As I was hinting in my previous post, I was looking for a decent exit level in Xtep holdings, today was the day. The company is still cheap and I think it is operating in a segment (running shoes geared towards Chinese) with clear tailwinds. Why I’m selling is for more subtle reasons. I think I will personally really struggle to fully understand this company, its customer base and the products they are selling. I have no idea if the customers like their products or how much they like and trust the brand. I tried to discuss the brand with people living in Shanghai, but nobody used the brand or barely had heard about it. They were all buying Adidas, Nike or perhaps Anta shoes. All the Xtep stores were also located far away from central areas. This is when I understood that this brand is just selling to a much poorer category of Chinese then I come in contact with. Since I have no contact with this customer base I deem it very hard for me to build any feel for the company beyond the numbers. I could possibly still keep this kind of company long term in my portfolio, for the general tailwinds of this segment and a belief in superior management. I think the deciding factor has been that I have not seen any signs of this superior management, rather this is one of the reasons why the stock is still selling so cheap.
I bought 14300 shares Feb 1st 2017 at 3.28 HKD, after a bumpy ride I thought the stock had lagged its competitors significantly and added Aug 22nd another 7150 shares at 3.16 HKD just before the semi-annual was released. The report was a disappointing and the stock traded down to a low of 2.6 HKD in the coming months. But this time I did not do the same mistake as with Zhengtong Auto (were I stop-lossed at the bottom). This time I held on and the turn-around thankfully came. Including dividends I made a return of about 36% on this holding as I sold the full holding today. As a reference my overall portfolio returned about 25% since the initial investment in February. With my increased cash position I will for the coming months rather consider what of my current holdings I will add to, rather than trying to find new investment cases. My portfolio is diversified enough already and it feels good for the first time to not have any stress of adding new and/or better holdings to the portfolio.
The last few weeks my portfolio performance has been very strong, in part thanks to Xtep, but also other HK listed holdings like Nagacorp and Fu Shou Yuan has performed very well. Last Friday the portfolio was just half a percent shy of all time highs, which feels as a pretty solid result considering the stock market correction we just saw.
The Huhtamäki analysis is now overdue due to high workload and a few other things that popped up, my apologies but it will take another few weeks before it is done.
In the graph of portfolio performance dividends are included, but in “Return (in USD)” of current holdings dividends are not included.
Holding comments
As you can see above, my portfolio has become more diversified than ever before (18 holdings). I would say the reason for that is the high valuations we currently see in stock markets. I used to at least find cheap stocks in the Chinese markets, but not so much anymore. In frustration over finding anything that feels like a home-run investment, I have gone defensive, both in the style of my holdings and also diversifying into a broader portfolio. With this kind of portfolio I do not expect to outperform as much as I have done in the past. Below I will give comments and thoughts on the larger holdings in the portfolio. Before I start I would like to mention Catena Media. I bought into the company when the stock price was falling rapidly from it’s highs. Soon after I bought the CEO was fired and the majority owner took over as CEO. It was a tough decision to hold on to the stock, as people speculated that the quarterly report would show some major issues (perhaps why CEO was fired). But no such thing happened, rather afterwards confidence grew in the company again. When I sold the full position in Catena it was actually the largest holding in my portfolio and a strong contributor to me managing keep pace with the benchmark. Now let’s focus on the five largest holdings in my portfolio:
I have not commented that much about LG Chem, although it has moved up to be my largest holding. The investment traces back to my investment theme 2 years ago when I started the blog. The six months before the blog was launched I had spent a lot of time to research the whole value chain of Electric Vehicles (EVs). I ended up concluding that it will be very hard to forecast a winner among the many car makers. As a side note I did and do still have a belief that Chinese automakers will step up and take a large part of the global vehicle sales pie. I looked at three segments of the value chain, mining companies, battery producers and semiconductor companies. Semiconductor companies I dismissed, since at the time I saw it as more linked to smart/self-driving vehicles. It then came down to mining or battery companies. When I looked into the supply situation of Lithium, from what I could gather there was actually plenty of supply, the bottleneck was rather Cobalt, but here there were no decent investment options. Batteries also had the tailwind of Energy storage systems, that could potential ramp up demand substantially on the back of more Solar energy usage. So batteries became what I focused on. LG chem was and continues to be a world leader in battery production, with the most advanced batteries in terms of performance vs price.
The problem with LG Chem, was like most of the investment cases around the EV value chain, it was not a pure play. Most of LG Chem’s revenue comes from chemicals sales which is totally unrelated to EVs. I tried to analyze the chemicals business best I could, but it is a complex field. I understood that I did not buy into something at peak valuations, but rather chemicals where trading at somewhat depressed levels, my analysis did not really go deeper than that. I reasoned that expanding battery production, to meet the enormous future demand, would require a sizable company with muscles to expand. So without knowing that much about the chemicals business, I saw it as a good backbone to build the battery production capacity on. And that is more or less what LG Chem has been doing. Capex and R&D expense is planned to increase substantially in the coming years, on the back of strong cash-flows in the last quarters.
Looking at the future, worries lies in if there will be any substantial margins left for the battery producers. As Chinese new giants like CATL steps up to the plate, it would not be the first time a thriving profitable industry, becomes like the solar industry where huge volumes are produced, but no money is made. What keeps me somewhat comforted is that there are safety and quality aspects to these batteries produced, which means that a battery product is not just only about cheapest possible price per kWh of battery power. There are also more long-term quality and safety aspects to a battery product.
Even after the strong share performance, the company is trading at an undemanding trailing P/E of 15 and a estimated forward P/E of 13, which is in the middle of the range of it’s long-term P/E band. I would argue there is still room on the upside, even short-term. Since we are closing in on the S-curve area of EV adoption, where LG Chem is bound to see strong Revenue growth. A few years ago, it was estimated we would see substantial EV sales come through around 2020. But it’s more likely that most cars will be Plug-In hybrids around 2020 and pure EVs really taking of on a massive scale, is still probably a few more years into the future. But say 2025, I’m certain 75%+ of all new cars sold will be either a hybrid or a full EV car. If LG Chem manage to keep in the forefront of battery production, it is a company I’m very willing to hold for the coming 10 years.
Dairy Farm being a conglomerate within a even larger conglomerate. One could argue that instead of buying into Dairy Farm I should take a position in the whole Jardine Group. But I do like being exposed to food in the Asian region. Food is of course important to everyone around the globe, but Asians are in my view even bigger foodies than westerns. As the region grows richer, which its more or less bound to do, if Dairy Farm plays its cards right, it should be able to long term leverage that trend. Of course it is a highly competitive market, but with the Jardine Group behind it, Dairy Farm has all the advantages you could have for this region. I see this as a very long term holding, which I would only re-evaluate if I saw that something major had changed in the direction of the company.
XTEP International
I invested in two steps into XTEP, you find my thinking at the time here: XTEP Posts
The more I learn about Hong Kong listed companies and market participants, I realize mis-pricing are more common, or at least market participants have another time horizon and sentiment shifts in their investments. When the sentiment finally changes, it’s a bit like the famous ketchup bottle, positive momentum builds quick and reprices the stock to a new level in a very short time. For a stock picker that is of course a good thing, if you can get in before the sentiment changes. But you also need to be very sure about what you are investing in, since your patience and thesis will be tested. XTEP has had a a similar story of under-performance and then a catch-up. The clear winner though has been the largest company Anta, which since I invested has continued to outperform its peers.
When I invested about a year ago, XTEP was the ugly duckling, trading at a much lower P/E than its peers. One of the reasons as I have understood more clearly is that XTEP competitors are aiming more for the branded high priced segment, competing with Nike etc. XTEP has had it’s niche more towards the cheap/affordable running shoes. Much of the growth trend (so far) in health and sport awareness among Chinese has been in the more affluent population which obviously will go either for western brands or top Chinese brands. I tried with this investment think second level, that since healthy living and exercising already is a strong trend in China among rich people, that maybe it would also affect the middle class population to consume more sports shoes. The jury is probably still out if XTEP will succeed in this.
Looking to the future, I think the sports apparel segment is a good segment to be invested in. The tailwind from Chinese consumers on these type of products should continue. If XTEP is a good enough company in terms of execution and brand building, that I’m less sure of. Basically because I’m not in touch with its customer base, or consume their products myself. So the case for me to generate alpha in terms of stock picking, is lower here, where I only go by what I can see in the data. For these reasons I will probably never be fully comfortable with this as a very long term investment and my strategy lately has been to ride this positive momentum that finally arrived and look for a good exit level in this holding.
I was reflecting on that I spent a lot of my research time on looking at Health Care/Pharma companies of different kinds, everything from more niche small cap companies producing probiotics or vaccines, too large companies like Teva. It’s a bit ironic then that currently I only hold one single Pharma company, and that is a company I spent less time researching myself and more followed the results of others that I respect for their knowledge. WertArt’s excellent analysis helped my jump the boat and invest. Since I invested Gilead has made some larger acquisitions, again I’m not competent enough to understand if this was positive or not. I can only see that the Gilead management has had a fairly good track-record in its larger purchases.
The question to ask myself really is, since I seem to have no to a weak edge in being able to understand and analyse big Pharma companies, should I even invest in them? I’m not a benchmark agnostic investor and the Health care segment has 12% weight in MSCI World. With such a large weight in the benchmark I would rather say that I want to hold at least one Health Care company. For now I’m happy holding Gilead as a good pick in the segment, but I will do my best to find smaller companies in this sector, which are easier to grasp.
In a very fragmented market Huhtamäki has managed to take a strong position in the food packing market by doing a large number of smaller acquisitions. Food packing I believe has a long-term strong tailwind. In terms of risk I see a trend where large companies decided to be more eco-friendly. Seeing the documentary “A Plastic Ocean” makes you very sad of. We treat our environment in a horrible way in terms of plastic packaging. Maybe in parts of the world, there will be trend towards more paper/wood based packaging products. Huhtamäki today does both, so even this I don’t think is a major risk long-term, although short term it could create some losses if the plastic production facilities would become underutilized.
In the case of Huhtamäki a full analysis of the company is long overdue, it’s something I kept pushing forward as I feel I understand the company fairly well. The truth probably is somewhere in between since I have not sat down and looked at detailed figures of the company, reading many of the previous annual reports etc, as I usually do when I fully analyze a company. Instead of doing a half-hearted attempt here now, I will instead try to deliver a full analysis of the company in the next few weeks.
So I continue my quest of reducing China exposure and finding good defensive plays. My portfolio changes are the following as of market closings today (Tuesday):
Buy 6% of my NAV into Gilead Sciences
Add 50% to my current holding in Xtep International
Sell 40% of my current holding in BYD
Sell my full holding in CRRC
All in all this slightly reduces my very large cash position. Some quick comments on the changes:
Gilead Sciences
As I have mentioned in several posts, I have been circling the Pharma sector for quite some time now. Since it is, at best, a murky area to try to estimate the value of a big companies research pipeline, I have struggled to come to an investment decision. It’s easier with companies where current cash-flow motives more of the value. I tend to end up a bit too much on Seeking alpha, trying to find people who do understand the intricate details of this industry and especially the pipeline. Someone that I do trust though on the topic is Martin Shkreli, who freely shares on his thoughts in his Youtube streams. He is a fan of Gilead lately (when the valuation has come down). That gave me some comfort to keep looking at the stock. After seeing this (WertArt Capital on Gilead) very in-depth review of Gilead, I realized I might be a bit late to the party. But nevertheless, I want exposure to the sector which I feel have come down valuation wise and is defensive. Giliead is the best I have been able to come up with after a long search. I feel confident enough to take a position at what I believe is still a decent entry point, with some confirmation that the down-trend is broken.
XTEP International
The case is simple, if this company is not a fraud, it is undervalued. All other Chinese shoe companies have continued to perform fairly well and outperformed XTEP. This might be the ugly duckling, but I don’t believe it is THAT ugly. We will also get a very quick answer on my bet, since the earning report is released tomorrow, I’m hoping for a +10% pop upwards in the stock-price.
BYD
The countries outside of China keep disappointing me in how much they dare to commit to electric buses, it’s already proven to work fine in China. This is where BYD is very strong and have a top product. On top of that I still don’t see BYD releasing a car anything near to Tesla Model 3 or Chevy Bolt, so my thesis from over a year ago, that I’m unsure of BYD’s success in the car market, stays the same. I haven’t given up on BYD, but I could see this one visit the high 30’s again and choose to reduce my position.
CRRC
This was my Belt and Road play, perhaps somewhat sloppily implemented. I decided to not invest in the theme before I understand it much better than I do right now. It has a holding I don’t have a strong view on and selling it reduces my China exposure, so out it goes.
My next post..
..will be about Teva. I have been very occupied lately and I still need some time to dive into the details. So stay tuned for Part 2 and let’s see if it becomes a new investment or not.
Having a global portfolio the earnings season is less of a season and more of a continuous thing over the year. Most European companies are long done with the annual reports, whereas many Chinese companies are still holding it off for another week or two. In general I’m not very happy with the result updates from my holdings, few positive surprised and several fairly negative ones. Let’s look at some of the companies and the figures released..
Rottneros
About a month ago Rottneros reported for the first time, since I made my initial investment (Rottneros – the SEK winner). The report was a clear disappointment and the stock traded down -7% on the day. Since then the stock price has recovered and is hovering around my average buying price. So what was the reason for the disappointing figures? The company blames a longer than expected time to start up the Vallvik plant (which has it’s scheduled maintenance stop each autumn). And this obviously had an effect, but it’s still somewhat surprising the effect became so big. the NBSK Pulp price in SEK was 5% higher this Q4 compared to Q4 2015 and even so the result was -7 MSEK compared to +1 MSEK in 2015.
The conclusion back in October when I wrote my analysis, was that margins look favorable as long as the USD stays at strong levels vs SEK and Pulp prices at least stays steady. These two factors have stayed true. The USD (with some volatility) has stayed at same level as when the analysis was written and Pulp NBSK prices have even strengthened somewhat. Some fairly major investments have also been made to upgrade the plant, this should start to feed through in terms of production volumes and bottom line. I expect a very strong Q1 result in May this year, in range of 0.45 SEK per share. Which should put the company on track of delivering a 2017 EPS of around 1 SEK. Meaning that Rottneros is currently trading at forward P/E below 8. This would warrant the share price increase I have been looking for to around 10 SEK. If the next earnings report is again a disappointment (below 0.4 EPS), I will look at selling my shares, because then they are doing something wrong compared to what they delivered a few years ago.
Nagacorp
The market was also pretty brutal on Nagacorp’s reporting day, trading down the share as much as -9% . The stock has since recovered, in my view mostly because the Hang Seng and Macau casino companies has traded up significantly. But the stock has felt very weak and from compared to the market Nagacorp is a clear laggard, for example Galaxy (27 HK) is up +18% since after Nagacorp’s disappointing report. So what was the problem with the report? Honestly not that much, figures came in somewhat weak, but nothing major. But this was the first time the dilution from the convertible bonds became obvious to investors. Henceforth the dividend will be shared with convertible owners bonds, which are entitled to the same dividend as the ordinary shares. 2017 will be somewhat of a wait and see year, since Naga2 will be launching in the second half of the year. If this stock is going to have any major upside, it will be reliant on a successful launch of Naga2. Basically the company plans to expand it’s VIP segment by moving much of the mass market players to Naga2 and refurbish the old complex to better satisfy demanding VIP players, about half of current revenue is from VIP. As long as we don’t see any very hurtful share dilution for the Russia project, I’m confident that we at these levels, have low downside (10-20%) while the upside is towards the 100% range over the coming 3-4 years.
Solid report, with significant increase in NII margins, home lending is growing very nicely. I’m a bit it worried that deposit volumes are standing still, maybe not right now, but at some point this will hinder further growth. Somewhat mixed feelings on this holding, long-term I think it is a very strong case in the bank sector. But short-term the stock feels somewhat overbought, I was very close to pushing the sell button around 77 NOK and now it has traded down to 71.50 NOK. In general my feeling of owning banks is a bit like picking pennies in front of a steam-roller, given that it will be very tough times day the housing market starts to fall (which I think is due, either due to normalized rates or economic downturn). Having said that, very long term a digital efficient bank that handles mortgages definitely feels like the future, and Skandiabanken’s current customers do seem to be agreeing (being the most satisfied banking customers).
XTEP International
This report came out after Friday close and on Monday we will see the markets judgement of the report. In the meantime I will give mine. The figures were disappointing, looking at head-line figures it looks awful and that is due to a one-time write off of the Kids store segment (impairment of trade receivables of 222m RMB). A larger number of stores have been closed during 2016, from 600 a year ago to 250 left today. I have not taken that much note of this kids segment, but looking back at sell side analyst reports, this seems to have been known in the investor community. With Footwear sales coming in very strong for the first half of 2016, the expectations on my side were quite high for H2. This did not impress, and the reason must be the 222m write of in the kids segment. The apparel part which made the stock trade down significantly over the last year, as I expected recovered nicely and is back to it’s long term trend of hovering around sales of 1bn RMB per half year. Below is an overview:
In a sector which such high growth as sportswear, XTEP is lagging, but I don’t see reason to sell just yet, the stock is so cheap. The biggest worry for me is the discussions we had in the comment section, where one of the readers made me aware of how huge cash pile the company is sitting on (~3bn HKD – MCAP 8bn HKD). I also had not reflected on how constant that cash pile has been since it’s IPO, this I think is my biggest worry. Why do they need so much cash? The comments raised possibility for fraud, I’m not overly worried about that, but at least it’s showing a very in-efficient use of the companies capital. From a pure value perspective it is of-course amazing buying a company with MCAP of 8bn HKD, with net cash of 3bn HKD cash and generating 0.6bn HKD of Net Income per year.
Last but not least, the most important holding in my portfolio (since it has the largest weight) has still not reported. The report is due on Friday 31st of March. Like XTEP the reporting is semi-annual. The last report was what got the stock moving big-time and rightfully so, since the company delivered 0.35 HKD half-year EPS on a stock trading below 4 HKD. Since then, for not really any major reasons the stock has been on a roller-coaster ride, moving between 6.9 and 4.1 HKD (I added to the stock on this weakness). My expectations on this report is high, for a few reasons. Some of the major companies Coslight deliveries batteries to, HP for laptops and BAIC for EVs have both been doing very well in their respective markets. HP is holding a very strong position in the laptop market and has even managed to gain market share (although I do not have data on market share on the models that Coslight provide batteries for). I would also suspect that Coslight has been given a larger allocation from HP, due to other battery-suppliers to HP have created problems with faulty batteries and very large recalls for HP.
BAIC as I mentioned before has been of the top sellers of EVs in China, especially over the last 6 months. Again is not totally clear how much of the total EV volume that has Coslight batteries, since BAIC has several battery suppliers, but it does look promising. All in all this means that it seems reasonable Coslight will be selling close to full capacity of it’s factories (which was also the companies guidance).
In the counter-balance we have the margin pressure in terms of lower battery prices world-wide and also as several sell side firms have been warning a potential oversupply situation in the battery market especially for 2017-2018. So there is a risk that Revenue comes in very strong, but that bottom line has suffered and that EPS comes in weak. Looking at history there has also been clear seasonality in terms of EPS. Average EPS for H1 is 15.5 cents since 2007, whereas EPS for H2 is 3 cents. But I do believe the market is factoring in a lot of these concerns already, the last time the company delivered a semi-annual EPS in the 35 cent range was H1 2009, in the wake of the crisis – the stock traded at 7 HKD pre-report and went to 16 HKD. When the company followed that up with a H2 result of 21 cents it had in the interim rebounded to 10 HKD and rebounded up to 14 HKD. So if Coslight just delivers something modestly good, say in the range of 15 cents EPS, this gives us full year EPS of 50 cents and I do believe we can see Coslight going quickly to 8-9 HKD.
If you have been following my posts on portfolio changes you know that I have been running a fairly high cash position lately. I have been struggling to find new good investments. With a few days off during Chinese New Year I have tried to search for new investment cases. I wanted to find something in Europe or the US but again it is a China exposure. I guess I keep coming back to this market because it’s here I still can find companies at reasonable valuations. American stocks for example just feel so expensive. Entering at a 5% weight in my portfolio – XTEP International Holdings a sportswear and mainly sports shoe maker listed in Hong Kong with almost all of it sales in mainland China.
Introduction XTEP
The company you can say is a copy-cat on the way Nike sell their products. A strong offering of running shoes and other type of sport shoes and then offering a whole set of other sporting apparel in the same shop. The company was listed in 2008 and share-price wise not much has happened since, although the company has delivered solid dividend over the years and increased revenue significantly in the early years. The company had a rough patch in 2013 and has now recovered closer to peak revenue levels.
Pros/cons
+ Dividend payout ratio around 50% – 5% Div Yield.
+ Attractive valuation multiple – Trailing P/E at 9.5
+ Sportswear and the “healthy trend” has also reached China, projected to have continued good growth for many years.
+ Working with popular celebrity Nicholas Tse who promotes their brand (my girlfriend who is Chinese thought this was an important point).
+ Looks wise, shoes improved significantly over the last few years. Now selling a shoe that looks as good as Nike but sells and half the price.
+ Seem to be ahead of competition in terms of e-commerce sales through Tmall and other online channels (including their own homepage).
+ Competitors share price has been rallying lately, XTEP is the lagger, a positive in my view since I see it as unjustified. But perhaps also a worry, what does the market know that I don’t know?
– History of trading at low multiples and high dividend yield in the past. Value trap? At least receiving a nice dividend is good, but why is the market so hesitant to multiple expansion?
– Just a few years ago fierce competition among local players, leading to weakest hands being shaken out. XTEP being a semi-small player also struggled, somewhat worrisome. The largest rival Anta held up much better during those years.
– Hard to judge what brands the Chinese would prefer among the local brands, some sell side analyst argue Li Ning has a better product offering and better brand image.
– Lately sales have been dropping in apparel (more on that later).
The competition
The market is lead by the international brands Nike and Adidas, likely one would expect more competition in the future from international players like New Balance, Asics etc. On the other hand there is probably room for consolidation of the “Others” piece of the pie, where probably Anta, Li Ning, XTEP, Peak Sports and 361 Degrees will be able to grow their market share.
So basically the local competition to XTEP is four other Chinese players, where Anta, Li Ning and 361 Degrees are all listed. Peak Sports was also listed but was recently acquired.
Market Value
P/E
Yield
CFO/Sales
Anta
62bn HKD
25
2.56%
16.7%
Li Ning
10bn HKD
N/A
N/A
8.6%
361 Degrees
7bn HKD
12
3.64%
5%
XTEP
7bn HKD
10
5.34%
16.5%
XTEP has been a clearly been lagging stock price wise and that’s the main reason why the stock look so cheap on metrics compared to the competition.
6 month return
12 month return
Anta
+49%
+35%
Li Ning
+18%
+36%
361 Degrees
+45%
+39%
XTEP
-19%
-4%
Sales and Revenue
The main reason for the weak performance lately (as far as I have been able to gather) is explained by this graph (Sorry for the first graph being reversed, 2016 to the left):
We can see the tough competition mentioned earlier, in 2013, where all players were witnessing pressure on sales. What has happened since is that apparel has not recovered, rather hovering sideways, whereas footwear sales has shown very nice sales growth. The last reported figures are a bit of a mystery and explains the share price weakness, apparel sales drops a lot, whereas if looking closely at the footwear data, H1 is normally weaker than H2, but the footwear sales comes in very strong. So what is happening with apparel? Well I don’t have a full answer, going in on their homepage I can see they are having heavy discounts on the clothes (80-85% discount on some items). The company has also stated a strategy on harder focus on footwear, becoming a leader in this field, expanding sales of soccer shoes etc.
Otherwise we can see that the business is operating profitably and generating cash (which is 50% paid out in dividend).
Risk reward looks attractive
I’m willing to take a bet here that apparel will recover to its previous trend of revenues around 900m and the H2 figures for footwear should come in strong. Even if it sales comes in at current levels, the stock is trading cheap and there is much more room for upside surprise compared to downside, which the market seems to already have priced in. I don’t really see why XTEP should be trading at such a steep discount to its competition, being a small cap stock I’m betting that the market has miss-priced the stock rather than that they know something I have overlooked.
If anyone has further input (on the ground testing of products etc) please do comment. I plan to visit Shanghai this month and will follow this up with a small field trip of checking out sportswear stores.
