Wednesday, February 24, 2010

Tat Hong – 1H FY 2010 Analysis and Review Part 3

In this final Part 3, we will look at Tat Hong’s Inventory levels and I will comment on their slow but steady transformation into a “rental” company and also their building of their tower crane business in China. I will also give a quick summary and low down on the progress of their planned China expansion so far, based on announcements filed with the SGXNet.

Crane Fleet Profile


Total Fleet Profile Review

It can be seen from the table above that Tat Hong’s total number of crane units has been rising steadily over the quarters, and one would notice that the total tonnage has been steadily increasing as well. It has risen from just 41,840 tons as at June 30, 2007 to the current 49,401 tons as at Sep 30, 2009. The most recent 3Q 2010 results show that as at Dec 31, 2009 total tonnage has once again risen to 51,156 tons, and this is the first time in 2 years that I had witnessed it surpassing the 50,000 ton mark. The focus has also been to build up more of the heavier tonnage cranes, with the >250 metric tonnes cranes rising from 32 as at Mar 31, 2007 to 46 as at Sep 30, 2009 and further to 53 units as at Dec 31, 2009. In the 100-149 MT and 150-249 MT categories, one can also note a steady rise in the number of such cranes. Presumably, these cranes have higher demand and can command better rental rates in the market, which is why the Group is slowly stockpiling on these units. Lower tonnage cranes tend to be more “generic” and there are many smaller competitor companies which can provide such cranes, so Tat Hong probably has less of a competitive edge with regards to biddingin this segment; and thus also most likely enjoys lower margins.

One troubling aspect which I noticed was that crane utilization rates have been steadily FALLING over the quarters, in line with the onset of the global financial crisis and the subsequent sharp recession. Crane utilization rates represent how much of the fleet is being utilized at any point in time on contracts and projects; and a lower rate simply implies that there are less projects with which to deploy cranes to; and this points to a depressed economy where major infrastructural and oil and gas are put on hold until financing becomes available. The effects of this shift have an adverse impact on Tat Hong’s rental earnings, and they had fallen with respect to prior periods, though Tat Hong mentions that rental is supposed to be relatively more stable and offers a better cushion as compared to equipment sales. The numbers do tell the grim story – utilization rates fell from a high of 83.5% as at June 30, 2007 (the “peak” of the bull market) to just 64% as at Sep 30, 2009. The most recent 3Q 2010 announcement shows that utilization fell to just 60.9%, which brings more bad tidings. Although an analyst report once mentioned that Tat Hong only requires 40% utilization to break even, such lowered rates will definitely impact on earnings and margins. Unless the situation improves in future quarters and utilization rates stage a rebound, the Company is not likely to see a significant rise in revenues or earnings for quite some time.

Tower Crane Fleet Review

Tat Hong’s Tower Crane fleet has been steadily building up, since the time they formed their first JV as at March 31, 2008 till the present. They started off with 216 units with total tonnage metres at 35,462 and ended Sep 30, 2009 with 362 units of total tonnage metres at 66,859. This is more than a 50% increase in number of units and an almost 100% increase in tonnage-metres, and reflects Tat Hong’s growth in this new business segment. The latest figures from 3Q 2010 show that their tower crane fleet stands at exactly 400 units with total tonnage-metres at 75,602; a testament to the growth of this division.

Utilization rates stayed relatively constant for Dec 31, 2009, at 77.4% against 76.7% for Sep 30, 2009. However, if we look back at better times, utilization rates were as high as 91.9% (June 30, 2008) and 83.9% (March 31, 2008). Still, with Tat Hong building up their fleet further, we can expect revenues to grow in future with Tat Hong’s JVC capturing a larger share of the market (and also a larger slice of the pie).

Business Prospects and Plans

As at the time of writing, Tat Hong is still focusing on its strategy of building up its rental income base and reducing its reliance on equipment sales. With the global financial crisis still lingering and corporate spending still not back to pre-crisis levels due to difficulties in securing financing, the Equipment Sales Division should experience continued weakness. Thus, revenues will not be as high as FY 2008 or FY 2009 as these were exceptionally strong years. It will be a slow and steady return to recovery for the economy and Australia’s mining and infrastructure projects will be under way only in FY 2011. Even in the South-East Asian region, companies are wary of spending too much on capex as the recovery is tentative and many issues remain, especially with China’s possible overheating and Greece going into default on its debt. Let’s examine the pillars on which Tat Hong will be able to enjoy a recovery, and see if it can translate into earnings resilience in the near future.

Tower Cranes In China

Below is a brief history of Tat Hong’s investment and development of their Tower Crane division:-

September 5, 2006 – Establishment of Shanghai Tat Hong Equipment Rental Co., Ltd.

January 10, 2007 – 90%-owned Shanghai Tat Hong Equipment Rental Co., Ltd enters into a JVC agreement with Beijing Zhongjian Zhenghe Construction Machinery Co., Ltd to establish a company named Shanghai Zhenghe Tat Hong Construction Equipment Rental Co., Ltd for the purpose of engaging in rental of towercranes and related construction equipment. Registered capital is RMB 70 million and Shanghai Tat Hong will take a 50% equity stake (Tat Hong Group’s effective stake is 45%).

April 3, 2007 - 90%-owned Shanghai Tat Hong Equipment Rental Co., Ltd entered into a JVC agreement with China Nuclear Industry Huaxing Construction Co., Ltd, Gao Song and Sun Zhaolin to establish China Nuclear Huaxing Tat Hong Construction Machinery Co., Ltd. Registered capital is to be RMB 66.6 million and Tat Hong’s shareholding will be effectively 76.36%.

November 10, 2008 – Entered into an MOU with Fushun Yongmao Construction Company Ltd to establish a JVC in China to be named Beijing Tat Hong Equipment Rental Co., Ltd for rental of towercranes in China. Registered capital shall be RMB 20 million and Tat Hong shall hold 55% equity stake.

August 4, 2009 – Tat Hong Equipment (China) Pte Ltd entered into a JVC agreement with Beijing Tat Hong Zhaomao Equipment Rental Co., Ltd and Mr. Yuan Zheng to establish Si Chuan Tat Hong Yuan Zheng Machinery Construction Co., Ltd with a registered capital of RMB 140 million. Tat Hong will hold a 53.8% direct and indirect equity stake.

As can be seen from the above corporate developments, Tat Hong has been working on building their Tower Crane division since 2006, when they established their subsidiary in China. There was a slow but steady commitment to pump money into setting up Joint-Venture Companies (“JVC”) in China, and till now there are already three JVC set up in various forms. With the help and support from AIF Capital, which Tat Hong had issued 65 million RCPS to, the monies raised of S$62.5 million (net of fees) was pumped into China to further develop their tower crane capabilities and expand their fleet. It remains to be seen how this will bear fruit for them, but I maintain a long-term view of at least 3-4 years before tangible benefits arise.

Economic Recovery and Crane Rental Focus

Tat Hong’s fortunes are, in a sense, tied to the global economic recovery as their business depends a lot on customers spending on capex to buy cranes and general heavy equipment. Thus, their business can be viewed as cyclical as it is linked to the economic situation of the world, and South-East Asia as well. It was fortunate of me to purchase some shares when the outlook for the economy was extremely depressed, as this meant valuations were also close to rock bottom (of course, I did not suspect so at the time).

But with the gradual healing of the economy, which may take a couple of years, Tat Hong should gradually also see their business picking up. However, with their focus on crane rental rather than equipment sales, this subtle shift in their business model would divert more earnings towards crawler and tower crane rentals. It is their aim that 75% of profits eventually come from crane rental; and this will form a stable “core” base of earnings as crane rentals are subject to less volatility and variability. This is the reason their Fixed Asset base has been steadily increasing while their inventory levels are dropping, as evidenced by their Balance Sheet every quarter. Whether this strategy works well in the near future remains to be seen, and needs to be more closely observed in terms of Cash Flows as well.

Tutt Bryant and Fagioli Joint Venture (Australian Market)

On February 17, 2010, Tutt Bryant released an announcement via ASX that they were entering into a 50% JV with Fagioli (a privately owned company, and one of the largest heavy lifting specialists in Europe) to form TBF Oceania Pty Ltd. The press release mentioned that the combined resources of both companies will enable the JV to provide a new level of lift and shift capabilities in the Australian market. The synergistic effects of this joint venture will probably take some time to manifest itself, but it is a step in the right direction as Tutt Bryant is taking measures to improve their product breadth as well as to garner new customers in the process. Recall that in 2006 and 2007, Tutt Bryant (which is 70% owned by Tat Hong) went through a series of M&A to expand their product offerings and entrench themselves more firmly in Australia. With the global financial turmoil, the Company had also seen their revenues and profits adversely affected. With the pick up in infrastructure and oil and gas projects seen to be slow, most analysts and economists only expect a significant pick up in activity from FY 2011 onwards (note that Tat Hong has a March year-end, thus FY 2011 starts from April 1, 2010).

Conclusion

The above is just a summary and preview of what’s in store for Tat Hong in the next couple of quarters. My focus will be more on their cash flow generation capability and also how they manage their Balance Sheet. Their gearing is still somewhat high and hopefully as economic conditions improve, they can manage to reduce this further. The RCPS may also be a potential issue in 4.5 years time as the conversion price has been set at S$1.50 and the current market price is nowhere near that level, hence it would be to ordinary shareholders’ disadvantage if the RCPS are not converted to ordinary shares.

Tat Hong’s FY 2010 results will be released in late May 2010, and I am hoping for a decent final dividend to be paid out as well.

4 comments:

Dou said...

Wow bro...u must have taken a lot of effort to come up with this articles..this is good info!! Thanks

brian seetoh said...

hey Musicwhiz, what does RCPS mean?

Musicwhiz said...

Hello Dou,

Thank you, I usually analyze and type when I have the info on hand and the inspiration to express myself. Not always in the mood to type out haha, but I tend to compartmentalize my analysis so it makes it easier to read.

Glad you like it!

Regards,
Musicwhiz

Musicwhiz said...

Hello Brian Seetoh,

RCPS means Redeemable Convertible Preference Shares.

Thanks,
Musicwhiz