kcchongnz blog
V.S, just how much does it worth? kcchongnz
“The secret to successful investing is to figure out the value of something-and then pay a lot less.” Joel Grenblatt
We first discussed about what a No-Brainer Investment, NBI, is in this article:
http://klse.i3investor.com/blogs/kcchongnz/76694.jsp
“A NBI is one which provides you with a cash yield of double, triple, or more the cash you can get from a bank fixed deposit interest, in a consistent manner.”
Cash yield is the amount of free cash flow (FCF) with respect to its price, or FCF/Price.
Since V.S has no FCF left for the last three years due to its high requirement in working capitals and capital expenses, so it can’t be a NBI.
We also discussed if V.S is a great company here.
http://klse.i3investor.com/blogs/kcchongnz/77138.jsp
In my context, it isn’t as its average return on invested capital, ROIC is only 8.2% for the last 5 years which is less than its cost of capital of about 10%. Even at its best four quarters results in the last trailing 12 months, its ROIC is only about 9%. Please bear in mind that when the ROIC is less than the cost of capital, don’t fancy the high growth of the business of a company, as high growth is a bigger shareholder destroyer.
In the same thread above, we also discussed if V.S at RM4.33 is cheap or not, and my conclusion is it is not cheap, as even taking its best latest twelve months results, it after-tax earnings yield (NOPAT/Enterprise value) is only 6.5%, far below my minimum requirement of 10%.
But just how much does V.S worth? We will deal with this controversial topic of discount cash flow analysis. Constructive criticisms are highly appreciated.
Discount cash flow analysis (DCFA)
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 free 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.
There are two major assumptions in using the DCFA:
1) The free cash flows for the firm (FCFF) for all future years. Obviously, this is a difficult task to forecast the future cash flows not only for us as retail investors, but also for the professional analysts. Alternatively we can base on its existing business and its previous performance and make a guess on the growth rate of these free cash flows. This estimate doesn’t have to be accurate. Just be reasonable and use common sense.
2) The discount rate. This is the rate at which you discount future cash flows.
Estimating Free Cash Flow of V.S
Table 1 in the Appendix shows that V.S’s FCF has been negative for the last three years. Its average FCF for the last 5 years is only RM4.3m. That is very little of FCF for a firm having a total of 205m shares outstanding. Using this average FCF as a base estimate will yield a very low intrinsic value (IV) for V.S. So let us be a little liberal and base on its latest last twelve months results to estimate the free cash flows of the firm, FCFF, from its trailing twelve months net operating profit after tax (NOPAT) of RM103.4m. That is another liberal assumption in my opinion.
What would the growth rate of its NOPAT and hence its FCF?
Many analysts give all sorts of growth forecast when doing valuation. Yes, it is the future growth which is the key, not the past growth, though the past can be used as a guide. A growth rate of 5% and 15% for another 10 years makes a lot of difference to the intrinsic value of a firm, if the return on capital (ROC) is higher than the weighted average cost of capital (WACC). If ROC is about the same as WACC, it doesn’t make much difference. If ROIC<WACC, growth is a shareholder wealth destroyer. So how do we check if growth assumptions are reasonable?
One way is to estimate the expected growth rate from the fundamentals, assuming that the company does not take up more debts, no issuance of more shares, there is no spurts of its margins and everything remains the same. Those are plenty fair assumptions, aren’t they?
Expected GrowthEBIT, g = Reinvestment Rate, RR * Return on Capital, ROC
We will make another liberal assumption that its ROC will further improve beyond its best last trailing twelve month ROC of 9% to 10%. We also assume that from now on, its NOPAT will grow by 7%, better than its last 4 years’ growth of 4.9%. Remember as ROIC is about its WACC, which we assume to be 10%, growth doesn’t make much difference in its intrinsic value.
RR = g / ROC = 7% / 10% = 70%. This means V.S has to reinvest back 70% of its NOPAT
Reinvestment rate, RR = (change in net working capital + net capital expenses)/NOPAT
We will also use this same expected growth rate of 7% and the result of RR of 70% to estimate the growth of its FCFF for the next 5 years. After five years, it is assumed that its NOPAT will grow at a rate of 3%, something close to the growth of GDP.
Terminal reinvestment rate = Growth rate* ROC = 3% / 10% = 30%
The future FCFF for V.S is computed and tabulated in Table 2 in the Appendix using the above assumptions. The base FCFF for 2014 was computed as RM31m as shown.
Discount Free Cash Flow Analysis of V.S
Table 2 in the Appendix shows the detail step-by-step calculations of the intrinsic value for FCFF of V.S. The present value of FCFF was obtained by summing up those of first 5 years of supernormal growth value and the terminal value. After adding the excess cash, less off total debt, and after accounting for minority interest, gives the intrinsic value of V.S at RM3.83. This IV is below the present market price at RM4.25.
For those who are interested in the secret of successful investing, please contact me at
K C Chong (2nd June 2015)
Appendix
Table 1: Historical cash flows of V.S
Table 2: Estimating FCF and discount free cash flow analysis for V.S
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Discussions
3 people like this. Showing 29 of 29 comments
While I dislike the use of discounted cashflow valuation due to the myriad of assumptions that have to be made, I do not dispute the importance of free cashflow. A company with low ROE and with huge capital reinvestment needs is unlikely to be cash cow in the long term.
2015-06-03 08:58
Agreed that a cash cow company is a good defensive play. Depending on a company's life cycle, at various stages, it needs to borrow to grow exponentially or else it will not gain market shares or meet orders from Clients.
Low ROE is of concern or course but one must go behind the numbers to find out why. For new machineries to be installed, it takes time for them to generate income as there may be glitches along the way to fine tune the machinery to produce at optimal capacity. If new machinery were bought in anticipation of new business orders or if they were bought as a result of current inability to meet demand, that is a good thing.
Growth companies normally have more needs for borrowings than matured companies like Robert Kuok's. Hence, "going behind the numbers" is important to understand where a company is at.
Also numbers can be different taking different assumptions. If we had taken the diluted weighed average number of shares (the company increased its paid up capital over the last 3 quarters) like what Thomson Reuters did, the P/E ratio is even lower at around 8.8. Hence depending what number you use, the perception can be very different.
Having an understanding of what the company does and where its business prospects are "beats" just using numbers only. This I learnt from my years of experience in the "real" world.
2015-06-03 09:42
All I can say from my experience is that if companies did not borrow, we will not have the "coca colas", "BP", "Perlis Plantations" of today. Neither will economies progress as the GDP depends on the velocity of money flow to generate income and prosperity
2015-06-03 10:07
1. 10% discount rate is just a 'standard' way without going into too much details, but it isnt considered high. When you compare to bank rates or EPF rates, you have to factor in liquidity premium, risk premium etc. People willing to accept lower return in bank rates because of the 'safety'. For someone to accept equity investment, rates have to be higher to entice them.
2. Company borrowing future money to invest is no harm if ROE is higher than cost of capital, which isnt the case.
3. PE do not differentiate a company with net cash of 300mil or net debt of 300mil. Therefore using 'PE' and '11' the number to derive your fair value price will end up very wrong.
4. New plants, machineries takes time to come online to meet demand and through efficiency eventually ROE will rise. The burning question is, efficiency/cost savings to who? Keurig or VS?
Keurig "Install this and that, need to meet demand and improve efficiency. If you dont pass the cost savings to us, there are plenty of manufacturers queuing up willing to install new machines and build keurig machine for us."
VS "Yes sure, all savings passed to Keurig". ROE remain the same.
You know the ending, if VS can retain the cost saving/efficiency to themselves yes ROE will improve, can they do that? When other manufacturers can buy the same machines, have the same technology and tell Keurig they can manufacture for them at a lower cost by sacrificing margin?
So it comes down to - what competitive advantage does VS have?
2015-06-03 10:32
1)And alternative way to figure out the fair value of VS is to look at VS's balance sheet instead of its P &L.
2)VS is definitely not a business that has pricing power or possess any superior technology that allows it to earn extra return than cost of capital. As such it would not fetch higher value than its capital otherwise competitors will join in and eventually bring the return down to the cost of capital level at which point it is no longer attractive for new competitors to come in.
3) Therefore a safe price to pay for VS is not more than its reproduction cost.
4)And a good and estimate for its reproduction cost is its book value of around RM3.
5) I think it is highly risky to pay a price much higher than RM3 for VS.
2015-06-03 11:12
I like to add that for businesses than can not expect to earn more than a market return of cost of capital, growth has no value at all! At best it is neutral, worse it can destroy shareholders value.
Therefore reasoning VS should fetch high multiples because of high growth is not correct.
2015-06-03 11:19
Just to conclude on this, as a contract manufacturer, the competitive advantage is when you are close to your customers. If you have been supplying goods as and when your clients want them and meet their needs as well as having little or no defects, then you have a "captured" customer. If you fool around and cut corners, you will surely lose your clients. Also if you can keep up with your Clients' needs as and when required with little turnover time to get the stuff at your Clients' doorstep, that is another competitive advantage.
Note also that to change suppliers when one is doing well for you does not make much business sense and there is also a risk on product quality as mentioned above.
Cost is not the only consideration when "employing" a contractor.
2015-06-03 11:22
Well then you have to measure the durability of 'captured' and factor that value into the price. To me, loyalty has little meaning when other manufacturers are knocking at your customers door promising 10-20% lower cost because their geography advantage, raw material advantage, higher tech advantage etc.
You know why IT companies like Oracle or SAP make outrageous profit margins? because of switching cost, switching your data from one IT supplier to another is so painful and jeopardize day to day operations most companies rather stay with the same provider.
For Keurig, any manufacturer can send as many sample machine keurig wants to establish their own reputation. Keurig can test those machines until they are confident to give them contract with small orders and slowly increasing it. There are no switching cost, no risk on product quality.
Not doomsday for VS, just saying what VS can do, everyone can do.
2015-06-03 13:14
additional note: Keurig or any company would not put themselves at risk by relying on 1 supplier, therefore they would already have 2-3 sub manufacturers ready on standby to ramp up production when and where required.
Manufacturing doesnt really have any product risk as long defects stay within the acceptable standard deviation. If you are talking about critical products like medical or military then perhaps. Coffee machine, here's your warranty and get it fixed.
2015-06-03 13:37
Really like this kind of discussion... Kiasutrader - give you a like! :)
For those debating that growth has no value addition when the ROIC is lesser than cost of of capital - WACC, i think the main point the others who are optimistic on V.S trying to tell is that:
1.) Investment / acquisition are taking place, and the revenue generated per unit invested capital may turn out to be higher than current in future.
2.) The Margin level of the future Sales revenue created due to the fresh investment / acquisition - PPE / human capital may start improving.
If thats true, then the future ROIC may be way way higher. Further investments of the same nature could only drive up the value..
Guess that clarifies where the DCF may fail, and the 'uncertain' room for optimism lies.
2015-06-03 14:44
I completely agree with KC Chong! I think it's just over the top false optimism for putting sky high valuation!
2015-06-03 14:46
Posted by SUMATECRM1 > Jun 3, 2015 07:54 PM | Report Abuse
whats the intrinsic value of C.IHOLDINGS?
Very good question but I have no answer, until I look at its business and make some analysis and valuation exercise. It will take a couple of days.
Anyone interested in this type of service for a fee? Please contact me at ckc14invest@gmail.com
Sorry ah for making use of this as an advertisement.
2015-06-03 20:51
if you make investment relying on 'may turn out higher in the future' & at this price you are really setting yourself up for alot of speculation and little of fundamentals.
To preserve capital you should be thinking 'may turn out to be lower in the future' and demand margin of safety.
The acquisition can increase ROE if the price being paid is cheap and the co being acquired has a higher ROE than VS itself. But i never really see any management that are so wise to achieve both.
2015-06-03 21:20
There is a question sent to my email address appended below.
"Name deleted>
1:26 AM (9 hours ago)
to me
Dear CKC
What price is resonable for VS to buy in?
Tq"
The answer is I don't know.
There are a number of threads in i3investor talking about this stock; KYY a few of them, Ooi Teik Bee and kiasutrader1, and surprisingly I managed to write a few too. Mine is the only different opinion about it.
However, the one who seems to know the least is me, as I don't invest in and have no interest in V.S and hence have no deep insights as the others.
Having said that, I think there are a number of concerns you need to consider, and a lot of information has been put up. The person who can help you to decide, I am afraid, is you.
The evidence on price patterns of the stock market in general and a stock in particular, in the short and long term suggests that there is much about markets that we cannot explain.
2015-06-04 07:13
KC, though I enjoy seeing your guys exchanging ideas here on VS. But till now you have opened 6 threads on VS..why??
Just like when some of us questioned the motive of Koon Koon acted like a broken records to promote VS n Latitude in I3 again n again..Meanwhile somebody questioned my motive of whacking Koon Koon here again n again... I think you have said enough on VS, those who support VS will continue to support and those who dont support VS will continue to do so...U have done a lot of your analysis on VS. Let go on VS n let go the old man...
2015-06-04 08:39
Though I love you slightly more than OTB,if I wanna make good returns from stock market I would prefer to follow OTB...It requires much more than FA alone....u need to understand TA, market intelligence, human psychology etc etc
2015-06-04 08:45
Whatever happened between u and the old man, let's forgive n forget...I will be the same, under one condition only..once Koon Koon stops abusing I3 for personal monetary gain I shall then cease fire...Instead, I will become his hardcore fan if he decided to donate more to the poor this year in view of his hugh profit on VS, Latitude, Liihen, Hevea, Homeritz etc. Thanks to OTB too for helping the old man to select these stocks. If OTB could help to persuade the old man to donate more this year, I think Koon Koon's long buddha ear will grow longer...Good Karma!!!
2015-06-04 08:51
Yeap, move on and find more good stocks for us....Bro KC, keep up your good work!! There is not many good people here and U are certainly one of them....
2015-06-04 08:55
Ks55, I sincerely hope that Koon Koon will not be Malaysia Ting Hai and is willing to accept some of the points we raised here. Donate more and promote less on his shares which he intended to sell...
2015-06-04 09:39
I hope he doesn't really believe deep from his heart that his "noble intention" is really noble....
2015-06-04 09:42
murali KC, though I enjoy seeing your guys exchanging ideas here on VS. But till now you have opened 6 threads on VS..why??
Just like when some of us questioned the motive of Koon Koon acted like a broken records to promote VS n Latitude in I3 again n again..Meanwhile somebody questioned my motive of whacking Koon Koon here again n again... I think you have said enough on VS, those who support VS will continue to support and those who dont support VS will continue to do so...U have done a lot of your analysis on VS. Let go on VS n let go the old man...
Do you see any problem of my articles in V.S? Do you see me attacking anybody personally? Or anyone making personal attack on me when I present arguments about investment in V.S? You have a totally wrong perception of my relationship with KKY which I thought you should know when I gave it to you when you kept on making personal attack on him.
http://klse.i3investor.com/servlets/forum/600076875.jsp?ftp=3
I sure learned from the feedback on my threads on V.S; from kiasu1, OTB, Soojinhou, Noby, JTYeo, Probability, bcllct, FMHSTOCK, sense maker etc.
Deliberations of opposite views are very good as it curbs overconfidence in us in investing, which can be very deadly to our outcome. Perhaps those who hold V.S share should thanks us for that, whether they want to accept or not.
2015-06-04 11:29
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 00:06
moneyface88...if you had actually learnt...i think you would have understood that he would not have been disappointed.
Unfortunately you fall in the majority...who are 'followers'...who really does not have the capacity to 'think independently'.
I am afraid there is no point in learning for you...i am sure you would agree with my suggestion. - as you are a 'follower' right? :)
2015-06-24 01:10
Dear moneyface88,
Here is my response to you.
http://klse.i3investor.com/blogs/kcchongnz/78867.jsp
Posted by moneyface88 > Jun 24, 2015 12:06 AM | Report Abuse
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 07:35
Sifu Probability,
Yes, I am follower, like to follow sifu because no time lah to write article. You sifu kah ? Tak nampak pun Article with your name as writter, also never see your name in i3 stock pick competitions, otherwise I can pay you for tips too.
Please lah.. don't talk like you are in the same league as KKY, OTB and KC.
You do not have any substance to lecture me.
My sifu told me to hold tight tight V.S, which I did. I just want to come out and write some nonsense to express my displeasure about all those well written articles.
Well, you can attack me again if you like, but I would not comment further as I am laughing all the way to the bank with V.S that I am still holding and when price hit $8 , I will come back and write some nonsense again.
Selamat Malam
2015-06-24 19:07
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kiasutrader1
Mr Chong, I always believed that whatever conclusions about whether to buy or sell a stock must be based on a rational approach. whether it be fundamental or technical.
I must congratulate you for your detailed work but as any corporate finance professional will admit, which you have also done, is to take assumptions of the growth rate etc. in your work to come to a fair value of V S.
That said, I am providing herein an alternative view rather than using DCF which, in a way is a lot less technical and easier to understand as to what is the possible value of V S going forward. Please note that it is not to refute your findings as we are employing different approaches to arrive at some conclusion, whether it is right or wrong, time will tell. My ego is not so big as to be right all the time, so I have no issues if I am wrong.
Firstly, I think you should pay particular attention to the discount rate which, if changed, can also change your conclusions. Why for example, did you use a discount factor of 10% which is exceptionally high given that bank deposit rates are hardly 4%. Even EPF gave only 6.75% which is quite high and may not be sustainable. I surmise that one should use a discount rate that represents an opportunity cost of capital for a normal individual investor, which should be more accurate as a measure of employment of one's capital to earn a return. Nevertheless, you are at liberty to use whatever rate you want.
Another point about increased gearing and expenditure on fixed assets which is affecting its cashflow. If the company is borrowing money for future income, there is no harm in doing that; but if it is borrowing for the sake of buying new non revenue generating assets like the latest Porsche or Mercedes, then there is definite harm to the company as a going concern.
A detailed analysis of the firm's balance sheet will show that its long term debt is falling as a result of timely repayments. A lot of its debt is short term in nature, given that it is in trading which requires trade lines and Overdrafts. Trade lines in particular are self liquidating and a very cost effective way of borrowing. Hence as long as the company continue to be prudent and do not have large amount of Bad Debts, there is no risk to the company's business at all. In this regard, there are no bad debts written off in the company's financials.
The cash in bank is also impressive at RM 201.75 Million @ 31 Jan 2015 compared to 6 months ago when it was only RM 123.464 Million. Note that the cash is more than enough to cover for its long term loans of about RM 135 Million.
In the latest unaudited results as at 31 Jan 2015, the following based on 12 months from 31 Jan 14 to 31 Jan 15 (some call this "rolling" = RM 93.8 M) are observed :
EPS on total number of shares of 205.3M = 0.4568
Current Price = 4.25 implying a current P/E of 9.30,
Just taking a P/E of 11 will equal to a share price of RM 5.02. I take the liberty of using 11 of course.
As at half year 31 Jan 15 :
The Revenue is RM 1.010 Billion (FYE 2014 12 months = RM 1.715 Billion)
Net Profit After Tax is RM 51.4 Million (FYE 2014 12 months = RM 46.67 Million)
Assuming a straight line basis, NPAT for FYE 2015 should be around RM 102.8 Million, If that is reached, its EPS will be 0.5034 and using a P/E of 11 = RM 5.537 per share
Just by comparing these figures, one can see that V S will do much better this year than last year.
Whether or not this is sustainable totally depends on their Managers' business acumen and market conditions going forward. This will be another study altogether as to whether the current Directors are up to the mark in employing their business strategies effectively. After all, at the end of the day, a business is only worth what it is, if it is run by able and capable Managers who are attuned the needs of the market place. Past performance have no relevance to the future as business is dynamic not static
Understandably, the analysis here is not akin to what you have proffered but it is a way in which we can come to a simple understanding of what the company should be trading at.
I welcome any comments from you and you can contact me at kiasutrader@gmail.com
2015-06-03 04:25