“..there are two possible endings to every story.”― Christie Watson, Tiny Sunbirds, Far Away
In my last article published in i3investor, “Margin Finance, EverSendai: A real time case study” below,
https://klse.i3investor.com/blogs/kcchongnz/133708.jsp
I use Eversendai to illustrate the peril of using share margin finance (SMF). Sendai was trading at 80 sen then, just for sharing purpose.
I illustrated that with SMF of 50%, a speculator following the “sailing” call punting on Sendai at RM1.37 would have lost a whopping 83%, in just two months! This has not included the set-up cost, the interest payment for the SMF, and other transaction costs.
That punter would have encountered margin calls, and as he had already “sailing”, and likely had no more money to top up his margin maintenance account. His investment banker would have sold off all his Sendai shares at huge loss, a confirmed and realized loss.
Here I received this interesting comment.
[stockmanmy has left a new comment on your post "Margin Finance, Ever-Sendai: A real time case study kcchongnz":
sendai from 80 sen to 95 sen now...................
KC lousy timing, lousy business sense and lousy analysis.]
What is so interesting about this comment?
"The stock market is filled with individuals who know the price of everything, but the value of nothing." - Phillip Fisher
The fellow above only knows about price movement of Sendai, without the faintest idea what its value is and was so sexcited when Sendai went up from 80 sen to 95 sen. He forgot that he had been asking people in i3investor to “sailing” with margin finance all over the place when it was trading at RM1.37. He doesn’t care that those who followed his calls had got their shares forced sold at about 80 sen, and hence had incurred huge losses, without having a chance to recover.
“Lousy timing”? Lousy timing writing the article when Sendai was trading at 80 sen and now it is 95 sen?
I have been writing about articles telling another side of a story about margin finance all the time, and timing of when to write has never been in my mind. I had no idea whether the share price of Sendai would go up or go down at the time of writing, nor do I know if it will go up or go down in the future. By the way, I have no interest on that.
“Spending an hour trying to predict the future movement of the stock market is an hour wasted in your life.”
“Lousy business sense” not investing in Sendai?
I would like to spend some time discussing the above statement by that fellow.
No business sense not investing in Sendai
Before deciding if to invest in Sendai, I would first seek answers to a few simple questions as below,
What is the industry it is in, and how is the competitive environment?
What is the expected bottom line, rather than the size of the order book?
What are the risks?
Construction industry, which Sendai is involved in, is filled with many problems and uncertainties. It is a dog-eat-dog world. Contractors, unless they have good contacts for negotiated contracts or they have special skills, win jobs by competitive pricing, and hence margins are generally low. Otherwise, forget about getting the job.
There are many reasons which can delay the construction works and causes cost overrun, almost for all construction projects, all the time. There are also a lot of contract disputes, payment problems, which often, contractors are the one who suffer most.
Is Sendai suffering from this predicament?
Please refer to my analysis on Sendai in the thread “Banging On EverSendai: Risk and Return” below,
https://klse.i3investor.com/blogs/kcchongnz/132084.jsp
Low margin, cost overrun
The net profit margins of Sendai were very low at about 3.5% over the last few years. Suddenly last year, it announced a huge loss of RM274m! In the cash flows aspects, it was even more precarious. At the cash flows from operations (CFFO) level, there already huge deficits the last two years, RM53m in 2016, and RM216m in 2015. Free cash flows (FCF), after capital expenses, were negative 4 out of the last 5 years. In the last 4 years, the company bled a whopping total of RM662m in cash.
That is the problem with construction industry when a construction company has to undergo competitive bidding for job. Many companies tender at low margin in order to secure the job. When everything goes smoothly, the company earns a low margin. However, when they encounter problems, most construction companies will encounter problems all the time such as cost overrun, and work delays, their jobs turn into losses, often huge losses like what happen to Sendai last year.
Why is avoiding investing in this type of low margin construction company considered as lousy business sense as claimed?
Construction Disputes
Construction is full of disputes, all the time. Contactor often claims that there are additional work and entitlement of claims for additional time and overheads, whereas the clients and consultants always accused the contractor of work delay and hence impose liquidated damages. There are always two sides of the story, and unfortunately, the contractor is always at the losing end.
The contractor may go for arbitration, or court cases, but ultimately the contractor is always on the losing side. Make no mistake about it.
Ever wonder why there have been growing receivables up to such a whopping RM1.7 billion, and suddenly such a big write off and losses of RM274m last year for Sendai?
Is it really such a lousy business sense avoiding in investing in a construction company with low margin but full of risks and uncertainties like that of Sendai?
Bankruptcy risk
Total borrowings of Sendai in the most recent quarter have ballooned from RM254m in 2012 to RM1190 million now with total debts 1.4 times its equity.
It is no surprise that there will be many cash calls to come for the next few years. The private placements, at 10% discount, as I see it, the company has no choice but to get this money fast, to pay down debts and money for working capital. I doubt the banks are lending more looking at its risks. If I were a shareholder, I would be very reluctant to put in more money too.
Is that really a lousy business sense avoiding investing in a risky company like that of Sendai?
Conclusion
In my opinion, it is full of business sense avoiding investing in a construction company with huge losses, low margins, and a precarious balance sheet.
If one really keens on investing in construction companies, there are so many others with higher margins, more predictable and stable and visibility in earnings, and cash flows. Many of them with solid balance sheet, and good dividends.
Focus on investing in a business of a company, with business sense, true business sense of course, rather than the price movement of a piece of paper.
Think of the downside in investing, the upside will take care of itself.
Invert, always invert.
KC Chong
ckc14invest@gmail.com
http://klse.i3investor.com/blogs/kcchongnz/134621.jsp
