Category

Value Investing

Brief Value Investing: Semen Indonesia Persero Tbk (SMGR IJ) – Fortress Mentality and more

By | Daily Briefs, Value Investing

In this briefing:

  1. Semen Indonesia Persero Tbk (SMGR IJ) – Fortress Mentality
  2. European Banks: Dividends in a Time of Crisis
  3. Nedbank: Castigation Towards Junk
  4. ITC IN
  5. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis

1. Semen Indonesia Persero Tbk (SMGR IJ) – Fortress Mentality

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Semen Indonesia Persero Tbk (SMGR IJ) released a decent set of number for 2019, with a strong finish to the year. It also realised significant synergies from the acquistion of PT Solusi Bangun Indonesia Tbk (SMCB IJ) (Holcim Indonesia), which were reflected in the numbers, although higher finance costs related to the acquisition hit the bottom line for the year.

Apart from the obvious concerns over COVID-19, the company had a tough start to the year, with heavy rainfall and flooding impacting volume for January and February, which saw a decline of -4% for 2M20.

Next few months will be impacted by a COVID-19 induced slowdown, which will hit both retail (bagged) demand as bulk, as demand from larger projects declines due to delays to the start of new infrastructure projects, as well as existing ones. 

The key message from the company’s call was one of maintaining a fortress balance sheet and attempting to maintain margins and cashflows. It has already restructured all its bridging loans related to its PT Solusi Bangun Indonesia Tbk (SMCB IJ) acquistion, which will mean significantly lower interest costs in 2020.

With the true impact and longevity of COVID-19 unknown, it is difficult to make sensible forecasts on the potential impact on the Indonesian economy and hence cement volumes for this year but safe to say volumes are likely to be lower than 2019.

Semen Indonesia Persero Tbk (SMGR IJ)’s share price is reflecting a doomsday scenario with the stock trading at close to book value and looks like an attractive entry point for long-term investors, who can stand the inevitable short-term volatility.

2. European Banks: Dividends in a Time of Crisis

Capture1

  • The ECB is holding talks with Eurozone lenders with regards to dividends, according to Bloomberg, in order to attempt to preserve capital during the coronavirus crisis
  • Many European banks are high dividend yielding, and an important element of equity income funds; in some cases, bank dividend payouts are also very high
  • Our main screen is based on European banks’ dividend yields versus dividend cover, in which we try to identify those European banks most at risk of potential dividend cuts
  • We recognize that consensus earnings estimates are subject to change, but we see this exercise as a starting point; we intend to revisit this exercise further down the line when there will hopefully be more clarity
  • We see Intesa Sanpaolo (ISP IM) as one of the most exposed European banks to a dividend cut amongst our coverage; also among the Italians, Mediobanca SpA (MB IM) and Unione Di Banche Italiane (UBI IM) are higher risk
  • Also not out of the woods are UniCredit SpA (UCG IM) , Banco BPM SpA (BAMI IM) and Banca Popolare Dell’Emilia Rom (BPE IM) even though they seem less exposed to dividend cuts
  • Risks to our bearish view on Intesa’s dividend outlook include better than expected credit quality limiting the adverse impact on cost of risk, as well as better than expected fee generation and very stringent cost control all serving to counter earnings pressures

3. Nedbank: Castigation Towards Junk

Nedbank%20group%202019%20annual%20results%20presentation page 21

South Africa continues to face well-documented challenges and risks. In their earnings presentation earlier this month, beleaguered lender Nedbank (NED SJ) puts a “more of the same” scenario at 50% for the next few years- a grey, twilight or penumbra zone of lacklustre GDP growth, moderate inflation, high single-digit credit growth,  and elevated interest rates. In this scenario, the vexing land question remains in the background, rearing its head now and again, while initiatives to stem corruption continue and Eskom’s finances remain perilous with load-shedding at level 1 and 2. Management at Nedbank seems resigned to the Moody’s downgrade but believes that a great deal is already priced-in. Of course this could all look a lot better with a full embrace of structural reform, policy certainty, public finance improvement, enhanced business and consumer confidence, more investment and less joblessness. The bank apportions a 10% chance to a high stress scenario over the next few years, underpinned by negative news on land reform and corruption, and a 20% probability of a much more benign scenario which is conditioned by better public finances, an Eskom turnaround, and the unlikely eschewing of a downgrade.

In November, Moody’s flagged load-shedding, a ballooning public debt and budget deficit, inequality and slow economic growth as among the risk factors that could lead to the country being downgraded. Since then, those risk factors have not got any better and are likely to be exacerbated by the economic downturn as a result of Covid-19. The yield on the 10-year South African government bonds spiked to above 12% on Monday. That means the government will have to pay billions more in interest to pay for local roads, hospitals, and services. Wider deficits and additional borrowing are a risk as elsewhere given Covid-19. A Moody’s decision could happen tomorrow. It would be one of the most telegraphed and torturous downgrades of all time.

Steven Holden at CFR shows that GEM managers have reduced positions in South African equities and are looking elsewhere broadly. Pending “junk” status means outflows as bond investors look elsewhere if they have not already made the decision. Fortunately, most of South Africa’s debt is rand-denominated. So even with the rand’s recent slump (from below R15/$ a month ago to near R17.54 currently), this will not threaten its ability to settle its debt. Many other emerging markets are not in the same position.

The collapse in the price of oil is a welcome tailwind.

South Africa has a relatively robust and well-regulated Banking System. Bank shares which “normally” trade at premium valuations, have not showed up as this cheap versus other EM peers for a very long time. First Rand is a highly prudent well-managed lender while Standard Bank always struck us as innovative but circumspect. These are Investment Grade banks trading at a junk rating now. Their relative valuations are a great deal more interesting today. But Nedbank, an inferior lender, is just too cheap to ignore as its share price has become overly detached from the others.

With such a disappointing, if not somewhat despondent, backdrop with a few positive drivers, it may seem counter-intuitive to recommend shares of a South African bank. But there is a price for everything and shares of Nedbank are at distressed levels.The pan-African franchise is struggling and is valued at zero under current valuation.

Shares trade on a Dividend Yield of 17% and an Earnings Yield of 30%. P/B and FV stand at 0.45x and 4%, respectively. Total Return ratio has reached 7.8x. A PH Score of 7.4 may reflect in great part the valuation but operational progress on Capitalisation, Efficiency, Provisioning, and Liquidity play a part too. Profitability though narrowed as credit costs  jumped forcefully on account of Asset Quality risks across the South African CIB franchise and as private equity holdings were revalued lower while risks in jurisdictions elsewhere in Africa (for example especially Zimbabwe but also Nigeria) where Nedbank has a presence rose and pose macro challenges going forward. 

Shares stand in the top quintile of our global VFM rankings.

4. ITC IN

Charting%20image%20export%20 %20mar%2025th%202020%2012 25 34%20pm

ITC Ltd (ITC IN) ‘s recent share price performance has been disappointing on all counts. The increase in Dividend Payout further re-iterates our view of ITC finding it a challenge to invest in other businesses, and therefore valuations now reflect that of global tobacco companies.  At current prices, the downside may be limited, but a Re-rating is unlikely. 

This Insight is labelled bearish, as we do not see any major PE Re-rating in the near term. 

5. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis

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  • Looking at 5 year average ratios vs. current ones quickly pinpoints best values in the sector in these selected tickers.
  • EV/EBITDA eliminates leverage that can sometimes mislead investors to better value companies.
  • The metric is also a good proxy for cash flow in a sector that historically can accumulate cash at a more rapid pace than many consumer discretionary categories.

You are currently reading Executive Summaries of Smartkarma Insights.

Want to read on? Explore our tailored Smartkarma Solutions.

Brief Value Investing: Itausa (ITSA4 BZ): Less Bearish, but Still Cautious and more

By | Daily Briefs, Value Investing

In this briefing:

  1. Itausa (ITSA4 BZ): Less Bearish, but Still Cautious
  2. Nakilat – 4Q19 Result Update
  3. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks

1. Itausa (ITSA4 BZ): Less Bearish, but Still Cautious

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  • Itausa-Investimentos Itau-Pr (ITSA4 BZ) has performed broadly in line with its largest holding Itau Unibanco Holding Sa (ITUB4 BZ) since September end 2019
  • Despite Itausa’s attractive dividend yield, the payout on 2019 earnings has decreased and we think that this is not compelling
  • The NAV discount has widened recently, but may widen a bit further in the short term should a near-term market recovery drive a rally in Itau Unibanco; the discount remains below the long-run average
  • Risks to our cautious view include better than expected performance in the invested companies, especially Itau Unibanco Holding Sa (ITUB4 BZ) 

2. Nakilat – 4Q19 Result Update

Nakilat%20fair%20value%20calculation

Vessel acquisitions drive strong results

Nakilat delivered strong 4Q19 results driven by vessels acquisitions in October 2019. We believe an attractive opportunity has emerged to own Nakilat stock post its recent decline. The company is well positioned to withstand the ongoing weakness in LNG shipping prospects given its solid revenue backlog.

3. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks

Sk

This is a follow-up insight to answer some questions I have received during the webinar. We want to discuss key holding company regulations that are imposed upon Korean conglomerates when envisioning restructuring scenarios. In this insight, we focus on Samsung, Hyundai, and SK. We also look into which affiliates within the group would face the lowest risks upon the restructuring.

The overall objective of South Korea’s holding company regulations is to prevent operating companies from being taken advantage of to finance the group’s aggressive expansion. The relevant rules include: 

  1. If the total value of the subsidiaries that a company owns exceeds 50% of its total assets, the company is automatically converted into a holding company and becomes subject to the regulations.
    • When the company is the largest equity investor in an affiliate, this affiliate is legally perceived as a subsidiary.
    • In principle, the value of the subsidiary is implied by fair value. The fair value corresponds to the market price for listed subsidiaries and the estimated fair value for unlisted subsidiaries. However, there are some companies that recognize the value of unlisted subsidiaries as the acquisition costs, not the estimated fair value, on their unconsolidated balance sheet. In this case, the cost of acquisition is perceived as the value of the unlisted subsidiaries to calculate the ratio.
  2. Subsidiaries (operating companies) are not allowed to participate in a capital increase of holding companies and thereby create a cross-shareholding link. 
  3. Subsidiaries and holding companies are not allowed to make joint investments to acquire other firms. This regulation, along with the #2 regulation, aims to prevent subsidiaries (operating companies) from being deployed to finance the holdco’s acquisition activities.
  4. A 2-tier subsidiary should hold a 100% stake in a 3-tier subsidiary. On the other hand, a holding company is required to hold more than a 20% stake in a publicly listed 1-tier subsidiary. If it is unlisted, a holding company should hold more than a 30% stake. The same rule also applies to a 1-tier subsidiary holding a stake in a 2-tier subsidiary. 
  5. Under the general holding company structure, the holding company and affiliates are not allowed to hold a stake in financial affiliates. The amendment to allow the creation of the “intermediate” financial holding company structure had been under review but was put on hold.

The most likely restructuring scenario for Samsung Group is to split Samsung Electronics (005930 KS) into a holding company and an operating company and to merge SamE Holdco with Samsung C&T (028260 KS). Upon the holdco conversion, Samsung C&T should buy off SamE shares from Samsung Life Insurance (032830 KS). Thus, those three affiliates face uncertainty, albeit in varying degrees. Meanwhile, Samsung Sdi (006400 KS) and Samsung Electro Mechanics Co, Ltd. (009150 KS) have the least exposure to such uncertainty. In particular, Samsung SDI would expect a cash influx by selling off its subsidiary shares to SamE Holdco due to the #3 regulation.

Hyundai Group may or may not adopt the holding company structure. In either case, the restructuring would inevitably involve Hyundai Mobis (012330 KS) and Hyundai Glovis (086280 KS). However, Hyundai Motor Co (005380 KS) is rather a place of relative calm, making it scenario-neutral. Still, there would be one risk facing Hyundai Motor in case of the holdco conversion; according to the #5 regulation, Hyundai Motor should sell off its majority stakes in Hyundai Card and Hyundai Capital. However, Hyundai Motor’s vertical integration with those financial affiliates that provide consumers with car loan services is one of the company’s important differentiating strategies. Thus, the Group would find a way to deliberately avoid being automatically converted into a holding company, though it forms a de facto holdco structure.

SK Group is working on its governance restructuring such that SK Hynix (000660 KS) becomes a 1-tier subsidiary. Currently, SK Hynix, a subsidiary of SK Telecom, is a 2-tier subsidiary of SK Holdings (034730 KS). Because of that, SK Hynix had to comply with the #4 regulation, which forces the company to wholly own the acquired firms. This must have been very costly for SK Hynix to seek business expansion in an active manner. The most likely scenario for SK Group is to split SK Telecom (017670 KS) into an investment company and an operating company and then merge the investment company with SK Holdings. Upon the split, SK Hynix would be moved to the investment company of SK Telecom. After the merger, SK Hynix would become a 1-tier subsidiary of SK Holdings, and thus, can be more active in JVs and acquisitions.

You are currently reading Executive Summaries of Smartkarma Insights.

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Brief Value Investing: European Banks: Dividends in a Time of Crisis and more

By | Daily Briefs, Value Investing

In this briefing:

  1. European Banks: Dividends in a Time of Crisis
  2. Nedbank: Castigation Towards Junk
  3. ITC IN
  4. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis
  5. Cafe De Coral (341): Time to Go Long

1. European Banks: Dividends in a Time of Crisis

Capture1

  • The ECB is holding talks with Eurozone lenders with regards to dividends, according to Bloomberg, in order to attempt to preserve capital during the coronavirus crisis
  • Many European banks are high dividend yielding, and an important element of equity income funds; in some cases, bank dividend payouts are also very high
  • Our main screen is based on European banks’ dividend yields versus dividend cover, in which we try to identify those European banks most at risk of potential dividend cuts
  • We recognize that consensus earnings estimates are subject to change, but we see this exercise as a starting point; we intend to revisit this exercise further down the line when there will hopefully be more clarity
  • We see Intesa Sanpaolo (ISP IM) as one of the most exposed European banks to a dividend cut amongst our coverage; also among the Italians, Mediobanca SpA (MB IM) and Unione Di Banche Italiane (UBI IM) are higher risk
  • Also not out of the woods are UniCredit SpA (UCG IM) , Banco BPM SpA (BAMI IM) and Banca Popolare Dell’Emilia Rom (BPE IM) even though they seem less exposed to dividend cuts
  • Risks to our bearish view on Intesa’s dividend outlook include better than expected credit quality limiting the adverse impact on cost of risk, as well as better than expected fee generation and very stringent cost control all serving to counter earnings pressures

2. Nedbank: Castigation Towards Junk

Nedbank%20group%202019%20annual%20results%20presentation page 21

South Africa continues to face well-documented challenges and risks. In their earnings presentation earlier this month, beleaguered lender Nedbank (NED SJ) puts a “more of the same” scenario at 50% for the next few years- a grey, twilight or penumbra zone of lacklustre GDP growth, moderate inflation, high single-digit credit growth,  and elevated interest rates. In this scenario, the vexing land question remains in the background, rearing its head now and again, while initiatives to stem corruption continue and Eskom’s finances remain perilous with load-shedding at level 1 and 2. Management at Nedbank seems resigned to the Moody’s downgrade but believes that a great deal is already priced-in. Of course this could all look a lot better with a full embrace of structural reform, policy certainty, public finance improvement, enhanced business and consumer confidence, more investment and less joblessness. The bank apportions a 10% chance to a high stress scenario over the next few years, underpinned by negative news on land reform and corruption, and a 20% probability of a much more benign scenario which is conditioned by better public finances, an Eskom turnaround, and the unlikely eschewing of a downgrade.

In November, Moody’s flagged load-shedding, a ballooning public debt and budget deficit, inequality and slow economic growth as among the risk factors that could lead to the country being downgraded. Since then, those risk factors have not got any better and are likely to be exacerbated by the economic downturn as a result of Covid-19. The yield on the 10-year South African government bonds spiked to above 12% on Monday. That means the government will have to pay billions more in interest to pay for local roads, hospitals, and services. Wider deficits and additional borrowing are a risk as elsewhere given Covid-19. A Moody’s decision could happen tomorrow. It would be one of the most telegraphed and torturous downgrades of all time.

Steven Holden at CFR shows that GEM managers have reduced positions in South African equities and are looking elsewhere broadly. Pending “junk” status means outflows as bond investors look elsewhere if they have not already made the decision. Fortunately, most of South Africa’s debt is rand-denominated. So even with the rand’s recent slump (from below R15/$ a month ago to near R17.54 currently), this will not threaten its ability to settle its debt. Many other emerging markets are not in the same position.

The collapse in the price of oil is a welcome tailwind.

South Africa has a relatively robust and well-regulated Banking System. Bank shares which “normally” trade at premium valuations, have not showed up as this cheap versus other EM peers for a very long time. First Rand is a highly prudent well-managed lender while Standard Bank always struck us as innovative but circumspect. These are Investment Grade banks trading at a junk rating now. Their relative valuations are a great deal more interesting today. But Nedbank, an inferior lender, is just too cheap to ignore as its share price has become overly detached from the others.

With such a disappointing, if not somewhat despondent, backdrop with a few positive drivers, it may seem counter-intuitive to recommend shares of a South African bank. But there is a price for everything and shares of Nedbank are at distressed levels.The pan-African franchise is struggling and is valued at zero under current valuation.

Shares trade on a Dividend Yield of 17% and an Earnings Yield of 30%. P/B and FV stand at 0.45x and 4%, respectively. Total Return ratio has reached 7.8x. A PH Score of 7.4 may reflect in great part the valuation but operational progress on Capitalisation, Efficiency, Provisioning, and Liquidity play a part too. Profitability though narrowed as credit costs  jumped forcefully on account of Asset Quality risks across the South African CIB franchise and as private equity holdings were revalued lower while risks in jurisdictions elsewhere in Africa (for example especially Zimbabwe but also Nigeria) where Nedbank has a presence rose and pose macro challenges going forward. 

Shares stand in the top quintile of our global VFM rankings.

3. ITC IN

Charting%20image%20export%20 %20mar%2025th%202020%205 08 05%20pm

ITC Ltd (ITC IN) ‘s recent share price performance has been disappointing on all counts. The increase in Dividend Payout further re-iterates our view of ITC finding it a challenge to invest in other businesses, and therefore valuations now reflect that of global tobacco companies.  At current prices, the downside may be limited, but a Re-rating is unlikely. 

This Insight is labelled bearish, as we do not see any major PE Re-rating in the near term. 

4. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis

360x 1

  • Looking at 5 year average ratios vs. current ones quickly pinpoints best values in the sector in these selected tickers.
  • EV/EBITDA eliminates leverage that can sometimes mislead investors to better value companies.
  • The metric is also a good proxy for cash flow in a sector that historically can accumulate cash at a more rapid pace than many consumer discretionary categories.

5. Cafe De Coral (341): Time to Go Long

Image 26628375121585206598860

The ongoing protests against China’s ruling power over Hong Kong were the chief reason why investors left Cafe de Coral. Fundamentally, the company is not out of the woods yet, however, with China’s lockdown is soon to be over and no overseas travel to start anytime soon, mainland Chinese tourists may flock to either Macau (therefore packing up Wynn Macau Ltd (1128 HK) and Melco International Development (200 HK) or Hong Kong.

Compared to the other chain restaurant names listed in Hong Kong Hang Seng Index (HSI INDEX) , Cafe de Coral is trading at the lowest valuation and it has the lowest exposure to hotpot menu. 

The soon-to-reopen China with pent up frustrations of being locked down and less likely able to travel overseas will provide the much-needed revenue increase for Cafe de Coral. Cover your shorts and start buying. 

You are currently reading Executive Summaries of Smartkarma Insights.

Want to read on? Explore our tailored Smartkarma Solutions.

Brief Value Investing: Nakilat – 4Q19 Result Update and more

By | Daily Briefs, Value Investing

In this briefing:

  1. Nakilat – 4Q19 Result Update
  2. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks

1. Nakilat – 4Q19 Result Update

Nakilat%20fair%20value%20calculation

Vessel acquisitions drive strong results

Nakilat delivered strong 4Q19 results driven by vessels acquisitions in October 2019. We believe an attractive opportunity has emerged to own Nakilat stock post its recent decline. The company is well positioned to withstand the ongoing weakness in LNG shipping prospects given its solid revenue backlog.

2. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks

Sk

This is a follow-up insight to answer some questions I have received during the webinar. We want to discuss key holding company regulations that are imposed upon Korean conglomerates when envisioning restructuring scenarios. In this insight, we focus on Samsung, Hyundai, and SK. We also look into which affiliates within the group would face the lowest risks upon the restructuring.

The overall objective of South Korea’s holding company regulations is to prevent operating companies from being taken advantage of to finance the group’s aggressive expansion. The relevant rules include: 

  1. If the total value of the subsidiaries that a company owns exceeds 50% of its total assets, the company is automatically converted into a holding company and becomes subject to the regulations.
    • When the company is the largest equity investor in an affiliate, this affiliate is legally perceived as a subsidiary.
    • In principle, the value of the subsidiary is implied by fair value. The fair value corresponds to the market price for listed subsidiaries and the estimated fair value for unlisted subsidiaries. However, there are some companies that recognize the value of unlisted subsidiaries as the acquisition costs, not the estimated fair value, on their unconsolidated balance sheet. In this case, the cost of acquisition is perceived as the value of the unlisted subsidiaries to calculate the ratio.
  2. Subsidiaries (operating companies) are not allowed to participate in a capital increase of holding companies and thereby create a cross-shareholding link. 
  3. Subsidiaries and holding companies are not allowed to make joint investments to acquire other firms. This regulation, along with the #2 regulation, aims to prevent subsidiaries (operating companies) from being deployed to finance the holdco’s acquisition activities.
  4. A 2-tier subsidiary should hold a 100% stake in a 3-tier subsidiary. On the other hand, a holding company is required to hold more than a 20% stake in a publicly listed 1-tier subsidiary. If it is unlisted, a holding company should hold more than a 30% stake. The same rule also applies to a 1-tier subsidiary holding a stake in a 2-tier subsidiary. 
  5. Under the general holding company structure, the holding company and affiliates are not allowed to hold a stake in financial affiliates. The amendment to allow the creation of the “intermediate” financial holding company structure had been under review but was put on hold.

The most likely restructuring scenario for Samsung Group is to split Samsung Electronics (005930 KS) into a holding company and an operating company and to merge SamE Holdco with Samsung C&T (028260 KS). Upon the holdco conversion, Samsung C&T should buy off SamE shares from Samsung Life Insurance (032830 KS). Thus, those three affiliates face uncertainty, albeit in varying degrees. Meanwhile, Samsung Sdi (006400 KS) and Samsung Electro Mechanics Co, Ltd. (009150 KS) have the least exposure to such uncertainty. In particular, Samsung SDI would expect a cash influx by selling off its subsidiary shares to SamE Holdco due to the #3 regulation.

Hyundai Group may or may not adopt the holding company structure. In either case, the restructuring would inevitably involve Hyundai Mobis (012330 KS) and Hyundai Glovis (086280 KS). However, Hyundai Motor Co (005380 KS) is rather a place of relative calm, making it scenario-neutral. Still, there would be one risk facing Hyundai Motor in case of the holdco conversion; according to the #5 regulation, Hyundai Motor should sell off its majority stakes in Hyundai Card and Hyundai Capital. However, Hyundai Motor’s vertical integration with those financial affiliates that provide consumers with car loan services is one of the company’s important differentiating strategies. Thus, the Group would find a way to deliberately avoid being automatically converted into a holding company, though it forms a de facto holdco structure.

SK Group is working on its governance restructuring such that SK Hynix (000660 KS) becomes a 1-tier subsidiary. Currently, SK Hynix, a subsidiary of SK Telecom, is a 2-tier subsidiary of SK Holdings (034730 KS). Because of that, SK Hynix had to comply with the #4 regulation, which forces the company to wholly own the acquired firms. This must have been very costly for SK Hynix to seek business expansion in an active manner. The most likely scenario for SK Group is to split SK Telecom (017670 KS) into an investment company and an operating company and then merge the investment company with SK Holdings. Upon the split, SK Hynix would be moved to the investment company of SK Telecom. After the merger, SK Hynix would become a 1-tier subsidiary of SK Holdings, and thus, can be more active in JVs and acquisitions.

You are currently reading Executive Summaries of Smartkarma Insights.

Want to read on? Explore our tailored Smartkarma Solutions.

Brief Value Investing: Nedbank: Castigation Towards Junk and more

By | Daily Briefs, Value Investing

In this briefing:

  1. Nedbank: Castigation Towards Junk
  2. ITC IN
  3. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis
  4. Cafe De Coral (341): Time to Go Long
  5. Cosco Shipping (517 HK): Stock +6% YTD; 74 Managers Should Start to Care About Unlocking Value

1. Nedbank: Castigation Towards Junk

Nedbank%20group%202019%20annual%20results%20presentation page 32

South Africa continues to face well-documented challenges and risks. In their earnings presentation earlier this month, beleaguered lender Nedbank (NED SJ) puts a “more of the same” scenario at 50% for the next few years- a grey, twilight or penumbra zone of lacklustre GDP growth, moderate inflation, high single-digit credit growth,  and elevated interest rates. In this scenario, the vexing land question remains in the background, rearing its head now and again, while initiatives to stem corruption continue and Eskom’s finances remain perilous with load-shedding at level 1 and 2. Management at Nedbank seems resigned to the Moody’s downgrade but believes that a great deal is already priced-in. Of course this could all look a lot better with a full embrace of structural reform, policy certainty, public finance improvement, enhanced business and consumer confidence, more investment and less joblessness. The bank apportions a 10% chance to a high stress scenario over the next few years, underpinned by negative news on land reform and corruption, and a 20% probability of a much more benign scenario which is conditioned by better public finances, an Eskom turnaround, and the unlikely eschewing of a downgrade.

In November, Moody’s flagged load-shedding, a ballooning public debt and budget deficit, inequality and slow economic growth as among the risk factors that could lead to the country being downgraded. Since then, those risk factors have not got any better and are likely to be exacerbated by the economic downturn as a result of Covid-19. The yield on the 10-year South African government bonds spiked to above 12% on Monday. That means the government will have to pay billions more in interest to pay for local roads, hospitals, and services. Wider deficits and additional borrowing are a risk as elsewhere given Covid-19. A Moody’s decision could happen tomorrow. It would be one of the most telegraphed and torturous downgrades of all time.

Steven Holden at CFR shows that GEM managers have reduced positions in South African equities and are looking elsewhere broadly. Pending “junk” status means outflows as bond investors look elsewhere if they have not already made the decision. Fortunately, most of South Africa’s debt is rand-denominated. So even with the rand’s recent slump (from below R15/$ a month ago to near R17.54 currently), this will not threaten its ability to settle its debt. Many other emerging markets are not in the same position.

The collapse in the price of oil is a welcome tailwind.

South Africa has a relatively robust and well-regulated Banking System. Bank shares which “normally” trade at premium valuations, have not showed up as this cheap versus other EM peers for a very long time. First Rand is a highly prudent well-managed lender while Standard Bank always struck us as innovative but circumspect. These are Investment Grade banks trading at a junk rating now. Their relative valuations are a great deal more interesting today. But Nedbank, an inferior lender, is just too cheap to ignore as its share price has become overly detached from the others.

With such a disappointing, if not somewhat despondent, backdrop with a few positive drivers, it may seem counter-intuitive to recommend shares of a South African bank. But there is a price for everything and shares of Nedbank are at distressed levels.The pan-African franchise is struggling and is valued at zero under current valuation.

Shares trade on a Dividend Yield of 17% and an Earnings Yield of 30%. P/B and FV stand at 0.45x and 4%, respectively. Total Return ratio has reached 7.8x. A PH Score of 7.4 may reflect in great part the valuation but operational progress on Capitalisation, Efficiency, Provisioning, and Liquidity play a part too. Profitability though narrowed as credit costs  jumped forcefully on account of Asset Quality risks across the South African CIB franchise and as private equity holdings were revalued lower while risks in jurisdictions elsewhere in Africa (for example especially Zimbabwe but also Nigeria) where Nedbank has a presence rose and pose macro challenges going forward. 

Shares stand in the top quintile of our global VFM rankings.

2. ITC IN

Charting%20image%20export%20 %20mar%2025th%202020%2012 25 34%20pm

ITC Ltd (ITC IN) ‘s recent share price performance has been disappointing on all counts. The increase in Dividend Payout further re-iterates our view of ITC finding it a challenge to invest in other businesses, and therefore valuations now reflect that of global tobacco companies.  At current prices, the downside may be limited, but a Re-rating is unlikely. 

This Insight is labelled bearish, as we do not see any major PE Re-rating in the near term. 

3. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis

360x 1

  • Looking at 5 year average ratios vs. current ones quickly pinpoints best values in the sector in these selected tickers.
  • EV/EBITDA eliminates leverage that can sometimes mislead investors to better value companies.
  • The metric is also a good proxy for cash flow in a sector that historically can accumulate cash at a more rapid pace than many consumer discretionary categories.

4. Cafe De Coral (341): Time to Go Long

Image 49219846321585213052495

The ongoing protests against China’s ruling power over Hong Kong were the chief reason why investors left Cafe de Coral. Fundamentally, the company is not out of the woods yet, however, with China’s lockdown is soon to be over and no overseas travel to start anytime soon, mainland Chinese tourists may flock to either Macau (therefore packing up Wynn Macau Ltd (1128 HK) and Melco International Development (200 HK) or Hong Kong.

Compared to the other chain restaurant names listed in Hong Kong Hang Seng Index (HSI INDEX) , Cafe de Coral is trading at the lowest valuation and it has the lowest exposure to hotpot menu. 

The soon-to-reopen China with pent up frustrations of being locked down and less likely able to travel overseas will provide the much-needed revenue increase for Cafe de Coral. Cover your shorts and start buying. 

5. Cosco Shipping (517 HK): Stock +6% YTD; 74 Managers Should Start to Care About Unlocking Value

2h19%20revenues%20comparison%20cosco%20shipping

Cosco International Holdings (517 HK) has been a dreadful performer for years. Many would refer to it as a classic HK value trap. However, YTD the stock is up 6% which is impressive given overall equity markets performance.

The company just published its FY19 results which saw a sharp fall in revenues (-66% YoY as a business line was discontinued) but a large increase in profits (+16% YoY as associate income from various JVs increased almost 400%).

Most importantly in times of crisis is Cosco’s cash position which remains extremely large at 6.3 billion HKD (4.08 HKD/share) vs its share price at 2.2 HKD. The dividend payout ratio will be 76% which is in-line with the percentage payout the past few years. The total annual dividend yield is 7.8%. NAV/share is 5.17 HKD which means the stock trades at 0.42x NAV.

Most importantly, the company has now announced the details of its option scheme for 74 of its managers. This is the first time an option program has been announced and it is linked to higher ROE, rising operating revenue and EVA. The entire option pool is valued at 67M HKD (8.6M USD) at today’s valuation. Shareholders will have to approve the option scheme in an SGM on 06/04/20.

The question is: will this finally incentivize management to unlock value? No complicated financial engineering is needed. It is extremely straight forward. The cash balance of the company is nearly 200% higher than its current stock price. Cosco’s International Enterprise Value is NEGATIVE 2.6 billion HKD. Management can do a few things to better utilize its cash: 1) accretive M&A; 2) special dividends and 3) buybacks. All of these should increase the stock price. The biggest risk to investors is that management keeps on twiddling their thumbs and does not use its cash to create shareholder value.

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Brief Value Investing: Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks and more

By | Daily Briefs, Value Investing

In this briefing:

  1. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks

1. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks

Sk

This is a follow-up insight to answer some questions I have received during the webinar. We want to discuss key holding company regulations that are imposed upon Korean conglomerates when envisioning restructuring scenarios. In this insight, we focus on Samsung, Hyundai, and SK. We also look into which affiliates within the group would face the lowest risks upon the restructuring.

The overall objective of South Korea’s holding company regulations is to prevent operating companies from being taken advantage of to finance the group’s aggressive expansion. The relevant rules include: 

  1. If the total value of the subsidiaries that a company owns exceeds 50% of its total assets, the company is automatically converted into a holding company and becomes subject to the regulations.
    • When the company is the largest equity investor in an affiliate, this affiliate is legally perceived as a subsidiary.
    • In principle, the value of the subsidiary is implied by fair value. The fair value corresponds to the market price for listed subsidiaries and the estimated fair value for unlisted subsidiaries. However, there are some companies that recognize the value of unlisted subsidiaries as the acquisition costs, not the estimated fair value, on their unconsolidated balance sheet. In this case, the cost of acquisition is perceived as the value of the unlisted subsidiaries to calculate the ratio.
  2. Subsidiaries (operating companies) are not allowed to participate in a capital increase of holding companies and thereby create a cross-shareholding link. 
  3. Subsidiaries and holding companies are not allowed to make joint investments to acquire other firms. This regulation, along with the #2 regulation, aims to prevent subsidiaries (operating companies) from being deployed to finance the holdco’s acquisition activities.
  4. A 2-tier subsidiary should hold a 100% stake in a 3-tier subsidiary. On the other hand, a holding company is required to hold more than a 20% stake in a publicly listed 1-tier subsidiary. If it is unlisted, a holding company should hold more than a 30% stake. The same rule also applies to a 1-tier subsidiary holding a stake in a 2-tier subsidiary. 
  5. Under the general holding company structure, the holding company and affiliates are not allowed to hold a stake in financial affiliates. The amendment to allow the creation of the “intermediate” financial holding company structure had been under review but was put on hold.

The most likely restructuring scenario for Samsung Group is to split Samsung Electronics (005930 KS) into a holding company and an operating company and to merge SamE Holdco with Samsung C&T (028260 KS). Upon the holdco conversion, Samsung C&T should buy off SamE shares from Samsung Life Insurance (032830 KS). Thus, those three affiliates face uncertainty, albeit in varying degrees. Meanwhile, Samsung Sdi (006400 KS) and Samsung Electro Mechanics Co, Ltd. (009150 KS) have the least exposure to such uncertainty. In particular, Samsung SDI would expect a cash influx by selling off its subsidiary shares to SamE Holdco due to the #3 regulation.

Hyundai Group may or may not adopt the holding company structure. In either case, the restructuring would inevitably involve Hyundai Mobis (012330 KS) and Hyundai Glovis (086280 KS). However, Hyundai Motor Co (005380 KS) is rather a place of relative calm, making it scenario-neutral. Still, there would be one risk facing Hyundai Motor in case of the holdco conversion; according to the #5 regulation, Hyundai Motor should sell off its majority stakes in Hyundai Card and Hyundai Capital. However, Hyundai Motor’s vertical integration with those financial affiliates that provide consumers with car loan services is one of the company’s important differentiating strategies. Thus, the Group would find a way to deliberately avoid being automatically converted into a holding company, though it forms a de facto holdco structure.

SK Group is working on its governance restructuring such that SK Hynix (000660 KS) becomes a 1-tier subsidiary. Currently, SK Hynix, a subsidiary of SK Telecom, is a 2-tier subsidiary of SK Holdings (034730 KS). Because of that, SK Hynix had to comply with the #4 regulation, which forces the company to wholly own the acquired firms. This must have been very costly for SK Hynix to seek business expansion in an active manner. The most likely scenario for SK Group is to split SK Telecom (017670 KS) into an investment company and an operating company and then merge the investment company with SK Holdings. Upon the split, SK Hynix would be moved to the investment company of SK Telecom. After the merger, SK Hynix would become a 1-tier subsidiary of SK Holdings, and thus, can be more active in JVs and acquisitions.

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Brief Value Investing: ITC IN and more

By | Daily Briefs, Value Investing

In this briefing:

  1. ITC IN
  2. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis
  3. Cafe De Coral (341): Time to Go Long
  4. Cosco Shipping (517 HK): Stock +6% YTD; 74 Managers Should Start to Care About Unlocking Value
  5. Softbank’s Stake Sale Will Be a Good Litmus Test of Alibaba’s Valuation

1. ITC IN

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ITC Ltd (ITC IN) ‘s recent share price performance has been disappointing on all counts. The increase in Dividend Payout further re-iterates our view of ITC finding it a challenge to invest in other businesses, and therefore valuations now reflect that of global tobacco companies.  At current prices, the downside may be limited, but a Re-rating is unlikely. 

This Insight is labelled bearish, as we do not see any major PE Re-rating in the near term. 

2. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis

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  • Looking at 5 year average ratios vs. current ones quickly pinpoints best values in the sector in these selected tickers.
  • EV/EBITDA eliminates leverage that can sometimes mislead investors to better value companies.
  • The metric is also a good proxy for cash flow in a sector that historically can accumulate cash at a more rapid pace than many consumer discretionary categories.

3. Cafe De Coral (341): Time to Go Long

Image 26628375121585206598860

The ongoing protests against China’s ruling power over Hong Kong were the chief reason why investors left Cafe de Coral. Fundamentally, the company is not out of the woods yet, however, with China’s lockdown is soon to be over and no overseas travel to start anytime soon, mainland Chinese tourists may flock to either Macau (therefore packing up Wynn Macau Ltd (1128 HK) and Melco International Development (200 HK) or Hong Kong.

Compared to the other chain restaurant names listed in Hong Kong Hang Seng Index (HSI INDEX) , Cafe de Coral is trading at the lowest valuation and it has the lowest exposure to hotpot menu. 

The soon-to-reopen China with pent up frustrations of being locked down and less likely able to travel overseas will provide the much-needed revenue increase for Cafe de Coral. Cover your shorts and start buying. 

4. Cosco Shipping (517 HK): Stock +6% YTD; 74 Managers Should Start to Care About Unlocking Value

2h19%20revenues%20comparison%20cosco%20shipping

Cosco International Holdings (517 HK) has been a dreadful performer for years. Many would refer to it as a classic HK value trap. However, YTD the stock is up 6% which is impressive given overall equity markets performance.

The company just published its FY19 results which saw a sharp fall in revenues (-66% YoY as a business line was discontinued) but a large increase in profits (+16% YoY as associate income from various JVs increased almost 400%).

Most importantly in times of crisis is Cosco’s cash position which remains extremely large at 6.3 billion HKD (4.08 HKD/share) vs its share price at 2.2 HKD. The dividend payout ratio will be 76% which is in-line with the percentage payout the past few years. The total annual dividend yield is 7.8%. NAV/share is 5.17 HKD which means the stock trades at 0.42x NAV.

Most importantly, the company has now announced the details of its option scheme for 74 of its managers. This is the first time an option program has been announced and it is linked to higher ROE, rising operating revenue and EVA. The entire option pool is valued at 67M HKD (8.6M USD) at today’s valuation. Shareholders will have to approve the option scheme in an SGM on 06/04/20.

The question is: will this finally incentivize management to unlock value? No complicated financial engineering is needed. It is extremely straight forward. The cash balance of the company is nearly 200% higher than its current stock price. Cosco’s International Enterprise Value is NEGATIVE 2.6 billion HKD. Management can do a few things to better utilize its cash: 1) accretive M&A; 2) special dividends and 3) buybacks. All of these should increase the stock price. The biggest risk to investors is that management keeps on twiddling their thumbs and does not use its cash to create shareholder value.

5. Softbank’s Stake Sale Will Be a Good Litmus Test of Alibaba’s Valuation

Image 11461334631585199309497

  • If Alibaba believes that its stock is under-priced, it is highly likely that the company would be interested in buying-back a larger portion of the stake sale.
  • Moreover, if Softbank also believes that Alibaba is under-priced, it’s likely that they would consider selling Alibaba’s shares through a forward contract, as they did four years ago. 

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Brief Value Investing: ActivistTalk:An Update On Bed Bath & Beyond (BBBY US) -A Bet On Management Worth Making and more

By | Daily Briefs, Value Investing

In this briefing:

  1. ActivistTalk:An Update On Bed Bath & Beyond (BBBY US) -A Bet On Management Worth Making

1. ActivistTalk:An Update On Bed Bath & Beyond (BBBY US) -A Bet On Management Worth Making

Image 55357791021582641077993

In our insight – https://www.smartkarma.com/insights/activisttalk-focus-on-bed-bath-beyond-bbby-us-why-the-market-s-skepticism-creates-opportunity – published on December 10, 2020, we highlighted the deep value proposition presented by the currently struggling US homegoods retailer Bed Bath & Beyond (BBBY US), now under the direction of newly appointed CEO Mark Tritton. Since that publication, the initial enthusiasm  that met Tritton’s appointment last November has all but evaporated following a poor 3Q FY 2019 earnings report and disappointing 4Q 2019 update. But, with Tritton only just getting his feet under the BBBY table and still in the process of building up his leadership team expected to be completed soon, having purged the core of the old executive management team, we believe these setbacks will prove temporary with the company in transition.

Our valuation  thesis and assumptions set out and explained below suggest significant share price upside – based on a rebound to a 6X-7X FY 2021 EBITDA multiple range –  we assess a share price value gap of ~135%-185% from the prevailing BBBY share price over the next 2 years, with the potential for greater upside should sales performance and margin recovery surprise on the upside. At the same time, investors have the benefit of a ~6% dividend yield which is ~3X covered by Free Cash Flow while waiting for the turnaround to take hold. 

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Brief Value Investing: Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis and more

By | Daily Briefs, Value Investing

In this briefing:

  1. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis
  2. Cafe De Coral (341): Time to Go Long
  3. Cosco Shipping (517 HK): Stock +6% YTD; 74 Managers Should Start to Care About Unlocking Value
  4. Softbank’s Stake Sale Will Be a Good Litmus Test of Alibaba’s Valuation
  5. Italian Banks: Credit and Sovereign Bond Risks

1. Gaming Stocks: EV/EBITDA Metric Reveals Best Bets in Battered Sector During Virus Crisis

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  • Looking at 5 year average ratios vs. current ones quickly pinpoints best values in the sector in these selected tickers.
  • EV/EBITDA eliminates leverage that can sometimes mislead investors to better value companies.
  • The metric is also a good proxy for cash flow in a sector that historically can accumulate cash at a more rapid pace than many consumer discretionary categories.

2. Cafe De Coral (341): Time to Go Long

Image 49219846321585213052495

The ongoing protests against China’s ruling power over Hong Kong were the chief reason why investors left Cafe de Coral. Fundamentally, the company is not out of the woods yet, however, with China’s lockdown is soon to be over and no overseas travel to start anytime soon, mainland Chinese tourists may flock to either Macau (therefore packing up Wynn Macau Ltd (1128 HK) and Melco International Development (200 HK) or Hong Kong.

Compared to the other chain restaurant names listed in Hong Kong Hang Seng Index (HSI INDEX) , Cafe de Coral is trading at the lowest valuation and it has the lowest exposure to hotpot menu. 

The soon-to-reopen China with pent up frustrations of being locked down and less likely able to travel overseas will provide the much-needed revenue increase for Cafe de Coral. Cover your shorts and start buying. 

3. Cosco Shipping (517 HK): Stock +6% YTD; 74 Managers Should Start to Care About Unlocking Value

517%20hk%20company%20overview%20march%202020

Cosco International Holdings (517 HK) has been a dreadful performer for years. Many would refer to it as a classic HK value trap. However, YTD the stock is up 6% which is impressive given overall equity markets performance.

The company just published its FY19 results which saw a sharp fall in revenues (-66% YoY as a business line was discontinued) but a large increase in profits (+16% YoY as associate income from various JVs increased almost 400%).

Most importantly in times of crisis is Cosco’s cash position which remains extremely large at 6.3 billion HKD (4.08 HKD/share) vs its share price at 2.2 HKD. The dividend payout ratio will be 76% which is in-line with the percentage payout the past few years. The total annual dividend yield is 7.8%. NAV/share is 5.17 HKD which means the stock trades at 0.42x NAV.

Most importantly, the company has now announced the details of its option scheme for 74 of its managers. This is the first time an option program has been announced and it is linked to higher ROE, rising operating revenue and EVA. The entire option pool is valued at 67M HKD (8.6M USD) at today’s valuation. Shareholders will have to approve the option scheme in an SGM on 06/04/20.

The question is: will this finally incentivize management to unlock value? No complicated financial engineering is needed. It is extremely straight forward. The cash balance of the company is nearly 200% higher than its current stock price. Cosco’s International Enterprise Value is NEGATIVE 2.6 billion HKD. Management can do a few things to better utilize its cash: 1) accretive M&A; 2) special dividends and 3) buybacks. All of these should increase the stock price. The biggest risk to investors is that management keeps on twiddling their thumbs and does not use its cash to create shareholder value.

4. Softbank’s Stake Sale Will Be a Good Litmus Test of Alibaba’s Valuation

Image 66732771721585199309496

  • If Alibaba believes that its stock is under-priced, it is highly likely that the company would be interested in buying-back a larger portion of the stake sale.
  • Moreover, if Softbank also believes that Alibaba is under-priced, it’s likely that they would consider selling Alibaba’s shares through a forward contract, as they did four years ago. 

5. Italian Banks: Credit and Sovereign Bond Risks

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  •  In this report we look at sovereign bond exposure and credit risk for the Italian banks
  • The leading Italian banks have reduced banking book exposure to domestic sovereign bonds, and the ECB’s recent QE announcements and action should help to support Italian sovereign bond prices in the near term at least
  • Credit quality is set to deteriorate going forward, but the ECB’s mitigating measures should help in the light of the coronavirus
  • We look at bank CDS spreads as a measure of risk, and reiterate our positive view on Unicredit, and see deep value at Banco BPM
  • We also look at the latest coronavirus trends in Italy, which we believe are encouraging
  • Risks to our view are that these data and ratios are based on the latest static data-points available; these “snapshots” of the Italian bank balance sheets are set to worsen going forward, and the real risk is that in the near term they could be worse than – the already bearish – market expectations impacting cost of risk and returns yet more adversely

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Brief Value Investing: Itausa (ITSA4 BZ): Less Bearish, but Still Cautious and more

By | Daily Briefs, Value Investing

In this briefing:

  1. Itausa (ITSA4 BZ): Less Bearish, but Still Cautious
  2. Nakilat – 4Q19 Result Update
  3. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks
  4. ActivistTalk:An Update On Bed Bath & Beyond (BBBY US) -A Bet On Management Worth Making

1. Itausa (ITSA4 BZ): Less Bearish, but Still Cautious

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  • Itausa-Investimentos Itau-Pr (ITSA4 BZ) has performed broadly in line with its largest holding Itau Unibanco Holding Sa (ITUB4 BZ) since September end 2019
  • Despite Itausa’s attractive dividend yield, the payout on 2019 earnings has decreased and we think that this is not compelling
  • The NAV discount has widened recently, but may widen a bit further in the short term should a near-term market recovery drive a rally in Itau Unibanco; the discount remains below the long-run average
  • Risks to our cautious view include better than expected performance in the invested companies, especially Itau Unibanco Holding Sa (ITUB4 BZ) 

2. Nakilat – 4Q19 Result Update

Nakilat%20fair%20value%20calculation

Vessel acquisitions drive strong results

Nakilat delivered strong 4Q19 results driven by vessels acquisitions in October 2019. We believe an attractive opportunity has emerged to own Nakilat stock post its recent decline. The company is well positioned to withstand the ongoing weakness in LNG shipping prospects given its solid revenue backlog.

3. Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks

Sk

This is a follow-up insight to answer some questions I have received during the webinar. We want to discuss key holding company regulations that are imposed upon Korean conglomerates when envisioning restructuring scenarios. In this insight, we focus on Samsung, Hyundai, and SK. We also look into which affiliates within the group would face the lowest risks upon the restructuring.

The overall objective of South Korea’s holding company regulations is to prevent operating companies from being taken advantage of to finance the group’s aggressive expansion. The relevant rules include: 

  1. If the total value of the subsidiaries that a company owns exceeds 50% of its total assets, the company is automatically converted into a holding company and becomes subject to the regulations.
    • When the company is the largest equity investor in an affiliate, this affiliate is legally perceived as a subsidiary.
    • In principle, the value of the subsidiary is implied by fair value. The fair value corresponds to the market price for listed subsidiaries and the estimated fair value for unlisted subsidiaries. However, there are some companies that recognize the value of unlisted subsidiaries as the acquisition costs, not the estimated fair value, on their unconsolidated balance sheet. In this case, the cost of acquisition is perceived as the value of the unlisted subsidiaries to calculate the ratio.
  2. Subsidiaries (operating companies) are not allowed to participate in a capital increase of holding companies and thereby create a cross-shareholding link. 
  3. Subsidiaries and holding companies are not allowed to make joint investments to acquire other firms. This regulation, along with the #2 regulation, aims to prevent subsidiaries (operating companies) from being deployed to finance the holdco’s acquisition activities.
  4. A 2-tier subsidiary should hold a 100% stake in a 3-tier subsidiary. On the other hand, a holding company is required to hold more than a 20% stake in a publicly listed 1-tier subsidiary. If it is unlisted, a holding company should hold more than a 30% stake. The same rule also applies to a 1-tier subsidiary holding a stake in a 2-tier subsidiary. 
  5. Under the general holding company structure, the holding company and affiliates are not allowed to hold a stake in financial affiliates. The amendment to allow the creation of the “intermediate” financial holding company structure had been under review but was put on hold.

The most likely restructuring scenario for Samsung Group is to split Samsung Electronics (005930 KS) into a holding company and an operating company and to merge SamE Holdco with Samsung C&T (028260 KS). Upon the holdco conversion, Samsung C&T should buy off SamE shares from Samsung Life Insurance (032830 KS). Thus, those three affiliates face uncertainty, albeit in varying degrees. Meanwhile, Samsung Sdi (006400 KS) and Samsung Electro Mechanics Co, Ltd. (009150 KS) have the least exposure to such uncertainty. In particular, Samsung SDI would expect a cash influx by selling off its subsidiary shares to SamE Holdco due to the #3 regulation.

Hyundai Group may or may not adopt the holding company structure. In either case, the restructuring would inevitably involve Hyundai Mobis (012330 KS) and Hyundai Glovis (086280 KS). However, Hyundai Motor Co (005380 KS) is rather a place of relative calm, making it scenario-neutral. Still, there would be one risk facing Hyundai Motor in case of the holdco conversion; according to the #5 regulation, Hyundai Motor should sell off its majority stakes in Hyundai Card and Hyundai Capital. However, Hyundai Motor’s vertical integration with those financial affiliates that provide consumers with car loan services is one of the company’s important differentiating strategies. Thus, the Group would find a way to deliberately avoid being automatically converted into a holding company, though it forms a de facto holdco structure.

SK Group is working on its governance restructuring such that SK Hynix (000660 KS) becomes a 1-tier subsidiary. Currently, SK Hynix, a subsidiary of SK Telecom, is a 2-tier subsidiary of SK Holdings (034730 KS). Because of that, SK Hynix had to comply with the #4 regulation, which forces the company to wholly own the acquired firms. This must have been very costly for SK Hynix to seek business expansion in an active manner. The most likely scenario for SK Group is to split SK Telecom (017670 KS) into an investment company and an operating company and then merge the investment company with SK Holdings. Upon the split, SK Hynix would be moved to the investment company of SK Telecom. After the merger, SK Hynix would become a 1-tier subsidiary of SK Holdings, and thus, can be more active in JVs and acquisitions.

4. ActivistTalk:An Update On Bed Bath & Beyond (BBBY US) -A Bet On Management Worth Making

Image 55357791021582641077993

In our insight – https://www.smartkarma.com/insights/activisttalk-focus-on-bed-bath-beyond-bbby-us-why-the-market-s-skepticism-creates-opportunity – published on December 10, 2020, we highlighted the deep value proposition presented by the currently struggling US homegoods retailer Bed Bath & Beyond (BBBY US), now under the direction of newly appointed CEO Mark Tritton. Since that publication, the initial enthusiasm  that met Tritton’s appointment last November has all but evaporated following a poor 3Q FY 2019 earnings report and disappointing 4Q 2019 update. But, with Tritton only just getting his feet under the BBBY table and still in the process of building up his leadership team expected to be completed soon, having purged the core of the old executive management team, we believe these setbacks will prove temporary with the company in transition.

Our valuation  thesis and assumptions set out and explained below suggest significant share price upside – based on a rebound to a 6X-7X FY 2021 EBITDA multiple range –  we assess a share price value gap of ~135%-185% from the prevailing BBBY share price over the next 2 years, with the potential for greater upside should sales performance and margin recovery surprise on the upside. At the same time, investors have the benefit of a ~6% dividend yield which is ~3X covered by Free Cash Flow while waiting for the turnaround to take hold. 

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