HL Global Enterprises (AVX.SI) - Cloud of Uncertainty Removed

In my previous post here, we discussed about HL Global Enterprises' relatively complicated disposal of LKN Investment International Pte Ltd (LKNII) and some salient features about why the shares of the company were worth a bet. Looks like most (if not all) of the points covered went through nicely and things are indeed looking very well for them.

In Summary:

1. Disposal of LKNII and CHQ is completed and the >S$100M proceeds are already received.

2. Part of the proceeds are used to pay off the Venture Lewis loan in full.

3. HL Global Enterprises' future earnings will be relieved of the heavy interest expense as a result of payment of the loan and we should reasonably expect positive earnings going forward.

4. The free cash flows of the group remains positive as usual.

5. The group has applied for removal from the SGX-ST watchlist and they had undertaken to provide a reasonable exit offer for minority shareholders should SGX-ST somehow rejects the application (in my opinion, this scenario is unlikely).

6. A 3-cents dividend is declared, giving a yield of 6.4% on current price of 46.5-cents. This is the first dividend declared since probably >10 years ago.

7. The group is reviewing the proposed development of their Melaka property as well as sourcing for sustainable and viable businesses with the huge excess cash that remains even after the payment of the 3-cents dividend.

8. There are some changes to the Board.

HL Global Enterprises has essentially gone from net debt to net cash of about 60-cents per share. Book value also went from negative to about +84-cents per share (higher than my previous estimate of 75-cents per share). As mentioned previously, even after this disposal the group still have various profitable operations, investments and properties. At just 46.5-cents today and considering that much of the uncertainty related to the disposal removed, HL Global Enterprises is still significantly undervalued and definitely worth a bet.

Disclosure:
Long HL Global Enterprises (AVX.SI) since Jul '17

HL Global Enterprises (AVX.SI) - Potential exit from SGX-ST Watchlist

A few interesting facts from the completion of the complex disposal of  HL Global Enterprises' (AVX.SI) share capital of LKN Investment International  Pte Ltd (LKNII), which consists of 100% interest in Hutai that owns the 106-unit serviced apartment building Elite Residences located near Shanghai's central district as well as the 60% interest in loss-making CHQ that consists of  the 455-unit Copthorne Hotel in Qingdao, located near Qingdao's central business district. More information can be gleaned here:

Elite Residences in Shanghai, the PRC

1. The company will receive net proceeds in excess of S$100M from both deals, the bulk of it already received.

2. HL Global will become a net cash company VS a net debt company before the disposal.

3. HL Global should report positive book value VS a negative book value previously.

4. The now positive book value should also be very much more than the current market cap (I estimate it to be around S$72M or S$0.75/share vs market cap of about S$44M or S$0.455/share).

5. The company will report a significant gain in earnings this year due to this disposal.

6. Main investments and properties of the group after completion still consists of:
a. 100% interest in Augustland Hotel Sdn Bhd which owns and operates the profitable Copthorne Hotel Cameron Highlands;
b. 49% interest in a management services company to Equatorial Hotel Shanghai;
c.100% interest in Victory Heights which owns a land located in Tengah Malaysia and finally;
d. 2 other pieces of land of approximately 8,400 sqm in Cameron Highlands, Malaysia.

As guided by management in earlier reports, I believe HL Global will use part of the huge cash proceeds for the repayment of the unsecured loan which has been one of the main causes of its losses the past few years via interest expense. Coupled with loss-making CHQ already out of the picture, HL Global should be able to report reasonable earnings going forward, fulfill the financial exit criteria and be removed from the SGX-ST Watchlist that is probably causing disinterest in the shares of this company. The company has also been reporting positive free cash flows.

Lastly, the substantial cash that remains even after paying the unsecured loan in full may be used to fund suitable acquisitions of new businesses and possibly, the payment of a dividend.

Management has been trying various ways to get HL Global out of the SGX-ST watchlist for some time now and I think this is one of the more favorable (if not most favorable) outcomes that potentially will lead to the exit of SGX watchlist.

Disclosure:
Long HL Global Enterprises (AVX.SI) since Jul '17

SMRT Corporation Buyout Offer: An Alternative Viewpoint

Temasek is buying out the 'troubled' transport firm SMRT at S$1.68 - valuing the company at about S$2.56B. Because Temasek owns 54.1%, they have to pay about S$1.18B for the remaining stake.

Readers of my blog would have known I bought SMRT back in 2014 at an average cost of about $1.02 and sold the same year at $1.49. I left a comment and highlighted that the non-fare segment of the company seemed attractive as follows:

Comment: Quite lucky here as a short while from my initial purchase, the price spiked up due to government's announcement about the new model. Nevertheless, the price at S$1.02 was clearly undervalued. The non-fare segment of the company was rather attractive too. Considering the nature and moat of the business, I probably run the risk that I've sold too low at S$1.49. Price now is S$1.58.

Some SMRT Non-Rail Results

Let's have a look at the results of 3 of the largest Non-Rail segments, namely: the Taxi, Rental and Advertising Segment -

As can be seen, all 3 segments have shown marked and consistent increase in both the topline and operating results (total in 2016: S$123M) over the past 6 years. The total operating profit for the Rail & Non-Rail Segments is S$142.6M. That means the 3 biggest Non-Rail segment is >85% of the total Non-Rail and Rail operating results. I think it is not unreasonable to expect that the Non-Rail segments will do quite well in the foreseeable future. These 3 very profitable, inherently stable and growing segments combined could probably be worth about S$1.7B (this is only a quick and dirty estimate of 13X - 15X operating profit). Also take note that there are other Non-Rail segments that may be of some value as well (classified as Engineering Services, Other Services and Investment Holding and Support Services).

I'm not so sure why the focus out there concerns so much about the Rail segment and why the management has not expressed any thoughts on the striving Non-Rail segment with regards to the buyout offer. But from the standpoint of the investor and those who are supposed have a duty to look after shareholders' interest, it is unwise to focus solely on the Rail segment and keep harping about the Rail's corresponding risk.

There seems to be much confusion whether SMRT Rails should be more concerned with the investors' interest or the public's. Also, Chief Executive Desmond Kuek (former army general) said that "significant risks remain and many factors are outside the control of SMRT such as uncertainty over future fare increases and ridership numbers." I'm not so sure how 'significant' the risk for the rail segment is in the future despite being relieved of their heavy operating assets under the new Rail Financing Framework. I would hazard a guess that both fare and ridership numbers will at least remain stable and it is likely that operations will be less risky compared to before the implementation of the framework.

Proposed Solution

1. Since the focus of the buyout seemed to be on the Rail segment: spin out the Non-Rail segments so that their proper value can be realized by the market. Existing shareholders should be more than happy to then sell off the operations of the Rail and Bus segments not owned by Temasek for a lesser, say S$500M (this values the Rail & Bus segments to be about S$1.1B. Assuming the above valuation of $1.7B for the 3 Non-Rail segments are correct, SMRT could potentially be worth in excess of S$2.8B which corresponds to a price of about S$1.84 per share). 
2. Offer a (higher) price that truly reflects the value of both the Rail & Non-Rail segments. (I read in the news that in the past 10 odd years, SMRT's price averaged about S$1.64. Offered price is S$1.68. Obviously some shareholders might be unhappy with the current offer).

Advantages are Two-Fold:

1. Rail and Bus assets out of the way and privatized - the role of a public transport operator can be better fulfilled in the long term without taking the pressure of short-term market expectations.
2. With the Rail segment out, the market can more easily discern the true value of the remaining Non-Rail entities. Not only can shareholders receive some cash from the disposal, they would probably be very pleased to have their hands on a growing and very profitable Non-Rail segment.

Some Things to Work Out

Now, the Advertising and Rental businesses are obviously highly intertwined with the Rail business. Therefore, the question to ask is if the above solution is possible at all? I'll leave these to the shareholders and management to answer for themselves. It's tough, but a fair and equitable solution should be created for all parties involved.

Disclosure:
No position in SMRT (S53.SI) as of 21 July 2016

Koyo International (5OC.SI) - Is It Worth The Risk?

Koyo International (Company Website) is listed in the SGX Catalist since 2009 and its principal activities broadly consists of four core segments, namely:

1. Mechanical and Electrical engineering services
2. Supply of renewable energy and green products for building services
3. Property development and construction
4. Supply of construction materials and ancillary services

The company has been operating since the 1980s. As of 1H2015, it has S$42.2M (VS S$20M Revenue for 2014) worth of contracts on hand with completion dates between 2015 to 2021. I'm not going to talk much here - readers can understand more and judge for themselves in the annual reports or company website.

As mentioned in my previous post, I would prefer to keep my articles brief in the future. I'll keep this analysis simple without delving too much into the specifics. Some basic metrics are as follows:

Price = S$0.061

P/E (ttm) = 7.8x

EV/EBIT = 3.7x (est $6M excess cash VS $14.9M net cash)

P/B (mrq) = 0.66x

ROE (TTM) = 8.4%

The Story

Over the past 1-2 years, for largely unknown reasons, the share price skyrocketed from around S$0.05 all the way to a high of S$0.40. Readers of my blog would have known that I bought into its shares a couple of years back and sold it for a decent profit. More details here.

On 15 Jan 2016, SGX released a statement and urged caution when dealing with Koyo International's share as >30% of the trading was done by the same group buying and selling among themselves.

When the market reopened the next trading day (18 Jan 2016), the share price crashed >80% to about S$0.05 and subsequently recovered to between S$0.055-S$0.065 range.

Summary of Investment Thesis

1. There's currently no evidence or indications from SGX that the management or insiders themselves are manipulating the share price.
2. On 18 Jan 2016, the company bought back 6,300,000 shares @ about S$0.099 for a total of $630K. That's about 3.3% of outstanding shares.
3. On 19 Jan 2016, independent director Serena Lee purchased 800,000 shares and raised her stake from zero to about 0.42% of outstanding.
4. On 20 Jan 2016, Serena Lee again bought another 700,000 shares, raising her stake from 0.42% to 0.78%. A quick check shows that if Serena does not sell any shares from this point on, she should be one of the top 20 largest shareholders of the company. To my knowledge, Serena did not own any shares of the company since at least 2011.
5. Current price is one of the lowest since 15 months back and my valuation work shows that the company would be worth at minimum S$0.07 and its intrinsic value should be closer to S$0.10.
6. Some brokerages have instituted trading restrictions on the company after the "Trade with Caution Alert" by SGX, causing the share price to remain depressed even after crashing significantly.
7. The company has a relatively long operating history, is in sound financial condition and I can reasonably expect it to continue turning in respectable results in the next 5-10 years.

Key Risks

The 2 main risks I observe were: 1. Accounting issues with financial statements and/or 2. Certain parties are in fact the ones manipulating the share price (its not hard to find out who stands to gain most when the share price of the company is up). If an analyst bought it even at such low prices, any one of these materializing may mean a disastrous investment result. No amount of margin of safety can save an analyst from a fraudulent financial statement and a management that lacks integrity.

So far, there's no indication or evidence of such risks materializing (yet). Also, the share buybacks from the company and an independent director provide some level of comfort.

Conclusion and Some Thoughts

At S$0.40, Koyo International is clearly expensive and a purchase at that point would certainly prove reckless. At the same time, a price of S$0.056 clearly undervalues the company and absent the 2 key risks coming true, a purchase should turn out profitable.

Does being slapped with a "Trade with Caution" alert by SGX warrant a significant sell-down to huge undervaluation territory? It really depends. Security selection requires a skillful balance between the facts of the past and possibilities of the future. The future is uncertain and as investors, we always have to take and manage risk. The risks mentioned above are very real but the fact is that there are currently little evidence that it will happen. An investor always have to deal with probabilities and as of now, my own judgement (I may be dead wrong) tells me that the risk to reward ratio is largely skewed to my advantage.

To be sure, if any of the risks mentioned turn out to be true, it is sensible to sell the stock (even at a loss). Before that, one can only control his/her risk by first understanding them and then diversifying adequately as well as sizing such positions appropriately so that it will not inflict mortal damage to the portfolio as a whole.

Interestingly, this situation bears some resemblance to that of Avi-Tech Electronics which is listed in the SGX Watchlist due to 3 consecutive years of pre-tax losses. The share price got hammered so badly that a purchase (do refer to my write-up here) made just last year would have reaped respectable results and dividends for the aggressive investor.

Let me know what are your thoughts.

Disclosure:

Long Koyo International (5OC.SI)

Note: Disclaimer applies. Not a recommendation to buy or sell.

The Question of Dividends as Passive Income

Recently, a friend directed me to Giraffe Value’s blog post titled “Investing For Dividend Income(Passive) is a Fairytale!!!”  The angle about dividends (that they cannot be considered passive income) brought forward by GV is refreshing indeed but I believe GV has missed out some salient points and thus decided to offer an alternative perspective in this topic by commenting in his blog. With GV's knowledge, I herewith copy my comments (with very minor edits to make things more easily understood) below. It may be helpful if you first read GV's article to understand his take on dividends.

With the CD & XD effect, are Dividends paid out still considered Passive Income to the investor?

Readers of this blog would have realized my reply are drawn out of and adheres closely to the "Business Perspective" section in my Stocks Investment Philosophy in which my investment framework is based on.

Also, as shown in my reply, I did agree with some points underscored by GV. My intention here is to bring about healthy discussions in the hope of getting more clarity in this subject matter through insights and thoughts provided by readers and investors.

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Hi GV,

Good effort on your post. However, I wish to highlight an alternative viewpoint that I personally feel provides a more inclusive and comprehensive take about dividends. I believe the point of contention here is whether dividends paid out is considered ‘passive income.’ 

First and foremost, I assume that your 2 questions are valid in identifying whether passive income is involved. I would also add-on a 3rd point to make the argument more robust:

1.           Are you richer after getting that dividend?

2.           Would your capital not get compromised after you receive the dividend?

3.           Is the money received passive (as opposed to the word ‘active’).

As a fundamental investor (I think you are one as well), perhaps it is more insightful to look at holding the stock as being part-owners of the business. To avoid complication, let’s just assume that we have 100% ownership of a business. This view point can be easily extended to one who have partial ownership of the business through buying its shares in the market.

As 100% owners of a profitable business, we employ officers to add value to goods and services produced so as to generate income for us. Every dollar earned from the business wholly belongs to the owners. In the general sense, if earnings are $10M and beginning of year assets is $100M, the company is now worth $110M. Going back to the 3 questions above, It is clear that with full ownership of the business and by way of earnings generated, the owners are now 1) $10M richer and obviously 2) their capital is not compromised. Also, as the officers are the ones doing the hard work, we can conclude that 3) it is ‘passive’ in nature. With this, we can say the earnings are passive income to the owners.

The owners have the option to either keep the money in the business as retained earnings or issue the earnings out as dividends. If say, $5M of the earnings are released as dividends, the company is now worth $105M. But because the owners own the business, their net worth is still $110M ($5M dividends received plus $105M worth of business assets wholly owned by owners) which necessarily means that in totality, their net worth still increased by $10M. Is this $10M still considered passive? I argue so based on the 3 questions asked above. To the owners, these dividends are in actual fact just a proxy to get hold of the passive earnings of the company.

Your take regarding the HDB is almost exactly the same as the above scenario where it fulfils the 3 questions asked. Because in the stock market, we are partial owners of the company, we tend to consider only the dividends ($5M) and neglected the fact that the remaining $5M of the earnings fully belonged to all shareholders as well (I believe your argument missed this point too). So this $10M of earnings is akin to the rental income we get from a fully owned HDB property.

Now let’s think from the standpoint of the stock investor. Here, I would agree with you that an investor should consider both capital appreciation and dividend return but I just want to highlight that dividends in the investor's perspective are still passive income. Investor A purchase a stock a $1 and price appreciates to $2. The company subsequently declares a $0.50 dividends and share price proceeds to drop to $1.50 due to the XD effect. Investor B purchases a stock at $1 and price appreciates to $2 with no dividends declared. Both investors had a net gain of $1 from their investments. Considering both realized and unrealized gain, it is clear that they are all passive income to both investors. Having no net gain between Investor A and B does not mean there are no passive income involved.

I also agree that your left pocket right pocket - zero sum game theory makes perfect sense (but this does not mean dividends are not passive income).  Because dividends are usually paid in liquid cash out of the company, it makes sense that stock price should drop by the amount of dividends released. If not, we will find that the net worth of the investor (which includes both dividends received as well as ownership of the business) increase inexplicably. However, this effect is just a logical stock market event to ensure that - assuming other things remaining constant - the total amount of what owners received and what the business have are the same before and after the event.

To conclude, CD-XD phenomenon is just an Event which fails to explain that dividends received are not passive income but it does not necessarily mean that dividends are not passive income. Viewed in the proper way, the owner’s earnings are passive income and since dividends usually comes from owner’s earnings, they are part of the passive income in every sense of the word.

I got to your post because a friend referred it to me. Your post must have generated strong interest as I understand that there are some follow-ups in other financial blogs which mostly agree with your point that dividends are not passive income. However, I feel that if we viewed this issue as a whole, the logical (as well as intuitive) explanation contradicts the point that dividends cannot be considered passive income. We've communicated some time back and I know you are, like me, a keen learner of stock investments. Hope to hear more about investments from you.

Secretinvestors

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PS: I appreciate that readers share their views about this in the comments section below. Also, GV gave an interesting reply to this comment. Readers can refer to his blog article for that and decide for themselves which view point is more valid and logical.


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