June 2020 Portfolio Update

S&P 500 Index Fund -4.52%
Straits Times Index Fund -17.95%
Tracker Fund of Hong Kong -10.96%
My Portfolio +0.81%

Transaction made in June 2020:
For mum's portfolio:
No transaction was made.

For personal portfolio:
Liquidate about 64% of Xinghua Port Holdings
Small purchase of OKP

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Earlier this month, rumours abound that the controlling shareholders is looking to sell their stake at about 200m USD.

That worked out, net of debt, to be around 1.1x-1.2x a share. So it was surprising to see the market giving it a sky-high 1.8x valuation just a few days ago, albeit briefly.

Unfortunately, I was not around to see it. Investors are commonly advised not to monitor the market so intimately and closely, but unfortunately this is one of those exceptions. I believe the market was out of wack-- the business, though sound, was not worth the earnings multiple. I have every reason to believe the management is responsible and honest, and the bad news (occupational death of 3 workers a couple of years ago) was the reason why I bet on it.

It wasn't the easiest decision as the balance sheet was not built like a fortress. But I attended the AGM and I believed strongly that my money is in safe hands.

I liquidated my shares at about 1.46-1.49. Optimistically, the take over price should not be anywhere over 1.6x. But that is my opinion.

The purchase of XHP began in 2018 March, and net me 66% in returns. I had the good fortune of buying more stock at 0.73 earlier this year during the COVID-19 selldown. Port business is resilient, having just reported results then. Insider had bought stock at 0.9x, and I trust them.

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When it comes to management integrity, Wirecard is right on the other end of the scale.

News this week was that it could not account for over 2B in cash. That is about as much cash in its balance sheet.

The cruel thing is that investors were, just last week, ready to buy that stock at way over 30 PE, given its place in the DAX30 index. When the news broke, the stock was sold down terribly, and traders bought them up. It was (though low probability) possible that someone could have made a quick 60% that day.

Those who depend on the market for guidance would then lost way more. As I write, the market has sold it down 70% from last evening's close. This is incredible.

The ex-management of Wirecard is subsequently arrested.

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There will be no chance in my investment strategy-- look for beaten down stocks which a nice balance sheet. It would be great if they are under a dark cloud of bad news... as long as the management isn't one of them.

A Vulture Looks at the Sembcorp/SembMarine Re-cap deal

Kyith of InvestmentMoat was probably the first prominent blogger to write about the implication of Sembcorp Industries (SCI) and Sembcorp Marine (SMM) deal. I would not repeat his (and many other bloggers' effort here). Kyith did a very good job in his prognosis on how the stock would go. He penned his post a day before trading resume, and the market did respond in line with his numbers.

In the minds of most investors, the jewel is SCI. Having got rid of its loss-making subsidiary, SMM, the earnings would be higher, and therefore deserve a higher stock price based on the same Price-Earnings (PE). Now, PE is subjective to the mercies of the market, but a range between 8-10 would still bring it way above than its pre-announcement of $1.5 a share.

Not only that, SCI's investors would receive 470-ish SMM stock for every 100 SCI stock held. It is clearly a fantastic time to be an SCI investor.

While everyone's attention is on SCI, the vulture (and contrarian) in me is looking at SMM instead. Let me explain why.

Firstly, let's establish that SMM's business is not wonderful. We are not talking about a capex-light-cash-rich company like Perfect Shape. SMM is far from a cheap price-to-book value stock like... ChangShouHua. We have no idea how valuable SMM's assets are, since the profits of SMM is somewhat, in a lagged manner, correlated to oil prices.

SMM's share price is going to be heavily depressed for a few reasons. When the prices are depressed to an unreasonable limit, it might make sense to buy a little. Here is why the prices will decline:

1) Nobody likes right issues to pay for debts. This is not a REIT acquiring a property, where it can be proven mathematically accretive.

2) It is a terrible business

3) Huge dilution

3) SCI's share holders are going to receive 470-ish shares from SCI's management. I believe they would dump the shares. It makes sense. Firstly, nobody likes uncertainty (maybe only value investors). Secondly, the odd number of shares make selling in the future, awkward.

Let's do some guesstimation on the numbers.

SMM shareholders would look at having to cough up $0.20 for every rights they wish to convert. They would receive 5 rights for every stock, which means the dilution is a considerable 1/6.

The existing number of shares is 2090.904569 million shares. Post-event, that would be 12545.427414 million shares.

Looking at the annual reports since 1998, SMM had very good years between 2009 and 2011, where they earned about 700, 860 and 751m in profits. 

Let's not depend on these rosy numbers and be conservative. when the oil prices are in the region of 45-50, SMM is capable of making around 90-120m annually at best. When oil prices were at 70+, it could earn 200m.

I going to make it easy for everyone and value SMM at about 12 PE. If SMM makes 100m a year, 1200m (12 x 100m) spread across 12545.427414m shares is 9.6 cents.

If SMM makes 200m a year, that would be 19.2 cents.

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As I write (17-June-2020, 1010pm), SMM is selling at 52.5 cents a share. 

In other words, $1.525 would give you six shares of SMM post-rights conversion.

The price of 1 SMM stock, in the eyes of the market, is 25.4 cents a share.

***

Let's assume that it takes 5 years for sentiments to pick up, If you expect a 20% return annualized, then you will be hoping that SMM, post rights, is priced at 12 cents a share. That is if you are expecting a 200m profit/year. It feels optimistic today, but maybe not when times are good.

IMO, the market is not stupid all the time, but just for brief durations. I expect the opportunity to come from possibly SCI shareholders dumping the free shares, another oil crisis, or something else. 

I do not believe too much in forecasting a trigger, but to pay attention to value/price gap. As of now, SMM is not a buy in my list based on my amateurish assumptions/projections, merely on the price itself.

In Defence of Buffett

In recent weeks, Warren Buffett had been criticised for not utilising Berkshire's cash hoard during the March correction, and hence missing out on its rebound. In fact, Ken Fisher (son of Phil Fisher, whom wrote the seminal "Common Stocks and Uncommon Profit." Ironically it was one of Buffett's favourite books) attributed it to Buffett's old age.  Selling all of the airlines holdings was puzzling, especially as he had made purchases on them just weeks prior.

It is true that Berkshire's performance in the last ten years were inferior to the index, and that Buffett, while managing Berkshire, has access to many deals that are not available to retail investors. However, in my humble opinion, Buffett had taught me things which I felt is still commendable and relevant. 

IMO, retail investors have a lot to learn from what Buffett did as an individual investor, and while managing the Buffett Partnership (BP).

1) Concentration, Conviction and Courage
As a young investor working/learning from Benjamin Graham, Buffett studied GEICO, and made a trip to the company to learn more about the business. Convinced that GEICO is a sound idea, he put 75% of his net worth into it. I am not sure if there are many people who can do this.

In buying GEICO, Warren Buffett shown that he is his own man, despite being told repeatedly by his idol and mentor, that "GEICO prices was too high."  

How many of you would have bought a stock at $19, and bought more at $8? This is what he did for Philadelphia Reading & Coal. When the price of a stock goes down after your first purchase, the discrepancy of value and price is now even wider, and your odds and risk is lower. This is what I learnt, but still have difficulty applying, because though the idea is simple, it takes a lot of courage.

2) Thinking Deeply
The Rockwood deal, as described in Alice Schroder's Snowball, was the the perfect example of how one should go beyond the obvious.

Rockwood was a company who had a large inventory of cocoa beans. At that time, the prices of cocoa beans shot up, but selling the beans would incur a huge amount of tax for the company. As such, they sought Jay Pritzker for advice, who spotted a loophole. Rockwood could avoid the tax by liquidating its butter-cocoa business and liquidating the cocoa beans.

Soon after, Jay Pritzker made an offer to all Rockwood shareholders. For surrendering every single share of Rockwood ($34 then), they would receive  $36 worth of cocoa beans. Hence the $2 arbitrage is riskless, and most money managers would settle for the 5.9% return (2/34). But Buffett had other ideas:

3) Avoid Questions that are "Too Hard"

"I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over."

Be it managing BP or Berkshire, Buffett avoid purchasing shares of business which he has little to no understanding. Word was that he avoided buying a certain bank just because he could not understand a small portion of its annual report. And banks are supposed to be something within his circle of competence... having such discipline is hard to come by.

With regards to his inaction during the selldown in March, it mirrored his decision not to buy any internet companies during the dot.com boom.

Even in Singapore, there will always be a company in focus, which might be in positive or negative light. It seems like one has to have some opinion of how that company will perform. 

Is SingTel going to recover to its earning ability of 2000s? I don't know.

Is SingTel able to earn sufficiently more than its dividend? I could tell the odds were not great. 

So I avoided the stock.

I have learnt not to be a smart-ass by just saying "I don't know." I will just wait for a simpler puzzle to solve-- and the stock market is not like a school examination. You don't get more marks for solving the harder questions.

4) Alignment with his clients' interest

In setting up the BP, his remuneration was as follows:

How many funds nowadays would do something like that? And how many open-ended funds would liquidate when they were still showing profits? Buffett did that in the 1969 when he felt that the market was overheated, and the opportunity of losing money for his clients is high.

5) Early Years Returns

Recent biases, such as Berkshire's underperformance to the index, is grave injustice to Buffett's ability, particularly when you study his BP's returns. Many of his ideas in BP, while in his own words, are not scalable for Berkshire, is still very much useful for the little guys like myself.

Any portfolio, especially a concentrated one, is capable of making 40+% and upwards of returns in a handful of years, but to do that over a decade, added to the pressures of managing other people's money, is the true hallmark of an investing genius. 

If you are keen to learn about his partnership years, Ground Rules is an excellent resource.

Conclusion

I don't really care if people thinks that value investing is dead-- in fact, it is to my advantage that I have it the room all to myself.

Value investing is simply sensible investing. There are multiple ways to determine the worth of a company, and it is not as simple as just looking at mathematical ratios like price-to-book. Having a sensible framework and an intellectual approach to investing, with a successful, consistent long term track record, is my objective.

I seriously doubt Buffett cares too much about what was said about him recently. A value investor that often seeks validation from others, is probably a poor investor.