HPHT lacklustre management dampens valuation amid trading opportunities

Make no mistake despite the headline, HPHT is still a strong BUY with our target of USD0.158 per unit or 46% above the current price of USD 0.108/unit. Now, we have added a catalyst to this target price – disposal of the ongoing management.

Management has failed to address many systemic issues that would have seen them ousted in companies with keen investor interest. There are enough external concerns on the minds of investors to warrant actions.

Concern #1: China passes security law, resulting in the US removing trading privileges with Hong Kong. Port volumes in Hong Kong would inevitably drop.

Bull says: There is a subtle distinction within port volumes. Gateway cargo volume refers to the cargoes that are destined for the hinterland. In contrast, Transhipment cargo volume relates to the cargoes that remain in the port waiting to board another vessel. The price-per-box of a gateway container is much higher than a transshipment container.

With the removal of trading privileges, the impact is felt mainly on Hong Kong’s transshipment volume. For each container that is to be imported from China, there will not be any tax and duty benefit to exporters to export their containers via Hong Kong. Hence, the transshipment volume in Hong Kong, consequently HPHT, would drop.

Against this backdrop, it is worthwhile to note that 1) it might not hurt as bad as the market expected as the transhipment volumes have skinny margins for the port, and 2) HPHT has about 56% stake in Shenzhen Yantian port located on the mainland. The port is competitive as a gateway hub with the capacity to expand. Removing of the trading privileges would hurt importers in the US, as the duties payable would increase or normalise as though the cargoes were exported directly from mainland China. It is also apt to point out that meddling with Chinese domestic affairs does not bring about any tangible benefit to the US citizens, at least from a trade perspective.

There will be retaliatory actions by the Chinese government. For sure, the immediate impact on trade volumes is not going to be pretty for HPHT and the wider maritime industry, which benefits from globalisation. The sentiment here should shift from expectation to mitigation. Are there credible measures management could take to mitigate the fall in transshipment volumes?

From an importer’s perspective, there needs to be logistical cost advantage of importing via Hong Kong vs importing directly via mainland China. HPHT could review the tariffs to be competitive against mainland China, offsetting the incremental import cost. Conceivably, there are many ways to evaluate the tariffs, either in port charges or marine charges or an improvement in port productivity to attract shipping lines to continue making regular calls.

The operational cost basis can be further rationalised to stabilise profits amid the loss of transshipment volumes. Based on its latest annual report, about 99% of the employees are full-time staff. With falling volumes, the employee-contract staff mix should be moderated to reflect a more temporal workforce.

Concern #2: Management and Directors continue to draw salaries and bonuses which are not in line with performance.

It is convenient for management to squarely lay the blame on trade tensions and coronavirus. Trade tension with the US has been around since Trump became the President of the United States (POTUS) in 2016. HPHT couldn’t possibly blame him throughout his term and perhaps the next 4-year term as well. Management needs to appreciate that they have to actively strategise to improve shareholders’ returns. The Board of Directors needs to safeguard shareholders’ interests. Suffice to say, the share price is a reflection of the incapability of management and the directors. Yet, at the same time, they draw salaries and bonuses that are incommensurable with the performance of the Trust.

Global trade screeched to a halt in March 2020. Since June 2020, major economies are gradually opening up to a new normal. Merchandise trade should resume flow. Is management capable of leading shareholders out of this crisis? For sure, if they continue to point the fingers to external factors, which they have done since IPO for the slump in the share price. Shareholders cannot be confident that they would implement structural changes to serve investors’ interests.

In this respect, based on the annual report filings, management continues to draw respectable salaries and bonuses for the dismal performance.

Concern #3: Debt level remains elevated. Would we ever see a manageable debt in HPHT’s portfolio?

No, management points fingers at external factors for scaling back its debt commitment. We thought it was a positive move by management to shed HPHT’s debt by HKD 1 billion annually. At least, there can be some reliefs in interest expense that crimps profit to unitholders. Year to June, it was disclosed that HPHT pared HKD 250 million. It is unlikely that management will keep to this commitment.

While we like the semi-annual distributions, it is apparent that the distributions are unsustainable. Instead of scaling back on distributions, which would have an immediate adverse share price reaction, we would have much preferred for HPHT to be a lean cash-rich trust without crushing debt burdens. Let us take a moment to remember Rickmers Maritime. HPHT could be a Rickmers Maritime if it prioritises share price performance over the core performance of its operations.

Understanding the risks of this counter

In all likelihood, HPHT could come to investors for more money to burn. How about unitholders back them up by supporting a potential rights issue? We would categorically slam this approach because Hong Kong is facing a structural decline in port volumes and that there are premium assets (land value) to be monetised. Think of SIA asking for more funds through rights and convertible bonds, instead of restructuring its assets. The share price tanked below the theoretical price, cum-rights. This is usually the case for companies begging for money to burn with no earnings-accretive plans or convincing strategy to stem systemic cash drains.

Complete acquisition or partial disposal? It could be that HPHT is left with just its legacy HQ assets in Hong Kong, with a sale of its mainland China operations to a Chinese port operator. The cash on sale would raise expectations of a bumper distribution to unitholders. Swapping Yantian Terminals (mainland Shenzhen) for Modern Terminals may happen, which would reduce the bumper harvest. We doubt the politburo would pass up a chance to exert commercial control over Hong Kong, especially in the port sector.

HKSA is detrimental to HPHT. Let us have a mini-throwback to the joint management scheme in 2017, whereby HPHT was confident of improving the profitability. It was apparent that was not the case. Despite narrowed cost base, the assignment of vessels to berths and the cargo mix to be handled are not favourable to HPHT. Consequently, HPHT profitability did not improve when it should have pulled a gap over the cost with a well-heeled revenue. The HKSA is no different in essence. Competition has eased now that the Kwai Tsing terminals in Hong Kong are under an operation team. As a bigger brother in Hong Kong compared to Modern Terminals, and certainly with a heavier invested asset, EBITDA should not be shared equally with Modern Terminals. It is of the case of a younger brother bullying the profits out of the older brother.

The critical risk is for management to continue leeching investors’ funds. Performance just does not match up with their remuneration, and that the Board of Directors is ineffective in expressing investors’ concerns.

Trading opportunities backed by the valuation

Our stress-tested valuation of USD 0.158 per unit takes into account the HKD 0 revenue in 2020, complete impairment of intangible assets, and an acquisition by a Chinese port operator when the political sentiments moderate. The implementation of the Hong Kong Security Law saw HPHT touching a low of USD 0.089 per unit on 30 June 2020, before mysteriously closing at slightly above the previous day’s close price.

The bulk purchase happened between 5pm and 5:05pm on that very day, pointing towards a keen institutional interest in a bottom-low HPHT. On 1 July 2020, the 23rd anniversary of Hong Kong’s return to China, share price surged 11% when for the past 2 decades or so, this day was a day of protests crippling Hong Kong stock market. The hardline approach by Beijing is working to bring about stability in Hong Kong. There is light at the end of the tunnel. Dissidents may leave Hong Kong to the UK (we bet UK residents are fuming now that they didn’t leave the EU for more Hong Kongers).

Where would the share price go is anyone’s guess. But without the 1H earnings report card, the benefit of the doubt would be given to HPHT to perform. After all, our valuation is based on HKD 0 revenue for 2020 amid the coronavirus outbreak.

Disclaimer applies.

SIA – Time to board the flight

Singapore Airlines Ltd, the SQ brand synonymous with The Best Airline, The Best Crew, The Best in whatever-you-can-think-of-in-the-air, is facing unprecedented headwinds in almost 5 decades of existence. All the awards amounted to nothing when borders are closed, and people just can not travel.

With the recent Rights issue, there will be price adjustment. We are analysing the pre-Rights price of SIA, which is at about $5.54. Post-rights, my buddy here had done his calculation, it would be $3.68. When his analysis was done, it was trading at $5.80 pre-Rights. With the recent share price decline to $5.54 on enhanced CoVid19 measures, it should be about $3.50 post-Rights, instead of $3.68. So if you are buying SIA now, be prepared to subscribe to the rights.

If this situation continues, shareholders of SIA are expected to lose $1.3bn every quarter, equivalent to $430 million every month. Here’s the mathematics just by back-of-the-hand calculation using April – June 2019 results as a reference. SIA’s financial year ends in March. Hence, the April to June period corresponds to the first quarter of its financial year.

For shareholders, SIA wipes off $1.1 per share every quarter. Before the CoVid19 became a pandemic that jolts the global economy, we took the share price of SIA on Dec 31, 2019. It was trading at $9.04. As of writing on Apr 1, 2020, the stock changed hands at $5.54. Covid19 has shaven $3.5 off SIA.

On the book as of Dec 31, 2019, SIA had $12,150mn, or about $10.10 per share. Prior to the crisis, SIA was already trading below its book value at 0.9x P/B. Assuming this discount widens to 0.8x P/B (on the back of equity dilution in the rights issue), the current market price equates to $6.9 of book value. The difference between $10.10 and $6.9 is what Robinson Street (instead of Wall Street) thinks SIA would lose to CoVid19. By calculation, it takes 9 months of 96%-capacity-cut to justify the price weakness, assuming every 3 months erased $1.1/share of the equity value.

We have cleared one month in March. “Robinson Street” expects SIA to resume normal operations by December 2020. Key markets in Europe, US, China and the Australia-New Zealand need to open.

While Europe and the US are mired deep in the pandemic, it is evident from the news reports in China (up to you to believe or not) that the coronavirus can be overcome. Social distancing is the last defence against the virus when no vaccine is yet available. The political and economic costs of not opening the border may knock sense in key decision-makers that the lockdown cannot persist. The quarantines and social distancing is to “flatten the curve.” I’m optimistic this curve can be flattened. There are many countries with successful experience for others to model.

In time to come, SIA would soar the sky again. Whether they will be profitable or not is not a key driver of the share price now. Sentiments have overridden fundamentals for now. The recapitalised balance sheet of SIA is sufficient, in my opinion, to weather the viral storm. Commitment from the government, one of the wealthiest in the world, to protect the national pride means that SIA is highly unlikely to go belly up.

Think about what jokes others would make on Singapore when we could afford the world’s most advanced fighter jets (recent purchase $3.7bn in January 2020), but can’t keep the nation’s commercial airline in service.

 

Give Hutchison Port Trust a second chance

Coronavirus, or CoVid19, is the hottest topic globally. If it were a stock, holding it would exponentially increase your net worth. Unfortunately, it isn’t. Having it would make you sick. We hope all readers will never catch it. For those unlucky few who did, the odds are on your side in getting well.

Trade screeched to a halt and the global economy is staring at the brink of a recession. The rate of decline dwarfs the Global Financial Crisis in 2008/09, and exceeded the Great Depression in 1929. It is hard to juxtapose the fact that just about one month ago, before CoVid19 hit shores of the United States, DJIA and S&P500 were at all-time highs. In the midst of the pandemic-roiled stock market, we are out in the market bottom fishing.

Hutchison Port Trust (Bloomberg: HPHT SP Equity) is tasty fish when the water is receding. We are possibly looking at the very raw fundamentals of the Li Ka-Shing-inspired company. If you remember, at the turn of the decade in 2011, HPHT came to the market asking for USD 1.01 per share, raising USD 5.8 billion. Hutchison Port Holdings’ Greater China port assets were carved out to form the trust. Fast forward about 10 years, HPHT is just 9% of its IPO price, at USD 0.09 as of 25 March 2020. Yes, you read it right, no typo with the decimal point. It is trading at 9 cents.

The Trust’s business portfolio remains essentially the same. It has 38 berths, handling some 23 million TEUs (a measurement of container boxes) in 2019. To put the cargo volume in perspective, Singapore PSA handled 37 million TEUs in 2019 and the port in Dubai (Jebel Ali) moved 14 million TEUs. Ten years of a share price slump to USD 0.09, yet the business is 10 years ago, standing shoulder to shoulder with the busiest ports in the world? What in the otherworldly crap happened in the past decade to result in this stark divergence?

Management is quick to point fingers at the global trade, saying HPHT is a victim of circumstances amid the US-China trade war. In my opinion, management is taking investors on a downward spiral. While hindsight is always perfect eyesight, the Trust was carved out and offloaded with the mature assets. At that time, the valuation was rich, trade was in a resurgence and the IPO sentiment was strong. The promise of flushing investors with dividends, as with all trusts do, was alluring. The perennial problems are that it had a weak balance sheet and that the cash flow was on a downtrend, making the dividend promise increasingly difficult to sustain.

If investors were looking for any sympathy, they needed a microscope. Nothing at all. In fact, while the share price was trending lower, management added loss-making Huizhou International Container Terminal to HPHT portfolio. In addition, the “cost-savings” from co-management of Kwai Tsing terminals with Cosco did not help a tiny bit to prop the crippling earnings. Lurching earnings in the dump was a goodwill write-down for the second time to the tune of HDK 12bn in 2018; the first round was in 2014 erasing HKD 19bn from its assets.

The best example of sympathy is this, you want management to ride out the trough with you. Sorry, my friends, you’re on your own. Total management remuneration rose at a compounded annual rate of 9.3% per year, from HKD 17.6 million (SGD 3.3m) in 2013 to HKD 30.2 million (SGD 5.6m) in 2018. The surprising fact is that most of the compensation (>50%) is in the variable component. How then when the share price is down could management remuneration go up? Don’t get us started on the CEO remuneration band. Mr Gerry Yim claimed up to SGD 1 million in 2012. In 2018, his package band was up to SGD 2 million. Ok, to be fair, management gloriously took a pay cut of some sort since 2015. Total package dropped from SGD 5.8 million to SGD 5.6 million (yes, steep drop!).

At the same time, dividends slumped from HKD 0.47 in 2012 to HKD 0.14 in 2019. In our worst-case scenario, HPHT would not declare second-half dividend, and that for Year 2021, the total dividend would just be HKD 0.05. This works out to be a prospective yield of 7.2%, which is kind of decent for a company continues to handle merchandise cargoes amid human border control. Airports would be severely impacted by human movement restriction. Cargoes still have to flow. Containers don’t sneeze and cough corona.

However, we are prepared to give HPHT a second chance, purely looking at the cheapness it is now. You know if you buy a car, you pay COE, OMV, car value and the whatnot for 10 years of use. Assuming you extend for another 10 years, you lose some 50% of the OMV. At the end of 10 years, you either scrap or export the car. You get the scrap value or slightly-higher-than-scrap export value. You see, at USD 0.09 per unit, HPHT is at scrap value. If you are like us, believing all the drama are reflected in the share price, we could potentially be looking at an acquisition of HPHT at this price; in our car analogy, the export value. By who? Possibly Chinese operators, but the latter can’t make it too obvious given the geopolitical tension between mainland China and Hong Kong.

Summarising my thesis on HPHT – why we would buy HPHT and why should we buy now:
1) Sitting on a valuable piece of land in Hong Kong, which could be monetised
2) Long concession years remaining, suitable for acquisition
3) Best-case scenario 16% dividend yield in 2020 if the Board maintains last year’s second half payout. Worst-case scenario no 2H dividend, and the yield is 7.2%. For a trust, dishing out dividends is the least they ought to do.
4) High-debt Trust, likely to benefit from reduced interest costs against the loose money pledged by central banks
5) Trailing P/E at 10x, forward P/E at 21x assuming a 50% decrease in earnings. This is cheaper than its IPO P/E of 30x, and is undemanding compared to peers like DP World and Cosco Shipping Ports if they were to take a 50% cut in CoVid19-impacted earnings.
6) There is limited downside. Management needs to be exceptionally “brilliant” to drive this stock to zero.

Take up this yellow ribbon play, buy HPHT!

Cargo volume trend of HPHT

Updated below with my back-hand calculated rock-bottom value of Hutchison Port Trust HPHT. See comment.

Global Invacom, our satellite play

We scoured the Singapore small-cap space and discovered this net cash company with decent fundamentals. Global Invacom (SGX: QS9) is one of the top 7 largest suppliers in satellite broadcast solutions, utilising its 61 patented (with another 53 pending) technology in manufacturing satellite dishes. The products are used by telecoms, media, aviation and defense industries.

Source: Global Invacom

How does the industry work? If you are a media broadcaster, your media content (radio, streaming TV etc) would be compressed and beamed up to satellite stations. Satellite dishes, installed at buildings, would receive the content of varying wavelength, and be “decoded” before being translated onto the pixelated TV screens. Internet that we use today are mainly transmitted through cables laid thousands of miles across oceans. For large countries such as Indonesia and China, some of the under-developed villages are not able to have access to the world without land-based fibre-optic cables connecting them. Hence, products of Global Invacom come into demand, as these villages just need a TV set and a satellite dish to receive content. Major customers of the company are SkyTV, Dish Network and Astro.

Why the company is interesting at this price?

1. Full year earnings to reverse last year’s loss, translating into dividends for shareholders. We assume 20% dividend payout on USD 2.7m full year earnings. Dividend yield may not be exciting at 1.6% (or 0.275Scents per share), but it is a first clear sign of a return to profitability after two years. By the time market cheers for it, we might have taken profit.
2. Net cash company that may boost net earnings should it pare down its debt. As of the latest financial quarter 1Q17, the company has USD 6.3m in debt, but sits on USD7.6m cash. Average interest expense of 8.3%, or USD0.5m can be saved should it deleverage. This interest saving represents approximately 1% increase in dividend yield.
3. Well-positioned to capitalise on new developments. Management is optimistic of its products that serve 32 stacking channels, and have been on trial with several clients. We expect substantial improvement in earnings to the tune of USD2.7m for the full year. A competent set of 2Q17 results are likely to catapult it into space.
4. Invacom invested close to USD4m last year in R&D, the highest amount in the preceding five years. We expect the company to reap the benefits of its R&D expense this year. We expect the patents to be monetised in future periods, while it tapers its R&D expense to 2.5% of Satellite Communications revenue.
5. Valuation support at $0.171, assuming 0.5% perpetual growth (vs industry estimate of 5.1% between 2014 and 2019) and WACC of 12.5%.
6. Deep-value should it be broken up and sold in pieces. At 1x net tangible asset value, Global Invacom would be worth S$0.205 a share. This is a distressed scenario that assumes no value is created, and that the 61 patents are useless. 1Q2017 did not show any indication of such.
7. Our underpinning valuation method is discounted cash flow, which yields similar intrinsic value at SGD0.205 per share. We relied on a set of conservative estimates. For examples, our perpetual growth for the company is 2% (well below industry average) and EBIT profitability of its core Satellite Communications segment, which makes up 86% of its total revenue in 2016) to contract from 7.7% in FY16 to 2.5% in FY21e. We have not factored in the cost saving should the company pare its leverage or negotiate long-term borrowing arrangements that reduce interest expense.
8. Foreign exchange gains, which will benefit FY17e numbers. Manufacturing base in the UK records British pound costs, while products transact in US dollar. Continued weakening of British pound, on Brexit concerns, boost earnings of Global Invacom.

There are risks to investing in Global Invacom. Ultimately, it is a manufacturing company. Customer de-stocking and inventory obsolescence will have an adverse impact on its financials, as was the case in FY16. Could there be a repeat? Definitely, but we do not see it as a near-term impediment to our fair value.

Management has the tendency of over-paying in an aggressive bid to expand its presence. This has resulted in impairments over the last few years. We would prefer management to consolidate its position internally, streamlining costs and seek areas of competitive advantage before acquiring horizontally, for the sake of growing revenue. It is a lesson reflected in share price, which investors have punished the stock from SGD0.41 in January 2015 to SGD 0.14 by the end of 2016. What an expensive ego-boost by being overly-bullish on targets, and a secondary listing in London AIM, giving investors another avenue to slam the stock.

The company is thinly-traded, which may have significant price volatility. While we may have accounted for it with a beta of 1.2, there may be shortcomings in valuing risks based on CAPM.

Global Invacom trades at 12.6x FY17e earnings, comparatively cheaper than similar manufacturing companies such as Valuetronics (SGX: BN2) and Venture Corp (SGX: V03) at 13.5x and 17.6x, respectively. The comparables have book value below market value, indicating that outright sale of net assets may not fetch as much as what the share prices suggest the companies are worth.

Hence, we believe Global Invacom, at current SGD 0.175 is backed by its balance sheet, unless management does not learn from its past lessons and screws investors up time and again.

Disclaimer applies. Please refer to homepage for Disclaimer, and you are required to do your own due diligence on the company before taking any investment action, which may result in a complete loss of capital.

Disclosure: We are long Global Invacom, and remain buyers on price weakness. Financial model available.

Contrarian- A sunset look at China Sunsine

We were long China Sunsine, but the market euphoria has us worried about the broader market valuation. Hence, we pared off positions and consider reasons why it would be wise to take profit now.

Our model yields 6% upside from 伤心’s current share price on assumptions more conservative than most houses that have published reports on Sunsine. As we dabble this S-chip counter with cold hard cash, it pays off to be on the safer side: to increase our safety buffer. We apply CAPM to DCF model for a four-year projection to 2020. Contrary to bullish forecast of average selling prices (ASP) remaining at 1Q2017 levels, our top line assumption rests on ASP exhibiting a 2-1 trend; two years of ASP weakness followed by one good year. Previous two cycles have supported this phenomenon, perhaps driven by closure and expansion of competitors, and the cyclical nature of its main customers- the automotive industry.

Some sell-side research houses have certain assumptions that are stretching logic. For example, Research House A suggests electric vehicles to power the next leap of growth for Sunsine, as customers have a fresh round of ordering transiting from conventional vehicles to greener mode of transport. Tyres are simply transferable from convention to electric vehicles. Furthermore, with oil price staying low, why would consumers invest in cost-savings by switching to electric vehicles? Not to mention electric vehicles (possibly higher power to weight displacement) and the sharing economy (Uber, AirBnB etc) will more likely taper the demand of vehicles than to increase vehicle sales. It is likely end-consumers in China- main market that Sunsine serves- would care less about pollution anyways. Blue-chip customers Sunsine serves (eg Bridgestone, Goodyear, Michelin) have manufacturing bases not just in Shandong province, and also not just in China. Thus, it is conceivable –though Sunsine would not mention the ranking or percentage of revenue derived from each customer- that some of them account for just a small proportion of its revenue.

Profitability may not increase despite elevating ASP. Customers usually sign mid-long term contracts with certain pricing mechanisms in place that reflect spot as well as the maximum customers will pay, especially if the quantities involved are large. Therefore, the surge in spot prices may not be fully trickle down to gain in gross profit. In this vein, it would not be unreasonable to assume that Sunsine would offer bulk discounts to retain customers, especially those with long-term relationships. Switching cost is not high, implying that customers can do so if they wish. Our adjusted EBITDA margin came in at 20.1%, a mere 0.9% increase in margin even as ASP for rubber accelerators remain above RMB 20,000/ton.

Assets are short-lived. To maintain capacity, the company has to continually invest in its plants and equipment. Much has been regurgitated about how Sunsine is less pollutive compared to its peers, but the fact is that the industry is pollutive and to be less pollutive, one simply cannot just install a filter at the tip of chimneys. More tangible efforts need to be applied (ie investing in new production equipment) to effect lower pollution in the supply chain. The group’s tax rate at 28%-30% is higher than corporate tax rate in China (25%). In industries that the government encourages, tax rates could be as low as 15%- obviously the government does not appreciate Sunsine’s efforts in the tyre supply chain. The percentage increase could be due to carbon tax. We estimate capex to tip RMB 350m this year, tapering to RMB 250m before picking up again in 2020, in line with management’s capacity Masterplan.

Procuring accelerators from Sunsine increases supply chain pollution. Ideally, customers desire to source products locally, reducing transport pollution unless suppliers tout themselves to increase carbon credit for customers. Shandong, where China Sunsine is located, does not have major car manufacturers. Rubber accelerators and such for use in vulcanisation process of rubbers have to be shipped to Shanghai, Jilin and Guangdong. The chart below should succintly give a sense of where regions of major auto production are… just not at Shandong. While freight costs typically borne by customers, we reckon that Sunsine may be partially subsidizing costs given that there are freight items. We cannot be sure, however, that the freight/port charges are related to customers or the purchase of its own raw materials.

Capacity utilisation rate at full capacity, but margins do not seem to have significant improvement. Most of its plants are near full capacity last year, but the company is incompetent in translating the higher ASP into cash profitability. EBITDA margin for accelerators dipped 0.5 percentage point to 20.5% in FY16. At the group level, margin improvement was driven by cost control. Gross margin grew in line with revenue, but administrative, distribution and marketing costs expanded at a moderate pace relative to revenue, therefore drives higher net profit. How much more scope does the company have left to raise net profit beyond 2018? Not much.

News of Sunsine being found guilty of flouting regulation have cooled the share price, but recent actions suggest that the market has short-term memory. Regulatory risk is significant in China, especially in Sunsine’s operating environment. While the company has clarified with investors its compliance with regulations, there are valid shortfalls acknowledged by the company that could be mitigated. Whether it is a case of authorities finding minor flaws in Sunsine or otherwise, it is a real risk that when new regulations kick in, there could be more serious implications like factory stoppages and such.

We would have loved to see state-owned enterprises supporting the largest rubberized chemical producer in China through stakeholding, but shares were placed out to fund houses at steep discount at $0.65/share. Some argue that it was trading at ~$0.60 before the share placement, but it didn’t conceal the fact that funds would always be subscribing at 10% below volume weighted price than what you and me will get. While we were enjoying the run up to $0.80, negotiations took place to crimp shareholders’ loyalty. This was all in the bid of increasing liquidity. The only way to increase liquidity, is for the funds to sell off the shares at immediate gains, to the detriment of existing shareholders. As with the market dynamics, big fish eat small fish, in this case, the unfortunate buyers are retail investors who bought Sunsine. Retail investors are buying probably on broking houses’ recommendations, stimulating brokerage income with a BUY-bias.

Another research firm pointed out that the share placement was a stamp of approval for Sunsine. Why would Sunsine need the stamp of approval when it has a strong business model and cash flow to expand capacity in line with Masterplan, if not for that the shares were overvalued in the view of management? Some points raised include projecting not just ASP, but the cost of materials. How rigorous would the research be to project crude oil prices (an input for rubber accelerators), especially into the future that is more than 1 year down the road? The company has zero debt, with funding coming entirely from equity capital. The cost of equity is significantly more expensive than cost of debt (~4-5%). We would have preferred a modest mix of debt and equity to drive capacity expansion.

With these considerations in mind, our fair value at $0.85 (WACC 13%, perpetual growth at 1%) is one of the lowest compared to other brokerage houses. Catalysts are bonus dividends that may be announced in celebration of its 10^th year listing anniversary in July 2017, reduction in cost of capital through swapping equity for debt, normalised 2Q2017 earnings that come off the low-base in the previous year 2Q2016. The company trades at 6.6x/7.9x FY17e/18e PE, which are at levels not too far off from the valuations of S-chip counters traded on SGX. We are not macro strategists here, but we hold reserved views on the Chinese economy. To this end, we believe the market is with us by ascribing a valuation discount to S-chips.

Flip-flopping from BUY to HOLD within 2 weeks is not our style, but hey, when put in more conservative numbers (WACC from 10% to 13%), applying more weight to certain risks, and adjusting for ASP trend, it is what it is at $0.85, down from $0.99. Why not we hold on and wait for a good run up to at least $0.90? Well, management waited for news to be leaked about the investigation findings by news outlet before issuing clarifications. We really can’t be sure when a repeat would happen when the company has a large number of investors sitting on thick profits.

Meanwhile, we will let the company take a breather while fund houses help the company “improve market liquidity.” It is not a SELL-call, as we have no reason to believe in fraudulent accounting practice.

* Disclaimer, which can be found on About page, applies. This blog expresses opinions of the author and may not be accurate to the facts considered in totality. Valuation model available, please write to vic.yc.wai@gmail.com

China Sunsine – Expanding market share

China Sunsine (SGX: CH8) is one of the largest rubber accelerator producers that boasts top tire manufacturers. Companies like Bridgestone, Michelin and Pirelli add the compound into their raw materials to strengthen the end-products. It is mainboard-listed on Singapore Stock Exchange and will be celebrating its decade-old listing in July 2017.

Why we like China Sunsine?

1. China Sunsine is one of the largest in its field, and it is set to grow its market share. Consider that the Chinese government is clamping down on highly-pollutive rubber accelerator plants, Sunsine has been investing heavily into its plants to ensure they meet, if not exceed, existing standards. Small-scale producers do not have the scope to plough CNY 60-70million in maintaining their plants, therefore, are being cornered into folding their businesses. Against this backdrop, Sunsine could consolidate its leadership position further.

2. New capacity in the pipeline. Sunsine operates near 100% utilisation rate for its current 152k tons capacity. It will add additional 20k tons capacity to its portfolio this year, with likewise strong take-up rate.

3. Stable margins, costs pass-through to customers. It is relatively sheltered from fluctuating raw material prices as a mid-stream player.

4. Expect special dividend as the company gained on sale of treasury shares. This should coincide with the 10th year listing celebration.

We have built a financial model for the company between FY11 and FY20e, with a DCF-derived fair value of SGD 0.99 (WACC 10.4%) on a set of consensus estimates. You may adjust the assumptions to see how the fair value changes. For more information, drop me a mail at vic.yc.wai@gmail.com

Meanwhile, trade safe and be prepared for some profit-taking pressure as it runs up from SGD 0.70 to SGD 0.815 (+16.5%) in one week.

Disclosure: We are long China Sunsine, and remain buyers on price weakness.

Disclaimer applies.

Key takeaways from E&E 1Q17 earnings

1. Shareholders’ profit nearly tripled to USD 8.9m compared with the same period last year. This metric drives our dividend thesis in August 2017.
2. Operating margin for its core business jumped from 1.8% to 8.4% in the past one year, while doubling from 4Q16 profitability profile.
3. Elec & Eltek is building up inventory on an expectation of strong orders in 2Q17. Shortage of upstream materials pushes up the average selling prices of its products. Cost of goods is stable, as E&E purchases from sister-companies that have bulk-order discounts. To this end, the current landscape benefits those with large operating scale. Elec & Eltek is one of the top 10 PCB players in the world. Margins are expected to widen this quarter, making a good run for your bet on a strong 2Q17 results.
4. Operating cash before working capital changes surged 59% to USD 20.6m. Free cash flow slumped from USD 8.9m to USD2.1m was not due to operational weakness, but that the company collected payment from debtors at a more efficient rate last year. Imagine if they collect payment as efficiently in 2Q17, cash would have expanded significantly for dividend distribution.
5. The company continues to repay debt. In FY16, the company paid USD20m compared with USD13m it paid in FY15. This quarter alone Elec & Eltek repaid close to USD6m. We do not see significant gearing risk when its net gearing stands at under 10%.
6. Forward valuation remains cheap at 10.7x/9.3x FY17e/FY18e earnings. This is a bargain compared to the already-cheap Taiwanese PCB makers.
7. Think about it. You have a restructured business growing exponentially, and a stable rock in property business to anchor dividend. All indicators point favourably towards a bumper dividend in August 2017. We sit pretty waiting for the next earnings guidance in July 2017 before the actual harvest the following month.

Elec & Eltek: Dividend gem backed by acquisition value

• • Current dividend yield 4.1% at USD 1.48 per share. Position for reinstatement of interim dividend that brings total yield to 6%!
  • Acquisition value at USD 1.95 per share, or some 30% above current price!

Elec & Eltek International Company (SGX: E16) will announce a buoyant set of earnings next month. According to preliminary estimates, the company submitted a regulatory filing to SGX that earnings for the first quarter will jump more than 170% compared with the same period last year.

As a background, Elec & Eltek manufactures Printed Circuit Board (PCB) that is used in personal mobile devices, cars, computers and a vast array of consumer electronics. Parent-company Kingboard Chemical took one of its subsidiaries private, fueling speculations that Elec & Eltek- as one of the subsidiaries- could be privatized as well.

We put forward a case of acquisition by its parent-company Kingboard. First, Elec & Eltek has decreased investment into its own business. Capex per revenue dollar dropped from 7.2% in FY10 to 4.7% last year, hitting a high of 11.9% in FY11.

Second, significant related party transaction. An undisclosed single customer, believed to be Kingboard, increased its invoice with the company between FY11 and FY16 at a compounded rate of 8.8% p.a. to USD95.4m. Meanwhile, dividend payout is aggressive into the pockets of parent company with little regard for future earnings growth. Even in loss-making FY15, shareholders received 3.8% dividend yield.

Third, directors and management have cross shareholdings in Kingboard. Furthermore, an independent Board of Director has resigned with no replacement to restore a rigorous corporate governance structure.

Lastly, there is cost synergy between the company and Kingboard, as they have similar business units. As one of the leading PCB manufacturers, Elec & Eltek could barely breathe. Hence, smaller-scale peers are expected to struggle in the current economic landscape. A wave of consolidation amongst PCB manufacturers should bring about firmer profitability for the wider group.

The PCB market is fiercely competitive. In FY16, Elec & Eltek recorded before-tax profit of USD 11.7m on USD 472m revenue, translating to a meagre 2.5% margin. The same metric was in the red a year ago, as compressed pricing in electronics weigh heavily on its profitability.

Last year, management decided to focus on higher-margin products, namely manufacturing PCB for the automotive industry. Sales and margins ticked higher, with a profitability boost that extends to the current quarter. Riding on the tailwind of Chinese manufacturing sector expansion that began since Oct 2016, earnings momentum is set to gain traction into the year.

Elec & Eltek is essentially a dividend play. Management has anchored the portfolio by leasing its factory space in Hong Kong, generating a sustainable USD 5.9m in passive rental earnings annually.

With stable rental income, the wildcard, ironically, will come from its core manufacturing business. Despite the return to profitability on higher-margin products, business volume remains critical to drive earnings.

Stronger profitability of Elec & Eltek lifts expectations of resumption in interim dividend come August 2017. It will be in line with earlier years when the PCB manufacturer was in the black.

Valuation of Elec & Eltek is undemanding, considering the price Kingboard Chemical Holdings paid for its supplier Kingboard Copper Foil (pending delisting on SGX). The transaction occurred at 12x EV/EBITDA for the core copper business. For a low-margin PCB manufacturing business, we apply the transacted multiple 6.8x EV/EBITDA between TTM Technologies and Viasystems. Thus, Elec & Eltek is easily worth USD 365m, or USD 1.95 per share.

On a P/E basis, the company trades at 24.5x, while peers trade at wide variance. Taiwanese PCB manufacturers are cheapest at an average of 18x P/E, while non-Taiwan-listed manufacturers are either loss-making or trade at close to 40x P/E.

We view Taiwanese manufacturers as value play with limited expansion scope into the mainland Chinese market. A conservative 35% earnings expansion would compress the FY17 forward P/E of Elec & Eltek, trading in line with the average of Taiwanese peers.

Profit-takers may put downward pressure on the share price that is just a whisker from its 52-week high. However, we are positioning for a bumper harvest with a potential dividend yield of 6% (USD 0.06 in May + summer special) on current share price.

Key risks to note are:

• Low-margin business that is vulnerable to margin erosion
• High payout ratio implies weak organic earnings in future
• Under-provision for receivables and inventories, with auditors Deloitte raising queries
• AGM suggests equity capital funding in the offing
• Low market volume with few shareholders willing to trade
• Depreciation of US dollar weakens potential returns

As per all posts, Disclaimer applies. Please conduct your own due diligence and consider your risk appetite before investing.

Biosensors Merger/Takeover Bid

Citic Private Equity Funds, a Chinese sovereign wealth fund, has submitted an offer to merge CB Medical Holdings with Biosensors International.

Paramount questions:

• Will the merger go through?

Most likely. Old stories finally crystallise. This is the first clear-signal, naming the acquirer, given by management to investors. Reasons why Chinese want to buy Biosensors: First, successful BioFreedom trials in the US. When commercialised, it could snap a market share from Abbott Lab and Medtronics, both of which manufacture cardiac stents. Second, supply chain efficiency. It is easier to find medical products on Alibaba which offers bulk ordering. Rising affluence in China necessarily imply purchasing higher quality stents trademarked in the US and Japan- Nobori stent affiliated to Biosensors- rather than domestic products. Third, macroeconomic factors. The steady growth of the US economy along with the appreciating greenback provide tailwind for the medical industry. Any merger or sort of a Chinese company with that of a US company is politically sensitive. Biosensors is neither listed in the US nor have its products in the US market yet. US FDA-approval of BioFreedom would accelerate sales and push other ancillary products of CB Medical into the US market. From a valuation perspective, commercial angle for holding company, and political standpoint, we believe the offer price will be significantly higher than it is right now.

• What would the offer price be?

We stand firm on our fair value of $50% premium to its last close price of S$0.68 will get us to VPM’s DCF-derived fair value of $1.025. Forward EV/EBITDA, based on the latest quarter result, is 6.7X, which is significantly below the Medtronics (22.8X EV/EBITDA) and Abbott Labs (18.7X EV/EBITDA). Our fair value implies 12X EV/EBITDA, which is undemanding compared to the industry peers.

As per all posts on VPM blog, Disclaimer applies.

Previous stock picks

Biosensors International Group – Target price hit
Initiated Biosensors with a Strong BUY on Aug 29, 2013 when the stock was trading at $0.835. Target price of $1.025 (FCFE valuation) hit on May 26,2014. It went close on several occasions on Oct 22, 2013 ($1.01) and Feb 25, 2014 ($1). Citic Group is sourcing for private equity buy-out, which offers potential catalyst for Biosensors’ investors.
https://vpmsingapore.files.wordpress.com/2013/08/biosensors_buy.pdf

Guthrie GTS Limited – Privatization at exactly $0.88
Initiated Guthrie with a Strong BUY on Aug, 21, 2012 when the stock was trading at $0.575. Target price $0.88 derived based on Discounted Cash Flow (DCF – FCFE). Unconditional Cash offer of $0.88 was offered and the company was taken private. Before that,
https://vpmsingapore.files.wordpress.com/2012/08/guthrie-gts-final.pdf

Old Chang Kee Ltd – Blasted past target price
Initiated Old Chang Kee with a HOLD on Sept 17, 2012 when the stock was trading at $0.375. Target price of $0.39 derived based on DCF – FCFE valuation. There wasn’t any catalyst at that time, just a value cash-rich company with steady growth in Singapore. Stock price surged on special dividend announcement of $0.05 per share. Since then, there the company never look back. Current price at $0.96.
https://vpmsingapore.files.wordpress.com/2012/09/ock_sep122.pdf

PEC Limited – Nearly hit TP before fading away
Initiated PEC on Nov 15, 2012 when the stock was trading at $0.60. Stock price was 3% shy of my target price of $0.745 (based on Residual Income Valuation) on Jan 11, 2013 ($0.725) before a stream of disappointing results and industry-wide headwinds confronted the company. Contract wins saw the company trading higher in recent days at $0.59. Cash on hand is a pale shade of its past, but forthcoming management may be able to streamline costs further amid industry slowdown in Singapore.
https://vpmsingapore.files.wordpress.com/2012/11/pec_final_nov2012.pdf

Healthway Medical Corp – Share price jumped on spin-off
Initiated Healthway Medical with a HOLD on July 23, 2012 when it was trading at $0.083 apiece. My fair value of the company was $0.078 (FCFE valuation). There was no basis for the stock to be a BUY when prior to my initiation, it had its goodwill written down by close to 50% and saw its auditors resigned. Still, from a top-down approach, Healthway Med is in a promising industry with significant outreach.
Share price jumped to $0.11 in May on announcement that Healthway will spin-off its international arm International Healthway Corp, giving shareholders in specie shares of 82.29 per lot. IHC was priced at $0.48 per share, and shares of Healthway Medical was trading at $0.079 on an XD-basis. If investors had sold off their 82.29 IHC shares on opening day at $0.46, the effective price for Healthway Medical was $0.118. Happy for those who had invested. I’m not going to be a hindsight genius, as I didn’t see the spin-off coming.
https://vpmsingapore.files.wordpress.com/2012/07/healthwaymedical.pdf

Raffles Medical Group – Share price beyond expectation
For everyone reading this, there (for sure) is a first report you can’t be proud of despite proving yourself as a decent budging stock picker. My first amateurish report on Raffles Medical was initiated on Apr 9, 2012 with a target price of $2.72 (Residual income model with 20% upside potential) when the company was trading at $2.27, near its historic high.
Share price continued to break new highs and recent trading saw the company trading at $3.70. At 24X P/E currently, I would think harder where growth is going to come from.
https://vpmsingapore.files.wordpress.com/2012/07/raffles-medical-group_1.pdf

General disclaimer applies