Relative Valuations of V.S Industry Berhad kcchongnz
Author: kcchongnz | Publish date: Sat, 6 Feb 2016, 03:30 PM
This article is for sharing of knowledge in investing. It doesn’t constitute a buy or a sell call.
There are a number of aspects of the company a smart investor has to look at before investing in its stocks. I have written about them in the link below, following the twelve tenets of Warren Buffet written by Robert G. Hagstrom:
http://klse.i3investor.com/blogs/kcchongnz/52152.jsp
Basically when buying a stock, you should take the same approach as you would if you were buying an entire business. The only difference is that instead of buying the whole of the business, or a partnership in the business, you are only buying a tiny share.
Smart and savvy businessmen when buying a business will seek answers to the questions below to check if that is a good business:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the business have favourable long term prospects?
- How good is the management?
- What is the return on equity?
- What are the profit margins?
- How healthy is its balance sheet
- Does it have good cash flows, free cash flows in particular
“Wonderful companies become risky when people overpay for them.”
Those who have invested in Amazon in the year 2000 at the adjusted price of about $85 then, which went down to $7 less than two years’ latter, would have to wait for another 10 years for them, just to recoup their losses, forget about the huge interest and other opportunity costs lost.
Go ahead to chase share price following the greater fool theory, ignore value at your own peril.
To decide on to buy or not to buy shares, there are basically two factors to consider:
What is the value of its business?
Can the business be purchased at a significant discount to its value?
This is where you determine whether the company is a good value and should be purchased. For this I have attempted to do a discounted cash flows analysis (DCFA) to obtain its absolute intrinsic value from its structural growth assumptions as shown in this article below:
http://klse.i3investor.com/blogs/kcchongnz/86545.jsp
My conclusion from the DCFA was,
“The present value of free cash flow for the firm was obtained by summing up those of first 5 years of supernormal growth value of RM121.3m, and the terminal value of RM1425.4m, totalling RM1546.7m. After adding the excess cash of RM243.7m, and deduction all debts of total RM412.2m, ignoring the minority interest, it gives the intrinsic value of V.S attributed to common shareholders at RM1378m, or RM1.20 per share. This shows V.S is overvalued by 34% at a market price now of RM1.60 apiece as on 20th November 2015.”
The business of V.S Industry?
VS Industry is one of the top 50 Multi-products OEM contract manufacturers in the world, specializing in Plastic Injection Moulding, Plastic Secondary Finishing, Tools design and fabrication, PCB assembly via Surface Mount Technology(SMT), Auto Insertion(AI), Chips on Board(COB), Manual Insertion(MI), and Final Product Box Build. It also involves in the production of a wide range of Remote Control units – ODM/OEM, Printers, Vacuum Cleaners, Home Appliances, White Goods, Audio, Video, DVD products for world class companies in full turnkey, pseudo-turnkey and consigned mode.
Figure 1: V.S Share price movement
Like someone said, a picture paints a thousand words. The share price of V.S has had a phenomenon rise since a year ago. It went up from the adjusted price of 50 sen to RM1.60 within a year at the end of last year, before falling back to RM1.32 at the close just before the 2016 Chinese New Year on 5th February 2016 as shown in Figure 1 above.
The total gain of investors, including the free warrants, will be one of the best short-term gains in Bursa for the last one year. How one wishes he has invested in this company a year ago!
The more pertinent question is, at RM1.32 now, is it still a good investment in the future?
Here I will share my relative valuations of V.S and leave it to individual to decide if he still wishes to invest in this stock.
Relative valuations of V.S Industries.
In this analysis, I attempt to use some simpler relative market valuation techniques to value V.S, and compare with the largest contract manufacturer in the world, Hong Hai Precision Ind Co Ltd listed in Taiwan. For the time being, we ignore the claim of the warrant shareholders of V.S which could reduce the value attributed to the common shareholders.
Table 1 in the Appendix shows some operating efficiencies, and the health of balance sheets of both companies.
Leaving those who just focus on price instead of value aside, most investors will look at the market valuations metrics of a company as shown in Table 2 below. The relative valuation metrics of V.S were worked out based on its latest trailing twelve month financial results ended 31st October 2015.
Table 2: Some simple valuation ratios of V.S
All metrics above show Hon Hai, the largest contract manufacturer in the world at NT76.70, is a much cheaper investment compared to V.S, even though Hon Hai is a much bigger company then V.S and has better operating efficiencies and healthier balance sheet as shown in Table 1 in the Appendix.
Hon Hai has a PE ratio of 8.0, compared to the 9.7 of V.S at RM1.32 at the close today on 5th February 2016. Price-to-book, price-to-CFFO and price-to-sales wise, Hon Hai also appears to be much cheaper investment. Hon Hai has very good dividend yield at 4.7%, four times better than the 1.2% of V.S. The Peter Lynch price-earnings ratio to expected growth ratio of Hon Hai at 0.8 also appears to be cheaper.
Compared to its historical PE ratio of V.S over the years as shown in Table 3 below, the PE ratio now at 9.7 now doesn’t appear to be cheap too. V.S has been most of the time trading at single PE ratio as extracted from Dynaquest’s Stock Performance Guide.
Table 3: Historical PE range of V.S
Year Low High Average
2010 5.8 11.1 8.5
2011 4.8 8.8 6.8
2012 7.5 8.9 8.2
2013 4.6 5.6 5.1
2014 4.8 9.1 7.0
2015 4.3 13.0 8.7
As V.S has substantial debts amount to 46% of equity, and also substantial minority interest, the valuation metrics as shown in Table 1 above just base on equity are not good enough. Table 4 below shows the more appropriate valuation metrics based on the whole enterprise value (EV).
Table 4: Enterprise valuation
Company V.S Hon Hai
Year Low High Average
2010 5.8 11.1 8.5
2011 4.8 8.8 6.8
2012 7.5 8.9 8.2
2013 4.6 5.6 5.1
2014 4.8 9.1 7.0
2015 4.3 13.0 8.7
As V.S has substantial debts amount to 46% of equity, and also substantial minority interest, the valuation metrics as shown in Table 1 above just base on equity are not good enough. Table 4 below shows the more appropriate valuation metrics based on the whole enterprise value (EV).
Table 4: Enterprise valuation
Company V.S Hon Hai
EV/EBITDA 7.7 5.5
EV/EBIT 9.9 7.8
EV/Sales 1.1 0.23
CY=FCF/P Negative 14.7%
The EV of V.S at 7.7 times earnings before interest, tax, depreciation and amortization, EBITDA, as shown in Table 4 above is 40% more expensive than Hong Hai’s 5.5. It is five times more expensive than Hon Hai in term of Sales. In absolute term, V.S’s EV of 9.9 times of its earnings before interest and tax, EBIT, is also higher than Hon Hai.
What about its cash yield for equity shareholders, or FCF/Price I talked about here?
http://klse.i3investor.com/blogs/kcchongnz/76694.jsp
V.S had a negative free cash flows, FCF, of RM53m the latest financial year. In fact it has no free cash flow for the last four years. Hence this valuation metric is not applicable because there is negative FCF, whereas for Hon Hai, the cash yield is very high at 14.7%. I am not too sure if this figure extracted from a public website is correct or not though, as it looks too good.
Is V.S a great company? Is it a great investment?
V.S has had a good round in its business performance with some great improvement for the last twelve months in terms of earnings and growth. I would say it is the best 12 months in its history of listing. Its share price has also risen in tandem. This is due to its growth in revenue and earnings the last couple of years, coupled with doubling of its ROE from its historic 7% to 14% in the last 12 months. Its ROE of 13.9% is now, for the first time, higher than the cost of equity.
V.S’s Achilles’s heel is its poor cash flows, and in particular its very poor FCF, which have been negative for the last 4 four years. I do understand growing companies sometimes have poor FCF for a year or two as cash is required for working capital and capital expenses for growth, but eventually, they have to produce cash inflows, otherwise the company may grow itself to bankruptcy when an economic or a financial crisis hits.
“Investment success doesn’t come from “buying good things,” but rather from “buying things well.””
Buying well means buying it when it is selling at a big discount to its intrinsic value, and relative to its peers in the same industry. At the present price of RM1.32, V.S appears to be selling above its intrinsic value (ignoring warrants) and much more expensive in every aspect compared to the largest contract manufacturer of the world, Hon Hai.
In order to have a higher probability of success in investing, one should know how to determine if a company is good, and whether it is selling at reasonable or better still, cheap price, before investing. There is no other way besides understanding the language of business, and how to do valuations, in my opinion.
For those who do not have the knowledge and wish to learn about it, or wish to have another opinion of a stock you are interested in before pouring tens or hundreds of thousands, or million Ringgit into it, you may contact me at
ckc14taining2@gmail.com
With this last article before the lunar new year 2016, I wish everyone a happy and prosperous Chinese New Year.
K C Chong (6th February 2016)
Appendix
Table 1: Operating efficiencies, growth and health of balance sheet
EV/Sales 1.1 0.23
CY=FCF/P Negative 14.7%
The EV of V.S at 7.7 times earnings before interest, tax, depreciation and amortization, EBITDA, as shown in Table 4 above is 40% more expensive than Hong Hai’s 5.5. It is five times more expensive than Hon Hai in term of Sales. In absolute term, V.S’s EV of 9.9 times of its earnings before interest and tax, EBIT, is also higher than Hon Hai.
What about its cash yield for equity shareholders, or FCF/Price I talked about here?
http://klse.i3investor.com/blogs/kcchongnz/76694.jsp
V.S had a negative free cash flows, FCF, of RM53m the latest financial year. In fact it has no free cash flow for the last four years. Hence this valuation metric is not applicable because there is negative FCF, whereas for Hon Hai, the cash yield is very high at 14.7%. I am not too sure if this figure extracted from a public website is correct or not though, as it looks too good.
Is V.S a great company? Is it a great investment?
V.S has had a good round in its business performance with some great improvement for the last twelve months in terms of earnings and growth. I would say it is the best 12 months in its history of listing. Its share price has also risen in tandem. This is due to its growth in revenue and earnings the last couple of years, coupled with doubling of its ROE from its historic 7% to 14% in the last 12 months. Its ROE of 13.9% is now, for the first time, higher than the cost of equity.
V.S’s Achilles’s heel is its poor cash flows, and in particular its very poor FCF, which have been negative for the last 4 four years. I do understand growing companies sometimes have poor FCF for a year or two as cash is required for working capital and capital expenses for growth, but eventually, they have to produce cash inflows, otherwise the company may grow itself to bankruptcy when an economic or a financial crisis hits.
“Investment success doesn’t come from “buying good things,” but rather from “buying things well.””
Buying well means buying it when it is selling at a big discount to its intrinsic value, and relative to its peers in the same industry. At the present price of RM1.32, V.S appears to be selling above its intrinsic value (ignoring warrants) and much more expensive in every aspect compared to the largest contract manufacturer of the world, Hon Hai.
In order to have a higher probability of success in investing, one should know how to determine if a company is good, and whether it is selling at reasonable or better still, cheap price, before investing. There is no other way besides understanding the language of business, and how to do valuations, in my opinion.
For those who do not have the knowledge and wish to learn about it, or wish to have another opinion of a stock you are interested in before pouring tens or hundreds of thousands, or million Ringgit into it, you may contact me at
ckc14taining2@gmail.com
With this last article before the lunar new year 2016, I wish everyone a happy and prosperous Chinese New Year.
K C Chong (6th February 2016)
Appendix
Table 1: Operating efficiencies, growth and health of balance sheet
