Tuesday, January 1, 2013

Review of 2012

The year 2012 marks my first full year as a serious fundamental investor, having indulged in 3 months of speculation in late 2011. It has been a great learning journey through the many ups and downs of the STI as well as my personal portfolio. Early in the year, STI rebounded sharply from the lows to the 3000 level and stayed there until May where the upcoming Greece Election resulted in a temporary flu that saw a 10% dip. Subsequently, STI broke past the 3100 level in October before dropping to 2945 in mid-November. And out of the blue, STI rebounded strongly past the 3100 level before ending at 3167.08 for the year.

My Portfolio

Anyone that has stayed invested throughout 2012 will have reaped substantial return with the STI returning 19.68% year-to-date so long as they have held tight to their stocks during some of the panics. My portfolio (including idle cash) has returned 37.28% through some luck as well as a highly concentrated portfolio that now only consists of 4 stocks: Boustead Singapore, The Hour Glass, Silverlake Axis and VICOM. Given the high concentration of the portfolio, return from any stock will have a huge impact on the portfolio return, be it negative or positive.

Personally, I do not expect such spectacular return every year and neither should you believe that anyone is going to deliver such return year after year. For our public listed companies, quarterly and annual result are sometimes of little guidance to how a company will perform in the long run. For our individual investment track record, it is not the 1 or 2 years of out-performance that counts but rather the total return in 1 full investment cycle (from one big bear [>50% decline] to the next) against the benchmark index return.

My targeted annual return will be 15% in the long run, which comes from a 4-5% dividend yield coupled with a 10% capital appreciation. Dividend has been an important factor for my return this year as they provided me with a 5% return in 2012. The 15% return will be achieved through investing in undervalued stock with great underlying business, through adopting a minimum investment time frame of 1 year and preferably 3 years and beyond. For more details, you can look at this post which I have written a while ago for my selection criteria of companies.

Portfolio Component

As of 31st December 2012, I have 32.1% of portfolio in cash and 67.9% invested in stock. Cash is king and especially in crisis where it can generate extraordinary return when rightly deployed. I have been building up my cash position as I have not bought anything for the last 6 months as a result of the market rebound and that there seemed to be no feasible target at the right price at the moment. Patience is a virtue in the market and I shall continue to wait for the right opportunity to surface. Preferably, I will hope to raise the invested portion to 80-85% to ride with the companies for the long term.

Boustead Singapore

Purchased in Mid-April 2012, this company has returned me one of the highest dividend yield among all my holdings. This is certainly a deeply-valued company that's not easy to understand with 4 divisions and 3 investments. Neither are the divisions easy to understand for the general public, being involved in Geospatial Technology as well as items like Process Heater and Waste Heat Recovery Unit.

The crown jewel in the company lies in its distributorship of ESRI as well as its slowly growing Design Build & Lease portfolio which generates recurring income. ESRI is likely to continue to enjoy double digit growth as GSI still has immense potential and coupled with the fact that both Indonesia and Malaysia have chosen ESRI as the official platform for the government.

Boustead International Heater is a well-established player in the field of process heater where competition is sparse. Their margin for this division has been slightly impacted recently due to their customer, the South Korea EPC, that has practically won almost all the contracts in Middle East with their competitive pricing and hence squeezing their subcontractors. Other than process heater, they are also involved in Waste Heat Recovery Unit for refineries. What the WHRU does is that it recycles the waste heat back into the system as a form of energy. This reduces energy cost and need to flare off gases which are important for refiners as they run on very tiny refinery margin. Every cost savings count. They also have a subsidiary Boustead  Control & Electric that is involved in the upstream business providing process control system.

Other than the current 100,000 sqm DBL portfolio, Boustead Project is the market leader in design and building of industrial building in Singapore, with an added capability of Green Mark with strong execution and delivery record. Lastly, that will be the poorest performing segment of all, Salcon Water which Mr FF Wong has not fully turnaround though its losses are no longer what they used to be. However, Salcon Water does have the technological advantage and is a different specie from the other water treatment companies found on SGX. It is pre-qualified by the Japanese EPC and provide industrial water treatment where the purity and quality are of utmost importance for the manufacturer.

What I like about the business model is that it is involved in the high-margin, asset-light area in the design, project management and execution while not being involved in the asset-heavy and high capex manufacturing which is outsourced to their pool of subcontractors. The problem with such a model is often the lack of control on the quality of manufacturing, but I believe that Boustead Singapore has done a good job to achieve where it is today.

With its net cash of $180m (representing more than one-third of its market capitalisation), strong free cash flow generation with its business model, and high ROE despite its $180m cash hoard and a capable leader, Mr FF Wong, who has certainly delivered more hits than misses - this is a company that I will hope to increase my position in if the price is right. The intrinsic value is certainly far away from its current price. However, this is certainly not a stock where one can expect strong return within months. This is the type of company where one should hold on tightly and ride with the company to enjoy great compounded annual return. As such, this is a stock where I have a investment horizon of 3 years and more, and will be willing to look beyond some of the poorer results that come with its partial order-book driven lumpy revenue. While time is needed to fully realise its value, the ~5% dividend shall be an appetizer during the wait. However, this is certainly not a company for the impatient.

The Hour Glass

Purchased in early January 2012, this company has delivered my highest return to date. A luxury watch retailer based primarily in Singapore, it has been a key beneficiary of the rising wealth of South-East Asia as a whole over the past decade. Luxury watch retailer does not really enjoy strong competitive advantage as the RSP and cost of watches are determined by the respective watch manufacturers ranging from Rolex to Cartier. In addition, retailer also suffers from the rising rental cost that is a further hit to their tight profit margin. So what is it that draw me to this company?

Strong management capability and a tight focus are what I see in THG. In fact, it has delivered one of the best performance I have seen in a pure retailer. Net Profit Margin in 2012 is 9% despite the increase in expenses in preparation for 2 new stores opening in 2012. ROA is very impressive at 14.9% and ROE at 17.7% considering the type of business and industry they are in. This high return on asset and equity is achieved through a respectable profit margin coupled with high inventory turnover that's traditionally more than 2x. For this upcoming fiscal year, inventory turnover has dipped below 2 times, as a result of a dip in macroeconomic condition and the added inventory requirement for the 2 new stores. However, this does not worry me as this is merely a temporary issue and the business is still sound. In any case, the financial metrics make it one of the best luxury watch retailer to be found.

Other than the financial metrics we have seen, there are many other positive signs. Looking back to its history, this company has been fond of diversification to irrelevant industries like selling pizza. However, since the current management, the uncle-nephew team, has taken over, the company has regained their focus in being a pure luxury watch retailer. Of course, the Gems TV mistake has been a bad one and I believe this will be a reminder for the management.

In early 2008, luxury watch industry in Singapore is still enjoying very strong demand. However, THG made a decision to reduce their inventory level despite the healthy demand they still enjoyed. This has been an amazing decision made as the demand collapse and the other retailers are forced to sell their inventory at a discount to generate cash. What this show is not only that they have great foresight but that they dare to act differently from the crowd.

In addition, the change in location of their stores over the year is also a positive sign of their focus. Before Mr Henry Tay mentioned about the Orchard Quadrangle in the 2012 Annual Report, it has been clear that they have executed the strategy with a high level of focus 4 years before. The company closed down the shop in Lucky Plaza and Peninsula Plaza by 2011 and has now secured shops in all 4 corners of the Orchard Quadrangle. At the moment, it has 6 shops in Ngee Ann City, KnightsBridge, Ion Orchard, Tang Plaza, Paragon and Orchard Central. It is amazing that the management takes the step to close down 2 profitable shops where they have been there for decades. Someone that is only focused on short-term profit will obviously not have closed down 2 profitable shops to reinvest in better locations. This is even more important for watch retailer where their working capitals are often tied in the inventory. The company has also waited for years before they open a 2nd store in Hong Kong when they are able to secure a favourable rental rate. They have often taken advantage of recession to expand and open new stores where the costs are often much lower. In 2008 GFC, while many other retailers are suffering, they chose to open 8 new stores across various geographic location over the next 3 years.

I have purchased this company at an average price of $1.14 which was approximately 5x PER and slightly less than the book value at that point in time. While the company boasts a very high ROA, I feel that this should not be a company that should trade at higher than 10x PER. The reason lies in the business model of luxury watch retailer where huge amount of capital is tied in the inventory. When the business grows, inventory in the balance sheet will also grow which means that higher free cash flow that stems from higher profit will be partially pumped in to feed the inventory growth. During a downtime, when revenue is down, inventory will be reduced, and that's when the company enjoyed the strongest free cash flow yield. However,  at the current price I believe that there's still a long way to grow when the economy recovers and with the 2 new stores (1 in Paragon and 1 in Hong Kong) enjoying a full year of operation in 2013. There's always reason behind why a company operating in the same industry can outperform its peers in terms of all the relevant metrics for a retailer. This will be another company where I have an investment horizon of 3 years and beyond. Should the price dip lower than its book value, I will certainly consider adding to my current position.

Silverlake Axis

Purchased in March 2012 where I also initiated a research report on the company at around the same time. Being a core banking software company, it enjoys wide moat and strong competitive advantage in the form of extreme high switching cost. Core banking system is equivalent to the central nervous system of a bank, where it is highly critical for a smooth operation. To change it comes with huge risk such that many are still using legacy system dating back to the 1980s. It is also certainly the market leader in the Southeast Asia region and in numerous countries like Singapore, Indonesia, Malaysia, Vietnam and Brunei.

Software company with a strong moat are often worth looking into as they have a high ROA, strong free cash flow generation, high margin and a huge portion of recurring income. These are characteristics that Silverlake Axis have with a 90% profit margin for licensing, and 65% profit margin for its recurring maintenance and enhancement services. While the profit margin for licensing is ridiculously high, it is not what that really matters for Silverlake. What that matters to me is that after they enjoy the one-time 90% profit margin, they get to enjoy the 65% profit margin maintenance recurring revenue for as long as the customers deployed their CBS. The maintenance income is approximately priced at 15% of the licensing fee which is much lower than many other competitors where their rate is around 18-20%. In addition, every 3-5 years, when the new version is created, there will also be additional revenue for the update. And for Silverlake Axis, all that's needed is to develop a one-time CBS which is a fixed cost that can be reduced as more banks chose their software.

To have an idea of the high switching cost involved, the management said that in their 20+ years of operations, only 2 customers have switched to another system. And in both instances, they came back to Silverlake Axis which means that they have never lost any maintenance customers. Such high switching cost allows Silverlake Axis to REPRICE their maintenance contract by around 2-3% per year whenever they expire. Of course, the management prides themselves on the ability to value-add in justifying the reprice of the maintenance contract. Such a business model is certainly a no-brainer and one of the best gems that's found on SGX though it is a Malaysian company.

When I purchase the company, it really seemed very expensive at a price of $0.350 and PER of 20X and that the licensing fee is a one-time. However, when I work out the profit to be derived from all the contracts that it has secured, this company certainly looks attractively valued given its immense growth potential and strong fundamental. This is a company where the sky is the limit subjected to the number of new contracts that they can secure and of which can change the valuation dramatically given its highly scalable business model. Of course, sky will obviously not be the limit given that high switching cost can also prevent them from stealing market share from their rivals.

They are also likely to be a key beneficiary of the trend where the banking system in the Southeast Asia is still highly fragmented and of which consolidation and M&A are likely to continue. When 2 banks operating 2 different systems merge, it is likely that the larger bank will preserve its systems. And in the customer profile of Silverlake Axis, their clients are of the largest in their respective market, namely OCBC, UOB, CIMB, Maybank, Hong Leong Bank, Bank Mandiri, Bank Rakyat, VietcomBank, BIDV, Bank Islam Brunei Darussalam and TAIB. Notably, 2 Malaysian Bank, CIMB and MayBank seemed to have been very aggressive in their regional expansion in the past few years. Merger contract comes with approximately 40% profit margin and the greater reward will be in the expanded customer base.

Another trend will be the outsourcing done by financial institution as they stick to their core operations. Obviously, the cost of developing the necessary software and maintenance is much higher for the banks themselves than vendor like Silverlake Axis. Of course, for large banks like Citibank, JP Morgan and HSBC, they might have the sufficient resources and the scale to develop their own CBS. However, for our banks in the SouthEast Asia, it is much cheaper to outsource it to Silverlake Axis. Given that many banks are still relying on the legacy system, it seemed like the potential revenue base is still huge.

Despite its spectacular rise, there still seemed room for further upside. Firstly, its associate Global InfoTech should be listing on the Shenzhen exchange in 2013. Secondly, the new RM 135 million contract add more visibility to its orderbook and comes at a time where there has been hardly any new contract of significant size announced. Thirdly, I believe that there's still quite a huge amount of maintenance income from its CIMB contract that has yet to be realised.

While valuation is rich, I do expect its intrinsic value to grow with the company. New contract will certainly be sparse due to the uncertainty that banks are undergoing, but when dust settles new contract win momentum should continue. In the meanwhile, as the maintenance and enhancement services continue to enjoy its slow steady growth, I shall continue to enjoy its quarterly dividend paid. Silverlake Axis simply has too much cash to spend. Mr Goh has also been forward-looking as he no longer view his company as a core banking software provider but rather delivering a Digital Economy Solution. This has been his direction for the company for this decade and reflects the changing dynamics of the banking IT industry.


Purchased in September 2011, this company has been my first stock purchased and has delivered a remarkable return. I also did an initiation on this company on January 2012 over here. VICOM is in the Inspection, Testing and Certification industry with its 2 core business in VICOM (Vehicle Inspection) and SETSCO (Non-Vehicle Inspection).

Regulation is what that allows the industry to thrive. In Singapore, cars have to undergo inspection every 3,5,7,9 year while buses and taxis have to undergo inspection twice every year. This not only forms a very stable recurring revenue, but also one that will roughly grow with the slow overall growth in the total vehicle population in Singapore.  The tightening of COE has been the key driver of growth for VICOM. In 2005, only 30% of the car population and 110% of the Goods & other Vehicle population undergoes inspection. In 2011, 45% of the car population and 132% of the Goods & other Vehicle population undergoes inspection. This is on top of the annual 3% increase in vehicle population in the past. Hence, what we see is a multi-bagger and one with revenue and profit growth for 9 straight years this coming fiscal year. In addition, it has a 75% market share in Singapore that has further expanded with the closure of Ayer Rajah Inspection Centre by STAI in August 2011.

Given its remarkable growth, it seemed like the time has arrived where VICOM is likely to enjoy slowing single-digit growth going forward. Growth will still be maintained by various policies like the Carbon Emissions-based Vehicle Scheme which will encourage take up of diesel vehicle as well as further tightening of vehicle population undergoing inspection. Vehicle population has also grown by around 1-2% this year. Looking at the chart below, one can see that in November 2012, the age distribution of car has reached what is roughly called a Normal Curve. This certainly means that further upside from increase in age distribution profile of vehicle population will be limited

As such, I do hope that its time that SETSCO will take over the growth momentum from VICOM. SETSCO is involved in the inspection, testing and certification of many products that range from chemical, biological, environmental, electrical and mechanical industry. There will be a portion that's highly resilient which include building inspection, food products while another portion will be depended on the economy like civil engineering and e.t.c. While not as attractive as the vehicle inspection business, the return on asset still beats many other businesses out there. Of course, they do have to face certain level of competition but I believe they will prevail with their wide range of services.

Valuation is rich and if we use Peter Lynch's PEG as a measurement, it seemed like it is certainly no longer a buy. This will be one in which I will consider selling should the price continue to rise and should there by a buying opportunity else where. In the meanwhile, I will collect its 4% dividend while awaiting a better switching opportunity.

Learning Journey

The best investment that any investor can make is always to invest in his personal education. In 2012, I have attended 7 AGMs (including 1 as an observer) and 17 seminars/events. This has been remarkable for me given that I have started school in August 2012 and that there has been numerous instances where I have to pull out of seminar due to school commitment. I believed that I have down at least 30 investment books in the year, including 6 books from the fisher investment series. Some of the more memorable books include Ken Fisher's Super Stocks, Pat Dorsey's The Five Rules for Successful Stock Investing, Bruce Greenwald's Value Investing: From Graham to Buffett and Beyond as well as local writers Dr Michael Leong's Your First Million - Making it in Stocks and Bobby Jayaraman's Building Wealth Through REITs. These are very insightful and offer varying perspectives to the game of investment.

I believed that I have grown quite significantly in terms of emotional stability and principles where it comes to investment. Not only am I now immune to the day-to-day and intraday changes in prices, I have now look towards 3 years as an appropriate investment horizon. Boustead Singapore and The Hour Glass are 2 such companies which I have convinced myself to give them 3 years to grow. Even in the daily life decision, I always remind myself to look at the long term and not the short term.

Going forward, I will strive to make further progress on knowledge and skills. Knowledge will be to understand and gain more breadth and depth of industry. Attending AGM and seminars have been extremely helpful in this aspect. The more one gain the faster it is as one will realise how cross-industries knowledge can come in handy for companies in other industry. Skill will be on valuation as well as on financial statement analysis. While I was lucky to have been barely scarred by S-Chip, Olam has reminded us once again that any company can turn out to fraudulent regardless of their backing. Due diligence is of even higher importance for a highly concentrated portfolio like mine. Hence, I will hope to brush up on my skill on spotting financial shenanigans. Of course, I am highly confident of companies in my current portfolio as they are excellent business with strong cash balance and strong free cash flow generation.

As for the blog, post will be more sporadic as I have to juggle my studies, my investment and the blog. While the post might be less frequent, the quality will still be kept at a high standard. If there is nothing worthwhile to write, I will rather not write anything. Just like if there is nothing worth investing, I will rather not invest in any company.

2012 has been an awesome year and I hope 2013 will be another spectacular year not only in investment return but my growth as an investor. In addition, I will like to thank all my readers for allowing me to hit above 84000 visits in a year which equates to 230 visits a day.

Wish everybody the best regardless whether STI will move up or down :)