WELLCAL (7231) WELLCALL HOLDINGS BHD – A dividend-yielding cash cow
With more than 20 years track record in the rubber hoses industry, Wellcall is currently the largest manufacturer of low and medium pressure industrial hose in Malaysia.
Wellcall exports to over 70 countries with a diverse customer base of more than 200 spanning worldwide.
In this article, we introduce Wellcall and explain the case of why we think Wellcall is worth your consideration. Visit us at www.the1994investor.com for more details.
Wellcall calls themselves the one-stop complete industrial hose sourcing center. They manufacture customized hoses of various specifications and applications based on each customer’s needs. Hoses’ specifications may vary in terms of sizes, pressure, temperature and abrasion resistance, etc.
Wellcall’s products serve a diverse range of applications, across sectors like mining, oil & gas, shipyards, automobile, food & beverage deliveries, and industrials, etc.
By geographical region, the Group’s main market is the USA/Canada (24.4%), followed by Asia (17.7%), Europe (17.5%), and Australia/New Zealand (11.0%).
STABLE REVENUE AND PROFITABILITY RECORD
For the past 6 years, the Group’s revenue was relatively stagnant with a 5-year CAGR of just 2%. In FY2020, the pandemic caused a 20% drop in the Group’s revenue following the production halts during lockdown and lower demand across most markets.
Nevertheless, in terms of profitability, the Group has over the years been showing healthy and consistent gross and net margins of about 35% and 22% respectively.
For the past 6 years, there were 2 outlier years in terms of profitability i.e. FY2015 & FY2018. The reason for the higher margin in FY2015 was due to a lower effective tax rate; whilst the lower margin during FY2018 was due to the higher cost of raw material prices.
Despite the above, we remain in favor of the Group for its resilient business revenue and consistent profitability. The impact of higher raw material prices was minimal on the Group.
The Group generates strong cash flows from operations, with its 6-year average CFO and FCF to net income ratio of 1.2x and 0.93x respectively.
The lower FCF to net income ratio in FY2015 was mainly due to RM35m investments allocated for the expansion of its 3rd plant and purchase of new machinery during the year. In the following years, the Group’s capital expenditure average at about RM4m p.a. only (10% of its annual CFO).
Wellcall’s strong FCF has enabled to Group to maintain a consistent dividend payout of 70% – 90% of its annual profit.
Considering Wellcall’s generous dividend distribution of RM25m – RM30m p.a. for the past 6 years, the Group’s cash position continues piling up. As at 31 December 2020, the Group is in a net cash position of RM57.5m (RM0.12/share).
They maintain a consistent and healthy cash conversion cycle of 60 days for the past 6 years.
According to the Management, high cash holding is necessary as they are constantly on the lookout for investment/acquisition targets.
FINANCIAL RESULTS FOR THE 1Q2021 (OCT – DEC 2020)
For 1Q2021, Wellcall’s revenue remains slightly behind the preceding year. Nevertheless, the Management was optimistic for FY2021 prospects as demand picks up gradually from the USA/Canada and Europe market.
KEY STRENGTHS
- Since 2003, Wellcall has maintained a perfect profit track record without a year of loss. Profitability was consistently above 15% in the earlier years, before improving and stabilizing at about 20% net margin.
The better margins can be attributable to better economies of scale and improved manufacturing processes mastered over the years.
Despite the occasional drop in revenue for some of the years, we note that the Group’s performance usually rebound quickly within the next year or so.
- Experienced management team with more than 40 years of industry experience.
- Wide geographical reach with various application markets including industrial, automobile, transportation, oil & gas and etc. The air and water, wielding and gas, and oil and fuel sectors are the major contributors, making up >70% of the Group’s top line.
- Efficient utilization of capital and cash. Return of equity (“ROE”) and return on assets (“ROA”) have consistently exceeded 20% for the past 6 years. Short cash conversion cycle with average receivable and inventory days of 20 and 60 respectively.
KEY RISKS
- Stagnant revenue growth for the past 6 years. Further understanding is required from the Management on its future growth plans.
- Weakening of the Dollars and Euros would impact on the Group’s margin, as they export 90% of its products worldwide.
- Low volume and illiquid counter with top 300 shareholders controlling about 80% of the Group’s total shares. Daily trade volume/value average at 437.5k / RM460k only.
- Highly reliant on foreign workers with about 100 of them or 45% of the Group’s total workforce. The Management informed that it is not viable for them to increase automation level as their products require a high level of tailor-made.
- High raw material prices had in the past impacted the Group’s margin, for example in 2018. Raw materials for rubber hoses are mainly natural rubber, synthetic rubber, and chemicals.
MAJOR SHAREHOLDERS AS AT 18 DECEMBER 2020
Tan Kang Seng holds a total stake of 11.5% in the Group.
Institutional investors include, ICapital Berhad (3.5%), Public (5.5%), Ministry of Finance (0.5%), Affin (0.2%), Manulife (0.2%) and PERKESO (0.2%), etc.
Based on the distribution schedule, top 322 shareholders of WELLCALL controls 85.1% of the Group, raising concern of illiquid / limited public spread.
PEERS COMPARISON
There aren’t any listed peers of Wellcall on the Bursa available for comparison purpose.
Nonetheless, we have picked a few companies within the industrial manufacturing for comparison of performance, including manufacturer of plastic products, polymer and adhesive products, oil & gas and engineering equipments etc. Refer to the table below for details:
With a superior net margin and ROE of more than 20%, Wellcall deserves a premium in terms of valuation against the rest.
As illustrated above, Wellcall has been traded within the range of 15x – 23x PE for most of the years since 2014. The consistency of its dividend distribution played a part in the strength of its share price.
Considering Wellcall’s financial track record, consistent dividend policy, and prospect forward, we would value Wellcall conservatively around its previous year PE range of 15x – 20x.
CORPORATE UPDATES / OUTLOOK
On Wellcall’s joint venture (“JV”) with Sweden’s Trelleborg Group, the Management updated on 23 February 2021 that progress of the production lines is within expectation, with certification for the lines to be received soon.
The JV was formed in January 2019 with Wellcall investing 49% stake and Trelleborg, 51% in the JV. The total paid-up capital of the JV is RM9.0m.
The JV was formed to capitalize on both Group’s specialty i.e. Trelleborg owns proprietary technology includes wear indicator systems embedded in industrial hoses and they are a globally recognized manufacturer of composite hose, while Wellcall provides Trelleborg with its diverse client base across the various sector.
Trelleborg is a world leader in engineering polymer solutions that seal, damp and protect critical applications. The Group has a presence in 50 countries and Asia alone is contributing 16% of its total sales. 2020 full-year revenue was SEK32.8billion (RM15.6billion).
Overall, we are optimistic of the recovery of orders to happen within the next 1 years, fueled by orders backlog from customers worldwide as the pandemic eased and the pace of industrialization accelerates.
HOW MUCH IS WELLCALL’S WORTH
1. FY2021 revenue projected to increase by 5% – 15% as compared to FY2020. Annualising 1Q2021 results would be equivalent to our worst-case assumption of 5% growth. We are optimistic on the Group to achieve RM20m / 15% growth in FY2021.
2. Gross margin assumed based on its 6 years average margin of 35.9%. In the latest quarter, Wellcall’s gross margin was 41.4%.
3. Operating cost estimated based on annualized 1Q2021 operating cost of RM3.4m. FY2020 full-year operating cost was RM12.9m.
4. Loss from associates is expected given the JV will only commence business in 2Q/3Q 2021. Based on 1Q results, we estimate a full-year loss of RM1m – RM1.5m.
5. Net margin assumption was benchmarked against the Group’s 6 years average net margin of 22.5%. The lower net margin considers loss from an associate of RM1m – RM1.5m.
At RM1.08, we opine that Wellcall is an ideal target for patient investors to initiate a position, on the basis of:
- The Group’s consistent and strong profitability track record for the past 20 years
- Reasonable valuation at 17.5x (base-case assumption), coupled with an expected dividend yield of 4.0% – 5.0%
- The expectation for demands to pick up across all markets as the world recovers from the pandemic
- Limited business risk/downside on the Group
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