Apollo Investment Management

Price stagnation, sensational valuation
Apollo Asia Fund: the manager's report for 2Q2000

The NAV of the Apollo Asia Fund fell 6% in the second quarter, giving up all the gains of the first quarter. NAV was US$102.29 at the end of June 2000, after all deductions. (NAV history and charts here.)

Our companies did fine, and on balance presented us with more pleasant than negative surprises. Currency weakness eroded our returns as denominated in US$, but will not necessarily be recurrent (I'd be more nervous of the US$ than of our portfolio currencies), and the politics of Indonesia provided an unhelpful backdrop, but we suffered no specific disasters.

It occurs to me that this last clause is a very negative construction, and that it is perhaps worth commenting specfically on the psychology. Expensive and fashionable growth stocks are often priced for perfection; never mind disaster, they are vulnerable to any slight disappointment. It is often difficult to rationalise the values ascribed to these stocks except by reference to greater-fool theory: Unicom is said to be cheaper than China Mobile, and therefore A Buy, or vice versa. Unfashionable old-economy companies may now be found (if one is selective and prepared to be lonely) at bargain basement levels, where only disasters can derail rational hopes of good returns. Emerging-market investors are all too aware of the potential for disaster - a far cry from the oblivious complacency at the top of a bull market - but they can price in the possibilities and still conclude that the risk/reward ratio is favourable.

At present that risk/reward ratio seems extremely favourable for our portfolio, despite my ongoing concerns about US market and economic risk, by virtue of the following numbers.

With the NAV today at around US$102.23, the current-year PE of the portfolio is estimated at 6.8, and the PE one year out at 5.7. By "current year" for these purposes we mean the next full-year figures to be reported, and 45% of the "current-year portfolio earnings" are already in the bag, although we are estimating the contents of that bag, for years which have already finished (years ending March and June). On a time-weighted basis, our companies' profits are therefore adding to intrinsic value at a rate of about 16.3%, and this plus assumed growth, less the fund's costs and fees, would be a reasonable basis on which to guess at long-term returns. This 16.3% earnings yield (15% for the current year, 18% one year out) may also be appropriately compared with rates on bank deposit or non-equity investments to judge whether it offers an appropriate margin of safety. Our companies are currently paying out about 45% of their profits, so the dividend yield on the portfolio, net of all Asian taxes, is estimated at 6.6% for the current year, and 7.2% one year out.

At present, we estimate that the earnings per share of the present portfolio are growing at about 18% pa, but the sustainable rate would surely moderate over time; on the other hand, we have in the past been lucky enough to benefit from irrational exuberance, offloading some of our high-flyers to reinvest in more attractive options, and thus achieved higher growth in "portfolio EPS" than the intrinsic growth of a static portfolio. Of course, there is always a risk that your manager's efforts in this regard may backfire - and also, we have no intention of being caught in a trap of managing by numbers, and we may sometimes consider Company A on a PE of 20 to be much more attractive than Company B on a PE of 5. For what it is worth, over the last twelve months (actually 26 July 1999 to 6 July 2000, with apologies for the eccentric calculation dates), portfolio EPS grew by 45%, but the PE fell by 11%, so NAV (of the Apollo Asia Fund and its predecessor portfolio) grew by 29%.

Going forward, valuation multiples may expand or contract - an astoundingly unhelpful statement, but I wish to comment on both eventualities. The second quarter has been characterised by extraordinarily robust economic and trade figures, almost enough to evoke the former glory of the Miraculous Asian Tigers - but accompanied by general cynicism that this cannot last. A new wave of optimism about China seems unusually well founded. A growing number of commentators are postulating a soft landing in the US, rotation into markets and sectors offering relative value, returning Asian confidence, peace and prosperity. If so, our companies will probably do well and their share prices better, particularly since current valuations are in many cases comparable to those in the depths of the Asian crisis, and our investors will doubtless be happy. If, however, renewed turbulence should cause severe declines in market valuation, it is probable that intrinsic value of our portfolio will be much less affected; it may even be enhanced if, as in the last Asian crisis, competitors go to the wall and our very sound and well-managed companies thereby gain opportunities. In this case, the risk/reward ratio would become even more attractive than at present. Investors on the sidelines waiting for even greater bargains may however risk missing those presently on offer. Individuals must make up their own minds: the intrinsic value approach and the numbers above may assist in an independent appraisal.

Comments and questions are most welcome. Thanks to all of our investors who relay their ideas for consideration, and allow me to "bounce" my own half-baked ones - you are a wonderful research team.
Geographical breakdown % of  securities  
Hong Kong 42  
Indonesia 9  
Malaysia 20  
Singapore 6  
Thailand 14  
Other & net cash    9  
  Major equity holdings (>4%)
  Bumi Armada
  Cafe de Coral
  China Hong Kong Photo
  MBK Properties
  Singapore Bus
  Unilever Indonesia
Wiik & Hoeglund


Claire Barnes, 6 July 2000

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