Bonus Investment Articles on Singapore Stocks

BONUS INVESTMENT ARTICLES ON SINGAPORE STOCKS

SG WEALTH BUILDER

5 SGX stocks to invest in 2018

With Dow Jones on course to hitting 25,000 points, the US stock market is certainly on a bull run. Over in Singapore, the Strait Times Index is not doing too badly either, adding 1.8% for the month of November and bringing its year-to-date dividend inclusive return to 23%, compared to an SGD denominated average returns of 18% for the benchmarks of Australia, Hong Kong and Japan. In this article, I will share my views on the 5 SGX stocks to invest in 2018.

For the past 7 years, I had been sharing my insights and strategies on a number of SGX stocks in this blog. However, two years ago, I have divested all my stock holding to fund the purchase of my new home. In spite of this, I have been analysing selected SGX stocks which I would invest in 2018 once my war chest is built up. On this note, it must be emphasized that I do not have a vested interest in the following SGX stocks. Readers and members must do their own diligence before investing in these counters.

OCBC

I am still beating myself for missing the boat on this one. Since 2016, I have been tracking OCBC when the shares were trading at about $8.00 level. Unexpectedly, the share price went on a rampage and stormed to $12.00. Is this counter over-valued? Based on my analysis, current shares are likely to be worth much more than its trading price. Why is this so?

Read my analysis on OCBC’s value, its recent financial performance and how it fared against DBS and UOB. To access the articles, please sign up as member of SG Wealth Builder.

1. Battle of Singapore Banks (OCBC, DBS and UOB) 2. OCBC shares worth $50? 3. OCBC Bank to rock the market with multi-billion hidden assets? 4. Will EZRA sink OCBC share price? 5. OCBC considering sale of United Engineers Ltd 6. Is it a good time to invest in OCBC shares? 7. OCBC Wing Hang Bank

Although not vested in OCBC shares before, this is my most favourite stock because of its investment moat, long history of track record, diversified business and strong brand name. Being a family-owned, professionally-run company, this bank spread its wings overseas in recent years by venturing into the China market with Wing Hang Bank acquisition. In doing so, it has managed to mitigate the double whammy of toxic corporate loans made to the ailing oil and gas companies and the sluggish home loans due to the property cooling measures.

The venerable bank has also stunned market by acquiring Barclays and National Australia Bank wealth businesses. Will wealth management become a game-changer for OCBC? After all, the real money to be made should be from the rich and mighty right? To be honest, it is too early to judge but in my own opinion, it will be a fight to the death for the three local banks (OCBC, DBS and UOB).

Ranked by Bloomberg Markets as the third strongest bank in the world, OCBC is expected to continue to do well in 2018.

Suntec REIT

Suntec City should be a familiar brand name in Singapore. Listed on 9 December 2004 on Singapore Exchange mainboard, Suntec REIT is the first composite REIT in Singapore, owning income- producing real estate that is primarily used for retail and/or office purposes. Since the IPO of Suntec REIT, there had been numerous other REITs in the Singapore stock market. But if given a choice, I would place my bet on this counter because of its long history, good management and track record of cash distribution per unit.

Read my analysis on Suntec REIT value and its recent financial performance. To access the articles, please sign up as member of SG Wealth Builder.

1. Bullish form of Suntec REIT shares 2. Analysis on Suntec REIT

The share price of Suntec REIT had been on a mighty bullish form since my last coverage in September 2017. The surging price could be due to the announcement of its Australia expansion plans. What are the risks for this counter and what is my entry price? Check out my analysis.

SingTel

Once a upon a time, it used to be the case that if you invested in a stock linked to Temasek Holdings, chances of making money would be high. Well, not anymore. The delisting of SMRT and NOL should serve as a stern reminder of the perils of herd investing. SingTel is one of the few companies of Temasek Holdings that has withstand the test of time. Listed in 1993, this telecom player has evolved into a juggernaut with 638 million mobile customers from across the globe.

Read my analysis on SingTel’s value, its recent financial performance and how it fared against StarHub and M1. To access the articles, please sign up as member of SG Wealth Builder.

1. SingTel knocked the wind out of StarHub 2. Three-way battle for SingTel, Starhub and M1 3. SingTel's NetLink Trust IPO application approved 4. SingTel at a cross road 5. Short selling on SingTel shares 6. SingTel shares to rocket on NetLink Trust IPO? 7. SingTel share in supreme form 8. SingTel increased investment moat aggressively

Fresh from the divestment of NetLink Trust, SingTel recently put up its Hill Street property for sale. What is the management up to? Could there be another mouth-watering acquisition to bolster its market share in the mobile sector? Competition is going to heighten with the entry of TPG Telecom and not to mention the ravage brought forth by technology disruptions. How is SingTel going to tackle these challenges? 2018 may turn out to be another interesting year for SingTel investors. Do not miss the actions!

Raffles Medical Group

Share price of Raffles Medical Group has taken a beating lately and is on a horror run. So why on earth is this stock on this list? To put things into perspective, you only make money at the point of buying, and not selling. This means that to have a higher chance of winning the stock market, you should adopt a contrarian approach. Raffles Medical Group is one of the stocks that have fallen out of favour but its business fundamentals remain very much intact.

Read my analysis on Raffles Medical Group’s value, its recent financial performance and how it fared against rival IHH. To access the articles, please sign up as member of SG Wealth Builder.

1. My stock analysis of Raffles Medical Group 2. Raffles Medical shares under siege! 3. Raffles Medical share price 4. Raffles Medical Group's Return on Equity (ROE) 5. Analysis on Raffles Medical Group 6. Raffles Medical shares power ahead 7. Raffles Medical Group stable growth 8. Raffles Medical Group's proposed stock split

Although the healthcare industry is an evergreen sector in Singapore, it does not mean that there are no risks involved. The challenges faced by Raffles Medical Group is not difficult to understand but I am glad that there are concrete plans by the management to ride out the storm. Various projects like the Raffles Holland V, Raffles Hospital Extension and acquisition of MCH clinics are expected to diversify revenue sources and strengthen Raffles Medical’s position in the region.

2018 could be an interesting year as Raffles Medical is building two hospitals in China. I expect share price to witness further weakness because of the expected surge in capital layout for these two projects. I have set an entry price on this stock earlier on and on current form, it is likely that the share price would drop to my entry-level.

MM2 Asia

As a matter of policy, I do not invest in IPO and would avoid investing in companies which debut within 5 years of IPO. But I think mm2 Asia could be an exception.

Within two years of listing in the Catalist, the entertainment outfit has witnessed such explosive growth that it ascended to the SGX mainboard on 7 August 2017. Along the way, it has also attracted investment from StarHub.

Share price of mm2 Asia had been surging in recent years. Since IPO, mm2 Asia share price has risen from listing price of $0.25 to the current $0.50 level. There was a stock split exercise of 1-into-2

4 exercise in early 2016. But that didn’t stop its meteoric rise. In late 2016, the company announced yet another stock split exercise of 1-into-2 exercise.

Based on my memory, I could not recall any SGX stocks that underwent twice stock split in a year and still continued to rise like mm2 Asia shares. If shareholders held on to the shares since IPO in 2014, they would have made a killing! In stock split, shareholders do not need to make any payment. Do I regret missing the boat for this multi-bagger? Of course I did! The paper gains would have been 8 times considering the fact that this counter has been split twice in a year.

Read my analysis on mm2 Asia’s value and its recent financial performance. To access the articles, please sign up as member of SG Wealth Builder.

1. The outrageous story of mm2 Asia

In 2017, mm2 Asia suffered from a brief loss of momentum after the botched acquisition of Golden Village. However, that did not deter the management. In November 2017, it announced the shock acquisition of Cathay Cineplex for a whopping $230 million. Being a leader in content production, the acquisition of Cathay Cineplex is expected to create synergy in the value chain for mm2 Asia. With a higher revenue forecast in 2018, the share price is expected to maintain its bullish form.

Will SingTel share price be rocked by commercial disputes?

It is an explosive time-bomb waiting to be ignited. Being the largest telecommunication player in Singapore, SingTel enjoys an incredible massive investment moat with 685 million mobile customers spanning across 22 countries. This is an amazing feat which not many telco in the region can replicate.

But its overseas adventure came at a price as the Singaporean telco engages in various commercial disputes with foreign government authorities. Collectively, the commercial disputes involved liabilities amounting to a whopping $4 billion.

I have been a big fan of SingTel and had written a number of investment articles on this great company for several years. But the lurking commercial disputes had deterred me from investing in SingTel. Make no mistake, the amount involved is monstrously huge. So I had preferred to err on the side of caution although that would mean loss opportunities on the dividends and capital appreciation of SingTel share price.

Financial performance

Notwithstanding the above issue, SingTel share price continues to power ahead in the face of the multi- billion lawsuits and challenging operating environment. Operating revenue for the third quarter of FY2018 increased 4% to $4.60 billion while EBITDA rose 6% to S$1.29 billion. Net profit was down 9% to $890 million while underlying net profit declined 8% to $898 million. However, the divestment of NetLink Trust in 2017 had provided an exceptional gain of $1.9 billion, leading to increase of 61.7% of the net profit of $4.6 billion for nine months ended 31 December 2017.

SingTel’s revenue is mainly derived from Singapore and Australia which respectively accounted for approximately 38% (31 December 2016: 40%) and 52% (31 December 2016: 53%) of the total revenue for the nine months ended 31 December 2017, with the remaining 10% (31 December 2016: 7%) from the United States of America and other countries where the Group operates in.

The above data shows that the management has carefully diversified SingTel’s operations across key geographical locations, thereby mitigating the risk arising from Singapore’s saturation market. Thus, the impending entry of the fourth telco player, TPG Telecom, is unlikely to inflict significant damage to SingTel’s market share. The virtue of mobile subscription is that most customers are generally reluctant to switch operator unless the benefits significantly outweigh the hassle.

Balance sheet improves slightly with current assets at $6.8 billion while current liabilities stood at $9.7 billion. SingTel had significantly reduced its unsecured borrowings repayable within a year to $1.6 billion from $3 billion. At carrying value of $7.94 billion, a large portion of SingTel’s non-current liabilities is in the form of bonds. Cash and cash equivalents improved to $840 million.

With a net debt gearing of 22.5%, I am not so overly concerned on the debt because of SingTel’s strong credit ratings (A+ from S&P and A1 from Moody’s). Free cash flow for 9MFY18 improved significantly to $2.8 billion, an improvement of 23% compared to last year. Net cash flow from operating activities was $4.55 billion for 9NFY18. With so much cash inflow, there is very low possibility of SingTel facing cash flow issues.

Regional associates

The regional associates of SingTel continued to post strong customer growth, with Australia’s Optus driving profitable growth. Revenue from Australia unit increased 8% to A$1.96 billion for 9MFY18. EBITDA increased 15% to A$680 million.

According to SingTel’s financial report, “In 2016 and 2017, Singapore Telecom Australia Investments Pty Limited ("STAI") received amended assessments from the Australian Taxation Office ("ATO") in connection with the acquisition financing of Optus. The assessments comprised of primary tax of A$268 million, interest of A$58 million and penalties of A$67 million. STAI's holding company, Singtel Australia Investment Ltd, would be entitled to refund of withholding tax estimated at A$89 million.

In accordance with the ATO administrative practice, STAI paid a minimum amount of 50% of the assessed primary tax on 21 November 2016. This payment continued to be recognised as a receivable as at 31 December 2017. On 2 November 2017, STAI received a tax position paper from the ATO in relation to the subsequent re-financing of the above loan. STAI has received advice from external experts in relation to the matters and will vigorously defend its position. Accordingly, no provision has been made as at 31 December 2017”.

Given that there is no provision for the Australia tax dispute, I am pretty confident that the Australia suits had been settled. In view of this, Optus would become an even more strategic crown jewel for SingTel.

While there were cheers in Australia, SingTel’s regional associates in India and Indonesia had not been so rosy. Airtel’s results were adversely impacted by the cut in domestic mobile termination rates and intense competition in India. Profit before tax dropped by a massive 73%.

In Indonesia, Telkomsel’s earnings fell as a result of heightened competition in data and declines in traditional voice services. Profit before tax fell 9% to $329 million.

Freakish commercial disputes

What freak me out are the on-going commercial disputes involving foreign authorities. According to SingTel’s report, “Bharti Airtel Limited (“Airtel”), a joint venture of the Group, has disputes with various government authorities in the respective jurisdictions where its operations are based, as well as with third parties regarding certain transactions entered into in the ordinary course of business.

As at 31 December 2017, other taxes, custom duties and demands under adjudication, appeal or disputes amounted to approximately Rs. 132 billion (S$2.75 billion). In respect of some of the tax issues, pending final decisions, Airtel had deposited amounts with statutory authorities”.

The sheer amount of claim against Airtel is massive and certainly introduced a huge dose of uncertainty for SingTel’s India operations. But that is not all.

Advanced Info Service Public Company Limited (“AIS”), a joint venture of SingTel, has various commercial disputes and significant litigations in Thailand. As at 31 December 2017, there are a number of other claims against AIS and its subsidiaries amounting to THB 27.2 billion ($1.11 billion) which are pending adjudication.

In Indonesia, the situation is not as bad. As at 31 December 2017, PT Telekomunikasi Selular (“Telkomsel”), a joint venture of the Group, has filed appeals and cross-appeals amounting to approximately IDR 180 billion (S$18 million) for various tax claims arising in certain tax assessments which are pending final decisions, the outcome of which is not presently determinable. Even if SingTel has to pay the claim, the amount is not significant given the annual profits generated from the Indonesia unit.

SingTel share price

Amid the market disruption currently taking place in the Singapore telco market, SingTel share price held on relatively well. The shares hit a peak of $4.40 in 2015 but has since fallen to the current $3.50 level. The share price seemed to mirror the revenue and ROE performance. Revenue peaked in FY2015, at $17.2 billion and tapered to $16.7 billion in FY2017. Similarly, the ROE dropped from 15.55% in FY2015 to 14.4% in FY2017.

SingTel has typically been generous with its dividends, which averaged about $0.170 for the past few years. Henceforth, for those who holding the stock for the long-term, SingTel is a good dividend counter. On 8 November 2017, the management approved an interim one-tier exempt ordinary dividend of 6.8 cents (FY 2017: 6.8 cents) per share and a special one-tier exempt dividend of 3.0 cents (FY 2017: Nil) per share, in respect of the current financial year ending 31 March 2018.

Full year results for FY2018 is expected to be better than FY2017, in terms of revenue, net profit and ROE. Thus, I think SingTel share price is likely to hit $4.00. However, given the uncertainties and risks arising from SingTel’s overseas contingent liabilities, I would adopt a wait and see approach before entering this counter. Till then, enjoy the ride

SingTel knocked the wind out of Starhub

Should Starhub investors run for their lives? The month of November had been a dreadful one for Singapore’s number two telecommunication player as its major shareholder, DBS, sold off 900,000 shares, then followed by the shock announcement of CEO Tan Tong Hai who will step down in May 2018. The bad news came swiftly after the announcement of the poor 3Q17 financial results. On the other hand, arch rival SingTel announced a set of smashing good financial results after the divestment of NetLink Trust.

Starhub in crisis?

The announcement of the departure of Tan Tong Hai was indeed surprising, coming at a time when the industry is undergoing a major shake-up. The disruptions caused by technology has led to challenging operating environment faced by all players as many consumers used applications to access overseas calls and short messages. The trend has led to declining revenue from mobile and fixed lines. In the past, IDD call charges and SMS had been cash cows for the telco players. Now, consumers typically use applications to bypass such services.

For Starhub, the decline started many years ago when it lost the monopoly of Pay TV coverage of English Premier League to SingTel in 2009. That was a real turning point and SingTel had really knocked the wind out of Starhub.

Turning point

Thus, it is unfair to pin the blame on Tan Tong Hai, who assumed the CEO position only in 2013. But under Tong Hai’s leadership, the subscriber base has been shrinking. As of 30 September 2017, Pay TV subscriber base was 467,000 subscribers after the quarter’s net churn of 10,000 subscribers. Compared to a year ago, Pay TV subscriber base decreased by 40,000 subscribers or 7.9%.

To put things into perspective, Starhub has never derived the bulk of revenue from its Pay TV. Traditionally, most of the revenue had been from the mobile services segment. But the telco has positioned itself very well with its unique “hubbing strategy” in which the Pay TV services were bundled with voice and data plan packages. Declining Pay TV subscriber base could see Starhub facing continued profit margin pressure. And the latest results certainly reflected this.

Financial results for 3Q17 were nothing disgraceful, but they weren’t good either. All business metrics declined as compared to a year ago, from revenue to net profit to customer bases for mobile and Pay TV services. Under the helm of Tong Hai, it seems that Starhub cannot figure out a solution to win the game. In the face of competition from major rival SingTel, looms a greater foe – technology.

Technology disruptions

Perhaps the emergence of Netflix and Amazon Prime Video should herald the beginning of the end for Starhub. As customers switched to online streaming to watch TV series, they are less likely to remain as Starhub’s Pay TV subscribers because such over-the-top (OTT) content services typically charge lesser. What this means is that content producer such as mm2 Asia will continue to thrive as demands explode. This is probably why Starhub had invested in mm2 Asia, probably because they had seen it coming long ago.

If you have been a long-term shareholder of Starhub, it is unlikely that you suffered from paper losses because this counter is known for being a dividend play. Starhub had been consistently giving out $0.20 of dividend per share every year since 2010. This was indeed very generous. Thus, if you have bought the shares in 2010 and hold it till today, you would still make a handsome profit. But going forward, investors may need to review whether to stay vested or cash out as Starhub had reduced the amount of dividend to $0.17 per share for this year. Given the intense competition in the telecom industry, I foresee the amount of dividend is likely to go downhill.

Listed in 2004, Starhub paid a heavy price for not venturing overseas. The telco player derives most of its earnings from Singapore market. This is unlike SingTel, which has 638 million of mobile customers from across the globe and derives 70% of its earnings from outside of Singapore.

Dominance of SingTel

Even in Singapore, SingTel is the number one leader with 49% market share in mobile customer and 42% market share in broadband. But of noteworthy is that its 100% subsidiary in Australia, Optus, provided more than half of the Group’s revenue and earning for the past five years.

Recently, SingTel share price has been on a roll, surging from $3.66 on 16 November to $3.80 on 7 December. The strong performance of the shares could be attributed to the special dividend of 3 cents declared by SingTel following the divestment of 75.2% stake in NetLink Trust. The special dividend totalled approximately S$500 million out of S$2.3 billion in proceeds from the divestment of NetLink Trust. The balance in proceeds will be used for future spectrum acquisitions and growth investments.

The NetLink Trust divestment certainly strengthened SingTel’s financial position. Free Cash Flow (FCF) increased 7%, from $1.87 billion in 1HFY2017 to $2.0 billion in 1HFY2018. Operating revenue for 6 months increased 7.6% but underlying net profit declined 3.8%. The drop in underlying net profit was due to lower pre-tax earnings from regional associates. Intense competition in India have hurt its profit. Airtel’s lower earnings in India were partially offset by improved operational performance in Africa. If not for the one-off gain from the divestment of NetLink Trust, SingTel would not have delivered the record net profit.

There had been concerns among investors that the entry of TPG Telecom could pose a threat to SingTel. In my point of view, this is unlikely to happen in the medium term because SingTel has managed to build up an impressive investment moat over the years. While the new player is likely to steal some market share from SingTel, it would not inflict much damage as SingTel derived most of its revenue from overseas market. For example, 2QFY18 revenue from Singapore market accounted for only $564 million while 2QFY18 revenue from Australia was a staggering $1.7 billion.

Among its subsidiaries and regional associates, the most often overlooked should be Telkomsel. The Indonesia subsidiary delivered profit before tax of $371 million for Q2FY18. This performance is even better than the Singapore business segment and only Optus performed better, with EBITDA of A$593 million. But Singapore and Australia markets are already very saturated. For Indonesia, the mobile penetration is still low, at about 43%. Henceforth, there is a lot of potential for growth.

Another business segment of SingTel that investors should keep a close watch on is the Group Enterprise unit. Revenue grew 6% due to robust growth in ICT services. However, EBITDA fell 5% due to investments to ramp up capabilities in cyber security and Smart Nation, a change in revenue mix and some accrual write-backs in the same quarter last year.

Looking forward

All in all, SingTel delivered a resilient set of financial results for the second quarter while Starhub struggled to keep up pace against the backdrop of intense competition. Share price of Starhub had plunged from $4.30 in 2015 to $2.90 currently. At Price/Book Value of 12.7 and P/E ratio of 17.4, Starhub shares are not considered expensive. But I would not invest in Starhub because of the murky outlook.

Between the two telco players, I prefer SingTel because of its strong investment moat in Singapore and diversified earning sources from regional markets and different business segments. Thus, the risk of investing in SingTel should be lower when compared to Starhub. It is going to be a rough journey ahead for Starhub. Till then, enjoy the ride.

Three-way battle for SingTel, M1 and StarHub

It’s going to be a three-way battle for SingTel, M1 and StarHub as competition intensified with the entry of a new player in the telco industry. Against this backdrop, will SingTel acquire M1 or StarHub? Recent developments in Singapore’s telecommunication industry suggest that such consolidation is only a matter of time for the incumbent players.

With Australia’s TPG winning the fourth telco license in both Australia and Singapore, it is imperative that SingTel take decisive actions to defend market shares. It is now or never for SingTel.

The battle of the giants

With a gigantic market capitalization of $63 billion, SingTel is obviously the leader of the pack and is in pole position to gobble up either of the two smaller players. Among the three existing players, M1 has the smallest market capitalization - $1.75 billion. Since 2015, M1’ share price crashed from a high of $3.96 to $1.88 level. With the current form, M1 could easily fell prey to a hostile takeover.

Incidentally, M1’s substantial shareholders, Keppel Corp and Singapore Press Holding (SPH) are going through hard times as well and they may be tempted to offload their shares in M1 to SingTel. Keppel Corp may want to sell its stakes in M1 and raise capital to focus its fight against the slump in the oil-rig industry.

On the other hand, media conglomerate SPH is facing a disruption in the media industry brought forth by digital technologies. In light of the disruption, SPH may want to dispose its stake in non-core assets like M1 to invest in digital media companies for revenue growth.

Temasek Holdings’s game

Sovereign wealth fund Temasek Holdings owns shares in all the above-mentioned Singapore companies and thus could be instrumental in kick-starting the game of musical chairs among the companies. Together, both Keppel Corp and SPH own a combined stake of 32.6% in M1. Assuming that Keppel Corp and SPH agreed to sell their stakes to SingTel at current price, the telco would only need to cough up about $1.18 billion of cash to acquire all the remaining shares. For SingTel, this sum is actually not considered a huge sum of money.

According to SingTel’s Q4FY17 results, the free cash flow for FY2017 was a whopping $3 billion. In addition to that, the recent divestment of NetLink NBN Trust has raised $1.095 billion of cash for SingTel.

With so much war-chest, SingTel has more than sufficient fund to launch an all-out hostile takeover of M1.

For StarHub, things are slightly more complicated. Through Singapore Technologies Telemedia, Temasek Holdings owns 75% of Asia Mobile Holdings, which owns 55.86% of StarHub. Last year, Qatar’s Ooredoo was reported to be considering the sale of its stake of 25% in Asia Mobile. If Singapore Technologies Telemedia is to acquire Ooredoo’s shares in Asia Mobile Holdings, then Temasek Holdings would have an indirect interest of 55.86% in StarHub. This could pave the way for SingTel to acquire more than half of StarHub’s shares.

However, being the number 2 player, StarHub shares do not come cheap. Currently trading at $2.70 level, StarHub shares is traded at Price/Book value of 18.87. SingTel would have to cough up at least $4.7 billion to acquire all the shares of StarHub. In doing so, SingTel would have used up all its free cash flow. In my opinion, I would favour the acquisition of StarHub to M1 because the former runs a HFC network that delivers multi-channel pay TV services, including HDTV, Internet TV, and on-demand services. Henceforth, StarHub’s paid TV business could complement SingTel’s pay TV segment.

SingTel’s overseas adventure

For the last two decades, SingTel’s focus had been expanding its overseas market with focus in Asia. This has resulted SingTel in becoming a regional force with 600 million mobile customers. However, it's overseas adventure came at a price. Over the years, there were numerous commercial disputes, taxes and significant law suits amounting to billions of dollars. In some cases, SingTel is defending the claims while there are those that required it to set aside large sum of funds for contingent liabilities.

In addition, being the largest telco company in South East Asia, SingTel is facing more resistances in its bid to penetrate new markets in Asia. Its failed Myanmar license bid in 2013 was an example. However, in view of the risks arising from potential lawsuits and currency exchange movement, this may turn out to be a blessing in disguise for SingTel.

Although Singapore market is already saturated, SingTel may turn its head on consolidating its local market share instead of embarking on another overseas investment adventure. Acquiring either StarHub or M1 is one way to bolster market share, increase revenue and profits. Personally, I would prefer StarHub being acquired but I doubt SingTel has sufficient funds to do so. M1 seems like a more viable target.

Financial performance

For fourth quarter 2017, SingTel delivered a set of robust financial report. Profit after tax was $955.6 million compared to $940.4 million last year. Full year profit after tax was $3.831 billion, a negligible decline from last year’s $3.858 billion. The return on equity (ROE) has been hovering around 14 to 15 for the past 5 years. To ignite growth, SingTel may look into how to deploy the $1.095 billion cash from the divestment of NetLink NBN Trust.

Of course, from the perspective of shareholders, they would want SingTel to distribute the cash in the form of special dividends. However, shareholders should think long-term and aim for capital appreciation in SingTel’ share price instead. A more sustainable approach should be to use part of the cash proceeds to pare down debts and then deploy the rest of the funds to make one mega acquisition that would stimulate significant growth.

For SingTel, the big money to be made is still in mobile telecommunications. Its crown jewel, Optus in Australia, raked in $1.741 billion of revenue in FY17 while its Singapore counterpart only achieved $589 million. Its Group Enterprise division is also doing well, with revenue of $1.723 billion in FY17 while the Group Digital Life continued to bleed. Given the patchy track record in digital investments, it is likely that SingTel would focus acquisition in either the mobile or enterprise ICT sector.

Conclusion

Since March 2017, SingTel’ share price suffered some loss of form but started to pick up in recent weeks with the divestment of NetLink NBN Trust. I am not vested in the shares but is monitoring the telco’s next move. If the management made the sensible approach of acquiring the right company, it would provide me the impetus to buy into this blue chip. Till then, enjoy the ride.

Is M1 a falling knife?

Sometimes, life is stranger than fiction. In my years of investing in SGX stocks, I have come across many investors who persisted in buying more shares of companies whose business fundamentals turned sour. Perhaps they did not have the time to read the financial reports or maybe they just lack the competence to do a proper due diligence. So in M1 case, is it a case of catching a falling knife?

When investing in stock, never just study the trend of the share price. This is especially so if you consider yourself to be a long-term investor.

Recently, several financial bloggers purchased M1 shares on the basis that the shares had reached a “break-through” level. Whether they had made the correct decision is subjected to debate. After all, there is no right or wrong in the stock market. The only thing that matters is whether you have made money from the stock investments.

In my point of view, I would avoid investing in M1 shares at all cost. And the latest financial results vindicated that business fundamentals of M1 continued to slide.

Full year net profit for FY2017 amounted to $132.5 million, a decrease of 11.5% year-on-year. Operating revenue for mobile telecommunication services, M1’s biggest revenue contributor, was $642 million, comparable to last year’s $640 million. International call services continued to decline, with revenue at $55.9 million, a decrease from last year’s $61.3 million. The saving grace for M1 revenue was the fixed services, with revenue of $129.7 million, an increase from $104.2 million.

The lost decade

While the latest results were nothing disgraceful, they illustrated how far the Singapore telecommunication player has fallen for the past 10 years. To put things into perspective, the operating revenue from mobile telecommunication services in 2007 was $600 million. In comparison, the management has grown the revenue from this segment to just $640 million. During this period, operating expenses increased explosively from $600 million to the current $900 million.

But the most obvious decline was the revenue from international call services, which used to be the biggest cash cows for Singapore’s telecommunication players. In 2007, the revenue from international calls was $127 million. By 2017, the figure dropped to $55.9 million, a massive decrease of more than 50%. In the face of technology disruption, the management simply has no solution to tackle changing consumer trend as more and more people turn to internet for international calls.

In view of the above data, it is inexplicable that investors continued to buy into M1 story. Logically, you would want to put your money on the winners in the stock market. Indeed, many people would argue that telecommunication companies are defensive stocks and are good for dividend play.

But technology and changing consumer trend had changed the game forever. Times have changed. You need to be careful with your money and not blindly follow the herd.

Unwanted child?

Being rated as Singapore number three telecommunication player, M1 is never really a true-blue home- grown company. Axiata Investments, a Malaysian conglomerate, is the largest shareholder, with stake of 28.69%. Keppel and SPH have combined stakes of 32.7%. In my opinion, the controlling stakes of M1 could be the contributing factor behind the lack of motivation for M1 to expand into overseas markets.

When M1 was formed in 1994 by the founding shareholders (Axiata, Keppel and SPH), the intent could be to penetrate solely the Singapore market and steal market share from SingTel. Back in 1992, Singapore telecommunication industry went through a period of major shake-up as the government announced the liberalization of the telecommunication industry. SingTel was listed on the stock

14 exchange in 1993, followed by M1 in 2002. In October 2004, Starhub became the third telecommunication company to be listed in SGX.

Unlike SingTel, there wasn’t serious intent by the major shareholders to grow M1 into a global player. On the other hand, the management of Singtel had used the IPO fund to expand into overseas markets like Australia, Indonesia, Philippines, India and Thailand. The overseas acquisitions had enabled Singtel to evolve into a regional telecom player with more than 600 million mobile customers. Australia’s Optus subsequently became Singtel crown jewel, generating huge amount of revenue and profit for Singtel. Conversely, M1 operates only in Singapore market and it had never penetrated foreign markets.

Currently, M1’s market share for mobile (postpaid and prepaid) is 24%. As a matter of fact, it did steal some market share from the dominant player, Singtel. But its not as if Singtel really care. With 600 million mobile customers, the competition from M1 or Starhub did not pose significant threat to Singtel at all.

Is M1 a sinking ship?

Investors who placed their bets on M1 must be very clear on what they are getting themselves into. As far as I am concerned, Singtel is too dominant for M1 to spring a surprise attack. In 2017, the major shareholders of M1 announced a surprising strategic review in relation to their shareholdings of M1. The review did not result in the disposal of their stakes because the offers from interested parties did not “meet their criteria”. Nonetheless, the strategic review did rock the boat and sent big signal that Keppel and SPH may not be interested in growing M1 anymore.

Return on Equity (ROE) has fallen from a high of 43% in FY2013 to 31% in FY2017. Revenue has grown slightly, from $1 billion in FY2013 to $1.07 billion in FY2017. Net income has fallen from $160 million to $132 million for the past five years. For investors, it had been a great ride as M1 had been very generous with its dividend pay outs for the past five years. The dividend yield is 6.1% for this year.

Conclusion

M1 is certainly at a cross-road. Being the smallest telecom operator, it lacks the investment moat to mount a sustainable challenge against Singtel and Starhub. Recent moves by its major shareholders also raised questions among investors on whether they are in this for the long haul. But the biggest mistake by M1 is not expanding into overseas markets. By concentrating its product and service offerings solely in Singapore, it faces the risk of a saturated small market. Now, the window of opportunity is gone and there is no way to roll back the time.

From the way I look at it, the digital projects by M1 to transform itself into a “Smart Communications Provider” is nothing more than a gimmick. Perhaps the management wants to prove to shareholders that they are not giving up without a fight but to be frank, these projects can hardly change the fortune of the company. For the telecommunication operator, the cash cow is still mobile data plan subscription. At this point in time, I don’t see M1 making much headway in this respect. Till then enjoy the ride.

M1 shares suffering from massive bout of diarrhoea

Being M1 customer, I like its unlimited free calls to three M1 numbers to local voice calls. Because of this innovative product, I have been its customers for many years. This is the power of subscription for a telecommunication company. In fact, mobile subscription is considered the most important investment moat for a telecommunication company because the motivation to switch to another mobile phone carrier is low once a customer subscribed to its data plan. However, as an investor, I would never invest in M1 shares.

From almost $4.00 in 2015, M1’ share price plunged to $1.73 lately. Being the smallest player, M1 faces the biggest risk of shrinking market share with the entry of new competitor, TPG Telecom. To make matter worse, Singapore market is very small and saturated.

According to Infocomm Media Development Authority (IMDA), the mobile penetration rate in Singapore is about 150%, making Singapore one of the most well-connected countries in the world. This means that some of the subscribers may be using more than one line. Being the smallest player, it is not surprising that outlook for M1 is worrying.

With falling share price, investors may be wondering if it is the right time to buy M1 shares on the cheap. However, a word of caution is that when it comes to stock investing, cheap may not indicate value. In March, the three major shareholders – SPH, Keppel Telecommunication & Transportation and Axiata Group – appointed Morgan Stanley to advise on a strategic review of their stakes in M1. In July, the trio announced that they would not proceed with the review.

In my opinion, I suspect that interested parties in M1 may have made low-ball offers to the major shareholders. That could be why the review did not result in any transactions. Nevertheless, investors did not take the outcome kindly and punished the stock. After the announcement, the share price fell from $2.10 to $1.73. On current form, the shares seem destined for an ominous downward spiral.

In terms of financial performance, the telco continued to struggle in light of challenging operating environment. Net profit after tax for first half of the year declined 17.6% to S$68.8 million, partly driven by higher depreciation and interest expense. Total mobile customer base decreased 2,000 in the quarter to 2.04 million, and mobile churn was higher at 1.7%. With this set of dismal results, it would take a very brave investor to enter this counter at the moment.

But what is striking about M1 is its feather-weight balance sheet. Among the three telcos, M1 holds the lowest amount of cash and cash equivalents – at $6.1 million as of 31 June 2017. While I can understand that the telco business is a highly leverage industry, it does not make sense to me that the cash holding is so low. Even Starhub has a much higher cash holding of $450 million, while SingTel has $533.8 million.

The reason why M1 can afford to hold so little cash while having no cash flow problem for so many years is because the telco industry is very cash-generative business. Net cash from operating activities was $108 million for the first half of the year, a decline of 42.1%. Given that the company derived the bulk of its revenue from mobile telecommunication services and its mobile postpaid market share was only 25%, things may not be rosy going forward.

Return on equity (ROE) was outstanding for the past few years. From FY2012 to FY2015, the average ROE was an explosive 44%. FY2016 was lower at 36% and based on projection, the ROE will be lower for FY2017. ROE measures the management’s ability to generate returns using shareholders’ funds. In this regard, M1 fared much better than Singtel, which has ROE of about 16% for the past few years.

With free cash flow of only $30.4 million, M1 claimed that “they are investing in start-ups and digital solution providers with new technologies to generate new revenue streams.” To be frank, scaling is critical for the telco players. With a small market like Singapore, it is difficult for M1 to sustain even if they invest in start-ups. Ultimately, the money to be made is still in mobile telecommunication services and unless the company ventures overseas, the future is bleak.

Being asset-lite, I am not surprised that the Price/Book Value is about 4, even against the backdrop of declining share price. Is the share price considered inflated? I should think so. Many investors bought M1 shares because of its rich dividend pay-outs.

Since FY2013, M1 had paid $0.81 of dividends per share to its loyal shareholders. However, since then, the share price has declined by about $1.60 per share. So, if you have bought M1 shares in 2013 and hold it till now, you are likely to suffer from paper losses even if you factored in the total dividends received. Should investors cut losses and run for their lives? I don’t know but unless the management figure out how to reverse the company’s fortunes, things are likely to get worse.

To be fair to the management, they did a relatively good job of generating returns for shareholders all these years. However, M1 made a mistake of not growing its business in foreign countries in the early years. Now, it has to pay the price of having its business concentrated in Singapore. It will be interesting how the major shareholders are going to play the game. One thing for sure is that any takeover will not be cheap because M1 is not a distressed business, yet.

From the perspective of a mobile subscriber, the entry of a new telco is definitely good news because increased competition means cheaper data plans and drives product innovation. Already, last year, the three telcos all slashed their mobile data plan prices. Hence, the biggest winner out of this telco war is the customer. For the M1 investors, it is going to be woes after woes. Till then, enjoy the ride.

Can SingTel fight gravity?

Hailed by many analysts as Asia top telecommunication company, SingTel is facing heightened competition from emerging players seeking to knock it from the perch. Australia’s TPG Telecom stunned the market by not only becoming Singapore’s 4th telecommunication player in late 2016, but also Australia’s 4th telecommunication player in early 2017. Given the increased competition in Singapore, Australia and India, can SingTel fight gravity?

To put things into perspective, SingTel did not sleep walk into the dominant position in Asia by chance. Listed in SGX main board back in 1993, the company embarked on a slew of overseas acquisitions spree, with backing from Singapore sovereign wealth fund, Temasek Holdings.

As a result, SingTel enjoyed a massive investment moat of 600 million mobile phone subscribers across South East Asia countries like India, Philippines, Thailand, Indonesia, Singapore and Australia. This is an impressive feat that took more than 24 years to establish. In this regard, it is unlikely that TPG Telecom’s entry would pose short-term threat to SingTel.

In Singapore, the telecom industry is regulated by IMDA. When the regulator announced that a fourth license would be issued a couple of years ago, many investors and industry players were puzzled. While consumers certainly wish for a price war in light of the increased competition, having four players in Singapore wireless market does not make sense. After all, with a population of 5 million, Singapore’s market is just too small and saturated for another mobile phone player to gain a meaningful foothold.

The local pie is just not big enough for the new firm to generate efficient network scale and earn reasonable returns on invested capital. Indeed, scaling is important as it allows telecom players to efficiently deploy new network technologies, reduce overhead costs and marketing costs. For TPG Telecom, it needs to roll out the entire network from scratch after winning the spectrum rights from IMDA.

Although analysts may argue that the network deployment would not be a challenge in a small country like Singapore, it should be noted that IMDA set very high service standards for telco players. For example, operators must ensure 4G networks cover at least 95% of outdoor areas, increasing to 99% from July 2017. For a new player to achieve this requirement is an uphill task and would certainly take massive investment and resources. Furthermore, in about 5 years, the new 5G network is expected to be rolled out. So by the time TPG Telecom roll out its entire 4G network in Singapore, the trend could be on 5G technology already.

According to SingTel’s 2014 sustainability report, it still control significant market share in Singapore, with 82% of the fixed line market, 47% of the mobile market and 43% of the broadband market. Being the big boy, it is unlikely that its market share would be eroded by the entry of TPG Telecom in Singapore. The large subscriber base has allowed SingTel to enjoy a formidable investment moat that ward off competition. The likely victims could be the smaller players - Starhub and M1.

Nevertheless, in 2016, all the telco players slashed mobile data prices for post-paid users for higher end data subscription by 25% to 50%. In doing so, revenues are expected to decline for all players in the foreseeable future. This trend signaled that the incumbent operators would defend their market shares at all cost, even to the extent of sacrificing revenue. However, the impact for SingTel should be the minimum among the three players in Singapore because it derives the bulk of its earnings from regional countries.

Unlike Starhub and M1, Singtel’s strategy has always being penetrating large markets with significant economic fundamentals (young work force with good earning abilities). Optus, its Australian subsidiary, remains a key revenue contributor. Therefore, the entry of TPG Telecom in Australia is worrying for SingTel because Australia is an important market.

For SingTel to win the game, it is not wise to continue to engage a price war with TPG Telecom. This is because this sort of approach may inflict collateral damage to its brand and hurt profit margins. Instead, it should continue to entrench customer loyalty by developing innovative products and services

18 in green fields like cybersecurity, pay TV and smart phone portfolio. For example, it could enter into exclusive deals to launch the latest Iphone or Samsung mobile phone models. Its recent partnerships with Alibaba on Cloud Access services is also a step in the right direction. Fundamentally, the key should be to win more customers and retain subscribers.

At the end of the day, customers are willing to pay a premium for quality and innovative services. There is no point in providing cheap data plans with consistent unreliable network connections. To ward off the competition from TPG Telecom in Australia, SingTel must continue to invest in infrastructure so as to continue providing high level of reliable telecom services. To achieve this, it needs additional capital to win the battle. The upcoming divestment of NetLink Trust could be the solution.

Regarded as the mega IPO of the year, NetLink Trust is a business trust in Singapore which designs, builds, owns and operates the passive infrastructure for Singapore’s Next Generation Nationwide Broadband Network (“NextGen NBN”) with Singtel as its sole unitholder. Under IMDA’s requirement, SingTel is to reduce its stake in NetLink Trust to less than 25% before April 2018. In view of this, SingTel has commenced preparation for an initial public offering of NetLink Trust and the IPO application had been approved by SGX.

With the cash proceeds of about $2 billion, SingTel has a substantial war-chest to go on the offensive against TPG Telecom. The management could consider using the cash to further develop its infrastructure investments in Australia through its Optus unit or penetrate new markets like China and Vietnam.

Ideally, I would prefer SingTel to use the cash proceeds from NetLink Trust divestment to pay off its debt. Current assets were $5.9 billion while current liabilities stood at $9.2 billion. The culprit was due to the unsecured borrowings of $3 billion to be repayable within one year. However, such approach would not help to expand SingTel’s investment moat. In view of the challenge of TPG Telecom, now is the time for SingTel to launch a pre-emptive strike before its opponent erode its market share.

The window of opportunity is still there before TPG Telecom close the gap. SingTel must seize the chance to increase its investment moat to protect its market share before time runs out.

SingTel at a cross-road

The gloves are off as SingTel engages in a battle with Australian rival, TPG Telecom. In late last year, TPG Telecom won the rights to become Singapore's fourth telco operator. In early April this year, TPG shocked the market by winning the rights to become Australia fourth mobile operator in Australia.

It is still early days to assess the impact of the heightened competition from TPG but SingTel is at a cross-road as it has to compete with TPG in both the Singapore and Australia market. While the impact of a fourth telco in Singapore would have minimal impact on SingTel, the same cannot be said for the entry of a new competitor in Australia. This is because the Australia market is very important to SingTel, which traditionally derived the bulk of its earnings from the regional businesses.

In the fourth quarter ending 31 March 2017, EBITDA from Optus, SingTel's subsidiary in Australia, was A$741 million, more than half of the Group's EBITDA of S$1.31 billion. This is not surprising given that the Australia market is so much bigger than Singapore. Net profit was up 1% to A$250 million while operating revenue rose 1.6% to A$2.11 billion.

Against the backdrop of increased competition, Optus continued to enhance the competitiveness of its network – with A$1.5 billion in capital expenditure. At the end of March 2017, Optus’ 4G network reached 96.1% of Australians. Through the deployment of significant spectrum holdings and innovative technologies such as 4.5G and native Voice over WiFi, Optus is improving network coverage and download speeds for customers.

Despite the challenging outlook, SingTel reported strong core revenue and earnings. Year-on-year for 4QFY17, operating revenue grew 5% to $4.3 billion and EBITDA increased 4% to $1.31 billion. Among its overseas joint ventures, Telkomsel’s pre-tax profit contribution rose 17% as it continued to deliver robust growth across voice, data and digital services. Profit before tax from Telkomsel in the quarter was an impressive $371 million. In years to come, contribution from the Indonesia market is expected to eclipse that of its Australia market.

Free cash flow was $3 billion, an increased of 12% from last year. With this huge war chest, SingTel is able to continue acquiring companies to boost future growth. On 10 April 2017, Amobee, Inc. completed its acquisition of 100% of the share capital of Turn, Inc. for an aggregate consideration of US$290 million after adjustments for working capital and net debt. Turn, Inc., a corporation organised under the laws of Delaware, USA, is a leading provider of a global technology platform for marketers and agencies.

As a growth company, SingTel's typical weakness is in its weak balance sheet. Current assets were $5.9 billion while current liabilities was $9.2 billion. The culprit was due to the unsecured borrowings of $3 billion to be repayable within one year.

As a big boy, SingTel enjoys a massive investment moat among its peers and thus has good credit reputation. In April 2017, the Group entered into agreements for total credit facilities of approximately S$4.1 billion for general corporate purposes and refinancing of existing facilities.

While I am not against companies borrowing to fund business growth, I would like to see SingTel's borrowing decrease to a more sustainable level. With the upcoming interest rate hikes, it may be prudent for SingTel to pare down its short term borrowings. Thus, the impending divestment of NetLink Trust is key to address this issue.

NetLink Trust is a business trust in Singapore which designs, builds, owns and operates the passive infrastructure for Singapore’s Next Generation Nationwide Broadband Network (“NextGen NBN”) with Singtel as its sole unitholder. Under IMDA's requirement, SingTel is to reduce its stake in NetLink Trust to less than 25% before April 2018. In view of this, SingTel has commenced preparation for an initial public offering of NetLink Trust.

NetLink Trust should be the blockbuster IPO in Singapore stock market and the growth story is indeed compelling. To illustrate this, its EBITDA was $221 million in 2017, an increase of 20% year-on-year.

Many analysts estimated that SingTel's stake could be worth $2 billion. My thoughts that it could be more, probably $3 billion, depending on the IPO performance.

Under normal circumstances, the impending divestment of NetLink Trust and the upcoming dividend payout in August should propel SingTel share price. But many investors must be wondering why the share price remain laggard despite the good news. Based on my observations, three factors may have caused SingTel share price to be bearish.

Firstly, the big boys are out in full force and had been short selling SingTel shares. From 15 to 19 May 2017, 22.2 million shares were shorted, with value of $83 million. From 8 to 12 May 2017, 26 million shares were shorted, with value of $98.2 million. The most ferocious week was 10 to 14 April 2017, when 36.5 million of SingTel shares were short-sold, with total value of $139 million. Incidentally, that was the week when news of TPG Telecom announced its victory of securing the fourth mobile operator rights in Australia.

Indeed, the increased competition could erode SingTel's regional market share. That was why investors had been dumping shares. While it is too premature to say that SingTel's downfall is imminent, many investors may not be prepared to pay a premium for SingTel's shares anymore. Some may feel that it is better to wait until the short-selling activities subside before accumulating the blue chip shares for the purpose of collecting the annual dividends.

Lastly, SingTel's foray into overseas markets are not without risks as the telco had been engaged in various legal disputes and tax claims amounting to billion of dollars in various countries. This is not surprising as most countries control the telecommunication industry tightly. While this issue is not considered critical at the moment, investors may view it as an uncertainty. Therefore, this explains the weak sentiment on SingTel shares.

Over the years, I had been tracking SingTel shares. Please read my previous articles on this giant:

1. Short selling on SingTel shares 2. SingTel shares to rocket on NetLink Trust IPO? 3. SingTel shares in supreme form

SingTel continues to be one of my favorite stocks but with big boy short-selling the shares, I would avoid entering this counter. In fact, Henderson Global Asia had cut SingTel equity stake in April 2017. Entering this counter now may be risky for me even though there are carrots dangling - dividend payout and the upcoming NetLink Trust divestment. My entry price remains at $3.20 because the way I see it, the decline will continue.

When investing in stocks, it is important to have a strategy in setting the entry and exit price. What is your strategy for SingTel shares? Enjoy the ride.

Short selling on SingTel shares

On 12 April 2017, SingTel shares experienced heavy shelling by short sellers. On that fateful day, the short sales volume was 21.7 million, with market value of $82.7 million. The heavy attack led to a decline in SingTel share price from $3.84 to the current $3.75. What could have caused the big boys to do massive short selling on SingTel shares?

The short selling of SingTel shares was disturbing because it has been on-going for several weeks. From 3 to 7 April, there was 16.7 million of short sales volume, with total value of $65.4 million. The week before it was 21.7 million short sales with total value of $85 million being shorted. Prior to that, another ferocious attack occurred in the week 13 to 17 March, with 20.4 million short sales volume of $81 million value.

It may sound far-fetched to investors but the reason for the SingTel shares attacks could be attributed to short-sellers plotting to pull back the Straits Times Index (STI), which closed 0.98 percent lower on 17 April 2017. Being the stock market bellwether in Singapore, it makes sense for the big boys to target SingTel in a bid to engineer a stock market correction in Singapore.

Previously, I have posted a series of research on this telco giant in this blog. Readers may refer to the following links:

1. SingTel shares to rocket on NetLink Trust IPO? 2. SingTel share price in supreme form 3. SingTel increased investment moats aggressively

Most investors would view short-selling negatively but nonetheless, such activity is needed to prevent market prices from becoming out of whack.

According to Monetary Authority of Singapore, short selling refers to the sale of securities that the seller does not own at the time of the sale, short selling may either be: ‘covered’ or ‘uncovered’ (also referred to as ‘naked’ short selling). In ‘covered’ short selling, at the time of the sale, the seller has borrowed the securities or has otherwise made arrangements to fulfil his obligation to deliver the securities. In ‘uncovered’ short selling, at the time of the sale, the seller is not in possession of securities or has not otherwise made arrangements to meet his delivery obligation.

Although there are positive effects of short selling, such activity may be disruptive to the market if it spirals out of control. Hence, there are measures by SGX to mitigate the negative effects of short selling. Notwithstanding this, retail investors should exercise caution and it is best to adopt a wait and see approach before investing in SingTel shares.

Another plausible reason for the massive shorting of SingTel shares could be the entry of a fourth telco player. Given the saturated Singapore market, the new entrant is viewed by many investors as an unwelcome competition leading to erosion of profits for SingTel.

However, in my previous article, I have also stressed that SingTel is a regional telco player and that the entry of the new telco would have minimal impact on its long-term business outlook. Hence, the current SingTel share price correction may be a plot devised by the big boys trying to play up fear among retail investors and in the process, make profits out of it.

Given the bearish trend, is it a good time to buy SingTel shares now? As one of the Strait Times Index constituents, SingTel is considered a blue chip in local stock market. In my point of view, the fundamentals of SingTel are still intact and the current correction may represent an opportunity to accumulate this blue chip darling at reasonable price. However, to avoid catching a falling knife, one must have long-term mentality and enter at comfortable entry price for this stock.

Setting an entry price is important because there is always a good time and bad time to buy stock. Apart from market condition, there are big boys’ movements that retail investors must watch out for. This is

22 not about market timing, but more of avoiding head-on clashes with the big boys, who often make big positions to drive up or down the share price of shares they targeted.

In my humble view, the ferocious attacks are unlikely to abate for the next few months because of the overall weak economy sentiments. Therefore, retail investors should not rush in at this juncture and start buying SingTel shares. Instead, one should remain calm and determine an entry price which provides a margin of safety for your investments.

Another thing about investing in blue chips like SingTel shares is that you need to have holding power to withstand the market swings. You are unlikely to hold SingTel shares for the long-term if you need the funds for purposes other than investments. So, if there is 10% or 20% drop in the share price in the short-term, you are likely to panic and sell at a loss.

In my previous article, I have highlighted that the impending divestment of NetLink Trust may be a game-changer for SingTel. I wrote that NetLink Trust IPO could be a windfall for SingTel investors because the management of SingTel may choose to issue special dividend or use the IPO proceeds to pay off its mounting debt. As of now, my view has not changed but given the short-selling attacks, the situation has evolved. As events continue to unfold, I am revising my entry-level for SingTel to $3.20.

Battle of the Singapore banks (OCBC, DBS and UOB)

Singapore “Big Three” local banks recently announced third quarter 2017 results. Although all three banks suffered from collateral damage arising from loan exposure to the oil and gas sector, the latest results were generally upbeat and data revealed resilient growth for OCBC, DBS and UOB.

Competition continued to be stiff among the banks but growth for all three banks is expected to be positive for the full-year as Singapore economic growth was predicted to exceed 3% for 2017.

OCBC took the lead

Net Performing Assets (NPAs) continued to weigh on the banks’ earning as the ailing oil and gas sector showed no signs of revival. DBS recorded a devastating 25% decline for 3Q17 profit as compared a year ago. Profit stood at $802 million, the worst among its close rivals. The dismal result for DBS was due to the massive allowances of $815 million made, largely for the loan exposure oil and gas sector. This was a huge provision and the amount indicated that the DBS CEO might have grossly underestimated the oil slump.

On the other hand, OCBC smashed in a solid profit of $1.06 billion for 3Q17, 12% above S$943 million a year ago. UOB came in second with profit of $883 million, 12% above a year ago. Among the three banks, OCBC made the least allowances for 3Q17, at only $156 million while UOB made provisions of $247 million. Whether the earning growth was attributed to lesser allowances remained to be seen but OCBC was leading ahead in terms of financial performance.

The key reason for OCBC trashing DBS and UOB was because the venerable bank traditionally derived its earning from various sources like insurance and wealth management. The oldest bank in Singapore remains the only bank that owns an insurance company - Great Eastern. OCBC also went on an acquisition spree in recent years to build up its wealth management arm. Barclays PLC in Singapore and Hong Kong and National Australia Bank’s Private Wealth were among the assets acquired.

Net-interest income

One key indicator in assessing a bank’s financial performance is the net-interest income. This is the difference between the interest earned from the bank’s investments and interest paid to depositors.

Basically, when you put your money in the bank, the bank would use your deposits to generate returns through home and corporate loans. In return, you get the saving interest rate. From the perspective of the bank, the interests paid to depositors are a form of liability. Hence, to generate higher margin, usually the saving interest is capped low while loan rate is kept at a premium.

At the moment, loans continued to be one of the main revenue sources for Singapore banks as 3Q17 net-interest income for DBS, OCBC and UOB was $1.98 billion, $1.38 billion and $1.41 billion respectively. However, against the backdrop of non-performing loans, this type of revenue is beginning to lose its shine.

Take for example, OCBC recorded the worst net-interest income for the quarter yet it had the best profit among the three banks. Perhaps OCBC had been prudent in diversifying its revenue sources in previous years. That could be why it was not so affected by oil and gas non-performing loans as compared to DBS and UOB.

Non-interest income

Other key indicator for banks is the non-interest income which include fees from wealth management, unit trusts and other investments. Non-interest income for OCBC was 1% higher at S$978 million as compared to S$970 million a year ago. Fees and commissions increased 14% to S$488 million, mainly from wealth management, fund management and trade-related income.

Wealth management fee income grew 32% year-on-year, partly contributed by the former wealth and investment management business of Barclays. It looked like acquisitions made in previous years is

24 paying off dividends and in years to come, wealth management may be the game-changer for OCBC earning growth.

Non-interest income for DBS was $1.084 billion for 3Q17 but its wealth management segment trailed behind OCBC as 9M17 income from wealth management was $1.57 billion. The result was inferior to OCBC’s $2.2 billion. Perhaps OCBC has the advantage of having Great Eastern as its subsidiary. Profit from life assurance rose 23% to S$201 million as operating profit from Great Eastern’s underlying insurance business grew year-on-year and its investment portfolio achieved positive performance due to favourable market conditions. In my opinion, Great Eastern would continue to cement OCBC investment moat for many years because insurance company is a very profitable business.

Over at UOB, the non-interest income was $830 million, the smallest among the trio. Fee and commission income for 9M17 rose 13% to $1.58 billion led by double digit growth in the wealth management, fund management and credit card businesses. Wealth management fees grew 39% to $405 million on higher sales of treasury products and unit trusts while fund management income increased by 27% to $173 million due to conducive market conditions. Credit card fees also grew 10% to $292 million from higher transaction volume in Singapore. Other non-interest income declined 2% to $900 million mainly due to lower net trading income.

Changing landscape

Traditionally, the banks derived their incomes from loans issued to home-owners and companies. Going forward, income from loans is likely to continue to be the bread and butter for the banks but data showed that contribution from wealth management is growing significantly. This could be the motivating factor for DBS to acquire ANZ and OCBC to acquire Barclays and National Australia Bank’s wealth management businesses.

For the past few years, Singapore banks had endured a challenging time as the industry faced the double whammy from the fallout of the oil and gas slump and the property cooling measures. Nobody knows when the oil price would rebound and the amount of toxic loans would likely to rise. The good thing is that the three banks have already made reasonable level of provisions to buffer the impact of non-performing loan.

In terms of non-performing loans, DBS has $6.1 billion, while OCBC and UOB only have $2.98 billion and $3.75 billion respectively. Given that DBS has far more non-performing loans than OCBC and UOB, I am wondering what sort of risk management that the DBS has implemented to contain the damage from bad loans. Notwithstanding this, all three banks remained in very strong funding and liquidity positions.

All the banks had Common Equity Tier 1 capital adequacy ratio (“CAR”), Tier 1 CAR and Total CAR were well above the respective regulatory minima of 6.5%, 8% and 10%. Hence, depositors can sleep well and be assured that the possibility of bank runs are remotely low for Singapore banks.

Share price

Underpinned by strong business fundamentals, share prices of OCBC, UOB and DBS had been on very bullish form lately. Share price of OCBC surged to record high of $12.10 with Price/Book Value of 1.317. Similarly, DBS shares went on a rampage and is now trading around the $25.00 with Price/Book Value of 1.37. UOB share price is not doing too badly either, currently trading at $25.77 with Price/Book Value of 1.219.

In my point of view, all the bank stocks are not expensive at the moment. But if your strategy is buy and hold for capital appreciation, then the potential for upside is limited. This is because the operating environment is getting quite challenging and unless management of the banks implement strategies to unlock value, I doubt the bull run is sustainable.

For OCBC, there is actually substantial unrealized valuation surplus of $8.8 billion from its properties and equity securities portfolio. The Group’s unrealised valuation surplus largely represents the

25 difference between the carrying values of its properties, its investments in quoted subsidiaries and an associate, the investment in Hong Kong Life, and the market values of properties at the respective periods. After valuation surplus is factored in, the Net Asset Value (NAV) of OCBC is actually $10.87.

However, if OCBC management is more proactive in diversifying its suite of investment properties, associates and joint ventures, then the true value of OCBC share price should be around $20. Of course, this is just my estimation. As for DBS, the unrealized valuation surplus is much smaller, at $529 million. UOB has about $4.55 billion worth of revaluation surplus.

Conclusion

For Singapore banks, it will be a fight to the very end as they battle for market share in loans, wealth management and financial services. Nonetheless, the winner would be the one which gained traction in foreign market penetration. As Singapore market is far too small to scale up, it is important for local players to embark on overseas acquisition in order to grow to the next level.

OCBC acquired Hong Kong’s Wing Hang Bank back in 2014 for $6.23 billion while the last major overseas acquisition of DBS was Dao Heng Bank in 2001 for $10 billion. After acquiring OUB for $10 billion in 2001, UOB did not make any major overseas bank acquisitions. Perhaps merger wizard, Wee Cho Yaw has something up to his sleeve? Until then, the saga will continue. Till then, enjoy the ride.

Superb form of Haw Par share price

For the longest time, home-grown multinational group, Haw Par Corporation had been in laggard form. Although the business fundamentals had been consistently good over the years, the share price had been hovering way below its Net Asset Value (NAV) of $12.00. But in 2017, the share price suddenly came to life and roar ahead to reach a record high of $12.28 recently.

Founded by the Aw brothers in the early 19th century, Haw Par is well-known for its Tiger Balm oilment products. However, the family business went through a tumultuous period in the 1970s when massive irregularities almost led to a spectacular collapse of the company. The government of Singapore had to intervene and pulled in the late Michael Fam to restore order.

Following the crisis, there was a three-way battle vying for the control of Haw Par between Hong Leong Group, Jack Chia Limited, and United Overseas Bank (UOB) headed by Wee Cho Yaw. In 1981, merger wizard Wee Cho Yaw emerged victory in the fight and the rest is history.

Under the brilliant leadership of Wee Cho Yaw, Haw Par grew from strength to strength and was transformed into a diversified conglomerate with operating business in healthcare, leisure, property and investments.

Today, Wee Cho Yaw remains its Chairman and his sons, Wee Ee-chao and Wee Ee Lim are also among the board of directors. Notably, Lee Kuan Yew’s younger brother, Lee Suan Yew is also one of the directors. The reason for the Wee Cho Yaw to retain control of Haw Par is probably because the company held about 71.9 million shares of UOB through its Investment arm in 2016. The UOB shares provided $49 million worth of investment income in 2016.

According to the 2016 FY report, the Investment arm also owned 69.5 million shares in United Industrial Corporation (UIC) and 44.7 million shares of UOL Group. In mid-2017, there was a reshuffling of shares involving the three companies. 27.3 million new shares of UOL were issued in exchange of 60 million UIC shares from Haw Par. The transaction would result in UOL increasing its stake in UIC from 44.7% to 48.9%. The injection of the new UOL shares would also see Haw Par Capital, a subsidiary of Haw Par Corporation, increased in book value of $219 million.

The shares transfer only served to add fuel to fire as the share price had been in red hot form since February 2016. Within two years, the share price has surged from $7.36 to reach a record high of $12.25 in September 2017. Do I regret missing the boat? Of course I did! If I had bought 2000 shares of Haw Par last year, I would be staring at $9700 worth of paper gains. For such a short-term investment, the return is indeed explosive.

From an investor’s point of view, Haw Par may be a potential multi-bagger. However, from a business point of view, the management has not been extremely good at generating returns for the company. The Return on Equity (ROE) had been an average of 5% for the past five years. The figure is hardly eye-catching. On the other hand, there are no long-term debts and revenue had been growing consistently, from $141 million in FY2013 to $201 million in FY2016. These track records indicated that the management is prudent in growing Haw Par through the years but may have no aggressive plans to expand the business operations.

At times, Haw Par do seem like a company suffering from identity crisis. At one point, it was known for owning Underwater World Singapore, Chengdu Haw Par Oceanarium, L'Aquarium Barcelona, golf driving range and bowling centres. These were past investments and now the Leisure arm of Haw Par only owns and operates the Underwater World Pattaya in Thailand. But the company actually derives the bulk of revenue from the Healthcare segment.

For the 2nd quarter ended 30 June, revenue increased 15.0% to $60.5m mainly due to higher sales from Healthcare. Demand for Tiger Balm products grew following the expansion in distribution network and increase in marketing activities. However, the revenue growth was partially offset by lower revenue from Leisure.

Very impressively, Tiger Balm remains the biggest cash cow for Haw Par despite its diversified revenue sources. Gross profit for 6 months ended 30 June was $77.5 million, an increase of 21.8% compared to last year. The balance sheet remained one of the strongest among the SGX companies. With current assets of $840 million, Haw Par was holding on to $329 million of cash and cash equivalent. The total liabilities were only $174 million.

Cash flow from operations remained healthy at $34.8 million for 6 months ended 30 June. This suggested that its core business (Healthcare) was cash generative. However, investment income received decreased to $8.8 million from $28.5 million compared to last year. Investment income came from dividends received from investments in UOB, UOL and UIC. The volatile income from its Investment segment suggested that the share price of Haw Par might be intricately affected by the performance of UOB, UOL and UIC.

Following the recent approved disposal of 60m UIC shares in exchange for 27.27m UOL shares, Haw Par’ strategic investment portfolio had been changed accordingly to include a larger shareholding of 8.57% (from 5.51%) in UOL.

Despite the share transfers, it does not appear to me that the Wee family had any grand plans to expand Haw Par Corp aggressively even though the core business operations had been growing well. Total revenue has been growing consistently, from $141 million in FY2013 to $201 million in FY2016. During this period, the share price had been hovering at the $7.00 level. So, it really caught me by surprise that the share price went on an explosive run and exceeded the $12.00 level.

Somehow, the share price had exceeded expectation but I could not identify a plausible reason to explain the bullish form. Perhaps the big boys were behind the surge in share price. Whatever the case, long-time investors should be happy.

As for me, the potential for upside is limited as the price has reached the peak. Would not enter this counter in the near term but is monitoring the situation closely.

Is SIA Engineering Company a value trap?

SIA Engineering Company announced on 30 June 2016 the divestments of its 10% stake in Hong Kong Aero Engine Services Ltd (HAESL) to Rolls-Royce Overseas Holding Ltd. At the same time HAESL will divest its 20% stake in Singapore Aero Engine Services Pte Ltd (SAESL). The divestments will result in a net gain of $178 million for the SIAEC Group, representing a windfall for SIA Engineering Company (SIAEC).

The move to divest SIAEC's stakes in several joint ventures is long overdue as its network of joint ventures (JV), associates and subsidiaries have become so complex that it affects the company's ability to compete for the aircraft aftermarket business. To a certain extent, some of its JV may even be competing against each other for maintenance, repair and overhaul (MRO) business. So this streamlining operation may bode well for the company going forward.

Business Challenges

Unlike its parent, SIA, the MRO business is more stable and predictable as compared to airline operations. This is because aircraft are required to be maintained at certain interval in order to be deemed as airworthy. Thus, the business model of SIAEC is recurring. However, the emergence of new composite aircraft like B787 and A350 changed the game for big MRO players like SIAEC and ST Aerospace.

The next generation aircraft require less maintenance works and longer interval of inspections and maintenance because of better materials and advanced technologies used in the design of the aircraft. While this trend is good for airlines like SIA, it presents a challenge for SIAEC, in terms of lesser work.

To mitigate the impact of technology advanced fleets, SIAEC went into recent partnerships with aircraft manufacturer like Boeing and Airbus. These strategic moves are needed in order for SIAEC to gain bigger market and increased competitiveness.

Shares buy-back

SIAEC has been buying back shares aggressively after its share price has plunged from a high of $5.29 in 2013. While analysts may argue that a company buying back its shares is a good sign that the shares are undervalued, one should be wary of value trap.

Notwithstanding the company has a profitable business model, its Net Asset Value (NAV) is only $1.32 while its Net Current Asset Value Per Share (NCAVPS) is only $0.55. So this means that SIAEC shares may be over-valued.

Investors may be caught off-guarded if business sentiments suddenly turned sour and resulted in massive market correction. The potential plunge may not be able to off-set the accumulated dividends dished out over the years. It is also a question mark when the stock price will recover, thus creating opportunity loss for investors as well.

New normal

The aviation landscape and trends have changed drastically over the last few years. While SIAEC's business is recurring because of the nature of aircraft fleet maintenance, technology has reduced the level of maintenance tasks needed.

SIAEC's investments in joint ventures with aircraft OEMs are good developments but they essentially wild-cards for the long-term. Whether such investments will become game-changers for the company will remain to be seen.

My strategy

At Price/Earning ratio of 23.37%, I feel that it is risky to buy the shares at the current price. Since July 2014, SIAEC's share price has been on a downward slide. The dividend yield is only 3.81% and therefore does not justify the risk.

The record low share price for SIAEC for the past 10 years was $1.58, during the Great Financial Crisis in 2009. Thus, I would pay a premium but set a safety buffer for SIAEC's shares. I would enter this counter only at $1.00. Not vested but monitoring this stock closely.

Is it worth investing in SIAEC shares now?

Currently trading at $3.73, SIA Engineering Company (SIAEC) shares have not reached the 5-year low of $3.35. But it does not mean that the company is doing fantastic either. SIAEC shares had been sliding from a record level of $5.29 since 2013 and many investors wonder whether it would be worth investing in SIAEC shares now.

For 1Q16, SIAEC announced profits amounting to $199.8 million as compared to $41.7 million in 2015. The explosive increase was due to $141.6 million gain from the divestment of its 10% stake in Hong Kong Aero Engine Services Ltd (“HAESL”) to Rolls-Royce Overseas Holdings Limited (“RROH”) and Hong Kong Aircraft Engineering Company Limited (“HAECO”).

In addition, the Group received a special dividend of $36.4 million from HAESL following the divestment of HAESL’s 20% stake in Singapore Aero Engine Services Limited (“SAESL”) to Rolls-Royce Singapore Pte Ltd (“RRS”), bringing the overall gain from the divestment to $178.0 million.

SIAEC financial performance

Apart from the one-off divestment, there are few bright spots for SIAEC. Revenue has declined for the past two years and for 1Q16, SIAEC registered a decline of revenue to $271.6 million from $277.3 million in 2015. Some analysts predicted in the news lately that lower passenger traffic for SIA would have serious impact on SIAEC’s business. But I beg to differ.

To put things into perspective, the aviation sector is very heavily regulated and this is even more so for aircraft maintenance tasks. So regardless of market conditions, operators like SIA are required to send their aircraft for maintenance checks. Thus, to attribute SIAEC’s decline in business to SIA’s decreasing passenger traffic does not make sense to me.

In fact, if investors bother to analyze the FY15 financial results, actually SIAEC derived only 34% of its revenue from SIA. The bulk of its revenue (66%) came from non-SIA work through its subsidiaries and joint ventures. Given the diversified revenue sources, SIAEC’s business performance being impacted by its parent company’s passenger load is minimal. So what could be the root cause for SIAEC’s decline?

SIAEC’s decline

One possible reason is the failure of management to capture growth. Recently, the company established joint ventures with Boeing and Airbus in a bid to leverage on their strengths to access larger market. However, prior to this, SIAEC had not been making significant investments to gain market share. With such a strong balance sheet and so much cash on hand, perhaps SIAEC may want to consider penetrating new markets like China or India for its lucrative line maintenance segment.

It does not help that new generation aircraft like A350 and B787 require less maintenance and longer maintenance intervals. This is because of the new technologies used in these aircraft and the use of composite fuselage has reduced the frequency of maintenance checks. Although the improvements brought by technology advancement are good for airlines, this trend results in less business for the MRO players.

Can SIAEC shares fight gravity or will this become the new normal for this MRO stalwart? Much of this will depend how management navigates the current headwinds. To continue to grow, SIAEC must pursue more strategic partnerships and deepen its overseas market penetrations. Based on past few years’ track record, SIAEC’s approach had always been calibrated and cautious. It is not SIAEC management’s style to pursue aggressive growth through mega acquisition deals. At least not that I know of in recent years. Thus, I expect a soft landing for SIAEC share price.

My strategy for SIAEC

Under the current business climate, it is not business as usual for SIAEC. Even though the company has been distributing dividends consistently over the years and business had been extremely profitable, the current price level does not reflect its financial performance. I expect share price to continue to slide

31 unless management came out with something drastic to reverse the sluggish growth. I will enter this counter only at $2.20 per share.

Research report on SIA Engineering Company

On 3rd February 2017, SIA Engineering Company announced 3Q results for 2016/17. It wasn’t exactly an impressive set of results but the data certainly reveals some interesting aspects of the company’s performance against the backdrop of a challenging operating environment for the maintenance, repair and overhaul (MRO) sector. This will be another research report on SIA Engineering Company (SIAEC).

Traditionally, SIAEC has a solid business model because it provides maintenance, repair and overhaul (MRO) of aircraft, engines and related components and offers the complete MRO suite of services. The business is recurring and with its vast network of joint ventures, the MRO stalwart managed to build an impressive investment moat in Singapore, rivalled only by local competitor, Singapore Technologies Aerospace.

However, the emergence of new generation aircraft with high reliability looks set to disrupt SIAEC’s business model because of the decline in demand due to extended maintenance intervals and lesser work-scope. In light of this, the management has started to position itself for the future through several initiatives.

Given that its joint ventures contribute a substantial amount of profits consistently to SIAEC, the management rationalized its portfolio of joint ventures periodically to extract value for shareholders. Some of these initiatives include restructuring and merger of associated entities and development of capabilities to support new generation aircraft.

During the first quarter, the Group made a $141.6 million gain from the divestment of its 10% stake in Hong Kong Aero Engine Services Ltd (“HAESL”) to Rolls Royce Overseas Holdings Limited (“RROH”) and Hong Kong Aircraft Engineering Company Limited (“HAECO”). In addition, the Group received a special dividend of $36.4 million from HAESL following the divestment of its 20% stake in SAESL to Rolls-Royce Singapore Pte Ltd (“RRS”), bringing the overall gain from divestment to $178.0 million.

The Group’s cash balance increased $166.3 million or 42.2% to $560.2 million, mainly from the cash received from the divestment of HAESL and cash flows generated from operations, offset in part by dividends paid. Total assets stood at $1,888.0 million.

Nonetheless, upon delving further into 3rd quarter results, it seems that the divestment of associated companies masked an underlying mixed performance for SIAEC. Operating profit of $25.2 million was $3.8 million or 13.1% lower than the same quarter last year. Revenue of $272.3 million reflected a decrease of $2.9 million or 1.1%, due to lower fleet management and airframe and component overhaul revenue. Staff costs also increased in the 3rd quarter from $116 million to $125 million. However, the increase in staff costs had been offset by the decrease in subcontractor costs.

For a blue chip company like SIA Engineering Company to continue growing, it cannot afford to rely on divestment activities to generate profits. To sustain business growth, there is a need to deepen its alliance network to have greater access to overseas market. Thus far, the management has done a good job in reducing reliance on parent company, Singapore Airlines, for work. Today, work from the SIA Group airlines forms only about 22% of their business, with the remaining volume coming from third-party airlines.

SIA Engineering Company’s new airframe OEM joint ventures with Boeing and Airbus would position the MRO service provider well in the long run. The Boeing joint venture offers fleet management solutions to buyers of Boeing 737, 747, 777 and 787 aircraft, enabling SIA Engineering Company to have a competitive advantage in securing MRO business at the point of aircraft purchase. The Airbus joint venture will position SIAEC as Airbus’ Centre of Excellence for Airbus A380 and A350 heavy maintenance in Asia.

SIA Engineering Company continues to be cash rich and enjoys one of the strongest balance sheets among the SGX counters. The Group’s cash balance increased $166.3 million or 42.2% to $560.2 million, mainly from the cash received from the divestment of HAESL and cash flows generated from operations, offset in part by dividends paid. Total assets stood at $1,888.0 million. Long term bank loan

33 stood at only $26.2 million. Cash generated from operating activities was a healthy $66.6 million. Net asset value per share as at 31 December 2016 was 136.1 cents.

SIAEC share price has crashed to a 5-year low of $3.35 on 23 December 2016. It has since recovered and is now trading at $3.66 per share. The business model is defensive because of the recurring works for aircraft maintenance. However, due to the emerging threats arising from the changes in the aviation landscape, it is not business as usual for SIAEC.

Even though the company has been distributing dividends consistently over the years and business had been extremely profitable, the current price level does not reflect its financial performance. I expect share price to continue to correct in the long run and will enter this counter only at $2.20. Enjoy the ride.

SIAEC share price crashed to 5 year low

SIAEC share price crashed to 5 year low! Amid the global economic uncertainties and challenging aviation outlook, SIAEC’s performance continued to slide as revealed in the financial results for 1HFY2016/17. This article contains my latest SIAEC stock analysis. I am not vested in this counter but have been monitoring this maintenance, repair and overhaul (MRO) stalwart for many years.

Operating profit for 2nd quarter declined to $24.5 million as compared to $27.0 million last year. Cash flow from operations was a negative $7.4 million as compared to positive $2.4 million in the previous year. The dismal quarter results reflected the massive challenge faced by the management in navigating SIAEC through this storm.

It is certainly not business as usual for this MRO powerhouse as airlines are buying new aircraft like A350, B787, A320NEO and B737-MAX to replace their older fleets. These new aircraft require less maintenance checks and longer maintenance task intervals, especially in the first few years of entry into service. Arising from this new trend, the MRO sector in Singapore has seen a decline in business for the last 2 years. This is because about 90 per cent of the local aerospace work is tied to aircraft maintenance and repairs.

For SIAEC, the outlook is indeed gloomy. Although 1st half performance recorded a profit attributable to owners of the parent of $233.9M, an increase of $148.1M, the result was largely due to the divestment of one of its units, HAESL. Operating profit for the first half of the financial year before the provision was $44.2M, a decrease of $3.7M or 7.7%. Usually I would give less credit to financial engineering tactics used by management to bolster financial profits and focus instead on the company’s core operating results.

Nevertheless, SIAEC continued to hold one of the strongest balance sheets among the SGX-listed companies. Net current assets was $667.4 million and non-current liabilities at only $53 million. The company remained cash rich, with cash balance increased $145.9 million or 37.0% to $539.8 million, mainly due to the cash consideration received from the divestment of HAESL and dividend received from HAESL following the divestment of its stake in SAESL, partially offset by payment of the final dividend.

With such strong financial position, SIAEC is poised to ride out the current storm, provided the management is able to strengthen the investment moats prudently. Even though the aviation maintenance industry is undergoing structural changes brought by new technological aircraft, ultimately every aircraft requires maintenance checks in order to be certified as airworthy under the aviation regulation. Thus, in order to grow, SIAEC needs to continue to grow its lucrative Aircraft and Component Services business unit in the South East Asia region.

There is a perceived notion that SIAEC relies on its parent company, SIA, for its revenue growth. Thus, most investors assume that when SIA is facing declining passenger loads, SIAEC’s business will be affected as well. Actually, this is a misconception because SIAEC derived most of its business revenue from non-SIA work.

For the current 1st half, 68% of its revenue came from non-SIA work, an increase of 4% from last year. Revenue from non-SIA amounted to $1.53 billion for the first half while SIA work constituted $708 million of revenue only. In this regard, management has done well in diversifying SIAEC’s business portfolio and mitigating the risk of relying on SIA for growth.

Following the divestment of HAESL, the management wasted no time in streamlining its operations to enhance operating efficiencies. During the quarter, they completed the merger of Singapore Aero Engine Services Pte Ltd and International Engine Component Overhaul Pte Ltd. Then in November 2016, SIAEC announced the integration of its joint venture companies with Pratt and Whitney, Component Aerospace Singapore Pte. Ltd (“CAS”) and International Aerospace Tubes-Asia Pte. Ltd. The rationales for these moves are the economies of scale and synergies from the streamlining of the business processes.

To spur growth in its Line and Heavy Maintenance arm, SIAEC has formed a joint venture with Airbus Heavy Maintenance Singapore Services Pte Ltd (“HMS Services”) provide airframe maintenance, cabin upgrade and modification services for Airbus A380, A350 and A330 aircraft families in Asia-Pacific and beyond. SIAEC holds a 65% equity stake in HMS Services and Airbus holds the remaining 35%. On 22 December 2016, SIAEC also formed a joint venture with Moog Inc. to provide maintenance, repair and overhaul services for Moog’s products, which include components on flight control systems for new- generation aircraft, such as the Boeing 787 and the Airbus A350.

All these initiatives by SIAEC are long-term investments to increase its competitiveness and investors should not expect to see the positive impacts in the short-term. Thus, SIAEC share price will continue to be affected by the current structural changes in the industry. Share price has tumbled from $5.29 in 2013 to a 5 year-low of $3.35. Nonetheless, the MRO giant continued to be profitable and had paid out interim dividend of $0.04 per share in November 2016. The dividend payout was lower than last year’s $0.06 per share.

The Net Current Asset Value Per Share (NCAVPS) is calculated to be $0.55 per share while Net Asset Value (NAV) is at $1.33. This implies that SIAEC share price is currently inflated. Based on current trend, the share price is set to decline further and it is likely to reach the $2.50 level in 2017. My target entry-level for SIAEC remains at $2.20 per share.

SIA Engineering Company shares rocked by JP Morgan’s sale

On 4 October, SIA Engineering Company shares tumbled to 6-year low following news of JP Morgan’ sale. Share price fell in the early morning of trading to $3.15 before recovering to $3.20 level. In my opinion, the correction is long overdue as the business outlook for the MRO giant has considerably dimmed in recent years with the entry-into-service of new aircraft requiring much less maintenance works.

Financial results for 1Q2017/18 revealed that profit declined 82% to $36.2 million. The huge decline was because of the absence of divestment gain in last year (SIA Engineering divested 10% stake in Hong Kong Aero Engine Services Ltd (“HAESL”) to Rolls-Royce Overseas Holdings Limited (“RROH”) and Hong Kong Aircraft Engineering Company Limited (“HAECO”)).

However, even after excluding the impact of the divestment in the quarter ended 30 June 2016, profit for the current quarter of $36.2 million was $1.8 million or 4.7% lower. Revenue also remained flat, at $272.8 million. Although the results were not exactly that disappointing, they seemed to suggest that SIA Engineering business fundamentals might have peaked.

To be fair to the management, SIA Engineering had tried to engineer growth in view of the challenging operating environment. Last year, SIA Engineering began to streamline its pantheon of joint ventures. Its joint ventures with Pratt and Whitney, Component Aerospace Singapore Pte. Ltd. (“CAS”) and International Aerospace Tubes-Asia Pte. Ltd, were integrated, presumably to reduce costs and create synergies between the subsidiaries. The group made a profit of $146 million from the divestment of HAESL. There was also the amalgamation of the business and operations of SAESL and International Engine Component Overhaul Pte Ltd (“IECO”), their second joint venture with Rolls Royce in Singapore, into a single entity.

In February 2017, SIA Engineering and Airbus formed a joint venture to provide airframe maintenance, cabin upgrade and modification services for Airbus A380, A350 and A330 aircraft families in Asia-Pacific and beyond. Interestingly, in June 2017, SIA Engineering have agreed to form a joint venture with GE Aviation to provide (MRO) services for the GE90 and GE9X engines. For the longest time, SIA Engineering had joint ventures with two of the biggest engine makers in the world, Pratt and Whitney and Rolls Royce. The agreement with GE Aviation to set up MRO base in Singapore should finally cement Singapore as the leading engine MRO hub in the world.

The recent announcement of the incorporation of joint venture company, Moog Aircraft Services Asia is unlikely to have major impact on SIA Engineering’s growth. In my point of view, Moog is not considered a game-changer as it is not an aircraft OEM nor an engine maker. The joint venture provides maintenance, repair and overhaul services for Moog manufactured flight control systems fitted on new generation aircraft including the Boeing 787 and Airbus A350.

However, I am pretty excited about the joint ventures with Boeing, Airbus and GE Aviation. These are the big boys in aviation and the long-term impacts should be more significant.

The strategy to keep forming joint ventures with OEMs is needed to diversify revenue sources. According to last year financial results, FY2016/17 saw SIAE itself derived 67% of its revenue of $662

37 million from parent company, Singapore Airlines. However, when revenue from subsidiaries and joint ventures were factored in, the total revenue from SIA accounted for only 33% ($1.49 billion) while non- SIA clocked in $3 billion. So the importance of the contributions from the subsidiaries and joint ventures cannot be underestimated.

The business fundamentals were still sound, with Return on Equity (ROE) standing at double digits for the past 5 years. This indicated that management had been pretty good at generating returns for the shareholders. The management was also prudent in managing the balance sheet, with cash balance of $628 million. With so much money on hand, the long-term debts of $20.7 million seems like peanuts. Nevertheless, the total revenue has been declining since 2014, from $1.178 billion to $1.1 billion in 2017. The drop in the revenue performance has seen the stock price fallen from a high of $5.12 in 2014 to the current $3.20 level.

Indeed, the outlook for SIA Engineering would be challenging as it is hit by changing trends in the aviation sector. Stiff competition among airlines had led to many operators implementing cost measures and these caused the pressure on the MRO rates. In addition, many airlines are renewing their fleets with new aircraft that comes with lesser maintenance needs and longer maintenance intervals. Examples would be SIA’s A350, Scoot’s B787 and SilkAir B737 Max.

Notwithstanding the challenges, growth opportunities remain because ultimately all aircraft would still need to be maintained according to airworthiness requirements. In this regard, the MRO business remains lucrative because of the nature of its recurring income. SIA Engineering’s various collaborative agreements with OEM would bode well because they serve to add value to airlines. However, these are all long-term investments and it would take time for the yield to be seen.

The motive behind the block sale of SIA Engineering was unknown. Perhaps the big boys were not confident of the growth prospect of the company. Maybe the sale was part of the institutional investors investment reshuffling. But when the big boys are in action, retail investors should be cautious. If you are not careful, chances of losing money are high when the "whales" flipped.

In conclusion, this SGX blue chip is currently navigating through un-chartered waters and this had impacted the business considerably. Is the current correction in stock price represents a good buying opportunity? To be frank, I don’t think so. At Price/Book Value of 2.449 and P/E ratio of 22.8, the share price still has room for correction. My entry price for this counter is still $2.20.

Is SingPost a value trap?

Being the national postal service provider for the past 150 years, SingPost has transformed into a mail and e-Commerce technology giant within Singapore in recent years. Throughout the years, SingPost had consistently received numerous awards for its branding, innovation and business excellence. Its largest shareholders include SingTel and AliBaba Group. With such an impressive background, the past few months must have been a nightmare for SingPost, at least for its investors.

Crisis brewing for SingPost

Following a special audit in early May 2016, the Accounting and Corporate Regulatory Authority (Acra) is investigating SingPost for potential breaches of the Companies Act. The special audit was undertaken to look into the disclosure of a board member's interest in the firm that advised on SingPost's recent acquisitions.

One of the most damaging findings in the 52 page summary report was the lack of “prescribed policy, process or procedure for the evaluation and approval of Merger and Acquisitions transactions”. For an institution that won two ASEAN corporate governance awards in 2015, this is indeed an embarrassing audit finding. It exposes the weak corporate governance on disclosure by its board of directors.

In light of this incident, the composition of the board committees was changed. Major shareholder, SingTel also stepped in and replaced SingPost chairman Mr Lim Ho Kee, with Mr Simon Israel. At this moment, SingPost is still looking for suitable candidate to replace group CEO Dr Wolfgang Baier, who resigned in December 2015. Its COO, Dr Sascha Hower also announced resignation on 21 June 2016. Amid the current mess the company is facing, will SingPost rise from the ashes?

Financial Performance

Despite the troubles, SingPost appears to be in good financial shape. For the latest full year financial results, revenue crossed the $1 billion milestone and net profits hit a record high of $248.9 million, boosted by one-off divestment gains. Notably, the financial report registered a net current liability of $133.2 million as at 31 March 2016 due to the acquisition of Trade Global. This increased the amount of borrowings, which increased from $238 million to $280 million year-on-year. However, cash flow from operating activities remained resilient at $202 million on full year basis.

The acquisition of Trade Global is needed as the Group continues its transformation into an e- Commerce logistics player. Trade Global is one of the top five e-Commerce end-to-end players in the United States and this deal would allow SingPost to expand its footprint in the international markets. However, it remains to be seen whether SingPost overpaid for it as the amount involved, $236 million, is substantial.

SingPost Investment Potential

One thing for sure is that Trade Global will not be SingPost’s final e-Commerce logistics acquisition. This is because SingPost has embarked on the transformation journey more than 10 years ago and is convinced that e-Commerce will fuel future growth for the company. Thus, its aggressive merger and acquisitions of technology companies in recent years. In fact, e-Commerce related revenue made up 35.8% of full year revenue, reflecting the importance of this segment to the growth of the company.

Due to changing lifestyle, SingPost will continue to face pressure in declining letter mails. Thus, the transformation for SingPost into an e-Commerce player is not an option. However, the transition will not be painful as SingPost can easily leverage on its existing network of branches, human resources and logistic facilities. Probably because of this, e-Commerce giant, Alibaba Group, saw the potential in SingPost and prompted it to invest in SingPost to become its major shareholder.

Dividend Track Record

Starting from financial year ending 31 March 2016, SingPost has enhanced its dividend policy. The company aims to pay-out a total annual dividend of 7 cents per share, to be paid on a quarterly basis.

Including the final dividend pay-out of 2.5 cents for financial year ended 31 March 2016, total dividend for this FY2015/2016 amounts to 7 cents.

If you have been a shareholder of SingPost since 2003, then you would have collected a total dividend of $0.93 per share. This is because the Group has been consistently giving out dividends to shareholders through annual and special dividends. So clearly, this counter is a dividend play suitable for long-term investors.

In my point of view, the risk of SingPost being took-over by foreign competitors is low because mailing service is a strategic service in Singapore. Even though the mailing service industry has been liberalized since 2007, SingPost is still the designated Public Postal Licensee with access to letterbox master-door keys, the right to issue national stamps and the right to maintain our national postal code system.

It is also unlikely that the largest shareholder, SingTel, will privatize SingPost, given that there are no compelling reasons to do so. However, in the corporate world, nothing is impossible. So the jury is still out on whether SingPost will be de-listed from SGX mainboard. Not vested but will continue to monitor this counter.

Will SingPost turn the tide?

When Simon Israel took over as SingPost’s Chairman in May this year, investors must be wondering whether SingPost will turn the tide. The group recently announced a set of disappointing 2Q16 results that saw net profit plunging 27.9% due to “transformational investments”.

Mr Israel, who is also the Chairman of SingTel, has been tasked to review the corporate governance and appoint a new CEO for SingPost. SingTel is the major shareholder of SingPost and currently holds 22.85% stake in the national postal service provider.

There was a leadership crisis in SingPost earlier this year and SingTel intervened after the exit of almost all of the top management. Even Chairman-designate Professor Low Teck Seng declined the offer to chair SingPost's board, claiming that the “role is too demanding”.

Judging by the recent financial results, Mr Israel certainly needs to accelerate the search for the new CEO so as to set strategic directions and lead the management team. Currently, Mr Mervyn Lim is the Covering Group Chief Executive Officer. Since the exodus of the previous management team, SingPost share price has declined steadily from $1.69 to a low of $1.37. The share price only starts to show sign of stability recently and currently hovers at $1.50.

To be fair to Mr Israel, it is not easy to implement reforms in an old institution like SingPost. Although SingTel is the major shareholder of SingPost, it does not necessarily means that both companies share the same culture. Thus, one of the sweeping changes that Mr Israel introduced was the capping of board tenure at nine years, similar to parent company SingTel. More changes may be on the card but it is important to note that Mr Israel cannot achieve much alone.

Thus, a new CEO is sorely needed. This is especially so given that SingPost is in the transition period of re-inventing its business model.

Perhaps the significant change that really turn off investors is the new dividend policy which is revised from an absolute amount to one based on a pay-out ratio ranging between 60 per cent and 80 percent of underlying net profit for each financial year. The board of directors hope that in setting the new policy, the dividends will be sustainable and to be paid out of underlying earnings.

Long-term investors of SingPost will be riled by the latest change made to the dividend policy as many Singapore investors were attracted by its rich history of dividends. In fact, investors who hold SingPost shares since 2002 would have received $0.93 per share worth of dividends, making SingPost shares one of the most shining dividend stocks in the SGX market. The appealing aspect of investing in SingPost was that the dividend was very predictable for many years and this gave dividend investors a sense of certainty. With the recent change, SingPost’s appeal as a dividend stock may decline considerably among stock investors.

SingPost’s domestic mail business continues to be disrupted by technologies and latest earning report revealed that its postal segment business remains challenging. As of 30 September, the group was in a net debt position of $284.4 million. Total borrowings increased from S$280.3 million as at 31 March to S$406.4 million as at 30 September due to the construction of the SPC retail mall and Regional eCommerce Logistics Hub.

Apart from the shaky balance sheet, the bigger concern should be the significant decline in the operating profits across all segments. Excluding the one-off gains, operating profit decreased by 30.5% and 16.9% in the second quarter and first half over the corresponding periods last year. Even though SingPost is in the midst of re-engineering its business model in this new economy, this is not a valid reason for this poor quarter financial performance.

Its e-commerce segment continue to bleed money, registering a whopping losses of $10.3 million in the 1H17, a 150% decline compared to previous half-year. Will its US investments in TradeGlobal and Jagged Peak turn out to be major flops? The jury is still out but the management has a mammoth task in extracting synergies from these acquisitions and making profits out of them.

To be frank, it is still a mystery to me that SingPost is able to secure investment from Alibaba. After all, Singapore market is so small and Alibaba would be better off scaling its online market businesses in big countries like Indonesia and China. Nevertheless, SingPost recently announced that the authority has granted approval for Alibaba to increase its interest in SingPost to 14.4%, from 10.2%. Alibaba’s further investment of S$187.1 million into SingPost is targeted to be completed by 28 February 2017. The funding would definitely help to boost the investments funds needed for transforming SingPost into a digital player and growing its current stable of subsidiaries.

Not all business turnarounds can be successful but many investors tend to be attracted to companies taking on new business models. For some unknown reasons, many people tend to believe business changes would bring about positive impacts and ignore the risks. In the case of SingPost, the outlook is murky and whether the group can navigate through the storm will depend very much on management’s execution in the coming years. But then again, without a new CEO in sight, there is too much uncertainty for me to enter this counter. I will not enter this counter unless the price drop drastically to $0.20.

In conclusion, I am convinced SingPost will turn the corner but patience is needed. Investors should not expect miracles to happen within the short term.

Do you invest in SingPost shares? What are your thoughts and comments on this article? Feel free to share your comments in this blog.

Analysis of SingPost

On 29 December 2016, SingPost finally unveiled a new Chief Executive Officer (CEO) through appointment of Mr Paul William Coutts who was previously from Toll Global Forwarding, one of the five divisions in the Toll Group. On the basis of the 2Q2016 financial performance, the new CEO will have his work cut out for him. This article contains my analysis of SingPost.

Suffice to say, SingPost’s business model has been disrupted by digital technologies, which led to declining traditional letter mail volumes in recent years. 2Q2016 financial results revealed that SingPost is a company still “work-in-progress”. Underlying net profit for Q2 fell 27.9% which the company attributed to “transformational investments and challenges”. Total expenses increased by 23.7% due to higher expenses in the eCommerce business and costs related to the new Regional eCommerce Logistics Hub.

As SingPost embarks on its business transformation journey, the incoming CEO has an unenviable task of leading an institution that has faltered in recent years. While the company is still making profits, operating profits across all its business units declined by doubt digits compared to last year. Its eCommerce unit lost $6.8 million and $10.3 million in Q2 and H1.

The eCommerce unit will likely to continue burning cash as SingPost seeks to enhance the eCommerce logistics capabilities to better serve the region growing online retail markets. A lot will also depend on whether the management is able to integrate and extract synergies from acquisitions made over the past few years.

Notably, there was an increase in short-term borrowings, which led to a net current liability position of S$239.1 million, compared to S$133.2 million as at 31 March 2016. The cash and short-term funds were largely utilised for residual expenditure on committed capex for construction of the SPC retail mall and Regional eCommerce Logistics Hub. The increased borrowings is essential to fuel future growth for SingPost but this has caused the balance sheet to appear slightly shaky.

Cash flow from operating activities was $21.3 million, an improvement from negative $37 million last year. Capital expenditure is expected to remain high in FY2016/17 from committed capital expenditure for the ongoing redevelopment of SPC retail mall. Thus, the investment from Alibaba Group would be very helpful in tiding SingPost over this critical phase of transformation. Infocommunications Media Development Authority has given approval for Alibaba to increase its interest in SingPost to 14.4 per cent, from 10.2 per cent currently. Alibaba’s further investment of S$187.1 million into SingPost is targeted to be completed by 28 February 2017.

Since IPO, SingPost has rewarded shareholders dividends amounting to 93.9 cents per share – compared to the IPO price of 60 cents per share. With this stellar dividend track record, SingPost is regarded as an attractive dividend stock to hold. However, SingPost recently revised its dividend policy recently from an absolute amount to one based on a pay-out ratio ranging between 60 per cent and 80 per cent of underlying net profit for each financial year. This move, while may be unpopular with dividend investors, is a strategy to retain fund for engineering future growth.

The redevelopment of the SPC retail mall is expected to be completed around mid-2017, and leasing for the mall has commenced. The Group continues to forgo rental income during this period of redevelopment. Once ready, the mall would provide a source of growth driver for struggling SingPost.

My past experiences had taught me that new leadership and change of business directions often create inherent business risks. In SingPost’s case, it remains to be seen whether the new CEO can successfully reverse the company’s declining fortune. Furthermore, the lack of operational experience in new business units like the eCommerce units means that SingPost will likely to continue losing money in this segment. For SingPost, this sort of growing pain is inevitable as it seeks to reinvent itself in this new digital economy.

2016 had been a nightmare for SingPost investors as the company seen a major overhaul of its top management. The Chairman stepped down while the CEO, CFO and COO all resigned within the span of one year. These abrupt changes led to concerns from investors and major shareholder, SingTel, has

43 to intervene. SingTel chairman, Simon Israel, took over as SingPost chairman and swiftly implemented various policies to strengthen the corporate governance.

The execution risks arising from leadership changes aside, the decision by management to pivot itself in eCommerce logistics is a right business goal because SingPost can leverage on its postal network as a backbone for delivery capabilities. While domestic transactional mail continues to decline, in contrast, eCommerce packages delivered through the postal channel are increasing. The trend is particularly evident in the International Mail business, which has been a conduit for increasing cross- border eCommerce deliveries over the last few years

With so much uncertainties arising from the slew of changes, investing in SingPost may be risky for me. I will not even determine an entry price for this counter because of its hazy business outlook. Nonetheless, if the new CEO can successfully transform SingPost into an eCommerce logistic provider, this counter can be an exciting prospect. Till then, SingPost will still be an unfinished article.

Horror show of SingPost shares

SingPost shares took a hit as the company announced a stunning quarter loss of $65.2 million. The loss came about after SingPost decided to write off $185 million for the ill-fated TradeGlobal, S$20.5 million for Postea Inc., and S$9.3 million for an industrial property at 3B Toh Guan Road East.

The latest setback for Singapore’s postal service provider came at a time of transformation for the 150 years old institution. As more and more companies switch to electronic statements, SingPost is transforming its business to eCommerce logistic. At the centre of the storm was the significant impairment of TradeGlobal, which was only acquired by SingPost less than two years ago.

Many investors were shocked that SingPost decided to write off its investment in TradeGlobal so soon. Two years are considered a relatively short time frame to judge a company’s potential growth. One plausible factor could be that the management is not convinced of a turnaround for TradeGlobal and hence, made the decision to cut losses early. It was reported that instead of a projected profit of S$9.4 million for FY16/17, TradeGlobal incurred a significant loss of S$25.8 million.

Given the extent of the impairment to SingPost’s investment in TradeGlobal, SingPost also appointed FTI Consulting, an independent global business advisory firm, which has verified that the impairment provision was properly calculated following an appropriate review process and that the assumptions adopted were reasonable.

Following the failed investment in TradeGlobal, investors might be questioning SingPost’s ability to transform itself into an eCommerce player. Make no mistake, when it comes to technology companies, there is always a high risk of failing. Out of ten companies, seven or eight would fail. To win the game, SingPost must push on and continue to invest in technology companies which are aligned to its business model. But most importantly, SingPost must learn the lessons from the failed project in TradeGlobal.

Excluding the one-off write-off items, the underlying net profit for the quarter would have been $21.3 million, bringing the full year underlying net profit to $115 million. The results reflected some hard lessons for SingPost. Firstly, even barring the impairment charges, the underlying full year net profit would be a decline of 25% year-on-year. The decline was due to management’s failure to rein in total expenses, which increased 22.5% year-on-year. The increased in expenses more than off-set the increased in total revenue. Higher expenses were due to inclusion of new subsidiaries and related expenses due to additional headcount.

Secondly, SingPost must expedite its business transformation as domestic mail revenue for the year continued to slide due to more companies switching to electronic statements. Full year revenue from its postal arm grew 1.5% to $544 million, with growth in International mail revenue offsetting decline in domestic mail revenue. In comparison, revenue from its eCommerce arm grew 171% to $267 million, notwithstanding the operating losses from TradeGlobal. This data illustrated the growth potential of the eCommerce for SingPost.

To develop the eCommerce segment, SingPost have partnered with Alibaba to drive volumes on its commercial logistics network. Efforts are also underway to expand the customer base, and develop collaborations and alliances with strategic partners to further increase volumes and economies of scale. Suffice to say, it will take time for these initiatives to translate materially into earnings.

Capital expenditure continued to be substantial for the full year, at $199.8 million due to the construction of the Regional eCommerce Logistics Hub and SPC retail mall. The capital expenditure wiped out most of the net cash generated from operating activities. This resulted in free cash flow of merely $0.3 million. Nonetheless, this was a marked improvement from negative free cash flow of $148 million last year.

As at 31 March 2017, SingPost’s cash and cash equivalents stood at S$366.6 million, up from S$126.6 million as at 31 March 2016. The Group recorded a net cash position of S$2.6 million. The cash injections from Alibaba proved to be useful as SingPost returned to net cash position.

Capital expenditure for FY2017/18 is expected to be lower than FY2016/17, as the majority of development projects had been completed. With lower capital expenditure, free cash flow is expected

45 to improve in FY2017/18. Thus, SingPost should have sufficient free cash to acquire more strategic eCommerce companies to fuel growth in the coming two years.

Indeed, the past two years had been a revelation for SingPost investors as the company underwent a dramatic management upheaval. The CEO, CFO and COO all resigned within the span of one year. Ex-chairman, Lim Ho Kee also stepped down last year. Amid the chaotic situation, SingTel Chairman intervened and took on the position of the new Chairman. After one year of searching, Paul William Coutts was finally appointed as the new CEO.

It is still early days to judge the performance of the new CEO but many analysts deemed the significant impairment charges as paving the way for him to implement his ideas. It is common practice for companies to write off worthless investments made by previous management to allow the incoming CEO to make fresh changes. However, judging by the latest financial results, the new SingPost CEO has his work cut out for him.

Share price plunged to 4 year-low as news of the quarter loss hit the news before recovering lately. Clearly investors’ confidence was shaken. To make things worse, one of the things that the new Chairman, Simon Israel instituted was changing the dividend policy from an absolute amount to a ratio pay-out between 60 percent to 80 percent of the underlying net profit for each financial year.

Because of this revision, SingPost has announced final dividend of 0.5 cent per ordinary share (tax exempt one-tier). This would bring the annual dividend for the financial year to 3.5 cents per share, representing a payout ratio of 66 per cent of underlying net profit. The proposed final dividend is subject to shareholders’ approval at the Annual General Meeting in July 2017.

SingPost is a company which I have always admired because of its competitive advantage in its postal network and ability to provide low-cost cross-border shipment. But the increased risks arising from the change in management and business model make me cautious in investing in this counter.

The major change in the dividend policy inadvertently also caused SingPost to be less appealing to me from the perspective of a dividend investor. In terms of upside potential, it is unlikely that SingPost can transform itself into a regional eCommerce player in the short-term. There are also numerous uncertainties pertaining to the successful execution of the various growth initiatives.

Hence, this counter might be a potential value trap. Given the hazy outlook, I would avoid investing in SingPost, at least for the next 5 years.

Invest in SingPost shares?

The past two years had been of great chaos for SingPost as it endured a significant management upheaval, a special audit, massive impairment of an overseas acquisition and adjustment of a long- standing company dividend policy. For a country that prides itself of being world-class efficient, the mess in Singapore’s national postman certainly raised a lot of eyebrows among concerned investors.

On looking back, the appointment of Dr Wolfgang Baier as CEO back in 2011 could be a knee-jerk attempt to re-invent the mailing company into an e-commerce company in light of consistently falling revenue from domestic mails. His appointment was itself surprising given his young age and the perceived lack of C-suite experience.

When Wolfgang was appointed as CEO, he was only 37 and was from a management consulting firm, McKinsey & Company. Given SingPost’s venerable standing in the industry, attracting a more experienced business leader should not be a challenge. To be frank, I have no objections to foreign talents taking on top positions in Singapore companies. However, Wolfgang lasted only four years and resigned abruptly in end 2015, leaving Mr Mervyn Lim to cover his CEO duties for one year.

During Wolfgang’s tenure, SingPost had mixed financial performance, with net profit falling from $160 million in 2011 to $141 million in 2013 and then rising to $161 million in 2015. SingPost also did not progress nor transformed itself into an eCommerce player as envisioned under his leadership.

Nevertheless, the appointment of Wolfgang seemed to have a positive effect in the stock market as the share price surged from $1.10 in 2011 to a record high of $2.14. Those who bought the shares in 2011 and sold them off in 2014 would have made about 100% profit. But then things started to turn unexpectedly sour as SingPost navigated through unchartered waters.

During Wolfgang’s reign, two assets were acquired and they nearly pushed SingPost to the brink of disaster. In late 2015, a special audit was convened to look into a possible lack of interest disclosure by one of its former directors, Keith Tay, concerning the acquisition of FS Mackenzie in 2014.

Apparently, Mr Tay held 34.5 per cent of Stirling Coleman, which advised FS Mackenzie's seller. That audit revealed that there were no prescribed policy nor procedure for the evaluation and approval of merger and acquisition activities.

The special audit raised a lot of questions on the corporate governance of SingPost. As the crisis unfolded, Wolfgang resigned, prompting the share price to plunge. Then ex-chairman Lim Ho Kee stepped down and major shareholder, SingTel, had to intervene. SingTel’s Chairman, Simon Israel was swiftly installed as the new Chairman to restore order and to stabilize the situation.

Widely regarded as a veteran, Simon Israel wasted no time in implementing various policies aimed at strengthening the corporate governance. One of the sweeping changes that Mr Israel introduced was the capping of board tenure at nine years. But it is the change in dividend policy that riled investors. The dividend policy has been changed from an absolute amount to one based on a pay-out ratio ranging from 60% to 80% of underlying net profit for each financial year, paid quarterly.

The appealing aspect of investing in this counter had been its attractive dividend pay-outs and this gave dividend investors a sense of certainty. With the recent change, SingPost’s appeal as a dividend stock may decline considerably among stock investors. But in my perspective, the new dividend policy could bode well for the company as it needs to preserve capital to build for the future.

Just when investors were about to put this dark chapter behind, another crisis began to unfold. Share price plunged once again as the company announced a stunning quarterly loss of $65.2 million. The loss came about after SingPost decided to write off $185 million for the ill-fated TradeGlobal. It was reported that instead of a projected profit of S$9.4 million for FY16/17, TradeGlobal incurred a significant loss of S$25.8 million.

To put things into perspective, investing in technology companies involves high element of risk and picking the winner is never easy. The write-off could be necessary to pave the way for the new CEO, Mr Paul William Coutts who was previously from Toll Global Forwarding. With this impairment, it is hoped that the new CEO will be given an opportunity to start afresh and continue the transformational journey for the company.

Despite the troubles, SingPost managed to attract significant investment from e-commerce giant, Alibaba Group, which became a substantial shareholder with 14.4% stake. SingTel remained the largest shareholder, with 21.7% stake.

In my opinion, it is indeed puzzling that Jack Ma is investing in a Singapore company as our market is so small and thus the growth potential is limited. In fact, the largest South-East Asia economy is Indonesia, not Singapore. For e-commerce business, size of the market is important in order to scale. That is why Alibaba is so successful because the Chinese market is so huge. So, I am not sure the motivation of Alibaba investing in SingPost. In this world, there is no free lunch. There must be something that Alibaba expects in return for its investment.

Financial results for Q117/18 vindicated that the new CEO has his work cut out for him. Although revenue increase 6.2% to $354 million, the underlying net profit slumped to $26.9 million, a decline of 24.7% year-on-year. The increase in revenue has been offset by the increase in expense, which increased from $297.6 million to $330.6 million. Apparently, management had not rein in cost, thereby resulting in the lacklustre financial performance.

Balance sheet remained strong with current assets at $632 million while current liabilities at $608 million. Free cash flow improved to S$32.0 million, from S$13.7 million during the corresponding period, due to lower capital expenditure with the completion of the Regional eCommerce Logistics Hub last year. Free cash flow determines the amount of war chest a company has for funding growth and is calculated by deducting the capital expenditure from the net cash from operating activities.

At this moment, SingPost share price is considered fairly overvalued, with Price/Book Value standing at 1.626 and P/E at 204.6. Return on Equity (ROE) free fell from 21% in 2014 to a shocking 1.79% in 2017. Perhaps the impairment of TradeGlobal has inflicted much damage to the financial performance and knocked the wind out of SingPost. No matter what, the leadership team must figure out the way forward in overhauling the business to stop the rot.

Indeed, the slew of troubles has led to the weakening in share price. If not for the recent share buy- back program, the share price would have plummeted further. SingPost is authorized to purchase up to a maximum of 227,146,452 shares and so far, 5,858,205 shares had been purchased. When a company is buying back its shares aggressively, it shows that the management is convinced that the shares are undervalued by the market. However, in this case, I am not convinced that this is the right time to enter this counter.

The TradeGlobal fiasco vindicated that SingPost has yet to morph into an eCommerce player successfully. Nevertheless, this is not to say that the company is in crisis, at least not yet.

The ingredients (in terms of network infrastructure and human resources) are there for the food to be cooked. The time has come for the cook (management) to turn up and manage the show. Will it be a happy ending? I don’t know. But time is running out for SingPost and it must quickly re-invent the wheel before technology make the business completely obsolete.

Temasek Holdings’ Pre-IPO investment in HRnetGroup

On 16 June 2017, HRnetGroup’s IPO on the SGX Mainboard created much hype among retail investors and local finance bloggers. Many investors had wanted a slice of the IPO because of the excellent financial performance indicated in the prospectus. But many investors may not be aware of Temasek Holding’s Pre-IPO investment in HRnetGroup.

What is pre-IPO and does it matter to you from the perspective of a stock investor? Read on to find out how the big boys make money in this game.

Fundamentally, how big boys like Temasek Holdings make money is very different from retail investors in the market. Most of us made money upon selling the shares allocated during IPO. But then again, there is no guarantee that you would be allocated the IPO shares because for the public, the shares are allocated through balloting. There is also no assurance that the share price would rise above the IPO offer price. In short, for the man in the street, it is like punting when it comes to IPO.

However, pre-IPO works in a different manner. Big boys like Temasek Holdings want certainty in their return of investments and they also want to win the game. In return for a sum of initial capital, they would demand for a portion of the IPO in the form of pre-IPO shares. Usually the pre-IPO shares would be offered at very dirt cheap level, maybe at only a fraction of the IPO price. After two or three years, the big boys would slowly divest their shares at market price to make explosive profits.

Hence, big boys make money at the point of buying the pre-IPO shares because of the safety margin given to them. This is how the rich become richer.

Most investors have been asking why HRnetGroup chose to go for equity financing instead of debt financing. They don’t realize that pre-IPO is the real money to be made for both the listed company and the big boys.

Take for example, HRnetGroup offered placement of 85.6 million shares to private investors while only 3.8 million shares to the public. Imagine if the placement shares were offered to the big boys at only $0.05 per share and then few years down the road, the big boys decided to divest the shares at market price. The profits would have been explosive.

Apart from institutional players like Temasek Holdings, some of the private investors may be accredited investors. These are the people with certain income level or net personal assets. Previously I have written a few articles on how to qualify as an accredited investor.

Effectively, big boys like Temasek Holdings create money out of thin air through such mechanism. Institutional players like private equity, hedge fund or sovereign wealth fund are not interested to manage the firms because their goal is basically to make money out of their investments. Thus, they would usually have some exit strategies. So be wary when the whales flip and don’t be get caught by the waves.

Being the first recruitment agency to be listed in SGX Mainboard, the financial performances for HRnetGroup seemed to be solid at first glance. But upon deeper examination, things were not exactly that rosy. Current assets had been declining from $189 million in 2014 to $176 million in 2016. On the other hand, current liabilities increased from $46.8 million in 2014 to $81 million in 2016. Perhaps the

50 acquisitions made over the years had impacted the balance sheet. At Net Asset Value (NAV) of only $0.109, the IPO offering price of $0.90 looked inflated.

Analysts may argue that the business model is asset-lite and thus it is unfair to use NAV as a gauge to value HRnetGroup’s worth. Indeed, as a recruitment agency, the key assets are the employees and not the equipment. However, it should be noted that the recruitment industry is a low-entry barrier sector. It is not difficult for HRnetGroup's employees to strike out on their own and form rival companies once they learn the rope.

Nevertheless, revenue had been rising since 2014, from $324 million to $365 million in 2016. What I like about this company is that its business is very profitable and able to generate cash. Net cash from operating activities increased from $40.2 million in 2014 to $53.4 million in 2016. As the business do not need huge capital expenditure, HRnetGroup is able to use the cash to fund more overseas acquisitions and thus drive higher revenue in the future.

Then many investors may ask why equity financing and not debt financing? After all, HRnetGroup has been self-funded through cash generated by their business, without any debt financing. In each of FY2016, FY2015 and FY2014, their operating activities generated substantial cash even after adjustment for working capital requirements and capital expenditures. To answer this question, one must not view this issue from the perspective of solely expenses.

It is true that debt financing generally incurs less cost when compared to equity financing. But let us not forget that the stock market is a platform that offer opportunities for companies to raise capital. Pre-IPO and IPO are just two of the various means for companies to raise capital. Then there are rights issues, bond offering, preference shares, etc. So, the opportunities to raise more fund is greater through a stock market listing rather than getting bank loans.

Overall, the growth potential of HRnetGroup is there if the management play the game well. There are certainly risks – such as economy downturn, currency fluctuations, competition from rivals and technology disruptions. However, with Temasek Holdings’ backing, I am convinced this counter would do well because for the foreseeable future, the sovereign wealth fund would want to grow this pot of gold.

HRnetGroup could be an interesting stock to invest but I would place this counter under monitoring for at least three more years to gauge the performance of its management. Till then, enjoy the ride.

The Outrageous Story of mm2 Asia mm2 Asia is one of the most exciting prospects to grace Singapore stock market in many years. Within two years of listing in the Catalist, the entertainment outfit has witnessed such explosive growth that it ascended to the SGX mainboard on 7 August 2017. Along the way, it has also attracted investment from StarHub.

In 2014, when the company, through its IR agency, requested me to help them promote free tickets for their Jack Neo’s movie, “Ah Boys to Men”, I didn’t really take notice of this company. Fast forward three years later, the shares had been on a red hot bullish run since IPO.

On 19 May 2017, mm2 Asia announced that the company is in discussions with Village Cinemas Australia Pty Ltd ("Village Cinemas") for the purchase by the Group of Village Cinemas' entire stake in Dartina Development Limited, a company incorporated in Hong Kong which holds the Golden Village Cinema business in Singapore.

However, the transaction did not materialize. According to mm2 Asia, “Village Cinemas Australia was unable to procure fulfilment of certain conditions under the Shareholders Agreement entered into between Village Cinemas Australia and their existing coshareholder of Dartina Development Limited, and the deal could not be completed”.

On hindsight, the failed transaction could be a blessing in disguise. After all, operating a cinema could be risky as the business is susceptible to technology disruption. Just ask yourself how often you visit the cinema nowadays. Very often, the latest movies or shows could be viewed online at a fraction of movie ticket. Furthermore, during economic downturn, people are less likely to visit cinemas.

However, mm2 Asia’s current business as a content producer is different. No technology can ever replace a content maker. Furthermore, its content products can be distributed at a lower price through online. Thus, during bad times, retailers may not visit cinemas, but opt to watch its contents through online.

The latest move came fast and furious after the listing of its subsidiary, Unusual Limited on the Catalist Board of the Singapore Exchange, raising an aggregate of $19.4 million, anchored by cornerstone investor SPH AsiaOne Ltd, a subsidiary of Singapore Press Holdings Limited (“SPH”).

Share price of mm2 Asia had been surging in recent years. Since IPO, mm2 Asia share price has risen from listing price of $0.25 to the current $0.47 level. There was a stock split exercise of 1-into-2 exercise

52 in early 2016. But that didn’t stop its meteoric rise. In late 2016, the company announced yet another stock split exercise of 1-into-2 exercise.

Based on my memory, I could not recall any SGX stocks that underwent twice stock split in a year and still continued to rise like mm2 Asia shares. If shareholders held on to the shares since IPO in 2014, they would have made a killing! This is because stock split is unlike rights issuance, which requires shareholders to cough up money. In stock split, shareholders do not need to make any payment. Do I regret missing the boat for this multi-bagger? Of course I did! The paper gains would have been 8 times considering the fact that this counter has been split twice in a year.

One of the reasons why I chose not to invest in mm2 Asia’s IPO back in 2014 was because of my lack of knowledge in the film-making and entertainment industry. Unless you work in this industry, most outsiders would lack understanding on the growth and prospect in this industry. Furthermore, my policy is not to invest in IPO because of their lack of track records. However, in SGX, mm2 Asia occupied a very niche area and based on its last two years’ financial results, the growth story has been compelling.

Full year net profit for FY2017 rose 146% to $22 million while revenue grew 149% to $95 million. The growth came about after a significant number of acquisitions, including the recent proposed acquisition of the Lotus cinemas in 13 locations in Malaysia, as well as the listing of one of Unusual Limited, on the SGX. As at 31 March 2017 (FY2017), cash and cash equivalents amounted to S$25.3 million as compared to cash and cash equivalents of S$4.1 million as at 31 March 2016 (FY2016).

The Group continues to harness its capability to provide services over the entire production and distribution process for movies and TV/Online content to address the demand for locally produced content in Singapore and Malaysia. But what I like about mm2 Asia is that its growth strategy is not just focused in Singapore or the South-East Asia market. It’s North Asia productions have contributed 55.9% of the Group's production revenue in FY2017, up from 35.7% in FY2016.

Being a young listed company, mm2 Asia is wasting no time in building its investment moats within the entertainment industry with a series of partnerships and joint ventures announced in the past year.

On 29 July 2016, the Group has entered into a non-binding memorandum of understanding with Mr. Richard Lee Peng Boon (Dick Lee) to establish a company (Dick Lee Asia Pte. Ltd.) in Singapore which will engage in music, artistes, creative direction, consultancy or related industries by Dick Lee, and any other future artistes and business with Dick Lee. The Group and Dick Lee each hold 51% and 49% equity interest respectively in Dick Lee Asia Pte. Ltd.

On 20 October 2016, the Group has entered into a format license agreement with Talpa Global B.V. (‘Talpa Global”) to acquire the exclusive license rights to produce and broadcast The Voice, Talpa’s flagship talent format, for the Singapore/Malaysia version.

On 8 November 2016, the Group has entered into a binding term sheet with Lotus Fivestar Cinemas (M) Sdn Bhd for the acquisition of the business of cinema management and operations of thirteen (13) cinema locations. It currently operates a chain of 23 cinemas in Malaysia and comprise of 90 screens with a total of 15,818 seats.

On 28 February 2017, the Group has entered into a Share Subscription and Shareholders' Agreement with RINGS.TV Pte Ltd (“RINGS.TV”) and its holding company, Mozat Pte Ltd, to acquire up to 20% stake in RINGS.TV over 12 months after the shareholders' agreement. RINGS.TV is Singapore’s first interactive broadcasting technology platform to stream and broadcast live concerts, performances, conferences and other events. Under the agreement, mm2 Asia will make an initial investment of S$2.25 million to acquire 15% of RINGS.TV, with an option to increase its stake by an additional 5% for another S$0.75 million.

On 3 May 2017, the Group has entered into a binding MOU with Cinema Pro Limited and Kbro Media Co. Limited to acquire 19.68% of the enlarged share capital in Cinema Pro Limited. Cinema Pro Limited (CP) provides an ALL-IN-ONE cinema management service and is formed by a group of experts in the

53 cinema industry covering Hong Kong and Mainland China including UA Cinema Circuit (UA 院線), Orange Sky Golden Harvest, Jinyi Cinemas and Dadi Cinemas.

The return on equity (ROE) was 231% in FY2013 and has been tapering to 31.5% in FY2016. This is typical of a young and growing stock. The revenue is expected to grow explosively for the next two years and is expected to be at least double digits due to the slew of acquisitions and partnerships in the pipeline. The acquisitions of cinemas in Malaysia and Singapore is a strategic move because it provides a source of recurring income for mm2 Asia. Furthermore, cinema operation is a profitable business.

This counter has not issued dividend yet because the management has chosen to re-invest cash into new acquisitions. At P/E ratio of 35, it is not considered under-valued too. Recently, in spite of announcing a good set of 1QFY2018 results, its share price suffered from a loss of form, presumably due to the failed acquisition of Golden Village. However, I feel that this counter may have been oversold. I have set an entry price of $0.35. On the basis of its bearish trend, I think my target price may be realistic.

Can SGX Win the World Largest IPO?

In what is believed to be the world largest IPO ever, Saudi Arabia oil company Aramco is seeking to list 5 percent of the company, which is valued at USD2 trillion, in both domestic and international stock markets. The move is part of the plan by the Saudi kingdom to diversify its economy and reduce the reliance on the black gold. International stock exchanges from New York, London, Hong Kong and Singapore have been vying to win the prized trophy of winning the IPO. Can SGX win the game?

To put things in perspective, the chance of Singapore Exchange securing the prestigious secondary listing in SGX is remotely small. The rate of success is probably 5% and I would be extremely surprise if SGX could pull it off. This is because if the intention of Saudi Arabia is to seek an international listing to diversify income, then market size is significant. Logically speaking, the natural choice would be New York, London or Beijing.

In my opinion, the New York Stock Exchange is the most likely destination for the Aramco IPO. London offers the prospect of being the major investment gateway to European market but Brexit had totally changed the game. As for Beijing, the stock exchange is not accessible to foreign investors and for Saudi Arabia to list Aramco there would defeat the purpose of a secondary listing. Thus, United States’ New York Stock Exchange is in pole position to land the blockbuster IPO of the century.

If the conclusion is forgone, why would SGX waste time in making pitches to the Saudi Arabian? In my humble opinion, it is probably because the stock exchange is trying to send a statement of intent.

Wave of privatizations

Since CEO Loh Boon Chye took over the helm from the late Magnus Bocker in 2015, SGX has witnessed a devastating wave of privatization led by a slew of huge delistings. Big names like OSIM, SMRT, NOL, Tiger Airways, Super Group, Keppel Land, Popular Holdings, Sim Lian and Eu Yan Seng have been delisted from the Singapore Exchange. There were many more of course. On looking back, there were various contributing factors for the exits, such as depressed valuation and listing fees. Regulatory requirements played a part as well.

For property developers like Keppel Land, Popular Holdings and Sim Lian, government regulations like Qualifying Certificate (QC) rule provided the motivation to privatize. Under QC rule, listed developers are considered “foreign companies” because technically, they would have foreign shareholders. To comply with this rule, they would have to sell their holding of private homes within two years of completion. Failing to meet the deadline would incur hefty penalties. They may apply for extension but the fee is not cheap. To avoid paying the penalty and extension fee, the most straight-forward approach is to apply for de-listing from SGX.

OSIM, home-grown armchair maker, had been privatized and subsequently went on to apply for listing in Hong Kong stock exchange as V3. BOC Aviation, Singapore-based aircraft lessor, also snubbed SGX and chose to list in Hong Kong bourse in 2016. The fact that these billion dollars IPOs are “made in Singapore” companies made it even more embarrassing for the local bourse. OSIM founder, Ron Sim, is a vocal critic of SGX, lamenting that sustainable reporting as “overkill” and quarterly reporting “destroying company value”.

Henceforth, it is vital that CEO Loh Boon Chye take actions to attract quality listings in a bid to drive liquidity. NetLink NBN Trust IPO falls under the big-league category. So is Aramco. Though chances of SGX getting the Aramco secondary listing is remote, the move signalled that SGX is not resting on its laurels. Something must be done to stem the rot. On the policy front, whilst it is unlikely that SGX would remove sustainability and quarterly reporting because of the need for investment transparency, the proposed dual-class shares policy is a pro-active measure to attract quality listings.

Bonds and derivatives to the rescue

Notwithstanding the challenging operating environment, SGX CEO managed to grow the stock exchange steadily. Since taking over in 2015, revenue grew from $778 million in FY2015 to $818 million in FY2016 to $800 million in FY2017. For 1Q2018, SGX continued to build on the strong momentum and announced revenue of $204.5 million, up 7% from a year earlier. The business remained very profitable, with net profits clocking at $91 million, up 9% from a year ago.

Interestingly, while there have been headwinds in attracting equity listings, SGX seemed to hit the jackpot with bond listings. Listing revenue grew 6% following a higher number of new bond listings, with 347 bond listings raising S$156.1 billion. In comparison, there were a total of 6 new equity listings which raised S$2.7 billion, while secondary equity funds raised amounted to S$1.1 billion.

Can bond be the game-changer for SGX? At this stage, it is still premature to gauge how fixed income will play a part in the stock exchange’s business growth but I like the revenue diversification from equity listings. Revenue from derivatives also grew, rising 14% to S$80.6 million, contributing to 39% of total revenue.

Part of the massive growth of the derivatives was due to the acquisition of Baltic Exchange, which drives the trading and clearing of iron ore, coking coal and freight derivative contracts. SGX had paid $138.8 million for the acquisition of Baltic Exchange in November 2016. On the basis of the recent quarterly results, the Baltic Exchange acquisition should be a good long-term investment.

Together, both bond listings and derivatives helped to cushion the impact of dwindling mega IPO and big delistings. Indeed, the landscape of global stock exchanges have evolved and SGX cannot afford to rely on the traditional equity IPO and clearing fees for revenue.

Outlook

Within Singapore, SGX enjoys the status of being the sole stock exchange, and therefore occupies a monopoly. Despite having a small market, the SGX remains the largest stock exchange in the South- East Asia region and enjoys a substantial investment moat. In good times, investors will be bullish on stocks and market activities generate income for the stock exchanges through equity listings and clearing fees. In bad times, market volatility also generate income for the bourses through clearing fees.

Nonetheless, the stock exchanges are not susceptible to technology disruptions and market consolidations. In the face of intense competition from global players, two emerging trends will impact the destiny of SGX – electronic trading platforms and merger and acquisitions.

On the merger and acquisition front, SGX is not new to the game. Having invested 5% in the Bombay Exchange for $42.7 million in 2007, SGX went on to bid for the Australian Securities Exchange (ASX). The deal ended up being blocked by the federal government. Subsequently, the proposed merger with the London Stock Exchange also fizzled out. Those deals were being initiated by the late Magnus Bocker, who was known to be a dealmaker. Baltic Exchange was successfully acquired in 2016. But I suspect it was due to the influence of the late Magus Bocker because he used to work in the Nordic Exchange.

Going forward, I hope to see SGX forming more partnerships and collaborations with other stock exchanges. Against the backdrop of growing global protectionism, I don’t envision that the company acquiring other stock exchanges. Even if it did, the acquired exchanges would be of smaller scale and generate less exciting growth opportunities.

Like many companies, technology trend can disrupt business models. Nowadays, technology has changed the game for investing and investors can easily access international markets through electronic trading platforms. What this means is that investors based in Singapore may favour trading in New York Stock Exchange because of the perceived dynamic, liquidity and quality of stocks. To mitigate this liquidity issue, SGX needs to figure out how to enhance the trading activities. The reduction of the board lot to 100 shares is a good initiative. But somehow, the results have not been significant.

If Aramco really got listed in Singapore stock exchange, it could start the ball rolling and herald more blockbuster listings. Once upon a time, SGX managed to grab Noble Group from right under Hong Kong stock exchange. Back then, Noble Group was a mighty $10 billion company. Those were the good old days and it was indeed a feather in the cap for SGX. Can CEO Loh Boon Chye fight gravity and bring back the old glory? Only time can tell. Till then, enjoy the ride.

Investing in SGX shares

Ex-CEO of SGX, Magnus Bocker passed away last week due to cancer. Bocker came to Singapore with a big reputation of being a dealmaker. Prior to heading SGX, he made his name for selling OMX to Nasdaq for USD4.9 billion. Bocker took over from outgoing CEO Hsieh Fu Hua in 2009 but left in 2015 when he decided not to renew his contract. In this article, l am sharing my views on whether it is worthwhile to invest in SGX shares.

Under Bocker’s tenure, SGX implemented various initiatives aimed at expanding SGX’s market share beyond the stock market. Notably, revenue from derivatives now formed 40% of the annual revenue. As a dealmaker, he also tried to transfer his merger and acquisition experience to SGX and made a bid to merge with Australia’s ASX. That bid ended up in failure when the Australian government rejected the proposal.

Bocker’s reign also saw SGX introducing a slew of policies targeted at boosting market liquidity and protecting investor’s interest. In 2014, dynamic circuit breaker was introduced to guard against disorderly situations in the face of rapid and unchecked market movements. In light of the penny stock crash in 2013, Minimum Trading Price (MTP) was introduced by SGX to prevent speculation and market manipulation. The initial rule required companies to maintain trading price of $0.20.

Bocker was widely credited with reducing the standard board lot size of securities listed on SGX from 1,000 to 100 units from 19 January 2015. It was envisioned that smaller board lot size will make it more affordable for retail investors to invest in a wider range of equities, including blue chips, and enable them to build more balanced and diversified portfolios.

It was the Bocker’s idea of removing the trading lunch break on 1 March 2011 that led to his ultimate downfall. In a press release, Bocker claimed that “Singapore’s leading position as an international financial centre depends on its ability to stay nimble and meet customers’ needs. Investors are constantly seeking trading opportunities and continuous all-day securities trading will provide more avenues for participants to invest, hedge and arbitrage their investments.”

Nonetheless, many remisiers did not agree with Bocker and there was an online petition calling for his resignation. Many of them were irked by Bocker’s relentless new initiatives and the removal of their lunch break was the last straw.

And then there were the 5 November and 3 December 2014 trading outages. The trading disruptions raised many eyebrows as SGX had enhanced its trading system by investing $250 million in a new trading engine when Bocker took over as CEO. Many investors took Bocker to task for the market disruptions and that swiftly led to his exit in early 2015.

To his credit, under Bocker’s leadership, SGX grew from strength to strength. Revenue increased from $648 million in FY2012 to $801 million in FY2017. Net profit increased from $292 million in FY2012 to $340 million in FY2017. The strong set of results indicated that Bocker’s strategy of diversifying SGX’s

58 revenue stream worked like magic. After his departure, he had left behind a company in good shape for his successor.

What is interesting about SGX shares is that the Return on Equity (ROE) has been consistently high for the past few years. The average ROE between FY2012 and FY2016 was 36.4%. ROE measures the ability of the management to generate returns using shareholder’s fund. SGX’s high ROE over the years demonstrated the management’s ability to grow the company consistently. In the 90s, SingTel used to have this sort of this sort of explosive ROE rates but subsequent growth has tapered in view of the slowing economy in recent years.

Another attractive thing about SGX is that it does not owe any debts and is sitting on a huge pile of cash. For FY2017, the cash and cash equivalents was $796 million. Its operation generated cash amounting to $444 million. With so much cash on hand, SGX used cash of $120 million to acquire Baltic Exchange Limited (BEL). In this respect, I like management that deploy excess cash to acquire businesses to spur growth. In doing so, SGX is essentially building for the future.

The principal activity of BEL is to provide freight market indices and information, membership services and facilities for the trading of derivatives shipping contracts. This acquisition should strengthen SGX’s ability to further develop forward freight agreement (“FFA”) related products.

The acquired business contributed revenue of $8.2 million and $0.2 million net loss after tax to the Group for the period from 8 November 2016 to 30 June 2017. Had BEL been consolidated from 1 July 2016, consolidated revenue and consolidated profit of the Group for the period ended 30 June 2017 would have been $804.2 million and $334.6 million respectively.

Hence, going forward, BEL should contribute significantly to SGX’s revenue and profits. Given that SGX’s annual profit for FY2017 was $340 million, BEL could potentially be its major flagship subsidiary based on the potential profit contribution. In this regard, I am very bullish on SGX’s share price for the coming years.

In terms of expense control, SGX’s management has performed well as full year expenses amounted to $399.0 million ($409.0 million) include costs relating to BEL of $12.6 million. Excluding this, expenses would be $386.4 million, a decrease of 5% from a year ago. This decrease is mainly due to lower processing and royalty fees and technology expenses. Moving forward, SGX should invest more in technology to address the trading disruptions in previous years.

For the past 5 years, SGX’s share price has followed a similar pattern. After August, its share will go on a bearish trend and bottom out till the end of the year. The start of the year will often see the shares surge. I presume that the dividend pay-outs played a part in the share price’s movement. Hence, this time, I think the same pattern will continue to play out. However, the profit contribution from BEL could potentially drive up SGX’s share price to a much higher level.

Thus, my strategy is to catch the stock when it is trading at $7.00. The basis for investing in SGX shares stem from its acquisition of the Baltic Exchange Limited. Going forward, I hope to see SGX acquire more companies to diversify its earnings. Previously, its key sources of earnings were through equity and IPO listing fees. To compete with arch rival Hong Kong, SGX must continue to expand its investment moat.

SGX's 1QFY2017 results

On 19 October 2016, SGX reported 1QFY2017 results. Notwithstanding the net profit amounted to $83 million, the overall performance was poor. This is not surprising given that the bourse operator is a proxy to Singapore economy, which has been sluggish for the whole of this year.

Key financial indicators

Revenue: $191 million, down 13% from a year earlier

Operating profit: $97 million, down 17%

Net profit: $83 million, down 16%

Earnings per share: 7.8 cents, down 16%

Interim dividend per share: 5 cents, unchanged

Revenue had been dragged by declines seen in the Equities and Fixed Income and Derivatives segments, both recording a drop of 9% and 22% respectively compared to 2016. The slowing global economic growth and the political uncertainties arising from Brexit resulted in lower trading volumes.

Strength of SGX

However, investors should not judge SGX's strength on the basis of one quarter's financial performance alone. The group's balance sheet is actually very strong - no borrowings and cash-rich. In fact, its current asset amounted to $1.53 billion and total liabilities stood at only $951 million.

Expenses decreased 8% to $93.7 million ($102.3 million), as all expense items declined year-on-year. Total staff costs decreased $2.4 million or 6% to $39.6 million ($42.0 million). Technology expenses decreased $1.1 million or 4% to $29.4 million ($30.5 million), due mainly to a 21% decline in depreciation to $10.4 million ($13.1 million).

While reining in expenses may reflect management's discipline in managing resources, my concern is that human resources and technology are critical investments. Investments in these two functions should not be drastically curbed to the extent of impacting growth.

The Net Current Asset Value Per Share (NCAVPS) stood at $0.55 per share while Net Asset Value (NAV) was $0.82. At the current price of $7.16, SGX's share price seems inflated.

Operating cash flow remained healthy for the past 4 years, averaging about $407 million. Barring FY2014, total revenue increased over the years, with FY2016 clocking $818 million.

But of more eye-catching indicator is its strong Return-on-Equity (ROE), which was a minimum of 35% for the past 4 years. This data suggests that SGX may be a growth stock. The thing about growth stocks is that their prices are sensitive to revenue performance. This can be seen in SGX's share price, which hovered around $6 to $7 range for the past four years, mirroring its stagnant revenue performances.

On another note, during bull market, growth stocks tend to perform well. This can be seen in SGX's share price, which surged to record high of $15.90 during the heady 2007.

My strategy for SGX

I am not vested in this counter but like its growth story. With so much cash on hand, SGX can afford to take on more risks in acquiring more companies in order to keep growing. It's recent acquisition of Baltic Exchange is a good development. Nonetheless, with many investors staying on the sideline due to retrenchments, trading volume is expected to slide in the coming months.

Thus, I see any major correction in SGX's share price as good opportunity to enter. My target entry price is $2.00.

Investing in Capitaland

Being one of the largest listed real estate companies in South East Asia, Capitaland remains an enigma in Singapore stock exchange. Share price reached a record high of $7.00 in 2007 and subsequent bombed out during the Great Financial Crisis.

Since then, this counter never really recovers from the setback, presumably due to the slew of property cooling measures implemented by Singapore government. The slowing down of the China market could also played a part in the laggard of the share price. In this article, the investment merits of Capitaland are examined.

Profile of Capitaland

Formed in November 2000 following a “big bang” merger between DBS Land Limited and Pidemco Land Limited, Capitaland is 40% owned by Temasek Holdings. Black Rock also has a stake of 6% in this real estate giant.

Capitaland is famous for its Raffles City integrated projects. The first Raffles City development was opened in Singapore in 1986. The Group later brought the brand to China in 2000 and has since expanded its stable to eight with a total development area of over 3.1 million square metres. In China, there are seven operational Raffles City developments in Beijing, Chengdu, Hangzhou, Ningbo, Shenzhen and Shanghai, and one under development in Chongqing.

Over the years, the management has demonstrated a track record in growing the company steadily. From revenue of $3.3 billion in 2001, the management has steadily grown the revenue to $4.6 billion in 2017. During these period, profit increased more than two fold, from $383 million to $908 million. Nonetheless, being a corporate conglomerate carries massive burden as Return-on-Equity (ROE) hovered around 6-8% for the past five years.

Based on the management’s track record, it is hard to categorize Capitaland as a growth stock. Neither is this counter considered a dividend stock as yield is merely 3.18%. Investors looking for dividend yields are better off investing in its array of REITs such as Ascott Residences REIT and Capitaland Mall Trust, which typically paid out higher dividends.

Portfolio reconstitution strategy

The reason why I find it difficult to understand Capitaland is mainly because of its complicated growth strategies. Unlike many typical real estate developer, Capitaland do not rely solely on building and selling residential homes for growth. The Group also monetizes its portfolio of investment properties for recurring income and for trading gains. To achieve this, Capitaland adopts a portfolio reconstitution strategy that keeps unlocking value for shareholders.

For example, in FY2017, Capitaland divested $2.6 billion worth of properties to realize gain of $318 million. Some of these properties included 50% stake in One George Street ($591.6 million), Wilkie Edge ($280 million), CapitaMall Anzhen ($232 million) and Ascott Orchard, Citadines Michel Hamburg

61 and Citadines City Centre Frankfurt ($502 million). The Group targets to recycle $3 billion worth of investment properties annually.

Capitaland then redeployed the proceeds from the divestments into new investments across asset classes. They included Asia Square Tower 2 ($2.1 billion), Rock Square in Guangzhou ($688.9 million), office and retail assets in Tokyo ($636.6 million), Main Airport Center, Frankfurt ($355.9 million) and Innov Center (formerly known as Guozheng Center), Shanghai ($424 million).

Apart from trading assets, Capitaland derives recurring income from serviced residences, shopping malls and commercial and integrated development. Many of these assets are listed in its REITs, – CapitaLand Mall Trust, CapitaLand Commercial Trust, Ascott Residence Trust, CapitaLand Retail China Trust and CapitaLand Malaysia Mall Trust.

The strategy of maintaining a balanced and yet focused approach on asset monetizing ensures that there is a healthy cash flow and value enhancements to shareholders. But most importantly, the focus on growth is geographically diversified between Singapore, China and South-East region.

For FY2017, Singapore and China markets remain the key contributors to EBIT, accounting for 93.8% of total EBIT Singapore EBIT was $285.5 million or 40.2% of total EBIT while China EBIT was $380.7 million or 53.6% of total EBIT.

Based on the data, it is heartening to note that although Singapore market is very small, this local real estate giant is still very much focused in growing its business over here.

Financial performance

Results for FY2017 had been mixed as revenue decreased by 12.2% mainly due to lower completion and handover of units from development projects in China. On the other hand, EBIT increased 31.8% due to gain from the sale of The Nassim, higher contributions of rental income from newly acquired/opened properties, consolidation of CMT, CRCT and RCST, higher revaluation and portfolio gains, as well as higher writeback of provision for foreseeable losses.

Capitaland was able to achieve such good EBIT because of two factors. Firstly, the portfolio gains of $284.7 million arose mainly from the divestments of Innov Tower in China, Wilkie Edge in Singapore, Zenith Residences in Japan, investments in Vietnam, as well as the re-measurement gain arising from the consolidation of CMT. Secondly, in terms of revaluation of investment properties, the Group recorded a net fair value gain of $668.2 million in FY 2017. The increase in revaluation gains came mainly from investment properties in Singapore, China and Europe.

Balance sheet remained fairly robust, with current assets of $12 billion and current liabilities amounting to $8.8 billion. With $9 billion in cash and available undrawn facilities and average debt maturity of 3.4 years, I don’t foresee significant cash flow issue for Capitaland in the short term if there is severe financial crisis.

Net cash generated from operating activities was $2.1 billion in FY2017, a decrease from $3.3 billion in FY2016. On the other hand, the net cash used in investing activities increased to $1.7 billion for FY2017 because of acquisition projects like Asia Square Tower 2 and development expenditure for Golden Shoe Carpark redevelopment. Net cash generated from financing activities was $980 million, primarily due to net proceeds from bank borrowings and debt securities as well as rights issue by CCT for the acquisition of Asia Square Tower 2.

From the debt management and cash flow activities, it is evident that the management displayed prudent financial management. This is important as real estate is traditionally a capital intensive sector and typically, many companies in the industry are heavily leveraged. By managing the downside risks, the management can then focus on capturing sustainable growth.

The restructuring

Since 1 January 2018, Capitaland had reorganised into two parts – the real estate investment and operating platforms. The real estate investment business is now undertaken by four principal investment units, mainly Singapore/Malaysia/ Indonesia; China; Vietnam; and rest of the world.

The global operating platforms focused on retail, lodging and commercial. It is Capitaland’s belief that the way forward is to treat real estate as a service rather than a “brick-and-mortar” commodity. Henceforth, the developer’ aims to build a stronger customer’s loyalty through enhancing underlying customer experiences, including experiential content, convenience and customer engagement.

My strategy

My view of Capitaland is that it has evolved from a typical real estate developer to one that requires a deep level of understanding. Even if you do work in the real estate industry, it is not easy to understand this giant as its businesses span across serviced apartments, shopping malls, commercial properties, REITs and management services. Generally, I would avoid investing in a stock if I cannot truly comprehend its business model and pin down its competitive edge.

In addition, having a diversified business empire makes it less responsive to changing environment and dilutes focus on achieving growth in each business unit. I reckon that this could be the initiating factor for the recent restructure of Capitaland.

Perhaps, many investors could be struggling to understand the direction of Capitaland as well because the counter is currently trading at price below its Net Asset Value (NAV) of $4.33. Price/Book Value is 0.871 and P/E ratio is 11.093. On the basis of these data, the share price of $3.77 indicates that this counter may be undervalued. For a blue chip, this is indeed rare in SGX.

Against the backdrop of recovering residential market and improving retail sector in Singapore, there are opportunities for price appreciation. However, the property cooling measures implemented by the Chinese government would put pressure on home price growth in China and dampen the prospect for Capitaland growth.

In conclusion, the above factors mean that I would rather invest in Capitaland’s REITs because it is relatively easier to understand their business models. The dividend yields are also relatively higher, thus providing better visibility on passive income. Till then, enjoy the ride

Wilmar International share price to rocket upon China IPO?

Will Wilmar International share price soar on the back of its impending IPO of its China unit? Being the largest listed agribusiness group by market capitalization on the Singapore Exchange, it is certainly a fascinating journey for Wilmar. From a start-up, Wilmar has overcome various challenges through the years to become one of the elites in the prestigious Straits Times Index (STI).

Many analysts have debated the need for Wilmar to list its Chinese unit in Shanghai while others had wondered the merits of announcing the plan at its infancy stage. In my point of view, the purpose of the initiative is more of business scaling rather than raising capital.

In recent years, Wilmar has struggled to meet great expectations due to the collapse of palm oil price, which was largely caused by overcapacity in the market. FY2017 results revealed that net cash flow from operating activities dropped significantly to USD 386 million, as compared to USD 1.1 billion in 2016. The terrible net cash flow was due to the huge increase in inventories (USD 1.2 billion in FY2017 as compared to USD 727 million).

Against the backdrop of ailing market demand, can Wilmar fight gravity? Ultimately, is this counter a value trap or potential multi-bagger? In this article, the investment merits of Wilmar International are examined.

The journey of Wilmar

Founded only in 1991, Wilmar International started life with backing from tycoon Kuok Khoon Hong (nephew of Malaysia’s richest man, Robert Kuok) and Singapore’s Peter Lim. Notably, Peter Lim is known as the “Remisier King” who became billionaire through investing $10 million in Wilmar when it was a relatively unknown start-up.

For the next 27 years, the management went on to build the company into a force to be reckoned with among the agribusiness community. Particularly, the period of 2006 – 2007 was a definitive milestone for the group as it stormed into Singapore Exchange on 14 July 2006 upon completion of a reverse takeover of Ezyhealth Asia Pacific Ltd after a successful equity placement exercise at $0.80 per share, which raised approximately US$180 million. Using the proceeds, Wilmar went on a slew of acquisitions and capacity expansions to significantly increase its investment moat as a producer of palm oil.

In 2007, Wilmar International completed a significant merger with Kuok Group’s palm plantation, edible oils, grains and related businesses in a deal worth US$2.7 billion, as well as a restructuring exercise to acquire the edible oils, oilseeds, grains and related businesses of Wilmar Holdings Pte Ltd (WHPL), including interests held by Archer Daniels Midland Asia Pacific (ADM) and its subsidiaries in these businesses, for US$1.6 billion.

Corporate profile

From a humble beginning, Wilmar become a global leader in processing and merchandising of edible oils, oilseed crushing, sugar merchandising, milling and refining, production of oleochemicals, specialty fats, palm biodiesel, flour milling, rice milling and consumer pack oils.

As at 31 December 2017, Wilmar is one of the largest oil plantation owners in the world, with an oil palm plantation covering an area of 239,935 hectares in Indonesia, East Malaysia, and Africa. It has over 500 manufacturing plants and an extensive distribution network covering China, India, Indonesia and some 50 other countries. The Group has a multinational workforce of about 92,000 people. Broadly speaking, Wilmar has four major segments: Tropical Oils, Oilseeds and Grains, Sugar, and Others.

Part of the reason for Wilmar’s explosive growth in the early years was due to its strategy in focusing its expansion plan in in Asia, especially in the three most populous countries of China, India and Indonesia. These countries experienced rapid urbanisation, increasing affluence and shifts in consumers’ consumption preferences, thereby enabling Wilmar to be in good position to capture growth. Specifically, China has become the most important market, accounting for the largest number of refineries (58) for palm oil and soft oils and crushing facilities for oilseeds (70).

Among the variety of oilseeds that Wilmar crushes in its Chinese facilities is soybean, a popular commodity among the Chinese. In 2017, China remained the top importer of soybeans, making up approximately 64% of the world’s demand. For Wilmar, the demand for soybeans in China grew a significant 15% from 83.2 million MT in 2016 to 95.3 million MT in 2017.

Financial performance

On 22 February 2018, Wilmar announced that work on the proposed listing of their China operations, with the internal restructuring of the operations is largely completed. As the proposed listing is still at evaluation stage, shareholders are advised to exercise caution in trading their shares. There is no certainty or assurance that the listing proposal will be carried out.

Indeed, it is very rare for a blue chip company like Wilmar to make the announcement at such early stage. Perhaps it is a strategy by management to revive interest in the ailing share price. Like many of its competitors, the past few years had been challenging for Wilmar because of the oversupply of palm oil in the market, causing the price to tumble. Correspondingly, the share price of many palm oil producers also dropped.

Share price of Wilmar crashed from a high of almost $7.00 in 2010 to the current $$3.20 level. Revenue since FY2013 hovered at an average of USD41 billion while net profit remained stagnant at average $1.1 billion. While the results for the past 5 years had been resilient, it reflects the challenging operating environment. Days of explosive net profits like those in 2008 (USD 1.5 billion), 2009 (USD1.8 billion) and 2011 (USD1.6 billion) are long gone.

Balance sheet

The balance sheet of Wilmar is generally healthy as current assets amounted to USD 22.5 billion while current liabilities was USD 19.7 billion. Nonetheless, short term borrowings jumped from USD 12.6 billion in FY2016 to USD 16.1 billion in FY2017. However, net gearing ratio improved to 0.79x in FY2017 (FY2016: 0.81x) on the back of strong results in FY2017. On closer look, 59% of total facilities were utilised as at December 31, 2017. Out of borrowings, 62% of utilised facilities were trade financing lines, backed by inventories and receivables.

Even though current amount of debt is still manageable, what I would like to see is the reduction in the gearing ratio. Given that interest rate is expected to spike this year, the cost of borrowing may increase significantly for Wilmar. For FY2017, the finance cost was already $434 million, a 25% from FY2016.

In terms of cash flow, the increased in inventories weighed on the amount of cash flow. In FY2017, the total net cash flow from operating activities dropped significantly to USD 386 million, as compared to

USD 1.1 billion in 2016. Inventories increased 17% to USD 8.2 billion in FY17 (FY16: US$7.0 billion), reflecting higher stockholding during the period, particularly in China where there was high volume of soybeans arrival during the year. Average turnover days increased to 66 days for FY17 (FY16: 64 days).

Potential of Wilmar

Most investors would agree with me that the commodity industry has cycles. Currently, Wilmar is experiencing the down cycle but based on the company activities, I think that the management is positioning itself for the next upturn. In previous years, Wilmar has diversified its revenue sources to include sugar and oilseeds and grains. This strategy has helped to offset the decline in the palm oil. For the tropical oil segment, while both CPO prices and plantation yield improved during the 9M2017, overall results for the year decreased by 38.2% to USD 426.2 million (FY2016: USD 689.2 million).

For the sugar segment, the Group posted an overall loss of US$24.6 million for the year (FY2016: USD 125.3 million profit). However, for the oilseed segment, profit before tax for the year tripled to USD 735.0 million (FY2016: USD 251.1 million). The good showing was due to the strong demand for soybeans in China. According to Wilmar’s annual report, “soybean meal consumption in China increased around 11% to 68.0 million MT while soybean oil consumption in China increased 10% to around 15.9 million MT in 2017”.

In my own view, Wilmar could be concentrating its firepower on the oilseed and grain segment, especially in the massive China market. That could be the reason for its China IPO. But if investors were to take a big picture view, essentially Wilmar is building its investment moat. With more than 500 plants and 92,000 workforce, it is considered one of the largest food giants in Asia. The listing in China would enable Wilmar to leapfrog to another league, given the sheer size of China market.

In 2017, the Group continued its slew of merger activities and forming of joint ventures. With Japan’s Lion Corporation, Wilmar entered into 50:50 joint venture agreement for the manufacture and sale of methyl ester sulfonate, an ingredient used to produce detergents. In March 2018, Wilmar raised its stake in India’s Shree Renuka Sugars Limited (SRSL), a sugar company, to 39%. Wilmar is also expanding into flour and rice milling in India, having acquired a rice mill in 2017 and will be increasing capacities in the flour and rice business this year. In Vietnam, the Group commissioned their fourth flour mill in July 2017 and we will start construction of the fifth mill in 2018.

The above are just some of the many growth projects of Wilmar. As you can see, the business structure of Wilmar is huge and the potential for growth is definitely there. But it takes time for these ventures to bear fruits. So existing shareholders should be patient.

My strategy

Currently trading at $3.180, the share price of Wilmar is slightly below its Net Asset Value (NAV) of $3.36. The China IPO may have a short-term “feel good” effect on the share price. But investors should look at Wilmar International from a long-term perspective. The commodity producer is currently experiencing a downturn in the commodity cycle but management is doing a reasonably well job in diversifying the risks by entrenching its position in key markets like China, India and Indonesia. Thus, I would enter this counter at $2.50. Till then, enjoy the ride.

Retrenchments for Singapore Airlines?

After announcing a recent shock quarterly loss of $132 million, CEO Goh Choon Phong hinted that there could be retrenchments for Singapore Airlines (SIA). Arising from the first quarterly loss in five years, the premium airline has set up a Transformation Office to conduct a wide-ranging review, encompassing network and fleet, product and service, and organisational structure and processes.

Upon closer examination of the financial results, the explosive loss suffered by Singapore Airlines was largely due to the provision of $132 million for the EU court fine slapped on SIA Cargo. More than ten years ago, SIA Cargo was alleged to participate in an air cargo cartel with 10 other airlines. Due to this, the EU antitrust regulator fined the airlines a total of $1.2 billion.

The massive fine incurred by SIA Cargo was a wake-up call and reflected the structural change in the air freight market over the years. This could explain the rationale for re-integrating SIA Cargo as a Division within SIA. The move is expected to be completed by first half of 2018 and aims to improve synergy and efficiency. However, the quarterly results indicated that SIA Cargo was one of the best performers within the SIA group. It clocked in operating profit of $3 million, a reversal from the loss of $50 million last year.

Retrenchments for Singapore Airlines?

Retrenchments could be imminent because the group, together with its affiliates and units, is estimated to employ about 24,350. This is a large number by any standard for a large organisation and some jobs may be deemed “irrelevant”.

Given that Cathay Pacific Airways announced job cuts of 600 in Hong Kong as part of business review, it is likely that Singapore Air could retrench about 400 staff. This was roughly the number it culled back in 2003 when it experienced quarterly loss. 2003 was a dark period for the aviation sector as Singapore was fighting SARS outbreak and tourist arrivals and business travels were affected.

Indeed, the outlook remains challenging due to intense competition arising from excess capacity in major markets, alongside geopolitical and economic uncertainty. Airline business is particularly vulnerable to these external factors and it is not surprising that Singapore Airline’s yield was negatively impacted. Operating profit for the Parent Airline Company declined $99 million or 20.4% year-on-year. Total revenue fell $592 million, mainly due to a $551 million reduction (-5.5%) in passenger flown revenue and lower incidental revenue, partially compensated by the up-front recognition of revenue from unutilised tickets.

Rationale for job cuts

The revenue decline in the premium sector is worrying because this segment continues to account for significant portion of the group’s revenue. Notwithstanding the robust travel demand in Asia, competition from China and Middle East carriers exerted pressure on the national flag carrier’s passenger yield. To make things worse, changing consumer trend has also led to a shift in favor of budget carriers. This explained the better performance of its subsidiaries, SilkAir and Budget Aviation Holdings which recorded operating profit of $101 million and $67 million respectively.

The rationale for reducing staff is very straightforward. A look at the cost composition of the Parent Airline company revealed that fuel cost was $2.8 billion while staff cost was $1.67 billion. These are the two largest expenses and among the two of them, it is not possible to bring down the fuel expenditure. Hence, reducing staff strength is the most viable route to reducing overall costs.

Read my articles on insights relating to Singapore Airlines:

1. SIAEC share price crashed to 5 year low

2. Is it worth investing in SIAEC shares now?

3. Research report on SIA Engineering company

4. Is SIA Engineering Company a value trap?

A review of the balance sheet revealed current liabilities $6.3 billion exceeding current assets of $5.7 billion, resulting in net current liabilities of $588 million. This is a reversal of the net current asset of $307 million last year. Net cash from operations declined to $2.5 billion from $3 billion last year and net cash outflow was $635 million. Overall, this is a terrible set of financial results – declining revenue, lower profits, shaky balance sheet and negative cash flow. No wonder CEO Goh is feeling the heat.

Financial performance

The poor financial results knocked the wind out of the share price performance and caused the shares to slide below $10 mark for the past two weeks. It is expected that the share price would continue to hover around $10 and likely to sink further after the dividend pay-out on 16 August 2017.

At current valuation, Singapore Airlines is not considered inflated but the business outlook is not positive either. A lot will depend on the strategic initiatives to be undertaken after the business review. The addition of new aircraft and cabin upgrades are expected to improve yield but Singapore Airlines should continue to expand its route development to capture more market share. The recent introduction of Stockholm via Moscow with the A350-900 aircraft is a step in the right direction. There should be also more synergies between SilkAir, Scoot and Tigerair.

My strategy

Although I have been working in the aviation industry for 12 years, I have avoided investing in airline stocks. This is because the airline industry is very volatile sector that is susceptible to geopolitical events, pandemic outbreaks, economy health, changing consumer trend and fuel price.

With so many risk factors to address, the airline business is extremely tough to sustain. To have a reasonable level of investment moat, Singapore Airlines should ideally have 400 to 500 aircraft to ward off challenges from overseas competitors. Till then, I would avoid investing in this counter. Enjoy the ride.

Singapore Airlines CEO won the battle but lost the war

It is akin to winning the battle but losing the war. Current chief executive of Singapore Airlines, Goh Choon Phong, got the top job after upstaging his former boss, Bey Soo Khiang in a four-horse race back in 2011. Bey was the former Chief of Defence Force of Singapore and having lost to his subordinate, resigned promptly from the national carrier.

Goh Choon Phong is the The Chosen One, thats for sure. But whether he is The Special One to take Singapore Airlines to another level is another question altogether. Make no mistake, this is Singapore Airlines we are talking about, the pride of our nation. For someone to lead the company, he must be distinctly special to take on the monstrous task of handling the world top airline. Ideally, he must be someone who possesses that magic to lead and return Singapore Airlines to former glory.

Recent incidents involving the credit card surcharge and insurance fiascos indicated that Goh Choon Phong may lack this unique ability.

The Chosen One

On looking back, the decision by the board of Singapore Airlines to appoint Goh Choon Phong as the chief executive was correct. You would need someone with strong understanding of the core business to handle the nature of the job. Goh fits that bill, though parent company, Temasek Holdings may share different views.

In 2011, Ng Yat Chung, also another former Chief of Defence Force of Singapore, was appointed as the CEO of Neptune Orient Lines (NOL). And then in 2012, Desmond Kuek, yet another former Chief of Defence of Singapore, was appointed as the CEO of SMRT.

Singapore Airlines, NOL and SMRT are all transport companies if you think carefully about it. Thus, it is not difficult to second-guess what those higher powers in Temasek Holdings had in mind when the position of CEO of Singapore Airlines was up for grab. Temasek Holdings is the parent company of Singapore Airlines.

On hindsight, it is a blessing that a former army chief did not lead Singapore Airlines. Under Ng Yat Chung, Singapore’s shipping carrier, NOL suffered from years of losses and was sold to French giant, CMA CGM in 2017. But what riled many Singaporeans was that the French shipping company managed to turnover NOL and made it profitable within a year. Under Desmond Kwek, SMRT was plagued with numerous operational issues that it was delisted from SGX. To be frank, I am surprised that Desmond Kwek refused to resign as CEO.

Widely considered by many to be a dark horse, Goh Choon Phong was never in the race. The public perception was that Bey Soo Khiang was shoe-in for the job. After all, he was Goh’s boss and the Temasek Holdings’ culture of dispatching army chiefs to head strategic assets certainly reinforced public perception.

But perhaps the board of Singapore Airlines had someone else already in mind and had planted Goh as the successor under Bey. Suffice to say, the upset proved too much for the former army chief to take. He was left with no choice but to resign “to pursue other interests”. In life, the higher you climb, the

70 harder you fall. Bey paid a heavy political price for losing the battle. But then again, he had his fair share of ride in Singapore Airlines.

Wind of Changes

To be fair to Goh Choon Phong, when he took over from former CEO Chew Choon Seng in 2011, Singapore Airlines was not exactly in a good shape. Once the world number one airline, our national carrier has lost that bragging rights to Qatar Airways and other Middle East carriers in recent years. Suddenly, our national carrier lost that aura of invincibility and the brand, “Singapore Girl” becomes no longer so prestigious among consumers.

Chew Choon Seng ended his tenure as CEO with the entry-in-service of super jumbo aircraft, the A380. Being the first nation to fly the A380, Chew’s legacy had been cemented forever among many Singaporeans. But in my opinion, during the latter stage of his tenure, he took things for granted and allowed the Gulf carriers to catch up on Singapore Airlines.

Perhaps the stress of managing Singapore Airlines over the difficult period of SARS in 2003 had taken a toil on Chew. Perhaps the emergence of low cost carrier had knocked the wind out of SIA Group. Whatever the case it was, Chew did not seem to foresee the threat of the Middle East and Chinese carriers. This oversight subsequently created a mountain too high for the younger Goh to overcome.

At that point of time, the market trend had already changed. With fuel cost hitting USD100 per barrel, flying a four-engine aircraft like A380 was suicidal in terms of operational cost. Even though the aircraft has capacity to address lucrative market, when demand fell below supply, Singapore Airlines would likely to suffer losses. When Goh took over as CEO, the damage was already done.

Return of the King

It has been seven years since Goh Choon Phong took over as CEO and I do think it is time to judge his performance. In my opinion, his performance has been mixed. There were hits and misses of course. Goh’s biggest achievement should be the creation of Scoot, a low-cost long-haul airline, immediately after he became CEO.

When Scoot was launched, the positioning of the carrier was not so clear at that point of time. This is because SIA Group already got SilkAir as the regional carrier and with Tiger Airways as budget carrier, many critics questioned whether the demand is there for low-cost long-haul flights to sustain in the long run. As a premium airline, Singapore Airlines’ strategy has never been focused on short-haul or budget flights. Instead, it concentrated its firepower in the premium sector, placing more efforts on business and first-class suites segments.

The challenge of low-cost carriers, specifically Jetstar Asia and Air Asia, forced Goh Choon Phong to change the game. Beyond preserving the premium brand of Singapore Airlines, Goh adopted a portfolio strategy to cover different travel segments – long-haul, regional and short-haul. The acquisition of Tiger Airways in 2016 and subsequent merger with Scoot was a sound move to consolidate the low-cost segment networks and create better synergies in terms of operational planning.

Besides tackling competition from low-cost carriers, Goh Choon Phong also faces the twin terror of competitions from the Chinese and Middle East carriers. To address this, the CEO is banking on new technology aircraft like A350 and B787-10 to expand into new and niche markets.

With A350-900 Ultra Long Range (ULR) coming on board, SIA look set to reopen this niche market again. Previously, the all-business premium A340 ULR to New York had been closed due to the high fuel cost. Again, that was the mistake of Goh’s predecessor when SIA chose to deploy all-business configuration for the A340 in 2004. Hopefully, with a fuel-efficient A350, SIA would not make the same mistake again. This route should be the most money to milk for Singapore Airlines, if the right moves were made.

The entry-into-service of B787-10 would allow SIA to fly to niche markets as well. The first aircraft would fly to Osaka, Japan in May 2018. Together, Singapore Airlines placed firm order of 67 A350 and 49 B787-10. These two fuel-efficient aircraft are expected to be the “work-horses” of the national carrier, replacing the ageing but reliable B777 fleet.

On the re-integration of Singapore Airlines Cargo, it is clear that the demand pattern of the cargo business has changed. When SIA Cargo was corporatized in 2001, the sector was growing and at the peak, SIA Cargo was holding 17 freighter B747-400s. However, the subsequent collapse of the dry bulk shipping rates led to much cheaper maritime shipping as compared to air freight. In view of this structural change, SIA Cargo was forced to right-size its fleet to the current 7 freighters.

Missing the forest for the trees?

From the above standpoint, it can be seen that Goh Choon Phong is a big-picture man who often places more focus on business strategies than marketing and branding. Although this mentality is feasible for other industries like ST Aerospace and Keppel Corporation, such approach is not tenable for the airline business, which is traditionally a customer-centric business.

In January 2018, CEO Goh was forced to make a U-turn on credit card fee for tickets issued in Singapore, just only a day after it announced it would. The swift about-turn came after numerous customers berated the premium airline in social media for lacking class. Indeed, as a premium airline, such miscellaneous fees should have been included in the fares. By slapping such a silly surcharge, it certainly lowered the class of Singapore Airlines and made customers questioned whether the premium fare had been justified in the first place.

Then on 30 January 2018, CEO Goh was forced to make another U-turn, this time on the auto-inclusion of insurance fees on flight booking. What happened was that the national airlines cheekily introduced an auto-included travel insurance in the online booking flow last year. The feature was not obvious to many and this led to numerous disgruntled customers. As a result, SIA was forced to amend the feature to an ‘opt-in’, rather than ‘opt-out’ function.

All these PR fiascos had, to a large extent, damaged our flag carrier’s branding. In the good old days, Singapore Airlines could get away with such missteps because of its fearsome reputation. But times have changed. In today’s context, with so many choices in the market, such mistakes can be fatal.

I know Goh wants to increase revenue and reduce overhead cost. That was the basis for him to launch the recent Transformation Project. But he should have spent more time in planning the roll-out of low value-add services that increase costs for customers. Any increase in costs without valid justifications would not go down well with customers. By making the U-turns in such short-time, it goes to show that the management did not plan adequately and was perceived to be totally clueless about ground situations.

More importantly, SIA should not have resorted to such tactics to make short-term peanut gains. In the long run, SIA could stand to lose big time when its market share got eroded due to declining branding power.

Financial performance

Share price had a free fall from $20 in 2007 to $10 in recent years. A massive decline of 50%. When Goh Choon Phong took over as CEO, the world was still reeling from the devastating effect of the Great Financial Crisis and persistent sky-high fuel prices. So it is understandable that share price languished at that low level.

But from 2013 onwards, there was global economic recovery and oil prices had plunged to record level lows. Instead of leveraging on these positive factors, Goh led Singapore Airlines into a period of low revenue growth. Arguably, his best performance came in at FY2016 when the airline achieved a net income of $804 million. But that performance was one-off and Goh did not manage to build on that success.

All eyes are on the full-year results for FY17/18 which is expected to be good as operating profit for the nine months to December 2017 improved by $248 million to $843 million (+41.7%). The good news was that revenue for nine months was $11.78 billion, much higher than last year’s $11.1 billion. Revenue grew by $631 million on stronger passenger and cargo flown revenue, partially offset by higher expenditure. It seems that the transformation programme is bearing fruit, in terms of revenue generation.

For a company of Singapore Airlines’ standing, the balance sheet is surprisingly weak, with net current liabilities of $1.29 billion. The cash balance had decreased to $2.3 billion, from last year’s $3.3 billion. According to the financial report, “The reduction in cash balances arose primarily from capital expenditure (-$4,333 million), payment of FY2017-18 interim dividend and FY2016-17 final dividend (- $248 million) and capital injection in associated companies (-$44 million). These were partially offset by proceeds from issuance of bonds (+$1,603 million), cash flows generated from operations (+$1,684 million), proceeds from maturity of investments net of additional acquisitions (+$296 million) and dividends received from associated and joint venture companies (+$73 million).”

The feel-good factor seemed to rub off on the share price, which had been rising steadily in recent months. Nevertheless, current price of $11.10 is still below the Net Asset Value (NAV) of $11.87.

Conclusion

Goh Choon Phong should be reaching the end of his tenure as CEO but because of his creation of Scoot, his reign may have been extended. To be frank, it is not entirely his fault that Singapore Airlines had been knocked off the perch by competitors. However, he had managed to right most of the wrongs left behind by his predecessor. In doing so, he is laying down a stronger platform for his successor to build on in the years to come.

Can Goh make Singapore Airlines great again? I don’t know. There is a thin fine line between a good company and a great company. Our flag carrier used to belong to that exclusive elite league but have since fallen into the former bracket. The transformation programmes would not be game-changer because at the heart of a successful organisation is the people. In the 80s and 90s, Singaporeans used to be hungry and it is in that spirit that led to the success story of Singapore Airlines. To restore the airline’s former glory, the CEO must make his staff hungry again. Till then, enjoy the ride.

SATS flying high in 2016

While the rest of the SGX-listed companies huffed and puffed their way through 2016, SATS was flying high. The share price of this blue chip darling even stormed to a record high of $5.11 in September 2016, setting a gold standard among fellow STI players. Amid the sluggish SGX market performance, it seems very strange that its stock has been so bullish. Just what did the management do that set the company apart from the rest?

The key reason for SATS' strong performance might be due to its investment moats in two niches - Gateway Services and Food Solutions. Their Gateway Services encompass airfreight handling, passenger services, ramp handling, baggage handling, aviation security services, aircraft interior and exterior cleaning as well as cruise centre management. Food Solutions include airline catering, institutional and remote catering, aviation laundry as well as food distribution and logistics.

Being a dominant player in provision of gateway services and food supplies, SATS derived most of its revenue from the aviation sector. For 1H16/17, revenue of $752.4 million came from aviation sector, while only $110 million of revenue were derived from non-aviation and corporate.

SATS has many associates, joint ventures and subsidiaries but they contributed only $23.7 million profit in 1H16/17. Among them are Singapore Food Industries (SFI) which provides food services to the Singapore Armed Forces and SATS-Creuers Cruise Services which provides gateway services for cruise terminals through . However, AISATS, AAT, BAIK, MIC and PT JAS contributed approximately 75% of their share of after-tax profits from associates and joint ventures.

One reason for SATS massive ran up in stock price could be also due to its strong balance sheet and free cash flow. The debt-to-equity ration was healthy at 0.08 times while cash and short-term deposits stood at $452.7 million. The free cash flow generated year-to-date amounted to $68.1 million, allowing the company to fund acquisitions for growth purposes.

For example on 27 December 2016, SATS acquired 10% of the shares of Evergreen Sky Catering Corporation from Malaysia Airlines Berhad for $32.3 million. The deal is thought to be in line with the company's growth strategy of scaling the food business.

In 2nd quarter FY16/17 results, Net Asset Value (NAV) was $1.36 per share while Net Current Asset Value Per Share (NCAVPS) amounted to $0.23. In my view, the current share price of SATS is inflated. Given that much of its business is focused in the aviation sector, the revenue and growth are sensitive to economic outlook as well. In fact, during the Great Financial Crisis in 2009, its shares were trading at the $1.00 level.

Notwithstanding the above, report card for 1HFY16/17 performance was excellent with revenue of $862.7 million, up 2.8%. Operating profit increased 14.4% to $118.1 million while underlying net profit surged by 10.1% to $117.6 million. On the back of such strong performance, SATS will likely to continue its bullish trend.

2017 will be an exciting year for SATS because the opening of Changi Airport's Terminal 4 will mean increased business volume. Thus, SATS Inflight Catering Centre 2 is being expanded to handle larger batch sizes. In addition, the company is spreading its wings in the Middle East region through its cargo projects in Dammam and Oman.

Since listed in 1999, management has been rewarding shareholders with dividend payouts every year. The ordinary dividend payouts for the past 10 years had been minimum 10 cents, with additional special dividends being given out in a few years. Because of this, I would think that SATS is a good dividend stock to hold.

Not vested in this counter but will continue to monitor the company's performance.

SATS share price

SATS is a SGX stock which I have always admired because of its historically strong business performance. The company is a leading provider of gateway services and food solutions, with the major bulk of business mainly in the aviation sector. Recently, the share price of SATS experienced a loss of form. What is the situation? Has the management lost the plot?

Since the announcement of the 1QFY2018 financial results in 21 July 2017, the share price experienced a major bout of decline. From $5.10 to $4.60, there was a drop of almost 10%. Technically, this represented a correction for SATS share price. It is only lately that this counter started to recover and climbed to $4.77 on 3 November 2017.

It appears to me that investors had decided to punish this counter for delivering quarterly profit of $57.3 million in Q1FY2018, a decline of 10.6% compared to prior year. But I think it is not justified because in the previous year, the profit was bolstered by the sale of the Senoko plant, which provided a non- operating gain of $9.3 million.

In fact, SATS performance should be considered resilient because current quarterly results excluded one-off items like disposal of assets. Revenue and operating profit remained flat, at $426.5 million and $53.5 million respectively.

The operating environment continued to be challenging for SATS because it is in the mid-level value chain. As a service provider to the airlines, it faces price pressure from airlines. Thus, if the airline industry suffered from low yields, business will be affected as well. Take for example, the operating margin has shrunk 0.3 percentage points to 12.5% for the current quarter.

With a market share of 80% at Changi Airport, SATS' main competitor is dnata. A few years ago, the two companies had entered into price war and this led to the players slashing costs for servicing the airlines. Although the price war is a happy problem for airlines, this is not sustainable for the industry because in a bid to secure contracts, the players often have to slash costs zealously and profit margins would be razor thin. In my opinion, a better strategy should be to provide better value for airlines through superior customer service, innovative product offerings and exclusivity. In today's context, companies are more than willing to pay a premium for differentiating factors that could enhance business revenue.

However, the balance sheet remained very strong. With current assets of $928 million versus current liabilities of $421 million, SATS enjoyed net current assets of $507 million. Debt-to-equity ratio remained healthy at 0.06 times. Cash and cash equivalent amounted to a whopping $544.6 million. With so much cash on hand, SATS certainly got a huge warchest to mount a slew of acquisition or partnerships to engineer future growth.

But then again, its business model generates a lot of cash and therefore, it does not need to dip into its cash holding for investments. For 1QFY2018, the free cash flow generated was $27.7million after including the capital expenditure of $18.9 million.

Going forward, I hope management can diversify revenue sources and reduce reliance on the Singapore market. Currently, the major bulk of the revenue is still derived from Singapore. For 1QFY2018, revenue from Singapore was $350.5 million, while revenue from the other markets was only $76 million.

Merger and acquisitions allow for scaling of the ground handling business in Asia. With the opening of Changi Airport Terminal 4, the recent partnership with AirAsia is an interesting project.

SATS has formed a new ground handling entity, SATS Ground Services Singapore Pte Ltd (SGSS) to serve customers at Changi Airport’s new Terminal 4. Under the terms of the partnership, SATS will acquire a 50% interest in Ground Team Red Holdings Sdn Bhd (GTRH) in exchange for SATS’ 80% stake in SGSS and aggregate cash consideration of SGD119.3 million (approximately MYR 372.2 million).

GTRH will be renamed SATS Ground Team Red Holdings Sdn Bhd, which will be the 50:50 joint investment vehicle of AirAsia and SATS that will hold stakes in both its Malaysia and Singapore subsidiaries, Ground Team Red Sdn Bhd (GTR) and SGSS respectively. AirAsia will effectively own 51% of GTR and 40% of SGSS while SATS will effectively own 49% of GTR and 60% of SGSS. Both companies will also be responsible for growing the ground handling business in their respective markets and will explore expansion into Indonesia, the Philippines and Thailand in the near future.

I like this project because SATS can easily afford the cost given the strong balance sheet and free cash flow. More importantly, the new partnership will give SATS, which already owns a 49% stake in the largest flight caterer in Malaysia, Brahim's SATS Investment Holdings Sdn Bhd, access to the Malaysian ground handling market. The partnership would enable SATS to gain access to AirAsia's ground handling operations at 15 airports in Malaysia. Currently, Singapore and Japan are the two main sources of revenues, in terms of geographical location.

Another aspect I like about this venerable company is the investment moat. The gateway arm offers a full of services, consisting of passenger services, apron, security, air cargo and flight operations and load control services. They also operate the Singapore cruise terminal, Marina Bay Cruise Centre. As Changi Airport grows its air hub, the company will benefit as well because it is the leading player in the Singapore market. But what I would like to see in future is that the management would expand into other air hubs in Asia and export the business model to overseas markets to capture growth in Hong Kong and Japan. Asia Pacific would continue to be the most attractive region in terms of aviation growth as airlines expand aggressively.

76 dividends being given out in a few years. Because of this, I would think that this is a good dividend stock to hold. I also like the management for growing the company prudently through careful acquisitions.

In my point of view, the current correction in share price is a healthy one and investors should not be alarmed by the decline. Since the Great Financial Crisis, this stock has gone on a massive bull run and it is inevitable that "what goes up must come down".

In light of the resilient business fundamentals, I don’t see anything wrong with SATS and hence the price correction could present buying opportunities for investors. Not vested in this counter but will continue to monitor the company’s performance.

Read my other articles:

1. SATS flying high in 2016

2. SATS to join STI

Creative Technology won the battle but lost the war

Singapore's Sim Wong Hoo, was famous for building Creative Technology (CT) from scratch. In the 80s and 90s, the SoundBlaster audio cards produced by CT was selling like hotcakes and propelled Sim from a struggling entrepreneur to Singapore's youngest billionaire.

In March 2000, CT's shares was even trading at record high of $58. Now, the share price is languishing at $1.00. Has Creative Technologies won the battle but lost the war?

As a Singaporean engineer, obviously I hope Sim can do well and make Singapore world-famous again. His SoundBlaster audio cards had put Singapore on the global map and proved to the rest of the world that Singapore is capable of creating world-class innovative engineering products as well.

But it is pity that IT is a very fast-paced and ruthless industry. The rapid evolution in the technology development led to cheaper, more powerful and better integrated computer audio systems than CT's SoundBlaster. This gradually marked the start of the decline for Creative Technology.

In 2006, Sim Wong Hoo made Singapore world-famous again by winning a legal dispute against Apple, which agreed to compensate Creative Technology $100 million over patent infringement. Back then, Apple's CEO Steve Jobs claimed in a press release that "Creative is very fortunate to have been granted this early patent". Steve Jobs was proven right as Apple shrugged off this compensation and scaled new heights with every version of the Ipod. Creative's Zen MP3 players were simply no match for Apple's Ipod, which really changed the game for the music industry.

The most frustrating thing is that even though Creative Technologies have won the epic battle against Apple, it never build on its early success in product innovation. Perhaps Singapore's Sim Wong Hoo lost to the late Steve Jobs, in terms of vision. At the peak of Ipod sales and popularity, Apple had already moved on and progressed into the development of Ipad and Iphone. Steve Jobs even predicted outrageously that Ipod will be obsoleted in the near future, which it did.

Should CT have invested the $100 million more wisely on research and development? Of course hindsight is always 100% and nobody would have predicted the outcome accurately. But technology is always a wildcard and in the corporate world, it can be very unforgiving.

Even though CT had been dishing out dividends to investors over the years, the decline in its share price more than offset the total dividends. Just imagine this. From $58 to $1 per share. This represents a massive wealth destruction for CT's long-term shareholders who held the share from 2000 till now. This is especially so as investors would have purchased the shares in board lot of 1000 shares.

A review of Creative Technologies only revealed more concerns for this once-mighty IT company. Revenue has been dropping alarmingly for the past 5 years, from $234 million in FY2012 to $114 million in FY2016. On top of this, CT has been losing money for the past 3 years. Unless CT come out with another best-selling product, things could become worse very soon.

Can Creative Technology rise from the ashes again? I don't know. A lot actually depends on the technology and market trends. Management also plays a big role because it is important to have a strategic vision on future consumer's needs. Steve Jobs possessed that ability and subsequently won the game. Sim Wong Hoo needs to figure this out.

For long-term investors of CT, cutting losses may not be an option because of the hefty losses incurred. But then again, it is important to gain lesson out of it. Have you diversified the risk and did you study the trend? Sometimes big boys' movements play a part too.

The Day Creative Technology Ltd sued Apple Inc

In 2006, Singapore-based Creative Technology Ltd sued Apple Inc for patent infringement over a menu interface for an MP3 player. It was an epic corporate story of David versus Goliath and pitted Singapore entrepreneur, Sim Wong Hoo squarely against the late Steve Jobs.

But the outcome was beyond what most people had expected. In fact, Apple had actually agreed to pay Creative Technology Ltd a massive USD100 million to settle the suit.

The battle against Apple marked a turning point for Creative Technology, which at that point of time, had been searching for another holy grail to replace its blockbuster SoundBlaster audio systems. More than a decade has gone since the legal dispute, but Creative Technology is no longer the force it used to be. Although it has won the corporate battle, the business had declined to an almost unbelievable level.

Sales for the fiscal year 2005 was at a peak of USD 1.2 billion but by fiscal 2016, the sales amounted to only a paltry of USD 84.5 million. That was a massive decline by any standard and something must be done before Creative Technology free fall from the cliff. It seems that the victory against Apple had brought more harm than good for this once-mighty technology company. What the hell happened to Creative? Has talented Sim Wong Hoo lost his Midas touch?

Regarded as the hero of our times, Sim Wong Hoo became the youngest billionaire in Singapore after building his early success with SoundBlaster audio cards. His Creative products used to dominate the computer market in the 80s and 90s and they were extremely popular among gamers. However, since 2000, OEM computer makers began to integrate sound board with the motherboard, marking the start of the decline for Creative Technology.

Against this backdrop, Sim Wong Hoo started to venture beyond computer industry into the consumer electronics and cell phone markets. He correctly predicted that the future lies literary in the hand of the consumers, who are inclined to a mobile lifestyle – listen to music, watch videos and obtain the latest news all on the go. Apparently, Sim Wong Hoo’s team had figured out how to successfully compress digital music and subsequently launched a series of digital audio players like NOMAD, MuVo and Zen. He also filed a patent for browsing music files in MP3 players.

Unfortunately, at that point of time, Apple entered the market and its Ipod was gaining more market share. Thus, when Creative Technology obtained the patent in 2005, it filed suit against Apple for infringement. It was a move widely regarded by many as a desperate attempt to counter the giant’s rising market share in digital audio players. Nonetheless, this led to Apple counter-suing Creative Technology for infringement in four patents in its hand-held players.

Eventually, Apple decided to settle the suit by paying Creative Technology USD 100 million. This was because Apple felt that a court injunction that results in the Apple and Creative products not being exported would only cause more damage to both parties. Hence, Apple wanted to settle the suit and move on as soon as possible.

Although USD100 million was a huge amount of compensation, for Apple, it was considered to be peanuts. To rub salt into injury, the late Steve Jobs even said in a press release "Creative is very fortunate to have been granted this early patent. This settlement resolves all of our differences with Creative, including the five lawsuits currently pending between the companies, and removes the uncertainty and distraction of prolonged litigation”.

Whether who was right or wrong does not matter because Apple had clearly put the whole episode behind and never looked back. In 2007, Steve Jobs declared that Ipod would be obsoleted in the near future with several new upcoming Apple projects – Iphone and Ipad. His words turned out to be prophetic. On the other hand, Creative Technology seemed intoxicated by the windfall and struggled to compete against rivals in the ensuing years.

As a Singaporean, sometimes I feel sorry for Sim Wong Hoo. He had put Singapore brand onto the world map and make us proud. Who would have thought that a small nation like Singapore could produce a remarkable engineering talent and then went on to pit against the big boys? But the corporate world is known to be ruthless and there are no room for sentiments. With falling revenue from product sales, Creative Technology must fight gravity at all cost. It is now or never.

Share price has free fall from a high of $40 in 2000 to the current $1. This represented massive value destruction for long term investors still holding on to its shares. The collapse in the share price is justified as business fundamentals had been spiralling downwards since the victory against Apple. On the latest quarterly results, the company recorded losses of USD4.6 million. Losses for nine months amounted to USD17 million. On the basis of the current results, Creative Technology is fighting for its life.

Surprisingly, the balance sheet looked strong with current assets amounting to USD105 million while total liabilities amounted to only USD37 million. There were no borrowings. Net asset value was USD1.14 per share and Net Current Asset Value Per Share was USD0.90. In view of this, the shares seem fairly undervalued.

But then again, Creative Technology is burning cash at the moment. For nine months ended 31 March 2017, there was a net outflow of USD17 million, against USD4.6 million last year. This means that the operating activities were unable to generate sufficient cash.

Can Sim Wong Hoo turn the tide and revive Creative Technology’s fortune? I certainly hope so. But time is running out and the Singapore tycoon must find that holy grail soon before things turn for the worse. Given the business performance and the cut-throat competition in the IT industry, I would not be investing in Creative Technology anytime soon. Until then, enjoy the ride.

Creative Technology staged “mission impossible” come-back

It was a “mission impossible” come-back for Creative Technology. On 6 March 2018, I can imagine long-term investors punching the air and screaming in delirious as its share price ripped Singapore stock market apart. Creative Technology shares surged almost 10-fold to hit as high as $9.77 during the trading session.

But for those who have not invested in Creative Technology, it is best to avoid this counter. The latest financial statement revealed that this company is still suffering from huge losses. In fact, if not for the USD32 million legal settlement windfall, there would be massive net losses for 1H2017.

In August 2017, Creative Technology scored a legal victory by suing China’s Huawei over a failed broadband network project in 2012. It was awarded USD36 million by the High Court in 2017. The victory marked the third victory in a row for the Singapore company. It had successfully sued Apple twice for patent infringement for Ipod and Ipad products.

The Lost Decade

On looking back, it was surely a bitter-sweet journey for long-term investors as the local IT company endured a period of “lost decade”. From $40 in 2000 to $1.20 in February 2018, shareholders have every right to be angry with founder, Sim Wong Hoo. Of course, there are many people who argue that the IT industry has its up and down cycles. But 18 years is far too long for the recovery of the share price. For those who have held on to Creative shares all these years, the lost opportunities represent a high price to pay.

Sim Wong Hoo gained fame when he created the Sound Blaster sound cards in the 1980s, an iconic home-grown product which made him the youngest billionaire in Singapore. As a young boy, I grew up admiring Sim Wong Hoo because many people in the world thought that Singapore is too tiny a nation to produce any sort of world-class creative products. Well, Sim Wong Hoo’s work has rubbished many claims that Singapore is too boring to be innovative.

But most importantly, he is a loyal Singaporean. As an IT company, he could have achieved much more success if he had shifted his base to United States’ Silicon Valley, the technology haven where technology talents abound. But he did not do so. Instead, he chose to build his empire in Singapore. I guess there are certain things in life that you cannot buy with money.

The battle against Apple

However, IT evolves rapidly and the relentless disruptions mean that change is a constant. Sensing that the Sound Blaster sound card was losing its magic in the early 2000s, Creative Technology launched another audio product that was destined to shake the music industry – the Zen Touch. Unfortunately, at that point of time, Apple entered the market and its Ipod was gaining more market share.

Sim Wong Hoo subsequently lost the battle against Steve Jobs. On hindsight, Creative Technology can take pride in losing the fight to a world-class player. As a visionary, Steve Jobs is an entrepreneur who was not bothered by competition but instead, built his products with a firm belief that his work can change the world.

It was back in 2006 when I vividly recalled the late Steve Jobs promising the world that he would go on to make his own product, Ipod, obsolete in a few years by launching even more state-of-the art communication tools – Ipod and Iphone. At that point of time, Apple had reluctantly paid Creative Technology USD100 million to settle a suit over a menu interface patent infringement. Thus, many people thought that he must be bragging. You must realize that at that time, the term “smartphone” was unheard of and people are still using Nokia handphones. But Steve Jobs proved all naysayers wrong and the rest is of course, history.

The battle against Apple marked a turning point for Creative Technology, which at that point of time, had been searching for another holy grail to replace its blockbuster Sound Blaster audio systems. More than a decade has gone since the legal dispute, but Creative Technology is no longer the force it used to be. Although it has won the legal suit, the business had declined to an almost unbelievable level.

Sales for the fiscal year 2005 was at a peak of USD 1.2 billion but by fiscal 2017, the sales amounted to only a paltry of USD 70 million. That was a massive decline by any standard and something must be done before Creative Technology free fall from the cliff. It seems that the victory against Apple had brought more harm than good for this once-mighty technology company.

Sue or survive?

From the perspective of an entrepreneur, I can relate to Sim Wong Hoo suing competitors for infringing patent rights. After all, there is a need to protect intellectual property. In the world of IT, first-mover advantage is critical and you would want to stay ahead of your competitors. This is especially if you have poured in million of dollars and time on researching the technology. Henceforth, I do not disagree with such approach.

Nonetheless, I do hope that Creative Technology can focus its resources in creating more products that are game-changers. Creative used to be very good at this when it invented the Sound Blaster and Zen Touch products. Though the legal settlements had brought in hundred of millions of cash, they can be quite a distraction for the management. Furthermore, the world wants to remember Creative Technology as a world-class technology company that hails from Singapore, and not a company that is prone to suing partners or competitors.

Third time lucky?

Since Sound Blaster and Zen Touch, it has been a long time since Creative Technology come out with a ground-breaking product. The recent launch of Super X-Fi headphone may enable Sim Wong Hoo to turn the tide. Dubbed as the ‘Holy Grail' of headphone audio, this product has earned rave reviews and has won the prestigious AVS Forum ‘Best of CES 2018 Award'.

I have not tried the product myself but according to the website, Super X-Fi is capable of delivering “experience of a high-end multi-speaker system in a theater and actually re-creating that same expansive experience - the same depth, detail, soundstage, three dimensionality, immersiveness, realism and more. It's like the magic of 3D holography, but in audio - for the headphones.”

As a Singaporean, I sincerely hope that X-Fi will be a runaway success for Creative Technology, which certainly needs another winning product badly. Q2FY2018 saw it making losses of USD4 million. In terms of balance sheet, it is never a crisis company because it does not have long-term debts and current assets amounted to a whopping $146 million vis-à-vis total liabilities of only $64 million. Net Asset Value (NAV) amounted to USD1.34.

Peril of investing in technology companies

Generally, I have always avoided investing in technology stocks because of the constant disruptions. Just take a look at the telco industry. Apart from SingTel, Starhub and M1 has seen their businesses

82 affected due to the rapid technology advancements. Unless the company possesses investment moats, investing in technology stocks can be risky. Creative Technology falls into this category of stock. The fault does not lie in Sim Wong Hoo’s management. The real culprit is the nature of the industry.

Will X-FI spark another growth revolution or is it just another false dawn for Creative Technology? Only time will tell. In the Singapore stock market, turnarounds seldom happen. So far, I can remember only Ron Sim of OSIM who have achieved a remarkable turnaround and successfully transformed OSIM from a technology to lifestyle stock. Till then, enjoy the ride.

Will Straco Corp be de-listed from SGX?

With a slew of SGX listed companies being privatized recently, one wonders whether Straco Corp will be the next to be de-listed. The latest company to be delisted from the Singapore Exchange is Super Group, which is acquired by Dutch coffee firm JDE for a whopping $1.45 billion.

Will Straco Corp be de-listed?

Recently, Straco Corp purchased a total of 269,800 shares by way of on-market purchase for a total consideration of $206,000 in 3Q2016. These shares purchased were made out of the company’s capital and held as treasury shares. As of now, the company is holding 10 million treasury shares.

The key internal stakeholders, namely Straco Holding Pte Ltd, China Poly Group Corp and Straco (HK) Limited, hold about 75% of the company shares. Under such situation, the management may make an offer to minority shareholders in a bid to de-list the company. Thus, I am cautious about investing in Straco Corp. What if the offer is way below the price level at which I buy the shares? If this is to happen, I would have sustained losses in my investment.

Of course, all these are just speculative thoughts. But assuming Straco Corp made an offer of $0.80 per share to shareholders, the management only needs to splash out an estimated $103 million to exceed the 90 percent threshold to de-list the company, Based on the latest quarter report, Straco Corp currently holds about $160 million amount of hard cash. Thus, privatizing the company would not be a major issue.

The motivating factors for Straco Corp would be the savings from listing costs and resources saved on corporate governance compliance efforts. Being a private company also means that dividends would not need to be distributed to external shareholders.

Straco Corp 3Q16 results

Notwithstanding the current weak market sentiments, the tourism-related operator continued to report strong performance for 3Q16. There was a marginal decline in Group revenue to $47.63 million for the third quarter ended 30 September 2016 compared to 3Q2015, mainly attributable to the lower revenue contributed by Underwater World Xiamen and Lixing Cable Car. Cumulatively, Group revenue for the nine months of 2016 decreased 1.8%, while Group profit fell 5.7%.

Executive Chairman, Mr Wu Hsioh Kwang noted that their two aquariums in China registered higher visitor arrivals during the summer holidays in July and August compared to the corresponding period last year. Mr Wu added: “Better yield was achieved for Singapore Flyer which contributed to an increase in overall revenue for the Singapore operation.”

To be frank, to be able to achieve a profit of $24 million for current third quarter is a very good achievement given the slowing market in China. Then again, the management had consistently delivered in the past. The Return of Asset (ROA) and Return of Equity (ROE) have been double digits for the past five years for Straco Corp.

My Strategy

Although Straco Corp's business is in tourism and the industry is not exactly sexy, the field is considered ever-green. Nonetheless, the company's prospect will be affected by government policies and market conditions. To grow and scale the business, Straco Corp will need to source for new tourism projects or form strategic partnerships to tap into the expected tourism boom in Asia.

The current price is way too ahead of its value and the possibility of Straco Corp being privatized deters me from investing in this interesting stock. I may enter this counter only at $0.20.

Straco Corp's latest financial performance

In my previous article, I wrote about Straco Corp's company profile and its acquisition of Singapore Flyer back in 2014. This blog post will analyse Straco Corp's latest financial performance.

On 10 August 2016, Straco Corp reported a 5.2% decline in Group revenue to $27.86 million for the second quarter ended 30 June 2016 compared to 2Q2015. The decline in revenue was due to lower number of visitors for its two aquariums in China. Interestingly, Singapore Flyer reported higher revenue for 2Q2016 on improved ticket yield. Cumulatively, the Group revenue for 1H2016 decreased marginally by 0.5%. Even though there was increased revenue at Singapore Flyer, this was offset by declines at the China aquariums.

Based on the latest earning report, the slow down in China definitely has an impact on Straco Corp's earning. Dividends per share have been increasing for the last four years. However, there are signs that the growth in dividends has reached a plateau. During the quarter, the company paid out dividends of $21.48 million for the financial year ended 31 December 2015. As at 30 June 2016, the Group’s cash and cash equivalent balance amounted to $124.69 million.

Straco Corp's cash flow remains healthy and has been increasing for the past four years. The company managed to generated net cash from operating activities despite the economy slow down in China. The company has a net cash of $56.8 million for the second quarter. Thus, barring unforeseen circumstances, it is unlikely that Straco Corp will encounter any cash flow issues for the foreseeable future.

Investment Risk

Straco Corp’s core assets are concentrated in Asia region, namely Singapore and China. The company operates Shanghai Ocean Aquarium, Singapore Flyer, Underwater World Xiamen and Lixing Cable Car. Straco’s headquarter is located in Singapore and most of its business activities are in China. Therefore, its financial performance will be impacted by the foreign exchange movements of these two countries. For example, stronger RMB currency in 2015 also translated to higher expenses in Singapore dollar for China operations compared to 2014. However, the increase was mitigated by absence of exchange loss amounting to $1.48 million recorded in 2014.

Like Singapore, the tourism sector is heavily influenced by government policies in China. Due to this, the business outlook for Straco Corp is, to a large extent, subject to China’s regulatory changes. For example, in 2015, Underwater World Xiamen recorded a 20% decline in revenue and profitability as a result of measures introduced by the authorities to limit visitor traffic to Gu Lang Yu, as part of the island’s ongoing efforts to attain status as a UNESCO World Heritage site. To mitigate the impact, Straco had to extend the operating hours and introduce new themes to the aquarium to draw more visitors.

Many analysts may argue that the closing down of Underwater World Singapore by Haw Par Corp was a missed opportunity for Straco to expand its portfolio of aquariums. Probably the stiff competition from S.E.A aquarium of Resort World Sentosa may have put off interest from Straco. Nonetheless, Haw Par Corp still have one remaining aquarium in Thailand. Given that Haw Par Corp’s core business is in selling the Tiger Balm ointment products, it may be a win-win proposition for Straco to acquire the Thailand aquarium. This would help Haw Par Corp to unlock its asset value while enabling Straco to scale its core business in tourism.

My strategy

Before its acquisition of Singapore Flyer in 2014, Straco’s shares were trading in the $0.20 to $0.25 bandwidth. The publicity generated by the acquisition has raised Straco’s profile among investors and turbo-charged the share price to a high of $1.05 in May 2015. Given that the Net Current Value per Share (NCAVPS) is $0.05 and the Net Asset Value for the Group is $0.24, the current trading price of $0.79 represents a high premium for investors.

As Straco’s business outlook is heavily dependent on economic and regulatory changes, the risk in investing in this counter is relatively high. Furthermore, it may take another 4 to 5 years for Straco to

85 break even its investment cost for Singapore Flyer. It has paid $140 million for the distressed asset but managed to turnaround and made it profitable. Hence, it is unlikely that Straco will splash out another sum of money to acquire new assets to add to its portfolio in the near future. This means that growth will likely to be moderate or even stagnate for the next few years.

Another point to note is the shareholdings among its internal stakeholders. Straco Holdings, China Poly Group Corporation and Straco HK Limited together hold more than 75% of the outstanding shares. Under such circumstances, the management could easily make an offer to minority shareholders in a bid to delist the company. Thus, I am cautious about investing in Straco Corp and will enter this counter only at a bargain level of $0.20.

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The story of Straco Corp and Singapore Flyer

In one of my previous articles, I wrote about the fate of Underwater World Singapore. In response to my article, a reader mentioned about Straco Corp and this prompted me to research on the company.

Listed on SGX mainboard since 2004, Straco Corp was found by local entrepreneur, Wu Hsioh Kwang who is the Vice-President (Singapore Chinese Chamber of Commerce), Vice-Chairman of Tourism & Leisure, Chinese Business Group (Singapore Business Federation) and Vice Chairman of the 4th Standing Committee of Chinese Association of Enterprises with Foreign Investment (China).

Not much else is known about Mr Wu except that he spent 30 years doing tourism-related business in China. In fact, he has two very successful aquariums in China, one is the Shanghai Ocean Aquarium, while the other is Underwater World Xiamen. What prompted Mr Wu to see the potential and subsequently invested in Singapore Flyer is a mystery.

When Straco Corp splashed out $140 million for the Singapore Flyer back in 2014, the iconic attraction was in a bad shape. The company that ran the flyer was facing financial problems and Straco stepped in to buy over the asset. By then, the number of visitors had declined due to stiff competition from other attractions and tenants were having poor businesses.

It doesn't help that Singapore Flyer suffered from a series of breakdowns and incidents. Among them was a fire in the wheel control room that resulted in 173 passengers being trapped for 6 hours in 2008. In 2010, a lightning struck one of its electrical cables of the air-con system, causing more than 200 people to be evacuated.

Thus, many analysts didn't expect Straco Corp to turnaround Singapore Flyer so soon, given the number of issues to resolve in order to draw back the crowd. In view of this, the risk that Straco Corp undertook in acquiring Singapore Flyer was deemed as high by analysts. Hence, at that point of time, many investors questioned the wisdom of the deal.

Perhaps, many investors overlooked the fact that Straco Corp is an experienced tourism asset operator, it did manage to turnaround Singapore Flyer swiftly. In its 2015 annual report, Straco Corp reported that Singapore Flyer has been profitable since end November 2014. To their credits, Straco Corp worked hard to "tighten service level and operating efficiency". To attract crowds, Straco Corp collaborated with Singapore Tourism Board and several key partners to market Singapore Flyer through several events like SG50 and Singapore F1 Grand Prix night race. The slew of proactive measures enabled Singapore Flyer to become a profitable asset for Straco Corp.

Although Mr Wu may not be as famous as UOB's Wee Cho Yaw, the Singapore Flyer episode demonstrated his experience and ability to run a tourism asset successfully. Hence, if Underwater World Singapore had been sold to Straco Corp, the attraction might not have closed down. This is because unlike Straco Corp, Haw Par Corp's core business is not in tourism. The latter has a very diversified business spanning across healthcare, property, investments and leisure. In this regard, it is hard to imagine that the management of Haw Par could focus its resources on the leisure segment which does not generate the bulk of its operation profits.

In the next article on Straco, I will do an analyze to check if the company is worth investing. So please stay tune.

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Formidable challenger for Challenger Technologies Limited

Crisis? What crisis? SGX mainboard-listed company, Challlenger Technologies Limited, appears unfazed in the aftermath of the closure of its 53,000 sqft megastore at Funan DigitaLife Mall since December 2015. Last year has been challenging due to the weak economic sentiment but on the basis of the 3Q2016 financial results, it seems that Challenger managed to reduce the impact of its megastore closure.

Last week. I visited the Challenger Technologies store at Bedok Point mall to purchase a software and was very impressed by their staff’s customer service and efficiency. Prior to the trip, I had done some research online and thus only spend less than 5 minutes in the shop. The whole experience had been positive but in the face of stiff competition from online and brick-and-mortar players in the market, Challenger faces a daunting journey ahead.

While Challenger tried to downplay the significance of the closure of its Funan DigitaLife mall through the rapid expansion of heartland retail stores, it has since moved on and announced a new flagship store at Bugis Junction. Spanning almost 14,000 square feet in space, the basement 1 location is set to open by the second quarter of 2017. In addition to complementing the existing Challenger store at level 3 Bugis Junction, the new flagship store will add to the Group’s overall portfolio of almost 50 stores island-wide.

In today’s context, the concept of a “destination specialist shopping mall” is not relevant anymore as there are so many channels for consumers to make purchases with the advent of e-commerce. In this respect, Challenger has correctly anticipated the changes in retailers’ lifestyle trend. Their strategy is to complement (and not substitute) their physical stores with their online stores. This is important as even though the online space offers tremendous opportunities for growth, physical presence is still needed to showcase the customers’ products and capabilities.

However, with online retail giant Amazon setting up shop in Singapore by early 2017, it is not going to be business as usual for the IT retailer. As Singapore market is very small and saturated, Challenger’s market share will likely be affected with the entry of Amazon. It is still early days and Challenge has claimed that it will not take on the retail online giant but instead collaborate together. With such formidable “challenger” coming its way, Challenger’s CEO Loo Leong Thye is indeed putting on a brave front. To top it off, he even claimed a sales target of $1 billion to be achieved in 5 years’ time.

Whether Challenger can achieve that lofty sales target remains to be seen but given that Challenger’s current principal market is in Singapore, it will be a tall order. It is not mission impossible because the company’s business model is scalable. But to achieve this target, Challenger needs to start conquering regional markets.

To hit the billion dollar sales target, Challenger will need a grandstand performance as revenue remained flat at $256.0 million for the nine months ended 30 September 2016. The current soft market also saw profit after tax decreased by 16% to $9.1 million. To tackle the weak retail market sentiments, the group is banking on their online marketplace, Hachi.tech to provide more channel offerings for customers. Challenger is also rationalizing weak performing retail stores and focus growth in strategically located stores like Tampines Hub and the new flagship store in Bugis Junction.

Balance sheet continued to be healthy with total current assets at $89.6 million and total current liabilities at $25.2 million. Net Current Asset Value per Share (NCAVPS) was $0.18 and Net Asset Value (NAV) at $0.22. The net operating cash flow was $7.8 million and free cash flow was $6.6 million. The cash generated by operations allows Challenger to embark on acquisitions to spur growth. In fact, Challenge Ventures Pte Ltd was established in Q32015 to invest in digital businesses and services. One such service is the group’s existing end-to-end integrated marketing solutions provider, inCall System Pte Ltd, which has been injected into CVPL. Another business is e-commerce marketplace Andios, which provides customers a platform to buy or sell their smartphones online. Apart from digital businesses, the Group has plans to establish a logistics hub in Singapore for ecommerce warehousing and fulfilment.

While critics may lament that it is a bit late for Challenger to enter the online business scene, I feel that it is better to be late than never. Investing in online startups involves certain level of risks and it is important for Challenger to invest prudently in online ventures that are relevant and can add value to its business, such as mobile marketplace, e-wallet and technology websites.

At the end of the day, in order to capture business growth, it is time for Challenger to venture overseas. Growing more retail stores and investing in online companies will have limited impact on revenue growth as Singapore market is too small for the company to evolve into a big boy. How many walk-in and online customers can Challenger count on to bolster its market share in Singapore? The arrival of Amazon could shake up the whole IT retail industry in Singapore, possibly even changing the game. If Challenger is not careful, it may find itself being drowned by the oncoming tidal wave brought forth by the US giant.

Currently trading at $0.50, the intrinsic value of Challenger should be $0.20. Thus, the current price valuation seems a bit inflated. The share price has obviously surged since the dark days of Great Financial Crisis in 2009 but I find it an attractive growth stock to invest in. The Return-on-Equity (ROE) had been double digits for the past 5 years and the company has no long-term debts. It is too premature to assess the impact arising from Amazon but it will be interesting to know how the stock will perform in 2017 given the headwinds it will face. Hence, I will only enter this stock at $0.30.

Is Old Chang Kee a value trap?

Since young, I have always enjoyed eating Old Chang Kee’s signature curry puffs. The history of Old Chang Kee, however, goes as far back as 1956 when it was just a small stall in a coffee shop outside former Rex cinema. In 1986, the current chairman, Han Keen Juan bought over the control of the company and subsequently transformed the stall into a listed company.

On looking back, Old Chang Kee is a story of coming of age and its brand is synonymous with Singapore food heritage. With a humble beginning, Han Keen Juan has certainly grown the Old Chang Kee into a household name.

When it was listed in Catalist in 2008, the IPO price was $0.139 and the shares were 111% over- subscribed. Now trading at $0.815, it is time to examine whether investing in the shares is worth the effort.

Fourth quarter loss

The Group was cruising along finely when it was hit by a 4Q2017 loss of $2.1 million. Prior to this, total revenue had been growing steadily from $65.6 million in 2013 to $78.3 million in 2017. However, net profit declined from $6 million in 2014 to $4.9 million in 2016. The net profit FY2017 was even worse – at $1.7 million, a decline of 64.9% year-on-year.

The surprising loss was due to the increase in other expenses of approximately S$3.3 million in FY2017 was mainly due to the following:

(a) revaluation deficit for the Group’s Singapore and Malaysia factory building by approximately S$3.0 million;

(b) higher foreign exchange losses of approximately S$384,000 primarily on Malaysian Ringgit denominated loans to associated and subsidiary company; and

On closer examination of the financial result, the revaluation deficit should be one-off loss and not a scheduled depreciation expenses.

Business fundamentals

Apart from the shock quarterly loss, the balance sheet looked reasonably well, although not exactly very strong. The amount of cash and cash equivalent stood at $15.5 million, more than sufficient to pay off the short-term and long-term debts. But what I like about the company is the asset-lite and simple business model.

Cash flow from operations for FY2017 was $10 million, a decrease from $12 million in FY2016. After deducting the $8.2 million used for purchasing property, plant and equipment, the free cash flow was

90 only $1.4 million. With such a small war-chest, it is unlikely that management would pursue an aggressive expansion plan.

The company basically sells snack and promote its brand through outlets strategically located at different areas of Singapore. Curry times, a curry theme restaurant at Changi Airport Terminal 3 is also under Old Chang Kee. In recent years, there was expansion into overseas, such as Australia Malaysia and Indonesia.

Risks

Like many food and beverage company, Old Chang Kee’s growth is greatly impacted by the foreign labour tax and the tight labour market. Due to the shortage of labour in the food industry, labour costs are expected to rise in order to attract staff.

The decision to expand into overseas market came at a price. In FY2017, the company suffered higher foreign exchange losses of approximately S$384,000 primarily on Malaysian Ringgit denominated loans to associated and subsidiary company. Hence, foreign currency exchange losses will continue to weigh on the Group.

With a market capitalization of only $98 million, Old Chang Kee is considered a very small listed company. Being small, the company lacks the investment moats to withstand changing demographics, evolving market trend and adverse market conditions. In view of this, it may lack the economy of scale to negotiate bulk purchases for raw materials from the suppliers.

Another risk factor to consider is that the core product of the Group is basically snack. There are many substitutes for the signature curry puffs it is selling. Besides pitting against so many different type of competitors, OCK’s products may also be sensitive to economic downturn. Consumers are likely to snack less during times of hardship. This probably explains why Old Chang Kee’s shares languished at $0.20 level for several years during the Great Financial Crisis.

Stock evaluation

With net asset value of $0.22 and P/E ratio of a whopping 57.7, the shares are definitely inflated. Return on Equity (ROE) has been falling from 15.8% in FY2015 to 6.3% in FY2017. ROE measures how efficient the management deploys shareholder fund to generate returns. All these data suggested that Old Chang Kee shares may have peaked.

Based on the above factors, I will not be investing in Old Chang Kee. Although the branding is reasonably good, the company lacks investment moat to ward off stiff competition and adverse market conditions. For those who had made substantial paper gains from the bullish run over the last few years, it may be time to take stock and rationalize whether to continue holding the shares.

Investors should note that Han Keen Juan is not exactly a company founder. He is actually a businessman who bought over a business and transformed it into a well-known brand. Although he may be passionate about the business, he may not carry the type of emotional attachments like many founders. After all, most venture capitalists are interested in the returns and not the day-to-day running of the business.

It has been a good and exciting journey for Han Keen Juan and at his age, he may be tempted to call it a day. With a direct and deemed interest of 65.93%, Han Keen Juan's stake in Old Chang Kee is worth a cool $66.4 million. In view of the declining performance, now may be a ripe time for Han to divest his stake and enjoy life in retirement.

Lastly, one thing I dislike about small cap SGX stocks is their low trading volumes. For Old Chang Kee, the average 3 month volume was only 30,000. With such low liquidity, investors would face much difficulty in disposing the shares during market corrections. Hence, Old Chang Kee may be a value trap in my opinion.

Can The Hour Glass roll back the time?

Once upon a time, there were three shining forces in Singapore stock market. Osim’s Ron Sim, Creative Technologies’ Sim Wong Hoo and The Hour Glass’ Jannie Chan used to dominate the entrepreneur scene. Together, the trio had won numerous awards for creating outstanding household brands. As a young boy, I have deep admiration for these business pioneers but Jannie Chan stood out among the three of them because of what she had done for The Hour Glass.

The Early Years

In the 80s and 90s, female entrepreneurs were almost unheard of, much less successful female entrepreneurs. The corporate and business community used to be dominated by males. Of course, there were female leaders but they were the exception rather than the norms.

Widely credited for co-founding The Hour Glass, Jannie Chan has been instrumental in building the luxury watch retailer into a SGX-listed company with international presence in Australia, Hong Kong, Japan, Thailand and Malaysia. Therefore, it pains me to read of her current plight because she had been my source of inspiration for several decades. Having achieved so much with The Hour Glass, I thought she deserved more during her twilight years.

In recent years, Jannie Chan had been involved in various legal disputes. Last year, she lost her appeal against ANZ seeking to recover $8.7 million in loan defaults by Timor Global in which she is a director and shareholder. She was also sued by former husband, Dr Henry Tay, for several times over defamatory emails. Recently, it was reported that she was given 2-week of suspended jail term for contempt of court.

Those good old days must seem so surreal for Jannie Chan. From the first store at the Lucky Plaza, she grew The Hour Glass into a regional force with 40 boutiques in nine key cities in the Asia-Pacific region. Impressively, the Group has evolved to curate collection of luxury watches from more than 50 of the world’s finest watch brands such as IWC, Patek Philippe, Rolex, TAG Heuer and the likes. Under Jannie’s leadership, it has been an exciting journey for The Hour Glass.

Business Performance

Notwithstanding the family disputes, The Hour Glass appears to be in good hands. Executive Chairman, Dr Henry Tay is currently running the company with Michael Tay, Group Managing Director. Full year profit for FY2017 amounted to $49 million, a decrease of 7% year-on-year. Although father and son are running the business well, the challenging retail climate has profound impacts on The Hour Glass’s business.

Fundamentally, The Hour Glass’ products are high-end luxury goods and therefore its business is pretty much sensitive to the market conditions. This is understandable as slowing economy means retailers are less likely to spend on luxury watches. The world number one market, Hong Kong, was affected as well, with the watch market falling by 25.1%. In United States, the market contracted 9.1% while Singapore’s market shrank by 10.4%. The declining demand for luxury watches led to the third consecutive year of contraction for Swiss watch export.

Dr Henry predicted that the decline for the luxury watch is expected to continue for the next few years based on several reasons. Firstly, there is the issue of overcapacity. Watch factories are still churning out watches even though global retailers are facing outsized inventories. With decreased demand, retailers are facing challenges in turning around inventory.

To be successful in business, a company must ensure the inventory turnover is good. This is because inventory may impact a company’s cash flow. In light of the overcapacity in the industry, The Hour Glass is facing pressure in the gross margin. As a matter of fact, gross margin fell gradually from 23.9% in FY2013 to 22.7% in FY2017.

But while the luxury watch retailer in facing significant challenges brought forth by changing market forces, the balance sheet remained very strong. Cash and cash equivalents actually grew from $79.5 million in FY2013 to $124 million in FY2017. During this period, free cash flow increased from $1.5

92 million to $57 million. With so much cash on hand, it is likely that The Hour Glass could be adopting a wait-and-see approach before making acquisitions for growth.

Technology disruptions

There are good reasons for management to be prudent in their cash flow because of the disruptions in the market trend. Technology has created a whole new world of e-commerce platforms for luxury watches to be sold. Against this backdrop, The Hour Glass is facing competition from e-commerce players. What this means is that The Hour Glass must evolve from its current brick-and-mortar model and re-invent its way of selling.

In the olden days, The Hour Glass could spend hundreds of thousands refurbishing one watch outlet to attract customers. Nowadays, such a strategy would not work. With digital, there are many more opportunities to grow the business. For example, with online channel, there are the possibility of capturing more global customers and do cross-border selling. With technology, companies could also price-discriminate customers or do geo-tagging – selling of products to specific customers based on their IP addresses.

Two years ago, Dr Henry had foreseen the potential disruptions and the resulting impacts of digitization. Thus, the Group has embarked on a transformation journey to respond to digitization. There were restructuring in the management structure, investment in technology, shift in customer experience management and most importantly, a change in organizational culture. The Hour Glass is embracing itself for the disruptions in the industry by entrenching itself as a “digital native” in the next three years.

Share price

Indeed, with changing market disruptions, it is not business as usual. The share price is now trading at $0.660, below its Net Asset Value (NAV) of $0.68. But based on my estimation, the actual value of the shares could be worth at least $0.70. This is because The Hour Glass owns a portfolio of investment properties and investment in associates.

For the property portfolio, rental income for FY2017 amounted to $2.4 million while the fair value gain was $3.4 million. Overall the value of investment properties was a cool $71 million. On the other hand, its investment in associates was worth $24.7 million.

At Price/Book Value of $0.972 and P/E ratio of 9.55, the shares are considered fairly valued. But due to market trend and adverse condition, there are more headwinds for the watch retailer. Dr Henry predicted that the downturn for the luxury industry could last a few more years. Although the management is prudent in its financial approach, I hope to see more growth initiatives from management before investing in this counter. In the meantime, I expect the stock price to continue to fall gradually in the coming years. Till then, enjoy the ride.

The Hour Glass Limited

Recently, I received the following email query on The Hour Glass Limited, one of the famous brands for luxury watches in Singapore. Hence, I decided to craft a post to capture some quick thoughts on this SGX-listed stock.

Hi there,

Chanced upon your blog while doing research on The Hour Glass Limited. Could I know whats your take on the management shuffle going on now? Quite a few board level executives are moving on.

Cheers

To be frank, apart from the resignation of Ms Wong Mei Ling as the Managing Director of Singapore, I am not aware of any major management shuffle going on within The Hour Glass Limited.

I have previously written an investment analysis on The Hour Glass Limited. Check out the report here.

According to the SGX filing, Ms Wong was responsible for the business development and management of The Hour Glass' Singapore Division and her departure was due to her pursuit of other interests. Prior to that, Ms Lim Jee Yah resigned as Managing Director of Luxury Enterprises in July 2016.

Family feud

Ultimately, investors must note that The Hour Glass is a family-owned and family-run business. So the departure of Ms Wong and Ms Lim should not be major concerns as the company founders are still managing the business. Nonetheless, behind the successful story of The Hour Glass Limited, lies a bitter family feud between founders Dr Henry Tay and Jannie Chan.

Dr Tay and Jannie Chan were divorced in 2010 and were engaged in a high-profile legal dispute over money issues back in 2012. Apparently, Dr Tay obtained an injunction to prevent Ms Chan from signing cheques for a family company, TYC Investment. Dr Tay also asked the court to order his former wife to return more than $3 million to TYC Investment. The couple subsequently managed to settle the family feud out of court.

Last year, Jannie Chan got into deeper trouble when she lost her bankruptcy appeal against ANZ Bank which sought to recover $8.7 million in loan defaults by a Timor firm in which she was a director and shareholder. Amid that storm, Jannie relinquished her executive functions within The Hour Glass and retired as the Executive Vice-Chairman of The Hour Glass Limited.

However, Jannie Chan continues to remain on the Board as a Non-Independent and Non-Executive Director and serves in the capacity of Senior Advisor to The Hour Glass.

Business as usual

Notwithstanding the family feud, it was business as usual for The Hour Glass management, at least for the past five years. Since 2011, revenue grew from $517 million to $707 million. Profit before tax remains healthy, increasing steadily from $43 million in 2011 to $53 million in 2016. The Return on Equity (ROE) has been double digits for the past 5 years, but is declining gradually. The trend indicates that The Hour Glass Limited performance might have peaked.

On the basis of the latest financial result, The Hour Glass current challenge lies not in the management but rather the headwinds currently experienced by the luxury watch industry. Profit for 3Q declined 7% to $13.6 million year-on-year while total profit for the nine months dropped a whopping 14% to $30.5 million compared to previous year.

The terrible retail market sentiments certainly caused a dent in The Hour Glass' profits but the management is not sitting idle.

Because of its reputable brand, The Hour Glass had managed to obtain extra lines of credit from their banks and launched a $500 million medium term note programme in 2016 to respond to any opportunity

94 that may arise in the coming years. During this slow-down period, the company is also reviewing its policies and procedures to enhance operational efficiency.

Hidden assets

I continue to like The Hour Glass for its strong balance sheet and healthy cash flow. Current assets were $441 million while total liabilities stood at merely $110.8 million. The Group continued to be cash rich with cash and cash equivalents at $95 million. Cash flow for nine months was $29 million.

At price book value ratio of 1.056, the current share price seems to reflect the intrinsic value of The Hour Glass. The Net Asset Value (NAV) was $0.65 while the Net Current Asset Value Per Share (NCAVPS) was $0.567. However, if investors factor in the hidden assets, which consists of the portfolio of investment properties measured at fair value of $66.9 million, the actual value of The Hour Glass should be $0.67.

Last year, The Hour Glass collected $2.6 million of rental income from its investment properties located in Singapore, Australia and Malaysia. With its free cash flow, it is likely that the management may acquire more properties and collect more rental income going forward. It will be interesting to see The Hour Glass transforming itself into a landlord indeed!

The Management

The Hour Glass has been established for close to 40 years and is a well-established brand in Singapore. The luxury watch company has won numerous awards for business and service excellence. A lot of credit must go to the management, especially the two founders, for creating such a strong Singapore brand.

To be frank, with Dr Henry Tay as the Chairman, the company is still in good hands. Even though there are some management movements in recent years, I don't foresee that the boat will be rocked.

I am not vested in this counter but feel that $0.60 will be a good entry price for me to enter.

Is it worthwhile to invest in The Hour Glass?

On 12 August 2016, luxury watch retailer, The Hour Glass, delivered a set of poor financial results for 1Q2017. Year-on-year, revenue dropped a whopping 7% to $149 million and profits after tax declined 23% to $8.3 million for the first quarter of FY2017. At the back of many investors' mind should be the question of whether is it worthwhile to invest in The Hour Glass now?

To be fair to the management, The Hour Glass has one of the strongest balance sheets for a listed SGX stock. The current assets amounted to $426 million, while cash and cash equivalents stood at $80.6 million. The current assets could more than offset the current and long term liabilities easily.

The Net Current Asset Value Per Share (NCAVPS) was $0.568 per share. This means that if The Hour Glass is to be liquidated, this will be the amount of tangible value per share after paying off the short term and long term debts. Net Asset Value (NAV) per ordinary share was $0.63.

For The Hour Glass, my estimation for the intrinsic value of each share is $0.66. This is because the Group holds a substantial amount of investment properties valued at $64 million according to the latest financial statement. Factoring this property asset into the NCAVPS, The Hour Glass' true value should be $0.66, which is very near the current trading price of $0.72.

Given that The Hour Glass' share price is currently fully valued, it may be very tempting to enter this counter. However, investors should realize the kind of headwinds that The Hour Glass is facing. The continuing global economic uncertainty is expected to sour consumer's buying appetite for luxury watches. So as the company navigate through this storm, expect many choppy tides and rough waves. It is not going to be a smooth sail for investors of The Hour Glass.

I don't have much knowledge on luxury watches but The Hour Glass' annual report revealed a lot of useful insights on the global shift in trend for this sector. Broadly, the slow-down of China economic growth is expected to see contraction of luxury watch retailers' network by up to a staggering 40%. This is a painful consolidation for the industry as the global economy continues to re-balance and growth is not expected to be rosy.

Notably, the management team of The Hour Glass has changed recently to adapt to the change in client demographic. Millennials now constitute over 45% of the team while Gen Xers 45% and Baby Boomers 15%. Clearly, the management envisage the potential purchasing power of the next generation and make it a point to "disrupt" themselves before others disrupt them.

Lastly, The Hour Glass is cognizant of the power of technology and how it can change consumer's pattern. The advent of online comparison apps will impact branding and drives the flow of shoppers.

As The Hour Glass undergo a transition cycle, it is a big unknown whether the management is able to transform itself successfully in this new economy. It is not going to be business as usual for sure and whether the business will continue to be profitable will depend a lot on its management execution.

My strategy is to enter this stock at $0.60.

The Explosive Surge of The Hour Glass

The Hour Glass is a listed luxury watch retail group in Asia with headquarter in Singapore. Founded in 1979 by the husband and wife team, Dr. Henry Tay and Dato' Jannie Tay, the company started operation in Lucky Plaza through a partnership with Metro Holdings. In recent years, the company’s share price has surged from $0.30 in 2009 to almost $2.00 in 2014. Post stock-split of a one-into-three exercise in 2014, the current share price is now trading at $0.74.

What sets apart The Hour Glass from other luxury watch competitors is that it also has a substantial property portfolio. According to its 3Q2016 financial report, the group is holding on to $64 million worth of investment properties. In 2015, it acquired two Australian properties, namely an 11,000 square feet heritage listed retail and commercial property in Sydney and an 8,000 square feet retail property in Brisbane’s prime luxury retail precinct for $6.3 million. Such property investments reflect the listed company’s strategy for growth in the future.

Besides laying the groundwork for future growth, it is also making the effort to grow its core business. Amid the global economy uncertainties, The Hour Glass acquired the Watches of Switzerland in 2015 for $13.3 million. These investments caused its cash flow to go into negative territory, to the tune of - $16.1 million. However, cash and cash equivalents are still solid at $69 million and profits for 9 months is at a healthy level of $35.5 million. Short-term borrowing is at $46.2 million while long-term debt is $24.2 million. Thus, the company should have no liquidity issues in the short-term as its cash holdings can meet its short-term debts more than sufficiently.

The company’s Net Current Asset Value Per Share (NCAVPS) is $0.43 per share. However, given that it has some hidden asset in the form of property investments, its actual true value should be $0.52 per share. Based on The Hour Glass’ current trading price of $0.74, it is only 30% overvalued. So is The Hour Glass a value buy or value trap? To have a holistic view, it is important to examine the market trends and extrapolate its future growth.

For the past decade, The Hour Glass’ share price has a fine run but going forward, such explosive performances may not be realistic. This is because the past performances had been anchored on the spending power of PRC customers. Over the years, as China’s economy mature and as the PRC spending habits changed, The Hour Glass’ earning performance have been inevitably impacted. Nowadays, the PRC buyers are more sophisticated and they are not willing to spend a premium for luxury watches. Against this challenging backdrop, The Hour Glass needs to adjust its business strategies in order to stay ahead. Whilst the brick and mortar business model will still be relevant in the near future, the company needs to build up its presence in the online community in order to reach out to its international customers.

Even though The Hour Glass is only a luxury watch retailer and not a watch manufacturer per se, the company can consider re-branding itself in the online world through sharing its extensive knowledge on luxury watches that it sells. In doing so, the company will be seen as an authority in the field of luxury watches and thus, will be able to forge a long-term relationships with buyers. To reach out to targeted segments of the market, The Hour Glass may also consider working with Singapore wealth blogs to create awareness on luxury watches.

What is the trend for the retail market in the near future? One thing for sure is that Singapore’s market is too small to influence global markets. In this regard, the US market is still the leader.

At this juncture, it is still to premature for wealth builders to classify The Hour Glass as a value buy as its potential to price upside will hinge heavily on how it executes the business transformation during this transition period. I am not vested in this counter but nevertheless is keeping a close eye on The Hour Glass. Probably if I have the funds, I would park some money in this counter. However, most of my money are not reserved for Executive Condominium purchase. Otherwise, I would probably invest in this local company which has exciting growth potential.

Sembcorp Industries Ltd

Keppel Corp’s massive fine of USD 422 million over corruption charges had cast a spotlight on rival Sembcorp Marine. The record fine had raised questions on whether Sembcorp Marine would be implicated and created much uncertainties for the company. This is because it is not known if Sembcorp is currently being investigated by the authorities over corruption charges. Nevertheless, it is timely to review whether it is opportune to invest in the parent company, Sembcorp Industries Ltd.

Being rated as the world no.2 oil rig builder, Sembcorp Marine had endured a challenging FY2017 like Keppel Corp. Revenue decreased for rig building and offshore platform projects as well as contracts termination and inventories written down arising from the contract signed in October 2017 to sell nine jack-up oil drilling rigs. Revenue for nine months shrank to $1.7 billion, a decrease of 36% year-on-year. But net profit remained stable, at $28 million, an increase of 3% year-on-year.

Notwithstanding the above, it should be noted that Sembcorp Industries Ltd (SCI) is more than just Sembcorp Marine, which is listed separately on the mainboard of the Singapore Exchange. SCI has three main businesses namely, Utilities, Marine and Urban Development.

Given the choice, I would prefer to invest in SCI than Sembcorp Marine because the parent company has positioned itself very well with strategic diversified businesses. On the surface, the three business units may seem to be in different business arenas but actually the core competency lies broadly in engineering – designing, building and operating projects This means that Sembcorp Industries is able to extract synergies among its business units.

A defensive investment moat?

Another thing I like about Sembcorp Industries is that it specialized in businesses that are sustainable in the long run. Whether you like it or not, water and electricity are critical resources for life. As cities developed, we need people to clear the sewage as well. Being a global leader in the provision of energy, water and solid waste management, Sembcorp Industries does the “dirty jobs” that not many people wanted to do. But it is this niche that gives Sembcorp Industries the competitive edge as it established a strong track record in supplying power, steam and natural gas, and water and wastewater treatment solutions.

The Utilities segment’s principal activities are in the provision of energy and water to industrial, commercial and municipal customers. Key activities in the energy sector include power generation, process steam production, as well as natural gas importation. In the water sector, the business offers wastewater treatment as well as the production of reclaimed, desalinated and potable water and water for industrial use. In addition, the business also provides on-site logistics, solid waste management and specialised project management, engineering, and procurement services.

The diversified business model helps to cushion the devastating impact of the oil slump on its Marine unit. Turnover for nine months increased 5.8% to $6.22 billion but net profit slumped 16% to $208 million. Utilities’ turnover for 9M17 was $4.3 billion, an increase of $1.3 billion, from $3.0 billion in 9M16, mainly due to higher high sulphur fuel oil (HSFO) prices, higher contribution from India and construction

98 revenue for Myingyan and Sirajganj Unit 4 power projects. On the other hand, Marine’s turnover of $1.7 billion was $982 million lower than 9M16, mainly from its rig building and offshore platform projects.

Utility performance

Utilities was the largest net profit contributor, accounting for 61% of the Group’s net profit. This was followed by Urban Development contributing 26% and Marine at 13%. What I like about its utilities segment is that the business is diversified across several markets like Singapore, China, India and Middle East. Interestingly, despite the diversification, Singapore operations was the largest net profit contributor to the Utilities’ net profit before exceptional items at 9M17. Singapore operations continued to perform well which mitigated the weak performance of SGPL in India as well as the absence of contribution from the Yangcheng power plant in China.

In 9M17, the Utilities business contributed $125.9 million in net profit to the Group compared to $258.8 million in 9M16. The division had been hit by exceptional items comprising of non-cash impairment charges mainly relating to Singapore’s assets ($25.8 million) and investments ($30.5 million). 9M17 exceptional items also included the refinancing cost incurred for the Indian power project ($39.1 million, of which $3.1 million was charged as finance cost).

Marine performance

Despite the challenging environment in the offshore and marine industry, Sembcorp Industries delivered a set of respectable financial results for 9M17. Net profit was $28 million, comparable to 9M16. Surprisingly, Sembcorp managed to ride the storm better than fellow competitor, Keppel Corp, whose offshore and marine unit delivered only $1 million net profit for 9M17.

During the peak of oil price, the marine segment used to be the 2nd highest contributor for Sembcorp Industries in terms of net profit. However, due to the lower contribution from rig building and offshore platform projects, contracts termination and inventories being written down, the performance of this segment has lost its shine in recent quarters.

Urban development performance

The urban development segment consists of two units – Land Development and Property Development. For the Land Development unit, Sembcorp has been involved in many important government-supported projects in Vietnam, Jiangsu and Chengdu provinces in China, Central Java and the Riau Islands of Indonesia, over the past 25 years. The key business model is basically to partner with foreign governments to create townships and industrial parks like Nanjing Eco Hi-tech Island and Wuxi Industrial Park. For the Property Development, Sembcorp develops factories, built-to-specification industrial offices, warehouses, commercial buildings as well as residential projects.

For 9M17, the Urban Development segment turned in a stellar performance as net profit amounted to $53 million, a seven-fold increase compared to last year. Higher net profit in 3Q17 was mainly due to higher land sales from its Vietnam and Indonesia operations. 9M17 higher profit was driven by higher contributions from all its markets, in particular, the higher land sales from its China associate.

Balance sheet

As a conglomerate, it is understandable that Sembcorp is highly leveraged. Total debts increased to $10 billion as of 30 September 2017 as compared to $9.2 billion in last year. Current assets stood at $7.88 billion. As utilities, shipbuilding and property development are typically capital-intensive activities, it is not surprising that Sembcorp took on large borrowings to finance its business activities. But with upcoming the interest hikes, it may be prudent for the management to reduce the borrowings.

Cash-flow

For 9M17, the operating cash flow was negative $90.4 million. This means that Sembcorp’s operations burned cash than generated excess cash. As a result, the free cash flow (FCF) plunged to $193 million, as compared to $1.11 billion in last year. A lower FCF limits the ability of Sembcorp Industries to pursue investment opportunities to engineer higher ROE.

Indeed, ROE has plunged from 18% in FY2013 to 5.3% in FY2016. Likewise, revenue declined from $10.8 billion in FY2013 to 47.9 billion in FY2016. The slump in the oil slump had a devastating impact on Semcorp’s business despite its diversified business activities.

My strategy

Share price of Sembcorp Industries had a free fall from $5.30 in FY2013 to the current $3.39. Currently, this counter is trading below its Net Asset Value (NAV) of $3.86. Is Sembcorp a bargain stock or a value trap? In my point of view, the share price is expected to continue to decline further in 2018 because the woes in the offshore industry. In addition, the management did not convince me that they are able to rein in the expenses and finance costs. I think I would enter this counter only at $2.00.

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