GRC NEWSLETTER 03 | 2019-03-25 | BLADEX - | Global Rational Capital

GRC NEWSLETTER 03 | 2019-03-25 | BLADEX

Since inception on 1 July 2017 to 28 February 2019, Global Rational Capital Fund (the “Fund”) has generated a net return of 40% while the MSCI All Country World Index has returned 12%. Our investment philosophy is simple – we look for good businesses we can understand and buy at a price below intrinsic value. We are discerning about public disclosure of individual securities since good investment ideas are rare, valuable and subject to competitive appropriation; however, we explain how we think so that you can assess our capital allocation approach. To foster an organised rational decision-making process, we classify investments into five Investment Categories – Fast Growers, Stalwarts, Cyclicals, Asset Plays and Turnarounds, and in this newsletter, I will describe a Turnaround investment which has and will likely continue to perform well for the Fund.

A turnaround could be a company that had been doing well; however, due to a temporary mishap, the company’s short-term results are affected and its stock price plummets. The mishap must be temporary in nature and not harm the long-term fundamentals and growth of the company. Banco Latinoamericano de Comercio Exterior, S.A. (“Bladex”, NYSE: BLX) is an example of a turnaround bank that had a minor mishap that was perceived worse than it really is.

Bladex specialises in trade finance throughout Latin America. Its target client base comprises corporations that are active in foreign commerce, mostly on the export-side, and domestic financial institutions that cater to these corporations with broad-based banking services. The Bank does not provide retail banking services to the general public, such as retail savings accounts or checking accounts, and does not take retail deposits.

I first discovered the company 5 years ago and I met their management team in Panama during a CFA Investment Research Challenge in which I was the mentor to a team of students from the Cayman Islands. I have been following the company ever since.

UCCI students at the CFA Investment Research Challenge in Panama, 2015

Bladex is a stable company, headquartered in Panama, that has produced a consistent return on equity of around 10% over the last 15 years. Their consistent returns are attributable to several factors. They have a stable deposit base provided at low rates primarily from the Central Banks of Latin America who are also the founders and supermajority shareholders of the Bank. Banks make money on the spread between the interest they receive on loans made and the interest they pay on deposits received. The low interest that Bladex pays on its deposits is important to enable them to make a spread profit. Bladex is a conservative lender and the niche trade finance loans they make are low risk (impairments to loans averaged 0.2% p.a. from 2013 to 2017) because the loans have short maturities of 6 to 18 months and are only made in US dollars to high quality financial institutions and corporates who are active in foreign trade. Bladex keeps a conservative ratio of liabilities to assets and maintains a strong investment grade credit rating. Bladex manages its costs well (their efficiency ratio averaged 32% from 2013 to 2017) and is exempt from paying income taxes.

All the above factors give Bladex an advantage in the Latin American trade finance market where competition comes from large local and international financial institutions and alternative sources of finance.

However, Bladex is the only bank in Latin America to specialise in trade finance. There are no direct comparables. All other banks have diverse portfolios with mortgage and other loan types. Trade finance is too low margin for most other banks. The low-cost funding from the Central Banks is the competitive advantage that other banks don’t get.

Bladex Loan Portfolio Exposure

Bladex Value Chain

Bladex is listed on the New York Stock Exchange and over the last 15 years its shares have traded at a price very close to its book value (assets less liabilities) per share for two main reasons: 1) the consistent return on equity of around 10% that Bladex generates is roughly equal to the return on investment that investors generally expect for taking on the risk of investing in a Latin American specialist trade finance bank; and 2) Bladex could theoretically be liquidated quickly at a value per share very close to book value per share because their trade finance loans are very short term and low risk in nature.

The historical price to book ratio has a normal distribution which means that about 95% of the values lie symmetrically within a range of 0.67 to 1.36 (within 2 standard deviations from the average value) and there is a strong tendency for the ratio to revert to its average value of 1.02.

There have only been two occasions over the last 15 years when the price to book ratio of Bladex has dropped below 0.67 (more than 2 standard deviations below its average value): during the Global Financial Crises in 08/09; and in the 4th quarter of 2018 after Bladex announced a write-down of a single loan to a sugar mill in Brazil.

In the earnings call that followed the announcement, management assured investors that the write-down was isolated. Brazil was the largest producer of sugar in the world until it was recently overtaken by India because the Indian government subsidised sugar production which caused the sugar price to drop below the cost of production for most Brazilian producers and this led to the bankruptcy of one of the corporates to which Bladex had provided trade finance. Bladex’s remaining exposure to the sugar industry is low (net 2% of loan portfolio) and is mostly outside of Brazil.

Management also confirmed that the remaining non-performing loans are low (0.04% of loan portfolio) and the book value of the bank continues to be solid; however, the market did not listen because the bank is not carefully followed by the market (there is only one sell side analyst who covers Bladex occasionally) and the market incorrectly extrapolated the mishap because of concerns around protectionist global trade wars and economic stress in emerging markets.

Bladex Statistics

Gabriel Tolchinsky, Chief Executive Officer of Bladex

I had several calls with management who described the industries and countries in which Bladex operates. Management also explained their plans to resume a return on equity of around 10%, despite the headwinds faced in certain Latin American markets. Firstly, they expect loan impairments to return to normal levels of around 0.2% per annum. Secondly, they expect to increase net interest margins without taking on undue risk by lengthening the average life of loans to high quality borrowers in low risk countries and industries, particularly to low risk financial institutions. Finally, they are very well capitalised (their Tier 1 capital ratio is 18%) and they have capacity to increase return on equity by increasing financial leverage without compromising their investment grade credit rating.

Management also pointed out that Bladex is well positioned to benefit from the US Federal Reserve Bank policy to increase market interest rates because rates on both Bladex’s assets and liabilities are variable and adjust quickly to increases in market rates and a portion of Bladex’s assets are financed with equity which means that the net interest margin will improve when market rates rise.

We purchased Bladex shares for the Fund in Oct 2018 when the price to book ratio dropped below 0.67 after the announcement of the isolated loan write-down in the 3rd quarter results. We purchased more shares in December when the price to book ratio again dropped below 0.67 as the equity market became concerned by the Fed’s intention to increase interest rates.

The share price subsequently increased by around 30% until the end of February 2019 when management announced results for the year ended December 2018 which confirmed that the loan write-down was isolated, no further write-downs occurred, and that Bladex is on track to resume a return on equity of around 10%. We sold some shares at that point and the share price has since moved to a price to book ratio of around 0.78 which means there is still upside to enjoy as the ratio gradually returns to its average level of around 1. The catalyst is the release of financial reports that continue to prove the mishap was temporary and the fundamentals are sound.

Bladex is a good example of a company that we understand well. A key component of our investment process is to understand businesses and we believe that meetings with management is an indispensable and highly efficient means of obtaining an understanding. We also believe that the more companies we understand and meet with, the higher the probability that we will find a few good companies that can be bought at a price materially below intrinsic value.

The more rocks we turn over with time, hard work, patience and persistence, the greater the chances we will find something of value. In the last 12 months, we have had over 100 company meetings over the phone and face-to-face. We visited companies and experienced their products and services in Hong Kong, mainland China, Japan, Australia, New Zealand, South Africa and the US. Next month we shall visit companies in the UK and in July we shall visit companies in Canada.

While we enjoy writing newsletters about our investment experiences, our attention is focused on the long-term performance of the Fund because we only manage one fund, all our investable net worth is in the Fund, and we are incentivised based on the long-term outperformance of the Fund relative to its benchmark. As time and opportunity permits, we shall continue to provide you with examples that will help explain our capital allocation approach.

Robert Tate

Founder & Investment Coordinator

GRC Newsletter 03 – 2019-03-25 – Bladex.pdf