Tuesday, February 28, 2012

Divestment of UOB Kay-Hian

UOB Kay-Hian bought at $1.65, sold at $1.67, total gain $1.42.
I sold it immediately this morning after the FY2011 result is announced despite a dividend of $0.06 being declared. The reason why I do so is that the calculation in buying the stock at the start was faulty.
Reasons why I bought the stock
  1. High Profit Margin
  2. High ROE
  3. Dividend Payout Ratio of 60%
  4. Conservative Management (one of the rare brokerage that likes to ban trading in hot stock)
  5. Largest brokerage in Singapore with operations in Hong Kong and Thailand
  6. It's a matter of time that the retails investor will return
  7. Brokerage demand has high potential for growth given that only 12% of population are trading or investing. This compared to 30% in Hong Kong and 50% in USA
And the reason why I sold it off is definitely not because of unsatisfactory result. I do expect the weak result given that q4 is traditionally where market turnover is at its lowest and with the euro crisis still unsolved. The only reason why I decided to sell it off is that after keying in the data into my spreadsheet, I realised that my calculation of its ROE of 17% is faulty by taking into account Peak Earning in 2007 and 2008. Under normalized situation, its ROE should average around 11%, though in a hot bull like 2008 it can go all the way up to 28%.
A 6% difference in ROE is too much for me. A ROE of 11% is not a good sign especially if the profit margin is as high as 30% and will make it just an average company out there. And this is it - I will never buy an average company at an average PE of 10 for my long-term portfolio, as it will be without much margin of safety. Of course, unless special situation exists such that I believe that its normalized earning can grow in the future to a point that the PE of the current price will be 5. And given that SGX has a ROA of 15% and ROE of 30%, I will rather buy SGX at a price of 20 than UOB Kay-Hian at a price of 10.
It is definitely not that this is a lousy stock. If one will to hold it till a bull market and collect the dividend in the meanwhile, profit is rather guaranteed. This will be a good buy if one can get it at $1.15 and hold it with a mid-term view in mind. However, being without much margin of safety and being low on cash, it might be better to source out a better price for value company.

Sunday, February 26, 2012

Berkshire Hathaway's 2011 Annual Letter to Shareholders

While there's a lot of Buffett books out there that sought to explain Buffett's stock-picking techniques, will not it be best to hear it from Warren Buffett himself? I shall share with you some of the more important point from his report. For the full text, you can check it out here:

"Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.

We have witnessed many bouts of repurchasing that failed our second test. Sometimes, of course, infractions – even serious ones – are innocent; many CEOs never stop believing their stock is cheap. In other instances, a less benign conclusion seems warranted. It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value."

Many companies have been doing aggressive share buyback in the recent correction, of which I supposed many are not putting the cash to good use. I supposed a easier way to see if the share buyback is well done will be first to check if the company has any high-interest yielding debt (Hyflux ?) that can actually be repaid. Secondly, perhaps we should ask ourselves if we will buy the company at the current price of which share buyback is being done. Else, distributing dividend might have been a better policy.

"The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply."

For someone like me with no foreseeable cash-generating abilities in the near future, I doubt it will make a difference if the stock tanks. However, for the rest out there, this is once again a great advice. Do not rejoice over the fact that your holdings have caught the attention of institutional funds and analyst.

"At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained."

A structure of which we can use to assess insurance company...

"To fulfill its societal obligation, BNSF regularly invests far more than its depreciation charge, with the excess amounting to $1.8 billion in 2011.

Massive investments of the sort that BNSF is making would be foolish if it could not earn appropriate returns on the incremental sums it commits. But I am confident it will do so because of the value it delivers. Many years ago Ben Franklin counseled, “Keep thy shop, and thy shop will keep thee.” Translating this to our regulated businesses, he might today say, “Take care of your customer, and the regulator – your customer’s representative – will take care of you.” Good behavior by each party begets good behavior in return."

Our dearest 2 Public Transport Operators should really take note of this point. This is perhaps the difference in running a business with a owner's mentality. This is also why I do have a slight preference for a family-owned business sometimes.

"This group of companies sells products ranging from lollipops to jet airplanes. Some of the businesses enjoy terrific economics, measured by earnings on unleveraged net tangible assets that run from 25% after-tax to more than 100%. Others produce good returns in the area of 12-20%. A few, however, have very poor returns, a result of some serious mistakes"

Always take into account the leverage level when assessing return on equity or return on net tangible asset.

"The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis.

As “bandwagon” investors join any party, they create their own truth – for a while. "

While I have always thought that gold can be a safe asset given the past Gold Standard, he really knocks the senses out of me with his reference to the tulip bubbles in the 17th century. While I have read about that story before, I will never have thought that this is precisely what Gold is all about now.

"My own preference – and you knew this was coming – is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment."

This is a short and sweet summary of what a long-term investment should be.

The annual letter does deserve a read and I have find that reading his letter to shareholder proves to be more worth it than many other books out there. And what's more its free, which implies an infinite return on investment:)

Saturday, February 25, 2012

Eratat Lifestyle - My First Stock, My First Mistake

This was the first stock that I bought, after I was enticed by its growth story of positioning itself in the premium market where there is higher profit margin. Profit margin is growing and profit and revenue have been jumping higher and higher each year. Coupled with its high cash position and low P/E of less than 2, this seemed to be the ideal stock.

So what was my first mistake?

Lousy and basic accounting skill. Looking at the current financial statements, there's in fact quite a number of doubts in its statement that I should have spotted earlier on.

First of all, lets look at their growth story as written in 2010 annual report:

Since 2008, we have made strategic changes to reposition ourselves as a mass appeal and casual lifestyle company and away from the sportswear segment.

Is it really so? In 2008, they added 3 more production lines to a total of 5 to produce an annual output of 7.2m pair of shoes. And in 2009, they added another 1 more production line to increase total output to 8.4m pair of shoes. In 2010, they sold a total of 5.42 million pair of shoes and in 2011 they sold a total of 4.63 million pair of shoes. This is a 40% underutilisation of production capacity. This should has been the first warning - Management is not following what they have said.

And if we are talking about this company, we will definitely need to talk about its receivables. Ever since it was listed in 2008, profit has been jumping literally. From an EBIT of 46m rmb in 2007, it rises to 80m in 2008, 150m in 2009 and 200m in 2011. This is pretty similar to its total receivables. While it is plausible and reasonable that receivables should rise in tandem with revenue, it is definitely not when you see the receivables turnover jump from 32 days in 2007 to 56 in 2009, 94 in 2010 and in 2011 - 130 days. It should have been around 140-150 days if not for the so called Sales Incentive Award of 52 million rmb.

What about the inventory turnover? From 40 days in 2007, it has dropped all the way to 11 days in 2010 and 2011. This implies that its inventory is able to turnover at 14 times faster than the receivables. High inventory turnover can be a very positive sign for companies like those in FMCG and fast food as it helps to increase their working capital. However, in the case of Eratat, it is unable to collect its receivables in time, which means it will need an enormous sum of working capital to be able to fuel its high inventory turnover. Given its receivables turnover of 150 days, it will need a working capital of at least 200m rmb to function since its trade payable is only at 25m. This is why a placement is being done to raise 60m rmb in May 2011 despite the fact that it has 160m in cash (This should also has been an important red flag). And a high inventory turnover means that the product is very hot-selling, but then again why did the distributors face difficulty in paying them?

The next question will then be how much cash has been generated from operation given that its profit has increased 5 folds in 4 years. From 2008 to 2011, a total of 557m of EBIT has been generated of which a total of 118m has been paid out as income tax, giving a total net profit of 339m. However, net cash generated from operation in that period sums up to only 60m in cash. In 2007 where profit is only half the amount of 2008, the company actually manage to generate 35m in cash from operation. So what has happened to the rest of the 279m of cash? it has been turned into trade receivables.

Many will then be concerned now if the 222m cash in the balance sheet is real. The answer is yes given that the auditor has checked with the bank. Why am I so confident that the cash is real given that it has only managed to generate 60m in cash so far? Well, through IPO, warrant and share placement they have raised a total sum of 300m in cash of which they have only used around 70m of it. 25m was used to create the production line for shoes in 2008 and 2009, 21m was used to purchase PPE in 2010 and another 25m was used in its acquisition of subsidiaries, Fujian Haimingwei. Therefore, the cash balance is likely to be real since it is in fact just shareholder's money that's not yet used. This raises another question, if it does not need that much of a working capital, why did it even bother listing in the first place?

And finally, the tripling in ASP (Average Selling Price) of Eratat's apparel to 242 RMB is rather surprising in FY2011 Autumn/ Winter. It is not just the fact that revenue increases by 50% that puzzled me, but the fact that gross margin remains the same at 38.2%. Using simple maths, we can easily figure out that if ASP triples and gross margin remain the same, it means that the cost of production has also tripled. So, if ASP has not tripled, will not Eratat has made a loss?

Being blinded by a growth story without checking its financial statement is definitely a road to self-destruction. I have a realised lost of 20% on this investment and it has been one of the most painful lesson I have learnt. All I have to thanks for is that my capital invested in it is rather modest and I have divested it after I realised something was wrong in Q3 2011.

The most important lesson I have learnt from this experience is that financial statement will never lie about the actual state of the company. Even in the case of a financial shenanigan, there will definitely be tell-tale sign like how the annual report will be too complex for one to understand.

Sunday, February 19, 2012

Singapore Budget 2012 and VICOM

Yesterday, we have discussed about how SBS Transit is going to be negatively impacted by the implementation of the Budget for the new fiscal year. VICOM, however, stands to gain from what might be a loss to SBS.
Under the Bus Services Enhancement Fund, 800 buses will be added by 2016 of which 550 will be funded from the government. Now, we can understand why it took nearly 20 years for the PTOs to add 800 buses in the past. With more buses entail more inspection revenues for VICOM, so we shall see how much of a revenue will be added.

As public buses, they have to be inspected every 6 months paying $68 per inspection. Being diesel operated, they will also have to undergo CDST for $26. This gives us a total of $188 per bus added per year. 800 buses = $150400 annually. While this might represent a very small sum given VICOM's $25m profit, it is a form of recurring income that they will enjoy.

While the bus might be a small bonus rewarded to VICOM, what's more important is the continued change in attitude of the government towards diesel vehicle, that will signify long-term income growth for VICOM.


In the above post, I have discussed about how the government has been slashing taxes for diesel car and how diesel car population has been growing. Here's the latest figure

Before 2009 - <20
2009 - 43
2010 - 138
2011 - 346
31/01/2012 - 374

Under the latest policy change announced, the annual Special Diesel Tax will be cut by 68% to around $320 - $500, which make it on par with petrol car driver whose petrol pump prices has been incorporated a duty of 41-44 cents per litre of fuel. As quoted from The Straits Times:

"Singapore will adopt the Euro V standard for diesel vehicles in 2014, and the slashing of the Special Diesel Tax is meant to encourage an earlier adoption of newer and cleaner diesel technologies, the minister explained."

This confirms my speculation that diesel vehicle will continue to grow until it accounts for a significant proportion of the vehicle population. It will definitely not be surprising if diesel vehicle population hit 1000 by end of the year given its growth rate, as diesel is a much more cost-effective and efficient fuel than petrol. All this will imply an extra $17 in inspection revenue for every diesel vehicle in the long term.

And with this, it shall lead to our Vehicle Emission Testing Laboratory, the one and only in the whole of SE Asia region and one of the world's few to be able to test for Euro V standard. As mentioned above, the special tax only applies to Euro V compliant diesel car and not to any of the diesel car out there. With the latest policy announced, our dear parallel importers will start to import more Euro V compliant diesel car models which has to be certified under the Mandatory Fuel Economy Labelling Scheme which only VETL can support. The price for each inspection will be 2-4k per model.

As such, the government has definitely handed a pretty nice Ang Pow to VICOM and I shall thank you on their behalf :)

Feel free to share which other company do you think has been affected by the latest budget

Saturday, February 18, 2012

Singapore Budget 2012 and SBS

Minister for Finance Tharman Shanmugaratnam revealed the Singapore Budget 2012 yesterday with the main aim of building an inclusive society, helping the aged, the poor and the disabled. 3700 hospital beds will be added over the next 8 years and proportion of foreign workers allowed to be hired will be reduced in a bid to gear up the productivity of firm. Among them all, the government announces a $1.1 billion funding for the Bus Services Enhancement Fund, where total bus capacity will be increased by 800 from the current 4000 fleet operated by SMRT and SBS.

According to the Budget, the government will provide funding for 550 buses while public bus operators will add another 250 buses on their own. The sum of $1.1b will be used to cover the cost of purchase of 550 buses as well as their running costs for the next 10 years. Such a huge sum seemed to be a big bonus for the Public Transport Operator (PTO), funding the provision of extra capacity. However, on a closer look, such scheme might turn out to be a big bane for the PTO.

Since SBS has a 75% market share in terms of bus fleet, we shall examine how they are going to be affected by this funding. I will be using the Annual Report FY10 of SBS as reference for the figures. Given that bus ridership is not likely to increase by 20% because of this extra capacity, we can conclude that if the funding is not able to cover the running cost, SBS is going to have its profit margin lowered.

The funded 550 buses

As the cost of purchasing buses is being sponsored, we shall check if the remaining fund will be able to meet the operating cost for the next 10 years. Last year, SBS ordered a total of 600 buses for $268 million. Therefore, of the $1.1 billion, around 250 million will be used to buy the buses, giving us a remaining sum of $850 million to cover the running cost of 550 buses for the next 10 years.

With a 75% market share, it is likely that SBS will get around $650 million to fund the running cost of approximately 425 buses for 10 years, or $65 million per year.

From the annual report,
SBS's bus segment has an EBIT of $15 million on Revenue of $549 million, while depreciation expense is $45 million. Operating cost of 3000 buses (SBS's fleet size) work out to be 549-15-45= $490 million.

Thus operating cost of 425 buses in a year work out to be 425/3000*490m = $69 million, which is $4 million more than what the government funds. This figure will be rather accurate given that most of the expenses in running a bus are variable costs like wages, fuel expenses, repair and maintenance.

Even if we will to say that my figure is inaccurate, there will still be a depreciation expense on the income statement though this will not affect its cashflow. Given that buses are depreciated over 17 years on a straight-line method, this will work out to be an extra $10 million in depreciation expense.

The non-funded 250 buses

Similarly, using 75%, it is likely that SBS will have to pay for around 185 buses on their own. The cost of purchase will work out to be $82 million

Operating expenses will be 185/ 3000 * 490m = $30 million
Depreciation expenses will be another $ 4.9 million

Total Additional Expenses incurred from the 800 buses

Funded - $4 million in operating expenses and $10 million in depreciation expense

Non-Funded - $30 million in operating expenses and $4.9 million in depreciation expense and a cash outflow of $82 million

Total - $49 million of expenses in income statement each year and a one-time sum of $82 million

To be more conservative since my figures may not be accurate, I shall cut the sum by 50% to $25 million

Against an EBIT of $15 million, SBS is still going to face a loss of $10 million from its bus segment. To counter such a loss, SBS will then have to increase their bus revenue by at least $200 million a year using a EBIT margin of 5%, which means it will have to increase its revenue by 40%.

I believe that SBS will rather that government funds its MRT which has much lower operating cost but a higher fixed cost. SBS is going to suffer rather badly in the years to come even with the government funding. After the 10 years funding period, SBS will then have to fund an additional operating costs of 425 buses.

Saturday, February 11, 2012

VICOM - FY 2011 Quick Update (Edited)

FY 2011 result has been announced today and I will do a short summary before the annual report is released.

For the Financial Year 2011, VICOM has achieved a profit growth of 14.2% to achieve a profit after taxation of $25.5m. While revenue increases by 8%, operating expense increases only by 6.4%, thus resulting in a 14.2% profit growth. Operating profit margin and net profit margin reach a new record of 33% and 28.1% respectively.

For the balance sheet, Cash and Bank Balances increases by 6 million to reach a high of $55m and of course without any debt. Trade receivables increases from $7m to $10.5m. Vehicles, Premises and Equipment increases from $49m to $55.5m, likely due to the finished construction of new building at Teban Garden.

FCF is at $18m due largely to purchase of Vehicles, Premises and Equipment of $12m. For the past 2 years, spending on this area has been at record high due to the construction of new building and laboratory. With its completion, FCF will be able to improved significantly baring any unforeseen circumstances. However, FCF/ Net Profit is still at a very healthy 70% despite this increased spending.

A final dividend of 7.5 cents and special dividend of 3.2 cents has been declared, totalling 10.7 cents, compared to a final dividend of 6.6 cents and special dividend of 3.2 cents. Total dividend for FY 2011 is 17.5 cents, which is a 4.49% yield based on current price of $3.90.

The only part that I am unhappy about is the increase in share capital from $31.4m to $34.4m, which results in a modest increase of 11% for EPS. This will have to wait until the annual report is out but from what I know the share option available is around 10%.

I just got the options and share capital figured out.
For FY 2011, a total number of 1,505,000 options were exercised, representing a 1.74% increase in total number of shares from 86,358,000 to 87,863,000. 779,000 options are not yet exercised and represent 0.89% of total share capital.

The reason for the 10% increase in share capital is that the original share was issued at a price of $0.50. This latest exercise of share option was done at an average price of $1.91, thus increasing the total share capital by a huge amount.

Many might have been worried about the share option, but I have just found out that this was in fact due to the "2001 VICOM share option scheme":

Resolution 11 is to authorise the Directors to issue shares upon the exercise of options in accordance with the 2001 VICOM Share Option Scheme. This scheme was approved by Shareholders at the Extraordinary General Meeting held on 27 April 2001 and has a maximum duration of 10 years. The aggregate number of shares over which the Committee may grant options under the scheme for its entire duration is limited to 15% of the issued ordinary shares in the capital of the Company excluding treasury shares from time to time. 2010 was the last year for which new options were granted under this scheme. The Company is not seeking a renewal of the scheme.

From 2006 onwards, no options would be granted to non-executive Directors."

Through some calculation, total number of share options granted in FY2011 stands at 24,000, which is likely to be only for the top management. Thus, option will not be a concern for those who have bought in 2011 onwards since only 0.89% is not yet exercised. However, we do need to be careful if the company is seeking a new share option scheme.

The number of vehicles due for inspection is expected to remain high as the de-registration rate of vehicles continues to be low.
With a comprehensive range and variety of services, it is expected that the test and inspection business will continue to sustain its performance despite the anticipated economic slowdown."


Saturday, February 4, 2012

Extraordinary Item - How They Should be Treated

The much awaited reporting season is here again and a careful review of any vested company should be done for an understanding of the direction of which the company is heading towards. Such a review can be timely to provide sufficient reasons in divesting or investing in a company, especially so when the reason for investing in it has changed for better or for worse. However, we may face with extraordinary items which can have a massive impact on the company's bottom line which will seriously complicate the matter.

Extraordinary items are usually stated in the financial statement in a separate line from the revenue. They are meant to be a one-off and infrequent event that should not occur often in the normal course of business. In fact, I will seriously consider part of the revenue as extraordinary profit so long as they are not generated from the core business or as mentioned "should not occur often in the the normal course of business". This is so that one can be conservative in the calculation and since one should not expect it to reoccur again in the next year or so.

Therefore, the frequency and likelihood of occurrence are to be the first factor in assessing these extraordinary item. If they are indeed that unlikely to occur, then they can be easily dismissed. In such a case, I will want a huge extraordinary loss so that I can buy at a much cheaper price provided that the company has sufficient financial strength to survive through it. Such example might be "Act of God", selling off of operation, lawsuit settlement or compensation.

However, in certain cases, such one-off event can be recurring of which then requires some careful examining. For e.g. the company might have a factory located in a flood-prone area in Thailand. After the flood, if the management treats this as a one-off event and not implement any measures like relocation or implementation of anti-flood measures, you can expect to have recurring extraordinary item year after year. Just look at how many times Wendy's at Liat Tower has suffered a loss for it, from damage to equipment to loss of income from closure of shop.

While extraordinary items are infrequent and should be discounted from the bottom line, they are not meant to be simply discarded. At the end of the day, they will still have an impact on the company's balance sheet and financial strength. One should be happy with the selling off of a high capex, unprofitable, cash-bleeding non-core operation. A lump-sum investment gain or settlement losses can double or halve the cash holding of a company and can even affect the dividend paid. In certain case, the company might return cash to the investor like in the case of San Teh. While the Japan's earthquake and nuclear incident are an Act of God, the company will face huge losses of physical asset and will have to fork out a rebuilding cost unless a catastrophic insurance is purchased.

In another very special case, a company in a recessionary financial year might choose to take extraordinary provision or losses since losses might be expected anyway. What happens might then be that losses that should have occurred in the next FY or so has been accounted in the current one. For the next FY, the company will have a huge turnaround with massive profit gain where in fact the gain should have been minimized. It will then be very hard to assess the company's profit other than perhaps to combine the results for the past years and average it out.

To conclude, extraordinary items should be treated with extraordinary care and caution. A comprehensive analysis is needed for an understanding of its impact to the 3 different financial statements. The worse of all will be if the management fails to recognize a one-off event or if a "Big Bath" is being taken.