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Tuesday, June 3, 2008

PARKSON & A Position Size Idea in face of Uncertainty

This article is dedicated to “dorraidd” who discussed Parkson passionately with me in my chatbox today, and kindly urged me to cut loss. I thank you for your kind advice. The article is also dedicated to all readers who wishes to explore alternative, non-standard position sizing idea. A disclaimer: I don’t necessarily practiced it exactly this way, although I do own Parkson at the time of writing.

PARKSON (5657.KL) is a stock that is popular in my chatbox, especially amongst the “investors” such as “bullbear” and “cycle” whom some would say are “die-hard” fans of Parkson stock. Dali (chatter, blog owner of Malaysia Finance blog) also likes it from a business perspective in the past, although lately he has been rather quiet about this stock. Of course, a local fund manager has also touted this stock in the Star recently and in his advisory services for a rather long time. (http://biz.thestar.com.my/news/story.asp?file=/2008/5/29/business/21384745&sec=business) As for me, from time to time, when I have vested interest (such as now), I will write about the stock too (smile). So, do be aware the vested interests involved when you read the cbox, newspapers, analyst reports, etc.

Having said this, the reason why Parkson is highly favored as a business is quite easy to imagine. Think past spectacular growth results and exciting future prospects from the huge China retail population. Think China economic miracle, rapidly and continuously growing and unstoppable rich and middle class with greater and greater purchasing power over time, proven business model in China and scalability to other areas, think untapped demographics and the huge 1.3 billion population, non-saturation even over the next 10 to 20 years in future, etc. There are many, many better and more skillful writers who can paint a better picture about the future prospects of Parkson’s business, as well as its phenomenal past growth.

However, the truth is deep inside me, I am not 100% convinced with such stories. Why? Because Parkson trades at a high P/E and its price action volatile. I immediately think of Green Packet and Top Glove, both of which were previously high growth stocks and now got punished hugely when they don’t deliver the earnings growth. Green Packet more than Top Glove.

But I must also say, that unlike Green Packet and Top Glove, Parkson does have the unique China appeal, making its growth story more robust. (I think you can see how torn apart I am). The dilemma is China growth – if Parkson can no longer grow its earnings from such a huge market potential like China, then which company can? Of course, Parkson also has operations in Vietnam and Malaysia, although we know the earnings contribution from these 2 countries are small, and the vast majority (nearly 90%) is from Greater China alone. As a trader cum investor, the question is how to take advantage of current low price (Reference : $5.6). Is this low price an opportunity? Or is it a bear trap? Or is the low price going to become high price in future?

In this situation, I personally find it useful to look at the situation from as many perspectives as possible.

The first perspective I would start with is that of a chartist trader. He would look at this chart here:

And he would probably say “UGLY” – don’t touch it. Why?

Well, if one is a trend following trader (trend following traders typically want a go signal from either trend following indicators such as MACD, Moving Averages, or a bullish looking chart pattern), then, Parkson does not fit the criteria. MACD is still moving downwards. EMAs across many durations are pointing downwards, even a downtrend is visible since the peak on 2 Jan 2008. So, trend-following traders would probably wait for the downtrend trend to reverse itself first, before thinking of jumping in. These include break-out traders as well.

What about the “oscillator-type” traders who buys low and sell high within a channel? Well, in such a situation, the stochastics would clearly show “over-sold” conditions across a wide range of parameter, and such suggests possible “Buy”, although experienced stochastics traders know that in a prolonged downtrend, they can indicate “over-sold” for quite a long time. And trading a channel that is declining is not exactly high probability stuff. So, prudent oscillator-type traders would also probably wait for a little while first.

Even traders using candlesticks would also not consider touching Parkson, as there is simply no “reversal” signal yet.

In short, I would think 90% of the professional traders probably won’t touch Parkson at end of today, at 4.59 PM.

However, as usual, when the price of what is perceived as a wonderful business comes down, another group of investors starts to salivate and get excited. These are the true investors, who wants to buy when the price is low and when they think it is a bargain. The question is is it a bargain at $5.6?

There are many types of investors, but probably the largest group of investors are those who likes the Sum of Parts of Parkson. As you know, Parkson operates in 3 countries – HK, Vietnam, Malaysia, and the proponents usually – for simplicity – put a zero value for Vietnam and Malaysia operations for convenience, even though both operations are profitable. The reason is because the earnings contribution is small. Whereas for Parkson HK, it is listed in HK Stock Exchange, it’s a fairly liquid stock, and so, the market value of the stock is easily referenced. In fact, Parkson owns approximately 53.5% of Parkson HK, and so, at closing price of HKD61.5, and using an exchange rate of 1 RM = HKD2.45, yields a Market Value of approximately RM7.5 Billion. When divided by 1.04 Billion shares outstanding currently, this gives a Market Price of say RM7.2.

Now, this is not the only way to put a value for Parkson, since even amongst the Sum of Parts practitioner, there are a huge variation of practitioners. E.g. some would argue that since Parkson also have approximately RM500 M Redeemable Convertible Secured Loan Stock (or RCSLS) of which RM195M has been converted leaving RM305M left, which represents approximately 76M additional Parkson shares, the price should not be divided by 1.04 Billion but 1.11 Billion. This gives a price of say RM6.7. But I think this does not give credit to the improved Balance Sheet after such conversions, not to mention that when such loans are converted to stocks, there is no longer any interest payments which represents savings. So, I would still put more weight on RM7.2 figure than RM 6.7 figure. Perhaps there is a spectrum there.

But more importantly, the Sum of Parts valuation assumes that HKD61.5 is a true and fair value for Parkson’s business. Investors are generally longer-term and patient people, and the fluctuation, current market value is not often a benchmark that determines the value. Herein lies a paradox, in that Sum of Parts valuation uses Market Value, but they don’t want to use Current Market Value! One variation wants to use Target Price for Parkson HK, which again, varies by analysts but generally speaking, far above HKD61.5. Parkson HK price peak was HKD91.5, and today’s price is quite a big fall from its peak on 11 Dec 2007. Knowing how analysts operates, I wouldn’t be surprised if back in Dec 2007, their TP is higher and possibly close to HKD100, but after the huge recent fall, expect them to downgrade the TP lower but still higher than HKD61.5.

And then, there is the “fusion” valuers who combines both TA and FA to get an idea of the fair value of Parkson. But these guys are probably rarer (since the discipline is to differentiate TA vs FA in valuation, i.e. valuation typically do not incorporate TA price targets in their valuation) and doesn’t appear to influence large institutional funds based on past analysts reports that I’ve read.

Looking from the perspective of the institutional holders, again, most of the stories sold are based on valuation and its future prospects. TA is not ignored, but not used alone for long-term position type holdings. It is interesting that the most recent reference is a “left hand” selling to “right hand” at market price is around HKD67.45 transacted at end May 2008. Prior to that on 9 Jan 2008, they were able to place a block of 8 million Parkson HK shares out at HKD78.66, a considerably higher price than HKD67.45, but close to market prices then. The gap between HKD61.5 vs HKD67.45 and vs HKD78.66 is quite large, ranging from 9% to 22%. So, current market price HKD61.5 seems low, although market prices are still market prices. And because Parkson holds Parkson HK, the market likes to apply a 20% discount factor, although in the original reasoning to split Parkson business from LIONDIV, it is argued that such an exercise should “unlock” this discount factor. Still market forgets, and revert to applying the 20% discount factor, and then, change their minds and spikes up each time Parkson disposes its HK shares at market prices. Such is the fickle and nature of market prices.
In short, there is a wide variety of investors, but the general consensus amongst this group is that Parkson is looking cheaper as the price falls. Nothing surprising there.

So, for someone like me who sees both sides, it’s quite a difficult decision. Buy or don’t buy? And how much?

I think the decision is very much individual and depends on one’s investment objectives too. Also, the current political uncertainty, the after effects of Vietnam stockmarket/economic/currency collapse, the present unresolved US uncertainties, etc. means that whatever the decision is, it is vitally important to make sure that if one buys Parkson, then, the total risk of loss should be small when one cut loss.

In other words, what I’m thinking is is there a way to combine both FA and TA in deciding the position sizing?

Let me explain more.

Currently, one of the attractions of Parkson is that maybe, the Parkson HK price is supported at say HKD50, which is a strong horizontal support. There is another higher support at HKD59. If price is an indicator of companies health and smart monies understanding of company’s health, then, one could say that Parkson’s business may still be healthy if the price does not fall below HKD59 or below HKD50. In other words, one possible strategy is to cut loss when Parkson HK price falls below HKD50 say.

In other words, when Parkson HK price is “healthy”, then, any local Parkson price dips is seen as opportunity to accumulate but when Parkson HK price crashes, one cut loss.

Let say the risk of loss when this happen is preset to 2% capital. Let say for simplicity, capital is $1 million. In other words, in the worst case scenario, you cut loss and the maximum loss is $20,000.

The question now is at what price should one enter, and how much?

Now, at HKD 50, Parkson is equivalent to $5.88. So, the current price appears to be a bargain in this respect. So, can we design a buy in schedule so that at progressively lower price than $5.88, we would buy increasing amount, but below the stop loss price, we would sell out completely so that the total loss is only $20,000?

On the local charts we see Parkson have a support of $5. The 22 day moving average of the True Range for Parkson is around 27 sen. Let’s set the stop loss at say $4.7. Let’s assume for simplicity commissions is 0.5% per trade. Let’s say we want to progressively buy in more as the price falls, in 10 sen steps, from $6 to $4.8. And at $4.7, we will cut our loss and sell out and lose $20,000. The question then is how much to buy at each price? Let say at each price we risk $20,000 / 13 = $1,538. 13 because we note that there are 13 possible buy ins, from 6, 5.9, 5.8, 5.7, 5.6, … all the way to 4.8.

So, how much to buy in? Here is the full schedule:

Do try to study this schedule carefully since it's the heart of this article. This schedule needs interpretation. What it says is that at each price from $6 to $5.7, you buy 1,000 Parkson shares only. At $5.6 down to $5.3, you buy 2,000 shares. And at price 5.2 and 5.1, buy $3,000 shares. At $5, buy another 4000 shares. At 4.9, buy 6000 shares. At 4.8 buy 10,000 shares.

In other words, you scale your entry in. Buying much larger amounts as prices fall.

There are advantages and disadvantages with this approach. Start with advantages first.

1. As price falls, you buy more and at an increasing rate as price gets lower without exhausting capital.
- In fact, at 4.8, the buy is 10,000 shares, much larger than all previous buys.
- If local Parkson price falls to $4.8, then, you should own 38,000 shares in total at a cost of $196,277, or 19.6% capital.
- The average price paid is $5.17 after commissions, which is near the low. (do appreciate this difference, since the average price between 4.8 and 6 is 5.4, which is higher than 5.17)
- And if Parkson price recovers to $6, then, the gain is 16%, or $31.7k, or 3.2% capital.

2. Chances are (no guarantees) - you shouldn’t need to execute your stop loss at $4.7 if Parkson HK remains above HKD50. Of course, do use a different figure and recalculate all this so that syndicates to run your stop. Consider setting the stop higher, so that if they do run it down to $4.7, then, you can buy it back cheaper. Or alternatively, set the stop lower than $4.7 so that they won’t think of running the price down to $4. Basically keep them guessing.

3. Even if you need to execute your stop at $4.7, you have preset the maximum loss to $20k. In fact, it turns out that it is $18.6k, or just 1.86% capital.

4. The Reward to Risk potential is good – a respectable 1.7 times and this is already net of commissions. If the loss is not executed, and price recovers, the trade is profitable, with low risk of loss.
5. The small buys starting from $6 is designed to keep your "itch" to buy in check. Basically, you don't buy big at high prices, but small at high prices, and it scratches the strong itch to buy.

Some disadvantages:

1. Hard to understand and apply in practice at first. But like any new skill, once it is learnt, it becomes easier, and one day, 2nd nature. For someone like dorraidd, I think the schedule should be fairly obvious to him in an instant glance.

2. Possible Inefficient use of capital. If the price doesn’t fall to $4.8, but stopped at say $5.2, then, you haven’t bought the full 38,000 shares (or 20% capital), and you end up sitting on a lot of cash.
- Think a little bit about this.
- Is this good or bad in face of uncertainty?
-In fact, if price drops to only say 5.2 (and not the full 4.7), you would only accumulate 15,000 shares at the cost of 83k, with an average price of 5.53. So, just using 8% capital, keeping 92% cash when price drops to $5.2. And not executing stop loss at all if price goes up after hitting a low of $5.2.

of course is not an exhaustive discussion about the pros and cons of the strategy, but it’s something for someone with sophistication like dorraidd to study and perhaps comment on.

Of course, the actual position sizing method I am using is different from the above. (smile) I can’t give away all my secrets right?

Happy Reading!
Disclaimer: As usual, buy/hold/sell at your own risk.

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