Monday, October 17, 2011

Boustead – FY 2011 EGM Highlights Part 1

October 13, 2011 was the date for Boustead’s EGM, and I took time off to attend this meeting. There was not much in way of resolutions for discussion in this post, but the reason for taking the time to go down and visit the Company was to learn more about how the business was doing, how the Company would cope in the current economic climate, its plans and strategies for growth and also to clarify various aspects of the business since the AGM which was held on July 22, 2011. As can be seen in the photo above, the meeting was held once again at Boustead’s headquarters at Starhub Green located at Ubi Avenue 1. The photo below shows a close-up view of Starhub Green. Fortunately it was a bright and sunny day and I had no problems navigating my way through to Starhub Green from the main road after alighting from a bus near ITE.

General Observations

The EGM was held on a Thursday afternoon at 3:30 p.m., so there were markedly less people attending this time as compared to the AGM. I recall that the AGM saw about 60 to 80 people turning up, and the boardroom was pretty packed with people as the chairs were arranged literally side by side with little room to manoeuvre, and this was made worse by two rows of tables on which the buffet food was placed. Fortunately, for this EGM the crowd was smaller at about 30 people or so, mostly made up of retirees. There were a number of younger folk who were seated across the BOD and who kept the EGM session abuzz even after the formal business of the meeting was concluded by asking pertinent questions about the business – more on that later.

On Restricted Share Plan 2011

Some shareholders had asked for clarifications regarding the merits of the proposed restricted share plan (the “Plan”) to be implemented and vetoed at the current EGM. Note that this new share plan is supposed to replace the old scheme of ESOP (Employee Share Option Plan) which had been in force for the past 10 years and which recently expired in August 2011. One shareholder had suggested that the plan would be flawed because share options may be issued at a time when the share price of Boustead was significantly under-valued with respect to its intrinsic value, and thus the scheme would unfairly favour these employees by giving them a lower strike price. Once the share price rose, they would then be in the money and would cash out and enjoy a significant “bonus”.

The newly appointed independent director Mr. John Lim served to correct the misconceptions surrounding the Plan. First of all, the BOD was still in discussion as to who specifically would qualify for these shares as they had to be key personnel (e.g. head of divisions, CEOs of various companies within the Group who had a say in planning, optimizing resources and strategizing). Secondly, there were stretch targets (which served as KPIs) which had to be positive and be over and above what was expected of the employee or director. Some examples of these targets were ROE, return on assets and Economic Value Added; and they are measured over a period of time so as to ensure consistency and that the performance was not a once-off “fluke” shot. Thirdly, there was also a “vesting period” clause for the Plan, such that the employee had to ensure that he stayed for number of years with the Group in order to enjoy the full vesting of the shares. Should he leave the employment of the Group at any juncture, there is a retention formula which would be activated to compute how many shares he has to return back to the Company as Treasury Shares. Fourthly, the shares which are awarded cannot be traded in the open market and can only be held by the employee for dividends. Thus, there is an incentive for the employee to enhance the value of the Group through metrics such as higher ROE and net margins in order to increase the intrinsic value (and by extension, the market price) of the shares, such that he would be eventually be able to sell them for a tidy profit should he eventually decides to leave the employment of the Group.

Two groups of people would be considered for this Restricted Share Plan 2011 – directors (both executive and non-executive, with the exception of Mr. FF Wong), and the associates of the controlling shareholder (namely Mr. FF Wong’s sons Mr. Wong Yu Long and Mr. Wong Yu Wei). To eliminate possibilities of favouritism, all share awards would be transparent and announced during every AGM (with reasons for award, amount of shares awarded etc). Independent shareholders (those with no vested interest in the award) can then vote during the AGM on whether or not to reward the said employees/directors with said shares. The whole process is meant to be meritocratic and transparent and will align the interests of the awardees with those of shareholders for the long-term prosperity of the Group.

On the Economy, M&A and Cash Deployment

Mr. FF Wong went on at length about his views on the current economic climate. He feels that the current solutions being proposed by the European Union are simply delayed tactics, and not a cure-all solution to the problems plaguing the Euro-Zone. He believes the problems will drag on for quite a while and the economy will remain in the doldrums for the medium-term, with probable contagion effects spreading to Asia and the world in general. This fact, coupled with the troubles still ongoing in USA and the seemingly hard landing and high inflation experienced in China, would throw up opportunities to acquire assets and companies on the cheap. Thus, Boustead is looking out for potential M&A which would enhance the ROE of the Group; as the Group is now sitting on a net cash balance of S$200 million which is generating a measly return of just 0.5% to 0.6% (as verified by Director Mr. Tong Weng Leong).

He also stated that during the last crisis of 2008-2009, the surprising thing was that no banks had pulled the plug on any businesses in Singapore in terms of the loans which were extended to these businesses, as a co-ordinated effort by major central banks around the world injected massive liquidity into the economic system and provided the oiling necessary to restart business activity which had previously been halted through fear and trepidation. Mr. Wong was admittedly surprised that the crisis, though deep, had failed to throw up any bargains for Boustead to capitalize on. For the current crisis though, he believes that it may finally create opportunities for Boustead to deploy their cash hoard, and this is the purpose of him keeping such a large cash stash; in readiness for such juicy opportunities which only present themselves during periods of economic distress.

Note too that Boustead maintains a cash management program utilizing about S$20 million to purchase short-term high-grade corporate bonds yielding about 6% per annum. However, due to prudence and liquidity issues, no more than $20 million can be deployed for such purposes.

On Libya and making mistakes

The situation in Libya has somewhat stabilized but intermittent and sporadic fighting is still going on, without a clear and forceful resolution to the conflict. One shareholder did query the Management on its decision to enter Libya (a similar question was asked during the last AGM) and wondered if Boustead had adequate risk management procedures in place. Mr. Wong (and Mr. John Lim) replied that risk management was very much a part of Boustead’s culture, and the returns from undertaking the projects were carefully calculated before the Group went into Al Marj to construct the Township and municipal wastewater plant. However, the events in the Middle East and the subsequent unrest which spread from Egypt to Yemen, Bahrain and Libya were unexpected and even the CIA could have not predicted that events would turn out as they did. Boustead has worked in Libya for years and for countries ruled by “strongmen” it would imply that they were more politically stable – but alas this was not to be.

The previous Libyan government under Colonel Gaddhafi still owes Boustead about $50 million, and full provisions have been made for all assets and equipment except for two corporate guarantees, of which injunctions had been sought and successfully granted under the clause of “Force Majeure”. Boustead will do their utmost best to try to recover whatever they can from Libya, but until then the amounts would have to remain written off and I guess shareholders should also not expect too much.

A related point which another shareholder brought up was that of the Big Box project which Boustead had abandoned with TT international some time ago. Apparently, until now there was no one willing to partner with TT to inject funds into the Big Box project, and Mr. Wong laughed and stated that this showed that their decision was right to pull out of the project, on hindsight. So asked shareholders not to just judge Boustead’s track record of making mistakes solely on the Libyan crisis, but also to note other instances where the correct decision had been made.

On Boustead Projects, and Design, Build and Lease plus turnkey projects

Regarding Boustead Projects, another shareholder noted that for the last three months, most of the contracts secured were those of design and build, with contract amounts being small to medium (in the S$15 to S$20 million range). The pertinent question is whether Boustead was still continuing talks and discussions to grow their leasehold asset portfolio, which was perceived to be much more important as it would build up a recurrent stable of income for the Group as opposed to short-term “lumpy” contract deals. Also, as FF Wong pointed out, the order book which stands at S$320 million today only includes design and build deals, and does not include the design, build and lease (DB&L) projects. The thing about DB&L projects is that they do not show up immediately in the bottom line (P&L), but will be capitalized as an asset on the Balance Sheet; and cash flows will only come in once the property is completed and leased out to the client.

The superiority of this model, however, is that Boustead actually owns the asset and is able to sell it to a REIT if need be, thus unlocking value for shareholders and realizing potential capital gains. With more and more REITs proliferating the market in recent times, FF Wong mentioned that these provided ample liquidity for Boustead to sell off its industrial leasehold assets if need be, and most of them would enjoy a significant premium to cost. In the interim, the Group would continue to benefit from recurring revenues and cash flows from the long-term lease of these properties to the client/tenant. With Design and Build projects, the Group did not own the property and thus would not be able to unlock further value from them once they are completed.

Boustead also has one turnkey project with SDV Logistics in which a separate subsidiary was incorporated in order to own the asset (property) in question. The revenue would be recognized on a deferred income basis based on completed contracts recognition in FY 2013, and the sale of the asset would thus be classified as a disposal of a subsidiary (within the Group) and subsequent gain on disposal, rather than as project/contract income recognized within Boustead Projects division.

This concludes Part 1 of the EGM highlights. It was originally supposed to be just one single post but somehow or other when I started typing out my thoughts it became rather lengthy and drawn-out; therefore I decided to split it into two separate posts so as to note bore readers. I am still endeavouring to write more succinctly and to be able to incorporate more information using less words, but occasionally I will get carried away with too much to say and end up writing a huge chunk.

Part 2 will focus on the divions of Boustead and some comments I received regarding them, and also detail some of my thoughts on Boustead’s dividend policy, share buy-backs and cash deployment. Finally, I will share what FF Wong mentioned on the value of the Boustead Group and how this has implications on my investment in Boustead.


GF said...

great post mw!
I own boustead as well, and agree with almost everything you have written about it (not just in this post but in previous ones as well)

I didn't attend the EGM due to work, but will definitely hope to see you during the other AGMs. Thanks for sharing the info!

I share your investing philosophy, and in fact, I find your previous post about your investing journey very similar to mine. Even our portfolio size is pretty similar, although the only company we have in common is Boustead.

I will look forward to your part II. Thanks!

Musicwhiz said...

Hi GF,

Haha hope to see you too at the AGM next year.

It's good to know that you also embrace the value philosophy. Would you mind sharing some of the companies which you own shares in? Are they listed locally or on other stock exchanges? It would be useful and educational for me to know what criteria you use and screens you employ to sift out your companies.

Part II should be on its way before the end of the month, stay tuned!


GF said...

Hi Musicwhiz

A large proportion of my funds are invested in Boustead Singapore (As you already know), Asia Enterprise Holdings (Steel stockist company) and Metro holdings (Famous for its retail but most of the profits are actually derived from property development in china)
If you look at all these companies, they are all extremely undervalued, with low or minimal debt. The debt is also only taken up due to property purchases i.e. mortgage loans. Their actually operations itself is pretty much self sustaining.
For retailers i tend to use DCF valuation models.
As for overseas companies, I own Wells Fargo even though admittedly, I understand their books much less. But they look very undervalued to me currently. They are still gaining market share even as their traditional competitors like BOA are scaling back operations, especially in consumer and retail banking sectors.

Musicwhiz said...

Hi GF,

Thanks very much for sharing the companies within your portfolio. I am unfamiliar with steel (therefore I avoid) and I've mostly known Metro for its retail, rather than property; but it probably is worth looking into. Appreciate the sharing.

Just curious though - why do you use DCF model for retailers? I would have thought that cash flows are very erratic for retailers as their sales will be seasonal, and the industry usually also has low barriers to entry. DCF in my opinion seems more suitable for Business Trusts like K-Green Trusts as they own assets with a steady stream of cash flow.

Wells Fargo is a company in which Warren Buffett is vested in, if I am not wrong, and it is a bank. But why do you feel it is undervalued? Due to its business model or some other aspects?


GF said...

Hi MW,

I use DCF for retailers that have consistent profits over a number of yrs. Also, I look at their cash flows on an annual basis, so that evens out the seasonal part. Yes, retailers tend to have low barriers to entry, so I look for retailers that manage their inventory turnover and outstanding credit tightly. I agree DCF is probably more suited for trusts, but I do not invest in REITS and trusts so I don't have much information on that.
Wells is very hard to value at this point (at least for me)
But they are still making a decent profit on their loans, despite their net interest margin narrowing slightly to just under 4%, i.e. the difference between its cost of borrowing and what it gets from loans. I feel that at a time when its competitors, (mainly in the consumer and retail banking sectors) are scaling back, wells is busy taking up market share.
They are also in the midst or rather, completing the integration with wachovia, and I'm optimistic that there'll be more cost savings in the coming quarters to add to profit.

Musicwhiz said...

Hi GF,

OK, guess I am not very good qith retailers so I will take a pass with them haha. Nice to learn about your methods.

As for Wells Fargo, I always had problems understanding the intricacies of banks and how they earn their money. I guess traditional banking will simply look at the Net Interest Income, but are there other factors involved? Banks are usually also the first to be affected by any economic malaise or crisis of confidence, but most Singapore banks are well-capitalized. Not sure for USA banks, though, so I can't comments.

I think I will take time to learn more about banks. Thanks for the heads-up!