Changes in portfolio

I decided to let go of the following stocks:

• Baidu
• China Mobile
• Sanofi

Dividends from China Mobile and Sanofi are being treated unfavourably by Finnish tax authorities in comparison to other foreign companies. Dividend from a company in Hong Kong (China Mobile) is treated as regular income and thus subject to much higher tax percentage than normal dividend or capital gain. Dividend from France (Sanofi) on the other hand is supposed to have zero withhelding by broker. Since my broker withhelds part of the dividend and this is not taken into account by Finnish tax authorities, I am being taxed partly twice.

As I was looking for passive ETFs where to put the money I came across an interesting ETF (PowerShares Golden Dragon China Portfolio; NYSE: PGJ) that had big exposure to Chinese technology companies like Baidu and also to China Mobile. Thus, I dediced to take the profits from Baidu which has risen nicely lately and spread also that money around more evenly. 

 

I don't like the big exposure to banking sector of ETFs like iShares China Large-Cap (NYSE: FXI). Nor I wanted to put all money from China Mobile and Baidu to PGJ so I selected another ETF to maintain our exposure to China. Guggenheim China Small Cap ETF (NYSE: HAO) invests into 241 companies like BYD which I had a direct investment in some time ago. Sector exposure is quite balanced (industrials 19%, consumer cyclical 17%, technology 14%, real estate 11%, basic materials 11%, consumer, non-cyclical 10%...).

To maintain some exposure to Telecommunications Service Providers beyond our position in TeliaSonera some our our money went to iShares Global Telecom ETF (NYSE: IXP). Three biggest holdings are AT&T, Vodafone and Verizon. Naturally China Mobile is within top 10 holdings as it is one of the biggest operators in the world by any measure.

From the pharmaceutical / healthcare sector I selected iShares Global Healthcare ETF (NYSE: IXJ). Sanofi is there within 10 largest holdings. Top 3 being Johnson & Johnson, Novartis and Pfizer.

Tasman Metals vs. peers

When writing my previous article on Tasman Metals, I noted that it would be useful to look at Competing HREE mines coming online elsewhere outside of China that might fill the same supply space. I started some work on this, but concentrated only on mines in or near Europe. A recently published article in Seeking Alpha seems to do this job rather nicely (as far as I can tell). I highly recommend it if you are interested about rare earth elements to begin with.
 
Best In Rare Earth Class And Undervalued: Tasman Metals" by "The Critical Investor". 

I recommend to read also all of the comments, since there is some good discussion and alternative views there on the subject.
 
Also, I recommend listening to the recent interview with Mark Saxon, CEO of Tasman Metals by Gold Stock Trades Editor Jeb Handwerger in Youtube. "Tasman Metals: Critical Supply Of Heavy Rare Earths In EU"

The projects I managed to find in or near Europe were:

• Storkwitz deposit (Germany)
• Kvanefjeld project (Greenland)
• Kutessey II (Kyrgyzstan)

Storkwitz, located near the town of Delitzsch, is confirmed to contain JORC-compliant REE resource. In comparison to Norra Kärr the ore body in Storkwitz is much more difficult to access as it begins at 300 meters below surface and continues to greater depths trending straight down. It is currently estimated to contain 20100 tonnes rare earth oxides (half indicated and hald inferred). The drilling data covers up to 700 meters, but the ore body is estimated to possibly continue up to 1200 meters. In comparison, Norra Kärr ore body starts near surface and current drill holes are up to 150 meters making it feasible for open pit mining.

Kvanefeld in Greenland is potentially a huge project. Compared to Norra Kärr, the project is far bigger. Due to uranium it likely will also be more controversial. Resources are split to three different deposits within a grid of 7x8 kilometers. There does not seem to be infrastructure (roads, power..) so it is going to take more capital expenses than Norra Kärr. Target for operations to start is same as for Norra Kärr (~2016).

Note: all information about the projects in or near Europe where gathered in June before I finished my previous articled on Tasman Metals.

 The author is long Tasman Metals and considers the investment as very high risk one as all junior miners typically are.

New position: Citycon

I have recently trimmed down our Nokia position as it has skyrocketed in value. That was a turn-around bet worth taking! I have routed money from Nokia to my other holdings in Finland (Helsinki stock exchange). I also took a new position in Citycon (Helsinki: CTY1S) that has been popping up constantly in my screens (see earlier post: Helsinki Top 20). I have bit altered my screen, but still all three Finnish property investment companies are in Top 10.

Citycon is specialised in retail properties, especially in shopping centres, in Finland, Sweden and in the Baltic countries. It was founded in 1988 by several large Finnish Corporations and initially invested in office premises.

At the time of writing last trade with Citycon was made at 2,43 euros. It has roughly traded between 2,1 and 3,3 euros last three years. My main expectation with this one is stable dividend. Valuatum screening tool that I use puts both 2013 and 2014 yeild at 6,2%. Price per book is below 1 at 0,94. P/E estimation for 2014 is 11,3. This looks like a solid value play should.

Our portfolio has been tilting very heavily to IT and Telecommunications so these latest moves reduce our exposure to those sectors. However, our exposure still remains to be very high.

Western Digital: my best pick so far

My best stock pick during last three years has been Western Digital (NASDAQ: WDC). My initial thesis was based on low valuations of hard disk makers Western Digital and Seagate (NASDAQ: STX) compared to their future prospects. [Previous blog posts].

Copyright ©1999-2008 by StockCharts.com Inc., Redmond Washington. All rights reserved.

Reproduced with permission under "Limited Licence" / General Terms of Service.

I was right about prospects of hard disk makers and our current unrealised gain is over 100%, but I would have done much better if I had bought Seagate instead. The difference in performance can be largerly explained by flooding in Thailand in October 2011 that severely impacted WDC and benefited STX. The chart below gives you idea of their relative performance in the last three years (WDC stock price divided by STX stock price):

Copyright ©1999-2008 by StockCharts.com Inc., Redmond Washington. All rights reserved.

Reproduced with permission under "Limited Licence" / General Terms of Service.

Lately (over last year) WDC has outperformed STX. Longer term, I would not be surprised if this trend continues. Therefore, I continue to hold WDC instead of STX. However, something to consider is to own both companies instead one or the other. That would also protect from one time events that have material impact to either company.

Comparing valuation and financials of WDC and STX there isn't many material differences. The market cap, for example, is currently almost the same. The most notable differences are:

• P/B: WDC 1,9 vs. STX 4,1
• Dividend yield: WDC 1,6% vs. STX 3,9%
• Long term debt / Equity: WDC 0,22 vs. STX 0,79

Source: FINVIZ.com

There currently appears to be significant difference in current P/E, ROA, ROI, ROE, but I believe those are not lasting differences.

• WDC recorded $681 arbitration charge in their Q4/2013 impacting their net profit. The award was from WDC vs. STX dispute so this seriously distorts TTM figures.
• The companies operate in exact same industry with significant market share. Their gross margins and operating margins are very close. I can't see currently any reason why net margin (profit margin) could be materially different for the two companies.

Full disclosure: Long WDC at the time of writing.

  

7 reasons why I hold Fortum

Fortum is a leading power and heat company in the Nordic area. It was established on 7th of February 1998 as combination of "Imatran Voima" (literally: "Imatra's Power"), one of the most famous Finnish power companies, and Neste (literally: "Liquid"), an Finnish oil company. Since then many investments and divestments have taken place. Most notably actions have been separation of oil business (Neste Oil) in 2005 and large investments in Russian power and heat companies (TGC-1 and TGC-10) between 2005 and now.

Fortum is among the most traded shares on the NASDAQ OMX Helsinki stock exchange where it is listed. It has market cap of approximately 13 billion euros which places it 5th in Helsinki stock exchange in terms of market cap. Finnish State is majority owner with 50,8% of all shares. Fortum is considered as strategic asset for Finland and the ownership is steered directly from the office of Prime Minister. Foreign investors have 25,5% stake in Fortum (June 2013).


The reasons I hold Fortum are:


#1 Dividend

For the past five years Fortum has paid dividend of 1 euro per share. Shares of Neste Oil distributed to shareholders of Fortum are not included.

Dividend policy:

"Fortum Corporation's target is to pay a stable, sustainable and over time increasing dividend of 50-80% of earnings per share excluding one-off items. "

Dividend yield based on closing price 14,78 euros (Helsinki 26th of July 2013) and assumption of 1 euro dividend would be 6,8%.

 
#2 Stability

Nordic power and heat business is very stable. Fortum is number #3 in power generation and #1 in heat generation in Nordic region where power market is still highly fragmented. There are over 350 power generation companies in the region.

That is where the money comes now.

In European scale Fortum is mid-sized player in power generation. However, in heat generation it is one of the biggest players in the world (5th in 2011).


#3 Very profitable business valued very reasonably

Gross margin 41%
Operating profit 30,2%
ROA 7,8%
ROI 3 year average (est 2013) 12%
ROE 3 year average (est 2013) 15,6%

P/B 1,23
P/E (est 2013) 10,5

Source: Valuatum


#4 Low carbon power generation

According to its strategy, Fortum seeks growth in low-carbon power generation, energy-efficient CHP production and customer offerings. 68% of Fortum's total power generation was CO2-free in 2012. In EU region the number was impressive 93%.

Power generation mix in 2012 was:

• Hydro power 34%
• Nuclear power 32%
• Natural gas 27%
• Other 7%

Heat generation mix in 2012 was:

• Natural gas 62%
• Coal 12%
• Biomass 11%
• Other 15%

Within Europe 91% of power is generated within either hydro or nuclear power plants. The share of biomass, heat pumps and waste in heat production in Europe is far larger than in the overall mix.


#5 Russian operations

OAO Fortum (former TGC-10) operates in the heart of Russia’s oil and gas producing region. TGC-1 operates in north-west Russia (area bordering Finland). Fortum owns a bit over 25% of TGC-1. Fortum's share of both combined is 26 TWh of power generation and 34 TWh of heat sales. Compared to Nordic figures (52 TWh and 15 TWh respectively) the Russian operations is significant in the company level.

Power market liberalisation is ongoing in Russia. There are separate markets for capacity and electricity. The rules favor "new" capacity over "old" (pre-2007) capacity. Bulk of capacity Fortum got in the TGC-10 deal was "old". However, they have extensive investment program at OAO Fortum to add 85% more capacity between 2011 and 2014. Majority of the capacity is to be rolled out between 2013 and 2014.

Currently operating profit coming out of Russian operations is fairly small. However, Fortum targets operating profit level (EBIT) of about EUR 500 million run-rate in its Russian division during 2015. That would yeild a significant improvement to the bottom line (was 1,4 billion EUR after tax in 2012; EPS 1,59 euros).


#6 Long term market coupling in Europe

Electricity is cheaper in Nordic region than in many other parts of Europe. New interconnections will double the transfer capacity between nordic and continential regions from current 4000 MW to 8000 MW by 2020. Net exports from Nordic region to continental Europe in 2012 was 18 TWh (2011: 7 TWh). Long term market coupling and expansion of tranfer capacity are likely to increase price of electricity in Nordic region and bring it closer to that of central Europe.


#7 Potential divestments

Fortum is assessing divestment of its electricity distribution business, which ties lots of capital, but the returns are far behind those of power generation business. Fortum is the biggest electricity distributor in the Nordic region. However, in European scale Fortum is a minor player.

The electricity distribution as separate business is likely valued higher than its currently valued as part of Fortum. This would unlock hidden value - eventually to shareholders in one form or another.




References:

All financial estimates: Valuatum (based on closing price 14,78 EUR on Helsinki stock exchange 26th of July 2013)

Company web site

Investments and divestments
http://www.fortum.com/en/investors/share-information/major-investments-and-divestments/pages/default.aspx

Strategy
http://www.fortum.com/en/investors/strategyandgrowth/pages/default.aspx

Investor presentation July 2013:
http://www.fortum.com/Lists/ArchiveLibraryList/Fortum%20investor%20material%202013/Fortum%20investor%20Material%20July%202013.pdf



Full disclosure: Author was long Fortum at the time of writing.