Quarterly Letter, VIP SEA

Quarterly Letter from CIO, VIP Southeast Asia Chapter, Q2 2023

Dear Sponsors, Board of Advisors and Members,

We are excited to share with you our latest updates and insights as we pass the half-year mark of 2023. All of our members have submitted their stock pitches onto our platform and we are excited to delve into each and every one of them to see if there are any companies that we would like to initiate coverage and/or positions for.

First of all, we are excited to announce that the International Chapter of the Value Investing Program has been rebranded as the Southeast Asia Chapter. We hope to focus our efforts on the region around us, both in terms of outreach and scholarships to those in SEA, but also to expand our knowledge of markets and businesses within this region. We also hope that this will put the Program in a good position to establish more regional chapters within Asia and beyond over the next couple of years.

We are also pleased to announce that Javier Chan, Cheng You Gin, and Mouli Raj will be taking on Deputy CIO roles. Each one of them has proposed directions that they wish to work towards, including initiatives for placing a stronger emphasis on generating returns to fund scholarships, refining the investment process to encourage more participation and opportunities for peer-to-peer guidance, new ways of interacting with industry professionals, and more efforts to organise bonding activities, trips and mentorship for our members to grow closer to one another. Thank you for stepping up, and to our members, please stay tuned and show your support for these new initiatives!

Portfolio Update

Alibaba's Split and Cainiao Global's Layout

Considering Alibaba's choice to divide itself into six distinct business units, it became imperative for us to delve into the underlying implications of this significant strategic move. Olivia Zhang, one of the members covering Alibaba, conducted thorough research into Alibaba's restructuring and presented her findings to us, recorded in her memo here.

Reviewing Alibaba's performance in the 2023 fiscal year, the numbers show a 1.83% year-on-year revenue increase to 86.869 billion yuan, reflecting the impacts of pandemic control measures. Notably, net profit surged by 40.42% to 65.573 billion yuan, and net profit attributable to shareholders climbed by 17.03%. This revenue breakdown reveals that core e-commerce constitutes a substantial 75.05%, while segments like cloud services, logistics, digital entertainment, and innovation contribute to the remaining shares. Shifting focus, Alibaba's adoption of the "1+6+N" organizational structure aims to enhance business autonomy, transforming the company into a holding entity concentrating on capital and asset management.

Drawing parallels with Google's 2015 reorganization, it's intriguing to consider the potential benefits of Alibaba's restructuring. Google's move led to core business concentration, independent management, and improved valuations. Could Alibaba's shift also enhance operational vitality and autonomy? The model's flexibility for independent financing and public offerings could indeed reshape the business's value and transparency. Additionally, the agility of individual subsidiaries might enable better responses to market changes and risks.

Turning to Alibaba's growth sectors, the numbers are striking. Cainiao logistics and international e-commerce shine, with Cainiao's accounts receivable soaring at an impressive compound growth rate of 84%. This aligns with government-supported trends of expanding overseas. Delving into the logistics strategy, Cainiao's "light and heavy combination" approach seems promising, allowing swift global expansion while staying nimble. Furthermore, Alibaba's emphasis on technological advancements positions it favorably in the overseas market. This may therefore be a new focal point for us as we continue holding BABA.

Taking a look at Q1 2024 results, Alibaba reported a substantial 14% year-on-year growth in revenue for the quarter ended June 30, marking its most significant annual sales increase since the September 2021 quarter. In response to this positive news, Alibaba's U.S.-traded shares surged by 4.5% in premarket trading. Alibaba's revenue reached 234.16 billion yuan ($32.29 billion), surpassing the expected 224.92 billion yuan, showcasing a 14% YoY rise. Moreover, net income attributable to ordinary shareholders amounted to 34.33 billion yuan, exceeding the anticipated 28.66 billion yuan, with an impressive 51% YoY growth.

Alibaba's core business segments also displayed promising results during the June quarter. The Taobao and Tmall Group, constituting the company's main business, recorded a 12% year-on-year revenue increase, totaling 114.95 billion yuan. Notably, the Taobao app for online shopping exhibited a 6.5% rise in daily active users in June compared to the previous year, escalating further to over 7% in July. Alibaba's strategic efforts to expand its presence in international markets yielded substantial results as well. Revenue from international commerce retail surged by an impressive 60% year on year, reaching 17.14 billion yuan in the June quarter.

Alibaba also experienced a 34% rise in revenue for its Cainiao logistics business, reaching 23.16 billion yuan, largely attributed to international demand during the same reporting period. The company's cloud business reported a 4% revenue growth, totaling 25.12 billion yuan. However, these results were somewhat hampered by reduced revenue from key customers and a decreased need for remote work, streaming, and education services following the pandemic.

Nonetheless, Alibaba observed strong demand within its cloud business for AI-related services and the training of artificial intelligence models. The company is resolute in its belief that the growth opportunities stemming from AI services are just beginning, heralding a new era driven by technological advancement. We note that Alibaba's management expressed their intention to increase investments in AI development and seize emerging business prospects. Moreover, management articulated their vision for the Taobao app to evolve into an all-encompassing intelligent hub for life and consumption, powered by AI technology.

BYD

Javier Chan, our newly-minted Deputy CIO, updated his view on BYD, which he pitched in Q1 this year following the release of new data.

Stock performance

We invested in BYD stock in end March, 2023. During this period, renewables and EV stocks have performed well in the Chinese market while most other sectors have slid. BYD has went up 26.3% since our investment while the Hang Seng Index (China Benchmark) is down -3.6%, implying alpha generation of ~30%. Delivery

Numbers

In June, BYD delivered 253k units worldwide, up 5.3% MoM. In H1’23, BYD delivered 1.3m vehicles – 2x from the same period a year ago. Industry competitive dynamics have intensified this year, with peers waging a price war. YTD, Tesla has cut Model 3 prices by 14% and Model Y prices by 10%, while BYD cut prices of the Seal by 10% in May. In Q2 2023, BYD delivered ~600k vehicles while Tesla only delivered 247k. This indicates that BYD captured almost >2x the incremental market share of Tesla despite only decreasing prices moderately. Market share is an important metric in the industry, especially in the entry-level market that BYD plays in, as on average each customer will only purchase1 vehicle. Hence, it is crucial for the company to capture each incremental customer, as that will lock them in for the next 7-10 years once the purchase has been made. BYD has been exceeding expectations on all fronts YTD and the market has rewarded them for it. Moving forward, we should be prepared for a potential moderation in delivery numbers in response to the increasingly difficult China macroenvironment. However, these effects will likely be felt industry-wide, and I believe that on a relative basis, BYD will still be the top outperformer among other China EV players.

Costco

Cheng You Gin, yet another one of our new Deputy CIOs, also pitched Costco Wholesale Corporation (NASDAQ: COST) at our IC meeting. The following is a summary of his investment case, which can be read in full here:

Company Overview and Financial Highlights Costco Wholesale Corporation stands as the world's third-largest retailer, operating membership warehouses across the globe, with 847 locations and 8 e-commerce websites as of 2022. Renowned for its diverse range of merchandise categories including groceries and household items, Costco follows a unique membership-based business model. In 2022, the company expanded with the opening of 26 new warehouses, 7 of which are located outside the US and Canada. The year saw a 16% increase in net sales to $223 billion, driven by a 14% rise in comparable sales and new warehouse sales. Membership fee revenue reached $4,224, up 9%, attributed to new member sign-ups, upgrades, and an increased renewal rate.

Business Segments and Industry Context Costco's revenue primarily stems from merchandise sales, accounting for over 90%. Membership fees contribute 2% of net sales, reflecting its exclusive membership model with over 120 million members. E-commerce sales account for 7% and are facilitated through various logistics arrangements, including Costco's own depots and drop-shipping. The global retail industry, estimated at $25.8 trillion in 2022, is projected to reach $32 trillion in 2026 with a CAGR of 5.53%. The post-COVID-19 landscape has seen technology emerge as a key driver, with e-commerce playing a pivotal role in adapting to market shifts and optimizing supply chains.

Challenges and Investment Thesis Elevated retail inventories, which surged by 17% from October 2021 to October 2022, have led to increased warehouse costs and higher supplier input costs due to marked-up products. Despite these challenges, Costco maintains its investment appeal. The ability to retain market share through its membership model, boasting a renewal rate exceeding 90%, positions it strongly. Costco's bargaining power, rooted in its size and purchasing concentration, results in lower prices for members while maintaining quality. This resonates with suppliers as they gain volume even with reduced margins. Moreover, Costco's efficient supply chain management and broad product selection drive cost advantages.

Global Expansion and Financial Strength Costco's outward expansion remains robust, with plans to open 23 new warehouses in 2023, 10 of which will be international. A focus on China is particularly notable, with six stores set to open there by the end of 2023. The company aims to achieve a balanced warehouse distribution between the US, Canada, and international locations. Financially, Costco maintains a strong balance sheet, with favorable liquidity and solvency ratios. Its lower debt-to-equity ratio and impressive interest coverage ratios position it well in varying interest rate environments.

Valuation and Growth Potential

While Costco's current multiple surpasses historical averages, its strong growth potential could justify its valuation. With an EPS growth rate of 16.7% CAGR over the past three years, the company's forward P/E ratio could remain at 35-40x PE. Assuming a similar forward P/E ratio and earnings growth, an implied share price of $582.54 is anticipated, indicating an 11% upside potential.

We have decided to allocate 10% of our portfolio to Costco and are in the process of executing the trade.

Macro Outlook and a Warm Welcome!

Amid China's era of subdued growth and low inflation, our attention remains steadfastly drawn to the pivotal juncture that Chinese tech companies find themselves in, a sentiment mirrored in the broader context of the nation's trajectory. As geopolitical tensions cast shadows, China is poised to recalibrate its strategies across various sectors, salvage struggling industries, address the needs of its aging population and its struggling youth, as well as embrace the realms of innovation and sustainability. While the challenging external landscape raises questions, we find ourselves at a crossroads of skepticism and optimism, wherein the sagacity of Howard Marks' words resonates: "Skepticism and pessimism aren't synonyms. Skepticism calls for pessimism when optimism is excessive. But it also calls for optimism when pessimism is excessive." In the face of multifaceted challenges, China's dynamic responses and transformations hold immense potential that we find too compelling to overlook.

Furthermore, we would also like to extend our approach beyond China. For the US, we aim to identify businesses that have not only weathered the inflationary climate but emerged as exemplars of resilience. We are drawn to enterprises that exemplify the capacity to offer customers unparalleled value without compromising service quality — a testament to their tenacity and acumen. These ventures, fortified by their competitive prowess, have demonstrated an unwavering commitment to both customers and long-term growth.

Looking at the big picture, we are attuned to the seismic shifts unfolding on the global stage, particularly in the context of evolving political dynamics. The United States, as an influential player, is undergoing a recalibration of its economic and diplomatic strategies. This recalibration may introduce intriguing prospects within the US as its companies navigate new trajectories. We hope to delve into these potential avenues, identifying nascent industries or trends that warrant dedicated exploration by specialized teams of members. Through a meticulous process of observation and analysis, by refocusing on sector-coverage, we hope to build our understanding more intentionally and help interested students easily find themes they feel passionate about.

This leads me to the ongoing, very-exciting Summer Bootcamp that I've been fortunate to be a part of. We have an extremely promising batch of candidates who wish to join the SEA chapter community and I would like to take this chance to welcome all our fresh faces, and wish you all the best as you embark on your investor journeys!

Walter Schloss once remarked, "One thing I will always remember, though, is how America has given me the opportunity to invest and the freedom to do what I enjoy doing. Being grateful for that opportunity, my goal was never just to bring value to my investors, but also to do what's right for those who trusted me." I hope that you too will walk away from the program feeling the same sense of joy and gratitude for how lucky we are to have as much support as we do. Please keep paying it forward with enthusiasm and proactiveness, and I hope you never stop discovering more about yourself along the way.

To everyone in the community, thank you for your unwavering support and we look forward to writing to you again next quarter.

With Best Wishes,

Rebecca Yang

on behalf of the Value Investing Program’s Southeast Asia Chapter