Value Hunting #1: SMRT

1) Introduction

Operates 89.4km of rail line, with 51 stations. Based on its 1Q08 (ended June 08) results:

• 3/4 of profit from MRT.
• 1/4 from building rental at MRT stations.
  
• small losses for bus and taxis operations, which are not counted in the above, and excluded here.

Its contract to operate the EW and NS lines lasts until April 2028. 10+30 years license for the future Circle Line (CCL).

2) Business Model

They own (the right to operate) the rail and trains. After deducting operating costs, the remainder is profit:

• About 40% of their operating costs come from Staff. That the CCL line will be fully automated, so this gives a higher fixed cost while meaning that extra staff do not have to be deployed if train frequency increases.
• 18% for depreciation
• 17% for fuel and electricity
• 8% for repairs and maintainence.

Surprisingly, fuel/energy prices are only a small part of their costs.

3) Future Growth

Soon:

• Circle line. From wikipedia: 33km long, underground, fully automated line. 6 km is scheduled to partially open in mid 2009, and the line is expected to be fully operational in 2011.
• Boon Lay extension: 3.8km extension, 2 new stations beyond Boon Lay. Operational Feb 2009.

So we are looking at a 10% increase in operations (and hopefully revenue and profits) in by end 2009. And an additional 30% increase by 2011 (for the remainder of the CCL).

Far future:

• 14km extension to the Boon Lay extension above, opened by 2015. To bve operated by SMRT.
• Thomson Line, 27km, probably by 2020.
• Downtown line, 40km, probably by 2020.
• LTA has announced that the tenders for operating the Thomson and Downtown lines will be only for 10 years, not the current 10+30 years enjoyed by SMRT.

4) Risks

• terrorist attack
• SARS
• Capex will eventually be required for more trains, if they want to increase frequency of trains during rush hour. Fat chance.
  
• In their 30 year license with LTA, the license fee set at 1% till 2010. After this we do not know what the fees are. I think they are unlikely to raise them when Temasek owns 54% of SMRT.

5) Valuation

• 1.5bn shares outstanding, 1Q08 profit is 2.6c, estimate 10c for whole year.
• 240m dollars cash, BUT 90m spent on acquisition. 1Q08 results says they will spend 91m (6c per share) on FY08 dividends.

I will take into account their projected 40% growth for the next 2 years, giving EPS of 14c. In a bear market, I want a PE of 8.

6) Conclusion
I need to see the share price drop to $1.12 before I am comfortable buying.

Value Hunting: Introduction

Hunting for value in a fallen market. I have 20K cash (from here). I may also use CPF money.

When catching falling knives, I want to be absolutely certain of the value that I am buying. Like buying $1 for 50c. That way, even if they fall below my buying price, I still have the conviction to hold for the long term. I only want companies that have these characteristics:

• Must have a recurring income stream, selling products that people will still use in a recession. Usually selling cheap, consumable goods for cash (e.g.: hamburgers, train rides, etc). Not for example, selling corporate IT systems or oil rigs.
  
• Should have a projected PE of 8 with small projected growth. May have a larger PE of 12 or 13 if they have projected continuous annual growth of around 20%. These are the type of valuations I saw in the 01/02 bear market.
  
• I prefer to deal with companies that have most of their operations in developed countries. I will halve the amount I buy for companies that have their main operations in third-world countries like India, China, Indonesia, etc. And I would not use CPF money for them.
• The usuall stuff abt having some sort of defensive moat or compeditive advantage their operations, as well as a good balance sheet also apply.
  

If the stocks do not reach my target prices, I won't buy. If the market recovers and runs away from me, I can use a more 'growth orientated' strategy (with appropriate cut-loss). From past experience, whenever I rushed and felt 'compelled to buy something', I always lost money.

Industrial Properties 'the only bright spot'

From OCBC Investment Research 'Property Sector' report 28th Oct 08:

Industrial properties- the only bright spot in 3Q08. Office and retail properties registered declines in prices and rental rates in 3Q08 on a weaker economic outlook but on a brighter note, the price index for industrial properties climbed 0.9% QoQ to 115, underpinned by the 2.6% increase in prices of multiple user warehouse. Industrial rental index also increased by a marginal 0.1% QoQ to 110.4 as vacancy rate continue to decline to a decade-low of 6.6% in 3Q08.

Bought Keppel Corp

1 lot @ $4.49. Now trading at $4.17.

Have not had time to do a full analysis:

• Most of their profits come from Oil and Gas (73% of revenue, 72% of profit, counting their investments (K1 and other offshore and marine) under this category)).
  
• They have orders until 2012.
• I expect oil prices to remain high, and to recover when economic growth comes back. Despite all credit crisis and stock market crash, oil is still above $70.
• With 35c profit in 1H08, they have a PE of 7.1 at a share price of $500. However I should discount or ignore their property profits as being cyclical.

Bought Cambridge and A-REIT

Bought 11 lots Cambridge @ 27c.

Bought 3 lots Ascendas REIT, 2 lots @ 1.59, 1 @ 1.58.

Long term. No cut loss. This is a gamble that the Banking Crisis will resolve - monitor the TED spread and SIBOR/SOR to confirm this.

Ascendas REIT

Quick notes. Got my attention with a trailing yield of 10%.

1) Competitive Position

Their clients are mostly blue chip eg: Singtel, Daikin, etc

According to their 08 Annual report, they have:
- 42% share of the hi-tech industrial space in Singapore
- 33% of Business & Science Park space in Singapore
- 11% of Logistics & Distribution space in Singapore

2) Cyclical factors

A report by CIMB says that:

• There is a 18-24 month lag time from the business slowdown to a pinch on real-estate demand. (The recession started 6 months ago, lets assume we'll see this).
• Default payments were 1.8% of gross revenue in the 2004 recession.

I will model 4% for defaults.

3) Financing. When it is due?

Has 1.5bn dollars of debt, due at different stages. From their FY07 AR, showing when their debt is due:

This consists of:

• 238m short term loans (revolving credit facility) - due within 2009 (SOR + margin)
• 279m Transferable loan facility : due Jan-Mar 2010 (SOR + margin)
• 300m notes due Aug 09 (SOR + 0.325). Related IR swap fixed at 2.9% until Sept 2012. Have 'firm commitment' to refinance 200m.
  
• 350m notes due May 2012 (SOR + 0.265)
• 395m notes due May 2014 (SOR + 0.200)

Not sure how to interpret this: potentially 817m needs to be refinanced by early 2010.

"As at 30 September 2008, A-REIT has 76.7% of its debt hedged into fixed rate for the next
3.93 years.". Unlike Cambridge, the hedging seems to be tied to the loans, and is not separate from loan renewal:
"The nearest refinancing requirement (excluding existing short term borrowings) is the Commercial Mortgage Backed Security (CMBS) of S$300 million due in August 2009. The Manager has fixed the interest rate at an all-in rate of 2.9% at the start of its issuance. The related interest rate swap contracts have a remaining weighted average term to maturity of 3.04 years as at 30 September 2008."
I am not sure if all their outstanding loans are tied to interest rate swap contracts, but for now will assume it so.

4) The numbers:

After reducing their revenue by 4% (190m - 7.6m), and increasing doubling their (non-hedged) finance costs (Add 6.2m to 27m), their 1H08 profit would drop by 13%. Their annualized DPU (15.3c) currently yielding 10% would drop to 8.7% (at a price of $1.50). This is good, but not irresistible... TODO: take a look at their growth prospects, to help determine target price.

[Updated 14th Nov] Based on the above, set my buy target price at $1.33. This is a projected 10% yield, in the bad case scenario

Cambridge Industrial Trust again

Share price has been hammered to sub 30c recently. Market must be afraid they cannot obtain financing. A quick review of their numbers:

1) Their 2H08 earnings (for 6 months) summarized in 4 lines:

Rental revenue: 35.5
Non-finance costs: 7.1m
Borrowing costs: 5.5m
============================
Operating Profit 23m
============================

This excludes interest rate hedging and change in investment property value (which they do not pay out in DPUs anyway).



2) Assume recession, deduct 10% from their revenue. I am assuming that 1 in ten business go under, as they are renting out to SMEs.

Rental revenue: 31.2
Non-finance costs: 7.1m
Borrowing costs: 5.5m
============================
Operating Profit 18.6m
============================

Assuming 800m units issued, DPU would be 2.3c per share (annualized: 4.6c).



3) Their current weighted average interest rate is currently 3.1%. What happens when this changes?

a) Assume interest costs double to 6.2%
Operating profit (excluding hedging) comes to 13.1, which gives 1.6c DPU (3.2c annualised). At a share price of 30c, this is a 10% yield

b) Assume Interest costs go up to 10%
Operating profit (excluding hedging) comes to 6.4, which gives 0.8c DPU (1.6c annualised). At a share price of 30c, this is a 5% yield.

4) Another way of looking at this is to assume someone wants to buy the entire assets of the company. Benjamin Graham: buying $1 for 50c. I don't look at NAV because this is a meaningless number that may change - the reason to buy the buildings is to get an income from them.

Lets remove the finance costs from the equation.


Rental revenue: 31.2
Non-finance costs: 7.1m
============================
Operating Profit 24.1
============================

48.2m annualized.

At a share price of 30c, Market cap is 240m. Buy it all. Then pay off the debt of 370m. Your total cost is 610m. With 48m annual profit, you would get your money back in 12 years. Most of the buildings have 40 years remaining on the lease (the shortest has 24).


Conclusion
I believe the market is pricing in scenario 3a (about a 6% borrowing cost). Their (potential) problems finding funding and the recession do not justify the low price, assuming that the credit crisis does resolve.

I will buy abt 3K worth. Not more, in case there is something wrong with it, and I need to be able to sleep at night if I lose the 3K.

Strategy and allocation: Oct 2008

Where I am now:
I have $67K cash. The only share I own is 11 lots of Pfood (spent 9K, currently worth about 4.4K @40c, ouch).

Where the world is:

• Banking crisis: This is where where banks can't or won't lend money. Governments are doing everything possible to stop get banks to start lending. There have been many banking crises before - it is not the end of the world. For companies that need capital, monitor the TED spread (here), and the SOR and SIBOR rates.
• Recession: I expect a recession. It is normal to have recessions after booms, and especially after credit crisises. Dont know how long it will last. Worst case, several years.
  
• Bear market: We are probably still in a bear market - too volatile to call any direction. From IBD: All the single largest day gains have previously occured in bear markets. dont know if there will be a quick recovery, like after the Asian crisis, or a multi year bear market like in US the 70s.
  

My Plan:
Use 32K of my portfolio for value investing. This is 'buying on the way down':

• Buy good companies when they become so cheap they are irresistible.
  
• No need to rush, can buy slowly over the next year, as I find them.
• Probably allocate small amounts to these companies (especially the second liners - around 5% each) as this style of investment has some risks - you lose everything if you get it wrong.
  

Use the other 35K (plus any extra if I did not find good companies to buy) for growth investment, speculation. This is 'buying on the way up':

• Wait for IBD to signal a follow through day, and identify leading stocks which have either: broken out (or at least held their ground), or made bottoming patterns on the SGX.
• Buy slowly and with cut-loss, as it may be just a tradeable rally, or a false signal.
  

How low can the market go?

Sometimes, stock values become so low they defy belief. Then you can just throw away your charts and buy for the long term, based on fundamentals. Are we there yet?

A look back....

First, lets wind back the clock 7 years to look at previous bear markets. I first came to Singapore in early 2001 with $5000 in my pocket. I arrived from Australia, which had escaped unscathed from the Asian crisis and had been in a bull market for several years. After buying a shares booklet from 7/11, I was astounded. Many mid cap companies with excellent fundamentals were trading at ridiculous valuations. From memory:

• Comfort was trading at a PE of 7 or 8, with a yield of 7%. With excellent cashflow, low debt, almost a monopoly with queues of poor uncles lining up to drive taxis, it had been able to increase its profits by 10+% for several years. I sold remember selling 2 weeks before the takeover by Delgro was announced :( ....to fund my stupid HDB rennovations.
  
• Robinsons was then a premier department store (as my wife said, it was the only one to segregate its offerings by price level (John little, Robinsons and 'Marks and Spencer') giving a more pleasant shopping experience. More importantly, it was profitable every year, and two thirds of its share price was cash. I didn't buy, no money. It eventually doubled.
  
• Unisteel, with a 50% market share, trading at a PE of 12. It was to grow 20+ %for several years. I bought at 78c and tripled my money in 3 years. Before I bought it, it had traded around 30+c.
  
• Want-Want, selling branded rice crackers, trading at a PE of 5 or 6, showing 20% growth. It traded at 60c, then moved up to 80c - I thought I missed my chance and didnt buy. It eventually reached $1.90.
  

I remember thinking that I thought I had come to Russia or Phillippines some other dirt poor, corrupt, disintegrating country! Where else would I find profitable companies with low debt, free cashflows, long operating history and potential 20+ percent growth, selling for single digit PEs?

Are we there now?

I cant find the same degree of undervaluation in the market right now. Key differences are:

• In 2001/2002, we were in a recession and earnings were coming off a low base, hence the potential growth. After going several years through the recession , things were so bad that they could only get better.
• The stocks mentioned above usually were blue chip (Robinsons) or had a sustainable competitive advantage (Comfort and Unisteel). Want Want was the exception. Looking at the blue chips today, for example, Comfort-Delgro, SMRT, Ascendas REIT, they do not yet have projected single digit PEs or yields of 7-8%. Trailing PEs are cheap, projected ones are probably not. The companies that have the ridiculously low valuations are the second liner companies which are a little weaker (eg: Cambridge REIT) or have a small market share (eg: TPV) in their industry, are are operating in China where it is hard to even determine their market share and count their competitors (let alone list their competitors).
• Also, I don't mean to say that once stocks reach that level they will not fall anymore. My past experience does not even cover the Asian Crisis (STI went to 800+) where stocks were even cheaper. what I mean to say is that at these levels, I would use about 50% of my cash, which I did not need for 5 years, to buy and monitor them for the long term, with the expectations that some of them will double or triple in years to come. (The other 50% cash I will use for speculation).
  

Buffet once said in dealing with the 1970s crash, "I feel like an oversexed guy in a whorehouse". I felt like that in 2001. I don't feel that yet. Close, but not yet.... we are getting there. I will detail my search for undervalued stocks in future posts.

China Susnine

Attempted fundamental analysis of China Sunsine (symbol: ChinaSsine).

China Susnine is a small specialty chemical company producing chemicals for the tire industry.

1) Competitive position

Their aim is to expand capacity to grow market share to 25% by 2010. From an Aug 07 article: "We are now China's largest maker of rubber accelerators. A market share of 25% [will] gives us pricing power... ".

In June 08, management believed they have a 19% China market market share (8% global) as China's largest rubber (2nd largest global), based on global rubber usage figures.

In an 2Q08, China Sunsine's annual production capacity for accelerators was 49,000 tons. This compares to:

Global producers:

Name	Capacity (tons)
Lanxess (spinnof from Bayer)	45,000 (estimated)
Chemtura	less than 30,000
China Producers:
Tianjin Organic (SOE)	26,000
Zhenjiang No. 2 Chemical (SOE)	19,000

(figures from company announcement on SGX: 'Clarification of press article', 11/9/08)

Based on these figures (from the company), they seem to be one of the strongest players in their niche, with only 2 or 3 other competitors being able to produce 1/2 as much as them. However the market is still fragmented, with many players.

2) Business Model

From their 1H08 results (at 92% utilization rate): raw materials are by far the largest proportion of costs (75-80% of revenue). Administrative (3.8%) and selling expenses (2.5) are next biggest. Their business model is similar to Pfood, in the sense that they add a small amount of value to their raw materials before selling as a consumable product.

Depreciation is small (2%) so it is not a capital intensive industry. Hypothetically, even if utilization was to halve with all other costs being fixed (with only raw materials being halved), they would still be profitable (profit would be reduced from 42m to 8m).

The biggest factor is raw materials costs. SIAS research, in their Dec 07 'Initiation of coverage' reports that raw materials contributed 80-83% to their costs of sales in 04, 05 and 06. Aniline contributed 35-40% of the above raw materials cost (they did not give the numbers to show how it was derived), meaning it contributed 28-33% of the total cost. How has the aniline price fluctuated recently?

• Benzene, the main raw material of aniline, spiked in May 08, before
• From this chart (from Netresearch free 'Initiation of Coverage' report on Sp Chemicals), we see that Aniline prices rose 18% in 1H08.

Accelerator chemicals make up only about 1% of the cost of tyre production, so the company believes they can pass on any production-cost increases to their customers. Lets check the gross margins for past quarters to see if they were able to pass on any raw material price changes:

3 Months Ended	Revenue (RMB 000s)	Cost of Sales (excludes export rebate listed in Earnings Stmnt)	Gross Margin	Comments
Dec 06	126700	88100	30.5%
Mar 07	125600	91100	27.5%
Jun 07	159632	122021	23.6%	ASP is RMB 19,455 per ton
Sep 07		not available yet
Dec 07	179600	143200	20.2%	The y-o-y margin decrease is entirely due to raw material prices. The company results include the export rebate, which I stripped out. Article: "Sunsine had to produce a range of accelerators with varying margins, instead of concentrating on just the high-end, since it wants to meet the needs of clients". Article: Sunsine experienced a shortage of internally-produced MBT, ... used as an intermediary product for the production... The shortage was .caused by sales volume increasing, year-on-year, in the past two quarters by an average of 35% each in Q2 and Q3. As a result of the shortage, Sunsine had to buy MBT from external sources at a higher price. Article: This year (in 2007), China Sunsine dropped average selling prices by 8.4%, a move aimed largely at edging out from the market some of its 100-odd Chinese competitors, especially the smaller ones.
Mar 08	167200	130600	21.9%	ASP increased 8.1% from Mar 07
June 08	234900	171500	26.9%	ASP increased to RMB24,764 per ton (up 27% y-o-y for the quarter). Group passed its cost increases on to customers.
Sep 08		not available yet

Even though Aniline increased substantially in 2Q08 (approx 18% y-o-y), ASP increased 27%, which means that it was able to increase its prices by more than the raw materials increases.

3) Quality of Earnings

Next I check for any problems with inventories or accounts receivables:

3 Months ended	Revenue (RMB 000s)	Accounts Receivables (trade + other)	Revenue/AC	Inventory	Revenue/ Inventory	Cash Inflow/(Outflow) due to working capital	CFO excluding WC
Dec 06	126.7	130.5		27.7		(4.9)	24.1
Mar 07	125.6	not given		not given		42.0	23.7
Jun 07	159.6	164.6		19.3		(42.8)	28.3
Sep 07
Dec 07	179.6	20.6		30.2		40.1	20.2
Mar 08	167.2	224.7		31.7		(31.9)	21.7
Jun 08	234.9	245.6		60.0		(25.2)	45.3
Sep 08

Working capital is very volatile on a quarter-to-quarter basis. But they generally seem to make money from operations (the sum of the last two columns is positive, overall).

The increased inventory in 2Q08 (up 90%) probably makes sense due to increased production (up 40%) and rising costs (e.g.: aniline, up 18%). Monitor this in 3Q08 results.

From 1Q08, the depreciation policy has changed to increase the useful life of new machinery from 4 to 7 years. This can be ignored, firstly because depreciation is such a small cost, and secondly, because it only applies to new (and future) capex, not for previously bought equipment. This change only decreased the deperciation expense by 0.1M RMB.

The company stated (somewhere) they have (or had) a policy of only allowing a maximum of 5% revenue from single client - but I cannot find this in their 07 AR.

4) Debt

China Susnine had no long term debt in 1H08 results. They report that they have finished using their IPO proceeds with a surplus of 32.1 RMB mill (out of 100 mill).

Future plans for 2008 are:

1. expand 5000-ton anti oxidant TMQ plant to 10,000 tons. Cost not given.
   
2. expand 5000-ton insoluble sulfur plant to 10,000 tons. Cost not given.
3. Increase capacity for MBT (an intermediate product): new 10,000 tons facility by 3Q08. Cost <= 20m.

Generally, past increases in capacity of 5,000-10,000 tonnes seem to cost 20-30m RMB. Lets assume this for a and b above, for a total cost of 70m.

No plans are given for beyond 2008. Here, they mention plans to produce aniline in-house, this must be later on.

Conclusion: FY08 capex can be covered by cash flow from operations based (50m in FY06, 59m in FY07).

5) Cyclical Factors

• Raw materials, as mentioned above. The article above about benzene prices mentions that China is building a new benzene plant which is expected to depress prices.
  
• Will follow the fortunes of the China tyre/automative undustry. See below.
  

6) Potential Growth

Entirely dependent on China's tire industry.

• Expected to grow, as China's GDP and car ownership grows. Seems to be experiencing a cyclical downturn now (along with the rest of China).
  
• Note on history of US type industry .... grew fast in the 1920s, then declined as the inductry consilidated...this is not a problem now but may be something to watch out for in years to come. Michael Porter may have written abt tires.
  

7) Valuation

At a share price of 20c:

• In 1Q08, the company declared a dividend of SGD 1c, giving a yield of 5% (assuming share price of 20c).
• FY-7 earnings were approx SGD 3.8c (18.22 RMB cents), giving a PE of 5.3.

8) Chart

Doesn't show anything.

9) Misc

Several misc. risks with this company:

1) All the information we have comes from company itself.

2) Family controlled and run: "Mr Xu’s two sons help him run the business. Eldest son Xu Jun, 37, is an executive director. The family has a deemed interest of 53% in the company". From article.

3) Very Illiquid. Only 5m shares were issued to retail investors. This means that funds cannot buy on the open market.

Because of these risks, especially number 3, I would limit any purchase to half of normal.

10) Conclusion

May be a good opportunity to buy a leader in (a small specialised segment of) China's automotive industry.

For now, wait. Market is still bad. The PE is low, but may stay low in such a bad market. I believe the PE will not go lower unless earnings drop.

Pfood: WTF happened?

On Sept 30th:


First thought was that this is something to do with China pork industry. But if there were problems the HK people would know about it first - Yurun's chart shows no selling:



I've lost abt 4K (unrealised), a small enough amount that I can still sleep at night. Even if I lose the entire amount invested (abt 10% of my portfolio), I would be able to recover.

Either theres something wrong with pfood in particular, or else the price has been hit irrationally, eg: by shortists or a fund being forced to sell quickly. I don't know. Given pfood's track record, it is probably the latter. But I decided not to buy more at a lower price, just in case.... I will probably regret it, but being able to sleep at night is more important.

Before it fell, I was previously tempted to buy more pfood, as it is the only good buy idea I had. Luckily I did not. This highlights the importance of risk management. Meaning "not getting killed when you are wrong".