Monday, 3 December 2012

Update on Recommendations

Since its only been 4 months since I've started this exercise and I've only had 3 trade recommendations, any performance numbers are just as likely to be the result of flukes  as they are result of actual value-added research. However, it should be a good time to reassess my thinking behind the trade ideas and expectations going into these trades. After all this is a learning exercise.

Trades Summary:
HMIN Long (Closed): +36%
SVN/HTHT Long/Short (Closed): +15%
KBH Short (Open): +10%
Average Return for Long or Short recommendations: +20.3%
S&P 500 Return from July 27 to Dec 3: +4.1%
100% batting average means it can only go downhill from here.

Opportunities passed on:
DSX - wait and see (no trade)- +14%

Marvell Technology - No trade (didn't understand business): +18%

Trade 1: Long HMIN at $17.65 with a $33 target, unfortunately closed my recommendation on August 15th at $24.00 (+36%). Currently trading at $27.42 (+55%).
Expectation: Due to the seasonality of the hotel business HMIN's acquisition of Motel 168 did not add any value to earnings for Q4 2011 & Q1 2012. This resulted in an extremely cheap valuation of the business as a whole. At the time, it was trading at a 6.1x EV/EBITDA for 2012 (even with relatively weak expectations of 2012 EBITDA contribution from Motel 168). As per my expectations, after a positive earnings contribution from Motel 168 in Q2, markets valuation of the business improved drastically.
Error: Trying to time to market. After the stock was up +40% in a month I decided to close the trade, thinking about short-term macro headwinds. At the time I justified the decision because the decision for QE3 and European Debt deal were looming. Lesson learned!

Trade 2: Pair trade- Long SVN at $9.00 and Short HTHT at $14.73. SVN is awaiting board decision on proposed acquisition at $12.70 (+41%), closed at $12.00 (+33%); HTHT trading at $16.98 (+15%)
Expectation: Extreme relative valuation disparity. Although the trade was profitable and the proposed acquisition of SVN helped bump it's share price relatively quickly, it also hurt the long term profit potential  a) it limited the relative appreciation of SVN to the acquisition price, b)it  boosted HTHT share price - the market thinks if one hotel chain is cheap, the other must be as well. 

Since there is now limited upside for SVN due to acquisition price, I would recommend closing the pair trade.

This graph shows the opportunity missed for a longer term improvement in the relative valuation of SVN.

Even at the target price of $12.70 SVN days is valued at approx. RMB45,000/Room, which is a 25% discount from the price paid for Motel 168 (a business with a 13% EBITDA margin at the time, SVN's EBITDA margin is above 20%), 18% discount from HMIN currently, and 54% discount from HTHT. On a EV/EBITDA basis, the acquisition price yields a 6x multiple.

Overall, a good trade, SVN remains cheap, and currently my only holding as the acquisition price still represents a 10% upside and I'm hoping there might be a competing bid from somewhere.

Trade 3: Short KBH at $16.14, currently trading at $14.50 (+10%). 
Expectations: Either a miss in housing starts (nothing goes up in a straight line), or the lag of KBH's new orders relative to housing starts continues. One reason why KBH will continue to underperform the headline housing starts is that growth has been driven by multi-unit housing starts. Also, as shown in initial analysis, valuation remains stretched.

DSX: $6.54 No trade, Currently at $7.44 (+14%)
Expectations: As lucrative longer term contracts expire, the company will experience a meaningful hit to earnings over the next 6-12 months. Low shipping rates persist for the time being.
Possible Error?: Current shipping rates cannot persist indefinitely because the lifetime earnings potential of a ship is much lower than it's purchase price (approx. 50% lower). Eventually ship owners will stop buying new vessels. Therefore, it's only a matter of time before the supply/demand balance is restored, and ship values start trading close to their cost of production. However, I believe the short term headwinds facing DSX will dominate investor sentiment for the time being. This is really the opposite of what any long-term oriented value investor would have done. Nevertheless, I'm sticking to my original negative catalyst and will be hoping for a more attractive entry point! Lesson learned?