Tuesday, July 1, 2014

Investing in UOA REIT using margin financing

Disclaimer: This article does not represent advice to invest in UOA REIT or to use margin financing. This is my first time using margin financing and my understanding of how things work may be flawed. There may also be errors in my analysis, calculations and other errors. Do your own damn research and take responsibility for your own damn investments.

I recently decided to use margin financing to try to unlock some hidden value in my portfolio. I still have positions in 2 Malaysian stocks (my margin facility doesn’t accept foreign shares as collateral) which I think will perform decently over the long-term. However, I could get even more value out of my Malaysian shares by pledging them as collateral to get some financing. As I only have a small margin facility, the effective rate that I got was around 5.76% which isn’t great but it isn’t too bad either as I’m just experimenting with a small amount of debt. The effective rate drops to a pretty reasonable 4.71% if I have a larger margin facility and borrowed more. Just like how a kid starts off with a Happy Meal before moving on to a Double Quarter Pounder set, I need to start out small and learn how to effectively utilize debt. Before I continue, I would like to bring you guys a quick update on the Greedy Dragon Portfolio. Apart from investing in UOA REIT, I also sold my shares in Overseas Education Limited as it went up quite a bit since I bought it and I wanted to increase my cash holdings.

Anyway, I figured that if I could find an investment with a higher income yield than the margin loan’s interest cost, I could increase the cash my portfolio generates every year. I also needed to be confident that the investment’s yield is sustainable or I could find my margin financing strategy turning cash flow negative.

There weren’t many investments in Malaysia that had a high enough yield to pay off the interest and still have a little somethin’ somethin’ left over for me. However, I did manage to find UOA REIT which I think is a suitable candidate for this margin financing strategy. I invested in the REIT at Ringgit Malaysia (RM) 1.39 per unit. UOA REIT has a portfolio of office buildings located in Kuala Lumpur, the capital city of Malaysia. Based on the 2013 distributions per unit, the REIT’s after tax distribution yield of 6.91% is high enough that I can still service my debt if the REIT experiences a small drop in earnings and distributions. You don’t want to be in a situation where the spread between the investment’s distributions and the debt’s interest is like a dollar; you need a margin of safety. According to the 2013 annual report, UOA REIT’s properties also have pretty high occupancy rates of between 87.3%-98.5% which should increase the odds of the REIT being able to maintain the rental it charges its tenants. Another advantage of investing in REITs with this strategy is that REITs are required by law to distribute most of their earnings. So, unless a REIT starts making losses, investors should still receive some income even during downturns.

Note: According to this article in The Star, Malaysia REIT’s distributions will be taxed at the lower 10% rate for local and foreign retail investors until at least 31 December, 2016. I don’t know much about tax laws, so please do your own research or consult a tax expert before making any investments.

I also tried to reduce my risk to a very low level with this position as I don’t want to end up being my bank’s boy. One of the main risks of margin financing is that interest rates might rise and result in the cost of servicing the debt being higher than the income from your investment. Interest rate risk is very low for my position as my cash holdings are large enough that I can easily pay off my margin loan anytime; I also have cash inflows from other sources that can be used to service the debt. Another risk of margin financing is of course the dreaded margin call where your position can get wiped out if you don’t top up your account. I mitigated this risk by over collateralizing so something really bad would have to happen before my ass gets margin called. A major risk for this specific position is that there might be a supply glut in Kuala Lumpur office space for a while. However, I think that even if UOA REIT’s occupancy rates and rental rates do come down a bit, it should still be at a healthy level in the near future.

To further reduce risk, I will set aside RM 1,441.15 in cash (2 years of interest payments) specifically to help me meet interest payments in case this position turns cash flow negative and I decide to wait on a recovery. Any positive cash flows (and I hope the cash keeps rolling in) will be used to reduce the debt or replenish the cash buffer if I had to tap into it in previous periods. The idea over the long-term is to pay off the debt using the cash generated by the REIT and convert the position into pure, yummy, delicious equity.

A good scenario to use this margin financing strategy would be when there are opportunities to invest in assets with 9%-10% yields. If I find myself in such a situation and my capital structure can afford the extra debt, then I might take a margin loan large enough to get the lower interest rate of 4.71% (assuming that the base lending rate stays the same). However, I think that financing some UOA REIT units with a margin loan is alright for my portfolio. This is the case as the debt that I took on is small relative to my portfolio’s size. I’m also treating this position as a learning experience to build up my competence in debt and cash flow management. I also think that buying units of UOA REIT on margin at its current price actually creates value for my portfolio. The following table breaks down the returns that I could potentially earn assuming that UOA REIT’s distributions per unit and the base lending rate stay at current levels:

Cash buffer
RM 1,441.15
RM 12,510
Effective Interest
After tax yield
Interest cost
RM 720.57
Income distributions
RM 864.27
Net cash inflow
RM 143.69
Cash on cash return

1Cash on cash return = Net cash inflow/cash buffer
2Again, the cash buffer represents the cash set aside specifically for this position and not my total cash holdings.

Whatever positive cash flow I get, I’m using to pay down the debt which gives me a reinvestment rate of 5.76% (not bad in this market, not bad at all). Really awesome things start to happen if UOA REIT is able to increase its distributions and/or if there’s an increase in the market price of the REIT’s units. If UOA REIT is able to boost its distributions per unit by 10%, the annual cash-on-cash return should increase to 15.97%. A 10% gain in the REIT’s unit price should result in about an 87% return on the cash buffer. I’m not taking this position with the expectation that UOA REIT will increase its distributions or that the price of its units will rise (although I think both of these things are likely to happen in the long-term).

Before I end this article, I would like to advice you guys to never take on debt for investing if you don’t understand debt and cash flow management. And even if you think that you can manage debt and cash flows well, don’t ever take on too much debt and put yourself in a position where your financial future is at risk of getting bitched out by a margin call. Thank you for reading. Take care and stay rational.

Saturday, June 21, 2014

The 4 main investment categories: Game Changers, Cash Gushers, YOLOs and Condoms.

To make the process of constructing or reconfiguring a portfolio simpler, I think of the portfolio in terms of its exposure to the 4 main investment categories: Game changers, cash gushers, YOLOs (you only live once) and condoms. In this article, I will be explaining these investment categories.

Game changers are generally top quality companies with durable competitive advantages which allow them to achieve superior returns on capital. However, unlike companies like McDonald’s or Apple which have a wide economic moat and generates high returns on capital, game changers still have a lot of opportunities to reinvest profits and grow their business. In short, game changers are companies that have the potential to become the next Starbucks or Berkshire Hathaway. It may be difficult to identify companies in this category. And even if you do find such companies, they may be trading at a rich valuation. However, investors should be patient in trying to build up this category of their portfolio. An investor could potentially move up a notch or two in life by buying a game changer at a reasonable price and holding it for the long-term, hence the term game changer.

Cash gushers are investments that have healthy income yields. The purpose of this category of investments is to provide you with a stream of cash to reinvest and expand your portfolio. It’s important that your cash gusher investments are able to maintain decent income distributions during a crisis as that’s when you will need cash the most to take advantage of bargains. Some examples of cash gushers are REITs, high dividend paying blue chip stocks, rental properties and private businesses.

Condoms are positions that give your portfolio some protection when shit goes down. I call these positions condoms because whenever I think of risk management, I think of a couple who don’t want to have kids and use a condom to prevent the risk of conception (because having the dude to pull out before he cums is too risky). The main asset in the condom investment category is of course cash. The investor can use his cash to buy up assets during a market downturn when they’re cheap; this will of course improve the investor’s odds of coming out ahead when the market recovers. If the investor uses leverage, he can dip into his cash reserve to in the event that the cash inflows of his portfolio drop below the cost of servicing his debt. Another asset that falls in the condom category is gold. Gold is thought of by a lot of people as a safe-haven asset and could help with maintaining some of your portfolio’s real value if really fucked up things like hyperinflation occurs. Short positions can also be considered as a position that falls into the condom category. An investor’s short positions are likely to go up in a recession; she can then liquidate her shorts and use the proceeds to go long on undervalued assets. I personally never took a short position in my life and know next to nothing about shorting. But it is something that I’m interested in learning more about.

YOLOs are investments that you won’t normally make but are attractive as they’re trading at stupidly low prices. Some examples of YOLOs are mediocre stocks with deep discounts to intrinsic value, undervalued distress debt, and commodities trading at below their cost of production. Investments that fall into the YOLO category are not meant to be held for the long-term and should be sold once they are no longer selling at stupidly low prices. Investors should allocate only a small percentage of their portfolio to YOLOs as this investment category can be riskier.  

As always, thank you for reading. I’m sorry if I haven’t analyzed any stocks recently, I know that’s the main reason you guys read my blog. It’s just that it’s very difficult to find attractive investment opportunities in this market as most of the stuff are either overvalued or fairly valued. Please e-mail me or drop a comment if you think there is an interesting stock that I should analyze. Take care and stay rational.

Sunday, June 15, 2014

Bullshit financial theories part 5: Risk-free investment

I recently read an article by a Malaysian investor claiming that certain stocks had no risks. Let me just clarify, I don’t think that this guy is bullshit. In fact, I think he is a successful businessman and that he means well. But I strongly disagree with his opinion on certain plantation counters having no risk. To be fair to him, he later clarifies that by saying there may be short-term market risk, but in the long-term investors will certainly make exceptional profits. But how can he be so sure? After all, the profits of palm oil plantation companies are highly dependent on the price of crude palm oil. And there’s always the possibility that if CPO prices are high, supply will increase and drag CPO prices down to levels that allow plantation companies to only earn average returns on capital. When I say there’s no such thing as risk-free investing, I meant both in the short-term and the long-term. Anyway, the rest of this article will not be related to what this investor said, instead I will further elaborate why I think the idea of risk-free is a myth.   

Side note: I personally have no idea how the palm oil plantation sector will perform in the long-term (I hope it does well, as a stock I own has some exposure to this sector).  

If you studied finance in university, you would have been taught that government securities were risk-free assets. All you have to do is look back at the European sovereign debt crisis to know that this isn’t the case. In fact, by investing long-term in U.S. treasury bonds (which are thought of as one of the safest assets in the world) at current yields, you will almost guarantee that your investment will get fucked in real terms when all is said and done. The ten year treasury has a yield of 2.60% and the long-term inflation rate is around 3-4%. Good luck using the proceeds of the Treasury bond in the future to buy as many cheeseburgers or mamak dinners as you could buy today.  

Even companies with large economic moats bought at low prices are not a sure thing. Sure, it would take a real shit storm for a company like P&G or Nestle to get its intrinsic value impaired. But such shit storms are still within the realms of possibility. Before I invest in something, I have to be reasonably sure that it can deliver above average returns. But I understand the risks, and I monitor the performance of the company to see if any major risks materialize and act accordingly. Once you think your investments are risk-free, you start becoming sloppy and the probability of losses increase. Thank you for reading. Take care and stay rational.

Sunday, June 8, 2014

My take on K. Fima’s quarterly results ended March 31, 2014

Please read the disclaimer here:http://greedydragoninvestment.blogspot.com/p/about-greedy-dragon.html. Enjoy the article, bitches!

In this article, I will be doing a quick analysis of the quarterly performance of Kumpulan Fima’s business segments. Before I begin, let me just disclose that I do own shares in the company. I used to have a theory that an analyst would do a better job if he had skin in the game as it would force him to really try to understand the company. But after seeing how some people vehemently defend overvalued shit companies that they got stuck with (I wish my future wife would defend me the way these shmucks defend their investments), I’m starting to rethink my theory. However, I think I have enough sociopathic traits to pull off an objective analysis.

Manufacturing of security and confidential documents: Profit before tax (PBT) from the manufacturing division experienced a significant decline of 56.7% from the previous quarter. The decline was the result of lower revenue and less favorable sales mix. However, I will cut the company some slack as the manufacturing division did post strong results over the past 12 months with revenue and PBT growth of 19+%. I will be monitoring the results of the manufacturing division closely to see whether the dip was cyclical or if it is more persistent in nature.

Plantation division: The plantation division really stepped up its game in the quarter ended March 31, 2014. Revenue and PBT grew by 91.8% and 60.7% respectively from the previous quarter. The stronger performance was a result of both the higher selling price of CPO and CPKO and higher sales volume. The fortunes of this division are tied to palm oil prices, so it’s difficult to predict how this division will perform over the long-term. All management can do is to keep striving to be even more efficient and achieve a lower cost structure as that’s the key to getting a competitive advantage in a commodity business.

Bulking division: When I first analyzed Kumpulan Fima, I really liked its bulking division due to its solid profit margins. Revenue and PBT increased by 7.8% and 15.7% respectively from the previous quarter. However, the business environment for this division remains challenging as revenue and PBT are down by 13.9% and 11.39% respectively from the corresponding quarter a year ago. Hopefully the performance of the bulking division can continue to pick up.

Food division: This division sucked this quarter and has been sucking for the past 12 months. As this division generates most of its revenue in Papua New Guinea, it has been brutalized by the weakening of the Kina (Papua New Guinea’s currency). A weakening Kina would by itself cause the division’s revenue and PBT to decline in Ringgit terms. However, the situation is made worse as a significant amount of the division’s raw materials are denominated in USD. The weakening Kina makes these raw materials more expensive and causes the division’s cost structure to increase. I don’t want to write this division off yet because it did report decent profits a year ago. If I was in charge of Kumpulan Fima, I would give this division 3 years to turn itself around. If it can’t at least earn its cost of capital by then, then I would seriously consider selling it off. As Kenny Rogers once sang : “You've got to know when to hold 'em, Know when to fold 'em, Know when to walk away, Know when to run”. One of the best fucking pieces of advice given for business and investing, ever. Thank you for reading! Take care and stay rational.