Brief Consumer: S&P 500 and S&P 600 Testing Resistance and more

In this briefing:

1. S&P 500 and S&P 600 Testing Resistance
2. Diageo Proposes Another Partial Tender for Sichuan Swellfun
3. Hyundai Motor Share Class: Time to Short Common & Long Pref
4. China Tobacco Intl (HK) IPO: Proxy For the Chinese Cigarette Consumption
5. New Century Hotel (浙江開元酒店) IPO Review – Higher ADR and RevPAR than Peers but Margins Fall Short

1. S&P 500 and S&P 600 Testing Resistance

We believe the market is at short-term overbought extremes and is contending with resistance. Resistance levels we are monitoring include 2,810-2,817 on the S&P 500 and the 200-day moving average on the S&P 600 Small Cap index… see charts below. We would welcome some consolidation or a mild pullback which would be a healthy correction of the current extended market conditions.

In today’s report we highlight attractive Groups and stocks within Manufacturing and Technology: Construction Equipment, Industrial Rental Equipment, Data Storage Solutions & Devices, Small-Cap, and Software, Financial Mgmt. Solutions.

2. Diageo Proposes Another Partial Tender for Sichuan Swellfun

UK alcoholic drinks conglomerate Diageo Plc (DGE LN) bought a stake in Sichuan Swellfun Co Ltd A (600779 CH) in 2007, then through a 49% stake in Sichuan Chengdu Quanxing Group which owned ~40% of the Chinese baiju maker. In 2011 Diageo raised its stake in Sichuan Chengdu Quanxing Group from 49% to 53% by paying US$21mm to Chengdu Yingsheng Investment Holding Co. which lowered its stake to 47%.

In 2013, Diageo spent £233m to buy out Chengdu Yingsheng Investment Holding Co.’s 47% to go from a consolidated 21.05% to 39.71% in Swellfun (which is also named Sichuan Shui Jing Fang, after one of its brands).

Last summer, Diageo offered to buy 20.29% of the shares outstanding in a Partial Tender Offer (PTO) which was announced June 25th leading to a brief pop to RMB 60.0, and then launched a few weeks later at RMB 62.00 a share, which was a 22.6% premium to the then-current share price. The shares paid a RMB 0.62 dividend on August 1st and the PTO price was lowered to RMB 61.38 accordingly.

Last year’s Partial Tender was for 99,127,820 shares to be acquired out of a total free-float of 294,546,100 shares, which gave a minimum pro-ration of 36.65%. Surprisingly, pro-ration ended up being quite low at ~40.1%. The shares fell sharply and buy-and-tender trades done at the low were OK but in the mid 50s were not.

The shares languished as the economy softened, real estate transactions slowed, and conspicuous consumption continued to be frowned upon, and buy-and-tender-and-own-back-end trades did not do well (though owning A-shares in general did not do well either) as the shares troughed at less than half the tender offer price.

The New News

On 26 February 2019, Diageo announced it had approached the board of directors of Sichuan Swellfun with a proposal to increase its stake from 60% to 70% at RMB 45.00. This was a 19.33% premium to the last close and a 40.05% premium to the 30-day average.

The proposal was announced on the Shanghai Stock Exchange as well in Chinese.

This deal obviously has a lower minimum pro-ration, and the shares have jumped limit up this morning to RMB 41.48 leaving only 8.49% upside if you can buy at limit up today. At 25% pro-ration, breakeven is RMB 40.31, 6.9% higher than yesterday’s close. Assuming yesterday’s close is The Right Price, today’s limit up would give an implied expected pro-ration of 55%, implying only 18.2% of the remaining 40% of shares outstanding would tender. 

What To Do? 

That is the question. A-shares are on a tear, with the SSE-SZSE 300 up 23% ytd. Historically, bull markets are good to buy. Consensus forecasts have come down so there is a reason why the shares fell to where they did, but even though consensus EPS for 2019 as of six months ago is now the consensus EPS estimate for Dec 2020, on 2019 the shares at the Proposed Tender Offer Price are at less than 30x PER and less than 24x Dec 2020.

If you are buying these to get the minimum pro-ration on a target price equivalent to the offered Tender Offer Price, don’t bother. If you are looking at this as a cheap put because you may decide to downsize your position if the A-share rally sees the brakes applied, this is more interesting.

This is a trader’s trade rather than an arbitrageur’s trade and should be dealt with accordingly.

Breakeven Arb Grids for Price, PER, PBR, EV/EBITDA below.

3. Hyundai Motor Share Class: Time to Short Common & Long Pref

• Common is widening pref discount today as it is generating the highest gain mainly on the Elliott pushing. As of now (1PM in Korea time), Common and 1P/2PB gain difference is nearly 1.5%p. This is putting price ratio at nearly 120D high. On a 20D MA, both Common/1P and Common/2PB are above 200% of σ. We see this level for the first time since mid Dec last year.
• It is unlikely that Elliott’s ₩4.5tril dividend demand will get shareholder approval in the upcoming Mar 22 AGM. But it is enough to create a market mood that Hyundai Motor will hand out more generous shareholder friendly measures. Generally, common gets favored market sentiment as we move into AGM cycle. This time should be different. Each time Elliott factor came in, HM Pref tended to outperform Common.
• This should be time again for HM Pref to shine more. Both 1P and 2PB are sufficiently undervalued relative to Common. Div yield difference to Common is also at the highest for both pref types. I’d go short Common and long 1P or 2PB now. 1P seems a little more safe bet. But 2PB is more liquid. Either way wouldn’t go terribly wrong.

4. China Tobacco Intl (HK) IPO: Proxy For the Chinese Cigarette Consumption

China Tobacco International (Hong Kong), a subsidiary of the China Tobacco International, is seeking a listing in Hong Kong. Per media reports, the company plans to raise USD 100 million. In this insight, we will discuss the following topics: 

• What does China Tobacco International do?
• What is its relationship with China Tobacco?
• How did its different segments perform?
• The industrial backdrop

5. New Century Hotel (浙江開元酒店) IPO Review – Higher ADR and RevPAR than Peers but Margins Fall Short

Zhejiang New Century Hotel Management Group (1158 HK) (NCH) is looking to raise up to US$179m in its upcoming IPO.

NCH is riddled with related party transactions, from the sales of consumer goods, carpets and wine to having 24% of its hotel management revenue come from related parties. There had been a handful of small acquisitions and disposals but it all seemed to be just reshuffling of assets between NCH and the controlling shareholder with no clear strategy. 

Key metrics show that even though NCH is operating at higher ADR and RevPAR compared to peers, it ultimately falls short in terms of EBITDA and net margins. It also has the lowest occupancy rate.

In this insight, we will focus on corporate governance issues, peer metric comparison, and relative valuation with listed hotel operators.