Sunday 1 February 2015

Q&A: Insights Gained from Interesting Comments

I mentioned previously in the post on Our Stock Investment Philosophy that one of the reasons for writing in this blog is to subject our investment thoughts to scrutiny and feedback so as to gain new insights in our investment journey. In the past 2 months, there are multiple comments from fellow bloggers and readers about my writings that I feel adds so much value to this blog. I couldn't ask for more. I'll like to take this opportunity to thank readers for their insightful comments and also republish some of these for the benefit of those who had have missed these comments despite reading the article.

I've tried my best to be selective and also to summarize these questions and answers so that readers can get the gist of it. Also, to save time, I've organized in such a way that you can go to the relevant heading and/or question that interests you. Of course, there are more comments which are very insightful and definitely worth a look if you have time. If you want more details, you can click on the headings to go to the relevant article (the comments section is below these articles, scroll down all the way if you want to read only those).

Sembcorp Industries - Is It Worth the Buy Now?

The one thing analysts and all investors (and myself) have been saying is the low PER their utilities segment is currently valued in. We think it's cheap if we compare it against fellow peers. But the question is, it has been for many years they are trading under PER of 10x, so I'm not quite sure what would propel the shares to be trading at 15x. We may be too optimistic in that sense. We may be wrong of course but the market has proven us wrong again and again. Will we see a day where it is trading at PER of 15x? Maybe yes one day, and we can only hope. 

Reply: I suspect that many investors or potential ones are still deeply fixated about Sembcorp’s Marine business and has not been aware of the success and growth of the utilities business, thereby undervaluing it. Like you, I’m also not sure what would propel the shares of the Utilities segment to 15x. But assuming we are not comparing with its peer businesses or the market's valuation, and only basing strictly on a discounted cash flow perspective, I think this valuation is fair considering the economic characteristics of Utilities segment (leading position, stability and predictability of cash flows etc). Basically on a zero-growth basis we are putting a discount rate of 6.7% for a respectable business.

Also, my hunch is that my valuation for the Marine segment is probably a tad too low (Earnings power of S285M vs TTM earnings of S$345M plus PER of 12-13X) and I have considered the Urban Development business to be worth zero which is definitely not true.

Lastly, some final considerations which I did not include in the post is that – the Marine segment is probably the one providing the cash for Utilities expansion traditionally. If Marine is unable to do well under current circumstances, the Utilities might be affected. Sembcorp claims that the small Urban Development business may be a springboard for further involvement in opportunities for Utilities side but so far I haven’t really seen any synergies in this aspect (anyone, please correct me if I’m wrong). I guess these business relations wasn’t completely factored into my analysis. The valuation might be higher or lower because of these but I must really thank the margin of safety for providing some comfort here.

As an investor of SCI too, I feel pretty confident. Yet, looking at the price curve, I noted that in Oct 2011, there is a dip of prices below 3.5? And that was already way beyond post crisis low period below 2.5. I had not followed SCI then and was curious why did that happen? Just pondering will a repeat happen?

Reply: Great questions posed there regarding the price chart. I think your guess is as good as mine whether a repeat of price below S$3.50 or even S$2.50 will happen. Personally, I feel there’s always a chance something like that will happen again though.

However, looking at this situation on a value standpoint may be a source of vindication. The ~S$3.40 price occurred in 2011Q4. In terms of available information then and for simplicity, we can use 2010’s financial data for reference. With earnings of S$793M (you may want to refer to the table in my post), the PER turns out to be about 7.7x which is also very attractive. Perhaps that is why over such a short period of time 3-6 months, the stock price recovered.

Alternatively, if you follow my post and using the same technique, (Here, I assume that my view of the fundamentals/stability for both Marine & Utilities is the same at that point in time as it is now (this is quite likely) & I also used latest results for Utilities but 7-years average for Marine instead of 10 years), the valuation becomes S$6650M or about $3.70/share. I ignored the other segments in both cases. It turns out that this is decidedly less attractive at that point of time compared to now on a price to value basis (Value VS Price – 2011 is S$3.70 VS S$3.40 & 2014 is S$5.15 VS S$4.15). Thus we can say that even though the price is lower at ~$3.40 in 2011, it is not necessarily more attractive when it is priced at S$4.15 in 2014. Of course there may be bias (hindsight) etc but I’ve tried to minimize them using the same method when looking at the company for both periods.

I guess the point here is that due to business developments over the years, we have better clarity in forming a rough intrinsic value estimate of the business itself which in 2014, we estimate it to be close to S$5.15 wherein we ‘wrongly’ estimate it to be at S$3.70 based on the available data in 2011. Without any doubts, we may yet again be proved wrong as the future unfolds. That's why we can't depend only on this counter in our entire portfolio.

Not satisfied with the dividend yield.

Reply: The dividend yield for Sembcorp Industries is not the best among many of the blue chip stocks around. However, I suggest that dividend yield is part of the overall analysis. 

If after analysis, we like a stock like Sembcorp but we feel the yield is too low, I think there's 2 ways to handle this: 

1. If you feel that dividends will remain constant, wait for the price to drop further to get a higher dividend yield; or

2. Ensure the current price is low enough such that there's good upside for capital appreciation. Buy at this low enough price and hope that based on the fundamentals & potential growth of the company, the earnings will increase in the long-term and maybe future dividends will increase as a result.

For me, since the current dividend yield is already good enough for me and the company has been paying dividends yearly for >10 years now, I opt for the latter point 2 which is obviously the less wiser way.

Avi-Tech Electronics - Is Quick Profit Possible?

Seems this company has trouble finding ways to make money? It's longer term prospect doesn't sound exciting. Be careful of considering liquidation value based on its current cash. Check how much it burns as well. Can disappear quickly due to operating expenses if it isn't generating profitable sales. That margin of safety may not exist.

Reply: Thanks so much for visiting my blog. I think you’ve raised a valid point here. The longer term prospect doesn’t sound exciting at all. However, I believe the beaten-down price coupled with the various corporate actions that act as some sort of catalyst have made the stock a potentially attractive investment.

With regards to liquidation value, I’ve used it as one of the indicators of the company’s value. Like I mentioned in this post, between 2011-2013, the bulk of negative earnings are attributed to the subsidiaries (they contributed –S$12.8M while core ops contributed +S$1.7M). These loss-making subsidiaries are the exact same ones that management will discontinue and this will help stem much of the losses. Core operations endured comparatively minor losses which was worst at -S$1.61M in 2013 (VS subsidiaries –S$7.6M in 2012). 1Q2015 shows core business operating profitably signalling a potential turnaround. 

With these, I believe the company is unlikely to burn as much cash as the past 3-4 years and correspondingly, the liquidation value can be used as a reasonable guide to its valuation at this point in time. Of course, the future is unpredictable and management can still burn cash in the future, especially through similar unsuccessful acquisitions. What I can say is that I did not place any positive prospects of the future in my valuation while the negative prospects are still guarded by some indication of margin of safety.

All in all, if I can find a few companies in this investment situation and at this price level for my even-type portfolio, I think the probability of profiting should be high overall. If you read my previous post on 
My SG Portfolio 2014 and Some recent picks,you will notice some companies in my event-type situations aren’t doing very well operationally and doesn’t seem to have bright prospects (one of them is facing a lawsuit too). I guess the point here for me is that because of these past losses, the price of Avi-Tech had been beaten down by investors/speculators to a point so low that they have essentially assumed these losses are very likely to continue far into the future.

How to Get Rich - The Beauty of Compounding to Investors & Companies

Have you tried using simulation which is the most important factor out of the three? Time, starting capital or return factor?

I think you’ve posed a very valid case here about finding out which is the most important factor. Honestly, I'm not very good at such simulations. But if you've noticed, I've used a factor of 1.5 for rate of return, r and starting capital, P in the case study (i.e $100K x 1.5 = $150K, 10% x 1.5 = 15%). For time period, t, if we use a starting capital of $100K and 30 years (20years x 1.5), the final amount would be about S$1.75M. From this single but likely inconclusive datapoint, it appears that time period and rate of return are the most important factors to consider.

Unfortunately the rate of return probably is one of the least predictable of the 3 factors since there's no way we can be sure we can achieve 10% or 15% return over the long haul. Because of this unpredictability, I thought it is not so useful to state which factor is the most important in the practical sense. However, very fortunately for us, the time period is quite within our control and easily ‘applied’ if and only if we are young enough to start. Then again, achieving a 2-3% return over the long haul is probably easier than say, compounding it for 50 years due to the limitations of being a human. A balanced effort in working on all factors should be the better way to handle the compound equation.

All the 3 factors are highly intertwined and complementary to one another. For example, compounding $100K at 15% for 18, 19 and 20 years will give $1.24M, $1.42M ($180K more from 18th year), $1.64M ($220K more from 19th year) respectively. A good compound rate is important but the effect will be more pronounced if the length of time is extended due to the exponential effect of the formula. Similar relation applies for the other factors.

In conclusion, due to the varying ease of application and unpredictable nature of some factors, it is quite hard to conclude decisively which factor will do most for us in our lifetime. Consequently, I believe the best way to reconcile this is to focus on all 3 factors based on my proposed method to tackle each factor in my post (under The Real Trick – Combining all 3 Inputs).


Good post again to show the different scenarios amongst the 4. It's interesting though that you actually used the book value as a measurement of growth. I thought book value growth is much harder to achieve than earnings growth as it covers a wider spectrum. It is like earnings is the subset of that.

Reply: I used book value in this case because it's easier for me to explain the compounding effect. Also, unlike earnings and cashflows, book value is less subject to fluctuations with time and thus more predictable for use. Besides these, book value is highly related to earnings - A consistently growing book value usually indicates healthy earnings over the period since whatever is left in net income after deducting dividends goes to the book. Lastly, we can also view book value as a rough gauge to the company's intrinsic value if it is to be a liquidated. This means that using book value is not wrong although it may not be the best choice in the end.

Other Articles:
My SG Portfolio 2014 (Top Realized Gains & Losses) and Some Recent Picks
AP Oil - A Neglected but Cheap Stock in Singapore
Our Stocks Investment Philosophy

1 comment:

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