Tuesday, March 08, 2011

Kingsmen Creatives – FY 2010 Comprehensive Analysis Part 1

This is intended to be a rather comprehensive analysis for Kingsmen Creatives, and will cover many aspects of the Company including financials, segmental breakdown, geographical revenue contribution, qualitative aspects, industry outlook, competitive landscape, prospects, plans and other pertinent facts. I guess it was conceived after reading through the recent reports which OCBC, DMG and Kim Eng had come up with on reviewing Kingsmen’s FY 2010 results. Most of them did a one to four-page write-up which I felt did not sufficiently cover all aspects of the Company, and thus could not lead shareholders and investors to make an informed decision on the Company. Of course, my review and analysis is NOT expected to be objective (as I am a shareholder), but it serves to at least highlight the many issues facing the Company and hopefully provide explanations and in-depth discussions on them.

Part 1 shall focus on the numbers aspect, and will cover the Profit & Loss Statement, Balance Sheet and Cash Flow Statements. 8-year historical numbers will be presented, as well as dividend payment history for Kingsmen since listing in FY 2003. Part 2 shall cover segmental analysis and associated companies, including discussions on stake increases for Fairtech and North Asia; as well as how the other associated companies will fare in the coming years. Part 3 will delve into the industry outlook, and provide some recent news articles which highlight the MICE industry, tourism industry and also outline plans for retail malls in Singapore, Malaysia and China. Part 4 will touch on the competitors for Kingsmen, namely Cityneon (a smaller local player) and Pico Far East (a much larger Hong-Kong listed rival), and attempt to dissect their numbers and place them side by side with Kingsmen. Part 5 shall end off with a discussion on the investment merits and also draw in some insights of mine which I formulated with respect to my investment in the Company.

Disclaimer: Please note throughout that ALL information here is solely provided by myself and should not be relied on as investment advice; therefore please verify facts and numbers independently and do not use this blog or any associated charts/figures/tables as a definitive source of information. The blog owner shall NOT be responsible for any factual errors or any losses arising from any reader relying on the information herein to make financial decisions. To summarize, when in doubt, please consult a qualified professional.

Profit and Loss Analysis

The above table only shows the key metrics and numbers which I have served to highlight, and discussion on the Income Statement should extend beyond the 8-year numbers shown above. Note that revenue for FY 2010 had dipped marginally by -2.8% to S$235.2 million from S$242 million a year ago; but was still respectable considering about S$78 million of last year’s revenues consisted of a large contract from Universal Studios Singapore (“USS”). The more important fact was that COGS dropped by a larger -7%, resulting in an increase in gross profit of 10% from S$59.5 million to S$65.4 million. Gross margin increased from FY 2009’s 24.6% to FY 2010’s 27.8%, and if you glance at the 8-year history of Kingsmen since listing, this gross margin was equalled only in FY 2003 (listing year) and bettered in FY 2008 (at 30.7%). Whether Kingsmen can maintain this gross margin moving forward is in question, but assuming the thematic projects it takes on involve smaller parcels of work, then gross margins can be sustained. One of the major gripes of the large USS contract was that gross margins were negatively impacted.

The bottom line was, however, impacted by the fact that other income was slightly lower, while staff salaries and related expenses rose by 8.1% and other expenses rose by a larger 17%. If we break down the reasons, it was mainly due to the increase in staff salaries of about S$2.6 million, as well as higher operating lease expenses of S$300,000 and a write-off for their fire-gutted Malaysian factory premises of S$400,000. All these added up to increase expenses to the tune of about S$4.4 million. Share of results from associates also dropped 74% to just S$87,000 from S$332,000 and was another disappointment which caused the profit attributable to shareholders to increase just 1.1% from S$14.9 million last year to S$15.1 million for FY 2010.

Historical PER remains relatively low at about 7x, but this is probably reasonable considering Kingsmen’s growth prospects are not expected to be strong, and competition in their arena is also keen. The next section will discuss salient aspects of the Balance Sheet, while also commenting on the net cash per share and using that to compute valuation metrics for ex-cash.

Balance Sheet Review

With a glance at the above table, one can immediately conclude that revenue growth seems to be tapering off in FY 2010, which explains why there is a drop in valuation for Kingsmen’s forward prospects. Of course, as mentioned before, if we stripped out the USS contract, then Kingsmen’s revenue growth would be more gradual and steady, rather than seeming to “spike” in FY 2009 and level off in FY 2010.

Trade Receivables has actually dropped about 9% from last year while Trade Payables has remained fairly constant. Trade Payable days has increased to 81 days (a good sign) while Trade Receivable Days has fallen by 7 days to 107 days (still high, sadly). The cash conversion cycle is a negative 26 days which is an improvement from FY 2009’s -40 days, but this still has more room for improvement. Of course, one can argue that it could be a matter of the timing of receipt and payment of cash which resulted in such ratios being generated, and this is one factor which readers should take into account as well.

The current ratio for Kingsmen is at its highest level in 6 years, at 1.45. The Group also has a high level of net cash at S$24.6 million, and net cash per share stands at 13 cents. Return on equity, the all-important metric, stood at 26.4% for FY 2010, dipping from 33.2% in FY 2008 and 28.7% in FY 2009. Still, at above 25% and with an increasing shareholder’s equity number (note that FY 2010’s equity number is about 33.6% higher than that of FY 2008), this is still a very respectable performance, and done without excessive leverage.

Interestingly, ex-cash historical PER for Kingsmen for FY 2010 is at 5.34x, one of the lowest as compared to prior years. This means that if you strip away the cash per share, in essence you are getting the entire business at just about 5.3x price-earnings; implying that you can make back your investment in just 5.3 years time with the business’ current profitability and cash flows.

Cash Flow Statement Analysis

Kingsmen always had very strong operational cash flows and very little need for capital expenditure (“capex”), so I would expect this to continue into the foreseeable future unless they suddenly had a drastic need for capex. Thus far, the only large capex item I see on the near-tern horizon is their announced plan to build an automated facility in China to be ready by 2H FY 2011. Otherwise, their capex requirements have always been low as Kingsmen’s core assets are its people and the brains behind their ideas and designs. It is, after all, a design company!

It can be seen that operational cash flows improved drastically for FY 2010 as compared to FY 2009, as cash flowed in from the completed USS contract which was booked as a Trade Receivable as at end-FY 2009. S$20.3 million worth of operational cash inflow was booked, while capex only amounted to S$6.2 million (and this includes two warehouses built in Selangor after fire destroyed the existing one), resulting in free cash flows of S$14.2 million. Financing cash outflows were low due to absence of repayments of loans to banks, unlike in FY 2009 when S$12.4 million was repaid to banks. Dividend payments formed the bulk of financing cash outflows, and this is likely to continue into the foreseeable future as Kingsmen usually is able to generate cash in excess of what it requires for working capital and capex. In fact, Kingsmen’s net cash level is at its highest since listing at S$28 million, which probably also explains why they can afford to pay a special dividend of 0.5 cents per share to celebrate Kingsmen’s 35th Anniversary!

Dividend History

From the above table, it can be seen that Kingsmen’s dividend history has been consistent and increasing. From paying just 0.75 cents per year (once a year) in FY 2003, Kingsmen has now increased it to 3.5 cents per share twice a year (excluding the 0.5 cents special dividend). I believe this is because Kingsmen’s business model does not entail high levels of working capital, and neither does the business require constant and consistent spending on capex to keep up with competitors and ensure the business stays viable. Staff costs are, however, an area of concern as Kingsmen has to continually tap on good talents to ensure it can innovate and deliver the best service to clients.

Part 2 will deal with segmental breakdown and margin analysis, and provide some discussions on these aspects.


Melvin said...

I'm a value investor. Have been applying it in US market. Now looking for opportunities in South East Asia. Your write up Part 1 was very high quality.

Just to help me frame my thoughts about this stock, what genre would you say it fits into:
1) Cigar Butt (early Buffett)
2) Great business, Long runway to growth (Fisher/Munger- I think Unilever Indonesia is one of these)
3) Great biz, great mgmt, right price (late Buffett)

The design business strikes me as a very local business (ie displays must fit local tastes). What makes Kingsmen win out local/foreign competition? Obviously price isn't the key criterion here (if it was then it's not really a great biz). Do they dominate Singapore market? ie pricing power locally make cash in singapore and then drain cash by trying to compete on price overseas

Looking forward to Part II.

Musicwhiz said...

Hi Melvin,

It's rare to receive a comment from a fellow investor who believes in value too, thanks for visiting (and also for the compliment)!

I would think Kingsmen has a decent business, great Management and can be bought at the right price. The business is not immune to competition as barriers to entry are low, but to achieve the scale and reputation which Kingsmen has built up over a period of 35 years is far from easy, hence that gives them a type of competitive "moat".

The design business is not as "local" as you may perceive it to be. Almost all of Kingsmen clients are international brands when it comes to Interior Fitting Out, such as Burberrys and Gap to name a few. Price is NOT a source of competitive advantage, rather it is the quality of work, ability to deliver on time and precision in co-ordination of simultaneous roll-outs in various countries (for a client) which earns them the reputation they deserve.