I want to start with a graph of EURUSD, because it has such profound effects on the market when it starts moving.
With the risk of being called something of a Chartist, to me this is a significant move. We are breaking out of a 2 year side-way trend. This could be the beginning of the normalization of major currencies, where we see EURUSD moving back to it’s previous range 1.20-1.50 which lasted for about 10 years. What is a normal range though? It all depends on what time perspective you take. If we look at 30 years of data, we are today already very close to the average exchange rate. The 360 month moving average is at 1.21 and the 500 month moving average is where we are now, at 1.18. If EURUSD moved to for example 1.4 over the coming year, that would definitely have profound effect in the stock markets and on all ours portfolio returns.
Exporters vs domestic
The kind of currency move we see now, leaves its mark on a Global portfolio and it’s returns. The effect is largest for domestic companies. For example if we take my largest holding Skandiabanken, which is a Nordic online retail bank, generating majority of it’s revenue from Norwegian Krona (NOK). Since all it’s costs and revenue is in NOK, its a purely domestic company. So when USDNOK moves, the portfolio experiences the full currency move, whereas the fundamentals for the company stays the same. Since investing in Skandiabanken I have realized an extra 6% return from the NOK strengthening, pure luck!
In comparison my holding in LG Chem, is traded in Korean Won (KRW). But the company exports all over the world meaning a lot of it’s revenue is priced in USD. So if KRW strengthen against USD, the company will earn less in KRW terms and the stock should fall. At the same time the KRW stock price is worth more in USD terms, so the effect negate each other.
This means that companies that mostly sell domestically adds an extra component of FX-risk into the portfolio. To make it even more complicated, the domestic company might have it’s cost in USD and chose to either hedge it or leave the currency risk open. If you as an investor compare yourself to a benchmark, your definition of taking risk in this sense, is if you have another mixture of exporters vs domestic companies, per market, compared to the benchmark. This will make you over and underweight a number of currencies. It all sounds very complex, but since weightings of for example MSCI World is so heavily tilted to the larger markets and large companies, in effect, you mainly have under/over exposures to a few major currencies (USD, EUR and JPY). The tricky part is that you won’t really notice this effect, before one of the major currencies really start moving, like now.
Conclusion?
So what’s the point of this analysis? My point is that major benchmarks is made up of large companies with revenues worldwide, so the majority of your portfolio from a Global benchmark will be USD exposure. But if you as a stockpicker, find smaller domestic companies, which have their revenues and costs in a local currency (either naturally domestic or hedged to a domestic currency). You will have an implicit bet on that currency versus the USD.
The reason why I bring it up, is because two of my holdings that have performed the best, is such holding, Skandiabanken and Ramirent. It’s nothing I lie sleepless at night about, just something to keep in the back of your head before you fill your portfolio with such holdings.
Portfolio Update
A quick look at the portfolio performance and composition shows continued strong performance, both for my holdings and the benchmarks. Especially Hang Seng is on a tear lately, somewhat frustrating when I already have come quite far in rotating away in my Chinese holdings (and the ones I have left have not really moved). For example my two previous large positions in Ping An Insurance and YY has in the month after I sold surged 15% and 33% respectively. Whereas the stocks I bought in Europe have trades more or less sideways (Tokmanni being the exception), I have also been somewhat saved by the weakening USD in these holdings. Cash level is still high, as always I’m spending a lot of timing searching the markets for something investable. And as always lately struggling to find anything worth buying. In my Portfolio page I have made my Watchlist a bit longer (in reality it is much longer than this) but maybe those stocks can give you some investment ideas.
Going forward
I will take one final slash sometime this year, to further reduce my China exposure (it will not go to zero as long as I find very interesting investment cases there). And according to my previous post about “where to hide”, I will try to move my portfolio one more step defensive (less cyclical) than it currently is.
This post will be about, how to best position your portfolio for a bear market. I just want to begin by saying, I’m not calling the market peak. As we know markets can stray irrational longer than you can stay solvent, at least if you are betting against it. I believe markets to be somewhat irrational right now, with little to no regard to risks, which is shown forexample in the record low market volatility. But with this portfolio I’m not in the game of betting against it (going short). I want to earn the long-term equity risk premium (a.k.a. Beta). Looking at stocks on absolute basis in a more normalize world (meaning healthy equity risk premiums, normal interest rate and inflation levels), I really struggle to find stocks that feels cheap, have a margin of safety etc. More and more I tend to see sell side analysis (and fellow bloggers) value companies on a peer basis, “this is cheap relative to this”. And when something actually is valued with a DCF, when you replicate their analysis, you find that they have used ridiculously low equity risk premia or WACC for the discounting. If you shift that discount rate up by only 1-2% and all of a sudden the stock goes from a buy to a screaming sell. I don’t like it, but as I said, I’m not going to try and time when we get a major pullback.
What do to?
So I believe we are in for a bear market with a -30% fall in stock markets from current levels in the coming years. But I (obviously) don’t know when it will come. This belief means that we will see a multiple contraction, or lower earnings/margins, or both. Let’s play with the thought that markets keep being valued (same multiples) as today and companies earn the same. For every year that the markets do not fall there is an equity risk premium (albeit lower) and dividends to be harvested. Which means staying outside the market waiting for the crash has a expected cost. The expected cost is more or less the current discount rate the market has on earnings (a.k.a. the equity risk premium). It’s good to have this in mind when playing with the thought of protecting oneself from a market downturn.
So what do to and where to hide?
Cash
Well the easiest answer is keeping some cash, and that is what I haven done. Since I started my portfolio, I have kept a high level of cash and only been fully invested for a short period. Holding this cash has been a way of for me to stay ready for the downturn. I want to hold some cash for that time when you can pick up companies on the cheap. This has been a stupid strategy so far. The GlobalStockPicking portfolio is up 40% since inception and I held and average cash buffer of 9.8% for that period, that is a performance drag of 4% (cash earns 0% in my model portfolio). Even if we see that pullback in markets I’m talking about (-30%), I will need to time it pretty darn well to come out positive, compared to always being fully invested. Meaning I would need to deploy all cash almost at the bottom to gain back what I missed out of.
Cash Levels in GSP Portfolio
As can also be seen in the graph above, during 2016 I did not consistently hold high cash levels, It was more an affect of my wanting to sell an holding and not having something new lined up. Whereas this year, 2017, I have with some variation, held cash at around 14%. It aligns fairly well with my feeling for the market, 2016 I was still fairly bullish (although still very worried). Now I’m turning fairly bearish and especially US markets feels insanely valued, especially considering that interest rates have moved up. I have probably been skeptical way too early, but I’m not about to change now. But the conclusion must be that this is been a quite poor strategy, which has been masked by me managing to pick stocks that have outperformed. Outside the world of this blog on a personal level I have kept even more cash on the sidelines, which has been terrible (so far).
Categorizing holdings
I would argue that I can categorize all my holdings into one of these 4 factors (although sometimes they might fit into more than one category):
Growth
Dividend
Quality
Value
A quant would use a stricter definition in terms of different ratios to define what stock falls into which factor. I will from the knowledge I have about my companies, in a more “soft” approach classify my holdings. These four categories have different general characteristics in terms being high/low Beta and also resilient in different macro economic environments. For example high/low inflation coupled with high/low interest rate levels. By looking at holdings in this way, we can get a better feel for how they will be repriced in a bear market and/or higher interest rate environment. The below picture is one guide to how different factors perform in different environments.
As you see there is other ways to categorize a portfolio than my 4 factors, for example if the company is a small or large cap (Size). This can be very important in a bear market, because what might seem fairly liquid in a bull market, can be very hard to trade in a bear market. And when liquidity dries up in a stock, that stock should all other things equal trade down, due to a increased illiquidity discount. But I will start by grouping the portfolio into the four categories above.
1. Growth – Highest risk
When the bear market already is a fact, growth stocks have in many cases already collapsed. The reasons for it is fairly simple. Growth stocks valuation is built on the expectation of continuous growth of revenue and earnings. And when markets fall significantly, that is usually the end to (high) growth for most companies. A more scientific way of putting it would be that a growth company has it’s cash-flows further in the future (the duration is higher than for a highly cash generative, non growing company). When markets fall the equity risk premium goes up, meaning that discounting those cash flows far away in the future will suffer more. The same duration argument is true when rates are rising, where the risk free rate is a component in the equity risk premium.
Whichever way you look at it, growth companies have high Betas and will drag down your portfolio more than the benchmark when markets fall. Of course if you manage to find the company that still grows while markets in general fall, you will be better off, stock picking still applies and that is your alpha. But in general with higher equity risk premia even your alpha generating picks will not yield you as much as in a bear market. The idea then surely would be to rotate out of these kind of stocks if one believes in a coming bear market. So somewhat surprising I have a large portion of my portfolio is in this category.
My holdings I consider Growth:
Skandiabanken
My largest holding, thanks to the tremendous gains (and favorable currency development). Mainly a Norwegian online bank, challenging the “old” banking model. The stock has traded up in the general strong trend of bank stocks, but has also with it’s superior growth been able to outperform. This has been something as unusual as a growth company which has not traded at so stretched multiples. One big worry right now is the Norwegian property markets which has shown its first signs of weakness. The real test will probably be this autumn when larger volumes will be moving to see if this a new trend. Long-term I believe in their case of challenging the big banks, but there will be serious trouble if the property market really dives.
Ramirent
I actually bought this knowing that we are late cycle with construction booming in the Nordic region, historically Ramirent then always does very well. The market usually reprices the stock fairly rapidly when the late cycle earnings start to kick in. This is something I’m looking at off-loading as soon as I find something new interesting to invest in.
BYD
The main company in China to benefit from larger EV usage. They are currently profitable, but most of it’s value is in the expectation on future earnings.
XXL
Sportswear and wild-life retailer with good track-record of profitable growth. Can they keep it up? I believe so, but if I’m wrong this company will for sure trade down.
2. High Dividend Stocks – defensive?
With zero interest rates high dividend and companies with large buybacks have both been popular strategies. Companies which such characteristics have in general seen great multiple expansion. And rightly so, such a stock can be seen as a perpetual bond. And with long term bond-yields decreasing, that should transfer into the equity world that all else equal, these stocks should trade higher. I have tried to hold some high dividend stocks in my portfolio, especially when I started my portfolio I held the SAS Preference share which had a yearly dividend yield around 10%. There is also an important difference between high dividend, high risk companies, and very stable non-cyclical companies paying decent dividends. Many dividend stocks should be defensive (low beta) in a market downturn. But high yield and leveraged companies where the market is crowded in search for high yields, could be a real minefield. My SAS Pref shares was of the later type and that was one big reason why I sold out when I thought the market started to reach the end of the bull market. I have tried to find dividend stocks that are less cyclical and can keep their pay-out levels even when the cycle has turned.
What I’m trying to say is that dividend stocks can be off all types, some defensive, some rather high leveraged companies in a market with falling revenues (oil/shipping/coal etc). If interest rates would go massively higher, the world will probably in general be vary shaken up. But of course a stable company with limited growth opportunities, yielding perhaps 4-5% will look much less attractive if the risk free interest on your bank account also is 4-5%. These kind of stocks could go from darlings to very uninteresting in such a scenario.
My holdings I consider high dividend:
ISS
My recent investment in ISS, I saw as a fairly high dividend case. Not because of current dividend yield, but due to my expectation on them raising the dividend. I also saw this holding as a way to make my portfolio more defensive. They have paid of their debt and are highly cash generative, which I hope means that they will raise the dividend yield up towards 4.5%. The cleaning and service business probably will be somewhat affected if markets fall, but I would not call it cyclical, their contracts will be fairly stable. But of course stable businesses with high dividend yields is a bit like looking for the holy grail, you will struggle to find it. I do not think ISS is the holy grail, but a decent option to make my portfolio more defensive through fairly high dividend payments.
Nagacorp
Another case where the dividend currently has plummeted, due to the complicated convertible bond structure. But with revenue increases from the newly build Naga2 casino expansion, I expect this to again be a stock paying healthy dividends in the 5-6% range. Another positive has been the latest development around this convertible bond, where the majority owner has agreed to somewhat more reasonable terms from conversion and therefor the stock has bounced significantly from it’s lows. It’s still a cheap stock, due to its dented reputation and the way the majority shareholder has treated the minority in the past.
Tokmanni
With the recent lowered guidance for growth and turbulence of the leaving CEO I got the opportunity to buy this company on the cheap, it has come up a bit now from it’s bottom, but still trading cheap. Even if the market environment seems to continue to be tough, I expect them to keep delivering a 5-6% dividend yield.
3. Quality is surely the most defensive?
Real quality companies maybe is the way to go then, for a defensive portfolio. Better than holding cash and safer than high dividend companies? Well.. ..in theory yes, but the problem is that defensive quality businesses are naturally more very expensive stocks. The question becomes how much are you willing to pay for this quality? Low interest rates and people scarred by the 08 crash have in my opinion created some crowding into these stocks, which means that they are many times trading at very stretched multiples.
Let’s look at a few examples of prime quality companies. I picked out some of my favorites (from a company perspective) out of Goldmans Sustain 50 list: Goldman Sustain 50
Some metrics Quality companies
And to put the figures into perspective, let’s compare it to my current portfolio
Same metrics for GlobalStockPicking Portfolio
Looking at the table above, I think there is plenty of room for multiple contraction for high quality companies. As well all know the FANG club and some other have been darling stocks for many many investors lately. This also happened in the 70’s when the large American companies were trading at very stretched multiples (Nifty Fifty). Let’s take a well known example, Coca Cola, what says that P/E 24 is a reasonable level for this company? Well with low interest rates maybe that is where it should trade. Let’s take a look from a long term perspective.
Coca Cola P/E the last 30 years
What this graph tells me is that, the market can get even more ahead of itself and value Coca Cola on P/E 30, giving it another 30% upside (+ future dividends currently at 3%). That is something of the blue sky scenario for a holder of Coca Cola shares. A blue sky scenario with 30% upside does not sound great to me. I rather see this one trading down to P/E 17 in a weaker stock market, but that of course still might be defensive and a smaller drop compared to the benchmark, still making this a defensive play. But again a defensive play with very little upside does not make sense to me (if the yield is too low). Then I rather keep cash, or rather, there must be better options out there. But of course fairly valued quality companies would be a very interesting candidate to invest in and perhaps I should allocate larger portfolio weights to the ones I found.
My holdings I consider Quality:
Microsoft
Given that this company is even on Goldman’s list I don’t think further explanation is needed why I classify this as Quality. What I will say though is that obviously I have been way to quick to scale down this holding, since this type of company just keeps defying gravity. But at this valuation levels I’m not far from throwing out his holding, a company can be wonderful, but not at any kind of valuation levels.
NetEase
Amazing company, delivering high quality gaming experiences to the Chinese, and the best part, the valuation is not too stretched. The reason for that in my opinion is that you are running other risks, in terms of concentration risk against the Chinese market and that the company needs to continue to deliver new hit games indefinitely to justify its valuation.
Huhtamäki
Delivering food packaging products world-wide with a strong track-record of execution and partnering with world leading companies to deliver coffee cups and much else when coffee companies expand worldwide. As long as management keep delivering as in the past I don’t see anything stopping this company to keep growing at a moderate pace for many years to come. A boring but high quality business.
Sony
A company standing on many legs, everything from movie production, TVs, to PlayStation. I think they have a strong product portfolio and I really like the video-games. VR has not become as big as I thought, but still has a lot of potential. Current P/E levels is pretty crazy at 79 (a mistake in my table above).
4. How about Value then?
We do not want to pay too much (high multiples) for our investments, we then end up in some type of value stocks definition. But in this market finding true value cases is not easy. In my opinion you either end up buying micro/small cap stocks in markets where the companies have been forgotten. You then run a large risk of a value trap, and illiquid holdings. Meaning yes you are right, the company is trading at a (unfairly) low multiple, but it could keep doing so, for years and years. It’s going to be a very frustrating investment. You are right on the numbers, but the market keep you in the wrong on the valuation.
If you instead move over to larger companies, you instead end up with cases where there is some serious market disruption or company specific crisis. Some of these cases turn around and you have a great investment on your hands, but it’s a serious wager against consensus. And although it’s good being contrarian one should be humble enough to accept that the market very often is right. Right now you could probably make a Value case for stocks like Kohl’s and Macy’s in the US. In the Nordic market perhaps Ericsson that I discussed and owned before as well as Pandora, the danish jewelry maker. All of them with their own set of problems.
I love to find good Value cases, but it is getting increasingly difficult, and mostly I end up finding them in the Chinese market.
My holdings I consider Value:
Coslight
After scanning the market for the best way to play the Electric Vehicle market, I chose this stock together with BYD and LG Chem, this has been the largest disappointment so far. It seems that a small company as Coslight with already high debt levels has a hard time scaling up in the way needed. I still haven’t given up on the company though. Recently they announced a partial buy-out of one of their main battery factories to be able to scale up and lessen the debt burden. It shows that there are investors out there that believes this company is sitting on a lot of value. They made a sizable profit last year and are trading at around trailing P/E 9.
LG Chem
This is reasonable priced Chemicals company, why I put it in the Value bucket, is the hidden value from the battery production business. This I believe will be unlocked and re-rate the stock over the coming 5 years.
CRRC
A Belt and Road play with fairly low multiples. This a holding I have got more unsure of as markets totally ignore the Belt and Road progress so far. Not sure if it was a good idea to invest in a company mostly owned by the Chinese government.
XTEP International
The company in my portfolio with the lowest valuation, but also of the type described above. Small cap and ignored by the market, classical value trap. And a very similar case like Zhengtong Auto which I owned before and sold after holding it for a long time to a loss. Unfortunately for me, the company is today trading 200% higher than my selling price. The value in that one was finally unlocked, but I didn’t have the patience to hold on to it. Will this be another case with a similar story, or just a company that never will deliver?
Conclusions
Stock picking is about alpha, and it should be possible to generate alpha both in bull and bear markets. But a lot of free out-performance can be gained in a bear market thanks to having the right type of factor tilts in your portfolio. My portfolio is fairly diversified in the different factors, but I could definitely have more Quality in my portfolio. I find it easier to find reasonably valued growth company cases right now, it naturally becomes easier to see companies as cheap when you put a high growth figure in your forecast. But as I said, that might be an unreasonably positive expectation if the cycle turns. I would like to have more Quality and Value in my portfolio, but I struggle to find good investment ideas. If you have some favorite stock picks which are defensive in nature, please share in the comments.
Another problem of being a stock picker is that you tend to hold much more small caps. Naturally it’s in the less researched stocks that you can find mis-pricing, this will also hurt the portfolio in a bear market. Buying small caps is not something I’m willing to stop with, because I believe it will be too hard (impossible?) to generate alpha otherwise. This is just an unfortunate problem you have to live with as a stock picker.
Holding cash has not been a successful strategy so far, it would have been much better to be fully invested. I put myself somewhat in a corner keeping this cash buffer, since I really believe we are in a very late stage bull market. So for the time being I will continue this strategy, although it is not in general a good idea trying to time the market top.
I have had a extra close eye on YY for a while now. The reason is that it had surpassed my conservative valuation in my analysis (YY Full analysis) of 56 USD. Actually I still wanted to squeeze out some more of the juice and believed we could see the stock trading up towards 70-80 USD. Especially considering how well other tech stocks are doing. But one of the concerns that I listed was a potential government crackdown on live-streaming. This is also something mainland Chinese people have warned me about when I have discussed the YY investment case. As an investor in China I have the fullest respect for what the government says and plans to do, in-fact many of my investment has China’s long term plans as a nice tailwind for the investment case.
On the 22 June a State administration announced it had requested to suspend several video portals due to lack of licenses. The largest company affected was Weibo and two others, this was not at all related to YY. Later on information came out that the number of services that had been named was larger than the initial 3. Today before opening the market realized this crackdown is more serious than initially expected. I haven’t myself managed to get to the bottom of this, just reading news articles like these ones:
Quite often these things just blow over, forgotten in 3 months and everything is back to normal. But sometimes it’s the real deal and nothing will be the same again. Given that I reached my target price and YY has not traded down drastically on this, I take it as an opportunity to both further reduce my China exposure and sell my holding close to my base-case target price, and a very healthy profit.
Tokmanni which today is something of a “Wallmart light”, started in 1989 and changed the name to Tokmanni in 1991. The first stores were established in Eastern Finland. In the 2000s it was decided to expand nationwide, and Tokmanni made significant acquisitions in 2004-2007. The larger acquisitions were Vapaa Valinta, Tajousmaxi, Robinhood and Säästöpörssi, in total about 90 stores were acquired from these four and over 100 stores in total was acquired. In 2008, a new administration and logistics center in Mäntsälä was started, including nationwide distribution of products. This was to oversee the previously decentralized activities. In 2012 PE investor Nordic Capital acquired 88.5% of the shares and Mr Seppo Saastamoinen acquired 11.5%. 2012 was also the year TokNet e-commerce opened. After this a brand harmonization followed, and as of 2016 all the stores and the online shop are known as Tokmanni.
Tokmanni is today the largest general discount retailer in Finland measured by number of stores and revenue, with 163 stores across Finland as at the end of first quarter.
The product assortment includes A-brand products from leading manufacturers, Tokmanni’s private label products, licensed brand products and non-branded products.
Tokmanni’s policy is to lease, and not own, its store premises. Stores are normally leased on a 15 year term
In 2013 Tokmanni entered into a JV with Norwegian listed Europris for sourcing of products from China. The joint venture has resulted in savings across various product categories thanks to both better pricing and scale of orders. Margins are 10-15% better on products sourced this way.
As of Dec 2015, the split of product types sold is the following:
Groceries – 31%
Tools and electrical equipment – 19%
Home cleaning and personal care – 16%
Leisure and home electronics – 12%
Home decoration and garden – 11%
Clothing – 11%
The good and the bad (+/-)
+ Tokmanni has successfully consolidated smaller players under it’s brand name. Economies of scale together with increased direct sourcing from Asia has the potential to support further margin expansion.
+ The Finnish market seems to be look more favorably at discount stores (although the stock market is very negative to bricks and mortars). The company is taking market share (still opening new stores) in what has been a tough market (defaults and low profitability among competitors).
+ Anttila department store bankruptcy in 2016 created short term weakness (store clearance), but should mean long term opportunities (Tokmanni is taking over Anttila empty store space). The store openings will also short term lower profit margins, but is of-course a long term positive. The store indicated to be added in 2017 is 26 000 m^2, which is roughly an increase of 6% of total floor space, much higher than previously, if this is executed successfully, it should give 5-6% revenue growth in 2018. I value this growth opportunity at 30 cents per share in 2018 and possibly more in the coming year.
+ Finland’s economic outlook has been lagging rest of Europe but lately there has been clear improvements, something of a turn-around? An improvement in Finland’s economic outlook would warrant a higher share multiple.
– Recent Profit warning for 2017 (Link), revising down guidance. Is this the beginning of a longer term trend? They blame weather (which I hate when companies do, although I can agree that snow in June in Finland is extraordinary). Listening to their latest full conference call after Q1 it sounded like it was not all weather related, but rather that they had not supplied stores efficiently.
– The Like-for-like store sales has not been that impressive (but the market has been weak). Tokmanni’s own data paints this picture:
– CEO was supposed to leave in September 2017, after 8 years at the company. A few days ago he announced that he is leaving early. Not sure how much to read into this, normally it wouldn’t be strange for a CEO to leave after 8 years, but if one wants to speculate, the way he left leaves some question marks. Obviously there is also uncertainty around the new CEO they are now looking for. The company was floated by Nordic Capital and they have now divested the majority ownership in the company, the lack of a new strong majority owner also gives some reason for concern in this regard.
– Its sales channels does not sound that modern, one would have hoped some more modern technology, like apps. But they rather have been spending their sales budget on this old style leaflets sent by ordinary mail, with the “weekly discounts”. Probably works well with the older generation, but not really for people below 40. The homepage they have is OK though and maybe their newly hired Business Dev Director Hanna Nikoskelainen can change that.
– The share price is not even in a negative trend, but rather in a free fall currently. Who knows when this turns around, one could get hurt (short-term) trying to catch the falling knife. This is off less concern for me though, although I prefer to buy stocks with good long-term momentum.
Seasonal results
As can be seen below sales (and profits) are highly seasonable, we have just now passed the weak first half year. The company has been growing at ~3% yearly rate (store openings rather than stores selling more), but the latest quarter was a disappointment and now they are warning that Q2 will also be disappointing.
Valuation
The valuation model is highly sensitive to both margins as well as the cost of capital. I believe research firms that get very high DCF values are using a fairly low Cost of capital when discounting the cash-flows. I’m more conservative here with a WACC of 7%. I like that the bear case shows so low downside risk (about -15%), given that we are already in a weak market in Finland and if anything, signals are for improvement.
Valuation assumptions – base case
Moderate average future revenue growth at 2.5% per year.
An EBIT margin of 6.5% growing to 7% over the coming 5 years.
Cost of capital: 7%
Gives a DCF value of 8.13 EUR per share.
Valuation assumptions – bear case
Low future revenue growth at 1% per year.
An EBIT margin of 6.5% decreasing to 6% over the coming 5 years.
Cost of capital: 8%
Gives a DCF value of 6 EUR per share.
Valuation assumptions – bull case
Maintain 3% revenue growth rate over the coming 5 years, thereafter lowered to 2.5% per year.
An EBIT margin of 6.5% growing to 8% over the coming 5 years.
Cost of capital: 6%
Gives a DCF value of 12.5 EUR per share.
Looking at Peers
Conclusions – Initiate 4% position
I would not say that this is my strongest buy case ever, but I like being contrarian and do believe you have to be contrarian to generate alpha. Or if you are not contrarian, at least you have to identify the new trends before everyone else. I think this is a stable business, which is just experiencing a bit of a soft patch and turbulence currently, which will have passed before year end. Indicators in Finland are improving (Consumer Confidence) and the bankruptcy of Anttila is actually an extra boost in long term revenue growth for Tokmanni. I also like the very healthy dividend yield. All in all the probability of outcomes seems skewed to the upside, I put a medium-term target price of 9 EUR and will re-evaluate the case when/if it is reached. I initiate a 4% position.
The Norwegian sporting goods retailer has been hit by the same negative trends as all bricks and mortar stores worldwide and the stock has traded down significantly from its highs. I’m not sure if it’s wise to go against this trend of bricks and mortar shops all dying from online competition, but my thesis is this niche will be less hurt.
Today the first sell recommendation on XXL was released by Arctic Securities. Arctic is claiming there is a structural concern, partly by competition, but mostly from the named headwinds from Online competition. Long term I don’t agree that should be the case for XXL, I believe this company has something unique and will continue to grow and take market share long-term. Everyone you talk to likes shopping at XXL, for a number of reasons. They have good products, the staff working there is competent and at the same time they have pricing which is good enough, so you do not go home and order it online instead. So I see this as a short term miss-pricing, where the baby gets thrown out with the bathwater in this trend of everyone selling bricks and mortar.
Initiate with a 4% position
This is a growth stock, and I’m buying it on the belief that they will be successful to continue to grow, in particular Sweden and Denmark. As a more long term option is the Austrian and later German market, that will take time to materialize, but I do like that they have ambitious targets of growing. I’m willing to add to my position if no negative news come out and the stock trades down to the 70 NOK range.
Catching up to do – Analysis on the way
I have quite a lot of catching up to do in terms of deeper research. I will spend my time during the rest of the month to try and produce more in-depth analysis of some of my recently bought stocks, including this one..
Although its my smallest position in the portfolio, I have writte quite a lot about Nagacorp in the past. More about Nagacorp.
When i finally took a position, I did so with some short term hesitance, given that I did not see any short term triggers. It will take time to scale up the revenue when Naga2 becomes fully operational. That means there is still time for potential share weakness when short term investors are shaken out. I think we have seen that over the last few months. And although the majority owner is not treating minority ownerd fully fairly, the crubles we get still goes a far away at these valuation levels. With a succcesful launch and almost doubling of revenue over the coming 2-3 years warrants a share price in the 6-7 HKD range depending on the margins they manage to achieve, as well as what the Camobidan government decides to do with its tax levels.
Im willing to double my holding at these levels, with further share weakness it could potentially become one of my high conviction holdings.
Shanghai Fosun Pharmaceutical
Although Nagacorp is HK listed and a part of its customers are Chinese, its not a pure-play Chinese company, given that it is located in Cambodia. Even so I feel obligated to keep reducing my China exposure. Which is not an easy task given that I see a lot of value (lower valuations) there than elsewhere. But as I written before this is a tactical portfolio decision, I just have to do my best to find interesting investment cases in other markets. Given this I say thank you and good bye to a holding that has become a real success investment, Shanghai Fosun Pharmaceutical. I bought the stock at 19 HKD in August and sell out now at 31.85 HKD, where a large part of the gains has been multiple expansion.
The long long term case for Chinese Pharma and stocks in the Hospital business particularly I think is still intact, I hope the future gives me another opportunity to buy this stock on the cheap.
I have in numerous post expressed in different ways my feeling of wanting to rotate my portfolio away from it’s heavy China tilt. But why did I end up with such a China exposure in the first place? Here is a few reasons:
I live in the region and spend quite a lot of time in general to understand China, this obviously helps in finding opportunities to invest in.
With a bull market roaring almost everywhere, stocks with China exposure has been one of the biggest pockets of reasonably or even cheaply valued companies.
My focus on Electric Vehicles and the changes that will bring about, has lead me to invest in Chinese companies.
Why I’m rotating away is more from a Macro perspective. I’m quite scared of the speed of the debt build-up in China. Many professional stock pickers I have met says, don’t try to time Macro events if you are a stock picker, generally I agree. One can’t be a master of all and you should try to stop predicting Macro events as the reason for buying or selling stocks if you are a bottom up fundamental stock picker. But there are circumstances in more extreme cases where I believe Macro should not be ignored. I believe we are starting to enter such territory for China. I think Kyle Bass (who has been wrong on China for quite some time) has some good insights it in this short interview: Kyle Bass on China – Bloomberg interview.
My views
I don’t have unique sources or insights on China. I read daily news on China, listen to people who live there, as well as more informal sources of information (blogs/vlogs etc). Much is great (and bullish long-term) about the Chinese people, their willingness to study hard, their respect for knowledge etc. But the picture I paint right now of all information I collect, does not look good.
If I focused on the negatives this would be my observations, much of it you have heard before:
People in general believe property prices can only go up, because they have never (since the 90’s) experienced anything else.
Property price to disposable income is among the highest in the world and if you can come up with the down-payment, there is no questions asked from the banks for you to receive your mortgage.
People buy property they do not intend to live in and which they sometimes struggle to rent out, but it’s OK, because so far they have still made capital gains on it.
Chinese construction companies build with awful quality and Chinese have a non-existent system of maintaining common space in residential buildings. So even buildings just 10 years old start to look old. Not keeping property in decent shape must be a very effective value destruction which is not much talked about. Just considered all Chinese property today marked at value 100, where 30% is down-payment and 70% is mortgage, what happens after 15 years when the property has deteriorated to such a state that people only are willing to pay 50 for it? This is not discussed because the property market goes up quickly, but when it’s not going up anymore, the bad building quality/maintenance will be eating away maybe 3% equity each year. On top of that, Chinese like new things.
Wealth Mgmt Products with 6-8-10% interest is virtually risk free in peoples minds, rare defaults are covered by state owned banks in most cases.
The speed of property price increases has gone into warp speed in the larger cities. Shenzhen is up +120%, Shanghai +55%, Beijing +56% – the last 2 years.
It used to be the case that Chinese people were diligent savers. Not so much anymore, younger Chinese are jumping on the borrowing band wagon and are willing to spend money they do not have, money is made so easily anyway and being an only child has meant being used to being spoiled by the older generation, which leads me to my last point.
China as many other countries is going to face the wall of retirees and a reduction in the workforce, at the same time as the country is doing the difficult transition into a more serviced based economy.
All of the above and the speed of how quickly Chinese are making money in the last few years is telling me this is a train about to derail.
Portfolio Changes
Even if I did not have any doubts about the state of things over in China, my portfolio which should have a global focus has been over exposed to China. In terms of fairly pure China exposure I have the following to choose from: Ping An Insurance (8.9%), Coslight (+7.1%), BYD (6.5%), YY (6.2%), NetEase (5.1%), Shanghai Fosun Pharma (4.5%), XTEP (3.9%), CRRC (3.7%)
Ping An Insurance – sell full holding
Even if I did not have any doubts about the state of things over in China, my portfolio which should have a global focus has been over exposed to China. So today’s changes is one step towards balancing my portfolio and taking profit in Ping An Insurance which has been having a tremendous run over the last months where I’m netting a +50% gain since I invested about 1 year ago. The stock still does not look that expensive from a stand alone perspective and I really like how innovative they are with developing their e-sales channels and products. But the low valuation which I have patently waited for the market to re-evaluate, has to a large extent happened. It is somewhat reluctantly that I sell, but given the discussion above on China, I have to start somewhere. In Ping An I don’t see more than perhaps 10% potential upside in a shorter term perspective and it also quickly reduces my China exposure, being the largest holding. After this sell I still have roughly 30% of my portfolio with China exposure, I intend to bring it down below 20% during this year.
Two New Holdings – ISS and Huhtamäki
The main reason for writing so little over the last months is that I focused my time on researching a number of companies. Unfortunately most of them has fallen short as investments and a few have had such tremendous runs during the time I researched so the upside potential diminished while I was doing my DD. These two companies ideas I got initially from a friend and both fall in to the bucket of fairly solid, boring, slow and steady investments. Both I think are excellent long term investments, rather than bargains at current levels. I will write a longer write up of both companies at a later stage. A brief description of the companies:
ISS – Long 6%
Based in Denmark, The ISS Group is one of the world’s leading Facility services companies. ISS was originally short for International Service System and from 2001, for Integrated Service Solutions. Today, it is only used as an acronym. In 2005 ISS was acquired by Swedish PE firm EQT and Goldman Sachs, they paid about 22bn DKK at the time. During the EQT ownership the company expanded into Emerging Markets and number of employees grew from 274,000 to 511,000. In 2011 G4S made a failed attempt to acquire ISS for about 45bn DKK. In 2014 the company was again listed on the Copenhagen Exchange through an IPO at 160 DKK per share. The company had a shaky start with the overhang of EQT and Goldman who wanted out of their investment. In 2015 they divested their last shares, at the same time, the Kirk Kristiansen family, the owners of the Lego brand, increased their stake in the company. The company is today trading at 274 DKK per share and has a MCAP of about 51bn DKK.
The investment case is built around ISS solid track-record in the past and strong cash-flow generation, which has been used to pay down debt since the financial crisis 2008. That debt pay-down is more or less done and ISS can now focus either on further growth and/or increased payouts to shareholders. With ISS services in a fairly defensive sector I find the company reasonably valued, without paying too much of “Quality premium” as is the case in many other companies. Currently trading at P/E 22, and forward consensus P/E is 16.6.
Huhtamäki – Long 6%
Based in Finland, Huhtamäki is a global specialists in packaging for food and drink. Again a company with a long solid track-record, where growth has come from a combination of organic growth, joint ventures and acquisitions of smaller packaging companies around the world. The business model is de-centralized in the sense that the packaging production units are smaller units, around the world, whereas Huhtamäki has a number of larger customers contracts, that they serve in various markets.
After several years of very strong stock price performance, the company is lagging the market significantly over the last year. The main reason I have found for this, is slowing growth. But as I see it they keep investing for growth and the market has been looking at this company way too short term. Just now I’m ready to push the button to order some dinner from deliveroo, one of many take-away services. Which with better IT-platforms for delivery are still just in early days of a trend I believe will continue for a long time. Big city people cook less and less at home and consume more of all kinds of take-away food. I also like how fragmented the market is and with Huhtamäki’s long track record of delivering clean/safe food and drink containers, it becomes one of the main choices for all global players as Starbucks, McDonalds etc. It’s exactly these kind of tailwinds I like, and Huhtamäki is well positioned in this niche, and also valued “reasonably” at P/E of 19.
So once again Rottneros delivered a solid top-line, but magically did not transfer fully to the bottom line. This time the company just refers to “non-planned costs”. Next quarter (as has already been guided) will also be bad due to a problem at the Vallvik plant, and the quarter after that is the seasonally weak quarter, due to the planned stop of production. I start to feel like this is a broken record with the same tune, there is always some reason why this quarter is not being as profitable as it should be. With the risk of me becoming a type of investor I don’t want to be (thinking too short term) I anyway decided to sell today. I decided that if EPS for the quarter came in under 0.3 SEK for some reason, I would sell, and I stand by that, although it might be somewhat short sighted. I can’t fully trust this company since they don’t seem to deliver like they did 3-4 years ago, so out it goes.
One should mention that pulp prices are extremely favorable at the moment and SEK still very weak vs USD and EUR. They have a golden opportunity in this market and I think with the top-line production increase, the market traded this stock back to flat for the day. Also there is a dividend that is received as of tomorrow. And that makes me happy, since I then managed to get out with a decent profit (+8%) for this trade, although in my view it was a shitty bottom-line given the nice pulp pricing currently.
Quick Portfolio update
Unfortunately my plan of lower portfolio turnover is not working out that well, and my cash levels (after Rottneros sell) are now very high again (~18%). Still struggling to find good investment cases, might use the cash to add in some of my names that have been trading very weak lately, another update will follow.
Looking at my portfolio, after suffering massively from the weak performance of my previously largest holding Coslight Technology (I will revisit this stock as well), my portfolio has now kind of recovered on the rising market tide. As you again can see, my portfolio still has the higher correlation with Hang Seng and follow upwards as soon as the index does well.
A couple of stocks have lately particularly helped performance
Skandiabanken – solid results lately with good lending growth. The market is also starting to reprice Norwegian banks in general, but slightly also increasing Skandiabankens P/E multiple more in line with the large banks, in my view with a higher growth rate, it should rather be on a P/E premium. Let’s see how that goes.
Ramirent – A stock that I believe is this perfect late cycle holding, which with it’s leveraged business model, will start a similar exponantial stock performance as 2006 to 2008. The latest quarterly figures were a strong beat and the stock traded up significantly.
YY – It would have been better investing in the competitor MOMO, but this has also been a good investment. Results that came out were pretty decent, market having a bit of a hard time valuing the company, its now a story of two parts. A solid user base of highly profitable user listening to girls singing and playing, only one problem, it has stopped growing. And another leg of extremely strong growth in the online gaming broadcasting, again only one problem, it’s currently not profitable (slight loss). My thesis still stands and that is why I like the stock, the singing girls is a value play and generates wonderful cash-flow to the company, in my mind you get the tremendous online gaming business for free and currently almost only paying for the cash-flows generated by the first part. Although I’m sure Mr Market has valued this company on the margin as a much more complex mix than that
A couple of stocks have lately been real dogs
Coslight Technology – I also expressed this in my hangover post below, but the stock continues to underwhelm. I think the market is scared of the potential price pressure on batteries, lead by Tesla/Panasonic and their Nevada factory ramping up, in combination with the short term oversupply in the battery market, which I mentioned before. The facts are still that this company at least in the past has held a cash-cow position in a smaller pc and mobile game company (which as a separate company should trade at high multiples). On top of this we are looking at a huge ramp up in demand of batteries over the coming 5 years mainly from EVs, but also Power companies building reserve power solutions, electric motorbikes and our continued usage of phones/laptops/tables/drones etc. Maybe maybe the pricing pressure will kill this company, but it might as well be the car companies that get squeezed in the fight for survival and the battery companies will be in a solid position to deliver the most important component to the car, in the same way as the engine used to be that component.
Xtep – Here I can’t see any major news, the stock is very tired, trading down without any news. Citic securites initiated coverage with a buy rating a few days ago but the market just responded by trading it down a few percent more. Either this is a fraud, or a bargain, in China you never know. What I can say is that in other cases, like Zhengtong Auto I have also been shrugging my head for a long time and then the stock suddenly do pop, unfortunately as you know in that case I sold before the pop. But momentum in this stock looks awful at the moment.
Again this wonderful company delivers very strong results, and I realize it was a mistake to sell out of the company. A small comfort is that at least since I sold I managed to recycle the cash in other profitable investments. But now I can’t stand on the sideline and therefor I take a position of 5% of my portfolio in this company. If you know nothing about this company, start by reading my analysis from 1 year ago: NetEase – Chinese Gaming.
Since that analysis a year ago, the company released extremely strong figures. For Q1 this year NetEase delivered the following headline results:
Net revenues rose 72.3% to 13.6B yuan (about $2B, above consensus for $1.73B); gross profit rose 63.2% to 7.5B yuan (about $1.1B).
Meanwhile, non-GAAP earnings per ADS were $4.75, above expectations for $4.03.
Taking the revenue of Q1 times 4, we end up at 2017 revenue which according to my analysis 1 year ago would be reached in 2021-2022. Geez I was wrong on this one (and most other people too). I’m going to stop putting shorter term target prices on this one and just keep it as a long term holding for now, since obviously I am not capable to model future cash flows at anywhere near correct levels. Just as a side remark a quick update of financials with the same future percentage growth (as my assumptions 1 year ago), a DCF gives a fair value of about 320 USD per share.
Three reasons why I think NetEase will continue to have a strong future, even-though competition is heating up:
They have the scale to distributing their games through their own platform in China, which means not sharing revenue with other sites. Also they are now confident enough to start launching their games outside of China in larger scale.
They are launching (world-wide) a potential blockbuster called Crusaders of Light (https://crusadersoflight.com/) this summer, which might become the first truly successful mobile MMO. The game was released in Beta a few weeks ago and so far reviews are very strong among gamers.
Launching of Minecraft in the Chinee market this year, as a free-to-play game (with in-game purchases) in co-op with Microsoft. The game will be available both on PC and Mobile, another highly likely blockbuster. Here income will be share with Microsoft, and I believe quite a lot of it is priced in already in the share price, but anyhow, it will generate significant cash-flow.
I recommend this video on NetEase, which I wish I would have found earlier:
The downside
NetEase is already a huge player in the Chinese market place and launching new games will not only take market share, but also cannibalize on their own games. On top of that, the gaming sector is very hot right now, with competition being very fierce. Like a drug company a gaming company like NetEase needs a portfolio of games in the pipeline, which needs to keep delivering the best games in the market, or the competition will quickly step in at fill their place. Extrapolating earnings in to eternity of this type of companies and doing so with high multiples, might be a too bullish way of looking at the company.
A personal downside with this investment is again getting a too high China concentration in the portfolio. The reasons for the long silence in the blog is that I have been doing my best to analyze companies for a potential new investment. I have been looking at Biotech in the US, Vaccine companies, breweries and much else. But really struggled to find something worth buying. I have two interesting companies on the radar though, but the valuation has unfortunately run a bit crazy right now
Well I didn’t get many days of celebrating a first year of strong performance, the hangover came quickly and pretty brutally. I was very upbeat about the upcoming annual report for Coslight Technology. They even released a profit alert a few days before, which I took as support that second half figures would come in strong, just as the first half had. But I couldn’t have been more wrong, the second half did not come anywhere near the first half. The market was rightfully pretty brutal today, trading down my largest holding by -20%. What one could ask though is, how the hell is the HK exchange rules set when a company is obligated to send out a positive profit alert before its year end figures are released, which refers to the old information released in H1. You live you learn, but this time it cost me some money too.
So what happened?
Lithium battery sales did not continue to increase, but rather flattened out. So even if it’s profitable business it did not grow profits or margins (both flat).
The company is not able (or does not want to?) to entirely cut the lead acid battery business (I had thought they were switching over the last production to lithium only), and this still loss making (20 cents per share loss only from the lead acid battery for H2).
The gaming business which has been a solid cash-cow came with a very weak H2, Average half year profit has been in the 15 cent range, in now came in at 3 cent. This was the biggest surprise for me.
So H2 profits for the company became a disappointing EPS of 0.04 cents. Where I had expected around at least 20 cents, but hoped for 25 cents.
I’m not ready to give up yet though, so I keep my shares.
Lithium battery sales long term case still looks strong (EV S-curve coming in a few years), although many companies are ramping up production, there is far fewer that has Coslight’s track-record of selling quality batteries (not even Samsung SDI has managed that as well as Coslight).
Still hopeful that they will cut their losses in the lead acid business, or that it turn profitable (competitors in lead acid like Tianneng has been talking about better margins going forward).
I hope the gaming business can bounce back, although I do not have much support for that more than that historically over all the years they managed to keep and grow this business. I believe if they spun out the business with it’s track-record, given how hot mobile gaming companies are today, just that company could be worth somewhere around 30-40% of Coslight’s MCAP.
Sell Summit Ascent Holding
Another report, on the same day, also disappointing. The volume ramp up I was speculating about, did not materialize in Q4 and I exit this position which was my smallest holding and more speculative (high risk/reward). In hindsight I should have been more patient to wait for a better entry level in this more speculative trade and this would have been a profit.
