Sunday, November 12, 2017

It’s the capital structure,stupid!



Whaddup, it’s your boy, the Greedy Dragon, back up in this motherfucker! It has been almost 8 months since I started working a 9-to-6, and I realize that some of the premises I once held were just fucking stupid. Like when the time I thought that you could even come close to retiring on 300k Ringgit and a fully paid-up house. Shit happens and will continue to happen. Few hundred bucks to fix this, few hundred bucks to fix that; at the end of the month you realize that you fucking outspent your paycheck, again. Maybe my lifestyle is a tad too baller for my income bracket, maybe I just had a string of bad luck. Whatever it is, I sure am fuck glad that I already have some capital to work with as I don’t think I have the right temperament these days to scrimp and save like regular folk. Anyway, let’s take a look at how a bad capital structure can keep an otherwise decent business down.

Update on the Greedy Dragon portfolio: Since my last article,  I sold 4,000 shares in Hua Yang at RM0.81 per share and 500 shares in Maybank at RM9.26 per share for liquidity purposes.

Say you invested in a car wash in Albuquerque that’s really a front to launder meth money, and it makes $80 million in EBIT a year. The car wash’s capital structure consists of $400 million in term loans with a 4% interest rate and $100 million in common equity; there are 50 million shares outstanding. To keep things from getting overly complicated, we’ll assume the corporate tax rate is 0% which will give the car wash a net profit of $64 million or $1.28 per share. All of a sudden cocaine starts taking a bite out of meth’s market share, and EBIT at the car wash falls 50% to $40 million.  

It’s just gonna suck for a while, right? After all the meth behind the car wash is 99.1% pure, customers will come back. Ain’t no thing, right? That may very well be the case, however, the term loans will mature in less than two years, and the banks that lent the car wash money don’t want to rollover the loan. Some time passes, and the car wash starts to get desperate and seeks alternative sources of funding. It eventually takes a $400 million loan with a 9% interest rate from a private equity firm. The car wash also has to give the PE firm warrants to purchase 20 million common shares at a really low exercise price as a sweetener.

Now I don’t blame PE firms for making huge profits to supply capital to companies in a bind. In fact, I think it’s beautiful. First off, it’s a voluntary transaction. There are higher risks involved in lending to distressed companies. The new injection of capital also gives struggling companies a lifeline to turn things around instead of just waiting around to die. Don’t hate the player, hate the game. In fact don’t even hate the game, the game is fucking intoxicating. It rewards intelligence, discipline, and guts, and no leftist pussy will ever convince me that this is a bad thing.

Anyway, the car wash will suddenly see its interest expense rise to $36 million from $16 million, and net profit will fall to $4 million. Let’s say that the meth business does eventually turn around and starts making $80 million again, the share price recovers somewhat, and all the warrants get exercised. The car wash will now be making $44 million in net profit. With the larger number of shares outstanding, earnings per share will clock in at $0.63; approximately half of what it used to be at the beginning of our story, and that’s assuming profits recover fully.

You might have noticed that I didn’t talk about the share price at all. Well, it's because it is not fucking important; what’s important is the profits that each share is entitled to (unless the share price is higher than what you paid for it, which is doubtful due to the significantly lower earnings per share).   

Here are some things to look out for when evaluating a company’s capital structure:

1)      Obviously a low debt-to-equity ratio is a good thing, but what is considered low depends on the industry, and even then what is conventionally considered a safe ratio may not hold up when the shit hits the fan. But a high component of equity just might put some sort of a floor on the price of the stock, which will give the company more options in terms of funding sources.

2)     When conducting your stress test, make sure to include a 6-8% increase in the cost of debt (this is just based on my own experience, you can do your own research on what would be a more appropriate increase) to whatever other negative things you are factoring in to your model.

3)      How far into the future are the company’s debt maturities? Will it be able to recover its earnings power by then to convince the financial markets to let it refinance its debts?

4)      Is the company generating enough cash flow to fund its CAPEX program without having to take on additional debt?

5)      Does the company have any contractual obligations that require significant cash outlays that can’t be paid for through cash on hand and cash flow?

The list is by no means extensive, as I’m still learning about the investment game. I know I’m still a long way off from becoming the Heisenberg of capital allocation. Anyway, thank you for staying with me on my journey to build my empire, even though I rarely post no more (because I’m a lazy puta). Take care and stay rational.

Saturday, September 2, 2017

Not Dead Yet...

Sup y'all, just wanted to drop by to say hi and that I'm still alive. I would like to say that I stopped blogging this past 6 month because I wanted to give my full to attention to my new job. But to be real, I just wasn't feeling it. The well of ideas went dry. Anyway, here's a little update on my life, and what I've been up to with regards to the Greedy Dragon Portfolio.

So, on the 20th of March I started working at an investor relations firm. I won't mention the name of the firm as I don't think they want to be associated with some puta cabron that calls himself the Greedy Dragon. Overall, the job is a job. People are generally nice, so I guess I should be grateful for that. I do miss waking up whenever the fuck I want, taking my time to enjoy a meal without glancing at the time every 30 seconds, or playing video games at 3 in the morning. But I guess that's what it means to "adult" as some mofos like to say. Can't say I'm a fan of some of the menial stuff I got to do, but everyone got to start somewhere. I'm not that delusional to think that I would be the capo di tutti capi of the investment world day on day 1.

When it comes to my portfolio, it reached a record high early in the year when people were optimistic that Trump would be good for business. The optimism started fade as the Trump administration displayed their incompetence time and time again. And no I'm not a fucking leftist SJW, I still think Trump is a better president than Obama, but that's setting the bar way too fucking low. I wish Margaret Thatcher could be president by communicating through a ouija board, she was really good for business (and yes, I know she is British). Anyway, since I took up my job, my stock holdings just kept sliding down like a motherfucker, and I've been catching some falling knives. Here are the positions I took since my last post:

Disclaimer: Please do your own research, I might not know what I'm doing. For all I know, I might be committing financial suicide.

Bought 400 shares in Cloud Peak Energy at USD4.05, sold 500 shares in Kerry Properties at HKD29.70, bought 700 shares in Northern Oil & Gas at USD2.45, sold 1k shares in Maybank at RM9.39, bought 250 shares in Oasis Petroleum at USD7.55, and bought 1200 shares in Northern Oil & Gas at USD 1.20.
I hope I will have more things to blog about in the future. Till then, I hope y'all keep on hustling for that paper. Thank you for reading. Take care and stay rational.

Sunday, February 26, 2017

Long-term profitability



Hey yo, I hope things have been working out for y’all. As value investors we are always looking for companies that can generate consistently strong profits over the long-term. As the big man Warren Buffett said “If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.” In this article, we’ll be looking at some of the clues that point to long-term profitability for a company.

A strong brand is definitely up there as a competitive advantage that can help a company maintain its profitability. The Apple brand makes the company’s products appear special and allows Apple to still make YUGE profits even as the smartphone market is entering the maturity phase (Tim Cook, who probably leans left, is gonna be pissed at me for using Apple and a word associated with Trump in the same sentence). On the other hand, the HTC’s of the world has seen their profitability fall off as competition intensified and smartphones become more commoditized.

A low cost structure helps protect the profitability of companies selling undifferentiated products. For instance, oil companies with high cost structures got fucking curb stomped when oil prices collapsed. However, there were oil companies that were able to operate within cash flow or even generate free cash flow due to their low cost structures. These companies’ low cost structures could be a result of acreage with good geology, ample pipeline capacity to transport their oil, proximity to distribution hubs, a low level of debt and/or a culture that prioritizes innovation and cost cutting.       

One good predictor of consistent profitability is if the company has little to no competition. This could be a result of the company owning assets that are difficult to replicate aka trophy assets. For instance, it is very difficult to build a major oil or natural gas pipeline in the US due to all the regulations and the democrats pandering to hashtag campaigns from those damn environmentalists (things are starting to get better now that the republicans are in charge with the Dakota Access Pipeline receiving final approval). This turns certain pipelines already in the ground into not just cash cows, but big fat Kobe cash cows. A company could also dominate its market by creating such a great product that most consumers just choose to use its product. Examples of such companies are Google & Facebook. The government can also grant monopoly power to companies by giving them exclusive licenses to conduct certain types of businesses in the country. Great intellectual assets can prove to be quite the money maker. Disney will probably continue to make pirate shiploads in royalties from the sale of Elsa dolls, backpacks and clothes for many years to come. After all, Elsa is a pretty awesome gal.

There are also industry-specific stuff that investors need to take into account when analyzing the ability of companies to increase profitability over the long-term. A property developer’s ability to sustain its profitability depends on its current land bank and its ability to acquire new land at reasonable prices. For an oil company to grow its volume, it would need an ample inventory of drilling locations that are economically feasible at current oil prices. Pharmaceutical companies can make a lot of money from drugs under patent protection. So, it would behoove them to have a robust R&D pipeline of promising drugs to replace their existing patents when they eventually expire.  

We’ve all read about how Netflix ate Blockbuster’s lunch, or how the camera industry has shrunk dramatically as Asians could just use their phones to take photos of their food (we truly are living in a brave new world). Obsolescence is a threat that investors should always be on the look out for. While it’s kind of a stretch to say that brick-and-mortar stores are obsolete, the impact of online shopping is very real for many retailers. Quite a number of retailers have seen their profits and stock prices plunge as they lose sales to online stores. To be competitive, traditional retailers need to develop and execute an effective omnichannel marketing strategy.    

One of the best ways to make that “fuck you” money is to invest in shares of companies with superior and growing profits, at reasonable prices, and hold them forever. That is why it’s important to learn about the competitive advantages that lead to long-term profitability, and the threats to a company’s profits. Thank you for reading. Take care and stay rational.

Monday, February 20, 2017

Can you retire on RM300k in Malaysia?



Hey, what’s crackin’ my value investing homeboys. You and your friends probably had discussions at mamaks or hipster cafes about how much investable assets you would need before you can quit your job to pursue your passion (whatever the fuck that is). That figure could be RM500k, a million, or more depending on how baller your lifestyle is. But to accumulate RM500k or more in investable assets indicate some degree of successful financial planning. But what about the guy who didn’t give much thought about retirement until one day he realized his erection isn’t as hard as it used to be?

Update on the Greedy Dragon portfolio: I recently sold 50 shares in Natural Resource Partners for USD 40.80 per share. I still own 200 shares in Natural Resource Partners.

Let’s call our carefree, live for the moment kinda guy Ah Chong (the most generic Malaysian Chinese name ever). Ah Chong is just your average guy earning an average salary. Therefore, he has average EPF savings. In 2015, EPF active members’ average savings at age 54 was RM194,438.37. This doesn’t include EPF’s annual dividend, so it’s more like RM206k if we assume a 6% dividend. Ah Chong wasn’t into the whole savings thing in his younger years. He bought a Japanese car the moment he saved up the down payment, and has been changing to a new model every 5 years or so. He always had the latest phone and a Prada wallet like every other fucking yuppie. Ah Chong regularly visits a KTV lounge and makes 2 trips a year, one to Genting and another to Bangkok. Playa gotta play, right? Thankfully, Ah Chong was nagged into buying a house by his parents. Ah Chong got a wake up call in his mid-forties when some leng lui called him “uncle.” Since then he managed to put aside about RM100k.

A quick disclaimer: I’m not a professional financial advisor, I’m just an asshole that no one wants to employ. Nobody should take anything I say seriously as there’s a chance that I will get some things wrong.

The first order of business for Ah Chong would be to set aside some money in fixed deposit for emergencies. So, let’s say he allocates RM20k for a fixed deposit that pays 3.5% a year. According to data I got from Ringgit Plus, at least 4 financial institutions offer interest rates of 3.5% or higher depending on stuff like deposit period, your age and deposit amount. Ah Chong then splits the remaining 280k evenly between bonds and quality dividend paying stocks. You need them stocks as they have the potential to increase earnings and, therefore, their dividends to help you keep up with inflation. You need bonds as they can be a  more reliable source of cash flow than stocks. If you're interested in bonds, you can check out my article bonds is love, bonds is life.

Considering that Maybank has a trailing twelve month dividend yield of 5.9%, I think it’s quite likely that an investor can put together a stock portfolio with a dividend yield of 4.5%. Disclosure: I own shares in Maybank. I believe an investor in Malaysia is able to get a distribution yield of 4.7% by investing in bond unit trusts*. So, this would leave Ah Chong with a portfolio yield of 4.53% which would in turn give him an income of RM13,580 per year or RM1,131.66 per month.

*I looked at data from 6 different bond unit trusts. They had yields of between 4.17% and 6.88%, and an average yield of 4.97%. I adjusted the 4.97% down to 4.7% to take into account any sales charge. I calculated the yields on my own which differs from the yields displayed on the factsheets.

Assuming he spends RM500 a month on stuff like electricity, internet and petrol, that would leave him with about RM20 a day for food. That would suck for a wide fella like me who loves good food, but I guess it’s workable if you’re thrifty when it comes to food. Ah Chong will have to go to government hospitals if he needs any significant healthcare. He would also need to pay for stuff like car insurance, road tax, property assessment tax and homeowner insurance. Let’s say that all these things come up to RM4k per year. Let’s assume that the stock portion of his portfolio appreciates by 3% per year, and he sells stocks equal to his capital gains. That would allow Ah Chong to increase his yearly income by RM4,200. So, it seems our boy got things covered, right? Well, not quite. First off, he impairs his portfolio’s ability to keep up with inflation whenever he sells stocks. Secondly, stocks don’t always go up, there will be negative years.

Can’t Ah Chong just dip into his principal to combat inflation? Let’s assume that stocks go up by 3% every year like clockwork, which brings his portfolio’s return up to 5.93%. How long will it take for him to deplete his retirement fund if he increases his year 1 annual withdrawal of RM17,780 (13,580+4,200) by 3% a year. After plugging in the numbers into some Excel model I got online, it would appear that our man will run out of money within 22+ years or when he’s 77 years old. With medical advances being able to turn us into fucking RoboCop, I think that there’s a good shot that someone would live way past the age of 77.

Maybe a single guy like Ah Chong could really retire with RM300k in investable assets if he further reduced expenses such as giving up his car. But I think he would be cutting things a little too close. Ideally, you would want a retirement portfolio that generates income significantly above your expenses so as to give you a margin of safety from shit like recessions and periods of high inflation. Dipping into your principal should not be a common occurrence, it should only be done in the down years when the income generated can’t cover your expenses. I know, I know... things don’t always work out the way we want.

I would advice Ah Chong to continue working until he is at least 60. Without even counting additional EPF contributions, his EPF savings would grow to around RM275k assuming EPF pays a 6% dividend in each of the 5 years. He should also work after he is 60 (maybe he can help his best friend Ali sell nasi lemak kukus at night). It would help his finances and keep him mentally active. You get self-esteem from working and being productive. You don’t have to give that up just because you hit a certain age. Take it from me. I desperately want to work, but so far nobody wants to give me a chance. Aight guys, I’m bouncing. Thank you for reading. Take care and stay rational.