Nifty valuations: Apollo Asia Fund: the manager's report for 1Q2012
At the end of March, our portfolio was on an estimated current-year PE of 14.2, compared to 11.8 six months earlier. Estimated current portfolio EPS were roughly the same as six months ago, as we rolled into a new fiscal year for many of our companies, offsetting the damage from the Thai floods etc mentioned in our last report. Thus the increase in PE reflects an upward rerating, as quantitative easing in the west succeeds in inflating the prices of Asian equities rather than the domestic properties targetted.
We parted company with BigC, the Thai retailer, which has done very well for us over the years. The price at which the last tranche was sold was ten times the price of our first purchase a little over eight years ago, and in the meantime we received a strong flow of dividends. When we first bought, the net dividend yield was 4.1%; when we sold our last share, it was only 1.1%. Dividends rose over the eight years by 2.3x, or 11% pa compound; the rest was rerating.
When we first bought, in 2003, the company was considered very boring; hence the PE of 10. We loved the strong cashflow, conservative accounting, and payout discipline. The few brokers who followed the company tended to fret about regulatory constraints on expansion, but the company continued to grow, while generating plenty of cash and paying good dividends. It took no big risks, and we were frankly astonished when in late 2010 it became the winning bidder for the Thai business of Carrefour. Losers grumbled that it had bid 50-100% more than their valuations. Nevertheless, BigC made a strong case to investors, justifying the price on the basis of the synergies achievable, as well as the strategic advantages of scale. It then implemented superbly, as far as we can tell. Instead of achieving Bt 1.2bn in synergy savings over three years, the company claims to have managed Bt 1.7bn within the first year, while enjoying a new surplus of managerial talent which is helping it to accelerate a move into small-format stores. No digestion pains are admitted: in October, as the rest of the country reeled from the devastating floods (which temporarily closed three of the company's four distribution centres, and many stores), BigC announced an accelerated expansion plan. Phenomenal 4th quarter results were reported, taking 2011's reported EPS growth to 86%. Now many brokers follow it, and the price rose to 28 times historic reported earnings.
However, the accounting is not as conservative as it used to be. In 2Q11, BigC suddenly extended the useful lives of buildings from 20 to 30 years, building improvements from 5 to 30 years, and building facilities from 5 to 20 years. The difference between old and new depreciation policies boosted 2011 earnings by an estimated Bt 717m. Income from insurance claims contributed another Bt 1,432m for the year. What particularly bothers us about the latter is that, although the company was fortunate enough to be covered for business interruption¹, much of this insurance income relates to assets - some inventory, which may have been immediately replaced, but a significant amount to fixed assets, which are thus being converted into 'income' although their replacements will be capitalised. Stripping out the insurance income not related to business interruption or inventory, and the reduction in depreciation rates, we calculate that earnings for 2011 would have been 28% below the reported figure, taking the historic PE at our exit price² to 38. While the new depreciation policies will remain in place, the insurance income is clearly non-recurrent (although we'd expect some more in 2012). Booking asset-related insurance income to the P&L sets up a demanding base for reported earnings: extrapolating future growth from this artificially high level may lead to disappointment.
