Thursday, March 27, 2014

Analysis of Mercadolibre Inc (listed on the NASDAQ)

“There are several types of men in this world…There are men who dream and never make it off their couch. There are men who dream and fail. And then there are men who dream and change the landscape of this world.” — Bray Wyatt, WWE wrestler

Please read the disclaimer here: Enjoy the article, bitches!

I hope you guys/gals have been keeping it real, making money and fucking bitches/manwhores. Anyway, today I will be analysing Mercadolibre which I think is a really interesting Latin American-based company. Mercadolibre provides e-commerce services such as online marketplace, advertising, payments solution and online stores solution. While the company operates mainly in Latin America, it was incorporated in Delaware, United States. The stock trades on the NASDAQ and closed at USD 94.71 per share on Thursday. I recently took a position in Mercadolibre.

Mercadolibre has returns on capital that are as hot as a burrito stuffed with jalapeƱo peppers (yes, I know my attempts at humour are lame). The company achieved return on equity (ROE) and return on assets (ROA) of 37.12% and 21.95% respectively in 2013. The company’s ROE and ROA are even more impressive if you consider that a large portion of the company’s assets consist of cash, cash equivalents & investments. Mercadolibre had $262.59 million in cash, cash equivalents & investments as at December 31, 2013; the company only had total assets of $592.36 million. An asset-light business model is particularly awesome for a company in the growth stage as it can increase profits very rapidly and create a ton of shareholder value by reinvesting in the business. Equity capital employed in the business grew from $93.42 million at the end of 2008 to $343.48 million at the end of 2013. Profit before tax grew from $29.44 million to $163.10 million in the same period. This would result in a pre-tax return on incremental equity capital of 53.45%; returns on capital like that would make any value investor wet/hard. Yes, I’m aware that not all of the increase in equity capital may be used to grow the business or that not all the increase in profits is a result of additional capital being applied to the business. But whatever, you get what I’m trying to say.

For the 5-year period of 2009-2013, Mercadolibre experienced net revenue and profit before tax growth of 28.10% and 40.83% respectively which is super awesome. The company grew net revenue and profit before tax at 26.49% and 16.32% respectively for the year ended December 31, 2013. As Mercadolibre is a growth stock, it will naturally have a high price/earnings ratio. To help me decide whether the company is overvalued or undervalued, I will use the following formula pioneered by Benjamin Graham: Intrinsic value = (8.5 + 2 x earnings growth over the next 7 to 10 years) x earnings per share. You can read more about the formula in this Wall Street Journal article. While I can’t accurately predict the company’s growth rate, I can rearrange the formula to find out how fast the company needs to grow for it to deserve its current stock price. Let’s get down and dirty with algebra:

94.71 = (8.5 + 2 x G) x 2.66
94.71/2.66 = 8.5 + 2 x G
35.60 - 8.5 = 2 x G
27.1/2 = G
G = 13.55%

Note: G represents growth and 2.66 is the earnings per share

So, the company needs to be able to grow earnings by a compounded annual rate of 13.55% for the next 7-10 years for you to get a fair shake at the stock’s current price. According to this article here, Forrester estimates that online retail in Brazil, Argentina and Mexico are set to more than double from almost $20 billion in 2013 to $47 billion in 2018.” This combined with Mercadolibre’s recent strong growth makes me think that it’s possible for the company to grow at a compounded annual rate of 13.55% over the next 7-10 years.  

The following is the breakdown of Mercadolibre’s 2013 net revenue by geography:


Overall, I think that Mercadolibre is an excellent business with a reasonable price. Sure, the stock may fluctuate in the future but I think it will do alright in the long-term. If the stock falls in the future, then I may take the opportunity to add to my position assuming that the company’s business fundamentals remain intact. After all, if I think that I’m getting a fair deal at $97 per share (the price I paid for the stock), then I should be getting an even better deal at $85 per share. Make Mr. Market your bitch, don’t let him make you his bitch.

Before I conclude this article, here’s a quick update on the Greedy Dragon portfolio. Other than Mercadolibre, I took a position in Banco de Chile and Tifa Finance. If you read my Risk management series: Foreign exchange risk article, you would know that I recently sold shares in Tifa Finance. I sold the shares because I thought they reached fair value and I wanted to increase my cash holdings, but I think Tifa Finance is undervalued now so I’m investing in it again. I won’t take any credit for my previous decision to sell Tifa Finance as I don’t believe in market timing; I will just chalk it up to luck being on my side this time around. Anyway, thank you for reading. Take care and stay rational.

Analysis of UK-based William Hill plc

Please read the disclaimer here: Enjoy the article, bitches!

Wasssuuuppp!!! Today I will be analysing William Hill plc. The company provides gambling services such as sports betting, online casino and operating gaming machines at its betting shops. While I don’t really dig gambling (which is kinda odd as I’m a Chinese dude and therefore should be genetically predisposed to love gambling), I can definitely dig making money off solid gambling stocks. And I definitely think that William Hill is really a solid gambling company. William Hill trades on the London Stock Exchange. The stock closed at 346.70 Pence on Thursday. I do not own shares in William Hill. However, I may invest in the company in the near future.

The company generated healthy average return on equity (ROE) and return on assets (ROA) of 21.99% and 10.56% respectively. The company’s ROE and ROA figures are even more impressive if you consider that £1.17 billion of the company’s £2.41 billion in total assets consists of intangible goodwill. William Hill’s asset-light business model should allow it to keep reinvesting for growth while still setting aside a significant chunk of the profits for dividend payments.

Amounts wagered by customers grew by 32.55% in 2013. However, there was only a 10.42% increase in gross profit as a large part of the increase in amounts wagered came from the Australian operations which have a lower gross profit/amounts wagered ratio. William Hill acquired its Australian operations in 2013. But a 10% increase in gross profits is still pretty decent so I won’t be a jerk about it. I think it’s important to look at both the increase in amounts wagered and increase in gross profits to get a better picture of William Hill’s business growth. This is the case as gross profit takes into account both payouts to customers and gross profits tax, duty & levies.

Despite the increase in gross profits, William Hill did experience lower profits before tax (PBT) from £277.7 million in 2012 to £257.0 million in 2013. The decline in PBT was partly due to exceptional costs of £22.8 million which includes early termination of a bridge loan facility, integration of assets and reversal of a previous gain. Another reason for the lower PBT was the introduction of Machines Games Duty last year which resulted in an additional £10 million in indirect taxation costs. There was also an additional week in 2012. While PBT might be lower, I think that the company’s earnings will still be resilient over the long-term. I mean there will always be demand for gambling just like there will always be demand for stuff like cigarettes, beer, sex toys and good cheeseburgers. From 2007-2013, there wasn’t a single year where PBIT (before taking into account exceptional items) declined by more than 10%. Keep in mind that the 2007-2013 period included the great financial crisis where almost everyone thought that the whole freaking world would go bankrupt.

The company faces significant tax increases in the near future. According to this article on The Telegraph, William Hill expects that the Point of Consumption Tax will cost it between £60m-£70m a year. The Point of Consumption Tax is a new online gaming duty that will be implemented in December. The same article also states that William Hill will try to mitigate some of the impact of the Point of Consumption Tax by cutting costs by £15m-£20m. Another factor which can potentially mitigate some of the impact of higher taxes is that the company’s U.S., Australian and online divisions may keep experiencing good growth and contribute more profits.   

William Hill has a P/E ratio of 13.06 which I guess is reasonable even after taking into account the increased taxes that the company will face in the future. In my calculation of the P/E ratio I accounted for dilution as well as added back profits attributable to non-controlling interest as William Hill bought out non-controlling interest during the year. The stock has a dividend yield of 3.35% which is pretty healthy. I think that this stock may deliver decent returns over the long-term and maybe even pleasantly surprise shareholders. Anyway, thank you for reading. Take care and stay rational.

Tuesday, March 18, 2014

Risk management series: Financial risk

I think of debt as cheeseburgers. There’s nothing wrong with grabbing a great burger (I’m talking heart busters with more than 1,500 calories) every now and then. The problem is when you become a cheeseburger addict; you will get fat and bitches won’t want to have anything to do with you. Similarly, having a capital structure that consists of some debt can enhance returns on capital, but too much debt can destroy shareholder value. In this article, I will be talking about what I personally look out for when analysing a company’s financial risk.

The first thing I want to do is estimate the percentage decline in the company’s earnings before interest & taxes (EBIT) during a recession. You can come up with an estimate of the percentage decline in EBIT by looking at data from historical periods of economic stress such as the great financial crisis. I will then calculate the interest coverage ratio (EBIT/Interest expense). But instead of using the company’s current EBIT to calculate the interest coverage ratio, I will use my estimate of EBIT if a recession were to happen. I want to be reasonably sure that the company can service the interest on its debts with its operating profits even during recessions. If the company has a diversified stable of businesses and/or a geographically diversified customer base, then I wouldn’t mind if its interest coverage ratio is lower. A company can also have a lower interest coverage ratio if it has significant cash holdings and marketable securities that it can tap into to cover interest payments during rough times. But whatever it is, I will generally be uncomfortable if the interest coverage ratio (after replacing current EBIT with the estimated EBIT during a recession) is below 2.

I would also look at the company’s debt/equity ratio to make sure that the company isn’t overleveraged. A company with a high debt/equity ratio could still have a high interest coverage ratio as it could have taken on a lot of fixed rate debt when interest rates were low. However, such a company runs the risk of getting fucked by burdensome interest payments if it has to refinance its debts at significantly higher rates in the future. So, regardless of how high the company’s interest coverage ratio is, it’s still important to make sure that the company doesn’t have too much debt. I generally feel uncomfortable if a company’s debt/equity ratio is above 1 (however, some businesses like banks can afford to be much more highly leveraged).  

I guess I will end the article here. Just remember that you will drastically improve your odds of making money and fucking bitches/manwhores if you’re competent at valuing companies and you keep your eyes on both profits and risks. Thank you for reading. Take care and stay rational.     

Saturday, March 8, 2014

Analysis of Malaysia-based IGB Real Estate Investment Trust

Please read the disclaimer here: Enjoy the article, bitches!

Before I begin my analysis of IGB Real Estate Investment Trust (REIT), there’s something I would like to get off my chest. I fucking hate it when people go gaga over a successful person because he/she is perceived as humble. While I don’t believe in being arrogant, I think it’s even worse to act humble. It’s moral to be proud of the fact that you can do something well. To be humble is to put yourself down and sate that there’s no difference between you and any mediocrity who simply goes through the motions of life. Someone who is truly humble doesn’t value himself, and that is truly immoral. But I guess that most people are mediocre, and a lot of them feel better about themselves if a successful person acts as if he’s just like them. By the way, I don’t think you need to be a billionaire and have a 10-inch dick to be successful. You’re successful as long as you’re doing something you love to the best of your ability; it doesn’t have to be your job, it can be a passion that you pursue on the side. Although I think you should try to find work that you enjoy as you will spend a significant amount of your life at your job.  Anyway, the annual report of IGB REIT came out recently and I decided to analyse the REIT to see if it has the potential to be a good cash cow. IGB REIT’s portfolio consists of two high quality properties: Mid Valley Megamall & The Gardens Mall which are located in Kuala Lumpur, the capital city of Malaysia. IGB REIT trades on the Bursa Malaysia. IGB REIT closed at Ringgit Malaysia (RM) 1.17 or approximately USD 0.36 on Friday.

The main risks to IGB REIT’s profits in the near future are potentially significant increases in property assessment taxes and electricity tariff. In 2013, 2.45% of IGB REIT’s gross revenue went towards covering quit rent & assessment expenses.  To put things into perspective, IGB REIT had a net profit margin of 48.05% in 2013. I don’t know how the assessment value of IGB REIT’s properties will be calculated (if anyone does, please feel free to share) so I can’t estimate the increase in assessment taxes. But according to this article on The Edge, various reports say that the assessment value of properties in Kuala Lumpur could be increased by up to 100%-300%. So, if the increase in assessment values is at the high end, IGB REIT’s profits could potentially take quite a significant hit. Maybe IGB REIT might be able to pass on some of the costs to its tenants, but I don’t know how much of the costs it can pass on.

Note: My calculation of the net profit margin excludes changes in fair value on investment properties.

According to this article in The Star, commercial consumers (which I assume IGB REIT falls under) will experience an average increase of 16.85% in electricity tariff. In 2013, 11.03% of IGB REIT’s gross revenue went towards covering utilities expenses. However, IGB REIT might be able to pass on some of the increase in electricity tariff to its tenants. IGB REIT managed to recover (I assume from its tenants) 48.13% of its utilities expenses in 2013. I don’t think the increase in electricity tariff will significantly affect IGB REIT’s profitability.

Mid Valley Megamall and The Gardens Mall are two of the most popular malls in Malaysia as evidenced by their relatively high annual revenue per square foot (psf) of net lettable area. The following tables present the annual revenue psf of net lettable area for IGB REIT’s properties and other good shopping malls in Malaysia:

Annual revenue psf of net lettable area for IGB REIT’s properties (in Ringgit Malaysia)

Mid Valley
The Gardens

Annual revenue psf of net lettable area for other popular malls in Malaysia (in Ringgit Malaysia)

Sunway Pyramid
Gurney Plaza
Sungei Wang Plaza

Other than Sunway Pyramid, all the other properties’ annual revenue psf of net lettable area is calculated using gross revenue data for the year ended 31 December, 2013.  Sunway Pyramid’s annual revenue psf of net lettable area is calculated using data from Sunway REIT’s 2013 annual report (the REIT’s financial year ends on June 30).         

Both Mid Valley and The Gardens have high occupancy rates of 99.9% and 98.8% respectively. In the 4th quarter of 2013, IGB REIT reported a year-on-year increase in gross revenue of 11.01%. The high occupancy rates and pretty good revenue growth could indicate that there’s healthy demand for space in IGB REIT’s properties.  Both Mid Valley and The Gardens are 99 years leasehold properties expiring on 6 June 2103.

Based on the number of units in circulation as at 31 December, 2013 and profits for 2013 (excluding changes in fair value on investment properties), IGB REIT had earnings per unit of RM 0.06. This will give IGB REIT a Price/Earnings ratio of 19.35 or an earnings yield of 5.16%. While IGB REIT owns really good properties, I personally would wait to see how the increases in electricity tariff and assessment taxes would impact IGB REIT’s profitability. But even if those increases have a small impact on profitability, I think that IGB REIT is a bit overvalued if it doesn’t demonstrate the ability to keep growing revenue and profits at a healthy pace. Thank you for reading. Take care and stay rational.

Thursday, March 6, 2014

Economic fallacies from the S&M show

I was listening to this week’s S&M show podcast on BFM: The Business Radio Station website and I was shocked at some of the economic fallacies brought up by the people on the show. The S&M show is where Salvatore Dali from Malaysia Finance and a few other guys discuss stuff about investment & business. I follow the show every week because I find it entertaining and the people on the show make sense for the most part. This week, the show was about bankruptcy laws in Malaysia. And while I agree with them that bankruptcy laws shouldn’t be so tough, some of the stuff they said about economics are just plain wrong.

One guy argued that more lenient bankruptcy laws could cause banks to tighten lending rules and that could choke the economy. I was like come on dude, it’s a bad thing if the laws cause banks to loosen their lending standards and make a whole bunch of bad loans. Just look at the United States where the government incentivises banks to make bad loans. They got a fucking asset bubble and had to go through a financial crisis when the bubble burst. When you lend to people that are not credit worthy, you’re misallocating resources and that can never end well. To be fair, there was another guy on the show that was against loose lending standards. Note: I personally don’t think that Malaysian bankruptcy laws encourage banks to make bad loans

A dude on the show later brought up that countries which are more capitalistic have higher inequality. Another guy said that inequality is a hallmark of a capitalistic society. To be honest, I don’t give a shit about inequality. Only people that are filled with envy worry over the fact that there are people who are richer than them. We should be happy if there are more rich people around (assuming they got their wealth through legitimate means) as they had to create a lot of value to get rich. What matters shouldn’t be how rich or poor you are compared to other people, it’s your standard of living that matters. And it’s a fact that the standard of living of people in general is higher in countries that are more economically free. I had rather be relatively poor in Singapore or the United States than be relatively middle class in a lot of other countries.       

They also complained a little bit about how Malaysia doesn’t really have a significant social safety net which could cause bankrupts in the country to really suffer. As an example of the people who would suffer without safety nets, one guy talked about how a fresh grad could get his life ruined if he’s declared bankrupt because he can’t afford to pay his credit card bills. I think that it’s a good thing that Malaysia doesn’t have significant social safety nets. I don’t want to be subsidizing losers who are too lazy to find a job. Safety nets are bad for the economy over the long-term as it incentivizes people to shirk personal responsibility and transfers wealth from productive people to bums. Look at how messed up Europe is with their big government and large safety nets. It’s not that I hate poor people or anything when I argue against safety nets. In fact, poor people will be better off if they lived in a capitalistic country with no safety nets. The country that has come closest to free market capitalism was the United States in the 19th century. Back then, people from all over the world flocked to the U.S. not because of safety nets (there were hardly any) but because they were free in the U.S. to keep the fruits of their labour and rise as far as their minds, effort and ambition would take them. Most of the people who are willing to work in a free economy will be able to find jobs and support themselves. Private charity is more than enough to take care of the small percentage of the population who can’t support themselves. Unfortunately, the American economy started to grow much more slowly as they moved towards bigger government and started putting safety nets in place. I don’t know when it will happen, but America will crash if it continues with its current socialist policies.               

I have nothing against anyone on the S&M show. In fact I find them entertaining. I just disagree with some of the economic beliefs that they hold. And to be fair, they’re not the only ones who believe in this mumbo jumbo. Most people don’t really understand economics because they listen to econ professors with socialist leanings and people like Paul Krugman who thinks that Keynesian economics actually work in real life. Anyway, thank you for reading. I’m currently working on an analysis of another Malaysian REIT. It will probably be up during the weekend so check back then if you’re interested. Till then, take care and stay rational.