BAIC, Brilliance China & MyEG

This week, some updates on some of the stocks mentioned in my previous entries.

  1. Brilliance China

Stock had collapsed since my last update . BMW has announced that it will increase its stake in the JV from 50% to 75%.  It will pay Brilliance China about US$4bn  for the stake or 7.8x PER18.  This is slightly higher than the current depressed valuation of Brilliance China of 6.6x PER when the deal was announced on 11 Oct 18.  (Share price was at HK$10.76).  If the management pays out the entire proceeds in special dividends, shareholders would receive HK$6.60 per share in return for the sale of the stake.  In fact, before the news was announced, the management had promised to do exactly that.  In addition, it said that only minority shareholders would be allowed to vote on the deal.

However, as it turns out, when the deal was announced, the notice to the HKEx gave management the leeway not to pay the entire proceeds out in special dividends and it did not say that the major shareholders will not vote in the deal.  Shareholders were shocked at the about turn and sold down the stock.  Last close for the stock was HK$6.90.  The stock had lost 71% from it’s recent peak of close to HK$24 this year!  Not that the business itself is actually doing very badly.  Consensus estimates are expecting the company to grow 34% in 2018 and 22.7 % in 2019!

Lessons to self:  Valuations and fundamentals of a company is one thing but the possibility of being disadvantaged as a minority share holder is another.  These things happen in a random fashion and short of having insider information, it is not possible to foresee such outcomes.  That is why it is important to diversify.  Why should the major shareholders sell its crown jewels at a pittance?  Remember that the company is a State Owned Enterprise whose real motive is not to maximise shareholder returns but to serve their political masters.  In this case, Prime Minister Li Keqiang has promised the world that China was serious about opening up its economy to foreign countries and he has mentioned publicly that the test case would be the Brilliance-BMW JV.  The deal had to be done this year despite its very bad commercial timing.  And minority shareholders were not going to be allowed to vote the deal down.  BMW obviously realised this and pressed it to their advantage, promising to bring more investments into the country and increasing employment, especially in the North Eastern region of China where the economy was weak.

Would this repeat itself in the case of Daimler-BAIC Motor?  Here are the reasons why I think it might not happen the same way.  First, notice the shareholding structure of Brilliance China.  Unlike Daimler (which holds a direct stake of 30% at the listed entity level of BAIC Motor), BMW does not hold a direct stake in the listed entity and parent Brilliance China but instead holds the stake at the JV level.  This means that if the interest of BMW and the minority shareholders of Brilliance China are not aligned i.e. if the share price of Brilliance collapse, BMW will not feel the pain.  Second, BAIC Motor is owned by the central government (Beijing) whereas Brilliance is owned by the regional government.  It can be argued that the financial position of Beijing is much better than in the Liaoning province where Brilliance is based.  Therefore they should be in a much better bargaining position.  And finally, the showcase deal in the auto sector is already done and there as less pressure for the Chinese government to do another deal so quickly.

brilliance-china-21102018.png

Brilliance China Growth Forecast Oct 2018Brilliance China Growth Forecast Oct 2018 - 2

2. BAIC Motor

Just a quick update on the stock.  The share price has declined since our last note on the stock.  This was dragged down by fears that the company might suffer the same fate as Brilliance China.  The entire auto sector has also entered into an unprecedented period of slowdown.  This is the longest stretch of negative monthly yoy decline in auto retail sales since the global financial crisis (6 months).  Even longer than during the stock market crash years of 2015-16. There are many possible explanations for this.  The first is that the rising property prices in the last 2 years have taken a toll on disposable income.  I have heard the same even from my younger friends working in the finance industry in Shanghai.  Many young people are forced to buy a piece of property as soon as they can raise the downpayment before home prices goes even higher.  Normally, if their parents could afford it, they would pay the downpayment amount for their kids (~30% of the value of the property) while their kids are responsible for the monthly installment.  Even then, many complain that more than half of their monthly salary is going into the installments, leaving precious little for everything else.  One interesting phenomenon we see this year is that while retail sales is hardly growing this year, luxury auto sales are growing at 15-25% YTD.  In other words, only the rich can still afford to buy cars.

A word on the valuations.  At the current share price (HK$4.48), the stock is trading at 5x PER18 and 3.5x PER19 and is expected to pay 7.8% in dividend yield.  What I find more extraordinary is that when you look at the cashflows generated by the company, the current valuation looks even more ridiculous.  The company is trading at 1.25x EV/EBITDA this year.  Last year, it generated free cash flows of roughly US$2.9bn.  Even assuming that the company doesn’t grow this year and the next and generates the same amount of FCF, this is ridiculous considering that the market cap is only slightly more than US$5bn!!  At the rate the share price is declining, they might as well give away the company for free.  Either the company is going to go bust or this thing looks like it should be priced a lot higher than the value that the market is giving it now.  I must say that this is probably the only really consistently cash generative stock that I have seen that it trading this cheap.  Most of the time you will see crappy small caps, unknown companies trading at these valuations.  But this is a real company, earning real cash paying real dividends.  To be honest, I’m pretty stumped by this.  I would be keenly following the subsequent developments in this company just to see if the market is really right in pricing the perceived risk with this company.  Indeed I have done a quick screen of all the companies listed in the Asia Pacific markets above US$1bn market cap and this was indeed one of the cheapest stocks at the current moment!  And remember, the company is not even forecasted to have declining profits this year and the next! Go figure…

3. MyEG

Finally, another quick update on MyEG mentioned in this last note.  The stock took another dive this week on 19 Oct 18 Friday closing down 25% in less than 2 hours before it was suspended. It was mentioned in a piece of news on the arrest of former Malaysian Deputy Prime Minister Ahmad Zahid Hamidi on charges of money laundering and corruption.  It appeared that bribes were paid to him by 2 companies Datasonic and MyEG to secure government contracts.  However, MyEG later issue statements to the exchange that it was not the one paying the bribes but it was someone paying the DPM the bribe in exchange for  a possibility to get a contract with MyEG. Subsequently they also issued another statement saying that the Malaysia Anti-Corruption Commission (MACC) clarified that the company was indeed not a target of the investigation.

Company statements clarifying link with ex- Malaysia DPM

MyEG Statement on MACC clarification

 

 

Drawdowns in Markets

Investors are obviously worried about the outcome of the Trump Trade War. Asian markets have entered into a technical bear market but the US markets have hit an all time high. Just last week, the US markets officially recorded the longest bull market in its history.

Usually markets have cycles. Some say there is a 7 year Joseph cycle in Asia. 7 fat years followed by 7 lean years. An entire book has been written about it and I shall not repeat its observations here. So why hasn’t it applied to the US markets today? I believe one of the reasons might be this unusual period of market interventions called the QE since 2008. Excessive liquidity pumped into the markets has certainly made its way into equity markets and real estate in general, and even the bond markets. The markets have been pumped up when on its own natural rhythm should have have started gong down from 2015. (7 years from 2009). In fact, the decline has been observed in Asian markets, especially in HK/China which saw a low in many stocks. Consequently by that same theory, we should have seen 7 years of up markets from then up to 2022.

So the current correction is probably just a typical market correction in a bull market. The underlying fundamentals of the companies seem to confirm that view. In China for instance, unlike in 2015, many companies are reporting strong results and not declining profits as was the case in 2015. Just looking at the China auto sector where representative stocks such as Brilliance China and BAIC Auto (Mercedes Benz) JV, stock prices have halved from their recent peaks less than 6 months ago, when the companies are reporting profit growth of 30% or more. The outlook also remains bright as their foreign JV partners such as BMW are expected to introduce more models into China. The structural trends are still intact, as Chinese consumers are still enamored with these foreign luxury brands. The decline in share prices is caused by the recent news that the auto sector would be slowly liberalized and foreigners are allowed to own majority stakes in foreign JVs. Some worry that this means that foreign brands no longer need to work with Chinese companies and can sell cars on their own. However, the current JV agreements are still in place at least until 2023. There is still plenty of time to negotiate the new arrangements. But markets of course hate uncertainty. But to half the share price because of that?

Brilliance China

brilliance china 27082018

[Ed (27 Aug 18):  Brilliance China incidentally announced interim profit growth up 54% and the stock popped 14.7% today.]

BAIC 

baic 27082018

 

I have observed that share price decline fall into several categories. Declines of up to 20% should not be treated with concern. This is still within the normal deviation of stock prices in general. In more volatile markets or stocks, fluctuations in stock prices up to 30% can happen as a normal course of action without any news or change in fundamentals. I have learnt that this can be heart wrenching if we look at our P&Ls on a daily basis. However the best thing to do in this case would be to do nothing or we risk being shaken out by short term market fluctuations. The only exception to this rule is if the stock price were to break its 200 day ma. We should then sell the stock immediately as this usually isn’t a good sign. It shows that investor sentiments have changed and we do not know how much further it would go. The caveat to this rule of course is if you are a truly long term holder in the stock like Warren Buffett and you need to have unshakable conviction in your investment and analysis. Make sure you are also sufficiently diversified. In life many things can go wrong even when you have done all you can to consider all things in your analysis.

The second type of correction is the 40% correction from the last peak. A stock that recently fits this criteria is HM Sampoerna in Indonesia, majority own by British American Tobacco. The stock has compounded total returns of more than 25% in USD since its listing. A very impressive achievement in Indonesian markets given its volatile history and unpredictable FX movements. (A feat achieved by the equally impressive Unilever Indonesia, it has it be mentioned.) Tobacco stocks, it has to be said, normally do very well over the long term. Once I did a study and dug out the share price performance of the longest listed tobacco stock I could find – BAT London and was amazed to find that the stock has also compounded close to 20% p.a. since the 1960s which was as far back as my data source went. If anyone out there has a longer listed history of a tobacco stock, I would be interested to know the compounded annual TR of the stock. This proves to me that certain consumer companies like tobacco companies are much suited to weather through all sorts of economic conditions. Well back to HMSP. It is indeed unusual to find these stable stocks correct so much in such a short period of time. To be sure, the decline from recent peak has been about 44% in USD terms and have rebounded recently. In local currency terms the correction had been less. Investors are worried that the company has been losing market share and have not taken recent excise duties very well. But if we understand the long term characteristics of the tobacco business, I would say this should at best be a temporary issue. Indeed BAT Malaysia has also more than halved from recent peaks but for a different set of reasons. It is my contention that these stocks therefore are probably pretty close to being ripe for long term investors. If only I could get it at a lower price… Haha… Patience…

HM Sampoerna

HMSP 27082018

HMSP 1991 to 2018 Returns

HM Sampoerna compounded at a compounded return of 25.44% since it was listed in 1991.  That is a total return of 43,528% over the last 27 years! And this is in USD terms (hence taking care of the weakness of the Rupiah over this period.)  Notice that the total return is a lot higher than the price return.  Which means that about 60% of the total returns are made in dividends!

BAT Malaysia

ROTH MK 27082018

The final and most severe correction are those that typically go down. 60%-90%. These normally signal a severe crisis of confidence such as the Asia Financial Crisis on 1997 or the Global Financial Crisis in 2007, or if there are some structural reasons in the stock or the industry that the stock is in. Stocks are sold because of fear and not because of the fundamentals. Indeed, fundamentals and valuations are no longer meaningful. The only question then is when the we buy the stock., This would have been more an art than science. This is where I believe that technical analysis would be useful. It would be advisable to wait until the long-term trend is confirmed to be changed. In other words, we wait for the markets to signal that the trend is changing. Currently, my preferred indicator would be to wait until the 100 day moving average line cuts across the 200-day moving average line. This will ensure that we will not be tricked by the many false starts that are typical of a downward moving bear market. The dumps out this approach of course is that we normally would not be able to pick the bottom of the market. In fact, from my own observations, we would typically miss about 20 to 30% of the price from the low. This would of course be a small price to pay in order to avoid catching a falling knife. And you would also help reduce too many sleepless nights while we all want to stop to find it only to go down further if we went in too early. Here, I’m of course speaking from my very own painful experience. This is just a guideline for myself and of course if you readers have any other alternative way of timing the bottom I will be interested to find out as well and to refine my own approach.

This has been a very long discourse but I thought this would be a good time to summarize my own views on what to do when markets are down. Of course, to minimize our risk and to maximize our outside, it would be advisable to enter a stock only when it has declined more than 40%, I find that this would be much safer in the long term. This would also mean that we might miss a lot of opportunities along the way. But I would very much prefer to keep my bullets for those few real opportunities for the stock has declined 50% or more and has a chance within the next two to three years to double in price. The compounded annual return for some of these stocks will then be more than 20% which I think is a very reasonable goal and a very lucrative one for many investors.