Value Investing

Petra Capital Management And Divergence between Samsung’s Common and Preferred shares

On January 20, 2017, we had the chance to catch up with Chan H. Lee, who happened to be in Singapore for business, over lunch. We had previously interviewed Albert H. Yong and Chan H. Lee in Hong Kong during the Asia Value Investor Conference 2015, which can be found here.

Albert and Chan are the managing partners of Petra Capital Management (“Petra”) – a long-term deep value-oriented firm based in Korea. Since its inception in September 2009, the Petra portfolio has yielded an annualised return of 14.9% net of all fees. The KOSPI Index, on the other hand, had an annualised return of 3.1% over the same period. Undoubtedly, it is an impressive record from an absolute or relative point of view.

Samsung
Image source: Wikimedia Commons

Samsung’s stellar performance

Over the course of 2016, we have seen the stock price of Samsung Electronics suffer a couple of dips especially after the announcement of the cancellation of the Galaxy Note 7 model and Jay Y. Lee, Samsung’s apparent heir, implication in the presidential corruption scandal that has rocked South Korea.

Despite these negative news, Samsung’s stock price has performed extremely well, with the common and preferred shares rising 54.6% and 41.1% respectively last year. Chan shared how investors have started realising that Samsung Electronics is not just a pure-play smartphone business but in actual fact has other business lines such as the semiconductor and display.

Based on the revenue made from DRAM and NAND products by leading semiconductor companies in the world, Samsung is ranked No. 1, followed by SK Hynix and Micron Group. Furthermore, with how smart products are expected to grow in the next few years, Samsung’s semiconductor business would definitely benefit from this huge growth market.

In terms of the display business, Chan shared how Samsung Display will be benefiting from the rise of their AMOLED display screens.  AMOLED (Active Matrix Organic Light-Emitting Diode) technology is now often seen as the next generation display screen. With these displays , individual pixels are lit separately on top of a thin film transistor array that passes electricity through organic compounds. In layman terms, colours will be typically brighter and without the need of a backlight, it allows smartphone manufacturers produce much thinner phones. This is why Samsung has been able to manufacture slimmer smartphones compared to Apple iPhones, as Chan was explaining.

Additionally, shipments of smartphone ready AMOLED screens by Samsung Display are expected to hit 560 million units by 2019. That would be a 114% increase from 2015’s shipments. Samsung is the leading provider of these AMOLED screens to smartphone manufacturers. Starting 2017, the Apple iPhone is expected to sport an AMOLED display as well.

Given how Samsung Electronics remains to be a well-diversified dominant technology company, and its other business lines, including semiconductor and display, are thriving, this has clearly been reflected in the increase in share price.

Divergence between Samsung’s Common and Preferred shares

Since the Global Financial Crisis, the divergence between the common and preferred shares have been slowly closing. However, as of late, we noticed the gap between the two widening again. This is due to the recent spate of corporate governance issues occurring in South Korea in light of President Park’s scandal as explained by Chan. However, given how the corporate governance is likely to improve within South Korea, this gap is still expected to close in the longer term.

Petra portfolio’s biggest laggard

As with every portfolio, there would be its winners and its laggards. Chan shared that their biggest laggard last year was LG Chem Preferred. The stock price continued to decline last year due to China’s regulations on electric car batteries that LG Chem produces and the lacklustre outlook of the electric vehicle lithium battery division. Having been removed from the approved list of batteries to be installed in Chinese automobiles, this has definitely affected the stock price negatively. However, considering how this protectionism from China is only temporary,  the strength of the company’s well-diversified chemical business and the long-term outlook of its electric vehicle battery business, Chan believes that the stock is substantially undervalued at this time. Once again they own the preferred stock because of the extra discount.