Saturday, January 16, 2010

Tat Hong – 1H FY 2010 Analysis and Review Part 1

I guess this review and analysis is long overdue, since Tat Hong released their 1H FY 2010 results back in November 2009! But then again, since I only do half-yearly reviews and analyses, I figured it’s better late than never. Anyhow, I will NOT be analyzing Tat Hong’s upcoming 3Q 2010 results, so readers should expect that this will be the only analysis on Tat Hong until they release their FY 2010 some time in May 2010. This analysis will take on the usual format of analyzing the Income Statement, Balance Sheet and Cash Flows in Part 1, the Business Unit Breakdown and Inventories in Part 2, and end off with prospects and future plans for Part 3.

Income Statement Review

Do note that 1H 2010 was a very dismal period for the Group as the global financial crisis hit home and caused a sharp drop in revenues as companies held back spending on capital expenditure (i.e. cranes and heavy equipment). This led to a huge drop in equipment sales of 56% in 1H 2010 compared to 1H 2009. Consequently, total revenue fell 35.6% from S$375 million to S$241.6 million. The drop would have been steeper if not for the cushioning impact of Tat Hong’s rental of crawler and tower cranes. These 2 divisions helped to mitigate the impact of the downturn somewhat. Gross margins actually improved from 36.8% to 39.6% as a result of the change in sales mix towards higher margin rental instead of lower margin equipment sales. More on this breakdown in Part 2.

Sadly, net profit actually fell 66.5% from S$51.3 million to S$17.2 million, and this shows poor expense control even as the Group exercised prudent COGS management. A combination of factors including higher expenses compared to drop in revenues, higher financing costs and share of losses of associates contributed to the bad performance; and I am of the opinion that things should get better in 2H 2010, otherwise it would demonstrate that Tat Hong’s fundamentals are deteriorating slowly but surely and this may be the start of it.

To get into more detail, there were lower gains on disposal of PPE, while distribution and administrative expenses both dipped just 18% compared to the 31% drop in gross profit. The worst area was in other operating expenses as they dipped just 10%, which implied that it was made up of a lot of fixed costs which did not decreased proportionally with the decrease in revenues. Finance costs increased 24% to S$7.3 million from S$5.8 million as the Group took on more loans to finance their fixed asset rental fleet build up, and also for their China expansion (JV setup costs). A double blow was when their prior year share of profits from associates of S$6.8 million turned into share of losses instead, of S$371,000 (this is most likely due to Yongmao which did poorly along with the onset of the global financial crisis. Their joint venture also recorded a loss of S$2.45 million, but most of it was from a one-off loss recognized from the sale of mining equipment. Therefore, all the items above added together to depress profit margins to just 7.1%, down sharply from 13.7% a year ago.

Balance Sheet Review

Admittedly, Tat Hong’s Balance Sheet is not exactly in the pink of health, as is evidently shown from the increase in financial liabilities (i.e. bank loans). An increase in fixed assets of about S$84 million was a result of Tat Hong expanding its rental fleet and slowly reducing its inventory levels in response to the muted demand for cranes and heavy equipment amongst the downturn. Glancing over the current assets portion of the Balance Sheet, inventories had indeed decreased by S$37 million or 17.3% to S$180 million over 6 months. Trade Receivables, however, dipped by only S$7 million, while cash and bank balances increased by S$5 million, primarily through financing activities as we shall see later.

Bank loans increased by about S$55 million (adding current and non-current financial liabilities) from S$217.5 million to S$272.5 million, ostensibly to finance Tat Hong’s China expansion and the formation of JV companies. This 25.3% increase in debt was what led to higher interest expenses in the Income Statement, and this is one red flag to watch out for as the Group makes use of leverage in order to grow their Tower Crane share in China. Of course, if plans go well, the Group could enjoy high ROE and good cash flows but if things went awry, the debt will come back to haunt them. Current ratio deteriorated from 1.29 as at March 31, 2009 to 1.19 as at September 30, 2009.

Cash Flow Statement Analysis

Tat Hong’s cash flows for 1H 2010 were also very poor, as a result of the financial crisis. Apparently, from the operating cash flows it can be seen that a lot of cash was used to pay off Trade Payables (S$52.4 million) while collections from Accounts Receivables only amounted to S$11.6 million. About S$8 million was spent purchasing inventories, and the overall effect was a net operating cash outflow of S$2.9 million, a large drop against a positive operating cash inflow of S$43.1 million for 1H FY 2009. Apparently, the crisis had severely affected their business to the extent that they were slower in collecting cash, yet had to settle their liabilities just as promptly – not a good sign in my opinion. Management could have been more efficient in managing their cash especially on the payables side. I will flag this out as a danger signal, to be monitored closely in future quarters.

Cash flow from investing activities was moderated slightly by the absence of acquisition of a subsidiary, which reduced the total cash outlay from S$43.9 million in 1H FY 2009 to S$23.6 million in 1H FY 2010. However, the fact that capex still remained high as a result of Tat Hong expanding their rental fleet meant that cash outflows would still be significant moving forward, and would probably still result in very little FCF, if any.

Most of the financing cash flows came from new bank loans taken up, and also proceeds from finance lease obligations. A lot of money is being generated by loans, and this is likely to be the case as long as the crisis persists and there is no sustained economic recovery, as Tat Hong’s business would be adversely affected. However, with the CEO mentioning that economic conditions had improved for 2H 2010, there is some optimism that Tat Hong’s business can get back on track and that the business can start generating operating cash inflows soon.

The key now is to monitor the Group’s cash flow movements to see if any further red flags are picked up. Currently, they are gearing up for their China expansion as well so the loans are not totally being funneled into capex and inventory. Assuming the China Tower Crane segment bears fruit over the next 2-3 years, it could put Tat Hong in good stead to improve on its earnings and cash flow generation capability.

Part 2 of the analysis shall touch on business unit analysis, including reasons for the apparently dismal performance, and I will also comment on trends for each division moving forward. A breakdown of crane fleet will also be done and commented on.


Akatsuki said...

Hi mw, sorry going off topic. But i want to ask you. Should value investors discard stocks like China Animal Health care just because its has a very large share base and its NAV is 0.06 sg cents while the share price is 0.29 ?
Looking forward to ur advise


Musicwhiz said...

Hi Akat,

Well, I can't profess to know much about CAH, but what I can say is that valuing a company is more an art than a science, therefore NAV alone should not be the sole basis for determining if a company is over-valued or under-valued.

In this case, the market may be looking at the earning power and growth potential of CAH to value it at S$0.29, so perhaps it is something you can explore (i.e. look into its business model more closely).


Hitori said...

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Musicwhiz said...

Hi Hitori,

Thanks for visiting, and yes I will drop by your blog as well.