Tuesday, December 27, 2016

Drinks with the Dragon: Find your investing soulmate, 2016’s biggest miss and most important lesson

Hey, value investing crew. It’s been awhile, but welcome back to another session of “drinks with the dragon” where I ramble about random shit related to business and investing. So, 2016 huh? A year that started out depressing as fuck but ended with a motherfucking bang. The Greedy Dragon portfolio had been hitting record highs soon after Trump won the presidency and the republicans maintained control of the house and senate. Republicans have always been better for the economy than the closet socialists aka democrats. If Trump would only be pro free trade and completely support free speech, he might actually turn out to be a pretty good president. The Greedy Dragon portfolio has backed down a bit from its highs in the past 2 weeks because that puta we call Mr. Market can’t let a real guy like me win too much. But whatever, 2016 was still awesome (as long as I don't get fucked over by the markets in the last week of the year).

Anyway, I think that most people can achieve better investment results if they had a partner. And when I say partner I don’t mean someone that you have sex with. I mean someone you could bounce ideas off, someone who is willing to argue with you if he thinks that you’re wrong. Although, I must say that it would be pretty fucking awesome if you could find a gal that you could both talk investing and sleep with. Warren Buffett & Charlie Munger, Batman & Superman, Walter White & Jessie Pinkman, and Sean Mcnamara & Christian Troy are some examples of two people coming together to do awesome stuff. You don’t need to pool your money together with your partner or nothing. Just go grab a cheeseburger or something, and have an honest conversation about investing ideas. I would have saved at least a few thousand ringgit if only I had someone to fight me and convince me to avoid just one bad investment. Just make sure your partner is not a moron. Or worse, a fucking yes man who nods along and smiles as you commit financial harakiri. You feel me?

Looking back on 2016, I should have invested in natural gas when Henry Hub natural gas was trading below $2 per MMBtu early in the year. Putting aside the fact that I didn’t know how to get exposure to the commodity, I felt that I could have made a few bucks betting on natural gas when the price was low. There’s the United States Natural Gas Fund that trades on the NYSE Arca, but there’s this issue with contango. Anyway, natural gas prices got whacked earlier in the year because stockpiles were very high as a result of the strong supply from shale and what with last winter being rather mild. No doubt, the price of natural gas needed to get got for the oversupply situation to be worked out. However, I thought that the selloff was excessive as natural gas share of power generation in the US had recently increased and had even surpassed coal-fired generation most months. I figured that with more normal temperatures, the increased reliance on natural gas for power generation would result in stockpiles eventually getting back closer to normal levels. The low natural gas prices also made many of them natural gas drilling locations unfeasible as evidenced by the falling natural gas rig count back then. According to YCharts, the US natural gas rig count stood at 88 on April 1, 2016, down from 222 on April 2, 2015. I believed that the sharp drop in natural gas rigs would eventually translate to lower natural gas production which would also help bring stockpiles back to more normal levels. Note: I have no opinion on natural gas as an investment at today’s prices.

Hindsight 20/20, I wasn’t too far off the mark. The January 2017 Henry Hub natural gas futures closed at $3.662 per MMBtu on December 23. The huge natural gas stockpile situation has improved dramatically.  According to the EIA, as at December 16, 2016, working gas in storage was 3,597 Bcf. This is down 5.9% from a year ago and just 2.2% above the 5-year average for this time of the year. U.S. natural gas production has also come down some. For the week 12/15/16 - 12/21/16, dry production was 70.4 bcf/day. This is down from dry production of 73.8 bcf/day last year. Winter is still young, and will probably play a big role on where natural gas prices will go from here. Will it be a warm, normal or cold winter this time around? Well, that’s something you should ask Sansa Stark or someone who knows what a fucking polar vortex is.

The most important thing that I learned in 2016 would be to pay attention to the covenants that apply to the company you’re analyzing. A company could be considered to be in technical default of its debts despite appearing solvent on the surface. A company with an EBITDA that’s 2 times greater than its interest expense would be in violation of a covenant that requires it to maintain an EBITDA/interest ratio of 4. The most common financial covenants would require a company to maintain a certain debt/EBITDA ratio, EBITDA/interest ratio and maybe some liquidity ratio. I would perform a scenario analysis to see if the company is able to comply with its covenants if its businesses were to take a significant hit. 

Sure, a company in violation of its covenants might be able to negotiate with its creditors to avoid default. But I had rather not be in a situation where I’m at the mercy of the creditors. The company might also be subject to a variety of other covenants such as covenants that restrict changes in control, additional borrowings, sale of assets, dividends, acquisitions and etc. You got to read like a mofo to know what’s up.

I hope y’all had a merry Christmas and a good 2016 overall. Thank you for following my investment journey despite me not punting out content on a regular basis. Have a happy fucking new year. Take care and stay rational.

Saturday, December 17, 2016

Bonds is love, bonds is life

Hey, what is up everybody? I recently read about bonds being the favored investment instrument of the wealthy, and that made me really want to get into the bond game. After doing some research and trying to recall what I learned in university way back when I was still a bright-eyed kid filled with optimism, I could only come to one conclusion about bonds. Corporate bonds are like watching Melissa Benoist in her role as Supergirl or a warm brownie drowned in melted chocolate with a scoop of Häagen-Dazs vanilla ice-cream on top. In other words, bonds are sweeeet. To be more specific, the concept of corporate bonds is awesome as overpaying for anything can lead to disaster. Just to clarify, I’ve never invested in a bond and my knowledge of bonds is limited. However, I do think that I can share some interesting points with someone who might also be new to bonds. I would also like to say that I’ve been hearing that the US bond market is overvalued right now, so you might want to be cautious there. Aight fam, let’s kick this bad boy off with a list of the positives of owning bonds:

Update on the Greedy Dragon portfolio: I recently purchased 100 shares in GameStop at USD 25.28 per share.

1) Bonds are less risky as a slimy or incompetent management team will have a harder time fucking over bondholders than they do shareholders. Management can slash or eliminate the dividend anytime, but the company is still legally obligated to pay interest on its bonds. Management can wreck their company’s stock price by engaging in value destroying activities or issuing a bunch of new shares, but the company is still legally obligated to redeem the bonds at face value when they mature.

2) You can also make a lot of money in bonds if you buy them at the right price. I’ve read crazy stories of people, during the great recession, getting yields to maturity of 15% to 20+% on bonds of companies that were unlikely to default on its debts. Even earlier this year, you could find bonds issued by decent natural resource companies with yields to maturity close to and even north of 20%.

3) In the event of bankruptcy, bondholders are more protected than shareholders. Yes, bondholders would no longer receive coupon payments in the event of bankruptcy, and might even lose a large chunk of their capital. However, bondholders would still be better off than shareholders in that situation as bonds have seniority over equity in the capital structure. In other words, bondholders would get paid from the proceeds of the liquidation before shareholders get paid. Alternatively, there might instead be a reorganization where bondholders get ownership in the company (which is less indebted) and shareholders get significantly diluted if not totally wiped out.

4) The predictability of the bond’s cash flows is another neat thing about bonds. Imagine the amount of options you would have when it comes to managing your portfolio if you could reasonably count on large cash inflows twice a year, even in the shitty years (bonds generally make coupon payments twice a year).

5) Due to the predictability of the bond’s cash flows, it’s much easier to value bonds than stocks. You don’t have to forecast the company’s future profitability. So, the risk of overestimating future cash flows and therefore overvaluing the security is reduced.

6)The bond might contain covenants that limit how financially degenerate management can be. Covenants that require the company to not exceed a certain debt/EBITDA ratio and to maintain the EBITDA/interest ratio above a certain level restricts the amount of debt management can take on.

It ain’t all rainbows and orgasms, though. There are risks associated with bond investing. As mentioned earlier, bondholders would no longer receive coupon payments and might lose a significant amount of their capital in the event of bankruptcy. Even if you did get all your capital back, bankruptcy can be a long ass process. So, your capital could be tied up for quite some time in the event the company goes belly up. Also, the bond you invested in might be subordinate to other series of bonds issued by that same company. A series of the company’s bonds might also be secured by specific assets, so there will be less assets to pay off the other bonds in the event of liquidation. The bonds may also include terms that allow the issuer to redeem the bonds early, defer coupon payments, make coupon payments in the form of additional bonds instead of cash, and etc. For the shitlords out there who don’t like to read, bond investing is definitely not for you. It’s so important to read the terms of the bond to know exactly what you’re buying.

Some of the ways you could reduce the risk of investing in bonds is to only buy the bonds of companies that 1) generate enough cash flow to comfortably cover the interest on their debt and 2) has significantly more assets than liabilities on their balance sheet. A company with significantly more assets than liabilities is more likely to be perceived as financially sound, and therefore has an easier time issuing new bonds to pay off maturing bonds. A company with a lot of assets will also have the option of selling some assets to raise cash to pay off maturing bonds. You also reduce your risk if you buy bonds at a discount to face value. Say that company FU goes bankrupt and the proceeds from the liquidation of its assets is only enough to pay back bondholders 65 cents on the dollar. A person who bought FU bonds for 70 cents on the dollar would be better off than the bondholder who paid 98 cents on the dollar for the same bonds.

Another way to reduce risk is to make sure that the yield on the bond you are analyzing is high enough to compensate you for its credit risk. To assess credit risk, you need to look at the historical default rates and the loss given default for bonds with that credit rating. Let’s say for example that BBB bonds have a historical default rate of 5% and a loss given default of 50%, the investor should then require a credit risk premium of 2.5% to buy BBB bonds. If memory serves me right, the required yield on the bond is the credit risk premium + the rate on a government bond with the same maturity. I personally would aim higher than the required yield  because I want to earn above average returns, and because I think that interest rates in the US are artificially low. Oh yeah, the whole thing about getting paid an adequate return to assume credit risk? Well, that shit only works if you have a diversified bond portfolio. While it doesn’t always work out in real life, the idea is that on average the good bonds will generate enough profits to more than offset the losses on the bad bonds. However, it doesn’t matter if you got a high enough yield on the bond if that’s the only bond in your portfolio and the bond’s issuer goes bankrupt. All the coupon payments will be gone and you’ll be hanging around McDonald’s at fucking 3 AM because you can’t sleep as you’re worried sick about the bankruptcy process. Bond investors should also be wary when chasing yield in a stable environment. There is usually a reason why a bond has such a high yield when the overall yield on corporate debt is at historical lows. Unless you’re really good at analyzing bonds, it’s better to wait for a crisis when you can find many bonds that are mispriced relative to their risks as a result of market panic.    

So, if I think that bonds are so freaking awesome, then why haven’t I bought a bond? The answer is I’m still new to bonds and I still have a lot of learning to do before I’m confident in my ability to invest in bonds. One hurdle I see preventing me from investing in US corporate bonds is the yuge withholding tax of 30% that the US government slaps on interest payments to foreigners. There might be a way for me to reduce the withholding tax by filing some form, but I still need to do more research on that. According to my broker, you need to be an institutional investor or a high net worth individual to buy individual Malaysian corporate bond issues. So, investing in individual Malaysian corporate bonds might also be out for me. My rugged individualism won’t permit me to invest in a bond unit trust fund. If I’m not the one calling the shots, then I had rather not invest in that asset class at all.  

Bonds can be an excellent instrument for investors looking to generate passive income and preserve wealth. However, stocks have historically outperformed bonds. For someone like me who’s looking to hustle his way to the top, my portfolio wouldn’t be bond heavy unless there is a selloff in the bond market or a sector of the bond market. Whether or not bonds is a tool that will help you achieve your financial goals is something that you will have to decide. Thank you for reading. Take care and stay rational.

Thursday, December 1, 2016

Analysis of Kerry Properties

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

Hey yo, I hope you’ve been getting what’s yours and making life treat you right. In this article, I will be discussing my investment in Kerry Properties which I made awhile back. Kerry Properties trades on the Hong Kong stock exchange. The group owns investment properties in China and Hong Kong. The group also has a property development arm and a hotel division. I don’t need to tell y’all that I’m all about that sweet, delicious cash flow generated by investment properties in Hong Kong and major cities in China such as Shanghai. The stock closed December 1, 2016 at HKD 21.55, which is slightly lower than the HKD 21.7 I paid per share. The stock traded above my purchase price for a bit, but dropped when Hong Kong raised the stamp duty on residential property transactions. The increased stamp duty could very well have a negative impact on the profitability of Hong Kong developers in the short-term. However, I think that the impact will be limited over the long-term. After all, there’s only one thing that the Chinese love more than gambling, and that’s real estate. Although a case can be made that some Chinese people view real estate investing as simply another way to feed their gambling habits. But I would think that speculating on properties is just a little less exciting than getting your smoke and your game on in some mahjong parlor. And to the SJWs out there, I’m not racist to Chinese people. I’m just trying (and probably failing) to get a chuckle out of some of my readers. In fact, I am Chinese although I like to identify as a dragon from time to time. For real tho, I don’t care about race. What I care about is someone’s character. Anyway, let’s get down to business.

Update on the Greedy Dragon portfolio: I recently purchased 800 shares of Northern Oil & Gas at USD 1.95 per share. I also bought 1,000 shares in Maybank at RM 7.67 per share. I sold 150 shares in Oasis Petroleum at USD 13.4 per share.

If you just look at Kerry Properties’ market cap/equity ratio, it would appear that the stock is undervalued. As at June 30, 2016, the group had equity of HKD 81.982 billion; the group had a market cap of HKD 31.10 billion when the Hong Kong market closed on December 1, 2016 (according to google finance). The group also pays out a healthy dividend, which makes sitting on the stock and waiting for its price to move up closer to intrinsic value a pretty fun proposition. Based on the dividends paid in the past 12 months and the stock’s closing price of HKD 21.55, the stock would have a gross dividend yield of 4.18%. But what I’m really interested in is if the value of the group’s assets on its balance sheet can be backed up by earnings. The rest of this article will detail my process of estimating Kerry Properties’ earnings power. 

Revenue from property rental was 35% of the group’s revenue for the 6 months ended June 30, 2016. But due to the high margin nature of the business, gross profit from property rental was 60% of gross profit. Revenue from property rental was approximately HKD 1.964 billion (73.93% of which were attributable to investment properties in China), up 12% from the same period a year ago. Gross profit from property rental came in at HKD 1.568 billion, up by about 7%. Investment properties in Shanghai, Beijing and Shenzhen made up 90.65% of the group’s gross floor area (GFA) in China. Apartment, office, and commercial made up 15.33%, 56.26% and 28.41% respectively of the group’s GFA in China.

The group had administrative and other operating expenses of HKD 584.197 million for the 6 months ended June 30, 2016. Total finance costs incurred was HKD 672.123 million. The group had interest income of HKD 127.116 million. The group also had dividend income from listed and unlisted investments of HKD 53.947 million. During the 6 months ended June 30, 2016, the group made a HKD 80.682 million provision for impairment loss for hotel property. I would add back the provision for impairment loss when assessing the profitability of the group as I will assume that it’s not an item that will keep recurring. The following table illustrates how I arrived at my estimate of profit before tax:

Figures are in millions of HKD
Gross profit from property rental

Administrative and other operating expenses
Total finance costs incurred

Interest income
Provision for impairment loss for hotel property
Dividend income from listed and unlisted investments
Profit before tax
Profit before tax annualized
The group also has other divisions that contribute to its profits. Gross profit from property sales was HKD 949 million for the 6 months ended June 30, 2016. As mentioned earlier, Hong Kong recently raised the stamp duty on residential property transactions which could have a negative impact for Hong Kong property developers. Revenue and profits from property development are also less predictable than rental income. To build in a margin of safety, I will assume that annual gross profit from property sales will fall back to the levels seen in 2015. Gross profit from property sales was HKD 1.21 billion in 2015. The group’s hotel operations generated gross profit of HKD 95 million. While gross profit from the hotel division has improved significantly (up 23% from the same period last year), I’ll be conservative and take last year’s annual gross profit of HKD 153.934 million for the purpose of calculating my estimate of the underlying net profit of the group. The group’s tax expense was HKD 894.802 million for the 6 months ended June 30, 2016. However, that HKD 894.802 million figure includes some HKD 391.07 million in deferred tax expenses which I will not be taking into account when estimating net profit. Some of Kerry Properties’ net profit are shared with non-controlling interests. For the 6 months ended June 30, 2016, profit attributable to non-controlling interests was HKD 476.526 million. The group’s share of results of associates also contributes significantly to its profits. For the 6 months ended June 30, 2016, the group’s share of results of associates was HKD 547.725 million. 

I did not take into account the increase in fair value of investment properties as that’s only relevant, in terms of cash flow, if the group embarks on a strategy to divest its investment properties portfolio. For the 6 months ended June 30, 2016, the group experienced an increase in fair value of investment properties of HKD 919.275 million. The following table illustrates how I arrived at my estimate of net income attributable to shareholders:

Figures are in millions of HKD
Profit before tax annualized from table 1

2015 annual gross profit from hotel operations
2015 annual gross profit from property sales
Annualized share of results of associates

Annualized tax expense (excluding deferred tax expenses)
Annualized profit attributable to non-controlling interests
Net profit to shareholders (my estimate)
My net profit to shareholders estimate is simply an estimate, and could very well be significantly off from the company’s actual profitability in the future. With that said, the group would have a P/E ratio of 18.88 if we used as inputs my estimate of net profit attributable to shareholders of HKD 1.646 billion and the group’s market cap of HKD 31.10 billion (based on the stock’s closing price on December 1, 2016). While I don’t think that the stock is an awesome gem at this valuation, I don’t mind taking a small position at this price. One of the reasons is that the net profit to shareholders I calculated would significantly underestimate the group’s profitability if its property sales division continues to perform as strongly as it did in the first half of 2016.

The other reason is that  Kerry Properties has a number of major investment properties under development that will add significantly to its GFA once completed. Major mixed use development and other investment properties slated for completion from between the second half of 2016 to 2019 would add slightly over 12 million square feet to the group’s GFA (one of the properties will be completed in phases from 2019). As at June 30, 2016, the group’s investment property portfolio had a GFA of 9,641,000 square feet. Now, I don’t know what the increase in rental income will be as a result of this expansion to the investment property portfolio as that would depend on things like rental per square foot, occupancy rates, and net lettable area. However, such a large planned increase to the group’s GFA is a good indicator that rental income has room to grow (duh!).  The group’s major mixed use development and other investment properties under development are all located in China; major properties under development in Hong Kong are all for sale properties. Please refer to “Kerry Properties, FY2016 Interim Results, Analyst Briefing Presentation” for more details on the cities in which these major properties under development are located.

I think I will end this article here. I hope I didn’t bore too many of you with this rather long analysis. As always, thank you for reading. Take care and stay rational.