Tat Hong - Analysis of Purchase Part 1

This is part 1 of my analysis of Tat Hong Holdings Limited which I had recently purchased on September 18, 2008 at an average price of S$1.055 per share. Please feel free to contribute comments and opinions on any part of the analysis. Note: This is NOT a recommendation to buy or sell shares in the company and I disclaim all responsibility for readers who follow any advice on this blog - please do your own research too.

Background

Tat Hong Holdings Limited is a crane-leasing company which also specializes in rental of heavy equipment such as foundation equipment, piling rigs, graders, ski loaders and compaction equipment. The Group has offices in Singapore (HQ), as well as Australia, Hong Kong, Malaysia, Thailand, Vietnam, Indonesia and China. The Group is very diversified and has a pan-Asian as well as Middle East presence. They are ranked No.1 in terms of crawler crane fleet size, and No. 4 in terms of total number of cranes owned.

The Group has five main divisions - rental of crawler cranes, rental of tower cranes (new division), rental of spare parts, sale of cranes and sale of spare parts. I will elaborate more on the separate divisions in a later post. Firstly, I will go through the financials and offer some comments:-


Note: Market Price on Sep 15, 2008 should be changed to "My Purchase Price". Sorry for the error. How the table should be read: I purchased Tat Hong based on FY 2008's historical PER of 5.95 times and with a dividend yield of 7.2% based on FY 2008's full-year dividend of 7.6 Singapore Cents Per Share.

Comments on Company’s Financials, Gearing, Cash Flow and Dividend Policy

Before FY 2004, revenues were flat and the company had even incurred a net loss. This was due in part to the downturn in Singapore’s construction industry and also because Tat Hong had not diversified its operations into the region (i.e. South-East Asia). Using 1Q 2009 as a gauge of the company’s growth (as their operations are not cyclical through the year), we obtain a revenue increase of close to 20% and a net profit increase of about 38.1%.

Debt equity as at June 30, 2008 was reasonable at 0.38 times, and has not exceeded 0.5 in the past 3 financial years. Considering their prudent growth strategy target of about 10% increase in net profit over the next 2-3 years (till FY 2011), I believe the company will not over-stretch itself.

Gross margin has been increasing over the years, which is a positive sign. From just 26.9% in FY 2005, this has steadily increased to 39% in FY 2008, and the most recent quarter (1Q 2009) saw a gross margin of 36.8% (partly reduced because of their foray into tower cranes, which have a lower gross margin – see Gross Margin by Business Unit table). Net profit after MI (less exceptional gain) has also been increasing steadily to the current S$84.6 million in FY 2008, as a result of expanded scope of operations and increasing diversification into different countries through organic growth and acquisitions (in Australia).

Net margins have been steadily on the climb – a very good sign. Net profit margin was 6.7% in FY 2005 and this has improved to 15.3% for 1Q 2009, more than double compared to 3 years ago. This shows that Management has focused on expense control amidst an environment of rising costs.

The issue of free warrants are exercisable at the strike price of S$2.50 per share. Currently, the market price is only 50% of the strike price and thus there is not much risk of dilution from the exercise of warrants. Tat Hong also has an ESOP which sees about 1 million new shares entering the market every financial year – this is hardly dilutive so can be considered immaterial.

Shareholder’s equity has been steadily increasing while gearing has been relatively constant. This is due in part to good profits made from business activity and also healthy operating cash inflows which help to offset the impact of bank interest payments, taxes and investments in subsidiaries and fixed assets. The annualized ROE for 1Q 2009 is 28.9% and much of it is NOT debt-funded but as a result of higher net profits. ROE has been steadily increasing over the years (from FY 2005) to over 25% currently. Note that maintaining high ROE gets increasingly difficult as the company’s equity base increases with the increase in retained earnings.

Dividend policy is twice yearly with payout declarations in September (interim) and March (final). Note that the company had only started paying interim cum final in the last 2 financial years due to good results and strong cash flows, and this may not always continue into the future. DPS for FY 2008 was 7.6 Singapore cents per share, representing a yield of 6.8% based on last done price of S$1.12. Assuming the company has better years ahead, the possibility of an increased dividend payout is high, assuming the company continues to generate excess cash flows with which it can use to pay out dividends, while retaining sufficient cash for expansion and growth.

As can be seen in the above table, the Group has been generating strong operating cash inflows over the last few financial years, which is an indication that its business is stable and generating strong Free-Cash-Flows (FCF). This gives a confidence boost that the company will not succumb to sudden shocks as it has manageable debt and also gives me assurance that it is paying out dividends with FCF instead of through borrowings.

Territorial Expansion Details

Below are some highlights and summaries I made of Tat Hong's foray into the region:-

Singapore

i. S$12.6 million convertible loan agreement signed with Hiap Tong Corporation Pte Ltd. Convertible into ordinary shares representing 20% stake in Hiap Tong. Hiap Tong will be going for an IPO soon on SGX.

ii. Singapore listing of China-based crane maker, Yongmao Holdings, for S$0.35 per share. Tat Hong currently owns 20% of the company after an open-market purchase of shares (average consideration of S$0.45 per share).

iii. Acquired 30.2% of Kian Ho Bearings Limited

China

i. Established Shanghai Hai Tong on Sep 5, 2006 to enter tower crane rental business

ii. Secured 5-year RMB 87.5 million contract from Sky China Petroleum Services Co, Ltd and a 4-year contract worth US$10.8 million with a China National Oil Company – both contracts carried out through joint ventures with KS Energy Services Limited;

iii. Completed investment in joint venture with Beijing Zhongjian Zhenghe Construction Machinery Co., Ltd (to enter China’s tower crane rental business);

iv. Completed investment in China Nuclear Huaxing Tathong Machinery Construction Co., Ltd (76.4% stake)

Australia

i. Listed Tutt Byrant on Dec 9, 2005 at A$1.00 in an IPO on ASX;

ii. Acquired Queenslands Equipment rental company, North Sheridan Pty Ltd and Muswellbrook Cranes Services Pty Ltd (A$17.8 million acquisition) through Tutt Bryant;

iii. On Dec 12, 2007, Tutt Bryant acquired rental business of Bradshaw Ultra Heavy Haulage Pty Ltd;

iv. Acquired Caradel Hire through Kingston Industries Pty Ltd, which is a wholly owned (100%) subsidiary of Tutt Bryant.

More to be continued in Part 2 of my Tat Hong analysis. The next part will feature each separate division and talk about their revenue contributions and gross margins.