Thursday, April 15, 2010

Kingsmen Creatives – Analysis of Purchase Part 3

In Part 3, I shall elaborate on the Competitor analysis for Kingsmen, which is a section I devote to understanding the competitive forces present which may affect Kingsmen’s business, and to evaluate the threat of scaling their competitive moat. Simple and brief write-ups will be provided on three of Kingsmen’s competitors. I will then touch on prospects and plans which the Company has in store to grow further, and finally wrap up with my decision for purchasing shares in the Company (weighing pros against cons).

Competitive Analysis

Pico Far East (“Pico”) is the market leader in the MICE industry and also does fitting out for reputable clients. Essentially, they have been in this business for as long as, if not longer, than Kingsmen Creatives. Pico is Hong-Kong based and listed on the Stock Exchange of Hong Kong, and as mentioned earlier most of its business is centred in Hong Kong and China, though it has a pan-Asian presence in many countries as well. More information can be found on its website.

More importantly, I used Pico as a benchmark for comparing Kingsmen as they are the certified market leader. Metrics such as revenue growth, gross and net margins were compared and I also looked at the list of clients which Pico had and some of the events which they were helping to organize. That was when I got surprised – there were overlaps in the event management arena (e.g. for Formula 1 Singapore) for both Pico and Kingsmen, which made me realize a mega-event could be so massive in scale that all players get a slice of the “action”.

In terms of financials, Pico had far higher revenues than Kingsmen (I used financials for half-year ended April 30, 2009), but net margins were slightly lower. Revenue was HK$1.05 billion (about S$210 million) for 6 months, thus annualising this would mean revenues of about S$420 million for full-year, about double that of Kingsmen. Gross margin for Pico was 33.7% against Kingsmen’s gross margin of just 26.4%, so it was obvious that Kingsmen had more room to go in managing their COGS (much of this depends on scale). However, Pico’s net margin was just 5.75%, while Kingsmen had a net margin of 5.9% for 9M 2009 and 7.4% for FY 2008. Even though Pico appears to have much higher gross margin, Kingsmen had better expense control and still managed to stay on par with the market leader. This is a comfort of sorts as it shows that Kingsmen did not fall behind Pico on too many aspects.

Design Studio is a premier furniture manufacturer, and the company also provides interior fitting out specialist outside Singapore. Design Studio's three complementary and versatile core businesses - the supply and installation of manufactured furniture products to private residential developments, interior fitting-out services to hospitality and commercial projects outside Singapore, Malaysia, Thailand, Vietnam and Indonesia, and distributorship of renowned imported brands (in Singapore only) and the export of two widely received in-house brands have been customised to reach a comprehensive spectrum of residential and commercial developments across major countries around the world. More information can be found on its website.

Suffice to say that Design Studio is starting to be a credible competitor to Kingsmen in the Fitting Out aspect, even though the Company was only started in 1991 (about 19 years of history). However, the difference ends there. Design Studio are more of a furniture manufacturer and they tie up with prestigious property developments (e.g. high-end condominiums) to provide quality furnishings; so the Company actually has a manufacturing plant and houses inventory, unlike Kingsmen which are purely service-based and rely more on human expertise. This is also why Design Studio has a much higher net margin that Kingsmen (at close to 20%). On the flip side, its working capital requirements are much higher due to the fact that they need to manufacture and stock up, and well as handle logistics and transportation of their finished goods.
I could not do a direct comparison between Kingsmen and Design Studio as the core nature of the businesses are different, even though people have lumped them together on many occasions as “comparatives”. Design Studio actually competes with other furniture manufacturers like HTL, Lorenzo and Sitra while Kingsmen’s direct competitor is more Pico.

Cityneon is a company which deals with exhibitions, events and fitting out, though it is a much smaller competitor to Kingsmen. Its annual revenues for FY 2009 stood at about S$90 million compared to Kingsmen’s S$242 million for FY 2009. It also has large clients for fitting out such as Asia Jewellers’ Boutique, YKK showroom and K4 Retail Superstore, among others. Along with Kingsmen, they are also providing services at the upcoming Shanghai Expo 2010. This is another example of overlaps in the events, which require more than one event management company to assist in.

The conclusion is that Pico and Cityneon seem to be targeting the same space as Kingsmen, but the overlap demonstrates that there are ample opportunities for all players to work on these mega-projects. While all players have a strong clientele base and international clients as well, Kingsmen can hold its own with its own client base. Competition will continue to be keen but with the growth of the industry and many more major upcoming projects, there is still room for growth in top line and bottom line for all the players. However, as a prudent measure, I will be closely watching the margins for Kingsmen as well as their order book to ascertain that all is going well.

Prospects and Plans

Kingsmen also has experience in thematic and scenic construction, from its experience with the Universal Studios Theme Park. This enables it to enter a new business segment within its Museums and Exhibitions division, and start to bid for theme parks in South-East Asia. Universal Studios also recently announced, on Jan 19, 2010, that they plan to build its largest theme park in South East Asia in South Korea at a cost of S$3.7 billion. There are also plans by China and the Middle East to build theme parks in the next couple of years, and these present opportunities for Kingsmen to grow their business.

In the meantime, they will continue to grow their order book with iconic events in the MICE space within Singapore and South-East Asia, and are continually attracting more international clients for their fitting out contracts.

The second phase of Universal Studios is also up for grabs, and Kingsmen are confident they can secure contracts for this. Most of the rides and structures also need maintaining and refurbishment over the next few years, which will provide Kingsmen with steady business.

Conclusion and Wrap-Up

The purchase decision was made based on the following points which are summarized below (negative points will be separately elaborated on):-

1) Track Record and Reputation – Kingsmen has been around for nearly 34 years, and has built up a solid track record of providing quality work done and professional services with its trained and experienced staff. Because of this, the Company has a stellar reputation and is known as one of the leaders in providing fitting out and organizing exhibitions.

2) Brand Recognition and Visibility – Kingsmen has a recognizable brand name and brand equity, and they are effectively leveraging on this to grow their business. Their focus on quality and high standards also means that they can easily attract international brands and big names to sign up with them.

3) Strong Management with years of experience – To be frank, this reason is always stated as a reason to invest on many listed company’s fact sheets. But let me just reiterate once more that Benedict Soh and Simon Ong (who were the founders) have a wealth of experience in managing the business and have built it up literally from scratch to where it is today. OK, end of cliché, let’s move on to the next point.

4) International Clientele – Kingsmen has a myriad of international clients such as The Gap, Burberry, Swarovski and others; and the good thing is that many of these are repeat customers, which means their customer base is strong and also growing. The presence of big name clients also mitigates the risk of bad debts, which are an important aspect of this business as most of the time the event has to be organized and over before clients pay up (though of course, they have to pay an upfront deposit first).

5) Economies of Scale provide barriers to entry – Some may argue that it is easy to organize such events and hire sub-contractors to set up the tentage or to do fitting out. This is true, and I do know of smaller companies who cater to the smaller scale road shows (of generic products or smaller brands). However, costs are always an uphill battle as there are no economies of scale or pricing power; so the smaller players are always struggling to contain costs and their profit margins are even lower than Kingsmen (assuming they even manage to break even, as it is a cutthroat business when you are a small player). Thus, Kingsmen’s scale gives them an advantage in terms of being able to bid for large projects with better revenues and margins, and to manage their costs better through economies of scale. This also acts as a barrier to entry as it is not easy for a small player to get larger because of existing business relationships between Kingsmen (as well as other large players like Pico) and international clients.

6) Low Working Capital Requirements – Kingsmen is essentially a service-based company and has no inventory, so this eliminates the risk of over-production and/or product obsolescence. As a result, it also has low working capital requirements as most of its expertise lies in its staff’s skills and service levels. Though staff costs are a large component of its cost structure, this is essentially a fixed costs except when using sub-contractors. This is the reason why the business requires little additional investment to scale up to other countries and it can continue to generate FCF every financial year.

7) Steady and increasing dividends – From the chart in Part 1 of this analysis, it can be seen that dividends are increasing every year since Kingsmen started paying an interim dividend, and this can be attributed to its business model which generates good FCF which it can pay out to shareholders twice a year. As the business is growing due to scaling up of competencies and capabilities, it looks like the dividend can at least be sustained. Assuming a yearly dividend of 3 cents per share (conservative), based on my purchase price of 56.5 cents, this represents a dividend yield of 5.3%.

As with any business, below are the negative aspects of Kingsmen which I have to list down as well, in order to make an informed decision:-

1) Low Margin Business – As a result of the nature of the business, net margins in this industry are generally low at 6-8%, and seldom exceed 10%. Low margin businesses are more vulnerable to “shocks” when expenses suddenly increase without warning, and a Company can fall into losses more easily if it does not practice good expense control. The good news is that the business is not exposed to commodity prices (raw materials), and also does not have financing costs as it is in a net cash position. This mitigates the risk somewhat.

2) Order-Book Driven Business – Kingsmen’s business is essentially order-book driven, and this has risks pertaining to % of completion of projects as well as ability to continually garner contracts/projects to ensure a steady revenue stream. Revenues and costs may also be “lumpy” due to the timing of recognition and progress billings.

3) Staff Costs are a major component of Kingsmen’s business model – As staff costs make up a large percentage of their total costs, Kingsmen are vulnerable to any economic or social policies implemented by Singapore which has a negative impact of staff costs, both in terms of welfare and benefits. For example, the Government recently announced hikes in Foreign Workers Levy (FWL), but it is not known if Kingsmen has a large proportion of foreign workers, so the impact of this measure should be muted.

4) Expertise and Experience is inherent in staff – Much of the expertise and skills which drive the business are inherent and internalized within staff and do not count as an asset on the Balance Sheet. This brings up the risk of key staff resigning or being “poached” by competitors, thereby taking with them valuable information and/or skill sets which Kingsmen may have painstakingly spent money to inculcate and develop. What the Company can do is to initiate a “buddy” system in which two staff have overlapping roles, to minimize the risk of a “vacuum” being left behind in case one suddenly resigns or falls ill.

5) Reliance on Sub-Contractors – Due to Kingsmen’s high reliance on contractors and sub-contractors, an increase in costs of materials will flow through to contractors and in turn, affect the margins Kingsmen enjoys through provision of services. Contractors may also have the upper hand in dictating prices to charge Kingsmen as Kingsmen may be highly reliant on them; this risk can be somewhat mitigated if Kingsmen uses more than one sub-contractor for a single event or fitting out.

6) Business is not recession-proof – Kingsmen’s business is NOT recession-proof, unlike industries like food and clothing which are considered necessities even in the event of a sharp downturn. Businesses will scale back on renovations and refurbishments during recessions and this will directly impact Kingsmen’s top line; for MICE industry, less exhibitions and trade shows will be held too if countries struggle to grapple with the effects of a prolonged recession.

From the above, it can be seen that the negative aspects are almost as numerous as the positive ones, which means a higher margin of safety is required. I have invested based on conservative price-earnings assumptions, low to zero growth and a constant (and perhaps decreasing) dividend payout. The economic recovery is not a given and many obstacles still abound, so being conservative means I still get to enjoy decent yield with no upside expectations. Therefore, I am unlikely to feel too disappointed and any upside in terms of earnings and valuation adjustments will represent a bonus. In the meantime, I will continue to keep a close watch on the Company's business, financials, industry and fundamentals.

Disclaimer: This 3-part analysis is not meant to be a guide or solicitation for readers to either purchase or sell shares in Kingsmen Creatives. It is merely meant to be a diary of my thought process when evaluating a Company for potential investment. Please do your own research and consult a trained professional if you are unsure of what to do.


JW said...

Hi MW,

My investment ideas are still gradually morphing... I would think that the economic moat of Kingsmen isn't that high, although a strong management can still help turn it around...

Given my style now, in 2009, I would (and should) have bought big into SMRT, just like how Buffett bought into Burlington.

1) Extremely strong economic moat
2) Near monopoly - They can raise their prices anytime and commuters still have to pay
3) Dividend yield is also increasing (~4%)
4) We have Circle Line opening up, Downtown line and other MRT lines in plan as well.

Given these, I don't really understand why you would choose Kingsmen instead of SMRT. Dividend wise, they are comparable. Growth wise, investing in SMRT is like investing in the future of Singapore economy and travel. Economic moat wise, SMRT is unparalleled.

Musicwhiz said...

Hi JW,

Yes, you are not wrong about Kingsmen. They do not have a rock-solid competitive moat like say, Coca Cola.

For SMRT, I don't like their Balance Sheet, which has a lot of debt in it. Take note that SMRT cannot simply "raise prices anytime", this is subject to the PTC agreeing to it and there have been cases where fares were raised downwards. Also, ridership is not always a given considering the Government intends to clamp down on foreigner influx into Singapore.

In addition to that, SMRT is also dependent on oil prices, which have been rising. Dividend yield is around 4% as you mention and lower than Kingsmen's >5%, and may I also suggest that Kingsmen may increase their dividend in future (as would all companies which continue to grow and have FCF).

Does SMRT have FCF? I would think the Downtown Line and future lines would need heavy capex and the engagement of contractors, and may result in cost overruns should raw material prices go up or if there are unfortunate accidents again like the Nicoll Highway one.

One other factor to consider is that SMRT now has to install platform doors at ALL its above-ground stations, to prevent suicidal people from jumping and causing massive delays in the system (admittedly, the delays cost SMRT quite a lot of money and "lost" revenue).

The physical growth of a business does NOT always translate into growth in profits or free cash flows. So even though you are right on the physical infrastructural growth of SMRT, there are so many other factors to consider in purchasing a company.


donmihaihai said...

Are you sure about SMRT?

A 5 min run thru of their number tell me that I like their B/S. It is almost rock solid. This is reason why interest coverage is about 40X.

Does SMRT has FCF? At 1st look it does and generated lot of it. Just start counting the amount of dividends over the past 10 years, number of shares and debt level. Pretty simple.

On the second look, it is somehow diff. What is the cost of building downtown line? SMRT has 2billion of assets sitting on it B/S at cost pre-depreciation.

MRT may never be started if government(Singaporean) had not put up the capital and then licensing it out to operators.

Musicwhiz said...

Hello Donmihaihai!

Haha I was expecting you to leave a comment, but surprised that it was about SMRT and not Kingsmen.

To be honest, I did not delve very deeply into their numbers. Since you are a very meticuoous person, I will definitely believe what you tell me about their dividend consistency, FCF and Balance Sheet strength.

But I would like to say this - I have a problem with both SBS Transit and SMRT because I believe these are public goods, and therefore should be run at a loss in order to make transportation affordable to the general public. In other words, I believe they should be run as government-subsidized entities and not for-profit organizations. Call it a political reason if you will, but I've always been against this concept and thus will not invest in SMRT and SBS Transit.

By the way, I am not sure what you mean by "2nd look". What are you trying to say? Do you happen to know how much the Downtown line will cost? You said SMRT has S$2 billion worth of FA in its Balance Sheet, pre-depreciation. How is this funded? I am pretty certain the capex has to come from somewhere. Will it be from more debt, or purely internal cash flows, or a combination?

I certainly hope it will not be from shareholders....


CreateWealth8888 said...

If you believe in long-term stable income strategy then SMRT is a better choice.

How long can Kingsmen last when the old man leave?

Musicwhiz said...

Hi 8888,

With due respect, many companies have continued to survive and grow even when the founder(s) are no longer around. That's the importance of building a good culture and proper systems and P&P (policies and procedures).

The Company doesn't just carry on based on 2 men alone, it's a team effort (always the case).


donmihaihai said...

To build and own infrastructure in Singapore, $2 billion is nothing even if consideration is given for historical cost and inflation. Since this $2billion already been funded, the best way to know how it was done is by going thru the book.

So just by reading the B/S, it is easy to know that SMRT has never fund the whole infrastructure.

Musicwhiz said...

Thanks Donmihaihai for your reply.


cif5000 said...

On SMRT. It's my regret for not having it in my portfolio.

I might be wrong, but I think the government (LTA) foots the bill for the Circle Line construction and owns the assets. The operator merely runs the line while LTA continues to own the infrastructure. To top it up, it looks like the Operating Assets (mainly trains) for the circle line are "sponsored" to SMRT for the first 10 years.

The cost of Circle Line is about $10bn, most likely to be recovered with their license fee to SMRT on 0.5% gross fare revenue and 0.5% gross non-fare revenue.

The kicker might come when it finally opens up advertising on train stations, or even the entire infrastructure.

Musicwhiz said...

Hi cif5000,

Haha, thanks for providing the numbers - they are very useful indeed. Well, I guess SMRT is really "Govt-owned", no big secret about that! It's a public service which is somehow "for-profit" and serving the shareholders who are asking for dividends. This is uniquely Singapore indeed!

I guess if the price cum valuation is not attractive to you at the present moment, you can always look elsewhere. There's no lack of good investment opportunities, all one needs is sufficient patience. :)

Take care and regards!


cif5000 said...

No thanks. Sorry to join in the SMRT talk as I have nothing more to contribute on Kingsmen.

My personal feel on SMRT is that the investment should be based more on "arrangement" rather than "numbers". The only important numbers are the dividend and price. The rest can be checked with a glance. Note the strong bearing on trying to create competition within MRT operations justified by measuring "service standard" when NEL was opened. We know what happened in the end.

BTW, what stocks are you eyeing on now?

Musicwhiz said...

Hi cif5000,

Haha, yes well that's the way our Govt works. I also don't think I can say much more about SMRT, and anyway this post is about Kingsmen. Hehe.

What am I looking at now? Perhaps Design Studio, it seems to pique my interest. And maybe also Hai Leck, since MTQ owns >5% of it so it may be worth a second look.

Take Care!


Shud'n said...

Hi MW,

Kingsmen's CFO for Fy2009 is only $1.4m and it was down from around $20m the previous year. Why is the reason for this? Do you think this will be a one-off thing?

Musicwhiz said...

Hi Shud'n,

If you notice, Trade Debtors went up by a lot mainly due to the USS contract (in which payment was probably due after year-end), so this was a timing difference. If you note 1Q 2010 financials, receivables have come down a lot even though revenue has increased year-on-year.

FYI, for FY 2009 there was also FCF generated. Just take OCF and minus capex for PPE. So Kingsmen has been generating FCF since FY 2004 (6 years in a row). I am confident this year will be the same as well.


6 said...

Hi MW,

Any updates on Kingsmen Creatives?

6 said...

Hi MW,

Any further updates for 3Q 2012 for Kingsmen Creatives and forward looking to 2013?