Is Poh Kong a proxy for gold?
Value Investing Case Study 29-1: A look at my investment in Poh Kong to decide whether to exit now or to keep it as a gold proxy. This is an update to the post that was published in Jul 2022. Revision date: 28 April 2024
Poh Kong Holdings Berhad (Poh Kong or the Group) is the largest gold-based jewellery retailer on Bursa Malaysia. I first bought Poh Kong in 2010 at RM 0.47 per share and held onto them until 2020 when I sold off about half of them.
At that juncture in 2020, the price went as high as RM 1.80 per share. This was significantly higher than its NTA of 1.39 per share. But I was greedy, and rather than exit completely, I held back about half of my investments hoping for higher prices.
However, the price spike was transitory as the RM 1.80 lasted for a few days. It then declined and is trading at RM 1.10 per share as of 19 April 2024. The question then is what to do with the current shareholdings.
The world is currently experiencing high inflation. While Malaysia has yet to see an inflation rate over 8 %, many believe this is due to price controls and/or subsidies.
In times of high inflation, gold is seen as an inflation hedge. I then have 2 choices. Do I sell my Poh Kong shares and invest in gold or do I continue to hold onto Poh Kong as a proxy for investing in gold?
I decide to continue to hold onto the shares. Join me as I lay out my rationale for this.
Should you go and buy Poh Kong? Well, read my Disclaimer.
Contents
- My Poh Kong Investment
- Poh Kong’s Fundamentals
- Valuation
- Gold Proxy
- Conclusion
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My Poh Kong Investment
I first bought Poh Kong in Dec 2010 as it was trading at RM 0.47 per share compared to its Graham Net Net of RM 0.54 per share. The Graham Net Net is a proxy for a company’s liquidation value.
Graham Net Net = Current Assets – Total Liabilities.
It is not common to find Graham Net Nets and whenever I come across one, I generally invest. Over the next 3 years, I slowly accumulated Poh Kong so that I eventually had 172,000 shares with an average price of RM 0.47 per share.
As can be seen from Chart 1, the price did not move very much over the next couple of years. However, in 2020 following the Covid-19 pandemic, the price of Poh Kong began to go up.
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| Chart 1: Share Price: Source: TIKR.com |
I began to sell and chased after the rising prices. The price went up to as high as RM 1.80 per share. I was selling in tranches at various price points and I had sold 80,000 shares at an average price of RM 1.33 per share when the price peaked.
But then I got greedy. After managing to sell a tranche at RM 1.80 per share in Aug 2020, I decided to hold onto the balance waiting for the price to go higher. That was a mistake as the RM 1.80 per share price was transitory. The price started to drop but I thought that it was a temporary drop so I did not sell further.
Unfortunately, as can be seen from the price chart, the price did not go back to RM 1.80 per share. From then it had been hovering around RM 0.80 per share for many years. However, in late March 2024 it started to go up so that as of 19 April 2024, it had risen to RM 1.10 per share.
My returns from my investments in Poh Kong (as of mid 2022) are summarized in Table 1. I have broken down my investments into 2 – the 80,000 shares that were sold and the balance of 92,000 shares that I still hold.
As can be seen, I achieved a compounded annual return of 15.7 % for the 80,000 tranches and 7.4 % for the balance. On an overall weighted average basis, the total return is 11.3 %.
A decent return compared to keeping the money in the bank. However, if I was not greedy, and had sold all in 2020, I would have gotten a higher return overall. The challenge today is whether to continue to hold on or sell.
If I target the same 15.7 % compounded return for the 92,000 shares, I should be selling at an average price of RM 2.059 per share. This was based on the following assumptions:
- Wait for another year to achieve the average selling price ie total stock holding period of 10.51 years.
- The dividend for another year is RM 0.012 per share.
- The capital gain = RM 2.059 – RM 0.47 = RM 1.589 and the cumulative dividends = RM 0.117 per share. Thus, the total gain for 10.51 years = RM 1.589 + RM 0.117 = RM 1.706 per share.
- The compounded annual return = [(1.706 + 0.47) / 0.47] ^ (1/10.51) -1 = 15.7 %.
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| Table 1: Computing the Return Notes (a) As of 13 Jun 2022 (b) Based on total dividends received from 2010 to 2019 divided by 172,000 shares. (c) Based on total dividends received from 2020 to 2021 dividend by 92,000 shares plus RM 0.074 per share. |
Poh Kong’s Fundamentals
Poh Kong was established in 1976 with its first outlet in Petaling Jaya and was listed on Bursa Malaysia in 2004. At FYE 2023, Poh Kong has 88 retail outlets with its manufacturing facility in Shah Alam, Malaysia.
Its business straddles the two major areas of gold utilization - the crafting and sale of jewellery and gold investments.
- The majority of its sales are within Malaysia.
- While online sales were reported to have grown by 157 % in 2021, it “…is insignificant compared to actual sales through its 89 retail outlets.”
- It is still focused on gold.
Besides developing its range of in-house brands, Poh Kong is also the sole distributor for world-renowned international jewellery brands such as Schoeffel luxury pearls from Germany, and two Italian brands – Luca Carati and Moraglione 1922.
Financial Position
As of July 2023, the Group has a Total Capital Employed (TCE) of RM 938 million. About 81 % of the TCE was contributed by shareholders’ funds with the balance from Debt/Leases. 94 % of the TCE was deployed for the operations with the bulk of the balance held in cash.
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| Chart 2: Sources and Uses of Funds |
I would rate the Group as financially sound:
- It had a Debt Equity ratio of 0.24 as of the end of Dec 2023.
- From 2012 to 2023, it generated generated an average of RM 34 million per year of Cash Flow from Operations compared to its average PAT of RM 36 million per year. This was a reasonable cash conversion ratio. There were 2 years out of the past 12 years where it had a negative Cash Flow from Operations.
- Based on its FYE 2023 performance Based and Damodaran’s synthetic rating, Poh Kong would be rated at Moody’s A1.
Performance Index
Over the past 12 years, revenue only grew at 5.3 % CAGR. PAT grew at a lower rate of 3.9 % CAGR. This is not a high-growth company.
There was only significant revenue and PAT growth post-2020. As can be seen from the left part of Chart 3, the PAT pre-2020 was lower than that for 2012.
You can see declining revenue and PAT in 2014. The Group attributed its 2014 performance to the following:
“Industry players decline in revenues were mainly due to weaker demand and the absence of gold rush compared to the previous year. The volatility of gold prices resulted in thin profit margins.”
There was not much growth in revenue or PAT from 2014 till about 2020. But the Group performance over the past few years was much better than those pre-2020. Poh Kong attributed its strong 2022 performance to the surge in gold prices.
Given the profit profile, you should not be surprised to see similar patterns of decline and upturn in the various return metrics. Refer to the right part of Chart 2.
What is causing the upturn in performance over the past 2 years?
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| Chart 3: Performance Index and Returns Note to Performance Index chart: To plot the various metrics onto one chart, I converted them into indices by dividing the values for each year by the respective 2012 values. |
While the Group achieved double-digit ROE over the past 2 years, it only averaged 7% over the past 12 years. This is not exactly a good performance considering that its cost of equity was about 10 %.
The other concern is that over the past 12 years, there was a slight downtrend in gross profitability. In other words, there was some decline in capital efficiency.
Store Performance
As a retailing operation, the performance of the stores is critical. Poh Kong did not provide any information on the same-store sales. However, I tracked the revenue per outlet. Although the number of outlets has declined since its peak in 2014, the revenue per outlet has an improving trend. Refer to Chart 4.
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| Chart 4: Store performance |
Valuation
I valued Poh Kong based on both the Asset Value and Earnings Power Value (EPV) methods.
- The Asset Value was based on the financials as of the end of July 2023 and I have broken it down into Graham Net Net, NTA, and Book Value.
- The EPV was the average value derived from the Free Cash Flow Model and the Residual Income Model. I used the past 12 years' weighted average values for the various parameters used in the models.
As there was very little growth over the past few years, I did not estimate the Earnings Value with growth.
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| Chart 5: Valuation |
As can be seen, the Asset Value was estimated at RM 1.86 per share while the EPV was RM 1.58 per share.
As a comparison, in the Jul 2022 article, the Asset Value was estimated at RM 1.54 per share while the EPV was RM 0.95 per share.
The Asset Value is very much larger than the EPV. There are 2 possible reasons for this.
- The assets are overvalued. In other words, there is some potential impairment.
- The assets are underutilized leading to lower returns.
The Current Assets accounted for about 80% of the Total Assets with a 20% balance in Non-Current Assets. The majority of the Non-Current Assets are PPE and Rights of Use Assets. As these are being used, I do not see any reason for impairments.
The question then is whether any of the Current Assets are overstated. The majority of the Current Assets are Inventories. In its 2021 Annual Report, the Group reported that in 2020, RM 4.6 million was written down to the net realizable value. This represented less than 1 % of the 2020 Inventory. Given that the past 3 years’ Inventory is about 10 months of Cost of Sales, I do not think that there are any significant potential impairments.
Given that assets are not likely to be impaired, the conclusion must be that they are underutilized. Is there supporting evidence for this?
- A comparison between Poh Kong’s average ROA for the past few years with that in 2007 to 2009 shows an improvement.
- A peer comparison among the jewellery retailers also showed that Poh Kong did well. Refer to Table 2. Note that Zhulian has other consumer products and not just jewellery and is thus excluded for this comparison.
The comparative analysis suggests that the market situation over the past 3 years has improved compared to those from 2007 to 2009.
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| Table 2: Peer Returns Note a) Based on 2007 and 2009 |
Margin of safety
The market price of Poh Kong as of 19 April 2024 was RM 1.10 per share. This is even lower than the Graham Net Net of RM 1.37 per share. If you are buying the whole company, the Graham Net Net offers a good margin of safety.
However, as a minority shareholder, I have learned over the years that Malaysian investors look at earnings. While Asset Value or even Graham Net Net can provide margins of safety, I prefer to look at Earnings Value. This is especially true when thinking about what to do with my shareholdings.
On such a basis the EPV of RM 1.58 per share provides a 44 % margin of safety. Since Poh Kong is trading below the Graham Net Net and there is a margin of safety based on the EPV, I would consider this an investment opportunity.
I had earlier opined that my average selling price for the balance of my shares in Poh Kong had to be RM 1.33 to achieve an 11.3 % compounded annual return. This RM 1.33 per share is in between the Asset Value and the EPV. It looks likely.
However, to achieve a compounded annual return of 15.7 %, the target selling price has to be RM 2.059 per share. This is much higher than even the Asset Value. The conclusion is that I am unlikely to achieve this 15.7 % return.
In hindsight, I should have sold the Poh Kong shares back in 2020. The question then is what to do with the current shares.
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Gold Proxy
Most of the world is currently facing a high inflation environment. While the impact on Malaysia is still muted so far, many think that is due to the price-controlled items and subsidies.
At the same time, many economists think that the efforts taken by the authorities will lead to slower economic growth or even a recession. Would this also happen to Malaysia?
Many have recommended that in high inflation or stagflation situations, gold can be a good hedge.
“…Gold is seen as a hedge against inflation and a store of value through thick and through thin. Holding gold, however, comes with unique costs and risks, and the data show that historically gold has disappointed on several of its purported virtues.” Investopedia
When it comes to investing in gold, the options are either to invest directly in gold (actual metal, or gold ETF) or gold proxy stocks. Gold mining companies are often seen as proxies for gold.
However, the general advice is that if you want gold as an inflation hedge, it is better to invest in gold rather than the mining companies.
- “Physical metal outperforms gold miners over the long run, and it should always be the preferred precious metals investment” Suisse Gold
- “…the shares of stock of gold companies are correlated with gold prices but also are based on fundamentals...This means investing in individual gold companies carries similar risks as investing in any other stock.” Forbes
But Poh Kong is not a gold miner. Can an investment in Poh Kong be considered a proxy for investing in gold?
Chart 6 compares the revenue trend for Poh Kong vs the price of gold since 2001.
There is a 0.74 correlation between the price of gold and Poh Kong's revenue from 2001 to 2023. I would consider this significant and hence the investment in Poh Kong can be considered an investment in a gold proxy.
If you look at the price of gold and Poh Kong's PAT there is a 0.58 correlation.
- From 2001 to 2023, the price of gold grew at 6.9 % CAGR with a Coefficient of Variation of 0.38.
- During the same period, the PAT of Poh Kong grew at 10.5 % CAGR with a Coefficient of Variation of 0.68.
The conclusion is that the returns and volatility of gold were less than Poh Kong PAT. The main difference is that as a stock, the valuation multiple will not be constant. In a bullish market, you can get a better multiple and hence a higher selling price compared to a bear market.
The first impression is that Poh Kong is a better investment than holding gold.
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| Chart 6: Correlation between Poh Kong Revenue and Gold Price |
But if you have a shorter time frame, would this be realistic? In such cases, you should be comparing gold price movements with Poh Kong's share price movements.
Table 3 shows the 6-month correlations for 3 different periods of gold price movements with Poh Kong share prices. Refer to Chart 6:
- 2010 when there was an uptrend in gold prices.
- 2015 when gold prices moved sideways.
- Past 6 months when there was an uptrend in gold prices.
You can see that during periods of gold price uptrends, there were significant correlations between them. When gold prices moved sideways, there was a negative correlation.
I would conclude that the market is anticipating the better performance of Poh Kong during periods when gold prices were trending up.
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| Table 3: Correlation between Poh Kong share price and a Gold ETF price Note that for these correlations I compared Poh Kong's daily prices with those of a Gold ETF. I looked at the prices over the corresponding 6 month period rather than matching them daily. |
But I am looking at returns from my shareholding perspective. For the share price to rise from RM 1.10 to RM 1.33, I am looking at a 21 % increase in share price. Given its price history and its RM 1.85 per share NTA as of Jul 2024, this increase does not look impossible.
However, to invest in gold I have to sell off Poh Kong at RM 1.10 per share and then invest the monies in gold at the current price. To get the same return as that for the shares, the gold price has to increase by 21 % over the coming year. The gold price has risen by 26 % over the past 6 months. It is currently at its past 30 years high. As such I think this is a very challenging price increase for gold.
From this perspective, I should continue to hold onto Poh Kong.
Conclusion
I bought Poh Kong in several tranches from the end of 2010 to 2013. During this period, the average ROE for the Group was 11%. However, from 2014 to 2021, the average ROE had declined to 4 %.
Because of market sentiments in 2020, the price of Poh Kong shot up and I took the opportunity to exit half of my investments. I sold them at an average price of RM 1.33 per share and achieved a compounded annual return of 15.7 %. However, I got greedy and held onto the balance expecting higher prices. This did not materialize.
The analysis shows that it is very challenging for the balance of my investments to achieve the 15.7 % compounded annual return. However, it is possible to sell them at RM 1.33 per share and obtain a lower compounded annual return of 11.3 %
The Group performance appears to be in line with the gold price pattern. From 2001 to 2023, there is a 0.74 correlation between the revenue of Poh Kong and the price of gold. It was 0.58 correlation between the gold price and Poh Kong's PAT. I would consider an investment in Poh Kong a proxy for an investment in gold.
While Poh Kong’s average return over the past 10 years was lower than its cost of equity, the Group is financially strong and still profitable. Its intrinsic value (using the NTA as a proxy) has been growing. There is thus the prospect of a share price increase and reaching my target price of RM 1.33 per share.
To achieve the same return for holding onto Poh Kong, the price of gold has to increase by 21 %. The gold price has already risen by 26% over the past 6 months and is currently at the past 30 years high. I am not sure that it can go up by another 21%.
My analysis shows that I should continue to hold onto Poh Kong rather than sell it and invest the proceeds in gold. In other words, Poh Kong as a gold proxy is a better bet than investing in gold itself.
End
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Disclaimer & Disclosure
I am not an investment adviser, security analyst, or stockbroker. The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies. Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them.
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