Portfolio Changes - Divestment of GRP and Addition of VICOM, SIAEC & Boustead

It’s been a while since I made some major changes to my portfolio, but this month seems to be a good month for it as Mr. Market went through a rather wild mood swing due to the historic downgrading of US Debt, which caused markets worldwide to tumble sharply and valuations to become more attractive. This event, coupled with debt problems in Europe and runaway inflation in China, served to unnerve the world and caused many bouts of forced selling and margin calls. The result, of course, was that the STI fell about 13% in 7 straight days of blood-letting, and this opened up very good opportunities for me to purchase shares. But before I go on about the additions, I have to declare my divestment of GRP and also the underlying rationale for it. Fortunately for me, the timing of the divestment was just right for me to pick up some shares of VICOM, which does vehicle inspection and testing in Singapore; as well as to average down on my cost for SIA Engineering. At the same time, I also bought some more Boustead to add to my current holdings. In the sections below, I shall elaborate on the reasons for the divestment and addition, and also give a brief account on the addition of SIA Engineering. All portfolio changes will be reflected in my month-end portfolio review, though I will provide some details within this post itself of the movement in cost, and also any dividend effects.

Divestment of GRP – Reasons and Rationale

I guess of all the companies within my portfolio, the one which was the most stagnant and which had a declining business had to be GRP. The original rationale for purchase was to enjoy a yield of 10% due to GRP’s large cash hoard and also its ability to generate free cash flows (FCF) due to the presence of rental income derived from its Bukit Batok industrial property. However, do note that the rental income from its property had ceased with effect from May 2010 following the expiry of the lease agreement in April 2010, thus 1H FY 2011 (ended December 31, 2010) did not include the effects of this rental income. As a result of the absence of this item, net profit fell 47% year on year. This was not the only thorn in GRP’s side – gross profit margin had also declined from 35.9% to 31.9% due to more intensive competition in its divisions. Though administrative expenses had fallen 23.8%, the more worrying factor was the erosion of gross margins, which was witnessed in Tat Hong and which also portended a slow but painful decline in its core business.

However, the above was not the only reason for the divestment. In the May 2, 2011 issue of The Edge Singapore, director Han Hai Kwang was quoted as being on the lookout for “synergistic” acquisitions to halt sliding profits, as GRP’s core business divisions suffered from competition and saw its profits eroding. Its PVC business in China, in particular, was suffering as a result of intense competition and the business itself was a commodity one in which GRP itself had no firm competitive edge. It would seem that throughout the years in which I was vested in GRP, Han had been continually looking out for such M&A but without much success, and this resulted in the cash building up into a hoard of about 9.5 cents/share. No special dividend was declared though, as I believe the Company saw that their business was vulnerable and therefore they wished to retain more cash for working capital.

What was more alarming, however, was that GRP’s operational cash flows for 1H FY 2011 had dropped to just $559,000, while capex was $95,000, resulting in FCF of just $464,000. The current dividend of 1 cent/share every half year amounts to $1.4 million, and this represents a shortfall of $1 million. Note that while rental income was still flowing, and using 1H FY 2010 as a comparison, FCF amounted to $$2.24 million, which would have been sufficient to pay out a dividend of $1.4 million and still retain roughly $800,000 for working capital. Looking at GRP’s balance sheet as at December 31, 2010, cash stood at $13.3 million and if they were to carry on with their current dividend policy, the cash would be depleted within 6.5 years ($2 million deficit per financial year), and that is not even counting in working capital requirements. Hence, my conclusion was that the current dividend policy was unsustainable (at 10% yield), and thus the original rationale for purchase was now invalidated; thus requiring an action to divest.

Another related point which I should mention was GRP’s announcement, on July 13, 2011, that it would be disposing of 63.5% of GRP (China) Pte Ltd, its uPVC business, for a cash consideration of $1.92 million; and will also, at the same time, book in a gain on disposal of $313,327. The reason for the disposal was the cash burn and losses suffered by this division for three consecutive years. On the surface, it looked like a good decision; but I have to question why Management took so long on their decision to divest, and also whether there are underlying unspoken reasons for wanting to divest for cash. One possibility (uncorroborated, no doubt) which crossed my mind was that the Company was foreseeing declining business and needed the money for additional working capital; and that they would also concurrently lower their full-year dividend from FY 2012 onwards (I am still expecting a final dividend of 1 cent/share for 2H FY 2011; as of this writing, GRP’s FY 2011 results ended June 30, 2011 have still not been released).

On August 3, 2011, I sold off my entire shareholding in GRP at 20.5 cents/share, realizing a capital gain of 2.5%. If I factor in dividends of $4,000 received since I first purchased GRP on October 28, 2009, then the total net gain on GRP rises to 22% (net of brokerage). Using XIRR on Excel, I have computed that the annualized return on investment amounts to 13.5% per annum.

Purchase of VICOM

The proceeds from the divestment of GRP were then used to purchase VICOM at an average cost of $3.40833 on August 8, 2011. VICOM is a company listed on SGX (68.19% owned by Comfort Delgro) which is involved in vehicle testing and inspection services (for all cars in Singapore). Revenue for this division hit $25.5 million (a 10.7% increase) for FY 2010 (it has a December 31 year-end) and 438,454 vehicles were inspected during the financial year. This division has seven testing centres spread out over Singapore, and include Sin Ming (lease just renewed for another 30 years), Changi, Bukit Batok, Yishun, Kaki Bukit, Pioneer and Ang Mo Kio. As of June 30, 2011 (based on 1H 2011 results), the Vehicle Inspection Business took up 30.5% of revenues, and had operating margin of 35.7%.

VICOM also has a wholly-owned company called Setsco Services Pte Ltd (Setsco) which provides non-vehicle testing and inspection. This includes construction material testing, certifications, calibration, training, inspection and consultancy. It has its headquarters at Changi but VICOM is in the midst of building a new four-storey building at Teban Gardens due to be completed by 3Q 2011. Revenue for this division hit a new high of $51.4 million (a 7.6% increase) for FY 2010. The division also has operations in Selangor (Malaysia) and Ho Chi Minh City in Vietnam. In FY 2010, Sestco formed a JV in UAE with Dubai-based Ali Omran Al Owais Investment Company to form a 49%-owned associated company called Setsco Middle East Laboratory LLC. This remained dormant for FY 2010, registering a loss for the year. As at 1H 2011, there was still no share of profit from this associated company, which implies that operations had yet to fully commence. For 1H 2011, the proportion of revenue from Setsco was 61.6%, and operating margin stood at a respectable 20%. The remainder of the revenue came from leasing and other related businesses.

I had already stated at the end of m SIA Engineering’s five-part analysis of purchase that I will not be doing a very detailed analysis of purchase for new purchases subsequent to SIA Engineering, thus I will be very brief on the reasons I purchased VICOM. VICOM has a captive market in its vehicle inspection business, as all cars in Singapore have to be periodically inspected as part of compulsory requirements to own a vehicle. As COE prices remain high (as of this writing a Cat A COE costs $49,000 while a Cat B one costs $65,000), fewer people will scrap their cars and thus will hold on to them longer, requiring more inspections. VICOM also has a clean Balance Sheet with no debt, and generates strong FCF every year. In its recent 1H 2011 results, VICOM declared an interim dividend of 6.9 cents/share, up from 6.3 cents/share a year ago. Assuming final dividend remains unchanged at 6.9 cents/share as per last year, total dividend for FY 2011 would be 13.8 cents/share, translating into a yield of 4% at my purchase price. Incidentally, I did not buy VICOM very cheaply; it was priced at about 12.2x PER and about 3x P/B; but this is to be expected since the business model is sturdy and it generates consistent and predictable FCF every year. A total of about $20,000 was spent purchasing shares of VICOM.

Addition of SIA Engineering

As Mr. Market was feeling particularly panicky in those seven days of decline, I decided to deploy more cash (about $10,000) to purchase SIA Engineering, and managed to average down on my initial purchase by buying at $3.51 on August 11, 2011. A quick analysis of SIAEC’s cash generation ability showed that since listing in 2000, it has only dropped its dividend once (in ten years) from FY 2008 to FY 2009 (20 cents/share to 16 cents/share), not counting special dividends. Even if we assume a drastic cut in dividend of 40% from 20 cents/share to 12 cents/share due to another global economic meltdown (crisis), that still represents a yield of 3.4% at my purchase price. With cash flows from associated companies and JVs remaining strong, I would expect SIAEC to at least maintain their dividend policy as they should have baseline cash balance of $400M after paying their recent final + special dividends.

As a result of the averaging down, average cost for SIAEC has fallen from the previous $4.064 to $3.97, and this will be reflected in my next portfolio review.

Addition of Boustead

Even more cash was deployed to purchase more shares in Boustead, at a price of 85 cents. The Company is sitting on a cash hoard of about $39.75 cents/share and has been paying consistent, increasing dividends over the last five years. This effectively values the rest of its business at a mere 5x PER ex-cash, and considering it is a global mid-cap company this “conglomerate discount” was not justified. It has a strong balance sheet with negligible debt (mostly, it is used to finance their real-estate portfolio) and generate very strong FCF every financial year. The strength of its business lies in Geo-Spatial and Real-Estate Solutions Divisions. For the former, it has a PBT margin of around 22-23% and is cash-flow positive, with Government agencies forming the bulk of their customer base (hence, bad debt probability is very low), while for the latter, Boustead is steadily building up its Design, Build and Lease portfolio to just above 90,000 sq metres currently. This is reflected under “Investment Properties” in the Balance Sheet, and the recurring income and cash flows will provide a stable base against the turbulence experienced these couple of weeks in Europe’s and America’s economies.

At my current purchase price, projected yield based on 4 cents/share is about 4.7%; and my average cost has increased from 55.8 cents to 62.2 cents.

Summary

The above transactions had the net effect of increasing my cost base from $220,000 to $238,700, as $20,000 was divested from GRP and re-deployed into VICOM, $10,000 was spent acquiring shares of SIAEC and another $8,600 to acquire shares in Boustead. This represents another new high for my cost, and I shall endeavour to continue to put more money to work if Mr. Market continues to offer me opportunities.