Apollo Investment Management

Earnings yield 19%, some risk discounted
Apollo Asia Fund: the manager's report for 1Q2001

The NAV of the Apollo Asia Fund fell 0.4% in the first quarter, to US$95.41: see performance charts and comments.

Turnover during the quarter was unusually low, even for us, at a little over 2% (9% annualised). This mostly reflected the pleasant activity of reinvesting dividends. The less pleasant but equally necessary task of acknowledging mistakes saw the eviction of Varitronix, as the risks of reckless management destroying a once-great business appeared to be rising. Sod's law dictated that the stock should bounce immediately after sale, but the decision appears for the time being to have been correct (not just because the price then subsided); I shall monitor events in the hope that my confidence may be restored, but now feel safer doing so from the sidelines. Sale proceeds were invested in strong old-economy firms such as Glorious Sun and Vitasoy - which had both then been beaten down to levels offering unusual value.
Top ten holdings
  as at 12 April 2001
Aeon Credit (HK)
Bumi Armada
Cafe de Coral
China Hong Kong Photo
Land & General Euro-CB
MBK Properties
Singapore Bus
Wiik & Hoeglund
Wong's Circuits

The list of top ten holdings shows no change on the quarter. Other holdings over 1% are Bangkok Insurance, BAT (Indonesia), Glorious Sun, Jusco (HK), Thai Stanley, and Vitasoy. Holdings of Kingboard Copper Foil and United Tractors are unchanged, but valuation losses have reduced their weighting in the portfolio to less than 1% each.

Reviewing the portfolio decisions of the last fifteen months, Varitronix was the only mistake which we realized (and which therefore does not have the capability to reverse itself into profit). With the benefit of hindsight, we can recognize quite a few. Notably, we would clearly have been much better off had we not held 36% this time last year in Malaysia and Indonesia, where we have been badly battered by stock price and currency losses. New cash and dividend income has been deployed elsewhere, and we sold one holding at a handsome $ profit, but nevertheless the portfolio would have made respectable headway had we not been exposed to these markets. However, the companies are not at fault.

This time last year I wrote about Bumi Armada, with a little nervousness because the share price had risen steeply and was then RM7.60; I did not wish to sell because the business was in great shape and the current PE was still only a little over 8. The share price is now 57% lower, at RM 3.30, and I estimate the current year PE at 3.5. The company in 2000 grew EPS by 19%, increased its dividend by 25%, paid down debt, prepared for expansion, and generally significantly strengthened its position. The number of shares we hold is unchanged over the year, the intrinsic value is that much higher, I remain just as optimistic about the growth prospects for the business (I think it can grow at a compound annual rate of 20%), and the risk-reward balance for the shares at an earnings yield of 29% appears decidedly attractive.

The macro-mismanagement of Indonesia last year was extremely disappointing. When we built up our Indonesian position in Nov-Dec 1999, in the wake of the general election, the rupiah was about 7,000. Now it is one third lower, at 10,650. Our shares would have had to rise 50% in local currency terms to keep pace. Unilever Indonesia shares did rather better, and outpaced our assessment of value, so we took our profits. Ramayana Lestari Sentosa's management almost kept up: they grew the business ( revenue and profits) by 40-45% last year, as they brought destroyed stores back online (and also achieved same-store growth), while planning significant geographical expansion and preparing for a major systems upgrade. To achieve this in such anarchic conditions (and in a cash business) is pretty impressive. This is one of the most highly-rated shares in the whole portfolio, which gives me some pause for thought as share prices decline elsewhere, but we have held on to date. BAT Indonesia was a less happy experience for the year, as volumes were decimated by changes to the tax structure; had this been foreseen we would clearly not have invested when we did, but management alacrity in mitigation appears worthy of acknowledgment (whatever one might think about prior decisions and positioning), and with a capitalisation now less than US$60m in a market with a population over 200 million, there should be some upside potential. United Tractors' reported results are as unpredictable as the exchange rate, because of its dollar debt (which is not disproportionate to its dollar-earning businesses), and it would do even better if the macro-environment were stable enough to encourage investment by its customers, but meanwhile its management battles on, not only maintaining the franchise but to a remarkable degree finding opportunities for expansion, and the shares are arguably on a PE of the order of one. Top-down, it remains hard to be enthusiastic about the outlook for Indonesia until there is a significant improvement in leadership, but bottom-up, the managers of our companies are clearly doing the job for which shareholders pay them. With the residual value of these holdings representing less than 3% of NAV, I am inclined to stick with them for their leveraged upside to any eventual recovery.
Geographical breakdown
  as at 12 April 2001
% of securities
Hong Kong-listed equities
Indonesian equities
Malaysian equities
Singapore-listed equities
Thai equities
Bonds & other

Turning to markets offering greater numbers of interesting opportunities to the stock-picker, Tuesday's Nation listed 327 shares in Thailand. Of these, 55 companies or 17% sported historic gross dividend yields over 10%. 28% of the companies were on historic PEs below 5. Just over half were on PEs below 10, and 70% were trading below book. Now, many of these are illiquid, even by our standards, but in a market where deposit rates are of the order of 2%, the anomaly is quite real. (I checked the figures for a number of specific stocks, and all were accurate.)

Some local investors are beginning to take note: among them Bangkok Insurance, Thai Reinsurance, and MBK Properties, all of which take care to buy only into businesses in which they have confidence. (However, state-owned Dhipaya Insurance two months ago explained solemnly that Thai equities were 'obviously' much too risky to contemplate holding for the long term, and therefore its considered policy was to hold equities only for short-term trading.) Our six Thai holdings are, we estimate, on a current-year PE of six, with a net dividend yield approaching double digits.

Hong Kong remains by far the most attractive market in Asia for our sort of investing, for reasons including culture and history (in particular, the absence of tax distortions to capital allocation), the number of big companies which enables most institutions to ignore a swathe of medium-sized companies which in Thailand would be considered 'large-caps', and of course China, a huge market in itself and a fabulously attractive manufacturing base, as well as once again a haven of relative economic strength (as well as, I submit, relatively level-headed leadership).

Our seven Hong Kong holdings are also, as a group, on a current PE of six, with a dividend yield of 9% and, we believe, excellent growth prospects. Kingboard Copper Foil, counted with Singapore by virtue of its listing and our only current 'tech' holding, is really a Hong Kong/China business and would improve the numbers further. Our one genuine Singapore investment, Singapore Bus, is a cash-generative play on Singapore Inc's restructuring; Wong's Circuits is a cash arbitrage following the disposal of its entire business.

Overall, our listed shares are now on a current-year PE of 5.2 (earnings yield of 19%), with a net dividend yield in excess of 8%. By 'current year' I mean, as usual, 'for the next full year to be reported'. 49% of portfolio earnings for the 'current year' relate to financial years already over (ending last February or March) but yet to be reported; these can be regarded as essentially 'in the bag', since they are still estimated but can no longer be affected by any change in future economic conditions. Forward growth is much less certain, but for what it is worth my estimates suggest EPS growth of 18% for our companies in the year ahead.

Over the last twelve months, the fund's US$ NAV fell 14%, but this is entirely to derating - not even currency movements, which are (in effect) taken into account in the 'portfolio EPS'. Between 6 April 2000 and 12 April 2001, the 'current year PE' fell from 7.2 to 5.2, a fall of 28%. 'Current-year EPS' for the portfolio however grew by 20% (as explained above, the estimates should be reasonably accurate, and more representative than taking overly-historic numbers). Similarly, we estimate portfolio dividends per share to have grown by 26%, and net tangible assets by 24%. Intrinsic value, in short, has been increasing. Further derating is always possible, but beyond a certain point is unlikely. This is not the US. We are closer to the ground, and valuations are already on the cheap side of reasonable; earnings yields and dividend yields compare very favourably with rates available on bonds and cash. We can have much greater confidence, starting from here, in our 'quality of earnings' - in terms of accounting standards, cash generation, sustainability, and what happens when the wheels come off. The state of Indonesia is unenviable, but the banking system and much of the formal economy has already collapsed, the cash economy continues, and people still buy food and clothing. Elsewhere, participation in the global economy is greater, but in all of Asia, businessmen remember lessons from past cycles, and in particular from very fresh memories of crisis. Our companies are already, to some degree, stress-tested. Our companies' managers continue, for the time being, to deliver excellent growth. Their shares, collectively, represent sensationally good value.

Claire Barnes, 13 April 2001

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