Investment Loss - IDT (Consumer Electronics - HK based)

Price @ 25/11/05 - 88 cts
Book loss - 48.5%

My first investment in IDT was made in 30 Jun 2000 @ $2.57 . In between the years, I bought and sold the stock and the lowest price was bought at $1.10 on 26 Oct 2001. Net investment loss was $401.06 for the trading while dividends earned was at $1,695. Adding back the investment loss, my average price for 3 lots would be $1.83 and if less dividend, would be $1.26.

Attracted by its high dividend yield and huge cash reserves, I had held this stock through the difficult years from 2001 to 2003 during which the profit declined 39% and finally reached a turn-around in 2004 profits by rebouncing 28%. The share price also hit the low of around $1 during the period and hit a high of $2.64 in Nov 2004 with recovery in results coupled with share buy-backs. Being blinded by the high dividend yield, I ignore even my own calculations of the intrinsic values of only $2.04 and $1.67 as of Feb'05 and Aug'05 (fell by 18%) which had reduced my margin of safety significantly. What I should have done is to reduce my stake to preserve my capital. I'm the main culprit as I did not want to affect my dividend projection next year!

I thought the Chairman, Raymond Chan, was a savvy businessman, having listed its parent in HK bourse and subsidiaries IDT & another co. (can't rem its name) in SGX. The latter was later privatised at a price substantially lower than its NTA (if I rem correctly, it has always been trading below its NTA) although its NTA was largely backed by cash. My impression of the management of IDT was that it has good finanical discipline as evidenced by high cash reserve w.r.t. to its equity.

IDT had consistently high GP of above 30%, average margin of above 15% and ROE of between 16% to 22%. The first sign of weakness came in for its results in 2005 when the sales hit a all time high of more than HK 1B but the profit was stangnant. Its 1QFY06 results was still comparable to 1QFY05 although the sales declined by 7.2%. It did give a warning in the 1st Q announcement as follows:

"The directors expect the second quarter profit to be significantly lower than the comparable period last year because of decrease in the sales orders and lower margins arising from a change in product mix and rising material and labour costs."

Why I didn't heed its warning and cut some? I was too hopefully that the management might be overly conservative in above. Perhaps, this could be due to the fact that in 2003 & 2004, the actual results did exceed my expectations despite the management informing of the challenging conditions. I thought 2QFY05 was an exceptionally good period anyway, and I had factored in a 47% drop in profits. However, a bombshell (at least to my forecast) dropped! 2QFY06 profits fell by a massive 95%. At the same time, Mr. Alain Jacques Gilbert Li, an Executive Director as well as the Chief Financial Officer, the guy we familiar with as the spokeman for results briefings, resigned!! Could he be the guy being blamed upon? At the holding company level, there have also been resignations of several directors. Could there been internal strifes?

The biggest mistake I made was not realising that the holding company has not been doing well for recent period, in fact, suffering worsening losses. As a OEM manufacturer for Oregon Scientific, how could IDT not affected by the dismay performance of its parent? Also, from my reading of the Fy05 annual report, I think there was something about the long term fixed deposits being tied with movement in interest rates (to investigate further). Could this be gone bad due to rising interests?

In 2QFY06 annoncement, there seem to be problem with tax for one of its subs from 1990 t0 2004 with HK authority. No provision have been made and alot of seemingly uncertainty.

The directors also expect the third quarter profit to be substantially lower than that for the comparable period last year because of the decrease in the sales orders and lower margins arising from a different sales and product mix.

Could IDT fall into red in next Q? The chances may be more than 50% judging at how things deteriorated in Q2 and at its parents.

The company skipped its interim dividend of 3 cts this time, which have been maintained for past few years despite the ups and downs. No share buy backs have been done at 88cts, compared to last year buy back price of more than $2.20. This is a bad sign... or is the management just conserving its bullets to tide over this tough period?

What should I do? Should I sell, hold or buy somemore????

One consolation is that the company is generating high operating cash. Even after the payment of last year's dividend, it's cash stood at HK$321.8M or S$70.1M i.e 39.9 cts/share. Its NTA @ Sep 05 of HK$3.91 or S$0.85 will provide a support at current share price.

Options:
1. Sell? Too late to sell!! Should have sold at the 2Q results, at least the one lot bought at $1.10 to be on the safe side. I have not done enough research on 1Q results that caused this great loss.

2. Hold? Yes, I guess this might be the best option now, although there is still risk that share price may drop further.

3. Buy somemore? It will depends on whether there is going to be a turnabout soon or unless share price drop to about the cash/share level. Unless there is a huge loss for current FY (should be less than 50% chance), the cash would not disappear over night. In summary, mistakes learnt

1. Understand the nature of business, in consumer electronics, the trends are fast changing (hence IDT invested alot in R&D and new designs) and could be cynical (which is evident by the 2001-2003 performance)

2. Be aware of deteriorating fundamentals - decreasing GP %, introducing more products than ever due to shorter product life span

3. Understand the business implication with related company (e.g. IDT as manufacturer of IDT HK marketing company) and look out for news about its associates esp the parent company which is listed. There were already signs that the parent were not doing well

4. Don't be greed by the dividend yield, it can disappear overnight by bad results. Don't be constraint by the dividend yield, preserving capital is more important. Divestment may reduce dividend in short term, but redeployment of capital to other safer stocks more yield more in the long run.

5. Be vigilent of the margin of safety. Do not pin too much hope that the price can substain at very high level without vast improvement in fundamentals. Are you overly optimistic?

6. Take management warning seriously and investigate. Do you know more than the management? Reduce investment gain is always better than loss in capital.