Boustead Singapore Part II

This is a continuation from the post “Boustead Singapore Part I”

Let’s start off with a table:

The data above basically confirms our thesis in part I: Boustead is currently facing strong headwinds. Dividend has been reduced to multi year lows (if you exclude the dividend in specie distribution of BP), ROE has dropped substantially. NAV too has dropped, largely due to the demerger of BP.

At the share price of $0.79, this means we’re paying a PER of 15 times, and a P/B of 1.4 times. Dividend yield would be 3.8%, but I postulate that this is artificially low. The distribution of 3 cents is because there has been an additional dividend in specie in FY16. I’d expect a dividend of at least 4 cents for FY17. (2 cent interim and 2 cent final). At least.

Boustead has a long term track record of growing the book value. CAGR of the book value, even accounting for the demerger, is around 10%.  Over the years, the P/B has ranged from close to 1.0, to almost 3.0 when valuations were better.

The current P/B of 1.4 is close to it’s all time low in the past decade.

Also, I’ll note that Boustead has a net cash position (after accounting for borrowings) of $165.6mil. That works out to 31.7 cents per share. That works out to be 40% of the current share price. On top  of this, the company has $76.1 million of financial assets for sale / held for trading, half of which are “highly liquid” aka cash equivalent.

To paint an accurate picture of the backdrop against which the company is currently operating, I thought FF Wong’s most recent comments after the FY16Q4 results are the most telling. They are, as always, brutally frank. In response to a question about how competitive the environment is, this is what he said:

“……the severity is beyond imagination. I personally have only seen this situation twice. This time being once, the other time being 1983 – 1997, in which there was huge consolidation in the industry because of the low oil prices.”

Deep value? Contrarian? Thus far it looks like all the boxes are ticked.

Let’s take a closer look at each of the 3 divisions.

Real Estate Division (Boustead Projects)

The results ain’t too bad, in fact, it’s better than what I was expecting. As one can see, the bulk of the drop in NAV is due to a 1 off payment of a $80mil dividend to Boustead. BP tends to have a recurring, stable revenue, regardless of how the industrial property market is doing. This is because the bulk of their profit comes from Design-Build-Lease (DBL) projects. In this type of project, BP actually procures the land and builds the project in consultation with the tenant. The project is built according to the tenant’s specifications and in return, the tenant is locked into a long lease with heavy penalties for early termination. This model involves a heavy initial investment, but in turn BP has a resilient revenue stream that’s predictable and recurring.

On top of this, BP has always focused on design capability. They have tried to win contracts which require certain expertise to build according to the tenant’s requirements, instead of the typical industrial builders.

Going forward, I’ll expect BP results to flatline or dip slightly. BP is actually trading close to it’s NAV right now. Their properties are very conservatively valued, and I find it hard for BP to go at a price substantially below it’s NAV. If one eliminates the $80mil 1-off payment, BP’s NAV should stabilise in the coming quarters.

On top of this, a substantial part of the loans taken up by BP has been paid off in FY16:

“Total borrowings (both current and non-current) halved to $93.4 million following the Real Estate Solutions Division’s repayment of bank borrowings to fully deleverage six properties and to reduce bank borrowings on remaining properties.”

Here, I’ll deviate a bit and try to analyse the demerger of Boustead Projects from Boustead in 2015. As Boustead still owns 51.2% of BP, BP is effectively still a subsidiary of Boustead and all financials are integrated accordingly. Only change would be that the non-controlling interests has risen with the distribution of dividend in specie.

In 2015, Boustead shareholders were given 3 shares of BP for every 10 shares of Boustead that they held. BP shares were trading at around $1.05 when they were listed. That effectively means for every Boustead share one held, approximately $0.315 worth of BP shares were given.

Boustead was trading at approximately $1.42 or so when BP was listed. Now, it’s trading at $0.79.

Even if one were to sell the BP shares immediately upon receiving them, and receive the $0.315, overall, it’d still have been more profitable to have sold the Boustead shares instead of collecting the dividend in specie.

Of course, this is a simplistic way of looking at it. The troubles in real estate and O&G has only intensified since then, but the demerger, at least up to now, has not proven to be value accretive to Boustead shareholders.

Energy Related Engineering Division

The figures say it all. This division has suffered the most in % terms. Revenue has dropped by 33% but PBT tanked 73%, indicating that margins have been eroded badly in FY16.

Boustead has managed to secure $95mil worth of orders in FY16, although this, together with last year’s $105mil, are considered the low end of the spectrum when comparing previous years’ orders secured.

Boustead’s strategy with regard to this division has always revolved around targeting the higher margin, higher expertise type of engineering, while outsourcing the easier but low margin work such as manufacturing. In this way, they can maintain their margins while growing “quality” earnings.

As with my earlier analysis on Hock Lian Seng, I generally favor companies who focus on their margins. In my experience, it’s easy to grow “low quality” earnings. Most companies can increase earnings to a limited extent by cutting prices and increasing volume.

The companies who can focus on high value, high margins work which require certain expertise or competitive advantages, are the companies that competitors will find difficult to dislodge.

There isn’t much else to analyse here, everything’s pretty much expected: O&G sector is getting killed right now.

Cuts in capex by all major O&G producers = less spending on supporting industries

I don’t think this is going to correct itself anytime soon, at least not within 2016, and even when energy prices pick up, it typically takes some time before the O&G players start to ramp up capex and this flows down to Boustead. In short, this division is likely to suffer for some time to come.

Geo-Spatial Technology Division

This division involves the distribution and support services of the ESRI technology system, which is a geographic planning system utilised by institutions and governments for planning infrastructure and other city planning.

It is used mainly by the governments and MNCs in SEA, particularly so in Australia, which accounts for their largest contract win to date for this division.

Now ESRI has a strong competitive moat, simply because of the “stickiness” of planning softwares. Imagine having had all the planing done on this software for the last x number of years. To switch now would be a huge upheaval. Staff would have to undergo training, there would have to be data porting and back up, and in many instances, the data involved is sensitive and confidential data.

Why would an existing client switch? Unless there are really really strong reasons to do so, existing clients would likely stick to ESRI, even if ESRI demands a slight premium to it’s competitors. This is certainly a durable competitive advantage.

In response to a question regarding the likelihood that Boustead would lose the ESRI license in Asia, FF Wong said that it’s highly unlikely as Boustead has been representing ESRI for 40 years and has a very solid relationship with them. Also, Boustead holds the franchise for several countries including Singapore, Bangladesh, Australia etc and has been amongst the top performers globally within the ESRI family. Hence, he believes it is unlikely they will lose the franchise.

Hence, the geo-spatial earnings continue to be rather resilient. The y-o-y drop is accounted for mainly by forex risks, as USD has continued to strengthen against both SGD and AUD.

AUD is the currency that Boustead receives the bulk of the revenuve , SGD is the currency that Boustead reports in and USD is the currency that Boustead buys inventory in.

Additional Considerations

FF Wong, the main driving force behind Boustead, is a very shrewd and capable man. I wont be elucidating on this here, but anyone who bothers can read about what he has done prior to Boustead. This guy is someone whom I’ll trust with my money if he says he’s doing a startup selling ice to Eskimos. He just makes things work.

However, that’s a risk too. At 70+ yrs old, he no longer has time on his side. IMO, a Boustead without FF Wong is likely to be considerably weaker. There’s no replacing a Messi in your team.

Aside from the key man risk, another point to note is that aside from the large cash hoard that I have described in Part I, Boustead also has a MTN credit facility of up to $500mil.

In other words, Boustead really has kept it’s powder dry and is likely able to capitalize on distressed sales if the downturn intensifies. This is the true mark of a powerful capital allocator.

My personal experience with Boustead

I initiated a small position of approximately 50,000 shares in Boustead back in 2012 at around $0.85 or so. At that time, it was the most richly valued stock I own and the only stock that was > 1.0 times of book value, which is why my position is not large.

Having a strict “Graham” philosophy, I resolutely refused to pay any higher, despite my initial analysis of Boustead being very stellar and a fantastic company.

Since then, the share price has gone ballistic to as high as $1.93! I watched and rued the day when I was pondering going big into Boustead, but kept refusing to pay a higher valuation. As the share price kept soaring, I kept wishing it’d just come down.

4 years later, the share price has now tanked, mimicking the general downtrend in O&G and industrial properties.

My Conclusions

I have no doubt that Boustead is one of the best managed companies that one can find in SGX. The management has strong integrity, and the company is one of the most transparent and shareholder friendly companies in my experience.

As optimistic as I am about the strengths and the intrinsic value of the company, I do not think now is the right time to start going into Boustead in a big way.

The 2 main engines are unlikely to start revving anytime soon. Energy is likely to stay depressed for at least another year, and the industrial property segment has just started to dip in the last 2 quarters.

USD is also likely to remain strong or strengthen further compared to SGD or AUD. In short, Boustead will continue to swim against a strong current.

All this is on top of what I view as a highly risky global state. The low credit environment for the past 7 years has made everyone complacent. I am generally very cautious at this stage, preferring to demand a very wide margin of safety. This caution may cause me to miss the boat on some big investment gains, but I think it’s the wiser thing to do in this current global environment.

I’ll be keeping 1, probably both eyes on Boustead though. I’ve missed the boat to get into Boustead in a huge way once, really don’t wish to miss it again. This becomes even harder to analyse as I’ll have to monitor BP as well, and at any 1 point of time, decide which has more value, before allocating capital.

While I’ve no intention to buy Boustead in the coming months, I’ve absolutely no intention to sell either. If the share price continues to drop, and valuations get even more attractive, I’ll be ready to pounce.

My most intelligent educated guess, is that Boustead’s share price will bounce along the current 5 yr lows (around $0.70) without going too much higher or lower, for quite some time to come. I use the word “guess” as it is a fool’s game to try to make such a specific prediction.

In the meantime, I’ll be paying attention to how Boustead utilizes it’s cash, and the types of acquisitions or deals it makes with them. Stay tuned.