Tea with Mike: UOB KayHian Holdings.

Getting a sense of a fair price to pay: UOB KayHian Holdings as a case study.

I was screening for companies with decent yield and growth for the past 5 to 10 years, using a Google screener, and I decided to do some in depth study of UOB KayHian.

UOB KayHian pays out about 50% of earnings as dividends for almost a decade. In the earlier years, the payout was more than 50%. So there is certainty of payment, and it has been profitable for the past 12 years, and last year was actually the weakest year in a decade.

I use the spreadsheet to churn out important numbers such as revenue, NP, margins etc for the various markets, such as Singapore, Hong Kong, Thailand. I wanted sustainability of dividend income. So, I want to know what income I can expect going forward and I gave myself a few scenarios:

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At its peak, net profits is almost 3 times of what it is in 2012, if you take the average of $100 million over 12 years, it is still higher than 2012.

1H2013 results has already recovered, its 1H EPS of about 8 cents, is already almost as high as full year EPS of about 9 cents in 2012. Assume full year EPS to be 16 cents, they will pay out about 8 cents, giving a yield of 4.8%. That is my best case scenario.

If you take the average of 12 years, EPS is about 13 cents, so payout will 6.5 cents, giving a yield of 3.9%. This is my conservative scenario.

Although Singapore contribution is in decline, it is generally in line with SGX trading income revenue, which reflect the prevailing market conditions and not loss of competiveness. The “other” and Thailand operations have been bucking the trend and is contributing more despite market weakness, this could be due to its expansion bearing fruits.

Next,

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I want to get a sense of market valuation of the counter throughout the years, so I use the highest price, lowest price and average price of each year to calculate the corresponding yield and PE.

If I take away the super exceptional year of 2007, the average lowest yield is 5% and average highest yield is 9%, and the average lowest and highest PE is 10 and 17 respectively.

If I take conservative EPS of 13 cents, and DPS of 6.5 cents. I would like a yield of 6% and a PE as close to 10 as possible, and what would that price be?

To give a yield of 6% based on EPS 13 cents, price will be about $1.09 and PE 8.4.

If I am content with PE 10, I need the price to be $1.3.

To give a yield of 6% based on EPS 16 cents, $1.33. And a PE of 10 at EPS 16 cents will be $1.6.

Now, I know I will not touch this company at price above $1.6, unless I believe the next few years will see EPS growing to its peak soon. But there were not many years in which the company had above average results. So, most probably I will only start buying at $1.6 and below.

Other considerations like market share, gearing level and positive average FCF are also looked at, they are not significant enough to offer a further discount or premium.

I do like its profit resilience and rather undemanding valuation as compared to SGX and GK Goh, but given the amount of competition and my estimated calculation of only 10% Singapore Market share, I would not allow myself to pay a premium above $1.6.
 

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2. STE's story: Investment strategy.
3. When to BUY, HOLD or SELL?
4. Interview with Matthew Seah: Value Investing.

Tea with Mike: A fundamental analysis of SPH (Part 2).

Now, let’s talk about the recent move to spin off some properties to become SPH REIT. There was some very misleading info and I thought it might be a good idea to clear it here once and for all.

 

SPH has stated that NET gearing would fall to 9.3% from 40.6%.  That led some to think the interest cost might be lower now, and given such low gearing now, SPH could gear themselves up to 40% again without any new consequences to develop their malls.

First of all, I do not know how the management will utilize the proceeds, and whether they will pay down debts using the proceeds. But NET gearing fell simply because the cash level went up. Absolute debt remains the same and hence finance costs will remain the same.

Also, it is very unlikely SPH will increase gearing further to fund the mall management business.  If they do increase gearing, and start using their cash, NET gearing is going to jump quite drastically.

So let’s assume, they simply use their proceeds for mall expansion, they will have a warchest of $760 million, and gearing will be back at 40%.

What can $760 million do?

Clementi Mall is valued at about $560 million. Well, it depends on which valuation report you take. So, the money can be used to buy or develop another mall of such a scale. If Clementi Mall is any guide, the potential mall would have an NPI of $31 million.

 

Seletar Mall has GLA of similar size to Clementi Mall. So, let’s assume they have the same NLA, and we take a 30% discount to the NPI, and that given the fact that Seletar Mall is  only 70% SPH owned, Seletar Mall will contribute $15 million. $15 million is hardly exciting but more than enough to offset the deterioration of revenue from the Classified section.

So, in conclusion, if you are looking for growth catalyst in SPH, and hence higher dividend yield, don’t get your hopes too high, but if you are worried that SPH might start going to the dogs soon, I think you worry too much.

Buying SPH will be buying into a stalwart, with a yield of between 5-6%, which is unlikely to see downward revision anytime soon, is not too bad a deal for me.

 

Read Part 1: here.

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AK71: I agree with Mike in that SPH is a good investment for income and it is a stock I will be accumulating on weakness. If share price should retreat to $3.60 a share, a DPS of 21c to 24c would mean a dividend yield of some 5.83% to 6.67%. Pretty decent.

Peter Lynch classified stocks into 5 categories. "Stalwarts" are "big companies which are not likely to go out of business. The key issue is price, and the PER will tell you whether you are paying too much. If you plan to hold the stock forever, see how the company has fared during previous recessions and market drops." (Page 230 in "One Up On Wall Street".)

See also: SPH is a better investment than retail S-REITs.

Tea with Mike: A fundamental analysis of SPH (Part 1).

SPH is a media company and many believe it has a dying media business. However, in the short to medium term, I think we cannot be so sure to deliver such a verdict.

First, let us look at the table below.

Click to enlarge.

 

Advertisement revenue has some correlation with economic activity, and the number we look at here is the GDP.

 

Margin is also not declining in a straight line but is rather volatile, with better margin during boom years, as can be seen in 2010 and 2004.

But, what about the onslaught of digital platforms? Do they not have an impact on SPH? Well, the answer is  "no". Huh? Am I contradicting myself here?

Advertisement comes from three segments: Display, Classified and Magazine & Others.

As I have posted in a forum before, if we track the revenue of these segments from 2009 to the most recent quarter (i.e. the most recent trough to recovery), the weak 2008 Q4 to 2009 Q4, Classifieds and Recruits ads suffered the biggest drop as compared to Display. When the weak recovery started in 2010, total advertisement revenue was smaller than in 2012 and 2013 YTD, yet Classified's revenue was higher in 2010 than in 2012 and 2013 YTD.

Hence, declining business was due to the decline of the Classified segment, which included the Recruits segment. It makes sense too, if you want to buy a house, or look for a job, you may no longer turn to the newspaper Classified segment anymore as there are many websites offering such services.  However, if you are talking about M1 or other telcos, or the supermarkets trying to market their promotions, chances are they will still do it through the Display segment of the newspapers.

The "Display" sections will probably be around for a long time and might even grow from strength to strength due to Singapore's growing economic strength with a bigger domestic economy over time.

The "Classified" section revenue was 28% of 2012 Ad revenue, at 218 million and continues to shrink in 2013.

Now, to look at it from the perspective of whether SPH's other businesses can offset this shrinkage, a 5% annual deterioration is only $11 million which is about 1.3% of annual advertisement revenue and less than 0.5% of total revenue. I seriously do not think it would be a tall order to offset this.

Another concern is circulation figures, the circulation of printed papers have been in constant decline, 2012 figures was pumped up because they included digital subscriptions, which I feel resulted in double accounting as the print and digital version would likely overlap (i.e. people who subscribed to print would automatically be given digital accounts).

 

So, if circulation keeps falling, wouldn’t Display advertisement revenue be affected too? My personal opinion is that as long as there is no drastic fall in circulation, Display segment revenue will be more affected by economic activity than by circulation, simply because SPH is a monopoly (and we might want to remember that they have a stake in Today too) and there are no credible alternatives.

 

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In Part 2, Mike will talk about SPH REIT and what it means for SPH: Continue reading here.

Tea with Mike: Analysis of Yangzijiang, an S-chip (Part 2).

Now, let’s address the various concerns I have with regards to investing in YZJ:

1) Falling margins for shipbuilding

Most of the fat contracts secured during the boom years in 2007-2008 are over. One should not expect margins to be fat today but I doubt we will see a free-fall in margins. YZJ's latest quarter's margin is about 20% for its core shipbuilding segment which is low by historical standards but if we compare it with Chinese peers, it’s not bad at all. Management has mentioned they will not drastically lower prices to secure deals. Although I take their word with a pinch of salt, the numbers seem to bear this out too.

2) Operation and execution risk

One of the bigger deals undertaken by YZJ that is due for delivery is the 10,000 TEU container ship. One should closely monitor the delivery as any prolong delay or problems after delivery will be serious, and I would run with my money at double quick time

 

3) Another fraud in the making?

Yangzijiang, being another S-chip, does need close scrutiny. I cannot ascertain their numbers, but there are a few things I take comfort in. They have FCF in all but 2011, and this translate to dividends, so it’s not a complete paper exercise. Due to the fact that they are dealing with ships, it is extremely difficult to fake a deal, you can check if there is indeed a deal from the customer side (Yangzijiang’s customers are renowned, big companies with ready information on their website) There is also third party website that track shipbuilding orders and the sale of 2^nd hand vessels, so chances of a fabricated deal is very low, but there is no way to track margin. E.g. they can be making a loss from building a ship due to cost overrun, but under-report the COGS in the quarterly reports, and there is no way can be sure when it comes to such nitty gritty.

4) HTM investments

This is my biggest concern. Yangzijiang has 12 billion in HTM (held to maturity) investments.  Such investment has provided them with a steady stream of supplementary income, and ensures their financial strength, which is critical in the ship building industry. The HTM investment is literally loans to companies who otherwise are unable to get loans at better rates. So, if you like, Yangzijiang has a banking arm.

More than half of its HTM is charging interest rate of more than 12%, and about 1/6 of it HTM is above 18% when the PBoC benchmark rate is about 6% and effective interest rate of YZJ loans is only 4%. (From 2012 AR)

I am concerned about the strength of the companies that need to loan from YZJ at above 12%  which is also known as the shadow banking rate. However, impairment level till 2012 is less than 5%, and from their latest quarterly report, there is zero bad loans, loans are covered by collateral pledged by borrowers.

Another reason why I find the HTM risk easier to bear is fact that about 55% of the collaterals are properties or land, and YZJ has set up a property development arm to develop land at the old shipyard when they were asked to vacant the land for other development purposes, so it seems that the management does have a contingency plan. From the interview with NextInsight, most of these land and properties are in Jiangsu where it operates. Hence, they do not have any problem that comes from a lack of local knowledge.

Ship building and its related activities still contribute up to 90% of its revenue. So, even if there should be some inflated issues with HTM, which are assets and not liabilities, YZJ should still survive.

In conclusion, if you cannot trust the numbers of YZJ, you should not invest in it. If you trust the numbers, there are several good things going for it. Hope my analysis make sense.

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Read Part 1: here.

Tea with Mike: Analysis of Yangzijiang, an S-chip (Part 1).

The recent episode with China Minzhong was viewed by many, including professional analysts, as the proverbial last straw that broke the camel's back. S-chips have been declared by them as untouchable and even toxic.

Surely, S-chips have reached a low point and are mostly unloved. In such a situation, are we brave enough to venture forth to sort through the debris to find hidden gems? See what Mike has to say about Yangzijiang (YZJ) which he is vested in.

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Before I start, to avoid losing sleep over this blog, I must say that  all information I am sharing here is to my best knowledge accurate but I cannot be held liable for any errors. Of course, please point them out if you should spot any.

I invested in YZJ because it fits my approach to investing which is to buy into an alpha company in a cyclical industry during a down cycle. In my opinion, the low valuation of this company is unjustified.

 

1. YZJ pays decent dividends, consistently paying out about 30% of their earnings, yielding about 5% based on recent share price. I like companies that compensate me while I wait for the upturn.

2. I like the management's foresight. In a time when China is competing head on with South Korea for a share of the global shipbuilding pie, many shipyards competed on costs, and offered great terms to build smaller bulk carriers and container ships. YZJ moved into “green” technology that saves on fuel costs and built large container ships. They are the first in China to build 10,000 TEU container ships for Seaspan, but lost the crown to Jiangnan Changxing, which has signed deals to build 16,000 TEU boxships.

If we followed the recent developments in the shipping sector, many are talking about LPG carriers, YZJ through an interview with The EDGE Singapore, mentioned they are in talks with companies for building such. While it is akin to counting eggs before they are hatched, it does show that the management is on top of things where industry trend is concerned.

3. I also like the management's prudence. They did not venture aggressively into the O&G sector which proved costly for COSCO, instead they developed a financing arm (Mirco-financing and HTM investment) which works well for them so far. Of course this is not without controversy and risks. I will talk about this later.

4. Although their order book has shrunk considerable from the boom years, it is beginning to grow again. Order book shows about USD3.24b with 47 outstanding options worth about USD2.54b that are not yet exercised by its customers. Their customers base has also grown since their IPO.  

5. Ratios and financial numbers? I have mentioned about low gearing, reasonable P/B of 1.1 and PE ratio of 5.4. Valuation has not taken future recovery into account. This is unlike many hot stocks which have valuations that have already accounted for expected strong growth for years to come.

6. There is favourable sector development. The PRC government is trying to reform the shipping industry. They want the top 10 shipping companies to account for 70% of the ship building contracts. YZJ is in the top 5.  Although no one will want to start a shipyard in China now, as demand recovers, domestic competition might increase and disrupt the consolidation of the industry. So, the PRC government has effectively closed off such competition by not issuing anymore license to potential new players. In addition, they also do not allow any expansion of capacity of existing builders'.

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In Part 2, we will see what Mike thinks are the possible risks of investing in YZJ.

Continue reading: Part 2.

Related post:
Tea with Mike: Approach to stock selection.

Tea with Mike: Approach to stock selection

There are many ways of selecting stocks. Some people use ratios such as PER and P/B. Some people look at charts, spotting 52 weeks highs and lows. Some look for the highest yields. The list goes on. When I first started, I felt overwhelmed and didn’t really know what to look for.

Over the years, I adopted an approach that is similar to Graham's “large companies that are out-of favour” tactic. I look at alpha cyclical companies during their down cycles and I believed that will offer some margin of safety.

I bought into 2 counters, Golden Agri and YZJ, using this approach. For shipping industry, the Baltic Dry Index (BDI) hit record bottom at 661 last year. The peak was 11,000. Even if one were to take the average, we can quite safely say the BDI was nowhere near where it would be mid-cycle. Shipping down cycle is characterized by a dearth of new shipbuilding orders, collapse of freight rates, and the bankruptcies of weaker players, and all these have happened in the past 1 year. So, I can safely conclude that we are near the trough of a down cycle. Near? Yes, because there is no way to ascertain if we have reached the bottom yet.

Then, we search for alpha companies. These are companies in the sector that have the strongest financial strength and operating efficiency. This is so that our investment does not go to the dogs and get consumed by the down cycle. I shall not go into detail about YZJ, as that itself would be a long blog but, particularly, I looked out for a low gearing level.

Both Golden Agri and YZJ have low gearing levels. More important is the amount of short term loans to be repaid. Down cycles combined with the maturity of large loans is what killed many companies. Even the biggest private shipyard in China, Rongsheng, is facing severe difficulties because of this.

Next, while profits would be affected negatively, there should not be losses, and the companies should be big enough to show resilience in earnings through previous crises. There should be Free Cash Flow (FCF) in most of the operating years too

Golden Agri’s earnings are levered heavily on Crude Palm Oil's (CPO) price, and its production levels. If we look at the last 30 years, 2013 has seen CPO price falling more than 40% from its last peak. Although inventory has been piling up, Golden Agri will not be able to increase its production at the same rate it has been able to in the past. I bought it for its vertically integrated businesses and its economies of scale. For higher production growth, one should, perhaps, look at First Resources.

This approach requires a lot of patience as the sectors are out of favour and there is very little chance that the share prices would shoot up suddenly. Also, as AK always says, cheap could get cheaper and this is especially true in such out of favor stocks. Say ship building and most people would frown. So, there might be selling pressure from time to time but if the companies are fundamentally strong, such selling pressure provides opportunities for accumulation.

I would like to acknowledge that I first got some ideas and information from Calvin Yeo of "Invest In Passive Income". A link to his blog can be found in the left side bar of AK's blog.

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AK's comment:

I was heavily invested in Golden Agriculture at one time, recognising that it was heavily levered to the price of CPO. When CPO price was rising relentlessly, Golden Agriculture was a good investment. I made a tidy sum from it. Mike's approach is valid, I am sure, but one has to be patient.

We could consider investing in Wilmar International which also has an exposure to CPO but it is less levered to CPO production which forms less than a fifth of its earnings. Wilmar has a pretty diversified earnings base. However, if we are looking for positive Free Cash Flow, then, Wilmar would fail our selection process.

As for ship builders, I would also frown when I hear the phrase. However, we can find nuggets in the sector and when we look at what Cosco and YZJ are doing, we know where to look because these yards are venturing into building for the O&G industry. This is what KepCorp and SembCorp have been doing for years. With more rigs delivered, there is a higher need for OSVs and, yes, I am invested in Marco Polo Marine which has the added advantage of a strong moat. However, if we are looking for positive Free Cash Flow, then, Marco Polo Marine would fail the selection process too.

I believe that Mike's approach is probably suitable for anyone who is more conservative since stronger companies in cyclical industries are unlikely to go bust in a down cycle. When the up cycle returns, these companies should lead the recovery.

Thanks, Mike, for offering us your perspective on stock selection. It has provided me with food for thought.