Some of the more recent reports on property as published by our incumbent major newspaper, The Straits Times, seem to imply that property prices have softened and thus has become much more affordable for the general public. In Saturday’s newspapers (December 4, 2010), an article called “Our First Home” appeared and talked about how median COVs have fallen since the August 2010 cooling measures were introduced, and also gave examples of two young couples who managed to find their dream homes. One of them purchased a 4-room flat at Bukit Panjang (Mr. Kelvin Teo and wife Alberta), while another (Mr. Ang Tiong Wei) was featured purchasing an EC at the newly launched Esparina Residences in Sengkang last month. Overall, the news article(s) tried to portray a very rosy picture of couples finally managing to clinch their very first home, while property prices have “softened” enough for most first-time buyers to readily afford a flat of their choice. But is this really the case?
Much has been talked about measures of affordability such as Price-to-income ratio (HPI), which compares median house price to annual household income. Another often used measure is the debt-servicing-ratio, referred in short-form as DSR. DSR is the proportion of income used to pay mortgages, and it is generally recognized that this should not exceed 35% for it to be comfortable for the mortgagee. In a very comprehensive article (published in TODAY November 12, 2010) written by our Minister for National Development Mr. Mah Bow Tan on housing affordability, it was mentioned that HPI for young couples was around 4.5 for resale flats. But in the example quoted in Saturday’s news, the couple was granted a $50,000 HDB grant on a 20-year old flat in Bukit Panjang (not the most accessible of places in Singapore), and their household income was less than $3,500 a month. A simple back of the envelope computation will show that if the grant was NOT given, the HPI would have been close to 9x or 10x. There may be other similar cases floating around Singapore which have not been highlighted by the mainstream media, but which will become easy fodder for the opposition parties or alternative independent news websites and blogs. The point here is that HPI is still significantly high in Singapore for most young couples who had just started working and do not have high incomes and large savings. Even though a few luckier couples managed to find their “dream” home, they may still be over-leveraged from the point of view of HPI. Now let’s take a look at the DSR in the next section.
The international benchmark for DSR is around 30-35%, and the same Mah Bow Tan article mentions that the DSR for new HDB flats in non-mature (i.e. remote) estates averaged 23% based on a 30-year loan. Accordingly, of course, the article then categorically states that these flats are affordable, even though the ratio comes close to 29% for premium projects such as Punggol Waterway Terraces. I think we have to keep things in perspective, though. What the articles have been talking about here are 30-year loans, which basically span close to half a person’s natural lifetime! I shudder to think of what our society is becoming when taking 30 or even 35-year loans is becoming the norm rather than the exception, as the articles talking about DSR use this tenure as a benchmark. One cannot assume that he is able to “flip” the property at a higher price within 5 to 10 years, as the market, being unpredictable, may frustrate such attempts and you may have to go on servicing your debt into your twilight years. Also imagine a case where the loan tenure was shortened to 20 or 25 years instead of the current default 30 years, I think the DSR would probably soar above 35% for many cases; and many would end up being forced to dip into their cash savings instead of just using their CPF OA to fund their over-priced houses. Not to mention that a lot can happen in a span of 30 years, such as job cuts, pay cuts and retrenchments, which may greatly affect one’s ability to service the mortgage loan. Therefore, generally DSR is a number which can be manipulated by the media depending on the metrics used, and readers have to be careful to sift out information which may contradict conventional wisdom (such as how many people actually fully pay out 30-year loans, as the interest accumulated by then would probably amount to close to 50% of the original cost of the property!).
Anyhow, back to the case of Mr. Ang buying Esparina Residences (an executive condominium or “EC”) at Sengkang. It was reported that he felt lucky to have secured a flat and that he “only” paid $899,000 for his three-bedroom, 1,184 square foot flat. Please note that this is AFTER a $30,000 housing grant, or else the EC would have cost a whopping $929,000! A simple calculation will show that the unit costs $785 psf, which is a hefty price to pay indeed for a condo with HDB-like features and in a remote location like Sengkang. Let’s not even consider the fact that Mr. Ang and his wife CANNOT be earning more than $10,000 a month or else they would be disqualified from purchasing an EC. Let’s take the scenario where their combined household income is exactly $10,000 a month, or $120,000 per annum. This means that the HPI ratio would be about 7.7x for them, which is not exactly low either. The DSR cannot be computed unless we know more about their loan quantum and tenure, but I can bet it’s probably a 30-year loan and that it is “affordable” by conventional standards of having a <35% DSR.
The problems as highlighted above are due to the pervasively low interest rate environment we find ourselves in. Note that for resale flats and EC, it is clearly stated on HDB’s website that one needs to take a bank loan to finance the purchase, and that purchasers are not entitled to obtain a HDB concessionary loan (at a constant 2.6% per annum). Of course, most readers should be aware that bank loans are being offered at phenomenally low rates now of about 1% to 1.5% for a lock-in period of 2 to 3 years, which makes the one taking a HDB concessionary loan look like an idiot (incidentally, I am one of those “idiots”). However, one should also note that interest rates for the last 18 months have been artificially low, and that the long-term average interest rates for mortgage loans should hover around 3% to 4% for bank loans (i.e. higher than HDB’s concessionary loans, which is why it was termed “concessionary” in the first place). So the couples featured in these articles are literally staring at a “time bomb”, as they are fully exposed to interest rate increases in the near future after their lock-in period for their super low-rate bank loans expire. This could literally mean a mortgage installment which is either double or triple that of their current amount, as rates may rebound from a low 1% to 1.5% to as high as 3% to 3.5% which is the long-term average. Even re-financing may not help as all banks would have raised the rates for their new bank loans in tandem with the global economic recovery some time in 2013 or 2014. Therefore, I assert that the low interest rate environment is exacerbating the illusion of affordability by granting couples with cheap current loans which may turn out to be very expensive mistakes in the future.
So with the above evidence being presented, ask yourself this – is property really affordable in Singapore?
Friday, December 10, 2010
Sunday, December 05, 2010
Boustead –1H FY 2011 Financial Analysis and Review Part 2
In Part 2 of Boustead’s review, I shall cover the divisional margins and also the plans and prospects for the Group, taking into account the recent interview with FF Wong as featured in Sep’s issue of The Edge Singapore. Note that much of the discussion will be based on plans and discussions which have yet to materialize, hence this material is meant to be informative rather than definitive. I would advise interested readers and investors to go through the actual articles and/or interviews (these can be found on Boustead’s website) to judge the content for yourself, if need be.
Divisional Margin Analysis and Review
The above table gives a very interesting snapshot of Boustead’s divisional margins for 1H 2011 versus 1H 2010. One can immediately see that for Energy-related Engineering, margins were adversely affected and had dropped to just 11.7% from 15.3% a year ago. So although revenues increased by a very healthy 38.7%, PBT only increased by 6.6% to S$8.8 million. It was mentioned in the press release that the upstream oil and gas business suffered a slow quarter, and I take it to mean that the contracts clinched also resulted in lower margins. This is rather disappointing as I had thought that with the successful restructuring of Boustead Maxitherm, this division would see stronger revenue as well as PBT margin contribution. Instead, it seems to be contributing to start-up losses, perhaps due to preliminary expenses or restructuring one-off costs?
For water and wastewater division, one can see that it has been a very valiant and admirable effort indeed by the team there, as they have managed to increase revenues by 65% to S$13.1 million for 1H 2011. However, as FF Wong had mentioned, this is a very low margin business, and this is reflected in the low PBT margin of 5.3% for a PBT of S$0.7 million. I guess the positive aspect of this is that even though margins are probably being squeezed, there is still some profit to be derived from the division which is adding to overall Group profit, rather than deducting from it. It remains to be seen if this can continue for 2H 2011, but with Salcon’s order book being much healthier than it has been in a long while, I am optimistic that the division will be able to pull off a second consecutive year of profitability.
Real estate solutions division (led by 91.7% owned Boustead Projects as well as Boustead Infrastructures) had a good half-year, with revenue rising by 41.3% to S$187.8 million. For PBT however, this was boosted by the one-off gain from the sale of a leasehold property which was booked in 1Q 2011, hence the PBT margin looks as though it jumped to 18.7%. The problem with the division is the lumpiness of earnings as it is very much project-based, and it also hides the fact that the Al Marj project in Libya is causing quite a bit of headaches for the Group due to the delays and design disagreements, which have resulted in slower-than-expected progress and cash flow hiccups. Still , for 2Q 2011, there were contributions from two major projects located at the Seletar Aerospace Park. With Boustead’s focus being on design, build and lease projects for more consistent income, this division should see better days ahead in terms of less lumpiness, though I suspect margins and revenues may suffer. Still, it may be a small price to pay in exchange for smoother and more predictable cash inflows for the Group.
The real surprise came from the Geo-Spatial Division, which (to me) always seemed like a slow growth division which acted like more of a cash cow. However, for 1H 2011 this division demonstrated revenue growth of 26.2% and PBT growth of 22%, with a very admirable PBT margin of 24%. I guess part of this can be attributed to the stable nature of geo-spatial technology demand, as most (if not all) of ESRI’s customers consist of government agencies; while the other reason could also be due to the recent acquisition of Mapdata Pty Ltd which provided a boost to the service offerings for ESRI Australia. Whatever the case, not much detail was given as to why the division managed to grow at such a healthy clip, but as they say – the numbers speak for themselves and I am very pleased with the performance of this division thus far. I hope that this encouraging performance can continue into 2H 2011 and perhaps we can see even stronger cash flows coming in to boost Boustead’s already-swelling cash stash. But then again, this stash is probably about to be deployed, as will be detailed in the section(s) below.
Prospects and Plans
(With extracts from The Edge Singapore article titled “Re-Orienting Boustead” published September 27, 2010)
There are plans for Boustead to make acquisitions in the coming months by making use of its huge cash hoard, and these acquisitions will leverage on its engineering expertise. Surprisingly, there was talk on possibly divesting of some of Boustead’s units in order to raise more cash for larger acquisitions. FF Wong’s focus is on becoming a pan-Asian company instead of spreading itself too thinly by going global, as it is very difficult to compete and be up against the very large players in the world. I believe this is part of the Group’s strategy to focus their resources on achieving more tangible results, and since Boustead is, after all, a Singaporean company, it made sense for them to focus on expanding their reach in Asia first.
It was mentioned that two countries where opportunities abound include Indonesia and Vietnam. My knowledge is that Boustead is actively exploring land banks in China and Vietnam and may even take a stake in them if it is deemed attractive, barring successful legal due diligence of course. It remains to be seen if there can be ample opportunities in these countries for Boustead to capitalize on to grow the business, but time will tell if things can pan out the way the Group wants.
Energy-Related Engineering Division
Interestingly, this division is expected to maintain its growth momentum on the back of high oil prices hovering around US$80 per barrel. The division was recently awarded about S$9 million in contracts in Brazil and Chile; and Boustead Maxitherm has also completed restructuring, which means I would expect contributions to flow in more swiftly for 2H 2011.
A surprising piece of news was that Boustead was contemplating divesting BIH (Boustead International Heaters), but the offers were “not right” according to FF Wong. BIH generated revenues of S$122 million in FY 2010 and occupy a “niche” market, hence Boustead is not in a hurry to sell and could consider expanding the division into the China market instead. Another option (which sounds quite appealing) is to list BIH separately in order to unlock the value of the business; and since the unit has built up an enviable track record over the years, this should not pose much of a problem. The advantage of a listing, as mentioned in the article from The Edge, is that investors can then better value the company and hence better appreciate Boustead’s diverse businesses. It was even mentioned that 91.7%-owned Boustead Projects could be considered for an IPO as it itself has a very good track record. I guess shareholders like myself have to wait with bated breath to see if there are any significant developments afoot with BIH and other sub-divisions of Energy-Related Engineering Division in the months to come.
Water and Wastewater Division
This division, represented by 100% owned Salcon, experienced a turnaround in FY 2010, and has been performing admirably for 1H 2011 so far. Salcon has been winning projects in Abu Dhabi, Vietnam and Indonesia and has been building up its order book, so even though margins are low and competition is keen, the division has still managed to eke out a small profit before tax. Barring unforeseen circumstances, I am confident that Salcon can continue to do so as they had just won a few major contracts (locally as well). Of course, recent news regarding Boustead’s intention to purchase a 20% stake in Bio-Treat through its convertible bonds for S$43 million also opened up the possibility of expanding this division quickly and decisively. However, as of this date, there has been no further news on this as the necessary due diligence (financial and legal) are still continuing, though the physical due diligence (inspection of assets) has been essentially completed.
A rather crazy idea which was mooted during Salcon’s loss-making years was to list the division when it chalked up three consecutive years of profits, as Salcon carried with it the reputation of being a Company with very strong technical expertise (not unlike Hyflux) and could hold its own in international circles. With the high probability of a second-consecutive year of profits for Salcon, this “dream” may yet come to fruition instead of remaining merely a fantasy. With Salcon operating in a tough environment amid stiff competition and tight margins, it may be better for Boustead to eventually divest itself of Salcon and realize some profits and cash; and use these to invest or focus on businesses which yield better margins, cash flows and ROE.
Real-Estate Solutions Division
It was mentioned in Boustead’s press release that the average value of enquiries has decreased even though the volume of enquiries has picked up. This is interesting as it would mean that the deal sizes would be smaller for Boustead Projects, but hopefully these also come with fatter margins (thus far the larger contracts seem to come with thinner margins). It’s actually not such a bad thing to snare numerous projects of smaller size, rather than waiting for one large project but getting worse margins for it. As things stand, Boustead is determined to focus its expertise on design, build and lease projects which are able to garner recurring income (and cash flows). This should bode well for the division in the years to come as it can leverage on its competencies to scale up its recurrent income base.
As for Boustead Infrastructures, it is disappointing to note that there are still teething problems associated with the Al Marj township project in Libya. Negotiations are under way to mitigate the negative impact of the delays and design modifications, but it looks like FF Wong’s foray into Libya may have resulted in more problems than benefits (though to be fair, it was unclear at the time that there would be so many issues). Even FF Wong admitted himself during the recent AGM that Libya was a headache. Hopefully, by 3Q 2011, the persistent problems can be solved amicably and an optimal solution be implemented to address the Group’s risks.
Meanwhile, another interesting development which I am tracking is the Big Box project which Boustead announced with TT International (“TTI”). Since readers can dig up some information on this from SGXNet and Boustead’s announcements, I will not go in depth into the salient details except to say that the Heads of Agreement and Long-Stop Date have both been extended, as TTI had recently been granted a court order to prevent it from being liquidated. This bodes well for the project which is expected to be cash flow positive and very lucrative for both Boustead (which is taking a 60% stake) and TTI (remaining 40%). It shall be very interesting to see how Boustead handles this deal and whether it can be successfully launched.
Geo-Spatial Technology Division
This division, traditionally recognized as the “cash cow” of the Group, has actually begun to grow quite steadily and I admit it was a surprise to learn of the increase in PBT. I guess this can be attributed to the stable nature of their client base consisting mainly of government agencies. Hence, this division is recession-proof as governments are unlikely to decrease spending even in the face of slowdowns or recessions. Looking ahead, I do not expect the same growth rate for this division as evidenced by 1H 2011; instead it will probably moderate back to the 5-10% level which is the long-term average. But as long as the division is raking in good cash flows, I am not complaining.
My next review for Boustead will be after the release of their FY 2011 results some time in May 2011. Until then, unless there are material developments associated with the Company, I will be content to just write about the Company in my monthly portfolio reviews.
Divisional Margin Analysis and Review
The above table gives a very interesting snapshot of Boustead’s divisional margins for 1H 2011 versus 1H 2010. One can immediately see that for Energy-related Engineering, margins were adversely affected and had dropped to just 11.7% from 15.3% a year ago. So although revenues increased by a very healthy 38.7%, PBT only increased by 6.6% to S$8.8 million. It was mentioned in the press release that the upstream oil and gas business suffered a slow quarter, and I take it to mean that the contracts clinched also resulted in lower margins. This is rather disappointing as I had thought that with the successful restructuring of Boustead Maxitherm, this division would see stronger revenue as well as PBT margin contribution. Instead, it seems to be contributing to start-up losses, perhaps due to preliminary expenses or restructuring one-off costs?
For water and wastewater division, one can see that it has been a very valiant and admirable effort indeed by the team there, as they have managed to increase revenues by 65% to S$13.1 million for 1H 2011. However, as FF Wong had mentioned, this is a very low margin business, and this is reflected in the low PBT margin of 5.3% for a PBT of S$0.7 million. I guess the positive aspect of this is that even though margins are probably being squeezed, there is still some profit to be derived from the division which is adding to overall Group profit, rather than deducting from it. It remains to be seen if this can continue for 2H 2011, but with Salcon’s order book being much healthier than it has been in a long while, I am optimistic that the division will be able to pull off a second consecutive year of profitability.
Real estate solutions division (led by 91.7% owned Boustead Projects as well as Boustead Infrastructures) had a good half-year, with revenue rising by 41.3% to S$187.8 million. For PBT however, this was boosted by the one-off gain from the sale of a leasehold property which was booked in 1Q 2011, hence the PBT margin looks as though it jumped to 18.7%. The problem with the division is the lumpiness of earnings as it is very much project-based, and it also hides the fact that the Al Marj project in Libya is causing quite a bit of headaches for the Group due to the delays and design disagreements, which have resulted in slower-than-expected progress and cash flow hiccups. Still , for 2Q 2011, there were contributions from two major projects located at the Seletar Aerospace Park. With Boustead’s focus being on design, build and lease projects for more consistent income, this division should see better days ahead in terms of less lumpiness, though I suspect margins and revenues may suffer. Still, it may be a small price to pay in exchange for smoother and more predictable cash inflows for the Group.
The real surprise came from the Geo-Spatial Division, which (to me) always seemed like a slow growth division which acted like more of a cash cow. However, for 1H 2011 this division demonstrated revenue growth of 26.2% and PBT growth of 22%, with a very admirable PBT margin of 24%. I guess part of this can be attributed to the stable nature of geo-spatial technology demand, as most (if not all) of ESRI’s customers consist of government agencies; while the other reason could also be due to the recent acquisition of Mapdata Pty Ltd which provided a boost to the service offerings for ESRI Australia. Whatever the case, not much detail was given as to why the division managed to grow at such a healthy clip, but as they say – the numbers speak for themselves and I am very pleased with the performance of this division thus far. I hope that this encouraging performance can continue into 2H 2011 and perhaps we can see even stronger cash flows coming in to boost Boustead’s already-swelling cash stash. But then again, this stash is probably about to be deployed, as will be detailed in the section(s) below.
Prospects and Plans
(With extracts from The Edge Singapore article titled “Re-Orienting Boustead” published September 27, 2010)
There are plans for Boustead to make acquisitions in the coming months by making use of its huge cash hoard, and these acquisitions will leverage on its engineering expertise. Surprisingly, there was talk on possibly divesting of some of Boustead’s units in order to raise more cash for larger acquisitions. FF Wong’s focus is on becoming a pan-Asian company instead of spreading itself too thinly by going global, as it is very difficult to compete and be up against the very large players in the world. I believe this is part of the Group’s strategy to focus their resources on achieving more tangible results, and since Boustead is, after all, a Singaporean company, it made sense for them to focus on expanding their reach in Asia first.
It was mentioned that two countries where opportunities abound include Indonesia and Vietnam. My knowledge is that Boustead is actively exploring land banks in China and Vietnam and may even take a stake in them if it is deemed attractive, barring successful legal due diligence of course. It remains to be seen if there can be ample opportunities in these countries for Boustead to capitalize on to grow the business, but time will tell if things can pan out the way the Group wants.
Energy-Related Engineering Division
Interestingly, this division is expected to maintain its growth momentum on the back of high oil prices hovering around US$80 per barrel. The division was recently awarded about S$9 million in contracts in Brazil and Chile; and Boustead Maxitherm has also completed restructuring, which means I would expect contributions to flow in more swiftly for 2H 2011.
A surprising piece of news was that Boustead was contemplating divesting BIH (Boustead International Heaters), but the offers were “not right” according to FF Wong. BIH generated revenues of S$122 million in FY 2010 and occupy a “niche” market, hence Boustead is not in a hurry to sell and could consider expanding the division into the China market instead. Another option (which sounds quite appealing) is to list BIH separately in order to unlock the value of the business; and since the unit has built up an enviable track record over the years, this should not pose much of a problem. The advantage of a listing, as mentioned in the article from The Edge, is that investors can then better value the company and hence better appreciate Boustead’s diverse businesses. It was even mentioned that 91.7%-owned Boustead Projects could be considered for an IPO as it itself has a very good track record. I guess shareholders like myself have to wait with bated breath to see if there are any significant developments afoot with BIH and other sub-divisions of Energy-Related Engineering Division in the months to come.
Water and Wastewater Division
This division, represented by 100% owned Salcon, experienced a turnaround in FY 2010, and has been performing admirably for 1H 2011 so far. Salcon has been winning projects in Abu Dhabi, Vietnam and Indonesia and has been building up its order book, so even though margins are low and competition is keen, the division has still managed to eke out a small profit before tax. Barring unforeseen circumstances, I am confident that Salcon can continue to do so as they had just won a few major contracts (locally as well). Of course, recent news regarding Boustead’s intention to purchase a 20% stake in Bio-Treat through its convertible bonds for S$43 million also opened up the possibility of expanding this division quickly and decisively. However, as of this date, there has been no further news on this as the necessary due diligence (financial and legal) are still continuing, though the physical due diligence (inspection of assets) has been essentially completed.
A rather crazy idea which was mooted during Salcon’s loss-making years was to list the division when it chalked up three consecutive years of profits, as Salcon carried with it the reputation of being a Company with very strong technical expertise (not unlike Hyflux) and could hold its own in international circles. With the high probability of a second-consecutive year of profits for Salcon, this “dream” may yet come to fruition instead of remaining merely a fantasy. With Salcon operating in a tough environment amid stiff competition and tight margins, it may be better for Boustead to eventually divest itself of Salcon and realize some profits and cash; and use these to invest or focus on businesses which yield better margins, cash flows and ROE.
Real-Estate Solutions Division
It was mentioned in Boustead’s press release that the average value of enquiries has decreased even though the volume of enquiries has picked up. This is interesting as it would mean that the deal sizes would be smaller for Boustead Projects, but hopefully these also come with fatter margins (thus far the larger contracts seem to come with thinner margins). It’s actually not such a bad thing to snare numerous projects of smaller size, rather than waiting for one large project but getting worse margins for it. As things stand, Boustead is determined to focus its expertise on design, build and lease projects which are able to garner recurring income (and cash flows). This should bode well for the division in the years to come as it can leverage on its competencies to scale up its recurrent income base.
As for Boustead Infrastructures, it is disappointing to note that there are still teething problems associated with the Al Marj township project in Libya. Negotiations are under way to mitigate the negative impact of the delays and design modifications, but it looks like FF Wong’s foray into Libya may have resulted in more problems than benefits (though to be fair, it was unclear at the time that there would be so many issues). Even FF Wong admitted himself during the recent AGM that Libya was a headache. Hopefully, by 3Q 2011, the persistent problems can be solved amicably and an optimal solution be implemented to address the Group’s risks.
Meanwhile, another interesting development which I am tracking is the Big Box project which Boustead announced with TT International (“TTI”). Since readers can dig up some information on this from SGXNet and Boustead’s announcements, I will not go in depth into the salient details except to say that the Heads of Agreement and Long-Stop Date have both been extended, as TTI had recently been granted a court order to prevent it from being liquidated. This bodes well for the project which is expected to be cash flow positive and very lucrative for both Boustead (which is taking a 60% stake) and TTI (remaining 40%). It shall be very interesting to see how Boustead handles this deal and whether it can be successfully launched.
Geo-Spatial Technology Division
This division, traditionally recognized as the “cash cow” of the Group, has actually begun to grow quite steadily and I admit it was a surprise to learn of the increase in PBT. I guess this can be attributed to the stable nature of their client base consisting mainly of government agencies. Hence, this division is recession-proof as governments are unlikely to decrease spending even in the face of slowdowns or recessions. Looking ahead, I do not expect the same growth rate for this division as evidenced by 1H 2011; instead it will probably moderate back to the 5-10% level which is the long-term average. But as long as the division is raking in good cash flows, I am not complaining.
My next review for Boustead will be after the release of their FY 2011 results some time in May 2011. Until then, unless there are material developments associated with the Company, I will be content to just write about the Company in my monthly portfolio reviews.
Tuesday, November 30, 2010
November 2010 Portfolio Summary and Review
Make no mistake about it – November 2010 was a rather sensational month, not just buoyed by news of QE2 (Quantitative Easing) and Hong Kong’s more draconian property measures, but was also filled with financial results announcements from five of my companies. This of course got me in a minor frenzy and had me busy for the last few weeks as I sought to read through all the news and updates to keep myself abreast of developments within the companies in my portfolio. Thus far, I have posted up my analysis and review of MTQ and Part 1 of Boustead, and this is set to continue with Tat Hong in December as I delve further into the results. I have also taken the liberty to include brief summaries of the results within my portfolio review for those who are not keen to read the (boring) details of a full analysis.
I think enough has been said of QE2 and I will not dwell further on that. The more interesting regional news (besides the release of Aung Sang Suu Kyi in Myanmar) is that of China and Hong Kong doing their utmost to rein in runaway property prices. Hong Kong made a rather draconian move of implementing a stamp duty of 15% on the sale of property, split equally between buyer and seller. While analysts and economists have remarked that the Singapore government is unlikely to follow suit (for fear of “scaring off” genuine buyers), the government has grudgingly acknowledged that the measures implemented on August 30, 2010 have failed to sufficiently cool demand and lower prices. As a result, a record amount of land has been released in order to ramp up supply for 2011 in an effort to bring down prices. Even MAS acknowledged that the current environment of ultra-low interest rates (SIBOR being just 0.44%) and the aggressive tactics used by banks to encourage loan growth may result in imprudent borrowing by a large swath of the population. It remains to be seen if there will be further measures implemented to cool the market.
On the COE front, prices have just hit a 10-year high with COEs for small cars hitting S$39,000, and those from the “Open” category hitting S$49,890. This means that a 1.6L Toyota Corolla now costs about S$110,000, while a mere Audi costs in excess of S$300,000 (note that this is enough to buy most couples a flat in a distant, remote part of Singapore). At the same time, the media reported that inflation was creeping up in Singapore, and stood at 3.5%. Incidentally, savings accounts at most major banks continue to pay a measly 0.125%, which means a lot of money will flow into equities, bonds and property. Part of the reason for the inflation is due to higher car prices, as dealers jack up prices in anticipation of a further shrinkage in the COE supply come February 2011. It all seems to be contributing to a boiling cauldron of speculation, and should the bubble burst suddenly and inexplicably, it would seem many will inevitably get burnt the way speculators got burnt back in 1997.
Another observation of mine is that there seem to be many more IPOs these days, the most recent being Sabana REIT (Singapore’s first Sha’riah compliant REIT). With sentiment being hammered by Ireland’s woes and China’s cooling measures, these new aspirants are seeing their share prices debut below their offer price, the most recent being Sabana (listed at $1.05) closing at $1.02. Amtek Engineering is another company which is due for a listing (at $1.30 per share), and all the shares to be offered are vendor shares. With the prevailing sentiment (on forums) being that it is an almost effortless task to apply for any IPO, receive an allotment, and stag it to receive instant profits, there seems to exists a cavalier attitude amongst punters and speculators; not dissimilar to the unadulterated enthusiasm being displayed at the height of the bull market during the heady days of late 2007. I guess it takes some loss of money (and face) to demonstrate the making money from Mr. Market consistently is extremely difficult and is not to be taken as a given. After all, everyone understands the concept of there being “no free lunch” and the all-important mantra of “Caveat Emptor”.
Below is a snapshot of my portfolio and associated comments for November 2010:-
1) Boustead Holdings Limited – Boustead announced their results on November 9, 2010. Revenue for 2Q 2011 was up 14% to S$130 million, but net profit attributable to shareholders was down 25% due to higher operating expenses and lower gross margins. For 1H 2011, revenue was up 38% while net profit was up 98% (due in part to the disposal of a leasehold property). An interim dividend of 2 cents per share was declared, up from 1.5 cents per share a year ago. More details can be found in my separate posts on the analysis of Boustead’s results.
2) Suntec REIT – Suntec REIT’s EGM was held on November 25, 2010 at Suntec City Convention Centre Rooms 325 and 326 at 10:00 a.m. Basically the EGM was held to approve the acquisition of the 1/3 interest in Marina Bay Financial Centre (MBFC). There was a good crowd and some people raised very interesting questions; but since I was just a small shareholder since IPO, I didn’t raise any queries and was content to listen to others vociferously voicing their opinions (and displeasure haha). It was also amazingly well-organized, with a meal voucher being given to each shareholder so that there would be no rush for the food (and some people sweeping everything into their tumblers or plastic bags). A bento box set was given to each unit holder consisting of bee hoon, 2 buns, bottled water and a host of other cakes and snacks. Best of all, a free Suntec REIT EZ Link card worth S$5 was given to every registered unit-holder, and I took the liberty of handing it over to the ticket office at the nearest MRT station to exchange it for a cool S$5 note. I guess I can treat that as an early advance dividend! A placement was done yesterday at $1.37 per share to raise the S$428.8 million gross proceeds to fund the one-third stake in MBFC, and an early dividend will be declared for the currrent units.
3) Tat Hong Holdings Limited – Tat Hong released their 1H FY 2011 results on November 13, 2010. Revenue for 2Q 2011 was up 20% but COGS was up 25%, resulting in a 12% rise in gross profit. Net profit attributable to shareholders was just up 7%, and for 1H FY 2011 profit was just up by 2%, demonstrating that the recovery was actually slower than expected for the Company and those within the industry. An interim dividend of 1 cent per ordinary share and RCPS was declared, and is payable on December 17, 2010. I will be doing a review and analysis of Tat Hong’s results, but not in as great detail as the FY 2010 results. In a separate announcement on November 12, 2010, Tat Hong also announced the proposed acquisition of 70% of Hup Hin Transport Co Pte Ltd, which is a heavy transport solutions provider. The Company has a diversified fleet which includes 200 units of transportation equipment from lorry cranes, rough terrain, all terrain cranes, prime movers and trailers. The consideration for the shares is S$7.7 million (effectively valuing the entire company at S$11 million) and the NAV was S$6.8 million (meaning Tat Hong paid a slight premium to book value), while profit after tax as at Dec 31, 2009 was S$3.05 million. This means Tat Hong paid about 3.6x PER for their 70% stake in the Company. The rationale being that the acquisition can help the Group to leverage off each other’s strengths and capabilities and to broaden the Group’s customer base in the region.
4) MTQ Corporation Limited – MTQ released their 1H FY 2011 results on November 3, 2010, and I have provided a review and analysis of their financials and prospects in a previous post. On November 22, 2010, the Company also announced that the price of each scrip share under their Scrip Dividend scheme would be 83 cents per share. I have chosen to fully take up my proportionate share of scrip and will not be receiving any part of the dividend in cash, hence my realized gains for November 2010 will NOT reflect this dividend. MTQ also sent over its annual newsletter called Horizons which provided an update on the developments within Oilfield Engineering and Engine Systems.
5) GRP Limited – There was no news from GRP for the month of November 2010. The dividend of 1 cent per share was received on November 26, 2010.
6) Kingsmen Creatives Holdings Limited – The Company released their 3Q 2010 financials on November 10, 2010. Disappointingly, 3Q 2010 revenue rose 7.6% but COGS increased 9.5%, resulting in just a 1.2% increase in gross profit. As a result of higher other expenses, net profit for 3Q 2010 fell 17.7% to S$2.5 million. For 9M 2010, net profit rose by 5.2% to S$9.4 million. Cash flow generation for 9M 2010 from operations was S$15.2 million and FCF was about S$9 million, hence I was fairly confident that Kingsmen will be able to maintain their final dividend of 2 cents/share come February 2011 when they release their FY 2010 results.
7) SIA Engineering Company Limited – Things were fairly busy over at SIAEC. First, they released their 1H FY 2011 results on November 2, 2010; and declared an interim dividend of 6 cents per share, up from 5 cents per share last year. Revenue for 2Q 2011 was up from S$248 million to S$277 million, while profit attributable to shareholders climbed by S$5.4 million from S$61.1 million to S$66.5 million. For 1H 2011, profit rose from S$106.2 million to S$137.3 million year on year. The Balance Sheet remained strong with no debt and cash balances of about S$406 million. There was –ve FCF generated for 2Q 2011, due to a decrease in creditors of S$27.2 million, but for 1H 2011 there was positive FCF of about S$40 million. Overall, most of the cash outflows were due to the payment of the final dividend, and cash flow generation continues to be strong. I will NOT be doing a detailed review of SIAEC’s 1H FY 2011 financials as I had just posted up my 5-part analysis of purchase for SIAEC. On November 4, 2010, SIAEC announced their 25th Joint Venture (JV) with Panasonic Avionics to set up a Singapore-based MRO facility for in-flight entertainment and communications systems and components. For this JV, SIAEC will own 42.5% while Panasonic will own the remaining 57.5%. On November 26, 2010, SIAEC announced that their 6th line maintenance JV was up and running, with them partnering Southern Airports Corporation in a 49%:51% JV. The JV company is called Southern Airports Aircraft Maintenance Services Co., Ltd and is located at Ho Chi Minh City’s Tan Son Nhat International Airport. Both these transactions are expected to accrue long-term benefits for SIAEC as they slowly but surely grow their stable of JV companies and extend their presence around the world.
Portfolio Review – November 2010
Realized gains have jumped to S$49.1K from S$46.4K due to SIAEC, Boustead and Tat Hong going ex-dividend, but note that for MTQ, I have chosen to accept the scrip dividend (which was priced at 83 cents per ordinary share), therefore the value of the dividend is not included under “Realized Gains”.
For the month of November 2010, the portfolio has lost -4.5% against a +0.1% marginal rise in the STI. On an annualized basis, the portfolio has gained by +13.7% against the absolute gain of +8.5% for the STI. Cost of investment remains at S$202.4K, and unrealized gains stand at +19.6% (portfolio market value of S$242K).
December 2010 is set to slow down as companies have all but reported their 3Q results, and this is usually the time when corporate activity slows down as staff take leave for the holidays along with their families. I will not be expecting much corporate updates during the month, and can probably concentrate on analyzing the results from my companies; as well as thinking about issues such as property, personal finance and alternative investments.
My next portfolio review will be on December 31, 2010 (Friday). I will also be including a special year-end commentary and summary of my portfolio to discuss the rights and wrongs; and also to detail my investment strategy for the new calendar year 2011.
I think enough has been said of QE2 and I will not dwell further on that. The more interesting regional news (besides the release of Aung Sang Suu Kyi in Myanmar) is that of China and Hong Kong doing their utmost to rein in runaway property prices. Hong Kong made a rather draconian move of implementing a stamp duty of 15% on the sale of property, split equally between buyer and seller. While analysts and economists have remarked that the Singapore government is unlikely to follow suit (for fear of “scaring off” genuine buyers), the government has grudgingly acknowledged that the measures implemented on August 30, 2010 have failed to sufficiently cool demand and lower prices. As a result, a record amount of land has been released in order to ramp up supply for 2011 in an effort to bring down prices. Even MAS acknowledged that the current environment of ultra-low interest rates (SIBOR being just 0.44%) and the aggressive tactics used by banks to encourage loan growth may result in imprudent borrowing by a large swath of the population. It remains to be seen if there will be further measures implemented to cool the market.
On the COE front, prices have just hit a 10-year high with COEs for small cars hitting S$39,000, and those from the “Open” category hitting S$49,890. This means that a 1.6L Toyota Corolla now costs about S$110,000, while a mere Audi costs in excess of S$300,000 (note that this is enough to buy most couples a flat in a distant, remote part of Singapore). At the same time, the media reported that inflation was creeping up in Singapore, and stood at 3.5%. Incidentally, savings accounts at most major banks continue to pay a measly 0.125%, which means a lot of money will flow into equities, bonds and property. Part of the reason for the inflation is due to higher car prices, as dealers jack up prices in anticipation of a further shrinkage in the COE supply come February 2011. It all seems to be contributing to a boiling cauldron of speculation, and should the bubble burst suddenly and inexplicably, it would seem many will inevitably get burnt the way speculators got burnt back in 1997.
Another observation of mine is that there seem to be many more IPOs these days, the most recent being Sabana REIT (Singapore’s first Sha’riah compliant REIT). With sentiment being hammered by Ireland’s woes and China’s cooling measures, these new aspirants are seeing their share prices debut below their offer price, the most recent being Sabana (listed at $1.05) closing at $1.02. Amtek Engineering is another company which is due for a listing (at $1.30 per share), and all the shares to be offered are vendor shares. With the prevailing sentiment (on forums) being that it is an almost effortless task to apply for any IPO, receive an allotment, and stag it to receive instant profits, there seems to exists a cavalier attitude amongst punters and speculators; not dissimilar to the unadulterated enthusiasm being displayed at the height of the bull market during the heady days of late 2007. I guess it takes some loss of money (and face) to demonstrate the making money from Mr. Market consistently is extremely difficult and is not to be taken as a given. After all, everyone understands the concept of there being “no free lunch” and the all-important mantra of “Caveat Emptor”.
Below is a snapshot of my portfolio and associated comments for November 2010:-
1) Boustead Holdings Limited – Boustead announced their results on November 9, 2010. Revenue for 2Q 2011 was up 14% to S$130 million, but net profit attributable to shareholders was down 25% due to higher operating expenses and lower gross margins. For 1H 2011, revenue was up 38% while net profit was up 98% (due in part to the disposal of a leasehold property). An interim dividend of 2 cents per share was declared, up from 1.5 cents per share a year ago. More details can be found in my separate posts on the analysis of Boustead’s results.
2) Suntec REIT – Suntec REIT’s EGM was held on November 25, 2010 at Suntec City Convention Centre Rooms 325 and 326 at 10:00 a.m. Basically the EGM was held to approve the acquisition of the 1/3 interest in Marina Bay Financial Centre (MBFC). There was a good crowd and some people raised very interesting questions; but since I was just a small shareholder since IPO, I didn’t raise any queries and was content to listen to others vociferously voicing their opinions (and displeasure haha). It was also amazingly well-organized, with a meal voucher being given to each shareholder so that there would be no rush for the food (and some people sweeping everything into their tumblers or plastic bags). A bento box set was given to each unit holder consisting of bee hoon, 2 buns, bottled water and a host of other cakes and snacks. Best of all, a free Suntec REIT EZ Link card worth S$5 was given to every registered unit-holder, and I took the liberty of handing it over to the ticket office at the nearest MRT station to exchange it for a cool S$5 note. I guess I can treat that as an early advance dividend! A placement was done yesterday at $1.37 per share to raise the S$428.8 million gross proceeds to fund the one-third stake in MBFC, and an early dividend will be declared for the currrent units.
3) Tat Hong Holdings Limited – Tat Hong released their 1H FY 2011 results on November 13, 2010. Revenue for 2Q 2011 was up 20% but COGS was up 25%, resulting in a 12% rise in gross profit. Net profit attributable to shareholders was just up 7%, and for 1H FY 2011 profit was just up by 2%, demonstrating that the recovery was actually slower than expected for the Company and those within the industry. An interim dividend of 1 cent per ordinary share and RCPS was declared, and is payable on December 17, 2010. I will be doing a review and analysis of Tat Hong’s results, but not in as great detail as the FY 2010 results. In a separate announcement on November 12, 2010, Tat Hong also announced the proposed acquisition of 70% of Hup Hin Transport Co Pte Ltd, which is a heavy transport solutions provider. The Company has a diversified fleet which includes 200 units of transportation equipment from lorry cranes, rough terrain, all terrain cranes, prime movers and trailers. The consideration for the shares is S$7.7 million (effectively valuing the entire company at S$11 million) and the NAV was S$6.8 million (meaning Tat Hong paid a slight premium to book value), while profit after tax as at Dec 31, 2009 was S$3.05 million. This means Tat Hong paid about 3.6x PER for their 70% stake in the Company. The rationale being that the acquisition can help the Group to leverage off each other’s strengths and capabilities and to broaden the Group’s customer base in the region.
4) MTQ Corporation Limited – MTQ released their 1H FY 2011 results on November 3, 2010, and I have provided a review and analysis of their financials and prospects in a previous post. On November 22, 2010, the Company also announced that the price of each scrip share under their Scrip Dividend scheme would be 83 cents per share. I have chosen to fully take up my proportionate share of scrip and will not be receiving any part of the dividend in cash, hence my realized gains for November 2010 will NOT reflect this dividend. MTQ also sent over its annual newsletter called Horizons which provided an update on the developments within Oilfield Engineering and Engine Systems.
5) GRP Limited – There was no news from GRP for the month of November 2010. The dividend of 1 cent per share was received on November 26, 2010.
6) Kingsmen Creatives Holdings Limited – The Company released their 3Q 2010 financials on November 10, 2010. Disappointingly, 3Q 2010 revenue rose 7.6% but COGS increased 9.5%, resulting in just a 1.2% increase in gross profit. As a result of higher other expenses, net profit for 3Q 2010 fell 17.7% to S$2.5 million. For 9M 2010, net profit rose by 5.2% to S$9.4 million. Cash flow generation for 9M 2010 from operations was S$15.2 million and FCF was about S$9 million, hence I was fairly confident that Kingsmen will be able to maintain their final dividend of 2 cents/share come February 2011 when they release their FY 2010 results.
7) SIA Engineering Company Limited – Things were fairly busy over at SIAEC. First, they released their 1H FY 2011 results on November 2, 2010; and declared an interim dividend of 6 cents per share, up from 5 cents per share last year. Revenue for 2Q 2011 was up from S$248 million to S$277 million, while profit attributable to shareholders climbed by S$5.4 million from S$61.1 million to S$66.5 million. For 1H 2011, profit rose from S$106.2 million to S$137.3 million year on year. The Balance Sheet remained strong with no debt and cash balances of about S$406 million. There was –ve FCF generated for 2Q 2011, due to a decrease in creditors of S$27.2 million, but for 1H 2011 there was positive FCF of about S$40 million. Overall, most of the cash outflows were due to the payment of the final dividend, and cash flow generation continues to be strong. I will NOT be doing a detailed review of SIAEC’s 1H FY 2011 financials as I had just posted up my 5-part analysis of purchase for SIAEC. On November 4, 2010, SIAEC announced their 25th Joint Venture (JV) with Panasonic Avionics to set up a Singapore-based MRO facility for in-flight entertainment and communications systems and components. For this JV, SIAEC will own 42.5% while Panasonic will own the remaining 57.5%. On November 26, 2010, SIAEC announced that their 6th line maintenance JV was up and running, with them partnering Southern Airports Corporation in a 49%:51% JV. The JV company is called Southern Airports Aircraft Maintenance Services Co., Ltd and is located at Ho Chi Minh City’s Tan Son Nhat International Airport. Both these transactions are expected to accrue long-term benefits for SIAEC as they slowly but surely grow their stable of JV companies and extend their presence around the world.
Portfolio Review – November 2010
Realized gains have jumped to S$49.1K from S$46.4K due to SIAEC, Boustead and Tat Hong going ex-dividend, but note that for MTQ, I have chosen to accept the scrip dividend (which was priced at 83 cents per ordinary share), therefore the value of the dividend is not included under “Realized Gains”.
For the month of November 2010, the portfolio has lost -4.5% against a +0.1% marginal rise in the STI. On an annualized basis, the portfolio has gained by +13.7% against the absolute gain of +8.5% for the STI. Cost of investment remains at S$202.4K, and unrealized gains stand at +19.6% (portfolio market value of S$242K).
December 2010 is set to slow down as companies have all but reported their 3Q results, and this is usually the time when corporate activity slows down as staff take leave for the holidays along with their families. I will not be expecting much corporate updates during the month, and can probably concentrate on analyzing the results from my companies; as well as thinking about issues such as property, personal finance and alternative investments.
My next portfolio review will be on December 31, 2010 (Friday). I will also be including a special year-end commentary and summary of my portfolio to discuss the rights and wrongs; and also to detail my investment strategy for the new calendar year 2011.
Saturday, November 27, 2010
Boustead – 1H FY 2011 Financial Analysis and Review Part 1
Boustead released their 1H FY 2011 financial statements on November 9, 2010. As has been the practice over the last few years, I will be reviewing just the half-yearly and full year results, and will post some comments and updates on the Company and its progress. Note that I will also include information from recent articles published in The Edge Singapore on Boustead, and present the information alongside the analysis and future prospects section to give a more balanced view of the Company and where it stands presently. Note that many plans are still sketchy and there are a number of initiatives which are stuck in “work-in-progress” mode, so readers should be mindful of them when making decisions about the Company (I will highlight these as I go along).
This review will be split into two parts (in order to keep each part manageable and readable). Part 1 will focus mainly on the financials (revenue and profit growth), margins, Balance Sheet and Cash Flows, and there will also be a little discussion on Boustead’s business divisions’ performance. Part 2 will continue with the business divisions’ margins and overall performance, and will also delve into the prospects and future plans for Boustead as we move into CY 2011.
Profit and Loss Analysis
For 2Q 2011, revenues rose 14% but this was offset by a rise in COGS of 20%, which resulted in gross profit falling by 2% to S$30.8 million. Gross margin for 2Q 2011 was just 23.6% against 27.5% for 2Q 2010. However, the problem arises when Boustead’s results are viewed on a quarter by quarter basis, as the Group has warned that revenues are lumpy due to the project flow nature of their work; hence it is better to use half-yearly or yearly comparisons. So if we view the 1H 2011 performance, revenues were up 38.4% while COGS increased a smaller 34%, resulting in gross profit improving by 50% to S$96.2 million. Gross margin actually improved year on year from 27.5% to 29.8%. 2Q 2011 saw higher expenses being incurred to expand BIH into Malaysia and China, and also for setting up a new office in Darwin for ESRI (Geo-Spatial). There was also a lack of contribution from share of results from associates. The good news was that admin expenses increased by just 16% due to Boustead’s consistent focus on cost-cutting, while finance costs remained negligible at S$194,000. The result was an increase in profit before tax of 79% to S$54.3 million for 1H 2011. With income taxes increasing just 35%, this led to an increase in profit attributable to shareholders of 98%. However, note that part of this included the revenue (of S$67.8 million) and profits from the sale of an industrial warehouse facility in 1Q 2011.
Balance Sheet Review
Boustead’s Balance Sheet has traditionally remained strong, and this time was no exception. Although cash balances dipped from S$223 million to S$208 million, debtors also dropped to S$99 million even though revenue improved. The reason for the cash dip was partly due to the drop in trade and other payables by about S$26 million to S$199 million. Current ratio stands at 1.97 as at Sep 30, 2010, compared with 1.78 as at March 31, 2010.
Debt levels are kept manageable, with short term loans standing at S$5.5 million and long-term debt at S$18.5 million (for a total of S$24 million). Net cash stood at S$174 million as at Sep 30, 2010 (net cash per share of 34.4 cents), and I believe they are keeping this cash hoard for potential deployment into either the Bio-Treat convertible bonds, or the Big Box project with TTI. More on this in Part 2 of this analysis.
Cash Flow Statement Review
Boustead’s operating cash flows for 1H 2011 are much healthier as compared to a year ago, when it was a negative S$12.7 million. For 1H 2011, there was positive operating cash flows of S$11.4 million, against capex of S$1.76 million, to yield free cash flows of S$9.64 million. For investing cash flows however, there was an acquisition of MI and purchase of AFS securities which drained cash of S$5.5 million. The net result was a cash outflow of S$6.4 million for 1H 2011, which was still lower in aggregate compared to operational cash inflows.
Most of the financing outflows were made up of payment of dividend, and the net cash outflow for the half-year was S$17.1 million. Boustead has still retained its war chest as it is expected to conclude the Heads of Agreement deal with TT International soon on Big Box (the agreement was extended till 1 December for signing, with the long-stop date set at April 11, 2011). Due diligence is also being conducted on the Bio-Treat deal and I would expect Boustead to make an announcement soon on whether they intend to proceed with this deal.
Divisional Revenues Analysis
Engineering services once again took the lion’s share of the revenue pie, contributing 85.6% as compared to last year’s 83.7%. Engineering service’s revenue also grew strongly, up 41.6% from S$195.1 million to S$276.2 million, largely boosted by real estate and energy-related solutions divisions. The difference this year is that the water and wastewater division is also making a meaningful contribution to revenue (and profits, as we shall see in Part 2). This had the overall effect of strengthening the rise in revenues, but of course the crux of the issue is the margins to be obtained from each division, as it is pointedly useless to discuss increases in revenues when profit before tax (PBT) does not budge at all. This will be well-covered in Part 2.
Interestingly, the mix is roughly the same for each division within Engineering Services. Boustead had been restructuring Boustead Maxitherm for some time now, and contributions should start flowing in from this FY onwards; while BIH and C&E made meaningful contributions to revenues. For 2Q 2011 alone, it was a slow quarter but Boustead sounded a note of optimism by saying that negotiations for small and medium contracts are expected to be facilitated.
Real Estate Solutions saw a slower quarter, as mentioned in the press release the value of enquiries had been going down even though this was balanced by an increase in enquiries. Another factor to consider is also the margins to be obtained on these design and build projects, and Boustead should also try to secure more design, build and lease contracts in order to fortify its recurrent revenue base. The township project in Libya is turning out to be more “pain” than “pleasure” as the progress has stalled repeatedly and FF Wong had mentioned problems regarding collecting of monies. Now, the Group is negotiating for a set of different terms to push forward, and to reduce their risks. Understandably, this also means that revenue contributions from Libya will be muted at best, non-existent at worst.
The surprise came from the 26% jump in the revenues for Geo-Spatial Division, as this has traditionally been a slow grower and more of a cash cow for Boustead. However, with the acquisition of Mapdata Pty Ltd back in Feb 2010, this has probably diversified its product range further and allowed the division (under ESRI) to bundle services to form a better package to customers (which are mainly corporations and government agencies).
Part 2 shall tackle the divisional margins and I will also be covering Boustead’s prospects and plans, along with the incorporation of some facts gleaned from a recent article in The Edge Singapore featuring Boustead and FF Wong.
This review will be split into two parts (in order to keep each part manageable and readable). Part 1 will focus mainly on the financials (revenue and profit growth), margins, Balance Sheet and Cash Flows, and there will also be a little discussion on Boustead’s business divisions’ performance. Part 2 will continue with the business divisions’ margins and overall performance, and will also delve into the prospects and future plans for Boustead as we move into CY 2011.
Profit and Loss Analysis
For 2Q 2011, revenues rose 14% but this was offset by a rise in COGS of 20%, which resulted in gross profit falling by 2% to S$30.8 million. Gross margin for 2Q 2011 was just 23.6% against 27.5% for 2Q 2010. However, the problem arises when Boustead’s results are viewed on a quarter by quarter basis, as the Group has warned that revenues are lumpy due to the project flow nature of their work; hence it is better to use half-yearly or yearly comparisons. So if we view the 1H 2011 performance, revenues were up 38.4% while COGS increased a smaller 34%, resulting in gross profit improving by 50% to S$96.2 million. Gross margin actually improved year on year from 27.5% to 29.8%. 2Q 2011 saw higher expenses being incurred to expand BIH into Malaysia and China, and also for setting up a new office in Darwin for ESRI (Geo-Spatial). There was also a lack of contribution from share of results from associates. The good news was that admin expenses increased by just 16% due to Boustead’s consistent focus on cost-cutting, while finance costs remained negligible at S$194,000. The result was an increase in profit before tax of 79% to S$54.3 million for 1H 2011. With income taxes increasing just 35%, this led to an increase in profit attributable to shareholders of 98%. However, note that part of this included the revenue (of S$67.8 million) and profits from the sale of an industrial warehouse facility in 1Q 2011.
Balance Sheet Review
Boustead’s Balance Sheet has traditionally remained strong, and this time was no exception. Although cash balances dipped from S$223 million to S$208 million, debtors also dropped to S$99 million even though revenue improved. The reason for the cash dip was partly due to the drop in trade and other payables by about S$26 million to S$199 million. Current ratio stands at 1.97 as at Sep 30, 2010, compared with 1.78 as at March 31, 2010.
Debt levels are kept manageable, with short term loans standing at S$5.5 million and long-term debt at S$18.5 million (for a total of S$24 million). Net cash stood at S$174 million as at Sep 30, 2010 (net cash per share of 34.4 cents), and I believe they are keeping this cash hoard for potential deployment into either the Bio-Treat convertible bonds, or the Big Box project with TTI. More on this in Part 2 of this analysis.
Cash Flow Statement Review
Boustead’s operating cash flows for 1H 2011 are much healthier as compared to a year ago, when it was a negative S$12.7 million. For 1H 2011, there was positive operating cash flows of S$11.4 million, against capex of S$1.76 million, to yield free cash flows of S$9.64 million. For investing cash flows however, there was an acquisition of MI and purchase of AFS securities which drained cash of S$5.5 million. The net result was a cash outflow of S$6.4 million for 1H 2011, which was still lower in aggregate compared to operational cash inflows.
Most of the financing outflows were made up of payment of dividend, and the net cash outflow for the half-year was S$17.1 million. Boustead has still retained its war chest as it is expected to conclude the Heads of Agreement deal with TT International soon on Big Box (the agreement was extended till 1 December for signing, with the long-stop date set at April 11, 2011). Due diligence is also being conducted on the Bio-Treat deal and I would expect Boustead to make an announcement soon on whether they intend to proceed with this deal.
Divisional Revenues Analysis
Engineering services once again took the lion’s share of the revenue pie, contributing 85.6% as compared to last year’s 83.7%. Engineering service’s revenue also grew strongly, up 41.6% from S$195.1 million to S$276.2 million, largely boosted by real estate and energy-related solutions divisions. The difference this year is that the water and wastewater division is also making a meaningful contribution to revenue (and profits, as we shall see in Part 2). This had the overall effect of strengthening the rise in revenues, but of course the crux of the issue is the margins to be obtained from each division, as it is pointedly useless to discuss increases in revenues when profit before tax (PBT) does not budge at all. This will be well-covered in Part 2.
Interestingly, the mix is roughly the same for each division within Engineering Services. Boustead had been restructuring Boustead Maxitherm for some time now, and contributions should start flowing in from this FY onwards; while BIH and C&E made meaningful contributions to revenues. For 2Q 2011 alone, it was a slow quarter but Boustead sounded a note of optimism by saying that negotiations for small and medium contracts are expected to be facilitated.
Real Estate Solutions saw a slower quarter, as mentioned in the press release the value of enquiries had been going down even though this was balanced by an increase in enquiries. Another factor to consider is also the margins to be obtained on these design and build projects, and Boustead should also try to secure more design, build and lease contracts in order to fortify its recurrent revenue base. The township project in Libya is turning out to be more “pain” than “pleasure” as the progress has stalled repeatedly and FF Wong had mentioned problems regarding collecting of monies. Now, the Group is negotiating for a set of different terms to push forward, and to reduce their risks. Understandably, this also means that revenue contributions from Libya will be muted at best, non-existent at worst.
The surprise came from the 26% jump in the revenues for Geo-Spatial Division, as this has traditionally been a slow grower and more of a cash cow for Boustead. However, with the acquisition of Mapdata Pty Ltd back in Feb 2010, this has probably diversified its product range further and allowed the division (under ESRI) to bundle services to form a better package to customers (which are mainly corporations and government agencies).
Part 2 shall tackle the divisional margins and I will also be covering Boustead’s prospects and plans, along with the incorporation of some facts gleaned from a recent article in The Edge Singapore featuring Boustead and FF Wong.
Tuesday, November 23, 2010
Personal Finance Part 20 – The Curious Case of Financial Literacy in Singapore
Perhaps I’ve been harping too much on this issue in my monthly portfolio ramblings, but it just occurred to me that Singaporeans (the youth in particular) are either becoming more and more ignorant of financial matters, or that it has been the case all this time but no one bothered to bring it up to the forefront for discussion. After all, financial literacy can be considered a critical life skill which most young adults (and I dare say even teenagers) should grasp as early as possible, in order to cement their views on spending and saving and to inculcate positive values within them regarding money management. Yet, it seems that many schools are not teaching such topics to students, and many parents also neglect to talk to their children about proper money management. This has resulted in many Singaporeans not even grasping basic financial concepts such as interest rates, investments, savings and rates of return.
Our local newspaper has been highlighting the effects of the lack of financial literacy for quite some time now, and the evidence stems from the fact that such a large group of people have been conned into scams such as Oilpods and Sunshine Empire. It may sound amazing that people out there can promise returns of 10% to 20% per month, but it strikes me as even more amazing that there are people who can actually believe such tall tales! Another phenomenon which has been making its rounds recently are the myriad “investment” seminars out there which can purportedly teach you how to generate unlimited and consistent passive income and to make huge percentage profits using just a small capital base. Simple common sense and logic should tell one that if such schemes were really true, then the operators would have resorted to using it themselves to get filthy rich, instead of “altruistically” wanting to share it with the general public for a “low fee”. Sadly, common sense is becoming less and less common these days.
But what is the cause of this seemingly pervasive lack of financial literacy and common sense? For one, schools are ill equipped to discuss and teach this topic as they claim that each individual is different and so will need to be taught differently on how to handle money in their own way. While this is true, I argue that there are many general principles out there which are applicable to every man on the street, regardless of his social status or wealth level. Simple concepts include the effects of interest rates, paying yourself first and compounding of one’s money; and these can be effectively introduced in schools at primary level to inculcate the right values and practices in children. As they progress on to secondary and tertiary education, more emphasis can be placed on broadening their understanding of financial concepts such as investments, equities, bonds and fixed deposits, to name a few. In other words, the Government should take a pro-active stance to introduce this curriculum into the mainstream so as to dispel the cloud of ignorance currently hanging over every child. It is not enough to just have initiatives such as MoneySense or IM$avvy, as these are targeted mainly at adults who may already have ingrained ideas which are difficult to alter.
Another area which needs to be worked on (and is admittedly tougher) is that of the family unit. Families are somehow reticent when it comes to discussing financial matters in detail, and most parents do not wish for their children to know their true financial situation. This could stem from a conservative belief that if a child knew how much their parents were worth, they would, at best, become lazy and corpulent (knowing that their future would be paid for); or at worst, start plotting to siphon off the family’s fortunes to be used for his own selfish reasons. Hence, talking about family finances and the proper handling of money is somewhat of a taboo subject in Singapore, and remains so even as the Government and society tries to open people up to being more financially savvy. It is therefore not surprising that those families which discuss money matters with their children at a young age and educate them on the importance of the value of money usually result in offspring which are not just savvy about money, but who are also aware of the importance of saving and investing instead of going on a bling-filled binge.
By chance, I have come across blogs written by late teenagers and young adults ranging in age from about 18 to 24. Most of them smack of materialism and peer pressure and talk a lot about material possessions and being “hip and trendy”. It is a sad facet of our society if these young adults grow up to be spoilt brats who cannot manage money, and who may end up with huge debts as their ideas on money are flawed. I am not exaggerating when I opine that this may turn out to be a major social problem two to three decades down the road, as such a cavalier attitude towards money may result in dysfunctional families and broken homes as many struggle to save for retirement.
What can be done for financial literacy? All is not bleak, as there are many instances where help is rendered for those who wish to know more. As previously mentioned, there are schemes such as IM$avvy and MoneySense by MAS which provide a wealth of information on financial matters. SIAS also regularly organizes free seminars to educate the general public on money matters and investments, and these are truly helpful and informative. New families should also be aware of financial matters and educate the next generation accordingly, and there are numerous websites which offer practical suggestions on how to slowly introduce the topic of personal finance for young kids.
Perhaps the battle for financial literacy may still be won, but it would take considerable effort on the part of educators, the Government and the individual. Still, this is a key life skill and therefore, it is best that it not be compromised or else the consequences would be devastating.
Our local newspaper has been highlighting the effects of the lack of financial literacy for quite some time now, and the evidence stems from the fact that such a large group of people have been conned into scams such as Oilpods and Sunshine Empire. It may sound amazing that people out there can promise returns of 10% to 20% per month, but it strikes me as even more amazing that there are people who can actually believe such tall tales! Another phenomenon which has been making its rounds recently are the myriad “investment” seminars out there which can purportedly teach you how to generate unlimited and consistent passive income and to make huge percentage profits using just a small capital base. Simple common sense and logic should tell one that if such schemes were really true, then the operators would have resorted to using it themselves to get filthy rich, instead of “altruistically” wanting to share it with the general public for a “low fee”. Sadly, common sense is becoming less and less common these days.
But what is the cause of this seemingly pervasive lack of financial literacy and common sense? For one, schools are ill equipped to discuss and teach this topic as they claim that each individual is different and so will need to be taught differently on how to handle money in their own way. While this is true, I argue that there are many general principles out there which are applicable to every man on the street, regardless of his social status or wealth level. Simple concepts include the effects of interest rates, paying yourself first and compounding of one’s money; and these can be effectively introduced in schools at primary level to inculcate the right values and practices in children. As they progress on to secondary and tertiary education, more emphasis can be placed on broadening their understanding of financial concepts such as investments, equities, bonds and fixed deposits, to name a few. In other words, the Government should take a pro-active stance to introduce this curriculum into the mainstream so as to dispel the cloud of ignorance currently hanging over every child. It is not enough to just have initiatives such as MoneySense or IM$avvy, as these are targeted mainly at adults who may already have ingrained ideas which are difficult to alter.
Another area which needs to be worked on (and is admittedly tougher) is that of the family unit. Families are somehow reticent when it comes to discussing financial matters in detail, and most parents do not wish for their children to know their true financial situation. This could stem from a conservative belief that if a child knew how much their parents were worth, they would, at best, become lazy and corpulent (knowing that their future would be paid for); or at worst, start plotting to siphon off the family’s fortunes to be used for his own selfish reasons. Hence, talking about family finances and the proper handling of money is somewhat of a taboo subject in Singapore, and remains so even as the Government and society tries to open people up to being more financially savvy. It is therefore not surprising that those families which discuss money matters with their children at a young age and educate them on the importance of the value of money usually result in offspring which are not just savvy about money, but who are also aware of the importance of saving and investing instead of going on a bling-filled binge.
By chance, I have come across blogs written by late teenagers and young adults ranging in age from about 18 to 24. Most of them smack of materialism and peer pressure and talk a lot about material possessions and being “hip and trendy”. It is a sad facet of our society if these young adults grow up to be spoilt brats who cannot manage money, and who may end up with huge debts as their ideas on money are flawed. I am not exaggerating when I opine that this may turn out to be a major social problem two to three decades down the road, as such a cavalier attitude towards money may result in dysfunctional families and broken homes as many struggle to save for retirement.
What can be done for financial literacy? All is not bleak, as there are many instances where help is rendered for those who wish to know more. As previously mentioned, there are schemes such as IM$avvy and MoneySense by MAS which provide a wealth of information on financial matters. SIAS also regularly organizes free seminars to educate the general public on money matters and investments, and these are truly helpful and informative. New families should also be aware of financial matters and educate the next generation accordingly, and there are numerous websites which offer practical suggestions on how to slowly introduce the topic of personal finance for young kids.
Perhaps the battle for financial literacy may still be won, but it would take considerable effort on the part of educators, the Government and the individual. Still, this is a key life skill and therefore, it is best that it not be compromised or else the consequences would be devastating.
Friday, November 19, 2010
MTQ – Analysis of 1H FY 2011 Financial Statements
For MTQ, which releases its financial statements only half-yearly and not quarterly, it is important for me to review them each time they are published, as the next chance will only come six months later. The Company will publish a newsletter around this time to update shareholders of material developments within the Group, and also to provide a summary of key financials. I had enquired before on the frequency of this newsletter and was told it would only be printed once a year to supplement the half-yearly results, and to provide updates which would otherwise not be available through SGXNet (or rather, considered not materially important enough to warrant an SGXNet disclosure). So here we are again staring at the latest set of results from MTQ, for the period ended September 30, 2010 (which I will refer to as “1H FY 2011” from now on). I shall NOT be presenting any numbers in table format on Excel, as I assume investors and readers of this blog will be able to download and obtain the necessary numbers yourselves from SGXNet. Hence, I will focus on the analysis and commentary itself.
Profit and Loss Analysis
Disappointingly, there was no segmental breakdown provided for the 1H FY 2011 financials which showed the breakdown between revenues and profits for Oilfield Engineering Division and Engine Systems Division. Hence, this analysis will focus solely on the Profit and Loss Statement proper, and whatever insights can be gleaned from the numbers provided in the MD&A and press release will be used to substantiate certain points I wish to make.
Revenues increased by 12% year on year but cost of sales increased by a higher 15%, which resulted in gross profit rising by just 9%. Cost of sales includes depreciation on PPE and the increase in PPE due to the Bahrain expansion as well as the sprucing up of Bosch Superstores may have resulted in higher COGS, which impacted gross margin negatively. Gross margins fell from 41.4% in 1H FY 2010 to 40% in 1H FY 2011. Other Income for 1H FY 2010 was made up of S$1.9 million gain on sale of available for sale securities, which is why there was a drop of 91% for this item for 1H FY 2011. Staff costs rose 16% year on year, and I believe part of this can be attributed to hiring of staff for the soon to be completed Bahrain plant. Finance costs, thankfully, remained within control at just S$78,000 (+8%) but I foresee that this will rise significantly in the coming months as MTQ draws down on its loans to complete the construction of their facility. However, cash flow generation from operations should be healthy enough to offset any interest effects in the Cash Flow Statement.
Profit before tax was S$6.9 million compared to S$8.5 million a year ago. If we strip out the exceptional gain of S$1.9 million, profit before tax improved by about 5%. Net profit margin was 12% against 13.3% a year ago as there were higher taxation expenses incurred of S$1.5 million for 1H FY 2011. Overall, it was a relatively decent performance though I will be commenting on the problems faced based on an interview with Mr. Kuah Boon Wee as featured in The Edge Singapore (week ended November 15, 2010).
Balance Sheet Review
PPE increased by 22.3% from S$18.5 million to S$22.6 million, probably as a result of the Group buying and bringing in machinery for their new Bahrain workshop facility. This explains the increase in non-current assets, which also saw a slight decrease in investment securities amount due to mark to market accounting.
Inventories under current assets also increased 17.7% to S$19.6 million, and I should attribute this to the increase in stocking up required for the Bosch Superstore concept expansion, and also because of their acquisition of an outlet in Northern Territory back in March 2010, and also due to the subsequent purchase of Highway Diesel (a fuel injection business) in August 2010. Cash balances remained pretty much constant at S$20.6 million as at Sep 30, 2010 against S$20.3 million as at March 31, 2010. Bank borrowings did not really increase drastically (just +49.4%) as MTQ probably has yet to draw down fully on their UOB term loans, and I am guessing we will see the full impact only in 2H FY 2011. Total bank loans came up to about S$5 million as at Sep 30, 2010, compared to S$3.3 million as at March 31, 2010. Net cash therefore still stood at about S$15.6 million as at Sep 30, 2010 (about 17.7 cents per share). Current ratio stood at 2.98 for Sep 30, 2010 compared with 3.00 as at March 31, 2010.
Cash Flow Statement Review
It was heartening to see the operational cash flows were once again strongly positive at S$7.38 million, against S$5.75 million a year ago. Acquisition of PPE was very high for 1H FY 2011 at S$5.6 million due to the Bahrain expansion, which translated into a much lower FCF figure of about S$1.7 million. Coupled with the purchase of business by a subsidiary company (which I suspect is Highway Diesel because it was announced that it would cost about A$2 million). As a result of the payments for PPE and the purchase of a subsidiary company, investing cash flows was negative at S$7.3 million (there was a small offset of S$1.3 million cash from disposal of PPE).
Under Financing Cash Flows, the drawdown on bank loans has more than doubled from S$1.1 million last year to S$2.6 million this year, which is a sign that more cash is needed for the new facility. Still, this is way below the amount of operational cash flows generated from the core business, and should not cause too much concern to the shareholder.
2H FY 2011 results should be the one for me to intensely scrutinize as it will probably include some of the start-up losses from the new workshop in Bahrain, as well as the full impact of the loans drawdown for the building of the Phase I and part of the upcoming Phase II.
Prospects and Plans – A Discussion
Oilfield Engineering Division
For Oilfield Engineering, MTQ’s press release mentions that the momentum of rising oil prices should keep the division busy through the rest of the financial year, while the results in this division’s top line (+7% from S$18.6 million to S$19.8 million) show that there was indeed increased demand for the Group’s services. Since the new facility at Bahrain (Phase I) will be operational from CY 2011, I guess shareholders can expect some form of revenue contribution from 4Q FY 2011 onwards, though the start up losses from depreciation, utilities and staff costs may be substantial depending on operating conditions.
In the article from the Edge magazine, where CEO Kuah Boon Wee was interviewed, he mentioned that due to the BP disaster with Deepwater Horizon, there would be much more regulation and inspection required for Blow-Out Preventers (BOP) moving forward. This would probably translate to more work for MTQ as BOP made by MTQ’s customers, one of which is Cameron International, would have to be inspected and certified more frequently. Regulations are set to become more stringent in order to prevent a repeat of the massive disaster which spilled millions of gallons of crude oil into the oceans, making it one of the worst environmental disasters in history. He also mentions that there is a lot of (old) equipment in Saudi Arabia and Indonesia which needs to be inspected and re-certified.
As for the new facility in Bahrain, MTQ maintains that the construction is on schedule and that there is no cost overrun. Machinery is arriving and the training of workers has already begun. He expects the first job to arrive some time next year but warns that there may be start-up losses and “teething problems”. However, he does sound a positive note by saying that there is a lot of “activity” in the Middle East, possibly alluding to better deals and increased workload for this division in the coming quarters. I guess it is reasonable to expect some write-off for preliminary expenses incurred in getting the facility up and running; and as business activity picks up these will soon be a thing of the past, though how much it would contribute to the Group’s revenue and profits is still uncertain and cannot be reliably quantified at this point in time.
Engine Systems Division
For Engine Systems, the much talked-about Bosch superstore concept was actually slower to take off than anticipated, and Mr. Kuah talks about how Australia is such a large country and to be able to connect up the sales network was a challenge; and that they had over-estimated their ability to do so in a short period of time. Although the press release talks of organic growth (through partnering Bosch) and acquisitive growth (through the strategic purchases of Highway Diesel and expansion of MTQ’s network into Northern Territory), the top line improvement was just 13% for 1H FY 2011. Since segmental reporting was not done, I could not assess the impact of the growth on Engine System division’s margins, though of course I would expect an improvement since Mr. Kuah Kok Kim mentioned a while back that there would be no necessity to expend a lot of effort and money to revamp existing MTQ branches with Bosch products.
Mr. Kuah Boon Wee says that the Group is working on improving MTQ’s sales coverage in Australia and also to improve the sales package to customers. The Engine Systems division may also be looking out for potential M&A opportunities to expand their sales coverage, and also to acquire businesses selling complementary products which can help to increase MTQ’s existing customer base and allow them to cross-sell products and services.
Conclusion
An interim dividend of 2 cents/share was declared, which was double that of 1H FY 2010 (at 1 cent/share). However, for this dividend a choice was given for scrip or cash, and I suspect the Kuah family will choose to accept scrip to increase their stake in MTQ, while at the same time helping the Company to conserve cash. As for myself, I will wait for the issue price of the scrip shares to be announced in order to make my decision, but at this point in time most likely I will accept cash so that I can deploy to other opportunities should they come along.
My next update and review of MTQ will probably be in May 2011, when they release their FY 2011 results. In the meantime, I can expect their newsletter to arrive and I will also be keeping track of any corporate developments along the way.
Profit and Loss Analysis
Disappointingly, there was no segmental breakdown provided for the 1H FY 2011 financials which showed the breakdown between revenues and profits for Oilfield Engineering Division and Engine Systems Division. Hence, this analysis will focus solely on the Profit and Loss Statement proper, and whatever insights can be gleaned from the numbers provided in the MD&A and press release will be used to substantiate certain points I wish to make.
Revenues increased by 12% year on year but cost of sales increased by a higher 15%, which resulted in gross profit rising by just 9%. Cost of sales includes depreciation on PPE and the increase in PPE due to the Bahrain expansion as well as the sprucing up of Bosch Superstores may have resulted in higher COGS, which impacted gross margin negatively. Gross margins fell from 41.4% in 1H FY 2010 to 40% in 1H FY 2011. Other Income for 1H FY 2010 was made up of S$1.9 million gain on sale of available for sale securities, which is why there was a drop of 91% for this item for 1H FY 2011. Staff costs rose 16% year on year, and I believe part of this can be attributed to hiring of staff for the soon to be completed Bahrain plant. Finance costs, thankfully, remained within control at just S$78,000 (+8%) but I foresee that this will rise significantly in the coming months as MTQ draws down on its loans to complete the construction of their facility. However, cash flow generation from operations should be healthy enough to offset any interest effects in the Cash Flow Statement.
Profit before tax was S$6.9 million compared to S$8.5 million a year ago. If we strip out the exceptional gain of S$1.9 million, profit before tax improved by about 5%. Net profit margin was 12% against 13.3% a year ago as there were higher taxation expenses incurred of S$1.5 million for 1H FY 2011. Overall, it was a relatively decent performance though I will be commenting on the problems faced based on an interview with Mr. Kuah Boon Wee as featured in The Edge Singapore (week ended November 15, 2010).
Balance Sheet Review
PPE increased by 22.3% from S$18.5 million to S$22.6 million, probably as a result of the Group buying and bringing in machinery for their new Bahrain workshop facility. This explains the increase in non-current assets, which also saw a slight decrease in investment securities amount due to mark to market accounting.
Inventories under current assets also increased 17.7% to S$19.6 million, and I should attribute this to the increase in stocking up required for the Bosch Superstore concept expansion, and also because of their acquisition of an outlet in Northern Territory back in March 2010, and also due to the subsequent purchase of Highway Diesel (a fuel injection business) in August 2010. Cash balances remained pretty much constant at S$20.6 million as at Sep 30, 2010 against S$20.3 million as at March 31, 2010. Bank borrowings did not really increase drastically (just +49.4%) as MTQ probably has yet to draw down fully on their UOB term loans, and I am guessing we will see the full impact only in 2H FY 2011. Total bank loans came up to about S$5 million as at Sep 30, 2010, compared to S$3.3 million as at March 31, 2010. Net cash therefore still stood at about S$15.6 million as at Sep 30, 2010 (about 17.7 cents per share). Current ratio stood at 2.98 for Sep 30, 2010 compared with 3.00 as at March 31, 2010.
Cash Flow Statement Review
It was heartening to see the operational cash flows were once again strongly positive at S$7.38 million, against S$5.75 million a year ago. Acquisition of PPE was very high for 1H FY 2011 at S$5.6 million due to the Bahrain expansion, which translated into a much lower FCF figure of about S$1.7 million. Coupled with the purchase of business by a subsidiary company (which I suspect is Highway Diesel because it was announced that it would cost about A$2 million). As a result of the payments for PPE and the purchase of a subsidiary company, investing cash flows was negative at S$7.3 million (there was a small offset of S$1.3 million cash from disposal of PPE).
Under Financing Cash Flows, the drawdown on bank loans has more than doubled from S$1.1 million last year to S$2.6 million this year, which is a sign that more cash is needed for the new facility. Still, this is way below the amount of operational cash flows generated from the core business, and should not cause too much concern to the shareholder.
2H FY 2011 results should be the one for me to intensely scrutinize as it will probably include some of the start-up losses from the new workshop in Bahrain, as well as the full impact of the loans drawdown for the building of the Phase I and part of the upcoming Phase II.
Prospects and Plans – A Discussion
Oilfield Engineering Division
For Oilfield Engineering, MTQ’s press release mentions that the momentum of rising oil prices should keep the division busy through the rest of the financial year, while the results in this division’s top line (+7% from S$18.6 million to S$19.8 million) show that there was indeed increased demand for the Group’s services. Since the new facility at Bahrain (Phase I) will be operational from CY 2011, I guess shareholders can expect some form of revenue contribution from 4Q FY 2011 onwards, though the start up losses from depreciation, utilities and staff costs may be substantial depending on operating conditions.
In the article from the Edge magazine, where CEO Kuah Boon Wee was interviewed, he mentioned that due to the BP disaster with Deepwater Horizon, there would be much more regulation and inspection required for Blow-Out Preventers (BOP) moving forward. This would probably translate to more work for MTQ as BOP made by MTQ’s customers, one of which is Cameron International, would have to be inspected and certified more frequently. Regulations are set to become more stringent in order to prevent a repeat of the massive disaster which spilled millions of gallons of crude oil into the oceans, making it one of the worst environmental disasters in history. He also mentions that there is a lot of (old) equipment in Saudi Arabia and Indonesia which needs to be inspected and re-certified.
As for the new facility in Bahrain, MTQ maintains that the construction is on schedule and that there is no cost overrun. Machinery is arriving and the training of workers has already begun. He expects the first job to arrive some time next year but warns that there may be start-up losses and “teething problems”. However, he does sound a positive note by saying that there is a lot of “activity” in the Middle East, possibly alluding to better deals and increased workload for this division in the coming quarters. I guess it is reasonable to expect some write-off for preliminary expenses incurred in getting the facility up and running; and as business activity picks up these will soon be a thing of the past, though how much it would contribute to the Group’s revenue and profits is still uncertain and cannot be reliably quantified at this point in time.
Engine Systems Division
For Engine Systems, the much talked-about Bosch superstore concept was actually slower to take off than anticipated, and Mr. Kuah talks about how Australia is such a large country and to be able to connect up the sales network was a challenge; and that they had over-estimated their ability to do so in a short period of time. Although the press release talks of organic growth (through partnering Bosch) and acquisitive growth (through the strategic purchases of Highway Diesel and expansion of MTQ’s network into Northern Territory), the top line improvement was just 13% for 1H FY 2011. Since segmental reporting was not done, I could not assess the impact of the growth on Engine System division’s margins, though of course I would expect an improvement since Mr. Kuah Kok Kim mentioned a while back that there would be no necessity to expend a lot of effort and money to revamp existing MTQ branches with Bosch products.
Mr. Kuah Boon Wee says that the Group is working on improving MTQ’s sales coverage in Australia and also to improve the sales package to customers. The Engine Systems division may also be looking out for potential M&A opportunities to expand their sales coverage, and also to acquire businesses selling complementary products which can help to increase MTQ’s existing customer base and allow them to cross-sell products and services.
Conclusion
An interim dividend of 2 cents/share was declared, which was double that of 1H FY 2010 (at 1 cent/share). However, for this dividend a choice was given for scrip or cash, and I suspect the Kuah family will choose to accept scrip to increase their stake in MTQ, while at the same time helping the Company to conserve cash. As for myself, I will wait for the issue price of the scrip shares to be announced in order to make my decision, but at this point in time most likely I will accept cash so that I can deploy to other opportunities should they come along.
My next update and review of MTQ will probably be in May 2011, when they release their FY 2011 results. In the meantime, I can expect their newsletter to arrive and I will also be keeping track of any corporate developments along the way.
Sunday, November 14, 2010
Can One Expand Their Circle of Competence?
This has always been a very intriguing question for me, more so since I started on my journey on value investing. It is well-known by now that Warren Buffett has strong knowledge of the insurance industry, which is why he focused his efforts on GEICO and this is also how Berkshire Hathaway is able to obtain so much insurance “float” with which to invest. Outside of insurance, it is useful to note too that Buffett had somehow acquired a keen insight into the businesses of furniture (Nebraska Furniture Mart), soft drinks (Coca-Cola) and credit cards (American Express). So the question now begs to be asked – how does one go about expanding his circle of competence on businesses he may not know or know well enough? Is this even possible and should an investor even attempt to do so?
Each individual has their own unique expertise and knowledge culled from years of either working in a particular industry, or because of his profession, has access to industry knowledge which others may not be privy to. To give an example, an oil rig engineer may understand the inner workings of oil rigs and the O&G industry very well, while an IT technician or software programmer would be more in tune with the rapid technological advancements in the realm of software design or hardware configuration. One’s profession and area of study also bestows knowledge of certain aspects of businesses; an engineer is more likely to understand an engineering company while a quantity surveyor would understand the property development process more intimately. As the above examples demonstrate, one can already have latent knowledge of a particular industry or business unit based on one’s education or work experience; and this will form the backbone of his understanding with respect to businesses when he embarks on his investing journey.
Armed with this knowledge, investors will then seek out investments which fall within their respective areas of comfort, suitably termed “circle of competence”. The fringes of this circle must be very clearly defined as there could possibly be overlaps in certain industries or companies which may cause unfamiliarity to the investor, so even though he may proclaim that he “knows” an industry, he may be unaware of the minute aspects which could escape his attention. I guess the worst feeling one could have is a false sense of security, which is why I keep stressing on the importance of really knowing an industry before committing your funds to it. If an investor can have intimate knowledge of an industry which not many people are familiar with, this is a distinct advantage as he can then invest with lower risk and higher certainty as compared to other investors who may not be equipped with such knowledge.
So can one expand this knowledge? The most obvious method would be through intensive reading of the said industry, for example for O&G industry, one could delve into articles written on the O&G industry, industry reports, brokerage reports compiled for that industry, as well as news articles and commentaries on the industry itself. One should start to familiarize with the terminology and jargon used in the O&G industry, such as E&P (Exploration and Production) and BOP (Blow-out preventers). Another method one could use is to speak to executives and management to find out more about the intricate business aspects of an industry and how a company within the industry works. Yet another method is to closely observe and study some of the companies within the industry over a couple of quarters, in order to build up the requisite knowledge and understanding of the business cycle present (if any) and the industry dynamics. In short, one needs to conduct intensive research, undergo diligent studying and have patience and perseverance to expand his circle of competence.
I myself started out as a novice investor who was not familiar with any particular industry. Over time, my reading and intensive research have enabled me to understand the O&G industry, MRO industry and the cranes and heavy equipment industry; though of course it is still not as well as I would like. But the knowledge was sufficient for me to feel confident enough to make an investment in MTQ, SIAEC and Tat Hong respectively. For Boustead’s case, I read up extensively on water and wastewater treatment and margins (including the CEO’s interviews), and also on real estate (as Boustead has a real estate solutions division headed by Boustead Projects). So to summarize, I would say I had managed to increase my circle of competence fairly significantly compared to when I first started out.
Of course, one should only expand the circle as far as one feels comfortable. I acknowledge that there may be certain industries which are difficult to understand for certain people, so one should prod and find your “resistance” level to such information, and to seek out information which best suits one’s character and temperament. To put it in another way, seek out what you feel comfortable with and feel confident on engaging, and you will find that you are able to slowly (but surely) expand that circle of competence.
So, in short, the answer is yes – you can expand the circle through reading, research and talking to people. But this will require time and patience and cannot simply be achieved in say, a couple of months. So if you are just starting out as an investor, take your time to read intensively and gather knowledge for at least 9 months to a year before you commit any money to companies trading on the Stock Exchange.
Each individual has their own unique expertise and knowledge culled from years of either working in a particular industry, or because of his profession, has access to industry knowledge which others may not be privy to. To give an example, an oil rig engineer may understand the inner workings of oil rigs and the O&G industry very well, while an IT technician or software programmer would be more in tune with the rapid technological advancements in the realm of software design or hardware configuration. One’s profession and area of study also bestows knowledge of certain aspects of businesses; an engineer is more likely to understand an engineering company while a quantity surveyor would understand the property development process more intimately. As the above examples demonstrate, one can already have latent knowledge of a particular industry or business unit based on one’s education or work experience; and this will form the backbone of his understanding with respect to businesses when he embarks on his investing journey.
Armed with this knowledge, investors will then seek out investments which fall within their respective areas of comfort, suitably termed “circle of competence”. The fringes of this circle must be very clearly defined as there could possibly be overlaps in certain industries or companies which may cause unfamiliarity to the investor, so even though he may proclaim that he “knows” an industry, he may be unaware of the minute aspects which could escape his attention. I guess the worst feeling one could have is a false sense of security, which is why I keep stressing on the importance of really knowing an industry before committing your funds to it. If an investor can have intimate knowledge of an industry which not many people are familiar with, this is a distinct advantage as he can then invest with lower risk and higher certainty as compared to other investors who may not be equipped with such knowledge.
So can one expand this knowledge? The most obvious method would be through intensive reading of the said industry, for example for O&G industry, one could delve into articles written on the O&G industry, industry reports, brokerage reports compiled for that industry, as well as news articles and commentaries on the industry itself. One should start to familiarize with the terminology and jargon used in the O&G industry, such as E&P (Exploration and Production) and BOP (Blow-out preventers). Another method one could use is to speak to executives and management to find out more about the intricate business aspects of an industry and how a company within the industry works. Yet another method is to closely observe and study some of the companies within the industry over a couple of quarters, in order to build up the requisite knowledge and understanding of the business cycle present (if any) and the industry dynamics. In short, one needs to conduct intensive research, undergo diligent studying and have patience and perseverance to expand his circle of competence.
I myself started out as a novice investor who was not familiar with any particular industry. Over time, my reading and intensive research have enabled me to understand the O&G industry, MRO industry and the cranes and heavy equipment industry; though of course it is still not as well as I would like. But the knowledge was sufficient for me to feel confident enough to make an investment in MTQ, SIAEC and Tat Hong respectively. For Boustead’s case, I read up extensively on water and wastewater treatment and margins (including the CEO’s interviews), and also on real estate (as Boustead has a real estate solutions division headed by Boustead Projects). So to summarize, I would say I had managed to increase my circle of competence fairly significantly compared to when I first started out.
Of course, one should only expand the circle as far as one feels comfortable. I acknowledge that there may be certain industries which are difficult to understand for certain people, so one should prod and find your “resistance” level to such information, and to seek out information which best suits one’s character and temperament. To put it in another way, seek out what you feel comfortable with and feel confident on engaging, and you will find that you are able to slowly (but surely) expand that circle of competence.
So, in short, the answer is yes – you can expand the circle through reading, research and talking to people. But this will require time and patience and cannot simply be achieved in say, a couple of months. So if you are just starting out as an investor, take your time to read intensively and gather knowledge for at least 9 months to a year before you commit any money to companies trading on the Stock Exchange.
Tuesday, November 09, 2010
SIA Engineering – Analysis of Purchase Part 5
For this Part 5 and final part of my analysis of purchase, I take a look at the outlook for the global MRO industry based on some industry reports and comments, while at the same time commenting on the prospects and plans for growth for SIAEC. I will also a pros and cons analysis and finally, conclude about SIAEC.
Global MRO Industry Outlook
First of all, I have to say that it’s pretty disappointing that SIAEC had stopped their coverage of the global MRO market since FY 2009; wherein the annual reports for FY 2009 and FY 2010 do NOT contain any commentary on the global MRO industry or market outlook. If a reader traces back through ten years of Annual Reports, he would find that every year before FY 2008 (inclusive) had a pretty detailed commentary on the global MRO market, to the extent that it helped a reader to understand a lot about the industry without the need to do much more independent research.
In terms of air traffic and the airline industry, a recent news report on Channel News Asia on June 28, 2010 stated that Changi Airport registered highest passenger growth in May 2010. The airport handled 3.39 million passengers for May 2010, a 22.6% increase year on year. Globally, increases were also registered for air traffic and this bodes well for the airline industry; translating into more business for MRO providers and SIAEC as well. Importantly, the article stated that aircraft movements for the 5-months ended May 31, 2010 rose 9.6% to 106,177; increased aircraft movements will mean more maintenance and upkeep work to be performed and seems to indicate that the industry will bounce back to pre-crisis levels, though of course this would be gradual rather than a sudden spike.
I shall attempt to use the SIAEC FY 2008 Annual Report on the global MRO market and draw inferences from it (where relevant) to project to the future of the market. In the article on Page 24 of the Annual Report, it was mentioned that the Middle East is another centre of aviation buzz, and that Dubai (in 2008) serves 35 million passengers annually. According to the website, Middle East MRO will see steady growth of 4.4% annually to reach US$3.4 billion by 2018, compared to US$2.8 billion in 2008, while the Middle Eastern fleet has doubled since 2007. The long-term outlook for the MRO industry remains positive as global growth is expected to be maintained at 4.3% CAGR through 2018. This bodes well for the long-term growth of SIAEC.
Note: Information for this brief summary was taken from here and here.
Prospects and Future Plans
I shall use this section to discuss some of the plans and prospects for SIAEC, which are part of their strategy to ensure long-term growth and increased cash flows for the Group; and hopefully will translate into higher dividends for shareholders!
1. Tie-up with Vietnam’s Tan Son Nhat Airport to provide line maintenance services – On February 24, 2009, SIAEC announced that they had signed an agreement with Saigon Ground Services to form a line maintenance JV at Tan Son Nhat International Airport in Ho Chi Minh, Vietnam. SIAEC is supposed to hold a 49% equity shareholding in the JV, but to date this has not been reflected in the Annual Report under Joint Ventures or Associated Companies. Strangely though, it was mentioned in the FY 2010 on Page 4 but the exact details of the contribution and the scale of operations were only touched on nearly 1.5 years ago; and since then there was no announcement or press release on this. However, I am optimistic that SIAEC will be able to tie the details down soon and hopefully in FY 2011 there will be a more definitive announcement on this, and also whether the service offerings will be extended to include maintenance checks and component overhaul services.
2. Establishment of a facility in Bahrain (MOU with Gulf Technics) to service the Middle Eastern market, with potential inroads into Africa and Europe – On January 21, 2010, SIAEC announced the signing of an MOU with Gulf Technics to set up and operate a facility in Bahrain for the maintenance, repair and overhaul (MRO) of aircraft. As of this writing, 7 months later, SIAEC and Gulf Technics should still be hammering out details and working towards a definitive agreement to set up an MRO maintenance facility in Bahrain. Note that MOU signing phase is simply an expression of interest and does not constitute any contractual obligation; thus this is still a WIP and thus was not reflected in SIAEC’s FY 2010 Annual Report. Based on the MRO Industry review in my previous section, assuming SIAEC is able to successfully penetrate the Middle Eastern market, it will hold lots of potential for SIAEC to grow their earnings and cash flows.
3. Investment in Engine Developments with Pratt & Whitney – This is something which is relatively new for SIAEC, investing in aircraft engine technology through their long-time partner Pratt & Whitney (P&W). On January 18, 2010, SIAEC announced that they will co-share and participate in P&W’s Risk-Revenue Sharing Program (RRSP); with a 3% stake in the C-Series aircraft engine program and a 1% stake in the MRJ aircraft engine program. Two special purpose vehicles Nexgen I and II have been incorporated for this purpose and are wholly-owned by SIAEC; and it remains to be seen how lucrative this venture is as it is still pretty “virgin” to SIAEC and the benefits are neither obvious nor clear. Eagle Services Asia, a JV between SIAEC and P&W, will be used as the first engine centre in the global RRSP MRO network for the PW1500G engine, and it was mentioned that Eagle Services is poised to benefit from this arrangement as this was cutting-edge new technology which P&W was investing in. The press release goes on to say that “SIAEC is investing in the future of aviation technology”, which seems to imply that SIAEC is trying to get in at the front door when it comes to new technologies and capabilities. Whether this translates into tangible results such as increased customer base, higher revenues or more share or profits/dividends remains to be seen, but it will be interesting to keep up with this development in the next few quarters to note its contribution.
4. Leveraging on SIA for business (see later section for pros and cons of SIA as “anchor” customer) – With SIAEC leveraging on SIA for business, this means that there will be a steady inflow of revenue and orders for MRO from their biggest client. In fact, just six months back in March 2010, SIAEC renewed its comprehensive Services Agreement with SIA worth S$2.2 billion over 5 years; and which covers a broad spectrum of MRO and fleet management support services. The existing services agreement expires in 2010.
5. More Joint Ventures in the offering – SIAEC has a long history of aggressively pursuing and concluding joint venture arrangements with internationally renowned partners; with Safran Group being the latest addition, as well as Gulf Technics of Bahrain. It will be fair to assume that Management will continue to focus on developing and extending their reach through such lucrative arrangements into the mid-term, as it allows them to grow and expand without high capex requirements. In the near-term, I guess I can reasonably expect their marketing and business development efforts to pay off with at least 1 joint venture/associated company being formed every 2 years (this was the average over the last ten years, with some years having none and other years seeing two to three such arrangements). These will all add to their earnings base and ensure more cash flows in for them to increase dividends over the long-term.
6. More innovative investments into complementary businesses – With the recently concluded P&W Engine RRSP agreement, it is fair to say that SIAEC could be coming up with other innovative ideas on how to use their spare cash (a lot of their cash is free cash which is being churned out) to invest in complementary businesses or service offerings which are tied to their main line of business. Though there is a risk of “diworsifiction” as mentioned by Peter Lynch, SIAEC’s Management has thus far shown a tendency to be able to grow the business through astute investments; and the P&W investment may be a test for them to see if they can think “out of the box”. I concur that it remains to be seen if they can successfully invest in other complementary businesses as time is too short to evaluate the most recent P&W one, but my belief is that the quality of Management is an important factor which I am willing to bet my dollar on.
Other Salient Aspects of SIAEC (Worthy of Mention)
• Comprehensive training facilities and to impart knowledge of Kaizen (continuous improvement) costing to staff.
• Adoption of NTUC’s motto of “Cheaper, Better, Faster” to improve operating efficiencies and cut costs. Recently announced that the Group had given out S$600,000 in rewards to employees relating to this scheme; and eventually SIAEC plans to save up to S$10 million in productivity gains for Phase I initiatives (there was no mention of Phase 2).
• Investment in good IT systems SAP as ERP software to integrate all divisions and departments together for streamlined process flows.
Pros and Cons Analysis for SIAEC
Pros
1. Very strong operating and free cash flows - As can be seen in the analysis in Part 1, SIAEC has very consistent and strong operating cash inflows for the last ten years; and in recent years there was also positive inflows coming from investing activities as its myriad of joint ventures and associated companies boosted its returns and cash. After subtracting capex for new machinery and for upgrades of fixed assets, there was free cash flow generated every year; hence the Group’s cash balance would continue to grow.
2. Growing list of JV and associated companies, with increasing dividends flowing in every financial year - SIAEC has continued to expand its list of JV and associated companies and has been increasing its dividends steadily over the years as a result of FCF generated; Part 3 has also shown how much cash has been flowing in from these alliances into SIAEC’s coffers, and there is thus a very high probability of dividends being sustained or even increased in the medium-term; and this provides a cushion of support for owning shares in the company in case growth tapers off. UPDATE: SIAEC just signed its 25th JV Agreement with Panasonic Avionics on November 4, 2010.
3. Symbiotic relationship with SIA which is a world-renowned brand and a leader in the airline industry - SIAEC has the backing of Singapore Airlines (SIA), which is a world-renowned airline and which is very profitable. Most of their MRO jobs come from SIA, but they are increasingly being less reliant on SIA for business as they diversify their revenue streams away from SIA and into other airlines.
4. Consistently high ROE with low capex requirements and an unleveraged Balance Sheet - SIAEC is able to generate consistently high ROE above 20% on average without debt at all in its Balance Sheet, which is very impressive considering the track record stretches all the way across ten years; and through recessions and busts as well. This demonstrates that Management is able to allocate capital efficiently to generate high returns on equity for its shareholders and the business model is able to sustain high returns without relying on either debt or equity issuance.
5. High barriers to entry industry - Although the MRO industry is admittedly fragmented and there are many players each servicing specific large airlines, the barriers to entry are high in terms of equipment needed and expertise required (of technicians and engineers). SIAEC has built up a proven track record over the years in terms of high quality service to international clients and this reputation and branding also helps to create a moat which competitors will find difficult to assail.
6. Clear and Successful growth strategy with proven track record - SIAEC’s growth strategy had been clearly articulated right from the start (in FY 2001’s IPO year); and Management has consistently followed this strategy to grow the Group’s business and cash flows over the last ten years. As a shareholder, I have the confidence that this business model is a proven one (with a decade of history and track record as evidence), and will guide the Group forward to better results and performance over the medium-term. This is much better than other companies which are constantly seeking new (and unproven) avenues for tapping growth and expansion, all with a high risk of failure which will result in shareholders’ monies being burnt away.
Cons
1. High valuations and high price to book ratio - Valuations are not exactly cheap, coming in at 15x historical PER and about 14x ex-cash historical PER. Price to book is about 3x and is pretty demanding as well; so one can argue that SIAEC is fairly valued rather than under-valued, based on historical results of course. Still, I must add that I am investing for the future, and I am expecting profits and cash flows to improve as the years go by, through the measures undertaken as mentioned in the previous analyses. Also, do note that SIAEC is a “blue chip”; hence valuations are expected to be higher than companies such as Kingsmen which are much smaller. Valuations for SIAEC are comparable against its close competitors and are currently hovering at its 5-year average; so its days of being severely undervalued during the Global Financial Crisis (actually, almost every company was under-valued then, some trading way below book value) are most likely over. Its yield and consistent FCF can be used as a margin of safety in case the business falters. Interestingly, Teh Hooi Ling wrote an article dated August 15, 2010 in the Business Times titled “In Search of Super Returns in Stocks”; where she mentions that investors would be willing to pay a high premium over book value if the Company can generate earnings above its cost of capital. She argues that if a company can earn substantially above its cost of capital (by measuring ROE) over an extended period of time, then the stock should trade above book value. Price to book ratio will be higher as long as the Company is having “abnormal earnings”, which is defined as ROE minus the cost of capital, for an extended and sustained period of time. Please check out her article here.
2. SIAEC’s business is dependent upon the aviation and air travel industry (hence not so resilient in the face of recessions and busts) - Air travel is pretty cyclical and is affected by downturns and recessions, and since SIAEC is intricately linked to SIA in terms of business volume, one can expect industry doldrums to impact SIAEC’s earnings and cash flows as well. Thus far, the effects are not that obvious due to the diversified nature of SIAEC’s JVs and business alliances, but there have been years in which they paid less dividends and earnings took a dip. Hence, this is a minus point for SIAEC even though its cash flows are fairly resilient so far.
3. Major customer SIA can also be a bane if SIA’s fortunes suffer - Despite the obvious advantages of having SIA as their major and “anchor” customer, this can also backfire badly if SIA themselves get stuck in a rut, or are experiencing problems with their top and bottom lines.
4. Core revenue did not increase by much as compared to competitors - This should be viewed in the light of SIAEC’s strategy compared with other MRO players, as SIAEC focused more on joint ventures and alliances as compared with their competitors. As a result, one should note that core revenues did not increases as much on a CAGR basis as compared to its competitors. On the flip side, SIAEC does make up for it with higher share of profits from associated companies and joint ventures as well as higher cash dividends from these investing activities.
5. There is a need to continually invest in technical skills and human knowledge base in order to remain competitive - SIAEC is in the service industry, which means its main costs will be concentrated in staff costs. Even though capex is low as a proportion of revenues, one should note that skills upgrading is a constant requirement for this industry and nature of work; and funds have to be continually invested to train technicians to handle new technologies and aircraft. Sometimes, this training can be very costly as it entails sending engineers and technicians to Europe to learn from the companies domiciled there. This is therefore a minus as the high fixed staff costs structure (including training and development) would imply that SIAEC cannot easily cut costs during a severe recession/downturn (if not they may lose out to their competition).
6. Majority-held by SIA (80% or 870 million shares), hence SIAEC is effectively still controlled by SIA - Being an 80% major shareholder, SIA is effectively controlling SIAEC and thus minority shareholders may not have much say in terms of voting on resolutions and/or other such matters pertaining to divestments or investments which require shareholder approval. There is an inherent risk of being “overrun” by the majority shareholders when it comes to voting on critical matters relating to SIAEC.
Conclusion
After evaluating the risks and rewards, I proceeded to invest an amount of about S$49K into SIAEC, at an average price of S$4.087 per share. The pros are a lot stronger than the cons, in the sense that many of the point raised as cons had already been mitigated (for example, costs did increase during the downturn as per point 5 but not to the extent of wiping out too much cash flows, which is the lifeblood of a Company). As for Point 6, though the risk exists; thus far there have been no boardroom “brawls” with regards to unpopular policies being unilaterally passed by parent SIA. The justification for the high valuation and PTB is that SIAEC is able to maintain very high ROE>20% for the last ten years, while generating loads of FCF; hence it is accorded a high valuation due to the quality of the business (which, incidentally, is still growing). The high PTB was already explained earlier.
Furthermore, the yield for SIAEC at my purchase price stands at about 4.38% historical; and this yield based on healthy FCF should act as a buffer in case the earnings of SIAEC suffer or there is some impairment in the strong fundamentals of the Group. In other words, my margin of safety exists using the yield as a “cushion” and the track record and blue-chip status of SIAEC as my support basis.
Global MRO Industry Outlook
First of all, I have to say that it’s pretty disappointing that SIAEC had stopped their coverage of the global MRO market since FY 2009; wherein the annual reports for FY 2009 and FY 2010 do NOT contain any commentary on the global MRO industry or market outlook. If a reader traces back through ten years of Annual Reports, he would find that every year before FY 2008 (inclusive) had a pretty detailed commentary on the global MRO market, to the extent that it helped a reader to understand a lot about the industry without the need to do much more independent research.
In terms of air traffic and the airline industry, a recent news report on Channel News Asia on June 28, 2010 stated that Changi Airport registered highest passenger growth in May 2010. The airport handled 3.39 million passengers for May 2010, a 22.6% increase year on year. Globally, increases were also registered for air traffic and this bodes well for the airline industry; translating into more business for MRO providers and SIAEC as well. Importantly, the article stated that aircraft movements for the 5-months ended May 31, 2010 rose 9.6% to 106,177; increased aircraft movements will mean more maintenance and upkeep work to be performed and seems to indicate that the industry will bounce back to pre-crisis levels, though of course this would be gradual rather than a sudden spike.
I shall attempt to use the SIAEC FY 2008 Annual Report on the global MRO market and draw inferences from it (where relevant) to project to the future of the market. In the article on Page 24 of the Annual Report, it was mentioned that the Middle East is another centre of aviation buzz, and that Dubai (in 2008) serves 35 million passengers annually. According to the website, Middle East MRO will see steady growth of 4.4% annually to reach US$3.4 billion by 2018, compared to US$2.8 billion in 2008, while the Middle Eastern fleet has doubled since 2007. The long-term outlook for the MRO industry remains positive as global growth is expected to be maintained at 4.3% CAGR through 2018. This bodes well for the long-term growth of SIAEC.
Note: Information for this brief summary was taken from here and here.
Prospects and Future Plans
I shall use this section to discuss some of the plans and prospects for SIAEC, which are part of their strategy to ensure long-term growth and increased cash flows for the Group; and hopefully will translate into higher dividends for shareholders!
1. Tie-up with Vietnam’s Tan Son Nhat Airport to provide line maintenance services – On February 24, 2009, SIAEC announced that they had signed an agreement with Saigon Ground Services to form a line maintenance JV at Tan Son Nhat International Airport in Ho Chi Minh, Vietnam. SIAEC is supposed to hold a 49% equity shareholding in the JV, but to date this has not been reflected in the Annual Report under Joint Ventures or Associated Companies. Strangely though, it was mentioned in the FY 2010 on Page 4 but the exact details of the contribution and the scale of operations were only touched on nearly 1.5 years ago; and since then there was no announcement or press release on this. However, I am optimistic that SIAEC will be able to tie the details down soon and hopefully in FY 2011 there will be a more definitive announcement on this, and also whether the service offerings will be extended to include maintenance checks and component overhaul services.
2. Establishment of a facility in Bahrain (MOU with Gulf Technics) to service the Middle Eastern market, with potential inroads into Africa and Europe – On January 21, 2010, SIAEC announced the signing of an MOU with Gulf Technics to set up and operate a facility in Bahrain for the maintenance, repair and overhaul (MRO) of aircraft. As of this writing, 7 months later, SIAEC and Gulf Technics should still be hammering out details and working towards a definitive agreement to set up an MRO maintenance facility in Bahrain. Note that MOU signing phase is simply an expression of interest and does not constitute any contractual obligation; thus this is still a WIP and thus was not reflected in SIAEC’s FY 2010 Annual Report. Based on the MRO Industry review in my previous section, assuming SIAEC is able to successfully penetrate the Middle Eastern market, it will hold lots of potential for SIAEC to grow their earnings and cash flows.
3. Investment in Engine Developments with Pratt & Whitney – This is something which is relatively new for SIAEC, investing in aircraft engine technology through their long-time partner Pratt & Whitney (P&W). On January 18, 2010, SIAEC announced that they will co-share and participate in P&W’s Risk-Revenue Sharing Program (RRSP); with a 3% stake in the C-Series aircraft engine program and a 1% stake in the MRJ aircraft engine program. Two special purpose vehicles Nexgen I and II have been incorporated for this purpose and are wholly-owned by SIAEC; and it remains to be seen how lucrative this venture is as it is still pretty “virgin” to SIAEC and the benefits are neither obvious nor clear. Eagle Services Asia, a JV between SIAEC and P&W, will be used as the first engine centre in the global RRSP MRO network for the PW1500G engine, and it was mentioned that Eagle Services is poised to benefit from this arrangement as this was cutting-edge new technology which P&W was investing in. The press release goes on to say that “SIAEC is investing in the future of aviation technology”, which seems to imply that SIAEC is trying to get in at the front door when it comes to new technologies and capabilities. Whether this translates into tangible results such as increased customer base, higher revenues or more share or profits/dividends remains to be seen, but it will be interesting to keep up with this development in the next few quarters to note its contribution.
4. Leveraging on SIA for business (see later section for pros and cons of SIA as “anchor” customer) – With SIAEC leveraging on SIA for business, this means that there will be a steady inflow of revenue and orders for MRO from their biggest client. In fact, just six months back in March 2010, SIAEC renewed its comprehensive Services Agreement with SIA worth S$2.2 billion over 5 years; and which covers a broad spectrum of MRO and fleet management support services. The existing services agreement expires in 2010.
5. More Joint Ventures in the offering – SIAEC has a long history of aggressively pursuing and concluding joint venture arrangements with internationally renowned partners; with Safran Group being the latest addition, as well as Gulf Technics of Bahrain. It will be fair to assume that Management will continue to focus on developing and extending their reach through such lucrative arrangements into the mid-term, as it allows them to grow and expand without high capex requirements. In the near-term, I guess I can reasonably expect their marketing and business development efforts to pay off with at least 1 joint venture/associated company being formed every 2 years (this was the average over the last ten years, with some years having none and other years seeing two to three such arrangements). These will all add to their earnings base and ensure more cash flows in for them to increase dividends over the long-term.
6. More innovative investments into complementary businesses – With the recently concluded P&W Engine RRSP agreement, it is fair to say that SIAEC could be coming up with other innovative ideas on how to use their spare cash (a lot of their cash is free cash which is being churned out) to invest in complementary businesses or service offerings which are tied to their main line of business. Though there is a risk of “diworsifiction” as mentioned by Peter Lynch, SIAEC’s Management has thus far shown a tendency to be able to grow the business through astute investments; and the P&W investment may be a test for them to see if they can think “out of the box”. I concur that it remains to be seen if they can successfully invest in other complementary businesses as time is too short to evaluate the most recent P&W one, but my belief is that the quality of Management is an important factor which I am willing to bet my dollar on.
Other Salient Aspects of SIAEC (Worthy of Mention)
• Comprehensive training facilities and to impart knowledge of Kaizen (continuous improvement) costing to staff.
• Adoption of NTUC’s motto of “Cheaper, Better, Faster” to improve operating efficiencies and cut costs. Recently announced that the Group had given out S$600,000 in rewards to employees relating to this scheme; and eventually SIAEC plans to save up to S$10 million in productivity gains for Phase I initiatives (there was no mention of Phase 2).
• Investment in good IT systems SAP as ERP software to integrate all divisions and departments together for streamlined process flows.
Pros and Cons Analysis for SIAEC
Pros
1. Very strong operating and free cash flows - As can be seen in the analysis in Part 1, SIAEC has very consistent and strong operating cash inflows for the last ten years; and in recent years there was also positive inflows coming from investing activities as its myriad of joint ventures and associated companies boosted its returns and cash. After subtracting capex for new machinery and for upgrades of fixed assets, there was free cash flow generated every year; hence the Group’s cash balance would continue to grow.
2. Growing list of JV and associated companies, with increasing dividends flowing in every financial year - SIAEC has continued to expand its list of JV and associated companies and has been increasing its dividends steadily over the years as a result of FCF generated; Part 3 has also shown how much cash has been flowing in from these alliances into SIAEC’s coffers, and there is thus a very high probability of dividends being sustained or even increased in the medium-term; and this provides a cushion of support for owning shares in the company in case growth tapers off. UPDATE: SIAEC just signed its 25th JV Agreement with Panasonic Avionics on November 4, 2010.
3. Symbiotic relationship with SIA which is a world-renowned brand and a leader in the airline industry - SIAEC has the backing of Singapore Airlines (SIA), which is a world-renowned airline and which is very profitable. Most of their MRO jobs come from SIA, but they are increasingly being less reliant on SIA for business as they diversify their revenue streams away from SIA and into other airlines.
4. Consistently high ROE with low capex requirements and an unleveraged Balance Sheet - SIAEC is able to generate consistently high ROE above 20% on average without debt at all in its Balance Sheet, which is very impressive considering the track record stretches all the way across ten years; and through recessions and busts as well. This demonstrates that Management is able to allocate capital efficiently to generate high returns on equity for its shareholders and the business model is able to sustain high returns without relying on either debt or equity issuance.
5. High barriers to entry industry - Although the MRO industry is admittedly fragmented and there are many players each servicing specific large airlines, the barriers to entry are high in terms of equipment needed and expertise required (of technicians and engineers). SIAEC has built up a proven track record over the years in terms of high quality service to international clients and this reputation and branding also helps to create a moat which competitors will find difficult to assail.
6. Clear and Successful growth strategy with proven track record - SIAEC’s growth strategy had been clearly articulated right from the start (in FY 2001’s IPO year); and Management has consistently followed this strategy to grow the Group’s business and cash flows over the last ten years. As a shareholder, I have the confidence that this business model is a proven one (with a decade of history and track record as evidence), and will guide the Group forward to better results and performance over the medium-term. This is much better than other companies which are constantly seeking new (and unproven) avenues for tapping growth and expansion, all with a high risk of failure which will result in shareholders’ monies being burnt away.
Cons
1. High valuations and high price to book ratio - Valuations are not exactly cheap, coming in at 15x historical PER and about 14x ex-cash historical PER. Price to book is about 3x and is pretty demanding as well; so one can argue that SIAEC is fairly valued rather than under-valued, based on historical results of course. Still, I must add that I am investing for the future, and I am expecting profits and cash flows to improve as the years go by, through the measures undertaken as mentioned in the previous analyses. Also, do note that SIAEC is a “blue chip”; hence valuations are expected to be higher than companies such as Kingsmen which are much smaller. Valuations for SIAEC are comparable against its close competitors and are currently hovering at its 5-year average; so its days of being severely undervalued during the Global Financial Crisis (actually, almost every company was under-valued then, some trading way below book value) are most likely over. Its yield and consistent FCF can be used as a margin of safety in case the business falters. Interestingly, Teh Hooi Ling wrote an article dated August 15, 2010 in the Business Times titled “In Search of Super Returns in Stocks”; where she mentions that investors would be willing to pay a high premium over book value if the Company can generate earnings above its cost of capital. She argues that if a company can earn substantially above its cost of capital (by measuring ROE) over an extended period of time, then the stock should trade above book value. Price to book ratio will be higher as long as the Company is having “abnormal earnings”, which is defined as ROE minus the cost of capital, for an extended and sustained period of time. Please check out her article here.
2. SIAEC’s business is dependent upon the aviation and air travel industry (hence not so resilient in the face of recessions and busts) - Air travel is pretty cyclical and is affected by downturns and recessions, and since SIAEC is intricately linked to SIA in terms of business volume, one can expect industry doldrums to impact SIAEC’s earnings and cash flows as well. Thus far, the effects are not that obvious due to the diversified nature of SIAEC’s JVs and business alliances, but there have been years in which they paid less dividends and earnings took a dip. Hence, this is a minus point for SIAEC even though its cash flows are fairly resilient so far.
3. Major customer SIA can also be a bane if SIA’s fortunes suffer - Despite the obvious advantages of having SIA as their major and “anchor” customer, this can also backfire badly if SIA themselves get stuck in a rut, or are experiencing problems with their top and bottom lines.
4. Core revenue did not increase by much as compared to competitors - This should be viewed in the light of SIAEC’s strategy compared with other MRO players, as SIAEC focused more on joint ventures and alliances as compared with their competitors. As a result, one should note that core revenues did not increases as much on a CAGR basis as compared to its competitors. On the flip side, SIAEC does make up for it with higher share of profits from associated companies and joint ventures as well as higher cash dividends from these investing activities.
5. There is a need to continually invest in technical skills and human knowledge base in order to remain competitive - SIAEC is in the service industry, which means its main costs will be concentrated in staff costs. Even though capex is low as a proportion of revenues, one should note that skills upgrading is a constant requirement for this industry and nature of work; and funds have to be continually invested to train technicians to handle new technologies and aircraft. Sometimes, this training can be very costly as it entails sending engineers and technicians to Europe to learn from the companies domiciled there. This is therefore a minus as the high fixed staff costs structure (including training and development) would imply that SIAEC cannot easily cut costs during a severe recession/downturn (if not they may lose out to their competition).
6. Majority-held by SIA (80% or 870 million shares), hence SIAEC is effectively still controlled by SIA - Being an 80% major shareholder, SIA is effectively controlling SIAEC and thus minority shareholders may not have much say in terms of voting on resolutions and/or other such matters pertaining to divestments or investments which require shareholder approval. There is an inherent risk of being “overrun” by the majority shareholders when it comes to voting on critical matters relating to SIAEC.
Conclusion
After evaluating the risks and rewards, I proceeded to invest an amount of about S$49K into SIAEC, at an average price of S$4.087 per share. The pros are a lot stronger than the cons, in the sense that many of the point raised as cons had already been mitigated (for example, costs did increase during the downturn as per point 5 but not to the extent of wiping out too much cash flows, which is the lifeblood of a Company). As for Point 6, though the risk exists; thus far there have been no boardroom “brawls” with regards to unpopular policies being unilaterally passed by parent SIA. The justification for the high valuation and PTB is that SIAEC is able to maintain very high ROE>20% for the last ten years, while generating loads of FCF; hence it is accorded a high valuation due to the quality of the business (which, incidentally, is still growing). The high PTB was already explained earlier.
Furthermore, the yield for SIAEC at my purchase price stands at about 4.38% historical; and this yield based on healthy FCF should act as a buffer in case the earnings of SIAEC suffer or there is some impairment in the strong fundamentals of the Group. In other words, my margin of safety exists using the yield as a “cushion” and the track record and blue-chip status of SIAEC as my support basis.
Subscribe to:
Posts (Atom)
