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Cash Flows and Latitude Tree Holding Berhad kcchongnz
Cash Flows and Latitude Tree Holding Berhad
When assessing the viability of investing in a stock, most people look at earnings, how much is the net profit or earnings per share of a company and decide in a quick and easy way based on price-earnings ratio. However there are a lot of rules companies can follow to reduce earnings or at times inflate them.
For example in 1997, Sunbeam reported $189 million income came from accounting fraud by using channel stuffing and improper recognition of revenue on contingent sales and indulging in improper buy and hold sales and incorrect accounting for supplier rebates.
A construction company can also inflate its earnings by booking claims of doubtful work done and variation works which are not yet or may not even recognized by the clients in accordance to terms in the contract. These claims are grouped in the receivables in the balance sheet.
In both cases above, there was no cash received by the company but just merely accounting numbers. The level of gaming that can be done to earnings makes some investors jittery about trusting earnings.
The job of every company is to make money, and there is no money like cash. Cash flow can let you assign a quality to earnings. Cash flow from operations (CFFO) available in the cash flow statement is the purest inflow and outflow of cash in relation to actually doing business. From a company health perspective it is one of the most important measures
Companies require capital expenses (capEx) in purchasing and upgrading plant and equipment for growth. The money is not gone. It is carried on the balance sheet as an asset. The end goal is for the company to generate a return on the asset. Free cash flow (FCF) is what is left after those expenses.
Free cash flow is like the end all goal of companies. The point is to do so well that you make so much money that even after all the checks written to expand the business you still have a lot of cash. Cash is pretty much the most important thing, and FCF is the most flexible kind of cash there is. With this FCF a company can pay out dividend consistently, buy back its shares when they are selling cheap, pare down loans, or invest in other profitable ventures, all done without assuming more debts.
There are some companies doing so well that even after heavy expansion they have a lot of cash left over. Latitude Tree is one of them.
Cash Flow of Latitude Tree
Latitude Tree Holdings Berhad (LT) specializes in the manufacturing and sale of wooden furniture and components, particularly rubber-wood furniture. Its manufacturing activities are operated from its three factories in Malaysia, two factories in Vietnam and one factory in Thailand. It exports 99% of its products mainly to the United States.
For the financial year ended 30th June 2013, LT’s revenue fell marginally by 5% to RM494 million. However, its margin exploded with gross margin improved by 40% to 14.4%. Net profit margin more than doubled to 6.5%. With that its net profit improved by 116% to 32m, and earnings per share (EPS) ballooned by 145% to 25 sen. Thanks to the lower cost of production in Vietnam.
At the close of RM2.57 today, the PE ratio is 10.3, not that cheap considering the industry average and its historical PE ratio. The attractiveness of investing in LT actually lies in its cash flow.
The quality of earnings of LT is very good as evidenced from its CFFO which is double of its reported earnings as shown in Table 1 in appendix below. After spending 5.2m in CapEx, FCF is abundant at 47.8m last financial year. This is 10% of revenue and 18% of invested capital (IC), in hard cash. It is like when you invest $10000 and you receive $1800 in cash end of the year.
Valuation of Latitude Tree using Free Cash Flow
Financial theory postulated by John Burr Williams in his “The theory of investment value” suggests that the value of a stock is worth all of the future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate. This is similar to what Seth Klarman described as the Net Present Value analysis in his book “Margin of Safety” which he said is the most appropriate method to be used to value a company of on-going concern. Arguably the best reason to like DCFA is that it produces the closest thing to an Intrinsic Value.
Anyone who is interested in this method can refer to the case study on Pintaras as shown in the appended link below:
http://klse.i3investor.com/blogs/kcchongnz/46864.jsp
Using the FCF of the fy ended 30th June 2013 of 47.8m, a growth rate of 5% for the next 10 years and 3% subsequently, and a discount rate of 10% as it has a reasonable healthy balance sheet, the FCF attributed to common shareholders is RM6.13 per share as shown in Table 2 in the appendix. This represents a very wide margin of safety of 58% investing in Latitude Tree at RM2.57 at the close on 11th March 2014.
Quarterly results of Latitude Tree on 31st December 2013
Subsequently on 23rd February 2014, LT announced its second quarter results ended 31st December 2014. Its cumulative 6 months revenue and EPS has increased by 38% and 138% respectively compared to the previous corresponding two quarters. LT’s excess cash has also increased by 68% from 68.5m to 115m. Best of all, its CFFO and FCF has also increased both by 26m to 42.2m and 38m respectively for the two quarters.
With its already stellar cash flows for the last fiscal year, coupled with its vast improved quarterly results in its financial position, financial performance and cash flows, latitude Tree at RM2.57 offers an excellent investment opportunity.
K C Chong (12/3/14)
Appendix
Table 1: CFFO and FCF of Latitude Tree
|
Year |
2013 |
2012 |
Average |
|
CFFO |
52921 |
36746 |
44834 |
|
CapEx |
-5166 |
-13824 |
-9495 |
|
FCF |
47755 |
22922 |
35339 |
|
CFFO/NI |
165% |
247% |
206% |
|
FCF/Revenue |
10% |
4% |
7% |
|
FCF/IC |
18% |
8% |
13% |
Table 2: Discount cash flow analysis of Latitude Tree
|
PV of FCFF |
$814,000 |
|
Add cash |
$68,487 |
|
Less debts |
($98,567) |
|
PV of FCFE |
$783,920 |
|
Less minority interest |
($187,871) |
|
FCF common shareholders |
$596,049 |
|
Number of shares |
97208 |
|
FCF per share |
$6.13 |
|
Margin of safety |
58% |
Gordon Constant Growth Model
Assuming the FCF grows at 3% forever in accordance to rate of inflation. Discount rate (r) as before at 10%, and the base FCFo of last year of RM47.8m.
|
PV FCF= |
FCFo*(1+g)/(r-g) |
|
PV FCF= |
702681 |
|
|
Add cash |
$68,487 |
|
|
Less debts |
($98,567) |
|
|
PV of FCFE |
$672,601 |
|
|
Less minority interest |
($187,871) |
24% |
|
FCF common shareholders |
$484,730 |
|
|
Number of shares |
$97,208 |
|
|
FCF per share |
$5.00 |
|
|
Discount |
48% |
The intrinsic value of latitude is RM5.00 per share. This represent a margin of safety of 48% investing in Latitude at RM2.57 a piece.
A ballpark analysis of corporate exercise on LTIGL
The proposed acquisition of all subsidiaries of LTIGL by LT was completed on 23rd January 2014 as shown in the link below:
http://www.bursamalaysia.com/market/listed-companies/company-announcements/1524261
As at 31st December 2013, LT has a total cash of about 155m and an excess cash of 115m. That was enough to pay off the acquisition of all the subsidiaries of LTIGL of RM118m. Assuming LT maintains a debt-to-equity ratio of 0.36 as previously used for the analysis, all the present value of RM814m FCF now belongs to the common shareholders and there is no “excess cash” now as before. The computation of intrinsic value would be as follows:
|
PV of FCFF |
$814,000 |
|
Add cash |
$0 |
|
Less debts |
($139,000) |
|
PV of FCFE |
$675,000 |
|
Less minority interest |
$0 |
|
FCF common shareholders |
$675,000 |
|
Number of shares |
97208 |
|
FCF per share |
$6.94 |
This intrinsic value of LT of RM6.94 is more than the previously computed figure of RM6.13 per share.
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Discussions
2 people like this. Showing 21 of 21 comments
Lii Hen may be cheap in term of valuations. But I ranked it behind Homeritz and latitude as an investment option as shown in the link below:
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/40360.jsp
It has nothing to do with the 2004 saga but mainly because of its relatively poor cash flows, especially free cash flow due to big capital expenses last year.
But most of all when the last quarter results were announced, most furniture companies made huge increase in revenue and net profit, eg Latitude, Hevea and Homeritz, Lii Hen had its revenue and profit decreased during the same period. This could be the main reason for the relatively poor performance of its share price.
Dividend yield is not my priority in selecting stocks.
2014-03-12 13:27
Gordon Constant Growth Model
Assuming the FCF grows at 3% (g) forever in accordance to rate of inflation. Discount rate (r) as before at 10%, and the base FCFo of last year of RM47.8m.
PV FCF= FCFo*(1+g)/(r-g)
PV FCF= 702681
Add cash $68,487
Less debts ($98,567)
PV of FCFE $672,601
Less minority interest ($187,871) 24%
FCF common shareholders $484,730
Number of shares $97,208
FCF per share $5.00
Discount 48%
The intrinsic value of latitude is RM5.00 per share. This represent a margin of safety of 48% investing in Latitude at RM2.57 a piece.
2014-03-12 17:02
Mr Kcchongz,
Can you elaborate how to get the figure for minority interest of 187871?
2014-03-13 10:06
Posted by miketyu > Mar 13, 2014 10:06 AM | Report Abuse
Mr Kcchongz,
Can you elaborate how to get the figure for minority interest of 187871?
This is how I did it.
In the financial year ended 30th June 2014, Latitude Tree made 32m in net profit. 7.7m, or about 24% belongs to the minority shareholders. Hence the intrinsic value of LT computed, 24% belong to the MI.
2014-03-15 17:57
Latitude is one of my favourites. I did not see the details though.
I think they just bought some or all MI over by taking the SGD unit private. So, cash will go down as it has been used to pay for that corporate exercise, while MI will go down or disappear. These two variables need to be used in your FCF calculation.
LT seems to be far ahead in moving towards OBM from OEM, in the process lifting its margin convincingly.
Market prices furniture companies lowly perhaps their earnings can be volatile. But LT seems to have broken from the past and entered into a new phase.
The risks I see about LT is to understand more about the timing of the costing practiced by the management. Some companies put a lot of provision for different costs like managmeent and staff bonus, etc only in the last quarter while others in certain 2 quarters. It is unclear if LT spread all cost accrual evenly throughout the year.
The second risk is Vietnam's country risk. Its currency can be volatile and its communist government may act erratically sometimes politically.
I expect LT's EPS to go down in next 2 quarters from the previous one. Still, it should fetch a fair value of RM3.50 a share.
Dividend yield for Liihen is 8.5% at the current price. I hope it will go down so I can buy more, together with some LT, but the high dividend yield now provides a strong suppport for Liihen's market price currently.
I love dividend and even if Liihen cut dividend by half due to economic crisis, I will still get 4.25% yield out of it at the current price.
2014-03-15 20:50
Posted by sense maker > Mar 15, 2014 08:50 PM | Report Abuse
“I think they just bought some or all MI over by taking the SGD unit private. So, cash will go down as it has been used to pay for that corporate exercise, while MI will go down or disappear. These two variables need to be used in your FCF calculation.”
Thanks for the comments.
A ballpark analysis of corporate exercise on LTIGL
The proposed acquisition of all subsidiaries of LTIGL by LT was completed on 23rd January 2014 as shown in the link below:
http://www.bursamalaysia.com/market/listed-companies/company-announcements/1524261
As at 31st December 2013, LT has a total cash of about 155m and an excess cash of 115m. That was enough to pay off the acquisition of all the subsidiaries of LTIGL of RM118m. Assuming LT maintains a debt-to-equity ratio of 0.36 as previously used for the analysis, all the present value of RM814m FCF now belongs to the common shareholders and there is no “excess cash” now as before. The computation of intrinsic value would be as follows:
PV of FCFF $814,000
Add cash $0
Less debts ($139,000)
PV of FCFE $675,000
Less minority interest $0
FCF common shareholders $675,000
Number of shares 97208
FCF per share $6.94
This intrinsic value of LT of RM6.94 is more than the previously computed figure of RM6.13 per share.
“The risks I see about LT is to understand more about the timing of the costing practiced by the management. Some companies put a lot of provision for different costs like managmeent and staff bonus, etc only in the last quarter while others in certain 2 quarters. It is unclear if LT spread all cost accrual evenly throughout the year.”
The analysis was done using the year-end financial results as at 30th June 2013. It is not annualized data from quarterly results. Hence this should not be an issue.
“The second risk is Vietnam's country risk. Its currency can be volatile and its communist government may act erratically sometimes politically.”
Volatility of Vietnamese currency works both ways. It would be good if it goes down as the cost would be lower and vice versa. We just don’t know which direction it goes. Political risk is real though.
“I expect LT's EPS to go down in next 2 quarters from the previous one. Still, it should fetch a fair value of RM3.50 a share.”
I don’t know if its EPS, and as a result its FCF will go down the next two quarters (January to June 2014), but for the first two quarters (July to December 2013) already show revenue and EPS has increased by 38% and 138% respectively compared to the previous corresponding two quarters. Best of all, its CFFO and FCF has also increased both by 26m to 42.2m and 38m respectively for the two quarters.
These improvements have not been incorporated in the analysis above.
2014-03-16 06:11
KC,
According to BursaD article, Latitude will only need to pay SGD2.3mil cash for the acquisition, the balance of SGD46.4mil will be settled by way of set-off against the capital due to be returned to Latitude Tree.
http://bursadummy.blogspot.com/2013/12/furniture-stocks-draw-attention.html
My understanding is that the SGD2.3mil is probably the goodwill as a result of the acquisition ? Overall, Latitud Tree cash holding will still deplete as what you explain ? I dont believe that the whole acquisition exercise will only cost SGD2.3 mil ? What is set off against capital ?
2014-03-16 09:43
Most cash was held in the balance sheets of the subsidiaries which was consolidated in LT's balance sheet. After the corporate exercise and setting off, the cash balance in LT's balance sheet will be reduced accordingly. There won't be much cash in LT's balance sheet after the privatization of the subsidiaries.
I am just guessing. Sense maker is the best person here to explain that.
The Revised Purchase Consideration shall be satisfied in the following manner:-
(i) by way of set-off against the capital due to be returned to LTHB amounting to the sum of SGD46,444,200.00 following the cancellation of 186,000,000 ordinary shares in LTIGL held by LTHB pursuant to a selective capital reduction exercise proposed to be carried out by LTIGL (“Proposed SCR”) within four (4) weeks (or such other timeframe as LTHB determines in consultation with LTIGL) after the satisfaction of all the conditions precedent (“Completion Date”) as stipulated in the Offer Letter; and
(ii) the balance of the Revised Purchase Consideration of SGD2,305,800.00 to be paid in cash (“Cash Portion”) on Completion Date.
2014-03-16 11:12
1) Consolidated Cash balance of LT had gone down by RM26.3m (117.7*22.38%), post privatisation of LTI. LT had paid this RM26.3m to MI of LTI. The SCR was done to move all subsidiaries from LTI to LT directly, to disburse the money to MI of LTI and to subsequently close LTI thereafter. The S$2.3m cash settlement was just to take care of the upward revision in offer price of LTI's privatisation.
2) Net asset of S$63.5m as at 31.12.13 in LTI's subsidiaries had been sold for S$48.7m on 23.1.14, resulting in negative goodwill on consolidation (it is like a discount LT got in buying over MI) in LT of around S$14.8, post privatisation of LTI, subject to it being deducted for the profit made by LTI from 1.1.14 to 22.1.14.
3) MI in LTI was 2.41*63.5m*22.38%= RM34.3m as at 31.12.13. MI will therefore go down from RM54.5m to RM20.2m post privatisation of LTI.
2014-03-16 15:19
sense maker,
Thanks for explanation. But I m still a bit blurr about some of your comments
1) Consolidated Cash balance of LT had gone down by RM26.3m (117.7*22.38%), post privatisation of LTI. LT had paid this RM26.3m to MI of LTI. The SCR was done to move all subsidiaries from LTI to LT directly, to disburse the money to MI of LTI and to subsequently close LTI thereafter. The S$2.3m cash settlement was just to take care of the upward revision in offer price of LTI's privatisation.
So you re saying that the cashpile will only reduce by RM26.3m + SGD 2.3m instead of SGD48.7m ? That means the offer of SGD48.7m was referring to the entire stake of LTI and not just the 22.38% stake that LTH does not own ?
3) MI in LTI was 2.41*63.5m*22.38%= RM34.3m as at 31.12.13. MI will therefore go down from RM54.5m to RM20.2m post privatisation of LTI.
I thought that LTI was the only direct subsidiary of LTH that wasnt 100% controlled. In this case if LTH buys over remaining 22.38% stake, wont be minority interest for LTH be 0 ?
2014-03-16 16:18
The following adjustments made to KC's second attempt of valuation.
1. Cash holding adjusted to RM36.6mil based on sense makers comments on the total acquisition cost.
2. Debt maintained
3. Minority interest set to 0
"Table 2: Discount cash flow analysis of Latitude Tree
after acquring LTIH"
PV of FCFF 814000
Add cash 36644
Less debts -98567
PV of FCFE 752077
Less minority interest 0
FCF common shareholders 752077
Number of shares 97208
FCF per share 7.74
Margin of safety 68%
2014-03-16 16:35
thanks mr kcchongz. fully understood. But some company balance sheet states minority interest as negative. How to derive FCF for minority interest from that?
2014-03-16 17:34
houseofordos,
According to sense maker, the MI of LT is reduced, not zero now. You got to figure out how much in percentage term is earnings attributed to MI and hence the intrinsic value of LT stock.
2014-03-16 17:36
KC,
Was actually waiting for sense maker to clarify on that point of minority interests not being 0. My understanding is that minority interests only exists if there are non-100% controlled subsidiaries. But from the org chart of Latitud, LTIL was the only subsidiary which LTH did not fully control, so if LTH was buying up the remaining stake, then why is there still minority interest ?
2014-03-16 18:02
LTI is now a shell company. Its net assets are solely cash of about RM26.3m (i.e with the cash balance already in LTI's company level before the deal plus the $2.3m from LH in the deal). LTI has noting to do with LT anymore, and there may be cash dividend given to minority shareholders of LTI before the deal (note: they are all the shareholders of LTI after the deal). LTI may or may not keep its listing status and may get injection of new biz into it. The only thing MI in LTI can hope is for reverse take over by some other companies of LTI.
I did not look at the structure previously. MI should be nil post deal. As LTI made very good profits from 1.1.2013 to 31.12.13, MI in LTI suffered a big blow from LT by not getting to share those 2013 profits, they are getting just Rm26.3m out of a net book value of RM54.8m as at 31.12.13.
MI of 22.38% in LTI is complaining but LT pushed the deal through. It is a super-good deal for the LT shareholders, unfair to the MI of LTI.
2014-03-17 01:23
Thanks again KC, i bought Latitude at 2.60 two weeks back. Eyeing quiet sometime on the price after your post. Thanks
2014-05-02 19:48
coolio, and also Miketyu, houseofordos, nice to see all of you here. And hope you all have bought Latitude at RM2.57 then.
2014-05-02 19:52
yeah. thanks mr kcchongz. bought a little only due to limited resources. Heart pain to see it soar so high. haha
2014-05-02 19:55
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This book is the result of the author's many years of experience and observation throughout his 26 years in the stockbroking industry. It was written for general public to learn to invest based on facts and not on fantasies or hearsay....
miketyu
Have you had a look at Liihen? is there any problem with the company balance sheet? Ev/ebit around 3.7 div yield 7% and yet nobody dare to buy that company. Is it the investors still haunted by the history in 2004 that the directors con the money of investors?
2014-03-12 11:26