Chow Sang Sang (0116.HK)

[Yoyo]

中国客赚钱大法　赴港买金转卖深圳 日赚数千
https://www.orientaldaily.com.my/news/bu.../21/598367

[karlmarx]

Looking at sales data from competitors like CTF, LF, and LFX, and also retail sales data from China and HK, it looks like the second half results of CSS could be similar to its first half.

Assuming that it does, and that CSS sales will continue to grow moderately in years to come, on the back of recovering tourism in HK and income growth in China, the stock can be considered to be selling at a tremendously low price.

[Choon]

Looking at sales data from competitors like CTF, LF, and LFX, and also retail sales data from China and HK, it looks like the second half results of CSS could be similar to its first half.

Assuming that it does, and that CSS sales will continue to grow moderately in years to come, on the back of recovering tourism in HK and income growth in China, the stock can be considered to be selling at a tremendously low price.

A quick check on Google,
- CSS PE is 7x
- CSS dividend yield is 4%

Are you referring to these levels of valuation when you regard CSS as being at a tremendously low price? 

Or are there other earnings / net cash adjustments to consider?

[bmann025]

Does not make sense, that these companies continue to hedge their gold inventory.
This produced significant losses over the past decade and did not really reduce the volatility of profits.

CSS's "Net loss on bullion loans designated as at fair value through profit or loss" was HKD 505 millions past year, approx. half of net profit.

[karlmarx]

Prices can go up and down, which is why hedging is done if one is worried that they may go in an undesirable direction.

Gold has been on a general uptrend for the past years, but this does not mean it cannot crash severely, suddenly, for whatever reason.

CSS hedges 40% of its inventory, so 60% is still exposed to gold price movements, which tells us they are generally bullish but still want to be somewhat prudent.

The unexpectedly poor results are partly from weaker diamond jewellery sales in China, which has declined 20% for the second year. This could be due to a general weak economy, lower marriages, or a change in attitude towards high-priced diamonds. It will be interesting to see how the natural diamond vs lab grown diamond competition will play out, and how that affects the rest of the diamond industry value chain. And whether CSS' investment in their LGD startup, TFR, will be profitable in a few years time.

The aggressive growth in store count, and migration to shopping malls, is also adding to depreciation, rents, salaries, and inventory financing cost. This is the downside to its owner-operator model, which is distinct from its competitors, all of whom operate a franchise model.

Based on latest results, PE is around 6, which is good but not great, as it is comparable to some other HK listed stocks.

[bmann025]

No, it is not like that.
This business is self regulating.
When gold prices go down ("in the wrong direction") demand picks up.
That's why Luk Fook had its best year in 2014 during a strong downturn in gold price.
When you look at the effect of the hedges in the past 10 years, they did not only destroy value, but also failed to achieve their supposed function which is to reduce profit volatility. They didn't, business self regulation did it all alone.
In the long run, alone due to inflation, hedging will continue to destroy profits, and with no benefits. Fees and borrowing interest for nothing comes on top.

[weijian]

No, it is not like that.
This business is self regulating.
When gold prices go down ("in the wrong direction") demand picks up.
That's why Luk Fook had its best year in 2014 during a strong downturn in gold price.
When you look at the effect of the hedges in the past 10 years, they did not only destroy value, but also failed to achieve their supposed function which is to reduce profit volatility. They didn't, business self regulation did it all alone.
In the long run, alone due to inflation, hedging will continue to destroy profits, and with no benefits. Fees and borrowing interest for nothing comes on top.

Hi bmann025,

I think it is more nuanced than that. If this is considered "self regulating", then most businesses that roughly adhere to a supply/demand curve are "self regulating". This is a market cycle rather than "self regulating". There are 2 reasons why it doesn't really work (at least most of the time):

(1) Rational economics say that when price goes down, demand goes up. Behavioral economics say that when price goes up, demand goes up. So what goes? Obviously both kind of economics are present at the same time. For example, those who buy for storer of value, probably buys when price goes up. Those who buy for consumption, probably buys when price goes down.

(2) Gold retailers buy gold at current spot prices, manufacture into pieces and then sell gold jewellery in the future (at future spot prices). So there is a duration mismatch here. Let's imagine it bought 1billion of gold inventory today, make all into pieces tomorrow and sell all the day after tomorrow. If gold prices dropped such that new inventory is only worth 700mil the day after tomorrow, they have to sell their jewellery at 30% discount to original intention --> This basically wipes out their markups and mfg costs. So a retailer will find themselves in a situation where the more it sells, the more it loses. Can it stop selling? As a retailer, of course it can't! This is obviously an extreme example I have here but this is a kind of risk that a businessman will want to avoid.

The bottom line is that hedging increases certainty and removes blow-up risk. It is probably more acceptable for most business operators to have a less profitable business than a chance to go out of business. This is why insurance and hedge are inventions that have stood the test of time.

There is probably 1 scenario that hedging may cause an issue, as demonstrated by SIA during Covid-19. SIA uses jet fuel, so it wants it to be as low as possible. It hedges by buying long contracts. So when price of jet fuel reduces, it loses from its long contracts but make more money from lower COGS. During covid-19, crude oil crashed and so it lost in hedges. Unfortunately due to closed borders, it was not able to make back the losses via operations.

So to apply the same to gold retailers like CSS, hedging becomes not useful when gold prices rise but it is not able to sell its jewellery --> it will lose money on its bullion loan/contracts but not able to make it back via sales.

P.S. I did not go into details why Luk Fook had its best year in 2014 during a strong downturn in gold price. But correlation may not be equal to causation, and a 1-off year may not be the best data point to conclude anything.

[bmann025]

1) Luk Fook repeated frequently that demand picks up with price decreases.
2) There is no 'blow up' risk for such companies without debt.
3) Do the maths. Past 10 years, hedging destroyed profits and did not reduce volatility of net income. Longterm it just reduces income on average without benefit.

[weijian]

3) Do the maths. Past 10 years, hedging destroyed profits and did not reduce volatility of net income. Longterm it just reduces income on average without benefit.

hi bmann025,

How did you came up with the above conclusion? Did you add all the hedging gain/losses over the years to conclude? If so, are hedging gains supposed to even out hedging losses?

Let's not forget that hedging is not an activity done alone but is done to complement the actual business. Below is an excerpt from CTF's AR22:

As at 31 March 2023, if the market price of gold had been higher or lower by 10%, profit after taxation for the year would decrease or increase by approximately HK$1,469.8 million (2022: HK$1,520.4 million) due to changes in fair values of gold loans. On the other hand, the gold inventory would not be revalued at market price as it is measured at weighted average cost, unless an impairment indicator exists. The changes in fair value of gold loans would be partly offset by the realised gain or loss impact on gold inventory in future sales.

So if gold keeps going higher in 1 direction, CTF will always make losses from its hedging (done via bullion loans). But because it sells jewellery ~290days later (inventory turnover days) than the day it purchased its raw gold, it will be selling its jewellery at a high price and record a low COGS, giving it better margins to compensate for the hedging loss.

And here is the inverse - if gold keeps going lower in 1 direction, CTF will always make profits from its hedging (done via bullion loans). But because it sells jewellery ~290days later (inventory turnover days) than the day it purchased its raw gold, it will be selling its jewellery at a lower price and record a high COGS, giving it lower margins that negate the hedging gain.

P.S. I can't help if you firmly believe there is no blow up risk when there is no debt, as both Karlmarx and I had already described a tail risk earlier.

[bmann025]

I did that for the past 10 years in the Luk Fook Thread for LF and Chow Tai Fook. Result are reduced earnings with no reduction in earnings volatility. CTF produced hedging losses in each year since 2016.

You can keep the issue much simpler, and this is how:

Instead of hedging, these companies could buy every day just the amount of gold they sold on that day.
That produces a positive cash flow every day, which is the margin they addon the gold price.

The other issue is the book value of the inventory, which fluctuates with the price of gold. But that is not a cash flow item. If the company has no debt, there is no risk here and there is no reason to hedge a book value.
And as gold goes up long term due to inflation & money printing, plus hedging costs borrowing and rollover fees & commission, this is not only senseless, but also destructive.