KAB - Charging Up

Warren Buffett puts a lot of emphasis on ROE. 

SUNCON, ECONBHD and INTA are examples of pure construction/ engineering companies that generate high ROE and have been doing well. 

KAB, an electrical and mechanical engineering company recently listed in Bursa Malaysia, is another engineering firm which offers high ROE.

A comparison is made between INTA and KAB. Both are pure engineering companies, listed on ACE market in 2017, and in net cash position after listing.

1. ROE

Both companies offer very attractive ROE (before listing). KAB has better ROE.

2. Margins

KAB consistently achieved better margins at gross, PBT and PAT levels

3. Order Book

As of 2 October 2017, KAB carried an outstanding order book of RM209.9m. It recorded a revenue of RM30.1m in 3Q17. In 4Q17 (another 2 weeks to go), it has secured RM38.3m of new contracts, which is higher than its 3Q17 revenue of RM30.2m. If we annualise the 9M17 revenue, its outstanding order book is roughly 1.9x its annual revenue.

Inta Bina's outstanding order book was at RM634.7m as of end-September 2017. That is about 2.2x of its FY17 annualised revenue. 

Inta Bina's appears to have slight better earnings visibility. 

4. Valuation

The earnings for both companies which were listed this year are affected by listing expenses. To have a more mearningful comparison of the valuations for these 2 companies, earnings were adjusted for listing expenses and PBT were used instead of PAT. 

Based on INTA and KAB share prices of RM0.37 and RM0.275, KAB has lower market cap/ adjusted annualised PBT. 

5. Competitive strengths and positive industry outlook

i) KAB is a nominated subcontractor in most of projects undertaken (an average of 70% for the past 3 years). Direct negotiation with project owners on the terms of subcontracts is less competitive as compared to a public tender and, thus, a better margin.  

ii) Potential market from old commerical high-rise buildings. There are plenty of old commercial high-rise buildings which require refurbishment/ replacement of electrical wiring and electrical items. 

iii) The company hopes to increase revenue generated from maintenance services, which is recurring, to 20% to 30% of its total revenue in 2 years' time

iv) Mushrooming of high density high rise developments which require competent and highly qualified contractors to perform the M&E works. KAB holds Class A, the highest class of electrical contractor certification registered with the Energy Commission Malaysia. Furthermore, KAB also holds Grade G7 license, the highest grade of license issued by CIDB which allows KAB to tender for projects with unlimited amount of value for general building works and various M&E works.

6. Top line and profit on an upward trajectory

Both top lines and PAT are on an upward trajectory. Excluding RM0.5 one-off listing expenses incurred in financial period ended 31 May 2017, PAT for FPE 2017 would have been higher than FPE 2016.

"We are confident that 2018 will be a better year for our group in view of our expansion plans, as well as the improving macroeconomic landscape," KAB managing director Datuk Lai Keng Onn said in a separate statement. (source)

7. Peers. Majority of listed companies with M&E as core business such as LFECORP, PASUKGB, YFG and MTRONIC are struggling to deliver good profit numbers.

8. Conclusion

Small base (market cap <RM100m), low capex, high ROE. A stock that I would want to include on my radar screen.

This posting is not implying KAB is superior to INTA nor KAB is cheaper in terms of valuation, but merely as a comparison made to have a better understanding of a stock against its peers.

Previous postings on stocks:

Lysaght - Too Good to be True? More so Now! http://bursastocktalk.blogspot.my/2017/11/lysaght-too-good-to-be-true-more-so-now.html

Scomnet - At an Inflection Point? http://bursastocktalk.blogspot.my/2017/10/scomnet-at-inflection-point.html

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London Biscuits - Talk without Speaking

Look without seeing

Hear without listening,

London Biscuit's 3QCY17 revenue dropped 18.7%. This prompted me to jump to "review of performance" segment to find out the reason behind the significant drop in earnings.

In the case of London Biscuit, it was talking without speaking.

London Biscuits produces confectionaery, sweets and candies, snacks and potato.

Then, eat without tasting?

Lysaght - Too Good to be True? More so Now!

Wrote about Lysaght - Almost too good to be true? about 4.5 months ago.

Surge in top line and bottom line
Lysaght released stunning 3Q17 results, whether you compared in YoY or QoQ

	Revenue growth (%)	Net profit growth (%)
3Q YoY	95.9	116.7
9M YoY	51.7	48.4
QoQ	23.6	54.3

9M17 sales tonnage increased by 27%, revenue jumped 51.7%, gross profit improved, 46.4% net profit surged 46.4%. It enjoyed higher average selling price. Margin was relatively stable.

PE 7.2x

Its current market cap stands at RM145.53m. If we annualise the 9M17 net profit, the stock is trading at an undemanding PE of merely 7.2x.

Net cash per share RM1.67

Its net cash per share improved to RM1.67/share, from RM1.42/share a quarter ago. 

Its cash makes up 47.4% of its market cap.

It has zero borrowing. 

Ex-cash, the stock is trading at a PE of  3.8x! (based on annualised 9M17 earnings), for a stock that enjoy 39.3% gross margin and 22.1% net margin!

Outlook

Commenting on the prospects on the company, the group expects to maintain its profitability.

Growth prospects?

The company announced in early October 2017 that it is acquiring 2 acres of land adjacent to its existing galvanizing plant in Tasek, Ipoh, to enhance production flow and to facilitate future expansion plan of the company (source).

Judging all the above, is it not a steal at current share price?

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SCOMNET - At an Inflection Point?

The carrot on the left can probably paint a thousand words about the recently announced proposed acquisition of the remaining 80% stake in Supercomal Medical Products Sdn Bhd (SMP).

BACKGROUND

SCOMNET (Supercomnet Technologies Bhd) was the first company to be listed on MESDAQ (now known as Ace Market) on 30 April 1999, carrying Bursa stock code "0001". It commenced its business in April 1991 and started with manufacturing of PVC compound, cables and wires for electronic devices and cable assemblies and data control switches. After it was listed, it diversified into manufacturing of advanced high technology cables for the automotive and medical instrument sectors. In 2015, its 20% associate company, SMP, introduced a new product, enhanced disposable pressure transducer (DPT) which has been driving the growth of the associate company.

AT AN INFLECTION POINT?

For the past 5 years, the share price had been fluctuating between 10sen and 20sen, corresponding to the rangebound financial performance of the company.

The share price made a breakout earlier this week after the announcement of the proposed acquisition.

WHY THE ACQUISITION COULD BE A GAME CHANGER?
1. Niche products
The target company sells medical cables and DPT. Being products of mission-critical nature where failure can literally means the difference between life and death, manufactruing of the medical products demand the highest quality. Therefore, the risk and cost of switching are high. Besides, the medical cable industry has relatively high barriers to entry with long production cycle as most of the products will require a gestation period of more than 15 months from product development, customer qualification to production on-stream. SMP's medical cable is approved by the Food and Drug Administration, US, as well as qualified by internationally renowned manufacturers and established players in the industry. (reference: company announcement)

2. Business has been growing
The target company was set up in 2004. It started commercial operation in 2005 and turned profitable in 2008. Business took off in 2009. Both the top and bottom lines surged in 2015 after the launch of a new product, DPT. The growths experinced by SMP in 2015, 2016 and 1H17 were mainly driven by the enhanced version of DPT.

3. High Margin
Since the operation has gained economies of scale in 2009, SMP has been recording extraordinary net margin of between 28% and 41%. This suggests that the products are niche and the company, as a supplier, seems to have strong bargaining power. This typically allow the company to pass on cost escalation to customers without much difficulty.

Its gross margins for 2014, 2015, 2016 and 1H17 were quite impressive at 44.8%, 46.2%, 45.7%, 47.4% respectively.

4. Zero Borrowings
Zero borrowings before and after the proposed acquisition.

5. Postive outlook
The existing business remains challenging with little prospect for growth but the outlook for the target company looks positive.

Source: Annual Report 2016

6. High ROE
SMP offers very high ROE. 37.9% for 2015 and 30.7% for 2016. ROE is one of the important factors Warren Buffett looks at when investing in a business. SMP is making a RM26m dividend payment prior to completion of the acquisition. This will increase the ROE as the denominator has been reduced substantially. The shareholders' fund as of end-2016 was at RM56m.

7. Major shareholders not cashing out
Of the RM80mn purchase consideration, only RM4m is paid in cash while the remaining purchase consideration is settled in shares. The major shareholders and PAC will collectively hold 74.7% of SCOMNET. This means the major shareholders are still very much committed to the business of SCOMNET and SMP.

VALUATION

On a pro-forma basis, at the previous closing price of 25.5sen, it is trading at a price/earnings multiple of 9.8x. To be honest, I am unsure what should the fair target price/earnings multiple be post-acquisition.

Medical related counters such as IHH, TOPGLOV, HARTA, KOSSAN, KAREX are trading at high price/earnings multiple ratios. They are in a different league, being giants in their respective fields.

Maybe quick comparisons can be made with COMFORT and LKL. COMFORT is trading at 14.0x based on annualised earnings while LKL is trading at 22x FY17 earnings. CAREPLS is not included as the price/earnings ratio appears to be an outlier.

The proposed acquisition of SMP is expected to complete by year end.

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Contractor Awarded a Construction Contract Despite Disastrous Safety Track Record

TRC was awarded a sizeable LRT 3 package despite a disastrous record in Kelana Jaya LRT line extension project.

Recall, there were 3 site accidents involving the public in the SINGLE project carried out by TRC.

A motorist was killed and another seriously injured when construction equipment hoisted by a crane fell and crushed two cars in March 2013 (source).

A crane carrying out piling work fell and crushed a car in August 2013 (source).

A male driver and his female passenger were nearly killed when a steel beam fell onto a car in June 2014 (source).

Despite the terrible safety record, the same project owner, Prasarana, still awarded a construction contract to TRC. Is Prasarana forgetful or safety track record does not matter at all?

Eversendai - Over-promise under-deliver?

1. Margin

An article in Star newspaper dated 6 April 2013

PATAMI margin of 11% seems to be a thing in the past after he made that statement in April 2013. PATAMI margin has been below 4% since 2013.

2. RM2b Revenue

(The Edge) 

The actual revenue recorded in 2016 was RM1,582.4m, below his target of RM2b.

3 New contract to surpass RM2b in 2016

(source)

In September 2016, Tan Sri Ak Nathan was confidence that the new contracts wins in 2016 would surpass RM2b before end of 2016. 4 months later, the actual total amount of new contracts secured in 2016 was RM1793.6m.

4. Serious Delay in the Completion of Liftboats

Source

In May 2014, Eversendai secured a contract to construct two liftboats. The liftboats were supposed to be ready by February and May 2016. However, to date, none of them has been completed. It probably takes about double the original contract period to complete the works. Whether the delay is caused by the client (related party transaction, a vehicle controlled by Tan Sri AK Nanthan) or Eversendai? And whether Eversendai would be compensated if the delay is caused by its client? Substantial overrun in overhead costs is likely given the prolonged delay.

5. Over-promise, under-deliver

A comment by a fund manager

Another blemish in the company was the bad investment in Technics Oil & Gas in which the company incurred more than RM100m of losses.

Conclusion

I would avoid the stock as it is not a stock that I could buy and sleep soundly at night given its track records and erratic earnings. There are more than 800 counters in Bursa Malaysia and I am sure there are some stocks that offer more attractive risk reward ratios. Furthermore, the stock is not cheap at current valuation, having high net gearing of 1 time (before private placement), and considering the payment risk associated with the liftboat project. Besides, decent dividend is unlikely in the foreseeable future due to its high gearing ratio.

While I have reservation on the stock, credit must be given to Tan Sri AK Nathan for his incredible track records in successfully completing various world class iconic projects.

LYSAGHT - Almost too good to be true?

Lysaght Galvanized Steel Berhad is a leading manufacturer of galvanised steel poles in Malaysia. Its main products are poles, masts, decorative poles and tubular steel structures.

An interesting smallcap stock for the following reasons:

1. Zero debt. Zero credit risk. A conservative company. It has been debt free for more than 10 years.

2. Strong net cash position. Its net cash stood at RM59.6m as of end-March 2017. That's 40.9% of its current market cap (RM145.5m)!

3. Single digit PE ratio at 9.2x (based of the net profit of RM15.751m for the most recent 4 quarters).  Ex-cash, it is trading at a PE ratio of only 5.5x!

4. Superb margin. The company has been enjoying margin expansion. Its FY16 gross margin and net margin were as high as 40% and 23% respectively. The margins tell a lot about its bargaining power, the competition among its peers and its specialty. More likely a price maker than a price taker. 

5. Products accepted worldwide. Its products are manufactured in compliance with recognised International Standards and are accepted worldwide as they are compliant with British (BS), European (EN) and American (AASHTO) standards (source: FY16 annual report). Export to advanced countries like Singapore, Hong Kong, Autralasia. About 47% of FY16 was generated locally and another 46% was derived from Singapore.

6. Low capex and cash generative business. It is in a low capex business. For the past 10 years, the capex was generally below RM2m a year except for FY12 and FY13 in which it spent a total of RM17.9m on land, buildings and machinery (including a RM11m factory on a plot of freehold land in Hicom-Glenmarie ). The capex was as low as RM67,560 in 2009. Despite paying out about 48% of cumulative core net profit between 2007 and 2016, its cash has ballooned from RM8.1m end-2006 to RM61.6m end-2016. It disposed off an investment property at RM6.4m in 2015. 

7. Product range and geographical expansions. Whilst the existing operations are fairly stable and sustainable for the moment, the group is currently looking into diversifying into a new product range to cater for tubular steel structures and export market. These products which carry higher loading are manufactured with heavier steel and more sophisticated know-how. Hence, better margin is expected from these products. In its recent AGM, the Board said the company has allocated RM10m capex for machinery upgrade.

8. Positive industry outlook. The group's business is largely reliant on supply to projects from the infrastructure and construction sector. Mega projects being implemented include MRT 2, LRT 3, East Coast Rail Line, Pan Borneo Highway, West Coast Expressway, Gemas-JB Double Track and KL-Singapore High Speed Rail. 

To get a feel for the amount of highway jobs being implemented currently, the longest existing highway in Malaysia, North-South Expressway is 772km long, while in near to medium term, various highways with a combined length of more than 2,500km are being implemented simultaneously. Besides these highways, LYSAGHT is likely to benefit from above mentioned rail-related projects as well. (Pan Borneo Highway >2,000km, West Coast Expressway 316km, East Klang Valley Expressway, and several urban highways which include DASH, SUKE, Duke 3 and Duke 2A)

The negative aspects of this stock:

Low trading liquidity. The Chew family and related parties are holding about 74% of the shares. Furthermore, it has a small share base with only 41.58m of shares issued. It is in the bottom 1% or 2% among Bursa Malaysia listed companies, in terms of number of shares issued. With a share capital of RM41.58m and retained earnings at RM85.3mn, a share bonus issue and/ or share split is overdue.

FY16 dividend yield unattractive. Its 7sen/share dividend for FY16 (2.0% dividend yield) has nothing to shout about. The Board said in AGM that the company is conserving cash for capex to widen its product range. However, for the past 10 years, it has cumulatively paid out about half of its cumulative core net profit. Between 2007 and 2016, it has paid out RM55.3m of dividends out of the cumulative net profit of RM114.5mn. Average payout was at 48.3%. It declared a special dividend of 50sen/share in 2014.

Board tussle. With the ex-MD, Mr Liew quit the MD role and ceased to be a board member, the tussle could a thing of the past. The MD position was taken over by Mr Chua, an old-timer in Lysaght. He was appointed as the acting CEO on 1 June 2016 and appointed as the CEO on 1 Jan 2017. Assuming Mr Chua took 3 to 4 months to settle down, the company under his stewardship, reported strong YoY growths in top line and bottom line for 4Q16 and 1Q17. If we annualise the net profit for the most recent 6 months, the stock is trading at a PE ratio of only 7.9x, and a mere 4.7x if ex-cash!!

Mr Chua is a loyal staff of Lysaght. He has been with the company for 45 years and works his way up to the top.

Conclusion:

Zero debt, strong net cash, low PE ratio, superb margin, worldwide recognised products, low capex, cash generative business, having growth potential and positive industry outlook.

If we annualise the EPS (based on the most recent 2 quarters) and set a target PE multiple of 10 times, the stock is worth RM4.44. This has yet to factor in its cash per share of RM1.43 per share and its growth potential. If we price in a premium of 2x PE multiple for its strong net cash position and growth potential, then the fair value of stock is RM5.33.

A savvy investor, Mr Teo Kwee Hock surfaced on list of 30 largest shareholders, as the 6th largest shareholder as of 31 March 2017.

The Other Side of the Story on Termination of Bandar Malaysia Agreement

Source: https://www.wsj.com/articles/deal-to-prop-up-malaysias-1mdb-falls-apart-1493828337

Was the termination of agreement due to failure of the consortium in meeting the payment obligation or the Chinese government refused to authorize the investment?

Also, will Malaysian government take action against WSJ for the accusations made by WSJ?

A company having older directors' average age than Public Bank's

Public Bank directors' ages average 71.5 years. There is a Bursa listed company with directors' ages older than this. Advanced Packaging Technology (M) Bhd at an average of 74, with the oldest director 87 years old.

Tan Teng Boo now sees KLCI and S&P 500 hitting 2,400 and 3,000 in medium term

This is on hindsight.

Tan Teng Boo had been bearish since April/May 2011.

"Since April/May 2011, I have been bearish on equities globally, including that of Bursa Malaysia. My bearish views have not changed one iota" (source).

He was still bearish on the equity markets last week, foreseeing KLCI possibly hitting  800-900 points and S&P 500 touching 1,350 in medium term. Just a week later, he made an unprecedented and very drastic revisions in index forecasts, revising his KLCI mid term possible target to 2,400, and S&P 500 to 3,000 from 1,350.

(See previous posting: another extreme forecast that went wrong.)

He was persistent on his bearish view and missed the the run-ups in stock markets.

Icap's average return since inception is still decent, thanks to exceptionally strong performance of the fund in the initial years.

Personally, I prefer a semi-log graph to linear graph in fund performance chart like this. It gives better depiction of a fund performance as the fund size grows. (In linear chart, a 30sen increase in NAV from a reference price of RM3 looks more impressive than a 10sen increase in NAV from a reference price of RM1, even though both having the same 10% growth.)

His global fund is not that lucky.

After about 9.5 years, the Global Fund generated a cumulative return of 5.9%, or at an annual compound rate of 0.6%. The fund's performance dipped below its benchmark, giving up the outperformance the fund had been enjoying since inception.

The International Value fund has a moderate cumulative return since inception, at a CAGR of 4.21%. It underperformed both benchmarks.

He had been reminding us the investing rule of never lose money. For a 50% loss in an investment, you need a 100% to make up the earlier loss.