Monday, November 27, 2017

Inspecting the Vicom Story - Part 1

Vicom has been one of the most amazing multi-bagger in the Singapore stock market. It was trading at 50 cents 10 years ago, with a market cap of S$150m and over just one decade, it became a $5 stock with a market cap of S$500m, generating S$30m of free cash flow per year on a revenue of S$100m and piled up another S$100m of cash on its balance sheet. Despite such a huge run, I took a look at this stock again and believe we can still squeeze some juice out of it. In fact quite a bit of juice especially if some of the optionalities come true.

Ok, first things first, what are Vicom's businesses?

Vicom is Singapore's leading testing and inspection company with two core businesses. The first is the vehicle inspection business which it has 70% market share across 7 inspection locations in Singapore. For car owners, we know this all too well, as we need to bring our vehicle to these dreadful places every year and get charged $60 for some 20 min routine work which doesn't seemed clear to us why it needed to be done except to satisfy the regulator.

The second business is industrial testing and certification which is done by its subsidiary SETSCO which provides calibration, testing and certification services to various industries. The important ones being construction, oil and gas, aviation. This business makes up 2/3 of its sales but only c.40% of its profits. There is some cyclicality in this business as industries grow or falter with global trends. In the recent years, the slowdown in both the construction and oil and gas sector had impacted earnings. 

So, now that we know more about Vicom, what's the story or rather the investment thesis? The investment thesis is the reason why we want to invest in some company and it should be simple enough for primary school kids to understand. So here's the version for Vicom.

Vicom is a stable, cash generative business (6-7% free cash flow yield) that is under-appreciated by the market. There is floor on its stock price underpinned by its strong cashflow and dividend but yet there are optionalities that would help boost the stock price even higher if they materialize. Vicom is also part of the ComfortDelgro group which might to take it private someday.

The stock market represents the view of all the investors and speculators and they tend to focus on the obvious and the recent events. The consensus view on Vicom is that there are now less cars on Singapore roads and most cars are brand new luxury cars then do not need annual inspections. (Only cars more than 3 years old require annual checks). Since c.60% of its profits come from vehicle inspection, so the stock is not interesting. The other business, as we discussed, is facing headwinds in construction and oil and gas. So, no story. This is why the stock did nothing for the last three years. Its stock price just hovered between $5.5 to $6 since 2014.

Cars are only 37% of Vicom's vehicle inspection business

However, astute investors, we dig deeper. We think at a higher, second level. The pie chart above shows the breakdown of inspection by vehicle type and as you can see, passenger cars only make up 37% of the total pie. The rest of it shows that 63% of the volume actually comes from commercial vehicles which require much more regular inspections. This is the reason behind Vicom's stable cashflow. Inspection is a recurring business. Taxis and buses are required to be inspected every 6 months and goods vehicle annually. There is some volatility due to the economic cycle but by and large, I would estimate that 40-50% of Vicom's overall revenue is very stable. This same argument can be made for its industrial testing and inspection business.

About 15 years ago, this stock was undiscovered as it was too small to matter to most global investors. It also only had the vehicle testing business since it had not bought SETSCO. But when SETSCO came in around 2003, the picture changed and investors took a few years to realize the beauty of its businesses. But still, for the next few years (2005-2009) it was still trading above 10% free cash flow yield. Over time, ultimately, it got bid up and is now at 6% free cash flow yield. 

This strong recurring cash generation capability is what underpins the stock price and hence it is very unlikely that it corrects a lot. To add more colour, Vicom's assets are all fully depreciated, these centres do not need capex, nor much labour, nor marketing or other expenses. Hence the $60 that we pay almost drops directly down to its net profit. That's why Vicom stopped reporting gross margins. But when it did report last time, it reported gross margin it was 96%! That's back in 2013. Today we know that its operating margin is still 30% which had stayed almost unchanged for the past 10 years.

Given such strong cash generation, it has to pay them out or else it would just drown in cash. Actually, it's somewhat drowning in cash. Despite paying 4% dividend annually, the firm amassed S$100m of cash over the years which is 20% of its market cap. They might have to do a big special dividend or something to clean this up. Needless to say, Big Brother ComfortDelgro would probably want it to uplift some of this cash given that its taxi business is really not doing so well and Big Brother really don't mind having a bit of that S$100m buffer.

So even without discussing further, we know that Vicom is a huge cash machine that we can get at 6% free cash flow yield of which 4% comes back annually as dividends. On conventional metrics, it is trading at 16x PE but if we strip out the cash it is actually more like 13x and EV/EBITDA is a reasonable 10x. In today's world of negative interest rates and low returns, these multiples are really not expensive for such stability.

Ok, next post we talk about the optionalities!

This author owns Vicom.

Sunday, November 19, 2017

Chart of the Month #5: Total Business Person!

This came from a book on restructuring businesses with an interesting analogy on how one should improve ourselves as a good business person simply by harnessing our bodies and senses better.

How to improve ourselves as human beings?

(1) Use our senses to first receive all the different inputs well
(2) Use our brains to analyze, strategize, think
(3) Use our heart, elevate our EQ and be able to empathize others deeply
(4) Use our gut, have the courage to make the tough decisions
(5) Use our composure, exhibit strength, character, lead by example
(6) Use our mouth, to communicate
(7) Use our arms and hands, these refer to skills we have learnt
(8) Move! Get into action, stop procrastination

It's quite deep if we want to think throroughly about this. For (1), oftentimes we miss the subtle cues like body languages, the meaning between the lines and hence fail to close the deal. It is about polishing our sensory inputs to the level where we capture good signals. For some this might come as natural but for others, it would take years.

(2), (3) would be pretty straightforward. The ability to use both our left and right brains is key to be a successful business person, or rather, a decent human being. Perhaps EQ is slightly more important than IQ today.

(4), (8) seem to go together as well. Human beings are cowards and sloths by nature. We need to overcome huge inertia to just have guts and to get things started. It is overcoming the daily grind that leads to greatness.

(6) has become very important today because speaking well gives the impression of being more capable of getting things done. That is why ang-mohs always get promoted. This is a skillset our education system should really focus on.

Besides talking, there are other skillsets that would be relevant in different fields such as being able to code, or being able to use special software or hardware. This is (7). In the world of finance, it is accounting, corporate finance, stock analysis etc.

Finally, we get to (5), I would put this as "aura". When we are quite accomplished, we somehow exhibit the composure or aura to be able to lead. For some, it is harder but it is almost a pre-requisite to success. Some people are born leaders, but for most of us, we need to develop all the other seven points to be able to get better at this. I think this is the essence of it all.

So, that's the theory of total business person, corny but deep, I would say. Japan didn't become the third largest economy by chance.

Monday, November 13, 2017

Chart of the Month #4: Singles Day

11.11 has taken a new meaning since it was started in China by Alibaba a few years ago. It's Singles Day! A day where everyone should buy bargain sales online. Somewhat akin to the Great Singapore Sale (which last one whole month in June) but it's just one day.

The same tradition in the US is the Cyber Monday for buying tech stuff and the infamous Black Friday. Here's a chart comparing Singles Day and Black Friday.

In the second year that it was launched, Singles Day sales exceeded both Cyber Monday and Black Friday combined. The sales online has been making new highs every year ever since. In 2016 it was c.USD 18bn and this year it was a crazy USD 25bn! That's more than twice the annual sales of Singtel, Singapore's largest company. It is also larger than the GDP of Iceland.

It remains to be seen if this craziness could continue If Singles Day grows at the average of 30% YoY for the next five years,  it would be bigger than the GDP of Ukraine. One day sales matching the GDP of a country of 45m people. 

Meanwhile, a very belated Happy Singles Day.

Sunday, November 05, 2017

2017 Oct High Dividend List - Part 2

This is a continuation of the previous post.

We are at the second post of this October's dividend stock list. This is the first year that we are doing a bi-annual list. This list has 54 names and we gone through half of those names already. Due to the configuration of Bloomberg, I was only able to capture 15 stocks each, which results in the list being divided into four parts. In the last post, we have Part 1 and 2. Now we shall discuss Part 3 and 4. This is not to be confused with the Part 1 and Part 2 of the posts. So, if each part of the list can contain only 15 names, how many names would there be in Part 2 of the posts? Confusing?

Yeah, that's also how Singapore set exam questions to confuse primary school kids.

The next two lists truly reflect one of the key ideas being talked about in 2017 - the Death of Retail. In the next 20 or so names, we see various retail names like Kohl's, Macy's, Foot Locker and Next PLC just to name a few. As these names get sold down, their dividend yield gets higher but meanwhile they are still generating strong cashflows and margins, well at least that was still true in the last three years, hence they show up easily on these screens. It is hard to say whether they will survive. But what's becoming clearer is that some retail formats are better. Convenient stores and supermarkets will still be around. Innovative concepts (Muji stores, Ikea stores) will still be around. But department stores, hypermarts, undifferentiated malls and shopping centres, these are tough. In short I would avoid these retail names.

Part 3 of 2017 Oct Dividend List

Perhaps the name to highlight in Part 3 would be Harley Davidson. This is a unique brand that has strong appeal to all bikers and its brand image, I would argue, goes beyond motorcycles and is attractive in a few ways. Harley Davidson stands at the pinnacle of motorbikes much like Rolls Royce is known as the most prestigious car every built. It is also analogous to Johnnie Walker Blue Label for whiskey and Patek Philippe for watches. Every biker's dream is to ride or own a Harley Davidson someday. But unfortunately, the draconian traffic regulations and hot weather makes that very much less appealing in sunny Singapore.

Nevertheless, Harley sells 250,000 bikes globally and has a target to reach 50% non-US sales by 2027 (currently at 37%). It has 50-60% market share in the luxury bike segment and generates a significant portion of its earnings from merchandise, customization and financing. These are recurring revenue streams. Harley riders are a unique bunch that won't mind spending a lot on their bikes even when they need to borrow money to achieve that. But there is a limit to such behaviour. Bike unit sales had dropped for the last few years as a result of the collapse of the oil and gas industry (which somehow has a disproportionately high number of Harley riders in the US) and the general weakness of the global economy had squeezed this segment of the population - the disenfranchised workers that would want to own or already owning Harleys. However with such a strong brand name, Harley should bounce back with a vengeance. Having said that, I am adopting a wait-and-see for this stock since there are more interesting names to buy globally. (To be revealed below)

Part 4 of 2017 Oct Dividend List

In the last part of this list, we see a few Singapore names, SATS, M1, UMS, Silverlake, KSH, Cogent and Zhongmin Baihui. Some of these names were discussed briefly in the past but given their small market caps, it would be always be high risk and high return. Much higher than we like it to be. Today, we shall talk a bit more about SATS which had been on this list on and off for many years. There was also a previous discussion in 2016. I had the opportunity to study more about this stock recently and had also visited the newly open T4! Hence it might be timely to give a quick update.

SATS' business is about delivering prepared food in Singapore. It had done a tremendous job in Changi and had expanded quite aggressively to other peripheral markets. It also has some business in Japan and most importantly, it delivers food to the Singapore Armed Forces. There are some issues with the quality of food as every male who had been through army would know, but hey, that's good for investors because recruits can never complain! But the biggest issue facing SATS is always labour cost. It is highly labour intensive and had been squeezed by the clampdown on foreign labour.

The company spins a good story with regard to how it has automated its processes, insofar mitigated the cost of higher labour. In the new Terminal 4, it's all about automated baggage check-in functionality and robot deliveries. These are visuals that sticks and investors appreciate the story better. A good PR and investor relations team is able to add 1-2x multiple premium to a stock! SATS would be in the top quartile in Singapore when in comes to investor relations.

In terms of fundamentals, the firm had also delivered. CEO Alex Hungate had done a great job and we have seen operating margins maintained at 10-13% for the last few years. The company had also delivered revenue and profit growth, which explained the stark contrast between SIA Engineering which had not seen revenue and profit growth for many years. However both stands to benefit from Singapore becoming an aerospace hub with more flights in and out of the country.

Given the strong share price performance over the last 18 months, I would advise buying if only it corrects a good 15-20% from here. SIA Engineering or ST Engineering with a c.5% dividend yields  look like better bets! So that's all for this year's October list!

Here's the past lists: