The Humble Cassava And A Very Fishy Deal

The humble cassava or tapioca as is commonly known in these parts of the world is the third largest source of food carbohydrates in the tropics after rice and maize.  It is a highly productive crop in terms of food calories produced per unit land area per unit of time, significantly higher than other staple crops.  Cassava can produce food calories at rates exceeding 250,000 cal/hectare/day compared with 176,000 for rice, 110,000 for wheat and 200,000 for maize.

For the poor masses, cassava is a rich source of carbohydrates but a poor source of protein, surviving on a diet of predominantly cassava can cause protein-energy malnutrition deficiency.  Apart from keeping the poor perpetually malnourished, cassava has other uses as well, namely as an ethanol biofuel feedstock (mainly in China), animal feed, laundry starch and some say, a treatment for bladder and prostrate cancer.  But there is no convincing scientific evidence that it is effective in preventing or treating cancer.

Care has to be followed processing cassava as they contain cyanide and eating unprocessed or poorly processed cassava can cause acute cyanide intoxication.

Cassava is mainly sold in large quantities in dried chips form.

Asia Cassava Resources

While the dangers and impact on human health from eating cassava is well documented, investing in Asia's largest cassava trading firm on investors' pockets is poorly understood. 

Asia Cassava Resources Holdings Ltd (ACR), a Chinese company listed on the HKEX in March 2009 is the largest importer of dried cassava chips into China.  It sources its supplies mainly from Thailand which is the largest exporter of dried cassava chips.

ACR is majority owned (50.15%) by the Chairman Mr Chu Ming Chuan who is a Chinese national.

According to ACR, revenues have increased significantly due to an "agreement" reached with a "third party" to procure dried cassava chips from Thai government warehouses.  There has been no disclosure who this third party is.  And whilst volumes have certainly doubled, bargaining power remains firmly in the hands of the suppliers.

Profitability remains chronic, decreasing substantially in the past two years with the share price similarly falling precipitously.  Whether the recent increase in net income margin for the six months ended 30 September 2013 can be sustained is anybody's guess.

Being Asia's largest trader of dried cassava chips is nothing to brag about.

Cheap stock or a value trap?

Early investors who bought into the story and backed management are still licking their wounds.  A short lived ramp in the stock price from increased revenues at the expense of further erosion in margins have successfully pulled in a bunch of new punters.  Unfortunately these second batch of punters will eventually lose money as well.

On all value metrics, the stock is cheap.  ACR PE is 9x and it is trading at a discount to NAV of nearly HK50cents to the dollar and HK70cents to the dollar on Net-Net basis.  I will not be surprised if it has caught the radar of value investors' screens.

Value investors' ought to be careful with this value trap: ACR is nothing more than a middleman in a very low value and cyclical commoditized business masquerading as good story. 

It also does not bode well that dividends are poor with overall stagnant gross margins and declining net income margins.

Creaming off ACR's cash holdings sold as a Benefit to Minority Shareholders

Understandably, the business operates in harsh environment and minority shareholders have been long suffering but recent action by management will mean shareholders are about to experience an even rougher ride.  You see, ACR Board had just approved the purchase of a hotel in Rizhao, China owned by Mr Chu.

According to management disclosure; extracted verbatim: "The Group has always been in search of appropriate business opportunities to diversify its’ business portfolio and asset base."  Now where have we heard this before?  It's a standard text intended to lure unsuspecting small investors and a whitewash for activities that ultimately decimate shareholder value. 

One of the tenets of good corporate governance is to ensure the efficient and careful use of the company's resources.  And this means that the Board has a fiduciary duty to act in the best interest of its shareholders.

Does this transaction pass the good governance smell test? 

One of the ways to assess whether management is acting in the best interest of shareholders is to check to see if management have considered all options when it comes to using capital.

These options are:

1. Pay down debt
2. Increase dividends
3. Share Buybacks
4. Acquisitions - related or not related to core activity 

Lets look at these options one at a time:

1. As at the latest interim, the company is carrying HK$430m of short term debt mainly denominated in USD which bears effective interest rate of between 1.80% and 2.80%.  Interest rates are considered low for a company of this nature.  Therefore it seems sensible that the debt need not be paid down.
2. The company declared dividends similar to previous year despite overall distributable profits increased 20%.  By right dividends should have trended up, however a massive HK$100m increase in the Prepayment had effectively wiped out cash flows from operating activities.  No explanation given apart from some related party balances amounting to HK$2.5m was explained.  Potential warning sign - say no more.
3. Share buybacks.  The stock as mentioned about is trading at nearly 50% discount to NAV and management should have taken initiated a share buyback program.  But this was not implemented. 

Which leaves option (4).  Buying businesses are risky affairs, usually it is the shareholders that are left holding a grenade.  There is a danger of overpaying and particularly in Asia it is a way for insiders to take minority shareholders to the cleaners.

This one is shaping up to be one of the cleaning variety.

Mr Chu is reportedly to have purchased the hotel for a princely sum of RMB47m (RMB15,400/sqm; RMB3,800/GFA).  He is now exiting at a profit of HK$165m a 180% return on his original investment.  What is such an astute property investor messing around with dried cassava chips you might add?  Good question indeed.  Mr Chu is shaping up to be more than a peddler of cassava, he is shaping up to be a charlatan.

Minority shareholders are now asked to pony up for a hotel more than 12 years old at a shockingly high valuation in a tourist area rather than a commercial hub.  I wonder what sort of valuer they will be using to justify this outrageous valuation.  A valuer that has been paid handsomely to come up with meaningless fudge.


The truth of the matter is, Mr Chu saw it fit to raid almost the entire unpledged cash balance of HK123.4m for himself.  This hotel is worth no more than what Mr Chu originally paid for it, if indeed he did even spent HK$59.2m in the first place.

If Mr Chu was really acting in the interest of shareholders, he would have initiated a share buyback program to buy back cheap stocks instead of pontificating how cheap the hotel is being acquired for - which isn't the case as there are many more listed hotel groups in HK trading at much lower multiples.

The other half of the of the purchase consideration paid in stock is nothing more than a smokescreen in a weak attempt to prove to minority shareholders that he still has a lot of skin in the game.  Mr Chu will cash out completely many times over this hotel deal.  Incidentally this devious transaction will mean Mr Chu now ends up holding 66.66% of ACR up 16.51%.  He can now treat minority shareholders with complete disregard.

Punters looking to profit from this misery should look at buying this stock when it goes down to HK20cents.  Because at that level, Mr Chu your friendly Chairman will have another transaction up his sleaves which will boost share price.

I will not be exchanging my tapioca cake for some ACR shares.

The Perils of Living In Asia

I had planned to write my New Year's message but was posthumously detained by the unceremonious arrival of dengue fever on the 4 January 2014.  Bitten between the 28th and 31st of December 2013, this is the first time I have ever experienced the kiss of an Aedes mosquito.

The raging fever took hold on the night of 3 January 2014 at around 11.30 pm.  By morning I was a complete wreck but I had no idea it was dengue; thinking that it might be influenza or something that I ate the night before that was not agreeable.  Fortunately, my sister called and mentioned the 'D' word and so it was off to the hospital.

Singapore had the highest ever number of dengue cases in 2013 with over 22,000 but only 7 deaths reported.  Malaysia has double the victims but the death rate is more than 10 times.

Problems in Singapore can be blamed on over fogging making the Aedes mosquitos immune to the cocktail of chemicals spewed out by the fogging machines.  In Malaysia, according to my doctor all the hot spots start with an 'S' - Selangor, Seremban, Sabah and Sarawak.  The reason?  Too many construction.  These sites are a magnet for the Aedes to lay their larvae.

Except for the uneasy feeling that one dengue carrying mosquito might be lurking around, there is nothing to fear.  But being knocked out for over a week is no laughing matter. 

Government hospitals are better equipped to deal with this that private hospitals.  I went to Assunta hospital because the government clinic operated from Monday to Friday.  We forgot, the A&E is fully available on weekends. 

The doctors at Assunta worry about platelet counts falling below 100 and will admit you if it does happen.  They seem able to diagnose dengue infection day 1. 

At the University Hospital, the parameters are slightly different - they will not admit you even if the platelet counts falls to zero.  I guess you do not need coagulating agent unless you are so unfortunate as to cut your hand or run over by a passing vehicle.  They worry more about the haematocrit count (the volume % of red blood cells in blood) as the higher the count, the increased danger of dengue shock syndrome. 

Haematocrit count in men is normally 45% and 40% for women.

I am told by UH that identification of dengue serology is only possible a few days into the fever.

The above table tracks the result of my blood test together with the cost.  Assunta, being a private hospital have significantly higher charges.  UH is actually free, as the government credits all money paid.  I claimed back RM$53 yesterday.

I had two pints of hydration on Tuesday as the platelet count was in free fall and the haematocrit count was leaping. 

The haematocrit count continued its ascent post being cleared of fever on Friday.  The critical period is the 24 to 48 hours after the fever has subsided.  The itchiness, caused by the fluid leaking into the capillaries started in earnest on Friday and lasted until Monday.  Luckily, I have been able to recover without developing into full blown hemorrhagic fever or dengue shock. 

It is important to drink at least 3 liters of water/fluids for speedy recovery.  Also watch out for irregular heart beat, forced breathing, vomiting and stomach pains, these are not good signs.  The occasional gum bleed or nose bleed is acceptable.

I would recommend UH over Assunta anytime as the doctors at UH have on balance, much experience in patient care of dengue victims.  I suspect, the sheer number of cases gives them that experience.




20 years ago, dengue was never a problem. 

A Collection of New Year Messages from The Telegraph UK

Ambrose Evans-Pritchard - Great dollar rally of 2014 as Fukuyama's History returns in tooth and claw

Douglas Carswell - The economy is growing. The free market isn't. That's worrying

Andrew Sentence - We (UK) have reached the end of the beginning in the 'new normal' economy

Jeremy Warner - A world economy on the brink of fracture

Gold suffers worst year since 1981

And to prove that I am not just all about money, parents take note here are some of the words that your children use that have entered the Oxford Online English Dictionary, amongst my favorite are:

Derp - Stupid

YOLO - You Only Live Once

Selfie - Self portrait photograph (Word of the year)

LMAO - Laughing My Ass Off

LOL - Laughing Out Loud

Hooveless Cattle, Lame Chickens and Monsanto GM Crops. Hello Hyper inflation 2014!

As 2013 comes to an end, we look back at the past five years since the global financial crisis with an uneasy calmness.  A sense that not everything seems right even though a lot of the economic data points to expansion.  As never before has the world been subjected to this scale of coordinated monetary stimulus to rescue the world from an economic abyss. 

The US Federal Reserve monetizes debt at US$85bn a month ($75bn from January 2014), UK maintain's its asset purchase program at GBP 375bn ($620bn) and Japan buys 7.5 trillion yen ($81bn) a month of its own bonds.  All these unrepressed money manufacturers make the annual production of Joss paper or Hell money (金纸) seem trite.

Ink Costs More Than Blood

Smaug: The Dragon In The Made In China Cage

China's debt problem is like having Smaug the dragon from the Hobbit locked up in a cage made in China. 

HKT's acquisition of CSL is a vote of confidence in Hong Kong's telecoms industry

On Friday (20 Dec, 2013), HKT (6823) a subsidiary of PCCW (8) ultimately owned by the Li family announced the acquisition of CSL New World for US$2.425bn (HK$18.9bn), a unit of Telstra.  This follows hot on the heals from Vodafone's summer sale of Verizon Wireless its US wireless joint venture wireless business to its joint venture partner, Verizon Communications Inc.  

Becareful What You Wish For, Priced Out From Your Own Backyard

Finance media are replete with editorials celebrating China's rise and the pivot of economic hegemony from the West to the East.  The saviour comes in the form of newly minted Asia's consuming class unleashed on the global stage as salvation to the problems of the West - over indebtedness and the lack of economic opportunities. 

Deflation Land: Why I stopped worrying and learned to love the cur...

Deflation Land: Why I stopped worrying and learned to love the cur...: For the past 300 years, the historical pattern has been for the era marked by a century to continue into the following century by fourteen ...

Report Card for the period to 30 September 2013

Freshman in the share market

In 1993 I had a short but bitter fling with the stock market. The tryst ended quickly with the market winning and my pocket lighter. Losses compounded from having one-night-stands with these companies instead of committing to long term relationships. I learnt my first lesson: when you haven’t the faintest idea of what you are doing but do it anyway, it is downright stupid if not reckless.

The Killing of Tony Blair

Bubble what bubble? Australian properties are cheap compared to Shanghai and Beijing

Beijing and Shanghai, the center of political power and commerce gateway respectively holds many attractions for those pursuing political influence and wealth.  But who really wants to live in Beijing, a city that is slowly being encroached by the desert and adjectives such as 'deadly' or 'dangerous' routinely used to describe air quality.  How about overbuilt and congested Shanghai?  Boiling hot and humid in the summer and freezing in the winter?

SmarTone’s party fizzled and moved on

Two weeks ago SmarTone’s share price was trading at $10.64 but the day before results were announced it shot up as high as $12.70 to close at $12.50 for a 17.5% gain. 

The two weeks leading up to SmarTone’s annual results were filled with hope.  The hope fed the frenzy and now there must be some pretty disappointed punters.  So where is the source of that hope?  I can only surmise that it is the combination of the three events below.

Safe Harbours in Stormy Weather

The mere talk of taking the punch bowl away from the financial markets have caused convulsions in emerging markets.  Syria gassing its own people did not help.  The US military industrial complex have mobilized their propaganda machine in response to the apparent "red-line" that was crossed by Assad (no concrete proof he did it - yet).  Does not matter, the Assad regime must go. 

How convenient, the US debt ceiling will be breached in less than two months and this is just the excuse needed to raise the debt ceiling to pay for the missiles manufactured by Raytheon. 

Where US and its western allies go, trouble follows shortly.  Iraq and Libya, both oil rich nations are now laid to waste.  Incidentally Syria also produces oil, not a lot, for those who do not know.  But in this instance it is not about oil in the ground but rather the gas pipelines running from Iran-Iraq-Syria and eventually connecting to Europe.  The Qataris want to do the same but they are not on friendly terms with Syria.

The US has already made up its mind, the back pedaling to congress with behind the scene lobbying will eventually build consensus to give the invasion legitimacy. 

It is not if, but when, US will lay siege to Syria.

I don't slavishly follow markets, but lately thanks to unintended consequences of central banks' meddling when they should not and the threat of another Middle East war, I am thinking better safe than be sorry.

Defensive utility stocks and social considerations

I generally try to avoid water and energy companies, particularly in Asian markets.  The reason has nothing to do with investment merits but rather social.  I believe people should have access to clean water and energy at a reasonable cost, even to the point of it being subsidized.  After all, corporates defile the environment and leave the clean up costs to taxpayers. 

In the UK, since privatization, water and energy bills have risen way faster than inflation.  And this have thrown many people into fuel poverty.  People are making choices between heating the home or feeding the kids.  Older people die from not being able to heat their homes properly in the winter.  Despite this, huge profits are made by utility companies.  Increasing dividends and rising share price have certainly benefitted shareholders and management award themselves even larger bonuses.  I cannot resolve the dichotomy: Bad for the conscience; Good for the wallet.

Water and power generation companies in Asia still require heavy investments to improve water quality and construct more efficient plants.  Unlike in the West, these strategic assets remains majority owned by the government.  This means at any point social agenda can override profit motive.

Telecom operators are different, apart from government gouging operators for spectrum and now the occasional snooping, they largely leave Telcos to the fate of the free markets.  This makes it more palatable for me.

Is there any good value Telcos out there?

I have been playing Hay Day and Clash of Clans since May 2013.  Both games are developed by Supercell, a US based games developer.  It is extremely addictive; when you need to feed your chickens, milk the cows and sell fresh produce or upgrade your defenses or lay siege to your enemies you just have to have your wireless devices with you all the time.

If you are not an insider, gaming companies are impossible to analyze.  Mostly stock prices already trade at sky high multiples when it gets the attention of the general investing public.  Instead of looking for the next big game company my attention turned to the telecom sector.  So for the last two weeks I have been busy trying to get up to speed with the telecommunications industry as my understanding of it dates back to the days of Alexander Graham Bell.

Hong Kong telecoms industry is super competitive

With a population of just under 7.2m and five telecommunications service providers, HK is one of, if not, the most competitive telco market in the world.  Little wonder, fighting over a slice of a small cake have driven service providers to be at their best.  HK currently ranks number one in the world for internet speed.  HK boast super fast internet connection 3 times faster than the global average.  The companies that compete in this space undoubtedly have to have huge financial power to compete in the global internet speed race.  These companies are subsidiaries of HK's largest companies:

• PCCW owned HKT (fixed line and mobile)
• Australian Telstra owned CSL (mobile)
• Hutchison Whampoa owned Hutchison Global (fixed line long distance carrier and mobile) 
• Sun Hung Kai owned SmarTone (mobile)
• China Mobile

Below are some statistics from OFCA, the industry's regulator.

• Mobile data usage 7.6 billion Mbs in 2012, it was 638 million Mbs in 2009 (3 year CAGR 129%)
• Mobile subscriber penetration rate is 231% (one of the highest in the world)
• 2.40m households, customers with home broadband at 2.25m, 94% penetration rate
• 2.5G and 3G/4G mobile subscribers 11m
• Public Wi-Fi access points 19,554

 

HK Telcos all fired up by Vodafone's sale of its Verizon Wireless stake

On Friday, 30 August 2013, Vodafone announced that is was selling its 45% stake in Verizon Wireless to Verizon Communications for $130bn perked up HK Telco's stock prices. 

SmarTone, the smallest of the five, largely tipped as a target jumped 4.66%.  HKT the market leader fell slightly possibly being viewed as the potential acquirer and Hutchison jumped 4.35% because it has to deal with one less competitor.

SmarTone underperformed its peers for the past two years

I have included Singapore's Sing Tel, StarHub and M1 for completeness given the similarities of the two island states.  It is unclear the reason for the underperformance of SmarTone.  It may have something to do with the negative publicity surrounding its parent, Sung Hung Kai and the Kwok brothers implicated in a corruption involving land deals. 

Business models of HK Telcos

PCCW-HKT is the market leader for fixed line/broadband with 63% market share of residential business and 12% of the mobile market.  Its dominance of the local fixed line market have not really been dented over the years.

Hutchison's owns an extensive fibre-optic network in HK and has a portfolio of submarine and terrestrial cable systems linking HK throughout the world.  Half of fixed line business is carrier services.  It has 28% share of the mobile market trading under the brand 3. 

SmarTone is a pure wireless provider.  SmarTone operates at the premium end of the market with 23% of the postpaid market share.  Based on a Credit Suisse report, SmarTone has the best network.

CSL is also a pure play wireless provider.  It reported revenues of HK$8.1bn and EBITDA of HK$2.1bn giving it a market share similar to SmarTone.  CSL's brands are 1010, One2free and New World Mobility.

Despite the intense price competition and huge investment outlays, market shares of each player have remain broadly stable which just goes to show how sticky the customer is once acquired.  Churn rates remains less than 2% overall.  All operators attempt to increase revenue and profit pool through better customer / service segmentation such as tiered plans and handset tie-ins.  All network operators have reported increased ARPU.  I suspect, it is the significant rise in data usage in the last few years rather than any clever marketing programs that have mostly contributed to increased ARPU.

Not an easy business

The huge cash flows operators make have not gone unnoticed by governments throughout the world.  Since the early 2000s when the UK government started the trend of auctioning spectrums, operators now have to pony up just to ensure they can stay in the game.

The pace of technological change from 2G, 2.5G, 3G and now 4G requires constant investment.  Even when no new technology is introduced, investments in maintaining network infrastructure is not cheap.  For example, over the past ten years, SmarTone spent on average HK$1.1bn or a quarter of revenues on PPE, licence fees and handset subsidies.  HKT and Hutchison spent HK$2.8bn (19% of average five year revenues) and HK$1.5bn (13% of average five year revenues) respectively over the period.

Consumer protection laws have made it easier for customers to change operators and made it easier for new entrants.  Global roaming charges have also fallen.  The constant roll out of new smartphones is both a blessing and a pain.  Subsidizing handsets to acquire new customers can be a drain on cash but conversely customers are tied into longer plans giving stability in revenue streams. 

Financial performance

SmarTone's last financial performance was relatively better than HKT and Hutchison. The 50% increase in revenues is mainly from 100% increase in handset sales and 24% in service revenues.  The combination of higher net margin, asset turnover and leverage results in higher ROE.

All three companies have decent cash flow generating abilities, with operating cash flows well above net income. 

SmarTone debt to EBITDA of 0.5X is the lowest amongst the three operators.  This reflects the recently issued US$200m guaranteed notes.  As the HK$ is tied to the US$, there is no danger of foreign currency risk.  I think it is quite smart of SmarTone to issue debt to lock in on rising interest rates.  The annual charges are well covered by operating cash flows so does not post a risk to the business.  Both HKT and Hutchison carry significantly higher debt loads.

Valuation

HKT trades at a higher multiple reflecting its near monopoly of the residential fixed line business and cash generating ability.  On a PBV basis, HKT is carrying significant amounts of goodwill which is more than the reserves.   

 

SmarTone lower PE I suspect is because its FY2013 revenues are expected to be lower than FY2012.  Its PBV is a bit on the high side but not much more. SmarTone's share price is underpinned by a 100% dividend payout ratio. 

 

From a valuation standpoint, I believe Hutchison offers better value providing a decent dividend yield and a lower PBV (ex goodwill).  Its business is also better diversified compared to SmarTone and its income profile is much more stable overall compared to SmarTone.   

 

 

Slipping on its own sausage skin, Shenguan's disturbing interim report

It has been awhile since my last post as I have been preoccupied by the half year reporting season in Hong Kong.  So far, the half year results have not been too bad.  I do not have hard data but overall, its been pretty bad for the manufacturing and basic materials sectors.  But I would not classify it as a disaster.  Where there have been positive news, it has been tempered with rising costs and slower revenue growth compared to the experience of the last 3 years.  

News on the street that China / Hong Kong markets are cheap, I believe, are wide off the mark.  In fact a lot of the quality names are trading at quite high multiples.  Case in point, SaSa (PE 28), Want Want (PE 31), Tencent (PE 41), AAC Tech (PE 20), Mengniu (PE 36) amongst others.  Hong Kong's cheapness, I believe is due to its large financial and real estate sector.  It is only appropriate that investors demand a margin of safety where there are concerns over asset quality and mounting debts in the system. 

For the careful investor, stock picking not index buying is the rule.  And you should be asking "why I should own this stock" not "why shouldn't I own this stock."  This change of emphasis should help to lessen your chances of making stupid mistakes. 

Shenguan needs to become more transparent 

I reviewed Shenguan Holdings Ltd. (0829.HK) a couple of weeks ago and decided that, despite its seemingly high profit margins and favourable prospects, the careful investor should give it a wide berth.  Shenguan gave a good story at its IPO in Oct 2009.  Now approaching its fourth year as a public company, the cracks have started to appear.  And it is not so much about cracks in industry prospects, which remains intact, but rather cracks in its corporate governance and management's less than frank assessment of the business.

Shenguan's revenues and net income over the period is down 1.3% and 2.6% respectively.  Management blamed the drop in revenues down to customers running down stocks and a preference for shorter wieners (no jokes here).  The greater fall in net income is due to the rise in utility and raw material costs and higher depreciation charges.  Operationally, the business have been impacted by the move to using whole pieces of cattle inner layer skins which have affected efficiency during the transitional period and the installation of new heating technology interrupted production.

Floating pig carcasses down the Huangpu River and bird flu outbreak clearly did not help the situation.

This all seems plausible, and it is a good story for a not so good result.  But without disclosing production data of casings produced and the number of production plants it has installed since it stopped reporting the number half way through 2011 is a red flag for me.  Indeed I have already raised the point about the decreasing level of disclosure in the MD&A section post IPO.  Instead, the "wishy washy" MD&A section, which any person with moderate intelligence can get looking at the numbers, leaves you none the wiser.

Another area of concern I have is the never ending capital expenditure.  Net PPE have been growing faster than revenues in 4 out of 5 years and increased 12% in the first six months.  Perhaps it is justified but without production data, I can only conclude the capex number is highly suspicious.  This suspicion is warranted because the company have made it clear that shareholders come second after the company dished out RMB92m in soft loans to the local government during the last financial year.  One wonders how much of the capex are actually soft loans or money that has just disappeared down the rabbit hole as opposed to enhancing production capability which will benefit the future.

Another area of concern is the huge increase in inventory.  Inventory turnover came in at 2 times compared to 3.4 times in the previous period.  It is carrying 70% (RMB144m) more inventory compared to the previous period.  No explanation have been given for this sharp rise.  Either the company have made a monumental mistake carrying too much inventory or it is simply pushing costs out to later periods or both.

If this be a small company, not Asia's largest sausage casings manufacturer, I'd be inclined to take a leap of faith and overlook some of the poor disclosures.  In this instance I'd rather keep my distance regardless of my previous good experience with UK listed sausage skin manufacturer Devro PLC.

The combination of lower profitability, higher inventory and capital expenditure have pushed the bank balance lower by RMB394m since the start of 2013 to RMB491m.

Clearly I am not the only one who is sceptical of this stock.  The company's stock had dropped over 4% since its interim results.  Even the announcement of a special dividend of HK2.8cents and share buybacks have not been able to stem the slide to HK$3.30. 

Shenguan remains a young public company, and the accounting gimmicks can only fool investors so long.  I think Shenguan will surprise on the downside in its 2013 annual results - there I said it here first!

Hope in China's small manufacturers transitioning from low to high value manufactuing

My very unsophisticated and entirely labourious method of working down the list of Hong Kong Stocks have led me to Sinoref, a small manufacturer of advance steel flow control products.  Its products are critical consumable components in the production of semi-finished slabs and steel billets.  The slabs and billets are rolled in rolling mills into various kinds of steel products. 

It is one of those rare private enterprises that manufactures high-value products that is the domain of foreign companies.  Steel production is highly polluting and the Chinese government have been shutting down inefficient mills forcing the industry to clean up its act.  Sinoref's products, being classified as "high-end" is benefitting from the move to more modern steel production techniques.

It is these small incremental contributions from businesses such as Sinoref that will eventually help shape the upgrading of China's manufacturing industry from low to high value, dirtier to cleaner and inefficient to efficient.

Shenguan Holdings Ltd (0829.HK) that niggling feeling it just does not square off...

Shenguan Holdings Ltd a company based in Guanxi China, is Asia's largest edible collagen sausage casings manufacturer.  Shenguan became a HK public listed company in October 2009 and currently has a market capitalization of just over HK$11bn and net assets of RMB2.3bn.

Although revenue growth has slowed to 10%, its overall financial results for the year ended 31 December 2012 is very good on a number of metrics.  But the share price have been on a downward trend over the past two years and currently trades at 11.8x earnings multiple. 

For value investors looking for lowly rated companies with favorable tail winds and a reasonably priced share, Shenguan seems to fit the description.

Marc Faber's forecasts for the global economy

 

Presentation made in Hedge.Funds World, Dubai July 2012

Tai Ping Carpets, Trophy Assets and A Dose of Reality for Value Investors

Tai Ping Carpets is a distinguished manufacturer of high-end carpets since 1956 and has been publicly traded since 1973.  The carpets grace the rooms of luxury residential homes, high-end commercial properties, air planes and yachts throughout the world. 

I have been following Tai Ping carpets for a number of months.  Having first came across the company in late 2012 when the stock was selling at a range of between HK$1.80-HK$1.90.  Financial results for the year ended 31 December 2012 were not out yet, but what caught my eye was the stock was trading a 60% below book value.  The business had a disastrous 2011 when one of their main factory located in Thailand was flooded in October 2011 resulting in a significant loss of HK$178 million for the financial year ended 31 December 2011.  But the business is resilient and by 2012, the company bounced back to a profit of HK$179 million.  However the PE remained at single digit, 3.2 to be precise.

About a dozen years ago, I had seen similar businesses such as Tai Ping selling excellent craftsmanship but at seemingly low valuations.  Companies such as Aga Rangemaster and Smallbone of Devizes that have showrooms in Bond Street, in Mayfair and Chelsea and Kensington where the well heeled go to kit out their fancy homes. 

These companies were typically small, run by long serving employees who have been promoted through the ranks, tightly held by founding family, highly localized patrons and very old brand names.  They charge ridiculously high prices for their custom made products.  And work therefore tended to be routinely feast and famine.  The result is lumpy and unpredictable financial results.  Something ordinary investors don't like.  The reason for these companies to go public was essentially to create a transparent market price for the passing of shares from one generation to the next or selling down.  So it was not so much to benefit the public but for the founders to cash out and employee participation.  However, it is also a fertile ground for large corporates looking to diversify their revenue streams by capturing the premium end of their markets.  Mondelez International, a food giant, buying artisan chocolatier Green & Blacks for example.

These businesses were essentially survivors as it had the patronage of the rich of one generation to the next.  It will never grow big conversely there will never going to be fireworks. 

However, things changed going into the 21st century, I remember in the early 2000s after the dotcom bust and the start of the housing boom, flushed with cheap funding (thanks to Greenspan) smaller Private Equity firms went out hunting for these businesses.  The strategic rational behind it was simply this: Sleepy brands that needed to be revitalized to expand into fast growing global markets and go mass-affluent. 

Made in Britain was a phrase that invoked strong association with quality, good taste and a distinguished lineage for the nouveau riche.

It was not so much about financial returns but an ego trip in the hunt for trophy assets.  It is similar to hunting lions that serves no purpose other that for the quick adrenaline rush and to pacify the ego. 

It is with this lens that I turn to Tai Ping Carpets.  The issue that keeps gnawing at me is this:  How can a company with a quality product and a rich history be selling at such low a multiple?

Going back from 2012 to 2003, the company made losses in 3 (2004, 2010 and 2011) of those 10 years.  Net margins averaged at around 5.3% and return on equity averaged 6.6%.  No fireworks.  Its book value grew steadily from HK$3.00 to HK$4.40 but throughout the whole decade, it traded at an average 60% discount to book value.   

The share price is a bit more upbeat producing a compound annual rate of return of 6%.  Cumulatively, the company paid out in total HK$61cents in dividends, giving an absolute return of 138%.  This return is considered poor when one considers the costs of living have skyrocketed in the last decade.

Tai Ping Carpets is a trophy asset, its designs often grace magazines such as Elle Décor, Elle Decoration, Maison Francaise but as an investment it, pardon the language, sucks.  Its operational costs are high.  Its showrooms are located in exclusive streets in major cities such as LA, NY, San Francisco, London, Paris, Hamburg, Hong Kong etc. where real estate rents are high.  It has to pony up for increasingly scare and higher material costs.  It employs expensive designers to keep product line exclusive and fresh.  Experienced employees are required to manufacture these carpets and so keeping long term employees on the payroll is not cheap.

Well you might say hang on a minute, what about LVMH? Prada?  Are they not similar to Tai Ping Carpets?  Three differences, firstly these companies no longer manufacture, infact their core competence are brand management.  Secondly, these are 'wearable' consumer brands; a whole industry is set up to encourage purchase by creating 'this season's style'.  Thirdly these brands have been able to transverse into global players, their price has become affordable luxury appealing to the aspirations of the mass affluent. 

There is still not many that can afford a US$1m home that can - just about - fit an Aga Rangemaster, a Smallbone kitchen or a Tai Ping carpet.  The story of Aga, which attempted to mass produce, bears out in its share price, it traded as high as GBP 16, but now trades at less than GBP 1.  Smallbone have gone into administration and is now in the private hands of a very wealthy individual.  It is run more out of a passion to keep the heritage alive than on cold hard investment principles.

And for the average Joe, there are better pursuits than trophy assets.

Niall Ferguson, The Great Degeneration, What We Can Learn - Part 2

Follow this link to Part I

Capitalism

In Part II, we examine the degeneration of the institutions of capitalism, the second key component of our modern day civilization.

Regulation is not to be blamed

Mr. Ferguson argues contrary to Washington's assertion, it is regulation rather than insufficient regulation that caused the financial crisis.  He says on the contrary, the banking industry is the most regulated industry and that post deregulation economic performance was much better compared to the 1970s in US and in Britain.

In his analysis, deregulation is not the main culprit, Mr. Ferguson sites that Bear Stearns and Lehman Brothers were pure investment banks whilst Countrywide, Washington Mutual and Wachovia were commercial lenders. 

It was rather rules outlined by the Basel Committee on Banking Supervision 1998 Accord which allowed banks balance sheets to explode relative to their capital and later modified to allow banks set their own capital requirements on the basis of their own internal risk estimates.   

In government, the Federal Reserve apparent lopsided policy of controlling core inflation failed to capture house price inflation.  And the US Congress was complicit in the blow up by passing legislation designed to increase home ownership amongst the lower-income families. 

The final layer of distortion was blamed on China's export driven policy which kept the value of its currency too low relative to the dollar over an extended period of time.  China was only happy to buy US Treasuries with its huge export surpluses which kept yields low.  Mortgages which were closely linked to Treasury yields helped to further inflate an already bubbling property market.

The only area where the lack of regulation were to blame for the blow-up were the unregulated OTC markets for derivatives such as credit default swaps.  Its economic and social utility are in doubt.