High note 5 - Know what you have invested

Recently, the hottest news in the press is about High Note 5 saga. As a result of bankruptcy of Lehman Brothers, the investors suddenly discover that the investment they thought was safe is actually not. Worse still, some lost their life long saving.

It is not exactly clear on the terms and condition of the product. But in a nut shell, these are the facts gathered on the web:
- The structured product is linked to a basket of banks and when the credit event trigger, investor is likely to lose money.
- If everything is fine, we get the 5% interest from this product.
- It is supposed to be a credit default swap(CDS) in disguise

A structured product is a combination of financial instrument to be sold as a package. They can package a lot of different instrument together and sell to investors. The key selling point is enhanced yield. This is the result of the income that some underlying instrument generates.

CDS is a form of insurance. The seller act as the insurance company, gives the buyer protection in return of a premium. If nothing happen on the protected asset, seller get to keep the premium.

The auntie uncle who bought the product was sold on the promise of 5% interest return. It is quite a high return consider the bank deposit interest rate in Singapore. Maybe the relationship manager did explain about the product features. However, how do you expect the man on street to understand CDS and credit event? Furthermore, the reference entities are all big names, which unlikely to fail.

The sales person often highlight more on upside rather than downside. Beside this, getting the customer to understand the product is also a tough job. More than often, if you cannot convice them, confuse them. Many investor claims that they are not aware that they could lose all the investment amount. It is either a form of ignorance or the risk is being down played. From another perspective, it is like putting all money into one basket. This basket was thought to be very safe, but is actually not.

Not an easy problem to solve.
- Bank has to refrain selling complicated product to people who cannot appreciate the product risk.
- There has to be constant education program for people to recognise that high risk high return.

When the sales person trying to sell you product, ask yourself, do you really understand the product. What I always believe is if it is too good to be truth, then it most probably is.

The current US financial system problem

Yesterday I read a news article from WSJ, it gives a great explanation on what happened recently in US and the seriousness of the problem. A good read: http://online.wsj.com/article/SB122169431617549947.html

We seems to have gone from over leveraging to aggressive de-leveraging. The new FED measure actually aims at clean up all the toxic asset and let bank back to conventional lending-borrowing. Then, the credit crisis that choke the economy could be over.

Super panic about AIG

Look at the queue outside the AIA tower, we know that many of them are in panic mode regarding their insurance policy and the cash value of their insurance. Many took the redeem first, think later approach when fear and panic set in. It is kind of human instinct to do that, just like stock market.

Of course, people who hold on to the AIA policy would be afraid, including me. But, we have to analyse the situation. AIA as a company itself, under the MAS regulation, should have operate within the guideline. From their statement, they have adequate fund to cover all the policy holder.

On a separate note, AIG is such an american icon, the FED won't allow a sudden collapse. This is hard to articulate, but it is a logical step for them. So, I am not that worried with my AIA policy.

This is human behaviour which could explain the current market rout. Now, it is driven by news and not really by valuation. We are just at one extreme end of the market cycle. But buying in now, means you have to endure the volatility and your nature fear. Unless you have mind of steel, you better stay sideline for now. Give it another 3 months and see how is the situation. Market is not likely to just recover suddenly, expecting more "collapse" maybe. Sit tight...

Lehman and Merrill Lynch in trouble

The shocking news today is Lehman to file for bankruptcy and Merrill Lynch to be bought over by Bank of America. The wall street fear has became a reality and financial market keep tumbling. It looks like the credit crisis would deepen before it gets any better. Before the light at the end of tunnel is sighted, stock market is going to fall whenever there is bad news. It looks like a knee jerk reaction now. The Asia market is reacting to US market news more violently than US itself.

At this juncture, the market direction is unclear. We are at the unique situation now, which Greenspan said is a serious crisis. As we don't know how worse it could go, holding back any buying decision seems to be the only wise thing to do now. Cheap could become cheaper, remember. There are still things you can do. Brush up your investment skill by reading more books and perform some reflection on your investment decision. This would aid the future adventure.

There are many short sellers out there who short on any bad news that come out from the US. I met an ex Uni friend who does regular trading. He mainly doing shorting now. That could explain the increased volatility we have witnessed. The problem with trading is not a few times of continuous win. It is the challenge of doing it right most of the time. One big bet that goes wrong could bring you back to ground.

I am also taking my time to go through my existing holding to eliminate the weak performer and search for future strong performer. The good part about bear market is you can take your own sweet time to do research and you are buying on cheap, if not, super cheap.

Trapped in bear trend

The US financial sector is in serious turmoil, because of the excess built up over the years and the creative bankers. When sub prime issue first came into picture, nobody expects this bad, or at least not the man on street. Now, it seems like the sub prime is only the trigger of the bear. We are not economist or expert(even the expert not always right), nobody could predict when it would end, earning downgrade is the in thing now.

The stock is now on fire sales, which is rare over past few years. The valuation is so depressed now, in my view, the risk of holding equity for a period of 3 to 5 years is significantly reduced. In fact, you have a high chance to make big profit (of course, not immediately). Financial market is a reflection of human instinct which tends to overshoot on both side - top and bottom. People still expect the equity price to fall, therefore there is no interest in stock. Hence, the forever falling price. Maybe 3 years later, when you look back, you would regret that you missed such a great opportunity to accumulate stock.

However, not all the stocks are equal, at this tough time, it is a real test to separate the boys and men. Look at the company competitive position, market leadership and future plan, to give a clear idea of whether this is a gem being indiscriminately sold down. Buy on cheap and wait.

The equity price won't stay at this depressed level forever, someday when the confidence return, the rebound could be significant. Although economy goes through up and down cycle, in the long run, economy is set to grow. Because the human population keep growing. Good company would earn more profit and stock price would follow.

Bargain is everywhere now. Of course, everybody is waiting to buy it even cheaper when it fall further. I am a long term China consumer bull, the consumer stock looks very attractive now. Even the blue chips are also selling at reasonable price!

China Sports International 2008 Q2 result

It is interesting to evaluate other sports player result also. Following is the China Sports International result for Q2.

Revenue +50%
Cost of sales +49.9% (in sync with revenue)
Selling and distribution expense +281.5%
Administrative expense +387.3%
Profit before tax increased only 25.7% as a result of high expenses incurred. The group is probably trying to put resource to grow faster.
Group has no debt

Look at cashflow statement, profit before tax +25.7%
Net cash generated from operation 123,932k RMB.
Minimum cash used in investing and financing activities
Cash at end of period 535,293k RMB. Strong cash position would allow them to grow aggresively.
Q2 EPS number fall from 9.92cts to 8.7cts. But this should not be a cause of concern, since company is newly listed and this is calculated using pre-invitation shares.

Revenue increase is evident. The cash raised during IPO was put into work and allow faster growth. The widen distribution network also contribute to the significant increase of operating expenses. This is normal. The rise of average selling price is a good sign the brand is gaining traction. OEM business seems to be getting the margin squeeze. Building own brand is the way to go.

The group believe that the Beijing Olympic would raise the sports awareness and contribute to long term growth of sports sector. This might be true, but we are not sure whether there is olympics overhang. Since the group was doing OEM for Kappa, they are into the fashion sports segment currently. I once read few reports about the fashion sports niche which Kappa is doing really well. People treat sports shoe as part of the fashion. The group is focusing on this niche but is really a small player in this aspect, although story looks promising. The tie up with sohu and CCTV might further raise the brand awareness. In overall, the prospect looks bright, but bear in mind of their size.

Looking at current market condition, everything is cheap. Investor can afford to cherry pick good deal. Let's assume this quarter of EPS 8.7cts is consistent across all quarters – 34.8cts RMB. This translate to 7.15cts SGD. At today closing of 0.32, it selling at PE of 4.47 only! What a steal. However, keep in mind the current market sentiment, china share situation and the inflation environment, one might choose to go in or wait for a while.

Not all is lost

It is kind of scary to look at the share price nowadays. If you bother to look at your share holding everyday, it is emotional challenging to look at the paper lost that you have right now. The stock once being a darling is fallen hard everyday.

But not all is lost, if you still hold till now, there is no strong reason for you to let go. Unless you found a better opportunity. The bear is surprisingly long, but bear in mind that on long term, the economy is growing. Stock price would trend upwards. Now is only the speed bump. Once we get over the crisis, market should stage a great rebound.

We saw many earning downgrade and true enough, some companies did suffer from the credit crunch and high inflation. But without going through the bear to correct the excess, we risk another dot com bubble burst. So, just hang on.

What can be done now is
(1) Hold on tight
(2) Identify great stock selling at fire sales price

Even you are not a great stock picker, go for the big cap/blue chip. The reward should compensate for the nights of sleep that you lost. Look at the company factor and invest with a long term view, as the great stock investors have done, it should be alright.

Celestial Nutrifood 2008 Q2 result

Soy bean price has risen a lot together with other commodity price. Let's look at how Celestial is doing.

Sales +37.1%
Cost of sales +46.5%
Gross profit +22.2% (cost increase faster than sales)
Distribution and Administrative expenses +53.8% and +44.3% respectively
Income tax +50%
Net profit +11.7% (clearly the high cost and tax weight the profit down)
Cashflow before working capital change +14.7% (the business is generating strong cash)
EPS increase slightly to 0.17 RMB

When we look at the sales mix, the industrial product sales grow faster. Gross profit margin dropped because of the higher raw material price and change of sales mix. Group has put in measure to mitigate the cost pressure. Selling price of most health food and beverage increased more than 20%, yet it still achieve growth, this might signal better pricing power.

There is increased plant utilisation of industrial protein business. Biochemical feedstuff and lecithin business also achieved strong growth. The component of cost increase include advertising and promotion, transportation and other distribution expense. The intense competition could be another reason. The administrative expense include donation to Sichuan earthquake, otherwise it would be lower. Increase in income tax also erode the earning.

The directors believed high raw material cost continue be a concern. The group is to launch four new health food and beverage in 2008.

The group continue to grow despite rising raw material cost. They also managed to increase price without affect the sales severely. Overall, it is a good result. Since the price of commodity is on down trend now, there is high change Celestial would do even better in the coming quarter. It does look interesting at this level.

China Hongxing 2008 Q2 result

The quarterly reporting season is back. It is number crunching time.

Revenue +53.1%
Gross profit +53.8
Selling and distribution expense +83% (so high)
Income tax +108%
Profit for shareholder +31% (obviously the cost and tax weight the profit down)

Bank balance 2,201,588k RMB vs current liabilities 227,954k RMB (more than enough to cover the liabilities)
There is an increasing cashflow to 150,676k RMB. But after adjusting receivables, there is net cash outflow from operating activities. Not a big problem, since company has so much cash.
EPS increased to 4.37 RMB cent, growth of 8.7%

Apparel and accessories sales is catching up. There is a decrease of gross margin. Expenses increased in line with outlet expansion and promotion activities. The environment is still favourable for sporting goods, but the group is mindful of the inflation situation which could affect the raw material price.

The growth is still on track, strong growth is still expected. I am assuming they would continue to growth at the 30% rate per year. However, inflation has indeed caught up with many China companies now. I still prefer company with strong brand like hongxing. There is the only way to mitigate the cost pressure. They are having some Olympic advertising, hopefully it would raise further awareness on the group's product. The sporting good bull seems to still going strong.

Consider the quarterly earning of 4.37 cents. Full year EPS should be 17.48 cents, which is 3.51 SGD cents. At today's closing of 0.49, it is selling at forecast PE of 13.9. If the earning accelerated, we are looking at even lower PE. I think it is quite reasonable for a company with high growth. If we compare the expected growth rate of 30% against this PE, it is really cheap. Of course, the market is going through the PE compression. To invest or not, depends on whether you are taking long term view of the business.