Tat Hong - Analysis of Purchase Part 3

In part 3, I will explore some of the regional prospects for Tat Hong, and also the Company's plans for growth based on their press release for 1Q 2009 (I also offer some comments for each point). But first, please see a snapshot of Tat Hong's fleet which I have summarized below:-

Comments on Company’s Strategies and Plans for Growth

1. There is a gradual shift to larger and bigger capacity cranes for rental and sales market - From the table, it can be seen that their fleet of cranes now consists of 42 cranes which are >250 metric tones, up from about 20-25 two years ago. The fleet also contains 82 crawler cranes between 150-249 metric tonnes, and the total fleet size has remained relatively constant over the last year, though the % of large cranes is higher now. These larger cranes can help to garner higher rental rates and also be sold at higher prices in a tight market. One important aspect of the Company's profitability is the utilization rate for cranes, which continues to remain high presently at around 75%. According to analyst reports, the Company's breakeven utilization rate is 45%, so there is still a margin of safety for them. However, there are risks that this can plunge in a protracted economic slump; but I am betting on the Management's astuteness to tide the Company through this difficult time (should it come).

2. The Company intends to focus on Singapore and Australia markets as key growth drivers in the coming years - Considering Singapore has the potential for many more construction projects, and that their Australian subsidiary Tutt Bryant has been actively acquiring companies to expand their market share, this bodes positively for the company.

3. Actively explore opportunities to secure more long-term structured rental contracts - The Group intend to negotiate for contracts which enable more stable and consistent revenue and cash flows so as to smoothen out the otherwise “lumpy” contractual nature of their current business.

4. Grow tower-crane rental business in China

a) Increase size of JV rental fleet to 200 units by 2009 – This can be done by purchasing more units of tower crane gradually over time, in order to stock up in anticipation of lower supply in the market. However, care must also be taken to ensure that the company does not buy expensively, and end up with excess capacity which are unable to be rented out.

b) Expand presence into more PRC cities – I assume this will be done through more joint ventures. Considering the company has a strong reputation in S.E.A and is one of the global players, this should make it easier for them to find potential JV partners.

c) Expand through strategic acquisitions – Tat Hong are looking out for companies to buy over in China too, and in the current economic climate, they may very well be paying a discount for a good company as valuations in general are very depressed.

d) Targeting 20% contribution from China to the Group’s bottom-line by FY 2010 – This implies that the Company intends to grow their tower crane rental business and let it make up a significant portion of net profit (not just revenues). In order to do this, they need to scale up and make use of economies of scale to lower COGS in order to grow this business division. I see this as possible if Management is careful in screening potential acquires and joint venture partners, and receives government support as well.

5. Expand Australian Operations – Tat Hong’s aggressive strategy of using Tutt Bryant to acquire companies in Australia is bearing fruit, as their scope of operations in Australia has increased significantly. North Sheridan, Caradel Hire and Bradshaw are expected to increase earnings significantly in the near-term. Contributions from associates jumped 234% in 1Q 2009 from S$789K to S$2.6 million, and it is expected that more profits will flow from associated companies to the Group in future.

6. Tat Hong owns 70% of Tutt Bryant - A quick check on ASX shows that Tutt Bryant is trading at A$1.415 per share*, with a total issued share capital of 129,913,000 shares; effectively valuing the entire company at A$183.8 million. Tat Hong’s 70% stake will be thus worth A$128.7 million, or S$181.9 million using a rate of 1 A$ = S$1.4131. Thus, their 70%-share of Tutt Bryant makes up about S$0.36 per share of value.

*Note: This information was accurate at the time of preparing my analysis, the market value may have fluctuated since then.

Comments on Regional Prospects (extracted from Tat Hong’s 1Q 2009 Presentation)

i) Middle-East is most active and vibrant with respect to construction activities, fuelled by oil boom. Even though oil prices have dropped to US$106 per barrel, it still has spurred the oil companies and oil countries to ramp up construction and building. Examples of “modern” Middle Eastern cities are Dubai and Qatar.

ii) In Indian news on July 9, 2008, the Government has planned capital outlay of 23,849 billion Rupees over the 11th five-year plan. Forecast growth of 15.6% over a period of 5-years till FY 2012.

iii) For China, forecast growth rate for construction industry is about 11.3% per annum during FY 2008 to FY 2012. The industry is expected to be worth about US$315.32 billion by FY 2012.

iv) For Australia, there is to be a Building Australia Fund which will provide funding for US$20 billion worth of infrastructural projects over the next 2 years from budget surpluses. The industry is forecast to grow to US$106.04 billion by 2012.

v) Vietnam’s government is assisting the infrastructure and real estate boom and urban areas are rapidly developing, industrial areas are being built and the entire country is modernizing rapidly.

vi) Malaysia has inherent uncertainties relating to its political climate, but the construction industry is still expected to grow at a high average of 6.58% during 2008-2012.

vii) The total value of construction projects from Indonesia had hit US$51.92 million from 4,682 projects country-wide, not a large figure and there is definitely room for growth. The industry is expected to grow at an average rate of 5.74% for the 2008-2012 forecast period.

viii) For Singapore, the Government is deferring S$4.7 billion worth of public sector construction projects to 2010 and beyond. This is because of existing projects such as the IR, Marina Business Financial Centre (BFC) and downtown MRT line taking up much resources. In future, there will be other projects like the development of the Jurong Industrial area which will see new hospitals being built, as well as the Sports Hub and National Stadium in Kallang area. All these should provide sustained demand for cranes and construction equipment, of which Tat Hong is a beneficiary.

From the above, one can conclude that regional prospects are decent, and I am cautiously optimistic that the Company can grow its bottom-line by about 10% per year (a very conservative and "steady" growth rate). Though the future is never clear, I am basing my cautious optimism on the fact that the Company is one of the largest in South-East Asia (hence, less prone to down cycles which traditionally weed out smaller players) and that they have a robust fleet renewal programme in place which ensures they continually update their fleet to ensure good rates and high utilization.

On a side note, I had passed by some construction projects in downtown area and near Chinatown, and seen many cranes with the "Tat Hong" label on the crawler crane. It makes me happy to know that their cranes are being utilized for these high profile projects. I have also spotted Hiap Tong heavy equipment being deployed on some of these construction projects, but I believe Hiap Tong will wait for market conditions to improve before listing as they can get a better valuation then.

For Part 4 and the last part of my analysis of purchase, I will be using Buffett's 12-step approach as a framework to analyze the Company and my reason for purchase.