Sunday, January 31, 2010

January 2010 Portfolio Summary and Review

I guess the most earth-shattering piece of news this month is the announcement by American President Obama about new controls over banks and what they can do. On January 22, 2010, he proposed that commercial banks be prohibited from entering the investment business; and to just stick to what banks do best – provide loans and earning money from loans and interest. Basically, this is the concept of the “old-fashioned bank” and seeks to move backwards in terms of banks’ allowable activities and roles. This has similarities with the Glass Steagall Act enacted in 1933 as a result of the Great Depression, and was a direct legislative measure in response to the failure of 5,000 banks during that harrowing period. In addition, he mentions 2 additional reforms – that of ensuring that banks (which received taxpayer-insured deposits), are not allowed to put such monies at risk by operating hedge funds and private equity funds; and to prevent big banks from further merging and consolidating till America is left with just a “few super large banks”, which will NOT benefit the average American. Of course, the markets did not take to his comments very well and a savage sell-down ensued, with the DJIA falling over 500 points in just 3 days.

In addition to this (apparently) ground-breaking news, news also trickled in about China’s economy growing 10.7% year-on-year for 4Q 2009; and its December 2009 inflation jumped to 1.9% from a negative inflation last July, while bank lending rose sharply as well. All these pointed to China possibly over-heating as its GDP growth for FY 2009 hit 8.7% (some websites report a “revised” figure of 8.2%), which for any nation is considered breakneck growth. China has begun the task of reining in runaway lending by banks, by hiking the reserve ratio and also directly telling banks to freeze lending. Of course, all these measures had the knock-on effect of providing yet more jitters to the stock markets as everyone got worried that the economic recovery after the Great Recession would grind to a halt. So instinct and emotion took over and caused the selling to intensify, especially in Asian markets as well.

Back in Singapore, signs are pointing to more property inflation in the months ahead, with our local newspaper reporting that private home prices rose 7.4% in 4Q 2009, following a blistering 15.8% increase in 3Q 2009. Resale prices for HDB flats also hit a fresh record in 4Q 2009, rising 3.9% (bringing the full year 2009 increase to 8.2%); while median COV (cash-over valuation) doubled from S$12,000 to S$24,000! And in a triple whammy, COEs for cars also crossed the S$20,000 mark for the first time since 2004, buoyed by high demand (as a result of sharp discounts given by retailers) and controlled supply of COEs (and less scrapping of older cars). These effects all add up to make Singaporeans a lot poorer, as property priced continue their relentless climb and people have to fork out more for their dream home.

For myself, I took the opportunity this month to clear off my entire shareholding in China Fishery, and had written a blog post about it a couple of days ago which readers can take a look at. The announcement of the dual listing came at a bad time as I had just written my post on dual listings, and to me this was like a slap in the face (it certainly felt that way, trust me!). The proceeds of about S$50,000 were then channelled into a company Kingsmen Creative which I had been researching for some time, and I felt it had decent growth prospects and could provide a steady dividend yield. Purchases were made on January 25 and 26, 2010. It had net cash (good balance sheet), strong cash inflows, a steady order book, dividend yield of about 5.3% and revenue and earnings growth over the last 5 years. I will be doing a more detailed analysis of purchase in due course; but in the meantime I had pumped in about S$42,000 into this company, with at least a 5-year view unless something goes drastically awry. This has raised the cost of my shareholdings to the S$150,000 mark, a new level which I previously had not hit. The good news, of course, is that my total assets are increasing month by month while my HDB loan is being paid down; so my net worth is increasing at a comfortable pace. Coupled with regular savings of about 45% of my net salary, I still manage to maintain a buffer in case of emergencies, and this also forms my growing opportunity fund in case more investment opportunities crop up.

For the month of January 2010, there was very little business activity announced among the companies I own:-

1) Boustead Holdings Limited – In early January 2010, Boustead announced that its energy division had secured S$68 million worth of contracts from around the globe. In a span of a few weeks, Boustead had boosted its order book by S$500 million; and this was a good start to the calender year. On January 6, 2010, Boustead announced that it had launched a portal called, which is an interactive map portal of Singapore.3Q 2010 results should be released by mid-February 2010.

2) Suntec REIT – Suntec REIT released their FY 2009 results and declared a dividend of 0.318 Singapore cents per share, on the new units plus existing units. If added to the previous stub dividend of 2.568 cents per share, total dividend would have been 2.886 cents per share, representing an annualized yield of 10.4% at my purchase price of S$1.11.

3) First Ship Lease Trust – FSL Trust released its 4Q 2009 and FY 2009 results and fortunately, there were no nasty surprises. DPU was US 1.5 cents per unit and there was a press release by Philip Clausius saying that the worst had passed but the shipping industry remains in the doldrums; however all lessees are still honouring their leases and cash flow remains healthy. A guidance of US 1.5 cents was given for1Q 2010, and FSL Trust may revisit the bond issue which was scrapped last year in the wake of the Dubai crisis; with the funds going into possibly purchasing distressed vessels with high yield. From the way I see things, the yield has got to be much higher than the proposed coupon rate of 12% for a bond issuance if FSL Trust wants to go ahead.

4) Tat Hong Holdings Limited – There was no significant news from Tat Hong during January 2010, except some clarifications on their Joint Venture company in China and also Tutt Bryant giving some market updates for 3Q 2010, saying that conditions remain “subdued” and revenues were not as high as expected (though expenses were also lower than expected). This would imply Tat Hong would NOT have a very good 3Q 2010, contrary to Mr. Roland Ng’s assessment that conditions will begin to improve from 2H FY 2010 onwards.

5) MTQ Corporation Limited – There was no news from MTQ for the month of January 2009.

6) GRP Limited There was (predictably) no news from GRP during January 2010.

7) Kingsmen Creative Holdings Limited – There was no news from the Company in January 2010. Full-year 2009 results are expected to be released in late February 2010, and the Company will also give guidance on its order book as well as the performance of its various business divisions (the major ones of which are “Museums and Exhibitions”, and “Interiors”).

Portfolio Review – January 2010

Considering the new turbulence in stock markets this past month, the portfolio managed to stay relatively stable and recorded a gain of 6% over my new cost of S$150,800. Realized gains had increased to S$52.6K due to the divestment of China Fishery, and as mentioned some of the proceeds from that divestment had been reinvested into Kingsmen Creative. The STI saw a drop of 5.3% this month on concerns about US banks (Obama’s speech) and also China’s policies on reining in overheating and rampant lending. It is expected that pessimism may continue for some time to come.

In the meantime, I will continue to seek out good investment opportunities; or I may also average down on existing positions if the valuations are favourable. February 2010 will be an interesting month as full-year results will be released for most companies, and I also look forward to quarterly reports from GRP, Boustead, Tat Hong and Kingsmen Creative.

My next portfolio review will be on February 28, 2010 (Sunday).

Tuesday, January 26, 2010

Divestment of China Fishery – Reasons and Rationale

I guess there’s a time for everything, and the time had finally come for me to close the curtain on my investment in China Fishery. On the morning of January 21, 2010, I decided to divest my entire stake in China Fishery at a price of about S$1.92, netting a gain of about 87% on my initial investment (excluding dividends). This decision did not come lightly, and follows on the heels of a somewhat love-hate relationship I have with this company, and also the turmoil and conflicts within my brain which came along in the process of owning it. Taking into account my total holding period of about 2 years 2 months, the annual return is approximately 40% (non-compounded).

On the morning of January 21, 2010, China Fishery (“CFG”) announced their intention to dual-list (secondary offering of shares) on the Stock Exchange of Oslo Bors, located in Norway. The aim of the dual listing was to increase recognition of China Fishery as many fishing and fish processing companies were listed on Oslo Bors (there are currently three – Aker Seafoods, Leroy Seafood Group and Austevoll Seafood). The listing would also raise the profile of CFG in Norway and Europe, where many of CFG’s customers and business partners were located. A third reason was also provided of attracting institutional investors in Europe who would be able to trade CFG’s shares in two different time zones, thus improving the trading liquidity of the counter. Apparently, Management believed that going the dual-listing way would improve valuations and allow the counter to trade at a significantly higher valuation (and hence market price).

The arguments and rationale provided above is indeed compelling, but then again once you scratch under the surface and reveal the underside of things, it started to get questionable. I will present the facts and logic of my reason for divestment, and though I do not classify this strictly as an investment mistake per se, let’s say that I did learn a lot of lessons from this episode and will, in future, be a lot more cautious and exercise more due diligence and prudence in conducting my investment affairs.

1) Weak Balance Sheet, High Capex

CFG’s Balance Sheet has always carried high debt, and this was a very uncomfortable aspect of the Company which precluded my original rationale for purchasing it (which was high barriers to entry, just to state the fact). In the most recent FY 2009 results (ended September 28, 2009) released by CFG, it stated that net debt to equity had decreased from 92.2% to 84.3%, which was still uncomfortably high. Finance costs for 9M 2009 stood at US$20.7 million alone, and for 12M 2008 interest expenses went to as high as US$31.1 million, which was about 6.7% of revenues. Debt continues to be a prominent feature of CFG as it took on additional bank loans in 2009 to finance its South Pacific expansion, and also previously issued Senior Notes due 2013 to finance its capex for additional reefer vessels/supertrawlers and to acquire fishmeal processing plans. The Group’s plans to expand further will probably result in more re-financing of their loans in future, and more additional debt taken on in addition to the Notes issued and existing banking lines. All these activities make this Company a high risk investment, as its gearing is a little too high for comfort.

2) Frequent Fund-Raising and presence of Scrip Dividend

It should become immediately apparent to the casual observer (and actually, to the astute investor, of which I am not), that the whole Pacific Andes Group has undergone frequent fund-raising. Pacific Andes Resources Development (PARD, formerly known as Pacific Andes Holdings Limited or PAH) recently concluded a 1-for-1 rights issue (announced May 22, 2009) of about 1.5 billion shares at S$0.15 per share, as well as 305 million detachable warrants at an exercise price of S$0.23 per share to raise a total of about S$300 million for working capital purposes. Previously, PARD had also issued 4% Convertible Bonds due 2012. Both CFG and PARD also have scrip dividend policies in place for FY 2009 dividend, in order to conserve cash; and it is estimated that the majority shareholders will choose scrip instead of cash, thereby diluting existing retail shareholders even further (for those who choose cash over scrip). Even in the previous year (i.e. FY 2008), CFG had a 1-for-10 bonus issue instead of a cash dividend, all in the name of further conserving cash. Thus, though the Cash Flow Statement of CFG shows an operating cash inflow of US$80 million for FY 2009, capex was US$119 million and new bank loans made up another US$178 million. This shows that the Group had consistently negative FREE CASH FLOWS, even though operating cash flows were mostly positive over the years.

3) Complex Group Structure

I’ve always wondered about this point, and it was one of the points brought up by concerned investors as well as readers of my blog. The relationship between PAIH (listed in Hong Kong), PARD and CFG is very complex, and involves a lot of cross-holdings using companies such as Golden Target for example. The Complex Group structure makes it hard to really compute the valuation and profits to be accrued from CFG to parent PARD, for instance, and also complicates matters when it comes to understanding the impact of Group decisions made and also how policies made at the parent level will cascade down to the subsidiaries. In short, complexity is NOT good for the investor as it makes matters more opaque and offers less clarity into the affairs of a Company. This inherently increases risk as well, as one’s understanding is compromised.

4) Not fully in tune with the Group’s business

I’ve realized over time that CFG’s business was not as simple to understand as I had previously thought. In the first place, there are the (Vessel Operating Agreements) VOA signed which are carried in the books as deferred expenses and deferred charter hire, and even the structure of the 4th VOA is not easily explained. Considering I am accounting trained and I don’t really understand the accounting treatment for these items says volumes about how ordinary retail investors must be able to understand these issues! There are also aspects such as pledging of inventory for loans, tracking of fishmeal prices, El Nino effects on the availability of fish and other aspects which are pretty hard to track and follow unless you have a good grasp of the industry and intimate knowledge of the operational aspects of the Group. Suffice to say I probably did not have the appropriate level of interest or inclination to dig out the facts to track the Company, and did not do enough detailed reading on the species of fish they caught (CJM and Peruvian Anchovy). Thus, I felt that this lack of understanding compromised my investment position and I was better off divesting my position since I did not truly understand the forces which affected the business.

5) Potential Dilution from Secondary Listing

In case most investors out there have not realized, the proposed secondary listing for CFG actually involves the issuance of NEW shares to institutions and retail investors in Norway; and will cause dilution equivalent to a private placement of shares (assuming it had been done in Singapore). As at the time of the announcement, it was still not known of the issue size and pricing for the secondary listing, or whether or not Oslo Bors would approve the listing (there is a high chance they will, though). But what is immediately apparent is that CFG has to raise funds once again, and they are doing it through equity issuance this time instead of turning to debt (e.g. loans and senior notes). The FC of Pacific Andes Group acknowledged that this move would “dilute earnings” but will ultimately benefit the Company because of the working capital raised. This does imply that the Group has insufficient recurring cash to work on and always needs to turn to capital markets to raise funds. This share issuance will dilute not just earnings, but also future dividends as well as there will be an enlarged share capital base!

6) Peer Valuations on Oslo Bors

According to a Lim and Tan Daily Review report, the other 3 seafood and fishing companies on Oslo Bors trade at around 8x-10x FY 2010 PER, and have a P/B of about 1.3x on average. CFG, on the other hand, is priced expensively at about 16x FY 2009 PER and 12x FY 2010 PER, and has a P/B of 3.4x. This seems to suggest that CFG is trading at elevated prices with respect to the other listed fishing companies in Norway, so I am not sure what kind of “improved valuations” the CEO was talking about. In fact, the P/B alone would probably signal that CFG may be trading at a premium price currently, with a lot of positives already factored in. For me, that’s my feel of the situation – a lot of the positives have been included in the share price, such as expansion into South Pacific, completion of their new mega-vessel The Lafayette, as well as implementation of the ITQ system.

7) Environmental Issues and Concerns about Over-fishing

This was kindly highlighted to me by a fellow blogger called Donmihaihai, who also pointed out certain aspects of Ezra to me in his blog; and he has been a very astute and helpful investor who deeply analyzes the numbers and facts. He did mention on the sustainability of fishing resources, and highlighted the fact that such supertrawlers actually destroy many natural habitats and are not environmentally friendly. The environmentalists are fervently lobbying against stricter regulations against over-fishing, but the vessel Lafayette would probably put a spanner in their works as it is able to fish all year round, without having to re-fuel. Separately, I myself also had personal misgivings about being vested in a Company which “rapes” the oceans; even though of course the Directors proclaim that they are adhering to international standards on over-fishing; but one has to take note that the South Pacific is a relatively new fishing ground and there are still inadequate legal controls over the fishing environment there. Therefore, one can argue that CFG would be left alone to do what it has to in order to “maximize shareholder value”. This was a nagging thought which stayed with me for quite some time, and I was unable to shake it off; and was a minor contributing factor to my decision to divest.

The case of CFG may be classified as an investment thesis which was partially flawed, since I first purchased my shares in late 2007 when I had just switched to the value investing methodology. During that time, I did not do much in-depth research into my purchases as I do now, and it was also a bit of luck that I averaged down on my purchase subsequently during the 2008-2009 bear market; and the Company had managed to stay afloat during this trying period. I recall being very nervous and being unable to sleep well because of the high debt which the Group was holding; and also seeing many companies like Ferrochina, Celestial and Fibrechem encountering problems and being suspended from trading. I had told myself, after learning the harsh lessons of the previous bear market, that I would never again over-expose myself in this way through the ownership of a Company with such high gearing.

Fortunately for me, the dual listing news came at an opportune time, as it raised a minor euphoria as had been expected from the recent announcements of dual listings from companies such as Z-Obee, Oceanus, Epure and Novo Group. I made use of the heightened expectations to sell and even though in the interim, the share price may scale new heights, there are no regrets as I had to move on to companies with better structures and with a less risky value proposition. Suffice to say that I now have the unenviable task of deciding how to allocate the monies freed up from this divestment; and I shall have to actively seek out investment opportunities in a climate of rising valuations.

Overall, this has been a positive learning experience, and the profits and resulting cash inflow will bolster my cash reserves and allow me to scout around for more investment opportunities. The realized profits from the divestment of CFG will be reflected in my January 2010 portfolio review. The total dividends I had received from CFG over my entire holding period amounted to S$220, so the bulk of the gains came from capital gains. Moving forward, I hope to achieve a more balanced mix of dividends and capital gains from future investments. More time and effort will be spent researching such opportunities to avoid the mistakes made for CFG.

Thursday, January 21, 2010

Investment Sins Part 7 - Gluttony

With the dawn of the new decade, I felt it was an opportune time to continue this Investment Sins series. I last left off with Anger/Wrath and now the next in line is “Gluttony”. Gluttony is defined as greed personified, and is basically an extreme case of wanting to eat more and more, even when one ceases to be hungry. A glutton will also eat for the sake of eating, which brings me to the description of this investment sin. Note: All these investment sins are described from the book “The 7 Deadly Sins of Investing” by Maury Fertig, which can be found in all good bookstores.

Signs of an Investor Afflicted by Gluttony

The book illustrates four examples of investors who are afflicted by gluttony. Are you afflicted as well? The four signs are described below:-

1) Buying in the worst possible markets

Normally, the correct mindset for an investor to adopt is to buy in plunging markets and sell in markets which are soaring on hope and optimism. Investing gluttons, however, buy indiscriminately and without doing proper due diligence or research. So it’s akin to throwing darts on a dartboard to try to pick those few winners. These people also like to take a small piece of positive information to justify a BUY, even though it may just appear to glitter like gold on the surface and have no substance within.

2) Viewing their investing with false optimism

Gluttons are great deceivers, of themselves! They tend to perceive everything positively, and remember their winners best while conveniently forgetting their losers. These are the guys who tend to claim they make money whenever they are at a cocktail party; of course this is simply the result of selective amnesia.

3) Becoming a 24/7 investor

The gluttons become so obsessed with investing that it dominates all aspects of their lives, including their personal lives and private time. As a result, they often neglect their jobs, loved ones and get into trouble at work because they are overly focused with investments. There is no proper balance in their lives and this mental state is unhealthy in the medium-term.

4) Investing heavily in small caps and options

The author mentions here the glutton usually gravitates towards small caps because they are cheap in absolute terms and also because of their volatility and potential for profits. The problem is that most small caps are not able to generate consistent gains for their shareholders in terms of earnings growth, and most fall by the wayside and fizzle out. The glutton neglects his research and will choose to punt recklessly in the hopes of quick profits; and he does this to his detriment.

So the above are the four classic tell-tale signs of investing gluttony. The book goes on to mention why gluttons almost invariably lose money. Four factors are stated but only three are applicable in Singapore’s context as one of them mentions about capital gains taxes on short-term trading gains, versus taxes on long-term capital gains. These are stated below:-

a) Commissions

This is the classic sandpapering of your gains when you trade frequently, and magnification of your losses – all the hallmark of the fervent glutton who trades frenetically as if there were no tomorrow. Even if commissions were much lower through the use of online brokers, gluttons tend to trade so frequently that the costs eventually add up and erode their gains. Commissions are one of the most insidious aspects of high-frequency trading, and gluttons often fall prey to this without realizing it.

b) Bid-Ask Differential

This represents the difference between what a buyer is willing to buy a stock for, and what a seller is willing to sell for. For liquid stocks, the differential may not be very significant, but for other less liquid stocks there could be a significant bid-ask differential of a few bids. This also adds up to additional trading costs if one decides to enter and exit in a hurry.

c) Over-Reaction Bias

This is the effect of over-reacting to positive or negative news and jumping in and out of the market, thus unknowingly exacerbating the reaction bias associated with this behavioural finance trait. Gluttons usually believe they can get in early when they first hear about the news, and get out quickly before the bad news hits the fan. While it is true that some money can be made this way, it is hardly consistent as the market does not always react as anticipated to news, as some of it may already be reflected in the share price. Also, once the news is out, most of the movement may already be reflected in the opening price for the day, thus obliterating any chances of profiting from such news.

So how does one rid themselves of this investing addiction? The key is to go Cold Turkey, but do so gradually. Just like a smoker cannot be expected to quit in just one day, or his nicotine craving would be too great and his withdrawal symptoms would be unbearable; so should the investing glutton slowly wean himself off trading. Some of the suggested methods are:-

i) Reserve 5-10% of your portfolio for “play” or active trading

Well, as the saying goes, if you simply HAVE to get your daily trading fix, make sure you limit the amount of money you risk, and by limiting it to 5-10% of your portfolio you also restrict yourself from losing too much. Of course, mental fortitude is also needed to prevent oneself from raising this limit to say 20% and higher in order to get more funds to “play”.

ii) Refuse to invest in the stocks and funds that everyone is talking about

In other words, steadfastly refuse to follow the herd mentality! It’s easier said than done though, and once again you need to tell yourself to hold your horses and not do the popular thing. Once you start getting used to this, it’s the first step towards curing that gluttony addiction.

iii) Substitute buying “beaten-up” stocks for high performing ones

One should actually do some real research for once and purchase quality, and not quantity. In this case, “beaten-up” may be beaten up for a good reason, as fundamentals may deteriorate or the Company may be managed poorly. Cut the losers out and focus instead on companies with good management, clear earnings growth visibility, good cash flow generation and are selling at cheap valuations.

iv) Increase Benchmarking

It’s a good idea to benchmark against an index to see how you are doing objectively in terms of performance, so this is an effective way to stop deluding yourself that you are better than everyone else!

v) Reduce the number of trades gradually

As mentioned before, do the slow cold turkey instead of the instant one. This is because addictions are mental habits which are difficult to break off suddenly. Therefore, slowly reduce trading until it becomes no more than an afterthought, and after that you should do fine.

vi) Use a passive or index strategy when investing in small caps

Since the risk of small caps is much higher than blue chips, it is advisable to use a passive strategy of investing in an index fund of small caps to diversify away the risk of any single company collapsing. In this way, you mitigate the chances of losing a huge chunk of money and also slowly kill that inner demon of a glutton within.

I hope the above is helpful, and the last section of the Investing Sins series will tackle the issue of Sloth, or laziness. Watch out for it soon!

Saturday, January 16, 2010

Tat Hong – 1H FY 2010 Analysis and Review Part 1

I guess this review and analysis is long overdue, since Tat Hong released their 1H FY 2010 results back in November 2009! But then again, since I only do half-yearly reviews and analyses, I figured it’s better late than never. Anyhow, I will NOT be analyzing Tat Hong’s upcoming 3Q 2010 results, so readers should expect that this will be the only analysis on Tat Hong until they release their FY 2010 some time in May 2010. This analysis will take on the usual format of analyzing the Income Statement, Balance Sheet and Cash Flows in Part 1, the Business Unit Breakdown and Inventories in Part 2, and end off with prospects and future plans for Part 3.

Income Statement Review

Do note that 1H 2010 was a very dismal period for the Group as the global financial crisis hit home and caused a sharp drop in revenues as companies held back spending on capital expenditure (i.e. cranes and heavy equipment). This led to a huge drop in equipment sales of 56% in 1H 2010 compared to 1H 2009. Consequently, total revenue fell 35.6% from S$375 million to S$241.6 million. The drop would have been steeper if not for the cushioning impact of Tat Hong’s rental of crawler and tower cranes. These 2 divisions helped to mitigate the impact of the downturn somewhat. Gross margins actually improved from 36.8% to 39.6% as a result of the change in sales mix towards higher margin rental instead of lower margin equipment sales. More on this breakdown in Part 2.

Sadly, net profit actually fell 66.5% from S$51.3 million to S$17.2 million, and this shows poor expense control even as the Group exercised prudent COGS management. A combination of factors including higher expenses compared to drop in revenues, higher financing costs and share of losses of associates contributed to the bad performance; and I am of the opinion that things should get better in 2H 2010, otherwise it would demonstrate that Tat Hong’s fundamentals are deteriorating slowly but surely and this may be the start of it.

To get into more detail, there were lower gains on disposal of PPE, while distribution and administrative expenses both dipped just 18% compared to the 31% drop in gross profit. The worst area was in other operating expenses as they dipped just 10%, which implied that it was made up of a lot of fixed costs which did not decreased proportionally with the decrease in revenues. Finance costs increased 24% to S$7.3 million from S$5.8 million as the Group took on more loans to finance their fixed asset rental fleet build up, and also for their China expansion (JV setup costs). A double blow was when their prior year share of profits from associates of S$6.8 million turned into share of losses instead, of S$371,000 (this is most likely due to Yongmao which did poorly along with the onset of the global financial crisis. Their joint venture also recorded a loss of S$2.45 million, but most of it was from a one-off loss recognized from the sale of mining equipment. Therefore, all the items above added together to depress profit margins to just 7.1%, down sharply from 13.7% a year ago.

Balance Sheet Review

Admittedly, Tat Hong’s Balance Sheet is not exactly in the pink of health, as is evidently shown from the increase in financial liabilities (i.e. bank loans). An increase in fixed assets of about S$84 million was a result of Tat Hong expanding its rental fleet and slowly reducing its inventory levels in response to the muted demand for cranes and heavy equipment amongst the downturn. Glancing over the current assets portion of the Balance Sheet, inventories had indeed decreased by S$37 million or 17.3% to S$180 million over 6 months. Trade Receivables, however, dipped by only S$7 million, while cash and bank balances increased by S$5 million, primarily through financing activities as we shall see later.

Bank loans increased by about S$55 million (adding current and non-current financial liabilities) from S$217.5 million to S$272.5 million, ostensibly to finance Tat Hong’s China expansion and the formation of JV companies. This 25.3% increase in debt was what led to higher interest expenses in the Income Statement, and this is one red flag to watch out for as the Group makes use of leverage in order to grow their Tower Crane share in China. Of course, if plans go well, the Group could enjoy high ROE and good cash flows but if things went awry, the debt will come back to haunt them. Current ratio deteriorated from 1.29 as at March 31, 2009 to 1.19 as at September 30, 2009.

Cash Flow Statement Analysis

Tat Hong’s cash flows for 1H 2010 were also very poor, as a result of the financial crisis. Apparently, from the operating cash flows it can be seen that a lot of cash was used to pay off Trade Payables (S$52.4 million) while collections from Accounts Receivables only amounted to S$11.6 million. About S$8 million was spent purchasing inventories, and the overall effect was a net operating cash outflow of S$2.9 million, a large drop against a positive operating cash inflow of S$43.1 million for 1H FY 2009. Apparently, the crisis had severely affected their business to the extent that they were slower in collecting cash, yet had to settle their liabilities just as promptly – not a good sign in my opinion. Management could have been more efficient in managing their cash especially on the payables side. I will flag this out as a danger signal, to be monitored closely in future quarters.

Cash flow from investing activities was moderated slightly by the absence of acquisition of a subsidiary, which reduced the total cash outlay from S$43.9 million in 1H FY 2009 to S$23.6 million in 1H FY 2010. However, the fact that capex still remained high as a result of Tat Hong expanding their rental fleet meant that cash outflows would still be significant moving forward, and would probably still result in very little FCF, if any.

Most of the financing cash flows came from new bank loans taken up, and also proceeds from finance lease obligations. A lot of money is being generated by loans, and this is likely to be the case as long as the crisis persists and there is no sustained economic recovery, as Tat Hong’s business would be adversely affected. However, with the CEO mentioning that economic conditions had improved for 2H 2010, there is some optimism that Tat Hong’s business can get back on track and that the business can start generating operating cash inflows soon.

The key now is to monitor the Group’s cash flow movements to see if any further red flags are picked up. Currently, they are gearing up for their China expansion as well so the loans are not totally being funneled into capex and inventory. Assuming the China Tower Crane segment bears fruit over the next 2-3 years, it could put Tat Hong in good stead to improve on its earnings and cash flow generation capability.

Part 2 of the analysis shall touch on business unit analysis, including reasons for the apparently dismal performance, and I will also comment on trends for each division moving forward. A breakdown of crane fleet will also be done and commented on.

Monday, January 11, 2010

The Hype over Dual Listings

Fresh into the new year, and after taking a good rest from the festivities, it suddenly struck me that I had some issues to comment on and wax lyrical over. Dual listings is one of them, and I got pretty much incensed over the recent hype over dual listing proposals made by several SGX-Listed companies (incidentally, I can recall about 6 and they all happen to be S-Chips or SGX-Listed China Shares).

The fact that everyone is getting excited over the dual listings had me thinking – was there a material change in the business which should elicit such a response? Or were people merely getting excited over a story (as usual) and following the herd instinct? The first to list on a separate bourse was China XLX, and when the shares started trading on HKSE, the share price over in Singapore jumped nearly 100% to 90+ cents before settling to a more “reasonable” level of about 65 cents, but still higher than the pre-dual listing news of about 40-50 cents. Apparently, the argument presented was that such companies which could list on two bourses should therefore command higher valuations, and so the Singapore share price should re-rate to follow those on HKSE.

The following is a laundry list of the China companies and their dual listing plans and status:-

One can observe that there are 5 companies in the list and they are either planning a listing in Taiwan or Hong Kong. One must then ask the rationale for the proposed listing, and whether it advances the company’s plans for expansion, or merely serves as a platform for its shares to be tradeable on both exchanges? Apparently, the issue of valuations had come up and was discussed in some articles around the time the news was made known of such dual listings. It is widely recognized and known (though never publicly acknowledged) that China companies in Singapore (“S-Shares”) trade at lower valuations than their counterparts in Hong Kong, Taiwan and even China. Arguably, of course, the size and scale of the company’s operations play a part in determining their valuation; but this can be conveniently forgotten as analysts scramble over themselves to compare companies in the same industry which are listed on different bourses.

If the reason was indeed that the company is seeking a dual listing to get “higher valuations”, this would necessarily imply that Management is share-price driven rather than value-driven, as a higher share price serves no practical purpose to the business except to raise its profile and provide more fodder for analysts and brokerages to crow about. Of course, one may provide the argument that a higher share price would mean money can be raised more easily through a secondary offering, with less dilution to existing shareholders. This again begs the question – why does the company need to raise money through a secondary offering? Seeing that the listing on another bourse is certain to raise more funds (except for China XLX where the listing is purely “cosmetic”), one should question why valuations should be higher in the first place and why Management places such importance on this fact. It is a hard question shareholders have to ask – is Management more concerned about building the business or are they being more share-price driven?

Another observation is that punters and traders are jumping up and down in excitement at seeing possible arbitrage opportunities by buying shares on one bourse and almost instantly selling them on another, until this bubble was burst when Hong Kong announced that it needed 15 days to deliver the scrip from Singapore over to Hong Kong, before the shares could be sold from there. That effectively killed off any enthusiasm for this method of money-making. However, it has not stopped die-hard punters from chasing up the prices of such dual-listing companies in the hopes that either a greater fool will buy it from them at a future date (most likely this refers to the actual listing date), as evidenced by the poor fools who bought China XLX at 90.5 cents; or that the prospects of the underlying business have suddenly become much rosier and the company is more investment-worthy than before it had announced the dual listing.

I find the latter reason to be untrue for a few reasons. Assuming the company, in all its good intentions, had decided to dual list to raise more funds, it could save costs and instead do a secondary offering right here in Singapore. The regulatory procedures and lodgement of a separate prospectus on another bourse incurs additional costs which shareholders have to bear. Being dual listed also means more expenses are incurred to maintain the listings, and more work has to be done to report news, press releases and results on two different exchanges. Recall that Creative Technology delisted from NASDAQ for this very reason – high costs of maintaining a listing on two separate bourses. At the same time, I also fail to see how exciting it can be when a company announces a fund raising exercise; and they do this by issuing new shares and diluting existing shareholders. Of course, companies may carefully conceal the true intention of the fund raising or cloak it in another form by releasing a very awe-inspiring press release, with mention of grand plans or new markets being conquered. However, I always like to err on the side of caution and assume that the laws of economics eventually ensure that all companies will revert to the mean in terms of growth potential, which means one need not get too carried away by optimism when the reality can be far more sobering.

To end off this post (which is beginning to sound like a rant – my apologies for that), all I will say is that one should be discerning and inquisitive when a company announces plans for a dual listing. One should scrutinize the announcement and its underlying implications before jumping into the deep end of the pool. Because sometimes, you may find that there are sharks in the water.

*Note: As of this writing, another 2 companies, Epure and Novo Group, have proposed listing on HKSE. It seems like the “fever” is catching.

Wednesday, January 06, 2010

Lessons Learnt from the 2008-2009 Bear Market

I know what some readers may be thinking from the title – that we are still in the midst of a bear market as no pundit or prognosticator has come out boldly to proclaim that the bear market has ended and that we are in a bull market. But obviously, from the way valuations and market prices have risen since May 2009, there is no doubt that the worst has probably passed for the global economy, and I would like to take the opportunity to share some lessons I had learnt through this emotionally and psychologically trying period. Note that this is my first true bear market, and it happens to be one of the worst in the last 70 years. In fact, this period of time would now go down in history as “The Great Recession”, characterized by the collapse of large investment banks such as Bear Stearnes and Lehman Brothers and the near-failure of the global financial system. These events shook the core of the banking system and caused many to re-think their model of capitalism and the so-called “greed” that accumulated over the years, resulting in the last 18 months of riveting terror. Many fortunes were lost and portfolios decimated as the bear market swept across the globe like a financial tsunami. From the ashes of the destruction, I have picked up more valuable nuggets of wisdom than I could possibly salvage from books, and I now pen them down here. They are in no particular order of merit.

1) Valuations can never be too low – When evaluating companies for purchase, one would usually look at valuation metrics as one of the criteria for determining if a stock was considered “cheap” or “expensive”. This is based on historical levels of valuation and one can also benchmark this against the broader index to obtain some level of comparison, albeit a rough one. What the bear market has taught me is that valuations can be pushed down to ridiculously low levels, so much so that it almost becomes ludicrous for companies to trade at such levels. During the Great Depression, Benjamin Graham discovered that many companies were better off dead than alive, for the share price was just a fraction of their cash value (or net asset value), creating a unique situation where there was plenty of margin of safety. Similarly, during the 2008 Bear Market, the manic mood swings of Mr. Market created a whole lot of bargains; but the discerning investor had to separate the wheat from the chaff and find out which companies were cheap for a good reason; and which were cheap by virtue of a wrongful appraisal by Mr. Market. The concept of margin of safety may appear irrelevant in the short-term as prices keep dipping to new lows; but this is a necessary by-product of loss aversion, over-reaction bias and forced selling/margin calls, and may not necessarily reflect the true state of affairs of the company. Though valuations can never be too low, they should be low enough for an investor to take comfort in his choice of selection of security which he feels will be able to generate a decent long-term return for him.

2) Optimism is the enemy of the rational buyer – This phrase, though oft repeated, struck me as particularly true during the bear market. When things were rosy in 2006 and 2007, companies were reporting rising revenues and profits all over the place; as well as fattening their order books and clinching contracts at breakneck speed. Examples are of course companies like Cosco and Swiber, which had full and burgeoning order books which lasted for the next 2-3 years and could seemingly guarantee steady and consistent revenues and profits for the short-term. Similarly, manufacturing companies such as textile companies in China were also reporting bullish sales and increasing production capacity in anticipation of even more orders. But once the sharp recession hit, it brought along a near standstill in global trade and an almost total collapse in freight rates, and many ships are still anchored, idling, off the waters of the East Coast of Singapore. Companies like Cosco faced many order cancellations and delays, while companies like Swiber saw their newbuild vessels being delayed in Chinese yards, resulting in third-party costs building up and leading to overall higher COGS. Textile companies in China faced over-capacity and collapsing demand and could not offload their massive inventories; and many had to make write-offs which hit their bottom line. All these events occurred amidst the backdrop of the sudden and unprecedented economic crisis, and the rational buyer could not have anticipated any of these events (on hindsight, it may have seemed obvious; but I can honestly admit I didn’t think that things would get that bad at the time). Which brings me back to my point – that optimism is very bad for purchasing companies because it implicitly assumes that things will chug along as planned; and positive expectations have already been factored into valuations, making market prices very high. When something unexpected occurs, the investor has scant margin of safety and is forced to acknowledge that all the optimism and hope had been just a pipe dream. The bear market has taught me to be wary of optimism and exuberance and to temper this with realism and caution.

3) The economy lags behind the stock market – Though I had read the theory behind this statement, only now had I personally witnessed it and known how true it can be. This is the reason markets are so difficult to time accurately. Market movements can foresee and predict the state of the economy well in advance, and acts as a leading indicator on the state of the real economy well before it can be detected by any economist. Markets in late 2007 and early 2008 had already began to tumble sharply even before the news of the severe recession had broken out, and in May 2009 the most amazing rebound I had ever witnessed propelled the index to its current levels, and has allowed it to remain there in advance of any news of an economic recovery (i.e. green shoots). This was my single most important lesson from the bear market – that valuations will revert to the mean eventually and one should stay vested. From the week beginning May 4, 2009 till May 13, 2009, in a mere 8 trading days, my portfolio had recovered from a loss of S$40,000 to a mere loss of S$1,000, which showed to me how powerful and unexpected a rebound can be. I still remember the stunned voices of my friends proclaiming that this would be a suckers’ rally and that prices will fall to new lows as in March 2009; but so far it is already late October and they have been forced to admit that they had well and truly “missed the boat”.

4) Avoid companies with high gearing – The bear market had also illustrated to me the dangers of owning companies which were highly leveraged, and I had entered the bear market owning several companies with such characteristics, such as Ezra, Swiber and China Fishery. Suffice to say that in the middle of the bear market, there was a sharp scramble (for myself) to evaluate the underlying business and financial strength for my companies, and I did encounter several sleepless nights wondering if my companies would survive or simply fall flat on their face. Such terrible stress came along because of my disregard for gearing and how it can be a double-edged sword. The sad case of Ferrochina imploding under a mountain of debt clearly illustrates the high risks of investing in highly geared companies when downturns hit. I count myself very fortunate to have escaped relatively unscathed while still holding on to these highly leveraged companies; and this has forced me to re-examine my investment criteria and to choose companies with less-grandiose growth plans and which have a stronger and more stable Balance Sheet. My recent purchase of MTQ has incorporated this lesson as it is a company with decent (not stellar) growth prospects and is in net cash and generates positive operating cash inflows every financial year. Moving forward, my selection criteria will encompass more of such slow growers and I will adopt a less aggressive approach to finding growth companies, and balance this out with stability of dividend yield and a sufficiently strong financial position.

5) Mistakes take time to surface – This is one of the “scary” aspects of investing. When investing during “normal” times, where economic growth is positive and everyone is gainfully employed, one may not realize if one had made a mistake or not due to the fact that valuations are at mid-cycle and everyone is reasonably positive about the macro-environment and about equities in general. Hence, it takes a somewhat long period of time (at least 3 to 5 years) for one to know if one has gone off a tangent and the company one had invested in is a dud. Recently, I found out the hard way about mistakes in investing in Swiber and Ezra as their Balance Sheets were heavily geared. Of course, one aspect of this may also be my inexperience and naivety in believing that the companies will become cash flow positive in time, while ignoring the fact that their business model does not allow them to do so.

6) Believe in yourself – Yes I know this sounds awfully clich├ęd, but had I not stuck to my guns and my beliefs throughout the entire bear market, I may have floundered, panicked and sold my shares at a significant loss. With a rigorous set of investment rules in mind and properly articulated selection criteria for companies, I used this framework for my decision-making as to whether I should hold on, increase my positions or divest. I am thankful that I had added to positions which I felt comfortable with (in Ezra, Boustead and Tat Hong), and not to those which I felt were inherently more risky (e.g. FSL Trust and Pacific Andes). All I can say is that I am glad to have formulated my investment philosophy before the bear market had hit, and also had the fortitude to hold out amid the mental pain of seeing one’s portfolio slide nearly 60% at one point. Note that the process (as I remember) was difficult and mentally draining, but coming out of it relatively unscathed in something I would always remember and rejoice over. I must remember, though, not to get complacent as I still have many years ahead of me in investing and will definitely go through many more bear markets before I retire as a working adult. I resolve to learn, grow and adopt as an investor, in order to survive and generate a decent long-term return for myself above inflation.

I would like to take this opportunity to thank my mentors in regards to value investing. Benjamin Graham for introducing the concept of margin of safety and for defining the difference between investment and speculation, Warren Buffett for his frugality and his strict selection criteria for companies, Charlie Munger for advocation of a multi-disciplinary matrix to analysing companies, and Phillip Fisher for his qualitative aspects involved in appraising suitable companies. Without these guys, I would have been lost and adrift in a sea of uncertainty.