June portfolio update

For the three months to June, my portfolio continued to fall, albeit less than the broader market. Unfortunately my stocks were not significant beneficiaries of the recent rebound in equity markets. Since June 30, my portfolio is down 1.79%, while the ASX200 index has gained 8.69%. There is little to no correlation between my stocks and the ASX index, so I don't spent too much time worrying about fluctuations like this. However, my recent performance has been disappointing, and I've made a number of regrettable mistakes. That said, I'm confident that, over the long term, the stocks in my portfolio will perform well.

Portfolio activity

I added two new positions in the June quarter, Countryside Partnerships (LSE:CSP) and US Masters Residential Property Fund units (ASX:URF). Shortly after I purchased Countryside, Inclusive Capital made a hostile takeover bid for 2.95 GBP per share. Countryside rejected the advance and instead put the company up for sale under a formal sales process. I sold my CSP shares recently for 2.94 GBP, which resulted in a small profit. While there is a chance CSP gets an improved takeover offer, there is no firm bid, and economic conditions in the UK have deteriorated. I was happy to take the money and move on. 

The URF situation has been well documented by CSK Capital and others. I bought the ordinary units in early May and then sold them in late June to purchase some more TTJ Holdings shares, which was under a takeover offer. I have since rebought URF's convertible step-up preference units, which trade as URFPA on the ASX. The URFPAs will almost certainly be converted to URF units on January 1 on a 1:205 basis. The conversion price is based on the 10-day VWAP of the ordinary units prior to the conversion date. If you adjust for the remaining $3.15 coupon payment, by buying URFPA at $59 (today's close), you are effectively buying URF units at 27.24 cents. Considering URF units closed at 28.5 cents today, URFPA seems an attractive bet. Besides this arbitrage on offer, each URF unit has an estimated unaudited net asset value (post tax) of 57 cents. While the near-term outlook for US property is poor, it's important to note that US house prices are up 9.79% YTD, according to the Case-Shiller National Home Price Index. This should add in a further buffer on top of the >50% discount to NAV. Finally, both URF's responsible entity and major shareholders appear to want a speedy resolution to this situation, which is good for unitholders.. I have a roughly 9% position in URFPA units across my PA and SMSF.

I sold my small position in Fenix Outdoor International (STO:FOI-B) for a small loss when it was trading around 1,070 SEK. While I am optimistic about the Fenix's long-term prospects, I felt the money was better deployed elsewhere. I also sold my position in Destination XL (NASDAQ:DXLG). 

Naked Wines

In late June, Naked Wines released its full year results, which showed that the business has significantly deteriorated. Naked is now guiding to basically no growth for the coming year. Unfortunately, that wasn't the worst of the news. Firstly, Naked's auditors highlighted a "material uncertainty" about Naked's ability to continue as a going concern. Naked also revealed that it had taken out a loan secured by inventory with the Silicon Valley Bank, and it was at risk of breaching covenants. Understandably, the market did not take this news well, and the stock ended the quarter at 1.713 GBP — down 52% for the quarter. Naked has continued to fall since the report, and is now trading around 1.30 GBP. 

Clearly, I have been very wrong on Naked. In hindsight, it's clear I did not pay enough attention to the downside risks. In the frothy market of 2021, I think it was fair to say I was caught up in the euphoria and was worried about selling (what was at that time) a big winner too early. While I have clearly made big mistakes on Naked, at current prices, if it simply survives, shareholders should do well. While the auditor's concerns are clearly worrying, it seems to me that the only plausible way for Naked to go bust would be for customers to withdraw their deposits en masse. (Customers deposit money each month which goes into a "piggy bank" that is used for future wine purchases. Naked uses this money to fund its operations.) I think this scenario is unlikely. I'm taking the time to look at Naked with a fresh set of eyes, and trying not to let my previous poor decisions influence my thinking. I have neither added to my position or sold my shares as yet.

TTJ Holdings

The other significant event in the quarter was the takeover of TTJ Holdings, a Singaporean structural steel business that was one of my largest holdings. Mr Teo, TTJ's founder and executive chairman, made a lowball bid for 23 cents per share. This opportunistic offer was made at a huge discount to TTJ's unaudited NAV as of January 31 of 36.79 cents per share. In other words, shareholders would have received 60% more if the offer was made at the most recent reported NAV. To make things worse, TTJ's true asset value was even higher. The IFA report found TTJ's true asset value was 46 cents per share, double Mr Teo's offer. 

I was very upset about the situation, and I tried my best to seek a better offer from Mr Teo. In the case of TTJ, there was only one major shareholder, Samarang. Despite my efforts, I was not able to reach anyone at Samarang. As TTJ's remaining shareholder base was fragmented, I figured the best approach was to make my case in the media. While I may have succeeded in raising awareness about the unfair offer, I may have had more luck using a less confrontational approach. We will never really know if that would have changed things. The truth of the matter is that I had zero leverage in the situation, so I wasn't in a position to negotiate myself. And while I did my best to coordinate efforts with other shareholders, it did not change the outcome. Mr Teo eventually made his offer final, ruling out the prospect of a price increase. In the end, I decided to tender my shares, as I did not want to risk hanging around with a hostile majority shareholder.

While the exit offer was egregiously low, I still made good money on TTJ, except for a small purchase above the offer price after the release of the IFA report. (I figured a bump was highly likely, but I was wrong.) On an annualised basis, most of my purchases were in the range of 30-40%, which is an excellent result. Considering the asset value backing, the risk was very low too. That said, I was very lucky in the timing of my purchases and the timing of the takeover. It's a good reminder of the importance of the margin of safety, especially when investing in companies such as TTJ with a controlling shareholder. Overall, I've learned some good lessons and made a bit of money as well. It could have been much worse.

New position: CEL Corp (5078.T)

After the TTJ situation resolved, I was left with a large cash balance. Thankfully, I found one new idea which I consider very attractive, CEL Corp (5078.T), a Japanese company that develops, builds and sells steel-framed apartments in the Tokyo metropolitan area and manages apartments for landlords.

The thesis for CEL is straightforward. CEL only listed in Japan this March. Shortly prior to listing, CEL recorded a huge gain on sale of a subsidiary in China. As a result, CEL has cash well in excess of its market cap. Management have said this cash will be used for acquisitions, and it may take some time to play out. I also asked if they had considered paying a special dividend, and the answer was no, so I think there is next to no chance the cash will be paid out soon.

On top of the huge cash balance, CEL has a decent operating business. In particular, the apartment management business creates recurring revenue and CEL should be able to add additional services to landlords over time. CEL currently trades around 1,950 yen, and has forecast earnings of roughly 192 yen, so the P/E is roughly 10. Management is investing significantly in the business, so I expect CEL will be able to grow earnings at a moderate rate, maybe 5-10 per cent over time. CEL has a policy of paying out at least 30% of earnings as a dividend, and the yield is currently over 4%. 

All that is not that exciting, especially in Japan, when there are plenty of cheap stocks. However, CEL's asset value is simply staggering. If you take CEL's cash less all liabilities, you are left with 2,932 yen of cash per share — 51% upside from the current price. CEL's NTA is 5,176 yen per share, meaning you are buying the assets (mostly cash) at a 62.44% discount. Even if you apply zero value to the excess cash, the operating business alone supports the current valuation. Finally, CEL's founder and president, Masatsugu Shinno, still owns 60% of the company after the float, which aligns our interests.

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 3.50% in April, up 3.18% in May and down 11.27% in June. The cumulative return for the period was -5.24%. The S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) fell 11.90% over the same period.

	August 3, 2017	June 30, 2022	Since July 1, 2021	Since Inception	Annualised
G&W Portfolio	1.0000	1.5910	-28.96%	59.10%	9.92%
Benchmark (SPAX2F0)	61,250.80	89,440.67	-5.59%	46.02%	8.02%

My SMSF was up 1.74% in April, up 3.85% in May and down 10.23% in June. The cumulative return for the period was -5.15%. The S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) fell 11.90% over the same period.

	August 4, 2021	June 30, 2022	Since July 1, 2021	Since Inception	Annualised
G&W SMSF	1.0000	0.8687	-13.13%	-13.13%	-14.42%
Benchmark (SPAX2F0)	98,123.18	89,440.67	-8.85%	-8.85%	-9.74%

TTJ Holdings (SGX:K1Q) — Media reporting on privatisation offer

For those following the TTJ situation, here is a round-up of reporting in Singapore's business press in recent days.

• 'Takeover loophole disadvantages minority shareholders of TTJ Holdings' — BT, Letter to Editor by Mano Sabnani
• 'Rationale to privatise follows a template' (behind paywall) — The Edge, Goola Warden. This article contains commentary from me. If you are interested to read it, and don't have a subscription to The Edge, send me an email.
• 'Hold out for better offer says Lim & Tan to TTJ's minority shareholders' — The Edge, Goola Warden

TTJ Holdings (SGX:K1Q) — Why shareholders should wait for a better offer

TTJ Holdings (SGX:K1Q) is one of my largest positions. On Friday, shareholders received a voluntary conditional cash offer from Mr Teo, TTJ's founder and executive chairman. Mr Teo's offer is for 23 cents per share, which values the company at roughly 80m SGD. As Mr Teo already owns approximately 85% of the business, he only needs about one-third acceptance to reach 90% ownership, after which he will be able to compulsorily acquire any remaining shares.

While the offer represents a 36.1% premium to the prior market price, it is deeply unfair to minority shareholders. As of January 31, TTJ had 36.79 cents per share of net tangible assets. This asset value consists of mostly cash and valuable real estate. Mr Teo's offer values these assets at 63 cents on the dollar. There is no justification for such a large discount.

So what is the real value of TTJ? There are the three main components: the steel business, TTJ's cash and securities, and the two properties from the waste management segment.

TTJ's steel business

TTJ's structural steel business is the company's most important asset. The steel business has been consistently profitable, earning an average of 10m pretax annually since listing. It has been EBITDA positive in every year since listing, while TTJ's competitors such as Yongnam have fared poorly. In the 12 months to January 31, the steel business earned approximately 10m in pretax earnings.

TTJ owns two properties in its steel segment: the office and factory at 57 Pioneer Road, Singapore, and the Keluli factory in Johor, Malaysia. The land area of the Pioneer Road property is 17,000 square metres, while the land area of the Johor property is approximately 86,000 square metres. It's important to note that both these properties were held when TTJ was listed back in 2010. They are held on the books at historical cost less depreciation, so their true value is likely well in excess of their carrying value.

The steel business would be worth an absolute minimum of 50-60 million SGD to a private buyer. This would represent 5-6x average pretax earnings. Using Singapore's 17% corporate tax rate, that would imply $8.3m in post-tax operating earnings. In other words, a 50-60m valuation implies a P/E of between 6 and 7.2. That seems very conservative considering the steel business's track record. 

There are two other important points to consider when valuing the steel business. Firstly, TTJ's order book is $187m. This represents roughly 2.5 years of revenue at current rates. TTJ's highest ever order book was ~$195m SGD in 2019, so orders are at close to all-time highs. The second important issue is that Yongnam Steel, TTJ's largest competitor, is in financial difficulty. This should present opportunities for TTJ to gain market share.

So we are now at roughly 60m in valuation just for the steel business. So what else is there?

TTJ's cash and securities

At January 31, TTJ had net cash and securities of $30.9m SGD. Since then, TTJ has also received the proceeds from the disposal of the property at Johor Bahru, formerly used for the PPVC business. TTJ estimated it would receive proceeds of roughly 41.27RM, equivalent to 12.9m SGD. I've assumed 12m in post-tax proceeds. So all up — excluding any profit made since January 31 — TTJ should have around 43m SGD in net cash. This works out to 12.3 cents per share, more than 50% of Mr Teo's offer.

But wait, there's more — TTJ's waste management properties

A few years ago, TTJ attempted to diversify into the wood pellet business. This business never got off the ground and it is currently mothballed. However, this segment contains two valuable properties, which I assume will be sold. The auditor's report in the 2021 annual report notes that the property of TTJ Greenfuel Pte Ltd was carried at $14.3m SGD as of July 31, 2021, while the property, plant and equipment of TTJ Green Energy (Thailand) Co Ltd was carried at $8.2m SGD. So these properties should be worth at least $22.5m SGD as well. Note that these values are net of the impairments TTJ has made to the waste management segment's assets. There were no significant changes to the carrying value of the waste management assets in the recent half-year report.

TTJ's fair value — more like 37 cents per share

Putting that all together, we can get a sense of TTJ's true value.

Conservative sum of the parts

	Value	Notes
Steel business	50-60	5-6x pretax earnings
Cash and securities	42.00	Does not include any cash generated since Jan 31
Waste management properties	22.50
Total value (SGD m)	115-125
Per share	33-36 cents
Upside from current 23c offer	43-56%

Net tangible asset value

TTJ's steel business is likely worth at least book value. The remaining assets consists of property and cash. I believe TTJ's net tangible asset value is therefore a reasonable proxy for the company's intrinsic value.

	Value	Notes
NTA as of January 31	128.58	Does not include gain on disposal of Johor property, nor any retained profits post Jan 31
Per share	36.79 cents
Upside from current 23c offer	60.00%

Why TTJ shareholders should wait for a better offer

TTJ's shareholder register is made up of a large number of small shareholders such as myself. If roughly one-third of the float accepts the offer, Mr Teo will reach the 90% ownership threshold — meaning he will be able to compulsorily acquire any remaining shares. The best thing TTJ shareholders can do is to ignore Mr Teo's offer and push for a better price. 

You don't need to just listen to me. In a report released today, Singapore-based brokers Lim & Tan said of the situation: "We think management is being opportunistic in an attempt to privatise the company on the cheap just at the inflection point of the construction sector upturn. Note that this offer is not final, and taking the above into consideration, we recommend investors hold out for a better offer."

What can TTJ holders do

If you own TTJ shares, I would recommend the following:

• Do not accept Mr Teo's current offer
• Do not sell your shares on market until the offer is improved
• Write to Mr Teo and TTJ about the problems with the current offer, and push for a better price.
• Reach out to other TTJ shareholders to express your concerns and urge them to reject the offer.

I have already spoken to a number of shareholders who share the same concerns as me, and who will be rejecting Mr Teo's offer. I'd be very interested to talk to any current TTJ shareholders, as it's important we stick together. You can get in touch with me via the contact form on my blog.

Good luck to any fellow TTJ shareholders.

March portfolio update

A lot has happened in the first few months of 2022. Besides the war in Ukraine, there are rising concerns about inflation, and growth stocks and other long-duration assets have been punished by the market. 

While my investments have usually performed well during volatile periods in the market, this was not the case in the March quarter. My PA dropped 20.62% while my SMSF fell 9.91%. This is my worst quarter since I started tracking the portfolio, and it has been challenging. While I am confident about the prospects of my holdings, especially at their current valuations, I've spent plenty of time thinking about how I can improve my process.

My results for the quarter were driven by my two largest positions, Naked Wines and Haier Smart Home D. 

Naked Wines

Naked Wines was caught up in the growth sell off, and fell from 6.40 GBP to 3.60 GBP over the quarter (-43.75%). The result was exacerbated by the strong Australian dollar, which rose ~6% against the GBP over the quarter. There was no significant news from Naked. The market is clearly concerned about inflation and/or the sustainability of the business model. I am sanguine on both issues. While I expect Naked's growth to be constrained in the short-term, and customer acquisition costs to rise, I see no reason why Naked should not continue to grow as it has throughout its history. 

It is also worth noting that Naked is not an expensive business. Naked now trades at 0.77x LTM sales. Management has guided to 20% growth in sales over the medium term and 10% EBIT margins at maturity. This seems achievable as Naked increases its sales in the US (which are far higher margin than UK/Aus sales) and scales up. This seems cheap for a business that has historically generated very high returns on capital, has a dominant position in a structurally growing market (Naked is the #1 DTC wine player in the world) and has a long reinvestment runway. Naked remains my second largest position.

All that said, I made a mistake by repeatedly topping up my Naked Wines position on the way down. My initial position in Naked was bought at around 2.1 GBP prior to the pandemic. When topping up Naked, I was thinking more about portfolio sizing than simply valuation. This is not the right way to think, of course. If you keep topping up a falling position, you can blow up your portfolio. (John Hempton has written an excellent post about this.) This has been an important lesson for me, and it has been costly. I hope I can avoid making the same mistake again.

Haier Smart Home D

My largest current position is Haier Smart Home D (690.D), which I have written about in previous updates. Haier fell 17.75% over the quarter. Again, the result was exacerbated by foreign currency movements, as the Australian dollar gained about 6% against the Euro over the quarter. The war in Ukraine has led many investors to worry about China. That does not explain the curious situation with Haier's D shares. Despite ranking exactly the same as Haier's H shares, which are listed in Hong Kong, Haier's D shares trade at a 57% discount. Haier is the world's largest manufacturer of home appliances, with revenue split roughly half and half between China and the rest of the world. It owns Fisher and Paykel in Australia, GE Appliances in the US and a number of other major brands. Based on the current D share price, Haier trades at less than 6 times forward earnings and roughly 3.5 forward EV/EBIT. This seems extremely cheap for a company that has grown earnings per share at more than 11% CAGR since 2016. While Haier has not made any move to convert the D share to the H share, this is an option — as outlined in the H share prospectus — and there is no practical reason for the D share listing to exist. If D shares were converted to H shares today, they would be worth 137% more, yet investors are effectively getting this option for free. Again, if investors are worried about the China situation, the exact same risks apply to the H share. Whether or not conversion happens, investors should do well in Haier D, and I see no reason to change my position.

A note on portfolio construction

Historically, my PA has outperformed in periods of market volatility. One reason has been my holdings of small, unlisted companies in Australia which trade irregularly. These stocks often trade very cheaply in relation to their assets and earnings and pay large dividends. For tax reasons, I transferred these positions to my SMSF when it was established last year. As a result, my SMSF has performed better than my PA of late. Another issue is that, in the past, I have had a higher portfolio allocation to special situations that aren't correlated to the broader market. Besides Yorkey, which worked out very well, I had no real allocation to these sorts of investments in the quarter. Effectively, I was quite concentrated and there were correlations between usually uncorrelated stocks (e.g. Haier and Naked). While I'm happy to trade increased volatility for better returns, I'm going to place more emphasis on having different types of bets in the portfolio, especially in rising markets. I'm also going to put a hard limit on new positions of 10% of the portfolio at cost. This will give positions like Naked, which have good long term prospects, room to grow, while avoiding problems of over-concentration. Effectively, if you're taking a very large bet, say 20% of the portfolio, you are implicitly saying that a particular investment is far better than everything else in your investment universe. Historically, I haven't been very good at predicting which stock will perform better than another in the portfolio. For that reason, I am more inclined to size positions similarly rather than betting 4x position X on position Y. 

Finally, the drawdown has somewhat affected my confidence — as much as I try not to be affected by short-term results, it has been hard to watch the portfolio falling month after month. I've been a bit more cautious entering into new positions for the time being, and I've been doing a lot of work re-visiting my existing positions. Overall, I think the portfolio is very attractively priced. Both my PA and SMSF trade on a dividend yield of >5%, which is the highest in memory. Most of my holdings trade on single digit multiples and less than their net current asset value. I am confident that my holdings will continue to perform well over the next few years, especially from today's levels. 

I have added a small position in Countryside Partnerships (LON:CSP). Countryside is a capital light homebuilder in the UK that has historically earned > 40% ROCE. The company is currently undergoing a turnaround after poor operating results in the March quarter. Activist investor Browning West now has a board seat, and the company is buying back a significant amount of shares. While execution is a major risk, Countryside has a good business and a clear policy for capital allocation (any excess cash that isn't needed for growth will be used to buyback stock). I think the risk-reward here is attractive, but I need more evidence of execution before adding to my position.

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 down 1.69% in January, down 12.05% in February and down 8.19% in March. The cumulative return for the period was -20.62%. The S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) gained 2.24% over the same period.

	August 3, 2017	March 31, 2022	Since July 1, 2021	Since Inception	Annualised
G&W Portfolio	1.0000	1.6790	-25.03%	67.90%	11.76%
Benchmark (SPAX2F0)	61,250.80	101,525.11	7.16%	65.75%	11.45%

My SMSF was down 0.75% in January, down 6.81% in February and down 2.60% in March. The cumulative return for the period was -9.91%. The S&P/ASX 200 Franking Credit Adjusted Annual Total Return Index (Tax-Exempt) gained 2.24% over the same period.

	August 4, 2021	March 31, 2022	Since July 1, 2021	Since Inception	Annualised
G&W SMSF	1.0000	0.9158	-8.42%	-8.42%	-12.57%
Benchmark (SPAX2F0)	98,123.18	101,525.11	3.47%	3.47%	5.34%

G & M Holdings — a HK-listed net-net with 10% dividend yield trading at 4.4x PE

As I've mentioned in previous posts, I've been finding a lot of cheap stocks in Hong Kong lately. One I've recently purchased is G & M Holdings (HK:6038).

G & M designs, builds and repairs podium facades, curtain walls, glass walls and other products in Hong Kong. At 16.2 cents per share, the market cap is 162m HKD.

G & M is an attractive opportunity because:

• It trades at a low multiple of earnings. G & M earned $36.8m net income in FY21, putting the company on a trailing P/E of 4.4. From FY16-FY21, G & M earned cumulative net income of 225.75m, equivalent to 22.58 cents per share (roughly 140% of the current market cap).

• It trades at a discount to its net current asset value. As of December 31, G & M trades at a roughly 33% discount to its net current asset value of $240m (calculated as current assets less total liabilities).

• It has a history of paying dividends. Since listing in June 2017, G & M has paid dividends of 7.25 cents per share. G & M recently announced a final dividend for FY21 of 1.1 cents per share, payable on July 8, 2022, bringing the total to 8.35 cents per share since listing. In other words, G & M has paid more than 50% of its current market cap in dividends since FY17. The trailing dividend yield is 10.2%.

• G & M has historically earned a reasonable return on capital. In FY21, G & M earned roughly 45m pretax on invested capital of 266m, ~16.9% ROCE. (Note I have not deducted any cash from working capital in calculating invested capital, for reasons I will discuss later.) ROCE averaged 15.72% over FY18-FY21.

• G & M has $574m in outstanding contracts, equivalent to 1.4 years of revenue at current rates. G & M is currently bidding or waiting on the results of four podium facade project tenders with an estimated contract value of $357.8m.

Financial data

	FY17	FY18	FY19	FY20	FY21
Revenue	315.71	365.44	299.76	243.40	403.21
EBIT	64.54	45.53	31.62	28.07	45.01
EBIT margin	20.44%	12.46%	10.55%	11.53%	11.16%
Net income	52.27	36.94	26.37	23.3	36.80
Net profit margin	16.55%	10.11%	8.80%	9.57%	9.13%

	FY17	FY18	FY19	FY20	FY21
Invested capital*	208.09	219.02	228.76	248.00	265.64
EBIT	64.54	45.53	31.62	28.07	45.01
ROCE	31.01%	20.79%	13.82%	11.32%	16.94%

* N.B. I’ve assumed zero excess cash, but G & M has historically held very large cash balances

Dividend history from David Webb’s site

Announced	Year-end	Type	Amount	ex-Date	Distribution
2021-08-25	2021-12-31	Interim dividend	HKD 0.0055	2021-09-08	2021-09-29
2021-03-31	2020-12-31	Final dividend	HKD 0.0110	2021-06-24	2021-07-21
2020-03-30	2019-12-31	Final dividend	HKD 0.0140	2020-06-23	2020-07-17
2019-03-18	2018-12-31	Final dividend	HKD 0.0180	2019-06-18	2019-07-12
2018-03-19	2017-12-31	Final dividend	HKD 0.0240	2018-06-11	2018-07-06

N.B. Final dividend for FY21 not included in table: https://www1.hkexnews.hk/listedco/listconews/sehk/2022/0328/2022032800190.pdf 

Why is this opportunity available?

• G & M is an extremely small company with a market cap of ~162m HKD (~25.5m AUD)

• The public float is only 250m shares (40.5m HKD/~$7m AUD at current prices). The two controlling shareholders — Mr Lee Chi Hung (chairman, CEO and co-founder, age 56) and Mr Leung Ping Kwan (non-executive director) — own 75% of G & M’s shares through their holding company, Luxury Booming Ltd. Mr Lee controls 75% of the issued share capital of Luxury, and therefore has ultimate control of G & M; Mr Leung owns the remaining 25% of Luxury Booming.

• Despite solid operating results, G & M shares have performed poorly since IPO. G & M currently trades 60% below its listing price of 41 cents. Even when dividends are included IPO buyers are still down ~43%.

• The Hong Kong market has performed poorly in recent years. The Hang Seng is down about 23.5% over the last year and down about 10% over the last five years. Besides the political unrest in Hong Kong, there has been a widespread sell-off in HK and Chinese stocks following the Ukraine crisis. HK is also experiencing a deadly COVID wave, however it seems the peak has passed.

G & M’s business

A podium facade is the external surface of the podium or atrium part of a building, typically made up of glass, cladding, granite and other materials.

Podium facade by G & M, Taikoo Place Development

A Curtain wall is the external surface of the building above the atrium portion, typically made of glass, aluminum or other materials. 

Curtain wall by G & M, KCTL 522, Kwai On Road, Kwai Chung

G & M is a subcontractor, and typically works with property developers, main contractors or public bodies. It specialises in podium facade projects; according to the prospectus, G & M was the second largest player in the HK podium facade industry as of 2015. 

The biggest risk with G & M is customer concentration. Typically, G & M has had a high portion of its revenue come from one or two main customers, including Sun Hung Kai Properties, one of Hong Kong’s largest property developers. In 2021, 93% of revenue came from two customers.

This is obviously not good news. However, Hong Kong’s property development sector is highly concentrated. Million Hope, a larger curtain wall business listed in HK, also has a high level of customer concentration, with 94% of revenue in FY21 coming from its top five customers. 

Historically, G & M’s most important customer has been Sun Hung Kai properties. G & M and SHK have a relationship spanning nearly 20 years, which brings some comfort. SHK has a strong balance sheet, with a 17.5% gearing ratio and interest coverage of 13 times as of December 31, 2021.

I am concerned about the customer concentration, but with G & M selling below liquidation value, we have significant downside protection. Additionally, we can manage the risk further with position size.

A note on G & M's cash

G & M has roughly $77m of net cash on its balance sheet, more than 50% of its current market cap. However, much of this cash is needed for operations. One of the reasons G & M listed was to raise cash to increase its ability to take on contacts. The prospectus notes:

“Based on the experience of the directors, according to the nature and specification of each project, the Group may generally incur maximum net cash outflows of approximately 23-28% of the contract sum at the early stage of its projects, particularly where the Group acts as a nominated subcontractor for the projects, and the customers generally make the first progress payment to the Group not until approximately five to seven months after the commencement of the relevant projects. Furthermore, the Group’s customers generally withhold usually 10% of each interim payment up to an aggregate of usually 5% of the total contact sum as retention money, which will only be fully released to the Group subsequent to the expiry of the defect liability period.”

While the cash offers some downside protection, I think it’s prudent to assume $0 excess cash (for enterprise value calculations, etc). On this basis, G & M still seems extremely cheap on both an earnings and asset basis.

• Trailing EV/EBIT: 3.6

• Trailing P/E: 4.4

• Price to NTA: 0.62

• Price to NCAV: 0.67

Outlook

G & M has contracts worth 1.4 years of revenue at FY21 rates. It is also bidding on additional contacts worth ~$350m. There is a significant pipeline of construction work in Hong Kong, with government spending on infrastructure projects expected to reach $100b annually in the next few years. 

However, there are number of headwinds in the near-term, including COVID, labour issues and rising costs of materials. 

The Group also experienced increasing staff drain owing to various social and labour market factors, reduction in work scope of already awarded projects attributable to economic uncertainties, and rising material prices as a result of disruption in supply chain, all of which will have lasting impact on the Group’s operations …

Faced with the uncertainties brought on by the prolonged COVID-19 outbreak, the Group will continue to adopt a more prudent approach in its bid for projects, focusing on those involving higher level of design element, technical capability and customized features with an aim to conserve its resources on quality projects by reputable customers with healthy profit margins.

While these issues are concerning, and will likely impact margins, G & M remained profitable through the initial COVID outbreak and has some protection from its forward order book. If we assume earnings fall back to 30m, G & M would still trade on ~5.3 PE, and could maintain the current dividend.

Catalysts

I don’t have a particular catalyst in mind. G & M seems extremely cheap whichever way you look at it. It would benefit from a recovery of the broader HK market (which has been depressed). If the stock continues to languish, the majority shareholder could also take it private, which could likely be funded through the dividends paid to date. 

If you buy today, you're entitled to a 1.1 cent dividend on July 8, worth roughly ~6.8% of your purchase price. (The ex-dividend date is June 13.)

If you have any thoughts on G & M, or if you spot a problem with my thesis, I'd be very interested to hear from you.