In this final part, I’ll aim to be more prospective. In the 2 previous parts, the view was more retrospective: an analysis of what went wrong and how it developed. There’s no point in crying over split milk though, now I’ve got to figure out what lies ahead.
KW is IMO, best analysed with a SOTP (sum of the parts) analysis. There’s not much use in utilizing CF models as everything that has gone wrong with KW thus far, is confined to it’s “investment holdings”.
As we have seen in Part II, the core business is still doing well. The key question is: Have we seen the worst in the investment holdings part? Are there any more hidden bombs? Any more writeoffs to come?
Firstly, let me try to figure out how much I’d pay for KW’s core business (minus all the investment holdings losers). In the analysis, we’ll assume KW’s share price is $0.185
As of KW’s latest Income Statement (FY16):
The “Other operating income” of $3.3mil includes stuff like interest from associates, income from financial guarantees etc.
I’m going to take that all out and assume the associates do not exist. That leaves us with $1,280,645 (see Page 77 of AR 2016)
We’ll ignore the “Other operating expenses” as that relates mostly to all the write offs from Dalian and the KTIS stake. Let’s also ignore the “Share of loss of associates“.
All that leaves us with a net profit of $7,061,941, which works out to a EPS of 2.02 cents. (I kept the income tax expenses and finance costs constant for simplicity sake). This means the PE ratio would be 9.2 (Based on share price of $0.185)
That’s not exactly a bargain type of valuation, but not expensive either.
This means that assuming all the investment holdings do not exist and do not contribute any profit (or losses for that matter), the PE would be 9.2 assuming the share price is $0.185.
Let’s study KW from a BS valuation perspective.
Trade receivables – These receivables relate mainly to KW’s core M&E business. KW typically sets aside $1.7- 1.8mil amongst this trade receivables for doubtful receivables, of which around $100k or less is written off in 2016 and 2015. (Page 58 of AR16). $650k was written off in 2014 and $0 in 2013. I’m going to take this figure as it is in the BS since the writeoffs historically are not that significant.
Other receivables and prepayments (Current) – This is where the complexity starts. Collectively, KW has $84.5mil worth of receivables from associates, of which $48.4mil are current.
This $84.5mil worth of receivables is AFTER the $12mil write off in FY15 and the $11.8mil write off in FY16.
The key question is: Will there be more write offs from this $84.5mil worth of receivables?
The current portion of the receivables has increased by $48.2mil from FY15. While there’s no break down of this current receivables, I can intelligently guess that most of it comes from the Meadows Bright associate (dealing with The Skywoods condo), since the project TOPs in 2016, as well as from The Starlight Suites project.
How do I “intelligently” guess this?
Well, cos this is the breakdown of the non current receivables just 2 quarters ago:
The $44.4mil then, which was non -current, would’ve been shifted to the current portion. The figures approximately add up.
This is a crucial point. If this current portion of receivables ($48.4mil) is fully collected this FY, it will immediately relieve KW’s BS greatly.
On the other hand, if there are more write offs to come, some will almost certainly come from this “Current portion” of receivables (since they’re due in the next 12mths)
Currently, I am not pricing in any write off in this current portion. It should be fully collected within the next 12 months, as The Skywoods is fully sold, and The Starlight Suites has been divested as well.
I called up a few property agents to check, and the owners of The Skywoods have just received their keys.
Recap: Alright, so far I’ve ascertained that the “current” portion of assets looks fairly solid. I’m not expecting any bombs to come from here, and if anything, upon collection of receivables, KW should be able to restart it’s dividend policy.
That in turn, should be a catalyst for it’s share price. (Baring other bombs)
Now let’s look at the non current portion because that’s where it gets interesting…
The non-current portion of assets though, is a potential minefield. Writeoffs can come almost in every line I analyzed.
The breakdown of these receivables:
1.The investment properties refer to commercial spaces in China.
This is NOT related to the Dalian Shicheng project. The loans due from the Dalian project has been fully written off, this is confirmed as well by the CFO. (BUT… the EXPOSURE to Dalian nightmare is not over, as I found out by digging deeper… ). I am not expecting any write offs to come from these investment properties. Although I do not have the detailed breakdown, from what I understand, the associates have not even fully utilized the cash yet.
I’m expecting this to be fully written off
Look at how GHD has performed. A loss of $5.6mil in 2016.
The only saving grace is that this stake is not carried in KW’s books. It’s completely written off. But come on, let’s not kid ourselves. Are we getting back this $3mil? I don’t think so.
But at least I’ve ascertained too, that our MD Chua’s sister and mum (who are the other stakeholders indirectly, in GHD) have also extended loans proportionally to their stake.
Not expecting any write offs yet. It’s still early days here and while this sector is feeling the heat, it’s hard to say until I get the next AR to scrutinize.
Available for sale investments
This relates to the KTIS stake. Since this is marked to market, trying to predict how much downside is here would mean one has to figure out how KTIS share price would perform.
After IPO, KTIS rose steadily for about 8 months, following which it went into a precipitous free fall. Currently, the share price has been making some sort of a bottom around the 7 THB mark.
Some valution metrics that I’ve calculated (based on FY16Q1 statements):
Book value: 2.27 THB
EPS in Q1: 0.01 THB (0.14 THB in corresponding period 1 yr ago)
CF doesn’t look good either. Net operating cash flow of -3.6billion THB. The company is propped up by short term loans, having borrowed 3.8billion THB in this quarter. Yet, the cash on the balance sheet stands at 352million THB.
The bulk of the current assets comprises 7billion THB worth of inventories.
This tells me that the company is capital intensive, and has been borrowing money. They probably pledge the sugar inventories as collateral for loans.
EPS in 2015 came in at 0.19 THB. I had to recheck this figure twice. Because that works out to a current PE ratio of 37! This is after the massive fall since IPO.
In my opinion, this whole KTIS stake is still overvalued. I’ve thought it to be overvalued at IPO, but am honestly surprised that even currently, I wouldn’t hold on to KTIS.
I don’t think KW management has any intention to divest though. Having seen the value of KW’s stake drop so much since IPO, the natural instinct is to hold onto the stake and hope for a recovery. My opinion differs, but from my communications with them, I don’t think KW is going to reduce their exposure.
I generally don’t bother with companies with PER >15. (Boustead was the 1 exception)
What all this means is that even after this massive fall, there may be yet more write downs from KW based on marking this KTIS stake to market. Ouch.
Investments in associates and a joint venture
The one saving grace for KW is that most of it’s direct equity investment in associates has been written off. The only direct stake that is carried in KW’s books currently are the Nexus associate (Dealing with the dormitory project) and the Meadows Bright (Dealing with The Skyoods), both of which are good for the money.
I’m not expecting any write offs from here.
Unfortunately, it’s not just a simple matter of looking at the balance sheet of KW.
KW is exposed to it’s investments in associates via several layers:
- Direct equity stake (not much risk here. Mostly carried at 0 as mentioned earlier)
- Loans to associates (IMO, risk of further write downs from the Vessel division)
- Loan guarantees to bank for associates to borrow money
It is this 3. that is a potential bomb.
Soon Zhou Investments. This looks like the next shoe to drop.
Earlier I mentioned that KW has written off all loans to Dalian Shicheng, and carries no direct interest in Dalian. However, KW still has a substantial exposure to Dalian via it’s subsidiary (50% owned) Soon Zhou Investments (SZI)
SZI currently owes KW $15.3mil, having recorded no impairments thus far. On top of that, SZI is spending some $36mil to buy units from the Dalian project.
KW is also exposed to Dalian due to it’s status as a guarantor of Dalian’s loans (Page 46 of AR 2016):
“The Company together with another shareholder (the “Joint Guarantor”) of the associate, DSPDS group, provided joint and several corporate guarantees to a bank for credit facilities utilised by DSPDS group for development of the Singapore Garden. At March 31, 2016, the outstanding bank loan of DSPDS group was $22,227,513 (2015: $24,500,000).
In 2016, the Company and the Joint Guarantor provided joint and several guarantee to bank for a bank loan taken by SZI group to fund part of the acquisition of properties from DSPDC (Note 3(b)(ii)). At March 31, 2016, the outstanding bank loan is $21,989,143 (2015: $Nil).
In assessing whether the Group needs to record any liability in respect of the above joint and several guarantees, management engaged an independent valuer to estimate the gross development value (“GDV”) of the properties of DSPDC which is the projected value upon full completion of development of properties which are currently partially developed or yet to be developed. The valuation also includes the market value in existing state which is the GDV less all cost to complete, marketing cost, sales tax and developers’ profit.
Based on these estimates, management expects that DSPDS group will be able to realise sufficient proceeds to repay its loan from the bank loan referred to in paragraph (i) above.
Management expects that future sales proceeds from units purchased by SZI group from DSPDC will be sufficient for SZI group to repay the bank loan referred to in paragraph (ii) above.”
To summarize that, KW is on the hook for $22.2mil worth of loans that Dalian has utilized, and another $21.99mil worth of loans extended to SZI, which is used to buy units from Dalian!
When I queried KW about their non current receivables from Dalian, the simple reply was that it has been fully written off, giving the impression that Dalian’s troubles will no longer affect KW.
By digging deeper though, it’s obvious that Dalian’s problems are far from over. KW’s management’s response as seen above, is that they have an independent valuer which has determined that based on the valuation of the completed properties, “DSPDS group will be able to realise sufficient proceeds to repay its loan from the bank loan”.
The question that pops up in my mind is, if DSPDS group is able to repay its bank loan, why can’t it repay KW it’s loan? Why must KW write off it’s receivables from DSPDS?
On top of that, KW has extended loans, and is acting as guarantor to SZI to buy more units from DSPDS. Maybe that’s why DSPDS is able to repay its bank loan… cos KW is buying these units!
Ouch. The only slight redeeming factor is that SZI is a 50% JV, so these loans and liabilities from guarantees will be shared with the other partner.
Still, I get very worried when I see deals like this. I get even more worried when KW takes much longer to reply me when I start asking tougher questions like these regarding SZI and KW and DSPDS. Why does KW management need to discuss first before wording a reply to me? Just give me a straight answer. Straight answers don’t need discussions.
1 + 1 = ?
If you’re going to answer “2”, it takes you a split second to answer. If you’re trying to convince someone the answer is really “3”, it takes you a long time to formulate your arguments and lookout for counter arguments.
1. Impending collecting of current receivables of $48.4mil will provide a nice cashflow boost. That’s something that KW needs desperatly.
2. With the collection of this $48.4mil, KW may even resume paying dividends, albeit not as much as previously. If this happens, the share price will surely correct
1. Direct loans to SZI of $15.3mil
2. Liability from guarantor to Dalian and to SZI: $44.21mil (technically it’s lesser as SZI is a 50% associate)
3. Further writedowns from KTIS stake
4. Vessel writeoff of $3mil
Now that this much is clear, I’m going to stress test the worst case scenario for KW.
Let’s assume the direct loans to SZI are fully written off, Dalian doesn’t default but SZI defaults and KW has to pay for SZI, a further 30% drop in share price of KTIS and a complete vessel writeoff.
(I assumed that Dalian doesn’t default as it is obvious that KW is backstopping Dalian, by writing off it’s receivables from Dalian, extending loans to SZI and guaranteeing more bank loans for SZI, and by buying up units in Dalian via SZI. How would Dalian default?)
This means a total write off of $15.3mil + ($21.99mil divided by 2) + (30% of $31.4mil) + $3mil = $38.715mil.
That works out to be a worst case scenario write off of 11.1 cents per share. In other words, I have established that the worst base case scenario for the NAV should be 10.8 cents.
Now let me stress test it against a more benign scenario.
What if we have writeoffs “only” from the vessel, and KTIS falls a further 15%?
The writeoffs would then amount to 2.2 cents per share, which would bring the NAV to 19.69 cents, which is approximately what the share price is right now.
Unfortunately, despite all my work in King Wan, it is still incredibly difficult to derive an accurate conclusion, or one that I have a high level of confidence in. This is because I can do all the research that’s possible, I can go deeper in my analytics than the typical guy that makes up the market would bother to do, but still, I am unable to determine if there would be more write offs, and to what extent.
I am skeptical of taking what the management says in the financial statements as they have proven to be wrong the past several quarters.
Thus, in this scenario, the only way forward is to project what is IMO a likely scenario, and a worst case scenario, to derive the 2 extreme “markers” and work from there. This is what I’ve done.
My current action right now, is likely to do nothing, hold on to my stake and sit tight. I may lighten my stake a little, but am unlikely to exit completely.
If there are future write offs, I think at some point the share price would over correct to be overly pessimistic (that’s how the world works. Swings to periods of over enthusiasm and over pessimism, with the bulk of the time being in the “normal” range).
When that happens, I hope that with my in depth knowledge of the business, I’ll have the guts to capitalize on it.
On a somewhat related note, I’ve come around to the idea of having a “cut loss” level. I have read in Michael Burry’s writings that he has a cut loss level. He tries to buy at the bottom, and if it makes a new bottom in the coming weeks, he cuts loss immediately.
While I am unlikely to have such a close cut loss level, I do think I’ve to incorporate some sort of safety mechanism like this. It’s better than having nothing right now.
While doing so will result in me losing some opportunity to gain mega profits, it’ll also eliminate the situations where I’m completely wrong and the investment drops to 0.
I’m giving the upcoming KW AGM a miss. I may send a proxy though. Any kind soul who’s attending, and has read this, I’d really appreciate if you could drop me an email or leave some comments here regarding what you’ve gleaned from the AGM.