SINGAPORE (Apr 22): Let me start by wishing our Christian readers a blessed Easter.
This week, I would like to take a bit of space to explain why we recently disposed of several of our investments, some at a loss. We make big mistakes too, and it highlights the limitations of investing based on data analytics.
We decided to cut our losses in DIP Corp, a stock that we have held since the inception of this portfolio. It operates the largest web portal and mobile application for part-time and temporary jobs in Japan.
The stock has performed poorly in the past one year, falling to as low as ¥1,665 during the global selloff in late-December 2018. Prices have since rebounded slightly, but remain well off the high of nearly ¥3,600 this time last year.
Its persistent share-price weakness had been puzzling to us — the company reported good earnings for the first three quarters of FY2019 ended February. Sales grew 10.5% y-o-y and net margin improved to 20.8% from 19.8% in 9MFY2018. Price-to-earnings valuations are hovering in the low teens and management raised dividend forecast from ¥43 in FY2018 to ¥49 a share for the current FY.
Recently, however, we have been reading some narratives on the Japanese labour market dynamics that could explain DIP’s lacklustre performance, specifically how the very tight job market is dampening the company’s future outlook instead of having the opposite effect, as we expected.
We believed that Japan’s economic recovery and ageing demographics would create more vacancies, which would be matched by the emerging trend of young workers and retirees opting for flexible part-time and casual jobs — and this fits nicely with the business model of DIP.
However, as the unemployment rate continued to decline, now at multi-decades low of 2.4%, owing to its ageing population and low childbirth rate, companies are finding it increasingly harder to fill these positions. According to recent labour ministry data, there are 163 jobs for every 100 jobseekers.
As a result, businesses have had to resort to hiring full-timers, offering better pay and benefits. And young workers are responding by shifting into full-time jobs.
DIP’s digital platform is an effective and cost-efficient means of matching market supply and demand compared with traditional print ads. It gains from economies of scale, owing to low marginal cost and, as usage increases, from the network effects.
Unfortunately, this business model breaks down when constrained by the shrinking pool of part-time and casual jobseekers — and accordingly, fewer job ads. Just this month, the industry minister urged convenience stores to cut back the typical 24-hour operating policies, owing to severe worker shortage. This could further undermine demand for part-timers and ad placements.
Given the intense competition in the relatively fragmented online job ads industry, DIP may be faced with more pricing pressure ahead. The company is looking to diversify into other areas of growth, but there is little clarity at this point in time.
Japan has a major structural problem in which its population is expected to keep shrinking for decades to come, owing to an increase in the number of deaths coupled with low birth rates. The situation is dire enough that it is now opening its doors to more foreign labour. This is a major policy shift for a country that has long held on to a deeply conservative immigration stance.
It is hard to see how domestic companies can grow sales and margins under such a macro scenario, except maybe those catering to funeral services, even if current valuations appear cheap.
By contrast, our decision to lock in profits on China Sunsine Chemical Holdings was attributed less to a change in its underlying fundamentals and more to a timing issue.
The company performed remarkably well in 2017 and 2018, capitalising on China’s more stringent environmental policies. Many smaller competitors failed to meet the tightened standards, resulting in temporary shutdowns and production disruptions that pushed product prices sharply higher in the previous couple of years.
China Sunsine’s average selling price rose 29% y-o-y in 2017 and a further 11% in 2018. Sales grew 34% and 20% in the two years respectively, while net profit jumped from RMB221.7 million in 2016 to RMB341.4 million in 2017 and further to RMB641.2 million ($129.6 million) in 2018.
However, selling prices have started to normalise in 4Q2018 and are expected to fall through the better part of 2019. In addition to supply recovery as players improve their environmental and safety measures, prices are seeing downward pressure from slowing domestic demand and lower raw material costs.
For instance, new car sales — which account for about one-third of tyre demand — have been on a downtrend. Volume sales were down 2.8% y-o-y in 2018 and fell 15% y-o-y in the first two months of this year. Preliminary data shows passenger car sales continued to drop in March, by about 12%. The Chinese government has announced tax cuts to boost consumer incomes and spending. Car sales could recover later in the year.
But in the meantime, China Sunsine has indicated that it will pursue a volume growth strategy, which could suggest greater price competition in the months ahead.
Over the longer term, we remain confident that the company will maintain its market leading position — and even benefit from any industry consolidation resulting from the prevailing challenging environment. Its balance sheet is strong, with net cash of over RMB1 billion. And investors can count on dividend income stream, although quite possibly lower than the 5.5 cents paid in 2018.
But expectations of weaker sales, margins and earnings this year are likely to keep a lid on potential upside in the near term.
This is also the reason we sold our shares in Nine Dragons Paper Holdings. Like China Sunsine, Nine Dragons benefited from sharply higher paper prices after China imposed stricter regulations over the quality of recycled paper imported into the country.
As the leading producer, the company is still able to import lower-cost recycled paper through government-issued quotas, though there are indications that all imports of “solid waste” will be banned by year-end.
Still, overall raw material costs have risen as more domestic old corrugated containers (OCC) are used. Meanwhile, demand for packaging boxes has weakened, owing to China’s economic slowdown as well as the ongoing trade dispute with the US — forcing producers to absorb the higher costs.
Nine Dragons has begun diversifying its geographical operations, for example, by buying pulp mills in the US and expanding plants in Vietnam. These have also resulted in higher operating costs.
As a result, net profit fell 48% y-o-y in 1HFYJune2019 to RMB2.26 billion. Margins may improve in 2HFY2019, but full-year net profit will remain far below FY2018’s record RMB7.8 billion. As with China Sunsine, we have no doubt its longer-term prospects are positive, but upside could be limited in the near term.
As a small equity investor, one advantage is that you can sell the stocks due to a change in short-term market dynamics even if you still like the companies. In other words, besides the long-term sustainable fundamentals of the companies, timing to buy and sell is an important consideration too.
The Global Portfolio gained 0.8% for the week ended April 17, boosted by the surge in The Walt Disney Co’s share price. Total portfolio returns stand at -0.5% since inception. By comparison, the benchmark MSCI World Net Return Index is up 5.5% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
