Market fears on US macro, US/China tensions (including de-listing of Chinese companies from US exchanges), covid-19 surge, China internet anti-monopoly investigations, etc isn't without merit. We've been wary of distortions in the market for a long time now and believe a broad asset valuation reset is inevitable once the current liquidity tide recedes. However from a micro perspective there are many attractive equity investments yet to recover to fair value or have now been oversold. Today one of the biggest pockets of undervalued opportunities are Chinese equities, particularly the US listed ADRs which are now too cheap to ignore. The market gyrations in May have been a testing ground for active stock pickers and in the words of Eminem, it's now "time to separate the sheep from the goats".
What does it mean to be a contrarian investor? Our actions over the past week demonstrates this investment philosophy. Post Alibaba's FY2021 results this week, the stock fell ~10% continuing the downward momentum which has seen its value decline ~40% from its mid October 2020 highs. The share price is now almost back to its HK IPO listing price in Nov 2019. We studied the results and found them to be excellent and consistent with its structural growth. We did a basic valuation of the company and weighed all the market concerns and found the risk/reward offer to be highly compelling. Acting quickly, we established a base position on Thursday and continuing buying throughout Friday.
Alibaba is now priced on low 20s x my conservative estimate of forward normalised GAAP earnings where earnings can maintain >20% CAGR for many years to come. These earnings are understated since Alibaba is under-monetising its e-commerce ecosystem and investing in many yet to be profitable businesses (which together reduces its operating income by ~20%). Note: unlike traditional industries which use capex to expand (and record these outflows in Investing Cashflow), tech companies expense almost all of their expansionary spending. Another way to look at it is: at current price, an investor is only paying the low end of fair value (mid 20s GAAP PE assuming 25% tax rate) for Alibaba's e-commerce business and getting everything else for free: net cash, investment securities, other business divisions and subsidiaries. The value of 'everything else' is conservatively between RMB1.6-2.3trillion or 40-60% of the current market cap. So dividing the expected return from Alibaba into its basic parts: 1) valuation 'reset' (one-off) upside of ~50%, 2) an ongoing annual compound return rate of >20%. That looks pretty good to me and it doesn't require excessive assumptions to get to this answer: GMV growth in the teens, increasing margins (lower losses, increased monetisation, etc) leading to profit growth >20%. People worry about government internet crackdown but I believe this has limited impact on the primary driver of Alibaba's earnings growth which is structural changes in user habits. Also the recent anti-monopoly fine lowers Alibaba's risk relative to its peers. The market is always good at rationalising share prices in hindsight and we find the current slate of bear arguments on Alibaba lacking or insufficient relative to its reward upside.
We are now happily (almost greedily) deploying our large cash position into many existing and new investment opportunities. Great companies trading at great prices such as Alibaba are rare. Another newly initiated position is Yatsen which is a hyper growth company whose valuation has dropped precipitously and is now compelling enough to offset the burden of proof still required on its business model. Meanwhile we maintain shorts on many dreamer stocks (see last post) whose lofty valuations do not yet reflect the many risks still facing them.
So what does it mean to practice a high conviction, fundamental and contrarian style of investment philosophy? It's maintaining a careful and considered risk/reward framework at all times, ignoring the excited or panicked bleating of the market and putting your own balls and hard earned capital on the line when the conditions are finally right. That's what separates the goats from the sheep.
Major portfolio changes:
Increase % long equity to 70% from 65%
Maintaining a 10% short position
Selling down and/or trimming investments which have now almost recovered to fair value e.g. Loomis, Exxon Mobil, some tobacco exposures
Increasing the % and/or absolute investments into various Chinese equities
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