In Part I, Centurion Corporation Investing Thesis Part I, I’ve mainly described Centurion’s industry characteristics, as well as the characteristics of the company.
Let’s take a closer look at the financials of the company:
Centurion did well growing their topline over the past 4 years, with revenue growing at a steady clip. As of 9M16, Centurion’s revenue has already hit $85.5mil, compared to $76.3mil for 9M15.
If we look at the profit attributable to equity holders though, that has fallen sharply in FY15 compared to the 2 prior years.
Why so? Why is the company raking in more $$$, but keeping less of it?
The answer lies in all the operational and interest expenses in between:
The company conveniently groups the COGS, distribution and administrative expenses together in their AR (something unusual). I guess this applies well for the company because well, what exactly is the COGS for a dormitory operator?
Anyway, if we see it in it’s totality, for FY12-FY14, the sum is fairly stable at $44-$46mil ++
In FY15 though, this figure shot up very rapidly to $57.4mil, and this is the reason for the sharp drop in EPS, despite increasing revenues.
As of 9M16, this figure has continued to rise to $59.1mil, and as it stands, already exceeds the expenses for FY15!
Why the ballooning expenses?
From the table, we can see that this is attributable to the rising administrative expenses, as well as the massive finance expenses, which stands at $15.9mil for FY15 and as of 9M16, is already $16.5mil.
From the data, we know that the company is fast expanding, but the costs of doing so are expanding just as rapidly.
There are positives though, if one were to peer hard enough:
Despite all the expenses, the company still enjoys crazily high margins at every level.
Taking the traditional metric of NPM based on the earnings may not be suitable for Centurion, as the company recognizes a lot of fair value gains on the dormitories it holds. Instead, we should strip away all the extraordinary, non cash gains to derive a more accurate picture.
Even then, the “true NPM” (as I term it), stands at a massive 30+%! This would be higher than many other business’ GPM…
Another positive that I’ve gleaned going forward, is more obscure:
The company has consistently amortized its goodwill/intangibles to the tune of $4.9mil annually. (see the table 2 diagrams above)
As of 9M16, as it stands, the BS holds only $3mil of goodwill:
This means that in FY17, the reduced amortization will provide a small tailwind for the company’s earnings, and in FY18, as it stands, we can expect 0 amortization with a resulting $4.9mil boost to earnings.
Moving on to the balance sheet, the company has boosted it’s investment properties portfolio massively, at the cost of taking on more debt.
Total debt has ballooned as the company took on more debt to acquire land and build dorms.
This is currently, IMO, the biggest factor holding back investors.
There is real, valid concern about the debt currently, simply because we do not know how the forward picture would look like in terms of demand for the dormitories.
If the company hits a rough patch, and the demand for it’s dormitory beds suddenly dry up, the debt would become a real headache to service.
On a +ve note, Centurion’s management understands this, and has been trying to allay concerns. Their outstanding $100mil worth of notes were redeemed in Oct 2016, and hence we should be expecting the total borrowings to be cut substantially when FY16 results are released.
Even then, the company is not out of the woods yet. It’s cash holdings of $116.3mil as of 3Q16 will be slashed to a mere $16.3mil since the company paid off $100mil worth of notes. (Assuming no new loans/status quo)
The total borrowings though, would only drop from $$705.1mil to $605.1mil after the repayment, although $559mil of this $605.1mil is non-current.
Owing debt of $605.1mil, when you hold only $16.3mil in cash, is certainly not very comforting is it?
To add to the uncertainty… and this is something that I believe the vast majority of investors do not understand, the $891mil value parked under “Investment Properties” isn’t the true value of the properties!
Why do I say that?
Well, this took me a long time to understand and figure out actually. We all learn something new once in a while.
Centurion capitalizes part of it’s finance costs.
This is taken from page 82 of AR 15.
As we can see, part of the borrowing costs annually are “capitalized in investment properties”.
This is mostly an accounting manoeuvre.
Basically what this means is that of the $18.8mil of interest expenses for 2015, Centurion recognized only $15.9mil as a business expense, and parked $3.6mil under “investment properties” as a future asset to be capitalized in later years.
Ditto for the prior years.
What are the accounting rules that determine how much gets capitalized and how much gets expensed?
Interest costs that are directly due to the land acquisition, construction or production of the dormitories are capitalized. All other interest costs are expensed in the period that they are incurred.
This is because the interest costs are treated as part of the costs of acquiring or bringing the particular asset to an operational state.
Think of the capitalized interests costs as a “goodwill” within the investment properties. Hence my statement that the figure doesn’t reflect the “true” market value of the properties.
Now, all this is rather arcane for someone like myself who is not accounting trained, and I took a long time to understand this. Actually, a quick check with an accountant friend of mine revealed that even accountants may not understand this either.
I wonder how many investors would really understand this point. It may sound simple now, but it took me quite some time to figure out what exactly is happening and why the company is delaying some interest costs to later years, and finally, why this cost is parked under investment properties.
Anyway, the next obvious question that should pop into anybody’s mind now, is that, exactly how much of this $891mil (that’s in FY15. As of 9M16, the figure is $937.5mil!) is made up of “capitalized interests”?
There’s no breakdown given in the AR, hence I queried IR, who obviously cannot handle such a specific and detailed question. IR passed on my queries to CFO, who basically said that yes, I’m right, it’s parked under Investment Properties, but no, we can’t give you a breakdown. That’s it.
Ah great. I hate hitting road blocks.
So, as it stands, I’ve illustrated how Centurion’s business enjoys nice fat margins, and the company is growing topline rapidly but keeping less of the cash due to cash drain from interest and administrative expenses.
I’ve gone through some of the specific accounts, and we’ve also seen clearly how the debt is a big eye popping question mark currently.
The next logical question is, is this debt sustainable/serviceable?
The answer to this question, obviously lies within the cashflows. Cold hard cash that they company’s cash generating business must create.
And since the company holds (projected) $16.3mil of cash whereas debt sits pretty at $605mil, we know that the company BETTER have some nice cash generation going on.
Fortunately, Centurion’s FCF are pretty reassuring:
FCF +ve in the past 4 years.
Also, in this nice table, we can see the amount of $$$ that goes into “Additions to investment property”.
Of course, the way I’ve described it may be a bit simplistic.
In reality, I think the company will constantly “roll over” debt maturities with the bank, using the investment properties as collateral. So although total debt is high, practially all this debt is secured debt.
In scenarios like these, the key question then is, will the CFs generated from the assets pay for both the interests expense, as well as pay down the capital? Or is it enough to pay down only the interests?
Think of it from the angle of personal finance:
If you bought a house and rent it out, is:
- Rent < Interest
- Rent = Interest
- Rent = Monthly Instalments (Interest + Part of the total loan)
In scenario 1, you’ve a big problem
In scenario 2, you’ll look good for a while, and after that the story can turn real bad. Scenario 2 is basically reminiscent of the interest-only subprime loans given out prior to the GFC. It can work…. if the value of the underlying assets keep appreciating unabated.
Scenario 3 is what any prudent borrower has to do.
Therein lies my concern about the debt. This brings me all the way to my point right at the start when I mentioned that the debt is the greatest concern.
If “rent” drops, or interest costs rise substantially, scenario 3 can quickly deteriorate to scenario 2.
“Rent” aka dormitory fees, have ALREADY dropped. Competition is strong, and the Westlite brand currently sits in a sweet spot in terms of fees, charging a bit higher than the norm, but not the most expensive. Occupancy rates are thus still well supported.
As for the other part of the equation, interest costs, well I am not a global macro kinda guy, but almost everything I’ve read points towards rising interest costs.
Valuations wise, Centurion is certainly undemanding.
Currently, the company trades at 0.6 times book value, with a PE ratio (based on true earnings) of 6.8 times.
Centurion gives a full year dividend of 1.5 cents, and that works out to a yield of 4.7% based on the current share price of $0.32.
ROE figures have dropped in line with the drop in NP in 2015, as well as the expanded equity base.
One big negative for potential investors, IMO, is the outstanding warrants. The company currently has 75.6mil warrants outstanding, each with an exercsise price of $0.5 for each share. The warrants expire on the 17th Oct 2017.
Looking at all the factors and figures I’ve discussed thus far, my immediate thoughts are that I wouldn’t want to buy any shares above $0.5. With all these considerations, it doesn’t make sense to get diluted by warrants getting exercised. I’d rather wait till they expire in another 10 months.
These warrants act as a “cap” on the share price right now. Once it crosses $0.5, you’d have a huge chunk of dilutive shares coming onboard. Of course, the share price is not exactly close to $0.5 right now.
In any case, the warrants are currently non-dilutive. I still don’t understand the company’s rationale of issuing such warrants though, it didn’t seem to give the company any benefit.
We certainly cannot fault Centurion’s management for not having vested interests though.
Centurion is very heavily owned by it’s management. The substantial shareholders are all insiders:
On top of that, the company carried out several rounds of share buybacks in recent years.
Despite all the buybacks though, the share price has continued falling, albeit at a slower pace.
In Part III, I’ll conclude by discussing the forward picture for Centurion, including my view on the prospects of the business and the industry.
Please let me know of any thoughts that you might have, either via email or the comments section below.