Biased Return On Equity (ROE)

In our previous blog, we have discussed the power of ROE which is a good measurement of efficiency of management in utilization of shareholders' equity. By comparing the ROE of different companies, we can observe which company is managed with better effeciency. However, sometimes ROE can be biased such that the actual situation may not be truly reflected. We have to look into the details to see whether the figure is reasonable.

One example is China Construction Bank (939). In its latest interim report 2007, it states that its annualised ROE have increased from 15.67% to 20.88% which is a significantly improvement. From this figure, it may be good to see that the management has hugely improved its efficiency. However, when you look into details of the ROE (ROE=Return/Shareholders' Equity x 100%), you will find that the great improvement is partially because the Shareholder's Equity has decreased. Shareholder's Equity has decreased by 1.35% from RMB330204Mill at 31th Dec 2006 to RMB325,738Mill at 30th Jun 2007. Obviously, this will not be a good news to the shareholders. An increase in shareholder's equity will be more favorable to shareholders.

From the above, you can see that simply comparing figures is not enough in drawing conclusions about a company. Devils may lie within the details.

Finding Prospectuses for Hong Kong Stocks

One of our blog reader asks about where to find the prospectus of Hong Kong stocks. Here is the way. Normally the prospectus is available online through the websites of stock exchange. For Hong Kong stocks, you may go to the website of Hong Kong Stock Exchange ie http://www.hkex.com.hk/ and follow the following instructions :

For Already Listed Stocks :

Click on the "Investor" section at the left and then click on the link "Current Securities" under Listed Company Information Search. Type the stock code (eg ND Paper is 2689), select a time period that covers its ipo and also select "Prospectuses" at the pull down menu of "Document Type". Finally click the "Search" button. You will find your needed prospectus.

For IPO Stocks :

Click on the "Listing Matters and Listed Companies" section at the left and then click on the link "Main Board - Prospectus" for the latest ipo prospectuses.

Blackstone - Will it Be A Wise Investment?

Private Equity (PE) has been the hottest topic in global financial industry recently. At its center is the IPO of Blackstone Group (NYSE symbol : BX) at the end of June, 2007. It is rather strange that both Forbes and New York Times have issued analysis with negative comments on this PE group after its IPO. Is Blackstone really a poor investment option for investors??? Personally, I don't think so!

The first point which draws my attention to Blackstone is that it has attracted the not yet established China State Investment Company to launch its first ever investment by purchasing its shares with an amount of US$3 billion. With an over-subscription of its IPO shares, it seems that everyone is expecting a great share price performance of the group when listed. However, after its IPO, its share price is really disappointing which are majorly due to the negative comments from the media just after its IPO. But why is the media post such comments just after the IPO which to all will know it will hurt the share price of Blackstone? I may think of some possiblities :

1. The investment of China State Investment may has positive impacts on Blackstone but also have negatives from the political side. Right now the major investment of Chinese foreign reserve is US Government Bond. If it diversifies its investments, who and what will be harmed most? Its successful intial investment may lead to a more diversified profile in this foreign reserve investment. This may also be one of the major reasons why the tax issues have been raised during its IPO which surely have negative impacts on its stock price performance.

2. If Blackstone is a good investment, it will be a good target for institutional investors as well as other central banks. They are more willing to buy its shares at a cheaper price. It is rather strange that media issue such negatives just after the IPO and why not before its IPO as their disclosed information has already been available when Blackstone published its prospectus. Don't they know that such publications will have negative impact on its share prices?

3. Nowadays major investment banks are all getting a close eye on the asset management work from Chinese government. These banks may not want a good performance of Blackstone share price which means a successful investment of China State Investment Company and putting a closer relationship between Blackstone and the Chinese. Such relationship will have an influence in their chances of getting asset management works from China State Investment Company.

All the above are just some thoughts from myself as alternative explanations for the poor performance of Blackstone share price. They may be right and also may be wrong.

However, I still believe Blackstone (BX) is a good investment opportunity for investors. My reasons are as follows :

1. The major incomes of PE company are from asset management and buy-outs. Blackstone will be benefited from its strategic partner, Chinese State Investment Company in both ways :

a) A stake of shares from Chinese Government have paved the way for Blackstone to get asset management works for the Chinese State Investment Company. To a PE company, more assets under management means more profit in the coming future. Chinese government is more willing to make Blackstone more profitable due to the issue of "face". This is also why the Hong Kong Stock market flying high during its 10th anniversary of establishment of HKSAR. The recent decline of Blackstone's share price has led to fierce discussions on the investment strategy of China State Investment Company. Therefore, decision makers of the State Investment company need to find ways to drive up the share price in order to reduce internal pressure. This in turn puts pressure on the Blackstone side. Blackstone will also work harder to raise up its share prices as they also don't want to harm the relationships with the Chinese.

b) Greater chance to do business in China which is one of the fastest growing economy in the world. One of the examples is the closing in of Blackstone on its first direct investment in China, a $400 million stake in state-owned chemical company China National BlueStar Group. There will be less obstacles to get into the major business in China and the take over of state owned enterprise.

2. The tax increase issue may only turn into effect on 2012 which is 5 years away. However, this may not be an issue that really matters as nowadays, it doesn't matter much on locations for financial business. There are a lot of locations with enough supports to become headquarter for a PE company and these cities also welcome huge PE group like Blackstone to come. Additional tax burden may force PE to move out of New York which will in turn hurt the finanicial industry of USA. Many financial institutes have already commented that the strict, rigid and complicated regulations in USA is the major reason for its loss of market share to London. Therefore, politicians may need to think twice before they bring critics into actions.

3. Financial service industry relies hugely on great talents. From the great track record of Blackstone, it shows that the company has been great in getting talents to achieve great results and its business model has been proved to be a great and successful one.

From the above, I truly believe that Blackstone is a good company to invest.

PS. I have turned my thoughts into actions and have bought stocks of Blackstone Group.

Lastest Analysis of KB Laminates (1888) Annual Result

Kingboard Laminates Holdings Ltd (1888) has announced its annual result for 2006 on 28th March, 2007. Let's have a close review of this company to see whether the company has any improvements over the past year. Figures obtained from its result announcements were summarized as below with a comparison with the figures from 2005 :

Summary of key figures in 2006 vs key figures in 2005 :

Revenue : HK$8.47 billion (2006) vs HK$ 6.13 billion (2005) +38%
Profit : HK$1.74 billion (2006) vs HK$1.14 billion (2005) +52.6%
ROE : 30.85%(2006) vs 22.62% (2005) +8.23% (simple subtraction)
Gross Profit : 28.45% (2006) vs 28.22% (2005) Similar
Debt to Equity Ratio : 81.74% vs 162.3% (2005) Dropped
Shareholders Equity : HK$5.64 billion (2006) vs HK$5.05 billion +11.68%
PE (2006) : 13.14
(Based on HK$7.53 closing price on 31/03/2007)

Analysis

1. The overall performance of the company is quite satisfactory as the growth of revenue and profit is 38% and 52.6% respectively. ROE also increases to 30.85% from 22.62% which means the management has made use of shareholders equity quite efficiently.

2. The management is set to increase its production capacity by around 35% in 2007 and right now the production is run at about its full capacity which quite encouraging.

3. Increase in shareholder's equity is not quite good as the increase is only around 11% from which it needs around 9 years to double the existing shareholders equity. The company should be more focused on increasing the shareholders equity.

4. Debt to equity ratio is still quite high though it has been dropped from 162.3% of 2005. Such high ratio is due to a 5-year term loan of HK$2.54 billion in December 2006 after the IPO. Without such loan, the debt to equity ratio of the company is only 36.7% which is much more healthy. The management's action of getting loans after the IPO is clearly to avoid the dilution of share interest of major shareholders for giving up too many shares during the IPO and KB Laminate after IPO is a company which can get loans from the bank more easier. However, such action has increased the debt of the company and in turn increase the risk of the company.

Future Risks
1. Price of Copper is rising quickly recently which will increase the cost pressure of KB Laminates.

2. Demand of laminates slow down a bit during the first quarter of 2007 as stated by its management in its result announcement.

3. High debt to equity ratio increases the risk of investment in the company which is led by the loan decision of the management after the IPO. It is no doubt that the Kingboard Laminate (1888) is a better performed company than Kingboard Chemical Group (148) as we have predicted before. However, if the management continued with the mindset (which is common within many major shareholders of Hong Kong listed comanies) of getting easy money from loans through a better company, the company will be harmed finally. This is also one of the reason why the share price performance of KB Laminate is worse than that of KB Chemical.

Conclusion

KB Laminate's performance in 2006 is good and I still recommend this stock as my recommendation of 2007. Many people have been very disappointed with the share performance of this company and it is time for the management to be more focused on increasing shareholders equity at a higher rate and decrease the high debt to equity ratio in order to maximize the interest of shareholders. As long as these aspects are improved, the share price will reflect the true value of the company.

REMEMBER : PATIENCE IS AN ESSENCE OF INVESTMENT

A Discussion on Strategic Investors of Hong Kong

One of the blog readers has posted the following comment which is quite interesting to discuss :

"Regarding stategic Investors. Both Cheng Yu Tung (New World) and Thomas Lau have "Interesting" histories and not always friendly to minority shareholders. Care to comment?"

My response is as follows :

Many people may have bad experiences in investing in the companies owned by these two people. The major problem is that many major shareholders of listed companies in Hong Kong have treated these companies as a way to gain money from but not sharing the profits with majority shareholders. The most profitable part is still hold in their own hands. For example, Chai Tai Fook is the most profitable company of Mr Cheng which is privately owned and New World Development (0017) is a listed company but with high level of debts. For profitable projects or investments, Mr Cheng will invest with Chai Tai Fook instead of New World. This is a typical example of common thoughts of Hong Kong rich people not just Mr Cheng. Even Mr Lee Shau Kee who is recently treated as Warren Buffet of Hong Kong is investing with his own investment flagship but not his listed company Henderson Land (0012) . Therefore, when considering the roles of strategic investors, we need to identity by what means these people are investing in the new companies. If they are not the major shareholders but simply strategic investors, it should be a good news to minority shareholders like us as we do not have to worry about any "capital tricks" and instead they can act in a positive way for us to push a good performance from the new company just like TCI 's role in the Link Reits (0823). However, in the case of Kingboard Laminates (1888), there is no confirmed information up to now that they actually have invested in this company.

In some forums, I have read that some people invested in Kingboad Laminates simply because they think that Mr Lau will drive the share price up. These thoughts are very dangerous. We have to remember profit is the final driving force of share price not strategic investors!

2007 Hong Kong Stock Recommendation - Kingboard Laminates Holdings Ltd (1888)

Kingboard Laminates Holdings Ltd (1888)

Background :
Kingboard Laminates Holdings Ltd is a subsidiary spinned off from Kingboard Chemical Group (148) which focuses in manufacture and sales of laminates and upstream component materials.

1. Is the industry has a growing demand? What is the relationship between demand and supply in the industry?
Ans : The demand for laminates is driven by the demand for PCB. The global laminates market was estimated to have a growth rate of 6~8% in the coming 2 years. The growth rate of China laminates market is around 20~30% in the past 3 years. This means the industry is still in a growing state. With the launch of Microsoft Vista and 3G in China, the demand for PCB is expected to increase in the coming years which in turn will increase the demand for laminates. Kingboard was rated no 1 in 2005 with 9.9% market share in global market and 31.7% in China market. With the large scale of economy, the company can achieve the cost competitive advantage stated by Michael Porter and gain greater market share in the future. In its growth to a larger capacity, it also creates greater barrier for new competitors to enter this industry.

2. Is the company profitable over a period of time and what are their average revenue and profit growth rates?
Ans : The company is profitable for the year 2003~2005 with a profit growth of 158%, 5.8% respectively. The half year result of 2006 has a growth of 58.4% over 2005. The revenue growth for the year 2003~2005 is 56.8% and 31.6% repectively. The company has experienced hard time in 2005 but the growth will continue in the coming future which is reflected in the half year result of it. The gross profit margins from 2003~2005 are maintained in a healthy state with figures of 23.9%, 33.1%, 28.3% respectively. The half year 2006 GP margin is 29.6%.

3. What is the company raising money for? Paying debts? Future development? etc
ANS: 60% of fund raised used for further development of factory production capacity in China. 30% of fund used for paying loans. 10% for working capital.

4. What are the major risk factors when investing in this company?
ANS:
a) The capacity of the company has reached nearly full operation. Its future growth relies on the increase of its capacity.
b) Rise in cost of raw material will damage its profit margin.
c) The tax examptions from Chinese government for some of its subsidiaries will expire in the coming years.
d) Management issues happen to Ocean Grands Chemicals Holdings Ltd may also happen to this company.

5. Are there any odd numbers in their financial statements?
ANS: Not yet find any odd numbers. But the debt rate is high in the past which can be improved after its IPO.

6. Is the IPO price reasonable when compared to its expected profits and dividends? Is it valuable when compared to those companies already get listed?
Ans : The IPO PE is a bit high when compared with other industrial company but it is quite difficult to compare with other companies in the same industry as many of the large competitors in the industry are subsidiaries of large electronics companies for which the results of individual subsidiary is not presented separately. For the dividend, Kingboard is expected to pay not less than 30% of its profits as dividend each year. With the forcast provided by the company for 2006 will not be less than 1623.8 million, the dividend yield will be around 1.95% at minimum. Not very attractive from dividend yield.

7. Find out some key ratios for study such as ROE, ROA, PE, PB, Debt to Equity ratio etc.

Ans:
ROE : 22.62% (2005)
ROA : 8.62% (2005)
PE : 15.4 (estimated 2006 PE based on HK$8.32 closing price on 29/12/2006)
(Assumption : Full 2006 profit : HK$0.54)
Debt to Equity Ratio : 162.3% (2005)
Gross Profit Margin : 29.6% (half year 2006)

As stated before, the debt ratio is quite high before IPO.

8. Any strategic investors? Which investment bank is the underwriter?
Ans : Two rich people in Hong Kong Mr. Cheng Yu Tung and Mr Lau Luen Hung have expressed intersts in buying the IPOs but no further information are disclosed that they have holdings in the company. Goldman Sachs is the underwriter and coordinator which has a good track record in the past.

9. Other Considered Factory

a) The company management have a good track record in managing the parent company of Kingboard Laminates. The chairman has stated the management target for Kingboard laminates is to double its revenues in the coming 5 years and seek proper acquisition opportunites to expand.
b) Kingboard Laminates is the most profitable part of Kingboard Chemical Group, its parent company. Its spin off for one reason is to lower the debt of Kingboard Chemical Group which provides a good opportunity for the market to have a more profitable investment. Spin off of subsidiary is one of the good factor as stated by Peter Lynch in investment.
c) The IPO price is set at HK$7.73 which is around US$1 for which it is clear to set the target for institutional investor holdings.
d) The Kingboard Chemical Group still holds 72.5% of Kingboard Laminates and the shares in the market after over-allocation is 825 million shares representing a market value of hong kong dollar 6.864 billion (calculated based on the closing price of HK$8.32 on 29/12/2006) which is not huge when institutional investors starting to buy its shares. However, the attitude of institutional investors to invest in such small medium enterprise may be affected by the issues happened to Ocean Grand Chemical Holdings Ltd. in 2006.

Conclusion :
After weighing the pros and cons of the company, I still believe that Kingboard Laminates Holdings Ltd (1888) is a company suitable for LONG TERM BUY and HOLD. See if it can be a "tenbagger" in the long run!

Reading Prospectus (con't)

In this section, we will take a newly listed company in Hong Kong Stock Exchange this year as an example for further explanation. We will use those data taken from its prospectus for analysis. This company is :

Nine Dragons Paper (Holdings) Limited (2689) - abbrev : ND Paper

Questions :

1. Is the industry has a growing demand? What is the relationship between demand and supply in the industry?
Ans : Yes, the industry has a growing demand. In the "Industry Overview" section, the company has provided a clear picture of the demand and supply relationship in the industry. The consumption of containerboard has exceeded its domestic consumption in the past five years and this trend is forecasted to continue at least to 2009. Furthermore, the entry barrier is this industry is high as it requires huge capital investment to install new production line. At the moment of IPO, ND Paper is at the highest volume in the country. This has provided them a great advantage. Even an average company can perform well in a growthing industry.

2. Is the company profitable over a period of time and what are their average revenue and profit growth rates?
Ans : In the "Summary" section, you can find that the company has an average revenue and profit growth rates of 46.6% and 65.7%. The profitable trend have continued for the past years. Such growth is exceptionally good.

3. What is the company raising money for? Paying debts? Future development? etc
Ans : You may find the answer in both the "Summary" and "Future Plans and Use of Proceeds" sections. Not more than 55% of capital used for establishing new production lines. Not more than 35% used for paying short term loans and the remaining used as general working capital.

4. What are the major risk factors when investing in this company?
Ans : These information are located in both "Summary" and "Risk factors" sections. Most of them are general statements. However, one point should be noted that the major supply of recovered paper is controlled in the hand of its chairman for which this supplying company is not included in the IPO. This means that the profitability of the listed company is controlled in the hands of its chairman who can earn her own money by adjusting the price of supplying recovered paper. Besides those listed, you should also pay attention to the type of management of this company which gives hints in the "Directors, senior managements and employees". Most of the top management are relatives of its chairman for which a family business may induce problem in its long term development.

5. Are there any odd numbers in their financial statements?
Ans : After reading the "Financial Information" section, it does not show any very odd numbers but the debt ratio of the company is exceptionally high. This may be the reason why they need to issue IPO instead of running as a private company.

6. Is the IPO price reasonable when compared to its expected profits and dividends? Is it valuable when compared to those companies already get listed?
Ans : In the "Summary" section, the company has provided a forecast of expected profit in the past half year. The expected PE is 13.6 if the IPO is set at its highest price. This is quite reasonable when compared with Lee & Man Paper (2314) which was trading at around expected PE ratio of 14 at the time of ND Paper IPO.

7. Find out some key ratios for study such as ROE, ROA, PE, PB, Debt to Equity ratio etc.
Ans : Some of the key ratios are listed below :

ROE : 13.7% (Year 2005)
ROA : 2.7% (Year 2005)
PE : 13.6 (expected)
Gearing Ratio : 53.4%
Net Borrowings to Equity Ratio : 212.7%

From the above, it is clear that the company is not operating in a highly effective way and has a high debt ratio. But the growing industry and IPO may improve these figures in the future.

8. Any strategic investors? Which investment bank is the underwriter?
Ans : The strategic investors are listed is "The Corporate Investors" section. There are three corporate investors including Ample Glory Limited (Mr Kuok Hock Nien), Chow Tai Fuk Nominee Limited (Dr Cheng Yu Tung) and Bestfull Limited (Dr Lee Shau Kee). They are solely investors but not involve in the company's management and Dr Lee has a good track record as being a strategic investor. The coordinator and underwriter of ND paper are BNP Paribas Peregrine and Merill Lynch which also give good track record in IPOs.

From the above, the analysis of ND paper is positive in IPO and this also explains why this company has a huge gain after its IPO.

Remember : Even an average company can perform well in a growthing industry.