Tips, Rumours and Hearsay
Somehow, during a bull market, people have the amazing tendency to throw all caution to the wind and pump in ever-increasing amounts of money into equities. Most of this is due to misplaced over-confidence and a general feeling of euphoria. The title is apt in that bull markets generally involve all sorts of "stories" of companies doing this and that, and people seize on any little bit of news to pile into a counter and push it sky-high. In essence, these are the characteristics of a raging bull market !
Tips are so-called hand-me-downs by individuals who think they know more than they do, to people who wish to know more than they should ! Call it the blind leading the blind, but most of the time the provider of these tips himself got the tip from someone else, and so on. It's sort of like a chain email; no one knows where or how it originated but it is propagated anyway and somehow manages to spread like wildfire. Tips would include the next big thing (like alternative fuels, casinos, construction) to company-specific events like mergers/acquisitions and the like. The reason why people love tips is due to human psychology. We can't resist knowing something that someone else does not, and it gives us an inflated ego and a feeling of superiority that we have "beaten the crowd". In actuality, most tips are like hot vapour - they dissipate without leaving much trace.
Rumours are somehow even more insidious than tips, as most tips have some form of basis (however nebulous) to back them up. Rumours swirl in dark, dank drains and rise up like phantoms to conquer greedy and weak minds, forcing people to believe incredible things and react in unsettling ways. I have heard rumours of shares soaring to high heavens and impossible company turn-arounds. Such rumours are usually (90% of the time) unfounded and those who chase up their pipe dream may end up much poorer. The problem with rumours and tips is that it gets infectious if one initially makes money; this causes them to listen out (to their so-called "reliable source") for more tips in order to generate more money. Thus, the hole gets deeper and deeper and the poor person simply sinks in more and more into the quicksand.
Rampant speculation and impossible valuations characterise the current market, and to me personally, this is worrying and a major cause for concern. Looking at a market volume of 3 billion shares valued at around 1.5 billion dollars simply means that on average, people are churning shares worth $0.50 ! I've seen cases where historical PER has reached 1,200, yet people are still calling "buy" and stating higher target prices. Most of the pennies are in play and even the BT calls it "rotational plays", meaning stories float from one industry/company to another to trigger either panic buying or panic selling.
Whatever the case, one thing's for sure. The market now is more emotion-driven than I have ever seen, and this is also reflected in the forums I have been browsing through. More and more people comment on how easy it is to make money, boast about their supernormal gains and pat each other on the back for profiting on a hot tip. It's herd mentality and is a perfect example of "the madness of crowds" (see my previous post on this).
In such markets, value investors do the best thing they can do in such circumstances. They wait. If the market does not produce prices which are below intrinsic value, value investors will wait patiently till the right opportunity comes along. Fervent activity is not akin to intelligence if you do not know what you are doing, and taking a slothful approach may actually be better in such a rising market.
I did ask a friend recently who gave me a hot tip about Unionmet. When asked where the tip came from, she was unable to say except that her broker had recommended it. When further quizzed if Unionmet was a good buy based on objective research, she concluded that no research or reading had even been done. This practise is common but becomes more and more frequent as the market climbs higher and higher. Those who don't want to miss the rally quickly take fresh positions, not knowing that with each successive price rise, they are only increasing their risk and their potential losses; while limiting their gains.
Saturday, June 23, 2007
Thursday, June 21, 2007
Investment Mistakes Part 2 - Buying a company with limited growth prospects at high valuations
To continue with the series on personal investment mistakes, I will now candidly give my account of my investment in Yellow Pages. As most Singaporeans know, Yellow Pages is a company which deals with the printing and circulation of....Yellow Pages booklet (yes that phone book which usually collects dust in the drawer until it is needed, which is like quite seldom unless you are in the tele-marketing industry !). Yellow Pages (YP) also has the Internet Yellow Pages which allows users to surf and search for various locations and their respective phone numbers.
I had bought into the company on May 4, 2005 at a price of S$1.71 and sold out at a substantial loss of 15.8% of my capital at S$1.46 on May 27, 2005. Thus, it only took about 3 weeks for me to lose 15% of my capital, and this was my first experience with a stock that "crashed". The crash in market price was due to Yellow Pages announcing disappointing earnings and the fact that the outlook and prospects for the YP distribution was not bright. My mistake was in buying YP on the basis that it had surpassed S$2.00 before, thus it probably could happen again. That was my first HARD lesson that past price trends do not influence future price movements, as the market price of the company is based on earnings and the earnings were decreasing. Note: YP has NEVER surpassed S$2.00 since the time I sold, the lowest point was below $1.00 and YP is now involved in a boardroom tussle as this post is written.
On hindsight and after much analysis, I concluded that I had not conducted enough research into the company before buying. In fact, I had only about 6 months of investment experience then and I coolly thought that a "stable" company such as YP (I thought it was comparable to SingPost) would generate a decent return as well as dividend. Most readers who read my mistake number 1 on MCL Land will know not to buy a company purely for dividend, as this may indicate limited growth prospects.
In YP's case, the business model was not scalable and there were limited opportunities for it to grow its earnings organically. One option was to acquire but even then, there were no complementary businesses for it to acquire which would generate synergies and enable economies of scale (unlike vertically integrated companies like Olam and Pacific Andes). It was also in a "sunset" industry in that Yellow Pages was a printed booklet and most people were relying more and more on online help to locate buildings/phone numbers. In this day and age, bluetooth, blackberry devices and WAP-enabled phones which are able to access the Internet are commonplace and these are the leading edge which has taken the rug from YP's feet.
Lesson Learnt: Always do sufficient research on a company's industry and its business model to see if it can deliver sustainable growth in the next few years. Also, analyze its competitive edge and see if this can be sustained in the long-term. Now, I use a basic Porter's 5-Forces Model (to be elaborated in a future post on competitive advantage) to assess the company's industry and competitive landscape. This can help eliminate most companies as one can see the erosion of margins and competitive edge which will lead to eventual decrease in earnings. Also, one should stick within one's circle of competence, meaning only invest in companies in which you understand (e.g. an IT professional will understand the computer industry better, while an analyst at Shell may understand the oil and gas sector better). If the business model is too complex or hard to fathom, then it is better to avoid and adopt a wait and see attitude. A lot of new-age industries such as alternative fuels, nanotechnology and solar-energy cells are grabbing headlines now, but the question is will the earnings be sustainable 2-3 years from now ? Ask yourself that before sinking your money into the company.
Business Trip - June 26th to June 30th, 2007
I will be away to Vietnam on business during the above-stated dates. Thus, I will most likely not be able to blog on a daily basis unless I can really find time. Internet connections are not a problem to find in Vietnam but the issue is speed of connection, and frequency of disconnection. I will be back in time to do a June 2007 month-end portfolio review and companies' review.
Research on companies to invest in will only take place from August 2007 onwards, as I am re-organizing my finances after my honeymoon to assess my financial position. In the interim, I will only be taking up a new position in Pacific Andes through the rights issue. More details to be posted once the OIS is released on OPERA and mailed to myself.
To continue with the series on personal investment mistakes, I will now candidly give my account of my investment in Yellow Pages. As most Singaporeans know, Yellow Pages is a company which deals with the printing and circulation of....Yellow Pages booklet (yes that phone book which usually collects dust in the drawer until it is needed, which is like quite seldom unless you are in the tele-marketing industry !). Yellow Pages (YP) also has the Internet Yellow Pages which allows users to surf and search for various locations and their respective phone numbers.
I had bought into the company on May 4, 2005 at a price of S$1.71 and sold out at a substantial loss of 15.8% of my capital at S$1.46 on May 27, 2005. Thus, it only took about 3 weeks for me to lose 15% of my capital, and this was my first experience with a stock that "crashed". The crash in market price was due to Yellow Pages announcing disappointing earnings and the fact that the outlook and prospects for the YP distribution was not bright. My mistake was in buying YP on the basis that it had surpassed S$2.00 before, thus it probably could happen again. That was my first HARD lesson that past price trends do not influence future price movements, as the market price of the company is based on earnings and the earnings were decreasing. Note: YP has NEVER surpassed S$2.00 since the time I sold, the lowest point was below $1.00 and YP is now involved in a boardroom tussle as this post is written.
On hindsight and after much analysis, I concluded that I had not conducted enough research into the company before buying. In fact, I had only about 6 months of investment experience then and I coolly thought that a "stable" company such as YP (I thought it was comparable to SingPost) would generate a decent return as well as dividend. Most readers who read my mistake number 1 on MCL Land will know not to buy a company purely for dividend, as this may indicate limited growth prospects.
In YP's case, the business model was not scalable and there were limited opportunities for it to grow its earnings organically. One option was to acquire but even then, there were no complementary businesses for it to acquire which would generate synergies and enable economies of scale (unlike vertically integrated companies like Olam and Pacific Andes). It was also in a "sunset" industry in that Yellow Pages was a printed booklet and most people were relying more and more on online help to locate buildings/phone numbers. In this day and age, bluetooth, blackberry devices and WAP-enabled phones which are able to access the Internet are commonplace and these are the leading edge which has taken the rug from YP's feet.
Lesson Learnt: Always do sufficient research on a company's industry and its business model to see if it can deliver sustainable growth in the next few years. Also, analyze its competitive edge and see if this can be sustained in the long-term. Now, I use a basic Porter's 5-Forces Model (to be elaborated in a future post on competitive advantage) to assess the company's industry and competitive landscape. This can help eliminate most companies as one can see the erosion of margins and competitive edge which will lead to eventual decrease in earnings. Also, one should stick within one's circle of competence, meaning only invest in companies in which you understand (e.g. an IT professional will understand the computer industry better, while an analyst at Shell may understand the oil and gas sector better). If the business model is too complex or hard to fathom, then it is better to avoid and adopt a wait and see attitude. A lot of new-age industries such as alternative fuels, nanotechnology and solar-energy cells are grabbing headlines now, but the question is will the earnings be sustainable 2-3 years from now ? Ask yourself that before sinking your money into the company.
Business Trip - June 26th to June 30th, 2007
I will be away to Vietnam on business during the above-stated dates. Thus, I will most likely not be able to blog on a daily basis unless I can really find time. Internet connections are not a problem to find in Vietnam but the issue is speed of connection, and frequency of disconnection. I will be back in time to do a June 2007 month-end portfolio review and companies' review.
Research on companies to invest in will only take place from August 2007 onwards, as I am re-organizing my finances after my honeymoon to assess my financial position. In the interim, I will only be taking up a new position in Pacific Andes through the rights issue. More details to be posted once the OIS is released on OPERA and mailed to myself.
Wednesday, June 20, 2007
Pacific Andes Holdings - Rights Issue Details and Comments
Today was the day that PAH went Ex-Rights (XR), and the price has adjusted according to the formula (Market Price + Rights Price)/2. In this case, the previous day's close was $1.41, thus theoretically, the XR price should be $0.965 based on the formula. PAH closed at $1.04 today, thus there was a 7.5 cent premium to the theoretical XR price. Computed backwards, the pre-rights price would have been about $1.55, which is an all-time high.
This phenomenon can be explained by the fact that PAH and CFG are rapidly growing their business, and from a business analyst perspective (as all value investors should be), this means that over time, the intrinsic value of the business and company can only increase. Without taking into account EPS growth, we are still likely to see positive results as ROE increases and net margin improves due to economies of scale in having more fishing vessels. Thus, the rights issue has achieved its objective of raising funds to grow the business, and Mr. Market has correctly factored in PAH's growth potential.
With the XR, it is perhaps prudent to explain the relevant important key dates and their interpretations for all PAH shareholders and other interested parties.
Ex-Rights Date (20 June, 2007) - This represents the date at which buying the shares in PAH no longer entitles you to the 1:1 rights to buy the share at $0.52. Dates before this date are considered the Cum-Rights (CR) period.
Record Date (22 June, 2007) - This is the books closure and record date for determining shareholders' entitlements to the rights issue. This will be T+3 from the last CR date.
Rights Trading Period (27 June, 2007 to 05 July, 2007) - This is the period whereby the rights are traded on SGX. Shareholders who were entitled to receive rights during CR period are able to sell their rights or buy more during this period. The rights are called nil-paid rights during this interim period as they have not been converted into shares yet. If rights are purchased, the buyer must still fork out $0.52 per right to convert it to one PAH share.
Rights Closing Date (11 July, 2007) - This is the final day for the rights, after which each right will be converted to one share in PAH at a price of $0.52 per right share.
As far as I know, there are no admin or brokerage charges which are applicable to the subscription for rights (could someone correct me on this if I am wrong ?). Thus, all it takes is x number of shares X $0.52 to get the amount to be paid. PAH is supposed to send an Offer Information Statement (OIS) to all shareholders to formally announce the rights issue and to inform about the indicative timetable of events.
The price of the rights in the market has to be such that a person buying the rights is no better off than buying the mother share (i.e. PAH). Thus, at the closing price of $1.04 today, and with a rights conversion price of $0.52 per right share, the theoretical market price for the rights should be at least $0.52. If it exceeds this, then it is more logical to buy the mother share directly rather than the rights. Thus, the rights' market price should keep pace with the market price of the mother share, to the tune of the formula Rights Market Price = PAH Market Price minus Rights Conversion Price.
If the fundamentals of the business remain strong, the temporary EPS dilution will not be an issue as the earnings will eventually catch up with the larger share float. If margins improve and economies of scale are achieved, EPS dilution may be minimal and intrinsic value can be maintained or even improved.
For the avoidance of doubt, PAH is only CR and not CD yet, even though the dividend of S$0.54 cents per share (post-rights) has been announced. This is because the dividend has not been approved at the AGM yet. Thus, shareholders who buy during the XR period will still be eligible to get the dividend as the CD period has not begun yet.
Boustead - Purchase of Remaining 10% of Boustead International Heaters
Boustead announced today that it was buying up the remaining 10% in Boustead International Heaters, which is the heater and waste recovery business unit in Boustead. The purchase will be done over 4 instalments (you can read more about it on SGXNet) and the total puchase consideration is about S$6.7 million.
Boustead is continuing to buy up minority stakes in their subsidiary companies in order to enhance shareholder value as the earnings from these units can then be fully recognized. This is in line with their strategy of selling off non-core units and focusing on their core competency, which includes Salcon (water and wastewater treatement) and Boustead Projects (Industrial real-estate solutions). More will be written on Boustead closer to the AGM.
Today was the day that PAH went Ex-Rights (XR), and the price has adjusted according to the formula (Market Price + Rights Price)/2. In this case, the previous day's close was $1.41, thus theoretically, the XR price should be $0.965 based on the formula. PAH closed at $1.04 today, thus there was a 7.5 cent premium to the theoretical XR price. Computed backwards, the pre-rights price would have been about $1.55, which is an all-time high.
This phenomenon can be explained by the fact that PAH and CFG are rapidly growing their business, and from a business analyst perspective (as all value investors should be), this means that over time, the intrinsic value of the business and company can only increase. Without taking into account EPS growth, we are still likely to see positive results as ROE increases and net margin improves due to economies of scale in having more fishing vessels. Thus, the rights issue has achieved its objective of raising funds to grow the business, and Mr. Market has correctly factored in PAH's growth potential.
With the XR, it is perhaps prudent to explain the relevant important key dates and their interpretations for all PAH shareholders and other interested parties.
Ex-Rights Date (20 June, 2007) - This represents the date at which buying the shares in PAH no longer entitles you to the 1:1 rights to buy the share at $0.52. Dates before this date are considered the Cum-Rights (CR) period.
Record Date (22 June, 2007) - This is the books closure and record date for determining shareholders' entitlements to the rights issue. This will be T+3 from the last CR date.
Rights Trading Period (27 June, 2007 to 05 July, 2007) - This is the period whereby the rights are traded on SGX. Shareholders who were entitled to receive rights during CR period are able to sell their rights or buy more during this period. The rights are called nil-paid rights during this interim period as they have not been converted into shares yet. If rights are purchased, the buyer must still fork out $0.52 per right to convert it to one PAH share.
Rights Closing Date (11 July, 2007) - This is the final day for the rights, after which each right will be converted to one share in PAH at a price of $0.52 per right share.
As far as I know, there are no admin or brokerage charges which are applicable to the subscription for rights (could someone correct me on this if I am wrong ?). Thus, all it takes is x number of shares X $0.52 to get the amount to be paid. PAH is supposed to send an Offer Information Statement (OIS) to all shareholders to formally announce the rights issue and to inform about the indicative timetable of events.
The price of the rights in the market has to be such that a person buying the rights is no better off than buying the mother share (i.e. PAH). Thus, at the closing price of $1.04 today, and with a rights conversion price of $0.52 per right share, the theoretical market price for the rights should be at least $0.52. If it exceeds this, then it is more logical to buy the mother share directly rather than the rights. Thus, the rights' market price should keep pace with the market price of the mother share, to the tune of the formula Rights Market Price = PAH Market Price minus Rights Conversion Price.
If the fundamentals of the business remain strong, the temporary EPS dilution will not be an issue as the earnings will eventually catch up with the larger share float. If margins improve and economies of scale are achieved, EPS dilution may be minimal and intrinsic value can be maintained or even improved.
For the avoidance of doubt, PAH is only CR and not CD yet, even though the dividend of S$0.54 cents per share (post-rights) has been announced. This is because the dividend has not been approved at the AGM yet. Thus, shareholders who buy during the XR period will still be eligible to get the dividend as the CD period has not begun yet.
Boustead - Purchase of Remaining 10% of Boustead International Heaters
Boustead announced today that it was buying up the remaining 10% in Boustead International Heaters, which is the heater and waste recovery business unit in Boustead. The purchase will be done over 4 instalments (you can read more about it on SGXNet) and the total puchase consideration is about S$6.7 million.
Boustead is continuing to buy up minority stakes in their subsidiary companies in order to enhance shareholder value as the earnings from these units can then be fully recognized. This is in line with their strategy of selling off non-core units and focusing on their core competency, which includes Salcon (water and wastewater treatement) and Boustead Projects (Industrial real-estate solutions). More will be written on Boustead closer to the AGM.
Tuesday, June 19, 2007
The difficulty in valuing Global Voice
Global Voice is a technology company which is extremely difficult to value, in terms of intrinsic value. It rose from the ashes of Horizon through a reverse take-over, and has only recently sold off its unprofitable legacy businesses in order to focus on its core competency: Private Fibre Networks. Because it was loss-making for FY 2006, PER isn't an appropriate measure. In addition, the following factors about GV make it all the harder to value:-
1) Contract values are not stated in their announcements of deals signed due to confidentiality requirements. Apparently, this is common within the IT industry where other competitors may use such information to benchmark their pricing. Thus, most press releases only contain details of the customer and the services being provided, as well as a short commentary by the CEO or another executive.
2) Gross margins and net margins are not known for each contract. For that matter, we don't even know the number of staff to be deployed for each customer and how costs are shared. Also, there is the matter of "purchases" in the Profit and Loss (for FY 2006). Just what does this relate to ? Technically, GV has all the assets it needs, it just needs to deploy them and allocate manpower. Thus, I can understand staff costs and contracting costs, but what constitutes "purchases" ?
3) Contract durations are only occasionally mentioned, also probably because of confidentiality requirements. Without an inkling of how long a contract lasts, it will be impossible to determine the recurrence of revenue for a particular contract/customer. A helpful point here is that GV did mention most contracts are of the 3-5 year duration type, thus we can safely conclude that most of the contracts captured and announced in late FY 2006 and FY 2007 will be recurrent in nature.
4) The re-branding of GV a.k.a EuNetworks has led to a significant increase in sales force as well as marketing personnel. The exact payroll cost increase is difficult to ascertain as some of the sales staff may be on fixed wages, while others may be incentivized through commissions. Furthermore, part of the costs may include outsourced personnel to handle the data storage solutions which GV is implementing.
5) Since late FY 2006 and for FY 2007, GV has embarked on promotional activities to raise its profile and also incurred A&P for its extensive re-branding exercise. It is difficult to estimate the extent of A&P expenses incurred so far as most of these are held in countries such as Holland and Germany of which most locals are unfamiliar with. Also, GV has sponsored several events in order to speak about the company's capabilities, and thus necessarily incurs costs which may or may not result in greater brand awareness and subsequent contract wins.
6) Cash flows are uncertain as well. In order to estimate intrinsic value, some value investors employ DCF methods which estimate a stream of cash inflows and outflows to the present. The only certain cash outflow is the interest expense of the convertible bonds of EUR 40 million. The coupon rate is 3% paid semi-annually which means an interest expense of about EUR 0.6 million every half-yearly (19 April and 19 October). Most of the deals mentioned are silent over the cash flow stream, meaning that the reader will not know the mode of payment arrangement between GV and the customer. This fuels further uncertainty.
The above factors serve to highlight the difficulty in assigning an intrinsic value to GV. Currently, the market price is hovering between 19 and 20 cents and this is the only indication of the "value" of GV, though I have alwqays reiterated that price seldom equals value. For those who are astutely wondering why the price is stagnant even though so many deals have been announced, the above 6 reasons should serve as a good guide.
Simply put, the market simpy DOES NOT KNOW what to expect from GV, and how to value such a company as there is no close equivalent of GV within the SGX. I have not done any research to find out if there are similar companies listed in Europe which can be used to benchmark against GV, but the uniqueness of their business model should be taken into account as well. Thus, there may not be any close comparables at all. Contributions are welcome if they are pertinent (just type it into the "comments" column, I will always read and reply).
The best thing to do now will be to wait for the HY 2007 results to be released in late August 2007. This will give an idea of GV's revenue growth as well as profit margins (assuming they are profitable). Hopefully too, the CEO and Chairman can shed more light on the uncertainties which I had highlighted and give some guidance on the future of the company in the next 3 years or so.
Global Voice is a technology company which is extremely difficult to value, in terms of intrinsic value. It rose from the ashes of Horizon through a reverse take-over, and has only recently sold off its unprofitable legacy businesses in order to focus on its core competency: Private Fibre Networks. Because it was loss-making for FY 2006, PER isn't an appropriate measure. In addition, the following factors about GV make it all the harder to value:-
1) Contract values are not stated in their announcements of deals signed due to confidentiality requirements. Apparently, this is common within the IT industry where other competitors may use such information to benchmark their pricing. Thus, most press releases only contain details of the customer and the services being provided, as well as a short commentary by the CEO or another executive.
2) Gross margins and net margins are not known for each contract. For that matter, we don't even know the number of staff to be deployed for each customer and how costs are shared. Also, there is the matter of "purchases" in the Profit and Loss (for FY 2006). Just what does this relate to ? Technically, GV has all the assets it needs, it just needs to deploy them and allocate manpower. Thus, I can understand staff costs and contracting costs, but what constitutes "purchases" ?
3) Contract durations are only occasionally mentioned, also probably because of confidentiality requirements. Without an inkling of how long a contract lasts, it will be impossible to determine the recurrence of revenue for a particular contract/customer. A helpful point here is that GV did mention most contracts are of the 3-5 year duration type, thus we can safely conclude that most of the contracts captured and announced in late FY 2006 and FY 2007 will be recurrent in nature.
4) The re-branding of GV a.k.a EuNetworks has led to a significant increase in sales force as well as marketing personnel. The exact payroll cost increase is difficult to ascertain as some of the sales staff may be on fixed wages, while others may be incentivized through commissions. Furthermore, part of the costs may include outsourced personnel to handle the data storage solutions which GV is implementing.
5) Since late FY 2006 and for FY 2007, GV has embarked on promotional activities to raise its profile and also incurred A&P for its extensive re-branding exercise. It is difficult to estimate the extent of A&P expenses incurred so far as most of these are held in countries such as Holland and Germany of which most locals are unfamiliar with. Also, GV has sponsored several events in order to speak about the company's capabilities, and thus necessarily incurs costs which may or may not result in greater brand awareness and subsequent contract wins.
6) Cash flows are uncertain as well. In order to estimate intrinsic value, some value investors employ DCF methods which estimate a stream of cash inflows and outflows to the present. The only certain cash outflow is the interest expense of the convertible bonds of EUR 40 million. The coupon rate is 3% paid semi-annually which means an interest expense of about EUR 0.6 million every half-yearly (19 April and 19 October). Most of the deals mentioned are silent over the cash flow stream, meaning that the reader will not know the mode of payment arrangement between GV and the customer. This fuels further uncertainty.
The above factors serve to highlight the difficulty in assigning an intrinsic value to GV. Currently, the market price is hovering between 19 and 20 cents and this is the only indication of the "value" of GV, though I have alwqays reiterated that price seldom equals value. For those who are astutely wondering why the price is stagnant even though so many deals have been announced, the above 6 reasons should serve as a good guide.
Simply put, the market simpy DOES NOT KNOW what to expect from GV, and how to value such a company as there is no close equivalent of GV within the SGX. I have not done any research to find out if there are similar companies listed in Europe which can be used to benchmark against GV, but the uniqueness of their business model should be taken into account as well. Thus, there may not be any close comparables at all. Contributions are welcome if they are pertinent (just type it into the "comments" column, I will always read and reply).
The best thing to do now will be to wait for the HY 2007 results to be released in late August 2007. This will give an idea of GV's revenue growth as well as profit margins (assuming they are profitable). Hopefully too, the CEO and Chairman can shed more light on the uncertainties which I had highlighted and give some guidance on the future of the company in the next 3 years or so.
Monday, June 18, 2007
Ezra Holdings Limited - An Update and Commentary
Ezra Holdings (Ezra) recently announced that it had been awarded a contract by oil giant ConocoPhillips for its heavy-lift accommodation pipelaying vessel Lewek Champion. This event in itself is significant in that it symbolically represents a shift towards deep-water exploration, with this vessel (slated to be delivered before the end of FY 2007) being the first designed for deep-water. Although the press release did not mention the contract value, it stated that the charter contract would "contribute positively" to earnings in Fy 2008.
A little note here for the reader - I have emailed to the Management of Ezra and accordingly received a reply regarding how the chartering system works. Apparently, Ezra projects vessel usage up to 3 years in advance and now the expected shift seems to be towards deep-water capable vessels; hence the recent order of a 2nd pipe-laying vessel and 2 ultra-large 30,000 bhp Rolls Royce AHTS. Ezra will identify the charter party before any any vessel orders are placed, and the charter contract can only be signed close to the vessel completion date as there may be damages incurred if the contract is signed too early, but the vessel is delayed in the shipyard. It is therefore safe to conclude that by ordering these new vessels for FY 2009, Ezra's Management has already identified potential charter parties who have expressed interest in chartering the new vessels once they come on board.
Thus far, Ezra has only ordered 3 vessels for FY 2009 to fuel its expansion. This is a tiny number when compared to the 10+ vessels coming on board in FY 2007, and my expectation is that the company will identify more charter parties in order to place more orders to increase their fleet size. Another option is stated below which I will elaborate on later. Suffice to say that net gearing has remained at about 0.6x (based on Feb 28, 2007 balance sheet) and the company does not have the habit of doing share placements which will dilute existing shareholder's interests. Thus, it will probably embark on yet another round of sale and leaseback in order to remain asset-light.
Nylect Technologies
The 21.83% acquisition of Nylect Technologies also raises questions on whether this associated company can contribute positively to earnings, considering they only managed to turn around in Fy 2006 with a small profit of S$274,000. The speculation surrounding Nylect has been nothing short of spectacular, as the company is now trading at about S$1.21, effectively valuing the company at an astounding and mind-bloggling historical PER of 1,090 !! The share price rise has been nothing short of speculative as the company needs to increase earnings by 72.6 times just to get the PER down to 15. That means the company needs to have profits of S$19.8 million to justify the current share price. It is known that EOC is contracting with Nylect to provide services, but it remains to be seen if Nylect can achieve this kind of astounding growth of7,200%.
Reuters Interview - June 7, 2007
On a different note, Reuters had an interview with the MD of Ezra Mr. Lionel Lee and the essence of the interview can be found at this link. The interview is interesting in that it presents, for the first time, information on how Ezra plans to expand into the Western hemisphere. The MD talks about an acquisitive strategy which involves buying firms with a foothold in the Gulf of Mexico, Brazil, North Sea and West Africa. These firms should be entrenched players who already have their own fleet of vessels which can complement Ezra's capabilities. Also, he talks about using debt as a form of financing which means the net gearing for Ezra is likely to rise. If notes or bonds are issued, this would mean higher interest costs in the near-term which may also impact profitability. Thus, the important issue is how much Ezra pays for the acquisition(s), and whether they are earnings-accretive enough to justify the price offered. Other qualitative factors to look at would be the reputation of the company, its fleet, its network, customer base and if it has any competitive advantages. I trust that Ezra's Management would carefully consider these factors before making a purchase, and I remain optimistic that they would be able to grow the company in this way.
The rest of the interview is pretty self-explanatory, but it is worth noting that Mr. Lee said that there are 3 years of visible strong demand for deep-water vessels. Thus, the company would be projecting for such growth up to 3 years in advance. Ezra is gearing itself to become a global player and for this to happen, Ezra must expand its asset base significantly and also clinch more FPSO contracts, in order to put in at least slightly on par with global giants such as Prosafe and Haliburton. Although that may still be a long way to go, it is achievable if the company has a strategic vision moving forward into the next 5 years.
In the meantime, there is still the issue of the bonus; of which the company is preparing a circular to send to its shareholders. The EGM will be held in due course once the circular is despatched.
Ezra Holdings (Ezra) recently announced that it had been awarded a contract by oil giant ConocoPhillips for its heavy-lift accommodation pipelaying vessel Lewek Champion. This event in itself is significant in that it symbolically represents a shift towards deep-water exploration, with this vessel (slated to be delivered before the end of FY 2007) being the first designed for deep-water. Although the press release did not mention the contract value, it stated that the charter contract would "contribute positively" to earnings in Fy 2008.
A little note here for the reader - I have emailed to the Management of Ezra and accordingly received a reply regarding how the chartering system works. Apparently, Ezra projects vessel usage up to 3 years in advance and now the expected shift seems to be towards deep-water capable vessels; hence the recent order of a 2nd pipe-laying vessel and 2 ultra-large 30,000 bhp Rolls Royce AHTS. Ezra will identify the charter party before any any vessel orders are placed, and the charter contract can only be signed close to the vessel completion date as there may be damages incurred if the contract is signed too early, but the vessel is delayed in the shipyard. It is therefore safe to conclude that by ordering these new vessels for FY 2009, Ezra's Management has already identified potential charter parties who have expressed interest in chartering the new vessels once they come on board.
Thus far, Ezra has only ordered 3 vessels for FY 2009 to fuel its expansion. This is a tiny number when compared to the 10+ vessels coming on board in FY 2007, and my expectation is that the company will identify more charter parties in order to place more orders to increase their fleet size. Another option is stated below which I will elaborate on later. Suffice to say that net gearing has remained at about 0.6x (based on Feb 28, 2007 balance sheet) and the company does not have the habit of doing share placements which will dilute existing shareholder's interests. Thus, it will probably embark on yet another round of sale and leaseback in order to remain asset-light.
Nylect Technologies
The 21.83% acquisition of Nylect Technologies also raises questions on whether this associated company can contribute positively to earnings, considering they only managed to turn around in Fy 2006 with a small profit of S$274,000. The speculation surrounding Nylect has been nothing short of spectacular, as the company is now trading at about S$1.21, effectively valuing the company at an astounding and mind-bloggling historical PER of 1,090 !! The share price rise has been nothing short of speculative as the company needs to increase earnings by 72.6 times just to get the PER down to 15. That means the company needs to have profits of S$19.8 million to justify the current share price. It is known that EOC is contracting with Nylect to provide services, but it remains to be seen if Nylect can achieve this kind of astounding growth of7,200%.
Reuters Interview - June 7, 2007
On a different note, Reuters had an interview with the MD of Ezra Mr. Lionel Lee and the essence of the interview can be found at this link. The interview is interesting in that it presents, for the first time, information on how Ezra plans to expand into the Western hemisphere. The MD talks about an acquisitive strategy which involves buying firms with a foothold in the Gulf of Mexico, Brazil, North Sea and West Africa. These firms should be entrenched players who already have their own fleet of vessels which can complement Ezra's capabilities. Also, he talks about using debt as a form of financing which means the net gearing for Ezra is likely to rise. If notes or bonds are issued, this would mean higher interest costs in the near-term which may also impact profitability. Thus, the important issue is how much Ezra pays for the acquisition(s), and whether they are earnings-accretive enough to justify the price offered. Other qualitative factors to look at would be the reputation of the company, its fleet, its network, customer base and if it has any competitive advantages. I trust that Ezra's Management would carefully consider these factors before making a purchase, and I remain optimistic that they would be able to grow the company in this way.
The rest of the interview is pretty self-explanatory, but it is worth noting that Mr. Lee said that there are 3 years of visible strong demand for deep-water vessels. Thus, the company would be projecting for such growth up to 3 years in advance. Ezra is gearing itself to become a global player and for this to happen, Ezra must expand its asset base significantly and also clinch more FPSO contracts, in order to put in at least slightly on par with global giants such as Prosafe and Haliburton. Although that may still be a long way to go, it is achievable if the company has a strategic vision moving forward into the next 5 years.
In the meantime, there is still the issue of the bonus; of which the company is preparing a circular to send to its shareholders. The EGM will be held in due course once the circular is despatched.
Sunday, June 17, 2007
Mid-June 2007 Portfolio Review
Dear readers, I am back from my honeymoon in Europe ! Was jetlagged the entire Sunday and slept from noon till about 8 p.m. (I feel like someone hit me in the head !). Now, my body clock is still that of Amsterdam and I think it will persist for a few days to come.....sianz.
Anyhow, imagine my surprise when I discovered that so much had happened to my companies while I was gone (and it's only been about 13 days !). I will now proceed with my review, more details for each company will be mentioned in future posts regarding the new events.
1) Ezra - Buy Price $1.30 (bonus adjusted), Market Price $5.65, gain 334%. On June 11, 2007, the company announced that it had been awarded a contract by ConocoPhillips for its deepwater heavy-lift accommodation pipelay vessel Lewek Champion. The vessel is expected to be delivered before end FY 2007 and the charter will commence in 1HFY 2008. An email to Ezra's Managment has confirmed that most charter contracts will be signed close to the date at which the vessel is slated for completion. I will discuss more of this and my email to the Management in a later post (there was also an interview done by MD Mr. Lionel Lee to Reuters on June 7, 2007).
2) Boustead - Buy Price $1.295 (average), Market Price $2.03, gain 56.8%. No new updates for Boustead. I am mainly waiting for the Annual Report and AGM to arrive.
3) Swiber - Buy Price $1.01, Market Price $2.33, gain 130.7%. Swiber has recently announced (on June 11) that it had signed an MOU with a Middle-Eastern company called Emirates Investment Group L.L.C. (EIG) to form a 50:50 joint venture in order to explore EPCIC activities within the Middle East. What's significant about this MOU is that the business contacts and market understanding which EIG has, and how it will act as a foothold for Swiber to explore lucrative opportunities in the Middle Eastern countries, including Pakistan. DBS has joined in the fray to upgrade this company with a TP of $2.76, while Westcomb has derived a TP of $3.00. For the life of me, I wonder how they come up with such TP when the company has not even signed a contract within Middle East ! Their projections for intrinsic value seem to come from the air, and I am not inclined to believe any prices set (I just read the reports for the facts). Intrinsic value remains relatively unchanged for now, except to factor in a slight premium for the company for its strategic tie-up. More to be said in a separate posting in future too.
4) Global Voice - Buy Price $0.1775 (average), Market Price $0.195, gain 9.9%. On June 6, 2007, GV concluded another agreement with a Dutch company called Illian Networks B.V. On June 13, 2007, they announced the appointment of a new Vice-President of Network Operations, Mr. Charles Cernicky. The announcement details can be found on the company's website. An email sent to the Management was met with no reply so far, so I question the so-called "efficiency" of their investor relations department.
5) Suntec REIT - Buy Price $1.11, Market Price $2.05, gain 84.7%. No significant updates for this REIT, which is well and good since there's so much updating to do for my other companies hehe.
6) Pacific Andes - Buy Price $0.81, Market Price $1.44, gain 77.8%. The China Fishery Group has purchased another 5 purse seine vessels on June 11, 2007, bringing their total number of vessels to 34 with a fish hold capacity of 9,395 square metres. CFG have been very aggressively acquiring vessels and assets since the issue of their senior notes due 2013. It is good to know that the Management is very pro-active in securing a foothold in Peru through these acquisitions, and it is hoped too that they are earnings-accretive acquisitions. At this point, it is rather difficult to assess the intrinsic value of PAH and Mr. Market has decided that he wishes to offer a better price for PAH recently, thus the spike up to $1.50. Patience rewards the rational investor, and I hope to see more good news flowing from CFG and PAH in time to come to benefit shareholders.
Overall Portfolio
My overall portfolio has increased by 106.7% from cost to date. I attribute this partly to bullish sentiments as the STI had a record close of 3,581.16 on June 15, 2007. The important thing is for my companies to keep being pro-active in order to grow earnings and the business, and even on my trip (during long journeys in the coach), I was thinking about my companies' business models, their competitive advantages and their customers and how it all gelled together. I will be talking about competitive advantages and a little about Porter's 5-forces model of analysis for companies soon, so stay tuned for that !
My next portfolio review will be on June 29th (last trading day for June 2007).
P.S. - I did not visit any European bourses though I did pass through the financial district of Belgium and Holland. What I did notice though, was the prevalence of banks such as ABN Amro, Citibank, CIC and Fortis. I also noticed the amazing amount of chocolate in my lap, which I was busy finishing up. Keke.
Tuesday, June 05, 2007
China Fishery - Acquisition of Panamanian Companies in Peru
Yesterday, China Fishery announced another strategic acquisition in Peru. They have acquired 2 Peruvian fishmeal producers with assets which include fishing vessels, fishmeal plants, canning plant and a dock. The total consideration is US$26 million, which is a US$5 million discount to the appraised market value of the assets at US$31 million done by an independent valuer.
With this acquisition, China Fishery (and thus Pacific Andes which is going to recognize 63.9% of the profits from CFG) has increased its fishmeal combined processing capabilities to 442 tonnes per hour, and it now has 29 purse seine vessels (up from the preious 26 in my last posting). The vessels total capacity is 8,419 cubic metres and represent 5% of the total fishmeal processing capability of Peru currently.
This acquisition is notably different from the previous ones in that the assets acquired are more diversified (rather than just supertrawlers or purse seine vessels). The canning facility is of note as it will allow for CFG to produce Peruvian anchovies as canned sardines for sale to consumers. As this specie is highly regenerative, there is no immediate danger of extinction for the species and this represents a highly lucrative income source for CFG and PAH. CFG also plans to start harvesting more of the under-utilized fish species in order to broaden their product range and offerings.
Peru will act as CFG's logistical base in South America and allow CFG and PAH to get a foothold in the Exclusive Economic Zone, where the government has already halted the issue of new licences for fishing. Thus, licences can only be obtained by purchase from existing Peruvian companies, hence PAH/CFG's strategy. They are simply continuing their vertical integration strategy by acquiring more control over the production/catch aspect, in order to boost the capacity in their fishmeal plants. Thus, it is an entire SCM system whereby catch increases, processing facilities increase (for fishmeal) and new product lines are also introduced.
So far for FY 2007 (for CFG), they have been embarking on an aggressive expansion plan to set up base in the South Pacific and to increase their processing and catch volume. Below are a list of the announcements made so far for FY 2007:-
1) December 27, 2006 - CFG acquires 2 fishing vessels to bring their purse seine vessel fleet to 18.
2) January 4, 2007 - Third VOA signed to add 3 supertrawlers to their fleet, boosting their number to 17. Total harvest will be no less than 210,000 tonnes of fish.
3) January 24, 2007 - Fourth VOA signed with Perun Limited, adding another 7 supertrawlers to their fleet and bringing the total number to 24. Total harvest has increased to become no less than 270,000 tonnes of fish.
4) March 15, 2007 - Acquires 4 more purse seine vessels bringing total fishing fleet to 23. Fish hold capacity increases to 6,671 cubic metres.
5) May 22, 2007 - Acquires 3 more purse seine vessels bringing total fleet to 26. Fish hold capacity increases to 7,363 cubic metres.
6) June 4, 2007 - Acquires 3 more purse seine vessels, total fleet now 29. Fish hold capacity increases to 8,419 cubic metres. Also acquires fishmeal processing plants (from 4 to 6 currently), one canning plant, a 200-metre dock and related fishing permits.
These 6 announcements show CFG's aggressive growth strategy to increase their fishing fleet which includes supertrawlers (VOA-related) and purse seine vessles (fishmeal related). I project that there will be more acquisitions to come in order to boost their fleet and to entrench themselves as one of the dominant players in the market. PAH can only stand to benefit from this as CFG's earnings will grow strongly. Currently, the terms of the 4th VOA are also being restructured. Once that is successful, margins are expected to increase. I am hoping for a net margin of 10% for PAH eventually.
Honeymoon from 6 June to 17 June, 2007 - Hiatus from the Stock Market
As readers may already know, my honeymoon starts from 6 June (midnight) till 17 June (early morning). I will be travelling to several parts of Europe, in an effort to study the various bourses and stock markets throughout Europe including the Amsterdam Exchange, FTSE and Parisian Exchange.
Gotcha ! No way, I was just kidding ! haha anyhow I will NOT be posting for these 2 weeks. Any announcements from my companies will have to be put on hold till I am back before I can analyze them; and my mid-June review of my portfolio will have to wait till 17 or 18th June.
Wishing myself a pleasant flight ! Hehe.
Yesterday, China Fishery announced another strategic acquisition in Peru. They have acquired 2 Peruvian fishmeal producers with assets which include fishing vessels, fishmeal plants, canning plant and a dock. The total consideration is US$26 million, which is a US$5 million discount to the appraised market value of the assets at US$31 million done by an independent valuer.
With this acquisition, China Fishery (and thus Pacific Andes which is going to recognize 63.9% of the profits from CFG) has increased its fishmeal combined processing capabilities to 442 tonnes per hour, and it now has 29 purse seine vessels (up from the preious 26 in my last posting). The vessels total capacity is 8,419 cubic metres and represent 5% of the total fishmeal processing capability of Peru currently.
This acquisition is notably different from the previous ones in that the assets acquired are more diversified (rather than just supertrawlers or purse seine vessels). The canning facility is of note as it will allow for CFG to produce Peruvian anchovies as canned sardines for sale to consumers. As this specie is highly regenerative, there is no immediate danger of extinction for the species and this represents a highly lucrative income source for CFG and PAH. CFG also plans to start harvesting more of the under-utilized fish species in order to broaden their product range and offerings.
Peru will act as CFG's logistical base in South America and allow CFG and PAH to get a foothold in the Exclusive Economic Zone, where the government has already halted the issue of new licences for fishing. Thus, licences can only be obtained by purchase from existing Peruvian companies, hence PAH/CFG's strategy. They are simply continuing their vertical integration strategy by acquiring more control over the production/catch aspect, in order to boost the capacity in their fishmeal plants. Thus, it is an entire SCM system whereby catch increases, processing facilities increase (for fishmeal) and new product lines are also introduced.
So far for FY 2007 (for CFG), they have been embarking on an aggressive expansion plan to set up base in the South Pacific and to increase their processing and catch volume. Below are a list of the announcements made so far for FY 2007:-
1) December 27, 2006 - CFG acquires 2 fishing vessels to bring their purse seine vessel fleet to 18.
2) January 4, 2007 - Third VOA signed to add 3 supertrawlers to their fleet, boosting their number to 17. Total harvest will be no less than 210,000 tonnes of fish.
3) January 24, 2007 - Fourth VOA signed with Perun Limited, adding another 7 supertrawlers to their fleet and bringing the total number to 24. Total harvest has increased to become no less than 270,000 tonnes of fish.
4) March 15, 2007 - Acquires 4 more purse seine vessels bringing total fishing fleet to 23. Fish hold capacity increases to 6,671 cubic metres.
5) May 22, 2007 - Acquires 3 more purse seine vessels bringing total fleet to 26. Fish hold capacity increases to 7,363 cubic metres.
6) June 4, 2007 - Acquires 3 more purse seine vessels, total fleet now 29. Fish hold capacity increases to 8,419 cubic metres. Also acquires fishmeal processing plants (from 4 to 6 currently), one canning plant, a 200-metre dock and related fishing permits.
These 6 announcements show CFG's aggressive growth strategy to increase their fishing fleet which includes supertrawlers (VOA-related) and purse seine vessles (fishmeal related). I project that there will be more acquisitions to come in order to boost their fleet and to entrench themselves as one of the dominant players in the market. PAH can only stand to benefit from this as CFG's earnings will grow strongly. Currently, the terms of the 4th VOA are also being restructured. Once that is successful, margins are expected to increase. I am hoping for a net margin of 10% for PAH eventually.
Honeymoon from 6 June to 17 June, 2007 - Hiatus from the Stock Market
As readers may already know, my honeymoon starts from 6 June (midnight) till 17 June (early morning). I will be travelling to several parts of Europe, in an effort to study the various bourses and stock markets throughout Europe including the Amsterdam Exchange, FTSE and Parisian Exchange.
Gotcha ! No way, I was just kidding ! haha anyhow I will NOT be posting for these 2 weeks. Any announcements from my companies will have to be put on hold till I am back before I can analyze them; and my mid-June review of my portfolio will have to wait till 17 or 18th June.
Wishing myself a pleasant flight ! Hehe.
Sunday, June 03, 2007
Projecting Growth - Not as easy as it seems
True be told, I didn't really know how to title this post, so I just left is as "not as easy as it seems" ! The main crux of this post is to explain how growth works for a company and how many people may over or under-estimate the growth of a company's revenues (top-line) and earnings (profits or bottom-line).
First, the basics. Growth of a company is what drives its top and bottom line to better performance every quarter/half-yearly, and this in turn drives up its share price as share prices are correlated to the valuation of a company (based either on DCF, PER or Sum of parts analysis). When we say "growth", it's not just growth based on recycling cash or capital, but also to grow owner's earnings based on actual increases in sales or through yield-accretive acquisitions. This is where it gets murky....some companies claim superlative growth over a period of 2-3 years but sometimes this is at the expense of shareholders. Some companies over-leverage and cause their debt to mushroom using growth as an excuse, while others do endless placements and/or rights to increase their equity base and further dilute existing shareholders. Thus, there is "growth" but this does not add to shareholder's value.
Strictly speaking, growth consists of 2 types: organic and through acquisitions. Organic growth works for most companies, in which they expand their customer base, get more sales and make more money ! While it may sound deceptively simple, growth does not come easily as most of the time, expanding customers and entering new territories incurs higher costs and there may be significant barriers to entry. From a marketing perspective, entering new markets or expanding existing product lines always carries a certain risk: that of lower sales and higher costs. Thus, be very careful of companies which claim to increase their production capacity, because this may not always mean higher sales and higher profits. In fact, increase of production should come with increased demand and the manufacturer should have a certain level of pricing power. Otherwise, as the market for the product matures, more entrants come in and drive down prices through competition. The result is that the capacity increase will come at a high cost: that of declining margins. Frequently, I have seen companies in "commodity" industries such as chips and PCB boards suffer from declining profits even as their sales grew. This is due to the margin erosion effect which cannot be effectively eliminated through economies of scale.
The other option is for a company to grow through acquisitions. One immediate example is Olam International Limited, an SGX listed company which deals with the SCM business of distributing foodstuffs ike peanuts and coffee beans. They are vertically integrated and cover the entire supply chain of production, distribution and selling. Recently, Olam was involved in a tussle with Louis Dreyfuss to buy over Queensland Cotton, with the bids getting increasingly higher at A$5.80 per share. The outcome is as yet unknown but one must ask: what price does Olam have to offer to make the deal unattractive ? The problem with growing through acquisitions is that a "fit" needs to be obtained. Frequently, acquisitions or mergers involve staff from different companies with different cultures, which may result in problems. Take the example of Daimler-Chrysler in which the Chysler unit was never profitable after the merger (it was eventually sold off just recently). Other notable Singaporean examples include Osim's acquisition of Brookstone which has dragged down the company due to the high debt financing the company had to undertake, coupled with losses incurred in the USA-based unit. Growth through acquisitions is therefore fraught with risks and uncertainties and I do not understand why shareholders get so amazingly excited when an acquisition is announced, as the merits of the acquisition have to be reviewed objectively before one can conclude if it is indeed "great news" for the existing shareholders.
Growth which is too swift also tends to fizzle out after a while. A lot of companies can report superb earnings growth for 1 year, maybe 2; but how many can consistently grow their earnings over a period of say 5-10 years ? The volatile nature of business these days means that shareholders are stepping on a minefield when it comes to expecting growth every quarter. Take UTAC for example, after 14 consecutive quarters of growth, it suffered its first quarterly decline in revenue of 2.4%. This is due in part to the uncertainty and cyclical nature of the industry. A shareholder thus has to sit back and think about the business: will it be able to sustain a consistent growth track record over a long period of time ? If not, then value investing dictates that this may not be a good long-term investment. The ability of a company to weather the storms depends on the nature of its business, its Management as well as the competitive advantage it commands.
For myself, I go for companies with consistent growth rather than superlative short-term growth. Examples I can think of are Pacific Andes and Boustead. Pacific Andes has steadily increased their revenues and profits through a series of acquisitions, as well as organic growth (though at the expense of higher gearing). Boustead has a 5-year track record of increased revenues and earnings ever since CEO F.F.Wong turned the company around in FY 2002 by selling off unprofitable units and steering and focusing on the company core competencies. His strategic vision has also, in part, contributed to the strong and steady growth of the company. These are companies which I feel comfortable investing in for 3-5 years, and which are more likely to survive a recession should one come along.
True be told, I didn't really know how to title this post, so I just left is as "not as easy as it seems" ! The main crux of this post is to explain how growth works for a company and how many people may over or under-estimate the growth of a company's revenues (top-line) and earnings (profits or bottom-line).
First, the basics. Growth of a company is what drives its top and bottom line to better performance every quarter/half-yearly, and this in turn drives up its share price as share prices are correlated to the valuation of a company (based either on DCF, PER or Sum of parts analysis). When we say "growth", it's not just growth based on recycling cash or capital, but also to grow owner's earnings based on actual increases in sales or through yield-accretive acquisitions. This is where it gets murky....some companies claim superlative growth over a period of 2-3 years but sometimes this is at the expense of shareholders. Some companies over-leverage and cause their debt to mushroom using growth as an excuse, while others do endless placements and/or rights to increase their equity base and further dilute existing shareholders. Thus, there is "growth" but this does not add to shareholder's value.
Strictly speaking, growth consists of 2 types: organic and through acquisitions. Organic growth works for most companies, in which they expand their customer base, get more sales and make more money ! While it may sound deceptively simple, growth does not come easily as most of the time, expanding customers and entering new territories incurs higher costs and there may be significant barriers to entry. From a marketing perspective, entering new markets or expanding existing product lines always carries a certain risk: that of lower sales and higher costs. Thus, be very careful of companies which claim to increase their production capacity, because this may not always mean higher sales and higher profits. In fact, increase of production should come with increased demand and the manufacturer should have a certain level of pricing power. Otherwise, as the market for the product matures, more entrants come in and drive down prices through competition. The result is that the capacity increase will come at a high cost: that of declining margins. Frequently, I have seen companies in "commodity" industries such as chips and PCB boards suffer from declining profits even as their sales grew. This is due to the margin erosion effect which cannot be effectively eliminated through economies of scale.
The other option is for a company to grow through acquisitions. One immediate example is Olam International Limited, an SGX listed company which deals with the SCM business of distributing foodstuffs ike peanuts and coffee beans. They are vertically integrated and cover the entire supply chain of production, distribution and selling. Recently, Olam was involved in a tussle with Louis Dreyfuss to buy over Queensland Cotton, with the bids getting increasingly higher at A$5.80 per share. The outcome is as yet unknown but one must ask: what price does Olam have to offer to make the deal unattractive ? The problem with growing through acquisitions is that a "fit" needs to be obtained. Frequently, acquisitions or mergers involve staff from different companies with different cultures, which may result in problems. Take the example of Daimler-Chrysler in which the Chysler unit was never profitable after the merger (it was eventually sold off just recently). Other notable Singaporean examples include Osim's acquisition of Brookstone which has dragged down the company due to the high debt financing the company had to undertake, coupled with losses incurred in the USA-based unit. Growth through acquisitions is therefore fraught with risks and uncertainties and I do not understand why shareholders get so amazingly excited when an acquisition is announced, as the merits of the acquisition have to be reviewed objectively before one can conclude if it is indeed "great news" for the existing shareholders.
Growth which is too swift also tends to fizzle out after a while. A lot of companies can report superb earnings growth for 1 year, maybe 2; but how many can consistently grow their earnings over a period of say 5-10 years ? The volatile nature of business these days means that shareholders are stepping on a minefield when it comes to expecting growth every quarter. Take UTAC for example, after 14 consecutive quarters of growth, it suffered its first quarterly decline in revenue of 2.4%. This is due in part to the uncertainty and cyclical nature of the industry. A shareholder thus has to sit back and think about the business: will it be able to sustain a consistent growth track record over a long period of time ? If not, then value investing dictates that this may not be a good long-term investment. The ability of a company to weather the storms depends on the nature of its business, its Management as well as the competitive advantage it commands.
For myself, I go for companies with consistent growth rather than superlative short-term growth. Examples I can think of are Pacific Andes and Boustead. Pacific Andes has steadily increased their revenues and profits through a series of acquisitions, as well as organic growth (though at the expense of higher gearing). Boustead has a 5-year track record of increased revenues and earnings ever since CEO F.F.Wong turned the company around in FY 2002 by selling off unprofitable units and steering and focusing on the company core competencies. His strategic vision has also, in part, contributed to the strong and steady growth of the company. These are companies which I feel comfortable investing in for 3-5 years, and which are more likely to survive a recession should one come along.
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