The 2004 Christmas Pick
5 December 2004
Webb-site.com is celebrating its 6th 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 corporate and economic 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.
Apart from devoting about half his time to the public good, your editor is also a private investor who specialises in smaller companies, panning the riverbed of some 900 smaller companies that make up 10% of the market value, and looking for specks of gold - undervalued stocks with above-average governance. He more often finds the opposite - over-valued and badly governed stocks, and these horror stories sometimes end up as case studies on Webb-site.com.
Before we tell you about this year's pick, a note of caution. Our annual pick also earns us annual criticism (usually from the same people) who say we have a conflict of interest. We look at it the other way: our money is where our mouth is, and if we are wrong, then we will lose money too, which is more than you can say for most analysts. Readers will also know that if there are any future corporate governance failures in the company we pick, then we have a strong financial interest in fighting for the interests of minority shareholders. That's not a conflict of interest, that's a common interest. Having said that, here are some ground rules:
- We only make one pick a year, because Webb-site.com is not a tip sheet, it is a corporate and economic governance site.
- We're not a licensed investment adviser, and you're not paying us for advice, so you have no right to rely on it. All we are doing is exercising our right of free speech, which is one of the few things the Government has not screwed up since the handover.
- For the rest of the year, we don't normally comment on our portfolio, nor do we comment on the stock we picked, until the next Christmas, when we review how it went. In the meantime, you are on your own, so don't write in asking us whether it is time to sell or buy some more. As long-term investors, the only time we would break this silence is if there was a major corporate event at the subject company.
- We reserve the right to increase and decrease our holdings according to market circumstances and our own capital needs.
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 previous recommendations performed.
2003's Pick
Last year, on 3-Dec-03, we picked Allan International Holdings Ltd (Allan, 0684), a maker of household electrical appliances and personal care products. This was our worst ever Christmas pick. It closed that day (before our pick) at $1.27. It reached a daily high of $1.71 on 8-Dec-03, and a low of $1.24 on 15-Nov-04. And on 3-Dec-04, when our year was up, it closed at $1.25. However, it paid dividends totalling $0.08, for a total return of $1.33, or a gain of 4.7%. By comparison, the Hang Seng Index, with dividends reinvested on a monthly basis, gained 18.1% in the year to 30-Nov-04 (we only have monthly figures). This is the lowest return of any of our 5 annual picks, and the first time that a pick has done worse than the Hang Seng Index.
For the year ended 31-Mar-04, Allan's turnover grew by 8% to HK$833.4m but net profit decreased by 18% to $45.89m. The board attributed the margin reduction to raw material prices and customer pricing pressure. The new factory block, which cost HK$30m, began operations as planned in the quarter to Dec-03. Staff headcount, which we use as a proxy for unit production, increased about 15% to 5,500.
Interim results for the half-year to 30-Sep-04 are expected to be announced on 15-Dec-04. We don't know any more than you do, but we would expect that turnover has continued to grow, due to the new factory and benefiting in part from the dollar weakness against the Euro (51% of last year's sales were to Europe). However, profit margins may still be affected by the volatile oil price which impacts on plastic prices, as well as higher metal prices.
It is worth noting that it is not so much the absolute price of raw materials which matters but the rate of increase that causes problems. If prices stabilise, even at high levels, then they can be passed on to customers more easily, but most manufacturers tend to fix sale prices for major customers several months ahead and cannot always lock in the cost of raw materials at the same time, although they should always try to do so.
One thing holding Allan back is its inefficient capital structure. It cannot be in the interests of shareholders to hoard so much cash. At 31-Mar-04, cash and securities net of debts amounted to $207.6m, or about $0.62 per share, before payment of the final dividend of $0.06 (which they should have earned back by now). This means that about half the share price is in unproductive cash, diluting the rate of return on capital. A one-time special dividend would resolve this and position the company for future growth. If they were to do this, then the price would almost certainly respond, because the core P/E, excluding the cash, is only about 5x.
Your editor still holds more than 5% of Allan.
2002's Pick
Two years ago, on 4-Dec-02, we picked Arts Optical International Holdings Ltd (Arts, 1120), which showed a healthy first-year return of 42.0% compared with a 27.9% return in the HSI from 30-Nov-02 to 30-Nov-03.
The stock closed at $2.425 on 3-Dec-03, and a year later it closed at $2.625, having paid out $0.24 in dividends, for a second-year return of 18.1%. Compound that with the previous year, and they've returned 67.7% in two years. This year, despite difficult market conditions, the stock performance was helped by the board's decision to start paying out surplus cash.
Your editor still holds more than 5% of Arts.
The five year history
Despite this year's abysmal performance, our Christmas pick track record still stands up well over the long term. Compounding the picks over 5 years, here it is:
| Pick date | Stock | Stock 1-year return |
HSI 1-year return |
Stock 2-year return |
|---|---|---|---|---|
| 3-Dec-99 | Boto (0585) | 23.3% | -7.0% | 81.6% |
| 4-Dec-00 | Kingmaker (1170) | 53.2% | -17.1% | 113.7% |
| 3-Dec-01 | Tungtex (0518) | 56.3% | -7.9% | 150.9% |
| 4-Dec-02 | Arts (1120) | 42.0% | 27.9% | 67.7% |
| 3-Dec-03 | Allan (0684) | 4.7% | 18.1% | |
| 5-year compound | 339.0% | 7.3% | ||
| Compound average | 34.4% | 1.4% |
If you put $1,000 into the first pick, and rotated into the next one each year, you would have about $4,390 by now. By comparison, if you invested the same amount in the Hang Seng Index 5 years ago, you would now have about $1,073 (which is less than you could have got in a bank). So our picks have out-performed the index by 309% over 5 years.
This year's Pick
Right then, let's see if we can do better this year. Our 2004 Christmas pick is: Karrie International Holdings Ltd (Karrie, 1050) which makes casings for servers and PCs and also manufactures on an OEM basis electronic items such as point of sale systems, tape drives, laser printers and multi-function fax machines. It has two factories in Dongguan, Guangdong province and has recently acquired land for expansion in the same region.
Customers include Konica Minolta, Canon, IBM and other well-known brands. The "electronic manufacturing services" or EMS business is high volume but low margin, and has been growing rapidly. The group is on track to have doubled annual turnover in the three years ending Mar-05, and in its interim report, management raised its target turnover growth for the year to Mar-06 from "low double digits" to 20%.
In the half-year to Sep-04, turnover grew 33% year-on-year while net profit rose 50% due to economies of scale. They wrote that "overall we should have a better second half year than the first half". Earnings per share for the first quarter were $0.0744 and the first half were $0.1571 on a diluted basis, so we would expect them to report at least $0.32 for the year to Mar-05 in the absence of unforeseen circumstances.
Karrie was listed on 16-Dec-96, and got off to a rocky start during the Asian financial crisis, running into problems with bad debts and a cash flow crunch. Then they discovered concepts like shareholder value and corporate governance, and have recently taken innovative steps in this area. For example, apart from the usual meetings with analysts and institutional investors, they have also opened the doors to a "tea break with management" to allow retail investors a chance to meet them in addition to the annual general meeting. The next such event takes place on 18-Dec-04, for details see their web site. We also recommend you read the latest results presentation for an overview of the business, its history and strategy. They are refreshingly candid.
Karrie is one of the few HK-listed companies that voluntarily announces quarterly results, keeping investors more updated. This reduces the potential for insider dealing and we wish more companies would follow suit. Most of the quarterly results you see in HK (and there are not many) appear because the company is dual-listed or has a parent which is listed in another market where quarterly reporting is required (such as mainland China). There is more that Karrie can do in terms of corporate governance, such as cutting the general mandate for cash placings to protect pre-emptive rights, but they are moving strongly in the right direction and we are impressed by the professionalism and focus of the senior management team.
The Chairman and his wife have a combined 54.1% of the company, and the only institutional investor above the 5% threshold is Value Partners Ltd, with 9.9% at the last disclosure. Based on 405.146m shares in issue at 31-Oct-04, the market cap is HK$1,033m (US$132.9m).
The shares closed on Friday (3-Dec-04) at $2.55, and go ex-dividend of $0.085 on Wednesday (8-Dec-04). So on that basis, the ex-dividend P/E for Mar-05 should be about 7.7x. They have a current stated dividend policy of paying out at least 50% of earnings, and last year paid an interim of $0.08 and a final of $0.12. This year, they paid an interim of $0.085, so we expect that they will raise the final dividend to at least $0.125, making a total of $0.21, although this will depend on whether they need the money for further expansion of the business. The running yield would then be around 8.5% after it goes ex-dividend this week.
So there you have it, our 6th Christmas pick. Karrie on!
© Webb-site.com, 2004
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