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.
