The Collapse of the Baltic Dry Index

My last update on the Baltic Dry Index was on May 17th 2008, Baltic Dry Index Soars Due to Quake Factor!

The Baltic Dry Index then was 11,459 points.

However things have not gone rosy for this sector since.

Last night the Baltic Dry Index was at 9419, down some 227 points or 2.3%.

And the following chart shows the terrible plunge in the index.


Trouble started on June 11th 2008.

• Drybulk index posts largest-ever 1 day drop
  Key drybulk index posts largest-ever 1 day drop as demand sinks for largest drybulk vessels
  June 12, 2008: 03:03 PM EST
  
  NEW YORK (Associated Press) - A key shipping index measuring drybulk vessel activity posted its largest one-day drop Thursday, dragged down as rates for the sector's biggest ships lost significant ground.
  
  The Baltic Dry Index, which measures drybulk shipping rates on 40 routes across the world, sank 963 points Thursday to reach 10,142. The index had wavered, but remained above 11,000, since hitting an all-time high on May 20 of 11,793. The index, managed by the Baltic Exchange in London, had previously posted its biggest one-day skid of 443 points on Jan. 17.
  
  The index's reading for Capesize vessels _ the largest drybulk carriers _ fell 16 percent. The average Capesize vessel now costs about $180,000 per day, compared with prices of more than $230,000 per day last week. Capesize vessels are so named because they are too big to fit through the Suez or Panama canals, and must instead sail around the Cape of Good Hope or Cape Horn to travel between oceans.
  
  Cantor Fitzgerald analyst Natasha Boyden said in an interview the significant drop was the result of Chinese iron ore importers working through their stock piles of the commodity instead of bringing more into the country. With the huge demand for iron ore, steel and other commodities carried by drybulk ships soaring, Boyden said Chinese importers turned to their own supplies as ports clogged and drybulk rates skyrocketed.
  
  But Fitzgerald noted that the Chinese only have about three to four weeks worth of iron ore stockpiled. After its resources are used up, Boyden said drybulk ships will again be in high demand to deliver goods to the country.
  
  "This (pull back) is merely temporary," she said. "Painful, but temporary."
  
  JPMorgan analyst Jonathan Chappell said in a client note that he expects the Baltic Dry Index to continue to fall through the third quarter, as the typically slow period will be compounded by an expected lull in trading around the Beijing Olympics and further draw downs of existing inventory by Chinese steelmakers.
  
  Although drybulk's decline should not be as significant as the slip seen from November to January, Chappell suggests that investors hold off until a buying opportunity emerges in the fourth quarter.
  
  In afternoon trading, shares of DryShips Inc. fell $6.44, or 8.3 percent, to $71. Navios Maritime Inc. lost 27 cents, or 2.8 percent, to $9.52, while Danaos Corp. gave up 70 cents, or 3 percent, to $22.83.
  
  Genco Shipping and Trading Ltd. sank $4.51, or 7.9 percent, to $52.85. Diana Shipping Inc. pulled back $1.17, or 3.9 percent, to $29.
  
  Excel Maritime Carriers Ltd. retreated $4.21, or 10.3 percent, to $36.60, and Eagle Bulk Shipping Inc. slipped $2.32, or 8.1 percent, to $26.21.
  
  Euroseas Ltd. fell 27 cents, or 2.1 percent, to $12.92.

Here are some other news clip offering clues to what's happening.

• Baltic Dry index fall hits shipping cos
  
  14 Jun, 2008, 0050 hrs IST,Sumantra Das, ET Bureau
  
  MUMBAI: The Baltic Dry Bulk index, the shipping index barometer for dry bulk vessel activity globally, on Thursday plunged 8.7% on Thursday after China ordered ports to cut iron ore stockpiles, impacting shipping stocks adversely.
  
  Analysts said the index is down 963 points from its record close of 11,793 reached on May 20, 2008. On Thursday, the index touched 10,142. Shipping Corporation of India lost 3.10% to Rs 244.10, Great Eastern Shipping (GE Shipping) declined almost 4% to Rs 433.40, while Mercator ended flat at Rs 114.25 on the bourses.
  
  The Baltic Dry Index is a measure of commodity shipping costs. It represents the cost paid by an end user to have a shipping company transport raw materials across seas on the Baltic Exchange, the global marketplace for brokering shipping contracts commodities on 40 routes across the world. The index, managed by the Baltic Exchange in London, had previously posted its biggest one-day skid of 443 points on January 17, 2008.
  
  According to a Mumbai-based analyst, the Baltic Dry Index is likely to continue to fall over the next three months. This may in turn impact fortunes of companies such as Shipping Corporation of India (SCI), Great Eastern Shipping and Mercator Lines. He also said that the index’s reading for Capesize vessels, the largest drybulk carriers fell almost 16% on Thursday. Currently, the average Capesize vessel charter rates are ruling at about $1,80,000 per day as compared to more than $2,30,000 per day last week.
  
  Analysts attribute the fall to China’s attempt to hoard supplies in an attempt to front-load industrial production ahead of the Olympics in August. Additionally, China’s plans to temporarily shut down many factories in an effort to limit pollution in Beijing during the games, is another factor leading to this situation.
  
  The index takes into account shipping rates over a range of shipping routes for a variety of large vessels that transport dry goods including coal, iron ore and grain around the world. The index is viewed as a proxy for global demand of raw materials. The Baltic Dry Index has surged 88% in the past year, as China’s economic growth fuels demand for steel to make cars, offices and factories.

And naturally the shipping stocks plunged as well.

• Shipping stocks in Asia plunge
  
  By Sandra Tsui and Marcus Hand - Friday 13 June 2008
  
  SHIPPING shares in Asia plummeted Friday morning following the sharp fall of the Baltic Dry Bulk Index yesterday.
  
  In Hong Kong, China Cosco, which took over its parent’s massive dry bulk fleet in January, was hardest hit. Its stock dived 8% in morning trade to HK$18.06 ($2.3).
  
  China Shipping Development, which announced a $428m order for eight 76,000 dwt panamaxes this week, lost 6% to HK$21.45 by the end of the morning session.
  
  Its affiliate, China Shipping Container Lines, although a container liner operator, was dragged down by poor sentiment and shed 4.6% to HK$3.12.
  
  Shipping analyst Stella Kei from securities house UOB Kay Hian Holdings said the June to August period is traditionally the low season for bulk shipping as volumes of steam coke and grain shrink and port congestion ease, but the sharp fall of the BDI yesterday shocked the market.
  
  Another factor contributing to the poor sentiment was that the lock-up period for the Shanghai-listed A-shares of China Cosco is due to end in two weeks.
  
  The more resilient shares so far are handysize specialist Pacific Basin, whose shares fell as much as 3.6% to HK$10.7 apiece. They recovered slightly to HK$10.86 by the close of the morning session, but were still down 2.2% from yesterday’s closing.
  
  Junhui Holdings, with most of its vessels being supramaxes, lost 2.6% to HK$4.56 a share.
  
  “Pacific Basin has already locked its profit this year and the company will record special income from vessel sales earlier this year, it is thus less affected by the BDI fall,” said Ms Kei.
  
  On the Singapore Exchange, shares in one of the world’s largest dry bulk owners and operators, South Korea’s STX Pan Ocean, fell 8.3% to S$2.77.
  
  In Thailand, despite rates holding up for smaller-sized dry bulk vessels, shares of handysize and handymax specialist Thoresen Thai Agencies fell 7.4% to Baht40.50, while Precious Shipping was flat at Baht22.60.

How?

Locally, Maybulk is the leading stock in this sector. Maybulk closed at 3.74 yesterday.

Right now, recent buyers of the stock purchased it because the Baltic Dry Index was soaring again. However, this very reason to buy the stock is no longer valid. As an investor, as a trader or as a speculator, how would you justify your position now?

OSK had a report yesterday.

Naturally some are not pleased at the way the report was made.

Randomly heard on a chatbox. "bdi go up they say wow earnings will rise. bdi crash they say nvm still got dividend can buy."

I can understand the displeasure. It's like no matter what happens, the recommendation is always a BUY.

And at this moment of time, I really do have to give credit to Chris Perruna. On my May 14th 2008 posting, Dryships, Maybulk and Dry Baltic Index (BDI), despite the incredible surge in the Baltic Dry Index, Chris wasn't a buyer of stocks in this sector! ( DryShips (DRYS) Drying up?. )

Let me quote what he wrote back then.

• All in all – I am not a buyer of the stock at this level. It may be a solid short term buy for traders that make these types of plays such as Blain and Rajin but it does not fit into my criteria for a trend trading opportunity. A challenge of new highs or a push into new high territory will change my perspective of the stock.
  
  
  

Sime Darby says "There'll be No More!"

Another thing my Granny always taught me is to learn from those that are more successful than me!!

Learn their tricks and most important learn from their mistakes!

A couple years ago, this rich man (and surely one that is more successful than me (LOL!)) , Datuk Tan, mentioned the following in his book!

• “I am already thinking about writing a book containing my favourite jokes about business and life. A couple of them are already in Never Say I Assume! For example, in an explanation of my book title, it really ought to be Never Say I Ass-u-me! because when you assume anything in business you make an 'ass' out of 'u' and 'me.' Don’t assume that there is a market for a product. Do the necessary work in advance to find out. Make sure there are enough mice before building a better mousetrap.”

Can I learn from it?

Can I?

Sure can!

In the stock market, there are so many things one cannot simply ass-u-me!

This morning, I see that Sime Darby CEO made the following press statement.

• SIME Darby Bhd's chief executive officer Ahmad Zubir Murshid ruled out further writedowns from unregulated futures trading at the Malaysian palm oil producer after the firing of the company’s finance chief.
  
  Sime Darby said on June 10 it fired chief financial officer Razidan Ghazalli and a second executive after a RM120 million trading loss at a refining division. Traders at the Golden Jomalina Food Industries unit lost the money between October 2006 and August 2007, before Kuala Lumpur-based Sime Darby bought the business in November 2007.
  
  “There’ll be no more,” Ahmad Zubir said in an interview in Kuala Lumpur today at the World Economic Forum on East Asia. “I’m a very conservative guy.”
  
  Sime Darby, formed in 1910, merged with Golden Hope Plantations Bhd and Kumpulan Guthrie Bhd in November last year to create a palm oil producer controlling about 8 per cent of global output. Golden Jomalina was owned by Golden Hope at the time of the losses.
  
  Traders broke internal rules at the unit and Sime Darby made provisions for the loss in the first half of the financial year, Ahmad Zubir said. - Bloomberg

Hmmm....

Last week the following article was posted on BTimes.

• Sime Darby’s RM120m loss: Trader goes missing
  
  By Zaidi Isham Ismail Published: 2008/06/12
  
  Company officials say the trader was one of 20 to 30 futures traders hired to sell Golden Hope’s premium crude palm oil in the open market to make higher profit
  
  SIME Darby Bhd’s RM120 million futures trading loss may have been the work of a single rogue trader who made the wrong bet and was poorly supervised.
  
  Existing and former company officials said the trader in question has since quit the company.
  
  Sime Darby has declined to comment on the matter. The trader could not be contacted.
  
  On Tuesday, Sime Darby fired two top executives after carrying out an inquiry into the trading losses at Golden Jomalina Food Industries, a subsidiary of Golden Hope Plantations Bhd.
  
  Golden Hope has since last year been merged with Kumpulan Guthrie Bhd and Sime Darby Bhd.
  
  Company officials said the trader was one of 20 to 30 futures traders employed by the company to sell Golden Hope’s premium crude palm oil (CPO) in the open market to make a higher profit.
  
  The company then buys standard quality CPO from the open market at a lower price so that it can make a better profit margin when used at its oleochemical division.
  
  That division processes CPO into value-added products like cooking oil, detergent and soap.
  
  This is a normal practice by almost all plantation companies in Malaysia to protect themselves from the vagaries of CPO’s fluctuating price.
  
  “However, he made a mistake by betting against the market since the end of 2006 by locking CPO’s selling prices at more than RM1,000 a tonne, thinking prices would go down.
  
  “Until August, however, CPO prices more than doubled and he tried to cover up the losses by counter trading but was unable to do so. As a result, the company accumulated trading losses right until the run-up to the merger late last year,” one of the officials said.
  
  Realising the loss, the rogue trader who has been a Golden Hope staff for 10 years, left without giving notice. Officials said attempts to locate him failed as the address listed in the company’s records turned out to be bogus.
  
  A former official said futures traders were poorly supervised.
  
  For instance, they did not have a limit that stopped them from trading when a certain level of loss was incurred

Hmm . the following statement in that article...

• This is a normal practice by almost all plantation companies in Malaysia to protect themselves from the vagaries of CPO’s fluctuating price.

Now I would ass-u-me, such trading still exist in Sime Darby, since these trading activities protects the planters from the fluctuating CPO prices.

Or am I making an ass out of me?

So what should I ass-u-me about Sime CEO Ahmad Zubir's "There'll be no more?"

No more trading or no more massive trading losses?

I am confused?

Macam mana ni?

Given what has happened, surely such a statement is not sufficient, yes?

So no more trading or no more massive trading losses?

And if it's no more massive trading losses, care to explain in detail how the trading activities will be supervised in the future to ensure that such an issue would happen no more?

By the way, last Thrusday, the following was published on Star Business.

• Thursday June 12, 2008
  Sime shines in transparency
  NEWS ANALYSIS
  By HANIM ADNAN
  
  SIME Darby Bhd is pushing the frontier to set higher standards in transparency and corporate governance via its stern action in sacking two senior executives said to be accountable for the RM120mil losses in futures trading at subsidiary Golden Jomalina Food Industries Sdn Bhd.
  
  The newly-merged entity is out to prove that no stones will be left unturned, especially pertaining to the irregularities in its highly-diversified operations.
  
  Most analysts viewed Sime Darby's action positively as the adoption of highest standards of governance was imperative for the protection and enhancement of stakeholders' value and the performance of the group.
  
  Kenanga Research, in its latest note, said: “The move clearly reflects the no-nonsense approach of Sime Darby in accountability of its senior management for their actions.”
  
  The brokerage is also maintaining a “buy” call on Sime Darby with a target price of RM12.90 as it expects the impact of the losses in futures trading to the group's 2008 earnings to be nil as provisions had been made earlier.
  
  Traders, meanwhile, want the Securities Commission to boost its regulatory powers and step up surveillance to curb speculation and prevent price manipulation by participants in the highly sensitive crude palm oil (CPO) futures market.
  
  The regulator must ensure market transparency by insisting on the publication of daily and weekly data showing the proportion of commercial, non-commercial and hedge funds participants to the public.
  
  “This is done in all US derivatives markets,” a trader said.
  
  Citing the losses at Golden Jomalina, he said: “I suspect a certain degree of speculation led the company to take short position to make quick profits but it backfired when the price of CPO continued to hit new all-time highs.”
  
  He said while most plantation companies took active derivatives position, they needed to draw the line on the importance of managing their risk exposure.
  
  The KPMG Forensic division tasked to undertake an investigative review on the trading losses at Golden Jomalina, however, declined to furnish the details of its audit report.
  
  Aseambankers, in its note yesterday, said: “We have cross-checked Sime's second-quarter (ended Jan 31) results and noted that RM71.6mil in losses at its downstream operation were accounted for in the first half.”
  
  The management then explained that the losses were due to higher feedstock costs and losses in its biodiesel division.
  
  For the nine months to March 31, the losses were subsequently reduced to RM22mil.
  
  “Hence, we believe that the RM120mil future trading losses may have been provided for in the first half.”
  
  Nevertheless, Aseambankers said, in the worst case scenario, if these losses were provided for in the fourth quarter, the net impact on its RM3.45bil net profit forecast for the financial year ending June 30 would be a mere 2.5%.
  
  More importantly, Sime Darby needs to address investors in detail at its upcoming briefing on how it can avert the occurrence of similar untoward incidents.
  
  Sime Darby fell 10 sen to RM9 yesterday, the lowest since June 5.

The following statement was most important in my opinion.

• The regulator must ensure market transparency by insisting on the publication of daily and weekly data showing the proportion of commercial, non-commercial and hedge funds participants to the public.

I'll give full marks to KPMG accountants for discovering this mess in Golden Hope and let me say this out loud, "If I was an investor in Golden Hope, there's no way I, the minority investor, would have discovered the potential risk in the trading activities and neither would I discover these losses!"

The following is the link to Golden Hope's last reported quarterly earnings, Quarterly rpt on consolidated results for the financial period ended 30/6/2007.

And here is the link to Sime Darby's latest quarterly earnings in May 2008, Quarterly rpt on consolidated results for the financial period ended 31/3/2008

Would the minority investor in you and I be able to spot these trading activities in both quarterly earnings report?

I simply would not be able too!

Good Investors Stay Humble

Here's a great lesson from Sun Tzu On Investing

GRANDIOSITY

Some psychologists point to a human behavioral concept called grandiosity, as the primary cause of bull markets and bubbles. Grandiosity is a very strong belief in one’s greatness, abilities, knowledge, or character. One of the earliest stories of the danger inherent in grandiosity is from the Greek myth of Daedalus. Daedalus had built a labyrinth for Minos, the King of Crete, and when it was finished he wanted to return to his home in Greece. Because Daedalus was a useful engineer, King Minos refused to allow him to leave Crete.

King Minos controlled the sea, so Daedalus and his son Icarus could think of no other escape route from the island of Crete except by air. Therefore Daedalus used his great engineering skills to fabricate wings for himself and his young son Icarus out of feathers and wax and gave the whole gentle curvature a shape like the wings of a bird. When the father and son were prepared for the escape, Daedalus warned Icarus: Keep at a moderate height, for if you fly too low the damp will clog your wings, and if too high the heat will melt them.

As the two took flight, farmers and shepherds on the hillsides watched them in amazement, believing they must be gods. Suddenly the young Icarus, exulting in his new-found ability to fly, soared upward toward the heavens. The sun’s increasing heat began to soften the wax that kept his feathers in place and Icarus plunged helplessly into the sea and drowned. Daedalus arrived safely in Sicily, where he built a temple to Apollo and hung up his wings as an offering to the god.

This Greek myth, as is common in ancient tales, has a dual lesson for us. First, the obvious danger involved when one is overcome with feelings of grandiosity. But also, the amazing accomplishments that are possible when such grandiosity is applied within the confines of rational ambitions and ideals. When investors are hot and feel they can pick nothing but winners, they tend to be overcome with grandiosity--invincible, brilliant, unable to make a mistake. They no longer feel the need to consider risks and insist on a rational margin of safety after careful evaluation within their disciplined strategy. At that point, you can almost smell their portfolio holdings melting into a ball of soft wax!

Hopefully there will be times when you feel brilliant for making some timely decisive investment moves that reward you quickly and significantly. Resist the tendency towards grandiosity. Sun Tzu-style investors control such foolish emotions, always rationally facing the fact that 40% of all investment decisions are likely to produce average or sub-average results. In other words, stay humble and you’ll stay financially healthy.

I would really agree that more often that not it is very costly to our pockets and to our souls when one is too arrogant in the market.

Knowledge is power and being confident in one's own method is extremely important but there is a very fine line between being confident and being arrogant.

When one is arrogant, naturally one feels that one is Ze Special One.

And Ze Special One is simply special. One that can pick one winner after another. And Ze Special One makes no mistake, yes? And Ze Special One needs not much of margin of safety for they are simply SPECIAL.

Hmm....but can Ze Special One be so dead sure in the share market?

Is it even possible?

Let's be honest with ourselves. Take a good look at what we are. Are we really blessed with super powers to be so-called Special One? One who could pick winners after winners all the time? If we could, we wouldn't even be lurking around in message boards, forums or blogs. Face it.. we are just ze normal ones. Sometimes we can get good winners and sometimes we will make mistakes.

By staying humble, we will at least have a chance to recognise and acknowledge a mistake, if and when we do make a mistake. And when we do, it's utmost imperial that we correct our mistake(s) immediately and not hope and pray for the market to correct our mistake(s) for life is never always that kind to all of us.
Now if one is arrogant, would one ever admit that perhaps one is wrong in their stock selection?

And since one is not wrong, obviously the danger is one would not even consider cutting loss on a wrongly reasoned investment!

And since one is not wrong, would one even consider selling even though the market is proving them wrong and the stock's tumbling prices is also proving them wrong?

See the danger in such thinking?

Me? I think it's always good to stay humble! I am just a normal bugger who can make mistakes! And when I do make the mistake(s), I will correct it ASAP!

I won't let the market make a fool out of me and me moolah!

Should The Investor Take The Safer Approach?

Dedicated to ValueLife.

There is this stock called FimaCorp.

Here is the financial data back in 2004.

Looks like a decent stock to invest in right?

On 8th March I made the following blog posting: ROI on Fima Corporation

Let me reproduce it here again.

~~~~~~~~~~~~~~~~~~~~~~~~~~~

I was asked if an investor could know 'something is wrong before it drops'.

For me, the investor could ALWAYS take some precautionary steps.

Take for example Fima Corp.

Fima Corporation, is the manufacturing arm of Kumpulan Fima. Fima Corp's core business is printing and trading security and confidential documents such as travel documents, permits and licences.

Ok.. little bit background on Fima Corp.

Now, Fima Corp has an interesting track record and if one looks at the historical track record, one would note that this company is enjoying a tremendous turnaround in its fortunes since fy2003. (err.. some might define it as growth too!)

Secondly, since the turnaround of fy 2003, look at the start of 2004 Q1 quarter. It's piggy bank then was 12.106 million. A year later at the start of 2005 Q1, it's piggy bank has now grown to 32.494 million. And come end of fy 2005 q4, its piggy bank now stood at 56.775 million. This is what I think is desired in OUR business isn't it? We want to see our business piggy bank grow! (tiok boh?)

Thirdly, business profit margins is real decent, plus its dividend is on the drastic rise too!

These are some of the criteria that an investor wants, isn't it?

So we have a decent company making big bucks... dividends is on the rise.... and perhaps one could have considered Fima Corp as an investment, rite?

So since we had reasoned that this could be a good investment, we went and purchase this stock as an investment, hoping that this investment could grow forever and ever, right? But as mentioned before, the Review of Investment is an important integral of one's investment. We need to review our investment to make sure that the stocks we are holding is still a good stock. We need to review if the very reasons to invest in the stock remains valid. We need to check if that there is any tell-tale signs that something bad might happen.

In big corporations, when things get too rosy, sometimes it is possible that the company's management could get too big headed for its own good and starts embarking on questionable funky corporate exercises in an attempt to grow the company. Company get rich, starts to lose focus...

So besides looking at the financials, we also need to gauge them corporate exercises too. If it simply gets too funky, should we be dancing and playing that funky music with them ..... ?!! :p

Anyway, back in June 2005, Fima Corp announced that its subsidiary, Percetakan Keselamatan Nasional (PKN) is buying a property for some 15 million. Nothing wrong really. Spending some 15 million in cash for a property that has existing rental income isn't too excessive. So perhaps for this exercise, one would consider this as a mere remark. Nothing more, nothing less.

However, in Aug 2005, the company announced huge plans.

• Security printing-based company, Fima Corporation Bhd, through its associated company, Giesecke & Devrient Malaysia Sdn Bhd, plans to invest about RM150 million to set up a new plant in Shah Alam, Selangor, next year. For the security printing segment, Roslan said Fima planned to spend RM20 million to replace the current machinery in order to increase its efficiency and production capacity

Hmmm... new plant... rm150 million and another rm20 mil to upgrade machinery...

First question that needs to be asked is if this project is too excessive?

Well despite its good recent track record, in fy 2004, Fimacorp made only 13 million and in fy 2005, Fimacorp only made 22 million.

How?

How would you want to rate such capex?

Do you think that such spending is required? Well, if we want Fima Corp to grow more, then the company must spend big to achieve greatness. Aiming big is good mah.

On the other hand, while it is always good to have an ambition and setting goal and targets to achieve BUT would you consider that this current project is simply way too big for their head?

Or perhaps... one should adopt the wait and see approach?

Ok. Not a problem. Now when Fima Corp announced their earnings back in Aug 2005... huge question marks began appearing.

• 1. Increase in Receivables... 12.087 million
  2. Increase in Inventories.... 6.1 million
  3. Net decrease in cash .... 7.123 million

How?

Another wait and see?

Now, present day, the Edge Weekly has an article on Fima Corp.

• Fima Corp Bhd is jumping on the plantation bandwagon by purchasing a slice of a small Indonesian palm oil outfit. In a statement on Jan 27, Fima said it will pay RM13 million for a 32.5% stake in PT Nunukan Jaya Lestari in East Kalimantan. This is part of a plan to diversify its earnings base. read more....

How?

Ok, an investment of 13 million is not a lot... but... here is my cow question... don't you really think that this company management, after achieving its recent success, has started to think way too big? Don't you think the company is really starting to lose focus? Diversification into palm oil???

How? Is this the 'something wrong before it drops'? Or should we want to continue the wait-and-see approach?

or... ahem... should the investor take SAFER approach... ?

~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Ever wonder the long term consequences of holding on to such a stock? Have a look at how the stock performed since March 8th 2006.

Ok, the stock did not fall off the cliff but if you look on the top left corner of the chart, FimaCorp on March 8th 2006 was trading at 2.37. On June 12th the stock closed at 2.25.

How?

Buying Opportunities for Warren Buffett

How does Warren Buffett define buying opportunities?

In her first book Buffettology , Mary Buffett wrote..

Warren believes that the technical mechanics of the stock market can create situations that will whipsaw security prices regardless of the underlying economics of the business. Buffett believes this irrational economic behavior can create situations that present excellent buying opportunities for the practitioner of business perspective investing, ie investing in excellent business selling at the Less Price.

This is slightly different than individual business aberrations or general business cycles created buying opportunities. This technical mechanics phenomenon is a quirk in the stock market infrastructure that occurs because of the ways and methods that securities are bought and sold. And combined with certain investment strategies such as portfolio insurance and index arbitrage, the stock market is always exploited in which the stock of an individual business becomes nothing but a commodity. Demand for the stock is then not driven by business values or economics but its demand is determined by the direction and rate of speed at which the price level of the whole market changes.

In which, this infrastructure problem can be the depature point of mass hysteria, in which people experience a great loss of wealth for no apparent rational reason, for they often panic and this selling their securities and staying on the sidelines until the market stabilizes. The panic exacerbates the severity of the situation, a situation that offers an opportunity for one to practise business perspective investing.

In a perfect world all the information about a particular company is interpreted and defined by two different stock market philosophies, in which one is short term oriented whilst the other long term. They, in turn, determine the market price for the stock of that company. Since the short term strategy is the dominant force in the marketplace and so will dominate the force that determine's the stock's price. And this is where the long term business perspective gets his or her buying opportunity.

In short, there are large forces at work that buy and sell huge amount of securities. And they couldn't care less about the economics of the businesses that they are buying or selling, for they treat as a commodity itself. And when to go bonkers, that is doing the total irrational things, like the stock market crash of 1901 and then the famous Black Monday of 1987, this always create wonderful opportunities in the stock market. And so it will happen again and again and again. Fools and greed go hand in hand which creates a field of opportunity for the rational.

In her other book, The New Buffettology , Mary Buffett spoke of the buying opportunity again, telling the tale of Benjamin Graham's Mr.Market again.

Benjamin Graham introduced Mr.Market to Warren. (see page 34)

Mr.Market had an interesting personality trait that some days allowed him to see only the wonderful things about the business. This, of course, made him wildly enthusiastic about the world and the business's prospects. On other days, he couldn't see past the negative aspects of the business, which, of course, made him overly pessimistic about the world and the immediate future of the businesses.

Mr.Market also had another quirk. Every morning he tried to sell you his interest in the business. On days he was wildly enthusiastic about the immediate future of the business, he asked for a high selling price. On doom-and-gloom days, when he was overly pessimistic about the immediate future of the business, he quoted you a low selling price hoping that you will be foolish enough to take the troubled business of his hands.

One other thing, Mr.Market doesn't mind if you don't pay any attention to him. He shows up to work every day - rain, sheet, or snow - ready and willing to sell you his half of the business, the price depending entirely on his mood. You are free to ignore him or take up on his offer. Regardless of what you do, he will be back tomorrow with a new quote.

If you think that the long-term prospects for the business are good and would like to own the entire business, when do you take Mr.Market on his offer?

When he is wildly enthusiastic and quoting you a really high price?

Or when he feels pessimistic and quotes you a very low price?

Obviously you buy when Mr.Market is feeling pessimistic about the immediate future of the business, because that's when you get the best price.

Graham added one more twist. He thought Warren that Mr.Market was there to benefit him, not to guide him.

You should be interested only in the price that Mr.Market is quoting you, not his thoughts on what the business is worth.

In fact, listening to his erratic thinking could be financially disastrous to you. Either you will become overly enthusiastic about the business and pay too much for it, or you become overly pessimistic and miss taking advantage of Mr.Market's insanely low selling price.

Warren says that, to this day, he still likes to imagine himself being in business with Mr.Market. To his delight he has found that Mr.Market still has his eye on the short term and is still manic-depressive about what businesses are worth.

Warren has discovered that to take advantage of the market's pessimistic shortsightedness, he must invest in companies whose economics will allow them to survive and prosper beyond the negative news that creates a great buying opportunity.

To do this Warren has to make sure that the company in which he is investing is not only intrinsically sound enterprise, but also has the economic ability to excel and earn fantastic profits. Warren isn't interested in the traditional contrarian investor approach of bottom picking.Only by selectively picking the cream of the crop is he able to recover, but continue upward.

Mary Buffett continues by telling the story of the two racehorses. Healthy and Sickly.

Think of it this way.

You have two racehorses. One, called Healthy, has a great track record with lots of wins. The other, called Sickly, has a less-than-average track record.
Both catch the flu and are out of action for a year.
The value of both shrinks because neither is going to win any money this season.
Their owners, intending to cut their losses, offer them up for sale.
Which would you want to invest your money in? Healthy or Sickly?

Healthy is clearly the best bet. First of all, you know that Healthy is usually a strong horse. Not only does Healthy have a better chance of recovering from the flu than Sickly does, he has a better shot at winning races (and making you tons of money) once he does!

Even if Sickly recovers, the horse will more than likely remain true to its name and get sick again and again. The return on your investment will be Sickly's health - poor.

And when put into business perspective, Mary introduces the reader the two categories of business. The healthy, durable-competitive-advantage business and the sick, price-competitive businesses.

Warren separates the world of businesses into two categories: healthy, durable-competitive-advantage businesses and sick, price-competitive-commodity businesses.

A company with a durable competitive advantage usually produces a brand-name product or occupies a unique position in the marketplace that allows it to act like a monopoly. If you want this particular product or service, you have to purchase it from the company and no one else. This gives the company the freedom to raise prices and produce higher earnings. These companies also have the greatest potential for long term economic growth. They have fewer ups and downs they possess the wherewithal to weather the storms that a shortsighted stock market will overreact to.
A price-competitive-commodity business manufactures a generic product or service that many other companies produce or sell and they competes for customers solely on the basis of price.

And some of the most common characteristics of a commodity business mentioned by Mary Buffett in her earlier book, Buffettology, are these companies operates on low profit margins, they have a low return of equity, lack of any brand-name loyatly, the existence of many similiar producers of the same product, excess production capacity of the same product in the same industry, eratic historical profits, and in some cases the profitability depends on the management utlization of its assets such as plant and equipment and not on such intangible assets as patents, copyrights, and brand names.

Uncovering A Company's Problems.

valuelife said...

From your articles, I can see you are very good at uncovering companies' problems/weaknesses. Mind to share how u did that?? Since many so-called investors just can see the pros/strengths most of the time.

Let me share one long old tale with you.

It's called Ze Funky Chicken.

There once was a listed company called Comsa Farms. Recently it was one of the company that was delisted!

Yes, it's all back tracking at this moment of time and some would argue that such back tracking theory has its flaws because we are simply looking back at Mr.Hindsight.

However, perhaps if you would indulge in my writings (most of the writing here are based on what I had written a couple of years ago) for now.

1. Let's take a look at Comsa financial track recrd.

From the above table, we can see that from fy2000-2002, there was some sort of growth.

However, signs of danger surfaced in 2003 in my opinion. For its fiscal 2003. Yes the sales revenue was increasing BUT the classical AVOID sign was there. Look at the table above. Sales dropped to 10.452 despite the drastic increase in sales. And the net margin dropped from 13.09% to 5.94%.

For its fiscal 2004. Sales revenue soared to 222 million. However, net earnings dropped again and worse still its profit margin is now a mere 4.43%. (see how important it is to know that sales revenue growth is such a NON-ISSUE?)

Did it made sense for an investor to invest in a stock whose earnings was clearly declining?

This for me was the biggest issue any investor has to ask themselves.

If the company simply wasn't making money or the company's earnings was declining, we know very well that there was something very wrong with the company or its business!

2. Searching for value? Ze asset issue.

Ok... let's have a look. In 2003.

For fy 2003 Comsa declared that it made 10.452 million. If one opens their earnings note for their fy 2003 Q4 ( Quarterly rpt on consolidated results for the financial period ended 31/3/2003 ), one would see two disturbing issues.

(1) Total debts increased from 148 million to 210 million.
(2) The cash flow statement included is simply a blur.

Any value in such an 'asset' back in 2003?

How about fy2004? Take a look at Comsa fy 2004 Q4 earnings pdf file here.

See how the inventory increased tremendously? (pg 2). Inventories increased from 63 million to 90.087 million.

Aha!

Simple logical question time!

This is a chicken business dude.

When the chicken inventory increased by so much in a single year, shouldn't one suspect something fowl? (:p)

And then... the biggest give way was so clearly stated.... in page 3.

look at the NTA section... do u see?

See how Comsa as early as in 2004 restated its NTA from 3.13 to 2.36?

Ahem!!!

Now given such mess in 2004... where one clearly saw declining profits, declining margins, increasing debts, surging inventory, restatement of NTA.... weren't there enough warning signs to avoid this stock??

How about 2005? Well, RAM on 28th January 2005 sounded a real warning on Comsa.

• The rating had been placed on a negative outlook in June 2004, to reflect the imminent weakening of the Group's credit fundamentals once it sank deeper into debt to finance its overdue sinking-fund payment.
  The assumption of additional debt would have further strained Comsa’s already precarious financial position - as highlighted by its weak operational cash flow of RM4.93 million vis-à-vis a debt of RM230.5 million as at Sept 30, 2004.

So could one have easily avoided the dangers in Comsa?

How?

And to educate ourselves further, let's study the issue of how Comsa Farms restated their earnings is really worth looking at. Let's see how these buggers did it!

Quarterly rpt on consolidated results for the financial period ended 31/12/2005

The restated earnings caused Comsa to report a loss of over rm110 million!

Here is a snapshot of the major adjustments in Comsa balance sheet.



(Click on the picture for a bigger view..)

As you can see the biggest adjustment was made in...

1. Inventory.

The adjustment of 90.273 million was made! So from an inventory balance of 98.301 million, Comsa's adjusted balance became 8.028 million!

Holy chicken!!! That's simply mind-boggling!

2. Trade receivables.

Comsa initially reported a trade receivable balance of 70.185 million. This figure is adjusted to 100.799 million!!

And the following announcement was made by Comsa explaining the adjustment.

(i) The adjustments to the inventories and biological assets are due to the adoption of International Accounting Standards ("IAS") 41 on 1 April 2005 and the related accounting policies. For further details, please refer to Note (I) (a) of the Restated Financial Results;

(ii) The adjustments to the consolidated revenue and cost of sales are due to the overstatements of sales and purchases, which have not been substantiated with valid invoices and other supporting documents;

(iii) The adjustments to trade receivables are due to the provision for bad and doubtful debts and the overstatement of sales mentioned in item (ii) above, whilst adjustments to trade payables are due to the overstatement of purchases mentioned in item (ii) above; and

(iii) The adjustments to the Property, Plant & Equipment ("PPE") are necessary to reflect the fair value of PPE as at the Said Dates.

Waaa.... consolidated revenue and cost of sales are due to the overstatements of sales and purchases which have not been substantiated with valid invoices! Holy chicken!!!!!

And the end result of this overstatement of sales... (from Comsa notes) (ahem! from 60.9 mil to just 9.9 mil!)

• The Group's revenue for the current financial period ended 31 December 2005 decreased to RM9.9 million from RM60.9 million in the prior financial period ended 31 December 2004 while the loss before taxation was RM110.2 million from a profit before taxation of RM2.5 million in the previous corresponding quarter. The decline in revenue and the loss was mainly due to the over-statement of sales during the period, loss on disposal of wholesale, retail, breeder and broiler operations and the provisions for bad and doubtful debt as disclosed in Note 7 of this section.

Truly incredible!

Wasn't the explanation made by Comsa insufficient?

So the areas to look out for.... overstating of sales, inventories and trade receivables, yes?

Overstating of sales is complex and not easy to spot but the tell-tale signs in inventories and trade receivables should never be ignored and discounted.

Remember the issues of inventory and trade receivable build-up?

And those that had been following Comsa for a while, Comsa has turned into deadly value trap because at one time, it was argued that Comsa used to be trading at a low price earnings multiple and it had always traded well below its NTA. See the dangers in investing based just on yardsticks?

Investing lessons yet again?

Hope you enjoy this write-up!


ps: here's a clip from The Wanderer.

When talk gets too cheap!

Flashback: 5th December 2005.

I wrote the following posting: Talk Is Sooooo Cheap

Let me reproduce it here:

~~~~~~~~~~~~~~~~~~~~

Talk is cheap because supply exceeds demand.

LOL!!!... Looks like I just have to repeat this over and over and over and over again.

Oh dearie me... what have upset my little-tiny-weenie-fingers yet again?

BSA targets RM70mil profit next year

BSA International Bhd is aiming for profits of RM60mil to RM70mil next year, said group executive chairman..

Ok, correct me England if i am wrong but it clearly states in this Bernama newsclip posted on the Star Businessnews that the BSA bossie is targeting/aiming/projecting a net profit of rm60-70million for next year.

Based on past performance, the company was confident of achieving a 30% increase in profits for 2006, he said.

Hmm... ok...ok... ok.... based on past performace.

Hmm... does past performance neccessary gurantee future performance????

Anywayyyy.... jom kita tengkuk saje... :)

_________2001____ 2002 ____2003_____ 2004

Sales_____91.544__ 113.701__164.759__ 198.434

Net profit_ 17.169__ 18.507___ 18.680___ 17.853

how?

Based on past 4 year's fiscal performance, earnings has been flat.

Real flat with no growth at all.

Tiok boh?

17.169 -> 18.507 -> 18.680 -> 17.853

No need to be a math genius but i see no growth mah.. numbers not increasing isn't it?

Ok.. ok... ok...

Let's see most recent 4 quarters...

Total sales: 254.616 million
Total net profit: 14.956 million

Ahh.. sales looks as if it's improving but net profit at this rate will even be worse than it's fiscal year.

Ok..ok....ok... let's see current fiscal year performance vs last fiscal year performance..

BSA just announced its 2005 Q3 earnings on 30th Nov. 2005.

Total sales: 199.909 million vs 143.769 million
Total net profit: 10.771 million vs 13.948 million.

Again... it shows that current sales is much, much better... but in investing, sales growth counts for nothing for the investor, for what is most important for the minority investor is the total net profit. So sales is up. Bang! Bang! Sound wor. But its total net profit is down. 10.771 million vs 13.948 million a year ago.

Soooo... how lah?

Last 4 fiscal years, no signs of growth wor.
Last 4 quarters earnings, olso no signs of growth. (err.. go-stan growth got wor!)
This fiscal year, olso no signs of growth. (err.. go-stan growth got wor!)

Based on past performance, company is the company is confident of achieving a 30% increase in profits for 2006 wor....!!!!!!

Can believe onot?

Do you think this company, which had been making net profit between 17-18 million, with signs of a poor current fiscal year, will be able to meet this bossie target of rm60-rm70million the next fiscal year?

Or again is talk so cheap?

~~~~~~~~~~~~~~~~~~~~~

2 and a half years later, how do you think BSA is doing?

Posted on the Edge yesterday.

• 11-06-2008: BSA falls to low of 10.5 sen
  By Surin Murugiah
  
  PETALING JAYA: BSA International Bhd fell 50% to a low of 10.5 sen with 1.15 million shares done yesterday after the company announced on Monday that it was an affected issuer and had fallen into the Practice Note 17 (PN 17) category.
  
  The company fell under PN17 category after it defaulted on its interest payments totalling RM2.63 million for its debts due at end-May.
  
  BSA had on June 2 defaulted in interest payments for its outstanding Murabahah primary medium-term notes (MTN) and collateralised loan obligations (CLO), which were due on May 26 and May 30, respectively.
  
  The company said RM45 million of the MTN still remained outstanding, while Kerisma Bhd’s CLO was in respect of a loan facility amounting to RM45 million.
  
  BSA’s subsidiaries BSA Manufacturing Sdn Bhd and CAM Component Alloy Manufacturing Sdn Bhd had also received statutory notices in respect of principal and interest claims of RM5.17 million and RM5.19 million, respectively, from HSBC Bank Malaysia Bhd.
  
  The company said its directors were currently negotiating with the lenders and noteholders to seek indulgence for a standstill period to propose a restructuring repayment of the outstanding amount.
  
  Last month, RAM Ratings downgraded the ratings of BSA’s RM150 million Murabahah Commercial Papers/Medium-Term Notes (MCP/MMTN) programme (2004/2011), from C3/NP to D.
  
  For the first quarter ended March 31, 2008, BSA posted a net loss RM12.88 million from a net profit RM2.61 million a year ago.
  
  Among the reasons the company gave for its financial situation was that it had been affected by the continuous rise in prices of raw material, its primary raw material of aluminium ingot and fuel as well as the weakening of USD in the recent years, which contributed to constraint in working capital.
  
  The company had then said that while it expected to strengthen its position in the local and global alloy wheels industry via new markets and higher margin products, its business was still constrained by limited working capital.
  
  It said this was made worst by the nature of its business whereby it needed to pay upfront for purchases of its main raw material, which is aluminium ingot that accounts for 60% of total production costs.
  
  Last March, the company said its indirect wholly owned subsidiary CAM Automotive Manufacturing (Fushun) Co Ltd entered into an alloy wheel manufacturing contract with Baoding Lizhong Wheel Manufacturing Co Ltd. (Baoding) of China to supply alloy wheels to Baoding.
  
  It said CAM Fushun was expected to generate annual sales of RM31 million from the contract, and would contribute positively to its financial year ending December 2008.

See the clues the investor can get by judging what and how the management says (behaves) in public?

Buffett's Investment Goals

(Taken from the wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors".)

Our goal is to acquire either part or all of businesses that we believe we understand, that have good, sustainable underlying economics, and that are run by managers whom we like, admire and trust.

~~~~~~~~~~~~~~~~~~~~~~~~

That's Warren Buffett's investment goal.

See how important Buffett stressed that the good business MUST be run by managers whom we like, admire and TRUST.

Or the issue of Management Integrity by the late Philip Fisher?

• It's not only the dislike for dealing with unscrupulous people but Fisher believes that companies managed by people of dubious integrity will definitely meet with failure.

And amazingly this very same issue was mentioned in the book Reminiscenes of A Stock Operator, "I have never thought it is good business to play any game in any place where it was necessary to keep an eye on the dealer because he was likely to cheat if unwatched."

Just like the investor, the trader too guards against inside chiches!

More from that classic books, Reminiscenes of A Stock Operator

• I would rather play commodities than stocks. There is no question about their greater legitimacy, as it were. It partakes more of the nature of a commercial venture than trading in stocks dies. A man can approach it as he might in any mercantile problem. It may be possible to use fictitious arguements for or against a certain trend in a commodity market; but success will be only temporary, for in the end the facts are bound to prevail, so that a trader gets dividends on study and observation, as he does in a regular business. He can watch and weigh conditions and he knows as much about it as anyone else. He does not guard against inside cliches. Dividends are not unexpectedly passed or increased overnight (to drive the stock prices up) in the cotton market or in wheat market or corn. In the long run commodity prices are governed but one law - the economic law of demand and supply. The business of a trader in commodities is simply to get the facts about demand and supply, present and prospective. He does not indulge in guesses about a dozen things as he does in stocks.

Understand that one law - the economic law of demand supply in a given trade. Guarding against inside cliches, trying to figure out what is happening. In short, stocks are easily manipulated. JL talked about how stocks announced dividends overnight just to drive up the stock price.

Any change then and now?

Nope!

Crooked owners are still crooked owners.

And crooked owners of stocks still cheats. They manipulate stock prices!