Value Unlocked or Value Trap??

In the midst of searching for undervalue stock, I have come across this company that has just announced its Q4 results with more than 3000% jump in profit compared to previous year’s Q4. There was a big jump in Other Income – due to the reversal of impairment loss on its property development project.

Upon further reading and searching, I find it interesting:-

Company: Poly Glass Fibre (M) Berhad

Market Capitalisation : Rm48.8 mil ( 160 mil shares @ Rm0.305)

Last 5 years performance:-

	Revenue (Rm ‘ Mil)	Profit (Rm’ Mil)
28/2/2017	47.9	34.2*
29/2/2016	41.8	4.4
28/2/2015	43.9	5.5
28/2/2014	40.6	5.9
28/2/2013	33.9	22.9*

• Both included reversal of impairment loss on property development project.

The company is in fibre glass wool business and has been listed for more than 20 years.

Latest PE ratio at 1.43 but PE (excluding one off item) = 22

Loan & Borrowing = Rm29 mil, Gearing =15.4%.

Cash balance only at Rm1.9 mil

Net Asset per share = Rm 0.995 ( Share price @Rm0.305, Price to Book ratio at 0.31, discount of 69%) and its biggest asset is the land held for development known as Diamond Creeks Country Retreat (more than 800 acres land in Tanjung Malim). In fact, it is a project that was “deferred” and there was a long disputed litigation which has dragged more than 20 years.

As the principal business of glass wool is not growing much over the years and cashflow is deteriorating, I would normally give it a pass. However, what triggered my interest  is the reversal of impairment loss was made by the company after the Federal Court decision to dismiss motion by plaintiff, is that an indication that the Company can revive the project and the value of this 800 acres land will be unlocked ?  

Further reading of past annual reports and checking on the company website as well as on Diamond Creeks Country Retreat, this is my personal view on the company:-

1. The cash position is low and it may get into cashflow problem soon
2. It has not declared any dividend ( at least for more than 15 years)
3. I believe the Tanjung Malim land is agriculture land, probably only for homestead or orchard. Since the company has acquired the land for around Rm3 psf in 1996, the value of the land may have appreciated but viability of the project is still a big question mark due to its location.

It is still not clear to me whether it is a gem or a dud. My biggest concern is its cashflow and the value of the land is still highly uncertain. Hence, I would rather wait till the Company could prove the worthiness of the land by generating good cashflow out of it.

Leveraging - good or bad?

Some definitions on leveraging found on google are shown as follows:-

1. use borrowed capital for (an investment), expecting the profits made to be greater than the interest payable:
2. Use (something) to maximum advantage

In finance, leverage (sometimes referred to as gearing in the United Kingdom and Australia) is any technique involving the use of borrowed funds in the purchase of an asset, with the expectation that the after tax income from the asset and asset price appreciation will exceed the borrowing cost.

The use of leverage is an investment option to further enhance the return on investments by using borrowed money. Leverage must be used with extra caution. Leverage can allows investors to increase the buying power of their investment capital. The ability to buy a larger amount of an investment multiplies the return on the invested capital. The benefits of leverage turn into large losses if the investor makes poor investment choices – it is a double edge sword.

What leveraging can we have in stock investment?

1. Share Margin Financing (SMF) is a type of revolving credit facility provided to investors to finance their share trading and investment activities. Investors can buy shares on borrowed money that is secured by collateral. Acceptable forms of collateral include cash, warrants of certain shares, unit trusts, fixed deposits and quoted securities on Bursa. For example, a stock is purchased in a margin account using the 50 percent leverage offered by stock brokers. An investor pays Rm100,000 to buy Rm200,000 worth of stock, borrowing the balance from the broker. If the stock increases 10 percent to $220,000, the investor earns Rm20,000 gross  or 20 percent (before deducting the interest on Rm100,000 borrowed) on the Rm100,000 initial capital.
   I personally has not done this as I am really kiasi and I can’t sleep if the market is down. Worst if I need to top up to avoid margin call, I don’t think I can take it. Some may argue that if we can borrow with interest at <5% and invest in REITs with dividend yield of >6% and reasonably safe, you still make some the extra 1%+. Well, I welcome you to share if you have the real experience. 
2. Invest in highly leveraged companies – you are indirectly exposed to leveraging through the company, the risk is similarly high as highly leveraged company has higher chance of bankruptcy during bad times. Obviously, highly leverage companies usually has very high Return on Equity(ROE) as capital is mainly from borrowing and if the company is profitable and managed its cash flow well, the return to shareholders is enormous. The below example is to illustrate the impact of leverage has on both companies (Company A with higher gearing) in identical business and operation with different capital structure.
    
   
    
   If it is loss making, the impact is also amplified in Company A, which has higher gearing.
   Obviously. this is not my cup of tea as I could not forget the impact of 1997/98 Asia Financial Crisis on some highly leveraged companies (eg Lion Group). As you can see, my portfolio mostly consists only of net cash companies except financial institutions (RCE Capital, Tune Protect)  where they rely on borrowed money or other people’s money to do business. Worst if you use Share margin financing for highly leveraged companies, eg if you have used share margin financing for Perwaja or Malaysia Airlines shares, what are you going to do when the share price fall 90%??
3. Invest in derivatives – in Bursa case, warrants – either call/put warrant or company’s warrant. I personally do not touch call / put warrant as it usually has short expiry period (< 1 year) while company warrants usually has 5 years period before it expires (some 10 years). I am more inclined to have a little leverage through company’s warrant on my portfolio to enhance return – the pre-conditions – if  It is “Out of Money” but not too much premium,  better if it is “In the Money” and with discount on the warrant, leverage ratio > 3 times, longer expiry (> 2 years) and must be a good company or at least financially sound. Again, as in any form of leveraging, you can still lose big even in company warrant, imagine if the warrant never get “In the Money” till expiry and all your money invested in this warrant is burnt !

I have only engaged in Type 3 leveraging and very selective on the company warrant I bought and the fact that I still do it, yes, the experience has been good so far. So, is leveraging in stock investment good or bad? There are some strong advocates of Type 1 leveraging on stock investment but there are also many with bad experiences. I believe it is very much depending on individual but my own preference, I don’t invest on borrowed money and yet still wish to leverage a little – hence through selective financial instruments. Your comment and experience are welcome to enhance my knowledge on this area.

Analabs - hidden gems??

I have this 'low profile and probably not known to many' stock in my portfolio, I wish to do some write up on this company if this is also your cup of tea.

Analabs - Background

Analabs has been involved in the environmental and industrial related business since 1936 in Singapore and 1965 in Malaysia. With more than 40 years of experience in this industry, it has been able to chart its success in the environmental business and has positioned itself as one of the pioneers in providing quality laboratory testing by meeting ISO/IEC Guide 17025 and ISO 9002 standards.

Listed on the Second Board of Bursa in year 2000 with initial paid up capital of Rm40 mil (40 mil shares @Rm1.00 each), IPO price was at Rm1.70 per share. There was a 1 for 2 bonus issue in 2002 and its enlarged share capital is 60 mil shares now.

It principal business consists of the followings:-

1. Manufacturing, formulation and sale of resin, chemicals & building materials
2. Recovery and sale of recycled products
3. Contract work, Pipe laying & rehabilitation

 Past 5 years Financial Performance

Income Statement

	2017 (Q3)	2016	2015	2014	2013	2012
	RM'000	RM'000	RM'000	RM'000	RM'000	RM'000
Revenue	117,055	155,176	142,088	140,324	147,376	120,465
Cost of sales and services	(75,480)	(122,509)	(113,830)	(116,949)	(119,508)	(88,929)
Gross profit	41,575	32,667	28,258	23,375	27,868	31,536
Other operating income	2,294	6,975	3,776	7,486	4,062	3,176
Operating expenses	(31,853)	(23,744)	(22,838)	(18,070)	(17,764)	(16,660)
Profit from operation, EBIT	12,016	15,898	9,196	12,791	14,166	18,052
Finance costs	(747)	(617)	(986)	(926)	(540)	(206)
EBT	11,269	15,281	8,210	11,865	13,626	17,846
Taxation	(2,188)	(2,926)	(1,866)	(2,770)	(4,080)	(3,269)
Net Income	9,081	12,355	6,344	9,095	9,546	14,577
DPS, sen	3.25	3.00	3.00	4.13	5.50	5.00
EPS	0.16	0.24	0.11	0.16	0.16	0.24

 

Operating Expenses - FY17 (3 Qtrs) > FY16 Full year, I believe was due to classification issue between COS & Operating Exp as FY16 Annual Report full year Operating Expenses was lower than Q3 FY16. That also explained why Gross Profit for FY17 (3 Qtrs) > FY16 full year.

Cashflow

	2017 (Q3)	2016	2015	2014	2013	2012
	RM'000	RM'000	RM'000	RM'000	RM'000	RM'000
Net Cash generated from operations	10,563	29,046	18,470	19,530	17,506	8,587
Free Cash Flow	9,485	29,055	16,599	11,429	16,902	2,080

Financial Position

	2017 (Q3)	2016	2015	2014	2013	2012
Assets	RM'000	RM'000	RM'000	RM'000	RM'000	RM'000
Current asset
Cash and cash equivalent	45,281	39,055	33,195	25,203	29,075	20,466
Other Assets	51,812	59,076	63,891	71,195	64,054	49,314
Total current assets	97,093	98,131	97,086	96,398	93,129	69,780
Non-current assets
Property, plant and equipment	147,515	150,115	155,127	159,840	95,228	91273
Intangible assets/ DTA	9,804	9,915	9,804	9,755	8,397	7,089
Investments	29,841	31,426	22,722	14,833	7,514	15,365
Total non-current assets	187,160	191,456	187,653	184,428	111,139	113,727
Total Assets, TA	284,253	289,587	284,739	280,826	204,268	183,507
Short-term loan & borrowings	11,292	11,961	19,707	10,488	10,874	3163
Other Payables	18,957	28,779	22,167	24,861	19,731	11,967
Total current liabilities, CL	30,249	40,740	41,874	35,349	30,605	15,130
Long-term loan	6,009	9,457	13,591	17859
Deferred tax & Others	18,570	18,138	19,360	20596	10406	9590
Total non-current liabilities	24,579	27,595	32,951	38,455	10,406	9,590
Total liabilities	54,828	68,335	74,825	73,804	41,011	24,720
Equity
Common stock	66,272	60,024	60,024	60,024	60,024	60,024
Reserve	43,945	50,213	49,467	51,189	14,234	16,934
Retained earnings	121,094	113,097	101,528	96,343	88,999	81829
Total common equity, E	231,311	223,334	211,019	207,556	163,257	158,787
Minority interest	(1,886)	(2,082)	(1,105)	(534)
Total Equity	229,425	221,252	209,914	207,022	163,257	158,787
Total liabilities and equity	284,253	289,587	284,739	280,826	204,268	183,507
No of shares outstanding ('000)	56,105	56,259	60,024	60,024	60,024	60,024
NA value/share	4.1	3.9	3.5	3.5	2.7	2.6

 

Key Financial Metrics

Key Metrics
Price	2.25
Intrinsic Value	3.7
MOS (DCF)	39%
Dividend yield	1.4%
P/FCF	8.9
PB	0.55
PE	10.5
EV/EBIT	4.2
FCF/ Market cap  ( cash yield)	11%
ROIC (Average)	6%
Average ROE	5%
EY = EBIT/EV	24%

The negative from the metrics – ROIC and ROE

1. Low ROIC – high PPE value mainly in land & building pull down the ROI, fortunately it does not require replacement such as Plant & equipment, hence, its' FCF is still very strong.
2. Low ROE – mainly due to low dividend payout(ranging from 10% to 30%) and company retained most of the profit and resulting in high Equity value but unable to generate more return from the reserve retained.
   Both these are signs that management are not efficient in resource utilisation and not able to invest for higher return.

The Positive from the metrics – FCF, EV/EBIT, PB

1. Strong FCF as low requirement in capital assets replacement ( cash yield at average 11%)
2. Low EV/EBIT 4.2 appears cheap from valuation point of view (Earning yield at 24%)
3. Low Price to Book - 0.55  (45% discount to book value – cash, Maybank share + land & building selling to us at 45% discount)
4. PE of 10.5 seems ok.

Indicative Valuation

Current Market Capitalisation : 56mil (net of treasury shares) @Rm2.25 = Rm 126 mil

 DCF method : Rm3.70

 – derived from Discounted Cashflow (DCF) basing on average FCF from the last 6 years, discount rate at 11% and growth at 2% p.a. This provide a margin of safety of 39%.

 

This is further supported by its Net Asset value of Rm4.1 per share. At Rm2,25 now, it is actually 45% discount to net asset value.

Assets mainly consists of: 

Cash                                               Rm 45.3 mil ( 80 sen per share, net of debt will be 50 sen per share)

Investment                                    Rm 29.8 mil (mainly investment in Maybank shares as announced in Apr 17, worth 53 sen per share)

PPE                                                  Rm 147.5 mil (mainly land & building, which has been revalued in 2014)

  

Past 6 years share price performance

 Shareholding as of 29 Jul 2016

1 KAN YOW KHEONG                                                                                      38.01%

2 KAN YOW KHEONG                                                                                      18.16%

 Mr YK Kan is holding 56% of Analabs and top 30 shareholders hold 85% of the shares, hence, the liquidity of the shares is quite low.

 

Any near term catalyst??

 Business prospect – the business has been relatively stable and Analabs has attempted to expand the business but did not bring much results. In its 2016 Annual Report, it has highlighted that it has downsized the Singapore operation that is not performing to cut operating cost and will not expand or venture into new business in the near term. It appears that this is a boring company with not much excitement in financial performance or corporate news. Hence, it does not get much attention from investors as it is really a dull and boring counter.

I tried to imagine if I were Mr Kan, what would I do? Well, I would privatise it (only need Rm55 mil for the balance 44%) and I can easily get back my money from the cash + investment in Maybank shares. ( must learn from Maxis, Astro and so many others, privatise first and put up a much higher value for re-listing). Obviously Mr Kan is also not keen on corporate exercise, even though with high net asset per share and low liquidity, it has only done a bonus issue back in 2002 (15 years back, It was due to the requirement for main board transfer - min Rm60 mil share cap then). He probably knows that does not create value.  

 As for me, if it is purely an asset based value stock (Net Asset/share = Rm4.1), may not excite me too. However, when it is also supported by strong free cashflow of average Rm15 million per year (market cap at Rm126 mil, cash yield >10%), I am willing to ride with Junior Kan (recently re-designated to Executive position)  if he will bring excitement to Analabs and how the cash reserve can be utilised for higher return or higher dividend to be considered. Yes, hope is not strategy, in this case, it only has opportunity cost but limited risk and based on DCF valuation, there is 39% margin of safety (60% upside potential). Yes, I will camp here for a while.