Whenever I get a bit too interested in macro economics I see it as a signal that I need reduce my commodity exposure. I wrote short write-ups on CLF (steel), PXD (mostly oil) and TOU (mostly gas) in the past month or so. And was long all three. I still like them, but not enough to hold on to them.
The problem is that I am also still long USDP, MTR (probably cheapest and most overlooked nat gas play), ECTM and FLMN as well. And I was almost 1/3 in commodities. Those commodity stocks are less levered to commodity prices, either because they are cheap trusts or because they are infrastructure with longer term contracts.
Additionally I am up nearly 70% so far for the year. This is not supposed to affect my decision making, but it kind of does. Then I still hold a large position (>10%) in $SBSAA that I refuse to sell. And $SBSAA has quite a lot of debt (although I think very bright prospects in the short and medium term and an insanely cheap valuation). But still, a lot of debt.
So this got me to do some digging into Evergrande and the Chinese real estate situation. And I think the amount of home building is probably unsustainable. A big emphasis on ‘probably’ in the short term though (source):
As can be seen from the above chart, about 220m homes have been built in past 2 decades. And total RE developer inventory doesn’t look that crazy.
With about 500m households in China and going from a 40% to a 60% urbanization rate, that figure is not all that unreasonable. Most Chinese housing was built in a period when GDP was only a tiny fraction of what it is now. Probably inflating total housing stock numbers. These homes often have shared bathrooms and kitchens and are probably close to worthless.
Normalized housing starts is probably about 5m a year (if it is similar as in the US). So current number is clearly very inflated. But if another 100m decrepit old homes are to be replaced in the coming decade though, that figure can easily stay inflated for a while longer. Or it will normalize very soon. And if it goes down too fast because the CCP loses control over the situation, it can get very ugly. And commodities are first in the firing line, and Evergrande could possibly be a catalyst here? Especially since local government revenue (and debt servicing) is so dependent on land sales.
Often insane Chinese home prices are quoted in the media, but they usually only include the big 4 tier 1 cities. Which are only 15% of GDP and 5% of China’s population. Home prices in tier 2 and 3 cities are much more reasonable. A 100 sqm (1000 sqft) apartment costing about $150k.
China also has a lot more room to grow out of the curren situation with a GDP per capita that is 30% of OEC average, vs Japan and Spain that had GDP pc that were roughly equal or greater to OECD average when their bubbles popped.
So yeah it can go a lot of ways, and the situation is probably a lot more complex than charlatans like Kyle Bass would have you believe. But still it is a situation that is hard to dismiss, precisely because of its complexity and opacity. So if I can choose between being in a commodity related stock with 100% upside, or in a stock with >50% net cash and 100%+ upside that is far less correlated to this stuff, it is an easy choice.
So I dumped CLF, TOU and PXD last week. About breaking even (sold just too soon).
And bought a large position in Currency Exchange (CURN and CXI) written up here and here by others. They have a very profitable legacy currency exchange business that has been hit hard by Covid. But also a very fast growing software business. Which I had not truly appreciated until I noticed how good their latest Q results were last week.
The company is required to hold a lot of currency, so net cash is $42m on a $71m market cap. Potential is to return to 2019 levels, with about $2m less costs, and 20% more market share as competitors have left the market. So $6-7m of net income is not unreasonable when everything normalizes. While there is room for taking more market share. And competition seems to be very limited here.
But also a very fast growing software payments business for banks. This grew 33% QoQ and almost 200% YoY. And currently has over $8m of annualized revenue. Market share here is supposedly still tiny (probably <2-3%). While being very sticky with a few large competitors. Of course this stickiness cuts both ways, but smaller banks are looking to switch to CURN because their current provider is another bank, so a competitor. And CURN’s software has some features that competitors don’t have.
Management has indicated this business can have a lot higher margins than their legacy currency exchange business (15-20% EBIT margins). So if growth keeps up, payments could easily justify current value of the company 1-2 years out. This is also mostly import/export related, so far less exposure to Covid/travel.
FCF per share could very well reach $2-3 per share if payments keeps delivering. Or it simply returns to depressed 2019 levels. And keep in mind this stock traded at 20-30x earnings regularly before Covid. And before payments business was of a significant size. With >50% of the market cap in net cash (although most of that is working capital) your downside is nicely protected here as well.
And despite all this, stock is still not far of its 2020 lows!