2nd Chance Properties

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.