Monday, February 28, 2011

February 2011 Portfolio Summary and Review

It has been a very relaxing month for me in terms of blogging as I have eased up on the frequency, and have instead focused more on my personal life and other pursuits. Other than checking on the results of the companies which I own, I also did some reading and simple analyses on other companies which had released their results, in a relaxed and non-hurried pace. After all, if a company is really good, it should remain so even into the future. The problem, of course, is getting Mr. Market to sell it to you cheaply so that you can maintain your margin of safety.

The economic and political news has probably been dealt to death in the newspapers so I will not dwell on it except to mention the headlines – troubles in Libya, Bahrain, Yemen and Middle East in general, an earthquake in New Zealand and COE prices moving north again in Singapore. Inflation hit 5.5% and raised quite a ruckus among economists who (as usual) did not expect it. And who can forget the most “sensational” news of all this month – (Election) Budget 2011 and the confirmation of electoral boundaries, signalling an impending General Election.

Without further ado, below is a snapshot of my portfolio and associated comments for February 2011:-

1) Boustead Holdings Limited – All I can say is, Boustead got hit by pretty bad news this month as the unrest and violence in Libya spiralled out of control and threatened the safety of staff situated there. As a result, on February 21, 2011, Boustead announced the evacuation of staff from Libya and on February 25, 2011, it followed up by announcing that all staff had been safely flown back home with the help of International SOS and embassies. Of course, such a political volatile situation will not bode well for Boustead’s Al Marj Project in Tripoli, even though it was announced on February 1, 2011 that they had reduced their stake in the Joint Venture from 65% to 35% and let their JV partner GCBC take over the completion of the Township to expedite matters. Additional announcements include one on February 1, 2011 where Boustead Projects clinched a Design, Build and Lease Project (its third since start of 2011) to build an integrated aircraft MRO facility for Hawker Pacific Asia Pte Ltd. This will add to Boustead’s recurrent revenue and cash flows as their real-estate solutions division builds up its portfolio. Boustead also released their 3Q 2011 financial statements on February 14, 2011. To summarize, 9M 2011 increased 34% to S$450.5 million, gross profit was up 41% to S$135.3 million and net profit attributable to shareholders was up 84% to S$53.3 million, but this included a one-off gain on disposal of a property. FCF generated was healthy and the business seems to be chugging along fine. On February 18, 2011, Boustead announced that it was purchasing the remaining 8.33% stake in Boustead Projects from Mr. Ngo Wu Ping for a consideration of S$16 million. Interestingly, this values Boustead Projects at about S$192 million. Boustead’s total market value is only about S$470 million (using 93 cents per share), so this implies the other 3 divisions in total are worth just S$278 million. Considering the other three divisions are very well-established with a good clientele base, it seems unlikely that it is just worth S$278 million. So perhaps this is an indication that Boustead may “spin off” some of its divisions in future to realize hidden value.

2) Suntec REIT – There was no news from Suntec REIT for the month of February 2011.

3) MTQ Corporation Limited – There was no news from the Company for this month, except that the unrest in Bahrain might have an impact on MTQ’s investment in Bahrain. Thus far, their IR has assured that they are monitoring the situation and that they plan to be in Bahrain for the long-haul. Still, I am concerned that the protests may escalate and cause major economic and political trouble, which in turn will affect Bahrain’s attractiveness as a commercial hub. I will keep updated with the latest events as time goes by, and hope for the best.

4) GRP Limited – GRP released their 1H FY 2011 results on February 11, 2011. Revenue fell 2.1% while COGS increased 4%, so effectively gross profit fell by 13% to S$4 million. Other operating income also dropped 92% to S$128,000 as there was no more rental income from the property at Bukit Batok due to expiration of lease. As a result, net profit dived 47.3% to S$1.2 million. However, in spite of the weaker results, Management declared the usual 1 cent/share interim dividend, and this has been reflected in my realized gains as the counter has gone ex-dividend.

5) Kingsmen Creatives Holdings Limited – Kingsmen released their FY 2010 results on February 22, 2011. FY 2010 revenue decreased by 2.8% to S$235.2 million but gross profit increased about 10% to S$65.4 million due to better gross margins. Net profit was flat (an increase of just 1.1% to S$15.1 million), but the Company declared a 0.5c special dividend in addition to a 2c final dividend due to their 35th Anniversary. I will be doing a more detailed analysis of Kingsmen’s FY 2010 results and prospects in a future post.

6) SIA Engineering Company Limited – There was no news from the Company for February 2011.

Portfolio Review – February 2011

Realized gains increased to S$55.4K as a result of realized gains from the divestment of Tat Hong, as well as dividend from GRP.

For YTD February 2011, the portfolio has fallen -5.7% (using XIRR and including GRP dividend) against a -5.6% fall in the STI. Cost of investment has decreased to S$185.3K, and unrealized gains stand at +11.8% (portfolio market value of S$207.1K).

March 2011 is expected to be a quiet month as there are no results being released, so it will give me time to do some analyses on my existing companies as well as allow me to analyse the results of companies which I find an interest in deploying my cash into. However, I must stress that there is no immediate urgent rush to deploy the cash unless ALL factors are in my favour and unless I can guarantee a reasonable margin of safety. Patience is the key to long-term sustainable returns and I intend to just let the money sit in the bank account if I cannot allocate it efficiently.

My next portfolio review will be on March 31, 2011 (Thursday).

Friday, February 18, 2011

Divestment of Tat Hong – Analysis and Lessons Learnt

My previous post on Tat Hong’s 1H FY 2011 results ended on a pessimistic note, as I had mentioned that I will be keenly monitoring the Company’s 3Q FY 2011 results to review margins, revenues, utilization rates and overall profitability and cash flow generation. Well, the jury is out – Tat Hong released its 3Q FY 2011 financial statements on February 14, 2011; but it was more of a Valentine’s Day nightmare than a gift, for the numbers were quite horrendous by any standards. This post is not just to highlight the numbers and the deterioration of the business, but also serves as a lesson and wake-up call to yours truly (yes, ME) on which companies I should choose to avoid in future when searching for a value investment. Note that this investment in Tat Hong was made back in September 2008, when my criteria for strong Balance Sheets and Free Cash Flow was not as rigorous as in 2009 and 2010.

Just for the record, the divestment was made on February 15, 2011 at a price of S$0.895 per share, and capital gains to be recognized amount to about S$5.2K. Taking into account the holding period of Tat Hong, including dividends and subsequent purchases during the bear market, my annualized gain is about +17% per annum. Admittedly, this could have been much better if I had recognized and heeded the many red flags and warning signals which popped up all over the place, but I chose to stubbornly ignore them and hang on as I felt the positives and economic recovery would kick in and lift earnings and margins. Anyhow, let me go point by point on Tat Hong to dissect the decision to completely divest myself of this investment.

1) Gross Margins – For 3Q 2011, gross margin deteriorated significantly from 38.0% to 34.4%. While this in itself may have been a temporary “blip”, the commentary is chilling in the sense that it casts a pall over the gross margins by stating that lower margins were obtained in crane division (55.6% versus 63.0%) due to more intense competition in local and Malaysian markets (Page 12), and that distribution also saw lower margins of 18.0% versus 19.7% due to strong competition and weak market conditions. Another worrying point was that Tower Crane division in China also contributed to the weaker gross margins due to higher COGS and keen competition, and gross margins fell significantly from 30.1% to just 21.8%. The common theme among these three pieces of negative news was the word “competition”. Note that in the first place, the crane industry is very fragmented; and that even though Tat Hong is one of the major players, there are still many smaller companies that can buy a few cranes and then lease them out, so this makes it a very price-competitive environment. The fact that Tat Hong is succumbing to keen competition signals that this is a permanent problem which is likely to persist, as competition does not just disappear overnight. It is one of the most difficult problems for a company to tackle, and if they did not have a very strong competitive moat in the first place, the first signs of weakness will show up in the gross margins, as what Tat Hong is demonstrating.

2) Finance Costs – Finance costs have been rising steadily, and for 3Q 2011 it went up 25% to S$4.7 million, against just a 1% increase in gross profit. For 9M 2011, finance costs hit S$14 million, up 26% from a year ago. The increase in debt was ostensibly to fund the acquisition of Tutt Bryant, but with the recent massive Queensland floods, it remains to be seen if this will have an adverse impact on Tutt’s operations. The fact is that finance costs are climbing and with a combination of slower revenue growth and lower gross margins, this signals a big red flag.

3) Expenses – Looking at 9M 2011, it is clear that expenses have risen more than revenues or gross profits. Administrative expenses were up 25%, while other operating expenses rose 23%. Apparently, keeping a tight lid on expenses is an effort for the company, as they are hiring for their new subsidiaries in China and also spending more money on upkeep and rental of their machinery in Australia. This has occurred not just in one quarter but I have observed the trend of higher expenses amid lower or flat revenues and earnings, and as a shareholder one should be rightfully worried. Controlling costs should be of utmost importance, and if companies such as Boustead can reduce costs even while growing revenues, then I would expect it of the other companies within my portfolio as well. Tat Hong has certainly not been able to control its expenses effectively, as can be seen in their bottom line performance.

4) Debt Levels – It was always worrying to me that Tat Hong held such high debt, and Management was constantly talking about net debt to equity ratios instead of concentrating on going net cash. I guess this points to a fundamental flaw in my original logic for purchasing Tat Hong – that it is involved in a high capex industry and therefore needed to rely on a lot of bank loans and financing for daily operations. Financial liabilities (ST) increased from S$91.2 million to S$142.9 million, which is a 56.7% increase; while LT financial liabilities increased significantly from S$153.8 million to S$227.7 million (a 48% increase). Total debt therefore increased from S$245 million to S$370 million, and the cash balance of the Company was just S$73.5 million as at Dec 31, 2010.

5) Persistent absence of Free Cash Flows – One of my major gripes was that Tat Hong’s cash flow statement always shows a persistent lack of free cash flows, as cash from operations is seldom sufficient to cover capital expenditures. The result of this, of course, is that Tat Hong has to rely on other sources of funding such as bank loans (as mentioned in point 4), and the recently issued RCPS to AIF Capital. For 3Q 2011, the situation looked even more dire as there was negative operating cash flows of S$15.2 million, while capex was S$12.4 million under “Investing Activities”. Needless to say, most of the cash came from the raising of bank loans (S$43.8 million) once again.

6) Company Characteristics – Tat Hong is a company which is similar in nature to Ezra and Swiber, in that there has to be constant high capital expenditure for it to function effectively. The buying and selling of cranes ensures that capex has to remain high, and even to replace old, worn-out cranes and equipment for rental would entail high capex as well. Considering the Company has diverse business operations in Australia and Asia, this means that upkeep and maintenance of this equipment necessitates high expenditures, and this is a characteristic of the Company which must be taken into account. Sadly, when I was analyzing the Company, I focused more on its size, scale and market leadership rather than these more important characteristics, and which resulted in this mistake.

The above points were sufficient to justify the decision to divest, and to deploy the monies at a suitable time and when a suitable investment-grade company can be identified. I will strive to actively avoid making the same mistakes, and focus a lot more on debt and free cash flows in future analysis of purchases. In fact, this had started with the purchase of MTQ, and then moved on to GRP, Kingsmen Creatives and lastly SIA Engineering. Thus far, their businesses have been more resilient as compared to Tat Hong, even in the face of an uncertain economic climate.

This divestment and change in my portfolio will be reflected in my month-end portfolio review. With the divestment of Tat Hong, it also means I lose an income stream which amounted to about $500 a year (assuming last year’s dividend history), and at a dividend yield of 2.9% (yes, nothing to shout about). Note that the cash will be kept in a bank account until suitable opportunities can be found to deploy it. There will be no rush to invest in a company until ALL the factors are in my favour, and if I have the requisite margin of safety. Capital preservation remains the cornerstone of my investing philosophy.