AI #13: The Asia Investor Performance Report

In Asia Investor this week, I'm going to be doing my regular quarterly review. We'll take a look at the performance of the portfolio so far, then I'll update you on developments and my current view for some of the stocks in detail.

In particular, I have the very latest updates from Eredene. The company put out its interims Tuesday morning and I got some further details at an analysts' briefing with the management. There are also few notes from management meetings that I managed to fit in while I was travelling in Asia last month.

Before I begin though, I'd like to ask you for some feedback. Asia Investor has been running for six months now and it would be useful to hear what you like about it and how you think it could be improved.

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So I'll be sending you a short online survey in the next couple of weeks and I'd be very grateful if you could take 15 minutes to complete it. (Of course, you're always welcome to email me on asiainvestor@moneyweek.com with your views but since there are some specific questions I'd like to answer, it would be very helpful if you could complete the survey as well.)

And now, let's let's get stuck in to the review

An average 14% paper gain in six months

The table below shows paper gains on the Asia Investor portfolio so far, based on price changes and dividends paid since each stock was first recommended (all numbers are as at 3rd December 2010).

You'll see that even though I mostly focus on growth stories, I include dividends in the calculations. That's because although they don't add very much to performance in the short term, over a few years the impact of receiving and reinvesting them becomes much more significant. The exact figure varies, but even over five years or so they can easily account for a third to a half of your total return.

So far, I'm fairly happy with the portfolio's performance. The paper profit is around 14% in six months in price terms and a little more when the impact of dividends is included. And we've outperformed the MSCI Asia ex Japan a broad index of the Asian markets - by about three percentage points.

I'm not too concerned about how the portfolio compares with the index in the short run; the market is too unpredictable for anyone to outperform all the time. But obviously, to be worthwhile in the long run, the Asia Investor portfolio must substantially outperform an index that can be easily and cheaply bought with an ETF, so it's only far that I include this.

I'm also pleased with the consistency. We've had just one significant loser so far Eredene Capital and as I'll discuss below, I feel that reflects a lack of steady news rather than anything wrong with the investment. YHI and Breadtalk are recent investments and haven't moved much, so the small loss on them reflects the bid-offer spread.

I will say though that this won't always be the case. We will lose money on some investments. And no matter how careful you are, sooner or later there's always at least one that blows up in a major way and incurs a significant loss. So please ensure that you only hold Asia Investor recommendations as part of a balanced diversified portfolio.

Let's take a closer look at just how the portfolio is balanced right now

How my next recommendations will change Asia Investor

The table below shows the current valuation of each stock in the portfolio, based on last year's numbers, the average of analysts' estimates from Bloomberg and my own estimates.

Overall, I'm happy with the portfolio yield it's good to have our investments producing a steady stream of income for reinvesting. But I'd like to bring the average p/e down a little.

Fortunately, I have a couple of interesting investments that trade on single digit or low double digit valuations that I investigated during my trip: I'm still running over the numbers, but I'm aiming to bring you a recommendation in the next issue.

I'll fly through the next three charts, since they're self-explanatory. The first shows which sectors make up the portfolio. Food and beverage is by far the biggest. That's because I believe that history suggests that this and other branded consumer goods such as household products and personal care are likely to produce some of the best returns in the long run. So I want to weight the portfolio towards them. And I am picking over the balance sheets of a couple of other companies in this sector at the moment.

The chart below shows which markets our stocks are listed in. There's no conscious decision to overweight Singapore or any other market. It's just that Singapore stocks tend to trade at lower valuations than peers in markets like Hong Kong and so on an individual basis they tend to look more attractive to me.

Even though most of our portfolio is listed in Singapore, they are based or do business across the whole of Asia. The chart below shows sales by region for the overall portfolio.

I aim to have roughly equal weights in India, Greater China (which includes Hong Kong and Taiwan) and Southeast Asia. That's to avoid us being too exposed to a single market.

So far, we're doing well on the latter two, but we're a bit underweight on India. That reflects the fact that as foreign retail investors, we can't invest directly in the Indian market. And the number of good quality firms that I'm prepared to invest in that have listings outside India is rather small. I'm still searching for more ideas.

And now, let's take a look at a few of the portfolio stocks. Please bear in mind that this is only a brief update. If you haven't already invested, make sure you read the full initial report for each before deciding to commit your money.

Eredene could be profitable inside a year

Our Indian infrastructure investment Eredene Capital is the worst performer in the portfolio so far, down 8.11% as at 3 rd December. There's no clear reason for this: rather it seems to reflect a lack of news to draw in new investors while the company is still setting up its portfolio.

As mentioned above, Eredene's interim results came out Tuesday morning. The actual results themselves are largely irrelevant, since with most of the projects are still at an early stage, any reported profit just reflect changes in the assessed value of the assets.

What's more important is the progress of the projects as we move towards a point when Eredene becomes profitable and dividend paying which should be the catalyst to get the shares moving. So let me run through the most important developments in its investments.

1) The Sattva Vichoor container freight station (CFS) serving Chennai and Ennore ports is doing very well. It's been operating since 2008 and is profitable and paying dividends to Eredene; in the first half, it posted a 73% year-on-year rise in cargo handled and management say that it's exceeding forecasts. The balance sheet valuation of this asset has been written up by £1.2m since year end and is now valued at five times Eredene's investment. Sattva Conware, the firm's second CFS project in the same area, is under construction and is likely to be generating revenue by the second quarter of next year.

2.) On the other hand, the Pipavav CFS is proving disappointing. Traffic at the Pipavav port is improving after operator Maersk invested heavily in redeveloping it, but growth has been slower than expected. The result is that while Eredene had expected its project to break even next year, that target is unlikely to be achieved. Management has written down the valuation by £0.56m.

3) The Haldia logistics park has been revenue generating from phase I of the development since October, serving the local petrochemicals industry. Phase II of the development next year should be when revenue begins to ramp up. The Kalinganagar logistics park in the same region was intended to be in operation by now, but has been delayed pending the approval of a pollution permit. Management expect it to begin generating revenue in early 2011. The company took a write down of £0.4m to reflect the slower start-up and delayed cashflows.

4) The Matheran low-cost housing project is still being delayed by a court case with a shareholder who gained an injunction prohibiting the project's capital structure from being changed, as I discussed in my last update. This means that Eredene is unable to use debt to finance the construction, slowing things down. Deposits have been taken on 2,850 apartments, the first group is nearly complete and the first buyers should begin to move in in Q2 next year. As previously updated, management intends to sell this project once the legal action is resolved.

5) The investment in Ocean Sparkle, the port services vessel operator, made in May, has paid its first dividend to Eredene. Revenues and profits at the firm were up 20-25% in the last fiscal year. Eredene invested on p/e of 13 and has since written its stake up by £1.33m to reflect higher comparable valuations in the market: when the company lists, management hope to be able to exit at a larger gain.

The rest of the portfolio is largely unchanged from the last time I updated. While there are some disappointments - notably Pipavav - overall Eredene appears to be largely on track, which is no mean feat when it comes to implementing projects like these in India.

There is obviously some operational risk even when the projects are complete, as the disappointing performance of Pipavav shows, but I think the main uncertainty now is the litigation over Matheran. Once this is resolved one way or the other, I think that the outlook should be fairly straightforward.

Overall, five projects are now revenue generating, while three more should follow by the end of this year or just after. I'd expect that the firm should be profitable in 12-18 months, with dividends commencing shortly afterwards. Eredene requires a bit of patience for now, but I believe it should be well worth it.

Maintain BUY up to a limit of 22p.

Hsu Fu Chi could become a dominant player in candy

Hsu Fu Chi, the Chinese candy and cookie maker, has been a top performer, returning a paper gain of 47% so far. No dividends have yet been paid, but a total of RMB75 in special and final dividends will be paid in January, amounting to a further return of 6.3% on our purchase price.

But first quarter results were somewhat disappointing. Revenues posted a healthy looking 29% gain year-on-year. But cost of goods sold was up an even larger 42%, resulting in the gross margin for the quarter dropping by 5.6 percentage points from a year ago. I discussed at the last results the near-term risks of rising raw material and wage costs in China, and that's exactly what's now feeding through.

Earnings still posted an impressive looking 24% year-on-year gain, but most of that was due to grants and incentives from local governments. Excluding this, I estimate that earnings would have been roughly flat.

So I suspect that earnings growth may be relatively weak this year, before these pressures ease next year. My base case estimates are shown in the table below.

On this basis, Hsu Fu Chi currently trades on around 22 times my FY2011 estimate. Dividends are paid once a year, so there's no guidance on that in the latest numbers, but for the last couple of years the payout ratio for regular dividends has been 50% and I would assume this will continue in 2011. That would point to a prospective yield of around 2.3%.

Putting a buy limit on Hsu Fu Chi is not straightforward at present. I have no doubts about its long-term potential. This is the number one player within its candy segment in China, yet the market is still so fragmented that it has a share of just 6%. This type of industry has tended to oligopoly over the long run elsewhere, so I think ultimately three or four key players will end up with market shares in the 20-30% range. And Hsu Fu Chi's track record since it was founded in 1992 makes me feel that it has an excellent chance of becoming one of them.

So at current levels, I believe that you will make good money over the long term and I certainly would not suggest that patient investors sell at this price. But at the same time, the shares have run up strongly in the last six months, price pressures are increasingly obvious and the firm appears to be feeling the effects more than some of our other food and beverage investments. I think there is a risk of soft second quarter results and the shares could weaken as a result.

If you got in up to my buy limit, you have a fair amount of protection against any downside. But I don't think it's conservative to put this back on the buy list yet, even though Hsu Fu Chi's long-term prospects may well merit a higher valuation.

While I wait to see how well management manage costs in the second quarter, I'm keeping it on hold, albeit at a raised limit (S$3.10, based on 20 times my FY2011 estimates). If it seems to be coping well, I may raise it to a 25 times p/e.

Maintain HOLD with a buy limit of S$3.10.

Vitasoy seeing major expansion in East China

Staying in the Chinese food and beverage sector, our soft drinks investment Vitasoy has returned a paper gain of 5% with a further 4% from its final and special dividend.

I hoped to fit in a meeting with Vitasoy when I was in Hong Kong, but the schedules didn't fit. However, the company has just put out its first half results, so let's review these. The firm reported the same pressure on raw materials and wages as Hsu Fu Chi, saying that "the operating environment for the packaged food and beverage industry in the remainder of the year will be more challenging than the first two quarters".

However, its cost controls seem to have worked. A 10% rise in revenues was matched by a 10% rise in net income. Competition and price pressures were tough in its traditional core market of Hong Kong with a 2% fall in operating profit. But the two high growth markets did much better.

In Australia and New Zealand, sales were up by 32% in Hong Kong dollar terms (20% in local currency terms) and operating profit by 69% (53%). The company is now number one in milk alternatives in this market I understand that its share is around 40%, having doubled in about five years.

Mainland China is the key long-term growth market and at first glance, a 14% rise in revenues looks very disappointing compared to the recent 30-50% trend. But this reflects capacity constraints at its China plants rather than weaker demand growth. Indeed, having long been the number one soymilk brand in Southern China, the firm says that it's now number one in Eastern China, where its expansion efforts are now focused. A new plant is under construction for completion in 2011, which will double capacity in China and should allow it to meet demand for the next four-five years.

Although Vitasoy seems to be managing costs well, the China constraints mean that I expect below-trend earnings growth to persist for the whole year. But with the new capacity on stream, I'd expect growth to pick up again the following year.

So Vitasoy currently trades on around 22 times my estimates for next year. It declared an interim dividend of 3.2 cents per share, and based on recent payout trends, I'd expect it to maintain the full year dividend at around 13.4 cents, suggesting a prospective regular yield of around 2.6%.

With substantial extra cash on the balance sheet, it has been paying a 10 cent special dividend yearly since 2005. The result is that effective payout ratio has been around 100% of earnings for several years. Given its expansion plans in China, there's the possibility that the firm will chose to redeploy excess cash into investment rather than dividends.

However, it's currently funding the investment in the new plant through increased borrowing, so I think the special dividend is likely to continue this year. If it does, Vitasoy is on a prospective yield of around 4.2%.

Maintain BUY up to a limit of HK$7.00.

Suntec deal is great news for ARA

Real estate fund manager ARA Asset Management has posted another good price performance, with a paper gain of 32%. Dividends paid so far add another 2% to that.

Good third-quarter results have helped propel ARA's shares faster than I expected, but the main driver recently has been the news that Suntec Reit, one of the funds that it manages, will buy a one-third stake in Singapore's Marina Bay Financial Centre (MBFC) for around S$1.5bn.

I'm not sure this represents an exceptional deal for Suntec's own shareholders but it's great news for ARA which will pick up a 1% own-off acquisition fee and ongoing management fees from the deal. This has made a sizeable difference to its prospective earnings next year, and my updated estimates are below. (The management fee might be booked this quarter or next year I've assumed next year.)

ARA now trades on p/e of 20.5 times my FY2010 estimates, although since its year-end is in December, investors will now be looking at the following year. My FY2011 estimate of 11 cents per share includes the one-off boost from the Suntec MBFC acquisition fee. I'd estimate recurrent revenue at 9.2 cents, meaning that it trades on just under 16 times my FY2011 estimate ex that one-off.

I had a chance to catch up with ARA's investor relations team when I was in Singapore, to get some more background on the firm's plans. There were no significant changes to what I already knew and it reaffirmed my view that this is a very attractive business that can continue to scale up without difficult for many years to come.

There are a few notes that may be interesting to shareholders on what to look out for. ARA manages five reits at present and intends to build a diverse range of good quality reits, rather than maximising the number under management. The target is to grow the range to eight or nine, filling in niches missing in the current line-up. Potential areas include a hospitality reit (giant Hong Kong conglomerate Cheung Kong, ARA's partner and minority shareholder, has suitable assets), an industrial reit (although probably not in Singapore, where the space is quite crowded) and a China reit (likely listed in Hong Kong).

However, the core growth strategy is to raise a series of private equity funds under the Asian Dragon Fund franchise. The first - ADFI - is now 70% invested and ARA is raising money for ADFII, which is targeted for close early to mid next year with a goal of around US$1bn in capital committed. When each fund reaches the end of its life, ARA aims to sell some of its assets into reits under its management, thereby creating ongoing management fees on an its asset base. For example, some of the ADF1's assets could be injected into the putative China reit mentioned above.

The mandate for each fund will specify when ARA can next raise money for a similar fund, with the usual condition being when the existing fund is around three-quarters invested. Thus ARA can probably raise a new ADF fund every four years if all goes well.

The immediate target is to have S$20bn in assets under management by 2012 and with assets growing at S$2bn a year, the firm is optimistic of hitting that. (This discussion took place before the Suntec MBFC deal, which makes it look well on track.)

My initial valuation for ARA was based on this target, assuming earnings of around 13 cents per share in FY2013, valued on a forward p/e of 15 and discounted back to the present at my minimum target rate of return of 15%. I think that still looks likely: since we're a few months further, the discount reduces slightly and the buy limit increases from S$1.35 to S$1.47 as a result.

One can argue that ARA's growth potential merits a higher valuation. But one thing continues to concern me. This firm is at heart a one-man band: it's all down to CEO and founder John Lim's connections and experience. A discount is needed to allow for key man risk on that scale, so a p/e of 15 seems more prudent to me.

ARA is trading around my new buy limit. As of now, it's slightly below, so it switches back from a hold to a BUY up to a limit of S$1.47.

Why I continue to hold ICICI Bank

Indian banking giant ICICI has also done well for us, with a paper gain of 40% so far. No dividend has been paid and the impact will not be significant, since ICICI is a low-yielding stock.

As I mentioned in my initial report, ICICI is not a typical Asia Investor investment, being much larger and better covered by analysts than most: I like to look for investments where other people aren't paying attention.

However, our limited number of banking investments will always tend to be larger stocks, while ICICI in particular seemed to offer exceptional value at the time: investors seemed to be taking an undeservedly short-term view of its prospects.

That quickly changed, thanks to better-than -expected second quarter results, although the stock has given back some of its gains in line with a general pull-back in the Indian market: a recent political scandal over telecoms licences has paralysed parliament and dented confidence.

A subsequent scandal involved bribes for loans at a number of state-run financial institutions has also done damage (ICICI is not implicated in this, and I believe that Indian investors have been switching banking investments into ICICI and its peer HDFC because they're perceived as being safer.)

ICICI is currently trading on around 26 times estimated current year earnings and 21 times FY2012E earnings. The bank pays one yearly dividend, which was Rs12 per share last year; I would expect the same again this year, putting it on a prospective yield of around 1%.

Banks in the developed world tend to be income plays, but in emerging market where financial services uptake is still very low, there's strong long-term growth potential. So it's not at all surprising that ICICI and its peers trade on higher valuations. And if you consider the huge secular growth potential of the Indian banking and financial services market, a p/e in the 20s does not look too high for India's biggest private sector bank.

The snag is that banking is cyclical. Banks lend enthusiastically when times are good and it can come back to bite them when the cycle turns down and bad loans start rise. Thanks to the global financial crisis, I don't think there are many investors who are ignorant of this now.

I would say that as a broad statement, the best emerging market banks are in far better shape than Western ones. They also have great long-term trends in their markets. And the strongest of them are extremely prudent, well-run institutions: Malaysia's Public Bank - which despite its name is a private company - may well be the best-run large bank in the world.

For all its potential, ICICI is not quite so good. The reason it was cheap a few months ago is because it was reckless in the last cycle and has been having to clean up its problems while its rivals could ramp up business.

Hopefully ICICI has learned some lessons. And certainly the Reserve Bank of India could teach Western central banks something about financial regulation: it recently clamped down on teaser mortgages with low starting rates by ordering banks to raise the amount of provisions they must make for potential bad loans on them; as a result ICICI and HDFC have now pulled their teaser products.

I hope this will help keep ICICI out of trouble. But there are risks and I'm not willing to overpay. My valuation for ICICI is based on looking out to FY2013, when I anticipate that it should have worked through the problems from the last cycle and profitability should return to a more normal level. I've pencilled in earnings of around Rs80 per share at that point on a price/earnings ratio of around 20, which gives a target then of Rs1,600 per share.

That target is then discounted back to the present at the Asia Investor minimum target rate of return of 15% per year to give a current buy limit. And since we are investing in ICICI through its US-listed American Depository Receipts (ADRs) since foreign retail investors can't invest directly in the Indian market, we then need to convert this to an ADR price. (Please see my original report for all the background.)

We are half a year closer to FY2013 and the rupee has strengthened a little against the dollar since I first recommended ICICI, so the target price needs to be updated to reflect that. My new buy limit is US$50.40.

Having fallen back from its high of US$58.22 in the last few weeks, the stock is currently trading around that level again. As of today it's slightly below, so it's formally a BUY.

Buy First Reit up to S$0.8

Our healthcare-based income play First Reit has been quite active since recommendation, and we're currently sitting on a small paper profit of 5%. We've also received one quarterly income distribution, adding a further 2% to that.

The main news has been the acquisition of two Indonesian hospitals from its sponsor, Lippo Group, and the announcement of a rights issue to fund them. This had been in the pipeline for some time and was discussed in my initial report; as noted in my later update, the terms were slightly better than expected.

With the shares now trading ex-rights, I now need to update my recommendation to reflect the changes. Management guidance alongside the deal is for a distribution of around 6.4 cents per unit next year, which would be a yield of 8.7% on Friday's price.

As mentioned in my original report, I think most investors will look at this as an income play, but I think there is capital gains potential as investors bid up income-producing assets like First.

Based on the possibility that the yield they demand might go as low as 7% in a year or so, that points to a potential price for First of around 91.5 cents at that time. Discounted back at my minimum target rate of return of 15%, that suggests a buy limit of around S$0.8 now.

Maintain BUY up to a limit of S$0.8.

Why cocoa suddenly looks interesting for Petra Foods

Chocolate and cocoa specialist Petra Foods has also been a decent performer more so than I expected in the near term. It's up around 17% on paper since I recommended it, with a small addition of around 1% from dividends.

I was able to have a very helpful meeting with Petra in Singapore to hear some more about the potential of its consumer brands in Indonesia and Philippines. I also learned quite a bit about the cocoa processing industry, which made me more interested in this side of Petra's business than I had been before.

My feeling is that this deserves a fuller discussion than will fit well into this week's issue. And I also want to further refine my valuation of Petra to reflect this. So I'll do a detailed update on Petra very soon.

Pending that, I'm keeping the stock on HOLD with a buy limit of S$1.6.

Finally, there are no changes to Silverlake Axis, Xinhua Winshare Publishing and Media, YHI or Breadtalk since my last update.

That's it from me this week. I'll be back in a fortnight with a new recommendation. As ever, I'm available in the meantime on asiainvestor@moneyweek.com

Prices as of 8/12/10

(Singapore tickers vary between brokers. The three common ones are listed for each stock.)

Note: Buy price for First REIT has been adjusted to assume the 5 for 4 rights issue announced in November 2010 was taken up.

Sources used to prepare this report

Eredene Capital interim results 2010

Eredene Capital briefing with management 07/12/10

Hsu Fu Chi Q1 FY2011 results Vitasoy interim results 2010

ARA Asset Management Q3 FY2010 results ARA Asset Management investor relations briefing 15/10/2010

Suntec Reit announcement "Proposed acquisition of a one-third interest in Marina Bay Financial Centre Towers 1 and 2 and the Marina Bay Link Mall" 26/10/2010

First Reit announcement "First Reit's 2011 distribution yield expected to increase to 9.14% following acquisition of two Jakarta hospitals" 10/11/2010

Data from Bloomberg