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

As mentioned previously, I’ll continue following certain companies even after divesting them as I think my in-depth knowledge about them is a competitive advantage. Also, I believe it’s far more advantageous to understand a company very well, rather than several companies on a superficial basis. In short, quality over quantity.

I have previously explained my reasons for divesting HLS (Post-mortem of Hock Lian Seng Divestment)

To summarize, the main points that I mentioned are:

• “There are some signs that convinced me to divest. For starters, HLS has lost their dorm as the lease is up. Earnings from this dorm accounted for almost 20% of gross profit in FY12 and FY13.  That works out to be about $5mil of gross profit.”
• ” I expect HLS earnings to normalize to the 4.5-6.5 cents range.”
• “the gross profit from civil engineering has already dropped from FY16Q1 compared to FY15Q1…. I believe HLS will show margin compression compared to previous years.”
• “There are also no major catalysts to earnings from now till FY18. In the meantime, HLS has to spend money to continue to build it’s Tuas industrial project. Property development, like the property market, moves in cycles. This is the time when HLS has to invest and build, without getting any returns yet.”
• “The Shine@Tuas South industrial project will be an “investment” of sorts for HLS. They’d have to pump in resources to build, and revenue recognition is only expected sometime in 2018.”
• “I noted the bearish signal from a TA perspective… Moving forward, the trend is still a downtrend, although I think it’ll form a base around the $0.35 mark.”

With the recent release of FY16Q2 results, I went to analyze the results to have a sense of how the company is performing, and whether my predictions are on track. If they aren’t, I’d update my thoughts on the general direction of the company.

The good thing is that HLS’s financials are very easy to understand. Nothing complicated, and HLS makes the effort to explain certain movements in their balance sheet and items in their income statement.

Thus far, HLS’s financial performance, and the subsequent share price movement, is exactly how I’d anticipated it would be. No surprises here.

Earnings has dropped with the expiry of the dorm, and without any contribution from property development. EPS as of FY16Q2 is 2.44 cents, compared to 4.10 cents as of FY15Q2. This is on track to be within my full year earnings forecast of 4.5-6.5 cents.

As expected, revenue from civil engineering forms pretty much the entire revenue, with almost nothing from property development and investment properties (dorm).

The margin compression that I was expecting also came true. GPM for the civil engineering is 5.44% as of FY16Q2, vs 8.96% as of FY15Q2.

There have been no positive surprises, or catalysts in FY16Q2. HLS continues to invest in the Shine@Tuas South dorm project, pumping in $8.7mil as of FY16Q2:

Finally, from a TA perspective, HLS share price continues to fall, albeit at a very gradual pace. Since my divestment at an ave of $0.375, HLS has dropped very gradually to the current $0.320.

I have no idea if it will continue falling, but barring any major contract wins, the share price is unlikely to rise substantially in the short to mid term.

The book value has dipped slightly to the current 43.4 cents as of FY16Q2. Although the valuations currently are not demanding, in my experience, builders generally can have such low valuations indefinitely.

On top of all this, what caught my attention is the “Results from a joint venture”

This relates to The Skywoods project. As one can see, of the $12.87mil in PBT, $10mil comes from The Skywoods project. The Skywoods project TOPs in end 2016, and as this projection is recognised on a POC basis, there would be minimal or no contribution from this JV after end 2016.

This item is also interesting to me because the other partner in this JV is King Wan, and having seen such a strong contribution from Skywoods, this gives me some visibility on the contribution for King Wan as well.

It’s like many pieces of the jigsaw puzzle falling in place, giving me an idea of how the overall picture would look like.

The one potential catalyst for the share price would be an announcement of a major contract win, beefing up the order books. Here, I am not optimistic that HLS will announce any major contract addition though.

Although the order books has dropped from $450mil in FY14, to $382 mil in FY15 and finally to $330 mil currently, HLS has seen years with much much lower order books.

History of order books for civil engineering projects (year end)

FY10 – $350 million

FY11 – $227 million

FY12 – $130 million

FY13 – $48 million

FY14 – $450 million

FY15 – $382 million

From my experience in years of analyzing this company, HLS is a different animal from other typical builders. They focus on maintaining margins (which is what I loved about them in the first place), and are financially prudent.

However, this means that there will be troughs in the cycle where HLS suffers from a decimated order book, and instead invests for the future while awaiting projects which require their expertise and that they can capitalize on by demanding certain margins.

If you look at the share price chart since 18 mths ago, it sure looks like HLS has formed a bottom:

A word of caution for those who may try to bottom fish, if one looks at the big picture though, HLS suddenly doesn’t look like it’s that cheap anymore:

OTHER INDICATORS

As of FY16Q2, the net of “contract work in progress” has turned negative.

The net work in progress is now -$5.6mil, compared to $10.3mil 6 months ago. This means that HLS has billed ahead of what they have completed building. This will have to be built in the coming quarters with no further billings / contribution to earnings.

Yet another indication of this “reinvesting” phase that I speak of is this 1 line in the statements:

“Increase in prepayment of $1.1 million was mainly relate to the advance payment of a land parcel acquired for construction of workshop for own use. The acquisition would be completed in August 2016.”

I consider this capex in nature. Meaning HLS has to invest to build up infrastructure, which would eventually somehow add to their earnings in future. Again, it does mean suffering in the short-mid term though.

CONCLUSION

Thus far, my initial hypothesis that the property sector moves in cycles and that HLS is currently in the “reinvesting” phase, stands true. There are no visible catalysts on the horizon, and I think the earnings will either drop below my predicted range after FY16 (without The Skywoods contribution), or barely maintain in the 4.5 – 6.5 cent range (I’m expecting contribution from  Civil Engineering projects to pick up as the projects enter the “active” phases).

The risk:reward profile currently remains unfavorable for me to reinvest in HLS. I’ll be looking out for contract wins, but from the current industry climate, and from my understanding on the profile of projects that HLS goes for, I’m not expecting any such announcement anytime soon.

As yet, I’m staying on the sidelines while waiting for the markets to recognize these headwinds, and for the share price to accurately reflect that.

Again, I’m constantly reminded that my focus (which has only been rather recent, in 2015 actually), is now on DEEP VALUE and on CONTRARIAN situations. Only longer term data will tell if this approach is truly successful for me.

My Thoughts On My Current Portfolio – July 2016

BBR Holdings

Since my previous post on increasing my exposure to BBR Holdings (BBR Holdings Investing Thesis) at prices between $0.165-$0.174, the company now has a new substantial shareholder: Dr Chiu Hong Keong

A quick google search would reveal him to be the founder of Pintaras Jaya berhad, interestingly, a piling and construction company listed in Malaysia. BBR’s top shareholder lists include several construction companies.

In my view, this can only be a good thing. Why would competitors take up individual stakes in your company with their own personal money otherwise?

BBR’s share price has also risen since my last bulk purchases. At the current price of around $0.185, the gain is approximately 10%  or so. Not something to be scoffed at time-weighted wise, as it’s only been 1 month or so.

Still, the volumes are too thin to be indicative, and anyway as a deep value investor, I’m looking for much much larger gains to justify the time spent analyzing.

Looking forward to the financials coming up in the next few quarters. If there are no surprise losses from the general construction arm, the gains should be quite substantial.

Boustead Singapore

Nothing much to say or add here. Boustead’s CFO, Mr Loh Kai Keong, just won the best CFO at the SGX Corporate Awards 2016, following in the foodsteps of FF Wong, who won the best CEO award back in 2009.

I don’t spend much time updating myself on Boustead’s activities. With FF Wong at the helm, I just trust his investing acumen. This guy’s track record is not to be scoffed at. He has proven to be value accretive, and most importantly, guards the company’s $$$ like his own.

It is telling that ever since the company introduced a scrip dividend scheme, I have not taken the dividends in cash, but instead permanently opted for scrip.

To paraphrase WB: I don’t think it’s my business to be telling Messi how to play soccer.

CDW Holdings

Again, not much to add here. CFO has previously answered all my queries. I’m eagerly awaiting news of how the latest guide panels are doing. There should be more info on that in the upcoming quarterly results.

Until then, I’m sitting tight in this position, without increasing or decreasing it.

Dutech Holdings

This is another company whose management I respect a lot. I have previously spent a lot of time analyzing hard, quantifiable data. I enjoy doing it, and it’s how my brain works. However, increasingly, I’ve started to realize that soft data like how strong is the management team is actually equally as, if not more important than data alone.

However, after the massive run up, I am not adding to my position. I haven’t reduced either, but will be monitoring the upcoming results.

I’d like to see more data that the integration of their acquisitions is proceeding smoothly. Dutech has grown by acquisitions in recent times, and the key thing with acquisitions, is to prove there’s synergy and show results from cost savings, cross selling products, sharing of client base etc.

Hock Lian Seng Group

Since my divestment, the share price has languished and remained largely flat. This is what I predicted based on both FA and TA (Post-mortem of Hock Lian Seng Divestment, Hock Lian Seng – Staying a step ahead of Analysts). I’m pleased with how this investment has turned out, as I can literally feel a direct correlation between the amount of work and the level of understanding, and the accuracy in predicting/guessing how the share price would react.

I’ll continue to study HLS’s financials, but I am unlikely to take a position again anytime soon.

King Wan Corporation

Obviously I’ve been occupied with this of late. Part III is still pending. The next step for me is to figure out what to do and this is turning out to be much much tougher than I expected.

CFO has been trying to answer my questions, but each time as I delve deeper and ask harder questions, I uncover more and more potential problems. At least now I know for a fact, that MD Chua Eng Eng knows of a number of shareholders (most certainly myself), who are not very pleased with her.

I hate to create trouble. I hate the limelight, and I value my anonymity greatly. My sole interest is to see the companies I have invested in, create value and do well. Unfortunately, in this instance, the management actions are so asinine that it really boggles my mind.

It’s very unlikely that I’ll go down this route, but I’ve done some back of the envelope calculations and with my capital, together with other deep pocketed investors’ capital that I do not directly control, but can strongly influence, and perhaps even adding in other disgruntled minority shareholders; together the position is sufficient to create some real problems for management.

Libra Group

Again, not much to add here. Just awaiting the next quarterly results. Mr Chu Sau Ben has articulated many grand plans for the company, it remains to be seen whether he can execute them.

Meanwhile, the valuations remain very attractive for me to stay vested. The good thing about bottom fishing is that you don’t need to get many big things right to realize a big gain.

Anyway, my position in this is rather small.

LTC Corporation

As I described in my thesis (LTC Corporation (Part I) & LTC Corporation (Part II)), this is a company where the SOTP is >>> the combined entity.

It’s going to be incredibly hard to take control of the company though, without the blessings of the Chengs. I don’t see any activist coming in anytime soon, although surely if I can see it, many “pros” should be able to see how easy it is to realize value simply by delisting and breaking up the company.

In my mind, LTC Corporation also forms like a mini insurance for my portfolio. At the current price, it is unlikely to drop any further. Both from a FA and TA perspective.

Which means the only other 2 scenarios are it remaining flat, or rising sharply.

I’ll take my chances with this.

Metro Holdings

I’m behind in my analysis with this. Still, based on my last analysis, I am generally not too optimistic about the company going forward. The company has done well, and is now incredibly cash rich.

This is a mightily under recognised company. Many people still associate Metro with retail, which is kinda ridiculous seeing that for several years, it’s retail accounts for <10% of net profits and in fact, has contributed losses in recent years.

Still, Metro’s expertise in investing in foreign markets, and focusing on it’s niche (Commercial properties including shopping centres and offices) is very respectable. They are also smart enough to find strong local partners.

King Wan needs to take a leaf out of Metro’s book.

Valeant Pharmaceuticals

I have quietly accumulated more of this since Brexit happened. (I now own 4,800 shares of VRX). So far it has been rather profitable. Today’s news of FDA’s approval of Valeant’s Relistor as well as Brodalumab didn’t come as a surprise to me.

The share price has rallied to around $24++, and I’m rather pleased with my recent acquisitions at $19++. Still, I am talking about a small tiny scale here. In reality, I’m awaiting much longer term data that will hopefully show that the markets have greatly undervalued VRX all this while.

I suspect that would take at least the next 3 quarters.

With regard to the FDA regulatory process, I did some prior work to try to understand this better. I spoke to someone who has experience in the equivalent drug regulatory process in Singapore. Being in the healthcare industry, I can understand this sector fairly well too.

Although this hoo ha about the FDA being concerned about Brodalumab’s 6 suicide cases in clinical studies kinda dominated the headlines, in reality FDA can only control VRX’s US activities. VRX would still be able to proceed with sales worldwide without FDA’s approval.

However, the regulatory process in many other places use FDA as a “Reference agency”. This means that FDA’s decision weighs heavily on their own agency’s decision. (Singapore’s equivalent is Health Science Authority)

The exception being the EU. Europe tends to have their own individual thought process and their approval (or rejection) seems to be more independent. Canada on the other hand, pretty much echos the Americans.

Hence, FDA approval is a big thing. I was confident of approval too, because FDA tends to be rather liberal. The drug approval itself is a big thing, because it does show that VRX has many hidden gems in its portfolio that are not valued at all currently by the markets.

Still, the key for VRX is not a couple of drug approvals. The key is the upcoming Q2 results (probably in early August).

I’ll be scrutinizing the results for any improvement in scipts for key drugs. If Q1 was meant to kitchen sink the results, Q2 should BEGIN to show a turnaround. This should be exciting, and hopefully rewarding.

Property

I’m in the market for a 3rd property in the next couple of years. My personal view is that it’s too early to start buying, and in any case I’m in no hurry to do so.

With this in mind, I do continue to follow up on the latest development, analyze, refresh my thoughts and look out for bargains.

At this point, I’d like to link to this fantastic article by Kyith over at Investment Moats:

http://investmentmoats.com/wealth-building-2/singapore-home-condo-landed-and-hdb-property-prices-grow-over-time/

The data in this article, and the conclusions are spot on. It tells me that the stories of astronomical gains from property investments are true…….. for a select few. It’s really not as common/often or as stable as one thinks.

As the article says, there are only that few periods where the property market showed massive falls, and it is a big question mark whether one can have the financial and mental capability to jump in during those periods.

The long wait in between these  periods would also have made several buyers jump in, leaving the lucky few with adequate capital to capitalize during the large falls.

Over the long term, and considering the general market as a whole, property would actually show gains similar to an equity portfolio.

Bearing in mind that the data presented doesn’t include all the other miscellaneous costs involved. Having gone through such a process, I can safely say that these costs add up to a very substantial proportion of the actual costs of the property. There are so many miscellaneous costs that I don’t even remember the names. Basically anytime anyone or any agency has to do something to verify, file, submit, approve, transact something for you, you gotta pay for it.

If it’s the agent, it’s called a commission. If it’s the government, it’s called a tax. If it’s the lawyer, it’s called legal fees. The result though, is most assuredly the same: you gotta pay.

I enjoyed this piece a lot. It’s informative, with substantial data for substantiation.

It also gave me a new perspective, which is surely the holy grail of reading.

SPY Shorts

I have gingerly started building a short position at this levels again (SPY is 217.32 right now). The position is still tiny, as I believe this false rally has legs to run a bit more.

I call it a false rally as, well, look at the corporate earnings and one gets the idea. The markets are rallying on the expectation of more easing from BOE, BOJ and basically everyone else.

On a TA side, the rally upwards has been on strong volumes. I’m starting a small short position via options, but will continue to add to it gradually. If the rally upwards starts showing much smaller volumes, I’d more likely go short more strongly.

Miscellaneous

I’m spending quite a fair bit travelling this year. The costs of this extravagance is getting racked up, and I’m planning to do a trip to Europe in Sept with my family. Travelling with one’s family has simply gotta be one of the greatest joy anyone can experience.

On a separate note, the “portfolio performance” page is in a mess. I still trying to figure out a way to present the information in a more readable way. I’ll get down to making it neater, yet still as transparent as currently. Eventually.

I’m still looking to deploy my relatively sizable cash holdings. I am in no hurry at all. (Many thanks to those who have sent me ideas, I do look into them.)

Finally, next month is earnings season again. It’s always fun  during earnings month.