To my fellow shareholders,
A very happy new year to all of you. Personally, I’m relieved 2020 is over and will be happy to forget last year. It has been a devastating year for me personally as I lost someone dear to me in my family. So I do hope 2021 brings better health, happiness and prosperity to everyone.
Financially, 2020 will be an unforgettable year given the wild roller coaster ride it has been. We started the year strongly with a compound return of 11.9% (since inception) and during the depths of the market falls in March, we basically gave up all the returns within a few weeks. But by the end of 2020 calendar year we more than made up for all of the lost ground and our returns now are greater than they were at the start of the year. Pretty wild ride but you do need a tough stomach to enjoy equity market returns.
Firstly, the June and September returns have been adjusted upwards slightly. Two reasons for this, (1) our accountant has calculated the tax position for financial year 2020 so this impacts the share price from the end of FY2020 (2) I mistakenly used a slightly higher share count to calculate the June and September’s share price. The good thing is that because the accountant independently calculates our share price, there is another layer of verification. This is one reason why I insist shareholders looking to exit do it after our financial close so that the share price can be independently verified. Moving forward, I intend to also get a second person to review my quarterly share price calculation to minimise the likelihood of mistakes occurring.
Taken together the share price has marginally increased for June and September as shown below.
I also want to touch a bit on subscriptions and redemptions prices. CV Capital as a company is an inefficient tax vehicle for making investments. However, what it lacks in tax efficiencies, it makes up for in low cost. Compared to a managed investment fund unit trust structure, our operating costs are miniscule. Given these tax ineffiencies, we have to make certain adjustments to our reported share price for subscription and redemption prices for it to be equitable for all shareholders. For example, if we paid a redemption price based on the reported share price (assuming we have unrealised gains) then the outgoing shareholder is potentially leaving capital gains tax on the unrealised portfolio gains for remaining shareholders in the fund to settle. Conversely, if new subscribers paid the reported share price then he/ she may end up having to pay capital gains tax on gains which they did not benefit from, being new shareholders. We calculate subscription and redemption prices as follows:
Subscription price = Share price less any franking credits and estimated capital gains tax from unrealised gains
Redemption price = Share price less estimated capital gains tax from unrealised gains
I will be sending out an information memorandum for the fund in the next few weeks which will provide further details.
Lessons from 2020
One of the key lessons for me in 2020 is to pay greater attention to events which have the potential to cause great economic and market turmoil and to understand these risks from first principles rather than relying on second hand (media) views.
Global stock markets were so optimistic in January 2020 despite Covid-19 raging in China. I suspect even a first year epidemiology student would have understood the grave risks Covid-19 posed to the world, yet the financial markets in developed countries were too busy hitting all time highs to take notice. I believe a key misjudgement was that investors used historical experience to project the future. They assumed that the authorities could get on top Covid-19 just like how Sars and Mers were tamed with little disruption to the economy. They also assumed that the health systems of developed countries were better equipped and organised to tackle the virus more effectively than China (which had to lockdown the entire country). How wrong the markets were on both counts.
Investors outside China had 2-3 months to see how contagious and deadly the virus was. The gravity of the situation was easily recognisable to those who had some knowledge of epidemiology and one had more than enough time to reduce equity exposure or put downside protection in place which a few famous investors actually did.
Last year also showed that financial markets are purely sentiment driven in the short term. Who would have imagined that despite the worst global economic contraction experienced since World War 2, both the US stock market indices (Nasdaq and S&P500) and US Covid-19 daily infection and death rates are currently simultaneously hitting all time highs. It is truly astounding to watch. There is a massive amount of capital riding on the speed of the global vaccine rollout. From my vantage point, the market appears to be pricing in a successful swift vaccination of the population in the developed countries and a quick economic recovery thereafter; lofty expectations perhaps.
Losers and winners
The biggest loser in the fund as at 31 Dec was Steamships Trading. If we sold the investment today we would cop a 35% loss. However, I do not deem our decision to investing Steamships to be a mistake. Instead, it was the disproportionate amount of capital allocated to this investment given its risk profile as a company based in PNG (a young country with an immature political system) that has hurt our returns. However, I am still optimistic for a recovery as the catalyst for growth (Papua LNG project) is still there albeit delayed by the current government. I have previously covered this in more detail here.
Another loser in 2020 was Kangaroo Plantations. Our thesis for investing in Kangaroo Plantations was that it had mature blue gum plantations on Kangaroo Island which was ready for harvest except that it was waiting for State government approval for construction of a wharf which would enable export of the timber off Kangaroo Island. What I didn’t predict was the intensity of the bush fires in January 2020 which ravaged all of their plantations across the island despite the plantations not being contiguously located. Although Kangaroo Plantations did receive insurance payout for the fire damage, it was significantly less than the market value of the timber destroyed.
If we sold the investment today we would incur a 37% loss and I regard this as a permanent loss of capital given the destruction of the timber assets. The company is still waiting approval for the wharf and so this loss may narrow once the wharf is approved (as they could potentially charge third parties for the use of the wharf). Fortunately, our allocation to this investment was circa 5% (based on cost) and the overall impact to the long term returns of the fund is currently 0.6%.
The biggest winner in the fund for 2020 calender year was Baby Bunting. As at 31 Dec, this investment makes up 15% of the fund and the total returns (including dividends) is circa 228%. I have discussed this investment in detail in previous reports (see here) so I won’t bore you again suffice to say the dumbest decision I made in 2020 also involved Baby Bunting. After rising to close to $4 pre-Covid it fell to circa $1.50 during the March market panic. I did top up our position by 20% but in hindsight it was such an obvious no brainer that we should have bought bucket loads of it. I understood the business well, it has virtually no brick and mortar competitors of significant size, it is selling essential goods for expecting mothers (so the lockdown affected it far less than other retailers) and it was going to double its store footprint over the next decade. The stock is currently trading close to $5. I deem our biggest winner for 2020 also to be my biggest mistake this year. In this game, mistakes of omission can hurt far more than mistakes of commission.
Another investment which materially helped our returns in 2020 calender year was Seek. We purchased this investment close to the lows in March which I regard as pure luck. Seek is the dominant job board site in Australia, New Zealand, South East Asia (via JobStreet), Mexico, Brazil and China (via Zhaopin). When we bought the stock at $11.75, the market was valuing Seek at $4.1 billion. Its average operating cash flows over the past 3 years was circa $350 million so we were paying about 12 times operating cash flow. Based on these numbers and the period when we bought it, it doesn’t look like an absolute steal. However, when you consider that the ANZ division (close to an unregulated monopoly) changed (Dec 19) its pricing structure to better align ad price to job value, and that its subsidiary Jobstreet will likely follow suit in due course then at $11.75 it’s starting to look like a significant bargain. The ability to charge higher prices for an unregulated monopoly is the ultimate no brainer investment.
To imagine the possible impact from a price hike, we can look to realestate.com, the leading online real estate advertising company in Australia which is comparable to Seek. In FY2015, realestate.com started its journey to market based pricing for its Australian business which basically meant charging ad prices based on property values (which is essentially the same thing Seek is currently doing). This change in pricing method helped realestate.com to increase revenue from $477 million in FY2015 to $874.9 million in FY2019 (before Covid), an impressive 83% growth for an already mature market leader. Realestate.com didn’t disclose ad volumes growth over the period but it couldn’t have been anywhere close to 83%, it could have even been flat over the period given the slump in property prices for Sydney and Melbourne in the first half of 2019.
In the last quarter we purchased a 5% position (based on cost) in Gowings. This investment is basically an asset play. Gowing is primarily an investment holding entity with a majority of its assets tied up in regional shopping malls alongside some equity investments. It owns Coffs Central and Port Central which are shopping malls located in the CBDs of Coffs Harbour and Port Macquarie making them the prime shopping and lifestyle destinations for both regional towns. There is development potential at both locations with approval given for the 7 storey hotel on top of Coffs Central and the potential to develop 12,000 sqm car park in Port Macquarie’s CBD. The managing director owns 39% of the company and has a good long term investment track record. It’s net asset per share was $3.64 as at 31 July 2020 and we purchased the shares at $1.51 after shopping malls lost favour amongst investors due to the Covid-19 social restrictions. As we have a large margin of safety, I see this as a low risk investment.
We sold 25% of our holdings in Schaffer Corporation. We sold the shares at $18 which I deem to be still slightly below its intrinsic value. I sold it to raise some cash as I believe that there are other better opportunities currently in the market which have more upside (and comparable risk) than Schaffer at $18. Our return on the sale of this parcel of shares was approximately 85% over the 3 year holding period.
As at 31 Dec, our top 4 holdings and cash accounted for circa 52% of the overall value and are as follows:
Cash and cash equivalents include cash and securities that currently have received a friendly takeover bid which is supported by the company’s board.
CV Capital return for FY2021 (1 July – 31 Dec) is 28% and since inception is 13.5% on an annual compounded basis.
The chart below shows our returns on $100,000 from inception to 31 Dec 2020 compared to our benchmark.
Our cash and cash equivalents position are circa 13.8% of the portfolio and the share price as at 31 December 2020 is $1.46. The share price can be broken down into the following: