Stock Pick Challenge 2013 2H

Stock Pick Challenge - [WILLOW] by kcchongnz

Tan KW
Publish date: Mon, 26 Aug 2013, 01:30 PM
Tan KW
0 430,553
Stock pick challenge based on the discussion @ http://klse.i3investor.com/blogs/kianweiaritcles/33790.jsp
Following Message

Willowglen MSC Berhad

https://www.youtube.com/watch?v=aJjY_m80bqE

 

Share price performance

The share price of Willowglen has been hovering around 33 sen for a long time from the whole of 2010 to end of 2012 as shown in Figure 1 below. It only started to move significantly at the beginning of this year when it rose up at a fast pace and almost touched 60 sen before falling back to the close of 53 sen on 23/8/2013.

 

Figure 1: 5-year price movement of Willowglen

 

The business

Willowglen MSC Berhad is engaged in the research, development and supply of computer-based control systems. Its supervisory control and data acquisition (SCADA) system is used in security monitoring, building management and environmental control systems that has been showing promising growth trends in recent years. Its operations are mainly carried out in Malaysia and Singapore with the Indonesian market in the developing stage. In the Klang Valley, there are some key areas that will lead to the increase in the demand for SCADA and Security Systems applications, such as the High Speed Rail System, MY Rapit Transit and Sewerage Non-River. In Singapore, there will also be more business opportunities in line with the Government’s initiative in construction of new infrastructure, facilities for transportation and utilities such as power, water and sewerage plants. This will directly or indirectly provide opportunities for growth and demand for SCADA and Security Systems.

Growth

For the past years six years from 2005 to 2011, revenue and net profit of the company was quite flattish at an average of 50m and 9m respectively as shown in Figure 2 below. However the last financial year saw revenue and net profit jumped by 60% and 80% to 83.4m and 15.4m respectively. This good performance continues in the second quarter of 2013 with revenue and net profit improved to 43.2m and 7.6m respectively for a rise of 28% and 46% respectively compared to the corresponding period of last year.

 

Figure 2: Revenue and profit (000) of Willowglen

 

Quality of business

For the past 5 years, the quality of earnings is reasonably good with cash flows from operations about the same as net income. Free cash flows is abundant at an average of 8.1m, or 15% and 34% of revenue and invested capital respectively as shown in Table 1 in the appendix. For the latest two quarters, CFFO and FCF have improved vastly to 14.5m and 14.4m respectively.

 

Figure 3 shows the operation efficiencies of Willowglen for the last 8 years. The net profit margin of Willow has been quite consistent at an average of 18% (>15%) which is pretty good. This high margin results in a high and consistent ROE of 18% achieved with zero borrowing. Willow in fact has an excess cash of 35.1m, or 14 sen per share (17 sen for the latest quarter). ROIC is even much better at 37% which is way above the cost of capitals, and improving.  All these demonstrate that the quality of the business is great and Willow is a good company.

 

Market valuation of Willowglen

At the price of 53 sen now, Willow is trading at a PE ratio of just 8.5 based on the earnings per share of 6.2 sen for the last financial year. Market Enterprise Value is only 1.2 times revenue and 5.3 times the earnings before interest and tax. This is equivalent to an earnings yield of 20%, much better than my 12% requirement. Price-to-book is at a reasonable 1.8 as the business does not require much fixed assets. I would say a good company of Willow is selling very cheaply at 53 sen now.

 

Intrinsic value of Willow

Financial theory postulated by John Burr Williams in his “The theory of investment value” says that the value of a stock is worth all of the future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate.

I would use the Gordon Growth Model to estimate the intrinsic value of Willow. A slight modification is made to replace the dividend used in the model with earnings before interest and tax, and hence the assumption that the dividend will grow in tandem with earnings. The constant rate of growth is assumed to be 3% for the rest of its economic life, approximately the long term rate of inflation.

The discount rate is set at 10% which is reasonable as the required return of equity holders. This is because Willow has a clean balance sheet with zero debt, steady income and constant cash flows for the last few years.

The intrinsic value of Willow is found to be at 83 sen as shown in Table 2 below, with an adequate margin of safety of about 36%.

 

Conclusion

Willow has a durable business which will last for some years to come. The quality of its business is good as evidenced from its high return of capitals, stable earnings and good cash flows. The market valuations are undemanding. A conservative estimate of its intrinsic value shows there is an adequate margin of safety investing at the present price of 53 sen per share. Hence I have included Willowglen MSC Berhad as a stock in my new portfolio.

 

 

K C Chong 

written in Auckland on 24/8/2013

 

Figure 3: Profit margin and return of capitals of Willowglen

 

Table 1: Cash flows of Willowglen

Year

2012

2011

2010

2009

2008

Average

CFFO

1623

5304

15065

8736

15309

9207

NI

15231

8381

9312

12614

8061

10720

CFFO/NI

11%

63%

162%

69%

190%

99%

FCF

617

4923

14607

6195

14202

8109

FCF/Revenue

1%

9%

27%

10%

28%

15%

FCF/IC

1.5%

20.1%

68.9%

23.2%

63.1%

35%

Table 2: Estimation of intrinsic value of Willowglen

Revenue,000

85930

EBIT

18320

NOPAT=EBIT*(1-tax rate)

15190

Average maintenance capex

-1457

Add average D&A

728

Normalised  EBIT

14461

Cost of capital, R

10%

Constant growth rate, g

3%

Capitalized earnings=Nor Ebit/(R-g)

206592

Less debts

0

EPV

206592

Less minority interest

-89

EPV to common shareholders

206504

Number of shares

248000

EPV/share

0.83

Margin of safety

36%

 

 

 

 

 

 

 

HOMERIZ (5160)
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Discussions
1 person likes this. Showing 13 of 15 comments

kcchongnz

Yes, correct.

謝和弦 - 柳樹下 (Good TV 好消息電視台 心靈樂飛揚)

2013-08-26 10:21

faberlicious

yo kc,

FCF/Revenue

1%

9%

27%

10%

28%

3%

Average should be 15% ,not 3% lah.

2013-08-26 11:51

kcchongnz

I was just testing if somebody actually read and check what I have written. Now I found out that there are two people who have spotted one mistake each.

No lah, faberlicious, you have sharp eyes and mind. Thanks for the correction. My excuse is there are too many figures and hence sure to make mistake somewhere. Is it excusable? Can lah.

So the average FCF is 15% instead of 3% of revenue. That paints a better picture for Willow too. I read a book from a famous value investor. I think he is Pat Dorsey of Morning Star. He said if the average FCF is more than 10% of revenue, put all your money in that stock. Just kidding, don't do that. Remember diversification.

There is also a mistake in the writeup about this. I really don't know why I had this "89%" there which should be 15%.

2013-08-26 12:06

faberlicious

No problem kc,glad to help.I was calculating how you got the figures for CFFO,FCF etc. etc. when I spotted the error.Thanks to you, I've learnt a lot about FA :)

2013-08-26 13:13

kcchongnz

Talking about contribution and dedication to i3, nobody beats Tan KW.

2013-08-26 13:33

yfchong

Bro KC just a simple question, how long do you take to be familiarise with the financial engineering methods, assuming you have a full time job in an engineering office ??.Thks yf

2013-08-26 14:17

kcchongnz

yfchong,
I think I have answered this question before. Engineering is many times harder than finance and investment. It is a matter of whether you want to take the first step. The first step is to go and buy a good financial statement interpretation book and familiarized yourself with the three financial statements first. That is the most useful part of investment in my opinion. That won't take you more than a month to familiarized with them.

Then the other part is by standing by the shoulders of giants like Peter Lynch, Warren Buffet, Charles Munger, Philip Fisher etc and see what their philosophies of investing are. There are also many good investment websites which you can learn. A couple I always go to are Old School Value of Jae Jun who were like you before; Professor Aswath Damodaran (hack, this is a free MBA course in Finance); Geoff Gannon,etc. Practice in the market and pay some tuition fees. This part can take you longer time, may be a year or 2 to become a more savvy investor. Just my opinion.

2013-08-26 14:47

i3raymond

Bro and most respected KC, what do you think of this article?http://www.malaysia-chronicle.com/index.php?option=com_k2&view=item&id=150392:is-klse-over-valued-and-how-deep-is-the-correction-in-the-coming-crash?&Itemid=2

Another anti establishment stunt?

2013-08-26 18:22

charan das

YES very scary to read such things sometimes.. whenever there is some correction on the market, such negative news will start appearing.. from my point of view, there are some who are trying to pull the market down deeply, maybe this group had already sold their shares.. so that when the market drop badly they can enter again.. actually our market is just undergoing some simple correction only, it s not a crash

2013-08-26 18:35

kcchongnz

i3raymond,
I am one who do not believe people can use macro economic events to predict the direction of the capital market. Appended was my comments on the main thread of this. I am more a follower of the folowing school of thought as shown in the video below:

https://www.youtube.com/watch?v=2It1fzcBoJU



Posted by kcchongnz > Aug 26, 2013 11:02 AM | Report Abuse X
Is macro economic influence on the capital market predictable?
Nowadays with the power of the computer,it is easy to simulate past macro economic events and used them to back test their influence in the capital markets in the past. This has been a favorite research topic and has been carried out by many academic researchers. From what I have read so far, there is no statistic significant results to show that past macro economic events have the influence over the capital markets. Is there any reason to believe that they can in the future?

Those people who have some knowledge about economics would know that the top economists in the world are only 50% correct in predicting the market.

Sure market does go in cycles, but pinpointing the exact or even approximately point of the cycle the market is in now is proven to be a futile exercise. If one is wrong, and he is often wrong in the past, missing out the last leg of a bull market can be a costly endeavor.

Hence using a top-down approach in investing has also proven to be a futile exercise.

2013-08-26 18:51

KC Loh

good youtube kcchongnz. i came across this recently. would you believe someone willing to pay US$26 for a US20 dollar note under certain conditioning or stress!? actually speaks of investors' psyche a lot!

https://www.youtube.com/watch?v=ynwMLjGzsJ0

2013-08-26 19:10

kcchongnz

The other KC,
Just watch the video you posted on behavioral finance, a new branch of finance. A very good video. I believe anyone study finance in NZ would have to watch this video. By the way, many characters there are Nobel price winners; Richard Thaler in behavioral finance, Eugene Fama in efficient market hypothesis, Robert Shiller (not very sure).

A few months ago I won a golf trundlers which is worth about NZD200+. I put it up for auction in our Trademe website for sale. I was happy if I could get NZD150. You know what? Somebody bid it up and it was sold at NZD325! Yes, I believe that a $20 note was traded at $26, definitely.

In the video i saw many sophisticated mathematical equation. One of them resembled the Black-Scholes stochastic calculus equation of pricing option, things like warrants, call warrants etc. I remember once I commented on SKPRes Wa that it was expensive basing on option pricing and your response was "nobody calculates like that". You were right, how many people know about Black-Scholes option pricing model with that bloody stochastic calculus equation?

But knowing people are irrational, including ourselves, don't you think that one must know the approximate value of something before rationally bidding for it? Because if not he will be paying too high a price for that? Yeah buy high and sell higher. sounds good theoretically. But what if it is like the tulip mania the video is talking about when people chased the price so high that eventually when one wanted to sell, nobody is willing to buy it and the price just plunged suddenly? No chance to cut loss.

The same thing about the chasing the house price and secularization of the mortgages in mid 2000s in the video. Everything seems well because of that but suddenly house owners stopped paying mortgages and the mortgage securities had no buyer at all and they just became worthless abruptly. No chance to cut loss.

So to me chasing something high in price and hope to sell at higher price is a very risky thing to do. On the other hand if one knows the value of something, for example if you can buy a stock with good business, there must be a minimum value it is worth. And if you can buy lower that that value, where is the risk?

Of course I am talking about investing, not trading or speculating.

2013-08-26 20:39

KC Loh

therefore Mr Market, conjured up by Ben Graham, was really a remarkable feat by itself! :)

2013-08-26 21:09

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