We started the year with a trip to Puerto Rico where we met with the CFO of one of the three listed banks, and the CEO and CFO of an insurance company. We have been closely monitoring the insurance company since it was adversely affected by an unexpected surge in Hurricane Maria claims in the most recent two quarters, which led to increased reserves provisioning and as a result a sharp decline in the stock price. The worst seems to be behind them now and their core business has been showing improvements despite a challenging macro environment, so we see great value in the company as it is trading at 0.5x book value, far below its normal 0.8x. We expect the stock to rerate once earnings normalize later this year as it will be trading at a 40% discount to its usual earnings multiple.
After the meeting, the CEO personally took us on a tour of the corporate office and gave us a sense for his servant leadership style. We also did further diligence during our trip by meeting with people from our business schools’ networks who were able to add context and validate the management’s reputation. This was actually our fourth interaction with the CEO and CFO, following a meeting and two phone calls last year. We generally find that multiple interactions with the same managers over time help us see consistency and increase the depth of our perspective.
February took us to Egypt, Turkey, Thailand, and Indonesia, where we met with 25 companies. In Egypt, we met four real estate developers. One of these was particularly cheap and had accumulated a lot of cash but had also failed to make new land deals, and its CEO was recently replaced. However, meeting with the company’s CFO, as well as the senior management of three competing firms, gave us useful insights regarding the problem. We also revealed substantial differences in the developers’ attitudes to sustainability. After asking about the firms’ ESG policies, the CFO literally laughed at us, while one of its direct competitors – which has been a UN Global Compact signatory, has done sustainability reporting for years, and has seen its gender balance ratio improve after opening an onsite kindergarten – had an observable difference in its culture.
In Turkey, we learned more about the aviation industry as we met with an airport operator, an airline, and a baggage handler. The timeliest theme was around the new airport that is expected to open in March, replacing the 66-year-old Ataturk airport that has operated at full capacity for years. With plenty of new capacity, the baggage handler should benefit from increasing passenger traffic in the medium term. Meanwhile the low cost carrier based in the city’s secondary airport may benefit in the short-term as the new airport is home to its main competitor, is farther from the city, and still lacks a metro line. Overall, we remain cautious on Turkey and only hold FX-hedged firms.
One of the most satisfying parts of our job is seeing investments work for the reasons we picked them. In March, we attended a large international investor conference held each year in Dubai. Although we prefer to visit companies on their own turf, this is a great opportunity to meet with several management teams just down the road from our office. One of these was an Egyptian conglomerate the fund holds. The company has returned 50% year-to-date, reflecting strong progress towards its plans to double earnings in three years and supported by drivers in several different businesses, including fertilizers and fiberboards.
This month we also visited several of the fund's investors in Finland. Two of these were prospective institutional clients who joined us on a research trip to Vietnam where we met with seven companies but only invested in one: a rubber manufacturer that owns real estate worth several times the market value of the company’s stock and that has a plan to unlock the value by monetizing the excess land. It was exciting to have them join the meeting with the CEO where we developed our thesis. We were pleased to share with them the outcome of our work: while the other six stocks have returned plus or minus 10%, this one is up 70%, driven by strong earnings from the beginning of land monetization. Sometimes we get lucky, but we much prefer to succeed through a repeatable process.
During April, we revisited the familiar markets of Malaysia and Thailand. In Malaysia, we met a current holding which has returned over 500% since the fund's first investment three years ago. This company has a reputation for manufacturing quality hard disk drive components and for staying out of the investor spotlight. Despite management’s refusal to take investor phone calls, the CEO and CFO were happy to welcome us for a meeting because we made the trip to their office which is located an hour's flight from the country's capital. We discussed the company’s strategy to expand capacity for hard disk drive components as well as open a new segment in the automotive sector once it finalizes the required certifications later this year. We expect these plans to add to both top- and bottom-line growth. The meeting was insightful, increased our conviction, and highlighted the importance of meeting companies in these markets in person.
In Thailand, we met companies in various industries, including real estate development, consumer goods, and medical supplements, and a common theme persisted throughout all meetings. As the Thai market matures, local competition intensifies and puts downward pressure on prices, squeezing margins and influencing companies to invest in projects outside of their core businesses. This environment, coupled with inflated market valuations, makes Thailand a difficult place to find value in quality companies. However, with a battle for market share dominance underway, we will continue to keep our eyes out for the winners.
In May, we performed deep-dive research and analysis of one of the fund's Malaysian investments operating in the semiconductor industry. We worked with company management to look for ways to unlock additional value in the company by recommending improvements in their ESG practices. After conducting interviews with the management, investors, sell-side analysts, and peer companies, we concluded that the company could improve its transparency, disclosures, and investor communications, and presented our findings to senior management. We hope these suggestions get implemented as we believe shareholders could benefit substantially.
We also travelled to Argentina, where we observed that despite macroeconomic challenges putting downward pressure on company valuations, some of the businesses continue to steadily grow profits thanks to their innovative, currency-hedged, geographically diversified business models. One example was a fast-growing e-commerce company deriving less than a fifth of its revenue from Argentina. Driven by the strategic vision of its senior team, the company benefits from strong local supply of skilled IT talent and resulting high output quality, concurrent with low local labor costs. This trip reassured us that despite loud headlines that may scare an investor, there are still fundamentally-strong hidden gems to be found on the ground. We continue looking for great companies on the frontier.
We spent the entire month of June in the Philippines, meeting CEOs and other senior management of 60 publicly listed companies, expanding our knowledge of this often overlooked yet quickly growing economy, and searching for the hidden gems that we strive to find in each of our markets. We also met dozens of our business school alumni, a powerful network consisting of the most influential and well-connected Philippine business leaders who are a unique source of local business information and reputation checks.
One company we visited was reminiscent of a Vietnamese holding that has doubled in value since the fund invested in it six months ago. This Philippine company owns a lot of land, which has increased substantially in value partially due to the country’s current administration incentivizing companies to move outside of the congested capital, but which investors have priced well below book value for many years. Management has only recently started monetizing the non-core land holdings through sales and joint venture development deals, which we believe is an excellent catalyst for unlocking shareholder value. Additionally, some of the land was revalued on the balance sheet earlier this year, further lowering the price-to-book multiple to 0.2x. Validating this thesis involved three separate meetings with the Chairman, CEO, and a board director, as well as reputation checks with dozens of independent sources and site visits to the assets located several hours away from Manila by car. This type of due diligence is only possible due to our commitment to spending significant time on the ground.
We spent the entire month of July in Malaysia where we met CEOs and other senior executives of 80 publicly listed companies. We also met local regulators, a sovereign wealth fund manager, and our business school alumni that hold prominent positions in the Malaysian economy, further building our network and expertise in the country.
One of the benefits of visiting companies on-site is the ability to observe company culture. We were impressed by a low-cost airline, a telecom provider, and an automated machine vision business, which are attracting the best talent. Their modern campuses are equipped with canteens and even giant slides which transport employees from the third floor to the lobby. One company has developed a unique environment where employees have access to a communal organic garden, are responsible for washing their own dishes, and can choose from 20 extracurricular clubs. Some CEOs even voiced a “concern” that their employee turnover is lower than optimal as they are less likely to lose less productive employees through natural attrition.
During our visit to Penang – an island 350 km from the capital that is the home to the two most successful investments of the fund – we met with an automation equipment manufacturer which, besides benefiting from exposure to electric vehicles and smart devices that will need to be replaced for the upcoming 5G technology, also offers an investment arbitrage opportunity. In addition to its existing listing in Malaysia, the company recently listed in Hong Kong where its valuation offers a 65% discount to the Malaysian listing. The market tends to close such gaps with time, and the fund invested in this strong business with an attractive upside potential.
We spent the entire month of August in Indonesia, visiting 75 publicly listed companies, undertaking due diligence site visits, meeting regulators at the central bank and ministry of state-owned enterprises, attending industry forums, and discussing the economy's prospects with domestic investors and members of the local business community.
One company we met with was a media business the fund owns. Its P/E ratio is only 7x despite its dominant position in the market, strong progress in the digital space (its news website overtook Google this month as the most visited site in Indonesia), and the recent return of the founding CEO who had been key to the success of the business before taking a hiatus to focus on politics. We believe there is potential for future earnings growth and valuation increase, and the fund built its position further.
August was a particularly turbulent month for investors with exposure to Argentina as the pro-market incumbent president lost in the primaries, which resulted in the country’s stocks falling 50% in euro terms, the second worst ever single-day loss of a stock exchange on record. Earlier this year, we ran a project whereby we analyzed all major emerging market currency devaluations over the past 30 years. We looked for common causes to develop a sophisticated macro risk management framework to integrate into our investment process. This project led the fund to sell its holdings in Argentina several months ago, partially because we found that political transitions tend to be a particularly likely time for crises to occur. As a result, while the closest index to the our strategy (which started the month with 8% exposure to Argentina) fell by 4%, the fund was protected. Even though we remain focused on bottom-up stock selection, we have found that avoiding the wrong countries can generate significant value relative to investing in passive investment strategies.
We spent the entire month of September in Bangladesh where we visited 40 publicly listed companies, met with the leadership of the local stock exchange and the SEC, made several due diligence visits to companies’ plants, and developed a network of local contacts.
A telecom company we met particularly caught our attention: it is in a longstanding dispute with the regulator, which has driven its valuation from 25x to 10x P/E. Given the company’s 45% market share, continuous earnings growth, healthy balance sheet, and robust corporate governance, this conflict appeared to be the only factor dragging the stock price down. Discussing the situation further with over twenty local business leaders, regulators, and analysts, we realized that as soon as the issue is resolved the stock price would be unlocked. In fact, during our stay the finance ministry announced that a resolution should be expected within weeks. We view this as a catalyst to increase the price of the undervalued stock.
We also traveled to Paris to attend the 2019 UN PRI conference, which was the largest responsible investing gathering in history. A common theme was that inevitable policy changes are not priced into the market, leaving investors exposed to downside risk. We concur that in many emerging markets investors are underweighting the probabilities. One of our key takeaways was that big problems such as climate change cannot be solved by simply shifting investments around from one investor to another. Active ownership is a much more impactful method, and we generated ideas on how to become more active owners. We found this to be a great conference; however, we were disappointed to see far more marketing and sales professionals present than portfolio managers.
We spent the entire month of October in Pakistan, meeting CEOs and senior management of 45 companies across three major cities: Karachi, Lahore and Islamabad. To deepen our understanding of the business sentiment in Pakistan, which has been hit by economic turbulence in the past couple of years, we also met with several state ministers, members of parliament, the central bank, IMF, World Bank, local fund managers, and business leaders. Our learning, in the end, led us to a few good, inexpensive companies that should be able to benefit from – or weather – the economic slowdown better than others. These companies happened to be exporters and import substitutes, additionally supported by government policies designed to reduce the problematic current account deficit.
The fund invested in a textile company, the largest exporter in Pakistan that is seeing very high production levels and growing earnings thanks to its strong operations and client relationships as well as weak currency. With a P/E of 5x, this company – whose factory we also visited as part of our due diligence – is a bargain. The fund also invested in a hydrogen peroxide producer that derives 80% of its sales from textile exporters; with a 6.5x P/E and growing production capacity in an undersupplied market, this firm – which enjoys modern technology and is currently deleveraging – was another bargain the fund picked.
A large local fertilizer producer was also reintroduced to the fund's portfolio. Manufacturing viable import substitutes, this firm of only 5x P/E additionally offers benefits of its parent company’s strong corporate governance and a dividend yield of over 20%, providing a cushion against potential future market volatility.
We spent the entire month of November in Thailand where we met CEOs and senior management of 90 companies as well as their board members and investors. Enhancing further our understanding of this market whose currency appreciated 10% over the past year, we also met with the local stock exchange leadership, central bank executives, and former central bank governor, finance minister and deputy prime minister.
An asphalt company we met (and whose product we tested multiple times during our month on the roads of Bangkok and beyond) is the leader in an industry which produces, in their words, a “shitty product that no one wants to do.” In addition to expected strong volumes next year, the IMO 2020 regulation being implemented in less than a month should create a supply tightness resulting in increased selling prices. Yet despite this growth, the company offers an attractive valuation at 13x P/E. Moreover, the firm is positioned well to benefit from the upcoming stimulus package by the government to include new infrastructure projects.
Another company the fund added to the fund portfolio is a media business that produces TV content for local and overseas distribution and broadcasts a local CNBC in the Thai language. The firm, led by a transgender CEO, has been growing its earnings while the stock price has fallen from its previous 30x to a more appetizing 10x providing an attractive entry point, given the company’s strong capabilities in content production, success at tapping the global export market, and recent convertible bond issuance to Morgan Stanley with a strike price 70% higher than the current market price.
We spent the entire month of December in Vietnam where we met with CEOs and other senior management of 50 public companies. To learn more about the potential macro risks for this market currently benefiting from the ongoing US-China trade war, we also met with the local stock exchange, had lunch with senior central bank executives, and visited the finance ministry.
Seeking hidden gems has never been easy, and sometimes we have to play detective to get meetings with companies we are interested in. This time, we had to involve our local sources, use social media networks, engage interpreters, and make multiple phone calls to get a hold of the CEO of one small industrial holding we found of great interest. Our attempts landed us a meeting with the company's CFO at a factory located a couple of hours from Ho Chi Minh City. Later in our trip, we also flew to another province to visit the company's other assets and busy factories, helping us get a better sense for the company's investment potential, in light of expanding earnings and lagging multiple.
We also found a few other companies whose facilities we saw first-hand, and which were reminiscent of successful investments the fund has made in other markets in the past couple of years: an IT distributor benefiting from digitization, a growing software company, and an airport services provider seeing expansion through increases in the number of air travelers in Vietnam.