I bought Asia Enterprises Holdings on 29th May 2008

About Asia Enterprises Holding Limited

Asia Enterprises Holding Limited (AsiaEntH) is a distributor of a wide range of steel products to industrial end-users in Singapore and the Asia-Pacific region. It is focused primarily in the shipbuilding and marine-related sectors, accounting for about 60% in revenue for FY 2007, with construction accounting for 8%. Stockists, traders, precision metal stamping, manufacturing and engineering/fabrication industries accounting for the rest.

Rationale

Financial performance (internal environment)

AsiaEntH is able to achieve consistent ROE (with comparable ROA) above 17% for the past few years. (Even when steel prices plunge in 2005, they could achieve an ROE of 17.1%). Net profit margin is consistent at about 10%. All of these are achieved without little or no debt. At around 1.1x book, I won't say its cheap, but at least it is inexpensive.

Business environment (external environment)

According the data from EDB, Singapore's transport engineering main achievements:

• 70% global market share of the conversion of Floating Production Storage Offloading (FPSO)
• 70% world market share in jack-up rigs
• Among the top 3 global centres for oil & gas (O&G) equipment manufacturing and servicing
• #1 in Asia by production volumes for 6 of the top 10 O&G equipment players

Moreover the major infrastructure and other big projects to rejuvenate Singapore over the next several years already annouced, the demand for steel products should be sustainable in the foreseeable horizon.

Major Plus

Due to the cyclical nature of the business, the company had been able to weather many storms due to its strategy of keeping a sound financial position (NIL debt). The following is quoted from the management Q & A with shareholders:


... We believe that our management expertise, experience and strong financial position are key in mitigating the risks arising from fluctuations in steel prices. With zero net gearing, we are not under significant pressure to liquidate our stocks during unfavourable periods. To cite an example, when global steel prices corrected steeply in 2005, the Group managed to sustain its net profit for the year, ...


Major Minus

Instead of one external cycle for typical companies, AsiaEntH is subjected to 2 cycles, Global Steel Prices and Ship Building & Marine Related Cycles. The worst for AsiaEnt could occur when the troughs of these two cycles coincide. Then, at least it has the financial capacity to sit on its stock pile of raw steel and hopefully enough to outlast its competitors.

Conclusion

I'm fully aware that the current outstanding business performance of AsiaEntH is the result of the current oil and commodity bubble. The final test would come for all the companies in this sector when the bubbles burst eventually. Hopefully, AsiaEntH will emerge as a stronger survivor.

I upped my stakes in Surface Mount Technology on 27th May 2008

History

I had gone in and out of Surface Mount Technology (SMT) in the past few years while I'm still new to investing. Then, I'm pretty pleased with getting things below book value and even better when their ROE was high. That was when I got Surface Mount Technology.

25th September 2006
Bought SMT at 45 cents. I've thought I found a good business at a bargain, 15% below NAV and ROE > 15%. I learnt later that this was not sustainable.

29th June 2007
Sold SMT at 46.5 cents. While fundamentals are still deteriorating, I managed to sell them all during a period of exceptional market euphoria.

New Insight

After reading several books, especially Financial Statement Analysis and Security Valuation - Stephen Penman I am able to really understand why some companies trade for a premium above their book value (good businesses) and why others trade below (cigar butts). It all boils down to ROE, the quality of the ROE and its sustainability. Good ROE (I won't use the word 'high' here because ROE can be boosted with leverage or other tricks) means company is adding value for shareholders, resulting in having an intrinsic value above book. Bad ROE means management is destroying value, hence an intrinsic value below book.

Value investing just means buying a stock below intrinsic value. This was why Charlie Munger taught Warren Buffet: "It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price". This is in contrast to the pure Benjamin Graham style of buying purely below book value.

My Insurance

While acquiring a wonderful business at fair price is obviously better than getting a cigar butt, the problem is how to identify that business. i.e. how sure am I that the business I've identified as good (after going through years of financial statements, annual reports, product & services analysis, business analysis etc) is sustainable?

Lucrative business ultimately attracts competition and drive returns to cost of capital by the theory of regression to the mean. The only guard against the latter is competitive advantage and sad to say, I've not acquired the business sense to identify one.

Hence, my only solution (until I picked up the business sense to identify one good business with sustainable competitive advantage) is diversification. I had 'good' business as well as 'cigar butts' in my portfolio. As far as cost of investment is concerned, each business in my portfolio take up similar chunks. This way, I minimize the cost of my mistakes. The flip side is I limit my gains too. Anyway, my investment objective is to insure against retrenchment, not to get rich (not that I don't want to get rich, but its not my foremost priority, I'm more paranoid about retrenchment and lost of income).

Bought again, with a clearer picture

If I bought SMT back in 2006 as a green horn to investing, now I won't have excuses any more. I gone into the mud with my eyes wide open, fully aware of the risk involved. Anyway, on 27th December 2007, I got in again at 26 cents a share, which is about 52% discount to the NAV then.

Grabbing the falling knife

Today, I upped my stakes again, at 13.5 cents a share. According to the unaudited Full Year results, it's about 75.3% discount to NAV. Looking at the balance sheet, (assuming the balance sheet numbers represent true and fair values):

Current Assets

1. Trade receivables per share----------------------26.0 cents
2. Inventories per share-----------------------------24.3 cents
3. Cash per share------------------------------------9.1 cents

Total current assets------------------------------------59.4 cents

Non-current Assets

1. Plant, property and equipment------------------80.2 cents
   

Liabilities

1. Total Debt-----------------------------------------88.1 cents
   

Assuming plant, property and equipment is fairly valued, together with a little of current assets, there is more than enough to cover all the liabilities. This means that at least 50 cents per share can be recovered if the company go into liquidation now.

If inventories are worthless in a fire sale, 50 cents less 24.3 cents equates to 25.7 cents. (nearly 2 times of 13.5 cents).

Risk

For a company to be sold at such a sorry price is not without reasons. The following might be enough to justify a discount (but not such obscene discount):

1. Profit margin squeeze (rising cost, pricing pressure from competition)
2. Profit to loss making
3. No recovery in sight (at least not in the next few quarters)
   

Conclusion

For companies like SMT, the management is obviously destroying value for shareholders. The resources could have been deployed elsewhere for much better returns.

The only way I'll be rewarded now is to wait patiently (but for how long???) for a coporate raider OR a complete turn around in the business. The good thing about cigar butts is the situation is normally pretty bad and are already condemned to the recycle bin by the market. Hence any improvement (from very bad to bad is also an improvement) will be rewarding for the shareholder who dare to catch the falling knife.

I trimmed my holdings on Super Coffeemix on 20th May 2008

Review on 1Q 2008 results

At first glance, Super Coffeemix's profit dropped about 27%. On closer look, removing other income or loss (mainly due to equity investments), net profit actually rose 33.5% from 7,543m SGD in 1Q '07 to 10.072m SGD in 1Q '08.

However, equity investment is a regular activity for Super Coffeemix, hence I can't ignore them this way. This only means their core operations is still doing pretty well and would have been better if they don't deal with the equity investments altogether.

Looking at the cash flow statement, at least cash flow from operations is still pretty strong.

Thus I can say the results are pretty encouraging, at least their core operations are still holding up in the midst of intense competition, pressure from runaway raw material cost and other operating expenses.

Rationale for trimming my holdings

While the results clearly showed good performance, I'm pretty skeptical these justify the current market valuation. To say its overvalued is just an understatement. However, my experience with Armarda and Golden Agri-Resources taught me not to underestimate the power of irrational market exuberance. So long as the market rumour on possible takeover is not formally clarified, I won't know what price it will aim for... and I'm not taking chances with my capital.

Thus, with today's run-up in prices, I'm happy to disposed about halve of my holdings at $1.15 a share, a neat gain of 78.3%, and almost covering my principal.

High-yielding notes a good buy?

I read with interest an entire page of Sunday Times, invest on 4th May 2008, dedicated to foreign currency investment:

1. Is it time to buy into foreign currencies?
2. How to profit from the forex market
3. Which high-yielding notes are a good buy?

Forex Fundamentals

While tonnes of books are dedicated to deal with the topic in detail (similarly to the topic of investment), I'm more interested in seeing it from a practical, non-academic layman point of view.

It seems to me that the strength of a currency boils down to 2 factors:

1. Demand (and supply)
   
2. Confidence
   

1. Demand (and supply)

It follows from simple logic that demand pushes the price of any item highly sort after, while too much of it will drive prices down. The same holds true for currency. To drive up the demand, a central bank rate for the relevant currency can pay a high yielding interest (e.g Australian or New Zeland Dollars) or the currency can be a common currency used for most market transaction (e.g USD).

To drive it down, the market can simply be flooded with tonnes of the cash, i.e. the country can just keep printing money.

2. Confidence

Confidence here does not refers to blind faith about any accurency. I'm referring to the confidence in an economy. The stronger the economy, the stronger or more stable its currency. Strength about any economy can be estimated or projected from the leading economic indicators such as GDP, GDP growth, trade balance, current account balance, productivity etc.

Forex Investment Vehicles

Given my limited knowledge in forex, the only vehicle that make sense to me is foreign fixed-deposit. If I want to bet currency X will appreciate vs Singapore Dollars, all I need is to open a fixed deposit account for currency X with any bank that offers one. My returns will be the capital appreciation (or depreciation) plus interest. Trading cost is negligible too.

High yielding notes are a good buy?

Fundamental investment logic states that returns must be proportional to the risk involved. Let's see whether it applies here.

On the table (taken from link 3 above):

Australian dollars:
Interest Rate = 6.74%

New Zealand dollars:
Interest Rate = 7.75%

Wow, these are few times risk free CPF rates! If these currencies don't appreciate, the interest rate is already very attractive! However, the concern is whether they will actually depreciate?!

Under the table:

Recall that the strength of a currency is a function of demand and confidence, i.e.:

strength = f ( demand, confidence)


Demand?

High interest rate can at least sustain demand, else how does United States continue to sell its bond for so long until China and Japan got stuck with overwhelming USD foreign reserves.

Confidence?

How about the economic numbers for Australia and New Zealand? The following data is obtained from the wikipedia:

Australia:
GDP: 908.826B
Account account balance: -50,960B
As a % of GDP: 5.6%
GDP growth: 4% (2007 est)

New Zealand:
GDP: 128.141B
Account account balance: -9.973B
As a % of GDP: -7.78%
GDP growth: 3% (2007 est)

Comparing with US:
GDP: 13,843.825B
Account account balance: -747.100B
As a % of GDP: -5.39%
GDP growth: 2.2% (2007 est)

In terms of % of GDP, both Australia and New Zealand ran a current account deficit even larger than US! Unless they can continue to maintain their GDP growth rate, any slow down will just widen the deficit, cutting rates will just be a matter of time. The resultant rate cut will then result in a currency devaluation, similar to USD depreciation when FED cut interest rate from 5.25% to 2% within a short time.

Thus the risk with high yielding notes are the 'hidden' potential for currency devaluation. However, most fixed deposits are short term, 1 mth or 3mth. So depositors are implicitly betting against devaluation within these periods. Yet again, how many of such depositors think about current account deficit or other economic indicators when they put money into foreign fixed deposits?

USD, out of the woods yet?

In an earlier article, I wrote about boom bust theory and value investing. In short, market perception (or reaction) always lags fundamental changes. For USD vs SGD, I believe
the fundamentals have change, but the market is still one step behind.

Common market perception is the believe that USD will continue to depreciate against SGD. The main supporting factors are:

1. The continued SGD strengthening policy of Monetary Authority of Singapore, MAS to fight inflation
2. The continued rate cutting by FED in US to avoid a recession

I believe otherwise, i.e. while short term volatility or even slight depreciation in USD is possible, downside is very well limited while appreciation is pretty much in the pipeline.

1. MAS's SGD strengthening policy

Singapore's economy is obviously better diversified (away from electronics) now compared to a few years ago when we were badly hit during SARS crisis, Asian financial crisis etc. While MAS is trying to fight inflation by allowing SGD to float higher against a basket of currencies, the higher SGD float up, the less room they have for maneuver. The sole reason is we are still a export oriented and services driven economy. There's a financial limit to breach before it start to hurt foreign investment and our competitiveness.

As for current inflation, I do not believe it will last very long. Overheated inflation can persist as long as the economy powers on at breakneck pace, e.g. China, Russia, Middle Eastern countries and other fast emerging economies. Inflation coupled with recessive factors just dampen demand eventually. Inflation should wane. If so, there is less incentive for MAS to continue to boost SGD.

2. Continued Rate Cutting by FED

To avoid a recession, FED rapidly cut short term interbank lending interest rates from a high of 5.25% in mid 2006 to the present 2%. However, the rapid rate cut resulted in a rapid devaluation of USD ever since. This seemingly resulted (controversially) in an escalation of commodity prices (mostly traded in USD), especially oil. The latter also resulted in a spike in food commodities because transportation cost went up.

Traditionally, FED used interest rates to control liquidity of USD in the market, thereby controlling inflation or spur the economy, depending on circumstances. However, current 'recession' (greatly anticipated, greatly discussed, but not seen... yet) is spurred by a liquidity crisis. The massive write-offs by so many major banks in US and Europe that arose from the defaults in sub-prime mortages in US almost render the cutting rates useless. Nobody seems to be willing to lend anymore.

Hence, it seems to me that FED can no longer use short term interest rate to control the current financial crisis, it had to look for something else. It is not to their best interest to see the USD depreciates against major currencies any further. I came across a few articles suggesting the same. Further rate cutting could just devalue the USD further and spur the commodities, especially oil price to shoot through the roof.

What other measures they could try I do not know. But I do believe that USD vs SGD will just make a U-turn from here. The question is how long the trough of the 'U' is, this I had no answer.

How would a stronger USD affect my portfolio?

An appriecation in USD will have a bigger impact on 2 companies in my portfolio, namely First Ship Least Trust and Multi-Chem.


First Ship Lease Trust

Their revenue streams are in USD and hence their quarterly payout is in USD, converting to SGD. Thus my dividend would see an appreciation in quarters to come.

Multi-Chem

I already wrote in another article that because USD make up a substantial portion in Multi-Chem's debt and payables, Multi-Chem's debt used to be 'shrinking', resulting in a huge forex gain. This gain will be slowly eroded away. Anyway, its a bonus to have forex gain, not a business critical earnings component.

Conclusion

One has to be careful of the hidden risk in investing in 'low risk' foreign fixed deposits.When the yield is high, the alarm bell should ring and careful analysis should be be done. There's no free lunch.