Please note that these articles are for discussion and informational purposes only and should not be relied upon as financial advice. Please read the full disclaimer available on the desktop version of my blog.
February has been an extremely volatile month with huge swings
in the equity markets. Thousand point moves in the Dow Jones Index meant that
volatility has shot up, and investors are worried and confused. Our Straits Times
Index wasn’t spared either. With all the negative headlines dominating the news
every day, you may be wondering – what’s next?
I would like to share with you the transactions I have made
in the past month, as well as my game plan to navigate the volatile markets of
today. I have made trades in four companies this month – I sold Eagle Hospitality
Trust and Far East Orchard; while I bought SATS and Frasers Property. Companies
on my watchlist – in the order of priority – include Mapletree Commercial
Trust, DBS, ComfortDelgro and Hongkong Land.
Later in the article, I would also share my thoughts on
Howard Marks’ latest memo, and how it ties in with my strategy in face of the
volatility. Howard Marks is the co-founder and co-chairman of Oaktree Capital
Management, which specialises in investing in distressed securities. He is also
the author of ‘The Most Important Thing’, which I read early during my
investing journey, and have applied the concepts discussed to my investing
philosophy. I would highly recommend all investors to read this book.
February Transactions
Took profit on Eagle Hospitality Trust (EHT) at $0.52.
Made a small gain from my entry price of $0.48. EHT was supposed to be a turnaround
play for me back in November 2019, when it was sold off sharply due to
uncertainties over its flagship asset, the Queen Mary. Subsequently, earlier in
February, EHT missed its IPO forecasts for Net Operating Income and Distribution.
Personally, missing IPO forecasts by a sizable margin would be a red flag for
me, even though there were probably some valid reasons given by the management,
including the hurricane which affected certain assets as well as the ongoing
refurbishment works.
As a result, dividends declared for Q4 2019 of 1.179 cents missed
the forecasted figure of 1.56 cents, a 24% variance. The recent resignation of
the CFO also added to the uncertainty over the company, and I decided that it wasn’t
ideal to hold on to a company with that much ambiguity involved. Additionally,
I was also concerned of the coronavirus situation worsening. At the time of
selling, the US wasn’t really affected by the virus yet, but subsequently, US
hospitality assets have sold off sharply, as seen from ARA US Hospitality Trust’s
decline as well. Thus, the recent decimation of the share price should not be entirely
attributed to firm specific issues, as there has been a broader selloff in hospitality
assets as well. If you’re keen to read about my reasons for buying EHT back in
November, you may refer to this post: An in-depth look at Eagle Hospitality Trust's (EHT) Assets . Do note that the valuations would have
changed slightly due to the lower NOI from the assets, as well as changes in
cap rates.
Cut loss for Far East Orchard (FEO) at $1.14. This
represents a 25% loss from my entry price of $1.52 back in late 2017, excluding
the two years of dividends collected (6 cents annually). I felt that the share
price has been on a constant decline since I bought in, and it this point of
time, there are better opportunities to deploy my cash, and thus decided to cut
my losses. Additionally, FEO is also exposed to managing and operating a number
of hospitality assets in Singapore and abroad, hence I felt that while its
share price has not sold off as steeply as other hospitality focused plays yet,
I should exit while I can.
This investment gone wrong has also taught me the importance
of not solely looking at the Net Asset Value of a real estate company when
investing, and instead to consider the earnings visibility of a company as
well. Evidently, investing while being overly fixated on the NAV of a company
may mean that the earnings power of a company is overlooked, and this may
result in declining earnings and dividends. I would candidly say that my level
of analysis that I’ve did at that point of time in September 2017 was pretty
superficial, when I was relatively still a newbie at analysing companies. Today,
I am also focused on ensuring the sustainability of earnings from real estate
assets, instead of solely focusing on the NAV of the company.
An additional thought that I had while divesting FEO was that
‘deep value’ companies trading at huge discounts to their NAV may take an extremely
long time for their intrinsic value to be realised – or sometimes not at all.
The problem with these small caps with low liquidity is that without many
investors coming in to bid the price up, the company can stay undervalued for a
long time. The low liquidity and small market capitalisation are also barriers
for institutional investors to enter, and sometimes a privatisation may be the only
hope for the value to be realised. An example would be Hanwell Holdings, which
I have written about previously here: HANWELL HOLDINGS: NET CASH 70% OF MARKET CAP. Currently, its net cash position of c.20
cents per share is at the same level as its share price. However, due to high
insider ownership and low liquidity, its value may take a long time to be
unlocked. I am also thinking of the broader trends towards passive investing,
indexing and ETFs, which means that index constituents continue to get more
attention and trading volume, while small cap stocks continue to be neglected –
even though from a fundamental point of view, these may be good investments.
Bought SATS at $4.49 in early February. This was
intended to be a long term investment, and I felt the at that price it provided
a good entry price. However, the subsequent worsening of the coronavirus
situation and the further suspending of flights to South Korea and Northern Italy
meant that SATS’ share price took a further beating. I still believe that my
thesis holds – betting on the long term growth of air travel as a proxy for
increasing affluence in the region - a
trend that I believe would play out over the next 5 to 10 years. As seen from
previous epidemics, the rebound in demand for air travel and tourism is usually
strong and quick once the epidemic blows over, hence I would expect passenger
figures to rebound to normal levels within a year or two.
I guess the main concern now would be that the coronavirus
situation would drag the global economy into a recession, which would mean a
further drop in demand for air travel. A UK based airline, Flybe, as just went
into administration as a result of the drop in demand for air travel. However,
many airlines in the region are national flag carriers, and there major
shareholders have vested interests in ensuring that they are able to stay in business.
To account for the worsening situation, I have revised my assumptions on my
discounted cash flow (DCF) calculations for SATS, with a revised expected fall
in passenger numbers of 30% at Changi Airport this year, while also increasing the
expected time taken for passenger numbers to rebound to last year’s figures. With
my revised assumptions, I would be looking to average down at around $3.80. Do
read my post on SATS here if you’re keen to understand more about its revenue
drivers: A detailed look at how SATS earns its Revenue and Profits
Bought Frasers Property (FPL) at $1.66. Won’t
elaborate much on this as I’ve recently wrote a post on FPL here: The Divergence of Performance between Frasers Property and its REITs. In short, I believe
that FPL’s share price has significantly diverged from its underlying REITs –
while its REITs have delivered strong performance, FPL as the holding company
has languished. Additionally, FPL’s dividends are also well supported by recurring
earnings from rental income. The lower interest rates going forward would also
positively benefit REITs and developers.
Companies on my Watchlist
Mapletree Commercial Trust – the key thesis here
would be that MCT stands to gain most from the proposed developments along the Greater
Southern Waterfront. I would do a write up when time permits.
DBS – I am already holding DBS, but any further declines
in share price presents an opportunity to me. DBS has the largest funding base
and is the strongest in wealth management and digital banking among the three
local banks, while having the highest ROE. Yet, it is trading at a c.100bps
yield spread compared to the other local banks. That means the market is either
pricing in a huge decline in DBS’ asset quality, a dividend cut, or both. Alternatively,
one could simply make the conclusion that DBS is undervalued.
ComfortDelGro – In decline due to competition from
private hire vehicles, while ridership for the public transport segment would
definitely take a hit from the virus epidemic as more employees are having work
from home arrangements. I have done a rough sum of the parts (SOTP) valuation for
CDG, which seeks to value each business unit in isolation, providing greater
clarity on the prospects and valuation of each segment. I would share more about
my SOTP valuation in due time when I have consolidated the information available.
Hongkong Land – Landlord of prime commercial properties
in HK and Singapore, which is facing headwinds due to the political situation
and the epidemic in HK. HKL recently reported underlying earnings which
increased marginally, while net profit declined 92% due to revaluation losses.
To me, it seemed positive that rental rates in 2H2019 were able to hold up
despite the protests which started in June. However, the market seems to take
the results negatively, as HKL declined yesterday, post earnings release. One
positive for me would be the privatisation of Wheelock & Company on the
HKEX recently, which shows that the property magnates still have the appetite
for buying. Perhaps the property magnates see an opportunity that the general
market has overlooked?
Summary
After my transactions in February, my current cash level is
at c.20% of my portfolio. I am looking to raise more cash by selling off some
more positions. I also take this opportunity to review my portfolio, with the
aim of consolidating my holdings to no more than 10 positions, so that I can
dedicate more time to thoroughly research each of my portfolio companies. I am also
looking to venture to the US market, with some big names including $MSFT and
$MA catching my attention. I am still relatively unfamiliar with the US market,
but I have friends who have a much better understanding of some of the companies
there, and we would discuss before initiating positions.
At this point, I think that referencing Howard Marks’ memo
on the coronavirus and markets today would be very apt. Marks’ view is that it
is okay to do some buying now, because to be honest, no one knows what the
future holds. Stocks may turn around, and you’ll be glad that you bought. Or
stocks may continue down, and in that case, you’ll want to have money and the
courage to buy more. “That’s life for people who accept that they don’t know
what the future holds.”
In practice, I can understand how retail investors may find
it hard to apply this strategy. As a billionaire, it is relatively easy for
Howard Marks to keep his conviction and stay with his strategy of averaging down
when prices fall further. However, for retail investors like us, who have painstakingly
scrimped and saved over the years to build up a warchest, seeing our positions tank
right after we bought in may be very painful. Having sufficient funds is also
another issue, as it is not like we have unlimited liquidity and are able to
average down forever.
But another way to see this would be that if we have
adequate rainy day funds set aside for any emergencies, and we only invest what
we can afford to lose, then volatile stock prices should not have an effect on
us. The long-term investor should not care about how wildly the price of a
security swings throughout his holding period – what matters is that he has
made a profit at the end of the period. This concept was shared by Howard Marks
in his book “The Most Important Thing”, which I had read during my National
Service days. I think the biggest takeaway for me was that volatility is not
risk, and this greatest risk that investors should fear is permanent
loss (think Hyflux, Noble, Swiber etc).
In fact, I am taking a class on investments this semester,
and I think that the academic concept of using volatility to measure risk is
completely ridiculous. Howard Marks purports that volatility is used by
academics to measure risk as it is quantifiable and easily calculated. However,
if you set yourself out to dive in depth into researching companies and select
high quality, solid companies with the ability to ride out the storm, then you
should not fear when prices decline in the short term – instead, it is an
opportunity to buy.
In these volatile times, bear in mind that volatility and
risk aren’t the same thing – do thorough due diligence, have a plan, and stick
to it. Stay the course, and we will get through this together.
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