AP Oil (
Company Website) is listed on the SGX and its main activities consist of 3 segments:
- Manufacturing of a range of lubricating and specialty chemicals for industrial, automotive and marine applications under the group's own brand names.
- Trading of base oils, additives, chemicals and some related 3rd party products.
- Franchising which includes trading in raw material for products under the company's brand name.
Their products are marketed to some 20 countries including Singapore, Bangladesh, Myanmar, Vietnam and others. What attracted me to this company is its relatively strong asset backing as well as ability to generate solid operating earnings and free cash flow. Also, throughout the company's more than 30 years of operations, it only suffered one year of loss which is due to one-off losses in a new business venture. Some key metrics are as follows:
Price = S$0.191
Shares Outstanding = 164,531,172
Market Cap = S$31.43M
P/E (ttm) = 7.0x
P/NTA (mrq)= 0.74x
EV/EBIT (ttm) = 4.3x
ROE (ttm) = 10.9%
AP Oil Financials
Having a P/NTA of 0.74x may not be spectacular but I would
like to highlight a few things. The first is that the balance sheet is pretty
clean and liquid, with net cash of S$20M (1H2014 Results) or S$0.12 per share.
This compares quite favourably with the current market price. Secondly, a close
look at the statements shows Associates contributing about $650K to the bottom
line while it is booked at $2.9M. If a knowledgeable businessman were to buy
this part of the company, I believe they would probably pay at least 7-8 times
of its earnings (i.e. about $5M). Lastly, management is able to grow its book
value consistently at a compounded rate of >10%/year since 2002 when the
statements are available.
Statistically, we see that the earnings and free cash flows
are on average, relatively stable and consistent. As alluded above, the
trailing ROE is 10.9% and has decreased significantly from 22% in ’09. However,
if we adjust for the low returns due to the huge excess cash horde, it should be higher (we estimate it to be in excess of
14%).
The company pays out 10-20% of its earnings, giving a
relatively mediocre yield of about 2.5%. The only consolation is that the
company has been paying dividends since 2010.
AP Oil Business
Now, we're no genius in the petroleum lubricating or specialty
chemicals industry. Much of the qualitative aspects of the
company should be reflected into the financials. Since there’s no easy way to
‘quantify’ its quality, our main concern is whether or not we can count upon the
company to remain in business like it has before in the foreseeable future.
Other than the usual risks like fluctuation of raw material
prices etc (which AP Oil has proven to manage quite well overall and our guess is that the current low oil price bodes well for its bottom line), the key
business risk is the concentration of its major customers. The top 2
customers contributes about 40% sales in 2013 and the top 3 about 59% sales
respectively in 2012. This got to be a big minus. As a sort of counterbalance,
the company has plans to grow market share in existing markets and foray into
untapped new territories. Hopefully, this will introduce both customer and
geographic diversification. With its strong financial position and experience, AP Oil is well poised to take advantage of further expansion opportunities.
AP Oil is likely to enjoy regular recurring sales from repeat
clients. Firstly, the lubricants and blended chemical are expendable products
and secondly, it is hardly ‘postponable’ (i.e. once it’s being used up or
expended, they need to replenish it pretty soon). Also, our guess is that for
some applications and clients, these products form a small part of their budget
and it is quite unlikely for them to actively source for another supplier.
Lastly, some products are non-standard and require certain R&D and technical know-how. When a customer orders a product to meet specific requirements, R&D is required to develop a new formula to meet these requirements. Note that AP Oil will retain ownership of the formulation
which builds on its existing knowledge and database. In some cases, customers provide
sensitive formulation owned by them (which may be sometimes a positive too in
terms of customer retention).
AP Oil - Valuation
It seems that AP Oil is a pretty solid business with decent
assets backing. Is the company undervalued relative to the market price
now?
As mentioned, AP oil consists of 3 segments. The financial reports
separated their individual revenue and gross profit contributions (all 3
segments are still positive here) but lumped all the expenses together. Thus
the best way to value the company is by considering the whole.
With its predictable & stable results, it is not hard to
have a conservative earnings power estimate for the company of about $4M, which
is lower than the past 5 years as well as the TTM results of $4.5M. Despite
having a relatively simple business model, nice track record, potential for
growth and strong financial setup, I hesitate to give a high multiplier due to
some key risks I’ve discussed earlier (I'll probably touch more on that in my future post). A 9-11x multiple should be good enough.
Adding to our $12M estimate of net excess cash,
the valuation becomes $52M or $0.315 per share. Comparing market price of 0.191, we have
an upside of 65%.
Of course, this is just a very simple but in our opinion, quite reasonable
valuation process. Although we did test this with other valuation models (which
coincidentally gives an intrinsic value range of between $0.25 - $0.35 which
reinforces this estimate of $0.315) I think this is good enough. As long as the
estimate is sensible and conservative, coupled with a huge margin of safety,
there’s no need for an accurate figure. It’s better to be approximately right
than precisely wrong.
Insider Ownership
Insider ownership is pretty high at about 50% and the
management should care enough for the business to do well. The question here is
do they own too much to ignore outside minority shareholders?
Conclusion
With a long operating track record, potential for growth,
coupled with a price that offers sufficient margin of safety, we decided to
take a position in the company. Sure, the business isn’t the best of the best
but a purchase at this low price should be well justified. It's not easy nowadays to find a relatively good ROE company with low valuations. If one can find 10
companies like this, the diversified result should turn out quite satisfactory.
Disclosure:
Long AP Oil (5AU.SI)
