Double dip recession? When will we learn from our mistakes?

As the 2nd quarter of 2010 winds down this coming week, 1H2010 comes to an end and 2H10 starts with an air of uncertainty. Look at it this way, the market will not be interesting if there was no mystery to what will happen down the road.

I need to apologise for not updating the blog yesterday but I was out getting sloshed with some buddies while watching the England vs Germany game. Overall, it was a good game, of course England supporters will definitely not agree but it was a great game for the neutrals.

A friend of mine while singing karaoke the other night asked me which way the market was going to go. I told him the only answer I knew, which was "I don't know". Fact of the matter was, in the short term, the market itself does not seem to know which way it was headed. Every day over the past 2 weeks, watching the market was as interesting as watching an episode of "Love" (Taiwanese drama series that never ends)or should I say 2 weeks worth of episodes.

In recent weeks, there have been lots of talk on the possibility of a double dip recession for most of the developed world. Poor economic data coming out from the US has only added fuel to perennial bears like Nouriel Roubini to speak with more conviction on the possibility of a double dip. I believe in one of my earlier posts, I did state that a double dip is a possibility and cannot be ruled out but it is by no means a sure thing.

Even if a double dip happens, it will not be as severe as the one we just experienced in 2008. This I am sure. If a double dip recession occurs, it will not be caused by a global credit crisis like what happened in 2008. History is on the brink of repeating itself with the European countries focusing on managing their fiscal deficits rather than ensuring their economic recovery is on a sustainable path. This is the time when politics take centre stage and political interests overwhelm economic interests, placing economic growth in the back seat while popularity and vote garnering takes the drivers seat. Politicians are pressurized into implementing austerity measures (i.e. Britain, Germany, France etc) when their economies (with the exception of Germany) continue to look shaky. With austerity measures in place, we can expect consumer confidence to falter and government investment to be tepid.

I continue to reiterate my view that the developed economies may be a little premature in their willingness to withdraw stimulus spending and implement austerity measures. Before I start criticising the govts and central banks, I would like to say that the world has learnt from the previous lessons that immediate actions and interventions are crucial to prevent a long term term depression. The sheer amount of money pumped into the global financial system, the near zero interest rates in USA and Japan, the hundreds of billions in pledged stimulus spending, the innovative measures like TARP and "cash for clunkers" have helped the world avert another Great Depression and probably prevented a longer recession. In that aspect, we have learnt our lesson from history.

On the other hand, we have not learnt from our lesson of withdrawing stimulus and tightening monetary policies too prematurely. During the Great Depression, the economy was down in the doldrums from late 1929 till 1932, after which the global economy started to show some improvement and equity markets started to rally strongly (very similar to what happened in 2009).



I attached the chart to show what happened to the market once the central bankers started to tighten monetary policy the moment they saw a recovery in 1932. This led to the equity markets dipping once again but it did not touch its previous low in 1932. This is the scenario that I believe will be very likely if developed nations continue to think about their own fiscal balances and not how their actions could cause a domino effect and put pressure on other nations to implement similar measures.

The holy grail of economic theory in my personal view is "expectations". If govts are able to manage expectations well, they will never need to worry about inflation, economic slowdown or even recessions. Why do I say that? Basically, the world we live in is build on the premise of "make believe". The money in your bank account is just a number, is it really there? I do not think so. The dollar notes in your wallet, is worth no more than the paper its printed on, but somehow you trust in the denominations printed on it. The stocks you buy, they are just names on a screen with numbers flickering next to it. If people stopped believing the stock is worth anything, no matter how well the company is doing, it will still be worthless. IF the man on the street does not think that there is inflation, then they will not be pressurised to demand for higher pay or even hog any consumer goods that they feel would go up in price in the future, thus inflation is controlled.

Why did I speak about expectations in this post? Its because I believe the govts are sending out the wrong signals currently. With them stressing so much on austerity measures and their fiscal deficits, it is no wonder why confidence in their currencies are waning. If you believe your neighbor is going bankrupt, would you lend him money? Its all about belief. If you perceive your neighbor as having a good credit standing, you would lend him the money 24/7. If the man on the street is worried about the sustainability of the recovery, their govts portraying a bleak deficit outlook, how is he supposed to find the confidence to spend his money? Consumer spending will not be picking up and government spending is cut back. That is just a recipe for a double dip. It is by no means a certainty, but if more austerity measures are introduced, we can start to move into a more defensive position for our portfolios. In my previous posts, I have already mentioned the best ways to go defensive on your portfolio of stocks. So I believe we are more than well equipped to manage our portfolios in the event of a double dip.

Now back to watching football.

Best,

SVI

Chinese yuan de-peg...A wise visionary move to curb inflation.

After spending a busy week in China, I should not be surprised that the most interesting developments in the the global financial markets have happened in China over the past 2 weeks. China has always been an interesting proposition for me. Their culture and habits peculiar as they may be (red wine mixed with 7-UP, drinking 60% alcohol content Baijiu etc), are always of interest for me.

Over the past 10 years, China has come a long way and it has been the "no brainer" investment theme for many investors. A lot of money has been made and lost in the Chinese stock market over the past 5 years, with the Shanghai composite trading up to 5800 points and falling to as low as 1728 points. Thus it is the last market for anyone to describe as boring and uneventful.

Latest news out of China over the weekend was the de-pegging of the yuan from the USD. This has been widely anticipated globally, with all their trading partners (esp USA) shouting murder at the Chinese exporters, this is viewed as a move to appease the G20 countries before their meeting. Not a lot is expected to come out of this de-peg because the Chinese government is not going to allow the yuan to be too volatile and in their statement, they emphasized on stability of the yuan and it is not possible that they will let it fluctuate too freely.

What are the repercussions from this move? First and foremost, it will make the Chinese exports a little more expensive from their current levels but rest assured, the Chinese are not ready to move from an export oriented economy to a domestic consumption oriented one. The move to de-peg is a vote of confidence in the global economic recovery. Finally after 23 months of pegging, the Chinese government finally feels that the global consumers are back to their spending ways and there is no need for them to protect their exporters.

Also, with a stronger yuan down the road, it will give domestic consumers cheaper foreign goods and also curb internal domestic inflation. I will discuss why inflationary pressure will be a problem going forward a little later.

Another interesting development in China has been the wage disputes in the manufacturing sector. It all started with Foxconn, having 8 suicides in their factory. Blaming it all on the low wages, driving them to commit suicide at the factory. Frankly, I think it is a joke that all the suicides are attributed to the hardship of the workers and the low wages that they have to live on. Foxconn was pressured into raising wages in some of their factories by 70%. This may sound like a lot but considering they were only earning less than 1000 yuan per month, a 70% raise is really not a big deal.

After Foxconn set the precedence, workers in Honda and Toyota factories have all gone on strike, pressurizing the car makers to re-adjust their wages upwards. I fully expect this to move to other manufacturers and the minimum wages will be raised across the board in the manufacturing sectors in China. This rise in wages in such a large sector will lead to a wage push inflationary situation. Why do I say that? That is because the "marginal propensity to consume" (MPC) for lower income consumers is much higher than the high income earners.

For the benefit of readers who have not studied economics, MPC refers to the additional consumption per dollar increase in disposable income. For lower income earners, they tend to consume below subsistence levels and as their incomes rise, they will start moving their consumption to move on par with subsistence levels and more. This will lead to stronger demand for basic goods and push prices higher. The Chinese consumer price index is predominantly made up by food and energy prices. With the biggest component being....make a guess....I bet you cannot guess it. PORK.

Hahaha, believe it or not, the Chinese love pork and prices can be expected to rise as more pork dumplings are consumed going forward. hahaha. Do not take this as a buy call for Synear Foods Limited in any way. Anyway, inflation numbers have been coming in higher than expected and going forward we can expect the wage increases to lead to more pressure on inflation. This wage push inflation scenario is something that I feel is very possible but I do not see it written in any of the papers I have been reading in the past 2 weeks. But as usual, by the time this comes out in the papers, the time to invest in the benefiting industries will be over.

The Chinese government's move to de-peg its yuan against the USD is also in anticipation of higher domestic inflation. This will give them an additional tool to cope with the inflationary pressures in the future. Lowering prices of foreign final and intermediate goods will help cushion some of the price pressures. Should prices start to rise too quickly, the government can allow the yuan to rise more, rather than just depending solely on raising interesting rates. I believe the Chinese government is not ready to raise interest rates too aggressively if the inflation picks up and this gives them more room to maneuver.

I believe this is a very good move by the Chinese and it shows they have the vision to anticipate the possible problems in the future. There was a very wise young man that pointed out that this may not be a good thing for China because if the USD depreciates against the yuan, their US$900 billion dollar treasury holdings will fall in price. But I would counter argue that this move will allow the Chinese to limit their losses as they do not need to keep buying USD to maintain their peg. Whatever treasury holdings they are holding now cannot be controlled but what they can do is to limit their need to buy more in the future. Having a peg will mean that they will have to keep buying USD to maintain it. All I can say is, the Americans better be careful what they wish for. They have been wanting this de-peg to happen but they do not see the risk of the chinese totally moving away from US treasuries. With the need to raise money to finance their debt, the US is heavily dependent on the Chinese to continue to support them by accumulating more US treasuries. What happens when they cannot gain financing support from the Chinese in the future?

Well that will be a discussion for the future. In the mean time, I would like to say, focus on companies that derive their earnings in RMB, Chinese companies that import foreign goods for their businesses and companies that depends heavily on domestic consumption. For specifics, I will leave it to another post.

Have a great week ahead.

Best,

SVI

Fragrance Holdings (S$0.485) Singapore's very own niche hotelier

People who know me well, will know I love dogs and that is why I put a daily dog tag on this blog to allow my readers to share the joy of looking at these adorable creatures. Today has been a tough day because my dog of 9 years has passed away and I would like to dedicate this day to my numero uno dog of all time. Thanks for all the great memories and loyalty you have shown to me.

I was away for the whole of last week and was not able to find the time to post anything on the blog. Even though I did not have the time to follow the market closely, it did give me the opportunity to think carefully about where I should place my money next and I did come out with a couple of ideas which I will be sharing down the road.

While I was away, the market improved quite drastically bringing a little reprieve to investors and tempting some punters back to the market. To be honest, I am skeptical about this recovery because the volumes are still pretty thin but we should be glad that the global sell down has somewhat slowed down. The thin volumes could be attributed to the world cup fever, with more traders and remisiers sleeping at home rather than being at their terminals trading.

While I was on my flight back, I read an article on the Business Times addressing the possible sale of IBIs hotel in Bencoolen and the tenders were coming fast and furious for this 3 star hotel. It got me thinking and I realised that there were just too much talk about 5 star hotels and how well they are doing and very little has been said about the lower rated hotels. Being a person who gets to stay in 5 star hotels very often, I have to admit that it is really amazing how much money is incurred in running such hotels. But 3 star hotels and budget hotels are a different proposition altogether.

The "no-frills" manner that these hotels are set up gives them a leaner and more flexible cost structure. It is also targeting a totally different segment altogether. Occupancy is normally higher and more stable with 3 star and budget hotels because the demand is stronger and the fact that hourly charges can be implemented helps significantly. These hotels tend to generate regular cash flows and helps is a cash business because people tend to pay in cash at these hotels. Partly because it is cheaper and more affordable and also its more discretionary nature of business. Heh heh.

By now, I believe by now you can guess which stock I am referring to in this post. I know for a fact that one of my readers is one of the largest shareholders for this stock and also an anchor tenant for it. Apparently, he has a habit of staring at air-conditions installed in the hotel rooms. Private joke. You know who you are.

Fragrance Group comprises of 2 core business operations, hotel operations and property development.

Fragrance Chain of Hotels is one of the leading chain of tourist class hotels in Singapore. Founded in 1996, it started its debut in hotel management with one hotel, but rapidly expanded and currently managing 21 hotels in Singapore.

Their property division has successfully launched more than 50 projects and consistent with their strategy in their hotel business, focusing on smaller and lower priced developments to create a niche for themselves.

I will not be expanding too much on the property division because it is too volatile and hard to value. The value of this stock lies in their hotel operations because the margins are large, very profitable and also stable. They currently have 1373 hotel rooms which makes them one of the largest budget hotels in Singapore, second only to Hotel 81.

Market watchers are expecting IBIs Hotel Bencoolen will be sold for more than S$200 million for the 528 room hotel. This works out to S$378k per room. This is very impressive because it is just a 3 star hotel. There are some older 5 star hotels that are valued at only S$500k per room, therefore you can see it is really not cheap. If we use this pricing as a guide to translate back to Fragrance's hotel rooms, we will arrive at a very nice number I am sure. Lets use the assumption that each room is valued at S$200k, that would mean their hotels are worth S$274 million. The current market capitalization of the company is S$407 million and the book value of the hotels carried on their balance sheet is only S$140 million. This means that the balance sheet is not reflecting accurately the value of the hotels.

On the macro side, I believe tourism is going to be one of the main key drivers for the Singapore economy going forward and hotels will start to rise in terms of valuations. With the casinos fully operational, we can also expect vice to rise and this will mean prostitution to become even more rampant and demand for "lovers" hotels such as this to grow strongly. It is true that the integrated resorts have added many rooms to Singapore's hotel sector but this is mainly in the 4-5 star categories and also the growth in tourism is going to be more than sufficient to take up the new capacity.

I totally expect hotels to become expensive commodities in Singapore because of the demand for them and also for the ever appreciating land that they sit on top of.

Fragrance's hotels are all built on very choice and central locations which is one of the key reasons to why I believe this stock will be re-rated eventually when investors realise that the land the hotels are sitting on are worth a ton more than what they are valued currently.

The company is paying around 2.5 cents dividend which translates to more than 5% per year. A very attractive payout which I personally think is sustainable for the company. You are paid to wait for it to be re-rated. This is definitely one that I am rooting for and will be allocating part of my assets into as time passes. Fragrance at $0.485 looks like a bargain to me and I like it for its defensive qualities because of its high dividend and strong balance sheet.

I am glad to say that in one and a half weeks, my last call on Asia Food and Properties have delivered 10% returns and I do think that there is still further upside for it. Do keep it in your sights.

Thats all I have for today and its time for me to get back to my mourning for my beloved dog.

Best,

SVI

Asia Food and Properties Ltd. Food and Properties, whats not to like about it? S$0.605

Last week, I went for a few interviews and guess what was the most common question asked to me during the process? It was definitely not "tell me more about yourself", rather "what do you think of the European sovereign debt situation?". Imagine being asked 3 times in one day? I got bored of the topic long ago and I do not wish to talk address this issue too much.

Thats why for this week, I have decided to pick a stock to recommend in this horrible market condition. I spent some time poring through the recent financial reports to try to find something that may be of interest or may even be a safe haven for us to hide in this current storm.

As fate will have it, this coming week I will be in Shanghai for a full week and the stock I have identified this week is doing a significant corporate action on their Shanghai operations. The company is no other than Asia Food and Properties.

Asia Food & Properties (AFP) is part of the stable of companies owned by the powerful Widjaja family in Indonesia. Its chairman Franky Widjaja is the son of the Indonesian tycoon Eka Tjipta Widjaja, who founded the conglomerate Sinar Mas Group.

The Widjaja family is also connected to local tycoon Oei Hong Leong, who is the son of Eka Tjipta Widjaja. Described as a maverick and a raider by the media, Oei Hong Leong has built a reputation for astute investments, including aggressive takeover bids of listed companies.

Besides AFP, the Widjaja family also owns Golden Agri-Resources and Asia Pulp & Paper, both of which are also listed in Singapore.

Actually, AFP used to own Golden Agri-Resources, which it sold off in 2006 as part of a capital reduction exercise. AFP's revenue since then has been much lower.

It still owns a property division in Jakarta, where it claims to have one of the largest land banks. In China, it is a property developer, hotel owner and noodle manufacturer. AFP also has country club and hotel operations in Singapore and Malaysia. Its Indonesian property business is its main revenue contributor.

Now, why do I think this company may be cheap. First of all, there is an existing corporate action proposing to distribute the their Bund Center Investment (BCI)business to their shareholders. The ratio will be 1 share of BCI to every 2 existing shares of AFP. Currently, BCI has a net book value of S$0.26 or so but the earnings have been falling over the past 2 years. Currently, it is earning about S$0.02 thus the valuation is pretty normal. The key value in BCI is its property value and the future potential for appreciation. For those that have been to Shanghai, they would tell you that the Bund Center office tower is located at a very choice location and is worth a ton. Secondly, they also own the Bund Westin Hotel that has 570 rooms. Total land area of more than 17 thousand square metres of prime land. With this proposed distribution in specie, it will provide a good support for the stock price in the short run.

Another significant transaction may be in the works for the company, with them announcing that they entered into a letter of intent with Golden Agri to negotiate the possible sale of their food business. This is another reason why the stock will be supported at this level. Their food business deals mainly in the business of instant noodles and snack noodles in China. The food business contributes 1/3 of AFP's revenues and profits. Any sale made on this segment will result in a large cash inflow into the company and add to its already large cash horde of S$380 million. Special dividend payout is a strong possibility, if not it may even take itself private.

Why do I like AFP? Because it is dealing in 2 of my favorite businesses. Food and Properties. Why do I like it even more? It's operations are in 2 of the fastest growing markets in the world, Indonesia and China. Did you know, Indonesia has the 4th largest population in the world? What makes business good? Lots of customers.

The company is fundamentally very sound with no excessive debt and no problems in servicing their covenants. Their operating cashflow is very strong, on a yearly basis, the company generates more than S$150 million per year in operating cashflow on more than S$600 million revenue. Profits range from S$150-155 million over the past 2 years, which only translates only to about 12 times historical P/E. Decent numbers but not overly attractive. However, the company is still trading at a discount to its NAV of S$0.71.

Buying at a company on a discount with plenty of assets, possible special dividend in the works and distribution of BCI shares. In times like this, you need to have a big cushion for the downside amd this stock will give it to you. I like it very much and believe that the sell down tomorrow gives everyone an entry point. I would be buying below $0.60.

Thats all for the week. I am sorry about not talking too much about the market because I really feel that its no point trying to explain the irrational market and rather focus on the making rational choices while others are making irrational ones.

Have a good week ahead and hope I have time to post another time while I am away.

Best,

SVI