Fusion Investor Chatbox

This chatbox is for fundamental, technical and related discussions on investing in Bursa Malaysia. Registration is required to join. Please email me at fusion.investor@gmail.com with your preferred name and password and I will inform you when registration is confirmed.

Disclaimer: As usual, you are solely responsible for your trading & investing decisions.

Monday, April 30, 2007

HEXZA, Ethanol, Nipah Palm

Reader "kent" sent an interesting comment yesterday that:

"A few weeks ago star newspaper published an article that a Malaysian Company with the Perak State Government has patented a procedure to make ethanol from Nipah Palm. They apparently have commenced construction of the production plants and are aiming for a target production of 8 to 9 billion litres of ethanol in 2009.Surely this is bearish for Hexza?"

Actually, I'm not so sure if it should rationally be bearish, although interestingly, the share price did drop from $0.695 on Apr 10, to $0.655 on Apr 19, before recovering. I found an article from Star Online dated 10 April, which might shed more light. As usual, I will highlight a few key words/phrases with my comments below.


Tuesday April 10, 2007
Malaysian company says bio-fuel from nipah can help halt global warming
KUALA LUMPUR: A Malaysian government-backed company claimed Tuesday it has found a new source of energy to replace fossil fuels - ethanol from nipah palm trees that it believes can help stop global warming.
Pioneer Bio Industries Corp. said it is building the world's first refinery to commercially produce ethanol from the short palm trees, found in equatorial countries, that could fuel everything from automobiles to power plants.
Pioneer says the nipah palm sap will be used in a patented process to make ethanol, which produces virtually none of the carbon emissions blamed for the climate-changing greenhouse effect and ozone depletion.
"This is a new energy source to save the world, to tackle global warming,'' Pioneer Chairman Badrul Shah Mohamad Noor told reporters.
The company envisions a fuel of the future that would be 85 percent nipah ethanol and 15 percent gasoline, he said, thereby greatly reducing dependence on fossil fuels.
With a production capacity of 100 million imperial gallons (450 million liters), the refinery in the northern state of Perak will go on stream by the end of 2008, Badrul Shah said. Pioneer plans to build 15 such refineries across Malaysia.
Badrul Shah said nipah ethanol is an better alternative to ethanol produced from palm trees, sugarcane, corn, cassava and other plants because ethanol from those sources eats into food production and raises their prices.
Nipah palm trees are not a food source and its sap can be drained every day without the need to harvest the plants.
"The plant will live for 50 years. We just have to collect its sap,'' he said.
He said Pioneer has received an order worth more than US$66 billion (euro50 billion) from one of the biggest trading companies in the world to buy its ethanol from 2009 to 2013.
Badrul Shah refused to identify the company, saying details would be announced at a later date.
The size of the order could not be independently confirmed.
The Malaysian government has given Pioneer the right to harvest nipah palm trees on 10,000 hectares (24,710 acres) of land in Perak.
That is enough to run 15 refineries for five years, and there are millions of hectares of nipah palm trees growing in the wild in the wetlands along the coast and on Borneo island that can produce enough fuel to "replace the entire fossil fuel needs of the world,'' Badrul Shah said.
Pioneer has taken an international patent on the process of producing ethanol from nipah palm tree, which was perfected over five years by 16 Malaysian scientists commissioned by Badrul Shah, a businessman with interests in construction and services.
Currently, ethanol accounts for only 2 percent of the total global fuel consumption.
Also, the demand for food-based ethanol has been blamed for deforestation as trees are being cut down for plantations. - AP

Quick Comments:
1. My impression from the above is that Pioneer's new product seems quite different than HEXZA's, even though both are "ethanol".
2. HEXZA's ethanol seems to be for non-biofuel uses (e.g. Kaoling wine, or food), whereas Pioneer's ethanol seem to be totally "biofuel based".
3. Apparently, Pioneer has already found a buyer for the years 2009-2013 in Europe. The demand for HEXZA's ethanol seems to be brought on more from China. So, the 2 target markets seems different to me.
4. From investor's perspective, it is more important to assess the impact on HEXZA's future earnings. To me, it is not clear if Pioneer will impact HEXZA's earnings over the next 6 years (2007 to 2013). I am inclined to dismiss it as "nil/negligible".
5. Also, HEXZA (at $0.715 closing last week) only trades at a P/E of 3.9. The margin of safety is still quite large (even in the present competitive market).
6. At this point in time, I think it is premature to be concerned about Pioneer. My advice would be to continue to monitor HEXZA's quarterly results.

Sunday, April 29, 2007

EUROSP - Business Proposition

Imagine you are a business analyst, and your neighbour came over to your house on a Sunday afternoon to seek your advice on a private business matter. Your neighbour is the sole owner of a private business, and is thinking of selling his business in its entirity. The business manufactures and sells a tangible product that is commonly found in most homes, including your own home. He would like to know how much he should sell his business in its entirity.

Since private owners own 100% of the business profits, you naturally enquired about that. Last year the business made $5.8M in after tax profits. This year, for the first 9 months (FYE 31 May), the business made $5M, and if Q4/07 follows Q4/06, then, the business can be reasonably expected to make $7.2M this year, or 24% profit growth. Ok, that’s not a bad growth result.

You further enquired about its balance sheet. Inventory low, receivables low. The company has from time to time made the necessary capital expenditure to maintain and upgrade its plant and equipments, but nothing fancy and kept capex tight. It also continuously kept tight control on costs. The company has no problems paying its suppliers. The company has no debts (neither short term overdrafts, nor long term loans). The business generates strong cash-flows, which nearly all goes to the cash till.

You learnt its management is fairly conservative and prudent. Whilst they have been consistently expanding their business, they have done so at a measured pace. According to your neighbour, the key management staff has been with the company for a very long time, and they are not expected to change.

You were informed that company revenue last year was $64M, and this year, is projected to grow to $74M, or approximately 16% growth.

What about future profit growth prospects? Well, according to your neighbour, the company thinks that whilst the costs of their raw materials are rising, they are continuously looking at ways to reduce usage of the more expensive material, and using cheaper alternatives that do not compromise quality and still meet their customer needs. They intend to spend more money on marketing, research and development to mitigate the effects of the rise in raw material costs. So far, their results have been encouraging, but no guarantees. Last quarter, profit after tax increased to $2.1M, up from $1.02M the same quarter prior year. This represents nearly 100% increase in after-tax profits.

So, the neighbour then asked you how much he should be asking if he wants to sell his private business.

Well, it might surprise you that this imagined “private” company is actually listed in the 2nd Board with the above characteristics. The Company is EUROSP, which is in the timber-furniture based business largely for exports. At last Friday’s closing price, the market is only valuing the company at a measly 2.3 times 2007 earnings. That’s right. EUROSP’s market cap is $39M, the company reported a net cash balance of $22.2M (28 Feb), i.e. EUROSP’s business is available for sale for only $16.8M. In a private market, that would clearly be a steal.

What is even more interesting is the fact that if one does a liquidation valuation for EUROSP, one could come to the conclusion that EUROSP is worth more dead than alive! Don’t believe me? Well, if one assumes only a conservative fraction of EUROSP’s assets in the balance sheet – say 50%, 50%, 80%, 100% of Plant Property Equipment, Inventory, Receivables and Cash – and subtract all stated liabilities in the Balance Sheet at 100% of the values stated, it would give a liquidation price of $0.99! Yes, that’s right. At $0.975, the market is valuing EUROSP lower than its liquidation value! Amazing isn’t it?

So, why does the stock market values EUROSP at such a low multiple? To me, I believe it’s due to several reasons:

1. Inefficient market in Bursa Malaysia, especially for micro-cap stocks and especially 2nd Board counters. Perhaps, there is a fear that micro-cap stocks earnings are rather volatile, although from a private business perspective, EUROSP is clearly much larger than most if not all “Mum and Dad” type private business. Even better, it is listed, its results audited by professional auditing firms such as KPMG and passed Bursa’s listing requirements (which private companies don’t need to comply), so, it should be safer than private investments.

2. No stock coverage by Bursa eResearch, nor any other stock brokerages that I am aware of. Investssmart covered EUROSP last year, and I recalled at least another blog also covered EUROSP. So, this makes it the 3rd blog, and I doubt I will be the last blog to cover it in future.

3. Absence of EPF, foreign investors, and mutual fund ownership, leaving the traded stock portfolio done by less informed retail investors. The Directors (the 3 Guan Brothers) collectively owns 55% of the outstanding shares. They didn’t sell, and interestingly acquired some more shares in 2006. So, management clearly eats their own cake. Institutions with long-term holdings like Ministry of Finance (#5, 3.3%), Lembaga Tabung Angkatan Tentera (#7, 2.4%), Lembaga Tabung Haji (#8, 1.9%), Koperasi Tanah Negeri Johor Berhad (#23, 0.4%) collectively holds 8%. This leaves around 37% of the outstanding shares owned by approximately 2,500 retail (less informed?) investors. It is my personal belief that as more retail investors become better informed, they should have greater appreciation for this stock.

4. It’s a generally thinly traded stock, with low liquidity on most days throughout the year, except the month before and after the ex-dividend date, during the bull run at the start of this year and the recent 228 correction.

5. Up till 2005, the stock paid a paltry dividend or no dividend (in the 2 loss years), causing it to acquire perhaps a boring reputation. However, this looks to be changing in recent years. The company has been steadily increasing dividends in the last 3 years, from 2.1% to 3.1% to 5.9% net of tax dividend yield (based on latest price of $0.975). I am speculating/ expecting the company to continue to pay a higher dividend in 2007, due to its higher earnings results this year compared to last year and its growing cash hoard. Potentially, there might be a lot of room to improve, since the last dividend payment only took 32% of earnings. If the company adopts a 50% dividend payout ratio, 2007 dividends could increase by 50%, potentially causing a fairly large jump in prices. However, it might be safer (albeit potentially lower returns) to look at the Director’s stock movements, to see if they acquire more shares in 2007. If they do, it may be a positive sign that the directors will increase dividends further in 2007, although this is not a guarantee.


It is clear that EUROSP is clearly an under-valued stock. There seems to be some appreciation for the stock, since the stock price jumped more than 7% to close at $0.975, as a result of an excellent earnings announcement. Despite closing at $0.975, it is still trading below its liquidation valuation of $0.99.

Putting on my value investing hat, it is very hard for me to contain my enthusiasm, when I see a stock like EUROSP. Initially, there were some doubts that the appreciating RM and the higher timber prices may cut into EUROSP’s margins. However, the latest earnings results showed that instead of cutting its margins, EUROSP superb management has managed to improved profits by 100%. In a sense, this is not surprising, because EUROSP controls its costs well. Compared to its high debt competitors, its margins are not burdened by high finance costs, giving it a competitive advantage. Further, it’s operations in northern Malaysia probably carries lower wages. It’s high cash position gives it considerable business flexibility. In this sense, I believe EUROSP has some economic moat over most of its Malaysian competitors. As EUROSP’s underlying business and earnings continues to improve, I get more and more excited about the future prospects of this stock, notwithstanding its price action. I will also not be surprised if like ROHAS, one day, the substantial shareholders decide to take the company private, due to its consistently poor valuation by the stock market, and the large cash hoard in the company.

Whilst there is clearly a much higher upside, I believe its downside is rather limited for a long-term investor who is quite content to collect a net of tax dividend yield of 6% per annum.

Mark Tier, in the book “Winning Investment Habits of Warren Buffett & George Soros” describes 3 different successful investor types on page 126. The Analyst (personified by Buffett), the Trader (epitomized by Soros) and the Actuary (who invests similar to insurance companies, such as Graham buying a basket of under-valued stocks. He often doesn’t know which stock will go up (like insurance companies not know who is going to die), but he is quite certain that provided he buys a pool of undervalued stocks – e.g. below liquidation value –then, the stock as a group is almost certain to go up, just like the way insurance companies makes a profit by underwriting a pool of lives at correct prices.). I believe EUROSP is very suitable for either the Analyst, or the Actuary. Either way, I would not recommend anyone to hold more than 5% of their stock holding in EUROSP, not because the downside risk is limited, but because it might take some time for the stock price to appreciate.

As usual, comments welcomed. Use your own judgement, and invests at your own risk.

Comment Moderation

Dear all,

If you have been following investssmart chatbox over the last few months, you may know that I was originally quite reluctant to blog. A key reason is because I didn't want to be distracted from doing what I love doing which is researching under-valued stocks and making profitable investments. Writing a post takes time ... reading, thinking and responding to comments by people with clearly other motives is simply a waste of everyone's time, besides reducing my own clarity of thought and distracting me from making the right and timely investment decisions. As a retiree, I simply have no wish to deal with nor argue with clearly stubborn people with other motives.

As a result, I have reluctantly decided to apply comment moderation. This means that before you'll see any comments posted here, it needs to be approved by me first. My criteria for posting a comment is simple. If I feel the comments are genuine, relevant and made in the interest of wanting to know more about the topic, then, it'll be posted. It might take some time, because I don't always check this blog nor my email but I will try to do so regularly. If I am slow to post a comment, my sincere apologies, but sadly, it is a fact of life that all it takes is just one rotten apple to spoil the entire basketful. Personally, I believe in quickly discarding that bad apple as soon as possible.

I hope comment moderation will not stop the genuine readers from commenting a valid view, even if their views are opposed to mine. My personal observations, inspired by Soros is that I too am also fallible, and I sincerely believe that one learns more when one listens and carefully consider opposing views .

It is possible I could be mistaken in my judgement. Hopefully, there will be few and far between. I normally give the initial comment the benefit of the doubt. However, where I see a 2nd recurrence, I will not hesitate to act.

As you can see, I clearly dislike moderating comments - it's simply extra work for me. But in view of recent experiences, I believe this is necessary, to save me time in the long run, and allow me to post many other numerous topics that I feel will be beneficial to like-minded individuals.

Hopefully this will improve our blogging experience going forward.

Thank you for your kind understanding.


Friday, April 27, 2007

LITRAK - A belated buy call

I believe it's better to be late than never. So, here is my Buy Call which I had repeatedly called in investssmart chatbox quite some time ago, and only found the time to do a write-up. As usual, apply your own judgement, and invest at your own risks...


In Berkshire’s annual Chairman’s Letter, Buffett sets out his 6 acquisition criteria. Whilst LITRAK does not meet the requirement in terms of size (LITRAK is too small for Berkshire despite being a solid mid to large cap in Bursa) and debt, I believe Buffett might have considered LITRAK in his much younger days (when he has a much smaller capital to work with) for the following reasons.

1. Consistent earnings power. (with an economic moat)

2. Business earns good returns on equity. Whilst LITRAK might not have met this requirement in the past, I expect the rise in the toll rates since 1 Jan 2007 to allow LITRAK to meet this requirement.

3. Management in place.

4. Simple business (LITRAK’s primary business is operating and maintaining the LDP toll-way, which is a simple and understandable business. It is definitely not high tech - you know what the business is going to look like in 5 years time - and even if the stock market closes for the next 2-5 years, I would not be the slightest worried about LITRAK’s strong earnings).

5. An offer price (which appears daily from the stock market quotes)

In addition, I seemed to recall that Buffett (or Graham) would make an exception to the debt requirement, if it is a utility company (with highly predictable and secured earnings). To me, LITRAK would certainly fall within this category, even though strictly, it is not a utility (power) company because it seem to share many of the same economic and financial characteristics with utilities.

If a stock met all of Buffett’s requirements, his typical approach would often be just to sit tight and do nothing, until the market provides Buffett with a "fat pitch" to buy. If Buffett was a Malaysian, I am 100% sure that he would have swung his bat, when the market provided an excellent opportunity to buy LITRAK at $2.60 during the end Feb correction. At that price, it is only half of LITRAK’s Intrinsic Value. Even at yesterday’s closing price of $3.52, I am still excited by LITRAK, as I believe the market has not yet priced in much of LITRAK’s strong future earnings, and is cautious.

Now, why did I say LITRAK’s Intrinsic Value is above $5+? 3 reasons.

1. LITRAK has raised toll rates by 60% on 1 Jan 2007. The rise in the toll rates are expected to contribute to the bottom line, as LITRAK’s long-term costs have not really changed (with perhaps more maintenance as the roads get older). Given that LITRAK has consistently run at around 45% gross profit margin, this is a huge boost to LITRAK’s long-term earnings starting from1 Jan 2007. (Imagine if you sell an item at $1 previously with $0.45 profit. Now, the item is $1.60 - you can reasonably expect profit to be close to $1, which is more than twice your old profit of $0.45, if revenue don't contracts). Note that this is a once in a decade boost, and the best gain in LITRAK’s prices is expected to be around now (actually, since Mar 5, up to the next earnings report in May 2007), as LITRAK will not increase rates again until 2011 and 2017, which is around 4 to 10 years from now.

2. In addition to the toll hike, LITRAK will also be compensated by the government for charging lower than contractual rates (which is $2.10 instead of $1.60). This is $150M over a 4 year period, or approximately $37.5M per year. In the last 12 months, LITRAK’s gross profit is $113M, so, an additional $37.5M is a huge boost.

3. In addition to above, LITRAK is contractually given the right to further increase rates 10 years from now. I seemed to recall in the original prospectus projections (from another blog) that the rate increase in 2017 is a huge one, that will increase LITRAK’s profitability many times from now. Notwitstanding this, we will ignore this factor for the moment, as my Intrinsic Value of $5+ is not dependent on this.

4. LITRAK also reported that one of its wholly owned subsidiary has recorded a realized gain after 31/12/2006 of $11.4M. I expect this to boost the coming quarterly results, although this is an extraordinary gain.

Because there is such a huge and fat safety margin, I have not bothered to do a detailed projection to LITRAK’s financials. But to be extra conservative, let’s assume that LITRAK’s long-term PAT is doubled last year (this is very conservative). That is, instead of $0.16, let’s say LITRAK’s long term earnings is $0.32. How much should we value LITRAK, given its earnings characteristics?

To me, LITRAK’s earnings is mostly dependent upon traffic volume and growth, which in turn is probably a very stable thing that can be predicted with quite a high degree of precision over the long-term. Yes, initially, after the toll-hike, traffic volume can be expected to decline. Unfortunately, I live in Penang, and don't use the LDP after 1 Jan 07, so, I don't have first hand information about the traffic there. However, I have used the LDP many times before, and in my limited experience, the alternative routes are just terrible. Initially, I probably would try using alternative routes just to save $0.60, but after some time, I would probably accept the toll rate increase and re-use LDP. In other words, I believe LITRAK's revenue problems (if any) will be a temporary one, and not a permanent one.

The risk of management doing something stupid, whilst not zero, is probably quite small. LITRAK’s economic characteristics is so good, that even an average management probably can’t do much harm (unless they go on a spending spree that doesn’t add value, but that would be a stupid management, not an average management). So far, I have not seen any signs of mis-management, but a few signs of prudent management.

If I have to apply a discount rate to valuing LITRAK’s future earnings, I would probably apply an interest rate that is not higher than twice 10 year government bond rates. 10 year bond rates currently runs at 3.5%. Double is 7%. If LITRAK’s future earnings were equivalent to government bond, then, the P/E multiple is 1/7% = 14. This is a conservative multiple in LITRAK’s case, due to point 3. above.

This suggests that LITRAK’s Intrinsic Value is at least $0.32 x 14 = $4.5 or higher. Again, this is a conservative valuation.

A more realistic valuation would probably apply a slightly lower rate of discount, such as 6%, which suggests a P/E of 17. This is close to LITRAK’s historical P/E and would suggest an Intrinsic Value of $5.4.

Of course, this assumes that LITRAK’s long-term PAT is $0.32 which is conservative, since the actual toll hike plus government compensation (i.e. revenue) is more than doubled. Now, think about this for a moment. Even TENAGA, when it raised its rates, only raises it around 12%-16%, not doubled! It will not surprise me if LITRAK’s long-term PAT turns out to be closer to $0.35 or even $0.40. If so, it would suggest an Intrinsic Value much higher than $5.4. In fact, I will not be surprised if LITRAK were to trade above $6 within the next 2 years.

Another view is that at yesterday’s closing price of $3.48, LITRAK seems to be valued at a P/E of 10. For a business with LITRAK’s economic characteristics, this is a steal.

I would not hesitate to recommend LITRAK at current prices to anyone who fits the following criteria:
1. Don’t have time nor inclination to monitor the stock market.
2. Has a lot of cash sitting on F.D. and is certain that he will not use that money in a year’s time.
3. Does not want to buy a stock right now due to fear that the market is close to all time high.
4. Can buy and forget about the stock until say a year later.
5. Who wants to earn superior return than F.D. rates of 3.7% per annum.
To me, it is practically certain that LITRAK will out-perform F.D. within 12 months time.

If you are afraid that LITRAK is currently trading at record levels, then, just buy 20%-33% of the amount you intend to buy, and leave the rest as "spare bullets". I have a feeling that LITRAK might not trade below $3.30 again, the first time that I realized that LITRAK was really a steal.

As usual, use your own judgement, and invest at your own risk.

Disclaimer: I own LITRAK since last year, and has more than doubled my holdings. LITRAK is by far my biggest holding, and is more than twice my next largest stock (MAYBULK & EUROSP). I strongly believe that LITRAK downside risks is disproportionately lower than its upside gains. There is no need to take higher risks for higher returns, despite conventional wisdom.

Thursday, April 26, 2007

A Millionaire's Plan

Since today is a public holiday, I had some time to browse other blogs, and came across this topic at Investlah.com titled "Can an average Joe become a millionaire by just investing?". It is interesting that the page was read nearly 300 times, with 2 pages of comments from a wide variety of people. Since this is a serious question, I thought I would share my 2 sen worth on this topic.

I personally believe that it's not difficult for an Average Joe to become a millionaire, provided:
1. He starts early.
2. He has a clear plan with a high degree of certainty.
3. He executes his plan consistently with discipline without fail.

By "Average Joe", I mean just that - just an average bloke, earning an average salary from being an average employee. Start early means starting from the first day of earning a salary, or as soon as possible. The plan is what I will call a "Millionaire's Plan" for easy reference.

You might rightly ask what makes me so confident or qualified to give such advice? As a early retiree, I've "been there and done it". If I didn't, I wouldn't be able to retire. In any case, what's important is not whether I've done it or not, but whether what's written below makes sense to you, and more importantly, whether you are actually able to execute the plan.

So, what exactly does the "Millionaire's Plan" look like? Is it complicated? Actually, no. It's fairly simple. It's simply based on the concept of "unfailingly pay yourself first before anyone else", and "invest that savings". That means to live within your means. A simple plan, but if followed faithfully, will give you that certainty of becoming a millionaire. Don't believe me? Well, take a look at the table below:

In the table, I define "average Joe" to be an average employee. For illustration purposes, he might be age 22 and earn $2,500 per month for uni graduates. As this is a projection, I assume a modest salary inflation of 3% per annum for simplicity, although in real life, I expect most readers to experience higher salary inflation from future promotions, extra savings from bonuses, etc, at least for the initial years. So, I believe this is conservative for most readers.

So, how can Joe become a millionaire? Let's consider for simplicity that Joe saves just 20% of monthly salary unfailingly. I believe 20% is modest. If Joe saves a higher %, he gets there faster. But for simplicity, let's assume 20%. Is this hard to do?

To me, it depends on the individual's mindset and the determination. It's hard, if you are not disciplined or don't believe that it's important, or don't believe that it makes a difference. It's easy, if you truly believe in the Millionaire's plan and make savings an automatic, unconscious habit.

Ok. Let's say Joe agrees to pay himself first, every 20% of his paycheck - without fail. That's $500 per month, or $6,000 per year. Note - without fail. Skip a month or two, and the plan fails and it will take longer.

Now, all Joe has to do is
1. Deduct 20% of his pay check before he spend a dime.
2. Sock away that 20% into a separate F.D. account immediately.
That's it!

Just keep doing this every month, and by the time Joe gets to age 65 (or 43 years later), he should have accumulated over $1 million in F.D.

Note that the actual $ saved is only $513k, and the remainder is compound interest, paid by the bank. Isn't that nice, with the bank making up the other half of your Millionaire's Plan?

So, what do you think about that? Too easy to be true? Just put away 20% of your paycheck, and by age 65, you become a millionaire? Well, the maths said so, so, why wouldn't it work? There are a few reasons why.

1. Joe failed to save at least 20% of his pay check - 90%-99% of the time, I believe this is the most common cause.
2. His salary didn't grow by 3% p.a.
3. The bank decided to lower F.D. rate to below 3.7% in future.
4. His starting salary is lower than $2.5k.
5. He dipped into his F.D. sometime during his savings period (another common reason).
6. He might have lost his job in between, or got married with kids with special needs, etc. in other words, 1. failed.

But if you asked me, there's no reason why 1. should fail if one starts early, and sock that money away and forget about it. After a few months, the action should become an automatic, unconscious habit, and Joe should not even think about it anymore, as he adapts his lifestyle to fit the remaining 80%. If one does not have the discipline to do this simplest act, then, the odds are that person will probably never become and remain a millionaire.

I suspect, even if he suddenly wins a $1 million, without the discipline, he will probably lose it in less than a few years (there are actually many studies done on these sort of very lucky people).

In my case, I recalled I also found the initial steps hard but not impossible, and stopped noticing it a few short months later. However, I was not perfect, there were occasions (a few years in total, due to absence / forgotten the Millionaire’s Plan) where I got sidetracked (late 20s) before I got back on track. It was only later when I got interested in tracking my daily expenses (after having rediscovered and understood the Millionaire’s Plan), to see where my spending was going to. I would jot down every night what I spend during the day and this would go on for a few months. Later, I would discover patterns to my spending that were not necessary and found new sources of savings. My savings % continue to grow over time. That act (monitoring for a few months) became a turning point for me. I then tracked the figures in my savings passbook closer, to compare the increase in the account balance against salary credited. I would silently give myself a pat at the back when I managed to save an even higher cumulative % than the prior month. In my final year prior to retirement, I was able to save quite easily 85%-90% of my salary, and still live a very comfortable and normal life. I'm sure there are some people who can do even better than I could.

Yes, there were sacrifices, but it really didn't make much difference once I got used to it.

Other thoughts of living simply (and frugally)

Cars. Cars are depreciating items. What that means is if you paid $100,000 for a new car today, it’s worth almost nothing 10 years time. That’s a minimum spending of $10,000 per year, or $200 per week, even when you are not using your car. That assumes you pay cash. If you take a loan, factor in the huge loan interest. So, when my friends bought nice cars and regularly upgraded them, for my very first car, I chose to buy a 2nd hand car (2 years old) that did the job – my depreciation was a lot less, the car was still relatively new with low maintenance, lower insurance, and I drove carefully to save fuel. I almost never brought the car to the car wash, but simply regularly wipe it with clean cloth and water (no detergent).

Car loans. For my first car, I used all my savings to take out the smallest loan possible, and I saved very hard in order to fully pay the car off in the quickest possible time. For my next car, I paid cash. So far, I only owned 3 cars in my entire life. But all the cars are reliable – in fact, I have yet to experience a break-down in the middle of a road (touch wood).

House loans. Whilst my friends bought bigger houses with bigger loans, my first house was small, with the smallest possible loan and a relatively short time to repayment. 7 years later, I paid off my house loans completely. Later in my life, when I got married (late) and have a child, I bought a bigger house with cash.

Daily habits.
- I almost never drank expensive Starbucks coffee (even today, just by force of habit) but just the free coffee at work.
- I almost never ate at McDonalds, just at the work canteen that is subsidized by my employer (which is not bad actually).
- I would eat a balanced diet, and exercise regularly. I don't join a gym (too expensive, unnecessary), but simply played social badminton with colleagues, friends, relatives and we split the costs. Sometimes, free jogging or morning walk at the park (I don't drive there, I walk there).
- I still occasionally go to the movies and do all the regular things with family and friends. At the movies, my wife and I would never buy popcorn and coke (except perhaps initially during courtship, and you cannot imagine my happiness when on our 2nd movie, she told me that she thinks the coke there is expensive and is a waste of money J ).
- I'm not someone who measure myself by the price of the clothes or shoes that I wear, in fact, as a matter of personal preference, I like my old clothes and my old shoes very much, as they are clean, neat, tidy and very comfortable. I don't buy expensive leather shoes - I have 2 pairs of business shoes that I would regularly rotate, and with proper care, would last me years, and they each cost less than $100 bought on a bargain sale (last year’s fashion) - I even wore that when I was working in my final years in senior management ranks of a multinational company.

Electronic gadgets / technology.
- Depreciating item, latest fashion changes too fast to be of lasting value. Definitely don’t own the latest electronic gadgets. In fact, I still own my Nokia phone which is more than 6 years old now, and it still works perfectly. I would choose the cheapest plan, and nowadays, I find pre-paid even cheaper as I rarely use my mobile and more fixed line.

Clothes. I have a couple of nice, moderately priced full 3 piece business suits that I regularly used for work (I rotate them regularly) and they would last me for a decade, and they are still very presentable. My waist size has not changed much, and is still close to where I was in my early 30s. Some of my colleagues have no hesitation buying ties that costs $1,000+, but I can't ever recall spending more than $40-$50 on a tie in my entire life (and I still got promoted at a younger age than they did)

Career. In the initial years, I focused on my career and almost nothing on investing (besides F.D. rates). I got promoted faster than the average colleague, and that helped to increase my savings rate faster.

Spouse, friends and family. You could say I chose my wife carefully, as my wife turned out to be an even bigger saver than myself, and we share many of the key life values including savings habits. I am lucky to be born in a family that practices frugality. I am also lucky to have chosen friends who have not diverted me from my financial goals (in fact, many of them don’t realize, noticed or makes an issue about how frugal I am).

These are all not difficult things to do. Once you get used to it, you don't feel it. It's about treating limited resources as precious, not wasting unnecessary resources, consciously developing a good savings habit, and still live life very comfortably. Another Buffett quote: it's not the $1 today that matters, it's what the $1 could become in 20 to 30 years time after compound interest that matters.

Anyway, back to the Millionaire's Plan. If you decide to adopt Plan 1 (earning F.D. rate), then, you are almost guaranteed to become a millionaire if you can stick to the savings plan. If you have a higher salary, or can save a higher %, then, you'll get there sooner. E.g. if you can double the savings, then, you could become a millionaire by age 53.

But the good news is that for the "Average Joe", he doesn't need to stick to Plan 1 all throughout his life.

At some point in future, after his life has settled, and his career taken a stronger foothold, he will have more time in his hands, and could start taking a greater interest in the stock market. Everybody is different, but for me, I found the stock market much easier than the property market. The idea of buying a rental property, dealing with tenants, repairs, etc. seems like hard work, compared to researching under-valued stocks. But I know people who think and feel otherwise, and that's perfectly fine with me - my motto is "whatever works for you best". But the basic idea is to look for returns higher than F.D. rates with almost equal certainty over the long term.

For example, if you could earn double the F.D. rate, suddenly, the goal arrives much sooner. At 7.4%, you could become a millionaire by age 54, or 11 years earlier. Your savings is only $315k, with investment returns forming the majority. Isn’t that nice, with the stock market contributing 70% to your $1M goal?

My own story here is that for a long time (whilst I was working), I had the goal of trying to maximize my returns with lowest possible risk. I would hold nearly half of my portfolio in cash (F.D.) and the other half in stocks. I was lucky, in the sense that my first investment book was on value investing and Buffett, and it made a huge impression and connection to me. I was also lucky, in the sense that my life experience included exposure to a couple of small business experience (when I was working part-time during my student days helping my cousin to manage her coffee shop, including the accounts), and later in my career, to work with and becoming part of senior management in a multinational company, and knowing how the Chairman thinks about constantly growing the business. In my late 20s, I was already thinking like an owner (in terms of how I can add value to my employer's top or bottom line), even though I was an employee, and that got me promoted faster. During the 97 Asian financial crisis, whilst my stock portfolio dropped by nearly 50% of my purchase price, I was fortunate enough to do nothing, kept on saving, and only later (when value becomes extremely compelling), transferred most of my cash to buy a lot more stocks at hugely bargain prices, and doubled my entire cash+stock portfolio a couple of years later - that was a nice 6 figure gain in total, and it forever changed my view about the stock market.

In my opinion, it's not impossible to earn 7.4% p.a. long term even when all you have is just a morning in the weekend to invest. The first rule is never lose money, and here, prevention is better than cure. Don't buy something you don't understand, because if you lose 50%, you will need to find another investment that returns 100% just to break even, and the odds of the former happening is unfortunately much higher than the latter. Also remember to never under-estimate the power of a single bad decision that could put you in negative return territory for years, instead of earning 7.4% p.a. each and every year.

Preparation is important and a careful plan is needed. Bursa might have 1000 listed stocks, but all you need is just 10 excellent stocks that is almost certain be around in 10 years time and is almost certain to be much larger than they are today. A few stocks that come into mind is PBBANK, PBB, TANJONG, etc. Even ICAP fund may also be suitable. If you focus on the long-term, and buy when the price is temporarily depressed and constantly keep the Millionaire's Plan in mind, then, these stocks should return to you 10%+ p.a. over the long term.

With 50% cash returning 3.7%, and the other 50% stocks returning 10%, your average portfolio return should be nearly 7% p.a. But before you even think of putting a single dime in the market, I strongly recommend you read books on Warren Buffett and value investing.

Holding cash is important for "insurance reasons" (cf. my experience from the Asian Financial Crisis). Whilst the long term expected return from stocks might be higher, the day-to-day returns can be volatile. But if the stock that you choose is sound, solid, with good long-term growth prospects and if it’s also one where you would trust the management to grow shareholder value in the long-term, then, there is no need to panic when the stock price goes down. Often, it's an opportunity to buy more at cheaper prices. That's when the cash will come in useful.

In the Millionaire's Plan, I also tabulated what would happen if your investment earnings grew faster than 2 x F.D. rates, such as 3x and 4x. This is just for information, to highlight the importance of investing as the "average Joe" gets older with larger savings $. As you get more experience in investing, you may choose to learn the more advanced investment techniques that provides you with even higher expected return, and still retaining a lower probability of loss. Yes, this is against conventional wisdom that says that higher returns can only be obtained from higher risk, but my limited investing experience has shown me that I do not need to take higher risks to get higher returns. As a wise person once said – Opportunities are everywhere, we just have to learn to see them. The sooner you learn about investing, the longer you can apply it for the rest of your life. We might all have similar life expectancy, but the one who learns good sound investment habits first can expect to benefit more than possibly his wildest dreams.

As usual, use your own judgement and invests at your own risk.

Saturday, April 21, 2007

SKPRES - Quick Comments on News

This one is dedicated to the folks at investssmart chatbox who first alerted my attention to this stock (you know who you are), and to subsequent folks who are persistent in asking me more about this stock. I am not an employee nor related to SKPRES owners nor management, merely a small minority share owner who enjoys trading the stock. Enjoy!


On Mar 16, the Star carried an article on SKPRES. It gives a good introduction and I feel a decent analysis on the company. I recommend studying the article to supplement your research on SKPRES. My comments are numbered and marked in square brackets below.


Friday March 16, 2007
SKP Resources eyes double-digit growth
By Izwan Idris
PETALING JAYA: Penny stocks offer a cheaper entry cost for investors [1], hence their popularity among retailers. It is also interesting to look at some of these companies, which are actually worth more than a punt.
SKP Resources Bhd, a Johor-based maker of plastic parts used in many consumer electronic gadgets like high-end television sets, in-car entertainment units and satellite radio receivers.
Its clients include household names like Sharp, Pioneer and Dyson.
SKP Resources' most recent quarter ended Dec 31 saw a 70% jump in net profits to RM4.8mil, or 0.8 sen per share. The company made a net profit RM2.8mil, or 0.47 sen per share, in the previous corresponding period.
“The third quarter was a record for the group. We also had a good start in 2007 and we hope to at least match the results in the last quarter (ending March 31),'' executive director Ivan Gan Poh San told StarBiz recently.
He said the strong performance was largely attributed to the group's expanded operations.
SKP Resources acquired rival SPI Plastic Industries Sdn Bhd in a RM30mil deal [2]completed in August last year.
The company had also completed a new factory in Senai during the year, which gives its an additional 176,000 sq ft of floor space.
“The acquisition and the new factory had given a lot of room for future expansion,'' Gan said. “With that, we don't expect to make huge capital investment over the next three years [3].”
SKP Resources had also benefitted from the trend among large multinationals to move their low-end manufacturing base to Vietnam or China, while existing factories in Malaysia shifted towards premium products [4].
“Margins are improving with better cost control [5] and, at the same time, we are now able to offer value-added services like product design and customisation of certain products,'' Gan said.
Items produced by SKP Resources include components for liquid crystal display TVs and some 200,000 sets of digital or satellite radio receivers bound for the US market every month [6].
“Our target is to register a healthy double-digit growth over the next two to three years [7],'' Gan said.
Assuming that SKP Resources would be able to repeat the performance in the last quarter, the stock is valued at around seven times [8] its estimated earnings for the financial ending March 31. (FY07).
For the nine months ended Dec 31, 2006 net profit had risen 36% to RM10.8mil, or 1.8 sen per share, on sales worth RM119mil. The results year-to-date have already surpassed the group's performance for the whole of FY06.
The stock gained 1 sen to 16.5 sen yesterday. It has risen 28% for the year and hit a 52-week high of 25 sen on Feb 22.
But it would probably take a few more quarters of rising profits for SKP Resources, with a market capitalisation of RM100mil, to attract the attention of big investors and institutional funds [9].
In the mean time, the stock's growth outlook and decent valuations make it a bargain for those willing to take a bet on a promising small cap play.



[1] "Penny stocks offer a cheaper entry cost for investors".
Comments: Whilst this does not affect SKPRES Intrinsic Value, it is worth mentioning briefly that penny stocks do NOT really offer a "cheaper entry cost". However, what it does offer is "excitement". Significant profits (e.g. 10%) can be had with what might incorrectly be perceived as small increase in prices over a relatively short period (e.g. a "small" 2 sen increase from $0.17 to $0.19). However, one must always take into account trading expenses (both buy and sell) into any profit calculations. If you don't understand all this, my advise is to avoid penny stocks - the odds of you losing money is higher if you don't understand all this.

[2] "...acquired rival SPI Plastic Industries Sdn Bhd in a RM30mil deal..."
Personally, I like the acquisition for several reasons. 1. The price paid is equivalent to just 6 times earnings, which is slightly cheaper than current SKPRES P/E of 7. 2. It is a good use of surplus cash which doesn't earn anywhere near the potential earnings yield of 16%. 3. The acquisition also enables SKPRES to diversify its earnings base, as the acquired company is largely domestic, whereas SKPRES earnings appears to be largely overseas. 4. The acquisition also removes a competitor domestically. 5. The acquired company is confident enough to provide a profit guarantee of $5M per year for the next 2 years, which makes the investment safer.

[3] "...we don't expect to make huge capital investment over the next three years .. "
Again, I find this very comforting - especially from a cash flow perspective - as the recent cash acquisition has significantly reduced the coy's cash holdings, and one might be rightly concerned if a coy has plans to further expand via huge debts (think MEGAN, although different business model).

[4] "...existing factories in Malaysia shifted towards premium products ..."
Normally, I find this sort of comments neutral. There are some companies that succeeds in the shift (i.e. raise both revenue and margins), and many more that don't (resulting in overall reduced PAT as revenue fall does not match increased margins). Personally, I like to see some evidence of net profit increasing in $ terms (and so far, it has).

[5] "...better cost control... "
A quick glance at the most recent quarter results showed higher PBT% than in the past few quarters, but I haven't really investigate in detail the financial statements to see if these has indeed been achieved via better cost controls (such as reduction in staff cost, etc). However, there seems to be no serious reason to doubt company management's claims.

[6] "...receivers bound for the US market every month... "
With strengthening RM, and possibly weaker US economy, there could be risks that SKPRES earnings could be adversely affected going forward. But I like the recent domestic acquisition which should increase and diversify its earnings base, mitigating this risk somewhat.

[7] "...target is to register a healthy double-digit growth over the next two to three years..."
For the next 9-12 months, I am quite certain that the coy will achieve double-digit growth, just from the recent acquisition alone. The challenge will be after that, if it has no more acquisition, as future growth will then depend on organic growth. The recent factory expansion which is expected to meet its growing needs over the next 2-3 years should give the company good odds of achieving their target. Given the relatively good odds, for the company to trade at a low single-digit P/E of 7 seems to suggest a significant mispricing.

[8] "...stock is valued at around seven times..."
At $0.185, SKPRES is now trading at slightly over 7 times. But FYE2007 only takes into account 2 quarters of recent acquisition results, and virtually nothing on its future growth prospects. Using a conservative FYE2008 which simply takes into account the full 4 quarters of recent acquisition results suggests a P/E of less than 7.

[9] "...attract the attention of big investors and institutional funds ..."
There's no doubt that should there be one large fund buying SKPRES, the only way the price can go is UP. I think, with current attention focussing on the big caps, it might take a (long?) while before the market shifts its attention to undervalued small caps. To be honest, I don't know exactly when - safer to assume it could be a very, very long wait, and not bet the house.

It's also quite possible that syndicates might not touch this stock, if this stock is a candidate for institutional investors - they might get cornered themselves, as they try to corner innocent retailers.

Like all stock investments, owning SKPRES has its own risks too. Some of the risks I perceive include:

1. Intrinsic value related risks ... e.g. possible increase in raw material prices for plastics. RM appreciation, reducing either the price competitiveness of its products in the US markets or its margins. Possible loss of key customers if not competitive. Etc. These are real risks, and much depends on management to control the controllable items and mitigate the risks as much as possible. So far, I like what I see - good use of cash, general avoidance of debt, sound acquisition at an attractive price, sound pace of business expansion, etc. And I like what the coy has achieved so far in the last 8 quarters. Whilst there are no guarantees in the stock market, I like the odds personally. (Remember to diversify, and don't over-trade).

2. Penny-stock reputation. Whilst penny stocks are popular with retailers, I won't be surprised if the vast majority of SKPRES owners in Bursa Malaysia don't really care a hoot about the underlying business behind the blinking ticker. I suspect "Buy and hold" investors might need to wait for a very long time, before the market appreciates its intrinsic value. I think shorter-term traders would fare much better with this stock, buying at the low end of the trading "box" and selling at the higher end of the trading box. Those who believes in its fundamentals may also do better by trading say half of their holdings in this manner. However, if you are a value investor who cannot identify the trading box (and they will vary over time), nor have the time nor inclination to watch the ticker symbol all day, then, my advise is don't buy this stock - there are much better value stocks around that will permit one to Buy and Hold, and sleep well at night. There are also risks with the syndicates "cooking" the price of the stock in order to profit from retailers, but I suspect that's what excites most experienced short term traders as the profit opportunities are bigger.

3. Possible lower interest and lower liquidity in future, as future profit opportunities get squeezed from having more better-informed investors, leaving retailers and syndicates to prefer other less sound, more exciting stocks with greater profit opportunities ...

I've read somewhere that it is unfair for any writer to give a stock a Buy recommendation, simply because when it comes to selling time, the writer is often unable to call a Sell recommendation in a timely enough manner to protect the owners who followed him. And since this is more of a trading idea than a "buy and hold" idea, I don't feel comfortable calling a Buy below a certain price, simply because I expect the trading boxes will change over time. So, this one, you're on your own.

I own SKPRES and have traded the stock several times in the past.
As always, buy and sell at your own risk.
Comments welcomed.

Tuesday, April 17, 2007

TENAGA - News on Dividend Policy

Biznewsdb.com has a post on TENAGA this morning ... over the course of today and tomorrow, I expect more updated news to be posted there ... it should be interesting to watch how TENAGA share price behaves over what is supposed to be "good news" over the next couple of days. If TENAGA share price does not rise further, it's probably a sign that "distribution" has occured, and in the absence of more good news, the more likely immediate trend then would be for the price to head south ... Of course, in real life, things are never equal and rarely that simple - e.g. it is always possible that there could be a sudden large inflow of foreign funds and volume say next week that could push prices up (in the midst of a downtrend), etc. so, all my comments here should be taken within the context of probabilities, rather than certainties.


Tenaga's Profit Soared To Record in 2nd Quarter Updated :
17-04-2007 Media :
Dow Jones Story By : ELFFIE CHEW
via www.biznewsdb.com

KUALA LUMPUR, Malaysia -- Tenaga Nasional Bhd., Malaysia's biggest company by market value, reported a record quarterly net profit for the fiscal second quarter due to stronger foreign-exchange gains, tax writebacks and rising power demand.

The state-owned utility's net profit for the quarter ended Feb. 28 rose to 1.55 billion ringgit ($450.4 million) from 399.5 million ringgit a year earlier, which was above the one billion ringgit to 1.3 billion ringgit forecast range of four analysts surveyed by Dow Jones Newswires.

Revenue increased 18% to 5.68 billion ringgit from 4.83 billion ringgit a year earlier, reflecting higher sales as well as the higher price of electricity from June 1.

Foreign-exchange gains amounted to 437.6 million ringgit, compared with 126.1 million ringgit a year earlier, the company said.

Tenaga also said it aims to return 40% to 60% of its annual free cash flow as dividends, its first-ever dividend-policy guidance. It also declared an interim dividend of 0.10 ringgit a share.

Second-quarter results improved despite higher costs resulting from the commencement of the Tanjong Bin Phase 1 power plant, the company said. Chief Executive Che Khalib Mohamad Noh said that for the first half, the company paid 220 million ringgit for power supplied by Tanjong Bin and will pay 630 million ringgit to buy 85% of the capacity from the first two phases of the plant for the fiscal year ending Aug. 31.

The three-phase, 2,100-megawatt, coal-fired power plant is being developed by independent power producer Malakoff Bhd. The third phase of the project will begin operations in September.

Tenaga said it expects the performance for the rest of the year to "continue to be encouraging" but didn't elaborate.

Mr. Che Khalib said the company should be able to improve on its operating profit in the second-half. Operating profit for the first half was three billion ringgit, compared with 1.73 billion ringgit a year earlier.

He said the higher operating profit will be driven by continued strong demand for power from the industrial sector. "The industrial sector accounted for 50% of Tenaga's total demand [in the first half]."

Mr. Che Khalib said overall power demand for the first half rose 6%, compared with 3% growth a year earlier, and he expects "electricity demand to be sustained in the second half."

Most of the content above are largely as reported. For Phase 2 of Tanjung Bin, management naturally opted for the lowest capacity payment (85%, instead of say 100%) due to current excess capacity, and so, the payment of $630M is smaller than what I used to estimate intrinsic value earlier.

To me, the most interesting news from above is the dividend policy. We should be able to estimate roughly how much the dividend might be. To me, the first issue is the definition of "annual free cash flow" since it is not defined in the article. My educated guess would be the "Changes in cash and cash equivalents" in the Consolidated Cash Flow Statement, but to be honest, I can never be 100% sure. I would like to think that what's distributed to shareholders should be after investing (e.g. after capex) and after financing (e.g. after repayment of bank borrowings). This would seem to be a more prudent and responsible way to run a company. Of course one could argue that if operational cash is guaranteed to be strong, then, why can't TENAGA just take new loans to pay dividends, but that is not what I would personally deem to be a prudent way to run a business. Still, it is important to watch how TENAGA management defines it, as it would give important clues as to the thinking of their management.

So, assuming it is the "annual net free cash flow" (i.e. net of investing and financing activities), this gives a H1/07 figure of approximately $2B. Annualize this gives $4B, and taking the mid-point of 40%-60% suggests a possible dividend distribution of $2B. A 10 sen gross interim dividend will cost TENAGA approximately $315M net of tax, so, $2B suggests that the final dividend might be quite generous, perhaps 5 times larger, say 50 sen gross. It will certainly be much larger than the final dividend paid in previous years which is only 14 sen in 2006 and 12 sen in 2005. Of course, my 50 sen final dividend is only a personal guess, and the actual value will depend on a number of variables, such as whether the company adopts a 50% figure, the actual definition, and the actual result and period for the annual free cash flow to be used in the calculation.

If the total dividend figure is 60 sen gross, this would translate to a gross dividend yield of say 5% p.a. (assuming $12 TENAGA share price). It would be interesting to watch how the market reacts to this news. For TENAGA warrant holders, it will be important to look out for the ex-Dividend date since warrant holders do not receive the dividends, but could potentially suffer from a fall in TENAGA prices on ex-Div date, if the prices don't recover immediately.

TENAGA - Quick Comments on Q2/07 Result

TENAGA posted its quarterly earnings results last night. PAT (Profit After Tax) for Q2/07 (Financial Year ending 31 Mar) was a mind-boggling $1.6B, compared to just $0.4B same period last year. On the surface, $1.6B is a huge number. For example, PBBANK reported a comparble $1.7B PAT but for the entire 2006 Financial Year, not 1 quarter. So, I suspect the market will react quite positively (perhaps irrationally) to cheer the latest TENAGA set of results, at least initially.

However, before we all rush out and buy TENAGA and its warrants, it is important to examine if these set of results are sustainable or not, whether the good results have been priced in fully (or not), and if not, what should be a reasonable long-term earnings and Intrinsic Value for TENAGA, based on what we know of TENAGA's business today. I am afraid this means that I need to pour some really cold water on TENAGA's latest hot, hot Q2/07 results first ...

1. Extraordinary currency gains. The $1.6B PAT includes approximately $430M of currency gains which requires some caution in interpreting. It is clear, this currency gain is not expected to be repeated perpetually in future. Yet, there is some expectation that going forward, at least for the next few quarters, that RM will continue to appreciate relative to USD, and TENAGA should be able to continue to benefit somewhat from this trend, due to its relatively high USD debt. For conservativeness, I think taking into account say 10% of the currency gain is probably a closer reflection to a reasonable PAT, than taking into account 100% of the currency gain.

2. Extraordinary tax write-back. In the last 2 quarters for FYE2007, TENAGA has written back approximately $170M worth of deferred tax to reflect the lower tax rates expected in FYE 2007 and 2008. Again, these are not expected to continue to benefit TENAGA perpetually in future, but has a very limited lifetime.

3. Tanjong Bin. The latest set of results, which ended 28 Feb 2007, has not yet reflected the recent commissioning of the second unit of the Tanjung Bin power plant on 28 Feb 2007. As stated in the news recently, we know that one of TENAGA's problems is its excess capacity payments to IPP. For FYE 2007, it is hard to put a precise figure on how much of Tanjung Bin's excess capacity could be actually utilized, but once the unit is commissioned, real costs can be expected to incur. TENAGA expects to incur costs of approximately $700M over the next 2 quarters. In terms of estimating future long-term earnings, it is not unreasonable to prudently assume a percentage, such as 50%-75% (say 67%) of that amount as being a true loss, as quite likely, it will take several years before TENAGA's present excess capacity can come close to being fully utilized in future. Note that 67% is just a rough and ready approximation, I expect the actual loss to be bigger in the immediate quarters (e.g. 100% on Day 1 of commissioning), and gradually reducing over time (e.g. 20%-40% after several years?).

4. Planned land bank sales, recovery of dilinquent accounts. At the start of the year, TENAGA announced that they planned to gain approximately $400M by FYE2007. For Q1/07, they gained $92M, close to $100M per quarter. I have not yet seen the figure for Q2/07. It is probably prudent to assume that there is some gains included in the latest set of results, leaving another $200M to be gained in the next 2 quarters. If it was nil in Q2/07, then, that should be a positive surprise. Again, it is unclear if these set of earnings are sustainable in the long term.

5. Potential additional revenue from 9MP, EGAT, etc. Higher electricity demand arising from the 9th Malaysia Plan projects as these continue to be rolled out. This is over-simplifying it, but steel companies are well known to consume huge amounts of energy in their manufacturing processes. It is hard to put a precise figure on the % increase in revenue that this would translate to TENAGA over the next year or two, but for the moment, it is probably enough to know that the potential additional revenue are more real than a dream.

So, what does this mean to TENAGA long-term sustainable EPS? Let's take a closer look at its historical results (in black). I have projected this to the end of 2007 FY, and the assumed inputs are in blue. In coming up with the projected values, I have tried to adhere to Buffett's principle that "it's better to be approximately right than precisely wrong" ... in other words, I know that my projections are precisely wrong, but the final EPS answer to be close enough to serve as a guide to TENAGA's intrinsic value.

A. Revenue.
It is comforting to see that TENAGA's revenue has been steadily increasing in the last 10 quarters, with a hike in Q4/06 (13%) due to the higher electricity tariff that came in at the start of the quarter. In the absence of fundamental changes (like tariff hike), a steady growth can be expected for TENAGA revenue due to natural GDP growth. So, for Q3/07, I would expect TENAGA revenue to continue to grow at a high rate (vs Q3/06). Then, for Q4/07, for the growth to slow down (as the impact of higher tariff rates are neutralized), but still slightly higher than past natural growth rates due to 9MP. So, I believe my projected revenue growth of 14% and 6% for Q3/07 and Q4/07 are not unreasonable.

Since the revenue for Q3/07 is close to Q2/07, I have made some adjustments to Q2/07 PBT to derive a suitable long-term, sustainable gross earnings, in order to value TENAGA's business more appropriately. Specifically, I have made adjustments to TENAGA's one-time forex gains and deferred tax write-back as noted in points 1 and 2 above, as well as Tanjung Bin's extra costs (as noted in point 3 above). More specifically, $860M = $1,651 - $430M (forex gains) - $170M (tax write-back) - $350M x 67% (Tanjung Bin loss) + $43 (10% forex gain). On the surface, this looks conservative since $860M is only a bit more than half of the recent fantastic result of $1.6B PBT ... but since our focus is on long-term sustainable earnings for TENAGA, I believe a figure like $0.9B-$1B is probably closer to the truth, than assuming the entire $1.6B PBT.
C. Tax rates.
We saw low tax rates for Q1/07 (7%) and Q2/07 (5%) due to the one-time deferred tax write-back. I am not an accountant by training, but I suspect, going forward, one can reasonably expect the write back to continue for the next 2 quarters. However, long-term, one should not expect future write-backs to continue perpetually. For Q2/07, I noted that tax was $242M, and write-back is $165M or approximately 2/3rds, i.e. if one strips out the write-back, the tax should be roughly 3 times bigger. So, I have assumed tax rates of 15% (= 3 x 5%). I use this instead of 27% (or 26%) tax rates as certain expenses incurred by TENAGA are probably tax deductible, and it is impossible for me as a lay person, to do a full estimation, and probably not worthwhile too. I suspect this assumption is quite debateable.
Based on the above methodology, I obtain an EPS of around $0.35 for H2/07 that factors in points 1, 2, 3, and some of point 5, and ignored point 4. Full year sustainable EPS is probably closer to $0.70, instead of $1.00 if one just adds up the full 2007 FY EPS.
Intrinsic Value Estimation.
To me, TENAGA is a consumer monopoly (no competitor) whose revenue, in normal circumstances, can be reasonably expected to grow at least, in line with GDP rates. Whilst it is a consumer monopoly, it is also a GLC, and it's ability to raise rates is somewhat limited, compared to a true consumer monopoly. Historically, its management calibre, rightly or wrongly, is also widely perceived to be below top corporates (e.g. the misjudgements made on the restrictive conditions set in the past limited-life IPP contracts). Nevertheless, I'm a believer that when average management runs an economically superior business, the economically superior business will eventually come out on top. Therefore, a P/E of 18 to 20 is not unreasonable for a business like this. Historically, I believe TENAGA has been rated at more than 20 times perhaps more often than not, and compared to its regional peers, perhaps even more, but I would feel somewhat uncomfortable personally to assume a P/E higher than 20, as the margin of safety then becomes smaller. Another way to view a suitable P/E is that with current 5 to 10 year government bonds running at 3.5% risk-free, it is probably safe (if one takes a long-term view) to assume that TENAGA's earnings should be valued at 5% interest rate from a security of earnings perspective. This also translates to an equivalent P/E of 20. So, a P/E of 20 looks about right.
This suggests an Intrinsic Value of $14, or maybe a bit higher.

Given the mind-boggling set of results announced last night, I expect the market to cheer TENAGA's share price initially. I would not be surprised if the cheering results in temporarily irrational prices. I will also not be surprised if the current bull run results in TENAGA euphorically shooting past $15 as it gather more pace. Still, the timing of the commissioning of Tanjung Bin power plant seems like a somewhat doubtful management decision (given the substantial excess capacity that remains unabsorbed), and one can name some other problems with TENAGA. However, bottom line is that it is widely expected that the 9MP and Malaysia's reasonable GDP growth (5%-6%) will continue to absorb some of the present excess capacity over time, which should be positive for its revenue and its earnings prospects, that some further upside from the current price of $12.1 can be expected. Technically however, there is a resistance at $12.5-12.6 from the last attempt in Feb. At $12.1, personally, I might consider buying some TENAGA (warrant) this morning if I can get it at the right price (and if I don't have any exposure yet), but I doubt I will be able to get it at an attractive price. Certainly, I don't recommend anyone to chase after a hot stock (especially for new investors who hasn't the experience). Given its doubtful track record in the past (e.g. past management decisions and GLC status), it might not be as attractive as some of the other better stocks to hold for the longer-term (e.g. PBBANK). However, I believe more experienced traders can benefit from playing this stock (and warrant) due to its large market cap and its consistently high liquidity, although there are also better stocks to play.
Disclaimer: As I am writing this in the early hours in the morning, it is possible that I might have missed something. If so, please don't hesitate to point out any factual errors so that I can make the necessary corrections. Thank-you in advance. Even though I tried to be as neutral and objective as possible, it is possible that I might not be completely neutral as I hold some TENAGA-CA warrants.

Tuesday, April 3, 2007

The Intelligent Investor

This used to be one of my favorite investment books. Nowadays, I don't pick it up as often, but sometimes, I will pick it up, flick through some pages, read the highlighted parts when I need some investment inspiration. In the past, I used to read it diligently, every word and every page, highlighting the key points that I didn't know before - I did this at least twice years ago.

Wikipedia has an introduction of the book here - http://en.wikipedia.org/wiki/The_Intelligent_Investor. It looks similar to the one I have, except mine has yellowed pages, marked with various coloured highlighters, and looked a lot older than it really is.

It's impossible to summarize a book like this in this blog. Everyone takes different things out from a book like this. Even the same person takes different things from this book at different times. To me, this is not the sort of book that will inspire one to earn 50% or 100% return from the stock market. Instead, it will teach you how to make intelligent investment amongst others, with "safety of principal" and "adequate return". (Graham believes that achieving a return similar to the market over the long term represents a great achievement - subsequent studies showed that 80%-90% of investors don't beat the market in the long-term).

Here is a small sample of the more interesting value investing concepts from various places in the book:

- "To invest successfully over a lifetime does not require stratospheric IQ, unusual business insights or inside information. What's needed is a sound intellectual framework to make decisions, and the ability to keep emotions from corroding that framework."

- A stock is not just a blinking ticker symbol... it's an ownership interest in an actual business with an underlying value that doesn't depend on its share price.

- The habit of relating (or comparing) what is paid (or price) to what is being offered (or value) is an invaluable trait in investment. A great company is not a great investment if you paid too much for the stock. An average company can be a great investment if it's given away close to nothing.

- Buying stocks is more intelligent when it is like buying groceries (looking for value and bargains) than when buying perfumes (when one typically tend to ignore the high price).

- The stock market is a pendulum, that swings between unsustainable optimism (giving high prices), and unjustified pessimism (giving low prices). Refuse to let other people mood swings govern your sound intellectual framework. Instead, the intelligent investor seeks to profit from this folly.

- Stock market fluctuations are certain. Prepare for it financially and psychologically. (E.g. in market crashes - you need both a lot of cash and a lot of courage to buy).

- No matter how careful you are, you can never eliminate the risk of being wrong. The future of security prices is never completely predictable. Always insist on a "margin of safety" to minimize the odds and the consequences of being wrong.

- Don't take foolish risks - it can put you so deep in the hole, that it's virtually impossible to get out.

- Being an intelligent investor is more "character" than "brains". The investor's chief problem - even his worst enemy - is likely to be himself. (To me, the hard part is not figuring out the sound intellectual framework, but sticking to it.)

- Whilst enthusiasm is necessary for great accomplishments elsewhere, on the stock market, it almost invariably leads to disaster. (e.g. stock market bubbles).

- Stocks become more risky, not less, as prices rises.

- Additional concepts for defensive (or passive) investors. 1. Limit the share universe to well-established stocks and funds. 2. Dollar cost averaging. 3. Portfolio or formula investing - "50/50 formula". (For 2. and 3., I used modified forms which I feel are more effective).

- Invest only if you feel comfortable owning the business, even if you have no way of knowing its daily share price. (or its daily volume; Buffett feels the same way too, as he always focus on "owners earnings" in his annual reports than the daily / closing share price).

- Graham thinks diversification can be achieved with 10 to 30 stocks (although if I'm not mistaken, I read somewhere that he himself holds nearly "hundreds" of stocks).

(If these concepts doesn't make sense, feel free to leave a comment or 2 here. All non-destructive comments and questions welcome! There's no such thing as a silly question. Graham goes into detail in many of the concepts in the book).

Most stock investors I know are not aware of the book. Fundamental and value investors might have heard it, but the few that has, have mostly yet to read the book in its entirity. Come to think of it, I have yet to know of another person who has actually read the book in its entirity twice (except for Buffett). The feedback I've heard is that it is heavy going, and it is ... but I must say that it has shaped my thinking a lot about investing intelligently. If it's any consolation, my first attempt to finished reading the book took me at least 4 years. If you are a value investor, and find the above concepts resonate within you, consider buying and owning this book as a lifetime friend and constant source of reference, especially if you still have decades of investing years ahead of you.

Special Note: If you are a trader ... sad to say Graham doesn't think too highly of traders ... during his time (he first wrote the book in 1949, and updated it several times in the 60s and until his death in 1976), he has yet to meet a trader who consistently beat the market in the long term. (Another interesting character in the early 1900s which Graham is certain to be aware of is Jesse Livermore, who is probably the world's greatest trader from that era - unfortunately, he lost nearly all his fortunes gained from trading, and eventually committed suicide ... ). What is interesting to me is that the few value investors I know are thrifty people who live simpler lives (including Buffett, the world's 2nd richest man), whereas the few traders I've heard about seem to have lived "the rich and extravagant life". Perhaps a generalization and stereotyping, but I can't help but wonder if that is because of the different approaches that successful value investors and traders acquire wealth - trading can bring wealth very quickly which can tempt one to spend it more lavishly, whereas value investors who patiently looks for bargains in the stock market tend to apply that habit to the other aspects of their lives, always subconsciously looking for value and bargain ... :-)

Happy reading and investing!

Sunday, April 1, 2007

HEXZA - Old Article #3

Some more interesting information about HEXZA's business. My quick take is:
1. Company has improved margins before when raw material cost increases (but this is never guaranteed for the future, although a good sign - can't read too much from 1 article).
2. The cash hoard has given them flexibility to expand their business with even better margins than in the past, further adding shareholder value.
3. They are market leaders in their own niche markets (60% ethanol market share, 30% resins market share in Sarawak).
4. Never missed a single dividend since IPO - that's impressive given that it has been listed since 1987, nearly 20 years!
5. In late 2005, SBB called TP of $0.68 - perhaps that explains why $0.67-$0.68 is an important resistance, as seen in the charts. Of course, HEXZA earnings have increased by another impressive 42% since then.

Sounds like a sound, long-term fundamental business isn't it? ... so, it's up to you dear readers to promote HEXZA more :-) Don't forget to buy more on weakness, and sell some at market tops, as it will take a while before the price shoot upwards ...


Corporate: Pricier raw materials don't stop Hexza
By Nadia S Hassan
October 18, 2005

Despite rising raw material costs and increased competition, Main Board-listed chemical company Hexza Corp Bhd still managed to post an impressive net profit growth for the first half of its financial year ending Jan 31, 2006 (FY2006). Although revenue has remained fairly stable, net profit for those six months increased by 90.2% compared with last year's. And the news gets better. Hexza is expected to perform even better in the second half of FY2006 compared with the previous corresponding financial period, according to its chairman, Datuk Dr Foong Weng Sum. All this indicates that margins are improving at Hexza, according to Ng Jun Sheng, an analyst with SBB Securities, which Foong confirms in an e-mail interview with The Edge. "For the first half of FY2006, profit before tax [PBT] margins increased to 13.7% from 8.4% in the first half of FY2005, which shows an improvement in operating efficiencies and economies of scale," says Ng This is an admirable feat considering that the price of primary raw materials used by Hexza, which include methanol, urea and molasses, has doubled compared with last year, according to analysts. This is mostly brought on by high demand from China and steadily rising oil prices. However, even with margins improving, Foong admits that it has been a challenging time for the company. "Raw material costs have risen and margins still remain under pressure, but we try to minimise this by improving operational efficiencies and yields," Foong says. However, ensuring further operational efficiencies is not the only thing Hexza is doing to secure growth. "Hexza has plans for expansion of all its core businessesformaldehyde-based resins as well as ethanol [ethyl alcohol] — some of which are in an advanced stage of implementation. The financial impact of these expansions should be accretive in the next financial year, (Seng: This refers to FYE 2007.) " Foong says. The company has already invested some RM9 million in capital expenditure to increase the capacity of its factories by early FY2006, as its Ipoh plants are already running at full capacity. With the expansion, Hexza expects output to increase by another 30% to 40%. Hexza also has factories in Port Klang and Sarawak. While its plants in Ipoh deal with the manufacturing of ethanol, its plants in Port Klang and Sarawak are involved in the manufacture and sale of formaldehyde and formaldehyde-based adhesives and resins for timber-related industries. To fund this expansion, Hexza has had to dip into its cash reserves. Even so, the company still holds about RM9 million in cash and cash equivalents and has hardly any borrowings, according to Foong. All of this should ensure that going forward, Hexza's margins should remain stable, says Ng. He adds that Hexza's pricing flexibility and product excellence would also help to sustain margins. According to a report by SBB's Ng dated April 12, Hexza is one of the largest local ethanol product manufacturers with a market share of around 60%. It commands about 30% market share in the adhesive resins market in Sarawak. Yet Hexza's public profile remains decidedly low key despite its good results and position as market leader. However, Foong says this does not mean that the company has not been active behind the scenes. "Hexza's core businesses are in very competitive sectors. And we are planning and working towards gaining greater market share for these core areas. But as to how much more only time will tell," says Foong. According to Ng, Hexza has a history of making prudent capital investments. "The group has invested about RM9 million over the last two years upgrading its R&D [research and development] and machinery in order to meet the high and stringent emission standards of overseas buyers." "Hexza has also signed an agreement with Orica Australia Pty Ltd, a leading multinational adhesives and resins manufacturer, for technology licensing involving the manufacture and application of low-emission resins in the wood adhesives and resins applications," says Ng. Hexza's share price has been hovering around the 47-sen mark over the past year. Its highest in 52 weeks was 50.5 sen on June 22 this year and its lowest was 44 sen (May 30). Ng has put a "long-term buy" call on the stock, with a 12-month target price of 68 sen. (Seng: No wonder there is strong selling pressure at $0.67-$0.68). There is also potential for dividend payments to increase. "Hexza has never missed an annual dividend since its IPO [initial public offering]. The company plans to declare a higher dividend with each passing year, although the increase will be at a prudent and measured pace," says Foong. Hexza's most recent dividend payment was 2.5% less tax. The company's net profit and revenue have also been growing steadily over the past three years. In FY2003, Hexza made RM3.7 million in net profit on RM97.8 million in revenue. For FY2004, revenue jumped to RM116.8 million, while net profit increased to RM4.8 million. Net profit then almost doubled in FY2005 to RM8.2 million while revenue increased to RM128.5 million.