Friday, April 27, 2012


VICOM's AGM is pretty boring unlike all the excitements I see from the newspaper and food-snatching is not very common there. There's quite a number of long-term shareholders present and I think it is good to have though some might complain this will make VICOM more illiquid. As it's my first AGM, I am more concerned about understanding the AGM's procedure and etiquette then finding out more about the company. After the formal AGM is over, it's the buffet cum meet up with management time. I realise that it is quite important to be able to recognise faces of the key management if it is your first time attending the AGM. While it may be boring, the trip proves to be rather fruitful.

Here's some of the key points gleaned from the trip:

Financial Statement
  • Someone queried about the higher receivables, Chairman Lim says there's no bad debt so far.
  • With the completion of SETSCO HQ, capex for the year will drop to normal (the norm from 2004 to 2009 is FCF/Net Profit of 100-120%). No further detail is provided as to acquisition or higher dividend plan though they say that as shareholder themselves they will also want to have higher dividend.
  • The parent company provided $2.6m in sales to VICOM, of which 2/3 comes from taxi inspection. (A new trick that I learn - check the parent company's annual report for inter-segment sales

Vehicle Inspection
  • They have no received any concrete details as regard to the government's adoption of Euro V in 2014. (Not sure if it is because they are not allowed to)
  • Comfort obviously send their buses and taxis to VICOM for inspection.
  • When queried about the proportion of inspection of private cars to overall inspection figure, they say the data is sensitive and thus they cannot reveal it. However, I believe that the data can easily be retrieved through finding the right combination of statistics from LTA. (I am not going to reveal the combination, that's for you to find out)

  • The wild card in Middle East JV has been called off. Mr Heng finds that they are not too comfortable operating in the region and decided to pull out of it.
  • SETSCO without the vehicle inspection business is the number 3 in Singapore. The largest 2 are SGS and TUV SUD with revenue of $60 million + as compared to SETSCO's $55m. 
  • The management admits that SETSCO is operating in an open market unlike the vehicle inspection business. So long as one can get the equipment, skilled labour and accreditation, they will be able to provide testing services.
  • Regarding the recent tussle between HSA and the medical community over medical device, SETSCO has been trying to get a slice of the pie. However, it is up to the government to decide if they want to allow SETSCO to do it.

The most important part of AGM is still to get a feel of the management team, and I am lucky to be able to interact with the current CEO Mr Heng and soon-to-be CEO Mr Sim Wing Yew.

  • The reason why Mr Heng sells part of his shares earlier on is as all his savings are in VICOM's shares. He will need some money now that he is retiring and to pay up loans, some of which has been used to exercise the option.
  • As for Mr Sim, this is his career and he still has 4 kids to support, thus he reassures us that he will also want to grow the top and bottom line. He is still trying to learn as quickly as possible and at the same time he is also teaching his new successor in Comfort Engineering. (which is he will not take dual CEO roles)
  • Mr Sim says that he will be going for evolution and not revolution when he takes over.
  • As for the growing cash balance, they say it is good to have excess cash as you will never know when you will need it. Neither do they want to overpay for acquisition like what TUV SUD offers for PSB. (Seemed to be $120m for 3-5m in profit).
  • Most importantly, they believe that a downturn will eventually occur in the long run and the right opportunity will surface (sound like the fat pitch theory). Mr Heng says he will rather pay with cash than to pay with credit cards for it and Mr Sim shares the same view. This was what happened in 2003 when they acquired SETSCO from Keppel Corp and they only need to borrow a bit of money for it.
  • One of the shareholders who works as a head-hunter, recounts how he fails to poach SETSCO's high quality staff with a 30-40% increment in salary. Mr Sim or Mr Heng says that he always tells his staffs that while he will not pay them the highest salary, they will be guaranteed a stable income and job even during recession. He says that the equipment is not a barrier to entry as anyone with the money can buy them, but it is these skilled workers that are their biggest assets.
  • Mr Sim mentions that the report of segmental revenue and profit is a disadvantage to the company, thus they cannot disclose more about SETSCO's other segments. For e.g. if competitors know that their margin is 20%, then they can compete by undercutting the margin to 17%.

Therefore, VICOM's management holds a rather conservative view though the results of the new leadership can only be assessed few years later. For now, let's wait for the FY 2012 Q1 result coming out on 10th of May as well as the dividend to be paid on the 14th of May. Using the latest figure, it will be no problem for the vehicle inspection business to show a 5-10% growth in profit in Q1.

I can't wait to attend another 3 more AGMs this coming July

Sunday, April 22, 2012

Diversification - Part 2 (Guide to Diversification)

Just to recap, these are the 4 major type of risks that we are susceptible to when we are investing:
  1. Systematic Risk
  2. Company/Industry Specific Risk
  3. Human Error
  4. Black Swan
Taking into account these risks, here is my personal guide on how many stocks one should hold:
  1. As many excellent stocks that one can find at a good price
  2. As many stocks as one is able to understand in depth and have the sufficient time to follow
  3. As many stocks as one can have without incurring too much transaction fee in the form of min brokerage fee (not applicable for standard chartered brokerage user) 
  4. As many stocks as you can afford to suffer a total wipe-out in any of the stock.
  5. As little concentration in a similar industry unless you are being kept highly aware of the intimate details of the industry or you are very confident in it.
Rule no 1 is pretty simple as it is one of the best defences against any risks other than human error. An excellent stock is one with an excellent business or one with a very clean balance sheet who can bounce back easily even after what might be a calamity to some. BP is going to survive through the Gulf of Mexico Oil Spill, so has many other companies did in the past – AMEX, GEICO, Adampak, Cerebos. In the case of systematic risk, all one needs to do is to continue to average down without the need to sell them at a discounted price.

Rule no 2 is a guide to the maximum number of stocks that one should have. If you are studying or working, it is pretty unlikely that you can take a portfolio of 10 stocks especially when the reporting season and AGM are here. If you are retiring, it seemed like going for 30 stocks is plausible given that you have all the time in the world and if you are really passionate about it. Going for that many AGMs will also help to enrich your life and prevent degeneration of the brain.

Rule no 3 will apply more for those without as much of a capital at the start. If you are not using Standard 
Chartered brokerage, the brokerage fee is going to eat up a significant amount of your return. Imagine spending $1000 to buy a stock and you will have incurred a total transaction fee of $60 in buying and selling, which will set you back by 6% even before you started out.

Rule no 4 is about the minimum number of stocks that you have. Are you comfortable having a total wipe out of 50%? If not, then you really should not just have 2 stocks in your portfolio. Generally, 4 stocks should be the minimum to prevent a severe hit to one’s portfolio. But then again, rule no 1 will still apply, if you cannot find that many excellent stocks, no point trying to increase your number of stocks. Mediocre business will only bring in mediocre return in the long run.

Rule no 5 is to prevent systematic risk as well as the occurrence of black swan. It is perhaps one of the most tricky as you have to factor in many other factors. Some industries are predominantly less risky than others (VICOM, SPH) where a black swan is really required to destroy them (I have no idea how it can happen; maybe the government decides to revoke their licensesJ). Concentration also has to do with how confident and how well you understand the stocks. That being the case, confidence bias exist and you may still be subjected to human error.

If you are working in the company, it is still wise not to throw all your money into the company though you can have a much higher concentration. The reason is simply because you do not want to get retrenched and suffered capital losses simultaneously should anything happen to the company or industry. Unless you are part of the key management where your job is really to grow the business and enjoy the fruit of your labour.

Generally, the minimum number of stocks that one should hold should be at least 3-4 while the maximum should be really around 30 which will mean you are able to devote 3 days per quarter to each of your companies. The above is my belief on optimum portfolio diversification, please feel free to give any criticism or suggestion.

Wednesday, April 18, 2012

Diversification - Part 1 (Understanding Risk)

Portfolio management is as important as stock selection in investing and determining your return on investment. In this aspect, the extent of diversification has always been debated with some supporting the idea of concentration while some diversifies up to 20-30+ stocks.

Diversification is the act of diversifying where the central idea is the maxim of "Don't put all your eggs in one basket". This is absolutely correct as you will not want to have all your fortunes to be destroyed by a single event. It is also one of the more encouraged methods of reducing investment risk other than hedging in finance. Using Modern Portfolio Theory term, the more independent assets that one has, the lesser the risk will be such that one can drive standard deviation of the portfolio down to nearly zero. The main point that I am trying to drive across is diversification is necessary, though the extent is debatable.

Before I touch on the issue of the number of stocks that we should hold, we need to understand the purpose of diversifying in greater depth. The main purpose of diversification is to reduce potential risks that we are subjected to. Just like in insurance, we are participating in an insurance pool where the risk is being spread over a huge pool of people. As much as we do not want to pay a premium, we can never be assured that misfortune will not strike us. Thus, should the unthinkable occurs, we will still be assured that our family can live on financially sound.

Similarly, we need to UNDERSTAND our needs before we embark on diversifying to avoid paying for redundant policies. Personally, I believe that there are 4 types of risks that we are subjected to:

  1. Systematic Risk
  2. Company/Industry Specific Risk
  3. Human Error
  4. Black Swan
Systematic Risk - those that will affect the entire stock market such that very few stocks can avoid it. These are your wide-reaching recessions like 2008 GFC and 1997 AFC as well as war like in 2003 or even smaller scale crisis like our Euro Debt Crisis today. When they occur, no matter how many stocks you have you will still get hit. With diversification, the chance that you will get a total wipeout is very rare unless you are very unlucky or you are playing with fire (margin). However, a better way of diversifying against such systematic risk is to always buy excellent companies with great business prospect as well as a high quality balance sheet where debt-to-equity ratio is low.

Company/Industry Specific Risk – This is the most diversifiable risk among the 4 simply by reviewing your portfolio and making sure that the correlation among your stocks is not very high. The easiest way is to ensure that your portfolio is not based entirely on the success of one industry or of a single story (for e.g. oil prices). Spamming highly cyclical stocks during a bull market is also not a very good move as these industries are subjected to the same type of cyclical forces. And the key here is not the stock prices but that the profitability of the company will get severely impacted.

Human Error – To err is human, thus we should always take into account that we are being subjected to miscalculation or insufficient understanding. All investors in their lifetime are likely to have made a number of mistakes due to the high emotional and knowledge demand. Even sage like Warren Buffett and Philip Fisher have made numerous flawed investments, why are we to be excluded? Since we are prone to making mistakes, you will not want to pay for the lesson with a big chunk of your wealth.

Black Swan – An event of immense impact whose probability of occurring is nearly zero as nobody will even think of it in the first place. For e.g. Arab Spring, SARS, Black Monday 1987. As there is not a single chance that you will be able to pre-empt it, the key here is still to diversify.

As seen, some of these risks occur simultaneously. For e.g. SARS is a Black Swan, hurts the airline and tourism industry and creates a mild systematic risk. Thus, the idea of running an extremely concentrated portfolio is simply absurd. For Warren Buffett, please take note that he definitely has more stocks and business than anyone else unless you are buying into S&P 500 Index. Should See Candy proves to be poisonous and inedible, Berkshire Hathaway’s profit is not going to take a big hit.

Through understanding the type of risks you are facing, you will be then know how much should you diversify for your portfolio. This will be discussed in part 2.

    Sunday, April 15, 2012

    VICOM - FY 2011 Review (Part 2 - Development of VICOM and SETSCO)

    As I have promised, this is going to be an exciting post as it is full of new developments that have happened in the financial year. Firstly, lets start off with the vehicle inspections segment.

    Figure 1 - Vehicle Inspection Segmental Result

    The vehicle inspection business has been seeing double digit growth in profits for the past 7 years and has managed to increase revenue by 10.6% and EBIT by 11.25% this year. CAPEX for this segment is extremely light throughout the year with the exception in 2006 and 2010. 2006 was due to building of CDST facilities while 2010 was as a result of the construction of the new HQ at Teban Garden. The construction expense is allocated to SETSCO for FY 2011. As seen, CAPEX usually occupies at most 10% of the total EBIT for the vehicle inspection segment.

    Figure 2 - Number of vehicles inspected

    As I have earlier mentioned in VICOM - Part 2B, it is expected that VICOM's market share will increase by another 5%. In 2011, market share expanded by 1.6% to 72.1% which shows that the impact of the closure of Ayer Rajah inspection centre is significant. Given that it was closed in Mid-August, another increase of 3.2% to 75.6% is expected this coming year. Hence, 3.2/72.1= 4.4% rises in revenue from its gain in market share for 2012 is expected. 

    Let's look at some of the developments this year that has an impact on the vehicle inspection industry at large. Budget 2011 has been a huge bonus for VICOM with an addition of 800 buses as well as incentives that level the competition between diesel car and petrol car. For the bus portion, it has been mentioned extensively here though the impact to the revenue is limited to perhaps 1%. 

                                                                             Figure 3 - Number of diesel cars

    As for diesel car, the trend has been pretty encouraging and this is going to be what that will drive further future growth in vehicle inspection segment from 2014 onwards. As seen, the month on month increase has been pretty strong at 10% per month, as such by end of 2012 there should be at least 800 diesel cars on the road especially given that COE has been very high.

    Another policy that many will have missed out will be LTA's tighter regulation in a bid to improve quality of taxi service. Under the scheme, minimum fleet size requirement to get a Taxi Operator License will be increased from 400 to 800 and all taxi companies other than Prime will need to have their TOL renewed by 2013. Based on the current fleet size, SMART and Yellow-Top will need to add around 600 taxis in total while Prime will be given the allowance to add 100 each year. Other than this 95% of passengers who successfully call book, the taxi need to arrive within 10 mins instead of 85% currently. For small taxi companies (less than 1000), the figure is 90% up from the current 65%. As such, the total taxi population is likely to increase further.

    Regarding the general trend of vehicle inspection and government's policy, there is something which I wish to clarify. The OPTIMUM condition for VICOM to thrive will be to have the growth rate set at 3% while COE is being priced equal or higher than the current level. It is ultimately the COE that determines the deregistration rate and the percentage of vehicle undergoing inspection. However, the impact of higher COE on vehicle inspection has come on stronger and earlier than I have expected. Based on figures, a total of 45% of the car populations underwent inspection last year, which means the situation might be gloom for VICOM in 2013. Personally, using the latest figures, I foresee that vehicle inspection is likely to be peaking this year in term of growth. While revenue is very unlikely to fall, I do not see visibility in earning growth in 2013. For 2012, the general trend is likely to contribute another 5% growth in revenue for the current year.

    As such, SETSCO needs to prove its ability to further contribute to the bottom line just for 2013.

    Figure 4 - SETSCO Segmental Result

    The soon-retiring CEO, Mr Heng Chye Kiou, has done an excellent job in making the decision to acquire SETSCO and transforming it to be the largest ITC company in Singapore. He has a great vision in using SETSCO to diversify against vehicle inspection and build it into a profitable business. While revenue only increases by 2.5 times, EBIT has increased by 7 times as a result of profit margin increasing from 7% to 19%.  For FY 2011, revenue increases by 7.37% while EBIT increases by 7.68%. Addition to vehicles, premises and equipment hit 10.5k as a result of cost of new building construction being allocated to SETSCO. This is pretty fair as other than HQ, another purpose of it was to build more testing facilities and laboratory for SETSCO. It involved training facilities for NDT courses, microbiological testing laboratory, office for NDT department and for calibration and measurement to expand their facilities.

    A few new developments has happened and I was unaware of it till the recent annual report.

    Firstly, SETSCO has been the first and only to be accredited by SAC in October 2011, to provide CAMS (Central Alarm Monitoring System) inspection services to security firms. CAMS not only involve all the intruder alarm installed in the private estate, it also includes security system at banks, pawn shop as well as ATM. Yes, it is on a very major scale and is a stable source of recurring income as CAMS operator's license are subjected to renewal on an annual basis. As for the actual requirement of SETSCO, I am still unsure if the inspection is supposed to be conducted yearly or once every 3 years. I am not willing to pay $60 to SPRINGS just to get the full documentation as it just does not make sense to pay money to check about regulation. According to SPF, there's more than 250 security agencies though not all are CAMS operator.

    SETSCO has also recently acquired the equipment and trained staff to conduct testing on sports flooring, being one of only 2 laboratories that is capable of doing the testing. Sport flooring is about the surface and the hardness of the floor found in indoor and outdoor sports hall. Currently, about one-third of all schools has been equipped with a modern indoor sports hall which work out to be around 100 schools. This test will be to meet the requirement of BS EN 14904 to ensure that the flooring of the school's sport hall meet the standard to be safe for use.

    Last but not least, it has a very significant development going on which I have not expected SETSCO to be venturing into earlier on - "We are also looking at developing more testing services including setting up a new electrical calibration & testing laboratory". Electrical products testing has always been TUV SUD PSB's strength, holding a significant market share in this area in Singapore.

    In fact, SETSCO has already embarked onto electrical and electronics product certification June last year. Just to recap, the ITC industry is about inspection, testing and certification. Traditionally, SETSCO has been very weak in the area of certification, but has since 2010 started to grow this segment aggressively by securing accreditation for certification of cement, fire products and now electrical and electronics products. This can be a rather lucrative field as product certification are done on a more frequent basis especially electrical products like adaptor, kettle, audio products, fans, lamp and 3 pin plug. For the full list, please refer to the following url:

    Figure 5- Competition in Electrical Testing

    As written on the annual report, the new laboratory that they are planning to set up is for electrical calibration & testing and not for certification. As seen from figure 5, the bulk of the competition in electrical calibration & testing lies in TUV SUD PSB with 29 approved area of testing whereas the others are just very small players. SETSCO has historically never touch on electrical product certification or testing, but since the certification side has already been established, it should been going into electrical testing as soon as this year. With 50 sub-categories within electrical testing and competition being sparse, it will not be a hard task for SETSCO to establish itself in this area. If it succeed in growing this segment, SETSCO will then be the only one in Singapore to be able to provide a full range of testing, certification and inspection services across all areas (electrical, biological, chemical, civil engineering, environmental, NDT, mechanical and calibration).

    As such, 2012 is likely to be yet another year of record profit and revenue, bagging its 8th year of double digit CAGR in profits.Vehicle inspection business will be reaching its peak earnings this year delivering its best ever results. However, 2013 might be a tough year in terms of its growth potential and prospect as the impact of closure of STAI Ayer Rajah and the slowing deregistration rate will be almost fully realised in 2012. 2014 will then be different with the implementation of Euro V standard by the Singapore government, increased diesel vehicle take-up rate as well as a revision to the growth rate of car population.

    Going forward, I will expect SETSCO to be the main growth driver as well as the main profit contributor. Vehicle inspection has done well over the past years but with its growth potential temporarily capped, it will in turn become a mature cash cow with a sole purpose of generating cash flow and not to grow in size. The transformation of SETSCO has been incredible especially in the area of profit margin growth. This growth is attributable to its continuous expansion in type of services rendered as well as growing demand coming from local and international standard and regulation board. While it has already become the largest ITC company in Singapore, it has always been seeking new sources of revenue as we have seen from its new accreditations gained in the past few years. The expansion into electrical product certification, testing and calibration will bode well for all shareholders as it is not only a large pie but one in which competition is sparse. Last but not least, let's not forget that there's still a wild card in its Middle East JV which has remained dormant in FY 2011.

    Thus, don't expect me to be giving up on this stock anytime soon unless you are going to offer me a really really good price, especially when I will be enjoying my 5% dividend yield by the end of August.

    Wednesday, April 11, 2012

    VICOM - FY 2011 Review (Part 1 - Financial Statement)

    This will be a 2 part review for Financial Year ending 2011 where the first part will be on the financial statement while the second will be business prospect of VICOM and SETSCO.

    Ending 2011, VICOM has once again achieved a remarkable result, breaking new highs and continue its track record of 8 years of top and bottom line growth.

    Fig 1 Income Statement

    For FY 2011, revenue increases by 8.05% while net profit increases by 14.2%. From 2004 to 2011, total profit has grown by 300% which is a compounded annual growth rate of 17% for 7 years. This is the typical Lynch stock - the unattractive business which has been able to grow its profit at double digits without people noticing it. Net profit margin hit a new high at 28.3% from 18.0% in 2004. This is what that has really been spectacular about VICOM.

    While total profit has grown by 300% in 7 years, total revenue has only grown 195%. As I have mentioned before, VICOM belongs to the type of business whose operating expense increases at a slower rate than its revenue. Since 2006 onwards, increases in operating expense has lagged behind increases in revenue bringing about double digit growth in profit. As seen in 2008, while revenue only grows by 5.56%, it has a profit growth of 25.6% as operating expenses drop by 1.14%. This is why I have such confidence in future profit growth in VICOM as all it takes is perhaps a 5-7% growth in revenue for profit to grow at double digit.

    Fig 2 Operating Expenses Breakdown

    As we see from the above breakdown on operating expenses, most parts remain the same with the exception of staff cost increasing by around 10%. This is pretty realistic as it is essentially a service provider whose main  cost like in its staff.
    Fig 3 Balance Sheet

    For the balance sheet, it's pretty unexciting. Capital structure remains unchanged with absolutely no debt while cash hit an all-time high of $55m. Despite a 60% payout ratio and spending on building the new HQ block, VETL, CDST, VICOM's total cash holding has never fail to increase over the year. Of course, this is starting to be a concern on the management's inability to utilise the cash and I am wondering if I should start to discount this cash balance.

    Fig 4 Financial Ratio

    Fig 5 CAPEX

    Cash Flow/Net Profit drops by a further 2.4% to 71.1% last year once again due to spending on the new HQ building at Teban Garden. As seen from the figure above on CAPEX, it has incurred a sum of almost $10m from Capital-work-in-progress, Leasehold Buildings and Leasehold Land. So will capex continue to reach new high next year? I can only answer you in Part 2 as it is directly linked to the business prospect itself.

    ROA and ROE continue to be very high at 19% and 24% respectively and the ROA is really amazing as it is not a technology company. I have also included a ROIC to see how well it has performed from its Invested Capital and you can see that figure has been really high at above 60% for the past 3 years. The tripling of ROIC in 6 years show VICOM's ability to scale up without investing additional capital.

    This will be the end of part 1, it's pretty short as there's simply no much changes in its financial statement. As for whether it's high ROE will be maintained, this will be discussed in part 2 on business prospect of vehicle inspection and SETSCO. There's quite an amount of new and exciting developments which many may have missed or not noticed.

    Sunday, April 8, 2012

    InvestFair Singapore 2012

    I was there yesterday from 10 a.m until 5p.m and attended 4 free seminars in between. I have to say it was quite a fruitful day given that I did not spend a single cent. At the start, there's this girl that asked me if I wanted to do a survey in exchange for a $60 voucher for the seminar. I rejected her as I don't see how useful these paid seminars are supposed to be since there are mostly about trading...

    The first talk that I attended was "Investing in Straits Times Index" by Chris Tse from FTSE Group and Geoff Howie from SGX. It's a good primer on the STI where I get to understand how the index is being constructed and how it changes every quarter. I had a chat with Chris Tse after the talk was over. The first question I asked was if FTSE Group is listed (given that I see some potential in it) and well it is in fact a subsidiary of the London Stock Exchange. Currently, STI is overweight on the financial sector with a 25% weightage but this might be reduced the next quarter should the DBS- Danamon deal be successful. This is because other than market capitalisation, the free float plays a huge role in deciding the weightage. As for why the sub-sectors are not available for investing, the reason is simply that there's not enough interest and participation in ETFs from Singapore.

    The next talk was "Experiencing Kingsmen" by Andrew Cheng, the group general manager of Kingsmen Creative. He did a presentation on the various segments of their business and I was impressed by the number of customers they have for trade shows and retail design. He also confirms one of my worries that Kingsmen     will face a problem in scaling its business upward. Understanding that there's not enough creative director and designer for interior design industry,  I posed a question asking if the inability to attract sufficient quantity of quality designer and creative director will have an impact on their growth potential. To this, he admitted that they did face the problem of hiring talented personnel such that sometimes they have to avoid taking on new projects. They have tried to mitigate it by hiring from aboard too. Of course, if you view it from another angle, it does shows prudence and owner's mentality of the management. He said that they have to make sure that every project is well-executed since this will have an impact on their ability to secure future projects. So if you are expecting that the company is going to be able to grow very fast, you can forget about this stock. However, with the ongoing growing retail and MICE scene coupled with the management's prudence, this could be a winner in the long run.

    The third I attended was "Leverage on the Practicability of Dividend Investing" by a product manager from one of the local brokerage. I thought it was supposed to be on how to do dividend investing, but at the end I realised that it was about how to use leverage to maximise dividend earning. What I feel is that a 10% or 20% leverage can help to increase the return on the basis that you choose a solid company whose profitability and free cash flow is predictable. However, the example that he gave made me worry about the rest of the audiences. A normal person with $30k seeking for dividend, put his money into SPH for a dividend yield of 6%. If he were to use the share financing option (3.5% interest pa for STI component stock) by leveraging up to $100k, his dividend yield will be 13%. Yes, the leveraged dividend yield looks awesome, but for a 230% leverage, you are obviously exposing yourself to significant risk including the potential loss of all your capital. In this case, all it takes will be for SPH to fall by 30% (easily attainable even for SPH in a fallen bull market like 2008 GFC) and I will say good luck to you.

    The last one was "How I Become Financially Free after 2 Crisis" by Ken Chee, CEO of 8 Investment. He seemed to be the only one in Singapore touting a Value Investing Program so I decided to have a look at it. Honestly, I have to say his program is pretty good for beginners and anyone who wanted to learn more about Value Investing can consider it given that the cost is only around $400 ($200 if you sign up on the spot) which is much cheaper than many other courses out there. (That was only for the foundation course, the actual MIP is $3495, that's definitely going to be one of the most expensive I have seen so far other than a $10k course on technical analysis) Another benefit will be the quarterly networking sessions which I think might be helpful in generating new investment ideas since fantastic companies are very rare to come by. What I think is that it is more like having a mentor while reading Philip Fisher, Benjamin Graham, Peter Lynch, Mary Buffett's classics. For e.g. grouping them into 6 types of companies is very similar to Peter Lynch's classification, while finding the right business model and management (2 of the 3R) are like Buffettology and "Common Stock, Uncommon Profit".

    After the end of the talk, he promised to share with everyone 2 value stocks and since gems are hard to find, I  decided to join him in the booth. The moment he showed the LTA's letter for mandatory inspection, I knew he was going to talk about VICOM. However, I do not like the way he presented it and I felt that the 100+ people there are going to be blindly considering buying it now. He concentrated fully on the vehicle inspection business and barely touched on SETSCO calling it a building inspection service which just represents a tiny portion of SETSCO. He went on his pitch about how vehicle inspection is mandatory and VICOM's monopoly position and then showed its revenue and profit growth which lead to its share price increasing. He did not realise that it was due to the dropping de-registration rate that led to the increase in profits. It was also the management's ability to grow and develop SETSCO that VICOM is what it is currently. The second company that he chose was OKP, but I was late for it and only managed to catch him selling his program at the end.

    Indeed, I learnt the most from the first 2 seminars than the latter 2. I also cannot help to feel that I am very blessed and lucky to have been shown the proper direction. Many retail investors are probably being "misled " into going for programs or taught improper methods of investing like the leveraged dividend investing. Even for the value investing program, the "misleading" part is done in the testimonial where people are getting 33%, 67% ROI to winning equivalent of a 5 room HDB. In case you wonder how it's achieved when Buffett is probably only earning 20%, they were all invested in 2009 which was the lowest point after the 2008 GFC. Neither do I believe that he becomes a millionaire solely by investing, a great portion of the income should have come from his brand consultancy company. While I didn't really attend Adam Khoo's seminar, hearing him for a few minutes and I knew that this guy was a great salesman and speaker. After the talk, I supposed there's at least 100 that went to flood the booth to sign up for the course. Neither is it really that evil since he's talking about index investing. However, do we really need to pay money for people to convince us to do index investing?

    Next week I will be doing a 2-part review of VICOM for FY 2011 before the AGM on 26th April.

    (I have no vested interest with any of the speakers and program above)

    Saturday, April 7, 2012

    Cordlife Group - Potential Growing Recurring Income?

    This seemed to be one of the most spectacular IPO that I have seen after Sheng Siong, with the share price being driven up by 50% from its original IPO price of $0.49. At the current price of 20, seemed like people is treating it as a healthcare stock like RMG and Q&M Dental.

    On the surface, the business model does look pretty enticing. It is the market leader in Singapore with a market share of 62% and the market is still relatively untapped at only 25%. CAGR is expected to be 9-10% till 2015 and competition is weak with 2 other competitors - Stem Cord and a public cord blood bank.  Most importantly, it has a recurring income as after you deposit with them they will continue to recognise revenue over the next 18 years. On a closer examination, this stock is more like a rose where the thorn is hidden underneath.

    Let's start off with the 62% market share. What exactly is the difference between Cordlife and its rival StemCord that creates a 26% disparity in market share? Both started at around the same time in 2001 and 2002. Both have enough spaces for storage of cordblood for many many more years to go. The key advantage that Cordlife has over StemCord lies in its AABB accreditation. From what I found on the web, this accreditation as well as the Sepax technology seemed to be the one that pushes people to choose Cordlife over StemCord, not unexpected. A quick look at the AABB and it seemed like it is not really hard to get one. If StemCord can get pass Singapore's standard, I doubt it can't get AABB. StemCord does have a FACT-NetCord accreditation, but the name is just not as sophisticated as AABB. So in essence, what is driving the market share is a better image though I am sure 90% of the people that chooses CordLife really understand AABB and Sepax. This is of course not a durable competitive advantage as nothing is stopping StemCord from getting it. Imagine StemCord having FACT-NetCord and AABB, then Cordlife will lose its market leadership.

    There's another challenge coming up from the Singapore Cord Blood Bank, which is a public cord blood bank with an AABB accreditation too. There's no fee in depositing with them as it is supposed to be a donation.Currently, it has a cumulative storage figures of 7000 and they are working towards the 10,000 figures by 2014. And when that happens, it means that they are able to provide Asian and Singapore's patients an 80% chance of finding a suitable match, which will make private cord blood banking rather pointless though there will still be people who will pay for it. This is possible because it is unlike a traditional bone marrow transplant which requires a 100 percent match.

    As for its Hong Kong's operation, there's a lot more competition there such that they only manage to secure 28% market share. There's 3 big player, 2 small players and 1 public bank. The largest is Healthbaby with a 45% market share and Cryolife with a market share of 23%. In Hong Kong, there is no regulation  to act as a barrier of entry as all that's needed is the registration of business.

    An estimated CAGR of 9-10% is pretty impressive which means a total increase of 40% - 46% by 2015. To achieve such growth for the industries, either the acceptance rate increases or the number of live birth increases. As seen from the above figures, total number of live birth remain the same after 30 years despite our population doubling from 2.4m to 5m. As such, to expect our total number of live birth to grow is simply ridiculous.

    For acceptance rate to grow from 25% to 38%, I am not too sure either. It's possible but checking with figures worldwide reveal that Singapore has one of the highest penetration rate at 25%. Estimated penetration rate in the UK and US are lower than that. In countries like Italy and France, private cord blood banking is banned as they believed in public bank. Other than acceptance, cost will be another major issue given that it's not exactly cheap either. The reason why acceptance rate remains low throughout the world is that it is still at an early stage of development where the long term applicability is still in doubt. It is only able to support the transplant of a person weighing at most 50 kg. Thus it is a limited 18-years insurance and not a whole-life policy.

    Given that 2011 has passed, let's look at whether there's the claimed 9% increase in number of customers. 2009 was a period of strong growth as Cordlife had a 60% growth in client deliveries. It continued to enjoy a 25% growth in 2010 of which Singapore's figure grow by 20%. This was also the year where the DTFAS report stated that penetration rate for Singapore reached 24%. This remarkable result is not very surprising given that the initial penetration rate was only 16%. Looking at 2011 results, Hong Kong suffered a 25% drop while Singapore had a 10% drop in deliveries. If CAGR is really at 9-10%, it just means that Cordlife loses its 62% market share in 2011 or that the the penetration rate drop by 10%. This is not forgetting the fact that in 2011, total live birth increases by 5% as seen from the figures earlier. The reason provided was due to "leading-on effects arising from the deteriorating global economic condition", which makes me wonder what will happen in a full-blown recession...

    If it's existing market fails to thrive, there's always new market to expand into. This paragraph in the prospectus catches my attention.

    "Currently, our targeted markets for acquisitions include Indonesia, India and the Philippines. In connection with our demerger from CBB, we had entered into the ROFR Agreement pursuant to which we were granted a right of first refusal to acquire CBB’s cord blood banking businesses and operating companies in Indonesia, the Philippines and India, should CBB propose to sell their cord blood banking businesses in these jurisdictions within the respective periods as stipulated in the ROFR Agreement. The Non-Compete Agreement prohibits our Company from undertaking any activities or carrying on any business or trade that competes directly with the business carried on or proposed to be carried on by CBB in Indonesia, India and the Philippines for the respective periods."

    "Furthermore, it is envisaged that once Cordlife India turns profitable, our Company, pursuant to the Right of First Refusal, will have the first opportunity to acquire Cordlife India, should CBB decide to dispose of Cordlife India at that time."

    This reminds me of the great business model of CapitaMalls Asia where, CMA will develop the asset before selling to its REITs. It seemed like the whole purpose of a demerger and listing in SGX is to help to provide cashflow to CBB who is listed in ASX. This is crucial to the survival of CBB who has been profitable in only 2 of the 8 years it has been listed. While it is normal to see accumulated profit in the Balance Sheet, there's only an accumulated losses of $62m found. The equity raised as well as future cash flow will all be used to fund acquisition of India, Indonesia and Philippines operation when they turned profitable. This is a reason why the management hinted that dividend payout will only be 10-25% despite the $5m recurring cash flow it will have. 

    Lastly, we shall talk about the recurring cash flow, which is worth around $5 million annually based on 20,000 customers multiplied by $250. This is pretty tricky as it is a recurring cashflow of $5m and not recurring revenue.

    "Revenue is recognised upon the completion of processing of cord blood units collected and subsequently at the completion of each year of storage. Once the processing of the cord blood unit is completed, based on existing costs information, approximately 88.0% of the total revenue is recognised. The remaining 12.0% is recognised in approximately equal portions at the completion of each year of storage."
    What this means is of the $6200 lump sum paid, $5456 will be recognised as revenue leaving $744 to be recognised over the next 21 years. This will be 0.6% per year subsequently which means recurring revenue is at its minimum. Even if you will to let Cordlife run for another 21 years, it will only generate at most 12% of recurring revenue. Then how did Cordlife mange to produce $5m recurring cashflow yearly, which is currently around 16% of its revenue?

    This is the key to the question. 3 payment options are provided but this does not change the way revenues are recognised. As mentioned, 88% of the cost is incurred at the initial stage ($5456) which means that the company will have receivables of $1200 or $3500 in their first year. Thus, in 2011, it has a non-current trade receivables of $23m and current trade receivables of $7m, which is $5m more than its total revenue in 2011. Of course, for those that paid in advance, it will be booked as Deferred Revenue which stands at $9.5m. So is the recurring cashflow to be desired? Obviously no, as the best case scenario will be for the customers to pay them $6200 upfront and not through instalment. The 20 years instalment will give them a total of $6950 in Future Value which is equivalent to $5700 using a 2.73% discount rate (Singapore's historical inflation rate) for the instalment. Not only do they have to take a 10% discount, they will also have to bear the initial cost for at least until the 14th years before they can recoup back. If cost were to be raised significantly, there's no way that they are going to pass on the cost to the customer.

    To conclude, any future rise in profit is likely to come from increased penetration rate on the assumption that Cordlife can maintain its dominance in Singapore. It has chosen a very good year to be listed as the Year of Dragon has always lead to at least 10% increases in total live birth. However, this does means that profit is likely to drop next year as the Dragon only comes round once every 12 years. If this bumper crop is only able to bring its clients deliverables to the 2010 standard, it simply means that 24% is likely to be the peak in the penetration rate. As with the CMA model, expect Cordlife to continue to feed its cash flow to the dying CBB, who is trying to cash out on whichever business that turns profitable first. At the current PE of 20, all potential growth seemed to have been accounted for.

    And of course, it does make CBB a better long option than Cordlife who is intending to give much more dividend to its parent than the shareholders.

    Tuesday, April 3, 2012

    6 Months Later

    It has been slightly more than 6 months since I have started investing and I am still holding on to one of the two stocks that I first bought on 22th of September 2011. One is a success (VICOM) while the other was a lesson learnt from blindly following Peter Lynch (Eratat Lifestyle). 9 out of my first 10 trades resulted in realised loss and this prompt me to become serious about investing. I did started reading The Intelligent Investor before that but to be able to internalize it and maintain one's emotional stability is another issue.

    I am pretty satisfied with the progress that I have made thus far, of course not before the various trip and fall that I have suffered. From getting very excited about the intra day up-tick and down-tick , I am now able to control myself to look at the stock prices only at the end of the trading session. The more one does not look at it, the easier it is not to get affected by Mr Market. Hopefully, I will be able to reach the stage where I will only be looking at the price once every month instead.

    Accounting wise, I am now able to decipher and interpret financial report of most companies, other than those unusual terms that may come out once in a while. I have also gained an understanding of what FCF and ROE are really all about as well as the difference between economic profit and accounting profit. This understanding has allowed me to build my screen and modify it along the way. There's no easier way to learn about these other than to practise analysing the various annual report. I will be focusing more on valuation techniques next though I do understand that they are meant to serve as a guide as they can never be a precise valuation. However, without having an estimation of the intrinsic value, how can I be following a margin of safety?

    For business fundamentals, the more I learn, the less I know. Whereas profit is all about revenue minus cost, business is often another issue. While cost management is important, focusing overtly on it is akin to being a short-term looking manager and not being an owner. For e.g., in The Hour Glass, staffs are being "very, very well-compensated" so as to keep staff turnover very low. This is because it often takes years to make sure that they are knowledgeable about watches and adequately trained. Reading "What I learned before I sold to Warren Buffett" by Barnett C. Helzberg, you will know that he is the classic owner-manager and how he goes about building the Helzberg Diamonds to what it is today.  In such relationship-type of business, customer satisfaction and quality of products are more important than cost. As buying a stock is the same as buying a business, understanding how business operates will be a key priority. I will also be exposing myself more to stocks outside my area of competence like finance, property, offshore and marine and manufacturing. By the end of the year, I hope to be able to do a write-up on who's the strongest bank in Singapore through analysing their financial statement.

    2 events of great significance happened during this 6 months journey. The first was joining Value Buddies forum in December. Value Buddies is a great place where you have lots of veterans there sharing their experience and knowledge. Serious questioning and debates help to challenge and train the mind, in applying the same rigorous thought process in stock selection. Positive peer pressure also helps to keep one in check in exercising control over Mr Market as well as Greed and Fear.

    The second was the decision to start this blog at the end of December 2011 when one of the blog that I have been following was discontinued. I am surprised that total visits have exceeded 10,000 in less than 3 months and I will like to thank all the readers for the support. This blog has allowed me to rationalise and structure my thought process as well as honing my equity research analysis skill.

    Going forward, I will like to focus more on doing shorter company write-up than doing equity research report as the latter involves a lot more time wasted on compiling and writing than the actual analysis. Given that my basic has been more firm, I will also be starting to venture out of my circle of competence and these shorter company write-up will be useful. As for equity research report, I will likely be doing one again in either June or July.

    Company analysis aside, Young Investor Series will also be part of my focus as I feel that financial knowledge and investment know-how are seriously lacking in our mainstream education. Of course, I must make sure that I am capable and knowledgeable before I can teach others, thus this will be done at a slower pace. And one last focus will be for me to pen down my thoughts and philosophy on investing , be it regarding business model, financial statement analysis or value investing principles.

    With all these in mind, I shall continue on the next 6 months of journey where I will reach the 1 year mark. I do hope that VICOM will stop spiking up so that I can reach the milestone of holding a stock for more than a year.