Boustead – FY 2011 Financial Results Analysis Part 3

Part 3 of my Boustead’s FY 2011 analysis will feature the entire transcript of Boustead’s FY 2011 results audiocast. As per prior years, I will be inserting my own thoughts and comments periodically throughout the audiocast session, and these will be indicated in square brackets [ ] and in blue. However, this analysis will be different from previous years in that I will NOT be sharing any insights from the Annual Report 2011. I will be splicing that into a separate post after I attend the AGM to be held at Starhub Green on July 29, 2011 (Friday) and combine my insights and remarks into one post to make it easier for readers (and myself) to digest. If the information is too voluminous (i.e. audiocast cum annual report), it makes it difficult to read on and by splitting it into two separate posts, I hope to be able to achieve better clarity and focus on these two separate yet connected events.

After the transcript portion, I will also discuss on plans and prospects briefly (as gleaned from the audiocast); but a more in-depth discussion of this will be provided after the AGM as I intend to touch on more detail during this event.

Boustead FY 2011 Audiocast Transcript (recorded on May 26, 2011)

Question (Tan Choon Kiat): I noted that the geo-spatial division has performed very, very well. And that is despite, you know, we sort of like was saying the growth of this division would plateau off. But it doesn’t seem to be so, in fact the geo-spatial division grew nearly 30%. Eventually, out of this 27% PBT growth, how much would you attribute to favourable currency effects, and also specifically, what is the sustainable long-term growth (for this division) in the next 3-5 years which your team is actually looking at? The other thing, of course, the recurrent part of the real-estate portfolio that you guys have been building up is looking very nice and is steadily growing notwithstanding the fact that the size of each project secured is becoming a bit smaller. My question right now is a very pointed one – it appears to me that looking at these two divisions alone, the profit before tax (PBT) of these two units seems to be hitting $35 million and is still growing.

FF Wong: First question first, Choon Kiat, Geo-Spatial. The main reason for the growth in this financial year was not really because of the currency. In fact, it is because of the growth of countries outside of Australia, especially Singapore, Indonesia and Malaysia too. And the other thing is the maiden contribution from Mapdata Pty Ltd which was acquired two years ago. So these are the two main reasons. You asked also whether it is sustainable. It appears to be sustainable because over the years there has been steady growth, even though percentage-wise it was not to my liking, or to shareholders’ liking. But that’s also because the Australian market is maturing, and yet we haven’t really been able to quicken the steps of development especially in Indonesia. So we have been putting in serious effort in growing the markets outside Australia and it appears that it’s bearing some results, and as you know Indonesia is so big, and with the current craze in resources development, mining and so forth, we see huge potential in Indonesia, and we have also embarked on non-traditional methodology to expand the market instead of following the standard global ESRI methodology. That, I believe, should be able to give us some quantum leap with respect to the growth in those respective countries like Indonesia. I firmly believe that our growth and our revenue in Geo-Spatial will be sustainable. Next question on industrial real-estate. The size of the projects are a bit smaller principally because in the year before (2009) when we secured Rolls-Royce projects, these two projects are huge (humungous). So, by comparison with the usual industrial building projects, these are unlikely to be repeated in future from what I can see, but who knows? But there are a lot more projects in the marketplace. We have secured quite a number, especially in the last 3-4 months. I would think that there are also a lot more design, build and leaseback projects – we are negotiating quite a number of them quite near closing stage but not quite yet, so can’t make any announcement as such yet but the pipeline is very healthy with respect to design, build and leaseback. That’s not included in the order book (in the backlog). Yes I think that’s about it, I hope I have answered your questions. You can pose another question later on.

[It would seem that Geo-Spatial still has ample room for growth, even after the seemingly sharp jump in revenue and profit before tax of 26% for FY 2011. Boustead’s efforts to expand beyond Australia and into Indonesia seem to be bearing fruit, and according to FF Wong Indonesia still holds untapped potential for this Division. It’s good to know that Geo-Spatial, being Boustead’s cash cow, can continue to be milked and that the tap would continue to gush for many more years to come!]

[As for Real-Estate Solutions Division, note that FF Wong mentions that “quite a number” of DB&L projects are being negotiated, and are “near closing”. If we look at the announcement pipeline for this Division since the audiocast, there was only one announcement of a Design & Build contract worth S$23 million for Bell Helicopter; so I am guessing that these DB&L contracts are probably still under negotiation, and may be announced perhaps in August 2011 (if we look back at 2010 there was one D&B contract announced then as well as one DB&L)]

Question (Mr. KK Phua): When is the AGM held (the actual date)? I would like to make myself available to attend.

FF Wong: We have not actually fixed the date yet, but from our previous practice, it is likely to be end of July 2011.

Question: Do you foresee any further recognition of losses arising from the civil war in Libya?

FF Wong: We have done a complete review with our lawyers. We believe that our present recognition of losses and provisions should be sufficient but then again, of course, it is a long tedious process. We are not 100% sure but we are confident.

[Disappointingly, on June 24, 2011, Boustead announced that there was possibly another S$23.3 million worth of exposure for Libya as a result of a litigation involving corporate guarantees given by the Group. It seems that Libya is turning out to be a very painful and long drawn-out mistake for Boustead]

Question: Previously, you estimated the maximum Libyan exposure at $39.6 million. The provision this quarter is about $14 million. How do you view the risk of the other exposures? Would there be more provisions in the next financial year?

FF Wong: I think we just answered this question. There is about $24 to $25 million exposures in performance guarantees. We have altogether made $19.1 million provision for the whole financial year. We believe that is sufficient – as mentioned we have consulted our lawyers and have taken advice from them.

Question (Francis Teo): What is your opinion of the investment in Hankore (i.e. Bio-Treat) so far?

FF Wong: Our investment in Bio-Treat is relatively small, it’s only $4 million. We like the Management, and we have been interacting with them for nearly a year and we think that this new Management are sincere people and they are good in what they are doing. The only thing is they will be embarking on BOT projects. The business model is something which I always find not quite attractive for us, however, they have a huge network especially in China (in this industry). We feel that there is a need for them to make use of our expertise, and being associated with them will help us to open up opportunities in China, especially in areas where they do not have experience and expertise, especially in seawater desalination, pure water purification and also in industrial water treatment applications for power industries. Being associated with them, I think, is a good move.

[Somehow on Hankore, I feel that FF Wong may be investing that S$4 million more for “relationship management”, rather than through a rational and objective assessment of the business which yielded solid prospects for the business. From what I can observe from the Balance Sheet and Cash Flows of Hankore, it will probably be an uphill task for them to achieve decent profitability and sustain it through more than a few quarters. This is due to the BOT business model which requires huge upfront capex. Even though the investment is “only” S$4 million which is a paltry sum compared with Boustead’s cash hoard, it’s the principle of the matter and I certainly hope FF Wong does not let this S$4 million dwindle into something a lot less!]

Question (Desmond Wee): With regards to working capital requirements, what is a current ratio that Management is comfortable with?

FF Wong: Very good question! We are principally an engineering company. There are a lot of opportunities in this region, and some of these infrastructure projects are so attractive we would like to keep a healthy cash balance in the bank so that we can capture these opportunities as and when they occur. In other words, we are rather flexible here. I always maintain we would like to keep ourselves cash-rich so that we can capitalize on the opportunities available.

Question (Desmond Wee): Can you identify the investments made in 4Q FY 2011 (the $16 million non-controlling interest, $6.4 million trading investments and $1.5 million available-for-sale investments?

FF Wong: The $16 million I believe you are referring to the remaining 8.3% shareholding in Boustead Projects. With the acquisition of that interest, we will end up with 100% control in Boustead Projects. The $6.4 million trading investments are relating to the purchase of corporate bonds which give us a pretty attractive yield as compared to so much money sitting in the bank giving us 0.1% yield. And $1.5 million, these are the convertible bonds.

[A minor note here – FF Wong was very sharp to buy over the 8.3% stake as I believe he is aware that Boustead Projects is gearing up for greater things in time to come, so it’s good for Boustead to be able to consolidate 100% of the earnings instead of letting part of it be shared by the non-controlling interest. As for the corporate bond investments, it would be interesting to find out what is the blended coupon rate on this investments, and whether the risk of default is high on those bonds?]

Question: How’s the economics of design, build, lease, sell projects so far in terms of margins, return on capital etc?

FF Wong: It varies. For design, build, lease and sell projects, there isn’t any fixed margin per se. However, the economics (if I can understand you correctly) obviously it will be better for us if we are able to secure design and build projects that cater for MNCs, generally we will be able to get cap rate there when we sell out to the REITs or property trusts. You work on cap rate instead of design, build – that would be on the basis of EPC, generally your margin will be (of course it varies from) 10% to 20% these days, being so competitive. In the case of IBM, I think you can read from the Balance Sheet. Our investment was $46 million and we were able to re-sell it back to IBM for $68 million, so we net a profit of $22 million. So you can work out the economics, $22 million against $46 million is nearly 45-46%; so that depends on what base you use. If you use 68 as the base, then it’s 40-odd percent.

[Apparently, the margins are indeed pretty good if there is strong demand for a piece of property. On July 8, 2011, Boustead announced the sale of a yet-to-be-built strata divided building located at 61 Ubi Avenue 1 (incidentally, this is located beside Boustead House), for a cash consideration of S$38 million. It was not stated if Boustead was also responsible for building this, and what is their cost of building it]

Question: You said that you hope to leverage on Hankore’s network in China to land some projects (different kinds of projects). Would you consider EPC or would you consider collaborating with them on a BOT basis?

FF Wong: Most of the people would know that I am pretty negative about BOT, because the cash flow is just no good, and if you notice the Company emphasizes so much on cash flow. BOT is not the type of business model we prefer. Of course, there are exceptions. At the moment in China, it’s so competitive and there is so much money going around. It’s difficult to get BOT projects that would interest us. However, EPC yes, especially in areas that we can compete. I early on said desalination projects, demineralization projects, pure water projects, projects for more sophisticated applications where very few Chinese competitors have acquired the skill and the expertise (as well as the track records). We have been invited recently to bid for a water treatment project for nuclear power plant but unfortunately we are tied up here. We are working on a big project over here so we thought perhaps we will leave it to next time.

Question: Over the years, we have been talking about new areas which Boustead will be looking into. In fact, I think Boustead’s history has been checkered by a lot of hits and misses. This year we really had one big miss after what we thought had been a big hit back in FY 2007. I think everybody acknowledged that. Nevertheless, I always salute the spirit of the Boustead team when it comes to looking into new areas and ventures and executing them. At the moment it looks as if there seems to be very new ground that the Group is actively looking at. We have read in the various media through your interviews with magazines like The Edge that you have been busy looking for these new opportunities. Indonesia is actually one area, Vietnam is another area. If I remember correctly, in that interview, there has been some mention about looking at infrastructure projects that are resource-based in Indonesia. And also, I think, Boustead has a presence in Vietnam for quite a while now. Vietnam has always been {not audible}, notwithstanding the volatility of the currency. So would you care to update about two new markets? Indonesia and Vietnam and perhaps some other regions where there is something that is actually coming through materially. Also, on top of it, I was also looking at power plant potential in Indonesia. Could you elaborate on what you will be focusing on and will it be contributing to the current income meaning it could be BOO or just an EPC type of project?

FF Wong: It’s a very long question but I’ll try, I’ll try. First of all, Vietnam. We have secured a small project recently under Boustead Projects. It is a construction project – not very big but it’s the second one and going on pretty smoothly. That’s one; we’re still working on an interesting project. It is – I don’t want to be too specific, but we have been working on it for 2.5 years. We’ve been promised the project; it is a BOT project but though we have got supposedly all the approvals but the approval process is so long. Until today we haven’t been able to complete it. We were told that we definitely have secured the project but it’s not coming, so frankly I have lost a bit of interest there. I thought I had lost all interest but surprisingly, coincidentally, yesterday we had just been notified that the license had been issued. We need one final presentation on the technical arena. Our guy is going to Vietnam, Hanoi, next week and hope that this will be the last hurdle. But I can’t be sure exactly because in Vietnam, with the bureaucratic complexity. In Vietnam, we are still looking at a lot of other projects. I will not say “die”. Indonesia, we have been very active in Indonesia, especially myself, in the last year or so. Yes you are right, we are looking at infrastructure projects with respect to resources development, including mining. We hope that soon we will have some good news to share with you all. And these are the projects that will give you recurring income. It’s supposed to be closed yet not yet there, a bridge too far perhaps; let’s keep our fingers crossed. That’s all I can disclose to you. I would not let our setback in Libya deter us from venturing into countries which give us tremendous prospects. I do know that some of you who are not used to working in emerging economies, you may be frightened but it’s all a matter of matching your exposure. In the case of Libya, we were carried away with the early successes in Libya – in fact we were doing quite well in Libya. We had put in a lot of claims and the project team had also agreed and approved (supposedly) these claims to be submitted to the authorities. All of a sudden the war broke out – what can I do? Perhaps you can say that with respect to our Balance Sheet, we probably put a bit too much in Libya. We knew about that, however, which was why we brought down our equity participation from 65% to 35%, but the implementation (process) of transferring the money out just took too long, and the war just broke out. Have I answered the question(s)?

[From the reply above, it would seem that FF Wong has got quite a bit on his plate, but these various initiatives have yet to pan out successfully and thus he cannot elaborate more specifically on them due to their market-sensitive nature]

Question: But Mr. Wong, yeah yeah you have answered the questions. But let me put it this way, I think in businesses, it’s not always smooth sailing. So don’t get us wrong, as shareholders we know your team’s track record. As long as we can make good with 1 out of 5, I think that’s life, life just has to go on. No worries about that.

FF Wong: Thank you. But I think if you look at the presentation with Keith, you’ll notice in the last 7 years we have been able to achieve from 20% to 30.9% on your ROE. And that’s even with that sort of equity base which is inflated by the cash hoard. If we were to take the cash out, you would notice that our ROE has been very, very respectable.

Question: Yes, we have no doubt about that. Being shareholders in this company for coming close to 9-10 years, we have already seen the company growing from strength to strength. Let us be forward-looking in terms of what the recurrent business is actually showing, it’s already giving us quite a fair bit of comfort, and with your initiatives which have been put in, I think we definitely have good years to look forward to, as long as all the execution and processes have been well-contracted. That’s all I have to say. Thanks for all the efforts.

FF Wong: Thanks Choon Kiat.

Question: Sorry to bug on the current ratio, but I was thinking that the net cash position is a little misleading, since when the cash is removed, the current ratio falls to about 1, which seems tight. So I was wondering if Management can give a rough figure on what current ratio is comfortable for them, and how much of the cash is ready for deployment in investments?

KK Loh: Hi Desmond, this is KK Loh and I will take your question. If you dissect your analysis, let’s just have a common understanding. In the Balance Sheet, if you remove the cash, current assets will drop to $226 million; but correspondingly, for current liabilities you must remove the borrowings which will fall to $219 million, so the current ratio will be about 1.03. In our borrowings of facilities with the bank (credit facilities which were obtained from the bank), the bank is comfortable with a current ratio of 1. And in FY 2010, our current ratio was 1.78 and in FY 2011 it was 1.95; and dissecting the net cash position, it’s $184 million. But actually cash in the bank is $210 million, we net off $3.5 million of unsecured debt and long-term debt of $21.6 million which would not payable in one year. Looking at it we are quite comfortable, but you are asking is how comfortable we are with our current ratio. I think it all depends on whether we have enough facility to gear. If you can borrow to the hilt (the exposure), and you have good businesses, why not? But at the present moment, we are cash-rich so I think that is not our problem in terms of the ratio. Hope I answered your question. Thank you.

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Plans and Prospects for Boustead (based on audiocast)

1. There was not much mentioned about Energy-Related Engineering, and the press release itself alludes to high oil prices benefitting this division, though growth was not expected to be significant. It would seem that short of a significantly large M&A for this division, there would be limited growth and I expect it to just plod along. Though it is expected to be profitable, I cannot see any catalysts which could spur a jump or permanent spike in revenues and profitability as most of the revenue is contract-based and therefore lumpy. Assuming Boustead is able to re-structure all units successfully, perhaps the increased efficiencies and economies of scale could improve margins further for waste to energy projects, but let’s wait and see.

2. Notice that almost nothing was mentioned or asked about Salcon (Boustead’s water and wastewater division)? It seems that after announcing the termination of the project in Libya due to the civil unrest, Salcon has not come up with any meaningfully large contracts, or even small ones for that matter. Interest in this division has also gradually waned as the turnaround had probably taken too long and there is no confidence in the division being able to sustain profitability after the Libyan blip. I guess questions about Salcon would be reserved more for the AGM rather than the audiocast.

3. The Real-Estate Solutions Division appears to be headed in the right direction, with FF Wong alluding to more deals in the next few months and a build-up in Boustead’s recurrent income flow through more DB&L projects. The fact that Boustead Projects can cater to niche markets bodes well for the now 100%-owned subsidiary, as this means more projects of significant size and clout would raise its profile and create a positive feedback loop. It remains to be seen if the division can manage to scale new heights in terms of revenue and profit contribution, as a large portion of its contracts are “lumpy” as well; but with FF Wong’s assurance that he is building up the DB&L orderbook flow, this may mean that revenues and cash flows at Boustead Projects would become more stable, consistent and predictable. One positive side effect is that dividends may also increase as a result.

4. Geo-Spatial can be classified as a slow performer, and is usually under the radar when it comes to shareholders asking about Boustead’s performance. I guess it can be classified as the least “glamorous” of the 4 divisions and many (including myself) do not fully understand the technical aspects involved in this division’s services being provided. It is evidently the cash cow division of the Group as it has high barriers to entry, high gross margins and very healthy cash flows (as most of its customers are government agencies and thus have the ability to pay). In terms of projected growth, unless another good acquisition like Mapdata Pty Ltd comes along, I would expect a 5-10% slow but steady growth for this Division. I will not rule out a possible collaboration or M&A for this division though, knowing how Boustead can evolve and continue to leverage on emerging cutting-edge technologies to enhance the user experience (with whereto.sg being launched recently), I feel this division has the latent potential to grow further, just that it requires patience and time.

5. On the investment front, it appears that Bio-Treat’s investment in Hankore will be a very long-term strategic kind of partnership, as FF Wong himself alluded that he does not take too well to the “BOT” business model for Boustead itself; but is somehow willing to invest in a company which derives the majority of its revenues from BOT projects. Granted, Hankore does have many concessions in China and the most recent announcement from the Company was that it had inked a strategic cooperation agreement with the Xianyang City Environmental Protection Bureau and was granted the preferential right to invest in environmental projects with value not less than RMB 1 billion. At the same time, on July 13, 2011, Hankore also announced a new substantial shareholder Firstree Group Limited which purchased 338,374,474 shares (8.17%) at a price of 5 cents per share. This is 20% higher than Boustead’s 100 million share investment at 4 cents per share, and makes Firstree the second largest shareholder of the Company.

6. Boustead’s ongoing cash management program is seeing the Group invest in corporate bonds, and utilizing their idle cash to generate returns at least above inflation. While the exact returns are not known, my understanding is that they invest in short-term liquid corporate bonds which can give a decent yield; but which also probably have a probability of capital loss. It will be good for me to clarify this point with them during the upcoming AGM.

My analysis above is predicated on the fact that some queries need to be raised during the AGM, and more questions will probably need to be raised as well after browsing through the Annual Report 2011 in greater detail. But for now, these are my observations and my accompanying analysis of Boustead.