Thursday, March 31, 2011

Monthly Review - March 2011

March was another great month for my investments and positive progress towards my retirement goals.

The standout performance was from my Hong Kong equities which advanced strongly. The ETFs made more modest gains and the Australian equities and commodities increased marginally.

All properties are fully let out and tenants are paying on time. There was only one repair. Cash flow was positive.

FX movements were slightly positive with the AUD and the NZD both rising against the HKD/USD.

Savings were minimal as income as low and expenses were inflated by the cost of our trip to New York. I continued to accrue for long term expenses.

Here are the details:

1. my Hong Kong equity portfolio increased signifcantly and was the biggest contributor to this month's performance. This month I made investments in K Wah (HK:173) and Xtep (HK:1368); ETFs were all up with the sole exception of Vietnam;

3. my commodities rose modestly with silver jumping significantly, the commodity ETF being flat and small declines in the HOGS and NICK ETCs;

4. all of my properties are occupied, the tenants are paying on time and there was only one small repair bill (I will have a larger one at some stage on a property suffering from a persistent leak). I had one lease expire and the tenant has renewed at a higher (but below market rent);

5. currency movements were slightly positive, as both the AUD and NZD appreciated against the HKD/USD. This had the effect of compounding some of the gains;

6. my position in bonds remains small. There were no purchases this month;

7. there were no outstanding derivatives;

8. savings were very poor with low income and high expenses. The former is inherent in the nature of my remuneration package and the latter the result of our trip to New York.

My cash position was reduced due to equity purchases. I am now down to 19 months of expenses in cash or equivalents (compared to 26 months at the end of February). This is more cash than I need and one of my current tasks is to find somewhere to invest at least some of it.

For the month, my net worth increased 2.61%. The year to date increase is 9.48%. My target retirement window remains sometime between early 2012 and early 2013. While the possibility of a one year extension exists, it will take some adverse market conditions or other unexpected event to require that. Every passing month brings me closer to my retirement goal - it's possible that I may be handing in my notice less than a year from today.

Scorecard - reviewing the results for portfolio companies

Quite a few of the Hong Kong companies which are included in the private portfolio have December financial year end dates and have been reporting their results. Needless to say, reading every results announcement and much of the related commentary has occupied quite a bit of my time for the last few weeks. The following is a summary scorecard of my thoughts on the results.

(Companies listed in no particular order)

Hutchison Whampoa* (HK:13): better than expected result as 3G produced positive EBIT. The one off gains were expected. Increased dividend. Stronger balance sheet following the spin off of Hutchison Ports

Yangzhou Coal* (HK:1171): excellent result. Increased dividend. Further growth expected

AUPU (HK:477): disappointing result below both my expectations and the markets. Current dividend is not sustainable absent an improved performance. Continued holding requires a belief that performance will improve. See separate post

Varitronix (HK:710): outstanding result. Increased dividend. Still looks good value inspite of recent share price increase

K Wah*(HK:173): significant fall in profit and cut in dividend was clearly disappointed the market as the share price dropped significantly. Given that revenue recognition is linked to the timing of the sale and completion of property developments, and the company has been very clear in communicating in this regard, the market reaction was surprising. In any event, a much better result can be expected for 2011

Xtep (HK:1368): excellent result. I particularly liked the margin expansion and what appears to be the emergence of brand name recognition for the company's products

Sinopec* (HK:386): I had mixed views on this result. The refining division is clearly facing difficluties created by high input costs (oil prices) and price controls on its output (refined products). The failure to at least replace its reserves is also of concern. That said, these issues are well known and presumably reflected in the share price - which continues to look superficially attractive

CNOOC* (HK:883): an excellent result. I was particularly happy to see the increase in reserves and the increased dividend

China Construction Bank* (HK:939): although the bottom line was slightly below consensus forecasts, it was still an excellent result. The improvement in NIM and growth of fee income were positives for me

China Blue Chemical (HK:3983): a solid result. Given the policy initiatives in the agricultural sector, I have to wonder whether more should be expected from this company. I also have to wonder about the company's ability to extract full market prices for its products going forward should price controls be imposed in an effort to control inflation

Jiangsu Express (HK:177): solid result and a nice dividend yield. The company remains debt free

Shenzhen Express (HK:548): in contrast to Jiangsu Express, this toll road operator has a high level of debt and a lower dividend. That said, the potential for growth is better and, given the nature of the business, I am not overly concerned about the debt levels

CMOC (HK:3993): a good result. I remain puzzled by the decision to declare a dividend which is much higher than the annual profit. The stock looks a little expensive in terms of PE. I need to do more work on this one

CKI (HK:1038): a good result and a good dividend. A clean balance sheet

Vodone (HK:82): a good result, but one that was expected. The growth story appears to remain intact. Given the speed with which internet based businesses are evolving in the PRC, this company that will need to be watched more carefully than most of the others which I hold

Companies which have a "*" next to them are large positions.

All in all it was a good set of results. AUPU was the only meaningful disappointment.

Tuesday, March 29, 2011

AUPU - results review

A number of companies which are included in the private portfolio have reported results for the year ended 31 December 2010. I have (obviously) followed each of the results and will post some thoughts on at least some of them, beginning with AUPU (HK:477). AUPU's results were disappointing, falling well short of my expectations and, judging by the fall in the share price following the release of the company's results, well below the market's expectations as well. The company was one of the 10 largest percentage losers the day after the results were released. The shares currently trade at HK$0.86 compared to HK$1.15 pre announcement, my purchase price HK$0.99 (before allowing for dividends received).

The following are some observations from the results announcement:

Things I did not like

1. Revenue fell 3.2%. On a segmented basis, revenue was down across all geographic segments except for the relatively small Sichuan and export sections. On a product basis, the fall was confined to the dominant "bathroom master" product with the smaller product lines (e.g. bathroom ceilings) showing growth;

2. There was a very large jump in administration expenses (+18.7%);

3. The combined effect of the fall in sales revenue and the increase in administration expenses (other factors were less material) was a fall in NPAT (-13.8%) and a similar fall in EPS;

4. Historical favourable tax treatment came to an end in 2010. At least one group company has been granted high-tech status which gives more favourable tax rates, but I cannot tell to what extent that will off set the general loss of favourable tax treatment. Absent any better information, I have to assume that tax rates are likely to be higher going forward;

5. cash flow contracted dramatically. The company is paying out more in dividends than it is generating in operating cash flow. Add in investments, including associated entities, and the company's healthy cash balance has been materially eroded (-48%);

6. the company has invested a relatively large amount of money in an associated entity (the rational for which is not explained in any detail) and made a further large investment in what appears to be a venture capital fund (I generally prefer companies to focus on their core businesses);

Things I liked

7. the company remains a positive cash flow generator with operating cash flow exceeding investments by a healthy margin (although much less than in 2009). The age of collectibles fell slightly and inventory turnover time also reduced slightly, suggesting good cash flow management;

8. however, the level of inventory rose significantly (+27%). Together with the high dividend payout and the investments made, the increase in the inventory contributed to the reduction in the available cash balance;

9. the company is aware of the issues it is facing and appears to be taking steps to address them by (i) attempting to move up the value chain through innovation and branding (ii) expanding sales channels through a push to retail and engagement of more sales agents and (iii) diversifying its product range;

10. the company remains debt free;

11. management continue to hold meaningful shareholdings;

12. there were no references to connected transactions in the results announcement.


I can no longer regard AUPU as a value based investment. The EPS, cash flow and NAV are all currently too low for that. It will require a meaningful increase in profitability to make the current dividend sustainable - possibly the proposed final dividend is a signal that management expects improvement?

However, I do like the clean balance sheet, the positive cash flow generation and parts of the strategy to grow the business going forward. Given the clean balance sheet I am willing to give management the benefit of doubt with respect to the historic associated company investments and the post balance date venture capital investments. For the time being I will continue to hold.

Qualification, disclaimer and general CYA

Since I am neither a qualified investment analyst nor a professional accountant, I'm sure I have missed things and/or made mistakes and/or drawn erroneous conclusions - hence the "trainee" part of "traineeinvestor". Corrections from people who actually know what they are talking about are welcome.

Wednesday, March 23, 2011

Confused about currencies

There is absolutely no shortage of articles expressing views on whether currencies are over-valued or under-valued. Without being too scientific about it, a random sampling of articles seen on the Internet showed far more articles suggesting that (i) the Yen (ii) the Euro (iii) the USD and (iv) the GBP are all over-valued or at least expected to depreciate than articles which are bullish on any of these currencies. A number of the articles which expressed bullish views, were focused on the short term technical outlook - and were sometimes caveat ed with the view that in the longer term the expectation was the the currency in question would continue to depreciate.

They can't all be right.

Currencies are priced relative to each other. In a two currency world, if one currency goes up, the other must go down. In the real world where there are many currencies, trading is dominated by the USD, the EUR, the JPY and the GBP which, according to Wikipedia collectively account for about 78% of turnover in the international FX markets. (While turnover is not the same as the amount of currency in issue, they were much easier numbers to find and, I guess, are possibly a better indicator of the relative importance of each currency in setting exchange rates.)

The simple reality is that in order for all four of the most traded currencies to depreciate, you need a very unrealistic amount of appreciation in a basket of lesser currencies. While it is reasonable to expect appreciation of some of the other tradeable currencies (the RMB and SGD being widely viewed as under-valued), it should also be remembered that there are plenty of currencies that I wouldn't touch with a very long barge pole.

So, of the four major trading currencies, if they can't all go down, at least one of them has to appreciate relative to the others. I have no idea which - quite frankly, I am concerned about macro issues with respect to all four economic zones.

Given the material impact of currencies on my investment portfolio over the last several years, it would be nice to correctly guess which will be the "winner(s)" (winner(s) in "" because many countries prefer their currency to be weaker compared to their trading partners). In particular the future direction of the USD against the AUD, NZD and RMB will be important to me. Given the absence of a functional crystal ball, my current thinking is to continue my strategy of having most of my investments denominated in the currencies in which I expect to spend money once I retire - HKD, NZD/AUD - and view anything else as a speculative positions which should be kept small. The impact of FX movements on my investments (and spending) is obviously more complex than that, but no better approach to dealing with the FX issue has occurred to me.

Saturday, March 19, 2011

Too many bullish views on Japan?

With investors looking beyond the tragedy of Japan's earthquake, tsunami and nuclear problems, I have been struck by just how many commentators have expressed bullish views on the Japanese stock market. Statistics and data have been quoted ad nauseum to support the view that Japanese equities are cheap: low PE (more so inthe mid and small caps - large caps are not all that cheap), the market selling at or slightly below book value (it may be more accurate to say that it trades close to book value), the limited impact on Japanese industry (possibly excepting tourism and insurance), the willingness of the BOJ to imitate the Fed and print money to support the economy, the renewed determination to weaken the yen etc etc.

While all these factors may be true (although I am not quite convinced) I am not that tempted to take a position and remain wary for a number reasons, not least because of the sheer number of bullish views. I could also add, that I have been listening to bullish views on the Japanese market since at least 2000 and, to date, such views have been mostly wrong. Other factors which give rise to doubts are the demographic handicap, the massive national debt and the reliance on technology based exports. The latter is something I expect to face increasing competition as a number of emerging economies continue to move up the value chain. Also, the impact of a lower yen on an investment in Japan cannot be ignored.

That said, the Nikkei remains about 13% below the level immediately before the tragedy, about half its most recent peak in 2007 and only about 30% above the most recent low in 2009. None of which really tells me a much about where the market will go in the near term future, and I remain cautious - I tend to agree with those who say that the market looks cheap but remain concerned about the macro headwinds. If I take a position it is likely to be a small one - my conviction is not high enough for more.

Friday, March 18, 2011

K Wah purchased (2)

This morning I doubled my investment in K Wah (HK:173) paying HK$3.19 for this purchase. This compares to HK$3.25 paid for the first purchase on Wednesday. My average purchase price is HK$3.22.

As an aside, an limit order to purchase more shares in Xtep (HK:1368) at yesterday's close of HK$4.93 failed.

Thursday, March 17, 2011

Fidelity survey on millionaires

Fidelity released its fourth annual survey on millionaires Fidelity Millionaire Outlook. The results made for interesting if unsurprising reading. Some key findings:

1. the outlook of millionaire households is the most optimistic since 2006. Given the intervening economic events it would be very surprising if the survey had produced any other result;

2. four out of ten millionaires do not feel wealthy. Again, this should not surprise anyone. In most developed economies, being a marginal millionaire does not make you wealthy enough that your standard of living cannot be adversely affected by rising taxation on incomes, rising property taxes, rising inflation and the potential for economic adversity to impact your business, your job and your investments. Add in the common perception that wealth is relative (usually to others) and the very substantial incremental costs of expanding living costs if you want to move "up market", and it is easy to understand why having USD1-2 million does not make you feel wealthy;

3. four out of ten millionaires are concerned about maintaining their lifestyle in retirement. Given the comments made in #2 above, this is understandable;

4. the average age of the millionaires surveyed was 56. For most of us, it takes time to accumulate wealth.

Fidelity's survey reinforces some of my long held beliefs:

A. preventing lifestyle expansion is essential. If you want to (i) retire early and (ii) feel comfortably off, living well below your means is critical - relying on rising income and/or investments to get you there will not work as often as people would like to believe. The more you spend the more you need and the greater the risk of being trapped into working for ever;

B. comparatives matter. If you want to feel wealthier, learn to enjoy a less expensive lifestyle. Move to a less affluent neighbourhood, hang out with less affluent people and keep reminding yourself that 99% of the world's population gets by with a lot less.

Wednesday, March 16, 2011

K Wah purchased

This morning I added property developer and investor K Wah (HK:173) to the private portfolio. My average purchase price was HK$3.25 per share.

K Wah is essentially an asset play, selling at a very deep discount to its NAV while, at the same time, offering a reasonable 3.4% trailing dividend yield. The balance sheet is acceptable, with about 34% gearing as at the most recent interim balance date. My expectation is that monetisation of some of the company's assets through the sale of completed developments will translate into a reduced discount to NAV.

Monday, March 14, 2011

Xtep purchased

This afternoon I added mid-cap sports wear retailer Xtep (HK:1368) to the private portfolio, paying an average of HK$4.94 per share (including transaction costs).

Xtep's share price had fallen along with the market generally and in reaction to issues at other participants in the sector to the point where the stock represents (IMHO) good value even if the company does not fully meet growth expectations and excellent value if it does. Specifically, the company offers a trailing dividend yield of 4.4% and PE of 14. Operating cash flow is strong by most measures and, crucially, significantly higher than expansion related capex. Earnings and dividends are expected to improve in the current and next financial years as the company expands its network of outlets and as overhead expenses shrink as a percentage of total expenses. Concerns over rising labour costs are (again, IMHO) likely to be more than offset by workers' increased income resulting in increased consumer spending.

The balance sheet is also solid with no debt and RMB2.4 billion in cash and equivalents as at the most recent interim balance date (30 June, 2010).

As an aside, once I got past the large number of gloss pictures, the annual and interim reports were very well written - giving a clear picture of the company's position and strategy with a nearly complete absence of the vague and unspecific or irrelevant statements that clutter so many corporate reports.

Saturday, March 12, 2011

Hong Kong property prices at all time high

Prices of residential property on Hong Kong Island have passed their previous peak set in 1997 according to an index compiled by Centaline (of Hong Kong's leading real estate agents).

Fourteen years is a long time to wait to recover to previous highs. A very long time. Of course, a person who had purchased at the time of the 1997 peak and held would have also received rental yield (or imputed yield in the case of an owner occupied home). Assuming a net yield of 4% during that time, the break even point for an ungeared buyer would probably have been reached some time in late 2006 (depending on how you do the numbers). Even so, that is still a long time to wait to "get your money back".

A couple of observations.

The first is that a property in 2011 is not the same property it was in 1997. Even if there have been no changes in its surroundings, at the very least it will have aged by 14 years - while it is very difficult to assess, depreciation is very real. That said, it also has to be asked whether the HKD is worth as much today as it was in 1997. The answer appears to be "not much different". The composite CPI stood at 113.0 at the end of 1997 and at 115.1 at the end of January 2011. This is not quite an apples-to-apples comparison (the peak of the property index was a few months before the end of 1997 CPI number and the January 2011 CPI number is a month behind the property market peak reached this month. None the less, there has clearly been at least some decline in the real value of the HKD during this time to partially offset the depreciation effect of time on the properties themselves.

The second issue is that property is not homogeneous. The number cited is an index for Hong Kong Island. Luxury properties have long since surpassed previous highs, indicating that at the other end of the market, there is still some catching up to do. Also, other parts of Hong Kong (most noticeably, the north west part of the New Territories) are still lower than in 1997 . This can crudely be attributed to supply (more new units being built off Hong Kong Island) and demand (more demand in the luxury and upper middle class segments of the market). The latter is also at least a partial reflection of the uneven distribution of the benefits of the economic recovery (boom!) subsequent to the Asian crisis and SARS in both Hong Kong and the rest of the PRC.

What does this tell us about future Hong Kong property prices? Not much. Properties may be expensive in absolute terms, but still remain affordable in relative terms if (and it is a big if) you have a deposit. However the relative affordability is largely due to the low interest rates applicable to mortgage finance.

While predicting the future direction of Hong Kong property prices is, at best, an exercise in uncertainty, given where prices have got to, the positive circumstances which have driven the increase in values since 2003 and the policy stance of the Hong Kong government, it would require a considerable degree of optimism to believe that prices will continue rising at the same pace. In contrast, it is much easier to envisage either stagnating or falling prices in the short to medium term future - rising interest rates, termination of US quantitative easing, increased supply and other factors all have the ability to adversely affect the market. The greater uncertainties are the issues of when it will happen and how substantial the decline will be. I have no views on either issue. However, the longer we continue to experience negative real interest rates and more than nominal inflation the better from my perspective.

Keeping the mortgages

Several banks have started talking up the rates they are offering on mortgages. The latest being Bank of China (Hong Kong) Limited which has raised the spread on its HIBOR linked mortgage product to HIBOR + 0.9 - 1.2%. At current interest rates that works out at 1.1- 1.4% pa and compares with the old rates of HIBOR + 0.8% (1.0% pa). While still extremely cheap, its another sign that the banks are trying to exert some upward pressure on rates and expand their NIM (net interest margin). The new rates apply to new mortgages and do not affect existing mortgages.

While I can understand the banks' motivation, given that the demand for mortgage loans has fallen due to higher deposit requirements and a fall in transaction volumes (courtesy of the HK government's punitive stamp duty on short term resales), it seems unrealistic for a supplier of a good (mortgage loans) to increase price (interest rates) while experiencing falling demand (less money being borrowed). As far as I am aware the supply of money (deposits) has not dried up and Hong Kong banks still have very healthy loan to deposit ratios. Also, there has been no noticeable increase in either deposit rates or bond yields. I have to wonder what I am missing here?

As far as my own position is concerned, the case for not making early repayments has got even stronger in recent months:

1. all my mortgages currently cost less than 1% pa;

2. CPI measured inflation is currently running at 3.6% pa (for the year to January 2011);

3. yields on equities and real estate are well above the cost of funds;

4. there is no risk of being called (absent default);

5. based on current bank valuations, my weighted average gearing on the Hong Kong properties is less than 31% (range 7-45%);

6. historically, banks have not called mortgages unless there is an actual failure to make payments due;

7. I will make either a full or a partial repayment of the mortgage on our home when I retire and get back my capital contribution (and, yes, I feel like a complete wimp for doing this).

In effect, my position is that negative real interest rates and low nominal rates mean that keeping the mortgages for as long as possible is a meaningful way of adding value to the portfolio through generation of positive carry (yield differential) and inflationary erosion of principal.

The major risk is that the floating interest rates (HIBOR) move above the yields on investments and/or that we revert to an deflationary environment. While I do expect interest rates to move up at some stage (but can only guess and when this will happen and by how much), I consider the downside to be limited (especially compared to the risk of holding volatile assets like equities and real estate). Given that I will cease working in the near future, this is an important point because I will have to service the loans from rental income without the security blanket of job related income.

I also have to accept that rising interest rates have the potential to cause property prices to fall. This is a very real and not immaterial risk to my portfolio. Given my gearing and cash flow position I have a high degree of confidence that I can ride out any downturn. Hopefully this will not turn out to be a case of famous last words.

Wednesday, March 09, 2011

HK Budget revisited

Prior to heading off to New York last week, I (along with a lot of other people) expressed my disappointment with the tepid and ill-directed budget. One of my specific gripes was the daft proposal to benefit the fund management industry by paying $6,000 per eligible recipient into MPF plans. The Financial Secretary subsequently caved into pressure, cancelling the gift to the fund management industry and substituting a cash payment to every Hong Kong permanent resident.

While it would have been more equitable and "fairer" for the excess taxation to be returned to the people who gave the money to the government in the first place (i.e. the taxpayers), in many respects I don't mind a near-universal cash distribution. It's a definite improvement over the previous MPF related proposal and reduces the excessive build of "reserves" held by the government (HK$1.3 trillion + at the last count). Also, given the rise of inflation some of the lower income groups could use some financial assistance.

Hutchison Ports entitlement

As a shareholder in Hutchison Whampoa (HK:13), I received a small allocation of units in Hutchison Ports which will be listed in Singapore later this month. The cut off for applications was today (so it was a good thing that my flight back from New York was not further delayed).

Although it required a physical visit to the nearest BOCHK office to fill in some paperwork and the amount of money involved was much less than my usual minimum investment, my view was that the investment was attractive and, trivial as it was, was worth doing. Since the issue was non-renouncable, I didn't have the option of selling my entitlement. My choice was to either let the entitlement lapse or take it up.

I will see where the price settles after listing but in the interests of avoiding investments which are too small to be meaningful, will either buy more or sell in the short term.

Rent review completed

One of my leases expires next week. I have negotiated a 16% increase in rent for a fixed two year term (no break clause). I have also agreed to leave the two months bond at the same amount as the previous lease.

The increase is less than the current market rent (which would suggest a 25% or greater increase), but I have accepted a smaller increase because:

1. the tenant managed to convince me that he would leave (and downsize) if I insisted on anything higher. Even a one month vacancy would be enough to negate the gain of getting to market rates if the agent's commission was taken into account;

2. the absence of a break clause is of value as it defers the risk of a future vacancy by 11 months. The only thing more important than cash flow is a predictable and reliable cash flow;

3. the tenant has been a prompt payer of rent who does not impose on my time. I like tenants like this.

Visiting New York

I have just returned from my third visit to New York. I really really like that city. Of course, as a short term visitor staying in the better areas, it's easy to find experiences to enjoy.

In between work related commitments, we took in three shows on Broadway, spent some time in the Metropolitan Museum of Art (nowhere close to being sufficient), visited the Guggenheim, took in a slow walk through Central Park and ate too much.

A few observations:
  • Shoes made in China are cheaper in New York (even with the NY sales tax) than in Hong Kong.
  • The city did not feel busy. Maybe my comparisons are off, but for the most part it does not feel as busy as Hong Kong.
  • Food portions in restaurants are huge.
  • Service standards are better than Europe (an admittedly low threshold) but not as good as most places in Asia.
  • We noticed that some places added 15% to the bill as a mandatory tip while other left it to our discretion (with 15% or more being expected). The former nearly caught us out the first time - we came close to double tipping.

The only negative was the 19 hour delay on the return flight with Cathay. These things happen but turn a long tiring journey into a really exhausting experience. That said, the cabin crew really did everything that could be expected on the service front.

Hopefully we will go again next year.