Apollo Investment Management 

Our type of company - and our type of valuation

Company A: single digit growth in turnover (last year 3%). Rather better growth in net profit. ROE 24%. Excellent record of sustaining ROE at around this level.

Company B: single digit growth in turnover (last year 8%). Rather better growth in net profit. ROE 22%. Excellent record of sustaining ROE at around this level.

So far, so similar. Now:

Company A is capital intensive, and pays out 13% of its earnings in dividends. Growth in net asset value per share comes from retained earnings, the occasional placing, and the exercise of executive options at prices which are very cheap against market but a premium to book. High degree of dependence on key clients, who themselves face an extremely uncertain demand outlook over next twelve months, let alone longer. Poor predictability of earnings, and poor transparency.

Company B's core business is highly cash-generative, and its capital expenditure is mainly discretionary;  it pays out 45-50% of its earnings in dividends. Growth in net asset value per share comes from retained earnings, the occasional placing, and the occasional buyback of shares when stock prices are extraordinarily low. Highly diversified customer base, and extreme resilience of demand in good times and bad. Relatively high predictability of earnings. Excellent attitude to investors and disclosure.

Company A is Venture Manufacturing, the electronics contract manufacturer in Singapore. Stock A is now at 54 times historic earnings, and according to analyst estimates 51 prospective. Price to book is over ten times, and the dividend yield 0.3%.

Company B is Cafe de Coral, the fast food, institutional catering and food processing operation in Hong Kong. Stock B is now at 12 times historic earnings, and less than 10 times prospective. Price to book is 2.3, and the prospective dividend yield 4.4%.

Both of these are our type of company. Although Venture's cavalier attitude to disclosure has always made me a little uncomfortable, its historic success is beyond doubt, and it always seemed to rank among the best of the Singapore electronics contractors which epitomised that key sector:  lean, efficient, and flexible. I owned this stock personally for several years, and transferred it to the fund on inception, but sold it last year at a mere four times my investment cost, given a high teens PE and rising business risks. That was at one third the present price. Fortunately, some of the lower-risk businesses into which I moved the proceeds have done even better, but by no means all. However, I would still defend the decision - and I would certainly not reverse it now.

One of my competitors reckons Venture to be a stock one should never sell. He may be right; one of the problems of selling a good company is whether one ever gets back in. However, the Apollo Asia Fund will be value driven. That does not necessarily mean that it will buy only shares which are "cheap" on the current-year ratios, but it does mean that the earnings and free-cashflow-for-shareholders, with our growth assumptions over a plausibly foreseeable horizon, need to stack up, so that the price is one which we are happy to have paid if the market evaporates and we have to hold the company for ever. We do not like making assumptions as to what other people will be prepared to pay. We also tend to prefer companies which can self-finance their growth to those which rely on borrowings or high stockmarket prices to do so, despite the leverage which can be achieved through such strategies. (We do sometimes buy into highly leveraged companies once the equity is bombed out, and may also have more risk appetite for leverage when we consider the international market cycle is in a different phase.) The expected returns from this intrinsic value calculation, ignoring assumptions as to future stockmarket valuation, should give a comfortable margin of safety in relation to international government bonds or to cash in the bank. Both Venture and Cafe de Coral are our type of company. Only one is currently at our type of valuation.

Claire Barnes, 5 September 1999

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