Lehman. Merrill Lynch. AIG. Washington Mutual. These were some of the big names whose scalps were claimed quite recently in the financial turmoil which unfolded in the past week or so. However, as some of the investors stayed at the sidelines, others who had bought on the recent weakness saw some rewards after plans were unveiled to save AIG and the Fed announced a huge bailout plan for banks. Questions abound in the markets on whether this was a time to stay vested to ride the eventual rebound from current levels. Before retail investors like us start to get carried away and put our entire house mortgages in the markets, it is better for us to think of the signs and symptoms that this might still be a bear market rally.
1) The bailout plan is still a plan after all, not a consequence. It is still debatable as to whether the Fed should, and can, rescue the banks that have fallen. It is arguably a distortion of the markets for the Fed to continually rescue the banks, and might merely delay the eventual selldown of the markets. The markets might be reacting to the prospects of a renewed banking sector, taking note that the stock markets are generally leading indicators rather than accurate indications.
2) The bottom of markets might probably only be found when the selling reaches a climax, i.e. prices stop going any lower despite bad news unfolding. I personally believe that perhaps good news of this magnitude might not be an accurate barometer of the reversal of the markets.
3) Notice the selldown recently before the news was unveiled. This might have been the work of short sellers taking to profit from the weakness. Similarly, the sharp rally might have been short-covering by this group of traders. Just simply what I thought of, sadly there's nothing to back me up on this claim;)
I wrote this post not for the purpose of making a market call, that the bear market is not over yet, but to remind investors like myself not to be complacent and over reliant on the Fed to clear up the mess. The mess might need to culminate in a selldown of extraordinary proportions before we can say a market bottom might have reached. Thus, it is essential again for all of us to invest in the markets only when valuations are truly attractive. No point looking to vest in counters which might still be at premiums despite the quite recent selldowns in the hope that they will fetch higher ratings in future.
Just some reality check there.
Sunday, September 21, 2008
Saturday, September 13, 2008
The Value Trap
Just a very short entry. Buying for value investors has frequently been a roller coaster ride. Buying when the stock is going down is a big faux pax for technical investors, but might be exactly what value investors are doing. Just a few points on what I think can be done to minimise being caught in a classical 'value trap' when prices that r cheap keep going down.
1) Stick to a big margin of safety before purchasing
Especially so in a bear market. Go for the big fat pitch, as Buffett says, rather than go for the small ones. If the stock does not fall within ur radar on valuation grounds, no matter how good it might be, do avoid it unless u have really sufficient reason to do so. Especially so since retail investors like us need to be more careful due to limited capital.
2) Yes, average ur way down, but don't put all in at one go
Do go for the big fat pitch. But prob is, if a stock goes down, it is likely to go down further for various reasons. So, hold ur cash first, don't put in a big portion at one go. The institutional investors with much deeper pockets can do that, but not the retail ones. Agreed, u might say that it's all about long-term investing, an it doesn't matter too much. BUT honestly speaking, who doesn't want to purchase at a lower price?
3) Only put in more if there's a substantial drop
I think that one shouldn't keep buying at approximately the same prices. It pays to be patient. Even averaging down is a skill; it doesn't mean simply buying when the prices come down further. If the stock only goes down say, 5%, do not think of purchasing more. If it goes much further down, put in more; if it goes up from here, be thankful u invested already and do not attempt to put in more when it goes up, because it will lower ur margin of safety.
4) Buy in smaller volumes at one go
Do determine how much u want to invest in a company, based on model's like Kelly Optimisation or anything that u find suitable. For example, if u think u want to invest $5,000, do not put in $5,000 in this company at one go. U might want to put in $1,000 first, and wait to see if it drops more, and put in another $2,000, before putting the remaining $2,000 if the stock still continues to drop. For myself, I try to invest 3 times and average down, if the stock does not go further down, I leave the remainder for another more attractive company. Well, I'm obviously not a guru, but just want to share some techniques that I use with others and invite comments.
5) However, do take note of transaction costs
Some might want to take note that u tend to incur transaction costs when u average down. Do calculate them and subsequently only average down if ur total value after transaction costs will bring down the average cost significantly.
1) Stick to a big margin of safety before purchasing
Especially so in a bear market. Go for the big fat pitch, as Buffett says, rather than go for the small ones. If the stock does not fall within ur radar on valuation grounds, no matter how good it might be, do avoid it unless u have really sufficient reason to do so. Especially so since retail investors like us need to be more careful due to limited capital.
2) Yes, average ur way down, but don't put all in at one go
Do go for the big fat pitch. But prob is, if a stock goes down, it is likely to go down further for various reasons. So, hold ur cash first, don't put in a big portion at one go. The institutional investors with much deeper pockets can do that, but not the retail ones. Agreed, u might say that it's all about long-term investing, an it doesn't matter too much. BUT honestly speaking, who doesn't want to purchase at a lower price?
3) Only put in more if there's a substantial drop
I think that one shouldn't keep buying at approximately the same prices. It pays to be patient. Even averaging down is a skill; it doesn't mean simply buying when the prices come down further. If the stock only goes down say, 5%, do not think of purchasing more. If it goes much further down, put in more; if it goes up from here, be thankful u invested already and do not attempt to put in more when it goes up, because it will lower ur margin of safety.
4) Buy in smaller volumes at one go
Do determine how much u want to invest in a company, based on model's like Kelly Optimisation or anything that u find suitable. For example, if u think u want to invest $5,000, do not put in $5,000 in this company at one go. U might want to put in $1,000 first, and wait to see if it drops more, and put in another $2,000, before putting the remaining $2,000 if the stock still continues to drop. For myself, I try to invest 3 times and average down, if the stock does not go further down, I leave the remainder for another more attractive company. Well, I'm obviously not a guru, but just want to share some techniques that I use with others and invite comments.
5) However, do take note of transaction costs
Some might want to take note that u tend to incur transaction costs when u average down. Do calculate them and subsequently only average down if ur total value after transaction costs will bring down the average cost significantly.
Monday, September 8, 2008
Styles
Went for a technical analysis workshop yesterday, not because of interest or curiosity but because of an obligation. Shall not elaborate on that. The speaker was a very engaging one, he claims to have found a trading strategy that nobody else has found, and demonstrated his technique through demonstrations by looking through previous charts. Seemed to be a wonderful strategy, did a live demonstration but wasn't as convincing due to the fact that he said certain blue chips were controlled by the big boys and wasn't so accurate, sounding doubtful in tt statement. Shall give him credit for the fact that some of his charts do look convincing on this technique, and according to his claims, this technique probably works well for him(he mentions earning a 24% p.a compounded interest on his portfolio for the last decade), and he claims that he is teaching and not trading because his passion lies in teaching people(MOE?) and not trading and earning money. He charges $3,000++ for his course and has a few months of mentorship for members. For those interested to know more, you can contact me. Shall charge him a commission for advertising his technique here, and tell him that my passion lies in advertising, and not in earning money.
The intention of this post is to bring out the point that well, the stock markets aren't something u can predict accurately in the next few days or so. He demonstrated this when like earlier mentioned, a person from the crowd picked out UOB as one of the stock picks to demonstrate his technique and he failed to find a discerning pattern. Well, when you can't beat them, join them as they say. Which probably explains why indexing is a great place to park ur funds right now.
The only fund that tracks the Straits Times Index is the streetTRACKS STI ETF. What the ETF does is to aim to track the movement of the underlying index, which in this case is the STI. The ETF is traded live on the Singapore Exchange in the secondary market, and is managed by fund managers who merely attempt to track the index, which is also called passive investing as there is no attempt to outperform the index. Units will be bought from Participating Dealers who create and redeem shares(because the STI ETF is open-ended), and this allows the fund price to be close to the Net Asset Value of the fund(which obviously changes everyday).
Since the ETF holds the same underlying stocks as the index it is attempting to track, the performance of the fund moves in tandem with the markets. There are several advantages of this:
1) There is a great amount of diversification. For e.g. the STI comprises of 30 of the largest companies according to market capitalisation, and by owing the STI ETF, the investor immediately diversifies his holdings according to the index, which is also relatively fairly represented in various sectors.
2) Low costs. Instead of attempting to time the market and trading very frequently which results in high transaction costs incurred, owning the ETF is much less costly. The charges will comprise of the brokerage fees (which depends on which brokerage you signed up for) and the management fees (which is kept minimal , <1%, because the fund is passively managed, as previously mentioned). Compare this to another mutual fund which attempts to outperform the index (and frequently fails to) and charges much higher transaction fees(~5% inital and 1-3% for management).
3) Easier transactions. An ETF can be sold intra-day like a stock, i.e. during trading hours from
9 - 1230 p.m and 2 - 5 p.m. Compared to unit trusts, the latter cannot be traded intra-day and will only be processed the next day when the order is received before 3p.m.(check your individual prospectuses for this one).
4) Cheaper alternative to real indexing. Indexing, not through a fund, will require a huge amount of money. To do so, the investor will need to buy the components of the stock at its individual allocated weights, and this will incur a transaction cost larger than that of the STI ETF(some stocks trade below the minimum level, so the minimum brokerage fee of $25 will be charged, and this $25 will be a larger percentage than the usual 0.25% for other stocks). The STI ETF will not require such a large amount to invest in, with the minimum trading board lot costing around $3,000 or so.
Every good thing has a bad side to it.
1) Illiquidity. The ETF is not currently a very liquid stock, with trading volumes varying around a few hundred lots per day, to a drab 48 lots exchanged for today.
2) Tracking error. The ETF also employs derivatives and options to attempt to track the index. There are times when the ETF has a tracking error, i.e. the ETF cannot replicate the performance of the STI. Don't forget the fact that there is a small management fee charged annually, just like any other mutual fund.
3) Health of the general Singapore economy. The economy's well being is essential to the STI ETF doing well, as the STI is a general indicator(albeit leading) of the economy's prospects. In the event that the STI does underperform, the ETF is expected to follow suit, and also vice-versa.
For the 1st point, although the STI ETF is relatively illiquid, it should not matter to investors who wish to invest for a longer time horizon. As for the 2nd, the ETF's tracking error is not expected to be large, although there are times when the price does lag the general market(possibly due to pricing in). The 3rd point is something that the investor cannot do anything about though, sad to speak.
In essence, the ETF is definitely suitable for investors who wish to compound their earnings in a more passive manner. Although it is tempting to attempt to pick up stocks that will outperform the market, however, those with little resources and energy, and also expertise, should try to stick to the ETF to maximise their returns. Active investing might add a few years to your retirement instead of shaving them off. Alright, that's a might, and there are probably other reasons you want to pick individual companies in the first place(e.g. for the experience of investing) The returns of individual companies might be tempting, but it is equally likely for the investor to falter when it comes to stock picking.
Back to the beginning, the investor who wishes to adopt a less active approach by minimising transaction costs will be better off doing fundamental approaches rather than technical approaches. Without going into a lengthy debate as to which camp will be better at maximising wealth, I would simply like to point out the main difference, which is seldom mentioned, between these 2 camps: that the technical trader will probably be more cash rich(provided he is a competent trader) whilst the fundamental investor will probably be more asset rich(provided he is a competent investor, which in this case his assets are in stocks). The trader is more likely to see more cash end up in his pockets whilst the investor who buys on fundamentals is likely to see his cash compounded in the markets in the long run. So, for those investors who wish to see more cash in the pockets, but are also fascinated by the riches and wealth of successful value investors like Warren Buffett and the like, do take heed. The idea of having lots of cash in hand, and also compounding earnings like other successful investors like Peter Lynch does, might not reconcile at all. Think twice before u set your mind on which style of investing is suitable for u. For those enticed by the potential riches, do note that fundamental investing might result in extended periods of time where cash flow is insufficient(on this note, please do not invest any money that u require for emergencies in the markets. That might create an emergency in itself!)And yes, do not for one actually think that u can compound ur earnings at the rates that the legends have done. Stay practical and be on ur feet.
Hang on. This is one hell of a ride.
The intention of this post is to bring out the point that well, the stock markets aren't something u can predict accurately in the next few days or so. He demonstrated this when like earlier mentioned, a person from the crowd picked out UOB as one of the stock picks to demonstrate his technique and he failed to find a discerning pattern. Well, when you can't beat them, join them as they say. Which probably explains why indexing is a great place to park ur funds right now.
The only fund that tracks the Straits Times Index is the streetTRACKS STI ETF. What the ETF does is to aim to track the movement of the underlying index, which in this case is the STI. The ETF is traded live on the Singapore Exchange in the secondary market, and is managed by fund managers who merely attempt to track the index, which is also called passive investing as there is no attempt to outperform the index. Units will be bought from Participating Dealers who create and redeem shares(because the STI ETF is open-ended), and this allows the fund price to be close to the Net Asset Value of the fund(which obviously changes everyday).
Since the ETF holds the same underlying stocks as the index it is attempting to track, the performance of the fund moves in tandem with the markets. There are several advantages of this:
1) There is a great amount of diversification. For e.g. the STI comprises of 30 of the largest companies according to market capitalisation, and by owing the STI ETF, the investor immediately diversifies his holdings according to the index, which is also relatively fairly represented in various sectors.
2) Low costs. Instead of attempting to time the market and trading very frequently which results in high transaction costs incurred, owning the ETF is much less costly. The charges will comprise of the brokerage fees (which depends on which brokerage you signed up for) and the management fees (which is kept minimal , <1%, because the fund is passively managed, as previously mentioned). Compare this to another mutual fund which attempts to outperform the index (and frequently fails to) and charges much higher transaction fees(~5% inital and 1-3% for management).
3) Easier transactions. An ETF can be sold intra-day like a stock, i.e. during trading hours from
9 - 1230 p.m and 2 - 5 p.m. Compared to unit trusts, the latter cannot be traded intra-day and will only be processed the next day when the order is received before 3p.m.(check your individual prospectuses for this one).
4) Cheaper alternative to real indexing. Indexing, not through a fund, will require a huge amount of money. To do so, the investor will need to buy the components of the stock at its individual allocated weights, and this will incur a transaction cost larger than that of the STI ETF(some stocks trade below the minimum level, so the minimum brokerage fee of $25 will be charged, and this $25 will be a larger percentage than the usual 0.25% for other stocks). The STI ETF will not require such a large amount to invest in, with the minimum trading board lot costing around $3,000 or so.
Every good thing has a bad side to it.
1) Illiquidity. The ETF is not currently a very liquid stock, with trading volumes varying around a few hundred lots per day, to a drab 48 lots exchanged for today.
2) Tracking error. The ETF also employs derivatives and options to attempt to track the index. There are times when the ETF has a tracking error, i.e. the ETF cannot replicate the performance of the STI. Don't forget the fact that there is a small management fee charged annually, just like any other mutual fund.
3) Health of the general Singapore economy. The economy's well being is essential to the STI ETF doing well, as the STI is a general indicator(albeit leading) of the economy's prospects. In the event that the STI does underperform, the ETF is expected to follow suit, and also vice-versa.
For the 1st point, although the STI ETF is relatively illiquid, it should not matter to investors who wish to invest for a longer time horizon. As for the 2nd, the ETF's tracking error is not expected to be large, although there are times when the price does lag the general market(possibly due to pricing in). The 3rd point is something that the investor cannot do anything about though, sad to speak.
In essence, the ETF is definitely suitable for investors who wish to compound their earnings in a more passive manner. Although it is tempting to attempt to pick up stocks that will outperform the market, however, those with little resources and energy, and also expertise, should try to stick to the ETF to maximise their returns. Active investing might add a few years to your retirement instead of shaving them off. Alright, that's a might, and there are probably other reasons you want to pick individual companies in the first place(e.g. for the experience of investing) The returns of individual companies might be tempting, but it is equally likely for the investor to falter when it comes to stock picking.
Back to the beginning, the investor who wishes to adopt a less active approach by minimising transaction costs will be better off doing fundamental approaches rather than technical approaches. Without going into a lengthy debate as to which camp will be better at maximising wealth, I would simply like to point out the main difference, which is seldom mentioned, between these 2 camps: that the technical trader will probably be more cash rich(provided he is a competent trader) whilst the fundamental investor will probably be more asset rich(provided he is a competent investor, which in this case his assets are in stocks). The trader is more likely to see more cash end up in his pockets whilst the investor who buys on fundamentals is likely to see his cash compounded in the markets in the long run. So, for those investors who wish to see more cash in the pockets, but are also fascinated by the riches and wealth of successful value investors like Warren Buffett and the like, do take heed. The idea of having lots of cash in hand, and also compounding earnings like other successful investors like Peter Lynch does, might not reconcile at all. Think twice before u set your mind on which style of investing is suitable for u. For those enticed by the potential riches, do note that fundamental investing might result in extended periods of time where cash flow is insufficient(on this note, please do not invest any money that u require for emergencies in the markets. That might create an emergency in itself!)And yes, do not for one actually think that u can compound ur earnings at the rates that the legends have done. Stay practical and be on ur feet.
Hang on. This is one hell of a ride.
Friday, August 29, 2008
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.
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.
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