People, Let's get a Grip!

Happy Sunday everyone. I just had to get that out of the way!

The hysteria around where I am, is almost laughable. People are hoarding toilet paper like it will give them immunity to Coronavirus! So, get a grip!

So, I am thinking that if people hoard toilet paper as a gut reaction to a virus, then certainly everyday retail investors are capable of selling way beyond what the current situation calls for.

Unfortunately for me, I own a lot of lower-tier stocks, stocks that are in emerging markets and the cheaper stocks in developed markets. So my stocks have actually dropped farther than the market as a whole.

Below are four of my holdings. Notice that they all yield dividends way above average. All four of these companies have improved earnings. All four of these companies have increasing earnings. Tachibana Electech (8159:TSE) is in fact is a netnet. This means that it is worth more dead than alive! While I do realize that the coronavirus crisis will materially impact Tachibana Electech — the company issued a profit warning for the current quarter — nothing that happens this year should take 35% off the valuation!

	Lewis	Tachibana	Riken	EUPIC
Price	R 23.81	¥ 1248.00	¥ 1770.00	€ 3.38
Shares (M)	80.3	26	23.6	27.5
Earnings TTM	398.1	4422	3857	10.9
Marketcap (M)	R 1911.94 ($ 117.30)	¥ 32448.00 ($ 306.11)	¥ 41772.00 ($ 394.08)	€ 92.95 ($ 103.17)
ROE	8.3	6.3	8.3	8.3
PE	4.8	7.3	10.8	8.5
PTBV	0.43	0.46	0.96	0.79
Div Yield	10.46	3.85	2.2	3.85
Price / NCAV	-	0.73	1.36	-

I am posting this table to share and also to remind myself that we shouldn't pay attention to the markets because the fundamentals reflect the value of shares, not the market whims.

While we always suspect the market is due to get a shock that will cause a drop, where the shock comes from is near impossible to guess with any certainty. I never thought that when the 10 year run ends, the shock would come not from geopolitical or world economic events, but from a germ!

In 2009 when the world was suffering a financial meltdown, I read up on the great depression, and tried to draw parallels. I found there weren't that many similarities.

	Fatalities	% of World
1918 Flu	50 M	3
1958 Asian Flu	2 M	0.06
1962 Hong Kong Flu	50 M	0.03
2020 Coronavirus	10,000 so far	0.0001

Now in 2020, the world seemingly is going through a cataclysmic pandemic, I think it pays to read up on similar pandemics of recent history. The table here shows the most deadly flu outbreaks during the last 150 years when we've had sophisticated financial markets. In that time, I can safely say that these worldwide health crises have not had a negative impact on world economic growth. World War I and the 1918-1919 influenza pandemic did not prevent the roaring twenties. The two pandemics in the 50's and 60's did not affect Warren Buffett's generation in the least bit.

Sure, the world economic output could be reduced significantly because of the Coronavirus, but probably only for two quarters. China, the vanguard in this crises, is already starting to stabilize its new infection rates. I wouldn't be surprised if things go back to 3-6 months there. And my feeling is the lessons learned when this crises is over will spur new economic activity in the health care and infrastructure sector to prepare for the next one. Also, lost production can be recovered when the world consumer market returns back to normal.

But many in the world will not try to rationalize the situation and instead make a sport of hoarding toilet paper and other necessities. It is in our human nature to do something active when danger is lurking and is out of our control. And really there is no harm in doing so. However, the same mentality cannot apply to retail investing, because the market will be rational in the end.

Today, the S&P 500 is down 25% from the peak because of a germ. I think this is definitely the time to be contrarian like Baron Rothschild, who famously said: "Buy when there's blood in the streets, even if the blood is your own.".

Portfolio Update

This blog is so devoid of recent entries that I felt compelled recently to post something, anything. Fortunately I have a lot of odds and ends I can update on my portfolio and the market in general.

After riding high under Trump for a year, I am convinced the US market cannot go any higher. The Shiller PE ratio is at a mind boggling 32.3! That is higher than anytime before the great depression and is only surpassed by the dot-com bubble in 2000. On the other hand, I have holdings that are still reasonably valued overseas and even some in the US. Plus I hate paying capital gains taxes. So, instead of selling a lot I settled on hedging the US market. After all, this is a perfect time to short the US market if I am convinced it cannot go any higher.

I hedged the US market by shorting the S&P500 mini futures. Each of these futures is a contract to buy or sell a contract that will pay out $50 times the S&P 500 index on the delivery date. So suppose on the contract expiry the S&P500 is 2700. Then the contract would conceptually pay out $135,000. In reality the contract settles financially everyday, so the original purchase amount and the settlement payout do not happen but instead the delta in the value of the contract is debited or credited at the close of each trading day. So far I am turning a profit shorting the mini futures. However, I really prefer that were not the case, as each gain means an overall downward bias in my portfolio. But it only confirms my belief that the market cannot go any higher.

 A Prussian general once said that "No battle plan survives first contact with the enemy". I feel that way looking back at my first merger arbitrage situation , between Anthem and Cigna. As it turned out, all the forecasts about its chances of success were too optimistic. The merger fell apart after various state governments voiced objections and sued to block it. Despite this, I fell into the golden period for managed care organizations and both companies rose handsomely. I have since sold my Cigna shares. So the moral of this story is that with careful thought and due diligence, even if I am wrong in my predictions, I can still come out ahead. The S&P 500 hedge is another play from this same playbook.

In addition to the hedge I have also reduced my exposure to US companies whenever he opportunity arose. This was the case with IEHC and Senvest.

While the S&P 500 and my US holdings have done wonderfully since Trump's presidency. My international holdings are a mixed bag There have been laggards such as Lewis Group of South Africa. And there are some wonderful stocks, such as Installux, European Reliance, Tachibana Eletech and Riken Keiki. I have listed the basic metrics of some of my international holdings below.

	Tachibana	Riken	EUPIC	Installux	Lewis	CMH
Price	¥ 2028.00	¥ 2504.00	€ 3.47	€ 415.00	R 31.20	R 27.50
Marketcap ($Mil)	¥ 51105.60 ($ 461.66)	¥ 58092.80 ($ 524.78)	€ 95.43 ($ 110.79)	€ 125.83 ($ 146.09)	R 2602.08 ($ 190)	R 2057.00 ($ 150.2 )
ROE %	6.4	11.2	13.8	9.7	4.8	35.6
PE	13.1	14.1	6	14.5	9.9	8.3
PTBV	0.84	1.67	0.94	1.39	0.49	2.97
Div Yield %	1.97	1.2	3.46	1.93	6.41	5.85

Note that all these companies, with the exception of CMH of South Africa, all have very little debt. The companies whose stock appreciated significantly did so with a combination of increased profits and multiple expansion. I am still waiting for that to happen in my South African stocks. I have not wavered in my belief that the long term future of world economy is in the emerging markets. But in the meantime while I wait, they are yielding 6%.

Why I Bought Lewis Group Ltd.

In the last year or two the US economy has been looking stronger and stronger. It is quite clear by now that it is in the mature stages of a recovery from the recession that began in 2008. Unemployment is going down as smoothly as a plane coming in to land. The fiscal deficit is down from the abnormal levels at the height of the recession. Housing inventory is no longer full of bank-owned foreclosures. US manufacturing and consumer confidence are all up. The US dollar is at the highest level in four years. The market appears to be fully aware of this and the US market valuation reflects this economic situation. So though the economy still has room to run, US companies are probably fully valued. Indeed, I am finding it harder and harder to find those knock-out bargains of two or three years ago. That is why I have been buying outside the US recently. This all a drastic change from 5 years ago, when news pundits were saying that the US premier position in the world will be eclipsed by China and Europe. Well there is a saying I keep: You're never as good as everyone tells you when you win, and you're never as bad as they say when you lose.

I find it also interesting that the market has taken the opposite view of the emerging markets six years ago and today. In the last year or two, money has consistently flowed out of emerging countries. The headlines are full of bad news everywhere you look. Russia doesn't respect shareholder's and will steal or confiscate at will. China has a colossal property bubble. Hong Kong is too close to China to be immune. In fact that goes for every other country in Asia. Japan is growing old and will forever be in recession. The commodity slump and mismanagement have meant that Brazil, Indonesia and South Africa all have high inflation and capital flight This juxtaposition of emerging markets and the US may be partially based on fact but I think it is also very much a matter of psychology. Someone always has to be a darling and someone always has to be the dog.

So, it is with this idea in mind that I decided to dive into my third South African stock: Lewis Group Ltd (JSE:LEW). Lewis Group is a large furniture retailer in South Africa and nearby countries. The company is extremely profitable and very shareholder friendly. I know of no other company that regularly pays a 8% dividend. The down side is that the company is very susceptible to the South African consumer. The company serves lower and middle class South Africans, and 70% of them buy from the company on credit. The company makes relatively low margins on the sale and makes most of its money from financing, interest and insurance on the debt. This model has worked well for Lewis as well as its competitors. But recently, over expansion has hurt furniture retailers. One big competitor with a thousand stores, Ellerine, filed for bankruptcy last year. Its one thousand stores have been sold to various competitors. Lewis Group bought 63 stores under the Beares name.

	JSE:LEW
Price	ZAR 57.800
Market Cap	ZAR 5178.01 M (USD $ 424 M)
P/E TTM	6.2 x
Div yield	8.9 %
P/BV	0.89
Debt / Equity	0.27
ROE	14.4 %

Now critics of companies like the Lewis Group may point out that such companies take advantage of those less well-off. I can't say I disagree with such critics. And now government is on to the company. In early July, the South Africa National Consumer Tribunal, fined the company ZAR10M for misrepresenting the insurance they sold. This apparently was the catalyst for the stock to drop by 40%! The fine was only 1% of last year's earnings but it reminds us there is regulatory risk. And that's all. It shouldn't be significant. But in reality it has had a big impact on the stock price, which gives me a buying opportunity.

Today at ZAR 58 it is back where it was a year ago before Ellerine's bankruptcy. Since then I feel things are much more clear for the industry and Lewis group. The company has had record earnings, although the economic situation in South Africa is considered negative because of the global slowdown in commodities.

Lewis Group Stock TTM in ZAc

Lewis Group has over 700 stores in three segments. The largest with 80% of sales is the Lewis chain of furniture stores. The Best Home and Electric chain sells electronics. And the just-purchased Beares chain sells furniture to slightly wealthier demographic.

The company's balance sheet looks strong. The largest asset item on the balance sheet is accounts receivable, which stands at ZAr 5400M. That is almost equal to the company's equity. Needless to say, customer debt management is a crucial aspect of the business. Almost 70% of the debtor customers pay their obligations in full. The company bad debt / impairment costs are about 13% of total debt. I am not an expert on consumer finance, but 13% seems like a very adequate number for a developing country like South Africa.

Below is part of the credit summary from Global Credit Rating Co., a local credit rating agency.

Lewis´ liquidity has strengthened over the past year. This has been a result of the initiation of its listed debt programme, which has increased its financial flexibility and enabled it to increase unused bank funding lines. Note is also taken of the sizable cash balances reported at FYE14, as well as the fact that the group´s asset base is entirely unencumbered; further boosting financial flexibility. In addition, the ability to tighten underwriting criteria and reduce credit origination is a tool available to management to improve cash flows if needed. Thus, despite continued working capital pressure associated with growth, Lewis has reported positive operating cash flows over the review period. With limited capex (as stores are typically leased and not owned), this has enabled moderate gearing levels and sound debt serviceability to be sustained. Further to this, net gearing and net debt to EBITDA were slightly lower at 24% and 105% respectively at FYE14 (FYE13: 30% and 111%), while net interest cover remained sound at 10.5x (F13: 12.8x).

I think Lewis Group is the financially healthiest furniture retailer in South Africa. Any shakeout would make the company stronger. Any bad macro economic scenario is covered by the company's cheap valuation.