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Rottneros – the SEK winner

As i mentioned in the previous post I have taken a position of 5% of my fund in Rottneros mainly because of the weakening SEK. Sitting on the beach (yes my life is hard) I was not in a position to write a full analysis, so here it is.

Rottneros at a glance:

  • MCAP: 1 234 million SEK
  • Shares Outstanding: 153.4 million
  • Largest Shareholder – Arctic Paper 51% of shares outstanding which in-turn is majority owned by Thomas Onstad.
  • P/E 7.5
  • P/B 1.13

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Simple company to understand

The company run two pulp mills located in Rottneros and in Vallvik in northern and middle part of Sweden. Because it is a debt free small company, running two pulp mill plants it’s also easy to understand the drivers of profitability and risk. It’s cash flows depend on a few variables so I will try to map out the main components that determines the value of Rottneros business. The below picture describes the full production process Rottneros is involved in.

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SEK bargains

The Swedish Krona (SEK) is plummeting further after the Riksbanks latest communication of a lower for longer scenario. In a fairly short period of time the Krona has gone from fairly strong to weak, particurlary to the USD which strengthen against more or less everything. In a perfect world a stock denominated in SEK, with earnings in EUR/USD should correct its stockprice to reflect the now weaker SEK. But we do not live in a perfect world, and potential bargains could exist out there.

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Winners on the weak SEK

A company which is a obvious winner on the weak SEK, has its costs in Sweden but sells all its products abroad. Good examples of such companies are Swedish pulp and paper companies. They usually source their timber/wood locally, use electricity from Sweden and has its labour costs in Sweden. Whereas the pulp is sold on the world market, with prices set in USD.

Most such companies are currently trading at high multiples at a point in time when pulp prices are at high historical levels, but i think i found an exception in the small cap lists in Sweden. The company is called Rottneros and has a somewhat troubled history ending in a rights issue in 2009. Since then they have shaped up considerably and the stock is in a nice uptrend and still trading at attractive multiples. Given the SEK plunge the operating margins are looking very nice indeed. On top of that the electricity cost is hedged, and they are rolling into lower and lower locked prices.

Risks are obviously if pulp prices on the world market plummet, I have no edge at all to predict those, but i can note that they are high from a long historic perspective.

Since Im sitting on the beach writing this i will do a more proper write up at a later time. As of close yesterday I have taken a position in Rottneros of 5% of my fund.

Ericsson

One word about Ericsson as well, the share price has continued to fall sharply and this is also a company benefiting from a weak SEK, as well as from an US investors perspective 44 SEK per share is a lot cheaper today than it was a few months ago. Im willing to continue my Value bet here and take another 2% of my fund to double up the position in Ericsson.

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Ericsson revisited

Little did I know how timely my recent analysis of Ericsson would become. It just ended up on the top of my “Value list” and because of that I decided to take a closer look (Value hunting – Ericsson). My conclusion was to buy in the 50-55 SEK range, and well, it entered and went below that in one single day. I won’t say I had any idea that this would happen, but what I can say is that I did mention the nasty downside risk Ericsson has showed in the past – and once again we experience it -20.21% on the day. The rumours of aggressive accounting must more or less be true, for this type of downturn in numbers.

Probability of bid went up

Before we had a fairly valued company, now it starts to look much more interesting to me. We will probably see lower dividends, perhaps back to the levels of 2009. But even so we still have a very healthy dividend yield of about 3.5% going forward. But to me the value is the patent portfolio and I believe Cisco gets more and more interested, the lower Ericsson falls. In my previous analysis I said that I don’t believe the majority owners would be interested to sell. On my latest flight to Asia I picked up a newspaper in the airplane which I took a photo of:

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The article is saying that the pressure on the majority owners is increasing and there are more or less rumours that they consider selling the company. There is apparently a lot of discussions going on behind the scenes on what is the best way forward. The article continues that there is a clear resistance towards selling Ericsson, but all options are at this moment evaluated.

Reading todays articles in the Swedish press, the majority owners and the Wallenberg family particularly is heavily criticised for not taking action. The press more or less demands the Chairman (Leif Johansson – feature image in post headline) is also thrown out. So a lot is going on, and in these situations it is really painful to go in and buy.

How to value potential Cisco bid?

Let’s do a back of the envelope valuation, based on the Sum of the Parts valuation table I presented before.

SOTP 2017E EV (SEKm) 2017E EV/EBIT (x) Per Share (SEK)
Networks excl Patents 48 350 8 15
Global Services 46 973 10 14
SS excl Patents 10 471 1 3
Patents 83 940 10 26

The idea is that Cisco is interested in the Patents portfolio and are willing to pay a good premium for that – without any deeper analysis they can pay a 40% premium on the patents parts of the business. The rest of the business is slaughter and valued at 60% of previous valuations (due to the deteriorating numbers).

Networks = 15 * 0.6 = 9 SEK

Global Services = 14 * 0.6 = 8.4 SEK

SS excl Patents = 3 * 0.6 = 1.8

Patents = 26 SEK per share * 1.4 = 36.4 SEK

Total = 55.6 SEK

But the probability of a bid is not 100%, let’s say it is 40%. Then the Patents portfolio is valued at 26 SEK + 40% * (36.4-26) = 30.16 SEK

And Total valuation is = 49.36 SEK. Which is inline with today’s valuation. I think the probability of a Cisco bid over the coming 1-2 years is in the 30-40% probability range and I don’t think the rest of the business should be valued as low as my back of the envelope calculations. I don’t find the price of Ericsson to be the bargain of a lifetime but interesting enough.

No brass balls

So since I’m not born with brass balls, I won’t take a large position here. I hold 12% of my portfolio in cash and I feel comfortable with taking a 2% position in Ericsson, with the option to increase my position to full size in case we see further share price deterioration towards the low 40 range, this is when the stock starts to become seriously interesting.

 

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Performance Review – since inception

Still a stock pickers market

In the future I will move to quarterly performance reviews, so this is the last irregular update. The portfolio has done extremely well and I must say this much out-performance does not come without a certain amount of luck. I feel we are reaching the end of this long bull-market and we are probably moving into a more challenging investment climate over the coming years. Even so I still think there is enough dispersion in the market that it gives some comfort in attempting to pick stocks. The strength of the USD is concerning I think. I don’t see how the US stock market can be at it’s peak and the USD keep strengthening as well, at the same time other equity markets are far from peak levels. Something got to give.

Performance

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The graph above shows The “GSP Portfolio” performance including all trading and dividends since the blog inception (no trading fees deducted).

Current Holdings

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Previously held stocks

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Notable Movers

+ Coslight Technologies

After tremendous results in it’s semi-annual report, the stock soared. I have been analyzing all the battery companies that are listed and I have been able to invest in. Out of all of those I placed my bets into two stocks, that were pure-play battery companies. One has with a lot of volatility, mostly gone sideways, but Coslight had the sales turnaround I was expecting, driven by China’s significant insentives for electric vehicles, both buses and cars. Nice to be right for once, after spending tremendous amount of research on the topic over a 1 year period. Now there is talks about a potential over-supply situation among the Chinese battery-makers, I’m somewhat worried about that, but more short-term than long-term. I see signs everywhere that the growth of Plug-in hybrids and all electric cars is just in its infancy. If this company keeps playing their cards right, this stock could go another 100% within the next 2 years. Previous write-up on Coslight.

+ Shanghai Fosun Pharma

This was an example where a lot of things together made me take the investment decision in this holding company. The chart looked like the stock was set for a leg up, I wanted a healthcare stock in my portfolio and the valuation started to look more and more compelling (SinoPharm holding >50% of Fosun Pharmas Market Value). Right after I bought the stock started surging, a quick 25% gained. Lucky yes, but at the same time it was strangely out of sync with SinoPharm. Now the stock is more fairly valued, although still not expensive. Since I have understood from Chinese friends that Shanghai Fosun’s management have a bit of a reputation, I might need to have some margin of safety in this one. I have another “Pharma” holding on my radar, if it looks more compelling I might switch this for something else. Fosun Pharma write-up

+ NetEase

This fantastic company is over-delivering for every report they release. But I can’t keep holding the stock at these valuations, so I sold all, at an average gain of over +50%. I’m hoping there will be a rebound, because this is probably still a great stock to hold over the long-term. NetEase full analysis

– MQ

Well, I thought I got this stock on the cheap, and I still think I did. But it got even cheaper. I’m surprised by how weak retail sales are in Sweden, given how well the economy is doing. This was a play on the Swedish consumer, and although I wasn’t dead wrong, I was not right either. Seems it’s sales through internet channels that are hurting retail all around the world and perhaps also in Sweden? Well I chose to move on since I don’t believe in the Swedish consumption over the coming 5-6 years anymore., even if it pains me to sell something that is still cheap.

– LG Chem

Again I thought I got in on a technically good level, where the graph looked like a move up was in the cards. And it was, but it became very short-lived, a month later the stock peaked and then took a serious turn downwards, now sitting -10% from my purchase price. But the stock falling doesn’t generally bother me much, I’m in for the long-run for their battery production (although it’s not a pure-play). But there was a reason for the stock falling, which was plans from LG to merge LG Chem with LG Life Science. I don’t know anything about LG Life Science, but what I do know is that I bought this for it’s future in battery making, not to own a conglomerate with a small part in battery-making (like Panasonic) – frustrating! So, right now it is wait and see, I’m not ready sell, especially when the stock is trading fairly cheap. On a more positive note the Chevy Bolt is coming out with great positive reviews from everywhere, just like the Tesla model S before the Tesla share surged with 300%. The Bolt is very much a LG product, with battery produced by Chem and the electronics inside is produced by LG Electronics. Looking at competitors it’s clear that LG is one step ahead of its competitors in battery technology (price per kWh). Short LG write-up

I leave you with this test drive of the Chevy:

 

 

 

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Trading update

Short update on changes in portfolio. Im happy with the performance of Netease and chose to close the rest of my position on todays closing price. This trade has given me an average return of almost 50% in about six months time. Great company but current valuation has as much to live up to.

I have become more skeptical about MQ for various reasons, mainly due to online shopping which seems to eat into margins of all clothing companies in a way i didnt expect. So I take my loss here and sell the full position. Right now i feel comfortable sitting on some cash (lowering my beta) waiting for new good opportunties to arrise as well as allocalate to new investment ideas.

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A story about Asian gambling and how it came to Russia

Asia and gambling

Since I first sat foot in Asia and started to meet more local Asians, I have been fascinated by how deeply ingrained gambling is in their culture. Sure we have all sorts of gambling in Europe and the US too, but what surprised me the most was how large sums of money the Asians were willing to part with for gambling (compared to their income). Someone with a monthly spending power (after costs) of 10 000 HKD could discuss with me that having a budget around 7-8000 for gambling over a weekend. That for me was unheard of except by more professional players.

Rise and fall of Macau

I guess nobody have been able to avoid the headlines from the Macau gaming sector and the mind-boggling turn-over figures and profits the companies were churning out, a few years back. Companies like Sands and Galaxy were the stars and for a short while Stanley Ho, the owner of Galaxy was the richest man in Asia. Well the Chinese leaders thought it went too far, and in their drive to rein in corruption, bribery and money laundering, it was suddenly not OK for the wealthiest Chinese to be seen in Macau, spending obscene amounts of money. This fairly small group of rich people, who stopped gambling, toppled the whole industry. On top of that the mainland stock market went from roaring bull to free-fall at the same time. Shares of HK listed Casino companies fell 60-70% from their peak levels and it all went very fast. Many investors who didn’t understand the dynamics of the sector must have been caught pretty bad in these companies. I talked to some US investors who obviously did not understand this deeply and jumped in just a few months before the peak. This is the first lesson in Chinese Casino gambling, a small group of VIP clients, can drive more revenue, than the whole mass market. But as they say, easy come, easy go.

Junket operators

The second lesson is understanding how the VIP segment of Chinese high-rollers are attracted through junkets. This is fairly shady business, although some junket operators are even listed on a stock exchange. What they do is providing a middle man between Casinos and VIPs, providing different “value adding services” (yes, I know what you are thinking of), arranging flights, pick-ups etc. For the interested reader here is a longer description: Junkets Factbox. But the most important service of a junker for VIPs is credit while gambling and the possibility to gamble for large amounts, and then settle potential debts back home in RMB in China. This is essential since the conversion of RMB to foreign currency is not freely available to mainland Chinese. This is then also a way of getting money out of China and/or money laundering. Casino and junket operators will probably not end up in ESG funds if we put it like that.

Russian Casino

Obviously there are other countries that wants to gain from the Asian’s willingness to gamble. Among them two that I studied, Cambodia and Russia. I spent the better part of a day updating myself about Nagacorp (3918 HK). Nagacorp run a casino in Phnom Penh, Cambodia. This is a company I know well, owned for a few years and followed since 2011 and I’m still interested in. But I’m waiting for an attractive entry point, which I think is in the 4-4.5 HKD range. I save that discussion for another time. Reading about Nagacorp I started to look deeper at their upcoming casino project in Russia. This then led me to another company, Summit Ascent Holding (102 HK) who have just opened a new casino in small scale in Vladivostok Russia. I found project and plans of the Russians to open this casino area very interesting. In fact it is somewhat similar to how Macau Cotai strip got developed. Or as Bloomberg asks, is Vladivostok the next Vegas (hardly but anyway interesting comments in the video): Putin’s Making a Big Bet on Building Vegas in Vladivostok

For research purposes I found this “boring” video more interesting, showing the plans for the casino resort area.

Summit Ascent Holding (102 HK)

Newly opened, small casino in Vladivostok Russia, yes, we are climbing out far on the risk ladder with this one. I have decided to take a small position (2% of my fund NAV) on today’s close in Summit Ascent Holding (SAH from now on). This won’t be a full analysis, but I will quickly try to work through why I invested. I needed to write such a long intro above, because it all ties together. Let’s start with the share-price.

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The stock was hyped a lot a few years back, because the company is started by the son of Stanley Ho (richest man in Asia for a short while), who runs Galaxy, perhaps the most famous of the Macau casino giants. This is what it sounded like back then: Hong Kong Billionaire Lawrence Ho’s Summit Ascent Boosts Stake In Russian Casino. Well as we know, things usually take longer than investors have patience and the stock price fell sharply. Especially when the operations were up and running, and revenue was not showing any sharp increase. That changed dramatically with the latest semi-annual report, when the stock jumped 40% within a week.

Targeting Chinese

Although located in Russia, the obvious customer targets are Chinese. Gambling is banned in China and therefor Macau’s success. But it is far to Macau from northern China – and hence we have Vladivostok in a much closer distance. This would also be the case for Japanese gamblers, although initially it is probably not the operators main targets. Also perhaps the city is able to offer another type of lifestyle more long term, compared to overcrowded Macau, as can be seen in the video about the area.

Quick revenue increase last two months

This table shows the VIP turnover and the revenue it generates, as you see a sharp increase for the last two months.

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This revenue increase does not show in the semi-annual figures yet (since it ends in June), but is only visible to the one that actually reads the full report. Here is the explanation:

“Our rolling chip business, targeting the Asian VIP market, has seen phenomenal month-on-month growth, vindicating our investment thesis that the Primorsky Krai IEZ is an ideal location to capture the significantly underserved gaming demand in Northeast Asia. Our strategy has been to start our rolling chip business using only casual junkets initially without fixed-room operators. This strategy is deemed necessary in order to preserve the bargaining power of the casino vis-à-vis fixed-room operators. Thus far, our strategy has been proven to be correct. This is evidenced by the fact that rolling chip turnover has been increasing on a month-on-month basis since the commencement of business in November last year and dramatically increased following the start of two fixed-room operators in late June 2016”

Investment case

  • The stock has been hammered and although a breakthrough has been shown in the figures, the market has not yet hyped the stock as before. Calculating on just current run-rate as of August for the Casino business, we are looking at a company valued around P/E 15-20.
  • I actually believe in this resort area as a whole, as long as Putin stands behind it, and it becomes a VISA free region, low tax and everything that has been promised. Build it and they will come!
  • The Ho family surely have all the right junket contacts, to bring in and focus on VIP players makes a lot of sense. The mass market will come when it is a big resort area with other activities. Also since it’s still somewhat no-no for Chinese VIPs to gamble in Macua, maybe they feel more comfortable in a very private setting in Russia with other high-rollers. I think we can see further growth from the numbers in the table above
  • The company has another project phase in their plans, although we do not know the success of the whole resort area or any build outs, it has at least some optionality value.

Obviously very high risk. But in my view worth a 2% position, since this can easily double or triple within the next year(s).

 

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