Popularity comes at a price

My wife's recent Hunt for Piano


I knew practically nothing about Piano and consider myself musically challenged. But after months of accompanying my wife on her hunt for a replacement to her 40+ year old Schubert Piano (the company went out of business in 1937), I found a striking similarity to the way I search for my car and the way I approach investment in general.

Established brands

The search began on piano forums such as Piano World Forums and familiar names of Yamaha and Kawai came up in recommendations more often than other names. We went from showrooms (Yamaha @ Plaza Singapura, Robert Piano @ Parkway parade) in major shopping centres to 2nd-hand warehouses (Asia Piano @ Citimac Industrial Complex). All sale persons we spoke to (all could play the piano quite well, at least to a music idiot like me) gave their recommendations. As expected, all recommend established brands like Japanese made Yamaha or Kawai, either exorbitantly expensive first hand or more down to earth prices but exorbitantly old (20 to 30 year old) 2nd hand ones.

'Unpopular' brands

We went on to look at other brands, particularly non Japanese brands (the supposedly 'better' but ridiculously expensive European brands are not in her consideration list). There are Chinese brands like Pearl River, Hailun and Korean brands like Samick and Young Chang.

Shortlist

While all the pianos sound beautiful to me, so long as I'm not playing it, my wife could tell the difference. Once she finalise her needs, a upright piano with a height of about 120cm (taller pianos are better, but disproportionately more expensive) she went through her choice:

1. Yamaha U1: 121 cm, $8,600 (new), Japan
   
2. Yamaha U3: 131 cm, $4,000 (26 years old), Japan
   
3. Hailun HL125: 125 cm, $3,600 (new), China
   

The shorter Japanese made U1 can buy 2 Chinese made Hailun. Even its 26 years older ancient cousin cost more than a brand new Chinese made one! Much had happen to Chinese made products, from food to toys to clothes... that the consumer confidence had plummeted over the years, but the difference in pricing is seemingly alarming.

Before coming out as a brand call Hailun, the piano company had already been manufacturing for prestige brands in the West. Being establised as Hailun only in 2000, bored down as a Chinese brand, made Hailun highly 'unpopular'. Thus the Hailun piano is fine. The music is pleasing (to my wife) and the piano design is comparable to most standard piano. The manufacturer is confident of their design, as seen from the 10 year defective parts warranty (compared to 6 for Yamaha).

Thus if she are to buy the Yamaha piano, is she paying for quality or brand? Chances are the Yamaha piano could indeed be better than the Hailun Piano, but for each difference in dollar, I would think more is attributed to popularity in branding than absolute quality. If the China made produce could one day improve in their general quality and weed out unscrupulous manufacturers keen to take consumers for a ride, and if people finally realise the true quality of the Piano, I am quite sure the price difference of a Yamaha and Hailun would not be this huge.

Anyway, my wife is a happy owner of the Hailun HL125 piano, judging from the din of the piano music in the background as I am blogging now. :)


My Hunt for Car 6 months ago

I recall my car hunt about 6 months ago. My wife had been 'emphasising' how inconsiderate most people in trains and buses who are oblivious to pregnant women standing around them and a car would be a nice thing to have if we can afford one. Her specifications to me was simple, she doesn't need prestige, power, look etc... She just hope to have 4 wheels. So out I went, looking for 4 wheels, any 4 wheels.

6 months ago, COE was far more expensive than $2 sold recently. After some financial estimates and budgeting, I found that we could only afford a car below $50,000 comfortably without being a slave to the car. We drive the car, no the other way round.


Popular brands

As a newbie, the first thing that came to my mine was Toyota. I still remember I told my friend back in University that I'm contented with a humble Toyota when I have more disposable income. When I found out that a Toyota Vios cost about $57,000 then, I realise I couldn't even afford a humble Toyota.

Shortlist

• After searching sgcarmart and comparing the specifications, I simplified my preferences:
• 1.6L sedan
• Safety features such as Airbags and Anti-lock Brake System
• Spacious

and narrowed now my list to two cars:

1. Mitsubishi Lancer GLX - $47,000
   
2. KIA Cerato Variant 2- $46,999
   

Specifications (Mitsubishi Lancer GLX)

• Engine: SOHC 16V, in-line 4 cylinder
• Power: 106 bhp
• Torque: 142 Nm
• Dimensions: 4535 x 1695 x 1445mm
• Wheel Base: 2,600mm
• Kerb Weight: 1,140kg
• Safety features: Dual Air bag, ABS
• Fuel Consumption: 12.74km/Litre

Specifications (KIA Cerato Variant 2 )

• Engine: DOHC CVVT
• Power: 121 bhp
• Torque: 143 Nm
• Dimensions: 4500 x 1735 x 1470 mm
• Wheel Base: 2,610mm
• Kerb Weight: 1,266kg
• Safety features: Single Air bag, ABS
• Fuel Consumption: 12.92km/Litre

Unpopular brands

Kia, being a Korean brand was obviously not as popular compared to major Japanese brand like Toyota, Honda, Nissan and Mitsubishi. Japanese cars of similar specifications are Toyota Altis, Honda Civic, Nissan Slyphy, all way beyond my budget. The Mitsubishi Lancer was within budget because it was an old model giving way to the new Mitsubishi Lancer Evolution X.

After going to showrooms, chatting with colleagues and friends, the reputation of Korean cars came across as one with low resale value (more expensive car obviously have higher resale value since it depreciate from a larger number), poor reliability (what is the regular maintenance for?) and poor fuel consumption (I don't drive like there is no tomorrow).

Hence am I paying for popularity (brand) or quality? Car technology don't really jump by leaps and bounds compared to computer technology. Thus I am more willing to bet on a new Kia Cerato Variant 2 (just released in late 2007) compared to the Mitsubishi Lancer (released in 2005). In order to stay in business, the Koreans would have tried their best to catch with with the Japanese. It is only a matter of time people realise their worth.

6 months down the road, I am still a happy owner of my Kia Cerato Variant 2.

Stocks and Popularity

Considering the way the Piano is chosen by my wife and how I choose the car, it became apparent to me that popularity comes at a price. Just because more people know how good some thing is, it commands a higher price.

The same goes to stocks. An undiscovered gem can go unnoticed for months, years. The price will languish at some ridiculous level, thinly traded (nil volume for days) with huge bid-ask spread. But when some analyst finally discover this gem, and started to initiate coverage on it, more people knew about it, the price starts to jump, so does the volume. When the market capitalisation grow big enough, the bid-ask spread flattens and trading volume surge, the institutions got in. That is when everyone starts to talk about it. By this time, the price will have been prohibitively expensive.

I am often questioned why I look at stocks with almost NO volume. How am I going to sell them? For good or bad I cannot be sure (despite all the margin of safety and diversification), at least I know most people do not know or care about them... yet.

When I bought Golden Agri-Resouces back in 2005 as I foresee the palm oil demand, the volume was so thin and bid-ask so huge. There can be days when it is not even traded. Fast forward to 2008, it was almost on top volume EVERYDAY.

Conclusion

When something is good, it only make sense to get it when it is cheap, and not wait until it became popular and expensive. Popularity does not make something good. It is the goodness that ultimately make something popular.

I bought Cambridge Industrial Trust ... again on 12th December 2008

Update

On 11th December 2008, after trading hours, Cambridge Industrial Trust announced their successful refinancing deal of 390m, 3 year tenor term loan at an effective interest rate of 6.6% per annum.

Rationale

Qualitative Assurance - fear allayed

By 2009, many REITs would have hefty term loans due for refinance, Cambridge Industrial Trust is one of them. The on-going credit crunch saw many banks cutting back on their lending. They would rather earn less than to suffer potential loss if the money lent cannot be recovered. One REIT in Japan had collapse after it had trouble repaying its debt. I was afraid Cambridge Industrial Trust could also face trouble refinancing its loan. I excited Cambridge in October 2008 at a significant loss (I sold at 30.5 cts comparing to acquisition cost of 49.5 cts). Looking back, I wonder whether my fear then had been irrational. Fortunately (or not?) I manage to get it lower now, at 22.5 cts.

My fear is allayed when Cambridge managed to refinance all its debt. While there is no foreseeable respite to the credit crunch in the near term. I am quite confident the credit market should stablise within 3 years, when its term loan is due again.

Quantitative Assurance - Impact on forward DPU for 2009 and beyond

I compared the new term loan facility with the existing one found in 3Q 2008 results:

Existing loan (At 30 September 2008):

Amount: 369.3m
Effective interest rate: 3.19% p.a.
Estimated borrowing cost per annum: $11.78m
Estimated borrowing cost per quarter: $2.945m
Actual borrowing cost in 3Q 2008: $3.126m ~ $3m

New loan facility

Amount: 390.1m
Effective interest rate: 6.6% p.a.
Estimated borrowing cost per annum: $25.75m
Estimated borrowing cost per quarter: $6.437m ~ $6.5m
Estimated additional borrowing cost: $6.5 - $3 = $3.5m

Impact on DPU

Using 2Q and 3Q results as a guide, quarterly distributable income is about 12m.

Estimated quarterly distributable income: $12m
Estimated additional quarterly borrowing cost: $3.5m
Estimated new quarterly distributable income: $12m - $3.5m = $8.5m
No. of units (At 30 September 2008): 796,405,934
Estimated DPU per quarter: 1.067cts
Estimated annual DPU: 1.067 x 4 = 4.269cts
Estimated yield (using purchased price of 22.5 cts): 18.97%


Current DPU per quarter (3Q 2008): 1.49cts
Estimated annual DPU: 1.49 * 4 = 5.96cts
Estimated yield: 5.96/22.5 = 26.49%

Estimated reduction in forward DPU: 5.96 - 4.269 = 1.691 cts
Estimated reduction in yield: 26.49 - 18.97 = 7.5%

According to the new debt facility announcement, the DPU impact is about 0.9 cts. But my estimation showed a higher cut of 1.691 cts. Anyway, after factoring the higher effective interest of the debt facility, the projected yield of 18.97% is still very attractive. (Could have been more attractive, but I didn't notice the annoucement until 12th December 2008. After digesting the news and doing my sums, I could only get it at 22.5 cts).

Risk

At 18.97% yield, the yield is still high or the assumed risk is high. There are quite a number of events that could affect the future payouts, i.e. DPU:

1. Term loan failure - The loan is still subject to completion and part of the loan is subjected to syndication on normal market conditions. Nobody will know what can happen is the last minute to scuttle the deal.
   
2. Declining rental income - Whether by defaulting or exiting tenants, this risk is mitigated by the relatively long term lease contract of average 5 years or more and average security deposits of 16 months.
3. Loan covenants - There is a gearing limit of 60% imposed on REITs in Singapore. Cambridge's gearing ratio is currently 37.6% and hence there is still significant margin for a downward revaluation of its assets.
4. Bank failure - Even though HSBC, RBS and National Australia Bank are huge banks, there is no certainty these will not fail under existing climate. (Seems to be over paranoid in thinking). Creditors of failing banks can force Cambrige to repay its loan or liquidate its assets, a near impossiblity in the current market condition.
   

Conclusion

Though Cambridge had to refinance its debt at a signifcantly higher interest rate (6.6% compared to 3.19% previously), they were relieved borrowing is still possible under the current credit crunch. Other REITs with debt due for refinancing in 2009 will also face the same problem and similar, if not higher, cost of debt. Their yield across the board should be reduced significantly.

Property vs Equity as an Investment

Rationale

I happen to have chat with my former colleague on the investment merits of equity versus property, in the context of passive income as primary concern and capital returns being secondary. Under this context, an investment must be one that provides a stable cash flow, either from monthly rentals or dividend payouts.

Property vs Equity

Rents vs Dividend

At first glance, property provides stable rental returns, usually in substantial monthly figures that can supplement or even substitute active incomes from work. Monthly rental figures in the magnitude of $3,000 to $5,000 are reasonable for renting out entire 3-room condominium units in reasonably attractive locations, close to basic amenities like MRT station, food centres etc.

On the other hand, dividend from equities are usually paid out once a year and are far less stable than rents. The amount are usually meagre and are regarded more as extra annual bonus than monthly income supplements.

Leveraged vs Unleveraged Portfolio

But on closer look, the significant difference in payout can be attributed to leverage. To obtain the rental figures listed above, a typical condominium would have cost anything from $700,000 to above $1,000,000. A typical well-to-do middle income household that can afford to purchase a second property would typically have to draw down a housing loan ranging from 80 to 90%. Few from this group will be expected to 'cash and carry' their property.

In contrast, few sensible people who invest in stocks with objective of getting stable dividend returns would take up any loan to finance their purchase. If the typical well-to-do middle income household above who can afford to pay a 20% down payment or $200,000 on a $1,000,000 property, instead use the down payment to for share purchase, it would have earned them only $14,000 in dividend annually or $1167, assuming a 7% dividend yield (a respectable figure in 'normal' times). This is way below the $3,000 to $5,000 for rents above. The difference attributed to leverage can hence be seen quite clearly.

What if they are willing to take up a $800,000 loan to buy shares? Combined with their original $200,000, there annual dividend income would have been $70,000 or $5833 monthly, a equally respectable figure. But in both scenarios, I have not taken into account the cost of borrowing. Since equity loan are usually unsecured and the cost of borrowing will be much higher than a comparable housing loan.

Fall out from current financial crisis

Every crisis offers new opportunities. The current credit crisis is no different. Property prices and rents have started falling and could plunge further given weaker demand and greater supply in the years ahead as more new property projects are ready. More information can be found in the URA's website.

If falling property prices offers opportunities, plunging equity prices offers even greater opportunities, though the risk should be higher (risk must commensurate higher returns). Once built, the condominium should remain there but there is no guarantee the company still exist to honour the claim by the shareholder.

I extract out 7 relatively high and stable dividend play equities from SGX and summarise them in the following table:

The 7 are well represented by 3 shipping trusts, 2 REITs and 2 food industry related business. The stability in yield arises by nature of the business, e.g. Singapore Airport Terminal Services and Pacific Andes, or by long term contracts e.g. The shipping trusts and REITS.

Taken together, these 7 offers an averaged yield of about 26%. Reusing the example of the middle income household above, a $200,000 investment would give $52,000 annually or $4,333 monthly, without leverage!

But the fact these equities offers such high yields is due to the underlying risk. Other then Singapore Airport Terminal Services, the other 6 businesses are highly leveraged and there is no certainty all will survive the current credit storm. Even if they could, there is a high chance dividend could be cut due to lower income and hence reduce the yield significantly.

Conclusion

Given the current credit storm, if I have the funds to purchase a private property, I would rather threw them into equity. The chance that all 7 high yield stocks above turn into useless scrap paper ALTOGETHER is actually quite low, at least, that's what I think. Unfortunately, I don't have such funds now...still waiting for Singapore Pools to give me a hand.