Welcome to the latest issue of Asia Investor. This week, I'm going to be doing a full review of the entire portfolio and updating you with my latest views on each stock.
Before I begin, there are a couple of points I should mention up front. The most important is that after reviewing the situation at dairy and catering firm Etika further, I now recommend that you cut your losses and SELL. Please see below for full details.
There are no other recommendation changes to other stocks, but the buy limits on a few have been revised with excellent prospects ahead for Hsu Fu Chi, Vitasoy, Ara Asset Management and Petra in particular.
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In fact today I'd like to add something new to the quarterly review. I'd like to spell out my targets for the potential gain on each stock in the portfolio over the next two-three years. As I've often said, I regard forecasting as a highly inexact business, so please don't take this a strict target it's solely a very rough indication of what I think the potential is on the balance of probabilities.
But I hope it will give you a good idea of just how much potential there is for some of the stocks over the months and years ahead.
Eredene could double within three years
There have been no major updates from Eredene Capital, our Indian infrastructure play, since I reported back to you on the interim year results briefing in my last quarterly review (Asia Investor #13, 8 th December 2010). That's no surprise, since at this stage most of Eredene's portfolio of projects are still under development or at an early stage of operations and there should be little to say.
The only news is that the firm's non-executive chairman has stepped down due to ill health and the senior independent director has temporarily taken over the role while the firm recruits a replacement. The main effect of this is that plans to raise new capital for the investment in the Ennore Container Terminal project have been delayed until a new chairman is appointed.
Eredene has been one of the worst performers in the portfolio, down 5.4% since recommendation nine months ago. I don't believe this reflects problems with the company, but rather a shortage of attention-grabbing news added to the general weakness of markets (especially with regard to India). The intention to raise fresh capital is also hanging over the stock, since this will probably be done via a large private placement (Eredene would like to bring in a strategic investor with a name in ports and shipping); this could involve some dilution for existing shareholders.
This investment is likely to remain a bit of a slow developer, with 2014 looking like the key date by which most of its current projects should be largely up to full speed; despite being a listed company, it is in many ways like a private equity investment with most of the pay-off coming at the end of a multi-year wait. Nonetheless, I'm optimistic that we may see it making an operating profit by the end of this year and ready to pay a dividend by the end of 2012 as milestones along the way.
My best estimate of share price potential over a two-three year period is 30-35p. Key risks that might upset this are execution error on its projects and difficult raising capital if markets go into another severe spin. For now, I retain a BUY recommendation up to a limit of 22p.
Silverlake is set for a rerating
Silverlake Axis, the Malaysian financial and commercial software developer, released its second-half results in February and I covered them in the last issue (Asia Investor #18, 15 th February 2011). To recap briefly, they showed strong earnings growth as recent contract wins fed into sales, while the outlook for new deals is good.
The controlling shareholder has also sold down a substantial portion of his stake in recent months, which I believe is probably a prelude to transferring the stock from the Catalist small cap board to the main board at some point. This would significantly increase visibility and investor interest and hopefully lead to the stock being rerated.
I've updated my estimates in the table below. I've brought down the estimate for this year a bit, but this represents slower revenue recognition from announced wins and higher costs from marketing and new hiring for expansion rather than any bigger disappointments.
My best estimate of potential is around S$0.6-0.8 over the next two-three years, with fairly healthy dividends being paid as well Silverlake pays out 40-50% of its earnings. Key risks include banks pulling back on spending due to another global crisis, the failure of its new ventures such as cloud computing to develop as hoped and the transfer from Catalist to main board not happening (this would not impact the business but would make re-rating less likely). I retain a BUY recommendation up to a slightly increased limit of S$0.45.
Hard not to get excited about Hsu Fu Chi
Our Chinese confectionary investment Hsu Fu Chi released far-better-than expected results in early February, as also covered in Asia Investor #18. I've reworked my numbers to take account of the current trends and my estimates have risen substantially the new ones are in the table below.
It is always dangerous to get too excited about a business because it's been performing well lately, but I am very intrigued by the potential of this company. To recap very briefly, it is the market leader in its segment of the market, but I believe it has a share of around 6% (probably a bit more by now). In developed markets, this kind of industry has tended towards oligopoly in the long run with three-four businesses having 20-30% each, and I believe it's likely that China will eventually do the same. Thus Hsu Fu Chi could have many years of strong growth ahead powered by rising incomes and market share gains.
My two-three year estimate would be for a potential price of around S$5.25-6.5. Key risks include raw material costs, tougher competition and brand damage (such as a contamination scandal, always a risk for even the best food firm). It remains a BUY with a revised limit of S$4.10.
Vitasoy on course for rapid sales growth
There have been no updates from Hong Kong soymilk and soft drinks firm Vitasoy; like many Hong Kong firms, this business only reports half-yearly, with the next update likely to be in June.
So there are minimal changes to my estimates in the table below since my last update in Asia Investor #13. Profit growth is likely to be muted this year due in part to capacity limits in its China production plants; once a new factory is in operation in later this year the rapid sales growth it's seen there in recent years should resume.
My estimated price potential for the next two-three years is around HK$9-11, although I don't think looking at this alone does justice to Vitasoy's prospects of growing its sales steadily for many years in China. Healthy dividends are also likely to continue. Key risks are similar to Hsu Fu Chi: raw materials, competition and brand damage. My recommendation is to BUY up to a limit of HK$7.00.
A very encouraging outlook for ARA
Real estate fund manager ARA Asset Management announced results for FY2010, with earnings per share rising 32% year-on-year to 9.14 Singapore cents. This slightly overstates the underlying earnings, since one-off fees earned on Suntec Reit's purchase of a stake in the Marina Bay Financial Centre contributed to a 134% rise in acquisition and performance fees.
Nonetheless, it was a good set of numbers and the outlook for ARA is very encouraging. Assets under management as at end December stood at S$16.9bn, maintaining its strong growth rate and putting the firm well on track for its target of S$20bn by end 2012. As previously discussed in Asia Investor #13, ARA is working on three new real estate investment trusts and plans to launch Asian Dragon Fund II, its second private equity fund, by the first half of this year.
The firm also announced a final dividend of 2.5 Singapore cents per share, which together with the interim dividend of 2.3 Singapore cents per share amounts to a payout ratio of over 50%.
I've slightly increased my estimates to reflect the faster growth of its asset base and the revised ones are in the table below.
My estimate of its two-three year share price potential is around S$1.9-2.35. Key risks are problems in global markets making it hard to raise finance for future deals, damage to its relationship with Hong Kong conglomerate Cheung Kong, which provides the assets for many of its funds, and the key man' risk of its dependence on the contacts, reputation and expertise of CEO and founder John Lim.
ARA remains an excellent way to get exposure to the growing global interest in investing in Asian assets, as well as buying into the real estate sector at lower risk than property developers or direct ownership. However, it seems a little too expensive to me at present to justifying a buy rating. I recommend you continue to HOLD andonly look to invest or add at S$1.47 or below.
ICICI Bank remains a strong contender
India's largest private sector bank is always in the news since it's by far the largest stock in our portfolio. However, there's been little of significance since my last update on its third quarter results (Asia Investor #17, 1 st February 2011). These showed earnings continuing to recover as I'd hoped.
The Indian market has had a tough few months on the back of scandals such as the corrupt awarding of telecoms licenses, plus the threat of inflation and the obvious need for the Reserve Bank of India to tighten policy further. This has hurt most stocks, with interest rate sensitive ones such as banks suffering the most.
However, it makes little difference to the fundamental outlook in my view. ICICI's earnings should continue to recover as bad loan provisions from its overstretch in the last cycle reduce and margins recover towards the levels enjoyed by peers such as HDFC Bank. My latest estimates, which are not substantially changed from the last ones, are shown in the table below.
I estimate that ICICI has price potential of around Rp1500-1600 over the next two-three years. We're invested through the US-listed American Depositary Receipts, so that translates to a price of US$62-US$71 at the current exchange rate (each ADR gives you rights over two India-listed shares).
Key risks are a further global financial crisis, a major downturn in the Indian economy that leads to soaring bad loans and an ongoing lack of confidence in the Indian market that leads shares to underperform regardless of what earnings are doing. At present, I rate ICICI a BUY up to US$50.4.
Petra profits up 81%!
Chocolate and cocoa specialist Petra Foods delivered an expectations-thumping set of results, with sales up 26% year-on-year and profits up 81%. The cocoa ingredients division saw returns improve substantially on higher sales of premium ingredients and the continued improvement in margins at its revamped European plant. Ebitda yield averaged US$215/tonne, from US$119/tonne last year.
Branded consumer the division we're really interested in requires a little more analysis. Headline sales grew at 22% in US dollars, with its core market of Indonesia up 27% and other regional markets up 13%; operating profit was up 41%. However, digging into the detail, much of the revenue gain represented currency effects from stronger regional currencies and in local currency terms sales growth was a more muted 9%.
Within that, Indonesian sales growth seems to have been around 15% in local terms, in line with my long run assumption. Other markets was a more muted 5%; however, this seems to be largely due to a sharp drop in sales in Singapore (where Petra is mostly a distributor of other firms' products), while the Philippines market where the long run potential is maintained a healthy growth rate that I'd estimate at 25-30% for the full year.
Despite bean cocoa prices which require higher working capital to finance inventories, even though the effect of price movements on margins is hedged out the balance sheet continued to improve. Net debt to equity stood at 1.72 from 2.02 at the end of 2009, while the figure excluding inventory financing stood at 0.34 from 0.7.
The firm announced a final dividend of 2.18 Singapore cents per share, adding to an interim dividend of 1.6 Singapore cents for a full-year payout ratio of around 40%. This will be paid in May.
I've updated my estimates to reflect the latest numbers and you can see the revised figures in the table below.
My two-three year estimate of the share's potential is around S$2.35-2.7. As with the other branded consumer firms, key risks include raw material prices, tougher competition and brand damage; because of Petra's high dependence on trade finance for the cocoa ingredients inventories, we should also add further financial shocks to that. I continue to see this as a BUY up to a limit of S$2.00.
Great growth and dividend prospects for Xinhua Winshare Publishing
There has been virtually no news from Xinhua Winshare, the Chinese publisher and distributor of educational and other media, since I first recommended it (Asia Investor #6, 20 th August 2010). This is no surprise, since the firm's investor relations efforts outside of annual and interim reports are very poor.
The one major piece of news related to arranging a loan for a subsidiary that will be developing a real estate project on a piece of land it owns in the centre of Chengdu, which suggests this development is moving forward. As you'll recall from my initial briefing, I regard this as a non-core irritant but some real estate interests are almost inevitable with any Chinese firm. In this case, the land is in a prime location and Xinhua Winshare was gifted it by its state-owned parent before listing, so the project should be relatively harmless and deliver some returns for shareholders.
Consequently, there are no changes to my estimates in the table below as I await the full year results, which should be published in April.
I estimate that Xinhua Winshare could potentially reach HK$6-7 in the next two-three years, in addition to a substantial ongoing dividend yield of around 7-8% on the current price. Key risks include the relative lack of transparency, the difficulty of knowing how a politically driven process of such as the consolidation of the Chinese publishing sector will ultimately proceed and the highly unlikely but extremely damaging prospect that it could lose its cash-cow monopoly over distributing educational materials to schools in Sichuan province. I retain a BUY on this stock up to a limit of HK$5.00.
How can investors ignore YHI?
I confess to being rather perplexed by the latest full year results from auto wheel and battery distributor YHI. The firm announced a 21% rise in revenue and a 45% rise in earnings, far better than expected. Net profit margin improved from 5.9% to 7.1%. The firm announced a dividend of 1.69Singapore cents, amounting to a payout ratio of 30%.
Thus YHI is currently on a price/earnings ratio of 5.7 and a dividend yield of 5.3%, yet the results attracted absolutely no interest from buyers. This is the kind of situation that can make you question your analysis of the firm and look for something you've overlooked. Yet in this case, there are no obvious red flags: for example, cashflow is very healthy and net debt to equity is just 14%.
The biggest gripe that I could make about YHI is that the management's announced goal of roughly doubling revenue to S$1bn focuses on expanding both the distribution business and its alloy rims manufacturing division, with the latter focusing especially on the Chinese auto industry. I like the distribution business a great deal, whereas the manufacturing business is less appealing; in fact, the entirety of the earnings growth this year came out of the distribution business, with manufacturing earnings actually falling on the back of higher raw material costs and currency effects.
Frankly, I would be perfectly happy if YHI were just to focus on the distribution side of things and handed spare cash back to shareholders. But at this price, one can live with a bit of sub-optimal capital allocation. My only explanation for the continuing lack of interest in this stock is that it's a small firm in a fairly dull line of work a classic small-cap value situation.
My revised estimates for YHI are shown below.
My estimate of this stock's two-three year potential is around S$0.5-0.7 and investors should also pick up some fairly decent dividends alone the way. Major risks look to be raw material costs, competition given relatively low barriers to entry in its industry and perhaps management missteps in expanding manufacturing. I'm keeping it on a BUY recommendation up to a limit of S$0.35.
A nice deal for First Reit
Our mostly Indonesia-focused healthcare real estate investment trust made one announcement last week. It's selling one of its Singapore properties, the Adams Road cancer centre, to Indian group Fortis Healthcare for S$33m.
I didn't know this deal was in the pipeline and I'm slightly surprised by it, because when I met the management in October I understood that they were looking to increase not decrease the Singapore portion of the portfolio. However, it represents a decent return to First, at a cash gain of around S$8.3m on its costs and a S$4.8m premium to the assessed value of the property at year-end, so it looks to be a good opportunistic deal.
The effect on distributions payable to shareholders is slight; the proforma adjustment for the year just finished points to a reduction of just 0.14 Singapore cents. And First's net gearing will fall from 17.6% to 14.2%, increasing its flexibility for future acquisitions. So overall, my first impression is that is a small but shareholder-friendly move by the manager.
Other small points to note with First is that its sponsor, Indonesian conglomerate Lippo, has announced that its hospital in Jambi has opened for business; this looks likely to be injected into First in the future (as are subsequent Lippo healthcare developments). And the stock is now under coverage at a major Singapore broker, OCBC, which should increase its profile among investors.
My latest estimates for First are shown in the table below.
I anticipate only a relatively small potential price gain for First over the next two-three years to around S$0.9-0.95; the main attraction is a large and fairly defensive income stream, with a prospect distribution yield of almost 9% on the current price. Further acquisitions of new properties on shareholder favourable terms could drive up both of these and are likely, but too uncertain in size and timing to factor in. Key risks include a bust in the Indonesian economy, troubles in financial markets making it hard to renew existing financing or raise money for new deals and problems at its sponsor Lippo. First remains a BUY up to a limit of S$0.8.
Breadtalk continues strong growth
Bakery and restaurant operator Breadtalk's results delivered what looks like a good full-year performance, with revenues up 23% and earnings down only slightly (by 4%) despite start-up losses at new ventures, thereby beating my expectations.
All divisions bakery, food courts and restaurants appear to be growing well, and I am continually reading about new Breadtalk outlets opening in new markets as the group expands into more countries through franchises. Given that this stock is a relatively recent recommendation, it's difficult to put much context on its progress so far, but overall things continue to look very encouraging. My revised estimates are shown in the table below.
I'd estimate that this share has the potential to reach S$0.9-1.2 over the next two-three years. Key risks include higher raw material costs, overstretch as a result of its fast expansion and renewed competition as other firms trying to latch on to higher discretionary and entertainment spending in markets such as China. I retain a recommendation to BUY up to a limit of S$0.72.
Why I'm selling Etika
Turning to the main disappointment of the portfolio so far, Malaysian condensed milk and catering supplies firm Etika is down almost 19% on my initial recommendation. As reported in my last issue, this is due to a shocking set of first-quarter results; to recap, net profit was down 80%, partly due to some one-off foreign exchange and staff costs but also due to a severe deterioration in margins caused by rising raw material costs. This was completely unexpected given that management had sounded fairly positive on the firm's ability to pass on costs in its full-year update.
Subsequent to the results coming out, Etika announced that its finance director had left the firm; he had been in the position for several years and the reason given was the bland and uninformative "pursue personal interests". He was the primary investor relations contact at the company. Since then I've tried to get further details about the results and also about his departure, but the firm has not provided me with any further information. (In fairness, I should say that his replacement was announced this morning, so communication may now improve.)
This puts us in a difficult situation when it comes to analysing the outlook for Etika. It's certainly possible that the firm will succeed in rebuilding margins and delivering an improved performance in the second quarter and beyond. Management sounded hopeful on this point in the results commentary, although their credibility is a little more questionable now given this shock result.
Conversely, the earnings miss may be a result of overreach as management try to integrate its new acquisitions. The sudden departure of a senior member of management adds an extra complication. At worst, it could reflect issues regarding the finance department or financial reporting that are of concern to shareholders although there are of course plenty of much more innocent explanations that are more likely.
I am also slightly concerned about the cashflow situation. Etika demonstrated weak operating cashflow in FY2010 as a result of its rapid expansion. I expected this to improve after year-end, but cashflow remained very low in the first quarter. This may well be due to increased inventory costs for raw materials and higher working capital needs due to the new businesses that will be resolved quickly, but cashflow problems can also often be an early warning that a business has overstretched.
I moved Etika to a hold immediately after the results came out while I tried to address my concerns. Having looked at it in detail, I believe that it is entirely possible that the second half results will be much better, that the shares will recover and the upbeat investment case I outlined in my initial note is still completely intact. That said, I have enough experience as I'm sure you do with investments that go wrong and shares that grind steadily lower while promising to turn the corner at any point.
And when a share has fallen, it's very tempting to anchor on the price that you invested at and hold on, believing that the price will inch back up and you'll be able to get out at a reduced loss. Tempting, but a classic trap in behavourial finance. In my view, the aim of successful investing is to cut your losers ruthlessly and run your winners; too many people do the opposite.
When a share has fallen below your initial purchase price on bad news, you need to ask yourself whether you would still be willing to buy at this price if you didn't already own it. If you wouldn't, you are not making a rational investment decision.
Had the latest news come out before I recommended the stock, I would not have recommended Etika to you. Consequently, my recommendation is to take the loss you have already incurred and SELL Etika.
Why Uni-President China has been knocked
There have been no updates from Taiwanese-controlled China-based soft drinks and noodles firm Uni-President China since I initially recommended it (Asia Investor #16, 18 th January 2011). The shares are down around 10% since then, but this isn't specific to UPC. Close peers Tingyi and Want Want are down by a similar amount.
There are two obvious reasons behind this. The first is the general sell-off in emerging markets; this can hit higher profile stocks such as these - which tend to be more widely owned by foreign investors than the typical Asia Investor pick - harder than the rest of the portfolio. The other is specific fears about the Chinese economy and inflation that are seen as hitting consumer stocks such as UPC harder than most.
I have no new concerns about the long run prospects for UPC though, other than the risks initially outlined in my recommendation. In fact, if this sell-off continues I would regard it as an opportunity to invest Tingyi and Want Want as well excellent businesses that have been a bit too expensive ever since Asia Investor began.
My current estimates for UPC are detailed in the table below there are no changes since my initial recommendation.
I'd estimate share price potential of HK$7.5-10 over the next two-three years. Key risks include raw material costs, competitive pressures and the success or failure of the group's aggressive strategy to regain surrender market share. UPC remains a BUY up to a limit of HK$5.70.
CSE Global sees 14% jump in earnings
My latest recommendation CSE Global, which produces specialist software for the oil & gas, healthcare and other industries, released its results in late February. These were pretty much in line with my expectations, with revenue up 11% to S$448m and earnings per share up 14% to 10.47 Singapore cents. However, this was somewhat below market consensus, which was more optimistic than me.
The company announced a final dividend of 4.0 Singapore cents per share, in line with my expectations and amounting to a payout ratio of around 40%. This will be payable in May.
But the shares have not done well in recent days, slipping around 11% from when I recommended them to S$1.21 at present. The fact that earnings were market assumptions probably played a part in this, but the bigger issue is the Middle East; any company with extensive earnings from the area is seen as an obvious sell and as an oil and gas services firm, CSE is obviously exposed. In fact, the company says that its operations in Qatar, Saudi Arabia and the United Arab Emirates have not been affected, but it has put off the planned acquisition of a Middle East firm while the troubles continue.
There are no fundamental reasons to change my view on the firm from any of this news. My estimates in the table below are unchanged, but now include figures for FY2012E.
I'd estimate that CSE has the potential to reach S$1.9-2.5 over the next two-three years. Key risks include a sharp fall in oil & gas company investment spending, a severe and prolonged escalation of the problems in the Middle East and the possibility that future acquisitions will not be as successful as past ones. I'm keeping the stock on a BUY recommendation up to a limit of S$1.53.
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