I bought Cambridge Industrial Trust on 18th September 2008

About Cambridge Industrial Trust

Cambridge Industrial Trust is a real estate investment trust (REIT) with a portfolio of 43 industrial properties spread across Singapore. The REIT have diversified property types and tenant base in various sectors such as logistics, warehousing, industrial, car showroom and workshop. The trust is currently seeking Shariah compliance to tap into a wider capital market.

Once in a life time buying opportunity

The subprime induced string of failures in giant financial institutions in the United States in a matter of weeks, the bailout of Freddie Mac and Fannie Mae, the collapse of Lehman Brothers, the sale of Merrill Lynch to Bank of America and climaxed (temporary?) on brink of collapse of AIG, helped to create rare buying opportunities. Almost every business, good or bad, are on sale. Almost a fire sale. Akin to a genuine closing down sale where everything must go.

How can I miss such a good opportunity. A better opportunity might come later (i.e. things could go even cheaper if the US government rescue initiaitve doesn't really work) but I'm enticed (and contented) by the sale right now, greed has no end.

Unfortunately, I do not have the cash and scanning through my portfolio, I decided to liquidate my remaining Super Coffeemix shares, currently still sitting on (declining) paper profit, to fund my new acquisition.

Rationale

I highlighted my renewed interest in REITs sometime back in July 2008, and raised a few attractive attributes about Cambridge Industrial Trust (CIT):

1. Diversified industrial portfolio in many sectors, manufacturing, service & commerce etc.
2. Long term lease of 5 to 15 years
3. Strategically located properties in key industrial zones spread across Singapore
4. Built-in rental escalations to provide organic growth

The yield then was already close to 10% and but I was hoping something higher. At 12.5% yield at the price I got, I am satisfied.

Dilemma

In fact, 2 opportunities cried out for my attention that day, namely CIT and First Ship Lease Trust. The latter plunged more than 10% that day, pushing the yield to a ridiculous high exceeding 20%!!! I was actually more tempted to buy into First Ship Lease Trust than CIT. Troubled AIG held about 8% of First Ship Lease Trust and this might had contributed to the drop but without concrete statements, no one know for sure.

Based on raw yield, I could have chosen First Ship Lease Trust. But I already had quite a bit of it. I do not want to end up in a situation where my portfolio is dominated by one company, not matter how good it is. My personal strategy, philosophy , principle is diversification. The last thing I want is to be caught off guard if that one dominating brilliant company in my portfolio collapse because of some bizarre reason beyond my control.

Thus after intense internal fighting going through my brain, the policy division in me triumph and I proceed to welcome CIT into my portfolio.

Risk

Nothing comes without risk. Both REITs and shipping trust are intrinsically debt funded vehicles. Given the current credit crunch, both will face severe resistance for growth in the best case case scenario and survival in the worse case scenario.

Syarish Compliance

Though CIT tried to seek syariah compliance to tap into a huge capital market, whether it could do so successfully and whether achieving that status will actually help CIT is a big question mark for now.

Refinance risk

CIT will need to refinance all its outstanding debt and negotiation with HSBC is currently underway. It is expected to complete it in 3rd quarter 2008. Under current liquidity crisis plaguing the market, credit will neither come cheap nor easy.

Conclusion

No one knows for sure how long the current credit crunch will last and whether the slew of government, central bank actions around the world will really help restore confidence in the finance sector. But what I do know is this crisis open up huge buying opportunities not seen since the Asian financial crisis. While many are bailing out, it is those who dare to invest, stay vested and hold till the next crazy boom in market that will walk away with handsome rewards.

Public Transport Companies --- a good buy?

I read the recent articles on Singapore public transport with both interest and concern, especially on the recent fare hike and restructuring. Public transport is meant for the mass and providing the services at a 'reasonable' and 'affordable' rate should be the main objective for their existence.

Many blog posts and articles were already dedicated to this topic, debating and questioning the need for the increase. I'll hence look at public transport issue from a different angle i.e. investment grade of the public transport companies.

Monopoly?

Valuation

No complex analysis or elaborate ground survey is required for one to conclude that the local transport companies, SMRT and SBS Transit operate in near monopoly in their respective fields, namely rail and bus services. Elimination of service duplication (waste of resources) is the rationale behind the seemingly lack of competition, e.g. removal of bus service once the train starts to run.

If so, aren't these companies a good buy? The following are the litmus test, valuation ratios for SBS and SMRT:

SBS

• P/E: 12.3
• Rolling P/E: 15.3
• P/B: 2.5

SMRT

• P/E: 20.2
• Rolling P/E: 19.9
• P/B: 4.2

A moderately high P/E (above 10) and P/B (above 2) do suggest this from a valuation point of view. i.e. the market could price these with monopolistic premium.

Financial Performance

How about their financial performance? Do they perform as well as a typical monopoly (my criteria) does? i.e.

• high profit margin (>10%)
  
• good profit growth annually (>10%)
• respectable ROE (>20%)
  

The following table list the financial performance of the last 3 financial years for SBS and SMRT:

A few conclusions can be reached almost immediately by looking at the table above:

1. Firstly, SBS's financial performance pales badly compared to SMRT.
2. SBS's profit margins are below 10 and deteriorating while SMRT's improving and way above 15%.
3. SBS transits operating expenses rose more than twice as fast as SMRT.
   
4. Other than SBS's improving ROE, all its key financial ratios fail to make the grade for a monopoly.
5. SMRT performed far better. All the key ratio made the grade.
6. Perhaps that's the reason why they trade at almost twice as expensive as SBS (i.e. 4.2 times book value versus 2.5 for SBS)
7. Direct government grant (in the various forms to offset asset purchases, trains & buses) as a percentage of earnings is extremely low for SBS as compared to SMRT.
   

Investment grade analysis

At first glance, SMRT might seem to make investment sense. Looking at the financials results, SMRT are able to achieve record profits year after year with commendable ROE (20's) and profit growth (~10%).

However, things are not rosy as it seems. It could not raise fares as it like. Possibly due to its performance, its fare increases were not approved by Public Transport Council (PTC) while that of SBS were mostly approved. This is the characteristic of a regulated industry.

Looking at their financials and fare approvals/disapprovals by PTC, it seems to me that there is downside protection for both companies. i.e. it is almost impossible to make loss, this is because the companies can be sure to pass on rising business cost to the consumer should the former threaten the bottom line. On the other hand, there is a ceiling to their upside. There is a fare adjustment cap forumula to regulate the fares.

Short Term Outlook

Both companies operate in a tightly regulated industry with SMRT performing obviously better. As a defensive play where the investor is more concerned whether a company will risk bankrupcy, he can definitely sleep well owning SMRT.

Long Term Outlook

A check on the Land Transport Masterplan shows many changes affecting public transport in the coming decade. While SBS and SMRT are expected to continue their existence, by virtue of operating in a tightly regulated, non-competitive industry means that whether they could thrive or die will depend almost solely on the transport policy in the future. Gambling was never legal in Singapore in the past. Two casinos will be ready in the next few years. No one can tell the future.

Conclusion

Public transport is meant for the general public. Keeping it afforable is one of the main objective for the regulators. But to the transport companies, being listed stipulates them to maximises profit for their shareholders. How they manage these conflicting interest will always be a thorny issue.

Analyst's analysis --- to be taken with a tonne of salt?

I read with amusement the morning news about the effect of quitting of Japanese PM on NIKKEI, on Channel NewsAsia on 2nd September 2008:

0846 hrs: Japanese shares open lower after PM's resignation
0917 hrs: Japanese stocks turn higher after PM resigned

How do these analysts know the stocks went up or down due to his resignation? Apparently they didn't, reversing their views just around an hour. This brought me to recall what I heard when I attended the analyst briefing of Surface Mount Technology sometime this year when its CEO commented:

... there are two professions who does not need to take responsibility for what they say, one is the weather forecasters, the other is stock analysts...

As a whole, their hits and misses are seemingly so evenly distributed that it became common sense to take them with a huge tonne of salt. Thus it is rather surprising (at least to me) that people still believe them (else why ask them for opinion) and even more surprising why they are still employed and so highly paid.

Reasons behind salty analysis

I read somewhere, in one of the books on the left column (can't recall which) that it is human nature to attribute cause and effect, e.g. trying to find a pattern when there is none. It works pretty well during hunting, i.e. aiming and throwing a spear ahead of a speeding deer instead of directly at its body when one can almost predict (correctly) that it will run straight.

But it is altogether a different story making forecast in a stock market, especially on a short term basis. It's as good as trying to predict the next roulette spin. The reason is that the sheer number of participants and events affecting a short term outlook in the market make the next price movement almost a perfectly random event.

I do not believe these highly educated professionals, with their training and experience could not understand the fundamentals causes behind macroeconomic events unfolding before them. But many seemingly like to make straight line forecasts. If that is so easy, anybody can become an analyst.

Lastly, being an accredited analyst, market expect them to give an answer, a projection. They have to call a number (any number is better than no number). "oil will hit 400 usd per barrel" sounds much better than "I don't know, probably the oil price will be very volatile".

Layman's view

I do not need to call a number if I don't know and I am under no pressure to kid myself. So it is great to look back at my past comments to see how I fare in my own macroeconomic views.

SGD vs USD (and other foreign currencies)


When USD was fast depreciating in 2007 and most of 2008, many analysts are calling ever lower targets with each record high achieved by Sing dollar against the USD. The lowest target I recall is 1.32. Might as well say parity. But the fundamental events clearly pointed otherwise as I wrote the article on 10th May 2008:

10th May 2008: High-yielding notes a good buy?

In it, I pointed out the limitations on how far US can allow its currency to drop and how badly it will hurt Singapore if MAS continue to strengthen SGD endlessly. Ironically, after being so bullish before the August decline in Sing dollar, many analysts now forecast a steeper decline in Sing dollar. Given MAS's policy of using SGD as an inflation fighting tool and mounting US debt, I doubt there will be a clear trend in SGD vs USD. It will most probably be volatile exchange rates until the dust settle down in the next few years.

On a separate note, my post was actually targeted at the prevailing interest then to buy high yielding fixed foreign currency deposits but I cautioned against the risk involved. There must be a reason for the high interest attached, and it is definitely not risk free.

Since that post, New Zealand dollar, NZD had depreciated about 7% against SGD:

and Australian dollar, AUD by about 7.5%:

Thus offsetting the 'high' interest rate on these fixed deposits (about 6 to 7% then). I'm not the first to see these fundamental changes, I read them somewhere, so can these 'analysts'.

Oil prices --- aiming for the moon?


When crude oil crosses USD 140 a barrel in June this year, analyst again extrapolated crude oil to shoot for the moon. Supporters of peak oil (oil supply had peaked but growing demand will ensure rising prices without conservation or alternative sources) are right to point out that growing global demand (esp. due to rising demand from China and India) will drive up prices.

However the run up in prices are seemingly more of a speculative adventure then a shift in fundamentals. I wrote another article on this back then on the unsustainable crude rise:

1st June 2008: Oil bubble or trouble?

When it hit above 140 a barrel, some predicted a 200 a barrel by year end. Now, when crude collapse below 110, some predicted it to retreat back to 80. In the long run, I do not doubt crude demand will definitely outpace supply unless more economically exploitable fields are discovered or more serious adventure in alternative fuels takes off. The following figures put the key consumers in perspective:

Crude oil consumption per capita per year:

US: 68.81
China: 4.96
India: 2.18

GDP to Crude oil consumption ratio:

US: 1.65
China: 0.94
India: 0.86

Crude oil consumption in absolute terms (1,000 barrels per day):

US: 20.59
China: 7.27
India: 2.53

Crude oil consumption if China & India's consumption per capita matches US:

US: 20.59
China: 100.86
India: 79.86

Even if China & India become as efficient as US in terms of consumption per GDP:


US: 20.59
China: 12.76
India: 4.85

(But this assumes China and India's economy remains unchanged. At the rate they are growing, both economies will match, if not surpass, that of US within the next decade. Thus at the same efficiency, both consumption will exceed US by a significant margin)

However, in the short term, it is somewhat incredible for oil to double in just 2 years. Similar to SGD vs USD, going forward, crude oil price could just be as volatile in the near future before it settles down to a price dictated by fundamental supply and demand.

Conclusion

It is sometimes amusing to read analyst reports on stock valuations. Many like to use P/E ratios. It is a convenient tool because it allows practically any number to be called for a stock valuation. In a bull run, for a forward or historical earnings, just pluck a high P/E ratio and you get a huge target price. Conversely in a bear market, with the same earnings, pick a low P/E ratio and you get a much lower target price. It is as good as a doctor trying to diagnose you with a wheel of fortune.

It is no wonder they are so handsomely paid. Not because their job are difficult to do, but its difficult to keep because any Tom, Dick or Harry can become one. Fortunately I do not depend on analyst reports for my stock picks.

Disclaimer

I am not saying all analyst are not up to mark, but the significant number of black sheep amongst the good ones are indeed bringing a bad name to the collective lot. It is those that can and dare to give better quality comments and reports that will capture the trust and confidence of rational investors.