Wednesday, October 29, 2008

Tat Hong - Analysis of Purchase Part 4

I apologize for the tardiness in posting this last portion of my analysis of purchase, but the last few weeks have been hectic and a lot of news has been released around the world. The entire global economy is a little topsy-turvy with the credit crisis (morphed from "sub-prime" into a larger Godzilla !) and currencies and interest rates (LIBOR) are going haywire.

My following analysis (based on Buffett's 12-step analysis) was completed on September 17, 2008 and one can see (on hindsight) that Mr. Market would price Tat Hong a lot cheaper over the next few weeks following my analysis. A current consideration of mine will be to average down my cost to ride out the next few years of downturn, which I am confident that Tat Hong can ride through with their established reputation, asset base and good management.

Business Tenets

1. Is the business simple and understandable ?

Tat Hong is a supplier of cranes and heavy equipment and its business consists of purchasing cranes and spare parts in order to lease them out to construction companies. The Company maintains a young fleet by constantly purchasing new equipment to maintain their fleet at less than 10 years old. The divisions within Tat Hong are as follows:-

a) Heavy Lift Department - Specializing in comprehensive heavy lift and haulage to customers. This division does rigging, project and site management, crane erection and provision of engineering services. This division looks like a service division which includes the rental of heavy lift and haulage equipment too.

b) Trading - Trades in new, reconditioned and used equipment. Products include crawler cranes, mobile cranes, earth-moving equipment and foundation equipment. Tat Hong has workshops in the region which repair and recondition used equipment and then re-sells it. There is a market for used equipment as it is cheaper than new equipment but can work just as well (in fact, less depreciation is incurred on used equipment as it is cheaper and may have its useful life extended through repair/reconditioning).

c) Machines - This department holds all the fixed assets of the company which are used to lease out to customers in order to generate revenue. The company also has a website at http://www.ecranes.com.sg/ to offer a one-stop portal for customers to browse for their preferred equipment. There is a search engine for cranes as well as spare parts and it was easy to navigate the site as it has a user-friendly interface and is customer-oriented. Tat Hong even provides training for crane operators through courses at its in-house training center (another source of revenue).

d) Spare Parts - Tat Hong also stocks up a wide inventory of spare parts for numerous renowned brands such as Hitachi, Linkbelt and Sumitomo. With such a good array of products, Tat Hong are able to provide service for a wide variety of clients, no matter what equipment they have.

e) Support Services - Provides repair and services for hydraulic systems, engines and other types of repairs to heavy equipment.

From the above, it would appear that the business is simple and understandable. The company buys cranes and either leases them out or re-conditions them to sell. They also provide training courses as a source of revenue and have a service department which caters to repairs and maintenance. +POSITIVE

2. Does the business have a consistent operating history ?

Tat Hong has been in this business of crane leasing since the 1970’s, and over the years has established itself as one of largest companies in the region supplying cranes and heavy equipment to industries such as oil and gas, and construction. Management are very experienced and have a good handle on the dynamics of the business (they are industry veterans). +POSITIVE

3. Does the business have favourable long-term prospects ?

As highlighted in the section on “comments on regional prospects” as well as the analysis of the Group’s prospects for growth (including their strategies to be undertaken and the state of the industry for crane leasing), it is reasonable to assume that growth is still present and the company will be able to leverage on this growth in the coming years due to their market leadership and their dominant presence. +POSITIVE

Management Tenets

4. Is Management rational ?

From the observations of how Management has grown the business (slowly but steadily) and how they have allocated capital to purchasing new cranes to keep up with a modern fleet; as well as the website ecranes set up to cater for customer login, Management appears to act rationally to build the business.

Recently, they had entered the China market through a joint venture and in Australia, they used their 70%-subsidiary Tutt Bryant to acquire Australian heavy lift and crane companies in order to expand their market share. I see these moves as being positive for the long run as it helps to build their market presence, penetration as well as expand their fleet to be able to offer more value-added services.

Management has also been observed to be buying back shares during the last few trading days. Ng Sang Kuey Michael (Exec Director) purchased 70,000 shares at S$1.50 on August 15, 2008, increasing his stake to 0.073%; Tan Chok Kian (non-exec Chairman) purchased 20,000 shares at S$1.51 on the same day, increasing his stake to 0.092%. Ng San Tiong (Managing Director) purchased 200,000 shares at S$1.35, increasing his stake to 1.60% on August 19, 2008. Further, on August 25, 2008, Ong Tiew Siam (Exec Director) purchased 30,000 shares in the open market at S$1.25, going from 0% to 0.006%. The next day, Low Seow Juan $(Non-Exec Director) purchased 40,000 shares at S$1.25 too, going from 0% to 0.008%. Finally, on August 27, 2008, Leong Horn Kee (Non-Exec Director) purchased 50,000 shares at S$1.25 from open market, raising his shareholdings to 450,000 or 0.089%. (Note this info was accurate as at Sep 17, 2008)

In addition to Management’s purchases, the company has also been actively buying back shares since September 9, 2008. 105,000 were acquired at S$1.2388 starting September 9, 2008, and the buying back continued on Sep 10, 2008 with 180,000 bought back at S$1.2161 and another 25,000 at S$1.244; making a total of 310,000 shares thus far. Share buybacks reduce the number of outstanding shares in the market and hence enhances EPS for shareholders. (Note: At present, the total shares re-purchased by the Company amount to 1,961,000 at an average price of S$0.9054). +POSITIVE

5. Is Management candid with its shareholders ?

To be honest, I have not engaged Management in a face to face conversation over the Group’s business, so am unable to accurately determine if they are candid. However, from reading the Chairman’s statement, I feel he is candid enough to highlight areas of success/failure and potential areas for growing. Not enough attention is paid to bad news, however, and this could either be because the Annual Report is a piece of PR document (it usually is) or that there is genuinely no bad news to report ! This tenet cannot be convincingly answered unless I can engage Management in depth. NEUTRAL

6. Does Management resist the institutional imperative ?

Unfortunately, I don’t think the Group passes this test so easily. They are into acquisition and joint venture mode and it is unclear if Management did their due diligence independently before considering these purchases, or if they were advised by an internal team which showed the numbers the Management would like to see (hence, institutional imperative). From the numbers over the years I can at least tell that they did not over-leverage, and neither did they stray far off from their core business. NEUTRAL

Financial Tenets

7. Focus on return on equity (ROE), not earnings per share (EPS)

ROE has been consistently improving since FY 2005, even as gearing has not gone up much (remained relatively constant over the years). From 11.7% in FY 2005, ROE is now an annualized 28.9%, and for FY 2008 it was 22.7%. This shows that the Group has been enhancing shareholder value over the last 4 financial years. +POSITIVE

8. Calculate owner’s earnings (i.e. Free Cash Flows or FCF)

The formula for FCF is changes in operating cash flows (working capital changes) minus capital expenditures. Looking at the table, FCF has been healthy since FY 2005 and for every year, there is positive FCF. This is because the Group has an established business and they are able to generate strong operating cash flows to offset any replacement of fixed assets. The FCF for 1Q 2009 was about S$21.8 million, which is a healthy sign for the Group moving forward as they tackle the slowing economic conditions. +POSITIVE

9. Does the company have high profit margins ?

Net profit margins of the Group started out fairly low, but have been increasingly steadily over the past 4 financial years to hit about 15.3% recently. Starting off at 6.7% for FY 2005, the company has steadily but surely increased its profit margins through diversification of its market segments (in China and other regions) as well as strengthening its core fleet of cranes by keeping them up to date, thereby creating economies of scale. +POSITIVE

10. For every dollar retained, has the company created a dollar of book value (and hence market value) ?

The company’s book value has been increasing at a steady rate, and in a bear market such as the current, there is no equivalent dollar of market value for each dollar retained. However, the long-term prospects of the Group seem favourable at this point in time. Note that the NAV (as at October 29, 2008 is stated as S$0.8015 per share). NEUTRAL

Market Tenets

11. What is the value of the business ?

The value of the business is the sum total of its future earnings, plus a lot of intangible factors like market leadership, penetration, brand recognition, market reach and Management quality. I don’t rigidly look for an intrinsic value per se; as long as the valuation using PER is not demanding, and the company has other factors which make it a good investment. It’s a multi-prong approach which makes use more of common sense and “soft” factors which are then supported by hard numbers. Thus far, this approach has served me well. NEUTRAL

12. Can the business be purchased at a significant discount to its value ?

The current forward PER of the business is about 5.3, which offers a relatively good margin of safety. By adding in factors mentioned and discussed above, the business does seem to have favourable characteristics which would lend itself to better earnings over the years. Of course, this could very well be a cyclical industry but the presence of more building and construction activity in the SEA and Middle Eastern areas will provide business for many years to come. In addition, the Group is more diversified now as compared to the late 1990’s and early 2000 years when it made flat revenues and profits – so one can argue that it’s a different animal now. However, there is still a real possibility of capital loss if the company’s earnings cannot take off as projected, in an uncertain economic climate. I have mentally prepared myself for such an eventuality, that earnings will decline and dividends will be cut. +POSITIVE

As at today's closing price of S$0.40, the Company is trading at a mere 1.74 times historical PER and also at 50% discount to NAV. Though the CEO has mentioned that earnings will slowdown in FY 2010, as an investor my time horizon is far beyond 2010. Looking ahead into the future (FY 2012 and beyond), there will still be many opportunities for Tat Hong to capitalize on growth in Singapore, China, Australia and perhaps even India in future.

The Company will be releasing its 1H FY 2009 results in mid-November 2008. It will be good to get an update from them on prospects and the current industry conditions for the construction sector.

26 comments:

TA said...

today drop shit to 0.39.. you should buy and average your position at above $1...

with Technical chart, I can tell you, the longer the price hovering around 40 cents, the chances are coming down is huge as these bunch of joker are mostly contra players..

so, i don't mind to wait to buy at 30 cents.. which is the IPO price at year 2000.. cheers ..

Anonymous said...

Hi MW,

Great analysis. I am also waiting to buy at $0.30 too. If it cannot hit my price, I will buy another good company.

Ryan

Ricky said...

Amazing we still have contra players around...for such small price movements, it's difficult to make a decent profit, the comms is so not worth it

equity said...

Dear Musicwhiz,

Thanks a lot for always sharing the reason why do you invest in Tat Hong. For me who do not have financial background, I learnt a lot from your blog. I never miss your post for about a year :-)

Cheers,

Anonymous said...

Hi Mr. TA,

What Musicwhiz is sharing is an approach which is about as different from Technical Analysis as chalk is from cheese.

Your comment does not add any value, and dare i say it, is quite simply put, rubbish in a nutshell.

Regards

V

musicwhiz said...

Hi TA,

I won't phrase it the way V has about what you said (he is being very direct !), but all I can tell you is that such comments are not helpful at all in me making an investment decision; and I will disregard them in future.

Thanks,
Musicwhiz

musicwhiz said...

Hi Ryan,

Thanks, just curious to find out which other good companies are on your list ?

Regards,
Musicwhiz

musicwhiz said...

Hi Ricky,

It is my personal opinion that contra players don't survive for too long. Brokerage itself is a frictional cost will continually eats away at returns, and compounds losses.

Regards,
Musicwhiz

musicwhiz said...

Hello equity,

Many thanks for taking the time to visit my blog. Cheers to you too :)

Musicwhiz

Anonymous said...

Hi Musicwhiz

I like your blog on fundamental analysis of the listed companies in Singapore and I am learning from you. Thank you. While the stock market is going crazy, I believe you are in a very good position to sieve out fundamentally excellent companies in Singapore that are presently below its intrinsic value to invest for the long term, besides the few companies you already own. May I suggest you look into the following:
1. Metro Holding (NAV $1.40, price $0.4)
2. Pan United Hld (NAV $0.42, price $0.32)
3. Haw Par (NAV $9.2, price $3.6)

These are cash rich mid-cap companies that will withstand the global recession and yet provides continual dividends to shareholders.

Regards
KL Lim

Ricky said...

Hi MW,

I totally agree. Our comms for local brokerage is simply too high, share movement too little and the contra time too short to do any meaningful trades.

Anonymous said...

Hi MW,

I have also learned alot from you just by following your posts without fail. I'm always eager to see what you have to write next.

I have one stock to share with everyone which happens to be on my watchlist. Midas. I'm not good with numbers and my knowledge of financial statement analysis is limited to what I read from your posts =) But I feel that this is a good long term investment. Midas main business is building trains. I read a report of the Chinese Government intentions to spend around 200 billion to increase the railway infrastructure to boost economic spending. Perhaps we could take a good look at this. I am not vested in this yet. I was hoping if you could give some insight.

Thanks
Gori Kun

musicwhiz said...

Hi KL Lim,

Thanks for visiting and also thanks for suggesting some companies for long-term investment. As a rule of thumb, I do not just base on NAV to consider if a company is attractive for investment. I prefer to use a holistic approach which also includes industry analysis and qualitative factors (including Porter's model and other models like SWOT or PEST) to assess if a company may be suitable for investment.

Being cash-rich is definitely good and will prevent them from collapsing, but growth is another question. For dividend plays, these companies may be good choices. I will consider cash rich companies for investment if I am nearing retirement age. Currently, I will want a mix between growth and yield.

Regards,
Musicwhiz

musicwhiz said...

Hi Gori Kun,

Thanks for visting too and I will consider your suggestion of Midas, which I understand manufactures train car carriages and has a good market share in China. Recent news involves them going into a JV of some sort. I have yet to fully analyze this company and intend to go slow and steady with my analysis as I intend to build up more cash reserves first before deploying.

Thanks,
Musicwhiz

Anonymous said...

Hi MW,
Sound like a good idea. I made recent purchases in Ezra and Boustead as well =) I hope that Mr market as another mood swing soon. He seems to be happy the past couple days. =)

Gori Kun

Anonymous said...

Hi MW

One company is Second Chance.

NAV= 0.32 cts
Market= 0.16 cts

regards,
Ryan

DN said...

Hi MW,

Very detail analysis you have. Just curious, did you make any research on Tat Hong's major competitor? What are their PER and NAV?
Would you consider using a baseline comparison of the leading competitors strength/weakness and results to gauge whether the company is cheap or expensive to own?

Regards,
DN

Anonymous said...

Hi MW,

Have you managed to access http://www.ecranes.com.sg/? I have tried but failed. =(

By the way, just like to share my 2 cts.

I'm in the heavy lifting industry. For the past 2 years and probably till end of next year we will see a consistent demand for cranes due to the projects on-going. In Singapore, besides the 2 IRs, we have the Shell ECC project(Pulau Ular) and Exxon Mobil SPT project(Jurong Island). These local projects will continue until end of next year. This will definitely sustain their business. In fact, we see there's an increase in profits last quarter for crane companies. They are doing well, at least for now.

Tat Hong has done very well for the past few years due to their cranes selling business.(consist of almost half of their business) There has been a shortage of cranes for the past years to satisfy the projects needs. Many times, once they got the cranes from manufacturers they can resell them almost immediately for millions of dollars gains. Hence you see the increased profits over a short period of time.

However, is the demand going to last?

Why the change in business strategy to focus on rental instead of selling? If I'm not mistaken(i stand to be corrected), under their balance sheet, there are more than $200millions of inventories. Are they having problems selling them and use them for rental instead?

In a crane rental business, it's a different ball game. It takes time to make your profits. To make the same amount of money as selling, it may take years.
And it involves not just the crane. You need a Project Manager, Engineer, Supervisor, and Riggers. These are manpower costs that have escalated over the past years due to shortages. Not just the cost being a concern, you may end up with inexperience people who may not carry out the jobs safely. And if accidents do happen, it will tarnish a company's brand almost instantaneously.

Again with the hugely increase of cranes fleet, is there sufficient demand to cater for the supply? Especially during the global credit crunch crises when fundings are scarce, will the projects go on as planned?

I definitely salute you for buying cheaply during this turbulent time. Yup, at 40cts it's only selling at ~2 times PE. However, what if the Earnings drop significantly due to oversupply of cranes? That is going to affect the PE ratio.

What if the worst scenario happen when the on-going projects have been completed? You have huge fleet of cranes but nobody to rent to? The overhead is still running, crane installments still got to be paid.

If the worst happens, can Tat Hong survive?

Regards,
Cranes freak

musicwhiz said...

Hi Ryan,

Thanks for the tip. I will research it if I have the time.

Regards,
Musicwhiz

musicwhiz said...

Hi DN,

The closest listed competitor to Tat Hong is Tiong Woon, which does the same business but is of a much smaller scale. I did do a brief comparison in Part 2 or 3, and generally the industry will decline due to the credit crunch, so all players will be affected in the short term.

Thanks,
Musicwhiz

musicwhiz said...

Hi Cranes Freak,

Thanks for raising these points and your comments as an insider to the industry, I really appreciate it. I cannot access ecranes at the moment but since it's the weekend I think it's likely that the website may be undergoing maintenance or updating. Tat Hong's website is working fine though at http://www.tathong.com.

I am aware of what you say about the demand for cranes lasting at least until FY 2010, when the projects will slow to a trickle and the Government may not award so many contracts in Singapore. However, with the deferred projects all over the island, I think there should still be sustained demand. Since Tat Hong is the dominant player in this industry, I would expect them to be able to grab a sizeable market share of all jobs offered.

I acknowledge that crane rental cannot generate so much "quick" profits as selling cranes, but I am hoping for a more sustainable recurring source of revenue for the Company to generate instead of relying on such "ad-hoc" sales. The reason (given by the CEO Mr. Roland Ng in a Reuters interview) for the switch in strategy from selling cranes to renting them is due to the economic crisis. He said that during times of crisis, companies would rather rent cranes than buy them, so this is a good opportunity for them to build up their rental business, which commands stronger margins than their crane sales (see Part 2 of my Analysis of Purchase). Also, in a downturn, I believe the value of cranes will also dip, hence there may not be good profits to be made from selling cranes. The company does have a large inventory of cranes and they are the exclusive distributor of many Japanese brands (stated on their website); so I am not worried about them not getting any business - it's more of whether they can get enough business to grow their revenues/earnings. Let's not forget that most of their revenues are generated in Australia and not just Singapore, and come FY 2010 there will be added contribution coming from their tower crane rental business in China as well. So I think the company is trying to diversify its revenue stream so that it is not too reliant on Singapore (as Singapore market is small in the first place).

Manpower is definitely an important issue, even for offshore companies like Ezra/Swiber whose Management told me that they have problems hiring skilled workers and have to spend money/time to train them. Getting good staff is always a problem for any company and Tat Hong will be no exception; hence I am not too worried about this aspect as it is endemic to all companies. In terms of quality control, I have faith that the Management (who have been in the business for many years) will exercise due caution when executing projects to minimize accident occurence.

You mentioned the global credit crunch affecting demand for projects - this is a short-term problem which I do not expect to last 3-5 years down the road. That is my time horizon for this investment.

Earnings will definitely drop, I have no doubt about that. But that is for the short-term. Let the company build its base and consolidate its resources, and Management should be ableto steer it to better times after this crisis blows over. As I said, Singapore is just a small market for them and the majority of revenues will be from Australia and China from FY 2010 onwards.

Regards,
Musicwhiz

Anonymous said...

Hi Musicwhiz,

If you expect the earnings to drop (hence the PE to drop), why not wait for the share price to correct further?

Regards,
Crane Freak

Anonymous said...

It should be (PE to rise), sorry.

musicwhiz said...

Hi Cranes Freak,

Just a note: Even if Tat Hong's earnings fall by 50% from FY 2008's earnings (i.e. EPS of 8.87 cents per share instead of 17.73 cents per share, assuming issued share cap of 506 million shares), the PER at the current closing price of 42.5 cents would still be lower than 5. In fact, it's arond 4.8 if you wish to be exact. Hence, my point is that even if there is a drastic 50% decline in Tat Hong's profits for FY 2009, the current price still provides good margin of safety and offers good valuation. Note too that the current price offers a nearly 50% discount to NAV of 80 cents, another measure of margin of safety.

We all know short-term predictions of price movements are all but impossible to make with certainty, thus yout suggestion to wait for the price to fall further means that one may miss out on good value just to wait for an uncertain outcome. Since timing the market has never been my intention, I choose to purchase only what I see as good value and with a margin of safety. As illustrated above in my explanation, both PER and NAV do offer margin of safety as valuations are NOT expected to stay at 5 times except during bear markets such as these. During "normal" times, valuations will revert back to the mean of between 8 to 10 times.

That said, note that earnings drop is but a short-term phenomenon and if the Company's Management is able to steer the company well and grow its business, it can overcome this bump and go on to make record profits in future years.

Thanks,
Musicwhiz

Anonymous said...

Hi Musicwhiz,

Before I continnue, I would like to say that I agree with most that you have said and have great respects for what you have put down in your analysis. *Thumbs up*

I agree with you that we cannot time the market. I do not think that I can, and I do not think that anybody out there who can too. What we can merely do is to set our price. The price we think is the right price to buy for the value that we are going to get from the company.

Since we cannot predict the future, the next best thing we can do is to estimate the worst case scenario.

You have assumed that the worst case is a 50% drop in profits, hence 5 times PE. At 5 times PE it's still a great bargain, no doubt about it. And that is the worst worst case scenario? Or is it? Could you shed some light, how do you come to this projection?

NAV is difficult to ascertain. There are $200M (about half of NAV) as inventories and hundreds of millions more as receivables.(both make up ~70% of NAV) The inventories are depreciating every year and the amount of receivables can be recovered is still a question mark. Unless it's cold hard cash, it's difficult to know exactly the actual NAV figure. And in this market, there are lots of companies selling at 20% NAV or even less than their cash holdings. If based on NAV, I doubt that Tat Hong is the right company to invest in.

Just my 2 cents...

Regards,
Crane Freak

musicwhiz said...

Hi Crane Freak,

Just to clarify, I did not say 50% drop is the worst-case scenario. It is just ONE of many possible scenarios and I am using 50% just as a convenient way of illustrating a point. There could very well be a more drastic short-term earnings crunch to hit the company, but as my focus in on the longer-term, I remain a shareholder for that very reason. The future is always unclear and one should purchase based on research and also confidence in Management being able to steer the company through rough waters. Without optimism to guide us, I think no investor would ever dare to put his money down.

Of course you are right about NAV, it is always changing as the company acquires and disposes of assets. I am merely making a point that with the current discount to NAV, it does represent a margin of safety if (and only if) the company is liquidated right now. I do not intend to use NAV as the sole determinant of my investing decision, and have other qualitative data to back me up as well.

For info, Tat Hong will release 1H FY 2009 results on the morning of Nov 12, 2008. Let's see what guidance they give on their future plans and how they intend to navigate the rough seas ahead in the next 2-3 years.

Cheers,
Musicwhiz