Friday, August 18, 2023

China's Lehman Moment

When the GFC broke out, we discussed that the repercussions will be felt worldwide across many years. In 2015, it hit Europe hard with the Grexit crisis and it was said that Asia and China needs to see its own Lehman moment. 

I think we just witnessed that - Country Garden's default and the collapse of Evergrande.

The buildup of woes at Evergrande was well known but no one thought that the biggest developer Country Garden could face issues. Now, all is laid bare and we know how deep the issues are. Property is a huge part of China's economy and when this piece of the chain breaks, it threatens the entire financial system. China's GDP growth may fall below 5% and there are concerns about China going into deflation, following Japan's experience in the 1990s.

Chinese authorities recently launched a stimulus bid by allowing major banks to reduce mortgage and deposit rates to boost sentiments. The stock market reacted positively for two days but the bullishness has since faltered as investors confidence remained low. The draconian measures to curb the Chinese private sector, notably private education and internet / gaming sectors remained fresh on people's minds and many market participants are still licking their ghastly wounds.

The representative stock would be Tencent (chart above). Once the darling of Chinese stock market, along with Alibaba, it is now trading not far from its pandemic low and the drawdown from 2021 to the bottom this year was a whopping 70%. The broader market is similarly trading near all time lows. See 2828 HK below.

China has been the world's growth engine for the past two decades and with this engine gone and with US equity valuation still high, it is unclear to me how markets can continue to rally. With risk free rate at 3-4%, the big question is why would anyone buy anything at 40-50x PER? We might be due for a big correction but as ex-Citi CEO Chuck Prince famously said in 2007:

"As long as the music is playing, you gotta keep dancing"

So, we continue to buy 50x PER names and not worried about just getting 2% earnings yield even though it doesn't make sense any more because risk free rate (or yield) is now 3-4% in the US. Interestingly, we can buy Chinese banks at 5x PER and receive 6% dividend yield but no, investors will still prefer 50x PER concept stock in the US rather than invest in China.

Many global investors believe that China could be an un-investable market as long as Xi continues to rule with an iron fist with the wrong advice and motivation from his top echelons advisors and inner circle. While he is not Putin, he needs to be more pragmatic and focus on the economy rather than his ego and China needs to return to the pre-pandemic days of embracing innovation, restore diplomacy and providing entrepreneurs freedom to grow their business domestically and then expanding globally to challenge western rivals.

Let's hope that can happen.

Huat Ah!

Thursday, August 03, 2023


I have written about this name in 2017 and not much has changed since then. The stock did well and the thesis played out and it seemed that it should continue to perform. The company entered a rough patch during COVID and I think this presents an opportunity for us to buy / add today. 

The following is what I wrote on Substack a few months ago and am reproducing here.

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. The second business housed under the brand SETSCO does industrial testing and calibration. It also provides certification services to various industries. The important ones are construction, oil and gas, aviation amongst food, sanitation and other test-heavy industries.

1. Fundamentals

I believe little has changed since my last analysis a few years ago. Vicom enjoys very strong fundamentals with stable demand that comes from regulatory requirement for vehicle testing. It conducts tests for 500,000-700,000 vehicles annually across its 7 test centres in Singapore. There is room to increase pricing as with everything else in Singapore.

SETSCO which makes up its second business in industrial testing, benefits from the global ESG* global trend. There will be more requirements and demands for tests and certifications in various industries. Singapore, the South East Asia’s hub for many industries, can also attract companies to do tests from other countries and SETSCO stands to benefit from this.

The company stopped disclosing the business splits years ago. We can only speculate that revenue is split roughly half in each and margins also more or less similar at 20+ percent. Putting the two businesses together, Vicom comes out as a solid compounder. Its revenue has grown from c.SGD50m in 2003 to c.SGD100m today. Similarly, its operating profit expanded from c.SGD11m to SGD30m with margins maintaining at 20-30% throughout the last 20 years

The ompany has never had a single year of negative free cashflow (FCF). It averages c.SGD20m over the last 20 years and is poised to generate a higher average over the next 10 years. In some good years, it has achieved over SGD30m and as you can imagine, cash has piled up nicely, reaching SGD100m back in 2017 but is at SGD65m today after returning some to shareholders. Its ROE is a healthy 18-20%, mostly on the back on strong margin and high asset turnover


That said, Vicom is not without risks. Every investment idea will have downside and it is vital to get these out in the open. Nothing is worse than being blindsided by obvious risks that we should have considered. Even when we have identified the risks, we have to keep monitoring and make sure things are under control. It will take willpower and courage to cut loss when things go wrong. Case-in-point is Hyflux, Singapore’s poster child in water purification that went bankrupt. I lost 100% of my capital even though I identified the key risk!

For Vicom, the key risk pertains to its passenger vehicle business. While this business does not account for the majority of revenue (only c.30% or less of overall revenue by my estimate), it is very visible and top of mind. Analysts and market participants immediately think about the drop in the number of passenger vehicles in Singapore when stratospheric COE prices and vehicle quotas are announced. These announcements come regularly!

It may be true that the number of passenger vehicles in Singapore will not increase much. But the majority of inspections are actually made on commercial vehicles (trucks, lorries, buses and also taxis) and importantly, there is room to raise prices to offset any volume decline. As such, the bigger risk, in circumspect, is the cyclicality that comes into Singapore’s economy for both vehicle inspection and industry testing and certification businesses

Vicom's end customers are subjected to the whims and fancies of business cycles. This is more pronounced in Singapore because we are a small open economy in the global ocean with big fishes generating bigger waves. In 2016, Vicom suffered a small revenue decline in more than a decade as the global economy plunged into crisis with China slowing down and Europe imploding on Grexit and Brexit. Although the share price did not react much, it did stagnate until 2019 and only crossed $1.5 for the first time around June in the same year.

Then in Mar 2020, at the height of the pandemic, share price suffered a 20% drawdown and fell through $1.5 again. On hindsight, that was also a good opportunity to add to this rare Singapore compounder

2. Technicals

This is a good segue to talk about technicals. As mentioned, all stocks have risks and the even best compounders suffer from drawdowns. With Vicom, we face a similar situation as the share price dropped from $2.1 to $1.9, c.10% decline in the last few months of 2022. This was likely due to:

  • a slight decrease in dividend and special cash over the calendar year when comparing 2022 against 2021 (8.5c vs 9.2c). Singapore shareholders hate dividend cuts. So, they voted with their feet (or sell orders in this case).
  • the relentless increase in COE prices bringing the initial cost of owning a car to SGD150,000-200,000 which was enough to buy a small 3-room HDB flat just a decade ago. Market is postulating that the Singapore car population will decline, therefore the number of inspections will decline and hence the share price weakness
This presents the opportunity for buying as the risk reward is now favorable. We shall further illustrate below:

The pandemic low for Vicom was $1.75 in Mar 2020. We always refer back to this period because the market exhibited complete pandemonium as panic and uncertainty gripped the world back then. As such, share prices around this time should mark the low price where shellshocked shareholders cowering in fear will capitulate when everything is messed up.

This is not to say that prices will not fall below this level. We have seen a lot of stocks trade below their Mar 2020 lows, like Netflix (until recently) and Peloton, the Netflix + bicycle gym stock darling of 2020-21 (PTON US) and Zoom Video Communications (ZM US). But for Vicom, with its stable business profile, $1.75 should represent some sort of threshold and we are here today!

In terms of risk reward, downside is limited from here, but the upside could be $2.4, which was the recent high. This is c.26% upside. Since this is a compounder, assuming that it compounds at 7%, the stock should double in 10 years (the famous rule of 72). So we are talking about c.9% downside but c.40% upside over a few years. Meanwhile we are also getting c.4% dividend annually

To add a cherry on top of the icing, Vicom is 67% owned by Comfort Delgro, the transportation conglomerate in Singapore that operates taxis, buses and the North East Line. For historical reasons, and because its fleet of taxis represent one of Vicom’s largest source of business, it has held to this 67% stake and suffers a 33% leakage to minority shareholders.

If Vicom gets too cheap, Comfort Delgro (CD) can simply take the whole company private. This is how the math can work. To buy the remaining stake that CD does not own today, it will require approximately SGD260m. This is assuming we put a 20% premium to buy out Vicom at market cap of SGD800m. Vicom has SGD65m on its balance sheet and churns out, say, another SGD75m in 3 years. So, technically, CD only has to fork out SGD120m (SGD260m - SGD140m). At a certain lower share price, for CD, putting some cash upfront to take Vicom private pays for itself.

Therefore we always have this situation that some kind of floor will be put on the share price. Of course, this is a theoretical exercise. We do not know whether CD will ever take Vicom private. But history has also shown that past share price drawdowns rarely exceeds 30%.

3. Valuations

Intuitively, we know Vicom can be worth a lot. Let’s use the usual three valuation methodologies (FCF, EV and PE) to triangulate to some intrinsic value. On FCF, we have alluded to Vicom capable of generating c.SGD30m per year. It did c.SGD18m last year and to be conservative, let’s assume it would do SGD25m on average for the next few years. Assuming it should trade at 3.5% FCF yield given its strong fundamentals, we get to SGD714m and adding back its SGD65m cash, we get to SGD780m of market cap

Based on experience, companies with strong business moats seldom trade above 5% FCF yield (except during crisis) and it gets to expensive to buy them at 2+% FCF yield. As such, I believe 3.5% FCF yield is a good level to get in.

With Enterprise Value or EV, Vicom will likely achieve an EBITDA of c.SGD45m in Dec 23. Using 15x which is near its last 5 year historical average, we get to EV of SGD675m and again adding back cash of SGD65m, we get to market cap of SGD740m.

Lastly, using Price Earnings or PE, Vicom should be able to achieve Net Income of SGD30m in Dec 23 and using PER 25x on the basis of its inherently strong business, we get to SGD750m and adding back its SGD65m cash, we get to market cap of SGD815m

Intrinsic Value

Taking the average of the three market caps, we arrive at SGD780m and translating this into share price, we get to c.$2.2 in terms of intrinsic value per share. This is 28% upside from today’s price and not as mouth-watering but that’s simply a function of the market’s efficiency. As we hold out stock for a couple of years and wait for compounding to do its job, we should see the stock going back to the recent high of $2.4 and exceed that in time to come.

Huat Ah!

This post does not constitute investment advice and should not be deemed to be an offer to buy or sell or a solicitation of an offer to buy or sell any securities or other financial instruments.