MMM Analysis - Part 3

This is the last post in the three part analysis of 3M.

We have discussed 3M's investment thesis and its positives. Here's a summary:

3M is an innovative industrial conglomerate that has built its brand in safety healthcare and other niche segments in infrastructure and consumer businesses. It benefits from growth in Asia and US healthcare on the back of strong pricing power. The management understands capital and resource allocation well and has delivered a stellar track record of shareholder return. It is also one of S&P's Dividend Aristocrat.

3M has close to 40% of its businesses in growth segments namely Asia and healthcare and these businesses would be its growth engines in the next few years. Coupled with its strong management capabilities and focus on shareholder returns, 3M is poised to be deliver good performance. But we also need to understand its risks and look closely at valuations. If the stock price has already factored in all the goodness, then as investors, we cannot benefit. This is an important point that even seasoned market practitioners sometimes fail to understand.

Buy when price is way below value

This is also the reason why Benjamin Graham, the grandfather of value investing said that, "The three most important words in investing is - "margin of safety". Margin of safety refers to a buffer we need to incorporate into our calculation of the intrinsic value of the company. This means that we can only buy when the stock is way cheaper than its true worth. In short, valuations matter, if we overpay, we are not going to get returns because the high price we paid has factored in the growth many years ahead.

This is like paying up for an expensive meal or an expensive wine or whisky. If we spent $1,000 on a fancy dinner, it could be a very nice experience, the food could be exceptional and the service top quality, but we didn't profit from it. We paid up. Similarly, drinking expensive wine or whisky brings little "profit" except feeling shiok*. Unless it's a hot date and even though she's wearing a mask, your heart is beating so fast that margin of safety is the last three words that would come to your mind.

Margin of safety sir?

Haha, ok jokes aside, paying up usually have very little benefits. It's just emotional high and bragging rights. As such margin of safety, i.e. don't pay up goes against dating rules. But it is paramount in investing. By not paying up, we reduces the risk of losing money, even if we got the whole investment thesis wrong and overlooked all the damned risks. Alas, in our new era of negative interest rates, disruption and bitcoins, nobody talks about margin of safety today.

However, an investment always carries risks. The only protection that investors have is to know the risks and know the valuations well so that we know we are not overpaying. Back to 3M, we know there are a few big risks overhanging. We will discuss two today. The biggest of which is PFAS litigation. PFAS is an acronym for per- and polyfluoroalkyl substances. These were found to be harmful to humans, like asbestos in the past.

PFAS are a group of man-made chemicals that includes many other acronymic chemicals which most people (including this blogger) have no idea what the non-acronym names actually meant. But importantly, PFAS have been manufactured and used in a variety of industries around the globe since the 1940s and it was discovered that PFAS are super harmful to both humans and the environment. Sadly, 3M has manufactured and used many of these chemicals.

One of the many PFAS chemicals

As things turned out, 3M is on the hook to pay off huge litigation costs related to PFAS. The company took a USD 200m pretax provision charge but analysts are saying that the true cost could be in the tune of USD 5-10bn. Meanwhile the markets had factored in even more, with 3M's market cap dropping more than USD 20bn after this risk broke out. So in an interesting twist, the PFAS risk is already factored in by the drop in share price. Is actual impact then mitigated? Well, yes and no. Yes, because it dropped more than what the analysts calculated. But no, because the future is not predictable. Is it really only USD 20bn? What we have to really worry about is that more litigations will come and the true cost is not USD 20bn but more, say USD 40bn. Then we as shareholders are on the hook.

This is why Ben Graham said margin of safety was important.

3M has another risk which is related to the economic cycle. 30% of 3M's sales is described as short cycle and capex driven. This means that when the economic cycle is going into a downturn, 3M's customers are prone to cut back on buying these short cycle products. Needless to say, capital expenditure or capex, would also be cut back. This is the reason why 3M tend to fall before economic indicators actually turn bad. Conversely, during an upcycle, 3M's share price tend to rise before the rest of the market.

3M is not doing well despite it being a COVID-19 beneficiary with its N95 masks selling like hotcakes and its healthcare business seeing strong demand. This could be due to the PFAS litigation overhanging but we could also say the overall economic situation with COVID-19 will weigh on 3M. So, 3M could go down before it goes up. This is a timing issue. It's not easy to catch stocks right at the bottom and usually we will miss the whole rally by trying to be too smart. Hence, value investors like to look at valuations.

3M's share price since 1970

At today's price, 3M trades at 6% free cash flow yield which is considered cheap for such a high quality company. This is derived by dividing 3M's market cap of USD 90bn over its free cash flow at USD 5 to 6 bn per year. Looking at other valuation metrics, 3M trades at 15x PE and 12x EV/EBITDA. Since the global negative interest rate regime started in 2016, we can hardly find quality at low to mid teens multiples, especially PE. Lastly, just to complete the picture, 3M's Price-to-book is at 8x with ROE at 50%. Ben Graham would have scoffed at anything trading at 8x book. But we are living in a different world today. Remember? Interest rates are negative! Book value is no longer as meaningful.

So rounding everything up, I would say 3M is cheap. 3M's share price peaked at c.$240 when its PE was 24x and FCF closer to 4%. I think we would see the company going back there when the PFAS issue is resolved. This might take a few years and that's the kind of trade that I have been quite successful with over the last decade (see Bayer). I think it's a good risk reward and I should buy the stock even if I couldn't get its N95 masks.

* Shiok is a Singapore slang referring to something being enjoyable. 

Monetary Bazooka and Multi-Curves

This post was first published in 25 Mar 2020 but things moved rapidly and my views have changed. The updated parts are in red.

Since we last discussed COVID-19, the world has gone from bad to worse. We now have a global pandemic which is increasingly out of control. It is becoming a crisis in the same order of magnitude as the 2008-2009 Global Financial Crisis. I have been using the original thebaselab website of daily checks. It is depressing. We have exceeded 15,000 100,000 deaths with no end in sight.

Courtesy of thebaselab

To combat the virus, many affected countries have gone into lockdown mode following China's example. But they didn't do it fast enough. Some countries' healthcare systems could not handle the situation and many lives were lost. It is important not to stress the healthcare system because there are only so many ICU beds and only so many respirators. Unfortunately, we don't learn fast enough. The first lesson from Wuhan was not learnt quickly enough to prevent the tragedies in Italy, Span and Iran and New York. Hopefully other countries and cities can still save themselves by working hard now.

Meanwhile, global markets went berserk. It did not help that Opec and Russia decided to shoot themselves by not reaching an agreement on production thereby causing a huge collapse in oil prices. (They finally agreed but the damage was done) The direct link between COVID-19 and crude is not clear. There is reduced demand but it's not 40%. However oil prices fell from the 50s to the 20s. In stressful times, as we had seen during the Great Financial Crisis (GFC), market participants adopt the mentality of "sell first, talk later". Hence the correlation of different asset classes goes to 1. Everything gets sold. Even gold got sold.

So last week (19 Mar) gave us a glimpse of the confusion that took place. As markets collapsed, we saw indiscriminate selling across stocks, bonds and commodities. The USD spiked because investors sold assets in other currencies and revert their holdings to USD cash. But the US Treasuries also got sold off, because that's another way to raise cash for redemption as well. This selling will continue. In Singapore, we have seen many blue chips hitting multi-year lows. As long as the global situation remains dire and fluid, we should not expect any recovery. (Then the market saw one of its sharpest rebound in history)

Why is everything going to hell in the markets?

While some of us in Singapore probably don't feel this way, this crisis could actually be worse than the GFC. The 350,000 1.7m infections had affected hundreds of millions of families directly. They are seeing their loved ones succumbing to the virus. But as the lockdown continues, the livelihoods of billions are are now badly impacted. We are talking about millions of people being laid off. They could be in the service industries, their employers only have days of cash left before going bankrupt. They could be the small suppliers in the airline/aerospace industry and/or the oil and gas industry. The big boys in these sectors are having issues, so what are the chances that the little ones can make it? 

The situation is really, really bad. People cannot pay their bills, their electricity is being cut off. They cannot pay rent, and face eviction. They have no money to buy food. It is literally life and death, even when the virus is not nearby. Some experts have drawn parallels to war. We are at war with the virus. Hence we need the monetary bazooka to come and save the day.

Helicopter Money

Alas, politics get in the way. The politicians cannot agree how this could be done. Can we bailout the corporates with no strings attached? What if these big oils and big aerospace just use the money to prop up share price instead of saving their suppliers? What about helicopter money? This is an interesting notion Milton Friedman coined in 1969 but made really famous by the previous Fed Governor Ben Bernanke. He famously said he would get on the helicopter and throw money on Main Street in order to stop the rout during the GFC. We are now doing it because families really need that $1,000 to tide over this month. Not next month, this month. 

So the politicians need to sort this out. They probably have days. Lives are at stake. (30 Mar update: they got their act together) The saving grace is that they managed it during the GFC, so it can be done. Then we need the virus situation to subside. China managed to contain it. So did South Korea. We need the major affected economies now (US, UK, Italy and Spain) to follow the playbook. Lockdown for a few weeks, things should get better. The situation will be different for many developing countries. Hopefully their leaders are learning fast. If they don't, their healthcare systems will not be able to cope. We will see a lot more deaths. May the Force be with them.

Finally, we come back to the big question, what do we do now? Buy, sell, wait?

Like I have said many times before, it is not possible to predict what happens next. The politicians could get their act together tonight and we are done with the bloodshed. Then we curse and swear that we didn't buy enough. My base case is the selldown continues and things get really cheap. It could be close to or even below GFC levels for some stocks. Then it will be the best time to buy. But we cannot tell in advance. So we buy incrementally. I plan to buy 1/5 of what I intend to deploy fully every week or two, something like that. It is not hard math or science, so you need to figure out what works for you.

Markets have since rebounded sharply but it might be consensus that this is a bear market rally. It is quite unthinkable we will recover and exceed the previous 2019 high any time soon. The upside is capped and given the bounce, the time to buy is not now (10 Apr 2020). If there are things that could be sold to raise cash, maybe we should raise some cash to have some more dry powder. The next selldown will test the 2020 lows.

The worst case is that the COVID-19 pandemic drags on for months and we did not move fast enough. One, two or three large corporates fail and drag down some banks. 100 million or even more jobs are lost globally. Or, we see continuing rise in infections and many more outbreaks. We see waves and waves because different countries are on different curves. Some successfully flatten their curves but not others. 

In Singapore, we see a full blown community spread. The fourth wave gets us. Our healthcare system gets stressed. Then we will fall below GFC levels. It is a doomsday scenario. Maybe we won't be worrying about our portfolios at that point. We must not let this happen. Stay at home. Keep the social distance. Flatten the curve!

In short, there are many scenarios. No one knows which one will pan out. I would wait now but would look out for stocks that becomes too cheap to ignore. For example, DBS at 0.5x book with more than 10% dividend yield looks good (albeit banks may not be able to pay dividend in 2020 given the situation). Sadly, I have bought it way too early at $21. Now the stock is trading at $18. Dairy Farm breaking its all-time low at $3.30 or Ho Bee revisiting $0.90 will be interesting. Genting does look cheap at $0.50 (it has since rebounded to $0.70) but we have to assume its businesses will recover strongly once the virus is defeated. We have discussed these stocks before so click on the links for related posts if interested. 

Meanwhile, hang in there. This is a marathon. WFH is here to stay. Don't scold the kids. Avoid the spouse. Flatten the belly curve on top of the other curve. 

Huat Ah!

What To Do With SQ’s Rights Issue

Last week, our beloved national carrier, Singapore Airlines (SIA), or SQ as it is known by its flight code, announced a bazooka rights issue and mandatory convertible bond issuance to shore up capital in the fight against the coronavirus. The two instruments amount to SGD 8.8 billion dollars but this is just the first wave. The firm alluded to further capital raise of SGD 6.2 billion if needed and subjected to shareholders’ approval within the next 15 months. 

In total, SIA is raising SGD 15 billion dollars which is roughly one year’s worth of revenue (last year’s revenue was SGD 16 billion) but probably 16 to 18 months of its annual cost base. It is also more than 15 years worth of last year’s net profit at c.SGD 900 million. From the balance sheet angle, 15 billion is also bigger than its equity base of SGD 12 billion. The firm cited many use of this massive amount of money but it’s not too important. We all know that without the capital raise, SQ will cease to exist. In accounting language, the firm will no longer be a going concern i.e. SQ will go bankrupt. This is serious! It's Singapore's national carrier, our pride and glory!

How is SQ falling?

Well, we are at war with COVID-19. These are unprecedented times. It was reported that all airlines will fail in three months. With global travel down 25-40%, no airlines can survive without new capital. Three days before the rights issue, SQ announced that it is cutting capacity by 96%. Ninety six percent! Then, we saw this SGD 15 billion dollar bazooka. To put this number in another perspective, this is 125% of its equity base and twice its current market cap. This magnitude is unprecedented and alarmingly dilutive. Essentially, existing shareholders will never see their invested capital if they don’t subscribe. 

SQ was trading at $6.5, the day before the announcement. The market cap was then SGD 7.7 billion dollars. This capital raise (the rights issue and the mandatory convertible bond or MCB) will be SGD 8.8 billion dollars. This means that the dilution will be more than 50% (53.3% to be exact). So whatever intrinsic value SQ should be trading at before, be it $10 or $12, it will only be half of that. We will show the number later in this post but it's hard to imagine SQ going back to $12, ever.

To be helpful with the math, SQ gives us a theoretical ex-rights price (TERP) of $4.4. This means that after the rights issue (just the SGD 5.3bn portion), all things equal, Singapore Airlines' share price should be traded at $4.4 vs the $6.5 the day before, because of the dilution. This does not take into account of the MCB dilution (SGD 3.5bn) and the additional capital raise (SGD 6.2bn) which is subjected to shareholders’ approval. 

That’s a lot of numbers to take in for most people. Some of the details are also not made public and only Singapore Airlines’ shareholders get to see all the numbers. Since I am not a shareholder, I can only analyse with what is available publicly. Here’s two simple conclusions to start with: 

Grounded or Bankrupted? Just kidding...

1. If you are a shareholder, you should subscribe to everything to maximize benefits. But that means coughing out a lot of money to stay in the game. So it's about how much dry powder you have. Do not use too much and don't ever use your savings. Royston Yang from thesmartinvestor reckoned that if someone bought 1,000 shares of SQ at $6.50 (initial capital of $6,500), he has to cough out another $7,450 to subscribe to the rights and the MCB. Do read his well-written post for the details. 

2. If you are not a shareholder, it might worthwhile to monitor SQ closely. It could fall below the theoretical ex-rights price or TERP of $4.4 and that makes it interesting. In an improbable but possible scenario, SQ might fall near or below its rights conversion price of $3. This is an arbitrage opportunity and one can earn a lot of money buying SQ at that ridiculous price (more on this later). Obviously nothing is ever 100%. If SQ falls to $3, it means the market thinks this capital raise is not enough or COVID-19 has won the war or something really apocalyptic. We have to then make a bet that the market is wrong. Remember it is never easy.

But first things first.

Let's try to come up with an intrinsic value for SQ. With that in hand, we can then verify that $3 is ridiculously cheap and justify buying SQ with a good margin of safety. I must say this is just a back-of-the-envelope kind of analysis. I have never been interested in airlines because its business model simply makes it difficult to generate cashflows and compound earnings. But if the share price do fall a lot from here (i.e. fall to $3), it makes an interesting arbitrage opportunity.

Singapore Airlines has never lost money since its listing and its net income hit SGD 1.3 billion in 2018. Its historical high was actually in 2007 and 2008 when net income powered north of SGD 2 billion for two consecutive years. Just looking at its own history, I would say that SQ can do a billion SGD in net income going forward. It has done this before and in the post COVID-19 world, it would be in a better position than most to continue pushing ahead. Singapore Girl Power!

Looking at its EBITDA, which is what most people like to analyze airlines with, we can also see that SQ has achieved SGD 2.5-3 billion dollar of EBITDA annually. Again, this is based on its past track record. I have subscribed to Warren Buffett's view that EBITDA is not worth looking at because it's not cashflow. We are using it here to help us triangulate SQ's intrinsic value. It is also worth reminding everyone here that SQ is not your typical high quality compounding value investor stock. This is just an arbitrage opportunity. If and when this analysis actually plays out, buy SQ close to $3 and sell it at close to $5. That's the thesis.

Okay, so we have the net income at SGD 1bn and EBITDA at SGD 2.5-3bn. Using PE of 12-15x, we have the first estimates of SQ's intrinsic value (IV) at SGD 12bn to 15bn. This is also where its market cap was over the last 5 years. With EBITDA, we would use a ballpark of 5-6x. At 5x, that gives us SGD 12.5-15bn as well! How coincidental!  (Actually, that is usually how valuation triangulation work, the no.s should come close to one another). Since SQ will have enough cash to cover all debt going forward, we can say that its market cap will be equal to its EV. So we have three sets of numbers that point to the same ballmark. I will add a fourth using 6x EV/EBITDA for a blue-sky scenario - SQ beats the coronavirus and rise to glory, take market share, blah blah. You know the story.

1. SQ's market cap at SGD 12-14bn

2. PE based IV at SGD 12-15bn

3. 5x EV/EBITDA based IV at SGD 12.5-15bn

4. 6x EV/EBITDA based IV at SGD 15-18bn (blue sky scenario, SQ did achieve SGD 20bn market cap before) 

Now, with this massive capital raise, SQ's share count will triple from current 1.2bn to c.3.6bn. By dividing the above IVs, we have a range of target prices from $3.3 to $5. I would say that we can take the median of $4.2 as our IV to work with. Coincidentally, this is within 10% of its TERP at $4.4. Recall that the rights issue and MCB allows the shareholder to get more shares at $3 and $1 (technically speaking, shareholders don't actually get it at $1, but simply even more shares), so if the current share price drops close to $3, we will be getting everything with a margin of safety of 40% (4.2/3).

Having said that, SQ is now at $6. It may not fall to $3. In fact, it's probably hard to imagine that happening. But it should fall. So if it falls through its TERP of $4.4, to say $3.9, then we have to start thinking hard. Maybe that's cheap enough. Remember its IV is anywhere from $3.3 to $5. As it gets close to $3, we have to act. In fact, the window will be super short at the bottom. Like just a single day or two. And all bets are off after the rights issue date, since we won't get the rights and the MCB. Hence it's important to have done the work before that.

Hope this helps! Huat Ah!

MMM Analysis - Part 2

This is a continuation of 3M's analysis.

In the last post, we gave the background on 3M and why it's a good stock. Today, we shall formally write down its investment thesis, analyze the other positive factors, look at its risks and finally determine whether valuations are reasonable. I find that documentation is really a good practice for all investors. It makes the whole process transparent and we can look at to learn what worked and what did not. So, do write down our thoughts before buying or selling, even if it's just one line.

Okay, here's 3M's investment thesis:

3M is an innovative industrial conglomerate that has built its brand in safety, healthcare and other niche segments in infrastructure and consumer businesses. It benefits from growth in Asia and US healthcare on the back of strong pricing power. The management understands capital and resource allocation well and has delivered a stellar track record of shareholder return. It is also one of S&P Dividend Aristocrat.

The Dividend Aristocrat is a list of stocks in the S&P500 index that has increased its dividend payout for at least 25 freaking years. As of 2020, there are 64 stocks according to the wikipedia page. The table below shows an old list with the annual returns and absolute price change. It seemed that one can get a high single digit return by any dividend aristocrat stock.  

Dividend Aristocrat - Old List

Let's return to 3M, so we have got the investment thesis. We would want to support it with a few strong points. In investment lingo, we usually call these positives. As alluded above, 3M has a few positives going for it. Its growth sectors are Asia, which makes up c.30% of sales and healthcare, which makes up c.25%. There could be some overlaps so growth in total might be 35-40% of sales. As these portions grow, earnings improvement could accelerate from the current low single digit levels to something closer to its historical performance (13% according to the table above).

How did we get these numbers? Can we be sure Asia and Healthcare makes up 35-40%? Well, we can never be 100% sure. It is just a ballpark. In the past, Warren Buffett spent all his time scouring through annual reports/10K year after year to figure all these out. We can still do that today, but analysts, Bloomberg and reports usually do a good job putting all these together. The following are the segment and regional splits we can get from its 10K. The parts in red are of our interest.

3M EBIT split, margins and short descriptions:

Healthcare 24%, OPM 25%, skin and wound care, infection prevention, patient warming and oral care, food safety indicators, coding and reimbursement software etc.

Transportation and Electronics 28%, OPM 23%, display materials and systems, automotive and aerospace, advanced materials and transportation safety etc

Safety and Industrial 34%, OPM 23%, personal safety, adhesive and tapes, abrasives, automotive aftermarket, roofing granules, electrical markets etc.

Consumer 14%, OPM 22%, consumer tapes, Post-It notes, home air filtration, cleaning products, bandages, braces and supports, retail abrasives etc.

Geography split:

US 39%

APAC 31%

EMEA 21%

Latam/Canada 9%

As we can see, 3M enjoys good margins across its business segments. None of the its businesses are below 20% margins. Its geography split is also well-balanced with growth regions making up half or more of its overall revenue. Its ROE is even more spectacular at 40-50% annually over the last few years. Besides its high ROE, we also know from the slide below that 3M is laser focused on good capital allocation and shareholder return.

As such, 3M's exposure to growth sectors (healthcare and Asia), its stellar track record of capital management built on the back of its strong brand rounds up the investment thesis for 3M. Needless to say, it benefits from idiosyncratic events such as the coronavirus outbreak precisely because of its strong brand as a safety and healthcare pioneer.The stock is also a leading barometer for the industrial cycle. It is usually the first stock to recover at the bottom of the cycle. Hence by having the stock in the portfolio, we then tend to be able to monitor the cycle better which helps with our assessment on the other stocks in our portfolios.

In the next post, we shall look at 3M's risks and valuations.

Huat ah!

Coronavirus to COVID-19, the Woes Continues...

Markets collapsed c.15% over the last two weeks as COVID-19 (renamed from coronavirus) raged and spread across the globe. The infection hit 100,000 people and caused over 3,000 death in 94 countries. The panic buying of toilet paper and other daily necessities in Hong Kong and Singapore were copied in Japan, Italy, US and various other countries. It's a complete pandemonium!

It is inevitable that masks run out. It is logical that people buy up alcohol wipes and disinfectants. It's acceptable that people go stock up on dried food, instant noodles, bottled water and other important items. But why toilet paper? We do not poop more because of the coronavirus. Some patients do vomit but we do not wipe with toilet paper to clean up afterwards. We wash. Toilet paper is not a necessity, we can always wash. Hundreds of millions of people wash daily, because they don't have the luxury of paying for toilet paper. Money needs to be spent on food, clothes, gas, the real necessities.

Why we are running out of toilet paper

The only reason, politically correctly speaking, is baseless fear. FOLO: fear of losing out or FOMO: fear of missing out. The crude Singaporean way of saying it not nicely goes like this. All these people stupid lah, monkey see monkey do, indiscriminately buying toilet paper without using their monkey brain. Most countries do not import toilet paper from China and is self-sufficient. But obviously, if every household chooses to buy and stock up 24 months of usage, no amount of production will be enough. This is human psychology at work and one of the key reasons market goes into bubble and panic mode so often.

The market is going into panic mode today. Highly leveraged companies find themselves in trouble as they lose revenue with the virus causing a huge global supply chain disruption, major slowdown in travel and reduction in consumption. In a normal world, they have access to bank loans, temporary credit lines, their suppliers and customers will give flexibility on payment terms. But as the COVID-19 crisis unfolds, all this goes out of the window.

We already saw Flybe, a UK carrier, going bankrupt. Unfortunately, more bankruptcies will come. Credit default swaps (CDS) are rising for many listed corporates. CDS measures the possibility of default on bonds. It is the insurance that bondholders pay in case the bond goes into default. In normal times, most companies with bonds see their CDS trading at 100-200bps but in recently weeks, CDS are rising by 20-30bps in a week and some companies have seen their CDS spiked.

This is not good. Corporate defaults will put stress on the banks or other parts of the financial system. Frankly speaking, our modern financial system is not very robust. Every crisis had started with stress at the weakest link which hit major financial institutions bringing about the crisis itself. The GFC started with sub-prime, a small niche sector in the US property market. The Asian Financial Crisis (AFC) was triggered by the Thai central bank breaking the Thai baht's peg to the US dollar. This in turn triggered the collapse of a hedge fund called LTCM.

When Genius Failed: The story of LTCM

This is where things get interesting, as we had seen with toilet paper - the actions of market participants causes a snowballing effect which ultimately leads to unfavourable outcomes.

LTCM was a huge hedge fund with 140 billion dollars of asset under management. In 1997, three years after the establishment of the firm, the AFC hit global markets. It turned out that LTCM had bet on many Asian currencies to strengthen and was bleeding. The was because the unpegging of the Thai baht had a contagion effect, and many worried about the ringgit, the rupiah, the peso and even the Singapore and the Hong Kong dollar. 

So most Asian currencies started to fall, worsening the woes at LTCM. What's worse, many other hedge funds had followed similar strategies and held similar positions. The market started to realize they needed to unwind the same trades before others. Just like consumer rushing for the same toilet papers before others bought them clean, traders rushed to put in phone calls to unwind these trades.

LTCM, being the biggest elephant, couldn't move fast enough and was at the verge of collapse. It was believed that while LTCM only had 140 billion dollars, its leveraged trades had nominal values north of a trillion dollars. The Fed had to step in to rescue LTCM because they believed if LTCM failed, it would bring down the whole financial system, triggering massive defaults, bankruptcies and bring about widespread panic.

This was "monkey see monkey do" at its worst.

Okay, back to today's crisis. It looks like it would get worse before it gets better, but it's really hard to time the bottom. My optimistic view is that 12 months from now, things would be better, we would have regretted not buying more. But right here, right now, we can only take incremental steps. Buy some stuff if you see it's cheap enough but leave some dry powder. It can get cheaper.

There is a tail risk that we do get a lot worse, like a pandemic at the scale of the 1918 Spanish Flu (500 million infections and 50 million deaths) or the Black Plague, then we won't be thinking about how our portfolios are doing. We will really run out of water, food and the real necessities. Everybody will wash. Definitely no toilet paper. The only asset in the portfolio that can help us if that happens is real physical gold, not even the gold ETF. Let's hope that scenario will just remain as a discussion topic here.

Meanwhile, fingers crossed. Don't hoard toilet paper.

Charts #30: Chinese students

Another interesting chart from FT thanks to coronavirus.

Despite the animosity between the big superpowers today, almost 3x more Chinese students are studying in the US than the next country (Australia).

Thoughts #20: More on Coronavirus

Coronavirus has been around and when kids get viruses, 1/3 are thought to be from the coronavirus family. Hence kids tend to develop some immunity to coronavirus and are less susceptible to this new type from Wuhan. Thankfully.

Coronavirus death rate may not be as high as 2%. As it goes round more humans, it should tend towards normal influenza rate of 0.1% to 0.2%. It is high now partly because it is concentrated in 1-2 Chinese cities whereby the healthcare system is tremendously strained. 

Masks are less effective than handwashing and maintain 1m from others (since the virus is not airborne, only aerosol). According to the WHO website, proper handwashing, avoiding contact of our own hands (unclean) to our eyes. nose and mouth would be more important. 

https://www.who.int/news-room/q-a-detail/q-a-coronaviruses

On investment implications, the virus is likely to bring down economic growth with impact on global tourism and supply chain disruption. The US stock market has not fully factored in this risk. But looking at past experiences (SARS, ERS), the virus is very likely to die down in summer and we can move on with our lives.

So, very short term wise, there could be buy opportunities as stocks correct on negativism and fear. Things are likely to get better from here. But we must bear in mind that we are in a decade long bull market and valuations, especially in the US, are stretched.

Chart #29: No more jams

Chinese road conditions after coronavirus last week. Courtesy of FT and Capital Economics.

Supply chain disruption ahead, stay safe everyone!

Happy Valentine's Day!

Coronavirus and Malicious Intent

The coronavirus from Wuhan has the world on its feet. We now have close to 35,000 infections and over 700 deaths and the numbers are rising. This is the worst pandemic since SARS 17 years ago and looks like it will get worse. In Singapore, panic ensued. For reasons unclear, we believe our city state will fall under siege. Not from any military invasion nor terrorist attacks but from our own fears. Singaporeans last night raided supermarkets for essential supplies. Shelves at NTUC, Sheng Siong and other large retail outlets supplying instant noodles, rice, biscuits, masks and toilet paper went empty. Of all the essential supplies, why toilet paper? 

NTUC raided

This is human psychology. We are programmed with this herd mentality. We don't want to lose out and we shun things when we see others shunning it. This is the reason behind bubbles and crashes. At the height of the Tulip Bubble in 1673, one tulip was sold for 5 hectares of land in Holland. Then when it crashed, nobody wanted to touch any tulips. We then saw the same bubbles over and over again. The British stock bubble in 1720 that caused Sir Isaac Newton to lose a lot of money. He then quoted the following:

I could calculate the motion of heavenly bodies but not the madness of people.

Then we had the US stock market boom in 1928 which was followed by the Great Depression (1929 to 1938). In recent times, we saw the Japan property bubble (1989), the dotcom bubble (2000), the bitcoin bubble (2017) amongst others. Alas, to be able to make good return at investing requires us to do the opposite. We cannot buy when share prices are sky high and we need to find gems when others shy away from certain sectors or industries. This is not easy. When we see everyone buying masks and the stock is running out, we panic and go on Amazon and pay up $50 just to secure some supplies. 

To become better investors though, we need to think out of the box and find better solutions to win the game. This is also what Howard Marks coined as Second Level Thinking. The stock market has followed the pandemic with China related and affected stocks crashing while masks makers and healthcare names are rallying. The following charts of SIA Engineering and Raffles Medical tell the two tales well.

SIA Engineering, falling in tandem with our beloved national carrier Singapore Airlines, hits a recent low in the last two weeks. 

Meanwhile Raffles Medical, with its Chinese hospitals, see a slight pop before succumbing to heavy selling. Then in the last two days, global stock markets rallied in the midst of the coronavirus pandemic because China decided to push forward the lifting of the trade war tariffs. However, this is a very myopic view. As the crisis unfold, the global supply chain will be affected. We are seeing impact in the electronics and auto industries. It could be more widespread. China is still the world's factory, right in the middle of the global supply chain. Some other stuff might be affected. This could be a small reason why some smart aleck want to secure supplies of toilet paper in Singapore. Just kidding. 

Maybe, they are trying to use toilet paper to make masks? Ok, lame... As mentioned, prices of masks has skyrocketed. People with malicious intent buy to stock up supplies and mark up to sell to others. This is very unfortunate. It is worth spending a few paragraphs discussing this as investors as well. As responsible investors, we should also not harbour malicious intent. It is a subtle but yet important point.

The coronavirus does not have malicious intent. All viruses are programmed to propagate. They make their hosts sick but they do hope to spread, find more hosts and multiply. They do not intent to kill their hosts. Death is a side effect. From the virus' perspective, what's the point of destroying your world? However, as mother nature goes, some viruses get very good at killing hosts, like Ebola or SARS. Once in millennium, humans do suffer big deal. The Black Plague kill 100 million people. But it is important to note, viruses, animals, mosquitoes cannot have malicious intent.

Don't hoard masks!

The hoarders of masks hoping to sell for profits had malicious intent. The Wuhan authorities trying to cover up during the initial days might have malicious intent. The US media going out of their way to blame China has malicious intent. Humans, unlike all living things, are the only species that can harbour malicious intent. The thing is, malicious intent, however small, is detectable. There is no quarantine possible. 

As investors, we must also be mindful. We may not have malicious intent 99% of the time. We just want to make money right? But when we buy tobacco stocks, what does it mean? If we short Singapore Airlines now, can we say we have no malicious intent? This goes for startup investors and entrepreneurs as well. If we are building a startup just to sell bitcoins and trying to make fortune for ourselves, knowing the business is crap, does it mean we have no malicious intent? Who did we trick into buying our bad business? Remember, malicious intent can only cause harm and is easily detectable. 

So, in the new era of sustainable investing, we need to be responsible investors and not make investment decisions that could imply malicious intent. To the mask hoarders, the world is already a horrible place, do more good please. We must strive to have no malicious intent, all the time. The wuhan virus will test many of us. We have already seen heroes and malices. Alas, this blogger also has no new good investment ideas for now. Maybe we can buy 3M, maybe buy SIA Engineering if it falls further. Meanwhile, stay safe, wash and sanitize, use more alcohol wipes!

Wuhan Jia You!

MMM Analysis - Part 1

3M (ticker MMM) is a stock that I have looked at ten years ago right after the financial crisis but never gotten to buy. This is one of the biggest opportunities missed. The share price at that time hovered around $80 to $90 but collapsed below $60 after Lehman Brothers went down. It was trading at 10x PER and looked really interesting. However, with the state of the global financial system at its brink and this blogger could not muster the courage to buy the stock.

Since then 3M went on to quadruple its share price hitting $240 at its peak back in 2017. It has since fallen to $170 on the back of the trade war in 2019. At the start of the year, Trump and Xi secured an initial deal to reverse the trade war which helped global markets but little did we expect the Wuhan virus outbreak to hit us. The stock fell further to $158 last week. When the dust settles, it might be a good opportunity to finally own a piece of this spectacular company. The chart below tells its history nicely.

3M was founded in 1902 as Minnesota Mining and Manufacturing company but has since evolved into a diversified industrial conglomerate with unique businesses. The chart above showed how it started as a maker of infrastructure supplies and subsequently branched into industrial, manufacturing and safety products. Some of these early businesses are still supporting its earnings today. It has built strong branding in specific industries, allowing the firm to charge higher pricing vs its competitors.

Today, the firm is focusing on retail and healthcare where its innovative prowess has helped created differentiated products from Post-It Notes to 3M N95 masks to waterproof band-aids for intensive wound care. 3M takes pride in its culture of creativity and has created one of the most conducive corporate environment to nurture innovation. Numerous case studies had been done to figure out how 3M continued to be an innovative company for 100 years.

3M's secret to unleash people's creativity was deceptively simple. It was to empower its employees and giving them freedom to create products as they wished. 3M was also a master at organizing people. Human organizations eventually get too complexed over time and 3M consciously keep its working groups small, making sure that politics and people issues are kept minimal. It is said that humans cannot have deep relationships with more than 150 people in their lifetimes and 3M had adhered to this logic. Without politics and empowering people to do what they want, creativity flourishes. In my view, this is 3M's secret sauce.

Today 3M is investing in new priorities and growth platforms as shown above. Some of these are really top global concerns: air quality, food safety, grid modernization. Business opportunities are abundant and 3M is ideally positioned to capture them. Together with its anchors in its core businesses today, 3M's foray into these areas would bring about the next phase of growth.

3M's ability to harness innovation is further strengthened because of its financial savviness. The company intrinsically understands the importance of growth, free cash flow, return on invested capital and margins. 3M's focus on ROIC and FCF are the tenets of good companies. This is evidenced by its consistently high ROIC (above 20%) and strong FCF (c.USD 5bn per year) over the last five years.

3M organizes itself into four segments: Health Care, Safety & Industrial, Transportation & Electronics and Consumer. All four segments boasts margins above 20% with Health Care leading the pack at 28% for 2018. These high margins are very sustainable on the back of its strong branding, innovation and economies of scale in some of the niches that the firm competes in. In the next post, we shall delve into some of its strengths here and discuss both valuations and risks.

Stay safe, wear masks and sanitize!