Monday, August 20, 2012

VICOM - 2012 1H Update

With the release of 2012 1H results, VICOM has hit an all-time high of $4.70 after PAT increased by 10.7% in 2012 1H.

Figure 1 - Income Statement

The 1st quarter has been the most spectacular with profit growing by 13.2%. Comparatively, Q2 2012 has not been as fantastic, delivering a 8.1% growth on profit after taxation. Revenue for both period grows at an average of 7.9%. Unfortunately, VICOM no longer discloses the segmental result after the change of CEO. Personally, I believe that both segments should be delivering similar growth at 7-8% and not that one particular segment has been driving the growth. 

Back to operating expense, total operating expense increases by 8.6% in 2Q 2012 and 3.1% in 1Q 2012. Staff cost increases by only 0.4% in 1Q 2012 due to write-back of provisional bonus while in 2Q2012 it is in line with total revenue growth. Depreciation expenses increase as a result of higher depreciation coming from the new building at teban garden. All other operating expenses continue to increase above the increase in revenue which makes me wonder if cost-saving is indeed achieved from shifting the HQ to teban garden.

With the help of lower taxation in 2Q 2012, VICOM managed to achieve a 8.1% growth in profit. Lower taxation comes from "enhanced capital allowances on qualifying expenditure under the Productivity and Innovation".

Figure 2 - Balance Sheet

After the distribution of $9.4m in final dividend, cash and bank balances manage to increase by $600k despite a $3.5m reduction in trade and other payables. Nothing else worth mentioning about the balance sheet other than that compared to FY2011, vehicles, premises and equipment decreases from $55.5m to $54.7m which shows that depreciation is more than total capital expenditure.

For cash flow statement, VICOM generated 81% operating cash on net profit after taxation. It is supposed to be higher as trade receivables increased by $1m and trade payables decreased by $3.5m. Total capital expenditure is only $1.9m for 1H 2012 which is about 15% of net profit. Personally, I do expect a 100% and above FCF/Net Profit Yield for FY 2012. As capex has been significantly reduced with the completion of new HQ at SETSCO, the interim dividend declared increases from 6.9 cents to 7.5 cents. This is still a very comfortable payout ratio for VICOM and there's certainly room for another 10-20% more. Total dividend paid for the interim will be $6.6m which is approximately net profit for a single quarter.


Just last month, Minister Lui has announced a few measures to ease the spike in prices of COE which are marginally beneficial to VICOM. Initially, car population growth rate is supposed to be cut from the current 1.5% to 0.5% by August this year and continued until 2014 where the growth rate will be subjected to change. The authority has since delayed the cut to 0.5% to February 2013 while maintaining a 1% growth rate from August 2012. According to LTA, an additional 390 COE will be made available per month which works out to an extra 2340 vehicles in total.

The clawback of oversupply of COEs will also be delayed by a year to July 2013, making available 266 more COE per month, which is 3192 in total. In another move, LTA has set the taxi fleet growth rate at 2% pa from Aug 2012 to December 2013 and they will not be bidding for COE. While the 2% growth rate will come at the expense of Cat E COE, a taxi contributes 7x the revenue of a civilian car in a 3 years period.

These measures are temporary moves that will only defer the cut so as to alleviate the spiking COE prices which played an important role in our CPI. Most importantly, they signal the will of the government to resolve the problem of overcrowding vehicle population.

Figure 3 - Age Distribution Data

The age distribution data has been one of the most important data that I monitored monthly from the LTA site as it determines the proportion of the population undergoing inspection. The continued ageing profile of vehicle population has continued to amaze me. As seen from Figure 3, the proportion of vehicle aged 6 years and above has increased by 9.7% in July 2012 as compared to December 2011. When this ageing will start to peak is beyond my ability though I do expect the trend to continue at least until the end of this year. For as long as the price of COE remains at the current level, I do not foresee any significant reversal in the age profile.

As for SETSCO, I am not aware of any new service that they have been accredited in FY 2012. As for inspection of central alarm monitoring station (CAMS), they are currently still the only one with the appropriate accreditation.

Should the earning growth continues, we should expect a minimum of 8-10% profit growth in FY 2012. Assuming a 10% growth, total dividend to be paid out for FY 2012 will be $0.194 based on similar payout ratio of 60%. At the current price of $4.56, it will give us a 4.25% dividend yield, PER of 15.4x or Forward PER of 14.3. Many will definitely ask me whether it is the right price to buy or not and my answer will be that the margin of safety at the current price will be limited. However, I will still be holding on to my shareholding as I believe that the growth story of VICOM is not yet over and will be able to prove its resilience during this period of economic uncertainty.

Tuesday, August 14, 2012

Healthway Medical Corp Ltd - Turnaround probably not in the short term

Healthway Medical Corp is one of the few companies in the healthcare sector listed on the SGX, operating the biggest clinic network in Singapore. Other than operating GP clinics and dental services, they are also involved in specialist & wellness healthcare division which is involved in Paediatrics, Orthopaedics and Aesthetic Medicine.

Figure 1 - Income Statement

FYI, 2005 to 2007 results are PRO FORMA results found from the IPO prospectus and hence might differ from the actual figure that you see from the FY 2008 annual report. In fact, the pro forma result in 2007 is the highest level of profit that the group has ever recorded in its operating history. The trouble in Healthway occured in 2010 when a group of specialists decided to leave en mass which created a vacuum and losses of customers. What happened is the start of a drop in profitability which accumulated till 2011 where a $58m of intangible asset is being written off. In 2010, they should have also been in the red if not for gain from acquisition of Crane Medical and disposal of Healthway Medical Enterprises. 

2012 1H looks like a pretty good set of result that shows some turnaround occurring with Healthway recording a 10% margin for 2 straight quarters. The question is then has it really turned around? In actual fact, it seemed like the company has largely relied on its other income to boost its profitability. Looking back into the annual report 2011, the company has deferred booking $7.1m in income due to prudent reason of which it has booked approximately $1.6m in 2012 Q2 and perhaps another $1.2m in 2012 Q1 under other income. For more details regarding the deferred income, please refer to$file/HMCMaterialVariances.pdf?openelement
Now, I shall present the pro forma income statement for 2012 Q1 and Q2 after stripping out these deferred income from 2011.

Figure 2 - Pro Forma Income Statement for 2012 1H

What we see is that nothing much has changed for 2012 1H after taking away the deferred income from 2011, and the company is obviously still struggling to maintain its profitability. Since these deferred income is non-recurrent in nature, it seemed like the company is still stuck in the limbo.

Figure 3 - Operating expense ratio

Figure 3 will allow us to understand the loss in profitability of the company since 2010. From figure 3, we can easily see that the main cause of the losses has been staff cost which has risen from around 44% in 2008 and 2009 to approximately 56% of revenue ever since 2010. In 2012 Q1 and Q2, this has also been held true which goes to show that the level of profitability is similar to that in 2010 and 2011. Do take note that actual percentage for 2011 should also be around 55% as the company chose to "derecognised staff cost recharges of $4.5 million to a 3rd party which remained unpaid" (part of the $7.1 million in deferred income).

However, it is not all bleak from the above figure. The cost of medical supplies and other operating expense as a percentage of revenue have held pretty steady which means that the company has been able to pass on increase in medicine cost and rental to its customers. Another positive point to note lies in its staff cost which in fact provide huge potential for operating leverage given that this is largely a fix cost. If Healthway can focus on increasing its revenue per clinic per doctor, it will definitely be able to return to its profitability in 2009. However, it seemed like the company's main focus is still on further expanding their services be it in specialist, aesthetic or in China.

Figure 4 - Balance Sheet

This is definitely not the ideal balance sheet that any company should have and the biggest problem will be in the intangible asset which stands at $119m compared to $198m in total asset and $160m in total equity. I will discuss about the intangible asset later on. The new management has done a pretty good job in reducing the total debt from a high of $68m in 2008 to the current debt level of $17m. Cash has unfortunately dwindled down to a worryingly level of $5m which raise the prospect of some form of financing option in the short term. However, the group has a loan receivables of $15m which are supposed to be returned to them in the current financial year and this will hopefully strengthen their balance sheet.  

Intangible Asset

Let's explore the intangible asset which is worth $179m at its high in 2007. When company A uses $10m to acquire company B with net tangible asset of $5m, the excess $5m over the NTA will be booked under intangible asset. Therefore, we have to trace back the history of HMC to understand how did such a huge amount of intangible asset appears in the first place.

Founded by Dr Wong Weng Hong in 1990, HMG expanded its network of clinic to 15 by 1997 and 31 in 2002 before it went on to acquire 4 clinics under "Singapore Family Clinic and Surgery". A management buyout was carried out in 2006 by the founder together with Fan Kow Hin, Dr Jong Hee Sen and a few other investors. By the end of 2006, the group only has a total of 38 clinics, which paled far in comparison to the 80+ they had by the time they were listed in 2008. In the mere span of 1 year, the group went on a massive acquisition spree paying $72.32 million for "Silver Cross" and "Peace" group of family clinic, "Aaron" and "Universal" groups of dental clinics, "Paediatric Centre", "BCNG Laser and Medical Aesthetics". They also went into agreement to acquire IOC, IOCH, SBCC Clinic and SBCC S&T for $107.9m. Therefore, by spending $180m the group managed to expand from a sole family medicine clinic chain into specialist and wellness healthcare services before they got themselves listed on the exchange. Given that they do not have that much cash at that point in time, the acquisition was done through offering of share which lead to its specialist leaving en mass in 2010.

Figure 5 - Intangible Asset

Figure 5 shows us the breakdown of intangible asset as well as the impairment loss carried out in 2011. We can see that the bulk of the write down are for Paediatrics and Orthopaedics which falls under the specialist segment. Family medicine is probably their strongest division as no write-down has been carried out so far. It seemed like it has been a huge mistake for the firm to acquire IOCC, Paediatrics Centre and SBCC in 2007.  

The greater concern currently will then be is the write-down in 2011 the last of impairment loss? Unfortunately, what I see is that another $60m in intangible asset needs to be written down. The calculation of impairment is based on DCF calculation using a discount rate of 8.5% and projecting a terminal value based on the EBIT "from the 6th year at annual growth rate of 1% to 3% to perpetuity." This is definitely acceptable to me. The devil is in the detail where the cash flow growth is projected for the first 5 years. For Family Medicine, Dentistry and Wellness and aesthetics, expected annual revenue growth is approximately 4% from 2012 to 2016.

However, for the Paediatrics and Orthopaedics division, the anticipated annual revenue growth is 9% from 2012 to 2016! Remember that these 2 divisions were the ones that have to be written off in 2011, then why does it have so much higher projected revenue growth than the family medicine? Specialist and Wellness segment produced a loss of $3.7m on revenue of $25.6m before the impairment loss. What's more, the anticipated annual revenue growth in FY 2010 for  Paediatrics and Orthopaedics was at 4% and after 1 year of poor performance, they are now expected to deliver double the revenue growth in FY 2011. I believe that the increase in anticipated annual revenue growth from 4% to 9% is done so as to reduce the amount of impairment loss being recognised in 2011 for both Paediatrics and Orthopaedics division. In any case, I believe that it is pretty reasonable to expect a complete write-off of total intangible asset of $59.5 m for these 2 particular divisions. Garbage In, Garbage Out, but not unexpected from a firm that seemed to love performing financial engineering since they are listed.

Figure 6 - Profitability Ratio

Many might have pointed out that its ROA even in its most profitable year is unimpressive at 7.7% based on the Pro Forma statement. However, if we were to strip out the intangible asset, it seemed like we have a highly profitable business at least before what happened in 2010. As for free cash flow, it seemed like has the ability to generate good cashflow in the long run should profitability stay or improve. Total capex for 5 years are only at $8.5 million of which majority occurred in 2010 where multiple specialist clinics are opened especially the ones at Tripleone Somerset. 

From a valuation point of view, despite the fact that price has tumbled since IPO, the company does not look attractive. With a PSR of 2.0, even if the company manages to return to a 10% profit margin, it will be a PER of 20 which is just slightly lower than the well-run Raffles Medical Group which has a much better track record and balance sheet.

To conclude, an actual turnaround has not really occurred despite the return to profitability in 2012 1H. Discounting the deferred income from 2011, profitability probably remains the same as the past 2 years. For as long as the intangible asset stays in the balance sheet, I believe it will be a time bomb that will not be welcomed by investor. While it is reasonable to say that some gestation period is needed for new clinics to turn in profits, it seemed like there remains numerous loss-making clinics around.

Without doubt, things have definitely changed for the better with the new CEO, Mr Lam Pin Woon in Jan 2011 as we see debt being pared down and a much lower staff turnover rate. Discounting the intangible asset, it is likely that they do have a crown jewel in family medicine clinic and management of clinic and asset. However, it seemed like the company has yet to internalise the importance of focus in operation as they embark on their expansion plan in China and specialist division in Singapore at a point where their balance sheet is weak and certain operations are bleeding. Whether the strategy will work out remains to be seen though it is likely that any turnaround will be visible only in the middle to long term, especially when their clientèle base for specialist and wellness builds up.

Sunday, August 5, 2012

SIA Engineering - 3rd Core Business in Engine Overhaul

Many that have attended the AGM for SIA Engineering on 20th July 2012 will have agreed that it has been a great session that provides important insights into the SIAEC's business model during the past decade. One of the most important will have been the fact that the management has been very willing to cannibalise their business to support the growth of their JVs and associate companies.

The first reason is that OEMs are increasingly going into the MRO space and it is either you compete or collaborate. However, as with all collaborations, there must be something which you can offer before the other party will be willing to do so (SIA's business). The second reason is that this is one of the best way for SIAEC to reach out to global clients. Without a JV, the management explained that other airlines might not be willing to engage the service of SIAEC due to certain sensitive data. By forming a JV with credible partners, competing airlines will be less guarded and SIAEC will also be able to tap onto the network of its partner.

The question that pops up now is obviously to what extent has the cannibalisation taken place? However, upon digging deeper into the past years annual report, initial prospectus, analyst presentation, I found a shocking truth with regards to its network of 26 JVs and associate companies. In actual fact, of the 26 joint ventures, there were only 3 that are really important - Eagle Services Asia, Singapore Aero Engine Service Limited and International Engine Component Overhaul Private Limited. What is even more surprising is that the share of profit of these 3 companies are very close to the total operating profit of SIAEC's core business of Line Maintenance and Repair and Overhaul. Coincidently, these 3 companies can in fact be grouped under the Engine Overhaul business and they are with 2 of the top 3 aero engine manufacturers Rolls Royce and Eagle Services Asia.

Figure 1 - Associates

Now, I will take you through the accounting of its associates and JV before I delve deeper into its Engine Overhaul Business. This part might be slightly complicated as it involves accounting for associates and joint venture. Note that Eagle Services Asia is being accounted as part of the Associated Companies as it is 49% owned by SIAEC. "Unquoted shares, at cost" is the initial outlay of capital by SIAEC in forming the associate. Under normal balance sheet term, it is also known as share capital under the Equity portion. "Share of post-acquisition profit" is SIAEC's share of the accumulated profit or retained earning by the companies. Translation adjustment is there as these associate companies don;t report their financial statement in SGD, instead most of them are reporting in terms of USD. 

Figure 2 - Share of Profits of Associates Companies

For 2005 and 2006, 100% of revenue, asset and profits are reported before the accounting is changed in 2007 onwards, where only SIAEC's share of the profit and equity of the company is being reported. Luckily, sufficient information has been divulged for us to understand the profitability of its associated companies. 

Starting with the balance sheet, there is supposedly very little off-balance sheet financing done as the non-current liabilities are only around 3% of net asset. The best measure of profitability are always profit margin as well as ROA and ROE. These figures have been very impressive for its associated companies as we see a profit margin of 8-15%, ROA of 15-25% and ROE of 19-28%. Just by its ROA of 15-25%, we can easily conclude that this business is definitely worth something. 

Something that your might have noticed is that, the performance of its associated companies seemed to have peaked in 2009 with share of profit as well as the profitability ratios dropping. Asking the CEO, he told me that as all its associated companies are being accounted in USD, it has suffered the effect of depreciating USD. Notice that I have sought to account for the translational effect in Figure 1. I applied this to the revenue and net profit and what we see is that revenue has increased but profits have dropped which means that certain business have been dragging the profitability. Given that 3 new ventures have been set up in the past 3 years namely Safran Electronics Asia, Southern Airports Aircraft Maintenance and Panasonic Avionics Services, it could be likely that some of it has not reached its point of break even and hence incurred some losses. 
Joint Venture

Joint Venture
Share of Profit of Joint Venture

There is a very interest fact about its JV, which is that it comprises of only 2 companies, Singapore Aero Engine Services Pte Ltd and International Engine Component Overhaul Pte Ltd which are formed with Rolls Royce. Therefore, we can safely conclude that all of SIAEC's share of profit of joint venture, comes from these 2 JVs which are in the business of engine overhaul.

Over the years, this division has been very successful in growing the top and bottom line ever since it started full operation in 2002. Given that the share of profit from JV companies is $74.7 million, it means that total revenue and profit from these 2 companies amount to $1.5 billion and $148m which is more than total revenue and operating profit of SIAEC in 2012! Compared to the associate companies, the balance sheet for JV is not as clean as there is a $58 million of long-term liabilities which is likely to be debt. Comparable margin with the associate companies, though it seemed to be a super profitable business with a ROA of 28.76% and ROE of 64.94%.  It is very rare to have such a high ROA, which is usually reserved for companies involved in technology or business services. Since 2010 onwards, dividend payout ratio has been close to 100%, which might mean that the business is in a rather auto-pilot mode already. 

Figure 5 - SIA contribution and Engine Overhaul Business

Figure 5 is made up of data derived from the analyst presentation done by SIAEC after release of its full year result. The first row is basically the contribution coming from different segment of its associates and JVs. Initially, it was just Engine Overhaul which comprises of Eagle Service Asia and Singapore Aero Engine Service, as well as all others. As we can see ESA and SAESL easily contribute around  60% of the total profit for share of profit of associate and JV for SIAEC. After FY08/09, the format has changed from Engine Overhaul to Engine Overhaul and Component.

The first table can also help us to pinpoint the weak division that has been dragging down the share of profit of associate. Ever since 2009, both division has taken some hit though the "others" have not yet recovered. What we can deduce is it is likely that the multiple new start-up in Safran, Panasonic and Southern Airport have created some losses, coupled with perhaps a slight drop in profitability of certain associate. As for engine and overhaul, we can easily deduced that ESA might be the culprit as we see that the result from JV has been improving over the years.

Moving on to the 2nd table which is SIA's contribution of JV & associate revenue, and which will reveal the extent of cannibalisation done by SIA to support the JV and associate. For "Others", SIA's contribution has been increasing hitting a peak in FY1112 with $55m in revenue contribution. This does confirm that the Panasonic Avionics is likely to account for the $14m increase in revenue contribution and the reason which the CEO attributed for dragging down the profitability of line maintenance.

For Engine Overhaul and Component, what we see is fluctuating numbers with the lowest point being in FY1011. And this coincides with the decrease in profitability of the division in FY 0910 and 1011. What actually happened? Checking through the Singapore Registered Aircraft Information from CAAS, I realised that it is because SIA has been reducing its number of B747 which runs on P&W engines from 33 in Jan 2008 to 20 in Jan 2011. With the addition of A330 and A380, 80% of the aircraft of SIA are now running on Rolls Royce Engine. This certainly explains why profit from its JV has been increasing over the years while the ESA has been suffering. Some might ask then if SIA switches from P&W engine to Rolls Royce engine, should not the overall contribution by SIA for Engine and Overhaul remains the same? The answer is simply that the new aircraft probably does not need to do an engine overhaul, and hence we starts to see SIA's revenue contribution return to the peak in FY 1112 as these aircraft reaches the stage where repair and overhaul needs to be done.
Now to the 3rd and 4th table, Non-SIA's contribution of JV & associate revenue, we can see that demand for Engine Overhaul and Component has a pretty strong demand. As for others, revenue drops by 60% since FY1011 and I wonder if this is due to an allocation of some revenue from Others to Engine Overhaul and Component. In any case, we can see that total revenue from Non-SIA has been increasing from $1.265 billion in FY0506 to $2.67 billion in FY1112. They have achieved success in growing the Non-SIA business  to more than 80% for the last 3 years.

Eagle Service Asia and Singapore Aero Engine Service Pte Ltd

Without much doubt, these 2 forms the core of SIAEC's associate and JV and they are in the business of engine overhaul and repair for P&W and Rolls Royce. Usually, when engines are purchased from the OEM, a package is purchased that includes repair and overhaul for a period of time. These aftercare services are often more profitable than the actual selling of the engine and also provides future source of income for the OEM.
Figure 6 - P&W

Eagle Service Asia is an important arm of Pratts & Whitney handling the engine overhaul business in South East Asia. P&W also provides engine overhaul services in New Zealand, North America, China and Turkey.  From a cost point of view, airlines will send their plane to the nearest service centre, giving ESA a monopoly status over the SEA region for repairing of planes running on P&W engine. And in 2012, ESA has been the first engine center designated to service the PW1500G engine, which has been selected as the exclusive engine for Bombardier CSeries aircraft. The PW1000G engine series will be in production by 2013.

Singapore Aero Engine Service Pte Ltd is Rolls Royce's Centre of Excellence that specialises in the repair and overhaul of the successful family of Rolls-Royce Trent aero engines. It is also the only one currently that is able to service all variants of "in-service" Trent Engine. As a reference, the Trent Engine has commonly been used in popular aircraft like B777, A340 and A380 which forms the bulk of SIA's fleet. SilkAir, Tiger Airways and JetStar Airways are all using 2 type of aircraft which are A319 and A320 which are all running on Rolls Royce V2500 engines. Currently, the facility is able to service up to 250 Trent Engines every years. While I am not sure how many other engine overhaul centres are in service around the world, it is likely that the OEM will want to minimize the number of such centres to reduce cost.

In conclusion, SIAEC has a 3rd core business in Engine Overhaul business, just that this has been done through partnering with P&W and Rolls Royce. It has also been a good thing that it has partnered with both OEMs in case any of the 2 loses to each other in competition to be the engine of choice. For this segment, growth will be directly linked to the total number of aircraft in service. As for its other 23 associates, it seemed like they are minor contributors though there is a serious lack of information on them. Feel free to comment on the data above.