As mentioned in Part I, LTC has been booking in fair value gains on its freehold industrial property. Logically, we will need to have some sort of visibility on the industrial market to make an educated guess on what this “fair value gain” would look like.
Because LTC gets the property valued only at the end of every FY (LTC has a june year end), one can roughly guess what the gain or loss would look like by comparing how the industrial market prices have changed over the course of the year.
This is the industrial property price index (given by JTC)
As LTC Corp has a June year end, we’ll compare the “2Q” dots in the above diagram.
The data above is actually pretty accurately reflected in LTC financials:
- 2Q2014 shows a slight increase compared to 2Q2013. LTC recognised a small gain of $2.1mil in FY14.
- 2Q2014 and 2Q2015 are pretty much at the exact same spot. LTC recognised a negligible gain of $0.8mil in FY15.
This is where it gets ugly going forward. Based on the chart, I’d expect LTC to mark down the value of the property it carries on it’s books in FY16. The figures have dramatically deteoriated from 2Q2015 and the downtrend is clear.
While we are unable to predict exactly how much a loss will be recognised, knowing that there’ll be a loss coming up in the next quarter results is significant. I suspect the market has not priced this in yet.
In the most recent quarterly financials, management has also guided for dark clouds ahead: “With a weaker economic outlook, the investment properties in Singapore may face some challenges in maintaining occupancy and rental rates”
Now let’s examine the 3 divisions that LTC derives its revenue from.
The collapse in oil prices dominates the headlines all the time, but in reality, steel prices has gotten it even worse.
The chart says it all. It’s priced in Yuan as China is by far the largest supplier of steel to the global markets. Specifically for our local markets, the steel reinforcement price index was 63 in July 2015, with a baseline of 100 in June 2006.
Steel rebar price was $900/tonne in 2011, $600/tonne in Oct 2014, $510/tonne in July 2015, $470/tonne in August 2015, $410.5/tonne in February 2016 before rebounding somewhat to $534/tonne in April 2016.
Not a pretty sight.
In Singapore, the only property development is the Seven Crescent bungalows. While the company has made progress selling most of the 14 units, I believe there are still 4 units that are unsold. These are parked under “Completed properties held for sale” in the balance sheet. The prices have been falling (as seen in the caveats lodged in URA website)
The other property developments are in Malaysia and in China, specifically Shenyang.
These developments face currency risk in the case of Malaysia, where the ringgit has depreciated significantly against the SGD.
In China, fortunately all the residential units has been sold, leaving mainly the shop spaces to be sold.
As discussed above, the industrial property segment weakened dramatically in the 1Q2016. Rents and occupancy rates will likely be impacted.
From this, we know that the earnings picture is not going to be pretty in the next Q4 results. It’d likely stay that way for sometime to come.
Balance sheet analysis + Valuations
LTC Corporation is severely undervalued based on the fundamental ratios. Of course it’s undervalued for a good reason. The earnings picture is as gloomy as it can be. How undervalued exactly?
As mentioned in Part I, the current price of 53 cents (thereabouts) is a mere 33% of the book value of 158.15 cents. On top of that, as of the most recent quarter, the company has cash holdings of 10.9 cents per share.
Think about this for a sec. Imagine someone offers you a deal where you pay $53, and in turn you get $10.9 back, together with actual goods worth $147.25. That’s the deal Mr Market is offering right now.
Yet another example to show how crazy the valuations look right now:
The 4 blocks of freehold industrial property is carried in the balance sheet under “Investment properties”, under “non current assets”, valued at $118,000,000. We’re talking about a hard asset that’s verifiable, and has been professionally valued. Sure, the prices must certainly have dropped since the last time it’s been valued, so let’s knock off a very generous 20% off the $118mil price. That gives us $94.4mil. Which works out to be 60.3 cents per share, which is above the current share price of 53 cents!
In other words, if one has the means to privatize the company right now, at the current price of 53 cents, the market cap is $82.92mil. After you own the entire company, you can simply sell off the freehold industrial property for $118mil (or $94.4mil if you assume the price has fallen by 20% in the past 1 year), and you’re still left with all the other assets of the company! The steel inventories, the seven crescent bungalows, the Shenyang shops, the Malaysian industrial land and units are ALL FREE!
This is pretty mind boggling to me. Why doesn’t an activist fund come in? Probably because the controlling family has a sizable stake and any hope of buying over the company requires their blessings.
Such a valuation is also very telling about the company’s management. I’d say upfront that I have little respect for their management. The fact that the markets assigns such a terrible valuation speaks volume about their confidence in the management, who has done absolutely nothing to narrow the gap between the share price and the book value.
The compiled multi-yr CF is below:
Well, LTC actually generates quite a bit of FCF. This is because it’s business doesn’t require much capex. It’s a relatively simple business to understand. They keep large inventories of the various types of steel required by their clients (construction companies mainly), and when required, they sell the necessary types of steel to their clients on demand. As their clients are mostly construction players, I’m guessing most of the inventory is in the form of rebar steel.
It comes in a standard form, gets transported and any cutting to size is done on site. Minimal capex / equipment needed. How much the client is charged depends on a certain benchmark or steel price index.
So where does this cash go to?
As one can see, the loans (both current and non current) have generally been reduced over the years.
In the latest financials (FY16Q3):
We can see the current loans is negligible, and the non current loans and borrowings have been drastically reduced to a practically minimal $2.5mil.
So we know that LTC has very minimal debt, and FCF generated has been utilized to pay down debt. That’s the 1 wise thing that management did. Unfortunately, the management has also done many stupid things with the cash generated.
Now that the debt has been paid off, any future CF generated goes straight to the balance sheet. I’m expecting the cash holdings to accrue in the coming quarters. I generally like businesses that generate a lot of FCF consistently. Because it’d take someone asinine to CONSISTENTLY destroy the cash that builds up.
However, this management seems to be able to do just that really well.
“Diversification” into retail sector
This is what really riles me.
In Feb 2015, management announced that LTC is acquiring a 50% stake in a company known as USP Equity Sdn Bhd (“USP”), with an option to acquire another 1% (for control of the company)
USP in turn owns 90% of the SOGO departmental stores in Malaysia. The purchase price was RM72mil, or approximately SGD 24mil. The purchase price was based on USP’s net profit of $3.144mil.
Now, let’s do the math.
Since LTC is paying $24mil for a 50% stake, that means LTC valued USP at a price of $48mil. If net profit is $3.144mil, we can then work out the earnings multiple they are paying as 15.3.
PER of 15.3 is very expensive in my opinion, for a retail business in Malaysia
This is based on my research on other similar retailers. On top of that, it is my opinion based on my previous investments with retail companies (my current holdings include Metro, which has a retail segment which is currently struggling), the future for retailers is very bleak. Many retailers are struggling to stay afloat.
What business does LTC have acquiring a retail business, something that is totally unrelated to their existing business? And paying a multiple of 15.3 times?!
I was against this right from the start, and in the 2 quarters since the acquisition was completed, USP has contributed:
a grand total of -$171,000 to the income statement.
Yes, there is a negative sign in front of that. In the 3 months since the acquisition was completed, they contributed $460,000. In the next 3 months though, the $631,000 loss resulted in a combined effect of a -$171,000 “contribution”. These figures are in the “share of results of joint venture” in the income statement.
Think about it: Management just busted $24mil, and the result after 6 months, is a further loss of $171k.
I have 2 questions:
- Why such a high multiple for a retail business when it is a well known fact that retail is currently and for the foreseeable future, going to be very tough?
- Why did the business have a net profit of $3.144mil, and now after 6 months, have a contribution of -$171k? Just to match the previous year’s profit, the next 6 months would have to have a profit of $3.3mil. The business has to perform a turnaround miracle. Highly unlikely.
So now, we’ve answered the question of where did all the cashflow generated go to. It went to pay off debt (that’s good), and to buy an unrelated, overpriced business. If management has no idea what to do with the cash generated, maybe I can suggest they distribute it to shareholders. Afterall, they just cut dividend. (yes, dividend is now $0 this year)
I do note that the controlling shareholding family, the Chengs, have extensive ties with retail businesses in Malaysia. Through the Lion group, they own several retail businesses in the region: Malaysia, Vietnam, HK, China etc.
I get worried about this. I have no evidence, and I am not alleging anything, but in such an instance, the controlling shareholder and management may not always have the best interests of the company. I cannot find any OBVIOUS relationship between the seller of USP and the Cheng family, but one will have to think of the answers to the 2 questions above. Why the high multiple, and why the very sudden drop in net profit AFTER THE ACQUISITION.
While on the topic of management, another fact is that one of their directors, Tan Sri William Jem, who has since retired, begun selling off his substantial stake Dec 2013 to July 2014 at prices ranging from $0.74 – $0.82.
Talk about selling at the peak. This guy must have amazing technical analytical skills, because right after the selling is completed, the share price tanked.
The difficulty in being a truly successful investor is not just to find out information, but how to interpret data. This is one of those cases that is very hard to assess accurately.
Of course, one has to do as thorough and in depth a research as possible, and with regard to LTC, I do think I have done that. But even with all this information, how does one determine the outcome?
We have a business here that’s CF generative, even when it’s main business is currently in a severe downturn. But management has been less than ideal. By all valuation metrics, LTC is currently severely undervalued, but there are good reasons for that.
I’d be holding on to my existing stake, and monitor the CF generated, as well as how it’s utilized in the next few quarters. Macro factors like the total steel production by China, and the steel prices in Singapore are also important.
At this stage, in my opinion, LTC has reached a bottom. I’m holding as I don’t see the share price falling any further now ($0.53), but neither do I see a catalyst that will make it rise substantially. I may add to my stake in the coming quarters if new optimistic data emerges.