Sunday, November 18, 2007

Pacific Andes – 1H FY 2008 Results Review and Analysis (Part 1)

On November 14, 2007, Pacific Andes released their 2Q and 1H FY 2008 results (the company has a March 31 year-end). Suffice to say that growth was not as impressive as I had expected, and my fears about the high interest expenses on the covertible bonds and senior notes came true as finance costs had soared as compared to the same period last year. This could possibly be a major source of headache for the company moving forward as it drains a lot of cashflow. On the positive side though, the recent acquisitions and move into the fishmeal industry has helped to smooth revenues somewhat, as can be seen that 2Q, which is traditioally a weak fishing season, showed better revenues as compared to a year ago. What Pacific Andes (PAH) needs to do is to better control costs and improve efficiency of operations, otherwise the company will not be able to add value to shareholders in the long-run.

My review will be in the usual two parts, the first concentrating mainly on the Income Statement and Balance Sheet, while the latter part will be on the Cash Flow Statement and future prospects:-

Income Statement Review (note: all figures quoted within are for 2Q 2008, not 1H 2008)

Revenues increased 111.1% from HKD 751.9 million to HKD 1.59 billion, which was mainly due to their increase in fishmeal and fishing activities through CFG (China Fishery Group) as well as their recent stake increase from 28.8% to 63.9%. However, cost of goods sold remained high, rising 116.1% to HKD 1.25 billion, thus leaving a gross profit of HKD 337 million (margin about 21.2%). Comparatively, for 2Q FY 2007, gross margins were slightly higher at 23.0%. Sadly, the momentum generated in the revenue increases could not be brought to bear on the net profits, as most of the increase was absorbed by higher selling and distribution expenses and finance costs. Selling and distribution expenses increased 4-fold (up 427%) to HKD 32.5 million, while finance costs ballooned 218% to HKD 101.5 million. These two expenses make up 8.44% of revenues already and play a big part in “shrinking” net margins for 2Q 2008, as compared to 2Q 2007. Net margin for 2Q 2008 was low at 10% compared to 15.9% a year back, largely due to these two costs. Selling and distribution costs have increased in line with the increase in operations for the Group, which I can understand, but 400+% seems a little surprising nonetheless. Finance costs are a major drain on cash and though the debt is used to fund expansion, it has not really translated into much earnings accretion (yet !). Fortunately, PAH has mitigated the risk of interest rate increases by “locking in” the interest rate on the senior notes and convertible bonds. Hopefully, in the next few quarters, there will be more margin improvement as a result of better streamlining of operations and better efficiencies resulting from economies of scale.

Profit attributable to shareholders increased 46.2% for 2Q 2008 and for 1H 2008, the increase was 41.5% to HKD 182 million. According to Note 6, EPS is now HKD 18.83 cents based on a weighted average share capital of 966 million shares; but the fully diluted EPS (taking into account full conversion of all convertible bonds) drops to HKD 17.63 cents. This is not even counting in the full effects of the 1:1 rights issue which has doubled the share capital base, thus I forsee more earnings dilution as a result of this. I will give an estimate of about 80% of fully-diluted EPS to be conservative, which is about HKD 14.1 cents. This translates to about 2.82 Singapore cents per share, or 5.64 cents per share annualized. At Friday’s closing market price of 71 cents, this values the company at about 12.6 times PER. At my current buy price of 65.5 cents, the PER I purchased at is about 11.6 times. If profit worsens or drops unexpectedly and causes my margin of safety to narrow, I will not hesitate to dispose of this investment. My concerns relate to the high gearing for PAH and I need to see Management do more to improve margins and lower costs in future periods. That said, 2Q did see a major cash outflow due to the acquisition of the additional stake in CFG, which may have distorted the results a little (the acquisition was only completed on July 23, 2007). I shall wait for the 3Q 2008 report to see if things have improved.

Balance Sheet Review

PAH’s balance sheet has traditionally held a lot of debt, which I am not particularly comfortable with. I acknowledge that it might be a necessary evil if the company has to resort to debt to expand its operations quickly and gain a stronger foothold in the fishmeal industry in Peru. Compare PAH’s method with Ezra and Swiber, where both companies also rely heavily on debt financing to boost their fleet of vessels. In PAH’s case, they need to increase their reefer vessels to cope with better SCM, purse seine vessels to catch more fish and put their super-trawlers for elongation and enhancement in order to fish in new waters. All this costs money and the non-current liabilities has seen an increase of about HKD 548 million for convertible bonds. Current ratio is 1.58 for Sep 30 compared to 1.91 for March 31. Quick ratio is 1.32 against March 31’s 1.51, as a result of an increase in current liabilities and a drop in current assets (lower inventories). Their interest-bearing bank borrowings together with senior notes forms HKD 3.1 billion, which is almost equivalent to their total current assets. I see this as a potential risk area for the Group moving forward, and hope that Management can find ways to bring down this high debt. Otherwise, PAH as an investment would not seem very attractive in the long-run.

Part 2 will be continued on a later date, do stay tuned and feel free to comment and give your opinions on the Company and Group.

23 comments:

Anonymous said...

'Selling and distribution expenses increased 4-fold (up 427%) to HKD 32.5 million, while finance costs ballooned 218% to HKD 101.5 million.'

At the top level, I have loved this stock for a while. Demand for fish will continue to skyrocket, both naturally (rising incomes) and as a substitution for ever more expensive land based agriculture. If China is going to be fed, that food will come from the oceans.

The fact that on the surface its relatively cheap, and pays a good dividend while you wait, is also attractive. On the surface.

The first red flag that has always caused me to hesitate from buying more is its corporate structure. PA HK controls PA SG which now controls CF (which just a little while ago was floated). As far as I am aware, management has never really given a satisfactory explanation for all the interlocking holdings.

A structure like PAs is ripe for rampant transfer price shenanigans, as PA HK can charge PA SG whatever it wants for the services it provides/goods it buys, within reason. And the same for PA SG and CF. The controlling family can relatively easily channel the profits to whichever entity it choses (including non listed ones). Its not an enviable position to be a minority shareholder in any company, and a corporate structure like this is doubly dangerous.

Let me emphasize that I have NO IDEA whether or not PA is playing this game, but it is possible given its structure. And I look at things like profits being sucked by a 400% increase in distribution and other costs and wonder.

To what companies is PA paying all these increased costs for distribution? Is this a legitimate increase in costs, or are the profits being sucked away to other parts of the group/family holdings.

Again I have no idea, but it is a troubling thought, and it is certainly stopping me from buying more despite the recent huge price dip in PA SG and especially CF (down 40% in last couple months).

musicwhiz said...

Hi there,

Let me first say that your comment really had me thinking, which is a good thing ! It was quite worrying, the way you had put your point across, but I concede that it is indeed perplexing for PAIH to have such a complicated holding structure. As you mentioned, a lot of funny things could well be happening which minority shareholders are unaware of, as in the case of Enron which hid its losses in overseas subsidiaries. But you also did emphasize that you have no idea if this is happening, that it is merely a possibility, and thanks for pointing this out so clearly so as to make me think hard about it.

Well, for myself, I will observe how the 3Q 2007 results pan out for PAH, as well as FY 2007 results for China Fish, before deciding how to proceed. One consolation I have is that I have purchased with a margin of safety for both companies (PAH and CFG), so that if any weird stuff is indeed going on, at least my losses will not be debilitating. Also, Management has shown a 5-year track record of growing revenues and profits; in spite of their complex structure. Whether this is a result of accounting "shenanigans" or not is anybody's guess, but I am willing to take the risk that Management is honest. Also note that most Asian companies are staffed with family members sitting on the BOD and at the helm of Management (this would include Ezra as well), so this is a factor I have considered too.

Once again, thanks for your valuable info, and keep the comments coming !

Regards, Musicwhiz

wheeboy said...

I was a pretty heavy investor in PAH and sold off when it hit a high of 1.45-1.50 before the rights issues.

What prompted me to sell off my shares was that I have lost faith in the complex structure of PAH and the Ng brothers.

If you do a search on google, you can actually discover some dirty linen about the Ngs.

http://www.abc.net.au/4corners/stories/s689740.htm

http://legalref.judiciary.gov.hk/lrs/common/ju/ju_frame.jsp?DIS=3129&currpage=T

"In count 4, the Applicant was charged with accepting an advantage as an agent, and in count 5 he was charged with offering an advantage as an agent. The allegations were similar to those in counts 2 and 3. The Applicant was alleged to have caused Rockefeller to purchase 9m. shares in Pacific Andes International Holdings Ltd. ("PAI") in return for a bribe from Ng Joo Siang, PAI's managing director, of 3.15m. shares in PAI (count 4). The Applicant was also alleged to have passed on to Eddie Taw half of the 3.15m. shares in PAI to reward Eddie Taw for causing GSIC to purchase 15.4m. shares in PAI (count 5)."

Anonymous said...

http://www.fordham.edu/economics/vinod/cie/%5Chongkong.htm

P.S. QF in channelnewsasia is blinded by his emotions about PAH to the point he is IGNORING all these.

I always believe that there will not be smoke without fire... and a leopard will never change its spots, especially when it comes to shady business dealings.

Anonymous said...

HONG KONG: CORRUPTION COMMISSION GETS ANOTHER FRAUDSTER, BUSINESSMAN SENTENCED TO 6 YEARS FOR $6 MILLION FRAUD Kevin Lee Kwok-wing, a former director of the Asian arm of Rockefeller & Co Inc., was sentenced to six years in prison after he was found guilty of corruption involving about HK$48 million ($6.15 million). In one of Hong Kong´s biggest stock market graft convictions, Lee, 41, was charged with 17 counts of bribery, conspiracy to defraud, and conspiracy to accept an advantage, for a web of corrupt stock transactions involving at least four publicly traded Hong Kong companies. ``Your criminality is serious,´´ said Mrs. Justice V. Bokhary, as she sentenced Lee. It ``was a violation of trust on your part to your employer.´´ The amount involved eclipsed the HK$870,000 of profit at the heart of a stock exchange scandal in 1990 in which the bourse´s chairman, Ronald Li Foo-shiu, was eventually sentenced to four years in prison. Francis Lee, ICAC spokesman, declined to comment if the

agency was investigating other people implicated in the case. Among those named in the case brought against Lee as having paid him bribes, though not charged themselves, are Kenneth Cheung, chairman of Hong Kong listed company Styland Holdings Ltd., Ng Joo-siang, managing director of fish trader Pacific Andes International Holdings Ltd., Tem Fat Hing Fung (Holdings) Ltd.

managing director Alexander Chan, and AWT World Transport then- chairman Alfred Lam King-ko. ``The court heard that Lee, while being employed by Rockefeller between 1992 and 1996, had acted contrary to the interest of Rockefeller by purchasing and selling shares to the company´s detriment and to his own benefit,´´ the Independent Commission Against Corruption, the city´s anti-corruption squad, said in a statement. Lee was also charged with bribing Eddie Taw Cheng-kong, former regional manager (Asia Pacific) of the Government of Singapore Investment Corporation. AOL News (Bloomberg) August 11, 2000.

Anonymous said...

fishy...

musicwhiz said...

Hi wheeboy,

Thanks for the links and I understand your concerns and where you are coming from. There are dubious transactions going on between the business men though nothing can be proven to charge Mr. Ng Joo Siang. However, one thing to note is that this case was in the year 2000, after which there have been no reports surfacing of any other potential fraudulent activities. This happens to be also the time when Pacific Andes started its 8 year growth track record. Coincidence ? Perhaps. But my investment in Pac Andes and China Fish were made on the basis of business fundamentals. Since nothing has been conclusively proven about Mr. Ng and the Ng family, I will nto jump to conclusions to say that things are "shady", "fishy" or suspicious.

The complex structure is a concern and I have gotten my margin of safety for that. As to whether QF is biased or not, at least he is able to support his arguments based on facts and figures; so I have nothing against that. I will also do my own research instead of relying on others too much.

I will think about the articles you posted, and will decide how to act accordingly.

Regards, Musicwhiz

wheeboy said...

Neither should you conclude that they are "not fishy".

wheeboy said...

And by the way, your margin of safety is thinning. If anything untoward were to happen, be prepared to wipe off 40-60% of PAH's current share price.

musicwhiz said...

Wheeboy,

Thanks for the reminder and for highlighting this. I am willing to take the risk that there is nothing fishy going on. I am also prepared to lose 50-60% of my investment should something really go wrong.

As I mentioned, there is no conclusive evidence, though the article does suggest there is graft.

Regards, Musicwhiz

wheeboy said...

by the way musicwhiz, there is a thin line between self-denial and faith.

i wish you luck, and hope you will see the facts and not ignore the glaring red flags.

wheeboy said...

no conclusive evidence? ha. You are starting to sound like the Sunshine "investors".

wheeboy said...

have you read the article on tooth fish pirates?

do you think the environmentalists will dare make such damning statements to even suggest the PAH is behind "international criminal syndicates" plundering the international waters?!?

OMG. Please open your eyes. These people obviously did MORE research about PAH's DAILY BUSINESS than YOU. So please. don't just keep harping on the point the Mr Market is manic depressive... it is a value investment etc.

Fact is.. something is wrong about this company. from all angles.. we have bribery allegations... SHARE PRICE FIXING (hmmm think about what happened before rights issue...)... even its CORE BUSINESS is under suspicion of being ILLEGAL!

COME ON MUSICWHIZ!

musicwhiz said...

Wheeboy,

I suggest you temper your language and tone. I can sense you are getting emotional about Pac Andes and it never helps a discussion when one gets too emotional.

My stand is this: Just present the facts, your opinions and I will think through it on my own. You do not need to push anything down my throat like the style you are using to post comments. The sarcasm is also totally unwarranted.

I am sure that if you put your views forward like an objective, rational individual, people will be more likely to listen to your opinions rather than dismiss them.

Thanks, Musicwhiz

wheeboy said...

I think I presented facts.


The environmentalists will made damning statements to even suggest the PAH is behind "international criminal syndicates" plundering the international waters - a fact.

These people obviously did MORE research about PAH's DAILY BUSINESS than YOU - again a fact

You keep harping on the point the Mr Market is manic depressive... it is a value investment etc - a fact

We have bribery allegations, SHARE PRICE FIXING - a fact.
Is CORE BUSINESS is under suspicion of being ILLEGAL - again a fact.

wheeboy said...

i hope you don't feel offended. But it can be quite sad when one bases his investment decisions on business fundamentals and one day wakes up to find that these fundamentals were but a smoke screen.

cheers, musicwhiz.

p.s. your other investments are pretty good ones though.

Anonymous said...

wee... have you reach the end of your story.. i actually quite enjoy it!

wheeboy said...

ha. thanks.

i think i just shut up now. you want more stories you can go and search in google.

Some keywords: Ng Joo Siang, pirates, bribe, pacific andes, syndicate.

Even Forbes carried something titled like this: Blue Waters GRAY areas.

http://members.forbes.com/global/2007/1029/034_2.html

I still stick to my belief that there cannot be smoke without fire.

Bye everyone.

musicwhiz said...

Wheeboy,

This comment section is meant for the sharing of views, opinions and ideas and I sincerely welcome that. However, I must caution you to tone down your language and the way you present your arguments, as they can be construed to be too forceful and intimidating. As it is, I am not offended by the facts you present, but more by the somewhat arrogant manner in which they are presented. Even if you are proven right and Management is indeed suspect, no medals will be given out. This is not a contest of opinions, but merely a place for sharing. I am sure we can do this in a mature, civilized manner without resorting to sarcastic barbs and remarks.

Factually, I had known for quite some time of the various allegations against PAH, so your news bits comes as no surprise to me. As I have said, there are many allegations and accusations but Management has still managed to grow the business well, and thus far Mr. Ng Joo Siang has not got into any legal problems. This is not to say that nothing is wrong, but I am concentrating merely on the objective aspects of the business such as margins, revenues and profits. Management can be very hard to read even at AGM and this is one aspect Phil Fisher told investors to delve deeper into. Sadly, I do not have the insights and gift of seeing through people just in one meeting (I have met Mr. Ng during PAH's AGM).

Thus, my margin of safety is based purely on the objective and quantifiable measures of the company and Group. I know about the facts of the case and the numerous websites detailing how PAH may be liable for all sorts of acts, but I still choose to invest as I believe the Management has created value for shareholders in spite of the negative publicity. Even if there was something going on, how material is the impact and can it be conclusively proven ? Note that there are many family-run businesses such as Ezra; and as a shareholder, one cannot know the detailed intricacies of each company to the extent of knowing if something "funny" is going on. As shareholders, we have to take a calculated risk that Management is honest. The case of Semb Marine proves that even a blue-chip Temasek linked company can get embroiled in controversy; let alone a China company ? As a value investor, I choose to live with the risks, knowing that my capital may diminish.

So my argument (to summarize) is that:-

1) I know what is happening and the myriad reports on PAH and CFG, some citing questionable practices;

2) I invest in the business with a margin of safety, and am prepared to lose 50-75% if something goes "terribly wrong";

3) I evaluate the salient aspects of the business and industry and did not account for Management's complex structure or family ties, as this is difficult to measure;

4) The concept of Mr. Market is when he chooses to appraise a business too lowly based on fundamental factors, so unless you are saying that Mr. Market knows some "weird" stuff that no one else does, I dare say that Mr. Market is still manic-depressive and the concept of value investment still holds true for PAH and CFG.

This is my opinion and I am putting it forward. You may have a different opinion, which I am fine with.

Regards, Musicwhiz

Anonymous said...

your annualised PER at this juncture did not anticipate the traditional 4Q huge revenue and profits. if you know the mgt timing the modifications of their vessels to be utilise in jan08, and also cny period, you'll know the Ngs really know their biz well.

Anonymous said...

Musicwhiz, U are cool, both being cool analyst and keeping a cool head when confronted with a very uncool person. U have my support. I share your view about moderating one's temper and emotion when sharing. And that there is not point forcing one's opinion down the throat of another person.

musicwhiz said...

Hi Anonymous,

Yes, my annualized PER did not take into account seasonality, and may not be very accurate in that sense. I understand that PAH and CFG's business is cyclical and so the PER will have to be adjusted with the 3Q and 4Q results for PAH. What I came up with is only a gauge so far.

True, they are going to deploy the new super-trawlers in early 2008 which is the 4Q FY 2008 for PAH, and this is traditionally the time for the best harvest.

Regards, Musicwhiz

musicwhiz said...

Hi Anonymous,

Thanks. I think all who post on this comment box can exercise appropriate restraint with regards to emotional outbursts and refrain from offending or sounding too pushy. I appreciate opinions and comments but not if they are phrased in a sarcastic tone. As mature investors, I think we can approach topics in a more civilized manner.

Regards,

Musicwhiz