Bearish on iShares MSCI Philippines (EPHE)

In early November 1991, just five months after the devastating eruption of Mount Pinatubo, typhoon Uring struck the Eastern Visayas with heavy rains and winds that caused Ormoc, Leyte’s capital, to be struck by a catastrophic flood like that produced in Tacloban by the tidal surge from typhoon Yolanda (Haiyan). In the case of Uring, thousands of homes were destroyed and 4,922 people died. Deaths from Yolanda have already exceeded the fatalities from Uring. As of November 22, the government listed over 5,600 dead and missing, about a million homes destroyed or damaged, and damage to the majority of the area's coconut trees and wide-spread destruction of the rice crop.

Four years after Uring recovery in Ormoc was still proceeding and recovery from Yolanda will be as slow or slower because:  

1. The Philippines has the lowest percentage of paved roads when compared with neighbors Indonesia, Malaysia, Vietnam, Thailand and Singapore, according to 2010 data. It also had the worst scores in other key indicators such as fixed phone lines, households with power and electricity lost in transmission. Poor infrastructure will delay rebuilding efforts. 

2. The Philippines is the country that’s most at risk to natural hazards, according to UK-based risk analysis firm Maplecroft. The country loses $1.6 billion dollars a year on average each year because of natural disasters, according to the Asian Development Bank. The effects of typhoons are increased by the inability of Philippine agencies to address chronic environmental issues such as deforestation, soil erosion and water pollution are heightened by frequent typhoons.

4. Crony capitalism and corruption are endemic. Awarding contracts to non-existent contractors and fake NGO's wastes millions in government funds each year. The judicial system vulnerable to political influence and corruption. Corruption and political instability result in pessimism in investment. 

5. Sectors of Filipino industry (such as banking, telecommunications, and property development) are almost entirely monopolized by a few elite families. In 2012, Forbes Asia announced that the collective wealth of the 40 richest Filipino families grew $13 billion during the 2010-2011 year, to $47.4 billion--an increase of 37.9 percent. Filipino economist Cielito Habito calculated that the increased wealth of those families was equivalent in value to over 3/4's of the country's increase in GDP at the time. This income disparity is the highest in Asia.

6. Overall national poverty statistics are high; according to UNICEF 32% of children under age 5 suffer from malnutrition, and about 60% of Filipinos die without having seen a healthcare professional. In 2009, annual reports found that 26.5 percent of Filipinos lived on less than $1 a day -- a poverty rate roughly the same level as Haiti's. This leads to low domestic private investment.

7. Local government units (LGU’s) are widely perceived as corrupt particularly by those living in other parts of the country. (In 2012, Transparency International gave the Philippines a rank of 105 out of 176, tied with Mali among others.) Tax revenues will drop particularly in affected areas. 

8. The country suffers from low levels of investment: the Philippines' investment-to-GDP ratio currently stands at 19.7% compared to 33% in Indonesia and 27% in Thailand. Small and medium enterprises (SMEs) account for roughly 99% of Filipino firms but SME's only generate 35% of GDP. The Philippine economy is strongly dependent on remittances from millions of overseas Filipino workers. This exacerbates skill shortages in technical areas.

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Chart looks good for Barnes and Noble...

The run-up to tomorrow's BKS earnings announcement

Excerpts of Nov 16th 2013 Economist Article on Political Resistance to Helmets

Biking without a helmet...No brainer    During the 2013 legislative session, 19 bills were introduced in 11 states to repeal all-rider helmet laws. None passed. Appeals to thrift can take some of the credit. For years, helmet-advocates stressed human suffering when giving evidence to state legislatures. Now they also stress costs to taxpayers. Libertarians often demand: “Let those who ride decide,” says Jacqueline Gillan, who heads Advocates for Highway and Auto Safety, an insurer-funded lobby group. Her retort is: “Let those who pay have a say.”

When states repeal or weaken motorcycle-helmet laws, as dozens have, helmet use falls, fatalities rise and head-injury hospitalisations soar. Biker deaths rose 18% after Michigan repealed its all-rider helmet law in 2012. A rule obliges unhelmeted Michigan riders to carry at least $20,000 in medical-payments coverage. That does not even cover initial stabilisation in intensive care after a nasty crash... Deaths-per-bike-mile rose 25% when Texas scrapped helmets, for instance. In Washington Tom Petri, the Republican chairman of the House of Representatives committee that oversees highways, wants the CDC to stop researching motorcycle safety. The agency seems to have “an anti-motorcycle agenda”, he growls. Asked about accidents involving the helmetless, he says: “I don’t think there’s that clear a correlation.”

Harley-Davidson: A Luxury Company

To assert that Harley-Davidson should be understood as a company that sells luxury items is to make an surprising claim for a company that has always played the populist card. However, as the company’s marketing is primarily based on presenting customers with the opportunity to display ownership of a product with a unique history and mystique the company has met the primary characteristic of a luxury brand. The company is certainly aware of this as can be seen by their exploitation of a product with a long-standing and unchanging sound, design and iconography. In addition, the company is always reinforcing the aspects of the motorcycles that create and preserve an emotional connection to the brand. Notably, Harley-Davidson does not primarily compete in the areas of product quality and technical engineering.

Two definitions of luxury as “something inessential but conducive to pleasure and comfort” and something expensive fit the company’s motorcycles. In fact, although I would argue that the public display is the dominant value that Harley ownership provides; other luxury attributes are also present in Harley products. For example luxury brands (e.g. airplanes, yachts, etc.) may have a group that is exclusive to owners. So we have the Harley Owners Club, similar to the Rolls-Royce Enthusiasts' Club, both sharing a penchant for anniversary celebrations, historical memorabilia and owner and museum collections. Also, Harley-Davidson’s use of limited editions, special series, but especially customization as a way to build a sense of exclusivity is standard fare for luxury products such as watches and sports cars.

Another attribute of luxury brands is a non-utilitarian focus. With the company’s bikes it is sufficient to merely own one and use it occasionally for social events. Whether diamonds or motorcycles, function can take a back seat to mystique.

Where Harley has a problem as a luxury brand is in the creation of scarcity, that distinctive feature of many luxury goods. In the early 2000’s the company could not keep up with demand and the wait for delivery became part of the experience. Now, however, the factory is not running at capacity and the company would love to bring scarcity back as part of the brand. Although this would eventually dilute the brand (imagine Harleys everywhere), unfortunately customers have become as scarce as bikes were ten years ago.

How should investors value such a company that makes luxury goods to a slowly declining customer base? If we factor out any prospects for growth the company’s value is very sensitive to P/E, borrowing costs, discount rate and free cash flow projections but my current estimate is that somewhere in the range of $25-$30 for 2015. After that, we shall see.

Idea Mechanic Report: Analysis of Harley-Davidson's Latest 10-Q

CLICK HERE for the latest H-D Report

CLICK HERE for the October H-D report.

An Aging Company Selling an Aging Product Tries Again to Broaden its Appeal.

Harley-Davidson announced the other day that they would make another attempt to attract a few customers from their rivals, e.g. Honda, Suzuki, Yamaha, BMW etc. The super-heavyweight bikes that H-D sells are facing a declining customer base, particularly for new bikes (between dealers, E-bay, craigslist, etc. there are hundreds of thousands of used Harley's for sale).  So, management has decided to try to sell a "lighter" bike (“These new bikes are leaner, yet still have a mean streak,” Mark Hans Richer, a senior vice president at Harley-Davidson, said in a statement. “They’re the real deal, made of real steel.”)

This attempt to attract a new customer base was tried before: in 1998, the Buell Motorcycle Company became a wholly-owned H-D subsidiary. This infusion of technology allowed H-D management to bring out the Buell Blast in 2000. It was, at 360 lbs and with a 492 cc engine, management's idea of an entry-level training bike and was used in H-D's "Rider's Edge" rider instruction schools.  However, the Blast (and other Buell models) never sold that well and under the cover of the 2008 financial crisis, in late 2009, Harley management shut Buell down. In a rare show of humor, H-D released an ad in July 2009, showing a Blast destroyed by an automobile crusher.

Yet this 10 year Blast experiment (selling a lighter, sportier bike for first-time purchasers) is now going to be repeated with the Street 500 and Street 750 models. Before marketing even begins, one  obvious problem with this approach is that a 500cc bike is too powerful for beginners...so who is going to buy it - certainly not riders in the market for the more sophisticated Japanese models. And it's unlikely that this bike can find much traction in the already mature Indian motorcycle and scooter market.

Redline of last two 10-Q's from Harley-Davidson

Here's a comparison of the company's last two 10-Q's. The red lines show the deletes and the blue text is new.

https://drive.google.com/file/d/0B4T33oZTuT6CcmFiVGx6N0pQcG8/edit?usp=sharing