Sunday, May 01, 2016

Teach Less Learn More - Lessons Learnt Part 1

Despite this being an investment blog, education posts written in 2011 and there after had delivered one of the highest pageviews as a result of our obsessively competitive education system and the interest it generated. There had been various changes since then: it was announced that PSLE would move away from the three digit scoring system, schools would be more holistic building on the TLLM (a.k.a teach less learn more philosophy) implemented almost a decade ago amongst other changes. Hence it might be a good time to give an update here.

Let's recap a few topics of the past:

1. Parents vs System
2. Teachers
3. Philosophy (new topic)

Parents vs System: this topic had been debated to the death, yes blame the kiasu parents. But the solution is not asking all the parents to stop being kiasu. That cannot be the case and as a parent, the solution is also not about stopping tuition for our kids, as to try to stop condoning the system which seemed to be some parent's mentality. If I do my part to not support the tuition industry, then the system has to change. Sorry it doesn't work that way. Tell the ladies: try not wearing high heels to stop condoning heels which are bad for ladies' feet, bad for stability and bad for the wallet. It doesn't work. Not letting your kids go tuition when he needs it in this day and age just makes it a handicap, likely purposely tying one arm behind in a boxing match.

Just to share another interesting revelation here. The education system in Singapore, in effect, is an epic battle between parents and their resourcefulness, the fight is not amongst students. As our young kids are made to learn more and more difficult concepts at younger and younger age, the key determining factor becomes how much resources the parents can put in the ensure their kids win. It is much less about the kids' true capabilities unfortunately.

Just take primary school math as an example: today an 8 year old Singaporean school kid is made to learn very difficult math concepts using fractions and algebra (but without introducing x and y and instead using bars and pies and what not) when their minds are not developed for these concepts. The solution to make them "able to do" these problems involve rote learning and memorizing steps without them truly understand the concepts. This requires major investments into either tuition or parent's involvement (time and effort) or both,  to make sure the kids keep regurgitate the rote steps to solve these math problems.

This is so silly, agreed?

This is like a video game where the parents throw money, time, resources to train their kid i.e. the character so that they can go fight other computer characters and prove their worth. Of course, the kids at this age simply move like the computer characters, fully controlled by their parents. Some good kids soon realize the game and become motivated to fight on their own, but alas, most kids are simply moving from command to command, like robots. We are training ourselves to be the gamemaster for our kids. This is the result of our f**ked up system.

Just to give the analogy a bit more meat, for some parents, the following game probably rings a bell. Animal Kaiser is a popular arcade video game where the player collects tonnes of cards in order to beat the opponent. These cards are of grave importance, some cards give the animal special powers, or even divine help, which is crucial during battles. Here, in the analogy, the parent is obviously the player, the kid is the animal that is going to fight all the other animals. And the tonnes of cards, which requires money, time and effort to collect represents the resources parents pour into their kids to ensure they win this animalistic epic battle. 

Animal Kaiser & Our Education System

So yes, in Singapore we are all stuck in this big Animal Kaiser education war. Our kids are all animals, training hard, controlled by their gamemasters (a.k.a parents) in this meaningless fight. Does it help them when they go to real world? Does the special powers exist elsewhere outside the game? What are we trying to achieve here?

Things really have to change.

For things to change, it has to be changes made to the system. Change cannot be asking the parents to stop what they are doing. Just like we cannot ask all ladies to stop wearing heels. We must change the system. Yes things are finally moving but unfortunately the changes are moving too slowly. We saw the PSLE changes and what not, which might help, but perhaps most importantly, we have to upgrade our teachers.

Teachers are the most important players in the system.

In the previous posts we discussed that teachers used to be quite well paid some 20 to 30 years ago. I remember my teachers when I was a student were relatively well to do. During those days, their vocation was a profession, they were respected members of the society. Hence they also had the luxury to buy good properties during those days and benefitted well from Singapore's property rise over the years.

Alas, today's school teachers are not having such fortunes. Public school teaching has become a job that is not well paid, very taxing and yet thankless. Parents are ruthless, demanding and oblivious to the consequences of their actions when they condone their kids' wrongdoings in school. Teachers are unable to tackle unreasonable parents given the change in their social status. This is a sad problem.

It is said that the crux of a successful education system ultimately depends on the quality of the teachers. We have destroyed this. We turned teachers into commodities and hence are now suffering the consequences. Is it a wonder now that we have to resort to a billion dollar professional tuition industry to educate our kids?

For things to change, we need to attract talent back to the teaching profession. A big part of the answer lies in raising the salaries of teachers. Ironically, in Singapore, money talks loud and we have to pour money to solve this problem which created the issue of having parents to pour money in the first place. The answer is as follows.

If we doubled or tripled the salaries of teachers, subsequently tightening the requirements such that only the best graduates can be teachers, automatically, the society would recognize this to be a noble job, giving it the same recognition in due time. However this is also easier said than done, most countries had not succeeded except some Nordic countries where they dictated that teachers needed to be PhDs and are paid really well. Subsequently, they raise the education standards, really making sure no child is left behind.

The Nordic education system which extends to early childhood education is said to be the best in the world.

Of course, the ability to pour money to solve the problem ultimately depends on the government's coffers. If the government has no money, then how can they double the salaries of teachers, who usually represent a huge number in the workforce? But Singapore's government has money. We can definitely pull this off if we wanted to.

Next, we talk about our system's philosophy.

Meanwhile a happy Labour Day to all!

Friday, April 01, 2016

Singtel bought out 8% for S$200m

Dear readers, it is a pleasure to make a splendid announcement today. Singtel has bought over this site for S$200m and all readers whom liked us on Facebook will get an equal share of the profits i.e. around SGD 500,000 per person. Woohoo!

Just kidding. Today is 1st of April after all.

Today we would like to share insights into some of the stocks that were discussed previously here. One of which was Colgate, the blockbuster toothpaste maker that dictate how Singaporeans brush our teeth. (Darlie is also owned by Colgate). It was reported that Colgate sales surged today as consumers found a new use that exhausts one tube in one hour.

Don't to this to your kids.

Another stock that caught the attention of readers was Herbalife. The firm that tricked users to buy tonnes of nutritional drinks to help lose weight. Alas, it didn't really work for most people nevertheless they continued to buy, deluding themselves that they will slim down someday. But when the nutrition was accidentally scattered on desktop PC keyboards, a strange phenomenon occurred.

Herbalife nutrition on keyboards

Herbalife stock spiked from $40 to $60. Again, please don't ever play this kind of jokes on colleagues on April's Fool. This is bad karma.

Okay, let's be serious. This is after all an investment blog where readers come to learn something. Today we discuss this issue of mind capacity. Investing is about having mind capacity. In this modern world, in today's time, we have to juggle much more than anyone in the history of humankind. We have to maintain jobs, health, family, friends and community and finally know more about investing and finance. We are parents, workers, subordinates, superiors, friends, brothers and sisters, sons and daughters as well as volunteers at the same time. There is so much to do yet so little time. Investing and finance usually comes as an after-thought. There is simply no time to manage portfolio, grow the nest egg and all the gimmickry talk about going for financial freedom and what not.

Or is it? Do we really have no time for anything?

The answer is not really. If we look hard into the details, like what we do when we analyse stocks. What we lack is mind capacity. Most of the "work" today does not need physical labour. We have it toughest when we are in the gym, probably. Most of the time, we operate in a sedentary mode. We write emails, make phonecalls, go for meetings. All these does not require physical effort. It requires mental effort. Our brains are wired to try not to think too much. We space out easily after some real mental work. In fact usually during real work and really important meetings. Most people cannot focus and concentrate for 30 minutes. We crave distractions. Actually some surveys showed that most office workers spend 30-40% of their time surfing the net and doing really non-work related stuff. Our minds simply lack the capacity to function a full day and carry out all the tasks that is required.

Think about it, most tasks usually do not take more than 1-2 hours. Be it writing an email to our CEO or Chairman or presenting to a group of 100 people. But our minds make it so dreadful that we can't even sit down properly to draft the email or the powerpoint. It's our limited mind capacity. For most people, accomplishing 2-3 real tasks per day seemed like the max. Some good ones can do 4-5. But in reality, shouldn't it be 10 or even 18 since we have 10 working hours per day and 18 waking hours per day?

Our capacity can definitely be increased. The question is how.

In the world of finance, this has been recognized for some time and there has been various methods mentioned to help people cope. We shall discuss three today.

1. Beginning the day with good intentions
2. Reducing distractions
3. Yoga and meditation

The start of the day is actually very important but the modern society has seemingly moved away. Singapore has a culture of starting later following Hong Kong and Tokyo. Most young people sleep to the last minute possible reaching the office just in time before 8 am or 9 am depending on when the firm starts. Parents are bounded by the primary school bell ringing at 7:30 am. But what's really productive could be starting way early like 5:30 am, have a good wake up routine that sets the tone for the day. Be it an early morning run and then spending a few minutes thinking through the tasks of the day and setting the best intentions to accomplish them. As the day flows, the mind capacity will diminish, hence it is important to work on the hardest stuff early on. The end of the day will be for winding down with light reading, playing with kids and so on.

Waking up at 5:30 am? Yes start the day early!

As such, investing and finance might need to come early in the day, provided it's an off day and work is set aside. If not, then it has to come during the weekend mornings. Do make it a habit to think through investing and personal finance maybe once a fortnight or at least once a month. Slowly building our knowledge over time. Let's hope to see traffic bump up on this site on Sunday mornings!

On reducing distractions, this has be taught for some time. It is about cutting ourselves off emails, phones, chats, Facebook when real work needs to be done. These are powerful distractions and we can hardly resist them in this day and age. We reach for the phones during meals, walking, driving, and needless to say during meetings when it gets bored. This is our cravings in control, not us. So do away with all these. Stipulate time for checking emails and whatsapp or Facebook. Do the real work when it is required.

Yoga and meditation relates to the first point. Some people put this into their morning routine and it works well for them. It might be worth a try. Both yoga and meditation are the modernized versions of very traditional Buddhism practices to calm the mind and free it up for more capacity. Our mind capacity is like an engine, it needs a good warm up daily. It is also akin to rebooting the computer when it is running out of memory. Hence lunchtime yoga is also very popular. There is also a growing trend for other religions to follow meditation given its benefits e.g. the meditation movement in Christianity. Also, praying is actually very similar to meditation as it focuses the mind on doing one very important task - connecting to the Ultimate Being. This is essentially the same as calming down the monkey mind.

Our monkey minds cannot stop jumping. We are constantly thinking anything and everything. We think about the past, the future, the next task, the last argument, the meal tomorrow but rarely about what is happening now. This is our nature. In order to increase our mind capacity, we have to tame it first. With every successful reset, be it a yoga session, or praying or meditation, the capacity increases a little. Hopefully over time, we can do ten tasks a day, one of which is thinking strategically about our investment portfolio.

Happy April's Fool!

PS: For those who haven't figured out, sorry Singtel is not buying this site YET. 


Wednesday, March 23, 2016

Overseas Education Ltd - Part 2

This is a continuation from the previous post.

A quick recap: Overseas Education (OEL) operates one of the largest international schools in Singapore and was listed on SGX in 2013. The stock has since collapsed below its IPO price due to the three issues discussed previously.

1. It move from Orchard to Pasir Ris, a less prestigious location and lost 20% of its enrolment.

2. Competition has increased with now over 70 international schools in Singapore.

3. The global economic woes hit Singapore hard with lots of expats losing jobs and going home.

OFS senior year students

As alluded to in the previous post, these are likely short term issues that would be resolved in a few years. Yes, value investing is a game measured in years. While these issues could persist for say 18 months, it is likely to normalize over years. So for readers looking to play monthly or quarterly games, well, then, this post is not really suitable. Although these same readers would probably not mind ogling at picture of the senior year students provided here. So read on!

Just joking, the above is a pic taken from The Princess Diaries starring Anne Hathaway when she was 18, fifteen years ago. Today, she is more beautiful as Catwoman (shown below) but alas OFS students are even more beautifulier. This hopefully inspires some readers to go kick the tires by doing actual visits to Pasir Ris :) Anyways, back to long term thinking, here's the thing, if we look out in years, not months, enrolment should have bottomed. OFS has managed to grow enrolment steadily for the last 20 odd years. It is likely to keep growing if we are willing to look out a few years. On average, it has experienced net gain of 150-200 students per year over its long history. So hypothetically it should get back to pre-move enrolment of 3,600 in just three or four years.

Anne Hathaway today, looking more beautifulier

As for competition, while there are c.70 schools in Singapore, the top few schools command high market share with their capacity and brand name. These are the numbers: there are c.40,000 students but the top five schools accounts for c.50% of market share. This means that the remaining 65 schools are not actually competitors as they can hold only a few hundred students each. Simply put, they are barely a tenth or a fifth the size of OFS. In fact quite a few of these schools are struggling to survive. If they do close down, OFS stands to benefit from their transferring students.

The world economy has collapsed in 2015 in the aftermath of China's slowdown, the bursting of the commodity super cycle and the bleak recovery in US and Europe. Global expats are moving back to their home countries and Singapore had its fair share of such woes. Despite this, it was surprise to see that the number of employment pass holders actually jumped from 175,000 in 2013 to 188,000 in 2015, a nice 7% increase over two years. This points to Singapore's continued attractiveness as a global hub for expats to come and work. As long as Singapore remains relevant, the number international students will grow and OFS enrolment should grow over time even though current enrolment is still weak.

Next we move to the financials.

As part of its listing requirement, OEL has produced detailed financial statements since 2010. Again, not to be confused, Overseas Family School or OFS is the name of the school and Overseas Education Limited or OEL is the listed entity. We now have five years of detailed financial statements. Analysis of its profit and loss, balance sheet and cashflow is quite straightforward, given the simplicity of the business model. Here's the cheatsheet:

OEL's Cheatsheet

As usual, this cheatsheet plugs out some of the most important no.s from the three statements and put them in a nice format for easy reference. These are numbers not from any single year but a mixture of estimates and actual figures for better analysis. For example: Sales of SGD 100m is an estimate of what OEL can earn in the next 1-2 years while current year sales is only about SGD 94m. Cash and debt are rounded to the nearest 10m based on last reported numbers.

Numbers in blue are derived from other numbers. We can see that the firm has incredible free cashflow or FCF yield (14.6%), Operating margins (24%) and so-so ROE (11%) but likely to increase as its net income normalizes in the next few years. The P&L is simply revenue minus costs, the largest being labour cost which is 58% of sales. The balance sheet has quite a bit of debt (SGD 180m) as a result of the past borrowings to build the new campus but that should decline over time. Free cashflow turned negative as it poured money into building the new campus but that should also normalize and the firm would likely hit 20-25m FCF per year as it did before it moved from Orchard to Pasir Ris.

As part of the drilling in this post, we look closely at these three numbers described above in detail for this cheatsheet, namely:

1. Labour Cost
2. Debt to Equity
3. Free cashflow and dividend

OEL employs international school teachers globally and it pays to get quality. As such, labour cost ie teachers' salaries is the highest cost component and would likely continue to be so. The school has established itself as the employer of choice for the global pool of international school teachers. These teachers usually sign three year contracts and depending on the student enrolment trend of the school, some would not be renewed. Conversely, the school also has a list of potential new hires for it to recruit rapidly when enrolment picks up and it needs more educators. While labour cost by and large will keep increasing over time with inflation, the school can offset this by increasing tuition fees. The school currently keeps slightly more teachers that needed given that enrolment just collapsed but that should pick up as discussed previously. Over the next few years, we can expect labour cost as a percentage of sales to drop closer to 50%. In short the firm has some flexibility in managing labour cost and offsetting it.

Next, we discuss the conversion of its debt enterprise value to equity enterprise value. OEL raised its debt significantly in order to build its new campus, resulting in the current situation of SGD 120m in net debt (180m debt - 60m cash). Its Enterprise value (EV) stands at SGD 299m. EV being simply market cap plus net debt (179m + 120m). Now, the enterprise value of the firm shouldn't change if the business is intact. So this means that as the firm generates cash annually to pay down its debt, eventually paying it to zero and attaining a net cash status as it has done so in the past, its EV should equate its market cap. This means that its market cap should jump from current SGD 179m to 299m ie up by 67% over time.

This is only possible if the firm keeps generating cash to pay down its debt. For OEL, well, it seems to work just perfectly alright. The firm is capable of generating SGD 20-25m of free cash flow per year, in fact, in the cheatsheet, it's even higher at 26m. This translates to an incredible 14.6% FCF yield, something as safe as a school rarely trades so cheaply. Even if we assume a more conservative number, say it can only do SGD 15m, it still translates to a decent 8.4% FCF yield and bearing in mind that it would use this 15m to pay down its debt means its market cap would grow by the same quantum per year ie 15m or 8.4% of 179m.

To sum this up, in a pretty bad scenario where things simply remain the same, OEL grows at a high single digit clip. If our thesis is right ie enrolment comes back, on top of the regular tuition fee increases, OEL is on its way to see its previous peak $1.02 (2.5x vs current price) and meanwhile we also get 4% dividend every year while it grows multifolds!

Disclaimer: this author owns OEL!

Monday, March 14, 2016

Overseas Education Ltd - Part 1

Part 2 is out!

Overseas Education Ltd (Bloomberg Ticker: OEL SP) is an intriguing small cap stock in Singapore listed in 2013 that almost doubled but then crashed spectacularly in the last 1.5 years. It now trades at 12% free cashflow yield, 11x PE and pays a 4% dividend (likely to be more going forward) and earnings are stable and growing barring Singapore's demise (i.e. our beloved little red dot one day becoming irrelevant).



For the uninitiated, OEL operates the largest independent international school in Singapore called Overseas Family School (OFS) providing expatriate kids with quality international education. It started in 1991 and currently has enrolment of 3,000 students. It is the third largest international school in Singapore after the Singapore American School (SAS) and the United World College (UWC). However, as it has no affiliation to any nationality, it is also the school with the most diversity in the world, boasting a record of educating kids from over 70 countries in our little red dot.

Well then, why did the stock collapse in the first place?

This was largely caused by its move from the prime downtown Orchard campus to Pasir Ris in 2015. It lost 20% of its enrolment and together with anxiety in the stock market since the start of 2016, OEL found no buyers for its stock. It is also likely that some large foreigner shareholders could be selling to get out of their positions which put further pressure on the stock price. Now, to me, this looks like the perfect scenario when value investors should pounce and buy when others are fearful and wait for the stock to go 2x (or even 3x) in a few years.

Well, let's not get too excited. To be fair, the bear story has a few valid points:

1. Losing the Orchard location was devastating, it lost 600-800 students with some in their early years which meant a lot of lost future income. But this is now all factored in the price.

2. Singapore has seen a huge increase in international schools and competition is intense. Last count there were over 70 international schools albeit some are quite small. There is now no longer any waiting list even at the top schools, this meant that Overseas Family School is facing a lot more competition.

3. The weakness in the global economy has translated to a lot of expats losing jobs in Singapore, which exacerbated the decline in enrolment numbers that we saw. These jobs include functions in the oil and gas industry, finance and managerial positions that might not be replaced soon. This meant less expats and their families staying in Singapore for the next few years.

We shall come back to these points later. First let's examine the bull case:

Education is one of the most fantastic businesses because the schools have a lot of pricing power. Parents are not about to be stingy when it comes to their children's education. They will pay an arm and a leg for good quality education especially if the school is "branded". Brand is very important and once built, its reputation lasts for decades (think Oxford, Harvard, Qinghua and in Singapore, Raffles and Hwa Chong) which meant that competition is actually largely irrelevant. Costs are relatively stable (teachers and depreciation essentially) and easily managed and offset by rising school fees which meant that marginal profitability is very high once the fixed cost is covered. 

OFS has been slowing building its brand name in Singapore for twenty over years albeit it has always been outshined by the Singapore American School, UWC, Tanglin Trust, Canadian and some others with affiliations to their home countries. Over time, however, it should slowly build stronger reputation given its dedication in hiring the best teachers and its sheer size and outreach in Singapore. It is well-known in the global recruitment of overseas teachers as one of the best employers globally. Hence its should have the ability to grow and retain its talent pool of teachers and continue to build its brand power.

Anecdotally, expat mums also like to share that their kids enjoy and learn a lot in the school and would not want to be transferred to some of the other top brands despite the school's low key profile. As a result of its diligence in hiring good teachers, emphasizing quality and good management of its strong executive team, it's enrolment had grown steadily from 200 students in its second year of operation to over 3,000 students today as shown in the chart below until 2013 (when enrolment peaked at 3,600 students). 

Overseas Family School Enrolment

OFS' test results have also improved over the years as a natural consequence of its focus on providing good holistic education. It has gradually nurtured more and more students getting more than 40 points out of the full marks of 45 in the globally recognized International Baccalaureate (IB) test. While it still has some distance from the three Singapore schools offering IB to Singaporean students (with c.25-50% of students getting 40 points or more), its test results are remarkable considering it does not have the advantage of nurturing most of its students for more than a few years since expats move around a lot to different global cities all the time.

Hence while OFS had seen a dramatic decline in enrolment as a result of its move to Pasir Ris, it should continue to grow as long as Singapore remains relevant economically and can attract global expats to live and work here. OFS should see net enrollment growing by 150-200 students or so which mean that it should take just 3-4 years for it to recover its enrolment to the 2013 level. From there the school could grow to fill up its campus capacity of more than 4,000 students at its new location over time.

One important point is this: even if enrolment growth is slower than expected, education, especially international school education, is a business that would see 5-6% price increase annually. This means that its FCF of S$20m currently should be the bottom because even without increasing enrolment, one should expect a base case scenario of its FCF growing 5-6% on school fees increase alone. Obviously there is quite a good likelihood that Singapore remains a magnet for expats, i.e. the number of students would increase by 5-7% per year (150-200 out of 3,000) and FCF explodes to S$30-40m by growing 10-15% over the next few years. At S$170m market cap today, this stock is a steal!

Next post, we look into more details surrounding its financials and the risks.

Disclaimer: The author of this post owns OEL!

Tuesday, March 01, 2016

Negative interest rates, skyrocketing asset prices!

This is a continuation of the previous post.

Inflation had always been around, so the nominal zero that we saw was never really zero. Inflation of 3% meant that money depreciated value 3% every year, we just didn't see it so we think it's not there. When inflation is 3% and interest rate is 2%, effectively money in the bank is still being burnt. After the Global Financial Crisis (GFC), nominal interest rate became zero, but inflation was around 1% and hence real rate was already negative. But unfortunately our primitive human minds can only think in nominal terms, not real terms. Hence in the long history of financial markets, nominal interest rate  (ie the one that we have been talking all this while, which is the one always quoted on TV and news) didn't need to go subzero since inflation was always positive.

But now that inflation is negative, things are really different, and actually also dangerous. It might make sense for interest rate to go negative. In real terms, we will still be fine though. In negative inflation or deflation, money now appreciates in value, so negative interest rates serve to stop that appreciation which is not normal and actually harmful.

Banana money issued in Singapore during WWII

You see, deflation is a silent killer. It is not as dramatic as hyperinflation when money becomes worthless like how Singapore's own history with banana money showed (pic above). Banana money notes worth $10 might be just $5 a few months later and then dropped to $3 after a year or two. By the end of the war it was not even justified to be used as toilet paper. There was a famous anecdote told by our late founding father Mr Lee Kuan Yew that when he received his salary in banana money, he simply bought anything he could because the money would be worth much less very quickly. So he quickly bought stuff like a billiard table, machines and what not even when he had not much use for them. It turned out to be an important strategy.

When the next global financial crisis hits, it might be worthwhile to learn this because fiat currency and investment assets could become worthless as the global financial system comes to a halt. It would be vital to own hard assets that are useful for sustaining life: land, livestocks, electric vehicle, solar panel and power generator etc. Well, that's story for another day.

The topic of the day is not inflation but deflation.

Deflation, as alluded to in the previous post, causes a different set of problems. First prices to decline, that's by definition. This procrastinates consumption, slows innovation and brings economic growth to a standstill, which exacerbates further price declines. It creates a vicious cycle and leaves the economy in stagnation. It's a slow death process that could trap an economy indefinitely. Again, we have go back to the Ant-Man analogy. It really feels pretty much like being trapped in the subatomic quantum realm.

Quantum realm, or rather, the black hole from Interstellar

Economic theory tells us that interest rate is the key lever to pull to regulate the economy. Inflation is one of the results that we see, the others being employment and growth. In an economy that is growing well, inflation is usually at around 2%. Interest rates could be around 2-3% to be moved up and down accordingly. If the economy is weak, interest rate should be lowered to stimulate growth and vice versa to prevent overheating. However, conventional wisdom put a limit on this powerful interest rate lever. Interest rate cannot go below zero. When the Global Financial Crisis (GFC) happened, interest rates were lowered to zero. But it wasn't enough. Now that China is at the risk of imploding, coupled with the world slowing drastically, the global central bankers are at their wits end.

Drastic times calls for drastic measures. In order to stimulate the global economy which is not growing and having negative inflation, a few countries started with negative interest rates. If zero interest rate is not enough to get people to borrow money, then we pay them to borrow money! In theory, this should work if it's not prolonged. People would wake up, work harder, come up with ideas, create new businesses which would require capital, borrow money, increase consumption, innovate and in no time, the economy is up and running again.

Unfortunately, reality works differently.

If money being deposited into the bank costs money rather than earning interest and if lending to people means I have to pay the borrowers instead of them paying me, then I better do something else with my money. What will happen is asset inflation. For quality assets, it would be massive asset inflation, perhaps even hyper inflation. The most accessible hard asset for most people is property. So negative interest rates also mean that property prices will skyrocket. This has important implications for Singapore's property market.

Stylized chart of Singapore Property Price vs Value

The chart above shows how Singapore property price and value had move over the past 10 years. Essentially prices nearly doubled from 2005 to 2008 but collapsed as a result of the GFC but went on to more than double, peaking at 220% of 2005 prices in 2013. The red line shows my estimation of the true value of Singapore's property. Recall that in value investing doctrine, we buy when price is less than value. Unfortunately, this only happened once in the last 10 years for Singapore property. This was in 2009 when the blue line i.e. price dipped below my estimation of value which is the red line. Well, we might get a chance in 2016 and 2017 if the world hadn't gone into negative interest rates.

In the following chart we try to understand what happens to value and ultimately price in the negative interest rate environment or NIRE. This has nothing to do with basketball shoes. Here we show prices in blue (price) and red (value) again, essentially the same data points from the previous chart but we also added a purple line.


Stylized chart of Singapore Property Price vs Value in NIRE

In the red value curve, I assumed that Singapore property value grew at 4-10% over the past 10 years. (4% growth during the lean years and 10% for the boom years) and should grow around 4% until 2020. Singapore is a mature economy and hence growth at 4% would roughly mirror GDP growth which is fair. This is just simple compounding at work and we see that in 2020, Singapore property value should be around 2.5x of what it was in 2005. In the graph, it reads about 250 on the y-axis. This means that if property prices remain where it is today until 2020, value gets to be higher than price and we would be able to buy Singapore property soon!

Alas, with the reality of NIRE hitting us (NIRE again stands for negative interest rate environment and has nothing to do with basketball shoes), what is likely to happen is that global money will start chasing high quality assets as discussed in the first half of this article. Singapore property is at the forefront of high quality assets. Global rich started buying Singapore around 2005 which caused prices to skyrocket as we had seen. Billionaires from all over the world starting to buy up bungalows. District 9, 10, 11 properties are already used for money parking of rich Chinese, Indians and Indonesians. This is going to further exacerbate.

This is depicted in the purple line in the same chart. While the red line shows a pedestrian growth in value mirroring GDP growth, negative interest rates know no bounds. We know that property value doubles when rental yield drops by half. Now that yield can go negative, it could only mean value can only skyrocket! In the chart, I arbitrary computed that value could shoot up to 600 by 2020 (vs only 250 for the red line).

To put this into better context, let's use some real numbers. In the past, say a good property in a good location (i.e. District 9, 10, 11) have provide a monthly rental income of S$4,000. This comes up to around S$40,000 a year after subtracting the peripheral costs. A property, valued at 4% rental yield means that its value should be S$1,000,000. As global interest rates fell, some of these good properties are being valued at 2% rental yield, which mean S$2,000,000, which is roughly what it is today.  This was more or less what happened with the Singapore property market over the past decade. Then the government stepped in to cool it down, some rationality prevailed and prices finally started falling in 2014 and 2015.

With negative interest rates, it means that money being put in the bank would lose value. The banks will be charging 1% for funds park there. These rich people having 10 million dollars in the bank will not be happy paying that bank $100,000 every year. They will be happy to buy Singapore property at 1% yield or even 0.5% yield. At 1% yield means the same property we talked about is worth S$4,000,000 and at 0.5% it is worth S$8,000,000. We may see Sky Habitat selling at $3,000 psf some day. This is the reality facing us.

Can this prediction be wrong? Of course, and actually it shouldn't be viewed as a prediction.

Nothing is ever cast in stone. The future is always a set of probabilities ascribed to a few scenarios. This could be one future reality. Its probability of actually happening gets higher if more central banks adopt negative interest rates. The big swing factor being the US Fed. There is always the alternative reality that the world finds its growth trajectory again, we move away from NIRE *Phew* and we get one chance to achieve the Singapore 5C dream again!

Let's hope that's the future waiting for us.

Thursday, February 11, 2016

Welcome to the World Of Negative Interest Rates!

The world is going to be a very different place. Since time immemorial, interest rate had been positive. This was very logical, at least to humanity. If we lend someone money, we are expected to be paid interest and at the end of the loan, we would get back the principal. No, that doesn't work anymore. The new rule is if we lend someone very, very credible some money, we would pay this person interest for the privilege of lending him money. Sounds great yah for people like us who are very, very credible! Welcome to the world of negative interest rates.

How did this absurd logic happen?

Well, we need to trace back its origin to the Global Financial Crisis a.k.a. the GFC. It was always said that there were three parts to this trilogy. It started in the US with the expansion of sub-prime credit which finally caused the Lehman bankruptcy. It then spread to Europe, as European banks held a lot of bad mortgages as well. This culminated to the Greek sovereign debt crisis. Now the issues are moving to Asia. This is the last instalment, when the excesses created by the Chinese government trying to avert the GFC caused bad debts and shadow loans across its whole financial system, which is now starting to implode. 

However, the world cannot afford to let China implode. In order to prop up global economic growth, central banks all over world needed more tools. Alas, the most powerful tool it had in its toolbox always had a limit - central banks could not reduce interest rates below zero. It contradicted human logic. So they used other half-fucked methods like QE, QQE, QE2, QE Infinity. It didn't work. Hence, we override the regulator and decided that we should go subzero into the quantum realm, In other words, we removed the arbitrary limit of zero and introduced negative interest rates. 

Ant-man going subatomic to fight his nemesis

Who said interest rates should always be positive? 

The Swiss and the Swedish were the first to experiment with the subzero realm, they have already dropped rates to minus 1%. This actually resulted in bizarre situations like some Swedish sex therapist actually receiving seven Kroner every month for her consumer loan. She's not complaining. The European Central Bank then went negative as well. And last week, we saw Kuroda Sensei bringing out his bazooka and brought the 10 year Japanese government bond interest rates to -10bps. This means that whoever lends money to the Japanese government is willing to pay the Japanese government 0.1%, every year, for ten years. The Japanese government is after all a very, very credible borrower. Investors are happy to pay to lend them money.

Okay, so much so for bizarre advanced countries. Now how might this impact the man on the street? 

So far, bank deposits had been shielded. While consumer banks pay central banks to put reserves with them, the negative spread that these consumer banks incurred were absorbed. However, if rates go further negative for much longer, it would come one day when we have to pay the bank to put money with them. After all, this is again a human-made logic that banks should provide banking deposit services for free. Why should it be free? 

Years ago, when the local banks imposed a fee for deposits less than $1,000 or some other amount, consumers cried foul. Today, it is the norm that is recognized widely: there is a cost to maintain a bank account and we need to put in at least a decent amount. So if we extrapolate the argument, we might some day need to pay the bank to put money, any amount. Theoretically, it could be up to 2-3%. Most credit cards companies charge 2-3% for using their network to settle financial transactions. It had been shown that this could work. So when push comes to shove, the banks might charge 0.5% to 1% initially and move it up to 2-3% for deposits over time. 

Those not willing to pay up can start buying high tech safes to store cash at home. At the same time please make sure no policeman sees your cash and be very careful if they were to conduct an exercise to determine that your safe is indeed safe by asking you to transfer the cash elsewhere. You don't want another Iskandar Rahmat to come after you! The moral of the story here is that there is a cost to deposit money, so consumers would come to the idea that they would have to pay for this service.

The other bigger implication would be inflation of goods and services and more importantly - asset inflation. Interest rates had always had a counterpart called inflation, the invisible enemy. Inflation is much tougher than Ultron or the other Avenger enemies that we have seen. Inflation cannot be too high, once it goes beyond 15-20%, it would morph quickly into hyperinflation becoming uncontrollable and would bring down the space-time continuum and the destruction of the universe. No lah, not so dramatic, but still, it could cause money to be worthless almost overnight, like the Deutsche Mark after WWI or our own banana money during WWII. During those days, whole existence of central banks centered on how they would fight inflation.

Inflation: the metaphorical Ultron

However inflation cannot be too low either. Inflation at 0-1% quickly meant that they would slip into the negative zone. This creates another set of problems like what we saw for Japan from the 1990s till today. Deflation meant prices kept falling, people procrastinated consumption, the economy stagnated, nothing grew, innovation stopped leading to more falling prices and less consumption. It became a vicious cycle. This was why Kuroda Sensei meant literally he would do whatever it takes to tame deflation. He had fired rounds of QE and now the negative interest rate bazooka.

Unfortunately, the world is slipping into this same problem Japan had faced for two and a half decades now.

Interest rates were setup by central banks to calibrate inflation into the sweet spot of 2%. But this is a profound art. It's so hard that no one has succeeded. Alan Greenspan was supposed to have succeed but it could now be argued that by eliminating the normal cycles over that many years (again around two and a half decades from c.1980 to 2005), the Fed created the GFC. We all need our ups and downs to recharge and grow. Earth has days and nights, summer and winter. Life has birth and death and offsprings. That's just universal.

So when inflation goes negative, in order to effectively combat that, interest rates had to go negative. This could be the future.

More on this topic in the next post!

Thursday, January 28, 2016

Lessons Learnt: Sembmarine and Keppel

Our beloved oil rig manufacturers had suffered a catastrophic decline in the last 18 to 24 months. Keppel fell from $10 to $4.8, a 52% drop and Sembcorp Marine collapsed from $4.5 to $1.5. a 66% free fall. Sembmarine's parent Sembcorp Industries didn't do that well either, falling from $5 to $2.2, again a more than 50% decline from its peak. All three stocks now trade below book, with single digit PE, with no recovery in sight. Apologies to anyone who had took advice from previous posts and bought these stocks.

Investing is as such. 40% of the time we get things wrong. With discipline and experience hopefully our wrongs are just 20-30% drops while our rights are home runs at 2-3x, which makes the overall portfolio return decent. Once in a while we would get these disasters. Then it's vital that we learn our lessons, take down good points and become better investors with them. This is the objective here today.

The original thesis with Keppel and Sembmarine was quite simple: it was a bet on energy, they were top global players in their field and they had exposure to growth in Brazil, US, North Sea, Middle East, which were growing very well not too long ago. Let's elaborate on these points:

1. Energy was the place to bet a few years ago. We have all been taught that we would run out of oil in time. I remember the limit was 20 years when I was a student 20 years ago. My teachers told me that the world would run out of oil in 20 years. Again that prediction did not come true. But it would also be true that we wouldn't have more oil right? Well we now have LNG and shale gas but still, it's not sustainable to just keep digging from our planet. Considering the growth of global economy, it's probably not incorrect to think that we cannot continue to rely on Mother Earth for fossil fuel forever. So the energy bet should be a long term positive return bet, we will run out of oil, oil price will skyrocket, Keppel and Sembmarine benefits from that. In theory.

An oil rig

2. Global #1 and #2: These two firms are the top manufacturers globally with combined 60% market share in oil rigs and they also have the technological advantage to do more. Both firms also started building other equipment like drillships and floating platforms. They also had very good global brand names and won large orders from Brazil, which unfortunately became the major cause of their downfalls. With dominant global share also meant that they had economies of scale, they could procure raw materials cheaper and could built the final products at lower costs vs their competitors. One very important factor that was not talked about was also the designs of the rigs. There are only 3-5 designs globally and both firms went to acquire these design firms years ago to make sure that the important ones would be kept in-house. This meant that future competitors i.e. the Koreans and Chinese would not be able to lay hands on these superior designs. They had to buy from the the remaining 1-2 independent designers out there which meant higher costs both for the design payments and the construction of inferior rigs. So we are betting with the winners, what could go wrong?

3. Betting into Brazil, US, North Sea and Middle East. It's always good to diversify our bets and it came as a good idea to be able to buy Singapore firms that had exposure in some of the fastest large growing economies. Again, that looked pretty good just a few years ago. Now the collapse in oil as well as other issues caused a lot of these economies to face serious growth impediments. It's consensus now not to invest in these markets at least for the next few years. 

So it was really a perfect storm. A metaphorical oil rig blow up like the one BP had in the Gulf of Mexico. Well, so much so for the past, what are the lessons learnt and what could we do better?

The biggest overlook here would be the crude oil price cycle and oil related heavy equipment investment cycle. While it's true that the world is short of energy and would likely be even more short going forward, it's also true that such cycles come and go and across decades. The following chart shows the prices of crude oil going back to the 19th century. We can see that crude cycles last for decades. Of relevance in recent times, one would need to look at the oil shocks in the 1970s and the long lull in the 1990s.

Long term crude oil prices

So analyzing Keppel and Sembmarine's ten or even twenty years of financial statements wouldn't be enough. We would need to see what happened in the 1990s and better to go back to the 1970s during the oil shocks. Obviously, that's a lot of work given that most readers here might not had been born in the 1970s. So while looking at the free cashflow (FCF) for Sembmarine from the late 1990s we see that the firm could do SGD 100-200m per year, this was not enough information. Looking back long enough, we would know that oil capex cycle could be as long as 15 to 20 years. There could be a period of time of maybe five years or more when these firms had mediocre or no FCF. Armed with this info, it looks like Sembmarine could be stuck in this state for the next few years. So that's the first lesson, not going back into history for long enough.

The other lesson learnt would be the most important lesson in value investing: it's not having enough margin of safety or MOS. When it was first proposed here that these are interesting stocks to look at, Keppel was around $8 and Sembmarine was around $3. They had fallen 20-30% from their peaks, FCF was strong based on the last few years, dividend was decent as well. Back then, the thinking was that, for these bellwethers in the Singapore stock market, getting a 3-4% dividend at mid teens PE were probably good deals. This was very gullible thinking with very little margin of safety.

Value investing doctrine taught that margin of safety should be at least 30%. Clearly with only 20% discount from all time highs didn't cut it. It didn't help that these were not staples or software, ie businesses with very low capex needs and high ROIC. These businesses were cyclical with different dynamics. Greed and exuberance in good times were culprits too. 15x PE looked cheap in bull markets, not across cycles. Well, markets are fair and whatever lessons that weren't learnt well enough would be taught again. So with oil prices crashing to $30 and these stocks falling over 50%. This margin of safety lesson come right back to haunt. So it's worth stating here in bold again: the three most important words in value investing is margin of safety.

Investing is as such, the future is unpredictable. Who would have predicted just a few months ago that oil would crash below $30? But having said all that, there are a few saving graces. Oil could easily rebound to $60 with some catalysts: be it Saudis cutting back production or some supply shock somewhere. Punters would drive these fallen angels back up a good 20-30% if oil rallies 100% (from $30 to $60). So that's a short term plus albeit a big "if" for oil to rally back to $60.

Also, other parts of the long term thesis remain intact. They are still the strongest players out there and they will emerge stronger in the next cycle even though it's far away. The Koreans and Chinese would fall further behind given the lack of scale and access to the all important rig designs. There could be value emerging now amidst all the doom and gloom. What's more, the firms themselves are not sitting still. There is now talk that Keppel will be reorganizing the whole group including divesting other parts of its business to unlock value within the group and also to raise efficiency. This would create both cashflow and increase its market value. 

For Sembmarine, it is rumoured that its parent Sembcorp Industries might buy it back and restructure it to become a stronger player. So it could be a buy for both entities. It's a buy for Sembmarine as the parent would likely pay a 30% premium to take it private but it's also a buy for Sembcorp Industries because they would be able to acquire a good business cheap and ultimately extract some value by creating cost and sales synergies. All three firms are now trading at 8-9% FCF yield on normalized FCF, below book and near their GFC lows. As the saying goes, it's the darkest before dawn. Hope that the light shines on our oil rig builders soon.

Last words: Lessons learnt help us become better investors over time. Hopefully this serves to remind us always to look back into history for as long as it takes, have enough margin of safety and think more holistically about cycles and capex businesses.

Monday, January 04, 2016

Happy New Year! Let's talk about REAL Investing!

Happy New Year folks, it's 2016. This year is meaningful in a way since this site started out in 2006. So, a decade just whizzed by with some intermittent writing, some charts and lots of thinking and oh yes, thanks for supporting this site for the past 10 years! It's been great so far, and there's another 40 more years to go! We are on track to at least match Berkshire or SG50, and it so happened that Berkshire is actually as old as Singapore and celebrated its 50th anniversary in 2015. So in 2056, we shall have 8PA50 or something. Do hang around! 

Today we would like to discuss some interesting notions about investing, and hopefully correct the layperson's perception of what real investing is all about. To most people, investing likely equates to making money in a money's game, which is linked to trades, making good speculation, being some hotshot trader, like those protrayed by Hollywood, especially in the film Wall Street starring Michael Douglas. In the Singapore's context, some might remember Da Shi Dai, or The Greed of Man, an epic Hong Kang drama series about stock manipulation that propelled a few young actors back then to stardom, like Liu Qing Yun and Vivian Chow.

DVD Cover for Da Shi Dai

Well real investing is nothing like what was portrayed in dramas, movies etc. But the images stuck. Today, when we think about investing, we probably linked it to all of the above: speculation, manipulation, big money game making the rich getting richer etc. Most would think it's a good way to get rich quick. Singaporeans, luckily or unluckily, get exposed relatively early, like in universities but soon learnt this game is really not that easy. Armed with some rudimentary knowledge, a desk and buying a PC for this purpose, we think we could make big bucks. Aspiring one day, our desks would look like those portrayed in the movies. Maybe like the one below:

A dream desk

A desk full of screens, with live prices and we become some hotshot investors sitting in plush chairs. That's the image for most people perhaps. They think that an investor's job would be to monitor markets day in day out, keeping updated with real time news, understanding price movements, making lots of trades, looking smart. Sorry, that's all just in our heads. None of these are close to any truths. A real investor's desk looks like the one below:

Warren Buffett's desk

For Warren Buffett, he doesn't even have a PC although most modern investors today do have a basic one, for news, excel and online trading. The truth is, an investor's job is really to read and to think. Hence the real desk would be filled with books, reports, newspapers, magazines more reports and more things to read. Then we have the all important thinking tools ever invented: the pencil and the paper. That's the truth. That's real investing. Okay today we need Excel to crunch some numbers, but when we do reach for Excel, the bulk of the mental work is over. Hence the real job is to read and to think. To think better that all the amateurs out there. In order to achieve that, it's also important to discuss. To challenge ourselves by talking to like-minded people, people who are smarter than us to point out our mistakes and of course people whom we love to hang out with. So read, think, discuss. If we have to surmise the real job of investing into three words. That's the three verbs.

What's so difficult then? If it's just the three verbs. Well, golf is also about swinging a stick to hit a ball, but it takes years to master right? Simple things may not be easy to accomplish. Take reading for example. Most adults today read some stuff, like the newspapers or books or magazines but to be a disciplined reader takes a different mindset and perhaps it's really a different skill set. In fact, most people would not be able to keep reading for hours on end. Personally, I find it hard to sit down and continuously read for more than an hour. And I don't recommend trying to be a four-hour bookworm to be a good investor. Maybe an hour or two per day would be enough, excluding newspaper reading. We have tons of other things to do still.

Thinking would perhaps be the hardest skill set, and it ties in with discussion. It would be easier to brainstorm with friends than to think alone. But it's not every day that we get to meet all our friends, so it might be useful to spend some time thinking everyday. That's perhaps the most important one to two hours we could ever spend. Again, it's not easy. Based on my personal experience, I usually squander these precious minutes randomly surfing the net. Before knowing it, the hour is up and I have to get back to real stuff, like laundry, or playing with the kids.

What about the portfolio? Or stock trades?

Well, the truth is, real investors don't spend too much time on these either. It's all thinking. When the time comes to enter the trade, it takes a few minutes. It cold be weeks of work done that led to the few minutes. It's just like pressing the final red button. With no drama. In fact, one value investor recommended never to put in a trade during market hours. Do it before and go to sleep. That's because the daily fluctuation of 2-5% shouldn't change the decision to buy a stock which could double or triple. The real time prices are just distractions.

As for portfolio reviews, the optimal frequency could be quarterly or longer but that's too far away for most people, so perhaps a monthly review would work but perhaps just reviewing a part of the portfolio. Long term stuff doesn't change weekly or monthly so it doesn't make sense to be doing reviews too soon. Say with a portfolio of 20-30 stocks, a monthly review on 2-3 stocks would work well. So we get back to the same stocks after 10 months. More on this on another post.

So putting it all together, a real investor could have a work plan as follows:

Daily
1. Read newspapers (at least 2: ST and FT)
2. Writing down relevant notes
3. Doing good in-depth reading

Weekly
1. Read at least one magazine (the Economist)
2. Discussion with friends
3. Immerse in good long term strategic thinking

Monthly or Quarterly
1. Review parts of the portfolio (more thinking actually)
2. Consolidate relevant trades and key them in

So, that's the truth about investing. It's boring reading, thinking and occasional chats with other investors. Once in a while, we get to kick the tires, go for factory tours or AGMs but most of the time, it's desk bound and pretty lonely way to work. But if we keep going at it, someday, we get to be quite good. That's when things shine through. 

To show with a bit of a stretched analogy, we come back to one of the stars of Da Shi Dai or The Greed of Man, Ms Vivian Chow. Here's how she looked in 1990, some 25 years ago.

Vivian Chow, 1990


Most male bloggers should be drooling by now. She was the girl-next-door star in Asia back then. She couldn't sing and her acting skills were so-so but who cares? Her posters were all over army barracks and teenage boys' bedrooms. Then she got tired of show business and disappeared. Only to reappear a few years ago. Here's how she look today.

Vivian Chow, 2015

Man! She looked even better, right? So people asked, what's her secret of keeping herself so beautiful after so many years. Her answer was simple yet profound. Every day, she strives to be happy, maintain her health and smile. That's it. If we take the liberty to translate that into three relevant verbs, it might be: exercise, eat right and smile. Do enough, and we can conquer aging. Beauty is a mere reflection of our internal construct and accumulation of our daily thoughts and actions. We keep them positive, we are good.

So to be a good investor with a solid portfolio, would require, similarly, the correct internal construction: the right thinking and good ideas from daily reads, insights and also the good temperament to execute the trades free of greed and fear. The portfolio would then be the reflection of years of wisdom and compounded growth, filled with quality companies with exposure to various sectors, secular trends and themes. And it all starts with these three verbs: read, think, discuss.

A belated Happy New Year to all!