Friday, January 10, 2014
Lee metals - 1st practice of DCF valuation after reading Pat Dorsey
Well, no rocket science, but here goes. First, if the operating numbers make any sense to go further. Most importantly, FCF, the lifeblood of DCF calculation is reasonable stable Only 2 years of negative FCF, which is more than offset by the other years, with the average FCF of the last 8 years to be 15 mio and the peak at 53 mio. To estimate the new year FCF, I use 15 mio, with a growth rate of 2%, 3% and 4%, which will be 18 mio, 19.5 mio, 21.3 mio respectively in 10 years time, conservative enough. The problematic part is the discount rate. Pat Dorsey suggest 10.5% for average firms, and use 14% for AMD, personally, I don't think Lee metals is worse than AMD in terms of operating numbers, so the range should be around 11 to 13. I calculate the numbers that show operation efficiency according to the book, and Lee metals didn't do badly. If you look at debts, it is decreasing as the merchandising arm business slows, and the need for bank bill falls. Non-current debts also get paid down, this is happening on the backdrop of Lee Metals expanding the capacity of the manufacturing and Fabrication arm for the past 2 years. As for CCC, FATO, TATO, inventory turnover etc, there isn't big red flag. I said this because I compare Lee metals with BRC asia, a competitor, which fare lower than Lee metals in almost every metric, especially the negative FCF, irregular increase of debt, while ROE, ROA are comparable,other metric like TATO, FATO etc lost out significantly, until I think it made no sense to go further. Quite clearly, Lee metals performance is not sub-par.While revenue is decreasing, net profits have been increasing. Until thus far, I think it is still reasonable to go on, although as a cyclical in the industrial sector, the book did mention it is no easy to find companies with Moat. From their prospectus: We are a “Mill-less One-stop Shop” providing a range of Reinforcement Steel Products without the need to make heavy capital investments in steel mills. We have also moved into higher value-added manufacturing of Steel Welded Mesh Products. We have developed a network of suppliers as well as land and marine logistics capabilities. Our ability to procure steel products from and supply SRM to our network of regional steel mills have strengthened our relationship with these mills and enabled us to obtain competitive prices for the purchase of steel products from them. I however, doubt the cost advantage of such business, as their merchandising arm sales is doing very badly (as with the industry trend), I wonder how much cheaper can they get their supplies as compared to competitors, although for the 7-8 steel companies that I researched on, none seem to have such a model. I also wonder why no one replicate this model if it does bring cost advantage. Had I have numbers of tonnage, I will be able to better ascertain if there is indeed a durable cost advantage, but such numbers are not available. If you look at margin, then Lee metals did not do any significantly better than others. If we are the low end of the business cycle, there perhaps is less risk of worsening conditions going forward, but Lee metals have benefited from the local construction sector, which has been going through a boom for the past few years. So although the merchandising arm is already in doldrums, we do not know when the local construction will turn down. If I read its business correctly, the high demand for steel, which is good for the merchandising arm, will also lead to higher steel prices, which is bad for its manufacturing and fabrication arm, at least in the short term. Also, the margins for the merchandising arm is really low, which range from 1-2%, whereas the manufacturing arm margin range from 6-10%, if we talk about good allocation of capital, it made sense that Lee metals squeeze as much as possible from the manufacturing arm when the going is good.It is hard to gauge, net net, if the merchandising arm improve, the net impact is positive or negative. So, it is unlikely that Lee metals will fire at both cylinders, but it is possible to be hit with downturns at both arms, which will then push it to a loss. As such, any gains is capped, but losses unlimited. However, in the bigger overall industry, Singapore local Construction is expected to continue to be resilient. While HDB might be tapering its supply, the MRT will provide the work. BCA estimate for 2014-2016 Just a year ago, BCA is still forceasting 20-28 billion for 2014. I believe the increase is due to the fact that MRT projects are starting. Since BCA start giving projections in 2010, they have been way too conservative except in 2010. The preliminary construction demand since 2010 - 2013 are 25.7b ; 32b ; 28.1b ; 35.8 b Again it seems that we might have hit a peak, although demand is unlikely to fall badly to affect the business of Lee metals. A lower-end construction demand of 31 billion and 29 billion should keep Lee metals business going well. And we are not accounting the profits of Austville. In conclusion, sound company with good track records, and a bountiful 2014 boast by Austville earnings. But risk increase significantly from 2015 onwards, should lets give a discount rate of 12% The share per price should be 31.5c, 35.2c and 39.6c respectively with growth of 2%, 3%, and 4% With a MOS of 20%, the price are 25c, 28c and 31c 31c happen to be the NAV price too. Oops... Overpaid. Lets hope the Austville earnings lead to a special dividend, and I am out of here.
Posted by Sillyinvestor at 8:09 AM