End-August 2008 Portfolio Summary and Review
If I had thought the first half of August 2008 was quiet, at least it was punctuated by the results releases from the companies I own. The second half of August 2008, without any earnings release, would thus qualify as probably the quietest half-month since I started preparing my half-monthly portfolio summaries. There was not a whisper of news from the companies I own except small snippets which I will be updating on the respective companies’ summaries.
With the Olympic Games in Beijing coming to a close, the Chinese markets and the rest of the world can seem to safely continue their downtrend, which is what I had observed over the last few weeks. By now, most speculators and traders are feeling the despair of a market which cannot seem to go anywhere but down, even though DJIA may be performing “well”. The de-coupling theorists seem to have gone all quiet for some reason. And as usual, there are the talking heads coming out to predict how long the bear market will last and when the index will “turn up” or “be in an uptrend”. Suffice to say such “research” amuses me to no end because these people are essentially being paid to do fortune-telling ! No one is able to know or predict when bear markets will end, but nevertheless, people try their best to predict and forecast.
Below is the summary of my investments and related news as at August 29, 2008 (STI at 2,739.95 points).:-
1) Ezra (Vested since October 6, 2005) - Buy Price $0.645 (bonus adjusted), Market Price $1.81, Gain 180.6%, YTD Loss 45.5%. There was no news for Ezra for the half-month ended August 29, 2008.
2) Boustead (Vested since September 13, 2006; averaged down November 13, 2006) - Buy Price $0.6475 (split-adjusted), Market Price $1.07, Gain 65.3%, YTD Loss 11.2%. There was no news from Boustead for the half-month ended August 29, 2008. The dividend of 7 cents per share (5 cents final, 2 cents special pre-split) was received on August 20, 2008.
3) Swiber (Vested since February 14, 2007) - Buy Price $1.01, Market Price $1.45, Gain 43.6%, YTD Loss 57.7%. Swiber announced on August 20, 2008 that they had signed an MOU with Rawabi, a Saudi Arabic firm, to pursue business opportunities in the Middle East. I had detailed this joint venture in a previous post. Other than this, there was no other news from Swiber.
4) Suntec REIT (Vested since December 9, 2004) - Buy Price $1.11, Market Price $1.46, Gain 31.5%, YTD Loss 14.6%. There was no news for Suntec REIT for the period ending August 29, 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 and July 3, 2008) - Buy Price $0.5475, Market Price $0.365, Loss 33.3%, YTD Loss 42.1%. There was no news from PAH for the half-month ended August 29, 2008. The scrip shares will be issued at 44 cents a piece, and with the current share price trading at 36.5 cents, it makes more sense to reject the scrip and receive the dividend in cash so as to buy more shares from the open market.
6) China Fishery Group (Vested since November 20, 2007) - Buy Price $1.50 (average), Market Price $1.20, Loss 20%, YTD Loss 35.1%. On August 19, 2008, China Fishery announced the acquisition of an additional purse seine vessel from a Peruvian Company for US$4.3 million. This vessel has a fish hold capacity of 204 square metres and will add to CFG’s total capacity, boosting it to 10,149 square metres. Management have reiterated their belief that positioning themselves in the South Pacific will be beneficial for the Company once Peru changes to the ITQ system, and the ITQ system is also believed to be able to boost EBITDA margins significantly.
7) First Ship Lease Trust (Vested since January 14, 2008) - Buy Price (Averaged Down) $1.105, Market Price $1.13, Gain 2.3%. There was no news from FSL Trust for the half-month ended August 29, 2008. The dividend of 2.8 US cents per share (converted at a rate of 1.4136) was received on August 26, 2008.
Overall Portfolio
The gain on my current portfolio is 12.8% from a cost of S$89.2K as at August 29, 2008. The market value of my portfolio is S$100.6K. Realized gains amount to S$8.6K as a result of the dividend from FSL Trust, Boustead, Suntec REIT (inclusive of the dividend from Pacific Andes which I will choose to accept in cash instead of scrip). Including realized gains, the total gain as a % of my cost is 22.4%.
Comparison against STI
Using my benchmarking technique:-
The FTSE STI had declined by 21.3% since the start of 2008. My portfolio (without FSL Trust and the new PAH purchase) has to date declined 39.3%. Therefore, I have under-performed the STI by a (whopping) 18 percentage points !
FSL Trust has gained 2.3% thus far from my date of purchase while the benchmark STI has fallen 14.9% (from my date of purchase Jan 14, 2008 when STI was 3,218.14); I am happy to report that FSL Trust has managed to out-perform the index for FY 2008 thus far.
The new Pacific Andes tranche which was purchased at 44 cents per share on July 3, 2008 will be analyzed separately from the rest of the portfolio. STI as at July 3 was 2,880.45 and STI today is 2,797.50, thus this represents a 4.88% loss. Current share price of Pacific Andes is 36.5 cents, representing a loss of 17%. Hence, my purchase of Pacific Andes has under-performed the index (I have excluded the dividend in my computation).
My next portfolio review will be on Monday, September 15, 2008 after market close.
Friday, August 29, 2008
Tuesday, August 26, 2008
Investment Sins Part 5 - Avarice
Avarice (another word for "greed"), our 4th discussed sin, strikes most investors during the peak of a bull market or during the middle of a raging bull market. It will be rather self-explanatory to the informed reader that greed is part of a normal investor's psychology, and therefore should be controlled as part of the fear/greed combination which occurs in such potent fashion while investing in the stock market.
However, what may not be obvious is that avarice can take different forms and may manifest itself in different ways (through various behaviours). The objective of this post is to highlight the various forms of avarice, how they are demonstrated and how to effectively curb such behaviour and prevent it from ruining our investing lives. First of all, Mr. Fertig's book points out that greedy investors tend to be unrealistic investors. To give an example, one may invest with the proper research framework and do their requisite reading and valuation tests to look for a suitable investment. However, when it comes to expectations of returns, avarice causes the investor to have wildly unrealistic expectations. He may envision a 200% rise in the stock price over a period of a year, or errorneously believe that his company is the best in the industry and immune to downturns. Such unrealistic expectations usually cause an investor to lose focus of reality and may cause recklessness and deep disappointment.
Another consequence of excessive greed is the desire to chase performance, which may result in even poorer performance than if one had just "stayed put". One example given in the book is the chasing of "hot" mutual funds (unit trusts) in the hope of maximizing returns. The greedy investor will "hop" from one year's top fund to next year's top fund, all the while switching from one to another in the (vain) hope of maximizing his wealth. However, this is usually a losing strategy as there is no guarantee that this year's top performing fund will continue to outperform. Frictional costs related to switching (some funds charge upfront sales charges) may also work to erode gains. leaving the investor worse off than if he had just invested in a low turnover, low expense ratio index fund !
A third result of greed is the failure to do proper due diligence. Greedy investors often throw caution to the wind and "invest" based on tips and rumours, with the hope of a windfall or jackpot (akin to lottery gambling). Such moves are often detrimental as investing based on such scanty and subjective information usually means the investor ends up not knowing what he is investing in, and this almost always spells trouble !
A further effect of greed is that it prevents investors from studiously monitoring their current investments for signs of any trouble. A greedy investor always assumes the best in his investments and fails to spot signs which may affect the companies which he invests in. This is a case of selective perception and the greedy investor wishes to look out for information which affirms his avarice, rather than objectively assessing information in order to make a more informed decision on whether to hold, or sell an under-performing investment.
The key to preventing greed from affecting our investment lives starts with proper self-control and being realistic. For example, it is unrealistic to expect to "beat" or even equal the performance of investing legends such as Peter Lynch, Warren Buffett and John Templeton. As retail investors, most of us are just average folk and therefore should accept a decent return on investment (in the region of 5-6% per annum is fair). Also, train yourself to assess an investment in an objective, calm and rational manner, so that greed does not cloud one's judgement and make an investment seem much better than it really is. And, probably the most difficult thing to do is to convince yourself that the market will eventually reward the patient, long-term investor and punish those who speculted without doing their due dilligence. In other words, greed does not pay and only in the long-term will this become obvious.
Warren Buffett's famous line is "You only know who's swimming naked when the tide goes out". Such a sentence is very true indeed in this current bear market, as most who purchased at very high valuations are sitting on significant paper losses now. Personally, I believe that greed will not give me a good outcome; thus I choose to "get rich slowly" instead of gunning for quick, ephemereal gains.
Avarice (another word for "greed"), our 4th discussed sin, strikes most investors during the peak of a bull market or during the middle of a raging bull market. It will be rather self-explanatory to the informed reader that greed is part of a normal investor's psychology, and therefore should be controlled as part of the fear/greed combination which occurs in such potent fashion while investing in the stock market.
However, what may not be obvious is that avarice can take different forms and may manifest itself in different ways (through various behaviours). The objective of this post is to highlight the various forms of avarice, how they are demonstrated and how to effectively curb such behaviour and prevent it from ruining our investing lives. First of all, Mr. Fertig's book points out that greedy investors tend to be unrealistic investors. To give an example, one may invest with the proper research framework and do their requisite reading and valuation tests to look for a suitable investment. However, when it comes to expectations of returns, avarice causes the investor to have wildly unrealistic expectations. He may envision a 200% rise in the stock price over a period of a year, or errorneously believe that his company is the best in the industry and immune to downturns. Such unrealistic expectations usually cause an investor to lose focus of reality and may cause recklessness and deep disappointment.
Another consequence of excessive greed is the desire to chase performance, which may result in even poorer performance than if one had just "stayed put". One example given in the book is the chasing of "hot" mutual funds (unit trusts) in the hope of maximizing returns. The greedy investor will "hop" from one year's top fund to next year's top fund, all the while switching from one to another in the (vain) hope of maximizing his wealth. However, this is usually a losing strategy as there is no guarantee that this year's top performing fund will continue to outperform. Frictional costs related to switching (some funds charge upfront sales charges) may also work to erode gains. leaving the investor worse off than if he had just invested in a low turnover, low expense ratio index fund !
A third result of greed is the failure to do proper due diligence. Greedy investors often throw caution to the wind and "invest" based on tips and rumours, with the hope of a windfall or jackpot (akin to lottery gambling). Such moves are often detrimental as investing based on such scanty and subjective information usually means the investor ends up not knowing what he is investing in, and this almost always spells trouble !
A further effect of greed is that it prevents investors from studiously monitoring their current investments for signs of any trouble. A greedy investor always assumes the best in his investments and fails to spot signs which may affect the companies which he invests in. This is a case of selective perception and the greedy investor wishes to look out for information which affirms his avarice, rather than objectively assessing information in order to make a more informed decision on whether to hold, or sell an under-performing investment.
The key to preventing greed from affecting our investment lives starts with proper self-control and being realistic. For example, it is unrealistic to expect to "beat" or even equal the performance of investing legends such as Peter Lynch, Warren Buffett and John Templeton. As retail investors, most of us are just average folk and therefore should accept a decent return on investment (in the region of 5-6% per annum is fair). Also, train yourself to assess an investment in an objective, calm and rational manner, so that greed does not cloud one's judgement and make an investment seem much better than it really is. And, probably the most difficult thing to do is to convince yourself that the market will eventually reward the patient, long-term investor and punish those who speculted without doing their due dilligence. In other words, greed does not pay and only in the long-term will this become obvious.
Warren Buffett's famous line is "You only know who's swimming naked when the tide goes out". Such a sentence is very true indeed in this current bear market, as most who purchased at very high valuations are sitting on significant paper losses now. Personally, I believe that greed will not give me a good outcome; thus I choose to "get rich slowly" instead of gunning for quick, ephemereal gains.
Friday, August 22, 2008
Swiber – 1H FY 2008 Financial Review and Analysis
It’s been a while since I had blogged about Swiber and related updates from the company. The company released its 1H 2008 financial results on August 13, 2008, and all I can say is that much was in line with what I expected, though quite a large part of its future is still uncertain at this point in time due to the absence of news about potential developments. Swiber’s presentation slides and Raymond Goh’s interview with Reuters did shed some light on the strategic direction the company plans to take, and I shall comment on it in a separate section after my usual financial statement review. I will keep the financial review short as I wish to focus more on the future and prospects for the company.
Income Statement Analysis
As expected, Swiber’s 2Q 2008 revenues increased by 391% from 2Q 2007 to US$124.5 million as a result of them working concurrently on 6 projects instead of 2 in the previous year. From their order book and award of contracts during the Jan to March 2008 period, one can already foresee that their volume of business is indeed growing. Gross margin came in at 25.9% for 2Q 2008 versus 29.4% for 2Q 2007, while gross margins for 1H 2008 weighed in at 25.9% against 28.6% for 1H 2007. I believe the reason for the fall in gross margins is due to the fact that Swiber is contracting third-party vessels for its projects until the new vessels arrive in 2H 2008. Net margins for 2Q 2008 and 1H 2008 were 17.8% and 16.7%, lower than 2Q 2007 and 1H 2007 mainly due to higher income tax expenses and higher interest costs as the company is gearing up.
Balance Sheet Review
The main points to highlight are that trade receivables and property, plant and equipment saw sharp rises in the last 6 months, due to the increased volume of business and also Swiber’s continued investment in new vessels to expand its fleet. Current ratio stood at 1.42 for June 30, 2008 compared to 2.15 as at December 31, 2008. This sharp drop was mainly due to the issuance of bonds, increased bank loans as well as a more than 100% rise in other payables. Net debt-equity ratio has increased from 0.53 to 1.03 times as at June 30, 2008, and this could represent a red flag if debt continues to remain high. However, in light of the nature of the company’s business and the industry in which it operates, I would expect gearing to remain fairly high. The question is whether it will get excessively high in future (i.e. more than 2.0) ? These concerns are addressed later on in my posting on prospects and plans.
Cash Flow Statement Analysis
In the previous quarter, there was a net cash outflow from operating activities which I flagged as a possible area of concern. For 2Q 2008 however, there was a net inflow of cash of US$18.5 million, chiefly due to the sharp rise in other payables and a drop in other receivables (using the “indirect” method of preparing cash flow statement). When compared to 2Q 2007, this is encouraging as net cash inflows increased nearly 6 times while net profit for 2Q had only increased 4 times. Still, such a comparison may be shallow as further analysis is required as to the nature of the “other payables” and the reason for the sharp increase. It could also be due to a timing difference which will result in a net cash outflow in the next quarter. With the indirect method of preparing the cash flow statement, sometimes I feel it is better to look at the full-year picture rather than just one quarter alone.
As expected, most of their cash was ploughed into purchases of vessels and also for assets held for sale (in their sale and leaseback arrangement). This sucked up US$117 million worth of cash in the 2Q 2008. Swiber paid off US$24 million worth of bank loans and raised another US$56.8 million through new bank loans, presumably using their new vessels under construction as collateral. Bond issuance helped to raise US$20.2 million worth of cash which will assist in financing the construction of vessels. It is these new bank loans and bonds which are responsible for raising the gearing of the company.
Valuation
Using a net profit figure of US$32.5 million and annualizing it, FY 2008 net profit will be about US$65 million. Using an exchange rate of 1.41 to the USD, this gives a net profit of about S$91.8 million. Earnings per share is thus about SGD 21.7 cents. At today's closing price of S$1.57, this translates into a PER of about 7.2 times (using a combination of historical and forward pricing). I have highlighted some factors below which may contribute to a higher intrinsic value for Swiber and may be worth considering. Based on my purchase price of S$1.01, I have purchased Swiber at a PER of about 4.65 times, and this gives me sufficient margin of safety in my opinion.
Order Book and Project Bidding
As at June 30, 2008, Swiber had an order book of US$664 million which includes the US$250 million CUEL project spanning 5 financial years. This order book is expected to be recognized as revenues progressively over the next 1.5 financial years, and a recent DBS report mentioned that the new bidding season for contracts will arrive soon from the November to January period. The total bids submitted as at August 2008 is for US$3.57 billion worth of jobs for the next 5 years. If we assume a conservative rate of 20% win, that’s an additional US$714 million worth of additional projects. One thing to remember is that bidding for projects is an ongoing thing and as Swiber expands its regional footprint, the chances of them clinching a project will be significantly higher. Thus, this should only be used as a gauge and not as an exact approximation. One issue with Swiber is that their project-based revenue tends to be “lumpy”, much like a property developer recognizes revenues for properties based on % of completion method. CUEL was the first multi-year dealed inked by Swiber and demonstrates that such contracts do exist in the industry and Swiber is more than capable of clinching one in the near future.
Qualitative Factors to justify higher intrinsic value
When one analyzes a company like Swiber, one may think that it is just another EPCIC player competing in the same space as other similar EPCIC players serving the oil and gas industry. However, several factors have been identified by myself as being of significance in assigning a higher intrinsic value for Swiber. Recall that the intrinsic value of a company is not just based on its financials, but also on “intangible” factors such as Management strength, network of clients, reputation of customers and other factors. These are as follows for Swiber:-
a) Completion of Mampak platform installation work for Brunei Shell on schedule and without incident. This demonstrates that the company is capable of handling larger, more complex projects without compromising on delivery timing and safety. The successful completion of a major project for a large reputable client like Brunei Shell will give Swiber an edge in bidding for future projects.
b) Gradual expansion of territories for client base – Swiber has gradually extended its regional footprint over the last 1.5 years since listing by signing MOU and LOI with parties in various countries. During listing in 2006, it only had clients located in Singapore, Malaysia, Indonesia and India. Currently, its client base has expanded to include Thailand (CUEL), Vietnam (PetroVietnam), Brunei (Rahaman and Brunei Shell) and most recently, Saudi Arabia (Rawabi). Thus, their expanding network shows that they are able to garner the confidence of the local parties in order to work hand in hand with them, and expands their area of influence.
c) Excellent Management Team for Offshore Drilling Services (ODS) – Swiber made a very good move by hiring Mr. Glen Olivera who has nearly 30 years of experience in drilling all over the world. With him to helm the ODS division as CEO (and also taking up a 10% stake in Equatorial Driller Pte Ltd), shareholders can be assured that only the highest quality will be delivered in terms of design and execution, due to this vast experience in drilling.
Prospects and Plans
Swiber has outlined its plans for growth in the next 5 years, and this will mainly be underpinned by its fleet expansion which will take its fleet from the current 30 vessels (to date) to 39 by the end of FY 2008 and then to 48 by the end of FY 2009. Their vessels are mainly to cater for higher value and larger EPCIC projects in which Swiber occupies a niche market, while at the same time, they are also providing offshore support services (OSS) through their fleet of AHT and AHTS.
However, Swiber intends to capitalize on its unique design for Equatorial Driller (ED) to take the company to the next stage of growth. Their immediate focus is to secure a drilling contract either in West Africa or Brazil, while at the same time finalizing the shipyard which is supposed to build the vessel. The vessel can only be delivered 24 months after the signing of the contract with the shipyard, so the estimated date of delivery will be about 4Q FY 2010. Mr. Goh mentioned that the ED will cost a lot less to build than a normal semi-submersible because of the difference in hull design and the lack of a DP2 positioning system. This is due to the target market which Swiber is aiming for as the operations for ED will be in mild waters which do not need DP2 technology. As ED will cost less, a competitive advantage Swiber will have is that they can charge clients lower day rates for the charter of the driller; thus creating a win-win situation for both themselves (their gross margin is preserved) and the client (cheaper day-rates as compared to semi-submersible drillers). I would expect Swiber to announced finalized plans for the ED by the end of September 2008 and hopefully a contract will follow swiftly.
Mr. Raymond Goh had also mentioned in a Reuters interview recently that he intended to maintain the debt-to-equity ratio of the company at about 1 (the current level). In order to do this, there are two possible options: he can either issue more shares through a secondary offering (thus diluting current shareholders) and then drawdown on the medium-term notes and bonds facility (hence preserving the ratio at 1) or to utilized sale-and-leaseback to free up cash and lighten the Balance Sheet (Swiber had already done this twice). The first option seems unlikely as current market conditions (in a bear market, valuations are lower) do not facilitate an efficient use of the capital markets for fund-raising, therefore I feel Swiber will gravitate more towards the second option of using more sale and leasebacks to free up cash for expansion. In light of their capital-intensive nature of business and the fact that larger contracts can only be secured through the expansion of their fleet and capabilities, this is a necessary evil.
In a surprising and (to me) somewhat unrelated announcement, Mr. Raymond Goh has commented that Swiber is studying the offshore windpower market to assess the potential for windpower as an alternative source of energy. In the Reuters interview, he mentioned that he hoped Swiber would be able to clinch a contract within a year with a major European company, and that windpower may contribute as much as 10% to Swiber’s revenue in 5 years’ time. Their powerpoint presentation to analysts does not paint a very pretty picture of windpower as costs have been escalating and many projects are stalling due to lack of funding. Though offshore windfarms are a new and interesting idea, it remains to be seen if a good enough return on investment can be achieved in order to justify future capex in this new business unit. The company may be biting off a lot more than it can chew if it plans to “diversify” its revenue stream. I would rather it focused on its core competence instead of trying too many different things at the same time. Hence, this is one area of worry for me in the near-term, as there are no earnings visibility for windpower and not much is known about the future potential as well as the gross margins for such contracts.
It’s been a while since I had blogged about Swiber and related updates from the company. The company released its 1H 2008 financial results on August 13, 2008, and all I can say is that much was in line with what I expected, though quite a large part of its future is still uncertain at this point in time due to the absence of news about potential developments. Swiber’s presentation slides and Raymond Goh’s interview with Reuters did shed some light on the strategic direction the company plans to take, and I shall comment on it in a separate section after my usual financial statement review. I will keep the financial review short as I wish to focus more on the future and prospects for the company.
Income Statement Analysis
As expected, Swiber’s 2Q 2008 revenues increased by 391% from 2Q 2007 to US$124.5 million as a result of them working concurrently on 6 projects instead of 2 in the previous year. From their order book and award of contracts during the Jan to March 2008 period, one can already foresee that their volume of business is indeed growing. Gross margin came in at 25.9% for 2Q 2008 versus 29.4% for 2Q 2007, while gross margins for 1H 2008 weighed in at 25.9% against 28.6% for 1H 2007. I believe the reason for the fall in gross margins is due to the fact that Swiber is contracting third-party vessels for its projects until the new vessels arrive in 2H 2008. Net margins for 2Q 2008 and 1H 2008 were 17.8% and 16.7%, lower than 2Q 2007 and 1H 2007 mainly due to higher income tax expenses and higher interest costs as the company is gearing up.
Balance Sheet Review
The main points to highlight are that trade receivables and property, plant and equipment saw sharp rises in the last 6 months, due to the increased volume of business and also Swiber’s continued investment in new vessels to expand its fleet. Current ratio stood at 1.42 for June 30, 2008 compared to 2.15 as at December 31, 2008. This sharp drop was mainly due to the issuance of bonds, increased bank loans as well as a more than 100% rise in other payables. Net debt-equity ratio has increased from 0.53 to 1.03 times as at June 30, 2008, and this could represent a red flag if debt continues to remain high. However, in light of the nature of the company’s business and the industry in which it operates, I would expect gearing to remain fairly high. The question is whether it will get excessively high in future (i.e. more than 2.0) ? These concerns are addressed later on in my posting on prospects and plans.
Cash Flow Statement Analysis
In the previous quarter, there was a net cash outflow from operating activities which I flagged as a possible area of concern. For 2Q 2008 however, there was a net inflow of cash of US$18.5 million, chiefly due to the sharp rise in other payables and a drop in other receivables (using the “indirect” method of preparing cash flow statement). When compared to 2Q 2007, this is encouraging as net cash inflows increased nearly 6 times while net profit for 2Q had only increased 4 times. Still, such a comparison may be shallow as further analysis is required as to the nature of the “other payables” and the reason for the sharp increase. It could also be due to a timing difference which will result in a net cash outflow in the next quarter. With the indirect method of preparing the cash flow statement, sometimes I feel it is better to look at the full-year picture rather than just one quarter alone.
As expected, most of their cash was ploughed into purchases of vessels and also for assets held for sale (in their sale and leaseback arrangement). This sucked up US$117 million worth of cash in the 2Q 2008. Swiber paid off US$24 million worth of bank loans and raised another US$56.8 million through new bank loans, presumably using their new vessels under construction as collateral. Bond issuance helped to raise US$20.2 million worth of cash which will assist in financing the construction of vessels. It is these new bank loans and bonds which are responsible for raising the gearing of the company.
Valuation
Using a net profit figure of US$32.5 million and annualizing it, FY 2008 net profit will be about US$65 million. Using an exchange rate of 1.41 to the USD, this gives a net profit of about S$91.8 million. Earnings per share is thus about SGD 21.7 cents. At today's closing price of S$1.57, this translates into a PER of about 7.2 times (using a combination of historical and forward pricing). I have highlighted some factors below which may contribute to a higher intrinsic value for Swiber and may be worth considering. Based on my purchase price of S$1.01, I have purchased Swiber at a PER of about 4.65 times, and this gives me sufficient margin of safety in my opinion.
Order Book and Project Bidding
As at June 30, 2008, Swiber had an order book of US$664 million which includes the US$250 million CUEL project spanning 5 financial years. This order book is expected to be recognized as revenues progressively over the next 1.5 financial years, and a recent DBS report mentioned that the new bidding season for contracts will arrive soon from the November to January period. The total bids submitted as at August 2008 is for US$3.57 billion worth of jobs for the next 5 years. If we assume a conservative rate of 20% win, that’s an additional US$714 million worth of additional projects. One thing to remember is that bidding for projects is an ongoing thing and as Swiber expands its regional footprint, the chances of them clinching a project will be significantly higher. Thus, this should only be used as a gauge and not as an exact approximation. One issue with Swiber is that their project-based revenue tends to be “lumpy”, much like a property developer recognizes revenues for properties based on % of completion method. CUEL was the first multi-year dealed inked by Swiber and demonstrates that such contracts do exist in the industry and Swiber is more than capable of clinching one in the near future.
Qualitative Factors to justify higher intrinsic value
When one analyzes a company like Swiber, one may think that it is just another EPCIC player competing in the same space as other similar EPCIC players serving the oil and gas industry. However, several factors have been identified by myself as being of significance in assigning a higher intrinsic value for Swiber. Recall that the intrinsic value of a company is not just based on its financials, but also on “intangible” factors such as Management strength, network of clients, reputation of customers and other factors. These are as follows for Swiber:-
a) Completion of Mampak platform installation work for Brunei Shell on schedule and without incident. This demonstrates that the company is capable of handling larger, more complex projects without compromising on delivery timing and safety. The successful completion of a major project for a large reputable client like Brunei Shell will give Swiber an edge in bidding for future projects.
b) Gradual expansion of territories for client base – Swiber has gradually extended its regional footprint over the last 1.5 years since listing by signing MOU and LOI with parties in various countries. During listing in 2006, it only had clients located in Singapore, Malaysia, Indonesia and India. Currently, its client base has expanded to include Thailand (CUEL), Vietnam (PetroVietnam), Brunei (Rahaman and Brunei Shell) and most recently, Saudi Arabia (Rawabi). Thus, their expanding network shows that they are able to garner the confidence of the local parties in order to work hand in hand with them, and expands their area of influence.
c) Excellent Management Team for Offshore Drilling Services (ODS) – Swiber made a very good move by hiring Mr. Glen Olivera who has nearly 30 years of experience in drilling all over the world. With him to helm the ODS division as CEO (and also taking up a 10% stake in Equatorial Driller Pte Ltd), shareholders can be assured that only the highest quality will be delivered in terms of design and execution, due to this vast experience in drilling.
Prospects and Plans
Swiber has outlined its plans for growth in the next 5 years, and this will mainly be underpinned by its fleet expansion which will take its fleet from the current 30 vessels (to date) to 39 by the end of FY 2008 and then to 48 by the end of FY 2009. Their vessels are mainly to cater for higher value and larger EPCIC projects in which Swiber occupies a niche market, while at the same time, they are also providing offshore support services (OSS) through their fleet of AHT and AHTS.
However, Swiber intends to capitalize on its unique design for Equatorial Driller (ED) to take the company to the next stage of growth. Their immediate focus is to secure a drilling contract either in West Africa or Brazil, while at the same time finalizing the shipyard which is supposed to build the vessel. The vessel can only be delivered 24 months after the signing of the contract with the shipyard, so the estimated date of delivery will be about 4Q FY 2010. Mr. Goh mentioned that the ED will cost a lot less to build than a normal semi-submersible because of the difference in hull design and the lack of a DP2 positioning system. This is due to the target market which Swiber is aiming for as the operations for ED will be in mild waters which do not need DP2 technology. As ED will cost less, a competitive advantage Swiber will have is that they can charge clients lower day rates for the charter of the driller; thus creating a win-win situation for both themselves (their gross margin is preserved) and the client (cheaper day-rates as compared to semi-submersible drillers). I would expect Swiber to announced finalized plans for the ED by the end of September 2008 and hopefully a contract will follow swiftly.
Mr. Raymond Goh had also mentioned in a Reuters interview recently that he intended to maintain the debt-to-equity ratio of the company at about 1 (the current level). In order to do this, there are two possible options: he can either issue more shares through a secondary offering (thus diluting current shareholders) and then drawdown on the medium-term notes and bonds facility (hence preserving the ratio at 1) or to utilized sale-and-leaseback to free up cash and lighten the Balance Sheet (Swiber had already done this twice). The first option seems unlikely as current market conditions (in a bear market, valuations are lower) do not facilitate an efficient use of the capital markets for fund-raising, therefore I feel Swiber will gravitate more towards the second option of using more sale and leasebacks to free up cash for expansion. In light of their capital-intensive nature of business and the fact that larger contracts can only be secured through the expansion of their fleet and capabilities, this is a necessary evil.
In a surprising and (to me) somewhat unrelated announcement, Mr. Raymond Goh has commented that Swiber is studying the offshore windpower market to assess the potential for windpower as an alternative source of energy. In the Reuters interview, he mentioned that he hoped Swiber would be able to clinch a contract within a year with a major European company, and that windpower may contribute as much as 10% to Swiber’s revenue in 5 years’ time. Their powerpoint presentation to analysts does not paint a very pretty picture of windpower as costs have been escalating and many projects are stalling due to lack of funding. Though offshore windfarms are a new and interesting idea, it remains to be seen if a good enough return on investment can be achieved in order to justify future capex in this new business unit. The company may be biting off a lot more than it can chew if it plans to “diversify” its revenue stream. I would rather it focused on its core competence instead of trying too many different things at the same time. Hence, this is one area of worry for me in the near-term, as there are no earnings visibility for windpower and not much is known about the future potential as well as the gross margins for such contracts.
Friday, August 15, 2008
Mid-August 2008 Portfolio Summary and Review
The first half of August 2008 was quiet, unless you take into account the rumblings of the general public who literally saw the value of shares on the bourse fall to new 52-week lows. In terms of corporate actions and announcements, there was little activity. While I do maintain that “no news is good news”, sometimes having some updates on matters pending is useful for listed companies as a means of communicating with shareholders.
Much of what is happening to the USA now is fairly well-known and widely reported in the news, so I shall not elaborate on the details. Suffice to say that economic activity is slowing and countries such as Australia and United Kingdom may be looking at a possible recession. Singapore itself has revised FY 2008 growth figures to 4-5% instead of the previous 4-6%, as there was a contraction in 2Q 2008 as compared to 1Q 2008. If 3Q 2008 reports a contraction, then Singapore will be in a “technical recession” (don’t ask me about this term, it was coined by economists) !
Meanwhile, the Olympic Games are on in Beijing now and the China stock market has reacted by crashing even further as people are now worried about a post-Olympic slump. Interestingly, S-Shares listed on SGX have seen valuations getting more and more attractive as investors become overly pessimistic, contributing to the irrational panic and selldown. There are now many bargains in the local bourse but of course one needs to assess the impact of rising inflation on a company before one decides to purchase.
Boustead released their first quarterly results (1Q 2009) on August 12, 2008, while Swiber released 1H 2008 results on August 13, 2008. Pacific Andes and China Fishery released their 1Q 2009 and 1H 2008 results respectively on August 14, 2008. Thus, the reporting season is over for my companies for now, with the next being Ezra’s FY 2008 results due in mid-October 2008.
Below is the summary of my investments and related news as at August 15, 2008 (STI at 2,797.50 points).:-
1) Ezra (Vested since October 6, 2005) - Buy Price $0.645 (bonus adjusted), Market Price $2.00, Gain 210%, YTD Loss 39.8%. Besides a brief announcement that the company was issuing S$50 million worth of bonds (at a coupon rate of 5.285% per annum due 2011), there was no other news for Ezra for the half-month ended August 15, 2008.
2) Boustead (Vested since September 13, 2006; averaged down November 13, 2006) - Buy Price $1.295 (average), Market Price $2.28, Gain 76.1%, YTD Loss 5.4%. Boustead released their first quarterly results (1Q 2009) on August 12, 2008. Revenues fell 11.3% while net profit due to shareholders dipped 38.6%. As mentioned in their FY 2008 Annual Report, their quarterly results are not expected to fully reflect the business of the company as many of their contracts are project-based, hence there may be deferred or delayed revenue recognition. Anyhow, if the sale of property in the UK for 1Q 2008 was excluded, then net profit attributable to shareholders would have increased 96.1% from S$2.87 million to the current S$5.63 million. Note that as many of Boustead’s projects are still in their initial phases, and the fact that the company itself has provided sufficient detailed explanations for each of their divisions, I will NOT be doing a 1Q 2009 results analysis. I will reserve this for their 1H 2009 results to be released some time in November 2008. Boustead went ex-dividend and I have added the dividend of 7 cents/share to my realized portfolio gains. My dividend yield for FY 2008 (based on a total of 10 cents per share) is 7.72%, beating the inflation rate which has hovered at 7.5% for the last 3 months. Note too that Boustead goes ex-entitlement for their 1:1 share split on August 18, 2008, so I will be adjusting my purchase price by 50% to S$0.6475 in my next portfolio review.
3) Swiber (Vested since February 14, 2007) - Buy Price $1.01, Market Price $1.65, Gain 63.4%, YTD Loss 51.9%. Swiber released their 1H 2008 financial results on August 13, 2008. I will be doing a detailed review of their results but I will give a snapshot here on this portfolio review. Revenues for 2Q 2008 grew 391% from US$25.4 million to US$124.53 million, while gross profit increased 333% (gross margin was slightly impacted, probably due to usage of more third-party vessels till the delivery of more vessels closer to end FY 2008). Net profit increased a smaller 258% from US$6.2 million to US$22.2 million mainly due to an increase in headcount and finance costs (from their increased debt). Their results were within expectations and do not come as a big surprise, though the shrinking margins beg an explanation. More details will follow in my analysis which should take a few days to compile and which will include snippets from a Reuters interview given by Mr. Raymond Goh.
4) Suntec REIT (Vested since December 9, 2004) - Buy Price $1.11, Market Price $1.42, Gain 27.9%, YTD Loss 17%. There was no news for Suntec REIT for the period ending August 15, 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 and July 3, 2008) - Buy Price $0.5475, Market Price $0.395, Loss 27.9%, YTD Loss 37.3%. Pacific Andes reported a decent set of results for 1Q 2009 on August 14, 2008. Revenues were up 10.2% to HK$2.35 billion while net profit after tax was down 15.1% due to higher costs impacting its low margin SCM business unit. However, profit attributable to shareholders increased 26.1% to HK$122 million. Moving forward, I would expect to see moderate growth from the company in the light of difficult economic conditions. I will not be doing an analysis for PAH and my analysis will be focused on China Fishery’s 1H 2008 results (since both companies are inter-linked and their future plans and prospects will be similar).
6) China Fishery Group (Vested since November 20, 2007) - Buy Price $1.50 (average), Market Price $1.23, Loss 18%, YTD Loss 33.5%. China Fishery released their 1H 2008 results on August 14, 2008. For 2Q 2008, revenues increased 24.1%, reversing a dip in revenues for 1Q year-on-year. Gross profit was slightly impacted from higher COGS for 2Q, but overall for 1H 2008 gross margins had improved. Net profit after tax increased 16.6% for 2Q 2008 to US$23.5 million, bringing 1H 2008 net profit to US$63.9 million, an increase of 26.2% over 1H 2007. I will be doing a detailed review and analysis of CFG (focusing more on the future and prospects), but this will take time and readers should only expect it by the end of August 2008.
7) First Ship Lease Trust (Vested since January 14, 2008) - Buy Price (Averaged Down) $1.105, Market Price $1.21, Gain 9.5%. There was no news from FSL Trust, and Management should currently still be busy trying to negotiate the additional loan to finance the acquisition of the third Yang Ming vessel. They did say that they had till October 2008 to do this. Another interesting fact is that the USD has been strengthening against the SGD in recent weeks, reaching a high of 1.41. This bodes well for me as the previous dividend was received at a conversion rate of 1.3608. The higher exchange rate, coupled with the higher dividend quantum, should make for a significantly higher dividend amount once converted to SGD and paid to me on August 26, 2008.
Overall Portfolio
The gain on my current portfolio is 21.5% from a cost of S$89.2K as at August 15, 2008. The market value of my portfolio is S$108.4K. Realized gains have increased to about S$8.6K as a result of the dividend from FSL Trust, Boustead, Suntec REIT and Pacific Andes (the dividend will be counted until the decision to choose scrip arrives – if scrip is chosen, I will adjust the realized gains accordingly). If the realized gain is included, the total gain as a % of my cost will be 31.1%.
Comparison against STI
Using my benchmarking technique:-
The FTSE STI had declined by 19.7% since the start of 2008. My portfolio (without FSL Trust and the new PAH purchase) has to date declined 34.6%. Therefore, I have under-performed the STI by 15.1 percentage points.
FSL Trust has gained 9.5% thus far from my date of purchase while the benchmark STI has fallen 13.1% (from my date of purchase Jan 14, 2008 when STI was 3,218.14); I am happy to report that FSL Trust has managed to out-perform the index for FY 2008 thus far.
The new Pacific Andes tranche which was purchased at 44 cents per share on July 3, 2008 will be analyzed separately from the rest of the portfolio. STI as at July 3 was 2,880.45 and STI today is 2,797.50, thus this represents a 2.88% loss. Current share price of Pacific Andes is 39.5 cents, representing a loss of 11.4%. Hence, my purchase of Pacific Andes has under-performed the index (I have excluded the dividend in my computation).
My next portfolio review will be on Friday, August 29, 2008 after market close.
The first half of August 2008 was quiet, unless you take into account the rumblings of the general public who literally saw the value of shares on the bourse fall to new 52-week lows. In terms of corporate actions and announcements, there was little activity. While I do maintain that “no news is good news”, sometimes having some updates on matters pending is useful for listed companies as a means of communicating with shareholders.
Much of what is happening to the USA now is fairly well-known and widely reported in the news, so I shall not elaborate on the details. Suffice to say that economic activity is slowing and countries such as Australia and United Kingdom may be looking at a possible recession. Singapore itself has revised FY 2008 growth figures to 4-5% instead of the previous 4-6%, as there was a contraction in 2Q 2008 as compared to 1Q 2008. If 3Q 2008 reports a contraction, then Singapore will be in a “technical recession” (don’t ask me about this term, it was coined by economists) !
Meanwhile, the Olympic Games are on in Beijing now and the China stock market has reacted by crashing even further as people are now worried about a post-Olympic slump. Interestingly, S-Shares listed on SGX have seen valuations getting more and more attractive as investors become overly pessimistic, contributing to the irrational panic and selldown. There are now many bargains in the local bourse but of course one needs to assess the impact of rising inflation on a company before one decides to purchase.
Boustead released their first quarterly results (1Q 2009) on August 12, 2008, while Swiber released 1H 2008 results on August 13, 2008. Pacific Andes and China Fishery released their 1Q 2009 and 1H 2008 results respectively on August 14, 2008. Thus, the reporting season is over for my companies for now, with the next being Ezra’s FY 2008 results due in mid-October 2008.
Below is the summary of my investments and related news as at August 15, 2008 (STI at 2,797.50 points).:-
1) Ezra (Vested since October 6, 2005) - Buy Price $0.645 (bonus adjusted), Market Price $2.00, Gain 210%, YTD Loss 39.8%. Besides a brief announcement that the company was issuing S$50 million worth of bonds (at a coupon rate of 5.285% per annum due 2011), there was no other news for Ezra for the half-month ended August 15, 2008.
2) Boustead (Vested since September 13, 2006; averaged down November 13, 2006) - Buy Price $1.295 (average), Market Price $2.28, Gain 76.1%, YTD Loss 5.4%. Boustead released their first quarterly results (1Q 2009) on August 12, 2008. Revenues fell 11.3% while net profit due to shareholders dipped 38.6%. As mentioned in their FY 2008 Annual Report, their quarterly results are not expected to fully reflect the business of the company as many of their contracts are project-based, hence there may be deferred or delayed revenue recognition. Anyhow, if the sale of property in the UK for 1Q 2008 was excluded, then net profit attributable to shareholders would have increased 96.1% from S$2.87 million to the current S$5.63 million. Note that as many of Boustead’s projects are still in their initial phases, and the fact that the company itself has provided sufficient detailed explanations for each of their divisions, I will NOT be doing a 1Q 2009 results analysis. I will reserve this for their 1H 2009 results to be released some time in November 2008. Boustead went ex-dividend and I have added the dividend of 7 cents/share to my realized portfolio gains. My dividend yield for FY 2008 (based on a total of 10 cents per share) is 7.72%, beating the inflation rate which has hovered at 7.5% for the last 3 months. Note too that Boustead goes ex-entitlement for their 1:1 share split on August 18, 2008, so I will be adjusting my purchase price by 50% to S$0.6475 in my next portfolio review.
3) Swiber (Vested since February 14, 2007) - Buy Price $1.01, Market Price $1.65, Gain 63.4%, YTD Loss 51.9%. Swiber released their 1H 2008 financial results on August 13, 2008. I will be doing a detailed review of their results but I will give a snapshot here on this portfolio review. Revenues for 2Q 2008 grew 391% from US$25.4 million to US$124.53 million, while gross profit increased 333% (gross margin was slightly impacted, probably due to usage of more third-party vessels till the delivery of more vessels closer to end FY 2008). Net profit increased a smaller 258% from US$6.2 million to US$22.2 million mainly due to an increase in headcount and finance costs (from their increased debt). Their results were within expectations and do not come as a big surprise, though the shrinking margins beg an explanation. More details will follow in my analysis which should take a few days to compile and which will include snippets from a Reuters interview given by Mr. Raymond Goh.
4) Suntec REIT (Vested since December 9, 2004) - Buy Price $1.11, Market Price $1.42, Gain 27.9%, YTD Loss 17%. There was no news for Suntec REIT for the period ending August 15, 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 and July 3, 2008) - Buy Price $0.5475, Market Price $0.395, Loss 27.9%, YTD Loss 37.3%. Pacific Andes reported a decent set of results for 1Q 2009 on August 14, 2008. Revenues were up 10.2% to HK$2.35 billion while net profit after tax was down 15.1% due to higher costs impacting its low margin SCM business unit. However, profit attributable to shareholders increased 26.1% to HK$122 million. Moving forward, I would expect to see moderate growth from the company in the light of difficult economic conditions. I will not be doing an analysis for PAH and my analysis will be focused on China Fishery’s 1H 2008 results (since both companies are inter-linked and their future plans and prospects will be similar).
6) China Fishery Group (Vested since November 20, 2007) - Buy Price $1.50 (average), Market Price $1.23, Loss 18%, YTD Loss 33.5%. China Fishery released their 1H 2008 results on August 14, 2008. For 2Q 2008, revenues increased 24.1%, reversing a dip in revenues for 1Q year-on-year. Gross profit was slightly impacted from higher COGS for 2Q, but overall for 1H 2008 gross margins had improved. Net profit after tax increased 16.6% for 2Q 2008 to US$23.5 million, bringing 1H 2008 net profit to US$63.9 million, an increase of 26.2% over 1H 2007. I will be doing a detailed review and analysis of CFG (focusing more on the future and prospects), but this will take time and readers should only expect it by the end of August 2008.
7) First Ship Lease Trust (Vested since January 14, 2008) - Buy Price (Averaged Down) $1.105, Market Price $1.21, Gain 9.5%. There was no news from FSL Trust, and Management should currently still be busy trying to negotiate the additional loan to finance the acquisition of the third Yang Ming vessel. They did say that they had till October 2008 to do this. Another interesting fact is that the USD has been strengthening against the SGD in recent weeks, reaching a high of 1.41. This bodes well for me as the previous dividend was received at a conversion rate of 1.3608. The higher exchange rate, coupled with the higher dividend quantum, should make for a significantly higher dividend amount once converted to SGD and paid to me on August 26, 2008.
Overall Portfolio
The gain on my current portfolio is 21.5% from a cost of S$89.2K as at August 15, 2008. The market value of my portfolio is S$108.4K. Realized gains have increased to about S$8.6K as a result of the dividend from FSL Trust, Boustead, Suntec REIT and Pacific Andes (the dividend will be counted until the decision to choose scrip arrives – if scrip is chosen, I will adjust the realized gains accordingly). If the realized gain is included, the total gain as a % of my cost will be 31.1%.
Comparison against STI
Using my benchmarking technique:-
The FTSE STI had declined by 19.7% since the start of 2008. My portfolio (without FSL Trust and the new PAH purchase) has to date declined 34.6%. Therefore, I have under-performed the STI by 15.1 percentage points.
FSL Trust has gained 9.5% thus far from my date of purchase while the benchmark STI has fallen 13.1% (from my date of purchase Jan 14, 2008 when STI was 3,218.14); I am happy to report that FSL Trust has managed to out-perform the index for FY 2008 thus far.
The new Pacific Andes tranche which was purchased at 44 cents per share on July 3, 2008 will be analyzed separately from the rest of the portfolio. STI as at July 3 was 2,880.45 and STI today is 2,797.50, thus this represents a 2.88% loss. Current share price of Pacific Andes is 39.5 cents, representing a loss of 11.4%. Hence, my purchase of Pacific Andes has under-performed the index (I have excluded the dividend in my computation).
My next portfolio review will be on Friday, August 29, 2008 after market close.
Sunday, August 10, 2008
The Double "Whammy" of Lower Profits and Lower Valuations
One cannot help but notice that in the current bearish climate, many companies with once sparkling results and bright futures would have their growth rudely interrupted by the arrival of high oil prices, runaway inflation and a slowdown in economic growth. Many companies which were once touted as "sure-fire" growth stories had their businesses marketed by analysts (who of course wrote equally sparkling reports) and their target prices continually raised in the raging bull market which all but ended late 2007.
Now, one also cannot help but notice that the target prices and valuations of such companies are being slashed and reduced by a margin as deep as 50-60%, with some cases even up to 70-80%. This is what I would term as the "double whammy" of lower profits and lower valuation. Together, they form a deadly cocktail mix which can cause a once high-flying company's share price to come crashing back to Earth. Ok, some may argue that it was not justifiable to trade at such valuations in the first place, but bull market baloney is common and pervasive during the final stages of any bull market; thus investors and punters will simply ignore good advice and continue playing the Greater Fool Game (to their eventual detriment).
Basically, the premise is simple: a company reports a fall in profits due to rising costs and inability to raise prices sufficiently to offset these costs. To add to their woes, staff and admin costs have also increased and put a further strain on net profits. This would of course lead to lower profits in subsequent quarters and the company may see its net profit contract by about 40-50%. The problem is that when this happens, the growth multiple assigned to a company (called the valuation metric or Price-Earnings Ratio - PER) will also correspondingly fall because of lower expectations for growth. This can be clearly seen in the cases of some China companies which had been trading at valuations of 20-25x during the bull market. In today's bear market, with falling profits and limited prospects for growth in market share and margins, analysts are valuing it at a measly 5-6x PER. Thus, the effect of these 2 events causes a severe share price devaluation due to anticipated lower profits as well as putting a screeching halt to growth expectations.
This scenario is best illustrated with an example (as shown below):-
In the simple example, Company ABC reports a 20% drop in revenues for 2008 compared to 2007. As a result of increased COGS (same COGS with lower revenues - probably due to high oil prices), they report a lower gross profit of 33%. Expenses actually increased marginally by 20% in this example but the impact is that net profit is reduced by 60% (due to the lower absolute gross profit figure). Net profit margin is slashed from 40% to just 20% as a result of rising costs. Assuming the same share capital base from 2007 to 2008, EPS is also reduced by 60%. However, the important part of this example is the valuation given to the company. For 2007 (when growth was still optimistic and everything looked rosy), the company was accorded a PER fof 20x, thus valuing it at S$1.60. When the problems kicked in and growth was shown to be stunted, the valuation accorded is reduced to a mere 5x, which values the company at just S$0.16, representing a 90% drop !
Although this example may seem rather extreme, the point I am making here is that the numbers could very well represent that of an actual company (many companies see profit drops of about 40-50% in the current economic climate); but the impact to share price would be far greater than just 40-50% and could be in the magnitude of 70-80% (as illustrated) due to lower valuations accorded. Thus, it is no surprise to see a company which once traded at S$2.52 (its peak) suddenly trading at a mere S$0.43, for a drop of about 86%. The effect can be adequately explained by the example above, though of course I am merely using hypothetical numbers.
Therefore, it is crucial for an investor to use a lower valuation metric when seeking margin of safety, and to assume that growth slows down or smoothes out over a period of time, in order to avoid such a situation. When one purchases a company with the assumption of an annual 100% growth in net profits and a valuation of 20x, one is either being unrealistic or downright foolish because a company cannot sustain such growth at such high valuations for an extended period of time.
One cannot help but notice that in the current bearish climate, many companies with once sparkling results and bright futures would have their growth rudely interrupted by the arrival of high oil prices, runaway inflation and a slowdown in economic growth. Many companies which were once touted as "sure-fire" growth stories had their businesses marketed by analysts (who of course wrote equally sparkling reports) and their target prices continually raised in the raging bull market which all but ended late 2007.
Now, one also cannot help but notice that the target prices and valuations of such companies are being slashed and reduced by a margin as deep as 50-60%, with some cases even up to 70-80%. This is what I would term as the "double whammy" of lower profits and lower valuation. Together, they form a deadly cocktail mix which can cause a once high-flying company's share price to come crashing back to Earth. Ok, some may argue that it was not justifiable to trade at such valuations in the first place, but bull market baloney is common and pervasive during the final stages of any bull market; thus investors and punters will simply ignore good advice and continue playing the Greater Fool Game (to their eventual detriment).
Basically, the premise is simple: a company reports a fall in profits due to rising costs and inability to raise prices sufficiently to offset these costs. To add to their woes, staff and admin costs have also increased and put a further strain on net profits. This would of course lead to lower profits in subsequent quarters and the company may see its net profit contract by about 40-50%. The problem is that when this happens, the growth multiple assigned to a company (called the valuation metric or Price-Earnings Ratio - PER) will also correspondingly fall because of lower expectations for growth. This can be clearly seen in the cases of some China companies which had been trading at valuations of 20-25x during the bull market. In today's bear market, with falling profits and limited prospects for growth in market share and margins, analysts are valuing it at a measly 5-6x PER. Thus, the effect of these 2 events causes a severe share price devaluation due to anticipated lower profits as well as putting a screeching halt to growth expectations.
This scenario is best illustrated with an example (as shown below):-
In the simple example, Company ABC reports a 20% drop in revenues for 2008 compared to 2007. As a result of increased COGS (same COGS with lower revenues - probably due to high oil prices), they report a lower gross profit of 33%. Expenses actually increased marginally by 20% in this example but the impact is that net profit is reduced by 60% (due to the lower absolute gross profit figure). Net profit margin is slashed from 40% to just 20% as a result of rising costs. Assuming the same share capital base from 2007 to 2008, EPS is also reduced by 60%. However, the important part of this example is the valuation given to the company. For 2007 (when growth was still optimistic and everything looked rosy), the company was accorded a PER fof 20x, thus valuing it at S$1.60. When the problems kicked in and growth was shown to be stunted, the valuation accorded is reduced to a mere 5x, which values the company at just S$0.16, representing a 90% drop !Although this example may seem rather extreme, the point I am making here is that the numbers could very well represent that of an actual company (many companies see profit drops of about 40-50% in the current economic climate); but the impact to share price would be far greater than just 40-50% and could be in the magnitude of 70-80% (as illustrated) due to lower valuations accorded. Thus, it is no surprise to see a company which once traded at S$2.52 (its peak) suddenly trading at a mere S$0.43, for a drop of about 86%. The effect can be adequately explained by the example above, though of course I am merely using hypothetical numbers.
Therefore, it is crucial for an investor to use a lower valuation metric when seeking margin of safety, and to assume that growth slows down or smoothes out over a period of time, in order to avoid such a situation. When one purchases a company with the assumption of an annual 100% growth in net profits and a valuation of 20x, one is either being unrealistic or downright foolish because a company cannot sustain such growth at such high valuations for an extended period of time.
Tuesday, August 05, 2008
The Beauty of a Bear Market
On hindsight, it would have been extremely obvious to a casual observer and a reasonable person that the market would turn bearish this year. That is the problem in general with predictions - they are usually extremely accurate only by looking at history ! However, this post is not to lambast people who attempt to time market cycles (some do get it fairly accurate but are often unable to repeat the "stellar" performance); but rather, it is a post to illustrate how one should take full advantage of a bear market to look for bargains.
I read, with some amusement no doubt, the views of various experts who were asked their opinions on the current market condition. There were varied opinions (as usual) ranging from the optimistic (the bear will only last 12 months and the market is also bottomed out) to the wildly pessimistic (we will get "buried" under a pile of earnings downgrades). It was all very amusing seeing people try to predict the market and to second-guess the economic environment and how long the current sub-prime crisis will last. The fact is that no one knows, yet everyone has an opinion and tries to make an "educated guess", in the process trying to sound intelligent and that they know exactly what's going on. I am not shooting down the opinions of famed investors; it's just that sometimes they should just admit they haven't a clue as to when this will end - I think that sounds more honest !
The beauty of a bear market will only be apparent to people who relish a bear market (usually value investors lah). Most other people see bear markets as something akin to the end of the world, depicting scenarios where people jump off buildings, declare bankruptcy and live the rest of their wretched lives in abject poverty. Such is the media spotlight which is thrown onto bear markets and the media's portrayal of such events. The doom and gloom can get so pervasive that you can hardly find much reason to cheer; in fact everyone is so enthusiastically predicting the end of the world that they fail to realize that opportunities abound to purchase cheaply. In fact, an investor's temperament should be the same regardless of whether the market is in bull or bear mode. He always has to emphasize margin of safety, as well as preservation of capital. Having such an attitude is important as it helps to minimize losses (this is in contrast to people who seek only to "maximize gains").
The Intelligent Investor by Benjamin Graham aptly mentions this point. Jason Zweig who wrote the footnotes for his book writes that without bear markets to bring valuations down to reasonable levels, no investor would be able to purchase with a decent margin of safety. Hence, bear markets are essential for investors and should be welcome with open arms. Bull markets are often dreaded by investors as they do not present suitable opportunities for investment.
That said, one must still be extremely selective in evaluating which company to invest in and to ensure that all aspects of the company are analyzed before a purchase is made. This is because in a bear market, everything looks cheap but the problem is that valuations may not actually BE cheap. During times of economic uncertainty and rising inflation, bear markets will usually occur. This has the effect of weighing on earnings of almost all companies and will throw their growth plans into disarray. Only companies which can pass on the higher costs or find a way around the difficulties will eventually emerge relatively unscathed. Thus, the "cheapness" of a company does not preclude one from investigative work to understand the nature of the business and whether it will be affected by higher costs and/or other economic factors. As a result, finding a worthwhile company to invest in can be a painstaking job and should not be considered simple.
Which is why Warren Buffett said that "Investing is easy, but not simple". The premise of investing is easy to understand, but the actual process to evaluate companies, churn numbers and to understand the workings of the economic environment and how it influenced a company are not simple. Therefore, every investor should work hard so that his/her rewards are well-deserved !
On hindsight, it would have been extremely obvious to a casual observer and a reasonable person that the market would turn bearish this year. That is the problem in general with predictions - they are usually extremely accurate only by looking at history ! However, this post is not to lambast people who attempt to time market cycles (some do get it fairly accurate but are often unable to repeat the "stellar" performance); but rather, it is a post to illustrate how one should take full advantage of a bear market to look for bargains.
I read, with some amusement no doubt, the views of various experts who were asked their opinions on the current market condition. There were varied opinions (as usual) ranging from the optimistic (the bear will only last 12 months and the market is also bottomed out) to the wildly pessimistic (we will get "buried" under a pile of earnings downgrades). It was all very amusing seeing people try to predict the market and to second-guess the economic environment and how long the current sub-prime crisis will last. The fact is that no one knows, yet everyone has an opinion and tries to make an "educated guess", in the process trying to sound intelligent and that they know exactly what's going on. I am not shooting down the opinions of famed investors; it's just that sometimes they should just admit they haven't a clue as to when this will end - I think that sounds more honest !
The beauty of a bear market will only be apparent to people who relish a bear market (usually value investors lah). Most other people see bear markets as something akin to the end of the world, depicting scenarios where people jump off buildings, declare bankruptcy and live the rest of their wretched lives in abject poverty. Such is the media spotlight which is thrown onto bear markets and the media's portrayal of such events. The doom and gloom can get so pervasive that you can hardly find much reason to cheer; in fact everyone is so enthusiastically predicting the end of the world that they fail to realize that opportunities abound to purchase cheaply. In fact, an investor's temperament should be the same regardless of whether the market is in bull or bear mode. He always has to emphasize margin of safety, as well as preservation of capital. Having such an attitude is important as it helps to minimize losses (this is in contrast to people who seek only to "maximize gains").
The Intelligent Investor by Benjamin Graham aptly mentions this point. Jason Zweig who wrote the footnotes for his book writes that without bear markets to bring valuations down to reasonable levels, no investor would be able to purchase with a decent margin of safety. Hence, bear markets are essential for investors and should be welcome with open arms. Bull markets are often dreaded by investors as they do not present suitable opportunities for investment.
That said, one must still be extremely selective in evaluating which company to invest in and to ensure that all aspects of the company are analyzed before a purchase is made. This is because in a bear market, everything looks cheap but the problem is that valuations may not actually BE cheap. During times of economic uncertainty and rising inflation, bear markets will usually occur. This has the effect of weighing on earnings of almost all companies and will throw their growth plans into disarray. Only companies which can pass on the higher costs or find a way around the difficulties will eventually emerge relatively unscathed. Thus, the "cheapness" of a company does not preclude one from investigative work to understand the nature of the business and whether it will be affected by higher costs and/or other economic factors. As a result, finding a worthwhile company to invest in can be a painstaking job and should not be considered simple.
Which is why Warren Buffett said that "Investing is easy, but not simple". The premise of investing is easy to understand, but the actual process to evaluate companies, churn numbers and to understand the workings of the economic environment and how it influenced a company are not simple. Therefore, every investor should work hard so that his/her rewards are well-deserved !
Subscribe to:
Posts (Atom)
