Market Timing with ECRI

I like these guys. Their announcements are clear and straightforward. And if they don't know something, they say it.

They do not make predictions, they just observe changes in their indicators. Their Weekly Leading Index (WLI) tracks short term changes in the economy. It has an average lead of 10 months at business cycle peaks and three months at business cycle troughs. The stock market is one component. Their Long Leading Index (LLI) is proprietary and leads about a year. It does not include the stock market.

We don't interpret the results ourselves, but wait for ECRI to make news releases. There is a lag, firstly because they are predicting the economy, rather than the stock market, and secondly because they alert their customers first. Too bad it seems they are not interested in individual subscriptions.

Lets see how useful their results have been:


They firmly called the recovery at point 1, in early April 09:

• 03 Apr 09: WLI Edges Up: "With WLI growth rising to a 23-week high, an upturn in the U.S. growth rate cycle is now in clear sight". [Note: Good call. Would have doubled my profit.]
  

From late 2009 to late 2010 (at 2), there was talk of a "double dip recession". ECRI generally discounted this. [I started following their releases here]:

• 31 Oct 09: No Double Dip: Growth is "broad based". "On the issue of double-dip recession, we do not see a real downturn in the next few quarters".
• 27 Nov 09: Sharp Recession Sharp Recovery? WLI is "consistent with a steady economic recovery."
• US Yearly growth gauge down, double dip unlikely (6th Feb 10): trends pointing to a double-dip recession are "nowhere in sight."
• 28 May 10: WLI Growth Tumbles: "The downturn in WLI growth evident since early 2010 has recently intensified, so it should be no surprise when U.S. economic growth slows noticeably in the months ahead," [Note: we must distinguish between a slowdown in growth and a slowdown]
• 19 Jul 10: Slowdown Call came long ago: "For now, ....the data indicates slowdown, not recession"
• 01 Sep 10: Recession or Soft Landing? Currently in a slowdown. Historically, slowdowns result in a recession more than 50% of the time. Inconclusive, will make a call by end Nov.
• 18 Oct 10: No Double Dip recession but Jobs Growth to slow: "We categorically rule out a double dip recession." GDP/production/jobs numbers will go weaker, but not negative...may feel like a recession.
• 06 Mar 11: Big Picture Outlook: Cyclical expansion is speeding up. Growth will continue at least till Sept.

In Mar 11 (at point 3), they signal a slowdown in growth rate (not a recession):

• 06 Mar 11: Global Industrial Growth Downturn and Growth to Peak for Global Industrial Sector: "We see, unambiguously, a downturn in the growth rate of industrial activity (incl. commodity prices) by this Jun/Jul. Not a recession, its a change in the rate of growth (2nd derivative). Expect strong market reaction. Global. [Note: Would SELL here if I was following them]
• 09-17 Jun 11: Soft Patch not a blip, A prolonged slowdown, Throttle back in economic growth Ahead?, Mirror Image of last Fall?: Growth will slowdown at least till end of year. US slowdown will spread to broader US economy. No recession till end of year, not sure after that.
• 19 May 11: ECRI Sees slowdown but no new recession
• 29 Jul 09: Slowdown Undeniable and Shocks during slowdown are risky: Not in recession yet. But combination of slowdown and any external shock is risky. Cannot rule out recession next year.

So far, their calls have been spot on. Lets see how the latest one turns out.

Always Coca-Cola (KO)

The world's biggest seller of sugar water, and a cashcow. Their competitive advantage is their distribution network. This is a short post - nothing to say that hasn't been said elsewhere - the only question is what price I would buy it.

The company estimates they account for 1.7bn out of 55bn (about 3%) drinks drunk daily (this must also include water). They now sell a large number of drinks, not just Coke. In Singapore, for example, we see Minute Maid Pulpy, Heaven & Earth Tea, Vitamin Water.

Quick summary of business
Coca Cola is actually 2 businesses: concentrate production, and bottling. (From Morningstar): The pressure on bottlers' margins and the demands by the syrup makers for distribution and production flexibility have been sources of conflict between the parent companies and their bottlers for many years. (In 2010) Coke has followed the lead of its great rival PepsiCo PEP by acquiring the North American operations of Coca-Cola Enterprises CCE, in a strategy intended to eliminate these conflicts and make the firm more responsive to changing consumer tastes.

Geographical breakdown
Looking at profit, note that:

• Only the North American sales include bottling.
• Any bottling done in other regions is in the 'bottling investment' category.
  

I'd estimate that half their profit comes from emerging markets (Pacific, Latin America, Africa & Eurasia, and perhaps a bit of Europe).

Cyclical and Growth
Trying to get some idea of their growth rate. Looking at growth over the 2008/09 recession. "Unit case volume" growth measures the amount of liquid sold:


They seem to be getting:

• zero growth in developed countries (~45% of their 2010 profits).
• high-single or low-double digit growth in developing countries (~55% of their 2010 profits).

Looking at these: 4-5% long term annual growth seems realistic (all driven by emerging markets).

Valuation
Discounting the 5bn extraordinary profit from buying over CCE's operations, their 2010 EPS is $2.87.

Morningstar (seems to) estimate their earnings at $4.20 per share (?), up significantly from 2010. They project lower growth of 4% in emerging markets, with growth following inflation rate in developed markets. They recommend buying at 13 PE (~ U$ 55)

Economic Moats

From "The Little Book that builds Wealth" by Pat Dorsey of Morningstar.

He gives a list of common economic moats. This is simpler and more stringent than using Porter's 5 forces. His approach is to go beyond the numbers and find the reasons for high margins.


Brands. Not as important as we think:

• May offer a sustainable competitive advantage if the brand makes people pay more for the same product (e.g.: Tiffanys vs Blue Nile).
• Most brands are for differentiated products, (e.g.: Coke, Mercedes-Benz), these two examples do not cost more than their competitors. A brand's popularity is no indication of an economic moat.
  
• Brands can be lost e.g.: Kraft used to dominate shredded cheese market, but was replaced by supermarket generic brands.
• Can't think of any in Singapore.
  

Patents

• Patents. "Beware of firms which rely on a small number of patents. The only time patents constitute a truly sustainable competitive advantage is when a firm has a demonstrated track record of innovation that you're confident can continue." e.g.: 3M
• Again, none in Singapore.

Regulation

• Prefer industries with strong regulatory barriers to entry, but where the government does not want to control prices. In SG, perhaps Vicom?
  

Switching Costs

• When it costs the customer a lot (in money, time, inconvenience or risk) to switch products. eg: changing bank accounts. Good example is providers of large scale IT projects to government/defense/banks. Maintainence can only be obtained same provider for the projects lifetime, usually 10 years. e.g.: Silverlake Axis
  

Network Effect

• People need to use the product because others use it. e.g.: Facebook, MS-Word, E-bay, Visa. Google does not have this, for example.
  
• Or the company has a strong branch network e.g.: Western Union (money transfer).
  
• In Singapore, Goodpack perhaps. SGX may be a negative example (compared to HK).
  

Cost Advantages

• Better processes. e.g.: Dell, AirAsia. This is a temporary moat, until the competitors are able to copy (usually takes a long time). Not sustainable.
• Location. Mostly for heave and cheap commodity products e.g.: cement, landfill
  
• Ownership of resources. e.g.: own cheapest mineral deposits.

Scale

• Large distribution networks. Extremely hard to replicate. e.g.: McDonald's, Coke, Fedex. On SGX, Petra?
• Economies-0f-scale (large fixed costs). Can't think of any in SG. Mabye Keppel?
• Dominating a niche market. e.g.: Some HDD component suppliers in Singapore.
  

Eroding Moats

• Avoid tech, products/markets change too fast (e.g.: Dell, Nokia). Also avoid anything affected by technology changes e.g.: newspapers, communications (post/phones), book-retailers, cameras). Hmm....these days, the internet changes everything...doesn't leave us with much to look at.
• Change in market landscape....the strength of customers/suppliers. eg: Walmart erodes the brand advantage of many consumer goods.
• Entry of Irrational competitor e.g.: a competitor facing bankruptcy or supported by govt.
• Falling margins is a sign of an eroding moat, may be hard to determine the cause.
  

A final note. Identifying economic moats, and determining if they are sustainable or being eroded, requires a lot of research on the industry. Probably years. Probably beyond a part-time retail investor.

Eu Yan Sang

Regional TCM company. Main business is M'sia, S'pore and HK, attempting to expand into in China:

What they do (breakdown by 2010 revenue):

• 81%: Retailing. Their main business. Their chain of 171 retail outlets sells their branded TCM and health products throughout HK, S'pore & Msia..
• 11%: Wholesale. Mostly in HK/China. In HK, sold to large chain stores like Mannings/Watsons. In China, sold to pharmacies/hospitals.
• Abt 8%: Clinics and others.

Their main products seem to be of two types:

• Proprietary medicines, taken from a complex traditional formula, put in powder/capsule form, and scientifically tested for results. eg: Bak Foong pill (menstrual symptoms), Bo Ying compound (f0r babies)
  
• Generic products, branded with a label (e.g.: birds nest, essence of chicken)
  

Business model:
Cashflow generated from operations is used to expand their retail network, introduce new products, and start other new businesses. They have been very successful with the first two - in 7 years from 2002 to 2008 (both troughs in recessions), revenue and PBT (excluding exceptionals) have more than doubled.

EYS has been profitable every year since listing in 2001:


Their core retail TCM business has been growing steadily and profitably, but overall profits have been more sporadic. Excluding the exceptional charges smooths out their core profits:

The exceptional charges are usually impairments to non-core businesses, write-offs and exceptional gains from sale of businesses. EYS' previous attempts to diversify into other areas have mostly failed:

Year	Exceptional Charges
01	none
02	-0.7 (impairment of goodwill: Oxford natural products) -1.4 (provision for diminution in value of investment?)
03	-2.9m (Write off for Oxford Natural Products) -0.7m (Provision for impairment Botanical Health Resources)
04	-1.4 (Impairment of goodwill - Australia (Your Health, Aroma Fresh))
05	-1.5 (Impairment of Goodwill - unknown...possibly Botanical Health?)
06	+3.2m (special gain: divestment of Synco)
07	+1.3 (special gain: sale of property) +1.4 (special gain: sale of Elixir)
08	-2.4m (write off RedWhitePure) -0.5 (YourHealth) -3.9 (impairment of investment in unquoted shares)
09	none
10	none

Only 6 of the past ten years have generated FCF, due to high CFI:

Most of the CFI (orange bar above) was spent on new retail outlets (furnishings and fixtures):

• 02: 7.4m (+9 outlets)
• 03: 7.8m (+13 outlets)
• 04: 5.4m (+9 outlets)
• 07: 4m (+13 outlets). 9.5m construction-in-progress
• 08: 7.5m (+19 outlets)
  

Competitive advantage:
They may have some sustainable competitive advantage due to 'upmarket' branding. Cannot quantify. No market share figures are available. The TCM market is large with no clear segment boundaries (e.g.: many small TCM businesses selling herbs). And no clear competitor in the same up-market segment (in S'pore at least).
I don't know if their proprietary products are truly unique, a quick search shows other brands have have similar products (1) (2).

Since the TCM market is so fragmented, I guess they have little or no pricing power. From a 2004 DBSV report:
The TCM market in Hong Kong and China is highly fragmented with many small retail operators and CPM manufacturers. The supply and retail of raw and processed herbs are carried out by 800 medicinal halls and retail outlets in Hong Kong and significantly more in China. There are, however, only 4 major retail chains in Hong Kong and China, namely Eu Yan Sang, Tung Fong
Hung, Nam Pei Hong and Beijing Tongrentang.


Inventories
Critical for retailers. Generally, EYS seems to stock slightly less than 1 quarter's sales as inventory:

Over the long term, have become more efficient, as sales have risen compared to inventory.

Balance sheet
From their latest Dec 2010 results, they have 5.6m long term loans. Less than one year's earnings.

From their Jun 09 Annual Report: they have 22m operating lease commitments within one year.

Cyclical
Does their business suffer during a recession?

In the 2002 recession and 2003 slowdown (SARS), same store sales suffered:

For 2003, the chairman noted that "SARS had a huge impact on retailing...tourist travel was sharply reduced...consumers stayed away from shopping centers".

However, in the 2008 recession, I can see no effect:
Can't draw a conclusion, other than sales seem affected by long recessions.

Valuations
Typically how low does EYS' valuation go in a bear market? EYS reached a trailing PE of around 6 to 7 in 2002 (long recession), and 9 to 10 in 2008 (short recession).

What a red flag looks like....

China Hongxing. With hindsight:

• Steady increase in receivables over the years. The YoY doubling in 3Q09 would be the tip-off here.
  
• Change of auditors in Oct 10. Lesson here is to go through the past 5 years SGX filings before buying.
  

Also, institutional ownership was no help (BT, Mon 28th):

• China Hongxing has a strong institutional following that includes Skagen Funds, Fidelity, JP Morgan Asset Mgt and State Street.
• Singapore based private equity Tembusu partners has invested in Hongwei.
  

Added more money

While waiting for the next recession....which there is no sign of yet....

Added 50K to portfolio. Savings from overseas assignment. Now have 250K. Moved it to an account paying 0.2% interest. Inflation is the big risk here.

Line-of-Credit approved for AUD 90K against overseas property. Must keep in mind:

• Can only reasonably withdraw AUD 50K for the rent to cover the loan amount
• Large forex risk. AUD very volatile, In 08, dropped 30% in a week against SGD, recovered in several months.
• At some time it may worthwhile to sell the property instead. Probably if it hits 30x gross rent. Bank's valuation at 250K last year was 24x gross rent. Also, get my Singapore PR renewed first.
  

Still doing nothing. Busy looking for new job.

Dairy Farm

Asian retailer. Owns and runs supermarkets, hypermarkets, health and beauty, and convenience stores.

Slow but steady grower. Over the last five years, sales are up 48% and profits up 70%.

Business Model
-------------------
Use cashflow generated from existing operations to set up new retail stores. If it succeeds, keep growing. If it fails, sell off and try again.

Most stores are owned and operated. Stores usually rented through operating lease. Convenience stores may be franchised.

Expanded steadily over the years:



Not sure how many convenience stores are franchised and how many owned.

Balance Sheet:
------------------

Their expansion has usually been through internally generated cashflow. Very conservatively financed: total borrowings almost always less than one years operating cashflow:
The debt above does not account for cash held - most years they were net cash.

Keep in mind their high fixed costs, esp. operating leases, below.

Competitive Advantage:
-----------------------------
For supermarkets/hypermarkets, they have a significant presence in HK, Malsysia, S'pore and Indonesia, but would not have pricing power (like Walmart in the US or Coles/Woolworths in Australia).

HK

• Largest supermarket operator with 276 stores. Closely matched by ParknShop (Hutchinson Wampoa) with approx 280 stores.
• Many other players: Yu Kee Food with 70 stores, DCH food mart with 60 stores, Jusco (AEON) with 10 stores.

M'sia

M'sia market more fragmented. DFI may be the largest, but have many competitors:

• DFI has 69 supermarkets, 58 hypermarkets.
• Carrefour: 22 hypermarkets, 5 supermarkets
• Jusco (AEON): 25 stores (09 AR)
  
• TheStore: 58 supermarkets, 5 hypermarkets
• Tesco: 34 stores, probably hypermarkets

S'pore
DFI is first or second largest (95 supermarkets, 7 hypermarkets) vying with NTUC (100 supermarkets) with a few competitors:

• Sheng Siong: 23 supermarkets and hypermarkets
• Carrefour: 2 hypermarkets

Taiwain:
Seem to be a smaller player, running smaller stores open 24hr. No hypermarkets.

• DFI has 299 supermarkets
• Carrefour: 64 hypermarkets
• Article: http://thelostswede.com/?p=33

Indonesia:
2nd largest, far behind Carrefour. This 07 report gives the 5 largest chains:

• Matahari: 53 foodmart, 11 hypermarts (for sale, Wallmart?)
  
• Carrefour: 66 hypermarkets, 14 supermarkets
• PT Hero, now owned by DFI: 113 supermarkets, 35 hypermarkets
• Alfa, now owned by carrefour: who may be forced to divest
• Superindi (Delhiaze): 66 stores

Cyclical
-----------
How much of their gross margin (in 09: 2117m) is taken up by fixed costs?

• Employee costs: 627m (~ 29%)
• Operating lease: 515m (~ 25%)
• Depreciation and amortization: 147m (~ 7%)
• 423m PBT (~ 20%)
  
• The other 400m (~ 20%) don't know

First 3 items are fixed costs (~ 60% of gross margin). Any slowdown in sales could have a large impact and swing their profits into losses.

How did they fare in the 08 recession? (The recession started with 2Q08 being the first quarter of negative growth in SG and HK):

Topline: No slowdown in sales, and gross margins did not fall:

Bottom line. This time break up by segment:

Can see:

• Increasing operating profits throughout the recession.
• C-Stores profits dropped even after the recession. Mgt said this was due to China restrictions on selling tobacco.
  

But, sales and profits were helped by the opening of new stores. Trying to estimate on a per store basis for their different segments:

• Supermarkets/hypermarkets are combined, I'm taking one hypermarket to equal 4 supermarkets.
• Did not exclude stores opened less then a year - not available. Could skew the results lower for stores opened halfway through the year.

We get:
Due to seasonality, show the YoY % change (e.g.: compare 2H08 with 2H07):


We can see:

• SSS for H n B is unaffected by recession. However profit was.
  
• C-stores most affected: biggest plunge in SSS and profit on 2H08.
  
• Supermarket/Hypermarket are still affected, but by less. Seems not all goods they sell are non-discretionary.
  

Comparing with the Operating Profit chart, we can see that even though sales/profits dropped on a per store basis during the recession, they were opened enough new stores to increase the overall numbers.