Last week, in the post
on the construction industry, I examined a list of 7 construction companies
that the stock screener on SGX StockFacts returned. Companies were eliminated
one by one until the list was narrowed down to just two counters: Keong Hong
and KSH. So in this post I shall be examining Keong Hong, in much further
detail.
Business Overview
Keong Hong (KH) has been
in the construction business for over 20 years, having a track record in
projects spanning from industrial and commercial to institutional and
residential properties. Since its IPO in late 2011, KH has been engaged only in
residential and institutional projects. The company also entered property
development in 2011. It was awarded the BCA A1 grading for general building,
allowing it to tender for public sector construction projects of unlimited
value (this has yet to be fully utilised).
Here are some stats to
look at before we go further in depth to the fundamentals:
Market Cap ($M)
|
101
|
EV/EBITDA
|
4.2
|
LTM Revenue
($M)
|
223
|
Dividend Yield
|
7.9%
|
Price/Earnings
Ratio
|
3.0
|
Payout Ratio
|
29.7%
|
Price/Book
Ratio
|
0.72
|
Total Debt/Equity
|
43.1%
|
Price/Sales
Ratio
|
0.45
|
Debt/EBITDA
|
2.2x
|
At first glance, the seems
to be undervalued, solely based on
its extremely low P/E and EV/EBITDA
ratios, and that it may well be a dividend cash cow, from that mouth-watering 8%
yield.
But before outright
declaring it as a good bargain and an obvious prey for yield hunters, we have to
look beneath the surface and examine its inner workings.
Staying Grounded - The Income Statement
All figures in millions of
SGD.
While “fantastic” does not
describe the results here, KH’s revenue and net profit has held up well in the
face of a slew of property cooling measures introduced in mid-2013. The effects
of such measures has dented, but not demolished, the group’s revenues and
profitability. That said however, the
group’s order book over the years is a troubling statistic.
*Order book as of the
beginning of each fiscal year
KH’s order book has almost
halved from a peak of $611m the beginning of
FY14 to $351m at the start of FY17. Worse still,
the size of its order book reported at the conclusion of its most recent
quarter (MRQ) dwindled further to $309m. About 60% of it comprised non-residential
projects (likely Raffles Hospital), and it is estimated to provide income for KH until end-2018.
Project
|
Location
|
TOP
|
Status
|
Skypark Residences
|
Sembawang
|
Aug ‘16
|
99.8% Sold
|
Jurong Gateway
|
Jurong East
|
Nov ‘16
|
100% Sold
|
The Amore
|
Punggol
|
Nov ‘16
|
100% Sold
|
Raffles Hospital Extension
|
Bugis
|
3Q17
|
Not Applicable
|
Parc Life
|
Sembawang
|
2018
|
29% Sold
|
Seaside Residences
|
Siglap
|
Apr ‘21
|
Sales start Apr ‘17
|
Most of
these condominium projects are joint ventures (JVs) with other companies,
mainly local developers and construction firms. While it is not explicitly
stated how much revenue KH has recognised from these projects thus far, revenue
is typically realised in stages as a project nears completion. Worth noting is
that KH was appointed as the main
contractor for all its JV projects. It does speak about the firm’s standing
and reputation among property developers.
As is the
nature of the construction/property development business, KH is reliant on keeping its order book filled.
This means constantly “topping it up” with new projects in the pipeline. While
some companies may bid aggressively for project tenders, KH’s management has a
policy of taking a back seat and only
pursuing projects with adequate returns. This explains the rather decent profit
margins enjoyed by the company as compared to its peers.
On the flip side, in an
environment where there is a dearth of business due to the property market slowdown,
waiting for “the right one” to pounce on puts
short term pressure on the order book and therefore revenue. Thankfully, KH
sits tightly on a pile of cash while
it waits for its chance to strike, which brings me to the next point.
Concrete Foundations – The Balance Sheet
While the building may
look a little flimsy at the moment, rest assured that KH has laid good
foundations. Its strong balance sheet
is the cornerstone of its stability.
Short term liquidity has
never been a problem with current assets
usually around a comfortable 1.6x current liabilities (current ratio of
~1.6). Its large cash pile constitutes
a large portion of its current assets (cash
on hand is $66.4m as of 1Q17), and forms the
bedrock of its sturdy foundations.
Commendably, management
has managed to keep total shareholder’s
equity growing constantly despite the difficult operating environment and
fluctuating revenues. While total debt has increased in recent years, possibly
to improve liquidity and provide working capital throughout this difficult
period, the company managed to stay in a net cash position in every fiscal year
except 2016. (KH is in a net cash
position of $6.1m as of 1Q17)
Factoring in its ample
receivables against its payables together with net cash (total cash – total
debt + total receivables – total payables), although an unorthodox method, further
illustrates it’s solid net cash position.
Debt wise, KH has an
outstanding medium term note (MTN) with a 6%
coupon due in 2018, and two other loans of about $5.48m and $5.69m each, with
interest rates of approximately 3.25% and 2.64% respectively. This brings the weighted average borrowing cost to about 5.45%, which seems a little on the high side.
The hallmark of stable
small companies in Singapore, they are usually have little or no net debt, and
are sitting on sizable piles of cash relative to their market cap. While
arguably the cash could be better utilised elsewhere, or used to enhance
shareholder value via share repurchases, many a time, a pile of cash is the company’s cushion against shocks. It also supposedly
boosts the balance sheet, enabling them to obtain more favourable borrowing
rates on their debts.
A Bumpy Ride - Cash Flows
And now for the cash flows.
Cash flows from operations
(CFO) have been very volatile,
reiterating the nature of the business and the difficult operating environment.
Nonetheless, free cash flow (FCF) produced remains healthy and dividends paid constitute only a small
percentage of FCF.
The company invested
heavily in new machinery and staff training from ’13-’15, explaining the surge
in capital expenditures (capex). Such seems to be a shrewd move on hindsight,
utilising this difficult time to improve factors of production, so the company
would emerge from the downturn on stronger footing.
Still, it pays to keep an
eye on the CFO figure as the company reports each quarter. Dividend payout
could take a beating should this unpredictable figure plunge violently.
Returns, Returns, Returns
However, profitability
metrics paint a bleaker picture of the firm, as they have declined by about a
third. As a whole, profitability of the firm has been broadly lower since 2012,
most likely hurt by the difficult operating environment.
Ambitious Diversification
As Singapore faces a
property market slowdown, and in the longer term severe land constraints, KH
has made it a policy to diversify
overseas.
It first forayed into the
Maldives by constructing resorts. Two resorts and an airfield are current under
construction. Mercure, the “middle class” resort, is expected to commence
operations in 1H17, while Pullman, the “high end” resort, opens in 2018. These
projects came at an estimated cost of US$120m.
As usual, KH is
undertaking these projects through a JV, Pristine Island Investments, in which
it holds a 49% stake after buying new equity,
making it the single largest partner. (The other partners are Sansui, BRC, L3
and HRC) KH can then realise revenues from tourism operations once the projects
launch. While I have not looked up visitor statistics, KH claims in its annual
report that visitor arrivals to the Maldives increased 4.2%
in 2016, and 1.72m visitors are expected in
2017. Resorts there typically see a 74%
occupancy rate. Assuming everything turns out in its favour, KH will stand to
benefit from this diversified source of income.
However, its track record
in local hospitality leaves much to be desired. KH has 20% interest in two
local hotels – Holiday Inn Express Singapore Katong and Hotel Indigo Singapore
Katong, which commenced operations in Jun ’16. While its initial investment was $200k, it is
appalling that KH’s share of losses so far runs at $585k
(down from $925k loss in 2015). This somewhat taints
the credibility of the diversification story and could be a red flag if losses are
not brought under control before long.
This does not impede the
firm’s march toward diversification though. KH has another JV project involved
in residential development in Nha Be, Ho Chi Minh City, in which it has a 15%
stake. It owns a commercial property in Osaka, Japan, which is mainly occupied by
offices and 85% tenanted. (somewhat like a REIT) I won’t be surprised if KH
spins off these holdings as a REIT one day in the distant future.
Despite ongoing efforts to
diversify overseas, KH still remains very exposed to the ebbs and flows of the
Singapore property market, with 89.5% of its revenue derived locally. Revenue from
the Maldives comes in at 10.3% and Japan a distant
third at 0.18%. Clearly, more has to be done to
make a concerted diversification overseas. CEO Ronald Leo has remarked in the
2015 annual report that “overseas investment opportunities will figure more
prominently as an engine of growth and continued sustainability” and that the
firm is “seeking opportunities in Japan, Australia, Vietnam and Malaysia”. If
such plans are actively pursued, we should be hearing from KH about an overseas
project or acquisition soon.
Welding Together Synergies
KH acquired a 15.12% stake
in Kori Holdings at $0.455/share in back 2015,
and holds a 5%
coupon $5m convertible bond issued by Kori
maturing in Sept ‘17. Kori considers itself as a “specialist builder in
structural steel works, piling works, ground support and stabilization works”.
It has a track record of MRT projects
in Singapore, having secured contracts from all 3 stages of the Downtown Line
and $30m worth of contracts for the upcoming
Thomson-East Coast Line.
It seems that management’s
ambition is to make Kori an associate
company one day. Should they convert the bond into equity (which seems
likely given that the conversion price is $0.42/share
and Kori currently trades around $0.47/share),
KH’s stake would increase to about 25.8%.
Acquisition of a company
involved in civil works is much in line with management’s strategy of “actively
exploring opportunities to participate in civil and structural engineering and
infrastructure works for the extension of the existing MRT network”, and
undertaking “high-value infrastructure projects, especially in the MRT segment,
through possible joint ventures and/or suitable acquisitions”, as highlighted
in their 2014 annual report.
Turning Kori into an
associate would give KH exposure to up and coming large scale civil infrastructure
projects, once again diversifying its source of revenue away from developing
and building condominiums. In the meantime, the 5% coupon on the convertible
bond can be used to roughly finance the interest payments on two of its ~$5m
outstanding loans.
Ownership & Management – Fingers Deep in Their Pie
It
is always a positive sign when company
insiders own a significant portion of their own pie, aligning their
interests with that of shareholders.
Chairman and CEO Ronald
Leo owns about 30% of KH. While not explicitly
stated, it is possible that insiders and related parties own shares through the
various nominee accounts listed.
The company itself has
conducted periodic share buybacks, and treasury shares comprise 4.5% of all outstanding shares. The shares bought back
are mainly used for employee share option schemes.
Management’s track record
is fairly decent so far, and their conservative stance has helped the company
maintain double digit net profit margins even in challenging times. However,
they may not be the most apt at selecting investment properties, as evidenced
by the large losses from their local
hotel JV. So far, management has been following through with its plans of
diversifying sources of income, but at present its talk of “stepping up efforts
at securing public sector works” and its plans to participate in MRT-related
civil works have yet to be fulfilled.
A “Fair” Price?
Construction counters have
a long term average P/E ratio of about 5.5x. While KH is currently trading for 3.0x P/E now, a 5.5x P/E valuation assuming earnings
remain constant would mean a “fair” value of about $0.80/share, or an 80% appreciation from current prices.
And should the stock
revert to its P/B ratio of about 1.0x, again assuming book value remains the
same, it would imply a “fair” value of about $0.61/share, or a 39% appreciation from current levels. However, these
are mainly simple approximations and should not be taken for an ultimate target
price.
Piece by Piece Assembly – Putting Together Tangible
Book Value
For this valuation approach
I am going to keep things simple by only looking at a few items. This gives a
basic approximation of the company’s “bare bones” worth as measured by tangible
book value, without including the expected value of future earnings and so on.
Property Assets
|
+$35m
|
Cash/Cash-Equivalents
|
+$66m
|
Total Receivables1
|
+$208m
|
Total Debt
|
-$60m
|
Total Payables
|
-$136m
|
Convertible Bond (excluding coupons and embedded
derivative)
|
+$5m
|
Stake in Kori
|
+$7m
|
Total
|
$125m
|
*Figures as of 1Q17.
1Note that about $46m of receivables
is classified as retention sum, or accumulated revenue from contract work to be
recognised in future
So a rough estimation of
KH’s tangible book value would be about $125m.
This trumps its current market cap of $101m. It seems like that market is undervaluing KH’s shares by about 20%.
But for a better “margin
of safety”, consider if we discount its property portfolio by 20%, and cut the
value of its stake in Kori by 40%, owing to the illiquidity of Kori’s shares.
We arrive at a tangible asset value of about $107m.
By this measure, KH is about fairly
valued. Since this value includes
unrealised earnings of about $46m, it can be
said that the market has only priced in
the value of contracts already obtained. This does not factor in any potential earnings from new contracts in future,
implying that they come for free (yay!), of course assuming that KH is able to
clinch them.
Kick out the convertible
bond and equity stake, discount its properties by 20%, throw out the retention
sum of $46m, and we end up with a tangible value of about $60m. Only under these conditions can KH can be viewed
as overvalued.
Trying the DCF Approach
And now, for a traditional
valuation method used by equity analysts, the Discounted Cash Flow model.
Over here is a simple DCF
model created using Excel. However, since the beta of KH is so low, at only 0.205, the model
becomes very sensitive to changes in beta. A larger beta would greatly increase
the intrinsic value per share. Thus, I have decided to leave out the
calculations of cost of equity using the capital asset pricing model (CAPM),
and just estimate a 10% cost of equity instead.
Assume that KH suffers a 30% fall in FCF this fiscal year, considering their
FCF was negative in 1Q. FCF falls a further 5%
before levelling out in years 2 and 3 respectively, and then grows at 10% annually as the industry recovers. In the long
run, assume that FCF grows at 1% per annum. This
gives us an intrinsic value per share of $1.05, and KH is currently trading at
a 58% discount
to that value.
To be pessimistic, I further
discount the DCF number by 30% to arrive at a “fair” value of about $0.73. So
assuming all the assumptions in the model hold true, then KH is trading at about a 40%
discount to “fair” value, meaning it has the potential to appreciate about 67%.
It also implies a rather ample margin of
safety at the current price.
Feel free to point out any
mistakes I may have made in the model.
Moo Moo – A Dividend Cow?
Remember that eye-popping 8%
dividend yield mentioned at the beginning?
Fiscal Year
|
Dividend/Share
|
Dividend Payout
Ratio
|
Dividends/FCF
|
2012
|
$0.02
|
15.8%
|
16%
|
2013
|
$0.025
|
25.5%
|
673% (oops)
|
2014
|
$0.0225
|
23.8%
|
13%
|
2015
|
$0.045
|
10.7%
|
12%
|
2016
|
$0.035
|
29.7%
|
39%
|
KH usually pays its
dividends twice a year, once around May, and the bulk of the dividend usually around
end-February.
While counters that yield
8% are typically vulnerable to dividend
cuts, as dividend burdens eventually become too much to bear (or stock
prices collapse thus pushing up yields, but usually for good reason), KH’s case
is very much the exception, with its dividend
payout ratios never above 30% of net income.
Ignoring the anomaly in 2013, we see that dividends are most likely financed by real cash flows generated (dividends/FCF),
as opposed to borrowed money or clever financial engineering.
Considering these factors,
dividend payouts can be expected to
remain steady for the foreseeable future, provided revenue and income do
not nosedive. Factor in that 8% dividend yield and the stock seems like a
fabulous candidate for dividend milking.
Price Charts – A Look at the Technicals
In the immediate term the
61.8% Fibonacci retracement level and previous weekly high at $0.445 serves as resistance, but $0.45 and $0.46 may
also be difficult to overcome, being strong support levels for much of 2016.
On the downside, the 50%
Fibo retracement at $0.425 serves as support. If broken, prices may fall to challenge
the next support at $0.405, the 38.2% Fibo retracement and a previous
significant low. Failing to break through either resistance or support could see
prices stuck in a $0.02 range from $0.425 to $0.445.
That said however, KH historically trades at a P/B ratio of
around 1.0x. Its current P/B of 0.72x seems like a big deviation and in this sense mean
reversion should take place moving forward. Expect bargain hunters to swoop in should the stock approach $0.40
(and the yield approaches 10%).
While KH has a very low 500-day beta of just 0.205, its volatility over the longer term can be
rather significant, the result of it being a thinly-traded small cap stock. Recently, it also tends to plunge
drastically after becoming ex-dividend (completely normal), only to remain at
that depressed level and consolidate for a long time (not so normal).This behaviour
reminds of me bond prices, which tend to creep up slowly before a coupon date (a
concept known as accrued interest), and dropping after the coupon payment.
Perhaps that 8% yield is making investors treat this stock like a bond?
Key Risks
Order Book
The lifeline of the firm
has to be monitored closely for warning signs of severe deterioration. Should
contracts dry up, the firm will have no revenue in future and this would
quickly put pressure on its balance sheet. It is of utmost importance that management is able to secure a litany of
contracts in the pipeline as reassurance to shareholders of earnings
visibility.
Industry Risk
Construction is very much
a cyclical industry and revenue can
be very volatile at times. Not forgetting the government’s property cooling
measures introduced back in 2013 still keeping a lid on the industry (although measures
were recently relaxed a little). Competition is also very intense as there are many firms with exactly the same business
model and no single firm has a dominant market share. The firms therefore, all operate without a protective “moat”
and can be trampled on by competitors
anytime. Forming JVs with other companies to bid for projects partially mitigates
this risk.
Liquidity Risk
Daily turnover rarely
exceeds 500k shares, and on average is around 200-300k shares. Multiplied by
its share price and daily total
transaction value is only about $100k, in contrast
to blue chip counters which see daily turnover worth millions of dollars. This
should not be a concern if one is a small investor, as there should be no
problem transacting small chunks of shares. However, if one intends to take a
sizable position, bear in mind the liquidity risk. Being a small cap stock with
hardly any institutional ownership or trading, the floor might fall out of the market (aka no bid prices) if suddenly confronted with panic selling,
leading to a huge crash in stock price.
The Final Word
All things considered,
Keong Hong looks like a very attractive
value investing proposition, and a very promising candidate for dividend investing. However, the stock has
its inherent share of risks as well
and those need to be weighted properly against potential returns.
Nonetheless, with the
stock trading under the estimated tangible book value and boasting such an
attractive dividend yield, one could adopt the “buy-and-hold” strategy, collecting the delicious dividends in the
meantime while waiting for its value to be realised.
Just my two cents.