Monthly Review - August 2011

August was not only another bad month for investments, in dollar terms it was the worst month I have experienced ever. Mark to market declines in asset values, particularly equities, were massively greater than the gains from rental income and were made worse by adverse FX movements. Even a healthy savings rate and positive cash flow from the properties were unable to offset the losses. My equity investments have produced negative returns this year (but are still ahead of cost overall).

Here are the details:

1. my Hong Kong equity portfolio declined sharply either in line with the market or due to industry or company specific factors. Some of my largest holdings (HWL, CCB, Hua Han, Yanzhou) recorded particularly large losses. There were few gainers. During the month I purchased shares in VODone, Tontine Wines, Sinopec, Sinopec, CNOOC, GDI and Varitronix;

2.my ETFs were down sharply in line with the local markets. There were no ETF purchases this month;

3. my commodities rose marginally, led by a gain in silver;

4. all of my properties are occupied, the tenants are paying on time. Two of my Hong Kong properties require minor repairs and one aircon unit needs replacing. I will have a single brief vacancy in late September/early October and will have to do the usual touch up and cleaning. One overseas property requires work on its roof. The collective bills are not significant but will temporarily dent cash flow in October;

5. currency movements were very slightly negative, as the NZD and AUD fell against the HKD/USD;

6. my position in bonds remains small. No bonds were purchased this month;

7. there are no open derivative positions;

8. savings were moderate with high income and high expenses. My major expenses were for a short summer holiday and the annual premium for the medical insurance.

My cash position decreased due to new investments. I currently hold 21.4 months of expenses in HKD cash or equivalents (compared to 26 months at the end of February).

For the month, my net worth fell by 3.23%. The year to date increase is now only 8.25%

VODone purchased

VODone (HK:82) put in a disappointing result for the six months to 30 June, 2011. EPS were down 4.5% to 4.3c cps. Other material negatives were:

• a substantial dilution in the share base through a combination of non-prorata new issues;



• one off expenses of HKD34 million for one-off fair value loss on deferred consideration shares and share-based payment expenses



• an explosion in selling and marketing expenses to HKD249.7 million (from HKD73.2 million)

It was not surprising that the shares fell sharply on opening - a continuation of a downward trend which has seen the share lose about 55% of their value since my purchase at HKD2.36 in September 2010. VODone is currently the worst performing investment in the portfolio.

However, the gross profit more than doubled on the back of a significant jump in revenue and the balance sheet remains clean with no borrowings and modest cash balance of HKD342 million.

IMHO, the second half profit has potential to be significantly better than the first half. The non-repitition of the one off items alone would produce a material lift in EPS (although not one that I can precisely quantify because of the effect of minority interests). More importantly, if there was a combination of further growth in revenue and a reduction in the selling and marketing expenses, then the bottom line profit could increase significantly.

Accordingly, I added to my position this morning paying HK$1.05 per share.

Tontine Wines purchased

This afternoon I added Tontine Wines (HK:389) to the portfolio, paying and average of HK$0.825 per share.

The company has just released its interim results, showing a 21.7% decline in net profit and a 32.7% decline in EPS for the six months to 30 June, 2011. On the surface, this looked like a very bad result and the share price fell 19% today.

My take on the results (available here ) is that the shares look attractive.

Firstly, the interim result included one off expenses/losses of RMB20.9 million relating to share options and RMB14.4 million relating to FX. If these items are treated as non-recurring and backed out of the results, the interim result actually looks a lot better - the EPS would be similar to the previous corresponding period. This is especially so when the 22.1% increase in revenue and 19.3% increase in gross profit show that the company successfully grew its business during the period.

Second, the balance sheet looks very healthy. The company is sitting on RMB1.2 billion (HKD1.4 billion) in cash and has no borrowings. It has shareholders funds of RMB1.68 billion (HKD2.0 billion). The market capitalisation is around HK$1.7 billion.

Like all companies, there are issues (e.g. the extended duration of the receivable, rising costs and absence of an interim dividend) but, on the whole, the company looks like an attractive entry point to China's growing domestic consumer market.

A very short vacancy

The tenant in my highest renting property gave notice to quit last Friday. If the property remained vacant, I would have negative cash flow on the rental portfolio as a whole (although principal payments are the biggest component of the cash outflows, so I would still be making a profit).

However, a new tenant has been signed up already and I will be banking the cheque at lunchtime.

While the new rent is 11.4% higher than the previous rent, I am not actually any better off unless the new tenant stays there for more than year because the negative effect of (i) agent's commission (ii) tidy up and cleaning costs and (iii) a two week vacancy between tenancies is equal to just under 12 months worth of the rental difference.

Inflation hits 7.9%

That's right - Hong Kong's CPI for the year ending July 2011 hit 7.9%. This is the highest level since November 1995 (8.4%) and compares to 5.6% for the year to June.

The main contributors to the sharp rise were (i) rents (ii) food (iii) travel.

The HKSAR government made a rather feeble attempt to spin the number saying that it was partly due to a lower base comparison arising from one off concessions granted in July 2010 (in particular a waiver of public housing rentals that month). At best, this is misleading as it is simply another way of saying that CPI was understated a year ago.

Some granularity:

• alcohol and tobacco rose 20.1% (there was an increase in the tobacco tax)


• housing rose 16.4%


• food rose 10.7%


• clothing and footwear rose 7.3%


• dining out rose 5.5%


• transport rose 4.8%


• utility costs fell 16% (the government used taxpayers money to subsidise eletricity consumption)

Even if you accept the government's arguement that the effective CPI was "only" 5.8%, this is still higher than the average pay increase (civil servants and a few other small groups excepted), much higher than the yield on good quality HKD bonds and multipiles of HKD bank deposit rates. For investors, the message is pretty clear - if you want to mainatin the real value of your investments, you have to buy risk assets and/or be a borrower. Conservative savers are keeping their money nominally safe, but accepting an assured destruction of real value.

Varitronix purchased

This morning I purchased a small number of additional shares in Varitronix (HK:710) paying HK$3.54 per share.

Varitronix was sold off heavily following the release of its interim results this morning. At the time of writing the shares were down more than 12% from Friday's close. While I usually proceed on the basis that the market knows more than I do, this was puzzling:

1. the result was a good one - EPS for the period was 30.38 cps, up 39% from the previous corresponding period

2. the interim dividend was doubled to 11 cps

3. the result was achieved in spite of (i) rising costs typical of those faced by PRC manufacturers generally (ii) the impact of the Japanese earthquake and tsunami and (iii) losing HK$19.9 million on trading securities

4. the company is sitting on HK$354 million in cash and HK$294 million in securities. While details of the securities held were not provided, it can be inferred from the break down of "other income" that the bulk of them should be debt securities. After backing out the HK$126 million in debt and arbitrarily discounting the securities by 20%, the company has net cash and investments of HK$463 million or approximately HK$1.41 per share

5. the Chairman's comments were cautious to slightly negative, leading to the conclusion that results for the second half may not be as good as the results for the first half. This is hardly surprising. However, IMHO, the second half results would have to be a lot worse to justify the sell off in the company's shares. Put differently, if the final dividend for 2011 is the same as the final dividend for 2010 (21 cps), then the annual dividend is 32 cps, a yield of over 9%

What am I missing?

CNOOC purchased

This afternoon my small limit order on CNOOC (HK:883) got hit. I paid HKD14.36 for the additional shares. With a trailing yield of 3.2%, a sound balance sheet and a number of brokers having price targets above HKD21.00 the sell down is (IMHO) over done - notwithstanding that the recent fall in the price of oil may not have been factored into valuations.

Guangdong Investments purchased

This morning I made a further investment in Guangdong Investments (HK:270), paying HKD4.26 per share. Once again, this is an attempt to add some low risk yield to the portfolio.

Hang Seng Bank purchased

This morning I made another small investment in Hang Seng Bank (HK:11), paying HKD112.80 per share. The attraction remains the 4.6% yield.

At the time of writing, several other limit orders remain unfilled.

Sinopec purchased

This morning I made another small addition to my position in Sinopec (HK:386) paying HKD6.60 per share. The company offers a trailing dividend yield of 3.7%.

Guangdong Investments purchased

This morning I made a small additional investment in Guangdong Investments (HK:270) paying HKD4.26 per share. The company is essentially a utility with its largest asset being the water business. The later is interesting in that the long term contract to supply water to Hong Kong is due to be renegotiated later this year. Given the way in which the PRC government has shifted the inflationary burden onto the toll road operators, there is at least some risk that the company may be put under pressure to absorb inflationary pressures itself (rather than set a free market price), but my view is that this is well recognised and already reflected in the price.
Trailing yield is 3.5%

Hang Seng Bank purchased

This morning I topped up my shareholding in Hang Seng Bank (HK:11) paying HKD113.20 per share. At current prices, Hang Seng Bank offers a nice fat 4.6% yield (paid quarterly). It won't be the most exciting of stocks on the upside, but it's one I feel comfortable owning for the longer term.

Living with the downside

As mentioned in my previous post, every equity I've purchased so far this year is now trading at below cost, in some cases well below cost. Add in the declines in value in the portfolio I held at the beginning of the year and the cumulative losses on equities far outweigh the net rentals and FX gains. As things currently stand, plans to retire in early 2012 are in jeopardy.

That said, there are some positives:

1. assuming no further investments, by month end I will be sitting on around 30 months of living expenses in cash or near cash. This is the most I have had for a considerable time;

2. interest rates remain low and are likely to remain low for the foreseeable future. The risk of higher interest rates on my floating rate mortgages has been significantly reduced;

3. I am still accumulating and the recent share market falls mean that I will be buying at more attractive prices than earlier 2011 or in 2010. The Hang Seng Index is trading at below 11x current year earnings. While this is not as low as in early 2009, it is well below the historic average;

4. it is better that this happen now when I am still working (although with considerable uncertainty when I come off contract at the end of 2011) than after I retire;

5. the weaker AUD/NZD provides an opportunity to move some money offshore to further diversify my asset base.

Obviously markets can keep falling - we are still well above the early 2009 lows, I could be facing unemployment next year and I could get some vacancies on the properties. A lot of things could continue to go wrong, but at some point the current market rout will become an opportunity. Although this may be evidence that I need therapy, I am more inclined to ignore the overwhelming tide of negativity and view the current market as a buying opportunity than to panic and sell. Famous last words I am sure.

Sinopec purchased

Insanity, it is often said, is doing the same thing over and over again and expecting a different result.

I've been "buying the dips" all year and, so far, every single equity purchase this year is currently underwater with Sino Oil & Gas (HK:702) being the most expensive in terms of unrealised losses and Specialty Fashion (ASX: SFH) being the worst performer in percentage terms. The losses on the equities (including those held at the start of the year) now exceed the net rental income and FX gains by a considerable margin. Things have reached the stage where my plans to retire in early 2012 are now very much in jeopardy. I'll post some further thoughts on the big picture separately.

In any event, I purchased some more Sinopec (HK:386) today - another small incremental addition to the portfolio. I paid HK$6.48 per share. Sinopec has been hammered by the inability to pass high oil prices through to end users. With oil prices falling (and PRC imports of crude still rising), I would expect Sinopec to perform better once the damage to the current reporting period is out of the way. It also offers an attractive dividend yield of close to 4%.

AUD/HKD FX contract

On Friday I entered into a short term (two week) AUD/HKD FX contract:

Spot rate at time of contract: 8.096
Strike: 8.05
Annualised premium: 10.06%
Fixing date: 18 August
Maturity Date: 19 August
Implied break even rate: 8.019

This is largely an exercise in attempting to extract a better yield from my bank deposits. While this is not always a sensible exercise, with inflation running at 4+% and deposits yielding close to zero, the alternative is to accept certain erosion of the real value of my savings. The amount involved is not particularly large - about the "standard" amount I would put into a single stock position.

The problem with bottom fishing...

The problem with bottom fishing is that you never know how deep the water is.

My previous efforts to add to the portfolio by picking up some "bargains" has, to date, been an exercise in catching the falling knife. It was fortunate that previous purchases were small incremental additions to the portfolio.

This morning I repeated the exercise making small incremental additions:

1. Sinopec (HK:386): I paid HK$6.98 for some additional shares;

2. Sino Oil & Gas (HK:702): I paid HK$0.34 and HK$0.36 for some additional shares;

3. CNOOC (HK:883): I paid HK$15.50 for some additional shares.