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.
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 today it is trading at RM 0.82 per share. 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 that 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 till today, it had been hovering around RM 0.80 per share.
My returns from my investments in Poh Kong 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 monies 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. Today, Poh Kong has 89 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 Jan 2022, the Group has a Total Capital Employed (TCE) of RM 796 million. About 79 % of the TCE was contributed by shareholders’ funds with the balance from Debt/Leases. 91 % 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 0.26.
- Over the past 12 years, it had generated an average of RM 30 million per year of Cash Flow from Operations compared to its average PAT of RM 28 million per year. There was only one year out of the past 12 years where it had a negative Cash Flow from Operations.
- Based on Damodaran’s synthetic rating, Poh Kong would be rated at Moody’s A3.
Performance Index
Chart 3 shows the key performance metrics of the Group over the past 17 years.
- Revenue grew at a 13.6 % CAGR from 2005 to the peak in 2013. Thereafter it declined for a few years before recovering in 2018/19. However, Covid-19 hit, and revenue fell again.
- PAT had a similar rise and fall pattern although it was more volatile than revenue.
- Gross profitability, defined as Gross Profits/Total Assets, seemed to have 2 levels. From 2005 to 2013, it averaged 32 %. From 2014 to 2021 it averaged 26 %. According to Professor Novy-Marx, this metric has the same power as PBV in predicting returns. This steady level augurs well for the Group.
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| Chart 3: Performance Index |
Looking at Chart 3, you can see that the Group’s performance can be categorized into 2:
- From 2005 to 2012 when revenue and PAT grew by more than double digits per year.
- From 2014 to 2021 when there was no discernible growth in revenue or PAT.
As shown in the Gold Proxy section, these 2 periods coincided with the pattern of gold prices.
After I had completed my share purchases, ie from 2014 to 2021, the average ROE was 4 %. Considering that the cost of equity is 10%, you would conclude that the Group had not been able to create shareholders’ value.
During the time of my purchase, from 2010 to 2013, the average ROE was 11 %. The Group returns had deteriorated over the years.
Store Performance
As a retailing operation, the performance of the stores is critical. Poh Kong did not provide any information on the sales per sq ft. However, I tracked the revenue per outlet. Although the number of outlets had declined since its peak in 2014, the revenue per outlet has an improving trend.
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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 Jan 2022 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 1.54 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 the lower returns.
The Current Assets accounted for about 80% of the Total Assets with the 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 were 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 a drop.
- A peer comparison among the jewellery retailers also showed that the drop in Poh Kong was the worst. Refer to Table 2. Note that Zhulian has other consumer products and not just jewellery and thus excluded for this comparison.
The comparative analysis suggests that the market situation over the past 3 years is much more challenging than from 2007 to 2009.
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| Table 2: Peer Returns Notes (a) Based on 2007 and 2009 |
Margin of safety
The market price of Poh Kong as of 13 Jun 2022 was RM 0.82 per share. This is even lower than the Graham Net Net of RM 1.13 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 when thinking about what to do with my shareholdings.
On such as basis the EPV of RM 0.95 per share provides a 16 % 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 for 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 compared the revenue trend for Poh Kong vs for the price of gold since 2001. Note the 2 periods that I mentioned earlier – up to 2012 and post-2012.
There is a 0.77 correlation between the price of gold and Poh Kong's revenue. 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 0.70 correlation.
- From 2001 to 2021, the price of gold grew at 7.4 % CAGR with a Coefficient of Variation of 0.39.
- During the same period, the PAT of Poh Kong grew at 7.5 % CAGR with a Coefficient of Variation of 0.40.
The conclusion is that the returns and volatility of gold and Poh Kong PAT are about the same. 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 I am looking at returns from my shareholding perspective. For the share price to rise from RM 0.82 to RM 1.33, I am looking at a 62 % increase in share price. Given its price history and its RM 1.54 per share NTA, this increase does not look impossible.
However, to invest in gold I have to sell off Poh Kong at RM 0.82 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 62% over the coming year. There is no such rate of increase over the past 2 decades. As such I think this is a very challenging price increase.
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 2021, there is a 0.77 correlation between the revenue of Poh Kong and the price of gold. It was 0.70 correlation for 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 8 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 the 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 62 %. Over the past 22 years, there is no history of the price of gold achieving such a growth rate.
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.
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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.
The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such.
I may have equity interests in some of the companies featured.
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