Monday, June 30, 2008

End-June 2008 Portfolio Summary and Review

The second half of June 2008 was peppered with bits of news from the companies I own. Ezra announced the completion of their first FPSO (under 48.9% owned EOC) and the clinching of a significant charter contract worth US$400 million over 3 years. I remember Ezra first announcing the news of the FPSO back in October 2006 and the buzz surrounding the news at the time. Now, the company is poised to continue growing as it undertakes expansion into the deepwater oil and gas segment. Boustead was also relatively active in announcing news (please refer to the section below on Boustead for more information).

With respect to the economy, the flow of data continues to pour in relentlessly from Wall Street, on everything from factory output, unemployment to inflation. It’s a wonder one does not go crazy from the constant influx of information ! The most important and note-worthy piece of news is that the USA Federal Reserve has kept the Federal Funds Rate capped at 2% (which was largely anticipated) due to fears over mounting inflation. Back in sunny Singapore, inflation for May 2008 managed to stay “constant” at 7.5%, despite consensus estimates that inflation would hit close to 8%. Wow, what a relief, I am SO HAPPY that inflation is ONLY 7.5% (mind the sarcasm).

The reporting season for 1H FY 2008 will begin in late July 2008, and I am expecting results and dividend announcements for both Suntec REIT and FSL Trust. The rest of the results are expected to flow in during mid to late August 2008, and Annual Reports for Pacific Andes and Boustead should also come in by then and will be separately reviewed on this blog.

Below is the summary of my investments and related news as at June 30, 2008 (STI at 2,947.54 points).:-

1) Ezra (Vested since October 6, 2005) - Buy Price $0.645 (bonus adjusted), Market Price $2.65, Gain 311%, YTD Loss 20.2%. Ezra announced on June 24, 2008 that EOC took delivery of its first FPSO, Lewek Arunothai, and that it is on a charter contract worth US$400 million over 3 years. There is also a two-year extension option for this charter, and EOC will continue to explore the FSO and FPSO market. I forsee significant earnings accretion to Ezra Group from this contract even though Ezra only owns 48.9% of EOC. Immediately on June 25, 2008, Ezra announced that it had established a multi-currency medium term note programme (similar to Swiber’s a while back) for S$500 million in order to fund future capital expenditures and for working capital purposes. In the current low interest rate environment, it makes good sense for the company to issue debt in the form of notes/bonds to capture and lock in the low cost of financing, rather than issue equity for which they may have to pay higher dividend yield (not to mention diluting existing shareholders).

2) Boustead (Vested since September 13, 2006; averaged down November 13, 2006) - Buy Price $1.295 (average), Market Price $2.36, Gain 82.2%, YTD Loss 2.1%. Boustead had, on June 23, 2008, announced the clinching of a turnkey contract by Boustead Projects (91.7%-owned) of S$60 million to build Singapore Freeport. This is a state-of-the-art facility which will be used primarily for the safe storage, display and trade of the world’s finest collection of valuables and antiques. The project will be in two phases, with Phase 1 to be completed by end-2009 and Phase 2 by 2011. On June 25, 2008, Boustead also announced that its 40% associated company GBI Realty Pte Ltd had entered into an arms length transaction to sell a property for S$200 million. The proceeds will be used for general working capital purposes, and the Group will recognize a gain of S$26 million for FY 2009. On June 26, 2008, Boustead announced that it had obtained in-principle approval for the share split. Management will proceed to issue a circular to all shareholders and convene an extraordinary general meeting (EGM) to seek shareholders’ approval for the split.

3) Swiber (Vested since February 14, 2007) - Buy Price $1.01, Market Price $2.47, Gain 144.6%, YTD Loss 28%. There was no significant news from Swiber, but the company was doing a road show in Hong Kong recently and the analyst who went with them mentioned that the Equatorial Driller will most likely be built by a smaller yard as Keppel and Semb Marine already have their hands full. The company should be releasing more details of the ED soon.

4) Suntec REIT (Vested since December 9, 2004) - Buy Price $1.11, Market Price $1.36, Gain 22.5%, YTD Loss 20.5%. There was no news for the company for June 2008.

5) Pacific Andes (Vested since March 29, 2006; Rights Issue July 11, 2007 at S$0.52 per share; averaged down August 17, 2007) - Buy Price $0.655 (rights-adjusted), Market Price $0.48, Loss 26.7%, YTD Loss 23.8%. There was no news from the company for June 2008. I am still awaiting more details of the scrip dividend scheme to assess if it will be good to choose shares over cash.

6) China Fishery Group (Vested since November 20, 2007) - Buy Price $1.50 (average), Market Price $1.70, Gain 13.3%, YTD Gain 8.1%. There was no news from CFG except for an amendment to the senior notes issued and due 2013.

7) First Ship Lease Trust (Vested since January 14, 2008) - Buy Price (Averaged Down) $1.105, Market Price $1.22, Gain 10.4%. There are still no updates from FSL Trust as at the date of writing this post, regarding their financing of the third vessel and their plans for growing their portfolio.

Overall Portfolio

My overall portfolio has increased by 65.2% without taking into FSL Trust’s cost. If included, the gain is 50.0% from a cost of S$80.4K as at June 30, 2008. The market value of my portfolio without FSL Trust is S$96.3K, and if FSL Trust is included then the portfolio value is S$120.6K. Realized gains have increased to S$6.2K due to the dividend from Ezra to be paid on June 18, 2008.

Comparison against STI

Using my new benchmarking technique:-

The FTSE STI had declined by 15.36% since the start of 2008. My portfolio (without FSL Trust) has to date declined 17.5%. Therefore, I have under-performed the STI by 2.2 percentage points.

FSL Trust has gained 10.4% thus far from my date of purchase while the benchmark STI has fallen 8.1% (from Jan 14 – my date of purchase); I am happy to report that FSL Trust has managed to out-perform the index for FY 2008 thus far.

My next portfolio review will be on Tuesday, July 15, 2008 after market close.

Sunday, June 22, 2008

Leverage - A Double Edged Sword

Leverage is a word often heard of these days, especially with the sub-prime credit crisis in full swing affecting everything from major US banks to far flung Japanese banks. Apparently, the amount of debt which investment banks take on is enough to cause a ripple effect and add to the major headaches experienced by reputable financial institutions, who have had to write down amounts of CDO and debt-related instruments to the tune of billions of USD. All these problems actually stemmed from debt, or leverage as it is known. There have been countless articles written on the ongoing sub-prime debacle, and George Soros has even written a book about it; so I will not delve further into this issue. Instead, let's examine the effects of leverage on companies and how it can make or break them.

As readers may know, many companies (public and private) grow by taking on debt into their Balance Sheets. The reason for taking on debt is to use the money to grow the business and to earn a return on investment which is HIGHER than the interest rate charged on the debt. In effect, you are using money to build more money. Of course, one may argue that there are businesses out there which employ purely equity or cash flows from operations to grow organically and expand, but these "great" businesses are few and far between. Warren Buffett has personally identified the "great" business of See's Candy, which I will elaborate on in a subsequent post; but he admits that companies can also be "good" yet take on substantial leverage in order to grow the business. He is referring to companies which gear up to either grow the business through asset acquisitions, construction of new plants to increase production capacity, or to grow the business organically through vertical or horizontal integration.

Leverage itself is NOT a bad thing, as long as one is mindful of the potential risks and pitfalls involved. It's a little like medication - enough of it is good for you and will cure your ailments and even make you healthier in some cases, but too big a dose may cause permanent harm and the effects may be irreversible. There are examples of companies listed on SGX which have taken on more bank loans and issued debt securities (e.g. notes or debentures) in order to grow their business. Recent examples include Olam in order to scale up the business through acquisitions, and also several China companies which have issued convertible debt to fund asset enhancements. Growth at a reasonable price (GARP) is a concept which is taught in some value investing books, and states that growth can come as a result of a debt being carried at a certain price (i.e. interest rate); provided the debt is cheap and the growth can be justified. In cases where growth is not sufficient to justify the debt taken, then the debt should be avoided and the company should seek alternative sources of financing (e.g. equity financing).

The situation becomes more problematic and dire when companies take on excessive debt over and above what would be required to grow the business. Firstly, this is a sign that operating cash flows are insufficient to grow and sustain the business, which results in a vicious cycle of borrowing to grow (this gives the investor the illusion that a company is growing, while its current ratio falls below one). Second, finance costs may become prohibitively high and eat away at gross margin, leaving the net margin in tatters. Thus, a company with a decent gross margin may still be left with little profit after accounting for financing costs. Of course, one has to be careful in assessing what is the "right" amount of debt for a company to take on, as this can be industry specific (some industries are highly capital intensive) and there may also be a short-term reason for taking on additional debt which justifies bumping up the leverage ratio. In short, there is no hard and fast rule for "sufficient or excessive leverage" as one must look at companies on a case-by-case basis.

Looking at my current portfolio of companies, Ezra, Swiber and Pacific Andes/China Fishery take on substantial amount of debt to grow their businesses, in the process fortifying their balance sheets with more fixed assets. For Ezra and Swiber, they have been able to "avoid" taking on excessive debt by using sale-and-leaseback, a form of vessel financing. However, for CFG and PAH, their issuance of senior notes and convertible bonds has added to their gearing substantially, and this represents a risk for the company should growth stagnate and their finance costs balloon above their ability to generate operating cash flows. Hence, this is one of the risks I take on as a shareholder. Seeing how Management have a good track record of growing the company despite having high leverage the last 10 years, I continue to be confident that their additional debt can be used effectively to grow the business and generate high ROE/ROI. Only one of my companies, Boustead, is sitting on a substantial pool of cash (S$150 Million) which it can deploy for acquisitive opportunities during a bear market and crisis. This is also one of the advantages of having cash instead of debt, the opportunity costs of NOT being able to take advantage of good deals during bad times.

To close off this topic (which I am sure should invite a considerable number of comments), I will talk about a company called OSIM and how they used a leveraged buyout scheme to purchase a company in USA called Brookstone back in 2005. Before the acquisition, OSIM was flushed with cash from their strong sales of their products; however after the acquisition they ended up in a net debt position which they are still trying to clear after 3 years. Unfortunately, the debt which they took up did not help to grow their bottom line to the extent that they were hoping for, and the result is that the debt is becoming a burden as they have to pay for high finance costs while suffering from declining sales and an erosion of their competitive edge. Their last corporate action was raising money through an issue of warrants to subscribe for shares at 30 cents, as a direct equity raising was not feasible. It remains to be seen whether the company can pull itself out of the doldrums and justify that the gearing they took up was indeed worthwhile.

Wednesday, June 18, 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.

Saturday, June 14, 2008

Behavioural Finance Part 3 - Over-Reaction Bias

To continue with this series on behavioural finance, I now touch on the concept of over-reaction bias. The first two parts dealt with the problems of mental accounting (compartmentalization of money into distinct and discrete "accounts") and over-confidence (a typical human trait where most people feel that they are infallible). Over-reaction bias is a type of behaviour which results in human beings over-reacting to certain news, which is another way of saying you "let your emotions override your good sense".

When applied to the stock market, over-reaction bias typically causes investors to over-react to BAD news, and react too slowly to good news. Why could this be so ? This is due to human being's tendency to panic and let fear grip him; thus over-reacting to bad news or negative information. Note that this is a natural human tendency which, from our caveman days, would have saved us from mortal danger as our bodies tend to respond to such negative stimuli by producing more adrenaline (yes, the fight or flight hormone), thus it allows us to have heightened senses and more energy to run in case we encounter danger (e.g. predators in prehistoric times). It is always better to over-react to real physical danger as we only have one life; but in the market, over-reaction bias can cause us to lose our rationality by conveying a similar "fight or flight" response. Since there is no one to "fight", most people will choose "flight" instead and sell away their investment when there is any small hint of negative news !

When viewed objectively and rationally, this might seem a very foolish, downright silly choice. After all, negative news flows in all the time and one cannot predict the sequence, extent or nature of such news accurately. On one day, it might be record inflation; on another day, it could be high oil prices and on yet another day, it may be increased unemployment or shrinking GDP growth. The point is that bad news is supposed to be part and parcel of investing and one cannot live in a fantasy world expecting nothing negative to happen to one's investments. By mentally insulating oneself from such mental shocks, one can develop better fortitude when hearing such negative news. Even for my own investments, I had recently encountered negative news in the form of record inflation in Vietnam (which affects my investment in Ezra as they have 2 yards in Vietnam) as well as a recent fire at Kreuz Shipyard which is 100% owned by Swiber.

My first reaction upon hearing this news was to calmly examine the facts of the case and to objectively assess the economic impact of the bad news. As an investor, one should be mindful of over-reaction bias causing the bad news to seem a lot worse than it sometimes is. In my case, it turns out that I discovered that Ezra's shipyards are securing contracts in USD, thus mitigating the risk of the depreciating VND; though one consideration is still rising costs of manpower as inflation kicks in. The impact will be minimal and is not likely to be long-lasting. For Kreuz, the incident was regrettable but will also not cause any serious economic harm to the company or its business. Thus, by objectively and rationally reviewing the facts of the case and delving into some research, one can pinpoint whether the bad news may have a permanent detrimental impact on one's investments; hence making the decision on whether to sell a more logical, rational one. Most of the time, if one had done sufficient research and due dilligence, I would conclude that most bad news is temporary in nature and should have already been factored in one's risk assessment when one purchases a company. Only if a black swan event occurs should it give a very compelling reason to sell an investment immediately (e.g. natural disasters destroying key assets).

To conclude, over-reaction bias is a pervasive mental force when one invests. To avoid its effects, one should always keep their wits about them when faced with bad news, and move on to objectively and coolly assess the news before taking any action. Actions taken during an adrenaline rush are usually ill-thought out and one is more prone to make costly mistakes. Always ensure that decisions made with regards to buying and selling investments are approached in a busines-like manner, which is how investing should be viewed.

Friday, June 13, 2008

Mid-June 2008 Portfolio Summary and Review

The first half of June 2008 was a surprisingly quiet month for me as my companies had nothing much to report. I would assume that their business is chugging along fine, though of course as the global economy reels from high inflation and a receding economy, this would inevitably have some impact on my companies’ businesses. Furthermore, Vietnam as a country is experiencing many economies woes such as high inflation, a ballooning trade deficit and a rapidly depreciating currency. This may affect my investment in Ezra as they have two shipyards located in Ho Chi Minh City and Vung Tau and thus will be exposed. It is a relief that their contracts for Saigon Shipyard thus far have been denominated in USD, but I am still keeping a watchful eye to see if their business may be adversely impacted.

A combination of high oil prices (hitting a record of US$139 before settling to US$136) and more troubles from reputable bank Lehman Brothers also caused global stock markets to correct sharply in the last 2 weeks. Opportunities abound for the intelligent investor to look for good growth companies trading at undemanding valuations for long-term investment, and one should always have funds ready in such environments to take the opportunity to deploy them to generate a decent return (hopefully above projected inflation rate of 8% in Singaopore !).

As for the coming 2H June 2008, I would expect it to be quiet as well as this period is traditionally less active in terms of newsflow from my companies. July 2008 will see the start of the reporting season for 1H results, and I am expecting results from Ezra (3Q 2008), FSL Trust (1H 2008) and Suntec REIT (3Q 2008).

Below is the summary of my investments and related news as at June 13, 2008 (STI at 2,979.56 points).:-

1) Ezra (Vested since October 6, 2005) - Buy Price $0.645 (bonus adjusted), Market Price 2.58, Gain 300%, YTD Loss 22.3%. There was no news from Ezra during the half-month ended June 13, 2008. As mentioned above, I am monitoring the economic situation in Vietnam as Ezra has substantial exposure there due to the presence of two shipyards being built in Ho Chi Minh City and Vung Tau.

2) Boustead (Vested since September 13, 2006; averaged down November 13, 2006) - Buy Price $1.295 (average), Market Price $2.23, Gain 72.2%, YTD Loss 7.5%. There was no news from Boustead during the half-month ended June 13, 2008, except a minor announcement that the company is setting up new subsidiaries.

3) Swiber (Vested since February 14, 2007) - Buy Price $1.01, Market Price $2.58, Gain 155.4%, YTD Loss 24.8%. There were no announcements or press releases for Swiber since the middle of May 2008, but there was news recently (on June 8) that a fire broke out on a vessel berthed at Kreuz Shipyard, Swiber’s 100% owned subsidiary, and that one man was killed and several others badly injured. The incident is not expected to have any material impact on Swiber and my condolences go out to the family of the man who was killed in the explosion. A recent Deepwater Drilling Seminar held at Swiber’s headquarters also highlighted the prospects for deepwater drilling, and a recent CIMB report was particularly bullish on Swiber’s prospects of securing a 3-year contract for its new equatorial driller, which Swiber is going to announce soon with respect to the yard which it commissioned to construct the driller.

4) Suntec REIT (Vested since December 9, 2004) - Buy Price $1.11, Market Price $1.53, Gain 37.8%, YTD Loss 10.5%. There was no news for the company except for the issue of units to the Trust Manager, thus resulting in slight dilution.

5) Pacific Andes (Vested since March 29, 2006; Rights Issue July 11, 2007 at S$0.52 per share; averaged down August 17, 2007) - Buy Price $0.655 (rights-adjusted), Market Price $0.505, Loss 22.9%, YTD Loss 19.8%. There was no news from the company (nor did I expect any) for the period ending June 13, 2008.

6) China Fishery Group (Vested since November 20, 2007) - Buy Price $1.50 (average), Market Price $1.70, Gain 13.3%, YTD Gain 8.1%. There was no news from CFG for the period ending June 13, 2008, culminating in a very quiet half-month indeed.

7) First Ship Lease Trust (Vested since January 14, 2008) - Buy Price (Averaged Down) $1.105, Market Price $1.21, Gain 9.5%. There were no updates from FSLT regarding the financing for their third vessel as well as their plans moving forward for securing additional funds to continue their acquisitive trail. Current market conditions have resulted in a unit price which gives an estimated forward yield of close to 13%; thus issuing equity will not be a good idea at this juncture. I suspect that Management may continue to increase the debt-equity ratio (i.e. increase their borrowings) in order to fund future acquisitions.

Overall Portfolio

My overall portfolio has increased by 65.5% without taking into FSL Trust’s cost. If included, the gain is 50.0% from a cost of S$80.4K as at June 13, 2008. The market value of my portfolio without FSL Trust is S$96.4K, and if FSL Trust is included then the portfolio value is S$120.5K. Realized gains have increased to S$6.2K due to the dividend from Ezra to be paid on June 18, 2008.

Comparison against STI

Using my new benchmarking technique:-

The FTSE STI had declined by 14.4% since the start of 2008. My portfolio (without FSL Trust) has to date declined 17.4%. Therefore, I have under-performed the STI by 3 percentage points.

FSL Trust has gained 9.5% thus far from my date of purchase while the benchmark STI has fallen 14.4%; I am happy to report that FSL Trust has managed to out-perform the index for FY 2008 thus far.

My next portfolio review will be on Monday, June 30, 2008 after market close.

Sunday, June 08, 2008

Bull Market Baloney and Bear Market Valuations

Strange title eh ? At the risk of sounding silly, the title is supposed to represent my posting on the valuations inherently found within a bull market, versus a bear market. Interestingly, as we have observed currently, the bear market is not even fresh into a year (12 months), yet people seem to be complaining that it's "too long" and everyone is hoping against hope that the bear market will end soon and signal the start of the new bull.

From a personal standpoint, I do not advocate either bull or bear as I focus on companies and the external factors which affect my companies' performance. Still, a bear market always makes it all the more attractive to search for bargains amongst the companies listed on SGX due to the low accorded valuations by Mr. Market. A quick scan I did this weekend turned up many companies (many of them China ones) which were trading at single-digit PER, despite decent prospects for growth. Just 8-10 months ago around August to Oct 2007, the same companies were trading at 20-30x PER. Which brings us back to the topic above - bull markets produce a lot of baloney (nonsense) because everyone bids up the prices of companies to absurd levels, bringing about ridiculous expectations which results in wanton speculation and excessive over-valuation. Of course, the term "irrational exuberance" (coined by Alan Greenspan himself) comes to mind but this term is so oft used it is becoming a cliche in itself.

The purpose of this post (which may look and sound like a Sunday ramble) is to highlight the follies of valuations found in a typical bull market and for the investor to recognize this and refrain from participating in the folly and foolishness. The greater fool game always gets played over and over like a macabre game of musical chairs; the last person without a chair gets left holding the baby at amazingly high valuations. Conversely, in our current market, notice that newspapers, newsletters, commentaries and pundits have expressed dire predictons about the market and economy in general; speaking of "record high oil prices" and a "worldwide recession" looming. Just as in bull markets, there is no end to good news; in bear markets there is always no end to bad, pessimistic news.

For the intelligent investor, he will recognize the advantage of bear markets which makes ALL companies cheap, and will take his time to do his careful research in order to identify potential gems. The bear market is very much welcome by true value investors as the only way to purchase companies with a decent margin of safety and at reasonable valuations. Of course, one must always separate the wheat from the chaff; which is why investing is easy but not simple. Some companies really DO deserve to be trading at low valuations and below NAV as their growth prospects may be unexciting, their industry may be stagnating or costs may be rising significantly. All these factors have to be weighed by the astute investor in order to fulfill a checklist of items which qualify a company for investment selection. Patience is always a virtue and the investor should be willing to wait for a good opportunity to accumulate the shares of a superior company.

Thus, it is better for a bear market to slowly drag itself out so as to maximize the time needed for an investor to hunt for good bargains and to purchase a good company. However, the majority of the folks out there are wishing for the exact opposite; for the bear market to end quickly and for the bull to arrive. All I can say is that these people have probably purchased shares during the bull market baloney period (at high valuations) and cannot bear the pain of cutting their losses; thus they hope for a similar rebound to their previously mentally-anchored price so that they can sell at a smaller loss or breakeven to make themselves look less foolish. The problem with this is that capital can be locked up for extended periods of time without decent returns and the effects may be disastruous as one does not have capital to take full advantage of the bear market. Strangely, the wise thing to do is to just accept the loss and move on; but a quick chat with many associates has revealed that this is one of the HARDEST things to do for an individual and thus many simply cling on forever hoping that the company will recover and to wait for valuations to hit baloney levels again.

In case the patient investor runs low on cash while researching companies to purchase, he can always fall back on the dividend income stream which he has set up by purchasing good companies at low valuations in the past. I would strongly advocate that investors purchase some form of yield stock to provide some cash flows as your capital may be locked in for a very long time. Even Warren Buffett's Washington Post pays him a check equivalent to his entire investment every year ! Now how about that for cash flows ? Thus, the two-prong approach of having cash for investment during a bear market and regular cash inflows from holding good companies purchased some time ago can benefit an investor by allowing him to have some yield as well as opening up opportunities for investment.

Tuesday, June 03, 2008

Swiber - 1Q 2008 Financial Statements Review and Analysis

Yep, this review was somewhat delayed but the past few weeks have been very busy and in addition, there was also Pac Andes and Boustead's FY 2008 results to contend with. Below is my brief analysis of Swiber's 1Q 2008 financial results; do note that quarterly results are not too significant on their own and it is better to see the overall trend in earnings and margins for any company rather than to focus solely on one quarter alone.

Income Statement Review

To compare 1Q 2008 with 1Q 2007, it is obvious that revenues and hence net profits have grown tremendously as a result of fleet addition and the presence of a new source of income (i.e. shipbuilding and ship repairs). However, one should also note that gross margins had fallen from 27.5% in 1Q 2007 to 25.9% in 1Q 2008. This can principally be attributed to the growth of Kreuz Shipbuilding and more revenues coming from the ship-building business unit, which traditionally commands lower margins compared to EPCIC. Moving forward, we should see more margin contraction as Swiber has yet to take delivery of its first drilling vessel (thus, it has to rely on third-party vessels which increase costs). The contraction should smoothen out once more of Swiber's fleet comes on-stream, but should still be below current levels as ship repairs/building takes a slightly larger chunk of revenues. That said, the gross margins for deepwater drilling should be very attractive and this unit should help to boost gross margins as the company heads on into FY 2010.

Net margin for 1Q 2008 was 14.6% against a net margin of 18.9% for 1Q 2007. This was mainly due to higher admin costs (up 185%) and much higher finance costs (increase of 896% on a low base). I would assume the higher admin costs are a result of more intensive hiring to fill up job vacancies for Swiber's new expanded operations and businesses; while the increase in finance costs are a necessary evil from the bond issue and the raising of additional monies through bank loans. Net margin should stabilize once Swiber stops relying on additional financing, and should even improve in future due to greater economies of scale between the various business units.

Balance Sheet Review

On to the Balance Sheet, the most noticeable items are trade receivables which have increased about 46% from US$100.7 million to US$146.5 million; and other receivables which have increased 81.2% from US$26.1 million to US$47.3 million. Presumably, these relate to monies which are yet to be received with regards to the sale-and-leaseback transactions (as Mr. Francis Wong had stated during the AGM). Another plausible explanation might be the 200+% increase in revenues which necessarily generates a greater receivables balance. It is precisely because of this receivables balance that the operating cash flows is negative.

Current ratio stands at 1.96 for 1Q 2008, against 2.15 for 1Q 2007. The ratio was lower due to the increase in trade payables and also the decrease in cash; but is otherwise still healthy. Quick ratio does not apply to Swiber as their inventories are negligible (they are a service provider, not a manufacturer or producer).

Also note that long-term liabilities had increased significantly due to the second bond issue of US$72.0 millio, as well as additional bank loans obtained. The additional gearing is to enable the firm to purchase new assets (vessels) in order to expand its fleet and garner more revenue.

Cash Flow Statement Review

There was negative operating cash flows mainly due to the aforementioned increases in trade and other receivables. The 1Q 2008 presentation slides presented this as "cash used to grow operations" and I would argue that this cannot continue for too long, otherwise the cash position of the company may be seriously compromised. A company can only rely on external funding for so many quarters before it MUST generate sufficient internal cash flows to operate on its own. As Swiber is currently in "rapid growth" stage, this is borderline acceptable though I am not comfortable with it should it shoot past 3Q 2008.

Cash outflows for investing activities was expected to be negative, as the company invested a lot of cash into purchasing assets for use in its EPCIC operations. In fact, cash inflows came mainly from financing activities, where US$70.2 million was raised via a bond issue and US$41.2 million was raised through new bank loans obtained (with collateral presumably on the vessels which were to be delivered to Swiber progressively).

Future Plans

As at March 31, 2008, Swiber's order book stood at US$476 million. According to Management, FY 2008 profit should be much better than FY 2007 due to the schedule for recognition of revenue from the projects. The order book does NOT include a 5-year US$50 million per annum recurring revenue stream from Swiber's tie-up with CUEL. With shipbuilding and EPCIC in full swing and the company about to take on a new business unit for offshore drilling in FY 2008, prospects look positive for the company. Risks would include delay in obtaining vessels, delay in completing projects and subsequent negative goodwill generated, slowdown in orderbook building and possible margin squeeze from rising costs.

I had also noted that most of the contracts and LOI seem to have been awarded in the Feb to April 2008 period, similar to last year's mega-project worth US$146.6 million awarded by Brunei Shell. Mr. Goh was quick to dismiss this idea and said that projects were clinched on an ongoing basis and that there was no specific timing to the award of projects. However, I personally suspect that smaller, lower value contracts are given out throughout the year while the larger ones have to be bidded for and are won close to certain periods of the financial year. Whether this is true or not remains to be seen, but it is hoped that Swiber can continue to build on their core competencies to grow the business, and to leverage on their networks, joint ventures and tie-ups thus far to secure more contracts of worthwhile size.

Sunday, June 01, 2008

Boustead FY 2008 Results Audiocast Transcript Part 2

Here it is, the continuation of the audiocast from Part 1. Enjoy ! I shall be doing my review and analysis of Boustead's FY 2008 results and prospects in a later post.

Question: Would Management be able to update on the business conditions in Vietnam ? Given the high inflationary environment and monetary tightening, does Management forsee a slowdown in projects being handed out ?

FF Wong: We were not very active in Vietnam in the past. We have done some small projects in Vietnam in the real estate solutions arena. However, we are very positive and bullish on Vietnam and have stepped up efforts. We have been negotiating with various Vietnamese Government Agencies on projects. I consider their current problems to be temporary. The very fact that they have problems creates windows of opportunities for us; in the last couple of years the market has been too “hot”. Of course, one has to be careful of environments where there is hyper-inflation, but then again in most cases where crisis abounds, opportunities also abound.

Question: Would Management be able to update on the hydro-power project in Vietnam ?

FF Wong: We signed the MOU like 2 years ago. That is only an MOU but we did not manage to go any further. There were far too many problems or missing pieces that we cannot put together. Having said that, we are not saying that we are not going to look at it, but we did not go any further.

Question: How many industrial real estate solutions are on the books and what are the book cost of these assets and their estimated market value ?

KK Loh: Currently, there are 3 industrial properties recorded on our Balance Sheet, with a total book value of S$29 million; one of which is still a work-in-progress. Earlier on, we were treating this as an investment in properties, thus there is no requirement for revaluation. Valuation was just to ensure that there was no impairment. In recent years, because of the buoyant property market, there was no danger of impairment but we have not obtained the market value of these 3 properties.

Question: Can you give us an outlook for all the business segments ? Do you see the securing of orders slowing down ?

FF Wong (very long reply): I would start with Geo-Spatial. This division has been enjoying steady growth, not exciting, about 5-15% in the past. I envisage we will continue to grow at that pace. We are making efforts to synergize the business with the rest of the group; like for instance water management utilizing geo-spatial technology. We are working with PUB to try to come up with a consortium to market our expertise in the Middle East and the surrounding region. But that’s going to take time, hence I expect this business to continue to grow as before.

On Energy related business, with high energy prices, I do not forsee there would be negative impact even if oil prices were to retreat back to US$60-US$80 per barrel. In this area, we should continue to enjoy fairly healthy growth for another 5 years or so. At least in the next 2-3 years, I do not forsee any problem.

For water and wastewater, this has been a big disappointment for us. It’s because, as I said earlier, the competition had caught up especially in China. Hence, we are trying to move up the technology ladder. We hope that we are able to successfully prove ourselves in this area and move in a big way in China. It’s a very competitive market and I am sure you have followed this market and some of our fellow competitors in this area. I frankly do not think there are many star performers in this area. However, having been in this business for a long time, we know exactly where we can compete and we have been able to move into certain niche areas where we have high barriers to entry. For instance, we are well-recognized and accepted by large EPC MNCs such as Japan Gasoline, Toshiba (newly-added on), Hyundai, Mitsubishi and the like. Our competitors in this area will be the Japanese and the Europeans. You may ask why we have not grown that much; this is a matter of focus. In the area of sewage treatment in China, it’s absolutely a very competitive marketplace; certainly not on BOT. For BOT, we are in essence buying a project instead of getting paid for our services. We are also moving away from Europe where we had lost a lot of money. Now, we are focusing on areas where we have strength. Of course, volume has gone down but if we are successful in the technology initiative (it would yield rewards). We are not only developing new technologies with universities, we are also looking at acquiring, purchasing or signing up licenses with various people who have the state-of-the-art technology which can complement our products and services.

For real estate solutions, our main profit comes from Singapore and we do expect that we can replicate the same winning formula in China and Vietnam. For Singapore, the property market has been doing very well. Residential is cooling down, commercial seems to be holding up while industrial property is buoyant. We have a very healthy pipeline and are negotiating with some big names (MNCs) for rather large projects (much bigger than previously seen). We hope that some of these projects can be design-build-leaseback, meaning we own part of the investment as well. Over the years, we have been able to accumulate quite a number of these leaseback projects which we were then able to on-sell to the REITS. There seems to be still a lot more in the marketplace for design and leaseback; thus we are very bullish about FY 2009. As usual, we will not give a forecast for FY 2010 due to the nature of our business. There is too much of a project to project basis (to forecast accurately); with the money on hand we are looking to acquisitions or M&A where we have expertise to generate recurring income to lay a stronger foundation for the Group to move beyond my tenure and in the years well ahead of my time.

Question: Does the weak US dollar have any significant impact on your bottom line ?

FF Wong: In certain areas, yes while in others no. In Geo-Spatial, we are buying certain software from USA and the weak dollar will be beneficial for us. The negative part is for projects located in Middle East and North Africa. The denominated currency is usually the USD but these days they also accept Euro as well. We are hoping to sell a mixed bag of USD and Euro but this has been difficult. So far, our company has been able to insulate ourselves quite well by buying forward or by outsourcing in the currencies that we are also selling. Thus, we create a natural hedge and we have not been adversely affected yet and we hope to not be.

Question: Are there any intentions to sell any part of the Group with low growth ?

FF Wong: Well, actually (FF Wong is talking about) Geo-Spatial which has steady growth (but good cash flow – 90% of our customers are governments or government-related companies), I would say unless someone is willing to offer a price I cannot refuse, we will keep it for cash flows. We are working hard to synergize it within the Group. As I said earlier on, we are working hard to bring this technology to manage water resources and utilities. For the other divisions, if you care to look at our Balance Sheet, perhaps you will notice that for each business, we started with very little money but we have managed to create a brand name and build up expertise that we have managed to export to most parts of the world. If you recall, Boustead in its early days was bringing in technology from the West (in particular England). Today, we are selling technology and services to other parts of the world instead. The world is huge if you have it as your market. Of course, it is not easy to establish oneself but we have done projects in 73 countries around the world so far. The growth at this juncture should be considered at its infancy. Obviously, one constraint is being able to recruit younger and new talent to grow the company.

Question: If the Group needs to lever up for an acquisition, what kind of leverage ratio would Management be comfortable with given a suitable target ?

FF Wong: I am a very old-fashioned man, so borrowing money has always made me uneasy. However, if short-term financing is required for a project, I would certainly consider it. To take on leverage just to acquire does not make me comfortable.

Question: In terms of M&A, is there any possibility with half-brothers Boustead Malaysia and Salcon Malaysia ?

FF Wong: Well, why not actually ? They are not half-brother actually; we are the father while they are the son ! Certainly, if we are looking for synergies we will explore such options should the opportunity arise. We have no qualms or quarrel with anybody with regards to M&A or doing business.

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