Apollo Investment Management

Climbing a wall of irritations
Apollo Asia Fund: the manager's report for 1Q2006

The Apollo Asia Fund's NAV rose 18% in the first quarter, closing at a new high of US$675.37. Over the twelve months to end-March, NAV rose by 27% - but much of this has been due to multiple expansion, rather than strong growth against the headwinds of rising costs, rising interest rates, & growing protectionism. Our ordinary shares are now on an estimated PE of 13.1 for the current year, with a dividend yield of 3.5% after Asian taxes - not too bad by international standards, but this is the most expensive for our portfolio since inception. Underlying growth in EPS, DPS etc seems to be running at about 10% pa - avoiding over-precision at present, since different perspectives give somewhat divergent impressions.

In any case the switch to the infuriating new International Financial Reporting Standards has probably made accuracy spurious, although we continue to work from our own calculations - particularly as regards earnings per share, where the new basis for calculating dilution is completely inappropriate for the investor, and tends to overstate EPS, a subject to which I may return in future. Meanwhile, the fanatical belief in the invisible hand which must underlie the profligate use of 'market pricing' seems far from the reality of illiquid markets - even for equities, let alone for derivative contracts - and it removes the anchor of objectivity. Historic cost has limitations, but they are well understood and the method was anchored in realised returns on invested cash: the use of subjective 'fair value' pricing subjects the figures to the delusional risks of crowd psychology, as well as to the more recognised volatility. Presentation is user-hostile, a disservice to users of the accounts, and therefore to market efficiency: reams of boilerplate verbiage and corporate governance ritual appear to be consuming time and displacing thought for auditors and company directors alike.

Geographical breakdown
  as at 31 Mar 2006
% of assets
Hong Kong-listed equities
Indonesian equities
Malaysian equities
Philippine equities
Singapore equities
Thai equities
Other equities
Net cash & receivables

Activity in the first quarter involved far more selling than buying. We sold out of six companies: three for the happy reason that the share had gone up too much to justify holding, and three for the much less satisfactory reason that we had lost confidence in the management or board. Three of the six companies were Singapore-listed, which accounts for the sharp fall in our holdings there; the Thai weighting has risen mostly with prices, supplemented by a little buying. (As always, these decisions are stock-specific, and we do not worry about country weightings except to avoid over-concentration, which we rarely consider to be an issue.)

The most irritating of the three duds was until recently a small-company gem, with ROE and EPS growth both over 20%, supplying services to the offshore oil and gas sector... déjà vu? remember the Pirates?... and once again we were mugged by Malaysians. This was an unpleasant surprise, since the company, Total Automation, was Singapore-based, excellently run by its founder-managers, and they were reporting no interference from their Malaysian shareholders - until the latter decided to sell the whole business to Wartsila of Finland. They did so on a PE of 11 for the year just ended, and on our estimates 8-9 for the current year, a strangely low valuation. The disposal announcement made no mention of distributing the cash proceeds: it said the board would ponder other businesses in which to invest. All executive directors resigned immediately, with no apparent thought of fiduciary duty to minorities. As startled investors who had bought the shares for its niche engineering business studied the diverse interests and dismal track record of listed companies in the controlling Melewar group, Total Automation shares slid to a discount of 25-30% to the expected cash. Seven weeks after the initial disposal announcement, having cancelled the routine analysts' briefing after the results and been parsimonious with access meanwhile, the company did announce an intention to distribute 75% of the proceeds, which may be sufficient to reduce protest - most investors will just curse and move on - but remains unfair, since the share price remains well below the level at which we believe it would have been trading if continuing with its existing business (7 times EPS for '06?), and the implied value attributed to the 25% balance implies no confidence in the directors. The pattern of trading and disclosure has been no credit to Singapore (nor of course to the Melewar group), and we were surprised to be told that minority shareholders would have no effective say. For the controlling shareholders to vote on the sale is fair enough, since unconnected, but we would have thought the decision should require a 75% majority, and/or that there should be a requirement for an immediate unconnected-shareholder vote on distribution of proceeds.

US stockmarket v rest-of-world
Source: CLSA

At this point readers may be hoping that I too will move on to discuss constructive uses of cash, and the glowing attractions of our selections: unfortunately there is too much money now chasing good ideas, and the most attractive are often driven to 'concept play' valuations, while those languishing closer to earth are often there for a reason. Old Asia hands tend to doubt that next time will be different and that the rest of the world can decouple cleanly from a US economic disaster which we continue to see as inevitable: however the accompanying chart suggests that it has been doing so remarkably smoothly over the last three years in particular, and a growing number of US investors are coming to realise that (1) they would have been 50% better off had they switched to overseas equities four years ago, (2) the statistics are, when still published, as bogus as the case for war, and their economy is in quicksand. Many rest-of-world investors who used to buy US assets are meanwhile beginning to wonder whether this is wise. In the absence of shocks, there is every reason for outflows from the US to continue. (Ever-helpful, such analysis that "the trend will continue, unless it stops"...) Moreover, with commodity prices still resurgent, inflation expectations are rising, and if the US moves swiftly to high or hyper inflation then the decline in nominal share prices may be muted accordingly - so says Steve Saville, with a useful chart of recent gold-standard returns on the US stockmarket, and this is an uncomfortable thought for holders of cash. In any case we do not sit on cash from a topdown view, but merely for frictional reasons while we try to work out reasonably sensible ways to deploy it, so we will continue to research these, continue to stave off further inflows, and continue to be helpful to anyone wishing to redeem.

woodblock print
'The more we talk, the more we must eat our own words. Dharma needs practice.'
Kamin Lertchaipraisert.

Some readers have grumbled that our quarterly reports have become progressively shorter. (This slightly longer one may have persuaded them to be careful what they wish for.) Frequently the length is because I have nothing original to contribute on broad trends to the abundant economic and big-picture analysis widely available on the internet, or to views which I have already expressed; and spot neither trends worthy of comment from our company analysis, nor specifics which I wish to discuss publicly. If I have only a little to say, it seems best not to add to the daily torrent of information, which is too frequently overwhelming. There is already too much 'noise' in the financial world: marketing spin, repetition, mindless chatter. (Financial television seems to me a real menace: too prone to soundbites and punditry, iniquitous to analysis.) Hype abounds, for BRICs, for a China / India new age, and for any concept which requires other peoples' money to be solicited. I could go on, but had better avoid adding unnecessarily to the load.

So instead of more words, I will reproduce a picture: a woodblock print which hangs in my office. I hope you like it as much as I do.

Claire Barnes, 7 April 2006

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