Sold out: LG H&H Pref. Shares (KRX:051905) , not expecting a turn-around

LG H&H is a South Korean consumer goods conglomerate. The company started as a supplier of laundry detergents, home cleaning products, shampoos, toothpaste and other branded household goods. Most of these are well-known brands within South Korea. A few products like Physiogel and Dr. Groot are also sold internationally with some success, although none are blockbusters. Later, LG H&H also became a bottling company for Coca-Cola beverages. In addition, it distributes a few of its own beverages throughout South Korea. As its third division, LG H&H runs a portfolio of branded beauty products selling worldwide at different price points. This cosmetics business has been going down lately, taking the LG H&H share price with it.

LG H&H common share (dark blue) and preferred share (light blue). Share price progression in percentages.

What went wrong? Over the last decade, cosmetics became LG H&H's most profitable division. This was mostly due to the success of the luxury brand The History of Whoo in China. This brand benefitted from the K-Beauty (Korean beauty) trend. It was successfully sold within Mainland China and through Korean duty-free shops to Chinese tourists and daigou traders.

The Chinese market accounted for 16 percent of LG H&H's total sales. If the company adds revenue created by Chinese duty-free customers, the ratio increases to 38 percent. This has worried many industry watchers, who argued that LG H&H should cut its heavy reliance on the Chinese market. 

The Korea Times, 21 April 2022

With the Covid lockdowns, the travel-related part of the cosmetics business disappeared overnight. The local sales within China were also poor. Nobody needs luxury cosmetics when staying at home in lockdown. However, post-Covid, neither the travel business nor the local sales within the mainland recovered. Investors noticed, and the share collapsed.

I will attempt to map out LG H&H's prospects. Is it a lost case, or can we expect a turnaround? I will structure my analysis around four questions.

1. Could the Chinese interest in The History of Whoo return?
2. Can LG H&H develop into a global cosmetics company? 
3. Do the non-cosmetics activities, i.e. beverages and household goods, justify the current share price?
4. Is the preferred share more attractive than the common share?

Let's first check the latest financials from the LG H&H 4Q2023 report

An 12.3% revenue drop in the beauty segment may not seem disastrous. However, 2022 was still a Covid lockdown year in Asia. For 2023, we would expect a post-Covid rebound, but there is a revenue drop instead. For a luxury product like The History of Whoo, such a drop could indicate trend-setters and early-adaptors abandoning the brand. This means a larger group of trend-followers may leave the brand later.  

HDB = Home Care & Daily Beauty. This segment includes cleaning products and daily personal care brands like Physiogel, Dr. Groot, and Euthymol toothpaste. Revenues dropped somewhat. Operating Profits dropped a lot more. This seems primarily due to price inflation of ingredients and transport costs. I am not worried about this segment.

Refreshment = Domestic Coca-Cola bottling operations plus distribution of LG H&H's own beverage brands. There are no big worries here, either.

The sales increase in North America looks promising, but let's note that LG H&H took a controlling stake in The Crème Shop in 2022. The Crème Shop sales counted for the first time for a full financial year in 2023. 

The segmentation by region clearly shows the decline in sales in China. Let's address this issue first.

1. Could the Chinese interest in The History of Whoo return?

I broke the answer into four sections.

• a. Limits to the daigou trade 
• b. Changing consumer tastes within China. K-Beauty wave is fading. China's own brands are increasingly doing well.
• c. Anti-Korean sentiment within Mainland China 
• d. The Chinese consumer is facing budget constraints due to economic recession. Luxury products are cyclical. 

1.a. Limits to the daigou trade.

Daigou are Chinese professional shoppers who travel to Hong Kong and other countries to buy foreign consumption goods. They bring those back into China for re-selling. You might think this is a marginal business, but there were 1 million daigou traders until the borders closed in 2020 to fight Covid.  

The daigou trade started because many foreign products were initially unavailable in China. Even when available, those were cheaper abroad because of lower sales taxes in those countries. It seems the Chinese authorities are now fed up with this type of tax 'arbitrage', or call it tax evasion. When post-Covid travel resumed, returning daigou traders were stopped at the Chinese border and held to luggage restrictions. 

A large part of The History of Whoo sales took place via daigou traders visiting duty-free shops in Seoul, Korea.  In addition, Chinese tourists who buy cosmetics for personal use are not returning yet. The decline in Chinese outbound tourism may be related to economic recession. I will address this below in the 1.d. section.

1.b. Changing consumer tastes within China. K-Beauty wave is fading. China's own brands are increasingly doing well.

The History of Whoo sales numbers within China are also poor. In the regional segment table above, we can see that Mainland China sales are down 19.6%. Does it indicate that The History of Whoo brand is history? There are mixed reports about the state of the brand.

I found several reports in which The History of Whoo scores well, such as this one about the Kuaishou 618 Shopping Festival. Admittedly, the value of these anecdotal reports from isolated events are hard to assess. It could be that a popular live-streamer promoted The History of Whoo during a peak broadcast hour. At the same 618 Shopping Festival, but on another platform (TMall), The History of Whoo and other Korean brands sold poorly. A news article concluded...

The decreasing popularity of Korean brands can be attributed to polarization between the dominance of high-end European brands and more affordable Chinese local brands, coupled with increasingly patriotic consumption among China's young generation. 

Korea JoongAng Daily, 26 June 2023

This patriotic consumption trend is known as the guochao movement. The article suggests that LG H&H itself has already identified this trend and is moving its focus towards other markets, such as North America and Vietnam.

1.c. Anti-Korean sentiment within Mainland China. 

During 2017, political tensions arose between South Korea and China, known as the THAAD crisis. South Korea’s decision to cooperate with the US to build the THAAD missile defence system in 2017 resulted in China banning Korean imports for two years. Naturally, this had an immediate impact on the beauty industry, from local e-commerce sites discontinuing sales to fewer Chinese tourists in Korea.

But it’s arguably the lingering effects, namely the anti-Korean sentiment and surging nationalism, that are proving more troubling.

Is K-Beauty’s Reign Coming To A Close? Jing Daily  5 April 2021

If you read only one article linked from this blog, make it this one. It is a mini-history of the rise and fall of Korean cosmetics brands in China and already identifies the guochao wave. The article is from April 2022, a few months before I bought my LG H&H shares. Unfortunately, I did not encounter this article at the time. It would likely have influenced my conclusion about LG H&H and would perhaps have stopped me from buying the share.  

1.d. The Chinese consumer is facing budget constraints due to economic recession. Luxury products are cyclical. 

Recently, there have been many news reports of an economic recession within the PRC of China. Other reports and opinions debate this perception. I don't have the specific macroeconomic insights to decide who is right, but it seems like Chinese consumers face personal budget constraints.

Cosmetics are usually filed under consumer staples, which suggests the sales figures are relatively non-cyclical. This might be the wrong category because cosmetics sales are sensitive to customer budgets, especially in the luxury cosmetics category, where we find The History of Whoo. Premium beauty products are better filed under consumer discretionary, a market category where consumer spending correlates with the economic cycle.

I am not sure whether an economic recession has started in China, but it would explain the decreasing sales revenues of History of Whoo. It is a more straightforward explanation than the three more case-specific reasons 1.a. , 1.b. and 1.c. The recession argument also gives some hope for LG H&H to return to former sales successes because recessions do not last forever.

2. Can LG H&H develop into a global beauty company? 

Let's assume for a minute that the lost Chinese market share will not be recaptured by LG H&H. Will the worldwide expansion of the LG H&H business compensate for the losses in the Chinese market? Over the last few years, LG H&H has started building its worldwide presence with the US market as its focus.  

To become a truly global beauty company, we must continue to expand our business in North America, the world’s largest trendy market.

Cha Suk-yong, former CEO of LG H&H, The Korea Times, 3 February 2022.

I will evaluate the success of LG H&H's globalization efforts in two parts.

• 2.a. Online mindshare review of the brands
• 2.b. My Avon rant

2.a. Online mindshare review of the brands

I wanted to get an impression of the current global mindshare of LG H&H brands, using the online presence of these brands as a rough and non-scientific measurement of success. I show the Google Trends direction of the brand name and its Instagram follower count. This survey is informal and flawed. I will address the limitations in footnote 1 beneath this blog posting.

From this data, I am not optimistic about the LG H&H brands. The company does not look like a global beauty powerhouse at all. As a comparison, I also displayed the eight L'Occitane brands. The L'Occitane portfolio looks much more promising.

When visiting The History of Whoo Instagram pages, you may initially agree that their pictures and video clips look gorgeous. LG H&H got the right creative people together. However, I do wonder whether this aesthetics-focused approach stops working at some point. The products are not explained in any way. There is not much content to appeal emotionally to potential customers. The whole styling feels aloof. The same goes for the O Hui and SU:M37 visuals. Is the marketing department going somewhere with these brands, or are they just showing pretty pictures?

2.b. My Avon rant

In April 2019, LG H&H bought Avon North America (US and Canada), which calls itself the leading social-selling beauty company in North America. It is an old brand that depends on its consumers joining as independent representatives and, after some training, selling cosmetics to friends, acquaintances, and their local community. 

I don't like direct-selling schemes, as I explained last year in my blog about Beshom / HAI-O. There are often controversies surrounding these networks. Admittedly, Avon is relatively non-controversial and has no MLM elements. There are no schemes for representatives to recruit other representatives into a pyramid scheme. Avon only accommodates direct selling, allowing representatives to sell cosmetics within their social circles. I still consider it unethical to exploit friends and acquaintances like that. 

More importantly, this type of sales is gradually becoming obsolete. Nowadays, people have neither the time nor the desire to meet with acquaintances and talk about consumer products. Shopping and comparison websites now offer all the information you need about these products. We can compare information and prices from different websites and get a less biased product overview than talking to just one person. 

Don't take my word for it. This is the Google Trends graph for the avon.com domain as visited from within the US. 

The interest in Avon is clearly diminishing. As a side note, there was an increasing interest in Avon.com in 2008 and 2009, which were years of economic crisis in the US. I think this extra interest was not in buying cosmetics from Avon but more likely in becoming an Avon representative and earning some extra money during financially challenging times. 

Despite the declining interest in Avon North America, former LG H&H CEO Cha Suk-yong decided to buy this company. He likely saw Avon as a distribution network for the existing LG H&H brand portfolio. When we visit Avon.com now, we find affordable LG H&H brands such as Belif, Dr. Groot and Isa Knox in the Avon online shop. However, these K-Beauty brands seem a poor match for the typical Avon customer in the US. 

In the 4Q2023 report, current LG H&H management listed 'Aim for Avon business turnaround' among its action points. Although Avon is in decline, it still has over 500,000 independent representatives. Turning this business around seems like a huge task to me.

3. Do the non-cosmetics activities, i.e. the beverages and household goods, alone justify the current share price?

I have a quantitative and a qualitative answer.

• 3.a. P/E calculation
• 3.b. Koo family drama

3.a. P/E calculation

Refer to the latest financials from the LG H&H 4Q2023 report in the second picture of this blog. Net Profit for 2023 is 164 bn KRW. When comparing this figure with other financial years, it does not seem particularly distorted by some one-off gain or loss. So, let's use this and assume that the beauty division, currently 30% of operating profit, will collapse further to 0% of total earnings next year. So, I am not assuming that the beauty division will not turn into a loss. Hence, 164 -/- 30%  = 114.8 bn KRW earnings will remain. There are 17,717,894 shares (Common + Preferred). In this scenario, earnings will drop to 6,479 KRW per share. 

Common share price = 336,000 (15 Feb 2024), P/E = 51.8

Pref share price = 150,600 (15 Feb 2024), P/E = 23.2

This theoretical P/E valuation seems high, considering the HDB and Refreshing divisions seem stagnant.

Next, let's assume that Beauty continues contributing 30% of profit in the future. In that case, the P/E will be 36.3 and 16.3, respectively. Still, it's not particularly cheap. It looks like investors are pricing in a recovery of the LG H&H beauty segment at the current share price of around 150,000 KRW.

3.b. Koo family drama

Who will drive this anticipated recovery of the beauty business? A listed holding company called LG Corp (KRX:003550) is the largest shareholder of LG H&H, with 34.03% of the Company’s ordinary shares. LG Corp, in turn, has been founded and run by the Koo family for over three generations. In general, I prefer to invest in family-owned companies for various reasons. However, in this case, I hesitate to label LG Corp and LG H&H as typical family companies. Both are part of a chaebol construction. 

A chaebol is a South Korean conglomerate run by a family. Politicians traditionally favour chaebols as a way to advance South Korea's economy. It is a complex arrangement. While writing this blog, CNBC released a clip explaining the chaebols in more detail. Against this background, we can question whether the LG businesses were grown by the entrepreneurial talent of the Koo family or more through government support. In this light, LG H&H may not have all the typical advantages of a family company over a professionally run corporation. 

Another question is whether the current LG Chairman and CEO of LG Corp, Koo Kwang-mo, has been entirely focused on his job lately. His predecessor, former LG chairman Koo Bon-moo, had only two daughters as biological children. However, women are not considered suitable heirs within South Korean business culture. Anticipating this 'problem', Koo Bon-moo adopted his brother's son, setting him up as his successor. When Koo Bon-moo died in 2018, the adopted son, Koo Kwang-mo, took the reigns as planned. However, he was relatively young (40) and had limited experience as a manager. Recently, affairs took a dark turn when the widow of Koo Bon-moo and the two daughters filed a lawsuit accusing Koo Kwang-mo of misleading them about the will and the inheritance of the former chairman. The New York Times has an article about the case, which sits somewhere between a K-drama and Shakespeare's King Lear.

Back to LG H&H, where Lee Jung-ae succeeded long-time CEO Cha Suk-yong at the end of 2022. News articles suggest that Cha Suk-yong himself did not want to leave LG H&H. In light of the Koo family drama, we could speculate that Koo Kwang-mo is placing his people in LG's companies to solidify his position. In any case, the replacement of Cha Suk-yong does not seem to improve the LG H&H management.

4. Is the preferred share more attractive than the common share?

I hold the LG H&H Preferred share (KRX:051905) rather than the common share (KRX:051900). The preferred share was, and still is, much cheaper than the common share. However, the preferred share does not allow you to vote at any AGM or EGM of the company. To compensate for this limitation, the holder gets 50 KRW (about 0.04 USD) more dividend per preferred share. Otherwise, the common share and preferred share are equal.

Talking about dividends, LG H&H has been cutting payouts in 2022, both in absolute numbers and as a percentage of the profit. The pay-out rate dropped to 16.6%, to be exact. The company is not doing well, so it seems prudent to retain earnings. However, the payout ratio was already low when business was booming, at about 20% on average. This is a general complaint about Korean companies. They prefer to hoard cash on the balance sheet rather than pay out dividends. As a result, Korean corporate balance sheets are often strong. Following this tradition, LG H&H has no net debt either. Suppose management will eventually hike the dividends back to the 2021 level of 12,050 KRW per preferred share. The dividend yield on today's share price would be about 7.5% in that case. That would be an attractive yield for a consumer staples company. 

Jonathan Pines of the investment firm Federated Hermes Limited published an essay aptly called enough is enough (link directly to the PDF), condemning the poor corporate governance within many South Korean companies. Most of his objections apply to LG H&H, too.

Finally, we could wonder whether the preferred share could one day be cancelled and exchanged for a common share, considering the minuscule differences between the two shares. This would reduce the voting power of LG Corp, so it seems an unlikely event for the moment. However, if the Korean government is serious about reducing the influence of the chaebols, it could be a consequence of regulation change. The preferred share trades with a relatively consistent discount of about 50% to the common share, which would mean an instant doubling in the value of the preferred share. However, I am not holding my breath while waiting for a simplification of the share class structure. I am not aware of any Korean company that already initiated such a simplification.

Final thoughts

My investment in LG H&H Pref. shares was the worst ever in my investing history, both in absolute numbers and as a percentage of the investment (-57%). While analysing this loss, I became aware of two psychological biases. 

1. Loss aversion

If the Chinese sales of The History of Whoo products recover, the share will likely recover, too. My decision to sell off the share now would be a big mistake. The same goes when LG H&H manages, against my expectations, to evolve into a globally successful cosmetics company. However, both events would qualify as turnarounds. Let's remember that Warren Buffett wrote that turnarounds seldom turn. 

2. Rationalizing selling

I was compelled to quickly sell the stock and move on from this bad investment. The -57% loss would disappear from my current portfolio overview, and my time and attention would be free to focus on other holdings. I tried to counter-act this urge by first writing this rather long evaluation of LG H&H. 

Conclusion

The LG H&H state of affairs is not clear-cut. There is not one big red flag, such as in the case of Mega Lifesciences PCL, where I got uncomfortable with the Myanmar activities. Instead, it is more of a string of orange flags, such as the Chinese business, the brand's global mindshare, the valuation and the ownership. None of these factors seem disastrous on its own. Hence, I was forced to weigh these factors in conjunction. Ultimately, I decided the picture did not look bright, so I sold the share.

Some lessons from the case

• From the newspaper article mentioned earlier, I could have known this was a turn-around situation before even buying the share. In the future, I should search harder for information that contradicts my bull thesis before buying the share. Perhaps I should have avoided LG H&H altogether because I do not speak the Korean language. I would have picked up on negative sentiment within the local news coverage much earlier if I knew the language.   
• A company that is technically a family company may not have the advantages of a typical family company.
• Luxury and premium cosmetics are more fashion-sensitive than I realized. Fashion fads come and go, even more so in China.
• Different complexities came together in one case: a difficult key country (China), irregular sales channels (daigou buying, duty-free selling, Avon direct selling), and leadership changes at the top (LG Corp and LG H&H). Charlie Munger fans might call it a negative lolapalooza effect. This defies the boring-consumer-staples-for-the-long-run and sleep-well-at-night principles behind the coffee can portfolio. 

Disclosure: Sold LG H&H Pref. shares. Long L'Occitane, InNature (Bodyshop Malaysia/Vietnam), Creighton's (Emma Hardie)  

Footnote 1: Objections to measuring brand mindshare through their social media presence. 1. Instagram users might not unfollow a brand even when they lose all interest in it; they just ignore its postings. 2. The Face Shop and The Creme Shop target young women who use Instagram more actively. 3. Chinese internet users do not use Instagram and Google; the interest in The History of Whoo is underreported. There are other linguistical, technical and cultural objections to using Google Trends and Instagram here. 4. A potential customer for an expensive brand such as The History of Whoo has a much higher value than followers for cheaper cosmetics and day-to-day personal care brands. Still, I am confident we are capturing the brand preference trends over time.

My position sizing system

• 5% initial position for a company incorporated in a developed market
• 2% initial position for a company incorporated in an emerging market

My old position sizing system was a two percent initial buy plus an additional two percent later for companies incorporated in a developed market. I usually did this second buy after a few months of holding the first portion. The purpose of this lag was to get comfortable with the company in the meantime. Sometimes, I did not get such comfort and sold the share. Similarly, I bought half percent positions plus a half percent later on in emerging market companies. It was a careful start because I started a whole new portfolio. However, I ended up holding 75 shares. There is no way to follow 75 companies as a part-time private investor. 

There is a lot of research addressing the proper diversification of a stock portfolio. I believe the picture below illustrates somewhat of a consensus conclusion.

We can see that a portfolio with only one stock results in a huge standard deviation of its annual returns. Adding one stock reduces this standard deviation considerably. Assuming that the added stocks are equally weighted, the variability of the total portfolio goes down as we add more stocks. At some point, let's say at 25 stocks where the arrow is placed in the graph, adding stocks does not reduce variability in any significant way. 

The graph is compiled by looking at a large number of portfolios. We are looking at reality, not a theory. Nevertheless, this perspective on diversification is debated. Many value investors argue that variability does not represent risk; only permanent loss of capital does. The number of shares does not matter either, but rather how confident you are about the business prospects of the underlying companies after intense research. Charlie Munger was not afraid to hold only three shares. However, I do not have the quality of information, insight, experience, and advisors that Charlie Munger had access to. For now, I will go with the traditional concept of risk as expressed by the diversification graph above. 

In any case, I was severely over-diversified, holding 75 shares. It will be nearly impossible to beat an index fund with so many shares. I already experienced that a very successful 0.5% position, such as my triple return with Luckin Coffee, will barely affect my overall portfolio performance. I concluded that my 1% positions in emerging markets China, Thailand, Malaysia and Indonesia did not make sense. I decided to take 5% positions in Malaysian companies from now on. For China, Thailand, Indonesia, and other emerging markets I will allocate 2% per company. That is still a small allocation, but I currently do not have the confidence to take a 5% position per company in these markets.

The reorganization

After deciding on my new position sizing rules, it was time to take action. I sold off a bunch of shares where I did not have the conviction to top them up to 5% or to 2% for a range of different reasons. This was a useful exercise in itself. I increased the allocations of all the remaining holdings, except for Greggs, ABF, Reckitt and Haleon, which already got too expensive. In the case of turn-around situation LG H&H, I want to wait for the Q4 2023 results. With the reorganization mostly done, I own 25 shares now. 

Further concentration?

Looking at the chart above, I could reduce my 25 positions further to 10 positions. The variability of the portfolio as a whole would not increase that much. I could start with taking 5% positions to 10% where I feel confident that a company is extremely undervalued, such as Boustead Singapore and Ibersol. However, from my past experiences as an investor, I have learned that my ex-ante level of confidence is often misplaced and irrelevant. There is no correlation between my level of confidence in a share pick and the subsequent performance of that share. 

As an example, my current best performers are Exotic Food PCL, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Associated British Foods PLC. I would never have guessed these picks as being my winners two years ago. I would probably have guessed Alibaba or Tencent then. Without a mechanical allocation system, I would have doubled down on these two stocks. This doubling-down behaviour is known as Get‐Evenitis or, more officially, loss-aversion bias. A mechanical sizing system is an antidote to this bias. It saved me from a bigger disaster in the Chinese tech space. 

Hence, I will stick to my mechanical allocation system. Should I ever change the current 5% and 2% sizing numbers, it will be wise to apply the new rules to all my shares, not to a selection.  

Disclosure: long position in all the shares mentioned, except Alibaba, Tencent, Tianjin Pharmaceutical Da Ren Tang Group Corp Ltd and Luckin Coffee, which I sold off

Breaking my own checklist rules

Earlier, I revealed my Stock Buy Checklist on this blog. Today, I will review the stock holdings violating this checklist's rules. This gives me a chance to explain some rules in more detail and the reasons for violating them sometimes.

United Plantation Berhad is not in the consumer staples or infrastructure industry.

My most constricting rule is to only buy consumer staples and infrastructure-related companies. United Plantation Berhad is the only real exception to this super rule. It runs oil palm plantations, counting it as a commodity producer. They sell some consumer products like NutroPalm Golden Palm Oil through their associate Unitata, but these activities are minimal. I decided to buy United Plantation shares anyway because its operations are run very efficiently. There are only so many great companies on the Malaysian stock exchange.

Several Malaysian companies have a market cap below 100 mln USD

InNature, Able Global, HAIO/Beshom, Suria Capital, and Spritzer are all flirting with the 100 mln USD market cap threshold. All these companies were well above this threshold when I bought their shares. However, the Malaysian Ringgit has devaluated against the US Dollar since then. That's not enough reason to suddenly remove these companies from my portfolio. The purpose of the market cap rule is to avoid buying a company so small that a black-swan event like a fire, a flood, or a fraudulent employee might threaten the continuity of its operations. In that light, it is not really relevant that a market cap goes from 100 to 98 mln in USD when the actually used currency is the Malaysian Ringgit.

Natural Food International Holding Ltd has a market cap and book value below USD 500 mln.

This company produces cereals and other healthy food products in the Chinese market. The book value is not even 200 mln USD, which is far below my threshold rule for mainland Chinese companies. As I wrote above, the market cap rule is set for my peace of mind regarding the stability of a company. In the case of Natural Food, we have the presence of US food giant PepsiCo as a significant shareholder. PepsiCo is also represented by a board member. I will assume that PepsiCo did due diligence into Natural Food before buying its shares and will continue to keep an eye on developments within the company.

Camellia PLC depends on operations in India and Africa for most of its revenues.

I focus my research on Asia Pacific, Europe, and US-based companies. Although Camellia is based in Kent, United Kingdom, its lands, gardens and plantations are located worldwide. It owns a few brand names, like Jing Tea and Goodricke. However, the bulk of its production should be considered agricultural commodities. Finally, Camellia is a conglomerate. So, here we have three violations of my checklist rules: 1. geography, 2. conglomerate, and 3. commodity-related. I bought Camellia long before I compiled my checklist. Likely, my experience with this company's poor management and its collapsing share price inspired some of the checklist rules. I will sell this share to finance an investment idea that conforms to my checklist better.

Boustead Singapore, CK Hutchison, Saha Pathana, ABF, F&N, and LG H&H are conglomerates.

Talking about conglomerates, I have a few others in my portfolio, although my checklist encourages me to avoid them. Like Camellia, I bought most of these shares before I wrote my checklist. In those days, I still had a value-investing approach where you would calculate the sum-of-the-parts of the different businesses and assets and then compare the grand total with the market cap. You often see a big 'holding company discount' making the share seem like a bargain. Value investing blogs and fora keep pouncing on such 'deep-value bargains'. The problem with this approach is that the discount usually does not close. The management and majority shareholders are simply not interested in closing the discount. You will remain stuck in these poorly performing conglomerate shares until management changes its priorities and reorganises the company's structure and activities, if ever. 

This is not a concern for the six conglomerates mentioned in the title. I gladly hold them for the long term, even if they remain conglomerates. Saha Pathana, Associated British Foods (ABF), and LG H&H are primarily active in consumer staples which is my portfolio focus. The same goes for Fraser and Neave Ltd (F&N), which also has a printing and publishing division, but it is only responsible for 11% of the total revenues within F&N.

CK Hutchison has consumer staples operations through their retail activities (A.S. Watson) and infrastructure-related assets with their ports and mobile telecom operators. This fits within my 'consumer staples and infrastructure' philosophy, although CK Hutchison also has investments in sectors such as utilities, pharmaceuticals, media, and energy, of which I have no knowledge. 

The same goes for Boustead Singapore Ltd, which is active in software, energy, and medical services, besides developing business parks through the listed Boustead Projects subsidiary. This share is also a relic of my deep-value investing days, long gone. The share price has been going nowhere for the last ten years, but the dividend yield is reasonable, and I trust the management. Because of the Boustead Projects activities, the stock fits in my infrastructure bucket. Although Boustead's other activities do not fit my philosophy, they seem stable.

Ho Bee Land and Boustead are developers.

Adding to my Boustead objections: its most significant subsidiary Boustead Projects, is a developer, not a REIT. I typically prefer a REIT over a developer because developers tend to have very cyclical earnings, and it is difficult to get reliable profit projections on the properties still under construction. In contrast, properties in a REIT portfolio are already operational and easier to value. In addition, the various regulations governing a REIT limit the opportunities to abuse minority investors. In fact, Boustead Projects recently initiated a REIT (Boustead Industrial Fund), but unfortunately, it is not publicly listed. 

Ho Bee Land is also a developer, but most revenues come from renting out its existing investment properties. It owns an impressive portfolio of offices in London and Singapore. Shareholders have repeatedly pressured management to divest this portfolio into a REIT. At a minimum, this will yield tax benefits, but it might also benefit the share performance. However, management has yet to honour this request. Ho Bee Land does not have many development projects compared to its portfolio of investment properties, so the company is safe enough for me to keep holding. The company seems significantly undervalued too.

DFI retail group and Imperial Brands have more debt than equity.

Two companies in my current portfolio violate the debt/equity < 1 rule. However, the Interest Coverage ratio in both cases is more than sufficient. Dairy Farm (DFI) runs supermarkets and restaurants. Most of its debt is the liability for its future store leases. According to current account rules, DFI has to list these under 'debt', but store lease liabilities are much safer than actual debts resulting from loans. When a company takes out a regular loan, it is to finance a new factory or some new business activity where the ultimate payoffs can only be guesstimated. In contrast, the expected yields on long-existing retail store rentals are much more certain than a new factory or a new business activity. I don't worry much about these store leases for existing restaurants, convenience stores, and supermarkets.

Imperial Brands is a tobacco company. The balance sheet seems weak at a quick glance, but incoming cash flows from smoking-addicted customers seem reliable and will relieve the debt burden over time. The management sets a "target leverage towards the lower end of our net debt to EBITDA range of 2-2.5 times." They are at 2.4 now and still reducing debt. If they indeed reach a net-debt/EBITDA = 2, that looks pretty safe. Fitch rates their debt as BBB. I am not worried but will keep an eye on debt repayments.

Luckin Coffee pays no dividends.

I prefer my holdings to pay dividends, but it is not a strict requirement. For growing companies, it usually makes sense to skip dividend payments and re-invest profits into the business instead. Luckin Coffee invests in the fast expansion of its coffee shop chain. 

Luckin Coffee is listed as an over-the-counter (OTC) stock.

OTC and Pink Sheet stocks are hardly regulated. I had never bought an OTC stock before Luckin, and I don't plan to do that again. There is a high chance of running into fraudulent companies in these markets. Luckin Coffee had also admitted to committing fraud when I started looking at the stock. My research mainly focussed on whether the fraud could be even bigger, as was exposed already. So far, that has not proven true, and the stock price has been going upward throughout 2022.

When I bought my Luckin stock in May 2022, the fraud-committing people were already removed from management positions. Luckin was entering arrangements to compensate the defrauded parties. My thesis is that Luckin can successfully move on from this dark era. It was a gamble when I took my position, but I considered that the most prominent Chinese coffee shop chain should be in a portfolio called The Coffee Can APAC. As I am writing this in December 2022, we can witness Luckin Coffee solving its legacy fraud issues while growing its operations quickly. I hope Luckin can re-list soon on the Nasdaq, preferably with a secondary listing in Hong Kong.

ABF's Primark is a fashion brand. 

Even worse than being listed as an OTC stock is running a fashion brand. I am not a follower of fashion myself, but I am aware that brands come and go, sometimes very quickly. It is impossible to assess those cycles in advance. Hence, I usually avoid investing in fashion retail companies. Nevertheless, in the case of Associated British Foods (ABF), I got comfortable with their Primark business, which delivers about half the profits for the overall conglomerate.

ABF started the Primark clothing stores initially in Ireland, then Great Brittain, then Europe, and recently jumped over to the United States. I visited several stores myself. Primark sells cheap clothes, packed to the brim in large stores at city-centre, triple-A locations. Customers love it, judging from the Google Map reviews and the consistent queues to pay at the cashier registers. The Primark brand signals a low price level and straightforward buying process rather than style and fashionability. I am confident that Primark customers will keep going to its stores as long as Primark sticks to its approach. It may be successful in Asia and South America too.

Daiwa House Logistics REIT is active in Japan. 

I am still contemplating whether I want to invest in Japanese companies. The demographics in this country predict a terrible economic future. Japanese company managements are often not shareholder friendly at all. Dividend payments are low and charged with a steep 20.42% withholding tax. Japanese stocks are generally priced relatively high from a value-investing perspective.

Daiwa House Logistics REIT seemed reasonably priced at its IPO and has an impressive portfolio of large, modern warehouses. Despite all properties being located in Japan, the REIT is a Singaporean entity. This means there is no dividend withholding tax for individual investors. Also, the Singaporean REIT regime requires the REIT manager to pay out at least 90% of earnings. This restricts the REIT manager from hoarding excessive cash on the balance sheet as many Japanese companies tend to do. For these reasons, I bought the REIT a few months after its IPO. My doubts about Japan's demographics and economic future still stand. Is this a Coffee Can REIT that I can hold for decades while sleeping well?  

Dairy Farm and Hutchison Port have sizeable operations in Hong Kong.

I reduce my portfolio exposure to companies that generate a lot of their profits from within Hong Kong. The city's future has been clouded for a few years already. Let's not get into the political details here, but it looks like the role of Hong Kong as a gateway into China is diminishing. Currently, Hong Kong is still ranked very high on surveys that estimate the cost of living. However, measured over the medium and long term, I wonder if much of this wealth may disappear. 

My holding Dairy Farm derives a lot of income from Hong Kong consumers. The management does not disclose the exact amount, but by combining other metrics, I estimate it to be about a quarter of total earnings. On the other hand, Dairy Farm is also exposed to many retail opportunities in China and South-East Asia. These could balance out deterioration in the Hong Kong market.

Hutchison Port Holdings Trust derives a lot of income from its Hong Kong port. This is obviously based on the geographical location as a deep-sea port which will remain unchanged. Different demographical and political circumstances are unlikely to affect these port operations.

Conclusion

I do not use my checklist blindly. As illustrated in this article, I break my rules when there are good reasons to do so. It is more important to keep an eye on the underlying concerns behind the rules. I felt some of these concerns while preparing and writing this article, for example, in the case of my last remaining Japanese stock, Daiwa House Logistics REIT. In addition, I feel uncomfortable around companies where several rules are broken simultaneously, as with Camellia and Dairy Farm. 

Coffee in my portfolio

I named my investment approach the Coffee Can Portfolio APAC after a buy-and-hold method developed by American analyst Rob Kirby. I tweaked the approach he suggested by focusing on infrastructure and consumer staples stocks. As a result, I have a bunch of coffee-related companies in my portfolio. I thought it would be fun to highlight those.

JDE Peet's is the unmistakable coffee king in my portfolio. The company offers many coffee brands all over the world: Peet's Coffee, Jacobs, Douwe Egberts, Campos, Tassimo, Senseo, L'OR, Super (Singapore), Old Town White Coffee (Malaysia), and tens of other brands. Some of those have cafe-type outlets which you can visit. The picture shows a pop-up store of Peet's Coffee in Shanghai.

Luckin Coffee is a Chinese coffee giant which runs cafes but has no packaged product yet. In some of their outlets, you can sit down to enjoy your coffee, but most are takeaway only. They have more stores than Starbucks in China, but in revenue, Luckin is still second because their products are cheaper.

Maxim's Caterers is a 50% participation of my holding DFI (Dairy Farm International). Maxim's has the license to exclusively run Starbucks stores in Singapore, Hong Kong, Macau, Vietnam, and Cambodia.

Maxim's Caterers has a joint venture with Fraser & Neave, another holding of mine, to run Starbucks stores in Thailand. This joint venture is also 50/50.

Staying with Dairy Farm International, its house brand Meadows offers instant coffee and 3-in-1 coffee mix in their supermarkets, such as Giant and Cold Storage as well as in third-party outlets (Foodpanda).

South-Korean consumer goods conglomerate LG H&H runs a beverage bottling operation that produces drinks from the Coca-Cola Company. The canned coffee brand GEORGIA is one of the Coca-Cola drinks they licensed for Korea. 

China Foods Limited is licensed to sell Coca-Cola beverages in 19 provinces of China. They don't offer GEORGIA, but they do have another canned coffee drink in their portfolio called Costa RTD coffee. Costa is a coffee shop chain acquired by the Coca-Cola Company in 2019. There are Costa coffee shops in China too, but it seems that China Foods is not involved in those. 

The strangest coffee drink from my holdings comes from Want Want China: Mr. Bond Coffee. I could not find any information about it. Are they referring to James Bond? The man shown on the can resembles detective Sherlock Holmes rather than master spy James Bond. Also, I am pretty sure Bond prefers Martini over coffee.

For the final two coffee servings, we leave Asia. British bakery chain Greggs sells coffee to go with their sausage rolls and sandwiches. Classics such as Mocha, Americano, and Latte, with special editions during holidays. Recently they added two canned coffee offerings: Caramel Latte and Original Latte, as the picture shows.

Associated British Foods offers various grocery items all over the world. In their long listing of those, I found Jarrah, which is an Australian brand of powdered coffee. You pour hot water over the powder to make it ready for consumption. Jarrah offers a hot chocolate variant too.