False signal

Today article features Victoria’s Secret (a difficult decision), Masan Consumer (a dump mistake) and Lindsell Train UK Fund (a good start to 2017).

Victoria’s Secret – A difficult decision

As an investor I’m split 80/20 between quality and value. I prefer owning shares of quality businesses at a reasonable price and hold them until the underlying companies show apparent signs of eroding competitive advantages. Some examples of quality businesses that I bought at reasonable price are Pepsi, Colgate, Visa, Sabeco and Vinacafe. These businesses get me very excited as I know my money is held in quality appreciating assets. What makes me even more excited though is the ability to acquire them at a CHEAP price. The reason is because in the former case (buying quality businesses at reasonable price) your return comes from 1/ future compound earning growth and 2/reliable and growing annual dividend whereas in the latter case (buying quality businesses at a cheap price) you have an additional force working in your favour: 3/ compound growth in valuation expansion.

Fortunately I have had an opportunity to be in the latter case twice. One of them was when I initiated a position in Burberry. Burberry is an exceptional business owning the most iconic British brand that sits in the top 10 of clothing luxury brands in terms of longevity – the brand has been around for as many as 160 years. The brand exhibits incredible pricing power placing the famous trench coats, handbags and other leather goods in the top quartile of the affordable core/affordable luxury category.

In the early of 2016 when the Chinese market crashed the stock plummeted to £10 dropping from as high as £18 a share (a fall of 44%). I was lucky enough to acquire the share at £10. After 10 month the stock delivered a staggering gain of 70%, oweing much to the 3rd factor of return: compound growth in valuation expansion, with a helping hand of upbeat quarterly earnings that proved the 44% drop in early 2016 was only economic-driven, not fundamental-driven.

(Note: I’m currently owning Burberry indirectly via holdings in Lindsell Train UK Equity fund. This was due to compliance issue that I would have experienced with my current employer had Burberry been owned directly in my investing account).

Now then you may wonder what Burberry has anything to do with Victoria’s Secret.

Well L Brands – the owner of Victoria’s Secret has seen its stock halved from $100 to now $47. This was my thought when I first came across L Brands:

“Holy shit! Everyone uses Victoria’s Secret. My gf and my best friend love their show, they are everywhere in the States, even I have heard of the brand name Victoria’s Secret – that show with models in beautiful lingerie and wings, oh not to mention the celebrity guests! They must command amazing brand image and capture a significant amount of market share. This would mean there are 2 amazing competitive advantages protecting the business. Additionally a drop of 50% will absolutely be a great “value” play. I mean, come on how can a quality business trades at a PE of 11x”.

To be honest I must admit that the drop of 50% was what got me super excited at first, so then I went ahead and started researching the business. If this thinking had turned out to be true, that Victoria’s Secret brand was Burberry-level then I would have capitalised on one of the best quality/value plays. All the 3 forces of return would have worked in my favour so well that it would deliver at least 15%-20% in annual return for years to come. 2 competitive advantages would have guaranteed the first 2 forces, being compound growth in earnings and reliably growing annual dividend, then acquiring the share after 50% drop would have ensured compound growth in valuation expansion.

…Sadly, after hours of creepily starring at girls in bras and panties and watching the show, I did not like what I found:

Number 1: L Brands does not have a good brand. I would go beyond and say Victoria’s Secret is not a good brand, it is only a so-so brand. Before any die-hard Victoria’s Secret fan starts screaming at me, please hear me out first.

The company discloses 3 sets of metrics that would help determine its brand power:

          a/ Sales per square footage and total amount of square footage. Victoria’s Secret only has 6 out of the last 10 years that their sales per square footage increased. Within the 6 years there were only 4 years of positive increase in square footage.

               b/ Sales per number of stores and number of stores. Similarly in both rationale and quantitative evidence as in a/

               c/ Average dollar sales and number of transactions. Out of the last 10 years there were 6 years of increase in average dollar sales but only 2 years where the number of transactions increased.

These are very POOR number compared to businesses held in my portfolio. Pepsi, Colgate and Starbucks scored a near perfect growth in price and quantity over the course of 10-20 years. That means out of 10 there would be at least 9 years pricing increases and out of these 9 years there would be at least 8 years of increase in quantity.

These numbers matter a lot because a brand does not have power if it cannot raise price consistently without jeopardizing its quantity. As such quantitative wise VS brand is slacking.

Number 2: L Brands commands a narrow competitive advantage in cost. The company owns the largest market share of lingerie in the US. This respectable position lends the firm the ability to lower unit cost and has allowed the firm to play around with its pricing policy more effectively than others. E.g to offer more frequently discounts on their lingerie without hurting margin much, or to confidently expand into lower-priced sport bras without hurting profitability.

However why the advantage is only narrow is because it fails to dominate globally and it is small when compared to the whole clothing industry. Inditex (owner of Zara), H&M, GAP or any other clothing giants can develop a separate lingerie line/or acquire competitors such as Triumph and Hanes, then leverage their existing distribution/manufacturing capabilities to compete with VS. Failure to go globally quickly would cost VS this advantage.

The 2 reasons above as a result prompted me to question very hard whether L Brands was truly a Burberry-level quality/value play…It was clearly not.

Conclusion: Sticking to my policy of 80/20 quality/value I confidently decided to remain an outsider to L Brands.

Future note: I would come back to L Brands if the company decides to premiumrise Victoria’s Secret and that premiumrisation is proven a success for at least 3 years.

Masan Consumer – a dump decision

I made a VERY dump decision of acquiring Masan Consumer’s shares at a price that would value the company EQUAL to the value of its parent company – Masan Group. Masan Consumer contributed roughly 60% in revenue to Masan Group and I was valuing its shares equal to that of the Group. This is just plain dumb and I blame myself for not taking actions timely. As a result this costs my family’s portfolio a dear 4% in just 3 months….

Lesson here is to never buy a listed subsidiary without checking the current valuation of its listed owner.

Anyway I’m now holding Masan Consumer at 5% of the family portfolio. In spite of this stupid decision my investing thesis for Masan Consumer remains unchanged. It is still a marvellous business commanding great brand power and cost advantage in most of what it does: from fish/soy sauce to instant coffee/water to instant noodle. On top of it the firm has a great dividend prospect which I explained in this article Here.

Lindsell Train UK Fund – a good start to 2017

I didn’t talk much about my significant holding in Lindsell Train UK Equity fund, so I thought I would just give a quick update on the fund here.

I have been a holder of the fund’s unit trusts for 2 years now and I firmly believe in the investing philosophy pursued by the firm’s portfolio managers. Nick Train and James Bullock have outlined much of their thinking in the “insight” column published on the fund’s website. I myself consider the 2 as great investing mentors to whom I follow closely. Partly for learning and partly for worshipping (just like them to the Sage of Omaha).

So in short, the first 3 month of 2017 has been great for the fund, beating FTSE All Share index by 3%. Several decisions/facts that are interesting include:

1/ Pearson: decision to keep the shares in spite of a near 50% drop in share price impacted by poor earnings, disrupted by technological forces and somewhat fundamental factors.

2/ Unilever: valuation correction following bids from Kraft Heinz to acquire the company, sending the stock up 10%-15%

3/Celtic: the Scottish football club rose 30% in 2017

4/London Stock Exchange group: failed merger with Deutsche exchange

Out of the 4 the scariest one is with Pearson. On the surface the company does show some signs of a weakening moat. However the switching cost advantage still remains intact given the nature between education provider (Pearson) with schools, universities and other educational bodies. E.g: once university picks an educational provider it will be very costly to switch to a new one because everything from student learning programs to studying materials is already in place. The firm though has struggled in adapting to digitisation. Specifically it has hurt the business’s brand advantage. For instance universities won’t go to Pearson because of weak online studying program which would subsequently hurt the switching cost advantage in the long run.

Though I respect the decision of the fund in keeping Pearson and would hope to see the company deliver a smoother transformation in the future.

So props to my guys Nicky and Jimmie. Keep doing what you do!

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