A call warrant trader's diary
Part I : Who the Hell Fills Up at Petron?
Don't worry, this is not going to be a deep dive into
the fundamentals and cash flows of refinery companies. It's just a full,
uncensored, transparent account of my experience with two of last
year's biggest gems : Petron Malaysia Refining & Marketing Bhd and
Hengyuan Refining Company Bhd.
Let me start with a bit of background : At the start of
2017 I was completely biased towards an oil price recovery scenario.
I'd love to buy a fundamentally sound oil and gas company, but there
didn't seem to be any. For the most part, anybody involved in the
upstream segment was still royally screwed. The lag time between crude oil's price recovery and the demand for upstream drilling services is too long (I've read and written
many wishful thinking-type stories on this very subject). Or you may
count on Petronas as a long term benefactor, but your earnings are
constantly sucked into a debt-servicing vacuum.
So who are the oil and gas players who can maintain
stable earnings in a benign oil price environment but can quickly report
fantastic earnings as soon as oil prices rally? It's the refineries.
As an added bonus : were refineries deeply unloved by
investors at the beginning of 2017, as shown by their single-digit PE
ratios? Were they being completely ignored by analysts who were averse
to being bold?* Yes and yes.
I was enthralled by Petron's potential. Its 4QFY16
results announcement on February 22 caused a spike in the share price
the next day : it went from RM4.50 to a peak of RM6.48. The price then
stagnated for about a month (the stock prices have been adjusted to
reflect dividend payouts during the year).
During this time (of stagnation), I thought long and
hard about initiating a position. About half of its FY16 earnings came
during 4Q alone, and it was ten times the 4QFY15 earnings. Their
respective revenue and gross profit figures suggest that the earnings
recovery was real. And this was a single-digit PE company that paid
dividends during the bad times!
March 16, 2017 entry on my trading journal.
1) The sloppier the handwriting, the more excited I am about a stock.
2) My best preliminary layman analysis at the time : 'they refine oil and sell it'.
3) The earnings recovery puzzle : did an extra
10,000 people a day started filling up at Petron stations in 4QFY16? Who
knows. One clue was that they reported higher sales during a quarter
where the government set petrol pump prices were higher compared to the
same quarter the year before.
After a slightly more thorough due diligence process, I was confident that a rally of at least 30%
is realistic - this is a prediction that Q1FY17 numbers will reflect a
continuation of the 4QFY16 recovery trend. I'm aware of what the
technical analysts are thinking - they will say that the next 'points of
interest' are at RM6.48 (the recent peak) and RM6.70 (the previous peak
in 2016). I began accumulating a cheap call warrant, Petron-CC, when
the stock was trading at around RM5.70.
Ignore the technical analysis. My parameters for this
trade were very simple. It only needs to rally beyond RM6 and stay above
that point over the next two months. That's only a 5% increase in the
stock. At that 5% gain level my call warrants would already be
profitable - from that point on I can stay with the position and rely on
the profit buffer. But Petron's stock has to rise over this two-month period, or time decay will start affecting Petron-CC's value.
My deadline for this trade to work was the next
quarterly earnings (since this is a one-quarter thematic play). And my
conviction was strong enough that I accumulated a massive position
gradually; a one sen move in the call warrants translates to a RM2,800
profit/loss. I finished buying by April 1.
By May 15 Petron's stock hit RM8.70 - a 52% increase. I hit the jackpot, but I made a pretty big mistake during this time.
Wohoo?
I failed to stick to my own plans - a typical human
failing. Instead of selling just before the 1Q earnings (sell on news;
trading interest wanes once the anticipated material information becomes
public), I decided to stick beyond May. I convinced myself that the
warrants can weather any short term decline post-earnings and continue
to rally further. Petron's price did recover but I was betting on the
wrong horse (warrant) by that point.
May 26 journal entry. By this point I was trapped in a big position as the warrant plummets.
As expected, there was an immediate decline in the
stock after its earnings release (the numbers were excellent). It fell
from RM8.67 to RM7 in a month - a staggering 20% decline. I then failed
to remember that a volatile stock translates to a much more volatile
warrant. My holdings fell enough to cut my profits by a third. Note that
the warrants never followed Petron's trajectory thereafter. It
stagnated until its September expiration date.
This was the end result. I wasn't complaining, but it's
normal to feel like an idiot when you threw away thousands of ringgit
in profits. In other words, good planning, but terrible execution.
Some RM9,000 in losses were subtracted from this final net gain figure.
By this time (June), the market has begun paying
attention towards refineries. Petron continues to rally towards RM9 by
August. By then I knew there will be further opportunities to trade.
Part II : Hengyuan Emerges.. and FOMO Strikes!
If you're still reading at this point, I'll reward your
tenacity with a brief fundamental background on Petron. It currently
has the third biggest market share in the country (from zero brand
recognition in 2012), it opened more stations than any other brand in
2015 and 2016 AND 2017, it counts on its big Filipino parent group for
support, and it's an integrated downstream player (they refine, sell,
and distribute the oil to their Petron stations).
The company owns the bulk of the stations after taking
over Mobil's sites, but they also have a franchisee program that offers
better rates for vendors than Petronas. Their improved sales numbers
seem to come just from having more stations and having better brand
recognition among customers - aside from improved selling prices.
Geographical focus must have helped too - they focus on underserved
locations in states like Johor, Pahang, and Kelantan, not the Klang
Valley.
You get the idea.
However, having retail and distribution activities as
well as new station openings involve substantial and ongoing
non-refinery related capex commitments (it's easier to calculate a
5-year capex when you're just building/upgrading a refinery). Lower
gross profits from these other operations can eat up into the fantastic
margins reported by Petron's refining and sales activity. So you'll
likely get lower gross profit margins at the group level.
So if you really only care about the refinery angle,
the solution is to buy Hengyuan shares. They just do refining and sales,
and the Shell Group buys their stuff under a long term agreement. It's
owned by a Chinese company who bought a 51% stake for the low, low price of RM1.92 a share. On paper the Chinese are currently sitting on a 750% gain in less than two years.
This is all Hengyuan needs to keep doing : take care of the 'products' and the 'pipe'.
'Pure play' (focus on one thing only) companies like
Hengyuan promises higher profit margins than integrated players like
Petron because its commitments are more concentrated (build refinery,
maintain refinery, increase production capacity). They don't have to
spend ever-increasing amounts of money on building and operating petrol
stations.
I've had a cursory look at Petron's and Hengyuan's
respective refining operations and their average production capacities;
assuming they're selling the same type of refined products, their gross
margins from refining during a typical quarter should be similar.
It's the other stuff that eats you up - old capex, new
capex, forex hedging, anything. Petron also does not disclose an
earnings breakdown of their refining, retail, and other operations. In
each of the past three financial quarters, Hengyuan's profit margins
have been consistently better than Petron's.
I just wanted to mention the oil price recovery theme
in all of this, but beware of how boring the following sentences are :
Improving oil prices are generally good for refiners up to a point ; it
depends on their crack spreads.
Another variable for these companies is stockholding gains ; higher oil
prices translate to higher inventory values on all the stuff they store
in their tanks. To reflect improving oil prices, they can recognise the
quarterly increase in inventory value as part of their profits. Their
selling prices are based on global benchmarks, so a short term supply disruption globally can be good for these guys, even if they predominantly sell oil in the domestic market.
Anyway, Hengyuan has rallied alongside Petron since March, but it didn't
have a call warrant. Only in August did one investment bank issue
Hengyuan-CA and a few other call warrants, and the market went nuts.
External factors didn't seem to have led to this - Brent crude prices
were still languishing in the 50s.
Whether by luck or design, the stage was set for
speculators to demonstrate their FOMO - they simply can't afford to miss
out on another Petron. Hengyuan was hit with a market query
just a couple days before Hengyuan-CA was listed. It ensures that the
first day of trading on August 2 will be crazy, and so it was.
Hengyuan-CA went from 38 sen to 74 sen in two days, or a 138% gain.
Speculators, syndicates, crooks, and investment bankers rejoiced (I'm
not saying you can't be one but not the other...).
I had a bout of FOMO too - a typical human failing. So I
bought some Hengyuan-CA for short term trading. Plus, I had Hengyuan in
my watchlist since March - I was preparing myself to trade this thing
for about five months, or so I thought.
It turned out to be a very good investment indeed! By
now you may have noticed that Hengyuan-CA is worth around RM1.25. That's
a 300% increase in about four months.
This was the outcome of my trade in September:
It's like owning bitcoin in 2013 and selling it in 2013.
So what happened? The simplest explanation is that I
bought it and sold it at the wrong time. I did not have the confidence
to stay invested and my timeline for the trade was all wrong. The
warrant remained flat at 30 sen for about two months with no recovery in
sight - until November when it skyrocketed. I understood the
fundamentals and the sentiment behind Petron, but I failed to do the
same kind of due diligence on Hengyuan. It's just hubris - you think you
know so much, but you don't. The lesson here is : do your homework.
The whole experience taught me the value of having real convictions and sticking to what I know. In this case, it was Petron.
Back to August 2017 : the mania in Hengyuan warrants
(Hengyuan-CA was just one; CB, CC, CD equally went nuts) sparked a
resurgence in Petron call warrants. The stock has well and truly
recovered from its post-earnings lows and the upsurge in sentiment
toward Hengyuan is benefiting Petron. I should note that in this
situation this is a sentiment trade, it is strictly not a fundamentals-backed trade - I'll explain this strategy another day.
I anticipated this and quickly bought some new Petron
warrants (Petron-CC was too close to expiry). The end result from a
trade lasting 20 trading days:
The second lesson is : stick to what you know and
understand. Also, there are few clean outcomes in investing or trading.
But you'll come out ahead if your gains (correct analysis and optimal
execution) outweigh the losses (sheer foolishness).
* By this time it's not a bold call anymore.
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- Everything you need to know about structured warrants can be found on Macquarie Malaysia's excellent knowledge portal : https://www.malaysiawarrants.com.my/home
- Search for all currently available structured warrants on Bursa Malaysia on N2NConnect's database : https://plc.asiaebroker.com/NSS/warrant.jsp?from=G&to=H&rate=300&
- i3investor is the best source for market chatter on all Bursa Malaysia stocks : http://klse.i3investor.com/index.jsp
- I use iTrade@CIMB
for all my trades (stocks and futures). Their online trading interface,
price charts, real time P&L calculator and broker execution are
second to none : https://www.itradecimb.com.my/index.php?ch=st&pg=st_prod&ac=1
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Dislaimer : This is
an investment newsletter outlining my market views on trading, Bursa
Malaysia, economics, global markets, currencies, and other financial
topics. On a regular basis, this will be an outlet for expressing
somewhat contrarian views backed with some empirical research and
personal market experiences. From time to time, I will also share the
progress of ongoing trades and what I think of them, but they should not
be construed as stock tips.
I hope to provide thought provoking content and
investment ideas which you may not find elsewhere, as well as some that
you may vehemently disagree with. Feel free to berate me with your
thoughts and thanks for reading.
Brief background on the author :
I'm a finance journalist who has worked with The Edge and StarBiz, two
of Malaysia's top business publications for a number of years. I started
out as a remisier, but I'm glad to say I was a terrible one (don't take
your remisier's advice seriously; your economic incentives are
misaligned). I've been trading for about four years, although my focus
is more on longer term holdings nowadays instead of day trading.
I'm currently based in Hong Kong working on bank risk management practices and European financial market regulations. Look up my professional profile here
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