My high conviction Hong Kong holdings

I promised in my “Summary 2022” to comment on the holdings that contributed most positively/negatively in 2022, they happen all to be Hong Kong stocks and among my largest positions.

Best stocks in 2022 – PAX Global and Vinda

Worst stocks in 2022 – Modern Dental & Greatview Aseptic

All four stocks have been reduced somewhat to raise cash during Jan/Feb but they are still high to fairly high conviction position. So without further ado let’s jump into discussing these for stocks. (click read more for a mega post)

PAX Global (327.HK)

For context all my transactions in PAX (basically I held most of my core position since 2020)

I got a fantastic return as from the get-go in PAX as the stock re-rated and delivered fundamentally. I spent more time to understand the company and felt I could verify it’s success by just observing the roll out of payment devices (POS terminals) verified through Nielsen reports. When the Hong Kong market turned around late last year I was expecting a sharp re-valuation – I did go up a few percent, but significantly less than the market. With re-rating I mean that the market puts a higher multiple on a company which in my view was too cheap. So expressed another way, since I invested, all the stock performance I gained has come from PAX fundamental performance whereas the market is rewarding the company the same multiple as when I bought the stock after the Covid crash. Normally this would not happen, a company that performs this well would be rewarded a much higher multiple. This is the EPS growth the past few years and in the coming week the full year numbers will come in well over 1 HKD in earnings per share (0.63 HKD in first half).

So the past three months I tried to understand why others (the market) do not see what I see. It basically comes down to trust in management being too low, so the stock never re-rates although fundamentally they deliver. The main issue clearly deterring investors is the raid at PAX warehouse in USA back in 2021, this straight away de-rated the stock and it never recovered. I was initially also shit scared when this happened, but PAX hired a credibly large independent investigator who found no faults. FBI has not issued any statements or taken any further actions since. Going into Bank of Americas main page for POS terminals, they have had for over the past year only one portable Android based terminal for sale, PAX best seller the A920: https://www.bankofamerica.com/smallbusiness/merchant-services/retail-pos-system/ . Surely FBI if they had grave concerns would make a call to BoA and ask them so change POS supplier, especially since the warehouse raid happened 1.5 year ago.

That BoA sells PAX terminals is one of the main reasons for me to keep the position at such a size and still sleep well at night. Given how low multiple the stock is trading at, clearly others see it differently. Trying to take the bearish view then, if one just looks at the Macro landscape of the US animosity towards China and that payments is one of many sensitive areas where such animosity could be expressed. I do also think there is a small but not entirely unlikely possibility that US would ban all POS terminals produced by Chinese companies or potentially even produced in China (even more unlikely since even the iPhone is produced in China). If this happened and PAX lost the US market entirely, the stock is still not wildly expensive. USA is about 15% of revenue and profits for PAX. If all of Europe would also follow suit then we have a real strong case that PAX is overvalued but I don’t see Europe taking these type of strong positions against China, it would rather be the negative spill-over of a US ban. So my bear case is that PAX loses the US market and the company would take a 15% direct hit, due to negative spill over lose another 15% through indirect effects. The stock is still trading around P/E 10 then in a very extreme bear-case scenario. Somehow it feels like the market is already pricing in this scenario, which to me is wild.

Focusing then on more base case outcomes I believe in: In my view the exceptional growth will finally slow for PAX in 2023, at least revenue wise. As the easy low hanging fruit of expansion with low competition on Latin America etc has been taken. But given PAX strong position in Android based machines I don’t believe that profits well be flat. I believe the top-line revenue guidance for 2023 might even be flat vs 2022 but profits should still be up, not only due to higher portion Android sales but also due to all the troubles in the electronics supply-chains easing which should give a boost to margins. I’m penciling a 2% net profit margin expansion, that is a boost to profits of over 10%. So my base is that forward looking PAX is trading below P/E of 5 with a dividend yield around 6% (depending on payout ratio). I will stubbornly continue to hold this as a large position but be humble to that nobody else dares to enter the stock, so it’s basically a very strongly performing value trap, or more kindly said, growth at a very reasonable price.

Vinda (3331.HK)

For context my transactions in Vinda since first purchase, core position from 2019 has been traded around

I just realized that although I held this for long and it contributed well to my performance (especially during early Covid days) I have written very little about this company. It actually deserves a full write-up given how unique, well performing and high quality it is. The stock being a bit less liquid also offers plenty of short term trading opportunities where the stock sells off strangely and often not long after rallying. I myself tried to under/overweight my core-position, which has further contributed to my alpha.

The company is simple enough to understand selling tissue, toilet paper and other pulp based products mainly in China and Hong Kong. The company has an ambition to also win market share in incontinence, feminine and diapers. Ownership structure is attractive with Swedish listed Essity having majority stake and the founder family as the second largest shareholder, this leaves a small free-float for a 3bn USD MCAP company. Two core brands, Vinda and Tempo are the growth drivers, with the potential to leverage mother company Essity’s brands. Especially Tempo is a very famous tissue brand for anyone living in Hong Kong and something I daily use. Tempo tissues have a clear premium feel compared to other tissues, the tissues are thicker, not flimsy and don’t fall apart when it gets wet. Over the years Vinda has successfully navigated the Mainland China market, outsmarting competition in the e-commerce space more recently and using the pricing power they have for their premium products. The Mainland market has quickly shifted its consumption to e-commerce, which as many of us know creates further barriers to entry. When you shop online you are less likely to try a new brand, than in-store. The company has based on sales volumes executed very strongly, but profit margins have clear cyclicality depending on input cost, the price of pulp. Shipping costs has also to some degree hampered profit margins lately.

As earlier said, this is a true quality company, hard to find better listed in Hong Kong, both because stability of sales but also governance with a Swedish majority owner. Although growth has come down over the years it’s still impressive: 15 year 17%, 10 year 12% and 5 year 8% CAGR of revenue. There is potential for a small re-accleration of sales as China now comes out of Covid. As you can see currently the operating margins hampered by Covid and high Chinese pulp price has brought down margins well below historical averages. As pulp prices recently have started to move down Vinda’s margins should quickly come back to at least historical averages over time. At the same time Vinda is only trading slightly above historical EV/EBITDA multiples whereas if margins just come back to the lower end of the historical range, the EV/EBITDA multiple will go down to half (profits double). This is clearly too low for a company with improving fundamentals and such strong revenue growth. Only if structurally the margins would never come back to the historical range would there be downside in the stock from here, I see no proof that would be the case. This company is as free from political risk and other non-sense as you can find. The CCP will never intervene the toilet paper market that I’m 100% sure off. So it’s a story of an extremely well run company, selling non-cyclical products, where the pulp price is at a cyclical high and coming down, at the same time as China is opening up and the economy is improving. This is clearly the safest China exposure I have in my portfolio, a lot of bad things could happen and this company is still around doing what it’s been doing these past 20 years. The only “problem” would be that due to it’s quality its not screaming cheap compared to other HK holdings (and it never has been).

Modern Dental Group (3600.HK)

For context all my transactions, except that I was too early to buy back shares in Dec 2021 I traded this well, again I kept a core position through the whole ride.

For the newer reader, here is my full write-up of the company when I first invested: http://www.globalstockpicking.com/2018/12/16/dental-industry-part-3-modern-dental-group-3600-hk/

This is a case where the stock price is more exciting than the underlying business, which is actually quite stable and slow moving. I guess we have to address why the stock made such a huge move as it did. The factors I can observe was that the company released very strong earnings during early 2021, at the same time as a much bigger dental related company IPO:d in HK (Angelalign which makes clear aligners). These two factors + the general growth stock hype created a mania re-rated it from a left for dead value trap to high multiple growth stocks. As you see I thought that the stock got overvalued and reduced my position. Then in Dec 21 I fell in the trap of buying because the stock was down -50% from highs, in hindsight this was stupid, the stock was actually not that cheap (which I clearly also did not think on the way up). But to not get to stuck in my trading of this position we can summarize like this, all my buy/sells means the outstanding cost for the shares I hold in my GSP portfolio is 3 000 USD whereas my position is worth 20 000 USD, so it’s clearly been helping my performance A LOT. As a side note, by this calculation I’m up 600% on my position but I don’t calculate realized gains into my purchase average.

More interesting than my stock trading rambles is how is the company actually doing. Before we go there, I just have to re-iterate, this company has world-wide dental product sales just as any other western company. The only difference is they have chinese leadership and are listed in Hong Kong, should that mean that the company is trading at half the multiples of western companies? Going back to my original analysis, the company is according to how I read the data, on track to deliver as my bull scenario back in 2018. Both in terms of revenue and improvement in net income margins. Although margins have really been tricky to judge as the Covid shut-downs which affected their factories/production has made it very hard to judge how much of a post-Covid margin improvement has already happened. The best guidance on revenue is the past year (with some upside that China has been closed) the best guidance on profit margins is much trickier. Recently a profit alert was released that 2022 revenue will drop some 5% vs 2021 and net profit will drop as much as 38% vs 2021. That might sounds very bad, but actually its not. That means H2-2022 vs H2-2021 both revenue and net profit is roughly flat, which given how locked down China was in H2-2022 is really strong. Also a Net profit for 2022 of 220m HKD is more than double than when I bought into the stock in end of 2018. Soon I can update this with the Q4-2022 data, but for now this is what we got.

Looking at trailing EBITDA multiple on can see it has come up from it’s lows, but that is also not accounting for that H2 is a big improvement on H1. These multiples for a company in the dental business with sales worldwide is very very cheap. This could easily be a 15x EBITDA/EV multiple company if it was larger (this was the reason I did not sell my full position even at the price spike). I’m quite excited what this company can deliver in the coming years. They have a clear aligner product coming to market now, at the same time there is a lot of pent-up demand in China for dental procedures (what better time to do it while you can still hide behind a mask for a while longer). The company has been saying since middle of Covid that the situation disrupted the smaller competitors much more and that MDG is coming out as a winner after a tough time period. Just the clear aligner area which the company recently invested in could be a whole new leg of growth for the company. I do think the company well continue to execute well and deserves a much higher valuation more in-line where it traded when it IPO:d on the HK exchange. I reduced my position somewhat but I think this is easily worth 5 HKD per share, almost a double from here.

I invite you to watch this 4 minute video to get a feel for how MDG operates, the only thing I can clarify which is brushed by quickly in the video is that MDG strategy is that much of the production is done in China (and soon Vietnam) at a low cost. Only returns from the dentists or products of highest quality is produced by the more local centers MDG owns. The majority of volume is still done in China. That said, the more local centers are of course crucial to build sales in each country MDG operates.

Lastly I leave you with a recent Sohn Conference stock pitch of MDG:

Greatview Aseptic (468.HK)

For context all my transactions, this has been a clear detractor in my portfolio, especially by increasing my sizing on the way down

Last but surely not least, Greatview, which perhaps should be renamed Badview Aseptic after all the trouble the company has gone through lately. It started with a full pull of the dividend, which chocked me and other investors. Why? Because this was a company which prided itself with an extremely high and stable payout ratio of around 80%. This stock was mostly a high dividend play with some growth sprinkled in on top. The stock entered a free-fall due to this and the poor sentiment on the HK-exchange (clear mistake by me to not just sell the full position straight away). On top of that I had speculated in a buy-out by the management as the reason for the div pull, therefore decided to instead of selling buy more into the falling knife. A buy-out of sorts did in the end materialize, but of the worst kind that I even in my nightmares could not have dreamt up. The largest shareholder Jardine sold it’s stake to an equally sized newly listed Mainland Chinese company, which had Yili as a backer and large owner. This upset Greatview’s other customers and mainly Mengniu Dairy which did not like becoming a customer to something that was effectively a Yili subsidiary. So instead of the stock increasing from Jardine’s sale, only Jardine got an OK price for it’s shares and then the stock tanked. Now the shareholders are so shell-chocked of everything that happened, including me, so it’s very hard to talk normal fundamentals and if this is trading at cheap multiples compared to its history etc. It is basically a shit-show, where selling now means selling your assets at fire-sale prices. Perhaps it is the best move given that Mengniu and others are threatening to leave Greatview incase the deal goes through. Greatview management tries to block the deal these past few days, but given that it’s not a majority stake I don’t think it will be successful. There are also more positive outcomes possible, where Mengniu actually defends its position by buying a stake in Greatview as well, blocking Yili to take majority ownership, basically starting a bidding war for my shares. Right now though the more likely scenario is that Mengniu will reduce it’s sales to Greatview and Yili will increase it, on-balance it’s probably a big loss for Greatview, meaning it’s a big guessing game if Greatview is still cheap at these levels.

One of my larger conclusions on this mess is that it’s taken up way too much mind-space for me, which is a good a reason as any to just take the loss and move on. I’m going to ponder on this a week or two more before deciding. Talking valuation, if this mess would magically disappear (which it will not), the stock is an easy double from here, as pulp price is coming down and China re-opening will add a nice tailwind. Also not to forget, half of the companies sales are not affected as that is in Europe.

 

Hope you enjoyed this mega post of my HK high conviction positions as of year end 2022.