Sunday, May 26, 2013

Who is Mispriced?

DKSH AG (DiethelmKellerSiberHegner) is a Zurich headquartered group which functions as an outsourcing partner to businesses seeking to expand in new or existing markets. They specialize in organizing and management of the entire product value chain - from research, sales, logistics to distribution. Their business activities are organized into four broad areas of expertise; namely: consumer goods, healthcare, performance materials and technology.

Leveraging on its nearly 150 years of experience, the group has a phenomenal global reach in 35 countries; including 660 locations in Asia Pacific. Having generated c. 8.8 billion in sales in 2012, DKSH AG is ranked as one of the top 20 Swiss companies (by sales and employees). The group also generated free cash flow of CHF249 millions in 2012.

DKSH AG went public in March 2012 on the SIX Swiss Exchange at an IPO price of CHF48 a share (or 18x of its 2011 net profit). Investors took favorably to the stock, probably due to its exposure to Asia. As on 26 May 2013, DKSH AG traded at CHF74.50, at 1.5x of its IPO price. Due to its management quality and history of growing its EBIT, the market accorded DKSH AG a 23x price to earnings multiple.

Interestingly, DKSH AG has a Malaysian subsidiary which listed on Bursa Malaysia in 1994. This entity, DKSH Malaysia contributes c. 14% to DKSH AG's total revenue. In Malaysia, it represents over 130 clients and distributes their products to over 13,000 sundry shops, hypermarkets and hospitals. Backing up its extensive network, DKSH's operations is supported by 18 regional offices, four distribution centres and seven regional warehouses scattered throughout Peninsular and East Malaysia.

Our Malaysian readers who live in Petaling Jaya will be familiar with the brands DKSH manages due its occasional warehouse stock clearance at Jalan University. For the uninitiated, the suite of brands it represents in Malaysia are testimony to DKSH's capabilities. They include Abbott, Boh Tea, Darlie, Ferrero, Indocafe, Mars, Quaker, Roche, Sanofi-Aventis, Wyeth. Its food segment also operates the Famous Amos Chocolate Chip cookie.

As it is essentially a distributor, its net margins is not large (c. 2%). However, it relies on pushing increasing volume through its very wide ranging and entrenched network. It also leverages on its global relationships to bring new products into emerging markets like Malaysia. For example, in Jun 2012, DKSH and Hershey's inked an agreement to provide sales, distribution and logistics services for the latter's chocolates and Bubble Yum gum in Malaysia.

For such an exceptional and storied company, DKSH Malaysia is trading at c. 14x of normalized earnings (stripping out exceptionals at RM860 million market capitalization) despite a strong run up. Given the quality of earnings and the segment DKSH Malaysia is operating in, applying a multiple closer to Swiss parent is not unrealistic. Assuming DKSH Malaysia trades at 23x, it would be a RM1.4 billion market capitalization on historical earnings. This implies a share price of RM9 per share (66% upside from current price of RM5.44). We had not factored in any earnings growth, a distinct possibility given its track record. Given the consumer and healthcare goods its handles, the resilience and growth potential of its earnings cannot be underestimated either.

Accumulating a large stake could be challenging as the stock suffers from low free float.  DKSH AG (75%) and Lembaga Tabung Angkatan Tentera (LTAT) (Malaysia Army pension fund) owns c. 85% of the company. LTAT is also DKSH Malaysia's bumiputera partner since 1991. Applying a liquidity and size discount on 20x earnings, DKSH Malaysia's fair value could be around RM7.80. Even at DKSH AG's IPO multiple of 18x, we are looking at RM7.06 per share fair value or 30% upside for DKSH Malaysia.

The above calculations obviously assumes DKSH AG is correctly priced at 23x. The converse could well be true, as in the valuations of DKSH AG is too high, rather than DKSH Malaysia being too cheap! That's the challenging of justifying using relative multiples. Perhaps, the truth is - where we believe it lies - somewhere in between 14 - 23x? Only time will tell. 


Soar Like Great Eagle

Langham Hospitality Trust (LHT), a fixed single investment trust, is anticipated to make its debut on HKEx on 30 May. Book building this week priced LHT at 6% a year, somewhat middle of the marketing range of 5.7 - 6.6%, implying a market capitalisation of c. HK$10 billion.

Its parent entity, Great Eagle (41 HK) should benefit from an uplift in sum of parts valuation. It is trading at a huge discount of 40% to book.
Post the spin off, Great Eagle would have net cash of HK$3.7 billion (assuming 51% ownership of LHT). The hotel management and licensing fees from LHT will also augment its recurring income stream from Champion REIT.

Furthermore, Great Eagle is anticipated to use part of the proceeds to fund its overseas hotel expansion plans. Great Eagle currently has four hotels in North America, including Langham hotels in Chicago, Boston and LA. One is under development in New York. The Singapore market has been receptive to its REITs holding offshore assets. For example, Ascott Residence Trust has assets in UK, Spain and other parts of Europe. Over the longer term, Great Eagle could inject its American assets into LHT.

In the nearer horizon, given its strong balance sheet at net gearing of 1%, Great Eagle should be in a good position to make a substantial payout. Its shareholders were rewarded following two earlier divestments (2006: 29% payout for Citibank Plaza to create Champion REIT and 2008: 53% payout when Langham Place mall and office was sold into Champion REIT subsequently).

The controlling Lo family still owns c 61% of Great Eagle, so we anticipate a sizable payout closer to the upper end of the range of HK$ 5 - 10 per share. Hence, Great Eagle at HKD33.70 remains a hold at least until its interim results in August 2013 when the special dividend could be announced.


Saturday, May 11, 2013

Next Better Player

Margin of Safety suggested initiating a position in Lian Beng Group (LBG) in February 2012 at S$0.39 per share. LBG has since had a good run to S$0.515 (close of 11 May 2013). Whilst it is inexpensive from a PER perspective, it is now at a premium to its NAV of S$0.47 per share.

Looking ahead, LBG's recurring income will increase as its workers dormitory at Mandai fills up and it could still surprise with more construction contracts win. What we are uncomfortable about is its stakes in the property projects.  Whilst small by our sum of parts estimate to LBG, sentiment could weigh on the counter as we expect the Singapore residential market to weaken considerably from here for several years. Word on the possible spin off of its engineering and machinery division on the Taiwan Exchange has also gone cold.

Having rode out a total return of 37% (c. 32% capital gain + 5% dividend yield) in 15 months, we recommend switching into other construction counters to ride the development boom in Singapore.