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I am primarily interested in value investing, particularly in areas like special situations. I created Dollarwise as a way to document and share my ideas.
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  • Allan International Holdings
    Current Price: 3.74 HKD 
    Current Book Value: 757M HKD
    Current Market Cap: 1,250M HKD 
    Exchange Rate: 7.77 HKD to 1 USD (fixed)
    Allan International Holdings is a holding company based in Hong Kong that specializes in constructing household electrical appliances. It drew my eye with its low P/E (6.35), relatively high yield (6.15%), and rock-solid financial position.
    AIH has virtually no debt and a cash balance of 332M HKD as of the interim report (Sep 2010). The company also has a recent record of positive free cash flow, so it has been able to fund its growth internally without needing to go to the capital markets. Both are good signs about the company’s ability to withstand another severe downturn, as is its strong performance during the last crisis.
    Management has a significant stake in the company (44%) and seems to avoid any equity dilution. The family’s been running it for decades and it feels unlikely that they would suddenly put that at risk to grab a quick profit. Given the size of their stake and the length of their involvement it’s fair to say that their interests are aligned with outside shareholders.
    So, why’s it so cheap? I see a few issues that might be putting off investors. There’s a lot of exposure to Europe, currency and commodity movements are squeezing margins, and receivables are way up as of the interim report.
    I think that exposure to Europe is the least of AIH’s problems. Sales in Europe accounted for about 50% of FY2010 sales volume, so it is definitely the primary geographic region, but sales there held reasonably steady even during the financial crisis. Sales are invoiced in dollars, so the weak dollar ought to help sales, and national debt crises probably won't prevent European consumers from replacing their blenders. It’s probably a short-term concern at most.
    Margins will probably be a bigger issue. Gross margin is currently at a five-year high (possibly longer since I only went back five years) but is already creeping down towards the historical average. I’m not going to try to predict the direction/magnitude of commodity price changes over the next year or two, but to be on the safe side it would make sense to assume that gross margin would be at or below the level of 2008 (lowest of the past five years). Applying that assumption to TTM earnings basically cuts them in half and results in an adjusted P/E of 13.4.
    The real issue comes from the growth of receivables. Receivables were way up at the interim mark and let to the company burning a lot of cash. A look at previous interim reports shows that mid-year receivable growth is something of a pattern for AIH, but this year’s growth was larger than in previous years and significantly outpaced revenue growth.
    AIH has very substantial customer concentration (another issue I’m not thrilled about), which makes the receivables issue more serious. Their largest customer accounts for 49% of sales and the top five collectively provide 92% of sales. Since the biggest three customers account for 80% of receivables on average, I’d wait to see the receivables balance decline a bit before jumping in. AIH doesn’t seem to have had any problems with bad receivables during the recession and despite the pile-up receivables also don’t seem to be aging - only a small fraction more are more than 90 days old - but a problem with any of their major customers would result in a a substantial write-down as well as a major decline in future revenue. With that in mind I’ll take a lesson from SKX and steer clear of even potential working capital issues. 
    Their fiscal year ended March 31, so the annual report ought to be due out soon. That ought to clarify where the receivables issue stands. There is also a growing percentage of finished goods in the inventory. Inventory growth didn’t exceed revenue growth, but I’d like to see that play out a little more as well. Overall it seems like an interesting opportunity and the annual report ought to give a good sense of how serious these issues actually are.
    Financial statements and vertical/horizontal comparisons:
    May 11 7:27 PM | Link | Comment!
  • York Timber Holdings: A Discount Timber Play
    Current price: R3.70
    Current market cap: R1,205M
    Current book value:  R1,984.2M
    Current exchange rate: 1 ZAR = 0.147 USD

    York Timber Holdings is an integrated timber company based in South Africa. After severe brush fires in 2007/8 and poor FY2009 performance, the company’s stock plunged from above R9.00 per share to below R3.00. Investors like Jeremy Grantham are very positive about the prospects for timber and it’s frequently touted as an excellent hedge against inflation, so this seemed like an interesting opportunity to explore.

    FY 2010 saw a lot of earnings improvement, but the true extent was buried under revaluations and write-downs. Biological assets were revalued upwards 10.5% after a switch to DCF valuation, reversing most of an impairment recognized in FY2009 and adding R200M to earnings. Impairments to goodwill resulted in charges of R42.6M. Directly removing all non-recurring charges gives an adjusted net income of R-93.1M or a total comprehensive income of R-29.6M. Definitely an improvement from 2009, but less so than the raw numbers lead you to believe.

    Improvement did continue in the six months ending December 2010. Two factors appear to be behind the improvement. The first is the drastically lower interest costs from the company’s 2010 debt reduction. Proceeds from a stock offering (about R450M out of the total raised) were used to pay down a large amount of debt and a comparison of year-over-year changes in financing costs illustrates the large savings. This more than anything else, I think, helped get normalized earnings positive again. York also managed to maintain the improvements to its gross margin that it achieved in FY2010. In fact, it boosted gross margin all the way to 46%. It’s probably unrealistic to expect gross margin to remain quite so high, but it suggests that the cost-saving restructuring York has undergone genuinely paid off for the company.

    Evaluating timber investments is a bit outside my circle of competence at the moment, but a quick comparison between York and a few U.S. timber companies demonstrates that it is fairly cheap on a relative basis:

    Obviously York’s P/E is inflated by the aforementioned non-recurring charges (the same appears to be true of WY from what I saw), so that’s not a terribly useful point of comparison. To me the interesting points are the substantial difference in P/B ratios and gross margins between York and the others. Investors would be buying into an improving business at a big discount to book value, which looks like a promising combination. Those with the knowledge/desire to invest in timber might find solid returns with a margin of safety by moving a little bit off the beaten path.

    Investing abroad does introduce other risks like currency fluctuations. That said, the Rand/Dollar relationship has been relatively stable over the long term in the past five years. In fact, the Rand appreciated a moderate amount since 2009 and would have benefited an investment made at that time. That’s probably at an end due to pressure from manufacturing groups, but it’s reassuring to see that the country’s currency has a recent history of stability.

    A related point of interest is the rights offering that York used to fund its debt reduction. The rights offering price was set at R2 per share, up to 30% below then-current prices. Of course there’s the cost of the rights themselves to consider but prior to the offering the stock price was hovering around R2.50 per share with roughly 78.4M shares outstanding. Book value at that point was about R1.35B, so the regular trading price at the time was a substantial discount to book value even after taking into account the diluting effect of the new shares. The rights offering provided potential investors with an even greater discount. It had never occurred to me to search out special-situations opportunities outside of major countries because I had assumed that information would simply be too scarce, but at least in this case that would have meant missing out on a promising opportunity. That’s a useful lesson.

    2010 Annual Report:
    Interim Report:
    Rights Offer Terms:
    Financial Statement Analysis:

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: RYN, WY, timber, inflation
    Apr 16 3:52 PM | Link | Comment!
  • Book Review: The Aggressive Conservative Investor
    The Aggressive Conservative Investor (Martin Whitman and Martin Shubik)

    When I first started reading Martin Whitman’s exhortations about the importance and neglect of assets as a tool of valuation I thought to myself, “But everyone knows that assets are an important tool. Is this really still relevant?”

    Then I looked at the front page of Seeking Alpha and saw articles about earnings, about commodities (definitely commodities), and about currencies. Nothing about neglected assets and not a lot about security. It occurred to me that even though Whitman’s been pointing out the excessive primacy of the income statement for around three decades, some things never change. And really, that makes sense in light of Whitman’s own writing.

    More than anything else, Whitman emphasizes perspective. As he points out, a lot of people are in the market for a lot of different reasons and investors have to appreciate this when they try to gauge the actions of the market and its participants. Activists have different guidelines for what constitutes a suitable investment than do purely passive investors and short-term traders have a lot more interest in volatility than long-term investors. That isn’t rocket science, but its a simple and powerful observation that a lot of people overlook when speaking of The Market and its irrationality. You see people characterize every transaction in the market as having a winner and a loser, but really the definition of winner and loser depends a great deal on perspective (Richard Bookstaber also sort of gets at this in A Demon of Our Own Design). For those with a long-term perspective, Whitman has a lot to add.

    Perspective also applies to financial statements. More so than most books on investment, The Aggressive Conservative Investor spends a fair amount of space digging into the subject of accounting and accounting presentation. Again, it’s not exactly news that there are gaps in GAAP, but few books devote as much effort to getting it its core assumptions, uses, and limitations. I think this is one of its most unique and appealing aspects.

    I was also struck by the simplicity of his investment approach. The financial integrity approach (re-dubbed “safe and cheap” in his new introduction) has four guidelines:

    1. Strong financial position
    2. Honest management and control groups
    3. Reasonable amount of information available
    4. A price below estimated net asset value

    Simple, but effective: Third Avenue had the best mutual fund record in its class over the past 20 years with a 12.84% annual return. Granted, Whitman seems to do a lot of his fishing overseas these days, but methods could probably be applied with a fair amount of success within the US market by investors who don’t have the same size constraints as a mutual fund the size of the Third Avenue Value Fund. I’ve heard the style he advocates here referred to as the “good enough” mentality and that’s fitting.

    As an amusing side note, Whitman seems to enjoy emphasizing his disagreements with and improvements on the methods of Graham and Dodd. Interviews and online reviews of his other work suggest that’s a constant theme. He also has a love of inventing new acronyms that do little or nothing to clarify his meaning. These quirks, along with his occasionally long-winded writing, detract a bit from the book overall but they don’t invalidate or obscure his points.

    This book makes it onto Seth Klarman’s recommended reading list (ironically, the writer at this site hasn’t read it) and with good reason. I’d definitely recommend it to anyone with an interest in value investing (and hey, didn't you see the recommendation from one sentence ago?).

    Full disclosure: I received a review copy of The Aggressive Conservative Investor from Wiley.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: I received a review copy of The Aggressive Conservative Investor from Wiley.
    Feb 20 2:20 AM | Link | Comment!
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