Earnings season and other thoughts

Having a global portfolio the earnings season is less of a season and more of a continuous thing over the year. Most European companies are long done with the annual reports, whereas many Chinese companies are still holding it off for another week or two. In general I’m not very happy with the result updates from my holdings, few positive surprised and several fairly negative ones. Let’s look at some of the companies and the figures released..

Rottneros

About a month ago Rottneros reported for the first time, since I made my initial investment (Rottneros – the SEK winner). The report was a clear disappointment and the stock traded down -7% on the day. Since then the stock price has recovered and is hovering around my average buying price. So what was the reason for the disappointing figures? The company blames a longer than expected time to start up the Vallvik plant (which has it’s scheduled maintenance stop each autumn). And this obviously had an effect, but it’s still somewhat surprising the effect became so big. the NBSK Pulp price in SEK was 5% higher this Q4 compared to Q4 2015 and even so the result was -7 MSEK compared to +1 MSEK in 2015.

The conclusion back in October when I wrote my analysis, was that margins look favorable as long as the USD stays at strong levels vs SEK and Pulp prices at least stays steady. These two factors have stayed true. The USD (with some volatility) has stayed at same level as when the analysis was written and Pulp NBSK prices have even strengthened somewhat. Some fairly major investments have also been made to upgrade the plant, this should start to feed through in terms of production volumes and bottom line. I expect a very strong Q1 result in May this year, in range of 0.45 SEK per share. Which should put the company on track of delivering a 2017 EPS of around 1 SEK. Meaning that Rottneros is currently trading at forward P/E below 8. This would warrant the share price increase I have been looking for to around 10 SEK. If the next earnings report is again a disappointment (below 0.4 EPS), I will look at selling my shares, because then they are doing something wrong compared to what they delivered a few years ago.

Nagacorp

The market was also pretty brutal on Nagacorp’s reporting day, trading down the share as much as -9% . The stock has since recovered, in my view mostly because the Hang Seng and Macau casino companies has traded up significantly. But the stock has felt very weak and from compared to the market Nagacorp is a clear laggard, for example Galaxy (27 HK) is up +18% since after Nagacorp’s disappointing report. So what was the problem with the report? Honestly not that much, figures came in somewhat weak, but nothing major. But this was the first time the dilution from the convertible bonds became obvious to investors. Henceforth the dividend will be shared with convertible owners bonds, which are entitled to the same dividend as the ordinary shares. 2017 will be somewhat of a wait and see year, since Naga2 will be launching in the second half of the year. If this stock is going to have any major upside, it will be reliant on a successful launch of Naga2. Basically the company plans to expand it’s VIP segment by moving much of the mass market players to Naga2 and refurbish the old complex to better satisfy demanding VIP players, about half of current revenue is from VIP. As long as we don’t see any very hurtful share dilution for the Russia project, I’m confident that we at these levels, have low downside (10-20%) while the upside is towards the 100% range over the coming 3-4 years.

Latest analysis: Nagacorp

Skandiabanken

Solid report, with significant increase in NII margins, home lending is growing very nicely. I’m a bit it worried that deposit volumes are standing still, maybe not right now, but at some point this will hinder further growth. Somewhat mixed feelings on this holding, long-term I think it is a very strong case in the bank sector. But short-term the stock feels somewhat overbought, I was very close to pushing the sell button around 77 NOK and now it has traded down to 71.50 NOK. In general my feeling of owning banks is a bit like picking pennies in front of a steam-roller, given that it will be very tough times day the housing market starts to fall (which I think is due, either due to normalized rates or economic downturn). Having said that, very long term a digital efficient bank that handles mortgages definitely feels like the future, and Skandiabanken’s current customers do seem to be agreeing (being the most satisfied banking customers).

XTEP International

This report came out after Friday close and on Monday we will see the markets judgement of the report. In the meantime I will give mine. The figures were disappointing, looking at head-line figures it looks awful and that is due to a one-time write off of the Kids store segment (impairment of trade receivables of 222m RMB). A larger number of stores have been closed during 2016, from 600 a year ago to 250 left today. I have not taken that much note of this kids segment, but looking back at sell side analyst reports, this seems to have been known in the investor community. With Footwear sales coming in very strong for the first half of 2016, the expectations on my side were quite high for H2. This did not impress, and the reason must be the 222m write of in the kids segment. The apparel part which made the stock trade down significantly over the last year, as I expected recovered nicely and is back to it’s long term trend of hovering around sales of 1bn RMB per half year. Below is an overview:

revenue_break_xtep_2017H1

In a sector which such high growth as sportswear, XTEP is lagging, but I don’t see reason to sell just yet, the stock is so cheap. The biggest worry for me is the discussions we had in the comment section, where one of the readers made me aware of how huge cash pile the company is sitting on (~3bn HKD – MCAP 8bn HKD).  I also had not reflected on how constant that cash pile has been since it’s IPO, this I think is my biggest worry. Why do they need so much cash? The comments raised possibility for fraud, I’m not overly worried about that, but at least it’s showing a very in-efficient use of the companies capital. From a pure value perspective it is of-course amazing buying a company with MCAP of 8bn HKD, with net cash of 3bn HKD cash and generating 0.6bn HKD of Net Income per year.

Recent analysis: XTEP

Coslight Technology

Last but not least, the most important holding in my portfolio (since it has the largest weight) has still not reported. The report is due on Friday 31st of March. Like XTEP the reporting is semi-annual. The last report was what got the stock moving big-time and rightfully so, since the company delivered 0.35 HKD half-year EPS on a stock trading below 4 HKD. Since then, for not really any major reasons the stock has been on a roller-coaster ride, moving between 6.9 and 4.1 HKD (I added to the stock on this weakness). My expectations on this report is high, for a few reasons. Some of the major companies Coslight deliveries batteries to, HP for laptops and BAIC for EVs have both been doing very well in their respective markets. HP is holding a very strong position in the laptop market and has even managed to gain market share (although I do not have data on market share on the models that Coslight provide batteries for). I would also suspect that Coslight has been given a larger allocation from HP, due to other battery-suppliers to HP have created problems with faulty batteries and very large recalls for HP.

BAIC as I mentioned before has been of the top sellers of EVs in China, especially over the last 6 months. Again is not totally clear how much of the total EV volume that has Coslight batteries, since BAIC has several battery suppliers, but it does look promising. All in all this means that it seems reasonable Coslight will be selling close to full capacity of it’s factories (which was also the companies guidance).

In the counter-balance we have the margin pressure in terms of lower battery prices world-wide and also as several sell side firms have been warning a potential oversupply situation in the battery market especially for 2017-2018. So there is a risk that Revenue comes in very strong, but that bottom line has suffered and that EPS comes in weak. Looking at history there has also been clear seasonality in terms of EPS. Average EPS for H1 is 15.5 cents since 2007, whereas EPS for H2 is 3 cents. But I do believe the market is factoring in a lot of these concerns already, the last time the company delivered a semi-annual EPS in the 35 cent range was H1 2009, in the wake of the crisis – the stock traded at 7 HKD pre-report and went to 16 HKD. When the company followed that up with a H2 result of 21 cents it had in the interim rebounded to 10 HKD and rebounded up to 14 HKD. So if Coslight just delivers something modestly good, say in the range of 15 cents EPS, this gives us full year EPS of 50 cents and I do believe we can see Coslight going quickly to 8-9 HKD.

Coslight analysis: Coslight

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Naga-World-Hotel-Phnom-Penh-outside2

Nagacorp – Casino in Cambodia

It’s about learning

Thanks for the good comments in the previous post, a discussion I hope to keep going during 2017. It think it will take me quite a while to understand enough about such a complex field as DNA sequencing. And I probably wont feel comfortable to invest before I at least know a bit more. I’m sure this will be an important area for decades to come. What I find so enjoyable about stock picking and aiming for good returns, is that as part of the process I learn a lot about so many new fields. But no more talk about DNA today. Instead I want to talk about something totally different, which is a company fairly well know to me, but perhaps new for you? A company listed in Hongkong which runs a casino in Cambodia called Nagaworld.

Company overview

+ Casino Monopoly

+ Strong tourism growth in Cambodia

+ Successfully delivered on strategy historically

+ High dividend (70% payout ratio)

– Serious share dilution in the past

– Potential for future dilution from Russian casino project

– Uncertainty around future VIP volume

– Country risk high and risk of tax increases (currently at 5%).

Nagacorp has been listed for about 10 years on the Hong Kong exchange. It is an easy company to understand as their line of business is running one large casino (Nagaworld) in Phnom Penh, the capital city of Cambodia. When building the casino they convinced the local government to give out a monopoly agreement where nobody else is allowed to open a casino in Phnom Penh for a period of 50 years, currently there is 41 years left in that contract. That’s one heck of a moat for gambling in the city. Stock performance over the 10 year period has been good, with regular high dividend payments (total of 2.15 HKD over 10 years). The stock has suffered quite a lot from dilution, both to the majority owner that has backed the expansion of the casino (more on that later) as well as private placements that normally has been done at steep discounts (10-20% disc).

performance_nagacorp

A play on Cambodia and travel preferences

Cambodia is incredible poor, average monthly salaries in the city is in the 150 USD/month range, well below Vietnam where people earn in the 200 USD range. The Nagaworld hotel/casino is so big that it’s revenue contributes a somewhat staggering 23.5% to the Cambodian tourism sector GDP and 1.26% to total Cambodian GDP. So analyzing futures prospects about Nagaworld is closely linked with future tourism for Cambodia. There are smaller casinos in southern Cambodia (where the ocean is). But Nagaworld is the only casino for tourist that visit the capital and/or going to the north to visit Angkor Wat, which is by far the most important tourist destination in Cambodia. For a first time tourist traveler in Cambodia, I would say 9 out of 10 is coming for Angkor Wat. I have myself visited the world heritage temples and it is definitely impressive, although I would not put it on top of anyone’s bucket list.

Given that people in general like to travel to countries where they feel that they get a lot for their money, I would say Cambodia is pretty high up on that list. If you also consider safety, weather (maybe somewhat too hot in Cambodia), food, Cambodia is ranking even higher to the competition of low cost travel destinations. This is also shown in the tourist data, where the number of visiting tourist has trippled in the last 10 years. The growth has slowed somewhat in later years, but is still growing at a healthy rate 5-10% per year. Without going through all the details of tourism (which can be found here Cambodia tourism statistics). It’s also the right type of tourist (for a casino) that has increasing visiting numbers. The number of visiting Chinese has increased with 16% over the last year.

There are three main routes for tourist to visit Angkor Wat.

1. Flying to Siem Reap, which is a small city next to Angkor Wat and flying here directly saves some time if the purpose of the trip is just to visit the temples.

2. Flying to the capital Phnom Penh, spending a few nights here and taking a bus up through the country and visit Angkor Wat.

3. First visiting Vietnam (Ho Chi Minh) and then transfer by land to Phnom Penh and potentially on wards to Angkor Wat.

inbound_tourism

As we can see from the statistics above there is healthy growth and the route through Phnom Penh is keeping a higher growth rate compared to Siem Reap. My guess is that the Siem Reap airport is closer to being saturated as it is a very small airport. Overall I’m bullish on tourism to Cambodia I think they will be able to keep up high single digit growth for many years to come, as it is one of few countries where Chinese people has a comparably much higher salary. As we will see later, another important group of tourist are the VIP players, or so to say high rollers. This I find harder to predict, as I don’t have as much insight into what destinations they prefer. From what I have managed to read, with the clampdown on excessive spending from the Chinese government, a lot of Chinese high rollers have moved from Macau to the coast of Vietnam. Casinos work very actively together with so called junket operators to bring in VIP players. In this arrangement there is a profit sharing between the junket operator and the Casino. This relationship with the junkets is very important for anyone running a casino in Asia.

Casino expansion

The Nagaworld casino has scaled up well and occupancy rates has climbed, in 2012 the decision was taken to expand the casino with a new building called Naga2. These two building were to be connected by an underground shopping walkway, NagaWalk. Instead of Nagacorp financing the project through capex this project was taken by the majority owner Chen Lip Keong. He funded the venture independently, via a special vehicle. Upon completion of the project, the properties was to be transferred to NagaCorp and the company will issue new shares and / or convertible bonds (see below about dilution). Just recently these projects were deemed completed, although the Naga2 hotel/casino is not fully up and running yet (to be fully operational during the year).

This expansion effectively doubles the casino size in terms of rooms and gambling space for tables and machines.

naga2expansion

Source: SWS Research

Russian expansion

Another early stage project is an building of a new casino in Russia, in the same area as my other holding Summit Ascent Holding (A story about Asian gambling and how it came to Russia). Some analyst see this as an option with a positive PV. But I regard this project currently as neutral, there might be some future value in this project, but it also increases the risk, both in terms of project success, but also further share dilution to finance the project.

Share dilution

Private Placements

Since I have owned this company in the past, I lived through some private placements that pissed me off big-time. First time this happend was in April 2012, the stock was trading in the 3.50 HKD range and a PP of 214 million shares was made at 3.04 HKD, the stock dropped and traded even below that level for a while. Later the same year a smaller PP of 90m shares was made, at that time investor interest was stronger after strong stock performance, it was placed at a small discount 4.50 vs 4.43 HKD per share. The next year in March 2013 the company was at it again, the stock was now trading at 6.60 HKD and another 200m shares were offered at 6.05. The latest offering was made in August 2016, where 190m shares were offered at 5.00 HKD with the stock trading at 5.50 HKD the previous days. All in all being a long term investor through these offerings, has not been as beneficial as if rights issues had been issued to existing shareholders. This shows how bad small investors can be treated when the stock exchange rules gives management a lot of freedom to allocate shares to larger funds who can buy in with 10% discount to current share price, which obviously gives extra dilution for an existing shareholder. I find this as a big negative in the history of this stock and I expect that this behavior will continue in the future.

Majority shareholder convertible bonds

Another important factor of share dilution comes from the majority shareholder Chen Lip Keong, a Malaysian investor. As mentioned above he has financed the Naga2 expansion. When the ownership is now transferred to Nagacorp, the company as agreed issues convertible bonds to Chen Lip Keong, which are convertible at 1.53 HKD per share for a total of 1 881 million shares. This bonds are entitled to the same dividend as the ordinary shares. If converted it would increase the shares outstanding from current 2 460 million shares to a new total of 4 341 million shares. At the same time the conversion would give Nagacorp 2.88 billion HKD in cash. All this is highly hypothetical though, because converting the bonds would both financially be difficult for Keong, as well as force him to bid for the whole company as his shareholding would then increase over the limit according to exchange rules. He effectively including the bonds own 65% of the company. So all this is a clever way for Keong to own a majority of the company without invoking a forced bid for the whole company.

This project has obviously given Keong a larger ownership of the company for a very cheap price, again diluting the ordinary investor. The benefit has been that Nagacorp has been able to operate at a debt free basis and it has also moved the risk of project completion from Nagacorp to Keong. I don’t think the transaction has been fishy, but definitely more beneficial for Keong than the other shareholders.

Is bigger better?

So the new bigger Nagaworld + Naga2 complex, is it better for the shareholders than the hold casino? I would argue no, it would have been better for investors if the Naga2 was never built, but just continued milking the old Nagaworld complex, paying out nice dividends. This dilution has not been favorable for investors and that is also seen in the stock price, which peaked around 8 HKD and now trading at 4.40 per share.

Valuation

I use the following conservative valuation assumptions:

Current Op Margin: +38%, decreasing to 30% in 10 years.

Revenue growth: 55% over the coming 2 years, accounting for the new Naga2 complex, after that 5% per year for 8 years. Terminal growth rate 1.9%.

Cost of Capital: 14%, after 5 years decreasing to 12% to account for country risk moderation.

Re-investments: 20% of Net Income

Tax rate: 10% – right now 5%, but the company have to negotiate the tax every year, its likely to go up.

I deduct cash from Present Value, including cash from Bond conversion, but also accounting for full dilution of bonds converted into shares.

–> This gives me a value of 4.84 HKD per share, with the stock trading at 4.4 HKD per share currently, the discount is not huge, but this I also regard as conservative assumptions.

 

Bullish scenario

Current Op Margin: +38% maintained indefinitely.

Revenue growth: 80% over the coming 2 years, accounting for the new Naga2 complex, after that 5% per year for 8 years. Terminal growth rate 1.9%.

Cost of Capital: 10%

Re-investments: 20% of Net Income

Tax rate: 5%

I deduct cash from Present Value, including cash from Bond conversion, but also accounting for full dilution of bonds converted into shares.

–> This gives me a value of 6.69 HKD per share

Also to consider is the 70% pay-out ratio for dividends, my current estimate of the dividend yield at current stock price, is about 5.2% annual dividend.

Initiating small position

It’s not an ideal margin of safety, but the stock is offering a very attractive dividend yield and still good prospects for further growth, I’m initiating a small position here at 3% of the fund, and willing to buy more if we see the share price around 4.00 HKD.

 

 

 

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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.

sah_perf

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.

vip_sah_rolling

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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