June 2011 Portfolio Summary and Review

June 2011 was one of those months where there was a lot of economic and political news – that of Greece (almost daily), USA, China and India; but not even a whisper of corporate news. So I guess I spent most of the days relaxing and catching up on precious family time as well as digging deeper into work (yes, my workload has increased). My previous post had mentioned that my daughter was admitted to hospital, and this also consumed my time somewhat. Fortunately, she has been discharged and I am now more wary of bacteria and viruses which could potentially infect my poor child again. Call it fatherly instinct if you will, but now every time she sneezes or coughs I almost have a fit. Thankfully, I have very helpful in-laws as well as my own parents who spend a lot of time fussing over my daughter to make sure she gets the best possible care.

On the property front, the release of a massive supply of housing (as mentioned in my last blog post) and the (in)famous $880,000 (reduced to $778,00 later on) Sim Lian DBSS had the whole internet community abuzz, though mostly with decidedly negative reactions. While it remains to be seen if the measures will have any effect, countries like China are still seeing real estate prices go UP. Only when the hot money stops flowing from the West to the East will this inflation finally subside.

To avoid being overly long-winded (again), let me dive right into my portfolio and corporate summaries. My portfolio and comments for June 2011 are as follows:-

1) Boustead Holdings Limited – Boustead had a relatively slower month in June 2011 as there was only one announcement of contract win. On June 16, 2011, Boustead announced that its Energy-Related Engineering Division had secured S$23 million worth of contracts for downstream oil refineries and gas processing plants in Australia, Singapore and Turkmenistan. Adding these contracts to the S$25 million announced in April 2011, Boustead’s order book for this Division stands at over S$55 million in just the first three months of the financial year, and represents a good start for Boustead. Since I am already planning an analysis of their FY 2011 financials to continue into Parts 2 and 3, I shall say no more here.

A piece of disappointing news announced on June 24, 2011 was that of Corporate Guarantees demanding from it from Bank of Commerce and Development for about US$18.8 million. These were related to the Libyan Township project which was now put on indefinite hold due to the ongoing crisis. Boustead had not made provisions for this amount in its FY 2011 results as it was advised by its legal counsel that there was no necessity for it at the time. So it looks as though Boustead may be exposed to another potential S$23.3 million in losses for FY 2012 which would impact its financial performance.

2) Suntec REIT – There was no news for Suntec REIT for June 2011.

3) MTQ Corporation Limited– There were no corporate announcements from MTQ for June 2011 per se, but Neptune Marine Services (“NMS”) did announce that Blossomvale (a 100% subsidiary of MTQ) had increased its stake in the Company from June 8 to June 27, 2011. Please refer to the table above for the stake changes. Over a period of 11 trading days, MTQ had taken the opportunity to average down on their original purchase of NMS shares (200 million shares at A$0.05 per share) by purchasing an additional 68,455,000 shares at prices ranges of A$0.035 to A$0.0387. This had the effect of increasing their stake in NMS to 268,455,000 shares (or 15.31% of the total issued share capital) and lowered their average cost in NMS from A$0.05 to A$0.0467.

I am also expecting MTQ’s FY 2011 Annual Report in July 2011, as well as news on the location and timing of the AGM.

4) GRP Limited – Predictable, there was no news for GRP for June 2011.

5) Kingsmen Creatives Holdings Limited – There was no news from Kingsmen Creatives for June 2011.

6) SIA Engineering Company Limited – On June 28, 2011, SIA Engineering announced the renewal of an MRO Agreement with SIA Cargo valued at $385 million over 3 years, to be extended by two more years if conditions are fulfilled. Since this is a renewal agreement, there is no material impact on FY 2012’s financials. SIAEC’s AGM will be held on July 22, 2011 11 a.m. at Marina Mandarin Ballroom.

Portfolio Review – June 2011

Realized gains have remained at S$59.2K due to the absence of any shares going ex-dividend (SIAEC will go ex-dividend in July while Boustead on August 3, 2011).

For the month of June 2011, the portfolio has dropped by -2.2% (using XIRR in MS Excel to compute) against a -2.2% fall in the STI; thus my portfolio performance is on par with the STI. This was 0.4% better than May 2011’s under-performance of -0.4 percentage points. Cost of investment remained at S$210K and unrealized gains stand at +12.2% (Portfolio Market Value of S$235.5K).

For this month at least, I managed to blog about some topics on valuations and also relate some of my experience along my investment journey. I guess July 2011 should see some interesting AGMs coming up – that of MTQ, Boustead and SIAEC. However, as I am bogged down with work commitments, I guess I have to be selective with regards to which AGM I decide to attend. Boustead’s analysis will also continue this month, and I may also have time to squeeze in a post on Porter’s Five-Forces and perhaps wrap up my long-overdue Kingsmen Comprehensive Analysis Part 5.

If you think June 2011 was amazingly dry in terms of corporate news (just see the above summary and you will know what I mean), July 2011 might just beat it as it is also well-known for having very little corporate news (at least, this applies to the companies I own). Some companies seem to release news almost daily, like Olam for example. Only Suntec REIT will announce results in July 2011, and since I own such a pathetic amount of shares I don’t even see reason to comment on it! I will have to wait till August 2011 to see Kingsmen release their 1H FY 2011 results. UPDATE: SIA Engineering will release their 1Q FY 2012 results on July 26, 2011 (Tuesday).

My next portfolio review will be on July 31, 2011 (Sunday).

Property – Expectation Theory and The Perfect Storm

It’s been a while since I wrote something on property, since there was nothing really new or ground-breaking for me to comment on since Mr. Khaw Boon Wan (KBW) took over from the reins of Mr. Mah Bow Tan after 11 years at the helm of the Ministry of National Development. However, on June 10, 2011, Mr. KBW blogged about a possible “perfect storm” which may brew in 1-2 years time, and which may either cause the property market to cool significantly, or, in the worst-case scenario, crash resoundingly. He said that housing prices could not go up indefinitely, and cautioned many speculators and investors to do their sums carefully and to make prudent purchases to ensure they could hold in case of falling prices. The perfect storm consisted of three aspects: record-high land supply, possible drop in influx of foreigners (demand-side) and the rising of interest rates. I shall tackle each of these points separately, then offer a summary of my thoughts and comments.

Record Supply of Land

In response to runaway property prices and the frustrations of young couples yearning to purchase their first HDB BTO property, Mr. KBW has released an unprecedented number of sites for development of residential units. For 2010, there were 13,945 units for private homes but for 2011, it is planned that 17,510 units will be released to cater for the strong demand. This bumper supply is supposed to assuage the fears of Singaporeans who constantly complain that there are insufficient HDB flats for application. Their complaints are not unfounded though – some of the recent BTOs have seen over-subscriptions by up to 6 to 7 times the number of flats offered. With the injection of such a massive supply of land in such a short time, the Minister’s aim is that an equilibrium will be reached in terms of prices as demand will then be balanced by adequate supply.

However, some experts and veterans have been quick to point out that as a result of KBW’s zealousness in solving the problem of under-supply, he may have inadvertently pushed the property market into an over-supply situation. Keeping in mind that property cycles are longer than stock market cycles and that a lot of the price determination depends on Government policies (especially those relating to % loan quantum), the effects of such a significant supply of land coming onstream probably will only be felt in 1-2 years.

Falling Demand

With Greece facing problems once again and the USA’s economy stagnating after the effects of QE2 have worn off, it looks as though the world in general may face another prolonged and painful slowdown. The usual suspects embroiled in economic hell are Europe, UK and the USA; and it looks as though the problems will get much worse before they get better. If printing cheap money is the way to solve problems, then the USA would have solved their problems long ago! As it is, inflation and the falling value of the USD may precipitate another crisis in terms of lowered consumer spending; coupled with a stagnant housing market, this means the projected US recovery may falter and splutter for the next few years at least. Even China and India are not spared from economic problems, as they seek to tame runaway inflation and soaring property prices (in China and Hong Kong). China recently raised its banks’ reserve ratio to curb bank loans for property speculation, while Hong Kong has reduced the amount which can be borrowed for property from 60% to 50%, in desperate but vain attempts to rein in prices.

Assuming the troubles persist in Greece, USA and other areas of the West, this would have a spillover effect over in Asia as less foreigners will be sent over here for work attachments or seconded here for jobs. This will lead to a fall in demand for foreigners renting apartments. A sharp fall in demand may also be the result of a combination of the above-mentioned, coupled with a tighter immigration policy, especially after it was made known that the foreigner influx has been continuing unabated for the last 5 years; and which has resulted in a lot of discontent and dissatisfaction amongst Singaporeans.

Rising Interest Rates

Probably the worst whammy of them all – rising interest rates will hit property investors hard, as though they had been pummelled by Thor’s hammer. The problem, of course, is that interest rates have been hovering around historical lows for more than 2 years (since late 2008), so there is not much fear or trepidation among the masses that it may rise. This may explain the somewhat gung-ho and cavalier attitude taken by investors who are rushing to leverage and lock in the low rates for the next 2-3 years. The flood of liquidity has also further exacerbated the problem and 4 rounds of cooling measures have failed to dampen the demand for loans and property. This is because the measures have only tweaked the loan quantum % but have not affected the interest rates charged by banks, as this is by and large pegged to USA Federal Reserve rates.

Problems will most likely arise only after most of the current crop of investors’ lock-in periods have expired, which will probably be in 2012 or 2013 (assuming most loans were taken up in 2009-2011 and have a lock-in fixed period of 1-3 years). Once interest rates start to float, and with banks charging their usual 125 to 150 basis points spread, the rates charged by then could be significantly higher than what they are presently. If an investor only has to cough up say $2,000 in instalments at 1.5%, then this will more than double when interest rates hit above 3% once the world economy normalizes, and there is reversion to the mean in terms of long-term interest rates.

The Perfect Storm

Yes, I know the title sounds like a bad Hollywood movie on tornadoes, but remember that if this potent cauldron of three factors comes into play almost at the same time, it most likely will result in a crash in the property market. Though it is unlikely that all three factors will converge at the same time, what we do know is that supply will most definitely come on-stream, while demand may or may not taper off in 2012 and 2013. Interest rates in Singapore are unlikely to rise in the near future, but it is very hard to see past 2012 as the economic picture looks very murky and uncertain at the moment.

Expectation Theory

Expectation theory ties in with markets in general (not just property), and is rooted in psychology. In brief, it simply means that if market players anticipate and expect changes to the macro-economy which may impact their investments or their decision-making process, they would take immediate action to mitigate their exposure and minimize their risks. This means that technically, prices could begin to fall even way before any of the above ingredients which constitute the perfect storm actually come to pass; because people are anticipating the storm in advance and are simply reacting to it as quick as they can. Hence, pessimism and risk aversion can set in suddenly and without warning, and like a disease, can spread like wildfire within a short span of time and “infect” more and more people, resulting in either a slump or a mini-crash. We see this occur in fast motion in the equity markets, when a sudden turn of events or a change in mood can precipitate a sudden crash in stock prices. For the property market, I will liken it more to a slow-motion train wreck instead.

Another Sign of A Bubble - New players in Property Scene

In a further sign of possible exuberance in the property market, there have been a rash of new players entering the property scene, some of whom have had no prior experience. It is generally acknowledged that many new entrants flooding into property is a tell-tale sign of a possible market top, and so one should view such signs with immediacy and a sense of trepidation that things may go downhill soon. For starters, Ron Sim of OSIM has, in his personal capacity, bid for commercially zoned land in Paya Lebar and Punggol. JL Asia Resources (owner of K-Box) teamed up with Mary Chia to open Porcelain Hotel in Mosque Street; while Thakral Corp, an electronic goods distributor, has taken stakes in several property projects in Sydney and Melbourne. All these were recently reported in the news barely a month ago, and most property booms have led to companies jumping into the deep end to capture a slice of (seemingly) lucrative money-making opportunities. Whether or not this will end in pain and misery, I guess only time will tell.

Conclusion

So the perfect storm may indeed come to pass, and for those who are willing to wait till 2013, the answer may turn out to surprise everyone, as such trends are difficult if not impossible to predict accurately. With recent news that a new DBSS flat was being offered (by Sim Lian Group, no doubt) at $880,000 (Centrale 8 in Tampines), I too am beginning to wonder if the market is getting way too frothy for my own comfort!

Investment Thoughts Four Years On

OK, I know this is probably another lousy title, but it was tough for me to think of what to call this post, which basically sums up my reflections and thoughts as an investor after blogging for 4 years. I guess you can call it an “investment style update”, one of many which I have over the months (the last one was in Nov 2010 in this post). Every now and then, I take the opportunity to crystallize my thoughts on investments, businesses and personal finance as part of my journey (the blog is, after all, “Musicwhiz’s Journey”) towards financial freedom. For now, it remains decidedly elusive, but that does not detract me from my eventual goal of reaching this summit. Many will remark that goalposts may change as you age and your personal circumstances change, and I do agree; but as times change, my investment style and knowledge has also evolved to prepare myself for the next 10-20 years, and hopefully my experience, reading, analysis and research can put me in good standing to tackle these challenges in life.

This blog actually acts as an investment diary and journal, as I use it to collect my thoughts and opinions in one central location. I formally started blogging back in 2006, though that was an on “immature” basis if you check out the posts back then. I only started blogging about investing and personal finance more seriously in May 2007. Since then, it has been four years and I never would have expected (back then) to be able to achieve the level of portfolio that I had achieved now, or the passive income generation. It is indeed a pleasant surprise to me to know that even though I may not be hugely successful (i.e. joining the ranks of a millionaire or the financially free), I had indeed improved my passive income generation ability and also greatly matured as an investor. This alone gives me a profound sense of satisfaction, even though it may not translate into tangible financial results. Remember: it is the process as much as the results which I enjoy, so for detractors who may remark that I am spending way too much time generating way too little returns, I must emphasize that investing is more than just a hobby – it is the passion of discovering how companies are run, what makes them tick and also how fascinating it can be to dissect numbers and make sense of them.

I usually must stop myself before I get too carried away and end up being long-winded again, so here are some of the lessons learnt since my post last November. Note that this list is far from exhaustive:-

1) Avoiding dud and mediocre companies is as important as finding undervalued gems – Interestingly, many people tend to talk about finding “The Next Google” or “The Next Facebook”, symbolic of the next great investment idea which could reap them tons of (seemingly effortless) money. Much attention is focused on finding great companies even before they become great, and funds tend to flow towards the next big idea (Artivision, it seems, as I type this). But the true essence of investing is not just about finding a great undervalued company with all the right characteristics for investment; it is also about learning to avoid the mediocre companies and the dud companies. Over these 4 years, it has become somewhat easier to identify the duds almost immediately, as I have developed automatic mental screens when I look at the financials of a company and study its business model. The greater danger, however, is in finding so-called “Value Traps”, companies which seem great but turn out to be painfully mediocre. These companies attempt to “ensnare” you with good numbers and a (seemingly) strong business model and competitive moat, but if one is not careful, they may see these “strengths” being rapidly eroded away as competitors flood in, regulations change and the industry evolves. Therefore, one has to be ever vigilant on the risks such companies may harbor, in the knowledge that it is better to avoid such companies before they turn out be a major pain in the ass.

2) The Erosion of Gross Margins – This was meant to take up a whole separate post, but I thought there would probably not be enough content so decided to slot it in here instead. While thinking through various companies’ business models, operating environment and unique characteristics, one metric which stood out is how often the gross margin can foretell things to come. Gross margin, for the uninitiated, simply means the gross profit (revenues less cost to acquire these goods) divided by revenue; and this measures how much profit you obtain from each dollar of sales, before factoring in expenses such as depreciation, staff costs and marketing/distribution costs. A careful study of gross margins for the last 5-8 years of any company can throw up some very interesting insights, and this is what I have been doing for quite a while on my investment journey. Erosion of gross margin is often the first tell-tale sign that something bad is going to happen, sort of like the first sign of trouble before the true rot causes a massive cave-in. Companies in industries which compete on prices normally experience a steady decline in gross margin, while other companies may suffer from stronger competitive forces which push down gross margins. One recent example was Tat Hong (which I divested about 3 months back). Their gross margins were steadily declining over the years, and this signaled that competitive forces were making it difficult for the Company to price its products as profitably as before, resulting in not just lower gross profits but also a lower market share over time. Companies which suffer from constant and chronic gross margin erosion should be avoided or sold off because it is often an early sign of deteriorating fundamentals. Well, seeing that I do have quite a bit to say on this, perhaps in future (if readers request it) I may do a full posting (along with examples) on this topic.

3) The importance of Purchasing Insurance – I know this is unrelated to investing per se, but since insurance is an important aspect of personal finance, I have decided to talk a bit about this. Recently, my daughter was admitted to hospital for about 17 days, and the significance of purchasing not just insurance, but the right insurance with the proper coverage, hit me hard. Fortunately for me, I had my daughter fully covered for all classes of wards up to private hospitals, which meant I could let her stay in a single room in a private hospital. The bill came up to close to $20,000 including medications, procedures and doctors’ visits; and fortunately this was fully reimbursable (though you have to pay upfront first then claim back later from Great Eastern – my insurer). In addition, there is also a clause which says that any hospital stay past 8 days entitles me to an additional claim of $500. If I had not purchased insurance, I would be staring at a massive financial hole of $20,000 which would seriously drain my reserves. So for all readers out there, do review your family’s insurance plans and coverage and make sure you are adequately covered for H&S and other emergencies (including Accident, Disability Income if necessary).

4) The Curious Case of the Disappearing Cash (for S-Chips) – I guess enough has probably been said in the newspapers about the status and reputation of S-Chips in general, so I will try to be brief. You would think that cash was one of the harder things to fake on a Balance Sheet, but so many S-Chips have done a “Satyam” that it really seems as if Chinese companies have an inherent knack for doctoring the cash numbers. After a particularly damning report issued by KPMG for China Milk Products (which has been suspended since 2009), it has brought to light exactly how onerous it is for special auditors (and forensic auditors) to gather sufficient relevant information on the financial activities of such dubious companies. Past cases with China Sun Bio-Chem and Sino-Environment have been equally daunting for the auditors, and shareholders can more or less kiss their entire investment goodbye as the Management and associated rogues have probably absconded with the money a long time ago! While the most recent cases still fresh in people’s minds were those of China Hongxing, Hongwei Technologies and Sino Techfibre (all still suspended pending further news and updates), there have been other suspicious S-Chips which seem to be sending out signals that something is wrong, yet no full-blown investigation has been conducted into their affairs. A case in point is Dapai Holdings, a backpack and luggage manufacturer. Despite having RMB 539 million (S$102.87 million) cash in its books as at March 31, 2011, the Company has announced a rights issue of 1 for 4 shares at $0.08 per share (a heavy discount to last done share price of 14 cents) to raise a paltry sum of S$19.3 million. This is purportedly for an acquisition but if the acquisition does not go through then the money will be used for “general working capital purposes”. It is quite inconceivable for a Company to raise such little money using such an EPS-dilutive method when it has a large cash hoard sitting around. Unless they have massive capex plans for that S$102.87 million which I am unaware of, I would say this exercise seems highly suspicious.

5) Reading up on Bond Investing – This is one of the more interesting major topics which I have been reading up on, and at the same time, I am also studying and observing what is happening in the real world of bond issues. Bonds are fixed income instruments which has a role to play in balancing one’s portfolio as one ages, and from my readings on portfolio re-balancing, I know that bonds are a security which one should start to introduce into one’s portfolio as one gets older. Though equities are known to trump bonds hands down in terms of long-term returns, the issue here is whether one can outlast a long bear market if one is at a more advanced age. Bonds (especially blue-chip, high-quality ones) provide good protection against downside as coupons are a compulsory feature, unlike dividends which can be (severely) cut in times of recession or economic upheaval. There is some argument over whether bonds should be a staple in an investors’ portfolio, it’s just the percentage allocation which should be tweaked. The Intelligent Investor by Benjamin Graham recommends that when one is young, it should be 25% bonds to 75% equities; but he also mentions that this proportion can be adjusted according to bullish or bearish markets, though it’s far from easy to be able to do it with ease. Considering the amount of information on bonds alone, I guess I will have to dedicate a separate post on this as well another time. In the meantime, I will continue to look for sources of reliable and dependable information on bonds and how to invest in them, in order to broaden my investment sphere.

That about summarizes my thoughts on investing at the moment, and covers some of the more current topics on my mind as I seek to better myself as an investor. It takes a lot more knowledge, reading and experience before I can say I am an all-rounded, confident investor. Considering my investment history is only about 6.5 years old (since Dec 2004), and the fact that I have not had a very consistent track record until I embraced value investing in late 2007, I think there is a ton more to learn and absorb in order to improve myself. Keeping humble is also an important attribute as I feel humility lets you have a better feel of your mistakes and prevents you from getting swell-headed and complacent. A ten-year track record of consistent returns would be something I can look forward to, and if you take end-2007 as the starting point, then I am not even halfway there!

Boustead – FY 2011 Financial Analysis Part 1

Boustead released their FY 2011 results on May 26, 2011, and this was followed by the usual live audiocast where Management would take questions on the phone, as well as through the internet. These results were interesting because they illustrated Boustead’s first major crisis since I started investing in the Company in 2006 – and this was in the form of civil unrest in Libya, which is where Boustead are building a township in. The numbers were predictably bad, but surprisingly the overall performance remained resilient and the Company continued to generate healthy amounts of FCF in spite of this setback. Upon closer inspection, the impairment loss was merely a book entry (including provisions) and did not significantly affect cash flows during the period. I will elaborate more in the following sections.

This analysis is split into the usual 3 major sections. Part 1 will focus on the numbers, chiefly the Income Statement, Balance Sheet and Cash Flow Statement, as well as dividends. I will also include a special section on my investment in Boustead to date, as well as dividends received over the years; as this is my 5th-year Anniversary of being a Boustead shareholder (OK, 4.75 years but close enough). Part 2 will concentrate on the divisional analysis; and since Boustead has 4 main divisions this discussion may take up significant space and contain quite a bit of content (I am estimating this since I have not written it yet). Part 3 will include a full transcript of Boustead’s audiocast as well as my comments on certain relevant sections of the transcript. I will also outline Boustead’s plans and prospects for FY 2012, and comment on the strategies the Group is taking to grow its footprint further in South-East Asia.

Profit & Loss Statement

Boustead was expected to go through a rough patch for 4Q 2011, as it was evident from their announcements and press releases that Libya was going through a civil war and that all foreigners had to be evacuated from the country. While the impairment and provisions took up about $17.6 million in total, note that this was merely an accounting entry and had no impact on cash flows. The cash flow statement analysis section will demonstrate that cash flows continued to be very strong for the Group. If we look at revenue alone, 4Q 2011 saw an 8.4% rise in revenues compared to 4Q 2010, to $110 million from $102 million. Gross margin hit a high of 38.9% versus 36% a year ago; and if not for the provisions made for Libya, Boustead would have recorded a very strong 4Q and also a record FY 2011 net profit attributable to shareholders.

The thing which still continually amazes me about Boustead’s Income Statement is how the Group manages to grow revenues, yet keep costs manageable. If we look at FY 2011 numbers, revenues increased by 28%, gross margin increased from 30.3% to 31.8% and selling/distribution expenses only grew 27%. Administrative expenses, which consist of staff salaries, hardly budged and only grew a small 3%. Considering business activities had increased significantly leading to record revenues of $560.5 million for Boustead, their ability to keep staff costs low has been nothing short of remarkable!

Finance costs continue to remain low as Boustead has about $25 million debt in its books. For the entire FY 2011, finance costs were only $613,000, down 38% from last year’s $995,000. Share of results from associates has now been removed because of the sale of property by GBI Realty.

Balance Sheet Review

Boustead’s Balance Sheet continues to remain rock-solid, thanks to FF Wong’s constant emphasis on cash flow generation and his conservative stance on debt. PPE fell while investment properties increased, largely due to the increase in the portfolio size for the Real-Estate Solutions Division (more on this in Part 2). AFS investments also increased from $5.55 million to $9.684 million, probably as a result of Boustead’s $4 million investment in Bio-Treat (now known as Hankore – more on this in Part 3). Current assets stood at $435.9 million, out of which $209.8 million (48.1%) consisted of cash and bank balances. Trade Receivables dropped by 13.2% to $96.8 million in spite of a 28% increase in revenues, signalling that cash collection was healthy and improving. If we compare the level of cash to current assets, FY 2010’s level stood at 47.2% ($223.3/$473.3); therefore the level of 48.1% is impressive considering Boustead paid out a 2.5c final dividend, 1.5c special dividend (both for FY 2010) and another 2c interim dividend (for FY 2011). This is another indication of healthy cash flow generation.

Total bank loans remained fairly constant over the two years, with the level increasing from $24.0 million in FY 2010 to $25.2 million (+5%). This increase in 5% should not result in such a drastic drop in finance costs; therefore I suspect the loans may have been refinanced at much lower interest rates as SIBOR rates were at all-time lows during FY 2011. Current liabilities stood at $223 million for FY 2011, and current ratio for FY 2011 was 1.95, against 1.78 in FY 2010. The improvement was due to a combination of higher total current assets due to contracts work-in-progress, as well as lower current liabilities due to payments to trade and other creditors.

ROE improved to 22.8% from 20.2% a year ago, and this was achieved with minimal debt and a large cash position.

Cash Flow Statement Analysis

Operating cash flows for Boustead remained strong, hitting $52.1 million compared to $52.6 million last year. This was in spite of slower orders for both Real Estate and Oil & Gas Divisions for FY 2011, with momentum only picking up in 4Q 2011. Cash flow for investing activities was negative for FY 2011 mainly due to the purchase of the remaining interest in Boustead Projects for $19 million. The inflow of $27.4 million and outflow of $33.1 million represented movements for the Cash Management Reserve which Boustead are maintaining. This reserve was basically created to invest excess cash for higher returns, and they are mainly invested in corporate bonds. It is not very relevant to compare with FY 2010, actually, as cash flows then were affected by the sale and receipt of cash from GBI Realty of $41 million. So, if we strip out all the “one-off” cash inflows and outflows, then basically this section consists of just capex. And capex for FY 2011 was lower than FY 2010 at $3.3 million against $4.4 million.

As always, the bulk of financing cash outflows consisted of payment of dividends, and I foresee this trend continuing into the mid-term as Boustead continues to generate healthy free cash flows. For both years, FCF levels were almost the same at $48+ million.

Dividends

Dividends at Boustead have an interesting way of increasing over the years, not that I am complaining! If we take a simple look at the dividend history of Boustead, they paid out 3.3 cents in FY 2007, and increased this to 5 cents in FY 2008 (inclusive of 1c special dividend), 4 cents in FY 2009, 5.5 cents in FY 2010 (last year); and now for FY 2011 they declared 7 cents. Revenues had actually doubled in 5 years and dividends have more than doubled (3.3 cents versus 7 cents). I have FF Wong and his team to thank for focusing more on slow and steady growth than explosive but unsustainable growth.

Investment Returns on Boustead and True Cost

This special section is devoted to analyzing my return from Boustead over the years and to compute the true cost of my investment after factoring in dividends received over the years. Please see below:-

According to the table above, my true cost for Boustead is about 40.2 cents/share. This takes into account my total investment cost in Boustead to date, minus all dividends received from Boustead to date. This does not, however, include the most recently announced final cum special dividend of 5c per share. If this was factored in, then true cost would be further reduced to 35.2 cents.

Part 2 of Boustead’s analysis shall cover Boustead’s business divisional analysis, and will delve into the prospects and aspects of each division, its order book as well as margins.

Update: Boustead's Energy-Related Engineering Division had just announced $23 Million worth of contracts yesterday (June 16, 2011). Together with $25 million secured in early FY 2012, this brings total order book for this division to >$55 million.

Period of Contemplation

The title of this post was actually meant to reflect my thoughts on the time required to mull over and consider a potential investment. It is also meant to be a “break” from the heavy analyses going on in prior posts on MTQ and SIA Engineering. There is another analysis coming up and planned for Boustead’s FY 2011 results. This post is to summarize some of the thoughts I have gone through while taking bus/MRT recently, and follows closely on my previous post on “Pace of Research”. I guess you can say that I would recommend reading both posts back to back, as this post is sort of a “follow-up” to the previous one.

So what exactly does the title mean? While pace of research was meant to assess how dedicated one should be while researching a company, to the extent of whether he can allocate sufficient time to dig deep into a company’s financials, stakeholders and business model; period of contemplation addresses the issue of how long one should study a company before deciding if sufficient research and study had been taken. This would naturally translate into a reasoned decision to purchase shares in the Company. The problem is that different companies have different characteristics, and I admit that some do require a lot more monitoring and following up than others, purely due to not just the nature of the business but also the way the company is run. Add to that strategic management decisions, varied management styles and an evolving business model and you get some very subjective views on how long one should evaluate a company before committing. I will now attempt to state, broadly, how much time one should adequately devote before making an informed decision.

Note that the default conditions for investment will be required, such as good margins, good and consistent free cash flow, steady earnings and decent ROE. What differs is the nature of the business and the type of industry the Company is in, as I shall elaborate.

Cyclical Companies

For companies in cyclical industries, one has to at least observe one entire economic cycle relating to that industry before deciding when, or whether, to buy some shares. Examples would be companies in construction or property like Tat Hong or Capitaland, where the housing boom/bust cycle would determine if valuations are demanding or not. Therefore, the period one should take should stretch into years if one wishes to fully understand the business cycle and determine when to make a purchase. Of course, history can always serve as a guide but the future may not always repeat itself in the same way. I would think these companies are best avoided unless you can time the cycle very well and go in at the point of lowest valuation, and just before the economic uptick.

Cash-Rich Companies in declining industries

Companies such as GRP would qualify, as they are very cash-heavy but are mired in a business which is declining and competitive. One should observe such companies to the extent that they actually plan to do something with the cash hoard, or if they undertake actions (e.g. M&A) to improve the business model. Alternatively, the investor could also study the company as a yield play, with potential to generate good FCF even in a declining industry. The time period in this case could be anything from a few months (for research) to perhaps one or two years to observe and study Management’s decisions.

Companies in new industries with low barriers to entry (many new entrants)

These are companies which have had a first-mover advantage with respect to a new and emerging industry; and therefore are enjoying supernormal profits, margins and very good cash flow. Some examples may include palm oil, bio-fuels and solar panels which are at the cutting edge of technology. However, more time needs to be spent observing such companies as many new entrants, seeing the huge profits being made by the incumbent, may scramble to grab a piece of the pie as well. The ever-changing economics and dynamics within the industry would require a longer-term study before any commitment is made. In addition, there is also not much history to fall back on as these industries may be relatively new.

Fast Growth Companies

Fast growth companies are those which are aggressively expanding, conquering new territories, opening new offices in new countries, and generally engaging in active M&A or corporate actions. They usually do not pay a dividend as profits are reinvested to grow the business. For such companies, one should observe only as long as one should in order to gain comfort on their plans, and current growth strategy. Once an understanding is formed, a position could be taken up without waiting for too long. Of course, one should also watch out for valuations – growth companies usually trade at higher valuations as a lot of potential future growth is already factored in. Investors may wish to discount for this growth in order to maintain some margin of safety.

Stalwarts and Stable Conglomerates

The final category of companies which I would like to comment on are the stalwarts, or stable blue-chips, as well as conglomerates. These would include ST Engineering and SingTel for the former and Keppel Corporation for the latter. SIA Engineering would also probably fall into this category. This type of companies probably require the least amount of monitoring and observation, as they already have an entrenched market position, steady earnings and decent cash flows. One would simply need to understand the business and be comfortable with the financials and numbers before deciding to invest, and this should not take a whole lot of time.

To summarize, the length of time taken should not be inordinately long, otherwise one may miss out of very good opportunities to accumulate shares in well-run companies, as well as miss out on the compounding effects of their investments growing over the years. Yet, one should not be unduly hasty in committing to a purchase before one has done sufficient research, otherwise the consequences could be disastrous and detrimental to one’s wealth.

SIA Engineering – FY 2011 Results Analysis and Review

Since SIA Engineering (“SIAEC”) is a blue-chip company and has a strong operating history and business, I shall be covering it within one post and will not require splitting the analysis into several parts. I guess readers will probably also heave a huge sigh of relief as the frequent splitting up of analyses into sections does feel jarring and I do have the tendency to become long-winded, resulting in a tedious and (probably) boring read. Nevertheless, I shall endeavour to cover as much ground as I can and also to get my opinions across on what I feel about the business, while at the same time polishing my business analysis skills. Constructive comments would be useful for me to understand how I could improve on the analysis and if there is anything lacking thus far.

The analysis will be structured more or less solely on the numbers aspect, as SIAEC generally have been rather reticent in providing more details of its ground operations, fleet management and other MRO aspects within its SGXNet filing. These details will be provided in SIAEC’s Annual Report which is usually issued in July 2011.

Profit & Loss Analysis

Revenue increased by 10% to $1.1 billion while cost of goods sold increased a smaller 8.4% to $971 million. This, combined with lower expenses, caused operating profit to rise 22.9% to $135.7 million for FY 2011. The rise in revenue was attributed to increase in activity for airframe and mainframe overhaul, as well as fleet management and line maintenance. The higher COGS arose due to higher staff costs and sub-contractor costs. Operating margin improved to 12.3%, which is a 5-year high, and net profit attributable to shareholders increased 9.5% year on year to $258.5 million. This is actually close to SIAEC’s historical high with only FY 2009 ($260.6 million) registering a higher figure for net profit. With SIAEC’s prudent cost management and slow and steady growth of their JV and associated companies (more on that in a later section), revenues and profits look poised to grow further in the medium-term.

EPS is 23.89 cents/share and the company is valued at a historical PER of about 17x. ROE is higher at 19.8% compared to 18.7% a year ago, and this was largely achieved through the use of low and minimal debt on its Balance Sheet. To be frightfully honest, 17x PER does seem rather high even though SIAEC is a blue-chip and has very strong FCF generation, but the special dividend provides some support for this valuation, and also the strength of its joint ventures and related collaborations with its associated companies.

Balance Sheet Analysis

There is not really a lot to say about SIAEC’s Balance Sheet, as it has been traditionally “clean” and uncluttered. Debt levels did increase marginally to $1.7 million, but against current asset levels of $864.3 million I concluded this was largely insignificant! Shareholders’ equity has increased further to $1.3 billion (an 11-year high) due to strong profit generation, and working capital levels have also hit an 11-year high of $602.1 million through very strong and consistent cash flow generation. As a result of their strong working capital position, current ratio has also improved to an all-time high of 3.30 since listing. These reasons, coupled with the cash flow explanations to be provided in the next section, form the basis with which SIAEC is using to declare a special dividend this financial year.

Cash Flow Statement Review

If we observe the 10-year cash operational cash flow generation history of SIAEC, FY 2011 will stand out as the year which generated the most operational cash inflow – a total of $218.8 million. As capex remained low at just $44.6 million, this means that FCF also hit a 10-year high at $174.2 million, compared with just $70.4 million in FY 2010. Net investing cash flows is also strongly positive at $121.5 million, which was higher than last year’s $115.5 million. The reason for this was due to the gradual recovery of SIAEC’s many JV and associate companies, and so cash has flowed in from them through dividends declared (see next section). Moving forward, as long as these companies continue to generate decent cash flows for SIAEC, they would be able to continue to grow their cash pile and to pay out good dividends. Cash outflow from financing activities was about $180.7 million, and consisted mainly of the payment of dividends.

As a result of these movements, cash balances rose to a new record high of $581.4 million, which prompted SIAEC to declare a special dividend of 10 cents/share in addition to their 14 cents/share final dividend, bringing total dividend to 24 cents/share. With 1,082,195,600 shares in issue, this means the Company will fork out about $260 million in dividends, to be paid out on August 11, 2011 (2Q FY 2012). This will bring cash levels down to about $320 million, assuming no other cash movements in the interim between March 31, 2011 and August 11, 2011 (a simplistic assumption), which is still a tidy sum retained for expansion and working capital purposes. Depending how 1Q FY 2012 and the rest of FY 2012 fares, I would expect dividends to be maintained at the 20 cent/share level, translating to a yield of about 5% based on a $4.00 share price. My yield based on purchase price of $4.064 is about 7.4% for FY 2011.

Share of Profits and Cash Flows from JV and Associated Companies

I had mentioned before during last year’s due diligence analysis of purchase of SIAEC that their cash flows from investing activities was very strong, and is one of the few companies whereby this section of the cash flow statement is strongly positive. It was also previously pointed out by me that even though SIAEC’s net profit attributable to shareholders had dipped during bad years, their cash flows from dividends from these JV and associated companies had continue to grow all the way till (then) FY 2010. FY 2011 saw this trend continue further and a total of $144.4 million was recorded as share of profits from JV and associate companies. Though this is off the peak share of profits recognized in FY 2009 of $173 million, SIAEC did report that conditions were slowly improving as the economic recovery took hold and we can expect to see this contribution increase over time.

Interestingly, though, the cash flow from dividends provided by these JV and associate companies has continued to climb in spite of the fluctuations in profit contributions. For FY 2011 it hit another new high at $165.3 million, up 7.8% from FY 2010’s $153.4 million.

Dividends

Dividends have been steadily increasing for SIAEC as well, as their business model does not hinge on heavy capex due to their collaborations with JV partners. Glancing at their 11-year dividend history, one can see that dividends have taken an upward trajectory, with three out of 11 years showing a special dividend declared. It would seem that SIAEC does not want its cash hoard to exceed $600 million and will declare a special dividend each time it threatens to exceed this mark. While this may signal to some that this blue-chip company is running out of ideas to grow its business and profits, I tend to see it from the point of view that the Management Team takes their time to negotiate for and align themselves with various initiatives (explained below), and these may take months or even years to fully pan out. As these initiatives are not capital-intensive, much of the cash can be returned back to shareholders even while retaining sufficient amounts for working capital and growing the business slowly but steadily.

The table shows that total ordinary dividend (i.e. interim + final) has been steadily increasing over the last eleven years. It started out with a total of 4 cents/share back in FY 2001, hit 10 cents/share in FY 2006 and for FY 2011, is now 20 cents/share. The only other time it hit 20 cents/share was in FY 2008 when the global economy peaked just before the onset of the sub-prime crisis in the USA. If nothing drastic occurs to the airline industry, we can reasonably assume dividends can continue to increase as SIAEC carries on with its strategy to grow through JV and collaborations.

Recap of Major Announcements during FY 2011

This is just a quick recap of the news bits throughout FY 2011 for SIAEC. Admittedly, news flow has been a lot slower for calendar year 2011, but I believe the Annual Report (to arrive in July 2011) will shed some light on Management’s plans for FY 2012 and beyond.

May 2010 – SIAEC adds Royal Brunei Airlines into its customer base.
October 2010 – SIAEC signs A340 MRO services contract with Airbus
November 2010 – SIAEC forms JV with Panasonic Avionics Corporation for MRO of in-flight entertainment and communications systems and components
November 2010 – SIAEC opens sixth (6th) overseas line maintenance joint venture in Vietnam, with line maintenance contracts with 9 airline customers.
December 2010 – SIAEC signs $300 million Services Agreement with Silkair
April 2011 (overlaps into FY 2012) – SIAEC opens Safran’s first avionics Centre of Excellence in Asia.

SIA – Setting up of low-cost long-haul airline

With the recent announcement that SIA will be setting up a low-cost airline which will fly long-haul within a year, this bodes well for SIAEC’s business as they may be able to snare more line maintenance contracts and MRO agreements with this new planned airline (as yet unnamed at time of writing).

Conclusion

While I am positive on the medium-term outlook of the business, it remains to be seen if SIAEC has any announcements up its sleeve for FY 2012 to show that they are committed to growing the business further. I shall be awaiting its Annual Report as well as its 1Q FY 2012 results in early July 2011.

May 2011 Portfolio Summary and Review

May 2011 was indeed an interesting month, as it was the month of Singapore’s General Elections 2011. The Election results are widely-known by now, and the Opposition made a breakthrough in being able to secure a GRC, a feat which had never been achieved since GRCs were introduced in 1988. May 2011 also saw the release of financial results for SIA Engineering, Kingsmen Creatives and Boustead; and saw two more dividends being declared (more details in each company’s summary). Cabinet shuffles also made headlines as Minister for National Development Mah Bow Tan finally stepped down after 12 years at the helm of Housing, to be replaced by ex-Health Minister Khaw Boon Wan. It will be interesting to note what effect this will have on property prices, which has been a major gripe for most people who are striving to purchase an affordable flat. COE prices also saw a steady rise to a five-month high, even as the Transport Minister Raymond Lim steps down, to be replaced by Lui Tuck Yew.

To avoid being overly long-winded (again), let me dive right into my portfolio and corporate summaries. My portfolio and comments for May 2011 are as follows:-

1) Boustead Holdings Limited – Boustead released their FY 2011 results on May 26, 2011, along with the usual LIVE audiocast where listeners can write in to ask questions which will be answered immediately by Management (including CEO FF Wong). Revenue for FY 2011 hit a record high of $560.6 million, and gross margin rose to 32% as cost of goods sold increased only 25% while revenues increased 28%. I had expected a full write-down of Boustead’s Libyan projects (both the Al Marj Township and the Waste-water project), but the impact on 4Q 2011’s bottom line was still unnerving. 4Q 2011 registered a loss of $1 million as a result of the write-downs of about $13.8 million in total. However, note that this is a one-off event and does NOT impact cash flows.

In fact, I was pleasantly surprised when the Company announced a bumper dividend consisting of 2 cents/share final dividend and 3 cents/share special dividend, making it a total of 5 cents/share. For FY 2011, total dividend inclusive of interim dividend of 2 cents/share came up to 7 cents/share, which represents a yield of 7% based on the last closing price of $1.00 as I type this (on May 26, 2011). Apparently, the Company’s cash generation ability remains strong despite their Libyan setback, but moving forward, I also have to ask hard questions as to whether they can continue to grow their top-line and bottom-line, as well as what plans and strategies they intend to employ to achieve their goals.

I will be preparing a detailed analysis of Boustead’s FY 2011 results in subsequent posts (after SIAEC’s analysis has been done) and also include a full transcript of the audiocast as in the two previous years.

Hot from the oven was an announcement just this evening of Boustead Projects snaring a $23 Million Design and Build contract for Bell Helicopter MRO Hangar Facility (artist rendering above). This will take up about 15,000 square meters and be completed in 2Q 2012.

2) Suntec REIT – There was no news for Suntec REIT for May 2011. The dividend of 2.388 cents/share was received on May 30, 2011.

3) MTQ Corporation Limited – As I had already done a detailed three-part review and analysis of MTQ in my previous three posts, I will not add anything else in this portfolio summary.

4) GRP Limited – There was no news for GRP for May 2011, though there was a one-page write-up in The Edge Singapore on the Company. In the article, it was mentioned that GRP was on the lookout for synergistic acquisitions to utilize its cash hoard, and will be looking to divest its uPVC business if it continues to bleed. A worthwhile read, and too bad it does not give me extra comfort as a shareholder that Management is aware of what it plans to do with its 9 cents/share worth of cash!

5) Kingsmen Creatives Holdings Limited – I did a brief write-up on Kingsmen AGM this month, and Kingsmen also released their 1Q 2011 results on May 6, 2011. Revenues fell 22% while gross profit dropped 11%, and the positive aspect was the rise in gross margins from 26.4% to 29.9%, possibly as a result of smaller parcels of work which command higher gross margins; as well as the strength of Export Fixtures which also yields better margins.

The main culprits affecting net profit were staff costs (down just -2.1%) and "other expenses" which actually increased 10% despite the drop in gross profit. I understand from the AGM that Kingsmen were hiring more designers in SEA in order to prepare for theme park projects and also to boost their Interiors segment in China and North Asia; so I guess this is one expense which is hard to keep low. Even the GM Andrew Cheng grudgingly admitted that staff costs were an aspect of expenses which was tipped to rise. The result was a drop in net profit by 42%, and net margin was only in the 3-4% region. Since 1Q is traditionally Kingsmen's weakest, it would not be fair to say that it represents the entire financial year.

Balance Sheet remains strong with current ratio at 1.60, and cash has increased to $30.8 million against a reduced debt level of $4.9 million (versus $5.3 million a year ago). Cash from Operating activities was a +ve $1.8 million and capex was $365K, so there was +ve FCF.

Division wise, M&E saw a drop in revenue as 1Q 2010 recognized some additional projects which were not present in 1Q 2011. Interiors was the shining star with revenues increasing further by 18.7%. It stands to reason that if staff costs can be kept in line as a result of this advance hiring, then if M&E secures more theme park projects in the next few months; and Interiors continues to do well, there would be an improvement in the net margin and net profit levels in 6M and 9M 2011 results. Since cash flow continues to be strong, I'd also expect Kingsmen to at least maintain their interim dividend of 1.5 cents/share.

The order book as at May 5, 2011 now stands at $154 million, of which $138 million is expected to be recognized in FY 2011. Compared to last year, contracts secured was only $133 million, so the order book has increased by $21 million. I believe this quarter's poor result is also due to the timing difference in revenue recognition, hence we have to look at 6M and then 12M performance to see how things pan out. I will not be doing a detailed analysis and review until 1H 2011 results are released in August 2011.

The final dividend of 2 cents/share and special dividend of 0.5 cents/share was received on May 24, 2011.

6) SIA Engineering Company Limited – SIA Engineering released their FY 2011 results on May 10, 2011. FY 2011 earnings rose 9.5% compared to FY 2011 to S$258.5 million, and the surprise was that a special dividend of 10 cents/share was declared in addition to a final dividend of 14 cents/share, bringing total dividend declared to 24 cents/share. Coupled with the interim dividend of 6 cents/share already paid out, SIAEC is paying out 30 cents/share for FY 2011, and this can be attributed to their strong FCF generation capability. I will be doing a detailed analysis and review for SIAEC in June 2011 so I will not add too much detail here.

Portfolio Review – May 2011

Realized gains have increased to S$59.2K as a result of Kingsmen Creatives going ex-dividend for its final cum special dividends. SIAEC and Boustead are still cum-dividend and thus the amounts have not been added to realized gains as yet.

For the month of May 2011, the portfolio has dropped by -1.3% (using XIRR in MS Excel to compute) against a -0.9% fall in the STI; thus under-performing by -0.4 percentage points. This was slightly better than April 2011’s under-performance of -2.3 percentage points. Cost of investment remained at S$210K and unrealized gains stand at +13.1% (Portfolio Market Value of S$237.5K).

I am aware that Kingsmen’s Comprehensive Analysis Part 5 is still outstanding, and I must apologize for not completing it sooner, but I have work commitments, family commitments and also my analyses for existing companies’ full-year results. At the same time, I am also finding time to go to the gym to stay healthy, as well as devoting some time for quality family bonding. There is also an intention to continue my series on Porter’s Five-Forces as well as Behavioural Finance, and I have a topic or two on valuations coming up as well as I have been thinking about this very often while I travel on public transport.

June 2011 is expected to be a very slow and boring month in terms of corporate news, as no results are slated for release until July 2011 (for Suntec REIT).

My next portfolio review will be on June 30, 2011 (Thursday).

MTQ – FY 2011 Financial Results Analysis and Commentary Part 3

Onwards now to Part 3 of my MTQ FY 2011 analysis, which will cover a major transaction by MTQ – that of its 100%-owned subsidiary Blossomvale Investments Pte Ltd purchasing 200 million shares in an Australian-listed (ASX-listed) company called Neptune Marine Services Pty Ltd (“Neptune”) at AUD 5 cents each. This was announced in a March 4, 2011 announcement posted on SGXNet, and costs the Company about S$12.93 million, which forms a significant portion of their cash and bank balances; hence I have classified this as a major transaction and am delving deep into the rationale. From the announcement proper, MTQ mentions that it seeks to participate in Neptune’s business as a significant investor and views Neptune’s capabilities as a “strategic extension of its predominantly workshop based operations in Singapore and Bahrain”. Kuah Boon Wee, CEO of MTQ, will also take a seat on the Board of Directors of Neptune. I will be breaking down this transaction into parts by analyzing and reviewing Neptune as a company, its proposed strategic changes made, and providing a summary of the actions taken to date to signify its commitment towards corporate overhaul and re-structuring.

Neptune – Introduction

Neptune is a company which specializes in providing offshore engineering solutions to the oil and gas, marine and renewable energy industries. It was founded in 2003 and is headquartered in Perth, Western Australia. Neptune has a comprehensive focus on subsea services with operations spanning Australia and the UK.

The Company, however, has been performing poorly thus far. In its 1H FY 2011 financial statements ended December 31, 2010 (it has a June 30 year-end), it recorded revenue of A$70.8 million and gross profit of A$22.1 million (gross margin of 31.2%), but posted a loss attributable to shareholders of A$11.5 million (after adding back one-off impairment charges). The main reason for this was the very high administrative cost base of A$31.4 million and also high finance costs of A$2.9 million. In the Balance Sheet, interest-bearing loans came up to A$50 million while cash was only A$8.7 million; and the Company is in a net current liability position (technically insolvent). Cash flows used in operating activities was A$4.9 million, capex was A$2.5 million and repayment of borrowings came up to A$4.4 million, resulting in a cash drain of A$11 million in total.

In view of the above poor results, which stems from Neptune’s inability to control costs and is also a result of unfocused operations spanning too many countries, an operational and structural review was undertaken (with PriceWaterHouse Coopers assistance) and has resulted in an offering to raise up to A$80.6 million. More details of it are provided in the next section. The CEO was also replaced in late November 2010.

Neptune – Summary of the Re-Structuring Review

As can be seen in table above, Neptune is planning to embark on a “Back to Basics” philosophy to streamline operations and to refocus on their core competencies once again. Apparently, the impression I got when I read through Neptune’s original businesses was that they had strayed too far off their core competence and had “diversified” too extensively. This had resulted in expenses rocketing up while profits were being eaten away as some business units may be languishing due to lack of focus or expertise. Apparently, the PWC review also brought up many aspects of cost reduction which should have been implemented in an expedient manner, instead of letting the problems fester and drag the Company so deeply into the red.

Some of the key initiatives include focusing more on organic growth versus an aggressive M&A path, which had pushed the Company into a heavy debt-laden position. The strategic review also identified businesses which are working and which should be retained and grown, versus those which are bleeding money and need to be divested. Overheads were too high and the previous CEO did not maintain a lean ship, hence cost-cutting was to be effected (more on this later). Owning assets is also a very expensive affair (as can be seen with Ezra and Swiber) and so JV relationships were more practical and would be easier on the cash flows. Most importantly, the Company wanted to de-gear its Balance Sheet and save on crippling finance costs.

Neptune – Rationalization of Regions

As can be seen in the table above, Neptune’s business is split up into four distinct regions, of which Australia remains their main base of operations. For Australia, though this region is profitable, staff head count was reduced in light of high overheads and commercial focus on NEPSYS was revised in Jan 2011. NEPSYS is a unique, class approved technology that produces a permanent surface quality weld in an underwater environment. For more on NEPSYS, check out this link.

USA is not sustainable and hence Neptune will exit from the business there, cutting costs and saving valuable cash in the process. As for Asia and Middle East, control will vest from Australia under a streamlined regional management structure. For Europe, though the business is profitable, further steps have been taken to reduce the cost base and to perform a more detailed review of options available to grow the business there.

Neptune – Rationalization of Businesses and Assets

Other than just rationalizing regional operations and streamlining operational control by region, Neptune has also undertaken to rationalize its business units and assets to see where it can achieve the greatest benefits, and to find areas to further cut costs. For USA diving business, the decision is to exit from this and look for other partnerships for NEPSYS. This does remind me of MTQ’s own subsea robotics business which was divested in 2006 as it was expensive and unprofitable. The fabrication business in Australia was also deemed not a “strategic fit” and there are plans to exit this. However, I was wondering if this division could complement Neptune’s other business units as even companies like Ezra have a fabrication sub-division even as they provide marine support services.

The ROV (Remote-Operating Vehicle) Supporter and Neptune Trident are to be sold off as these assets no longer contribute meaningfully to the business, and hence should be divested. As of this writing, Neptune Trident has already been sold off (announced in April 2011) for A$14.025 million (more on this in the next few sections). While Neptune has made clear their focus for re-positioning NEPSYS, I am still unclear as to how this technology can be harnesses effectively to produce good profits and attract more reputable clients. By saying that NEPSYS has the “potential for future profits”, one may take it to mean that the technology is slated for a revamp or re-positioning. Since there have been no concrete announcements or plans relating to NEPSYS as of this writing, I assume Management is still hard at work at the problem.

As for the ROV business, I am unaware of how it contributes to Neptune’s bottom line (I only took a cursory look at the financials and did not drill too deep), but since it is profitable but has low utilization, there is thus potential for utilization to increase if the business is positioned correctly and marketed properly. A “full strategic review” will be performed and I guess we can look forward to some corporate decisions regarding this business unit in the near term.

Neptune – Proposed Financial Effects of Restructuring

The first line of “offense” (if it can be called that!) as depicted in the above table should result in annual savings of about A$9.5 million (for Phases 1 and 2); and these involve cutting staff strength and reduction of corporate overheads to make the organization more lean and trim (it’s surprising how inefficiently some processes and operations are structured as a Company expands over the years). This represents the first drastic cost cutting (for Phase 1) which was executed successfully in January 2011 and which resulted in cost savings of up to A$8.5 million. Another A$1 million will come from further corporate restructuring which also includes (ahem) cutting out some Managerial-level staff which may be redundant.

Interestingly, the divestment of non-core businesses is expected to save from A$2 million to A$4 million, as these businesses probably soak up expenses which not churning up sufficient cash and profits to justify their continued existence. Another positive from the divestment is that cash is immediately freed up which can be used to pay down debilitating debt, and also for general working capital purposes. It is expected that such divestments will result in a one-time charge (i.e. loss on disposal) which will hit the Income Statement for FY 2011 (and which may drag into part of FY 2012 as well), but this is inevitable and moving forward, the annual cost savings and cash retained will actually benefit the Group in the medium-term.

If we assume that Neptune can really reduce overheads and administrative expenses by A$12 million to A$13 million annually, and that the Company can continue to garner contracts of significant size, then there is a very good chance of them recording an operating and net profit down the road.

Neptune – Fund Raising and Contract Awards

Neptune had suggested raising funds of up to A$84 million, but in the end they managed to hit the minimum level of A$60 million, which will allow them to pay off almost all of their debt, and un-gear their Balance Sheet. The rest of the money will be used for working capital. New shares were offered at A$0.05 per share, with MTQ subscribing for 200 million shares as many of the existing shareholders did not take up their pro-rata share of the offer. A total of 1.2 billion new shares were issued, bringing total issued share capital to 1.648 billion shares. NTA per share post-rights issue will be A$0.043 cents against the issue price of A$0.05.

Meanwhile, contract flow continues to remain strong for Neptune, as can be seen from the Table above. In Nov 2010, A$8 million worth of contracts were secured, while in Jan 2011 A$12 million more were secured. This may not seem much when compared to its half-year revenue of A$70 million, but note that the rationalization will cause revenues to drop, but expenses to drop even more, thus ensuring that the overall result is profitability even while operating on a lower revenue base. High revenues make no sense at all if they are accompanied by growing losses and continual bleeding of cash. Australia still has its huge Gorgon project which requires the services of many O&G companies, of which Neptune is one. Since Management claims that contract flow continues to be strong, I guess shareholders like MTQ should be expecting a decent top-line performance. Hopefully, this can be coupled with a pleasing bottom-line performance as well.

Neptune – Recent Updates

As mentioned above, Neptune Trident vessel has already been sold for A$14.025 million. A loss on disposal of A$7.5 million will be recorded in 2H FY 2011 as the Net Book Value of the vessel is A$21.5 million, but the good news is that this generates cash which can be used to pay down long-term debts. The targeted completion of sale is in May 2011.

In another recent announcement on May 17, 2011, Neptune confirmed that key initiatives had been completed. These include the finalization of annual cost savings of A$9.5 million (as previously explained), ongoing marketing and planned orderly sale of ROV Supporter vessel, as well as the planned sales of the Australian Fabrication and USA Diving businesses. At the same time, a board renewal plan was also put in place to appoint three (3) new non-executive directors to the Board via a succession plan.

As a result of these measures, Neptune managed to achieve unaudited, normalized break-even operating EBIT for quarter ended March 31, 2011, before write-downs and one-off costs. Greater impact can be seen on the bottom line only in FY 2012, as the measures take effect for the full financial year ended June 30, 2012.

Neptune – Conclusion

It would seem, from all the available evidence and presentation materials, that Neptune is a so-called “turnaround” play, where a major restructuring can bring about much-needed changes to push the business back to profitability and growth. Neptune reminds me somewhat of MTQ back in 2000 to 2004 where they also engaged in all sorts of businesses, from Foundry to Subsea Robotics, and incurred losses every year till Kuah Kok Kim streamlined all the business units, divested the unprofitable ones, and retained just Oilfield Engineering and Engine Systems. For MTQ’s case, it took about 4-5 years (and a skilful divestment of RCR Tomlinson back in FY 2007) to build up core competencies and streamline costs. I would expect roughly the same amount of time for Neptune to realign its business divisions and achieve the efficiencies which it targets. So for MTQ, this should qualify as a medium to long-term strategic investment. As to how Kuah Boon Wee is able to contribute to Neptune’s fortunes and how MTQ is able to synergize, I am as yet unclear until there are further announcements by either company.

MTQ – Resignation of CFO and Company Secretary Mr. William Fong

On April 29, 2011, it was announced that Mr. William Fong, as Group CFO and Joint Company Secretary for the past 12 years, will be resigning from MTQ with effect from June 15, 2011. The Board has appointed Mr. Dominic Siu as CFO with effect from May 18, 2011. I was certainly saddened when I read this piece of news as I had been liaising with him for about a year regarding matters relating to MTQ, including AGM and the recent news on Bahrain. I had also met up with him before during the AGM and found him to be helpful, friendly and supportive. I’d like to wish him all the best in his future career and I guess I now have to start liaising with the new CFO, Mr. Dominic Siu!

Conclusion

MTQ will be going through a very interesting phase of its growth, with its Oilfield Engineering Division firing off the new FY 2012 with its operations commencing in Bahrain. Coupled with high oil prices and investments by major O&G players to the deepwater segment, as well as more stringent regulations governing BOP after the BP Deepwater Horizon incident, this should bode well for the Division and ensure its slow and steady growth. For Engine Systems, I am confident that MTQES can continue to build on the momentum of recent acquisitions as well as their partnership with Bosch to further improve margins and increase top-line contribution. Of course, this will all take time and watching the growth of a business through the years is a very satisfying process and validates my commitment to being a value investor who has his eye on the business performance of a Company rather than constantly tracking its share price.

As for Neptune, the detailed analysis and summary which was provided above made me realize that MTQ is in this for the medium-term of at least 3 to 5 years, similar to their previous investment in RCR Tomlinson which was divested in 2007. While it may look like a bad idea in the short-term (with Neptune’s recent share price hovering around AUD 3.6 to 3.9 cents), I am also quietly confident of Mr. Kuah Kok Kim and Mr. Kuah Boon Wee’s business acumen in being able to identify suitable investment opportunities in mis-priced businesses to grow MTQ’s business value over the years.

For future reviews of MTQ, I will also be including a review (both financial and operational) for Neptune. The next review for MTQ should only be out in late October 2011 as they will be releasing their 1H FY 2012 results then. In the meantime, I await the final issue price (yet to be decided) for the final scrip dividend of 2 cents/share; and also await the arrival of FY 2011’s Annual Report.