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Rotate away from China & Portfolio changes

Time to rotate away from China

I have in numerous post expressed in different ways my feeling of wanting to rotate my portfolio away from it’s heavy China tilt. But why did I end up with such a China exposure in the first place? Here is a few reasons:

  1. I live in the region and spend quite a lot of time in general to understand China, this obviously helps in finding opportunities to invest in.
  2. With a bull market roaring almost everywhere, stocks with China exposure has been one of the biggest pockets of reasonably or even cheaply valued companies.
  3. My focus on Electric Vehicles and the changes that will bring about, has lead me to invest in Chinese companies.

Why I’m rotating away is more from a Macro perspective. I’m quite scared of the speed of the debt build-up in China. Many professional stock pickers I have met says, don’t try to time Macro events if you are a stock picker, generally I agree. One can’t be a master of all and you should try to stop predicting Macro events as the reason for buying or selling stocks if you are a bottom up fundamental stock picker. But there are circumstances in more extreme cases where I believe Macro should not be ignored. I believe we are starting to enter such territory for China. I think Kyle Bass (who has been wrong on China for quite some time) has some good insights it in this short interview: Kyle Bass on China – Bloomberg interview.

My views

I don’t have unique sources or insights on China. I read daily news on China, listen to people who live there, as well as more informal sources of information (blogs/vlogs etc). Much is great (and bullish long-term) about the Chinese people, their willingness to study hard, their respect for knowledge etc. But the picture I paint right now of all information I collect, does not look good.

If I focused on the negatives this would be my observations, much of it you have heard before:

  1. People in general believe property prices can only go up, because they have never (since the 90’s) experienced anything else.
  2. Property price to disposable income is among the highest in the world and if you can come up with the down-payment, there is no questions asked from the banks for you to receive your mortgage.
  3. People buy property they do not intend to live in and which they sometimes struggle to rent out, but it’s OK, because so far they have still made capital gains on it.
  4. Chinese construction companies build with awful quality and Chinese have a non-existent system of maintaining common space in residential buildings. So even buildings just 10 years old start to look old. Not keeping property in decent shape must be a very effective value destruction which is not much talked about. Just considered all Chinese property today marked at value 100, where 30% is down-payment and 70% is mortgage, what happens after 15 years when the property has deteriorated to such a state that people only are willing to pay 50 for it? This is not discussed because the property market goes up quickly, but when it’s not going up anymore, the bad building quality/maintenance will be eating away maybe 3% equity each year. On top of that, Chinese like new things.
  5. Wealth Mgmt Products with 6-8-10% interest is virtually risk free in peoples minds, rare defaults are covered by state owned banks in most cases.
  6. The speed of property price increases has gone into warp speed in the larger cities. Shenzhen is up +120%, Shanghai +55%, Beijing +56% – the last 2 years.
  7. It used to be the case that Chinese people were diligent savers. Not so much anymore, younger Chinese are jumping on the borrowing band wagon and are willing to spend money they do not have, money is made so easily anyway and being an only child has meant being used to being spoiled by the older generation, which leads me to my last point.
  8. China as many other countries is going to face the wall of retirees and a reduction in the workforce, at the same time as the country is doing the difficult transition into a more serviced based economy.

All of the above and the speed of how quickly Chinese are making money in the last few years is telling me this is a train about to derail.

Portfolio Changes

Even if I did not have any doubts about the state of things over in China, my portfolio which should have a global focus has been over exposed to China. In terms of fairly pure China exposure I have the following to choose from: Ping An Insurance (8.9%), Coslight (+7.1%), BYD (6.5%), YY (6.2%), NetEase (5.1%), Shanghai Fosun Pharma (4.5%), XTEP (3.9%), CRRC (3.7%)

Ping An Insurance – sell full holding

Even if I did not have any doubts about the state of things over in China, my portfolio which should have a global focus has been over exposed to China. So today’s changes is one step towards balancing my portfolio and taking profit in Ping An Insurance which has been having a tremendous run over the last months where I’m netting a +50% gain since I invested about 1 year ago. The stock still does not look that expensive from a stand alone perspective and I really like how innovative they are with developing their e-sales channels and products. But the low valuation which I have patently waited for the market to re-evaluate, has to a large extent happened. It is somewhat reluctantly that I sell, but given the discussion above on China, I have to start somewhere. In Ping An I don’t see more than perhaps 10% potential upside in a shorter term perspective and it also quickly reduces my China exposure, being the largest holding. After this sell I still have roughly 30% of my portfolio with China exposure, I intend to bring it down below 20% during this year.

Two New Holdings – ISS and Huhtamäki

The main reason for writing so little over the last months is that I focused my time on researching a number of companies. Unfortunately most of them has fallen short as investments and a few have had such tremendous runs during the time I researched so the upside potential diminished while I was doing my DD. These two companies ideas I got initially from a friend and both fall in to the bucket of fairly solid, boring, slow and steady investments. Both I think are excellent long term investments, rather than bargains at current levels. I will write a longer write up of both companies at a later stage. A brief description of the companies:

ISS – Long 6%

Based in Denmark, The ISS Group is one of the world’s leading Facility services companies. ISS was originally short for International Service System and from 2001, for Integrated Service Solutions. Today, it is only used as an acronym. In 2005 ISS was acquired by Swedish PE firm EQT and Goldman Sachs, they paid about 22bn DKK at the time. During the EQT ownership the company expanded into Emerging Markets and number of employees grew from 274,000 to 511,000. In 2011 G4S made a failed attempt to acquire ISS for about 45bn DKK. In 2014 the company was again listed on the Copenhagen Exchange through an IPO at 160 DKK per share. The company had a shaky start with the overhang of EQT and Goldman who wanted out of their investment. In 2015 they divested their last shares, at the same time, the Kirk Kristiansen family, the owners of the Lego brand, increased their stake in the company. The company is today trading at 274 DKK per share and has a MCAP of about 51bn DKK.

The investment case is built around ISS solid track-record in the past and strong cash-flow generation, which has been used to pay down debt since the financial crisis 2008. That debt pay-down is more or less done and ISS can now focus either on further growth and/or increased payouts to shareholders. With ISS services in a fairly defensive sector I find the company reasonably valued, without paying too much of “Quality premium” as is the case in many other companies. Currently trading at P/E 22, and forward consensus P/E is 16.6.

Huhtamäki – Long 6%

Based in Finland, Huhtamäki is a global specialists in packaging for food and drink. Again a company with a long solid track-record, where growth has come from a combination of organic growth, joint ventures and acquisitions of smaller packaging companies around the world. The business model is de-centralized in the sense that the packaging production units are smaller units, around the world, whereas Huhtamäki has a number of larger customers contracts, that they serve in various markets.

After several years of very strong stock price performance, the company is lagging the market significantly over the last year. The main reason I have found for this, is slowing growth. But as I see it they keep investing for growth and the market has been looking at this company way too short term. Just now I’m ready to push the button to order some dinner from deliveroo, one of many take-away services. Which with better IT-platforms for delivery are still just in early days of a trend I believe will continue for a long time. Big city people cook less and less at home and consume more of all kinds of take-away food. I also like how fragmented the market is and with Huhtamäki’s long track record of delivering clean/safe food and drink containers, it becomes one of the main choices for all global players as Starbucks, McDonalds etc. It’s exactly these kind of tailwinds I like, and Huhtamäki is well positioned in this niche, and also valued “reasonably” at P/E of 19.

 

 

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Portfolio update and Rottneros out

It’s always something with this one..

So once again Rottneros delivered a solid top-line, but magically did not transfer fully to the bottom line. This time the company just refers to “non-planned costs”. Next quarter (as has already been guided) will also be bad due to a problem at the Vallvik plant, and the quarter after that is the seasonally weak quarter, due to the planned stop of production. I start to feel like this is a broken record with the same tune, there is always some reason why this quarter is not being as profitable as it should be. With the risk of me becoming a type of investor I don’t want to be (thinking too short term) I anyway decided to sell today. I decided that if EPS for the quarter came in under 0.3 SEK for some reason, I would sell, and I stand by that, although it might be somewhat short sighted. I can’t fully trust this company since they don’t seem to deliver like they did 3-4 years ago, so out it goes.

One should mention that pulp prices are extremely favorable at the moment and SEK still very weak vs USD and EUR. They have a golden opportunity in this market and I think with the top-line production increase, the market traded this stock back to flat for the day. Also there is a dividend that is received as of tomorrow. And that makes me happy, since I then managed to get out with a decent profit (+8%) for this trade, although in my view it was a shitty bottom-line given the nice pulp pricing currently.

 

Quick Portfolio update

Unfortunately my plan of lower portfolio turnover is not working out that well, and my cash levels (after Rottneros sell) are now very high again (~18%). Still struggling to find good investment cases, might use the cash to add in some of my names that have been trading very weak lately, another update will follow.

Looking at my portfolio, after suffering massively from the weak performance of my previously largest holding Coslight Technology (I will revisit this stock as well), my portfolio has now kind of recovered on the rising market tide. As you again can see, my portfolio still has the higher correlation with Hang Seng and follow upwards as soon as the index does well.

A couple of stocks have lately particularly helped performance

  1. Skandiabanken – solid results lately with good lending growth. The market is also starting to reprice Norwegian banks in general, but slightly also increasing Skandiabankens P/E multiple more in line with the large banks, in my view with a higher growth rate, it should rather be on a P/E premium. Let’s see how that goes.
  2. Ramirent – A stock that I believe is this perfect late cycle holding, which with it’s leveraged business model, will start a similar exponantial stock performance as 2006 to 2008. The latest quarterly figures were a strong beat and the stock traded up significantly.
  3. YY – It would have been better investing in the competitor MOMO, but this has also been a good investment. Results that came out were pretty decent, market having a bit of a hard time valuing the company, its now a story of two parts. A solid user base of highly profitable user listening to girls singing and playing, only one problem, it has stopped growing. And another leg of extremely strong growth in the online gaming broadcasting, again only one problem, it’s currently not profitable (slight loss). My thesis still stands and that is why I like the stock, the singing girls is a value play and generates wonderful cash-flow to the company, in my mind you get the tremendous online gaming business for free and currently almost only paying for the cash-flows generated by the first part. Although I’m sure Mr Market has valued this company on the margin as a much more complex mix than that

A couple of stocks have lately been real dogs

  1. Coslight Technology – I also expressed this in my hangover post below, but the stock continues to underwhelm. I think the market is scared of the potential price pressure on batteries, lead by Tesla/Panasonic and their Nevada factory ramping up, in combination with the short term oversupply in the battery market, which I mentioned before. The facts are still that this company at least in the past has held a cash-cow position in a smaller pc and mobile game company (which as a separate company should trade at high multiples). On top of this we are looking at a huge ramp up in demand of batteries over the coming 5 years mainly from EVs, but also Power companies building reserve power solutions, electric motorbikes and our continued usage of phones/laptops/tables/drones etc. Maybe maybe the pricing pressure will kill this company, but it might as well be the car companies that get squeezed in the fight for survival and the battery companies will be in a solid position to deliver the most important component to the car, in the same way as the engine used to be that component.
  2. Xtep – Here I can’t see any major news, the stock is very tired, trading down without any news. Citic securites initiated coverage with a buy rating a few days ago but the market just responded by trading it down a few percent more. Either this is a fraud, or a bargain, in China you never know. What I can say is that in other cases, like Zhengtong Auto I have also been shrugging my head for a long time and then the stock suddenly do pop, unfortunately as you know in that case I sold before the pop. But momentum in this stock looks awful at the moment.

Graph_20170512

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Back in NetEase – at a higher price

Beat of highest estimates

Again this wonderful company delivers very strong results, and I realize it was a mistake to sell out of the company. A small comfort is that at least since I sold I managed to recycle the cash in other profitable investments. But now I can’t stand on the sideline and therefor I take a position of 5% of my portfolio in this company. If you know nothing about this company, start by reading my analysis from 1 year ago: NetEase – Chinese Gaming.

Since that analysis a year ago, the company released extremely strong figures. For Q1 this year NetEase delivered the following headline results:

  • Net revenues rose 72.3% to 13.6B yuan (about $2B, above consensus for $1.73B); gross profit rose 63.2% to 7.5B yuan (about $1.1B).
  • Meanwhile, non-GAAP earnings per ADS were $4.75, above expectations for $4.03.

Taking the revenue of Q1 times 4, we end up at 2017 revenue which according to my analysis 1 year ago would be reached in 2021-2022. Geez I was wrong on this one (and most other people too). I’m going to stop putting shorter term target prices on this one and just keep it as a long term holding for now, since obviously I am not capable to model future cash flows at anywhere near correct levels. Just as a side remark a quick update of financials with the same future percentage growth (as my assumptions 1 year ago), a DCF gives a fair value of about 320 USD per share.

Three reasons why I think NetEase will continue to have a strong future, even-though competition is heating up:

  1. They have the scale to distributing their games through their own platform in China, which means not sharing revenue with other sites. Also they are now confident enough to start launching their games outside of China in larger scale.
  2. They are launching (world-wide) a potential blockbuster called Crusaders of Light (https://crusadersoflight.com/) this summer, which might become the first truly successful mobile MMO. The game was released in Beta a few weeks ago and so far reviews are very strong among gamers.
  3. Launching of Minecraft in the Chinee market this year, as a free-to-play game (with in-game purchases) in co-op with Microsoft. The game will be available both on PC and Mobile, another highly likely blockbuster. Here income will be share with Microsoft, and I believe quite a lot of it is priced in already in the share price, but anyhow, it will generate significant cash-flow.

I recommend this video on NetEase, which I wish I would have found earlier:

The downside

NetEase is already a huge player in the Chinese market place and launching new games will not only take market share, but also cannibalize on their own games. On top of that, the gaming sector is very hot right now, with competition being very fierce. Like a drug company a gaming company like NetEase needs a portfolio of games in the pipeline, which needs to keep delivering the best games in the market, or the competition will quickly step in at fill their place. Extrapolating earnings in to eternity of this type of companies and doing so with high multiples, might be a too bullish way of looking at the company.

A personal downside with this investment is again getting a too high China concentration in the portfolio. The reasons for the long silence in the blog is that I have been doing my best to analyze companies for a potential new investment. I have been looking at Biotech in the US, Vaccine companies, breweries and much else. But really struggled to find something worth buying. I have two interesting companies on the radar though, but the valuation has unfortunately run a bit crazy right now

 

 

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