Tuesday, February 28, 2012

Divestment of UOB Kay-Hian

UOB Kay-Hian bought at $1.65, sold at $1.67, total gain $1.42.
I sold it immediately this morning after the FY2011 result is announced despite a dividend of $0.06 being declared. The reason why I do so is that the calculation in buying the stock at the start was faulty.
Reasons why I bought the stock
  1. High Profit Margin
  2. High ROE
  3. Dividend Payout Ratio of 60%
  4. Conservative Management (one of the rare brokerage that likes to ban trading in hot stock)
  5. Largest brokerage in Singapore with operations in Hong Kong and Thailand
  6. It's a matter of time that the retails investor will return
  7. Brokerage demand has high potential for growth given that only 12% of population are trading or investing. This compared to 30% in Hong Kong and 50% in USA
And the reason why I sold it off is definitely not because of unsatisfactory result. I do expect the weak result given that q4 is traditionally where market turnover is at its lowest and with the euro crisis still unsolved. The only reason why I decided to sell it off is that after keying in the data into my spreadsheet, I realised that my calculation of its ROE of 17% is faulty by taking into account Peak Earning in 2007 and 2008. Under normalized situation, its ROE should average around 11%, though in a hot bull like 2008 it can go all the way up to 28%.
A 6% difference in ROE is too much for me. A ROE of 11% is not a good sign especially if the profit margin is as high as 30% and will make it just an average company out there. And this is it - I will never buy an average company at an average PE of 10 for my long-term portfolio, as it will be without much margin of safety. Of course, unless special situation exists such that I believe that its normalized earning can grow in the future to a point that the PE of the current price will be 5. And given that SGX has a ROA of 15% and ROE of 30%, I will rather buy SGX at a price of 20 than UOB Kay-Hian at a price of 10.
It is definitely not that this is a lousy stock. If one will to hold it till a bull market and collect the dividend in the meanwhile, profit is rather guaranteed. This will be a good buy if one can get it at $1.15 and hold it with a mid-term view in mind. However, being without much margin of safety and being low on cash, it might be better to source out a better price for value company.

8 comments :

  1. Brokerage business is pretty competitive nowadays as they are basically selling a commodity product, i.e. service of buying stocks. They need to compete with CFD providers, private banks, foreign brokerages setting up shop here, etc.

    Exchange business is supposed to have a better moat, but I am rather doubtful about SGX (especially at high multiples) because I doubt the quality and quantity of companies that would want to list in Singapore. In turn, I doubt whether SGX can realistically increase trade volumes by much going forward, especially now that the fever of the red chips have subsided. In fact, the past failed acquisition attempts of SGX (which resulted in losses to shareholders) gives us a good clue that even the SGX management is struggling to improve their revenues.

    Futures exchange such as the CME or CBOE have better competitive advantages but they tend to be overpriced.

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  2. While brokerage can be a competitive business, a sort of oligopoly situation is what's going on now in Singapore. In fact, the liberalisation of brokerage industry has already started since 2001, from an original fixed rate of 1% down to 0.4% that year. Further cut has then be rather uncommon with DBS doing so only if it is a cash trading account.

    Ultimately, brokerage is still a viable business if they are able to reach a critical size that's much larger than their competitors. Economics of Scale can be enjoyed from the common team of research analyst and a support of their online platform. This has been one of the reason why the government tries to liberalise the borkerage industry then though its not the main reason.

    Based on the ROE, I figured out that UOB Kay-Hian has been big enough to be cost-effective. But, a re-calculation of figures show that it has not been able to reach a size that makes it attractive enough as a long-term investment.

    Going forward, SGX still has a lot of potential. The key here lies in expanding the retail investment scene in Singapore which is only at 12% of the population. More also needs to be done to increase the range and sophistication of financial instruments available. The ASEAN Trading link due to come out this June might also prove to be a game-changer and will be beneficial to the development of our secondary market.

    Something which I have to admit though is that Singapore is still far away from being a financial centre for capital debt and equity market. We are seriously lacking in the range of financial instruments and this can be partly due to the lack of knwoledge and interest from the public. Neither do we have pension fund who's one of the main institutional client overseas. The government has also been trying their best to encourage development of our bond secondary market by allowing SGS to be traded.

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    1. The First AnonymousMarch 1, 2012 at 2:15 AM

      Interesting point about EoS, but the question remains about the loyalty of customers. How do you tie down a customer to one particular broker, since retail SGD stocks are all held in custody by CDP? How does a Kay Hian "reach a critical size that's much larger than their competitors"?

      And even if Kay Hian holds significant size now, its future is unknown, as potential strong competition may appear over the horizon in an essentially commodity business.

      Btw, private banks are gobbling up the high net-worth clients with lower-than-retail commissions. These clients transact huge volumes. I believe private banks post a real and significant threat to the brokerage business model by taking away these deep pocketed clients.

      Perhaps the EoS which you speak of applies more to fund managers? They enjoy the same EoS benefits, plus they can build up a strong reputation and branding if they consistently outperform. Not forgetting that they charge annual management fees of 1%+ and pass on transaction fees to clients. Trumps the 0.3% of online brokers. Blackrock comes to mind.

      As for your point about SGX, I must admit I do not know much about the ASEAN Trading Link you mentioned. Care to enlighten me?

      12% of population buying shares is actually quite a lot. Most people have a day job, family commitments and hobbies that occupy bunk of their waking hours. Only people with extremely passion for stocks (like yourself) or penchant for gambling (stock punters, technical traders, etc.) will actively trade, bother to learn more about stock investing or invest in stocks. This is my personal view though, and I may be wrong.

      Another personal bias of mine is the view that the more sophisticated a financial instrument is, the more probable it is to lose money in it. Warrants, options and margin trading are products that contain inherent leverage and potential for large losses. They are certainly not suitable for the layman investor. Furthermore, even a perfectly good idea like a straight-up low-cost index-tracking ETF has be "innovated" into synthetic leveraged ETFs. I would hope not to see this land in Singapore anytime soon. It may be good for business, but I think there is a societal cost involved.

      I agree with your last point that a better developed secondary SGD bond market is desirable for Singapore. I hope they will find a way to reduce the current minimum trade size of S$250K for SGD corporate bonds. Not many retail investors can stomach such large amounts...

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    2. In case, you wonder why your comment did not appear, it was labeled as spam by blogspot and not that I deleted it away.

      It is nearly impossible to tie down retail investor since the liberalization, and given that people will have multiple accounts according to their needs. I do foresee myself having at least 3 accounts in the near future. However, if we are talking about remisiers, it might be different as this is a relationship business.

      EOS can be realized as there are huge amounts of fixed cost that can be cut. For e.g. equity research analyst, office rental, HQ, technical support and e.t.c . Just to illustrate, from 2000 to 2002, personnel cost and other operating costs occupy 60% of total revenue. This figure dropped to 50% in 2004, and by 2006, the figure is now at 40%. Yes, this includes 2008 and 2009. Thus over the decade, UOB Kay Hian has managed to decrease its fixed cost as a percentage of total revenue from 60% to 40%.

      UOB’s strength lies in UOB bank support, its international operations and constant acquisition.

      UOB Kay Hian has been successful in its growth through acquisition policy. Since its merger with KAY Hian in 2000, it has since acquired many other brokerage like Credit Suisse First Boston, RHB - Cathay Securities Pte Ltd, OUB Securities Pte Ltd, JM Sassoon, Millenium Securities, just to name a few. Through these acquisitions, it can gain customer base while reducing cost like research and office.

      Having international operations allow it to cut cost when investors wish to trade overseas. Its Thailand operation has established itself to be able to be listed in 2006 on the Thai Exchange. When it’s Thai operation stock price drops a lot, UOB Kay hian has bought quite a bit of its stock.

      http://www.reuters.com/article/2011/12/03/stocks-asia-link-idUSL4E7N300P20111203

      You can check out the Asean Trading Link here, with the world looking towards the emerging market, there’s definitely quite a bit of potential going forward. 12 % is definitely very little as compared to other exchanges. Looking at turnover velocity – SGX’s figure is 46% in 2009, compared to 74% in Australia SE, 67% in Hong Kong Exchange, 149% in Korean Exchange, 61% in National Exchange of India, 200% in Shanghai SE, 400% in Shen Zhen SE, 168% in Taiwan Se and 62.5% in Thailand Se.

      While societal cost will definitely increase, Singapore has to rely on its service sector for growth. Developing itself as a financial centre has been one of the economic policy of Singapore since independence when it set up the Asian Currency Unit in 1969 to trade FOREX.

      I do really hope that bond market will open up as bond should occupy a good portion of a standard portfolio to allow one to liquidate extra fund to be deployed during a bear market. But the very fact is that due to our budget surplus, the government simply does not have the need to fund its budget through SGS. SGS has been set up with the main purpose of developing our bond market and to provide a risk-free standard for other bonds and assets.

      I enjoy this conversation a lot:) If you want to contact me further, you can email me at sgyounginvestor@hotmail.com.

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    3. The First AnonymousMarch 2, 2012 at 1:54 AM

      You write pretty well. Useful skill-set in future if you wanna move into investment research. Anyways, my first comment did appear. I just didn't wanna get confused with the gentleman asking about the 2 cents profit (no offense, but pretty lame lei hahaha...)

      So the way I interpret it, you are saying that Kay Hian can be like a Walmart of retail stock brokering, i.e. expand fast so that they can be the lowest cost competitor in the region. Possible... but still not too convince about how wide their moat is. Useful to see the differing view and logic though.

      Cheers!

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    4. Thanks for your compliment.

      Kay Hian will not become like a Wal Mart even if it manage to achieve one of the lowest cost structure.

      The model of Wal Mart is that they are able to achieve the lowest price and then pass on to their consumer to generate high inventory turnover while they can take their time to pay for the goods.

      Kay Hian will likely not be doing so as price war is not going to work for them. Firstly, local brokerage today are all backed by banks like DBS, OCBC, Maybank and CIMB, thus providing mutual-support to each other. Thus, it is rather unrealistic to engage in a price war, as the weak are unlikely to fizzle out or be acquired. Secondly, if the price war is unable to weed out competition, what's the point in doing so just so that your profit margin will fall?

      When it becomes the lowest cost operator, the key is not to beat its competitor but to be able to increase its revenue and profit margin. As I mention earlier, Kay Hian's growth policy for the past decade has always been through acquisition. This has been a wise decision rather than to compete in the internal market.

      To illustrate my point:
      Currently kay Hian has a 30% net profit margin. Assuming 400m in revenue, fixed cost accounts for around 160m. Next, they acquired a smaller brokerage with 50m in revenue and 30m in fixed cost. Total Revenue increases to 450m, while fixed cost might only rise by 10m to 170m through rationalisation. In this way fixed cost as a percentage of total revenue continue to shrink from 40% to 36%. Synergy in cost is very high in the financial industry.

      By having the lowest cost structure, Kay Hian needs not worry if a price war were to be carried out, as it is able to stay nimble. And neither will anyone else wish to carry out a price war, as they are not the lowest cost operator nor the market leader.

      In this case, it is not exactly a moat. A moat is where it is being protected from competition in some way.

      The way to think about it is whenever it acquires a new company, it expands its revenue while decreasing its fixed cost per revenue. There's not many companies out there where one needs not worry about the success of its acquisitions.

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  3. 2 cents difference. how many lots did you buy to make a profit?

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    1. Sorry, but I can't answer your question as I want to have some form of privacy. Anyway, I didnt buy it with the intent to make a profit out of 2 cents difference. it was because the reason to buy it has changed.

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