Tuesday, November 18, 2008

Tat Hong - Analysis of 1H FY 2009 Financials and Prospects

Below is my analysis of Tat Hong's financial statements as well as a discussion on their prospects in the next couple of years in light of the global financial crisis, which has so far thrown Singapore, Hong Kong and Japan into recession (in Asia). I will do the usual sectional analysis for Tat Hong but will keep it short in order to discuss more of the growth and cash flow aspects of the company in the coming years. I will also be posting a transcipt of an interview which CEO Mr. Roland Ng did with Reuters on October 7, 2008, in order to extract some sections to comment on.

Profit and Loss Analysis (note: numbers are for 1H 2009, not 2Q 2009)

Revenues increased 26% from S$298.3 million to S$375 million, as a result of all divisions growing their revenues by double digits. More on that later as I drill into the divisional analysis. Gross margins however, contracted by 1.7 percentage points from 38.5% in 1H 2008 to 36,8% in 1H 2009, as a result of higher COGS (an increase of 29%), therefore gross profit only increased by 20% from S$115 million to S$138.1 million.

Expenses for 1H 2009 were kept well under control, as evidenced by all categories of expenses increasing by less than the increase in revenues of 26%. Other operating expenses and finance costs only increased by 16% while share of profits of associates increased by 24%. However, moving forward, I would expect share of profits from associate (Yongmao) to fall as the tower crane rental division may take a temporary hit from the global economic crisis.

Net profit (attributable to shareholders) increased by 28% from S$40.2 million to S$51.3 million. Since earnings will be fairly stable and be driven more by rental income rather than sale of cranes, I will use a rough PER approach to ascertain the PER at this point in time. Using S$51.3 million and annualizing it, we get S$102.6 million. EPS is therefore 20.32 Singapore cents. At today's closing price of 56 Singapore cents per share, Mr. Market is valuing Tat Hong, the world's largest crane company by crawler crane fleet, at a mere 2.75 times projected FY 2009 PER.

Balance Sheet Review

PPE went up to S$370 million as a result of additions to their crane fleet, while inventories remained or less constant. As mentioned in the financial report, the increase in PPE was due to expansion of rental fleet to meet increased rental demand. In the interview below, Mr. Roland Ng mentions that Tat Hong will be moving towards a rental business model in order to generate recurring income and sustainable cash flows. Cash had decreased from S$75 million as at 6 months ago compared to S$47.7 million at present (Sep 30, 2008), and more will be elaborated on in the cash flow statement review. Non-current financial liabilities had increased from S$96.5 million to S$122 million, which was the result of the drawdown on financial leases to purchase plant and equipment.

Cash Flow Statement Review (note: all numbers are for 6M 2009 and 6M 2008 cash flows)

Cash flows from operating activities increased by S$43.1 million and this is very healthy. Most of the cash inflows was generated by through profits and working capital changes did not reduce this figure very much (based on the "indirect" method of cash flow statement preparation). For investing activities, S$34.1 million was spent to acquire more fixed assets as mentioned, for rental purposes in the coming periods. Thus, FCF amounts to S$8.9 million for 1H 2009, compared to a negative FCF of about S$3.6 million for 1H 2008.

Cash flows from investing activities was a negative S$43.9 million for 1H 2009 mainly due to said PPE purchases, as well as the acquisition of a subsidiary and shares in Yongmao (increase of their stake to 20%, thus Yongmao is now equity-accounted for as an associate).

For 1H 2009 financing activities, the net proceeds from bank loans came up to just S$3.3 million, while the net effect of finance lease obligations is a payment of S$700K. Most of the decrease in cash from this category came from the payment of dividends, as a result of healthy operating cash inflows. Note that 1H 2008's cash flows from financing looked so good mainly due to a share placement raising S$56.8 million.

Business Unit Analysis

Please refer to the table below for the breakdown of business units, and associated explanations:-

As can be seen, tower crane division is their new growth area, with revenues rising 2.5x and contributing to 3% of total revenues for 1H 2009, as compared to just 1.1% of revenues for 1H 2008. I would expect the sale of cranes and equipment division to contribute much less to revenues in future due to falling crane prices in this recessionary environment. Management intends to ramp up its rental market (more to be explained later) and since rentals can command gross margins of up to 60% and above, this bodes well for gross margins in future, even though total revenues may dip for a few quarters running.

Tat Hong Interview by Reuters

As promised, below please find the transcipt for the interview (in blue) of Mr. Roland Ng by Reuters. I have highlighted certain sections (in red) for further explanation.

Tat Hong says slowdown will hit 2010 profit

* Slowing economy will curb profits in 2010
* Will meet profit forecast of S$96m this year
* Eyeing rental acquisitions worth up to $50m

SINGAPORE - Singapore crane rental firm Tat Hong said turmoil in the global economy will hurt earnings in 2010, but that existing leasing agreements will help it meet this fiscal year's profit forecast.

'We cannot run away and be unaffected by the world financial crisis,' Tat Hong chief executive Roland Ng told Reuters in an interview on Tuesday. 'But our projects are for six to 18 months so for full year 2009, we will still do pretty well.'

The firm, which rents cranes in Southeast Asia and Australia, will achieve its three-year target of growing net profit by an average of 30 per cent a year to hit S$96 million (US$65.39 million) in the financial year ending March 2009, he said.

Mr Ng said demand for cranes will continue to be strong in the resources and infrastructure sectors, picking up the slack from slowing residential construction.

Singapore still has a pipeline of mega projects including the republic's two multi-billion-dollar integrated resorts, a $1.9 billion sports complex and the upgrading of its train network in the next few years. In Southeast Asia, Mr Ng said resources projects in Indonesia will also boost demand for building equipment.

But Tat Hong's distribution business, which involves the buying and selling of earth-moving equipment, will be affected as the sluggish economy weighs on consumers and demand for residential housing, he said.

He also said the firm is looking out for further acquisitions in Australia through 70 per cent-owned subsidiary Tutt Bryant . Tat Hong will focus on companies worth up to $50 million each.

Tutt Bryant earlier this year bought an Australian equipment hiring firm for A$3.4 million (US$2.39 million). 'We have a very good credit standing, so borrowing such amounts shouldn't be an issue,' he said. Mr Ng also plans to further boost Tat Hong's cash pile, which stood at $80.6 million end June, by reducing inventory in its distribution arm.

The operator of the world's largest fleet of crawler cranes reported $29.2 million profit in the first quarter which ended June 2008. 'When the market is bad, people don't buy - they rent,' Mr Ng said.

Note the following points (in red):-

1) Tat Hong has projects which stretch till 18 months from now and will provide good earnings and cash flows until at least mid 2010. This means that the company should at least be able to sustain a decent level of dividends until mid-2010. Their most recent dividend declared was an interim dividend of 3.5 cents per share, putting my dividend yield at 4.9% based on my purchase price of 71.5 cents.

2) Demand for cranes is expected to continue to be strong, in light of recent developments such as the new expressway costing S$5 billion announced by the Singapore Government to be built by 2013, the deferment of the Sports Hub to 2012, the releasing of more construction and infrastructure projects by the Government to boost the export-oriented economy of ours and public housing demand remaining firm. Many public sector projects had also been deferred in 2007 due to the glut (at the time) in construction projects (coupled with the IR). These can be progressively "released" to provide consistent demand for crane rentals and heavy equipment usage, of which Tat Hong is a beneficiary.

3) Tat Hong's sales division which deals with cranes and heavy equipment will be affected by lower prices and the sluggish economy. Thus, I already expect this division to contribute less in future to Tat Hong's total revenue. Since this division has a gross margin of only 20%, I think it is a wise idea for Tat Hong to shift more of the revenues to rental so as to improve overall gross margins.

4) Management is on the lookout for further acqusitions in the range of S$50 million through 70%-owned Tutt Bryant Group. With valuations around the world being so depressed, Tutt Bryant should be able to source for a juicy deal. I am confident they can find a good acquisition target similar to Caradel Hire or Bradshaw in order to boost revenues (and earnings).

5) Tat Hong's cash pile stood at S$47.2 million as at September 30, 2008. Most of the decrease came from the payment of dividends. With the strong recurring operating cash flows, and Management's intention to raise more cash through divestment of assets meant for its distribution arm, Tat Hong should be able to boost its cash hoard even further to reduce its gearing and possibly pay out a very decent dividend by FY 2009 year-end.

6) Mr. Roland Ng is speaking from experience when he says this. During recessions, companies rent cranes instead of buying them as the capex upfront for buying can be saved and conserved for rainy days. Rental affords more flexibility to companies, but of course Tat Hong enjoys a higher mark-up and gross margins of up to 60% in its crawler crane rental business. Over time, we should see the effects of this move in Tat Hong's improved gross margin.

Prospects and Future Direction

In addition to comments from the interview, below is also a list of other points which I wish to independently raise to illustrate Tat Hong's prospects and how the company will cope with the current crisis:-

a) China had, on Nov 5, 2008, announced that they will spend an additional RMB 5 trillion (about S$1 trillion) in the transport sector to build roads, waterways and ports. This is in addition to its previous announcement to inject RMB 2 trillion (about S$400 billion) to upgrade infrastructure between 2006 and 2020. These moves bode well for Tat Hong's Tower Crane division as revenues and rental rates will be boosted by such measures.

b) The rental businesses for Tat Hong are expected to remain relatively stable as demand for rental is still present. Thus, these divisions should not see a very large negative variance in revenues. Margins could possibly suffer temporarily though, which I will not be surprised at, unless crane supply continues to remain tight.

c) Australia will continue to spend on infrastructure projects so Tutt Bryant should see steady demand for its services, even though Tutt projected a slowdown in the next few quarters. I encourage readers to visit Tutt Bryant's website (sidebar on the right of my blog) to read more of their financials and plans. It's too troublesome to post everything here !

d) Acitivites in the Middle East are also expected to remain firm, and Tat Hong's global reach should help it to buffer against the downturn somewhat.

I will be doing full reviews of most of my companies only at half-year or full-year results release. Either that, or when there is a major development worth writing about. Please leave comments if you wish to, and we can have a discussion in the comments box. Anyone posting nonsense or insulting remarks will get instantly removed without further warnings.


Wisdom Investments said...

Hi MW,

Good analysis on Tat Hong, captured its strengths and weaknesses well.

However, what is your opinion on the depreciating SGD/AUD? 60% of Tat Hong's revenue is sourced in Australia, thru Tutt Bryant.

Short term rental rates might be shielded by 6-18 months lock in period, but should they fall after lease expiry, in tandem with industry slowdown, how will it affect their cashflows?

Hope this can start a robust discussion on this great company.

Anonymous said...

Good analysis.
Due to global economic slowdown, the pace of construction or new construction will definitely be affected. This may affected the company's earnings and cash flow.

The company has been doing well for a number of years due to the past few years of economic growth.

The question here is; what happens if the economic slowdown last about 2 years?

JC said...

Informative review. As mentioned by wisdom, the SGD/Aus rate is one of the concern to me. The other is the their quick ratio of only 0.7.

musicwhiz said...

Hi Wisdom Investments,

My view is that the depreciation of the AUD should be a short-term phenomenon, as Australia has natural resources and the government is spending to boost infrastructure and avert a major recession. Of course, in the short-term we will probably see weakness persisting in the AUD, but over the long-term I think the exchange rate should strengthen (after all, Singapore is already in a bad recession and its currency could weaken further against other major currencies).

I am banking on Tat Hong being able to secure rental contracts as the Government will release projects over a period of time to sustain the construction sector and boost GDP. As I mentioned in my write-up, many projects were deferred in FY 2007 and the gradual release of these projects means that Tat Hong's cranes should have reasonably high utilization rates. Management had also purchased more PPE (cranes) for rental in 2Q 2009 to boost their rental fleet.


musicwhiz said...

Hi Anoymous,

Definitely Tat Hong will be affected by the economic crisis, I am not saying it won't. Earnings and revenues will probably fall in the next few quarters; but my focus is on the long-term cash generating ability of the company, and whether it provides margin of safety.

Even if the crisis lasts more than 2 years, there will be a time (some time in the distant future) where economic growth will be back. And hopefully, Tat Hong will be well-positioned to take advantage of it, being the market leader with a recognized brand name.


musicwhiz said...

Hello JC,

Thank you for visiting. Yes I agree the AUD is a concern, but over long-term I feel it should correct itself.

As for quick ratio, it's not very indicative of the business as theirs is not a retail/distribution or manufacturing business; but rather a rental one with ad-hoc sale of cranes. Thus, I think quick ratio may not be representative. A better measure may be gearing instead.


patrick ho said...

Hi MW,
nothing to do with this post. Nonetheless, just wish to say that you're right, sometimes whilst looking at the risk management, I've chosen to conveniently ignore the simple fundamentals i.e. profit margins.the whole idea of having high margins,coupled with high cash flow,helps a company to consistently deliver with high earnings visibility.

For Olam, I'm afraid I've been too preoccupied with analysing its debt position(which I still think that the market has misunderstood somewhat,although I might be wrong of course). The very reason behind its high leverage is because of its low margins, and it might be best to steer away from such companies with high recurring operating expenses.

I'm in the midst of detoxifying my portfolio, choosing to take profits with some counters simply because I have been too preoccupied with low value around me without analysing the true value proposition. Will choose to hold on for some others, even cutting losses if need be so that I can buy into more sustainable businesses. Thank you for that timely advice(although it might not have been intended to be:))


musicwhiz said...

Hi Patrick,

Erm, you're welcome ? Haha, thanks for sharing and good to hear your thoughts on views. I think both of us are still in the process of learning, so please keep the quality comments coming !


soros said...

Good analysis...hi how does one go about buying and selling US stocks?wat a/c do i need?

musicwhiz said...

Hi soros,

Give a call to your broker or call the brokerage house. They will give you further instructions.


P.S. Thank you for visiting.

SGDividends said...

Hi Soros,

Just open a stock account with DBSVickers Online and tell them explictly you want to buy US shares. They should give u a W8 Ben form to sign.

We say DBSVickers Online as this account is good for long term investing as there is no custody fees for the US sharess unlike POEMs.

SGDividends Team No 4

musicwhiz said...

Thanks SGDividends,

I also did not know DBSV does not charge custodian fees for USD shares. I may consider opening an account with them in that case.


Anonymous said...

Hi Musicwhiz,

Does Tat Hong has significant exposure to Chinese market? Somehow noticed that its tracking rather closely to HSCEI Index.

musicwhiz said...

Hi Anonymous,

Tat Hong's exposure is currently not very high, only through their JV with Yongmao to manage tower crane rentals. By 2010, they hope to have 20% of their earnings coming from China, though I am sure the global financial crisis may derail their plans.

As for tracking indices, I have no comment on that.