For 2018, the Global Stock Picking portfolio is down -2.5%, that compares to MSCI World Total Return (i.e. including dividends) down -8.2% on the year. My return is also including dividends but no trading fees deducted. In the counterbalance to fees, I do not calculate any return on cash, which has averaged around 9% of my portfolio. Given my fairly heavy China tilt I have in the past compared myself with Hang Seng, down -10.5% on total return basis. During the first 9 months of the year I struggled to keep equal steps with MSCI World, given the benchmarks high weight to the U.S. When U.S. markets sold off sharply towards year end I increased my alpha quite significantly against the benchmark. As you can see in the graph below, I was flat performance wise from mid-October to year end. This meant that my cumulative alpha reached it’s highest level towards year end. Total return is 47% since inception vs 22.8% for MSCI World. Although a negative year is not very encouraging, I’m still happy with the results, given how exposed I have been to China, which has had a terrible year.
Significant Portfolio changes over the year
Funeral investments – Dignity and Fu Shou Yuan
I entered into my demographics investment case beginning of 2018. It did not play out as planned, I changed my mind and sold both holdings in late November.
Brewery and liquor companies – Olvi, Diageo and Kopparbergs
Olvi and Diageo I still hold, I see them as defensive good companies, 2018 performance wise has been unspectacular. Probably Diageo is a bit too big company to deliver outstanding returns, it would be better to find something smaller, like Olvi, which I like a lot. My best investment was the one I sold, Kopparbergs, good return and the stock has totally collapsed after I sold. I think this was a case of my being a bit lucky with the timing, but also being ahead of the market understanding the cider business fairly well. Behind the scenes I have done a lot of research on other cider companies and how the big breweries are ramping up their cider offerings. I also done a lot of on the ground research, always checking stocks in stores around the world and in pubs of course. All of this made my change my mind on Kopparbergs prospects, selling has so far paid of very well.
Larger portfolio reshuffle – Selling Tokmanni, Microsoft, Catena Media and Criteo
This selling was partly due to my change in investment style. One reason was that these companies are hard to understand and grasp, therefore hard for me to have an edge against the market. Hard to grasp also means high maintenance to keep on top of what is happening. Performance wise selling these holdings was neither good or bad, on average they are about flat since i sold. So overall they were not bad stock picks, given that flat performance is also out-performing the market.
Special Situations – Radisson Hotel and Amer Sports
Radisson was my HNA related turn-around idea, which played out like clockwork. Somewhat luckily I bought at absolute bottom (24.1 SEK) and the stock repriced upwards before the bid for the company came. I choose to sell out before the actual bid at 35.8 SEK, whereas in hindsight, like one my readers has pointed out, it would have been better to keep holding it. Currently trading at 42.4 SEK.
Amer Sports was just that I had pretty good understanding of the Chinese company Anta, which had indicated a bid for Amer Sports at 40 EUR per share. The market did not really believe this, I saw it as something that made total sense for Anta. I got my shares for 34.1 EUR and sold at 38.37 EUR 1.5 month later, currently trading at 38.75 EUR.
HK listed small caps – Tonly Electronics, Dream International and Modern Dental Group
I have invested long enough now on the Hong Kong exchange to have confidence enough to invest in the smaller companies listed in Hong Kong. It’s pretty dangerous waters, mis-pricing can last for very long periods of time and many of the companies are not run with shareholders best in mind. Anyhow I found three companies which I believe had few of these dangerous characteristics, low valuations and fairly bright future prospects. To summarize, so far so good, all companies have out-performed the market, although under very low volumes. All these stocks are easily manipulated up/down 10% on a single day. When I bought Tonly and Dream Hong Kong was one of few exchanges that had sold off, and these stocks were in my view uniquely cheap. Now when valuations are coming down everywhere, they seem less and less unique for each day that goes by. It might come a point when these are still good investments, but there are safer options that are valued as low as these. Still I think there is some way to go before we are there.
Speculative/Opportunistic holdings enter the portfolio – UR-Energy, Scorpio Tankers, Irisity and JD.com
The timing (mid Sep) of me buying more speculative, loss making companies was not really fantastic. Just when the markets really started to tank. Given that it’s no surprise that these stocks have not performed very well, all of them being a significant drag on performance. Currently I have most hope to Irisity which is making some acquisitions, trying to consolidate Swedish knowledge on video/camera detection software. Given the market climate I might make some changes and lower the weight towards these type of companies, it might get very brutal in a bear market.
JD.com is also an interesting case, the rape charges were thankfully dropped. On the other hand China feels much more wobbly now than 6 months ago. I’m a few dollars under water on this position, a bit hesitant if I should keep it, due to this being 100% China exposure. As argued earlier, with stocks repricing, there might also be better opportunistic investments than looking for a bounce in JD.com.
Thoughts about 2019
I believe we have entered a bear market. Opposite to a bull market when the market grinds higher and has sudden drops downwards, I think one can start to see that markets rather grind downwards and have large jumps upwards. That is for me the strongest sign of a typical bear market. 2008 was a bit special, since that was more of a collapse. I don’t believe in collapse this time, rather a longer grinding bear market, like in 2000-2003. It’s not going to be very fun performance wise in the next few years if I’m right. It’s also going to be frustrating finding a good investment case, just to see it trade down another 20%, becoming even cheaper. On the upside, it will be like a kid in the candy store, with a lot of great investments and fantastic prices. Probably all of this will not play out in 2019, but continue into 2020 (if I’m right). As always these things are impossible to call and I will just try to hold my long portfolio through it all.
I recently read a book with the title: China’s Great Wall of Debt – Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle. The author definitely has a negative bias on China but it struck a cord with me. I had not read the book when I wrote this post: Rotate away from China. He of course summarizes it much more nicely in his book, but he brings up a lot of points, which is just in line with my own observations. Reading the book it kind of re-emphasized that something pretty bad is lurking in China and when it turns, it’s going to be ugly. On the flip-side China still has many weapons to fight a downturn. Just the other day PBOC announced a Reserve Ratio cut for the banks which will release a lot of liquidity into the Chinese market. I think the big bad ugly China crash is still some years away, probably dependent on how much of a downturn we now will see in the rest of the world.
+ Strong core business of dental prosthetic production with good cash flow generation. Possible margin improvement after factory move in 2019/2020.
+ Although listed in HK, this company mostly has stable revenue from developed markets – Europe/USA/Australia.
+ A kicker is the growth opportunity in China where the need for dental care is huge as well as the high fragmentation in the market.
+ Debt tenor recently extended, which shows prudence of liquidity management.
+ Low valuation with good potential for turn-around and multiple expansion if management can integrate acquisitions successfully.
– So far acquisitions has just grown top line, nothing has feed through to the bottom line. Markets are currently in doubt of management execution on the investments.
– Strange history of running core operations on land where the lessor did not have the right to lease out the land (might have been hard to understand beforehand though).
– Recently started a share buy-back program (about 1% of float so far), although this is general is an acceptable way to shift out earnings to shareholders, it more looks like a way to prop up the share. The management should concentrate their efforts and cash in improving the businesses they bought.
Modern Dental Group (hence forth called MDG) is the only listed company in the previously described segment of prosthetic producers and distributors. The company floated on the Hong Kong exchange in December 2015, offering 175m new shares and 75m secondary shares at 4.2 HKD. This brought in about 660m HKD cash to the company. The current market cap of MDG is 1.2bn HKD.
The company started growing significantly during the early 2000’s with centralized production facilities in Shenzhen, China, for dental prosthetics production. The company used third-party distributors to sell their low prices dental prosthetics. This co-operation grew over the years to a large number of distributors world-wide, selling their products to local dentists. The offshoring of prosthetic production to China has seen strong growth (as discussed in Part 2) and created good cash flow for MDG. This enabled the company to bit by bit acquire it’s distributors and smaller local labs. MDG has through acquiring these companies become a direct distributors to the dental clinics with the purpose to control the whole mid-stream segment. The goal as I interpret it, is to be able to provide a full-service offering, both low cost options from China and the higher quality products from the local labs.
As we learned in previous posts, the development of CAD/CAM technology enables the local labs (who can afford it) to fight off the low cost production in China. With machines doing most of the work, low labor cost is not as big of an advantage as in the past. This is probably the main reason MDG has been on a spending spree over the last 5 years. My guess is that MDG see the next leg of growth as consolidating the small local dental labs into bigger units where economies of scale works better with CAD/CAM. In fact MDG has already created such labs of larger scale in Hong Kong, Melbourne and Emmerich (close to the border of Netherlands). By consolidating the market MDG might be able to out-compete smaller local players.
47.4% of the company is held by the Chan family
16.1% of the company is held by the Ngai family
The rest 36.5% is free float.
A family majority owner is very common in HK listed company. This is both a blessing and a curse, if it’s the right family leading the company, it could be very good with a strong owner to lead company. HK also has many cases where this has gone totally wrong and money is more or less embezzled into other non listed entities which are family controlled. Given the nature of the business in this case and that two separate families are large owners, I see this risk as minimal. It’s rather the risk of incompetent leadership which would be the largest risk. At the same time, the families have all the motivation in the world to not mis-manage their company, since they are more heavily invested than anyone else. On balance in this case I see it as a positive that this company has a strong family owner.
The core of this company has been the large production facilities in Shenzhen China, they have delivered solid cash-flow (some 150m HKD per year back in 2014) and continues to do so. Although exactly how much is not fully visible anymore, since income is now mixed together with all the acquisitions done (more on that later). The company has some 780m HKD in debt, which recently has been refinanced (at a cost) at a longer tenor (5 years). Being prudent and taking up longer term financing, even if it costs more, I see as a positive and responsible management. I would not want to see debt levels escalate, now at 2.45x EBITDA.
As we can see above, Europe is the largest market, followed by the U.S. Unfortunately profit contribution and margins per region is not available, but from my readings Europe together with Hong Kong (included in Greater China) are the two regions which contributes most to the bottom line.
Revenue and Net Income
Top-line has increased significantly (mainly from acquisition) but so far small effect on bottom line. One reason is that a loss making US operations was added into 2017 figures. Maybe it will be famous last words, but my investment thesis here is that we are experiencing the worst right now. On the flip side there is a lot of potential for margin improvements, if management delivers in terms of synergies and operations of scale in general and for the U.S in particular. Another factor for margin improvements, will be few years down the line, when the move to the new factories in Dongguan are completed.
Given the declining share price and flat Net Income, the P/E has just kept contracting, reaching as I see it, attractive levels.
Given the large number of acquisitions this becomes an important component to poke a bit deeper into. The below tables summarizes the acquisitions over the past 5 years.
Smaller acquisitions (dental labs)
In total since 2013 MDG has done acquisitions to the tune of 1.2bn HKD, the current market cap of MDG is 1.29bn HKD, adding on net debt of about 450m HKD, the Enterprise Value of MDG is 1.75bn HKD. For MDG to currently be fairly valued they must have grossly overpaid for the companies the bought. Or the market has miss-priced the company and its significantly undervalued.
Has MDG in general overpaid?
The short answer is, probably yes. The slightly longer answer is, the earlier acquisitions seems to be OK-ish. Its hard to judge exactly how improvements and synergies are moving along per region and contributing to the bottom line. The jury is still out on the execution of their strategy of lab purchase RTFP (MicroDental) being the main one. Just looking at the purchase prices of the larger acquisitions, the market price seems to be around 1x Revenue of the companies, which without any deeper insight, sounds fairly cheap. The problem child in my view is RTFP, which is bleeding pretty badly.
One case where the company was somewhat unlucky was the SCDL acquisition in Australia/New Zealand. Australia’s government changed the contributions to dental healthcare, which has reduced the business significantly overall in Australia. The market is slowly recovering from this.
A look at RTFP Dental (MicroDental)
This acquisition in 2016 is quite different from the larger ones done in the past. First, this is the only large scale dental lab acquisition done. Second, this is the first significantly loss making operation bought. As you can see in the second table above, MDG has also started to selectively buy Dental Labs in other places of the world, but that has been small scale compared to this huge acquisition of 21 labs in one go. MDG acknowledged that RTFP was losing a lot of money, US$-9.3m which translates to -73m HKD (that is a lot for MDG which has a historical Net Income of about twice that).
These were their main rational why this still made sense to acquire:
Brand Name – MicroDental is a renowed brand in USA.
Customer network – Platform for MDG to further penetrate the USA market, mainly through the 21 labs around USA.
Laboratory EBITDA – at US$5.9m EBITDA on lab level shows there is actual value in the company. RTFP is burdened with high admin costs, an expensive facility in Dublin etc. MDG believed it could improve results through offshore product lines, elimination of unnecessary corporate expenses, reductions in rent and operating expenses for the facility in Dublin and streamlining measures.
Location of dental labs of RTFP Dental
Tax benefits – MDG can enjoy tax deductions through amortization of goodwill, to the tune of US$7-9m.
Finance cost – 2016 US$2.4m of the losses were due to Finance costs and MDG would be able to fund this more cheaply.
The Latest comment released last month on MicroDental business outlook:
“The North American market has experienced a slight drop in sales (of less than 2%) and a drop in sales Volume (less than 3%) due to (i) the management’s focus and attention on the ongoing restructuring and integration of MicroDental during the period as a result of the temporary distortions arose from closure of inefficient locations and relocation of production facilities during the period; and (ii) the management’s planned decision to focus on higher priced and margin products and gradually phase out the lower priced and margin products in MicroDental Group.”
In the latest semi-annual report they disclose how the reshaping of the MicroDental business is progressing, in total it contributed -9m HKD in loss for the first half of the year. Still terrible, but much better than the 73m HKD loss before. This progress will be key to MDG’s long term success and potential share price recovery. I think it will be hard to come out of this and create shareholder value, meaning turning this business highly profitable. So far the market agrees with me and I think this the main reasons why the stock is down -60% since the acquisition was announced. This of course give us that invest now, a good discount. So the damage done by this acquisition is in my view already reflected in the share price, now there is upside if they actually manage to turn it around properly. There are some early signs that they are making good progress.
The strange land story
Going through the IPO documents a very strange story emerges. The very short version is something like this: The factories MDG are running in China are rented by some type of local community in the suburbs of Shenzhen. This was all well for many years, until Shenzhen grew so much that the land became more valuable. The city has after that re-evaluated the claims different people or groups have to that land. It happens so that Shenzhen government has realized that this local community does not have the legal rights to this land and therefore MDG ends up in a very strange position. Basically MDG could at any point be evicted from the land (with a grace period for moving out). Since this local community of course strongly opposed the Shenzhen governments view on the matter, this has ended up in some type of legal conflict. Consequently MDG decided, it’s time to start to look for a new factory in neighboring Dongguan. This also makes sense from a labor cost perspective, since Shenzhen starts to become a bit too developed and rich. Back in the IPO days, 2016, there was still a long runway until a new factory would be up and running. I can’t understand how investors would be willing to bare this big risk of being thrown out of their factory, before the new one is finished. Now this issue is diminishing, the first phase of the constructions of the new factory is scheduled to finish end of this year. Even if MDG was told to start to prepare to move out by tomorrow, the impact would not be terrible. I would not have been comfortable to invest in MDG earlier than now, just by this fact. These kind of issues is not something I contemplated for my other investments, you always learn something new and the number of traps in emerging markets are so much greater.
Being the only listed company in it’s segment of course makes valuation from a peer perspective more challenging. What MDG themselves paid for the acquisitions is one guideline of the value of the business. Currently the Enterprise Value of MDG is about 1.75bn HKD with revenue of 2.28bn HKD for rolling last 12 months. On the very simple metric of paying 1x revenue, the stock is undervalued by some 30%. I don’t suggest this to be a very good method though, I prefer to look at cash flows.
As we have seen in Part 1/2, the dental business is not very cyclical and has a nice growth trajectory in many parts of the world. These are important reasons, since it gives stability to revenues and income. The big question for the valuation is, what will be happen with the margins? The company has gone from stable 14% Net Income margins in 2012, down to around 6% in the past years. Will that improve, become even worse, or stay stable going forward? This all depends on how well the company manages all the acquisitions done over the past 5 years, since they brought down the margins.
For revenues I do not assume further large acquisitions, just some minor labs being bought. Majority of revenue growth is assumed to be organic growth. China as we have seen is growing very quickly and that will also feed through in the companies revenue growth. The growth rates are 2%, 4% and 6% per year.
My base case assumptions is that some type of efficiencies of scale will start to take effect. Also that the bleeding stops in the U.S. dental labs turn into a profit, there is a few percentage points of margin improvement just from that. Making the base case in my view, fairly conservative.
WACC = 12%, given the stable nature of the business with revenue from developed markets I think a lower WACC is warranted. 12% maybe is not even low enough. I would go even lower, if it wasn’t for that I wanted to keep some risk premium for the uncertainty around management execution.
This gives me my three valuations:
Base = 1.42 HKD per share (I give this a 60% weight)
Bull = 2.19 HKD per share (I give this a 30% weight, since I see it as more likely that margins will improve)
Bear = 0.53 HKD per share (I give this a 10% weight, I see it as unlikely that margins would further significantly deteriorate)
Which in turn gives me a weighted target price of 1.56 HKD per share and about 20% upside to the current share price.
I have been somewhat torn if this is a good enough case to invest in or not. I do love a good turn-around (maybe I like them a bit too much). It’s not easy to catch the bottom and this stock is currently a slow falling knife. 20% upside at a WACC of 12% is not extremely good, but a DCF is also tricky. I’m not a slave to the DCF and there is a lot about this company not captured in my simple DCF. Just changing the assumptions a little bit moves the valuation up and down by quite a bit. For example a WACC of 10% instead of 12% gives a Base case valuation of 1.86 HKD per share.
I like that the family is so heavily invested in this company, they must have a great understanding of the dental industry. They are executing on a strategy they believe will be fruitful in the long run and there are some early signs that the losses in USA are coming to an end.
I think what made me finally decide is the defensive nature of this business. There is a reason this company initially traded at a P/E of 30 and most healthcare and dental related companies are trading at very high multiples. So buying this below a P/E of 10, is pretty darn good for a defensive business.
I initiate this at a 4% position as a Long Term Holding in my portfolio, I will not increase my position before I see proof of margin improvements. I’m willing to give the company about 1-1.5 year to prove that they can improve margins from here.
After a very tough October, my portfolio has recovered somewhat and is in total down -1.6% on the year. That compares to MSCI World which is down -4.4% on the year. Both have achieved these returns, with the exact same volatility, 15.1% for the year (calculated on weekly returns). My correlation is 79.5% to MSCI World, which is rather high, but also somewhat expected. When markets fall correlation tends to increase between all equities (the correlation during 2017 was 64%). After being down to 0% cash, when I introduced my new three bucket investment approach, I’m now back above 10% cash after divestments in my funeral related companies and Amer Sports, which I will comment further on below.
Amer Sports – The Chinese are buying
When I launched my big portfolio change: GlobalStockPicking 2.0 – Major Portfolio Changes, it just happened that information came out about a non-binding interest from HK listed Anta to make a bid for Finish listed Amer Sports at 40 EUR per share. Having looked into Anta when I invested in XTEP, the other sport shoe producer I thought this really made sense. Mainly because Winter Olympics in China is coming up. So I used my new Opportunistic investment bucket to take a 4% position in Amer Sports at 34.1 EUR per share.
I wrote at the time: “My own expectation is that this should be priced at 85%*40 + 15%*29 = 38.35 EUR”. I think the market has caught up with my analysis now, given that the stock closed at 38.37 on Friday. I still think this will go through, but there are some small tail risks, that for example USA will block the deal. Usually these things also take quite a long time, needing Chinese approvals. So I’m happy to leave the last 1.5 euro on the table and close my position here. This netted my a 10% gain in USD (some currency headwinds) in a market which was down -9% for the period, very happy with that. As always when an investment goes well, you just wished your bet was a bit larger.
This is the second time I got a more short term bet right, where there was Chinese related corporate action around a Nordic company. The first time was the Rezidor/Radisson case (Adding Rezidor Hotel Group – HNA related idea) which also ended with a buyout from another Chinese company.
Swedish Match – Adding 30% to my holding
The producer of Snus and moist snuff which through countless of studies have proven to be much less destructive to your health than smoking. The stock has been on a wild ride lately, first the markets have been very positive on the possibilities for growth of Zyn in USA. Lately the focus seems to be elsewhere, for example that Swedish Match will not be allowed to sell it’s products in the rest of Europe. I think they have a terrific product as good as all the e-cigarette alternatives. The company is very well run and highly cash-generative. This is one of those companies I plan to hold forever, now was a good opportunity to add to my holding. I add about 30% to my holding as of close Friday, bringing this holding to 6.1% of my portfolio.
Defensive feels good in these times
For the frequent reader, you know that I have been skeptical of markets for quite some time. I have expressed this in many ways, but the main theme has been finding defensive long term holdings. Early on in the sell-off my defensive approach did not really work out, because the only thing that held up MSCI World, was the U.S. market and tech stocks in particular. Being underweight both was therefore short term not good for relative returns. Lately it started to work better though when tech “finally” stopped defying gravity. Defensive feels very good right now, but that doesn’t mean I want to miss out on the stocks with higher return potential, or very undervalued cases. I will hold true to my defensive style as long as the valuation difference to growth/value doesn’t become too large. Now I’m actually more excited about stock picking than I have been for quite some time. Today I find much more interesting investment cases than I did a year ago, one example of that being Tonly Electronics – Another Hong Kong value investing case. There are many more I have on my Watchlist and even some not yet mentioned there. The point of my dental series has been an attempt to find 1-2 companies to invest in, which are defensive health care companies I can understand. To summarize my defensive holdings:
Olvi (5.7%) – Finland/Baltic – Produces beer and other alcoholic and soft-drinks, selling mainly in Finland and the Baltic countries.
Gilead Science (5.2%) – Global – Biotech company with market leading products against HIV and hepatitis.
Essity (5.2%) – Global- New Holding Essity – Wood base hygiene products, like tissue paper, diapers, feminine care etc.
Diageo (4.1%) – Global – One of the worlds largest distillers with brands like: Johnnie Walker, Smirnoff, Gordon’s Gin, Captain Morgan and numerous others. Also Guinness is a large portion of revenue as well as its 34% stake in Moet Hennessy drinks division of LVMH.
Inditex (2.8%) – Global – The world famous clothing retailer Zara, so far keeps defying the e-commerce slaughter by producing outstanding clothes at a fantastically low price point.
Total = 53.8% of my portfolio is held in defensive companies or cash.
The above companies are a mix of daily needs, like food, clothes and hygiene and vices, like alcohol and gambling. All of the above holdings I’m confident to hold long-term, especially in a bear market. That doesn’t mean though that none of them will ever leave the portfolio. I try to think long term and get to know my companies well, something I didn’t appreciate enough in the past. Part of being long term is to not rush into the new investments, I will take my time and get to know new companies properly before investing. But if I find a new investment that feels much stronger than what I currently hold, the old will go out.
Currently thinking about
Lately I spent a lot of time trying the understand the Chinese tech scene better. There are a couple excellent podcasters out there who educate anyone willing to listen, on everything related to China tech. One thing that is very clear, is how extremely hot this sector is and how fierce the competition is. It seems to be on a totally other level than outside China. On top of that we have the Chinese government interfering in a lot of different niches. The competition and the intervention has again made me more negative in general. So the three of my holdings I’m currently thinking most about all have strong China and tech ties:
NetEase – Great company, with quality games and co-ops with western gaming companies. Given how much U.S. listed Chinese companies have been punished lately I think investors still really like this company, trading at a trailing P/E of 37 and estimated P/E of 24, is not dirt cheap. Obviously partly this is due to the halt in new game launches in China and everyone is expecting this to be temporary. Still, the government is showing who is boss and they won’t allow especially young people to be gaming addicts. Just as the funeral case, this hampers the upside for NetEase. Although I would argue that it probably very long term is healthy for the company to have more balanced customers and not school drop-out gaming addicts. The other aspect is the competition, which seems to be brutal. In Sweden a number of listed gaming companies have plummeted lately, it’s not that easy to keep delivering one of the few hit games everyone is playing. I have a hard time deciding of this a long term keeper or not, maybe the competition will eat up NetEase future? My Original Post on NetEase: NetEase – Chinese Gaming
JD.com – Here we have a company that is again fighting in fierce competition in the e-commerce space. The moat though and reasons for investing in this company is the fantastic delivery/logistics network they have built up. This is the hidden value in the company and the reason I invested. Some nasty details has been coming out about what the CEO has done in rape allegation case. It doesn’t feel very good to be shareholder alongside someone accused for something like this, but the company as such, I think is valued very low currently. If we disregard from personal feeling around the allegations (which is hard to do), this is in my mind a value investment at these levels.
Coslight – I haven’t written much about this company for a long time, it has been a big disappoint lately. This was an early investment for me on the theme of EVs and back-up power stations. The company has developed poorly due to needs for large investments which has been impossible with the already high debt levels (a misjudgment on my side). The solution became to sell of parts of the factory producing batteries for laptops. I think that was the best they could do out of a bad situation, but I’m not sure if they will be able to succeed to play with the big boys like Panasonic, LG, Samsung and CATL. Already back in 2016 it was clear to me I needed to wait until 2020, before EVs would start to sell in larger scale, now we are almost there. This should perhaps move into the Speculative bucket, but I held it for a long time and I will let this Electric Vehicle hype actually play out before I decide further on Coslight. The same reasoning goes for LG Chem, but there I don’t have doubt about their success, they are and will continue to be one of the market leaders. My original post of Coslight: Coslight Outstanding results
In this second post we will start to understand more of the dental supply chain and it’s players. The below picture borrowed from a Modern Dental Group presentation, gives a nice overview of the different market players. This pictures also reveals the major investable industry players:
The focus in Part 1 was on total industry level, revenue and all the different services provided by a dentist. There are a handful of listed dental clinic companies globally and some of them are listed in the picture above. Singapore listed Q&M has an interesting spin-off that I might come back to, but for now I find the other segments more interesting. The next layer in the supply chain are the laboratories and distributors. There is only one listed company in this layer of the supply chain, Modern Dental Group. It has been listed about 2 years now on the Hong Kong stock exchange.
How are dental prosthetics made
There are many different services at a dentist, the more simple ones being just a filling. But when you need a prosthetic of some kind, you enter into a more complex product supply chain, with companies supporting the dentist. This is what we will learn more about now.
Before we dig into more detail we non-dental experts need some more background info first. It’s a pretty complex production flow to replace or repair teeth, I found videos like the ones I linked below very helpful to understand the process and turn-around time to produce any type of dental prosthetics. This is what makes it so fun to be an investor. On the journey to find new investments, you get to learn so many new things. I really had no idea about these processes a few months ago!
Early this year I was really trying to find new long term investments, that I could hold for years and years. I thought I had come up with a very defensive and good investment idea. From my perspective it also seemed somewhat overlooked by the market. Great long term tailwinds with a increasing old population that will eventually pass away. The old generation is also wealthier than before meaning they would leave all that money and assets behind. All boding very well for a nice structural position for listed funeral companies in my view. Great invesment case, stocks were a bit expensive, but given these fundamentals that mattered less in the long run. So i invested, in one UK listed and one Hong Kong listed funeral company. What I didn’t forsee was that governments would come in and have a view on how expensive funerals should be. I have come to realize that society sees this as a service in line with schools etc. For these types of services it is not accepted to make large profits in the same way as for things not everyone needs. After seeing comments like these about Chinese funerals and what has happened lately in UK I started to look at this in a different way. Looking at it from this light, this will perhaps not be a great long term investment, even though demographics guarantee that demand will be there.
Dignity a disaster investment
With the above thesis of great tailwinds I bought into Dignity early this year at 18.8 GBP per share, only a few days later the stock plummeted with 50%. This was on the back of tougher price competition and that Dignity decided to change their pricing strategy. At the time I thought this was a big over-reaction by the market and a great buying opportunity, so i doubled up: Double Pain & Doubling down in Dignity At 8.7 GBP per share I bought as many shares as I bought at 18.8. The strategy seemed to do fairly well at first, the stock recovered and set a high around 13 GBP per share, on my average I was not really even down that much. Then came the next hit, the UK CMA decided to look into the British funeral market and the pricing of funerals, the stock took another dive. Today a clarification around this came out: “Nov 29 (Reuters) – Britain’s funerals industry could face formal investigation after the UK competition watchdog found that high prices were taking advantage of grieving families.” Link to article: Reuters article. The stock is currently down -17% on the day and back trading around the same price I picked up more shares. All in all a disaster investment for me.
Giving up on my Funeral theme
This all has made me realize I have misunderstood this segment. Given that the kind of thinking from UK CMA is probably even more true how the Chinese think, I decided to divest in both my funeral stocks (Dignity and Fu Shou Yuan) as of close today. I still see the structural tailwinds and defensive characteristics of these stocks as attractive. But these markets UK and China, will most likely not allow this companies to be highly profitable for the long term.
Fu Shou Yuan has not been an equally terrible investment, but also a loss. I bought it for 6.49 HKD per share on the same day as Dignity on Jan 15th and I sold today at 5.9 HKD. Which is not terrible given that Hang Seng is down -15% for the same period. But given that Fu Shou Yuan was trading above 9 HKD in June, it again feels like pretty poor timing on my side. This stock has been strangely volatile and I didn’t really understand why it went up (or down afterwards). The Hong Kong market has been extremely peculiar this year though..
So I am a bit bruised by these investment mistakes. You always learn something from your mistakes and here was another angle to consider. A similar story has taken place for my gaming stock NetEase, which was on real roll, until the Chinese government froze all new game launches in China. This has hurt NetEase a lot and it’s greatest rival Tencent. These kind of out-of-the-box disturbances from politicians and governments is not just disrupting in terms of Trade War, but most obviously also be considered from a more narrow sector perspective. As always the market is good at keeping me humble.
Now on and upwards to new investment ideas. Stay tuned for a Part 2 of my dental series!
I had several sector themes in the past and some of them are still in my portfolio (EV’s, breweries, funeral). My most well covered theme has been Electric Vehicles. It’s time to learn about a new niche segment of the market. Over the past year I have spent a lot of time looking in to many different Pharma/Biotech/Healthcare related companies. Unfortunately it has not yielded in anything I can confidently hold long term. I thought I had an investment case with Teva, which I spent a lot of time researching (Teva – The Perfect Storm in 2 parts) but at the later stages of my analysis I decided not to. The main reason why I in general have such a hard time pulling the trigger on a Health related investment, has been the research pipelines. These Phase I, II & III research pipelines often drives most of the value in these companies. I just feel I never have an edge, in understanding the probability, if a product is going to pass through these stages. In the search for something more understandable but still healthcare related, I ended up with dental care. Although still complex, I think this is a niche which is understandable and therefore for me – more investable.
Some segments and markets in the dental services industry has very attractive investment dynamics. First of all it’s generally very defensive, especially in countries where dental care is government sponsored or part of a health insurance. Second, is demographics and economics, the world is getting older and we also live longer combined with increasing wealth. Old people need dentures and implants, and reaching a certain level of wealth, you start to take care of your teeth in another way. These two factors create a significant long term tailwind for these products. Third, it is a very fragmented market, with custom made products. This creates a very low price transparency for the end customer, it will take a long time before end consumers have proper price comparison, for dental services. In many cases it’s also not needed, given government sponsorship or insurance covering the procedures.
This will be a multi part exploration in understanding the dental sector and the investable players in that space. If any of you readers happens to be a dentist or just have deep knowledge in the sector, please do help out over the coming posts to explain the dynamics of the industry.
The Big Picture
It is very hard to get a good global industry overview. First of all because of scarcity of data, secondly because different sources group different products and services in different ways. I have done my best to pull together a industry overview from a number of sources. Most of the industry data is from 2014-2015.
One can divide everything related to mouth health into two main segments, my focus will be on the first of these two:
Dental Services – All products and services when you visit the dentist (teeth check-up, tooth filling, dental implants, cosmetic changes, xray, etc).
Oral Care products – All products and services outside the dental clinic (toothbrush, toothpaste, dental floss, mouthwash, etc). Although a large market, I will leave this segment for now, this series will focus on Dental Services.
Tooth decay (dental caries) is the most widespread chronic disease worldwide and constitutes a major global public health challenge. It is the most common childhood disease, but it affects people of all ages throughout their lifetime. Current data show that untreated decay of permanent teeth has a global prevalence of over 40 percent for all ages combined and is the most prevalent condition out of 291 diseases included in the Global Burden of Disease Study. Another very common disease is periodontitis, which means inflammation of the gums and supporting structure of the teeth. Periodontitis starts with gingivitis, where the first sign is bleeding from the gums. I think many of you have experienced early stages of this, when you are flossing your teeth and the gums start bleeding.
We can also see that teeth is a question of economic background, as people get richer they eat more sugary food and get more tooth decay. But as income rises, more of those teeth gets fixed:
The U.S. dental services is today a market of more than a 130bn USD. The European dental market is valued at above 80bn USD. The U.S. dental market is growing at an average growth rate of 5.8% per year since the 1990’s. The European Dental market is a more mixed picture, but on average it is growing at a slower pace of 1-2%. For the Asian region the data is much more scarce. Large countries like China and India has not come nearly as far as the highly developed countries, but growing at significantly higher pace (from low levels).
The below picture gives a feeling for when markets are saturated in terms of number of dentist per 1000 population. One can see a pattern of about 0.5-0.8 dentists in developed markets, whereas a country as China has significant growth ahead:
Dental Services explained
To explain the different parts of the industry I use this split from 2015 on the U.S. Dental Services:
This gives a brief explanation of these different sub segments of dental services
Restorative – Dental fillings, dental crowns, procedures treating damaged or decaying teeth or gums.
Preventive – Routine dental exams, cleanings, fluoride and sealant applications.
Diagnostic – Digital radiography and x-rays, etc.
Orthodontics – Treating improper bites and misaligned teeth.
Prosthodontics – Artificial teeth, partial or full dentures, bridges and implants. This also includes veneers, a thin layer placed over a tooth and other types of tooth restoration.
Oral surgery – reconstructive surgery, jaw alignment, dental extraction. This segment also include cosmetic surgery to the jaw.
Endodontic – Root canal procedures and other treatments related to the pulp of the tooth.
Other – Includes services to dental practices, distributors, software solutions, HR, marketing, financial planning etc.
Within all these areas the are a number of large to medium sized companies providing different products and solutions to the dental clinics. In coming posts I will dive into some of these segments and see what kind of investment opportunities we can find.
Highly Fragmented Market
Dental centers do not normally belong to large chains or a company group. The dental service industry is in fact highly fragmented, with smaller dental shops run by one or a few dentists. The top four dental service firms in the US account for less than 2% of domestic market share, and over 88% of the US dental service companies operate with less than three dentists, according to a IBISWorld Dentist report. The same situation is seen globally in most countries. Some exceptions are: China, where some 350 dental practices control over 50% of the market. This is due to most current centers are government run, in a similar way as hospitals. But as could be seen in the above picture, China is a very under-served market in terms of number of dentists overall. The growth currently seen in China is coming from smaller groups of private centers. In Europe the situation is also mostly of a fragmented market (with Finland perhaps being the exception):
This fragmentation seems to have been something the Private Equity firm have picked up on. Obviously there are synergies to be had by running a larger operation. So from a very fragmented market we have seen the early days of some consolidation. This article (Pan-European dentistry is here, but at what price?) though argues that some players have been overpaying.
This fragmentation in dental clinics has also meant that the bargain power has been sitting with the dental suppliers. These companies are huge in comparison to the small dental clinics and supply the clinics with all the products they need, to run a modern dental clinic. Given this fragmentation on the dental clinics side, most of the investable universe is with these companies supplying the dentist with their products.
Your mouth is expensive
A strong motivational factor for spending on dental care is of course just pure looks. To change the appearance by moving misaligned teeth, using veeners, or just a simple whitening. This is a fast growing segment in the market, where products like Invisalign has grown tremendously. These procedures though are like cosmetic surgery, a luxury product, which will cost you a lot. The Invisalign procedure will cost you anything between US$4000 – Us$8000.
Very few people in the world can afford to out-of-pocket front the full bill for dental care when more advanced procedures are needed. Replacing a lost tooth with a single implant will cost you between US$2000-$6000 depending on where you are in the world. Since dental issues, like a lost tooth seldom is an emergency, we end up with a lot of untreated cases. Because of the high prices, the dental market is to a large extent driven by the level of government support. Few countries has totally free dental care to the whole population though. A rich country like Australia for example seems to have a very lively debate on this, where even young people go with untreated tooth decay: The dental divide – and the decay of public dental services.
Countries like northern Europe which are famous for their welfare states, have free dental care for kids up to around 18 years of age. Even in these countries adults have to pay, although there is still usually some type of back-stop coverage from the state. For example in Sweden 50% is covered between 3000-15 000 SEK and 85% of the amount above 15 000 SEK is covered by the state. This kind of coverage is similar to expensive health insurances in other countries which include dental. For example the health insurance I myself have (global coverage), covers 80% of my dental bills. Even if this sharing of cost helps, people still need to pay out of pocket fairly significant amounts when doing a larger change, like implants or dentures.
So the growth of dental care is very much up to governments willingness to pick up the bill. The other factor is is increasing overall wealth, like in China, where a rising middle-class is deciding to start to pay themselves, either out-of-pocket, or through better health insurances. To reach a larger part of the population, price is obviously an important factor, if companies are able to lower prices, volume will follow.
End of Part 1
I hope this set the stage for a series of posts on dental related companies. Do you have any investment favorites in this market segment and why? Anything you would like to add in terms of important industry trends? Please leave a comment!
I like reading, both for pleasure and as a great way of educating myself. A nice combination is when the educational book is written in such a way that it feels like pure pleasure reading. Michael Lewis is an example of such a writer for me. His books become page-turners for me, I just can’t get enough. Slightly more heavy educational material, usually get’s a bit boring and dry. The book Thinking Fast and Slow by Daniel Kahneman was a typical love/hate relationship of the sort. The book material was extraordinary interesting, probably top 3 educational book I ever read. But written in such a way that halfway through the book I really struggled. The latest book I read, Superforecasting: The Art and Science of Prediction, is an easier read. It draws some of it’s material from Kahneman’s book and for an equity investor like me it was almost more intriguing and interesting.
Superforecasting: The Art and Science of Prediction
In a 20 year very impressive study, Professor Philip Tetlock showed that even the average expert was only slightly better at predicting the future than “monkey’s throwing darts”. Tetlock’s latest projects has since shown that there are, however, some people with real demonstrable foresight. These are ordinary people, who are nonetheless able to predict the future with a 60% greater degree of accuracy than regular forecasters. They are superforecasters.
Reading this book is about understanding what things these regular people do, to make them such great forecasters. Surely one would like to pick up such skills! The examples are mostly related to forecasting politically related events, but I think almost all of it is applicable in the world of investing as well. There are many reviews online of the book, so I will not provide that. Mostly I urge you to read the book, it is really good. But there are so many great books to read, so for the ones that do not have the time here are some personal reflections:
Some of my personal takeaways from the book (interpreted into a financial context)
This book resonates with me on multiple levels, but what spoke to me the most, was Tetlock’s description of perpetual beta: “a computer program that is not intended to be released in a final version, but will instead be used, analyzed, and improved without end.” As you might guess, we are not talking about computer programs really, but rather an approach to life itself. I finished my Masters studies many years ago now, the first few years working in Finance was very intense and I really learned a lot. But later on, I realized I had started to fall back on old knowledge in many occasions. I was still learning new things, but at a much slower pace than at Uni (or the first year working). And I realized I didn’t like it. It’s somewhat hard to explain, I have this need to constantly keep learning and understanding new things. I’m just very curious about understanding things. From how people think, to how a certain company operates and how it all slots in together in the bigger picture and the world we live in. Since back then I have found multiple ways to keep developing and improving: proper financial studies with exams, reading books on topics I want to understand better, listening to podcasts, reading blogs, following great people on Twitter and vloggers on YouTube. The world is today filled with so great, easily accessible ways to keep learning! The latest way of improving is my very own blog, where I can structure some of all that information I take in and do something useful out of it. One of the main points of the book and how to be a superforecaster, is to constantly keep learning and improving. Or in Tetlock’s words in the about superforecaster Bill Flack: “I can’t imagine a better description of the “try, fail, analyze, adjust, try again” cycle—and of the grit to keep at it and keep improving. Bill Flack is perpetual beta.”. Just like Bill I’m trying to very humbly be perpetual beta as well.
Another important concept of becoming a great forecaster is to actually measure how you are doing. Tetlock takes the example of medicine. In the old days, there was no actual follow-up on if what doctors did actually worked or not. It was just assumed by their reputation and knowledge that they knew what they were doing. This illusions of knowledge and accepting the doctors view was a terrible way to actually improve medicine. It was only when we started of putting medicine to test, through randomized controlled trials, that medicine science really took off. In the same way for investing, one should not forget to evaluate free from bias, what did one forecast and how did it actually turn out. Which leads to the next point
Be specific and clear in your forecasting. The financial field is full of people going on TV everyday, voicing their views and forecasts of the future. It is very seldom any TV-program goes back and reviews over the past 3 years, of all the people we brought here multiple times, who got in right and who was wrong? Except the problem that its not evaluated at all, next time you hear one of these people on TV, listen to what they really say. They use vague words, which basically never makes them entirely wrong (or right). To actually be able to evaluate yourself, you have to force yourself to make actual precise forecast, use percentages! And try to use as detailed percentages as possible! Example: Right now, weighting all factors available to me, there is 78% probability that the S&P 500 is lower at year end than it is today, that we can follow up upon! And if I do a hundred forecasts like that, we can start to see if I’m a superforecaster or a dart throwing monkey. Which leads me to me final main takeaway of the book:
Forecasting should be evaluated in two dimensions, calibration and resolution. To cite the book: “When we combine calibration and resolution, we get a scoring system that fully captures our sense of what good forecasters should do. Someone who says there is a 70% chance of X should do fairly well if X happens. But someone who says there is a 90% chance of X should do better. And someone bold enough to correctly predict X with 100% confidence gets top marks. But hubris must be punished. The forecaster who says X is a slam dunk should take a big hit if X does not happen. How big a hit is debatable, but it’s reasonable to think of it in betting terms. If I say it is 80% likely that the Yankees will beat the Dodgers, and I am willing to put a bet on it, I am offering you 4 to 1 odds. If you take my bet, and put $100 on it, you will pay me $100 if the Yankees win and I will pay you $400 if the Yankees lose. But if I say the probability of a Yankees victory is 90%, I’ve upped the odds to 9 to 1. If I say a win is 95% likely, I’ve put the odds at 19 to 1. That’s extreme. If you agree to bet $100, I will owe you $1,900 if the Yankees lose. Our scoring system for forecasting should capture that pain. The math behind this system was developed by Glenn W. Brier in 1950, hence results are called Brier scores. In effect, Brier scores measure the distance between what you forecast and what actually happened. So Brier scores are like golf scores: lower is better. Perfection is 0. A hedged fifty-fifty call, or random guessing in the aggregate, will produce a Brier score of 0.5. A forecast that is wrong to the greatest possible extent—saying there is a 100% chance that something will happen and it doesn’t, every time—scores a disastrous 2.0.” And the book then goes on describing that a Brier score needs to be set into a contex: “Let’s suppose we discover that you have a Brier score of 0.2. That’s far from godlike omniscience (0) but a lot better than chimp-like guessing (0.5), so it falls in the range of what one might expect from, say, a human being. But we can say much more than that. What a Brier score means depends on what’s being forecast. For instance, it’s quite easy to imagine circumstances where a Brier score of 0.2 would be disappointing. Consider the weather in Phoenix, Arizona. Each June, it gets very hot and sunny. A forecaster who followed a mindless rule like, “always assign 100% to hot and sunny” could get a Brier score close to 0, leaving 0.2 in the dust. Here, the right test of skill would be whether a forecaster can do better than mindlessly predicting no change. This is an underappreciated point. For example, after the 2012 presidential election, Nate Silver, Princeton’s Sam Wang, and other poll aggregators were hailed for correctly predicting all fifty state outcomes, but almost no one noted that a crude, across-the-board prediction of “no change”—if a state went Democratic or Republican in 2008, it will do the same in 2012—would have scored forty-eight out of fifty, which suggests that the many excited exclamations of “He called all fifty states!” we heard at the time were a tad overwrought. Fortunately, poll aggregators are pros: they know that improving predictions tends to be a game of inches. Another key benchmark is other forecasters. Who can beat everyone else? Who can beat the consensus forecast? How do they pull it off? Answering these questions requires comparing Brier scores, which, in turn, requires a level playing field. Forecasting the weather in Phoenix is just plain easier than forecasting the weather in Springfield, Missouri, where weather is notoriously variable, so comparing the Brier scores of a Phoenix meteorologist with those of a Springfield meteorologist would be unfair. A 0.2 Brier score in Springfield could be a sign that you are a world-class meteorologist. It’s a simple point, with a big implication: dredging up old forecasts from newspapers will seldom yield apples-to-apples comparisons because, outside of tournaments, real-world forecasters seldom predict exactly the same developments over exactly the same time period.”
This long explanation in a Financial context is such a nice way touching upon my very first post on the blog, where I tried to argue that it’s important to know what your benchmark is: Know your benchmark. Because if you do not know your benchmark, how can you then even start to test how well your investment strategy is doing?
How good was my forecast in Tonly Electronics?
I just published my analysis of Tonly a week ago. I ended the post saying that soon the Q3 Sales figures will be out, well now they are out. In the spirit of forecasting, let’s look how well I forecasted the newly released Sales figures for Q3 in my three scenarios:
So far it seems I’m very far from being a superforecaster, when non of my three investment scenarios managed to capture the total Sales of Tonly would come in for Q3. Sales came in higher than my Bull scenario! Given the great results on a revenue basis and that the stock has traded down another 10%, I decided to allocate all the cash I had left, into Tonly (which was about another 2% of my portfolio) as of Friday. These Sales results doesn’t mean it’s a home run, something could still have happened to the margins, that we have to wait until next year to know. One could also notice that the segment I thought would drive future growth, with smartspeakers, did not actually even live up to my Base case of 550 million HKD. So although New Audio Products delivered extremely strong, it was still not a perfect report. One should not make too big of a deal of a quarter either, but very nice to see the execution of this company and I can’t believe that the market did not take notice of this at all and actually traded the stock down during the day (it ended flat, where I took my position at 5 HKD per share).
Forecasting is hard
To book brought up how hard it is to forecast something, and the further out in time you go, the harder it gets. The message more or less was, forecasts further than 5-6 years out is more or less meaningless, at least from trying to have an edge in guessing outcomes. I leave this post with a letter which was mentioned in the book, as a way of proving this point. The letter was written in April 2001 by Linton Wells, who at the time was principal staff assistant to President George W. Bush’s secretary and deputy secretary of defense.
Before we start this analysis I just want to point out a few things. I spent a lot of effort to reduce my exposure towards China about 1.5 year ago. And here I am, pitching another Hong Kong listed company. I’m aware of this, but I just can’t give up on a investment just because it’s listed in Hong Kong. The actual China exposure in terms of sales is actually rather modest. That being said, I will be careful to increase my exposure further and I have worked hard trying to find investments elsewhere. Right now Hong Kong is one of few equity markets that has seen a major sell-off and valuations are in some cases, like this, too good to pass on. My next point is on liquidity. This is again a fairly illiquid stock, buying or selling large blocks in this company will affect the stock price. As always do your own due diligence and don’t consider my posts investment advice. The last thing before we go ahead, I made a mistake regarding my stated position size in UR-Energy, it was supposed to be 3% not 2%. It was just an unfortunate typo in my previous post.
Tonly Investment case summary
+ Low valuation (P/E ~7) growth company, 0.7bn Cash with a MCAP of 1.48bn HKD.
+ Dividend yield based on previous payout, north of 6%.
+ TCL main shareholder and incentive structure for staff in place (high stock/option ownership with management).
+ Track record of quickly shifting business into new products, high R&D spend.
+ Headphones and smart speakers growing rapidly on back of large respectable customers like Harman, JBL, Google, Alibaba etc.
– US/China Trade War is a worry and will most likely create real impact.
– As many Chinese OEM/ODM factories the reliance on a few companies is high, the largest customer (Harman) in 2017 stood for 42.8% of sales. Harman was acquired by Samsung in 2017, this puts some uncertainty towards the future relationship with Tonly.
– Products shifting quickly, no guarantee today’s successful sales will last more than a few years.
– Low margins showing low moat and high competition.
– Although aligned management is a big positive, options programs have lately been too generous in my view.
Tonly Electronics is a OEM/ODM manufacturer of home electronics. ODM (Original Design Manufacturer) is one step higher in the value chain, than pure assembly (OEM). This means that the company design and manufacture products which are later branded by another company for sale. Previously the products were mostly DVD/Bluray players, but that has changed over the last few years. Today the company mostly generates its revenue in the field of acoustics – speakers, soundbars, ear & headphones and smart audio devices. This transition is something we will look a little closer at, it is also a part of the reason why I decided to invest in Tonly.
I have followed this company since it was introduced on the Hong Kong stock exchange. Back in 2013 I owned a Chinese LCD TV producer called TCL Multimedia (recently renamed to TCL Electronics). They decided to spin-off a smaller segment of their operations, which they named Tonly Electronics. Tonly produced DVD/BlueRay players, digital TV-boxes, speakers and soundbars. At the time I scratched my head somewhat what do with this holding. It so happened that all the ETFs/funds that held a position in TCL, just dumped their holdings as soon Tonly started trading. Probably because it was too small for their funds. This put significant pressure on the stock, which led me to my first case of bargain hunting among Hong Kong’s small caps. I liked what I saw an invested at cheap levels a few months after the spin-off. At first this went great, the company paid out a nice dividend, stock price recovered and then some. But then in 2015 things started to turn south. With rise of Netflix and other streaming services, DVD/BluRay player sales just fell of the cliff. Although audio products kept growing steadily, 2015 ended with decreasing revenue and 2016 sales were down further. Although the company still managed to stay profitable, the stock market did not like what it was seeing. The stock lost some -50% from its 2015 highs, into 2016. Around the time I started this blog in 2016 I locked in some profits, but kept a small position (hence I did not take it up as a GSP holding).
Tonly Video Products revenue contraction 2014-2016 (in million HKD)
During earlier parts of 2017 I gave up on this holding, believing it was a lost cause, and allocated my money elsewhere. That was a mistake, I should have followed the company more closely and understood what could be seen already in 2016 figures. Something was cooking in the Audio Products segment. By second half 2017 revenue just exploded in the Audio Products segment.
Tonly half year sales 2014-2017 – Audio Products revenue growth (in million HKD)
And this is where the investment case starts. Tonly was facing major headwinds, nobody was interested in DVD & BluRay players anymore and this was the largest revenue driver of the company. Management redirected its around 500 engineers to increase its R&D efforts in audio products. Management built new relationships with Audio product brands. Within just a few years time, the company manages to grow that business so that total revenue sets new all time highs in 2017 second half. The old revenue driver “video products” is now almost non existent. Be it that the company caught some tailwinds within the audio space, but to me this is a proper turn-around. It shows quality of management as well a testament to the research team to be able to develop new products. If I could just have spotted that in the second half figures for 2016, but alas I did not.
What does Tonly look like today and why is the stock price plummeting lately? Let’s find out.. (more…)
Before I start this post, I just have to comment on the last months terrible portfolio performance. After being comfortably ahead of the MSCI World benchmark, I’m now behind by almost 5% on the year. The portfolio is down nearly -8% in 1.5 month. Some of it, is company specific stuff, like the gaming halt in China (NetEase). Some of it is just general Emerging Markets and China sell-off, versus how strong USA (which I’m heavily underweight) is in comparison. A picture says more than a 1000 words:
Now over to something more fun than my under-performance, which I’m not too worried about, its bound to happen, especially when you have such large regional tilts.
In a recent post I laid out my new and hopefully improved portfolio construction/allocation. I summarize my new portfolio construction in the following three buckets:
The idea is to keep the main focus on the long-term portfolio. This bucket contains about 15 stocks and carries the majority weight (65-90%) of my total portfolio . Given a 5+ year holding period, this implies that I should not change more than 3 holdings in a year. I did not put that as a strict requirement, because sometimes more action is needed. But the Target Holding Period defined above is really there to imply that this should be a low turn-over portfolio of great long term holdings.
I have been following stocks and the market so long now, that I see stocks that are miss-priced for one or another reason. When I see the risk/reward as favorable, I now have the flexibility to take part on a more short term basis. The analysis on my side here could be anything from very deep to more shallow.
I’m not sure if this the gambling genes in me that likes this so much, but I just love speculative stocks. I added this investment bucket for two reasons:
1. I spend quite a lot of time researching and reading about these kind of stocks. I think I sometimes actually have an information advantage (that is yet to be proven).
2. Because its fun. Investing is mostly serious business, but it should also be fun and exciting.
Portfolio Changes – Selling 3 holdings
It will take some time to have a portfolio that is fully in line with the above buckets. I think for example the Opportunistic cases I present today are not the strongest ideas ever. Nevertheless I think they are good enough to enter my new and shiny three bucket investing strategy. Below I will go through what has to leave the portfolio. At a later stage there still might be 1-2 long term holdings that needs to be evaluated if I’m really comfortable holding long-term.
Kopparbergs – Sell Full Holding – 5% investment return
Since I bought into Kopparbergs I spent quite a lot of time, Peter Lynch style, looking at cider products in stores around the world. Walking around daily life, like in a supermarket is just full of investment opportunities don’t you think? In fact this is in general something I draw quite a lot of inspiration from. The more important step in that process is both figuring out what you think of the product compare to its competition and more importantly, how other people feel about it. In the case of Kopparbergs, I think that competition has stepped up significantly and consumers are now having choices similar to Kopparbergs. Kopparbergs more or less created a new cider segment, with very sweet cider. From what I see in stores, although less sweet, for example Carlsbergs Sommersby cider is extremely popular. My case was that Kopparbergs cider had a good chance of being a hit in the US, I now changed my mind about that and see it as less likely. Kopparbergs product offering is not strong enough to really stand out in this competition. Another important factor is that selling these products is as much about distribution and network as in having an awesome product. For all the above reasons I decided that the likelihood of Kopparberg continuing a strong growth journey in cider sales, is low.
A behemoth in property services, mainly related to cleaning with almost ½ million staff is an impressive entity. My investment thesis was a turn-around in free cash flow after paying down debt and after that a significant dividend increase. That didn’t really play out as planned and the stock market has also been as disappointed as I. Selling this holding is for totally different reasons though and that for me is too low growth opportunities. This is a steady (potentially) high dividend paying company. Although high dividend stocks have many nice characteristics, it’s not really what I look for in a long-term investments. There has to be both growth and dividends. Mature businesses which are just fighting with operational efficiencies is not what I believe will generate alpha long term. It might do so in a bear market, given the stability and quality of the company, but I’m not going to hold ISS as a timing play on a bear market.
I will have to expand what I look for later, in my Part 2 of the “Art of Screening”
Radisson Hotel Group – Sell Full Holding – 39% investment return
I’m usually pretty tough on myself and my investments failures. That’s because I’m not here to brag, but to become a better investor. But now I will do a bit of bragging. Damn it feels good when you are spot on in an investment idea. I painted out a investment scenario whereby HNA would be forced to sell it’s position in Rezidor (now renamed to Radisson). On top of that I had listened to a 3.5 hour investor presentation on how the hotel group was going to structure it’s turn-around. So it was a double whammy turn-around + bid case. As it happened the market started to believe the turn-around, especially when it already started to show in the latest results. Then came the bid by a Chinese hotel company: HNA sells Radisson Holdings to Jin Jiang-led consortium.
Unfortunately this bid did not give as much of a stock price bump as I had hoped. There is still some un-clarity around how much Jin Jiang will need to offer the minority holders, but they might low ball investors and keep the stock listed. There still might be more upside here, but my investment case has played out and I’m happy stepping off here, overall a great investment which returned 39% in less than 6 months.
I will at end of trading today add 5 new holdings to the portfolio, and after selling the 3 above holdings, this is what my new 3 bucket portfolio will look like:
Short comments on new holdings
Obviously this will need to be expanded over multiple posts, but here is the quick and dirty on these 5 new holdings:
Amer Sports – Opportunistic – 4% position
Since my previous investment in Xtep, I have both researched and followed the Chinese sportswear and sport shoe producers in China. I invested in the one (Xtep) that was trading cheap on all kinds of metrics. If I had taken a more long-term approach, perhaps I should have considered the local champion Anta instead. Anta which is a 13bn USD MCAP company recently showed a tentative interest in bidding for Amer Sports, a Finnish holding company for a long list of attractive brands/assets. The tentative offer was at 40 EUR per share and the stock quickly after repriced from 29 EUR to 36 EUR, but has after that come down to 34 EUR. If one wants to play mathematics on that, one can say the market is pricing about a 50% probability of this bid actually going through.
My investment case is two fold:
I liked Amer Sports already before this bid and had already done a quick due diligence on the stock. Even if the bid falls through, I’m not in panic mode holding this stock, it could convert to the long-term time bucket if I did a deeper due diligence and like what I see even more than I already do. There has already been other speculations that Amer might spin-off parts of its business to unlock value.
The market is way too skeptical on the bidder in this case. I take this as typical “China fear”. This investment, so makes sense for Anta. If and when it goes through I will be very compelled to add Anta to my long-term holding bucket, I think they would do great things with Amers portfolio of companies. We have Winter Olympics coming up in Beijing 2022 and Amer holds several “winter” assets. Anta has the network in China to actually being able to grow these brands in this tricky market, in the past Anta has bought the China rights to the at the time quite poor brand Fila in 2009. They have totally re-positioned the brand in China over these years, growing it into a real success, from 200 to over 1000 stores in the country. I put the probability of Anta being serious with this bid at 90-95% and I take the probability of a successful takeover somewhat lower (85%), since there is some overhang with for example USA wanting to meddle in this, given that many of the brands under Amer are tightly related to USA.
My own expectation is that this should be priced at 85%*40 + 15%*29 = 38.35 EUR, giving about 12.5% upside on current market price of 34.1 EUR.
JD.com – Opportunistic – 4% position
In this pretty brutal China sell-off I have been scratching my head if and when I should poke my hand in trying to catch any of these “falling knives”. I somewhat randomly felt that now would be a good time to catch one of the stocks I have been looking at for quite some time. JD.com is the case of a quickly growing e-commerce company with tremendous revenue growth. The company plows all of the cash back into investments in its own business and other businesses. For example it’s a co-investor in Yonghui Superstores, which my largest holding Dairy Farm owns 19.99% of. For a primer on JD.com I kindly refer to Travis Wiedower who presents the case in his investor letter: JD.com in Letter, EGREGIOUSLY CHEAP blog.
A pretty disastrous allegation having hanging over you, I will refrain from speculating in the probabilities of this being true. The main point here is that at this stage the company is bigger than Richard. Yes, Richard built this company and yes this will have a negative effect on JD’s perception among the Chinese. What did Richard do in the US when he got arrested? He was actually studying at Carlson School of Management to complete the American residency of a US-China business administration doctorate programme. Having time for these types of studies shows that other people are running the company by now. There is some issues with the governance structure if Richard would be imprisoned, but we very far from that right now, he is not even charged yet. Richard has built a fantastic business in China, in many ways better than Alibaba’s model. My best guess is that these allegations will die out and JD.com will on a 1-2 year time horizon trade significantly higher. When/if this allegation overhang is removed, this might move into my long term time bucket.
Irisity – Speculative – 2% position
The company listed in 2013 under the name Mindmancer. The idea was to provide smart camera surveillance systems to construction sites, schools and such. The whole package of software imagine recognition, cameras and installation was provided by Mindmancer. They had some success and have installed this in numerous places over these last ~5 years. The problem was that the business model didn’t scale and it was hard to keep the company profitable. There was also management issues, where one of the founders, a very young an enthusiastic guy was the CEO. He probably had the heart in the right place, but was to inexperienced to run and grow this company. The largest shareholders which is connected to the University in Sweden where the company started, decided to appoint a new CEO, change the name of the company to Irisity and do a rights issue (24 MSEK at 7.8 SEK per share) to strengthen the balance sheet. After that the new CEOs strategy has been to go for scalable sales model, just selling the software they develop. The software is proven in all the live conditions where it has been installed already. They are going for so called Software as a Service (SaaS) model. Somewhat surprisingly this quite quickly has got a lot of interest from market participants, both G4S and several of the worlds largest camera producers.
“Irisity AB (publ) signs license agreement with Hangzhou Hikvision Digital Technology Co. Ltd.
Hikvision is the world’s largest supplier of innovative video surveillance products and solutions. With 20,000 employees, including nearly 10,000 in R & D, the development of intelligent cameras leads. Hikvision is listed on the Shenzhen Stock Exchange with a valuation of USD 46 billion. The company shows a strong YoY 32% growth, with sales of USD 6.6 billion (2017). In collaboration with Hikvision, Irisity now evaluates embedded integration of IRIS ™ AI software in Hikvision’s camera platform.
– Hikvision is a wish party to Irisity, we already have our AI with several of their IP cameras, but are also looking forward to creating a Linux embedded solution right in the camera. This is the future, since very few cameras will be delivered without built-in AI! Comments Victor Hagelbäck, CTO on Irisity.”
What is not mentioned in the press release is that Hikvision produces almost 100 million cameras per year, so the potential is gigantic if these companies really like the Irisity software.
So to summarize, the company has a proven product in the Nordic markets. They are currently trying to convince huge players, that its software algorithms are good enough. In a best case they would want to pay Irisity to embedd them in their products. Right now this license agreement is not worth any money, its just shows that Irisity has got to actually showcase their products and on some level for example Hikvision (several other big companies are doing the same) is evaluating their product. I find Irisity (valued at about 35m USD) at a very attractive risk reward right now, even if the probability is very low to see large orders. This is truly speculative, one of these lottery tickets, but with much better odds than playing the lottery.
Scorpio Tankers – Speculative – 2% position
This is a fairly simple case, market analysts seems to think that Day Rates should normalize. They have not done so, so far. Equity markets have given up and stock is tanking (ha ha). Taking the long term view on day rates, its seems plausible that they would increase from these levels. I’m a firm believer in mean reversion. Scorpio has a attractive fleet of new vessels, as long as day rates recovers somewhat, they are highly cash generative. Let’s see if that happens or not.
UR-Energy – Speculative – 2% Position
Canadian listed Uranium miner, that I actually owned already back in 2006-2007. At the time, it was the only junior Uranium prospecting company, that actually came out on the other side of the bull and following bear Uranium market. They are now a small scale Uranium producer, with a large portion of their production hedged at higher levels. I will have to write another time about Uranium, but its a very special market and a strong case can be made for long term increases of as its called yellow cake. I’m choosing UR-Energy as my Uranium proxy, because they have excellent management, a very crucial detail in the mining industry, which is full of crooks and cheaters.
Please comment what you think of my new holdings and I will try to follow up with more details in later posts!
This will be an exploration in how to set up stock screenings, if you have a lot of experience of playing around with this, please do comment and help me out.
A stock screening could have many purposes, most screens are not related to finding the “hidden gems”. The screening could be used to list companies with certain characteristics, for example all Bank stocks in Asia. This post will not be about these type of screens. It will be about screening for stocks you otherwise would struggle to find and stocks that hopefully few others have looked at. Later post will explore other angles of screening, for example dive deeper into what stock characteristics I’m looking for. The beauty of being a Global investor is that you work with the widest possible set of publicly traded companies. I think would be a waste if you as a Global investor did not take advantage of having access to all markets. This should be exploited to the largest extend possible. According to Bloomberg there are 61 000 listed companies in the world. Just like my catch-line of this blog, surely among the 61 000 companies there is bull market somewhere? But with 61 000 companies it is like finding a needle in a haystack, the question is, how do we find the needle?
I will divide the challenge of finding the needles in the haystack into two parts:
Where should one look? Meaning what should be filtered away from categorizing metrics. Examples being: Country, Company Size, Industry
What type of metrics? Meaning what company specific criteria are on average delivering out-performance? Examples being: Price to Book, P/E, Growth, Piotroski F-Score, Momentum
Obviously in practice as a private investor you do not have access to every single market in the world. Few professional investors do either. So in practice, in my case the Global Universe of stocks is listed on one of these countries exchanges: Australia, Austria, Belgium, Canada, China (Shanghai & Shenzhen), Czech Republic, Denmark, England, Finland, Germany, Greece, Hong Kong, Hungary, Indonesia, Ireland, Italy, Japan, Malaysia, Netherlands, Norway, Philippines, Poland, Portugal, Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey and USA.
What is the competition?
To understand where we should look to find the hidden gems, we first need to understand the current investment landscape and competition. I’m a firm believer that markets are fairly efficient. One should respect the huge amount of clever highly educated people spending all their efforts trying to find the best investment cases, all with the goal to outperform markets. Lately a lot of money has gone into passive investments but there is still a lot of money sitting with fundamental active managers.
Not only passive investments drive return today, we also need to compete with machines. In the last 10-15 years the competition from computer algorithms have increased significantly. In the beginning it was only hedge funds, like AQR, Renaissance Capital and a few other that were using statistical analysis to find stocks characteristics that on average outperformed the market. They applied much of their strategies in a market neutral or at least hedge manner. Meaning going long the stocks they thought had the right characteristics and short the ones that had the opposite. Today this market has exploded, Smart Beta, Factor/Style investing has gone mainstream and huge amounts of money is invested in it. Also fundamental fund managers use these screens to come up with stock picking ideas and evaluate their fundamental portfolios from a factor/style perspective. When I started this blog my ambition has always been to apply similar screens, but on parts of stock universe which institutional investors can not reach.
On top of that, with internet, cheaper brokerage fees and everyone having all the information in the world at their fingertips, private individuals have entered the space of stock picking in a way never seen before. Just look at the amount investment blogs out there, with young and old trying to dig up new investment cases.
To summarize – Three categories of investors:
Professional investors, most of the money sitting with long only mutual funds, but also hedge funds and family offices has large pools of money to deploy. Through company visits, and deep analysis they find the miss-priced stocks according to a multitude of investment styles and approaches.
Smart Beta / Factor / Risk Premia / Statistical Investing, it has many names, but all of them is based on the idea of sifting through large amounts data, finding patterns in that data that indicates as high probability as possible of out-performance. The styles here are also developing, but having worked in this field, the strategies tend to be more similar. The sophistication is rather related to the type of Quant strategy, the simplest being large smart beta ETFs and Funds and the most sophisticated are still firms like AQR and Renaissance Capital.
Individual investors – everything from total beginners, to very professional individuals, investing mostly their own money. Here many have no idea of what they are doing, but there is also wisdom in crowds and on average they might be right, that’s all that matters. There is also a large group of clever hobby investors or finance professionals who invest their own money.
Where to look
My main thesis is to look where few are looking. Do not look for stocks in the same pool as where one or all three above listed categories of investors are looking. The probability to find something “unique” is pretty low, but at least concentrate your efforts where the above three categories is looking less.
Sabre Capital (John Huber) wrote an excellent piece on this, well worth a read: What is your investing edge?. As is argued, many investors believe that if you just look for small caps you have an edge. You have then solved the problem of competing with the “big fish” in category 1-2 above. That is probably true, but one then forgets the “small fish” in category 1-2, as well as the whole category 3. Meaning just buying small-caps is simplifying it a bit too much. Actually as we all know many private individuals love investing in small caps, penny stocks etc. This is appealing to anyone with some gambling genes in them, the thrill of fast gains is exciting even for the most professional investor. Just like the option market has a volatility smile, meaning investors are willing to pay more for call options with a high return potential. I believe small and micro caps in bull markets could actually on average be overvalued, due to this effect, people love buying a lottery ticket. Again, in bull markets this might be an area to avoid.
Avoiding Category 1 & 2
Professional investors come in all shapes and sizes, but to manage money in today’s world comes with certain levels of costs. If your AUM (Assets Under Management) is too small, those costs become unreasonably large compared to your potential income. Without doing a big deep-dive into this, this is my thinking in a few sentences. I would argue that firms with less than 200-300 million USD in a fund, does not really bear itself long-term. There is definitely a lot of funds smaller than that. But they either do not have the resources to actually do all that research that we are afraid of competing with, or they belong to a larger fund group, where they have some small funds but total AUM is higher. Such a firm usually will focus its research on larger companies, for its larger funds.
What are the smallest companies these funds can then reasonably invest in? Again we want to avoid the stock pickers, small funds that run a 200 stock portfolio, would not worry me. The amount of research spent per company, by a small fund with 200 holdings, will be more like an index fund than actually doing deep research. Let’s say 30 holdings for a small stock picking fund of 250 million AUM. That gives us 8.3 million USD invested per holding. What would such a fund managers requirement on liquidity be for buying position in the 8 million range? Well I don’t think they would be comfortable holding anything more than 10 daily turnovers. Actually if the fund is registered under UCITS or such, this would not be allowed for a daily traded fund, but some funds are not daily, like hedge funds. So let’s stick with the generous assumption to begin with. This means that stocks with daily turnover below about 800 000 USD would be a no-go.
If we look at Quant funds, I would say their requirements on liquidity is much much higher. Having worked on building such quant strategies, in a long/short context, for Europe we would not go outside the Stoxx 600 companies, so anything below that, would be under the radar for our factor strategies. Some other funds do go lower, but not much much lower, meaning there is still a huge chunk of the market where factor strategies is not applied. Again this something we then instead could explore to copy their ideas, but in a stock universe they can not touch.
Avoiding Category 3
So my first idea of avoiding the three types of investor above would be something like this: Avoid category 1-2 by looking at small enough companies so most of the competition is gone. Avoid category 3 by looking at markets where individuals are not participating to a large extend in direct ownership of shares. This idea led me to a fairly lengthy search trying to finding out, what markets have low direct ownership of shares from the local population. The data is somewhat sketchy on this and some of the data is unfortunately old, but I managed from several research papers collect together a fairly good overview of direct ownership:
The source of this data is 3 different studies: “Participation Matters: Stock Market Participation and the Valuation of National Equity Markets – Journal of Financial and Quantitative Analysis”, “Stock market participation and household characteristics in Europe” and “The Effect of House Price on Stock Market Participation in China: Evidence from the CHFS Micro-Data – Emerging Markets Finance and Trade”.
For the few markets that has data both from 2000 and 2007, one can see stock participation in most developed economies has increased significantly (Sweden, Denmark) over the year. In general if we would have data for 2018, participation it probably higher in most markets. Better data would be great, but if the pattern stays the same the above is still useful. We can definitely conclude that less people are participating as direct owners of companies in Italy, compared to Sweden. My thesis here is that on average one would have more success looking at smaller companies in Italy, than in Sweden.
From my list on markets that I’m able to trade, data on participation rates are missing in some cases. But a good guess is that also these markets have low participation rates, just because they are not very developed. So adding those back in and making a somewhat arbitrary cut, I come up with these markets as good hunting grounds:
How many companies are we then left with?
Applying the above Country Filter: 61 000 –> 12 700 companies
Now let’s also define a liquidity filter. Unfortunately my screening does not support a turnover screening, instead I have translated it into a rough estimate in terms of MCAP. After some sample checks a Market Cap below 500 MUSD combined with a free float above 30%, is more or less in line with a daily turnover under 800 000 USD. Another filter I throw in putting floor on MCAP at 15 MUSD. I’m not interested in investing in too small companies.
MCAP < 500 MUSD: 12 700 –> 9400 companies
MCAP >15 MUSD: 9400 –> 7700 companies
Free Float > 30%: 7700 –> 5774 companies
So by trying to look in the right place, where other people are not looking, we are down to 5774 companies. This is how they are distributed country-wise
Hunting Grounds established – Time for factors
So if these 5774 stocks is our new hunting grounds, what do we do next? It is still too many stocks to read up on, now its time to apply different metrics. These metrics should be something you believe in that your companies should have to be great investments. One such metric is the Piotroski F Score (More about Piotroski).
Applying Piotroski F Score > 8
5774 –> 111 companies
Here are all the 111 companies
Now we got the universe down to something manageable. From this stage on, its time to go back to the regular due diligence process. This list above contains 111 new companies for me. The screening has helped me with:
Pick out a universe of stocks where few others are looking.
Use a quantitative metric like Piotroski F-Score to within the this universe pick out stocks with good characteristics.
The idea of this is that this selection should on average out-perform the market. For this to be true, one has to believe that these are stocks less covered by the market and that Piotroski F-Score actually works as an indicator for alpha generation. If you start a fund investing according to my steps above, basically you then have a Piotroski Quant Fund. This fund is probably picking stocks where no other Quant-funds are looking. I hope such a Quant fund would outperform the market, and we could back-test this model (if I just had the time). But even if it does not, my idea is to apply my own due intelligence on top of this, to pick the best companies from the above 111. So for me it matters if the above 111 stocks generates alpha, but its not the end of the world if they do not. As long as the stocks I pick from the 111, generate alpha.
Another way which I played with earlier to find certain investments, has been identifying sub-sectors with future great prospects. For example I believe certain type of beverage and brewery companies have a very attractive business profile. Instead of using countries to define the universe, one could combine sub-sectors with metrics to find the for example few undervalued Beverage companies.
This was one example of a screening process. One could endlessly modify how one picks out the first the universe, and then the metrics. A will write more on this topics in a follow-up post, creating especially more metrics. The trick is to figure out what your investment style is, express that in metrics, and the screening will do the rest. Well maybe not the rest, you still need to decide what on the shortlist you want to invest in.
Happy to take any input on what you think would be successful screening methods, preferably backed up by some good reasoning!