VICOM - Part III

Growth Analysis

Growth is going to come more from the non-vehicle testing, where margins are lower than vehicle inspection. Growth will depend on both top line growth and margins expansion. Top line growth is likely to continue, though one wonders how much more can margins possibly grow at this rate. Arithmetically, it is impossible because if it continues like this, its margins will hit 100% in 15 years!

VICOM - Part II

Segmental Analysis

VICOM and JIC vehicle inspection centres
It is a statutory requirement to inspect your vehicle periodically. Hence, demand will always be there. The risk however is that regulations become less stringent (e.g. # of inspections reduces) and this will have a significant impact on the business. This was what happened in the vehicle assessment business.

Vehicle Age Inspection Requirement
Motorcycles & Scooters > 3 years Once a year
Motorcars 3 - 10 years Once in 2 years
Motorcars > 10 years Once a year

The business is driven by 1 long term secular trend and 1 cyclical trend. The secular trend is the increasing number of cars on the road. Have you not noticed more cars on the road than 5 years ago? The number of cars is driven by new COEs issued (+) and vehicle deregistration (-). A lower vehicle deregistration tends to be accompanied by a lower number of new COEs because the government takes an active effort to control the growth of the vehicle population (ASSUMPTION). This is what is happening now and the increase in older vehicles will benefit VICOM in the short to intermediate term.

A lower vehicle deregistration benefits the company immediately because the number of old cars on the road stays high but it will dis-benefit them in the long term because the lower number of new cars now, means a lower growth in number of old cars in the future. This relationship dictates the cyclical nature of growth. Note that this is true if the assumption above is true. It could very well be that we see both a higher number of new COEs and lower vehicle deregistration than historically.

VICOM Assessment Centre (VAC)
IN 2005, it was no longer compulsory to make accident reports at the Independent Damage Assessment Centre (IDAC) which VICOM runs. This immediately saw business shrink by 80% and even now, the business borders on the line of unprofitability. This highlights the regulatory risk which I mentioned above.

As it stands, this business segment is insignificant in terms of bottom line contribution.

SETSCO
The company has branches across Singapore (Teban Gardens, Changi), Malaysia (Selangor) and Vietnam (Ho Chi Minh).

According to the FY09 annual report, the company expects to expand its scope of work to new areas like digital radiography, phased array ultrasonic testing and thermal conductivity testing. The company is also planning to test new products such as sanitary ware, electrical, glass and drinking water treatment appliances.

To meet the growing demand for non-vehicle testing services, Setsco has installed both a modern universal test machine that is able to test stronger materials, and a sophisticated metal analyser that can test metals at a faster turnaround time.

This year (2010), construction on an additional laboratory and office block at Setsco’s current premises in Teban Gardens will begin. It is expected to be completed in the first half of 2011.

This is the key driver for VICOM’s business. Things always need to be tested so growth is partly independent of economic growth.

Growing business – can expand scope to test an increasing variety of things. Things always need to be tested So growth can be independent of economy because

Testing volume = ∑i (# of unique items being test i * frequency of testing/item i * # of clients for item i )

The # of unique is driven by expanding in business scope to other areas (endogenous/controllable by company). Frequency is more of an exogenous item and driven by economic activity (e.g. construction biz)/regulations for testing. The # of clients is also within the company’s control because the company can go acquire more clients and increase market share for the testing of a particular item.

In terms of said endogenous factors, the company has been trying to achieve both and has proven to be quite successful in growing the business. This can be seen from the fact that top line growth of the segment has been strong (>10% p.a.) and they need to expand current facilities to meet demand.

In terms of exogenous factors, regulations can go either way – a wild card. But the trend has always been more testing because of quality and safety reasons (think melamine milk and lead in toys). Economic activity is definitely a factor but you are safeguarded by the fact that you are diversified across industries. Proof is that biz grew even in downturn (2008/09).

So overall, expect the business to continue experiencing top line growth. Bottom line growth will depends on sustainability of margins.

Rental Income
Should go up as rental rates pick up.

VICOM - Part I

Have you been sending your car for inspection lately? If you have, you will probably have visited a facility run by the company that I am going to introduce shortly. Not only does the company provide good service for your car, it will perform a great service for your wallet too!

What is VICOM

VICOM Ltd was incorporated in 1981 and publicly listed on Singapore's stock exchange in 1995. The VICOM Group is a subsidiary of ComfortDelGro Corporation Limited.

Vicom owns 3 main business divisions:

VICOM and JIC vehicle inspection centres With over 300,000 vehicle checks conducted at our centres annually, and with car evaluations at 30,000 and counting, VICOM is the premier one-stop inspection service provider in Singapore. In 2009, it has 70% of the market share in Singapore.

VICOM Assessment Centre (VAC) provides a one-stop, post-accident service solution – towing services, car rentals, assistance in accident reporting, claims filing, repairs and safety checks through its three Independent Damage Assessment Centres (Idac), co-located within our VICOM inspection centres. VAC has also expanded its capabilities to include accident reconstruction using computer simulation and analysis, which assists in court litigation of disputed accident cases.

SETSCO forms VICOM’s non-vehicular inspection and testing arm. SETSCO provides testing, calibration, inspection, consultancy and training services to the

i) aerospace,
ii) marine and offshore,
iii) biotechnology,
iv) oil and petrochemical,
v) building construction and
vi) electronics manufacturing industries.

Its services include
i) quality assurance testing and evaluation of building materials,
ii) structural and chemical analysis,
iii) food and microbiological analysis,
iv) environmental monitoring, amongst others.

One of its recent developments is the setting up of SETSCO Aerospace Testing Centre (SATC) in November 2006. SATC provides a range of non-destructive testing of aircraft components. SETSCO’s advent into the aerospace industry has been duly validated, as demand has been strong with many top local and foreign companies utilising their services.

They also lease out parts of the buildings which they occupy and so rental income comprises a small part of their income (~5%). They also offer some miscellaneous services like consulting, motor insurance which form approximately 10% of 2009 income.

Cerebos Pacific

Been a while! Been wanting to update on ARA but unfortunately, yours truly, is a lazy bum. All I can say is that ARA has been up 50% since I first wrote my post, partly due to bottom line growth and partly due to mutiples expansion (yield compression). Both which are expected but the latter surprised on the upside.

K. Now that I got that out of the way (k. fine. i will write a longer one later), let us take a look at this stock called Cerebos Pacific. I am writing this off the top of my head, so pardon me if I may be a tad brief on the details.

*spoiler alert* i am not recommending a buy on this one *spoiler alert*

I am writing this primarily to note down some salient points about this company.

Cerebos Pacific is the company best known for its Brands Essence of Chicken and related products. Its has 2 main business segment - Health Supplements and Food.

Health Supplement
The Health Supplements business operates primarily in Asia. The products under this division can be split into liquid health supplements (e.g. Essence of Chicken) and tablet health supplements. The company has been trying to leverage off the strong brand name of "Brands" by creating new products such as "Bird Nest with Rock Sugar" under the same brand name.

The 2 key markets are Taiwan and Thailand. These 2 markets provides almost all the net profit of Cerebos's. Other minor markets include Singapore, Hong Kong and Malaysia. They also have operations in China but that has been perenially unprofitable, though one can argue that the small losses in the short run help lay the way for large potential returns when the brand gets established.

Food
The Food division can be sub-divided into coffee, asian sauces (think the Woh Hup brand) and western sauces.

The food division operates primarily in Australia and NZ. The company focuses on gourmet coffee and western sauces. The Asian sauces sub-segment mainly exports to U.S and Europe. The Asian sauces sub-segment is small compared to the other 2 segments.

The food division contributes significantly to the top line but nothing to the bottom line.

Financial Performance
The truth is that the business as a whole is not great. The only gem in the business is the Health Supplement division. The Food division does not contribute meaningfully. In fact, losses in the division drag down earnings and compresses margins by contributing signficantly to the topline but nothing to the bottomline. Maintaining and attempting to grow the Food business in Australiasia consumes money and it begs the question - why deploy equity into an area that is not making any returns? The Food business may turn a profit in the future but it did not in the past and one should not harbour hopes that it will in the future. If it does, then it should just be taken as icing on the cake.

The only reason why anyone would buy into Cerebos is for its Health Supplement business. The "Brands" brand name is one which is well known for quality. Essentially, it is the thing that keeps giving in both good times and bad. One should note, however, that the key markets are Thailand and Taiwan. These 2 markets contributes >90% of the earnings. Hence, put simply, buying Cerebos for the Health Supplement business is to underwrite the risk/growth in the markets of Thailand and Taiwan.

The company has consistently returned a ROE of >20% over the past 5 years. The company's earnings has been growing through the past 10 years though it tends to face a dip in earnings in poor economic condition too. But they have always bounced back up to the long term secular growth trend when the economy recovers. The rationale goes like this - People might cut back a bit on health supplements when the economy is down and the wallet is tight. However, many would still continue to be a consumer especially since the product is usually targeted to students (parents will pay a good price to make sure their kids do well with 'brain food' such as Essence of Chicken).

A Branded Cash Cow
The company is a cash cow. It has been giving out 25cents of dividends per share consistently for the past 5 years. I note that there were years where the payout ratio was more than 100%.

The company claims that good management with good cost control and innovative packaging to mitigate pricing pressure (e.g. selling in packs of 3 at X price instead of packs of 2 for Y price) allows the company to continue churning out cash. I say that all these might be true. But the real reason is that its brand name allows it to maintain pricing power and be the preferred choice despite being a pricer option. And this benefit does not cost a significant amount to maintain as compared to the benefits it churn out. The company has been hiring celebrities such as Wang Lee Hom and organizing activities such as Suduko to promote the brand name (their target audience is the student population).

Liquidity
The market cap is >S$1b. However, the free float is low because its parent, Suntory, holds >80% of the stock. Conseuqently, there is a lack of liquidity. For most months, <1m stocks gets traded in the month itself.

Why Buy This Stock
At its current price, the dividend yield is ~6%. That is pretty decent. You also get consistent earnings growth of 20% y-o-y.

And the dividend might increase beyond 25cents because the company is churning out more and more cash while not deploying it since they have already spent most of the capex they needed to increase production capacity.

It is however trading at 3x book and will take a good 6years for you to get your initial investment back.

Don't expect the stock price to move up too much since the float is low and there won't be stock catalysts coming into the picture (its a nice, stable, growing business) and there won't be liquidity coming in from institutionals to boost up the stock price.

So buy it if you are a long term holder and accumulate on any dips because it will always bounce up.

Conclusion
As it stands, I don't find the price particularly attractive (or unattractive for that matter). Hence, I doubt I will put my money up for this unless the pricing goes down to a more attractive level. Moreover, will need to do a bit more further research/digging before the funds can be committed.

Ways to Make $ in Stock Market

There are 2 main ways to make some moola in the stock market:
1) Buy low, sell high
2) Buy high, sell higher

If you can short, you basically doubled the number of ways available. Since shorting is symmetric to longing, we can just limit our discussion to taking a long position. I note that there is another method which is to arbitrage - combining both long and short method. But let's leave that for another day.

The 1st method is best examplifed by fundamental investing. In essence, fundamental investing describe what prices SHOULD be by its derivation of intrinsic value.

The 2nd method is best represented by momentum investing. In essence, it describe where prices WOULD be by an array of tools such as charts.

1st Method - What Prices Should Be
The 1st method works best if you are patient money and you can wait for the price reversion to the intrinsic value. Note that it may take eternity to happen -i.e. no good.

It is best to couple this approach with identification of catalysts which would spark a reversion to intrinsic value. E.g. M&A activity, potential positive news release about new ventures/results which are not anticipated by market.

It is also advisable to couple this with a huge margin of safety - i.e. % difference between intrinsic value and current price. This is because you could be wrong in your "intrinsic value" determination. Firstly, your input may be faulty. Secondly, your model (based on the very flawed DCF, CAPM concepts) could spit out a wrong number because it converts the inputs into a faulty output. So you need a margin of safety to compensate for your potential errors.

2nd Method - What Prices Would Be
The 2nd method works best if you can identify trends and capital flows well. It puts aside the concept of intrinsic value. What is important is knowing how prices are determined (what prices would be) and not what is the right price (what prices should be/intrinsic value). I postulate that prices are determined by demand and supply. And the factors that affect future prices are current prices, preferences, budget constraints and probabilities. What is critical is the 2-way relationship between these factors and their 2-way relationship with fundamentals (i.e. feedback loop) and the changes in these components. I note that the expression of demand is in capital flows (voting with your $) and is a key focus of this approach.

This approach is more concerned about direction rather than a certain price point.

It might also be used to assess when the direction will change. So it can be for buying low and selling high as well (e.g. timing the bottom) but it is not an integral component of the concept.

Additional Dimension - Time
Let's add another dimension to the discussion - time. You can adopt a proactive approach or a reactive approach. You can invest in anticipation of relization of a certain event. Or you cna invest subsequent to the realization of the event. For example, you can invest in anticipation of a bottom. Or you can invest after it is clear that a bottom has been established.

The 1st method implicitly apply the proactive approach - you anticipate price to revert to intrinsic value. The 2nd approach can be both proactive and reactive. You can buy in anticipation of a change in direction (e.g. tops and bottoms) or you can ride the trend after the change in direction has been established.

It is often times safer to take the reactive approach because the proactive approach implicity assumes that you can hold on long enough for the event to occur or may even implicity suggest that you know when the event may occur. That requires 20/20 foresight. Which is not easy. It is easier to be reactive because the event has already occur. So yes, you may not be out before a market top but you never know it is a top until after the fact and it is presumptuous to say you know. So why not react only after the fact. You may not make as much money because you got out late but you may also have lost out on the continued climb upwards if you call the top wrongly.

The reactive approach put the odds in your favour. The proactive approach work well too if you have significant certainty about the event happening - e.g. you are sure positive news will be released.

Conclusion
There are basically 4 combinations
1) What Prices Should Be + Proactive
2) What Prices Should Be + Reactive
3) What Prices Would Be + Proactive
4) What Prices Would Be + Reactive

No one way is superior all the time and differ under different circumstances. But why choose? Use all 4!

Cheers.

ARA Results

Extract From The Edge Singapore:

ARA Asset Management Ltd announced a 32% increase in net profit, to $48.3m for the year ended 31 Dec 2009. Revenue rose 23% to $86.3m, led by higher acquisition and performance and project fees, including the establishment of the ARA Harmony Fund in September as well as the acquisition of 3 retail properties in Hong Kong by Fortune REIT.

As at 31 Dec 2009, ARA had assets worth some $13.5b under management. ARA is proposing a final cash dividends of 2.5 cents per share, as well as bonus issue of new shares at 1 bonus share for evey 5 existing shares. Going forward, ARA plans to strenghten its foothold in the industrial logistic sector, led mainly by the impending listing of Cache Logistics Trust - a joint effort with CWT.

Water Analysis - Part III

On a global basis, there is sufficient water to go around to meet demand. However, the issue is one of demand/supply imbalance across different parts of the world. As it is, you already need to increase supply and decrease demand. The situation is made worse by the fact that demand is still increasing and supply is decreasing.

One need to note an interesting point on pricing – a demand/supply imbalance does not affect prices of water here because prices are government regulated. Generally, the price of water is below the economic cost of providing the water. Hence, there is an implicit government subsidy being provided here. Theoretically, a demand/supply imbalance should make such subsidies unsustainable, especially as the imbalance worsens and the cost of providing such subsidies increase. This is true but one must acknowledge that subsidies tend to be persistent/sticky and any expectations of rapid changes in the pricing of water need to be taken with a pinch of salt.

The demand/supply imbalance is one experienced globally across many countries. Hence, we should think global when making our investment decisions. To that end, we need to decide where to invest in particular. Ideally, the best place to invest should be:

1) facing a demand/supply imbalance – an opportunity

2) have a supportive regulatory environment which recognizes the situation and actually support that with action – increase in tariffs, favourable tax laws, PPP that lead to more investment. An important point, because this industry is largely a regulatory play. Moreover, even if an imbalances imply a need for investment, it does not necessarily translate to actual investment unless the government takes active step to. This is largely because it is a regulated industry and does not react as readily to market forces.

These are the basic criteria because a demand/supply imbalance is already serious enough in many countries and there should be cause for action to address the issue.

But to sweeten the deal, additional favourable factors should be considered

3) growing demand for water – because this will increase the utilization of your plant. So you want places that are experiencing industrialization, urbanization, etc

4) growing imbalance (e.g. supply decrease at a faster rate than reduction in demand) – so that government is compelled to act

These 4 factors should be taken into account when deciding where to invest globally.

After filtering down on the countries, we need to decide the particular segment(s) of the value chain to invest in.

In particular, we want:
1) a particular segment which is facing the most stress and which the government feels the most need for action on – favourable regulations and PPP opportunities

2) a particular segment that does not serve the public so that there will be no/low public opposition when prices are moved – so that tariffs can be raised to reflect the true economic cost with little opposition. This may not be a necessary requirement in countries where the public are generally more okay with price changes but you have the best odds when you avoid the risk altogether. Note that segments which serve the public are generally more stable as public demand is less volatility – so you may be trading higher returns from increase in tariffs for higher volatility stemming from volatility in volumes.

3) Low cost of funding environment

After deciding on the sector, you will need to do the filtering by companies
So firstly, you need to determine whether to invest in the operator or just the EPC or something between those 2 – companies with both EPC segment and a BOT/TOT segment.

Logically, an EPC might be better than an operator in an environment where regulations are unfavourable and you don’t earn enough to adequately cover your costs. But if we work backwards, we may also realize that an EPC will not do well in an environment where their client (the operator) may not make profits because few will venture into the industry if it is not profitable. And if few would want to venture into the industry, then demand for EPC works will correspondingly drop. Hence, even though the EPC will be a better play relative to operators in such environment, it may still not be such a good play overall on an absolute basis. Ideally, you want to be in a sector that works well for both types of company.

Regardless of which type of company, you need to choose one that is able to get debt and at a low cost. This is because this is a capital-intensive industry.

In particular, a company transiting from a pure EPC to a TOT/BOT operator will have greater pressure on their funding because they recover their cost over a much longer period of time than when they were doing EPC work, where they recover the cost + profit once they finished the construction. On this point, companies with the potential to improve their capital structure/ improve their financing cashflows via capital recycling through a water trust will be preferred.

In terms of size, we may want to look at mid-caps (what abt small caps?) This is largely due to the fact that contract size has reduced due to several factors – 1) companies are moving to smaller cities which are growing, need the infrastructure but need it on a smaller scale compared to the larger cities, 2) shorter payback periods for smaller plants, 3) its easier to scale up to meet increased demand than to scale down and risk having a plant running at low utilizations.

We could also switch the sequence of analysis around, look at sectors first than countries before we filter by companies. It might lead to a set of companies that are unique from the initial approach.

Filter…

§ By Countries
But following the initial approach, we see that the countries we want to invest in are likely to be emerging markets like MENA, Brazil, China and India. In particular, the list get reduced to Middle East, Brazil and China. North Africa is removed as it is unclear that clear favourable regulations exist. India may have a supply/balance imbalance but there is a surprisingly lack of coordinated effort to address that (just like their transport system). There might be other countries. Any suggestions welcomed.

I am particularly for a focus on China because I can get access to China-related stocks much more easily than companies which do Middle East or Brazil.

§ Sectors

In terms of these countries, low-priced water is a given. Hence, to expect huge tariffs hikes in these countries without the relevant public backlash might be unrealistic. Nonetheless, I note that China has proven an ability to hike prices in the recent years. More research need to be done here to ascertain the quantum of increase but it might still be better to play in segments with less risk of a public backlash.

Using our criteria list, we see that companies dealing with wastewater treatment plant and water recycling plants are the best placed to ride the trend. As water consumption increase, wastewater naturally increases. In particular, industrialization and urbanization often leads to hikes in wastewater volumes that need to be treated due to construction works. Wastewater plants may deal with the public (municipal) or it may not (industrial). Hence, you may have companies that do both and thus give you a portfolio of assets and exposures to both segments – one offering more stability (municipal), while the other offer the returns (industrial) Moreover, from a regulator’s perspective, a wastewater treatment plant kills two birds with one stone. Firstly, it helps increase supply of water as it reduces the pollution that brings water supply down. Secondly, it helps improve the pollution issue that governments are concerned with and help improve the overall standard of living.

Water recycling plants are equally attractive to a regulator because by recycling the water, you help to immediately increase the supply of water available (think x2) And recycled water is generally cheaper than other forms of new water supply (e.g. desalination) and suitable for use in industrial applications where water of high quality standards is not needed, which inevitably free up potable water for use by the general population. By the same vein, water recycling plants tend to concern themselves with the non-public sectors.

§ Companies
In these 2 sectors, I am personally for operators because I like the associated cashflow stability and the asset-heavy nature of the business. Makes it easier to value. Plus, volumes and in turn utilization should go up as demand growth is pretty rapid in emerging markets like China, especially with the rate of urbanization and industrialization which lead to increase in wastewater volumes.

However, I recognize that the true potential might lie in EPCs who are transiting to an operator model. Such companies are preferred because their earnings stream will increase in stability, and this will lead to improved valuations as investors preferred that. Hence, therin lies an opportunity but as mentioned, there is a risk here because of the financing stress which the companies might face. it is important to have a sound funding model due to increased stress on funding that comes with the change in the business model. Hence, the companies best positioned for this will be companies who already have a portfolio of assets which they can create a trust with. They could list the trust and use the trust as a capital recycling vehicle. Being able to do a trust will see a marked improvement in the financing structure and will represent a growth inflection point.

Lastly, choose mid-size (small size?) companies, with low cost of funding.

So in a nutshell, mid-cap (small cap?) Chinese water companies in wastewater and water recycling sectors, transiting from EPC to BOT/TOT model and has a portfolio of assets to create a water trust with. Need also to have a successful track record of growth/winning contracts, so that the capital raised from the water trust is able to fund growth.

Now, you just have to find that company!

"Mama say waterrrr is goooddd" - From the movie Water Boy