Month: March 2014

Company Updates

UMS Holdings

Recently, UMS Holdings has declared a bonus issue of 1 share for every 4 held. Given the company’s progress and how the economy has been improving, I would be holding onto UMS and receiving the bonus shares. Hopefully, the company will be able to continue distributing dividends of 5c per share, which translates to SGD 21.5 million. This is possible given its net cash generated from operating activities over the past few years. However, we have to take note that in recent years, the CAPEX has been pretty low, given how much the company has spent on CAPEX previously. Hence, with CAPEX increasing, it may be slightly harder for the company to maintain a 5c per share dividend. However, I would continue observing the earnings of the company, especially with Applied Materials having stronger growth in sales, UMS Holdings would benefit from this as well. With the share price running up to SGD 0.80 from the initial purchase at SGD 0.50, I would start analysing the fair value for UMS Holdings.

New Toyo

Recently, the ex-CEO Gary Yen would be stepping down. With Father and Son no longer managing the company, they have elected David Lim an expert at M&A to be the next CEO. Furthermore, there has been speculations that the family’s 52% stake in the company is up for sale. Given the expertise of the new CEO, perhaps there may be some truth in the speculations? Furthermore, looking at New Toyo of late, the trade volumes have been increasing and today closed at SGD 0.32.

Disclosure: The author is long UMS Holdings, New Toyo

ADT Corporation

Have been pretty busy recently to actually post part 2 of New Toyo. However, will post the full analysis done on ADT Corporation first.

adt

ADT Corporation is a provider of electronic security, interactive home and business automation and monitoring services for residences and small businesses in the US and Canada. The company provides home, business and home health solutions and services. It was a spinoff from its parent company Tyco in September 2012, and is the largest home/small business in USA and Canada.

Fundamental Analysis:

(I) Earnings:

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While growth of gross profits and net profits have been fluctuating year on year, it is important to note the consistency in gross profit margins and net profit margins at approximately 57% and 12% respectively. Furthermore, EPS has been increasing each year.

(II) Balance Sheet & Cash Flows:

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Being a relatively young company, it is still a net debt company. However, given it ability to generate positive FCF of approximately USD 500 million, I do not foresee much issues with its debt. Moreover, most of its debt are long term debt, hence, in the short run, the company only has to settle the debt of USD 3 million. Moreover, if one calculates the LTD/Equity, which can be seen later, it is less than 1. Therefore, with the issue of indebtedness, it is not much of an issue. Looking at the cash conversion cycle, it is positive and the huge difference between trade receivable days and trade payable days is something worth taking note of.

(III) Financial Ratios:

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In terms of ratios, we can observe that current ratio has increased quite significantly from FY2011 to FY2012 and stagnated somewhat from FY2012 to FY2013. While Debt/Equity and LTD/Equity has increased over the years, as said previously, I do not foresee much problems going forward given how the company has been able to generate positive FCF and that these figures are still below 1. In terms of ROE and ROA, it has been generally been quite stable.

Qualitative Analysis:

Looking at the company’s revenue, 91% of it comes from recurring income from existing customers. Hence, it is crucial to analysis if the company is able to retain customer loyalty and if they are able to defend this economic moat they have well. Also, in the home security industry, the other top 2 players are Protect America and FrontPoint Security.

(I) Economic Moat:

Looking at a survey done by Bain Capital:

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We can seen that ADT Corporation is definitely a brand many US residents are able to relate to and are the first to consider when it comes to home security. Furthermore, what is important to take note of is that there are actually 50% of their customers who did not bother considering any other brands when choosing home security.

(II) Business Analysis:

(II.1) Essentially, when choosing a home security company, what qualities are we actually looking out for?

1) Experience matters – One definitely wants a security company who has the experience in keeping their families safe. It need not be a long track record but rather one that has proved itself efficient and effective over a number of years and comes highly recommended from respected sources.

2) Wireless matters – Wireless is the way going forward. Wireless systems cannot be disarmed with a snip nor are they easy to tamper with. A weak cellular signal, not even a phone line, is needed to operate a wireless security system.

3) Power backup – In an event of a power shortage, we definitely want the alarm to still be live.

(II.2) Now, we will compare the advantages and disadvantages of choosing ADT Corporation as our home security system.

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(II.3) Evaluation:

1) Cost – Comparing ADT to other reputable brands , the monthly cost is approximately the same. Picking the other top 2, FrontPoint Security cost $35 – $50. While Protect America cost from $20 – $43.

  • NB: Protect America charges for the number of door and window sensors, meaning that for lower cost packages there will be doors/windows without sensors which defeats the point of a home security system.

2) Complaints – Compared to FrontPoint Security, ADT definitely has failed in this aspect. FrontPoint Security has very few negative complaints. In fact, they have always responded directly to either apologize, or to explain the situation. Only 28 complaints registered by the BBB. Likewise with Protect America, they have only 395 complaints registered with the BBB. All complaints to date have been closed and its important to note that with 130,000 monthly customers that’s 0.003% complaints of their customer base.

3) Wireless – ADT has been pushing their wireless services, trying to mitigate such problems from occurring.

(III) Valuation:

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Looking at ADT Corporation in terms of P/E, it is definitely not cheap especially based on empirical research. However, comparing it to the S&P 500 and Industry Average, it is still relatively cheap. In terms of EV/EBITDA, at 5.17 it is definitely cheap in terms of empirical research. While in terms of FCF yield of approximately 8% compared to the US 30Y Treasury or Corporate Bond yielding at approximately 4%, it suggests that there is a 100% upside in price. However, giving a 30% discount for any miscalculations and errors, there is still a 70% upside in price which is a relatively comfortable margin of safety in my opinion.

(IIII) Conclusion:

Looking at ADT Corporation in all aspects, while in terms of fundamentals, it may still not be very strong, however, given that it is a relatively young country, I would not use current results to project what the company would be like 5 or 10 years down the road. Qualitatively, ADT is a household name, with strong consumer penetration within the United States. While it has its fair share of negative complaints, so do other companies. While not trying to defend their mistakes of not resolving issues quickly, with 6.4 million customers, one has to understand that they are unable to provide the kind of personalised feedback like FrontPoint and Protect America. While ADT may be slightly costly, it pays to know that our family is safe. Lastly, in terms of valuations, I would say that with all indicators showing that the company is undervalued, and an upside of 70% after discounting for mistakes and errors, I would say that ADT Corporation is an undervalued company.

Disclosure: The author is long ADT Corporation (USD 28.50). It will not be reflected in my SG holdings, but it is held within my family portfolio. 

New Toyo (Part 1)

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New Toyo International Holdings is a leading regional provider of specialty packaging materials with over 30 years of experience. The Group has two core divisions – Specialty Papers Division focusing on production of laminated foil paper, and coated paper and metalised paper, while the Printed Carton and Labels division offers mainly gravure and lithography or offset printing of packaging materials for cigarettes and fast-moving products.

The company has a strong manufacturing base with multiple facilities located strategically across the region, in Singapore, Malaysia, Vietnam, Australia, China and Thailand, to ensure effective support to its customers in Asia Pacific and the Middle East. The Group specialises in high quality packaging products for international tobacco companies as well as government-owned tobacco monopolies. It also serves locally-based companies in the consumer-related industries.

Fundamental Analysis:

(i) Earnings:

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In terms of earnings, we can see that the period-on-period growth rates for gross and net profits have been pretty choppy, with no consistency over the years. However, in terms of margins, the company has been pretty consistent, with gross profit margins approximately 16% – 17% and net profit margins averaging around 5% – 6%. Also, EPS has been relatively stable over the years.

(ii) Balance Sheet & Cash Flows:

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We can observe that the company has been able to turn around from a net debt to a net cash company, with SGD 25.3million net cash at the end of FY2013. Furthermore, the company has been able to reduce their long term debts from SGD 62million to SGD 6million. Going forward, if the company is able to continue this performance, it would definitely signify long term competitive advantage because the company is so profitable that even expansions or acquisitions are self financed.

One can observe that the growth in revenues had outpaced the growth in receivables in all years except FY2013. Also, the growth is not really aligned, where for certain years, growth in revenue is positive, yet growth in trade receivables is negative. For this, I still have not found any adequate reasoning. Also, in terms of cash conversion cycle, we can observe that is is negative for a number of years which can be dangerous. However, given the company’s clients being renowned, reputable and of good credit standing (e.g. BAT), it mitigates the risk of defaults and the negative figures are not a cause for worry.

In terms of cash flow, it is strong where the company is consistently producing positive free cash flows every year. Furthermore, cash from operating activities net investing and financing activities, is still positive, hence the company has consistently been able to add cash back to its reserves. This is evident from the fact that their cash and cash equivalents has been growing steadily each year to an all time high in FY2013 of SGD 59.9million. However, we have to take note that increase in free cash flow is partly due to the reducing of CAPEX spending, and in the long run this may be worrying as it signifies that the company is not reinvesting in its capital goods.

(iii) Financial Ratios:

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Looking at the ratios, the company’s ROE and ROA has not been very consistent. However, in terms of indebtedness, the company has been steadily increasing their current ratio, signifying that the ratio of current assets to liabilities is increasing. Furthermore, in terms of total debt and long term debt to equity, it is under 1 and decreasing every year. This is another indicator of the company being able to manage their debt well. Going forward, with the tapering of QE and increases in interest rate, it is encouraging to see the debt levels of the company decreasing.

In my next post, I would be covering the qualitative aspect of the company.

Economic Moats

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Economic moats a term coined by Warren Buffett just simply means structural business attributes that allows companies to generate high returns on capital. The businesses I love are ones that have strong economic moats, allowing companies to protect their profits from new entrants.

One classic case in Singapore of a business that lacks a strong economic moat is the bubble tea business. Due to the lack of barriers to entry, new entrants flooded the market resulting into the erosion of profit margins. Hence, we should always be asking ourselves what is the competition advantage the company has over its competitors. In this post, I would be explaining the 4 sources of economic moats.

  1. Network Effect
  2. Cost Advantages
  3. Intangible Assets
  4. Switching Costs

Network Effect: It is present when the value of a service grows as more people use a network. With each additional node, the number of potential connections would increase exponentially. The classic example would be credit card companies and new entrants would find great barriers to entry in competing with these giants.

Cost Advantages: Being able to reduce cost efficiently, it allows firms to sell their goods at the same price as competition and gather excess profits. Also, they have the option of undercutting competition. The ability of being able to reduce cost efficiently is derived from economies of scale or perhaps cutting out the middle-man and dealing directly with customers.

Intangible Assets: Refers to Branding, Patents, Licenses & Government Approvals etc. Strong brand names (e.g. Microsoft, Tiffany & Co., Tod’s etc) allows companies to charge a premium compared to competitors. Patents of drugs gives pharmaceutical companies to be the sole seller of the drug, resulting in supernormal profits.

Customer Switching Costs: Companies try to employ strategies that incur some sort of high costs in order to dissuade customers from switching over to competitors. Such as the telecommunications industry, moving to a different mobile provider and wanting to keep the same phone number? It’s a real headache to notify everyone of your new phone number. Another great example would be the alcohol industry, when customers are physically and psychologically addicted to your product, they would be hooked – legal and ethical issues aside.

NB: Empirical research done by Morningstar has shown that fundamentally, the best competitive advantage appears to be intangible assets.

Company Updates

King Wan Corporation

Spoke to my Thai friend recently about the political and economic scene in Thailand. He was explaining to me how the opposition party behaves, the riotings, the bombings etc. When asked of his opinion of when we would expect to see things settling down, he said at minimum he is looking at the end of this year. In view of this, I feel that the listing of KTIS is pretty unlikely this August. That said, in the event that that really happens and the price drops back to approximately $0.20, I would be deploying most of the cash to buy King Wan Corporation.

LionAsia Pac:

When my friend and I first discovered this company, I would consider it a value buy. It was definitely an undervalued company without any doubt. Cash deducting for all liabilities was approximately the same as the market cap back then and going forward, this figure started to increase whereas the market cap decreased due to the share price dropping. Essentially that meant that buying the company at market price, we are practically getting the core business and side businesses all for free! The catalyst we identified was their stake in Mindax, a mining company in Australia. On hindsight, we should have considered the aspect that whilst the company may have such huge amounts of cash, it is due to the inefficiency of the management. Holding onto that much cash just shows that the management does not know where to deploy it and is overly conservative. The point of being very conservative was also a point highlighted to me by my father having managed their accounts before in the past. That said, I would be monitoring the development of the land they recently bought in Yangzhou, China. At any sign of weakness of the China property market or a contraction, I would consider selling the stake the fund holds in LionAsia Pac. This is to increase the amount of cash available to purchase more shares in King Wan Corporation if price does drop. A snapshot of their most recent balance sheet. Back in 2012, when I saw the amount of cash, I couldn’t believe my eyes.

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UMS Holdings:

Net profit jumping 70% and the company proposing a normal dividend of 2c and a special dividend of 1.5c. Given the company having no debts, I expected the special dividend to be 1c. Going forward, given how Applied Materials have bought over Tokyo Electron, gaining a global market share of 25% and strengthening their position as the global leader for semiconductors, I believe would be one strong year for UMS. Furthermore, with the economy recovering, this would definitely flow back to the semiconductor industry, evident when looking at the PHLX Semiconductor Index.

ImageMy apologies for the lack of posts. The past week has been one hell of a week at Uni with assignments due and me running for elections within my society.

Disclosure: The author is long KingWan Corp, LionAsia Pac, UMS Holdings