Analysis

Analysis of Ajinomoto (M) Bhd

Dear Readers

In the last 11 trading days, the shares of Ajinomoto (M) Bhd (“Ajinomoto“) took a nosedive from an average price of RM26 (24.08.2017) to an average price of RM19 (13.09.2017). That is an average RM7 drop in share price. Percentage-wise, that is close to a 27% loss.

In my personal view, the negative movement in the share price was caused by:

  1. an adjustment to the share price as the dividend and special dividend, to the tune of RM1.55, went ex on 30.08.2017; and
  2. a widespread selloff in a cascading manner.

There were high volumes of transactions at that time during which RM400 million was wiped off from Ajinomoto’s market capitalisation.

Ajinomoto_logo1

For the benefit of those who are in the dark, a special dividend was approved for distribution from a one-off compensation of RM166 million. The compensation is with regard to a compulsory acquisition of a 7.58 acre land, at Jalan Kuchai Lama, KL. The land which houses one of its plants was acquired by the government for the Mass Rapid Transit Line 2 project.

Now as it seems like the dust has settled, the more fitting question to be asked is whether the shares of Ajinomoto are attractive at their current average price of RM19?

Let’s find out.

Overview

Ajinomoto is part of the Ajinomoto Group which was founded in Japan. Its principle business is the manufacturing and sale of umami seasoning. Umami is one of the basic tastes such as sweetness, saltiness, sourness and bitterness.

In Malaysia, Ajinomoto’s business can be categorised into the manufacturing and sale of:

  1. retail products; and
  2. industrial products.

Apart from the basic monosodium glutamate a.k.a. MSG seasoning (AJI-NO-MOTO), Ajinomoto’s retail products have branched out to include chicken stock (TUMIX), instant seasoning of various local dishes (SERI-AJI), pepper (AJI-SHIO), sweetener (Pal Sweet), blended garlic and onion-based seasoning (AJI-MIX) and a premium taste enhancer (AJI-NO-MOTO Plus).

Group-retails-2017-1
Meet the Ajinomoto retail familia. Credit: Ajinomoto

Its industrial products consist of TENCHO which encompass a range of industrial food ingredients used in the food processing industry such as noodles, sauces, processed food and etc.

Apart from the Malaysian market, which accounts for 60% of Ajinomoto’s sales, other sources of revenue come from overseas markets such as the Middle East (14%) and Asian (24.8%), among others.

During the FYE 2017, Ajinomoto’s retail business contributed RM305.3 million (73%) to its revenue whilst its industrial business contributed a cool RM114.6 million (27%).

Resilience 

Ajinomoto is a well-known for its umani seasoning since it was first marketed in Japan in 1909.

In Malaysia, Ajinomoto has become a household name since 1961 due to its aggressive television marketing in the past. Further, the use of umani seasoning is deeply entrenched and synonymous with Asian-styled cooking. The versatility of umani seasoning meant that it can be incorporated into a variety of ethnic cooking including Indian and Malay.

Through its leading market share and strong branding in the local scene, Ajinomoto’s products gets an unparalleled competitive edge over rivals.

Being a staple consumer product means that it has enjoyed steady sales even during economic downturns and the same will stay true in the future.

Potentials

Ajinomoto plans to introduce a new segment in its business which may entail the manufacturing and importing of food products as part of its plan to diversify beyond the seasoning products line. It wants to emulate what its counterpart in Thailand is doing; by selling food products and food seasoning. If indeed so, there is a likelihood that Ajinomoto may be producing or importing 3-in-1 coffee sachet, canned coffee and instant noodle. However there is nothing concrete to this regard yet.

The company also intends to boost sales in the Middle East as it sees potential in that market, especially in Saudi Arabia, Jordan, Oman and Yemen. Ajinomoto’s product which are produced in Malaysia has a better chance of penetrating the Islamic market.

Financials
DATA 2017 2016 2015 2014 2013
REVENUE (RM’000) 419917 400200 340376 345351 332908
OPERATING PROFIT (RM’000) 211469 53941 40596 37596 28085
PROFIT (RM’000) 187462 40787 29733 28041 19403
SHAREHOLDERS’ EQUITY (RM’000) 474638 307813 279524 262077 244344
DEBT (RM’000) 57800 59240 53422 45942 50060

RATIO

DEBT TO EQUITY RATIO 0.12 0.19 0.19 0.18 0.21
OCF RATIO 1.20 1.26 0.92 1.27 0.76
OPERATING PROFIT MARGIN 0.50 0.13 0.12 0.11 0.08
PROFIT MARGIN 0.45 0.10 0.09 0.08 0.06
EPS (CENTS) 308.30 67.10 48.90 46.10 31.90
EPS (ADJUSTED) CENTS 308.30 67.10 48.90 46.10 31.90
DPS CENTS 0.00 33.80 20.00 18.50 20.00
DIVIDEND PAY OUT (%) 0.00 50.40 40.90 40.10 62.50
P/E 5.16 13.40 12.90 11.10 13.90
ROE 39.50 13.25 10.64 10.70 7.94

With the exception of FY2017, there is a steady growth of earnings from FY2013 to FY2016. FY2017 is a little tricky though as there was a one-off gain, of RM166 million, from the said compensation. Generally a one-off gain would be discarded when valuing the fair value of a company; Ajinomoto is no different.

Of the RM166 million, only about RM144 million was recognised as profit. This can be seen in Ajinomoto’s Q4 FY2017 income statement and it’s Annual Report for FY2017.

By discarding the RM144 million from profit, Ajinomoto made only about RM42 million of profit or an EPS of about RM0.70 for FY2017.

Hence, between FY2013 and FY2017, earnings progressed at the a compound annual growth rate of about 17%. Impressive!

Other praiseworthy qualities are its low debts, good cash flow, improving profit margins and improving business efficiency. Dividend was erratic throughout the years but on the plus side the payout was on the modest side, with the exception of FY2017.

Conclusion

Even if Ajinomoto could sustain its current high growth rate in the foreseeable future, its average price of RM19 per share is, unfortunately, well above its fair value. My calculation of Ajinomoto’s fair value is about RM11.

Before I am accused of ruffling feathers, I would like to fortify my opinion that Ajinomoto is a company with solid fundamentals. Further it has a commendable economic moat in that its core MSG products are resilient from competition and economic downturns.

However, my only concern is that, at the price of RM19, there is a higher risk of a downside than an upside. Hence, a potential investor, contemplating purchasing at RM19 per share, is left with no margin of safety should things take a turn for the worse.

Having good fundamentals should not only be the sole consideration of whether a company is worth buying. This is because those fundamentals may change as time passes. To ensure that you are well protected from any adverse change in the fundamentals of the company, you must deploy a safety net in the form of a margin of safety. That means becoming a part-owner of the company for a sum lesser than its fair value.

While I am not suggesting that Ajinomoto’s share price will likely to decrease to a level near to RM11 over time (in fact it, at the time of writing on 13.09.2017, Ajinomoto’s shares are massively oversold, and may even rebound), I suggest putting Ajinomoto to your watchlist and only contemplating purchasing its shares are priced favourably in the future.

If you find this write-up helpful, please hit that like and share buttons on my Facebook for more updates and analysis.

Reference
  1. Q4 FY2017 report
  2. FY2017 Annual Report
  3. http://www.ajinomoto.com.my
  4. http://www.thestar.com.my/business/business-news/2016/12/22/ajinomoto-accepts-rm166mil-compensation-award-for-land/
  5. http://www.thestar.com.my/business/business-news/2016/11/30/dividend-windfall/
  6. http://www.theedgemarkets.com/article/ajinomoto-diversify-product-offering
  7. http://www.theedgemarkets.com/article/ajinomoto-venture-food-products
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Analysis

Analysis of Superlon Holdings Bhd

Dear Readers

Ever thought something as simple as thermal insulators could be such a profitable business. To understand why, we shall delve into what makes Superlon Holdings Bhd (“Superlon“) tick.

thumb-e1503405746912.jpg
Credit: Superlon
Overview

Superlon is principally a manufacturer of, among others, high quality nitrile butadiene rubber (synthetic rubber) thermal insulators (“NBR“). NBR is mainly used in Heating, Ventilation, Air Conditioning and Refrigeration systems (“HVAC&R“) in residential, commercial and industrial buildings.

Superlon’s focuses on the premium segment in terms of quality of its manufactured thermal insulators. Superlon branded those products as its namesake.

The majority of its clients are product distributors and sales agents. You can also find Superlon’s products sold on Alibaba.

Superlon’s secondary activity is the trading of HVAC&R components, The earnings from trading is nominal and will not be mentioned in this write-up.

Manufacturing of thermal insulation

Insulation is extremely effective at saving energy. The science behind insulation is rather simple; to stop heat transfer.

Imagine turning on the water heater on a cold winter’s night. When hot water runs through the pipes, heat from the hot water dissipates because the hot water pipes are exposed to the cold environment. Energy is then wasted.

On the other hand, in a tropical climate, such as the one in Malaysia, insulation works the other way around – by keeping heat from affecting air conditioning or refrigeration systems. That way, the air conditioning compressors do not have to work harder to keep the air cold. A thermal insulator will also prevent air conditioning or refrigeration pipes from sweating (or condensation) by preventing hot air to come into contact with the cold pipes. This prevents water damage to building structures, furniture and machineries.

These are a couple of scenarios where thermal insulators are utilised to achieve energy savings and to prevent condensation.

Energy savings, although may not seem much at first glance but at a grander scale, such as air conditioning or refrigeration systems in shopping malls, hotels, airports, mega factories or cruise liners, thermal insulators take on a much impactful role.

Superlon diversifies production, from thermal insulators to exercise mats (yoga mats) and acoustics insulators. If you are unsure of what an insulation foam is, have a feel of a yoga mat.

Superlon’s thermal insulators have a market share of about 50-60% in Malaysia. Its major export markets are Asia, North America, Europe, Oceania and more recently, Africa. Major markets in Asia include India and Vietnam.

Its manufacturing site is located at Klang, Malaysia.

On top of that, Superlon also sells adhesives, copper tubes, compressors, refrigerant gas, vacuum pump, fan motor and a variety of temperature and gas detectors.

Financials
DATA 2017 2016 2015 2014 2013
REVENUE (RM’000) 106,269 90,411 74,509 61,787 59,959
PROFIT (RM’000) 23,715 16,660 9,381 5,851 4,098
OPERATING PROFIT (RM’000) 30,379 21,555 12,845 8,047 4,471
SHAREHOLDERS’ EQUITY (RM’000) 107,989 89,444 79,940 59,062 55,766
DEBT (RM’000) 36,093 20,153 17,485 13,946 13,093

RATIO

DEBT TO EQUITY RATIO 0.33 0.23 0.22 0.24 0.24
OPERATING PROFIT MARGIN 0.28 0.23 0.17 0.09 0.07
OCF RATIO 0.76 1.78 1.19 1.01 1.20
PROFIT MARGIN 0.22 0.18 0.12 0.09 0.06
EPS (CENTS) 29.87 20.98 11.81 7.34 5.19
EPS (ADJUSTED) CENTS 14.82 10.41 5.86 3.66 2.56
DPS CENTS 11 9 8 3.3 1.8
DIVIDEND PAY OUT (%) 36.8 42.9 67.7 45.0 35.6
P/E 11.38 9.39 10.33 8.72 6.74
ROE 21.96 18.62 11.73 9.91 7.35

Over the course of 5 years, there was a significant improvement in areas such as: turnover (revenue), profit, profit margin, dividend and cash flow (OCF ratio).

In 2013, Superlon achieved a profit margin of 6%. Fast forward to 2017, that profit margin increased exponentially to 22%. Concurrently, return on equity also increased threefold.

The factors which contributed to the increase in earnings and revenue were increased sales volumes, the weakening of Ringgit Malaysia, lower raw material costs and increasing production efficiencies (economies of scale).

The major raw materials which make up the production of NBR are acrylonitrile and butadiene. The price of both raw ingredients intertwines with the price of crude oil. Therefore, a low and stable crude oil price will translate to lower raw material costs.

During the years under review, earnings per share increased at a growth rate of 41%. That is phenomenal.

To keep up with demand and production, Superlon started the construction of a warehouse in 2016. The warehouse is now in operations. The construction of the warehouse hopes to alleviate the production bottleneck caused by the lack of storage space in Superlon’s factory. The freed up space in the factory will be utilised for the installation of more production lines. This is expected to add to its manufacturing capacity by an additional 30%.

Potentials

Superlon is in the midst of erecting a new factory-cum-warehouse in Vietnam. This is Superlon’s first overseas production plant and is expected to commence operations in the first half of FY19 (1H FY19). Not much details are available about the said production plant except that the company is set to invest about USD4 million to its setting up.

An expansion to Vietnam makes so much sense it is already one of Superlon’s major export markets and is geographically closer to Superlon’s other export markets, such as India and the cluster of South East Asian countries. In addition, the cost of doing business in Vietnam is well below that of Malaysia due to its lower wage level.

Conclusion

I like Superlon for:

  1. Increasing its earnings at an incredible rate.
  2. Tapping export markets such as Vietnam and Africa.
  3. Strong research and development (extended product range to acoustic insulators).
  4. Capital expenditure on the construction of a warehouse in Klang and a manufacturing site in Vietnam.

Superlon is unattractive for the following factors:

  1. Share price has increased about 165% from a year ago.
  2. Affected by the volatility of raw material price (crude oil) and currency fluctuation.
  3. Capital expenditure in Vietnam may not be a fruitful venture.

If you find this write-up helpful, please hit that like and share buttons on my Facebook for more updates and analysis.

Disclosure

I do not own any shares in Superlon.

 Reference
  1. 2016 Annual Report
  2. Q4 FY2017 Quarterly Report
  3. http://www.superlon.com.my
  4. http://economictimes.indiatimes.com/markets/commodities/fall-in-crude-oil-prices-fails-bring-cheer-for-synthetic-rubber/articleshow/50554238.cms
  5. http://www.theedgemarkets.com/article/superlons-profit-attributed-higher-volume-better-margins
  6. http://www.theedgemarkets.com/article/attractive-valuation-superlon
  7. http://www.theedgemarkets.com/article/superlons-new-facility-boost-its-production-rate
  8. http://www.theedgemarkets.com/article/superlon-hits-alltime-high-solid-fy17-positive-fy18-earnings-forecast
  9. https://markets.ft.com/data/equities/tearsheet/summary?s=SUPERLN:KLS

 

 

Analysis

Analysis of Three-A Resources Bhd

Dear Readers

Three-A Resources Bhd (“3A“) is a manufacturer of halal and kosher (Jewish) certified food and beverage ingredients such as:

  1. Caramel colour, a food colouring.
  2. Natural Fermented Vinegar such a rice and distilled vinegar.
  3. Hydrolised Vegetable Protein/Soya Protein Sauce which is pretty much soy sauce.
  4. Glucose/maltose syrup.
  5. Maltodextrin, a thickener like starch which is used in food and beverage.

3A’s main operating site is in Sungai Buloh, Selangor.

subsidiary_sssfi
Credit: 3A
Financials
DATA 2016 2015 2014 2013 2012
REVENUE (RM’000) 387,718 352,400 311,410 302,910 306,428
PROFIT (RM’000) 38,921 20,082 18,214 10,316 17,638
OPERATING PROFIT (RM’000) 60,493 38,636 33,768 23,113 26,563
SHAREHOLDERS’ EQUITY (RM’000) 279,435 248,171 231,825 219,031 213,754
DEBT (RM’000) 60,142 70,948 47,824 73,748 100,894
RATIO
DEBT TO EQUITY RATIO 0.21 0.28 0.21 0.34 0.47
OPERATING PROFIT MARGIN 0.15 0.11 0.11 0.07 0.09
OCF RATIO 2.33 0.14 1.64 1.11 0.03
PROFIT MARGIN 0.10 0.06 0.06 0.03 0.06
EPS (CENTS) 10.00 5.10 4.60 2.60 4.50
EPS (ADJUSTED) CENTS 7.91 4.08 3.68 2.10 3.23
DPS CENTS 1.80 1.40 1.40 1.20 1.20
DIVIDEND PAY OUT (%) 18.0 27.4 30.4 46.1 26.7
P/E 13 20 19 32 24
ROE (%) 13.9 8.09 7.86 4.71 8.25

FY2016 was reportedly the best performing financial year of the company since being listed in 2002. 3A recorded a revenue of RM387 million as compared to RM352.4 million, in FY2015. That is an increase of 9%. Generally, the revenue trend is increasing over the years.

Of the total revenue for FY2016, 33% was derived from export sales which includes Singapore (10%). The remainder 67% of sales was derived from the local market.

Profit in FY2016 (RM38 million) increased 90% as compared to FY2015 (RM 20 million). Following the strong profit uptrend, earnings per shares also rose in tandem with higher revenue and increased profit margin. In fact, profit margin rose from 6% in FY2015 to 10% in FY2016. That is a tremendous increase of 60%. Further, the increase in earnings per share is validated with the increase in return of equity.

According to the Annual Report for FY2016, the main reason for the surge in profitability and profit margin is due to targeted pricing strategy employed by 3A. The company targeted high value customer to get better margins and profits. A higher operating margin (15%) in FY2016 (compared to 11% in FY2015) also indicates that management was effective in in keeping costs in check.

Suppose if 3A keeps up the trend of increasing profits and lowering costs (the fundamentals of a business), I am confident that this year’s profit will see an improvement from FY2016.

Potentials

Not letting success to invite complacency, 3A continued to invest in the business by initiating capital expenditures such as the construction of an additional maltodextrin plant namely Maltodextrin Plant No.3. This project is tagged as a growth driver for 3A in the near future and it is funded purely from internal funds. Maltodextrin Plant No.3 will add another 2,200 metric ton of maltodextrin a month and will bring the overall capacity of maltrodextrin production to 5,500 metric ton per month.

As of May 2017, Maltodextrin Plant No.3 is at 25% capacity and that capacity is expected to rise.

The management of 3A has also earmarked RM40 million for capital expenditure for FY2017 and FY2018. About RM17 million will be used to acquire 2 pieces of land for future plant expansion.

Conclusion

I like 3A for:

  1. Its involvement in the food business. The saying in the food business has always been “Everybody’s gotta eat.”
  2. Increasing the capacity of Maltodextrin.
  3. Sound financials.
  4. High earnings growth rate of about 19% CAGR by my calculations or about 20% CAGR as calculated by FT.

3A is unappealing because:

  1. In 2010, 3A partnered with Yihai Kerry Investment Co Ltd, a subsidiary of Wilmar International Limited,  to set up a factory in Shanhaiguan, China, to manufacture food and beverage ingredients. The collaboration is still suffering losses to the tune of  RM7.3 million in FY2015 and RM5.8 million in FY2016. Losses are expected for another 3-4 years because the products are getting a slow response from consumers in China.
  2. The directors of 3A are being charged for insider trading in relation to the joint-venture with Yihai Kerry Investment Co Ltd. Corporate governance is definitely put in the spotlight.

Notwithstanding the negatives, my take is that at its current price of RM1.35, 3A is trading at a bargain. Hence, this counter is on my watchlist.

As for the cherry on top, Three-A Resources Bhd is a pretty dull name for a company and there is no coverage of this company by any research houses. These traits fit into the investment philosophy propounded by Peter Lynch (not a joke).

If you find this write-up helpful, please hit that like and share buttons on my Facebook for more updates and analysis.

Reference

  1. FY2016 Annual Report
  2. http://www.three-a.com.my/bursaAnnouncements/files/2017/2017-5-11-3A-AGM-Summary%20of%20Key%20Matters.pdf
  3. https://markets.ft.com/data/equities/tearsheet/financials?s=3A:KLS
  4. http://www.theedgemarkets.com/article/3a-and-wilmar-begin-partnerships-china
  5. http://www.thesundaily.my/news/2015707
Analysis

Analysis of Evergreen Fibreboard Bhd

Dear Readers

Today, we look into Evergreen Fibreboard Bhd (“Evergreen“).

Introduction

Evergreen is, for all intents and purposes, a manufacturer of medium density fibreboard (“MDF“), so much so that MDF accounted to 80% of Evergreen’s revenue in FY2016. Other than MDF, Evergreen also produces particle boards (“PB“) (15% of FY2016’s revenue) and ready-to-assemble furniture parts (“RTA“) (5% of FY2016’s revenue).

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The main raw materials in the production of MDF are rubber wood, derived from rubber trees, and resins, an adhesive substance. MDF is produced by binding the fibres, which have been chipped off from rubber wood, with resins, and to be pressed together to form a piece of board with varying thickness.

20170702_125954-e1498974393343.jpg
Particle board used to make my study table drawer

Evergreen has about 8 operation sites located in Malaysia (Johor, Negeri Sembilan and Kedah), Thailand and Indonesia. Resins are produced in Batu Pahat, Johor, and Gurun, Kedah.

The main markets of Evergreen’s products are ASEAN countries and the Middle East. Other notable markets include the USA, Europe and Far East Asia.

Financials

DATA 2016 2015 2014 2013 2012 2011
REVENUE (RM’000) 997,795 1,012,017 941,994 938,670 1,031,662 1,061,668
PROFIT (RM’000) 71,679 90,904 170 -42,776 32,170 63,602
OPERATING PROFIT (RM’000) 100,228 118,941 16,367 -35,147 40,272 76,830
SHAREHOLDERS’ EQUITY (RM’000) 1,124,019 1,038,285 801,655 786,172 825,820 818,710
DEBT (RM’000) 408,804 377,171 439,077 478,187 505,488 476,545

 RATIO

DEBT TO EQUITY 0.36 0.36 0.54 0.61 0.61 0.58
OPERATING PROFIT MARGIN 0.10 0.12 0.017 N/A 0.039 0.07
OCF RATIO 0.86 0.44 0.26 0.11 -0.10 0.50
PROFIT MARGIN 0.07 0.09 0.00 N/A 0.03 0.06
EPS (CENTS) 8.7 17.6 0 -0.01 6.3 12.4
EPS (ADJUSTED) CENTS 8.4 10.9 0.02 N/A 3.8 7.51
DPS CENTS 2 1 0 0 4 0
P/E 11.1 13.4  

2016.7 (this is not an error)

N/A 9.3 7
ROE (%) 6.3 8.8 0.02 N/A 3.9 7.8

Between FY2011 and FY2016, Evergreen’s top line was flat; never far off from the RM1 billion mark. In the same period, operating profit margin, profit margin and EPS were a hit-and-miss. Only in FY2015 did Evergreen perform exceptionally well as prices of resin and rubber wood were low and therefore contributing to an increase in earnings.

The severe monsoon, at the tail-end of 2016, which ravaged most of Indonesia, Malaysia and Southern Thailand, had disrupted production of rubber wood and caused prices of rubber wood to soar thus reducing profits. As a result, earnings were lower in FY2016, as compared to FY2015, and the spill over from such also affected Evergreen’s earnings for Q1 FY2017 (the last quarter). The lukewarm earnings were reflected in Evergreen’s share price, which tumbled from a high of RM1.12 in October 2016 to about RM0.870.

Adverse weather affected not only Evergreen but other wood-based furniture players too. In anticipation of a reduction in rubber wood supply, caused by the last monsoon season, Evergreen, prior to the monsoon season, increased its inventory of rubber wood. However, such mitigation is limited in its effectiveness because rubber wood can generally be stored up to about 3 months after being harvested.

Even though adverse weather is a matter of concern, I reckon the main grievances faced by Evergreen is the lack of a growth impetus as its top line growth has become stagnated over the years.

Potentials

Evergreen reckons that the antidote for a stagnated growth is a major restructuring exercise, which it has executed in phases, since 2015.

On top of capital expenditure, to upgrade plants and equipment and increasing production lines, the company has also initiated cost-cutting measures, which resulted in the closing down of non-performing operation sites, such as a MDF operation site in Masai, Johor.

While the Masai operation area is being stripped down, and eventually, to be put on sale, the equipment and plants from Masai will be relocated to Evergreen’s Segamat operation site. Segamat, which houses Evergreen’s PB production, has undergone refurbishment to accommodate the receipt of equipment and plants from Masai. Furthermore, the current PB production line in Segamat has been upgraded and modernized to include the installation of Dieffenbacher pressing line from Germany. Dieffenbacher pressing line aims to:

  1. substantially increase production of PB from 120,000 cubic metres per annum to potentially 550,000 cubit metres; and
  2. allow the production of PB of less than 10mm in thickness, which Evergreen was unable to produce before.

Having MDF and PB productions integrated under one roof would mean that wastage from the production of MDF could be used in the production of PB. This leads to less wastage in totality.

PlywoodVsMDF-e1478442569522

The relocation, refurbishment and upgrading is expected to reduce processing time and increase production capacity.

Another benefit of the restructuring is to enable Evergreen to diversify away from MDF production. Evergreen intends to increase production of value-added products which entails RTA lower-end furniture. This can be seen from its investment in additional RTA production lines which will see commercial action in 2H 2017. The increase in PB production (which is the basic component of RTA lower-end furniture) will synergise with Evergreen’s plan to increase RTA furniture production.

Conclusion

I am liking the potential that will ooze from the restructuring program. I reckon higher profit margin could be obtained by increasing the production capacity of RTA furniture, which is where Evergreen is heading. With existing expertise in RTA furniture production, I expect that an increase in RTA furniture production will contribute positively to its earnings in the future due to better profit margin in RTA furniture.

As if nothing else can be more favourable to Evergreen, the Malaysia government announced that, as of 1 July 2017, all export of rubber wood from Malaysia will be banned. This aims to curb the shortage of supply of local rubber wood and its effect is expected to lower the price of rubber wood. Ultimately, Evergreen’s increased production capacity in Malaysia will benefit from such policy.

Evergreen is not without its negative. Concern is warranted especially with the economic slow down in the Middle East, the biggest contributor to Evergreen’s revenue. The low crude oil price environment (the new norm), although benefits Evergreen,  in decreasing the production cost of resins (the second largest cost component after rubber wood), will affect the sales of Evergreen’s products in that region.

There is also mixed economic data coming out of the USA which points to a economic slowdown, albeit positive outlook in Europe and Japan. Also exacerbating the whole situation is the Feds’ adamant stance of hiking interest rate at a time of economic weakness.

Disclosure

I am holding shares in Evergreen.

If you find this write-up helpful, please hit that like and share buttons on my Facebook for more updates and analysis.

Reference:

  1. FY2016 annual report
  2. Q1 FY2017 report
  3. http://www.displays2go.com/Guide/Comparing-Building-Materials-Particle-Board-MDF-Plywood-17
  4. http://www.dieffenbacher.de/en/company/public-relations/news/holzwerkstoffe/dieffenbacher-sells-two-plants-to-asia.html
  5. http://www.woodbizforum.com/malaysian-allgreen-ordered-a-new-particle-board-plant-from-dieffenbacher/
  6. http://www.thestar.com.my/business/business-news/2016/05/23/evergreen-fibreboard-aims-to-be-among-top-10-in-the-world/
  7. http://www.theedgemarkets.com/article/evergreen-fibreboard-1q-profit-falls-489-due-floods
  8. http://www.theedgemarkets.com/article/earnings-prospects-intact-evergreen-fibreboard-says-hlib-research
  9. http://www.thestar.com.my/business/business-news/2017/04/10/evergreen-fibreboard-diversifies/
  10. http://www.thestar.com.my/news/nation/2017/06/30/govt-to-ban-rubberwood-export-cabinets-decision-is-to-address-shortage-of-raw-material-says-dr-wee/
Analysis

Analysis of the IPO of Lotte Chemical Titan Bhd

Dear Readers

Seeking to raise a massive RM5.3 billion, Lotte Chemical Titan Bhd’s (“LCT“) initial public offering (“IPO“) is said to be the largest IPO in Malaysia since August 2012 and the largest in Southeast Asia since May 2013.

An IPO is one of the many avenue which a company, seeking to raise funds, offers a portion or all of its shares to be purchased by the general public. The general public then become part-owners of the newly listed company.

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Introduction of the initial public offering

About 30% of LCT, or approximately 740.5 million shares, will be offered for subscription at a retail price of RM8.00 (subject to final retail price which then depends on the demand for the IPO).

Of the 740.5 million shares, 684 million shares will be set aside for institutional investors. Cornerstone investors which will take the plunge are said to be Permodalan Nasional Bhd, Maybank Asset Management Sdn Bhd, Maybank Islamic Asset Management Sdn Bhd and Eastspring Investment Bhd and Great Eastern Life Insurance (Malaysia) Bhd. They represent 18.4% of the would-be-floated shares or 136 million shares.

The general public can only subscribe to an allocated 48 million shares (24 million to bumiputeras and 24 million to non-bumiputeras), via balloting.

The controlling stake of LCT will remain with South Korea’s Lotte Chemical Corp (“LCC“) (70%) which is part of the Lotte group, a South Korean conglomerate, well-known for its confectioneries.

Introduction of the business

LCT is for all intents and purposes, a petrochemical company. It manufactures principally two types of products:

  1. polyolefins, comprising of polyethylene and polypropylene; and
  2. olefins, comprising of ethylene and its derivatives such as butadiene, tetra-n-butylammonium (“TBA”), benzene and toluena
e73f8085_appendix_09_09
LCT’s Pasir Gudang Plant

Polyolefins are used as building-blocks in an extensive range of consumer and industrial products such as packaging films, trash bags, automotive parts, plastic bottles, caps, compound for wires and cable insulation. LCT supplies their products to plastic fabricators in the packaging, household, automotive and construction industries.

On the other hand, olefins are feedstocks in the production of polyolefins products. To put simply, olefins are used as raw materials to make polyolefins products.

In FY2016, product sales of polyolefins contributed 80% of LCT’s revenue. Polyolefins, as they are higher up the value chain, contribute to a higher gross profit than olefins.

In 2016, LCT is the fourth biggest producer of polyolefin in Southeast Asia with regard to production capacity.

LCT’s products are sold domestically and overseas. In FY2016, LCT’s customers are located in 60 countries such as Indonesia (28.5%), Southeast Asia (9.7%), China (11.3%), Indian sub-continent, South Korea, Oceania and Europe (collectively about 11.8%). In the same financial year, the domestic market contributed to roughly 38.7% of LCT’s revenue.

Pasir Gudang and Tanjung Langsat are where LCT concentrates its operations. They are 12 kilometres apart and there is an underground pipeline which delivers feedstocks from Pasir Gudang to Tanjung Langsat.

Risk

As a petrochemical company, LCT’s earnings are affected by the volatility of crude oil prices. The major component in the production of LCT’s products is naphtha and it constitutes a majority of LCT’s cost of goods. The price of naphtha correlates with crude oil prices. Therefore, a significant volatility in crude oil prices may affect the costs of procurement of naphtha thus putting pressure on LCT’s profit margin. This is because the sale price of LCT’s finished products may lag behind the price increase of the procurement of naphtha.

In addition, an environment of high crude oil prices would translated to lower operating margins as the cost of higher crude oil prices may not necessarily be passed on to LCT’s customers. Demand and quality of products are amongst other factors which influence the sale price of LCT’s finished products.

In an industry where price competitiveness is the major selling point, I would expect profit margin to be squeezed when competition amongst petrochemical manufacturers intensifies. The main competitors to LCT include Petronas Chemicals Group Bhd (“Pet Chem“) and PT Chanda Asri (Indonesia). Consideration however must be accorded to the fact that once Pet Chem has completed the RAPID project in Pengerang, Johor, the market competitiveness may intensify. The effect of the RAPID project is may be more pronounced with regard to LCT as the RAPID project is relatively close, in distance, to LCT’s plants in Pasir Gudang and Tangjung Langsat.

Also, the supply and demand of petrochemical products are dependent on market conditions.

Other noteworthy risk is currency fluctuation in particular RM/USD as raw materials such as naphtha are purchased in USD. Overseas transaction for the sale of LCT’s finished products are USD-denominated.

Objectives of the IPO

The main objective of the IPO is to finance capital expenditure to increase production capacity. Most of the funds raised in the IPO will be channeled to finance an integrated petrochemical facility located in Indonesia. The said facility will cost an estimated RM15 billion. The facility, once operational in 2023, will be used to boost production of olefins (feedstocks for the production of polyethylene). A total of  RM4.9 billion from the fund raised from the IPO will be poured into this project. The remaining balance of RM10.1 billion will be funded through borrowings.

Other projects (designated as TE3 Project and PP3 Project) being funded by proceeds from the IPO are enhancement of existing operations in Pasir Gudang. Those projects seek to boost production efficiency and capacity of polypropylene and olefins. Interestingly, the PP3 Project will utilise technology from LCT’s controlling shareholder, LCC. Commercial operation of PP3 is expected to commence in the second-half of 2018.

Financials
LCT profit and loss
LCT’s audited income statement from FY2014 – FY2016 taken from LCT’s Prospectus.

A glance of the above financial statement indicates that, in the last 3 financial years, LCT’s revenue may appear to be under pressure. However, the gradual decrease of LCT’s revenue is not attributed to lower sales volume of its products. In fact, sales volume has increased. The effect of low crude oil prices means that the selling price of LCT’s products are reduced thus affecting revenue.

On the flip side, gross profit and net profit increased tremendously despite lacklustre revenue between FY2014 and FY2016. Again, low crude oil prices contributed to an increased profit margin and earnings. In fact, EPS doubled from 35 cents, in FY2015, to 76 cents, in FY2016.

Untitled
Cash Flow Statement

 

Untitled 2
Balance Sheet – Part 1
Untitled 3
Balance Sheet – Part 2

The overall cash flow is healthy. LCT experienced better cash flow generated from its operating activities in FY2015 and FY2016 thanks to an environment of low crude oil prices. In FY2016, the company was investing heavily to boost efficiency and production. On top of that, a negative cash flow in financing activities, in FY2015 and FY2016, indicates that debts were pared down. As at the end of FY2016, borrowing (short term) are at RM75 million. That only accounts to 0.9% of shareholders’ equity.

Dividend policy

The company proposes to pay around 50% of net profits every year. If all things being equal at the end of FY2017, dividend of 50%, from an EPS of 76 cents, would translate to a dividend of 38 cents per share. At a share price of, say, RM8.00, that would translate to a dividend yield of about 4.75%. This decent dividend yield may be ideal for a dividend play.

Potentials

Potential for growth can be seen from LCT’s commitment to capital expenditures which will increase production and improve production efficiency. This will contribute positively to its earnings down the road.

Untitled 5
Capital expenditure up until 2021
Conclusion

Before I conclude, lets look at the downside risk associated with LCT. Those risks are:

  1. Volatility of crude oil prices.
  2. High crude oil prices.
  3. Competition.
  4. Market conditions.

At this current time and the foreseeable future, I believe that:

  1. Crude oil prices are and/or will be less volatile (within the range of USD50 – 55 per barrel).
  2. Crude oil prices are relatively low to its high of USD100 per barrel in 2014 and the current market condition will remain as a new normal, inevitably with the rise of electric cars and investment in renewable energy
  3. Until RAPID comes online in 2020, it is safe to say that competition dynamics between existing petrochemical players will be somewhat similar and unaltered.
  4. There is a general optimism and consensus that the world’s economy, including Malaysia, is heading for better times. I expect demand for petrochemical will rise in light of better economic prospect.

Further, LCT is entering the IPO with strong financials – a cash reserve of about RM1 billion, positive cash flow and coupled with low borrowing debts. If market conditions remain the same, there is much room for growth for LCT.

Parting thoughts

To wrap up, I want to say that I find it admirable that LCT is getting the needed technical and technological support from LCC, its controlling shareholder, especially in the upgrade of its existing plants in Johore. This reminds me of the uncanny resemblance of the support CSC Steel Holdings Bhd received from its parent company, China Steel Corporation of Taiwan.

If you need to know more of the IPO (and you should), please have a read the IPO prospectus which can be found here.

Important timetable 
  1. Opening of IPO application – 16 June 2017
  2. Closing of IPO application – 28 June 2017
  3. Balloting of application – 03 July 2017
  4. Allotment of IPO shares to successful applicants – 07 July 2017
  5. Listing date (tentative) – 11 July 2017

Do hit the like and share buttons on my Facebook for updates on the IPO.

Reference:

  1. http://www.thestar.com.my/business/business-news/2017/06/16/lotte-chemical-titan-to-raise-rm5pt92b-from-ipo/
  2. LCT’s IPO Prospectus
  3. https://www.nytimes.com/2017/05/25/business/energy-environment/oil-opec-shale-renewables.html
  4. http://www.thesundaily.my/news/1602125
Analysis

Analysis of CSC STEEL HOLDINGS BHD

Dear Readers

CSC Steel Holdings Bhd (“CSC“) announced, on 22 February 2017, that it has approved a 10 cents final dividend and, on top of that, a 4 cents special dividend. This brings the dividend to an aggregate of 14 cents.

Do note that the dividends will go ex on 28 June 2017.

csc-steel-holdings-bhd_v2_3

CSC’s shares has been depressed since the start of the year. It has been hovering around the RM2 mark giving the 14 cent dividend a dividend yield of about 7%. Very high indeed.

Untitled2

Dividend pay out in itself should not be a sole reason for one to purchase a stock. The company must also be fundamentally strong and has good prospects.

Though I am not too concerned about CSC’s fundamentals (as you will find out later), CSC’s prospect hinges on a couple of externals factors which are beyond its control: the price of steel (or its derivative, iron ore) and the health of the economy. This makes CSC’s stock very cyclical in nature thus it may be an unsuitable candidate for a solid dividend play. In good times, dividend may be bountiful but on the flip side, dividend may be scarce.

Introduction

CSC is a holding company of which its subsidiaries are in the business of producing cold rolled steels, pickled and oiled steels, hot dipped galvanised steel  and pre-painted galvanised steel or colour coated steel.

Cold rolled steel coils have applications in the manufacturing of home appliances, automotive, commercial drums and furniture.

Pickled and oiled steels are used as automotive parts and strapping structural materials.

CSC is also marketing and selling products from galvanised steel and pre-painted galvanised steel as roof truss, roofing, wall cladding,  under the brands RealZinc and RealColor.

A major shareholder of CSC is China Steel Corporation of Taiwan. CSC benefits from the supply of steel, equipment, technology and management from China Steel Corporation of Taiwan.

Abour 80% of its revenue is derived from the local market and the rest, from various markets overseas.

Financials
DATA 2016 2015 2014 2013 2012 2011
REVENUE (RM’000) 1,035,197 1,017,137 1,048,469 1,141,727 1,126,994 1,206,148
PROFIT (RM’000) 68,689 54,602 (21,266) 29,350 28,008 29,551
OPERATING PROFIT (RM’000) 73,730 61,505 (25,739) 30,766 29,906 31,064
SHAREHOLDERS’ EQUITY (RM’000) 808,551 769,251 728,523 776,186 773,098 771,767
DEBT (RM’000) 67,164 60,769 63,186 63,291 74,480 74,517

RATIO

DEBT TO EQUITY 0.08 0.08 0.09 0.08 0.10 0.10
OPERATING PROFIT MARGIN 0.07 0.06 N/A 0.02 0.02 0.02
OCF RATIO 2.24 1.39 -0.02 1.90 1.50 0.07
PROFIT MARGIN 0.06 0.05 N/A 0.02 0.02 0.02
EPS (CENTS) 18.63 14.75 (5.72) 7.89 7.5 7.9
EPS (ADJUSTED) CENTS 18.63 14.37 -5.6 7.64 7.37 7.78
DPS CENTS 14 8 3 7 7 7
DIVIDEND PAY OUT 0.75 0.54 0 0.88 0.93 0.88
P/E 11.54 7.39 0 15.71 15.84 16.79
ROE 8.51 7.00 0 3.80 3.60 3.80

As indicated in the table, top line growth was on a downtrend between FY2011 and FY2016. Despite that, bottom line growth was rising during the same period. This is due to the drop of the production cost as a result of lower raw material cost and an increased of production efficiency. EPS saw a substantial increase from 7.78 cents, in FY2012, to 18 cents, in FY2016.

With the increase in EPS, dividend pay out also increased. In fact, CSC has a policy of distributing 50% of its profit as dividend.

The increase in dividend does not hurt it financially because CSC has zero borrowings. On top of that, CSC is sitting on a mountain of cash reserve of over RM190 million as per its Q1 FY2017 report. Cash flow is also a breeze.

The growth outlook of Malaysia in 2017 is more optimistic than in 2016. First quarter GDP growth stood at 5.6%. This effect has seeped through the steel industry as witnessed by the surge in CSC’s net profit from RM6 million, in Q4 FY2017, to RM16 million in Q1 FY2017. That’s an incredible increase of 166% in net profit.

EPS growth rate is about 18% (as indicated by FT) even though I am of the opinion that EPS  growth rate is not sustainable owing to CSC’s flat top line growth which has been consistent from the past years.

Further, there is limited room in which an efficient production can contribute to an increase in profit margin, EPS or ROE without diminishing returns. Premised on that, I reckon that CSC growth rate would be in the vicinity of 2% based on sustainable/organic growth (without any borrowings).

Notwithstanding that the group strives to achieve cost-cutting measures with a RM26 million capital expenditure, in 2016, on production equipment which will improve the quality of its products and the efficiency of the production line. I hope to see the investment being fruitful for the rest of FY2017.

Conclusion

I like CSC for:

  1. Strong support from its major shareholder, China Steel Corporation of Taiwan. The bond is so strong that China Steel Corporation of Taiwan supplies materials to CSC.
  2. Strong cash reserve and zero borrowings means the group is resilient even when economic conditions are unfavourable.
  3. Dividend pay out policy of at least 50% of profits.
  4. Efficient production and quality products.

CSC is unappealing because:

  1. Cyclical nature of the steel industry (although that could be a positive point depending if you are buying the shares at the top or bottom cycle)
  2. In the mercy of external factors beyond its control such as price of raw materials and dumping schemes.
  3. Lacking growth catalyst (top line earnings have been flat).
  4. Retaining its market share from the onslaught from Chinese steel imports may pose a challenge. In April 2017, the government announced that it is implementing import levies on Chinese steel products to safeguard the Malaysian steel industry. I noticed that this anti-dumping measure does not encompass the steel coil segment but only includes steel concrete reinforcing bar (rebar) and steel wire rods & deformed bar in coils (SWR & DBIC). Given that scenario, CSC would be in a tough position to compete with Chinese steel imports in the near future.

Ultimately, if you are looking at a dividend play, this looking like a solid counter.

Disclosure

I do not own shares in CSC.

References
  1. http://www.thestar.com.my/business/business-news/2015/06/17/csc-steels-revenue-down-8-in-fy14/
  2. http://www.cscmalaysia.com/brandBrochure.asp
  3. http://www.thestar.com.my/business/business-news/2016/10/01/putting-the-steel-back-in-steel-industry/
  4. http://www.theedgemarkets.com/article/definitive-safeguard-duties-imposed-imported-steel-products
  5. https://markets.ft.com/data/equities/tearsheet/summary?s=CSCSTEL:KLS
  6. FY2016 Annual Report
  7. http://www.federalgazette.agc.gov.my/outputp/pub_20170413_P.U.%20(B)%20191.pdf
Analysis

Analysis of Samchem Holdings Bhd

Dear Readers

Introduction

Samchem Holdings Bhd (“Samchem“) is one of the biggest industrial chemical distributors of Polyurethane, intermediate chemicals and specialty chemicals in Malaysia. At the time of its IPO, in 2009, Samchem has a market share of about 33% in Malaysia.

Samchem is predominantly an industrial chemical distributor (about 98.5% of its total revenue in FY2016). However, it is also involved in the retail sales and distribution of projectors and Information and Communication Technologies system (“ICT“).

Samchem_3
He sees me rolling, he hating. Credit: Samchem
Industrial chemical distributor

It is important to note that Samchem is not a chemical manufacturer. It only distributes industrial chemicals which it sources from suppliers and chemical manufacturers locally and internationally. Samchem has a long standing relationship with chemical manufacturers such as Petronas, Shell, EP, ExxonMobil Chemicals, Momentive Performance Materials (Thailand), Tylose GmbH & Co. KG (Germany), Kuraray Specialities Asia Pte Ltd (Japan) and the list goes on.

It has distributing rights to 400-500 chemicals. Samchem’s products are used in an array of industries including petrochemical, automotive, electronics, paint, furniture and etc.

Further, Samchem has a blending operation, in Johore and Selangor (not too sure), to produce customised solvents tailored to client’s needs.

Audio Video & ICT

As strange as it is, Samchem is making full use of its established distribution networks (warehouse and other logistical infrastructure) to conduct a retail business of selling audio video equipment such as projectors and ICT systems. Sales in this segment contribute a minute portion of about 1.5% of total sales in FY2016.

Financials
DATA 2016 2015 2014 2013 2012
REVENUE (RM’000) 697178 600005 630592 543021 526448
PROFIT TO SH (RM’000) 15077 4034 5966 8740 8702
OPERATING PROFIT (RM’000) 33832 15715 20656 21451 20139
SHAREHOLDERS’ EQUITY (RM’000) 119510 111520 111641 108582 102785
DEBT (RM’000) 217900 155898 192897 187955 164182

RATIO

DEBT TO EQUITY RATIO 1.82 1.40 1.73 1.73 1.59
OPERATING PROFIT MARGIN 0.048 0.026 0.033 0.039 0.038
OCF RATIO 0.04 0.35 0.04 -0.10 0.13
PROFIT MARGIN 0.02 0.006 0.01 0.01 0.01
EPS (CENTS) 11.1 3.0 4.3 6.4 6.4
EPS (ADJUSTED) CENTS 5.49 1.5 2.3 3.2 3.2
DPS CENTS 6.5 3.5 2.5 2.5 2.5
DIVIDEND PAY OUT 0.58 1.16 0.58 0.40 0.40
P/E 12.89 29.13 14.81 10.03 9.69
ROE 12.62 3.61 5.34 8.05 8.47

Samchem’s revenue has been on the rise since 2012. There are 4 major markets that contribute to its revenue namely: Malaysia, Vietnam, Indonesia and Singapore.

Samchem was also sitting on a net cash of about RM46 million (Q1 FY2017). According to the same report, cash flow from operating activities was very poor (-RM28 million). This is because a bulk of its cash is tied up on inventories. Further, inventories are at a high of RM114 million which is an increase of RM26 million from Q4 FY2016.

Despite abysmal profit margins, profit margins improved dramatically from 0.6%, in FY2015, to 2%, during the last financial year. Cost cutting measures or administrative efficiency may have attributed to the better margin of profit as suggested by the operating margins (see table).

FY2016 was a tremendous year for Samchem. Regional markets such as Vietnam (31% of total revenue), Indonesia (13% of total revenue) and even Singapore (0.4% of total revenue) saw an increase in revenue and profit. Overall, profit grew by 152% on the back of a rise of 16% in revenue, from FY2015.

The rise in Samchem’s share price is in tandem with the rise of its earnings. Share price has risen about 133% since a year ago. Before that, its share price was stagnant.

My calculations indicate that Samchem’s growth rate, in the past 5 years, was about 11.3%. Sustainable growth rate is about 5.3%. My rough estimation of Samchem’s fair value is about RM0.80-RM0.85, taking into recent the bonus issue of 1:1 in May 2017.

Since the bonus issue, Samchem’s share price has dropped about 16% from RM1.07 to RM0.90 (as at 26.05.2017) on profit taking and also because of the boardroom showdown between, a number of substantial shareholders (forming 19% of shareholdings), some of whom are also office bearers, and the current executive director, Ng Soh Kian.

An EGM has been called, on 23.06.2017, to vote for the removal Ng Soh Kian.

Conclusion

I like Samchem for its:

  1. Improving cost efficiency.
  2. Improving profit margin.
  3. Increasing revenue.
  4. Wide-based clientele/not dependent on a single industry.

The cons are:

  1. With such a thin margin, it is exposed to any drastic increase in the costs of its chemical supplies.
  2. As most of its international trades are USD denominated, it is also vulnerable to fluctuations in currency exchange. The reason being it does not only distributes to the ASEAN markets but it also sources for supplies overseas. Notwithstanding that, Samchem has currency hedging in place.

If you were to buy Samchem’s shares at about RM0.90, be prepared to pay a premium. It may be the case that its share price may drop further due to the boardroom drama and recent market consolidation. However, the said boardroom drama will not be a matter of substance to the fundamentals of Samchem. This is because Samchem has sound financials, it is already a major player in the chemical distribution market and it is backed by established distribution and supply networks. Any drop in share price, owing to the boardroom showdown, should be construed as a buying opportunity. Be on the lookout.

Disclosure

I do not own shares of Samchem.

Reference:
  1. http://samchem.com.my/
  2. Samchem IPO prospectus
  3. FY2016 Audited Report
  4. Q1 FY2017 Report
  5. https://markets.ft.com/data/equities/tearsheet/summary?s=SAMCHEM:KLS
  6. http://www.thestar.com.my/business/business-news/2017/05/24/samchems-statement-points-to-boardroom-conflict/
  7. http://www.thestar.com.my/business/business-news/2017/05/24/samchem-shareholders-to-decide-on-eds-removal-on-june-23/
Analysis

Analysis of Elsoft Research Bhd’s Q1 FY2017 Report

Dear Readers

Elsoft Research Bhd’s (“Elsoft“) was published on 22 May 2017. I have had a read of the report since.

This post is a summary of the pertinent contents of the report and my thoughts of Elsoft’s performance throughout Q1 FY2017.

BIZD_MM_2311_p4d_R
Gaming on the job. Credit: The Star Online
Finances
  1. Revenue was up by 50.1% from the corresponding period of Q1 FY2016. On the flip side, revenue was down by  7% from last quarter being Q4 FY2016.
  2. Because revenue increased (that means more equipment was sold), cost went up. Cost of sales for Q1 FY2017 was RM7.392 million; up from RM4.309 from the corresponding period of Q1 FY2016.
  3. Elsoft recorded a net profit of  RM6.046 million which was up 285% from the corresponding period of Q1 FY2016 (RM1.562 million). However, net profit was down by 34% when compared to Q4 FY2016 (RM9.222 million).
  4. Cash and other equivalents went up by RM6.056 million from the last quarter (RM11.642 million) to RM17.698. It is good to have cash about the same amount as ones’ profit.
  5. However, from the increase in cash of RM6.056 million, only RM2.161 million (before adjustment made to take into account exchange rates) was from operating activities. Initially I thought that this was alarming compared to the RM5.7 million cash it obtained from operating activities in Q1 FY2016. However, from further perusal, the report indicates that Elsoft had pared down a lot of its cash (RM6.240 million out of the RM8.481 million cash generated from operating activities) to pay other suppliers in Q1 FY2017. When one uses cash to pay its suppliers, it will have lower cash (common sense). Elsoft still generates a majority of cash from its business.
  6. There was a loss of RM1.322 million on foreign exchange as opposed to a realised loss on foreign exchange of RM576,446.00 for the whole of FY2016. The only compelling reason for the sudden hike, in my opinion, is the the implementation of Bank Negara’s policy of requiring exporters to realise and convert 75% of proceeds in US dollar to Ringgit from December 2016.
  7. There was more demand from the automotive industry as compared to the the corresponding period of Q1 FY2016 but less demand from the smart devices industry compared to the last quarter (Q4 FY2016) .
  8. Management summed up the lower profit from last quarter due to lower of revenue, lower gross product margin, share of losses in associate and foreign exchange losses in current quarter.
  9. About 94% of revenue is derived from Malaysia, about 2% from China and the remainder from an assortment of countries, not identified.
My thoughts

In the corresponding period in FY2016, Elsoft only achieved an EPS of 0.57 cent compared to 2.20 cents in Q1 FY2017. That’s an increase of 285%. I was ecstatic! What a good way to start a year. Notwithstanding that, the market had an unexpected contrary view which caused Elsoft’s shares to drop 4.12% on 23 May 2017. This could well be that the market had so much expectation that Elsoft would perform much better than the last quarter (which it didn’t).

At the end of the day, it is a matter of perception. Should this quarter be compared to another quarter on an YoY (year over year) basis or QoQ (quarter on quarter) basis?

YoY or QoQ comparison?

QoQ comparison may not be able to consider seasonal factors which may affect the demand and thus the earnings of a company throughout a year. Therefore YoY offers a better picture for comparison.

I am of the opinion that the semiconductor industry is seasonal in nature albeit to a lesser extend than say the airlines or retail industry. For example, most smartphone flagships are released in August or September (just enough time for people to lust over them before the holiday season). Even if Elsoft states that it not affected by seasonal or cyclical factors, I am of the opinion that Elsoft’s fortune does somewhat hinges on semi conductor production. This is because an increase in smartphone production, for example, will increase the need for more automated testing equipment. Therefore to compare performance on a YoY basis would be more appropriate in Elsoft’s case.

However, how I look at things may not be how you look at things given that both of us are looking and analysing the same set of data.

The legendary Peter Lynch has often recited in his book “One Up on Wall Street” that humans are often irrational beings. This creates inefficiencies in the market which can be exploited as opportunities. When opportunities come by (very so often), make full use of them.

This was why I construed the drop in the share price, after the announcement of the Q1 FY2017 report, as an opportunity to purchase more shares in Elsoft on the backdrop of its sound financial performance and potentials.

Thank you for reading.

Reference
  1. Q1 FY2017 Report
  2. FY2016 Annual Report
  3. http://www.investopedia.com/terms/q/qoq.asp
  4. http://www.investopedia.com/terms/y/year-over-year.asp
  5. http://www.theseasonalinvestor.com/2013/09/does-seasonality-move-semiconductor.html
  6. http://www.wikinvest.com/stock/United_Microelectronics_(UMC)/Seasonality_Cyclical_Nature_Semiconductor_Industry_Periodic_Overcapacity_Make

 

Analysis

Analysis of Ekovest Berhad

Dear Readers

To recap, shares in Ekovest Berhad (“Ekovest“) closed at RM1.43  on 3 May 2017. However on 4 May 2017, its shares tumbled and closed at RM1.17. That’s a steep drop of 18.18%. That drop was a ripple effect caused by the termination of the development arrangement between, Iskandar Waterfront Holdings Sdn Bhd and its joint venture partner,  China Railway Engineering Corp, and TRX City Sdn Bhd, an entity own by the Ministry of Finance.

The common denominator between Iskandar Waterfront Holdings Sdn Bhd and Ekovest is the major shareholder of both said companies, Tan Sri Lim Kang Hoo.

But was the selling pressure justified? Without further ado, let’s jump right into the analysis of Ekovest.

1

Introduction

Ekovest is a construction company which operates three distinct businesses namely:

  1. Construction.
  2. Property development.
  3. Toll operations/concessionaire.
Construction

Ekovest, through its related companies, are involved in major construction projects namely the River of Life (“RoL“), the extension of the Duta-Ulu Klang Expressway   (“DUKE“) Phase 2 and the Setiawangsa-Pantai Expressway (“SPE“).

Ekovest’s construction book order stands at RM5.3 billion at the end of FY2016.

River of Life

RoL project is a major rejuvenation project of the Klang and Gombak rivers in Kuala Lumpur. A budget of RM4.4 billion has been set aside for it. Ekovest’s wholly-owned subsidiary, EkoRiver Construction Sdn Bhd (“EkoRiver“), is the sole project delivery partner.

More recently, in May 2017, EkoRiver was awarded an 18-week project worth RM79 million to complete a section of the RoL project in the vicinity of Masjid Jamek.

Another wholly-owned unit,  Ekovest KL Bund Sdn Bhd, has also been cashing in on the RoL project. It entered into an incentive agreement with the government for enhancing existing sewage treatment plant in Bunus. Ekovest KL Bund Sdn Bhd will reap an estimated RM70 million for the cost-saving attributed from its enhanced design of the Bunus sewage treatment plant. This exercise will save the government a projected RM94.67 million.

DUKE Phase 2

Another major infrastructure project under Ekovest’s belt is the extension to DUKE, simply known as DUKE Phase 2. Duke Phase 2 costs an estimated RM1.1 billion and will be completed in mid-2017. This is despite its initial completion date, in December 2016, which Ekovest was unable to meet.

SPE

In early 2016, Ekovest was awarded a concession which includes the design, build, operation and maintenance of the SPE for 53½ years. SPE is a highway with a length of 29.8km. Upon its completion, SPE will be serving locations such as University Tunku Abdul Rahman, Wangsa Maju, Setiawangsa, Ampang, the Tun Razak Exchange & Bandar Malaysia development corridor and Kerinchi.

Ekovest has funded SPE through the issuance of Sukuk Wakalah of up to RM3.6 billion which has a rating of AA- . The tenure of the Sukuk Wakalah is for a period of 23 years and the issuance was completed on 23 August 2016.

Other funding sources include a RM500 million interest free reimbursement interest assisted scheme by the government  and RM850 million equity from Ekovest.

This project is ongoing and is estimated to be operational in 2020.

Property development

Other than construction, Ekovest has a commendable property development business in the thick of bustling Klang Valley. The crown jewel of Ekovest’s RM7.8 billion property development portfolio is none other than EkoCheras.

EkoCheras is a RM2.11 billion gross development value mixed development mall, service apartment, hotel and office tower development with about 1 million square feet of retail space. It is slated to be completed in December 2017.

EkoTitiwangsa is another development which is strategically located along DUKE and KL River City area. It will host 696 units of service apartments and some retail space.

Another notable development is Oasis Kajang which is largely a double-storey terraced house project.

Toll operation

Ekovest is the operator of DUKE, an 18 km expressway from the east to west of the northern corridor of Kuala Lumpur since 2009/2010 (I may be wrong).

By mid of 2017, DUKE Phase 2 is slated to be completed and operational. DUKE Phase 2 will be an addition to Ekovest’s growing list of recurring and sustainable income generators.

It is worth noting that Ekovest’s concessions in DUKE and DUKE Phase 2 were extended from an initial 34 years to 53 years, with the option to extend for another 10 years.

Financials 
DATA 2016 2015 2014 2013 2012
REVENUE (RM’000) 793582 438015 229126 140966 208948
PROFIT (RM’000) 155412 18512 13200 50071 72644
OPERATING PROFIT (RM’000) 285736 123026 138049 84066 89020
SHAREHOLDERS’ EQUITY (RM’000) 1317138 1182443 1098587 779424 410420
DEBT (RM’000) 2674480 2483714 2311361 1103931 223434
                                                                         RATIO
DEBT TO EQUITY RATIO 2.03 2.10 2.10 1.42 0.54
OPERATING PROFIT MARGIN 0.36 0.28 0.60 0.59 0.42
OCF RATIO 0.11 -0.30 0.26 -0.08 -0.15
PROFIT MARGIN 0.20 0.04 0.06 0.36 0.34
EPS (CENTS) 18.2 2.2 7.2 25.1 40.6
EPS (ADJUSTED) CENTS 7.31 0.87 2.20 2.57 3.40
DPS CENTS 3 2 2 1 5
DIVIDEND PAY OUT 0.16 0.90 0.28 0.04 0.12
P/E 8.26 47.22 15.62 11.30 6.15
ROE 11.80 1.57 1.20 6.42 17.70

FY2016 was a tremendous year of success for Ekovest. The group improved in many areas such as revenue, profits, earnings per share, return on equity, cash flow/ liquidity and profit margin.What stood out the most was the 700% increase of its return on equity from FY2015.

A low dividend pay out in FY2016 indicates that Ekovest intents to retain its profits to be reinvested in its projects. This is a prudent decision by the management having to take into consideration the increasing numbers of capital-intensive projects that Ekovest is undertaking.

The improvement in Ekovest’s financials is attributed largely to the construction segment. I foresee that this segment will continue to contribute favourably to Ekovest’s revenue and earnings because of its enlarged book order of about RM5.3 billion (as at FY2016) in the span of 4 years to come.

From my calculations, Ekovest has a commendable growth rate of 16.5% based on earnings per share. Financial Times, on the other hand, has calculated Ekovest’s growth rate at 20.15%, based also on earnings per share. Sustainable growth rate (a company’s growth rate without borrowed money) is calculated about 10%. These are surprisingly good growth numbers.

Potentials

In January 2017, Ekovest was successful in receiving a principal approval for another highway concession, dubbed DUKE 2A. The proposed DUKE 2A consists of the privatisation of Kampung Baru Link, Istana Link and Kapar Link Expressway with a proposed length about 75km. The estimated cost of DUKE 2A is in the region of RM6.3 billion. Ekovest’s construction book order may swell to RM11 billion, from its current RM5 billion, if Ekovest was awarded the construction of DUKE 2A as it had for DUKE Phase 2 and SPE.

Also in January 2017, Ekovest entered into a joint venture with the Samling group from Sarawak to construct a 95.4km stretch of road from Semantan to Sg Moyan Bridge plus Kuching-Serian roundabout interchanges worth RM2.11 billion. This is part of the colossal Pan Borneo Highway. The group holds a 30% equity in the joint venture.

There are also talks about floating DUKE  and DUKE Phase 2. So far, nothing about the float is concrete.

Conclusion

I like Ekovest for its:

  1. Improving financials.
  2. Good growth rates.
  3. Ability to secure major infrastructure projects.
  4. Ability to deliver major infrastructure projects.

I don’t like Ekovest because of its heavy reliance on concessions from the government (then again, major infrastructure projects are usually initiated by the government).

Disclosure

I own shares in Ekovest.

Reference
  1. Ekovest’s Annual Report 2016
  2. http://www.thestar.com.my/business/business-news/2017/05/03/bandar-malaysia-agreement-with-iwh-crec-lapses/
  3. http://www.theedgemarkets.com/article/ekovest-managing-director-share-sell-down-temporary
  4. http://www.duke.com.my/
  5. https://www.ekovest.com.my/
  6. http://www.thestar.com.my/business/business-news/2016/10/24/ekovest-clinches-rm255mil-new-river-of-life-contract/
  7. http://www.thestar.com.my/business/business-news/2017/04/19/ekovest-may-gain-up-to-rm71mil-in-govt-incentive-payment/
  8. http://www.nst.com.my/business/2017/04/232405/ekovest-unit-signs-incentive-deal-govt-bunus-stp-enhanced-design
  9. http://www.thestar.com.my/business/business-news/2016/08/19/epf-mulls-buying-a-40pc-stake-in-duke-highway-from-ekovest/
  10. http://www.thestar.com.my/business/business-news/2016/09/21/epf-buys-40pct-stake-in-duke-highway-operator-for-rm1pt13b/
  11. http://ekovest.listedcompany.com/newsroom/ENG-PR-EKOVEST_INKS_40_PER_CENT_DUKE_SALE_WITH_EPF_FOR_RM1.13B.pdf
  12. http://www.theedgemarkets.com/article/ekovest-gets-concession-rm374b-setiawangsa-pantai-expressway-project
  13. http://www.thestar.com.my/business/business-news/2016/07/18/ekovest-to-launch-issue-sukuk-of-up-to-rm3pt64bil/
  14. http://www.thestar.com.my/business/business-news/2016/08/16/ekovest-to-issue-sukuk-for-expressway/
  15. http://www.nst.com.my/news/2017/02/208902/ekovest-targets-listing-2-more-divisions-bursa
  16. http://www.thestar.com.my/business/business-news/2017/01/19/ekovest-surges-after-winning-highway-concession/
  17. http://www.thestar.com.my/business/business-news/2017/01/06/ekovest-joins-pan-borneo-highway-project-with-jv-work-package-worth-rm2bil/
  18. https://markets.ft.com/data/equities/tearsheet/financials?s=EKOVEST:KLS
  19. http://www.theedgemarkets.com/article/insider-moves-datasonic-group-bhd-gabungan-aqrs-bhd-ekovest-bhd-boon-koon-group-bhd
  20. http://www.malaysiapropertyreviews.com/ekocheras/
  21. https://www.pressreader.com/malaysia/the-star-malaysia-starbiz/20160521/281492160549966
Analysis

How did Elsoft Research Bhd fare in FY2016?

Dear Readers

Having read Elsoft Research Bhd’s (“Elsoft“) annual report for FY 2016, after it was published 27 April 2017, I have decided to a write up which serves as an addendum to Analysis of Elsoft Research Bhd.

Let’s get right to it.

Elsoft

Finances

This is a summary of the financial performance of Elsoft between FY2015 and FY2016:

  1. Revenue increased to about 26%, from about RM49 million to roughly RM63 million.
  2. Costs of sales went up about 7.7%, from RM27 million to RM29 million, owing to an increase in staff costs and raw material consumption.
  3. Other income (indirect income) decreased about 47%, from RM7.6 million to RM4 million, because of lower contributions from other investments and lower foreign exchange gains.
  4. Administrative expenses increased about 82%, from RM3.9 million to RM7.1 million, due to an increase in staff costs, professional fees, fair value loss from other investments and recognition of shares based payments as a result of the implementation of Employee Share Offering Scheme.
  5. Lower taxation rate partly owing to 100% tax exemption under pioneer status.
  6. Inventories increased by 96%, from RM2.6 million to RM5.1 million, as a result of increasing work-in-progress to meet higher demand for FY2017.
  7. Cash or cash equivalent dropped 23%, from RM11.6 million to RM15.1 million. This is because Elsoft placed more money in money market funds with financial institutions and they are recognised as “other investments” in accounting.
  8. Trade and other payables increased 37.7%, from RM9.2 million to RM12.7 million, owing to higher purchases in FY 2016.
  9. Elsoft spent RM6.6 million or 10.4% of revenue for research and development (“R&D“).

Other salient matters worth mentioning:

  1. Elsoft employs 27 R&D engineers. Engineers work on digital and analog design, mechanical design, firmware and application software development.
  2. Elsoft has increased production and service workforce from 25 to 32 employees to keep up with demand in production.
  3. Butterfly House (PG) Sdn Bhd, a 21% owned associate of Elsoft has reopened a butterfly farm, at Teluk Bahang, Pahang, called Entopia.
Conclusion

There is no secret that FY2016 was a good ride for Elsoft. However what particularly struck me was that inventories increased by 96% owing to higher demand in FY2017.

Disclosure

I own shares in Elsoft.

Reference
  1. Elsoft’s annual report 2016