+ Exchange business are attractive both for their moat and resilience in an inflationary environment.
+ GPW is trading a highly attractive valuation where even a bear case gives upside in share price.
+ Attractive dividend yield north of 5%.
+ Polish stock markets have not seen the rally developed markets have, perhaps the best is yet to come?
– Poland is politically moving in a worrying direction and GPW is majority own by the state.
– Although revenue has increased nicely in the past 10 years, net income has not expanded as much.
First, thank you all for the warm words in the comment section, it’s good to be back! The inflation debate is still raging, transitory or not, at least temporarily it is a reality. Some companies are really hurt by inflation, struggling to pass on the cost, others do better. I put quite a lot of thought into what companies except banks do well in a high(er) inflation environment? I came to the conclusion that stock exchanges with reasonable current valuations (not priced for too much growth) could be a sweet spot. The hunt started and I quickly honed in on the Polish exchange – GPW. A lot of listed exchanges has re-rated in the past 5 years, many driven by the strong local equity markets, buyouts etc. Others, like Hong Kong Exchange have benefited from the US/China conflicts with Chinese companies opting to list in Hong Kong. But Poland has not seen a proper equity bull market for a very long time, valuations are still very reasonable in general and the country and its savings/pension mechanism are in early days. So the days in the sun for the Polish exchange seems to still lie in the future. Let’s dig into what the company is about and if it’s something for our portfolios.
History
The Warsaw stock exchange held its first trading session on April 16, 1991 with five listed companies, all of which were formerly State-owned companies that had been privatized. In 1999, Poland reformed its pension system, which contributed to an increase in domestic institutional investment, and in 2004 it joined the EU. With a record high growth in EU over the past 20 years, all these developments helped to boost trading volume on the exchange. In 2010 Giełda Papierów Wartościowych w Warszawie (GPW) listed on its own exchange.
Through my other Polish holdings I have written about how Poland is one of Europe’s strongest growing markets. On the back of such growth naturally a large population like Poland is creating national champions. Two worthy mentions would be CD Projekt (18bn PLN) and Allegro (71bn PLN) which recently listed. Overall the Polish equity market is very strong in gaming companies with many smaller players listed. GPW has also successfully developed a commodities exchange over the past 10 years. Today the commodities segment revenue is as large as the Equity/Fixed Income trading segment. To summarize on the back of Poland’s growth, so has also the exchange grown. That said, GPW is still tiny compared to developed markets with a market cap of 430m USD. Being in such an early stage of development I see plenty of long term growth opportunities for Poland and the exchange.
Company Overview
To get a better grasp of the company the below picture gives a good overview of how revenue is generated (press to read more):
Back in May-June after my last blog post my life and portfolio was in bloom, I had my best outperformance since the blog started and I was back good physical shape. That did unfortunately not last and things went quite wrong from there on. I had struggled with my health for the past year and early this summer it got worse than ever when a injured myself quite badly. I’m much better now but going through something like this really drain you. Currently going through the slow process of trying to build up strength again. Due to these unfortunate health issues I haven’t had the mental capacity to post anything or research as much as I used to. But now after exactly 4 months of inactivity I’m back blogging. I got a bit of a writers block starting off this post, I try to just come as you are. Nevermind my health issues, let’s put focus back on what happened this summer and especially China.
Having a strongly China tilted portfolio has really been bad beta exposure these past months, the spread between developed markets and Hong Kong is really remarkable. Just like health issues which sooner or later emerge, I knew the day would come when China would have to clean up its imbalances and go through a readjustment/bust. I read plenty of books on the topic and spent considerable time trying to understand the dynamics of for example the Chinese housing market. Being somewhat mentally prepared and thinking through the downside helps, but it still hurts when it happens. My portfolio has taken it on the chin lately, but perhaps not as bad as one would expect. I had such a tremendous run in some of my holdings previously, that gave me plenty of cushion. Also I have had minimal exposure to all the sectors that have been worst hit. As of last Friday my portfolio is now in-line with MSCI World (20% vs 18%) and massively ahead of Hang Seng (-8%) YTD.
Portfolio changes/comments
Modern Dental Group
Although I haven’t posted I have stayed somewhat active in the market. I had to, for example Modern Dental continued to double yet again from where I started to reduce my position. I was very happy to unload another portion of shares at 9.4 HKD, keeping half of my initial position for the long term. This stock alone saved a lot of my bacon in terms of performance this year.
Greatview Aseptic / Vinda
I have been gradually increasing my position size in Greatview Aseptic, which I think is underappreciated and undervalued here. Yes the semi-annual was a bit weak in terms of revenue falling down to the bottom line, but revenue grew nicely YoY. Given the increased raw materials prices and the extremely stretched transportation market it was no surprise to me that profit wise it would be a somewhat softer half year. This is still a growth company (growing revenue some 9% YoY in the past 4 years) with a 8-9% dividend yield, priced as a zero growth company. Doesn’t make any sense, so I will continue to back up the truck and load up more. I added shares at 3.74 and 3.45 HKD, which apparently was too early as its now trading below 3 HKD.
In the same manner Vinda has come down in valuation, I added some shares at 23 HKD, again not the best timing but quite happy to add shares at this level. Both of these companies have similar characteristics: totally unsexy business, factories producing daily necessities, founder led and both taking market share in a market with a tailwind. This means the can post high single digit growth rates, which is nothing to scoff at in the long run.
Pax Global / Essex Biotech
Did some profit taking in both to fund the additions in above mentioned stocks, here I sold at good levels, 9.76 and 7 HKD per share. The selling has not really anything to do with not believing in these companies (they are even after selling my largest positions), just that I want to balance the portfolio and re-allocate to for example Greatview which I see as having better return potential from this point.
Dream International
When I added this company to my portfolio I wrote this post, with the question mark a dream Investment? I wouldn’t say it turned into a nightmare, but not far from it. I bought at 4.11 HKD and sold out 3 years later at 2.88 HKD, throw in a couple of dividends of some total 40 cents or so and its still a handsome loss, during a period my portfolio almost doubled. Incredibly enough most of the loss comes from the EV/EBITDA multiple contracting from 5 to 4, cheap got even cheaper. It’s ridiculous to sell but also ridiculous to allocate capital to something where shareholder value never seems to unlock. It would be painful to see the company announcing a special div or something like that now and the stock doubles, which would be reasonable. Such is life in value investing land, some stocks are just to deep value traps and this one I throw in the towel on. I could write tons more about this company, but choose to cut it short since its no longer in the portfolio.
Irisity
I have been flip flopping a bit in Irisity. I reduced my position in July thinking the odds for a continued rally seemed weak. Then they announced a merger with an Israeli company in the same sector, basically removing a one of the largest competitors (not that any of these players are large) and maybe more importantly gained a decent sales force. I think building some scale into this company is really needed and I saw this move as worthwhile to put on a position again, which I did a few SEK higher than where I sold 58 vs 61 SEK per share.
Nagacorp
Oh boy this has become a tricky one. The share price has taken a proper tumble dropping more than 50% from ATH. The market seems to focus more on the short term pain of Covid and Casino closure than the possible long term gains. Here you can see the sentiment difference between for example the US cruise liners like Royal Caribbean which has fully recovered from its Covid drop, although cruise sales worldwide has not fully returned. In this cases the market was quick to take the long term view but in Nagacorp’s case the market is either short sighted or changed its view significantly on future income potential. My interpretation of what the market thinks, its a bit of both. Short term scared that it could still take years for Cambodia and Asian markets to resume travel, combined with what has been happening in China with new rules for Casino Junkets, which makes it likely VIP business will not come back as before. This double uncertainty has just killed the stock. On top of that there is also some overhang fears of how the funding of Naga3.
I decided to add to Nagacorp (again too early) in July at 6.98 HKD per share. My reasoning being that Cambodia is a friend of China, which can be seen by high vaccination rates they got compared to the rest of south east Asia. My guess is that Cambodia will be one of the first countries which will open some type of travel towards China. But say I’m wrong and travel does not resume say in another 2 years, then the situation is tricky. Naga3 will be delayed and probably cost more to finalize, the down period will then be so long that I think share dilution etc will be a fact. Nagacorp will turn into a disaster investment with permanent loss vs current limbo situation. In my view all of South East Asia can not afford to be closed for another 2 years, yes it would crush Naga as an investment case but it would crush the economies of these countries more. Still I’m humble to the possibility of being wrong and I don’t want to size my bet too big, I’m not going to add further (7% position) until I see signs of actual improvement. In regards to VIP business, yet to see where this lands, I have a small hope that junkets will be more controlled in Macau but will find ways to continue to operate in Cambodia, but my base case is that VIP does only come back to 60-70% of previous levels, which is still good. In other words in my view risk reward looks good, but outcomes could be extreme both on up and downside.
New holding – GPW SA
A third Polish holding enters the Portfolio, the Warsaw stock exchange itself, a separate post will come soon!
China
A few words on China specifically as well, given all the things that happened perhaps I should dedicate a separate post to it. Since I started this blog I always had mixed feelings about my tilt towards HK listed companies and China exposure. First time I got bearish on the blog was 2017: Rotate away from China. Already back then I spelled out my worries of China property and sold out of my holding Ping An. Ping An has lately been one of the largest indirect losers of this Evergrande mess. Trade War feels like a really old topic by now, but its very much alive and kicking. The whole de-globalisation feels like a long term new theme one could do investment after
It’s clear to my by now that China has decided to decrease the wealth gap created in the past 20 years. There has been some obvious losers, like education companies but a lot of companies have been hammered for various reasons. In my view even the Evergrande mess is part of this same theme (at least partly). What is less talked about is that there are also some winners in equalization. Just like in the US with stimulus checks which created a huge buying freenzy. If the poor in China got less poor thanks to wealth redistribution, perhaps the customer base of Vinda’s Tempo tissues grows from a few hundred million to half a billion? If a dedicate another posts to thoughts on China I would like to explore this are more. As always happy to hear you input, who do you think are the winners if China wealth gets more equally distributed?
It’s very good to be back posting, hope you got the tribute hints, man 30 years already!
A study of small caps listed on the Hong Kong exchange
Over the last couple of years much of my portfolio performance can be attributed to a few holdings which have 2-5x in a short period of time. The latest one being Modern Dental Group where the price recently just took off.
If you want to read my Modern Dental Group analysis just click here.
Discussing with other small cap value investors, investing in HK small caps can be a bit like tapping on the Heinz ketchup bottle. Stocks do nothing for years and then all return comes at once. I hadn’t really experienced it like that in the past but lately this resonates a lot with me. As you can see the price graph of Modern Dental above is was a grueling holding which went from 3 HKD down to just above 1 HKD. Consider that this happened in an environment where stock markets where extremely bullish. Then suddenly the stock just pops fantastic when it happens. I want to explore what drives these sudden burst of returns. How to catch them, how to act when they break out and also try to identify if and when its time to either reduce or sell your position. This is Part 1 which focuses mainly on how to catch these type of holdings.
Catching the Rocket
The very first step of enjoying the returns of a small cap that significantly re-rates is to actually be there when it happens. I have a number of stocks that I held and sold, just to see them sky-rocket later. Or stock that I held for a long time when they started to move upwards I was quick to sell and afterwards looking like a fool when the stock continued to double from my selling price. First step is to actually be there when the stock takes off. As we will see from a few examples of stock price graphs, its easier said than done.
Miserable failure
Modern Dental was a success example, let’s look at some failures as there is probably more to learn from those. For the ones of you that have been reading the blog from the very beginning, you might remember this:
Recently some of you readers have contacted me either through the blog or on twitter to discuss Essex Biotechnology. Since I also recently increased this to a high conviction position, I thought I would share my thoughts on why I did so and some very recent development.
To start with I want to say so far Essex has been a terrible investment, I allocated significant capital to Essex on 5th of April, very close to the market bottom. And the stock is trading flat since then, whereas my portfolio is up 54%, a pretty remarkable underperformance. Why am I then adding to this holding which obviously the market doesn’t really see any value in? Well the (maybe obvious) answer is that I believe that the market is wrong and that there is significant upside in Essex to hopefully be unlocked. The most exiting trigger is that Essex today posted what I have been waiting for for some time now.
The Board is pleased to announce that, as informed by Mitotech, the topline data of VISTA-2 will be released and presented on 24 February 2021 after trading hours, and an announcement will be made by the Company accordingly
This post won’t be very structured but I would just comment on different aspects of the company. Let’s jump in
+ Hidden Champion in a niche of IR detector market.
+ The future use cases of detectors is very large and is growing (for example self driving cars)
+ Very high margin sales speaks of the quality of Vigo’s products, also a nice track record of growth.
+ Founder led with high ownership from current and previous employees.
+/- Mass market products could lift Vigo into another level, but also high uncertainty who of Vigo’s customers will come up with a good enough use case to scale sales.
– Valuation already fairly stretched (in my view) but on a peer comparison level still not expensive.
– EU has decided to ban metals like Mercury which is essential for Vigo’s currently sold detectors, a 7 year exemption is likely.
– Very hard to fully understand this company and its product offering, the competitive landscape and what use cases have high potential for Vigo.
Introduction
In the 1980s, a team lead by Joseph Piotrowski, at the Military Technical Academy, developed a unique technology for the production of infrared detectors working without cryogenic cooling. This invention led to the establishing of what now is VIGO System S.A. VIGO is located to the west of Warsaw, Poland, and with over 130 employees they have a global market reach providing customers with world leading uncooled infrared photon detectors.
The Company’s unique position and quality of products is confirmed by the usage of its products and the high margins the company enjoys in its small niche. The company is a true “hidden champion” with an estimated market share of over 50% of the market. VIGO is also in the pursuit to keep pushing the boundaries of its products quality as well as lower price products. Its recent investments in production capacity is ramping up production capacity from 10,000 detectors per year up to 100,000 detectors. The investment thesis is that the world will find more and more use cases for VIGO’s products. With YoY growth of some 25% in the past years and given the wide usage of its products already, its a compelling case.
VIGO’s mid-IR detectors are complicated to understand and his has taken me considerable time to wrap my head around how they are produced and more importantly where they are used. This write-up will therefore spend quite a lot of keystrokes on the products and their use cases. Let’s jump into it
With ~5 years of announcing every buy/sell transaction on the blog, I have now for a while shifted to only post changes under “Trade History”. Sacrificing some transparency but with the aim to focus blog posts on more interesting things than every trade done. I imagine this will be my new format, where I look back on the past months and comment on what I feel is most relevant to mention. This is the batch of trades I will discuss.
As you long term readers know by now this blog has two main themes, stock picks and evaluating my investment style. This is another one of those posts where I explore one aspect of portfolio management – should one hold on to winners as their valuation gets more stretched?
In the past year markets have both become easier and harder to invest in, depending on your style of investing. I try to keep an open mind, be adaptive but at the same time invest in a way that works long term. I do believe some very basic fundamentals of investing rules will always stay true. Valuation does matter for me, but so does other things as knowing your holdings well. My portfolio returns have been especially good in the past year (on both absolute and relative terms). This has been driven by a handful of my holdings which have re-rated substantially. As an investor thinking in terms of margin of safety, this margin has in many cases reduced significantly as the stocks have gone up. Fundamentals improved warranting an increase of 20-30%, but the stock has gone up 60%, in other words reducing margin of safety (multiple has expanded). What is the prudent thing to do in such a case? Keep the position and let your winner run, or immediately re-allocate your capital to something which you perceive to have a higher margin of safety? These are for me very difficult questions to answer as manager of my portfolio. Below I want to contrast two different approaches to investing to highlight the issue.
The Coffee Can portfolio
The Coffee Can portfolio concept harkens back to the Old West, when people put their valuable possessions in a coffee can and kept it under-the mattress. The story that explains the concept the best goes like this:
I had worked with the client for about ten years, when her husband suddenly died. She inherited his estate and called us to say that she would be adding his securities to the portfolio under our management. When we received the list of assets, I was amused to find that he had secretly been piggybacking our recommendations for his wife‘s portfolio. Then, when I looked at the total value of the estate, I was also shocked. The husband had applied a small twist of his own to our advice: He paid no attention whatsoever to the sale recommendations. He simply put about $5,000 in every purchase recommendation. Then he would toss the certificate in his safe-deposit box and forget it. Needless to say, he had an odd-looking portfolio. He owned a number of small holdings with values of less than $2,000. He had several large holdings with values in excess of $100,000. There was one jumbo holding worth over $800,000 that exceeded the total value of his wife’s portfolio and came from a small commitment in a company called Haloid; this later turned out to be a zillion shares of Xerox.
So at its extreme it is not never sell anything you bought, but perhaps a slightly less extreme version is to never sell your winners. Would this be a reasonable investment strategy and something I could really commit to?
Every day is a blank sheet of paper
Another extreme way to see your portfolio was something I learned a long time ago talking to some seasoned portfolio managers. Every day is a blank sheet of paper, they pretended their whole portfolios was in cash. Basically they went through the exercise of pretending they did not own any stocks and they needed to deploy all of their funds in the market every day. If their current portfolio looked different than how they would deploy their money if they started from scratch they rebalanced their portfolio to look like the weights they actually wanted to have. In reality I don’t think they thought of their portfolio like this on a daily basis, but for sure some did this on a monthly basis or so. If one holding in the portfolio for example doubled in a months time and went from 2% weight to 4% weight, they would scale it back to what they then thought was appropriate. Perhaps after such a run-up it was only 1% position or something the sold entirely.
At its extreme this type of portfolio managed will constantly sell winners if the stock price increase was not based on fundamentals that would warrant to hold a larger position. If the stock price just increased its multiple with no new information that should move the stock, this type of investor would quickly sell down that holding and re-allocate the money into other holdings. A true mean-reverting strategy which would work very well if the stock that increased in price came back down again.
Middle road – Thesis Investing
A middle road to this would be to care less about current valuation and just focus on if your long term thesis for the company holds. As long as the thesis holds you never sell. This would mean you could hold a company that is short term grossly overvalued (but still within some limits of reasonableness). I think the investors who have been most successful in the past few years have fully allocated their portfolios into this type of holdings. Leaning on the powerful laws of compounding, for something growing 20-30% YoY valuation matters little if they keep this up for the coming 10 years. Obviously the hardest part is to figure out if they really will keep it up for the coming 10 years – which then means coming back to that the thesis for the investment still holds. The nice thing with thesis investing is that you filter out a lot of noisy and just focus on where the company is going long term – this in its simplicity is appealing to me.
Tesla as a use case
If I just play out the thought process of investing with a Coffee Can approach owning Tesla. Tesla could have been an investment in my portfolio since I looked at the company when it was still trading around 30 USD per share. I was early on the EV theme (as you long term readers know) and of course also looked at the Tesla stock. I even read the book about Elon Musk and how he created Tesla and SpaceX. I was very impressed with him after reading the book and especially impressed with SpaceX (and still am). With benefit of hindsight its obviously a big regret not buying the stock around 30 USD back when I started this blog. Let’s just play with the thought that I did. How would I then reacted when the stock suddenly popped from 35 USD up to 80-90 USD? Back then there were a lot of naysayers, this company is going bankrupt soon, huge pile of debt etc. – risks seemed high and the valuation was already “stretched”. I’m very sure I would have sold close to the 80 USD level and been very happy with such a quick big return, breaking both the Coffee Can and Thesis Investing rule. .
So what kind of investment mindset does one need to have to hold on to a winner like Tesla from 30 USD all the way to 800 USD? Is the Coffee Can strategy of letting your winners run and never sell, the approach one should take to investing? If I used Thesis investing it would have come down a lot to what my thesis is. With the successes Tesla had over the past few years probably the initial thesis would need to updated. An initial thesis back in 2013-2014 could probably have been that Tesla would be one of many future EV car makers (but no market leader). Few people back then believed Tesla would get even that far. I think this is not really a reasonable thesis anymore if one is long Tesla. That would be some type of bear case that Tesla would only be one of many EV makers. Todays valuation is pricing in more than that initial thesis, so it would have been time to sell some time ago, but perhaps one would have held on to the stock up towards 2-300 USD per share using thesis investing.
Talking about updating the thesis, I realize that is the big issue I have with Coffee Can approach. It basically assumes to take one decision at one point in time and then never update your thesis. Obviously there are many factors to consider if Tesla is a buy or sell at current levels. But let’s just take the argument around competition.
What drives Tesla valuation today?
Barring very special circumstances, competition will always eat away at successful companies. If the cake is too big and juicy, the market will never let just one or two companies enjoy the spoils for all eternity. Perhaps the entry barriers to get a seat at the table are high, perhaps the market leaders are extremely good at what they do. In the end people will keep trying to get a piece of that cake. This dynamic means that there is long term tendency for something to mean-revert. A new industry flares up, profits increase rapidly for early entrants and things looks great. More entrants enter the market offering products at lower margins and margins are eventually reduced. Sometimes there are special circumstances where this margin compression does not occur – for example by branding. It doesn’t matter how many watch companies enter the market, they will not be the same as Rolex, not until they built the brand value. So to every rule there are always exception. I try to follow basic principles like competition (and many others) to not get carried away with my investments and dream up blue sky scenarios which are highly unlikely to materialize. These type of arguments are closely linked to valuation. In my view a key point for someone that takes either a long or short position in Tesla is competition and brand value. I think most of us can agree that Tesla’s brand value is extremely strong, basically across all age groups and quite broadly in society. Two very relevant questions to ask is then, will it keep or even increase its brand value over time? And more importantly how much extra are people willing to pay to drive a Tesla instead of say a Mercedes, BMW, Volkswagen or even a Porsche?
These type of thoughts around a holding is in my view essential for investing, otherwise I might just throw darts at a board and put them in my Coffee Can. Just like the original article hints, I think the Coffee Can approach is more of an alternative to index investing and nothing I’m interesting in entertaining.
Conclusion
In the case of Tesla it would have been fantastic to hold it since I considered the stock until today but thinking through this hypothetical investment, makes it clear to me that my investment style if very far away from holding a stock like Tesla from 30 USD to 800+. Have I missed out on some big gains by selling out of some of my stocks? I few years back I evaluated how all holdings I exited performed after I sold them. The strong conclusion that came out of that was that I escaped more failing stocks than missed out on stocks that soared after I sold. Read the whole post here: Look in the rearview mirror.
Everyone wants to find and hold the next Tesla, but the likelihood that it ends up in your portfolio is very low to begin with. After that to hold it through all ups and down needs a very special investment approach which is close to Coffee Can investing or at least Thesis Investing where the thesis is updated to more and more bullish future scenarios as the company delivers and fundamentally gets stronger. I would have benefitted the past years to invest more based on thesis and less on fundamentals. But I believe we are going through a very extreme stock market cycle currently and valuations will come back as a stronger factor for investing. So currently I land somewhere between Blank Sheet of Paper investing and Thesis Investing. I try to give my holdings a little bit of room to be overvalued for shorter periods, but as soon as that overvaluation gets a little bit too stretched I mercilessly sell my holdings although I still think the company is doing great things. To become more long term, perhaps I should move a bit closer to Thesis Investing and a bit further away from the Blank Sheet of Paper approach. I would appreciate my readers input on the topic, always happy to hear your thoughts!
With these thought as a backdrop I will follow-up with a post on how I reason about some of my latest portfolio changes. If you take a peak at my Trade History page you can get a preview of what those decisions were.
Much can be said about this year, I choose to focus on how extreme the dispersion been this year. A very small subset of the markets has been doing tremendously well in 2020. Bitcoin has tripled and Tesla and other ESG trendy “hot stocks” soared hundreds of percent on back of the massive stimulus we seen. 2020 has been a treacherous year for us long term more value oriented investors. With the exception of 1999, it has probably never been harder to stay true to your investment philosophy. The liquidity flywheel has been turning extremely quick in a smaller segment of the total market at the same time we all know how poorly the real economy is doing. I’m pretty active Twitter user and never have I seen such euphoria among investors that had a portfolio of loss making, high growth tech stocks with as many SaaS etc in the company description as possible. I was still very young in 1999 and history never repeat itself, but I’m pretty sure it rhymes. And the rhymes I have been hearing lately are not positive for the returns for the coming years.
2020 has also been a terrible year from the perspective of have and have nots. And I’m sitting as a clear winner here from that perspective, with a stable high paid job and and assets that just keep appreciating at a high speed. At the same time a lot of the people who don’t have the luxury of big savings even lost their jobs this year.
The crisis months
What defined most investment returns in 2020 was how one navigated the period of February to April this year. Given that I live in Asia I had a front row seat to what was happening in Wuhan. In my post from Feb 9th I wrote the following:
I would like to start of by saying, that I think we are facing an extremely serious virus spread. It’s the sneaky feature of the virus that it can spread before people feel sick, which really makes this so very dangerous. Thanks to very powerful actions taken in China and elsewhere, we might just dodge a major major global health crisis.
When I started to write on this post a few days ago I felt my fellow investors in the US and Europe had not understood what is going on in China. But just over the past few days I think investors are getting input from company management and decent news reporting on what is actually going on. I felt all worked up, how could equity markets continue up when 1.4 billion people had decided to sit at home, not work and basically tend to basic needs!?
We humans are pretty easy to scare and what influences most of all, is the behavior of the people around us. People can be calm and rational about the likelihood of catching the virus, but change mindset very quickly when put with a new group of people that act more panicked about the virus spread. It’s very quick back to basics in situations like this, Maslow’s pyramid comes to mind. Nobody is any longer thinking about which Hermes bag or new car to buy, when you are fighting at the local supermarket for the last rolls of toilet paper. Maybe it sounds like a joke, but this has been the actual situation in Singapore and Hong Kong over the last few days.
I think I was fairly spot on in my analysis in early February and really early to voice my views/concerns as well. After that point of being correct early I got a lot of things wrong. First of all I was very bearish and thought this bull market had in general ran its course. I thought we where staring at a crisis that would trigger a more long term economical decline. This meant I did not think of upside potential and buying potential winners from the crisis. I focused all my energy on downside protection and rotating out of anything with high leverage and/or severely affected by the virus. When all the stimulus packages started to kick in, again I was more thinking downside protection, that the USD would be devalued long term, so I took some positions in gold. The right move of course, now that we now the results would have been going in heavy on what was a Covid winner. For example I wrote my analysis on Valneva late 2019 so I was well aware of Moderna, go back to my post and you will see I compare Valneva to Moderna. A company probably nobody heard about in late 2019. In general the strength of the stock market boom from the lows really surprised me and still does.
The year of Poland
2020 was also the year that the Polish stocks in a more significant way entered my portfolio. It’s always a bit scary when one starts to trade a new market, where a lot of information is not available in English. My earlier investing years was very Europe and US focused and later when I moved to Asia I focused much of my investments on mastering investing on the Hong Kong exchange. I know feel I have a good grip of the western markets + HK/China. The become a truly global stock picker, I have over the past 2-3 years tried to widen my scope to other more undiscovered markets. I firstly focused on Italy but struggled to find real gems to invest in there (the market is still clearly on my radar). I then shifted my focus to Poland, a more emerging market than what I previously invested in. The companies have very tiny market caps and one has to accept poor liquidity to buy anything except the 5-10 larger companies on the list. The one big market I have left to look at would be Japan. I know there are tons of interesting companies there and I have from time to time been close to pull the trigger, but so far not.
Exceptional return in an exceptional year
I’m both extremely pleased and somewhat surprised over my return in 2020. With twice the return of MSCI World and at a lower standard deviation (measured on weekly data), it’s my best year since the blog started from an outperformance perspective. When I say that I’m surprised it’s because how strong the US tech segment been, which has a large weight in MSCI World. I have had very little to no such exposure (perhaps you can count LiveChat and JOYY in that segment). If you look at the below table of where most of that performance was created, it’s almost all from holdings that I added during 2020 (holding period less than 1 year). Many of my 2020 losers are my long term holdings such as Nagacorp and Dairy Farm, so activity has definitely paid off this year.
Thank you all for following my blog all these years, if you do enjoy it, please subscribe go get all my posts in your mailbox.
+ Strong core business of radiopharmaceuticals, natural moat where products can only be produced locally.
+ Added an extremely successful leg as exclusive Polish distributor of Da Vinci surgical systems. Sales have exploded on back of pent up demand for these systems.
+ Product for heart disease in pipeline, finalized Phase 2 trials, seeking Phase 3 partner. Similar product by US listed Lantheus brought 60m USD in milestone payments. Synektik MCAP is ~60m USD.
+ Strong Polish Macro backdrop with Europe’s strongest GDP growth as tailwind for Poland to catch-up in terms of medical advancements.
– Covid-19 is as for most Pharmaceuticals hampering sales.
– There has already been some delays in finding a partner for the Phase 3 study.
Company Background
Synektik Group was established back in 2001 and started off servicing different types of medical equipment mainly for Siemens. Fairly early some IT solutions were also developed for archiving and distributing images as well as patient data admin. In 2004 a laboratory was established for medical imagine diagnostics. In 2010 the company acquired IASON and entered the field of radiopharmaceuticals. On this heritage of servicing equipment for large medical equipment companies and radiopharmaceuticals the company has grown together with the Polish economy and delivered strong revenue growth and product innovation.
Today, Synektik is a leading Polish supplier of services and IT solutions for surgery, diagnostic imaging and nuclear medicine. Synektik operates a research laboratory for diagnostics imaging systems and a service center for medical equipment. The company is also the first commercial manufacturer of radiopharmaceuticals used in diagnostics for oncology (PET) in Poland. The Synektik Group operates three radiopharmaceutical manufacturing plants. Moreover, Synektik operates its own Research and Development Centre working on radioactive tracers for oncology, cardiology and neurology.
Management
The two largest shareholders are Mariusz Wojciech Książek, a Polish businessman (26%) who acquired his stake in the company late 2017 and the company CEO Cezary Kozanecki (25%).
Business Segments
The company is standing on two main legs in terms of cash flow generation:
Radiopharmaceuticals
Distribution and service of medical equipment
The third important leg is the cardiotracer product where they are looking for a Phase 3 partner.
1. Nuclear medicine / Radiopharmaceuticals
Nuclear medicine is a medical speciality that uses targeted radioactive compounds, called radiopharmaceuticals, to diagnose, stage, treat and monitor diseases. Nuclear medicine can be divided into two categories: diagnostic nuclear medicine (or molecular imaging) and therapeutic nuclear medicine (or theranostics). The nuclear medicine market is predicted to reach $30 billion by 2030 worldwide.
Positron-emission tomography (PET) is a special form of medical imaging which enables doctors to visualize specific function inside the body in 3D. This is done with the use of a radiopharmaceutical, which is a special molecule combined with very small amount of radioactivity, and a special scanner. The images obtained can provide physicians with information to help them to diagnose, monitor and treat disease. The most frequently used PET imaging radiotracer is fluorodeoxyglucose (18F) (FDG), a compound made from a simple sugar and a small amount of radioactive fluorine (18F). This radiotracer accumulates in the body’s tissues and organs where there are increased levels of activity, such as in tumors. FDG is used in cancer imaging to search for tumors, metastases or to monitor response to certain therapies. However, it does not work well in some anatomical areas such as the prostate and the brain.
Synektik group produces a number of these basic radiopharmaceuticals and some special radiotracers. One example of a special radiotracer is produced under an agreement with Blue Earth Diagnostics. Fluciclovine (18F), a compound that is formed from a synthetic amino acid and includes a small amount of the radioisotope fluorine (18F). Fluciclovine (18F) accumulates in the body’s tissues and organs where there is an increased uptake of amino acids, as can occur in certain tumors. A PET/CT scanner is used to detect the distribution of the fluciclovine (18F). The images obtained from the fluciclovine (18F) PET scan give doctors information which can assist in the management of the patient. Fluciclovine (18F) is approved in the USA and Europe for PET imaging of biochemically recurrent prostate cancer.
The key point to understand with radiotracers are that they have to be produced locally. The whole idea of the compound is to have a very short half-life or radioactivity, to harm the patient as little as possible. So the product is made in a nearby cyclotrone the same morning. This creates a wide moat for the product, since a production facility in another country is too far away. There are 4 public cyclotrons, but they don’t have the license, they can only produce for their own hospitals. On top of that, Synektik is the only Polish company that can produce special radiopharmaceuticals, which translates to a 30-35% EBITDA margin. From this base of stable cashflow Synektik has been able to build up and scale its operations, organically and through acquisitions.
PET Tracer sector is hot
In recent years larges players have been snapping up assets in this space. Blue Earth Diagnostics that Synektik co-operates with was acquired by Bracco for 475m USD: Link
Novartis invested $6 billion to acquire Endocyte to expand expertise in radiopharmaceuticals: Link
This is from a global perspective, as interesting to Synektik is how the market has developed locally in Poland. As you can see below there is plenty of room for growth.
This is also translated into stable sales for Synektik with very stable EBIT margins:
Cardiotracer – the gamechanger
What is most hot in this sector is of course not old technology that has been around for years, but new innovative tracers. Synektik has for a number of years been working on an improved tracer formula for heart disease. This project has been sponsored by EU Getting to the heart of diagnosis for imminent coronary artery disease.
The benefits of this new type of tracer is summarized by the following points:
high quality of image, strong sensitivity and adaptivity of the scan.
the same image quality for small and large patients, people with breast implants and those unable to lift up their hands.
four times less radiation (of significance to children and people with chronic coronary heart disease).
faster imaging protocols, leading to shorter test times
This cardiotracer product is Synektik’s major research pipeline item and is a potential gamechanger for the company. The company has finalized Phase 1/2 studies and is now seeking a partner to take the product through stage 3 and to the market. Synektik have been dragging their feet a bit on finding a partner which has disappointed some investors.
Some comments around this topic from a recent investor chat with Synektik management:
We assume that 2021 will be the optimal time for concluding a contract with a partner. Of course, we DO NOT judge that it will happen. Why the frequent changes in schedules and delays in this area. I would like to ask for a more detailed explanation of
this problem, as you have already failed to meet your declared deadline several times. You are talking about 2021 now, but you DON’T SEE it. So it may be later or not at all. This is very disturbing Dariusz Korecki:We would like to emphasize – we believe that concluding a contract next year would be optimal. But we are not going to make a deal at any cost under time pressure. Kardiagnnik is a one-of-a-kind project, and we will conclude a partnering contract for it only once. I assume that we all want this to be the best possible deal that will allow Synektik to become a global player. The game is at stake for our company. It would also be irresponsible on our part to ignore the impact of COVID on the course of the project in our plans.
The market speculates that the partner with whom the company will complete the third phase of clinical trials of the cardiac marker will be Astra Zeneca or Blue Earth. Can the company relate to these speculations? Dariusz Korecki:We cannot, by nature, comment on such speculations. In terms of direction, our partners may include drug manufacturers, manufacturers of medical equipment, who are also the largest producers of radiopharmaceuticals in the world. At this stage, we can reveal that we are in dialogue with the leading players in the global medical industry.
Do you have knowledge of the work on competitive markers for the tested cardiac marker? Cezary Kozanecki: We monitor the market, we have the fullest possible and current knowledge about it. The potential sales market is very large and competition is invariably limited.
Dariusz in the investor chat also points to Lantheus Medical one of few listed players in this space which made a deal with GE Healtcare, which provided for an upfront fee and success fee of approximately USD 60 million. This payment with potential good royalties for Lantheus was for more or less the same type of product: Phase III development and worldwide commercialization of flurpiridaz F 18, an investigational positron emission tomography (PET) myocardial perfusion imaging (MPI) agent that may improve the diagnosis of coronary artery disease (CAD), the most common form of heart disease. Link to press release.
Just to be clear, up-front and milestone payment during Phase 3 to Lantheus is 60m USD, which translates into 223m PLN and current MCAP of Synektik is 232m PLN. This 60m USD does not include future royalties if the product is launched. Synektik does not even need to land a deal half as good as Lantheus and this would still be massively accreditive to share price of Synektik.
2. Distribution and service of medical equipment
Synektik has a number of products they distribute and do maintenance on in Poland. But the main driver of this sales is from the Da Vinci surgical machines.
Synektik is the exclusive distributor of da Vinci robotic systems in Poland. Under the agreement concluded with Intuitive Surgical, Synektik is responsible, for the sale and service of robots, instruments and equipment accessories, as well as training of operator doctors. Selling these machines gives firstly a nice one off cashflow (profit sharing with IS) but long term more importantly it builds up a base of service income of the surgery systems. Although Covid-19 has been very bad in Poland, Synektik has still managed to land a few sales during 2020:
November 2, 2020 the Company concluded an agreement with Międzyleski Szpital Specjalistyczny in Warsaw (Hospital). The contract was concluded as a result of the public procurement procedure conducted under the open tender procedure for the total net value of PLN 9,050,885. The system will be delivered by November 30, 2020.
April 21, 2020 the Company signed an agreement between the Company and the Independent Public Clinical Hospital No. 2 PUM in Szczecin. The contract was concluded as a result of the public procurement procedure conducted under the open tender procedure. Its value is PLN 12,496,500 net.
As you can see the agreement with Intuitive Surgical in July 2018 has been a game changer for this segment. My expectation is that sales of Da Vinci systems will increase further again after the pandemic. Synektik has made the estimate that approximately 40 Da Vinci systems will deployed in Poland until 2025. And very importantly create a new steady stream of service income. Synektik estimates by 2025 that service revenue will be more than yearly sales of Da Vinci systems (4 in past year and 5 estimated for 2021).
Other products
There are also other products where Synektik co-operates with various companies to access the Polish market. For example ZAP-X a new innovative system for stereotactic radiosurgery (SRS). The company has also continued to develop its IT platform for storing images. Called Zbadani.pl the company has ambitions to expand the platform to more centers with a wider set of functionality.
Another example is that Synektik obtained exclusivity in Poland for the distribution of Genomtec’s two-gene tests (Genomtec® SARS-CoV-2 EvaGreen® RT-LAMP CE-IVD Duo Kit) for the diagnosis of SARS-CoV-2 infection.
Valuation
Although some larger Da Vinci sales in past years makes the EBIT quarterly data a bit lumpy, it’s clear from the above picture that Synektik has established a new higher level of EBIT. And this is during Covid-19 when hospitals and the country is in partial lockdown. With Covid (hopefully) gone in 2022, I see possibilities for a very bullish growth scenario.
With a discount rate of 9% (Stable industry in Emerging Market) this gives me the following range of valuations:
Bull Case: 49 PLN per share – Assigned 30% probability
Bear Case: 14.6 PLN per share – Assigned 10% probability
Base Case: 35.5 PLN per share – Assigned 60% probability
Gives a weighted target price of 37.5 PLN per share versus its current price of 27.3 PLN. A decent 37% upside, but perhaps nothing to write home about. For the ones of you who read my post from top to bottom you know what I will say know. This does not account for the value for the cardio tracer product. Given that the company seems to have struggled somewhat to find the right partner I will be conservative and assign a third of the value of what Lantheus would get from only milestone payments. That is another 20m USD in pipeline value which translates into 8.8 PLN per share.
So my target price for Synektik with a conservatives pipeline valuation is 46 PLN per share or 68% upside to current share price.
If the company continues to execute as well as the past years and with a partner found in 2021 on good terms, I see much more upside than this over the coming 2-3 years.
Key metrics to follow in the future
Margin development – Valuation is fairly sensitive to changes in margin
Continued sales of Da Vinci machines and that nothing happens to the sales agreement (which currently lasts to 2022)
Further growth of radiopharmaceuticals expected, confirm that trajectory is intact
It’s high time to review my holdings and if anything changed in their investment thesis. This will be a monster post, for me it’s a great way to review all my holdings and make sure I stay up to date. For you, if you hold or are interested in one of these stocks you will get a quick “what’s the latest” with some sprinkles of why this is a great company (or not anymore). As a bonus there is a short elevator pitch of my two new holdings.
I stopped posting updates for every portfolio change (instead found under Trade History tab), so I have some changes to comment on: MIX Telematics left the portfolio and Lvji entered and exited without comment from my side. MIX Telematics was a case of having too high exposure to the oil industry in the US, I don’t see that coming back at all in the same way as in the past. This was something I did not understand when I invested, properly hidden oil exposure and a mistake on my side. Lvji was a tech play on travel guides for Chinese, but soon after taking a position some twitter friends alerted me of doubtful accounting. I looked at it myself and couldn’t really feel comfortable, better safe than sorry I then sold at almost the same price I bought.
Now on to comments on all my current holdings from top to bottom in the table below.
