 2 pips that night. The next day, Didi's management announced that they are delisting from America and re-listing in Hong Kong. Its price plunged 20+%, and the option contract spiked 1900%. Very poor luck... never go to sleep before you covered your put!)

I have no luck with options. Thinking that it would be exercised, I wrote prematurely that I had purchased stock. After market rallied (Alibaba went back above 100), obviously the contract holder did not exercise his rights. Unfortunately, that means I only bought 200 shares of Alibaba (direct purchase from market) that month, albeit at a very fortuitous price of 71.8 HKD a share.

-Token purchase of Clifford Modern Living. After which, dividends are cut from 0.027 to 0.022 HKD a share. If I have to guess: illiquidity and its boring, property services business kept the share price from plunging. 

Market capitalization is 490m. Growth is modest and its cashflow is reliably positive, averaging 60m a year for the last 8 years. Dividend payout is on the low side, but still respectable at 4.6% yield currently.

-Token purchase of Central China Real Estate-- it is still far from the previous amount of stock that I sold down from. It appears that the situation at CCRE is indeed better than other property developers-- at least they got their financial statements out! Sunac and Evergrande remains in suspension by HKEX...The central china coys positions remains a bet on Mr Wu Po Sum...

-Token purchase of IGG (I Got Games). After a huge profit warning at the start of this year, the stock looks something like this: 

The stock gapped down from 6.2 HKD to 5.09 in a single day. The sell down was relentless and continues after result release. If you had bought at 5.09, you would still be looking at a loss of 33% today!

Presently, the price per share is 3.37 HKD a share. The problems (I am always attracted to problems) overhanging as follows:

a) Results paled when compared to the year before, particularly with the divestment of XD at huge profit last year; its current position in its 2 funds are not doing so well.

b) Increasing capex: marketing on existing games, construction of a HQ, as well as R&D on upcoming games

c) Losses from operating in "Russian-speaking" countries due to sanctions.

d) No interim dividend this year. I think this is prudent.

All of these problems, in my opinion, should be temporarily (with exception for the Ukraine invasion). If it continues, IGG could declare an impairment. That could be an opportunity.

Despite looking downtrodden, IGG still has a huge cash position of 1.9B, and the current market cap is 4B. 

Figures from Stock.cafe

This is a company has a decent track record. Current prices mirrored what it was priced at 2013, which in that year it was able to make 100+m in cash flows. If the cash-burn continues for 1 more year, my worst assumption is that it will take another billion dollars out of its coffer. Hence we could be paying for 4B market cap - 1B of cash= 3B in the future.

The stock would be priced on the high end of fair value (almost to overpriced region of 30x for me) under such pessimistic assumptions. The lifetime of its most popular game, Lords Mobile, is reaching the end. Its second breadwinner is achieving revenues nowhere near to Lords Mobile, and the most promising game, Project Yeager, will only be release much later this year. The stock is, imo, cheap, but not irrationally priced down.

Looking Forward

Performance this year should be dull at best, supplemented by an agreeable sum of dividends. Positions adopted this month have increase the number of holdings to 16, which is way more than I like. Top 5 positions contribute to 70.8% of the entire portfolio, and they are:

1. OKP (28.83%) - hopefully the outcome of the arbitration will be positive. There should be news this Sep.

2. Central China Management (11.68%)

3. Alibaba Group (11.27%)

4. Centurion (9.6%)

5. Carpenter Tan (9.44%)

I have (over)subscribed to the rights issue for Lendlease REIT and the results should be unveiled by 20-April (shares are credited on 21st). These positions are for my parents...

Till next month.

Methods of Determining Value

The following outline the general methods in which I look for value in the market

1) Adjusted Book Value

As the term suggests, this is more than looking at the "shareholder's equity" value of the balance sheet, and taking into what the account that some assets are more reliable than others.

In a bullish market, an investment portfolio that consist of stocks in vogue (such as Perfect Medical's investment in tech stocks) should be adjusted downwards. Obviously you have to make a judgement call. Likewise, it might be prudent to be skeptical with property valuation which are based on level 3 inputs, or those based on a very low capitalization rate. More so, such valuation are less trustworthy if they were valued by the same company over an entire decade.

(cap rate = rental / property valuation; hence if rental does not change over the years, this would suggest that valuation has gone up, which can be unreliable). 

Good will will classically be adjusted downwards to zero by most geriatric investors (like myself). 

A note about non-interest bearing liabilities, such as payables. Always remember that account payables should be adequately covered by account receivables. Inventories should be revised aggressively downwards unless appreciation over time is possible (luxury watches, for e.g.). 

Look for an increasing net current assets throughout the years-- it is usually a sign of an attractive company.

This is, by far, my favourite.

2) Heavy Insider Buying

Between salaried employees and majority shareholders, I would certainly prefer that salaried employees be the ones buying stock, and that of reasonably large sums. I recalled before the ship sunk for Noble (the commodities trading company in Singapore), the owner was buying huge chunks of shares. Owners can be irrational.

Unfortunately, this could be the same case as one of my major holdings (Central China Real Estate Holdings), so I do feel uncomfortable writing this.

Company share buybacks are less convincing than directors buying stock out of their own pockets. Shares, from the former, could be willfully used for employee share option schemes, instead of cancellation.

3) Low PE adjusted for cyclicality

Within the category of  price to earnings, one could argue that Company A is trading lower than its peers in an industry group. This falls under what I call "relatively undervalued," which is one of my least favorite kind of valuation. For instance, company A could be selling at 20 times earnings and deem cheap, if most of its peers are selling at 40. Obviously 40 is high number, and 20 is not modest.

If you were to find companies that fit John Neff's criteria, in the area of neglected growth, that is even better. Neff have this beautiful simple formula which takes growth in earnings (as a percentage) + dividend and divide the sum by its PE. Comparing this with the index, it does reveal bargains. But I am not a fan of this approach and I do not use it as it is too complicated for me.

Generally I am not a fan of using earnings.

4) Troubled stocks selling at a low free cash flow multiple

This is one of my favourite categories-- of course not all companies could generate consistent cash flows. I use an average of multiple years of cash flow, against the market cap, as a gauge of bargain. Unfortunately, there is always some kind of trouble involving these companies, and holding them takes a lot of heart and patience.

(The following are what some call 'special situations')

5) Restructuring

A company consisting of different business segments may choose to rid itself of the underperforming ones. For instance, a company dealing with a loss-making student hostel accommodation, and a very profitable foreign worker lodging arm, could choose to sell off the student hostel business. This would result in better earnings in the end, and is likely to cause the share price to appreciate.

This is one way how a loss-making company could outperform a profitable one.

6) IPO/ Spin-offs

This does not refer to the typical IPO which happens very often when the market is frothy. I am referring to perhaps, company A, who has a huge chunk of stock in B, which is going public through the form of an IPO. 

Generally, an IPO underwriter try to serve two parties of interest-- the owner, which wants the price as high as possible; and itself, who wants to set a price modest enough so that price appreciation is possible. The latter is much less probable these days. 

Spin offs refer to companies who wish the list a subsidiary, by distributing shares to existing share holders of the parent. The main motivation of such an act is to reward management in the spin-off, or to improve the financial conditions of either the parent or the spin off. Sometimes a spin off could be used to highlight how undervalued the parent is, usually when view from a "sums of the part" perspective. 

7) Going Private Situations

When a company decides to de-list, it would usually have a reasonable amount of success by offering a respectable premium over its last transacted price, or book value.

By offering this premium, most existing shareholders will cash out so as to avoid the pain of watching the price fall back to pre-announcement levels. On the other hand, arbitrageurs, or parties acting in concert with management, would hold on and vote favorably to de-list.

On the flip side, when deals fall apart, and the price do fall back to pre-announcement levels, it might be wise to accumulate some shares. I have two reasons why this might be ideal: 1st, the pre-announcement price is likely reasonably modest, or else why would there be interest for a de-listing? 2nd, the interested party is likely to try again sometime in the future.

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There are other niche areas, such as distress investing, bond buying, price arbitraging; but these means are far too complicated for myself and hence not practiced.