The Biggest Investment Potential: BGEO & HSBK

What is your background? 

Hi there! Stoked to participate in this interview.  

I am a South African in my early thirties based in Cape Town. I am an accountant by training with a wide array of professional experience across multiple fields in global finance at various levels of seniority. My career began in audit and financial reporting followed by stints in corporate finance advisory and private equity. Today, I am an equity research analyst. 

Your Twitter nickname is “Deep Value Situations”. Can you define what you mean by "deep value situations"?

I started my anonymous Twitter account in early 2021 predominantly to serve as a public investment idea sharing diary. Twitter is ideal for this purpose as the character-limit forces one to get down to the nitty-gritty of an investment thesis. The platform is incredibly useful in subjecting your most-loved ideas to public scrutiny. For the time-being, I’ve decided to keep my anonymity and hide behind the avatar of legendary investor, Walter Schloss.

“Deep value” is a colloquial term in investment circles void of consensus on a uniformly accepted definition.

When I think of “value”, I think of “asymmetry”. I want my bread buttered on both sides. I want to achieve a handsome investment return and at the same time, I don’t want to lose (much). The higher the probability of outsized returns, and inversely the lower the probability of permanent capital losses, the more “value” is potentially embedded in a particular investment situation. The magnitude of potential investment upside (and, at the same time, the level of downside protection) is highly dependent on the “price” of the assessed security.

The following quote from Walter Schloss, in essence my investment mantra, brings it home: “Price is the most important factor to use in relation to value” – it underpins my entire philosophy, approach, process and investment style.

“Value” is however anything but an objective concept. An assessment of a security’s “value” is often unduly and unjustifiably influenced by contemporary sentiment as reflected in temporary share price gyrations. From reported earnings disappointments, unexpected adverse macro events to regulatory and legal matters, various issues could have a negative impact on the prevailing share price. To me, this is where the idea of “deep” comes in – identifying, contextualising, analysing and assessing the countless factors, matters and events that impact “price” in an attempt to ultimately determine the impact (if any) on the underlying franchise value.

“Value” is not always immediately apparent – you have to look “deep(er)”. 

How do you identify potential deep value investments?

I follow both a bottom-up and top-down approach.

From a bottom-up perspective, I have devised a sophisticated quantitative screening model covering all globally listed equities. The model extracts and sorts specific historical accounting and financial data points (tailored depending on sector and industry) for each company. I then meticulously go through each datapoint for each company – line by line – literally from the bottom up. I don’t use filtering criteria as the risk of unintentionally or arbitrarily “filtering out” a potential investment opportunity is just too high. Each company is idiosyncratically different and requires an independent “human” assessment or analysis. Furthermore, I arrange the data points in such a way that it is quick and easy to identify companies that are immediate “NOs” – this applies to roughly 95% of the total investable universe.

From a top-down idea generation standpoint, I regularly analyse various macro-economic and trade data sources to identify sectors, industries and countries that are currently experiencing hardship and are in the doldrums in terms of sentiment. “Crisis investing”, although ostensibly counter-intuitive, can be exceptionally rewarding often offering opportunities to buy quality assets at rock-bottom prices. I’m always on the lookout for any scenarios of “stress’’ and “panic” which almost invariably lead to forced, irrational and nihilistic selling. If one accepts that the broader market is rational and efficient most of the time, your best bet is to stack your chips during rare spurts of temporary insanity.

Google-alerts, certain financial news publications and newsletters are excellent sources for scouting “event-driven” and “special situation” opportunities. Announced/anticipated asset sales and value unlocks (especially in the small and microcap space) are specific areas I focus on.

Finally, Twitter (“Fintwit”) is an invaluable treasure trove for investment idea generation. There are many talented and smart individuals graciously sharing incredible investment ideas on a daily basis. 

What is your approach to risk management in your portfolio of deep value investments?

My approach to “portfolio” risk management is more philosophical than quantitative. In my mind, the “quantitative’’ risk management work should be done at the individual investment level. It goes back again to the concept of “asymmetry” – I require substantial downside protection. A useful risk management by-product of having an unencumbered investable universe in addition to a highly selective risk/return hurdle rate, is that diversification in terms of sector, industry and geography sorts itself out. 

Can you share some examples of successful deep value investments you have made in the past?

My most profitable investment to date is Thungela Resources (JSE:TGA / LON:TGA), a South African thermal coal producer that used to be part of the Anglo American Plc mining group. The set-up in mid-2021 was the perfect recipe for a multi-bagger return:

Spin-off of an ESG pariah asset resulting in indiscriminate institutional forced selling

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Inflection point in the seaborne thermal coal capital cycle

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Global supply constraints due to weather issues (Indonesia), hard-lockdowns in Asia (Mongolia) and a geopolitical war (Russia)

=

Enormous cashflow generation and special dividends bagging a 12x return in less than 18 months.

(Strike.Market TGA Profit Margin, Debt To Assets, Cash Flow Data)

I’ve since exited the position given the major logistical issues the company currently faces and the normalisation of both the global coal capital cycle and seaborne thermal coal prices. Cyclical “plays” are not ideal buy-and-hold situations.

Another highly successful trade was a South African IT holding company nano-cap called Etion Limited (JSE:ETO). The situation was a classic activist value-unlock play via assets disposals with the proceeds earmarked for lucrative shareholder distributions. Due to its tiny size, trading liquidity constraints and lack of analyst coverage, the share price was structurally depressed. As a result of perennial earnings underperformance and the intangible nature of the company’s assets (that were either fully amortised or impaired), the IFRS compliant financial statements were not very useful in elucidating the company’s value unlock potential. Furthermore, regulatory approval requirements added an extra layer of uncertainty.

However, investors who paid close attention, did the work and placed their bets in late 2020 (when prices bottomed), were handsomely rewarded by pocketing a 12x return in less than 2 years. I was slightly late to the party but still walked away with a 5x return within an 18-month timeframe. 

What are some of the key metrics you use to evaluate the performance of your deep value investments?

Whenever I assess a potential investment opportunity, I spend a lot of time on identifying, quantifying and monitoring the COMPOSITION of expected return. In other words, how will the estimated or expected return potential (if any) be realised.

The composition of return comprises of: earnings growth / return on incremental invested capital + multiple expansion / contraction + shareholder distribution yield (dividends and share buybacks) + real options (e.g. unlock of underutilised / idle assets, unencumbered net cash etc.). For emerging and frontier market investments, foreign exchange gains/losses are also material components to consider.

The sweet spot, and my ideal entry point, is where each component is geared to the upside from an absolute and relative perspective.

How do you handle market volatility and sudden drops in the value of your deep value investments?

As a deep value investor, volatility is your friend. Volatility presents buying opportunities and is often (not always) indicative of market participants buying and selling for non-value oriented reasons.

Furthermore, being “early” is an occupational hazard – ask any true value investor. The price can always go lower once you enter a position. It is thus wise to “smooth into” a position over time.

Having a fair amount of cash on the side, to opportunistically benefit from market volatility and/or to average down into an existing position, is a trite yet underrated portfolio management “tool”.

Can you tell me about the performance of your portfolio over the past year or other specified time period?

2022 was a solid year for my little portfolio and I managed to generate a return just shy of 50% for the year.

The portfolio was off to a flying start in the first two months of this year, but a material portion of initial gains were “given back” in March. Year-to-date I am basically flat. I am however cautiously optimistic about my prospects for the remainder of the year.

What is your portfolio allocation among different stocks or sectors?

My bottom-up and top-down idea generation process will usually guide me towards the “hairy” and hated contemporary corners of the market. I am completely agnostic when it comes to industry, sector and geography. I look for value wherever it can be found.

My current portfolio has a substantial allocation to the following current “deep value” themes:

• Central Asian banks
• European Automotives
• US Discretionary Retail

 My research efforts are currently focussed on the following themes:

• Hong Kong, especially companies in the construction, materials and household durables periphery.
• Emerging and Frontier Markets in financial and/or political distress (Pakistan, Sri Lanka, Ghana, Nigeria, Egypt, Chile).

Which stock in your portfolio do you believe has the best investment potential?

Bank of Georgia Group Plc (LON:BGEO) and JSC Halyk Bank (LON:HSBK) are two Central Asian banking champions respectively operating out of Georgia and Kazakhstan. As ex-Soviet countries in close geographical proximity to Russia and Ukraine, both stocks took a serious tumble shortly after the start of the Russian invasion in early 2022, which in turn presented excellent buying opportunities. Over the course of the past year, despite significant price recovery since the start of the conflict (predominantly on the back of record annual earnings and material foreign exchange appreciation) both banks are still trading at low single digit forward earnings multiples and offer mid-to-high teen dividend yields.

The investment setup is uncannily similar as both banks have:

• Top class management teams at the helm;
• Dominant competitive footholds in their respective operating territories generating very high returns on equity in spite of conservative capitalisation levels.
• Excellent platforms to benefit from regional structural and macro growth tailwinds.

In addition to idiosyncratic political frictions affecting both countries, the spillover risk of the Russia/Ukraine conflict which could significantly impair the investment case of both situations, is not immaterial. It is however my view that the negative externalities have been too heavily discounted into the respective prevailing share prices and fail to make allowance for material upside should the current status quo be maintained.

(Strike.Market BGEO Profit Margin Data)

Kohl’s Corporation (NYSE:KSS) and Qurate Retail, Inc. – Preferred Stock (NASDAQ:QRTEP) are my two big “US Discretionary Retail” bets. Both situations are effectively priced for bankruptcy and have both simultaneously been villains and victims of severe global supply chain challenges, inventory management and procurement headaches and internal logistical own-goals. These issues have resulted in severe inventory gluts leading to extended and expansive discount selling (which in turn, destroyed margins) all the while US consumers are tightening their belts in the midst of an imminent economic recession. It goes without saying that recent earnings results have been more than a little disappointing. However, considered from many angles, it is my view that the market has over-extrapolated recent earnings results implying a significant deterioration in the respective underlying franchise values. I remain unconvinced. By acquiring and rebalancing my respective positions at all-time low price levels, representing a significant discount to my assessments of intrinsic value, I believe that the probability and magnitude of investment upside are asymmetrical relative to the underlying downside.

NB: This is not investment advice and readers are advised to conduct their own research. 

(Strike.Market KSS Insider Trading Data)

​​You mentioned in your tweet that Pakistan is the most undervalued market in the world. Can you elaborate on the specific challenges faced by Pakistan's market, such as commodity prices, devaluation, debt rescheduling, and political crisis?

Pakistan finds itself in a perfect storm of substantial fiscal, monetary and political challenges. In an attempt to manage a balance of payments crisis, the country is anxiously awaiting the IMF’s approval for yet another funding programme. The country has already complied with the IMF’s stringent conditions ranging from aggressive monetary tightening to increases in tax rates, relaxing import restrictions and implementing energy tariff hikes. The IMF is apparently stalling as it seeks bilateral assistance assurances from Saudi Arabia and the UAE.

Last week, Pakistan’s central bank raised its policy rate by 100bps to 21% - the highest level since official record keeping began three decades ago. Inflation rose to 35.4% in March, the highest level in over five decades, and is expected to remain high in the near term.

On the political front, Imran Khan’s PTI opposition party is pushing for early elections while the current coalition government continues to press for corruption charges against Khan. Experts note that a truce between the government and the opposition party and more clarity on the timing of national elections are critical in quelling a brewing political meltdown.

With all that said, the stock market in Pakistan is trading at a multi-decade low valuation of 3x forward-earnings. The market valuation preempts and already discounts a severe and sustained crisis. Therein lies the opportunity. 

Have you ever invested in a stock on the Pakistan Stock Exchange? If yes, then which company? 

Not yet. I am waiting for a macro inflection point as I expect the issues to get worse before it gets better. 

How have these challenges affected investor sentiment towards Pakistan's market?

As is implied by current market valuation levels, investor sentiment locally and abroad are at multi-decade lows. 

How should investors approach investing in Pakistan's market, given the current challenges and uncertainties?

In a nutshell, I would advise investors to thoroughly do their homework in assessing both macro and company-level risks. The focus should be on quality businesses with shareholder-friendly management teams. Also, proper position-sizing and adequate diversification practices are equally important.  

Are there any specific sectors or industries in Pakistan's market that you believe are particularly attractive or vulnerable at this time?

Based on my analysis, I see incredibly attractive opportunities in the banking and energy sectors.