Boustead Singapore Limited – 1H FY 2012 Analysis Part 3

Part 3 will be interesting, as I delve into Boustead’s leasehold property portfolio and also its dividend history. I guess I had already mentioned quite a bit about Boustead’s prospects based on its divisions in prior reviews and analyses, therefore I shall not dwell too much on the same facts again in case I start putting readers to sleep! Basically, the underlying thrust of the Group’s strategy is still the same, though of course they are shifting their focus to earn more recurring income from their real-estate portfolio rather than endure the lumpiness from their Water and Oil and Gas divisions. This will be a slow and ongoing process and I am willing to wait as “Rome was not Built In A Day” to use the popular phrase.

Boustead Leasehold Property Portfolio

As can be seen in the table above, Boustead currently has nine leasehold properties in its portfolio, and this is set to rise further next year if it manages to clinch more of such deals. Note that as at 1H FY 2012, six are already completed and thus should be contributing rental income to Boustead’s top and bottom line from 3Q 2012 onwards. Another fact is that their clients are all heavyweights and multi-nationals, therefore the risk of default or late payment is also significantly reduced. Most, if not all, of them are in the technology, aerospace or logistics industries, and attests to Boustead Projects’ reputation as a design specialist which can customize facilities to meet international clients’ needs. Though this may seem like a niche market, remember that there are still many companies which are eager to enter and set up base in Singapore, as we are a very business-friendly country (with tax rates at 17%). Recent news also mentioned Rolls Royce (one of the largest engine producers in the world) setting up shop here at Seletar Aerospace Park, and looking to hire 500 staff to work in its new production facility. With the Government thrust to develop more areas of Singapore and add in hotels, entertainment and industrial sectors, this trend looks set to continue into the foreseeable future. Some examples which immediately come to mind are the Kallang Riverside Project and Jurong Lake District Rejuvenation Project, both of which have been envisioned and are in the pipeline for development in the next five years.

The remaining three properties will be completed in 2012, with the latest being June 2012 (1Q FY 2013). Therefore, the financial impact of the entire portfolio will only be felt in late FY 2013, and this does not include possible additions to the portfolio during the first six months of 2012. The total square metres of the properties has exceeded 90,000, and it is Boustead’s aim to grow it to 200,000 to 300,000 sqm before the entire portfolio can be considered for sale to an industrial REIT. I had attempted to compute a blended rental income per square metre using information from CommerciaGuru dot com, but apparently different areas of the industrial park can command different rental rates, and the variance can be rather pronounced as it is also tied to the age of the building. Therefore, I have not been able to pin down a rate which is “reasonable” and which I can use to forecast rental income for each property. Rather than use an estimate which may be way off the mark, I will just leave it as it is and wait for the Group to state the amount of recurring income it receives from its properties, or perhaps I can drop an email to the IR for more clarifications.

Dividends

In the interest of brevity, I shall not discuss too much about dividends as I believe the above table already summarizes most of what I have to say regarding dividend history. Boustead supplements a lot of their recent dividends with special dividends, and FF Wong repeatedly makes it clear that these should be labelled “special” and thus one-off, and shareholders should not expect something of an SPH-type “special” dividend situation which seems to repeat every year (then why call it “special” in the first place??). One can notice that except for FY 2006 and FY 2007 (where there was a dividend in specie of Easycall shares and a booster final dividend respectively), dividends have trended up quite smoothly over the years.

Interestingly, dividend payments only started back in 2003 when the Group turned around under FF Wong’s leadership and overhaul. Previously, there was a lot of deadwood and the Group had many unrelated businesses which were dragging down the bottom line and consuming unnecessary resources (sounds somewhat similar to MTQ in this respect, though MTQ has since taken on a lot more leverage than Boustead). FF Wong streamlined all the businesses and divested the under-performing ones, and it was only in FY 2009 that Salcon turned around (there were too many legacy issues relating to it). Note that interim dividend payments commenced in FY 2005, and interim dividend has steadily climbed from just 0.5 cents/share in FY 2005 (split-adjusted) to 2 cents/share in FY 2012. Final dividend has been a little more erratic, with FY 2011 seeing a drop in final which was “replaced” by a very high special dividend of 3 cents/share.

However, from a total dividend per financial year perspective, it has been steadily rising except for a minor “blip” from FY 2008-2009 (drop of 1 cent/share). Therefore, I feel that shareholders can reasonably expect another 2 cents/share final dividend and also perhaps another special dividend to equal last year’s payout.

Another possible scenario (which I had mentioned that I will talk about during Part 1) is that Boustead may require more upfront capex investment into its three leasehold properties, as well as set aside additional cash for any planned upcoming projects, and so has less to pay out in the form of dividends for FY 2012. Therefore, dividend per share may fall to perhaps a total of 5.5 cents to 6 cents/share; but unless the cash is being earmarked for a major M&A, I feel that the payout should be quite similar to the previous year.

Conclusion

This analysis may be the last which I will post on my blog, for reasons which I will explain in a later post next month. Typing out and posting analyses on my blog is very stimulating for the mind, but unfortunately is also very time-consuming and tedious as I have to collate the necessary information in Excel sheets and also write out everything in a Word doc. Plus, I have to proofread every line for grammatical errors (I hate those) and punctuation errors. Considering the New Year is coming and I may be busier than ever, I may have to take a back seat on these detailed analyses. Anyway, I also realize that hardly anyone comments on them (unlike the more popular personal finance series), so I assume no one will miss them!

For Boustead, the Group may yet be on the cusp of something big, as long as FF Wong and his team can remain focused on the Group’s core competence and channel its resources into value-added activities. Though Boustead is sitting on a large cash hoard which is being eroded by inflation, it allows them to be ready to pounce on any opportunities which may be thrown up by the ongoing European crisis. Their well-managed Cash Management Program also means that at least some of the cash is earning higher rates of returns as provided by blue-chip corporate bonds, while an increasing amount of cash is also funnelled into their growing leasehold property portfolio. This will, in time, increase their ROE and allow for better returns. Considering the Group is already achieving admirable rates of return despite having a huge cash hoard and negligible leverage, I guess with proper Management and direction, this can only improve in future. I am happy to have been a shareholder of Boustead for the past five years, and if the business continues to remain resilient, I may remain a shareholder for very much longer.

Boustead Singapore Limited – 1H FY 2012 Analysis Part 2

Part 2 of this three-part analysis will focus mainly on divisional analysis, as Boustead has four very distinct divisions which make it one of the harder conglomerates to put a value to. The interesting thing about Boustead which has somehow eluded me all these years (but which has somehow perplexed many an analyst) is that it has four disparate divisions which makes it a very difficult company to classify. On one hand, it is not an oil and gas company even though it has a strong energy-related engineering division and has contracts in many countries around the world for waste heat recovery and boiler systems. Neither is it purely a real estate development company though it has a large (and growing) portfolio of industrial leasehold properties and is considered a niche player in the biotech, logistics and aerospace industries. The best way to describe the company to someone (and mind you, many people have asked me!) is to say that it is a Company with a Pan-Asian focus which is in multiple industries, then quickly move on to explain each arm of Boustead before the listener has adequate time to react (and retort).

But before I become disarmingly irritating with my oft-repeated rendition of the interesting facets of Boustead and its myriad arms, let me assure the reader that there is a reason for the above. I shall end off Part 2 with reference to what was mentioned in the first section of this post, and use this to illustrate a very interesting fact about the Company which somehow continues to endear me to it (yes, someone will inadvertently remind me about the well-documented psychological bias – the endowment effect).

Segment and Divisional Revenue Analysis

Engineering Services as a whole saw a significant decrease in revenue for 1H 2012, down 53.5% to just $128.5 million from $276.2 million. This can be largely attributed to the drop in revenues in the real estate solutions division which saw a 73% year on year fall in revenue to $50.9 million (but 1H 2011’s numbers included the disposal of an industrial property worth $67.8 million). With Boustead’s focus being more on DB&L projects in order to build up their portfolio of recurring rental income, there has thus been less D&B contracts awarded. This, coupled with the slowdown in 1H 2012 also meant that there was less revenue to recognize for the division. However, my view is that Boustead’s Real Estate Division would serve as a buffer for the Group should the Euro Zone collapse, and also help them to generate steady and predictable cash flows during uncertain times. Since most (if not all) of their clients are blue-chip companies, there is also a lower risk of non-payment or default unless a major crisis occurs within the specific niche industries that each client is in.

Revenues for Energy-related engineering and water and wastewater engineering were slightly better for 2Q 2012, but nevertheless when compared on a half-year basis, the increase was not too impressive. For the former, the Group mentioned that more of the revenue will be recognized in future periods as many of the projects are in their initial stages of execution – therefore as a shareholder I should be expecting not just a higher revenue contribution year-on-year, but also hopefully better PBT margins (more on this later). For the latter division, though there was higher revenue recognition in 2Q and 1H, it failed to clinch additional contracts during the first half of the financial year. Somehow my feel is that the intensive competition of this industry and the thin margins are reasons why Boustead has to be very selective in bidding, and also to ensure it maintains its focus on high-value engineering services instead of degenerating into the model used by many China BOT companies (in which a huge capital outlay has to be expensed before cash flows start to stream in). That said, Salcon’s future at this point still looks uncertain as year after year sees more or less flat-lined revenues and PBT (last year saw a LBT because of the Libyan write-off). Sustaining the division may be possible over the long-term, but growing it seems tough and my view is that Boustead should still try their best to realized value from this division by selling it off! My worry is that too many resources, manpower and effort are plugged into the Division in order to sustain it, such that other divisions or areas are neglected or not given sufficient attention.

Geo-Spatial Technology seems to be the star performer – revenues grew 14.3% for 1H 2012 compared to a year ago, and the division is also generating healthy PBT margins and cash flows. Demand for software and professional services remains strong and is poised to grow over time, as Boustead focuses its business development efforts in Australia and South East Asia (e.g. Indonesia).

Divisional Margins Analysis

It’s pretty telling by looking at the table above just how each division has performed not just with respect to its PBT year-on-year, but also its PBT margins. Energy-Related Engineering disappointed by shaving off about 4.4 percentage points off its PBT margins to end at 7.3%, and registered a PBT of $4.6 million against $8.8 million a year ago (a steep 47.7% drop). The sad fact is that revenues had only fallen 17%, and the significant margin deterioration was not adequately explained by the Company as they chose to focus their commentary more on Geo-Spatial (the “star” performer). My view is that Management should also strive to be as candid as possible regarding ALL divisions and weak areas of the business, so that improvements can be devised to improve results.

Water and wastewater engineering (Salcon) has demonstrated another weak half-year, with a LBT of $0.1 million against a profit of $0.7 million a year ago. Not much was mentioned on why the division had incurred this loss even though there were no further write-offs from Libya, and the commentary simply mentioned that there was “steady progress” at its two major projects at Al Wathba in the UAE and Tuas Power Tembusu Multi-Utilities Complex in Singapore. PBT margin was already thin at 5.3% to begin with, and it would seem that pushing on, it would be a challenge to raise PBT margins higher, and SembCorp Industries and other larger companies make much stronger competitors and also have the financial muscle to outbid Boustead for water projects. Therefore, it may not make sense for Boustead to “knock its head against the wall” figuratively speaking to try to grow Salcon into a major player, and FF Wong has been trying to do so since FY 2002. I will continue to monitor this division but my heart feels heavy just talking about it, and I certainly hope Management has some ideas or strategies to turn things around.

For Real Estate Solutions, PBT plunged a very “impressive” 67.3%, but that was before adjusting for the sale of industrial leasehold property in 1H 2011. The sale last year actually depressed PBT margins such that they ended up at 18.7%; and for 1H 2012 the PBT margin had normalized and risen to a more decent 22.6%, with PBT at $11.5 million. There was slower recognition of revenue (and hence PBT) for the period in question, and shareholders should also recall Boustead’s increased focus on more DB&L projects which will provide future recurring income; thus in the short-term, revenues and cash flows would suffer a setback. Since it’s all in the name of “long-term shareholder value” (yes, I know it sounds horribly clichéd), I am willing to tolerate the short-term “lumpiness” in view of enjoying stable, steady and consistent future cash flows and profits.

Interestingly enough, the star performer (I think I must have used the word “star” at least three times, forgive me for that as I try to substitute for a better word) was Geo-Spatial Division, with revenues rising 14.3% and PBT rising 21.6% (implying costs and expenses had actually risen less than the rise in revenues). PBT margin is an impressive 25.6%, even higher than that of Real Estate Solutions Division, and it was also an improvement over the 24% registered a year ago. I did mention in my last analysis and review that this division was Boustead’s “cash cow” and it would show steady and moderate growth; plus cash flows were consistent as most, if not all, of their clients are large multi-national corporations or government agencies. With the recent contract with Earthmine announced in March 2011 making use of ESRI Singapore’s technology, and also with booming demand from resources and terrain planning coming from countries such as Indonesia, there is further potential for this division to grow further.

So as I close off this section of the analysis, I will refer back to my assertion that Boustead’s four divisions do have potential not just to weather the economic storm through “diversification”, but also creates very unique opportunities for the Group to take advantage of in the current turbulent climate. The two divisions which show potential and are performing above expectations (at least, in terms of contracts secured and near-term prospects) seem to be real estate and geo-spatial. Barring a complete collapse in confidence in the real estate industry in Singapore, Boustead’s real estate arm looks set to continue its momentum of contract wins, though the more recent announced wins have been mainly D&B, rather than DB&L. FF Wong is obviously trying to grow the leasehold portfolio (currently at 90,000 square metres, more on this in Part 3) in order to generate more predictable cash flows; and also to perhaps realize value should the portfolio be bought over eventually by a REIT.

The fact that Boustead has such varied arms makes it resilient to a downturn, as some sectors and industries tend to be more affected than others in an economic recession (example, banks or construction). Unless it is a protracted recession which covers ALL aspects of the economy (something akin to a second Great Depression), otherwise I believe Boustead should see resilience in its business model, and the huge cash stash should also act as a good buffer.

Part 3 will focus on something more interesting – Boustead’s industrial real estate portfolio, as well as its dividend history which I had not covered before in previous analyses. Watch out for that.

Boustead Singapore Limited – 1H FY 2012 Analysis Part 1

Boustead released their 1H FY 2012 results on November 14, 2011, and frankly it was not as disastrous as I had anticipated, considering there was an economic tsunami at our doorstep which would affect most companies. Though the numbers did not look spectacular, the Group put up a credible performance in general, with my only grouse (for the last few years, actually) being Water and Wastewater Division.

This analysis will be split into the usual three parts. Part 1 will touch on the financial statements, including income statement (briefly), Balance Sheet (more important) and Cash Flow Statement (the lifeblood of any company). Part 2 will focus on divisional analysis, and will break down the contributions by each division to Group revenue and PBT, and compute PBT margins as well. Part 3 will discuss Boustead’s industrial leasehold asset portfolio, dividends and also the plans and prospects moving forward, and how Boustead can navigate the stormy economic climate.

Financial Analysis – Profit and Loss Statement

On the Income Statement, there is nothing much to elaborate on as it was previously indicated that yearly results are more indicative, rather than quarterly. For 2Q 2012, revenues fell 30% year on year to $91 million due to slower recognition of revenue for real-estate projects due to Boustead’s focus on Design, Build and Lease (DB&L) projects, and the Energy-Related Engineering Division also saw slower recognition of revenue as contracts were in initial stages. These were the two main reasons for the drop in revenue, but it was more than offset by the 44% drop in COGS to $55.7 million, thus lifting gross profits by 14.4% to $35.3 million. For 1H 2012, the effect on gross profit was also stark (as can be seen from the table above); with revenues falling 43.7% but gross profit only falling 29.4%. Note that for 1H 2011, the results included a one-off sale of leasehold property which distorted the results. After adjusting for this, revenue would have fallen only 29% year on year for 1H 2012, instead of 43.7%.

An interesting point to note is that gross margins have, apparently, improved significantly. Gross margin for 2Q 2012 increased to 38.8% from 23.6% a year ago, and much of this improvement can be attributed to the Geo-Spatial Division (which we shall see later in Part 2, has a very high PBT margin as well). Also, several projects under the Real Estate Solutions Division garnered higher gross margins, thereby pulling up overall Group’s gross margin. For 1H 2012, gross margins were at a very healthy 37.4%, and hopefully Boustead can sustain this momentum for 2H 2012 as well in order to achieve better overall profitability.

Considering that net profit attributable to shareholders (for 2Q 2012) increased 12.7% while gross profit improved 14.4%, this shows good expense control. A glance at the Profit and Loss shows that selling and distribution and admin expenses both increased 15% respectively, in line with the increase in gross profits, with only a spike seen in finance costs as more debt was undertaken to finance Boustead’s leasehold portfolio under construction (more on this in Part 3). The same distortion can be seen for 1H 2012 due to the one-off sale of leasehold property, and after adjusting for this, profit attributable would have decreased a much smaller 5% instead of 56%.

Financial Analysis - Balance Sheet Review

Boustead’s Balance Sheet displays some changes since 6 months ago (March 31, 2011), and the focus now would be to comment on these changes and how they will impact the Group moving forward. For current assets, cash has fallen by about $17 million (more on this later), while trade receivables has seen a large drop of $30 million, offset by an increase in other receivables and prepayments of $9 million. The most significant increase, however, is that of investment properties under non-current assets – it had increased from $13.5 million to $41.4 million in just six months. Obviously, a lot of progress had been made on the construction of Boustead’s industrial leasehold properties and this was reflected in the increased capitalization as witnessed on the Balance Sheet. AFS investments also increased as part of Boustead’s Cash Management program, which involves the purchase of short-term blue-chip bonds with yields higher than bank fixed deposits.

Bank loans did not fluctuate much at all and remained relatively constant at $24 million, down slightly from $25 million six months ago. Current ratio was a healthy 1.69 as at Sep 30, 2011, against 1.95 in the previous period. ROE stood at 15.9% (annualized using 1H 2012 net profit attributable to shareholders), which is a little on the low side as a result of Boustead’s large cash hoard generating paltry returns.

Financial Analysis – Cash Flow Statement Review

Boustead’s cash flows have always been healthy, but for 1H 2011 OCF was lower than usual, at just $11.4 million. One year later, for 1H 2012, OCF hit $54.7 million, up nearly 3.8x, largely due to better collections from debtors and also an increase in Trade Payables. 1Q 2012 already saw an inflow of $34.4 million OCF, and 2Q 2012 has added another $20.2 million, and this shows that the core business is generating a lot of healthy cash flows, which are then used to invest in investment properties (and of course, with some left over for the payment of dividends). I will tie this in later with Boustead’s dividend history, and come up with a conclusion on whether I think dividends will be sustainable.

For investing activities, it should be noted that very little was spent on capex (in fact, just a mere $870,000 for 1H 2012). Most of the cash went into purchase of AFS and HFT investments, and I understand that this is part of Boustead’s strategy to reap higher returns on its cash hoard as it waits to deploy it into suitable acquisitions. A last check with the Company has revealed that this cash is most likely invested in high-grade bonds with short tenures, thus the yields are better than bank deposit rates though it may not exceed inflation rate of 5.5%. I guess what is more important is the protection of capital as even high-grade bonds may see instability in their pricing amidst the current turbulence.

Boustead’s stable of industrial leasehold properties is taking shape, as it spends $12.6 million in 1Q 2012 and another $15.6 million in 2Q 2012 for a total of $28.2 million for 1H 2012, and this shows up in the Balance Sheet as an increase in investment properties (by about $28 million as well). Part 3 will display Boustead’s portfolio of industrial leasehold properties, and I will also offer my comments on how I think Boustead will grow this portfolio and realize more value for shareholders in the long-run. From the table above, if we compute FCF the traditional way, then 1H 2012 would have seen a massive FCF inflow of $53.8 million. If we exclude the additions to leasehold property, then it would still have been a very healthy $27.7 million. Boustead has declared an interim dividend of 2 cents/share which amounts to about $10 million, and it can be seen from a glance that the $27.7 million FCF (net of leasehold property additions) is more than sufficient to support this payout. I will elaborate in Part 3 why I think Boustead did not pay out a higher interim dividend, using its dividend history as support.

Under Financing cash flows, most of the outflow was due to the payment of final cum special dividend (final dividend of 2 cents/share and special dividend of 3 cents/share for FY 2011), and about $1.5 million was spent in repaying some long-term bank loans. Cash balance remains healthy at $192.7 million, and with about $24.2 million in bank loans on its Balance Sheet, Boustead is currently carrying a net cash balance of some $168.5 million.

Part 2 of the analysis will delve into Boustead’s divisional performance, and I will have quite a few comments here based on my understanding of the Company, and whether I feel the Group can get through this difficult period relatively unscathed. This will be based on an analysis of each division’s contribution to Group Revenue and PBT, as well as the PBT margins by division.

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.

Conclusion

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.

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.

Boustead – FY 2011 AGM Highlights

I attended Boustead’s AGM on July 29, 2011 held at the Company’s headquarters at Starhub Green. It was to be my fifth consecutive AGM for Boustead, and it was indeed amazing to realize how the Company had evolved over the years, since my very first attendance at the FY 2006 AGM. At the time, it was held on 6th floor of Boustead House and the Company was much smaller and less established. Now, the meeting was held at the second level of the new Starhub Green which Boustead Projects helped to construct, and the venue was a large and very beautiful-looking conference room. Since I was there very early (I like to be early for my AGMs as this means more chances to rub shoulders with key management executives in order to ask some questions before other shareholders arrive), I took some nice photos of the place. This would have been impossible later on as this year’s AGM was packed literally to the brim, with about double the number of attendees as compared to FY 2010’s AGM. More on that later.

General Comments on the AGM

Most of the AGM was, again, characterized by FF Wong (CEO and Chairman) giving his views on various aspects of the business, updating everyone on Libya and handling questions posed by shareholders and analysts on topics of interest. In his usual candid and casual way, he endeared himself to the crowd by being affable and approachable, coupled with a sense of humour to boot. His easy-going manner is definitely welcome as compared to some CEOs I had met who were a little too serious and uptight as they probably felt pressured to conform to market expectations of being a listed company, or possibly they were being “harassed” about why the Company was not doing better than it should be.

During the AGM, he was peppered with questions regarding each division of the business, which I shall elaborate on in the separate sections below. Some shareholders also bombarded him at length about the troubles in Libya, which caused him slight agitation as the questions were persistent and somehow one could detect a hint of blame behind the tone of the questioner, which put the CEO on the defensive. I will discuss my thoughts and opinions on the Libyan issue in a separate section as well.

The overall mood was one of satisfaction that the Company was well-managed even with the Libyan “blip”. Of course, the special dividend of 3 cents/share helped to sweeten the mood, even as shareholders deliberated on how the $200 million net cash on the Balance Sheet was to be utilized (incidentally, FF Wong did mention that this balance had ballooned to $228 million as at July 29, 2011).

Energy-Related Engineering Division

Boustead International Heaters (BIH) deals with detailed engineering processes and has a presence in many countries such as London and Malaysia. FF Wong said that BIH is in a niche industry and only has about four competitors. Their net margins are about 10%-13% and are under pressure currently due to competition, but volume has grown steadily since the recession ended. By comparison, Herte of France (which is one of the competitors of BIH) has only net margins of 3%.

For Boustead Maxitherm, an area of growth which Management is looking at is Green Energy. Boustead will be moving towards this direction in the years to come as it represents good potential. For power plants, the outlook is becoming more positive and buoyant and countries such as Indonesia require a lot of such plants to generate power to outlying areas. The country is too large to have a national grid in place, thus small power plants are required to cater to small pockets of the population; and this development represents good opportunities for Boustead Maxitherm to grow over the mid-term.

Water and Wastewater Engineering Division

Salcon will continue its focus on the niche water treatment industry and pitch itself for such projects. Even though it is up against global giants, it has still managed to clinch several high-profile contracts from reputable clients and has built up a respectable portfolio. Without the Libyan write-off, FY 2011 would have been another profitable year for the division.

Real-Estate Solutions Division

This division is easily Boustead’s largest revenue contributor and also its cash cow (aside from Geo-Spatial, of course). In Boustead’s AR, it was stated in the Chairman’s Statement that the aim was to build up an industrial leasehold property portfolio of 200,000 to 300,000 sqm. When I queried Management more on this, the reply was that this was the critical mass required for them to sell the entire portfolio to a REIT, thus unlocking value for shareholders. The rental revenue to be derived from Boustead’s current industrial leasehold property portfolio cannot be ascertained as it depends a lot on the type of building and the zoning (which affects the rental rates). As of this writing, the Design, Build and Lease portfolio has grown to about 90,000 sqm.

It is Boustead’s aim to grow their Design and Build portfolio as well, even though these contracts are sporadic and “lumpy”, in addition to focusing on their DB&L projects. It used to be the case where Boustead could sell at least one industrial leasehold property every financial year, but the problem with this strategy was that even though it brought in a lot of excess cash, it also meant that the Group would have to deduct one recurring income source. Boustead’s business model has to shift to one where the recurring income and cash flows from maintaining such a portfolio outstrip the benefits of selling the properties to clients for lump sum cash inflows. To do so, I reckon that Boustead’s other divisions have to ensure that they are all cash-flow positive and that the cash inflows more than cover the outflows to be made for progress payments to be made to contractors during construction of these leasehold properties. Once this “steady state” is reached, Boustead Projects can focus more of its attention on growing its leasehold portfolio, with the occasional Design and Build contract thrown in for good measure.

Geo-Spatial Division

Not much was discussed about this division as it is a pretty stable one with good and steady growth. FF Wong mentioned that in Australia, their market share was 85% while in Singapore it was 50%, with most of the clients being government agencies (hence, there exists a very low bad debt probability). There was already a good discussion on this during the recent audiocast, therefore I have nothing more to add.

Investments

With regards to Boustead’s most recent investment in HanKore (previously known as “Bio-Treat”), FF Wong mentioned that extensive and exhaustive due diligence was done on the Company prior to the investment. To recap, Boustead invested $4 million in HanKore by purchasing 100 million shares at 4 cents/share. HanKore has a complex group structure and the recent rights issue and fund raising meant that more parties were roped in to help the troubled company. It was mentioned that cash flow was poor for BOT projects (which is why Boustead themselves do not utilize the BOT business model) but prospects were good.

Recent reports on HanKore have been largely optimistic that the Company has put its troubled past behind it and would be able to generate healthy cash flows and profits. It remains to be seen, however, if this comes to pass. Boustead’s Management is not terribly excited about HanKore’s near-term prospects, and my feel is that they intend for this to be a medium-term investment.

Cash Management

Boustead’s cash management program allocated $50 million for the purchase of corporate bonds, and it was mentioned that $12 million was invested, out of which $1 million of profits were made (yield of about 8.25%). This ongoing program helps to ensure that the cash is properly invested in products which are not too risky, yet are able to generate a return higher than inflation. Instead of letting the cash sit idle, it will be put to good use while Boustead waits for a suitable M&A opportunity.

As at July 29, 2011, Boustead’s net cash balance amounted to $228 million. After the payment of the final plus special dividends, this will dip to “only” $200 million. FF Wong mentioned that holding so much cash has its advantages as well, as it allows flexibility for Boustead and also attracts more suitors who are eager for Boustead to assess their business to see if it can be bought over. Therefore, this opens Boustead up to more opportunities as compared to if it did not have its large cash reserve. Holding so much cash also improves Boustead’s reputation as a well-managed company and boosts its standing in the corporate world.

Boustead will continue to keep its eye out for potential M&A opportunities to utilize its burgeoning cash hoard. With the Europe crisis flaring up again and a crisis of confidence engulfing the Euro Zone, perhaps this may throw up juicy opportunities for Boustead to consider. However, since its focus is mainly Asian (and Asia has yet to experience a crisis as severe as the AFC in 1997), it may not be able to find attractive investment opportunities around SEA and may have to venture to Europe or USA. Whatever the case, shareholders like myself will have to keep the faith that the CEO knows what he is doing.

Conclusion

The above summarizes the main points gathered from my attendance at the FY 2011 AGM. The buffet spread was quite marvellous this time round (with lobster salad, crayfish and other high-quality food), but the experience was marred by a very cramped corridor which everyone had to literally squeeze through to get to the food. This meant a delicate balancing act when it came to shuttling food back and forth, and drinks were particularly tricky. It did not help that the conference room also felt cluttered with many chairs blocking the way. One of the shareholders requested that an auditorium be booked for next year’s AGM, and the Management said they would look into that request as they had not expected such a good turnout and were similarly caught by surprise.

I shall be providing another update on Boustead when it releases its 1H FY 2012 results some time in November 2011.

Portfolio Changes - Divestment of GRP and Addition of VICOM, SIAEC & Boustead

It’s been a while since I made some major changes to my portfolio, but this month seems to be a good month for it as Mr. Market went through a rather wild mood swing due to the historic downgrading of US Debt, which caused markets worldwide to tumble sharply and valuations to become more attractive. This event, coupled with debt problems in Europe and runaway inflation in China, served to unnerve the world and caused many bouts of forced selling and margin calls. The result, of course, was that the STI fell about 13% in 7 straight days of blood-letting, and this opened up very good opportunities for me to purchase shares. But before I go on about the additions, I have to declare my divestment of GRP and also the underlying rationale for it. Fortunately for me, the timing of the divestment was just right for me to pick up some shares of VICOM, which does vehicle inspection and testing in Singapore; as well as to average down on my cost for SIA Engineering. At the same time, I also bought some more Boustead to add to my current holdings. In the sections below, I shall elaborate on the reasons for the divestment and addition, and also give a brief account on the addition of SIA Engineering. All portfolio changes will be reflected in my month-end portfolio review, though I will provide some details within this post itself of the movement in cost, and also any dividend effects.

Divestment of GRP – Reasons and Rationale

I guess of all the companies within my portfolio, the one which was the most stagnant and which had a declining business had to be GRP. The original rationale for purchase was to enjoy a yield of 10% due to GRP’s large cash hoard and also its ability to generate free cash flows (FCF) due to the presence of rental income derived from its Bukit Batok industrial property. However, do note that the rental income from its property had ceased with effect from May 2010 following the expiry of the lease agreement in April 2010, thus 1H FY 2011 (ended December 31, 2010) did not include the effects of this rental income. As a result of the absence of this item, net profit fell 47% year on year. This was not the only thorn in GRP’s side – gross profit margin had also declined from 35.9% to 31.9% due to more intensive competition in its divisions. Though administrative expenses had fallen 23.8%, the more worrying factor was the erosion of gross margins, which was witnessed in Tat Hong and which also portended a slow but painful decline in its core business.

However, the above was not the only reason for the divestment. In the May 2, 2011 issue of The Edge Singapore, director Han Hai Kwang was quoted as being on the lookout for “synergistic” acquisitions to halt sliding profits, as GRP’s core business divisions suffered from competition and saw its profits eroding. Its PVC business in China, in particular, was suffering as a result of intense competition and the business itself was a commodity one in which GRP itself had no firm competitive edge. It would seem that throughout the years in which I was vested in GRP, Han had been continually looking out for such M&A but without much success, and this resulted in the cash building up into a hoard of about 9.5 cents/share. No special dividend was declared though, as I believe the Company saw that their business was vulnerable and therefore they wished to retain more cash for working capital.

What was more alarming, however, was that GRP’s operational cash flows for 1H FY 2011 had dropped to just $559,000, while capex was $95,000, resulting in FCF of just $464,000. The current dividend of 1 cent/share every half year amounts to $1.4 million, and this represents a shortfall of $1 million. Note that while rental income was still flowing, and using 1H FY 2010 as a comparison, FCF amounted to $$2.24 million, which would have been sufficient to pay out a dividend of $1.4 million and still retain roughly $800,000 for working capital. Looking at GRP’s balance sheet as at December 31, 2010, cash stood at $13.3 million and if they were to carry on with their current dividend policy, the cash would be depleted within 6.5 years ($2 million deficit per financial year), and that is not even counting in working capital requirements. Hence, my conclusion was that the current dividend policy was unsustainable (at 10% yield), and thus the original rationale for purchase was now invalidated; thus requiring an action to divest.

Another related point which I should mention was GRP’s announcement, on July 13, 2011, that it would be disposing of 63.5% of GRP (China) Pte Ltd, its uPVC business, for a cash consideration of $1.92 million; and will also, at the same time, book in a gain on disposal of $313,327. The reason for the disposal was the cash burn and losses suffered by this division for three consecutive years. On the surface, it looked like a good decision; but I have to question why Management took so long on their decision to divest, and also whether there are underlying unspoken reasons for wanting to divest for cash. One possibility (uncorroborated, no doubt) which crossed my mind was that the Company was foreseeing declining business and needed the money for additional working capital; and that they would also concurrently lower their full-year dividend from FY 2012 onwards (I am still expecting a final dividend of 1 cent/share for 2H FY 2011; as of this writing, GRP’s FY 2011 results ended June 30, 2011 have still not been released).

On August 3, 2011, I sold off my entire shareholding in GRP at 20.5 cents/share, realizing a capital gain of 2.5%. If I factor in dividends of $4,000 received since I first purchased GRP on October 28, 2009, then the total net gain on GRP rises to 22% (net of brokerage). Using XIRR on Excel, I have computed that the annualized return on investment amounts to 13.5% per annum.

Purchase of VICOM

The proceeds from the divestment of GRP were then used to purchase VICOM at an average cost of $3.40833 on August 8, 2011. VICOM is a company listed on SGX (68.19% owned by Comfort Delgro) which is involved in vehicle testing and inspection services (for all cars in Singapore). Revenue for this division hit $25.5 million (a 10.7% increase) for FY 2010 (it has a December 31 year-end) and 438,454 vehicles were inspected during the financial year. This division has seven testing centres spread out over Singapore, and include Sin Ming (lease just renewed for another 30 years), Changi, Bukit Batok, Yishun, Kaki Bukit, Pioneer and Ang Mo Kio. As of June 30, 2011 (based on 1H 2011 results), the Vehicle Inspection Business took up 30.5% of revenues, and had operating margin of 35.7%.

VICOM also has a wholly-owned company called Setsco Services Pte Ltd (Setsco) which provides non-vehicle testing and inspection. This includes construction material testing, certifications, calibration, training, inspection and consultancy. It has its headquarters at Changi but VICOM is in the midst of building a new four-storey building at Teban Gardens due to be completed by 3Q 2011. Revenue for this division hit a new high of $51.4 million (a 7.6% increase) for FY 2010. The division also has operations in Selangor (Malaysia) and Ho Chi Minh City in Vietnam. In FY 2010, Sestco formed a JV in UAE with Dubai-based Ali Omran Al Owais Investment Company to form a 49%-owned associated company called Setsco Middle East Laboratory LLC. This remained dormant for FY 2010, registering a loss for the year. As at 1H 2011, there was still no share of profit from this associated company, which implies that operations had yet to fully commence. For 1H 2011, the proportion of revenue from Setsco was 61.6%, and operating margin stood at a respectable 20%. The remainder of the revenue came from leasing and other related businesses.

I had already stated at the end of m SIA Engineering’s five-part analysis of purchase that I will not be doing a very detailed analysis of purchase for new purchases subsequent to SIA Engineering, thus I will be very brief on the reasons I purchased VICOM. VICOM has a captive market in its vehicle inspection business, as all cars in Singapore have to be periodically inspected as part of compulsory requirements to own a vehicle. As COE prices remain high (as of this writing a Cat A COE costs $49,000 while a Cat B one costs $65,000), fewer people will scrap their cars and thus will hold on to them longer, requiring more inspections. VICOM also has a clean Balance Sheet with no debt, and generates strong FCF every year. In its recent 1H 2011 results, VICOM declared an interim dividend of 6.9 cents/share, up from 6.3 cents/share a year ago. Assuming final dividend remains unchanged at 6.9 cents/share as per last year, total dividend for FY 2011 would be 13.8 cents/share, translating into a yield of 4% at my purchase price. Incidentally, I did not buy VICOM very cheaply; it was priced at about 12.2x PER and about 3x P/B; but this is to be expected since the business model is sturdy and it generates consistent and predictable FCF every year. A total of about $20,000 was spent purchasing shares of VICOM.

Addition of SIA Engineering

As Mr. Market was feeling particularly panicky in those seven days of decline, I decided to deploy more cash (about $10,000) to purchase SIA Engineering, and managed to average down on my initial purchase by buying at $3.51 on August 11, 2011. A quick analysis of SIAEC’s cash generation ability showed that since listing in 2000, it has only dropped its dividend once (in ten years) from FY 2008 to FY 2009 (20 cents/share to 16 cents/share), not counting special dividends. Even if we assume a drastic cut in dividend of 40% from 20 cents/share to 12 cents/share due to another global economic meltdown (crisis), that still represents a yield of 3.4% at my purchase price. With cash flows from associated companies and JVs remaining strong, I would expect SIAEC to at least maintain their dividend policy as they should have baseline cash balance of $400M after paying their recent final + special dividends.

As a result of the averaging down, average cost for SIAEC has fallen from the previous $4.064 to $3.97, and this will be reflected in my next portfolio review.

Addition of Boustead

Even more cash was deployed to purchase more shares in Boustead, at a price of 85 cents. The Company is sitting on a cash hoard of about $39.75 cents/share and has been paying consistent, increasing dividends over the last five years. This effectively values the rest of its business at a mere 5x PER ex-cash, and considering it is a global mid-cap company this “conglomerate discount” was not justified. It has a strong balance sheet with negligible debt (mostly, it is used to finance their real-estate portfolio) and generate very strong FCF every financial year. The strength of its business lies in Geo-Spatial and Real-Estate Solutions Divisions. For the former, it has a PBT margin of around 22-23% and is cash-flow positive, with Government agencies forming the bulk of their customer base (hence, bad debt probability is very low), while for the latter, Boustead is steadily building up its Design, Build and Lease portfolio to just above 90,000 sq metres currently. This is reflected under “Investment Properties” in the Balance Sheet, and the recurring income and cash flows will provide a stable base against the turbulence experienced these couple of weeks in Europe’s and America’s economies.

At my current purchase price, projected yield based on 4 cents/share is about 4.7%; and my average cost has increased from 55.8 cents to 62.2 cents.

Summary

The above transactions had the net effect of increasing my cost base from $220,000 to $238,700, as $20,000 was divested from GRP and re-deployed into VICOM, $10,000 was spent acquiring shares of SIAEC and another $8,600 to acquire shares in Boustead. This represents another new high for my cost, and I shall endeavour to continue to put more money to work if Mr. Market continues to offer me opportunities.

Boustead – FY 2011 Financial Results Analysis Part 3

Part 3 of my Boustead’s FY 2011 analysis will feature the entire transcript of Boustead’s FY 2011 results audiocast. As per prior years, I will be inserting my own thoughts and comments periodically throughout the audiocast session, and these will be indicated in square brackets [ ] and in blue. However, this analysis will be different from previous years in that I will NOT be sharing any insights from the Annual Report 2011. I will be splicing that into a separate post after I attend the AGM to be held at Starhub Green on July 29, 2011 (Friday) and combine my insights and remarks into one post to make it easier for readers (and myself) to digest. If the information is too voluminous (i.e. audiocast cum annual report), it makes it difficult to read on and by splitting it into two separate posts, I hope to be able to achieve better clarity and focus on these two separate yet connected events.

After the transcript portion, I will also discuss on plans and prospects briefly (as gleaned from the audiocast); but a more in-depth discussion of this will be provided after the AGM as I intend to touch on more detail during this event.

Boustead FY 2011 Audiocast Transcript (recorded on May 26, 2011)

Question (Tan Choon Kiat): I noted that the geo-spatial division has performed very, very well. And that is despite, you know, we sort of like was saying the growth of this division would plateau off. But it doesn’t seem to be so, in fact the geo-spatial division grew nearly 30%. Eventually, out of this 27% PBT growth, how much would you attribute to favourable currency effects, and also specifically, what is the sustainable long-term growth (for this division) in the next 3-5 years which your team is actually looking at? The other thing, of course, the recurrent part of the real-estate portfolio that you guys have been building up is looking very nice and is steadily growing notwithstanding the fact that the size of each project secured is becoming a bit smaller. My question right now is a very pointed one – it appears to me that looking at these two divisions alone, the profit before tax (PBT) of these two units seems to be hitting $35 million and is still growing.

FF Wong: First question first, Choon Kiat, Geo-Spatial. The main reason for the growth in this financial year was not really because of the currency. In fact, it is because of the growth of countries outside of Australia, especially Singapore, Indonesia and Malaysia too. And the other thing is the maiden contribution from Mapdata Pty Ltd which was acquired two years ago. So these are the two main reasons. You asked also whether it is sustainable. It appears to be sustainable because over the years there has been steady growth, even though percentage-wise it was not to my liking, or to shareholders’ liking. But that’s also because the Australian market is maturing, and yet we haven’t really been able to quicken the steps of development especially in Indonesia. So we have been putting in serious effort in growing the markets outside Australia and it appears that it’s bearing some results, and as you know Indonesia is so big, and with the current craze in resources development, mining and so forth, we see huge potential in Indonesia, and we have also embarked on non-traditional methodology to expand the market instead of following the standard global ESRI methodology. That, I believe, should be able to give us some quantum leap with respect to the growth in those respective countries like Indonesia. I firmly believe that our growth and our revenue in Geo-Spatial will be sustainable. Next question on industrial real-estate. The size of the projects are a bit smaller principally because in the year before (2009) when we secured Rolls-Royce projects, these two projects are huge (humungous). So, by comparison with the usual industrial building projects, these are unlikely to be repeated in future from what I can see, but who knows? But there are a lot more projects in the marketplace. We have secured quite a number, especially in the last 3-4 months. I would think that there are also a lot more design, build and leaseback projects – we are negotiating quite a number of them quite near closing stage but not quite yet, so can’t make any announcement as such yet but the pipeline is very healthy with respect to design, build and leaseback. That’s not included in the order book (in the backlog). Yes I think that’s about it, I hope I have answered your questions. You can pose another question later on.

[It would seem that Geo-Spatial still has ample room for growth, even after the seemingly sharp jump in revenue and profit before tax of 26% for FY 2011. Boustead’s efforts to expand beyond Australia and into Indonesia seem to be bearing fruit, and according to FF Wong Indonesia still holds untapped potential for this Division. It’s good to know that Geo-Spatial, being Boustead’s cash cow, can continue to be milked and that the tap would continue to gush for many more years to come!]

[As for Real-Estate Solutions Division, note that FF Wong mentions that “quite a number” of DB&L projects are being negotiated, and are “near closing”. If we look at the announcement pipeline for this Division since the audiocast, there was only one announcement of a Design & Build contract worth S$23 million for Bell Helicopter; so I am guessing that these DB&L contracts are probably still under negotiation, and may be announced perhaps in August 2011 (if we look back at 2010 there was one D&B contract announced then as well as one DB&L)]

Question (Mr. KK Phua): When is the AGM held (the actual date)? I would like to make myself available to attend.

FF Wong: We have not actually fixed the date yet, but from our previous practice, it is likely to be end of July 2011.

Question: Do you foresee any further recognition of losses arising from the civil war in Libya?

FF Wong: We have done a complete review with our lawyers. We believe that our present recognition of losses and provisions should be sufficient but then again, of course, it is a long tedious process. We are not 100% sure but we are confident.

[Disappointingly, on June 24, 2011, Boustead announced that there was possibly another S$23.3 million worth of exposure for Libya as a result of a litigation involving corporate guarantees given by the Group. It seems that Libya is turning out to be a very painful and long drawn-out mistake for Boustead]

Question: Previously, you estimated the maximum Libyan exposure at $39.6 million. The provision this quarter is about $14 million. How do you view the risk of the other exposures? Would there be more provisions in the next financial year?

FF Wong: I think we just answered this question. There is about $24 to $25 million exposures in performance guarantees. We have altogether made $19.1 million provision for the whole financial year. We believe that is sufficient – as mentioned we have consulted our lawyers and have taken advice from them.

Question (Francis Teo): What is your opinion of the investment in Hankore (i.e. Bio-Treat) so far?

FF Wong: Our investment in Bio-Treat is relatively small, it’s only $4 million. We like the Management, and we have been interacting with them for nearly a year and we think that this new Management are sincere people and they are good in what they are doing. The only thing is they will be embarking on BOT projects. The business model is something which I always find not quite attractive for us, however, they have a huge network especially in China (in this industry). We feel that there is a need for them to make use of our expertise, and being associated with them will help us to open up opportunities in China, especially in areas where they do not have experience and expertise, especially in seawater desalination, pure water purification and also in industrial water treatment applications for power industries. Being associated with them, I think, is a good move.

[Somehow on Hankore, I feel that FF Wong may be investing that S$4 million more for “relationship management”, rather than through a rational and objective assessment of the business which yielded solid prospects for the business. From what I can observe from the Balance Sheet and Cash Flows of Hankore, it will probably be an uphill task for them to achieve decent profitability and sustain it through more than a few quarters. This is due to the BOT business model which requires huge upfront capex. Even though the investment is “only” S$4 million which is a paltry sum compared with Boustead’s cash hoard, it’s the principle of the matter and I certainly hope FF Wong does not let this S$4 million dwindle into something a lot less!]

Question (Desmond Wee): With regards to working capital requirements, what is a current ratio that Management is comfortable with?

FF Wong: Very good question! We are principally an engineering company. There are a lot of opportunities in this region, and some of these infrastructure projects are so attractive we would like to keep a healthy cash balance in the bank so that we can capture these opportunities as and when they occur. In other words, we are rather flexible here. I always maintain we would like to keep ourselves cash-rich so that we can capitalize on the opportunities available.

Question (Desmond Wee): Can you identify the investments made in 4Q FY 2011 (the $16 million non-controlling interest, $6.4 million trading investments and $1.5 million available-for-sale investments?

FF Wong: The $16 million I believe you are referring to the remaining 8.3% shareholding in Boustead Projects. With the acquisition of that interest, we will end up with 100% control in Boustead Projects. The $6.4 million trading investments are relating to the purchase of corporate bonds which give us a pretty attractive yield as compared to so much money sitting in the bank giving us 0.1% yield. And $1.5 million, these are the convertible bonds.

[A minor note here – FF Wong was very sharp to buy over the 8.3% stake as I believe he is aware that Boustead Projects is gearing up for greater things in time to come, so it’s good for Boustead to be able to consolidate 100% of the earnings instead of letting part of it be shared by the non-controlling interest. As for the corporate bond investments, it would be interesting to find out what is the blended coupon rate on this investments, and whether the risk of default is high on those bonds?]

Question: How’s the economics of design, build, lease, sell projects so far in terms of margins, return on capital etc?

FF Wong: It varies. For design, build, lease and sell projects, there isn’t any fixed margin per se. However, the economics (if I can understand you correctly) obviously it will be better for us if we are able to secure design and build projects that cater for MNCs, generally we will be able to get cap rate there when we sell out to the REITs or property trusts. You work on cap rate instead of design, build – that would be on the basis of EPC, generally your margin will be (of course it varies from) 10% to 20% these days, being so competitive. In the case of IBM, I think you can read from the Balance Sheet. Our investment was $46 million and we were able to re-sell it back to IBM for $68 million, so we net a profit of $22 million. So you can work out the economics, $22 million against $46 million is nearly 45-46%; so that depends on what base you use. If you use 68 as the base, then it’s 40-odd percent.

[Apparently, the margins are indeed pretty good if there is strong demand for a piece of property. On July 8, 2011, Boustead announced the sale of a yet-to-be-built strata divided building located at 61 Ubi Avenue 1 (incidentally, this is located beside Boustead House), for a cash consideration of S$38 million. It was not stated if Boustead was also responsible for building this, and what is their cost of building it]

Question: You said that you hope to leverage on Hankore’s network in China to land some projects (different kinds of projects). Would you consider EPC or would you consider collaborating with them on a BOT basis?

FF Wong: Most of the people would know that I am pretty negative about BOT, because the cash flow is just no good, and if you notice the Company emphasizes so much on cash flow. BOT is not the type of business model we prefer. Of course, there are exceptions. At the moment in China, it’s so competitive and there is so much money going around. It’s difficult to get BOT projects that would interest us. However, EPC yes, especially in areas that we can compete. I early on said desalination projects, demineralization projects, pure water projects, projects for more sophisticated applications where very few Chinese competitors have acquired the skill and the expertise (as well as the track records). We have been invited recently to bid for a water treatment project for nuclear power plant but unfortunately we are tied up here. We are working on a big project over here so we thought perhaps we will leave it to next time.

Question: Over the years, we have been talking about new areas which Boustead will be looking into. In fact, I think Boustead’s history has been checkered by a lot of hits and misses. This year we really had one big miss after what we thought had been a big hit back in FY 2007. I think everybody acknowledged that. Nevertheless, I always salute the spirit of the Boustead team when it comes to looking into new areas and ventures and executing them. At the moment it looks as if there seems to be very new ground that the Group is actively looking at. We have read in the various media through your interviews with magazines like The Edge that you have been busy looking for these new opportunities. Indonesia is actually one area, Vietnam is another area. If I remember correctly, in that interview, there has been some mention about looking at infrastructure projects that are resource-based in Indonesia. And also, I think, Boustead has a presence in Vietnam for quite a while now. Vietnam has always been {not audible}, notwithstanding the volatility of the currency. So would you care to update about two new markets? Indonesia and Vietnam and perhaps some other regions where there is something that is actually coming through materially. Also, on top of it, I was also looking at power plant potential in Indonesia. Could you elaborate on what you will be focusing on and will it be contributing to the current income meaning it could be BOO or just an EPC type of project?

FF Wong: It’s a very long question but I’ll try, I’ll try. First of all, Vietnam. We have secured a small project recently under Boustead Projects. It is a construction project – not very big but it’s the second one and going on pretty smoothly. That’s one; we’re still working on an interesting project. It is – I don’t want to be too specific, but we have been working on it for 2.5 years. We’ve been promised the project; it is a BOT project but though we have got supposedly all the approvals but the approval process is so long. Until today we haven’t been able to complete it. We were told that we definitely have secured the project but it’s not coming, so frankly I have lost a bit of interest there. I thought I had lost all interest but surprisingly, coincidentally, yesterday we had just been notified that the license had been issued. We need one final presentation on the technical arena. Our guy is going to Vietnam, Hanoi, next week and hope that this will be the last hurdle. But I can’t be sure exactly because in Vietnam, with the bureaucratic complexity. In Vietnam, we are still looking at a lot of other projects. I will not say “die”. Indonesia, we have been very active in Indonesia, especially myself, in the last year or so. Yes you are right, we are looking at infrastructure projects with respect to resources development, including mining. We hope that soon we will have some good news to share with you all. And these are the projects that will give you recurring income. It’s supposed to be closed yet not yet there, a bridge too far perhaps; let’s keep our fingers crossed. That’s all I can disclose to you. I would not let our setback in Libya deter us from venturing into countries which give us tremendous prospects. I do know that some of you who are not used to working in emerging economies, you may be frightened but it’s all a matter of matching your exposure. In the case of Libya, we were carried away with the early successes in Libya – in fact we were doing quite well in Libya. We had put in a lot of claims and the project team had also agreed and approved (supposedly) these claims to be submitted to the authorities. All of a sudden the war broke out – what can I do? Perhaps you can say that with respect to our Balance Sheet, we probably put a bit too much in Libya. We knew about that, however, which was why we brought down our equity participation from 65% to 35%, but the implementation (process) of transferring the money out just took too long, and the war just broke out. Have I answered the question(s)?

[From the reply above, it would seem that FF Wong has got quite a bit on his plate, but these various initiatives have yet to pan out successfully and thus he cannot elaborate more specifically on them due to their market-sensitive nature]

Question: But Mr. Wong, yeah yeah you have answered the questions. But let me put it this way, I think in businesses, it’s not always smooth sailing. So don’t get us wrong, as shareholders we know your team’s track record. As long as we can make good with 1 out of 5, I think that’s life, life just has to go on. No worries about that.

FF Wong: Thank you. But I think if you look at the presentation with Keith, you’ll notice in the last 7 years we have been able to achieve from 20% to 30.9% on your ROE. And that’s even with that sort of equity base which is inflated by the cash hoard. If we were to take the cash out, you would notice that our ROE has been very, very respectable.

Question: Yes, we have no doubt about that. Being shareholders in this company for coming close to 9-10 years, we have already seen the company growing from strength to strength. Let us be forward-looking in terms of what the recurrent business is actually showing, it’s already giving us quite a fair bit of comfort, and with your initiatives which have been put in, I think we definitely have good years to look forward to, as long as all the execution and processes have been well-contracted. That’s all I have to say. Thanks for all the efforts.

FF Wong: Thanks Choon Kiat.

Question: Sorry to bug on the current ratio, but I was thinking that the net cash position is a little misleading, since when the cash is removed, the current ratio falls to about 1, which seems tight. So I was wondering if Management can give a rough figure on what current ratio is comfortable for them, and how much of the cash is ready for deployment in investments?

KK Loh: Hi Desmond, this is KK Loh and I will take your question. If you dissect your analysis, let’s just have a common understanding. In the Balance Sheet, if you remove the cash, current assets will drop to $226 million; but correspondingly, for current liabilities you must remove the borrowings which will fall to $219 million, so the current ratio will be about 1.03. In our borrowings of facilities with the bank (credit facilities which were obtained from the bank), the bank is comfortable with a current ratio of 1. And in FY 2010, our current ratio was 1.78 and in FY 2011 it was 1.95; and dissecting the net cash position, it’s $184 million. But actually cash in the bank is $210 million, we net off $3.5 million of unsecured debt and long-term debt of $21.6 million which would not payable in one year. Looking at it we are quite comfortable, but you are asking is how comfortable we are with our current ratio. I think it all depends on whether we have enough facility to gear. If you can borrow to the hilt (the exposure), and you have good businesses, why not? But at the present moment, we are cash-rich so I think that is not our problem in terms of the ratio. Hope I answered your question. Thank you.

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Plans and Prospects for Boustead (based on audiocast)

1. There was not much mentioned about Energy-Related Engineering, and the press release itself alludes to high oil prices benefitting this division, though growth was not expected to be significant. It would seem that short of a significantly large M&A for this division, there would be limited growth and I expect it to just plod along. Though it is expected to be profitable, I cannot see any catalysts which could spur a jump or permanent spike in revenues and profitability as most of the revenue is contract-based and therefore lumpy. Assuming Boustead is able to re-structure all units successfully, perhaps the increased efficiencies and economies of scale could improve margins further for waste to energy projects, but let’s wait and see.

2. Notice that almost nothing was mentioned or asked about Salcon (Boustead’s water and wastewater division)? It seems that after announcing the termination of the project in Libya due to the civil unrest, Salcon has not come up with any meaningfully large contracts, or even small ones for that matter. Interest in this division has also gradually waned as the turnaround had probably taken too long and there is no confidence in the division being able to sustain profitability after the Libyan blip. I guess questions about Salcon would be reserved more for the AGM rather than the audiocast.

3. The Real-Estate Solutions Division appears to be headed in the right direction, with FF Wong alluding to more deals in the next few months and a build-up in Boustead’s recurrent income flow through more DB&L projects. The fact that Boustead Projects can cater to niche markets bodes well for the now 100%-owned subsidiary, as this means more projects of significant size and clout would raise its profile and create a positive feedback loop. It remains to be seen if the division can manage to scale new heights in terms of revenue and profit contribution, as a large portion of its contracts are “lumpy” as well; but with FF Wong’s assurance that he is building up the DB&L orderbook flow, this may mean that revenues and cash flows at Boustead Projects would become more stable, consistent and predictable. One positive side effect is that dividends may also increase as a result.

4. Geo-Spatial can be classified as a slow performer, and is usually under the radar when it comes to shareholders asking about Boustead’s performance. I guess it can be classified as the least “glamorous” of the 4 divisions and many (including myself) do not fully understand the technical aspects involved in this division’s services being provided. It is evidently the cash cow division of the Group as it has high barriers to entry, high gross margins and very healthy cash flows (as most of its customers are government agencies and thus have the ability to pay). In terms of projected growth, unless another good acquisition like Mapdata Pty Ltd comes along, I would expect a 5-10% slow but steady growth for this Division. I will not rule out a possible collaboration or M&A for this division though, knowing how Boustead can evolve and continue to leverage on emerging cutting-edge technologies to enhance the user experience (with whereto.sg being launched recently), I feel this division has the latent potential to grow further, just that it requires patience and time.

5. On the investment front, it appears that Bio-Treat’s investment in Hankore will be a very long-term strategic kind of partnership, as FF Wong himself alluded that he does not take too well to the “BOT” business model for Boustead itself; but is somehow willing to invest in a company which derives the majority of its revenues from BOT projects. Granted, Hankore does have many concessions in China and the most recent announcement from the Company was that it had inked a strategic cooperation agreement with the Xianyang City Environmental Protection Bureau and was granted the preferential right to invest in environmental projects with value not less than RMB 1 billion. At the same time, on July 13, 2011, Hankore also announced a new substantial shareholder Firstree Group Limited which purchased 338,374,474 shares (8.17%) at a price of 5 cents per share. This is 20% higher than Boustead’s 100 million share investment at 4 cents per share, and makes Firstree the second largest shareholder of the Company.

6. Boustead’s ongoing cash management program is seeing the Group invest in corporate bonds, and utilizing their idle cash to generate returns at least above inflation. While the exact returns are not known, my understanding is that they invest in short-term liquid corporate bonds which can give a decent yield; but which also probably have a probability of capital loss. It will be good for me to clarify this point with them during the upcoming AGM.

My analysis above is predicated on the fact that some queries need to be raised during the AGM, and more questions will probably need to be raised as well after browsing through the Annual Report 2011 in greater detail. But for now, these are my observations and my accompanying analysis of Boustead.