Building a Special Situation Portfolio #2

When revenue do not need to increase and the investment will do just well...

When investing in companies with high Return on Equity, they usually comes with high growth rate.

For simplicity sake, lets assume that a company has a capital of $1 and is growing at 30% ROE per year, they would have a capital of $1.30 at the end of the first year and then $1.66 at the end of the second year.

After 10 years, with no PE expansion you would have a >10 bagger!

That is the beauty of compounding. If we can recognise a few of these investment before anyone else, then we are set for life!

This type of investment usually falls under the Unrecognised Growth Portfolio.

Not every company has a huge target addressable market (TAM). Most will exhaust their easier growth opportunities, and then will need to make some difficult decision.

These decisions include

  1. Lowering your investment return criteria and go after revenue increase with lower margins

  2. Buy/Invest in competitors in the industry to consolidate market share

  3. Move into a new/adjacent industry with a decent TAM and hope to build up capacity and capability there

Other than special instruments issued which we had detailed in our Building a Special Situation Portfolio #1, Special Situation could include a capital allocation decision as seen above.

What happens during such capital allocation exercise is that there would bound to be hiccups and the growth/optimistic investors start to grow disillusioned with the negative, zero or minimal growth.

There would be a gradual change in the type of shareholder in the company, first a trickle then then a torrent.

We believe that is what is happening to Diary Farm for a while now.

While Diary Farm will not be growing at high rates in the near future, we believe that the

  • higher dividend rate being received,

  • high possibility of the company having a ROE > 15% in 2020 and beyond

  • ability to improve and sustain supermarket margins to historical rate or competitors’ rate

will more than compensate the lack of revenue growth.

When we created a model on the improvement in margins from the supermarket segment coupled with a higher dividend yield, we continue to find Dairy Farm to be a decent investment despite having zero or minimal growth in their revenue going into the future.

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Average Purchase Price: USD 4.188

Current Price: USD 3.94 @ 27th Sep 2020

Catalyst: When the market recognise that the supermarket margin for South-East Asia is here to stay