Aligning with my strategy – portfolio changes

To align my portfolio further with my investment philosophy it’s time for another larger portfolio change with as many as four new holdings – Tethys Oil, Valneva, Tianneng Power and Union Medical Healthcare. I haven’t written as much over the past months, but I have spent a lot of time trawling for new investment ideas and yes I have quite many of them coming! But first what goes out:

Inditex

As of the last day of 2019 I sold my full holding in Inditex, which holds the famous clothing retailer Zara as it’s main asset. This is another of my very large cap companies where I took the view that the market was overly scared of the retail-apocalypse and that Zara would come out strong in this. In my view today, I have a very weak edge to make such a call – although it this time turned out to be fairly true, both fundamentally and stock price wise. Therefore I today sell this holding, as I by know surely have no edge in forecasting where this stock is going to move on from here. I did my best to hold the stock in the weak positive momentum it’s been in for a while and I was rewarded nicely lately with a strong rally towards year end. My only doubt here is that I probably should ride the positive momentum a bit longer, but I’m eager to get to prioritizes right in the portfolio. Good riddance Inditex, you are truly a quality company, but you do not fit my strategy any longer.

Swedbank

This was a opportunistic holding which did not really turned out as planned. I had a quick gain for a while, but did not cover. More “dirt” was uncovered about Swedbank as the months passed by. I think banking stocks in Sweden in general are going to perform better now that the negative interest rate is gone. So the stock traded up not on me really being right, but just general revaluation of banking stocks. I have to say this was an opportunity which I should not have swung the bat on. Again maybe I’m a bit early to sell now, but I’m not a big believer in Swedbank has a winner in the Swedish banking sector long term. So the opportunity has pasted and this was a speculation that did not give me the quick gains I hoped, so now it’s time to close the trade. I sold my full position as of close 30th Dec.

AK Medical

As I mentioned in my performance review this quickly became my best performing stock during 2019. I have to thank twitter handle @alexeliasson for this investment idea. He was the one that first mentioned this stock and this has actually opened my eyes to look more broadly into the healthcare space on the HK exchange. Unfortunately I had only taken a “starting” position in the stock and was expecting to get to know this holding better over the years. I have been back and forth on if I should keep this holding, even though the valuation now is very stretched. First I just reduced my position with the plan to keep the rest “no matter what valuation wise”. But I come to the conclusion, that doesn’t work for me. I need to feel that the valuation is not pricing in some type of blue sky scenario that might never happen. I would not buy the stock today if I did not have it already, that is sometimes a little bit brutal way to look at it, but at the end of the day that’s how you should evaluate things in my view. So I decided to sell the full holding I had left in AK Medical. I’m very happy to buy this back if the valuation would come down somewhat again, I think the most probable scenario is that they have a long runway of growth in-front of them, but things can always go wrong in terms of competition, Chinese policy changes etc.

Dairy Farm

I have been reducing and increasing in Dairy Farm since my initial investment. I recently bought quite a lot more, punting on that we have seen the worst in Hong Kong in terms of protests. I changed me view on this and I’m afraid that the annual results that will come out of Dairy Farm is going to be terrible. On top of that the big holding in Yonghui Superstores has declined quite a lot in value lately, whereas Dairy Farm stock has been trading water sideways at very depressed levels. So I take the opportunity to reduce my holding with as much as I recently bought. I’m very close to closing out this position, but although the company is fairly big it’s still an overlooked stock in my eyes. The most important question though of course is if the company is a good enough investment. I will need a bit more information during 2019 to decide on that, but it’s not a high conviction position for me anymore.

In the below stocks I have taken a position on their last trading of 2019

Tethys Oil – 4% Long term position

I love being contrarian and right now sector wise, there is nothing more contrarian than the Energy sector. But I’m no macro investor, I need to be able to express this through a stock which seems unreasonably cheap and at the same time is a well managed company. I think Tethys Oil qualifies here on many levels. I have followed this company for a very long time and seen it’s execution. Very few oil companies has delivered such returns as Tethys Oil. Since 2004 the stock has compounded 21% annualized (incl dividends). If we instead look from the worst possible time, just before oil prices crashed from over US$100/barrel in 2014, the company has still compounded 7.5% per year.

The company has a 30% share in an oilfield in Oman with very low production cost, meaning that the company is cash flow positive even at very low oil prices. The downside of this is that you don’t get the same leverage in the share price if oil actually goes up. But my whole point of this investment is not speculate in if oil is going up or down, but buying a company that hopefully can perform well no matter what. Then as a kicker I love to get some energy exposure into my portfolio.

The company has a very high pay-out ratio, which is done both through dividends and special shares that are redeemed by the company (more tax efficient). In 2019 the company returned a total of 8 SEK and the stock is today trading at 84 SEK. Even so they still have money left over for exploration in Oman where they own quite vast areas of land. So there is a significant kicker to the upside if they strike oil.

Downside risk factors that should be mentioned is Oman itself. The country is run by a dictator (Sultan) and it seems that not all in the country are so happy with this. The country in general got rich on oil, but supplies are dwindling and it’s harder to please the people when cash is not pouring in anymore. Another risk factor is that the field which today is steadily pumping oil to Tethys would dwindle quicker than forecasts, but that is a small risk compared to the general country risk. This stock will probably always be trading at fairly low multiples due to the country risk, but I think there is a good chance for some general multiple expansion for energy stocks in 2020 and Tethys would benefit from that. Even with that not happening it’s a cash cow which just keeps pouring in money to investors. Insiders have recently also made some smaller purchases which is nice to see.

Valneva – 4% Long term position

Back in 2017 when I did my first rounds of trying to find some good exposures towards the Pharma sector I came across this company. I was very close to taking a position, but then the stock ran away from me when it quickly gained some 35%. I kept it on my radar since and now recently it traded down below where I initially were interested. And this time with in my view better fundamentals than back in 2017. Valneva is something as unusual as a vaccine producer. This is a bit of a sidestep from the investment case, but something that is good to understand looking at this type of companies:

Vaccine producers are a very strange animal in medicine since you are only selling one shot and then hopefully the patient never gets infected/sick. Whereas a normal drug is the most “successful” when you have patented something that the patient need for a long time, in the “best of worlds” to even survive. It’s pretty cruel when you think about it, but Pharma companies does not really have an incentive to cure us, but keep us needing their drugs as long as possible. So vaccine instead belongs to a total different category which is preventive care, just like exercising or eating healthier. One would think that there exists a ton of vaccine companies then since surely preventing care is more clever? Well this is were free economics kind of fail us, due to the above argument of it being more profitable that we are sick. This also means that governments understands this dilemma, especially governments which pay for public healthcare. So they actually are pretty helpful in promoting in various ways to develop vaccines. For example via grants or speed up trial processes. The trial process which has it’s Phase I/II/III like drugs is also quite different. Given that you can’t give 500 people a vaccine and then infect them with whatever the vaccine was for you end up with a bit of a dilemma, how do you test the vaccines effectiveness? Well basically you have to develop vaccines for something that is so common to be infected by that within a large enough group you know a certain number of people will be infected. This means you either need a huge test group, or a vaccine for something which is extremely common (at least within a certain region). This is why vaccines for example for the ZIKA mosquito can be developed so quickly, the outbreak is so significant, that testing if a vaccine works is a very quick process. But if you are a small company doing such large scale tests is still very burdensome. And unfortunately given the income potential of only 1 shot of vaccine is so low, very few companies finds it worthwhile developing vaccines even for things that many people suffer from around the world.

Over to the investment case. Valneva has one star vaccine on the market for a very serious infection called Japanese encephalitis, I have myself taken this vaccine when I moved to Asia. The vaccine is called Ixiaro and the largest customer for the vaccine is the US military, where this vaccine is a mandatory shot for every soldier sent abroad. The US military spends as much on this vaccine as the rest of the world combined. The second product is Dukoral, which is a Swedish developed drinking vaccine for prevention of diarrhea. Basically the product is used for tourists which are afraid that some type of Delhi Belly will destroy their vacation plans. Canada is here the largest market for this product.

A few things make the investment case interesting here:

  1. The cash flow from Ixiaro and Dukoral is now enough to fund research for new vaccines without burning cash (which has been the case in the past). The company is actually turning a profit in 2020 if nothing goes majorly wrong with the current trend.
  2. The company has a very promising vaccine in the pipeline for Lyme disease. This is a very serious unmet medical need with a huge number of cases in Europe and North America every year. Due to climate change the number of cases has increased even more over the past decade. This would be a vaccine which probably would be recommended to almost the whole population of some countries, if released. Back to governments supporting this kind of development for example FDA has fast tracked the development of this vaccine.
  3. Chikungunya is a disease that has existed in poorer countries for a long time. But not so long ago a huge outbreak happened in the Caribbean, also affecting USA. Since richer nations see as in their interest that such outbreaks should not be widespread they allocate funds to finds vaccines. In this case for Valneva some 20 million EUR was awarded (current MCAP 236m EUR): CEPI award Valneva. This vaccine has competitors developing their versions, but here comes Valneva’s deep expertise in producing vaccines in, where they are the only product which will give coverage with only a single dose/shot. Obviously this is a big plus for a government which wants to protect their population, a lot of people miss to take follow-up dosages. So also here Valneva has a strong candidate for a good future income stream.
  4. Valneva recently raised 50m EUR from mainly US Pharma funds at 3.75 EUR per share:  Valneva Raises €50 Million in Oversubscribed Placement Led by US Healthcare Investors. Today the stock trades 2.57 EUR, without anything fundamentally being worse in the company.
  5. And why this is a good investment long term? Founder led and the family has a large shunk of shares (15%) which I always see as a positive. Track record of building something good long term, building a vaccine portfolio takes much longer time, but has a very long payoff profile too. I’m also convinced that the world has to wake up over the coming years to actually promote more preventing healthcare. It’s just in the interest of every government that is going to struggle to keep paying the populations healthcare bills through taxes.

Tianneng Power – 4% Opportunistic position

So this is probably not a great company which when I have sold we can go back and look at the fantastic return it had over the coming 10 years and I wish I just held on to it. This is a swing the bat, because now is a good opportunity to do so case. Since I followed the Electric Vehicle sector for so long I know a lot of players in this supply chain. This company looked for a while like it was going to a player in the battery space for EVs. Instead they took another route. When all other battery factories scrambled to develop the latest generations of Lithium ion batteries this company instead perfected in making the more simple old technology. Basically the lead batteries you have in your petrol car to turn the ignition on. I understood early that EVs would one day be big, which is happening right as we speak, even buses. But what i did not consider as much were to two wheeled objects we have, like motorbikes, scooters and even bicycles. It’s become a huge trend worldwide to have electric versions of these. In fact in China electric scooters has totally taken over the market. And the thing is, that these batteries need to be cheap, really cheap, otherwise the economics don’t make sense. So majority of these batteries are of the older cheaper type. Which has made Tianneng selling volumes go through the roof and hugely profitable in a market where most Lithium ion battery producers are fighting a very tough pricing war battle in the EV space. So for a few years now the cash has been raining in, but the market has not really revalued Tianneng because there will come a reckoning day when Lithium batteries will be cheap enough and take over the market. But how cheap should the company be?

The company is currently trading at P/E of 4.5 this is historically below average, but due to cash build up EV/EBITDA is a better measure.

The company is then incredible cheap. So it could be stuck in value trap land for a few years and then lithium battery prices gets so low that fundamentals start to deteriorate. To counteract the value trap you often need a corporate event of some time. That just happened the other day when they filed to spin-off parts of the company on the Mainland exchange. This might unlock some of that value and this is the trigger to take a bet on the company here right now. They plan to spin-off the battery division on the mainland exchange, where it will most likely be valued much higher than the depressing valuation on the Hong Kong exchange currently. The maneuver is a bit complicated though since the shareholders in Hong Kong can not own the mainland listed shares directly. So the listing of the shares in mainland China will have to go to a new set of investors. But effectively a new set of investors are going to pile into this company at a much higher valuation. I’m not sure where that leaves the HK listed stock in terms of share price, theoretically it could stay the same of course, but most likely some convergence will happen. I see fundamentally little downside to punt on this and potentially quite a lot of upside, although somewhat unclear how much. This will be an interesting one to follow.

Union Medical Healthcare – 3% Long term position

This is another stock that I came across in my search for healthcare related investments in Hong Kong. The same twitter handle that found AK Medical I believe is invested here as well. This is a Hong Kong healthcare provider that started off in the more light services around medical beauty services and has from there expanded into dental and doctor clinics. A big part of the growth story has been mainland Chinese that come to Hong Kong for medical services. Obviously with the situation in Hong Kong that should have slowed down significantly lately and it also explains why the share is trading weaker the past six months. But what drew me into this case is the founder. He has a bit of story how he came to found the company, he is still fairly young and the way he consolidated and built this company really impressed me. I don’t think this is the perfect timing to enter this company, there might definitely be setbacks in the next annual report due to the HK situation. That’s why I start with a small position, but I do think the founder is on to something here and the fundamentals speak of it, with revenue growth of some 30% YoY and EBITDA in the same range. At the same time the stock is trading at P/E 14 trailing and P/E 12 expected for 2020. I hope I will be able to buy more even cheaper going forward, as long as the underlying business keeps going in the right direction.

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2019 Performance review and some conclusions

2019 was a disappointing year from the perspective of not nearly meeting the returns of my benchmark MSCI World. On the other hand the portfolio is at all time highs and has in total delivered a fantastic return since I started the blog. The Global Stock Picking portfolio is up 14.3% in 2019, that compares to MSCI World Total Return (i.e. including dividends) up 28.4% on the year. The GSP 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 7.8% of my portfolio during 2019. The volatility of my portfolio was 9.7% vs 9.8% for the benchmark.

I concluded my last years performance review with that I thought we had now entered a bear market. I probably held that belief sometime up until the summer. This created a certain defensiveness in what I invested in. For example I increased my positions in tobacco companies and other more value related positions. In hindsight I also spent a little bit too much time on my Speculative investment bucket, with a number of investments, like JD, UR-Energy, Irisity and Swedbank. I made some attempts at looking at new sets of companies, like 3D-printing. Where the holding AK-Medical became the best “play” on this theme. This became a very lucky timing, since the stock doubled in a short time-frame after I bought it. One of few holdings really saving my performance during 2019. This was also the year of the trade war escalations and Hong Kong protests, which put a dampening mood on the Hong Kong exchange, where I have a number of holdings. But the company most directly affected by this that I hold was Dairy Farm listed in Singapore. It’s most profitable market Hong Kong was hit hard and Maxims which runs restaurants in HK is now hated by a large part of the population.

Conclusions

Some conclusions has emerged for me during 2019, not at least from my post the other day where I went through all stocks I sold. By the way, that post is now updated with all the missing graphs and comments. Apologies for this, it was a long write-up and something went wrong when I was cutting and pasting pictures/text. Let’s move on to my 2019 conclusions:

1. Only buy companies where I have an edge in my investment

If you are a frequent reader of my posts you will have seen that I talked more and more about edge in the past year. I only want to only invest into companies where I can at least hypothetically see that I could have an edge in my investment. The easiest example of a clear edge is that the stock is overlooked. Often stocks are overlooked because they are small illiquid companies, but it could also be for other reasons. This gives me an opportunity to buy a good or great business to a low valuation if the few market participants looking at the particular company has not managed to price the security “correctly”. There are many other edges, which I have explored and mentioned in other posts. This means I will more or less never invest in a company like Microsoft, or Apple, although they are fantastic businesses. Does that make sense when they have been among the stocks that performed best in the world in 2019? Well, to me it does, because if I’m buying stocks without any type of investing edge, I might as well just buy an Index ETF! Actually the end goal of this blog has been to explore if I’m good enough at this to long-term beat the benchmark. Against all the clever people out there in the world, managing to pick a basket of large cap stocks that significantly out-performs the benchmark, is very very hard. I think there are some people clever enough to do just that. I’m not that clever, I need something easier, where I have a head start to do well. I took quite a lot of action in the portfolio during the autumn this year due to this: Portfolio changes.

2. Focus on finding good and great businesses at as reasonable prices as possible

It was clear from all the companies I sold, that not nearly enough of them are actually solid businesses fundamentally. The graphs I presented of all sold stocks, where stock price graphs, and that can deviate from fundamentals obviously. But not for so many companies over such long periods of time. I hope I have improved already since those investments I sold back in 2017/2018, because too many of them where pretty poor companies to hold long term. Which means I should not have bought them in the first place (always easier said with hindsight). I like to buy growth at a reasonable price but I need to get a touch of more quality into these businesses as well. I hope if I redo this exercise of “here are all the stocks I sold in 2019-2020” sometime in 2023, then a big portion of the companies I sold would still have done reasonably well. The portfolio should be of such high quality that the stuff I sell, I sell because I found something even better to put in the portfolio, not that the previous investment was fairly mediocre to begin with. Of course that has never been my intention to invest in something mediocre, but I need to come up with more solid investment cases and less opportunistic/turn-around etc.

3. I’m good at swing trading

I think a third conclusion from tracking all my buys/sells, I’m actually pretty good at swing trading stocks. I have since I was a kid been sitting watching stock graphs. Somehow I have a pretty good feel for when companies are at infliction points and I manage to pick them up quite often just before they rally. On the other hand I managed to find a few pretty terrible infliction points on the downside as well, like buying Dignity 2 days before a -50% day, that still hurts, a bit. So I will keep my Speculative investment bucket, because it suits me as an investor, I just need to be better at only swinging the bat at the best cases I see and then focus most of my time on point 2 above.

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