Saturday, May 30, 2009

May 2009 Portfolio Summary and Review

If April 2009 was the “Month of Reflection”, then perhaps May 2009 can be aptly described as the “Month of Green Shoots” ! The start of the month saw a sudden improvement in business sentiment and the theory was put forward that “green shoots” were being observed which slowed the pace of decline in the real economy. Other horticultural terms were being flung around as well, with some saying that there were equal amounts of “brown weeds” and that a recovery was not clear at all despite signs that some areas of the US Economy were bottoming out. The situation was echoed back here in Singapore as well, with prominent MPs giving divided and conflicting views over the economic situation.

The result of the sudden burst of optimism was the biggest one week jump in global stock market indices I had seen so far in my limited years of investing. It was just back in March 2009 when STI hit a low of 1,456, and as of this writing, the STI is close to the psychological resistance point of 2,300. That’s almost a 58% jump in the Index within just two short months, and does illustrate the point that when valuations revert to the mean, they can do so suddenly, sharply and without prior warning. Suffice to say almost all the people I spoke to were taken completely by surprise, and many are somehow convinced that this is a bear market rally and not the “real” recovery. Whether this is so will only be known on hindsight.

My divestment of Pacific Andes this month has returned some capital back to me to be recycled to other worthy investment opportunities. Suffice to say I am devoting some time to research and studying some potential companies right now, and admit I was rather slack and lazy over the past few months and thus was only comfortable in adding to my existing positions (back in October 2008 and March 2009). It would be splendid indeed if I could find another value investment when conditions have not totally improved, and sentiment continues to be depressed. Once valuations revert fully back to the mean, it may prove difficult to find sufficient margin of safety.

With the FY 2009 reports for Boustead and Tat Hong released on May 28, 2009, I shall be busy in the coming weeks doing some in-depth analysis for each company and its prospects, and will post these up separately when they are available.

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

1) Ezra Holdings Limited – Ezra had done a placement of 78 million new shares at $1.185 to raise capital for paying down debt and possible M&A. This was detailed in a previous blog post of mine, therefore I will not give further details here.

2) Boustead Holdings Limited – Boustead released their FY 2009 results on May 28, 2009. Revenues for FY 2009 rose 17.9% from S$438.3 million to S$516.6 million. Gross profit, however, increased by a smaller 5.4% due to higher COGS booked. Net profit attributable to shareholders increased by 16.8% to a new record S$60.1 million, as Boustead celebrated their seventh year of record revenues and profits. A final dividend of 2.5 cents per share was declared, payable on August 20, 2009. My dividend yield was 6.63% after taking into account my additional purchase of Boustead in March 2009 (based on a total dividend of 4 cents/share for full-year 2009). I will be doing a detailed analysis and review of Boustead’s financials and prospects in a separate blog post, but I have to caution that FY 2010 will definitely not be as good as FY 2009 as the global economic crisis hits home for Boustead.

3) Swiber Holdings Limited – Just yesterday, on May 29, 2009, Swiber announced a share placement of 84 million shares at 88 cents each, raising about S$71 million (after deducting expenses). The fund raising was done through CIMB GK Goh and was stated as being for general working capital purposes. The new capital raised is about 20% dilutive, which represents an exercise similar to Ezra (incidentally, at least Ezra got a better deal with 78 million shares at $1.185). Oil prices have been trending up to US$66 per barrel at the time of writing and the prospects for the industry look bright with more deepwater E&P taking place in the years to come.

4) Suntec REIT – There were no updates from Suntec REIT for this month, and I received the dividend on May 29, 2009. There was a proposal from MAS, however, which mentioned that REITs should conduct AGM from FY 2010 onwards. That would indeed be a welcome change with respect to improved corporate governance.

5) China Fishery Group Limited – CFG released their results on May 15, 2009 and reported a 40% increase in revenues year-on-year, but only an 8% increase in net profit due to higher COGS and also higher selling expenses. As this is a 1Q 2009 results release, I will not go in detail on the analysis. Readers are welcome to visit SGXNet to obtain relevant information on CFG’s latest results and press release.

6) First Ship Lease Trust – I received the dividend of US 2.45 cents per unit from FSL Trust on May 29, 2009. It was converted at an exchange rate of 1.458 to the SGD. Conditions in the shipping market appear to have improved, as evidenced by the BDI jumping to the 3,200 level; its highest level since Sep 2008 on higher demand for iron ore from China. However, my feel is that there is still a long way to go before the shipping industry recovers, thus all shipping trusts would still face significant headwinds moving forward. As long as the cash flows from lessees are steady, I do not feel overly worried about my investment in this Trust.

7) Tat Hong Holdings Limited – Tat Hong released their FY 2009 financials on May 28, 2009. Revenue for FY 2009 was flat at S$632 million, while gross margins stayed constant at 38.2%. However, net profit attributable to shareholders declined 23% from S$89.8 million to S$68.9 million, mainly due to a S$16.1 million forex loss, impairment of goodwill and disposal of associated company, as well as provision for losses. A final tax-exempt dividend of 1.5 cents per share was declared, bringing my yield to 2.2% based on my purchase price of 68 cents. The dividend will be paid on August 18, 2009, subject to shareholders’ approval at the upcoming AGM. Taking into account my additional purchase in March 2009, average dividend yield for FY 2009 was 6.31% (using a total dividend of 5 cents/share for FY 2009). I will be doing a detailed review and analysis of results and prospects for Tat Hong in a future post.

Portfolio Comments – May 2009

My portfolio for May 2009 is not directly comparable to April 2009 as there was a divestment of Pacific Andes, which lowered my cost of investment. However, one thing I can conclude is that with the recent reversion of valuations towards the mean, I also saw a substantial increase in the value of my portfolio. It has now turned positive for the first time since October 2008 and is up 22%. The loss from the divestment of Pacific Andes had reduced my realized gains from S$12.8K to a mere S$4K. If this is added on to the unrealised gains, the total gain on my portfolio cost is 25.6%.

May 2009 itself has proven to be an amazing month as my net worth has increased substantially due to the rise in market value of my portfolio. This is the fastest and most drastic increase since I began embracing the concepts of value investing, and it is a small testament on how investment principles can help one to preserve capital and give one a decent return on investment. However, I must remind myself not to be overly complacent as my focus is still to closely monitor my companies to ensure they adhere to my original purpose for investing in them. After all, the financial crisis is far from over and recovery still seems remote as of this writing, so the companies I own may face further headwinds and difficulties in the months to come. While I do believe that most of them will be resilient, it is an undeniable fact that they would still be negatively impacted in one way or another.

On a separate note, the companies I owned had seen a total of two placements (Ezra and Swiber) and one rights issue (PAH) for the month of May 2009 alone, and this itself proves that my method for selecting companies needs to be fine-tuned and improved. Companies should be using most of their internal cash flows to sustain and grow their businesses, and should also be paying out a healthy dividend to their shareholders. That said, one must keep in mind that the balance between growth and income is tenuous, and my investments in Swiber and Ezra are considered “growth” investments; hence the fund-raising itself does not come as a surprise, though it is admittedly unwelcome. My screening process in future will account for high gearing and cash inflows as being a critical and pertinent part of the decision-making, and I will be more rigorous and demanding in my selection criteria as well.

My next portfolio review will be on Tuesday, June 30, 2009.

Monday, May 25, 2009

Pacific Andes - Rationale for Divestment

I sold off my entire stake in Pacific Andes today, capping a three-year long investment which saw one round of capital injection; and which resulted in a significant 38% loss. Even though the Company had announced a decent set of full-year (FY) 2009 results, with net profit attributable to shareholders up 38% to HK$664 million, the nail in the coffin came with the announcement of a fresh rights issue, coming hot on the heels of a previous one in March 2007. The offer this time was a 1-for-1 rights issue at 15 cents per share (a 50% discount to the last closing price of 30.5 cents) with additional warrants attached (1 warrant for every 5 rights shares subscribed for, exercise price 23 cents). The rights were supposed to raise about S$228.6 million while the warrants could potential add another S$70.1 million to the Company's coffers.

So one might ask - why is this the "nail in the coffin" ? Presumably, if I had wanted to increase my stake in PAH, I could have done so at 18 cents back during March 2009, but hesitated from doing so. In fact, a cursory glance at PAH's business model and financials would not leave one surprised as to the timing or magnitude of the rights issue. While I had previously added more PAH back in 2008 at a price of 44 cents, I had failed to take into account the inherent business model flaws which would precipitate a full-scale rights issue, and apparently Management also "forgot" about the massive dilutive impact of such a fund-raising exercise on both earnings and (future) dividends per share. Some of the reasons for my divestment are stated below in point form for easy reading and reference.

1) Paid too high a valuation - This fact was apparent right from March 2006, when I first purchased the company at a high price of 81 cents (pre-rights). It was probably valued at around 8-9x historical PER at the time, and I had neglected the fact that it was in SCM and trading and was a high volume-based business, but more on that later. The rights shares issue back in March 2007 were offered at 52 cents, seemingly a juicy offer since my purchase price was a high 81 cents. In August 2007, I continued to purchase more at 61 cents to further average down my cost. This was till July 2008 when I added my last round of PAH at 44 cents, giving at least 8 good reasons for doing so. Since I could justify my purchase so succinctly, I could also figure out what I had omitted to make this such a glaring error. All my reasons and rationale had not accounted for the Balance Sheet weakness of PAH and its business model which I shall elaborate on later. Taking the FY 2009 net profit of HK$664 million, it's about S$132.8 million. Dividing this by 1.391 billion shares gives an EPS of about 9.54 Singapore cents. At the current price of 35.5 cents, the PER is about 3.72. This may seem undemanding at first but considering the dilutive effects of the rights issue, the share capital base will "expand" to 2.8 billion shares and EPS will be halved. Thus, it does not seem like such a bargain any longer.

2) Holding Company Effect - PAH suffers from this effect which means it derives most of its value from their investment in another company, namely China Fishery Group Limited (CFG), in which I am also vested. It holds a 64.1% stake in CFG and works closely with CFG in its SCM and Trading business. However, PAH itself does not have the hard assets which CFG has. This means that much of its valuation is derived from the valuation of CFG; and CFG is the main downstream revenue generator as it is the Company which catches the fish. Hence, PAH is involved in a very high volume-based business (not unlike Noble or Olam) in which net margins are very thin. In fact, it can be readily observed that PAH has a net margin of less than 10% based on FY 2009 results, while CFG has a net margin of 26% based on 1Q 2009 results.

3) Lack of Tangible Assets limits collateral for loans - The rationale for PAH to raise funds is to provide for working capital needs (see point 4 as well). Notice that the company had NOT managed to secure any funding through bank loans and the CEO commented that it was difficult to do so during this harsh credit crisis. Yet, a quick glance at CFG shows that CFG had recently (in 1Q 2009) obtained a US$60 million bank loan to finance its expansion into the South Pacific Ocean. The reason for this is the lack of tangible assets belonging to PAH which can be used as collateral for loans. Previously, PAH would have used shares in CFG as collateral to banks, but during this severe credit crunch, banks are more cautious when lending and would prefer tangible assets such as fishing vessels and inventory (such as fishmeal) as collateral, all of which are owned by CFG and not PAH.

4) No clear objective for Fund-Raising - Most companies which issue rights have some specific objective in mind. Capitaland and its REITS CCT and CMT raised funds to pay down debts and to act as "pre-emptive" capital for M&A opportunities (or so they claim). Other companies raise funds to (presumably) capture opportunities for expansion and growth as there are many assets out there selling at distressed levels. Such cash is vital for taking advantage of opportunities. PAH only said that the cash was to be used for working capital, which I assumed to be for normal operating expenses and for daily use. This implies that the Company was short on cash for the normal operations of the Company, and did not have a specific objective for the cash, which makes the fund-raising all the more suspicious. It is CFG which has the clear growth strategy, with its elongation of vessels, deployment of vessels to the South Pacific, as well as introduction of ITQ. Therefore, it can be clearly seen that CFG's business model is very different from PAH as it has high net margins, high cash generation ability and has clearer scope for expansion.

5) Lack of Catalysts for Growth - As mentioned before, much of PAH's "growth" can be attributed to its 64.1% stake in CFG; hence its "value" hinges upon the value of CFG. This in itself is a very risky proposition for investment as the Company itself has no objective, clearly-derived value for which one can make a value proposition. Its SCM business can be likened to a commodity business as SCM models are essentially the same, are volume-driven and suffer from thin margins. This fact, coupled with the lack of tangible assets and the Company's excessively high gearing, made for a poor investment choice.

Unfortunately for me, I had to learn from this mistake the hard way - by taking a substantial loss by selling at 34 cents per share. But this mistake actually offers me better insights as to how to value a company, what to avoid, things to watch out for and more facets to consider when assessing if a company is suitable for long-term investment. The cash call was a timely reminder to me that this mistake had been made 3 years ago, and finally the time has come to divest of this mistake before it became a full-blown debacle. The opportunity cost of NOT divesting can sometimes be greater than the actual financial loss from divesting sooner (rather than later). Because of my reluctance to take a larger loss on this earlier (Oct 2008 through March 2009), I also omitted the chances to recycle the cash to other more promising companies like Boustead and Tat Hong. Thus, my mistake is two-fold and I feel mortified.

Moving forward, I will seek out more opportunities to purchase under-valued companies at attractive prices and a decent margin of safety; and will pay special attention to Balance Sheets and business models, as well as the fact that the companies I own are supposed to provide me with money (through dividends) and NOT keep asking me to pump in money instead ! I shall endeavour to pick myself up from this mistake, dust myself off and move on. I treat this as a good (though painful) learning experience, and promise not to make a similar mistake in future.

Note: This realized loss will be reflected in my May 2009 portfolio review as an offset against realized gains (currently standing at S$12.8K) and I shall cease all coverage of Pacific Andes from now on. Readers can access archives for PAH but all further updates shall be confined to CFG (which I still own).

Thursday, May 21, 2009

Ezra - Share Placement of 78 Million New Shares

The announcement of Ezra's share placement caught me by surprise, frankly, for I had thought from their 1H FY 2009 press release that they had already enough cash to fund their MFSV purchases as well as expand their Vietnam Yard. For those who are unaware of the details of the above transaction, Ezra placed out 78 million new shares at a price of S$1.185 per share to raise gross proceeds of S$92.4 million. Considering their issued share capital is now about 580 million shares, this exercise will be pretty dilutive (about 13%) as it enlarges the share capital base to 658 million shares. Suffice to say that as a shareholder, I am unhappy about both the exercise and the rationale. However, I am willing to objectively and rationally analyze the underlying reasons for this corporate action.

With previously announced capital commitments of US$350 million, Ezra had mentioned that they had secured sufficient bank lines and would use internal cash flows to finance their expansion. It was also stated in several analyst reports that growth for Ezra would not be vessel-driven from FY 2011 onwards; instead the Company would re-package its services by combining Energy Servicess Division to provide customers with an all-rounded solution, thus commanding higher customer retention and loyalty and also garnering higher-value (and hopefully higher-margin) contracts.

The rationale for this fund raising exercise was stated as lowering their gearing from 0.5x to about 0.26x as at end-February 2009. One then wonders if Ezra had prudent capital management policies in place to ensure it had sufficient working capital, as raising money during an era of low/depressed valuations (as in this bear market) is usually not a good idea. Perhaps, of course, this exercise had already been on the cards; but news was NOT allowed to leak on the proposed share placement ahead of time, otherwise it may jeopardise the share price and cause a lower placement price to be set. Since the volume-weighted average price is used for the determination of the final placement price, leaking such news beforehand would be tantamount to asking for lower prices; thereby leading the Company to issue even more shares just to raise the required amount.

That said, one must also question if the Group had considered debt financing instead of equity financing and if they had weighed the pros against the cons. Apparently, having a high gearing of 0.5x and a somewhat fragile Balance Sheet meant that getting additional loan commitments (even with standby collateral) would not be easy. The cost of debt is also much higher during these troubled times as we are in the midst of a credit crisis which has yet to fully abate. With more difficulty now in securing needed funds through financial institutions and the higher cost of such capital, Ezra may have then decided to raise monies through capital markets instead; hence the secondary issue. One should also note that in the long-term, such capital is cheaper as Ezra has no obligation to pay dividends on the new shares, unlike debt where there is a clear obligation to pay interest. However, the downside is to the shareholder (including the major shareholders Mr. Lee himself) as they all suffer from shareholding and earnings dilution of 13%. All future dividends must now be divided amongst a much larger pie than before, and the thought rankles.

Incidentally, the previous fund-raising exercise (aside from listing EOC on Oslo) was held during Feb 2007 when they sold 15 million shares at S$5.18. If we take the split adjusted share price, it's like selling 30 million shares at S$2.59. That's about 100% higher than today's placement share price announcement. So they are issuing more than double the number of shares (78 million) at half the price ! Not a very good deal in my opinion, and it may indicate that they are starved of working capital.

Another issue which cropped up in my mind is whether the Management had anticipated such a working capital requirement and whether they had thoroughly planned for such a fund-raising, or was it an off-the-cuff reactionary corporate action predicated by unusual circunstances ? By now, the recession would have swept through most companies and left visibility in tatters. The lack of direction in terms of the future may mean that a Company like Ezra is left to flounder in deep waters (no pun intended) for meaningful direction when it comes to corporate strategy. This has been the case for many players in the oil and gas industry, and it perhaps a probable reason for this fund raising.

Yet another perspective I can offer is that the Group has somehow identified distressed assets or a good M&A opportunity, and are hurriedly raising funds (through Credit Suisse) to take advantage of the situation before the opportunity is lost. Note in the announcement that funding possible M&A takes up a 5-50% allocation, while paying down debt and funding capex takes up 10-50% and 10-70% respectively. This could perhaps hint that there is something out there for the Company to capitalize on, and obviously they cannot make their intentions too apparent through a public press release, otherwise it may alert potential bidders that something may be stirring.

That said, this whole exercise may just be an attempt to lower their gearing and ensure they have sufficient funds for opex and capex without straining their Balance Sheet further. Disclaimer: The scenarios which I have run through above are meant to be discussive, and are in NO WAY insinuating that Mamagement are either inept or are attempting to hide anything. I am also not implying that there is any other intention than the one stated in their press release, but it bears mentioning that a number of plausible scenarios may arise as a result of today's fund-raising which are worthy of contemplation.

So dear reader, please also air your views on how you feel about Ezra's placement, and about share placements in general. Are they "better" than having rights issues (e.g. Keppel Land and Capitaland) ? Is this an indication of poor financial management or a case of being "pre-emptive" and raising capital to take advantage of opportunities which may be lurking ?

Sunday, May 17, 2009

Value Traps

The title looks simplistic and deceptively simple, doesn't it ? However, do not be taken in - value traps are defined as companies which appear to have "value" and margin of safety but in reality are far from being investment-grade. As an aspiring value investor, value traps are one of the most insidious things to look out for, as they can confound and confuse for years before you finally realize them for what they are. By then, you would have lost not just a substantial and significant portion of your capital, but also suffered from opportunity costs of deploying your capital in companies which truly qualify as "investment-grade".

So what constitutes a value trap ? I could probably give some examples in real-life context (coupled with mistakes I had made before when I first started investing); but the underlying theme is that such traps consist of companies which seemingly have an edge or competitive edge over other competitors and are able to generate a high ROE/ROA, but the problem is that this is fleeting and temporary or it may be at the "peak" of its earnings cycle. Therein lies the danger - companies whose businesses are cyclical are likely to suffer from poor revenue growth and earnings deterioration once the cycle is over; while those which did not adhere to a business model which works over time may likely get surprised when economic conditions deteriorate (as they have done now). Other examples are companies which seemingly have a value proposition and some competitive edge, but which cannot make use of this edge or hold on to it to generate high returns on capital.

Lest the reader thinks that the companies I currently own are NOT value traps, let me first state that some of them MIGHT BE. This is the difficult aspect of value investing - the fact that it may be difficult to spot a value trap till it is too late, or I may be myopic in my business assessment of the companies I own; or something could go drastically wrong with the business to render all prior analysis and study irrelevant. The idea is to pick companies with a business moat and few competitors, or are at least large enough in their own right to be able to command superior margins and a competitive edge, coupled with good and honest Management. There have been cases where an investment into (supposedly) such companies failed to yield positive results, due to the fact that my analysis was flawed or incomplete; or business conditions evolved to such an extent as to render the previous analysis obsolete. One recent example is Trek 2000, which manufactures and has patents for their Thumb Drives. Although much of its revenue is earned from licensing agreements with major technology players, its revenue base and gross margins have been declining of late as the technology sector ran into problems and they were unable to come up with innovative new products to sustain revenues. A similar case in point would be Creative Technology, which was unable to replicate the success of its SoundBlaster in the 1990s. Creative has now had the misfortune of falling into the red and are frantically scrambling to cut costs amid a severe slump as well as losing market share to Apple Computer (the i-Pod and i-Tunes).

Other cases of value traps would be companies which trade at very low price-earnings ratios like the current batch of S-Chips listed on SGX-ST. Some of them are valued at a mere 2-3x PER while peers listed in Hong Kong are trading at valuations of at least 10-12x PER. So why is there a valuation "gap" and can this be exploited ? Again, the issue of size, competitive strength and market share come into play. Listed footwear makers in Hong Kong like Anta, for example, are much larger in terms of size and scale and distribution network as compared to smaller players like China Hongxing, China Sports and Hongguo. Similar examples include comparing Synear Foods and Youcan with larger players like Mengniu and Yili. Such cases show that the market will value a company based on future growth prospects, and the reasons for trading at low multiples could represent a value trap for investors who do not understand the nature of the business or the expansion potential of the Company. The recent results from the fibre companies like China Sky and Li Heng also illustrate that growth may be slowing or margins severely crimped, thus also "crimping" valuations. Hence, low valuations may represent more of a value trap than a value proposition - the key is in analyzing the qualitative aspects of the business and not just the quantitative aspects and being able to conclude on what constitutes a good "buy" and what represents a good "bye" !

One final category I can think of in terms of value traps are companies which trade below their Net Asset Value (NAV), of which there are quite a handful in this bear market and sharp economic recession. There are those who argue that such companies represent good value because an investor is able to obtain at least the NAV upon liquidation, which is stated as a value higher than the currently traded market price. However, one should be mindful that such businesses are unlikely to be liquidated anytime soon, and the liquidation value is based on the historical cost of assets on the Balance Sheet, NOT market value of their assets. This can be very misleading as a forced liquidation of current and fixed assets may not fetch more than 60 cents on the dollar, for example, as compared to an orderly liquidation. Firesales of assets for companies which are burning cash and struggling to survive will not yield much returns for assets stated at cost on the Balance Sheet; therefore the NAV number may be deceiving at best, and totally misleading at worst. Thus, I have classified companies with poor business prospects, high cash burn, very low margins and poor revenue visibility under "value traps" even though they may be trading at a huge discount to NAV.

The value investor's job is to avoid value traps; however it is unavoidable that some will be encountered during the course of his investment journey due to either inexperience or flawed analysis. It is thus important to be able to identify such cases quickly (so as to cut losses and not repeat the mistake) or to avoid such cases altogether (through dilligent study into the cases where value traps exist as pointed above). My knowledge on this area is still expanding and I endeavour to continue to learn of value traps and to identify true good value in companies.

Wednesday, May 13, 2009

Handling Mr. Market’s Mood Swings

With the recent volatility experienced by Mr. Market’s violent mood swings, investors may have been left in shell-shocked mode. These violent episodic mood swings can be likened to what occurred last October 2008 with the collapse of Lehman Brothers, and as the market digested the possibility of the collapse of the global financial system. Back then, the market had begun a nightmarish tailspin into the depths of depression, and valuations had hit a nadir (at least, for some of the companies I was eyeing back then). So there is some truth to the adage that investing is best when pessimism is at its peak, as it creates situations whereby superb and advantageous valuations arise on well-run, fundamentally-sound companies !

During such times, it is important to have a sound investment philosophy and criteria with which to rely on in order to make investment decisions. It used to be the case that a few years ago, before my value investing days, I was still stumbling around in the dark trying to ascertain if I should trade, contra or invest ! I had no guidance and was not aware of what was going on out there, and that is a very dangerous situation indeed. Of course, I lost some money along the way and made the classic mistakes which most “newbies” make, which I have detailed down under my “Investment Mistakes” category. Fortunately, I did not have to try out and get burnt by warrants and shorting for me to realize that those were extremely risky speculative activities which could have landed me in hot soup ! So it actually pays to learn from others’ mistakes instead of making your own.

With the proper framework and mindset, one can then go about searching for good and sound companies which are trading below their intrinsic value. It is the investor who welcomes bear markets and Mr. Market’s volatility as a way to scoop up shares cheaply and at attractive valuations. When one perceives the ownership of shares as being part-ownership of a company, his perspective will change and he will welcome lower prices and pessimism as a way to collect more shares cheaply. I did not realize this until I read up on books which described value investing and in making Mr. Market my servant, not my master. By accepting quotes from him only when they are attractive, you are taking advantage of his pocketbook and are free from his mental influences.

Though people speak of bear markets fearfully and shun low share prices, it is the wise and astute investor who can separate the wheat from the chaff and go after the fundamentally sound companies which have been beaten down along with the rest of the rubbish. A good and easy way to invest would be to select strong blue chips such as banks, telcos (SingTel) and renowned property companies (e.g. Capitaland, CDL) during such troubled times, as they will be the first to bounce back in terms of earnings due to their sturdy Balance Sheets.

Ultimately, as investors, we have to maintain mental discipline in the face of what is sometimes described as a mentally taxing environment. Since money plays such a significant role in our lives and livelihood, the thought of losing money can affect one emotionally and leave one scarred. The stock market is a place where emotions are running high all the time, and it is up to the intelligent investor to remain calm, patient, rational and objective in searching for gems to purchase. This is my advice to aspiring investors; and also one which I have to constantly remind myself of. After all, being a human being myself, I cannot avoid the feelings of greed and fear. It is the control of these emotions which will eventually allow one to derive a decent long-term return from the Stock Market which exceeds inflation.

Note: Many of my companies’ financial results will be released starting from May 14, 2009 (Swiber), so I will spend time digesting the information before reviewing and analyzing in a separate post. China Fishery should report on May 15, while Boustead and Tat Hong are reporting on May 28 and Pacific Andes on May 29.

Saturday, May 09, 2009

Swiber – AGM and EGM FY 2008 Highlights

I attended the AGM cum EGM of Swiber Holdings Limited held on April 30, 2009 at 9 a.m. Due to the fact that there was quite a heavy torrential shower in the morning and also the presence of an accident near the AGM venue (which was the Company’s headquarters), several directors as well as shareholders arrived late. Due also to the fact that there was a lack of signs pointing to the location of the AGM and also a lack of hourly parking lots (the carpark at Swiber’s HQ was all season-parking), this also caused quite a bit of disgruntlement and there were some accusations that the AGM was not organized well. Management acknowledged the issues and said that they would learn from the experience and that all feedback would be noted and that FY 2009’s AGM would be a better experience.

The entire AGM and EGM lasted about 3 hours in total, with Management candidly answering questions from several shareholders who took to the microphone. I also managed to clarify some doubts I had with regards to certain issues which had been nagging me since the late deliveries of Swiber Concorde and Swiber Supporter, as well as some recent corporate activites. I shall now proceed to give a point by point review of the queries which were raised, issues discussed and explanations given.

1) Late Deliveries of Swiber Supporter and Swiber Concorde – Management has explained that these delays were unfortunate and unforeseen as the yards were unable to cope with so much work and did not have the capacity to finish the vessels on time. This resulted in delays and deferred revenues while costs escalated due to commissioning and de-commissioning as well as third-party vessel charters. When quizzed if this would be a one-off scenario, Management mentioned that this was unlikely to happen in the near future as yards are now begging for business as the slowdown has meant that many customers are cancelling contracts. I also asked if there would be any penalties involved as the oil majors who had contracted Swiber would have suffered delays in the commencement of the contract. Management assured that they work very closely with the oil majors and have obtained their understanding that such delays were an inevitable part of business and oil majors accept this as part of the cost of doing business. Moreover, there are a lack of incumbent players in South-East Asia who can perform such EPCIC work, which also means Swiber has better bargaining power. To date, these vessels have been delivered and are being prepared for their respective jobs (see FY 2008 Annual Report Page 28).

2) Oil Prices – One shareholder did bring up the issue of a breakeven price level for oil which would make Swiber’s business viable. The reply was that should oil fall to an improbable US$20 per barrel, this would certainly curtail E&P activities and would trickle down to affect Swiber’s core business. However, Management mentioned that they think this to be unlikely as most analysts are of the consensus that oil prices would hit about US$70 to US$80 per barrel by end-2009. Even then, Management reiterated that Swiber was doing good business back in the late 1990’s (before listing) when oil prices were much lower, and had been profitable then as well.

3) Contract Wins and Sustainability of Order Book – I did bring up the fact that Swiber’s order book seems to be drying up as no recent contract wins were announced on SGXNet. Mr. Raymond Goh did mention that US$70 million worth of contracts had been won for Jan-Feb 2009 but these were all made up of smaller individual contracts and each by itself was not material enough to warrant a press release. Management also said that their current order book would last them for the next 2 years till end-2010 and that they were currently bidding for projects in 2010 as their new fleet arrives. Their order book was currently filled by Brunei Shell’s extension contract as well as CUEL’s 5-year US$50 million per annum contract. In addition, there are possible “spill-over” contracts from joint-venture partners which Swiber has established in Brunei and Saudi Arabia.

4) Offshore Drilling Services (ODS) Division Plans – I was enquiring on the future of ODS now that it was announced that the Equatorial Driller would be postponed till economic conditions improved. It would have been a heavy burden for Swiber to finance this vessel and there were also no shipyards at the time to take up this project which involved the design of a radically new type of drilling vessel (different from the normal semi-submersible). Management also made the wise choice of deferring the construction of this vessel as the recession would mean cheaper construction costs in the near future should they take up this task again. My question to them was about their plans for this division in the interim as Swiber had hired a full drilling team headed by Mr. Glen Olivera. They said that ODS was now providing drilling expertise services and moving forward, there were plans to restart the Equatorial Driller project once conditions improved. I suspect gross margins and prospects for drilling expertise services would not be as good as being able to own and charter out a cost-efficient drilling vessel, but that would be the best move which Swiber can make in the meantime while waiting out the recession.

5) Sale of 51% of Swiber Victorious to ICON Capital – I was asking about the rationale behind the sale of 51% of this vessel to ICON Capital for US$19.125 million. Management said that this helped to lighten their capital commitments, but it does not mean that only 49% of the contract value would be recognized for Swiber. The reason for ICON buying 51% of the vessel was to look for a fixed, steady return which Swiber would provide; but technically the vessel was still contracted under Swiber to carry out its contracts and so 100% of the earnings will still accrue to Swiber. In other words, Swiber was farming out some of the cost of the vessel while enjoying the full benefit of the contracts which the vessel was engaged in; thus it was a win-win solution for both ICON (which received a fixed return on its investment in the vessel) and Swiber (which could lower its ownership costs yet partake in the full benefits of each contract). It was also reported in Upstream Online that CUEL had agreed to buy Swiber Chai for an undisclosed sum, after which Swiber would probably lease it back from them for use in its contracts. Swiber’s partnership with CUEL meant that there was mutual sharing of assets and the synergy would continue to work for both parties as each benefited from vessels as well as co-operation on contracts.

6) Divestment of Swiber’s 30% stake in OBT – It was announced that Swiber had divested its entire 30% stake in OBT at cost, netting them a total of S$3.9 million. I questioned the rationale for this sale and Management replied that OBT was actually used for coal transhipments using coal and crane barges. Now that coal prices were coming down, this made owning OBT less attractive (I assume the margins would become much thinner) and Indonesia was also becoming more stringent on such barges. In view of these negative developments, Management made the decision to divest OBT and they viewed it as fortunate that they could divest it at cost instead of at a discount (i.e. loss).

7) Offshore Wind Power Potential – Swiber is exploring this business opportunity as it presents a very lucrative proposition for the Company should they be able to break into this growing market. Many countries are rooting for clean energy and wind power was a growing source of capex for companies which are keen to ride on this trend. Swiber would mainly be the contractor to provide barges and cranes to transport wind turbines, which could be very large and heavy indeed. Although it is too preliminary to talk of securing any contracts, Swiber is in discussion with several companies on the possibility of providing their vessels for such wind power projects. There was no mention of the gross margins, size of contracts or duration.

8) Joint Ventures with Strategic Partners – Swiber’s tie-ups with partners in Thailand (CUEL), Vietnam (Vietsopetro), Brunei (Rahaman) and Saudi Arabia (Rawabi) are ways for them to break into a new market. The aim is also to share assets (to lighten the debt burden as vessels are costly assets) as well as to partake in mutual contracts. It was mentioned that Rawabi was a very good partner as they had connections with Saudi Aramco and thus could garner good contracts which would probably flow through to Swiber. As to whether there will be any future JV, Management said this was a possibility but could not give further details.

While the above may not signify a rosy future for Swiber, at least it provides some comfort that the Company is not in danger of collapse due to over-leveraging, as their capital commitments of US$318 million have already been covered by existing cash, sale and leasebacks and bank loans. Management’s assertion of contracts stretching till late 2010 also gives some comfort on revenue visibility, while the non-deliveries of the 2 vessels can be construed as a one-off event; implying that margins will improve in the near future (they have been trending down for 3 consecutive financial years since FY 2006 and this is a worrying sign).

Still, I am waiting for 1Q 2009 results to see if there is any spillover effects from the late vessel deliveries, or if any more unforeseen issues haunt the company. As at this writing, the future is still murky and uncertain and even though oil and gas companies are still spending on capex as oil reserves are expected to run out in 50 years time, there is no confirmation that Swiber is able to snare contracts of sizeable value to boost its order book any time soon. I am hoping that Management remain prudent and conservative with regards to cash flow management, in order to see the Company through this difficult period.

Tuesday, May 05, 2009

Stakeholder Influences on a Company

For want of a better title, this post is about how stakeholders affect a company even though the company itself may be fundamentally strong. The truth is this recession and sudden sharp downturn has revealed to me that companies which were once “strong” can quickly see their fortunes reversed due to many factors, some of which are beyond their control. As investors, even though we are unable to predict exactly how bad things can get to the extent of how adverse the economic environment can degenerate to, we should nonetheless be aware of risk factors which may crop up now and then to make us more careful before we put our money down.

I would like to explore several aspects of stakeholder influence on a company which may cause concerns once the economic environment worsens. These are by no means an end to itself and it may open up a can of worms as readers may wish to comment on other aspects which make a company “vulnerable” as well. But my motive is to highlight some aspects which I think have been revealed in the recent recession and which I feel may have a bearing on out investment decision-making going forward. After all, it’s supposed to be continuous learning and learning from others’ mistakes is a good way to avoid committing the same ones yourself.

CUSTOMERS – The loss of a major customer due to bankruptcy, or inability to pay in a timely manner can severely affect the future of a business. In the semi-conductor industry, Chartered faced problems when main customer Motorola saw a drop in orders, which in turn tricked down to lower demand for Chartered’s products. Heavy reliance on one customer is risky as most of the revenues will be hinged on that one customer, and even if a company has a good Balance Sheet; it may be affected by the customer who cannot pay in time. This would have a bearing on the Cash Flow Statement of the company and may lead to severe cash burn. Some companies are able to recover from this but others may either file for bankruptcy or be forced to raise funds through a dilutive rights issue (as in Chartered’s case).

SUPPLIERS – On the flip side, the financial problems affecting a major supplier can also have a huge and adverse impact on a company. To give a hypothetical example, imagine if a dumpling company’s supplier ran into trouble and could not supply most of the pork and flour required for their dumplings. Assuming the company only had one major supplier, this would mean they are vulnerable to “supply shocks” and thus would have problem fulfilling customer orders. Hence, it is risky for a company to rely solely on one supplier or even one major supplier for its raw materials. Even if a company was perfectly healthy, a collapse in one or more of its suppliers could spell big trouble unless it can quickly look for substitutes. In specialized industries, this is made tougher than for commodity industries.

FINANCIAL INSTITUTIONS – With the severity of the sub-prime crisis, once untouchable banks in the USA are now falling like a house of cards. Once lauded as the largest bank in the world by market capitalization, Citigroup has been reduced to tatters and now requires a few rounds of Government bailout in order to stay alive. The health of a financial institution is instrumental in determining if a company can obtain sufficient financing. This problem is difficult to mitigate, however, as the current crisis has shown that almost ALL banks have been hit and financing has more than dried up. This has taught me to watch out for highly leveraged companies as this means it gets harder to refinance short term debt. A case in point in Ferrochina which had a leverage of about 300%. I will comment more on this in a separate post on gearing, debt and leverage for companies.

MAJOR SHAREHOLDERS – By now, most people would have read the cases of major shareholders of the company pledging their shares to obtain personal loans. With the advent of the financial crisis, these stakes have been forced sold due to margin calls on the shareholders’ personal loans, thereby causing chaos with respect to the ownership of the company. The latest victim of this is Sino-Environment which has seen the founder’s stake reduced to a mere 6+% as a result of many rounds of forced sale of shares. I feel that this can be mitigated if SGX publishes which companies’ shares are being pledged for loans; but so far this is still not a mandatory requirement.

The list above shows some of the ways in which one can get “tripped up” even though one has analysed the company from top to bottom. Stakeholders have a major influence on a company and thus we cannot avoid studying these influences in order to arrive at a fair conclusion as to the risks and rewards relating to a potential investment.

Friday, May 01, 2009

April 2009 Portfolio Summary and Review

I guess April 2009 can be dubbed the “Month of Reflection”. Why do I say so ? This was the month where leaders from many countries as well as central banks mulled over the effects of their policies and also waited for signs of improvement (so-called “green shoots”). While it is highly debatable that we have put behind the many years of excesses, over-leveraging and excessive risk-taking; it is also questionable if things can continue to worsen as they have for the past 12 months. Arguably, this is because the decline has been so sharp and the recession so protracted and extensive that most are of the view that “things cannot get much worse”. Whether this is true or not will only be known on hindsight, unfortunately.

Thus, as retail investors, one should take a long-term view of the world economy and of the ability of companies to survive and sail through the storms relatively unscathed. A quarter or two of bad earnings and missed expectations are not to be confused with the permanent and pervasive value destruction which a company would be subject to as a result of this downturn. The devil is in the details and it requires diligent study and analysis to weed out the survivors from those who fall by the wayside. Already, many S-Shares (China companies listed on SGX) have fallen prey to the downturn and their shares have been suspended. These include (but are not limited to) Ferrochina, China Printing and Dyeing, Fibrechem, Guangzhao IFB, China Sun, China Sky, Oriental Century and more recently, Sino-Environment. They are suffering from a myriad of problems and serve as a good lesson for investors to learn from and ensure that one treads carefully when selecting companies to invest in. I consider myself fortunate to have escaped the carnage thus far and the numerous land mines which have been scattered across the barren landscape to ensnare the unwary investor.

April 2009 did not throw up attractive opportunities for investment, hence I have kept my powder dry and continued to build up on my savings and cash stash in anticipation for opportunities to average down further. While many “experts” have opined on the fact that markets are in a recovery phase as the recent rebound was about 20-25% from the bottom, my view is that of adopting a neutral stance and to continue to monitor my companies closely, while of course keeping a watchful eye on economic developments and getting updates on industry reports concerning the companies I own.

In terms of Singapore corporate reporting, the season will really kick off in May 2009 with the blue chips reporting results. I would also be expecting full-year result from Tat Hong, Pacific Andes and Boustead as well as quarterly reports from Swiber and China Fishery. The consensus expectation is for earnings to dip by 30-40% as a result of the recession, but not many have considered the future earnings potential for these companies once the recession lifts (and yes, it would eventually lift, the question is simply that of “when”). Singapore’s GDP contraction is poised to be the worst on record but the silver lining is that things will probably improve closer to the end of 2009. By the time news tickles through that things are indeed getting “better”, valuations may not be as attractive as they are currently any longer.

For April 2009, it was a somewhat busy month. Corporate updates for my companies are as follow:-

1) Ezra Holdings Limited – Ezra released their 1H FY 2009 results on April 8, 2009. I have provided a two-part analysis on their financials and prospects and readers are welcome to check back on those postings. No other news was reported from the Company.

2) Boustead Holdings Limited – On April 15, 2009, Boustead announced the award of a contract to design, build and lease a facility awarded by a Fortune 500 company. There were no details of the exact location of the facility, the name of the customer or the value of the contract. This news does shower a beacon of light for Boustead Projects, as their previous announced project was in July 2008 (9 months ago). On April 24, 2009, Mr. Wong Fong Fui, CEO of Boustead, received the prestigious CEO of the Year Award under the mid-cap category during the Singapore Corporate Awards 2009 held at the Shangri-La Hotel.

3) Swiber Holdings Limited – No concrete announcements were made by the Company in April 2009 relating to future plans or to their contract wins, except for a small mention that US$70 million worth of new contracts were secured in Jan-Feb 2009. I attended the AGM/EGM today and will be providing an update on the Company and its prospects in a separate post.

4) Suntec REIT – Suntec REIT released their results on April 28, 2009. A DPU of 2.918 Singapore cents was declared. This represents an annualized yield of 10.5% according to my purchase cost. They also announced refinancing of their loans due 2009 by garnering a 3-year term loan (from a consortium of 7 banks) worth S$825 million. Their next due date for debt repayment has now been pushed to FY 2011. As my holdings in Suntec REIT are not significant, I will not be doing a review of this REIT.

5) Pacific Andes Holdings Limited (PAH) – There was no significant news from PAH during April 2009, other than the purchase and subsequent extinguishment of another US$5.5 million worth of convertible bonds. This leaves a total value of US$83.5 million left of convertible bonds, exerciseable by 2012. Tentative date of results release for FY 2009 is May 29, 2009 (Friday).

6) China Fishery Group Limited (CFG) – CFG had no significant announcements for April 2009, but after attending their AGM, I did manage to obtain some clarifications on their cost structure, plans, prospects and their current status. I may do a post on this in future if I have the time, but no promises. Note that the tentative date of results release for 1Q 2009 is May 15, 2009 (Friday).

7) First Ship Lease Trust – FSL Trust released their results on April 21, 2009 and declared a dividend of 2.45 US cents per unit. They also activated the DRS (Dividend Re-investment Scheme) for the first time to try to conserve more cash in order to pay down their outstanding debt (pre-emptively). So I would of course expect more dilution from the new units issued and possibly an even lower 2Q 2009 DPU, even though the stated guidance was for 2.45 US cents. That’s what happens when I purchase a shipping trust with an aggressive 100% payout ratio without considering the high leverage and the consequences of not paying down some of their debt and accounting for it as an amortizing loan. I guess I cannot say this enough, but my mind must have been stuffed with wool at the time which clouded my judgment; or perhaps it’s just plain old greed ? Whatever the case, it’s a constant mistake which taunts me; and the dividend is becoming more of a return OF capital rather than a return ON capital. I cannot even begin to describe the irony, so I shall stop here.

8) Tat Hong Holdings Limited – Other than some perfunctory announcements on the establishment of a joint venture company in China, there was no other significant news from Tat Hong in April 2009. I would expect, though, that the recent announcements for the Marina Coastal Expressway and the Sports Hub would be positive for their business as it indicates a continued demand for cranes and heavy equipment. The date of release for FY 2009 results is currently slated for May 28, 2009 (Thursday).

Portfolio Comments – April 2009

April 2009 saw the portfolio improve significantly from a total loss of -34.1% as at end-March 2009 to a total loss of -20.3% as at end-April 2009. This was mainly due to improved sentiment (as evidenced by the significant increase in the STI from end-March 2009 to end-April 2009), rather than an improvement in the fundamentals of the companies I own. My portfolio is more weighted towards the more stable and resilient companies Boustead and Tat Hong, as I see them being more able to sail through the current financial storm and emerge stronger in 2-3 years time. In the meantime, of course, I shall source for other investment opportunities, keeping in my the mistakes I made over the past 18 months which have more than revealed my fallibility.

As for wealth-building, I will continue to save a substantial portion of my income as the emergence of swine flu and the continued financial turmoil has hardened my resolve to save for a rainy day. All through the last 24 months, it felt like a big struggle trying to build wealth, and my savings are the only tangible effect of my frugality. By investing monies into the stock market during one of the most bearish periods in modern history, I am hoping to be able to subsist on a decent return over the next 10-20 years. Perhaps this sounds too ambitious, but I still view it as being preferable to over-extending myself over unwanted gadgets, or blowing the money on monthly instalments for a car which I don’t need.

My next portfolio review will be on Sunday, May 31, 2009.