Hock Lian Seng Group

Present From Hock Lian Seng – An Unintended Trade

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“Trade”.

That’s a word that you don’t commonly see on SG TTI. Since when am I in the business of trading?! But 2017 has started well for me. Mr Market is unusually generous.

This is a company that I’m very familiar with, and I’ve previously wrote several posts about HLS, from accumulation, my thoughts, till my divestment and even post divestment.

I’ve previously said I’ll continue monitoring the company and my view of HLS is still immensely favorable in the long run.

Well, in early Jan, literally on the 1st trading day of the year, I took up a moderate position in HLS, buying 4 blocks of 50,000 on 4 separate (almost consecutive days) at $0.38, $0,375, $0.385 and $0.38 respectively, for a total of 200,000 shares at an average of approximately $0.384.

Barely a week+ later, I sold out 100,000 yesterday at $0.425, and the remaining 100,000 today at $0.44.


So what happened? Afterall, SG TTI is not known for grandiose claims of fancy TA. Nor is SG TTI known for having conducted power trades to earn eye popping figures in short time periods. (If you haven’t caught the drift, I’m being sarcastic. I don’t think anyone can do this CONSISTENTLY over a long period of time)

The short answer is, I got lucky. Plus, I like to think that I understand HLS almost as well as I know my 2 kids at home.

32) Portfolio 25052016

RATIONALE

My initial rationale is actually mind bogglingly simple. HLS is due to report FY16 earnings sometime in end Feb.

My current expectation is that they’ll declare a dividend of either 2 or 2.5 cents (2.5 cent dividend was declared in FY15)

Even based on a reduced 2 cent dividend, that’ll work out to be a yield of 5.5% or so, which is pretty good since I’ll only have committed capital for probably a few months. And if it’s 2.5 cents, the yield becomes 6.6%. And if you annualize it, the actual yield is much much higher (prob above 10%)

The thing is, I don’t even intend to collect the dividend. 

I noticed that because of the fat juicy dividend payouts in FY14 and FY15, HLS tends to attract a lot of funds just before FY results announcement. These guys are probably thinking of collecting a nice yield in a relatively short period of time, like myself.

So my simple game plan is to enter before the crowd does, and exit before they do as well, which is probably a sweet spot between release of FY results and just before the div ex-date.

For me to be early, I figured that I can’t just wait till results are released. I can’t even wait till results are going to be released. I’ve to be a month or more early.

All that is my simple thought process, and perhaps, a little influence from my previous years of experience holding HLS.

Well, this week has turned out to be profitable, much much MUCH sooner than I expected.

I have no idea why the share price went ballistic this week. Many people are speculating a ton of reasons, personally, any thoughts regarding the reasons, that I write here, would be just that as well: speculation.

Unlike the general opinion though, I actually DON’T think it’s a new contract win. Knowing the company as well as I do, I just don’t think that’s the reason.

Best guess? Well, it’s the reason I’ve mentioned above. People/Funds are expecting a bumper dividend and hope to get a nice yield in a short period of time.

1 thing I’ve noticed though, it used to be that people buy in expectation of collecting a nice dividend yield. The problem is, as more and more people do that, the drop in share price right after ex-div, is pretty much = to your dividend yield.

So more participants try to run ahead of the curve and buy earlier and sell just before ex-div. This cycle keeps getting earlier.

I’m honestly caught by surprise. I’m not expecting the sharp rise so early. Obviously I’m not complaining.

Anyway, I’ve sold out everything yesterday and today for a total gain of around $9.5k. Which isn’t a lot but for a holding period of 2-3 weeks…….

I actually think it has run too far ahead of itself. I mean, if I bought my shares at $0.38 for example, and if I expect a dividend of say $0.025, and of course I’ll add in a bit more leeway because there’d be some accumulation, some excitement, so I’d think the share price, inclusive of the effect of dividends, should reach say $0.415 or $0.42? At $0.44, it does seem like something else is brewing aside from my simple hypothesis of yield. Or maybe I’ve underestimated the excitement of the markets.

Maybe it’d continue to rise next week.

Maybe HLS will really announce some ground breaking deal that makes me kick my own balls for selling out.

Maybe some major fund will buy even more next week and the share price shoots through the roof.

I don’t care. It’s not my game. It turned out well enough, I got lucky enough. That’s it.

I’ll continue to be an interested, albeit not currently vested, party to HLS’s happenings.

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My Thoughts On Hock Lian Seng 9M16 Results

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Hock Lian Seng kicked off the local earnings season for me, and they’re even kind enough to do so on a Friday so that I would’ve more time to analyze it leisurely.

To top it off, HLS’s financial results are my absolute favorite to analyze: It’s “clean cut”, they mention the reason for the changes for every item as best as they can, the business is relatively easy to understand and there are no fancy, techie type of words that make my simple brain pause and make me re-read it a few times to try to understand (re: my previous post about S i2i)

On a related note, some time ago I read a study that indicates that companies that release earnings results earlier, tend to outperform expectations compared to companies that release them later.

The study was retrospective and the conclusion is that “p” is significant aka meaning that the results of the study are valid. That’s just a thought that I’ve kept in mind ever since.

I went back to re-read some of my earlier thoughts to see whether it needs to be changed/updated. Thus far, nothing major has changed:

Updates on Hock Lian Seng Holdings (Post-Divestment) – August 2016

Hock Lian Seng – Staying a step ahead of Analysts

On a somewhat related note, I’ve often been asked in emails, about how does one go about analyzing a financial statement. I don’t really have a step by step process kinda answer to that. I think the best way is just to be guided by common sense, and dig deeper to answer each question that pops up in your mind.

It’s like asking a detective how does he go about solving mystery crimes. There’s a very broad structure (go gather the evidence, catalogue the evidence, roundtable with colleagues to discuss, spread the workload, compare results, identify potential suspects blah blah)

But the way to go about it specifically at each step, certainly has to be guided by one’s own thinking and questioning.

Let me use HLS’s FY16Q3 results as an example, because it’s financial statements are easy to read and understand.

Here, take a look:

financial-statements-and-related-announcement-for-the-financial-period-ended-30-september-2016

One can glance through it, and be done with your analysis in something like 10mins. Then you’d have no competitive advantage over the markets.

But if one thinks logically about each step, the thought process and the thinking involved, as well as the subsequent digging to find answers, will probably take you hours. Perhaps even days if one is so adventurous.

Let me illustrate:

Income Statement

Here’s HLS’s FY16Q3 income statement:

289-hls-fy16q3-income-statement

At 1st glance, it’s not a pretty sight. Net Profit has dropped 26.3%, but that’s not the worst part. The worst part is the gross profit has dropped even more, by 69.6%, with the results being helped by the “Share of results of joint venture”, aka The Skywoods condo project.

The results are inline with my previous expectations, and should not be a surprise to any serious HLS shareholder.

We can expect that for the FY2016 results, the headline news though, wouldn’t be nice. I don’t think the share price can rise substantially with headline news reporting “……. Earnings slumped 27% y-o-y”

But all these thoughts are too simplistic. Let’s dig deeper:

Revenue dropped by 43.3%, Gross profit dropped by 69.6%, Net profit by 26.3%.

But wait! FY14 and FY15 results were boosted massively by “one-off” revenue and earnings from their Ark@Gambas and Ark@KB projects. So comparing it y-o-y like what the financial statements have done, really doesn’t tell us anything. Of course, it has dropped, what’d you expect?

What’s more accurate, is for us to analyze the normalized results, without these “extraordinary items”. Don’t forget that the revenue and profit recognition via the “Completed Contracts” method, is largely an accounting measure.

It doesn’t reflect what goes on in real life, on the ground.

So what’s more accurate, is to compare the results to that of FY13. With that, I drew up the FY13Q3 results to take a look:

290) HLS FY13Q3 income statement.jpg

Revenue in “normal” years, at this 9M stage, was $68mil in 2013 and $77mil in 2012.

This means that HLS’s current $85mil is actually rather impressive!

On top of that, 9M2013 revenue was boosted by a $7.6mil contribution from “Investment properties” aka their worker’s dormitory, which is no longer present now in 9M2016.

So, in short, the revenue that the civil engineering segment rakes in now is >>> in “normalized years” 2013 and earlier.

Perspective huh. Suddenly, the 43.3% drop in revenue in 2016… doesn’t look too bad afterall.

Well, here I’ve to temper any enthusiasm. The headline news is NOT going to be perspective. And whether one likes it or not, the news moves the share price.

Because not everyone is a value investor, and not everyone is going to spend their sat evenings peering at HLS results till 1am. But that’s not a bad thing. Otherwise, deep value investors like myself would’ve to find another hobby.

Alright, so now we’ve established that HLS’s civil engineering arm is actually not doing too badly, and considering that’s traditionally their main business, surely that’s good news.

The next logical part, is to assess their margins. I’ve mentioned in many earlier posts, that I view that as their competitive edge. And there’s not too good news here.

9M2016 Gross margins are 11.34%. I use gross margins first, to negate the effect of The Skywoods contribution, which is also one-off and extraordinary (yes, it lasts a few quarters because it’s POC method but as I’ll show later, my best guess is that it’s mostly over by the next quarter) (Also, if you find that you don’t understand some terminology in this post like “POC”, pls go read some of my earlier HLS posts)

In contrast, 9M2013 Gross margins are 30.62%. 9M2012’s is 26.93%. I further compared to Full Year Gross margins, just to iron out potential lumpy revenue recognitions quarter on quarter, and the results are outright ugly.

291) HLS GPM results 05112016.jpg

HLS’s current 9M2016 gross margins of 11.34% is the lowest amongst all the data I’ve compiled.

The only slight positive is that it’s risen from the 5.47% for 6M2016 and that it is higher than the civil engineering segment gross margins for 9M2015.

This is basically what I’ve predicted in my earlier posts, and one of my main reasons for divesting: the decimation of margins, which is why I vested in the 1st place, and the likely drop in earnings for 2016 and 2017, compared to prior years.


Alright, just to recap. Now we know that the revenue, although it looks bad currently, is actually… not too bad. The civil engineering segment is growing revenue-wise.

The bad news is that, the even though it’s raking in more $$$, it’s keeping less of it. Margins are much weaker than before, and it’s to be expected. The whole construction industry is working on razor thin margins, trying to bid for projects now. All the manpower issues come to mind too.

And, to put things in perspective, over the years I have analyzed many construction companies. 11.34% is actually very impressive if you compare to other peers.

It’s like if Ronaldo scores 15 goals in a single season, the fans are going to get on his back, the news will say he’s a goner, probably many pundits will analyze if he should just retire.

But 15 goals a season in many other teams, will probably mean you’re the top scorer. Again, perspective.

Alright, let me move on.

As we can see in the financials above, the 9M2016 results were boosted by a $10.7mil “Share of contribution from a joint venture”.

This is VERY significant. Why?

Not only is it significant in quantum terms ($10.7mil contribution when the net profit is $18.6mil), the profits from The Skywoods are already taxed at the joint venture company level, so this means that the $10.7mil flows directly down to the bottomline!

Again, guided by simple logic, seeing 9M results are so heavily reliant on a boost from The Skywoods contribution, the next question that any analyst would have to think about, surely must be: “How much more is The Skywoods joint venture going to contribute to HLS in the coming quarters?”

Makes sense right?

Again, based on logical reasoning, to know how much more the JV will contribute, one has to know what’s the approximate profitability of this project. Then one has to track the amount of contribution given already in previous quarters, before one can finally try to guesstimate if The Skywoods will come to save HLS in further quarters.

OK here it gets a bit more tricky, because it’s notoriously difficult to predict the profitability. Still, some ballpark figure would be better than no attempt at all.

Some details:

The Skywoods project is a 50-50 JV. The land was tendered at S$244,318,000 on 25 September 2012. ($616 psf land cost). I’ll assume development costs to be about $500 psf. From my calculations, the ave sale price for the entire development works out to be $1,210 psf. (Got this by adding up and averaging all sales transactions derived from URA)

That works out to be a profit of $94 psf, or a total profit of approximately $42.82mil. I’m going to be generous and assume a tax rate of only 10% (it should be 17% for corporate tax rate, but in recent years there are tons of tax breaks and benefits that the JV could’ve utilized.)

That means HLS’s share of profits would ultimately be about $19.27mil.

Thus far, HLS has received $10.73mil in 9M2016, $8.01mil in 2015 and $43k in 2014 for a total of $19.17mil.

Now, obviously my calculations for the share of profits are arbitrary, but the ballpark figures would give a hint that we shouldn’t be expecting mega profits to come streaming in subsequent quarters from the JV.

Perhaps all the calculations above are redundant. Why? Simply because the project has TOP-ed in June 2016 (last 2 units sold in June 2016 too), and based on POC, we’d expect the final profit distribution sometime after TOP. It’s the 3Q now, so for sure I’ll be expecting the JV to distribute profits.

Another hint is the return of the $60mil loan from the JV to HLS, as we can see in the CF statement.

Yet another hint is that the share of profits from JV was $1.07mil in 1Q16, $10.04mil in 2Q16 and $10.73mil in 3Q16.

The massive jump in 2Q coincides with the TOP of the project.

The conclusion is that for full year 2016, I expect the contribution from JV to increase only very minimally, if at all, from the current $10.73mil i.e. most of the profits are distributed.

By extension, this also means that I can somewhat predict that the full year profit for 2016, will drop > 26.3% compared to 2015.

Now, part of my interest in monitoring The Skywoods project, is not just because of HLS. Part of the JV includes King Wan, and since the JV has distributed $$$ to Hock Lian Seng, I’m expecting King Wan to receive it’s share of the profits in this quarter too.

This is a classic example of how in depth understanding allows one to derive a competitive advantage. King Wan’s 3Q results are not out yet, but if I am pondering whether the upcoming results will be positive or negative, or how it’d perform relative to the market’s expectations, surely such information would give me an advantage in determining that.


Now it’s not all gloom and doom though.

The BS is where shareholders can find comfort:

292) HLS BS 9M2016.jpg

Just look at the amount of Cash and cash equivalents! A large part comes from the $60mil reduction in “Loans due from a joint venture”

The cash on hand works out to be about 37 cents/share. And the share price now is 36.5 cents. Doesn’t make sense isn’t it.

And that’s not even including the non-current investment securities. From HLS’s earlier releases, these securities are mostly bonds type securities, so one can argue that they are technically cash equivalents.

In short, the company is incredibly cash rich, with very minimal debt.


Finally, from a CF perspective, the company is likely to have increased it’s cash holdings a lot  for FY16, simply because of the $60mil loan return from the JV.

HLS also has a great FCF record, only having a -ve FCF year back in 2012 due to investments to develop Skywoods.

From 2010 to 2015, the FCF record looks like this:

Free Cash Flow 32,125 30,892 -187,402 27,659 108,347 12,001

CONCLUSIONS

Well, it’s similar to my previous thoughts when I divested actually. The company earnings picture will not be fantastic this or next year. I’ve previously predicted the full year earnings to come in between 4.5-6.5 cents.

It’s still on track to be within this range, but in all likelihood, I’m expecting it to be below 6 cents.

Seeing how cash rich the company is, I’m expecting dividends to be around 2 cents. Yes, lowered from last year’s 2.5 cents but we must remember last 2 years had extraordinary earnings to justify that.

HLS continues to be a company that I’m interested in, despite having divested. I’ll continue to stay updated, to understand the company better than the markets, and hopefully capitalize on my knowledge.

The main reason for this post, is not just to analyze HLS actually. Rather, I was hoping to illustrate how one can do a cursory analysis of a financial statement, vs how one can dissect a statement in detail and derive much more useful and important data.

Have no doubt about this: it is hard and tedious work. But then again, almost any competitive advantage anywhere is derived from hard work. Or pure luck.

In other unrelated happenings, I’ve just divested my tiny 90,800 shares in Libra Group at $0.192 on Friday, for an equally tiny profit. Still, I’m pretty pleased to have divested at a profit, seeing how the general markets have performed.