31 Oct 2013 13:39
Terra Partners Asset Management Limited
Portomaso Tower Suite 8/5A
St. Julian's Malta STJ4011
Telephone +356-2371-7000
Regulated by Malta Financial Services Authority, Reg. No. C56353
Manager's Third Quarter Report for 2013 October 31, 2013
The opinions expressed in this report represent the views of the Investment Manager (Terra Partners Asset Management or "Terra") at the time of its preparation. All reasonable precautions have been taken to ensure the accuracy of the information utilized and relied upon in preparing this report and which are provided herein, and Terra believes this information to be reliable; however no representation or warranty as to the accuracy of the information contained in this report is made or is to be implied. The information reported herein does not represent all of the information Terra had available, or which it relied upon, when making its initial and continuing investment decisions and therefore this report will necessarily be incomplete and/or condensed. Terra reserves the right to amend this report and its opinions at any time. Please note that investments in Emerging and Frontier markets usually suffer from liquidity problems, and are often affected by governmental interference in the free market, local politics and vagaries in commodity prices; therefore, their prices can be very volatile. This means that it can be difficult to acquire and subsequently sell the shares noted in this, and prior, reports.
This report is for information purposes only, and is not intended as an offer or solicitation with respect to the purchase or sale of any security or investment vehicle. All offers or solicitations are on the public market of the AIM Section of the London Stock Exchange and occur solely by reference to the information contained in the document titled "Tender Offer to Purchase Ordinary Shares at the Tender Price and Restructuring and Amendment to the Directors' Incentive Plan and Change of name to Terra Capital PLC and Notice of Extraordinary General Meeting" (the "Circular") accessible on the Fund's website www.terracapitalplc.com in the "Investor Center" under the Documents and Announcements section of the file "AIM Rule 26". This website contains important information which may supplement, modify or differ from the information contained herein and no prospective investment decision should be considered before careful reading of the documentation found on the Fund's website. All current and prospective investors should be aware that PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Update on TCA's 3Q Portfolio: The Fund's equity exposure increased to 56.70% at quarter end, from 52.80% at the end of the 2nd quarter, despite exiting a number of positions. Europe remained the largest regional exposure at 26.41% of the Fund's September NAV, down roughly 1.5% from the 2nd quarter, due mainly to trimming back of some of the Fund's larger positions. The allocation to Asia increased by almost 4% to 14.86%, partially through appreciation, but the majority occurred through increasing current positions or adding new positions. As opposed to Europe where several positions that approached our estimate of fair value were trimmed or sold, no positions in Asia were reduced during the quarter. The allocation to the Middle East rose slightly on performance, but there were no new purchases or sales. Africa increased marginally on adding to the Housing Finance position and beginning to accumulate an African telecom. The Americas allocation rose through a 20% gain in the Argentine REIT IRSA and doubling the shares held in Scotia Group Jamaica.
http://www.rns-pdf.londonstockexchange.com/rns/8878R_1-2013-10-31.pdf
Purchases: The Fund continued to deploy additional capital into 5 current positions and initiated investment in 5 new positions (please refer to accompanying table). Total capital deployed during the 3rd quarter came to 4.64% of the Fund's June 30 NAV.
Korean Preferred Equity: Three of the five newly added positions are preferred shares of listed Korean listed companies. The "preferred" appellation is misleading since these are in practice simply non-voting common equity that pay the same dividend as the common stock plus a formulaic additional amount. Although the additional dividend amount is a positive factor influencing the decision to buy these positions, the primary impetus for investing in these securities is the substantial discount the preferred shares trade in relation to the common and the yield multiplier created by both the structure and the discount. As one example, the common shares of Daelim (a major Korean construction and chemical firm) trade at a P/E of 9.68 and a P/B of 0.78, while the price we can buy the "preferred shares" at creates an implied P/E of 2.96 and P/B of 0.24. Although the preferred's higher dividend still only provides a relatively mundane 1.86% yield, it is more than 3 times the common's paltry 0.56% yield; furthermore, this yield multiplier is quite dramatic. If the yield on the common stock simply rises to the industry average of 1.5% for Korean construction and energy firms due to dividend increases (as opposed to a declining price), then the preferred's yield would rise to 5.24%. If the yield premium the preferred equity earns over the common were to narrow to 2x from 3x, whether the common's dividend is stable or increased, the preferred's share price could rise 65-70%.
Investment Rationale: The 3 preferred stocks bought for the Fund are among 148 preferred equities listed on the Korean Stock Exchange and each one trades at a varying discount to its respective common stock, with some yielding nearly 10%. We ended up investing in this select group for 3 reasons:
1. The underlying businesses are strong and have significant cash flow which allows them to maintain or increase their dividends;
2. The discounts to the common equity are significant and result in substantial discounts to the company's tangible book value, providing unusually low earnings multiples and a buffer to further price compression; and
3. The trading depth of these stocks is sufficient high enough so that the Fund is not adding significant liquidity risk by buying these counters (some of the 148 preferreds trade by appointment only).
Potential Risks: Beyond the normal corporate risk in each position (which we tried to minimize this by making a thorough analysis of the underlying businesses and diversifying across three substantial companies in varied industries), the primary risk to this trade seems to be either a stagnation or decrease in the underlying common dividends which we project would adversely affect market interest, further widening the discount and impacting liquidity.
African Telecom: We are in the process of buying shares in an African telecom company which is the dominant provider in its domestic market. It is majority owned by a foreign telecom, which we believe materially reduces the risk of a reduction in its strong dividend payout. The country has a very low cell phone penetration rate by African standards providing significant scope for further growth. The company's introduction of 3G services appears to be a significant catalyst for further market penetration growth as well as market share growth. As soon as we reach our targeted holding we will provide a full report on this investment.
Subsequent Events:
Subsequent to the quarter ending the Fund made a significant block purchase of a company already held in the Fund, Galenika Fitofarmacija, from another institutional investor we have been trying to acquire for some time. Due to the size of this transaction (1.6% of the fund as of the date of this report, bringing the equity part of the portfolio to over 60%) we thought it would be more transparent if we disclosed it at this time rather than wait for the 4th quarter report. We have not changed the above chart which shows the positions as of quarter end.
Galenika Fitofarmacija: This is a leading Serbian producer of plant protection products (herbicides, insecticides, fungicides etc.) based on generic active substances. The portfolio of the company is dominated by its own brands, with a smaller component of products from global companies it co-operates with through agency, co-operation and distribution contracts. The Company generates more than 90% of its revenues in its domestic market while ensuring its compliance with European regulatory regulations.
Investment Rationale: The Company is a market leader (25% market share in Serbia) with high profitability (ROE of 21%), growing sales on an expanding market, no net debt, and a strong, stable operating cash flow. Galenika trades at a 17% discount to book at a trailing P/E of 5.4 with dividend yield exceeding 5%.
Potential Risks: There are 4 main risks to the position:
1. During 2013 there has been a marked increase in the insolvency of many Serbian businesses dealing in agriculture. The crisis may go deeper, taking into account the current prices of agricultural products especially commercial wheat and corn. This may lead to a spike in write-offs on the company's receivables;
2. Serbian dinar weakening against the euro or dollar which would lead to an increase in the price of its imported raw materials that probably cannot be matched by an increase in the prices on its products;
3. The company is spending considerable resources to attain approval for the sale of 4 of its compounds into the EU. If these are rejected or significantly delayed, that would impede a major potential source of future growth; and
4. The risk of continuing absence of a catalyst in the stock market. In this case, despite the Company's profitability, its value would remain locked in for some time due to its low liquidity.
Sales
Despite the increase in the Fund's invested positions, the Fund also completed the liquidation of one position (KHGM Polska Miedz) that it began selling in the 2nd quarter and reduced exposure to 6 others totaling 3.75% of the Fund's June 30 NAV. Of the six positions the Fund reduced, four have risen to prices that are at or near prices that we estimate to represent their fair value. We slightly trimmed our position in Equity Bank in Kenya (which was less than 4% of the Fund's holdings) during the frontier market's July surge to manage the Fund's exposure (Equity Bank is the Fund's 3rd largest equity position). The Fund also moved to exit its position in the Frankfurt-listed REIT Prime Office as Prime's board agreed to a merger we believe is disadvantageous to Prime's shareholders.
Significant Events in Current Positions:
Egis Pharmaceutical: This Hungarian company is 51% owned by Arts et Techniques du Progrès, a wholly owned subsidiary of France's Servier Group, a privately held pharmaceutical concern. During the quarter Servier offered HUF 28,000 per share for the remaining shares in the company on September 24th, an approximate 35% increase to the stock's previous closing price. Egis was the Fund's largest equity position at the end of the 2nd quarter and we sold a portion of its holding before quarter end to lock in the gain and reduce the Hungarian currency risk. The Fund is submitting the remaining shares to the merger.
ANY Security Printing Company:ANY is a Hungarian document security company that specializes in producing cards (identity, bank, hotel, loyalty, public health), identification systems (identity documents, product identity, RFID), forms (lottery, election ballots), digitization of physical documents, and mobile banking (mobile wallet: MasterCard PayPass, Visa Paywave, etc.). The company's 12-month earnings have increased over 21%, debt continues to be reduced (debt-equity: 28%), and the yield is in excess of 8%.
U-Blox: This company produces wireless and GPS semiconductors and registered revenue growth of 35% and 33% EBITDA growth over the previous year and introduced its first 4G LTE compatible chip. The stock has risen almost 100% year-to-date, and 23.44% on the quarter. If it continues to rise, we will likely realize some of the position to lock in the substantial profits we have made on paper.
Acron Group: This company, a vertically integrated fertilizer producer, owns a large stake in the Russian potash miner Uralkali that amounted to 40% of its equity at the end of the 2nd quarter. In last quarter's report we identified this stake as a potential risk to the position, and that risk unfortunately came to the fore during this quarter. The duopolistic cartel that Uralkali had established with Belarusian Potash Company (BPC) abruptly collapsed during the 3rd quarter, forcing investors to adjust their forecasts for potash prices and Uralkali's price fell as much as 34%, before finishing the quarter 22% lower. Moreover, Acron has embarked on an effort to develop its own potash mining operations, which is now in serious doubt given the current conditions. Acron fell 17% on the quarter.
Prime Office: Prime is a German REIT with properties located primarily in Frankfurt and Dusseldorf. The REIT went public in 2011 and subsequently its price fell dramatically to trade at a 50-60% discount to NAV, where we bought in. Its inability to maintain its debt-equity levels as required by law was threatening its REIT status. Oaktree, a large U.S. asset manager and significant owner of Prime's shares, offered to merge its OCM German Real Estate Holdings with Prime. We had closely scrutinized Prime as a potential takeover, but before we could finish our due diligence on its underlying properties, Prime agreed to merge with Oaktree. After studying the terms of this merger, we concluded that the merger created only a dilutive structure for Prime's shareholders and offered no clear catalyst to eliminating Prime's discount to NAV. Accordingly we decided to exit this position and are almost out at the time of this report.
Respectfully submitted,
Terra Partners Asset Management Limited
Portomaso Tower Suite 8/5A,
St. Julian's Malta STJ4011
Regulated by Malta Financial Services Authority, Reg No. C56353
Contact:
Galileo Fund Services Limited (Administrator)
Ian Dungate or Suzanne Jones
+44 1624 692600
Panmure Gordon (Nominated adviser and corporate broker)
Paul Fincham or Jonathan Becher
+44 20 7886 2500
Terra Capital plc.
Howard Golden or Filip Montfort
+356-2371-7000