LITRAK News - Commentary

The Star posted an article on LITRAK today - http://www.biznewsdb.com/english/newspage/newspage.asp?ID=7052616&file1=7&bulan=05&kw=wwqq.

My usual highlighting and comments in italics below:

________________

Litrak sees rebound after toll hike
Updated : 26-05-2007
Media : The Star
Story By : DARSHINI M. NATHAN via www.biznewsdb.com

LINGKARAN Trans Kota Holdings Bhd (Litrak) was thrust into the limelight early this year after the scheduled 60% toll hike for the Damansara-Puchong Highway (LDP) triggered a backlash among consumers.

But with uncertainties over the toll rate hike now resolved and traffic volume on the highway recovering somewhat after suffering in the first few months of the year, the investment case for Litrak is starting to look a lot more appealing.

[As I highlighted earlier in my first posting on LITRAK, as well as others who called LITRAK before me, the investment case for LITRAK looked really appealing when its stock price fell to as low as $2.60 in February this year.]

At the heart of it all is the fact that the toll concessionaire is fast turning into a cash cow. Its rising free cash flow (FCF) has emerged as the key driver of several research houses' "buy" ratings and revised target prices.

Most of the analysts tracking Litrak are banking on the company announcing a second capital repayment exercise as early as the second half of this year.

[To the best of my (limited) knowledge, this is not confirmed by LITRAK yet. However, I would not be surprised if it occurs in 2nd half of this year.]

Litrak embarked on its first capital repayment in November 2005, when it announced a distribution per share of 25sen.

This time around, analysts say the quantum is likely to be much higher. Most of them reckon a distribution of at least 50 sen per share could be on the cards.

[It pays to be a little skeptical whether it will really be 50 sen. Below, AmResearch is projecting 26 sen EPS for FYE 2008. My own projection is around 31 sen. There needs to be a very strong reason to make a capital repayment that is larger than the yearly earnings, since this would most likely mean that LITRAK would need to take on extra borrowings. Personally, I would be more than satisfied with a capital repayment of say 25 sen, same as last year, as it would imply a yield of 0.25/3.5 = 8.3% net of tax ... very, very nice].

There are several reasons for their optimism. The government-approved toll hike that took effect on Jan 1 this year means that motorists using the highway now have to pay RM1.60 compared with RM1 previously.

With that, some expect the LDP to generate an operating cash flow (before debt obligations) of about RM200mil per annum for Litrak in financial year (FY) March 2008.

[Most likely an error by the journalist. Already, the operating cash flow reported in LITRAK's latest quarterly report is larger than $200M, and closer to $300M. I don't expect LITRAK's cashflow to reduce in 2008 after the toll rate hike. ]

The agreed toll rate under the concession agreement however was much higher at RM2.10.

The government has agreed to a compensation package, which comprises a cash payment of RM150mil, to be paid in two tranches this year and in 2008, and a one-year extension to the concession period. Litrak received the first tranche of the compensation worth RM75mil in January.

[Most likely another error by the journalist. If LITRAK has already received the $75M, how can its quarterly "Revenue" be reported as only $69M? Also, how can its "Other Income" be reported as only $13M? Examining LITRAK's quarterly reports and studying its notes in detail, I believe LITRAK has not yet accounted for this in its earnings statement.]

This would boost its revenue and earnings in the fourth quarter of FY07. A local research house estimates that this would lead to a revenue growth of 3% and 12% in FY07 and FY08, respectively.

[There is no need to estimate FY07 revenue growth, as it is already reported by LITRAK last night. The actual revenue growth is $256M / $243M, or approximately 5.3% growth for FY07. Another poor reporting by the journalist.]

Litrak, which also operates and maintains the SPRINT or Sistem Penyuraian Trafik KL Barat highway for a period of 36 years ending December 2034, is set to announce its results for FY07 this week.

[Again, LITRAK already announced its results last night]

Apart from the compensation, the latest figures will also reflect the net gain of about RM11mil it realised from the disposal of all its investments in quoted shares in the third quarter of the last financial year.

AmReaserch, however, notes that higher losses at SPRINT following a staggered step up in its finance cost since the second quarter of FY07 could throw a dampener on Litrak's FY07 earnings.

Litrak's share of SPRINT's losses is expected to peak in FY07 at RM21mil, before falling to RM9mil-RM11mil over FY08-09. The research house, nevertheless, says SPRINT's cash flow would gradually improve if it successfully restructures its Islamic bonds. It is also up for a toll rate increase on the Kerinchi and Damansara links next year.

Milking the cow

Until then, the focus remains on the LDP. Traffic volume on the LDP has fared better than expected after the toll rate increase. According to AmResearch, daily traffic volume declined 8%-10% in the first two months of the year, compared with last December. However, the figures for March and April apparently suggest that volume has rebounded slightly.

[I have some doubts about the 8%-10% decline. I believe it is larger. Q3/07 Revenue (for 1 Oct - 31 Dec 06 period) reported was $62.4M, at $1 per entry (or approx 62.4 million entries). Q4/07 Revenue (for 1 Jan - 31 Mar 07 period) was $69.6M, at $1.60 per entry, or approx 69.6/1.6 = 43.5 million entries. So, reduction is 1-43.5/62.4 = 30% from Q3/07. So, 8-10% decline seems a bit on the small side. Nevertheless, despite the decline, net earnings still grow significantly due to the large toll rate hike.]

As pointed out by Aseambankers, there is limited downside risk to the LDP's traffic volume growth ahead owing to the lack of an alternative route to the LDP. The 40km toll road also stands to benefit from the frantic pace of development in the Bandar Sri Damansara, Damansara Perdana and Mutiara Damansara areas.

[Good points. Nice economic moat so far. Nice potential for growth / limited downside risks.]

This has prompted AmResearch to upgrade its FY08 traffic forecast to a growth of 1.5% from 7% contraction previously. Its analysis shows that every 1% increase in LDP traffic volume would lift FY07-FY09 earnings by 2%-4%.

"Factoring in a nine-month impact from the 60% hike in LDP toll rates, we project Litrak's FY08 core earnings per share to rise 60% to 26 sen,¨ it says.

[It's unclear what is meant by "core earnings", but if 26 sen is the full EPS, then, I believe AmResearch is too conservative with the 26 sen EPS. FY2008 (1 Apr - 31 Mar 2008 period) will reflect the toll-rate hike fully. My personal estimate is at least 31 sen, including $37.5M government compensation. However, if anyone has AmResearch report, I would appreciate receiving a copy for further perusal. Thanks.].

Early this month, the investment research outfit issued a report on Litrak to highlight its revised target price of RM4.50 per share.

[Not unreasonable, although I think a bit lowish since my own target price is $4.70 to $5.60 - see my earlier posting for the basis. Interestingly, the implied P/E is 4.50 / 0.26 = 17.3, which is within the range of 15-18, and not unreasonable compared to investssmart P/E of 15, Deutche Bank P/E of 18, and my earlier P/E range of 14-17, although bear in mind that P/E are not absolutes, and it may be better to apply a relativity principle rather than an absolute principle to P/E.]

The higher net asset value (NAV)-based target price reflects the lower discount to NAV of 15% it has now ascribed to the shares, as opposed to 35% previously.

AmResearch reckons that with uncertainties over the LDP toll rate hike resolved, the company's FCF is likely to rise to anywhere between 33sen and 50sen per share from FY07-FY09, compared with 16 sen per share in the latest financial year.

That the toll concessionaire's parent company Gamuda Bhd has raised its stake in the former to 43% from 38% a year ago supports the case for the capital repayment. Gamuda started accumulating shares in Litrak since January last year. The idea is to bring its stake closer to 50%.

[Interesting, although I have not personally heard yet that GAMUDA intends to raise its stake to 50%. I would appreciate it if any readers can help confirm this, e.g. from past press releases, etc.]

However, under the Securities Commission's ruling, Gamuda can only acquire up to 2% of Litrak shares every six months or it will trigger a mandatory general offer for the rest of the shares it does not own.

[Interesting ... although I am surprised since other companies could do this without triggering an MGO - e.g. OSK's shareholding of OSKVI is higher, and it increased its shareholdings more than 2% in 6 months without triggering an MGO ... Appreciate comments from more knowledgeable readers.]

On its part, Gamuda has guided that it would reward its shareholders with a dividend of 46 sen per share or net dividend per share (DPS) of 33 sen going forward, from 12 sen per share net DPS currently.

It is understood that part of this dividend payment would have to be financed using the higher dividends it receives from Litrak.

The toll concessionaire's management is also working on extending the maturity of some of the debt taken on for the LDP to match that of the concession's lifespan. Whereas the LDP's debt expires in 2016, the concession ends in 2030.

If this happens, and given that the company has no significant investment capital expenditure plans in the near to medium term, it would free up cash that could be returned to shareholders.

A foreign research house suggests that Litrak may also choose to take on additional debt, given its net gearing of slightly above one time is backed by some solid recurring concession earnings.

[In the earlier posting, I note that LITRAK has actually reduced its debt in Q4/07. So, IF LITRAK were to take on additional debt in 2008, then, it could mean several things, including the possibility that it may wish to make a higher capital repayment than supportable by current year's earnings & cash holdings.

The speculative reason that GAMUDA wants to pay higher dividends to its shareholders is interesting... hmmnn ... since I don't yet know for sure, let's wait and see since to me, LITRAK's business case is already so good that I'm more than happy if LITRAK pays the same amount as last year.

Unfortunately, the name of the foreign research house is not supplied. Does anyone know?]

At this juncture, it is still not tax efficient for Litrak to pay out dividends, as it does not have enough tax credits to frank the dividends. As a result, the toll operator's dividend yields are below the regional average.

Given those circumstances, a foreign research house says it is important that Litrak embarks on a capital repayment exercise to enhance return to shareholders.

LITRAK - Q4/07 Results Commentary

This evening, LITRAK - my favorite stock - announced its highly anticipated results for Q4/07. Since LITRAK's financial year ends 31 March, this result is really in respect of 1 Jan 07 - 31 Mar 07 period, i.e. it should reflect the full impact of the toll rate hike on 1 Jan 2007.

Q4/07 Income Statement

Observations:

1. Q4/07 EPS of 9.1 sen has more than doubled Q4/06 EPS of 4.3 sen. On the surface, this is good news!

2. However, it is boosted by one-time realized gain by its subsidiary amounting to $11.3M, or approximately 2.3 sen. Excluding that, the EPS is 9.1 - 2.3 = 6.8 sen only, of just 54% increase over Q4/06 EPS. Personally, it is marginally dissappointing, as I had hoped to see something higher, although 54% increase in PAT is normally a good result.

3. A possible reason for the smaller increase is due to lower than expected increase in revenue, i.e. lower traffic volume. My rough estimate indicates that this could be around 26% reduction, or say a quarter, compared to same period last year. In a sense, this is not completely unexpected, as this is only the first quarter after the implementation of the toll-rate hike. I expect traffic volume to gradually increase over time, as more of the public accepts the toll-rate hike, i.e. I don't expect this to be a permanent reduction, but only a temporary problem.

4. It is also unclear if the government compensation of $150M payable over 4 year period from 2007-2010 has been included in the revenue above. My belief is that it is unlikely, as there is no direct mention in the notes, and it does not appear in the accounts, based on the size of the numbers reported. The amount per quarter is quite significant, approximately 1.9 sen EPS per quarter.

5. Maintenance expenses have also increased slightly from $0.8M to $2.6M. Perhaps due to one-time increase due to toll-hike change? Needs monitoring.

6. If one assumes that:
- FYE 2008 traffic volume improves slightly to say 80% (instead of 74%) of pre-toll-hike levels
- 90% of the revenue increase from the toll hike flows through to profit
- $37.5M government compensation payment per annum,
- otherwise, the business remains largely unchanged, then,
my estimate of 2008 EPS is around $0.31.
As traffic volume improves, I expect future EPS to grow higher than $0.31.

7. If one uses a reasonable P/E range of say 15-18, then, this suggest that a fair value for LITRAK may be around $4.7 to $5.6 within the next 2 years. If so, this would be equivalent to a potential upside of 22% to 46% from today's closing price of $3.82.

Q4/07 Balance Sheet



Observations:

1. Total borrowings (short term + long term) at 31/3/07 = $890M. The equivalent on 31/12/06 (not shown above) is $99M+$905M = $1,004M. This represents a significant reduction in total borrowings by $114M in just 3 month period. This is comforting.

2. The reduction in total equity is largely due to capital repayment and dividend payments in 2006 of $122M and $35M respectively. Otherwise, everything else seems ok.

Q4/07 Cash Flow

Observations:

1. Nice 12 month operating cashflow of $306M. Given that this only includes 1 quarter of the higher toll rates, I expect FYE 2008 cashflow next year to be even higher, from having 4 quarters of higher toll rates, government compensation, as well as expectation of slowly increasing traffic volume effects.

2. LITRAK continues to repay its loans, which is a prudent and responsible thing to do. I like this. In fact, in the past, LITRAK M.D. has indicated that they intend to fully repay their loans in 8 years time. Looking at the above, they certainly have the cash-flow to do so. In fact, maybe even much sooner than 8 years if they really want to. However, I suspect LITRAK wants to share the cashflows with the shareholders, at least with higher dividend payments, and possibly even more capital repayments over the next 8 years.

CONCLUSION

LITRAK's latest Q4/07 results are within my personal expectations. There is a slight dissappointment with traffic volume and revenue, but this is not entirely unexpected as this is only the first quarter of implementation of the toll-rate hike. Overall, I still like what I am seeing very much, and would hold on to my LITRAK purchase. If Mr Market wants to be irrational and provides me with an opportunity to buy at discounted prices, I intend to oblige him and purchase more, as I believe it still has a nice potential upside from its current price of $3.82.

Disclaimer: I own LITRAK and it is my largest holding at the time of writing. Do read my previous post on LITRAK for context. Bear in mind I could be biased, and I could be wrong in my analysis. Naturally, I also reserve the right to change my mind in future without notice. Therefore, I strongly urge you to use your own judgement, and always remember that whenever you invest (buy, hold, sell), you do so at your own risk.

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.