The Asia Report episode 4: Deep value investing in Singapore

Hi, everyone. Welcome back to another episode of The Asia Report. Today, I’m going to be talking about deep value investing in Singapore. Let’s just get the ball rolling. When we first look at a market, there are mainly two types of investing. Number one, you can be looking at the much larger cap companies, essentially companies in the STI, companies like UOB, OCBC, DBS and City Developments. Then you have the small to mid-size companies which really have very little research or analyst coverage. Those are the two kinds of opportunities that I see. I’m going to talk about the first one which is the large cap stocks in general.

I like the Singapore market, because the Singapore market is very small. It’s a lot easier to understand than a big market like the U.S. or even Hong Kong for that matter, especially if the operations of the business are centered around Singapore. If you look at a company like M1 which is mainly domestic driven or even StarHub, it’s much easier to get a feel of the market and the dynamics and the drivers of that market. However, if you’re looking at a large cap space and the U.S. market, maybe a company like Johnson & Johnson or Microsoft, you’ll see that a lot of revenue is global, which is good in its own way, because it gives you a form of diversification.

At the same time, it’s much harder to understand the structural changes in the market when it does happen. My stand has always been quite simple, that to get an informational advantage when looking at these large cap companies like UOB, OCBC, DBS, companies like ComfortDelGro, SPH, to get a real informational advantage especially when it’s widely covered by analysts from the major brokerage houses, is extremely hard. That means even if you do a lot of analysis, even if you’re doing your legwork, I always tend to feel that you’re not really going to get a very deep insight into the company that you could have gotten from a company that has zero analyst coverage.

In a way, this relates to the whole idea of efficient market theorem. The more something is well-known, the less likely you are to get a good bargain on it, the less likely you are to get an informational advantage over it. That’s why for the most part it’s quite rare that I invest in any of these large cap companies. In fact, for a quite a few years we’ve never owned a single stock in the STI Index in any large part, especially the big banks, or even though I’ve been asked about them many times, simply because we thought the valuations were never that attractive.

I have an exception to this rule though. I feel that the key to buying stocks like that is to wait for very, very serious bouts of depression. What do I mean? One of the things that drives a lot of the changes in stock prices is a lot of institutional money moving in and out, and now more institutional money tends to be much smarter. They are also constrained by their own market forces at work, because your big institutional funds are only able to buy very large companies, which have a certain amount of liquidity that allows them to buy and sell. These in turn are helped by individual investors and maybe some institutional investors.

When the news is very bad, these investors also tend to sell off. In order to meet their fund redemptions, they too have to systematically sell whatever is in their portfolio and seeing that most of the institutional funds that I see are actually closet indexers, in other words, they track the STI Index quite closely, you have a situation where they become forced sellers. If you know when they are forced sellers that puts you in a distinctive advantage, because you may have a situation where the fund manager thinks that this company is a good prospect, it’s going to be around five, ten years, valuations are very cheap but he is not in a position to continue adding to his portfolio, because he’s out there meeting fund redemptions.

A good time when this actually manifested itself was in early 2016 and mid-2015 when the China stock market bubble burst, but especially early 2016 where you had a lot of forced selling and you even had rumors that Aberdeen Asset Management was about to sell itself. Aberdeen Asset Management is a very successful and it’s an emerging market specialist as Asia-Pac specialists. They were out there meeting fund redemptions too. That’s a situation where you can see there’s a lot of bad news, there’s a lot of depression, there’s a lot of selling and it’s a very emotionally driven market. That’s when I like to look at these large cap companies like property developers and banks because they are impacted by the cyclical nature of the industries. Some of you will probably reference companies and I’ve had people asking me this even late last year about the three telecom operators, companies like SPH or even ComfortDelGro and it’s no doubt that these companies have faced the bulk of forced selling quite recently.

This is where I would throw in a bit of caution. It’s a very different situation from last year when you’re looking at big property developers and even at banks, when they were in a cyclical downturn. There was bad news. Oil and gas companies were defaulting and the loan books of these banks were being disrupted. But the underlying business that they were in, taking deposits, lending a certain rate, engaging asset management and providing financial services, these weren’t industries that were facing severe pressure.

When I look at companies like the telcos for example, my own gut and my own research has shown me this is quite a different dynamic because you have a situation where the fourth telco operator is actually coming in. In the case of companies like ComfortDelGro, again a different situation because now you have a situation where there’s a price war between Uber and Grab, as many of you can tell from subsidies you’re getting in a barrage of advertisements. There’s a lot of capital entering the industry, some of it I consider to be a bit irrational that is essentially funding a lot of business activity that shouldn’t be happening.

It’s not really a case where the business is in structural decline but as a huge amount of capital flowing into the industry that is impacting the market because your supply is going up dramatically, but your demand is definitely increasing but I doubt is increasing to the extent to offset an increase in supply, considering our population growth has really matured in the recent years.

I talk a lot about this in a course which I’m launching with The Fifth Person. It’s called the capital cycle. Essentially it simply dictates that high returns attract capital. In this case the transport industry was ripe for disruption and the problem though is when a lot of capital enters the industry, increases the supply and reduces the returns for everyone. That’s essentially what is also happening with SPH. Initially my own thoughts were that it was a cyclical downturn but once I started looking at reference points in the U.S. especially, you can see that the traditional media industry, the print industry, has been decimated by the online entrants coming in.

It’s a similar situation in Singapore altogether. SPH has actually taken steps to diversify into the other industries, most notably into the property side of things. But at the end of the day, the cash cow of the business was really the print media business and that’s the business which is in deep structural decline. A lot of capital has been pouring in and there’s been a lot of disruption which is the new buzzword. Essentially a lot of new competition was appearing in the online media, YouTube, online news sources, so on and so forth.

It’s a situation where they once had a competitive moat but that competitive moat has essentially eroded dramatically and I don’t think it’s something that’s coming back. How I support my thesis is that if I look at countries like the U.S. and see what has happened to the state of the media industry, you can see dramatically that’s what the issue is really. It’s simply a change in the entire structure of the economy. The best analogy I can give is that in the past before there were cars, there were people who would essentially use horses, right? If there was a horsing stock, a company that essentially built the wagons and all that, they used to have a competitive advantage.

This a case where you have to spot: Is it a structural decline or a cyclical decline and this case I would say this is more a structural decline. Does that mean we should go out and buy the new media stocks? This is probably why I urge a little bit more caution too. I’m just going to detract slightly because if you look at a lot of very obvious things such as how aviation has changed the industry, how the automobile industry has changed the entire world and the way we travel. If you look at the resulting effect of what has happened in the last 100 years, yes, it’s true, the entire industry and landscape changed but if you look at the number of car companies there were a hundred years ago and the number of car companies there are today, you’re only left with a handful of global giants. Same thing for airlines. As Warren Buffett always likes to say: If you collectively look at all these airlines combined, you actually see that the net profit to investors is actually zero given the amount of losses they have taken.

That’s why looking at obvious business trends does not always translate necessarily into profit. I think I probably talked about Netflix in passing before. I probably do another podcast on this. It’s a very, very interesting situation. But now just to go back to this whole idea of deep value investing in Singapore. I’ve talked about the large cap companies and now I probably just want to talk about the small to midsize companies, which I think offer extremely compelling opportunity for out-performance especially if you do extremely in-depth research or even a reasonable amount of research.

The great thing about investing is that you don’t have to be the smartest guy in the room but you definitely have to be smarter than the next guy, the average guy in the room. Even though Singapore is quite a sophisticated financial market, when you attend a lot of these AGMs, I think two things become quite apparent. Number one you don’t have a lot of institutional ownership and number two from the quality of questions being asked you can tell that a lot of people simply do not read the annual report, which is great if you’re investor that wants to do in-depth research.

If you ever look at the entire structure of the industry which itself has undergone a structural decline and not a cyclical decline, one thing becomes clear is that the industry has been heavily decimated by competition from online brokerages. Where brokers once held all the keys, being the provider of information, you had to call them up to trade, pay 1% commission each way. Today they’re in a price war and commissions keep getting squeezed.

If not for the fact that the Singapore government is also protecting the industry in a certain way, if you look at the commissions that some of the overseas brokerages are charging for trading Singapore stocks, they go as low as six basis points or seven basis points which is 0.06-0.07% without any minimum commission. You can see that this is an industry which has faced tremendous pressure. The resulting impact of this is that the quality of sell side research has also dropped dramatically because they are unable to pay for it the same way that they were able to do when they were earning a lot of money back then. Hence when you look at a lot of the coverage, it is actually focused around the very, very liquid stocks.

You have some more enterprising brokers like KGI Fraser or RHB which tend to cover small to medium-sized companies too but this really is a rarity in my view. Now, the great thing for investors looking at these companies is that just by flipping over annual reports, you can get a real idea about the industry, about the company especially if their focus is Singapore and you can also see some very obvious situations.

I’ve looked at companies trading 30-40% of book value, where management essentially has said we’re going to sell everything and distribute it back to shareholders. This is an area which is ripe and fertile for small to mid-sized investors anywhere up to if you’re managing 30, 40 even 50 million dollars. The reason why this anomaly hasn’t really disappeared yet for those of you who like to think about these kind of things, it’s really that this isn’t a market that’s highly liquid compared to Hong Kong or Japan.

Even if you were to run a fund, and I start to see funds that focus on Singapore, eventually you hit a capacity constraint where you have too much money and you can’t really look at these situations anymore. Now, just adding to that, again I like to stress that one of the great things about investing in Singapore is that it’s not hard to actually understand government policy over the last 30 years simply because we really only had one ruling party for the last 30-40 years.

Again, it’s not like situation in the U.S., where you have the Democrats, you have the Republicans, you have different ideologies and philosophical thoughts about how to run the economy. Once in Singapore, you have a remarkably consistent set of policies and thinking driving those policies. You can see that the government here has huge physical reserves, they act in a manner to stimulate the economy when economy is not doing so well by increasing things like construction and civil engineering projects when there are downturns by helping the local SME economy by doing things like PIC grants which benefits certain companies like Challenger. You can see they act in a certain manner when the economy is not doing so well and these policies have remarkable consistency that for the student of history provides a huge advantage.

With that, I’m going to end my podcast here. I hope I gave you a brief understanding of the differences in looking at large cap stocks, where to look for opportunity in large cap stocks, and also, more importantly, differentiating between a structural decline and a cyclical decline and also some of the things which I see in small to mid-cap stocks that offer such compelling opportunity for investors that really want to earn the additional return because they want to do the in-depth research required to do so.

Read more: Everything you need to know about deep value — including property conglomerates, Singapore banks and graham’s classic net-net stocks.

Tay Jun Hao is the fund manager of the Heritage Global Capital Fund at Swiss-Asia Financial Services Pte Ltd. Cumulative performance of fund tsrategy net fees from Jan 2012 to June 2017 is +137.89 (CGAR +17.07%).

Tay Jun Hao graduated with a Bachelor of Laws (Honours) degree from University College London.

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