Apollo Investment Management

Turbulent times, but underlying growth has continued
Apollo Asia Fund: the manager's report for 1Q2003

The Apollo Asia Fund's NAV fell 0.4% in the first quarter, to US$176.45. Over the last twelve months, NAV is up by a short 11%; almost all of that was in the first two months and very little in the last ten. However, the outcome could have been worse: over twelve months, the regional index is down 27%. (Performance charts.)

Encouragingly, 'portfolio earnings-per-share' - which reflect not just business growth but also changes in the list of companies held by the fund - have over the last twelve months risen 24% (historic), and 33% (estimated current-year). Estimated 'portfolio dividends-per-share' have risen by 25%, and 'portfolio book value per share' has risen by 40%. These figures are substantially higher than those I reported three months ago, and are more in line with the historical averages. They outpace the organic growth of the stocks we currently hold, for which we are currently guessing at per-share earnings and dividend growth of the order of 14% in the current year. This is because we occasionally manage to sell relatively expensive stocks and find cheaper ones. Actually we sold nothing in the first quarter, apart from the forced realization of Bumi Armada, but we do have the benefit of reasonable cash dividends, as well as portfolio inflows, so are regularly rebalancing the portfolio. One should not place too much store on the portfolio per-share figures, as they can be significantly affected by the purchase of 'cheap' companies in particular (we have added to our low-multiple holdings in Indonesia, as well as in Thailand and Hong Kong, but also bought some more highly valued companies), and it would be foolish to manage according to these numbers. The historic rate of growth in these figures, as in the NAV, should be assumed to be unsustainable - but meanwhile it is, to repeat, encouraging, and may help to put in context the prevailing macro gloom.

The shares in our portfolio are on an average historic PE of 7.3, and an estimated 'current-year' PE of 6.4; inverting the latter, we have an earnings yield of 16% for the current year. We estimate the net dividend yield, after Asian taxes, to be 6.4% for the current year. We are as comfortable with the quality of the businesses and their managers as ever before, and although business conditions are certainly as tough as we have seen since the darkest days of the Asian crisis, these valuations are attractive.

(It is probably timely to emphasize again that we place at least as much importance on cashflow as on reported earnings, but find that the most relevant measures of cashflow vary from one business to another, and do not at present use standardized measures which lend themselves to calculating such aggregates. It might be interesting to try, but do not hold breath while waiting.)

The US continues to look like the world's greatest emerging market disaster, unfolding on a timescale commensurate with the length of the bull market. I fear the political consequences of the Iraq war, but see even least-bad outcomes as adding significantly to the stresses on the US economy and the global financial system. Most other currencies, and gold, seem better long-term stores of value than the US$. Marc Faber's latest Gloom, Boom & Doom Report is entitled 'Of War Cycles and their Economic Consequences' (and subtitled with Voltaire's description of history: 'a collection of the crimes, follies, and misfortunes of mankind'). We are in momentously interesting times (in the sense of the Chinese curse), and Marc's grasp of economic and financial history combined with a global network and perspective are therefore of great relevance. I agree with his warnings on the necessity of diversification, by financial institution and by country - and these have become all the more relevant in the fortnight since publication. True to bear market form, 'whatever can go wrong will go wrong', and the SARS virus has burst onto the stage with a roar. There has been some alarm, and expatriate flight, in Guangzhou since at least early February, but it was only the week before last that it started to hit the economies of Hong Kong and Singapore, and in the last week the impact has been severe. It is unnerving to comment in a quarterly report on a phenomenon which is changing so quickly, but my current best guess would be that the epidemic will be brought under control within weeks and that panic will soon begin to subside. However, aviation and tourism will be affected for a few months, affecting China, Vietnam and Thailand as well as Hong Kong and Singapore. As Stephen Roach has pointed out (Morgan Stanley Global Economic Forum, 4 April), this undermines the most dynamic economies in the world's one remaining growth area. I still regard Asia as a haven of resilience, but this at least dents the short term growth.

Crisis can of course create opportunity, and the chairman of Cafe de Coral, one of our larger holdings whose business is temporarily battered, has already been quoted as musing undiplomatically on the possibility of competitor bankruptcies. As school-of-Buffett investors, we might in an ideal world concentrate entirely on individual businesses and ignore the backdrop; in practice the great waves are too distracting (and we need to watch out for those which might sink the ship), but it is a useful principle.

A brief update on my grumble in the last quarterly that a Big-4 accounting firm had agreed a description of money-market fund holdings as 'cash equivalents'. Neither the company nor the auditors have apparently changed their view; meanwhile I found another company proud that its 'cash and bank balances' were earning a high single-digit return on its US$ (in contrast to current very low deposit rates), thanks to structured notes recommended to it by a major US bank. A director of one of our companies, operating in a modest office in a Hong Kong industrial area, told us that he now receives dozens of innovative financing proposals per week. There will always be companies which are street-wise and cynical, and others which are gullible (guess which we prefer), but that auditors should be so sloppy is a serious problem. Actual deployment of cash balances is now one of our standard questions.

Top ten holdings
  as at 31 Mar 2003
Aeon Credit (HK)
Bangkok Insurance
Cafe de Coral

Jusco HK

Ocean Glass
S&P Syndicate
Thai Stanley
Thoresen Thai
Geographical breakdown
  as at 31 Mar 2003
% of assets
Hong Kong-listed equities
Indonesian equities
Malaysian bonds
Singapore equities
Thai equities
Other equities
Net cash & (mostly) receivables

Thai stocks remain the largest group in our portfolio. We remain fairly comfortable with the economic and market backdrop there, and with the merits of the specific Thai businesses which we hold, but continue to be more interested in Hong Kong and China, and our weightings there are likely to rise. We are also finding some opportunities in Indonesia and Singapore.

Aeon Credit has moved up to our top ten, without any change in the holding; it replaces the privatized Bumi Armada. There are no changes in our other major holdings. We have added a few new names, as yet in small size. All are small companies, so the issues of portfolio scaleability remain and the fund remains open only by appointment (with a queue until end-May), but at least we are finding some new ideas with merits to match our existing holdings.

More ideas are always welcome, and my co-investors continue to provide them. I am most grateful to you all.

Claire Barnes, 6 Apr 2003

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