5 Reasons Why You Should Own HEVEA (5095)

Part 2 of a 6-Parts Series

2)    Retiring The Debt Entirely

Hevea has just released its 4^th Quarter 2013 and the full year financial statements for FY2013 ending December 31, 2013 on the evening of February 25, 2014.

It is another remarkable and spirited performance by Hevea as the company is continuing its established momentums through 2013 and charging itself full-steam ahead into FY2014. Hevea’s relatively high debt level vis-a-vis its industry peers like Latitud, Homeriz, Pohuat and Lii Hen who are all cash positive, further took a big dip from RM 87.379m in FY2012 to RM 63.394m, hiving off another RM 23.985m chunk in FY2013. This reduction in outstanding debts saved Hevea RM 1.235m in interest expense alone. (RM 7.856m vs RM 6.621m).

The largest creditor bank of Hevea’s total outstanding loans is Bank aus Verantwortung of Germany (“KfW Bank”) with an USD-denominated Term Loan. This Term Loan was taken as part of the payment for plant equipment and automation machineries acquired as a result of Hevea’s aggressive expansion plans just before the arrival of Subprime Crisis 2008. As at the end of FY2013, the remaining portion of this Term Loan is US$ 21.21m with a monthly instalment of US$ 750,000.00.

 One would have perceived that with the appreciation of USD, it would put more salt on Hevea’s wound in trying to repay this USD-denominated loan. However, due to the diverse revenue streams of Hevea which spread rather evenly among the USA, Europe, the Middle East, China and Japan, one man’s loss is another man’s gain. The revenue received in USD goes entirely toward paying off KfW Bank whilst Hevea gets to enjoy the sweet fruits of a weakening Ringgit. 

However, as per the standard accounting requirements, Hevea needs to state the effect of any foreign exchange impact to its book on an unrealized basis, nonetheless. It is to this effect that Hevea recorded an unrealized loss in foreign exchange of RM 4.897m in FY2013 against a gain of RM 4.417m in FY2012. Had it not because of this accounting requirement, Hevea FY2013 result would have been RM 27.207m instead of the announced RM 22.31m. The revised EPS would have been 30.1 sen and a Forward PE of 4.186x based on the RM 1.26 closing price of Hevea on February 28, 2014.

In short, despite carrying an US$ 21.21m loan in its book, the continued appreciation of USD or inversely the continued depreciation of Ringgit actually is a positive factor for Hevea going forward.

Now, if we assume that the USD exchange rate stayed at current level throughout 2014, try envisaging the compounding effect Hevea stands to gain in FY2014. Based on FY2013 financial statement, the exchange gain and the saving in interest expense alone have raked in a combined RM 6.132m to the book. If Hevea can continue with its established loan retiring momentums which have been inspiringly displayed since 2009, please let your imagination run wild for now what would it be come December 31, 2014.

As at December 31, 2013, Hevea’s total outstanding loan is RM 63.394m. By the rate Hevea has been able to pay down the loan at almost RM 25m a year since 2009, barring any unforeseen circumstances and adverse change in macro socio-economy of course, we will not be surprise to see that this RM 63.394m reduced to mid thirties million with the compounding effects above come the next time Hevea presents its full year report card. One must take note that this is only solely based on the organic growth of Hevea.

What could Hevea do then or rather what is available readily to Hevea if it decides to completely wipe-off the high debt wariness by the stock market? (Question : Do you still regard it a high debt level if it is only RM 35m ?) Please don’t forget that this is the ONLY reason that is impeding the “fair” valuation of Hevea shares price.

Notwithstanding any corporate or fund raising exercise which may be announced by Hevea to eradicate this debt once and for all, the likelihood of which is near zero as the management did not even ask the shareholders for money at the nadir of Hevea’s financial situation. What’s more with Hevea’s strong and  healthy financial footing now.

So in the alternative, the answer may rest squarely on Hevea Warrant 2010/2020 (Hevea-WB). As at April 26, 2013, Hevea has an issued and unexercised 42,666,666 warrants which entitle the warrant holders to convert the same to a Hevea ordinary shares of RM 1.00 each at an Exercise Price of RM 1.00. The last opportunity to do so is December 31, 2020.

Assuming these warrants are fully exercised and converted into Hevea ordinary shares within this year, it will raise RM 42,666,666 to the coffer of Hevea. More than enough to eradicate the lingering concern of a ‘high debt’ level in Hevea, and with a change of some RM 7.66m cash in the bank account.

As the present operations of Hevea is running optimally and efficiently without the need to embark on another round of major equipment acquisitions in the foreseeable 3 to 5 years time, the rate of cash accumulation will be a lot faster than the rate of debt reduction in this instance. It may take Lii Hen to saved up RM 28m in cash since listed, but it will take Hevea just a year to do that. Hevea will be a well oiled milling machine spewing cash then!

The big question now is how to induce or encourage these Hevea warrant holders to start tendering their warrants for the Hevea ordinary shares by topping up with RM 1.00 for every ordinary shares of Hevea. As Hevea-WB or more affectionately known as the “son” by punters alike is now trading at RM 0.675 as compared to Hevea ordinary shares or the “mother” at RM 1.26 at the close of business on February 28, 2014, it is grossly out-of-the-money by RM 0.415 now. That said, the exodus of the warrant holders to convert will spike up as soon as the disparity between the mother and son tightens. This can happen either when the ascending acceleration of the shares price of Hevea is greater than Hevea-WB, or that the descending  acceleration of Hevea-WB is greater than Hevea mother shares. Judging by the recent interest as shown in the active traded volumes of Hevea-WB, the latter is deemed highly unlikely to happen.

As a result, the only likely proxy for the possible inducement for a full conversion of all the 42,666,666 Hevea-WB may be that the shares price of Hevea will need to start closing the gap between the mother and son. Simply put, without the rise in Hevea shares price, there will be no upward traction in Hevea-WB shares price due to its own natural characteristics of being a derivative.

For any investor with a longer term perspective and who are convinced with the successful turn-around story in Hevea as a growth company, then Hevea (5095) is your cup of tea.

As for those who may like to take a ‘convenient ride’ or opportunistic in nature, then Hevea-WB (5095WB) definitely deserved a worthy short term punt or a mid term hold.