Valuing excess cash: A case study on Pintaras Jaya kcchongnz

In the article appended below, we used Katsenelson’s Absolute PE valuation method to obtain a fair Price-earnings ratio of 14.9 for Pintaras. With the last earnings per share of 33 sen for year ended 30^th June 2013, the fair price of Pintaras is RM4.90. This provides a wide margin of safety of 39% for investing in the stock of Pintaras at the closing price of RM2.98 on 16^th February 2014.

http://klse.i3investor.com/blogs/kcchongnz/46422.jsp

However a closer look at the adjusted income statement in the appendix below shows that out of the total 52.3m net profit, 12.1m or 20% is from the gain on disposal of financial assets (stocks of listed companies) and income from the dividends and cash holding in banks. This income, especially for the former is non-recurring as it depends on the performance of the equity market of the year. The “actual” income from the ordinary business of construction and metal can manufacture amounts to only 55m as shown in the appendix, or about 43m after tax. This is equivalent to after-tax profit of 27 sen per share.

Hence if we are using the Katsenelson’s Absolute PE valuation, the fair price of Pintaras is about RM4.00 (14.9*0.27), instead of RM4.90 previously. But what about its cash holding which includes cash in banks and traded securities amounting to RM157m or RM1.00 per share and zero debt? Is this cash of no use at all and we should totally ignore it? Is the management likely squandering away all this cash? I don’t think so.

Financial theory postulates two motives for management to hold cash -- the transactions motive and the precautionary motive. Pintaras’s management has been saying that they need to hold cash for short-term working capital needs and future investments in new plant and equipment. But are those reasons valid for holding that huge amount of cash? With the consistent profit and cash flows from its operations, don’t you think it can get any loan from banks in case they need those cash?

In my opinion, Pintaras could distribute all this cash amounting to RM1.00 a share and will not affect the performance of its ordinary business a wee bit. As a shareholder, I would prefer to have the cash in my control such as investing myself rather than by others. In such circumstance, Pintaras’s fair value would be about RM5.00 (4.00+1.00) with its EPS of ordinary business alone of 27 sen.

In fact, Pintaras could recapitalize its balance sheet, not only distributing the excess cash, but using an optimal capitalization structure of 60:40 equity-to-debt ratio, borrowing some money from banks and distribute to shareholders, and still would not affect the performance of its ordinary business much. Its fair value could even be higher. This is because of the lower cost of debts plus the tax shield as interest charge is tax deductible for the company.

Do you think Dr Chiu will do any of the above? I highly doubt so, not until he employs this engineer (me loh) as his finance director (just kidding here). However, I am still very happy as a shareholder of Pintaras with its great performance and most of all its inexpensive price, and yes, also the huge pile of cash it has. At least I know I would be quite safe investing in its stock and good and growing dividends in the future will likely to continue. I am actually quite confident that the management of Pintaras will manage the cash well too. Somehow I am different from some super-investors who prefer the companies they invest in to have huge debts.

K C Chong (17/2/14)

Appendix