Monday, May 31, 2010

May 2010 Portfolio Summary and Review

I guess this month can be counted as “exciting” and “thrilling”, if those words can be used to describe the roller-coaster ride in the stock markets around the world! The Greek crisis and the devaluation of the Euro had caused all major market indices to hurtle towards a major correction, and markets had dropped so swiftly that it erased all of 2010’s gains so far, and then some. Strange thing was that the Greek crisis has been in the news for the past few months but investors seemingly chose to ignore it, till now! With the close to US$1 trillion bailout approved by Germany and other stronger European nations pledging to support the Euro and their weaker neighbours, there should have been ample confidence and stability; yet this was not so as Mr. Market’s pendulum swung from irrational exuberance to unjustified pessimism. The fear this time was that Greece’s debt would affect other weak nations in the Euro Zone such as Portugal and Spain and cause the entire Europe to derail, thwarting the global economic recovery.

While at this point in time it is unclear if the contagion will really spread across the world, what I can conclude with certainty is that companies will still continue to do business, and cash will still continue to flow; and perhaps everyone should just relax and continue buying good companies. I took the opportunity to deploy about S$25K in cash to bolster my shareholdings in Kingsmen Creatives (as mentioned in my previous post). By reviewing Kingmen’s business model and cash flows, the company has been consistently generating healthy FCF without the need for heavy investment in capex and without needing a lot of working capital; hence I can foresee that dividends should continue to be paid. Assuming the dividend remains unchanged for FY 2010, the shares will provide a potential yield of 6.2%; and this is in addition to potential growth as Kingsmen extends its footprint across South-East Asia and the Middle East. Since I had already reviewed Kingsmen in my last post, I shall not provide further details here.

Property prices seem to be have hit another high in Singapore with buying momentum strong. However, on May 21, 2010, the Government announced that it had released 31 residential sites in 2H 2010, which can generate 13,905 private residential units. Most are located in suburban areas or the city fringes. With this inflow of supply, will it indicate that housing prices will begin to stabilize and perhaps dip? Housing affordability is one big bugbear of mine, even though I already “own” an HDB flat, as some of my friends are having trouble affording an HDB flat as the COV is too high! Those who earn a combined income of more than S$8,000 are finding HDB resale flats too expensive, and condos are far worse of course. I will talk more about this in next month’s portfolio review, once the effects of this announcement have taken their time to seep into the property market.

Regarding personal finance, of which I blog about occasionally, there was a news article in the Straits Times on younger Singaporeans struggling with debt (May 21, 2010). The article mentions something shocking – 7.16% of those in the 21-29 age range defaulted on their credit card debt in 2009. Apparently, a lot of youths in this age group had just started work and could not manage their expenses and assets well; thus landing in trouble by racking up huge credit card bills. Paying only the minimum sum meant that the debt snowballed beyond control, and led to defaults. The main reason, says Ms. Chen Yew Nah (Managing Director of DP Credit Bureau, which compiled the numbers), was that youths like to acquire possessions “that signify they are successful”. By this I would automatically assume she is referring to iPhones, gadgets, cars, branded luxury goods and other material items. One should always be prudent with spending and avoid keeping up with the Joneses; in order to have enough savings to act as buffer and also for investment.

This month was a busy month as Kingsmen had released their 1Q 2010 results, and Tat Hong and Boustead also released their FY 2010 results (which will be reviewed later and posted up). Below is a snapshot of my portfolio and associated comments for May 2010:-

1) Boustead Holdings Limited – Boustead announced their FY 2010 results on May 26, 2010 and it was followed up by an audiocast similar to FY 2008 and FY 2009. Revenues were down 15% year on year, while gross profit was down just 7%. Net profit attributable to shareholders decreased 28% to S$43.1 million (largely due to absence of a S$22.7 million gain on sale and leaseback of an industrial property), while net profit margin was about 10% and ROE about 20%. A final dividend of 2.5 cents/share was declared, and in addition a special dividend of 1.5 cents/share was also declared, making it a total of 4 cents/share. I will be doing a detailed review of Boustead’s FY 2010 results, and will also be transcribing and posting up the question and answer session with Mr. FF Wong from the audiocast like I did for FY 2008 and FY 2009.

2) Suntec REIT – There was no news from Suntec REIT for May 2010. The dividend of 2.513 cents was received on May 27, 2010.

3) First Ship Lease Trust – There was a big negative whammy for FSL Trust this month, and it came in the form of a payment default by Groda Shipping, one of FSLT’s lessees. As a result, FSLT have to take re-delivery of their two vessels Verona I and Nika I. The vessels are now under contracts of affreightment with Rosneft, and the Trustee-Manager is exploring alternative solutions which will reduce risk of cash loss, while assuring (hapless) shareholders that no trigger of event or default and that there is no interest cost impact. Sadly, the 2Q 2010 DPU guidance of 1.5 US cents is now under review, and this may mean another DPU cut as cash flows get even thinner. The shipping crisis is far from over and this has been one of the most nerve-racking investments I have made so far; this mistake will reverberate for many years I think!

4) Tat Hong Holdings Limited – Tat Hong released their FY 2010 results on May 24, 2010. FY 2010 revenue was down 22% to S$495 million, while gross profit was down 21% to S$190.8 million (there was a slight improvement in gross margin). Profit attributable to shareholders was down 44% though, as the Company was hit by higher admin expenses and poor contributions from associates and joint ventures even though gross margin improved. A final dividend of 1.5 cents/share was declared on both ordinary and RCPS. I will be scrutinizing the numbers and facts and coming up with an analysis of Tat Hong’s FY 2010 results in due course.

5) MTQ Corporation Limited – Since I had already written Parts 1 and 2 of MTQ’s analysis, I won’t say anymore on MTQ as there was no news for May 2010 anyway. Look out for Part 3 which I am working on to be released some time in June 2010.

6) GRP Limited Unsurprisingly, there was no news from GRP for the month of April 2010. In other words, shareholders are still waiting with bated breath to find out what Management intend to do about their cash stash!

7) Kingsmen Creatives Holdings Limited – I had already written a post on Kingsmen’s 1Q 2010 results, and hence will say no more here. There was no news from the Company for the month of May 2010.

Portfolio Review – May 2010

Realized gains remained at S$54.0K in the absence of any of my companies going ex-dividend (even though dividends were declared, they were not yet approved at the respective AGMs). No direct comparison can be made between last month’s portfolio and this month’s as I have added to my position in Kingsmen Creatives and therefore increased my cost. My investment cost has increased to about S$175.4K (a new high) and as at May 31, 2010, my unrealized gains now stand at +3.9% (portfolio market value of S$182.3K).

June 2010 should be a relatively quiet month as none of my companies are expected to report results; and corporate news is also usually slow during this period. Hence, I will most likely make use of this month to fully analyze Tat Hong and Boustead’s FY 2010 results, as well as to continue to build up cash reserves for investment.

My next portfolio review will be on June 30, 2010 (Wednesday).

Thursday, May 27, 2010

Kingsmen Creatives – 1Q FY 2010 Analysis and Commentary

The reason for this review and analysis is because I had not done one for Kingsmen’s FY 2009 results, as I was busy preparing my Analysis of Purchase (which was posted up in 3 parts). Furthermore, there were also some items within “Other Income” which I felt had to be adjusted to get a better picture of Kingsmen’s true performance, so I have prepared a spreadsheet showing the differences (you can view this later in the Income Statement Analysis section). This review is not meant to be very comprehensive and simply serves to highlight salient areas which I feel deserve mention; as an investor I have to look out for red flags as well as positive areas, so as to obtain some measure of assurance that I still have my requisite margin of safety.

Profit & Loss Analysis

As can be seen in the above table, I have plotted Kingsmen’s original Profit and Loss Statement, and at the side I have shown another Income Statement but removed the one-off items which are found in “Other Income”. I have also normalized the tax expense to be in line with the adjusted profit figure in terms of % increase in Profit Before Tax (“PBT”) of 55.4%; these lines are highlighted in grey. It can be clearly seen that when adjusted as such, PBT is actually 55% higher year on year due to one-off items such as bad debts recovered, foreign exchange gain and jobs credit (all highlighted in orange in the table below the Income Statement). 1Q being the traditionally slower quarter, this table shows that for 1Q 2009 Kingsmen actually only earned about S$1.5 million if the one-off items are removed; hence for 1Q 2010 they did significantly better as net profit on a comparative basis would have improved 55% while revenues only increased by 30.8%. This, I feel, is more reflective of the true situation as one should notice that staff costs only increased by 16.1% and other expenses by 9.2%, all lower than the increase in gross profit of 27.6%.

Depreciation expenses decreased and so did Finance costs, but Finance costs are set to jump after Kingsmen took on a S$4 million loan to purchase two factories units in Selangor, Malaysia. Gross profit margin held more or less steady at 26.3% versus 26.9% in the previous year, but once the larger projects are over and done with we should see gross margins improving somewhat. 4Q 2009 was dismal as the bulk of the USS revenues were recognized, and along with it came weaker margins.

Overall, net margin has fallen to just 4.9% for 1Q 2010, not a very positive sign admittedly; but since this is their weakest quarter it will not be fair to judge the entire’s year’s performance based on this one quarter (note that net margin was 6.2% for FY 2009, down from a high of 7.4% for FY 2008).

Balance Sheet Review

Instead of reproducing the entire Balance Sheet with variance analysis (which I felt was a waste of time since readers can access the relevant doc on SGXNet anyway), I think it would suffice for me to just give a simple commentary on the Balance Sheet, which appears much stronger than the Income Statement, thankfully!

PPE had gone up due to the acquisition of two factory units as mentioned earlier, up by about S$4.5 million. Notice that the loans taken up amounted to about S$4 million, so I suspect some cash was paid out as down payment for these units while the rest was bank-loan financed. A quick check at the cash flow statement shows that I was right – S$4.8 million was spent buying the assets while just S$4 million worth of bank loans were taken up. This is a long-term loan so it is not an immediate worry for Kingsmen; anyway they have more than enough cash to repay the loan anytime.

Trade Receivables fell by about S$21 million, reflecting collections from USS which showed up as a timing difference in FY 2009’s financial statements, and which resulted in FY 2009’s operating cash inflow falling to just S$1 million plus. However, there were also significant payments made to Trade and Other Creditors to the tune of about S$17 million, so there was an offsetting effect which will be seen later in the Cash Flow Analysis. This is a positive sign as Receivables are dropping even though revenue is up year-on-year, though the timing is not exact as these receivables are as at Dec 31, 2009 whereas the basis for comparison for Income Statement is 1Q 2009. Still, it helps to see that Receivables are not building up excessively, which could indicate a likely impairment.

Cash has gone up slightly from S$22.8 million to S$28.1 million, which is another positive sign. Borrowings remain low at about S$5 million, so net cash stash for Kingsmen is about S$23.1 million, implying net cash per share of about 12.22 cents.

Cash Flow Statement Analysis

Now we come to the all-important cash flow statement, which represents the life blood of the company and from which dividends flow from. Kingsmen’s 1Q 2010 showed a stronger operating cash flow as compared with 1Q 2009, with an inflow of S$6.4 million against an outflow of S$2.3 million. The main reason was the large inflow arising from the decrease in trade receivables, but which was offset somewhat by the cash outflows arising from payments to trade and other creditors. Purchase of PPE took up S$4.8 million worth of investing cash flows, so there was still free cash flows generated of about S$1.6 million. Moving forward, as Kingsmen begins to collect more on USS (due to variation orders) and other clients, cash flows should improve significantly and hopefully by year-end, it will show the same strong performance as FY 2008 (which saw operating cash inflows of S$25.7 million against capex of just S$11.2 million).

Cash flows from Financing mainly came from bank loans, as there were no dividends paid out in the 1Q of the year (they are usually paid out in the 2Q after the approval at the AGM, and received in late May; FY 2009’s final dividend of 2 cents/share was received on May 19, 2010).

This concludes my short and sweet review for Kingsmen’s 1Q 2010 results. For the commentary on prospects, I think the financial review and MD&A will suffice. For now, I am hinging on the revamp of Orchard Road and the rise of heartland malls to provide more business for Kingsmen’s interiors fitting out division, while more MICE events should stream into Singapore as a result of the opening of the two IR. There is also a chance of Kingsmen clinching scenic and thematic works due to their experience with USS, so that is a wild card which hopefully can become reality.

Incidentally, I took the opportunity to load up on more Kingsmen shares as a result of Mr. Market acting manic-depressive. Purchases were made on May 6 at 57.5 cents, May 7 at 56.5 cents, May 19 at 56 cents, May 21 at 52.75 cents and May 25 at 50 cents. A total of about S$25K was pumped in and my new average cost (which will be reflected in the portfolio review) is 56.0 cents. Total portfolio cost has not increased to S$175K.

Below is a photo I took (not very professionally, sadly) of one of the shops which Kingsmen is fitting out at Marina Bay Sands. It's a Korean shop called iRoo.

Sunday, May 23, 2010

MTQ – FY 2010 Analysis and Commentary Part 2

Part 2 of my analysis and review shall focus on MTQ’s business divisions, namely Oilfield Engineering and Engine Systems. I shall be comparing the proportion of revenues taken up by each division as well as delving into the net margins provided by each division. A year-on-year comparison will be made to judge if there has been any improvement in each division, and I will also comment on the overall business climate and environment for MTQ going forward, based on pertinent facts which I am aware of right now.


Revenue Breakdown – FY 2010 Vs FY 2009 (1H and 2H)

Looking at 1H FY 2010 revenue breakdown, Engine Systems and Oilfield Engineering roughly contributed equal proportions to total revenue, as compared to 1H FY 2009 when the ratio was more skewed towards Oilfield Engineering (at 55.9% versus 44.1%). This was due to the weakening of demand in the O&G sector as major players cut their E&P spending and caused a slump in oil prices (and hence demand for repair services which MTQ provides). On the other hand, revenues for Engine Systems remained fairly stable at around S$20 million, and were flat year-on-year, and this demonstrates steady demand for MTQES’ offerings in spite of the global financial crisis. From the first half analysis alone, it can be seen that despite Engine Systems being a much lower margin division as compared to Oilfield Engineering, it has a more stable revenue base and more sustained demand. Let’s move on to second half now (figures for 2H are derived by subtracting 1H figures from FY numbers).

For 2H FY 2010, the ratio of sales for both divisions remains constant as in 1H FY 2010, and this is due to the stronger sales in Engine Systems compared to 2H FY 2009 which helps to boost the revenue figure amid a slump for Oilfield Engineering. For 2H FY 2009, Oilfield Engineering took up nearly two-thirds of revenues (66.6%) while Engine Systems took up just one-third (33.4%). It should be noted that revenues for Oilfield Engineering recovered slightly in 2H FY 2010 compared to 1H FY 2010 (from S$19.7 million to S$20.6 million), while for Engine Systems revenue improved to S$21 million from 1H FY 2010’s S$20 million, presumably due to the scaling up of offerings by MTQES. If this division’s expansion gains more traction in FY 2011, we could potentially see a much higher revenue contribution in absolute terms, and in terms of proportion it could keep pace with the growth in Oilfield Engineering division (due to the recovery in the O&G sector). Of course, it can be argued that revenue growth is useless without corresponding margin growth, which is what I will tackle in the next section of this analysis.

For FY 2010, the ratio remains constant as per 1H and 2H of FY 2010, while for FY 2009 it can be seen that Oilfield Engineering takes up the lion’s share of revenues. Taken in context, this means that Engine Systems’ revenues are catching up with Oilfield Engineering, and will surpass this division in time to come if not for the planned Bahrain expansion. The last financial year has seen MTQES building up their capabilities by extending their reach into Northern Territory in Australia (and increasing their distribution network), as well as scoring a coup by partnering with Bosch to create Bosch Superstores for automotive parts. I envisage that revenues for Engine Systems will continue to grow and probably will surge past Oilfield Engineering, as Oilfield division’s recovery hinges on the global economic recovery and E&P spending by oil majors. Until the Bahrain facility is fully operational by FY 2010, I do not expect to see a big jump in revenues from Oilfield Engineering.

Margin Analysis by Division

Looking at the revenues comparison, it is clear that Oilfield Engineering suffered a slump for FY 2010, with revenues falling 27% to S$40.3 million. Engine Systems picked up steam, though, with revenues increasing 17.5% to S$41.1 million. This can be attributed to the Bosch Superstore deal which MTQES signed, and which commenced on November 1, 2009. Thus, the jump we see here represents just 5 months of increased sales. If we include the additional contribution over the full 12 months (for FY 2011), then the revenue should increase even more. Recall too that MTQES had purchased Premier Fuel sometime in March 2010, so the additional contribution should flow through beginning April 2010 (i.e. FY 2011). Overall, revenues fell by 9.3% which was reflective of the depressed economic situation due to the global financial crisis. Businesses regularly suffer some dip in revenues and earnings due to economic cycles, but as long as they remain profitable and are able to make use of the slump to grow their business and consolidate their positions, they will emerge much stronger from the crisis.

For segment net profit, Oilfield Engineering’s net profit fell 30.9%, greater than the fall in revenues of 27.2%. This indicated that costs had remained fixed and were unable to be reduced even in the face of decreased sales. However, since the difference is not very great (3.7 percentage points), I am inclined to conclude that net profit had fallen in line with sales. Of course, more evidence of this has to be seen from tracking net profit increase to sales increase in future periods. For Engine Systems, the jump in net profit as a result of economies of scale (from the Bosch Superstores) is apparent as revenue increased 17.5% while net profit increased 171%. This reflected better margins as Mr. Kuah did mention that incremental costs to stock up existing MTQES stores were minimal, while the tie-up with Bosch would significantly increase both their customer base as well as sales volume. The 2H FY 2010 figures would have justified his statement (but unfortunately, there was no breakdown given between 1H and 2H in the financial statements released on SGXNet) as sales value ramped up while costs were adequately controlled.

I had written in my analysis of purchase for MTQ that Engine Systems division had traditionally suffered from very low net margins, as was apparent from my 5-year analysis of the division’s margins. Part of the reason can be attributed to the loss-making Indonesian unit, which has since been liquidated. Re-structuring of the division also took some time and now, with better economies of scale kicking in from the Bosch tie-up, I can begin to see net margins creeping up, though they are still at pretty dismal levels. Net margins for Engine Systems increased from 1.4% in FY 2009 to 3.2% in FY 2010, which was a very respectable improvement. Moving forward, it remains to be seen if net margins can be further improved past the 5% level, as the purchase of Premier Fuel was only completed some time in March 2010. If what Mr. Kuah projected back in October 2009 was accurate, the increase in customers and cross-selling of MTQES’ own products combined with Bosch can allow for better sales figures, while keeping costs controlled. I believe that for this division, a net margin of 10% or more would be decent, and not the margins existing at current levels.

Part 3 of this analysis shall examine the prospects of each division, based on best available information; as well as comment on the Bahrain expansion and the risks involved, as well as the planned change in the capital structure of the Group (i.e. taking on more debt) in order to finance this expansion.

Wednesday, May 19, 2010

Sun Tzu - War On Business Part 6 (Witchmount Winery)

Part 6 of this series features James moving on to Australia, where he checks out a winery business and visits a vineyard owner. The scene is set in Melbourne, Australia and the vineyard is called Witchmount Winery (WW) and its owner is a man called Tony Ramunno (“Tony”). The background on this business is that it is a family business founded in the early 1990’s. The vineyard occupies many acres (exact area was not mentioned) and Tony’s wine had just won a prestigious award from France for “Best Shiraz In The World”. However, Tony did not really leverage on this award to establish networks or push for more sales, resulting in lost opportunities. Early in the program, James mentions that one of Sun Tzu’s sayings is “Always be ready to seize an advantage”. This is very true in war as well as business – if you have a superior advantage over your enemy (competitor), you should fully utilize it to win the war and battle. Tony’s Witchmount brand had good coverage as a result of the award but because he did not leverage on it, he let the opportunity slip to promote his wines to the next higher level.

When interviewed, Tony admitted that “sales was always a challenge” and that there were 15,000 wineries in Australia, thus competition was keen and it was mainly a pricing game as it would be difficult for consumers to differentiate between brands. James brought in 5 wine experts to taste Tony’s wines, and all agreed it had quality and was a good product, but the problem was differentiating it from the competition as other consumers may not have such discerning palates. According to James, it was a disappointment but not a disaster. Tony did not have a concrete plan to increase sales and was just plodding on currently, so that was a gap which needed to be filled. James cited one example where a sales rep from Tony’s office did not show up at a restaurant which was selling their wines, and it was this lapse in service which could make or break a good deal, as restaurants are the main channel for Tony to distribute his wines to (he has no retail presence).

James interviewed one of Tony’s employees called Adrian Machioiro and he mentioned that staff in general need more guidance from Tony when it came to higher-level decision-making. Tony was sometimes uncontactable, which resulted in many decisions being left by the wayside and it severely slowed down the process of getting things done. Management staff also got impatient as a result of these delays and it negatively affected overall staff morale. On a side note, Tony did comment that for Adrian’s case, he feels that he is not competent enough to execute some of the marketing initiatives which Tony himself had come up with, but he declined to elaborate on camera.

An Australian entrepreneur called Ash Hunter was called in to take a look at Tony’s business and comment on it. He mentioned that a glaring problem was that there was no budget drawn up for the business and the business also lacked a marketing team. There is no effective costing system in place to measure which wines brought in the highest contribution margin (defined as revenues less variable costs). As a result, it was impossible to know which wines to focus on selling more within Tony’s existing product line, and also which products to target the marketing and promotions on.

To add insult to injury, Tony also admitted problems in the distribution company which WW engaged, in terms of expectations and also the need for close monitoring. James mentioned another Sun Tzu line: “Let your methods be as infinite as your circumstances”. He was trying to state that Tony should try out different techniques for improving sales and distributing his products, but that Tony lacked a strategy and also the proper Public Relations department.

James then challenged Tony to come up with a campaign to push wines through to five-star restaurants to increase exposure for WW. Tony focused his efforts on Sofitel, which is a very highly-acclaimed 5-star hotel chain in Australia. A few weeks later, he managed to tie up with executives from Sofitel to launch a special dinner with 5-star meals to showcase WW’s wines. 6 wines would be presented to 60 invited guests, even though technically speaking Sofitel only agreed to carry 2 of WW’s wines. Tony’s staff Stephen Goodwin was tasked with matching wines to dishes in an appropriate manner (e.g. white wine for fish, red wine for meat) and this was done in a successful manner, resulting in very positive reviews and impressions of Tony’s wines.

Lessons to be learnt here:-

1) Lack of a defined sales and marketing strategy and plan – It was painfully obvious throughout the whole program that Tony was lacking in terms of sales plan and marketing strategy, and this caused sales to stagnate at WW and he was unable to bring the business to a higher level.

2) Know your competition – Tony mentions that there are 1,500 vineyards in Australia, so he should have done a simple survey or spent some money to try to find out more about his competition, in order to benchmark costs, pricing and best practices. In other words, he should actively try to learn from his competition instead of staying in his own “shell”, like a hermit.

3) Availability of Boss for strategic decision-making – It was obviously disruptive to the workflow when Tony could not be contacted to make important decisions, and by right he should have delegated some measure of decision-making authority to his Management Team, instead of retaining full control. While some may argue that Tony retains more control over key decisions with this type of Management style, ultimately when the business expands and grows it will become a problem unless he delegates some responsibility down.

4) Employee Morale and Employee Relations – During the program, it was alluded that Tony had some “issues” with his staff like Adrian for example, which would not be pleasant to highlight on camera. One has to wonder if other such problems exist with him and other staff, who may be disgruntled with his attitude or management style. Since employee relations are such an integral part of running a business, this is something which every business owner has to look out for. Morale can literally make or break a business!

5) Computing the numbers to review profitability, hence trimming product portfolio – This is a mistake which is not too common for businesses, not knowing which are your most profitable products! For the case of alcohol, the strange thing is that a particular vintage may sell very well but actually generate the least profits, as the CM is very low or even negative. Thus, Tony should run through the costing and come up with a detailed costing sheet (hire a cost accountant!) to see which products should be “dropped” and which he should continue to focus on.

6) Problems with Distribution Network – Tony should have put a stop to the poor distribution company’s practises a long time ago, but his argument was that this kind of relationship was difficult to disrupt and it was more of relationship rather than efficiency which caused him to retain the bad distributor.

All in, I feel Tony was probably a very good “wine” person, but not a very good businessman or manager at all! He made a lot of mistakes which a business person should not have made, and I dare say the business was built up to this scale because of his predecessors, and he is merely “taking over”. While the marketing campaign at Sofitel went well, it remains to be seen if he knows how to leverage on the success to scale the business up to a higher level; and also if he manages to resolve the lingering problems with his staff.

The next episode features another Australian business called Zak’s Surfboards, and is about the surfing industry and the sun, sand and sea!

Visit Witchmount Winery’s website at

Friday, May 14, 2010

MTQ – FY 2010 Analysis and Commentary Part 1

MTQ released their FY 2010 results on April 30, 2010 during lunch time, one of the earlier companies in my portfolio to release their full-year results (MTQ has a March 31 year-end, similar to Tat Hong and Boustead which will release closer to end-May 2010). Suffice to say the results looked surprisingly good considering their main Oilfield Engineering Division had taken a hit (this was already apparent in 1H FY 2010’s results) and that their Engine Systems had previously been highlighted by me as having very low operating margins. Even with the recent partnership with Bosch to create MTQ’s Bosch Superstores (managed by MTQES in Australia) and the purchase of Premier, I did not have high expectations for the Engine Systems division to pull off a good performance. I was pleasantly surprised on this count, as we shall see in the segment analysis for both divisions. In the meantime, this analysis will follow the usual pattern of financial statement analysis and commentary, followed by business division review (including margins) and lastly discussing prospects, plans, risks and potential hurdles for the Company.

Profit and Loss Analysis

As can be seen in the above table, I had plotted out the 1H FY 2010 numbers which were released by MTQ in November 2009, and alongside it I had added in the 2H FY 2010 numbers, which were derived from subtraction of the FY 2010 from the 1H FY 2010 numbers (MTQ conveniently left out 2H performance, so I had to do my own back calculations).

If we glance at 1H versus 2H, it is quite apparent that revenues improved dramatically in 2H as the dip was only 5.2% and was attributed mainly to Oilfield Engineering. Engine Systems saw a boost in revenues due to the aforementioned Bosch deal, and also the purchase of Premier which expanded MTQES’ network around Australia. Cost of Goods Sold had dropped by 17.1% for 2H against a drop of 15% for 1H, and this showed better economies of scale as MTQ moved along in the financial year. The FY 2010 resulted in a drop of 8.8% in revenues while COGS dropped by a larger 16.1%, resulting in a RISE in gross profit of 4.2%. Cost control is very apparent at this juncture and it was a very good sign that even though revenues fell due to decreased spending by oil majors on E&P, MTQ had managed to eke out a small rise in gross profit due to their better performing Engine Systems division. With the closure of unprofitable segments of MTQES, I believe this division will continue to grow and expand with improved margins as time goes by. Note the gross margin expansion from 36% for FY 2009 to 41.1% for FY 2010. 2H FY 2010 showed the largest margin expansion, jumping from 32.3% to 40.9%. Note that 2H was also the time the Bosch deal was sealed and Bosch Superstores started operating from November 1, 2009 (essentially 5 months of the 2H FY 2010). I cannot stress enough how important it is for gross margins to improve as this signals not just economies of scale, but also indicates possible pricing power. I will be keeping a close watch on gross margins in the upcoming 1H FY 2011 results to see if it continues to improve.

One point to note is the S$1.86 million worth of realized gain from divestment of quoted equities, which is an exceptional gain and should be removed from the computation of recurring EPS. MTQ had purchased quoted shares during the downturn (company not stated), and had proceeded to divest some of these holdings to raise cash (presumably to fund their Bahrain expansion and their Engine Systems division’s initiatives). Later in the Balance Sheet, it will be pointed out that MTQ is sitting on a fairly large unrealized gain (of about S$2.9 million) on its long-term shareholdings (marked-to-market gain).

One disappointing aspect to note is that administrative expenses had increased significantly (by 26%), even though revenue had fallen over the same period. An adequate explanation was not provided in Management’s MD&A and I can only suspect that this relates to higher expenses incurred to beef up their Bosch Superstores, as well as purchases to stock up on new line of items and other associated costs relating to Engine System’s expansion into Northern Territory. It will be worthwhile to question the Management on this increase during the upcoming AGM (and after reviewing the Annual Report) as it is a significant jump in light of the fact that revenues had in fact dropped. Staff costs had also crept up by 6.2% for FY 2010 (of which the majority of the increase came in 2H where the jump was 23.3%), and this could possibly be attributed to increased hiring as a result of the Bosch deal, in order to man the stores amid an increased range of products being displayed. I also took into account the fact that higher staff strength will equate higher training costs and staff welfare as well.

Finance costs were kept under control, dipping 8% year on year, as borrowings remained low. This may be set to change, however, with MTQ embarking on the second phase of their Bahrain facility construction soon. The Group had mentioned taking up debt to fund this expansion, as they wish to leave their cash intact for possible M&A opportunities. Therefore, I can expect a much higher financing cost to impact the bottom line in the year to come.

Profit after tax increased by 10% for FY 2010, but this was due to the fact that there was an exceptional gain of $1.863 million due to sale of equities. Stripping this out, net profit would have been about S$10.2 million (a drop of 6.4%). Net margin cum exceptional gain was 14.7%, but drops to 12.6% ex-exceptional gain (still higher than FY 2009’s 12.2% though). Considering all of the $1.863 million gain came from 1H FY 2010, this means 2H FY 2010 performance was much stronger and pulled up the overall performance for FY 2010, as net profit surged 21.8% to $4.8 million (no adjustment was needed as there was no exceptional gain). Assuming the momentum continues to build up for MTQ’s 2 core divisions, I can expect a reasonably better performance (barring unforeseen higher staff and operational costs) for 1H FY 2011. 2H FY 2011 will likely be impacted by the recruitment and subsequent training of the new Bahrain staff (without associated revenues). See interview on NextInsight as evidence of this piece of news, which I had used to factor into my projections and expectations.

At a valuation of 7.36 times historical earnings ex-exceptional gain, MTQ is not trading at expensive valuations; but neither is it cheap.

Balance Sheet Review

MTQ’s Balance Sheet is still rock-solid, for the fact that it has a net cash reserve of about S$16.9 million, just a slight drop from FY 2009’s net cash reserve of S$17.5 million. However, there are a few aspects of the Balance Sheet which are worth some attention, and I shall devote some attention to these items so that I may remind myself to watch over these “red flags” in the next few reporting periods, to ensure the numbers do not get out of hand. As an investor, that is the least I should be doing.

Trade and Other Receivables had increased by S$5.1 million or 31.5% to S$21.4 million, and this occurred even though there was a dip in revenues by 8.8%. It is always worrying when receivables increase when revenues dip, as it may signal a collectibility problem and potential bad debts moving forward. A possible explanation could be that the Engine Systems Division had garnered more sales as a result of the Bosch partnership, but also at the same time extended longer credit terms to its customers as a result of the increased sales. This has to be clarified by me during the next AGM as I consider this a potential red flag.

The good news is that current ratio had increased to 3.01 from 2.60 and quick ratio improved from 1.94 to 2.09, though this was mainly due to the increase in receivables. Receivables turnover days increased significantly from 66.4 days to 95.7 days, but payables turnover also increased from 68.7 days to 97.4 days. The cash conversion cycle had dipped from 2.3 days to 1.8 days; and though this is not a significant dip, it still presents a worrying trend as the cash conversion cycle is one of the important metrics by which to measure a company’s ability to convert receivables to cash faster than it pays its suppliers. I shall be closely monitoring this in future periods and will label this as a “red flag” as well.

Debt equity ratio has fallen from 7.7% to 4.6%, but with the scaling up of the construction of their Bahrain facility in FY 2011, I would expect this ratio to head higher in the following financial year. The good thing was that ROE remained high at 19.4% with minimal debt, down from 23.9% last year. As long as the Company can maintain such high ROE with minimal leverage, I would conclude it is still doing decently. This fact, coupled with the knowledge that the Company still has a healthy net cash balance, reassures me that my investment is still doing fairly well.

Cash Flow Statement Review

MTQ’s cash flow statement was, thankfully, quite healthy. A quick glance shows that the Group generated a healthy operating cash inflow of S$3.9 million, despite seeing a big rise in Trade Receivables which resulted in an “outflow” of S$8.5 million (quotation marks are used because this Cash Flow Statement was prepared using the Indirect Method). Inventory increase accounted for a cash “outflow” of S$2.5 million, and together these two items resulted in a cash outflow of S$11 million. One reason I can think of was the aforementioned Bosch Superstore customers increased credit terms, and also the stocking up of the Superstores to include Bosch range of products as well as MTQES’ own range, which resulted in the higher inventory figure.

It’s also worthwhile to note that income taxes had fallen substantially to S$2.2 million from last year’s S$7.1 million, which included capital gains tax paid on MTQ’s disposal of RCR Tomlinson. Assuming (and this is a big assumption) that inventories and receivables’ days normalize after MTQES’ expansion gains momentum, MTQ’s cash inflows from operations should improve substantially. However, their Bahrain expansion could throw a spanner in the works as more cash needs to be paid out to hire workers and train them for the new facility; thus both these events may negate each other and the net effect may still be more cash flowing out rather than in.

Purchase of PPE took up about S$5.1 million for FY 2010, slightly down from S$5.7 million the year before. Because of this capex, one can easily note that there is negative free cash flow for MTQ as capex exceeds operating cash inflows; however with the scaling up of MTQES’ operations in Australia and in future, the operation of the Bahrain complex, MTQ may see positive free cash flow in 3 to 5 years time.

Most of Financing cash flows were made up of repayment of bank borrowings as well as payment of dividend. It is quite surprising (to me at least) that the Group can still maintain its dividend payout of interim 1c per share and 2c per share final even though there are spending to build Phase I of their Bahrain complex.

Part 2 shall discuss each business division and their margins, and I shall discuss how each business division is performing relative to last year; and also provide a snapshot of what I feel an investor can expect from each division in the coming year.

Monday, May 10, 2010

Sun Tzu - War On Business Part 5 (Ozone Gym)

Episode 5 of the Sun Tzu series brings us back to Beijing, China once again. This time we are introduced to a businessman by the name of Tomer Rothschild (“Tomer”), who has started up a chain of gyms called Ozone Gym around Beijing. It has been 7 years since Tomer set up the gyms and extended its branches around Beijing, but he is just barely surviving. James takes a visit to one of his gyms to see the facility, and also does some impromptu interviews with some gym goers around the area, and comes up with his conclusion on why the business cannot grow.

The main problem which James first notices is that China people like to do their exercise outdoors! This means that most of the Chinese will reject the idea of western style gyms as the climate and weather in China is generally conducive for outdoor exercise (generally cool and low humidity). This fact, coupled with Tomer not having a concrete marketing plan to draw in more crowds and advertise for Ozone Gym. James interviews Alejandro Angulo, one of the body combat instructors, who mentions that on a good month, there are about 100 joiners but on a bad month, as little as 30 people sign up. Considering there are 10 branches around Beijing, this translates to as little as 3 to 10 people per outlet per month. This is way below the optimal level required for operations to sustain themselves; James also brings in a venture capitalist and business expert called Cha Li, who commented that the gyms seemed to have lots of space but was simply lacking in crowds!

James went on to randomly interview some passers-by near Tomer’s gym, and one gym goer could not even recall the name of Tomer’s gym, displaying a lack of brand loyalty and non-existent brand awareness. Others simply did not even know a gym existed nearby, even though they had passed by the area umpteen times.

Armed with these facts, James and Cha Li met up with Tomer in the War Room and gave him advice on how to grow his business. James suggested initiating a marketing campaign (using traditional and guerrilla marketing) by tying up with a sports brand, in order to draw in the crowds and give membership a big boost. Tomer agreed to give it a try and roped in his experienced Management team to organize the campaign and get it going. Photo shoots were taken of models exercising, which were to be placed on the promotional banners and flyers to be given out. There were promotional items given out for referrals as well, a tactic which had worked well in the past (though its efficacy was limited by the lack of marketing support and planning prior to the current launch). Prizes would also be given out for new members (in a tie-up with Nike), and the marketing budget was to be kept at 5% of revenues (which is usually a standard).

In one ingenious move, Tomer’s team had also managed to liaise with the Beijing Subway Company to distribute brochures on the subway targeting the East Side of Beijing, which did not have any Ozone Gym outlets. Nancy Gao is the appointed manager in charge of launching the campaign, but had warned that there was a possibility the campaign will not take off due to the pending Lunar New Year holidays, when a lot of Beijing people were travelling to other parts of China for visitation. Tomer chose to ignore this advice and push on with the campaign, as he was afraid that the time lag would mean valuable time wasted in trying to recruit more members.

At the end of the one-month promotion, the result was that only 400 new members had signed up. Normally, this would be considered a resounding success; but James commented that Ozone Gym had 10 outlets, and assuming Tomer had spent considerable sums of money on this marketing campaign, it implies that the costs had far outweighed the benefits. James attributed it to bad timing and planning as Tomer had pushed ahead with the promotion in spite of being warned by his Chinese Management Team, and as a result of the bitter winter weather and the CNY period, had failed to attract more people than it should have. James concluded the episode on a sombre note, saying that Tomer did not win this battle.

Lessons to be picked up from this episode included:-

1) Survey your target segment’s lifestyle habits before plunging into a business – Apparently, Ozone Gym had been opened for nearly 7 years but membership numbers were still dismal. Tomer had neglected to understand the Chinese penchant for outdoor activities and exercising outdoors, or maybe he felt that habits would shift towards more “western” practises with the modernization of China. In reality many of the younger Chinese are indeed more westernised in terms of thinking, beliefs and behaviour; but this does not transcend all the way down to the way they do their exercise, as is evidenced by the slow and low take-up rate for Tomer’s Ozone Gym.

2) A good marketing plan is important – The lack of a vision and marketing plan seems to be a common theme for most of the Sun Tzu episodes thus far, and most of the time the CEO (boss) is clueless about expansion and how to go about it. In Tomer’s case, he wanted to expand but did not know how to go about creating a marketing plan to achieve his objectives. I guess James and Cha Li acted as a sort of catalyst to make him get going.

3) Moderate spending on capex if demand is low – This is something which I had observed of Ozone gyms, and that the scale of the gym is very large and has a lot of floor space with many pieces of equipment. Perhaps Tomer was emulating western style gyms which are generally spacious and have many different types of equipment, to provide a good assortment of training aids for those who wish to work out. But seeing that demand for his gyms was not high in the initial years, one wonders if he would have been better off down-scaling his gyms to smaller areas in order to save on rental costs and staff costs. He could have designed his gym to cater to niche customers instead, and this is linked to the previous point on not having a detailed marketing plan, thus he just carried on operating as usual without trying to reduce his costs.

4) Good advice should be taken – This point is simple and straightforward. If Tomer was aware that his Management team (which was composed of Chinese) knew the ground well and the habits and culture of the people, then he should have taken their advice seriously to delay the launch of the marketing campaign till after Chinese New Year. As a result of his insistence to push forward with the campaign despite objections from his team (who reluctantly acceded to his plan because he was the “boss”), it resulted in poor response and a lot of marketing dollars spent but wasted.

This is the first episode in this series I have seen in which James concludes that due to mis-timing, Tomer would not be successful. It would seem that not everyone which he advises in the War Room ends up executing their plans well, as evidenced by the way Tomer (mis)managed the marketing campaign.

Watch out for the summary and lessons learnt for the next episode six (6) on Witchmount Winery in Australia.

Note: Visit Ozone Gym’s website at

Thursday, May 06, 2010

Why Traders are Important for Value Investing

OK, before someone lambasts me for switching to trading, please read and re-read the title carefully. I mentioned that “traders” are important for investing, and not “trading”. The use of the two somewhat similar-sounding words makes a whale of a difference though, and this post shall proceed to explain why, and how I can justify the above statement.

In any stock market, there always exists an abundance of traders/speculators while there are usually only a handful of investors. The investors sit on their butts and wait patiently for their shares to reach their perceived fair value, all the while exercising patience and engaging in detailed due diligence to ensure all is moving right. By contrast, the active traders are the one who zip around like dragonflies on a hot noon day, flitting from counter to counter in the hopes of entering and exiting with maximum profit (and minimum loss). There exists a certain relationship between the two camps – one whereby each takes advantage of the other’s actions to generate opportunities to make money. Let’s take it from the point of view of the investors, first.

Investors have the unenviable job of researching, reading and analysing company fundamentals, and waiting for margin of safety to appear when Mr. Market presents it. Traders help to accelerate this process by 1) creating liquidity and also 2) creating instances where mis-pricing is so evident that investors will be “forced” to react. These two factors alone are pertinent reasons for the importance of traders to the investing process. Liquidity can be seen as the oil which greases the wheels of the stock market, and it is important when an investor wishes to take a position in a company which he feels offers long-term investment potential AND a margin of safety. However, it is well-known that illiquidity in some counters creates wide bid-ask spreads, and this can severely hamper an investor’s ability to purchase a significant stake in a company at a low enough price due to the illiquidity premium, and also the prohibitive bid-ask spread which results in higher fees. Traders are responsible for providing much-needed liquidity, so that an investor can find the volume to purchase a sizeable stake, and also to avoid the associated higher costs which come from a wide bid-ask spread.

During instances of market frenzy or market panic, traders are responsible for the gamut of emotions which flood the stock market, creating over and under-valuations of sound securities. The emotional tenor of the market is determined by these traders, and share prices can be severely marked up or down depending on the prevalent news, rumours and/or reports. Investors make use of such opportunities to find bargains to purchase, when share prices are uncharacteristically depressed due to one-off events or due to fear and panic in the markets. Conversely, traders who are excessively exuberant will also bid up prices of securities far above their fair value, and this presents opportunities for investors to offload their shares for a comfortable profit, as the share price may have run far ahead of fundamentals and prospects.

The above two situations illustrate how traders help investors by reducing the opportunity cost of holding cash, and also creating situations which benefit the conservative investor. Investors, on the other hand, also help traders by providing liquidity with their persistent buying or selling, especially when they target to invest in or divest a certain company. Generally though, I believe the presence of traders helps to enhance the opportunities present for an investor, but the investor must do his own due diligence and be vigilant for such opportunities presented by Mr. Market.

However, it should be noted that traders usually stick to companies with heavy volume (institutional favourites), and hence the “churn” which is produced will usually be limited to the same few blue chips and/or speculative counters which see cyclical volume spikes. Certainly, if there are bargains to be found, they may mostly reside in the quiet, untraded counters which dot the landscape; and these may still present the same problems to investors who wish to accumulate a sizeable stake. Liquidity is contingent upon certain events in which the market either recognizes the true intrinsic value of a forgotten gem, or a corporate event which throws the company into the spotlight. Both instances do not create conducive buying opportunities, however, because people will then bid up the price of the under-valued security. Hence, it may still be a challenge for investors to accumulate good companies in suitable quantities to make a positive difference to their portfolio.

Ultimately, investors should still watch for events to unfold which may offer them some glimmer of hope to accumulate at a price far lower than intrinsic value, in order to maximize margin of safety. A lot of patience and fortitude is required for such an operation to take place successfully. In the meantime, it would be a worthwhile exercise to let cash pile up until it can be deployed at a suitable time and in suitable securities which can yield a decent (better than inflation) long-term return.