Thursday, August 06, 2009

Tat Hong – FY 2009 AGM Highlights

Let me start off by saying that Tat Hong’s office is extremely hard to locate and get to, and for me, using public transport meant that I had to figure out which MRT station was the nearest to Tat Hong so that I could minimize my cab fares in. It was only when I got there that I realized I could have taken a bus and alighted along Woodlands Road, then walked in along a narrow path beside a canal ! Anyhow, it was a good learning experience for me on how to navigate my way around Singapore.

The AGM started somewhat punctually, at about 10:05 a.m. with more shareholders trickling in close to ten o’clock. The room used for the AGM was a very simple room, spartan yet well-equipped; and it had some old equipment lying around, which gave it the semblance of having been used as a storage room once upon a time. Immediately outside this room was a pantry area with chairs, tables and a long table where the food and drinks were located. The whole atmosphere looked and felt cosy and homely, unlike the usual business-like settings during other AGMs, which are held in conference rooms or large board rooms with slide projectors.

Meeting the Board of Directors and Management Team for the first time was indeed refreshing, as they are the ones who work for shareholders to enhance value. Taking into account the fact that the Board themselves are shareholders (Ng Family own about 60% of Tat Hong), this is where interests are aligned. The Chairman Mr. Tan Chok Kian was surprisingly sharp, witty and humourous for his age (he is in his 70’s!), and managed to elicit sporadic laughter while reading out the ordinary business of the AGM. Overall, the mood was relaxed but a few shareholders did raise queries about Tat Hong’s strategic direction and expressed concern over how the business was faring amid the worst recession in 60 years.

Mr. Roland Ng (CEO) was very candid with the crowd and offered to provide an update of the situation after the business of the Meeting was concluded; and all resolutions were passed henceforth. He mentioned that Tat Hong has thus far steered through every crisis and emerged stronger, as a result of their prudent policies and also because they take advantage of the situation to grow. Recessions will put some smaller competitors out of business, which is good for Tat Hong as they have the size and scale of business to survive; plus now that the Company is moving towards a “rental” model, this ensures steady earnings and cash inflows. In fact, one of the notable things Mr. Ng mentioned was that during good times, companies build; during bad times, the Government builds! So it was a case of always having the contracts and work to allocate their cranes and heavy equipment to; and the countries of Australia and China also hold good promise as the Governments there are churning out massive fiscal stimulus packages to jump-start the flailing economy.

I shall divide the discussion into three distinct sections for presentation, namely by territory:-

1) Singapore – There are many ongoing construction and upcoming infrastructure projects such as the Marina and Sentosa IR, Marina Coastal Expressway and MRT Downtown Line which will keep Tat Hong busy for quite some time. Mr. Ng did mention that there would be pricing pressure for crawler crane rental as the recession meant that customers wanted to negotiate for lower rates. For their distribution business (sale of cranes), this would remain a problem due to the ongoing credit tightening situation by banks and financial institutions, which limited many companies’ ability to finance large capex spending and thus deferring purchases till the economy recovered. Since Tat Hong is positioning itself to be a “rental” company, Management will use most of its cranes for rental instead of re-sale; thus ensuring a continuous and recurring stream of income and cash flows for the Group.

2) Australia – The crawler crane fleet is being expanded in Australia and it should remain strong within the next 3-5 years as it services the oil and gas as well as mining industries there. General Equipment rental business (Caradel and Compactor Hire) follows the economy and with economic recovery, this division should see better revenues. For the equipment sales division in Australia, Mr. Ng mentioned that Australia does not manufacture equipment, hence it has to import all its required equipment and with a large agriculture base there, this means equipment needs to be continually replaced and this will create the demand for the purchase of equipment. The exchange rate of AUD:SGD has also improved (it is currently about 1.20 to the SGD), and business is slowly improving.

3) China – Tat Hong’s main growth market is centred on China, as it is a huge market there for Tower Cranes. According to Mr. Ng, China has about 300,000 tower cranes, while the two current JVC only own about 262 tower cranes (partnering with Yongmao), so this makes up about 0.1% of the total Chinese capacity! Therefore, there is room to expand in China and with the August 5, 2009 announcement of the formation of a new 53.8% JVC to capture the south and south-western regions in China, this proves that Tat Hong is mapping out its strategy to grow this division. Mr. Ng mentioned that the Group was actively seeking out partners with which to form JVC in order to grow their tower crane fleet there, and he also elaborated on the methodology which the Group would use to penetrate the Chinese market (I have left out describing the key aspects as they deem it to be sensitive information which may be copied by competitors).

Other than the above, I have also clarified certain aspects of their business as well as their Annual Report 2009. I shall list these down below as separate points for clarification:-

a) Hedging Policy – Management were quizzed about the unrealised losses of S$16.1 million incurred in 3Q 2009, and whether hedging policies were in place to prevent the recurrence of such a debilitating loss. Apparently, this was due to the weakening of the AUD against SGD (impacting Tutt Bryant’s revenues) and the strengthening of the JPY against SGD (thus impacting liabilities to suppliers). The reply was that the violent swings in currency were not witnessed for the last 30 years, and were unlikely to occur again; hence this was a one-off issue and no amount of hedging can adequately prepare a company for volatility of this magnitude. Management assured that appropriate measures were in place to hedge against normal foreign exchange transactions by entering into forward contracts (if necessary) to lock in favourable rates. Note: All the losses are realized!

b) For their rental business, utilization levels are expected to remain around 60% to 75%, and contract duration stands at 9-12 months for Australia and 3-9 months in Singapore; implying that the duration is pretty short. However, with the upturn in construction spending by the respective Governments, utilization should remain high though rates will probably soften slightly. Mr. Ng did point out that utilization levels are a function of their crane base (denominator) and since they are deploying more cranes toward rental rather than re-sale, this rate would naturally go down in the near-term; but he assured that there was no cause for alarm.

c) Crane obsolescence was not an issue as most of the cranes are new ones, and they can always shift some cranes over to Australia if the demand there increases. Management hopes to enter into longer-term contracts for their cranes. The next growth area they are targeting is Malaysia and Indonesia. Management also reiterated that their market share stands at about 20% to 30% as there are many small players, but my opinion is that their size and reputation as one of Asia’s largest crane companies will give them an edge in securing contracts and negotiating for better prices.

d) Management will stick to its policy of paying out about 40% of its earnings as dividends.

Since I started this post on Tat Hong’s AGM 2009, there has been news on AIF Capital injecting funds into Tat Hong for an 11% stake, but in the form of RCPS (Redeemable Convertible Preference Shares) on the basis of 1 preference share to 1 ordinary share if converted. I will not go into detail on the terms of the agreement as they are quite technical, but suffice to say that such a method of capital injection prevents immediate dilution and allows the Group to raise S$63.5 million (after fees) in cash for M&A activities in Australia and China (they have slated 80% of the proceeds for this). Should the share price in the 30 days before the first anniversary exceed S$1.50, one-third of the RCPS will be converted to ordinary shares. It is in Tat Hong’s best interests to convert ALL RCPS before the fifth anniversary as after that, the RCPS attract a dividend rate of 25% (cumulative 5% for 5 financial years).

Immediately one day after the announcement of a strategic partner, Tat Hong followed up with an announcement that they had formed an equity Joint Venture Company (EJVC) with BJTH and Mr. Yuan Zheng for a 52.98% stake (direct + indirect) in a newly-formed Company called Si Chuan Tat Hong Yuan Zheng Machinery Construction Co., Ltd. The principle activity of the Company is to engage in tower crane rental in the south and south-western parts of China, and this will help to expand Tat Hong’s fleet of Tower Cranes in China and give them a stronger foothold in the Southern region of China. A total of US$10.25 million will be injected in two separate tranches into the Company, while Mr. Yuan Zheng will do his part by injecting the capital assets and tower cranes. Tat Hong will ensure Board representation as they will appoint 3 members to the Board and one to the supervisory committee.

The above announcement serves to cement Tat Hong’s status as a leading tower crane player in China and their previously announced plans to penetrate the Chinese market are moving ahead. My opinion is that the fund raising for S$63.5 million is another step towards securing more M&A in China through such EJVC, and Management should be aggressively expanding during turbulent times, as valuations of companies will generally be cheaper during such recessionary times. Of course, such acquisitions should be earnings accretive in order to offset the cost of funding which is 5% per annum (excluding declared ordinary dividends). The hurdle rate is not very high and Management can leverage on the contacts, expertise and network provided by AIF Capital in China to expand their reach and grow their business.

I look forward to more potentially accretive M&A announcements from Tat Hong. Their 1Q 2010 results will be released on August 14, 2009, and Management should provide an update on their business units and the prospects for the rest of FY 2010.


simon said...

you were saying the room used for the AGM was simple and spartan, but i can't help it but notice all the big mercedes and bmws parked at the compound of the office in the first picture. the carpark definitely doesn't look simple and spartan. haha =)

Createwealth8888 said...

Are those mercedes and bmws under company registration number?

cif5000 said...

"Earning Accretive"
If you spend 5% to earn 6%, that's "accretive" but your return on investment is only 1%, not the best (or even good) use of capital. The check should be on ROE and not EPS.

musicwhiz said...

Hi Simon,

Well yes you have a point. There were many such vehicles parked in the car park. As long as the BOD and Management Team do a good job of building the company and enhancing shareholder value, I have no issues with the vehicles they drive. :)


musicwhiz said...

Hi Createwealth8888,

I did not notice, sorry. My intention was simply to head on into the building and attend the AGM.


musicwhiz said...

Hello cif5000,

Thank you so much for pointing it out; yes that's very true - ROE should be the measure and not simply EPS. I will ensure I use ROE as the appropriate measure in my analyses instead of focusing too much on EPS or EPS Growth alone.


donmihaihai said...

"such acquisitions should be earnings accretive in order to offset the cost of funding which is 5% per annum (excluding declared ordinary dividends). The hurdle rate is not very high"

Are you trying to say if CRPS converted or redeemed early, cost of fund and hurdle rate = 0%(excluding declared ordinary dividends)

musicwhiz said...

Hi Donmihaihai,

Thanks for visiting.

My understanding was that hurdle rate is the rate of return which causes an acquisition to make sense; and if Tat Hong is paying 5% cumulative dividends on RCPS, then hurdle rate should be 5% and if an M&A surpasses this rate, than it would make sense (quantitatively - I did not factor in qualitative).

No, I do not think cost of funds is 0% because there is a cost to everything. There will be dilution to existing shareholders (yes, me) and also the cost to shareholders will be the ordinary dividends declared on the converted RCPS.

Assuming a static pool of cash, it will now be divided among more issued ordinary shares (assuming conversion); thus dividend per share will drop. But of course, the pool of money (40% of net profits) will not stay static.


CreateWealth8888 said...

If these mercedes and bmws are under company registration number, then is a matter of concerns especially for family controlled biz which has backdoor of charging big expenses to the company account although the cars are for "personal" use only. Then it doesn't go well with the statement "room used for the AGM was simple and spartan". Next AGM, you check the licence plate. Just kidding. ha ha!

musicwhiz said...

Hi Createwealth8888,

Haha you have quite a healthy sense of humour ! I think we all need a good dose of that in our personal lives in order for us to remain happy and healthy !

Cheers to you too,

meliorixt said...

Dear musicwhiz,

First off, this is a great blog! Very informative. Just wanna ask a few questions on Tat Hong.

I did a quick look and scanned thru reuters, and noticed a YoY change (frm 08 to 09) in operating cashflow. It dropped from 64.7m to 8.8m. Even taking into acct the 16m forex losses in 3Q09, this drop is quite large? Perhaps you could give some insight on this.

Also, did you do any DCF valuation on Tat Hong? Im personally interested in this company (due to a nice cash war chest, and recurring income) but wonder if its price of $1.20 now is above its fair value. Also worried about the RCPS and its impact on fair value.


musicwhiz said...

Dear Meliorixt,

Thank you for visiting !

Looking at the cash flow statement in the FY 2009 AR, Tat Hong had generated about S$141M worth of operating cash flow before working capital changes, compared to S$154M in FY 2008. If we drill down into the working capital movements,

1) cash outflow from inventories was S$87.5M, this could be the result of an increase in inventories coupled with a concurrent slowdown in equipment sales, thus leading to a net cash outflow due to slower equipment sales. Tat Hong is trying to reduce their inventory in light of the downturn but are unable to do so quickly, and are also trying to shift more of their re-sale inventory to their rental fleet instead.

2) Trade and Other Receivables generated a net cash inflow of S$10M, which shows that collections from customers are still not a problem despite the downturn,

3) Trade and Other Payables saw a net cash outflow of S$19.9M, probably as a result of credit tightening policies from suppliers as a result of the global downturn, and this sucked up quite a bit of their cash.

The 3 factors above, coupled with higher income taxes paid of about S$31M, caused net operating cash inflow to drop drastically to S$8.8M.

Note that the exchange loss has nothing to do with cash flows as it is a non-cash item, but the liability which crystallizes and is due and payable as a result of the exchange loss does have a negative cash flow impact.

I did not do any DCF valuation on Tat Hong as it is not my style. The current market price may have taken quite a lot of positive factors into account already; therefore I am also wary as to whether it represents good value and a margin of safety. However, you may wish to factor in more long-term ROE-accretive acquisitions and the fact that they have a stable rental base, in order to do your computations.

As for the RCPS, they are dilutive by 1/3 assuming the S$1.50 per share conditions are met; but it is also in Tat Hong's best interest to redeem them as soon as possible. I would not worry too much about them in the short-term; and for the long-term the Company is projecting earnings and revenue growth so the fair value would adjust upwards accordingly. But as things are uncertain right now you may wish to use an appropriate discount factor to factor in a worst-case scenario (to protect your downside).