The End of a Tumultuous Year

The year's been long, with ups and downs, but what a good year it has been. Looking back, I must say that I have learnt a lot about the markets and investing, and how to handle emotions. Let's take a quick flashback on the year that is just about to pass.

2008 ushered in one of the worst performances of the markets to date. The markets were hit by bad news one after another. We started off with Bear Stearns, the quickfire sale to JP Morgan and the U.S government's involvement in it. The 4th largest bank, a century old bank, brought to its knees, once worth $180/share, and the idea of selling it at $2/share was mooted at one point of time.

Now, nobody's gonna forget the mortgage lenders as well, Fannie and Freddie. There used to be an air of invincibility about the 2 lenders, that government support would render them infallible. And then, the markets actually started to doubt the sustainability of the 2 lenders, and the selldown ensued.

Lehmann Brothers was the next victim to have its scalp claimed. Another century old bank, suffering a run, and it went down within a short period. This is bad, the market claimed, and we saw fresh new lows being set and risk aversion at its highest.

Then, around the same period of time, the famous bull of Merrill Lynch, the world's largest brokerage, was sold to Bank of America. Morgan Stanley and Goldman were "converted" to commercial banks for purpose of raising of equity, and this marked the demise of the investment banking business model that had been the success story of the decade where all excesses of the financial world had gathered.

Many high profile corporations were victims of the crisis. Bill Miller, proud record holder of beating the S&P for 15 straight years, has been brought down to his knees, now currently amongst the top 3 for the worst performing fund in 1-yr,3-yr and 5-yr. Washington Mutual, the nice resident bank, with the highly-rated WaMu business model, also went kaput. Many scandals plagued the financial world as well, we had the Madoff scandal, and closer to home, the controversial Lehmann Minibonds saga.

So many incidents, so much turmoil. Consider ourselves lucky to have the chance to look back, years from now, upon this year where presidential elections and terrorist attacks were not the ones that screamed across headlines, but rather, a whole slew of events that threatened to cripple the grand 'ol America.

Even if some of us might emerge from this crisis bruised financially, however, whatever doesn't kill us only makes us stronger. The crisis would almost definitely make us mentally stronger, and emerge as a far better investor by training us to handle our emotions better.

On a personal level, my investing journey has started from the time when the STI was around 3400+ to today's 1700+. That's a close to 50% drop, a very scary period indeed for a novice investor. Nonetheless, coupled with dividends, some nimbleness, a little trading plus lots of luck, I have managed to stay pretty decent. A quick look at my holdings, and the lessons I have learnt from my trading so far.

Let's look back at some lessons that I have learnt.

1) Do nothing when I've nothing to do.

My first foray into the markets was the STI ETF. I lost about $100 on it. The purchase was bought on impulse, I did not think about whether the ETF would be a better alternative to the other companies trading on the SGX at that point of time. I decided to cash out at about the same price that I bought it at, but minus the trading fees.

2) Really understand the businesses that you own, and if u're unsure, stay clear.

I didn't really learn this lesson the hard way, though I looked back and realised that things could have been much grim-mer. I did my research on both companies, but it was very insufficient and I did not have a clear mind as to how the company's operations would be hit and it's competitive strengths. I bought NOL and Sembmar and sold them at around 15% and <10%>

3) Don't take profits for the sake of taking them.

I took profits for NOL and Sembmar because I felt the market's were starting to become a bit optimistic. Pretty silly looking back, because I did not exactly determine, through calculations, why the market was optimistic. It brought me some cash in, and the decision "paid off", but problem is that this is definitely not a method I would be able to employ successfully for my entire investing journey. Pure luck I would say.

I have learnt to not take profits and hold on to them, and even if the profits turn into losses, it's perfectly fine. Do the homework, be sure to handle the price levels and reasons behind them, and we're probably on the way.

4) Build in expectations to ur calculations, and have a handle on why the prices are reflected at this particular level.

I did this for some of the property companies that I held. I incorporated the mark-to-market writedowns into the assets valuations, and found that some of the companies were trading at reasonable levels. It is NOT OUR JOB to predict how much write-downs there will be, but rather, to find out if the market is pricing in earning drops at reasonable levels. If you think so, pick them up. E.g. the markets priced in about 75% write-down in assets, but do note that Kepland's assets are backed by 25% of cash, and you can;t really write down cash can you? Thus I picked them up. Even if prices were to become even more depressed, I am comfortable with a 75% write-down level for Kepland.

5) Do your homework and have confidence in yourself.

I must admit that I have done some homework but still felt a dearth of confidence, which resulted in me previously taking profits. I have since ceased to do so a few months ago. Do your homework, estimate some downside risks. Try not to use relative valuations from previous crises, I believe, because companies that have survived the crises are probably more resilient and valuations will be different. Refer to operational performance instead.

Since then, I have still done a little trading, but very very minimal, and the last done was a few months ago for Parkway where I was "forced" to sell my shares as the markets were being overly optimistic, I figured, pricing in a 10% growth over the next few years when obviously the Group had been hit in the previous few crises( I took a look at the reports during those times). I booked some pretty decent profits of around 40+% before I bought it back at a lower price.

Shall probably talk soon about my individual holdings, the size of my portfolio, and other lessons I have learnt so far, other than the abovementioned 5.

Ciao 2008. Let's usher in the New Year.

A good company = good business?

After looking at Qianhu's financials, I've decided not to become vested. Why so? I've taken away some valuable lessons from this.

1) A good company might not be a good business.

From my business overview so far, seems that Qianhu is a well-run company, led by able management. It might turn out to be a great ornamental fish company, I do not have too much doubts about it. But the problem lies in that a well-run ornamental fish company is at most, a great ornamental fish company. It might not necessarily be a good business. As someone once said, "A horse which can count from one to ten is a remarkable horse, not a remarkable mathematician., or at lest something in the realms of this. There are restrictions in the industry, one the more prominent being the small worldwide industry size of $14 billion (even though it has been growing very impressively).

2) Good management does not necessarily = good outcome

Few will disagree with me on the management capabilities of the Yap family. Rarely do you see someone who has contributed so substantially to not only the company itself, but to the industry as a whole with various product and innovations. Nonetheless, a fantastic manager managing a chicken rice stall can ultimately, only see his chicken rice stall grow larger in size and open a few more stalls, but nothing more than that. Similarly, Mr Yap and family have chosen to continue their family business and venture into the ornamental fish industry. Nonetheless, the industry seems to have relatively muted prospects at this moment. A growing industry, but not huge enough for me to want to own this business for years to come.

However, I might be wrong and rue my missed opportunity for years to come. I shall continue to monitor events within this company though, and hopefully my judgement will be proved wrong in the years to come.

Qian Hu analysis - Business overview

Shall do an analysis on Qian Hu, a company which is not widely covered nor actively traded. My whole analysis shall revolve around one word: sustainability.



What does Qian Hu do? Qian Hu is an ornamental fish service provider, breeding, selling, importing and exporting ornamental fish from around the world. Physical presence in 4 countries, namely Singapore, Malaysia, Thailand and China. Accounts for >10% of Singapore's ornamental fish exports.



Its business generally revolves around 4 areas:



i) export of ornamental fish and accessories

Qian Hu imports, exports, breeds, quarantines, conditions, farms and distributes ornamental fish. When I went down for a visit however, a quick enquiry revealed that Qian Hu acts more of a "holding" area for fishes as opposed to a breeding area, because the costs of breeding are high and not worthwhile. Its ornamental fish are imported from countries in South-East Asia, South America and Africa. It has > 500 species and varieties of ornamental fish, exporting directly to >70 countries and also distributes to local retailers and exporters, including the "Qian Hu" dragon fish(one of which Chow Yun Fatt owns haha)



ii) distribution of ornamental fish and accessories; &

iii) manufacturing of aquarium and pet accessories


The distribution of accessories complements its ornamental fish business, meeting customers' aquarium needs. Qian Hu distributes > 5,000 types of aquarium and pet accessories from more than 20 major manufacturers and principals to local retailers and wholesalers in Asia, including supermarkets operated by NTUC FairPrice, Cold Storage and Carrefour.



Qian Hu has also developed its own brands of aquarium and pet accessories, namely
"Ocean Free", "Delikate", "BARK", "Nature's Gift" and "ARISTO-CATS YI HU", and they are sold through Qian Hu's subsidiaries. Rather silly-sounding names if u ask me.



Qian Hui also manufactures plastic bags(not the NTUC kind, its for packaging fishes) as an ancillary business. Qian Hu manufactures plastic bags for its own use to package ornamental fish for sale in a separate factory located in Woodlands. The plastic bags are also supplied to third parties in the ornamental fish, food and electronics industries. The investment in this area is treated as a sunk cost, and a quick enquiry revealed that the CEO Kenny Yap treats this business as a cash cow for its other segments.



iv) breeding of dragon fish



A licence is required to breed and distribute Dragon Fish, and there are 6 farms in Singapore registered with AVA for the breeding of Dragon Fish. The barriers of entry to the breeding of Dragon Fish are high in view of the knowledge and experience required and the high capital investment involved in the breeding of Dragon Fish, for example, Qianhu has been breeding Dragon Fish (through Wan Hu) since 1995 and capitalised 350 pieces of Brooder Stock amounting to $1.5 million as fixed assets in 1999. This is not exactly something that ordinary fish sellers/farmers would want to go into.



Having gone through the business overview, shall now do an analysis on the sustainability of Qian Hu's business, through a simple SWOT analysis.



Strengths



i) Market leader (shall talk about this slowly in more detail since everyone claims to be a market leader):



a) accounts for >10% of Singapore's fish exports



b) Only fish company in the world to be able to export fish from 4 countries in Asia



ii) competitive positioning

carves a niche by not only rearing Arowana(dragon fish), because most other competitiors like Xian Leng(Malaysia) also do that; Qianhu also sells pet and fish accessories. The reason lies in that the accessories industry is a much larger market than that of the fish itself. Let's do a simple logical explanation: would u keep buying fish or keep buying fish food? That's assuming that you have the skill not to kill your $3000 Arowana once every few weeks. The total customer equity of fish food customers would be the present value of the future consumption(or rather purchases) of fish food. This thus does not come as a surprise that for every $1 spent on fishes, >$2 is spent on accessories($4.5 billion dollar industry for fishes but $10 billion industry for accessories).



The clever part about this is that the accessories industry helps to improve sustainability of Qianhu. Now, let's think again, if Qian Hu sells Arowana solely, will it be sustainable? Perhaps. But think in this way, customers do not keep buying Arowana, this is perhaps a one-off purchase in say, once every few years? It's akin to us not buying wardrobes every few months; similarly, customers do not keep buying Arowana every few months. It does not mean of course that its other competitors do not sell fish accessories, but from management statement(for Xian Leng's, choosing it because it's the largest competitor), there is a noted emphasis on Arowana. However sadly, for some reason, the segment and geographical breakdown is not reported in the financials, so I am unable to conclude whether Xian Leng does in fact emphasise on Arowana and less on accessories. But if Qianhu continues its emphasis on the accessories and Arowana portion, it will bode well for the company, and its actions thus far have proven so.



iii) High barriers to entry



Bredding of Arowana requires R&D(yes, even for fishes). Qian Hu's collaborated with Temasek Life Sciences Laboratory, and the research team has completed the genotyping of all the brooders owned by Qian Hu and has set up an efficient method to identify breeding pairs. For the first time in the history of Arowana breeding, offspring collected from the mouth of
brooders can be assigned to both their parents, opening the way to pedigrees based
on pair-wise breeding. The team is now searching for sex-linked DNA markers that
can be used on juveniles and even larvae.



Qianhu has also invested about S$3m on a new farm in Singapore, next to its current fish farm. This new farm will be 2-3x bigger than the existing one and is under construction(it's the big piece of land beside it which is currently undergoing construction, for those who have gone to the fish farm before.)



Now, how does this help in sustainability? Qianhu's R&D efforts are largely to keep up with competitors(it does not state this in the website of course, you need to look at its competitors'). Its competitor, Xian Leng, is the first Asian company to secure CITES registration, permitting the trading of the Asian Arowana. Although Qianhu has first-mover advantage here in Singapore, however, it has its work cut out to achieve its aim of being one of the top breeders and exporters of Arowana to China(where the market is still damned big despite the one-child policy) and also the top ornamental fish exporter in the world. This expertise has however enabled Qianhu to ensure customers of a loss rate <3%.>60%, which is indeed very high, considering the current gross margins and net margins of 35% and 8% respectively.



v) Vertically integrated



Qian Hu is dependent on the importing of ornamental fish for its supply. However, other than that, everything else can be done in-house because they have the expertise and facilities, i.e. breeding ground, employees, packaging of fishes to be exported(plastic bags). So what does this mean? It means that Qianhu has most production factors are under its control. The control of such factors reduces the lead time required for the entire chain of importing the fish to exporting the fish, or selling it locally, and this high turnover results in a higher potential to convert this into profits.



Now, what's the competitive advantage again? Again, Xian Leng's 4 main subsidiaries revolve around breeding of its Malaysian Golden Arowana; trading of ornamental fish and property holding(#%@!); supplying and trding of aquarium accessories; and trding of aquaculture products. The vertical integration of the supply chain is lacking here where the accessories of Xian Leng in the exporting of fish is actually purchased.



There are other "strengths" which include a management which has been in the business for decades(Kenny Yap and family), employee satisfaction rates of 97.5%(2007), ISO 9001 and 14001 etc, but these are signs and symptoms of strengths rather than actual strenghts itself. Furthermore, there are no significant others to compare with, so I shall not spend more time talking about these little aspects.

vi) Cash convertion

Qianhu's fishes are sold through the conventional pay-at-counter method. There are little problems with receivables as people don't normally pay for fish using cheques, do they? This allows for quick conversion to cash, and Qianhu can now use the cash for investments in breeder stock, instead of having "profits" locked in account receivables. Shall talk about the financial ratios with regards to this in later analyses.

Weaknesses



i) Largely dependent on family management.



Qianhu is largely run by the Yap family, having inherited their pig-rearing business from their fathers 2 decades ago. It is largely controlled by the Yap family, i.e Kenny Yap, Alvin Yap, Andy Yap etc.



Now, why is this a weakness? The Yap family has been running Qianhu's business well for many years, without showing much signs of complacency. However, as it is pretty much a family-run business, it might not augur well for shareholders as the board might not have much say in the running of the business, and the Yap family MIGHT make business decisions which might not be in the best interests of shareholders, although I might be tempted to dismiss this. Kenny Yap has largely been ascribed to the success of the business, and has been largely accountable to shareholders, as shown by its winning of the Most Transparent Company 2 years running(SIAS) and also by Business Times(since 2002). In 1997, Kenny took on a project to automate its fish-packing processes by designing a proprietary auto-packing machine. These are evidences of competent management and help to dispel the abovementioned worries. Furthermore, on a more personal note, Kenny Yap can actually be found chatting online in forums and discussing about fish rearing. This is a clear indication that he is devoted to his job and loves his business, something that long-term investors would like to see. This is a "weakness" that might be seen as a strength too.



ii) Dependent on suppliers for supply of ornamental fish



As mentioned earlier, Qianhu has a integrated supply chain, with the only part of the chain not within control being the supply of the fish itself. When I went down for a visit, the workers revealed that fish breeding(except for Arowana) is generally not practiced in Qianhu(and also other oramental fish companies) because of the large amount of space required and also resources. However, this dependence on suppliers in Malaysia and Indonesia could meet difficulties like export problems( as they are obtained from overseas). This is one major factor that Qianhu cannot control, and I do not foresee that happening in the short run due to their recent $3 million investment in the new Arowana farm. Even if there's capability to purchase a new farm for breeding of ornamental fish, this would not make business sense as it is akin to "inventory pile-up".



iii) Dependence on Asian markets

The revenue contribution from Asian markets is 70% as opposed to European markets which makes up the remaining 30%. This is a modest 2% increase from its previous 28%. Nonetheless, the point here is that the Asian markets are more receptive towards the Arowana (dragon fish), especially so for the Chinese which believe in the superstitions related to the Arowana. This trend is not likely to change in the near future because this is a cultural habit, and consumption patterns take very long to change. Nonetheless, the Chinese market is still large enough for Qianhu at the moment, and geographical diversification is not an absolute necessity.

Opportunities:

1) Growing market

As aforementioned, the ornamental fish industry is currently about $14 billion, not big as compared to other industries, but what is most important is the sustainability. This has been proven so far, with the market growing at a CAGR of 15% p.a since 1985, very impressive indeed. To appreciate this figure, try imagining if your current equity holdings right now are being compounded at 15% p.a. for 23 years ala Buffett-style.

Nonetheless, what does it bode for Qianhu? A growing industry is likely to bring in new competitors. But bring in the point about the industry having high barriers to entry. This likely means that the current leaders in the industry will enjoy the bulk of the growth. Furthermore, Singapore has the nickname "ornamental fish capital of the world", having been the top exporter in the world in 2005 with a current global market share of approximately 20%, and is already the world's largest farm breeder of ornamental fish. Qianhu, being the biggest player here, seems poised to capture a large market share.

Now, why is this important for Qianhu still? Do take note that, as earlier mentioned, ornamental fishes are not bought at the frequency you buy toothbrushes or chocolate bars, perhaps only fish accessories. People are likely to buy 1-2 Arowanas or slightly more, but probably not much more than this figure, nor will they repeatedly buy ornamental fishes. Thus, it is increasingly important for Qianhu to outsource and increase its customer base instead of solely focusing on customer retention, at least more important than other companies not in this industry. The increasing market share will increase the amount of fish sold to new customers, and since this is a somewhat personalised service, customer retention will take care of itself through post-purchase service and fish accessories.

ii) Arowana popularity in China

Like earlier mentioned, the dragon fish has a position in the hearts of the wealthy Chinese due to their aesthetic beauty and its purported luck, something that us Chinese can personally relate to.

iii) Accessories business

Some of these are repeated points. As earlier mentioned, there is a potentially much larger market for accessories rather than fishes. The financials indicate $2 spent for every $1 spent on fishes, but an enquiry with Kenny Yap revealed that the figure is around $5 for every $1. Agreed, this might be a lower margin business. But using logic again, does Qianhu need to actively market its accessories? The customer base comes from the people who buy fishes, and people will purchase accessories after purchasing their fishes, thus it is a complementary business, and there is no need for Qianhu to spend more resources in marketing this segment of the business. In fact, it doesn't make sense at all for Qianhu to market its accessories solely. Thus, this means that not much extra effort is needed to sell the accessories, and this can be seen as a potential cash cow for Qianhu, or rather a cash multiplier. There's no such term, but I feel that it suits the nature of this business because it reaps in more revenue for Qianhu than without this segment.


Threats

i) Disease outbreaks

Qianhu lost its entire brood of 4000 loach fins about a decade ago, and this had threatened to send the family into bankruptcy. Not to say that such events will not happen, as there is still a likelihood that disease outbreaks or other unforseen scenarios can wipe out portions of Qianhu's breeder stock. However, this is likely to have a smaller material impact as Qianhu's farms are now geographically diversified, and the experience gathered these years in rearing fish would minimise the impact of disease outbreaks. Furthermore, do again take note that these fishes are not totally in-bred as mentioned earlier due to space constraints, and the majority of the fishes are imported, then immediately exported within a short period of time.

ii) Forex risks

Qianhu has exposure to certain currencies like the baht, USD, yen and ringgit. This is likely to have an impact on earnings, with forex losses at around 7.7% at present. There are currently no measures to hedge against these positions, and might have a more significant impact on Qianhu during times of crises. However, I believe that holding such forex swap contracts or their equivalents will chalk up increases in expenses that are totally not related to the business, and this amount of money may actually be better off invested in breeder stock. Thus, I do not see this as a problem for now. Even if forex risks are to increase substantially in the short run, I do not see this causing a huge problem for Qianhu's sustainability, as it is highly unlikely that forex risks will cripple Qianhu's earnings at the current level.

iii) Government legislation or regulation

This is the biggest weakness of Qianhu in my opinion, as this is something that will materially impact Qianhu's business and at the same time, not something that Qianhu's management can control as this is the nature of the business. There are certain species of fishes that are restricted due to them being endangered. In fact, the Arowana is an endangered species, and under CITES, the fishes actually have to be tagged and the sales monitored to ensure that wild stocks are not being traded.

One important weakness of a business is its restricted markets, and this is one good example. This indicates that the business might not have the potential to continue to grow at the rate it has seen previously due to restrictions not within its control.

Is the ornamental fish industry any different? Somewhat. Firstly, Qianhu has already obtained its licence to breed Arowana. 2ndly, the beauty of ornamental fish is that fishes are not all identical, as in-breeding can occur. This means that the supply of ornamental fish can be said to be unrestricted save for the ones that are endangered. This again, bodes well for the sustainability of Qianhu.

That was one long analysis. Shall talk about the financial portion in my next analysis.