A Medical Thriller in Manila

It has been far too long since my last visit - in fact nearly five years.  As a value seeker the Philippine stock market has been a difficult place for some time.  We had an overweight exposure there between 2010 and 2013, but as the market moved up and multiples expanded we were compelled to move out, booking good profits but leaving a lot on the table.

Philippine equities have been one of the best places in Asia to invest over the last five years; but the market is narrow and lacks liquidity.  A few families still control almost everything of importance both listed and unlisted.  All of which makes the country tricky for foreigners, especially if you have a large fund.

Still the country has among the best demographics you can find anywhere, and its economic trajectory is one of the best around.  So it is impossible to ignore.  The people offer several advantages.  In addition to widespread if imperfect English employees tend to be loyal, or at least less mobile.  I gleaned an interesting insight into what this means from a meeting with Luen Thai a Hong Kong listed textile company that has a large operation in the country sewing bags : both backpacks as well as some of the better brands.  They are there because while sewers with a similar level of experience are more productive in China, overall the average output of a large number employees in the Philippines is as good or possibly higher.  The reason is stability in Cebu compared to high turnover among the workforce in Guangdong.  It helps of course that the Philippines has preferential tariffs when exporting these categories of product to the US compared to China.

Another interesting observation is how some of the service industries in which the Philippines excels are moving up the value added chain.  The BPO business is booming, but its mix is changing.  There is more medical and accountancy back office, and less telemarketing.  Companies claim that the clarity and politeness of their staff enables them to win business from Indian competitors.  Not sure how those competitors would choose to respond to these claims.

A similar trend can be seen in the Overseas Foreign Workforce.  Approximately 10% of the country works somewhere else : a truly staggering statistic.  While the total number of OFWs does not seem to be growing much of late, remittances continue to rise – roughly by 5%+ p.a.  The explanation appears to be that here too the mix of that workforce is on the way up.  Maids in the Middle East continue to be in demand, but white collar workers and increasingly managerial level personnel, are also finding employment and at higher salaries:  one reason why the Peso, though down against the US$ in 2015, has held up better than most other Asian currencies.

I was located downtown for two days, the first at a conference organised by Maybank/Kim Eng.  This pan-Asian broker has been raising its game as their research is getting better at a time when much of the coverage is getting worse.  They are also investing in the business when many houses are focused on cutting costs.  My point person in Singapore, Richard Harding, is a true value contrarian and a good guy to know.  Maybank had rounded up an impressive roster of corporates, with many of the most important listed companies in that country in attendance.  My favourite, based on the businesses I met, was Concepcion Industrial.  That management team was able to articulate a clear and realistic strategy, and seem to operate in a reasonable growth context; but alas I am not the first person to notice that.  The share has already done well.

How to play the positive themes in the Philippines?  One thing OFWs almost always want is to buy a house back home.  Two listed companies target this market.  Vista Land is the largest.  We own Filinvest Land.  Both have large networks of agents all around the world and organise Tupperware-type parties in places where there this is a critical mass of Filipinos.  They can construct homes for less than $50,000, including land cost yet still make a good margin.  Impressive!  Filinvest Land also has a large instalment loan book with security over the very same houses it is building, and a spotless record of close to zero loan loss as a result.  Local brokers for some reason do not appreciate the value of this part of their business model.  For me it is one of two excellent reasons to own Filinvest rather than Vista, even though Vista in my opinion has a somewhat better land bank.

Recognising the excellent quality of nursing care with Filipinos active in hospitals all over the world, I acquired a couple of suites in a medical complex constructed and operated by Century, another listed property company.  While called the Centuria Medical Makati, it is not actually as close to the main Makati Hospital, arguably the country’s best, as one would like.  Terrible traffic downtown - some of the world’s worst - can mean any journey of over 1 km is an ordeal at the wrong time of the day.  The building is only just open.  Tenants needs time to settle in, so most of the units are still empty, including alas mine.  Yet the low cost X-ray department should attract business and one emergency room operator has signed up for substantial space.  There is still a fair amount of decoration in process and some snagging to sort out, but the building could well become a prestige destination in the healthcare space once it is operating properly.  It should look rather different and also be more active twelve months from now.  I am optimistic about this investment.

The location remains a drawback as it is not in the nicest part of town; but it is an area that is on the way up with a new shopping mall next door, a high-end apartment block going up on the next lot, and a major new office complex also in the works.  Happily my units are on the other side of the building away from all this construction, and have a good view.  

Medical is definitely a growth sector, but hard for investors to access.  There is no pure play.  Metro Pacific has the best portfolio of hospitals.  The plan is to spin that division off via an IPO at some point.  Still you would not buy Metro Pacific for that operation alone.  You have to like the other bits.  Fortunately as a proxy on infrastructure in the country in general the company has attractions.  Then there is Century.  Its first medical building sold fast.  If it starts to do more of them that would give it a point of difference set against other developers.  It is also the cheapest relative to net assets, but the balance sheet is not the best, and it is tier two not tier one player.  Tourism is another obvious area.  Again there are few pure investment plays other than the casino stocks and a couple of not especially distinguished hotel companies.  Meanwhile medical tourism ought to be booming; but no-one here does that yet as well as the Thais.  All in all there are no undiscovered gems in the Philippines for the voyaging equity investor in either of these spaces at this precise time.   

      

  

Was the First Half of 2105 really so bad?

Apologies for a rather lengthy absence but first an enjoyable holiday made it tempting not to do anything for a few days.  Then markets have been frenetic over what is usually a relatively quiet period in the summer and demanded more than my usual amount of attention. 

I have a couple of interesting postings in the works having been to Manila and Hong Kong recently as well as some insight from what is going on in Italy; but for now, thought I would share an edited version of a letter I wrote for the month of August to shareholders in one of the funds we advise; CIM Dividend Income, a high yield equity fund that largely focuses on Asia.  Please note that nothing in this letter should be taken as giving advice to invest either in the fund or in any of the companies named; and also please note that I have edited out one or two elements which are pertinent to shareholders only.  Hopefully what is left will provide interesting insights into the crazy world of financial markets, especially in Asia.

You will be aware that the markets in Asia have been dire during the last few weeks.  China-related shares in Hong Kong have been hard hit with the main index off approximately 12½%.  Elsewhere local declines were aggravated by weak currencies relative to the US dollar. 

The only consolation, and it is not much of one in the short term, is that there is a significant disconnect between what is happening at companies compared against the behaviour of the financial markets.  Performance in Hong Kong in particular has been adversely affected by measures taken by the Chinese government to try and protect savers who invested in domestic Chinese shares, whereas there has been no effort at all to encourage support for Hong Kong.  Indeed selling pressure has increased in Hong Kong as a result of these measures.  That said the companies are on average reporting reasonable results and providing cautiously comforting guidance when taken as a whole.  I just returned from meeting many of these companies.  Overall the team met over 40 companies during the last two weeks and reviewed nearly 70 results.  I think it is useful to summarise our findings in the table below, albeit our categorisation is a somewhat crude assessment of whether the businesses we own are getting more or less valuable.  Flat means plus or minus 5.0%.

Performance: HK/China Interims - 1H 2015

	Sales	Earnings Per Share	Net Asset Value	Leverage
Up	33	32	36	25	Better
Flat	15	15	24	19	Same
Down	19	20	7	20	Worse

 

You can draw a couple of conclusions from this data.  The first is that significantly more companies delivered reasonable topline growth than were down.  Most also delivered Earnings Per Share growth albeit the ratio is a little lower on this measure.  There has been a trend to margin compression due to overcapacity in some sectors but the area that has suffered most has been property.  The reason why that is happening now is that most reported bookings relate to contracted sales for late 2013 and early 2014 when restrictions on the property market were biting hardest and pricing pressure was at its peak.  Generally the companies in that sector are expecting material margin recovery in 2016 and most believe that their mix will begin to improve in the second half of this year.  I think we are seeing the trough, but do not expect margins to return to where they were in 2013.  Still every single property company we met claims that the gross margin they expect out of the 2015 contracted sales book is considerably above the level reported in the income statement of 1H 2015.  Of course we will not see any of that until 2H 2016.

Growth in underlying Net Asset Value has also on balance been heavily positive.  The one area we have to watch is leverage.  There the data is more ambiguous. 

If you are wondering why there is no mention of the dividend, we have not included that metric in the table since only a minority of companies pay interims; and thus the sample is skewed and also too small for us to draw any conclusion.  What I can say is that there were no negative surprises and a couple of positive surprises in our universe.  

Turning to a much larger sample, all China listed companies covered by Australian broker Macquarie, the analysts at that firm saw real improvement in several areas when aggregating 2015 1H financials.  In contrast to all the media negativity they detected reasonable average earnings growth, somewhat better balance sheets, and arguably most important and interesting of all higher Return on Assets, a trend they have noticed and monitored since the end of 2013.     

There are times when I feel I am living in a parallel universe.  This is one of them.  Overall earnings are up, as are NAVs though margin movements are varied.  Still there is nothing on the ground to justify the treatment Hong Kong shares have received over the last two months at the hands of the market.  The economy is in transition.  Some sectors may be in decline while others are enjoying good growth, but across the board the larger listed companies are gaining market share.  At the risk of repeating myself, Hong Kong never enjoyed the run up that took place on Chinese domestic exchanges; yet it has participated to a large extent in the decline.  The CSI is off 40% from its June peak, while the Hang Seng has retreated by 24% since its April high.  The same index was down at the end of August YTD by 8% and YoY by a similar amount, while the Hang Seng China Index is down 19% this year.

Over in the real world management run businesses in which you can invest; and investors can monitor the collective effort of a workforce, working on our behalf combined with assets, real and financial, to deliver services or produce products consumers are prepared to pay for.  Over time good businesses build value and the value of our investment goes up as well regardless of the mood of Mr Market.  Occasionally Mr Market goes off the rails.  When that happens those with their feet on the ground get gifted with a great opportunity: as they did in 1981 and in 1987, and then again in 2001/2, and one more time in 2008.  Possibly we are nearly there again in 2015, at least as far as Hong Kong goes as on most valuation metrics the market trades between one and two standard deviations below its average.  Some shares are back where they were in 1H 2009 post the GFC sell off.

Since future returns are generally recognised to be a function of entry price it is worth remembering what came after 1981, 1987, 2001/2 and 2008 when entry prices were attractive due to severe market setbacks; and also it is worth remembering what happened to shareholders who reduced their equity holdings at those moments (a large number unfortunately).  Most never got back in and missed the rallies that always follow when markets are oversold and valuations fall over 1 standard deviation below average : which is where we have got to now in our main market.  Sentiment surrounding Hong Kong is dire and valuations reflect such sentiment.  That is a time to buy not sell.  Of course prices can still go lower and seasonal patterns suggest they will at least in September and October; but if they do we should enjoy an even stronger rally when the market turns.

The most surprising feature of last month was the drop in share prices of Singapore REITs.  This occurred regardless of whether the relevant underlying currency was neutral (Singapore assets), negative (the Rupiah) or positive (the Yen).  So one thing is clear: investors are not bothering to look at either the underlying assets or the income streams in this environment.  Many REITs dropped 10% during August.  Yields blew out from 7% to 8%.  Some now yield 10%.  Yields such as these were last seen in the second quarter of 2009.  Subsequently in 2010 and 2011 most of these shares rose 25-50%; a few even more.  While concern relates to an expected interest rise in the US, and some modest increases in local rates, the gap between REIT yield and SIBOR has widened over the last few weeks. 

My assessment is that we are seeing margin calls.  Singapore is regarded as conservative; but certain aspects of its financial services are not.  The high net worth/wealth management industry offers leverage, often at 3 to 1, for what are viewed as conservative assets.  Many REITs fall into this category.  Thus a 10% decline in price translate to a 40% decline in equity requiring a margin call; and so it goes.  Banks and brokers are notoriously unhelpful and can be vicious when margin calls are not met.  If you happened to be on the beach with your mobile off, you can come back from lunch to find your shares were sold.  Anecdotal evidence suggests some of this was going on last month.  The result is that we are now getting to see attractive buying options.  10% in Singapore dollars underpinned by a reasonable property portfolio is not to be sniffed at.  I tried to convince some clients in the first half of 2009 to help me create a Singapore REIT fund and think the time may be coming once again when investors with cash should consider doing just that. 

In Indonesia the share price selloff starting in July has been the steepest recorded over the past 10 years.  While nothing guarantees it cannot continue, history shows that this sort of decline does not last for long; so we should be more or less done here as Indonesia has gone from relatively expensive to relatively cheap in a matter of a few weeks, even assuming lower growth.      Indonesia remains an area of concern.  The government has been a disappointment with reforms stalled, planned infrastructure acceleration intermittent, and inconsistent policy making.  A recent cabinet reshuffle followed by renewed commitment to the all-important drive to upgrade infrastructure and reignite FDI hints that things may improve, but the market will want clear evidence this time round.  A new round of measures to stimulate the economy shows the right spirit, but implementation has been the weak part of Jokowi’s reform packages.   

Another upset in August came from Taiwan.  There is no particular reason why this should have happened except that everywhere else was going down.  Taiwanese shares have come down considerably.  Even before the latest selloff they were close to one standard deviation below the 10-year averages for that market, on both a Price-to-Earnings and Price-to-Book basis.  Now on the negative side one should note that there are no major new electronic product categories in the pipeline over the next year that could stimulate another round of growth at the core component sector that makes up so much of the listed market and also has been a driver of the overall Taiwanese economy.  Still when the price is right you are not paying for any topline growth; and Taiwanese management is notoriously good at extracting cost.  It is perfectly feasible to expect improvement in margin sufficient to deliver a degree of profit growth in 2016 even if sales are static; and that dynamic can continue for an extended period along with the opportunity to change product mix.  Therefore this latest, incremental collapse in share prices seems unwarranted.    

   

One encouraging sign is that we have begun to see a repeat of a pattern that emerged in the last quarter of 2008, when management and controlling shareholders of companies started to buy shares and increase their ownership, and a number of companies also began to buy back shares.  In contrast to US practice, Asian companies seem to buy when their shares are cheap and issue them when they are expensive.  It is too soon to say that this is a firm trend but the number of instances noted suggests this activity could become significant; and it underlines the gap between what insiders see and what the financial markets think. 

Insiders got it right in 2008.  When insiders use cash to buy shares it is usually a positive signal for investors if not necessarily for short term traders.

Smog in Singapore

Every year there is a smog season.  It usually occurs in June and July.  The cause is always the same : land clearance in Indonesia.  

The cheapest, if not the most efficient, way to dispose of tired palm oil trees is to set a fire and let them burn.  When the palm oil price is low, as it is now, the temptation to take this short cut is all the stronger.  The economies are clearly tilted in favour of slash and burn rather than carefully removing poor producing plants and processing the detritus.  These trees give off smoke.  Some land is peat like.  The combination can be toxic.  Once the land is smouldering the fumes can last for days, even weeks; and the smoke contains nasty residue that can damage lungs, especially those of young children. 

Villagers and small scale local farmers get the blame; but large companies listed on stock exchanges across the region have plenty of cover if they choose to take out old trees this way.  It is hard to prove who started a fire.  The Indonesian government demonstrates its incompetence each year; and even if the central government has good intentions local officials either do not care, or all too often are given inducements to look the other way.  Since the prevailing winds tend to take the worst of the smoke to Singapore and Johor, rather than Jakarta, this is not so difficult.  Finger pointing at someone else is the easy response as no-one seems to want to admit responsibility.  

Of course Indonesia is a poor country but offers of intervention and assistance from Singapore are routinely rejected.  Sovereignty is cited as one reason, but I suspect the main reason is that clean and competent Singapore firefighters might discover what is really going on; and pinpoint the culprits – some of whom almost certainly live in Singapore so could be prosecuted.  Cash is changing hands but investigative reporting is counter cultural and environmental NGOs who on this occasion might be able to make an useful contribution seem unable to get to the bottom of the scandal and present conclusive evidence to the authorities.  All they have been able to accomplish so far is to persuade many Western investors to boycott companies in this business; and this is a blanket ban regardless of whether the company has good sustainable farming practices or is one of the bad guys.

So we all suffer.  Strangely we are suffering now in September when in most years the skies should be clear as the annual damage has been done.  Checking with several sources - including my team in Jakarta - it seems that this year the fires really might be natural.  There has been insufficient rain.  El Nino is to be blamed.  Spontaneous combustion can happen.  Many areas are much drier than usual.  Not all the fires are in plantation areas due for renewal.       

That last point is the most powerful, but does not make conditions here any better.  Several days last week the PSI went well over 100.  That is the threshold for unhealthy.  Masks have reappeared.  The view from my office is shrouded in haze.  The sun struggles to break through.  We know it is up there; but it is totally obscured by smog.  Yesterday it got up to 160.  200 is the cut off point for very unhealthy.  We have flirted with that level.  

Conditions are not as bad as they were a couple of years ago when at its peak the index exceeded 400 and schools had to close.  300 by the way is classified as hazardous.  This is London back in the 1930s, but caused by palm oil rather than coal burning.  

The Indonesian government appears powerless if not indifferent.  There is not much love lost between the two countries.  I have observed that when things get really bad in Malaysia, Indonesian officials take somewhat more notice of those protests and a little more effort is made to reduce the problem.  So here we are hoping the wind will change and take the worst of it over to Malaysia as that should stimulate some action on the ground in Kalimantan and Sumatra; or praying for rain : a lot of it.  We shall know soon if seeding really works.  There is rain today here, but will it fall where it is needed most and will there be enough of it?  Sadly there is not yet enough evidence of that.

Time to Remember

70 years ago at about this time of the year, POWs in Singapore were released from three and a half years of hell as captives of the Japanese; or at least the survivors were.  Too many did not make it.  Those who did were diseased, emotionally drained, filthy, starving and wretched.  It is hard to imagine what they went through.  We are most fortunate not to have experienced anything like it.  My great aunt lived through it and told me that one of the first things the army did when opening up the camps was to deliver blocks of salt.  The inmates licked them like animals.  They had not seen salt in nearly two years.

That is one reason why I found myself at a ceremony on the 11^th September at The Changi Museum honouring those who had been held there during World War II.  The other was that the old Etonian Association was unveiling a plaque to commemorate OEs who had been in Changi.  There were a surprising number for just one school, 24 OEs in total plus a future head master Anthony Chenevix-Trench.    

                                        

We mustered a good turnout of OEs for the occasion.  It was a moving moment for all of us who had family interned.  There was a beautifully judged speech by Michael MacKenzie, head of the OE Association of Singapore, followed by several readings by descendants, one so poignant it deserves to be reproduced here and should have much under circulation.  Please feel free to pass it on.  Entitled Freedom it was written just after his release on 6^th September 1945 by Lieutenant Robert Fletcher of the Gordon Highlanders.

Freedom

For every little boy and girl it's always been the thing

To honour all those authors who the praise of freedom sing.

But don't you be like them, my son, when you to school are sent; Those smug complacent poets never knew what freedom meant.

Secure in England's land they sang "We must be free or die" —

They who had never even felt the threat of tyranny.

But if you're seeking praises that are not mere fulsome cant,

A victim of the Kempei or Gestapo's what you want.

For when you've had to fawn upon a callous, vicious foe

To get a wretched dole of food, or when you've had to go

And labour in a chain-gang with your friends who once were free —Then, and only then, you'll know the worth of liberty.

So when the theme is freedom and the poet free and fat,

Just take a prisoner's word for it, he's talking through his hat.

And ask yourself this question when you next read Burke and Co. "What can they know of freedom, they who only freedom know?"

Kranji, 6th September 1945
Lieutenant Robert Fletcher

Least we forget it was not only the British army and civilians who suffered.  The Indian army was the largest victim of Japanese aggression and abuse.  67,000 of the 132,000 troops defending Malaya and Singapore were Indians.  They were treated terribly too; and in some cases even worse with many sent to remote Pacific islands to build air strips.  Few returned as we were reminded in a speech by Captain Sachin Sequeira, the Defence Adviser at the High Commission of India in Singapore.  He unveiled plaques to the six regiments that fought as part of the doomed campaign and suffered terrible casualties.  The Sikhs were prominent in that war and a special plaque was also added in their honour along with a deeply touching prayer session led by Mr Gurcharan Singh of the Central Sikh Gurdwara Board.

All of this was more than appropriate.  The role of the Indian soldiers in the Second World War has been shamefully neglected by historians, though two recent books on the subject should help put that right.  More Indians died defending Singapore than any other nationality, some in regiments where OEs were among the officers.

This was a wonderful occasion of remembrance slightly marred by Captain Sequeira’s reference to Subhas Chandra Bose.  Whatever one’s political views this was not the occasion to bring up a man who fought alongside the aggressors when you are remembering the victims. 

It is all too easy to forget that only a generation ago so many people were willing to die for their beliefs.  I wonder whether that is still true.  Watching from Asia at the terrible scenes of migration out of the Middle East and into Europe raises the concern that this invasion, whatever its cause, could easily end up in civil dislocation and violence on a scale not seen since World War II.

The Changi Museum is a special if slightly distressing place.  A visit should be mandatory as part of any history course.  We need to remember what can happen when politicians get it wrong.  And we need to remember what man can do to men, women and even children when nations go to war.  And we need to place a proper value on freedom. 

In the immortal words of Lieutenant Fletcher:

         “What can they know of freedom, they who only freedom know?”

Compared to him we are all free.  Time spent at Changi Museum may not bridge the gap but could bring us closer to a better understanding of and respect for its importance.