VICOM - Part VI

Risks

Regulations
Changes in regulations that affect growth of vehicular population and more importantly, inspection requirements can impact earnings significantly. Regulations will also affect the non-vehicular testing business as less stringent requirements will lead to lower level of testing needed.

This is a huge underlying risk of this investment. In fact, so much so that I will call this a regulatory play on sustained need to test more things so as to increase safety and quality.

Execution risk
Growth in non-vehicular testing may slow if company is unable to continue expanding scope of items tested, acquire new business and maintain/grow margins.

Liquidity
The stock is tightly held by ComfortDelgro and has a low daily volume traded. So you may not always be able to exit at the current quoted price (liquidity discount). Neither are you able to buy a huge amount at any point in time. Hence, you CANNOT place a huge amount in this stock.

Things Which Are Still Unclear – ALSO A RISK!

What are drivers of non-vehicle testing business? / What’s the huge other payables in the balance sheet?/ Sustainable Margins?
I note that the only information I have are from the annual report and the company’s website. Hence, there might be blind spots and faulty conclusions reached. For instance, I had to come up with the drivers of non-vehicle testing business. With no confirmation from management of my understanding, I could very well have got it wrong.

I also could not identify what constitute the huge “other payables” in the balance sheet. It is unclear why other payables are consistently more than trade payables.

Neither could I confidently ascertain the growth and sustainability of the margins. I suspect operating leverage is at play and maybe (just maybe) improved pricing power and billing for finished work done for the integrated resorts. But I note that all these are merely my suspicions.

Why cash not given out? Why hold so much cash?
Why give out only 50% when cash generation capabilities have continued to increase? I propose the following hypotheses:
1) Earning figures are fake so they can't give out as much
a. Evidence 1 – margins jump too crazily and is faked
b. Counter Evidence 1 – Why would they lie when they are not covered by any analyst? Maybe ComfortDelgro wants wants to boost their earnings and thus pressured Vicom to fake the earnings. However, Vicom’s contribution to their earnings is insignificant compared to their overall earnings (S$220m in 2009). Hence, ComfortDelgro has little incentive to manage earnings and would desire accurate reporting instead. In fact, I propose the notion that ComfortDelgro will want to see more cash being sent back up to them instead.
2) Margins at this level are not sustainable so current cash generation capabilities is unsustainable. Hence, want to manage expectations by not giving out too much dividend, so that they can show DPS growth next year
3) They need the money to expand the non-vehicle testing biz - like building a new extension and to buy new equipment.

I believe that hypothesis 2 and 3 are more likely than 1.

I note that they don't pay out all when they face certain uncertainties and when they want to grow the business by buying eqpt (e.g. 2005 – Idacs business slowdown, 2008 – recession, 2009 – construction for new extension) But then, the current payout ratio is low compared to average of past 10 years where they pay at least 60% of earnings. With sufficient money (30+m of cash) set aside for the construction, I believe there is a good chance that they might not need to retain so much more cash. Hence, the payout ratio is likely to increase.

There is nothing wrong with giving out less if they can use the $ more productively and return 20% ROE on the money retained. In fact, if they can grow the money at 20% IRR, I will rather that they keep it because I sure can’t find many 20% IRR opportunities myself!