It has reached the midpoint of The Edge Singapore’s top 10 global stock picks for this year. To recap, we started with a portfolio of 10 stocks in 2020, which returned 98.1% for the year. This year, we recommended 10 stocks, consisting partially of the previous year’s stocks picks and new stock picks. The portfolio inception date was on Jan 24, 2020, while the 2021 portfolio start date was on Feb 18. This portfolio accounts for capital changes and dividends but not for exchange rate fluctuations and transaction costs, to make it simpler in tracking the performance.
Chart 1 shows the individual performance of each of the stocks for the 2021 portfolio while Chart 2 shows the overall performance of the portfolio against other benchmarks. Table 1 shows the holdings of the portfolio as at Aug 18 before the changes while Table 2 shows the current holdings of the portfolio with the most recent portfolio updates.
Accounting for capital changes and dividends, our 2021 portfolio performed strongly for the six-month period of Feb 18 to Aug 18 despite having four losers in the portfolio. The top performer was Kier Group with 94.2% returns while the worst performer was Vertex Pharmaceuticals with a 7.2% loss. With 25.1% returns, our portfolio outperformed every other benchmark comfortably. We replaced two stocks in the portfolio with two new names and the gains from the sale will be retained and not reallocated until next year when the one-year period has lapsed. We will try to allocate as close to 10%, if possible, to the 2 new stocks, similar to the initial allocation on Feb 18.
Disclaimer: This is a private 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.
We have decided to take profits for Kier Group and Ted Baker, both of which were turnaround stocks and represented the highest-risk stocks in the portfolio. To replace them, we have Tokyo-listed Nexon Co and Hong-Kong listed New Oriental Education & Technology Group, both of which are high-risk counters. This is to ensure the portfolio is balanced with stocks of varying risks consisting of stable dividend-paying stocks, value investing stocks, growth stocks, high-yield stocks and turnaround stocks.
Kier Group returned 94.2% for the six-month holding period which is decent returns for a turnaround stock within the timeframe. The rationale for letting go of Kier is because the target returns were well met, which was to return 50% over four to six quarters. Kier is a turnaround company and not a buy and hold company, hence it is imperative that it is sold once targets are met.
More importantly, it is about sticking to the investment plan and practising investing discipline. Although the company is showing good progress in cutting its debt and turning around its business, the recent spike in Covid-19 cases is likely to cause slowdowns and delays in Kier’s business and might negatively impact the company’s order book over the short-term.
Furthermore, labour shortage issues might be a problem and Kier might have to redirect funds set for debt reduction into operating expenses. Overall, the impact is uncertain and volatility in share price is expected but the risk is less calculated if the share price has gone up significantly.
Ted Baker returned 54.4% for the six-month holding period which is good returns for a turnaround stock within the timeframe. The rationale for selling Ted Baker is the same as Kier — the target returns were met, which in this case was 50% over four to eight quarters. Some stocks have short-term holding periods and this company is one of them. Ted Baker has shown decent progress through the new management, for example through its online business strategy and signing of licence agreements.
However, the company’s recently-issued profit warning indicates that sales are not up to par and margins across its business segments were relatively lower than expected though they have made some progress since the worst. The outlook for the company’s sales also appears to be underwhelming as the company is struggling to sell its products at full price. Overall, the company could very well go back to its multi-year trend of declining profits and that is a risk we are not willing to take.
Worth the risk
The first of our new additions is New Oriental Education & Technology Group (NOET). The highest risk stocks are usually the turnarounds and sometimes, some stocks might be trading at really cheap valuations despite their mediocre fundamentals. This is usually caused by the market overreacting to negative news pertaining to the company or a series of consistently underwhelming news compared to expectations.
Hong-Kong listed NOET is the largest private educational services provider in China. NOET covers online education in its business and is one of China’s most recognised brands in private education.
In light of recent news regarding the Chinese government’s policies on education and online education, companies such as NOET have been hit hard due to restrictive policies. Government-led price controls on core academic subjects, along with bans on holiday and weekend tutorial services, are some of the key updates on the state’s new policy on education.
Demand for the Chinese for-profit tutoring industry, which was previously substantial, is expected to see a plunge as the Chinese government aims to promote the healthy development of students and institute more regulatory control on the education sector. Business-wise for the companies, they are not allowed to accept overseas investments nor seek to raise capital through the stock market.
Overall, this news is negative to education companies like NOET as the company is left to make profits from a limited and regulated space.
To put the impact of this news into perspective, NOET has fallen more than 90% from its February highs, largely due to very bleak projected prospects of the company. The measures are indeed harsh and will impact the financials of the company adversely. NOET has had more than 10 years of steadily growing revenue with positive net income, operating cash flow and free cash flow, which reflects well on the company’s fundamentals.
However, the challenge is to assess the impact of these regulations to the company. It is projected that the company’s revenue could drop by 75% if the situation gets worse while enrolments are expected to drop by 60%. The regulations apply to the major and other selected cities, and prices of education services are expected to drop by about 50%.
Yet, as consumer demand for education services is high, the student enrolments are expected to be higher on weekdays. Furthermore, NOET could expand into lower-tier cities for their education services, of which already makes up close to 70% of the company’s education services outlets.
The takeaway is that although revenue is expected to decline significantly, the margins and profitability of the company will likely not be as severely impacted. For example, the increased regulatory surveillance and control could lead to cuts in promotional and marketing related expenses, which can boost the company’s margins. As it stands, the impact of NOET’s share price appears to be moving as if the worst-case actually crystallised, taking into account projections for the next three years.
We think a 90% drop in price is mostly driven by fear as the projected figures for the decline in fundamentals, even with worst-case scenario figures is realistically much lesser than the impact to the share price, which has climbed steadily and tantamount to the fundamental growth of the company over the past 10 years. Currently, the analyst consensus for the company post-assessing the impact of the regulations is a 60% upside from its current price for the next 12 months.
In a nutshell, we think that this stock should have tanked following announcement of the regulation but not as much. Afterall, investing is sometimes about picking companies that have a divergence in their fundamentals and share price and, in this case, if the decline in price is significantly more than the projected drop in fundamentals, it is worth the risk, at least over the short-term.
Recovery play
The other company that we have added to our portfolio is Nexon Co. Companies are bound to face headwinds but it is important the business has a plan to handle the headwinds or a recovery plan for it to be considered investment material.
Tokyo-listed Nexon develops online games for PCs and other devices, along with offering consulting related services for online games globally. With gaming companies, margins are important, which can be improved through the release of new gaming titles through innovation, or offering in-game services which can be monetized. Nexon’s moat stems from its long operating gaming franchises with over 10 years in service and having a global reach.
Nexon has been facing trouble with its business, for example through slowdowns in the release of its key gaming titles. The company has also seen a significant reduction in its growth outlook as weakness in these gaming titles did not compare well against previous-year comparable figures. This impacted the share price negatively, which has seen a 40% drop since its April highs. Nexon is a recovery play and we think the company has what it takes to recover from its poor performance in the most recent quarter.
Nexon’s capacity to recover is predicated on its focus of maintaining the performance of its key established franchises, for example through additional in-game offerings and content updates, along with launches for new platforms. On the growth front, the company’s pipeline of new gaming title releases for multiple platforms is a good catalyst for the company to recover over the short and medium-term.
The company’s fundamentals are strong too, with 10 years of revenue growth and positive net income, operating cash flow and free cash flow. The focus on offering games on different platforms from its established franchises is also strategic as its players are steadily converting from the conventional PC platform to mobile gaming platforms.
Additionally, Nexon has partnered with peers to create and distribute games based on their individual franchises. This will allow Nexon to expand beyond its core markets which are in China, South Korea and Japan. The focus on developing games for other platforms, particularly mobile, should enable the company to maintain its moat for its established key franchises. Nexon is trading at a good discount to its global peers, with a 12%, 8% and 11% discount for its Price to Earnings (P/E), Enterprise value to Earnings before interest, taxes, depreciation and amortisation (EV/Ebitda) and Price to Book (P/B) respectively.
The company’s balance sheet is solid, with a current ratio of 10 times and a net cash position. The company’s fundamental yields are also very attractive compared to the Japanese 10-year risk-free rate of 0.01%, with an earnings yield and free cash flow yield of 2.2% and 4.2% respectively.
The plunge in share price provides a good opportunity for investors to purchase the business at a cheap price. Nexon isn’t exactly a short-term turnaround play per se, as its fundamentals are strong with good long-term prospects. The analyst consensus for the company is a 35% upside from its current price over the next 12 months with no “sell” calls.
Nexon is a great company that has been in the business for close to 30 years and this short-term hiccup is not a sign of eroding fundamentals and moats but instead a good buying opportunity as the company is adapting to the challenges it is facing.
Photo Credit: Bloomberg
