How to own prime property in Causeway Bay for only HK$14

Ever been to Causeway Bay in HK? If you had, you would most likely walked past Sogo which is right smack in the middle of CWB. And if you had just googled online, you would discover that Sogo is owned by Lifestyle International Holdings (1212 HK). 1212 HK currently trades at ~HK$14 and ~12x FY12  core earnings.

Company profile

1212 HK operates the Sogo department stores in HK - 1 in CWB and another in Tsim Sha Tsui (TST). It also operates the 久光百货 department stores in China, which is essentially the equivalent of Sogo. 久光百货 can be found in Shanghai, Suzhou, Dalian & Shenyang. The company owns all the stores with the exception of its Tsim Sha Tsui and Shanghai outlet. The Sogo and 久光 brands are targeted at the mid-high end market.

It also owns a stake in Beiren group, an operator of supermarkets, department stores & other retailing outlets in Shijiazhuang, Hebei. They hold a 49% stake of Beiren group, via a 60% owned subsidiary, thus giving them ~30% effective shareholding.

It also owns a stake in Lifestyle Properties (2183 HK), which will be the vehicle to pursue property development & investment projects in China. This is a subsidiary which is spun out of 1212 HK back in 2H 2013.

Overall, I think 1212 HK is a decent business operated by above-average management. I don't see it as a great business but maybe a good-enough business. It will be interesting for an investor who is able to find the right price that provides a good margin of safety to compensate for the risks (see main analysis below). 

The risks tend to revolve around macro concerns about China but on a company level, 1212 HK is well managed, pays a 4% dividend for the patient investor and has a strong balance sheet which allows for growth through acquisitions. In the short term, we might see some operational hiccups (see main analysis) but the silver lining is that it may create an opportunity to build a stake in the company at an attractive price.

Financials

The company has always been profitable (at least for the past 7 years that I looked at) and has grown core earnings by ~90% over the past 7 years, which is ~ 10% p.a. Profit growth has been positive in all years except 2008 during the financial crisis. Its associate, Beiren group, has also demonstrated tremendous growth across the years (net profit growth in 2012 was 26% y-y)

The balance sheet of the company is strong and is close to net cash levels, if you include its investment portfolio. Even without counting its investments, its net debt-to-asset-ratio is <15%. The business constantly generates free cash flow, some of which gets paid back to shareholders in the form of dividends. It has a 40% dividend payout ratio and its FY12 dividend was 49.4 HKcent, which is ~4%. 

Management

Overall, the company appears to be well managed as its HK operations has consistently outperformed its peers or at least performed on par. Its China operations has also performed well on average as year-on-year sales growth were positive, with the exception of the Dalian outlet which saw a down year in 2012. 

Management appears credible, as evidenced by the transparency of information in its reports. Having said that, I think it can share more on a timely basis. It seems that they have yet to do anything which is unfriendly to minority interests, which is a positive.

Quick evaluation

1212 HK is a good example of an average business run by an above-average management. 

Retailing is a difficult business and department stores are structurally challenged by the trend of online shopping. 

Its sensible strategy of owning its own outlets has given them a cost advantage over competitors which faced the brunt of rising rental cost. 

Across time, it has also built up a brand name in the markets it operates in and management has demonstrated competence by outperforming peers in generating sales through improving foot traffic, buy-stay ratio and ticket size per customer. 

Its strong balance sheet has allowed it to acquire growth across time and may still do going forward. It doesn't hurt that a rising tide of wealth creation in China has raised all boats, including theirs. 

Issues/Risks

Notwithstanding my opinion about management's competence (and they are not all perfect IMO), the business model is still structurally challenged in the long term. It is unclear how the business will perform when the tide of wealth creation in China recedes (or slows), which seems increasingly likely with each piece of data coming out from China. The worst case could see China turning into Japan with its decades of lost growth

In the short term, the company is also facing a hiccup with its Sogo outlet in TST, where it was unable to renew the lease and has to relocate by Feb 2014. I would imagine that this may mean higher rental rates and a short term depression in earnings contribution fom Sogo TST where it has to rebuild its foot traffic, especially if the new location is not as good as the old one.

There are also concerns that cost increases, primarily due to wage increases, could outstrip revenue growth and lead to a contraction in profit.

Valuations

It trades at ~12x P/E FY12 core earnings. The question remains as to what the right valuation should be if the structural growth of the industry & retail market slows as China economic growth moderates. 

Without doing a detailed peer comparison table, I note that its peers trade at a wide valuation range with Debenhams in UK at ~8x P/E and Macy's in US at ~18x P/E. I observe that the 1212 HK valuations has been de-rating across a past number of years, after being bidded up to as high as 20+x P/E and appears that it might eventually settle at a more resonable level.

Conclusion

I will be looking for a price level that grossly over-compensate me for the risks, especially those on the macroeconomic front. If the right price level can be found, 1212 HK will be interesting for the patient investor who gets paid a 4% dividend yield, while owning a piece of a well run company backed by a strong balance sheet that may allow for growth through acquisitions and which could potentially benefit from the long term China growth story (if you believe in that).

N.B. The analysis here is simplified and in no part constiute a buy/hold/sell recommendation. Readers should do their own analysis and make their own decisions. Caveat emptor.

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3 thoughts on financial habits

Three thoughts on financial habits

On earnings: Never depend on a single income. Make investment to create a second income

On spending: If you buy things you do not need, soon you will sell things you need.

On savings: Do not save what is left after spending, spend what is left after saving.

Investing may be more accessible in 2014!

Now, investing will be made more accessible wth the smaller lot size to 100 shares.

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A Straits Time article (1 Jan 2014)

CHANGES on the regulatory and corporate governance front should improve the lot of retail
investors this year.

One key reform will allow Central Provident Fund (CPF) share investors to ask questions and vote at shareholder meetings.

Another big change will force Singapore-listed companies to hold shareholder meetings here rather than offshore, as has been the habit of a handful of firms.

But the reform with the largest impact will probably be the reduction in the trading lot sizes of shares to make them more accessible to the public.

All eyes are now on the Singapore Exchange (SGX), which said in August that it wanted to reduce the lot size from 1,000 to 100 shares.

It said the change could happen as early as the first quarter of this year.

That would mean the minimum investment in a $5 stock will fall to $500 for a lot of 100 shares from $5,000 currently, which is the cost of 1,000 units.

Around 40 per cent of the shares on the blue-chip Straits Times Index trade at $5 or higher.
"The blue chips will become more affordable," said marketing executive Jae Teo, a retail investor who invests in both blue chips and penny stocks.

Ms Teo, 24, said she is looking forward to the reduction of lot sizes: "In terms of the penny stocks, this can also lead to more demand, which can lead to more volatility. It will be more fun to play."
The other changes concern company meetings.

Many investors often skip annual general meetings (AGMs), especially if they are held during working hours. However, AGMs offer a chance to learn more about the company from its bosses and directors, and for investors to ask any questions they may have.

Corporate governance experts said they advise investors not to overlook AGMs and other company meetings.

In this regard, there will be improvements.

Starting today, all SGX primary-listed companies and trusts must hold their general meetings in Singapore.

Where there are legal constraints preventing them from holding their meetings here, companies are advised to provide "alternative modes of engagement", such as webcasts and information meetings, to give shareholders access to the board and senior management.

Most companies hold their meetings here but some still have meetings abroad. For instance, last year, some China companies listed here - Full Apex (Holdings) and Kingboard Copper Foil Holdings - held their AGMs in Hong Kong or mainland China.

The second change will have to wait until amendments to Singapore's Companies Act kick in, which is expected in the second half of this year.

The actual timing will depend on governmental and legislative processes.

Under current rules, CPF members who invest in shares through the CPF Investment Scheme can attend shareholder meetings only as observers and they cannot vote. They may not even be allowed to ask questions.

But the changes to the Companies Act will allow CPF investors to vote, speak up and ask questions at the meetings.

"The two changes (regarding company meetings) are overwhelmingly positive and should have been implemented earlier," said remisier Gary Goh.

He added: "CPF investors should not be discriminated against. They are investing their money, so why can't they attend the AGM, ask questions and vote?

"On the issue of overseas meetings, it's not cost efficient for you to fly overseas to attend if you hold only a small number of shares."

What is risk?

I was recently asked how I managed risk in my own stock holdings, on a portfolio level. And I must admit that I was stumped for a moment. Because, you see, I don't manage risk on a portfolio level per say.

I am, at heart, a stock picker. And I manage risk by picking stocks/companies that I know the value of and which I know possess attractive risk/reward propositions. The logic behind that is that, if my individual holdings are attractive on a risk/reward basis, then my portfolio as a whole should enjoy the same characteristic.

A counter argument to this view is that there may be correlations amongst stock positions that may make the portfolio seem riskier than it appears. But clearly, there are two issues here - 1) how does correlation affect risk here on a portfolio level?; 2) is that an unsolvable issue?

On the latter, simple common sense will guide a reasonably prudent man to not hold all its positions in one sector for instance (e.g. real estate). So by construct, a reasonable man would naturally source for attractive ideas across a number of sectors, rather than just one.

So I do not set out to have a concentration in one sector (or not) for my portfolio. The construction of my portfolio is just a product of the ideas I have, at any point in time. If it so turns out that I am heavily weighted towards one, it is not necessarily a bad thing, as long as I have conviction that my individual ideas are good. But of course, I do consciously avoid betting my house on 1 single sector/factor exposure. Plain old common sense is what guides me here.

On the first point about correlation and risk, my reply is that it is largely an academic exercise. First, how do you measure correlations, other than stock price correlations. Is one able to realistically, with precision, break down each position into the factors that drive it and draw correlations across positions? That seems rather hard and way too many assumptions involved. The more assumptions you make, the more likely you will be wrong.

If so, then we are down to price movements as our last bastion of hope in measuring correlations and the implied assumption there is price movement - i.e. volatility - is risk. Risk is bad and as such, price volatility is evil.

And this is the juncture which I evoke the brilliance of Buffett, and which I absolutely agree with.

"I think volatility as a measure of risk is nuts. You should really try to understand the business instead, and try to understand the volatility of the business instead. Risk should be measured in terms of the quality of the business and the risk of permanent capital loss. That makes far more sense to me. It has nothing to do with volatility." - Buffett

As such, to manage risk, all you have to do is understand what you own and assess what your downside is (i.e. risk of permanent capital loss).

The open secret: why does value investing still works

Why does value investing still work despite being such an open secret? To answer that, I quote Professor George Athanassakos in the extract below.

The short answer, for those who desire instant gratification is this - the stock market is dominated by i) humans which are fallible and ii) fund managers who act in ways that serve their self interest rather than their clients and in doing so lead to irrational outcomes. This causes mispricing in the market which allow value investors to come out ahead.

Note that I did not quote the entire article because I do not necessarily agree with it in its entirety, especially the point that value investors are contrarian. Nonetheless, you could access the article, in its entirety, in the link below.

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http://www.ftadviser.com/2013/08/12/investments/global/the-human-psychology-behind-value-investing-QaFquIhxGCx7eyXvI1QORL/article.html

"If the evidence in favour of value investing is so overwhelming, why isn’t everyone a value investor? Why does a value premium (that value, on average, beats growth investing) still exist? Shouldn’t it be eliminated? Not necessarily, because the forces behind the value premium are psychology and institutional biases
.
Human and institutional behaviour bias stock prices in such a way that give rise to the value premium. Individuals are subject to irrational behaviour. They are overly optimistic, they overreact and most importantly they herd. They herd to protect their jobs. If the group loses and a portfolio manager is in the losing group, his job is protected as he lost as everyone else – but if he is wrong and others win while he loses, then his job and reputation are at stake.

At the same time, individuals working for institutions have their own agendas that may conflict with those of their clients or investors. They act on these agendas to benefit themselves, rather than those who hired them. They rebalance their portfolios throughout the year to earn their Christmas bonus, they window dress to look better than they are to their clients.

Weaknesses of human nature and institutional biases are not going to go away – just as portfolio managers do poorly not due to lack of stockpicking abilities, but rather due to institutional factors that encourage them to over-diversify to protect their jobs and assets under management, investors will also continue to believe the promises that growth (glamorous) stocks make, overbidding them, and giving rise to the value premium."

Is Education the Great Equalizer?

Some say that education is the Great Equalizer that will provide social mobility to the poor. Our parents believe in that, which is why they told us all to study hard.

But times have changed. That bastion of hope is getting eroded as branded tuition centres serve to extend the rich-poor gap from a young age, amongst other things that erode the Great Equalizer.

Plus, even as it is, many young graduates have since learnt that their years of studies is only getting them a meager $2 - 4k starting pay. How do you close the income gap with that sort of salary? A $2k salary, even if you saved it all for 40yrs, barely gets you to S$1mn!

Nonetheless, I continue to believe that education is the way to go. Because frankly, there are not many pathways to success. But the substance of said education is where I differ. 

How many have left school and continue to apply quadratic equations and the principles of thermodynamics in their daily life? Shall we compare this to the number of people who grapple with their finances? 

The truth is that some of the things we learnt in school are important, some make us a more well-rounded person, and some are just plain useless. And some really important skills such as simple budgeting and investing are not being sufficiently emphasized.

I would go one step further to argue that the stock market is the Great Equalizer that allows a transfer of wealth from the incapable to the capable and potentially from the rich to the poor. The stock market is agnostic. It does not judge or discriminate against who you are, but just whether you are capable or not. A true meritocracy is what we have here.

Everyone has a good chance of making $ and profiting from Mr. Market, as long as you have the right skills. Skills that you would pick up if you bother to learn. (No ten year series textbook here though)

Some may argue that the stock market is manipulated by the rich and in doing so, the rich get richer. Fair enough, the world is not perfect. But with the right knowledge, you would know when to avoid situations like those and when to take advantage of it.

One of the worst things in life is ignorance. Ignorance is not bliss. It has consequences. To invest without learning how to do so is no different from jumping into the sea without knowing how to swim. 

In short, education is important. Being educated in the right things is even more important.

P.S. I am planning to do some pro-bono financial literacy courses for students. Appreciate any feedback/ideas on course content/delivery and contacts within education institutions.

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