Category Archives: Research

More from Singapore: Nam Lee Pressed Metal Industries

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Another name in the boring and cheap category from Singapore is Nam Lee Pressed Metal Industries. It’s a family business that designs and manufacture metal products for the housing industry and aluminium frames for container refrigeration units. The company is headquartered in Singapore but also has production facilities in Malaysia, Indonesia and China. As usual I’ll start with some quick valuation metrics:

Last price (Sep 27, 2013): 0.30 SGD
Shares outstanding: 241,159,000
Market cap: 72.3M SGD (57.4M USD)
Free float: 41%
P/B (mrq): 0.63x
P/E (ttm): 7.4x
EV/EBIT (ttm): 2.9x

Financials

The metric that looks the best is the EV/EBIT ratio because the company has a large cash position. If we count a recent bond investment also as a cash equivalent the company has 16 cents per share in cash while the shares trade at 30 cents. The net cash position has been depressing their return on equity, but it is on average still a very respectable 11% since 2007. It’s good to see that even in 2009 when revenue was down sharp it was still profitable:

Historical financials Nam Lee Pressed MetalsThe historical financials paint the picture of a solid, but not a spectacular business. The quality of their reported earnings seems to be fine based on how much is converted to cash flow. The FCF for the TTM doesn’t look good, but I think it’s probably a positive. The low free cash flow is mainly caused by increased investments in working capital (inventory and account receivables) due to higher sales and projects picking up pace. Unfortunately the gross margin is down significantly compared to last year, but not outside the historical range. No immediate reason for panic.

What’s also positive is that the company has been paying a decent dividend that averages 33% of net income. I think they could return a bit more money to shareholders given how much cash they have, but you can also see in the recent results how quickly cash can disappear when more working capital is required. The family probably prefers to finance the business conservatively and keeping some cash on hand is totally fine with me.

Valuation

The valuation of a stable manufacturing company is straightforward, and the main question is what you think the cost of capital of this firm should be. I think something around 10% is reasonable, maybe a bit more,  which would imply the firm is worth approximately 10 times earnings plus the value of the non operating assets. Net income for the TTM is 9.7M SGD while the 7 year average is 9.1M SGD. This would imply a valuation around 130M SGD, or almost two times the current market cap.

Insiders

Nam Lee Pressed Metal was founded by the Yong family in 1975 and three of six members of the board are family members who have been with the company since it’s inception. The family still owns almost 60% of the stock and they appear to be shareholder friendly by paying out a decent percentage of income as dividends. It’s of course a question what the company is exactly going to do with the large amount of cash on the balance sheet, but insiders certainly have the right incentive given how much of the company they own. What’s a slight positive is that the high cash balance is a recent phenomenon.

Risks

One specific risk that the company faces that deserves some discussion is the following:

A major customer accounts for a substantial portion of our revenue. We are therefore dependent, to certain extent, on this major customer, as any cancellation of its sales and purchases would have an impact on our operations. Although we have long-term contract with our major customer, it may alter its present arrangements with us to our disadvantage, which would in turn have an impact on our operating income, business and financial position and consequently, our operating profits may, to a material extent, be adversely affected.

The big customer (I’m guessing it’s Carrier) buys aluminium frames for container refrigeration units and is responsible for more than 50% of revenue:

In the current financial year, revenue from two major customers amounted to $89 million (2011: $114 million) arising from sales by the aluminium segment and $11 million (2011: $15 million) arising from sales by the aluminium and mild steel segments respectively.

Being dependent on one customer for a big part of your revenue is a major risk risk, but the company does have a few things going for it. It has a long relation with this customer, so apparently both parties are happy with the status quo. The oldest annual report I could find online was from 2008 and since then nothing has really changed. Nam Lee is also the only worldwide third-party manufacturer of aluminium frames that is used by this customer. It’s not the only supplier, but the other suppliers are related parties that are located in the US.

Conclusion

Nam Lee Pressed Metal Industries is a boring but solid business. Their customer concentration is the only major risk factor I see, but given the amount of cash on the balance sheet the downside is somewhat limited. I also think that there is no real reason to believe that this will become a problem anytime soon given how it hasn’t been a problem in the past. In the end this idea is very similar to the earlier discussed Spindex Industries: both are cash rich businesses with high insider ownership, decent returns on equity and a nice dividend yield. If I would have a lot of cash laying around I would probably buy some shares.

Disclosure

No position in Nam Lee Pressed Metal Industries

Hunting bargains using a screener: Kantone Holdings

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A fellow poker player recently started investing using a, mostly mechanical, process mainly based on the Quantitative Value book. The screen selects companies with a high earnings yield, and from that group the companies that score poor on quality metrics such as the F-score are eliminated. I think it’s a pretty solid strategy that most likely will outperform the market. One of the companies that appeared at the top of the list this month is Kantone Holdings, so what do they do and how cheap is it exactly?

Kantone Holdings is part of Champion Technology Holdings that owns 55% of the company while the other 45% is traded on the Hong Kong stock exchange. Champion Technology itself is also traded on the Hong Kong stock exchange and has a 874M HKD market cap while Kantone Holdings is slightly smaller with a 818M HKD market cap. The company describes itself as a leading provider of IT driven communication systems with a presence in over 50 markets. They provide solutions for example for emergency services communications, they have a home land security division that makes things like radiation monitors and they develop online betting websites. Before diving deeper in the company lets start with a quick overview of some key metrics:

Last price (Sep 13, 2013): 0.109 HKD
Shares outstanding: 7,504,576,000
Market cap: 818M HKD (105M USD)
Free float: 45%
P/B (mrq): 0.25x
P/E (ttm): 8.13x
EV/EBIT (ttm): 6.35x

Financials

Based on earnings yield this doesn’t directly look very cheap, it got probably included in the screener because it ignores exceptional items such as impairment losses (more about this later). On an asset basis the company does look remarkable cheap, and it’s in fact also trading at 25% below net current asset value. Especially this got me interested because it seems at first sight that we have not only earnings power but also a classic net-net. The historical financials from a high level perspective look like this:

Historical financials Kantone

When we look at the first few rows everything looks solid. We see nice gross margins and a long history of profitability. But there are also a few very worrying things going on: despite the good gross margins the return on equity has been very low and the amount of free cash flow that the business generates is extremely poor.

The disconnect between the high gross margins and low returns on equity have two reasons. The company has an history of taking impairment losses on items such as (prepaid) development costs. The latest annual report includes a nice graph on the first page of total bullshit earnings: EBITDA adjusted for impairments and other non-cash items. Since the normal EBITDA is also included in the figure it nicely shows how big and structural the impairment losses are.

Kantone bullshit earnings profileThe screener is ignoring the one-time impairment charges, but they appear to be anything but one-time. The reported earnings are in this case a way better estimate of normalized earnings power, but I doubt that even the lower earnings figure is accurate or useful.

The company capitalizes a huge part of their software development costs, and the biggest asset that they have on paper are 1.4 billion HKD in development costs for systems and networks. If these costs are indeed investments that the company can use for the years to come that could make sense, but it’s looks to be aggressive accounting: based on the historical low returns on equity it doesn’t really seem that it’s worth much (if anything). If the company would expense the software development costs instead of capitalizing them they would have shown a loss in almost every year since the free cash flow as a percentage of net income is minus 50 percent on average. Almost all their capex are investments in software development.

What’s also curious is the quickly increasing share count. This is the result of a few rights offerings, an acquisition that was paid in shares and the company also gives shareholders the choice to get a dividend in cash or in shares. I don’t mind a rights offering to raise capital because existing shareholders can participate without being diluted, but why pay a regular dividend if they need to attract capital on a regular basis? As a results of the rights offerings book value per share has been going down significantly.

Insiders

A small positive to the story is that the chairman of the company owns 15.11% of the outstanding share capital through his 27.47% stake in Champion Technology and that’s roughly the same as his 28.49% stake 10 years ago. So that means that Champion Technology did participate in the various rights offerings.

Conclusion

I don’t think that Kantone Holdings is a ticking time bomb, but I do think the accounting is very aggressive and most of the book value and earnings are simply air. This got the screener fooled despite the incorporated quality checks.

Even though this result isn’t encouraging for using a mechanical approach I don’t think using a screener to pick stocks is a bad idea. You sometimes pick a bad apple, but if we can believe the back tests you pick enough bargains to make up for that. The screener also returns Conduril at the top of the list, and I think you all know by now what I think about that pick :). I think I can do better than the screener, but it’s going to take years before I can be confident in that assessment, and one thing is certain: it’s a lot easier and it takes lot less time to run a screen. And who knows, I could absolutely be wrong about Kantone Holdings…

Disclosure

No position in Kantone Holdings and no intention to initiate one

Boring and cheap: Spindex Industries

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My screening process for stocks is simple: I just wait till I stumble on something that sounds really cheap, and then I start digging to find out if that’s true, or if there is more to the story. Spindex Industries caught my eye because it’s trading at an 3.3x ex-cash PE-ratio, it has been profitable every year since 2003, insiders own a decent chunk of stock and it’s paying a 4.6% dividend. The company is a manufacturer of precision machined components for various sectors such as imaging & printing, and automotive & machinery. The company is listed in Singapore and has manufacturing locations in Singapore, Malaysia, China and Vietnam. Lets start with some quick stats from Yahoo Finance first:

Last price (Sep 12, 2013): 0.39 SGD
Shares outstanding: 115,365,000
Market cap: 44.99M SGD (35.5M USD)
Free float: 75.29%
P/B (mrq): 0.71x
P/E (ttm): 6.28x
EV/EBIT (ttm): 2.83x

Valuation

So the key ratio’s above hint that the stock we are looking at isn’t expensive, but what of course also matters is how fast the company is growing and how good the business is. The table below shows historical financial data that should shine some light on those questions:

Historical financials Spindex IndustriesSpindex Industries seems to be a reasonable solid business. Gross margins are stable and despite a net cash position the average return on equity is decent. Book value has grown 7% a year since 2006 while they returned on average roughly 30% of net income to shareholders through dividends. If a stable solid business has on average a return of 10% on equity I’d say it should be worth roughly book value. That’s of course if the company is just the company itself, and not a company + cash box.

So in this case the company should be worth roughly book value + the value of the net cash on the balance sheet. Book value is 54.7 cent per share while there is 18.9 cent per share of cash for a total value of 73.6 cent per share. With the shares trading at 39 cents it implies a possible upside of ~90 percent.

That’s pretty decent, but I would argue that at that point the shares would be overvalued. The large cash position of the company implies in my opinion sub optimal capital management and some sort of discount should be warranted to account for this. I have no idea how big of a discount would be fair, but it should be bigger than zero (and smaller than the current 47%). In addition you could argue that you would want a bit of a discount because of the countries the company is active in, or that some of the cash on the balance sheet is required as working capital.

Insiders

I know little about the insiders of the company, but there are two things that I like. They are not paid with options, but cash bonuses, keeping the share count constant. Secondly the executive chairman owns a 24% stake in the company, probably since he assumed the position in 1989. I do wonder though what the hell an @-sign is doing in his name: he’s called “Tan Choo Pie @ Tan Chang Chai”.

Conclusion

Is Spindex Industries cheap? Absolutely. Do I own it? No. Why not? Good question! Part of the reason is probably that I’m at the moment almost fully invested. If I would have 100% cash and zero other idea’s I would absolutely buy some shares. The second part of the reason is that it’s cheap, but it’s not the magical 50 cent dollar. It’s a bit of an arbitrary hurdle, and I have to admit that I have bought plenty of times stocks at a smaller discount, but when you are almost fully invested you can afford to be picky.

Disclosure

No position, but might change my mind at any time

A look at mortgage closed-end funds

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There are a handful professional investors that I follow closely to see what they think is attractive and what isn’t. Murray Stahl’s (FRMO CEO) letters to shareholders are always an interesting read, and so are the (semi-) annual reports of the Special Opportunities Fund that is run by Philip Goldstein. Both were released recently, and as you could have guessed based on the title of this post both like mortgage closed-end funds.

From the FRMO 2013 letter to shareholders:

Recently, fixed income as an investment has become questionable, given increases in interest rates. We have no views as to the likely direction of monetary policy. Yet, the closed-end fund market is one of the least efficiently priced areas of securities markets. It is frequently possible to purchase funds at not insubstantial discounts to net asset value that are managed by genuinely talented individuals. In other words, we can buy the same bonds that they buy except, in our case, they are cheaper since we take advantage of the discount. Most recently, it has become possible to purchase mortgage funds at discounts to net asset value. These funds hold mortgages of 2005 vintage with high loan to value ratios, since that was accepted practice in 2005. However, the mortgages are current and there is a strong incentive against default because of the self-amortizing nature of a mortgage when existing for 8-9 years. The mortgages trade at discounts to par. The funds yield between 8-9% with yields to maturity of meaningfully higher levels. Our investments are not very substantial. However, that is the general direction of our fixed income investing.

When you read this it certainly sounds like an attractive investment, and since the number of closed-end funds invested in mortgages isn’t high it isn’t hard to figure out the funds in question (more about that later). First lets take a look what Philip Goldstein is doing:

BSP and CSP are sister closed-end funds sub-managed by Nuveen. Each fund invests a substantial percentage of its assets in whole mortgage loans and to a lesser extent, in U.S. Government securities, corporate debt securities, preferred stock issued by real estate investment trusts, and mortgage servicing rights. Both funds’shares have long traded at a double digit discount to NAV. We have had discussions with management about the need to provide an exit for shareholders of CSP, our older position, at or close to NAV, but nothing definitive has resulted thus far. As a result, on July 10th, we formally submitted a proposal recommending that CSP’s shareholders be afforded an opportunity to realize a price at close to NAV for their shares. If the board does not respond favorably, we intend to seek representation on the board via a proxy contest. BSP is a new reporting position for us. We filed our initial Form 13D on July 26th. BSP is similarly in need of a liquidity event and we intend to pursue a similar strategy to achieve that.

Reading this description it’s clear that Murray Stahl and Philip Goldstein aren’t invested in the same funds. BSP and CSP have been trading at a discount for years while the unnamed funds that Murray Stahl likes have only started trading at a discount recently.

The CEF mortgage space

The number of CEF’s that invest in mortgages is limited: there are just 13 different funds so it’s easy to get an overview of the entire sector. I have compiled an overview of the various funds in the table below:

Mortgage closed-end funds overviewBased on the description in the FRMO 2013 letter I think the funds that Murray Stahl likes are the two Nuveen Mortage Opportunity Term funds. They yield between 8 and 9 percent and have only recently started trading at a significant discount to NAV.

One thing that’s in my opinion very positive about the two Nuveen CEF’s is that they have a limited life: they are automatically dissolved 10 year after their creation. JLS was created at the end of 2009 while JMT was created in the beginning of 2010. If a manager doesn’t add any alpha a CEF deserves to trade at a discount to NAV because you will be paying fees perpetually, unless of course an activist investor like Philip Goldstein comes along and put the CEF out of it’s misery.

With JLS and JMT you know you will get back your investment at NAV, so when you buy at a discount near 10% you basically get professional management for free. Murray Stahl seems to think those fund are managed by genuinely talented individuals and that the underlying assets are very attractive. Unfortunately for me I don’t know a whole lot about mortgages, how attractive these assets are and the quality of the funds management.

The funds have obviously a pretty decent yield, but they also employ leverage (slightly above 25%) and I doubt that the yield is sustainable given the fact that they currently pay out a bit more than they earn.

What might also be an interesting opportunity is the American Strategic Income I fund. Philip Goldstein is already involved in the #2 and #3 funds, and the #1 fund has by far the biggest discount currently at almost 17%. I think it’s a safe bet that he has noticed this, and you might be able to buy before he announces a position (unless there is of course a good reason why this specific fund isn’t a good candidate for activism). Usually the discount already shrinks when an activist investor announces that he has taken a position in a CEF.

Conclusion

I like to buy things that are so obvious cheap that a monkey can understand the investment case. Unfortunately I don’t think this is true at the moment with JLS, JMT or ASP. They are not expensive, but a ~10% discount doesn’t scream value to me either. Maybe the underlying assets are indeed attractive, but I have no idea what I’m exactly buying when I look at the funds holdings… That’s too bad because I have to admit that I do like the idea of owning Mortgage Backed Securities simply because it’s an asset class that I don’t already have in my portfolio. Maybe I have a reader with more knowledge about the sector?

Disclosure

No positions at the time of publication in any of the mentioned funds.

Craven House Capital: cheap, or not?

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While browsing a bit random on the internet I found this post on Craven House Capital at the Investing Sidekick blog. The author is quite enthusiastic about the company with a 30% portfolio allocation. The company in question is an obscure investment trust focusing on frontier and emerging markets. Part of the attraction is the fact that the company has repeatedly issued equity at 1.25p per share while it is trading at ~0.25p. So far all things that I like, so my interest was piqued enough to dig a bit deeper.

Equity transactions

The biggest and most obvious problem that the company faces is it’s size. Readers of this blog know that I’m often attracted to small and obscure companies, but you need some size to cover fixed costs. At the end of this year the company reported a NAV of just £2.5 million while it’s current market capitalization is just £1.78 million (approximately 2.75 million USD). If the company is indeed able to grow by issuing equity at 1.25p per share it’s not going to be a problem, but in order to believe they will be able to do this you need to believe that the shares are indeed worth this much today. Because why would someone otherwise want to buy their equity at that price?

Looking at transactions in the past months it seems that they have no problem using their equity as a currency at 1.25p/share, but there is one big problem. Most of the transactions are structured as follows:

In January 2013, the Company purchased 17,502 shares in Finishtec – Acabamentos Técnicos em Metais Ltda. – ME (“Finishtec”) representing 50.1% of Finishtec’s issued share capital.  The shares were purchased at a price of approximately $57 per share, amounting to a total consideration of $1,000,000, from the founding partners of Finishtec (the “Shareholders”). Simultaneously, the Shareholders agreed to subscribe for 49,739,760 new ordinary shares of 0.1 pence each in the Company for 1.25p per share, amounting to an aggregate subscription of £621,747 (approximately equivalent to $1,000,000).

So if you sell a big part of your company for one million USD would you accept payment in shares that are worth just $200,000 on the market? I wouldn’t, unless of course the stake isn’t worth one cool million but something more in the direction of the current market value of Craven House Capital shares. And this brings us directly to a related problem: can we trust the reported net asset value? Craven House Capital has multiple investments on the books at the original cost price, and with those non cash transactions I’m not really trusting it as a good approximation of intrinsic value.

Incentives

The second big problem I have with the company are the performance fees that are paid to the investment manager. When you read how they are calculated it seems pretty reasonable: they get 20% of the growth in NAV above a 5% hurdle. There is however one big problem: it’s not on a per share basis. Last year NAV went from minus £200K to +£2.5 million, resulting in a £552,368 performance fee.

That would have been pretty insane for a company with a sub £2 million market cap, but the investment manager ‘very generously’ accepted shares priced at 1.25p/share. This resulted in ~8% dilution for current shareholders which isn’t too bad, but it’s still a lot considering it’s based on a largely irrelevant performance metric. A payment in shares also doesn’t decrease the NAV of the company, making it easier to hit the 5% hurdle next year. The performance fees also provides an incentive for the manager to structure deals that artificially inflate NAV: exactly the thing I’m already worried about with the equity swaps.

You also wonder who would want to buy a significant amount of equity if the manager immediately takes a big cut. Makes it only harder to argue that 1.25p is fair for new shares.

Conclusion

Is everything related to Craven House Capital negative? No. The company did for example manage to raise £721K cash at 1.25p/share in 2011, but why anyone would want to pay that for this company is beyond me. Their NAV/share doesn’t even come close, even if you believe it’s accurate, and with the current size of the company I think you would be crazy to pay a premium. I simply don’t see the value here…

Disclosure

No position in Craven House Capital.