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What We’re Reading (Week Ending 5 April 2020)

The best articles we’ve read in recent times on a wide range of topics, including investing, business, and the world in general.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 5 April 2020:

1. Message from Ser Jing’s friend

Ser Jing’s friend recently sent a wonderful text message on a list of wholesome activities we can all do during these difficult times to still add grace, beauty, purpose, and meaning to our lives:

– Picking up a book that you have been wanting to read
– Taking this period of time to rest and re-calibrate yourself
– Spending quality time and doing stuffs for your loved ones
– Taking up online courses. Think Coursera and etc
– Starting up your own side line business
– Developing a new skill or hobby
– Practicing meditation, yoga and journalism to master your inner thoughts and emotions [Ser Jing meditates regularly]
– Spending some time alone in nature
– Getting in touch with your friends
– Spend time reflecting

2. A Coronavirus Fix That Passes the Smell Test – Michael Lewis

Encourage everyone in the world with access to the internet to report whether they can or cannot smell. Make it easy for them to do so. Find widely admired people with big social-media followings to make short videos on the subject — at the bottom of which there’d be a simple button that allows anyone watching to report their sense of smell. Go viral with the virus [COVID-19]. Before long you’d have a pile of data that smart analysts could use to map it, and evaluate its risks. The results might not be perfect, but they were far better than what we have now in any rich country and far better than what they might ever have in countries with fewer resources.

I love this idea. Hancock is well on his way to building an organization to make it happen — the website is sniffoutcovid.org. He is in the market for both widely admired people and data scientists. Here’s to hoping he finds them before my father calls me to say that he can no longer smell his Burgundy.

3. Great Love & Great Suffering – Josh Radnor

I have noted in myself a kind of reflexive optimism (i.e. “This is going to be okay,” “We’ll get through this,”) of which I’m becoming suspicious. Do I just feel that way because I’ve been inoculated by my privilege? Surely this is going to be calamitous for many people – far beyond the sick and the dying – and I don’t want to turn a blind eye toward that suffering: the suddenly unemployed and homeless, the relapsing addict and those that love them, those trapped in abusive and unsafe homes, etc.

It feels like this moment is asking me to grow up, to stop relying on false-hope granting platitudes and accept that pain, suffering, and grief are part of the birthright of being a human being. I say that with the full knowledge and deep belief that love, joy, laughter, and art are also part of that birthright. Light and shadow are inextricably bound up with each other and it’s naïve to think that darkness can be vanquished or banished in favor of everlasting light. That’s magical thinking of a kind to which I refuse to subscribe.

4. The Greatest Investment Quotes of All Time – Nick Maggiulli

“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get.”
-Charlie Munger, Interview with BBC

“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
– Paul Samuelson

“I tell my father’s story of the gambler who lost regularly. One day he hears about a race with only one horse in it, so he bet the rent money. Halfway around the track, the horse jumped over the fence and ran away.”
-Howard Marks, The Most Important Thing

5. The Corona Crisis vs. The Great Depression – Ben Carlson

However, there are a number of differences between 1929-1932 and its aftermath and the current situation.

The Fed. The Federal Reserve was still relatively new during the Great Depression, having been founded just 16 years prior. Not only did they pour gasoline on the fire during the speculative period leading up to the crash, but they did next to nothing in trying to stop the crisis as it was unfolding.

John Kenneth Galbraith once wrote, “The Federal Reserve Board in those times was a body of startling incompetence.”

In the current crisis, the Fed has acted fast and they’ve gone big. Central banks around the globe have pumped liquidity into the system to make sure the plumbing of the financial markets continues to function.

This was not happening during the Great Depression and it’s one of the reasons there was a run on the banks and a huge number of bank failures.

Government Spending. During a severe economic contraction, individuals and corporations spend less money so it’s typically up to the government to make up for this shortfall.

During the Great Depression, they did the opposite. Republicans and Democrats alike sought to balance the budget and cut spending. Even in 1932, at the depths of the depression, they wanted to shrink government spending by 25%.

Today, we’re getting $2 trillion in fiscal stimulus rescue funds plus another $4 trillion in loans from the Fed. It’s likely we’ll need even more government spending depending on how long it takes to beat the virus.

6. Why does Covid-19 get the blame when Eagle Hospitality Trust’s woes predate it? – Marissa Lee

UC’s fixed payments were supposed to account for 66 per cent of EHT’s projected rental income in 2020, though the US lodging market began to weaken in the second half of last year. EHT’s revenue for 2019 came in 10 per cent lower than forecast. On Feb 17, 2020, a week before the US confirmed its first case of local Covid-19 transmission, UC amended the master lease agreements to allow EHT to receive more rent from any hotels that produce excess cash ow, to make up for shortfalls in any underperforming hotels.

The master lease agreements also formed the basis for EHT’s adopted valuations of its hotels.

According to EHT’s oer document, UC was required to hand over a US$43.7 million security deposit to EHT during the IPO, equivalent to nine months of fixed rent. UC funded US$23.7 million in cash, and indicated in the offer document that it would provide the balance of US$20 million by way of a letter of credit on or around EHT’s listing on May 24, 2019.

After EHT’s IPO, most investors assumed that the full US$43.7 million was safely in escrow, until they were told differently on March 19, 2020.

What they learnt is that UC had used US$5 million in cash to top up its security deposit to US$28.7 million, though it still had not managed to procure a letter of credit for the remaining US$15 million of the US$43.7 million.

7. The Shock Cycle – Morgan Housel

Then you ignore good news because you’re once bitten, twice shy. Avoiding further downside becomes such a focus that you lack the mental bandwidth to even recognize good news.

Then you deny good news. You’re so attuned to risk that you reflexively think good news must be wrong or out of context. Anyone promoting good news is criticized by the masses, who enjoy safety in numbers.

Then you realize you missed the good news. In hindsight you realize things turned a corner while people were most certain about how bad it was. You look back and can’t believe how obvious it was that people were too pessimistic, and can’t believe clear the signs of improvement were.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

Singapore Stocks That May Face a Liquidity Crunch

COVID-19’s economic impact is being felt by many companies. Those with high fixed costs, weak balance sheets, and disrupted businesses could be fighting for survival.

By now, you might have heard that Singapore Airlines Ltd (SGX: C6L) is being saved by Temasek who promised to inject capital into the debt-ridden company. But our flag carrier is not the only company that may need saving.

Many local businesses in Singapore face an existential crisis in these challenging times. Companies that (1) have high fixed expenses, (2) have insufficient cash on the balance sheet, and (3) face major disruption to their business, are most at risk.

Here are some Singapore-listed companies that could be fighting for their survival in the coming weeks and months.

Neo Group (SGX: 5UJ)

Singapore’s leading food catering company is high on the list. As of 31 December 2019, Neo Group had S$20.4 million in cash and equivalents but S$34.9 million in short term bank borrowings that need to be repaid within a year. On top of that, it also had $45.7 million in long term debt.

Neo Group’s food catering business has also likely been heavily disrupted due to the recent restrictions on gatherings of more than 10 people. The extent of the problem is made worse as Neo Group’s catering segment was its most profitable business in the financial year ended 31 March 2019.

The company also has a substantial amount of fixed costs. In the last quarter, Neo Group incurred S$14 million in employee expenses and S$1.1 million in finance costs. These are overheads that are unlikely to go away, even as orders dry up. Given Neo Group’s weak balance sheet, it could face difficulty obtaining a loan to bridge it through this challenging period.

Sembcorp Marine (SGX: S51)

Another one of Temasek’s investments, Sembcorp Marine could face a similar fate to Singapore Airlines. Sembcorp Marine is highly dependent on the health of the oil industry and faces major disruptions to its business amid tumbling oil prices (oil prices are near 20-year lows now).

Like Neo Group, Sembcorp Marine has more short-term debt than cash on its balance sheet. That’s extremely worrying given that credit may dry up during this trying times. As of 31 December 2019, Sembcorp Marine had S$389 million in cash and a staggering S$1.42 billion in short-term borrowings. In addition, the company had S$2.98 billion in long-term debt.

And let’s not forget that Sembcorp Marine also has heavy expenses. In the quarter ended 31 December 2019, Sembcorp Marine racked up S$29 million in finance costs alone and also had a negative gross margin. The company also spends heavily on capital expenditures just to maintain its current operations. Sembcorp Marine was free cash flow negative in 2019 after spending S$316 million in capital expenditures.

Sakae Holdings (SGX: 5DO)

Restaurant operator Sakae Holdings has been on the decline in recent years. Even before the COVID-19 pandemic began, revenue and earnings for the company have plunged. In the six months ended 31 December 2019, Sakae’s revenue fell 13.9% and it reported a S$1.56 million loss.

Worryingly, Sakae looks likely to run into cash flow problems in the very near future. As of 31 December 2019, Sakae had S$4.3 million in cash but near-term bank loans amounting to S$45.7 million.

I don’t see how Sakae can pay back its debtors and I doubt it can negotiate to refinance such a large sum over the next 12 months.

The COVID-19 crisis could be the straw that breaks the camel’s back for Sakae Holdings.

My conclusion

Obviously this is not an exhaustive list of companies in Singapore’s stock market that could face a liquidity crisis in these trying times. The pause in the global economy (Singapore’s included) will definitely impact many more companies than those I listed.

Companies that are not prepared and do not have the resources to ride out this period could be in big trouble. Companies that go broke will see a steep fall in their share prices and shareholders will get very little or nothing back if a company is forced into liquidation.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

“Why Are You Confident That Booking Holdings Will Survive The COVID-19 Crisis?”

Booking Holdings is suffering because of the coronavirus, COVID-19. Can the company survive the crisis? I think it can. Here’s why.

A few days ago, I received a text from a friend asking the question that is the title of this article. He knew that Booking Holdings (NASDAQ: BKNG), an online travel agent, is one of the 50-plus companies that’s in my family’s investment portfolio.

Stalled growth

On 18 February 2020, I published my investment thesis on Booking. In it, I wrote that “The world – particularly China – is currently battling COVID-19. If the situation worsens, Booking’s business could be hurt.” Little did I know how badly Booking would suffer. International travel activities have essentially grounded to a halt since the publication of my thesis for Booking, with many countries closing their borders to control the spread of COVID-19.

In particular, the businesses of hotels and airlines across the globe have been crushed. A few days ago, Arne Sorenson, CEO of hotel operator Marriott International, said that the company’s seeing revenue declines of more than 75% in the US. At home, Singapore Airlines cut 96% of its flight capacity last week. Booking, as an online travel agent focusing on accommodations, is also facing a brutal operating environment.

Confidence

What gives me the confidence that Booking can survive? The company is the largest online travel agent in the world. The entire travel industry is awash in pain at the moment. But this also gives Booking the opportunity to win even more market share if some of its smaller/weaker competitors falter.

I believe that the COVID-19 crisis will blow over eventually (hopefully sooner rather than later, so that the incredible human suffering that’s currently happening can end as soon as possible). This will allow the travel industry to return to strength. When this happens, Booking will be in an even stronger position compared to before.

But Booking has to survive from now till then. I think the chances are very good that the company will. At the end of 2019, Booking held US$8.5 billion in cash, short-term investments, and long-term investments (this sum excludes US$3.3 billion in strategic investments) against total debt of US$8.6 billion.

I would prefer Booking to have significantly more cash than debt. But Booking’s debt is mostly long-term in nature (88.5% comes due on or after 31 December 2020). Moreover, the company’s debt has well-staggered maturities as shown in the table below. The earliest due-date for Booking’s long-term debt is September 2021 and it involves a manageable sum of US$1 billion. So there’s plenty of time for Booking to maneuver, and to wait for the travel industry’s health to improve.

No guarantee

But there’s no guarantee that Booking will survive. It could eventually crumble should the travel market undergo a long winter if COVID-19 proves to be a particularly tricky disease to combat. This is where diversification is important.

I mentioned earlier that Booking is one of the 50-plus companies in my family’s investment portfolio. Even if Booking fails to survive, my family’s portfolio will. Diversification is how I guard the portfolio against specific-company risks. With diversification, my family and I are able to stay invested in Booking and participate in its potential recovery without having to worry about a significant hit to the portfolio.

3 Lessons From My Biggest Stock Market Losers

Here are 3 lessons I’ve picked up from my biggest investing mistakes, so that you can benefit from my experience without going through the same pain.

It’s great to learn from our own mistakes. But it’s even better to learn from those of others. COVID-19 has brought extreme market volatility and economic distress to the world. In a time like this, it’s easier for us to make investment mistakes.

I’m here to share the eggs I’ve had on my face in the stock market and what I’ve learnt from them, so that you can benefit from my errors.

The backdrop

I started investing for my immediate family on 26 October 2010. The portfolio I help manage consists of stocks listed in the US market. There are currently over 50 stocks in it.

Some of the biggest losers in the portfolio include Atwood Oceanics, Ford (NYSE: F), Gilead Sciences (NASDAQ: GILD), GoPro (NASDAQ: GPRO), National Oilwell Varco (NYSE: NOV), Tapestry (NYSE: TPR), Under Armour (NYSE: UAA), and Zoe’s Kitchen.

*Source: Yahoo Finance for current prices*

Atwood Oceanics and Zoe’s Kitchen were privatised in October 2017 and November 2018, respectively, and I sold their shares on September 2016 and November 2018. I sold National Oilwell Varco in June 2017. I still own the other stocks mentioned.

Lesson 1: It’s okay to fail if you have the right investment framework

My family’s investment portfolio has clearly had many epic losers. But from 26 October 2010 (the inception of the portfolio) to 29 March 2020, the portfolio has still grown in value by 16.0% annually, without including dividends. This is significantly higher than the S&P 500’s return of 10.7% per year over the same period, with dividends.

*Source: S&P Global Market Intelligence; Google Finance; author’s calculations (from 26 October 2010 to 29 March 2020)*

It’s okay to have multiple failures in your portfolio. There’s an investment framework that I’ve been using for my family’s portfolio for years. It has guided me towards massive winners, such as Netflix (NASDAQ: NFLX), Amazon (NASDAQ: AMZN), and MercadoLibre (NASDAQ: MELI). The winners in the portfolio have more than made up for the losers.

If you’re investing with a sound investment framework, then don’t beat yourself up too hard if some of your stocks are down big. Look at your performance from a portfolio-perspective, and not harp on how each position is doing.

Lesson 2: Diversify smartly, and stay away from commodity-related companies

Atwood Oceanics and National Oilwell Varco are companies in the oil & gas industry. When I invested in them, Atwood was an owner of oil rigs while National Oilwell Varco was supplying the parts and equipment that kept oil rigs running.

They were among my first-ever investments, back when I was a greenhorn in the stock market. I invested in them because I wanted to be diversified according to sectors. I also thought that oil & gas was a sector that is worth investing in since demand for the commodities would likely remain strong for a long time. My views were right, but only to a small extent. I was wrong on two important areas.

First, it is important to be diversified according to sectors (and geography too!). But there are some sectors that are just not worth investing in for the long run because their economic characteristics are poor. For instance, the energy, materials, and transport sectors have historically produced poor returns on invested capital. This is illustrated in the chart below from a 2006 McKinsey report which mapped out the average return on invested capital for various sectors from 1963 to 2004. Charlie Munger, Warren Buffett’s long-time lieutenant, once said:

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount.”

Second, demand for oil did indeed grow from 2010 to 2016. But oil prices fell significantly over the same period. The trends in oil consumption and oil prices for that period are depicted in the chart below.

The sharp fall in oil prices despite the rising demand illustrates the difficulty in predicting oil prices. In fact, it’s practically impossible. I recently learnt about a presentation that Peter Davies gave in 2007 titled What’s the Value of an Energy Economist? In it, he said that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum, one of the largest oil & gas companies in the world.

With lower oil prices, the business results and share prices of Atwood Oceanics and National Oilwell Varco plummeted. The chart below shows National Oilwell Varco’s share price and earnings per share from 2010 to 2016 (data for Atwood Oceanics is not available since it’s now a private company). I think the predicament of Atwood Oceanics and National Oilwell Varco can be extrapolated to other commodity-related companies. It’s tough to predict the price movements of commodities; this in turn makes it difficult to have a good grasp on the business results of a commodity-related company over a multi-year period.

Lesson 3: Not selling the losers is as important as not selling the winners

You’ll notice that my family’s portfolio is still holding onto many of the big losers. The sales of Atwood Oceanics and National Oilwell Varco happened because of something that Motley Fool co-founder David Gardner shared a few years ago:

“Make your portfolio reflect your best vision for our future.”

Part of the vision I have for the world is that our energy-needs are entirely provided by renewable sources that do not harm the precious environment we live in. For this reason, I made the rare decision to voluntarily part ways with stocks in my family’s portfolio (referring to Atwood Oceanics and National Oilwell Varco).

I sell stocks very rarely and very slowly. This aversion to selling is by design – because it strengthens my discipline in holding onto the winners in my family’s portfolio. Many investors tend to cut their winners and hold onto their losers. Even in my earliest days as an investor, I recognised the importance of holding onto the winners in driving my family portfolio’s return. Being very slow to sell stocks – even the big losers – has helped me hone the discipline of holding onto the winners. And this discipline has been a very important contributor to the long run performance of my family’s portfolio.

Making Financial Sense Of Singapore Airlines’s Massive Fundraising

Recently, Singapore Airlines announced a complex rights issue and mandatory convertible bonds offering. I’m breaking down the factual numbers.

Singapore Airlines (SGX: C6L) recently announced a massive round of fundraising. In all, Singapore’s national carrier is looking to raise S$15 billion. The first slice of the fundraising involves a S$5.3 billion rights shares issue, and a S$3.5 billion tranche of mandatory convertible bonds (MCBs).

Temasek Holdings is one of the Singapore government’s investment arms and the current major shareholder of Singapore Airlines (SIA) with a 55% stake. It has committed to mop up all the rights shares issue and MCBs that other SIA shareholders do not want.

My blogging partner Jeremy Chia published a wonderful article yesterday. He shared his thoughts on why he’s not interested in investing in SIA despite Temasek’s promise to provide up to S$15 billion in capital. I’m not here to share my thoughts on investing in SIA. Instead, I’m here to provide you with a factual breakdown of the numbers behind SIA’s rights shares issue and MCBs.

I recognise that SIA’s latest fundraising activity is complex, and there’s a lot of confusion about it. I want to help clear the air, to the best of my abilities. The Good Investors exists to demystify investing for you – so here I am!

Details of the rights shares issue of Singapore Airlines

Here are the important numbers concerning SIA’s rights shares issue:

Total sum: S$5.3 billion.
Number of rights shares to be issued: Up to 1.778 billion rights shares to be issued, on the basis of 3 rights shares for every 2 shares of SIA that currently exist. There are 1.185 billion SIA shares that exist right now.
Price per rights share: S$3.00.
Renounceable? Yes, this rights shares issue is renounceable, so you will get to trade the rights.
Changes in SIA’s book value per share (BVPS) and earnings per share (EPS) because of the rights issue: As of 31 December 2019, SIA’s BVPS and trailing-12-months EPS were S$10.25 and S$0.67, respectively. After the rights shares issue, the BVPS will fall to around S$5.89 while the EPS will decline to S$0.27, assuming everything else stays constant.
What you have to effectively pay for SIA’s shares: At the time of writing (11:20 am, 30 March 2020), SIA’s share price is S$5.82. If you subscribe for your full allotment of rights shares, you’re effectively paying a price of S$4.13 per share for SIA’s shares. The math works this way: Effective price per share = [S$5.82 + (S$3.00 x 1.5)] / 2.5.
The effective valuations you’re getting: At an effective share price of S$4.13, SIA will have a price-to-book ratio of 0.7 and a price-to-earnings ratio of 15.

Details of the MCBs of Singapore Airlines

For the MCBs, do note that the total sum SIA is looking for is S$9.7 billion. But the current tranche involves just S$3.5 billion. The key financial numbers for the current tranche of MCBs are as follows:

Total sum: S$3.5 billion.
Number of rights MCBs to be issued: Up to S$3.5 billion, in the denomination of S$1.00 per rights MCB, on the basis of 295 rights MCBs for every 100 shares of SIA that currently exist. As mentioned earlier, there are 1.185 billion SIA shares that exist right now.
Issue price per rights MCB: S$1.00, meaning you’ll pay S$1.00 to purchase each rights MCB.
Renounceable? Yes, this rights MCB issue is renounceable, so you will get to trade the rights.
Maturity date of MCB: 10 years from the date of issue of the rights MCBs.
Conversion terms of MCB: SIA is obliged to convert the rights MCBs into SIA shares when the MCBs mature. The conversion price is S$4.84 per SIA share. When the MCBs are converted at the maturity date (10 years from the date of issue), every S$1,000 worth of the MCBs will “grow” to S$1,806.11. This S$1,806.11 will then be converted into SIA shares at a price of S$4.84 each, giving us 373 SIA shares. The math works this way: Number of shares obtained upon conversion = S$1,806.11 / S$4.84
Redemption terms of the MCB: SIA has the right – but not the obligation – to redeem the MCBs every six months from the date of issue at a certain price, giving you a certain yield. If the MCBs have yet to be redeemed when we hit the 10-year mark from the date of issue, SIA is obliged to convert the MCBs into SIA shares, as mentioned earlier. The redemption prices and yields are given in the table below. Note that you cannot ask for the redemption – it is entirely up to SIA to decide.

What you’re effectively paying for SIA’s shares under the MCB, assuming it is converted: As mentioned earlier, if the MCBs are converted, every S$1,000 in MCBs will be converted into 373 shares. This gives rise to an effective price of S$2.68 per SIA share under the MCB. The math works this way: Effective price paid = S$1,000 / 373 shares.
What you’re effectively paying for SIA’s shares, in all, under the MCB, assuming it is converted: But to get hold of the MCBs, you’ll have to own SIA shares. Every 100 shares has a full allotment of 295 rights MCBs. At the time of writing, SIA’s share price is S$5.82. This works out to an overall effective price of S$3.47 per share. Here’s the math: Overall effective price paid = ([100 x S$5.82) + (295 x S$2.68)] / (100 +295).
Circumstances where you’ll make money on the MCBs alone (ignoring what happens to your SIA stake): There are a few scenarios where you’ll make a profit: (1) SIA redeems the MCBs before they are converted; (2) SIA allows the MCBs to convert into shares 10 years later and SIA’s share price is significantly higher than S$2.68 at that point in time. To be clear, the price of S$2.68 is the price you’re effectively paying for SIA’s shares in the event of the MCBs’ conversion. If SIA’s share price is around S$2.68 at the point of conversion, it’s very likely you’ll be losing money on the MCBs; if SIA’s share price is lower than S$2.68 at the point of conversion, you’ll be losing money on the MCBs.
When is it beneficial for SIA to redeem the MCBs? Redemption of the MCBs will require SIA to fork out cash, which negatively impacts SIA’s financial health. On the other hand, the conversion of the MCBs does not require SIA to dole out any cash. So from this perspective, it’s beneficial for SIA to not redeem the MCBs at all. This is important to note for the MCB holders for cash-flow-planning purposes, since SIA could very well choose not to redeem the MCBs.

Other important points to note

Shareholders of Singapore Airlines can choose to participate in the company’s fundraising activity in one of the following ways:

Subscribe for both the rights issue and rights MCBs
Subscribe for just the rights issue but not the rights MCBs
Subscribe for the rights MCBs but not the rights issue
Do not subscribe for both the rights issue and rights MCBs

If you’re a Singapore Airlines shareholder and you choose the fourth option, you can still recover some capital by selling the rights issues and rights MCBs (both are renounceable, so the rights can be actively traded). But you will face massive dilution, since the airline’s share count will increase significantly.

I hope laying out all these numbers will help you – if you’re a Singapore Airlines shareholder or are interested in its shares and/or MCBs – to make a better-informed decision.

Why I’m Not Buying Singapore Airlines Shares Even After Temasek Promised To Save It

Temasek is underwriting a massive rights offering that will provide Singapore Airlines with much needed capital. But here’s why I’m still not convinved.

Much ink has been spilt on the whole Singapore Airlines Ltd (SGX: C6L) fiasco.

The latest news now is that Temasek, one of the Singapore government’s investment arms, has stepped in to provide our country’s flag carrier with much-needed capital.

This comes as Singapore Airlines (SIA) is confronting liquidity problems due to its high debt load and fixed costs, and the disruption to its business because of the COVID-19 pandemic.

The rescue

In essence, Temasek, which currently owns around 55% of SIA, has underwritten a S$5.3 billion equity fundraising by the airline. Temasek has also underwritten a $9.7 billion issuance of mandatory convertible bonds (MCBs) by SIA; the MCBs will either be converted to shares in 10 years or redeemed before then. What this means is that Temasek will not only subscribe to all the rights and relevant bonds that it’s entitled to; it will also purchase any of the rights or bonds that other SIA shareholders do not want.

But despite Temasek coming in to save the day, I’m not interested in investing in SIA, even at these seemingly low prices.

How did it get into this situation in the first place?

Much like other airline companies, SIA is heavily leveraged due to the capital-intensive nature of its business. The high cost of replacing and upgrading SIA’s fleet has also led to negative free cash flow in four of the last five years.

To keep itself afloat, our flag carrier has been increasingly making use of the debt markets for its cash flow requirements. In fact, the company issued bonds to the public just last year to raise more capital. At the end of 2019, the airline had S$1.6 billion in cash, but S$7.7 billion in total debt.

The aviation industry is highly competitive too and the emergence of low-cost carriers have led to thinner margins for airlines.

The COVID-19 pandemic was the straw that broke the camel’s back as the significant loss of revenue (SIA recently cut 96% of its flight capacity) finally led to severe cash flow problems for the company and Temasek ultimately had to step in to save the day.

Temasek saving the day but shareholders will be diluted

Let’s be clear, this is not a government bailout. It is nothing like what the American airlines got from the US government, which included a massive grant.

SIA’s situation is simply a major shareholder promising to back the company when it sells new shares to raise capital.

The new shares will dilute existing shareholders if they don’t take up the rights issue. On top of that, the mandatory convertible bonds will also dilute shareholders in 10 years when they are converted, unless they are redeemed before then.

SIA shares seem cheap but it really is not

Under the rights issue portion of SIA’s latest fundraising exercise, existing shareholders of the airline will be given the opportunity to buy three new shares at S$3 per share for every two shares they own.

Based on SIA’s current share price of S$6.03, I will get shares for an average price of S$4.21 each if I buy in today and subscribe to the rights issue. That seems cheap – but it really is not.

As of 31 December 2019, SIA had a net asset value per share of S$10.25. But that will drop substantially after the rights issue.

The rights issue will increase shareholders’ equity from S$12.1 billion to S$17.4 billion, or an increase of 43% from 31 December 2019. At the same time, the number of shares will increase from 1.2 billion to 3 billion. After the dilution, the net asset value per share will fall to around S$5.80 per share based on SIA’s last reported financials.

I also expect SIA’s net asset value per share to fall even more than that because of the heavy losses suffered as a result of the COVID-19 pandemic.

In the quarter ended 31 December 2019, Singapore Airlines incurred about S$800 million in staff costs, S$210 million in aircraft maintenance expenses, and S$522 million in depreciation. Most of these fixed costs will likely still need to be accounted for during the period of near-zero flights, despite SIA grounding its planes. These costs add up to around S$0.50 per share per quarter.

Together with the upcoming dilution and the heavy losses, Singapore Airlines’ shares could have a net asset value of close to or even less than S$5.30 per share in the future, depending on how long the pandemic lasts.

Earnings per share dilution

Earnings per share will also fall after the issuance of new shares because of the rights issue. SIA reported trailing 12 months profit of S$765 million.

Even if our flag carrier can achieve similar profit after the whole pandemic passes, its earnings per share will drop substantially because of the larger number of outstanding shares.

By my calculation, normalised earnings per share will decline from S$0.63 to just S$0.25 after the rights issue.

I’m not buying shares just yet…

The injection of cash will put SIA in a much better financial position but I’m still not convinced.

Even if I buy shares today and subscribe to all my allotted shares in the rights issue, I don’t think I’ll be getting that great of a deal. I’ll be paying an average price of around S$4.21 per share, which translates to only a small discount to my calculated adjusted net asset value per share. It is also slightly more than 16 times SIA’s normalised earnings post-rights issue, which is not that cheap.

Moreover, if SIA is unable to redeem the mandatory convertible bonds before they get converted in 10 years time, they will potentially lead to further dilution to shareholders.

Let’s not forget too that our flag carrier (1) has a history of inconsistent free cash flow, (2) operates in an industry that is a slave to fuel prices, and (3) has strong competition from low-cost carriers.

Given all these, despite the seemingly low share price, I still don’t think Singapore Airlines shares are cheap enough for my liking.

What We’re Reading (Week Ending 29 March 2020)

The best articles we’ve read in recent times on a wide range of topics, including investing, business, and the world in general.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

Here are the articles for the week ending 29 March 2020:

1. Wounds Heal, Scars Last – Morgan Housel

When people feel the correlation between their decisions and their outcomes is high, there’s less desire for a strong social safety net. But when something impacts everyone at once, and can ruin the careful as much as the reckless, there’s a history of people coming together to support a public backstop. We saw that Wednesday, when a $2 trillion rescue package passed the Senate 96-0. I suspect we’ll be seeing more of it for years to come.

2. Why the Stock Market Rallies on Bad News [link goes to video] – The Compound

Michael [Batnick] and Barry [Ritholtz] discuss the latest record-breaking unemployment numbers and why the market is rallying on this bad news? What is going on?

3. What we learn from the past – Samuel Rhee

The markets were down almost 50% and everybody had lost their shirt. We worried we wouldn’t have any money to manage when all was said and done. And more importantly we thought we would all soon be out of a job. We were desperate for some guidance and sage advice from Barton. I asked him, “Barton – is this the worst thing you’ve ever seen?” He paused and thought for a moment, then he slowly opened his mouth. His answer was completely unexpected to everybody in the room. He said, “to be honest, I think 1974 was much worse.” We all turned to each other and looked around the room and asked. Wait what? 1974?

4. Stock Market Commentary: Confront the brutal facts, yet never lose faith – Chuin Ting Weber

So we keep the faith amidst the brutal facts in the short term, because the faith in our long-term destiny is ultimately our faith in humanity’s ability to overcome, as we have done in the past. Once again, our economies will grow on the back of human innovation, industry and our collective and relentless pursuit of a better life. Together, or probably preceding this, the stock market will go up again. We do not know exactly how long the pain would last or when the upturn would come, but come it definitely will!

5. How Did We Ever Get to The Roaring Twenties? – Ben Carlson

It’s also hard to believe the U.S. was ever able to pick itself up off the turf to make the Roaring 20s happen in the first place. Let’s go through a list of what occurred in the lead up to one of the biggest boom times in our country’s history:

World War I (1914-1918)… Influenza Pandemic (1918-1919)… Post-War Recession (1918-1919)… The Depression (1920-1921)… This 8 or so years looks like hell on earth:

And yet…look at what came during the aftermath.

6. What If You Buy Stocks Too Early During a Market Crash? – Ben Carlson

I know of a professional trader who foresaw the Great Recession, went to cash in the summer of 2008 before things got crazy and came up with a wonderful plan to put his money back to work at the lows.

He planned on putting his cash into a simple S&P 500 index fund in 25% chunks when the S&P hit 650, 600, 550, and finally 500. It was a generational buying opportunity and I was jealous he had such a wonderful plan of attack.

The only problem with this plan is the S&P never got to those levels, even though plenty of people were predicting it at the time.

The S&P hit an intraday low of 666, he put his cash to work and ended up never getting back in. He assumed the initial bounce was of the dead cat variety and a double-dip recession would give him another opportunity to buy but stocks never looked back.

I’m not sure many investors sitting in cash or bonds at the moment are worried about being too late. Those with dry powder left are far more concerned with being too early, as most assume things will only get worse.

Government Bailouts and What They Mean For Shareholders

US airlines are getting a massive US$60 billion bailout. Here’s a look at bailouts in the past and how shareholders have been impacted.

US airlines finally got something to cheer about.

Earlier this week, US senate leaders came to an agreement on a US$2 trillion stimulus bill. A whopping US$60 billion of that will be used to bail out struggling US airlines.

Airlines, in return, must forgo layoffs until the fall (sometime in the fourth quarter of 2020), accept limits on executive compensation and dividends, and maintain certain routes. Despite the limitations, I think this is a deal the airlines will happily take to save themselves from bankruptcy.

Bailouts are nothing new though. The US has a long history of bailing out companies that were deemed too important to fail. These companies either provided essential services, accounted for a decent chunk of the economy, or employed a large number of people.

But bailouts take different shapes and forms. The ways that the government injects cash into companies (or individuals), the kind of industries the government tries to save, and the impact on shareholders differ every time.

In light of the latest bailout, I decided to take a short trip down memory lane to see the different kinds of bailouts that have occurred.

The Great Depression

One of the greatest economic catastrophes of modern history occurred from 1929 to the early 1940s. It was the longest, deepest, and most widespread depression of the 20th century.

In 1933 US President, Franklin D. Roosevelt took the oath of office and started implementing solutions to bring the economy out of the recession.

One of the things he did was to bail out struggling homeowners. At that time, the national unemployment rate was around 25%, so many Americans who lost their jobs were unable to pay off their home mortgages and were left homeless.

The Home Owners’ Loan Corporation was set up to solve the problem. The newly formed government agency purchased defaulted mortgages from banks and refinanced them at lower rates, allowing about a million homeowners to benefit from lower mortgage rates.

This bailout was targetted at individuals at that time and kept people off the street. However, it was not until World War II ended that the depression was officially over and the post-war boom began.

The Great Financial Crisis

The next most important economic crisis occurred much more recently in 2007-2008. Known as the Great Financial Crisis, the collapse of Lehman Brothers amid the bursting of the housing bubble culminated in a global financial crisis.

However, this time, the US government’s response was swifter and the bailouts introduced saved banks, restored confidence, allowed banks to lend again, and eventually led to the 12-year bull market that ended this year.

So what did the US government do in 2008? The Emergency Economic Stabilisation Act of 2008, often called the “bank bailout,” was signed into law by then-President George W. Bush. The new law led to the creation of the US$700 billion Troubled Asset Relief Program (TARP) to inject capital into banks. But these funds were not given as grants, rather they were used to purchase toxic assets from the banks.

A key part of the US federal government’s plan was to buy up to US$700 billion of illiquid mortgage-backed securities. These were essentially a bundle of home loans packed into one.

On top of that, the US government injected cash into banks through the purchase of preferred stock. Citibank needed a particularly big injection of capital, with the government purchasing US$45 billion in preferred and common Citigroup stock. Selling stock when your share price is down 80% is never going to be pretty and Citigroup shareholders learnt that the hard way as they were diluted almost six-fold. Till today, Citigroup’s share price is still more than 80% off the high it reached in 2007. However, what the bailout achieved was to save Citigroup from insolvency and shareholders could at least survive to fight another day.

Overall, TARP improved the balance sheet and reduced the potential losses of banks and financial institutions.

The net effect for the government was also positive as it was reported that TARP recovered US$441.7 billion of US$426.4 billion invested, earning a US$15.3 billion profit when everything was done and dusted.

COVID-19 Crisis

Fast forward to today and we are once again seeing a massive bailout, this time with the aviation industry.

As mentioned earlier, struggling US airlines are getting an early Christmas present this year, to the tune of US$60 billion.

According to a draft of the legislation, airlines will receive up to US$25 billion in direct grants. That’s practically free money for the airlines as long as they promise not to layoff workers till the fourth quarter of 2020, accept limits on executive compensation and shareholder dividends.

Additionally, the bill also grants US$25 billion in loans and loan guarantees for passenger airlines and US$4 billion for cargo air carriers. The promise of loans will help struggling airlines raise much needed new capital even if the banks won’t lend to them.

The news is, of course, great for shareholders and employees. Employees get to keep their jobs while shareholders don’t have to worry about potential bankruptcies. The injection of cash will tide airlines through this challenging period. Airline shares have been creeping up since rumours of a bailout began.

The Good Investors’ conclusion

Bailouts may seem like a bad word but they are great for shareholders. The injection of cash into a company can tide them through when all hope seemed to be lost.

However, bailouts also bring to light that the company was not managing its finances well enough. Overleverage, bad investments, and in the case of Airlines, overspending on share buybacks destroyed their balance sheets to the brink of collapse.

Although bailouts can eventually save the day, they are one-off special situations and investors should never rely on them to get them out of trouble.

Is Zoom’s Stock Too Expensive Now?

Zoom’s stock has defied gravity, climbing around 30% in the past 30 days compared to the brutal 20%-plus fall for the S&P500. But is it too expensive now?

While stocks markets around the world plunged over the last month, Zoom Video Communications‘s (NASDAQ: ZM) share price has defied gravity, zooming up by close to 30%.

Investors are anticipating great things for the company this year as the COVID-19 epidemic accelerates the adoption of video conferencing tools around the globe.

With the hype surrounding Zoom, I thought it would be an opportune time to share some of my thoughts on the fast-growing company and whether it is still worth investing at today’s price.

Fast growth

Zoom is one of the fastest-growing listed software-as-a-service firms in the world today. That says a lot.

In fiscal 2020 (ended 31 January), Zoom recorded revenue of US$622.7 million, up a staggering 88% from a year ago.

New customers and a net dollar expansion rate of more than 130% contributed to the sharp rise in sales. Over the course of 2019, Zoom had 641 customers contributing more than US$100,000 in trailing-12-months revenue, an increase of 86% from a year ago.

Consistently strong performance

Last year’s growth was by no account a one-off. Zoom has been growing rapidly for the three years prior to its IPO in 2019. Annual revenue increased by 149% and 118% in fiscal 2018 and fiscal 2019, respectively.

The company’s net dollar expansion rate has also been north of 130% for seven consecutive quarters, a testament to the strength of the business platform.

COVID-19, a catalyst for greater use of Zoom’s tools

On top of the long-term tailwinds for video conferencing, the COVID-19 pandemic has accelerated the adoption of Zoom’s video conferencing tools. Many people – from university students to work-at-home employees – have begun using Zoom’s software as they take shelter at home.

My sister who has returned home from Australia during this COVID-19 outbreak is using Zoom’s software for “long-distance” tutorials. Fortune magazine reported that teachers are even conducting piano lessons through Zoom.

Huge addressable market

Video is increasingly becoming the way that individuals communicate with each other at work and in their daily lives. And Zoom is the market leader in the space.

Zoom addresses the Hosted/Cloud Voice and Unified Communications, Collaboration Application, and IP Telephony Lines segments within the communication and collaboration market. Market researcher International Data Corporation estimates that these segments would be worth US$43.1 billion by 2022.

Remember that Zoom’s trailing-12-months revenue is just US$622.7 million. That’s a mere 1.4% of the addressable market, so there’s plenty of room for Zoom to grow into.

A cash-generating business

Unlike some of the other fast-growing SaaS (software-as-a-service) companies, Zoom is already cash-flow positive. In fiscal 2020, Zoom generated US$151.9 million and US$113.8 million in operating cash flow and free cash flow, respectively. That translates to a healthy free cash flow margin of 18.3%, with room for further margin expansion as usage of Zoom’s services grows.

In addition, even after accounting for stock-based compensation, Zoom is still profitable, with GAAP (generally-accepted accounting principles) net income of US$21.7 million in fiscal 2020, or US$0.09 per share.

Zoom’s high gross margin of more than 80% enables it to spend a large chunk of its revenue to acquire customers and grow the business while still sustaining a decent free cash flow margin and squeeze out some GAAP profit.

A robust balance sheet

A time when many businesses are being momentarily put on hold due to the COVID-19 spread highlights the importance of a company with a strong balance sheet. Companies that have enough cash to pay off their fixed costs during pauses in sales are more resilient to economic hardships.

Although Zoom is thriving in the current COVID-19 situation, there could be other incidents that may cause temporary disruptions to its business. It is hence heartening to note that Zoom has a robust balance sheet.

As of 31 January 2020, the video conferencing software company had US$283 million in cash and no debt. In fact, Zoom has been so adept at generating cash flow that it said that much of the primary capital it had raised prior to its IPO was still on its balance sheet.

Competition threat

Competition is perhaps the biggest threat to Zoom. The video conferencing company faces competition from mega tech firms such as Google, which has the free Google Hangout video conferencing service. Facebook and Amazon have also spent heavily on video communication tools.

However, Zoom’s video-first focus has propelled it to become the market leader in the video conferencing space. Unlike other companies that added video tools to their legacy communication software, Zoom built a video-conferencing tool with video at the front and centre of its architecture. This focus gives Zoom users a better video conferencing experience.

For now, Zoom remains the forefront in this space with most users preferring its software over competitors but it must consistently add features and update its software to keep users on its platform.

But is it too expensive?

There is no doubt that Zoom has all the makings of a great company. The software-as-a-service firm is growing rapidly and already boasts free cash flow margins in the mid-teens range.

I foresee Zoom’s free cash flow growing much faster than revenue in the future as margins expand due to economies of scale. Moreover, the COVID-19 pandemic is accelerating the adoption of video conferencing software, which is great news for Zoom, being the market leader in this space.

Having said all that, Zoom’s stock has skyrocketed well above what I believe is reasonable. Zoom, which is still run by founder Eric Yuan, has a market cap of around US$38 billion currently.

That’s an astonishing 62 times fiscal 2020 revenue. Even if Zoom’s profit margin was 40% today (a level I think it can achieve in the future), its current market cap would still translate to 176 times earnings.

My conclusion

Based on its share price, the market is anticipating big things for Zoom in the coming quarters as more companies are forced to adopt video conferencing software. On top of that, Zoom, even before the COVID-19 outbreak, was already successfully riding on the coattails of a rapidly growing industry.

As an investor, I would love to participate in Zoom’s growth. However, I think Zoom’s stock is priced for perfection at the moment. Even if Zoom can deliver on all fronts over a multi-year time frame, investors who buy in at this price may still only achieve mediocre returns due to its high valuation.

As such, even though I wish I could be a shareholder of Zoom, I’ll happily wait at the sidelines until a more reasonable entry point arises.

Which S-REIT Could Face a Cashflow Problem?

REITs have fallen hard the last couple of weeks. Here’s a look at some REITs that could face cashflow issues if their tenants defaults.

It has been a nightmarish two weeks for Real Estate Investment Trust (REIT) investors in Singapore’s stock market.

Almost every S-REIT was massively sold down, with many losing more than 50% of their value. Investors who invested on margin were hit especially hard as their losses were amplified and they were forced into selling off positions at a loss.

Investors of REIT-ETFs also reportedly rushed to the exits, further exacerbating the situation.

It does not help that global economic activity has slowed down significantly because of COVID-19. Although most REITs will likely be able to weather this short-term storm, there are some that could face difficulties.

Last week, I published Which S-REIT Can Survive This Market Meltdown? In it, I said that some REITs may face a cashflow crisis if their tenants default on rent. This can lead to a vicious cycle of REITs struggling to pay their interest and end up having to sell assets or raise capital through rights offerings or private placements.

REITs that have a concentrated tenant base, high-interest expense, and less headroom to take on more debt (the regulatory ceiling is a 45% debt-to-asset ratio) are more at risk of a cashflow problem.

In this article, I will highlight some REITs that sport some of these unwanted characteristics.

High tenant concentration

REITs most at risk are those with tenants that cannot pay up their rent. Having a high tenant concentration means that the loss of revenue will be massive if the major tenant defaults.

Below are some S-REITs that have relatively high tenant concentration. Do note that this is not an exhaustive list, they are just some REITs that I have studied:

First REIT (SGX: AW9U): The healthcare REIT derived around 82% of its rental income from PT Lippo Karawaci Tbk and its subsidiaries in 2018.
EC World REIT (SGX: BWCU): The E-commerce and specialised logistics REIT owns China assets and is dependent on two major tenants: Hangzhou Fu Gang Supply Chain Co Ltd and Forchn Holdings Group Ltd. Combined, the two tenants contributed 67.4% of the REIT’s total rental income in 2018.
Elite Commercial REIT (SGX: MXNU): The UK-focused REIT rents practically its entire portfolio to the UK government.

High tenant concentration is risky but it also depends on the type of tenant that the REIT is renting to.

In First REIT’s case, its assets are healthcare properties such as hospitals and nursing homes. Business in healthcare properties should continue as usual during the COVID-19 pandemic, so the tenants will most likely have the means to pay its rent.

Elite Commercial REIT’s tenant is the UK government, which will almost certainly have the means to cover its obligations.

So, while it is important to think about tenant concentration, it is equally important to judge the likelihood of the main tenant defaulting.

High gearing

REITs that have high gearing will have little debt headroom to take on more borrowings if the need arises.

Below are some REITs that have gearing ratios that are close to the 45% regulatory ceiling.

ESR-REIT (SGX: J91U): With a gearing ratio of 41.5% at end-2019, the industrial REIT is one of the highest geared REITs in Singapore.
Cache Logistics Trust (SGX: K2LU): The logistics REIT has a gearing of 40.1% as of 31 December 2019.
Ascendas REIT (SGX: A17U): As of December 2019, the largest REIT in Singapore by market cap had a gearing ratio of 35.1%.

Again this is not an exhaustive list and not all REITs with a high gearing ratio will face default. However, REITs that have high gearing have less financial flexibility and may need to tap into the equity markets to raise money in the unlikely situation of a cashflow crisis. Tapping on the equity markets could mean dilution for a REIT’s existing unitholders.

Low interest coverage

For a simple but not exact definition, the interest coverage ratio compares a REIT’s interest expense against its net property income. A high interest coverage ratio means that the REIT is able to service its interest expense easily with its income.

In a time of crisis, it is important that a REIT’s rental income can at least cover its interest expense to tide things over. Defaulting on debt obligations can hurt a REIT’s credit rating and ability to negotiate lower interest rates in the future.

Here are some S-REITs with a low interest coverage ratio (again, it’s not an exhaustive list):

ESR-REIT: With its high gearing, ESR-REIT’s interest expense is naturally high compared to its rental income. As of 31 December 2019, it had an interest coverage ratio of 3.7 times.
EC World REIT: China-focused REITs traditionally have a higher cost of debt so its no surprise that EC World REIT has a low interest coverage ratio of just 2.5 times:
Ascendas India Trust (SGX: CY6U): Technically a business trust, Ascendas India Trust owns IT-related and logistics properties in India. It has an interest coverage ratio of 3.6 times.

The REITs above have low interest cover so a drop in rental income may result in their inability to pay their interest expense.

Wait and see…

The above-mentioned REITs have some of the unwanted characteristics that make them susceptible to cash flow issues. However, it is not clear whether they will end up facing tenant defaults.

Ultimately, whether the REIT can weather the storm comes down to if their tenants can meet their rental obligations. So far, none of the REITs have made any announcements of tenant defaults, so it is best not to panic yet. As a REIT investor, I have not sold any of my positions and I believe that most of the REITs in my portfolio will be able to weather this storm.

For the time being, I am taking a wait-and-see approach but will be keeping a close eye for any announcements or earnings updates.

*EDITORS NOTE: The article erroneously stated that Ascendas REIT had a gearing ratio of 39.9%. We have since edited to reflect the correct figure of 35.1%.