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Wednesday, February 7, 2018

Largo resources

This blogger has pretty much summed up the thesis for this stock.

It looks really scary right now because of the debt, but I think the situation will change significantly over the next year. Fully diluted market cap is about $730 million (all CAD$ unless indicated otherwise). They will get about $50 million from the exercise of those warrants over the next few years. Latest net debt was about $249 million. Average prices for Vanadium were about US$8 during Q4.

They produced about 2600 tonnes in Q4 and plan to produce a little over 10k annually over the next decade or so.

So they produced about 5.73 million pounds in Q4. Multiply that by US$8, and multiply again by 1.25 and you get $57 million in revenue. Costs are about $44 million. So that is $13 million in free cash flow. Their debt has a really high yield though. They could save $10 million per quarter here if they pay it off.

If they produce 2600 tons in Q1 at US$12 (the current price), then that is $42 million just in Q1, or $160 million in 2018. So they will likely pay off most or all of their debt within the next 2-3 years at US$8-12/lb prices. I can imagine a refinance at some point this year to let's say 6-8%.

If they are debt free and produce at US$8 per lb, that is almost $100 million per year in EBT. They got quite a bit of NOLS. So unless prices crater back to $5-6 with no spikes in the meantime, this stock is not nearly as scary as the debt makes it look like. A spike to US$20/lb for Vanadium would make this stock very cheap.. That looks at least somewhat likely given the supply/demand situation.

So got a 1.5% position at $1.12.

Wednesday, January 31, 2018

Jiashili

I bought Jiashili last year at a much higher price. They manufacture biscuits, and are getting into baking cakes. Stock is trading at LTM 8x PE. I did sell at roughly the same price as I did now. I thought it was suspicious that gross margins declined (given the IPO recently, inflated margins to get a better price?). It appeared they had not raised prices like they usually did. The bull case was kind of based on pricing power. In the interim report they did mention they would raise prices in H2. I sold out because of the lack of insider buying as the shares had cratered. If they could raise prices, why didn't they do it in H1?

Usually by year end they have a large net cash position, but by midyear they have large amounts of prepayments. So getting net cash position is a bit hard. For example in the last annual report it said they had more than HK$500 million in net cash. But now net cash is much lower at about HK$140 million. Add in about HK$50-70 million in H2 earnings and net cash will be HK$190-210 by now. NCAV is HK$200 million though (or HK$250-270). It seems like they wanted to lock in lower prices and prepaid a lot of ingredients. By year end, net cash position will probably be around HK$500 million again. I think it is probably better to take the midyear net cash position vs the year end net cash position?

It does appear they either pay out their earnings and actually invest some of the IPO proceeds. They did pay a HK$0.15 per share dividend in the past 2 years. Which amounts to a dividend yield of almost 8% on the current price. The last one does not show up on google finance, but I did get it in my account last year.

So I was sceptical they could further raise prices and that their cake venture would amount to anything and sold out.

But then I saw that the chairman had purchased 2.5% of shares outstanding recently for about HK$26 million at a price of HK$2.4. Which is 18% above market price at the time, and more than 2 months worth of volume! So I took a closer look again.

The bear thesis here is that they languish, and trade at a 10x PE with no growth. So besides opportunity cost, little downside. The bull thesis is that they can raise prices like they have in the past. And that their cake venture takes off.  This is supposed to be higher margin, and was postponed in H1 last year. Then the PE multiple could be much below 5x even.

I think downside is covered by the solid balance sheet and the dividend here. And the large purchase by the CEO tipped me over the edge to get back in again for a 3% position. It seems like a classic 'heads you don't lose much, tails you could win big' stock.

Tuesday, January 30, 2018

Asia Orient

Asia Orient (AOI) owns 52% of Asia standard international (ASI) and about HK$1.25 billion of mostly mainland property developer bonds on their own books net of debt. It is kind of a net net. The thing is that on the Asia Standard level, there is a lot of debt. The Asia Standard level also own office towers in Hong Kong, and a 67% stake in subsidiary, Asia Standard Hotel (AHI), which owns several hotels in the middle of Hong Kong. Then ASI owns a ton of real estate in various stages of development in Hong Kong and Mainland China.

What I did is take all the cash, equity securities and owned debt securities (not including receivables), first on the Asia Standard level, and subtracted that from all the debt. On the ASH level, Debt seems to cancel out equities cash and bonds. So I ignored that, and only looked at the ASI level. Then I subtracted that from the assets and debt (not including property plant and equipment) on the AOI level. This way you basically get all the real estate and hotels 'for free' and do not need to factor in debt. It makes it easier to analyze the whole thing. I summed it up here:

I wrote up Asia standard before on this blog. Although I was not too accurate. And they also did not disclose what bonds they owned. They recently became more detailed in their disclosure. As you can see, if the bonds go down in value, their 'net cash' position can evaporate quite quickly. So it is would be worthwhile to analyze some of the risk they are taking here with those bonds.

Of the HK$11 billion of bonds on Asia Orients books, 77%, or about HK$8.5 billion, seem to be made up out of the following:

  • HK$4.66 billion of 9.375% 2024 Kaisa notes.
Kaisa went through a restructuring recently. They got about HK$30 billion in equity. And a market cap of about HK$30 billion. With about HK$92 billion in net debt. And about HK$200 billion worth of assets, not including cash. The notes trade something like 98% of par value. You can actually buy them on IB. Also their assets seem to be mostly tied up in tier 1 cities like Shenzhen. And they generate about HK$500 million of recurring income, outside of property development. So risk of impairment is probably low.

  • HK$1.26 billion of 8.75% 2025 Evergrande notes. 
Then Evergrande has about HK$120 billion of equity. With a market cap of HK$366 billion. They got HK$440 billion in net debt. HK$1.4 billion in assets minus cash. Average cost of debt seems to be below 4% though.  The bonds trade above par on IB. 

  • HK$1.10 billion of 11% 2020 Mingfa notes.
Mingfa actually stopped trading in 2016, and stopped issuing reports. See here on page 22 and 23 why that happened. Market cap was HK$11.5 billion. HK$12 billion in equity. HK$12 billion in net debt. HK$56 billion worth of assets, excluding cash. Seems like they purchased the bonds recently. I cannot find a quote anywhere though. They trade on the Singapore exchange. And trading there has not been suspended. They do not trade on IB, but it says that the last transaction was at a value of 100. So I assume they trade at par?  Given their low level of debt, significant impairment is not too likely. Unless the whole thing is a complete fraud. But since they very recently completed an offering of US$200 million of 11% bonds, I would say that is unlikely. 

  • HK$0.79 billion of 13.75% 2018 Wuzhou notes.

Wuzhou has a market cap of HK$4 billion. HK$10 billion in debt, net of cash. And HK$4.6 billion in equity. And HK$28 billion worth of assets minus cash.  According to IB, the bonds seem to trade roughly at par (that C97.8 figure on top right?). Since they will be repaid this year, this will be converted into cash soon.
  • HK$0.70 billion of 13.75% 2018 Hydoo notes. 
Hydoo has a market cap of HK$2.7 billion. Equity is about HK$6 billion. Net debt is HK$3.2 billion. Assets minus cash are almost HK$17 billion. 


So I think it is safe to say, it looks reasonably likely those bonds will keep their value. The Chairman only started to buy significant financial assets in 2009. And has so far generated almost a 20% IRR since 2009 (with just the financial assets). So he outperformed all indices (knock on wood).  He also probably knows the Chinese property market a lot better than I do. On top of that, they have been stingy with land acquisitions recently. So all their real estate in development that is sold now, is built on land that was bought at much cheaper levels. This signals to me that they are at least somewhat opportunistic with their capital allocation.

Plus if you own ASI through AOI, you get HK$1.7 billion worth of bonds with only HK$0.45 billion of debt. So your downside risk is covered that way in case of impairment, with less leverage.

The remaining assets

Let's start with ASI's office buildings. Lease net income was about HK$155 million annualized. And they expect further increase in rents. The office market in Hong Kong is pretty tight and demand is growing with limited supply. If they grow rents a further 10%, that would mean about HK$175 million of income on HK$210 million of revenue. If they would spin this off in a REIT, assuming further HK$25 million of SG&A expenses and no debt, and a yield of 6.25%, that would value these office buildings at HK$2.4 billion. Or HK$1.20 billion to AOI.

So add this to current net liquid asset value of HK$2.2 billion to get HK$3.40 billion. 

Basically my valuation assumes a large discount to book value for the hotel and office buildings, while a likely premium on their real estate in development. This is because hotels and office buildings in Hong Kong trade at ridiculous cap rates of 2-3%. Unless they sell, it is unlikely these valuations will be realized anytime soon, unlike their real estate in development, which will most likely be turned into cash over the next 5 years. 

For the hotels I can be quick, I assume HK$400 million (or market values). This is likely too low, as they over depreciated their Canadian hotel assets. On top of that, capex has been much lower than depreciation for the past 20 years (excluding their new additions which will go into operation soon). So I assume HK$50 million of annual capex, plus another HK$20 million in revenue growth. That gets me to HK$170 million in segment results. But there are HK$60 million of corporate expenses. Although some of those are development expenses. In 2015 corporate expenses were HK$37 million and in 2014 they were HK$24 million. So I assume HK$30 million and a 20% tax rate (on fully depreciated income) to get HK$126 million in normalized free cash flow. 

So 35% of HK$1.2 billion, would amount to about HK$400. Let's take a 25% holding co discount to get to HK$300 million. Or HK$3.70 billion total.

Then there is their real estate in development. On ASI's books, this is HK$3.7 billion in joint ventures and HK$700 million in real estate for sale. 

The joint venture could throw off HK$2-3 billion in cash soon. Presales in the latest AR were HK$3.24 billion alone. This is for their Shanghai project, where they own about 500k sq feet in luxury real estate. But since it is a 50% joint venture, it was unclear whether the HK$3.24 billion was just their part, or the total. It is also unclear how much debt the joint venture has. 

Then there is the more than 590k square feet they plan to build in Hong Kong, Hung Shui Kiu. They got this land in 2007. So profit margins will probably be quite nice. Based on current valuations in the area, this could net them another HK$3-4 billion in revenue. And HK$5-600 million in profit? This has yet to be built though. 

Then there is the Beijing project which will kick off soon. They also bought this land a long time ago. They own almost 1.2 million sqft in GFA in this project. Building will still have to start though. 

So it is safe to say that this will probably net them another HK$1 billion over the next 3-4 years. And possibly HK$2-3 billion. 

Or another HK$500 million to Asia Orient. Or HK$4.20 million in total. 

This is a pretty conservative valuation. And provides more than 120% upside. 

The main issue is, what if their financial assets decline in value? The counter argument against this is that they could also increase in value.  And several bonds will be likely turned into cash within the next few years (I assumed about 20% in my above model). If you wait 2 years, and there are no impairments, liquid assets would have increased by HK$1 billion. Your upside would then be 176%. 

If financial assets decline by 20% in value, current NAV to Asia Orient would be HK$3.25 billion. This assumes a negative value of liquid assets on the ASI level, and still the same value for everything else. 

If this does not happen, your NAV increases by probably 15% a year (assuming income from offices and hotels cancels out real estate development costs, and before any cash inflows from real estate development projects). So not a bad deal, considering the market cap is only HK$1.9 billion, or EV of only HK$650 million of Asia Orient. 

A catalyst could be increased dividends from Asia Standard, Asia Orient buying more of Asia Standard (they have been slowly increasing their state), those office towers being spun off into a REIT. And I did not count the redevelopment project in Canada on the AHI level, which could be substantial (but AOI only owns about 35% of AHI), and various small projects in Hong Kong owned by ASI.

I think the risk of capital being wasted on expensive real estate projects to be limited. If there is a crash, I think Poon Jing will take advantage and buy assets at a discount. 

I think it is likely that AHI becomes 100% consolidated into ASI at some point, and ASI is going to be milked for cash into the future, with increased dividends. With AOI buying more of ASI. This will help close the discount to NAV.  So 3% stake for me. 

Monday, January 29, 2018

Further thoughts on when to sell a stock

I recently changed my approach with selling stocks. A lot of the big investors often say that it is better to hold longer than to sell too soon. I disagree. Before I continue though, it is worth noting that I do not pay cap gains taxes. If you pay cap gains taxes, this will probably not apply to you.

I think generally you want to look at the available information for a stock and then look at what is priced in probabilistically. It is probably a more intuitive method than using a discount rate. And closer to how the market actually values a stock. Because there are many market participants with each their own opinion. And the market price and volume reflects the average opinion (if you average it per share sold and bought and not per buyer).

And then look what else you can buy for that price. And always try to own the stocks where a lot of (hopefully mostly unwarranted) pessimism is priced in. And never get too attached. Sell if more and more optimism is priced in. If I seriously hesitate to buy it, I should sell it. And I never treat gains like free money now. 

And you always remember that stock that you sold too soon. Because it feels like a loss. And we tend to remember those. But how many times can you remember the time you sold, and rode the stock up twice? I find that I have a bias to hold on to stocks after they go up. A lot of value investors suddenly turn into momentum investors after their portfolio increases in value. 

Bluelinx again

Let me use the recent example of Bluelinx. The old me would have said, there is a pretty good chance based on the recent trend that they will earn $20-25 million in 2018. So a 10x multiple would be reasonable, so the equity is probably worth $200-250 million. So selling when the market cap is $140 million would be bad. As there is still 42-77% upside. 

The new me would say, well what is currently priced in? They have not yet earned that much. Only recently are they getting their shit together. They will likely earn $9-10m in 2017 (adjusted earnings). But what is the probability they will earn more in 2018? And what is the probability the market will value them at 10x earnings a year from now, with no track record? And can I reasonably say it is very likely (80% chance?) they will earn $25 million in 2018?

And what are the odds this stock will not be cheaper again in the future?

Let's say there is a 20% chance they will earn $25 million, a 20% chance they will do $20 million and a 60% chance they will do $10 million. Then their probable earnings are about $15 million in 2018. And the stock seems like it is suddenly a lot less cheap at a $140m market cap. Now how certain am I that the odds are really more than 40% that they will earn at least $20 million? Unless you have very good information by doing scuttlebut type of research, saying the odds are more than 50% would probably be optimistic. 

Obviously you can tweak this all you want. A 30% chance they earn $10m, 30% they earn $15m, 20% chance they earn $20m and 20% chance they do $25m would get you $16.5m in probable earnings for 2018. Value that at 10x and the stock is close to fairly valued given the current information.

Then since they are a cyclical company with low margins and with still over $200 million in net debt and they have suffered losses in the past few years, the market might not give this a high multiple for a few years. Even if they earn $20-25m!

So to hold on, you would have to be quite certain they earn $20m or more within the next few years. And that the market will rate this at least at a multiple of 10x.  And you take a moderate amount of risk for anoly 40-70% upside. Not a great deal really. 

Plus I actually bought this at $7.5 early in 2017. then sold it at $11. Since at that point I had not seen the impressive margin improvements of the last quarter. But then the market gave me an opportunity to get back in at $9 after a lot of positive information had come out already and insiders were buying. So I had new information which made the stock cheaper than when I sold it at $11, and I could now get it for $2 cheaper on top! So I made a 150% compounded return in less than a year, while the stock is only up a little over 100% from my initial price. And I took less risk. So that could be the other side of selling too soon that you also need to factor into your selling decision. 

Hemacare

I bought Hemacare at $2.7 almost a year ago. It seemed like revenue in 2017 would be $20m with 53% gross margins. They had really good growth prospects with mostly fixed SG&A expenses of about $7.5m. So it looked pretty cheap if they could keep growth in the double digits. Given the industry they were in and the fact that Oneblood was buying at above $3 per share, gave me the confidence that explosive growth was very likely in the near future. Also H2 2016 revenue was almost $8m. Only needed about 30% growth from H2 results into 2017 to get a 17x earnings multiple. With the operating leverage involved, earnings would grow a lot faster than revenue. So in that case 17x earnings with no debt can be quite cheap. If earnings surprise on the upside, it could be a lot cheaper, and you only have to wait a year to see it happen. 

But currently the market cap is about $67m at $4.85 (where I sold). Revenue in H1 clocked in at $8.7m. Which was slightly disappointing. Let's say that revenue in 2018 grows another 40% to $28m from $20m in 2017. This would yield $5m in net income (assuming a 21% tax rate). So now it trades at 13.5x 2018 earnings IF they grow another 40% from a revenue base that is still speculative, since we have not seen H2 results yet. To get into really cheap territory of 7x earnings, they would need to grow yet another 40%. 

Going from $14m to $28m is easier than going from $20m to almost $40m (where it would be cheap again). Plus now you have to wait longer to see if they can pull it off. When I bought in may I had to wait a little over a year, now I have to wait almost 2 years. 

If there is a 50% chance they will grow 40% in 2018 and 2019 (on $20m of 2017 revenue), and a 50% chance they will just grow 20% in 2018 and 2019 (on $20m of 2017 revenue), then probable after tax earnings would be about $7.5m by 2019. A 14x multiple on that would get you a $105m market cap. And that is more than 2 years from now (when we know 2019 H1 results at least). This is 56% upside, with quite a bit of risk, and you probably have to wait a year or two. Add in a decent chance of a no growth scenario and upside would look worse even. And there could be a decent chance this dives down 50% if they growth disappoints.  

Of course if you think they can earn $9m after tax in 2018, and the stock should trade at 20x earnings, upside would be 167%. The problem is, how sure can you be that is the case? And what are the odds that in the next year or so, the market becomes seriously inefficient? Maybe they do $23m in 2017, there is some macro scare, and you pick up shares at $4? Or maybe the shares languish at $5 over the next two years (when everything is going as expected), and you can still get in a year from now at the same price? Especially since the choice is between holding Hemacare or another potentially cheaper stock. And not between holding Hemacare or cash. 

Also can they really scale up to those numbers? After all they need blood donors to sell their product. And SG&A increased to $4m already in H1, what are the odds this will not grow more than expected as well?

And add in a scenario of worse 2017 numbers and only 10-15% growth, and it looks worse. It is not a bad investment at this point, just that the juicy bits have been taken already. With the risk you are taking.

So I decided that there are more attractive alternatives, and that there are odds I can pick this up cheaper over the next two years, so I sold my entire stake for a neat 85% gain. 

Of course I will look stupid if they grow faster and the stock goes to $12-15 over the next year. I would still think selling with the given information was a good decision though.

All this to talk myself into selling, to buy some cheaper stock!

The alternatives

Selling looked especially attractive since I saw other stocks that were cheaper and had less risk. The first one is King's Flair. I will write a post on the other two soon. I had this stock on my watch list, and it got 10% cheaper. So I decided to take another look. I thought they sold kitchens, but they actually sell kitchenware with a replacement cycle of only 2 years. And I had not noticed the large dividends for some reason, so that tipped me over the edge. Net cash is 70% per share (subtracting the dividends and adding about HK$55m of earnings in H2), and it trades at ~6x earnings. With a more than 10% dividend yield. Earnings are reasonably steady with flattish revenue. 

I think there is a reasonably chance this will trade to 11-12x earnings at some point, plus I get large dividends in the meantime. At 11x earnings, you would get about 75% upside plus dividends (which is better than upside for Hemacare shares with less risk). And stock would still only trade at about 7x EV/earnings. There is a chance earnings go down, but there is also a chance they recover to its 2015 high of HK$162m. Then earnings multiple would only be 4.6x. And assuming a small chance that earnings go down significantly, and a small chance they up significantly. But most likely they stay around HK$100-130m given its history.

Edit: I have to add, one customer accounts for 50% of their revenue. And has been for some time. This adds some risk, so that is why I keep it a small position. 

If for example Hemacare results of H2 2017 come out good, King's flair goes up 20%, and Hemacare goes down to $4 (with no negative information) over the next year or so, I will probably hop back into Hemacare. With no cap gains to worry about, I think you can get a performance boost by constantly rotating in the cheapest stocks (within reason to account for transaction costs).