I’ve been having the hardest of times piecing together an analysis on Sinarmas Land. Unfortunately, I am unable to overcome my various apprehensions and doubts about the company to produce a complete analysis. This is solely due to my (lack of) depth of knowledge; it certainly does not reflect anything negative about the company but through the course of my attempted analysis, I did learn a few vital lessons which I would like to share.
I’ll start by what analysis I have of the company and draw out the lessons from there.
Sinarmas Land Limited is engaged in the property business through its operations in Indonesia, China, Malaysia and Singapore. It combines two big developers: Bumi Serpong Damai Tbk (BDSE) and Duta Pertiwi Tbk (DUTI) that are both listed on the Indonesian stock exchange.
BDSE and DUTI comprise a large part of the Sinarmas entity. We focus our attention first on determining a fair value for these two subsidiaries.
As of 16/5/2014 and assuming an exchange rate of 0.0011, BSDE has a market capitalisation of SGD3232.8m and is 49.87% owned by Sinarmas. Similarly, DUTI has a market capitalisation of 402.2SGDm and is 44.16% owned by Sinarmas. Using an equity weighted approach, they constitute a market value of SGD1789.8m in total. This actually exceeds Sinarmas’ current market capitalisation of SGD1719m. Considering that Sinarmas has substantial assets besides the two, it seems that the counter is severely undervalued, at face value. It is certainly tempting to conclude as such, but if we do believe that price will converge to its true value in the long term, then the risk in such a conclusion would be that the true value of BDSE and DUTI is actually less than it currently is. We therefore have to ascertain the fair value of BDSE and DUTI, i.e. are they currently overpriced?
A quick snapshot of the Balance Sheet of the 3 companies:
BDSE – Market cap of SGD3232.8m vs equity of SGD1475.7m.
Paying 2.19x BV is very steep for a developer; most developers in the Singapore market trade below book value. From a value perspective, the only reason to do such a thing would be if the RNAV is significantly higher. Personally, I feel that a price of 0.8-1.0 times of RNAV would be a comfortable range for a fair value. In this case, this would require the RNAV to be at least double of BDSE’s current BV. Typically, the bulk of asset revaluation lies in a company’s non-current asset which, for BDSE, comprises largely of its Land for Development account.
Unfortunately, imperfect information is often a bane of retail investors and particularly so when it comes to dealing with foreign companies. The only information I could get out my secondary research in terms of market pricing was the news about BDSE selling up to 95 hectares of land for RP 2 trillion to joint ventures. This translates to RP 2,105,263 per sqm of land in BSD City versus RP 120,221 per sqm (amount divided by land area) in the book. That’s 20 times more.
This is where I ran into my first roadblock. If you choose to believe such reasoning, this counter would be severely undervalued. However, looking at the historical values of the various lands in the account, I notice that the amounts have been revised even when the land area has remained the same. This points to the likelihood that the book value is actually revised yearly which contradicts the purpose of our revaluation exercise and this is only the tip of the iceberg. My next roadblock is due to the consolidation of subsidiaries and it provided me with the most important revelation I have had in a long time.
Pitfalls of Consolidation
Based on common accounting practices, a parent company is required to consolidate its reports with its subsidiaries. This is why there is often a ‘Profits due to non-controlling interests’ line in the income statement. While most would only focus at the bottom number, this is something you should adjust for (or I would anyway).
As can be seen in Sinarmas’ case, there is a substantial difference between both numbers which will drastically affect your valuations.
In terms of balance sheet at the parent level, the balance sheet of the subsidiaries is always fully consolidated, regardless of the percentage of ownership by the parent. The rationale is that as long as a parent has a majority stake, it will have full control over the subsidiary’s assets. We investors should know better that this does not equate to full ownership over all of the subsidiary’s assets, therefore, adjustments would have to be made to reflect the percentage of ownership.
Sharp-eyed readers will notice that the sum of BDSE’s and DUTI’s accounts exceeds that of Sinarmas which might seem to refute the point I just made. For example, total current asset for BDSE and DUTI is around SGD1700m vs Sinarmas SGD1300m. This is because when consolidation is done by the parent, adjustments are made to remove intra-group transactions; you cannot earn money by selling to yourself. Therefore, the equity value of a parent should always be less than the sum of its subsidiary’s book value, assuming they are not fully owned and that there are not other assets owned by the parent company. The same concept applies when calculating fair value.
To deal with this, common practise is to apply a holding company’s discount of 20-30%. A better method would be to subtract the value of the company’s books from the group’s (for the various accounts), and then compare this value to the sum of the subsidaries’ books to approximate the percentage discount, but that’s only if they are listed. Caution will also have to be exercised when valuing the ‘Associated Companies’ account of the parent because there might not be a conspicuous distinction between associates of subsidiaries and associates of the parent company. If you are not careful, you might end up valuing the same entity twice.
It gets more complicated when it comes to the cash flow statement because cash flow statements are always consolidated at a group level and is unadjusted for subsidiary contributions. If the subsidiaries were all from similar industries, we might be able to assume that their cost make-up are similar (same percentage of depreciation etc.), then we can adjust the cash flows based on a percentage of ownership basis as well. Nevertheless, it is still a rather stretched assumption because the sizes of the subsidiaries may still differ. It’s even worse when the subsidiaries are in vastly different industries, and unfortunately in this instance I do not have the slightest clue. I admit this is an area I have yet to seriously contemplate but it is definitely something I will explore deeper so till then, all that I have said about cash flow statement might be just gibberish.
The implications are dire and clear; how often have we taken a group-level cash flow value to calculate free cash flow? And when we did that, did we even consider the degree of subsidiary contribution? For parents with fully owned subsidiaries, we would have dodged a bullet. But for companies like Sinarmas which considers 49.87% and 44.16% owned companies as subsidiaries, the difference would be far, far too huge.
With that and after so much deliberation on how to analyse Sinarmas Land, I suddenly recall a very wise man’s analogy about baseball and investing.
“What’s nice about investing is you don’t have to swing at pitches. You can watch pitches come in one inch above or one inch below your navel and you don’t have to swing. No umpire is going to call you out. You can wait for the pitch you want.”
Disclosure: The authors have no vested interest in A26.SI