HKD Liquidity – If affordability is irrelevant…

This will never work (Vol 1, No 33)

Going to try to squeeze in one more post before I disappear for two weeks of summer vacation. Be warned, in the past, whenever I went on long holidays, the markets tend to go crazy (both up and down).

Screen Shot 2018-06-23 at 10.24.12 AM

Revisiting the HKD Aggregate Balance

Two days ago, we talked about the strong USD and the weak Rmb. In Hong Kong, although our currency is officially pegged to the USD, there is a band that allows the HKD to trade within 7.75-7.85 to the USD. When the currency hits the weak side, 7.85, of the convertibility undertaking, the HKMA steps in, buys HKD from the market, and shrinks the money supply.

As we have written previously, HK$100bn in the Aggregate Balance was supposed to be the magic number whereby liquidity tightens and forces banks to raise the prime rate. So far, although the US Fed has raised rates seven times and 175bps, the Hong Kong banks have stood pat.

Stops and starts, could another move be on its way?

In the middle of April, the aggregate balance moved furiously, dropping from HK$179bn to HK$128bn within a span of eight days. There was another leg down in the middle of May when the balance dropped from HK$128bn to HK$109bn.

Over the past month, the aggregate balance has been more or less unchanged, providing a bit of reprieve for those fearing a hike in local interest rates.Liquidity is Shrinking

Total Monetary Base now back to January 2017 levels

While the Aggregate Balance has been stable since May 16, Hong Kong’s Total Monetary Base has continued to shrink bit by bit.

Unlike previous instances where the reduction in Aggregate Balance was more than offset by an increase in Outstanding Exchange Fund Bills and Notes, this time around, there hasn’t been a corresponding offset.

Since May 16, Hong Kong’s total monetary base has fallen from HK$1,664.088bn to HK$1,642.077bn. To put this in historical context, Hong Kong’s monetary base has now returned to January 2017 levels.


If you look at downtick on the far right side of the chart, you’ll see that this is not like the past adjustments.

If affordability is irrelevant, then it’s all about liquidity

Why is this important? Because, it’s been all about liquidity.

The property bulls have argued that affordability is now an obsolete concept and nowadays it’s all about liquidity and capital flows from China. If they are right, then Hong Kong monetary base better start ticking up again real soon.

But then again, I’m sure as liquidity continues to drops, they will just find another argument like how property is a lower volatility asset, a better alternative to the stock market, a safe haven for Chinese money, or how it benefits from a sharing economy (btw, if we share spaces, doesn’t it mean less demand and not more?)

Photo by Toa Heftiba on Unsplash

Go ahead, have your cake and eat it too but just remember when you go for all three vices, your arteries will eventually clog and you know what come next.

See you in two weeks.

This will never work.


Small Moment: Weaker CNY

This will never work (Vol 1, No 32)
Screen Shot 2018-06-20 at 3.14.48 PM
The Renminbi is falling again

Everyone is talking about the trade war and everyone is talking about the strength of the USD. What hasn’t received nearly as much play is the decline of the Reminbi.

As the DXY has strengthened from its mid-February low of 88.59 to 95.21 (up 7.5%), not only have the JPY and EUR weakened, so has the Rmb.

The Rmb was strongest on April 11, 2018 when it was trading at 6.26759 to one USD. Since then, it has weakened by 3.4% to 6.49086.

Airlines and Developers are Supposed to be Hurt by Strong USD

Conventional thinking has it that when the USD strengthens, Chinese airlines and Chinese developers get hurt. It basically comes down to a currency mismatch between their assets and liabilities (Chinese developers) and revenues and expenses (for Chinese airlines).

Let’s look at a HK$347bn market cap example

In order to put more flesh to why Chinese developers are hurt by a strong USD, let’s take a look at the 13th largest company on the Hang Seng Index. Country Garden has a market capitalisation of HK$347bn (or US$44.2bn). It is the second largest developer on the Hang Seng Index, just a shade behind SHKP’s HK$354bn market cap.

Over the past five years, as Country Garden’s revenues have grown, so has its balance sheet. Net debt has grown from Rmb20bn in 2012 to Rmb66bn. Considering its current market cap of HK$347bn, this level of net debt does not seem that large.

Rmb215bn gross debt and Rmb148bn of cash

However, if one were to split its net debt figure into the cash and gross debt component, we see that Country Garden’s gross debt has increased from Rmb36bn in 2012 to Rmb215bn in 2017. Meanwhile, as of December 31, it also carried cash balance of Rmb148bn. I guess when you have trade payables of Rmb331bn, you need a big float.

Country Garden - Cash, Gross Debt and Net Debt Position

Net USD liabilities of Rmb50.0bn

For many Chinese developers, offshore USD bonds have been a key source of financing. Since 2012, Country Garden’s USD net liabilities have increased from Rmb14.9bn to Rmb50.0bn. In the context of a company that generated contract sales of Rmb550.8bn in 2017, Rmb50.0bn of USD-denominated liabilities may not seem much but numerically speaking, the 3.4% drop in the USDCNY has now increased this liability by Rmb1.7bn.

If one were to compare Country Garden’s USD exposure to its shareholders’ funds, this has gone from an average of 44% between 2012-2015 to 50% over the past two years.

Net USD liabilities exposure (Rmb 000s)

Substance over form – Interest costs are going up

Due to an accounting quirk that allows Chinese developers to capitalise interest from borrowings, the combination of Rmb215bn of gross debt and Rmb148bn of cash results in net finance income of Rmb3,276mn (made up of Rmb146.6mn finance costs and Rmb3,422.7mn finance income).

But as they say in accounting circles, let’s focus on substance over form. You can call it capitalised interest or cost of goods sold but what matters is cash flows. If one were to look at actual interest paid, this has increased from Rmb3bn in 2012 to Rmb10.8bn in 2017.

Again, for a company that generated Rmb550.8bn in contract sales, the bulls would argue that this is just chump change.

But bear in mind that interest rates have fallen significantly over the past five years. Dividing interest paid by average gross borrowings, Country Garden’s cash interest costs had fallen from 8.2% in 2013 to 5.4% in 2016.

Interest paid and cash interest costs

But you see that little uptick to the right? In 2017, Country Garden’s cash interest costs have already started to rise, moving to 6.16%.

Unless one is prepared to pay down debt with surplus cash (and again this is a company with Rmb550.8bn of contract sales), the combination of the US Fed hiking rates as well as widening yield spread means interest burden is likely to rise.

The timing of when interest rates reset may vary but against a gross debt position of Rmb214.7bn, a 1% rise in effective interest costs works out to Rmb2.1bn.

A rising tide better lift all boats

The good news is that unlike 2012 to 2015, the company is finally able to generate positive cash flow from operations.

Cash generated from operations

For the Chinese airlines, the combination of a rise in oil prices and a strong USD, their share prices have fallen by 30% off their 52 week lows.

Screen Shot 2018-06-21 at 12.20.31 PM
Air China share price performance

But for the Chinese developers, they have been more resilient (only down 18%). Perhaps the market is anticipating that the ever rising tide of contract sales will see another wave of monetary easing.

Screen Shot 2018-06-21 at 12.18.14 PM
Country Garden share price performance

As a final contrast, let’s consider the price-to-book ratio of the two biggest property companies on the Hang Seng Index. SHKP is at 0.7x. Country Garden is at 3.0x.

This will never work

Time to be greedy? But who is “others”

This will never work (Vol 1, No 31)

Be fearful when others are greedy, and be greedy when others are fearful

Warren Buffett

It’s been a brutal day.

Screen Shot 2018-06-19 at 4.27.45 PM
Source: CNBC

As I write this post, the Hang Seng Index is down by 2.8%.

Over the border, the Shanghai stock market is off by 3.82% and the Shenzhen stock market has done even worse, plunging by 5.56%.

Across the pond, the Dow Futures is indicating down by nearly 400 points.

Who is “Others”? It could be you and me

If one were to apply Warren Buffett’s maxim to be greedy when others are fearful, then today’s sell off should be a buying opportunity, right?

Not really.

The Buffett rule sounds simple but it is actually incredibly hard to apply.

The problem is that one has no idea what state “others” are in.

Yes, the markets may be selling off and you might think that others are being fearful. But by the very act of trying to bargain hunt, others would judge you to be greedy and hence the right move may be to be fearful instead?

Perhaps the better rule to follow is “Don’t catch a falling knife”.

Photo by Lidye Petit on Unsplash

Otherwise, hamburger meat.

Crap floats? Some things I just don’t understand

On a related note, one issue that I’m really struggling with today is why does crap float?

In today’s sell off, some stocks have been remarkably resilient.

Samsonite is up 0.5%, Anta is only down 0.9% and TAL Education was up 3.7% overnight.

What these three stocks all have in common is that they have all been subject of recent short sellers’ reports.

Yes, they may have sold off recently but Samsonite is still trading at 16x PE, Anta is trading at 30x and TAL is at 117x earnings. They are not exactly cheap.

Shouldn’t portfolio managers be reducing their high risk positions instead of trimming companies with solid balance sheets and proven track record?

To make matters worse, you can’t even distract yourself with the World Cup. The three matches on schedule are (i) Japan v. Columbia, (ii) Poland v. Senegal and (iii) Russia v. Egypt.

This will never work.

Roast Goose: Can you sell at least 72 a day?

This will never work (Vol 1, No 30)

We’re talking property today.


News #1 – Yat Lok Roast Goose Store Sells for HK$82.8mn

The first piece of news is about Yat Lok Barbecue Restaurant.

Yat Lok is famous for their roast goose but they closed two months ago. They recently sold their shop for HK$82.8mn. Based on the 2,800sf space, the sale price works out to HK$29,571psf.

Since Yat Lok owned their own space, they didn’t have to pay rent. But market participants have estimated that the transactional yield is around 2.2-2.9%. This implies monthly rent of HK$150,000-200,000.

Back in January, before Yat Lok closed down, the price for one whole Roast Goose was HK$460. In order to cover the rent, they would have to sell 326-434 roast goose a month. Since this would only be about 11-15 goose a day, no problem.

But hold on, rent is not the only costs. Generally speaking, for a F&B establishment, occupancy costs in Hong Kong should be around 10-20% (Cafe de Coral at 11.8%, LH Group at 18.4%). If we take the mid-point, say 15%, whoever winds up renting the previous Yat Lok space would have to earn monthly revenues around HK$1.0-1.3mn. In roast goose terms, this means selling 2,174-2,899 geese each month. At the bottom of the range, this works out to a minimum of 72.4 roast goose a day.

I suppose if you are a Michelin one-star restaurant and had been previously featured in Anthony Bourdain’s No Reservations, selling 72 goose a day is no problem.

But for anyone else, it’s going to be a lot of cholesterol.

News #2 – Greatest Trade from the Greatest Asset Trader in Hong Kong?

Source: British Land

Li Ka-Shing is one of the best asset traders in the world.

Last year, he sold The Center in Hong Kong for HK$40bn. When he was asked why, he said that he expects to deploy the returned capital and generate at least double the recurrent income that The Center earned.

He’s off to a good start. Just a little over one month after completing The Center transaction, he has deployed about one-quarter the proceeds and generated about 62% of the income.

The HK$10.5bn that he’s spent in buying 5 Broadgate in London is believed to carry a 5% passing yield.

Consider the following:

  • 5 Broadgate is reported to generate HK$500mn rental income a year. This is 62% of the HK$800mn rent that The Center generated.
  • The HK$10.5bn spent is only 25% of the HK$40bn that he got from selling The Center.
  • 5 Broadgate was completed in 2015. The Center was completed in 1998. He’s switched from a 20-year-old building into a three-year old asset.
  • 5 Broadgate is let to UBS until 2035, giving Mr. Li 17 years of certain cash flows. The Center’s leases are generally for three years, and by the way, Goldman’s back office has just moved out this year.

Hmm, what’s that saying about “Actions Speak Louder than Words”?

News #3 – CKA Secures Plans to Convert Service Apartment into Office Complex

According to the HKEJ, back in January 2018, Cheung Kong Asset got approval for building plans to redeveloped Harbourview Horizon in Hunghom into two new office blocks.

Although the building plans is only meant to be for long-term planning purposes and there is no detailed timeframe for the redevelopment, you’ve got to wonder “Why now?”

Screen Shot 2018-06-15 at 3.50.19 PM
Floor Plan of Harbourview Horizon All-Suites Hotel

Harbourview Horizon is officially called an “All-Suites Hotel” but it’s really more of a serviced apartment complex. In 2014, the 1,980 serviced apartments at Harbourview Horizon were 88% let and generated rental income of HK$325mn.

If you think about the current climate where the Hong Kong Government is conducting a Public Consultation entitled “How to tackle land shortage? Land for Hong Kong: Our Home, Our Say”, isn’t it strange that Asia’s best asset trader is making plans to change 1,980 homes serviced apartments to offices in an unproven business district?

And this is happening when everyone is saying that Hong Kong home prices will never go down. Clearly, someone is zigging when everyone else is zagging.

This will work.

Nolan Ryan’s Fastball

This will never work (Vol 1, No 29)


Basketball season is over. Hockey season is over.

In the NBA, the Warriors won for the third time in four years.

In hockey, the Washington Capitals ended the cinderella season of the Vegas Golden Knights.

The World Cup is starting up but I’m not a big fan so we’re going to turn to baseball.

5,714 strike outs over 27 years

For those unfamiliar with Nolan Ryan, he holds the record for the throwing the most strike outs in Major League Baseball. Over his 27 year career, he struck out 5,714 batters. His best pitch was the fastball. What was amazing about Nolan Ryan was that he was able to throw pitches above 100 miles an hour well into his 40s.

In baseball, if you’re facing someone like Nolan Ryan, you’re not going to be able to pass on many pitches.

But fortunately, when it comes to investing, you can pass on as many pitches as you like. Yes, you might kick yourself when a certain idea that you passed on goes up but as long as you’re not striking out, you’re making forward progress.

Letting a lot of pitches pass

Over the past few months, we’ve let a lot of pitches pass. A number of ideas have popped up but rather than taking action, we’ve let most of them pass. Some have been too hard to understand. For others, the themes was interesting but it just felt too late to chase on extended valuations.

Too early or too late?

I don’t believe in the efficient market hypothesis.

I believe the market knows more than we do but I don’t think that share prices always reflect all available and relevant information. If that were the case, it shouldn’t have taken so long for Enron to blow up.

I have a lot of respect for short sellers. Not only are they very thorough in their research but they also have to be very good in their timing. Their thesis might be right but it still takes time for thing to play out. Unfortunately, in this part of the world, retail investors don’t have many instruments to bet against a stock.

Will have to let this pitch pass.

Star Wars Episode 4

The first Star Wars movie came out in 1977. It was entitled “A New Hope” and was actually Episode 4 in the Star Wars franchise.

In the investment world, hope is a powerful driver. For growth stocks, you hope that revenue growth can be sustained.

But for turnaround stories, hope is more elusive. You know that things have been bad for such a long time but you’re just not sure if the latest turnaround story will stick or whether it is just another false start.

For one truly Asian market, investors seem uncommitted to its turnaround story.

Year to date, it is only up 0.1%. Valuation wise, it trades at 16x PE but carries a generous dividend yield of 5.6%.

Timing wise, not sure if it’s a good idea to initiate new positions just before summer holidays but hopefully this pitch will come around again.

…But also 3,923 hits and 2,795 walks

Incidentally, Nolan Ryan also gave up 3,923 hits and 2,795 walks during his career. So, it’s possible to get on base, you just have to be patient.

This will never work.


Mass Consumption 14 – Take Your Meds

This will never work (Vol 1, No 28)

It’s been a while since we looked into the Mass Consumption theme. This time around, we’re looking at Healthcare.

Photo by Thought Catalog on Unsplash

According to the National Bureau of Statistics, although healthcare is only the sixth biggest per capita spending category, it is the fastest growing. It currently make up around 7.3% of per capita spending but grew at 15.8%.

Screen Shot 2018-06-11 at 2.39.51 PM

While’s China’s 7.3% per capita spending may appear low, it’s not. In the US, healthcare expenditure make up around 8% of annual household expenditure. The big difference is in the nominal amount of spending (US$4,612 per family Vs Rmb352 per capita).

Healthcare Index Representation – 13.9% Vs. 1.2%

Where there is a really big discrepancy between the US and China is index representation. In the US, the healthcare sector carries a 13.9% weighting but in Hong Kong, that’s only 1.2%.


Intuitively, the call should be straight forward, healthcare representation in the HSI should rise. But’s it’s not that easy. Remember my Investing Junkfood posts about trying to avoid investing on (i) 52 week highs and (ii) high valuation multiples?

+123% off the 52 week low and 49x PE

The three largest healthcare stocks in Hong Kong are CSPC Pharma (US$19b market cap), Sino Biopharmaceutical (US$14bn) and Sino Pharm Holdings (US$13bn). Compared to the US giants like JNJ (US$332bn), Pfizer (US$214bn) and Amgen (US$122bn), the China pharma stocks are minnows.


What gives me pause is the current valuation and recent performance. CSPC and Sino Biopharm are both trading at 49x PE (JNJ and Pfizer at 20-23x) and are up 193% and 123% off their 52 week lows.


By comparison, Sinopharm appears a bit more palatable. It’s only up 17% off its 52 week low and its US$15bn market cap only implies 15x earnings.

But hang on, it’s not that simple.

Distributor vs. Manufacturer

While they all have the word “Pharm” in their names, Sinopharm’s business is actually very different from CSPC and Sino Biopharm. It’s a drug distributor and not a drug manufacturer.

This difference becomes very stark when you look at their gross and operating margins. In 2017, CSPC and Sino Biopharm enjoyed gross margin of 60% and 80% and operating margins of 23% and 26%. As a distributor, Sinopharm only earned gross margin of 8.3% and operating margin of 4.4%.


China vs. US Pharma companies – Two key differences

When I was previously looking into some of the US biotech companies, I was struck by their low PEs and high dividend yields. For the likes of Gilead, Amgen and AbbVie, uncertainty about their drug pipeline had turned them into value plays.

Across the pond, with PEs near 50x, growth expectations are very high for CSPC and Sino Biopharm. But how are they similar and where are they different?

Comparable gross margins

Looking across Gilead, Amgen, Celgene and AbbVie, their gross margins range from 75% to 96%. The average gross margin of 84% is not dissimilar to Sino Biopharm’s 80%. For CSPC, given their generic and vitamins business, it has a lower gross margin at 60%.

Much lower R&D expenses in China

One key difference is in the research and development spending. For the four US companies, R&D expenses were around 23% of their revenues (range of 14.3% for Gilead to 43% for Celgene).


For Sino Biopharm, R&D was 10.8% and for CSPC R&D spending was only 5.3% of revenues.

chart (d)

This difference becomes much bigger when you consider it in nominal terms. In 2017, Sino Biopharm spent US$249mn in research and development and  CSPC spent US$127mn. In the US, Celgene spent US$5.9bn, AbbVie US$5.3bn, Amgen US$3.6bn and Gilead US$3.7bn.

M&A has not been a big driver for the Chinese

Another key difference is M&A. For the more mature US companies, one source of innovative drugs is acquisitions.

Among the four US biopharm companies, goodwill and intangibles are often the biggest assets on their balance sheets. These range from around 30% for Gilead and Amgen to 61% for AbbVie.chart(g)

But for the Chinese pharma companies, perhaps due to the relative infancy, goodwill and intangibles were only 1-4% of their total assets.


Hepatitis Meds – One man’s poison is another man’s medicine

As a final point of contrast, take a look at their best sellers list.

In China, meds to treat hepatitis account for 44.2% of Sino Biopharm’s revenues. In 2017, this rose by 11% YoY.

Screen Shot 2018-06-11 at 4.39.01 PM
Sino Biopharm – Revenue by therapeutic categories

In the US, HCV anti-viral meds account for 36% of Gilead’s revenues. This fell 38% YoY in 2017.

This only goes to highlight that often times, one man’s poison is another man’s medicine.

So what would you go for, value or momentum?

Choose your poison carefully.

This will never work

Two Tips from “The Tipping Point”

This will never work (Vol 1, No 27)
Photo by Jack Gisel on Unsplash

Hong Kong’s radio stations are lousy. They hardly ever play any music and when they do, the DJ’s keep interrupting the song with their comments. On the talk radio side, it’s generally some rant against the government or whether Ms. Wong should cut her loss on China Life since it’s fallen 2% today.

Partly due to the lack of decent programming, I’ve started to listen to more podcasts lately. Since most episodes are around 30-45 minutes, they’re great when you go for a run.

Where does creativity come from?

Yesterday, when I was on the treadmill, I happened across Malcolm Gladwell’s “Revisionist History” podcast.

If you’ve read any of his books like “The Tipping Point” or “Outliers”, you know he makes some amazing observations and he is a master storyteller.

One question that he was asked on this podcast was on his creative process, i.e. how does he come up with his ideas? His answer was “Specificity” and that being specific is a key trait of interestingness.


What does he mean? In his example, it’s like instead of saying “I really like that Hitchcock film”, people with a high degree of specificity in speech and thinking would say, “I really like that 30 second moment when that character said this, the camera panned away and that’s when you realised this was happening”.

And it is this level of specificity that makes things interesting.

He didn’t really answer the creative process question directly but what is clear is that for the creative idea to be interesting to other people, it needs to be highly specific.

Did you cheer for Nadal? You did the right thing

The second interesting remark that Gladwell made is that he always cheers for the favourite team/player. He roots for the favourite not because he’s on the bandwagon but because he feels they are under tremendous pressure.

The favourites are expected to win and the underdogs are expected to lose.

If everything plays according to script, the underdogs would lose but they shouldn’t feel too bad since they kind of expected it anyway.

But if you’re the favourite and the overwhelming favourites like the 2015-16 Warriors that went 73-9 or the Undefeated 2007 Patriots, when you lose, you’ve got to deal with the additional overhang of being “The Greatest Team that Didn’t Win”. In other words, the favourites feel the sting of defeat much more than the underdogs.

Interesting observation? But you see what he did there. He took a conventional idea, turned it upside down and wham, it’s brilliant and “interesting”.

So, here are two takeaways on creativity:

  • Be highly specific
  • Do a handstand, turn ideas upside down

Now, if you cheered for Nadal to win his 11th French Open title or the Warriors to sweep the Cavs, tell your friends you only did it because you felt sorry for them.

This will never work