Tuesday, August 31, 2010

August 2010 Portfolio Summary and Review

August 2010 was indeed an interesting month for me in terms of portfolio changes; as I made the somewhat painful decision to divest of my entire stake in FSL Trust (as I had previously blogged about in this post). The decision was a mixture of relief and regret, as the funds from this investment can finally be freed up to be redeployed into a more promising investment. What I dislike most is “deadweight” in my portfolio, and I will not hesitate to cut loss on a position in order to re-allocate the funds to another position should I objectively conclude that it would be in the best interests of my portfolio.

I had mentioned that I expected August to be a relaxed month; but it was not to be so as I spent quite a bit of time researching and poring over Annual Reports for my latest purchase – SIA Engineering Company Limited (“SIAEC”). In order to do a more comprehensive analysis as compared to my previous one on Kingsmen Creatives, I spent a lot more time dwelling on the Annual Reports, doing deeper analysis on each division, poring through SIAEC’s many associated companies and joint ventures; as well as doing a detailed competitive analysis for three of SIAEC’s competitors. The result is a rather lengthy report to justify my purchase of SIAEC which I will split into five separate sections (in order to keep each section readable). The full report is about 32 pages (along with 14 tables of figures) and it is my intention to post up as much of the analysis as I can in its entirety; as this is the first blue chip company (SIAEC is, incidentally, part of the Straits Times Index’s 30 component stocks) I have seriously researched on and I will need to get some feedback so that I can improve for future research and analysis work.

The five sections will cover aspects such as Financial Analysis, Divisional Review and Historical Progress, SIAEC’s myriad associated companies and joint ventures, cash flows and share of profits from these ventures, competitive analysis, the MRO industry; as well as prospects, plans and a pros and cons breakdown. These will be posted progressively (not consecutively) over a period of about 2 months, and also as I intend to compile the information to make it suitable for posting up. Note that this may be the first and final time I post such a comprehensive analysis of purchase on this blog; as subsequent purchases may simply rely on my own private research which I will justify in a succinct summary.

In addition to the above analysis, I also spent time attending AGMs for MTQ, Tat Hong and Boustead. Suffice to say I had made useful notes for all 3 AGM, but due to the fact that these notes are brief and summarized, I will not post them up on the blog.

I will not be commenting much on economic and local news as there’s just more of the same thing in general, and this news can get dreary and boring if repeated ad nauseum. One interesting event which had been held in our little red dot of a country was the Youth Olympic Games (YOG), which was very widely covered by our local media. The reason I mention this is because Kingsmen Creatives happens to be one of the main sponsors; other than this I am not really too interested in watching sporting events!

Interestingly, our local Straits Times also had back to back articles on August 24 and 25 on cars and smart phones, respectively. They state that more and more Singaporeans now own 2 or more cars, even though cars in Singapore are the most expensive in the world! Also, smart phone penetration rate is about 40% in Singapore, as compared to the worldwide penetration rate of only about 23%; implying that Singaporeans are simply tech-crazy/hungry. I somehow suspect that this % is misleadingly low as almost 7-8 out of 10 phones I spot on the MRT and bus are smart phones (majority being Blackberries and iPhones); so perhaps the % will be revised to 70-80% in time to come. And these articles came just after I blogged about C&C under my Personal Finance series; which I felt was pretty coincidental as it highlights (once again) how materialistic we are as a nation, as newspaper articles regularly exhort people who own 2 or more cars, and who carry the latest gadgets. It’s not easy for the average man on the street to try to be thrifty when they are constantly bombarded by such articles in which interviewees claim that they “need” two cars and that a smart phone is “an essential item”. It’s a pretty sad state of affairs to see this culture of conspicuous consumption being so firmly ingrained in our society.

A late announcement by Ezra Holdings (one of my prior holdings which had been divested a year back) during lunch today stated that the Group plans to issue 1-for-5 rights at S$1.18 per rights share, which is a 33.3% discount to the last done market price of S$1.77. Somehow the announcement does not surprise me as Ezra’s Balance Sheet is already very heavily geared and the only route to raising more cash is through equity (as the Group has consistent negative free cash flows). However, what surprised me was the discount of 33.3% which is very significant and will increase the dilution in EPS and DPS (if any). However, a counter-argument is that if the rights shares had been offered at a higher price, it would not be enticing enough for existing shareholders to subscribe for them. Hence, I believe the discount had to be present to make the whole offer attractive; disregarding what the Group says about “strategic growth”. More comments on this as details emerge and after the Group reports their FY 2010 results in October 2010.

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


1) Boustead Holdings Limited – Boustead announced their 1Q FY 2011 results on August 12, 2010; and not surprisingly, their results showed a major improvement over 1Q FY 2010. This was mainly due to the completion of the sale of IBM Singapore Technology Park. Revenues were up 101%, gross profit was up 100% while net profit attributable to shareholders rose 237% from S$9.5 million to S$31.9 million. Stripping away the profits from the sale of this property, Boustead would have earned S$10.4 million for 1Q FY 2011, which is a 10% rise in net profit and is quite decent. Their order book as at June 30, 2010 stands at S$580 million which should stand them in good stead to tide through any potential double-dip recession or another economic slowdown. In addition to the results announcement, on August 5, 2010, Boustead announced back to back contract wins for its 91.7%-owned Boustead Projects. This division clinched a S$12 million Design and Build contract for a specialized cold chain logistics facility from World Courier Singapore Pte Ltd, as well as a Design, Build and Lease contract from Hankyu Hanshin Express for a logistics facility of 12,000 square metres to be completed in the second quarter of 2011. Together, these contracts will not only boost the order book for Real-Estate Solutions division, but will also increase Boustead’s recurring income as they had bagged yet another design, build and lease project. Separately, on August 12, 2010, Boustead also signed an agreement with TT International Limited to take over the construction of “Big Box”, which was a S$95 million development project at Jurong East MRT which was abandoned by TT International due to lack of funding during the financial crisis. Boustead will pump in S$150 million for a 60% stake in this transaction, and TT International will be the Master Lessee. It is envisaged that this project will greatly increase the recurring income for Boustead Group; though the salient details have yet to be worked out. Boustead’s final and special dividend of a combined 4 cents/share was received on August 20, 2010.

2) Suntec REIT – There was no news from Suntec REIT for the month of August 2010. The dividend of 2.528 cents/share was received on August 27, 2010.

3) Tat Hong Holdings Limited – Tat Hong released their 1Q FY 2011 results on August 13, 2010. Suffice to say that even though revenues rose by 24%, gross profit only rose by 15% due to overall lower gross margins (sales mix leaned towards lower margin equipment sales compared to higher margin crane rentals). Unfortunately, distribution expenses increased by 26% while other operating expenses increased by 30%, which resulted in net profit attributable to shareholders falling 2% to S$10.4 million. In spite of what analysts claim was a sequential quarter on quarter growth in net profit and sales, I fail to understand why the Company cannot control their costs well enough to at least demonstrate some profit growth year on year. All divisions showed growth though, except equipment rental. While I am not too pleased with the results, I am cautiously optimistic about Tat Hong being able to grow their earnings base and cash flows over the next few quarters as the economy picks up. Also, their purchase of the remaining shares in Tutt Bryant may be a sign that things are starting to pick up in Australia and hence they want 100% of the company to consolidate its earnings into the Group’s Profit & Loss. For their China Tower Crane operations, it will take a while before it can significantly contribute to top and bottom line, so this should be at least a 2-3 year wait. There will be no further analysis as this is only the 1Q results. The final dividend of 1.5 cents/share was received on August 20, 2010.

4) MTQ Corporation Limited – On August 26, 2010, MTQ announced that their wholly-owned subsidiary, MTQ Engine Systems (Aust) Pty Ltd, had acquired the assets of a fuel injection service business located in Brisbane, Australia called Highway Diesel. According to the announcement, “Highway Diesel is primarily engaged in the diagnostics and servicing of diesel fuel injection and holds service dealerships with major brands such as Bosch, Denso and Delphi. The acquisition of Highway Diesel would enable MTQES to further expand its range of service and repair capabilities as well as its business network within Brisbane”. The upfront consideration will be A$1.5 million, with another potential A$500,000 payable upon certain EBIT milestones being met within a year. Interestingly, the book value of the business assets acquired was just A$1.069 million, implying that MTQ paid a substantial premium of about 2x book value. My feel is that this acquisition should be pretty attractive in terms of synergy for Engine Systems for MTQ to pay such a premium for the company. The final dividend of 2 cents/share was received on August 17, 2010.

5) GRP Limited GRP released their FY 2010 results on August 20, 2010. I had already done an analysis on their FY 2010 results in my previous post and thus will not say any more here.

6) Kingsmen Creatives Holdings Limited – Kingsmen released their 1H FY 2010 results on August 12, 2010; and it was a pleasant surprise to note that revenues had increased by 25.5% for 1H FY 2010 year on year; while net profit attributable to shareholders had increased by 17.2% from S$5.9 million to S$6.9 million for the half-year. The reason for this was a much stronger 2Q 2010 (as compared to 1Q 2010), which saw revenues rising by 21.9% and net profit attributable to shareholders rising by 30.2% (for 2Q 2010 year-on-year comparison against 2Q 2009). Debt levels remain low and the Balance Sheet is still healthy, while there were positive operating cash inflows of S$14.6 million for 1H 2010 and FCF of close to S$9 million, boosting cash and bank balances to S$32 million from S$21.4 million a year ago. An interim dividend of 1.5 cents/share was declared, similar to 1H FY 2009. The ex-date for this dividend was August 27, 2010 and it will be paid on September 15, 2010; thus I have included it under “Realized Gains” in my portfolio review. Interestingly, the latest issue of The Edge has a one-page write-up on Kingsmen and their prospects; and the September 2010 issue of Pulses magazine also has a 4-page spread on Benedict Soh and Simon Ong. I grabbed them just to enhance my knowledge of the Company and its founders.

7) SIA Engineering Company Limited – There was no news from the Company for August 2010, other than a minor announcement on August 5, 2010 that SIAEC would be giving out S$0.6 million to staff in productivity share gains as a result of the “Cheaper, Better, Faster” initiative. SIAEC hope to save S$10 million in Phase I of this initiative.

Portfolio Review – August 2010

Realized gains have dipped significantly from S$56.7K to S$46.4K due partly to the realized loss on FSL Trust; but the decrease was offset by the 1.5 cent/share interim dividend declared by Kingsmen Creatives for 1H FY 2010. On an annualized basis, the portfolio has gained by +8.6% against the absolute gain of +1.8% for the STI. As a result of the divestment of FSL Trust and the purchase of SIAEC, my investment cost has increased from S$175.4K to S$202.4K as at August 31, 2010. Cost of investment has finally surpassed the S$200,000 mark, which was my intention for FY 2010. Unrealized gains stand at +15.9% (portfolio market value of S$234.5K).

September 2010 is expected to be a very slow month with no corporate results and usually no corporate announcements as well. I expect to find myself taking some time off investing to reflect on life, love and relationships; while waiting for the November 2010 reporting season to arrive.

My next portfolio review will be on September 30, 2010 (Thursday).

Friday, August 27, 2010

GRP – FY 2010 Analysis and Review

GRP released their FY 2010 results on August 20, 2010 (the company has a June 30 year-end). Suffice to say that there were no major surprises; either negative or positive, but the prevailing sentiment from me is that the Company can do more to either increase their dividend or to reinvest the cash which is just piling up. There was not much articulated about how the cash will be utilized or how the business would be grown beyond what it is now; so it was quite a disappointment for me. I will go through the usual review and analysis which will be kept brief as this is a simple company to analyze; but I will focus at the end on what I’d expect from the Company in FY 2011 and how I hope it can communicate better to shareholders.

Financial Analysis

Profit & Loss Statement

Revenue was essentially flat, rising just 1.4% from S$25.3 million to S$25.6 million; and was mainly due to the weakness in Hoses and Marine as well as the PVC pipes division (in China). Cost of goods sold, however, increased by 6.2%, which resulted in gross profit falling by 6% from S$10 million to S$9.4 million. Gross margin fell from 39.6% to 36.7% mainly due to exchange differences in the Measuring Instruments division (so I understand it is unlikely to persist). Other revenues consisted of rental revenue from their property at 1 Bukit Batok Street, which terminated in April 2010. Henceforth, from April 2010, GRP will no longer enjoy rental income. This was a factor which I had accounted for initially when investing in GRP; and more will be said on this in the review of the Cash Flow Statement section, which is key to this investment as it is a yield play.

Profit for the year actually dipped only 3.1% due to the reduction in distribution costs by 5.7% and decrease in administrative expenses by 14.2%. These two items helped to mitigate the impact of lower gross margin and lower revenues by blunting their impact; and allowing net profit to remain flat.

Balance Sheet Review

GRP’s Balance Sheet has traditionally been very “clean” and spartan! For this review, the same can be said, although Trade Debtors did inch up a little; but was offset by yet higher cash balances of S$14.5 million compared to S$13.6 million a year ago. However, Trade Payables and Income Tax payables decreased which brought current liabilities down to just S$4.4 million from S$5.5 million a year ago. The result of this was an increase in current ratio from 4.77 to 5.99 over just a year! It really boggles the mind to know that the current ratio keeps increasing year after year till it’s about 6.0 this financial year, yet Management has yet to declare a special dividend to utilized all that cash! ROE stands at 15.2% as the cash has added on “drag” to the ROE. Last year’s ROE was 17.5% and was noticeably higher.

Cash Flow Statement Review

Cash flows from operations continue to be positive for GRP for FY 2010, at S$4.2 million versus S$5.5 million for FY 2009. Capex was very low at just S$240K (it was just S$175K for FY 2009); meaning there was FCF of about S$3.8 million for FY 2010. Assuming the rental income of about S$2 million is removed for FY 2011, there will still be FCF of about S$1.8 million assuming business conditions, revenues and net profits remain largely stagnant. Perhaps this is one reason why GRP does not want to pay out more dividends; because their cash flows may be in danger in FY 2011 and Management have decided to be prudent and conserve some cash in order to make future dividends more sustainable.

Prospects and Plans

There is some concern about a slowdown in the Company’s business because of their prospect statement stating that market conditions will remain “challenging” in the next 12 months. Even though they have a very good track record of stable revenues and cash flows for the last 8 years, I must warn that past performance is not indicative of future performance. I am cautiously optimistic that the Company can continue to provide a decent yield of 2 cents/share, which translates into a 10% yield at my purchase price.

I acknowledge that the concept of a low risk, high yield investment does not exist in this world except in concept; due to the nature of business cycles and competition, any so-called competitive advantage and moat which cannot be suitably maintained will eventually be eroded through time (just as a steady drip of water droplets can, over time, penetrate a block of stone). Companies which continue to innovate and think of novel ideas to package and sell their products and/or services will continue to flourish. Those who are not able to do so will naturally fall by the wayside, and are either soon forgotten or remembered for the sake of use in classroom textbooks for business students. Let’s all hope GRP can continue to maintain some edge in maintaining the business (and drawing in cash flows) and not end up as a cigar butt with no more puff left......

Monday, August 23, 2010

Personal Finance Part 18 – To Crave and Covet (C&C)

It’s been a while since I’ve talked about aspects of personal finance, as I was kept busy the whole of May to July 2010 with analyzing the financial results of the companies in which I hold shares, as well as writing about Sun Tzu’s War On Business episodes. I’d realized the last entry on personal finance was back in April 2010 and was on cycling! I had been thinking in the last couple of weeks about the problems associated with our society in relation to over-spending and lack of prudence or knowledge about financial matters; and it boils down to one major problem which I term “C&C – Crave and Covet”. This will link up to many other concepts which I will point out later (and which have been popularized by the mass media as well).

The simple definitions of the words crave and covet are as follow (from Dictionary.com):-

Crave – To long for; want greatly, desire greatly
Covet – To desire wrongfully, inordinately, or without due regard for the rights of others

It is in our basic human nature to crave and desire for more, of course after ensuring our basic necessities are provided for. But society today is a lot more materialistic and capitalistic than it was say, two generations ago. This is sadly due to the modernization of Singapore, which in some ways has outpaced the maturity of the young minds, who are still struggling to adapt to the “First-World” mentality inculcated within them by our education system. A mature mind is one which is able to handle pervasive emotional influences which may have a detrimental effect on one’s wealth and spending habits. Craving and coveting are an embodiment of that philosophy where everyone starts to compare what possessions their friends and peers have, and it results in a relentless vicious cycle and downward spiral into poverty, debt and bankruptcy if not arrested early.

The Generation Y and Z have been, arguably, brought up in a world of peace, stability and abundance and have not been through the ravages of war (those born in the 1920’s and 1930’s) or recession/inflation (those who lived through the 1970’s). Even more recent is the memory of the Asian Financial Crisis in 1997 which brought many rich people to their knees. Because of this lack of awareness of how fragile wealth can be and how difficult making money is, most youths tend to be apathetic when it comes to personal finance and succumb to the evils of C&C. The latest iPhone, iPad, car or luxury item is always an enticement to use debt (credit cards) and to make one spend beyond their means. In this regard, I should introduce some terms which readers may be familiar with:-

Retail Therapy – The action of shopping for clothes etc, in order to cheer oneself up

Conspicuous Consumption – Public enjoyment of possessions that are known to be costly so that one’s ability to pay for such things is flaunted.

Affluenza – Guilt or lack of motivation experienced by people who have made or inherited large amounts of money.

What the above coined terms have in common is the mentality that we should live for today, spend for tomorrow and heck care about the future. It is about wanton spending, looking good (at the expense of having a wallet with a hole burnt through it) and enjoying the comforts of modern life. There is nothing inherently wrong with this if you can comfortably afford it; but the problem which is surfacing is that many youths have a distorted image of how they should live their life even before they enter the workforce, and the constant desire to mirror their peers’ possessions and obsessions may ruin their financial future and drive them further away from their retirement goals.

But first ask yourself – why do we covet? In the movie “The Silence of the Lambs”, mass serial murderer Hannibal Lecter (played by Anthony Hopkins) mentions that “we covet what we see every day” in order to help detective Clarice Starling (played by Jodie Foster) solve a crime. So the genesis of coveting is actually being exposed to so many images of wealth and success being associated with material items and spending a lot of money. We also covet because we feel that owning more items enables us to be “hip” and popular, or modern and fashionable. Other root causes include exhibitionist tendencies, to show the world that “I am rich and successful”, even if your Balance Sheet looks tattered.

So how do we solve the persistent and pervasive problems associated with C&C, which have inflicted a majority of our youth and left them almost defenseless against the barrage of advertising by companies eager to suck their money dry? This may sound clich├ęd but the answer is – Contentment. Contentment is the secret to happiness, and not having more money or owning more physical possessions. I have travelled to countries such as Myanmar and Cambodia where children scavenge rubbish dumps for food, and naked children play along the streets because their parents have no money to buy clothes for them. With this in mind, I have developed within myself a sense of contentment for what I have, and thus have no desire or ache to acquire more material possessions. I see no need to justify to the world that I am rich or successful; my internal self knows the status of my Balance Sheet and Cash Flows and I am happy to keep that to myself. Contentment is telling yourself daily that you are lucky to have a job, a happy and complete family, are healthy and can enjoy the simple pleasures in life with your five senses.

If we are able to propagate this message of contentment instead of continually egging on our graduates and students to strive to earn more (in monetary terms), perhaps this can solve the perennial problem of being rich, yet unhappy. Then again, with the way values are degenerating in this country, perhaps C&C will remain an inseparable aspect of our culture, and it will forever be etched on the faces of our future generations, to our eternal detriment.

Thursday, August 19, 2010

Tat Hong – FY 2010 Analysis and Review Part 3

Part 3 of this analysis delves into Tat Hong’s inventory levels for crawler cranes as well as tower cranes. It also attempts to discuss Tat Hong’s prospects for the next financial year and beyond by incorporating recent news as well as from attendance at Tat Hong’s FY 2010 AGM which was held on July 27, 2010.

Crane Inventory Levels (All Cranes)


Looking at Tat Hong’s total fleet profile, it can be seen that their inventory levels have hit a new high of 481 units even as they are trimming their inventory and boosting their fixed assets (transfer from trading stock to fixed assets for rental). The one glaring figure which explains the depressed performance is the overall utilization rate of just 56.6%, which is a far cry from their “peak” performance of 83.5% utilization as at June 30, 2007 (nearly 3 years ago). This would explain why revenues for crawler crane rental are so depressed – companies have not really kick-started their spending on buildings, oil and gas projects and infrastructure as these will lag the economic recovery; hence Tat Hong’s performance in this division will generally lag the economy by about 6 to 9 months.

The total tonnage for cranes has increased significantly though, from just 46,261 to 51,216 in one year (a 10.7% increase). Total units has also steadily increased from 438 units nearly 3 years ago to the present 481 units. Moving forward, Tat Hong should continue to focus on their transition to being a “rental” company, with more inventory moved over to fixed assets to be utilized for rental instead of for equipment sales. The effects of this may only begin to manifest over a period of 1 to 2 more years.

Crane Inventory Levels (Tower Cranes)

The tower crane fleet has grown rather significantly over the past year, with just 262 units as at March 31, 2009. This has about doubled to 551 units as at March 31, 2010 and will continue to grow as Tat Hong seeks to expand their asset base through joint ventures and acquisitions of crane companies in China. Tat Hong’s Roland Ng did stress that China was a vast market and Tat Hong still had plenty of opportunities there, but it was to be the people which mattered as the Group needed to find the right people to propel the business to the next level (note: this was mentioned during the recent AGM). He does not rule out further M&A in China to enable Tat Hong to grow its business there, but did concede that it would take about 2-3 years for the China side to bear fruit and show results. In the meantime, one can see that their inventory levels will continue to build up, as this division shows the highest potential for long-term growth.
Update: There are 614 units as at June 30, 2010.


Prospects and Plans

For Tat Hong, their strategy got growth continues to be with China and possibly India in the next 2-3 years, and of course by now I have repeated their strategy of being a “rental” company to bits, so I shall not dwell further on that in case I bore everyone to tears. I think what shareholders can reasonably expect from the company are the following:-

1) Tat Hong to ride on global economic recovery – Basically the Group’s business can be described as following the economy; though they tend to lag the real economy by about 6 to 9 months. The reason for this is because Tat Hong’s customers need to secure bank financing in order to purchase their heavy machinery and cranes; and this can only happen when there is sufficient business visibility and economic strength, otherwise companies would rather conserve and preserve their cash. Recall that Tat Hong’s results were hit by a combination of poor results from their core business of equipment trading as well as crawler crane rentals, and also lower contributions (i.e. share of profits) from associated companies (see Part 1 of this analysis). With a moderate and gradual recovery underway, share of profits of associated companies should also rise, albeit slowly, to contribute to cash and profits. Already, Yongmao Holdings Limited, an associated company of Tat Hong, has reported improved top-line growth of 61% for 1Q FY 2011, and higher net profit year-on-year of RMB 4.15 million (up 126%). In 4Q FY 2010, Tat Hong had also reported a surge in orders for equipment sales, and if the trend continues, will assist in the recovery of Tat Hong’s key revenue contributing division.

2) Tower Crane Division in China – Tower cranes will continue to be an avenue for expansion for Tat Hong in China; and they do not rule out more synergistic partnerships or accretive acquisitions which will help to boost their tower crane fleet. China’s construction landscape is somewhat different from Singapore as tower cranes are mostly used instead of crawler cranes; thus Management sees this as a viable growth strategy to become China’s dominant tower crane player. Mr. Roland Ng did caution that such growth would likely take a couple of years as relationships and networks had to be built and the “right people” needed to be found to work with Tat Hong. This is where Mr. Ng’s expertise and skills come in as he is good at bringing in such talent and expertise with knowledge of the China market.

3) India Expansion through AIF Capital – There was a brief mention of India within Tat Hong’s FY 2010 Annual Report, and I also enquired with Management on the possibility of expanding into India. Mr. Ng did mention that AIF Capital’s contacts and networks extended into India, and if Tat Hong was going to move into the country, it would be with their assistance. However, that said, there are many incumbents in India and therefore competing there was not going to be easy; plus India is “fragmented” in the sense that it has different states speaking different dialects, so communication is an issue and the way of doing business is different from both Singapore and China. I would think Management would let this simmer first and focus on building their China business before making any moves.

4) Purchase of all remaining shares of Tutt Bryant Limited – On July 15, 2010, Tat Hong announced the acquisition of all the remaining shares in Tutt Bryant that they do not already hold (as at the date of announcement, Tat Hong held 70.36% of Tutt Bryant). The offer price was A$0.92 per share and represented a premium of 46% above the last traded price of Tutt Bryant. The rationale was to cut the costs of staying listed as Tutt Bryant need not raise funds through secondary offerings; and Tat Hong could also consolidate 100% of earnings from this lucrative subsidiary in future. My feel is that Tat Hong is acquiring Tutt Bryant “on the cheap”, as Australia is just recovering from the effects of the global financial crisis and future infrastructure and oil/gas spending will boost Tutt Bryant’s profits and revenues significantly. Management’s rationale would be to be able to enjoy more of the fruits of Tutt Bryant and also assume more control over the operational aspects by holding 100%. However, as with many of their strategies, this one will probably truly “bear fruit” only in 2-3 years time, as the economic recovery at this stage is still tentative and fragile.

Quick Comments on 1Q FY 2011 Results

Since the 1Q 2011 results had been released at the time of this writing, I shall provide a quick preview. It seems the economic recovery has not flowed down through to Tat Hong yet, as the bottom line for 1Q 2011 decreased marginally by 2% year on year. However, it can be seen that revenues were up 24% even though gross margin dipped (as a result of lower margin projects in Singapore through crawler crane rental). Expenses continued to climb which was a headache, but I feel it is part of the expansion which Tat Hong is undertaking in China; and probably also for their Australian division. The Balance Sheet shows higher debts but there was also more cash to offset it, as Trade Receivables dipped due to better payment from customers.

Over at the Cash Flow Statement, there was some good news as operating cash inflows were relatively strong at S$26.6 million. Then again, there was negative free cash flow as capex for 1Q 2011 stood at S$31.1 million! Altogether, cash equivalents increased by S$10 million and the Group ended with S$87.2 million worth of Cash as at June 30, 2010.

The Group are cautiously optimistic of a better performance for FY 2011 as stated in the prospect statement, but are unwilling to commit too much to saying that things will definitely be better. I guess at this stage it’s still hard to tell, but coming off from a low base in FY 2010, it should look at least a little more positive. Also note that Tat Hong’s associates Yongmao and Kian Ho Bearings have reported better results, and this should eventually flow through to Tat Hong’s bottom-line as well through share of profits of associated companies. As long as the business continues to improve, albeit slowly, I can still look forward to a decent interim dividend come Nov 2010.

Conclusion

Tat Hong’s strategy for growth will need time to pan out, and it is essential and integral for them to manage their cash flows prudently and ensure that they do not “over-expand”. The financials will not look good in the short-term due to the fragile economic recovery; but longer-term wise it should start to get better. In the meantime, I can look forward to a 1c/share interim dividend and a 1.5c/share final dividend, which seems to be the “crisis-level” payout. Anything higher than this 2.5c/share yearly bonus will be indeed a bonanza!

Saturday, August 14, 2010

Sun Tzu - War On Business Part 11 (Ultizen Games)

Episode 11 of this highly successful series brings James Sun back to China, Shanghai. In this episode, he meets up with entrepreneur Lan Hai Wen, who heads a video-gaming company called Ultizen Games. Ultizen is in charge of producing and marketing games for adults and children, but the Company recently was awarded a contract (thanks to the CEO’s networks and contacts) to produce and develop a children’s game, for the Chinese mass market. As can be imagined, the potential is huge as China has a very large child population, and if the game takes off it could elevate Ultizen to a whole new level.

However, as with all businesses, it is prudent to check out the competition first. The video gaming industry is large and fragmented and there are many companies which are muscling in to grab a piece of the lucrative pie. Ultizen is purportedly one of the larger gaming companies in Shanghai, but it is difficult to grab the leadership position as people’s tastes keep changing and the industry has to continually churn out new games and software to keep consumers interested. There is also not much product and brand differentiation as people usually just buy the game without bothering much about the company behind it (as well as the legions of developers who helped produce it). I can safely say this because I used to be a gamer too, and seriously I cared more about the content and graphics than the actual gaming company (OK, maybe except Blizzard which produced Diablo II)!

James checks out the Ultizen office where the programmers, software engineers and developers are busy at work. Most of them reported experiencing quite a bit of stress as this was Ultizen’s first major project and everyone as under pressure to deliver an excellent product on time. Some of the staff also complained of not having enough guidance to work on a child’s game and some had no clue as to where or how to begin. Ultizen made the software engineers watch hours and hours of Chinese cartoons to better understand what children look for in a computer game, but James finds it strange that no children were consulted or interviews done with kids during the game development phase. Hai Wen mentions that this would not be feasible as the game was targeted at children, and so had to be worked on by adults. James looks rather sceptical when he hears this.

Eventually, James again enlists the help of Cha Li, who together with James advises Hai Wen in the War Room to enlist the assistance of kids in a focus-group interview setting to enable the software engineers and developers to understand better what children look for in a game. Hai Wen agrees to this as he finally begins to understand that one needs to involve the consumer if one is to be successful in developing something FOR them. By going through several iterations without involving children, the developers were essentially groping around in the dark, and it was a case of the blind leading the blind as even those watching the cartoons could not fully comprehend what the final consumer would find appealing or enticing.

Finally, a batch of kids are selected to take part in a “controlled” focus-group study, but chaos soon reigns as the kids are excited and hard to control! Most of them do give feedback on the game designs, characters and other aspects of what the developers had come up with thus far, but all this information had to be carefully sieved through and collated and made sense of later. Still, it turned out to be an eye-opener for Ultizen’s team who managed to incorporate the new insights into their design and enhanced their final product.

There are interesting lessons to be learnt from this episode:-

1) Involve feedback from the consumer when developing a new product – This also applies to any product which involves repeated usage or even food products. If possible, do blind testing or conduct interviews with the intended target consumer segment to garner feedback and/or opinions. Pay a fee or give away some freebies if need be, but such money is usually well-spent as he feedback can be invaluable.

2) Use Focus-Group Interviews – Focus groups are very effective for getting feedback on a product or service to be launched, and it also has a captive audience who can give constant information. However, that said, such interviews should be properly structured and organized to maximize the utility, otherwise it would be a waste of everyone’s time and resources.

3) Be aware of staff welfare – I noted in the episode that not much was done to alleviate the staff’s stress and concerns about the project deadline and the difficulties encountered. More could have been done to ease the frazzled state of mind and calm nerves. Staff turnover could result if this aspect is not managed properly.

4) Channel resources productively – In the episode, the team at Ultizen were told to watch many hours of Chinese cartoons, which did not assist much in the creative process as the developers had no inkling of what the final consumer would have wanted. Therefore, it is important to prioritise resources and ensure time is not wasted on such activities which generate no value-added to the organization. For example, the team could have been tasked to find out more about the children’s gaming industry in other countries instead (to get a more holistic view).


Overall, the episode explored a very interesting industry, gaming, in which I myself have experience and intimate knowledge of. It was interesting to note how designers and developers went about creating a game, and how they factored in many inputs and tweaked the images to obtain the final product. Of course, a lot of extensive beta testing is also involved and the whole process can be mind-numbingly tedious! But as an ex-gamer, I can appreciate the hard work put in by these people. My previous favourite games used to be Heroes of Might and Magic III as well as Diablo II. I am currently sporadically playing Heroes of Might and Magic V......oh well it's a lifelong "addiction"!

For the next episode (incidentally, the second-last), James is back in China again (Suzhou this time) and will meet up with Yvonne Huang, who runs a company called Diploma dealing with food and laundry outsourcing services.

Check out the website for Ultizen Games over here:-
http://www.ultizen.com/about.asp?id=1&langs=3

Monday, August 09, 2010

Divestment of FSL Trust

I guess this was an action which should have been taken some time back, but trust me to allow inertia and false hope to dull my thought processes, rationality and objectivity; thus causing me to delay my decision to completely divest First Ship Lease Trust (“FSL Trust”). For the record, I have completely divested my position in FSL Trust on August 3, 2010 at an average price of S$0.41125, crystallizing a realized loss of about S$14,000 (or about -64%). If dividends of S$6,300 are taken into account over the years, the actual loss from this investment stands at S$7,700 or about -35%, still nothing to sneeze about. Since I had recognized realized gains from dividends under realized gains/losses in my portfolio review, I shall now take in the full S$14,000 loss there to offset the $6,300 recognized over the years (as per proper accounting procedures).

Let me categorically state right now that even as early back as mid-2008, I was “warned” about the structure of Shipping Trusts and of FSL Trust in particular as being vulnerable and unsustainable. An expert and very detailed forum poster by the nickname of d.o.g. (Disciple of Graham, no doubt) pointed out that a shipping trust could be evaluated and valued based on a DCF (Discounted Cash Flow) basis, since its cash flows were “supposed” to be predictable, stable and consistent. When he ran the model through using an appropriate discount rate, it was discovered that the discounted cash flow value of FSL Trust was less than the share price at the time (above S$1.00). I chose to ignore that pertinent piece of advice at the time as I was indignant and obstinate and wanted to prove that the Shipping Trust model was sustainable and that the value of the cash flows would grow (through M&A of vessels) over time to render the original DCF analysis invalid. All I can say was that it was a very expensive piece of advice to ignore, and if you count in the opportunity costs of having the capital invested in FSL Trust, then the mistake is sadly compounded many times!

In some ways however, the decision to divest has been long overdue and it is actually a big relief for me to be finally rid of this investment, which has been providing perennial headaches and problems for the past 1.5 years (since the global financial crisis hit the shipping industry hard). The point here is that there is no logic or sense in holding on to a sinking ship (mind the pun) while letting your capital languish; hence I saw the opportunity to free up this capital and reinvest it into a more worthwhile company. Considering my investment in FSL Trust was made in January 2008, a time when I was in transit with regards to my investment philosophy and a “virgin” learner in the value investing field, I guess I probably made some “classic” mistakes and committed several easily avoidable cardinal sins. These mistakes have been thought-out by me and will be detailed below for future reference in order for me to learn and avoid making the same errors again.

1) Not understanding the risks fully (e.g. LTV Covenants Clauses) - One of the basic rules in investing is that you should fully understand the investment you are making, or at least the important aspects of it so that you are not caught by surprise. Apparently, I had read up on shipping trusts in a cursory way and did not delve deeply into the details of LTV clauses and interest reset clauses, which conveniently kicked in when ship values plummeted along with the crisis. There were other risks such as counter-party risk which was perceived to be low at the time because “times were good”; but which came back with a vengeance to “haunt” the Trust recently (when Groda Shipping defaulted on payment for NIKA I and VERONA I). Some investors mention that of the three shipping trusts, only FSL Trust has a full-time risk officer; but then again a risk officer is quite useless when the risks cannot be foreseen or properly mitigated! At the time the Trust was constituted, no one could have predicted the kind of severe fallout in the industry which would severely depress values of ships.

2) Under-estimating the downside, over-anticipating the upside - A classic case of investor myopia. When times are good, people (including myself) can only see clear skies and a nice breeze ahead; and no one even imagines there will be storm clouds, thunder and a lot of lightning! I recall very clearly that during the AGM for FSL Trust held in April 2008, investors were talking about “yield compression”, which essentially implied that the share price would move up to reduce the yield which was then a high 9-10%. Of course, no one could foresee that instead of the share price moving up, the yield went down instead…..

3) Overly aggressive payout (initial was 100% payout) - Warning bells should have rung loud and clear when it was declared that FSL Trust would have a 100% cash payout and not retain any cash for paying down loans at all. Back then, the loan was structured as a “bullet” repayment in 2012 and was not treated as an amortizing loan (which required regular repayments similar to a mortgage loan). This overly aggressive payout ratio meant that Management was more focused on the short-term rather than the long-term viability of the Trust, as they did not create a buffer for the Trust in case something went wrong (and true to Murphy’s Law, something DID go wrong, as we can all see from hindsight). I even recall a shareholder questioning the rationale for Management to pay out 100% while passing a resolution to raise funds through issuance of new units; and the reply given by Philip Clausius (if I recall correctly) was that Management wanted to maximize returns to shareholders. In the end, Management were forced to reduce payout ratio from 100% to 70%, then to 50% and to the current 33%. With no end in sight to the crisis, bank loans being due in 1 to 2 years time and having two vessels on the spot market instead of long-term charters, it would seem that payout ratios may dip even further in future.

4) Ships as depreciating assets; unsustainable business model which requires either fund raising or debt issuance - It has been argued on many forums that shipping trusts are inherently inferior to property trusts (known as REITS) as ships are depreciating assets whose values MUST go down over time, while properties will retain a significant portion of their value even through the passage of time. The opponents of shipping trusts feel that this makes shipping trusts unsustainable as investment vehicles as the Trust must continually raise funds to acquire new vessels which are accretive to DPU in order to sustain the payout. In time to come, this can only mean more debt to buy vessels, or else a secondary offering of securities to raise funds (which dilutes existing shareholders). A rights issue would totally defeat the purpose as a Trust is supposed to pay out cash, and not suck it back from unit-holders!

5) Loan bullet repayment in FY 2012 - On hindsight, I would conclude that the Trust was setting itself up for trouble when it agreed to a “bullet” one-off repayment of its loan by 2012. This was on the assumption that it was either able to raise enough funds to pay off the loan by then, or it could roll over the debt by posting up more vessels as collateral. Both options did not materialize and I can safely say that the Trust will now have a major headache come 2012 as it mulls over how to settle its debt obligations. They should have structured it as an amortizing loan in which they pay down the debt progressively, while reducing their payout ratio to say 80%.

6) Risk mitigation is close to impossible - Despite having a stringent screening process, a risk officer and many levels of review before selecting a lessee for their vessels, FSL Trust still experienced a client default by Groda Shipping. Its ships were arrested and had to be put up in the spot market for spot charter. Risks are very tough to mitigate in the shipping industry as the industry itself is cyclical by nature, which means that companies may seem healthy and fine during good times, but will struggle to survive during bad times. It is a known fact now that the global crisis caused several shipping companies to go bust; while NOL reported a whopping US$700 million loss in the previous financial year (at the nadir of the crisis).

7) No visibility in terms of cash flows, more costs may be incurred for lawsuit and other associated costs relating to VERONA I and NIKA I - The default by Groda Shipping was the tipping point in terms of my decision to finally divest, as this meant that there was no more reliability in the cash flows for the Trust and it should be noted that the Trust has stopped providing forward guidance on DPU. Up until 1Q 2010, they were still guiding for US 1.5 cents per unit DPU; and it was only recently that this dropped to US 0.95 cents due to the default. Other future costs may be incurred for lawsuits and guarantees to be posted on the two vessels, and this clouds the visibility for future payouts. The point of a Shipping Trust is to have predictable and stable cash flows for the unit-holder. Once cash flows become unpredictable and inherently unstable, I do not see the point for staying vested.

8) Go for sustainable yield even if it is moderate, rather than for high yield which may not be sustainable in the medium-term - Another classic mistake made by me was the constant chase for high yield, so much so that the risks are blindly ignored in the process. The key is to look for sustainable yield rather than high yield; thus I am willing to accept a dividend yield which is higher than inflation but I have to be assured it can be sustained.

9) Yield is about 4.5%, but risks are high due to leveraged balance sheet and consistent pressure from bankers (at the mercy of bankers) - The yield for me for FSL Trust has fallen to about 4.5% (using US 0.95 cents as a gauge), but with the highly leveraged Balance Sheet and the fact that the Trust is subject to the whims and fancies of bankers (for LTV Covenants, advance payments to “appease” the banks, and stuff like market disruption clauses), this makes investing in FSL Trust particularly unsettling and worrisome. In short, it does NOT give me a good night’s sleep and I can find assets which yield a similar level of dividend yield which would probably allow me to sleep much better. Hence, I can safely conclude that it was the sharp decrease in yield which has contributed to my decision to divest too.

10) Risk of DPU becoming lower in future periods due to LTV covenants, debt repayment issues and vessels on spot charter - There is a further risk of DPU further declining in the face of many uncertainties, such as LTV ratio, vessels on spot charter, and legal wrangles for NIKA I and VERONA I. Not to mention the fact that the bankers also need to be paid their interest; and the impending bullet repayment in FY 2012, all this comes together to make up a “perfect storm”.

11) Unable to raise financing during Dubai Crisis indicates lack of attractiveness - The fact that the Trust was unable to issue bonds as a result of the Dubai Crisis also indicated that they did not have much bargaining power and clout. Of course, some may argue that it turned out to be a blessing in disguise as the bonds were to have an 11%-12% yield, so how in the world could you have accretive acquisitions when you are paying through your nose for interest expenses (yes, to the same bankers, no doubt)?

12) Recent attempts to acquire a vessel have also fallen through (no potential accretive DPU acquisitions) - FSL Trust’s recent attempt to conclude the purchase of a vessel had fallen through (as per the audiocast session Q&A). This further puts a spanner in the works and reaffirms my belief that the business model is inherently flawed.

13) Relatively new business model (shipping trust), IPO was too recent and no track record or stability of performance - In fact, the only comparables were to the two (also newly listed) shipping trusts Pacific Shipping Trust and Rickmers Maritime Trust. The more established Shipping Trusts were Seaspan listed in the USA, but even then this was not a proxy for stable performance as the Trusts had all yet to undergo “hell and high water” conditions. Only if they had survived through downturns and recessions and emerged unscathed (or even stronger) can we conclude that the business model is sound and can stand the test of time.

14) Weakening USD:SGD rate also does not boost dividends once converted into SGD as dividends are declared in USD - This may sound like a minor point but it also contributed to the frustrations and resulted in lower dividends for me.

In conclusion, the above points were the culmination of much rumination, analysis and critical thinking on my part over the course of many weeks (and even months actually). I certainly will keep the above lessons in view and judiciously avoid repeating them again for my future and current investments. The capital released from the sale of FSL Trust will be deployed once a suitable investment opportunity is found.

Thursday, August 05, 2010

Combining FA and TA

This post was conceived and written due to the prevalence of many practitioners of methods of stock investing which purport to combine the “best of both worlds”. To recap, the world of equity investing is usually recognized to be split rather cleanly between two camps – those who practice fundamental analysis (FA), and those who practice technical analysis (TA). There are, however, a whole range of people who fall somewhere in between the two extremes; and more recently a new breed of people has emerged on forums (and some even have their own blogs) who are championing the successful merging of both disciplines. In simple layman’s parlance, FA and TA are considered to be like night and day as they employ very different philosophies, methodologies and ideologies. Let me explore a little on this (rather) contentious issue. Incidentally, value investing falls more towards the FA camp, arguably it involves more than just FA as it attempts to derive an approximate intrinsic value for a company.

First of all, in order for someone to claim that a certain method is workable, he needs to demonstrate, through meticulous and objective record-keeping, that the method works over the long-term. Long-term in this case would imply at least an investment horizon of three to five years, or one full cycle of bull to bear market, whichever is longer. Records need to be kept in detail which specify the quantity of shares bought/sold, commission paid, profits made, dividends received and dates of investment and divestment. If possible, the investor should also include details of the rationale behind the decisions made to buy or sell; including all fundamental and technical reasons which led to the decision. Most websites which combine FA and TA do not have a sufficiently long track record to be able to make a claim that the method works better than say, a passive ETF investment strategy. Since a combination of TA and FA would render an approach which is necessarily more active as compared to index investing, one should therefore demand a higher rate of return for one’s efforts. It is up to the investor to demonstrate that he is able to achieve such a return, otherwise he will be no better off investing in an index fund.

The second point which I have to make is that a practitioner of FA/TA should make his investment philosophy very clear right from the start, in order to avoid the cardinal sin of not being able to decide if a buy/sell decision stems from an FA or TA perspective. This results in “losers” ending up as “investments”, and winners being sold off too soon as they fall into the “trading” bin. If we factor in the erosion of profits from frequent transaction costs, then it would appear quite daunting for the average practitioner of an FA/TA combined philosophy to make money over the long-term.

Another point is whether one can manage to successfully “marry” both FA and TA styles to create a unique (and successful) hybrid. I would argue that it may be better to concentrate on being good at either FA or TA, rather than being a “Jack of all trades, Master of None”. Readers may feel free to dispute this (and I know my views are contentious to those who practice this), but combining FA and TA may simply dilute any advantages which each style purports to convey on the practitioner, resulting in sub-par performance over the long-term as opposed to a more “purist” approach. To give an analogy, a company which has many disparate business divisions doing unrelated work may actually increase costs and decrease profitability as there are dis-economies of scale, and may result in a case of “diworsification” as espoused by Peter Lynch.

Interestingly, and for reference, a book written by Burton Malkiel titled “A Random Walk Down Wall Street” (2006) makes direct comparisons between FA and TA, and also serves up reasons for FA and TA to work and/or fail. He presents pretty objective, persuasive arguments which are backed by facts, research and data. In short, he does not believe TA can work well consistently, and that any style which works well in the short term will soon lose its efficacy over time. On the flip side, he acknowledges the flaws in FA as well and how it could end up losing money for the investor. Basically a practitioner who is weak in FA would suffer a similar fate to one who is weak in TA; hence it seems to be more of an astute application of methodology rather than concluding if any one particular method is more superior or inherently flawed.

So, to conclude a post which might have dragged on to become unnecessarily long-winded, I am an advocate on concentrating on either FA or TA in order to excel in either; rather than try to “marry” the two methods together to produce a hybrid. Perhaps one can really come up with such a successful union, but even then it has to be rigorous, consistently applied as well as time-tested. These conditions may sound harsh, but are necessary to prove that a type of method is due to skill and not just luck.