Challenges Facing Challenger Technologies

onlineretail
The recent news for Challenger Technologies hasn’t been too rosy. In the latest quarterly earnings release, the company has reported a 15% drop in revenues and a 26% drop in earnings. Reasons given were weaker corporate sales, higher operating costs, and the winding down of retail operations in Malaysia. Retail sales, however, grew by 2% due to the opening of more stores in Singapore.

My recent interactions with the brand appear mixed though. Going about my daily activities, I have chanced upon many people carrying Valore bags, an indication of the popularity of the house brand. However, at the same time, I have noticed the increasing usage of online retail due to the cheaper prices that can be found there. Moreover, during a recent visit to Challenger to hunt for a new camera, I found that its prices were higher than its competitors. Challenger’s business model is one that will be seriously affected by online retail. Unlike groceries, technological products can be purchased easily online without the need of paying a visit at a local retailer. It is true, though, that online retail has been in Singapore for the past few years, and Challenger has still grown despite this seeming structural change.

Earnings will likely decrease next quarter due to the closure of a megastore in Malaysia, although this might be offset by the openings of new stores in Singapore. The question now is, can its private label, Valore, drive the growth of the company moving forward? Margins for the private label are higher as the company owns the brand. If management is able to bring the brand into other ASEAN markets, as highlighted in their strategy, earnings should see a lift. However, management’s plans of expanding the Challenger concept in Malaysia was not successful. Nevertheless, if we take a look at the positive track record of the management in growing the business over the years, the growth of the Valore brand in ASEAN does seem plausible.

This requires time, and we would need to pay attention to the future performances of the company, to understand better whether it is able to tackle these challenges.

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Purchase of Riverstone Holdings

Riverstone Holdings
On 07/05/14, I purchased Riverstone Holdings at a cost of $0.875. Similar to Kingsmen Creatives, I had been waiting for the stock’s price to become more attractive before sowing, but the price ran up instead. I was expecting the stock to go down in price after giving ex-dividend, but due to a favorable earnings release, it shot up instead. Currently, the stock price has gone down a little to $0.855, which serves as a lesson to me to let the waters calm first before going in.

Riverstone Holdings has a simple business model. It manufactures gloves for the cleanroom and healthcare industries. It exports its products to countries across the world. In the cleanroom industry, it is the market leader (~60%), with HDD stalwarts like Seagate, Western Digital, Hitachi, Toshiba, and TDK as clients. This area provides the highest margins, as cleanroom gloves tend to be around 2.5-3 times more expensive than healthcare gloves. The company has also entered into the lower end cleanroom industry by targeting the panel and tablet market. This area, which currently represents ~20% of total cleanroom gloves, has the same margins as the high end cleanroom gloves, but a lower selling price. The company mostly sells direct to its customers. For the healthcare segment, the company has entered the industry in 2009, and currently sells to distributors who relay the customisation of the end customers’ needs, eg. hospitals. The production breakdown is currently 69% healthcare, and 31% cleanroom, but the revenue contribution is 49% healthcare and 51% cleanroom. Due to the relatively higher margins cleanroom gloves command, the gross profit is weighed 70-30 in favour of cleanroom gloves.

The company is targeting 8 billion pieces in FY19, and wants to grow production by 25% each year. Lower margins is expected going forward due to the expansion into the medical sector. The HDD industry has remained flat, and most of the growth in the cleanroom division has been driven by the mobile segment. I think one key question here is whether the demand is able to absorb the supply coming onboard? The big 4 players in Malaysia, namely Hartalega, Top Glove, Supermax, and Kossan have stated their intent to grow their production capacity. Hartalega aims to grow its capacity to 28 billion by 2020. Nitrile gloves demand is expected to grow by 20% yearly for the next 2 years moving forward while healthcare gloves demand is currently estimated to be more than 155 billion pieces. Perhaps the more pertinent outlook would be the penetration of nitrile gloves in the world. Currently, the US and EU have 148 and 98 per capita glove usage (pieces) whereas China and Asia have a per capita glove usage of 4.6 and 4.8 pieces. If demand in China picks up to the level of the EU, total demand for gloves from China alone would be 132 billion. There remains opportunity for industry expansion in Asia, especially from China and India. The growth in demand for nitrile gloves has also been attributed to the decrease in demand for latex gloves as nitrile gloves are seen as stronger and have lower allergy issues. However, nitrile gloves tend to be more expensive, and this is why growth of nitrile gloves has largely come from developed markets. Nevertheless, a good thing about the gloves industry is that gloves are fast moving and a consumable. Due to its low cost, people do not usually wear the same gloves throughout the day due to the risk of contamination. For example, a doctor does not wear the same gloves when inspecting two patients as germs may be spread between the two through the gloves. Moreover, in the cleanroom industry, contamination is regarded seriously, and customers would not want to risk the quality of their goods just to save a few cents. In this regard, the company’s healthcare gloves segment marked an impressive growth of 30% in 2013.

Key risks for this investment are the depreciation of the USD/MYR exchange rate. Although there is some form of natural hedge as raw materials and products are both purchased and sold in USD, other factors like labour are usually paid in their domestic currency. Management has attributed the strong performance in recent quarters due to a favourable exchange rate and lower raw material costs. That being said, we cannot expect raw material costs like nitrile which is linked to crude oil to remain low. In fact, I do not think crude oil is currently low, but it is relatively stable. However, the latex prices are very low at the moment, something which I do not foresee staying for long. Considering that raw materials makes up 25-30% of total costs, this is significant. The last key risk for this investment is the oversupply of gloves in the industry leading to pricing competition and low utilisation of plants. In fact, CIMB has released a report recently, downgrading the gloves sector as it believes the overproduction would lead to fierce competition between glove players, resulting in lower ASPs.

The risks for this investment are real. Raw material prices will not stay low for long, and it will rise again due to the cyclical nature of the commodities market. However, I think a rise in raw material costs can be partly transferred to the customers due to a pricing agreement between the manufacturers and customers. As for forex risks, I believe that the USD will continue to appreciate against the MYR as its economy recovers and because of strong fundamentals of the country. Pricing pressures will undoubtedly affect Riverstone, but I think it will be be partly muted as the company is a niche player and does not want to be engaged in the price war among the mass producers. An example of niches the company targets would be the HDD industry, the mobile industry, and premium healthcare gloves. In all these markets, the company looks at customisation for each customer as opposed to mainly mass producing.

The company is currently expanding, and is building a plant in Taiping, Perak. Expected production is estimated to be 4.2 billion by Dec 2014. The plant is situated on a 30 acres land, while current plants only occupy 22 acres. Total cost is estimated to be around RM 400 million, in which the first two phases of RM 80 million and RM 40 million is estimated to be funded through internal resources. The next 2 phases are likely to be funded through bank borrowings. Additional production per phase of 1 billion gloves is estimated.

Riverstone Holdings 5 year Financials                          *Taken from 2013 Annual Report

If we take a look at the 5 year financials, the company has seen revenues and earnings almost increase every year from 2009 to 2013, as gloves production increased from 1.1 billion to 3.1 billion. From the table above, we see that margins were the lowest in 2012. This was due to reduced ASPs for its gloves because of increased production by competition and a lacklustre HDD market. Taking the same margins, and using a conservative back of the hand forecasted revenue of FY15 RM480 million derived from a target of 3.57 billion gloves (utilisation rate of 85% and a capacity of 4.2 billion in FY15, 2.635 billion gloves from a utilisation rate of 85% and a capacity of 3.1 billion in 2013), I arrived at a net profit of FY15 RM60 million. This is a low ball figure as I used a fair utilisation rate, a low net margin and a low capacity as capacity should be higher in FY15 due to the different phases of development. For Riverstone to show such earnings in FY15 would indicate low or minimal growth in earnings. If that is the case, would its PE then drop, resulting to a drop in its share price? The current PE at my purchase price is 14, and FY12 historical PE was at 8.65. Using FY12’s PE, we would arrive at a share price of around $0.55, giving a downside of 37%. On the other hand, assuming a utilisation rate of 90%, capacity of 4.7 billion in FY15, net profit margin of 16.2%, and a PE of 14, we would arrive at a share price of $1.37, representing an upside of 56.6%. The question now is, which case is more likely to happen? I believe that production and utilisation will remain strong as the demand for its goods is there. The HDD industry is forecasted to pickup from now till 2017, according to research reports. As for the forex and raw material costs, this should be slightly offset by pricing agreements in place and improved manufacturing efficiency when more lines are produced. The key battle would be the ASPs of its products, in which Riverstone needs to pick its battles carefully to avoid price wars. One has to keep in mind the net profit margin in the next few quarters.

Management owns most of the company (~60%), with the two top shareholders being the two founders. Compensation plans for these two are geared towards profit sharing plans (74%), as compared to mainly salaries (26%). Dividends have been growing strongly each year from 2006 to 2013, and dividend payout is in the range of 45-50%.

At my purchase price of $0.875, the company was trading at a PE of 14 based on FY13 earnings. Its ROE in 2013 is 18.0%. It is currently net cash, with cash buffers of RM108.9 million as of 1QFY14. This is expected to drop due to capital expenditures for its Taiping plant. Compared to the average of its peers, it is trading at a lower PE and PB ratio with a higher dividend yield. The strongest competitor would be Hartalega which is the world’s largest nitrile gloves producer with a ROE of around 30%. However, most of its competitors are players in the healthcare segment and are expected to compete aggressively moving forward. Dividend yield of Riverstone Holdings, at my purchase price is around 3%.

In conclusion, after weighing the risks, I feel the visibility of earnings for the company is strong, the management has a track record of growing revenues, earnings and paying dividends, and its conservative strategy of choosing its battles appeals to me.

 

Disclaimer: The author owns shares in the abovementioned company. The ideas expressed in this blog should not be construed as an enticement to buy or sell the securities, commodities or assets mentioned. The accuracy or completeness of the information provided cannot be guaranteed. Readers should carry out independent verification of information provided. No warranty whatsoever is given and no liability whatsoever is accepted for any loss howsoever arising whether directly or indirectly as a result of actions taken based on ideas and information found in this blog.

 

 

Purchase of Kingsmen Creatives

kingsmen logo

On 02/05/2014, I purchased Kingsmen Creatives at a cost of $0.95. I have been researching on this company over the last few months, and have been patiently waiting for the price to become more attractive before I sowed the seeds. However, the chance never came and its share price slowly rose instead. Thus, I have decided to bite the bullet while the price is still attractive to me. At its current price, it is selling at a PE of 10, with a dividend yield of around 4.2%.

The company is a communication design and production group with four divisions, namely retail and corporate interiors, exhibitions and events, thematic and museums and alternative marketing. To put it simply, the company conceptualizes the design of a project (for eg. the interior of a retail outlet or an event) for its client and executes the finalized design plans. Some clients under the retail and corporate interiors division include Uniqlo, Coach, Tag Heuer, The Hour Glass, Swarovski, DBS, UOB, NYDC, Swensens, etc. Clients under its exhibitions and events arm include Audi, BMW, Nestle, Formula 1, etc. Projects under the thematic and museums division include attractions in Universal Studios Singapore, the Cloud Forest in the Gardens by the Bay, the Enchanted Garden at Changi Airport, exhibitions at the National Museum of Singapore, and museums across the region. Its main competitor is Pico Far East Holdings, which is headquartered in Hong Kong and trading at a PE of 11.

The company has a strong track record of earnings and dividends growth, and is still being helmed by its two founders, Benedict Soh and Simon Ong, whom have stakes of around 20% each, representing strong insider ownership. It has paid out dividends even in the crisis period from 2008-2009. In fact, its dividends rose from $0.035 to $0.04 from 2008 to 2009. The company has seen a steady increase of its earnings per share from 2006 – 2013 at a compounded annual growth rate of around 18%. Management has been able to utilize shareholders’ funds well, producing an impressive ROE of 22% in 2013. The ROE of the company has been consistently above 20% in the last 8 years. Kingsmen Creatives has operations in many parts of the world, and only gets 37.4% of its revenue from Singapore, in the recent FY 2013. Its key markets in the region are Greater China (33.8%), Malaysia (7.1%), Vietnam (5.4%) and Indonesia (5.1%). Other markets include Europe, Middle East and US & Canada which together form around 6% of the company’s turnover.

In a recent interview with Biz Daily, Simon Ong mentioned that the secret of the firm’s success is due to its people, who strive to uphold the portrayal of “kings men”, whereby the client’s success is the firm’s success. Although the barriers of entry are low, the “reputational” barriers in the industry are high. In this regard, Kingsmen has a strong brand, as seen by the well established clients the company attracts. Moreover, the company’s diverse operations around the world enable it to offer convenience to their clients. For example, this would bring cost-savings to clients who want to roll out outlets in different countries in emerging Asia as Kingsmen, having operations internationally, could help design the stores in the local market that the client wants to expand in. The firm’s four divisions also provide a one-stop shop for clients as clients are able to engage the firm in the design of its interiors, and the marketing of its brand or products through exhibitions, events or alternative marketing concepts.

Taking a look at the salaries of the management, I find that the key executives are not excessively compensated. Being majority shareholders, both founders would undoubtedly be receiving huge dividends from the company. I personally feel that a company might be sending a wrong signal to its shareholders if the founders are themselves drawing huge paychecks in addition to their dividends. In Kingsmen’s case, both founders are drawing a salary of $1.3 million – a compensation plan which is largely based on bonuses, which is fine with me, as the management has led the company well. Moreover, Kingsmen is heavily reliant on its staff, as it is in the creative industry, where talent is the main asset. Thus, I understand the need for it to pay its staff attractive salaries.

As of Dec 2013, the company is net cash, having a cash hoard of $63.7 million while total debt stands at $4.6 million. This makes its ROE even more impressive, since it was achieved with minimal debt. Capital expenditures for the past 8 years have been below its operating cashflow, giving healthy free cashflow to the firm. In 2013, capex was around $4.6 million while operating cashflow was $22.9 million, giving a free cashflow of around $18 million. Given an increasing EPS and FCF, dividends seem to be sustainable going forward. In 2009, the company’s FCF was low, but dividends were still paid out due to the firm’s healthy cash hoard.

I will be looking forward to receiving the $0.025 dividend later this month.

 

Disclaimer: The author owns shares in the abovementioned company. The ideas expressed in this blog should not be construed as an enticement to buy or sell the securities, commodities or assets mentioned. The accuracy or completeness of the information provided cannot be guaranteed. Readers should carry out independent verification of information provided. No warranty whatsoever is given and no liability whatsoever is accepted for any loss howsoever arising whether directly or indirectly as a result of actions taken based on ideas and information found in this blog.

The Dhandho Investor: The Low-Risk Value Method to High Returns

The Dhandho InvestorThe Dhandho Investor by Mohnish Pabrai is an easily understandable investment book whose main message is simply “Heads, I win! Tails, I don’t lose much”. It espouses the concept of “Few Bets, Big Bets, Infrequent Bets” and the idea of the stock market being a marketplace where such opportunities can be found. Dhandho basically means endeavours that create wealth. Pabrai uses the analogy of how the Patels, a small ethnic group in India, began to dominate the motel industry in America using the concepts of low risk, high returns approach to business. Some key concepts would be to invest in simple businesses and to focus on arbitrages. I found the book easy to read, and enjoyable as the author uses interesting anecdotes and stories to portray lessons in investing.

Mohnish Pabrai is a well-known value investor who grew his fund at a rate of around 13.3% per annum between 1999 to 2012, while compounding his own wealth at a annualised return of 26% since 1995. He famously won a lunch bid with Warren Buffet and Charlie Munger in 2007, in which he paid $650,000 for. He is a fervent follower of Warren Buffet’s teachings, and believes in the idea of “cloning” the best. He prefers companies which look forward to replicating the strategies of other successful businesses. In fact, the set-up of his fund was ‘cloned’ from Buffet’s very own partnerships in the 1960’s.

Overall, it is a book I would recommend to newbie investors as the concepts and lessons are simple yet important.

Financial Habits – Spending Lavishly or Saving Frugally?

spend-vs-save

A habit is a routine of behaviour that is repeated regularly and tends to occur unconsciously. In the financial sense, many of us tend to have the habits of either spending lavishly or saving frugally. Many of my friends who hail from the former camp tend to have the thinking of “Life is short, and that we should spend to enjoy it now”. They work hard and then spend almost all of their hard-earned money on clothes, the latest gadgets, regular dining at expensive restaurants and rarely save. On the other hand, some of my friends who stem from the latter camp usually have the mentality of “saving for a rainy day” where they see delayed gratification as a form of financial prudence. In extreme cases, some may be even seen as misers who are rarely generous.

As usual, I think the key is to always strike a balance between excessive and miserly spending. Life is indeed unpredictable, and we do not want to squirrel away every single cent only to not be able to enjoy it should anything unfortunate happen. On the other hand, we do not want to spend every single cent, and live from paycheck to paycheck. In the event of a crisis, there might be insufficient savings to tide us across and our lifestyle would be totally wrecked as a result. Perhaps the only similarity in both camps is the individual’s pursuit of happiness. The former camp believes in spending now to enjoy one’s life now while the latter camp believes in enjoying one’s life at a later stage. I believe we should all strive to live one’s life in the present while wisely planning for the future at the same time.

In this regard, I have realised that only a few things truly bring me happiness. I tend to care less about the latest fashion trend or the latest IT gadgets but I do have a soft spot for food, especially the occasional steak and sashimi. However, I rarely visit expensive restaurants and usually satisfy my craving at budget restaurants, which are good enough for me.  In addition, I enjoy catching Chinese and HK movies, especially the crime and wuxia ones, which I grew up watching. Exercising regularly through a good workout or an evening swim also makes me feel more energetic and as a result, happier. Most importantly, spending time with people I love brings me contentment and gratitude in life. Maybe, its true that the best things in life do come free (or inexpensive) afterall. Well, at least it does for me.

When asked about what surprises him most about humanity, the Dalai Lama answered, “Man. Because he sacrifices his health in order to make money. Then he sacrifices money to recuperate his health. And then he is so anxious about the future that he does not enjoy the present; the result being that he does not live in the present or the future; he lives as if he is never going to die, and then dies having never really lived.” Enjoying the life we want now and living in the present while at the same time ensuring that we are still able to do so in the future requires financial prudence when it comes to our spending habits.