Thursday, September 30, 2010

September 2010 Portfolio Summary and Review

As expected, September 2010 was a very quiet month with hardly any corporate announcements from the companies in my portfolio. This was to be expected as September has traditionally been a very quiet month, and I have confidence that the businesses I own are slowly but surely building up their competencies and capabilities to tackle the new challenges ahead.

This month was one of quiet reflection over the business aspects of the companies I own, as well as a little more delving into SIA Engineering Company, which was an investment I had acquired in early August 2010. As can be seen, most of my posts have been on property, investing and SIA Engineering. Moving forward, my thoughts are focusing more on personal finance areas and also on the latest news on Singapore Airlines (SIA) issuing corporate bonds for retail investors. This is a very interesting development as corporate bonds had never been available to retail investors before; previously they were issued to either institutions or sophisticated investors (accredited high net-worth investors). SIA will be issuing S$300 million worth of bonds at a yield of 2.15% per annum, coupon to be paid annually (the announcement did not say otherwise). Suffice to say that the yield is really pretty dismal, considering one can get yields of at least 3-5% in equity markets right now. However, in the current low interest rate environment, getting a coupon rate of 2.15% is still significantly better than the abysmal 0.125% which is being paid by most savings accounts. Of course, one has to also consider the fact that SIA is one of the well-run and well-established airline companies in the world; hence the risk of default will be low, which is why the bonds are paying such a low interest rate. Another advantage of bonds is that they rank above equities in terms of payment should anything untoward happen to the Company, although they rank behind secured debt. It will be interesting to see the general public’s response to this bond offering, and also observe how the media covers this and “plays it up”.

On the economic news front, USA is obviously undecided whether it will have a double dip, with most economists and “experts” trying (in vain) to second-guess one another. Obviously, the one who happened to get it right will be lauded as the new “soothsayer of the year” and enjoy a reputation akin to what Nouriel Roubini is currently enjoying. Such is the strangeness of this world, where people constantly try to predict that which cannot be predicted, only to have to “revise their forecasts” constantly. I still think economists have the best job in the world because they can always afford to be wrong yet still retain their jobs. Imagine if that were to happen in the engineering field - a suspension bridge is calibrated wrongly and collapses. Someone would lose their life, and not just their job.

Over onto the property scene in Singapore, it appears that the recent “draconian” rules which I had written about a while back appear to have dampened sentiment considerably, especially in the HDB resale market. COVs appear to be headed southwards, and sellers are becoming more realistic in their asking price. The Government has also released more plots of land for development and developers appear to be a little more cautious in releasing their projects; though most report that sales are still “healthy”. The Business Times published a Property Supplement on September 23, 2010 in which one of the article contributors, Kelvin Tay (Chief investment strategist at UBS), mentions that the market may be in a state of denial over the presence of a bubble, and he cites examples of Japan’s real estate bubble in the 1980’s and the more recent American sub-prime housing debacle. All I can say is that if one is prudent and makes provisions for exigencies, he will not get caught by surprise should prices crash suddenly and inexplicably.

Interestingly, on the personal finance front, the Sunday Times (in its September 26, 2010 issue) ran an article in its “Invest” section called “Generation Debt”. The article reports rather shocking statistics where it mentioned that those in the 20-29 age group had the highest rate of defaults on their debt, at 7.16% (which far exceeded the average of 3.11% for all consumers). Credit card defaults were the most common, with other types of debt including overdraft, mortgage and motor vehicle payments. Mr. Ben Fok, CEO of Grandtag Financial Consultancy, comments that 20-somethings “cannot exercise self-control, and have not mastered the art of delaying gratification and (thus) spend more than they can afford to”. It’s quite a worrying trend to see this happening as this generation is supposed to be the “future” of Singapore as they will be entering the workforce and setting up families in 5-10 years time. If they cannot manage their finances properly, the future of Singapore appears bleak….

And just yesterday, news reports mentioned a sensational and unbelievable fraud case involving two employees of Singapore Land Authority (SLA) of up to S$11.7 million! The sheer amount and audacity of it really stunned me (this news coming hot on the heels of the widely reported SPH cheating case), and I guess the perpetrators had not expected to be caught red-handed, which was why they freely went on a shopping spree, scooping up luxury cars, designers bags and watches, jewellery and properties. It really boggles the mind how such a massive fraud could take place and yet go undetected for 2.5 years. I’d be interested to know the inner workings and machinations behind this fraud case to see just how these jokers managed to keep it under wraps for so long.

Below is a snapshot of my portfolio and associated comments for September 2010:-

1) Boustead Holdings Limited – There was no significant announcement from the company for the month of September 2010. However, The Edge Singapore did run a 3-page interview with FF Wong of Boustead; and in it he details his plans for expansion of the Group through various avenues, and also his plans to grow the company in the next couple of years.

2) Suntec REIT – There was no news from Suntec REIT for the month of September 2010.

3) Tat Hong Holdings Limited – On September 13, 2010, Tat Hong announced that the Group would be subscribing for further equity interests in Tat Hong Zhaomao Investment Co., Ltd. This will raise their stakes in these China joint ventures slowly but steadily, and allow them to recognize a larger portion of revenues and earnings. On the Tutt Bryant front, the acquisition of the remaining shares is proceeding well and the transaction should be completed by CY 4Q 2010. I expect earnings recognition to start flowing in during 3Q FY 2011.

4) MTQ Corporation Limited – On September 3, 2010, MTQ announced that they had injected an additional USD 2.97 million into MTQ Oilfield Services W.L.L (MTQ Bahrain). Following these injections, the registered capital of MTQ Bahrain now stands at USD 3.6 million. Separately, on September 24, 2010, MTQ announced the appointment of Mr. Nicolas Campbell Cocks as Independent Director of the Company.

5) GRP Limited – There was no news from GRP for the month of September 2010. The Annual Report should be out by October 2010 and the AGM will be held in November 2010.

6) Kingsmen Creatives Holdings Limited – There was no news from the Company for September 2010. I did manage to meet the CEO Mr. Benedict Soh in a “Meet the CEO” session organized by Kim Eng Securities. There, Kingsmen’s General Manager Andrew gave a brief presentation on the Company’s competencies, projects and customer base; and those present (including myself) also managed to ask a few questions of Management. It was a fruitful session, and I also received hard copies of Kingsmen’s latest annual newsletters (one for Exhibitions & Museums, another for Interiors).

7) SIA Engineering Company Limited – There was no news from the Company for September 2010.

Portfolio Review – September 2010

Realized gains have remained constant at S$46.4K as there was no transaction for the month and also no companies going ex-dividend. For the month of September 2010, the portfolio has gained +7.28% against a +5% rise in the STI. On an annualized basis, the portfolio has gained by +18.1% against the absolute gain of +6.9% for the STI. Cost of investment remains at S$202.4K, and unrealized gains stand at +24.3% (portfolio market value of S$251.6K).

October 2010 will be somewhat slightly more interesting than September 2010, as one of my companies (Suntec REIT) will be announcing its 3Q 2010 results. Other than this, expect more of a wait till November 2010 where Boustead, Tat Hong, MTQ and SIA Engineering will release their 1H FY 2011 results. I somehow have an uncanny tendency to pick companies which have March 31 financial year-ends! GRP will also be releasing their FY 2010 Annual report, and the AGM should be some time in late October 2010.

My next portfolio review will be on October 31, 2010 (Sunday).

Sunday, September 26, 2010

Sun Tzu - War On Business Part 13 (Palate Palette)

We have come to Episode 13, which is the final episode of the Sun Tzu series, and it’s one which brings us to Kuala Lumpur, Malaysia; a country which has not been covered so far in this series. Here, James Sun meets up with a lady called Sun-Ann Wong (“Su-Ann”) who runs a café cum pub called Palate Palette. There is a reason for the phonetic play on the two words, which we shall see later! This café was set up three years ago and offers more than just food and drink; it also serves as a place for regulars to rest and relax. However, it remains small as there have been no attempts or plans made for expansion.

Su-Ann is a London-trained graphics designer and she had entered the restaurant industry 3 years ago to start up a café which boasted creative artwork and murals on its walls, in order to provide a refreshing concept as compared to other more “mundane” cafés. However, James quips that “standing on the defensive indicates insufficient strength”, implying that her business model is not strong enough for her to expand and grow the business. In the Food and Beverage (F&B) industry, competition is always very keen and margins are therefore razor-thin. Palate Palette was making a marginal profit but at the expense of Su-Ann putting in a lot of work and effort; and the fact was also that it was stagnant and not growing. Her partner, who had opened the café along with her at the time, had left and thus she has to handle everything (one-woman show!).

The interior of the café is filled with very creative artwork and graphics and this makes up the feel of the restaurant and helps to attract customers and patrons. On the second floor, a space has been set aside for private parties and events. There is also a marketing website with information on events held and Su-Ann relies on word of mouth to spread the news about her café.

All this, however, is insufficient to generate a critical mass of customers for her to grow and expand the business. In spite of all her efforts, there does not seem to be much room for growth, and anyway she has not really planned or thought about it. When James asked if she would like to make her cafe “bigger”, he got an emphatic “Yes”. The problem is how to go about executing a strategy to ensure growth is on track, and also put in place some monitoring mechanism to ensure she is not going off tangent.

James advises Su-Ann to spruce up the menu and also ensure service levels are up to standard, because in the F&B service industry, poor or tardy service would irritate and “scare off” customers, and through the ripple effect of word-of-mouth, this could potentially create a lot of negative vibes for her business and ruin her plans for growth. Su-Ann first has to ensure that her head chef is always present to ensure the smooth running of the kitchen; while she herself also has to be present to oversee the operations, and not play “remote-control”. Physical presence is very important in running a business, as it will at least prevent workers from slacking off or idling in the initial stages of implementing formal processes and procedures. As these catch on and employees familiarize themselves with them, they will become more efficient and are able to teach subsequent new batches of employees, thus creating a virtuous cycle of learning and development.

The key lessons to be learnt from this episode:-

1) Ensure there is proper control over food being served – During the episode, it was shown that there was considerable confusion over the food being served, and there was also the issue of the head chef not being there when Su-Ann needed her. Therefore, proper policies and procedures should be drawn up to ensure all the employees know how to react in the event of an emergency or contingency.

2) Proper marketing can greatly help in promoting a food outlet – Su-Ann realized that she had to resort to other methods of promoting Palate Palette aside from just word of mouth through regular patrons. That was when she hit upon the idea of using a website to promote her restaurant, and this worked well because the crowd which she wanted to attract was savvy in using the Internet and hence it was an appropriate medium for her to market through to them.

3) Have a proper theme for a café or restaurant – It is important to have some form of concept or theme relating to a food outlet, so as to differentiate it from other competitors who may be located in the vicinity. Su-Ann did the right thing by having artwork on the walls of the restaurant and choosing a very catchy name as well.

This concludes the highly popular Sun Tzu – War On Business series hosted by the enigmatic and charismatic James Sun. I would like to thank him for hosting this series and giving me good material for analysis in the form of thirteen enlightening episodes on businesses, how they run and how they can be improved.

I was hoping he would start a second season of his highly popular series but so far there has been no further news, so I guess readers will have to make do with this first season for now. Hope all readers have enjoyed the episode narrations and analysis!

Please visit Palate Palette’s website at:-

Wednesday, September 22, 2010

SIA Engineering – Analysis of Purchase Part 2

Part 2 of SIAEC’s analysis of purchase will look into its Business Divisions and provide some background on what the Group does; and also follow the history of each division.

SIA Engineering Company has two dominant business divisions – namely repairs and overhaul (forming the bulk of their MRO business), and line maintenance, which includes inspections for aircraft for major airlines. This section shall attempt to chart out the business history of each division and to give an overview of the progress of each division over time, highlighting its notable achievements in particular. Note that I have lumped together Fleet Management under repairs and overhaul, as it is basically part of the division which provides comprehensive technical assistance to the airlines for their aircraft.

Repair and Overhaul
Brief Description of Business Activities

Airframe Maintenance and overhaul sub-division facilities comprise of 5 hangars with a combined total of 8 bays and total floor area of approximately 43,200m2. With these facilities, we are able to provide total support solutions to our growing portfolio of third party customers.

Component maintenance and overhaul sub-division has 22 workshops which test, repair and overhaul components including those removed from the aircraft in the hangars.

Engine overhaul sub-division is able to provide engine parts repairs and overhaul services to high-performance engines such as Rolls-Royce Trent 500, 700 and 800 series as well as Pratt & Whitney, just to name a few.

Historical Development of Division
April 2000 > Launch of “Skysuite” workshop dedicated to the maintenance and overhaul of “Skysuite” seats used in SIA’s Boeing 747-400 fleet.

October 2000 > SIAEC signed a ’Total Support’ maintenance contract with Region Air for three Airbus 310 and one Airbus 300-600. The contract covers airframe maintenance, component overhaul and component exchange for a period of five years. Contract value is about S$40 million.

January 2001 > SIAEC broke ground for the Company’s third hangar. Located adjacent to the two existing hangars and costing S$25 million, Hangar 3 is targeted for completion in the 2nd quarter of FY2001/02. The new hangar will be specially equipped to handle Boeing 777 heavy maintenance checks.

FY 2001 > Contract signed with Atlas Air for the heavy maintenance of its Boeing 747-200/300 fleet.

October 2001 > First heavy maintenance on an SIA B777-200 aircraft in brand new third hangar at Changi Airport. Reduction of “D” check duration from 31 to 20 days.

October 2001 > Standard Work Implementation introduction; resulted in improved productivity as cycle times are reduced through the use of improved processes.

March to July 2002 > Modification programme to improve the reliability of video and audio in-seat entertainment systems (System 2000E) on board SIA’s B777, B747-400 and A340 aircraft.

FY 2003 > Several new customers, including Air Asia, Pegasus Aviation, Air France and Iberia L.A.E., were added to customer base, which includes Atlas Air, Air Canada, Asiana Airlines, Biman Bangladesh Airlines, Polar Air, Air India, Federal Express and China Northwest.

FY 2003 > Signed a 7-year airframe maintenance contract with Air Asia, covering its fleet of five B737-300 planes. Completed “C” checks, modification and painting on two of Air Asia’s B737 airplanes.

May 2002 > The first two SIA B747-400 aircraft were retrofitted with SpaceBeds, while the first two B777-200ER aircraft were retrofitted in July 2002. The in-flight entertainment system was also upgraded to the new-generation Matsushita S3000 system.

August 2002 > NDT laboratory received a certificate of accreditation from the Singapore Accreditation Council (SAC). This is in recognition of our achieving the SAC-Singapore Laboratory Accreditation Scheme (SAC-SINGLAS) accreditation ISO/IEC 17025. The SAC-SINGLAS accords formal recognition to laboratories that have demonstrated technical competence and capabilities in performing specific services in calibration and testing.

FY 2004 > Clinching of new contracts from airline operators, such as Air Europe, Air Pacific, Air Plus Comet, China Eastern Airlines, China Northern Airlines, Debis Air Finance, Dubai Air Wing, Global Supply Systems, Iberia, Islandsflug and Northwest Airlines.

July 2003 > Training for the handling and maintenance of the airframes and engines of SIA’s new Airbus 340-500 aircraft.

February 2004 > Special on-the-job training was conducted by Goodrich’s engineers to assist us in broadening our knowledge of the A340-500 undercarriage systems.

February 2004 > Commenced construction of Hangars 4 and 5, with investments of S$120 million. Plan is to raise airframe maintenance capacity by 30%.

May 2004 > Embarking on B747-400 passenger-to-freighter (PTF) conversion as part of our strategy to offer a complete suite of MRO services in Singapore.

May 2004 > SIA Engineering Company received the CAAS Limited Design Organisation Approval (LDA) to perform limited engineering design and modification work on Singapore registered aircraft.

August 2004 > Successfully commissioned the $5 million Rolls-Royce Trent 500 Test Adaptation System to gear up for the Airbus A340-500 aircraft.

December 2004 > Eighth operational line established to optimise workflow and manpower utilisation. This line has its own painting, sheet metal and fibreglass repair capabilities within the hangar.

June 2005 > Fifth hangar operational, bringing overall hangar capacity to 43,200 square metres.

FY 2006 > Workshop division reorganized and renamed Component Services Division, which has 4 separate business units. Also merged our Hydraulics shop with our newest joint venture Aerospace Component Engineering Services (ACE Services)

December 2006 > Among the first MRO players in the world to gain the capability of servicing the Boeing B777-300ER, an extension of the highly popular B777 series.

FY 2007 > Signed a 10-year Integrated Materials Management (IMM) agreement with Boeing. Under the agreement, the aircraft manufacturer takes
responsibility for purchasing, inventory management and logistics for expendable aircraft parts used to support our MRO activities.

FY 2008 > Extended our FMP territorial coverage to Australia to support Tiger Airways. The FMP contract with Cebu Pacific Air was also extended to cover an additional 18 aircraft.

November 2008 > Commenced construction of first narrow-body hangar at Clark International Airport, Phillipines.

February 2009 > Inked an agreement with Saigon Ground Services to establish a jointly owned line maintenance facility at Tan Son Nhat International Airport at Ho Chi Minh, Vietnam. Plans are in the pipeline to expand to other airports in Vietnam and to scale up operations to provide heavy maintenance when conditions are right.

March 2009 > Clinched major contract with Bahrain’s Gulf Air to manage its Airbus fleet of more than 40 aircraft (comprising A320, A330 and A340).

September 2009 > Opened first heavy maintenance facility outside Singapore (JV with Cebu Pacific Air). Based at Clark International Airport in the Philippines to provide maintenance services for Cebu Pacific Air’s Airbus fleet, the facility has completed 15 ‘C’ checks by March 2010.

Hangar Specializations

Hangar 1 > B747 heavy maintenance and modifications
Hangar 2 > Airbus and narrow-bodied Boeing aircraft heavy maintenance
Hangar 3 > B777 heavy maintenance
Hangar 4 > B747 Passenger to Freighter (PTF) conversions
Hangar 5 > B747 heavy maintenance and modifications
Hangar 6 > A380 Aircraft

Line Maintenance
Brief Description of Business Activities

This division provides aircraft certification and ground handling services to an international client base; while a dedicated team of engineers and technicians also provided dedicated cabin management services to ensure high despatch reliability for in-flight entertainment and cabin systems.

History and Development of Division

April 2000 > Line Maintenance Division added Transmile Air from Malaysia to its client base of more than 60 airlines at Singapore Changi Airport.

September 2000 > Base Maintenance Division carried out an Airbus 310 “C” check for new customer Emirates from the United Arab Emirates.

December 2000 > Line Maintenance Division commenced technical handling services for new customer Airwagon from Indonesia.

FY 2002 > Invested in capital equipment that helped boost productivity and
work efficiency: a platform for window change operations as well as fuel tank purging equipment.

FY 2003 > Welcomed 6 new airline customers; Air Macau, Australian Airlines, Gemini Air Cargo, Pacific Airlines, Orient Thai and Xiamen Airlines.

FY 2003 > Expanded work scope by undertaking maintenance of inflight entertainment systems and major component changes, such as landing gears and engines.

September 2004 > Implemented the concept of Cluster Operations to improve operating efficiencies

August 2005 > Implemented a computerised system for manpower allocation known as the Dynamic Resource Assignment Module (DRAM). Line Maintenance is able to present the flight and manpower allocation plan on a central display system called the Flight and Resource Information Display System (FRIDS). This gives everyone, including units in different locations, clear visibility of resource allocation.

FY 2007 > Successfully introduced the Integrated Maintenance Operations Control (IMOC). This is an integrated centre that monitors daily aircraft operations for customers under our FMP (Fleet Management Program).

January 2008 > SIA Engineering Company’s team of qualified A380 Licensed Aircraft Engineers and Technicians undertook the first 750-hour check for SIA’s first A380.

FY 2008 > Completed a total of three B747-400 conversions, which were delivered to Dragonair. We also significantly reduced the turnaround time from 163 days to 106 days with process improvements

As can be seen in the above, SIA Engineering Company has come a long way in the last 10 years in growing the business and its capabilities and competencies. It has managed to stay abreast of new developments in aviation, avionics and aircrafts and is always at the forefront of the newest technologies in the industry. And it manages to do all this through the formation of strategic partnerships and joint ventures, thereby keeping its capital expenditure minimal (in relation to its revenues).

The next part (Part 3) of this Analysis of Purchase will focus on SIA Engineering Company’s numerous subsidiaries, associated companies and joint ventures; including describing their evolution, principle activities, value-add and how they contribute to the Group’s growth. I will also be providing some compelling numbers to show the significance of these alliances and joint ventures to the Group.

Note: Just to inform all readers that the new value investing forum Value Buddies is now up and running! This is a continuation of the Wallstraits/Afralug forum which focuses on value investing. You can visit at this link and register to start reading all the threads!

Saturday, September 18, 2010

The Human Aspect of Investing

We often talk and think about investing in terms of numbers, business models and facts; but when you really drill down to it, investing is actually all about people. Why do I say that? This is because corporate fundamentals are built upon the people who run the business, people who delegate the work to others; and the rank and file staff who execute the mundane (yet necessary) daily transactions. Without the role of people and human beings, investing would not even exist! However, this post is not to extol the virtues of humans within organizations; in fact it seeks to take a closer look at the very aspect of investing which is almost impossible to quantify – that of the quality of the Management Team, Directors and staff on board. In short, this post is to discuss the human aspect of investing in creating a successful corporate culture, identity and how it adds up to creating enhanced shareholder value.

Interestingly, I once read an investment book which did mention about the importance of assessing Management characteristics (sorry, I can’t remember the title!). But the crux of the book was that investing is more than just the sum of the parts in terms of assessing aspects of the company such as market share, financials, industry analysis and business models, which are the so-called “tangible” aspects of the business and which can be readily scrutinized. Management and people, on the other hand, are a part of the business which adds an extra dimension of quality without being directly measurable or tangible. The converse is also true if a good business is being run by crooks – sooner or later the Company will implode under mis-management and fraud. I think what the book wanted to stress was the kind of people out there which a retail investor might meet and how to size them up in order to enhance our view of a company as a potential investment.

I think for this post, I would confine my discussions on human behavior and personalities to CEOs or Chairmen, as they are the people in charge of steering the Company ahead and are usually the ones who are “on top of things”. Most of the company’s strategic vision is also embodied and articulated by top management; hence the cues given out by these people will mean much more than signals given out by, say, the finance manager or the marketing director (for example); even though of course one should also try to speak with them on the Company to get a broader perspective of things. However, I have noticed that corporate behavior tends to cascade down from the top, and “infect” the entire organization, be it good or bad. If a CEO has the habit of hiding bad news from his staff, then his staff will similarly try to hide bad news from investors and the media. If a CEO is open, honest and forthcoming, it is also likely to flow down to his management team and it will show up clearly as well.

So what are some of the good traits to look out for, and which can give an investor confidence in the Company? For one, a CEO has to be open, honest, inclusive and not afraid to admit mistakes. This can be very easily deduced from the Chairman/CEO’s statement in the Annual Report, and also from conversing with the person during the AGM. A CEO who is open will share the good and also the bad bits from the last financial year, and be candid about the state of affairs of the company. After all, it cannot possibly be good news all the way, and even if things look good for the company, it is the prudent CEO who will temper expectations and not be overly optimistic. The CEO should also be willing to share his mistakes, admit them openly and assure shareholders and investors that he will not repeat such mistakes; and it takes a very brave CEO to admit he made errors, as it is a natural human inclination to accentuate the positive and bury the negative.

Other positive traits to watch for are a passion and drive to grow the business beyond the current state of affairs, and having the right strategy, knowledge and foresight to grow the business; yet manage the cash flows and Balance Sheet of the Company well at the same time. This, of course, can be deduced from the financials over the years, but when one comes into contact with a CEO, watch how he talks about his company and his plans for the company. Some CEOs are simply unrealistic and will project 50% CAGR in revenue and earnings for the next 5 years, others have their head in the clouds all the time dreaming of the big break for the company (with a new technology or patent); while the more pragmatic ones will have a more realistic target like doubling sales in 5 years for example (which is achievable because it’s not doubling of profits). The important thing here is to weigh your view of the Company’s prospects against what the CEO is projecting or forecasting, to see if the person is a realist or an unjustified optimist. The CEO who blows his trumpet in public may very well delude himself in private that he is somewhat special and can take the company through all obstacles, and so end up acting in an impetuous and brash manner which may result in the company’s fortunes sinking over time.

I guess I had already alluded to some negative traits in the above paragraph, and these include arrogance, refusal to admit mistakes, a flippant attitude, aggressive behavior (not physical but in the allocation of capital) and poor knowledge of the industry or his company’s place within the industry. Some CEOs are pretty new to the job, hence may be green around the ears and new to the job. Others may be very “PR”, and laugh and chat with shareholders and fund managers, but if you look closer there’s actually not much substance. I could certainly go on to give examples, but I think the reader should get my drift at this point.

To be able to ascertain a CEO’s competence and character from a meeting at the AGM is certainly not a simple task, even if one can pick up subtle cues here and there. Usually, one should do his homework and read up about the person prior to the meeting, and also understand more about the company and peruse through the Chairman’s Statement and MD&A. If this is done studiously, a lively engagement will then ensue and you can literally “test” the CEO to see if he can handle your questions, and also note his body language when he responds.

To conclude, I will say that often times, investors neglect this very important aspect of investing which is the human touch. Though it may not be easy to assess, I feel it should still remain an integral cornerstone of investing and should be worked on. My method was to attend many AGMs and EGMs or any briefings or press conferences which featured the CEO or Chairman in question, and proceed to observe and learn. Over time, one can accumulate sufficient experience to judge character and be able to distinguish the good, the bad and the downright ugly!

Tuesday, September 14, 2010

Draconian Property Rules

This is probably only my second post on property, as I am still a greenhorn who is observing the market and trying to understand the intricacies of this very interesting investment class. The reason for this (timely) post is mainly due to the recently announced new property cooling measures by Mr. Lee Hsien Loong at the National Day Rally on August 30, 2010. These measures were the direct result of the relentless increase in property prices since the middle of 2008, when the global financial crisis had hit the Singapore economy with full force. The Government had witnessed HDB resale prices moving upwards and hitting new all-time highs, even as manufacturing and output dropped off a cliff. This apparent dislocation between economic stagnation and property price rises had more than one person complaining bitterly, while speculators were eagerly loading up on properties with the hope of making a quick buck. In spite of two rounds of cooling measures implemented by the Government in the last 1.5 years, including increase the Minimum Occupation Period (“MOP”) for resale HDB flats from 1 year to 3 years, prices continued to escalate and for 2Q 2010 had hit new all-time highs. The cacophony of voices (mainly from young couples who were getting married and were buying HDB for the first time) asking for some action to be taken grew louder as the months passed; which culminated into the new measures announced close to the tail end of August 2010.

So just what are these measures? First off, those who are holding a private property have to sell it off within 6 months should they buy a non-subsidized HDB flat; and this is one of the most stringent laws which I had heard of to date. This effectively shuts people out from buying a resale HDB flat if they own a private property, as they will then be “forced” by the law to dispose of their private property. I guess this rule was intended to chase out speculators who intended to purchase resale HDB flats for investment or rental, rather than for genuine occupation purpose. However, this creates problems for people with genuine intentions to buy another flat for their parents or children to stay in, for example. Under such a rule, they thus cannot register the resale HDB under their name or they would be forced to give up their private property. Hence, the resale HDB flats have to be purchased in another person’s name. This can be onerous and troublesome even if the funds are not coming directly from the registrant’s account, and would cause headaches for those intending to buy non-subsidized HDB for their relations (assuming their income busts the S$8,000 ceiling).

There is also an extension of the 3-year minimum occupation period (“MOP”) to 5-years for non-subsidized HDB flats to dampen demand for those who are not in urgent need of housing. This in turn was an increase from the 1-year period and is the second increase in MOP in as many years. This move is pretty drastic as it means that speculators or “flippers” will need to hold for at least 5 years before they can dispose of an HDB flat, which may frustrate their attempts to “make a quick buck” from the transaction (one year is not a long period). However, this may also penalize those families who wish to upgrade to private property and are “barred” from selling their resale HDB flat which they had purchased within the five-year MOP. These may be genuine upgraders who need more space for their growing family or even to stay together with their parents. So this knife is double-edged in that it will slice through speculators’ plans as well as those of genuine home-buyers.

The seller’s stamp duty holding period has also been increased from 1 year to 3 years. Note that previously, the Government had acted to cool the property market by imposing a seller’s stamp duty if the property were to be bought and sold within 1 year. Originally, there was no such stamp duty payable and only the buyer’s side would be paying stamp duties; but the Government wants to make it more difficult for speculators to profit from such short-term transactions and so has narrowed the margin for profit with the imposition of this tax. Incidentally, there were some articles written in Straits Times (I think it was a Sunday edition) which compared the potential profits from buying/selling a property before and after the stamp duty rule kicked in. Since most property speculators use leverage to magnify their gains, a stamp duty of say 3% may significantly reduce profits and magnify losses when leverage is employed.

And the final, probably most drastic measures involve those of financing and LTV (Loan to Value) limits. If you have an existing housing loan, and intend to take up another to buy another property, the minimum cash payment you would have to cough up increases from 5% to 10% of the valuation limit; and the LTV limit goes down from 80% to 70%. What this means, in simple layman terms, is that buyers have to cough up higher cash amounts as compared to before, and they can only borrow up to 70% of the property’s value, which also implies higher cash/CPF upfront payment. To give an example, suppose a buyer would like to purchase a S$1 million condominium. Under the old rules, the buyer would be able to borrow up to S$800,000 and would have to pay S$200,000. Of the S$200,000, just S$50,000 needed to be in cash while the remainder (S$150,000) can be in CPF. Under the new rules, however, just S$700,000 be borrowed, while the other S$300,000 has to be paid up front by the buyer. Of the S$300,000, S$100,000 needs to be in cash while the other S$200,000 can be from CPF OA. So this represents an increase of S$50,000 cash and another S$50,000 in CPF OA needed under the new rules. Assuming a person is cash rich and has a good CPF balance, this should not pose a problem. However, for those who purchased and intend to flip, they may not wish to cough up the additional requirements; and it may also erode their ROI as the gains (if any) are now divided by a larger denominator!

So I would conclude that the latest set of measures do seem to be harsh on speculators, and it is likely (but not completely certain) that housing prices are poised to fall as a result. However, Singapore being Singapore, we might just witness a further rise in housing prices for whatever reasons; and the Government may need to mete out even more forceful measures to stem the relentless price increases.

Thursday, September 09, 2010

SIA Engineering – Analysis of Purchase Part 1

This is Part 1 of a 5-part series in my analysis of purchase for SIAEC, and is the most comprehensive analysis I had done so far for my value investing. However, please note that this investment analysis was done with safety of principal in mind, and capital preservation is of utmost importance as I hold value investing concepts close to my heart.

As mentioned in my August 2010 portfolio review, this will be the final comprehensive analysis I will post up, as it involves huge amounts of time, effort and research. Future purchase decisions will be summarized in a more succinct manner for brevity, while keeping the underlying reasons and rationale intact.


SIA Engineering Company (SIAEC) is a major provider of aircraft maintenance, repair, and overhaul services in Asia Pacific. The Company has a client base of more than 80 international carriers and aerospace equipment manufacturers. It provides line maintenance services at Singapore Changi Airport for more than 50 international carriers, as well as airframe and component overhaul on some of the most advanced and widely used commercial aircraft in the world.

The company was formed on April 1, 1992 from the engineering division of Singapore Airlines Limited (SIA) and was listed on the Stock Exchange of Singapore on May 12, 2000 (FY 2001). It is still currently 80.1% held by SIA and has a total issued share capital of 1.08 billion shares. It has been a listed entity for 10 years and has historical data for 10 years which can be analyzed through annual reports and corporate announcements/press releases. Information for this research and analysis of purchase report were all obtained from public sources such as industry reports, annual reports as well as published financial statements of publicly-listed competitor companies.

SIAEC also has approvals from 23 national aviation regulatory authorities to provide MRO services for aircraft registered in the U.S., Europe and Japan, among others.

Disclaimer: The author accepts no liability or responsibility for the accuracy and reliability of the information contained herein; so please do your own reading and research to obtain the facts and figures which you require to verify details within this report.

This analysis of SIAEC is pretty detailed and will therefore be broken up into five (5) parts, as follows:-

Part 1 – Introduction and Financial Analysis (P&L, B/S and CFS – 10 years)
Part 2 – Divisional Analysis, timeline, history, developments and status, including operational review
Part 3 – List of Subsidiaries, Associated Companies and Joint Ventures + Profits and cash flows (dividends) attributable to the Group
Part 4 – Competitive Analysis (using HAECO, ST Aerospace and Vector Aerospace)
Part 5 – Global MRO Industry Outlook, recent developments for SIAEC, prospects, pros and cons analysis and conclusion.

Financial Analysis

Profit & Loss Analysis

By referring to the above 10-year analysis, we can see that revenues have remained relatively stable over time and have grown marginally over the years (from S$662 million in FY 2001 to S$1 billion in FY 2010). Expenditure has more or less tracked growth in revenues in terms of following the highs and lows of the economy, in which the aviation and travel industry was affected by several major events including the 911 disaster in 2001, SARS in 2004 and the global financial crisis in 2008-2009. Operating margin remained fairly consistent at around 13.9% on average; and represents SIAEC’s core businesses of Repairs and Overhaul (including Fleet Management) as well as Line Maintenance. Part 2 will delve a little deeper into SIAEC’s business divisions and how they have fared in terms of operations and in generating decent margins for the Group.

One should note that over the years, net profits attributable to shareholders has been steadily increasing, and this was due to the greater recognition of share of profits from associated companies and joint ventures, of which SIAEC has 24 currently. The global financial crisis had brought down SIAEC’s profit attributable to shareholders to S$236 million, from S$260.6 million a year back. Share of profits from associated companies and joint ventures, however, has been steadily increasing and hit a peak in FY 2009 at a total of S$173 million, and this dipped to S$129.7 million in FY 2010 due to the crisis as a result of depressed air travel (detailed numbers for this will be provided in Part 3 of this Analysis of Purchase). With the recovery in the global economy and Changi Airport reporting a surge in air travel, this will also benefit the MRO industry and with SIAEC continuing to invest in their core competencies and in joint ventures, this share of profits will continue to rise in the foreseeable future.

As a result of this steady stream of profits from its associated companies and joint ventures, net profit margin for FY 2009 was 24.9%, while for FY 2010 this dipped 1.4 percentage points to 23.5%. Average net margin over the 10 years was 23.1%, so it would seem this is currently the normal range. For 1Q 2011 the net margin was 24.6% as there was more contributions from associates and JV, but it remains to be seen if this can continue as the years go by.

Balance Sheet Review

SIAEC’s Balance Sheet is very interesting as it contains no debt at all! One would have expected that a leading MRO player with technical capabilities would need to invest in a lot of fixed assets and hence would need a lot of gearing, but for SIAEC this is not true and this also adds to its attractiveness as an investment. Contrast this to ST Aerospace (Part 4 of this analysis) which has quite a bit of debt in its books. Apparently, capex is very manageable for the Group and is low compared to its revenues, and thus there is no need for leverage as internally generated cash flows (I will come to that in a while) are more than sufficient to cater for expansion, strategic alliances as well as staff salaries; with a lot to spare!

The current ratio has also been consistently high in the last few years, ranging from a high of 3.3 in FY 2004 to the current 3.08 for FY 2010. The average current ratio is 2.49 over the last 10 years, so this shows that SIAEC’s Balance Sheet is very strong and one need not lose sleep over it. Working capital has also been steadily increasing over the years and stood at S$502 million as at March 31, 2010, and S$580 million as at June 30, 2010.

Return on Equity has also been consistently high; with a 10-year average of 22.5%. For FY 2010, ROE was 18.7% due partly to the crisis and the depressed volume of air traffic, thus affecting SIAEC’s business. However, for 1Q 2011, ROE picked up to 21.1%, and if air travel continues to pick up and the global economy rebounds, ROE should bounce back towards the 10-year average.

(Note: Quick Ratio and metrics such as stock turnover ratios were not used as SIAEC is predominantly a service provider, hence inventories are negligible and not an important aspect of the Group).

Cash Flow Statement Analysis

A quick look at SIAEC’s cash flows over the last ten years reveals that operating cash flows were consistently positive; and that for 1Q 2011 the operating cash flows rose to S$71.7 million. Assuming we annualise it, we would get something close to S$280 million operating cash inflow for FY 2011, which is unusual as operating cash inflows did not surpass S$200 million in any of the last ten years! Whatever the case, the more important metric here is Free-Cash-Flows (FCF), defined as operating cash inflows minus capital expenditures. FCF was consistently positive for every year in the last ten financial years, except that it did dip dangerously low during the recession periods such as SARS and the recent global financial crisis. Capex will be for equipment and machinery which are used for testing and inspection, as well as the building of new hangars which had taken place over the years (e.g. Hangars 4, 5 and the current Hangar 6 for servicing of A380 aircraft). Surprisingly, capex is not high for SIAEC as a % of revenues, with most years seeing not more than 5% of revenue being spent on capex. This can be attributed to the many strategic alliances and joint ventures which SIAEC has (more on this in Part 3) which means they can leverage on the expertise and financial strength of their partners without having to cough up additional capital themselves.

In terms of investing cash flows, SIAEC is unique in that they usually end up with positive investing cash flows, while most other companies show a negative figure as this is the section where the Group spends on capex and investments in companies (e.g. subsidiaries and associated companies). From FY 2006 onwards, net cash flows from investing activities turned strongly positive (S$35.6 million for FY 2006) and stayed so every single year thereafter and peaked in the latest financial year FY 2010 (S$115.5 million). Most of the cash which came in was the result of dividends received from associated companies, joint venture companies as well as long-term investments. Over the years, as SIAEC’s pool of joint venture companies has grown, so has the amount of cash flowing in from these companies. Part 3 will give a very clear indication of this trend, which is set to continue as the Group shows no sign of slowing down on their strategy to partner global names to expand the Group’s capabilities.

For Financing Cash Flows, the bulk of the outflows (>90%) was due to payment of dividends to shareholders. There’s nothing much else to say here as the Group has no bank loans to pay back, no cash to raise from shares or rights and also no need for payments for convertible bonds or any such debt/derivative instruments. In other words, this section of the Cash Flow Statement is very “clean”.

To summarize, the Group is basically churning out cash at an alarming rate, which they have been paying out as dividends over the years. The next section will look at the dividend history for SIAEC and how it has been increasing over the years. Note that cash balances stood at S$531 million as at June 30, 2010 (1Q 2011).

Dividend History and Review

It can be seen from the above table that dividends from SIAEC have been consistently rising over the years, beginning with 4.0 cents for FY 2001 to the current 18.0 cents for FY 2010. Note too that the Group always pays an interim dividend as well as a final dividend, and only in two out of the last ten financial years did they pay a special dividend (of 20 cents – in FY 2004 and FY 2006). The strong FCF of SIAEC means that they can continue to pay increasing dividends, even as they plough some of that cash back into growing and expanding the business.

What I’ve noted is that for both the years in which special dividends were paid, cash balances had hit a high of close to S$500 million. For FY 2004, cash balance hit S$472 million while for FY 2006, it hit S$500.6 million; and in both years a special dividend was declared. As at 1Q FY 2011 (June 30, 2010), note that cash balances have hit a new high of S$531 million. Cash flows from associated companies and JV remain very strong and FCF was S$71.7 million for 1Q 2011 alone, so there is a good chance of this cash balance increasing further; and this also increases the probability that a special dividend may be declared for FY 2011. Of course, one should also be aware that total dividends were much lower than in recent years; hence it was possible to pay out a special dividend of about S$200 million without severely reducing the cash balance for the Group. With last year’s total dividend at 18 cents/share (or S$180 million), there is probably less chance of a “bumper” dividend, though I do acknowledge the likelihood of a smaller one (depending on their cash flows for the remaining three quarters of FY 2011)

However, the above is only a possibility; and even if there is no special dividend, the interim + final dividend would give me a yield of at least 4.38% based on FY 2010’s dividend payout.

This concludes Part 1 of this analysis of purchase. Part 2 will delve deep into SIAEC’s business segments and operating divisions, and will provide some background on them and also some operating numbers over the years.

Sunday, September 05, 2010

Sun Tzu - War On Business Part 12 (Diploma)

We have come to Episode 12 of the Sun Tzu series, which brings us to Suzhou, China. James visits a company called Diploma which provides cleaning and logistics services (yes, it is a rather strange name to be associated with cleaning, as cleaning is generally a menial, blue-collar task which is not associated with educated graduates, but oh well). Diploma provides essential services to various industries and has a rather complex business model as it provides a myriad of services, of which cleaning and meal catering are but two of them.

Diploma is a 12-year old company which services about 100 clients, most of which are Fortune 500 companies which have set up operations in China. Diploma can be referred to as a “logistics outsourcing company”, and its main focus these days is on food as it has a major event coming up – the Shanghai Expo. This is a new market and represents a good opportunity for Diploma to showcase its talent; however to handle such a mega-event requires expertise and skilled personnel, both of which are somewhat lacking at the company.

The company is experience fast business growth but unfortunately there is no proper structured staff training and so there is no reflection on their growth path as so far no mistakes have been made and documented. They had a large plant with two sizeable buildings, hence there would be ample room for expansion. There is also a lot of empty office space which was originally reserved for expansion purposes. The central kitchen was built with funds gathered from 2007 and it generated 50% of Diploma’s total revenue in just the last 2 years.

Regarding their biggest contract at Shanghai Expo, the company is running a 300-seater café that can take 6,000 diners daily. They have developed a speedy and efficient system (though still untested) which will be used to support the logistics of the massive café and so far everything looks to run like clockwork. However, a point was made by James that the lack of staff training could be Diploma’s downfall, as the service staff were not good with food arrangement when James put them to the test. At Diploma’s training school, staff were rote-learning on how best to serve customers; but in a service industry where good and personalized service is paramount, this method of instruction may not be suitable at all. Even the HR manager mentioned that it was a daunting task involved in training all the staff properly.

James once again invited his resident China expert, Mr. Cha Li, to look at Diploma’s business and comment on it. Cha Li observed the renovation area at the Shanghai Expo and commented that the café will be opened 14 hours a day and serve about 6,000 diners at any one time; hence service quality needs to be very high or else it would leave a bad taste (no pun intended) in customers’ mouths.

Yvonne is also mulling over the problem of service quality and how to improve it, as right now Diploma is staffed with a lot of unskilled labour. But if Diploma’s aim was to raise their quality and service levels, then this had to change as they envisioned that their future customer base would focus more on quality and taste of food. Therefore, efforts needed to go towards ensuring their catered food was up to standards and their service delivery on par with international standards.

The problem was that cleaning, laundry and cooking were viewed as being more inferior compared to say jobs in the Information Technology (IT) and Logistics line; hence it was difficult to recruit competent staff as there was a disincentive to join Diploma. This also meant that additional “perks” needed to be incorporated into the remuneration structure to entice potential candidates to apply for jobs within Diploma and raise the overall skill level of the labour force there. Recruiting and training costs would also have to go up substantially to ensure an appropriate level of service was delivered which could stand the Company is good stead amongst customers. How was Diploma to add value-added services? Cha Li gave some suggestions such as adding a television set within the café as well as newspaper racks.

The key is to not just focus on customers as their own employees also form the backbone of the company (and contribute to its eventual success, much the same as a previous episode on Meru Cabs). Better working conditions and being a “better brand” in terms of visibility would indirectly attract people to join, constituting a “pull” factor in human resource recruitment. All these factors would serve to boost employee morale, allowing for word-of-mouth transmission of the Company’s merits and providing a positive feedback loop to attracting even more capable and talented people.

Over to the training side, a suggestion would be to set up a practice café to provide practical hands-on training for staff. Another suggestion was to work with high schools and colleges to develop first-time managers, in order to give staff more platform and more development in their careers (i.e. career planning). Yvonne then hit upon the brilliant idea of organizing team building events for the staff to enable them to bond and establish a sense of identity within Diploma, and to make the overall environment more cohesive and conducive for work. Eventually, James was confident that with the revamped training style and schedule and the team-building events, Diploma would be able to fulfil its role at the Shanghai Expo and get the exposure it needed.

Lessons to be learnt from this episode are:-

1) A company should always have a structured growth path, and everything should be clearly documented – This is an important aspect for any company as it needs to know what are its critical success factors. If there is no documentation, then one will not know what went wrong and how to rectify it and avoid the same mistake(s) in future.

2) Staff Training is important – As witnessed in the previous episode on Skoda Cars, appropriate training is integral to the success of a company. Diploma’s staff were mostly new and not trained, so the tendency to fumble and be ignorant of what to do was much higher.

3) Rote Learning is not applicable for certain types of jobs – Another important lesson here is that rote learning is the wrong method to use when it comes to the service industry. It’s quite useless to get staff to intone words which represent good service when their attitude and actions do not demonstrate this; it becomes somewhat of a robotic gesture! Thus, it is important to have on the job training in a dynamic situation to teach staff how to adapt to changing circumstances and to react to the situation appropriately.

4) Motivation factors are important for attracting and retaining talent – This episode highlighted the importance of building good morale for staff through corporate image branding and also through team-building activities. Bonding amongst colleagues is an important aspect of morale and will significantly boost productivity and efficiency at the workplace, and also create a more conducive environment for learning and developing.

5) Service Quality is a critical aspect of a service-oriented business – For Diploma’s case, service quality was a very critical success factor for them to gain visibility and grow their business; hence Yvonne could not afford to compromise on that. Recognizing what’s important to an organization can help steer strategic initiatives in the right direction and maintain proper focus. However, this requires brainstorming on the part of Management and BOD, and they may also consider enlisting the assistance of “consultants” (though this could be costly). But the long-term benefits should outweigh the short-term costs.

For the final episode of this series, James visits Malaysia and gets to meet the owner of a cafe cum pub (Palate Palette) called Wong Su-Ann, and he offers her advice on how to improve her business and her customer base.

Unfortunately, I have not been able to locate the website for Diploma despite repeated searches on the Internet. It could be that they have not set up a website or my search string is wrong. If anyone has any info on the website, kindly forward me the URL, thanks!