Wednesday, November 30, 2016

Hierarchy of Financial Needs

Most readers would probably have come across Maslow's famous hierarchy of needs: a pretty neat explanation of how humans should view our existence in terms of our needs. Abraham Maslow, an Amercan psychologist, created this hierarchy as he was trying to understand human nature. 

The hierarchy of needs is usually produced in a pyramid like the one shown below. The theory goes like this: humans have needs and we need to fulfill our basic needs before we can advance to the next level. For example, the most basic needs like food, water, shelter have to be fulfilled before we can think about health, starting a family, owning a property etc. As we move up the hierarchy, we need friendship and connections, develop self esteem and finally achieve what we are supposed to achieve - self actualization. In short, reaching our potential in life.

Maslow's hierarchy of needs

As civilization progressed, most developed countries today, including Singapore, have moved up the pyramid and a lot of individuals do have opportunities to achieve self actualization. Maslow postulated that only 1% of humans would actually succeed. Well, that's probably not far from the truth given that a few hundred million people still live in poverty, in war torn territories, fearing for their lives, wondering if they could eat the next meal. Let's pray for them. However, in developed countries, the population of people who can self-actualize would be much higher, including most readers here.

In the world of personal finance, we can modify the pyramid to map our financial needs following more or less the same rules as the original Maslow pyramid. In this new hierarchy of financial needs, we also need to fulfill the lower levels before we advance upwards. The lowest level corresponds to the very basic and important needs. In life, obviously we need food and water before we talk about other needs. In finance, it's the same reasoning, we should fulfill fundamental needs first. However there would be minor differences as we delve further. 

At the most fundamental level, we first need to build our foundation before anything else. This foundation incorporates, most importantly, stable income which is salary, or for entrepreneurs, cashflow from their core business. Once we have achieved that, we should own our homes or for some countries, make sure that the salary takes care of the rent (unfortunately Singapore might fall into this culture some day as it gets too expensive to own our homes). And as the old adage goes, we also need savings for the rainy days. As a rule of thumb, we should have cash savings of around 12 months of expenses to cater for emergency needs. Since this website started out talking about investment, we often neglect these bread and butter issues. Investment actually comes after we have our foundations built! The following pyramid gives a sense of how the financial needs are ranked.

Hierarchy of Financial Needs

The second level is security, or protection. This is where we make sure we are protected by buying insurance and strive to have more incremental savings (beyond 12 months of expenses) if we can. We also then try to supplement our cashflow by investing these savings, thereby receiving dividends if we buy stocks, or bond coupons if we have bonds. Needless to say, one of the best security is having a second property that gives good rental income. The goal here is that the dividends, coupons, rent received from stocks, bonds, property here would cover expenses some day. It is worth mentioning that salary, by and large, will always be the main source of income. Rich Dad Poor Dad did the world a major dis-service by introducing the concept of passive income. It's a lie. Passive income cannot replace salary or an entrepreneur's main source of cashflow. Even if we reach aforementioned scenario where our dividends, coupons and rent can cover all our expenses, we should still work if we are employable. Of course, we then have the freedom to choose jobs that we find meaningful and hence can truly enjoy.

Insurance is a topic that deserves more scrutiny, but perhaps in another post. The whole industry is made complicated by agents as most of them mis-inform and mis-guide their customers. While it is important to have insurance, it's more important to buy the right ones with the right amount of money! A rule of thumb could be using 5-10% of the overall income to buy the correct insurance (usually term insurance) for good protection. Insurance is ultimately a cost paid to gain protection from adverse events and agents like to use emotional blackmailing to make people pay more than they should. We need to exercise common sense and rationality extremely well when dealing with insurance agents.

At the growth level, the focus for this website, we are actually talking about investing like the great investors - Warren Buffett, David Einhorn, Ray Dalio etc. We think hard and try to pick stocks well - stocks that compound growth and becomes multi-baggers over time. Or we take advantage of rare arbitrage opportunities to compound wealth. Hopefully we beat the markets when we measure ourselves across decades and make really good money. By right, this level should only be attempted when we have fulfilled the lower levels. But we do need stable income from dividends and bonds (at the security level). So, in a sense, there are overlaps. We need a few good stocks to supplement our income at the security level, yet the same capital would help catapult our growth. It's also worth noting that the growth level takes on higher risks to achieve higher returns. 

The highest level, arbitrary termed wealth maximization is about maximizing returns, which means we engage in the highest risks investments which can pay out big amounts, usually by utilizing a small percentage of our net worth (say maybe only 3-5% of our total net worth). For instance, buying long dated options or bio-tech stocks or for high net worth individuals investing in venture capital and the likes. This is a stage where we are prepared to lose the whole amount, but since it's limited to a small percentage of the portfolio, it doesn't really change things. But we have the opportunity to hit the jackpot i.e. like finding the next Facebook or Alibaba. Again, as with Maslow's needs, perhaps only 1% of the global population would reach this stage. 

Over the years, many experts had also reviewed Maslow's original hierarchy and it was proposed that changes should be made to reflect how the world had evolved since Maslow's days. So the new hierarchy looks something like this:


Haha! Yes more fundamental than anything else, today we need WiFi! It comes before the need to eat, sleep and having a shelter. Okay, just kidding. The new hierarchy actually adds to the highest level which is termed self-transcendence or simply transcendence. Later in his life, Maslow and others believed that perhaps self-actualization was not the ultimate goal in life. It was to self-actualize and use that ability to help others. In Maslow's own words:

Self Transcendence - seeks to further a cause beyond the self and to experience a communion beyond the boundaries of the self through peak experience

In our hierarchy of financial needs, perhaps there is a similar transcendence. What is our purpose of accumulating so much wealth when most of our financial needs would probably be finite? Most billionaires have come to this conclusion. They would never finish spending their billions and it might not be such a good idea to simply give it to their sons and daughters, as it kills their motivation to work hard. Hence people like Warren Buffett and Bill Gates actually pledged to give away more than 80% of their wealth to further progress the human race. This is very noble and perhaps an inspiration for us as well. No matter where we are at the hierarchy, we can always transcend and give away whatever we can afford to those who need it more.

Financial Transcendence - giving away what we can afford to help others

Thursday, November 17, 2016

Vietnam Property: 5 Bagger! - Part 2

This is the continuation of the previous post on Vietnam Property.

We have established the following in the last post:

1. Vietnam has a huge and hungry population and is on the growth trajectory to be a developed country. GDP will continue grow at high single digit and property prices at a multiple of that over time. It might be the last Asian Tiger in our lifetimes.

2. The development of the Ho Chi Minh City (HCMC), mirrors the development of Shanghai. With the east of the city growing much faster: the analogy of Pudong and Puxi vs HCMC's District 2 and District 1. At current $2,000 psm, we can expect prices to see $10,000 psm in the future when HCMC becomes like Shanghai or Bangkok.

One big secular trend behind this is also the urbanization of Vietnam. As a country develops, its population moves from the rural farmlands to urban cities. Urbanization ratio over time climbs over 50% to reach 60-70% eventually. Vietnam today is at 34%. As we already know, Vietnam has a population of 94 million of which only a mere 8 million lives in HCMC (another 7.5m in Hanoi). As the country urbanizes we can expect HCMC population to explode. Most big cities in the world houses 15-20 million people when we include the sub-urban population, HCMC should see its population increase at least 50% over the next 5-10 years. 

Big Picture: HCMC City 

This is a major point because it debunks the over-supply argument. Most amateur investors would point to the enormous number of property development in the two big cities and say that over supply would come and prices would collapse. But when we think about how 5 million or even 10 million people would eventually find homes in HCMC, or for that matter Hanoi, over supply would never be an issue over a long enough time frame. Besides we are investing in the Central Business District or CBD, the core of the city where land will be limited. It is too easy to paint a bear story without seeing the big picture. 

Today, Vietnam is at an inflexion point. It's GDP per capita has almost doubled from $1,300 in 2010 to $2,200 today (chart below) and is likely to hit the all important $3,000 in a few years where the demand for cars, properties and modern goods takes off. The Vietnamese government relaxed regulations and allowed foreigners to own properties in 2015 and started to privatize many state own enterprises in 2016. These are all important milestones for growth. We can pretty much say that Vietnam is all out to transform from a developing to a developed country. 

Vietnam GDP per capita

If history is any guide, Vietnam would continue to grow its GDP at a high single digit, not unlike China in the 1990s and 2000s and its GDP per capita would reach $10,000 to 15,000 in time. The same chart above shows how it has grown steadily over the years but still at a low $1,300 which is lower than Indonesia, South East Asia's largest economy at $3,500 GDP per capita and Philippines, another rising star at $2,800 GDP per capita. The difference is that Vietnam is going to be another manufacturing hub, from shoes, to white goods to electronics. The formula that has proven to work as we saw how South Korea, Taiwan and needless to say China transformed their economies that way.

Coupled with the reasons hitherto, Vietnam stands to prosper and Ho Chi Minh City, being the commercial centre, stands to benefit the most. There is an estimated five or six new condominium developments coming on-stream in the next 1-2 years that are targeting foreigners. The HCMC property market is finally recovering after its huge decline as it was dragged down by the Global Financial Crisis (GFC). The Singapore developers already has some successes with a few earlier project launches, building on Singapore's brand name and property development prowess. One of the prominent project in District 2 called The Nassim launched by the Jardine Group targeting the luxury segment had done really well (more than 90% sold) and is set to redefine HCMC's luxury segment with potential for astronomical price increase.

The Nassim

The cherry on the cake is the affordability as a result of the low quantum of these projects. The Nassim, is going for c.$200,000-400,000 per unit and for the less luxurious projects, a state-of-the-art 90 square metre condominium can be bought for c.$150,000 - a quantum that can't even buy a 2 litre car in Singapore. Such is the irony of life. This is the function of Vietnam still being a frontier market and perhaps a reflection that everything in Singapore is really too expensive.

Well, if the story is so good, why isn't everything sold out?

As described before, there's always risk. Nothing is certain in investing and the future, though painted here as rosy and prosperous, is always but "one of the probably futures". The future is a set of probabilities. There isn't just one but many possible futures. When pundits predict one future and it turns out to be correct, more often than not, it's just luck. The true expert, points out all the possible futures and assign accurate probabilities, knowing that one of them would come true and how to bet in a win-win manner. The high probability future of Vietnam is that it succeeds as another Asian tiger and we get our 5 bagger. There is always another chance that it would falter. The government reforms could fail and the Vietnamese Dong collapses again and the story is pushed out for another decade. Or infighting in the Communist party resulting in some power struggle and the politics is thrown into disarray. If these futures pan out, unfortunately, the money put in would see substantial losses. The author would attribute a 10-20% chance of this happening. But still, the risk reward profile is highly favourable. It's 5 bagger vs losing say 50% of the capital. More likely than not though, investors won't lose their pants. There is always a buyer to sell to if the price is low enough.

The other major concern for investors at this juncture is actually financing. Because the Vietnamese economy only started to open up, there is actually no means of financing. There is no such thing as a mortgage in Vietnam today. The mortgage market is non-existent and the banks don't know how to do it. This is the state of affairs in frontier economies. However over time we can expect the Vietnamese banks to introduce mortgages and future investors would have it easier. Without mortgage or financing means, investors must put in 100% of the cash needed and be subjected to full currency risk. The Vietnamese Dong is ultimately an emerging market currency, the exchange rate is volatile and the bid-ask spread is very wide. These are the costs to investing. Although if the story pans out as we have discussed, then such trivial should be overlooked. Why think about a 3% spread or a 10% currency depreciation when the return is going to be 500%?

The other risk is the possibility of intermittent rental income.

As alluded to in the previous paragraphs, Vietnam is only starting to open up very recently. There is no concept of mortgage yet. Global manufacturing firms only started to setup shop 1-2 years ago. The rental market is only for expats working with the global firms. Most Vietnamese people are still living in villages and couldn't afford rental. The rich and famous Vietnamese are actually fellow investors in these luxury properties and they are not about to rent. They just buy properties when they need to stay in the city. Hence while the rental yield is touted to be a good 6-8%, actual rental would be a function of how good the property agents are, whether they can secure good tenants working for MNCs. The rental market is thus highly competitive given the new capacity for these luxury condos coming in the next 1-2 years.

Nevertheless, if the main scenario pans out, then the return should be in the tune of a few hundred percent and missing one or two years of rental yield of 6-8% shouldn't move the needle too much. To reiterate, this is a five bagger story. Vietnamese properties in Ho Chi Minh today sells at $2000 psm but should reach $10,000 psm which is closer to what global cities like Shanghai, Taipei and Bangkok is selling at. Such opportunities don't come often. 

Seize the day!

Read from the first post! This author owns a property in HCMC.

Saturday, October 29, 2016

Vietnam Property: 5 Bagger! - Part 1

Here's an investment opportunity of a lifetime, yes once in a lifetime. If there is one post that you should read in 2016, this is the one. It's about Vietnam - the last Asian Tiger.

For most of us in sunny Singapore, Vietnam is probably not on most people's radar. It's not as vibrant as Bangkok and the rest of Thailand, there is no historical site like Angkor Wat or Borobudur, hence not as big a tourist attraction. There are also no famous beaches, and no theme parks. Even the traditional costume Ao Dai (pic below) doesn't appeal much (sorry Vietnamese ladies) because it is an obvious rip-off of the Chinese cheongsam with an added disadvantage - showing less skin. Also, the investment story sort of pales against Myanmar's, which we saw a huge hype that started when Ms Aung San Suu Kyi was allowed to run office after spending 21 years under house arrest. Of course, Myanmar's property prices actually skyrocketed since 2012. Meanwhile, Vietnam had major issues after the Global Financial Crisis (GFC) which it still hasn't fully recovered from. It's currency, the Dong depreciating big time, the nascent property bubble burst and most investors then were still licking their wounds.

Vietnamese lady in Ao Dai

So what's the story now? Well here's the plot. In the past few years, China has gotten really expensive as a manufacturing base and global MNCs were looking for alternatives. Vietnam has a huge and young population (c.100m! Almost as big as Japan!) that is highly literate, hardworking and hungry. The Communist government has also seen how successful China has become and strived to modernize Vietnam. It's the same roadmap that all the past Tigers had followed, including our own beloved motherland's plan: start with manufacturing, lure MNCs with cheap workforce and government support, built up the skills of the people and put money in their pockets. As the nation prospers, GDP per capita compounds and property prices skyrocket. South Korea, Taiwan, Hong Kong and Singapore all prospered. Before the Asian Tigers, we had Japan and after, China, the biggest dragon of them all, basically following the "manufacturing to first world status" master plan. These countries succeeded following the same path transforming from developing to developed countries. So will Vietnam.

What's more: Vietnamese are also descendants of Han people, known for their tenacity and vigour. They will work hard and compete hard. Vietnam is also a coastal country with access to the vast oceans (as with all the other Tigers), which allows it to export manufactured products and import goods for internal consumption when the economy grows and its people become rich enough to buy good stuff. Hence it is highly probable than not that Vietnam will be as successful as all the Tigers and Dragons before her, if not more successful. She will also most likely be the last Tiger of our lifetimes, barring North Korea opening up. That's another story for another day though.

But why property?

Well, stocks are also possible, but I believe the property story is easier to understand and probably gives higher ROIC and lower risk as we shall discuss below. As the country develops, not all regions will grow as quickly, it's good to bet on the commercial centre of the nation - usually the one or two main cities. Stocks are more difficult to capture one or two city's growth. In the case of Vietnam, the commercial centre that we are talking about is the Ho Chi Minh City (HCMC). This is a beautiful city originally named Saigon but changed to be named after the Father of Vietnam - Bac Ho, who led the country to freedom by defeating the Americans after a bloody ten year war. Or rather it was the Viet Cong, using guerrilla tactics against modern technology that won the day. The Vietnamese dug elaborated labyrinth of tunnels beneath American camps and surprise attacked them until the US soldiers were so fed up that they decided to wipe out Vietnamese by the villages. Elderly, women, kids were all not spared. (Well, that's an over-simplification but for more, check out Wikipedia or google My Lai Massacre).

Bac Ho on a T-shirt

That's all history btw. The war ended in 1975 and the country started to rebuild after decades of trial and error, the last effort thrown off course by the GFC and set the country back for a few years. But today, HCMC is a spiralling city, something like Singapore in the 1960s, Shanghai in the 1980s and Bangkok some years ago. Motorbikes, rather than cars, jammed up the roads, high rise buildings are starting to pop up and road side stores and shophouses co-exist to provide local food and international cuisines. In today's world, we also see the co-mingling with global brands and modern concepts. Starbucks and designer cafes littered downtown HCMC and Zara and H&M have also setup their flagship stores. So this is the first important point - at the rate the city develops, we should see more modernization and property prices go up multiple folds.

Today, HCMC property prices range from $2,000 to $4,000 psm or per square metre (the convention used in Vietnam). In comparison, Shanghai is at $10,000 or more per square metre, Taipei is at $8,000 psm, Bangkok high end properties are at $6,000-9,000 psm. Needless to say, Singapore and Tokyo are much higher at $12,000 psm or more. If HCMC becomes on par with any one of these cities, we can expect HCMC properties to be multi-baggers. At the very least, it should double. 

Now let's look at HCMC in detail, this is where it gets even more interesting.

Ho Chi Minh City (HCMC) is divided into two halves much like most major cities by a river. The Saigon River runs through it like a snake and the old city was mostly built on the west of the river. This is very much like Shanghai where Puxi was the old town and Pudong was designated as the new CBD, given that land was abundant and bare, so the government could designate and plan much better without historical baggages.

Stylized HCMC map

In HCMC, the old CBD (marked as CBD in a white circle above) was labelled District 1 or D1 while the new areas were labelled District 2 to 7 (D2-7). District 2 (D2) is the most interesting, spanning from the north east to the east with parts of it already connected to the upcoming metro network. The stylized map above from Capitaland's Vista Verde project shows it better. D2 spans from the area near the top two bridges are where current expat communities and international schools are located with metro lines being built to where Vista Verde stands, which is supposedly near the new CBD. Capitaland, Keppel as well as other developers are building multiple projects in the areas mentioned above. The price for some projects starts at $2,000 psm while District 1 prices are now at $4,000 psm and above.

If we trace the development of Pudong, we can perhaps see where HCMC D2 will go. Pudong started development in the 1990s when the Chinese government realized they needed to grow the city to cope with the development of the country. Pudong was ideal given its proximity as well as the availability of raw land. Today Pudong commands higher prices than Puxi which is why HCMC D2 could see prices leapfrog that of D1 and go even higher. Bearing in mind that both D1 and D2 prices will keep going up as the economy grows which means that D1 can go from $4,000 to $8,000 psm while D2 can go from $2,000 to perhaps $10,000 psm ie five bagger.

Of course this process will take many years as development of a new CBD would not be just a 1-2 year affair. While it is possible for stocks to achieve similar returns, it would take a lot more effort trying to analyze which stocks could do that with better risk reward profiles. It's also more difficult to buy Vietnamese stocks given that its stock market is still too nascent and lacks liquidity and depth. 

Next post we look at some other factors and the risks, stay tuned!

Thursday, October 20, 2016

SIA Engineering - Part 2

This is an continuation of the previous post on SIA Engineering (SIAEC).

As described in the last post, SIA Engineering has a solid business model that helps global airlines maintain their fleet. SIAEC's business moat is built on strong branding, economies of scale, efficiency which churns out high free cashflow and a high return on equity (ROE). It's also worth noting that the business is somewhat counter cyclical - when the macro economy slows and air travel is reduced, the airlines send more of their aircrafts for overhaul. This is shown in the same table (used in the last post as well) below which has 2010 and 2011 having strong FCF despite the world going into a slowdown after the GFC.

Okay, as promised, we would need to explain the rest of the table in this post.


For readers well-versed in DCF which stands for discounted cashflow, the calculations would be straight forward but for others, let's just walk through this a bit. We have described the left columns which are just historical FCF and we have the FCF projections under FCF Proj. Right in the middle we have the column "Discounted" with numbers starting from 245, 250, 254... finally ending with 235 and 225. This is essentially discounting all the future cashflow into today. Hence the term: discounted cashflow model or DCF model. The concept of discounting is the opposite of money earning interest. In finance, a dollar today is worth more tomorrow bcos money can earn interest. Putting into government bonds will earn 2% (well used to be easier, now we need to put it for 30 years to earn 2% per year, but still, there's interest income/return on capital). In any case, since future dollars are worth more, we should discount future cashflow back to today's dollars. The discount rate used is 8%. This is depicted as the WACC at the top right.

Now as to why do we use 8% to discount is a major convoluted academic argument. To some, it's still inexplicable, like why is Singapore's first ever gold medalist Joseph Schooling standing inconspicuously in a midst of pilots and Singapore Girls at his own celebration party. Humble as he is, Joseph probably doesn't give a damn how all these attention seeking corporates are leveraging off his big win. That's story for another day. In a similar vein though, the world's greatest investor Warren Buffett doesn't give a damn about the convoluted academic argument about discount rates.

(Note: SIA Engineering is a separate entity from SIA)

But we need to explain WACC. WACC stands for the weighted cost of capital which is literally the cost of capital taking into account of the two type of capital: debt/bonds and stocks/equity. Capital is not free. Debt investors ie bondholders typically want to earn a low single digit return as their capital is more or less protected. Shareholders however stand to suffer permanent capital loss and hence it had been argued that the return that they earn should be a high single digit, which is why for our purpose, we have put in 8%, this knowledge site's namesake. For more, pls read this long article - Value Investing.

There are few more numbers that require some explanation: VCF, TV and IV (boy this is getting dry, but that's real investing, so bear with it!). VCF stands for the value of the cashflows projected which is essentially summing up the numbers in the discounted column. TV stands for Terminal Value.  This is the value of all the cashflows the firm will earn starting 2023 into perpetuity. Since we determined the cashflow from 2016 to 2022 (that's VCF), we need to determine the rest, and since firms can last forever, that's captured in the terminal value (TV). There is a formula for this:

TV = FCF*(1+Growth) / (WACC-Growth)

As explained, WACC is also the discount rate of 8% (for simplicity let's just put WACC = discount rate), and Growth at the far right is at 2%. The Growth here is an important number. It is also called Terminal Growth, which means the final growth rate for the firm into perpetuity. In theory, this should be GDP growth ie only 2-3% or even 0% for some countries. There is no such thing as 10% terminal growth. Since nothing grows 10% into perpetuity (it gets too big and overwhelms everything else!). Finally we are getting close to the end.


The same table again for easy reference

Now that we have the TV we add VCF, TV and the net cash of the firm, we can finally get to its intrinsic value or IV. To be exact, it's the intrinsic equity value of the firm. Again it's:

VCF + TV + Net Cash = IV

In this case it would 1714 (VCF) + 3535 (TV) + 560 (net cash) =  5809 (IV). SIAEC has 560m of cash which gets added (if it's debt we need to subtract). As stated, we then get to the IV of S$5.809bn and by dividing by the number of shares, we get to an IV per share (IVPS) of $5.2, or a 36% upside! This is the conclusion of the last post. SIAEC is a BUY.

But wait, all this number crunching, how accurate can it be? Isn't prediction futile? The answer is yes. As explained in the last post, all this number crunching is to just have a sense, most probably the numbers won't turn out right. In 2022, we shall see, more than half of those numbers would be wrong. So keep reading on, just eight more years! DCF modelling is just that - to give a sense. In fact, we should be doing multiple models. So here's another one below. This is the bear case model which have the starting FCF at a much lower S$200m and the T4 growth at only 5% for three years and then future growth at 2% which is same as the terminal growth. So for this model as you can see, the IVPS drops to $3.8 which means that there is no upside. Some might argue that's not conservative enough and we adjust the terminal growth to 1% and IVPS drops to $3.5 which was the stock price low in the last few years.


SIAEC's Bear Case

As you can see, the range of intrinsic value per share is from $3.5 all the way to $5.2. Now we are on to something. We have perhaps established that the risk reward is favourable. If things go really badly, the stock might drop to $3.5 ie 10% downside from here. But if things go well, then we have 36% upside or more. There could be a good bet here.

This is the crux of investing. We cannot predict the future. The future is a set of probabilities. We want to bet such that if it pans out the way we think it should pan out, then we make good return. But if it doesn't we don't get killed. In SIAEC's case, if it crashes to $3.5 and we lose 10%, we can easily make that back with two years of dividends.

This is why we love moat companies that pays dividends!

SIA Engineering - Part 1 

The author owns SIA Engineering since 2013.

Friday, September 23, 2016

SIA Engineering - Part 1

SIA Engineering (SIAEC) is one of the strong blue chips name in Singapore to buy and hold for dividends. It has also made regular appearance in the annual dividend stock list posted on this site in almost every year since 2009. The long term stock chart below shows that it has compounded its intrinsic value, albeit with some cyclicality while paying annual dividends for the past 14 years (based on Yahoo! Finance, the "D"s representing when dividends were paid). An investor who bought the stock at $1.5 in 2002 would have almost tripled his money including dividends.

SIAEC's long term share price

SIA Engineering's business deals with the maintenance of aircraft when they land in Singapore as well as in the other airports in Asia where the firm has presence. 40-50% of its revenue is ultimately tied to its parent: Singapore Airlines but the other businesses are also growing. SIAEC also operates line maintenance in Australia, US, HK, Indonesia, Philippines and Vietnam via joint ventures and subsidiaries.

The investment thesis for this stock quite straightforward.

SIAEC is a play on the rise of global tourism alongside the influx of Low Cost Carriers or LCCs operating in Asia. It also benefits from more full fledge airlines outsourcing maintenance to established third parties like itself. As a leader in the industry, it enjoys a strong track record, economies of scale, an accumulation of knowhow and efficient processes and a strong branding via its relationship with Singapore being an aerospace hub and its parent SIA. It has generated strong free cashflow in the past and is likely to grow its earnings with the opening of T4 and T5.

Aircraft maintenance is a flow business that thrives on more air travel, more aircrafts in the skies and more efficient safety checks. SIAEC is one of the few key players in Asia in the space alongside ST Engineering and HAECO, the maintenance arm for Cathay Pacific and has benefitted from this trend. The maintenance, repair and overhaul (MRO) business as it is formally called has high barriers to entry as it requires a certification process for each and every airline as well as a steady track record in order to win customers. In fact, some airlines view this as fundamental that it doesn't outsource this entirely but conduct some MRO operations in-house. Hence SIAEC had benefited mainly from LCCs in recent years since LCCs do not have the capacity to have full fledge MRO operations in-house.

However more national carriers are also choosing to outsource maintenance to players like SIA Engineering as they can they reduce their asset footprint, sell hangars and facilities. It is also expensive for airlines to maintain a competent MRO workforce. Hence established players like SIAEC that have know-how and once they get economies of scale, can do MROs much cheaper than established airlines.

With Changi Airport embarking on an ever-expansion to Terminal Four or T4 in 2017 and ten years later to T5, SIAEC will also stand to gain more business simply by being the dominant player in Singapore. Airlines would definitely love to stopover in Singapore, do a quick overhaul and move on. This has always been our advantage. We are efficient, can turn around fast, has the reputation to get the job done well and all these in turn help to suck in more traffic and strengthen our brand name.


The Singapore Girl, helping SIA builds its brand name over decades

In fact, branding is one of the key business moat for any companies. SIA started building its brand name since the inception of the company. The Singapore Girl is iconic. To this day, most people when ask what they know about Singapore Airlines would answer, "Singapore Girl." For SIA Engineering, it is imperative that they strengthen on their own brand name as a reputable MRO operator capable of delivering the best maintenance with high efficiency.

For SIAEC, the parent SIA business is doing well too. The SIA Group has built a sizeable fleet over time across its four brands: Singapore Airlines, Silk Air, Tiger and Scoot and this MRO business is captive for SIAEC. It generates the base earnings which allows the firm to re-invest in JVs in Singapore and in the region. SIA owns almost 80% of SIAEC and hence is happy that its subsidiary does well.

However while the story sounds good, SIAEC's earnings had stagnated for a few years. Part of the reason was cyclical as the global maintenance schedule has a cycle with major checks done only periodically. There was also an influx of new airplanes in the last 2-3 years which require less maintenance at the initial stage which led to a decrease in workload for the industry. But we should expect maintenance to come back as these airplanes mature. Also, the total installed base of airplanes globally had continued to increase, so logically, maintenance work over the cycle shouldn't decrease. In fact, maintenance would only increase over time with a larger installed base.

The other key risk for SIAEC was the increase in labour cost in Singapore. With the government restricting immigration, SIAEC, as with many labour intensive businesses with our other listed entities (Sembmarine and Keppel), had suffered from an increase in labour cost as they were unable to hire cheap foreign workers for the more menial work. The mitigating factor here would be its strategy to diversify into lower cost regions such as the Philippines and Vietnam.

So that's the investment thesis as well as the risks.

Next we look at the free cash flow (FCF) generation of the firm. The table below shows a quick and dirty analysis of SIAEC's FCF and also a simple Discounted Cashflow (DCF) model for the firm. Most analytical work that real investors do really don't need 20 tabs excel spreadsheet with each tab running into thousands of lines. We just need to know the key drivers and try to model it as simple as possible. So that's what the following table tries to achieve.

SIAEC's FCF analysis

On the left we have SIAEC's FCF for the past few years. As stated, it had stagnated. It only made S$168m in FCF in the last year which was less than half of its peak at S$353m made in 2011. However the average FCF is a much more decent S$233m over the past seven years which translates to a FCF of c.6% (shown in the far right as FCF Yield). In the projections, in the middle, we try to forecast the future FCF. As with all predictions, it's almost 100% that we won't get this right. The whole purpose of doing the projection is to have a sense of how the stock price is trading vs its intrinsic value.

So as simple as it can be, we project its Dec 2016 FCF to be slightly higher than average of S$233m at S$245m. This is also what the company might be able to achieve in 2016-2017 after a weak 2014-2015 esp with the opening of T4. For the next few years though, we are projecting a 10% increase in FCF per year for three years as we expect T4 to be up and running full speed by the end of 2017. Then in 2019 the growth tapers off at around 3% per year. With this scenario, we get to an intrinsic value per share (IVPS) of $5.2 with an upside of 36% (beside FCF yield). Incidentally, the stock hit its high in 2013 at $5.29! Often times, we see such convergence between technical and fundamental analysis.

In the next post, we will dive into the full DCF calculation and analysis. But for now, it suffice to say that SIA Engineering looks like a good investment giving 36% upside. Its moat had allowed it to generate both a good ROE (at 16%) as well as a 6% FCF yield. It has consistently paid dividends and continues to pay c.4% today. This is one of the true blue chips in the Singapore stock market.

The author owns SIA Engineering since 2013.

Tuesday, August 16, 2016

2016 High Dividend List - Singapore, US, Australia

It's out!

The second section of this year's list threw out a few interesting names in the tech, finance and other sectors and there's an interesting discussion point that would serve to transform fundamentally the way some of us might want to invest! Yes, it's a big deal. First, here's the list:

2016 Dividend List - Part 2

Again, since the list gone global, Singapore names were relegated. To just one in this second portion - SATS. This name had appeared multiple times over the years, it continues to be a good firm although valuation might be too expensive at this juncture. The issue with SATS could be more fundamental depending on how we want to look at it. More on this later.

There are actually a few interesting names here which we could discuss a little and interested parties could do more work. In my opinion, some of these are moat companies, but unfortunately time is always limited and there is not enough work done to be able to make buy decisions. Western Union is a global payment network that serves the un-banked, under-privileged class. Most of us in sunny Singapore perhaps only use Western Union for sending money to Philippines for domestic helpers. And this is their moat. It's a powerful business that the firm has built over many years and today links 500,000 financial institutions across the global. The big risk is how the internet and dotcom can disrupt the business but again this is an unknown. It might take years, or it might be like Uber vs taxis - taxis globally are suffering bcos of Uber. For payments into emerging markets, we haven't seen any strong global challenger yet, so perhaps Western Union is safe.

Symantec is another super interesting name as it is touted as the cybersecurity play. As everyone would know, cybersecurity is a big thing with global hacking and global scamming becoming so rampant. Large MNCs are actually at their wit's end against hackers. We heard about these large scale hacking at Sony, Target with credit card numbers stolen etc, and heard no solutions. Even in Singapore, we had these scams with our banks and the banks couldn't do much to recover the lost monies. It's a big problem. Symantec has a strong track record in anti-virus and this business generates superior free cashflow (FCF) year in year out. However anti-virus is actually quite different from cybersecurity. The firm had been trying to market itself as a leader but savvy investors know all too well. It just spent four billion dollars buying Blue Coat, a supposedly real cybersecurity play. So if they were already a leader, why spend the kind of Jho Low - 1MDB money buying Blue what? Well, there is not enough homework done to draw conclusions. It's something interesting but let's move on.

IBM, the tech stalwart, trading at 10% FCF for a few years now, with a 3% dividend and a $100bn revenue. Some say it's the big data / A.I. play given its strong branding with Watson (one of the real viable A.I. business solutions). Of course more than 50% of its revenue is recurring by locking customers in binding software contracts and it continues to move into ever higher margin businesses like consulting and platform solutions. But with such a big base, it is struggling to grow. Buffett also hasn't made money here although it could be said that of the three quick highlights, perhaps IBM would be the safest. It's the cheapest in terms of PE and FCF and mostly likely the one to sustain or even raise its dividends - that's what this post is about yah?

There are some interesting Australian names as well. Computershare stands out as a database for listed companies in this part of the world. There are a few comparables and the one in Singapore being Boardroom. The business is mundane but cashflow generative. They handle share registries and provide software that specializes in share registry and stock markets and also provide corporate trust services. It's like IBM's recurring annuity business and there are very few competitors globally. It looks good at a first cut but again, more work needs to be done. 

Okay, back to SATS. This is a great franchise selling food to Singapore businesses. Its core focus is of course its airline food business where it has a monopoly selling to all the airlines stopping here in sunny Singapore. With Changi expanding terminals out to T4 and T5, SATS would just ride on our traffic growth. It has other businesses like selling food to our beloved armed forces, food to cruises and ships and what not but those are pretty marginal. So what's the issue?

The issue is much more fundamental and something to really think about along the lines of ethics and the way we want to really invest. SATS also has an abattoir business which involves taking lives and hence putting some vegan investors off. Now this may not be a big deal to non-vegan investors but let's extent the concept further. 

Natalie Portman Vegan Quote


#37 on the list is Imperial Brands, the fifth largest tobacco company in the world. Again this is a strong dividend play that gives out 3.6% dividend while generating a stellar 6.5% FCF yield every year. And it will continue to churn out cash enough to drown investors. Tobacco is one of the best business in the world. It costs almost nothing to make cigarettes, decades of regulations have restricted marketing expenses to pittance, hence gross margins are super high at 70%. The irony is that despite such high margins, tobacco companies can raise prices year in year out with dictated tax increases which further improves margins. There are also no new competitors since new entrants cannot market their products and hence unable to grow their market share. As such, existing tobacco companies have become global oligopolies, maintaining their global share and piling up mountains of cash, all of them. Meanwhile despite the number of smokers declining (as they die out) and the number sticks smoked also dwindling, volume reduction had been more than offset by price increase and tobacco companies had grown earnings at double digits due to what we discussed, and will continue to do so for the foreseeable future. So it's not just strong FCF but strong and growing FCF!

Warren Buffett had described that tobacco companies are one of the best businesses to own, yet he doesn't own one. Why? Because tobacco and smoking is also the single largest cause of human death in the history of humankind. According to the website Tobacco Altas, tobacco had killed 100 million humans which is more than the number of death for WWI and WWII combined. Projecting forward, it would be responsible for 1 billion deaths by the end of the 21st century. Okay, some might dispute these numbers, but throw your own number, it definitely doesn't change the fact that tobacco killed a lot of people.

So here's the important point, do we want to invest in companies that are killing people? Or killing animals? Destroying lives? This is a big question and it is also difficult to draw the line. If we are still eating meat, then why stop buying SATS? Should these actions be synchronized? What about gambling stocks? Genting is another great business, but do we want to be partially responsible for destroying families? What about companies making firearms? Or companies involved in drugs? Or even Pokemon GO? Or for that matter, all addictive games since there are millions of youngsters throwing their lives away in virtual worlds when they could have done more in this real world? 

Buffett himself hasn't sorted this out. He had been lambasted for being invested in Coca Cola knowing that sugar causes obesity and hence a whole host of health problems. The argument goes that if the Oracle of Omaha is really ethical shouldn't he say or do something about sugar? So it's not easy to deal with. The investing world is also grappling with the so-called ESG compliant wave. ESG stands Environment, Social and Corporate Governance. This is not new, in the past it was CSR or Corporate Social Responsibility and now it's ESG. The idea is to invest in companies that are doing the right things, and doing things sustainably, i.e. not harming our planet, nor the society etc.

I guess as individual investors, we should draw the line that is right for us. For me it would be selling out all my tobacco, gambling, abattoir names over time. For others it could be just tobacco. Or it could be no Pokemon GO names. Something to think about when hunting stocks or rare Pokemon perhaps.

Here's the past list:
2016 Dividend List - Part 2
2016 Dividend List - Part 1
2015 Dividend List - Part 2
2015 Dividend List - Part 1
2014 Dividend List
2013 Dividend List - Part 2
2013 Dividend List - Part 1
2012 Dividend List
2011 Dividend List
2010 Dividend List
2009 Dividend List

Thursday, August 04, 2016

2016 High Dividend List - Singapore, Europe, US

The annual dividend list is out! As per last year, restricting the list to just Singapore can only yield a handful of names, hence it's more worthwhile to see things from a global perspective. The criteria for the screen had not been change for years except minor tweaks. Here's the first 20 names:

2016 Dividend List - Part 1

There are two Singapore names in the list: Yangzijiang and UMS. Yangzijiang is a shipbuilder which unfortunately is stuck in a bad part of the shipping industry which would take years to unravel i.e. low probability of making good money relying on fundamental analysis. It might worth a trade but definitely not a moat company that value investors would buy and hold. On UMS, this stock started appearing in 2014 and its financials do look pretty good. It had been generating steady FCF since 2010 and currently trades at an impressive 12% FCF yield. Alas, there were also stories about the management which in this post serves to to flag out another important point - not to invest in companies with corporate governance issues.

One of the most fundamental principles in investing and perhaps in life is actually about integrity or trust. In the case of investing, it would be trusting the accounts, in life, it is about integrity. Sometimes, this is so fundamental that it is often overlooked and we get into big trouble because of it, like trusting a "friend" with money and never seeing the money or the "friend" again. In fact, because integrity is not 100% most of the time, we setup legal systems to deal with it. So if the accounts cannot be trusted, what's there to analyse? How do we apply fundamental value investing in such situations? The answer is we cannot, so when there is a reasonable doubt that the accounts or the management cannot be trusted, we are better off not looking.

Having said that, it's impossible to say if UMS is that bad, it's just one or two stories told in the market. There are more clear cut poorly accounted companies out there, some trading at multi-billion market caps. Sometimes, it takes years to figure things out. Sometimes even if it's figured out, the share price could pop! Re: Herbalife. The SEC ruled that it wasn't conducting its business correctly, but stop short of saying it's a Ponzi scheme and the stock pop! Such is investing, you can make money when you are wrong and lose money when you are right! 

Alanis Morissette's hit song really comes to mind!

It's like rain on your wedding day 
and good advice that you didn't take
and isn't it all ironic

Ok, back to investing, stock ideas and the dividend list, sadly the first part of this year's list didn't really give any good ideas. What stood out were the number of IT has-beens or energy related names which unfortunately would not be a good place to start. Would Cisco come back? How about a Chinese utility company? Not too exciting. 

If someone put a gun to my head and ask for one name, then perhaps I would suggest Michelin. This is not a high conviction idea. Again tires are pretty much old economy, and nothing to shout about. With self-driving cars and Ubers, the world view is perhaps one of "Who needs to change tires?" However, as long as cars don't fly, I believe tires will sell. Also a significant part of tire makers' earnings actually come from performance tires that we don't see as passenger car drivers and laypersons. These are tires that are used in aerospace, trucks, mining, construction etc. These had grown well over time and Michelin had been the dominant player in these are markets, alongside Bridgestone.

Michelin long term share price chart

Michelin's long term share price says as much. The chart above shows its stock price performance since 1990 and we see the familiar compounding chart. An investor could have bought the stock at 5 Euros in 1990 and made close to 18x today. Michelin generates 1-1.2bn Euros of Free Cashflow (FCF) today and trades at 16.7bn, i.e. giving investors a nice 6-7% FCF. The French are somehow simply just good at building brands. Who wouldn't love the Michelin Tyre man?

For some reason, to better its brand, it started its famous restaurant guide a hundred years ago and is now the Bible for food lovers worldwide. Singapore had the good fortune (some say bad) to actually see its version come out this year! For those who missed it, here's a portion of the Singapore's list (the well designed Michelin website does not make it easy to cut and paste the full list here)

Singapore's Michelin Guide (just one part)

So that's the first instalment of this year's dividend list with one important philosophy: find integrity, or not to invest in dubious companies, and one so-so stock idea: Michelin giving 6-7% FCF yield and a stolen food idea list (above) and as usual, we have all the past dividend list (below).  

2015 Dividend List - Part 2
2015 Dividend List - Part 1
2014 Dividend List
2013 Dividend List - Part 2
2013 Dividend List - Part 1
2012 Dividend List
2011 Dividend List
2010 Dividend List
2009 Dividend List

Tuesday, July 12, 2016

Great Scot! Brexit?

It's been three weeks into Brexit and the financial world now think that maybe it was never an issue at all? US S&P is back near all time high, the FTSE 100 bounced back with a vengeance and hit its high for 2016. Even the STI is now close to 3,000. Brexit? Nah. Let's Move On! That's market short-termism for you.

For most people, it was actually more disappointing that in the same week, England was knocked out of the Euro Finals. By Iceland. Ouch! People asked, "What happened?" This was the Great Britain, we were talking about the most powerful empire of the 19th century! First, it took a big retreat on globalization with Brexit, then it lost its prowess in football. To rub it in, even the British Gentleman spirit was lost when Michael Gove, a former Secretary of State for Education backstab his political ally Boris Johnson to announce that he would run for Prime Minister, and not support Johnson instead. It was one of the darkest days for the UK in recent history. May God not just save the Queen but the Empire on which the sun never sets.

English Football

Okay, things really looked bad. This could be it for the UK, literally, now that Scotland might want to seek another referendum for independence since the Scots really wanted to be part of EU. Great Scot! How are we gonna ship enough Johnnie Walkers if we are not part of the EU! If Scotland leaves UK, then what about Ireland? It would mean breakup of the United Kingdom. This further implied the same fate could await the EU and other alliance (ASEAN, NATO etc). This is MAJOR. Globalization has been the big trend of our lives and now the people of UK voted and demanded that they didn't want more. It was a vote that the common man said, "Enough is enough." It could be the beginning of the Great Class Divide, the elite vs non-elite. This is the rebellion against capitalism. It had already started in some ways. ISIS, random bombing and shooting, refugees, Donald Trump, even going back earlier in Singapore: Worker's Party winning Aljunied GRC!

Okay, breathe.

For now, let's drill a little deeper on the financial markets, what are the really big implications for Brexit? Where's the catch and most importantly where's the big money making opportunity? As markets become more and more short term, most market participants had already failed as long term thinkers, most simply prefer to trade. Brexit went from "Not Gonna Happen" to "Oh Shit" and to "Nah, it doesn't matter" in three weeks! It really showed something about the intellectual depth of the markets i.e. really shallow. Brexit has big long term implications that wouldn't have changed in three weeks, if what is described in the previous paragraph unfolds, this could ultimately lead to WW3, or some global anarchy, maybe we might evolve into the human society depicted in the Divergent Series. This is really big deal. Ok, hope everyone got the idea. Here's the three biggest deals today:

1. Currencies
2. Financials and F4
3. UK stocks

Needless to say, currencies saw the most volatility with the British pound or GBP collapsing to its 30 year low. In one fell swoop, the GBP fell from 1.5 against the dollar to 1.3. It was said that we might see parity. That has never happened since the pound and dollar exchange rate was recorded in 1791. The closest it ever got to was GBPUSD of 1.1 in 1985. Against the SGD, it also fell to an all time low of 1.77. Singaporeans are now rushing to change pounds and buy UK properties but alas no money changer would be dumb enough to effect that transaction now and banks are also unwilling to support the purchase of London condominiums. No easy lobang bros!

GBPSGD exchange rate

Meanwhile, the second order impact on currencies was even more significant. As the pound lost its status, the other currencies benefited. Obviously the dollar and Swiss Franc rose. In Asia, the yen strengthening much more than expected, negating the effects of Abenomics causing the Nikkei to plunge. The Chinese government took the opportunity to weaken against all other currencies in order to boost its exports, it was called a stealth devaluation, but this would cause further capital outflow. The Chinese simply couldn't have their cake and eat it. 

The other big impact would be on the global financials. The key cities that controlled the global financial markets were always New York in the States, London in Europe and the three Asian contenders: Hong Kong, Singapore and Tokyo. With Brexit, what does it mean for the financial gateway into Europe that was the UK and the hub that was London? If Brexit meant that UK loses its privileges as a EU country, perhaps a new hub might be needed. There is already talk of a F4 alliance (more on this later). This major stress strained on the global banks. JPM, HSBC and Standard Chartered fell 5-10% immediately but had since recovered. Again, vultures targeted the weakest links, such as the Italian banks and Deutsche Bank, now trading at 0.28x book. Investors are saying 72% of the largest German bank's book is worthless. As we had seen over the last few years, there is an increasingly discerning power amongst investors. Good stuff stays good. There was that 5-10% drop in the solid banks but that was it - the minuscule, small window to buy. In a week, everything good rallied. Junks though collapsed and stay cheap. 

F4 in Taiwan

Then there's F4. Sorry, no, not the Taiwanese boy band. Sorry. This is different. This is another gamechanger. Shortly after Brexit, the Swiss Bankers' Association took the chance of a lifetime and ran with it. They proposed forming an alliance by the same name F4 which comprises of four new financial hubs in Switzerland, UK, Hong Kong and Singapore as a counterweight against new possible emerging hubs in the EU: Paris, Frankfurt, Brussels etc. If this succeeds it would bring about a new force as the Swiss controls a quarter of global asset management business. It was proposed that the F4 alliance would coordinate positions on global financial regulations and create new international standards as well. This could even rival the US and make them conform to global standards rather than letting Uncle Sam always writing his own rules. It's a very interesting development to say the least and our beloved motherland is part of it!

The last point would be on UK stocks. So everyone was expecting UK stocks to be hit badly with Brexit and there might be opportunities to buy on cheap. Alas, the window was just one day - the day of the Brexit announcement. Then the stocks took off and never looked back. As said, investors are becoming very discerning when it comes to premium good stuff. Global powerhouses listed in UK like Unilever, Reckitt, Diageo (yeah Johnnie Walker) and even Royal Dutch Shell share prices jumped as the pound fell. This was because their business was global. While the stocks were denominated in pounds, since the earnings were global, a cheap pound meant that the share price should rally. This is an important point as most investors tend to only think about which currency their stock is denominated in, believing they would earn in that currency. But in reality, it doesn't matter! A rose by any other name will smell as sweet. A good stock denominated in ringgit would simply compound faster. Diageo's share price above showed as much. The stock did nothing for three years and rallied 20% mirroring the fall in the pound.

Diageo's share price

Diageo had been mentioned previously but it might worth reiterating that this might be one of the best stocks to own globally. Diageo is the world's largest spirits company with megabrands such as Johnnie Walker, Smirnoff, Guinness and Bailey amongst others. It has 40% value share in Scotch (whisky from Scotland) and is the world's largest producer of vodka. 40% of its earnings comes from the emerging markets while it continues to enjoy pricing premium in developed world with its key brands, It also has an unparalleled global distribution built over the last 180 years that ensure its products reach every corner of Earth. Pirates robbing East India Company's ships in Singapore were after crates of Johnnie Walker whisky in 1819. 

Diageo's Portfolio

Okay, fast forward to today, Diageo, with 20% of its earnings from Johnnie Walker, has been a cashflow generating machine given its business of selling highly priced beautiful bottles of alcohol to rich men and high end bars in the last few decades. It churns out GBP 2bn in FCF globally (soon to be GBP 2.5bn with the collapse in pounds) and this is expected to grow at a 5-6% clip annually. This means that Diageo's FCF doubles every 11-12 years and it had indeed been the case so far. Its FCF in 1999 was GBP 0.5bn and it grew to GBP 1.3bn in 2006 and now almost doubling to GBP 2.5bn in 2017. Of course the market knew this and bought it up since three years ago. Today, as was three years ago, Diageo trades at high multiples: 22x PE forward in two years, EV/EBITDA of 17x and FCF to market cap at a whopping 26x. It fell around 5% during Brexit to teens PE before rallying 20%. Now the ship had sailed.   

In conclusion, Brexit was a lesson about market's short-termism, the world's populace dismay at globalization and the wealth discrepancy it created, the possible emergence of a new financial order led by F4 (no, no, again it's not the boy band) and the power of great companies with strong business moats. On the last point, it was a reminder that we should simply buy a portfolio of these stocks and sleep soundly, not worrying over the whims and fancies of global markets.

Well, maybe Brexit won't really happen, it would take at least two years just to iron out the exit road map (and ten years to fully exit). Let's hope England do better in the 2018 World Cup and God Save the Queen!

PS: This writer owns Diageo.