Saturday, December 11, 2010

1+1 =1, 1+1=2, 1+1=3

Your school teacher or most parents in our today's culture will teach you 1+1 = 1.
A con man or a dreamer would probably tell you 1+1 = 3.
A rich man would say 1+1 =2.

Wait, wait wait...what...a con man would tell you 1+1 =3...well I guess everyone understand that but your school teacher would teach you 1+1 =1....that doesn't sounds right. Well that's I've been taught and I believe most did. Your school teacher would probably teach you 1+1 =2 in math but not in life. "Your life is 1+1 = 1 and you have to pick one", that's what we've been taught. Still don't get it?

Your teacher most likely would tell you to have a bright future in your life you gotta be a doctor or a lawyer or an engineer or a chemist...etc etc whether or not you like it.  And if so happen that your passion is in one of those then it is good for you but if it is other wise, you'll have to pick one. And you better pick the "right" or you'll be branded as "useless". And even if you got the "right" one, you won't be probably end up with 1+1 =2 because they have another piece of advise for you. "Work your ass off and race to the top, else you are no better than those "useless" ones". And you'll end with 1+1=1 as well. [Watch part 2 of the videos]

Warren Buffett "...It's like saving sex for old age"

What is with all these numbers anyway? Well, I call it life. If you work so hard and put so much effort on the things that you don't like you'll lose half of your life. And you can never have a full one.

Don't get me wrong, I have nothing against teachers or any parents. And I'm not blaming neither of them. In fact, my family are from educational background. It is just the system. The system in our society that goes into our education system.

I've been lucky enough to spend some time with some "rich" folks for the past few weeks. And I do notice they have one thing in common. They just do what makes sense. Most of us know 1+1 = 2 but end up doing the other 2 instead. I have few friends and relatives who come to me and talk about their business or investment ideas that can make tons of monies. But when I ask them, what's the business model or how does it look like? They have no idea at all. Hmm.....

Anyway, below are the links to a Warren Buffett speech videos. I know they are people who have no time to read investment books or don't like reading long text at all. This video pretty much tells his principal in life and investment.
And if you don't have time to watch still, basically what's he's trying to say is 1+1 =2.

Sunday, November 28, 2010

ReValuation - Entry and Exit Strategy

Some of the valuation on The List has been dated. With so many earning reports passed by, lets do some re-valuation on some of the businesses.

Note: All valuations are done by having 10% discount on free cash flow with 20% margin of error

Let's start with JobStreet Corp [JOBST]. Quarterly revenues are recovering as expected and is on track to return to its heights in 2008. Q4 should should be an active hiring seasons for most corporates as employees tend to leave in Q1 after...well if you know what I mean. Taking the industrial average growth at 12% and 20% growth this year, it'll gives its value to:
Max Entry Price: RM2.80
Exit Price: RM3.15 (30% growth this year)

As for Freight Management Holdings (FREIGHT), the management has announce their intention to expand their business abroad especially in the Asean region through JV and acquisition to diversify its earnings. Currently, 78% of its earnings still comes from Malaysia so we should expect the expansion plan will happen in the next few years to come. Historically, everytime FREIGHT involves in an expansion plan, its revenue grows by more than 15%. Given to this I'll be using 12% growth:
Max Entry Price: RM1.23
Exit Price: RM1.95 (15% average growth)

Hai-O Enterprise (HAIO), has a challenging year this year and is expected to drag on in near future. MLM division has been disappointing this year. I can see they are having 2 problems. 1 is the new amendment made on the direct sales act, which will give them a temporary hiccup. 2nd is their products which they have not admitted.This is very much evident from their Q1 result. The massive drops shows how unsustainable their MLM revenues are. They need to come out with a more sustainable products sales strategy and they can't rely on big ticket items anymore. Their venture from the energy division to a new thermal technology is promising but their decision to manufacture the products itself has create some uncertainties to me. Recent announcement that they would like to venture into property development sector has made my decision to sell even easier. That's is one sector that I normally avoid for many reasons. The timing of their entry to property development sector is pretty much the same as they did before 1998 crash.So,
Valuation: Uncertain

NTPM Holdings (NTPM), one of my favourtie. This is one competing in a competitive industry and playing second fiddle to Kimberly-Clark as fas as products pricing are concern. Their products are seen as "greener" as compared to Kimberly-Clark which may provide some competitive advantage. Sales growth have seem to slow down. So I'll be using industrial average of 2% for its growth.
Max Entry Price: RM0.30 
Exit Price: RM0.75 (13% growth rate)

As for the rest, I'll do it next time as it is bit late now. From the list, there doesn't seem too much upside we have here. And with the bull run in KLSE this year, it is more difficult to find good value business than we have previous years. Evidently, Tan Teng Boo's (ICAP) has seem to increase its cash position recently. Yea...ICAP. There is still an interesting choice here. ICAP applies value interesting strategy in its fund. If they are still holding the equities in there, chances are they are still undervalued. Even if they were to cash out all of'll probably buying RM1.20 of cash for RM1.00 since it is still selling at a discount to its NAV. Yea I know...they do made losses at times but who doesn't. So if I don't feel comfortable holding some idling cash and don't know where to put my money, I'll leave it to Uncle Tan to manage.

Thursday, November 11, 2010

Money Creation - Simplified

Well, I'm not here to talk about history of the invention of money but to talk about how money is created today. Yes, money creation. Perhaps some of you might have know this, for those who doesn't, you probably should continue reading this. No, this is not quantitative easing or 'money printing', this is different.

Money creation?...Today?....What?
Yes, today, everyday. When? Every time you swipe your credit cards, every time you take loan from banks to buy car or house, just about every loan you just help to create money in the economy.

That's how the economy works today - partly.

It is quite simple. Ever heard of Fractional Reserve Ratio? You can find the explanation from wikipedia if you interested in the details, if not this is the simplified one. Basically what it means is that the minimum amount ratio of deposit  the bank must hold in order to lend money to its borrowers. Lets say if the minimum amount ratio is 10%, 90% of the deposited amount can be lend out. Take for example:

Bank A, a car seller and a car buyer. 
Imagine both car seller and car buyer has an account in Bank A. The car buyer deposited RM100,000 in bank A. Somehow he decided to borrow money from the bank to buy a car worth RM90K. So he borrows from bank A. With the fractional reserve ratio of 10%, Bank A is allow to lend out RM90K which is 90% of the amount of cash it has in its deposit. When the car buyer pays the car seller RM90K, Bank A will key in that amount of money to the car seller account which happens to in Bank A. See here, no real cash movement are involved and the bank has now RM190K in its deposit and thus RM90K has been created. Now the bank has RM100K in cash and RM190K in liabilities.

Now, when the bank key in RM90K into the the car seller's account it also means the car seller has deposited  RM90K into its account. This will give the chance for Bank A to lend out another RM81K (90% of RM90K). If this cycle continues, Bank A can expand its reserve to the maximum amount of RM1mil or create RM900K (RM100K + RM90K + RM81K + RM72.9K +.......= RM1mil). The multiplier can be calculated by this simple equation:

multiplier = 1/ratio = 1/10% = 10

Means if the ratio is 10%, 10 times of the amount deposited can be created, 20% means 5 times and so on. The ratio differs from country to country. Of course in the real world, it would not be just one bank, but this is regulated by the central bank. Even if the money is deposited in Bank B, Bank A could still loan out 90% of it as long as the total for both does not exceed 90%.

Does Malaysia has this?
Yes, of course. The only difference is that we call it Statutory Reserve Policy (SRP). What is the ratio then? Erm....1% as of the day I wrote this. This would mean, every RM1 deposited in our banks RM100 can be created. From 2008 till today, our statutory reserve requirement has been cut from 4% to 1%. Well, normally when a central reduce the requirement it is to increase money supply to the market or in other words to get the economy going. If the economy is improving, why is there a need to increase money supply? Or is it? Hmmm..... I don't know. But....GDP can be improved by incurring more debt. How? Maybe next time.

Well that is how it works for now. Unless any reform takes place which is still in discussion now. We'll see.

Tuesday, November 2, 2010

Financially Stupid?

Normally I use harsher words than that and I'm even harsher if I were to talk about personal finances verbally. So I don't think that is a harsh question that everyone should ask themselves. 

I am halfway reading this book by Jason Kelly "Financially Stupid People are Everywhere.....Don't Be One of Them". Well, the first 2 chapters of the book basically covers personal finances stuff (i'll mention later), and the rest are pretty much about the mess in the US which are more relevant if you are living there...or if you are interested.

Okay, I'm not going to do a book review on this of course I haven't finish the book yet. But I gonna share with you some of those personal finances tips and disaster from the book - plus some of my thoughts.

He mentions about the 3 Cs: Credit cards, cars and castles. 

Credit Cards:
What he suggests is pretty simple, leave NO balance. Pay your statement balance on time and not just minimum payment but ALL of them. With this it'll help you stay out of credit cards problem that most of us had. The reason for this is plain simple, NO balance equals NO interest charge.

My thoughts: He has his points, 1.**% per month is a lot of money. That is at least 12% pa. If you are into investment, you would have probably see "magical" of 12% growth to your money is. But if that is know the math. He also mention about installment payment. Those who had done that 0% installment charge aren't really 0% at all. They charge some 3-5% initially. Does that mean installment payment aren't good. Not really. There is this thing call bad debt and good debt. The book uses a business example, but I'll use an investment simple example. Say you have RM5000 in cash but you purchase something worth RM5000 with a 12months installment and the bank charge you 5% services charge for it which make your total credit balance RM5250. What this mean is that the bank will pay the RM5000 amount to the seller and charge you RM250 for that. So instead of using the RM5000 of cash to pay for your product, you invest it in an income fund (which probably gives you about 5-6%pa in return). What does this mean? 

You get what you need in advance and have the service charge covered and in possible earning position. 
Bank: 0 vs You: 1. 
If you put them in M-REITS for example which yield about 8-9%, you'll be in positive position. 
Bank: 0 vs You: 2.  
But if you miss all your installment
Bank: 12 vs You: 0

Get the idea? He actually went on to explain how disastrous for those to purchase goods after goods believing they "own" them and the danger of balance transfer. But I'll keep this post short, if you can understand the example above, you'll why people go bankrupt for doing that.

He suggests buy cars with cash. I know most you will shout WTH? or even WTF? He says ask yourself this simple question if you plan to purchase your car by 5 or 7 years installment, will your car still be cool after 5 or 7 years? We all know the car you drive belongs to the bank until you services all your loan. Will it still be cool then?

My thoughts: Well, actually I agree with unless UNLESS there is a real need for a car. I understand in Malaysia, we NEED a car. Public transports are as if they weren't there and it is safer to swim in Taiping Lake than to drive in Malaysia road so bike is not a good idea. It would be great if we can afford a car with cash. So for me, buy a car if you need one. If I were to get a better car (upgrade), wait till I can afford it with cash not when I'm Polo enough. Simple.

Kelly suggests a 20:80 rules. That means, pay with AT LEAST 20% down payment and 80% on loan. Buys only when you can afford and really comfortable with the installments. There is nothing wrong staying in a rented property.

My thoughts: Castles here aren't the property for investment. This is your home where you stay. So in Kiyosaki's definition this is a liabilities where cash flows out from your pocket. All these make sense. Yes, your house does appraise in value over time. Question is, in order to capitalize on the gain, you would have to sell the house. Are you going to do that to buy a cheaper or probably smaller house? With the property price goes soaring over the past few months, affordability has become an issue among many of us. This book did mention on not to get tricked by banks' fancy package. I mean those flexi interest rate type of package. Yes, the installment does look really cheap the first 3 years or so but what really matters is when the interest rate eventually increase. Can you afford it it with your current pay? Is it still 1/3 of your take home income? Some of the working class claim that their salary will increase over time. Well, that's for me a gamble a person can ill-afford. And when decide to purchase a home, do take into account, the renovations, insurance and maintenance for the house.

So are you financially stupid?

Saturday, October 9, 2010

It Opens Our Mind

First, this is not a political blog nor it is intended to be.

Someone shared this on Facebook today. Although this movie that I shared here has nothing to do investment, I feel that it is my responsible as a citizen to share this. Because I don't think this movie is going to be shown on our cinema.

So sit back and relax, get some snack, gather your family, friends or relative and watch :)

Movie Title: Gadoh
One of the great Msian movie in the modern days after Sepet. A truly Msian movie and it touches everyone of us. Congratulations to Big Pictures Production and Pusat Komas for this piece of art.

Click on this link below to watch. Trust me it worths your time.

Sorry for being emo, but this movie touches my heart and I kinda laugh at some scene. They nail it.

And if you ever wonder how I look like, urmm.....well, if my hair is little longer and if I kena belasah by someone I would probably look something like this. Haha.

Saturday, October 2, 2010

The Great: Freight Management Holdings Bhd

If you have notice I have swap the position of FREIGHT and HAIO few days back. Okay it is definitely not because I have a quota that there must be two companies in The Great list just that I'm pretty impressed by what FMHB has done over the months of following them.

Again, these are my right brain thoughts of FMHB.

If you read my first post on FMHB, the reason I did not place them at the great is because of their tight operating margin. Well it may not. Its operating margin has been above industrial average (7.6% vs 3.3%) from Reuters only below those in the S&P 500 (16.6%). The same goes to gross profit margins (21% vs 12.7%) but still below the S&P500 (29%). Anyway, those in the S&P 500 do not compete directly against FMHB here but it is still good if they can achieve the figure. Again, previously I am a bit uncomfortable with the tight operating margin versus the rest of the choices that I have but I think it is fairer to compare them to industrial average which we see it clearly performed above them.

Why its tight operating margin doesn't bother me?
Okay, this is because the nature of FMHB business. How it works is that it takes an order from a customer and ask the transportation company in which the customer has selected to transfer its goods. That order to the transportation company is the cost of revenue to FMHB than they'll charge a premium to their customer. Then their staff will do all the paper works and there is where the SGA expenses come into play. So from here you'll see how asset light is this company and the major overhead they have is the human assets which can be "easily" although unpleasantly dealt with if you know what I mean. Anyway like it or not, it's the same for any company you work with and you'll see that pretty often if you study US businesses. Blame capitalism if you like. Back to the FHMB, asset light doesn't mean no asset at all as their tug and barge as well as warehouses still requires assets. Looking at this, you must have thought they need plenty cash to do business and yes indeed. So don't expect them to pay out all the cash as dividends because that is your working capital.

How about the high receivables then as compared to cash and liabilities?
Well there is still a little bit of a risk here BUT it is pretty unlikely to put them into trouble because they serve more than 2500 customers. So default risk is pretty low I would say.

Is this kind of business sustainable and why not just do it themselves instead?
There are few reasons for this. One being it involves lots of complicated paper works with taxes, duties, laws and etc. especially when it involves cross border transfer. So there is a lot of risks involved if you are unfamiliar with all these and you don't want to be late sending your products to your customer. Why not setup a department instead? It might not that cost effective to most because you don't send or receive products everyday or constantly. So one might end up with less productive department. And it has not counted the cost to train new staffs yet. So having a freight forwarder is a great thing to many businesses. Plus FMHB has more than 22 years of experience doing this so you might expect them to have a huge network and giving customers the best deal.

The thing that I like FMHB compare to others on the list?
What is that? They are like sotong. They expand their business either by acquisitions or JV or partnership. That is Sun Tzu-like. Freight forwarding business relies a lot on the relationship between them and their customers. So you don't jump in straight and go for a war because it'll cost you in many ways. Instead, you make friends with them leveraging on existing advantage and infrastructure. That is a win-win situation for both. If you look at it, there is one massive company who does that with great success. Who?.......I bet you know Berkshire Hathaway.

So all these make Frieght Management Holdings Bhd into my Great list.

Thursday, September 30, 2010

The Good: Hai-O Enterprise Bhd

Well, I've been away from this for quite some time (holiday you might call it) partly because I've buzzing around with my another hobby, photography which uses my right hand brain a lot. So it's not that easy pulling it back to the left or 50:50 I suppose. Using the right-sided of the brain to think of all these sometimes does show me the other side picture. I wouldn't call it a better view but rather an extra view. So these are what I see from the right brain.

Alright, as you might see, I've downgraded Hai-O to Good. I just thought about this 2 days ago and the quarterly result announced just few hours back might just confirm it. I think, it has lost its competitive advantage in its MLM division. Okay, it is partly due to the stricter rules by the government which I really welcome to be honest. But it is more than that. Looking back at its MLM structure there are some noticeable flaws in it. First is its product. Not to say its products aren't good just that they are products with high life cycle. How often would you replace you water filter or corset? (Not 100% sure about corset cause I don't wear one). Unlike Amway who are selling health care products, Hai-O existing consumers won't return and purchase again unless they got a new member. Yes, filtered has to be replaced all 6 of them periodically but come on Malaysian, are we gonna follow that.

So how does it able to grow so quickly few years back? I've say that the products help them but not just that. The marketing plan as well. Their previous marketing plan allows their existing members to recruit new members quickly which are abused by some putting their downline into trouble. On the other hand these people are exploiting other people's greed. Don't get me wrong, I am still a believer of MLM and this industry does grow and contribute. But like many good ideas, it can be engineered to so something it wasn't intended at first just like how E=mc2 turns into an atomic bomb. Kudos to Hai-O realize this problem is not quick enough. It has hurt its reputation and it is not going to be easy to recover from here. Of course some of its CDM (okay it means top sales if you're aren't familiar with MLM) have been terminated which I think is good but...yea..late.

So what they are currently doing now is to clear up their "unfortunate" members piled inventories as required by the new Act. To be honest, I can't say that I pity them. It is just like those who lost monies in the stock market because of greed. Yea...they might felt cheated in a way...but man...come gotta make it real hard to be cheated. And it is aren't cheating anyway. It is pure greed. Joining an MLM company is like investing in a business venture. You gotta do all the necessary work as a business person.

What do I think of this? This is a temporary setback of course BUT different from most setback. It'll start from a new base. In short a restart. This is not a good news for the current shareholders. But I am still confident they'll be able to sail through but it won't be as great as it once were.

MLM contributes about 90% of Hai-O revenue that's why I talk about it a lot. But there is another division about Hai-O which makes me a little uncomfortable. Hai-O Energy. I think they have found a very promising technology and are in the process of patenting them.....and also,,,they might manufacture products out of this as well. Which is Not Good. Selling patent means existing players can buy their patent and compete against them. Not a very good idea since they have no experience in doing this. The recent MoU with Utar might means 2 thinks, continuing RnD or manufacture it. So it is good to keep an eye on this development.

Monday, September 13, 2010

The Good: Hup Seng Industries Bhd

Ping Pang Chiao Chiao Bing, that is what I can think of when someone mentions Hup Seng to me - well, not that bird thingy of course. Anyway, kiam piah or ham peng or sien bing or in ABC cream crackers, that's what they are famous for anyway. Business-wise, they have been around for decades but I have know this biscuit since I was 7 and I believe it has been around longer than my age. Although I have to admit, I don't really like the biscuit when I was younger (lack of taste) but as I grow older, it starts to taste pretty good.

Founded by Mr Kuo Choo Song and Kerk Chu Koh, Hup Seng has grown into one of the largest biscuit manufacturer in Malaysia with about 1400 employees. Their business model is pretty simple; make biscuits, distribute and then sell. And yea, since they have acquired In-Comix, now they are distributing instance coffee as well.

What got me into this business is its quite recent announcement of a special dividend that cause a sharp increase of its stock price. Special dividend can mean two things to me, superb cash generating business or "irrationally" managed business. Perhaps maybe, someone inside is messing around with the market.

Historical Business Performance

For a start, Hup Seng is not the most exciting business in the world. Revenue have been relatively flat with CAGR of 3% and profit after tax at about 8% (1998-2009). So, nothing to shout about really. Plus there is an indication that it doesn't have pricing power to its products (I don't really eat biscuit that much, but I hope you can tell me).  Graph below shows a PAT margin and we can clearly see how its margin got squeezed in 2004. The improved margin in 2008 and 2009 is largely due to raw materials price drop - Or are they?

Lets have a deeper look into their quarterly performance on the graph below.

If we could remember well, the crisis hits somewhere between Q3 and Q4 2008 and commodities prices are at their peaks still in Q1 and Q2. Plus a look at their SGA expenses in 2007 and 2008, there isn't much changes which means no cost cutting in terms of staffing or salary or even advertisement. With this, I could conclude, prices of their products have been adjusted and 2009 improved margin benefited from that adjustment. 

Hup Seng is not just a pure biscuit player, after its listing, it acquire 100% stake in in-Comix so they are selling instant hot drinks as well. In fact, they themselves have a good products mixes of varieties of biscuits such as Deluxe sandwich, cookies and all other kinds of biscuit. The closest listed competitors I could find is Hwa Tai.

The graph above shows the gross profit margin between Hup Seng and Hwa Tai and clearly we can see, Hup Seng consistently performed better than Hwa Tai which signifies Hup Seng competitive advantage over its competitor. On liquidity wise, Hup Seng has seen to be much prudent versus its counterpart who stays below 1 over the past 5 years. And as of today, Hup Seng has no long term debt and has a cash of more than RM47million which translate to nearly RM0.39 per share. That is almost 22% yield if they were to give all of them back as dividend.

Return on Capital Emplyoed (ROCE), has definitely improved ever since the price adjustment although, I expect it to reduce to around 10%-15% when raw materials prices pick up in which they will...sooner or later.

What I like about Hup Seng is its exports which contributes almost 30% of its revenue. Its products are exported to 25 different countries mostly in Asia some in Australia and Africa. Its export growth outperform its local business with a double digit growth rate of 10% per annum versus 1.2% local CAGR. The likely biggest source of growth is the overseas business.


Hup Seng has a pretty simple business model with simple products. It has 3 subsidiaries one which is a biscuit confectionery, the other is to distribute and sells and the one it acquires, InComix. It is not a great business and some of its products compete in a pretty competitive F&B business industry against the likes of Kraft and Nestle. Hup Seng's competitive advantage is its relatively lower price or maybe some customers who prefer its taste better than the other. However F&B industry is unique, as the advantage of one product over another is very subjective to consumers' personal flavor. Plus, it could be difficult to duplicate although it could still be easily substituted. Unless if it has a champion products like Coca-Cola or Kraft's Twisties. It sure does have the ability to survive and generate cash especially if we look at how it turns around in 2008 when it is squeezed to almost death (well red actually) in 2007.

To do a DCF valuation on a business with loads of cash like this may not serve its justice. But still, no one knows what are they going to do with its cash and they could well end up like Genting Malaysia. We should get too excited about the recent special dividend unless we see they consistently doing that as they may just do it to keep some of its shareholders happy.

Revenue: I don't think Hup Seng is going to perform above industry standard of 6%, so I think they'll probably grow at the average of 3%. Local business is pretty much saturated so their source of growth is likely to be from its overseas exports.
Cost of revenue would stay at 73% while SGA expenses should be about RM41million all years.
I took its average Capex for RM5.1million for machine maintenance and possibly upgrade.
Tax about 25% and terminal growth value at 3% as well.
Discount value of 10% and Margin of Safety of 20%.

That would give Hup Seng a fair value of RM1.05 which is way over valued given its current price of RM1.78 -even if you add in its RM0.39 cash.

Friday, August 27, 2010

DCF Valuation Explained - A Little

Say, someone was to sell you a vending machine. It is placed at a strategic place where it could consistently earns him RM1000 per year and is expected to increase at a rate of 5% each year. It has a lifespan that could last for another 5 years. How much would you pay for it?

This is where Discounted Cash Flow Valuation comes into play. That RM1000 is the net cash which is the coins you collected from the machine minus the maintenance cost....and so on. That is the amount of cash that goes into your pocket. And it is expected to grow at the rate of 5% for the next 5 years. So your free cash flow table would look like this:

If you sum it all up it is about RM6802. And if that person quote you this price, you can ask him to go to......well whatever you prefer. I bet most of you know there is a time value in money. RM1276 in 2015 does worth RM1276 today and the same goes the other way round. (Just like you char kueh teow. You use to buy it for RM3 5 years ago but now it is RM3.50). That is why the bank charges you interest when you borrow money from bank. And that's also why you need a discount.

So, what rate should you use? Let's go back to the bank. A bank charges interest at rate say 6% on loan because it thinks it can earns 6% if it has not lend you the money and invested it somewhere else instead. So, the bank thinks 6% is its opportunity lost and you will have to pay 6% extra when you return the money. Welcome to the world of capitalism. So for you, you are pretty sure the next RM1050 will arrive a year later and so on. By receiving the cash late, you have lost the opportunity to invest in something for a better return then you put a discount. The question is how much you more think you could earn elsewhere? That will determine your rate. You can use FD rate, EPF, or bonds you are able to purchase one. Let's just use 5.5% (roughly the average EPF dividend) for this. Your discounted cash flow table will now looks like this:

The one on the right most column is what those money worth today - for you. So you add it all up, and you'll get RM6299. That is the fair value for this machine. But it doesn't end here because you are not 100% sure you are able to get 5% return every year. So you need a margin of safety but what is the best rate? Any number that can make you sleep well at night. If you take 20%, RM5039 is the maximum amount that you will pay. Simple huh?

How bout for business then? The idea is the same, just that a little more homework is needed. You can try visit this wikipedia page about DCF; Looks complicated huh? Forget about the mathematics, just click on the picture on the top right hand corner to enlarge it. It pretty much explains everything. A picture worth a thousand words ma. 

Investing is a simple art but not easy. The trick here is to pluck in those numbers onto that table from left to right. What is the right number then? There is no right number, just numbers that make sense. Yea, you'll have to guess, assume or maybe just pluck from the air which ever makes sense to you. Whichever number that could make you sleep at night or more importantly makes you able to make DESICION.

DCF calculations can be explained in a few Greek letters. Since Greek can be difficult to understand at times, I'll try to explain in Manglish.
WARNING: You might fall asleep while reading this. 

First thing you'll see is EBITDA. This earnings after you minus cost of sales and SGA expenses from revenue. The difficult part is to guess the future revenue. Okay la, forecast la..not guess. You can use historical earnings or growth consistent enough. Normally I use this for mature businesses. Or you can visit, use the industrial average growth or S&P500 average growth to forecast its revenue. These are the average growth, value investor normally picks above average businesses. If the business consistently outperform the average results, you can be pretty safe using the average forecast. Will you undervalued a business if you do this? Yes you might.But what is the worst that can happen? You'll miss the boat. But remember Rule No.1 and No.2. Or if you are Buffett or Teng Boo, meet the management for forecast adn ask them to convince you how they come up with the number. Yes, if you read his letters, that's what he did. As for cost of sales and SGA expenses, consistency is the key. If the ratio for all these aren't consistent, chances are, you are looking at a company in a very competitive industry. So, you might consider to skip it.

And then you minus the capex, changes of working capital, taxes and whatever cash outflow that is relevant to the business. For these, I don't really have any guide to follow, they all depends on the business really or how they operate. To be comfortable, check all the announcements including pre-IPO plan see if there is any plan especially for Capex or talk to the IR see how the business works. If you are bit lazy, just use the average. That of course comes with higher risk lo. There you'll get the DFCF for the next few years. 

That's for the first part. For the second, you'll try to get the terminal value. Market will eventually gets saturated. So growth are now limited. Or if not, competitors may arrive to have a slice of the pie. For this, free cash flow growth is lower than the discount for the terminal value equation to work. If you can't understand the equation, nevermind. It is basically like this. If growth < discount, you'll see or future FCF decreasing BUT leh, it'll never reach zero until it gets brankrupt or the end of the world. So you can see that it is converging. What this formula does is to add up all the numbers until the convergence that never happens. Confused? Nevermind, that's calculus. So just use the formula. 

Now you have two numbers. Add them up and you'll get the fair value. Apply some margin of safety to it. And there you have it. Tada!

This is just the quantitative side of a valuation.  

Sun Tzu: "Attack only when you know you are winning"

Thursday, August 26, 2010

Another Buffett's Lesson

Found this interview from Motley Fool UK. Prem Jain is the author of the book, Buffett Beyond Value.

 These are some key important takeaways from the interview:

  • Ensure that the downside risk of an investment is extremely low. A classic investment rule "Rule No.1, don't lose money; Rule No.2, don't forget Rule No.1"
  • A company's profitability has to be sustainable and has a business economics for possible growth. Talking about business predictability
  • Track record, cost consciousness, ROE and integrity are all important criterion when you look at the management. This is to ensure the management not just grow the shareholders value but most important of all, don't destroy it.
Okay, all these advices sounds simple but they aren't easy to do. If being Buffett was so easy, everyone would have achieve a result like him. But it is NOT impossible. 

I bet if you read any book about Buffett or even his letters to shareholders, they are all gonna be the same. 

Here is the link:

Tuesday, August 17, 2010

The Good: Kawan Food Berhad

Just had a pretty informative day last Saturday from Tan Teng Boo's Investor Day; though he didn't presented much as mostly are done by his - I guess students. Anyway is quite good. For those who went there and who have heard about the Malaysia's economics outlook and got freak out, I have something that might interest you here. For those who haven't, I wish I could get the data one day to show you where we are and where we are heading. 

For those who plan to sell all their Malaysian shares tomorrow or plan to own some companies with business which have more international exposure, Kawan Food Bhd might interest you. Established in 1977 under the name of Kim Guan Trading Co, it started as a supplier of pastry products kulit popiah and kuih bakul to local groceries and supermarket. The founder Gan Thiam Chai and Gan Thiam Hock don't seem to have much to do with its companies name. Today, it has grow into manufacturing and sale of frozen food products such as spring roll pastries, wanton and dumpling pastries, glutinous rice balls, stuffed pancakes, rolls, buns and loaves, pita breads, frieds, wedges and veggies, sauces, curries and mantou, among others mostly under the name of "Kawan" and "KG Pastry". About 60.5% of its sales are derived from international sales and majority of them come from North America.

Sales Distribution Chart FY2009

Sales Chart

As we can see from the sales chart above, sales across continent except South Africa have seen a double digit annual growth over the past 5 years. And as for FY2009, they have yet to penetrate into China's market in the Asian segment - although I wasn't quite sure how well roti praathas will be accepted in China. 

Products and Brands
Kawan - Mostly West Asian foods such as roti praathas, naan, etc
KG Pastry - Oriental East Asian foods such as man tou, rice dumpling, etc
Veat - The goreng-goreng stuff
Passian Bake - Basically Breads
Kayangan Manisan - Chinese kuih such as Ang Ku, Multi-layered cake etc
I did try one of their man tou the other day. Hey, there are quite good. Really soft and yea, as they claimed, taste is consistent. And also, "just like handmade" if not better than most - really

Non of Kawan Food direct competitors are listed on Bursa so I can't get much of their information. Anyway they do look quite strong with gross profit margin of 37%-43%. Although there is a question of how much they are able to adjust their prices to inflationary pressure because the rise of wheat flour prices does seem to have eaten their margin a little. 

And if we were to take 2005 sales off, their sales growth from 2006 to 2009 is at the CAGR of 18.6% and net operating profits grow 20.9% annually. The rise of wheat flour prices is felt at the bottom line as well when  operating profit margin is squeezed to 15% and 16%. 

Liquidity wise, Kawan Food should have no problem servicing its short term debts and historically they have been quite prudent. 

They are able to turn their inventories into sales in a month or two. Receivables are collected in less than 3 months. So they are doing okay here. 

Kawan Food 5 years average ROE has been above industrial average at 15.3% and pretty much above most of the food manufacturers in the country. This could be down to the strong demand for their products and effective management. 

Business Operations
Locally, Kawan Food does everything by itself from manufacturing, to packaging, to sales and up until distribution. All that to ensure the quality and freshness of their products as it is pretty sensitive to temperature.  However, their exports are handle by third party local distributors.

With 60% of its sales come from exports, I think this is what we call an international company. Although I'm not quite sure how well our Malaysian foods are accepted by the foreigners and I don't think they have reach Mat Salleh either. Most exports sales are contributed by the Asian communities living in those countries particularly the Indians as foods that are sold under the brand of Kawan bare their origin from India. Currently, Kawan Foods product are only sold in local convenient stores and yet to reach the likes Tesco or Carrefour supermarkets. So there are some room for growth over there given the Indian populations are the second largest in the world and like the Chinese, they are everywhere - mostly in UK, US and Canada.

The group has set its priority to develop its market in China. Foods will be manufactured in Nantong which has become the subsidiaries of Kawan Food (HK) Ltd for tax saving purposes. I'm not sure if they'll sell roti praathas there - perhaps try to carve a niche market. Selling Chinese kind of food might put them into heavy competition. Like, what I've said many time, China's market are huge but so as the competitions. But does that means we shouldn't enter the Chinese's market at all? No no. In fact, we should. It is an ocean full of sharks. But that doesn't mean there are sharks in every part of a sea. They just have to find their way through. Perhaps they could just make friend with those sharks. Kawan mah...

What I like about Kawan Food is their continuous investment into R&D and automation of their manufacturing facilities. These investments have not just improve the quality and consistency of their products but it could be more cost efficient as well. Besides, they are making high value job opportunities which are badly needed by the country. If only there are applicants for such job. 

Some might argue, it is still quite cumbersome to defrost, reheat and makan for a lazy people like me. Personally I still do prefer to go mamak stall to have my roti canai together with my Milo kosong panas (if they ever listen) which they charge more than RM1.50 per cup. Yes Bandaran, they still do that. But...we can't deny not just Malaysian, people are more health conscious nowadays. Sorry la, macha...but continue to make good food still ya. So, there are definitely people who still prefer to less oil or less "reusable" oil in their food. 

Substitute? Instant mee? Hey, those rotis are substitute for instant noodle as well la. Trust me, I've been through that. You are not going to eat instant noodle 4 days straight. You'll get "mual" after some time. And I think of rotis when I feel tired of all these instant noodles. That's me la....

For this valuation, I've make an assumption or guesstimate as below for 5 years average:
Revenue: I take the industrial average growth from Reuters at 6%
Cost of Sales is 60% of sales
SGA expenses will be at 25% of revenue
Depreciation roughly about RM3.8million all year
For Capex, I assume about RM7million 5 years average factoring the facilities in Nantong and assuming no new facilities to be build.
Income tax is at 25% 
Discount is at 10%

With 20% margin of safety, Kawan Food is fair valued at RM0.98. So, I guess it is pretty expensive for me now. 

Friday, August 13, 2010

The Great: Hai-O Enterprise Bhd

Well, I have been working to get some conservative valuation on Hai-O, which has taken a heavy beating losing 32% of their market value ever since hitting the heights at RM4.93 to RM3.34 (yesterday closing price). I remember a guy asked me is it time to accumulate this stock?

Well, before I come to that lets have a recap on what make the market suddenly turn bearish. I'm not really that good looking at charts or graph but I don't really see there are smart money "cooking up" or playing around with stock by looking at the volume - apart on the period when the stock splits which somehow excite ....people. Yea, and also the point where support seems to have broken. In fact, I told my friend the other day when it stucked around RM3.40 that my "crystal ball" the price going to drop further. So, I am a good gypsy - with an accuracy rate of what........1/10 maybe.

Anyway, what I say is, the current price drop is likely due to investors concern about its business. So if the market if so efficient, there must be something wrong with the business. I can basically categorize their business into, wholesale and retailing, MLM, energy-thing and the rest which are so-so and not so large. To cut long story short, retailing is doing well and that normally means wholesale is doing well. That heat transfer (or if don't understand energy-thingy) is promising. The rest are the rest. so good. So the worry must be the MLM which contributes more than 80% of its sales. All these due to Hai-O pro active measures to restructure its MLM segment to comply with the new DSA ammendment which sounds something like this:

(a) Presentation of scheme not to be misleading
(i) In the presentation of the direct sales scheme, a person who carries on any direct sales business shall not mislead participants by overemphasizing on disproportionately high bonus or bonus payout.
(ii) Each participants shall be provided with sales kit that includes the marketing plan and code of conduct of the company.
(b) Payment of incentives
Any person who carries on a direct sales business shall provided an incentive based on the volume or quantity of goods or services sold or distributed by each participant and not based on recruitment of persons into the scheme
(c) Participants not to purchase goods or services in an unreasonable amount Each participants is required to purchase goods or service in an amount that can be expected to be resold or consumed within a reasonable period of time.
(d) Agreement (i) Any person who carries on any direct sales business shall provide each participant with a
written contract or statement which described the material term of the agreement.
(ii) The agreement shall provide the following:
a. The participant shall be given not less than ten working days from the date of the
recruitment to cancel his membership (Cooling Of Period);
b. Upon the cancellation of his membership under Paragraph ‘a' the participants shall be
refunded all of payment as specified in the agreement; and
c. At the request of the participant, a person who carries on any direct business shall buy
pack any marketable goods sold to the participant with the previous six months at the
price not less than ninety percent of the amount paid. (Company must have a buy back
d. Any person who contravenes or fails to comply with any provision of these regulation
commits an offence.

I've taken a look at their MLM business model. They should have no problem with (a) and (b). But clause (c) might give them a little trouble as I know there are member who purchase big loads of stocks...just Google Hai-O Marketing. Clause (d) is the one that is likely impact the earnings and in fact not just Hai-O but all other MLMs that operate in Malaysia. 

I take the same view as their management or I shouldn't say that because no matter how many times any one of us calls or email their IR, they are always bullish. But, yea, I have to agree with RHB who somehow seems always bullish as well. Yes, there will be an negative impact on the shorter term but look at the longer term and what (d) could do on the longer term. You'll get quality products + committed members (no one shouting scam...hopefully) = sustainable growth. 

How about the valuation?
Gosh, you gotta love the market don't you if you invest long-term don't ya. Chances are, business "hiccup" or "below expectation" performance are likely to happen within that period. Remember how excited the experts were few months back? And now how depress they look?  
Well, I use 3 scenarios. Since the main contributor for Hai-O is from their MLM business - as for now, I take the average industry sales growth rate of 5% (got this by searching Amway on Reuters).

Scenario 1
All variables are the same as my previous valuation except I take a more conservative approach by using industry average for sales growth at 5% for the next 5 years. It'll show me RM5.15. Too optimistic?

Scenario 2
Sales take a EXTREMELY bad hit next financial year, sales drop by 50% by growing back to 5% CAGR next 4 years. I get RM3.50. Hmmmm.........

Scenario 3
If you are a bit speculative, maybe you can try wait for the next quarter report which is going to out soon and hope it turns out badly so that you can buy it even cheaper. Anyway, those investment bankers are "predicting" a bad one for the coming 2 quarter.

1, 2, 3...which one? So fickle minded one. If you ask me, I'll just say it is a good price.

This comment is based on my personal thoughts, opinions and my risk tolerance. It should not be considered as an investment advise. Please consult your financial advisor or do some research of your own before making any decision. You might have your own thoughts. I would love to here from you. You can always place your comments here and or email me privately

Sunday, August 8, 2010

What the Heck is a 'Super Stress Test'?

I've been getting some question about what is a 'super stress test'. Well, you won't find this in books it is just a ratio I come out with. That is why the name sounds a bit weird.

In a normal liquid test, we use (Current Assets-Inventories):Current Liabilities to test the liquidity of a company. The logic behind this as what Buffett has mention before, inventories can't be taken as a liquid asset as it is difficult to turn inventories into cash in the case of emergency and definitely not within a day or 2. Even if a company manages to turn them into cash, it might be well below its current value written in the balance sheet because if this were to happen, the company becomes a desperate seller.

So how about 'super stress test'? This test exclude another element, Trade Receivables, where liquid assets become Current Assets-Inventories-Receivables or just Cash & Equivalent. Okay, this is an extreme case and it is not really relevant to most product based companies. However it is more applicable to project based companies or a company who has less diversify customer base (for me I take less than 10). It is to see, how well a company could cope if its customers were to default payment. One good example is LCL and DIS Tech. LCL especially looks good in the liquid test but they have extremely high receivables. And worst of all, most of them (90% if I'm not wrong) come from a single customer which is in Dubai. So when this 'you know who' defaults payment, LCL run into the mess that they have today.

However, this is an extreme case test where it is assume all receivables are defaulted. It is pretty unlikely to happen to companies with huge customers base.