I have chosen FAVCO as one of the stock picks for the i3investor “2017 stock pick challenge” two months ago when it was trading at RM2.38. It was more for sharing of the fundamental investing.

http://klse.i3investor.com/servlets/pfs/71070.jsp

For sharing purpose, I have written my investment thesis as shown in the link here,

http://klse.i3investor.com/blogs/kcchongnz/114879.jsp

The rationale of the pick was,

[Favco is a good quality company with resilient and easy-to-understand businesses which should last for some time to come. It has long history of stable earnings and cash flows. Revenue and earnings have been growing steadily for the last 10 years. It has an excellent set of balance sheet with abundant cash and little debt. The investment thesis of Favco lies in its characteristics of a good company, low market valuations and its high intrinsic value obtained from a conservative discount cash flow analysis using EPV, in relation to its market price. Best of all, it pays out good and increasing dividends over the years. At RM2.58, its dividend yield is high at 5.8%, much higher than bank fixed deposit. Its high net cash holding is likely to provide the sustainability of the high dividend payment.

With some new contracts procurement and prospect of improving oil prices ahead, Favco provides a good investment opportunity.

Investing in a good company of FAVCO at a low price fits the principle of the Magic Formula Investing. It also satisfies the Dhandho Principle of Investing of Mohnish Pabarai,

“Heads we win big; Tails we don’t lose much”]   

We knew FAVCO’s business would not be as good as the past couple of years due to the depressed oil price. However, the management has been proven its capability in increasing shareholder value. It can redirect its focus to other industries such as the construction, wind turbine etc. Besides, it has an excellent balance sheet and cash flows and it was selling at low market valuations then.

FAVCO’s share price closed at RM2.69 on 24^th February 2017, or for a gain of 13%.

FAVCO Final quarter 2017 Results

Owing to the continued depressed oil price, revenue and operating profit for the period dropped in tandem, which is in line with industry climate and order book. Revenue for the quarter decreases by 38% to RM136.8m while profit before tax, PBT, deteriorated by 24.2% to RM16.1m compared to the corresponding period last year. Net profit attributed to equity shareholders, however, decreased by 21.4%. Earnings per share for the current quarter is 8.4 sen.

Compared to the immediate preceding period, revenue increased by 8.2%. However, PBT decreased by 14% while PBT deteriorated by 19% due to higher operating expenses.

For the full year 2016 ended 31^st December, revenue and PBT were both down by 33% to RM582.3m and RM78.9m respectively. Profit after tax for common shareholders is RM74.46m, or an EPS of 33.6 sen. 

Basing on the annual result, return on equity, ROE, remains good at 12%. At the firm level, excluding all the excess cash it has accumulated, return on invested capital, ROIC, stays very good at 30%, much higher than its costs of capitals.

Cash flows from operations remain very good at RM106m, or 47.7 sen per share. After capital expenses, free cash flows are at RM67.38m, or 30.4 sen per share. It is a cash generating machine.

Due to the continuous good cash flows of the ordinary operations, FAVCO has been declaring good dividends. it has just declared another 15 sen for the financial year ending 2016, or a dividend yield of 5.6% at the closing price of RM2.69 on 24^th February 2017.

Besides the high dividend, the balance sheet remains strong with an excess cash of RM337m, or RM1.52 per share, with no long-term debt. This excess cash is more than half of its market capitalization.

It is this continuous cash flow generating of the business and the abundant cash holding in the balance sheet that FAVCO is likely to continue to distribute good dividends in the future.

The price at RM2.69 is only 8 times its net earnings of the last twelve months. At the firm level, its enterprise value is just 3.3 times its earnings before interest and tax, or earnings yield of 30%. The dividend yield is high at 5.6%, almost double that one can get from placing his money in bank deposit.

The management has guided that,

“Despite the challenging outlook in the current market, the Group has outstanding order book of RM620.3m as at 15 February2017 from the global oil and gas, shipyard, construction and wind turbine industries.”

It is hard to predict whether oil price will stay low, and for how long, or whether FAVCO can deploy their resources in other business, like the construction and wind turbine cranes etc. in the local, regional or the world markets and hence may find a breakout in their business.

Let’s hear what our guru Howard Marks says below,

“How do you make money as an investor? The people who don’t know think the way you do it is by buying good assets – a good building, stock in a good company, or something like that. That is not the secret for success. The secret for success in investing is buying things for less than they’re worth.

What determines the success of the investor is not what he buys but what he pays for it.”

I still see little risk in investing in a good company like FAVCO at a cheap price, but potential in extra-ordinary gain when the industry it is in recovers.

K C Chong