margin of safety

A steal at EV/EBITDA at less than 1x?

2012-02-12T17:41:00.003+08:00

Lian Beng Group is a A1 grade general building and A2 grade civil engineering contractor listed on the Singapore Exchange. Its A1 certification implies that it is eligible to tender for contracts of all sizes in Singapore.

In recent years, Lian Beng had focused on private residential projects. In November 2011, it turned its sights back on the government market and won a S$13 million contract from the HDB. The contract in Tampines is expected to be completed by September 2013.

With 25,000 BTO flats which HDB has committed to pushing out in the next 12 months, we expect Lian Beng to continue to score its share of contract wins as the Group has over thirty years experience in building construction.

Competition in the sector is fierce but the firm managed an impressive net profit margin of 9.6% for FY2011. Its impressive order book which stands at S$772 million should keep the firm busy until 2014.

Lian Beng is aware of the need to build up a recurring income stream to cushion the volatility of contract work. Hence, it teamed up with Centurion to develop a foreign workers dormitory in Mandai. We project that the dormitory would be completed by June 2012 and can generate approximately S$11 million in rental income annually.

Valuation for the firm is very compelling. At S$0.39 per share, Lian Beng is trading at its book value despite boasting an impressive return of equity of 25%. On an EV/EBITDA basis, Lian Beng is trading at approximately 2x (FY2011) and 0.7x (FY2012F)!

About 44% of its market capitalization is net cash which stands at S$83 million. Hence, Lian Beng should have no issue paying out about paying out another 1.6 cents in dividends for every share at the end of FY2012. Hence, we are confident of a base case dividend of 4.1%.

Management which owns 25% of the firm is keen to unlock value for shareholders via a listing of ready mix concrete and engineering business on the Taiwan Stock Exchange. The exercise should release more cash back to Lian Beng and hopefully catalyze the stock to greater heights.

A Sound Investment (so far)

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

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

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

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

On a rising tide

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

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

Show Me the Money

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

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

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

On the Right Track

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

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

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

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

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

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

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

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

Nerves of Steel

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

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

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

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

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

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

A Year Older, but None the Wiser?

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

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

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

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

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

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

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

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

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

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

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

Lion Asiapac declares a 15 cents special dividend.

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

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

Mahatma Gandhi

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

Never Ask a Barber if you need a Haircut

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

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

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

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

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

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

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

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

How far out do you look?

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

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

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

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

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

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

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

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

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

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

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

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

Run Keck Seng Run

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

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

Welcome to the "World of Innovation"

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

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

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

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

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

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

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

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

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

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

Will the Lion Roar?

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

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

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

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

Christopher Browne passes on

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

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

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

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

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

Running on Empty

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

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

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

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

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

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

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

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

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

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

The Wayward Son?

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

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

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

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

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

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

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

A Return to the Gold Standard

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

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

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

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

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

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

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

We will all laugh at Gilded butterflies

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

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

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

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

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

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

Prim and Proper Property

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

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

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

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

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

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

Nobody is thinking in the Herd

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

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

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

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

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

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

Life in Hamelin

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

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

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

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

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

(1) Birth of bull or suckers' rally?

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

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

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

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

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

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

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

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

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

(5) Last Words, MOS?

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

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

Feel free to drop comments with your opinions.

Laughter is the Best Medicine

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

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

DDD: Deflationary Death Decline

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

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

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

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

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

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

All that Glitters may not be Gold

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

No Bull in the China Shop

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

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

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

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

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

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

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

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

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

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

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