Seems like people are really interested in what my friends have to say. My last post (Lessons From A Super Investor – A Personal Friend Of TTI) became the most clicked on post here in the short span of 2 days.
I said that probably out of the 1,000+ people who will read it, nobody would know who he is. But within the 1st day, 1,700+ people have read it and I get tons of queries about him on IN. Anyway, coincidentally, just yesterday, I saw that Bloomberg reported on yet another highly successful acquaintance of mine. I may write about that at a later stage.
But now, let me get back to my drug: deep value analysis.
As a previous shareholder of Asia Enterprises Holdings (AEH), this is a company I am familiar with. Plus it’s financials are a breeze to examine in detail, compared to some of the other companies I’ve worked on. All it took me was 2 hours of work on a cold rainy night with a cup of hot chocolate in hand, and I could dissect the Q4 results and relate it to the steel industry more intimately than most existing shareholders probably understand.
AEH was a pretty profitable investment for me, and my divestment several years back, was due to a recognition of the severe stresses the industry would likely face in the future (which is now). Basically, I didn’t like how China was churning out record amounts of steel then.
“Asia Enterprises Turns Around in FY2016 with Net Profit of S$2.4 M” This is the heading of the news release accompanying the Q4 results release. On closer inspection, I think it’s somewhat inaccurate. Not wrong, just inaccurate.
This is AEH long term, compiled financials. As we can see, the earnings really started deteriorating from FY12 onwards. Instead of the 3 cents prior to FY12, normalized EPS became <1 cent after that, culminating with a massive loss of -3.53 cents in FY15.
The steel industry has gone through hell in the past couple of years. The recent FY16 did show an improvement, closing with a 0.68cent full year EPS. So it does look like a turnaround of sorts.
However, steel prices did not rise significantly in FY16. Neither was AEH able to raise their prices, and in fact, their ASPs (average selling prices) actually dropped, albeit buffeted by an increase in volume moved:
So how did this “turnaround” come about?
As per the statement above, it came about from “a higher gross profit margin and its continued tight rein on operating overheads and expenses…”
But wait! We just mentioned that the ASP dropped, how did the company achieve a higher GPM then? In fact, if you look at the table above, GPM more than DOUBLED y-o-y!
Well, if your selling prices dipped, volume maintained, and yet you can more than double your GPM, the only logical conclusion is that the COGS has been more than halved!
I’ve previously described how the company calculates it’s inventory. It’s done via a weighted average approach:
FY15’s massive loss was largely due to a huge writedown of approximately $10mil +. See the table above, that’s parked under “Other Charges”
Well, following this write down, the inventory cost recorded in AEH’s books are now much lower than before. Which explains AEH’s much larger GPM, and that in turn explains the “turnaround”, despite industry conditions still remaining in the doldrums!
And that’s why I said it’s “inaccurate”
Essentially, AEH bit the bullet and took most of the pain in FY15 (“kitchen sinking” is the term, I believe). This allows them to look better in subsequent years.
Probably a more accurate way to look at it is the average out the EPS to iron out the massive write off. So you could think of it as AEH having -3.53 EPS in FY15 and “turning around” in FY16 with 0.68 EPS, OR you could think of it as AEH reporting -1.425 EPS in FY15 and FY16 each.
Obviously, the former scenario is a more sexy story.
AEH currently trades at 68% of the book value. It is this parameter, that seduces many “value investors”. I can imagine many value investors crunching numbers in some spreadsheet, or using some app with parameters. AEH will surely show up in such a superficial screening.
I have previously cautioned against using such a simplistic manner to invest. Trust me, I’ve been down that road.
AEH will ALWAYS trade at a discount to book value.
So it looks deceptively cheap. Let’s think about it. In industries where you typically get companies trading for long periods, at large discounts to their audited book value, you’d start to see M&As happening.
And that makes perfect sense. Cos the bigger, better capitalized players will see that hey, I can buy over these guys at pretty much book value, and grow much more rapidly than taking the organic growth path.
Yet the steel industry has practically no M&A to talk about. Zilch. Kosong. Nothing.
The reason is because these companies are worth at the extreme most, as much as their inventory. That’s all. There’s minimal differentiating factor amongst each of them. You don’t get more “branded” rebar steel to build an upmarket condo, do you?
This means that when assessing the value of a steel middleman like AEH, one has to consider a 20-30% discount to book value as the norm.
Imagine if you have the funds and you decide to buy a private steel middleman. Would you pay book value for the inventory? No! Cos if you’re going to pay book value, you might as well buy directly from the steel mills right?
If you’re buying in bulk, you want a massive discount to account for the larger capital outlay that you’re committing, the risk of obsolete inventory (yes, even steel inventory can be obsolete because some of their steel bars come in specialized shapes and sizes and may not be commonly utilized by the end clients), the opportunity costs etc.
The other minor bugbear that I have with AEH, is that the father-daughter management pair, have no qualms paying themselves relatively well, as a proportion of the profits of the company.
Yes, yes, theoretically their remuneration is decided by the Remuneration Committee and not them but I’ve already explained in earlier posts, why this is hogwash.
In 2012, their combined remuneration (not including the other directors!) is $915k. The company’s NP for the year is $1.7mil.
In 2013, the combined remuneration is $1.041mil. The company’s NP is $3.7mil.
In 2014 and 2015, they got smarter and started reporting in bands instead, putting some roadblocks in front of pesky deep value investors like TTI. Their combined remuneration ranges from $750k-$1.25mil, when the company’s NP is $1.9mil and loss of $12.1mil(!!!) respectively.
Paying yourself 1/3 – 1/2 of the company’s entire NP seems excessive.
On top of that, one item caught my attention several years back when I was a shareholder and since then, I’ve been monitoring it.
Every year, the company pays an external vendor (Penta Transport Services) a certain sum. It is a private company, but logically I am guessing that Penta transports the steel bars from the warehouses to the end clients.
This is also reflected in the amount paid to them. In years where more inventory is moved, the amount paid is higher and vice versa.
Plus it says as much in the name, doesn’t it? LOL.
Anyway, and this is not in the AR, I had to investigate this separately: Penta Transport Services is a sole proprietor business, and it’s registered business address is…
36 Penjuru Lane
Hmmmm….. does that address look familiar to you?
Well, it should if you are a shareholder. Because it’s the address of one of the 3 warehouses the company owns!
Uh huh. So the company pays an external vendor for transportation services, it is an IPT and the business is a sole proprietorship so probably it is owned by a family member. The registered business address is also that of the company’s property.
My simple question to the management , if I’m still a shareholder, is that why can’t the company set up and provide it’s own transportation services?
This is not high science. You get a lorry, hire a driver and that’s it. Why must we do an IPT and allow profits to be earned by more of the Lee family? And yes, of course it’s profitable. I don’t think the Lee family is so charitable as to have a privately owned transport business absorb some losses for the sake of publicly listed AEH.
These little tidbits of information that I’ve dug up, tells me that the father-daughter pair, do look out for themselves. They remunerate themselves well, and I’m sure they are doing a fine job at AEH and all that, but I don’t think there’s the… errr…. hmmm how do I explain this… sacrificial? type of management attitude here.
The most successful management I know, have a certain attitude towards their companies. Basically, the company is like their baby. Ask any parent how they feel about their baby and you’d know what I mean. I see that in many privately held companies, where the main guy is the founder.
It may be wishful thinking, but I do think there are some listed companies where the main guy running the show still has this sorta attitude. One has to attend AGMs, meet the people in charge and literally look them in the eye and ask hard questions to get a sense of this.
Or you could follow SG TTI and dig deep and hard for such clues.
Anyway, I did say at the start that these are minor bug bears. I don’t consider them to be big issues because well, there are many companies where the management pays themselves excessively well. On top of that, if the earnings of the company isn’t high, proportionately, the remuneration tends to look high. (Not every one is a Johnny Liu who pays himself dirt little and still performs at that level)
If the company has losses for the year, it is also not realistic to expect management to not pay themselves right? I still think it’s excessively high, but am not surprised by it.
The IPT is not surprising as well, similar set ups can be seen in many other listed companies. All that I am saying, is that if AEH is a private company, owned by the Lees, and if Penta is an external vendor not owned by their family member, AEH would probably have taken over the transportation themselves and kept the profits within the company.
This is a minor issue though, simply because the IPT figures are not high:
In short, I can’t really fault management for looking out for themselves. I don’t particularly like it, but at this stage, it’s not a big issue.
I wrote 2 earlier posts on AEH:
Back in August 2016, I concluded:
“I’ve always maintained that it’s a fool’s game to try to accurately predict share price movements in a specific manner in the short term. Still, I’d attempt to be a fool by stating that my best guess is that AEH’s share price will remain within a tight range of between $0.17-$0.19 thereabouts for a long time. Perhaps till the end of 2017.
Looking at the chart above, if one makes an investment in AEH sometime in late 2009/early 2010, you’d have seen almost no real capital appreciation since almost 7 years ago.
I’d reassess the company again if the share price approaches $0.165, before determining whether to take a position in the company.
Finally, I’d like to stress that I do not have a negative view on the company per say. I just don’t think there’s sufficient MOS at this price for me. The company may do ok, or even moderately well in the short to mid term. All I am saying is that this isn’t the deep value, contrarian opportunity that I’m hunting for. If I already own shares in AEH, I wouldn’t be selling out at this level either.”
Seems like I’m a pretty accurate fool thus far in this regard.
The share price rose very gently and practically hovered around $0.17-$0.19, and at the time of writing this, is at $0.186.
My conclusions back in August 2016, remain my opinion today.