Webb-site Reports

Season's greetings to all our readers - and that means it's time for our annual stock pick, when we rummage in our sack of small-cap investments for the stock we think is most likely to perform over the next year. For the last 4 years, the compound return on our picks has been 319.2% while the Hang Seng Index made a net loss of 9.2%. So what's are we putting under the Christmas tree this year? Read on...

The 2003 Christmas Pick
3 December 2003

Webb-site.com is celebrating its 5th anniversary, and loyal readers will know that we only give one gratuitous stock pick per year - something nice to say in the season of goodwill to make up for the campaign against bad governance in the rest of the year. We rummage in our sack of investments and pick the stock from our portfolio that we think is most likely to perform over the next year - our money is where our mouth is, and if we are wrong (which is not impossible), then we will lose money too.

Before we tell you what we've picked this year, first we'll do something you seldom see the professional analysts do - look back at how our first four recommendations performed.

2002's Pick

Last year's pick, on 4-Dec-02, was Arts Optical International Holdings Ltd (Arts, 1120), which closed the previous day at $1.87. Well, a big round of mince pies and sherry for the boys in spectacles. They closed today at $2.425, and paid out dividends of $0.23, for a total return of 42.0%. You could even have bought them cheaper than when our recommendation was made - they closed at $1.77 on 14-Apr-03 in the midst of the SARS outbreak, and reached a daily high of $2.55 on 17-Nov-03.

Arts also became the first company to comply with our Project Vampire recommendations on non-pre-emptive share issues, restricting their placing mandate to 5% of the issued shares and a maximum discount of 5%.

At roughly the same time, the Hang Seng Index, including reinvestment of dividends, gained 27.9% during the 12 months to 30-Nov-03 (we only have monthly data). So if you put $1,000 in the HSI on 30-Nov-02, then a year later you had $1,279. Not bad, but if you put $1,000 in Arts, then you'd have $1,420. So Arts out-performed the HSI by 11.0%.

The business, like many exporters, has actually had quite a difficult year, with sales in the six months to Jun-03 falling 17%, and net profits falling 28%, partly due to the reduced economies of scale. They have cut back on their mainland retail operation, closing unprofitable outlets, and consolidated two retail brands into one, so a lot of house-keeping was done in the first half. At least part of the slowdown was SARS related. The interim report said that orders rebounded in July and August compared with the previous year, which should affect sales in the last quarter of 2003, but we still expect them to record a reduction in profit for calendar 2003 and recover in 2004.

Arts has begun to respond to our calls to distribute its surplus cash rather than hoard it in their shop window, which inevitably encourages their customers to push for longer credit periods. For the first half, they repeated the 2002 interim dividend of $0.08 but added a special dividend of $0.07. That still leaves them with a large pot of cash around HK$150m, or $0.40 per share, and no borrowing, despite the current low interest rate environment.

We urge them to pay out more of the cash pile. Assuming time deposit interest rates of 1% on $0.400 of cash, they will only earn about $0.004 per share in interest this year, and at the historic P/E of about 8.5x, this would only be worth about $0.034 off the share price, so it is clear that a special dividend would boost total returns. The same theory applies to any cash-rich company - the market always discounts the value of the cash the company holds.

2001's Pick

Speaking of cash-rich companies, on 3-Dec-01 we picked Tungtex (Holdings) Co Ltd (Tungtex, 0518), which showed a healthy first-year return of 56.3% compared with a negative 7.9% return in the HSI from 30-Nov-01 to 30-Nov-02.

The stock closed at $2.05 on 3-Dec-02, and a year later it today closed at $3.075, having paid out $0.215 in dividends, for a second-year return of 60.5%. Compound that with the previous year, and they've returned 150.9% in two years. Ding dong merrily on high, in heaven the tills are ringing.

They still have about HK$300m of net cash, or about $0.85 per share (dividend, please) and they are on an undemanding P/E of about 10x current-year (Mar-04) earnings - the P/E is even lower if you exclude the cash. It's no longer a screaming bargain, but after a bull-run in small-caps, screaming bargains are hard to find.

2000's Pick

On 4-Dec-00 we picked Kingmaker Footwear Holdings Ltd (1170), which showed a robust first-year return of 53.2% compared with a 17.1% negative return in the HSI from 30-Nov-00 to 30-Nov-01. In the second year, they made a total return of 39.5%, closing at $1.99. So how did they do in their third year? Well, the stock closed today at $3.60, having paid out $0.105 in dividends, for a total return of 86.2% - which was somewhat beyond our expectations. Compounded over 3 years, this stock has made a total return of 298% - or practically four-folded our money. Now trading on about 16x this year's earnings, we think the stock is fairly valued and while the business is still growing healthily, you cannot expect the same rate of return in future.

1999's pick

Four years ago, IMI Global Holdings Ltd (then Boto International Holdings Ltd, Boto, 0585) was our first Christmas pick. As readers will know, this company returned 81.6% in its first two years, but in 2002 sold its core Christmas Tree and Garden Furniture business to a management/private equity buy-out, so we cannot analyse the returns on the business since then.

Summary of returns

So how are we doing so far? Here's the track record of the Webb-site.com Christmas Picks:

Pick date	Stock	Stock 1-year return	HSI 1-year return	Stock 2-year return
3-Dec-99	Boto	23.3%	-7.0%	81.6%
4-Dec-00	Kingmaker	53.2%	-17.1%	113.7%
3-Dec-01	Tungtex	56.3%	-7.9%	150.9%
4-Dec-02	Arts	42.0%	27.9%
	4-year compound	319.2%	- 9.2%
	Compound average	43.1%	-2.4%

If you put $1,000 into the first pick, and rotated into the next one each year, you would have about $4,192 by now. By comparison, if you invested the same amount in the Hang Seng Index 4 years ago, you'd now have about $908. So our picks have out-performed the index by 362% over 4 years.

This year's Pick

This has been a bull-year for small cap stocks, and it has become increasingly difficult as the market rises to find deeply undervalued shares. But there are still some out there, little nuggets hidden away in the corporate governance graveyard of Hong Kong's smaller companies.

Alright, enough suspenders, this year, our stocking-filler is Allan International Holdings Ltd (Allan, 0684), a maker of "household electrical appliances and personal care products" - think food processors, juicers, hair dryers and shavers. All the sort of things you would put under the Christmas tree if you couldn't buy the shares instead. Last year, 51% of sales went to Europe and 36% to America, with Asia and other markets accounting for the rest. Allan should benefit from a stronger Euro against the dollar.

Listed on 10-Nov-92, the small, family-run group, with a market cap of HK$426m (US$55m) recently celebrated its 40th anniversary, and the Cheung family owns about 55.26% of it between them. It's probably never going to be a large-cap - very few companies make the transition - but it has produced steady earnings.

Your editor, David Webb has, as required by law, a latest disclosed interest of 5.04% in the shares of Allan (all shareholdings of 5% or more must be disclosed, and any subsequent movement through a whole 1% boundary). The other disclosed non-management shareholder is asset manager J.P. Morgan Chase & Co., which held 7.24% (excluding its lending pool) at 24-Nov-03.

In its Annual General Meeting this year, Allan complied with the recommendations of our Project Vampire, restricting its general issue mandate which reduces the risk of dilution for investors.

Allan reported EPS of $0.172 for the year to 31-Mar-03, and at today's closing price of $1.27, the historic P/E is 7.4x. Last year they paid regular dividends of $0.08 per share, or a yield of 6.3%.

But that's not all. Look beneath the kitchen counter, and you will find that at year-end, the group had net cash (including held-to-maturity securities, time deposits, money-market funds and bank balances), after paying the final dividend, of about HK$172m, or about $0.51 per share. We have urged them to pay out the surplus as a special dividend, to improve the return on equity and the total return for investors, including the Cheung family.

As the annual report went to press, a new factory block in the PRC was in the final stage of completion with operation due to commence in the 3rd quarter at a cost of about HK$30m, which can easily be funded from the year's operating cash flow. This should add to their capacity and sales next year.

Excluding the cash of $0.51 per share, which would only have earned interest of about $0.005 per share, what you have is a core EPS of about $0.167 and a core P/E of about 4.6x, so there's plenty of upside potential there, particularly if they release value through a one-off dividend.

Allan is due to report on 12-Dec-03 interim results for the six months to 30-Sep-03, and we have no idea whether the order flow in the first half of the year was impacted by SARS, but if it was, then consider it a buying opportunity.

So there you have it, our 5th Christmas pick. And if you decide not to buy the shares for Christmas, well at least buy someone a food processor - it might be one of Allan's!

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The 2003 Christmas Pick 3 December 2003