Saturday, February 28, 2009

February 2009 Portfolio Summary and Review

February 2009 can be summarized as a month in which the entire world’s economy deteriorated further, and one can read juice bad news in the papers on an almost daily basis (hourly, if you subscribe to “Breaking News” service by Straits Times). So for those with a morbid fascination for pessimism and depressing news, just tune in every hour to either Bloomberg, CNN or CNBC for the latest bad news. It’s almost a guarantee that this is simply the tip of the iceberg, as the economic situation is expected to go downhill a lot for quite some time yet. Call it gravity’s pull if you wish.

Events are happening at almost lightning speed in President Obama’s office, as he unveils a US$787 billion spending plan and a US$250 billion mortgage loan plan to prop up the economy and to inject liquidity into the system. I won’t go into details as every major financial website probably has more than enough information and commentary on the details and the supposed effectiveness of such methods. The shocking headline news is the US$1.75 trillion Budget Deficit which was announced by the President just yesterday, and this is set to grow to an even more alarming US$3.55 Trillion spending plan for FY 2010, amounting to a total of 12.3% of USA’s GDP. Is spending going to be the solution to an economic crisis of such magnitude ? No one really knows the answer and yours truly (not being an economist) will reserve comments. However, readers are always welcome to share their views via the comments box.

As for Singapore, we seem to be bearing the full brunt of the economic downturn due to our status as an export-oriented economy. Countries with huge domestic demand such as Indonesia and China are able to ride out the crisis relatively unscathed, though of course some negative effects of the credit crunch and recession will still trickle in. Singapore’s GDP is expected to contract between 2% to 5% and all the big shots are warning of rising unemployment (99,000 jobs to be lost this year, unemployment rate to hit 5% by mid-2010) and more retrenchments to come. The huge fiscal stimulus measure unveiled during the recent budget (termed “Resilience Package”) is supposed to pump-prime the economy and ensure money continues to flow, and the effects should be visible from FY 2010 onwards. In the meantime, my advice would be to reduce spending and save for a rainy day as these are uncertain times and one should protect their source of active income. It is also prudent not to rely on just one source of income but to have some form of passive income such as rental or dividend income to prepare for the worst.

In terms of the Singapore stock market, I would describe it as “bleeding slowly but surely”. Volume is dwindling and share prices are making a steady but constant descent. S-Shares took a major hit in terms of confidence when Fibrechem (a former market darling) reported irregularities in its Trade Receivables and Cash Balances and called for a trading suspension. Rumours are now rife of other corporate scandals involving Singapore-listed China companies after this most recent fiasco, as well as the lingering bad memories of China Printing and Dyeing.

February 2009 was a month of earnings releases for most of my companies (except Ezra, FSL Trust and Suntec REIT). Suffice to say they all performed decently, and the brief details shall be outlined in the following commentaries below:-

1) Ezra Holdings Limited – No news flowed from the Company except to mention that they had claimed an amount of US$25 million from the insurance on the sunk Liftboat Titan 1 belonging to Casadilla Group Pte Ltd (a joint-venture company between Ezra and KS Energy). This is pending the issuance of the final loss adjustment.

2) Boustead Holdings Limited – Boustead announced their 3Q 2009 financials and net profit attributable to shareholders for 3Q 2009 showed a healthy increase of 40.2% from S$7.3 million to S$10.2 million. For 9M 2009, net profit was still lower by 23.7% as a result of lumpy contract revenue recognition and slower progress on their Libyan Township project. Furthermore, the S$175 million wastewater treatment project has not contributed yet and earnings will only accrue from late 4Q 2009. The good news is that the Group has net cash of about S$135.2 million and this is before taking into account the sale of a property for S$200 million by GBI Realty to conclude in 4Q 2009. I will not go into more detail as this is a quarterly announcement, but I should be expecting a decent final dividend come May 2009 when Boustead releases their FY 2009 results.

3) Swiber Holdings Limited – Swiber released their financials on February 28, 2009 and off-hand, the numbers look simply terrible. A net loss was incurred for 4Q 2008 of US$11.2 million as a result of inflated cost of goods sold due to the delay in delivery of 2 vessels Swiber Concorde (a pipelay barge) and Swiber Supporter (a dive-support work barge). In fact, the cost of goods sold increased much more than revenues and resulted in a gross loss of US$12.3 million; the first instance a company I owned has ever reported a quarterly gross loss. The delay in delivery was obviously detrimental to the Company's business; and now Swiber's business model must be questioned on whether they are over-reliant on the timely delivery of their vessels in order to make decent profits. Overall, FY 2008 net profit fell by 20.6% to US$39.5 million from US$49.7 million a year back; simply due to this disappointing 4Q 2008 result. I will cover Swiber in greater detail once I go through all the material, and will do a separate post on this later on.

4) Suntec REIT – Suntec REIT’s dividend of 2.858 cents per unit was received on February 27, 2009. There was no other significant news from Suntec REIT for February 2009.

5) Pacific Andes Holdings Limited (PAH) – PAH released their 3Q 2009 financials and net profit attributable to shareholders for 3Q 2009 rose 11% from HKD 79 million to HKD 87 million. For 9M 2009, net profit rose 16% from HKD 261 million to HKD 303 million. These results were better than I expected as the global downturn made me wonder if demand for fishing products had affected their SCM business adversely. Revenues for 9M 2009 were up 13% to HKD 5.45 billion and 4Q 2009 will be a traditionally stronger quarter for CFG and PAH, so I would expect better results as fuel prices have also come down a lot from the heydays of USD 147 per barrel. Debt to total assets stood at 44% which is still very worrying but hopefully, in the months to come, PAH can work towards reducing this debt load. The upcoming ITQ (elaborated in CFG’s FY 2008 analysis) will further allow efficiencies to flow through the entire supply chain structure, translating into higher margins and better performance.

6) China Fishery Group Limited – CFG released their FY 2008 and I performed a detailed review of this in my previous post, so I shall not elaborate further on this.

7) First Ship Lease Trust – FSL Trust’s dividend of USD 3.08 cents was received on February 27, 2009. The exchange rate used was 1 USD = 1.5288 SGD. Other than this, I am just hoping the Trust does not collapse due to the triggering of any covenants as the shipping industry goes through violent convulsions. In the worst-case scenario, I am prepared to write-off my entire investment in FSL Trust, painful though that decision might be.

8) Tat Hong Holdings Limited – Tat Hong announced their results on February 13, 2009 and net profit for 3Q 2009 took a hit from severe forex losses, of which about 70% are unrealized (due to revaluation of trade payables balances and revaluation of inventory at period-end) while the rest were realized (settlement of trade payables). I view this as a one-off event as the JPY has started to weaken after dismal figures thrown up in Japan due to slumping exports. It is possible for a reversal of accounting entries to take place to write-back this loss in 4Q 2008, though it will be good not to hold out too much hope for that. If not for the forex losses, net profit for 9M 2009 would have increased by 33% from S$55.9 million to S$74.2 million. Cash flow generation was decent though demand was affected by the ongoing financial turmoil. I would expect a decent dividend for FY 2009 once results are released in May 2009.

Portfolio Comments – February 2009

February 2009 was at times turbulent as the USA Government came up with measures to help the economy as well as rescue the major banks. Instead of improving, sentiment has worsened considerably as more and more bad news about the economy is reported, while layoffs are increasing dramatically in USA and in Singapore. My portfolio has dipped from a total loss of 30.3% as at end-January 2009 to 34.9% as at end-February 2009. This is somewhat similar to my portfolio structure as at November 2008, if you care to check back. It is still considerably better than the end-October 2008 portfolio loss of 41.8% even though the STI has dipped to its lowest since late 2003 (the previous low was 1,600 points back on October 24, 2008).

Going forward, I would expect more cash to flow in from future dividends from FSL Trust, Suntec REIT, Tat Hong, Boustead and hopefully Ezra as well (in April to June period). Also, with the sentiment being so stinky, I am also increasing my time spent on researching good companies as this would present a golden opportunity to purchase stakes in good, cash-rich companies which have potential to recover (in terms of business prospects, not share price) after this sharp recession is over. I have been steadily increasing my cash reserves since my last purchases in October 2008 and am now sitting on cash which is waiting to be deployed should I see good opportunities. If I do not spot these opportunities, then the cash will NOT be utilized (I just let it pile up).

My next portfolio review will be on Tuesday, March 31, 2009 after market close.

Tuesday, February 24, 2009

China Fishery - FY 2008 Analysis and Comments

China Fishery (CFG) had released their FY 2008 financials some time back, and I had the chance to do a detailed review of the Company's financials. Suffice to say that I was not entirely happy with the numbers that I saw, and a few aspects of the financials caused me a considerable degree of worry and consternation. However, my fears were assuaged due to the fact that a lot of the debt in CFG's books had collateral tied to it (i.e. their fishmeal processing plants, fishing vessels and fishmeal inventories) and assured me that CFG could re-finance its short-term debt. I will be touching more on CFG's debt in the Balance Sheet review below. Perhaps astute readers out there can point out facts which I myself had over-looked when I decided to invest in this company. However, things change and the future is never certain; thus one must always question one's original premise for investing in a particular company.

Profit and Loss Analysis

In such uncertain times and in the midst of a severe recession, most investors would find it more prudent to scrutinize a Company's Cash Flow Statement and Balance Sheet rather than its Income Statement. This is because a strong Balance Sheet and regular and stable cash inflows can help a company tide through long downturns to emerge even stronger after that. CFG had managed to grow its top-line revenue by 13% from USD 406.4 million to USD 459.4 million. The rise in revenues was mainly due to higher catch volumes and higher selling prices for its fish with regards to its trawling division, which accounted for 74.7% of total revenue. The other 25.3% was made up of fishmeal operations and this created a minor drag on revenue as fishmeal prices softened during FY 2008 compared to FY 2007. A latest check on fishmeal prices from Copeinca's 3Q 2008 financial highlights shows that fishmeal prices averaged around USD 988 per metric tonne (MT), lower than the USD 1,100 to 1,200 per MT hit in FY 2007.

Gross margins dropped from 34.8% in FY 2007 to 32.3% in FY 2008. The main culprit was higher bunker fuel costs as the price of oil shot up to as high as USD 147 per barrel around July-August 2008. The ratio of fuel to total sales increased from 14% to 17.9% as a result of this. However, with oil prices slumping to below USD 40 due to the global recession, CFG should be able to regain their high margins again for FY 2009, barring unforseen circumstances.

Finance costs also rose slightly for the Company from USD 26.8 million to USD 31.2 million, a 16.4% increase. This was due to higher bank loans taken out during FY 2008 for the acquisition of fishing vessels and fishmeal plants. As the credit crisis dragged on and credit became tighter, the Company had also ceased their acquisition of assets until more clarity emerged. This will be discussed under future prospects and directions. As a result, net margins decreased from 21.8% to 20.5% (helped by a tax credit of USD 2.4 million from the recognition of tax losses carry forward by CFG Investment S.A.C.) and net profit rose just 6.5% from USD 88.5 million to USD 94.3 million. Using an exchange rate of 1 USD = 1.52 SGD, this translates to about SGD 143.3 million net profit. EPS is about SGD 18.3 cents and using the closing price of 60 Singapore cents as at February 24, 2009, this translates to a historical FY 2008 PER of 3.28 times.

Balance Sheet Review

Well, I have to admit CFG does not have one of the cleanest Balance Sheets around; after doing a quick comparison to companies such as Boustead and Tat Hong, I was forced to conclude that CFG's Balance Sheet represents a lot of risk and notwithstanding the fact that their trawling operations generate lots of operational cash inflows, the Management must make a sustained effort to reduce their gearing and improve their cash balance. A quick glance would show that the Company had debts amounting to USD 317.3 million for FY 2008 (bank loans + senior notes) of which about USD 60 million is up for re-financing within a year. Gearing is dangerously high at 43.6% debt to total assets and about 94.5% debt to equity ! The fact that the Company had a measly cash balance of just USD 7.7 million is of great cause for concern ! I will cover this aspect during the review of the Cash Flow Statement, and though this may be a timing difference, having so little cash in the face of so much debt is not something I like to see as an investor.

Current ratio actually improved from 1.05 in FY 2007 to 1.28 in FY 2008, mainly due to the increase in trade receivables and inventories, coupled with a large drop in trade payables. However, the worrying fact is that short-term debt increased in order for them to finance their acquisitions, and only the assurance of better cash inflows in future can make me feel more worry-free. Suffice to say this is a Balance Sheet which had me beleaguered for quite some time, but seeing that CFG and PAH have a good track record and are a major industry player, and that the CEO is prudent enough to manage inventories and debt; this has caused some of the worry to ease, though some doubts still linger which I will attempt to address at the upcoming Annual General Meeting.

Cash Flow Statement Analysis

A quick glance at their Cash Flow Statement shows that CFG generated healthy operational cash inflows of USD 65.4 million for FY 20008, down from USD 172.8 million for FY 2007. Knowing that their business is very cyclical and is based upon quota allocation and fishing seasons, one might attribute the changes in working capital to such seasonal fluctuations and the fact that the Company is gearing up for its first ITQ fishing season in 2009. The entire year's cash inflow is just about sufficient to cover the short-term debt which is due for re-financing (or repayment, assuming they have the cash to do so). I have no doubt that CFG can generate strong cash inflows from their trawling and fishmeal operations, but a major problem now is that they are paying out USD 28.4 million just in interest alone, so unless they reduce their debt quickly, a lot more of their cash flows will go into feeding the banks and bankers' salaries rather than being ploughed back into the business to generate higher ROE. This in itself is very worrisome.

For investing activities, CFG spent USD 57.5 million acquiring PPE which consists of fishmeal plants and fishing vessels. Note that part of this money may also be capitalized expenses resulting from the elongation of existing super-trawlers; thus CFG's growth is part organic and part acquisitive. Another USD 19.7 million was spent acquiring a subsidiary (which includes fishing permits as well). All in all, they spent significantly less in FY 2008 on investing activities as compared to FY 2007, when a massive USD 277.7 million was spent on acquiring PPE, subsidiaries, fishing permits and prepayment of charter hire.

For the financing side, more bank borrowings were raised to acquire assets, while the final dividend for FY 2007 paid came up to USD 12.6 milllion. The result was a net cash inflow of USD 8.8 million, and was lower than FY 2007's fund-raising efforts which saw issuance of new shares as well as bank borrowings totalling USD 96 million.

For FY 2009, my wish is to see CFG halt all acquisitions and focus their efforts on building up their operational cash inflows in order to pay down their bank loans (and possibly redeem some of their senior notes due 2013). During lean and tough times, organic growth may be preferred to acquisitive growth especially since the Company is already so highly leveraged. If CFG had a lot of cash on hand and no debt, I would encourage more asset acquisitions at fire-sale prices. Because of the fact that they have so little cash and such high borrowings, I would rather the Company focus on cash generation, in order to avoid the risk of ending up as another "Ferrochina".

By the way, another indication that the Company is cash-strapped is the declaration of a share dividend (scrip instead of cash) of 6.03 Singapore cents per share. I see this move being purely cosmetic as the Company can choose NOT to declare a dividend and cause dilution to EPS, so I will bring this issue up at the AGM too.

Disappointing though the above sounds, I do still have faith that the Management Team can steer the company to better times with their growth plan, assuming nothing drastic occurs in the meantime.

Prospects - ITQ Implementation

The long-awaited ITQ (Individual Transferable Quota) system will be in place in Peruvian waters in the first fishing season of 2009. This was issued by the Peruvian Government on June 28, 2008 and places individual limits of capture per vessel instead of having a quota for a specific specie of fish. A maximum limit of capture will be set and vessels will not need to "race" to catch as much as fish as they anymore. This was the case for the old system called the "Olympic" quota system, in which the Ministry of Production decides the total quota for the country and each vessel owner must then rush to maximiser share of the total quota. The fishing season then ends when the quota has been achieved.

For the ITQ system, each vessel can catch the allocated quota at heir own discretion. There are several advantages with regards to the ITQ as compared to Olympic system:-

1) There will be better rationalization of plants, fishing vessel fleet and personnel as scheduling becomes more efficient and effective. Previously, during the "race" to catch as much as possible, it would have been difficult to plan for and allocate vessels to maximise catch. However, under the ITQ, this would now be possible. The result is better economies of scale and hence lower cost of goods sold (translating into higher gross margins).

2) There will also be significantly improved utilization of assets as a result of the economies of scale. The projection by Copeinca (a major competitor of CFG) is that EBITDA will increase 30-40% as a result of this.

3) The quality of fish and fishmeal will also improve as there is no rush to catch as much as one can, thus compromising on the quality of catch due to the race for quantity. This would translate into higher selling prices for the fish and fishmeal and again improves gross margin.

4) The ITQ system will also continue to ensure that fish populations are sustainable and do not deplete too quickly.

However, one thing to note is that the full effects of the ITQ system will probably not be felt until FY 2010.

Prospects - Fish Demand and Fish Prices

Worldwide fish demand is expected to remain consistent with moderate growth as the global recession kicks in. The move towards more healthy diets means that more will start consuming fish instead of red meat; however this effect is likely to be mitigated by the loss of wealth in affluent countries as a result of the economic crisis; therefore the income effect may cause people to temporarily downgrade to cheaper alternative sources of protein, thus neglecting fish. However, I do not see a major negative impact for this as fish consumption should remain relatively steady and demand should stay resilient despite the growing recession.

As for fish prices*, consumers will start to switch to alternative species in the more affordable range and this will boost sales volume, though margins are likely to stay constant. Expected worldwide deflation may also cause prices to drop, though a >10% drop is not likely and should not be prolonged. It is expected that fishmeal prices should stay steady at around USD 1,000 per MT in the near term, with the long-term trend showing a steady increase.

Prospects - Deployment to South Pacific

CFG had mentioned deploying super-trawlers to the South Pacific which is currently relatively unexplored and has untapped fish resources. CFG was in the midst of upgrading their super-trawlers in FY 2008 and perhaps this was one reason why they could not ahieve full potential during FY 2008. As of year-end 2008, two super-trawlers had been deployed to the South Pacific Ocean and more (exact number unknown) will be deployed there in FY 2009. This has to be confirmed with Management during the AGM.

Falling oil prices will also benefit these super-trawlers which are able to increase their hold capacity after elongation (I checked this during the last AGM). Naturally, being larger, they will consumer more fuel than non-upgraded super-trawlers so the fall in bunker prices will benefit CFG greatly, plus the increased hold capacity means more fish can be stored for transport to the nearest fishmeal processing facility.

The Future - Krill ?

Apparently, during an interview with The Edge Singapore (August 18, 2008 issue), Ng Joo Siang mentioned that he thinks there might be big demand for krill some day. This is a minute marine bio-organism which can be found in the Antarctic in large numbers. They are at the bottom of the food chain (whales eat them in abundance) and there have been warnings by conservationists that removing them from the food chain may severely impact other species and cause a catastrophe in terms of bio-diversity. Notwithstanding this, the potential for krill is good because it can be made into krill oil and krillmeal for animals and is also rich in Omega-3 fatty acid. In some news reports, krill is also being tested for use in skin care products !

Thus, I will be bringing up the subject of krill to the Management to see if there are any plans underway to harvest this new species, and the potential for growing this business.

*Note: Fish prices relate to prices of Peruvian anchovies as well as Chilean Jack Mackerel.

I will provide another update for the Company come AGM time. In the meantime, I expect to hear more news of the scrip dividend scheme and hopefully it will allow me to average down my cost without me having to cough up extra funds.

Saturday, February 21, 2009

Tat Hong featured in The Edge Singapore

The Edge has a 2-page article on Tat Hong and Mr. Roland Ng. I shall not reproduce the full article here due to copyright issues, but I will do a summary as follows. For more details get a copy of The Edge at $3.80.

Tat hong faces weaker demand and currency volatility, analyst opinion divided

1) Roland Ng says Tat Hong has "the right business model", and he believes the pace of building activity won't slow due to massive stimulus spending packages unleashed by many Governments as a result of the economic downturn.

2) In Singapore, over S$18 billion worth of public sector infrastructure projects are up for grabs.

3) Tutt Bryant is expanding its fleet of crawler cranes for LNG projects in Sydney and Melbourne. Roland Ng says although there is news of delays and stoppages of projects due to funding problems, there is still a big part of the business which is ongoing.

4) Tat Hong's associate, Yongmao, will benefit from China's RMB 4 Trillion stimulus package. Tat Hong itself has done a "roaring business" renting tower cranes in China.

5) Analysts add that renting equipment helps construction companies stay flexible and adapt quickly to changing demand.

6) Roland Ng concedes that even if rental demand remains firm, rental rates are likely to dip 5-10%.

7) Tat Hong imports cranes from Japan and earns most of its revenue in Australia and Singapore. In 3Q 2009, JPY strengthened against SGD by 19%, and against AUD by 41%. Though the Company has usually been able to adjust selling prices to factor in unfavourable exchange differences, Ong Tiew Siam (Exec Director at Tat Hong) says that this time around, the JPY was really volatile and that's why Tat Hong got "hit so bad".
Comment: This makes the exchange loss seem like a one-time problem which is unlikely to occur with such magnitude in future periods.

8) The problem was further exacerbated by a slowdown in crane demand, which meant a build up of inventory. According to CIMB, 30% of the exchange loss was due to inventory value adjustments, while the remaining 70% is due to a revaluation of its trade payables.
Comment: Thus, quite a large part of its exchange loss should be unrealized, and will hinge upon the strength of JPY against SGD and AUD.

9) Due to the ongoing crisis, Tat Hong has cancelled half its outstanding orders for cranes and transferred S$43.5 million worth of inventory to its rental fleet, which still enjoys strong demand.

10) The Company is banking on its rental business (see below) to sustain it through the entire downturn. They expect to remain profitable for 4Q 2009.

Under the section "BIG MONEY" by Assif Shameen, there was an interview with Mr. Roland Ng. A summary as follows:-

How a King of Cranes positioned his firm for a downturn

i) Roland Ng is the eldest in a family of 15 children and a UK-trained civil engineer. He joined the family's equipment trading and leasing firm in 1979 after a brief stint with Jurong Town Corp and has been CEO since 1991.

ii) Tat Hong was set up by his father, Ng Chwee Cheng, in the 1960s as a tyre and battery service shop. In the 1970s, Tat Hong branched into the trading of second-hand excavators and eventually, cranes.

iii) In 1996, just before the onset of the Asian Financial Crisis, it bought control (70%) of Tutt Bryant as it proved to be a good move as it helped to cushion Tat Hong during the dark days of 1997-1998.

iv) Ng says Tat Hong was successfully transformed from a diversified company that was selling, distributing and leasing heavy equipment to a predominantly [b]rental[/b] company. He says it's a more steady, stable and predictable revenue model.

v) Up to 10% of rental income comes from China, under 50% from Australia and the remainder from Singapore and S.E.A.

vi) Tat Hong remodelled its business model after the financial crisis as the volatility was "too much" for the conservative businessman. Eventually, Ng hopes that Tat Hong will be a predominantly crane and heavy equipment rental firm.

vii) Roland Ng insists Tat Hong is not tied to the global property boom, so with the collapse of the boom, Tat Hong should not be adversely affected. He insists that Tat Hong's cranes are not helping to build luxury condos whether in Singapore, Sydney or Shanghai; but the cranes are building bridges, ports and other infrastructure.
Comment: I have seen this for myself in Singapore. Most of their cranes are used to build either HDB flats, the IR or for road works and highways (tunnels) + MRT.

viii) The firm is NOT over-exposed to the mining bust in Australia either. Ng says they rent equipment to the oil, gas and energy projects rather than mining.

ix) Ng is seeing a lot of potential as Singapore has infrastructural projects coming up, plus China will be building more power plants, ports and bridges which will need Tat Hong's equipment and cranes. Indonesia is also reviving a lot of large infrastructural projects.

x) As the downturn takes hold, Tat Hong is ready to pounce. Ng says when valuations come down to more realistic levels, Tat Hong might buy equipment rental companies in Australia and China, maybe even South East Asia.

xi) Governments often try to kick-start economies by splashing big on infrastructure. What Tat Hong’s CEO has learnt about his business is that it isn’t tailored just to ride booms but it is also a key cog in the wheel of recovery.

Note: As a result of this article, my China Fishery analysis (which is already half-done) will be pushed to a few days later. Check back for details !

Tuesday, February 17, 2009

Gaining Knowledge from Books

In my quest to improve myself, I have taken to reading more books in order to furnish myself with the required knowledge and basic competence to understand equity investments as well as the world around me. In addition, I have also recently started to read other types of books to expand my breadth of knowledge instead of just focusing on depth of knowledge. There are a few basic types of books which I read and I shall list down the main categories and at the same time, give a few examples:-

1) Books on Value Investing - This is clearly self-explanatory and forms the basis for my knowledge for value investing techniques and principles. Such books are usually written with either Benjamin Graham or Warren Buffett as an example because they embody the essence of value investment, and these books attempt to distill the knowledge, methods and techniques used by these great investors and list them out to the layman reader. Suffice to say that the books offer just a foundation for understanding what goes into value investing, but the actual practitioner's effort should concentrate on modifying his style to suit his temperament, abilities and be country-focused (USA companies are different from Singapore companies in terms of certain aspects of revenue recognition, depreciation policy and tax regimes). No book can prescribe a method for proper investment except to lay down the template and fundamentals, and teach one how to interpret and understand financial statements. Examples of such books are "The Intelligent Investor" by Benjamin Graham and "Warren Buffett Wealth" by Robert P. Miles.

2) Books on Behavioural Finance - These books deal with a somewhat new and emerging philosophy which goes against the traditional beliefs in the efficient market hypothesis. This new branch of psychology is called Behavioural Finance and deals with people's behaviour and attitudes towards handling investments and money. Examples can be found in my behavioural finance series which include terms such as loss aversion, over-confidence and anchoring, among others. Behavioural Finance is important as it defines an investor's moods and behaviour with regards to his investment, and also help to explain market psychology and can help one to understand his own money management techniques and habits. With this knowledge, one can become more aware of these biases and behaviours and seek to actively correct them. Without the benefit of this knowledge, I may have suffered from a number of so-called "stereotypical" traits without being cognizant of them, thus severely impairing my ability to make worthwhile investments. I would strongly recommend that readers delve into such books to enhance their understand of the human psyche and to be aware of their own worst enemy within them ! Examples of such books include "The 7 Sins of Investing" by Maury Fertig and "Your Money and Your Brain" by Jason Zweig.

3) Books and websites on Personal Finance - I've been exploring the topic of personal finance for quite some time now, as it pertains to a very important aspect of one's investment philosophy, namely to accumulate wealth so that one can invest it ! In fact, my motto in life has always been the 3 "I" - Income, Insurance and Investments. These are part of my philosophy of saving, protecting and growing respectively; and one should note that saving is the most critical aspect of the 3 as it ensures you will have money with which to protect and grow ! Mainly, I've been surfing the web for websites on personal finance and also reading articles on personal finance. I have started a series on this and it is an open-ended series which helps me to collect my thoughts on personal finance and also to ensure I adhere to my principles for building wealth. Some websites I highly recommend are Five Cents Ten Cents (for Singaporean readers) and The Simple Dollar (more geared towards USA but the principles are still very helpful). Moving on to books, I am currently reading "The Richest Man in Babylon", a classic by George S. Clason as well as "Secrets of The Millionaire Mind" by Harv T. Eker.

4) Books on Market Cycles - Another area which I am currently reading and researching on is the concept of distinct market cycles, which of course are tied to economic cycles as well. Interestingly, this forms the basis of the stock market (as well as companies') valuations and is a key reason why people label companies as "cheap" or "expensive". Valuations as they stand in isolation do not mean much, but when viewed in the context of economic cycles, one can then infer if a company's valuation is rich or poor with respect to macro-economic growth, interest rate policies and industry stability and robustness. Such books also give insights into market panics, bubbles and subsequent busts and study the reasons for such cycles, as well as giving signs on how to tell if a bubble is forming or about to burst. I've begun to appreciate how useful such information is with regards to value investing as it can help one to identify a company and decide if it was over-priced with respect to its growth prospects. Admittedly, this can be somewha subjective but having an understanding of economic cycles means that one is equipped with an understand of what constitutes a clear future, and what represents a murky or bleak one. I am currently reading "Market Panic" by Stephen Vines and will move on to "Bull! A History of The Boom 1982-1999" by Maggie Mahar next.

The above 4 categories of books have helped me to expand my universe of knowledge significantly. Since knowledge is limitless, it is my goal to continue to enrich myself through reading and also the application of the knowledge to my personal finance habits and investment philosophy. Perhaps readers would care to share which books have had a major influence in their life with regards to investment (not trading) and personal finance as well ? The comments box is available for your sharing and thanks in advance.

Note: My next post will analyze the FY 2008 results for China Fishery Group Limited, and in a subsequent post I will summarize snippets from the results from Pacific Andes (3Q 2009), Tat Hong (3Q 2009) and Boustead (also 3Q 2009).

Wednesday, February 11, 2009

How Much is Enough ?

In case you were wondering that the title implied that this post will be about money, you're not too far off. But for this case, it's meant to ask how much money is required to "flood the system" to enable the USA to lift itself out of this persistent downturn. Just yesterday, the US$838 billion "Financial Stability Plan" was approved by the Senate and it was prepared by the new Obama Administration, with a speech delivered by the Treasury Secretary Mr. Timothy Geithner. The next step is for them to detail the use of the remaining US$350 billion of the original TARP (Troubled Asset Relief Program) fund of US$700 billion to get troubled assets off major banks' balance sheets to be able to allow them to lend again, as well as tackle the worst housing crisis since the Great Depression. Wow, seems like this new administration really has their hands full ! The question is: how much is enough, and what will the tipping point be ?

The issues here involve not just the banks, but also how to stimulate domestic spending in order to provide a fiscal boost to the economy as well as kick-start the dying housing market where foreclosures are mounting daily. So the US Government needs a three-prong approach, and admittedly it's not easy being where they are due to the fact that such a situation is unprecedented (with the closest comparison being the Great Depression of the 30's) and requires many untried and untested methods to solve. So far, the Bush Administration kept on getting it wrong by doing stuff which did not help, but in fact was blamed for worsening the crisis (and causing the collapse of Lehman Brothers in October 2008). The reason being that no one really knew the effective way of saving the financial system as a result of excessive and wanton leverage, and so everything was being thrown at the system to try to see which would work. Apparently, this did not go down too well, with the result that the Obama Administration has to work to pick up the pieces of the shattered plan(s) and come up with some new, bold initiatives of their own.

In assessing how much is enough, one must question if there is currently ample liquidity flowing through the banking and financial system for normal credit to flow and markets to function normally. Liquidity is being constrained because of banks' tattered Balance Sheets, which make other banks hesitant to lend for fear of the loans becoming NPL; while loans to corporations have also dried up due to fears of companies not being able to service the principle and interest due to waning demand for products and services. It's a vicious cycle which feeds on itself, and only Government intervention through the injection of money into the system can counteract such effects. Thus, one might be tempted to place a dollar value on this crisis, whether it be US$800 billion, US$1 trillion or even as much as US$10 trillion (a truly astounding number, no doubt !). However, my view is that it is not just a matter of liquidity, but also one of confidence. Restoring the mental capacity of banks, hedge funds and private equity funds to invest and keep credit flowing is paramount, and it's a matter of sending them to a psychologist who will counsel their problems away and allay their fears, providing reassurances that "things will be all right". The reality is that everyone knows the world has gone topsy-turvy, and so such advice tends to fall on deaf ears and the same problem crops up repeatedly, one of fear, trepidation and anxiety.

So if such a systemic failure to get credit moving continues to persist, what will become of the world and of the financial system ? One should rightly assume that if the entire system seizes up, it's like a person's body going into spasms and all its muscles and nerves freezing up, meaning the person cannot move at all ! Imagine a petrified mummified person who has his "acu-points" blocked in those kungfu movies, and perhaps the image becomes clearer. People out there have to know that enough is being done to unclog the financial system and restart the lending, so that confidence is restored and liquidity can start to flow again. It's a pretty contentious thought - that a stimulus package needs to be big and bold enough to just kick-start confidence, and a positive feedback loop can then ensue to ensure the world recovers, albeit slowly.

Of course, as mentioned, thawing out the credit markets is but one step towards an eventual recovery. The other 2 aspects would be consumer spending and the property market in the USA. As of this writing, unemployment rate is the USA is officially at 7.6%, and is tipped to rise to double-digits as the recession worsens. With people losing their jobs at an alarming rate, no one is quite in the mood to spend, resulting in the retail and auto-mobile industries suffering crushing losses amid rapidly declining sales. The US Government has to get the people to start consuming again, as the irony is that the "Paradox of Thrift" would become a vicious cycle which will cause the economy to sink further into recession. In this aspect, Governments have to do their part to inject fiscal stimuli such as tax breaks, food vouchers or assistance programs to alleviate the pain of the common man. With retrenchments, mass layoffs and pay cuts on the rise, spending will be severely curtailed and may not rise again for at least several quarters; or until the job market stabilizes and companies have cut enough costs.

The entire tangled mess actually began from the sub-prime crisis, which in turn impacted home values and led to mass foreclosures. Housing prices have fallen into a tailspin and as of this writing, have not yet stabilized; thus it is imperative for the US Government to come up with a plan to stabilize home prices and to make homes more affordable to the general public, so as to reduce the over-supply of homes which is causing prices to plunge. It would be interesting to observe in the coming weeks the plans being formulated to tackle the housing crisis. Some possible suggestions would be to lower interest rates further to make home loans more affordable, and to make refinancing easier so that each person pays a lower monthly installment.

After all that's said and done, one must know that money is not always the solution. It takes confidence, courage and quite a lot of pain and suffering before recovery can take place. Obama mentions that "tough love" must be applied to banks, and I fully agree ! There must be a lot of pain involved in deleveraging (like cutting an infected pus-filled wound away from the body) before banks can declare themselves "clean" and start lending again. Though the recovery may be long and slow, it is nevertheless interesting to watch and learn. For learn we must, in order for history to not repeat itself !

Friday, February 06, 2009

Corporate Complexity

In the entire world of companies and businesses, a quick glance would immediately tell a casual observer that some companies are simpler than others. By the use of the term “simple”, I imply that some companies have business models and structures which are relatively easier to comprehend than others, and so are easier to subject themselves to comprehension and scrutiny in order to assess if it is a viable investment target. These companies are often producers or providers of a type of product or service respectively, as compared to global conglomerates who may be providing multi-industry products and services. As we shall see next, this can have positive and negative impacts on one’s investment thought process as well.

Using just the examples of Singapore-listed companies, one can find many companies which are focused on just one main type of business. For example, Capitaland is dealing in property development, SPC is doing oil refining and DBS is providing retail and corporate banking. To slot these companies into defined categories is easy due to the specialized nature of their principle activities and also based on the fact that they operate within popularly categorized industries such as property, oil and gas as well as financial companies. Of course, things start to get a little hazy and complicated when we observe companies which have multiple units or are into multiple industries and/or business segments. One example would be Keppel Corp, whose main business is in the building and provision of oil rigs for major oil companies. At the same time, it also has a property arm (Keppel Land) and it also owns part of SPC as well. Another pertinent example is one of the companies I own – Boustead Holdings. It has operations spanning oil and gas, real estate, water and wastewater as well as Geo-Spatial Services.

When we broaden our horizons further past Singapore and look to USA companies, one can easily find companies which are multi-industry conglomerates. Take 2 components of the Dow Jones Industrial Average for example – 3M and General Electric. These companies manufacture everything from post-its to electrical appliances to doing financing for loans (just check out their respective websites). These companies have a worldwide presence and their intangible goodwill probably values them far above their current market capitalization. So the question to pose here is: how does one go about analyzing companies of such complexity ?

Companies which are operating in a single industry often are much easier to analyze as there are peer comparisons to be made, and the business itself is also easier to comprehend. However, that said, the brand name may not be synonymous with the common man at all, and thus there may not be a premium to be paid in terms of brand recognition for the products sold by the company. Famous brand names such as Proctor and Gamble, Coca-Cola and Gilette are very specialized companies which produce a very specific product or set of products, but still manage to retain worldwide recognition.

If we turn our attention to conglomerates and companies in multiple industries (e.g. General Electric), most of the time, sum-of-the-parts analysis is used to”break-up” the company into its constituent parts, where they are then separately analyzed. A PER valuation is assigned to each component, which is then weighted according to the stake held by the parent company (e.g. 50% or 20% stake). These individual values are then added up to give a final “value” for the entire firm. While this approach is not wrong per se, it fails to take into account synergies and intangibles between the separate components of the Group. This would usually mean under-stating the true value of the conglomerate if we just base it on the individual sum of parts. Similarly, disparate business units may also not have much synergies and thus a discount ought be factored in. Hence, corporate complexity may be a hindrance when one tries to analyze and value the company as there are so many factors to account for, while one may also not realize or be aware of potential synergies within or among the business units.

That said, in my current investment journey, I have not yet ventured to value such complex entities with global reputations and reach. The closest I have come is to owning Boustead which is multi-industry but since they only have 4 distinct divisions which are quite separate from one another, this job is somewhat easier. If readers have tried analyzing a complex conglomerate for potential investment before, please do share your thoughts on the process and the factors one should look out for.