I have kept this counter in my watchlist for a long time now and I decide to enter into a position recently at a price of $0.29 for 70,000 shares. I have been sick recently because of the cold so didn't have time to write the report immediately.
Some of you may have heard of this stock before and there’s a couple of great written articles on this previously so I will not go into the details that have already been presented but more on what I think of the business. But let’s go through some basic findings about the company first.
Business Overview
The company designs, fabricates, supplies, and installs steel and aluminium products in Singapore and Malaysia. The core business operates through four segments: Aluminium, Mild Steel, Stainless Steel and Others. Its steel and aluminium products comprise of gates, door frames, staircase nosing, laundry racks, letter boxes, sliding windows, doors and curtain walls for construction flats and houses. The company also offers aluminium mainframes for container refrigeration units, grilles, drying racks, hoppers and other metal and steel based products.
The company has a rather small market capitalization of around $70M and a free float of around 40%.
Financials Overview
This is a company that is abounded by the various great looking metrics all around and I am pretty sure many investors are attracted by them to be invested in the company. But let me give some views to highlight both the positive and negative of that.
The company is well known to be a great net-net example of what Benjamin Graham preach in his book. Great assets, mostly great income producing and working capital assets, good majority amount of cash, virtually no borrowings on the book and trading undervalued at good valuations. This is to a large extent true if we look them from a liquidation point of view as the current price is trading at a 42% discount (P/B = 0.58) to its NAV at 50 cents. A value investor would also see this gap as a margin of safety as it provide a buffer to the running operations of the business.
However, there are still things that we should be taking note of more closely.
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| B's customized financial statements (2007 - 2015) |
1.) Cash – The company used to own a larger majority of cash of over $50m at one point before they were reduced to where they are now at around $33m (latest balance sheet). Out of this, $6m belongs to long term bond investment which they were invested in maturing in 2020.
The problem with holding so much cash on the books is first it erodes the return on equity the company is churning out and secondly it inflates expectations from retail investors to the management to distribute more dividends from its earnings and cash hoard. We know how hard that can be to explain to investors from the management point of view as we will see next.
2.) Cashflow – Due to the nature of its business, the company has often a long chain of working capital that it has to manage with, resulting in the need for cash on its books to make buffer for unexpected emergencies. Inventories and trade debtors are often associated with the product mix completion of certain construction projects which can be lumpy at times. This is probably why we are seeing a bumpy ride of years with great operating cash flow followed by years of negative operating cash flow next.
Maintenance Capex is often in the range of $1 - 2m while the company had recently purchased a one-off acquisition of a factory in Malaysia which costs them around $8m, which will boost the scale of operations along with the other four operating facilities. This was funded via internal so cash decreased by around the same amount.
Free cash flow is positive most of the times, except for recent years due to the purchase of operating facilities and changes in the product mix which increases the working capital inventories.
Often, people has this misconception to treating this as a weakness but I personally don't think too much into it, other than the fact that those cash we are seeing cannot be distributed to shareholders. As far as I am concerned, I only see this as a risk if we are seeing plenty of impairments to the inventories or an increase to the bad debt provision to the trade debtors. Other than that, this is simply a timing issue which will eventually goes back to company's pocket. Still, we want to see cashflow going back to the company as fast as possible.
3.) Return on Equity - The return on equity seems to go back in recent quarters and this is despite having such a humongous cash hoard that hurts their roe.
4.) Earnings Yield and Dividends Payout - The company has been consistently generating double digit earnings yield for the past 8 years. Even during the gfc crisis the company managed to churn out 10.1% yield. Recent quarters seem to suggest that the trend could be coming back, though we still need to look out for potential slowdown for the construction business.
The company has been paying out roughly less than 50% of the earnings as dividends and retained the other half. This come across to me as being reasonably conservative and I would rather they do it slow and grow the business rather than being aggressive and pay out higher dividends.
Segmental Business
There’s some sort of problem for investors trying to evaluate the company since they did not specifically state the segmental difference between their container and construction business. One of the reasons I could think of is due to competitiveness since they would have to bid for these businesses. This is rather similar to what Vicom did since 2011 when they stopped their segmental reporting. However, from the recent negative outlook surrounding housing flats, it appears that the majority of the revenues and profits come from the container segment.
However, the company did report a breakdown from a product categories level which we can infer from its recent annual report. According to the AR, Aluminium contributed the major share of turnover and profit contribution at 78.5% and 51.3% respectively. Mild Steel came in second with this category contributing 21.2% and 28.3% for revenue and profits respectively.
The price shown below will have an impact to the profit margin of the company since they are dependent on the metal.
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| Aluminium Price (2005 - 2015) |
Concentrated Risk
One problem that highlights the company's main operation risk is the customer concentration. It seems that a single major customer accounts for a substantial portion of its revenue and profits, which appears to be Carrier, a subsidiary from the big player United Technologies.
This is also the main reason why I decide to hold off my purchase because from the latest announcement, it seems that the company has just renewed its long term contract with the customer for another foreseeable future of 5 years or more. The company seems to have a long term relationship with the customer, so the renewal seems to confirm that both parties are happy with doing business with one another.
Valuations
I didn’t want to really do a deep dive calculation based on discounted cash flow valuation this time round because I do not think that would be the most suitable valuation methodology to use for this company.
Instead, I will be looking at it from two direct perspective.
First, as mentioned above, the company is trading under great liquidation value so from the assets perspective, I am looking that as a base to protect any unexpected impairments or earnings downside.
Second, from the earnings perspective, the company is trading under a trailing earnings yield of 10.4% for FY14, a year which I thought they have bottomed out and done pretty poorly in terms of project cost overrun. Based on the first quarter results, it appears that margins are starting to improve and they are getting back on a better track, so I am expecting things to improve from here and the company to generate an earnings yield of at least around 12% for FY15. Do note in mind that this is based on a scenario where aluminium price was lower than average and demand for construction is low and they are still able to generate a strong earnings yield. Current EV/EBITDA is still only at 5x. Back then when things are booming, EV/EBITDA was at 2.7x, a fantastic position to be in.
Second, from the earnings perspective, the company is trading under a trailing earnings yield of 10.4% for FY14, a year which I thought they have bottomed out and done pretty poorly in terms of project cost overrun. Based on the first quarter results, it appears that margins are starting to improve and they are getting back on a better track, so I am expecting things to improve from here and the company to generate an earnings yield of at least around 12% for FY15. Do note in mind that this is based on a scenario where aluminium price was lower than average and demand for construction is low and they are still able to generate a strong earnings yield. Current EV/EBITDA is still only at 5x. Back then when things are booming, EV/EBITDA was at 2.7x, a fantastic position to be in.
Conclusion
Overall, I think that this is a good company with a great track record that is currently trading at a relatively good valuation. I do not look at the potential upside from an asset point of view because of the abovementioned reasons but rather as a good potential liquidation back up value with the strong cash and working capital assets they currently have on their books.
The dividend yield is pretty decent for the shareholders at around 5.2%. Unlike Reits which are structured to give out majority of its earnings as dividends, the strong earnings yield generating capability and a conservative payout suggest that the company is able to retain the same to further grow its assets. The increase in NAV every year would suggest to prove that's the case.
If you are looking to do a quick hit and run, I'll suggest you skip this stock and look for counters that tend to give out higher dividends payout. I blogged a few of these stocks in the past. But if you are looking for a slow and steady grow to the business that you intend to keep for long term, this could be one to look out for with a consistent payout and great track record.
Vested with 70,000 shares after recent buy.
What do you think of this stock? Does the numbers look conservative to you?
