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TTI’s Short Hedges

Since my previous post on Dutech (Dutech Holdings FY17’s AGM), the company has released it’s FY18Q1 results and I’ve had time to peruse it. I feel pretty much  vindicated, although the headline news don’t quite describe it as such. Anyway, maybe I’d write about some new findings in the next post.

Of late, markets have been on a tear. US earnings season is well underway and in fact, near completion. Judging from how the S&P index has been performing, it seems like the general consensus is that good times are back, and that the earnings thus far, have met the market’s expectations.

743) S&P 500.jpg

My US options and equity portfolio have also done immensely well the past couple of months. Too well, in fact. I get cautious when things rise too fast, too soon.

I don’t know exactly how well is well, but I withdrew $50k USD from the US portfolio to put into the bond markets, after taking profit on some positions such as CTL and CHK.

Yet, today, the net liquidation value (As calculated by Interactive Brokers), is basically the same as before I did the withdrawal. So the gains in the past month++ or so must’ve equaled this $50k USD.

I’ve since swung to the slightly bearish side, and loaded up with some protective shorts as hedges. So where do we stand right now?

This is the S&P chart YTD:

744) YTD.jpg

Personally, I don’t think we’d ever see or cross the high (circled out in red) of 2,872 reached in end Jan. I don’t even think we’d cross the other high (2nd circle in red) of 2,786, although that seems more probable.

In just under a month from now, the Fed meets again, and it’s pretty much expected that the Fed will raise interest rates again from the current 1.75%, to 2%.

Not too long ago, as the Fed was loosening and pumping liquidity into the system, the excess liquidity pulled global markets from the brink of depression. Now that we are doing the reverse…… the same massive force that was at our backs, will now be in our faces.

This is the financial equivalent of Newton’s Third Law.

Ah, it took me sometime to find this link, I knew I just watched this not too long ago.

https://www.cnbc.com/2018/05/11/fed-is-about-to-deliver-a-punch-in-the-face-peter-boockvar-says.html

This pretty much sums up what I feel are the likely risks ahead. Of the few US companies that I followed closely enough, the earnings season wasn’t that fantastic. Not sure why everything seems to be rallying of late.

The “punch in the face” is coming, and it’d hurt no matter how forewarned you are. In fact, the markets probably pre-empt is all, as treasury yields have risen, bond yields have risen and the yield curve has flattened of late. All of which hints of tightening conditions.

I’ve chosen to add on protective short hedges via what I think, is a creative sorta way.

I’ve sold far OTM call options on the SPY, and used the premiums to partially pay for some of the put options that I’ve bought.

I’ve also gone nett long on volatility, by loading up on VXX, and at the same time, selling far OTM call options on these same VXX positions. The rationale is that volatility can spike up and I’d make a lot of money from these positions, but I don’t think we’re going into a great depression and volatility will go absolutely crazy. If it does, I’d end up forgoing the largest portion of profits, but will still sit pretty with a sizable profit.

745) Volatility long.jpg

746) Volatility long.jpg

I prefer to add on to the positions gradually over multiple days, and only add on a small 3 lot position each time. The above is just a small snapshot, the actual list is quite a fair bit longer.

In short (pun intended!), I really wouldn’t be complaining too much if the markets start turning south right about now.

I think my previous experiences dealing with volatility derivatives, and some new found insight, made me somewhat confident of building up these short hedges.

The Big Short: TTI’s Version. But Where Are My Millions?!

An In-depth Look Into Volatility By TTI

Another reason for going long VXX right now, is that of late, there’s been a divergence between the fortunes of SPY and VXX. The “fear index” doesn’t seem very indicative recently.

For many days in the past fortnight or so, whenever the SPY drops, VIX drops along with it, instead of rising.

Now, since VIX is calculated based on prices of S&P options, I’d expect some form of correlation. As it turns out, they ARE fairly well inversely correlated, as this table shows:

747) Correlation.jpg

Although this correlation is imperfect, the odds are pretty much in the favor of an inverse relationship:

748) correlation table.jpg

When S&P move down, VIX moves up in 78.40% of the instances, which is pretty well inversely correlated.

Yet, the recent breakdown of this inverse correlation that I’ve noticed in the past couple of weeks, indicates to me that something must change soon.

Either the VIX must start moving up very strongly when the S&P is down, or the S&P must start moving up dramatically (less preferred for me).

Since we’ve seen earlier that S&P has already been trending upwards strongly in the past week, I’d think that the odds are in my favor that the S&P starts coming down, and VIX starts moving up again (there’s a 78.40% chance that that happens)

And since I’ve pretty much been observing the scenario of S&P and VIX moving in tandem, which is only a 21.6% probable scenario, it seems logical to bet on the 78.40% scenario coming back pretty soon.

So let’s see what happens from here.

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Dutech Holdings FY17’s AGM

1stly, something unrelated to Dutech Holdings.

I drove down to BBR Holding’s project, The Wisteria to take a look today. Kinda disappointing that the project is taking so long to TOP. I was informed by sources a few months ago that it’s slated to TOP in mid April. So, obviously, they’re late, cos today it still looks like this:

736) The Wisteria.JPG

Officially, the given time frame for TOP is announced as Q2, so the project is not considered delayed. (But unofficially, I know it is)

I can see the signboards of the various tenants though, so it can’t be too far away now. The Wisteria is going to provide BBR with some much needed recurring income from mall management, and that’s badly needed right now, seeing that BBR’s FY18Q1 is going to be unprofitable. They just can’t seem to execute on projects profitably. All the years of pumping money into and investing into PPVC didn’t seem to yield any tangible results.

The rental rates are probably highly confidential, so I don’t think I should reveal the exact numbers here out of respect, but they’re pretty much in line with the other malls that I’m familiar with.

The ground level where most of the footfalls are and visibility is maximal (frontage along the main road), commands rent in the low $20s psf, whereas the basement level commands rent in the upper teens psf, both together with the standard nominal few % of GTO of the tenant.

These rates are similar for all suburban malls, and have been kinda frozen in the past 4 years or so, don’t see much difference.

The last I checked, The Wisteria’s occupancy is amost 80%, but since we’re approaching TOP, perhaps the occupancy has increased further.

Having done a site visit and analyzed the surroundings, I gotta agree that this project has been rather successful. Although not directly linked to an MRT station, and facing some competition from the nearby Northpoint, which is now super massive after the asset enhancement, The Wisteria itself will command a certain captive crowd, as the numerous residentials around the area is currently under served.

There are no real retail options in the vicinity, and I can see that once The Wisteria is operational, there’s no reason for the nearby residential crowd to go that little further to Northpoint mall for their needs. The tenants in The Wisteria Mall are all familiar names too: Kopitiam and NTUC Fairprice being anchor tenants.

737) tenants.JPG

Being a mixed development also means that the fully sold residential units above will provide an immediate boost to the retail portion, once residents start moving in.


Anyway, this post is about Dutech Holdings. BBR’s management  needs to go take some classes on project execution and management from Dutech’s, IMO.

I attended Dutech’s FY17 AGM about 1.5 weeks ago.

737) Dutech FY17 AGM

I’ve received quite a few requests to write about Dutech’s AGM, and have been procrastinating. But well, here it is. I’d also add on some of my further DD at the end.

As this is not a new holding, I won’t waste time talking about the basics. They can be found here:

Dutech Holdings Investing Thesis

Dutech Holdings – What’s Next? Realize $117k Profit, Hold Or Add More? (Part I)

Massive FY16Q4 For Dutech Holdings – Digging Deep To Understand The Impact Of Metric Group Acquisition (Part II)

Dutech Holdings – What Lies Ahead? Part III

For the uninitiated, a very quick summary. Dutech made some quickfire acquisitions in the past few years and that greatly expanded their capabilities, at the expense of their otherwise, solid financials prior to the acquisitions.

DTMT was acquired in 2014, Krauth in 2015 and Metric and Almex in end 2016.

Of these, DTMT has been turned around and was profitable in FY17.

In the past year, the share price of Dutech dropped… I dunno how many %.

Certainly a lot.

As of FY17Q4, the numbers still do not show a successful integration of their most recent acquisitions: sister companies Metric UK and Almex.

Anyway, here are my notes from the AGM. For the sake of brevity, I’d cut to the chase and just put everything down in point form.

  • Turn around for their most recent acquisitions, Almex and Metric, is guided to be in 2018 or 2019.

Of course, I’d expect someone to ask about their M&A strategy. Dutech has very cleverly, bought out these businesses when they are failing and going into bankruptcy. Everyone wants to buy successful businesses, but nobody’s selling a successful business for cheap.

The key question when buying failing businesses for a song then, is…. “WHAT NEXT?”

I have full faith the integration is progressing nicely. Each piece of the business is complementary to the others.

Someone asked about the 7.9mil RMB impairment loss. Management’s answer is that the loss recorded is due to an impairment of Almex’s loss of a contract when they declared insolvency and Dutech bought them out. It is a valuation loss, not an actual operational loss. Management feels the impairment is reasonable and extraordinary.

  • “Long tail” decline in ATM business

Johnny candidly stated his view is that the traditional ATM business is in a long term secular decline, dropping a bit every year over a long period of time. When pressed, he mentioned perhaps a 10% drop every year for the next decade.

But this doesn’t mean that there’s no money to be made in this sector anymore. ATMs will likely move from the traditional money dispensing functions, into intelligent machines which can provide a variety of functions.

And this is a major reason for Dutech’s acquisitions. The acquisitions allow Dutech to move from being just involved in the assembly portion, into a player along the entire value chain, from planning to assembly to even the software management.

  • Still on the acquisitions….

Johnny indicated that the acquisitions are to buy the customer base of Metric and Almex, as well as their know-how and intellectual property, patents etc. It is not based on the companies’ assets. (I’d add my own DD at the end later, so more on this later)

  • Margins

Someone queried about Dutech’s declining margins. In FY17, Dutech’s margins for the High Security segment was affected by the drop in the USD vs SGD exchange, and the massive rise in steel prices. Dutech is trying to pass on some of these increased material costs to clients, but it takes some months for the variations in their contracts to materialize.

  • Administrative costs

Johnny pointed out that the spike in administrative costs is due to the acquisitions. The core business of Dutech, less the acquisitions, has no change and in fact, a drop in administrative costs.

Also, because the acquisitions were completed in FY16Q3, from a y-o-y perspective, the administrative costs seem to have spiked up because the costs of the acquisitions have had only 3months impact in FY16, but we see the full impact in FY17.

Management also guided that the administrative costs will not increase any further in FY18, and that they’re working on cutting it.

(My own DD says that they’ve cut jobs by 25% at Almex, and at the same time, reassigning personnel within the subsidiaries.)

“Of the original 400 employees, Almex still has 120 employees – another 170 jobs have been retained at the British sister company.”

Source:

http://www.haz.de/Nachrichten/Wirtschaft/Niedersachsen/Almex-will-als-Nachfolger-von-Hoeft-Wessel-wieder-ein-Start-up-sein

  • Dividends

This question gets asked every year. Really.

Why does Dutech NOT pay a year end dividend, but only pays 1 after Q1?

This is because Dutech’s funds are in China. After the year end closing of the books, and after auditors have gone through the accounts, they can then declare a dividend and move funds from China to SG to pay out. So it’s always just in time for an interim dividend after Q1, never after Q4. If the company is headquartered in SG and their funds are in SG, they’d be able to pay a year end dividend instead.

  • Cash buybacks, increase dividends

Seeing that the share price has declined substantially over the past 12 months, it’s inevitable that there’d be some disgruntled shareholders.

And there were.

1 shareholder pressed on (aggressively) about why the company doesn’t do share buybacks, giving data on it’s utilization of its cash holdings and the ROE to substantiate. Mr Graham Bell took the question, gave some background details on what the BOD deliberates about when considering capital requirements. Personally (his view, not the BOD’s), is that the company needs to hold sufficient capital when dealing with turning around companies. In this aspect, it’s better to be conservative.

The company is in a period of change, as the High Security business of manufacturing of safes is likely to be in a secular downtrend. The BOD has long identified that they need to move up the value chain, and hence, the timely acquisitions. All this would not be possible if they did not have adequate capital to capitalize on the bankruptcy of other companies.

There was a moment of awkwardness when Mr Bell took offence at a strong word the aggressive shareholder used to describe the board. Ah well, it’s all in a day’s work being on the BOD of a publicly listed company.

  • Someone asked a question comparing the business dynamics of the Business Solutions segment vs the High Security segment

Business Solutions has not much bigger competition, unlike in the High Security segment. Also, for smaller sized orders, their competitors are either too slow to respond, or are unable to handle sudden orders due to various limitations. Johnny gave an example based on the manpower requirements. Some companies are unable to handle sudden changes in volume, as they would have to suddenly ramp up manpower to meet the demand, but when the project is over, they’d suddenly be stuck with excessive manpower.

Dutech has its own manufacturing facilities in China and hence, more control over production. On top of that, they do hire several contract staff.

(Can’t rem if he actually said this or is it from my own deduction, but in my notes, I wrote that their European competitors have stricter labour laws that make it difficult to hire contract staff in deals that make sense for the company)

  • Large drop in margins in BS segment in Q4 of 2017

Quarterly, the margins in this segment range in the 20++ %. In Q4 of 2017, it dropped to 14% (or so), with the reason given as “a change in product mix”

Johnny clarified that some projects utilize middlemen. If they manage to go to the end clients directly and cut out the middlemen, the margins are higher. Longer term, they expect GPM of this segment to be 25-30% and NPM to be 8-12%, without the middlemen.

  • General discussion on the company’s prospects

Johnny gave some color on what they’re working on and his experience in the industry.

Dutech is no longer a hardware company, neither are they just a mere safe manufacturer. All the talk about the society going cashless is missing the whole point.

Every human transaction, even without the use of actual cash, requires recording. Dutech’s business is the business of recording these transactions.

Johnny described Almex and Metric’s products, such as the validating machines and the SmartQube machines (not a spelling error ok!)

Also, their clients require the software to analyze commuter patterns for eg, and Dutech is able to provide these services. Johnny reiterated that the acquisitions are done with the IP and knowhow in mind, and these have morphed the company into a player along the whole chain.

Alright. Those are my notes from the AGM. The important ones at least.

There are several other questions that I don’t bother to type out here, as I think they are not very useful, and in fact, some are a bit…. hmmm….. uninformed. Like for eg, 1 not-so-happy shareholder asked why can’t the company write off the entire goodwill in the acquired Almex, instead of just writing down 7.9mil RMB related to the loss of the contract. Johnny replied that the write down is dependent on accounting rules, and verified by their auditors. (But of course.)


Now for TTI’s enlightenment.

I’ve really heard many folks think of Dutech as an “S-chip”. It’s not difficult to see why ppl think of that. Superficially, they do look like an S-chip. No real operations in SG, no office even, with management hailing from China, and manufacturing operations in China too.

But if Dutech is an S-chip, then so is Capitaland.

To illustrate this, perhaps I’d have to give a history lesson of sorts.

Dutech’s most recent acquisitions: Metric and Almex, were bought at bankruptcy for a song. Prior to that, their predecessor is the famed Höft & Wessel, which is recognized as the leader in the field.

https://en.wikipedia.org/wiki/Hoeft_%26_Wessel_AG

Data on wikipedia is a bit outdated though, but u get the idea.

The business solutions segment of Dutech is where the focus is right now.

This table compiles the revenue and margins of the segments over the years:

738) Dutech margins.jpg

The trend is obvious.

High Security revenue will continue to trend down, with declining margins.

Business Solutions’ revenue grew in 2017, but mostly from the acquisitions.

739) Pie Chart Dutech.jpg

Going forward, it’s obvious that BS will increasingly form the core of the company’s business, specifically its operations in Europe.

Johnny wasn’t kidding when he said that BS has less real competition. The only real major competitor that Dutech faces in this segment is Scheidt & Bachmann.

https://www.scheidt-bachmann.de/en/

They’re the number 1 player in the ticketing and parking machines sector, followed closely by the integrated Dutech, in terms of market share.

Unfortunately, since they’re privately held, there’s no published financials for me to do a comparison. That’d be so nice. And in fact, I think if their financials are public, it’d immediately correct what I think is the mispricing of Dutech currently, since everyone can do a simple comparison of their financials.

The other smaller competitors include Parkeon Transportation, VIX technology and Ridango. None of which are listed. In fact, I can’t find any single player in this field that’s listed. (Anyone who knows, pls kindly let me know!)

So how large is the European market currently?

The Europe smart ticketing market revenue is estimated to be $1.74 billion in 2017 and is expected to reach $5.38 billion by 2023, growing at a CAGR of 20.69% during the forecast period 2017-2023.

In this growing market, the players are mostly still smaller, fragmented outfits, fighting for market share. By buying Almex, Dutech already has direct access to certain major clients that otherwise, would never consider Dutech.

For example, in end 2017, Dutech won a contract with the all important Deutsche Bahn (DB), to redesign DB’s software for all ticketing machines to make them more flexible in integrating with all future hardware modules:

740) Almex.jpg

(DB Vertrieb is a wholly owned subsidiary of DB)

This project has just begun, and is slated to last until the beginning of 2019.

But it’s just upgrading the software to provide more flexibility right? No mention of contract value too, doesn’t sound like a big project?

“The new DB machine platform will be used on all DB existing vending machines as well as on new video machines, which ALMEX GmbH will also supply to DB Vertrieb for a first project next year.”

https://www.lok-report.de/news/deutschland/industrie/item/1994-almex-auftrag-der-deutschen-bahn-im-rahmen-der-innovationspartnerschaft-neue-db-automatenplattform.html

Now, DB is a helluva important client. If Almex is winning contracts to supply new ticketing and validation machines, it’s certainly very good news, and they’re likely winning market share.

(Travellers who have used Europe’s train system will understand that in Europe, you can buy a ticket, but u need to validate it to prove that it’s being used during that certain time period. So every station has multiple validating machines along the platform)

In fact, Almex already has a long term working relationship with DB, and this relationship is set to deepen as DB continues to refresh their equipment, and ticketing solutions.

For example, currently, DB’s train attendants utilize hand held mobile devices for ticketing, and guess who supplies these devices for DB?

741) Mobile terminals.jpg

Hmmm look at the picture of the mobile ticketing device from DB.

Yup, that’s in Almex’s product catalog:

742) Almex product.jpg

Aside from ticketing and car parking solutions, both the hardware and software side, Dutech also supplies inventory management solutions, through skyeye.com,  for logistics companies. (Again, both the hardware and software)

I guess this would be self explanatory:


TTI’s Thoughts

Actually, currently, I don’t think Dutech currently has any real, indisputable economic moat so it isn’t a Buffett type of company. But I do think the business is currently completely misunderstood by the markets, and hence, completely mispriced.

Reading the above, does the business still sound like a “S-chip” to you? I kinda roll my eyes a little whenever I hear someone bring up “S-chip” concerns regarding Dutech.

I increased my stake recently at $0.25, and am continuing to add to my already substantial holdings.

Going forward, there’s still many exciting things happening in the industry. Dutech, like all other companies, obviously doesn’t reveal what their R&D is about right now, but my DD tells me that every company is gravitating towards what is known as “Be in Be out” technology. The future of transportation payments will involve commuters carrying a personalized device, linked to an account.

The vehicle is able to detect such devices, and when the commuter hops on and off the vehicle, the device is detected and the appropriate fare is directly deducted. BIBO is what most research is geared towards, and is likely to be the future for the industry. It’s completely contactless, and in future, may  even be part of wearable tech.

This technology is still in its infancy though, with minimal real life testing done. Other concerns include privacy concerns, and problems with device detection when carried out on a massive scale.

When I was doing my DD, I can’t help but think that this BIBO mode of payment reminds me of NS guys doing their IPPT. You cross the sensor and it detects your device, and each time you cross the barrier, it goes “beep” again. Should be the same tech I guess.

Looks like SAF has far more advanced tech than all these MNCs combined…

Back to Dutech. I think FY18 will be very interesting. I’d be watching closely for the turnaround to be confirmed in cold hard figures. Right now, the share price is very depressed, but has risen in the past couple of weeks. (Partly due to accumulation by yours truly. Some days, I’m the sole guy accounting for the entire volume that day)

I think signs of a turnaround could come as early as 2 weeks from now, when the company releases FY18Q1 figures. I’m also expecting a slight tailwind with the recent strengthening of the USD, although that impact will only materialize is later quarters.

The company is also naturally very thinly traded, since there are only 20 shareholders/entities that hold >1million shares, and all these top 20 SHs collectively hold just over 90% of the company. Most of them are long term SHs, and this locks up the bulk of the company’s shares. I’ve never been afraid of illiquidity for my core positions anyway.

Currently, I hold (I can’t rem offhand exactly how much tbh) around 740,000 shares or so and would be happy to continue accumulating at the right price.

Alright, that’s all I have, or at least, that’s all I’m willing to write right now.

Peace out.