kcchongnz blog
Is V.S Industry Cheap Cheap? kcchongnz
This article is for sharing of knowledge. It doesn’t constitute a buy, or a sell call.
There are a number of aspects of the company a smart investor have to look at before investing in the company. I have written about them in the link below, following the twelve tenets of Warren Buffet written by Robert G. Hagstrom:
http://klse.i3investor.com/blogs/kcchongnz/52152.jsp
Basically when buying a stock, you should take the same approach as you would if you were buying an entire business. The only difference is that instead of buying the whole of the business, or a partnership in the business, you are only buying a tiny share.
Smart and savvy businessmen when buying a business will seek answers to the questions below to check if that is a good business:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the business have favourable long term prospects?
- How good is the management?
- What is the return on equity?
- What are the profit margins?
The above is just part 1 of the exercise to determine if that business is a good business. However this was what Peter Lynch said:
“Wonderful companies become risky when people overpay for them.”
Those who have invested in Amazon in the year 2000 at the adjusted price of about $100 then would have to wait for another 10 years for them, just to recoup their losses, forget about the huge interest and other opportunity costs lost.
Go ahead to chase share price following the greater fool theory, ignore value at your own peril.
To decide on to buy or not to buy shares, there are basically two factors to consider:
- What is the value of its business?
- Can the business be purchased at a significant discount to its value?
This is where you determine whether the company is a good value and should be purchased.
The link below shows a simple discount cash flow analysis to estimate the value of a company and the margin of safety investing in the stock.
http://klse.i3investor.com/blogs/kcchongnz/54146.jsp
What is the value of V.S Industry?
In this analysis, we attempt to use a simpler market valuation technique to value V.S.
Leaving those who only focus on price action alone, instead of value, aside, most investors will look at the market valuations metrics of a company as shown in Table 1 below. The valuation metrics of V.S were worked out based on its trailing twelve month financial performance up to 31st January 2015.
Table 1: Some simple ratios of V.S for ttm 2015
|
Company |
V.S |
|
Price |
4.33 |
|
Price-to-book |
1.4 |
|
Price-to-earnings |
9.5 |
|
Price-to-sales |
0.5 |
|
Price-earnings growth |
1.9 |
|
Price-to-CFFO |
8.0 |
All metrics above show V.S is inexpensive. In fact if you were to use technology stocks as benchmarks, it is rather cheap, especially the PE ratio of 9.5. However, it is arguable whether technology is the appropriate benchmark for V.S. If you flip the PE ratio over, you get an earnings yield of about 10%, not bad too compared to fixed income return of about 4%-5%. Assuming an expected growth rate of 5%, the price of V.S valuation is slightly on the high side at a PEG of 1.9. Again I would be terribly underestimating it if the actual growth rate is say 20% for the next 5 years.
Price-to-book at 1.4 is not cheap too considering the poor quality of assets, about 85% in PPE, inventories and receivables, and its latest mediocre return on equity of 10.8%, is below my personal requirement of 12% for a company like V.S. Price-to-CFFO of 8.0 is alright, if you ignore its persistent high capital expenses requirement. Dividend yield of 1.4%, or 6 sen for the present share price of RM4.33 is rather low though.
As V.S has substantial debts amount to 45% of equity, and also substantial minority interest, the valuation metrics as shown in Table 1 above just base on equity are not good enough. Table 2 below shows the more appropriate valuation metrics based on the whole enterprise value.
Table 3 in the Appendix shows the computation of the enterprise value of V.S based on its closing price of RM4.33 on 22nd May 2015.
Table 2: Enterprise valuation
|
EV |
1298965 |
|
EBIT |
111325 |
|
Tax rate |
24% |
|
NOPAT |
84607 |
|
NOPAT/EV |
6.5% |
The after-tax earnings yield for the enterprise, (NOPAT/EV) of 6.5% is a little low. I would expect an earnings yield of 10% for my investment, considering the risk of equity investment.
What about its cash yield for equity shareholders, or FCF/Price I talked about here?
http://klse.i3investor.com/blogs/kcchongnz/76694.jsp
We recall that V.S had no free cash flow for the last three years. However, its FCF for the latest two quarters have improved tremendously. The FCF for the last twelve months (ttm) ending 31st January is RM57.7 m as shown in Table 4 in the Appendix.
Hence the ttm cash yield, CY = 57.7/889105 = 6.5%. This CY is acceptable as it is above bank fixed deposit rate, if this continues.
Is V.S a great company? Is it a great investment?
V.S has had a good round in its business performance with some great improvement for the last twelve months. I would say it is the best 12 months in its history of listing. Putting aside trying to forecast the future which is unknowable and uncertain, and taking into consideration of the power of mean reversion in all businesses, we find the performance of V.S is ok lah with ROE of 10.8%. It is certainly not a lemon, but not that great too, at least to me, as I can find many great businesses with ROE of more than 15%, or some even more than 30%, and more consistent too.
“Investment success doesn’t come from “buying good things,” but rather from “buying things well.””
Buying well means buying it when it is selling at a big discount to its value. At the present price of RM4.33, the enterprise earnings yield (NOPAT/EV) of 6.5%, it does not meet my personal requirement of at least 10%. Equity Cash Yield of 6.5% is ok, provided it sustain, in view of its not-so-good past.
K C Chong (22nd May 2015)
Appendix
Table 3: Enterprise value computation
|
Price |
4.33 |
|
Number of shares |
205336 |
|
Market cap |
889105 |
|
Total debt |
359608 |
|
MV of MI |
264573 |
|
Cash |
-201751 |
|
Other NOA |
-12570 |
|
EV |
1298965 |
Table 4: Cash flow of V.S
|
Ttm CFFO |
111432 |
|
Net PPE |
-53764 |
|
Free cash flow |
57668 |
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| Chart | Stock Name | Last | Change | Volume |
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Discussions
2 people like this. Showing 17 of 17 comments
someone posted - 'a picture says a thousand word'..so it only matches a thousand word.
a person who comments w/o any biases..and who has proven his integrity..time an time again..
..with his 'one word'...you may not even need 'to see' to get convinced!...he he he
thanks KC :)
2015-05-22 22:27
MoneyFace88, EVERGREEN can give VS a tough fight in the next 6-12 months...Why? Its controlling shareholder cum management had spend considerable money and time to empower its biz model that will in future sustain its competitive advantage cum sustains its EPS growth...
2015-05-22 23:18
I will always put tremendous premium on the the strategic mindset of the controlling shareholder/shareholders that invest its free cash flows to improve upon its biz model that will empower it to earn increasing profits that result in increasing EPS...
It is quite simple biz strategy really....invest free cash flows to improve on its biz model that empowers the company to earn good cashflows that sustain its competitive advantage to earn increasing future EPS...
2015-05-22 23:38
I will however place great emphasis and focus on the controlling shareholder's skillsets on the strategic planning, on strategic execution of its chosen strategy to empower further its biz model being a partner to Global brand leaders. As shareholder, I wish to see VS being in the top 20 EMS producers in the next 5 years!!
2015-05-22 23:58
True there are plenty of stocks have much better financial ratios compared to VS. The question is how much room of improvement is available for those stocks. The macro economy now favours precision plastic mould & semiconductor businesses. VS is at the right spot at the right time. The numbers / ratios very likely will change from Q to Q.
2015-05-23 11:31
I like companies with debt as long as current ratio & debt to equity ratio look good. In financial language, WACC (for company with debt)is always lower compared to cost of equity (for debt free company). In layman language, We can expect double boost during the good time; increase in earning from sale & increase in earning due to lower finance cost as company continue paying up loan.
2015-05-23 11:39
Hi MF88,
Let's compare VS with 2 other technology based companies in my portfolio.
VS - http://www.klse.my/stock/result/financial/6963.jsp#stockDetailDiv
vs
VITROX - http://www.klse.my/stock/result/financial/0097.jsp#stockDetailDiv
ELSOFT - http://www.klse.my/stock/result/financial/0090.jsp#stockDetailDiv
2015-05-23 12:49
at least another 2 years the business will sustain at consistent growth as long as US dollar is strong.
2015-05-23 14:06
TOTAL ASSETS= SHAREHOLDERS FUNDS + TOTAL LIABILITIES
ASSETS= Current Assets + Non Current Assets
SHAREHOLDER FUNDS= IPO Capital + Rights issue + Private Placement + Retained Earnings(Accumulated Losses)
TOTAL LIABILITIES= Current Liabilities + Non Current Liabilities
ROA is a good performance measurement of how well any company manage its total assets.
A company will organize, utilize and manage its total assets to grow its top and bottom line over time and in that process generate sufficient profits, free cash flows to invest further in improving its biz model and/or distribute as dividends to its shareholders.
To fund its investment in ASSETS that will yield future profits, free cash flows ..a company can utilize shareholders funds and/or Debt to invest in FUTURE ASSETS that can generate incremental future income, free cash flows for the company
A long term shareholder would like the company management to invest on improving its biz model to have better competitive advantage , grow its assets and consequently generate increasing ROA, increasing cash flows. AS long as any company has the capability to generate a return higher than its weighted average cost of capital, it should employ the cash flows generated through operations to invest in improving the competitive edge of its biz model..
If the company management has run out of ideas to generate better returns on the excess cash flows generated that can yield a return above the weighted average cost of its capital then the excess cash is best returned to its shareholders.
2015-05-23 14:11
Posted by JT Yeo > May 24, 2015 06:45 PM | Report Abuse
obviously VS didnt have the capability to generate higher return than WACC
The return on capital is the thing to look at, not growth in profit. Imagine this, a company can keep on borrow money by issuing bonds or bank loans, say RM1 billion and invest in something which earns RM10m extra for the year. There is still growth in profit, isn't it? But what is the return of this marginal capital? 1%. What is the cost of this debt? 5%?
Is it shareholder value enhancing, or a shareholder wealth destroying?
Mind you, the cost of debt say 5% is cheap and if you can't beat that in your return, you are likely to grow yourself to bankruptcy as mentioned by a commentator here. The weighted average cost of capital which includes the required return of the equity shareholder is much higher than the cost of debts.
2015-05-24 21:07
all opinions ae weicome, no heart feelings. remember a chinese poem which says, the higher the mountain you climb, the colder you would feel.
2015-06-03 19:04
Hello Mr Sifu KC Chong .... from New Zealand ?
Your article very Keng , very analytical. I have learnt a lot reading this article of yours.
Then got worried and sold my V.S Share then share price moved up strongly.
Today Q2 result announced, not what you have expected, you must be disappointed
How much you charge ah to learn something from you ?
Please tell me so that I can subscribe to your tips
2015-06-24 00:05
Dear moneyface88,
Here is my response to you.
http://klse.i3investor.com/blogs/kcchongnz/78867.jsp
2015-06-24 07:37
Sifu KC, you were right. V.S was cheap cheap. Now 5.44 already, too expensive to buy liao
2015-07-14 13:14
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MoneyFace88
Mr Chong, which stock that has the same price as V.S can outperform V.S in the next 6-12 months ?
2015-05-22 21:04