September portfolio update

Hello again. It's a been a while since I've posted an update for the portfolio. From now on, I'll try to keep posting updates each quarter, as discussed in my last post.

First things first, the big development for me lately is my self-managed super fund. It's now up and running which gives me some more capital to invest. For those interested in setting up their own SMSF, it cost me about $1,345 to set up the fund with a corporate trustee. The process was relatively straightforward. I'm expecting ongoing costs of roughly $1,400 each year using a low-cost administrator.

Now to the business end of things, and there's quite a bit to discuss as I've been more active than usual lately. In July, I established a large position in Chen Hsong Holdings Ltd, which trades in Hong Kong. Chen Hsong makes plastic injection moulding machines which it sells in China, Europe and elsewhere. In July, when I started investing in Chen Hsong, it had a market cap of roughly $1.8b HKD. It had net cash of $1.1b, NCAV of $1.9b and NTA of roughly 2.9b. It earned roughly $200m in the year to March 31, 2021. In other words, if you backed out the net cash, it was trading at under four times earnings. 

When faced with statistically cheap situations like this, I have two initial questions. The first is whether the company is a fraud or the directors are stealing the money. In this case, the answer is clearly no. Chen Hsong has a long history as a company, sells real products and the properties it owns are real. The second question is whether I — as a minority shareholder — will ever benefit from the company's cash and assets. In this case, Chen Hsong also seems to pass the test. It has consistently paid a dividend and the payout ratio has hovered around 50% in recent years.

What makes Chen Hsong particularly interesting is the fact it holds significant property holdings on its balance sheet at cost less depreciation. The most important of these properties is in Shenzhen, China. Chen Hsong owns an industrial park in Pingshan District, Shenzhen, with a site area of roughly 550,000 square metres. Chen Hsong has entered into a framework agreement with a property developer, Gaw Capital, to seek approval from Chinese authorities to develop this site into residential/commercial high rises. With the help of a friend, I looked at transactions of similar properties to get a sense of the potential value of this development. It seemed to us that the value could well exceed Chen Hsong's market cap. 

Shenzhen is one of the hottest real estate markets in the world — at least until recently. China's credit markets are in turmoil following the Evergrande crisis and prices for new developments in Shenzhen have fallen between 5 and 10 per cent in recent months. Considering the extreme prices of property in China, and particularly Shenzhen, it seems prices could fall much further. 

Chen Hsong is now trading at $2.34, roughly 15 per cent below my purchase price. The dilemma now is what to do. I am reluctant to sell my holdings, as the company is currently trading at a roughly 20 per cent discount to its net current asset value (calculated as net current assets less total liabilities) and roughly half net tangible asset value. However, the immediate catalyst — the potential property development — is now in doubt. It seems to me that Chen Hsong and Gaw may find it difficult or impossible to finance the project. Property prices could continue to fall, which could make the development less valuable. On the flip side, the situation may lead to a privatisation offer from the controlling family at a premium to the current share price.

For the bear case valuation of Chen Hsong, my friend and I valued the Shenzhen property as industrial land only. Our research indicates that, prior to the Evergrande situation, the land would be worth roughly $2.7b HKD on this basis. Once we take into account taxes (roughly $600m, assuming 25 per cent tax rate) and relocation costs (we assumed 720m, as the Shenzhen factory is Chen Hsong's main plant) we're left with roughly $1.4b HKD for the property. 

For conservatism's sake, let's knock 40 per cent off that for the Chinese credit situation. That would leave us with roughly $840m HKD. To that, we can add the operating business and cash. I've assumed the operating business is worth $1b (5x TTM net income) and excess cash is worth only $500m as Chen Hsong has consistently held a high cash balance. Even with those haircuts, we get to 2.34b HKD in value. That works out to ~$3.70 per share, roughly 60 per cent above the share price at time of writing. I have slightly reduced my Chen Hsong holding in light of the broken property development catalyst but I am comfortable maintaining a decent position at current prices. I have invested roughly 7 per cent of my net worth in Chen Hsong.

Chen Hsong wasn't the only position to go against me in the quarter. I purchased shares in Destination XL Group, a fashion retailer in the US, which promptly fell in value following a divestment from a major shareholder. I am currently down about 10 per cent on my purchase price. Naked Wines, one of my other major positions, fell roughly 14 per cent. Haier Smart Home D shares fell slightly more than 7 per cent. I am comfortable with all of these positions and have been adding to Naked Wines and Haier recently.

Periods of poor performance are part and parcel of the investment game, and we can't get upset when the tide turns against us. However, I am disappointed by a large and avoidable mistake I made during the quarter. I had a significant amount of cash and was itching to find a new investment. It led to me putting a very large amount of my net worth into a Japanese company after only preliminary (and poor quality) research. The stock is not wildly overvalued, and there is nothing seriously wrong with the business, but I should never have invested in the first place. Li Lu says analysis should be accurate and complete and mine was neither in this case. Thankfully, this particular mistake has not been costly. I have been able to sell half my position for a small loss, and I expect to sell my remaining shares in the near future. Hopefully, I can avoid making this particular type of mistake in future. 

The results of my private investment account and SMSF are summarised in the table below. The portfolios are constructed differently and performance will vary. 

My PA was up 2.81% in July, down 3.41% in August and down 6.79% in September. The cumulative return for the period was -7.44%. The S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) gained 2.66% over the same period.

	August 3, 2017	September 30, 2021	Since July 1, 2021	Since Inception	Annualised
G&W Portfolio	1.0000	2.0730	-7.44%	107.30%	19.41%
Benchmark (SPAX2F0)	61,250.80	97,261.73	2.66%	58.79%	11.75%

My SMSF gained 1.88%  in August and fell 5.29% in September. The cumulative return from inception on August 4, 2021, to September 30 was -3.52%. The S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) fell 0.88% over the same period.

	August 4, 2021	September 30, 2021	Since July 1, 2021	Since Inception	Annualised
G&W SMSF	1.0000	0.9648	-3.52%	-3.52%	-20.50%
Benchmark (SPAX2F0)	98,123.18	97,261.73	-0.88%	-0.88%	-5.49%