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Enterprise Value and Acquirers’ Multiples of some plantation companies KCChongnz

kcchongnz
Publish date: Sat, 30 Apr 2022, 02:32 PM
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This article is purely written for education purpose. It has no other intention. It was written a couple of weeks ago, but not much has changed since then except some prices of the stocks involved have gone up.

Most retail market players do not have a clue of what the stock is worth. Those who do, including most analysts and investment bankers, at most would use the simplistic price-earnings ratio as a yardstick for presentation of price versus value.

Investment bankers and analysts are well-trained professionals in the field of financial analysis and valuation. I do not think they don’t know about other better valuation techniques in valuing stocks. I believe they use PE as it is simple, easier to understand and more acceptable for retail investors. They want their reports to be understood, well read and readily used by their readers.

That is a good thing, in my opinion. However, there is a limit to simplicity in stock investing.

If something is so simple, it is unlikely one can get extra-ordinary return from the stock market.

With the sharp rise in palm oil price up to RM7100 per metric ton now, and it seems like the price will continue to go up in the near future, plantation stocks have been offering a good investing opportunity.

Here is a post written by a high-profile individual who has been dabbling in the stock market for decades, promoting his stock in this popular public forum.

https://klse.i3investor.com/web/blog/detail/koonyewyinblog/2022-04-09-story-h1621365179-Subur_Tiasa_is_selling_at_lowest_PE_Koon_Yew_Yin

He ranked 11 plantation companies listed in Bursa using the PE ratio, with the cheapest company, Subur Tiasa, with a lowest PE ratio of just 3.1, using his “forward” and “formidable” quarter earnings multiply by 4 to obtain the annual earnings of the plantation companies as listed in Table 1 in the Appendix.

There are a lot of things, including earnings of companies involved lumpy and seasonality. Just look at the earnings of United Plantation below,

1st 2022

14.4

4th 2021

37.06

3rd 2021

37.16

2nd 2021

32.74

1st 2021

18.04

Which quarterly earnings do you use to multiply by 4 to get its annual earnings? The latest earnings per share, EPS of 14.4 sen, which is more than 60% drop in profit compared to the immediately preceding quarter? But there was a huge hedging loss in its palm oil refinery segment which will be reversed at the end of the financial year when the hedge is unwind.

 

As shown, Subur is no longer the cheapest stock, although it is still one of the cheapest plantation stocks at a PE of 6.7 (not 3.1). It is still very cheap and a very good investment, isn’t it?

Well, not really, if you care to use the right earnings valuation metric.

Let’s compare the two stocks with approximate the same market cap and PE ratio, Subur and Cepat as shown in Table 2 in the Appendix. Subur has a market cap of RM377 m and PE of 6.7, and Cepat with a market cap of RM346m and PE of 7.0.

Here is the difference between them. Subur has a whopping net debt of about RM600 m and Cepat, on the other hand, has cash about the same of total debts. Clearly, Cepat has a much healthy balance sheet.

Based purely on PE ratio, which stock would you prefer to invest?

No price for the right answer for such a simple question.

The right way to evaluate price versus value, especially for plantation stocks, is the enterprise value, the value of the entire firm, which includes all the capital providers, the equity shareholders as well as the debt holders, and the acquirers’ multiples, such as EV/EBIT, EV/EBITDA.

Enterprise value and Acquirers’ multiple

In the evaluation with enterprise value, it has the advantage that the capital structure is included. High level of debt makes a business less attractive and cash holdings on the other hand is rewarded.

Enterprise value = market cap + total interest-bearing debts + Minority interest – Cash and equivalents

For highly indebted businesses, the earnings before interest, tax, depreciation and amortization, or EBITDA is often used by creditors of the company to assess its interest paying capability and comparison among companies in the similar industry. This metric is closely related to the cash flows from operations.

EBITDA multiple = EV / EBITDA

Some investors hate the use of EBITDA and prefer to use Earnings before interest and tax, EBIT. When future capital expenditures are expected to about equal depreciation, EBIT will be a good proxy for net cash flow.

EBIT multiple = EV / EBIT

The other acquirers’ multiple is the EV/Sales multiple.

Sales multiple = EV / Sales

Most investors, including professional analysts like to use price-to-sale multiple which is theoretically wrong as the numerator, which is price, or market cap, is inconsistent with the denominator, Sales, which is for the whole firm.

Is Subur Tiasa still the cheapest stock using the right approach of market valuations? Table 3 in the Appendix shows the market valuations using enterprise value.

Using the right approach, the enterprise approach in valuing the stocks, the cheapest stock using the PE, the wrong approach, has become the most expensive stock, by wide margins, in every respect as shown in Table 3 in the Appendix.

The cheapest stock, in almost every aspect, whether in PE, EV/Revenue, EV/EBIT, EV/EBITDA, was Sarawak Plantation as shown, followed by SOP, whereas the most expensive stock is none other than Subur Tiasa, touted as the cheapest stock by someone in so many articles, followed by KLK and United Plantation.

KLK and United Plantation are expensive for good reasons as they are large and very well managed companies with stable earnings and cash flows, healthy balance sheets, whereas Subur is expensive using the right approach of valuation and is far away from the league in performance metrics, management credibility and good corporate governance.

KC Chong

Table 1:

 

 

Table 2:    4/16/2022

RM

million

 
 

Price

MC

PE

MHC

1.29

254

6.1

Sarawak Plantation

2.85

795

6.2

Subur Tiasa

2.00

377

6.7

Cepat

1.12

346

7.0

Ta Ann

5.94

2616

8.4

SOP

6.15

3545

9.3

Boustead Plantation

1.10

2464

10.0

Hap Seng Plantation

3.02

2415

10.8

KLK

27.20

29326

11.7

United Plantation

16.02

6645

12.8

Jaya Tiasa

1.07

1036

15.3