Sunday, 13 August 2017

No Need to Maximise Profits with Cash of Last Resort

CPF funds are my cash of last resort in investing. I have quite a good record of investing my CPF funds. However, that statement would be incomplete, because majority of the time, the funds are parked in bank preference shares and collecting regular dividends that pay higher than CPF Ordinary Account's interest rate of 2.5%. On equity investments, there were only 2 occasions when CPF funds were deployed. The first was during the market doldrums during 2000-2003, when I ran out of cash for investments and had to rely on my CPF funds. The second was to buy more of Global Logistic Properties (GLP) than what was allowed for in my cash portfolio (see What is My Target Price? for more info).

Since CPF funds are my cash of last resort, the overriding principle is safety rather than maximising profits. Hence, majority of the time, they were parked in bank preference shares rather than being invested in equities. Furthermore, on the 2 occasions when they were invested in equities, they were not held until profits were maximised. On the first occasion, CPF funds were invested in STI ETF when the STI was at 1,316 points in Feb 2003 and sold when the STI reached 2,169 points in Mar 2005 for a 66% gain. The STI went on to hit a high of 3,876 points in Oct 2007. The reason for selling STI ETF early was because by early 2004, the stock market had recovered from the doldrums and my cash portfolio had turned a profit. There was no longer any need to use CPF funds for equities investment. Hence, they were returned to CPF.

On the second occasion, I bought GLP at $1.985 in Nov 2016 on rumours that a Chinese consortium was interested to buy GLP. Last month, GLP announced that it had selected the Chinese consortium as the preferred bidder, which offered to privatise it at $3.38. I sold the GLP shares bought with CPF funds at $3.22, even though there is another $0.16 to gain if they were held until completion of the privatisation, which has to be completed by 14 Apr next year (unless extended). The gain is 62%. In my opinion, the job is done. There is no need to further expose the CPF funds to unnecessary risks to get the remaining gains. They can be returned to CPF until the situation calls for them again.

When you have a cash of last resort, the important thing is to keep them safe and have them ready when you need them. There is no need to expose them to unnecessary risks for longer than is required.


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Sunday, 6 August 2017

What Are Driving Those Numbers!

The quarterly earnings season has started and I have been busy reading the financial results. It is sometimes frustrating that the reports do not reveal much about why the business is doing well or poorly and whether the trend will continue. The reports contain a lot of numbers and some discussions, but most of the time, the discussions just regurgitate what the numbers already show. To illustrate what I mean, I will use M1's financial results as an example, but it is not the only company that has the issue.

The figure below from M1's financial results shows the numbers generated by the various business segments in 2Q2017. For instance, it shows that revenue for the mobile telco services segment dropped by 2.1% Year-on-Year (YOY) in 2Q2017, customer subscriptions rose by 4.5% YOY, etc. These are useful numbers to understand how well the business is doing. But they do not explain why revenue has fallen even though customer subscriptions have increased. By right, if customer subscriptions increase, revenue would also increase correspondingly, isn't it?

Fig. 1: Numbers

Following the numbers in the financial results is a discussion of those numbers. The figure below shows the level of sophistication of the discussion. 

Fig. 2: Discussion

The opening paragraph of the discussion says, "YOY, operating revenue at $251.6M for 2Q2017 and $512.3M for 1H2017 were 4.7% and 2.9% higher respectively due to higher fixed services revenue and handset sales. Compared to 1Q2017, it was 3.5% lower." Haven't all these information been reflected in the numbers already? What extra information do investors get after spending time to read the discussion?

What investors really want from the discussion is to understand the factors driving those numbers. Investors should not be left to guess why those numbers rise or fall and whether the trend would continue. An example of a good discussion is actually given by M1 in the second paragraph of Key Drivers, which explains why churn rate hit a high of 1.7% in 2Q2017 when the average historical churn rate is only 1.0%. It explains that "Churn rate was 1.7% for 2Q2017 and 1.4% for 1H2017 as a result of the migration of customers who were previously on 2G data to the M2M platform following the shutdown of the 2G network in April 2017." This gives investors assurance that customers did not desert M1 in droves in 2Q2017.

The discussion should not just be a repeat of what the numbers already show. If companies are serious about providing a discussion, I hope they would be more forthcoming and provide an intelligent discussion about the challenges the company faces and what plans does it have to overcome those challenges. Investors who are informed of these challenges and plans would be more willing to stick through thick and thin with the company when it is going through a difficult patch.


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Sunday, 30 July 2017

Properties and the Arrival of Robots and Automation

Recently, I went to view some houses and realised how expensive houses have become. A 2-bedroom condominium in Jurong could go for $1 million and a 4-room HDB flat in Clementi could sell for $700K to $800K. If you read my past blog posts on Properties, you would know that I am not a fan of properties in the long-term, mainly because of the ageing population in Singapore (see Properties, the Population White Paper and the Land Use Plan for more info). 

In the past 1 year, I have also begun to worry about robots and automation taking away jobs (see Early Retirement Maybe A Luxury That I Cannot Afford for more info). I believe that everyone would need to keep on learning and re-learning, and be prepared to change careers at least 1-2 times in their economic lifespans in order to adapt to changes brought on by technology. And in the worst case scenario, a lot of human jobs would be displaced by robots and automation.

For most people, housing is an expensive item and it can take 20 to 30 years to fully repay a housing loan. When you superimpose the trend of robots and automation displacing human jobs with the 20 to 30 years of steady employment required to service housing loans, it raises the question of whether most people can fully pay down their housing loans. And if they could not, what would happen to the housing market in, say, 20 years' time when the full effects of robots and automation happen?

Having said the above, at this point in time, it is not clear whether robots and automation would really displace human jobs on a wide scale as some writers fear, or whether they would allow governments to provide a basic income to every citizen so that everyone need not work and could pursue his/her own dreams. 

Personally, until the effects of robots and automation and governments' responses to them become clear, I would prefer to be more prudent in my housing decisions, i.e. to buy a HDB flat instead of a private condominium if possible, and/or to take a shorter loan tenure such that by the time I am displaced by technology, I would also have paid down the loan fully.

For investors buying properties with the hope of renting them out to foreign talents, robots and automation also raises another issue. If robots and automation really were to displace human jobs, the no. of foreign talents will also decline. Will properties still provide good rental yields in the future? I do not know.

I have raised more questions than answers in this blog post. This is because I also do not have the answers. We can only monitor and act accordingly.


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Monday, 24 July 2017

Oil & Gas, Show Me the Orders!

When I sold out of Keppel Corp in Jan at $6.16, my colleague laughed that I had sold too early. Nevertheless, I was pleased to get out of Keppel Corp before it announced results for 4Q2016. I was concerned that orders were not coming in fast enough to replace those orders that had been completed and that Keppel Offshore & Marine (O&M) would show a loss for 4Q2016. True enough, Keppel O&M reported a net loss of $138M for 4Q2016 after asset impairment. I was concerned that Keppel O&M would continue to report losses from that point onwards.

Nowadays, when I consider buying or selling Oil & Gas (O&G) stocks, I look at 2 key information. The first is where is the company positioned along the industry value chain (see My Upstream Oil & Gas Rescue Operations and My Downstream Oil & Gas Recovery Operations for more information). I do not mind the Exploration & Production companies that are at the start of the value chain and the Engineering, Procurement and Construction companies that are at the downstream side of the value chain, but not those in the middle, i.e. Offshore Support Vessel, oil services and ship/ rig building companies.

The other metric that I look at is orders-to-revenue ratio. This is similar to the book-to-bill ratio for the semiconductor industry. If the book-to-bill ratio is higher than 1, it means that the industry is expanding. Conversely, if the book-to-bill ratio is lower than 1, it means that the industry is contracting. Likewise, the orders-to-revenue ratio is able to show whether the companies are getting enough orders to sustain the business through the long and harsh O&G winter. The other way of looking at this metric is that orders will eventually translate to revenue down the road. If the order is $1, you cannot report a revenue of $2 later (nevertheless, you can do 2 years' worth of work in 1 year and report revenue of $2, but the maths dictate that total revenue cannot exceed total orders over time). Thus, the orders-to-revenue ratio is an useful metric in analysing O&G companies.

Based on the above explanation, you will now understand why I sold Keppel Corp in Jan. In FY2016, Keppel O&M's revenue was $2,854M. Its new orders secured over the same period was only about $500M. The orders-to-revenue ratio was only 0.18. A couple of years down the road, would Keppel O&M still be able to report profits based on annual revenue of $500M (or $1,000M if you combine 2 years' worth of work into 1 year)? I thought it was unlikely. Thus, I was pleased to exit Keppel Corp at a price higher than my average cost of $6.08.

Nevertheless, I have to admit that Keppel O&M has continued to surprise me. For 1H2017, it still managed to report a net profit of $1M when I was expecting it to report a loss. And my assessment of Keppel Corp's ability to navigate the rough waters remains unchanged (see Keppel Corp – A Good Captain Sailing Through Rough Waters).

This year, I have considered buying/ bought 3 O&G stocks. In all 3 cases, orders-to-revenue played a key role. The first was Dyna-Mac. Compared to the other O&G stocks, its level of debts is low and therefore has a higher chance of surviving the O&G winter. However, its orders-to-revenue ratio as at end Dec 2016 was only 0.06 (net book order of $12.8M versus FY2016 revenue of $204.0M). In other words, it only had enough work for 1 month and would be idling for 11 months if new orders could not be found quickly. I gave up the idea of buying it.

The second was Triyards. In FY2016, it obtained new orders of US$273.9M, versus revenue of US$324.9M, translating to an orders-to-revenue ratio of 0.84. Compared to Keppel O&M's ratio of 0.18, this is considered very good. The other reason why I bought Triyards even though it is in the shipbuilding sector is because it is a distressed asset play. It is 60.9% owned by Ezra, which went into Chapter 11 bankruptcy protection in Mar. The shares had been pledged to the banks as collaterals for a secured loan. If the banks were to sell the shares, it would trigger a general offer for the remaining shares. As at end Feb 2017, Triyards' net asset value was US$0.673. Unfortunately, in the latest results for 3Q2017, it reported a loss per share of US$0.208 due to asset impairment and cost overruns and the net asset value dropped to US$0.478.

The third stock was Rotary. My average cost was $0.62 and I wanted to average down for a long time. Last year, there was an opportunity to buy at $0.29, but I decided to give it a pass. In May this year, I bought at $0.37. The reason? Again, it is because of orders-to-revenue ratio. When it was trading at $0.29 last year, it only had outstanding orders of about $150M, versus FY2016 revenue of $233.9M. When it reported 1Q2017 results in May this year, the outstanding orders had increased to $435.9M. To me, it was not safe enough to buy at $0.29 last year, but safe enough to buy at $0.37 this year because of the increase in orders. 

As things turned out, I sold Keppel Corp and it went higher. I bought Triyards and it went lower. Nevertheless, the orders-to-revenue metric is sound and I will continue to use it to guide my investments in O&G stocks.


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Sunday, 16 July 2017

Interest Rate Hedging Smoke Screen

After US Federal Reserve increased interest rates in Dec, Mar and Jun, and after Yellen's congressional speech last Wed, interest rates are confirmed on the way up. This will impact companies with large debts, especially REITs, as higher interest expense would mean lower distribution for shareholders. The usual response that companies give to questions of rising interest rates is that they have hedged the majority of their loans by swapping floating loan rates for fixed loan rates. However, are such measures adequate to mitigate the impact of rising interest rates?

If you ask any person who took up a fixed-rate mortgage loan to finance his housing purchase, he will tell you that even though it is a fixed-rate loan, the interest rate is only fixed for 2-3 years. After that, the interest rate will revert to a floating rate. Although he can refinance to a new fixed-rate loan after 2-3 years, the new fixed interest rate will be based on the prevailing interest rates then, not the interest rates now. Currently, a 2-year fixed-rate loan is available at 1.6%. But if interest rates were to rise to say, 2.6%, 2 years later, the new fixed-rate loan after refinancing would be at 2.6%. So, fixing the loan interest rate does not eliminate the effect of rising interest rates. It only postpones the impact to 2-3 years later when the loan or interest rate swap expires.

Moreover, unlike mortgage loans in which you pay down the loan principal over time, company loans are usually bullet loans, in which repayment of the loan principal is only required when the loan matures. Furthermore, these bullet loans are usually refinanced and rolled over to a new bullet loan. In other words, the loan principal is not paid down over time. When you fix the interest rate and pay down the loan over the period of the fixed interest rate, you reduce the increase in interest expense when the rate is reset after refinancing. But when companies do not pay down the loan when the interest rate is fixed, the increase in interest expense 2-3 years down the road is the same as if the interest rate fix does not exist! The only benefit is that companies save some interest expense during the 2-3 years when interest rate is fixed. But it does not eliminate the impact of rising interest rates altogether.

So, when companies say they hedge interest rates, please be aware that it only postpones the impact to 2-3 years down the road.


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Monday, 10 July 2017

Which KrisEnergy Should I Buy?

If you read my earlier post on My Oil & Gas Fightback, you would know that one of the stocks I am interested in is KrisEnergy. The main reason for my interest in this stock is because it can potentially turn around quickly when oil price recovers and become a multi-bagger. However, there are 3 KrisEnergy counters listed on SGX, namely, 
  • the KrisEnergy stock itself;
  • a warrant named KrisEnergy W240131, which is convertible to the stock and will expire on 31 Jan 2024; and 
  • a zero-coupon bond named KrisEnergy z240131, which will also mature on 31 Jan 2024.
Which KrisEnergy should I buy for maximum capital gain?

KrisEnergy the stock is the simplest. If oil price goes up, it will make money. Conversely, if oil price stays down, it will lose money. There is no expiry date to the stock, unless the company goes bankrupt.

KrisEnergy the warrant is also easy to understand. It can be converted into the stock at an exercise price of $0.11. Because of the exercise price, it trades at a much lower price compared to the stock. Thus, the potential for a price increase is many folds that of the stock. However, it has an expiry date of 31 Jan 2024, after which it will become worthless. Thus, for  speculators who believe oil price will go up at least once in the 6.5 years before it expire can consider the warrant.

For me, there is another consideration in choosing between the stock and the warrant. I treat KrisEnergy as a minion, meaning it is a small speculative position which is mentally written off the moment it is purchased (see Meet The Minions for more info). Since the money will be written off,  it does not matter whether I buy the stock or the warrant. The stock and warrant currently trade at $0.12 and $0.038 respectively. For the same amount of money, I could buy 3.16 warrants for every 1 share of the stock. Coupled with the fact that if oil price were to recover, the rise in the warrant is many folds that of the stock. Thus, between the 2, the minion strategy always prefer the warrant.

KrisEnergy the bond is an interesting one. It is a bond, which means that it will be redeemed at face value when it matures. Furthermore, in the event of bankruptcy, the bond ranks higher than the stock and warrant and might be able to recover some money back for its holders. Thus, it has less risks compared to the stock and the warrant.

Moreover, it is not a plain vanilla bond that pays regular coupons (i.e. interest) to bondholders at regular intervals and does not move much in price. It is a zero-coupon bond. Zero-coupon bonds are bonds that do not pay any coupons. Instead, zero-coupon bonds are sold at a discount but redeemed at face value when they mature. Thus, investors who buy the bonds make money by gaining capital appreciation instead of regular coupons. For KrisEnergy's zero-coupon bonds, the last traded price is $0.44. When the bond matures on 31 Jan 2024, it will be redeemed in full at $1 (assuming KrisEnergy does not default). Hence, bondholders would gain $0.56 over a period of 6.5 years. This is equivalent to a coupon rate of 13.5%. Of course, the caveat here is that KrisEnergy does not default or restructure the bonds. 

Not only that, it is also a junk bond. Junk bonds are bonds whose issuer's ability and willingness to meet the bond obligations are uncertain. Their prospects are closely linked to the issuer's ability to pay dividends on the stock. Thus, both junk bonds and stock will rise and fall along with economic developments affecting the company. In other words, junk bonds can be as volatile as equities.

Thus, to gain capital appreciation, either the stock, warrant or bond are feasible options. The best instrument to speculate in will depend on your outlook for oil price. If you are bullish about oil price in the next 6.5 years, warrant will give the best capital appreciation. If you are neutral about oil price, bond will provide the best capital gain. If you are bearish about oil price, all instruments will be bad, with bond being less worse off. An estimation of each instrument's performance under the various scenarios on oil price is as follows.

Outlook Bond Stock Warrant
Bullish Good Good Best
Neutral Good Neutral Bad
Bearish Bad Worse Worst

P.S. I am vested in KrisEnergy stock but planning to switch to KrisEnergy warrant.


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Monday, 3 July 2017

Wills, Trusts, AMDs and LPAs

I just attended a 2-day estate planning talks on wills, trusts, Advanced Medical Directives (AMDs) and Lasting Powers of Attorney (LPAs) organised by RockWills Corp Pte Ltd. There are some interesting facts about them that I share below.

Wills 

Most people know what is a will, so I will skip the basic facts and mention what I learnt from the talk. As you may be aware, you need to identify who are the executor and trustee of the will. The executor is the person who will carry out all necessary actions to distribute the estate according to the wishes of the will, while the trustee is the person who will hold on to the estate until it is completely distributed to the beneficiaries of the will. Although you can nominate an executor and trustee to carry out the wishes of the will, they can actually renounce these roles! The beneficiaries will then have to appoint another executor and trustee to execute the will.

The other point highlighted is that while you can write a well-planned will, if the will cannot be found or is destroyed, it is useless as well. This may sound like common sense, but the safekeeping of the will is sometimes taken for granted. For example, I made my will approximately 10 years ago. It is sealed inside an envelope and placed in an easily accessible location as nobody knows the existence of this will. However, for these past 10 years, I never open up the envelope and check the content. Who knows, maybe the ink might have faded or the paper on which the will was written might have turned yellow such that the will is no longer legible? 

The other concern for leaving my will so easily accessible is if someone were to read it after I am gone and dislike its content, he could simply destroy it and there would not be a will left behind.

The reason for my complacency is because I believed a copy of the will is kept by the law firm who wrote my will and by the Wills Registry under the Ministry of Law. I was reminded at the talks that the Wills Registry does not keep a copy of my will; it only has a record of when and who drew up my will. Will the law firm still keep a copy of my will 10 years after making it? I believe so, but I better not count on it since it did not charge me any custody fee. I will have to seriously think through how should I keep my will securely while still keeping it accessible when needed. 

Trusts

This is the most interesting topic that I learnt from the talks. If you have read my blog post on There is Really a Regular-Payout Term Insurance, you would know that I have a preference for insurance policies that pay out regular sums of money over a period of time instead of a lump sum. This is because my dependents might not be financially savvy enough to handle a large sum of money suddenly and might unwittingly invest the money in some risky investment products. A regular payout provides greater certainty on the financial sustainability of my dependents.

Similarly, a will pays out the inheritance as a lump sum, which has the same disadvantages mentioned above. However, if you write a will to pay out the inheritance into a trust, you can provide instructions on how regularly a trust disburse the funds to the beneficiaries. You could also set certain milestones for your beneficiaries to achieve before they get further payouts, such as getting a degree, etc.

Advanced Medical Directives (AMDs) 

AMDs are instructions that you set in advance to inform doctors whether you wish to be kept on life-support in the event of a terminal illness and when death is imminent without life-support. You can refer to Ministry of Health's website on AMDs for more information.

The key thing to note is that the witnesses to the AMDs should not be beneficiaries of your will.

Lasting Powers of Attorney (LPAs)

LPAs are legal documents authorising a trusted person (known as a donee) to make decisions related to your personal welfare and financial matters in the event of mental incapacity such as dementia or stroke. This is a very powerful document as the donee(s) can make many decisions on your behalf. Thus, whom you appoint as donee(s) is very important. For the simple LPA, you can appoint 1 or 2 donees and specify whether the 2 donees need to act jointly or can act alone. You can also appoint a replacement donee should one of the originally appointed donees becomes unsuitable. You can refer to Office of the Public Guardian's website on LPAs for more information.

Some other practical considerations that the speaker mentioned at the talk are the donee should preferably not be of the same age, because both the donor and the donee might suffer from dementia when the LPA needs to take effect. Also, the donee should not be someone living overseas as he would have difficulties overseeing daily matters related to personal welfare and/or financial matters. 

That's all for the lessons I gathered from the talks. It is useful to attending such talks from time to time to clear up any misconceptions and understand the options available for estate planning.


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