Thursday, February 23, 2006

From East to West

Thomson Medical Centre [Thom SP, S$0.29]
The last post featured a traditional chinese medicine player in mainland China. Today, we traverse from East to West. Unlike Tong Ren Tang, Thomson Medical Centre ("TMC") is a niche hospital in Singapore that specialises in obstetrics & gynecology ("O&G") and paediatric services. It has only one medical centre located in Thomson which operates a 190 bed private hospital. TMC delivers about 600 babies a month. A milestone in its history was that its Fertility Clinic delivered Singapore's first surviving IVF triplets in 1988.

Let's look a summarized breakdown of TMC.

Niche positioning: With its fees and charges, it targets the "middle segment" of mothers to be who do not wish to pay high end private hospital rates nor stay in a government hospital.
Established brand name with mothers: Whilst it has only been listed for over a year, TMC has a fairly long operational history. From memory, it has at least been around for 25 years.
Possible boost to top and bottom line: Six new O&G specialists have set out practice in TMC in middle of 2005. TMC expects their full year contribution only in the coming FY.
More satellite clinics in housing estates: TMC is targeting to open 2 or 3 such clinics to add to its current seven. These clinics serve as an outreach of TMC into the population and allows it to refer mothers to be to TMC for inpatient or other diagnostic services.
Consultancy work: An MOU has been inked for TMC to provide its O&G expertise to a Vietnamese hospital in Binh Buong Province, near Ho Chi Minh City. TMC will provide hospital planning, design and project management, technical advisory and operational planning services. TMC is attempting to sign a 3 - 5 year contract to run the medical centre. If successful, this should provide another source of a recurring earnings.
Major stake by founder/chairman: Founder and executive chairman, Dr Cheng has retained more than a third of its shares after its IPO in Jan 05.
Pro active government perks for child birth: Singapore's child birth rate is below current population replacement levels. However, in recent years, the government has been doling out baby bonuses, in a bid to encourage procreation. The most recent package was introduced in August 2004. Recent statistics show that these measures have helped to reverse the declining birth rate. Unfortunately, based on studies in other developed European countries, such stimulus are unlikely to persist in the long term, suggesting that the child boom could be a short term phenomena unless steps are taken again. In this connection, it may be heartening to note that the government pays close attention to this issue.

Limited growth: Other than the Vietnamese tie-up, organic growth of TMC is expected to be limited. As pointed out above, the managing the birth rate in Singapore is a severe challenge. TMC may have to venture abroad for growth but for a traditionally local player, its first forays overseas should be tough.
Management renewal: TMC is the result of chairman's Dr Cheng's life work. Whilst Dr Cheng is nearly 75 years old, he still runs its own clinic at TMC. Dr Cheng's son has assumed the role of deputy chairman of TMC too.

Even though, the contribution from the Vietnamese venture has not been factored in, TMC looks relatively cheap compared to its local hospital plays in Parkway and Raffles Medical. The latter two are trading at historical P/Es of about 30 and at a P/B of about 3. In contrast, TMC's historical P/E is approximately 19 while its current P/E is 13. As for P/B, it is at an inexpensive 1.1x as TMC owes the medical centre at Thomson Road. Its ROE of about 9 is comparable to both peers too and it is managed with a low debt to asset ratio of 12%.

Granted that TMC is the smaller of the three hospital plays and its growth prospects appear limited currently, the discount applied to TMC appears overly done. Over the long term, if its growth stagnates, TMC could also appear attractive as a yield play. Its current yield is 4.2% and with a quick ratio of 1.1, TMC could dip its hand into this kitty to fund future payouts.


Saturday, February 18, 2006

Efficient traditional chinese medicine

Tong Ren Tang Technologies ("TRT") [8069 HK] is a researcher, manufacturer and distributor of traditional Chinese medicine in mainland China. It was founded over 300 years ago. TRT was established during in the reign of the last Qing Dynasty in China. It is listed on the Hong Kong Stock Exchange and it closed at HK $17.00 per share today.

Its price recently look a hit when there was a 8.5% decline in its 3Q05 profit. There are also fears that as a result of the mature growth of its flagship drugs, TRT will experience slower earnings growth.

Key ratios:
P/E: 15.7
Div yield: 2.6%
P/B: 4
Current ratio: 1.9

A succinct breakdown of the merits and risks of TRT is set out below:

Strong brand name with experience history. Verified with Chinese counterparts that TRT has one of the strongest brand name in traditional Chinese medicine in China.
Experienced management that has delivered results.
Management is of the view that 3Q05 results were only a blip and full year target of double digit earnings growth is still on track. Hence, TRT may be undemanding on a PEG basis.
New plant in HK likely to be completed in middle of 2006 which will increase its overseas reach. Expect to penetrate Taiwan market.
Established distribution network.

As a result of relatively poorer intellectual property rights in China, other manufacturers may replicate its mature products.
There is stiff competition from lower priced generics.
Continued expenditure in R&D to produce new drugs to replace older ones.

A variant of the discount cash flow was applied to the historical cash flows of TRT. It is noted that whilst income grew steadily along with top line growth over the last five years, TRT had periods of high capital expenditure too; particularly in 2002 and 2004 which led to a hit on its free cash flow. As a result, it is probably unreasonable to do a straight line projection growth of free cash flow. However, in an attempt to put a finger down on its intrinsic value, it is assumed that TRT's owner earnings for 2004 is able to grow at a growth rate of 3% for 10 years. A relatively growth rate of 3% was selected in an attempt to smooth out its historical fluctuations. No terminal growth rate was assigned.

The above assumptions lead to a fair price which is close to the current market price. There appear to be no margin of safety at current quoted prices. Well, considering that TRT is considered a "blue chip" garnering a large number of coverage by analysts, it should be no surprise if the market is efficient with this one!


Thursday, February 16, 2006

Undervalued property & gas play?

The last post rambled on the outlook for oil from the demand and supply angle. In today's post, a company which derives a substantial portion from providing engineering services to the oil & gas industries is featured.

G&W is traded on the Singapore Exchange. It is the holding company of Oakwell Engineering which also trades on the same stock exchange. [Last closing price: G&W: S$0.18, Oakwell: S$0.05] G&W has three core businesses - building materials, oil & gas and real estate, which contributes 49%, 39% and 12% respectively. Its building materials division provides concrete products such as precast and ready mix concrete to the local construction industry, parts of China (Beijing, Shenyang) and Indonesia. As for its real estate arm, it engages in property development in China. In particular, 70% of its phase 2 of its Sentosa Gardens project in Shenyang was sold. It is also exploring property management services as a means of providing a steady income stream to the group. The majority of its oil and gas division has been spun off as a separate listed entity Oakwell. It handles distributorships for oil and gas related equipment and products.

In its annual report for FY04, G&W reported a NAV per share of S$0.61. Does today's price of S$0.18 present an opportunity?

G&W holds over 57% of Oakwell. This stake translates to S$0.14 per share (Note, however, that Oakwell's NAV is only about S$0.06.). G&W is also cash rich. It has S$0.22 of cash and cash equivalents per share. The other substantial current assets of G&W are trade debtors and inventories. We are unsure whether: (a) sufficient provision has been made for allowances for bad debts, (b) inventories are realisable at recorded value. So, a discount of 20% is applied to their recorded value. This yields S$0.66 per share. G&W also owns a fair bit of plant, property and equipment. Part of the property/land lies on the Indonesian island of Batam. Due to potential geopolitical risks and short 30 year lease, the full value of such properties may not be realisable. In view of the foregoing, a generous discount of 40% is applied to the recorded value of PP&E. This yields S$0.17 per share.

It would be ideal if the valuation ended here. However, G&W has sizable amount of debt on its books. Its total liabilities amount to S$0.82 per share. The above yields a net valuation of S$0.37 per share. At the current market price of $0.18, it appears to offer a margin of safety of about 50%.


Sunday, February 12, 2006

Show me the Oil!

Are the days of cheap oil over? The question hogged the business headlines for much of 2005 and the issue was brought to the fore again with Matthew Simmons' new book. But Mr Simmons' hypothesis of a "peak oil" theory isn't novel. Geophysicist Marion King Hubbert was probably the first to voice similar concerns in 1956 when he controversially predicted that world oil production would peak in 2000.

To literally drill down to the root of the pricing equation, a systematic approach to examining the determinants of price, oil's demand and supply, is necessary.

The Demand
Let's start with demand. The North America region of USA and Canada is responsible for about 33% of the world's energy consumption. Currently, Asia is placed second; guzzling about 25%. But with Asia housing the world giants of China and India, it is expected that Asia will double its energy needs while demand in the US will increase by about 25% by 2020. Already, consumption in a rapidly industrializing China has rapidly outstripped its domestic production levels as the former increases exponentially. In fact, China became a net importer of oil in 1993. In India's case, it has already been a net importer for the past decade.

For years, engineers and scientists have touted the viability of alternative sources of energy which, when they come on stream, should reduce the demand for oil. However, it is not particularly clear that clean and safe alternatives such as solar, wind energies have proven to be commercially viable and may be produced on a mass scale. Even when they do, the question of time comes in for these technologies cannot be mass produced over night at a cheap price to penetrate and replace products which oil power. As with all products, the initial prices of such advances are expected to be high as firms need to recoup their R&D expenditures.

Instead, what I suspect has increased is the number of drivers who zip around with larger capacity cars (think SUVs which guzzle oil) and increased flights following the proliferation of cheap air travel. While budget air travel is common in Europe and USA, it is only starting to take root in certain parts of Asia. With increasing affluence levels, it is expected that Asians' appetite for automobiles and air travel will increase.

The Supply
What about supply then? Is it on the wane? The largest oil exporter is Saudi Arabia who churns out over 8 million barrels each day. The Saudis have claimed that there is a fair bit of reserves in their fields. As pointed out by several "peak oil" proponents, the numbers have not been independently audited, thereby raising questions on their authenticity. And because OPEC's current export quotas are pegged to the levels of members' reserves, there appears to be perverse incentive to artificially inflate the claims. Coupled by the fact that there are no great discoveries of oil fields for the last 35 years internationally, the nagging suggestion that oil is depleting simply cannot go away.

It is ironic that much of the oil exporters are located in the Middle East region where many states share a love-hate and yet symbiotic relationship with the West. From the religious angle, this geographical region embed potential flashpoints. The rise of certain pockets of Islamic extremists, whose views are certainly not representative of the larger Islamic community, is worrying for it threatens to polarize nations. As things stand, tension between the West and Islam probably sits on a tight balance and pushing the wrong buttons repeatedly won't do matters any good - think the current situation in Europe (Denmark).

Other than the Saudis, the Iranians (4th largest exporter) also chip in by exporting about 2.5 million barrels a day. But the Iranians have ruffled the feathers of some super-powers by insisting on pursuing nuclear enrichment work, arguably for energy purposes only. One wonders whether there will come a day when tensions between the Muslims and the West deteriorate to the point in that oil will be used as a weapon? Is there a risk of the oil tap being turned off as a form of retaliation? Risk has no religion but religion has risk.

In recent years, I have traveled to the Middle East. Skyscrapers are abound in Dubai. Qatar is rapidly modernizing and Bahrain has embarked on an ambitious billion dollar project to construct a US$2 billion financial harbor on largely reclaimed land. These ambitious projects are undoubtedly fuelled by their oil wealth and these states seem intent on developing an alternative pillar in their economies. The conspiracy theorist in me cannot help but wonder whether the increased urgency to devote increased attention to growing an alternative sector in financial services stems from knowledge that oil supplies may run out? Indeed, some quarters venture that Dubai's oil may dry out in as early as 2010. Recently, it got increasingly worrisome when the industry newsletter Petroleum Intelligence Weekly ran an expose suggesting that Kuwait had overestimated its oil reserves.

With limited domestic supplies, China has turned its sights overseas for more. As the old saying goes, "actions speak louder than words". China has gone out of its way to cultivate good relations with oil producers in their bid to secure their oil supply. Without the ideological baggage that besiege Western nations, Beijing has demonstrated that it is prepared to close deals with countries which the West may shun due to human rights or ethical reasons. Case in point: The Chinese has secured a multi billion stake in a Nigerian offshore oil field. It has also done a deal with Petro Kazakhstan and has secured rights to prospect and import in Algeria. Also, have we conveniently forgotten that CNOOC attempted to purchase a stake in a US oil corporation in 2005?

Whilst the supply picture for oil appears bleak, there have been suggestions that there may be substantial oil deposits under Canada. The reports could well be true but the issue here, from what I gather, is that extracting them will not be a piece of cake. Apparently, the oil deposits are fused with sand. Thus, extracting them will be a technological feat. Just as technology served up the diamond drill bit to enable deep sea drilling, it is likely that the day will come to allow the extraction from oil from difficult deposits or far flung corners. But the issue could well be that the world has to tolerate inflated oil prices before the day arrives.

Let's also not discount the supply chain bottleneck which could cause oil prices to spike. When was the last major oil refinery built in USA? I believe it was several years ago and no new capacity has come abroad on existing ones. Essentially a bottleneck situation could arise if any of the refineries should fail due to a terrorist attack or be affected by a natural disaster. Scenarios not entirely impossible with the heightened security concerns internationally and the increased frequency of hurricanes affecting USA (think Katrina).

The Positioning
The demand and supply scenarios are set out very starkly above. So what's the lowdown? Will there be inflationary pressures? The recent Fed statement, the last presided over by Mr Greenspan, suggested that core inflation remained manageable. But is core inflation, which exclude oil figures, truly reflective? Should the nightmarish scenarios for oil pan out, there could well be an oil led inflation. And history suggests that equities do not perform when prices of commodities such as oil surge [Link to previous post on market cycles].

A critical appraisal of the holdings in one's portfolio may be necessary. In particular, it may pay to be more cautious towards the raw materials used by the companies which one invests in. For example, plastic OEM manufacturers which have no pricing power may see their margins squeezed if oil prices spiral. Prices of oil by-products such as plastic resins could escalate and erode margins of manufacturers of plastic thin films too.

Many macroeconomic predictions have gone awry. The above demand and supply analysis could have been overly pessimistic and I am no petroleum expert. Despite the grave uncertainly in the oil picture, it is clear that to increase the probabilities of being successful in investing will require a sound grasp of one's circle of competence and purchasing only in attractively priced companies within it. Understanding your companies inside out and outside in, knowing how high prices of oil will affect it, could well make the difference between holding a sinker or a multi-bagger in one's portfolio.


Thursday, February 09, 2006

Hotung - No longer as hot.

What a coincidence in timing! When this blog highlighted the run up in Hotung yesterday, Third Avenue Management disclosed to the Singapore Exchange on the same evening that it was winding down its position in its counter. Third Avenue now holds 7.51%, down from 8.02%. Was yesterday's sell down by Third Avenue a prelude to further reductions?

Our original posting in Nov 05 asked whether "Will HIH prove to be another gem in the bag for Amit?" The current gross return appears to suggest so!


Tuesday, February 07, 2006

Hotung on the roll

This blog first mentioned how attractively priced Hotung Investments was on Nov 05, 2005 in a post titled "Bargain Technology VC" [Link to post]

Then, the Taiwanese company was trading at US$0.09. In recent weeks, market sentiment towards the counter has improved significantly. It closed at US$0.14 today. This represents approximately a 55% gain over a space of 3 months!

As noted in the earlier post, Third Avenue holds a substantial stake in HIH and this must also represent a fruitful position for them too!