Monday, August 22, 2011

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.


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.


风隐(Phileas.Wind) said...

I didn't go into details for SIAE, and Boustead, I think their valuations are fair,
but for Boustead Jan-Mar result, the profit dropped quite a lot, which could be a concern.
While for VICOM, I'd think the valuation at current level is high, especially after checking the price trend for past 5 years, it has risen a lot to current level.

Drizzt said...

hi Phileas, you are confusing technical analysis and valuation.

if you look at the earnings potential the safety it provides even if it is 0% growth, it is a value buy even at that price.

Musicwhiz said...

Hi Phileas,

For Boustead, the profit drop was due to timing differences in revenue recognition; and also a one-off sale of property in 1Q 2011. If you check the Cash Flow Statement, Boustead generated very strong FCF for the quarter ended June 30, 2011.

As for VICOM, I did admit the valuations were NOT cheap at 12.2x and 3x book value, but as the price was fair, I found it to be a decent purchase. Yield was also hovering around 4% and VICOM have a strong moat.

Not very sure what you mean by price trend though - I don't look at price charts or graphs. I prefer to focus on the business and its future outlook.


Musicwhiz said...

Hi Drizzt,

Haha you have a good point. Earnings potential is what I look for, as well as cash flow generation potential and how much of it is FCF. Value purchases may not always consist of just growth but for me it encompasses growth and yield. If the business is growing albeit slowly it's not a problem for me as I let time show up the quality of the business.


风隐(Phileas.Wind) said...

Hi Musicwhiz,

Thanks for your reply,
Yes I think you're right that price trend should not matter to a value investor.


yyt said...

Hi MW,

is your focus on growth+yield the reason why you generically stayed out of the REITs arena?


Black Cat said...

Hi MW,

I've been meaning to look at Vicom for a while, due to their captive market. There will always be the same no of cars in Singapore, even if there is a recession and the COE falls to $50! But for Setsco, I wonder if it would be affected by a downturn: how much of their revenue is to cyclical industries (e.g.: construction)? And is all their revenue project based, or is some of it recurring?

I'm not necessarily expecting a downturn now...I just feel more comfortable waiting for one to buy in to.

Musicwhiz said...

Hi Phileas,

Thanks for your comment.


Musicwhiz said...

Hi yyt,

Yes I guess you can say that - another reason is because I don't really understand the myriad factors which affect REITs and their valuations, including RNAV, Debt levels and yield hinging on rental reversions etc. It makes it a little too difficult for me, so I'd rather stick to something I am more comfortable with - non-REITs and Property counters with cyclical cum "lumpy" earnings and cash flows.

Still, I am always learning more and perhaps I can revisit this area again some time in future.


Musicwhiz said...

Hi Black Cat,

There's no info on Setsco's revenue breakdown by industry, but I feel they have competencies in various areas which do not just include construction. Their new associated company in the Middle East offers many services which should encompass more than just construction (by inference).

Also, as to whether it is contract-based, I doubt it. Just as vehicle inspection is not contract-based but it part of an ongoing revenue stream, I believe Setsco's non-vehicular inspection services are also ongoing and not subject to contracts. One reason for my deduction is that Setsco would have announced such contracts had they existed, but a trawl through VICOM's last 5 years of announcements shows no such trend of announcements, and neither have the Annual Reports alluded to Setsco's services being contract-based.

Hope this helps!


hiflyer said...

hi- i took a quick look at your portfolio and also remember some of your postings on shareinvestor, no offence but i think you are still in very early stage in your journey as you seem quite confused on what to buy- you have/had a smattering of poor cyclical small caps like ezra which you confused with value picks and luckily got out, then you went into poor busineses like grp just because they have cash- a BIG BIG misrake, which you seem to have realized now, you then have the worst managed reit of all suntec, suggest you get rid of this before you get burnt, you are making the typical mistakes of so called value investors you often see in forums, just list a few of these

1. you "value investors" seem to be mesmerized by a net cash b/s not realizing the simple fact that it is because their business is fundamentally bad/deteriorating or they lack confidence, also a big big mistake novices and sometimes experienced investors make is that they think the cash belongs to them.. think carefully about this and you willundestand what i mean, if you want to really buy net cash companes nothing wrong with this but sticks to blue chips like keppel, sembcrop, st engnr etc, SIA engnr is also good

2. another big big mistake is finding some obscure stock with a low pe and thinking they have discovered a gem just because they made profits for 2 or 3 yrs- think tiong woon or tat hong

3. confusing cyclical stocks with value

4. diagnosing b/s and income statements line by line thinking they are going in-depth, this is the mentality of a finance manager , to make money in stocks you need to think like a businessman

5. buying extremely hi risk companies like MTQ which depend on project wins to generate cash, NEVER PAY more than realistic book value for them, dump MTQ before you get burnt, the owners have long made their money and are now making high risk acqusitions at shareholders expense..

anyway, your value oriented attitide is the right one, long way to go, all the best!

Musicwhiz said...

Hi hiflyer,

First and foremost, let me thank you for your very detailed and constructive comments. It’s much better for me to read constructive criticism about my choice of companies than to hear from readers who just agree without detailing their reasons for agreement or objection. In your case, you’ve provided clear and concise reasons, although I admit some of the points may be based on an incomplete understanding of the methodology I use to invest. This is what I hope to explain in the points below, so please bear with me.

I guess first of all, I should stress and reiterate that I am not an experienced and “polished” value investor. My journey only began in late 2007 after reading and applying Ben Graham and Warren Buffet’s techniques; and at the time I was already holding on to Ezra, Swiber and China Fishery, which you should be aware do not fit value criteria at all since they have high capex and lousy Balance Sheets. Along the learning curve, I picked up Tat Hong because of its (seemingly) strong economic moat which I later discovered to be illusory as the industry was too fragmented for it to have such an advantage, both in market share and pricing. So I would classify that as a mistake which aspiring investors make along the journey. As for GRP, yes you are definitely correct to spot that as a “classic” mistake in thinking a huge cash pile makes a good value investment – I had since identified and blogged about this and will ensure the mistake does not get repeated. I live and learn and will become a better investor as a result of these oversights. The one factor which motivates me is that at least I had not repeated the same mistakes I made for Ezra, Swiber and China Fishery in my latest stock picks.

To tackle your statements one by one:-

1) A net cash balance sheet may not mean much by itself, as every company in different industries has their own comfortable level of gearing, while some can operate seemingly without any debt at all (e.g. VICOM, SIAEC). I do not agree that this implies their businesses are deteriorating or bad or that Management lacks confidence in deploying the cash. For Boustead’s example, the cash is lying around because of Management’s stringent criteria for M&A. The cash, of course, does not technically “belong” to shareholders unless Management chooses to increase their dividend, but after thinking about it I do not think it’s right to also assert that just because the cash is languishing, it means there must be something wrong with the Company per se.

2) For this, you are talking about a value trap. I am mindful of these supposedly low PER stocks which are trading at such low valuations for good reasons.

Musicwhiz said...

3) I’ll admit companies like ship-building, construction and real estate are cyclical, but thus far the only one I got confused was Tat Hong; therefore I am in agreement with what you said.

4) Actually as an investor I do not dissect BS and PL line by line. I should know this since I work s a Finance Manager, thus I understand what it means to go analysing stuff line by line and it’s simply too micro and “accounting” for it to work. As an investor, I think like a business owner and I look at certain numbers within the statements, and analyse key ratios.

5) Your view of MTQ is interesting. Their work and revenue flow is NOT contract-based and this was reiterated many times by the Company as they are essentially servicing equipment such as BOP for the O&G industry. Their Engine Systems Division is also not contract based as it is selling engines and turbochargers, so am unsure why you feel MTQ is a contracts-based company similar to Ezra and Swiber. From your tone and language you sound very negative about MTQ without providing more concrete reasons. Yes they did gear up significant for their PSL acquisition, and have done three M&A for Engine Systems. From my analysis and questioning, these businesses are all cash-flow positive and PSL has no debt on its Balance Sheet. To classify it as a “risky” acquisition based on 4.7x PER just because the Group had to gear up sounds a little flimsy. Many other companies gear up for acquisitions and as long as the gearing is manageable and the Group generates good cash flows, I feel it is a justifiable investment. Anyhow, I have just added a small additional stake at 90 cents, pending the outcome of Bahrain and PSL.
Thanks for your encouragement – I am sure the journey will be rough and bumpy along the way; but most importantly, I am enjoying the process and also the experience of being an investor. I definitely don’t claim to be a good investor, but I dare say I am one who can reflect and admit to my (many) mistakes and will endeavour to be much better over time.


Black Cat said...

Hi MusicWhiz,

Thanks for your answer. It must have been a lot of work to trawl through the last 5 years announcements! So it appears that their business is either recurring (e.g.: maintenance) or else they are a large number of standardized, smallish transactions (i.e.: no need to announce).

Musicwhiz said...

Hi Black Cat,

I think it is probably the latter.