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  • "The market can remain irrational longer than you can remain solvent" - John Maynard Keynes

    Wednesday, July 23, 2008


    Sensible Comments on Australian Banks

    The publisher of the Intelligent Investor, an Australia based value investing newsletter was on sky news talking about Australian Banks. At last someone is saying that the banks have opaque balance sheets and even as the interviewer tried to bully him into recommending banks the publisher stuck to his position. He couldn't recommend the banks because no one know what the true state of their assets and liabilities are.

    Tuesday, July 15, 2008


    Aussie Banks Gone Wild

    I wrote about banks in late April , specifically that it was impossible to value them. This was generic but I think the Australian situation is worth discussing in more detail.

    There are lots of market prognosticators in Australia promoting the banks as a fantastic investment. They've fallen so far and have such high yields. The fact is no one knows what Australian banks are worth right now because there is no transparency about their assets and liabilities.

    The "Barefoot Investor" a common sense, popular, newspaper columnist, talks about Australian banks as being "strong companies" that you can "buy on the cheap". He goes on to say "Investors are reacting as though Australian banks are as vulnerable as their problem-prone European and US counterparts. They aren't." . The fact is he has absolutely no idea how prone they are. They don't have to report their assets and liabilities in a way that would give him or any other potential investor any idea about their financial strength.

    According to the "Report on Foreign Portfolio Holdings of U.S. Securities" there is 32.6bn of long term US agency debt sitting somewhere in Australia. There is a further 10bn of US Treasuries, 27Bn of corporate debt and 6.6bn of short term agency debt. For a start they have lost 10% (10% of 70bn is 7bn) over the last year in foreign currency movements or 33% over the last 3 years. The agency debt is not over mortgages (houses) but is only secured by Fannie and Freddie.

    "Australians are more indebted than Americans and Australian houses are higher priced and less affordable than those in the US. If anything, the Australian economy is more vulnerable to a housing/mortgage market crisis than the US.". This article briefly discusses the difference between US and Australian accounting standards. The fact is that Australian banks do not need to mark their assets to market and instead show them on their balance sheet at cost. This means that all the garbage they have purchased from the US, such as the CDO & CLO exposure that NAB had to admit to lately, is still shown at the price they bought it for rather than the much lower price that they could get it for it now.

    The banks have not come out with voluntary disclosures about their assets and liabilities precisely because they don't want you to know.

    Try this at home and see if the bank will value your home at what you paid for it when the price goes down!

    So far we've covered the fact that banks have toxic product on their balance sheet and that they don't have to value at market prices. There is another enormous set of liabilities and assets that they have completely hidden off their balance sheets. This includes derivatives with a notional value of 12.9 Trillion. Far more than the $110bn of equity capital (as of February 2008, the equity is probably much lower now and the liabilities have probably risen). As of September 2007, Westpac had nearly 100 times their equity in derivative exposure. The banks may believe that they have "slick" risk management systems but so did a long list of US and Australian institutions that are no longer with us. These systems use models based on the recent past and there is a long history of them failing at inflection points.

    Analysts and journalists are all making the same mistake. They're looking at the earnings power of the banks and not at their balance sheets. Sure the banks competitive position is improving. The problem is - are they a viable going concern?

    To value a bank and know that it's a viable going concern you need to be able to evaluate all of these factors. The banks do not release the appropriate data for you to do so. They may be a great buy at these prices or they may be technically insolvent. It's foolish to recommend them when the data just doesn't exist in the public domain to analyse them.

    Thursday, July 10, 2008


    Strathmore Minerals (STM) Comparative Valuation

    I wrote about Strathmore Minerals back in 2005 , it has done a wonderful round trip from around $1.8 up to $5.50 or so and then back again to about $1.51 today. In fairness they spun off 1/3 share of FIS which is worth about 25c.

    I mention this because Rio Tinto just sold their Kintyre deposit in Western Australia. They received $495M USD for between 62-80M pounds of Uranium Oxide (U3O8).

  • Rio never completed a JORC compliant reserve estimate
  • You aren't allowed to mine Uranium in Western Australia and both the state and Federal government are against Uranium mining.

    Rio has sold the in ground resource for $5.88 to $7.69 per lb. Of course grade matters and based on this reference the grade in Kintyre is bettwen 1.5 - 4 Kg/t U3O8 (.15% - .4%).

    Strathmore's average site has a grade of 0.7 Kg/t and only a quarter of their pounds on an equity basis exceed 1.5 Kg/t. Their best grades are at 2.1 Kg/t. Clearly none of STM's areas are as high quality as the Kintyre deposit. That has to be balanced in Strathmore's favor against the fact that mining Kintrye is currently illegal.

    STM has between 1.3 and 1.6 lb per share depending on how you weight the measured, indicated, inferred and non-NI 43-101 resources. At the price Cameco and Mitsubishi just paid, STM would be worth $7.5 - $12 per share. STM is worth less because of the awesome grades at Kintyre but this needs to be balanced against the uranium mining ban and lack of JORC compliant resource estimates.
  • Tuesday, July 08, 2008


    Asian REITS

    Marty Whitman and Warren Buffett have both recently, in their own way, promoted owning productive assets in currencies that will appreciate. Buffett has highlighted that it’s better to own productive assets than straight currency because often in currency transactions there is a negative cost of carry (which I’m experiencing right now with my short GBP JPY and short EUR JPY positions).

    Whitman has explicitly commented on his large holdings in Hong Kong and lesser holdings in Japan. Hong Kong is so exciting because the Hong Kong dollar is still pegged to the US dollar and unlike the Chinese RMB has not moved at all. It is inevitable that the HKD will either freely float or be replaced by the RMB. Either outcome will move it vastly from its current 7.79 HKD per USD peg. A quick and dirty estimate would be the Economist Big Mac index which puts the rate closer to 3.73 . Singapore scores about 18% undervalued and Japan about 17%. Other PPP analyses point in the same direction.

    Hong Kong, Japanese and Singaporean businesses, where the primary income is foreign sourced, will not see the sort of appreciation that a domestic business will realize when the eventual exchange rate revaluation occurs.

    With the current subprime and gradually spreading (to Alt-A) mortgage morass, companies that own real estate worldwide have been impacted. Their cost of capital has gone up substantially. They have had trouble refinancing and investors have sold their shares because of the sector taint. Hong Kong is not going to get any more land, neither is Singapore or Japan though Japan is getting fewer people which is somewhat equivalent. These factors lead me to look into Singaporean, Hong Kong and Japanese companies in the real estate business and especially REITs.

    It’s easy for an outsider to think that Japan must be coming out of its economic slumber because things have been so bad for so long. In fact left to its own devices it may well. Unfortunately its public companies appear to be driven by something other than a desire to reward shareholders ( In researching a number of real estate related companies they are all in many different businesses (one was in real estate and fish food). Their return on equity is woeful (though ROE is woeful across the board in Japan) and the business environment is against them. Finally many of them actually lost money on an operating cash basis. This sounds like an opportunity if only there was some catalyst. From the government on down, it sounds like Japanese companies are as staid as ever. Every Japanese company thinks it’s a conglomerate. US companies have wisely spun out non core businesses so that you are left with an easy to analyze, consistent core. Trying to analyze Japanese companies (when the report is even published in English) is difficult.

    Singapore ends up in the middle of the pack with some good discounts to net asset value, better distribution yields and excellent medium to long term asset appreciation potential. The currency doesn’t have such a tailwind as the HKD but Singapore is the destination of choice in Asia if you want to both live in Asia and breathe air. It’s a small peninsula with excellent exposure to commodities, financial services and technology. As fortune would have it (for a new buyer) one of the major REITs in Singapore has recently had to conduct a large rights offering to pay back some of a bridging loan. This is the result of the subprime crisis spreading out all over the world and the resulting contraction in credit. This REIT is largely owned by two other larger companies, one of whom provided the bridge financing and both of which have fully subscribed to the rights offering. There is very little chance of bankruptcy given the corporate support (no one is talking about bankruptcy but it is the ultimate risk).

    K-REIT Asia is trading at price to book ratio of 0.65 (post rights issuance), it grew its NAV by almost 90% last year, will reduce it’s gearing to about 50% and is close to an all time low in stock price. After the rights issuance nearly 80% of shares will be in the hands of the two largest shareholders who plan to sell down over time. This site is very kindly keeping tables of Singapore REITs key financial ratios and it’s easy to see that K-REIT is quite undervalued. With a yield of 5.1%, you can borrow money at 3.76% in USD (that’s from a bad broker!) and still get paid in Singapore dollars while you wait for K-REIT to reach NAV and for the Singapore dollar to reach purchasing power parity with the USD. K-REIT has upside somewhere between a double and a triple.

    Having saved the best for last, let’s look at Hong Kong. This small island is not getting any bigger. It is going to have a special prestige for a long time to come that is not equaled by moving out of the special administrative region and into PRC proper; just like most financial firms are not moving out of Manhattan into cheaper office space in Nashville.

    Champion REIT has $7 worth of assets and is selling for $4. It has a yield around 6.25% and increased its NAV by 16% last year through upward office revaluation. They previously owned a single office building and are now diversifying into retail. They purchased a property for potentially a 10% discount (from a related party, though some analysts believe they overpaid) and expect to achieve similar yields to their current A-grade property. They are small, have a gearing ratio of 26% and currently have $600M of cash on their balance sheet. Their current arrangement with their primary owner (the ones that are selling them the new property) has some financial engineering elements which the company believes has kept shareholders away . The new acquisition will remove these elements and leave in place a regular REIT which is likely to be a catalyst for revaluation.

    Prosperity REIT has a NAV of 2.5 and is selling for 1.61. It’s yielding closer to 8% but has a higher gearing ratio of 33.5%. They only increased their NAV by 5% last year and have $25M of cash on their balance sheet. They are less interesting than Champion REIT but still seem like great value.

    By way of comparison it is interesting to look at The Link REIT which is selling at a 25% premium to NAV with a 4% yield. It should give you some confidence that REITs in Hong Kong don’t always have to sell at a discount.

    A final Hong Kong real estate company of interest is Great Eagle. It is actually domiciled in Bermuda which puts me off but NAV is $24 and they are selling for $21.3. They have a PE of 3 and a 2% dividend. They are involved in property, mainly in PRC and Hong Kong but with some worldwide exposure. It is the company that sold the office building to Champion REIT and they retain a large holding in Champion REIT. They have grown their core (take it with a pinch of salt) earnings by 55% over the last year. They are concentrated in Asia and the southern hemisphere with a little exposure to the US. They had $14Bn of mainly Hong Kong property at the end of 2006 and this was revalued upwards to $17.6Bn by the end of 2007. They are interesting because of their large land and property portfolio and the potential this has for upwards revaluation. Over the long term they are retaining and reinvesting assets whereas the REITs are paying out retained earnings.

    Up to the minute reports indicate a strengthening of demand in Hong Kong for quality real estate which should allay fears of the US real estate crunch affecting these ideas. In fact "Mass market property prices are still 35 to 40 percent below their peak in 1997," said Nicholas Kwan, Asian head of research at Standard Chartered Bank .

    REIT’s attact more favorable tax treatment in Singapore where there are no taxes levied on rental income or capital gains even if eventually distributed to foreign individuals. Hong Kong charges 17.5% tax on income at the corporate level (actually at the SPIV level) and then distributions to domestic or foreign holders are not taxed.

    By comparison US office REITS have a median price of 2 times book and a median yield of 6%. Even the lowest price to book value is 1.2 though the highest dividend yield is 9.7%! Even after the carnage in US real estate, REITs are cheaper in Asia. The US office REITs are also 30% above their 52 week lows and 20% off their highs.

    With the opportunity to wait for a doubling in price to reflect current asset values (or compounded earnings growth in the 40% region in the case of the non-REIT) and then another doubling (if you account in USD) for removing the USD peg these make for some interesting, low risk, high reward ideas off the beaten (US/ Australia / UK) track.


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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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