Saturday, April 7, 2012

Second Chance Properties

Traditionally a niche consumer business selling traditional Malay clothing and jewelry; has recently ventured into holding commercial real-estate to use all the excess cash generated. Operates in four segments:
- Gold retail (Singapore):
- Clothing retail (Singapore):
- Clothing Retail (Malaysia):
- Property (Singapore)

Gold Retail (Singapore)
Operates a large outlet in Tanjong Katong complex. Claims to have the largest selection of Malay design jewelry in Singapore, and to dominate the Malay gold jewellery market.

"Segment profit" below excludes finance costs and company-wide Admin costs:

Their one shop is stunningly profitable, with 17m in sales in FY2011, and an operating margin in the last 5 years between 17% (bad times) and 20% (good times). For comparison, Aspial (which owns Goldheart, Lee Hwa and Citigems, with at least 40+ stores) made 140m sales in 2011, and operating losses in 2011 and 2010.

Management stated they will not open other stores, as these will require higher rental and will cannibalize sales in the existing store. They also do not see any chance to replicate this business model in Malaysia, as the same factors which allowed them to dominate the Malay jewelry market in Singapore (being a small, highly connected and prosperous city), are not present in Malaysia.

Their profits seem to be most affected by general economic conditions. FY09 seemed worst (FY ends June, Hari Raya being Sept 09): revenue was down 7.4% due to bad economy, resulting in a 20% decline in earnings).

Movements in gold prices also affect their reported profits due to inventory management. Rising gold prices increase reported profits. Management stated it is theoretically possible that a sudden collapse in prices could be a "big hit to our profitability" and may even cause a one-time loss. As most of their years business is done in the 2 months leading up to Hari Raya, there is probably a short time time of the year that they hold inventory. At end Dec 2011, they had $10.8m gold stock.
Apparel Retail (Singapore)
Sells ready-made traditional Malay clothing, from a two outlets in Tanjong Katong Complex. Business model is similar to the gold one: a centralized store in a single location dominating a niche market in Singapore.
Again, "segment profit" excludes Admin and Finance costs, but it is still astoundingly high at 45-65%!

Was not able to get the 06-08 profit numbers from the annual reports.

The 1.28m drop in Singapore sales in 2010 is due to "a result of the poorer consumer sentiment in general". No mention of why the 2011 sales did not pick up.

Apparel Retail (M'sia)
Sells ready-made traditional Malay clothing in M'sia, currently have several stores in each state for a total of 36 (at Jun 11). They are aiming for a total of 100.
Segment Margins range from 3 to 6%: a lot lower in Malaysia due to the cost of running so many stores. So even though revenue is 2 to 3 times that of Singapore, operating profit is barely a third. If they reach 100 stores, they may be able to reach the same segment profit (in dollar terms) as Singapore.

Business Model (Costs)
(For Apparel and Gold) Their largest cost is inventory (60% of their costs). Next is employees (14%), and rent (7%). This business requires a lot of working capital, especially considering that most sales are before the festive season.

All their properties are commercial retail units, for example:

Revenue and Profits:
The company started property investment in 1999 and now holds 65 units. Most are leasehold, about 1/3rd are freehold. As a general idea:

The company plans to "hold back property purchases for the time being" and instead grow the apparel business. They will use the time to decrease debt, in order to later "take advantage of opportunities to purchase distress properties in a potential crisis." (I like this idea)

Their business model seems to just be to buy individual properties when prices are low, then sit back and collect the rentals forever. Seems they rarely sell or 'trade' properties, even the leasehold ones.

The company is a cashcow. Only a tiny part of Cashflow from Operations needs to be spent on Property, plant and equipment to sustain/grow the core Apparel and Gold businesses:

Balance Sheet

Total borrowings are around 72m, of which 39m is short term (-ve working capital) and 33m long term. I guess that the gold and apparel businesses require high inventory, especially leading to the festive season. The company stated they prefer to fund this through short term loans, freeing up the cash for real estate investment. As an investor, I would look at this as long term debt - no matter how you recognize it on paper, you are using the money to fund property purchases.

More than 90% of the 72m loans are for less than 1 year - therefore interest rates may vary when the loans are rolled over. Interest cost in 2011 was just under a million, so they can survive a doubling or even quadrupling of interest rates. They've no hedge against rising interest rates.

With a CFO of 12m in FY11 and FY10, they can pay off their debt in about 6 years.

Operating lease rental was 2.3m in 2011. Assume its a fixed cost.

Questions, and things to watch for:
  • Falling Singapore Apparel sales: seems to be a long-term decline in Singapore apparel revenue after 09, even as economic conditions improved. This carries over into 1H12, where revenue dropped 10% yoy. However, operating profits rose in 2011 (not given for 1H12). What are the reasons behind the falling revenue trend (e.g.: younger customers spending less on traditional clothes, new competitors, etc?)
  • REIT: Management mentioned they are considering spinning off their properties into a REIT. Should be OK as long as the parent company does not lease from the REIT. As Second Chance is not a property developer, there is no conflict of interest usually found between REITS and their parents (and they can continue their plans to buy cheap properties during downturns).
Incidentally, Second Chance has the clearest and most well-written Annual reports I have seen for an SGX listed company. Their business models are clearly explained in the list of commonly asked questions.

Definitely adding this stock to my watch list.

Vicom and Silverlake Axis

Taking a break from looking at the large, 'world dominator' blue chip companies, and looking at locally listed small-caps instead. With these, I would only buy a small amount due to liquidity and the risk that I-am-wrong. Small caps rise a lot more, typically 2 to 5X from bear to bull, rather than the 1 to 2X of the larger companies.

Two companies I am interested in are covered by someone else. Links here for future reference.

VICOM: here.

Silverlake Axis: initial look, later reports.

I'll get back to them when there is a bear market.