Author: DC

To my fellow shareholders,

We are fast closing in on our second anniversary of CV Capital (our financial year end is 14 January). As we come to the end of our second year, I would like to detail key mistakes and successes in 2019 which I have not previously covered.

Mistakes

There are two types of mistakes in investing, mistakes from action and mistakes from inaction. One of the biggest mistakes in 2019 was inaction on my part. My friend and teacher, Tony Hansen of EGP Capital invited me to a meeting with the CEO of a payment processing company which was growing strongly and was quite cheap. I thought it looked like a good opportunity but a sharp uplift in the share price within two days of the meeting caused me to wait. Mentally it is hard to buy a stock after seeing it go up 20% but about a week later, the company announced that it sold an overseas business resulting in the doubling of the share price. The lesson is that what happens in the past doesn’t really matter, if we understand the business and if the stock is cheap, we should at least buy some immediately.

The other mistake which I actually made last year but is now acting like an anchor on our returns was over weighting our investment in Steamships. Based on cost, we allocated 13.4% of the fund into Steamships. My investment thesis was that this was a “blue chip” company trading below the book value of its investment properties whose earnings would be getting a massive tailwind from the development of large gas fields in PNG (namely Papua LNG and P’nyang) and other big mining projects. The chart below shows the expected capital expenditure for mining projects in PNG including Papua LNG.

When we made the investment, the government under the leadership of Peter O’Niel was very supportive of these projects. However in May 2019, Peter O’Neil was replaced as prime minister by James Marape. After taking over leadership the new PM shored up public support by stirring up nationalist sentiment with slogans such as “take back PNG”. This led to the government attempting to re-negotiate the Papua LNG deal with the project owners. After months of negotiations, the new government finally backed down and agreed to honour the terms of the Papua LNG agreement. As a result of “losing face” over the Papua LNG re-negotiations, the government is now trying to play hard ball in the P’nyang negotiations (which has not been signed). As P’nyang is integral to the overall Papua LNG project, the entire project is now in limbo as the negotiations between the project owners and the government appear to have come to a stalemate. Given my thesis had assumed that the economic stimulus from the project would have started by end of 2019/ start of 2020, that assumption has now gone out the window. Even though I still believe we will make money from Steamships over the medium term (even without these LNG projects Steamships has property development pipeline which should grow their asset base and contribute to future earnings growth), it has acted as an anchor on the overall portfolio return given its significant weighting (our paper loss as at 31 December 2019 is circa 22%). Given the uncertain nature of PNG politics, it was a mistake to have put so much weight on this investment.

Wins

Moving onto our wins, I’ve previously discussed Baby Bunting in our September 19 report and how it has greatly contributed to the returns for this financial year. I’ve got nothing to add but to reiterate that I believe Baby Bunting is fast on its way to become as dominant in its category like Bunnings is in theirs.

Another win has been Salmat. We acquired the shares at 55 cents in the last quarter of 2018. At the time, the Company had about 40 cents of cash per share and two business segments. The catalogue business was in structural decline but the managed solutions business was growing. I figured that both businesses were worth $120 million in total (60 cents per share) and that it was a possibility that the company would divest all its assets and shut shop. Therefore, at 55 cents it was trading below its intrinsic value of $1 (cash plus value of businesses) with a possible future catalyst. Fast forward to today the Company has sold both businesses for $125 million and will no longer have any operations come end of Februray 2020. I’m quietly confident that Salmat will distribute most if not all the remaining cash to shareholders over the next 6 months. Although it looked like my valuation of the business segments were spot on, in reality I overestimated the value of the catalogue business and underestimated the value of the managed solution business. Revenue for the catalogue business fell more than my forecast and due to its fixed cost its earnings declined at an even greater pace. With the conclusion of the sale of the managed services business in February 2020, the Company should have circa $174 million in cash and 20 million of franking credits. Therefore, before closure costs and other statutory expenses, it could potentially distributed 97 cents to shareholders (cash plus franking credits). With the shares trading at 81.5 cents as at 31 Dec 2019 and including dividends received, our return has been 57% over a 14 month holding period.    

We also had success in an investment which I’m not yet ready to disclose. It is a financial institution operating in a frontier market, let’s call it Bank XYZ. I was attracted to this investment because it had close to 60% market share in its home market, growing its net profit at low teens, generated returns of equity (ROE) close to 30% which is unheard of in Australia for a bank but more importantly did not earn those high returns by lending to high risk borrowers. It could make those returns because of its dominant position in its home market coupled by a lack of competition. When we made the investment, it was trading on a price earnings multiple of 6x and was paying a dividend yield of 10%. Its valuation is cheap because it is listed on its home stock market which has poor liquidity, unsophisticated group of local investors and hardly any foreign investors. Management is aware of the problems with its local stock market and have told me a future option is to get a secondary listing in a more sophisticated stock market. If that happens, then I believe that its price earnings multiple would get re-rated to 12x instead of the current 6x. While waiting for that to happen (fingers crossed), we’re getting paid a 10% dividend yield which is not bad. Even without a secondary listing and assuming the price earnings multiple of 6x remains constant, my valuation calculation suggest that this investment could yield a 400% return over a 10 year holding period (equivalent to a 22% compound annual return). We’ve own the investment for more than 18 months and our total returns (including dividends) up to 31 December 2018 is 40%.  

Activity

In my last quarterly report, I mentioned that we were casting a wider net in search of undervalued securities. This search took me to places like Hong Kong and Russia where we have made some small investments. I would like to provide a quick summary of the criteria’s used in selecting our overseas investments:

1. I mostly limit my selection of opportunities to stocks which are profitable and in mature industries that are not in structural decline. I avoid any turnaround stories, companies with no track records of earnings and companies which are not conservatively leveraged. 
2. Given the higher risks associated with some overseas markets and my lack of local knowledge, I try to select stocks whose valuations are so cheap that there are unavailable in Australia. As an example, I screen for companies whose market capitalisation are below their current assets (cash, stock, trade receivables) less total liabilities value (known as net nets). These net nets are so cheap that if the carrying values of the current assets approximate their market values, an investor would make money by shutting the business down. And if the carrying values of the current assets are overstated, there are usually some fixed assets (non-current assets) which could potentially be monetised at a value greater than zero (given the market assigned no value to these assets). These net nets are extremely cheap and at this point in the cycle they rarely show up on the ASX. Ones that do show up are usually high risk, overleveraged or have dodgy management etc.

A net net which we recently discovered and invested in is a company listed in Hong Kong called Chow Sang Sang Holdings International (CSS). CSS was founded in 1934 and is the 7^th largest jewellery company in the world (by revenue).  Based on Deloitte’s Global Power of Luxury Goods 2019 report, the top 8 global jewellery companies are as follows:

When I was researching the industry, I was surprised that a Hong Kong company took top spot and that Hong Kong companies dominated the list. The rise of the Chinese middle class and growth in their jewellery consumption over the past two decades has made China the largest jewellery market in the world and these Hong Kong companies have exploited this trend by expanding their retail footprint into China.

CSS’ shares suffered a 30% drop between April and Oct 2019 mainly due to the protests in Hong Kong. This resulted in its market capitalisation falling below HK$6.5 billion which looked very attractive when compared to the value of its current assets less total liabilities of HK$7.3 billion. At this level it was trading at price to earnings ratio of 6x, paying a 7% dividend yield with the share price being at a 10 year low. In my opinion, CSS is an unbelievably high quality net net for the following reasons:

1. Its brand has a long history in Hong Kong associated with quality and trust. Most Hong Kongers would know this brand and consumer trust is essential when selling expensive jewellery.
2. Culturally the Chinese have an affinity for gold. Not as much as the Indians but gold is traditionally given at weddings and births. I believe the demand for gold jewellery is likely to increase as the Chinese middle class expands and becomes richer.   
3. The last financial report shows CSS had cash and gold inventory worth HK$9.4 billion and debt of HK$2.2 billion compared to market capitalisation of HK$6.5 billion.
4. The management team is made up of descendants of the company’s founder and has jewellery retailing in their DNA. They are also the largest shareholders which suggest that their interests are closely aligned with minority shareholders.

Over the past 9 years CSS has grown their footprint in China by 130%. As of June 18 they had 534 China stores vs 87 stores in other locations (HK/ Macau and Taiwan). The chart below shows revenue growth from CSS China stores vs HK/ Macau stores over the past 8 years.

My thesis is that even in the very unlikely event that Hong Kong doesn’t recover from recent events, over the next 5 – 10 years, revenue from China will eventually dwarf HK/ Macau as the Chinese middle class expands and becomes richer. CSS has no plans to increase their HK/ Macau footprint but is focusing on opening 50 new stores in China annually. Although the Chinese stores on a per store basis currently generate significantly less revenue than HK/ Macau stores (as they sell products at lower price point), their profit margins are higher due to the lower rent and wage cost. This investment provides a cheap entry point for exposure to the fastest growing middle class in the world.

We did make a few more smaller investments which I’m looking to buy more of and once we’ve finished buying I’ll talk about these in more detail in the next report.

Performance

The portfolio appreciated marginally by 1.4% in the December quarter. There were ups and downs in the portfolio. Given that we are nearing our second year anniversary, I’ve decided to change how we present the results and show the returns both on an annual basis and since inception.

CV Capital’s objective is to beat the benchmark over the long term (3 – 5 years) and although some of our early investments are now coming to fruition, there are still many investments which has not played out yet. Therefore, I’d prefer to form a more concrete judgement of our performance after our third year anniversary. The table below shows out performance (before taxes). Our cash position is circa 12% of the portfolio and the unit price (including taxes) as at 31 December 2019 is $1.24 (rounded).

To my fellow shareholders,

You may have noticed that I have not provided an update since April and the main reason for this is that I have decided to change the reporting frequency from monthly updates to quarterly updates. Given our long term investing strategy, changes in the monthly returns really are inconsequential in the scheme of things and an overemphasis on monthly returns can be detrimental to long term returns. Our selectivity in trying to wait for all the ducks to line up before pulling the trigger also can result in long period of inactivity where I am unable to identify any opportunities, in which case there may be nothing to report. For these reasons, I decided to move to quarterly updates.

The ASX200 is having a very strong run in 2019 and our benchmark STW is up 18.6% (excl dividends) and 21.9% (including dividends, franking credits) for the calender year to June 2019. One of the hottest sectors pushing up the market is technology and in particular software as a service (SaaS) companies. In the US, the FAANG stocks (Facebook, Amazon Apple, Microsoft and Google) are amongst the most valuable companies globally and locally we have an equivalent “WAAAX” group. This group is made up of Wisetech, Afterpay, Altium, Appen and Xero. I’ve also included Nearmap to this group as it has been the top performing stock in the ASX200 index over the last 6 months to 30 June 2019.

The table below compares valuation benchmark for the FAANGS and WAAX goups (all in Australian dollars).

Our local WAAAX stocks clearly trump the FAANG group in terms of gains over the last 6 months and on revenue multiple basis appear to be valued much higher than their US peers. Supporters of the WAAX group will argue that their high growth rates justify these lofty valuations. Time will tell but I strongly suspect that most will not live up to the current hype.   

In terms of activity, we have not bought any new positions over the last 3 months. The main reasons are:

1. The last two months has been busy period for me as I’ve been doing a bit of consulting. Although consulting takes up some of my investing time, I feel that it can add value as it can give me exposure to new company, industry and contacts.
2. With the market being at an all time high, there are fewer opportunities to buy good quality companies at attractive prices. We have come across a handful of opportunities but have not pulled the trigger for one reason or another.

A good thing about low levels of activity is that we’re not constantly paying our brokers.

I’ve reported below our results for June and July.

CV Capital’s objective is to beat the benchmark over the long term (3-5 years) and therefore I do not place too much emphasis on current performance given the relatively short history. The table below shows our performance (before taxes). Our cash position is circa 24% of the portfolio. Feel free to write to me about ideas as we have cash to put to work.

	15 Jan 18	30 Jun 19	Gross dividends (cumulative)	Simple return (pre-tax)	Compound return (pre-tax)
CV Capital	1.00	1.11	-	10.7%	7.2%
Benchmark - STW	56.7	61.39	4.17	15.6%	10.8%

	15 Jan 18	31 Jul 19	Gross dividends (cumulative)	Simple return (pre-tax)	Compound return (pre-tax)
CV Capital	1.00	1.15	-	14.7%	9.3%
Benchmark - STW	56.7	63.15	4.94	20.1%	12.2%

 

To my fellow shareholders,

The market continued its strong run in April. Since the beginning of the year, our benchmark (STW) has returned 17.3% inclusive of dividends and franking credits. I have to admit that I am surprised at the strength of equity markets globally given the trade hostilities between the two largest economies in the world, USA and China. I continue to believe that investors should thread carefully and err on the side of caution as I believe there are heightened risks in today’s markets.  

I believe one of the major driving factors pushing up the equity markets is the low interest rate environment. The recent proposed acquisition of Duluxgroup by Nippon is an example of this. The proposed acquisition price offered by Nippon represents approximately 25.3 times Duluxgroup’s prior year net profit after tax. Now assume Duluxgroup can achieve 3% long term net profit growth after adjusting for inflation (equivalent to about 5% nominal growth) and whilst this is lower than recent growth rates (which I believe have been boosted by the housing boom), it is still higher than 1) long term housing stock growth and 2) population growth. This means that it will take Nippon approximately 20 years to recoup the price paid (ignoring any cost savings in combining the two entities). For a company that already dominant locally and is legally restricted from using the Dulux name outside Australian and New Zealand, it is certainly a very rich valuation and I believe the availability of cheap financing from Japan is one of the factors that enabled the high price.

In relation to the fund activities, we did not buy or sell any positions in April. I did try to add to an existing position but the illiquidity in the stock meant that we were not able to buy any shares without moving the share price. I will continue to try and add to this position.   

Our portfolio was up 4.8% in March.

Although I have been reporting CV Capital’s performance on a month end basis, I’ve done it mainly for the purposes of transparency. CV Capital’s objective is to beat the benchmark over the long term (3-5 years) and therefore I do not place too much emphasis on the current performance given the short history. The table below shows our performance (before taxes). Our cash position is circa 23% of the portfolio.

I will be opening the fund to new subscriptions/ investments in the first week of July. The deadline for new subscriptions/ investments will be 5 July 2019. Please contact me directly if you would like to subscribe to more shares.

	15 Jan 18	30 Apr 19	Gross dividends (cumulative)	Simple return (pre-tax)	Compound return p.a. (pre-tax)
CV Capital	1.00	1.14	-	13.6%	10.4%
Benchmark - STW	56.7	58.99	4.17	11.4%	9.0%

To my fellow shareholders,

Our accountant has finalised the FY2018 financial statements which I have sent to you by email. They have also independently calculated our pre-tax net asset per share value to be $1.0755 (Page 4) which verifies my calculation for FY2018 return of 7.6%. 

I read that Geoff Wilson, a famous Australian fund manager once described the stock market as a much better game than horse racing because one can put a bet at the start of the race and then revise the bet according to how the company is performing. One can increase the bet if the company is doing well or remove or reduce the bet if the company is faring poorly. Contrast this with horse racing where a bet cannot be changed once the race has begun. 

That analogy provides a perfect segue for why we partly sold down our position in NZME. NZME was spun off from APN News & Media in June 2016. It is a leading media company in New Zealand with two large divisions; a news print division, a radio division and a small but growing digital division. My thesis for this investment was that the sum-of-parts was more valuable than the market capitalisation and that  the decline in news print would slow, the radio division would be flat and the digital division would grow. My first and third expectations have broadly come true but the results of the radio division have been disappointing over the last two financial years. Whilst the digital division (Oneroof) shows some potential, it is still early days for this initiative. Based on the poor performance of the radio division, I think the stock is less attractive (reduced margin of safety) than when we first bought it and therefore I decided to cop a 20% loss and sell down a third of our holding to reduce our exposure. I have not completely sold out as I still believe there is a possibility that the results of radio will improve and that the digital division will gain more traction.

In my FY2018 year-end letter, I talked about Steamships Trading and how if approved, the Papua LNG project would provide a huge tailwind for Steamships and the entire PNG economy. Well a major hurdle was cleared with the signing of the Papua LNG gas agreement between PNG government and the project partners in early April. The FEED study will commence shortly and is expected to result in a final investment decision in 2020. The signing of the gas agreement was a big deal and the prospect for Steamships over a 2-3 year period is looking good.  

Our portfolio was up circa 0.9% in March. Returns are calculated once cash is received so although STW’s March quarterly dividend has been announced, it has not been accounted for as it will only be paid in April. 

Although I have been reporting CV Capital’s performance on a month end basis, I’ve done it mainly for the purposes of transparency. CV Capital’s objective is to beat the benchmark over the long term (3-5 years) and therefore I do not place too much emphasis on the current performance given the short history.

The table below shows our performance (before taxes). Our cash position is circa 25% of the portfolio.

	15 Jan 18	31 Mar 19	Gross dividends	Simple Return (pre-tax)	Compound return p.a. (pre-tax)
CV Capital	1.00	1.088	nil	8.8%	7.2%
Benchmark - STW	56.7	57.58	3.21	7.2%	6.1%

To my fellow shareholders,

I have recently got back to Sydney after being away for a month which is the reason for the slight delay and brevity of February’s report.

The stock market is having an amazing start to 2019. Year-to-date (1 Jan 19 to 28 Feb 19) our benchmark STW is up 11.8% erasing all the losses experienced in the last quarter of 2018.

In terms of trading activity, we have added one new position and added to an existing position in the portfolio. These investments were not substantial and we are still sitting on 25% cash weighting in our portfolio (27% cash in the last report).

Our portfolio’s return has been flat since the last report (increase of 0.2%). As a result of our monthly returns being flat and the stock market’s return surging, we are back level with the benchmark. Given CV Capital is more than a year old, I have presented returns on an annualised basis. The equivalent simple return is 7.9%.  

The financial statements for FY2018 is currently being prepared by our accountant and I expect to be able should be able to send them to all shareholders within the next few weeks.

Although I have been reporting CV Capital’s performance on a month end basis, I’ve done it mainly for the purposes of transparency. CV Capital’s objective is to beat the benchmark over the long term (3-5 years) and therefore I do not place too much emphasis on the current performance given the short history.

The table below shows our performance (before taxes).

	15 Jan 18	28 Feb 19	Gross dividends	Annualised returns
CV Capital	1.0	1.079	nil	7.0%
STW (Benchmark)	56.7	57.84	3.21	7.0%

To my fellow shareholders,

CV Capital has recently completed its inaugural year on 14 January 2019. The past 12 months has been a story of two halves for the stock market. In the first half (15 Jan – 30 Jun) the ASX 200 accumulation index (ASX 200 index including dividends) appreciated by 4.1% and in the second half (1 Jul – 14 Jan) it reversed course and depreciated by 4.7%. A combination of US-China trade war fears, rising interest rates in the US, sharp decline in FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) all contributed to the second half being disappointing one for the market.

All in all, the ASX 200 accumulation index finished down 0.8% for our financial year (15 Jan 18 – 14 Jan 19). Our benchmark (ASX:STW) did better, ahead by 0.5% over the financial year. One reason our benchmark did better than the ASX200 accumulation index is because it includes returns from franking and foreign tax credits, whereas the ASX 200 accumulation index only includes cash dividends. As CV Capital also reports franking credits as part of its returns, the STW ETF is a better yardstick than the ASX 200 accumulation index.

Before I delve into CV Capital’s performance for FY2018, I would just like to reiterate that we are investing for the long term and that the focus on 12 month returns as a measure of success is foolish. As Warren Buffett once wrote, “why should the time required for an investment to payoff synchronize precisely with the time it takes the planet to go around the sun?” 

Given this backdrop, our 12 month return was 7.6% after costs (8.2% before costs). The main expenses was compliance (tax and accounting) and travel cost for attending AGMs. I will continue to keep costs as low as possible and as the company grows its asset base, the expense ratio (expenses as a percentage of assets) will further decline.

Although we did generate excess returns of 7.1% (7.6% minus 0.5%) over the benchmark, we gave back close to 9.5% of the gains from August 2018, which is disappointing. The paper losses we suffered since August was primarily due to 1) my stupidity and 2) random market movements (in combination these spoke for 90% of the losses from August).

My stupidity

My biggest folly for the year was Donaco. Donaco is a gaming company and operates two casinos, one in Lao Cai, Vietnam and another in Poipet, Cambodia. It acquired Star Vegas (Poipet casino) in 2015 from a Thai vendor with an arrangement where the Thai vendor would manage the casino for two years and be paid a success fee upon achieving specific earnings targets.

Once two years was up, Donaco decided to take back management of Star Vegas and during that period in mid 2017, there was a falling out between Donaco and the Thai vendor.  Donaco alleged that the Thai vendor breached the non-compete agreement by operating two casinos in the Poipet area. Business at Star Vegas slumped as the Thai vendors poached the VIP junkets. Donaco then proceeded to sue the Thai vendors in Cambodia and Singapore.

We purchased the shares in Feb 2018 after the shares fell more than 50% due to the problems. The shares were cheap and I believed that the problems faced by management were surmountable. However, the extent of the trouble was not fully disclosed by the company and some of the details only emerged much later from a recent article published in the SMH, an extract which I’ve included below.  

“According to the court documents, on the afternoon of June 30, 2017, all the slot machines at Star Vegas were turned off and the gambling tables closed. Around 4pm an announcement came over the speaker system within the casino that the Star Vegas had ceased operation and all players were required to move to the “Star Paradise”, the new casino next door. The Thai vendor allegedly took computers, kitchen equipment and corralled about 550 staff to the new casino. He also told VIP junket operators he would not extend credit to their clients and could not guarantee their safety unless they started visiting Star Paradise casino instead.” – smh article on 12 Jan 2019.

Both parties are now suing each other and the biggest risk for Donaco is if the Thai vendor (as landlord) manages to terminate Donaco’s 50 year lease on the Star Vegas land. The shares were trashed as institutional investors fled given the uncertain outcome of the litigation proceedings and potential for further underhanded tactics by the Thai vendor.

At the end of the financial year, we recorded a 70% paper loss on this investment which reduced the portfolio returns since August by 2.6%.

One of the principles at CV Capital is that success is not measured by winning or losing on a single investment but rather having a robust process that identifies low risk investments with favourable wininng odds. A simple analogy is that every bet we make, we want casino odds rather that player odds. Therefore, my folly was not that we lost money on this but the fact that I was aware of the risk of operating in a frontier jurisdiction with potentially shady characters but still overlooked it.

At the end of our financial year, the market capitalisation of Donaco is slightly above $50 million. I believe that the market has more or less fully discounted the value of Star Vegas so there is no point selling at current prices (Donaco also operates the Aristo casino in Vietnam). In the event Donaco is able to get a favourable outcome in the lease arbitration case in February 2019, this would remove a huge cloud of uncertainty over its future. 

Random market movements

Our largest position in CV Capital is Schaffer Corporation. The shares were transferred into CV Capital at $11.10 per share at the beginning of the financial year. On 15 August, Schaffer reported a 174% increase in underlying profits for FY2018. Investors responded to these solid financial results by driving up the share price to $17.05 by the end of August. From September onwards, the shares then reversed course into a declining trend and by the end of our financial year the shares were trading at $13.06.

There was no fundamental reason for this decline. In fact at the AGM in mid November, the Chairman broadly confirmed that the first half results for FY2019 would be similar to the first half results for FY2018. Nonetheless, the share price still fell and is currently trading at a level lower than where the shares were trading two weeks before the company reported their strong results for FY2018, which doesn’t really make much sense to me. Since August, the decline in Schaffer’s share price has shaved off 6% gains in our portfolio.

However, I continue to believe that the shares are undervalued and have elaborated more on this below.

Top holdings

At the end of the financial year, our top 3 positions including cash accounted for 69% of the value of CV Capital.

No.	Investment	Weighting
1	Schaffer Corporation	18%
2	Steamships Trading	13%
3	Baby Bunting	11%
4	Cash	27%
	Total	69%

 Note 1: Returns include unrealised capital gain, dividend and franking credits

I am quietly optimistic about our three largest investments and have given a high level summary of each one below.

Schaffer Corporation

At current prices, I believe Schaffer is undervalued by the market. The entire company is being valued by the market at $181 million and it has no net debt. It has a property portfolio worth $84.6 million net of capital gains tax.

Schaffer has two operating businesses, Automotive Leather and Building Materials (which is insignificant relative to the Automotive Leather division). The Automotive Leather division reported net profit after tax of $23.7 million in FY2018 and is expected to report similar levels of profit in FY2019.  

Backing out the value of property from Schaffer’s market value, it implies that the market is valuing the Automotive Leather division at $96.4 million ($181m – $84.6m and ignoring the Building Materials division) or at a price earnings multiple of 4 times ($96.4m/ $23.7m). I believe this is a very low valuation for the Automotive Leather business given:

1. It has secured multi-year supply contracts with Land Rover, Audi and Mercedez Benz.
2. It has the opportunity to increase volumes after being awarded new contracts to supply leather for Mercedez’s electric cars commencing in early 2021.
3. Similar businesses have been sold at much higher price earnings multiple. 

In addition, Schaffer owns two development sites whose which can add significant value in the medium term. The first is a large development site for industrial use in Jandakot, Perth which is adjacent to an established industrial zone with links to a major freeway. The second is a residential development site approved for high density apartments within the Cockburn coast redevelopment project (just south of Fremantle, WA). This redevelopment project will create a township for 12,000 residents over the next 20 years. I believe the development risks are relatively low given the sites are located in already established areas and without any debt associated with the sites, it has the advantage of waiting for the right market conditions to launch the developments.

For the above reasons, I believe Schaffer to be undervalued at current market prices. FY2019 dividend is forecast to be at least $0.60 per share fully franked which represents a gross dividend yield of 7.7% based on our cost per share. I’m happy to collect the dividends whilst waiting for the market to realise its intrinsic value.

 Steamships Trading

Our second largest holding is Steamships. Steamships is the leading logistics, hotel operator and property developer in PNG. Steamships is not only undervalued by the market at current levels but it also has the potential to double its earnings over the next 3-5 years.

Steamships’ market capitalisation was $580 million (14 January 2019) and it had net debt of $133 million, valuing the company at $713 million or PGK1.7 billion (exchange rate of 1A$:PGK2.4). It owns investment properties valued in the range of PGK$1.6 billion to PGK$2 billion. Therefore, the market is only placing value on its investment properties and ignoring the value of its shipping business, land transport business and hotel business.

As Steamships is one of the largest conglomerates operating in PNG, its fortunes are very much tied to PNG’s economy. Over the last few years, PNG has been in an economic slump due to low commodity prices and cuts in government spending. However, there are huge resource projects in the pipeline with the most significant being the Papua LNG project, which once developed would be PNG’s second LNG project.

The first PNG LNG project commenced construction in 2010 and was completed in 2014 at a cost of US$19 billion. This provided a massive stimulus to the economy which resulted in profits for Steamships nearly doubling from PGK96.5m in FY2009 to PGK177.7m (FY2012).

The Papua LNG project is expected to cost US$13 billion and if history is any guide, during its construction phase it should provide an economic tailwind to Steamships similar to the first LNG project. Of course there is risk that the Papua LNG project gets delayed or does not proceed. However, with the company’s market value backed by its property assets, I see this bet as heads I win and tails I don’t lose.

Baby Bunting 

Our third largest security holding at year end gave us the highest gains in FY2018 (total returns 48.6%). Baby Bunting is the leading baby product retailer in Australia. Calender year 2018 was a watershed year for Baby Bunting as many of its key competitors including Baby R Us shut shop leaving Baby Bunting as the sole national bricks and mortar baby store retailer in Australia.

Baby Bunting has doubled its store footprint in the last 5 years to 50 stores. The company has plans to expand their footprint to 80+ stores and I believe with the closing down of its key competitors it has further scope to enlarge their footprint. It has a successful store format so replicating it into new locations should generate similar success.

The biggest threat to Baby Bunting is online shopping, i.e. Amazon. However, there are still some advantages that Baby Bunting has over its online competitors, such as:

• Baby products are an emotional purchase so new parents would want to touch and feel the product first.
• For first time parent (I should know) buying big ticket items such as strollers and car seats is daunting mainly because of the extensive range of products with different features, types, brands etc. Having someone explain to you the differences and the pros and cons of each product is extremely helpful.
• Proper installation of a car seat is important. Baby Bunting provides baby car seat installation service which an online retailer would not be able to provide.
• Some products are exclusive to Baby Buntings. For example, they have their own private label products or exclusive colours on branded strollers (very important for the stroller to match mommy’s handbag!) etc.

In addition, for big ticket items such as strollers, baby seats and cots, Amazon Australia currently only has a fraction of the product range sold by Baby Bunting. It appears to me that Amazon Australia’s baby segment focuses more on smaller items whereas the bulk of Baby Bunting’s revenue come from the big ticket items such as strollers, car seats and cots.   

So I’m quite bullish about the prospects of Baby Bunting given advantages of scale in being able to negotiate prices (higher margins) or exclusive products from its suppliers, potential growth from new store rollout and population growth. In my view, Baby Bunting is on its way to becoming the “Bunnings” of the baby speciality retail segment.

Cash

Our largest holding at the moment is cash. The current levels of cash is not 100% intentional, we had two takeovers in this financial year (Watpac and SVWPA) where we generated returns between 25% to 29% on each investment and have not been able to fully redeploy the cash. Although we are not trying to time the markets and in general prefer to be fully invested at all times, I do believe there are reasons that justify a bit of caution in today’s markets.

There are risks such as Brexit, fallout from the China US trade wars, slowing economy in China, fall in Australian house prices, sell-off in the US high yield bond market etc.

So at the moment, we’re still investing but being more cautious and selective in our investments.

The remaining 31% of the portfolio is made up of 7 securities. At 14 January 2019 we have a portfolio of 10 securities.

Overall

This first year has been a learning experience for me and I think I’m a better investor now than at the same time last year. Whilst it would have been nice to report double digit returns for the first year, 12 months is still a very short period in investing and we did manage to generate some excess return which is nice. Even though we have generated excess returns of 7.1% over our benchmark, we have decided to waive the performance fees this year given it was our inaugural year and to show appreciation for the trust that you have placed in us.

I’m optimistic about the portfolio because there are some investments which have the potential to do really well in this year. We will continue to turn over as many stones as possible to look for mis-priced bets.

Thank you for entrusting us with your capital.

	15 Jan 18	14 Jan 19	Gross dividends	Return (incl franking credits)
CV Capital	1.00	1.076	nil	7.6%
Benchmark - STW	56.7	53.78	3.208	0.5%
ASX 200 accumulation index	60,545	60,043	n/a	(0.8%)

To my fellow shareholders,

Maintaining the trend from October, the ASX 200 index was down approximately 3% in November, without taking into consideration dividends. US China trade war and rising interest rates in the US have all weighted on the market. Unless there is a major rally in December, it is increasing looking like calender 2018 will be a negative year for stocks.

As discussed last month, I accepted Besix’s offer for our Watpac shares. I still think Besix’s offer undervalued Watpac but between the choice of selling now and locking in a gain of 29% or  holding onto the shares and becoming a minority shareholder in a situation where Besix will have voting power greater than 75%; I thought it was a no brainer.

We recently acquired a small interest in a mining company. This is unusual territory for me as I tend to stay away from the resource sector given the risks. Earnings for mining companies tend to be volatile, a key reason being the inability to determine prices for their products (i.e. price takers). The reason why I invested in this junior miner was that I thought it was very cheap and had huge potential upside. This company had purchased a brownfield mine from the liquidators of the previous mine owner for $40 million. The previous mine owners spent $500 million on plant & equipment and mine development. For a junior miner which has $200-$300 million worth of plant & equipment (bulk of capital expenditure already spent for production ramp up), very experienced management, currently breaking-even with production ramping up and quarterly sales of $30 million, I thought it was cheap when it was trading at a market capitalisation of $70 million. This investment is not without risk but I believe the upside potential is huge.

The portfolio had it worst month to date, falling by 3.9%. One of the stocks which dragged down our performance is Donaco. This is a gaming company with casinos in Vietnam and Cambodia. Donaco is in dispute with the former owners of their Star Vegas casino in Cambodia and this dispute is getting uglier and looking like it will get dragged out with a small risk of Donaco losing the casino. A poor trading update for the first quarter of FY2019 saw a huge sell-off, it is down 52% in November. Arbitration between the parties will take place in July and will confirm whether this investment has been a mistake but it is looking like it at this stage. The only silver lining was that it was a smallish investment.

Although I have been reporting CV Capital’s performance on a month end basis, I’ve done it mainly for the purposes of transparency. CV Capital’s objective is to beat the benchmark over the long term (3-5 years) and therefore I do not place too much emphasis on the current performance given the short history.

The table below shows our performance (before taxes) from inception to 30 November 2018. Our cash position is circa 17% of the portfolio.

	15 Jan 18	30 Nov 18	Gross dividends (cumulative)	Return (incl. franking)
CV Capital	1.00	1.134	nil	13.4%
Benchmark STW	56.7	53.23	2.67	(1.4%)

To my fellow shareholders,

October has not been a kind month for stocks, the ASX 200 fell 5.5% in October. This drop was not triggered by domestic issues but rather events in the US market which spread around the globe. The phrase “When America sneezes, the world catches a cold” is especially true in the financial markets.

Given our concentrated portfolio, I had expected to report a lower return in October than in September. Our big winners did give up some gains in October but this was offset by gains from one of our smaller positions, Watpac which went up significantly due to a takeover offer. I first wrote about Watpac in March, when Besix (majority shareholder of Watpac) tried to buy 50% of the shares it did not own via a scheme of arrangement. Institutional investors voted down the scheme and seven months later Besix is back to buy 100% of the shares it does not already own. In my opinion, although Besix’s offer still undervalues Watpac, it would be risky to remain a minority shareholder in an entity which Besix may end up with a very large controlling stake.

In terms of activity, we have been very slowly buying shares in a marketing company. I say slow because our bid has been in the market for 6 weeks and only 66% of the trade has been filled. The stock’s illiquidity and my allergy to paying high prices are the main reason for this slow digestion.

Although I have been reporting CV Capital’s performance on a month end basis, I’ve done it mainly for the purposes of transparency. CV Capital’s objective is to beat the benchmark over the long term (3-5 years) and therefore I do not place too much emphasis on the current performance given the short history.

The table below shows our performance (before taxes) from inception to 31 October 2018. Our cash position is circa 20% of the portfolio.

	15 Jan 18	31 Oct 18	Gross dividends (cumulative)	Return (incl franking )
CV Capital	1.00	1.173	nil	17.3%
Benchmark - STW	56.7	54.48	2.672	0.8%

To my fellow shareholders,

September has been a relatively quiet month as I have been travelling. However, we did make our biggest exit to date.

We sold our entire position in SVWPA (my original thesis here). SVWPA was a perpetual preference share issued by Seven Group Holdings (SGH) that was trading at $82 (below par value of $100) with a dividend yield of 8.3% (fully franked) when we acquired it (it was transferred from my personal holdings). My thesis for this investment is that I believed SGH could access cheaper debt compared to SVWPA and therefore it would be redeemed eventually. I wasn’t sure when this would happen but we were getting paid 8% while waiting, which in an interest rate environment of 2% was pretty attractive.

In September, SGH proposed to convert SVWPA into ordinary shares. This was subsequently approved by the SVWPA holders. We sold our stake on market prior to the conversion for $101.40 per share (above par value). I elected not to convert the SVWPA shares into equity because:

• SGH is a large conglomerate with many moving parts and I don’t fully understand all the businesses. In my opinion the understanding and knowledge needed for a debt investment is very different from what is required for an equity investment.
• The stock price has nearly doubled from a year ago and is trading at a price earnings ratio of nearly 19x. Not exactly cheap and I see better risk reward opportunities elsewhere.

Including dividends and the capital gain, our return on this investment was 25% (not compounded) over a 9 month holding period. I enjoyed this trade as we made money taking very little risk.

The portfolio fell 0.4% in September. The concentration of our portfolio mean that normal price fluctuations in our big positions can affect the overall portfolio. Cash received from the above sale and dividends received in September have pushed up our cash position to be circa 22% of the portfolio.

Although I have been reporting CV Capital’s performance on a month end basis, I’ve done it mainly for the purposes of transparency. CV Capital’s objective is to beat the benchmark over the long term (3-5 years) and therefore I do not place too much emphasis on the current performance given the short history.

The table below shows our performance (before taxes) from inception to 30 September 2018. Please note that STW went ex-dividend in late Sept with its price subsequently falling. I understand that the dividend will be paid in October. As I only account for dividends on a cash basis, September’s out-performance is slightly exaggerated.

	15 Jan 18	30 Sept 18	Gross dividends (cumulative)	Return (incl franking)
CV Capital	1.00	1.166	nil	16.6%
Benchmark STW	56.7	57.9	1.259	4.3%