Update No. 188 – 07/11/14

I wrote last week about the first of our recently completed sales. I will repeat the exercise & cover another stock we finished selling recently.

The sale represents the worst result of EGP to date. Fortunately it was one of our smallest positions and the overall effect was immaterial in terms of our overall results during the holding period (less than 0.1% annually trimmed from returns as a consequence of the position).

The stock in question is a tiny, illiquid clothing manufacturer called GLG Corp Ltd (GLE.ASX); it has a market capitalisation of about $18m at current prices. When we began purchasing the stock in late 2012, I had determined it had most of the characteristics I look for. There was a founding manager with a massive shareholding running the show, the stock was cheap on virtually any metric you looked at and having made recent trips to the US, I had determined their major customer, Macys was going to do very well over the coming years in comparison to the other US department store players.

In hindsight, I would have been better to buy Macys, which was trading at less than US$40 per share when I started buying GLE and was recently trading at around US$60, having paid a steady stream of dividends amounting to a few dollars (it would have been an even better result when you factor the declining AU$ over the period). The trouble is, despite being correct about how strongly Macys and the US retail market would recover, I failed in my analysis to account for the fact that most of the benefits would accrue to the retailer and the employees of the manufacturer (via rising wages). With crummy businesses, capturing improvements in the business cycle is sometimes difficult; GLE certainly didn’t catch a cyclical upswing the way I’d expected.

We held our GLE stock for an average period exceeding 2 years and sold for a price slightly below what we paid for it. The stock did not pay a dividend in the period, meaning a low single digit negative IRR. It was a mistake, but not an expensive one.

We began with a small parcel in 2012, in order to be eligible to attend the AGM and ask some questions of management. As the only shareholder who attended the 2012 AGM, I got the board to myself, and after the formal business was concluded, was able to talk at length with them about the business and the industry. It may have been my misinterpretation, but I came away from the meeting with the view that the recommencement of dividends was likely in the near future (this was 2 years ago). Another reason the stock was depressed pertained to a related party borrowing, dating back to the separation of two businesses when GLE listed. Some creative minds were sure fraud was the only possible explanation, I was relaxed about this, the repayment terms were clearly laid out and the amount has subsequently been repaid as per these terms.

Another strike for me is the remuneration of the CEO (and 73% shareholder) Estina Ang Suan Hong. Over the last 2 financial years, CEO remuneration of US$1.687m has compared to total NPAT of US$7.153m, this is a very high price for a single employee in a small business, there are companies 5 times the size with less well paid CEO’s. Over the same period, operating cashflow was negative to the tune of over US$10m, as all profits disappeared into working capital.

The most important thing when we make a mistake is to examine whether we would do the same thing again on the same information. For the most part, when I read through my initial analysis for GLE, I think the idea was conceptually correct, but I would not arrive at the buy decision today.

The primary reason is dividends. If you are going to hold a foreign domiciled, illiquid stock that trades in a difficult industry, you need some certainty about capital being returned to you. More importantly, you need certainty that management has the best interests of all shareholders at heart.

If the stock had a 30 – 50% payout ratio, about 2cps would have been returned annually over the last couple of years, meaning the CEO could have earned via dividends more than the impressive salary she awarded herself, while the minority holders felt they were being looked after (yield of about 8% on the average price of about 25c over the period).

There exists a reasonable prospect that if this business is managed for cashflow over the next few years that it will do very well, for over the last few years, all profits have disappeared into ‘receivables’. I pride myself on being a patient, long-term holder, but given the lack of shareholder friendly behaviour in this holding, and given it was such a tiny holding in any case, disposition seemed the percentage play, for we have a number of shareholder friendly homes for the funds that probably have better prospects – Tony Hansen 07/11/2014

EGP Fund No. 1 Pty Ltd. Up by 0.86%, trailing the benchmark by 3.75% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 71.82%, leading the benchmark by 36.79% all-time (April 1^st 2011).

^{*1 after 31May 2013 dividend of 2.333 cents per share plus 1.000 cent per share Franking Credit & 31 May 2014 Dividend of 7.000 cents per share plus 3.000 cent per share Franking Credit}

^{*2 calculated based on dividends reinvested}