Thursday, June 25, 2009

Boustead – FY 2009 Financial Analysis and Review Part 3

In this last section Part 3, I will present Boustead’s FY 2009 audiocast and also briefly discuss their future plans and prospects. Suffice to say that for this year’s audiocast, there were much less questions posed and less was discussed if compared to FY 2008. One reason could be that there was much less clarity with respect to the future as the global financial crisis tore through the world, rendering the immediate future bleak and downcast. Another reason could be the significant slowdown in orderbook and order flow which was already evident in the late part of FY 2009, and which was expected to carry on into FY 2010. Except for the contracts already clinched by Boustead in FY 2008 and FY 2009, it is not expected that many more deals will come their way. This is something to be expected as the Company cannot be immune to the economic downturn.

Note that after the text of the transcript, I shall be discussing the prospects and plans for Boustead, so please be patient and go through all the questions herein.

Boustead FY 2009 Audiocast Transcript

Question: Please give more details on “Allowance for Forseeable Losses” of S$5.77 million (Note 2). Would we be seeing more of this in future ?

FF Wong: This refers to provisions for principally 3 projects. One is the litigation in Manila (MWSS – Municipal Water Project) – this is going through arbitration and we have not lost any money as yet and forsee a reasonable chance of success. For Olam, this is a provision where we will have difficulties recovering. The third is for Libya. This is a new project and we have not commenced work as yet, however there have been overheads incurred and in order to be prudent we have made provisions for this.

Regarding your order backlog, you have an order backlog of about S$580 million. Given the current situation, what kind of visibility do you have regarding the recognition of this order book in the upcoming FY 2010 ?

FF Wong: Haha you are asking us to do a forecast ? Obviously we will try to do our best. Those projects in Singapore and South-East Asia have seen smoother execution so we tend to be able to recognize this earlier. Those in Middle East and Libya, from time to time we do experience delays – not so much of payments but more of unforeseen circumstances which are beyond our control. We will always try to anticipate and prepare ourselves and ensure we are able to manage within the budget.

Question: I understand that after climbing up Mount Everest in FY 2009 (7th year of record revenues and profits), the Company will have to return to “base camp” (experience a fall in profits) due to the unprecedented financial crisis. So in your opinion where is base camp located ? FY 2007 profits?

FF Wong: It’s a bit difficult for me to pinpoint what the “base camp” should be. I guess what you are trying to look at is for FY 2010 what are the profits going to be like ? We do expect that we would not be able to match FY 2009’s performance but we are trying very hard to achieve somewhat near this level or not too far away. Mentally, you have to be prepared that we would not be able to match FY 2009’s performance; nevertheless we will continue to remain profitable and the bottom line will be healthy. I believe that we should be able to do at least FY 2007 and we are targeting to out-perform FY 2007. (Note: in FY 2007 net profit attributable to shareholders stood at S$35.2 million. This would signify a 41.4% fall in net profits should we use FY 2007 as a “base camp” scenario).

Question: Are you able to elaborate on the allowance for foreseeable losses relating to Olam ?

FF Wong: We do not expect any more foreseeable losses relating to Olam. This is well-provided for.

Question: With the expected downturn, and with such a large cash hoard, what are your intentions for future dividend payouts ?

FF Wong: I believe we are paying rather generous dividends. Right now, for 4 cents per share for FY 2009, with the number of shares in the market, we are paying out a total dividend of about S$20 million. Our after-tax profits are S$60 million, so we basically paying 33% of after-tax profits. In the current market, I believe this is the right strategy and will keep shareholders happy. Given the current market downturn, there should be M&A opportunities and we should keep a fair amount of cash in the kitty so that we can react and respond quickly should there be opportunities. We have to move fast. Another consideration (earlier pointed out) is that in the Industrial and Real Estate Solutions, there will be less Design and Build projects; instead there is a stronger pipeline of Design, Build and Leaseback projects which would require us to invest our own money. The good thing is that we can enjoy recurring rental income, but from a cash flow point of view we will have to invest our own money though it would not be a problem raising funds from banks.

Question: There has been much talk about “green shoots” emerging especially in the last 2 months. What is your personal view or the Team’s views on the ongoing dynamics in the global economy ? What are the strategies to be adopted by the Group in response to such views ?

FF Wong: I am not an economist but from time to time I do talk as if I do know something about the economy ! But much of what I said is the result of what I had read from the newspaper and the financial news. Green shoots, I do not know but given the severity of the market downturn and loss of wealth around the world; even though there are green shoots emerging, it is not going to be significant enough to warrant a “V” or even a “U” shape recovery. My own feel is that the downturn is going to last longer than we all thought. That’s my personal view. Hence, we have to be prepared for a long-drawn downturn. Even if my assessment is wrong, we are well-prepared for the worst. That is a better proposition rather than taking too much of an optimistic view. From a strategic point of view, we will make sure that we have a cash hoard to cushion ourselves and to keep lean and mean. In the meantime, we will keep looking out for opportunities resulting from the current fall-out. I believe shortly we should be able to see some depressed assets and investment opportunities. Right now, in the emerging economies I have not seen that many attractive M&A opportunities; but in the developed countries like the USA and UK where the loss of wealth is greater amid the fallout from high leverage, we should be able to see a lot more distressed sales. But over here, we have not seen any.

Question: Regarding forex, are there any plans to hedge in the future ?

KK Loh: With regards to forex hedge, our two major overseas subsidiaries namely BIH (Boustead International Heaters) and ESRI Australia, they are adequately hedged in relation to their exposure (i.e. their cost could be in USD or Euro and in terms of Australia, it is mainly in USD as the supplies come from principles in USA). From a group point of view, for our exposure to the GBP and AUD, we are reviewing the possibility of NAV hedge. It is pour policy to flow up dividends from these two profitable subsidiaries. So in terms of the buildup of the NAV, initially it was negligible but now it is beginning to take significance and we will be reviewing such hedges in future.

Question: With regards to water and wastewater division, there have been many years of trouble. Going forward, what is the updated potential in this current climate ?

FF Wong: I am ashamed myself to say that actually for this division (which I have promised the market of a turnaround in years), it has been false hope and if you look at it, much of the losses were due to legacy problems. I must say this was not due to the current Management; but having said that I won’t run away from the responsibility. Perhaps what I should have done was to change the Management a lot earlier. Moving forward, for FY 2010 we have cleaned up the legacy problems and we have made 2 consecutive provisions which the previous person had asked about (2 out of 3 provisions were for waste-water – we have not lost the money but for prudence sake we have made the provisions. We should be able to recover these monies, if not in FY 2010 then in FY 2011). Principally, the Balance Sheet is cleaned up and there is a healthy pipeline (of projects). We are bringing in better quality staff and of course, also pulled in better monitoring systems and processes. I definitely expect that in FY 2010, we should expect some profit. How big it is I am shy to commit myself to give you a forecast.

Question: With regards to your Industrial Real Estate Division, it appears that Boustead is re-emerging to be another land lease to position for another upturn in the medium-term. Is that correct and should Boustead take on such contracts ? I think the team must be relatively confident of the credibility of the underlying clients. Would it be fair to say that ?

FF Wong: I think you got to have a bit of faith in the Management (laughter). Our track record speaks for itself. We have not suffered any fall out or bad debts in this division – in other words, taking risks with our clients. At the moment, all the clients which we take on such contracts with (i.e. leaseback), they are multi-nationals. In fact, some of them are such big names that if they go under, the world will go under anyway !

Question: Mr. Wong, I know that whenever you look at a project, you have a minimum and very specific margin and ROE criteria that you would accept. Given the current downturn going forward, will your parameters change or do you think there are enough good projects out there which would meet your strict and stringent criteria? I am very happy with the previous dividend answer.

FF Wong: The criteria of our investment, of course, would move with the market clearly. The competition is clearly different. Today, we do not see much competition in the leaseback business. Clearly, money is more difficult to come by and we have raised our benchmark (standard and criteria) which is a lot more stringent now. Just to give you an idea on what kind of criteria we should be happy with should we take on a project (on leaseback for multi-nationals) – it would have to be minimum 12% and we will be happy with 15-17% un-leveraged.

Question: With regards to Libya, after a thunderous start it seems that there has been little rain thus far. Are your team disheartened by the initial setback so far or do you think that Libya remains a fertile ground that Boustead has built a head start over the rest of the competition ?

FF Wong: Never say die ! Obviously there has been a thunderous start with little rainfall so far. We always say that we long as you have the stamina and are persistent and if you take the bull by the horns and solve the problems (which are not really insurmountable), the payback will come (I am sure it will come). We just have to devote more time in order to move faster than we are able to do. Partly, this has to do with the local conditions and the local obstacles which were a lot more than we had anticipated. That said, the problems would not have been foreseen not just for our part of the world but also for other parts of the world. This is really a virgin land. The Libyans themselves have no idea of how they can execute the project with established norms and procedures. They are on the learning curve as well. Fortunately, they are rich and can pay, the only thing is that we have sit down and talk and that is frustrating.


Future Plans and Prospects

In the interview above, it was stated that Boustead would NOT be able to repeat the success of FY 2009’s financial performance, and that seven successive years of record revenues and profits would probably signal the longest track record of growth for the Company before it succumbed to the crisis as well. This is not altogether surprising – but what is important is whether the Company can use its cash hoard to spring some surprises in the M&A Department, of which FF Wong had alluded to more than once. While negotiations for contracts will lengthen and the size of contracts will probably be smaller and scaled down due to the uncertain economic environment, Boustead can reasonably be expected to garner some contracts due to their stellar track record and their extensive global reach. Let me briefly touch on each department and relate what we can expect.

Energy-Related Engineering Division

So far, this division had secured S$64 million worth of contracts in late 4Q 2009, and to date there have been no announcements of any new contracts, which clearly shows that the momentum of contract wins is slowing. Of course, one might argue that as at the time of writing, 1Q FY 2010 is just under way and it may be too early to pass judgement as to whether this division can clinch more contracts. However, with the press release mentioning that negotiations will be more drawn out, the prospects do not seem particularly bright and as a shareholder, I remain cautiously optimistic. One factor which is helping is the oil price which has managed to remain steady at between US$68 to US$72 per barrel these last couple of days. This at least helps to revive the possibility of more contract wins as oil majors and companies continue to invest in E&P spending, albeit cautiously.

Boustead Maxitherm should have completed its re-structuring and should finally be able to clinch sizeable contracts. The ongoing crisis has dampened the prospects of this sub-division but if the re-organization works out well, it may boost the overall performance of the Energy-Related Division.

Water and Wastewater Division

This division has secured three very significant contracts which should keep the division afloat (no pun intended) through FY 2010. Apart from these, it has also cleared up its legacy issues as is evident from the interview transcript above. Even though FF Wong has embarrassingly admitted that the division has failed to turn a profit till now, there is some light at the end of the proverbial tunnel as stated by the man himself. With the provision for foreseeable losses out of the way (in FY 2009), it is not envisaged that there would be any other obstacles to this division achieving profitability for FY 2010. It would also be an extra boon and boost to the business if the new technology which is being explored at the Chinese textile factory turns out to be workable on a large scale, and can be applied to future project tenders. That said, it should be emphasized that wastewater itself is a very competitive industry and margins are thin; thus costly R&D must be undertaken in order to sustain a competitive edge. Thus far, I note that Hyflux, widely considered the market leader in wastewater treatment, has been more successful in its forays into the Middle East, with their presence in Algeria and more recently with the General Desalination Company of the Great Socialist People's Libyan Arab Jamahiriya. If Salcon were to try to replicate the success of Hyflux, I think they may still have some way to go; even though admittedly when FF Wong acquired this division, he knew of its potential and its competitive edge. There was some talk of listing the division some years back but it eventually died down when the division could not turn in a profit (you need at least a three-year profit and revenue growth track record to even consider an IPO). Suffice to say that should an IPO for Salcon materialize, it would certainly unlock a lot of hidden value in this division, but this possibility is extremely remote in the light of current circumstances.

Real-Estate Solutions Division

This division experienced very strong growth for FY 2009 with revenue of S$265.5 million, as they clinched many design and build contracts under Boustead Projects. However, the environment for such design and build projects is expected to slow significantly, and Boustead had communicated that they are sourcing for design, build and lease projects in order to ensure a more consistent and recurrent income stream. Although such projects are unlikely to be as lucrative in terms of size or margins, they will provide steady cash inflows and a more stable revenue flow for the division. In each of the last five financial years, Boustead had managed to sell at least one leasehold property; but this is unlikely to materialize for FY 2010 due to the financial crisis. Hopes are now pinned on the new division Boustead Infrastructures which had clinched the deal to build the S$300 million Libyan township. To date, the many snags and thorny issues had been settled and more than 10% of the project had been completed, which signals that the bulk of revenue recognition and cash inflow would occur in FY 2010 and beyond. Even though this division is unlikely to repeat the performance of FY 2009, the ongoing revenues from the Libyan project should be able to provide sufficient cash inflows to enable a decent performance. From what I understand, the agreement was for a cost-plus pricing model which can protect the Company in the event of sudden raw material cost escalations. Whether this model can be adhered to strictly or not depends on the implicit agreement with the Libyan authorities on passing on cost increases, and whether it is in good business interest for them to do so.

Geo-Spatial Technology Division

This division has been the gem of Boustead with steadily growing revenues and customers which are financially sound, thus reducing the likelihood of bad debts and uncollectible amounts. Demand for this division’s services should remain strong as location intelligence solutions and infrastructure management systems are more or less “recession-proof” and should not be subjected to the same slowdown seen in the Energy-related engineering and real estate solutions divisions. I think that from the track record displayed by the Division and Management’s prudent handling of its growth profile, it is reasonable to expect a 5-10% year-on-year increase in revenues.

Future Plans – Merger and Acquisitions (M&A)

It was already highlighted in the FY 2008 audiocast that Management was on active lookout for M&A opportunities. This was, in part, due to their ballooning cash balance and was also driven by the desire for a more recurrent and predictable revenue flow as compared to the current “lumpy” contract-based revenues for all its divisions (except Geo-Spatial). An attempt was made to evaluate an M&A opportunity back in FY 2008, and about S$1 million was spent doing the necessary and requisite due diligence; but sadly, the investment did not pass the filters which Boustead set and thus nothing materialized.

Moving forward, FF Wong has mentioned that he expects to see more distressed assets in the UK and the USA, where the sub-prime meltdown has been most acute, and where assets there have been marked down to low levels due to pervasive pessimism. He also mentioned that he has not seen much evidence of depressed asset prices in South-East Asia as the impact of the economic crisis has been indirect (in terms of exports and demand). To fulfil Management’s criteria for M&A, the investment would have to be offered at a good value (price-earnings wise as well as in relation to the NAV of the Company in question) and also have the ability to integrate itself into Boustead’s current business model and divisions. Based on FF Wong’s view of distressed assets and the fact that Boustead’s cash hoard is expected to grow even further with the receipt of monies from the sale of leasehold property by GBI Realty, I think it would be reasonable to expect a sizeable acquisition in the coming months. I have faith that Management would not compromise on their strict screening criteria for M&A, and they have shown their ability to reject even though they had spent S$1 million on due diligence. To resist the institutional imperative is not an easy task, but judging from FF Wong’s conservative style and prudent stance in building up Boustead, I have no doubt he will continue to add value for shareholders.

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