August 2015

It’s been an interesting week, with emerging markets swinging to its classical “risk off” mode again. China has given up most of its gains since the start of the year. I don’t feel so stressed out now as I did a couple of months back when the market was riding high on optimism and hope.

Emerging markets have caught the flu, and have been hit across the board. It looks like a perfect storm, with problems in almost every major economy: Thailand, Malaysia, South Korea, China etc. It’s one of those moments where investors have forgotten that emerging markets aren’t actually a homogeneous bunch of countries to be lumped together.

Still, I think we as investors should ask ourselves what has really changed in the real economy (as opposed to the stock market). Many of the concerns today are not actually new ones. Just that people have awaken to the fact that the world isn’t as rosy as it once was. But I suspect investors today are shooting on the other-side in pessimism.

To be fair, much of the speculation in recent months has actually gone on in the US markets, and China. Valuations in the rest of the world such as Hong Kong, South Korea and even Singapore have been reasonable by historical measures. Will we get a repeat of 1997? Its anyone’s guess, but the majority of countries have learned from their mistakes.

Stock markets can always go lower (just like it did in 2008 and 1997), but we have to weigh against the probability of it actually doing so which valuations already being on the low side.

I guess its easy to think that the current market volatility and the price drops are “new”… but lets just take a look at what the STI has done over the last decade.

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Well… I think its pretty clear that investing in stocks is VOLATILE. That’s the nature of the beast. Leaving aside 2008, you still saw a significant drop in 2011 (despite the low valuations). What’s interesting is that in the last 2 years (and this year by the look of it), the market has pretty much gone nowhere.  This is a gross generalization, but markets tend to do better after a serious period of under-performance, and terribly after a period of over-performance.

This is pretty much why value investing works – mean reversion. I don’t want to get into the unreliable world of forecasting stock prices, but if I had to bet, I would say that the next couple of years should provide investors with a very satisfactory return.

Warren-Buffett’s-Net-Worth-By-Age-chart[1](Photo Credit: Micro Cap Club)

Are healthcare stocks in Singapore overpriced? – (LINK)

Secrets of Sovereign: By going into uncharted territory where most investors don’t dare to tread, the Chandler brothers have, in the space of 20 years, grown a family fortune of $10 million into a cool $5 billion — and they’re still in their mid-40s. – (LINK)

Trump Has Done Well, but Not as Well as the Stock Market (LINK)

Beijing Blunders: Bull in a China Shop! (LINK)

 

I am back from my visit to Macau & Hong Kong. The industry has definitely a beating with the general economy, and the corruption clampdown.

Many casinos rely heavily on VIPs to generate the bulk of their casino revenue, as opposed to the mass market audience.

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Interestingly enough, while flipping through my notes from the London Value Investor Conference in 2014, one of the presentations  touched upon the casino industry. You can really see how dramatically market sentiment has swung towards depression in less than a year. Optimism always comes at a cost.

The contranian in me is however optimistic.

Even in its current state, the casino industry is a highly profitable industry with most of the upfront capital expenditures (i.e. the casino already paid up for). Its a business tied to the general performance of the economy, and you can take a look at the businesses itself performed in 2008/2009 to get a feel for their profitability.

Despite the rally (and subsequent fall) in China stocks earlier this year, its worthwhile to note that the stocks were already beaten up.

Based on my conversations on the ground, the industry seems to be stabilizing. Still at current prices, I think many stocks will do well if the casinos simply survive this dry patch. The headlines have been overwhelmingly bearish over the last few months. Here are just some of them:

Macau Analyst Who Called Stock Drop Says Worst Yet to Come

http://www.bloomberg.com/news/articles/2015-03-04/macau-analyst-who-predicted-stock-drop-says-worst-is-yet-to-come

As Macau casino stocks sink, long-term investors look past the abyss

http://uk.reuters.com/article/2015/05/03/uk-macau-stocks-idUKKBN0NO0TO20150503

Macau casino giant SJM Holdings sees profits plunge

http://www.channelnewsasia.com/news/business/macau-casino-giant-sjm/2045860.html

Still, my gut feel is that a lot of its priced in. Of course, casino stocks could do even worst if the slowdown in China persists. On the bright side, the Hong Kong Zhuhai Macau Bridge will be completed at the end of next year, and the government is focusing its efforts on the Hengqin to further moves its revenue base from just gambling. At current prices, you don’t need a lot to go right for the stocks to rebound from their lows.

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What is Powermatic worth?

I primarily think that companies can be valued in two ways: based on cash flows in the future discounted to the present, or based on what a company has. An analogy is a household who has bought a property, car and paid off all its debts with some cash in the bank account. There are two parts to it, the future income stream, of which you can get a good feel based on their previous performance and work history, and what they currently own.

Their equity (total assets – total liabilities) act in the same way the “liquidation value” of a company is. A comment I hear often is that the “value” of these companies can only be realized if they liquidate… but in my experience this is not the case. Very few companies actually undergo liquidations, and there are a variety of ways for “value” to be realised outside of liquidation.

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The “Hidden Value” in Powermatic

Base Value of Powermatic

This is where Powermatic strikes me as being a compelling investment opportunity. Even on a conservative appraisal of their assets, the liquidation value of Powermatic comes close to $40 – $50 million, against a market capitalization at $30+ million. There is no reason in my view for a company of such a track record to trade at such a discount. You could literally buy out Powermatic out today at its current price for its investment property – and receive its business and other assets net liabilities for free.

I look at it as buying a $1 for 50 cents. The kicker in my view is that its like buying a REIT – since Powermatic pays a dividend yield of 5.35% at today’s price, and has done so for the last 9 years consistently. Management has a vested interest to keep this payout, with them owning 64% of outstanding shares.

The biggest differentiation with a REIT is that at this point Powermatic has not engaged in any borrowings. I pressed the point to management, and suggested they engage in significant share buybacks as one of the resolutions to be passed was a buyback mandate for up to 10% of their outstanding shares. After all, who knows the business best than management themselves… and they are well aware of the gross mismatch between price and value.

Some concluding thoughts:

Howard Marks once said that in investing, take care of the downside and the upside will take care of itself. Powermatic has something which I look for in my investments – an asymmetrical risk reward payout.

The worst case scenario provides an attractive return, and we get a free option on management turning around their business. The consistent 5% + dividend yield makes it all the more compelling.

Time is on my side too, as the value of the freehold property appreciates as the years go by. The current dividend is very much sustainable (costing the company $1.74 million per annum), and management has multiple ways to create value going forward.

Disclosure: The author is long Powermatic.

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I was at the AGM of Powermatic last week. Its not a well known company, but has a small following among the value investing community so I thought a write a post on it.

They operate in tough industry – and have done as well as anyone could have done faced with a similar situation. They’ve had 9 year of straight profits, and have paid dividends for the last 8 years which is impressive by my standards for a company listed on the SGX.

I had a chat with management after the AGM. They strike me as honest, down to earth people with an understanding of the current situation that the company faces. They have a vested interest in seeing the company succeed and turn its fortunes, with Dr Chen Mun & Ms Ang Bee Yan owning 64% of the shares.

So what makes Powermatic interesting?

What really strikes me is that Powermatic trades at 0.7x book value. There are many companies that trade at a huge discount to their book value, but plenty of them have assets which by measure are hard to value (intangibles, property, plant and equipment specific to their industry etc).

Powermatic on the other hand has a significant portion of its book value in current assets, and a freehold investment property that is stated at $18.6 million. 

Footnote details their investment property at  7,9 Harrison Lane. However, read deeper, and you will see that the property is in fact worth significantly more based on a independent valuation by Knight Frank, and is worth $35 million at the 31st of March 2014.

In order words, Powermatic really trades at 0.5x its book value.

More importantly, the property is freehold and not leasehold, making it all the more valuable. Rusmin Ang from the Fifth Person was kind enough to send me an interesting article on freehold industrial property, which you can check out here.

Here’s the relevant bit:

“The freehold property is a “rare commodity for an industrial site as most buildings released by JTC are on a 20-year lease”, said Ms Christina Sim, the director of investment (capital markets) at Cushman & Wakefield.”

Diving Deeper Into Their Balance Sheet

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Now I was quite curious about the make-up of the Thailand portfolio, but unfortunately wasn’t able to get more information on it.  Mr Yee Lat Shing, one of the directors who seems like a seasoned investor himself from his comments), has said that the equities are reasonably priced, and offer an attractive return going forward.

Still, I have my reservations given the considerable run-up in price of close to 60% in a year, and I wish the board had been more forthcoming about the portfolio.

A Closer Look at Remuneration Levels

ScreenClipA glance at their remuneration reveals that they are by comparison, very lowly paid compared to most boards in Singapore, with most of their remuneration coming in by way of dividends. This is an exceedingly fair arrangement if you compare it to most other listed companies in a similar position, with management taking ridiculous salaries despite the business going down hill (a story for another day).

Conclusion:

Part 1 concludes some of the “hidden value” that lies in Powermatic, and some points that I noted while running through its Annual Report. The next post will cover what I think Powermatic is worth, and why its a compelling investment opportunity.