GRP – Analysis of Purchase Part 1

This is not meant to be a long rambling post and in-depth analysis of GRP Limited, though of course any justifications and basis for my purchase should be rendered in at least enough detail to provide readers with sufficient information about the company and its merits/demerits to enable them to delve further on their own. I had set out to look for a company which provided good and steady yield, instead of a combination of yield plus growth, and GRP stood out with its fundamentals, boring but steady business and strong Balance Sheet and dividend policy. Note that since GRP can be classified as a dividend yield company, I will not go into too much details on the prospects and future plans section, as these are as yet unknown anyway and cannot be articulated with any clarity.

Background (taken from GRP’s website)

GRP stands for General Rubber and Plastics Limited. The Company was established in 1977 as a supplier and manufacturer of high-end quality hoses and fittings for the marine and oil and gas industries. In 1990, an office and production facility at Tanjong Penjuru Crescent, Singapore was acquired for the purpose of machining, fabricating and warehousing Hose & Fittings close to our customers.

In 1993, Region Suppliers, an international supplier of Precision Measuring Instruments, was acquired as a wholly owned subsidiary of the GRP Group. In the same year, GRP (China) was formed to take advantage of the opportunities being presented in China, particularly uPVC Pipe and Fittings Manufacturing for the local construction industry. The Company is also Master Distributor for brands like Dunlop, Goodyear and Elaflex.

In 1996, construction of an 11,000 square metre Industrial & Commercial Office Facility in Singapore was initiated. It was completed in 1997.

The Company thus has 4 main divisions as follows:-

1) Hose and Marine
2) Metrology and Measuring Instruments (Region Suppliers)
3) China’s uPVC Pipes and Fittings
4) Industrial and Commercial Property Leasing

I shall do a cursory review of GRP’s financials, without going into nitty-gritty specifics for each of the three statements (refer to summary table and trends table). Next, in Part 2, I will be providing some numbers on the performance of each business division by revenue, as well as a breakdown of the gross margins and net margins for each division, based on information gleaned from historical Annual Reports provided by the Company. I had to request for the older annual reports to be mailed to me (e.g. FY 2005 and FY 2006) as they were not available either on SGXNet (which keeps only the last 3 years’ annual reports FY 2007 to FY 2009), or the company’s website (which is spartan, to say the least). I shall, at the same time, try to squeeze in some information on the dividend history of the Company. Forgive me for not doing much competitive analysis as I was concentrating more on their revenue trends, divisional reputation (to be elaborated on) as well as their financials.

Financial Review and Analysis


From the table above, revenues have shown remarkable resilience over the years, through booms and recessions. The 8-year analysis shows that revenues have hovered around the S$20 million to S$30 million mark for all this time, averaging about S$27.6 million over the 8-year period under review. Considering FY 2002 till FY 2009 included part of the dot.com bust, SARS and the fallout from the sub-prime financial crisis, this represents a very stable and consistent pattern of revenues for the Company, and says a lot about demand for its products and services. The numbers imply that demand does not fluctuate much with economic conditions and that their products are “staple”. Of course, one must also see if gross and net margins can hold out in spite of almost constant revenue levels, and I will explore this in Part 2 of this analysis of purchase.

Overall gross profit margins have been rising in the last few years, but that is mainly due to the recent sale-and-leaseback deal inked in 2007 whereby GRP sold their 16,000 square metre industrial office facility in Bukit Batok for a period of 3 years commencing April 19, 2007. This lease ends on April 19, 2010 and will NOT be renewed, thus the cash flows from this division are likely to run dry in FY 2010 (the company has a June 30 year-end). In spite of this, it is clear from the Balance Sheet that the company is oozing cash from its ears, as evidenced by the very high current ratio of 4.77 as at June 30, 2009. As to what Management intends to do with this cash hoard, it is unclear but they will be looking out for suitable M&A opportunities to enhance the Group’s top and bottom-line. In a way, it is good that Management are taking it slow and steady while looking for a target. At most, if none is found, then the excess cash can be paid out as a special dividend to shareholders.

Notice too that the Company had ungeared itself since FY 2007, when it performed the sale and leaseback transaction for its Bukit Batok property. In spite of this, its return on equity has remained high for the last five years, with the most recent FY 2009 registering a commendable ROE of 17.5% (without debt!).

11-Year Trend Analysis


From the above table, it can also be seen that revenues display surprising stability in spite of the many ups and downs in the local and global economy. However, one should note that the Company had been making losses from FY 1999 till FY 2001, and only turned profitable in FY 2002 onwards. FY 2004 saw a blip because of a write-off due to impairment loss of S$2.4 million on their industrial property, but which otherwise would have been a profitable year. Other than the anomalous FY 2004, FY 2005 till FY 2009 has seen comfortable profit levels.

A glance at the above table also reveals that cash has been building up since FY 2002 (no records prior to that). Of course, bank loans were also very high at S$17.3 million in FY 2002 and it was only with the sale of the property in FY 2007 that ALL debts were cleared, and the Company stood in a net cash position of S$10.3 million (or about 7.36 cents per share). Subsequently, the cash built up to S$13.6 million or about 9.76 cents in FY 2009.

Trade Receivables has not gone up noticeably over the years; in fact it has even gone down a little which shows that collections are healthy. Inventories have built up steadily over the years and this may be a potential cause for concern in time; but so far cash generation ability has not been hindered or hampered by this slow buildup, so it could be attributable to holding a larger range of products to service customers.

Cash Flows


The reason for a special section mentioning cash flows is due to the consideration for this purchase, which is focused mainly on sustainable high yield. At my purchase price the historical yield works out to be 10%, and it is my job to ensure that the factors are present to justify that this yield is sustainable for the foreseeable future.

Operating cash flows have been positive for every single financial year since FY 2002, which is very rare for a company. Another noteworthy aspect is that Free-Cash-Flows (FCF) has also been consistently positive for the last 8 financial years, and lends strong credence to the belief that this trend will carry on as the business of the company is essentially unchanged and they still occupy a niche market. Cash outflows for financing activities for FY 2008 and FY 2009 consisted ONLY of payment of dividends, so it was an extremely clean Cash Flow Statement which greeted me when I first saw it and it caught me by surprise. Notwithstanding any unforeseen and major event occurring which may adversely affect the Company, it is reasonably safe to say that the Company can and will continue to generate FCF every financial year, and be able to maintain or even increase its dividends moving forward.

Part 2 shall continue on with some business unit analysis, and end off with a simple summary of my purchase decision.

Boustead – 1H FY 2010 Financial Analysis and Review Part 2

Part 2 of my analysis of Boustead will focus on their revenues by division and also each division’s PBT margins. Boustead has now provided shareholders with the breakdown of PBT by division and how each division is doing in terms of profitability; which is good because it helps us to evaluate how well each division is doing in terms of profitability and not just based on growth in revenues. Efficiency is an important aspect of a company though it often escapes notice; and some companies do not stress enough on profitability but tend to harp too much on revenue growth alone, which I feel is totally missing the point.


Divisional Revenue Analysis

As can be seen in the table above, Engineering Services managed to grow divisional revenues by 15.9% for 1H 2010, and this constituted 83.7% of total revenues compared to 80% in the previous period. When one looks more closely at the breakdown, it becomes apparent that the increase was due mainly to a 70% increase in revenues from the real estate solutions division, whereas the other two divisions of energy-related engineering and water and wastewater engineering posted fairly steep declines in revenue. Geo-Spatial, being Boustead’s cash cow, managed to keep revenues fairly steady as most of their contracts and customer base consists of governments and municipal townships, hence this is a stable market which will not be much affected by the global financial crisis. In fact, the 9.2% dip in revenues for this division could be almost solely attributed to the weakening of the Australian Dollar against the Singapore Dollar (which has by now reversed).

For Energy Related Engineering, apparently queries have been coming in rather slow according to the company, as oil and gas companies tighten on their spending for E&P amid a backdrop of tight financing. Negotiations are taking longer to conclude and contract size has also shrunk, with the last announced contract on November 10, 2009 being just S$14 million. Prior to this, there was a contract announcement as far back as July 27, 2009 (nearly 3.5 months gap) worth S$27 million. If one looks even further back, Jan 12, 2009 was the date of announcement of 5 contracts worth S$64 million (implying each contract is worth S$13 million on average). From this evidence, it seems the contracts for BIH and C&E are only coming in sporadically, and so far for 1H 2010 has amounted to only S$54.3 million of revenues compared to S$73.2 million for 1H 2009. Another problem is that of Boustead Maxitherm – it seems to be going through a never-ending period of “re-structuring”, which I have read about in almost every Boustead announcement so far. This begs the question: what exactly is going on with Maxitherm and why is the restructuring taking so long? So far no answers are forthcoming from the Management on this, and is something to raise up during the next AGM as it is dragging down the performance of this division.

Water and Wastewater Engineering Division (represented by Salcon) was dismal once again, registering revenues of just S$7.9 million, a 53.3% drop against S$16.9 million in the previous period. The reason provided was that revenue recognition on existing projects was “slow”, with another ominous announcement that the S$175 million Libyan Water Project (of which Boustead had taken a 65% stake in) has met with teething problems due to disagreement with the client’s consultant and hence may not even proceed. It was originally slated to be completed by 1Q 2011 but seeing how things are moving, Salcon may have to give up recognizing any revenues on this entirely. From these developments, one must start asking if the effort involved in turning Salcon around is akin to flogging a dead horse; for it has been nearly 3-4 years of restructuring and selling off unprofitable aspects of the business and yet the division has yet to show a profit. While FF Wong has been candid and up-front about this persistent failure to turn this division around, he nevertheless doggedly hangs on and expends considerable effort in realizing his dream of having 4 profitable divisions within Boustead, instead of just three. My feel is that without a strong competitive edge, it may be very tough for Salcon to secure significant contracts with high enough margins to ensure a turnaround. Recent unfortunate developments have further exacerbated the old problems and dampened shareholders’ hopes that a turnaround can be achieved in FY 2010, even though Management sounded a note of optimism.

For the real estate solutions division, it is helmed by Boustead Projects which is 91.7% owned by Boustead Group, as well as the newly formed Boustead Infrastructures which is in charge of the S$300 million Libyan Township Project in Tripoli, Libya. This division registered a very healthy growth of nearly 70% in revenues from S$78.2 million to S$132.9 million, and this was largely due to increased completion of the Libyan township project (about 1/3 done), rather than Boustead Projects securing more Design and Build Projects. In fact, in the next section, it is revealed that PBT margins actually fell even though revenues surged, probably due to higher costs involved. If one takes a quick glance at recent business developments for Industrial Real Estate Solutions, one would notice that so far for 2009, Boustead have been awarded just 3 projects; as compared to four each in 2008 and 2007. Management has also reiterated that FY 2010 will not see a sale of leasehold property, and so profits will be lower solely due to this as there had been a sale of at least 1 property in each of the last five financial years. More will be discussed in Part 3 regarding the prospects for this division.

Geo-Spatial is the only division within Boustead which is not contract-based, and represents the Group’s cash cow as it has steadily growing revenues, a captive customer base and high margins. The technology is used by Governments for satellite mapping and 3-D event modelling and ESRI Australia is in charge of marketing the software in Australia, while ESRI South Asia markets it to the rest of South-East Asia. The revenue decline was minimal in this case due to the factors described.

Analysis of Divisional PBT Margins


From the table above, it clearly shows that while some divisions seem to be doing “worse” compared to the previous period, in terms of PBT margins they are actually better off. This is why an analysis of revenues alone is insufficient to determine the strength of each division and also to assess its potential moving forward. Though trend analysis for margins can be used to project and extrapolate into the future, one must take note that changes in business and operating environment can result in changes in PBT margins which may either surprise on the upside or downside.

For Energy-related Engineering, though revenues dropped 25.8% PBT only fell a modest 4.6% and PBT margins actually increased from 11.9% to 15.3%, which is positive news. This implies that though the Group was taking on lesser projects as a result of the global financial crisis causing negotiations to lengthen and some clients to defer spending, they have managed to make up for this by reducing costs on the projects which they did take up; and probably this was as a result of stringent cost control and definite guidelines on which projects to accept or reject.

Water and wastewater engineering was a major disappointment despite the repeated promises by the Chairman to turnaround this division. Revenues dropped by 53% due to the slower completion of projects, but higher costs caused net loss to increase by 33% (even though technically lower revenues should result in lower costs). I am not sure why Management is confident enough to assert that this division would register a profit by FY 2010; but this is something I would like to see with my own eyes instead of believing time and again that they can turn things around. My opinion is that if they are unable to turn this division profitable, perhaps they should consider selling it away and channelling the cash for other more profitable pursuits instead of letting it bleed away.

Real-Estate Solutions division saw an encouraging 70% increase in revenues, mainly due to the progressive recognition of revenues for the Al Marj project in Libya; but PBT margins had dropped from 14.2% to just 11.3%; probably due to higher sub-contractor and raw material costs. While the project has been reported to be proceeding smoothly, Management needs to keep an eye on costs to ensure the increase in revenues is not more than wiped out by the increase in costs.

For Geo-Spatial, PBT margins have dropped as well from 28.5% to 24.9%, probably as a result of higher costs due to the exchange difference (costs incurred in SGD, revenues in AUD). Still, the division managed a decent PBT of S$9.1 million on revenues of S$36.6 million; and moving forward the AUD:SGD exchange rate have stabilized somewhat, so this should smoothen the fluctuations in revenue recognition for this division, and also minimize the impact of exchange losses.

Part 3 of my Boustead analysis will focus on the Company’s plans and prospects in the next 6 months, and also comment on how they can create more value for shareholders.

November 2009 Portfolio Summary and Review

November 2009 was an interesting month – not for the stock market but for news coming out regarding the economy, inflation and jobs. There was a lot of debate as to the strength of the recovery and whether it would be able to carry the economy to a weak, but fragile rebound. Everyone from top economists and analysts rushed to give their views, and the result is a rather tangled mish-mash of half-baked opinions on the strength of the economic recovery. I personally think one could not find a more motley crew of people commenting about something in the future they could not possibly know about; but then lots of people get paid top dollar this way, so who am I to complain?

Foremost on the list is that USA’s economy has rebounded and it definitely on the mend, even as unemployment rate continues to creep up and housing starts continue to drop. Lagging indicators are often used to determine if the recovery is truly under way, and if an investor is trying to pre-empt the recovery by watching out for such news in order to determine when to purchase shares, he will feel left out and sorely disappointed. As we have witnessed, both USA and Singapore had exited the recession in 3Q 2009; but the stock market rebound occurred in May 2009 and was sharp and sudden; hence the idea of properly timing the market as to when to enter is again rendered moot and futile. Nevertheless, I do know of friends and peers who continue trying, and I wish them luck in finding the “Holy Grail” in market timing.

In Singapore, it was reported that sales of private residential properties hit just 811 units for October 2009, down from 1,143 units in September and 1,805 units in August. While market watchers agree that October is usually a slow period, I cannot help but wonder if the recent measures taken by the Government to cool the market by increasing supply had anything to do with it. It is also in my interest to see prices for HDB resale move downwards as I have friends and relatives who are searching for an affordable HDB to buy but are being priced out of the market by the high COV levels. Higher private residential property prices also means that buyers who purchase such units have to take up higher leverage and financing, which may lead to problems 5-10 years down the road should interest rates rise. An article in the Sunday Times November 22, 2009 highlights this issue of affordability and prudence in purchasing a home, which many young and excited couples may not have planned or considered before-hand.

Just to comment on cars, COE prices have remained super-high (in my opinion at least), with cars up to 1,600 cc ending at S$17,189 and for cars above 1,600 cc ending at S$18,389. This makes it quite impossible for me to even consider a buying a car as the prices are simply amazingly high. I recently read about the newly launched and heavily promoted Volkswagon Polo, which is a 1.4L car and selling for a hefty S$63,000+. It seems Singapore continues to hold the record for being one of the most expensive countries to own a car. In line with my strategy to watch my cash flows, I am unable to reconcile (to myself) how I can own such cars as the cash flow drain would be enormous.

Anyhow, my portfolio did not see any changes for November 2009, as I was busy building up more cash through dividends while continuing my research for a suitable investment opportunity. I received dividends from MTQ, GRP, Suntec REIT and FSL Trust this month, amounting to about S$1,500 in total. Next month, dividends from Tat Hong and Boustead are due and will provide a boost to cash flows as well.


For November 2009, corporate updates and result announcements for my companies are as follow:-

1) Boustead Holdings Limited – I am in the midst of doing a detailed analysis on Boustead, part 1 of which was posted 5 days ago. Parts 2 and 3 should follow-up soon so watch out for it, but I may blog about other issues along the way as well. An interim dividend of 1.5 cents/share was declared.

2) Suntec REIT – There was no significant news for Suntec REIT for November 2009. The dividend of 2.92 Singapore cents per share was received on November 26, 2009.

3) China Fishery Group Limited – China Fishery released their FY 2009 results ending September 28, 2009 on November 26, 2009. I will be doing a detailed analysis and review but only after I finish up with Tat Hong and Boustead (too many things on my plate haha). In other related news, Pacific Andes International Holdings (PAIH) listed in Hong Kong mentioned that finishing touches were being put on their new super-vessel The Lafayette, and it was ready to set sail to the South Pacific along with 5 super-trawlers and seven catcher vessels. It is able to operate all-year round as it can freeze the fish on board once the vessels bring in their catch, and can re-fuel itself too. According to estimates from PAIH, profit margins for CFG may increase from 35% to 50% as a result of the increased efficiencies. The Group had spent US$100 million on the vessel, so I’d say it better be as good as they claim! There is also the question of sustainability of fish resources in the South Pacific once this vessel is deployed there, and in the interests of conservation and “saving the earth”, I may also have to consider if this could be a potentially “non-green” initiative which the Group has taken on.

4) First Ship Lease Trust – On November 23, 2009, FSL Trust (FSLT) announced a proposed issuance of US$200 million in senior notes due 2016. They are using the rest of the month to market the notes to international investors, and will keep shareholders updated on material events. The dividend of 0.23 US cents per share was received on November 26, 2009. There are some sources which state that FSL Trust is asking for "just below 12%" yield on the bonds, which are supposedly callable after 4 years.

5) Tat Hong Holdings Limited – Tat Hong released a very dismal set of 2Q 2010 results during the month, and saw their Balance Sheet and Cash Flow Statement deteriorate further. I guess it was quite a tall order for me to expect them to be immune to the financial crisis, but the drop in revenues and even larger fall in earnings was shocking and bewildering, to say the least. I had expected them to be able to hold up better as they had invested in a “rental” business model and were supposed to have learnt their lessons from past financial crises. An interim dividend of 1 cent/share was declared for ordinary shareholders and for holders of the RCPS. I shall be doing a review of the 1H 2010 results in subsequent posts.

6) MTQ Corporation Limited – There was no news from MTQ for November 2009. The interim dividend of 1 cent/share was received on November 24, 2009.

7) GRP Limited – There was no news from GRP for November 2009. The dividend of 1 cent/share was received on November 19, 2009.

Portfolio Comments – November 2009

November 2009 saw no changes at all to my portfolio, and I have been happy to remain vested and building up cash in the meantime. Realized gains have increased from S$26.6K to S$28.4K as a result receipt of dividends from Tat Hong, MTQ, GRP and Suntec REIT. Unrealized gains remain low at +7.5% as a result of recent purchases, but overall gain has remained steady at +28.4% of adjusted cost of S$135.4K. This was mainly due to increases in realized gain due to dividends which offset the drop in unrealised gains due to market weakness across second-liner companies.

My year-end portfolio review will be done on Thursday, December 31, 2009. At the same time, I will also be doing a special full-year review of my investment decisions and comment on the investment performance of my portfolio. It’s time to get candid and honest about my mistakes and misconceptions.

Boustead – 1H FY 2010 Financial Analysis and Review Part 1

Boustead released their 1H FY 2010 results on November 12, 2009. Suffice to say that I was pleasantly surprised that even though revenue had fallen by 12.7% for 2Q 2010, net profit attributable to shareholders actually increased 12% to S$10.8 million, and was up 33.4% to S$20.2 million for 1H 2010. The table below offers a quick glance at the results of Boustead for 2Q 2010 and 1H 2010, and a comparison against the corresponding period last year.


Profit and Loss Analysis

One would immediately notice that gross margin has weakened considerably for 1H 2010, as the 10.8% rise in revenues was more than offset by the 17.2% rise in COGS, resulting in a decrease in gross profit of 3.3% from S$66.2 million to S$64.0 million. This can be attributed to margin erosion as costs are now higher and margins are also depressed as contracts are harder to come by, and customers have had to bargain for lower prices in order to accept jobs as financing is also tight. Gross margin contracted from 31.4% to 27.5%, and a closer look at each division will be done in Part 2 of this analysis, as well as offering a peek into PBT margins and I will provide possible explanations for the margin erosion, and whether I think it will persist in the medium-term.

Other income had also dipped by 40% from S$3.3 million to S$1.9 million as result of lower interest income and rental income. Fortunately, Boustead’s focus on cost controls managed to reduce selling and distribution expenses by 7.8% from S$12.8 million to S$11.8 million, and administrative expenses by 16.7% from S$22.9 million to S$19.1 million. Financing costs also fell by 52% as the Group had repaid some long-term bank loans during the 6-month period ending Sep 30, 2009. All these measures helped profit before tax to rise by 10%.

Income tax expenses also decreased by 16.2% in spite of the increase in profit before tax due to non-deductible items being present in the previous period and also due to difference in tax jurisdictions for their various subsidiaries. The result was a healthy net profit attributable to shareholders of S$20.2 million against last year’s S$15.2 million, up 33.4%.

Balance Sheet Review

Boustead’s Balance Sheet remains solid, with debt levels slightly down, net cash and sufficient liquid assets to tide it through a protracted downturn. Cash and Bank balances managed to rise by another S$10 million during the 6-month period to hit S$190 million, though the increase was attributed to investing cash flows rather than operating cash inflows (elaborated on in the next section on Cash Flow Analysis). Nevertheless, net cash now stands at S$163.4 million as at Sep 30, 2009 against S$150.6 million as at March 31, 2009, an increase of 8.5%. This represents a net cash per share of 32.3 cents, based on issued share capital of 505,512,000 shares. If we strip out net cash per share, this means the rest of the business is being valued at just 41.7 cents per share (last done market price of 74 cents minus 32.3 cents), effectively this means PER is just a low 5.2x based on an annualised EPS of 8 cents per share.

The increase in trade receivables is in line with the increase in revenues, so there is not much to get worried about here. Trade payables however decreased by about S$10 million and this represents a worrying sign that the company may be paying off its creditors quicker than it should, thus resulting in negative operating cash flows. Bank loans dipped slightly as Boustead had made repayment of loans during the 6-month period. Current ratio improved from 1.72 as at March 31, 2009 to 2.01 as at Sep 30, 2009. Quick ratio (defined as current assets less inventories and properties held for sale) rose from 1.51 to 1.78 over the same period.

Cash Flow Statement Analysis (all numbers quoted refer to 1H 2010 versus 1H 2009 only, and NOT 2Q 2010 versus 2Q 2009)


Boustead has traditionally had healthy operating cash flows but for the half-year ended Sep 30, 2009, operating cash flows were a negative S$12.7 million against a positive operating cash inflow of S$6.6 million in the prior period. This was due to the combination of an increase in receivables, coupled with the decrease in payables of roughly S$15.6 million and S$12.5 million respectively. If capital expenditures are factored in (see table above), then FCF is a negative S$13.8 million for 1H FY 2010. Better cash control should be exercised by Boustead to ensure it does not pay its creditors faster than it can collect from its debtors, otherwise it would lengthen their cash conversion cycle and this could become a problem.

Most of the cash came from investing activities, and as can be seen there was a net cash inflow of S$39.1 million for 1H 2010, as opposed to an outflow of S$18.4 million for 1H 2009. This can be attributed to the repayment of loan by an associate (GBI Realty) and dividends from the same associate of S$20 million and S$20.1 million respectively. Thankfully, capex was kept low for 1H 2010 with a cash outflow of only S$1.2 million for PPE, as compared to S$8.7 million outflow for 1H 2009.

Cash outflows for financing activities were mainly made up of share buy-backs worth S$3.75 million as well as payment of dividends worth S$12.7 million. The Group also paid off more bank loans than it took up, resulting in a net cash outflow of about S$1.4 million here. By comparison, in the previous year, higher dividends were paid out but there was absence of share buy-backs. It remains to be seen if the Company will use its excess cash to buy back more shares; or if they are saving up the cash for a suitable M&A opportunity.

The effects of the cash movements led to an increase in cash of about S$11 million to S$190 million as at Sep 30, 2009. This cash hoard still awaits deployment and I certainly hope the Management Team is scouting around for suitable investment opportunities, as holding too much cash can be a drag on returns.

Part 2 of the analysis shall be up after my November 2009 portfolio review, and will consist of an in-depth analysis, breakdown and explanation of Boustead’s divisions and how they are faring. Part 3 will end off with me giving my prognosis of the situation, prospects for each division and also to discuss where Boustead is headed for the remainder of FY 2010.

Recycling and Reallocating Capital

As investors, it is important to regularly review our shareholdings and to ensure our money is being put to productive use. This is because the enemy of inflation is always out there and will constantly and consistently erode the value of your cash holdings, making them worth about 3-5% less than the previous year. The insidious effects of inflation have been discussed in many economic textbooks and therefore one cannot afford to leave their money idle in bank accounts earning a very miserable and paltry 0.5% per annum. This brings me to the topic of recycling and reallocating capital, and I shall touch on each in the following paragraphs.

Recycling capital is one method whereby one can ensure one’s capital is always growing and put to productive use. This method involves selling shares which one feels has not much further potential for capital gains, and moving the capital to an undervalued investment with more potential for capital gains in future. Of course, this is predicated on the fact that one will be able and willing to look for undervalued gems to park his money in, and to adopt a patient attitude to be able to recycle his capital. One also has to be able to determine (according to his own personal prescribed philosophy), what is meant by “over-valued” and “under-valued”. Thus, this method of recycling capital may sound easy but is in fact fraught with considerable risk. Take for example an investor who invests $1,000 in Company A. Company A grows over the years and his investment becomes $2,000 over 4 years. The investor then recycles the new capital of $2,000 into Company B which he feels has a growth rate of 20%, compared to say 10% for Company A as its period of rapid growth is over. Thus, the investor wishes to grow his capital by 20% to $2,400 instead of being content with $2,200. Capital additions along the way can also assist to grow one’s portfolio and ensure one has a larger “base” with which to compound; and this is why the savings habit is of critical importance to building financial stability. Only when your capital base is significant does compounding start to work its magic; hence recycling of capital should be done on an adequately large capital base (of say 6-figures). What one can do early on in his investing days is to aggressively add to his capital base through savings (from salary) and bonuses (one-off windfalls) rather than through gains from investing.

Reallocation of capital is different in the sense that I am segregating the two terms based on capital gains and dividend yield. I use the term “reallocate” to mean shifting capital from one low dividend yield company to one which is paying a higher, sustainable dividend yield. For example, one may wish to reallocate some capital from REIT A (paying 5% yield per annum) to REIT B (which is paying 10%), thus effectively doubling your yield. Of course, it’s never so simple on paper and one has to evaluate the salient aspects of both REITs including the probability of capital loss should one decide to conduct the reallocation. In contemplating the merits or demerits of this kind of exercise, one has to also investigate the underlying fundamentals behind the high yield and to justify to oneself that it is sustainable and that the risk-return trade-off is favourable. No use exposing yourself to 4x the risk just to double your yield.

I can give two personal examples of the above using my own portfolio to illustrate. In August and more recently in October, I had divested Swiber and Ezra and recycled the capital from those investments into MTQ, as I believed that the growth prospects for these two companies were limited due to their heavily-geared nature, and their propensity for raising capital through financing activities rather than through operations. In addition, the two companies were (I felt) richly valued and thus appeared to be risky, because if growth failed to materialize there might be a collapse in valuation metrics and I could suffer a permanent loss of my capital. Hence the decision to recycle the capital to MTQ which has a much better Balance Sheet, a steady business generating positive operating cash flows, and which is valued at just 4-5x PER and which has potential to grow further in the medium-term due to initiatives undertaken by Management (Bahrain investment and Bosch superstores in Australia).

During October 2009 itself, I reallocated some of my capital from the previously mentioned divestments into GRP Limited, as the latter was paying an attractive dividend yield of 10% and was supported by a stable business, good cash flows and a strong Balance Sheet. The reason for the reallocation was because Ezra was paying a paltry dividend, and Swiber and Pacific Andes are probably going to suck up more cash than pay it out. Therefore, rather than keeping the money in a bank account earning a miserable 0.5% per annum, I chose to park it in GRP over the long-term to enjoy the higher yield. Of course, one can argue that there are also correspondingly higher risks involved, but this is to be mitigated through a prudent and thorough analysis of the business of the company to ensure no substantial permanent loss of capital occurs.

It is important for the investor to constantly seek better investment opportunities and to do portfolio re-balancing and review from time to time. Recycling and reallocating capital is vital to ensuring one gets a steady return on their investment; and not to let any investment sit idle and erode over time. This, of course, also involves cutting losses decisively on companies which are below par and shifting the capital to a more worthwhile company. This process necessarily entails painful decisions and determination and is thus easier said than done. But it must be done in order to ensure one’s portfolio does not become cluttered with last season’s “duds”, where useful capital simply wastes away from inflation and share price erosion.

MTQ – 1H FY 2010 Financial Analysis and Review

MTQ released their results for 1H FY 2010 (they have a March year-end) on October 28, 2009. Since the company only releases results every half-yearly instead of quarterly as they are below the S$75 million market capitalization threshold, this means that I will only be able to review the company’s performance every six months, barring any updates which the company may provide in the meantime. A pleasant surprise I got was a newsletter which the company sent out to all shareholders to provide updates on the Company – most companies I know do not do this and MTQ is certainly very shareholder-friendly in this respect. This is even though its shares are not very liquid and the company is relatively unknown.

My analysis will be split into the usual 3 sections as per my other analyses for my companies; and at the same time I will discuss briefly on prospects and plans.

Profit and Loss Analysis

As expected, revenues dropped 12% year on year from S$45.3 million in 1H 2009 to S$39.8 million in 1H 2010. This was due to softer demand for the Company’s oilfield engineering services as many oil and gas projects were put on hold as a result of the financial crisis and subsequent recession. Engine systems, however, remained relatively resilient and managed to slightly increase its revenue level (in AUD), but with a forex translation loss the net effect was a S$0.2 million decrease in revenue in SGD terms.

The revenue mix has also changed slightly as a result of the weakness in Oilfield Engineering versus the resilience shown by Engine Systems. Previously, and in my analysis of purchase, I had stated Engine Systems as one of the “cons” as my analysis had thrown up the fact that operating margins were low and revenue was flat over the last couple of years. However, it was a pleasant surprise to learn that revenue from Engine Systems stayed fairly constant at S$19.5 million (down S$0.2 million from 1H 2009’s S$19.7 million), compared to Oilfield Engineering’s revenue drop to S$19.7 million from S$25.4 million. As a result, the revenue mix for Oilfield Engineering versus Engine Systems shifted from 56%:44% to 50%:49% (remaining 1% came from “others””).

Gross margin had actually improved from 39.5% to 41.4% even though revenue fell, and this was due to the reduction in COGS by 15% against the 12% drop in revenues. Gross profit, as a result, fell only 8% from S$17.9 million to S$16.5 million. Other income rose substantially from S$705K to S$2.3 million, and this was mainly due to one-off transactions of about S$2 million comprising realized gain on disposal of available-for-sale investments as well as the Singapore Government’s Jobs Credit Scheme. Staff costs actually fell about 7% but other operating expenses increased 15% due to an exchange loss booked for the Engine Systems division. The result was PBT of S$8.5 million for 1H 2010, flat against the previous year. Lower taxation meant that net profit after tax improved 3% from S$7 million to S$7.2 million. Net profit margin was 18.1% against 15.4% last year. However, stripping out the one-off gain of S$2 million, MTQ would have reported a net profit of just S$5.2 million, a drop of 25% from prior year. Net profit margin would have been 13.1% in the absence of the one-off gains, due to the higher other operating expenses amidst falling gross profits.

Balance Sheet Review

One fact I wish to mention is how much analysts have “hyped up” MTQ’s NAV of 82 cents as at Sep 30, 2009, and using this as a basis for recommending a BUY on the company due to the fact that it is trading below book value. The truth is that this adjusted NAV (up from about 66.5 cents as at March 31, 2009) is a result of the increase in fair value of available-for-sale securities, as reflected under “Long-Term Assets” in the Balance Sheet. Investment securities rose 140% from S$4.1 million as at March 31, 2009 to S$9.9 million as at Sep 30, 2009; mainly as a result of the across the board increase in market prices of quoted equities for most bourses around the world. Thus, the NAV is predicated on market values and should not be relied on without due consideration on the nature of composition of the NAV.

Inventories remained relatively stable, with only a slight 6.5% increase mainly due to forex translation differences. Debtors increased 12% to S$18.3 million, and this was marginal and could be a result of slower payment by customers due to the credit crunch. However, overall cash and bank balances increased 26% from S$22 million to S$27.7 million, and net cash increased even more by 32.4% from S$17.6 million to S$23.3 million. Overall, current assets had increased due to the inflow of cash, and current ratio stood at 3.1 as at Sep 30, 2009 against 2.6 as at March 31, 2009. Quick ratio had also improved from 1.94 to 2.3 during the same period.

Total borrowings remained fairly constant at S$4.45 million as at Sep 30, 2009 against S$4.44 million as at March 31, 2009. Current liabilities actually fell slightly due to marginally lower trade payables and also lower provision for taxation, while being slightly offset by a marginal rise in long-term liabilities from S$6 million to S$6.18 million due to a rise in deferred tax liabilities and provisions.

Overall, the Balance Sheet is healthy as the company has sufficient working capital of S$43.4 million, high current and quick ratios and a net cash position.

Cash Flow Statement Review

In my analysis of purchase of MTQ, I had highlighted the nature of their cash flows and how MTQ had consistently positive operating cash flows for the 5-years under my analysis (from FY 2005 to FY 2009). This has not changed with 1H FY 2010 registering a healthy positive operating cash flow of S$5.75 million. What’s different this time though is that capital expenditure amounts to just S$990,000, which means there is FCF of about S$4.75 million for 6 months ended Sep 30, 2009. This was a contrast to my 5-year analysis showing just 1 year of FCF and 4 years of negative FCF due to the need for investment in fixed assets to keep up with the Oilfield Engineering Division. However, one should also note for comparison sake that for last year, there was capital gains tax paid on disposal of RCR Tomlinson which pushed operating cash flows into the negative. Without this one-off tax, cash flows for 1H FY 2009 would have been positive.

Under investing cash flows, there was a net inflow of S$1.5 million due to the timely divestment of quoted shares, raking in S$2.5 million. If one compares the cash inflow of S$2.456 million from this sale against the gain on sale of S$1.863 million, it would be apparent that MTQ had made a gain of 314% over their cost of S$593K. Thus, Management have once again demonstrated that are adept in timing the disposal of their investment in quoted equities, similar to the timing of disposal for RCR Tomlinson back in FY 2008. Note that there was also a minor purchase of quoted shares worth S$172K, against last period’s cash outflow of S$4.16 million from subscription of shares in Hai Leck’s IPO.

Financing activities was relatively muted and the main movements were for dividends paid out and small amounts of repayment and taking up of bank loans. Net cash outflow was reduced from S$3.8 million last year to just S$1.79 million due to the absence of share buyback for 1H FY 2010.

It is worth noting that with the 1 cent per share interim dividend being declared, this represents a cash outflow of just S$880,600, which comprises just 3% of their total cash reserves of S$27.7 million. Note that dividends are NOT paid on the treasury shares of 7.48 million, and this can be verified by glancing at the cash outflow of S$1.761 million for 1H 2010 – it was the payment of the final dividend of 2 cents per share on 88,059,117 shares (which excluded the treasury shares). The Company is probably retaining the bulk of their cash for their Bahrain expansion, which they estimated would need US$20 million (about S$27.6 million using SGD 1.38 to the USD). This is already adequately covered by their current cash balance without them having to take on additional loans, and since their business is cash flow positive this cash balance will rise further throughout FY 2010 and part of FY 2011. I will discuss more on the Bahrain project in a later section.

Bosch Superstores

Along with their 1H FY 2010 announcement came the press release for what MTQ terms “Bosch Superstores”, which is a collaboration with world-renowned Robert Bosch Group to sell Bosch products in Australia, using MTQ’s network of 9 outlets throughout Australia. MTQ will be awarded distribution rights to all of Bosch’s product range in Australia, and will act as a “one-stop shop” for customers looking for Bosch products. In addition, the company would be able to cross-sell their existing products too.

This arrangement will be effective from November 1, 2009 and according to an interview Mr. Kuah gave to NextInsight, the incremental cost for the Engine Systems division will be small (in the range of just S$200,000 to S$300,000) because the infrastructure is already in place. All that is needed is to add more shelf space and to hire more sales staff. However, the potential revenue boost will be significant, and as MTQ puts it, they expect the turnover to “increase substantially” in the near future. Partnering with Bosch also means that MTQ can substantially increase their current customer base, and Mr. Kuah expects MTQ to double its Engine Systems customer base from the present 1,250 to 2,500. The reason for the partnering was because Bosch was unable to effectively distribute their products throughout Australia using their present supply chain.

One thing to note, however, is that margins for the Engine Systems division are very low. In my Analysis of Purchase Part 2, I highlighted that EBITDA margins for this division for FY 2009 were only 3.6%, compared to Oilfield Engineering’s 28.5% EBITDA margin. Net margin was even more dismal at just 1.4% for FY 2009, and prior to FY 2009 Engine Systems consistently recorded a net loss. While one can argue that the partnership with Bosch may allow them to increase the selling prices of their products as they are now offering a one-stop solution for customers, it remains to be seen if this division can sustain profitability and even if so, what the margins will be moving forward. Readers should note that increasing revenues significantly without keeping COGS under control will amount to nothing. One mitigating factor is that Mr. Kuah mentioned that the incremental cost of selling Bosch products will be small compared to (presumably) the potential revenue boost, and we shall have to wait for subsequent years to hopefully see the positive financial effects of this collaboration.

MTQ Bahrain - An Update

MTQ had announced back in Jan 2009 of their intentions to set up a facility in the Kingdom of Bahrain, similar to their Pandan Loop facility but three times larger. I had also discussed this at length in my previous post on Analysis of Purchase Part 3. The latest update as obtained from the NextInsight interview and MTQ’s presentation slides states that everything is going as planned, and the design has been finalized and construction will take place in early 2010. The facility should be operational by early 2011. What was not mentioned, however, was how the project would be funded; whether through internal funds or through bank borrowings as well. I suspect it’s a mixture of the two, since MTQ can generate operational cash inflows of about S$3.7 million (average for FY 2005 through FY 2009) per year. With their current cash balance of S$27.6 million as at Sep 30, 2009, and their previously stated requirements of about US$20 million, I expect they should not have to gear up too much.

Prospects - Oilfield Engineering

With the recession slowly easing, oil and gas projects are also re-starting, albeit slowly. Note that Keppel Corp has not announced any significant rig contract for some time now, but the industry news I’ve read about indicates that oil and gas E&P spending will start to rise again from the sluggishly low levels of 2008. This fact, coupled with many ageing rigs out in the market, should provide MTQ’s Oilfield Engineering Division with a decent volume of business in their Singapore branch, though the rates they can charge may still be depressed due to the fragile nature of the economic recovery. Mr. Kuah himself had mentioned that activity was expected to pick up from 2H 2010, and with the building of the new Bahrain facility, there would be potential for further growth. Mr. Kuah did caution that the Bahrain facility will be a green field project and thus may not contribute to profits for at least 2-3 years.

Prospects – Engine Systems

With the above section discussing the MTQ-Bosch deal, I guess nothing more needs to be said about the prospects for Engine Systems till we can see some tangible results. But the overall feel is that this deal by the Company is very positive and will enable the division to achieve steady long-term growth and better margins.

Prospects – Other Long-Term Investments

With Management’s astuteness being demonstrated in RCR Tomlinson and more recently, Hai Leck; it is reasonable to assume that they would be able to identify other suitably attractive investment opportunities. They can thus put their cash hoard to good use as stock markets have not fully recovered as at this point, and bargains are still out there. It will be heartening to know that Management has used their sharp insights to purchase under-valued companies, and to divest them at a suitably appropriate future time.

My next analysis will be 6 months later when MTQ releases their FY 2010 results some time in May 2010, as they do not do quarterly reporting. I will only do an update if there are any further material developments relating to the company.