Earnings

FALLS CHURCH, Va.–The current earnings reporting season is critical in the sense that the numbers are always important. But also, in light of the current instability in the global economy, what’s reported now will have a significant impact on investor sentiment. Guidance for future operations is the primary factor I’m focusing on.

A number of Silk portfolio stocks have reported this week, and I summarize results below. I’ll conclude the bulk of my fourth quarter and 2007 earnings analyses next week.

My long-term thesis on the emergence of Asia remains intact. The stocks in the Silk portfolios are well positioned to capitalize on this transition. Continue to buy according to parameters detailed within the Fresh Money Buys, particularly during periods of weakness.

Invest some of your funds in the recommended hedges to help portfolio performance. There’s still time to enter the trades detailed in the Permanent Hedges section of the portfolio.

Long-Term Holdings

Keppel Corp (Singapore: KEP, OTC: KPELY) reported yearly numbers last week, its sixth consecutive year of record profitability. Revenue rose 37 percent with net profit reaching USD775 million. The company is involved in three main business areas: offshore and marine (76 percent of sales), property (15 percent), and infrastructure (7 percent).

Although all divisions showed strong profit growth, the all important offshore and marine division experienced lower margins due mainly to setbacks in its oil projects in Brazil, where the company is fulfilling rig building contracts for Petrobras.

The company has experienced higher costs because of Brazilian personnel productivity issues. The situation became quiet dire, forcing management to a USD57 million impairment writedown. Given the company’s long-term commitment in Brazil, this is an issue it has to address, and it’s done so by making sure that the new project contracts included clauses for currency movements and cost escalation.

Nevertheless, Keppel’s well-known operational sharpness has been questioned by many investors, but I view this as a one-off problem that management will try hard to avoid in the future. Rather, the short-term problem with Keppel is simply that it’s a cyclical stock that will be negatively affected if things get worse.

This is why Singapore was dropped down the list of Fresh Money Buys in the beginning of the year. However, it remains one of the best-run companies in the world and deserves its place in a well-diversified portfolio.

I do expect lower growth numbers as a global economic slowdown would affect its spectacular 30 percent growth rate of the past couple years. I also expect the company’s stockholder-friendly policies to continue with increasing regular dividend payments and special dividend payments such as Keppel’s special 40th anniversary dividend. Keppel Corp is a buy.

Singapore Telecom (OTC: SGAPY) again delivered solid quarterly numbers. Revenue grew by 11 percent, with Singapore, Indonesia, and India as the key contributors.

SingTel is an integrated telecommunications company that competes across all segments of the Singaporean market. It also owns 100 percent of Australian operator Optus, which competes in fixed and mobile markets. Its main investments in Asia are mobile operators, including Telkomsel in Indonesia (35 percent), Bharti in India (31 percent), AIS in Thailand (21 percent), Globe in the Philippines (45 percent),Pacific Telecom in Bangladesh (45 percent) and Warid Telecom in Pakistan (30 percent).

The company remains the key proxy to Asian wireless growth and its well-diversified earnings base makes it a holding for all seasons. With a combination of growth and solid visible cash flows Singapore Telecom remains a core holding of the Silk Portfolio.

Korea-based Shinhan Financial (NYSE: SHG) reported solid earnings and higher-than-expected profits. The company continues to improve operations and should perform even better in a lower interest rate environment given the company’s high exposure in credit cards. In addition, its loan book has been growing strongly at 18 percent; the big growth in sales of mutual funds and other financial services indicating that local investors continue to support the market were of special interest.

Shinhan remains my favorite stock in Korea and its strong market position in all the segments of the business (i.e., wealth management, brokerage, life insurance and consumer credit) is an added benefit. Buy Shinhan Financial.

Ericsson(Sweden: ERICB, NSDQ: ERIC) continues to be a disappointment. In the short term, the stock won’t reward us.

But the company is perfectly positioned to take advantage of one of the best long-term growth stories: wireless telecom. The beauty is that this growth story is applicable to both developed and developing economies.

Emerging markets in particular are important; such economies continue to build huge wireless networks, with China and India at the forefront. Ericsson is the world’s leading architect of mobile systems (the premium segment in telecommunications) and should be the big beneficiary. It’s only a matter of time before the company’s margins start improving because Ericsson has been adding new contracts in its portfolio projects.

Ericsson will have some challenging quarters ahead as it tries to improve performance and persuade investors that its long-term strategy is still on track. The stock will remain in the portfolio for now and is a long-term buy, always in the context of a diversified portfolio, and preferably following–in terms of importance–the advice offered in the Fresh Money Buys below. Buy Ericsson.

Mitsubishi Heavy Industries (Japan: 7011, OTC: MHVYF) reported nine-month numbers; profits were up 41 percent on contracts to build ships at higher prices.

The company is Japan’s biggest heavy-machinery maker with a diversified business base that also includes power plants, both nuclear and conventional. Japan relies on nuclear power for its electricity needs. Mitsubishi Heavy Industries is a leading builder of nuclear plants within Japan, and the company also builds plants outside Japan, including China.

Even more compelling, though, is the company’s aerospace and defense business. It manufactures the Patriot Advanced Capability 3 (PAC-3) missiles that are used to intercept and destroy incoming missiles. Orders have also been growing for terrestrial launch facilities of the missiles as well. PAC-3s are manufactured under license from Lockheed-Martin.

The company also builds airplanes, such as Japan’s F-2 fighters, and ships, including destroyers. Sales to Japan Self-Defense Forces amount to more than $2 billion annually.

On the commercial side, Mitsubishi Heavy Industries is planning to build a factory in Vietnam to make parts for commercial planes, setting up the country’s first aircraft-related production facility. The factory is expected to start production in 2009, assembling wing flaps for Boeing’s 737s.

The company also works closely with several foreign defense companies, including Lockheed. A change in Japan’s arms export laws allows Mitsubishi Heavy Industries to export missile nose cones and command and control systems to countries like the US.

It’s been steadily improving profitability, while working to lower costs and has shown good progress in both counts. Buy Mitsubishi Heavy Industries.

Alternative Holdings

Korea Electric Power (Korea: 015760, NYSE: KEP, Kepco) reported a loss for its final quarter of 2007. The company is troubled by costs, especially higher fuel costs. A turnaround play, Kepco will be able to perform well if the new pro-business government in South Korea goes ahead with a tariff system change.

Kepco is 51 percent owned by the government. It controls 100 percent of the national grid network and has 90 percent of wholly owned generation capacity (59.3 gigawatts). The company recently began investing overseas (mainly in China and the Philippines) and intends to invest another USD1 billion over the next 10 years.

One of the plans the government is considering is the changing tariff setting method to automatic pass-through fuel cost. Under such an arrangement the company’s level of returns are guaranteed and would allow the stock to trade at higher levels. The stock has a lot of upside, provided the changes come thorough. Korea Electric Power is a buy.

Bio-Treat Technologies (OTC: BOTRF) had a good second financial quarter with earnings up 49 percent. Importantly costs were down 21 percent but were helped from improvement across the board (e.g., transportation costs, administrative costs etc). The company has been quite successful in winning new water treatment projects in China. And given the growth in the water sector, I expect its growth to solidly continue.

Bio-Treat is one of China’s leading wastewater treatment companies. It specializes in the use of biotechnology to treat polluted water to a level whereby it can be released into the environment. A relatively young company, Bio-Treat was established in 1993 and was listed in Singapore in early 2004.

The company has a unique proprietary technology as a long-time operator in China and has built a strong track record. It’s concentrated in the wastewater treatment market, and because of its relative size, Bio-Treat doesn’t compete head-to-head with the big multinationals that control the biggest part of China’s water supply and water treatment market.

Bio-Treat concentrates on medium-scale projects and has been quite successful bidding on such, winning enough to build a strong order backlog. The company is working to improve existing technology and to create new ones in order to offer new products and gain access to new growth segments of the market.

This is a high-risk, high-return play on the water investment theme that I expect will evolve over the course of several years. Buy Bio-Treat Technologies.

The Short Trade

During the November market turmoil, I recommended shorting the Chinese insurers for extra protection. See Silk, 13 November 2007, Flash Alert: Hedging the Portfolios.

My US trading recommendation was to short China Life Insurance Co (NYSE: LFC). The profit was around 34 percent as of 6 February 2008. If you’ve shorted China Life Insurance Co, stay with the position and set your stop-loss at USD66. This is a hedging trade for a long-only portfolio, which is why the stop-loss is fairly loose.

Fresh Money Buys

The investment process is constant. So if you’d like to add to your positions in portfolio recommendations or allocate new funds in a diversified way, focus on the following markets, in order (for both countries and sectors). Consult the portfolios on the left-hand side of your screen for details.

  • Russia (energy, telecommunications)
  • Hong Kong (real estate, banking, infrastructure)
  • South Korea (banking, electric power)
  • Philippines (telecommunications, real estate)
  • India (pharmaceuticals)
  • China (consumer, telecommunications, coal, e-commerce, oil, water)
  • Singapore (banking, telecommunications, industrial)
  • Taiwan (telecommunications, ETF)
  • Malaysia (ETF)
  • Europe (industrials, communications equipment)
  • Japan (banking, industrials)

How Silk Works

The Silk Portfolio has been constructed around the view that domestic economic demand and investment are driving Asia’s economic ascent.

The Portfolio should be viewed as a whole rather than an assortment of stocks. It’s my hard-earned assumption that investors seldom follow such advice, so I also offer some direction in an effort to assist with the decision-making process in the Fresh Money Buys.

In this section, I rank countries and sectors so readers will have a guide at all times. The ranking changes often, so pay attention.

The ranking starts with the countries I prefer and then lists specific sectors you should look into. When I mention a sector, it’s assumed that the first pick will be from the Long-Term Holdings. Then, if more exposure is warranted, additional picks will be from the Alternative Holdings.

Of course, if a country isn’t represented in the Long-Term Holdings, refer to the Alternative Holdings for a selection (which is the case for Macau).

Portfolio recommendations should be taken at face value. For instance, if a stock is recommended as a buy and trades below the price indicated in the portfolios, the recommendation stands for newcomers as well as longer-term readers.

Occasionally, I recommend that long-term readers take profits off the table by booking any gains while letting the initial capital invested. The same is implied when a country or a sector is moved down in the Fresh Money Buys.

In other words, I expect investors to look at their profits (i.e., how much money they’ve made above the initial investment) and then calculate how many shares they needed to sell in order to take those profits off the table.

If you’re not a long-term reader, chances are you probably don’t have profits to take from the specific stock; you’re unaffected by the recommendation. The fact that I haven’t advised selling the stock outright indicates that it remains a good, long-term holding.

Silk has one main portfolio, the Long-Term Holdings, and an alternative, the Alternative Holdings-Permanent Hedges. Look first to the Long-Term Holdings for asset allocation in the markets covered here.

In the Alternative Holdings-Permanent Hedges Portfolio, readers can track permanent hedges and shorter-term recommendations. It also includes companies I’ve recommended for longer-term or more fundamental reasons, and they represent additional exposure to favored investment themes. For example, Lukoil (OTC: LUKOY) provides extra exposure to a favored theme: Russia and energy.

On the left-hand side of the Web site’s main page, under Portfolio Performance, you can get a snapshot of the Portfolio’s return compared to other major indexes.

On the Portfolio page, you can click on the asterisk next to each holding to review the original commentary and recommendation. I plan to enhance the portfolios with extra features and welcome comments and suggestions.

Many new readers have also asked, “What do we do when the market drops substantially?”

Since Silk’s inception, I’ve been skillful and lucky enough to have booked profits before precipitous falls, in which case I recommended sitting still through the turmoil. I’ll also get word to you via Flash Alert if events turn too quickly.

Silk is built around a set of core themes. I often revisit those themes or certain analyses through a link to a previous article or by reproducing relevant paragraphs. You can also read previous issues in the Archives to gain an understanding of the investment philosophy of the publication.

Or you can ignore my advice and try to find the next big hitter the Portfolio will produce. You may succeed, but be aware that I don’t play that game; “fast guns” are wasting their time with this publication, as well as Asia and the rest of the international markets as an asset class.