This company is not a very widely followed company, and is not covered by analysts. Its market capitalisation as of 29 Aug 2008 was approximately $111 million, and thus can be categorised as a small-cap company. Shall talk a bit more about its business since not many people may have prior knowledge of this company, although most would have seen and recognised the brand.
2nd Chance Properties Ltd is a company which sells Muslim apparel under the "First Lady" name, as well as gold jewellery under the "Golden Chance" brand. It is also a small property player in Singapore, owning retail property in places like City Plaza, Toa Payoh and other places. It has rather ambitious aims to be the largest Malaysian retailer and wholesaler of modern Islamic apparel in the region, hoping to expand to 100 stores in Malaysia in the next few years from 30(although it recently mentioned that it will slow down expansion in Malaysia less aggressively due to the deepening political crisis).
The CEO of 2nd Chance, Mr Mohd Salleh, has been adopting the strategy of investing the cash flow from its retail and gold businesses in selective retail property, acquiring about $85 million worth of property in total, with an eye on the future growing demand for City Plaza. It then paid of its debt relatively, bringing its debt-equity down from 1.26 in 2003 to 0.40 in 2008(full year FY2008 unauditied statements).
A quick look at its 2008 profit/loss statement saw a 10.39% rise in revenue, with a jump in its net profit for the period by 31%, recording its 6th consecutive year of record profits. Its competitive position has been highlighted by its margins, with its profit margin increasing from 38.1% in 2007 to 45.4% in 2008. Its cost of sales had impressively dropped by 6.90%. Do take note of the fact that gold has been rising at astronomical rates following the weakness in the equity markets. Operating cash flow jumped 47.3% for the same period. After revaluation of its property value by Jones Lang LaSalle, it showed a $15.1 million increase with total value now standing at $118.4 million. Its book value sood at 34.27cents, which translated to a price-to-book value of 1.00 as of today.
Taking a look at cash flow, free cash flow for the firm dropped though, by a drastic 68.2%. A quick look at it revealed that there was a 6-fold jump in the investments in property, as well as securities held for trading. The recent weakness in the property markets have brought down property prices to more realistic valuations, and the large increase in acquisition activities does not come as a surprise. However, its increase in securities trading, where the firm actually bought REITs, although the board had previously mentioned would be cutting down, could be a cause of concern. Although the selloff in equity markets might have brought prices down, however, as an investor, it would probably be a little more re-assuring if the company places its emphasis on its core businesses. A little more reassuring could be the fact that it had a net outflow in securities due to disposal.
Taking a look at the breakdown in contributions, revenue from Malaysian operations increased by 26.3%, in-line with management's ambitions of expanding in Malaysia. There were 10 new stores opened in the financial year. Rental from investment in properties increased by 13.0%, as most of the shops fetched higher rental rates for the company. The revenue from the gold business however dropped by 9.7% due to the decrease in demand for gold in times of rising gold prices. The Malaysian business saw a 36.4% increase in gross profit due to the expanding business, and although gold revenue dropped, the profit rose by 5.4% due to lower average cost of gold in stock.
Going on to debt, although there was a decrease in debt-equity, however, the current ratio rose to 1.44 from 0.9, the reason being the management's change in focus by switching its fund from long-term funds, which were carrying higher interest rates, to short-term loan facilities. Debt-equity was not totally reflective of the debt level of the firm, which rose as a whole, because the shareholder's equity rose more than the debt, from $96.7 million to $113.6 million. This is however not a cause of concern for the firm's current liabilities can be covered by its current assets despite a drop in working capital. The firm has been adequately backed by strong cash flow from operations as well. Also, looking at the brighter side, the firm can finance its operations through borrowing relatively easily because of its low gearing.
Inventory turnover dropped from 2.2 to 1.9. However, as the breakdown of inventory(which consists of gold and apparel) was not shown in the reports, it is hard for me to ascertain which particular item led to this drop. A guess on my part though, could be that the drop in demand for gold could have resulted in higher inventory levels, thus affecting the inventory turnover, especially so since gold would have been a large portion of its inventory.
Looking forward, the company faces times where its profits from First Lady Malaysia could be affected due to inflation and the political crisis, as earlier mentioned. As for gold prices, the volatility could result in either higher profits(if it rises) or lower profits(if it drops). The retail segment looks more promising however, due to the rise in rentals and a strong SGD which could keep the SIBOR and other interest rates down. The management has declared a dividend for next year and 2 years later at 3.5cents and 3.8cents respectively, which at current prices translates to a dividend yield of slightly more than 10%.
I believe that 2nd Chance now stands in a unique position whereby property rental income might now be the cash cow for the firm. Due to its previous efforts of 'biting the bullet' and paying off its debt for the retail property, the rental is now bringing in the cash for the firm. This could bode well for its gold and retail arm, which had previously supported the property business of the company.
Going on, its new concept of the Muslim Mart seems to be kicking off, but however, the full impact and revenue contribution from this concept will only be seen in the next FY. The concept revolves around providing a one-stop destination for Muslims to purchase their clothings, books, toiletries and other items together. I paid a visit to its Mart and found that this concept had brought about a big difference as compared to the fragmented retailers which were situated nearby. Although I agree that the retail industry is a relatively low barriers-to-entry industry with many fragmented players, however, I believe that the niche lies in its appeal to the mass market and the branding of First Lady. It is distinctively the most recognisable brand, alongside other brands in the area, and apparel are going at low prices(so the high margins are due to its gold and jewellery business). It also aims to gain the heart share of the market through its regular Lucky Draw promotions, although I believe this would have a limited impact on the business of the company. Its easily recognisable brand however plays a huge part in the capturing of the heart share, as Nike, Addidas and other big companies have shown in decades.
After applying a conservative 5% increment and 9% discount rate to my DCF method, i arrived at a implied value of around 41cents, not including its dividend yield of around 10%. The market seems to be projecting a modest growth of the firm, without being influenced by the board's ambitions and the CEO's views that 15% CAGR is attainable for the firm. Now then, you would probably want to ask, with the stock trading at relatively comparable prices to its implied value,and thus a smaller margin of safety, why would I want to single out 2nd Chance as a candidate for someone's portfolio?
To answer this, we shall look at several factors. This stock was not spared in the equity market weakness, dropping around 32% as compared to the STI's drop of approximately 29%, underperforming the index slightly. Weak sentiment in the property market could have led to the company trading at current valuations. However, it has not fallen as much as the rest of the property players, possibly due to its high dividend yield and also because it is not a pure property play. It is my belief however, that this stock is still trading at a discount to its intrinsic value, due to the following reasons. Its ROE has been relatively 'low' at 21%. This is probably due to the fact that it owns the property that it rents out, as compared to other property players which might lease the property and thus rake in much higher profits. This would mean that the ROE would only increase in future, as can be seen from the latest financials when its ROE increased despite increase in shareholder's equity. Also, I would like to think that because of this factor, 2nd Chance is currently situated in a position whereby it can either increase its income by raising rental rates or expand by pumping in money from its rental income into its retail businesses, both being win-win situations. The recent weakness in the property market might entice the astute CEO, who has won the Malaysia Businessman Award, to go hunting for more property. The current retail stores in City Plaza and Paya Lebar area have en-bloc potential with Paya Lebar being earmarked as a sub-regional centre. This could easily fetch high prices on sale, and result in special dividends or capital gains, either way which could bode well for investors. With the CEO's good track record of investing smartly in property, I wouldn't bet on him not repeating his actions again.
There are of course downsides to the stock. One big problem I would like to point out is that the stock is largely illiquid, with days where not a single trade had been completed. This is largely due to the low amount of free float, with the CEO himself owning around 50% of the stock(which might make u think if the CEO has another motive in being so dividend happy, but which of course is another story altogether).
Now, for those who have had the patience to read up till here, I would like to emphasise that this company is not the sort of deep-value plays that have been characteristic of value investors. It is essential however, to keep in mind the main advantage of the company: providing stable, free cash flow and at the same time providing growth potential. Its retail segment is a stable source of regenerating income and the retail segment, especially with the new Muslim Mart concept, could be an opportunity for 2nd Chance to improve on its market share(by its own estimates, 40% of the market share in Malaysia and Singapore). A pseudo-REIT, with the potential for more growth as compared to the average REIT. It probably deserves at least a 2nd look.
Also, pardon me for not being so specific in my financial analysis, the reason being that I don't want to make this post too long. For people who might be interested to know more, do feel free to make a comment or drop me a mail.
Friday, August 29, 2008
Saturday, August 23, 2008
Test of resolve
The blue-chip index, the Straits Times Index, ended the week at2,723.30, capping its losses with a small 9.83 point increase. With many companies having their market capitalisation wiped off, surely one may ask, the downside is now very much limited and it is probably time to bottom-fish.
However, many who have started to invest during the recent bear-trap where the index rallied to around 3,200 points on renewed hopes that the sub-prime crisis was nearing an end only found themselves surprised by the magnitude and velocity the index came tumbling down, the exact way it went up. Its recent lows were levels last reached 2 years back in 2006.
Now has come the time for investors to truly test their resolve and their belief in the investing methods that they have espoused. Value investors, most of whom pride on their belief in investing based on a "margin of safety", have found themselves falling into a value trap. This occurs when a stock price falls, and falls, and falls.(quoted from the Business Times, 20 Aug 2008). The margin of safety rule has not been that safe after all. Now, the 'value investors' who have gone through the market in the previous years and found themselves sitting on handsome profits might have seen most of them wiped out. The question now is, of course, that whether value investing still works for them or not, or rather, if it even works for them in the first place. Most types of investing would have worked anyway in the bull markets which ended not too long ago. But for now, the volatile swings in the markets have most investors embracing the motto for now, "buy into weakness and sell into strength". This tactic seems to have done well for most investors at this moment of time, and could probably entice a few into adopting similar strategies.
But for those who have kept faith with value investing, this appears to be tough times indeed. To see the other investors pulling ahead and earning profits may not be the best kind of medicine to swallow at this point of time. But before one decides to adopt a change of strategy, please do consider the following: in the past 15 years, large-cap value funds have had an annualised return of 8.66% whilst for the same period of time, large-cap growth funds have progressed 8.03%(Morningstar). Note that this period of time includes the '87 stock market crash and the bursting of the Internet bubble.
Now, some may question, but the '87 crash was a steep one, and the Internet bubble was not exactly the best times for growth stocks. The sub-prime crisis has seemingly been a never-ending one, and the ones who have stuck their heads out to proclaim the crisis near to an end have had eggs in their faces. Detoxifying in itself is a long and ardous journey, and value investors could have underestimated the length of the unfolding of this crisis.
For now, those of us who have managed to escape relatively unscathed either through skill or luck, should take the time off to decide if each investing style previously adopted is suited for you. For now, I stick with my faith. Let's take all in good stride and that if Mr Market decides to go berserk any further, do take this chance to capitulate on more opportunities. And pray.
I shall try my best to look at individual companies very soon.
However, many who have started to invest during the recent bear-trap where the index rallied to around 3,200 points on renewed hopes that the sub-prime crisis was nearing an end only found themselves surprised by the magnitude and velocity the index came tumbling down, the exact way it went up. Its recent lows were levels last reached 2 years back in 2006.
Now has come the time for investors to truly test their resolve and their belief in the investing methods that they have espoused. Value investors, most of whom pride on their belief in investing based on a "margin of safety", have found themselves falling into a value trap. This occurs when a stock price falls, and falls, and falls.(quoted from the Business Times, 20 Aug 2008). The margin of safety rule has not been that safe after all. Now, the 'value investors' who have gone through the market in the previous years and found themselves sitting on handsome profits might have seen most of them wiped out. The question now is, of course, that whether value investing still works for them or not, or rather, if it even works for them in the first place. Most types of investing would have worked anyway in the bull markets which ended not too long ago. But for now, the volatile swings in the markets have most investors embracing the motto for now, "buy into weakness and sell into strength". This tactic seems to have done well for most investors at this moment of time, and could probably entice a few into adopting similar strategies.
But for those who have kept faith with value investing, this appears to be tough times indeed. To see the other investors pulling ahead and earning profits may not be the best kind of medicine to swallow at this point of time. But before one decides to adopt a change of strategy, please do consider the following: in the past 15 years, large-cap value funds have had an annualised return of 8.66% whilst for the same period of time, large-cap growth funds have progressed 8.03%(Morningstar). Note that this period of time includes the '87 stock market crash and the bursting of the Internet bubble.
Now, some may question, but the '87 crash was a steep one, and the Internet bubble was not exactly the best times for growth stocks. The sub-prime crisis has seemingly been a never-ending one, and the ones who have stuck their heads out to proclaim the crisis near to an end have had eggs in their faces. Detoxifying in itself is a long and ardous journey, and value investors could have underestimated the length of the unfolding of this crisis.
For now, those of us who have managed to escape relatively unscathed either through skill or luck, should take the time off to decide if each investing style previously adopted is suited for you. For now, I stick with my faith. Let's take all in good stride and that if Mr Market decides to go berserk any further, do take this chance to capitulate on more opportunities. And pray.
I shall try my best to look at individual companies very soon.
Saturday, August 16, 2008
Turnaround Companies
One particular type of investing style that I had always wanted to try but did not have the courage to do so revolved around looking for companies that had fallen out of favour with investors due to declining profits and weak fuure prospects. The exact opposite of growth stocks, they suffer from PE re-rating every now and then when they publish their quarterly reports showing declining figures in every single aspect of their business. This approach however, involves looking for exactly such companies. The bleaker the prospects, the more suitable it is as a candidate for investing.
Now, why would an investor want to look at a company which is losing money? The reason is that this particular style of investing banks on the hope that the management will keep the company afloat for as long as they can, and hopefully, be able to survive for long enough until the company turns profitable again. They reason, that these businesses will naturally find a way back into profitability as management would try means and ways to keep the company afloat, although I believe that this proposition itself is up for contention. Nonetheless, the trick is in finding such companies who have enough stockpiles of cash to tide them through these trying periods, so that in the event they turn profitable again, the company will be back in favour with investors.
Benjamin Graham popularised the term 'Net net current asset value", which is the current assets net of total liabilities. He set a criteria of buying into a company if the market capitalisation was at 2/3 the value of its NNCAV. For a compay to be priced at this level, the markets would probably be so pessimistic about the prospects of this stock that they are unwilling to pay even the NNCAV of the company. Now, there probably aren't that many companies out there trading at such levels, so you could tweak the criteria a little, according to your own comfort level. Then, the next step is to evaluate the balance sheet strength of such a company. Determine the cash burn rate of the company, i.e. the rate at which the company is using up its cash. For e.g., if the cash holdings of the company is $8 this quarter, and $6 the next, then the company is probably using up cash at approximately $2 per quarter. So, making an intelligent guess, you might figure out that the company might be able to hang around for probably 2-3 more quarters. Now, depending on your comfort level, you might want to look for a company which can hang around for at least a year or two.
What then about the business model? Is there a need to look into the sustainability of the business model? Well, the reason why I quoted the "cigarette butt" investing phrase is because the company that you are looking at is probably gonna be around for only a short period of time before it finally folds. Good for just one more puff, but nothing more. The very fact that the company is in dire straits at this moment of time bears testimony to the inferior business model of the company, unless of course there are other reasons that you believe resulted in the company's current situation. But do of course be cautious in your stock picking. Other than the cash burn rate, the liquidity value of the company could be another part that you want to consider. NNCAV is simply just a measure of how the company's working capital can cover its long-term liabilities, but this assumes that in the event that the company really does wind up, inventory and other receivables may not be totally redeemable at the price indicated on the balance sheet. If the company you are looking at it is in a sunset industry, you might want the company to be trading at a huge discount to its NNCAV before you even consider buying up its stock. There are also many other factors that you want to consider, things like its operating cash flow(profits dropping but operating cash flow increasing would be a good sign). In essence, do your homework with regards to its financial strength, but you could be forgiven for not wanting to take a second look at its business model.
Now, why would an investor want to look at a company which is losing money? The reason is that this particular style of investing banks on the hope that the management will keep the company afloat for as long as they can, and hopefully, be able to survive for long enough until the company turns profitable again. They reason, that these businesses will naturally find a way back into profitability as management would try means and ways to keep the company afloat, although I believe that this proposition itself is up for contention. Nonetheless, the trick is in finding such companies who have enough stockpiles of cash to tide them through these trying periods, so that in the event they turn profitable again, the company will be back in favour with investors.
Benjamin Graham popularised the term 'Net net current asset value", which is the current assets net of total liabilities. He set a criteria of buying into a company if the market capitalisation was at 2/3 the value of its NNCAV. For a compay to be priced at this level, the markets would probably be so pessimistic about the prospects of this stock that they are unwilling to pay even the NNCAV of the company. Now, there probably aren't that many companies out there trading at such levels, so you could tweak the criteria a little, according to your own comfort level. Then, the next step is to evaluate the balance sheet strength of such a company. Determine the cash burn rate of the company, i.e. the rate at which the company is using up its cash. For e.g., if the cash holdings of the company is $8 this quarter, and $6 the next, then the company is probably using up cash at approximately $2 per quarter. So, making an intelligent guess, you might figure out that the company might be able to hang around for probably 2-3 more quarters. Now, depending on your comfort level, you might want to look for a company which can hang around for at least a year or two.
What then about the business model? Is there a need to look into the sustainability of the business model? Well, the reason why I quoted the "cigarette butt" investing phrase is because the company that you are looking at is probably gonna be around for only a short period of time before it finally folds. Good for just one more puff, but nothing more. The very fact that the company is in dire straits at this moment of time bears testimony to the inferior business model of the company, unless of course there are other reasons that you believe resulted in the company's current situation. But do of course be cautious in your stock picking. Other than the cash burn rate, the liquidity value of the company could be another part that you want to consider. NNCAV is simply just a measure of how the company's working capital can cover its long-term liabilities, but this assumes that in the event that the company really does wind up, inventory and other receivables may not be totally redeemable at the price indicated on the balance sheet. If the company you are looking at it is in a sunset industry, you might want the company to be trading at a huge discount to its NNCAV before you even consider buying up its stock. There are also many other factors that you want to consider, things like its operating cash flow(profits dropping but operating cash flow increasing would be a good sign). In essence, do your homework with regards to its financial strength, but you could be forgiven for not wanting to take a second look at its business model.
Monday, August 11, 2008
Complacency
Most investors, especially young and brash investors like myself, tend to be overexcited by initial success on the stock market. Many investors are besotted with short-term gains and believe that they have the bragging rights after a short period of outperformance of the stock market. Many of us can probably recall how often they have found a stock which has outperformed the market by a huge percentage and feel exceptionally proud of themselves.
However, without sounding too morbid, things in life always do happen for a reason. But whether u know the reason or not is another matter altogether. A stock might rise for numerous reasons, for e.g. M&A prospects, quarterly earnings surprise on the upside, and other short-term catalysts. For value investors, they ignore short-term catalysts, believing instead that the current market price tends to underprice the intrinsic value of the stock because it tends to lag the fundamentals. As such, value investors can be termed "long-term arbitrageurs" who tap on this window of deviation between fundamental value and current market price, and hopefully when the market realises the potential of the stock, the stock price will correct itself to its intrinsic value. However, what investors should ask themselves is, why should a stock be priced below your calculated intrinsic value? Is the market really being too short-term orientated, or is it panic selling that has led to a recent weakness in prices? Or are there other reasons behind it?
Papers have been published on the EMT and random walk theory to propose the idea that individuals will not be able to beat the market consistently, and if one does that, it is purely by coincidence or chance rather than skill. Proponents feel that a fund manager is no better at picking stocks than a monkey who chooses by throwing darts.
To a big extent, I agree. Look no further than our surroundings: can you name me an instance whereby u think that u have discovered something that someone else hasn't? simple things like the quiet corner to study in school which nobody knows of, or even a stall where you can buy the cheapest chicken rice in Singapore but without a compromise in the quantity? Now, like I'm going to emphasise again, things do happen for a reason. The reason why nobody wants to study at that secluded corner could be because the place is the furthest from the lecture theatre, or the cheapest chicken rice stall could be selling at such prices only because their rental rates are one of the cheapest in Singapore.
Now, try to apply this to the stock markets. A particular counter that you think has the best prospects e.g. high ROA and ROE, fat margins, rising profits and revenue, consistently generating high cash flow, may trading at very low PERs compared to their peers, or could be at a discount to book. Now, before you throw your hard-earned savings into this wonder counter, take a step back and try to understand this very simple concept: everybody wants to make money on the stock markets. And, if everybody has this mentality, why are they shunning away from this particular stock? In other words, does the market know something that you do not already know? Even in bear markets, where the general mentality of "long-term investors" is that the prices of securities in bear markets will only go north from here and not south, and that holding your stocks for the "long-term" would mean that your stock price will eventually go above your purchase price, the likelihood is that you might be in for a surprise.Or rather, shock.
Whenever I do a qualitative analysis of a counter, I include a particular point that I feel that: 1) either the market has viewed a particular aspect of the company too bearishly, or 2) the market has probably discounted this aspect altogether. The likelihood of (2) happening is rare, but if you think you have found a company which fits the bill, bet heavily. 3 possibilities I can think of: 1) you are already rich. 2) you are going to be very rich. 3) your last name is Buffett. Either way, please do leave a comment behind. And your contact no. as well. Please.
I'm not trying to drive across the point that it is impossible to discover such a company. But, it is better to be less complacent and figure out why the company is "depressed" according to your valuations. I came across a company recently which is in the property sector. Its ROE is nothing in the league of the big boys, nor are its profits and revenue, although both have been rising steadily. What I noticed though was that this company actually owned the property they were renting/leasing out, unlike the other developers which rented out property that they themselves had leased on a long-term basis. Now, the reason why the company is changing hands at a lower value is probably because of its less-stellar results. But, could the markets have overlooked the fact that this company actually owns the property that they rent out? Naturally, a company which owns their own property will have a lower ROE, coupled with the fact that it has been slowly scaling down on its gearing which results in an even lower ROE. It will only be a matter of time before the company's performance starts to accelerate north. This is just an example of what I think the markets could have overlooked in a company, but then again I could be wrong and have egg in my face. But at least I would have the contact no of the rich guy who leaves the comments on my blog to fall back upon. Margin of safety.
All investors in the market are generally smart. Even value investors who claim that market inefficiency is the reason why they are able to earn money actually pray for the market to be efficient. For, if not, there would never be a convergence between current market prices and their calculated intrinsic value, and Buffett would probably have to continue his newspaper selling business instead of compounding his savings at such astronomical rates. Benjamin Graham may have made famous his ficitious personna, Mr Market, who has the erratic behaviour of quoting prices which fluctuate daily. But, Mr Market wants to make money as well. And the fact is, he is not stupid.
However, without sounding too morbid, things in life always do happen for a reason. But whether u know the reason or not is another matter altogether. A stock might rise for numerous reasons, for e.g. M&A prospects, quarterly earnings surprise on the upside, and other short-term catalysts. For value investors, they ignore short-term catalysts, believing instead that the current market price tends to underprice the intrinsic value of the stock because it tends to lag the fundamentals. As such, value investors can be termed "long-term arbitrageurs" who tap on this window of deviation between fundamental value and current market price, and hopefully when the market realises the potential of the stock, the stock price will correct itself to its intrinsic value. However, what investors should ask themselves is, why should a stock be priced below your calculated intrinsic value? Is the market really being too short-term orientated, or is it panic selling that has led to a recent weakness in prices? Or are there other reasons behind it?
Papers have been published on the EMT and random walk theory to propose the idea that individuals will not be able to beat the market consistently, and if one does that, it is purely by coincidence or chance rather than skill. Proponents feel that a fund manager is no better at picking stocks than a monkey who chooses by throwing darts.
To a big extent, I agree. Look no further than our surroundings: can you name me an instance whereby u think that u have discovered something that someone else hasn't? simple things like the quiet corner to study in school which nobody knows of, or even a stall where you can buy the cheapest chicken rice in Singapore but without a compromise in the quantity? Now, like I'm going to emphasise again, things do happen for a reason. The reason why nobody wants to study at that secluded corner could be because the place is the furthest from the lecture theatre, or the cheapest chicken rice stall could be selling at such prices only because their rental rates are one of the cheapest in Singapore.
Now, try to apply this to the stock markets. A particular counter that you think has the best prospects e.g. high ROA and ROE, fat margins, rising profits and revenue, consistently generating high cash flow, may trading at very low PERs compared to their peers, or could be at a discount to book. Now, before you throw your hard-earned savings into this wonder counter, take a step back and try to understand this very simple concept: everybody wants to make money on the stock markets. And, if everybody has this mentality, why are they shunning away from this particular stock? In other words, does the market know something that you do not already know? Even in bear markets, where the general mentality of "long-term investors" is that the prices of securities in bear markets will only go north from here and not south, and that holding your stocks for the "long-term" would mean that your stock price will eventually go above your purchase price, the likelihood is that you might be in for a surprise.Or rather, shock.
Whenever I do a qualitative analysis of a counter, I include a particular point that I feel that: 1) either the market has viewed a particular aspect of the company too bearishly, or 2) the market has probably discounted this aspect altogether. The likelihood of (2) happening is rare, but if you think you have found a company which fits the bill, bet heavily. 3 possibilities I can think of: 1) you are already rich. 2) you are going to be very rich. 3) your last name is Buffett. Either way, please do leave a comment behind. And your contact no. as well. Please.
I'm not trying to drive across the point that it is impossible to discover such a company. But, it is better to be less complacent and figure out why the company is "depressed" according to your valuations. I came across a company recently which is in the property sector. Its ROE is nothing in the league of the big boys, nor are its profits and revenue, although both have been rising steadily. What I noticed though was that this company actually owned the property they were renting/leasing out, unlike the other developers which rented out property that they themselves had leased on a long-term basis. Now, the reason why the company is changing hands at a lower value is probably because of its less-stellar results. But, could the markets have overlooked the fact that this company actually owns the property that they rent out? Naturally, a company which owns their own property will have a lower ROE, coupled with the fact that it has been slowly scaling down on its gearing which results in an even lower ROE. It will only be a matter of time before the company's performance starts to accelerate north. This is just an example of what I think the markets could have overlooked in a company, but then again I could be wrong and have egg in my face. But at least I would have the contact no of the rich guy who leaves the comments on my blog to fall back upon. Margin of safety.
All investors in the market are generally smart. Even value investors who claim that market inefficiency is the reason why they are able to earn money actually pray for the market to be efficient. For, if not, there would never be a convergence between current market prices and their calculated intrinsic value, and Buffett would probably have to continue his newspaper selling business instead of compounding his savings at such astronomical rates. Benjamin Graham may have made famous his ficitious personna, Mr Market, who has the erratic behaviour of quoting prices which fluctuate daily. But, Mr Market wants to make money as well. And the fact is, he is not stupid.
Saturday, August 9, 2008
Conglomerates
F & N, who has recently hogged the spotlight for its search on a more effective management structure of its different divisions, recently posted a set of results for the 3QFY08, with revenue dropping 7.5% year-on-year to S$1.2billion, and net profit rising 13.6% to $110.3million. The F&B and property arm of the conglomerate posted revenue growth, whilst the Printing & Publishing division(P&P) posted a slight decline. Without going through the financial statements again, I would like to express my views on the recent shake-up developing within F&N.
F&N has profitted from the recent property boom, which has boosted its bottom-line, whilst the F&B and P&P segments have dragged the performance of the business down, or so as analysts would have you believe.
However, with the recent downturn in the property market, the property division of F&N will probably fail to repeat their sterling performance in recent years, or worse, bring down the performance of the company. So the question that shareholders should be asking is: is this the right time to spin off the P&P and F&B divisions?
Look no further than Sembcorp Industries and Keppel Corp for a clue to answering this question. Keppel Corp's results were dragged down by Keppel Land's delay in launches, but their results were propped up by the Offshore & Marine (O&M) segment. As for SCI, its entire business ex marine(including Utilities, Parks, Environmental Engineering etc.) was a disappointment, but the reason why it managed to eke out a marginal 1H08 net profit growth of 1% was because of the stellar O&M division on the back of a $9.4 billion order book. Now, if both Keppel and SCI had seen their other underperforming divisions as a drag to earnings, would spinning off be better? But, would they have anticipated the lacklustre performance even before it had started?
The reason why this conglos have their heads above their waters is because of the diversified nature of their business. While the property arm of Keppel Corp did badly, the O&M segment shone. While the utilities and other divisions of SCI did badly, their O&M division shone. The nature of Keppel's business is that both the property and O&M segments are cyclical in nature, but it just so happens that these cycles overlap each other to a certain extent, so when one is on the downtrend, the other just so happens to be on the uptrend. So, who is to say that the property arm of Keppel is dragging down its earnings? In a few years to come, the exact opposite might happen. But well, I shall not touch on the topic of diversification for now.
Now, let's go back to F&N's business. The P&P and F&B divisions are not exactly the most cyclical divisions. People don't drink more F&N Grape because the weather is hot in January, nor do they start to print more brochures in June because it's the school holidays and there are people out in the streets to take notice of the flyers. They are stable, cash generating businesses which unfortunately, do not grow as much as their shareholders would like them to. As for the property arm, it is famously cyclical, although I wouldn't comment on whether the property market is starting a downtrend or not. However, what you will have to agree with me is that there is a pronounced slowdown at this moment of time. Now, wouldn't this be a really bad time for F&N to spin off its business? It's easy to denounce the P&P and F&B divisions during times of good growth for the property arm, but their importance is only emphasised more during trying periods like this. You don't miss your Printing & Publishing and Food & Beverage divisions until your coffers run dry.
Just some food for thought.
F&N has profitted from the recent property boom, which has boosted its bottom-line, whilst the F&B and P&P segments have dragged the performance of the business down, or so as analysts would have you believe.
However, with the recent downturn in the property market, the property division of F&N will probably fail to repeat their sterling performance in recent years, or worse, bring down the performance of the company. So the question that shareholders should be asking is: is this the right time to spin off the P&P and F&B divisions?
Look no further than Sembcorp Industries and Keppel Corp for a clue to answering this question. Keppel Corp's results were dragged down by Keppel Land's delay in launches, but their results were propped up by the Offshore & Marine (O&M) segment. As for SCI, its entire business ex marine(including Utilities, Parks, Environmental Engineering etc.) was a disappointment, but the reason why it managed to eke out a marginal 1H08 net profit growth of 1% was because of the stellar O&M division on the back of a $9.4 billion order book. Now, if both Keppel and SCI had seen their other underperforming divisions as a drag to earnings, would spinning off be better? But, would they have anticipated the lacklustre performance even before it had started?
The reason why this conglos have their heads above their waters is because of the diversified nature of their business. While the property arm of Keppel Corp did badly, the O&M segment shone. While the utilities and other divisions of SCI did badly, their O&M division shone. The nature of Keppel's business is that both the property and O&M segments are cyclical in nature, but it just so happens that these cycles overlap each other to a certain extent, so when one is on the downtrend, the other just so happens to be on the uptrend. So, who is to say that the property arm of Keppel is dragging down its earnings? In a few years to come, the exact opposite might happen. But well, I shall not touch on the topic of diversification for now.
Now, let's go back to F&N's business. The P&P and F&B divisions are not exactly the most cyclical divisions. People don't drink more F&N Grape because the weather is hot in January, nor do they start to print more brochures in June because it's the school holidays and there are people out in the streets to take notice of the flyers. They are stable, cash generating businesses which unfortunately, do not grow as much as their shareholders would like them to. As for the property arm, it is famously cyclical, although I wouldn't comment on whether the property market is starting a downtrend or not. However, what you will have to agree with me is that there is a pronounced slowdown at this moment of time. Now, wouldn't this be a really bad time for F&N to spin off its business? It's easy to denounce the P&P and F&B divisions during times of good growth for the property arm, but their importance is only emphasised more during trying periods like this. You don't miss your Printing & Publishing and Food & Beverage divisions until your coffers run dry.
Just some food for thought.
Friday, August 8, 2008
Dividends - boon or bane?
The Singapore Exchange recently posted a set of full year results for FY2008 at $478.3m, as opposed to Bloomberg's poll of $460m. This results came in slightly better than expected, mainly on the back of its growing Asian Gateway business, of which 45% of its revenue is generated from. The board decided on an increase in base dividend(the dividend which is guaranteed to shareholders) from 12cents to 14cents, with a base dividend of 3cents and variable dividend of 26cents announced this time round, bringing full year payout to 38cents.
This dividend yield, based on current prices assuming that you bought it on 08 August 2008, would have given you a dividend yield of 5.65%, which isn't too bad simply based on these figures. But it this a cause for joy, or rather, for concern for shareholders? Without poring through the financial statements for the year, I would like to express my views on dividend payouts as a whole and not focus on SGX.
A dividend payout is typically announced when the company has positive accumulated retained earnings, coupled with cash to pay out the dividend. Dividends are seen as a form of compensation for the volatility that shareholders experience during trying times like this, and at least provides some relief for shareholders of this high-beta stock. However, the burning question that all investors would, or should ask is: is this cash better off being invested in the business for organic growth, or dished out to shareholders?
To answer this question, I think one would need to go back to the basics of the role of the board. The board is elected by shareholders on a timely basis to maximise shareholder's benefits. To maximise shareholder's benefits of course would entitle increasing the holdings of the shareholder, and this would include both potential capital appreciation and dividends. So when should a company dish out dividends rather than invest them in the business? Typically, for every extra dollar of earnings/profits retained by the company for Year X, the returns generated in Year X + 1 need to be at least $1 as well?
To simplify things further, let's use this example. Say one day, you meet a guy on the streets who offers to help you earn money. You are tempted by this sweet offer, so what you do is you decide to give him $1 to see how much he earns from there. The next time you see him, he gives you back $2, an extra $1 which he earned for you. Being a smooth talker, he persuades you into giving him $1 out of your total $2 to earn something even more.
Now the question. Assuming that well, you were convinced of his prowess and thus decided to give him that $1 more, would you be satisfied with
a) a return of $1
b) a return of > $1
c) a return of < $1? Maybe what people tend to think of is that well, since this extra $1 is already something extra that I have earned on top of my original capital, it doesn't matter whether the return is less than what I invested. Based on this, c) is acceptable, while a) and b) are bonuses. So, assuming he returns you 50cents after investing your $1, your total holdings would now be $1(your base investment) + $0.50 = $1.50. And what did you have after the original 1st investment? $2. You wouldn't need to be a rocket scientist to figure out which is better off for you.
And, let's assume that the glib tongue in him manages to persuade you to to put this 'extra' 50cents with him to make more money, and you duly oblige. Judging from his 'prowess' and historical performance of 50cents for the dollar, he returns you 25cents. So now, your total holdings is $1(base investment) + $0.25 = $1.25. How's that for making money for you? You will never lose your original capital, based solely on this example, but you will never be making money as well. Wouldn't it then be much better if he had just given you that original $2 that he earned for you, and let you allocate this money yourself?(even buying an ice-cream with this money would give more emotional benefits than seeing this money growing smaller by the day)
The reason why I feel this is overlooked by some investors is because the example cited above is much more glaring whereas a chairman's statement of 'growing profits and revenue at a CAGR of quartrizillion % per annum' would have you believe that your money is in safe hands.
Now the biggest question of them all: is your board one of these people?
This paves the way for interesting ratios that I have not seen being used before, but I use frequently, like 'additional retained earnings-revenue' or 'additional retained earnings-profit', depending on your view on either. Of course, this metric is coined by me, so please please do not come throwing the ice cream that you have bought from example 1 on me.
Also, note that this does not apply for all cases. Sometimes, there are capital requirements set by banks and other debtors on the amount of cash holdings that a company should have, of course to protect their own asses(not a typo error) in the event that the company does a Houdini and runs away without paying off liabilities. Do check up on your company with regards to this. Also, there are other companies which are, or would have you believe, better off holding cash so as to capitalise on investment chances. Do be wary of such companies though, because acquisition as a form of growth, as opposed to organic growth, is normally not sustainable in the future and definitely less desirable due to complications associated with integrating two companies of inherently different systems. I shall not touch on that point for now, this rather much being subjective. Also, there are certain companies which require heavy maintenance capital expenditure due to the nature of the business. Whether this is good or not will not be discussed now either.
So, if you feel that the company is actually better off holding more cash for further acquisition or capital expenditure purposes, and am comfortable with giving a leeway(e.g. $0.70 for the dollar retained), do tweak your ratios. But an encouraging sign would be to see an increasing amount generated for the dollar retained, as it means that the amount you put in is increasingly making more money for you.
A similar, and much more popular, metric is the Return on Equity, which I fully subscribe to its usefulness. It is extensively used to measure the return to shareholders. However, the ROE encompasses other components like asset turnover, and even lowering debt would decrease ROE, so this metric may not be as useful or precise in comparison with the ratios mentioned above.
To make things simpler for investors like myself, I shall note down the points that I think need to be considered before investing in a company, and compile them into a list for future use. Shall start from now.
This dividend yield, based on current prices assuming that you bought it on 08 August 2008, would have given you a dividend yield of 5.65%, which isn't too bad simply based on these figures. But it this a cause for joy, or rather, for concern for shareholders? Without poring through the financial statements for the year, I would like to express my views on dividend payouts as a whole and not focus on SGX.
A dividend payout is typically announced when the company has positive accumulated retained earnings, coupled with cash to pay out the dividend. Dividends are seen as a form of compensation for the volatility that shareholders experience during trying times like this, and at least provides some relief for shareholders of this high-beta stock. However, the burning question that all investors would, or should ask is: is this cash better off being invested in the business for organic growth, or dished out to shareholders?
To answer this question, I think one would need to go back to the basics of the role of the board. The board is elected by shareholders on a timely basis to maximise shareholder's benefits. To maximise shareholder's benefits of course would entitle increasing the holdings of the shareholder, and this would include both potential capital appreciation and dividends. So when should a company dish out dividends rather than invest them in the business? Typically, for every extra dollar of earnings/profits retained by the company for Year X, the returns generated in Year X + 1 need to be at least $1 as well?
To simplify things further, let's use this example. Say one day, you meet a guy on the streets who offers to help you earn money. You are tempted by this sweet offer, so what you do is you decide to give him $1 to see how much he earns from there. The next time you see him, he gives you back $2, an extra $1 which he earned for you. Being a smooth talker, he persuades you into giving him $1 out of your total $2 to earn something even more.
Now the question. Assuming that well, you were convinced of his prowess and thus decided to give him that $1 more, would you be satisfied with
a) a return of $1
b) a return of > $1
c) a return of < $1? Maybe what people tend to think of is that well, since this extra $1 is already something extra that I have earned on top of my original capital, it doesn't matter whether the return is less than what I invested. Based on this, c) is acceptable, while a) and b) are bonuses. So, assuming he returns you 50cents after investing your $1, your total holdings would now be $1(your base investment) + $0.50 = $1.50. And what did you have after the original 1st investment? $2. You wouldn't need to be a rocket scientist to figure out which is better off for you.
And, let's assume that the glib tongue in him manages to persuade you to to put this 'extra' 50cents with him to make more money, and you duly oblige. Judging from his 'prowess' and historical performance of 50cents for the dollar, he returns you 25cents. So now, your total holdings is $1(base investment) + $0.25 = $1.25. How's that for making money for you? You will never lose your original capital, based solely on this example, but you will never be making money as well. Wouldn't it then be much better if he had just given you that original $2 that he earned for you, and let you allocate this money yourself?(even buying an ice-cream with this money would give more emotional benefits than seeing this money growing smaller by the day)
The reason why I feel this is overlooked by some investors is because the example cited above is much more glaring whereas a chairman's statement of 'growing profits and revenue at a CAGR of quartrizillion % per annum' would have you believe that your money is in safe hands.
Now the biggest question of them all: is your board one of these people?
This paves the way for interesting ratios that I have not seen being used before, but I use frequently, like 'additional retained earnings-revenue' or 'additional retained earnings-profit', depending on your view on either. Of course, this metric is coined by me, so please please do not come throwing the ice cream that you have bought from example 1 on me.
Also, note that this does not apply for all cases. Sometimes, there are capital requirements set by banks and other debtors on the amount of cash holdings that a company should have, of course to protect their own asses(not a typo error) in the event that the company does a Houdini and runs away without paying off liabilities. Do check up on your company with regards to this. Also, there are other companies which are, or would have you believe, better off holding cash so as to capitalise on investment chances. Do be wary of such companies though, because acquisition as a form of growth, as opposed to organic growth, is normally not sustainable in the future and definitely less desirable due to complications associated with integrating two companies of inherently different systems. I shall not touch on that point for now, this rather much being subjective. Also, there are certain companies which require heavy maintenance capital expenditure due to the nature of the business. Whether this is good or not will not be discussed now either.
So, if you feel that the company is actually better off holding more cash for further acquisition or capital expenditure purposes, and am comfortable with giving a leeway(e.g. $0.70 for the dollar retained), do tweak your ratios. But an encouraging sign would be to see an increasing amount generated for the dollar retained, as it means that the amount you put in is increasingly making more money for you.
A similar, and much more popular, metric is the Return on Equity, which I fully subscribe to its usefulness. It is extensively used to measure the return to shareholders. However, the ROE encompasses other components like asset turnover, and even lowering debt would decrease ROE, so this metric may not be as useful or precise in comparison with the ratios mentioned above.
To make things simpler for investors like myself, I shall note down the points that I think need to be considered before investing in a company, and compile them into a list for future use. Shall start from now.
List of considerations 09 Aug 2008
- company must at least generate $1 (or close to) of revenue/profit for every $1 of extra earnings/profits retained.
Love to hear any comments and ideas to add to this list.
My 1st entry
This is my first entry on the blog. I am an investor who tries(and hopefully succeeds) in value investing. The main purpose of this blog is to use this channel to post my views on the listed companies in Singapore., and anything to do with investing, but primarily in stocks. Just wanna start things off with a bit on valuation metrics, and hopefully move on to analysing certain counters which I feel are worth taking a second look.
I have always been a fan of investing based on book value, specifically on net tangible assets, due to the relative limited downside based on this metric, and also the "margin of safety" that Benjamin Graham coined to emphasise on the importance of investing safely. Read an interesting article recently on a different type of valuation used, unlike the PERs and the DCFs that analysts and other professionals use. This form of valuation revolves around the book value of the company, whereby the expected free cash return above capital expenditures is projected for a foreseeable(therefore, not unrealistically too far ahead) future, and then discounted to present value and added to the current book value.
This assumes a few things: book value does not substantially increase over the years. Secondly, that the capital expenditures are either steady or steadily increasing over the years.
I personally feel that this form of valuation has a few advantages:
1) It serves to value a firm independently without referring to other similar companies' valuations, as the case for PERs.
2) It is technically more realistic as the markets would not want to pay more than book value for a company if it is loss making.
Take for example, a pen, which costs $1 to make, and which will generate you 20cents for the next 5 years, and nothing more. By using a simple DCF and an appropriate discount rate to account for the opportunity cost, you will arrive at a value somewhere between $1 and $2. That is roughly the price that another person will want to buy from you when you sell it. Similarly, if the pen will make losses for you, someone else will only buy it below $1, and not at your cost price.(although I can't think of any legitimate reason behind why he/she will even buy the pen from you in the first place.)
Disadvantages:
1) assumes that the book value of equity remains constant throughout this period. This may not be realistic for firms that will continue to grow(asset-wise, and through equity funding).
2) capital expenditures may not be stable for companies which are capital intensive, as they tend to spend more when they have more cash at hand, and less when raw material costs start to fall.
Please feel free to post your comments, and would love to have more ideas.
I have always been a fan of investing based on book value, specifically on net tangible assets, due to the relative limited downside based on this metric, and also the "margin of safety" that Benjamin Graham coined to emphasise on the importance of investing safely. Read an interesting article recently on a different type of valuation used, unlike the PERs and the DCFs that analysts and other professionals use. This form of valuation revolves around the book value of the company, whereby the expected free cash return above capital expenditures is projected for a foreseeable(therefore, not unrealistically too far ahead) future, and then discounted to present value and added to the current book value.
This assumes a few things: book value does not substantially increase over the years. Secondly, that the capital expenditures are either steady or steadily increasing over the years.
I personally feel that this form of valuation has a few advantages:
1) It serves to value a firm independently without referring to other similar companies' valuations, as the case for PERs.
2) It is technically more realistic as the markets would not want to pay more than book value for a company if it is loss making.
Take for example, a pen, which costs $1 to make, and which will generate you 20cents for the next 5 years, and nothing more. By using a simple DCF and an appropriate discount rate to account for the opportunity cost, you will arrive at a value somewhere between $1 and $2. That is roughly the price that another person will want to buy from you when you sell it. Similarly, if the pen will make losses for you, someone else will only buy it below $1, and not at your cost price.(although I can't think of any legitimate reason behind why he/she will even buy the pen from you in the first place.)
Disadvantages:
1) assumes that the book value of equity remains constant throughout this period. This may not be realistic for firms that will continue to grow(asset-wise, and through equity funding).
2) capital expenditures may not be stable for companies which are capital intensive, as they tend to spend more when they have more cash at hand, and less when raw material costs start to fall.
Please feel free to post your comments, and would love to have more ideas.
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