Purchase of Lian Beng Group Ltd

Lian BengOn 05/02/15, I purchased Lian Beng Group at a cost of $0.62. I first got to know about Lian Beng Group a few years back when I invested in Tiong Seng Holdings. Back then, I was attracted to Tiong Seng and compared it to its peers, which included Lian Beng and Chip Eng Seng. During my comparison, I realized that Lian Beng’s margins were much higher, but chose to invest in Tiong Seng as I had observed its strong pursuit of technology in its business. I exited my investment at a small loss after the China Minzhong saga, as I realized that I did not have the necessary competence to understand the industry.

So without further ado, let’s get into the business of Lian Beng. Lian Beng is mainly a construction company, with fingers in the dormitory business, ready made cement and upcoming ventures in the supply of asphalt and granite. Studying the financials in the graphs below, we see that construction has been the main revenue driver in the past 4 years. The other construction related business has seen its revenues rise due to the growth in the RMC segment, where Lian Beng is now estimated to be the 4th largest concrete supplier (Sinmix) in Singapore. Its property development division’s revenues are lumpy in nature, and this might cause large spikes and falls in earnings. Its investment holding division, which mainly consists of its dormitory business, has started bringing in revenue in the past year. Its maiden foreign workers dormitory in Mandai is freehold, and estimated to bring in around $7m in earnings each year. Unfortunately, there is no breakdown on the profits of each individual division, but the property development division is likely to bring in the highest net margins of around 15-25% (as seen in pure property developers like Oxley). The construction segment’s pre-tax margins are estimated to be around 10% while the RMC segment is estimated to have the lowest margins of 6%.

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If we study the 5Y financial summary of the company, revenues and earnings have been growing rather steadily. However, it is important to note that the figures here are restated to include fair value gains. If we were to remove fair value gains and minority interests, the figures are estimated below.

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I estimated FY14’s EPS to be around $0.12, after removing fair value gains and minority interests. This is a rough ballpark figure. As such, at today’s price of $0.62, the company is trading at a PE of around 5.17. Its ROE has been above 15% for the past 4 years, despite having a net debt to equity position of 0.452, which is one of the lower geared construction companies around.

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The company also has one of the stronger profitability ratios in the industry, when I compared it to peers like Chip Eng Seng, Tiong Seng and Wee Hur. Only Chip Eng Seng’s profitability has been better than Lian Beng’s. I believe its closest peer with regards to the business mix would be Wee Hur, who has fingers in construction, residential property development, and the dormitory business. In this case, Lian Beng’s ROA, ROE and NPM figures are higher than Wee Hur’s, but it is important to note that Wee Hur has a much stronger balance sheet, with a net cash position.

Lian Beng’s dividends are decent, but not fantastic. In fact, I rather the company hoard cash instead of distribute it out as dividends due to the capital intensive nature of the construction/property development industry. Having a large cash hoard helps to reduce scares from interest rates risks, and a languishing property market where the developer finds himself unable to move its units. It would be a nightmare to not have reserves when one finds himself overleveraged in development projects or investments.

With that, we can see that Lian Beng is currently trading at a low PE of 5.2, attractive PB of 0.8, and a dividend yield of 3.6%, with good ROA and ROE figures while using a reasonable amount of debt (net debt to equity ratio of 0.452). However, as the property division revenues and earnings are lumpy in nature, I have decided not to include it in my calculations. I estimated Lian Beng to be trading at a PE of around 6 if I were to remove the estimated earnings from the property development division for the last year. I acknowledge that my estimate is at best a rough gauge, and may hugely differ from reality. My estimate of the CAGR of its EPS is around 28% for the last 5 years, while CAGR of its revenue is around 22%.

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Looking at the company qualitatively, I feel that it has grown from strength to strength in the past years. Starting out as a construction company, it has expanded into property development, the supply of construction materials and the dormitory business. It has kept to its core focus and expanded into the value chain, making it vertically integrated, which has seen its profitability rise generally throughout the past 10 years, from 0.991% in 2005 to 11.558% in 2014. During the financial crisis in 2008, Lian Beng was still profitable and its EPS continued to grow. The company has also been careful in the property development area, preferring to invest as a minority investor in joint ventures with more experienced developers like Centurion, Oxley, KSH and Heeton. This is one aspect that I am favourable of, as it reduces the risk that one bears if one were to develop the property by himself. Furthermore, it is likely that Lian Beng would be given the contract to construct the development that it has a small stake in. A large number of Lian Beng’s JVs have been selling well, with the exception of Floraville and Floravista. We would have to follow this space to see how the management performs when it comes to identifying promising developments. Lian Beng has also been seemingly successful in its investments, one of which was the recent purchase of the Prudential Towers from Keppel Reit. Lian Beng had a 32% stake in the 92.8% purchase of the building at a cost of $2,316 per square foot, and recently sold half a level at $2,750 per square foot. This is an 18% increase in the selling price within a few months. However, much of the building is still in the JV’s hands, and we would have to follow how things play out from here.

The company is also venturing into the asphalt and granite supply business, which will help to further grow the company in the future. Recently, the company bought a plot of land in Leng Kee Road and has clarified that it intends to enter the automotive business in a 80-20 JV with Vincar, a parallel importer of European and sports cars. I am not too optimistic of this, as it seems that Lian Beng is veering off its circle of competence, especially since its the majority investor. In this regard, Lian Beng announced that it wants to leverage on the business experience and expertise of its joint-venture partner (Vincar) who is familiar with the automotive business, in planning for the usage of the property as the vicinity of Leng Keng Road is an automotive belt with an abundance of car-related business. It is also contemplating to engage in the provision of car maintenance and general services as the group has a fleet of cars and commercial vehicles which are used in connection with its building construction and civil engineering business, which will become a ready pool of users for such services, if the acquisition is successful. While this gives me a glimpse of the management’s foresight and desire to further monetise its assets, but as mentioned earlier, I am not too optimistic of this until further details are given. What I am optimistic about is the management’s focus on growing recurring income through its dormitory business, asphalt, granite and RMC segments.

The company is majority owned by the Chairman and his family, with a deemed interest of around 35% of the company. Looking at their remuneration which is largely bonus based for the top 3 executives, we see that it has generally followed the net profit of the company. Although the remuneration is high, these give me an indication that management interests are still aligned with minority shareholders.

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Furthermore, management has been buying back shares aggressively in the past year. Throughout 2013, the key shareholders have been purchasing shares, with the highest price being paid at $0.56. The company has also been doing buybacks in 2014, with around 19.6 million shares transacting for a value of $12.6 million. This gives an average purchase price of around $0.645, with shares being purchased at a high of $0.695. This could be a sign that the management thinks its share price is currently undervalued. Purchasing at a price of $0.62 currently would sit somewhere in between the max price shareholders paid in 2013 and the average price at which the company bought back shares in 2014. Shares buyback would help to bolster the EPS moving forward.

The question now for me, would be – Can Lian Beng continue to increase its earnings in the future? There seems to be good growth prospects for the firm to increase its revenues (asphalt, granite, dormitory), and with the company buybacks, EPS is likely to increase. Since the company is already trading at a discount to book value and at a low PE, I believe the downside is limited.

Nevertheless, there are always risks that one must note. The property industry has been affected by the government’s cooling measures, and this might result in less developments and subsequently less construction contracts going forward. However, the company’s strong orderbook of $821 million in 1H15 helps to mitigate that impact. Other risks would include not being able to sell off its property development projects and decreased margins in the materials supply segment. In 1H15, margins of its RMC segment has dropped, and competition is stiff, considering that it is a commodity afterall. With interest rates expected to increase towards the later part of the year, property companies and REITs may be adversely affected if they are too highly geared.

I believe this investment is the case of “heads I win, tails I don’t lose much”. The company’s competitive advantage is its integrated business model and its ability to partner experienced companies in venturing out. However, it is not a fantastic moat, and does not give the business the power to increase prices without affecting the demand largely. My motivation for this investment is mainly for capital gains, as I feel the market is undervaluing this share at the moment. My purchase is a small one as I would like to conserve some cash in my portfolio to take advantage of any market dips in the future.

 

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.

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