Alternative Asset Opportunities, Argo Group, benchmarking, Brexit, Donegal Investment Group, Fortress Investment Group, JPMorgan Russian Securities, KWG Kommunale Wohnen, Newmark Security, portfolio performance, Rasmala, Saga Furs, Tetragon Financial Group, value investing, VinaCapital Vietnam Opportunity Fund, Zamano
Yeah, it’s that time of year again…and hopefully a chance to step back from some of this recent Brexit insanity. Let’s jump right in – here’s the H1-2016 performance of my usual benchmark indices:
Of course, what jumps out immediately is the UK. Brexit schmexit…the FTSE’s performance is actually bang in line with long-term averages! Which reflects its predominantly international exposure, but the much-cited FTSE 250 certainly wasn’t much of a disaster at (6.6)%, while the AIM All-Share managed to limit its decline to (4.2)%. [Sterling took the real walloping, trading down 10-12% vs. the dollar & euro]. Unfortunately, this is a sad reminder the real risk of home bias for investors may not be portfolio return. It’s the fact they wake up to a shrinking portfolio…and suddenly realise their currency’s dumped, their housing market’s locked up (& their house value’s probably dumped too), not to mention their employment & economic prospects may also have dimmed substantially. [At least Brexiteers won’t notice the currency impact, since they seem to think only in terms of Mighty Blighty & The Pahhhnd In Your Pocket]. Only a fool would question (or ignore) the benefits of greater/global diversification in the face of such potentially existential risks – particularly as there’s no obvious long-term cost(s) to such a strategy.
At first glance, Europe has borne more of the Brexit brunt, with the Bloomberg Euro 500 significantly trailing the UK indices – down over 10% (which must delight the Brexiteers!). However, it’s worth noting escalating NPL/capital issues in the Italian banking system (& a mounting EU-Italy war of words) have been overlooked by the media recently (hat tip to The Economist though)…I suspect this is responsible for a significant portion of the index decline. Despite efforts to date, this crisis will require an expensive & long-drawn out resolution, and will probably continue to exert a significant drag on sentiment. Fortunately, it shouldn’t pose any kind of existential threat to the European banking system ultimately, at least for stronger banks & countries…Draghi & the ECB will presumably continue to do ‘whatever it takes’. But the ongoing compression in European banking valuations is puzzling – who the hell wants to bet & sweat over sub-0.5 P/B banks, when the cream of the crop remains on sale at 1.0 times book (or less)?! [And the US banking situation isn’t much different].
Perhaps the real Brexit victim here is Ireland, with the ISEQ suffering a 17% decline. Then again, with the market clocking an impressive multi-year string of gains (& a late-2015 double top), a correction was overdue…regardless of Brexit. [Hmph, so why didn’t I dump my Irish shares?!] Of course, now we have to figure out the medium/long-term consequences for the Irish economy & market – a challenge which I think nobody, no matter how authoritative, is qualified to tackle at this point. But anyway, let me throw my (initial) ten cents into the ring:
As both a trader & an investor, I’ve always been impressed with the ability of Irish companies to thrive over the decades, despite substantial IEP/GBP & EUR/GBP rate volatility…so I have no serious concerns on that score. I’d also note sterling weakness as the sole driver of the recent EUR/GBP rally. Which may sound bleedin’ obvious, but in terms of exporting to the UK, it does mean no other country or trading bloc has suddenly been handed some giant step-change in competitive advantage vs. Ireland. Which implies a potential slow-down or reduction in UK demand for Irish imports is far more likely, rather than any kind of immediate cessation or wide-scale substitution. And agri-food output comprises a substantial percentage of total Irish exports, so one might reasonably hope UK import demand will prove to be somewhat inelastic. [Unless Brexiteers envision the UK transforming itself into some kind of utopian agrarian economy…I wouldn’t put it bloody past ’em!?] I suspect Ireland will also be in prime position for a potential EU Brexit aid package, and/or benefit from other grandfathering & transitional arrangements. Not to mention a final Brexit could still take years to negotiate & fully materialise…well, if it doesn’t end up being derailed or hijacked by UK political events to come.
All in all, Ireland still strikes me as the most logical European bet to make. Sure, it may well face the most Brexit risk(s) – but in return you’re getting what has been the fastest-growing economy in the EU (even if you discount last year’s 26% GDP growth!?), one that’s clearly built plenty of domestic momentum & has now become an even more compelling FDI target & financial services centre. It’s hard to argue another EU country is suddenly offering a far superior risk-reward proposition. Naturally, prudent stock-picking is implied here, and this Brexit aftermath is best treated as an ideal opportunity to upgrade to higher quality/growth companies at a better price.
As for the US, the S&P’s 2.7% gain & subsequent record high is a reminder: i) Brexit doesn’t matter all that much in the larger scheme of things…after all, the UK now contributes just 4% of world GDP! And ii) Trump as President really could happen (for much the same reasons as the Brexit vote), but now the market (like the GOP) already seems to be moving on to bargaining (& acceptance)… And anyway, a) East Coast-West Coast shame at the idea of a Trump presidency shouldn’t precipitate an actual market decline, b) a President who likely ends up isolated from Congress is sure to be pretty ineffectual (as Obama’s proved), c) if Trump manages to get anything done, it would probably be stimulative for the market, and d) if Hillary wins…yawn, plus ca change!
Ultimately, the market keeps proving it can climb a relentless wall of worry. And as I’ve argued before, even a crap economic (and/or earnings) outlook may prove irrelevant…perhaps all that really matters here is the lack of gravity (i.e interest rates) & the potentially bubblicious consequences. [Say hello to a new Nifty Fifty!?] And if such a new paradigm turns out to be (even half-way) correct, America’s effective high yield status in the developed world could have even more bullish implications elsewhere – I mean, what’s the appropriate discount & ultimate valuation multiple for markets like Europe (or Japan, or the UK, etc. etc.), when their risk-free rates are close to zero (or even negative) the whole way out the curve?! In the end, the safest way of anticipating & playing out this potential scenario is (again) to upgrade one’s portfolio to focus on higher quality/growth companies at a better price – i.e. companies which can ideally offer stability & secular growth, regardless of the economic environment & outlook.
Before we move on to portfolio performance, I must report two recent portfolio sales:
KWG has all but eliminated its gaping NAV discount, which was obviously one of the key attractions for me originally – it now trades on a mere 4% discount to its latest book value per share. Of course, sector valuations suggest it could trade higher again from here – its largest peers continue to enjoy an average 1.4 P/B multiple, as per Bloomberg. But KWG’s two key executives have long departed, its investor relations website has gone dark (i.e. reverted to German-only), and the recent Conwert Immobilien Invest (CWI:AV) tender offer (which threatened a KWG de-listing) has increased its majority ownership to 87%. Unless you view it as a potential squeeze-out play (however long that might take), the situation’s become less & less promising for small minority shareholders. And even the hope Conwert’s own valuation might benefit from a premium KWG multiple no longer seems viable, as its shares now trade at an NAV premium & boast a steady upward trajectory.
I’ve now eliminated my remaining stake, realising a tasty 104% final gain vs. my original write-up just over three & a half years ago. German residential property investment’s still a compelling investment proposition (perhaps more so now, with the 10 yr Bund yield turning negative), but sector large-caps seem like they’re priced accordingly, and I’m not convinced I want to chase down a cheaper small/micro-cap company. But the sector remains on my radar, as I suspect it’s now close to a consolidation point where a dividend/yield-driven REIT business model takes over (average large-cap dividend yield’s now only 2.2%), which could trigger a new wave of investor sentiment & demand.
The last big activist push here came in February, with a campaign to vote AGAINST Argo’s £2 million share buyback proposal. This was purely tactical – any kind of dividend/return of capital would obviously be welcome, except where it permits management to consolidate majority control with no outlay of capital or bid premium paid. At best, the objective here was to (ideally) vote down the proposal & bring management back to the table to negotiate a larger compulsory share tender offer/redemption (which would ensure no change in management’s stake). And at worst, a critical campaign would encourage management to actually follow through & complete the share buyback. [If this seems like an odd statement, don’t forget many buyback authorisations are never actually acted upon…picture it, what could be worse than management confirming (via a winning vote) they have absolute control of Argo & then not even rewarding shareholders with a return of capital?!]
You know the result: While the AGAINST vote was an admirable 36%, it was swamped by an unexpected FOR vote (I saw/heard no indication ANY shareholders were actually voting for the proposal). In the end, I suspect an automatic/default nominee vote sealed the deal, which (if it’s true) is obviously frustrating….but at least £2 million (which is pretty substantial vs. ARGO’s market cap) was ultimately returned to shareholders, book value per share was enhanced, the share price benefited, and a liquidity/exit opportunity was presented to investors. However, management now owns a 53%+ controlling stake in the company (so I have little hope governance/investor relations/shareholder value will suddenly improve from here on), and there’s still no sign of a potential turn-around in the business/AUM. Granted, the intrinsic value of Argo’s cash & fund investments remains obvious, but it will surely take an eventual sale (which management wouldn’t pursue to date) or liquidation to realise this value somewhere down the road…
In the end, if you buy carefully enough, any loss on stocks like this is (hopefully) limited to opportunity cost. Versus my average entry price (net of dividends), I’ve suffered a 10% loss, but obviously I could have been invested elsewhere (ideally, far more profitably) for the last 3-4 years. And in the current environment, the value gap here isn’t so compelling now – I was actually pondering Argo’s 0.4 P/B multiple (by my reckoning, post buyback, inc. cash/fund investments only), while also considering Goldman Sachs (GS:US) (for example), which was trading on a 0.8 P/B. At those respective multiples, just think about it…would you prefer to bet on Andreas Rialas, or the Masters of the Universe at Goldman Sachs?!
And so, all (um) entertaining stories must inevitably come to an end… I’ve now eliminated my entire stake (& re-invested the proceeds elsewhere). My sincere thanks again to all those shareholders (large & small) who provided their support & insights along the way – it was greatly appreciated.
So, here’s the Wexboy H1-2016 Portfolio Performance, in terms of individual winners & losers:
[**Exited holdings. Other holdings: Gains based on average stake size (actually my yr-end 2015 allocation, as there were no incremental buys/sells to report), and end-H1 2016 share prices (also used as sale prices for ARGO:LN & BIW:GR). NB: Year-end VOF:LN share price converted to GBP (at year-end GBP/USD FX rate), reflecting its end-March listing change from USD to GBP. Otherwise, I’ve ignored all FX gains/losses & regular dividends.]
And ranked by size of individual portfolio holdings:
And again, merging the two together – in terms of individual portfolio return:
Despite a (2.4)% result, I’m pleased to report a significant out-performance vs. a benchmark result of (5.1)% – even more so, as it came in the wake of what was (for me) an unexpected Brexit result. I was convinced the waverers & undecideds would propel the Remain campaign across the finish line. But like many elections, it’s those who are passionate about their cause (no matter how deluded) who actually go out & win the vote, whereas preserving a decades-old status quo was far too uninspiring a chore for many to even bother in the end…
Fortunately, as it so often does, diversification saved me from the error of my macro/political views. While I have an affinity for the UK (& obviously the Irish) markets, for me London’s mostly about access to international funds & companies. And noting the UK’s global GDP ranking, I’ve never felt any great compulsion to own domestic UK stocks. [Which is harder than it sounds when you’re bombarded by a UK-centric financial media. The only antidote is to globalise your media consumption, or eliminate it entirely…it’s debatable which is better!?] It turns out Zamano (ZMNO:ID), an Irish stock, is actually my primary UK exposure. As for the rest of the portfolio, it mostly offers (underlying) euro, dollar & emerging/frontier currency exposure which has been reassuring.
[Some readers have previously urged me to adopt a home currency & include FX gains (or losses) here…haha, maybe it’s a good time to adopt sterling!?]
In the end, the real irony here is that my out-performance was actually derived from my emerging/frontier market exposure. Naturally, this occurred after I concluded last year I was no longer as bullish on emerging/frontier markets (indirect Western exposure seemed the better bet). [I stress ‘markets’, as I remain just as bullish about their long term economic prospects]. Damnit, isn’t this always the way..?! Fortunately, I highlighted cherry-picking certain markets as a still compelling strategy, which proved right on target – most notably, with the VinaCapital Vietnam Opportunity Fund (VOF:LN).
OK, it’s only half-time, let’s move on – here’s an up-to-date & fairly brief snapshot of each of my winners & losers:
Vietnam continues to deliver 6%+ GDP growth & tame inflation (at 2.4%), bank NPLs have been partially resolved & property prices are climbing again, and its labour market dynamics continue to attract supply chain relocation within Asia. The VN Index has broken out of the 525-640 range it’s occupied for the last few years, but still trades on a (trailing) 13.7 P/E. And VOF continues to pursue a gradual divestment of its direct property holdings & reinvestment in an attractive private equity pipeline. What’s not to like..?! Despite all the positives, VOF continues to trade on a 26% discount to NAV, which the board has described as ‘stubbornly and annoyingly wide’ – accordingly, we can expect buybacks to continue here, otherwise ‘further measures will have to be considered’.
[NB: Again, all prices/ratios/etc. quoted in this post are as of Jun-30th, for consistency. If appropriate, I’ll also highlight any significant/subsequent news & share price movements.]
Sold – see above.
The Russian market did benefit from the commodity bounce, but the H1 jump in the JRS share price was actually more about currency gains, with sterling weakening 10% vs. the dollar & 20% vs. the ruble. Russia remains dirt-cheap, a single-digit P/E market…but sanctions are still in place, and commodity prices are obviously a key economic/market driver. However, we’re now seeing some positive revisions to both economic & corporate profit outlooks, and market risk/reward does appear asymmetric if we see real change here. I’m not sufficiently convinced though (by the commodity revival) to increase my holding further at this point (plus I own another small legacy Russia-related holding), but Russia remains the kind of market one should maybe average into over time. Meanwhile, a 16% discount to NAV is attractive.
Sold – see above.
TFG’s positive attributes continue to fall on deaf ears…but pretend, for a moment, I never mentioned TFG: What do you think of an investment fund which has averaged a 13.2% RoE since its 2007 IPO, has grown its dividend 12% pa in the last 5 years, which contains an alternative asset management business which has more than tripled AUM to $17.2 billion in four years, and where management ultimately owns a 21% stake…and it’s on sale at a 6.6% yield & a 50% discount to NAV (post-June tender offer, all else being equal)?! Just goes to show how long management’s past actions can impact investor trust, and how terrifying the idea of investing in CLO equity can still be to the average investor. All of which seems like a real misperception at this point: a) Management is successfully pursuing the asset management/seeding strategy they laid out for investors, they’ve executed a number of value-enhancing tender offers, and they also appear focused now on the long-term rewards to come from being shareholders (rather than screwing shareholders!), and b) CLO equity represents just 27% of TFG’s net assets today, not much greater than net cash (at 21% of net assets). What can I say: Come for the yield & stay for the gains!
Newmark has required patience in the last year, but things looked promising with this in-line (vs. market expectations) FY trading update in May, with the CEO Marie-Claire Dwek wrapping it up by stating ‘I look forward to updating the market further at the time of the Group’s full year results’. Even Brexit didn’t seem a threat (as was subsequently confirmed…or should I say, wasn’t even commented upon). But scarcely a month & half later, this bombshell update was delivered: Needless to say, it’s jam tomorrow for another year & the share price suffered accordingly, now 32% lower (vs. end-June) at 1.88p per share.
I’ve no problem with management laying out a clear plan in advance to invest for growth…in fact, I’d applaud it. But this kind of communication is pretty irritating – a lesson in Under-Promise Over-Deliver is clearly needed here. Perhaps more annoying is that most of the problem (& management’s attention) seems to lie with the Electronic division – Newmark’s perpetual problem child, which hasn’t grown revenues in nearly a decade & whose average 23% margin has now evaporated completely. [And adding insult to injury, it utilises nearly two thirds of segmental net assets, despite contributing only a third of revenues]. Enough is enough, and ‘synergies’ be damned…the division’s better off sold (a larger competitor could still afford to pay a nice price), and the proceeds/cash on hand invested in i) a share tender offer, and ii) bolt-on acquisitions. Meanwhile, looking at cash generation over the past 18 months, it’s reasonable to assume the company’s cash balance may now (end-June) have reached £7.0 million – which would put NWT trading on a pretty absurd ex-cash 0.08 P/S multiple today.
[NB: At this point, I’d be delighted to hear from like-minded (or not?) shareholders – NWT may now warrant closer examination & engagement. Feel free to comment below, or just email me.]
Rasmala appears to be going nowhere fast: AUM declined in the last two years & the long-touted $3 billion AUM target by 2016 has been abandoned. Well, it wasn’t abandoned, or even acknowledged…the CEO simply deferred it another three years!? And more alarming is the fact acquisitions are now being touted in pursuit of this ‘new’ objective. Frankly, there appear to be few suitable targets available (& I suspect price expectations remain high), and in today’s environment there’s little reason to presume sentiment would improve on the news of an acquisition. In fact, the share price might even decline if investors still insisted on a large discount…one that’s based on a much lower level (post-acquisition) of net tangible assets.
And as I’ve highlighted before (here & to the CEO), even if this $3 billion AUM target were achieved, an acceptable return on equity doesn’t appear all that likely (based on the current business model & balance sheet). [The notion an asset management business requires an expensive & loss-making investment banking business to ‘manufacture product’ seems like an anachronism in this day & age]. All things considered, an acquisition would simply be empire building… And with Rasmala trading for a mere 28p on the pound, its own shares are the best value-enhancing acquisition opportunity available…the board needs to live up to its responsibilities here & seek to address such a huge value gap, by exercising the recently approved buyback authorisation as soon as possible & by also proposing another tender offer (the balance sheet clearly has the liquidity to fund it).
Looking head, we have: i) The monetisation of An Grianan & the 30% stake in Monaghan Middlebrook Mushrooms, margin normalisation in the Produce division, and a breakout of Speciality Dairy revenue (& profits?): All should happen, but will require some patience…a likely 6-12 months for the An Grianan sale, 12-24 months for the MMM sale, and as for the rest the obvious alternative is a sale. ii) A potential debt pay-down from sale proceeds: Presuming some degree of Produce margin normalisation, arguably no pay-down will be required as current net debt (of €12 million) should be entirely sustainable. Otherwise (noting Produce revenue has stagnated for three years now, with essentially zero profit), the board should man up & tag Produce as another non-core asset…in that case, they might as well go ahead and sell the whole kit & caboodle. iii) A substantial return of capital: At the recent AGM, the board stated it’s now ‘actively considering, subject to the requirements of the Group’s businesses, a return of capital to its shareholders’ – share tender offer(s) & an expansion of its ongoing buyback programme are the best way to enhance value here. All told, DCP shares continue to offer a compelling risk/reward, in terms of this indicative timeline & my last estimate of underlying intrinsic value (€9.46 per share, which still looks reasonable) – of course, the catalyst will be the sale of An Grianan & MMM, which could now realise close to DCP’s current market cap of €55 million – but the real multi-bagger potential here would obviously come from a sustained programme of disposals & buybacks.
Too many investors have hated FIG for years now, and in the past year they also started hating the entire alternative asset management sector…what’s it gonna take for shareholders to finally catch a break here?! Who knows, but investors are obviously picking on the entire sector as some huge beta bet on an eventual market downturn/collapse. Which may prove misguided in a world of near-zero rates…so don’t be surprised if & when the sector comes roaring back. And if you believe a permanently crap economy is all we should look forward to, PE shops are probably the best bet anyway, since: a) PE teams are built to plan on & thrive in low-growth environments, whereas the majority of corporate management teams will inevitably hurtle off a cliff instead, and b) desperate pension funds (& investors) will be forced to believe PE firms can deliver superior returns. Meanwhile, I’m exhausted spelling out the compelling investment thesis here, let’s just refresh a few of the best metrics instead: Net cash & investments amount to $2.39 per share – that’s well over 50% of the current share price, and that ignores an additional $2.59 per share in unrecognised gross embedded incentive income. Ex-cash, this leaves FIG trading on an extraordinary 1.1% of AUM (now at $70.6 billion, ignoring $7.3 billion of ‘dry powder’) – which equates to a 0.8 P/S multiple (or a 1.4 P/S, if you wanted to assume incentive income disappeared completely). Plus a base dividend yield of 8.1% keeps things ticking over nicely…
Who could be more reliable than the Grim Reaper? Certainly not his little helpers at TLI… Charles Tracy & Ian Reynolds, both on the board since day one, deserve their fair share of the blame for a litany of mishaps & generally nasty surprises over the years…leverage, currency hedging, tax liabilities, credit exposure, life expectancies, policy expiries, premium increases & whatever other risks/issues I may have forgotten at this point. Perhaps even more galling is the ‘expert’ guidance from SL Investment Management, TLI’s investment manager (also since day one, formerly known as Surrenda-link). Even a blind squirrel uncovers a
nut dead body occasionally…but the only thing these guys find are landmines. And like all experts, each new issue always seems to kick off with a somewhat innocuous disclosure, then evolves into a frenzied scramble…to be followed by a detailed explanation of how they always knew such a risk existed*, but in their opinion (just like the rest of the industry) it was considered a remote & improbable risk (that existed outside normal codes of industry practice). [*So they won’t end up having their heads handed to them by the lawyers…] If you consider quality of management crucial, TLI’s clearly not for you – otherwise, a 25% discount to NAV (as of end-June, with 7.0p net cash per share), on an uncorrelated dollar investment in a post-Brexit world, would seem like a fair/bargain price now (in spite of new & lingering premium/expiry/life expectancy risks). After all, given time, an NAV with an embedded 12% IRR can still wash away plenty of sins… Especially now there seems to be a few parties interested in a possible sale of the entire portfolio (the shares have continued to rally since, though it’s probably unwise for shareholders to presume a sale would magically deliver NAV/NAV+ in the next few months).
While fur continues to consolidate its popularity in the luxury/fashion industries, with 70% of the most recent A/W collections featuring fur, clearly this will be a bad year for Saga Furs. Weaker economies/currencies in China, Russia, Greece & Turkey, plus the new Chinese import duties, continue to exert a negative influence – but the real culprit here was last year’s substantial step-up in Chinese & Western production, based on a cold Chinese winter, higher spring-2015 pelt prices, a weaker euro & excellent breeding conditions. More generally, the Chinese now dominate both production & buying – which may ultimately be beneficial, creating a larger market bifurcated between higher quality/transparency European fur & cheaper/lower quality Chinese fur, but also implies a more volatile Saga business model. The abrupt collapse in sales & turnover this year, primarily due to lower pelt prices, is exacerbated by the scaling-up of Saga’s operations over the past few years (for example, FY-2009 sales of €248 million may be a useful comp for FY-2016…but Saga’s operating costs coming into 2016 are over 50% higher than 2009). This needs to be addressed regardless (recently announced restructuring is obviously insufficient), but the substantial adjustment in pelt prices will restrict supply & stimulate demand – and longer-term, the fur industry continues to grow, and Saga still strikes me as a genuine cyclical growth stock. Fortunately, at this point, it’s priced for (permanent) recession…trading for 0.6 times book, 0.7 times (peak) turnover (noting adjusted operating margin also peaked then, at 39%), and 2.5 times (peak) earnings. One to lock away for a brighter day…
Both the Chairman & CEO have departed here, and investors are currently on hold (although ZMNO’s recovered most of its H1 loss since) as they await news of their replacement – notably, the AGM’s less than three weeks away now, so hopefully we can expect a meaningful update then (or better yet, a definitive announcement). But noting Zamano’s poor capital allocation record in the last few years – no dividend payments, no restructuring of the balance sheet to enable a return of capital, and no acquisitions, not to mention an offer falling through – I’d anticipate a potentially asymmetric risk/reward from this executive turnover. At worst, we end up with more of the same & the share price continues to lag its underlying intrinsic value…or fresh management parachutes in with a new broom & a plan to allocate the company’s surplus cash pile far more efficiently. At this point, what do you think the company’s top three shareholders (who control an aggregate 52% stake) would like to see? Meanwhile, noting cash generation in the last couple of years, it’s reasonable to assume cash has increased by an additional million – which would peg end-June net cash at (say) €7.3 million. Granted, recent EUR/GBP volatility will present a fresh head-wind in H2, but hopefully if see anything like last year’s momentum (+22% revenue growth) continued, it would obviously help mitigate/offset this impact. Regardless, ZMNO trades on a dirt-cheap 0.2 P/S ratio (ex-cash) & a rather improbable 1.6 EV/Adjusted EBITDA multiple – so if new management can’t address/eliminate the obvious value gap, sooner or later a predator will finally follow through here & do it for them…
Right then…best of luck in H2, folks!