Sunday, 26 April 2020


Gross Profits : RM7,335
Return on Investment : 34%
Duration : 2 weeks

 From the Editor In Chief of the Pelham Blue Fund

My skepticism about everything was at all time highs.
I didn't believe in the markets, I keep getting things wrong about the market's direction, and I had doubts about the long term viability of any investments.

The problem was that although we can trade perfectly fine in irrational markets - we quite like the volatility - there is an issue when we analyse a company's fundamentals. No matter how good they are, we keep circling back to a most important question : we are heading towards a recession, aren't we? 

So the skepticism brings some conflict. We would love to accumulate positions for the long term, and although you may not believe this, we could use a bit of less trading on a day-to-day basis. Sometimes it's just exhausting, and most of the big money is made on the sitting and waiting.

Guan Chong Bhd (GCB) is a company we are quite familiar with. Decent business, global standing, economies of scale, all sorts of great stuff. It's already doing big things, and will keep getting bigger. 

And even though we are out of this trade in GCB, we still like it for the long term.

We went into this trade with the thinking that we can hold on to it indefinitely. We changed our minds halfway, hence making this a fundamentals trade that turned into a technicals one.


Why do we do deep dive fundamental analysis? It's not just for research and to correct our biases/expectations on a stock. It's also, really, to make ourselves feel better about the stock. Especially one we wanted to hold for a while.

GCB is in the cocoa refining business. Chocolates are a steady growth business for the long term,  and as long as dentists tell kids not to eat them, kids will keep eating them. And they'll turn to adults, and still eat them.

But I digress - it's these kinds of fundamental research that I was reading on (consumption trends by product, geography, sourcing of beans, difference between premium and mass market chocolate product margins, Ghana's economic outlook, etc).

I remember catching myself while reading about the living income differential structure in the Ivory Coast at 2AM on a Sunday morning. My thoughts were "what the hell? Go to sleep already - this shit is not that important".

But it actually was important - we were putting some money on the line.

We have made profits from GCB in a previous trade, but the fundamentals need revisiting.


1) Limited exposure to China and Europe.

2) Overseas expansion ongoing, with facilities in Indonesia, Ivory Coast (2021) and recent purchase of a German facility. 

3) Cocoa price stable at around $2,200 per tonne. The last time GCB was making losses, it was impacted by a $3,100 per tonne cocoa price peak in 2014.

4) GCB has locked in about 80% of FY2020 sales due to forward orders from chocolate manufacturers (Hershey's, Mars etc).

5) Cocoa grinding is an economies of scale game. GCB is comfortably Asia's biggest grinder and the world's fourth biggest for years to come. Barriers to entry in this business is high.

6) Ivory Coast and Ghana has instituted an added tax (LID) to boost earnings of small cocoa farmers. GCB will likely pass through the cost to its customers. Barry Callebaut - the world's No.1 cocoa player - are already doing this. The quantum of the LID is currently $400 on a per tonnage basis.

7) We think chocolate demand is going to be stable and growing for years to come.

8) We don't see cocoa prices skyrocketing anytime soon due to current surpluses. In fact, inventory is building up as global firms have already secured their prior orders. New orders this year are slow amid the COVID outbreak.

9) The situation in Ghana and Ivory Coast is still normal, with relatively small numbers of COVID infections.

10) Short term negative impact expected for GCB due to closure of its cocoa grinding facilities due to MCO (last 2 weeks of March, and likely first 2 weeks of April at least). (Update, 23 April 2020 : it is in fact operational, at 50% of the workforce)

11) Main concern going forward as an international business is to reduce cost of transportation and overall tax liabilities. Forex fluctuations may also impact earnings (reporting currency is in MYR, although its earnings are mainly denominated in foreign currency)


The technicals aspect was at least as compelling as the fundamentals. During the March market crash, GCB fell to as low as RM1.50 before staging an epic recovery. It went back to RM2 levels - up 33% in just under a week - when we contemplated a trade. And this trade was best expressible with a call warrant; it's the only way we'd take up the risk, since the payoff is quite decent.

We have made similar trades about a hundred times. To get a decent payoff which is a fair reflection of the risk taken, we prefer call warrants.

Our assumptions were simple:

1) There's a good likelihood of further market recovery at least in the short term, despite lousy underlying fundamentals (for the country, not the company).

2) GCB's stock doesn't have to move much for us to achieve great double digit percentage gains.

3) The call warrant that we chose was exactly the right one. It had to be, otherwise we might be screwed and lose shit-tonnes of money. I don't want this to affect our own living income differentials!

The warrant is GCB-CL, an issuance by Kenanga Investment Bank. It's pretty cheap, and its sensitivity to the mother share movement is acute.

(Editor's Note : if you're unfamiliar with the basics, here's how it works. Warrants move where the underlying 'mother share' (the actual stock) moves. There is a price setting mechanism by the investment bank where they have to make sure the warrant price reflects the mother share price exactly.)

Hence the table below shows exactly what's in store, if our trade works.

We analysed the odds, and they were favourable. In hindsight, it's easier to say that it was probably an asymmetrical trade with a higher-than-average probability of success.

This likelihood of success presents itself only under strict conditions that must be met:

1) A positive broader market momentum
2) GCB continuing its uptrend to break new highs in its share price

Best of all, it didn't have to move much for us to strike it big. As the table above shows, a mere 10 sen movement (RM2.04 rising to RM2.14) is enough to yield a 42% payout.

But of course, everything has a catch. In GCB-CL's case, it's awfully illiquid. Gumption is needed if we were to build up a meaningful position in this.

The other little problem is that GCB's stock sometimes swings like a mother.... you know.

The cross below shows a huge one-day swing in the stock - a 12% movement between trough and peak. And of course the warrant moves proportionately. These are the risks we have to live with.

Now comes the technicals application. It's part tactical, and part contrarian. We absolutely had to enter the market when the stock is weak or unenticing, not when it's in the green. You can try doing this; it's not easy.

So we made a conscious decision to buy into GCB-CL when the mother share seems to be at a weak point during the day; this essentially means when it's close to break-even point or even better, when it's in the red.

The protocol for us was simple:

1) All the stock has to do is not fall below RM2.
2) There's a channel (shown above) between RM2 and RM2.10 where we should ideally finish any buying we want to do inbetween these points.
3) Wait for signs of incremental upward movement before fully committing.

We got 250,000 warrants at the start, on April Fool's Day.

We then upped the ante a bit by buying another 100,000 warrants at an average price of 5.3 sen on 6 April. After that, we supplemented the position with small lots only, just to see how far it can go.

In the days subsequent to our first purchase, we patiently (somewhat anxiously) waited for a positive sign. This came in the form of stable movement in GCB, and incremental movement upwards in the stock. Exactly what we wanted to see.

As you can see below, the second purchase was initiated when GCB breaks out of the channel. We thought of it as a teaser of what was to come.

And the breakout happened, giving us ample time to consider an exit.

So the whole trade was wrapped up in 12 days.

When we began formulating this trade, we initially wanted to hold on to the position for longer term, effectively making it an investment. But we decided not to.

The movement in the markets at the time unnerved us, and since we had no clue whether the market will reverse or go up forever, we had to consider the payoff.

34% yield in 2 weeks? Hard to turn down.

Is GCB stock still volatile and high risk? Oh yes. It can suddenly fall 20 sen if conditions are not favourable, and we'd have risked too much on the line.

Perhaps we had sold too early and the warrant is set to go to 20 sen. Or perhaps we timed it right. Either way, our views revert to neutral once a trade is done.

We still think GCB is a great long term investment proposition, but if there's a recession coming, we would not want to stand in front of that freight train. 

We have traded the same stock seven months apart. Hope to revisit it again sometime.

In the two weeks following our trade, GCB looked like weakening, and then it shot up again.

And you know what? I think we just changed our minds again....

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