The Value Edge

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The Hour Glass

C1 Est. in 1979, THG is one of Asia’s reputable luxury retail groups with 30 boutiques in nine key cities throughout the Asia Pacific Region. THG prides itself as world’s leading cultural retail enterprise. They have been recognised by notable international publications such as Monocle and Vanity Fair as one of the most influential specialty retailers in the world. Furthermore, THG has been accorded the ‘Best Watch Retail’ honours by Singapore Tatler in 2014.

Fundamental Analysis

(I) Earnings: C2

Business Operations

THG operates across several countries – Singapore, Malaysia, Hong Kong, Australia, Thailand and Japan. The bulk of their profits, about 72%, come from their South East Asia and Australia operations. It may seem that THG has minimal reliance on the Chinese spending power, however, their exposure to Chinese mainlanders actually account for about 20% of THG’s sales. We would argue that this key clientele is responsible for THG’s historical performance and it is evident that the past few years have boded well for THG – profit attributable to shareholders increased at a 4-year CAGR of 13.9% while gross margins remained consistently above 20%. Similarly, net profit margins have been very consistent in the last 4 years. This reflects the management success in margin control by keeping operating expenses below 14% of sales.

Driven by Same-Store Growth

From FY2010 to FY2014, overall store count remained unchanged at 32 which indicate that growth has been due to same-store sales growth. We can attribute this to the spending power of Chinese tourists, with Hong Kong, Thailand and Singapore ranking among their top 5 travel destinations. While the THG’s Chinese story has weakened in the past year, exacerbated by the political situation in Thailand, it was offset by the effects of Abenomics, allowing THG to eke out a slight growth in FY2014. Moving forward, recovery in Thailand is a source of growth; THG plans to open another 2 boutiques in Bangkok and 2 Laduree points of sales. Looking at 1Q2015 results, recovery in Thailand has definitely begun, with results from Thailand increasing by 95% quarter on quarter. Unsurprisingly, the primary risk would be a China slowdown.

(II) Balance Sheet & Cash Flows: C3

Efficient Inventory Management

THG has a very high current ratio of 4.9 and cash ratio of approximately 2.9x (more on this later). Some might frown upon such abnormally high current and cash ratios as inefficient cash management. However in the case of THG, we view this as a necessity given the relatively high 3-year average inventory turnover days of 192. This is typical of the luxury watch industry; in fact, companies like Sincere Watches and Cortina have even higher inventory turnover days at 313 and 258 days respectively.

Cash Hoard and Lumpy Cash Flows

We note the lumpy cash flows under Free Cash Flow (2) if we were to consider working capital changes and it is indeed a stark contrast to the FCF before working capital changes. We had 2 primary thoughts on this – one, why is this so? And two, is it a concern? To address the first issue, the disparity is due to large increases in inventory levels from same-store sales growth, as mentioned above. Also, Trade Payables/Trade Receivables has sharply increased from FY2010 to FY2014. What this means is that THG is able to get more favourable credit terms with its suppliers. Now, as per our second concern, is this a serious issue? In some sense, this can   essentially be perceived as a snowballing of liabilities. However, given that this is accompanied by increasing cash reserves, we see little risk in any liability implosion. As growth slows, the disparity between the two FCFs will also decrease. As such, we deem it appropriate to use FCF before working capital changes for our cash flow analysis.

Undervalued Associates

From an asset perspective, there is upside in the valuation of their Thai associates held at SGD8.4m. For FY2014, it had ownership-adjusted profits of SGD2.9m, in spite of the political unrest in Thailand, and based on their recent FY2015 Q1 results, we expect profits to be maintained at this level at the very least. This gives us an ROE of about 34.5%. It is quite likely that their fair value is upwards of SGD8.4m, but of course there is always a question of unlocking value and it is highly improbably that management will be cashing out their stake anytime soon. Therefore, we do not account for any re-valuation but merely view it as a subtle positive note.

(III) Financial Ratios: C4

As a regional company, there is no escaping comparison with its regional competitors, of which only Cortina is Singapore-listed.  The figures above are based on the latest annual reports except for the calculation of FCF-yield which is normalized on a 5-year average. To put it simply, there is no competition – THG triumphs the others by a fair margin. However, readers should be aware that this is a mere face value judgement; more detailed analysis on the other companies might yield new findings.

Qualitative Analysis

(I) Competitive Advantage/Moat:

If we were to be owners of THG, one key question would be ‘How does THG compete?’ What makes THG stand out from the rest? Inventory management aside, the core purpose of a luxury retailer, or any retailer at that, is to attract customers. We opine the following factors in evaluating a retailer’s ability to attract customers:

1) Pricing & Profitability Pricing is typically a key factor in differentiating retailers. However, for luxury goods, this is not so much an issue. In fact, THG increased their average unit retail sale price by 8% and was still able to grow their revenue and NPAT. This is does not mean that profitability is expected to be similar across the board – this is where efficient inventory management comes in in lowering costs. THG stands out in this aspect, as evident by its superior net profit margins. However, higher profitability does not translate to consumer utility when price is relatively inelastic and therefore does not help to attract customers.

2) Number of Stores and Store Locations C7

Prima facie, THG has the third highest number of stores at 32. However, it is always important for us to understand the intricacies behind the numbers as numbers alone can be misleading. For example, 21 of Sincere’s 39 stores are exclusive Franck Muller boutiques which in my opinion, restricts its appeal to a very niche group of customers. And even though Hengdeli has the second largest network of stores, it has an uncomfortably high exposure to the Chinese market. We can see that Sincere, THG and Cortina are equally diverse in terms of geographical market exposure, with all of them highly concentrated in the South-east Asian region. I would say that Sincere actually has the best network of stores but THG and Cortina come a very close second and third respectively. However, if we were to consider the fact that most of Sincere’s stores are Franck Muller boutiques and that it is more exposed to the Chinese market, THG would take the crown in terms of overall store network quality. To conclude, THG does not fair any worse to its competitors in terms of its ability to attract customers. We cannot conclude that THG is superior – firstly, because all of them are very close in terms of store networks and secondly, because higher profitability does not translate to consumer utility when price is relatively inelastic. It would not be wrong to say that THG has no economic moat; they have little capability in retaining customers. In terms of branding, I do not think that Cortina and Sincere are any less reputable than THG. When it comes to luxury watch retailers, the purpose of branding, in my opinion, is to provide a degree of assurance to customers that they will not be buying any fake products. Past that level, there is little marginal benefit to the retailers; ultimately, it is the brands and reputations of watches that count rather than that of the store front. On the flip side, while there is little to differentiate the companies to consumers and there is little moat, we can take comfort in knowing that THG is the one that gets the most out of every dollar in sales.

(II) Industry Outlook According to the WorldWatchReport report released on 26 March 2014:

“Despite a slowdown in sales in Asia, global consumer demand for luxury watches grew by +5.7%. Global demand was fuelled once again by BRIC markets with the highest year-to-year increases in China (+59.4%), Russia (+20.4%) and India (+12.0%) The Chinese luxury market is not dead: Interest in all luxury watch categories continues to escalate, led by Omega, Cartier and Rolex. Though sales at home may have declined, Chinese thirst for luxury watches is not showing any signs of slowdown, according to exclusive data shared for the first time by Baidu, China’s leading search engine, for Digital Luxury Group.”

This is definitely positive news and with 2 new stores in Thailand in the pipeline, THG is well-positioned to leverage on this trend. Nevertheless, the prospect of a Chinese crash is an ever-present overhang which is beyond our expertise to analyse. As such, we adopt a conservative stance and assume zero sales growth moving forward. This assumption will also guide our valuation.


If we were to look at relative valuation, THG would be an easy call to make. However as far as possible, we refrain from relative valuation for if one were to compare less-rotten apples with even more-rotted apples, the less-rotten apples would always seem fresh. In a simpler sense, it could mean that THG is undervalued, or that the rest are overvalued, and we can never be certain of either. Once again, there is no right or wrong and if relative valuation is your cup of tea, by all means stick with it. As a form of absolute valuation, we value THG based on FCF yield which currently stands at 10.7% at a price of SGD1.80. We think that anything above 10% is adequate compensation for the risk of a luxury retailer. Based on a FCF yield of 10%, we will have a target price of SGD1.93.


THG is a solid company with consistent cash flow and a neck above its peers considering its share price. While our target price does not seem to indicate much upside or margin of safety, it was arrived at under conservative assumptions to accommodate for possible downsides in industry outlook.  In fact, anything above 8% FCF yield will not be considered expensive for Mr. Market. THG may not be the blockbuster counter that we all seek, but if you are looking to make your cash work in the meantime, THG will be a suitable candidate.

Disclosure: The authors are long E5P.SI

King Wan Review

We have briefly covered King Wan (KW) previously with a 3Q update. At that time, KTIS has yet to be listed on the Thai Exchange. Fast forward to the present, with the completion of KTIS’s listing and the release of KW FY14 Annual Report, we take this opportunity to revisit our investment in the company. As our thesis was based mainly on asset value, the bulk of our analysis will be as such.

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KTIS Holdings

Upon listing, KW received approximately SGD47.6m worth of shares in KTIS at a listing price of 10 THB each. Taking into account the recent fall in price (9.55THB), KW’s holdings are now worth SGD45.5m, of which SGD21.6m has been recognised in books. Therefore, we have revaluation gains of SGD23.9m.

Vessel Holdings

KW also owns a ‘Supramax’ Bulk carrier held through its 30% owned associate. Gold Hyacinth Development Pte Ltd.  This was originally purchased for USD21m, or approximately SGD26.25m based on an exchange rate of 1.25, during a period when the Baltic Dry Index was floundering near a post-crisis low level of 698. Based on DMG’s report in April, the vessel then commanded a market value of USD28m or SGD35m. Correspondingly, KW’s stake will be worth SGD10.5m, a gain of SGD2.6m. However, do note that the Baltic Dry Index in April was almost twice of its current level.

Dormitory Venture

KW recently ventured into the worker dormitory business via a 19% stake in a consortium. The land (in Tuas) has a lease term of 20 years and is to be developed to a facility with 9200 beds. It is anyone’s guess how much profits this will bring, but based on my research, the average rate for 1 bed will conservatively be around SGD250/month. Assuming an occupation rate of 80%, I expect the facility to generate about SGD4.2m in annual revenue for KW. If we use Centurion’s Holdings 3-year low net profit margin of 15% as a reference, we get estimated profits of SGD0.6m. Assuming a dummy discount rate of 10% (I have no confidence in my WACC calculation), terminal growth of 0%, we value the dormitory holdings at SGD5.5m

Pseudo-Sum-of-Parts Value

Adding all gains, totalling to SGD32m, to the current reported NAV of SGD86.4m, we arrive at a RNAV value of SGD118.4m. Based on the current number of outstanding shares, we therefore have a fair value of about SGD0.34, which is fairly close to its current share price.

Challenging M&E Industry

Due to public displeasure about the amount of foreign workers, the Singapore government has been steadily tweaking its policies to reduce the amount of foreign workers employed by companies. As a mechanical engineering company, KW relies heavily on foreigners for its labour. You can see that we are starting to observe the effects of the policies through the increased labour costs, with gross profit margins falling consistently from 23.8% in 2012 to 14.8% in 2014. While revenue has been increasing steadily, this hasn’t added much to the bottom line. If we discount KTIS’ contribution of SGD7.2m in 2012, net profit has from its core operations have actually been decreasing. In the past, the price afforded a margin of safety sufficient to offset this, but given KW’s share price increase, this is no longer something we can be certain of.  To put things simply, even if KW were to maintain its very impressive top line growth, profits would still be decreasing. To top it off (pun intended), with the slowdown in property markets, I think it would be a challenge for KW to continue its top revenue growth.

Property Developments

Things are not all bad for KW however; our fair value of SGD0.34 has been based on the assumption that we value its operations and its property developments at book value. Through its associates, KW has stakes in a number of properties in Singapore, Taiwan and China which are accounted at book value of SGD2.1m. The properties and their estimated values are as below:

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The estimates are based on average transacted prices from Squarefoot Research multiplied by the net leasable area from the official condo websites, note that these values do not include the cost of development and percentage sold. Unfortunately, we do not have enough information to value the remaining properties in China and Thailand, but I think at book value of SGD2.1m, we are fairly safe from much downside, in light of the fact property sales in Singapore and China have slowed down considerably.


Upon KTIS’s listing and its current share price of SGD0.345, we think that our original thesis (value of KTIS) for KW has already run its due course given our targeted fair value of SGD0.34. Moving forward, we have identified downside risks to its operations, negated by upside potential from its property developments. Potential for future revaluation gains are definitely present, but since we are unable to place an estimate, we refrain from including them in our calculation of fair value to be on the safe side. One thing is clear that the margin of safety is much lower now, with future returns to be more uncertain than before given the volatile nature of KTIS shares and KW’s vessel holdings. Furthermore, given how KW is currently trading at P/E 17.9x, normalised EV/EBITDA 13.1x and normalised FCF yield of 3.23%, we have decided to exit our position in King Wan Corporation. We leave it to each individual to weigh the risks and potential gains based on your risk appetite..

Disclosure: The authors have no vested interest in 554.SI

Accounting Fraud – A Common Theme

Value investors are constantly sourcing for undervalued companies in every possible way, setting our filters to help us screen out that initial list of companies. I believe many out there would agree that majority of these undervalued gems would come from Asia, Chinese shares in particular, be it A-shares, P-chips or S-chips. However, shares are never undervalued for no apparent reason. These Chinese shares have fallen out of favor given the numerous corporate scandals.

Back in 2006, when China initially opened her doors, S-chips were investor’s darlings, where we see companies like Fibrechem Technologies having a run up in prices. However, such enthusiasm quickly faded as earnings started falling short of estimates. Many have had their fingers burnt when these share prices plummeted when problems such as accounting frauds and defaults started surfacing. Personally, I have witnessed friends having all their money locked in such shares and unable to exit due to the stocks getting suspended.


With this growing fear that Chinese companies will just disappear when their over inflated sales figures, empty coffers and huge debts comes to light, it is no wonder that there are so many Chinese companies trading at such cheap valuations. Just applying a net-net filter for the Singapore Market, 65.5% of the counters are China companies.

Talking to my colleagues in Shanghai, many have admitted that they too suffered losses in the Chinese stock market due to Chinese companies cooking their books and have ever since stopped investing in the stock market. In my opinion, many have decided to not touch any China related stocks to avoid any possible risks, given the difficulty to differentiate which are the good ones and which are the black sheep.


However, should we value investors just give up on all Chinese stocks and pass up on discovering hidden gems like Sino Grandness? Given how such stocks were able to pass the audit checks of reputable audit firms, many would be thinking, what then can we retail investors do? Talking to auditors from the Big 4, I do believe that it is definitely not easy for us retail investors to spot accounting frauds. However, this does not mean that it is impossible. Over the years, we would notice the trends and similarities in companies that have been suspected and found for corporate frauds.


While I may have presented common themes amongst Chinese companies found of fraud, it is not some hard and fast rule but merely a guideline for us to use when investing. Nonetheless, only invest in companies that you are able to feel comfortable with.

Disclaimer: The author is long T4B.SI

Asia Fund NAV Update July 2014

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Initial Net Asset Value (per unit): $10,000

Net Asset Value as of July 2014 (per unit): $13,248

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The 1H2014 was generally a good period. Our Asia Fund was up 11.14% in the first six months of 2014, against a 2.24% return of our weighted benchmark. The Hang Seng Index was down 0.64% while the Straits Times Index was up 2.55%. The performance of the fund was significantly affected by the drop in UMS Holdings share price due to the sale from the CEO and AMAT. However, it is in our view that fundamentals of the company are still intact and the dividend payout is still sustainable based on current free cash flow levels.

In the 2Q2014, we would observe major changes within the portfolio. We have completely divested our investment in New Toyo. We felt that with our revised calculations, New Toyo does not offer us a wide enough margin of safety as initially calculated especially with the uncertainty of the business operations going forward. Also, we have been reducing our stake in Kingsmen Creative, in attempt to align our overall portfolio’s investment strategy.

At the same time, we took positions in Memtech International and SHC Capital. SHC Capital has recently announced a disposal of all their operations, and if successful would value the company at 37c per share. Current share price remains depressed due to investor’s skepticism of the deal going through and perhaps the lack of coverage on such a small-cap company. However, such a scenario is something similar to what we encountered in 2012 (Elite KSB).

Please feel free to email us if there are any questions regarding our investments.

Welcome to SG Value Fund

I started this blog as a platform to not only allow me to chronicle my investing journey, how it has evolved over the years – allowing me to reflect on my investment’s philosophy and mistakes. But more importantly, create a platform to share such experiences with others, which would definitely help prevent others from committing the same mistakes. After all, failure is a better teacher than success. Hence, what better way to expedite our learning through the mistakes of others.

Going forward, I will be posting up articles about the following topics:

  • Updates to my personal fund
  • Equity Research
  • Company Analysis
  • Quotes/Personal experiences etc.

Some really useful links I use (I owe a huge amount of my success to these sites).