Monday, October 31, 2011

October 2011 Portfolio Summary and Review

October 2011 was somewhat weird, considering the negative sentiment which pervaded stock markets and the economy from August to September 2011 seems to have somewhat dissipated. In fact, in an embarrassing turn of events, the local market has rocketed up more than 10% after I wrote my piece on “My Second Bear Market”, and is a testament to how difficult it is to gauge and predict short-term market movements with accuracy. Apparently, that post is now irrelevant, but I assure that the lessons learnt are still applicable and the fact that I am able to say that my financial position has improved should at least be of some comfort to me. I am also proud to admit that I have absolutely and completely no skill or special foresight in predicting market movements, so for readers who have somehow stumbled upon this blog looking for something akin to the Holy Grail, please do look elsewhere (for info: there is a never-ending flow of market “gurus” who continually try to predict every twist and turn of the stock markets).

To cut a long story short, out of the six companies within my portfolio, three had released their results as of this writing, while the other three will release them in November 2011. I have provided summaries of the results and dividends declared (if any), but detailed analysis will only be conducted subsequent to this portfolio review as I would need time to digest and reflect on not just the numbers, but also the qualitative aspects of what was written in the announcements.

Below please find my portfolio as well as corporate summaries for October 2011:-

1) Boustead Holdings Limited – On October 12, 2011, Boustead announced that Boustead Projects, its 100%-owned subsidiary, had clinched 2 contracts. One was a S$19 million contract to design and build an integrated manufacturing and R&D centre for Greenpac Asia (S) Pte Ltd located at Tukang Innovation Park in Singapore. The Facility will occupy 18,000 square metres and be completed in 4Q 2012. The second contract is a small one – a S$2 million contract to design and build a 1,800 square metre extension to an existing facility owned by Golden Spring Export Pte Ltd at Changi International LogisPark. With these two contracts, Boustead’s order book stands at S$320 million. I had just written a two-part post on Boustead’s EGM highlights, so I will not be elaborating too much on the Company until they release their 1H FY 2012 results on November 14, 2011 (Monday).

2) Suntec REIT – Suntec REIT released its 3Q 2011 results on October 25, 2011. A dividend of 2.533 cents/share was declared and this will be payable on November 29, 2011. As I do not have a significant stake in this REIT as a proportion of my portfolio, I shall not go into details on the press release and presentation slides, and readers can go to SGXNet to download the necessary information. In another announcement on October 27, 2011, Suntec REIT announced that it had divested its entire stake in Chijmes (which it purchased for $128 million in 2005) to Pre 8 Investments Pte Ltd for a sum of $177 million, and will recognize a gain of $49 million. This was 23% above valuation, and the proceeds will be deployed within the Fund and be used to either value enhance (whatever that means) or pay down debt.

On October 31, 2011, Suntec REIT announced a massive asset enhancement plan called “Remaking Suntec City”. ARA Asset Management will spend $410 million on the plan (which will commence in mid-2012), with $230 million slated for remaking Suntec City mall, and $180 for remaking Suntec City Convention Centre. On completion in 2015, Suntec REIT is expected to have about 1 million square feet of net lettable area. Net property income is expected to increase by 33% of $23 million, and proceeds from the sale of Chijmes will be used to mitigate the temporary dip in DPU while renovations are taking place.

3) MTQ Corporation Limited – On October 11, 2011, MTQ announced the completion of their acquisition of Premier Land and Sea (PSL). Based on the audit of PSL as at June 30, 2011, the NTA of PSL was US$17.1 million, including cash balances of US$2.6 million. As this value exceeds the minimum NTA guaranteed by the vendor, MTQ paid the vendor an additional US$2.6 million, bringing the total consideration to US$21.9 million. There was no news or information on PSL’s financial results as at June 30, 2011, and the NTA per share after the acquisition has now been amended to 72.52 cents/share. MTQ also released their 1H FY 2012 results on the morning of October 31, 2011. Revenue was up 40%, largely due to the acquisition of PSL and organic growth in Engine Systems Division, but gross profit was up just 27% due to lower gross margins as a result of sales mix. Staff costs and other operating expenses were also significantly higher due to start-up losses at Bahrain (which has yet to contribute meaningful revenues for the Group), up 33% and 47% respectively. Finance costs were also predictably higher at $505K as the Group geared up for both their Bahrain expansion and PSL acquisition. The Balance Sheet has weakened compared to the previous reporting date, and Cash Flows are also weaker due to more outflows for acquisition of shares and subsidiary. I shall be doing a comprehensive 1H FY 2012 analysis and review of MTQ in my upcoming posts. An interim cash/scrip dividend of 2 cents/share was declared, unchanged from last financial year.

4) Kingsmen Creatives Holdings Limited – On October 21, 2011, Kingsmen announced the incorporation of a wholly-owned subsidiary in Shenzhen, China. The authorized share capital of this company is RMB 500,000 and its business scope will include designing and producing architectural interiors for commercial and retail properties, pavilions, museums and theme parks. Uniqlo has also announced that it plans to increase its number of outlets from five to 20 within the next three years. Its regional headquarters will be set up in Singapore and they are one of Kingsmen’s clients, so this bodes well for Kingsmen’s Interiors Division.

5) SIA Engineering Company Limited – SIA Engineering released its 1H FY 2012 results on October 28, 2011. Revenue for 1H 2012 decreased 2.7%, while net profit attributable to shareholders increased 15% to $139.3 milllionm partly due to a tax write-back of $3.1 million. As expected, there was no debt carried on the Balance Sheet, and glancing over to the Cash Flow Statement, I note that for 1H FY 2012, there was operating cash inflow of just S$20.7 million, due to an outflow of $24.3 million for 2Q 2012, while investing cash inflows came in at S$40.2 million, therefore free cash flows totalled S$60.9 million. This was lower than 1H FY 2011’s total FCF of S$109.6 million. However, SIAEC managed to maintain their interim dividend at 6 cent/share, similar to the previous year. This will be paid out on November 29, 2011.

6) VICOM Limited – There was no news from VICOM for October 2011. VICOM’s 3Q 2011 results will be released on November 10, 2011.

Portfolio Review – October 2011

Realized gains have remained at S$67.4K in the absence of dividends received for this month (no counter going ex-dividend).

With the addition of more shares of Boustead, my portfolio cost has increased to another new high of $242,600 as at October 31, 2011. Sadly and most unfortunately, the recent upsurge in share prices and valuations has scuttled my attempt to accumulate more shares in companies, and therefore the cash which was awaiting deployment would have to sit around a while longer.

For the month of October 2011, the portfolio has decreased by -4% (using XIRR in MS Excel to compute) against a -10.5% fall in the STI; thus my portfolio performance has outperformed the STI by +6.5 percentage points. This was a worse performance compared to September 2011, when the portfolio out-performed the STI by +11.6%, but it is to be expected as a value portfolio would find it very tough to beat the index during periods of bullishness and pervasive optimism. Cost of investment has increased from S$238.7K to S$242.6K and unrealized gains stand at +5.2% (Portfolio Market Value of S$255,100).

November 2011 should be a very interesting month with many companies reporting their 3Q results. I will be expecting results from Boustead, Kingsmen and VICOM, and the receipt of dividends from Suntec REIT and SIA Engineering.

My next portfolio review will be on November 30, 2011 (Wednesday).

Wednesday, October 26, 2011

Boustead – FY 2011 EGM Highlights Part 2

Here is Part 2 of the highlights from Boustead’s recent EGM held on October 13, 2011 at Starhub Green.

On Energy-Related Engineering and Water and Wastewater Engineering Divisions

I was rather concerned about how the state of the world economy had affected oil prices, to the extent that they had hit one-year lows recently. When I asked about how this would impact the energy-related engineering division, the reply was that oil and gas will always be an integral part of the requirements for the economy; and the Middle Eastern countries would continue to chug along producing this key commodity for major markets. Boustead’s upstream and downstream divisions are still receiving healthy enquiries, and there were many smaller contracts which were concluded which would not be announced due to their size. Another factor was the secrecy required for contract announcements for this division – some of Boustead’s clients have stringent requirements regarding disclosure since these may be sensitive. It was good for me to know though, that BIH still had healthy enquiries and that the waste-to-energy division was also doing fine. However, it was mentioned that margins may be impacted due to the presence of aggressive bidding by Korean EPC contractors (a point which was brought up already during the AGM).

Regarding water and wastewater (Salcon), I also asked about the apparent lack of contract announcements lately. It seems that Salcon itself is busy at work with its current projects, including the S$25 million demineralization plant contract which was clinched together with Boustead Projects. I expressed concern over Salcon’s performance and how it may drag down the Group as they had reported a LBT (Loss Before Tax) instead of a PBT (Profit Before Tax) last year. However, I was reminded that the reason for the LBT was due to the write-downs for Libya, otherwise the division would have registered a PBT of about S$3 million. My worry was more for the relative instability of the division to generate a consistent PBT, what with legacy issues dogging the division since FY 2002 all the way till FY 2009 when they managed to break-even after restructuring, to the relatively tough competition and tight margins the division faced when bidding for contracts. My view was that the division should be divested if it continues to be a drag on the Group’s performance, and that I will be watching the 1H 2012 announcement closely to review the performance of this beleaguered division.

On Geo-Spatial Division

Geo-spatial division was a consistent performer and I did not have a lot of worries about this division as long as it could grow top and bottom line by 10%, organically. After the recent 2010 acquisition of MapData Pty Ltd, it saw a boost in ESRI’s earnings and Mapdata was considered a synergistic acquisition which really helped to enhance and boost ESRI’s service offerings. Management mentioned that they are always looking out for possible M&A, but since geo-spatial already has a 40% global market share, it will remain a good performer within Boustead and for myself, I knew that it was Boustead’s “Cash Cow” which not many analysts are aware of. It would be interesting to observe how this division performs in the upcoming 1H 2012 announcement as well.

On HanKore

Boustead owns 2% of Hankore Environmental right now (formerly Bio-Treat) and they had invested S$4 million into the company, purchasing 100 million shares at 4 cents/share. A shareholder did ask if Boustead intended to increase their stake in the company, and how HanKore could add value to Boustead.

On Share Buy-Backs

Boustead had re-purchased shares over six market days amounting to $391,000 for 475,000 shares. Treasury shares now stand at 12.492 million and the remaining issued share capital net of treasury shares is 503.25 million. At the last done market price of 81.5 cents, this values the entire Group at $410 million – more will be said on this later. One explanation given for the share buy-back was to support the share price; but my impression of a share buy-back was that the Group was unable to utilize its cash hoard to generate better returns of say 10% and above, which explained the rationale for re-purchasing it at a price which would yield about 4.5% (most of the repurchases were made around 83.5 to 85 cents). I did communicate my discomfort at this but apparently it was one of the ways of deploying cash which the Group had, and since I do have faith in Mr. FF Wong and the Management, I will also not dispute this practice. The key, however, is for me to eventually see the cash stash being put to good use rather than being continually spent on share buy-backs.

On retaining Good Talent

Another under-stated reason for the implementation of the Restricted Share Plan 2011 (which took 18 months to conceive and refine, incidentally) was to retain suitably good talent to enable Boustead to excel and do well for the future. Boustead wanted to retain a talent pool of capable and competent human resource but FF Wong complained that MNCs would poach talent from Boustead as they are considered an industry leader (Boustead Projects was at the forefront of such recognition). He cited an example of one project manager who was offered 2.5 times his salary to join an MNC, and lamented on how tough it was to retain good talent to be able to drive the business to greater heights. Hence, the introduction of the Plan would also tie into improving executive compensation in order to ensure employees who excel would feel adequately rewarded and not be persuaded to join a competitor.

On the value of the Boustead Group

When asked about the value of the industrial leasehold properties within Boustead’s stable, FF Wong gave a candid assessment, stating a market value of about S$160 million. After netting off the associated loans relating to these properties, one would still end up with about S$120 million worth of cash. Add this to the current S$200 million net cash and you would end up with a net cash balance of close to S$320 million, which is close to almost 80% of the current market capitalization of $410 million (above) purely in cash. FF Wong joked that this meant that you are getting essentially the rest of Boustead’s business almost free of charge! FF Wong went on to mention that the value of the name “Boustead” itself would be worth about S$50 million should he attempt to sell it, as they had already built up a very recognizable brand name within the industry.

When quizzed about Boustead Berhad having a higher asset value (the Malaysian arm of Boustead which Boustead Singapore had broken away from years ago), FF Wong replied that Boustead Berhad had the benefit of owning much more capital-intensive assets such as plantations which therefore increased their Net Asset Value. However, Boustead Singapore has achieved much more by remaining asset-light and focusing on retaining good human resources, and they had built up the Company by using this successful approach which was no mean feat.

My thoughts on Boustead

The purpose of my visit to Boustead was not purely to get an update on the operations and business conditions of the Group (though that was an integral part of it), but also to gain some comfort as to the plans and strategic director which the Group was taking over the next year or two. With economic conditions being so volatile and uncertainty reigning, there were other shareholders who also voiced concern over how Boustead would navigate the choppy waters and emerge unscathed.

From this meeting, I have obtained comfort that the Group has in place a rudimentary succession plan (still ongoing, no doubt, but it’s work-in-progress) and that they are also motivated to put their cash to good use. Management is keeping an eye out for good M&A opportunities now that the Eurozone is giving so many problems, and FF Wong is quietly confident that they would be able to finally put the cash hoard to good use. Boustead have a team of professionals who are adept at conducting due diligence on potential M&A targets, and I am sure that with FF Wong’s stringent requirements, Boustead would be able to select a suitable M&A target which would add value to the Group.


With the update being given to me and my own understanding of how the Group has done thus far, I do have the confidence that they can weather the upcoming storm. The numbers and facts also do give me the notion that the Group is undervalued from the point of view not just of the value of its leasehold property assets, but in terms of its core business, prospects and Management quality. Simply put, for a S$60 million net profit company to trade at a market cap of about S$410 million implies a PER of just below 7x, which is valuing the core business very cheaply indeed if you net off the cash hoard which the Group has.

I shall keep my eyes peeled for the next set of results for Boustead (1H FY 2012) due by mid-November 2011.

Saturday, October 22, 2011

How To Think About Yield

After my previous post on how to think about valuations, this can be considered a “follow-up” post on how to think about yield. Oftentimes, I read about comments in forums or the newspapers which mention how attractive some yields are for certain companies, REITs or business trusts. I also hear of friends, peers and colleagues talking excitedly about high yields and how easy it would be to beat the dismal 0.05% interest rate which DBS is giving on its savings accounts. But what most people may fail to realize or consider is that higher yield is usually accompanied by higher risk – both in terms of the business model of the underlying company/trust and the sustainability of the yield. In other instances, computation of yields is also not conservative as most people make use of past yields to justify purchase decisions by implicitly assuming that yields will carry on being high without adequate consideration for the future. These actions have dangerous implications on one’s portfolio as they may lull an investor into a false sense of security, as he would rely on high yield as a “cushion” or buffer for his investment and expect that he would be able to weather a downturn. The reality is much starker – during economic recessions a myriad of factors may lead to yields being slashed and capital values declining, and that will lead to a double whammy when it comes to an investor trying to beat inflation and also preserve his original investment value.

High Yield from Business Model

There are many instances of high yields to be found in the current stock market environment, with many REITs and Business Trusts advertising yields of 8% to >10%. This in inherently tied to the business model of the underlying assets and the investor has to be astute and take a very keen look at the said business model to ensure that the yield is able to sustain. While many REITs can boast high yields, one should also observe that most are highly leveraged and this could be an issue if a credit crunch of severe downturn hits. To add to this, the risks of a property downturn (leading to a fall in rental rates once rents are due for renewal) could also hit the revenues of many REITs. Yet another factor is the increase in borrowing costs for REITs once their loans are due for roll-over. Perhaps an investor can learn some lessons from the previous credit crunch of 2008-2009 to know that high yields from such securitization of assets is not always guaranteed, and that a fall in capital values of the underlying assets (due to revaluation, no doubt) could also have a devastating effect on the yields being provided by said assets. Not to mention, of course, that capital losses could also offset many years of future yield, as in the case of Babcock and Brown Structured Finance Fund (BBSFF).

High Yield Sustainability from Business Operations

Assuming a steady state business which is of a going concern and which does not involve depreciating assets with finite lives (as in the case of business trusts which hold assets with a finite concession like K-Green Trust), high yield should be viewed from the perspective of ongoing business operations and whether it can be sustained as such. To explain this further (I apologize if it sounds rather lengthy and dry), one should focus on the free-cash-flow generation history of the Company and its consistency to determine if the business can withstand downturns and recessions and still be able to pay out a decent dividend, thus forming the “core” part of the expected yield. As businesses grow and mature over time, they will build up a larger customer base and also forge stronger customer relationships, thus a large part of the revenues and orders may be sustained even if there is a major downturn, unless the Company has an illusory moat or one which cannot be maintained. An ideal business is, of course, one which is able to increase dividend payout ratio as profits trend upward over time, and this demonstrates the classic case of the company with excellent economics and an almost unassailable moat.

In reality, however, most companies do suffer from dips in their earnings, and consequently their cash flows. Hence, in order to portray a realistic picture of the yield from a Company, one should do a 10-year analysis and pick the worst 2-3 years and observe the cash flows during those years. If the Company is still able to generate free cash flows during periods of great economic distress and upheaval, and the business has not suffered long-term and permanent deterioration or setbacks; and if the Company has still maintained its dividend policy throughout that period, then there is a good chance of getting a fairly decent yield which is sustainable. Using this dividend as a benchmark, compute the expected yield based on extremely bearish and pessimistic conditions, and see if it still manages 2-3%. If so, then the Company can be said to be resilient and worth collecting as it may either have superior economic characteristics (e.g. strong, stable moat and repeat customers) or require very little additional capital to function efficiently. Either condition would make the Company suitable for consideration in a value investment portfolio.

Computation of Yield – Pitfalls and Perils

The most common mistake I notice when I speak to investors regarding yield is that they always tend to use last year’s dividend payout as a basis for computing expected yield. This not only assumes that history would always repeat itself, but also makes the mistake of ignoring economic cycles and their (probable) detrimental impact on the business. The perils of computing yield based on historical payouts is that as the business cycle moves, the fortunes of the Company may fluctuate as well. A Company may have good years and bad years, or it could also be a one-off disposal/divestment of an asset or a business division which saw a large inflow of cash and hence the declaration of a special dividend. So investors must be cautious and conservative in their calculation and remove all effects of special dividends, no matter how consistent they seem to be. One example which immediately comes to mind is that of bellweather stock SPH. In its latest FY 2011 results, it declared a final dividend of 9 cents/share and a special dividend of 8 cents/share. In the prior year, there was a final dividend of also 9 cents/share and a special dividend of 11 cents/share. Even though SPH has been paying a special dividend since FY 2002, I feel that an investor still cannot take it for granted that it is a given that this trend will continue, unless he assesses that the business is stable/growing and NOT declining. To be very conservative, one should simply take the interim + final dividend as the total dividend and divide it by the last done share price to compute the expected yield.

Another example in my own stable of companies is Boustead, which had also paid out special dividends in the last two financial years. For FY 2010 (ended March 31, 2010), it paid out a special dividend of 1.5 cents/share while for FY 2011, it paid out a special dividend of 3 cents/share. But core dividend for full-year remains at 4 cents/share for FY 2011 (2 cents interim, 2 cents final) and thus yield should be computed based on this, and not the full 7 cents/share. If special dividend is counted in, it would distort the yield.

Another pitfall often seen is that investors tend to over-estimate company performance and project increasing dividends over the years, even if there is no objective or reasonable basis for doing so. In other words, investors may purchase a Company with the assumption that the yield can either sustain or improve, which may be a fallacious assumption. Margin of safety (for yield) may end up being illusory if the Company suddenly cuts its dividend or announces huge capex to replace old machinery/assets. Business conditions may also force a company to scale back on dividends and divert more cash to fund working capital requirements.

The Illusory Yield "Cushion"

I would say that one of the more dangerous assumptions one can have when investing in companies is to assume that yield can act as a “cushion” should capital values plummet. When speaking to different people, I get the sense that those who invest in assets with high yields are basically assuming that the high yield can somehow compensate for any losses in capital values due to either asset deterioration or a declining market value. While it is true to a certain extent that high yields (high being defined by myself as anything exceeding 7%) can offer some measure of protection against a temporary decline in market prices, it cannot hope to offer a long-term “buffer” against declining business or a major shake-up relating to the underlying asset.

A good and rather recent example would relate to the shipping trusts back in 2008-2009. Yields of >8% were touted back then for FSL Trust, with stable, locked-in charters and a 100%-payout policy (which was to prove not just unsustainable on hindsight, but overly aggressive as well). However, when the underlying asset value (of the ships) began to plunge, many hitherto unknown clauses were triggered (such as loan convenant ratios) and the Trust suffered major hiccups and setbacks. Suffice to say that the touted high yield was unsustainable and the share price drop was massive in order to reflect the new realities after the shipping crash. The permanent and irreversible drop in share price more than offset any quarterly dividends received, and is a prime example of how unprepared one can be for such events and how yield can eventually prove to be both illusory and unsustainable.

Seeking Comfortable, Sustainable Yields

After going through the experience (and heartache) of abruptly plummeting yields, I believe it is better to focus instead on obtaining yields which are lower than the often-touted 8-12%. Good businesses which are generating decent cash flows and maintaining or growing their market share should theoretically be paying about 5-6% yield, with the exception of major market depressing moods which temporarily cause stock prices to plunge (and hence yields to rise sharply).Sustainability should be the focus of an investor seeking yield, rather than going for eye-poppingly “high” yields which can usually be associated with higher risks. Some of these risks may not be readily apparent as the Company or REIT/Trust may not have undergone a baptism of fire and emerged unscathed, thus investors (most with short memories) may not be aware of the potential perils of investing in such securities.

While I do admit there are occasional good deals in which companies can sustain an inordinately high yield, my experience thus far has been one of scepticism and caution. Most companies may seem to pay out high historical yields but the all-important question would be whether these are sustainable moving forward. If not, as an investor I would rather stick to a company with a lower yield (but still higher than inflation) which I feel would be consistent and sustainable over time.


The issue of yields is as thorny as my previous post on valuations, because after all, nothing in the stock market is cast in stone. One has to continually review and analyze the facts on a case-by-case basis and form their own conclusions based on objective data, instead if relying on “preset formulae” when making investment decisions. The best investors have always used a mix of personal experience, business knowledge and theoretical foundations (plus throw in emotional resilience and control) in order to earn consistent returns for themselves without losing money (capital preservation), thus holding true to the mantra of value investing as espoused by Benjamin Graham. Any aspiring value investor out there (including myself) would be doing himself a favour to follow their footsteps and to seek continuous improvement in their methods, techniques and processes.

Monday, October 17, 2011

Boustead – FY 2011 EGM Highlights Part 1

October 13, 2011 was the date for Boustead’s EGM, and I took time off to attend this meeting. There was not much in way of resolutions for discussion in this post, but the reason for taking the time to go down and visit the Company was to learn more about how the business was doing, how the Company would cope in the current economic climate, its plans and strategies for growth and also to clarify various aspects of the business since the AGM which was held on July 22, 2011. As can be seen in the photo above, the meeting was held once again at Boustead’s headquarters at Starhub Green located at Ubi Avenue 1. The photo below shows a close-up view of Starhub Green. Fortunately it was a bright and sunny day and I had no problems navigating my way through to Starhub Green from the main road after alighting from a bus near ITE.

General Observations

The EGM was held on a Thursday afternoon at 3:30 p.m., so there were markedly less people attending this time as compared to the AGM. I recall that the AGM saw about 60 to 80 people turning up, and the boardroom was pretty packed with people as the chairs were arranged literally side by side with little room to manoeuvre, and this was made worse by two rows of tables on which the buffet food was placed. Fortunately, for this EGM the crowd was smaller at about 30 people or so, mostly made up of retirees. There were a number of younger folk who were seated across the BOD and who kept the EGM session abuzz even after the formal business of the meeting was concluded by asking pertinent questions about the business – more on that later.

On Restricted Share Plan 2011

Some shareholders had asked for clarifications regarding the merits of the proposed restricted share plan (the “Plan”) to be implemented and vetoed at the current EGM. Note that this new share plan is supposed to replace the old scheme of ESOP (Employee Share Option Plan) which had been in force for the past 10 years and which recently expired in August 2011. One shareholder had suggested that the plan would be flawed because share options may be issued at a time when the share price of Boustead was significantly under-valued with respect to its intrinsic value, and thus the scheme would unfairly favour these employees by giving them a lower strike price. Once the share price rose, they would then be in the money and would cash out and enjoy a significant “bonus”.

The newly appointed independent director Mr. John Lim served to correct the misconceptions surrounding the Plan. First of all, the BOD was still in discussion as to who specifically would qualify for these shares as they had to be key personnel (e.g. head of divisions, CEOs of various companies within the Group who had a say in planning, optimizing resources and strategizing). Secondly, there were stretch targets (which served as KPIs) which had to be positive and be over and above what was expected of the employee or director. Some examples of these targets were ROE, return on assets and Economic Value Added; and they are measured over a period of time so as to ensure consistency and that the performance was not a once-off “fluke” shot. Thirdly, there was also a “vesting period” clause for the Plan, such that the employee had to ensure that he stayed for number of years with the Group in order to enjoy the full vesting of the shares. Should he leave the employment of the Group at any juncture, there is a retention formula which would be activated to compute how many shares he has to return back to the Company as Treasury Shares. Fourthly, the shares which are awarded cannot be traded in the open market and can only be held by the employee for dividends. Thus, there is an incentive for the employee to enhance the value of the Group through metrics such as higher ROE and net margins in order to increase the intrinsic value (and by extension, the market price) of the shares, such that he would be eventually be able to sell them for a tidy profit should he eventually decides to leave the employment of the Group.

Two groups of people would be considered for this Restricted Share Plan 2011 – directors (both executive and non-executive, with the exception of Mr. FF Wong), and the associates of the controlling shareholder (namely Mr. FF Wong’s sons Mr. Wong Yu Long and Mr. Wong Yu Wei). To eliminate possibilities of favouritism, all share awards would be transparent and announced during every AGM (with reasons for award, amount of shares awarded etc). Independent shareholders (those with no vested interest in the award) can then vote during the AGM on whether or not to reward the said employees/directors with said shares. The whole process is meant to be meritocratic and transparent and will align the interests of the awardees with those of shareholders for the long-term prosperity of the Group.

On the Economy, M&A and Cash Deployment

Mr. FF Wong went on at length about his views on the current economic climate. He feels that the current solutions being proposed by the European Union are simply delayed tactics, and not a cure-all solution to the problems plaguing the Euro-Zone. He believes the problems will drag on for quite a while and the economy will remain in the doldrums for the medium-term, with probable contagion effects spreading to Asia and the world in general. This fact, coupled with the troubles still ongoing in USA and the seemingly hard landing and high inflation experienced in China, would throw up opportunities to acquire assets and companies on the cheap. Thus, Boustead is looking out for potential M&A which would enhance the ROE of the Group; as the Group is now sitting on a net cash balance of S$200 million which is generating a measly return of just 0.5% to 0.6% (as verified by Director Mr. Tong Weng Leong).

He also stated that during the last crisis of 2008-2009, the surprising thing was that no banks had pulled the plug on any businesses in Singapore in terms of the loans which were extended to these businesses, as a co-ordinated effort by major central banks around the world injected massive liquidity into the economic system and provided the oiling necessary to restart business activity which had previously been halted through fear and trepidation. Mr. Wong was admittedly surprised that the crisis, though deep, had failed to throw up any bargains for Boustead to capitalize on. For the current crisis though, he believes that it may finally create opportunities for Boustead to deploy their cash hoard, and this is the purpose of him keeping such a large cash stash; in readiness for such juicy opportunities which only present themselves during periods of economic distress.

Note too that Boustead maintains a cash management program utilizing about S$20 million to purchase short-term high-grade corporate bonds yielding about 6% per annum. However, due to prudence and liquidity issues, no more than $20 million can be deployed for such purposes.

On Libya and making mistakes

The situation in Libya has somewhat stabilized but intermittent and sporadic fighting is still going on, without a clear and forceful resolution to the conflict. One shareholder did query the Management on its decision to enter Libya (a similar question was asked during the last AGM) and wondered if Boustead had adequate risk management procedures in place. Mr. Wong (and Mr. John Lim) replied that risk management was very much a part of Boustead’s culture, and the returns from undertaking the projects were carefully calculated before the Group went into Al Marj to construct the Township and municipal wastewater plant. However, the events in the Middle East and the subsequent unrest which spread from Egypt to Yemen, Bahrain and Libya were unexpected and even the CIA could have not predicted that events would turn out as they did. Boustead has worked in Libya for years and for countries ruled by “strongmen” it would imply that they were more politically stable – but alas this was not to be.

The previous Libyan government under Colonel Gaddhafi still owes Boustead about $50 million, and full provisions have been made for all assets and equipment except for two corporate guarantees, of which injunctions had been sought and successfully granted under the clause of “Force Majeure”. Boustead will do their utmost best to try to recover whatever they can from Libya, but until then the amounts would have to remain written off and I guess shareholders should also not expect too much.

A related point which another shareholder brought up was that of the Big Box project which Boustead had abandoned with TT international some time ago. Apparently, until now there was no one willing to partner with TT to inject funds into the Big Box project, and Mr. Wong laughed and stated that this showed that their decision was right to pull out of the project, on hindsight. So asked shareholders not to just judge Boustead’s track record of making mistakes solely on the Libyan crisis, but also to note other instances where the correct decision had been made.

On Boustead Projects, and Design, Build and Lease plus turnkey projects

Regarding Boustead Projects, another shareholder noted that for the last three months, most of the contracts secured were those of design and build, with contract amounts being small to medium (in the S$15 to S$20 million range). The pertinent question is whether Boustead was still continuing talks and discussions to grow their leasehold asset portfolio, which was perceived to be much more important as it would build up a recurrent stable of income for the Group as opposed to short-term “lumpy” contract deals. Also, as FF Wong pointed out, the order book which stands at S$320 million today only includes design and build deals, and does not include the design, build and lease (DB&L) projects. The thing about DB&L projects is that they do not show up immediately in the bottom line (P&L), but will be capitalized as an asset on the Balance Sheet; and cash flows will only come in once the property is completed and leased out to the client.

The superiority of this model, however, is that Boustead actually owns the asset and is able to sell it to a REIT if need be, thus unlocking value for shareholders and realizing potential capital gains. With more and more REITs proliferating the market in recent times, FF Wong mentioned that these provided ample liquidity for Boustead to sell off its industrial leasehold assets if need be, and most of them would enjoy a significant premium to cost. In the interim, the Group would continue to benefit from recurring revenues and cash flows from the long-term lease of these properties to the client/tenant. With Design and Build projects, the Group did not own the property and thus would not be able to unlock further value from them once they are completed.

Boustead also has one turnkey project with SDV Logistics in which a separate subsidiary was incorporated in order to own the asset (property) in question. The revenue would be recognized on a deferred income basis based on completed contracts recognition in FY 2013, and the sale of the asset would thus be classified as a disposal of a subsidiary (within the Group) and subsequent gain on disposal, rather than as project/contract income recognized within Boustead Projects division.

This concludes Part 1 of the EGM highlights. It was originally supposed to be just one single post but somehow or other when I started typing out my thoughts it became rather lengthy and drawn-out; therefore I decided to split it into two separate posts so as to note bore readers. I am still endeavouring to write more succinctly and to be able to incorporate more information using less words, but occasionally I will get carried away with too much to say and end up writing a huge chunk.

Part 2 will focus on the divions of Boustead and some comments I received regarding them, and also detail some of my thoughts on Boustead’s dividend policy, share buy-backs and cash deployment. Finally, I will share what FF Wong mentioned on the value of the Boustead Group and how this has implications on my investment in Boustead.

Wednesday, October 12, 2011

My Second Bear Market

As I write this post* to chronicle my continuing investment journey, the STI has just entered bear market territory, having fallen >20% from its peak close of 3,279.70 back on Jan 6, 2011. The reasons are obvious by now – Greece on the verge of a default which would send the whole Eurozone into a tailspin, and massive debt loads held by countries such as Portugal, Spain and Ireland. The crux of the issue is that a default would trigger bank runs all through Greece, and lead to a systematic collapse of confidence in the banking system throughout Europe. Ripples of these will then spread across the globe and drag the whole world into yet another global financial crisis, possibly eclipsing the previous one in 2008-2009.

*This post was written on October 4, 2011. At the time of publishing, the STI has still managed to avoid a bear market scenario with 4 successive days of rises.

Essentially, I realized that the roots of each crisis are pretty similar. While the 2008-2009 GFC was caused by sub-prime mortgages going bad in the USA and a collapse in confidence in banking giants Bear Stearnes and Lehman Brothers, this time the cause of the crisis is also due to excessive debt; and it belongs to a country not just a company. Thus, the solution may not be as apparent as it seems, and there may be no easy solution to this crisis of confidence. Therefore, as investors, we should prepare for a long and possibly arduous journey undertaken by the powers that may be to restore confidence and avert total economic collapse.

In the meantime, I thought I would do a quick comparison between my status during the previous bear market, and the current one; and highlight the changes between now and then and how I have grown and matured as an investor. I will also be providing some convenient numbers and statistics to be used as comparisons.

1. Portfolio Size – From my historical records (which I have kept religiously to remind myself of the previous downturn and bear market), my portfolio cost was $126,000 as at Oct 31, 2008 (during the period when the market plunged sharply) and STI closed at 1,794.20. Before the sharp plunge occurred, I was steadily accumulating shares up till the months of July through September 2008 (my portfolio cost increased from $80,000 to $125,000). As of Oct 31, 2008, the market value of my portfolio was $64,000 for a nearly 50% loss.

Fast forward to today, my portfolio size has grown to a cost base of $242,000 (inclusive of my recent purchase of Boustead on October 4, 2011), which is almost double of what it was during the dark days of Oct 2008. In fact, doing a same-level comparison when STI was hovering around 2,500 level back during September 22, 2008, my portfolio cost then was just $109,000.

Another important difference was that I only had a realized gain “buffer” of $9,500 as at Oct 31, 2008, while my current realized gains buffer stands at $67,400, which is nearly 7x the quantum three years ago. This indicates that at least it would be a lot tougher to experience a net combined loss (i.e. unrealized loss offsetting realized gains) as compared to the situation three years back.

Another interesting “fact” – my portfolio first went into the red back on Sep 11, 2008 when STI hit 2,541.15. As at the time of this writing (Oct 4, 2011), STI is hovering at 2,531.02 and my portfolio is up by +2.1%, so apparently my current portfolio is only marginally better than my previous one in terms of share price performance (but this is just for academic interest, of course).

2. Knowledge Base (of companies and how markets work) – Compared to 2008, my knowledge base with respect to companies and how they work has improve dramatically. Though I have to admit that I still have a long way to go to understand the fine inner workings of the operations of companies within certain industries, nevertheless I feel that I had gain much more in-depth knowledge as compared to three years ago. In addition, after observing a full bull-bear cycle in the stock markets, I also have a better understanding on how markets work and the sentiments and psychology which drive it; and these are all key to forming a more informed judgement on when and how to invest. Suffice to say the last three years have been “educational” – there is no better teacher than experience itself, and the months of ruminating over companies, their fundamentals, inner workings and plans/prospects have certainly equipped me with more maturity and also endowed me with a richer understanding of being a part-owner.

3. Investment Mistakes – During the transition from the previous bear market to the current downturn, I had the fortune (or some may call it “misfortune”) to make numerous mistakes, all of which have been meticulously documented along the way. Scattered across the pages of my blog were the mistakes committed for Ezra, Swiber, China Fishery and Tat Hong, just to name a few. These mistakes have since made me a much wiser investor and taught me what to look out for when it comes to assessing a potential investment, and I am thus thankful that I have made these mistakes and not suffered debilitating losses as a result.

4. Keener understanding and better awareness of behavioural finance – A key aspect which was missing from my knowledge base during the last bear market were the important concepts relating to the field of behavioural finance. I now enter this downturn and bear market armed with greater knowledge of the psychological biases which most investors (including myself) are afflicted with, including but not limited to expectation theory, loss aversion, over-confidence, over-reaction bias, confirmation bias, endowment effect, anchoring bias and other little tricks of the mind which are continually experienced by our brains (and detailed in a very good book by Jason Zweig called “Your Money and Your Brain”). But note that being armed with the knowledge is only the first step, the second is to conquer your innermost demons and be able to stand stoic in the face of great fear and unreasonable panic. As mentioned by Benjamin Graham, it requires great fortitude and confidence for an investor to trust in his own objective research and to ignore the madness of crowds. Certainly, I hope that with this knowledge into biases which investors are prone to make, I can avoid more of the pitfalls and perils which bedevil investors in general.

5. Portfolio Composition – A quick comparison between my portfolio composition back in Oct 2008 and now reveals many glaring differences. Back then, I entered the bear market owning companies such as Ezra, Swiber and China Fishery, companies which had significant amounts of debt in their Balance Sheets and which did not generate FCF. Their capex requirements were also very high and this meant raising funds continually from either bonds/banks (debt) or the market (secondary offerings and/or dual listings). Currently, the companies in my portfolio consist of companies which have strong free-cash-flows and balance sheets with either low debt or no debt (with the exception of MTQ). The only company which is the same in both my portfolios then and now is Boustead (not counting Suntec REIT as it is a REIT). I guess you can say that in essence, I had almost completely switched out of my weaker portfolio into my current stronger one, and the cash flows and dividend history should be able to sustain me should this bear market turn out to be protracted.

6. HDB Mortgage Loan Quantum – This may seem like a minor point, but the balance of my HDB mortgage loan does also have a psychological impact on my psyche and affect my moods and behaviour as I sit through a bear market. As a comparison, I entered the Oct 2008 bear market with a balance mortgage loan of $135,000. As at the date of this posting, the outstanding loan amount has been reduced to $75,000, for a reduction of $60,000 principal over three years. This fact, coupled with the knowledge that my portfolio size has grown significantly over the years (along with the quantum of realized gain acting as a “cushion”), has made me more relaxed and less prone to behaving like a nervous wreck. I am still on target to clear off the loan in the next 5 years by the time I hit age 40.

I would say that this second bear market is indeed going to be even more insightful for me, as I will be able to further refine my value investing techniques and my understanding of companies. As to whether I will be able to weather the storm successfully, my answer will probably be the same as when I encountered my first bear market – I do not know for sure. But what I do know is that I will continue to stick to my core principles of sound investment and continue to manage my affairs and personal finances prudently and conservatively.

Thursday, October 06, 2011

How To Think About Valuations

At this juncture, and after all the thinking, mulling and silent contemplation on the trains and buses, I thought it timely for me to write down my thoughts on valuations and how I approach this slippery topic. With stock markets around the world going into a violent tailspin in the last 8 weeks, perhaps it is also a good time to revisit this topic and to deliberate on exactly how one should think about valuations. The reason for this is that valuations do not exist in a vacuum (unlike what analysts would love for you to believe) and are constantly in flux, changing as often as business conditions change (which is, to say, virtually all the time). Pinning down an exact valuation and projecting it into the future is always difficult, but during volatile and turbulent times this becomes even more of an impossibility. So how should an investor navigate the frigid waters of corporate valuations to find some semblance of dry land? Can he firmly root his feet on the dry sand or will he quickly find out that he is standing, instead, on quicksand?

Valuation as a function of historical corporate profitability (business model approach)

Companies which have been operating for many years (or decades) and which have a track record of steady and growing profitability and stable cash flows should see valuations which are somewhat high as compared to companies which are just starting out and have yet to find their niche. From this standpoint, valuations should be assessed based on a company’s business model and how efficiently it can continue to generate profits and cash flows through good times and bad. As such, recognized blue chips tend to trade at higher valuations even during recessionary periods because of their ability to generate consistent profits throughout all economic cycles, but this has not always been shown to be true.

A conservative and prudent investor should thus assess each company on its own merit, and dissect its business model to see if it is able to function as efficiently through all business cycles. History may not always be able to foretell the future, and there have been numerous cases of companies which had succumbed to new technologies or advances which completed changed the industry landscape and eroded their (seemingly) impenetrable competitive advantage.

Hence, after a review of the business and its underlying prospects and characteristics, one should make a rational assessment of whether it deserves to be accorded high valuations (for a superior and adaptable business model which has a long-lasting impact and can shield the company from the vagaries of the economy), or whether it should be given lower valuations for possible risks (whether perceived or real). This is possibly the most difficult aspect of investing.

Valuation based on economic cycles

Coupled with the above, one should also account for valuations with respect to the stage of the economic cycle. Since the stock market normally precedes the real economy by about six to nine months, it is therefore no easy feat to assign valuations to companies based on economic cycles; but one can use a very rough approximation to cushion for possible error (the proverbial margin of safety so to speak). So let me give a simple illustration:-

As the economy expands and grows, all companies benefit from increased demand for their goods and services, and accordingly these companies will grow, hire staff, expand and earn higher profits and generate better cash flows for their shareholders. Valuations at this stage are thus moderate to high as expectations of growth will rest on a wave of optimism for the future. An investor thus has to temper his expectations of growth in this regard in order not to get carried away on the sea of optimism and hope. Conversely, when the economy is faltering and sputtering and there is trouble left and right (as is the case currently), then valuations would accordingly be much lower as it is expected that companies would suffer from a drop in demand and hence earn lower profits and cash flows. Valuations will therefore be correspondingly lower, and this is something the investor has to accept as part of the economic cycle.

The idea, of course, is to effectively marry the two aspects I mentioned – economic cycles and business characteristics, to be able to determine an approximate level of valuation which is acceptable to the conservative investor. For some companies go into decline, their valuations hit a trough, but they never are able to pick themselves back up and resume their previous growth trajectory. Other companies may prove more resilient and spring back from adversity; thus this underscores the importance of not just financial analysis but also business analysis from a quantitative and qualitative perspective. There is no right or wrong answer, and the investor has to take it upon himself to search for a level of valuation which he feels gives good value and provides adequate justification for his purchase of shares. [Yield does come into the picture, which I will elaborate more on in a separate post.]

Valuation Metrics – Price-Earnings and Price-To-Book

A rather pertinent question one may ask is what kind of valuation metric one should use to determine if valuations are indeed fair, demanding or bargain. The two most common ones which I use and which I feel are relevant to investment decisions are the price-earnings (PE) and Price to Book (PB). PE is essentially how much premium one pays for the earnings of a company, and is the most commonly used metric to gauge valuation. PE can be rather deceiving as it may not apply to all types of companies (e.g. property companies and companies with “lumpy” revenues). Other times, a one-off event may also distort PE and may something look cheap when it is actually expensive. PE should not be used in isolation to weigh valuation but should be used in conjunction with other metrics like ratios as well as yield (also factoring in, of course, the qualitative characteristics of the Company in question).

PB is usually only applicable in cases when earnings are either not stabilized, or when the company has a strong asset base with low earnings. Book value is, very simply, the liquidation value of a company, minus any fire-sale conditions which may result in a haircut discount given to fixed assets and marketable securities. I note that PB is generally used by analysts during protracted bear markets as earnings cannot be reliably predicted during such periods of economic turbulence.

An important note which I have to emphasize (sometimes repeatedly) is that these valuation metrics should not be used in isolation to determine if a company is “cheap”. There are a myriad factors to consider and PE and PB are just two of them. Life (and investing) is certainly much more complex than that!

Relative (Peer-to-Peer) Valuations

One final method I can think of offhand is using peer to peer valuations as a quick rough and dirty method of determining if a Company may be cheap or expensive. Of course, this method is rather rudimentary and requires a lot more in-depth research and refinement, but by itself it should at least offer the investor a glimpse into whether a Company is lagging or leading its competition.

The use of competitors within the same industry ensures that an “apple to apple” comparison can be made. However, one risk of using this apparently simple method is that the industry as a whole may be in decline, thus everything would seem “cheap”. Thus, the conclusion cannot be made using peer valuation in isolation, but should be used in conjunction with Porter’s Five Forces analysis and industry analysis.

Conclusion - how to think about valuations

To conclude, valuations are a rather tricky business as there is no hard and fast rule as to what constitutes cheap or expensive valuations. It depends a lot on not just the economic cycle but also the operating characteristics of the Company in question. During periods of recession and economic slowdown, investors should get used to lower valuations in general, as Mr. Market is feeling pessimistic and is unable to forecast a bright future with much certainty. Investors would then adjust their expectations for future growth accordingly and demand their requisite margin of safety.

Conversely, during periods of economic prosperity (during a boom), valuations will be correspondingly higher; and it is up to the prudent and wary investor to be sceptical of such high valuations and to ensure he is emotionally unaffected by the euphoria and optimism. Of course, this is all easier said than done, but it’s good to have the theoretical foundation as a starting point.