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Return to Normalcy

January 2023 Newsletter

Return to Normalcy

“We mean to hold firmly to all that was ours when war involved us and seek the higher attainments which are the only compensations that so supreme a tragedy may give mankind. America's present need is not heroics, but healing; not nostrums, but normalcy; not revolution, but restoration; not agitation, but adjustment; not surgery, but serenity; not the dramatic, but the dispassionate; not experiment, but equipoise; not submergence in internationality but sustainment in triumphant nationality.”

Warren Harding, May 1920

The last few years have been painfully abnormal for society, as well as for investors. The Pandemic taught the world to learn things in 2020 that the history books had almost forgotten. 2021 brought revenge buying of merchandise and securities. 2022 brought war, and taught the developed world the “I” word that some Emerging Markets will probably never manage to forget. We’ve reached 2023, and in many ways we deserve to ask ourselves, what’s next? Investors are weary, and FOMO (“fear of missing out”) tendencies are timid, not carried out with the fervor and intensity that existed before 2022.

At about this time a year ago we wrote about country risk. Lessons had been reinforced. But were they? Political and macroeconomic risks to portfolios emanating from Whitehall to Beijing were hard to avoid in 2022. Some of these risks have receded, and some may be hiding behind the curtains. 2022 was a difficult year for a bottom-up investor. It sounds strange to hear that from a Value investor when growth stocks had such a torrid time in 2022. It wasn’t so much the negative returns that made the year difficult. No one likes to lose money. No, the difficulty was that the geographic trading location and currency of your security were paramount. It should be no surprise to the readers of Ballina letters that the aforementioned factors are relatively modest in our approach. Thus, we move on to the next.

2022 was ironically, the return to health for financial markets. This sounds crazy to say. But it’s true. The #1 complaint that seasoned market followers and investors had for markets previous to 2020 was that the cost of capital was all wrong. See the chart below. If you had to use one chart to explain to an everyday person how the financial framework that existed for much of the last decade was extreme and experimental, it would be this chart. And 2022, War, inflation, etc…eviscerated the mountain of negative yielding debt. We begged and pleaded for normalcy, and it has now returned.

This repricing of credit to something more normal lead to terrible performance for Growth and REIT stocks, with the standout beneficiary being Commodities. See below.

Source: Factset

As for what we aim to be good at, security selection, below we have a reminder of our stocks that we highlighted for 2022. Yes, four of the companies were and remain essentially Chinese. It was not the greatest year for Emerging Markets (-18% in 2022 in the table above). The Hang Seng market did a bit better than that in USD terms, -12.6% (source : Factset), but the heavy lifting for that performance came in the final two months of the year as the Hang Seng was down roughly 35% in USD heading into November 2022. Hong Kong and China were not the equity markets for the faint of heart in 2022. The one non Chinese company from our list, Australian utility AGL Energy, had a positive return of 26.5%. We continue to own shares in AGL. Of the remaining four, interesting that the worst performer was the Chinese company that is listed in the United States, China Yuchai. (We find that investor wariness of Chinese securities grows the further that you are from Beijing) Today we do not own shares in any of these four Chinese companies. Different circumstances surround the sale decisions. For Xiamen C&D, the stock performed well and went through our price target. The stock moved down our rank sheet, and we could not justify owning it anymore. For China Overseas, Hisense and China Yuchai, the decisions were based more on risk tolerance and diversification. We have had many attractive investment opportunities for China exposure within the past year, and we cannot participate in all of them[1].

For 2023, we have selected to highlight the five stocks below. See below. A few characteristics will not surprise those familiar with the Ballina story: a) the largest market cap of the group is less than $6bn, b) the expected Price/Earnings column has no data for four of the companies because they have no sell side research coverage, and c) all five companies trade at less than 1x Price/Book. The Financial services company, Banca IFIS, has strong capital ratios. But we like this group for more than their small size, and a few metrics. Another factor that is not presented in the table below is that all five of the companies currently trade for a substantial discount to their own historical valuation. This is a factor that we believe improves our risk reward profile.

Cheap, relatively unknown international equities pepper the landscape in which we toil, so the following choices are not that surprising. We discussed Tianneng Power (ticker 819, Hong Kong) on our recent Q4 2022 presentation. Among our rank sheet, the privately owned Tianneng stands out for it’s historic and potential top line growth in the Chinese electric battery marketplace. What really stands out for us is the generous free cash flow that emanates from the company, even with the investment required of the growth profile. Part of what allows this is that Tianneng essentially has no working capital in the business on a net business. This leaves them with less to finance. Tianneng has an Enterprise Value[2] (“EV”) of roughly 4.6bn HKD (source: Ballina Capital). We estimate[3] Free Cash Flow[4] of 1.9bn – 2.2bn HKD over the next few years (2022-2024), and this would equate to roughly a 40% Free Cash Flow yield. Since Tianneng already has Net Cash on the Balance Sheet, this Free Cash Flow can be used for more investment and possibly dividends to shareholders. Crystal International (ticker 2232, Hong Kong) is one of the largest clothing manufacturers for global brands (Lululemon, Uniqlo, Adidas) and does so from factories in China, Cambodia and Vietnam. Like Tianneng, Crystal produces generous amounts of free cash flow, and has Net Cash on the Balance Sheet. Part of Crystal’s attractive financial regime is a low tax rate, roughly 14% (source: Factset). Crystal has an EV of 532mm HKD (source: Ballina Capital). We estimate[5] Free Cash Flow of roughly 150-160mm in coming years, and this equates to a Free Cash Flow (“FCF”) yield of nearly 50%. Crystal has been acquisitive in recent years, and it is likely that some of this FCF will be used for this purpose. Kingboard Holdings (ticker 148, Hong Kong) is a privately owned Chinese manufacturer of Laminates for the electronics industry with about 18% global market share (source: Prismark Partners). We are believers that the reopening of the Chinese economy and supply chains will aid a revival of Kingboard’s profits beginning in 2023. Kingboard profit warned on their 2022 results in early January of 2023, and we believe this will prove to be backward looking and due to China COVID shutdowns and inventory overhangs.

Banca IFIS (ticker IF, Milan) is a specialty finance bank in Italy, although they are not a typical main street bank in that they do not have branches, a large employee base and retail mortgages. They specialize in a few specialty finance verticals such as Bad Loans and Leasing. Typically, the discount on the stock expands coincident with how investors feel about the political and economic climate in the EU. However, Ifis has a time tested and resilient business model that is liquid, and actually benefits from domestic difficulty because they buy bad loans from other Italian financial institutions and work them through a recovery. We can’t help but notice that sell-side analysts have been publishing estimates for 2023 and 2024 that look too conservative by our measure[6] (consensus has 2024 net profits roughly 19% above those of 2022) (source: Factset). IFIS has a strong track record, and we trust them to move profits closer to their internal goals and beyond the market expectations. Finally, Centerra Gold (ticker CG, Toronto) is a gold producer (with some Copper as by product) based in western Canada, with important assets in Turkey. Centerra has decreased the political risk in the portfolio in recent years. Yet the valuation of Centerra, relative to it’s own history, is at too large of a discount in our opinion. On Ballina estimates, Centerra trades for an EV/Sales of roughly 0.5x, but over the last five years this ratio has averaged 1.6x (source Factset). 2023 looks to be a recovery year for profits, and we see financials that merit a valuation closer to the historical level.

Harding’s speech in 1920 aimed to restore America to a pre-War, pre Pandemic, more isolationist calm. What followed in the coming years was, of course, far from calm. We do not pretend to be able to forecast the geopolitical events that may be in front of us as investors. We do believe that the interest rate, commodity and currency volatility of 2022 were part of restoring the cost of capital to a more healthy and sustainable level. Hope springs eternal for the New Year after a tough 2022. Active equity investors have been clamoring for the return to the bottom-up work making a difference again for some time. With a proper cost of capital back in the mix, and a difficult market trajectory, we may have the right backdrop for a return of the prominence of active stock selection. Is that “normalcy”? Not sure, but what we’ve been used to cannot possibly be “normalcy”. We’ve highlighted a few names that we believe are poised to be solid investments under varied financial conditions, with cheap prices and solid tangible asset backing providing some protection of downside. As always, our assignment is to remain nimble, and prepared for all challenges that may come.

Strategy Performance

International All Cap Value returned 7.14% on a gross basis, and 7.05% on a net basis, in January 2023 versus 8.68% for the benchmark.

International Small Cap Value[7] returned 7.72% on a gross basis, and 7.63% on a net basis, in January 2023 versus 8.76% for the benchmark.

Top Contributors and Detractors

International All Cap Value’s top contributor in January was Tianneng Power International. The HK listed Chinese electric battery manufacturer was strong as investors gained confidence that the Chinese economy would rebound in 2023. The strategy’s top detractor was Ryohin Keikaku, owner of the “Muji” Japanese home goods retail chain. Ryohin Keikau reported Q1 results in early January, and the profit figures from the Japanese market were light compared to the annual company forecasts.

International Small Cap Value’s top contributor in January was Tianneng Power International. In addition to positive Chinese recovery sentiment, Tianneng was also pursuing an additional listing of it’s Battery subsidiary on the Swiss exchange. The strategy’s top detractor was Ryohin Keikaku, owner of the “Muji” Japanese home goods retail chain. Ryohin Keikau reported Q1 results in early January, and the profit figures were light. Investors remain concerned about the growth strategy of the group.


The opinions expressed herein are those of Ballina and are subject to change without notice. Past performance is not a guarantee or indicator of future results. Returns are presented gross and net of fees and include the reinvestment of income. The benchmarks being shown for comparison purposes are: a) for International All Cap Value - the Vanguard Total International Stock ETF (VXUS), and b) for International Small Cap Value - Vanguard FTSE All-World ex-US Small-Cap ETF (VSS). The information contained herein is not investment advice. The information contained in this commentary represents the opinion of Ballina Capital and should not be construed as personalized or individualized investment advice. You should not consider the information and commentary published herein as a recommendation to buy or sell any particular security. The securities identified and described do not represent all the securities purchased, sold or recommended for client accounts. You should not assume that any of the securities discussed in the commentary published herein are or will be purchased for your account, or are or will be profitable, or that recommendations we make in the future will be profitable or equal the performance of the securities listed in commentary. Consider the investment objectives, risks, and expenses before investing.

For the Top and Bottom Contributors: Contribution reflects the impact of performance and the portfolio weight to total portfolio return. Data show is from a representative account of the International All Cap Value and International Small Cap Value Composites. All returns are Gross of Fees. Timing differences of purchases and sales may have a modest impact on the actual contribution numbers presented. The calculation methodology along with detail on all holding’s contribution to the overall accounts performance during the measurement period are available upon request.

[1] On our 4th Qtr presentation, we reference a few of the shares of China related companies that entered our portfolios during Q4. You can find this presentation on our website [2] Enterprise Value = Market Capitalization of Equity – Value of Associates/JV’s + Provisions + Minority Interest + Net Debt (or minus Net Cash). Enterprise Value is a proxy for the value of the entire firm to all stakeholders. [3] Tianneng FCF estimates could prove to be too optimistic if: 1) the Chinese reopening disappoints, impacting revenues, 2) margins are hurt by pricing and cost pressures, or 3) investment demands increase relative to history. [4] We define Free Cash Flow as Earnings Before Interest Depreciation & Amortization – Unlevered Income taxes (Tax Rate * Operating Profit) – Net Capital Expenditures +/- Change in Working Capital. [5] Crystal FCF estimates could prove to be too optimistic if: 1) clothing demand from major markets disappoint and impacts revenues, and 2) margins are hurt by labor cost pressures. [6] Ifis estimates could prove to be too optimistic if: 1) economic conditions in Italy deteriorate and credit provisions increase on the corporate loan book, and 2) regulatory actions prove to be damaging to the Ifis business model. [7] On October 17, 2022, the Global Small Cap Value strategy transitioned to the International Small Cap Value strategy. From this date forward the focus of the strategy will be on International Small Cap stocks. The benchmark changed on 10/17/22 to Vanguard International FTSE All-World ex-US Small-Cap ETF (VSS).

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