Tuesday, September 16, 2014

Growth - Not all are equal

We know we all look to a company to grow its top line and bottom line to create shareholder value. Growth is a very subjective yet important factor when analyzing a company. Growth can make a fairly priced company cheap and the lack of, can make a cheap company even cheaper. Based on my primitive observation, I felt not all growth are equal, and in my feeble attempt, try to rank what kind of growth seem to be of higher value then others.


First tier Growth - High probability, low stress on balance sheet and certainty of  flow to shareholder in terms of dividends.

What determined probability of a growth indeed materializing? The easiest in acquisition of a profit making company/ business at a reasonable price. If the acquisition is made with internal resources, and no or little debt, the more attractive it is. If management has a fix dividend/ distribution policy of say certain percentage of earnings, you can be sure that the growth will be shared by all shareholders. The only pitfall is be wary of acquisitions used to mask the negative growth of existing units. Raffles education, anyone?

I can't think of any examples, if you have one, then the only catch is current valuation. Please let me know the counter too. LOL

Second tier Growth 1: Medium probability, low stress on balance sheet and certainty of flow to shareholder.

I do have an example, CM pacific. Yes, I know, there is dilution and Jiurui expressway is loss-making, but that is due to high interest costs, also loss is narrowing. Also, the interest cost by CM pacific, a vehicle identified by SOE China Merchant to grow as an asset play, is lower than other SMEs in Singapore. The automobile is growing, and the projection to growth is rather clear. So I think probability of profitability in 2 years is quite high, and since it bought a loss-making road, if they can turn the expressway around, the price paid is very reasonable. CM pacific has a dividend policy to pay at least 50% of the income.

It is important that when we look at probability of growth, we should look at it in the long run, a minimum of 3-5 years. Sometimes, with order book visibility, and the right reading of capex cycle, we can be confident of growth in the next 2 to 3 years. However, that will not be classify as a medium probability in my eyes. In my very small universal of Sillyinvestor's investment radar world, Venture has high probability of growth to 2015, but that is too short and and Venture's track records is mixed as compared to its peers. It is in a highly competitive and cyclical industry where M&A can be frequent or order of the day. Also, given Venture deals mainly in the high mix, low volume of EMS projects, it tends to be lumpy as the revenue is less recurring but of higher margin. Why did would I buy Venture? Well, growth is important, but it is not the only factor we should look at. Compare it with the CM pacific example given above, as long as there is no change in China toll regulation, once the expressway is up and running, it will be there, collecting tolls and raking in revenues for CM Pacific, after costs considerations

Second tier Growth 2: High probability, medium stress on balance sheet and certainty of flow to shareholder.

Example? Singapore Shipping Corp (SSC). Singapore Shipping Corp has recently announced the acquisition of a third PCTC, with this order, SSC has now more or less assured of 3 years of rather significant growth. Think of SSC as a shipping trust without the financial engineering. 

The ships are chartered to blue-chip charterers of long term charters, eg. the earlier 2 ships will be chartered for 15 years. Also, SSC loans are amortized over the lifespan over the ships.That means, when the ships are due for the scrapyard, the loans will be completely paid. 

The only bug is gearing, its gearing to equity ratio will be above 1 after this third acquisitions. However, since the ships are already on long term charters with blue-chip companies and their loans are amortized,  unlike trust structure, I see it as medium stress on balance sheet rather than high stress. You can disagree with me on this. 

Ow, the "Captain" of SSC, has been fair to shareholders, and has proven to be a shrew businessman. Dividend records is good, the big fall in dividends is due to the 1- off selling of vessels during the peak of the shipping cycle (talk about shrew), and he returned the profits of the selling to shareholders. Unfortunately, I know of people who got sucked in purely by numbers when he declared bumper dividends and thought they will continue. 

Third tier Growth:  Any other less favorable combination

That is perhaps what Paullow said about "flipping" or Warren say about cigarette butt. Does that mean we should not look at such companies? I think I still look at them, for reasons like valuation or flipping.

APTT, can I be sure about certainty of flow of dividends? Yes, because of its trust structure, growth? Low, but they have the Taichung Story, the Broadband story and the organic growth through cross-selling Premium content and broadband. But leverage? OMG, it is high, to the extend that if growth does not panned out, dividends will not be sustainable. But, for a yield of 10% and ability to pay out the next 2 years hardly a question, is it worth a bet? I think so.

In fact, there are a few companies in the cleaning/ repair/ maintenance sector that I feel have medium to high probability of growth, like ISO team and 800 super. But for super800, I can concerned about the debt level and not sure if dividends will grow with better earnings, and current dividends is too low for my liking. ISO team track record is too short. Although both appear in my radar. I might look at them further.

Conclusion:

My universal of companies is small, what I said here might not be applicable to everyone. I would like to think most of my counters are in third tier growth segment, I just hope they can limb along, most of the time, it is strong balance sheet plus certainty of payment, like SPH, ST engineering (Yes, I added it with the fall in price yesterday), as for Lee metals and Parkson, I hope to catch the right cycle, or not too far off to benefit from the cycle as I wait safely with their strong balance sheet and payout. I have difficulty finding 2nd tier growth company at fair valuation, so I will keep expanding my radar.

Do however understand that concept of growth and promise of growth are not equal to high probability of growth. Some common pitfalls, expanding capacity, will it actually be utilized? Of course, the expansion of capacity show that the management think there will be growth to be captured, but that is a concept unless, the orders is already fulfilled before they expand, like leasing of space for shipyard expansion or like SSC, the ship is already chartered before they are bought. Even order book does not equate to growth, this is especially true if you look beyond 2 years. Are the terms of contract fixed? Most of the time, retail investors will not know the details of contract, cost of production of delivery of service could be quite different in 2 years time, will the order book continue to have good margins? So a 2 years worth of orderbook that is constantly updated is better than a feast and famine kind of order wins. IMHO 

Also, growth due to financial engineering is really a short puff. As I defined 3 years as the minimum period of growth to consider a company as having medium probability of growth, I am not interested in financial engineering to achieve growth. I want operating numbers to show growth. Financial engineering include shares buyback, wavier of rights to distributions, spin off of subsidiaries. Financial engineering is not a hindrance to growth, but we should look beyond that.

Reits and business trusts offer certainty of payout, but the bugbear will be its balance sheet. Its loans are bullet loans, and hence exposed shareholders to re-financing risks. So, the probability of growth and valuation must be able to compensate that when we invest.




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