Pacific Andes - Rationale for Divestment

I sold off my entire stake in Pacific Andes today, capping a three-year long investment which saw one round of capital injection; and which resulted in a significant 38% loss. Even though the Company had announced a decent set of full-year (FY) 2009 results, with net profit attributable to shareholders up 38% to HK$664 million, the nail in the coffin came with the announcement of a fresh rights issue, coming hot on the heels of a previous one in March 2007. The offer this time was a 1-for-1 rights issue at 15 cents per share (a 50% discount to the last closing price of 30.5 cents) with additional warrants attached (1 warrant for every 5 rights shares subscribed for, exercise price 23 cents). The rights were supposed to raise about S$228.6 million while the warrants could potential add another S$70.1 million to the Company's coffers.

So one might ask - why is this the "nail in the coffin" ? Presumably, if I had wanted to increase my stake in PAH, I could have done so at 18 cents back during March 2009, but hesitated from doing so. In fact, a cursory glance at PAH's business model and financials would not leave one surprised as to the timing or magnitude of the rights issue. While I had previously added more PAH back in 2008 at a price of 44 cents, I had failed to take into account the inherent business model flaws which would precipitate a full-scale rights issue, and apparently Management also "forgot" about the massive dilutive impact of such a fund-raising exercise on both earnings and (future) dividends per share. Some of the reasons for my divestment are stated below in point form for easy reading and reference.

1) Paid too high a valuation - This fact was apparent right from March 2006, when I first purchased the company at a high price of 81 cents (pre-rights). It was probably valued at around 8-9x historical PER at the time, and I had neglected the fact that it was in SCM and trading and was a high volume-based business, but more on that later. The rights shares issue back in March 2007 were offered at 52 cents, seemingly a juicy offer since my purchase price was a high 81 cents. In August 2007, I continued to purchase more at 61 cents to further average down my cost. This was till July 2008 when I added my last round of PAH at 44 cents, giving at least 8 good reasons for doing so. Since I could justify my purchase so succinctly, I could also figure out what I had omitted to make this such a glaring error. All my reasons and rationale had not accounted for the Balance Sheet weakness of PAH and its business model which I shall elaborate on later. Taking the FY 2009 net profit of HK$664 million, it's about S$132.8 million. Dividing this by 1.391 billion shares gives an EPS of about 9.54 Singapore cents. At the current price of 35.5 cents, the PER is about 3.72. This may seem undemanding at first but considering the dilutive effects of the rights issue, the share capital base will "expand" to 2.8 billion shares and EPS will be halved. Thus, it does not seem like such a bargain any longer.

2) Holding Company Effect - PAH suffers from this effect which means it derives most of its value from their investment in another company, namely China Fishery Group Limited (CFG), in which I am also vested. It holds a 64.1% stake in CFG and works closely with CFG in its SCM and Trading business. However, PAH itself does not have the hard assets which CFG has. This means that much of its valuation is derived from the valuation of CFG; and CFG is the main downstream revenue generator as it is the Company which catches the fish. Hence, PAH is involved in a very high volume-based business (not unlike Noble or Olam) in which net margins are very thin. In fact, it can be readily observed that PAH has a net margin of less than 10% based on FY 2009 results, while CFG has a net margin of 26% based on 1Q 2009 results.

3) Lack of Tangible Assets limits collateral for loans - The rationale for PAH to raise funds is to provide for working capital needs (see point 4 as well). Notice that the company had NOT managed to secure any funding through bank loans and the CEO commented that it was difficult to do so during this harsh credit crisis. Yet, a quick glance at CFG shows that CFG had recently (in 1Q 2009) obtained a US$60 million bank loan to finance its expansion into the South Pacific Ocean. The reason for this is the lack of tangible assets belonging to PAH which can be used as collateral for loans. Previously, PAH would have used shares in CFG as collateral to banks, but during this severe credit crunch, banks are more cautious when lending and would prefer tangible assets such as fishing vessels and inventory (such as fishmeal) as collateral, all of which are owned by CFG and not PAH.

4) No clear objective for Fund-Raising - Most companies which issue rights have some specific objective in mind. Capitaland and its REITS CCT and CMT raised funds to pay down debts and to act as "pre-emptive" capital for M&A opportunities (or so they claim). Other companies raise funds to (presumably) capture opportunities for expansion and growth as there are many assets out there selling at distressed levels. Such cash is vital for taking advantage of opportunities. PAH only said that the cash was to be used for working capital, which I assumed to be for normal operating expenses and for daily use. This implies that the Company was short on cash for the normal operations of the Company, and did not have a specific objective for the cash, which makes the fund-raising all the more suspicious. It is CFG which has the clear growth strategy, with its elongation of vessels, deployment of vessels to the South Pacific, as well as introduction of ITQ. Therefore, it can be clearly seen that CFG's business model is very different from PAH as it has high net margins, high cash generation ability and has clearer scope for expansion.

5) Lack of Catalysts for Growth - As mentioned before, much of PAH's "growth" can be attributed to its 64.1% stake in CFG; hence its "value" hinges upon the value of CFG. This in itself is a very risky proposition for investment as the Company itself has no objective, clearly-derived value for which one can make a value proposition. Its SCM business can be likened to a commodity business as SCM models are essentially the same, are volume-driven and suffer from thin margins. This fact, coupled with the lack of tangible assets and the Company's excessively high gearing, made for a poor investment choice.

Unfortunately for me, I had to learn from this mistake the hard way - by taking a substantial loss by selling at 34 cents per share. But this mistake actually offers me better insights as to how to value a company, what to avoid, things to watch out for and more facets to consider when assessing if a company is suitable for long-term investment. The cash call was a timely reminder to me that this mistake had been made 3 years ago, and finally the time has come to divest of this mistake before it became a full-blown debacle. The opportunity cost of NOT divesting can sometimes be greater than the actual financial loss from divesting sooner (rather than later). Because of my reluctance to take a larger loss on this earlier (Oct 2008 through March 2009), I also omitted the chances to recycle the cash to other more promising companies like Boustead and Tat Hong. Thus, my mistake is two-fold and I feel mortified.

Moving forward, I will seek out more opportunities to purchase under-valued companies at attractive prices and a decent margin of safety; and will pay special attention to Balance Sheets and business models, as well as the fact that the companies I own are supposed to provide me with money (through dividends) and NOT keep asking me to pump in money instead ! I shall endeavour to pick myself up from this mistake, dust myself off and move on. I treat this as a good (though painful) learning experience, and promise not to make a similar mistake in future.

Note: This realized loss will be reflected in my May 2009 portfolio review as an offset against realized gains (currently standing at S$12.8K) and I shall cease all coverage of Pacific Andes from now on. Readers can access archives for PAH but all further updates shall be confined to CFG (which I still own).

Corporate Results Announcements

As I have a serious lack of time, I will not be doing reviews for ALL my companies which have released results recently, but will just focus on one or two. I've realized that it takes a lot of effort to analyze and post all the analysis here on my blog, when actually one should be more concerned with the long-term prospects of the businesses rather than staying too focused on quarterly results. That is the domain of analysts, whose job is just to churn up reports based on short-term forecasts (yes, 1-year price targets are considered short-term !).

Tat Hong Holdings Limited

Tat Hong released their 1H FY 2009 results on November 12, 2008. Revenues for 2Q 2009 rose 15% but this was offset by higher COGS (increase of 20%), resulting in gross profit increase of only 5%. Profit for 2Q 2009 dipped 3% from 2Q 2008; but looking at half-yearly figures, net profit increased a decent 25%. The Company declared an interim dividend of 3.5 cents per share, payable on December 12, 2008. At my purchase price of 71.5 cents, this represents an interim yield of 4.9%. I will be doing a more detailed review of Tat Hong's financials and prospects in due course, as I have quite a bit to say about their various divisions and also for their regional prospects in the longer-term (up till FY 2012).

Swiber Holdings Limited

3Q 2008 revenues surged 186.5%, while COGS increased an even heftier 247.3%, resulting in a 68.4% rise in gross profits. As a result of lower exceptional items for 3Q 2008, net profit fell 7.4% while profit attributable to shareholders fell 18.7% on quarter. For 9M 2008, profits increased a healthy 58.9% to US$47.1 million, and this already more than covers the entire FY 2007 profits. During bear markets, analysts love to focus on the negatives, and I am sure the "surprise drop" in profits of 18.7% on quarter will be mentioned many times. Putting things in perspective, the lumpy nature of contracts and the increase in headcount and administrative expenses as a result of business expansion into the region probably added quite a bit to Swiber's cost structure, as did the finance expenses on their bank loans and bonds. While this is not good for the company in the short-term, in the longer-term their asset-light strategy and their larger spread of vessels will help to snare them larger contracts which are hopefully long-term (e.g. is the CUEL 5-year contract for US$50 million per annum).

Their Balance Sheet is healthy with gearing at about 1.06 and current ratio >1, thus there is no immediate cause for worry as their debt is not due till FY 2011. Their cashflows from operating activities is also healthy at US$19 million for 3Q 2008, though the bulk of their cash inflows still came from the raising of more banks loans worth US$74 million. Still, there is probably more visibility now in terms of operating cash inflows, and the Company will take a more cautious stance towards expansion, and has put their deep-water plans on hold until oil prices firm up in future years. Prudence will see the company through these lean times, and they should emerge stronger and more ready for challenges by FY 2010. I will NOT be writing a detailed review on Swiber.

Using US$47.1 million at an exchange rate of 1.50 to the USD, EPS is about 16.76 Singapore cents per share for 9M. If annualized, EPS will be about 22.35 Singapore cents. At today's closing price of 61 cents, this values the company at a mere 2.73 times PER.

Pacific Andes (Holdings) Limited

Revenues for 2Q 2009 dipped 4% while gross profit dripped 12.6% due to higher fuel costs and also the supply chain management division getting disrupted due to the Olympic Games. Net profits decreased by 16% on quarter and about 16% for 1H 2009 too. However, due to PAH's increased stake in CFG, profits attributable to shareholders rose 18.5% on 1H FY 2009 compared to 1H FY 2008. Management has reported that fish product prices have risen 10-20% due to increased demand during the economic slowdown (hey, people still have to eat fish right ?). Due to the deployment of less fishing vessels to the North Pacific, they suffered a temporary drop in fishing volume which will be made up in 3Q 2009 (4Q 2008 for China Fishery).

Higher fuel costs were also cited as one of the reasons for the fall in profits, which was largely in line with what I expected. Fuel prices have since dropped to around US$56 per barrel and are likely to remain low for as long as the recession does not blow over. Thus, this should ease the gross margins for CFG's fishing division. Catalysts for profit growth in 2H FY 2009 will include measures taken by CFG to fish for more catch and also for deployment of their elongated vessels to the North and South Pacific. In CY 2009, higher total allowable catch (TAC) is also expected as fish supplies have remained healthy due to sustainable fishing practices. There will be NO further review from me for PAH's 1H FY 2009 results.

China Fishery Group Limited

Revenues for CFG were up 3% for 3Q 2008 and 8.4% for 9M 2008. However, net profit dipped by 28.1% on quarter due to the problems mentioned in PAH's review - higher fuel costs and deployment of vessels to defer catch volume till 4Q 2008. As a result of these, lower volumes of fish were caught even though prices had risen. Gross margin for 9M 2008 was high at 34%, while net margin was a respectable 22%. The Group managed an 11% rise in 9M net profit to US$78 million. Assuming oil prices remain at current levels, and CFG replenishes the fish which they had failed to catch in 3Q 2008, this means that annualized profits should hit about US$104 million. Using exchange rate of 1.50 to the USD, annualized EPS will be about 20 Singapore cents. Using closing price of 61 cents, FY 2008 PER is just about 3 times. Considering their revenues are consistent and recurring (unless the ocean runs out of fish !), this is a very low valuation for a good fishing company to trade at, which is one example of Mr. Market's mood swings.

Net cash from operating activities was a healthy +US$42 million for 3Q 2008, and +US$60.1 million for 9M 2008. Net increase in cash was US$23.2 million for 9M 2008 after factoring in acquisition of PPE and subsidiaries. Net gearing improved to 92.9% from 108.3% as at December 31, 2007. Prospects are decent for CFG as they are expanding their number of vessels and also elongating their existing ones to increase the fish hold capacity. When the ITQ is implemented in Peru in FY 2009, this should provide a further boost to prices as quality of catch will improve. I have also noted the Chairman Ng Joo Siang's plans to eventually branch out to catching krill by FY 2010 and hope that they can implement this as an additional revenue stream. I hope to get more updates on this at the next AGM. Meanwhile, I will provide no more further analysis on CFG until the FY 2008 results are out some time in Feb 2009.

Boustead Singapore Limited

Boustead released a decent set of results today, underscoring their slow but steady growth in all divisions despite the economic downturn. Since I will be doing a more detailed review of Boustead's 1H FY 2009 results, I shall not say too much during this post. Suffice to say that the Company has grown all divisions decently, and has a net cash position of S$117.6 million. They have declared an interim dividend of 1.5 cents per share (a yield of 2.6 cents based on my purchase price) which is payable on December 18, 2008. On a comparative basis, after removing one-off items, net profit attributable to shareholders improved 30.2% to S$15.2 million.

One must note that the Company usually does better in 2H of the financial year and shows weaker financial results in 1H. Thus, due to their lumpy project nature of their revenues, it will not be wise to annualize their net profit to derive a valuation as it would be misleading. Also note that the sale of a leasehold property will net the Company another S$200 million in 2H 2009, and this should result in a very decent final dividend for FY 2009. I will be doing a detailed breakdown in a future post for Boustead, and discuss possible strategies which the Company may take to grow their top and bottom line.

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Stay tuned for more posts coming on Investment Sins, as well as a continuation of the Behavioural Finance series. I am also planning a future "Your Money and Your Brain" series after reading the book by Jason Zweig, to draw out snippets to illustrate the fascinating relationship between money and our own brains.

Pacific Andes – A Discussion of the Scrip Dividend Scheme

The circular for the proposed scrip dividend scheme implemented by Pacific Andes (PAH) had just arrived yesterday, and I spent some time reading it and digesting the facts; and some more time after that lying in bed thinking about the ramifications, possible effects and choice to be made. Suffice to say that this scheme is new to me as well as I had never invested in a company which came up with a scrip dividend scheme before, and I am now analyzing this scheme using my own understanding of how it works (as described in the circular) as well as my own personal interpretation of the merits and demerits of this scheme.

First of all, some of the salient points in this scheme should be mentioned:-

a) The scrip dividend scheme is optional. This means that shareholders can opt for the cash dividend or for the scrips, depending on their preference. They can also issue a standing order for all future dividends to be paid out as scrips, which can be terminated at any time in writing should the shareholder wish to revert back to receiving the dividend in cash.

b) You CANNOT elect to opt for only part of your holdings to be paid in cash, with the rest in scrip. This means that you either choose for ALL of your shareholders (as at books closure date) to be paid fully in cash or all in scrip (additional shares of the company). Unless one receives more than one Notice of Election (NE), this is not possible and anyway it would be an administrative nightmare should the company allow for this.

c) The computation for the number of scrips issued is based on the formula X = (A x B) / C, where X is the number of scrips issued, A is the shareholding as at books closure date, B is the dividend per share declared (net of corporate income tax) and C is the issued price of each scrip share. The interesting part is how C is computed, as A and B are known variables and are objective facts. The price per scrip is taken as the arithmetic average of the closing market price of PAH for the last twenty (20) market trading days prior to books closure date, with a maximum allowed discount of 10% to this price.

a. Note the word arithmetic is used and not weighted average, thus this means the simple average of all the closing prices taken from 20 days BEFORE the books closure date (i.e. not inclusive of the actual day of books closure);

b. 20 days is used as a benchmark seemingly to even out any fluctuations in the share price which may result from speculation or panic selling, and I think it is intended to assuage investors that they are getting a fair price based on market conditions;

c. A maximum discount of 10% is allowed to this average price, but is up to the sole discretion of the directors, which means this is the only wild card in the equation which cannot be determined by shareholders until AFTER books closure date. Thus, the discount can be anything from 2% to 10%, but of course everyone who chooses the scrip option hopes for 10% so that they can get the maximum number of shares for a lower price.

The analysis of these facts yields the following conclusions:-

i) By choosing the cash dividend instead of the scrip, one must believe that one is able to grow the amount of money which is received at a higher rate of return than that which PAH can provide. This is because choosing the scrip is actually a form of reinvestment of dividends, and is similar to what Berkshire Hathaway does when it chooses NOT to pay dividends but instead reinvests them for higher compounded annual growth. If one believes that one’s ability to grow his/her own money is better than that of the company, then one should choose to take the cash and reject the scrip.

ii) Choosing the scrip dividend has advantages to the company itself as well, as they would be able to conserve cash for reinvestment into the business and also grow their equity base at the same time. The amount of dilution to earnings will be very minimal and immaterial, and I think PAH’s intention to declare this scrip dividend was precisely for this reason – they are hoping more shareholders choose scrip over cash so that the company can conserve cash for expansion.

iii) Shareholders should also note that should they choose NOT to accept the scrip dividend, they will suffer mild dilution as the equity base of the company will grow but their shareholdings will remain the same. Thus, the pie will grow larger but your share of the pie (in percentage terms) will be reduced. However, the effect is not very pronounced and can also be considered immaterial.

iv) The choice will also depend on whether the scrip is being offered at a price which is attractive relative to one’s own cost of investment. I will use a hypothetical example to illustrate my point. Assuming Mr. T has 10,000 shares originally purchased at 60 cents per share. The arithmetic average of the closing price of the last 20 market trading days is about 48 cents per share (as at today). Hence, assuming a discount of 5% (to be prudent), this works out to be 45.6 cents per share. Mr. T would then receive a total of 453 scrip shares based on the final dividend of 2.07 cents per share for FY 2008. Thus, his total cost would now be S$6,206.57 on a base of 10,453 shares, which means his new average cost per share will be reduced from 60 cents to 59.38 cents. This simple example shows that this is one good method for averaging one’s cost assuming the final scrip dividend price is lower than one’s original buy price. One more additional plus point is that such scrip dividends do not incur brokerage costs or commissions and are free of transaction costs.

v) One negative aspect of this exercise is that one would almost surely end up with odd lots (i.e. shares which are not rounded to the nearest thousand which are traded as board lots on the SGX). This means that disposing of the additional scrip shares may prove a problem as one has to sell it in the odd lot market, which is generally more illiquid and has wider bid-ask spreads. However, if one adopts the perspective of a value investor and is willing to hold on to their additional scrip as the company’s value increases, then he will eventually reap the fruits of his patience.

Based on the analysis above, as well as my personal perspectives of the company and its growth potential, I will prefer to opt for scrip dividend. It allows me to increase my stake further to participate in the growth of the company, allows the company to conserve cash, allows me to average down my current cost and also prevents me from being diluted when others exercise their choice for scrip dividend.

Pacific Andes - Rationale and Reasons for Increase in Stake

On July 3, 2008, I increased my stake in Pacific Andes at an attractive price of 44 cents per share, thereby taking advantage of Mr. Market's manic and depressive mood swings. Below are a list of reasons (including some risk factors outlined) which underlie my decision to purchase more of this company. This move was a calculated and well-thought out decision and was not made on the spur of the moment as I had been studying and reading up on the company and industry since my first purchase, and have been waiting for Mr. Market to sell to me at an attractive valuation. Please feel free to criticize or discuss the reasons below:-

1) Pacific Andes is in an industry which has high barriers to entry. Only a few large players have access to fishery resources and many players are limited by the high capex which is required to operate a fishing SCM system and fishmeal plants. Smaller players only own a few vessles and cannot achieve the economies of scale which will make their operations more efficient; thus they risk being bought out in an industry consolidation (which has been occurring during the last few years). PAH also owns 64.1% of CFG which is growing its business with respect to its trawling operations and has expanded its activities and fleet through their 3rd and 4th VOA. CFG has plans to grow its revenues and bottom line which will enhance the earnings flowing to PAH.

2) Dividend yield is attractive at my purchase price of 44 cents per share as the final dividend declared is 2.07 cents per share. This translates into a yield of 4.7% which is 5.3 times better than the prevailing interest rate offered by Maybank’s iSavvy account (0.88%) where I am stashing my opportunity fund.

3) Peru had recently, on June 28, 2008, introduced the ITQ (Individual Transferable Quota) system, and this will be applicable for the next 2 fishing seasons once all the applicable regulations and legislation are passed through. The benefits of this system are as such:

a] Ensuring the long-term sustainability of fish sources and preservation of the environment – this move will prevent over-fishing and is good for the long-term future of the industry and for all players within the industry;

b] Austevoll Seafood ASA and Copeinca have both commented on the ITQ as opposed to the old method using the “Olympic” system. Austevoll says that this will ensure a move away from an “expensive” way of harvesting to one which is more focused and will reap economies of scale and improvements in the quality of raw materials and finished products. This would translate into higher prices for the industry overall as higher prices accompany higher quality. Copeinca has also commented that it envisions a 30-40% increase in EBITDA as a result of greater efficiencies in fishing processes and deployment of vessels (in a separate press release). However, one small downside is the imposition of a new fee of USD 1.95 per ton of fish unloaded which is to be set aside for the fisherman’s retirement fund (this also helps to build loyalty among the fishermen and minimizes strikes and riots which could disrupt operations);

c] The new ITQ system makes it easier to schedule and plan for vessels to be allocated to various fishing grounds as it is no longer a “mad rush” to fish as much as you can before the season ends and the quota is reached. Thus, this benefits all players within the industry as they can now selectively deploy their vessels and schedule them for maximum efficiency; further enhancing economies of scale.

4) In the last 2 quarters (3Q 2008 and 4Q 2008), there has already been evidence of PAH achieving better efficiencies in terms of lowering their COGS with respect to their revenues. The growth of revenue is greater than the increase in COGS, which implies economies of scale from the Peruvian acquisition of fishmeal plants and vessels should be kicking in and showing its effects. For China Fishery’s 1Q 2008 financials, the results are very dramatic in that revenues dropped 2% while COGS dropped 42.3%, thus it shows the dramatic efficiencies being achieved for CFG with respect to its new fishmeal business as well as trawling operations. The ITQ system should help to enhance this efficiency and make it even more pronounced, but this will take time (probably in 2-3 years).

5) Valuations are attractive as PAH is only trading at a historical PER of 6.2 times (using net profit attributable to shareholders of HK$481 million @ 1:5 divided by share capital of 1.35 billion shares to get EPS of S$0.0713). Compared to global peers such Copeinca which are trading at 10-12x, this makes Pacific Andes under-valued (perhaps due to the China inflation factor depressing the valuations of many S-shares listed on SGX, regardless of the nature of the business or inherent characteristics of the company).

6) Management has a good track record and understanding of the business and they have built up many years of growth for the company by using strategies to grow their fleet organically (through fleet enhancements) and through acquisitions. It is because of this track record that I have confidence that Management can steer through any rough patches (which any normal business will encounter). Many Chinese companies have just come into the market (in 2 to 3 short years of operation) and hence lack a good track record to justify purchase.

7) Management is planning to add a new revenue stream from July 2008 by deploying 3 upgraded super-trawlers to South Pacific to fish in Chile. They will target a new species (Mackerel) and a new market (South Africa). This will add to the company’s top line and hopefully, bottom line as well.

8) Mr. Dennis Chan has mentioned in an earlier interview that PAH intends to increase its investment in Peru, though he did not give details due to disclosure confidentiality requirements. The fishing industry there is still very fragmented (according to a discussion with him during CFG’s AGM) and there are many opportunities for PAH to acquire smaller players in order to boost their fleet.

Risks involved in this investment decision

9) Even though a key risk is bunker costs rising as a result of record high fuel prices, this is an industry which can raise prices without affecting demand too much as it is controlled by a few large players, and fish are part of the staple diet of much of the world’s population and also a good source of protein. Hence, I see short-term price pressures which may push down net margins due to high fuel costs; but the trend for fish and fishmeal/fishoil prices is upwards over time, due partly to food inflation and rising consumption of fish by the world. In the long-term, I believe this risk will be mitigated.

10) PAH has always had high gearing and finance costs are a major source of expense which will eat into their net margins. However, CFG and PAH are in a business with high operational cash inflows, as observed by their financials over several quarters (adjusted for some timing difference in recognition of receivables and inventories). Thus, I see this gearing as merely assisting them in aggressively expanding their fleet, which they can then use to generate FCF to pay off their loans, bonds and notes gradually. As mentioned in a previous posting on leverage, it is difficult to determine the optimal amount of leverage required for a company operating in a certain industry, unless we are keenly aware of how that industry works. For example, Olam is also aggressively taking on debt in order to finance acquisitions which are earnings accretive to its business, and which help it to vertically integrate. Thus, it can be argued that high gearing is not necessarily bad as long as the company knows how to properly manage it and not to let it get out of hand.

11) As a result of high finance costs and record-high oil prices (US$146 as at time of writing July 3, 2008), PAH and CFG could see short-term margin squeeze which would affect profits in the next few quarters. However, taking a long-term perspective, there is much to look forward to with regards to their business model and expansion plans as Management have a clear vision of what they wish to achieve and are NOT in a hurry to execute. Instead, they are adopting a more cautious stance amidst the current economic slowdown and choosing to conserve cash; while trawling out (mind the pun !) for quality opportunities to increase their asset base through acquisitions of vessels or plants.

My average cost has been reduced from 65.5 cents per share to 54.75 cents per share as a result of the purchase. This will be reflected in my next portfolio review due on July 15, 2008.

Pacific Andes - FY 2008 Financial Review and Analysis

This review and analysis was long overdue, I admit, but analysis takes time and I did not want to do an analysis that was too short and shoddy in case I missed out something important. As it is, there was recently an interview with Pacific Andes where CFO Dennis Chan gave updates on PAH's plans for CY 2008 and on how to tackle rising costs. More on that later.

Profit and Loss Analysis

For FY 2008, revenues were 32% up from HK$5.3 billion to HK$7 billion, while cost of sales only increased 26.3% from HK$4.3 billion to HK$5.5 billion. This reflects better efficiencies which PAH was able to employ in their operations, and gross margin improved from 17.8% in FY 2007 to 21.6% in FY 2008. However, selling and distribution expenses rose significantly (by 214%) as a result of higher expenses incurred in selling fishmeal and also PAH's expanded operations. Finance costs also ballooned to HK$402 million (up 76%) due to additional bank loans taken (HK$1.1 billion), coupled with the senior notes and convertible bonds.

As a result, net margin after tax for FY 2008 was 11.8%, when it could have been higher if not for the increased expenses. Still, it was better than FY 2007's net margin of 10.6% (after removing the exceptional item HK$385 million on gain on dilution of a subsidiary). Net profit after tax increased by 47.1% from HK$561 million to HK$826 million, reflecting the increase in business activity as PAH and CFG expanded their operations into Peru and into the fishmeal business in CY 2007. Profit attributable to equity holders increased by 25.2% to HK$481 million, and a dividend of 2.07 Singapore cents per share was declared. At my purchase price of 65.5 cents, this represents a yield of 3.16%.

Balance Sheet Review

For the balance sheet, the most obvious sign of PAH's increased operations is the increase in fixed assets to HK$1.6 billion, up from HK$864 million a year ago. This ws due to CFG acquiring 3 fishmeal plants and 11 additional purse seine vessels, plus the supply chain management division acquiring 2 reefer vessels to increase transportation efficiency.

Current ratio for March 31, 2008 stood at 1.52 versus 1.91 for March 31, 2007. The decrease was mainly due to higher short-term borrowings for PAH, increasing from HK$1.25 billion to HK$2.48 billion. Signs of increased borrowing are not always positive but as the (fishing) industry is capital intensive, I see it as a necessary evil for PAH to borrow so extensively. Whether or not this makes commercial sense, only time will tell and it also depends on Management's ability to utilize assets to generate more cash and earnings. A check on quick ration showed that it had dipped to 1.23 from 1.51 a year back. Cash position had improved slightly but this was mainly due to cash generated from financing activities, which means FY 2008 is a year of "borrowed money". Let's hope FY 2009 will see more cash flowing into the company from operations and investments, rather than financing.

Cash Flow Statement Review

Cash inflows from operating activities was weak at only HK$103 million, compared to HK$436 million a year back. This can be attributed mainly to the high finance costs paid for and much higher income taxes due to operations in Peruvian waters. As a result of this, there was substantially less operating cash inflows, and I hope this situation will improve when PAH releases their numbers for 1Q 2009.

Most of the cash outflow for investing activities went to acquire the additional stake in CFG, upping it from 28.8% to 64.1%. The company paid HK$2.37 billion for their increases stake in CFG. Seems expensive, until you realize that a lot of the value had crystallized from CFG into PAH as a result of the stake increase; and I think there will be long-term benefits coming from this increase in stake. Though of course the question remains whether PAH paid too much for their stake in CFG !

For financing activities, most of the cash came from 3 sources: proceeds from issue of convertible bonds, proceeds from 1:1 rights issue and additional bank loans taken up. This resulted in a net cash increase of just HK$53 million, and PAH are cutting it pretty close by raising just enough money for operations and investment. Since the acquisition of increased stake in CFG is a one-off event, I am not worried about future cash outflows to the tune of HK$2 billion ! Let's hope the company can manage to generate more free cash flows in time to come.

Prospects and Plans

PAH has highlighted several initiatives to grow revenues and to diversify its revenue stream moving into FY 2009. One of these is to deploy 2 additional reefer vessels to improve efficiency and increase performance, another is to send 3 upgraded supertrawlers to South Pacific Ocean for the fishing of new species, to be shipped to new markets. In the XFN interview with Mr. Dennis Chan on June 16, 2008, he mentioned that the aim of this deployment would be to ship 60,000 tons of Chilean Jack Mackeral to Nigeria (Africa). Africa would represent a new market for PAH but there are currently no plans to ship this species to China.

Rising fuel costs were cited as a major concern for PAH as their vessels and trawlers use fuel extensively to fish. I expect increased fuel costs to negatively impact margins in the next few quarters, with the result being a possible dip in earnings as the increase in revenues may not be able to fully compensate for the increase in cost of sales as a result of increased bunker costs. Assuming Management can control selling and admin expenses, net margins will probably dip and PAH may report lower earnings in the near-term. However, a long-term view of the business should see it sailing through the rough patches as it extends its footprint.

Mr. Chan also did not rule out potential future acquisitions within Peru as the fishing industry there is still very fragmented (he did mention this during the CFG AGM back in April 2008). PAH has managed to increase catch volume at Peru and Alaska, its 2 key fishing areas. Mr. Chan also alluded to the fact that PAH will have a "significant share" in the global catch of anchovies and Alaskan Pollock, though he did not provide further disclosure due to confidentiality reasons. I would conclude that it is prudent for one to be cautiously optimistic of PAH and CFG prospects, amid a high inflationary environment and high fuel costs.

Pacific Andes - 3Q FY 2008 Results Analysis and Review (Part 2)

To continue my review, I will be touching on Cash Flow Statement and prospects and plans for PAH in this post.

Cash Flow Statement Review

Please note that for my cash flow review, I will be referring to numbers for 9 months ended Dec 31, 2007 (not the 3-month figures as these are more short-term by nature).

Cash generated from operating activities continues to remain healthy, as cash inflows before changes in working capital came up to HK$958 million for Dec 31, 2007 compared to just HK$542 million a year ago. Their cash generation ability from operations is not the worrying section, but I am keeping an eye on their interest paid and income taxes paid, which saw a significant rise from a year ago due to higher financing costs and expansion of their operations.

Most of the cash outflows were from investing activities, as PAH had already announced their intention to raise their stake in CFG. HK$558 million was spent on acquiring property, plant and equipment, while a whopping HK$2.37 billion was spent on raising their effective interest in CFG from 28.8% to 64.1% ! This culminated in a total cash outflow of HK$3.43 billion, a 203.5% rise over the cash outflow of HK$1.13 billion a year ago.

For financing, PAH raised cash through the issue of convertible bonds and rights shares (at $0.52 per share cum-rights). This amounted to a total of HK$ 2.49 billion, and was used to pay for the acquisition of CFG. More monies were also raised through finance leases and bank borrowings too. The result was a net cash inflow of HK$2.57 billion for 9M 2008.

These cash flows are not reflective of the usual business operating conditions for PAH as they involve a very large acquisition of CFG which is funded by pure debt, equity and convertible debt. Thus, I believe it will be more indicative to review PAH's cash flow for FY 2009 after the acquisition has gone through, in order to assess its effects on cash.

Prospects and Plans

According to PAH and CFG, the global demand for fish is on an uptrend and will rise steadily due to consumers' increasing awareness of healthy alternatives to red meat, as well as steadily rising income levels for consumers in China which means that they have the spending ability to purchase healthier products which are fish-related. This trend should see PAH and CFG improving their revenues for the forseeable future as the demand for fish is a constant and growing one which is unlikely to die down anytime soon.

PAH increased their transportation fleet from 2 to 4 reefer vessels to enhance competitiveness and efficiency. I believe the Management will be looking out for other attractive acquisition opportunities to build up their fleet in order to further enhance capacity and hence improve margins through economies of scale. Their plans to commence fishing operations in the South Pacific Ocean in FY 2009 should see new revenue flowing in, and they will deploy 3 upgraded super-trawlers there. The re-structuring of the 4th VOA is also in progress to ensure it is on a prepaid charter hire basis and not daily basis. If all this sounds uncannily familiar, it's because I had mentioned it on CFG's FY 2007 review as well ! The two companies are very closely tied and thus information may tend to get repeated.

For their fishmeal operations, Management plans to acquire more vessels and fishmeal plants in order to increase their capacity for catch and also enhance their efficiency in having more locations for unloading their fish catch. However, of late, the sub-prime crisis in USA has made financing more difficult, which may be the reason for the slowing down of their acquisition pipeline. Still, I am confident of Management's ability to negotiate for quality assets at an acceptable price to enhance value for shareholders.

Finally, shareholders should also be waiting for more news and information on PAH's proposed scrip dividend scheme. I believe this should accompany the FY 2008 financial results announcement as Management had mentioned paying dividend just once, instead of an interim and a final one.

Pacific Andes - 3Q FY 2008 Results Analysis and Review (Part 1)

I know this review is long overdue, but I really haven't had time to get down to it till today. Anyhow, as my investments are long-term by nature, the fortunate thing is that it does not really matter if I analyzed it today, yesterday or even last month. The nature of Pacific Andes' business is not going to change overnight, or for the next 5 years for that matter ! As it is, they will probably be even more diversified (I hope !) in the next few years after announcing their intentions to expand their fishing activities to South American seas.

Anyhow, below is my quick and brief review for PAH's 3Q FY 2008 financials. Note that I will place more emphasis on the FY 2008 results once they are out by late May 2008.

Income Statement Analysis

For 3Q 2008, revenues were HK$1.11 billion, a 52% increase over the same period last year. However, economies of scale meant that COGS only increased by 40.3% over the same period, resulting in an increase in gross profit of 101%. GP Margins for 3Q 2008 stood at 24.6%, compared to inly 18.3% for 3Q 2007. For 9M 2008, gross margins were 20.7% against 9M 2007 gross margin of 17.1%. This clearly shows that economies of scale in PAH's fishing operations are beginning to bear fruit, as they are able to reap cost benefits from their enlarged fleet of purse seine vessels.

As a result of the issue of bonds to fund the increase in stake in CFG from 28.8% to 64.1%, interest expenses ballooned from just HK$57.7 million in 3Q 2007 to HK$111.3 million in 3Q 2008, an increase of 93%. For 9M 2008, the increase was 146.2% due to a low base for finance costs incurred in early FY 2007. As a result of this, profit before tax rose only 93.8%, less than the increase in gross profit but nevertheless still impressive. The fishing division (now bolstered) accounted for 55% of 3Q 2008 revenues, up from just 37.4% previously. China still made up the main bulk of sales (77.5% for 3Q 2008) and it remains to be seen if there will be pricing pressures for the Group due to the Government's announcements to combat inflation. Fish being a staple food item on Chinese menus may not make this effect too pervasive, but their next results update should mention something about their ASP (average selling prices) to hopefully be able to maintain their margins.

As explained in Note 8 (Page 10) of the result announcement, finance costs had risen due to interest attributable to US$93 million 4% convertible bonds, US$225 million 9.25% senior notes as well as increased short-term borrowings. The Group seems to have taken on a lot of debt in order to increase the contribution provided by the fishing division, and the effects of this additional debt are going to follow the company for some time into the future. I view this as part of PAH (and CFG's) expansion plan to increase their reach into the South American seas, and CY 2008 should be the year in which they manage to extend their footprint to these regions and also to add a new revenue stream to their business. As it is, it will be prudent to watch for their gearing, cash flows and financing costs in subsequent quarters.

Balance Sheet Review

The most notable increase within the Balance Sheet under "Non-Current Assets" belongs to PPE, and this increase is 77.4% from HK$863 million to HK$1,533 million. This reflects the Group's purchase of their additional stake in CFG and shows up CFG's related assets. Goodwill has also increased due to their acquisition of CFG.

Inventories have dipped slightly as this is the "low" season for PAH (4Q 2008 will be the peak season). Bills receivable has increased to HK$177 million in line with the increase in scale of operations and revenues. Current and Quick ratios are 1.56 and 1.27 respectively for 3Q 2008, and are 1.90 and 1.51 for 3Q 2007. The dip is due to the higher bank advances drawn on bills and also higher current portion of interest-bearing borrowings. As the ratios are still above 1, the company is not in any immediate danger of insolvency.

For non-current liabilities, it is worth noting that there is an amount of HK$615 million now appearing for convertible bonds. There is also an amount of HK$416.5 million worth of deferred consideration payable which I believe is a one-off amount. Net assets had increased to HK$4.25 billion from HK$2.78 billion from March 31, 2007, representing an increase of 52.9%.

Stay tuned for Part 2 of this analysis, which I will try my best to keep short and succinct !

Pacific Andes – 1H FY 2008 Results Review and Analysis (Part 2)

This is part 2 of my analysis of Pacific Andes’ 1H FY 2008 results. I will be analyzing and commenting on the Cash Flow Statement as well as the prospects and plans for the Group moving forward.

Cash Flow Statement Analysis

Pacific Andes generated a lot of cash inflows from operating activities for 2Q 2008, amounting to HK$856 million, as compared to a much lesser HK$255 million for 1Q 2008. This caused the net cash inflow for 1H 2008 to total HK$1.11 billion. However, this was still about 11.2% lower than the total 1H 2007 operating cash inflow of HK$1.25 billion. This was due mainly to the larger decrease in inventories for 1H 2007, lower trade receivables as well as an increase in bills receivable for 1H 2008 as compared to 1H 2007 which had a decrease (and hence recorded a cash inflow). As PAH scales up their operations in Peru, it is understandable that they have higher inventories and also higher trade receivables, thus causing a slightly lower net cash inflow. The interest paid was HK$173 million for 1H 2008 compared to HK$61.7 million for 1H 2007, a 180% increase; which was due largely to the increased amount of debt which PAH took on. Income taxes were also much higher at HK$33 million due to taxation on their Peruvian operations, all of which ate into cash flows. These 2 items alone accounted for nearly HK$144 million increase in cash outflows, which is more than the difference of HK$141 million between 1H 2008 and 1H 2007.

For investing activities, PAH had acquired property plant and equipment worth HK$364 million in 2Q 2008. However, the main cash outflow was the acquisition of additional interests in China Fishery Group Limited (CFG), effectively raising PAH’s stake from 28.8% to 63.9% currently. A total cash outlay of HK$2.22 billion was paid to acquire the additional interest in CFG. The goodwill recognized for this transaction was HK$2.11 billion, which will be reflected in the Balance Sheet. For 1H 2007, PAH had spent money acquiring PPE, investment properties and paying for charter hire of vessels. The total cash outflow for 1H 2008 was HK$3.32 billion, as compared to only HK$339 million for 1H 2007. I see this move as PAH crystallizing more value from CFG at a good price, thus the positive effects should only be felt some time in the future.

There was quite a lot of “action” within the cash flows from financing activities. For 1H 2008, PAH had a 1:1 rights issue at 52 cents per rights share, thus raising an amount of HK$1.78 billion. This resulted in the issued share capital doubling and caused dilution in earnings per share. However, the rationale for this exercise was to raise PAH’s effective stake in CFG so as to recognize more value from the fast-growing CFG. Thus, I do not expect the earnings dilution to be overcome so quickly. In fact, it will probably take at least half to one year before the increased earnings from their present 63.9% stake kick in to overcome the dilutive impact. Another positive note is that they have repaid more bank loans for 2Q 2008 amounting to HK$97 million. For 1H 2008, they had repaid a total of HK$255 million worth of bank loans, and I hope that their operating cash flows can continue to stay strong for them to gradually reduce their gearing, so as to also reduce their interest costs. A dividend was not declared for 1H 2008 as I believe the Group wishes to conserve cash; instead, a scrip dividend scheme was proposed to allow shareholders to choose between a share dividend or a cash dividend. More details on this scheme should be out in due course.

Prospects and Plans

PAH has plans to grow their fishing division through CFG, as this is the division which shows the fastest growth and most promise. In the fishing industry, getting access to more supply of fish is critical, as the industry is more or less dominated by a few major players and there are also quotas set on the amount of fishing allowed. By purchasing more purse seine vessels and securing more VOA, CFG and hence PAH can increase its fishing fleet and get access to more supplies of fish in order to expand the business. From what I read, PAH and PAIH have a leading position within the global seafood industry, and PAIH’s supply chain management provides fish for about 20% of China’s market, thus this makes PAIH one of the dominant players in the industry. With greater access to fishing vessels and by obtaining their third and fourth VOA, PAH and CFG can then grow their business further. Management should be on the lookout for more earnings-accretive acquisitions of vessels or fishmeal plants, as well as attractive VOA opportunities. These will be the catalyst to further grow the business.

Another aspect which PAH intends to improve on are its margins. CFG is currently upgrading its super-trawlers to increase hold capacity, and this can help to bring back more fish to process at fishmeal plants using the same vessel, thus PAH will benefit as well as it provides the supply chain management services for the fishing division. The upgraded vessels will also be used to hunt for Chilean Jack Mackerel, which is a new species PAH has not utilized yet. Other improvements on operational efficiency will also help to improve margins, and Management is actively working on this.

For 1H 2008, the Group acquired 16 vessels and 3 fishmeal plants in Peru. Another was recently acquired in Chimbote and was announced on October 10, 2007. This gives the vessels greater access to fishmeal plants to unload their catch so that they can be re-deployed to catch more fish.

For their frozen fish SCM business, PAH is working towards reducing chartering expenses by growing their own fleet of reefer vessels. PAIH is also working towards harvesting under-utilized species of fish in order to grow the Group’s product lines, and to avoid over-fishing for the more “popular” species. As such, the Group has also engaged a qualified international audit firm to audit its practices with regards to over-fishing, and so far the report has been positive on all aspects.

Note that PAIH has constructed a new processing complex in Qingdao, China which will be operational by December 2007. This is a 333,000 square metre sprawling complex with state of the art facilities and equipment, built at a cost of US$85 million (about HK$663 million). Once operational, it can greatly enhance the Group’s seafood processing capabilities and help the Group to attain new levels of efficiency and quality.

The future looks positive for PAH and CFG, assuming they can scale up the business and also maintain or improve their margins. The key risk is if they cannot secure more VOA or acquire more vessels in future, thus limiting their ability to grow their supply side. I will be awaiting PAH’s 3Q 2008 as well as CFG’s FY 2007 results, after which I will do another review.

Pacific Andes – 1H FY 2008 Results Review and Analysis (Part 1)

On November 14, 2007, Pacific Andes released their 2Q and 1H FY 2008 results (the company has a March 31 year-end). Suffice to say that growth was not as impressive as I had expected, and my fears about the high interest expenses on the covertible bonds and senior notes came true as finance costs had soared as compared to the same period last year. This could possibly be a major source of headache for the company moving forward as it drains a lot of cashflow. On the positive side though, the recent acquisitions and move into the fishmeal industry has helped to smooth revenues somewhat, as can be seen that 2Q, which is traditioally a weak fishing season, showed better revenues as compared to a year ago. What Pacific Andes (PAH) needs to do is to better control costs and improve efficiency of operations, otherwise the company will not be able to add value to shareholders in the long-run.

My review will be in the usual two parts, the first concentrating mainly on the Income Statement and Balance Sheet, while the latter part will be on the Cash Flow Statement and future prospects:-

Income Statement Review (note: all figures quoted within are for 2Q 2008, not 1H 2008)

Revenues increased 111.1% from HKD 751.9 million to HKD 1.59 billion, which was mainly due to their increase in fishmeal and fishing activities through CFG (China Fishery Group) as well as their recent stake increase from 28.8% to 63.9%. However, cost of goods sold remained high, rising 116.1% to HKD 1.25 billion, thus leaving a gross profit of HKD 337 million (margin about 21.2%). Comparatively, for 2Q FY 2007, gross margins were slightly higher at 23.0%. Sadly, the momentum generated in the revenue increases could not be brought to bear on the net profits, as most of the increase was absorbed by higher selling and distribution expenses and finance costs. Selling and distribution expenses increased 4-fold (up 427%) to HKD 32.5 million, while finance costs ballooned 218% to HKD 101.5 million. These two expenses make up 8.44% of revenues already and play a big part in “shrinking” net margins for 2Q 2008, as compared to 2Q 2007. Net margin for 2Q 2008 was low at 10% compared to 15.9% a year back, largely due to these two costs. Selling and distribution costs have increased in line with the increase in operations for the Group, which I can understand, but 400+% seems a little surprising nonetheless. Finance costs are a major drain on cash and though the debt is used to fund expansion, it has not really translated into much earnings accretion (yet !). Fortunately, PAH has mitigated the risk of interest rate increases by “locking in” the interest rate on the senior notes and convertible bonds. Hopefully, in the next few quarters, there will be more margin improvement as a result of better streamlining of operations and better efficiencies resulting from economies of scale.

Profit attributable to shareholders increased 46.2% for 2Q 2008 and for 1H 2008, the increase was 41.5% to HKD 182 million. According to Note 6, EPS is now HKD 18.83 cents based on a weighted average share capital of 966 million shares; but the fully diluted EPS (taking into account full conversion of all convertible bonds) drops to HKD 17.63 cents. This is not even counting in the full effects of the 1:1 rights issue which has doubled the share capital base, thus I forsee more earnings dilution as a result of this. I will give an estimate of about 80% of fully-diluted EPS to be conservative, which is about HKD 14.1 cents. This translates to about 2.82 Singapore cents per share, or 5.64 cents per share annualized. At Friday’s closing market price of 71 cents, this values the company at about 12.6 times PER. At my current buy price of 65.5 cents, the PER I purchased at is about 11.6 times. If profit worsens or drops unexpectedly and causes my margin of safety to narrow, I will not hesitate to dispose of this investment. My concerns relate to the high gearing for PAH and I need to see Management do more to improve margins and lower costs in future periods. That said, 2Q did see a major cash outflow due to the acquisition of the additional stake in CFG, which may have distorted the results a little (the acquisition was only completed on July 23, 2007). I shall wait for the 3Q 2008 report to see if things have improved.

Balance Sheet Review

PAH’s balance sheet has traditionally held a lot of debt, which I am not particularly comfortable with. I acknowledge that it might be a necessary evil if the company has to resort to debt to expand its operations quickly and gain a stronger foothold in the fishmeal industry in Peru. Compare PAH’s method with Ezra and Swiber, where both companies also rely heavily on debt financing to boost their fleet of vessels. In PAH’s case, they need to increase their reefer vessels to cope with better SCM, purse seine vessels to catch more fish and put their super-trawlers for elongation and enhancement in order to fish in new waters. All this costs money and the non-current liabilities has seen an increase of about HKD 548 million for convertible bonds. Current ratio is 1.58 for Sep 30 compared to 1.91 for March 31. Quick ratio is 1.32 against March 31’s 1.51, as a result of an increase in current liabilities and a drop in current assets (lower inventories). Their interest-bearing bank borrowings together with senior notes forms HKD 3.1 billion, which is almost equivalent to their total current assets. I see this as a potential risk area for the Group moving forward, and hope that Management can find ways to bring down this high debt. Otherwise, PAH as an investment would not seem very attractive in the long-run.

Part 2 will be continued on a later date, do stay tuned and feel free to comment and give your opinions on the Company and Group.

China Fishery – Acquisition of Fishmeal Plant in Chimbote, Peru

On October 10, 2007, China Fishery (for which Pacific Andes now owns 63.9% of) announced the acquisition of their seventh (7th) fishmeal processing plant in Chimbote, Peru for US$15.3 million. The Group already has two other plants in Chimbote but this is the first plant which is capable of processing both steam-dried and flame-dried fishmeal within the same facility. This would prove beneficial in terms of efficiencies and economies of scale. The plant has a processing capability of 103 tonnes per hour, for which 60% is for steam-dried fishmeal and 40% is for flame-dried fishmeal.

Steam-dried fishmeal is considered a higher quality product than the flame-dried variant (this could be because of the way it is prepared ?); thus it can command a higher market price, which implies higher margins. The fact that the new plant is 60% dedicated to steam-dried fishmeal is comforting and shows that Management was looking out for this factor when considering the acquisition. According to the press release, producing steam-dried fishmeal is also more energy-efficient and thus will lead to better cost savings as well as environmental benefits. The acquisition will increase CFG’s fishmeal processing capability to 549 tonnes per hour, of which 220 tonnes will be exclusively for steam-dried fishmeal. Since these offer higher margins, I expect the Group to gradually shift production towards this higher margin product in order to boost earnings.

The plant also contains a cannery (for canning the fishmeal), an ice plant and 44,500 square metres of ocean-front land for future expansion. The last point is important as it allows the plant to be expanded and extended in future, in case the production volume for fishmeal needs to be ramped up. With this acquisition, the time taken for the fishmeal to be brought to the coast for unloading by trawlers and vessels can be reduced as CFG already has 6 fishmeal plants along the coast. This reduction in turnaround time means that the trawlers and fishing vessels can be put out to sea more quickly in order to improve their catch; and it will help to optimize the supply chain. Chimbote, being the largest fishing port in Peru, will help to aggregate and consolidate the Group’s resources and assist in achieving better economies of scale.

The Group is currently looking out for more plant acquisition opportunities and leasing opportunities in order to scale up their operations more effectively. Currently, CFG already owns over 5% of the total vessel capacity available to the industry. If the Group makes more meaningful acquisitions, it can serve to improve margins significantly, in addition to CFG’s current refurbishment of the super-trawlers to elongate them (so as to increase their hold capacity).

PAH is set to benefit directly from this acquisition as they now own 63.9% of CFG. The financial results for 1H FY 2008 should be out by mid-November 2007.

Pacific Andes – 1Q 2008 Results Analysis

Pacific Andes reported their 1Q 2008 results on August 14, 2007. The results were in line with my expectations as the Group (including CFG) has been aggressively expanding their fleet of purse seine vessels as well as supertrawlers. The surprise came from the growth in their fishmeal operations and also the increased margins for PAH, as cost of goods sold increased by only 33.7% while revenue zoomed ahead by 42.5%, resulting in an increase in gross profit of HK$197.9 million (101.5% increase). I will analyze the results according to the following sections:-

Income Statement

Top line growth was strong with 42.5% growth in revenues to HK$2.138 billion. The frozen fish SCM business made up HK$1.275 billion (59.7%) of the revenue pie, while the fishing division made up the remaining HK$0.863 billion (40.3%). This increase for the fishing division was more than 100% as compared to 1Q 2007. This was mainly due to PAH’s fishing division under CFG which saw strong growth in 2007 with the acquisition of more vessels and associated economies of scale. The frozen fish SCM business did not register much profit growth (only 15.4%) but the fishing division saw an 81.8% growth in profits. Thus, PAH’s strategy of acquiring a larger stake in CFG through the convertible bonds and rights issue was a wise move, as much value was crystallized from this division. Moving forward, more growth is expected from the fishing division as the recent acquisitions of the additional supertrawlers and purse seine vessels have yet to be fully incorporated into the operating results.

As for margins, taking the net profit attributable to shareholders breakdown from each division divided by the revenue contributions, we get a margin of 3.64% for the frozen fish SCM business and 5.85% for the fishing division. This is just an indication of the relative profitability of each division as it should be noted that as at the date of this report, PAH still owns only 28.8% of CFG and this is why net margins seem to low. Still, it can be readily seen that the fishing division has a higher margin than the SCM business; and since this is the main growth driver moving forward, we should expect strong earnings accretion from PAH for the rest of FY 2008. Note: PAH will recognized the 63.9% earnings from CFG from 2Q 2008 onwards.

Gross margins were 18.4% for 1Q 2008 versus 13% for 1Q 2006, boosted mainly from the economies of scale in operating a larger fleet of vessels, as well as efficient use of their supertrawlers. Net margin improved from 8.62% to 10.4% which is also an encouraging sign that Management can control expenses effectively even though finance costs have risen 172%. Overall, net profit (before allocation to shareholders and MI) grew an impressive 71.3%.

A quick note on the breakdown of revenues by geographical regions: China still made up the bulk of revenues, taking up 78% or HK$1.667 billion for 1Q 2008. Recently, China has been rocked by various scandals involving tainted toys (recall by Mattel), cardboard in buns and contaminated toothpaste. As a result, consumers all over the world have been wary of China food products and China’s reputation has also been tarnished as a result of this. Even the Chinese themselves are more wary of their own country’s food and fortunately, PAH sources for ocean catch which means that they should not be affected too badly by this current negative sentiment.

Balance Sheet

PAH has a sound balance sheet in which current liabilities are more than adequately backed up by liquid current assets. Current ratio stands at a healthy 2.25 for 1Q 2008 as compared to 1.91 for 1Q 2007, while quick ratio improved from 1.51 in 1Q 2007 to the current 1.93 in 1Q 2008. Of course, part of this improvement came as a result of lower inventories as the fishing season is very cyclical (more fish tends to get caught around 1Q of the financial year i.e. April to June); but the increase in cash and bank balances is also a welcome surprise as PAH have had to bear much higher interest payments as a result of the issuance of their US$93 million convertible bonds due 2012.

Speaking of convertible bonds, PAH reported that US$9.1 million of convertible bonds were exercised in 1Q 2008 giving rise to the issuance of about 12.8 million shares, causing slight dilution to shareholders. The remaining convertible bond amount is US$83.9 million and the conversion price has been reset to S$0.8553 as a result of the rights issue. This is actually a blessing in disguise (even though shareholders may not welcome the dilution) as this means PAH can save on a portion of interest expenses moving forward.

Cash Flow Statement

Net cash received from operations actually decreased from HK$636 million in 1Q 2007 to HK$254 million in 1Q 2008. This was due to higher interest expenses from the convertible bonds (about 5.5 times higher) and also much higher income taxes due to the tax regulations imposed by the Peruvian authorities. These two major cash flow drains are likely to persist for quite some time, but PAH has still managed to chalk up a net operating cash flow in spite of these ramped up expenses as their operations have also expanded proportionately. Moving forward, I would expect the higher contributions from the fishing division to bring in healthy cash inflows to offset the increases in income taxes and interest costs.

For investing cash flows, the main culprit for the reduction in cash was the acquisition of an increased stake in CFG (from 28.8% to 63.9%, as many shareholders would by now be aware of). Funds were raised from the issuance of convertible bonds (under financing cash flows) in order to pay for the increase in stake. A total of HK$555 million was paid out as a deposit for the acquisition of shares, and to date the acquisition has already been completed. The cash flow statement is not indicative or representative of the normal operations of the company as they are in a state of transition from owning 28.8% to 63.9% of CFG; thus shareholders should not be unduly worried about the large cash inflows and outflows resulting from the two sections as mentioned in this paragraph.

Outlook and Prospects

PAH should be able to enhance their earnings from the fishing division strongly as this is the faster growing division for PAH and CFG. Powered by recent acquisitions and economies of scale, shareholders should see margins improving and revenues plus earnings growing strongly as more value is unlocked. CFG is also continuously on the lookout for more potentially earnings-accretive acquisitions in Peru in order to position itself as one of the dominant players in the fishmeal market. The rise of fishmeal prices and growing worldwide affluence also bodes well for the industry and should contribute to strong growth for CFG and consequently, PAH as well.

New fishing grounds will also be tapped for the fishing of Chilean Jack Mackerel, which is a “relatively under-utilized” fish species. All PAH would say is that they had conducted “trial operations” for this species and results turned out to be “satisfactory”. The new upgraded supertrawlers will be deployed for this task so we have to assume that fish hold capacity is integral to achieving high enough yields of this species (as well as other profitable species) to justify the capex for the upgrade(s). However, much is left intentionally vague as I believe Management have no clue as to whether this new species would prove to be successful in generating good margins (similar to fishmeal and Peruvian anchovy). Still, it’s a step in the right direction since it shows that Management is pro-actively seeking new revenue sources while at the same time, growing their existing operations for SCM and fishmeal.

Finally, yet another positive for the Group is the ability to enjoy better efficiencies once it deploys the new upgraded supertrawlers by the end of CY 2007. This will not only enhance fish hold capacity (which is integral in increasing their catch) but also allows the Group to reduce reliance on third-party suppliers of fishmeal, thus improving margins. Moving forward, catalysts to look out for will be further acquisitions of Peruvian assets to drive growth, as well as positive developments within the fishmeal industry.

Update: I have purchased 4 more lots of PAH at S$0.615 today, lowering my average cost in PAH to S$0.655 from S$0.665. The situation in Peru is still uncertain, but as shareholders we have to hope for the best !

Pacific Andes - 7.9 Point Richter Scale Earthquake in Lima, Peru

This is an urgent update as I have received news about a major earthquake in Lima, Peru. As of this writing, 330 people have been reportedly killed by this earthquake, and a tsunami alert has also been set off just to warn people of possible tsunamis hitting the coastal areas. Pacific Andes and CFG have substantial operations in Peru (fishmeal operations) and so far the companies have updated that they are NO casualties and the main office (80 km north of the epicentre) is doing fine. As communication lines are down, it will take some time before contact can be established with the other offices and plants within Peru. However, I anticipate limited damage for PAH and CFG's operations as their plants were not located close to the quake centre. Still, this is one of those events called "act of God" which no value investor can predict with certainty !

Let us all say a prayer for those who died in this tragedy and also wish those injured a speedy recovery. Life is a lot more precious than the pursuit of money and profits, sometimes I feel ashamed of myself for being such a capitalist prick......oh well we are Singaporeans after all and are so driven by money and wealth that sometimes we fail to see people struggling to survive and get by in such disaster zones. I will strive to do volunteer work when I get older, just to give something back to society.....

Straits Times Index - Drop of 243.43 points within 2 trading days to 3,152.16

This is a special post on the above, which illustrates vividly the effects of a crisis on financial markets. Within just 2 trading days, the STI has lost what it took 4 months to gain. What people don't realize in general is the volatile nature of markets and how important sentiment can be in the functioning of markets. Liquidity is another concern, of course, and if this dries up further we should see more bloodletting and more chances to buy good companies on the cheap.

Dear readers, I urge you to take this sharp correction as a reminder that you should ALWAYS purchase with a reasonable margin of safety; otherwise the steep drop in prices will be all the more painful psychologically for anyone to bear. All humans have a greater loss aversion (about 2x) as compared to reward satisfaction, which means we feel the pain of a loss more than twice the enjoyment of a gain. Thus, during this turbulent time, I would expect more people to sell low and those who have been playing on leverage to feel the sharp prick of the double-edged sword. Take this volatility as a lesson learnt that money is never easy to make consistently in the market, and that value investing helps to buffer against such times by ensuring that you get a decent return (it does not have to be exceptional) on your investment.

Good luck to all investors, and may you all find more good bargains in this market.

Swiber – EGM July 31, 2007

I attended the Swiber EGM today, and surprisingly there were hardly any shareholders at all. Perhaps it was because it was mid-week and there was only one resolution, but I had expected more people to turn up to talk to the Management about the future prospects of the company. Still, this turned out to be a blessing in disguise as I had the chairman’s attention all to myself !

Aside from the usual perfunctory rituals of proposing, seconding and approving the transaction, I would like to highlight several points brought up by Mr. Raymond Goh (who so graciously ignored analysts just so that he could talk to shareholders).

a) The US$300 million medium term notes are preparation for their fleet expansion, and will not be drawn down in one large tranche; rather, it will be progressively utilized as and when the company needs the funds to grow their operations. The interest rate is not fixed yet as the notes have yet to be issued.

b) Another shareholder was asking Mr. Goh about the company’s operations. He stressed that Swiber was one of only a few EPCIC companies operating in this part of the world. He did mention a competitor based in India but this was a new company and thus had yet to build up a sizeable fleet to threaten Swiber’s position. Barriers to entry are high for this industry and Swiber intends to grow quickly with the funds raised from the equity placement and sale-and-leaseback in order to capture a larger slice of the market.

c) Swiber’s order book is about US$200 million currently, but the worldwide market for oil and gas investment totals about US$20 billion; thus Swiber has only got about 1% of this. According to Mr. Goh, there is much room for more contracts to flow in as long as the vessel fleet can be expanded so that more vessels can be deployed for contracts at any one time.

d) With regards to building the company, Mr. Goh mentions that Swiber stresses not only on building assets (i.e. vessels), but also on human resources. He is building process improvements using Shell as a role model in order to retain good talent and skills within the company. Swiber currently employs a Management team comprising 18 different nationalities.

e) The previous announcements for the LOI and contracts were from Indonesia and Malaysia. I asked if it was easy to break new ground into India and the Middle East and his reply was that prospects were good as the company has already laid the foundation for expansion into these countries by establishing an office and appointing VP of operations (for India).

f) The revenues from contracts are all taxed at a reduced tax rate as compared to normal revenue sourced from Singapore. This is because the Singapore Government is pro-active in promoting businesses and Swiber’s effective tax rate is thus only about 7% ! Even IE Singapore has approached Swiber with a view to helping it expand to other territories which it presently has no access to.

Prospects are good for the company to expand their operations and capture more contracts. With more of their own vessels coming on board and a new wave of vessels being ordered for FY 2008, Swiber is on track to improve on their profit margins and also capture larger contracts with prominent customers.

Pacific Andes – Annual General Meeting July 31, 2007

Many questions were raised at this AGM, both on a formal basis (i.e. addressed to the Board of Directors) as well as on an informal basis (talking with the Chairman after the meeting proper). I shall attempt to capture the essence of what was discussed as I did not write everything down (neither did I bring a tape recorder !):-

i) One shareholder asked about the earnings of the Group per quarter, which seemed to fluctuate somewhat. Mr. Ng (chairman) said that seasonality is a factor in the business and some months, you catch more fish and some months, you catch less.

ii) The elongation of the super-trawlers will enable fish hold capacity to triple. This will help to bring in more catch for each vessel as they need about 2-3 weeks to travel back and forth to the fishing grounds. Thus, a larger fish hold will ensure more fish can be brought back for processing each time in order to maximize efficiency.

iii) The problem of over-fishing is currently under control and many measures and regulations have been drawn up by Green Peace in order to discourage fishing companies from over-fishing. Mr. Ng mentioned that this was a good thing because setting quotas and limiting fishing would only drive prices up, which in the long run meant that margins would also improve for the entire business.

iv) A possible substitute for fishmeal was soya bean meal, which is a plant-based extract. However, Mr. Ng said that soya bean meal tends to pollute the water when placed in water, thus killing fish. Thus, it is not a good substitute for fishmeal and till now, this problem has not been solved. Fishmeal will continue to enjoy good margins for quite some time. When PAH bought over the fishmeal businesses and vessels in Peru, the price of fishmeal was only US$500 to US$600 per ton. This has risen in recent months to as high as US$800 to US$900 per ton (after a 15% correction off an all time high of over US$1,000 per ton), thus ensuring a very good margin for the Group in future.

v) One shareholder asked about the potential political risks involved in dealing in Peru, which is a South American nation. Mr. Ng mentioned two factors which mitigated this risk; one was that the Singapore Government has an agreement with the Peruvian government to protect Singapore businesses operating in Peru. Second was that in the contract signed with the Peruvian government under the current laws, it provides 10-year protection against the changing of laws which may restrict of impede CFG’s vessels from fishing in Peruvian waters.

vi) When asked about whether canning would form a major part of PAH’s revenue, Mr. Ng said that this was in a trial stage and canning would only form a minor portion of revenue for now. However, with the demand for fish rising in China and demand for canned anchovies (sardines) rising, canning operations may scale up in future.

vii) CFG and PAH currently operate under the Olympic fishing system, whereby a total allowable catch (TAC) is allocated to ALL fishing vessels within Peru. Thus, every month, all the vessels (including CFG’s) would essentially “rush out” to catch as much fish as possible. CFG’s strategy of increasing their number of supertrawlers and purse seine vessels means that they can catch a bigger piece of the TAC, which is why the senior notes were issued in order to buy over 5% of the total fleet in Peru. Mr. Ng mentioned that hopefully, in time to come, this would be changed to the quote system, whereby each company would be given a specific quote to catch (based on past years’ catch) in order to maximize yield and efficiency.

viii) Mr. Ng said that they have yet to prepay for the 4th VOA, and that the effects of the 2nd and 3rd VOA have yet to kick into the financial results. Also, the 63.9% ownership of CFG will only take effect from July 2007, thus 1Q 2007 financials would still reflect the 28.8% ownership.

ix) CFG will continue to actively seek out acquisitions of more vessels and to capture more VOA as this is a strong competitive advantage for the Group.

Based on the above observations, I would say there are still some risks and uncertainties relating to PAH’s business. Gearing is still uncomfortably high and Management has avoided directly replying to shareholders on how gearing can be reduced over time. As one shareholder put it, no use achieving higher growth and EPS as a result of the issuance of more debt as debt-boosted high ROE is useless. It remains to be seen if PAH can reduce their gearing to a more comfortable level, and I will have to monitor this as the months go by. One mitigating factor is that Mr. Ng mentioned that PAH has enjoyed 5 to 6 years of consistent growth in top and bottom line (except for a slight hiccup during the SARS period).

Thus, I remain cautiously optimistic on the Group’s prospects even as I await the 1Q 2008 financials to be released in 2 weeks time.

Note: My end-July 2007 portfolio review will be done possibly on 1 or 2 August as I will be away on a business trip to China. I shall return late Friday and only resume posting on Saturday August 4th.

Pacific Andes – Annual Report FY 2007 Review

As promised, this is my review and analysis of the Annual Report by PAH. Suffice to say that it has not been easy “reviewing” the Annual Report and I should be forgiven for missing out certain parts which may be of concern as there is really a truckload of information to go through. The problem is that most companies only give you something like 2 weeks plus to go through the Annual Report before holding their AGM. To me, this is just too little time !

This post will review the annual report and highlight areas which will cause concern for the shareholder. Suffice to say I took about 4-5 days to go through the entire report and I would like to point out the following items which may require further attention as we move into FY 2008. Note that I am commenting on some of these items in my capacity as an “finance guy”, and it may sound jargon-ish and technical to those who are not familiar with accounting concepts and principles (my apologies for that !):-

1) Debt-equity ratio has risen to an unhealthy 117% as of FY 2007, and this was caused by the issuance of the 5-year senior notes to raise money for CFG to acquire the purse seine vessels as well as to fund more acquisitions of companies operating in Peru. While the acquisitions are expected to be yield-accretive, we should note that PAH’s interest expenses will shoot up much higher in the coming years (it was HK$40 million for FY 2007 just for interest on senior notes as compared to zero for FY 2006, see Note 9 Finance Costs).

2) On Page 44 Note 2 regarding deferred charter hire, it is stated that this is capitalized as a prepayment and subsequently amortized off in the Income Statement over the period in which the benefits are expected to accrue. Since the charters are going to be for 5-10 years, the amortized cost will be over this period of time. The current portion in the balance sheet Page 33 is HK$173 million, while the non-current portion stands at nearly HK$1.8 billion. Shareholders should note that charter hire expenses form part of cost of goods sold and this could increase over time, thus having a dampening effect on gross margins even as the Group attempts to elongate its super-trawlers in order to maximize economies of scale.

3) Refer to Page 45 Note 2 on deferred expenditure, it is interesting to note that expenses on each voyage (to catch fish) are actually deferred until matching can be done between revenues and expenses (an accounting concept). This technically means that if the fish from the catch are never sold, then the expenses could be deferred indefinitely ! Also, there is a catch which says that if expenses actually exceeds the revenues from a particular voyage, it will be immediately recognized in the Income Statement due to the prudence principle. This rule means that expenses from many voyages could potentially be “deferred” by the Management if they wish to prevent recognition before a certain cut-off date, as all they need to do is to sell a different batch of fish. This is one possible avenue for manipulation.

4) Also on Page 45 Note 2 on deferred expenditure, charter hire fees are separated into fixed and variable. For the fixed charter rates, these are expensed off regardless of whether the vessels under the VOA are being deployed, which means that in theory, expenses could very well still be incurred during the vessels’ downtime ! This could potentially lead to higher expenses should any damage befall the vessels and it s significant risk factor in my opinion.

5) Under Page 49 Note 3 on critical accounting judgements, it is stated that the carrying amount of deferred charter hire is stated as such on the balance sheet (without provision for impairment losses) mainly because the charter hires are expected to be profitable in the foreseeable future. The risk here is a sudden decrease in the carrying amount of the charter hires (for whatever reasons relating to the fishing industry), thus causing the auditors to pass an entry to write-off a s significant amount of impairment losses over to the Income Statement.

6) On Page 55 Note 8, there is an exceptional gain on dilution of interest in CFG as a result of CFG doing a placement of shares. This exceptional gain must be deducted from the net profit after tax in order to arrive at the true EPS for the Group.

7) On Page 55 Note 9 on Finance Costs, pay particular attention to a more than 120% increase in finance costs from HK$103 million to HK$228 million in just one financial year. This is a cause for concern as the Group is gearing itself up more and more over the years (refer back to Point 1).

8) For Page 65 Note 21 on Other Intangible Assets, it is good to note that fishing permits are essentially perpetual in nature and do not have a finite useful term. Thus, there will be no amortization expenses associated with the acquisition of these fishing permits ! Unless there is a drop in the carrying amount of these permits, it is unlikely that there will be any impairment loss recognition in the books in the near future as permits are no longer issued by the Peruvian Government.

9) For Page 67 Note 25, note that prepayments for fish has increased substantially from HK$135 million in FY 2006 to HK$500 million in FY 2007, almost a 270% increase. It will be good if Management could explain what this prepayment was for and whether the amounts are collectible; including why there was such a substantial increase (could it be due to fishmeal ?).

CEO Statement Review

The chairman Mr. Ng Joo Siang gives an operations review, financial review and an outlook and forecast for the financial year ahead. This is pretty standard fare when it comes to giving statements, and encompasses most aspects of the financial year under review.

For operations, he mentions that China has grown and expanded as one of their key markets and they expect to maintain growth in the current financial year. He also touches on the three new VOA acquired under CFG, as well as the integration of their newly acquired Peruvian operations into PAH’s vertically integrated business model. All this is pretty standard fare for a shareholder who has been actively keeping up with the company’s announcements (including CFG’s), but will act as a useful summary for a new shareholder or a person seeking to invest in PAH.

In the financial review, he basically touches on increases in revenues, net profit for the year and net profit attributable to shareholders. He also gives a year-on-year comparison for performance of net profit after excluding exceptional items, which is the correct approach considering that PAH have an exceptional gain due to dilution of interest in CFG. The dividend is also stated (0.54 cents per share post-rights) and he goes on to elaborate on how PAH and CFG tapped on the capital markets to issue debt such as convertible bonds and senior notes to accelerate their expansion. For readers of the Annual Report, this should sound alarm bells for them to check on the Balance Sheet’s liabilities section and the section on loans and finance costs under Notes To The Accounts.

The outlook ahead section is perhaps the most important as it gives shareholders guidance on the future for PAH. I have summarized the section into several points which are noteworthy:-

1) PRC market volumes for fish has increased 14.1% from 2001 to 2006, thus more growth momentum is projected for fish demand in the PRC. The PRC government is active in promoting aquaculture, and want aquaculture production to hit 46 million tonnes by 2010, which is an annual growth rate of 6%. Analysis: If the above measures are true, then there is room for growth within PAH’s largest market which is China (it constituted 76.1% of their total revenues for FY 2007, according to Note 6 Page 54).

2) Strengthening the harvesting capacity and efficiency of existing vessels, and also building up the fishmeal division to ensure it contributes more strongly to revenues and bottom line. He expects the fishing division to contribute strongly to growth in FY 2008, as the harvest volume has not increased to 270,000 tons after acquiring more vessels. Analysis: PAH is focusing on organic as well as acquisitive growth as it seeks to increase the holding capacity of its vessels by acquiring more, as well as by elongating their supertrawlers. It remains to be seen if these will translate into better margins as a result of economies of scale, but at least shareholders are being informed of the said improvements which we can look forward to.

3) The fishing division is set to lookout for other attractive opportunities to acquire more Peruvian assets which will be earnings accretive to the Group. Analysis: Whatever acquisitions CFG makes has to be value-added, meaning there must be economies of scale and must substantially increase CFG and PAH’s operating capacity above current levels, as well as (possibly) reducing costs. The acquisition should be priced at a reasonable level to ensure that it is a good deal (the Group should avoid paying more than it should even though it may sound like a good deal).

Overall, the tone of the Annual Report is one of optimism. Apart from the following points mentioned above, the rest of the numbers look good and I look forward to engaging the Management in a frank discussion of the Group’s prospects and strategies for FY 2008.

Pacific Andes – Application for Rights & Excess Rights (ARE)

This post will help to explain the process of applying for the rights shares in PAH and how to go about applying for excess rights shares. The relevant forms must be filled in and the relevant details provided in the ATM application in order to qualify for it to be a valid application. There are basically 2 methods to subscribe for the rights shares: through CDP (post) or through the ATM. The ARE form given is unique to each individual shareholder and is NOT transferable. Shareholder should only use the hard copy form if they decide to apply through CDP and not through ATM.

Application through CDP

If application is made through CDP (by post), then the manual ARE form has to be filled in. Write down the number of rights shares which you are entitled to subscribe for (this will be equivalent to your shareholdings as at June 22, 2007 as it is a 1:1 rights issue), and multiply this by the rights price of S$0.52 to obtain the total amount payable. If one wishes to apply for excess rights shares, one has to fill in the number of shares (in the next row) he wishes to apply for, multiplied once again by S$0.52. The total(s) will then be added together and a cheque should be prepared and sent together with the ARE in the self-addressed envelope provided to back to Pacific Andes for processing.

Assuming excess rights are allocated, the portion will be pro-rated to the amount you have applied for (example, if 1 in 5 excess rights were given and you had applied for 5,000 excess rights, then you would receive 1,000 and pay S$520). The excess rights monies will then be refunded back to you by cheque or through your bank account (the remaining 4,000 rights share multiplied by S$0.52 or S$2,080 in this example).

Application through ATM

If applications are made through ATM, then there is no need to fill in and submit the manual ARE form. The subscriber should log into his bank account through the ATM and choose security application. He will then proceed to follow the instructions to apply for the rights shares and (if any) excess rights shares. He must also verify his CDP account number (it will be flashed on-screen) to see that it is correct, before confirming the number of shares to be applied for. The number of shares which one is entitled to is essentially the number of provisional rights shares (nil-paid) allocated on ex-rights. The procedure is similar to the CDP method except that the funds will be automatically debited from your bank account immediately.

Several options are available for investors who plan to trade in the rights shares on the open market. They are as follows:-

Purchase of additional rights shares from the open market

The additional rights shares purchased will be dealt with separately (another form will be provided by CDP after T+3 days) and should NOT be included under the rights share provisional allotment or excess rights shares application amount in the ARE. The purchase amount of the rights shares should still be settled according to the contract note in T+3 days.

Sale of Partial Allotment of Rights Shares, retention of remainder

Assuming an investor is allotted 10,000 provisional rights shares and decides to sell 5,000 on the open market. He will then receive the proceeds from the sale of the 5,000 rights shares at S$X, after T+3 days. However, he can still proceed to apply for his remaining 5,000 provisional rights shares at S$0.52. He only needs to indicate 5,000 in the ARE and ATM application and not 10,000 as he had already sold off 5,000 in the open market.

Sale of Full Allotment of Rights Shares

If an investor sells his entire provisional allotment in the open market, then there is no necessity to use the ARE or the ATM to subscribe (unless he wants excess rights shares, which sorts of defeats the purpose of selling it in the first place right ?). However, note that by doing this, the investor will be diluted as his original shareholding is now dividend by double the size of the original share capital base.

Conclusion: Only by subscribing fully to the provisional allotment will you maintain your proportional shareholdings in PAH and suffer zero share dilution. If one purchases or applies for excess rights shares (and gets allotted), then one actually increases his proportionate shareholdings with respect to the enlarged share capital base. This rights issue is currently earnings dilutive from the perspective of current FY 2007 earnings (even with the 63.9% consolidation of CFG). However, from the perspective of future earnings, there is not much clarity as the results for 1Q FY 2008 are not out yet, profit margins are not known; and the impact of the 63.9% of CFG has yet to be fully assimilated into the financials. Remember that PAH’s performance is now strongly dependent on earnings strength of CFG (as they now own 63.9% instead of 28.8%).