Tuesday, December 25, 2012

Sales of SIA Engineering

SIA Engineering purchased at average price of $3.562 and sold at average price of $4.107 with total dividend received of $0.10 in early November 2012. Total gain is 18.1% in a timespan of 10 months.

Before we review the rationale for sale, it is important to look at the rationale of purchase. At that point in time (Dec 2011), it was 3 months into my investing journey and I had given up on speculation. At that time, SIA EC drops to $3.55 and it looks like one of the blue chips that I can rely on after drifting into the red. MRO is a growing business and SIA EC has quite a strong market share in MRO and line maintenance with its link to SIA. Both segment of the businesses are pretty resilient given the regulation in place for checks to be conducted. It has a very clean balance sheet and shows a respectable ROE. Strong free cash flow yield and dividend from associate results in a close to 6% dividend. In other words, safety was my key concern then.

Rationale for Sale

And in 2012, we witness a mild bull run among all the dividend stocks, be it in REITs or in the high-dividend paying blue chips. This yield compression is as a result of the uncertain gloomy economics condition, continued monetary easing and the low interest rate circumstances which investors are stuck in with no other place to go. Will interest rate continue to stay low forever? Perhaps for the next 2-3 years until US's unemployment rate falls below 6.5%. In any case, there seemed to be a limit to further yield compression though Mr Market can be really unpredictable at times. Hence, the upside seemed limited on the assumption of the same dividend paid.

While all along I have known the importance of the JVs and associates to SIA EC, it was only after attending  the AGM that I realised the amount of cannibalisation going on during the past decade and that 3 particular associates account for a highly significant proportion of the results from associates and JV. And the problem is that I am unable to fully understand ESA and SAESL though their profitability seemed to be amazing. I hate it when I cannot get a good grasp of all there's to know about the company especially when these are significant contributors to the bottom line.

As for its growth potential, there's seemed to be some factors that might slow the growth. Slow is the word and not no growth. Firstly, almost all of its associates and JV's revenues are earned in USD. And as everybody knows, the USD has been depreciating against the Sing dollars and over the decade this has greatly reduced the absolute Sing dollar growth from its associate. If they reinvest all their profits, then this exchange rate problem will be just a mere accounting problem. However, since it is so highly reliant on its associate and JV to fund its dividend, those USD will have to be converted to SGD and hence growth will continue to be impacted by the movement in exchange rate. Margin will be impacted as labour cost is paid in SGD. For as long as USA still prefers to print money to resolve its debt and economic problem, USD will continue to weaken.

Another factor will be that new aircraft has much lower maintenance cost as compared to other aircraft. For e.g. Boeing 787 Dreamliner will only need to undergo a D check after 12 years as compared to the traditional 4-5 years for normal aircraft. In all, Boeing claims that it will reduce the maintenance cost by 30%. It seemed to be a trend that newer aircraft requires much lesser maintenance as compared to the previous generation.

Fundamentally, the overall growth of the MRO sector seemed intact but I believe that the 2 factors mentioned above will be a drag on its growth. And on a portfolio basis, as the STI continues to rise, it seemed like holding on to the cash option sounds much more attractive. As I have advanced in my investment journey, small cap and mid cap will be preferred over the blue chip unless great opportunities arrive. I believed that more opportunities will exist in the small cap and mid cap space where they are less covered and attract less attention from the institutional investor.

Monday, December 10, 2012

Genting Singapore - Part 2

For this part, we shall have a look at the business of Genting Singapore. As everybody knows, the key attraction of Genting Singapore is that it is one of the only 2 IR operators in Singapore and many believe that casino and duopoly equate to a highly profitable business as seen from the prosperous Macau.

Understanding the business model of a casino

More than 80% of Genting Singapore's revenue come from its gaming revenue while the other 20% comes from hotel, USS and Marine Life Park. Hence, gaming is at the core of Genting Singapore and will be the focus of the post today. To operate a casino, one needs a license from the government and in the case of Singapore, the area of casino is capped at 15,000 sqm. Thus, within this limited 15,000 sqm area, a casino will have to optimize its area by placing the table and machine at the appropriate place to maximize its revenue per sqm. Next, for each table it has to maximize the turnover by having as much game played as possible. Finally, odds are calculated in such a way that the casino operator will always have an edge over the gambler. Win rate for the casino operator is often much lower at 1-8% as compared to much higher rate than Toto, 4D or lottery operator. Hence, volume is much more important for casino and the higher the volume, the higher their profit and the more likely the win rate tends to their edge due to the law of large numbers. Another reason why volume is important is that casino requires huge initial capital expenditure and outlay as seen from Genting's balance sheet where PPE accounts for 55% of their asset.  There's also high fixed cost in the number of dealers, tables and cards which need to be paid for regardless whether there's only 1 gambler at the table or there're 10.

Industry Outlook

It is indeed true that the casino operators in Singapore enjoy a very healthy duopoly market structure which should theoretically bestow upon them high profit margin and ROE. However, many have not realized that for the casino in Singapore to prosper, they will need to rely much more on foreigner rather than the locals. Singapore certainly has a much lower population compared to other countries in the region which means that to generate higher volume of gamblers, Singapore will need to continue to attract tourist and foreigners to come to Singapore to gamble. What this means is while we can safely say that it is a duopoly in terms of capturing the local market, it seemed to be a regional competition for foreign gamblers that is much more important.

However, as a results of its initial success for its 2 IRs, there are now increasing competition in the region as we see numerous countries in the region opening new casinos from 2012 -2015. Vietnam, Philippines and Cambodia will be opening new casinos in 2012 and 2013. Russia and South Korea will also be building new casinos to attract the tourist while Taiwan has already legalized casinos. Both Japan and Thailand are also debating on the issue of legalization of casinos. As such, it seemed like competition is fierce within the region with better and newer casinos built over the next few years.

Given these various forms of competition, it seemed like Macau is still going to be the most thriving gaming countries in Asia. More casinos are going to open in the Cotai Strip and Macau easily outclassed the 2nd largest casino market, Las vegas, by 2-3x more in revenue. Despite supposed slowdown in China in lieu of the changeover of leadership, Macau is still expected to grow by 10-15% this year as compared to 5% for Singapore according to S&P. In the next 5 years, Macau's gaming industry is expected to grow by 15% as compared to 5-8% for Singapore. So what exactly is the secret to Macau's success that is hard for Singapore's 2 IRs to replicate? What is the reason to Macau's average ROA of 20% and ROE of 60% as compared to Genting Singapore's 10-15%.

The business model of Macau's casino

Essentially, Macau's casino runs on a junket model where the junket accounts for 75% of their revenue. Junkets are middleman who will bring in the high net worth individual (HNWI) to the casino and will take in a portion of the HNWI's total chips played. The casinos will also offer rebates and free chips to HNWI to attract these big whales to play in the casino. Hence, in such a model, the profit margin for the casino operators will be much lower. However, they will be able to attract the volume which is essential for the casino as the fixed cost of a casino is high.

In fact, junket has been the critical factor for the success of Macau's gambling industry that other countries are unable to replicate. These junkets are like the private bankers that establish the relationship with important clients and bring in the revenue. Many of the HNWI from China will prefer to go in a group lead by junket as they enjoys special rebate and networking opportunity. Coupled with its close proximity to China, Macau is the natural destination for the wealthy Chinese which takes on a more active attitude towards gambling as compared to the Westerner.

However, in the case of Singapore, the government does not allow and is very cautious of junket operation. Even for the 2 operators allowed for Genting Singapore, they are called as International Market Agent and they are very small players based in Malaysia and not Macau or Hong Kong. This is bad for RWS and MBS as the mass market often stagnate within 2-3 years and it is the junket that is needed to drive VIP's volume growth.

High DSO and impairment loss of receivables

In part 1, I have discussed about the high DSO of 5 months for Genting Singapore and the frequent impairment loss on receivables of 17% for Genting Singapore.This is in fact linked to the lack of junket operation in Singapore. In Macau, not only does the junket brings in the HNWI, they are also responsible for the collection of the debt. As such, Macau has very low receivables on its balance sheet and is able to enjoy higher ROA and better working capital management. Debts are often a problematic issue for VIP customers for casino as they are also afraid that being too aggressive in collection of debt will deter the clients from visiting their casinos again.

For Singapore, due to the lack of junket operation, the 2 operators have been slack on their credit policies in a bid to attract the VIP customers. They allow them higher credit, longer term of collection and these results in the high receivables amount as seen on its balance sheet. If we were to take into account that the mass market often produces no receivables as no credit is to be issued to them, the actual DSO from the VIP business is much higher. As seen, the implication of junket is not just a higher revenue but a better working capital management as well as higher quality of earning.

Given the huge differences in growth potential, ROE, DSO, it seemed like the 2 casino operators pale in comparison to the many Macau's casinos listed on the Hong Kong exchange who are also able to offer much higher dividend yield as compared to Singapore. Unless the government approves the junket operation in Singapore (which is very unlikely), it seemed like Genting Singapore is going to face a stagnant market where growth will at best be single digits and the fact that 16% of its receivables have to be impaired annually.