Pembridgecap

A Wealth Creation Journal

Category: Investment Updates (page 1 of 2)

Live Portfolio – Update #2

Make two small adds to Yixin Group (1%) and AddCN (1%) respectively @ 1.64 and 230.

 

Avanza 4Q 2019 Update

Avanza reported strong results and continued to grow its customer base which is up 17% year over year from 837k to 976k in 2019 (Avanza report its customer base in terms of the number of funded customers). A growing customer base is the single most important metric for long term value creation. It demonstrates that Avanza continues to be the most attractive retail investment platform in Sweden. Avanza’s customer base is ~10% of the Swedish population but only has 4.2% market share in the Swedish savings market. Avanza announced the ambition to increase savings market share to 7% by 2025 which means a double of savings capital from SEK ~400bn to ~800bn. This should then translate into a doubling of revenue.

 

Stock brokerage is high switching cost business, especially for retail investors. The high switching cost works both ways – it protects Avanza existing customer base from poaching by other online stock brokers but also deters Avanza’s attack on incumbent financial institutions. Avanza is winning market share because it is the lowest cost broker in Sweden AND provides a user-friendly investment platform.

 

Revenue grew 14% which was mainly driven by net interest income growth. Net profit grew 28% due to lower operating cost growth of 6%. Riksbank decided to go against their peers and raise repo rates in Sweden. The repo rate in Sweden is now at 0%. This has helped to increase net interest income by 70%.

 

The new CEO, Rikard, is very ambitious and continues to build on the customer-focused culture that has driven Avanza’s success in the past.

 

My view on Avanza remains the same: the best value-for-money investment platform in Sweden that has a very user-friendly online platform. It has an incredible mind share with young professionals, and as they progress in their careers, their savings on Avanza will grow too. There are two main optionalities with Avanza:

 

1) interest rate sensitivity where every 1% increase in interest rate will lead to incremental interest income of SEK 300m (2019 net profit is SEK 447m). I don’t count on it for the investment case to work but I consider a very valuable;

 

2) Avanza might grow into an online bank and offer more services to its existing customers hence increase product per customer and then revenue per customers

 

Trading at 36x P/E, Avanza is not cheap. But the strong growth visibility and the long growth runway means that I can be patient. Since my initial purchase in 2017, the stock is up 55% and generated 14.5% annualised return albeit with huge volatility. Over a longer time period, I believe Avanza is a 10-15% annualised return investment with very limited downside risk. Maintain current position and will add if Mr Market presents attractive opportunities to do so.

Live Portfolio – Update #1

Sold all Bitatuo shares and swapped into Yixin group shares. Believe that given the probability of success is the same for two stocks, Yixin clearly offers better risk-reward. Yixin has around 10-20% upside while also offering 15% upside. Bitauto, at current prices, has less than 3% upside but more than 30% of downside.

Live Streaming My Investment Portfolio

I am not sure if there is much benefit to broadcast my portfolio online. But it certainly sounds FUN! I was born in a small village with a very auspicious sounding name which loosely translates to mean a hundred victories. I really love that name and in honour of the village, I am calling my portfolio – Invictus. I hope it also brings me many victories in the years ahead.

I have included here is a breakdown of my portfolio as of 31 Dec 2019 and Invictus’s performance since inception in 2016.

  • Invictus Gross Return is the return after trading cost, admin fees and so on…
  • Invictus Net Return is the return after I applied an artificial fee structure of 0% fixed charge + 20% of the profit above 5% return. Unfortunately, nobody is paying me any fees now but I am determined to change this!
  • While I could not care less about what the index does in any month, quarter, and year, it is the best yardstick to measure performance over the long term

Here is how I will update my portfolio on this blog:

  • Every investment action will be updated here with at most 2-3 days of delay
  • I will try to explain all of my investment decisions as much as possible but no promises here
  • Every 6 months, I will provide a comprehensive portfolio update with performance and detail portfolio breakdown as seen above
  • Every 6 months, I will write a letter to explain my thinkings in more detail

Please feel free to share any feedback/comments with me! Even better if you share an investment idea with me!

Disclaimer: All information and material presented here are based on a virtual portfolio where there might or might not be actual trading activities behind it. The information contained herein is not intended to be a source of investment advice, credit analysis and trading recommendation. The sole purpose of this document is to document general investment thoughts and reflections on different businesses.

 

Games Workshop – 1H 2020 Results Update – The Best Is Yet To Be

07:57

1H 2020 (6 months ending 1st Dec 2019) results were excellent! What a privilege to be a partner in this spectacular business! Especially the kind of hardworking partner where all I have to do is just sit and watch.

The most exciting part of the earnings release was the doubling of the licensing income from GBP 5.5m to GBP 10.7m due to the launch of a new video game. A big part of my investment thesis on GW relies on the increased monetisation of its Warhammer IP beyond just miniatures. While this is a step in the right direction, I fully expect the licensing income to be lumpy and would take years to materialise fully.

In the meantime, the core miniature business is firing on all cylinders….

The revenue grew 18.5% to GBP 148.4m which is above my long term expectation of 10-15%. New games and miniatures release schedule will impact the growth in a specific period. My long term expectation remains unchanged in this regard.

A more detailed study of the revenue growth reveals some encouraging signs. GW breaks down revenue into three channels – Trade, Retail and Online.

Trade channel is 52.6% of the total revenue and growing the fastest at 27.2%. Trade is mostly made up of local mom and pop hobby stores which stocks a variety of trading card and board games such as Magic the Gathering & Catan. These hobby stores are usually the centre of local hobby community which is very similar to GW’s own retail stores. There are 4900 distributors at the end of 1H 2020. The distributor count grew 11.4% and the annual revenue per distributor grew 14.2% to GBP 31.9k. The annual revenue per store for GW’s own retail store is GBP 173k. So there is a 5x gap. Over time, distributors should increase retail sales productivity to close this gap.

Retail channel is 31% of the total revenue and growing at a slower rate of 7.5%. Retail consists of Warhammers stores owned by Games Workshop. The store counted increased by 2.5% while the revenue per store increased by 5% on a YoY basis. Finally, the online channel grew 15.6% and makes up for 16.5% of the total revenue base.

Opening retail stores will help to build brand awareness and seed the initial Warhammer community in a new locality. However, the independent hobby stores is likely to remain the most important driver for revenue growth for the next few years. Because it is uneconomical for GW to open stores everywhere. Online will remain a complementary channel to help fans acquire miniatures that are not stocked in the local hobby store.

Due to the completion of the new factory and optimisation of operational controls, the gross margin has expanded by 2.5% to 69.5%. Different revenue mix of newer vs older miniatures in any one period lead to fluctuating gross margin. Gross margin of an older miniature is higher as the fixed cost of building a plastic mould is amortised over a larger volume. I would expect the gross margin to fluctuate between 67-70%. The core operating profit was GBP 48.5m which was up 37.8% due to the beautiful effect of operating leverage. Core operating profit margin stood at 32.7%.

Investment consideration – at ~GBP 67 per share, GW is valued at roughly 25-28x 2020E earnings. While it is not cheap on a headline basis, I am holding onto my positions due to 1) healthy top-line growth + operating leverage and 2) a very positive prospect on IP monetisation.

Baoye Group – a mistake & a lesson

I recently sold my ownership in Baoye and ended the 4-year partnership with the business. I registered a 5% loss, but the real economic loss is much higher after accounting for the opportunity cost of having the capital tied up in an unproductive venue.

This experience changed my view on what constitutes a truly conservative investment. I used to consider securities, such as Baoye, trading below its net asset value as a conservative investment. However, for such an investment to be profitable, the discount to intrinsic value needs to narrow over a reasonable time period. Unless there are clear paths such as activist involvement to value realisation, time may not be your friend in these situations. On the other hand, time is the friend of a great business that can grow its intrinsic value. Mr Market may at any point misprice a great business, but the market value will generally grow alongside intrinsic value. Hence a truly conservative investment is a great business selling at cheap to fair valuation. The lesson is not about avoiding average businesses with dirt-cheap valuations; instead, it is about a better calibration of the relative attractiveness of investment opportunities.

Phil Fisher believed that there are only three reasons to sell the ownership of businesses: 1) “a mistake has been made with the original purchase”, 2) the company’s business quality starts to deteriorate with the passage of time, and 3) a more attractive investment opportunity that is more deserving of the capital. In this case, Baoye was sold because of the first reason as I committed a mistake in my original investment analysis. The most unfortunate part is that it took me four years to recognise and correct this mistake. I promise to learn faster next time!

As a reminder, Baoye Group is a Chinese company that is vertically integrated with construction, residential real estate development and building materials. We became a partner in the business because Baoye offered 1) very attractive valuation, 2) good and well-aligned management team, and 3) potential growth prospect from prefabricated buildings. My biggest analytical mistake was with Baoye‘s growth prospects. I believed that prefabricated buildings would drive growth at Baoye’s building material business. While Baoye did build numerous prefabrication factories, they only contributed 2% to operating profit. Most of the business’s profit is still in residential development.

This is evidenced in the capital allocation decision as well. Over the last four years, management allocated capital in the following manner:

  1. ~RMB 5.7bn in land purchases for residential property development
  2. ~RMB 1bn in capex (mostly for building housing industrialisation related factories)
  3. ~RMB 0.2bn in share buybacks

The vast majority of capital was recycled in residential development. On its balance sheet, Baoye has a book value of RMB 8.7bn as of June 2019. It carries a cost value of ~RMB 9bn land and properties for residential development. While the founder of Baoye, Mr Peng, has been talking about the revolution in construction through prefabrication for many years now, he has not allocated capital according to his vision. Without growth from the prefabricated construction business, Baoye is just a regional residential property developer in China with undifferentiated product offering in an increasingly consolidated sector. I do believe that housing industrialisation will one day revolutionise the construction sector, but I am not sure Baoye will be the main beneficiary of it.

I have misjudged the management team’s desire to profit from the cheap market valuation as it is trading at 0.3x P/B with 50% of its market capitalisation in net cash. Given Hong Kong Stock Exchange’s listing rules, the company is only allowed to buy back 1-2% of total share base each year. So, sizable share buyback is impossible. There is a lot of social status attached with owning a listed company in China that I suspect Baoye management enjoys. I believe they are fully capable of taking advantage of the cheap valuation. But they chose not to because they have other capital allocation priorities.

TC comments

I haven’t sold and have learned at least a few things.

As your partner blogger, I reject the “great biz at fair” vs “fair biz at cheap” argument. This seems only correct in hindsight. As you say, the lesson is not to never do fair biz at cheap, it’s the calibration of correctly trading off these two that needs to be good.

I still believe this is a very “fair” (neither great nor bad, but high conviction of being “average”) business at a *very*  cheap valuation (high conviction of cheapness). So in terms of this calibration it seems fine to me. Rather, if this was a stock listed on US (it isn’t & not saying this is somehow “unfair”), this might have worked in the same ’16-’19 time-frame.

Maybe the already large management ownership together with the steady share buyback is working against minority shareholders, as the stock becomes more illiquid and the market starts discounting a future where a squeeze-out becomes a possibility. A calibration takeaway here might be to prefer management owning 20-40% versus more than 50% from the thesis outset.

Another calibration for me is to lighten up on a similar company when management *that already has high ownership percentage* stops the dividend. If I recall correctly, we could have trimmed our positions at roughly the same price when this happened years ago. In hindsight, the reasoning management gave “housing industrialisation capex” was only a half-truth, as the company still has plenty of cash. The company has only done buybacks since.

Another interesting thing is that we learned (or indeed both have the illusion of having learned) different things.

Maybe it is not as important to the thesis, but the following is an insight for which I have the highest conviction that it is actually a correct insight from this situation:

A few years ago, I became a dogmatic believer in tax-efficient buybacks, always preferring buybacks to dividends because of taxes. Indeed, from a theoretical point of view, when keeping future stock “% discount to NAV” valuations *constant* to the current % NAV discount, buybacks are exactly as accretive as dividends (only difference is taxes).

However, as I outlined above, in situations were minorities might get nervous because liquidity decreases disproportionally (buying 1% of outstanding if float is 30% outstanding is 3% of float, vs buying 1% of 99% of outstanding only 1%) and a squeeze out is getting discounted, this is where practice starts disagreeing with my theory. In other words, % discount to NAV does not remain constant (i.e. “value + return of capital in bb/divi is its own catalyst” argument) but widens. I believe the devil’s advocate argument here is to say that 1 pp buybacks of a very small float should also have a very big boosting effect to the share price when they are carried out.

That is a long-winded way of the hindsight gut feeling “bird in the hand is worth two in the bush” that really teached me the virtue of a dividend. Tax efficiency is NOT the only difference with buybacks in practice.

My last take-away is that I am reinforcing my belief that countries with stock markets that are going sideways or down do *not* tend to become more efficient in the cross-section. In other words, in a rising Chinese stock market, this stock might have gotten discovered by more sophisticated international stock pickers. Instead we got increasing international scepticism vs China / HK, even from the “low base” when we invested in 2016.

A thought I wrestle with: is this truly a safe stock because of its large cash position? Or does it tank when the global economy sinks, as geopolitics typically becomes more muddy (or at least the perception) and international investors lose faith in (1) enforcing property rights in the future (2) values denominated in a currency that has capital controls etc. This is what I will call “cyclicality thru geopolitics”. Is Baoye similar to owning a cash-rich “safe” net net in Georgia or Taiwan (with invasion of neighboring country becoming more probable to please populace when the economy sinks)? That would make its fundamental *conditional* beta higher in black swan situations higher than we might think (i.e. low beta until things really go awry). But yes, I am probably overthinking this, and maybe this is already under-owned by the international investor community.

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