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Turbo-Mech - An undervalued O&G Process Equipment Provider

NOBY
Publish date: Wed, 07 May 2014, 01:43 PM
NOBY
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TURBO MECH
 
QUALITATIVE ANALYSIS
 
Business description briefly
 
1. Involved in the supply and maintenance of various types of pumps (centrifugal and metering), rotating equipment (compressors, industrial fan) to the O&G and petrochemical industry players
 
2. Based on the 2009 prospectus, the sales of specialized pumps made up the bulk of revenue.  Singapore operations are the largest contributor to earnings
 
3. The company does not produce the products themselves but chose to adopt an asset light business model. It is appointed as authorized distributor and maintenance by foreign companies:-
(i) Shin Nippon Machinery (Japan)- Distribution of centrifugal & metering pumps
(ii) Sundyne Nikkiso Company (Japan) - Distribution of centrifugal & metering pumps
(iii) Dalian-Moyno Pump (China) - Distributorship of progressing cavity pumps
(iv) Hudson Products Corp (USA) - Distribution of industrial cooling fans
 
4. The company has a wide network of sales offices spread across the SEA region. It's corporate structure can be summarized as below, highlighted are their associates (<50% stake)
 
 
 
Customer base
1. The customers are mainly industry players in the upstream and down stream O&G / petrochemical industries located in the SEA region. The customer base is sufficiently diversified since the company does not sign any exclusive distribution agreement with its supplier. Its customers include some big MNC such as Chevron and Exxon Mobil.
 
2. Sales offices in mostly SEA countries including Singapore, Thailand, Philippines and Vietnam, Malaysia and Brunei. Majority of its revenue >90% came from the Singapore segment
 
Economic Moats (Strengths)
1. Due to the sales/distribution nature of the business, the company's main strength is in its network effect. Here they excel with a regional footprint in SEA with a network of workshops in Singapore, Philippines and Malaysia gives it an edge as a preferred supplier.
2. The company is highly efficient due to its low capex and asset light model. This has benefited its bottom line greatly judging from their superior net profit margins of >20% for the past few years
 
Management qualities
1. While the Gan family still holds a significant stake in the company, the founder steers clear of dynastic type approach in appointing management, preferring to employ professionals to run the company. 
2. The compensation of management has been reasonable at < 3% of revenue and no unfair RPT seen.
3. The dividend payments of >50% payout shows that management is willing to share the profits with shareholders. Based 5 sen DPS distribution for the past years, the dividend yield is fair (3.8%)
 
Opportunities
1. The company's fortunes would be tied to the O&G industry (upstream and downstream). Its presence in Singapore and proximity to the new RAPID project in Pengerang Johor should bode well for its sales in future.
2. The company;s good network of distribution offices and maintenance workshop in SEA allows it to capture future O&G markets in SEA
 
Risks
1. Loss of distribution license for its pumps from Japanese companies due to high dependence to mainly marketing the pumps from 3 companies. Earnings risk in terms of concentration of client base
 
 
QUANTITATIVE ANALYSIS
I like to use magic formula by Joel Greenblatt to determine if Turbo Mech is a good investment. In his The Little Book that Beats the Market, Joel Greenblatt describes a Magic Formula to beat the market. His magic formula is basically “a long-term investment strategy designed to buy a group of above-average companies but only when they are available at below-average prices”. 
 
The key driving formulas used by Greenblatt for his Magic Formula are: 

• Earnings Yield = EBIT / Enterprise Value 
• Return on Capital = EBIT / (Fixed Assets + Net Working Capital) 

My criteria would be to find good companies at a good price are companies with earnings yield greater than 15% and ROIC greater than 15%.
 
More information on the Magic Formula can be found here:-
 
 
Although EBIT typically excludes income non-core operations (example associate income), in the analysis of Turbo Mech, I found that the associate net profit contributed to about 50% of the total net profit of the company. Since the business of the associate are close to the core business of the company, I made adjustments to the ROIC, EV and EBIT equations to include the associate’s profit in the valuation process.
 
For ROIC equation
NOPAT = EBIT (Core) * tax rate + Share of profit from associates
 
For EV/EBIT equation
EBIT = EBIT (Core) + Share of profit from associates *[1+ tax rate (assume an average of 25% based on tax rate for the countries of operation)]
 
Since information on subsidiaries is not readily available, it also assumed that enterprise value portion of the associates is equal to the investment value in the balance sheet with no debts or excess cash. Therefore the EV equation remains unchanged. I am not sure if this is the right method but eventually decision to invest will depend on margin of safety available.
 
Profitability analysis using magic formula
 
Summary
        
Year
2013
2012
2011
2010
Revenue,000
38202
45979
46197
42815
Gross margin
36%
30%
29%
34%
Operating margin
14%
11%
14%
17%
NI
9786
8446
10325
9294
Net profit to common share
9822
8374
10124
9306
Net profit margin
26%
18%
22%
22%
No. of shares
108000
108000
108000
108000
EPS
0.091
0.078
0.094
0.086
Dividend
0.05
0.05
0.075
0.05
Payout ratio
55%
64%
80%
58%
Book value per share
0.70
0.63
0.61
0.59
Operating cash flows, CFFO
11742
4203
3600
10463
Capex
-74
-1300
-3075
-957
Free Cash Flow, FCF
11668
2903
525
9506
CFFO/NI
120%
50%
35%
113%
         
Equity
75681
67978
66108
63457
ROE
13%
12%
15%
15%
ROIC
28%
23%
32%
44%
 
 
EV = 95512
EBIT (including associate earnings) = 11271
EV/EBIT = 8.5x
 
The company has been able to sustain very high profit margins and superior ROIC (>20%) even in a declining revenue environment. I expect that the revenue will be able to improve in tandem with the recovery in the petrochemical industry and the take off of the Pengerang project. Besides this, the company is also debt free with excess cash of RM0.39 per share.
 
However, the company meets only part of magic formula requirements. It is able to generate very good ROIC but its valuations are not undemanding with earnings yield of only 11%. This could be in part due to the limitations of valuing the associate stake more accurately. A peer to peer analysis will give an idea on its relative valuation to its peers.
 
 
Peer to Peer comparison (in the O&G process equipment based on 2013 numbers and closing price on 29/4/14 )
Company
Price (RM)
Market Cap (RM mil)
ROIC (%)
EV/EBIT
FCF/Revenue
Dividend Yield (%)
SEB
0.75
60
11.7
9.1
no FCF
2.7
APB
1.11
125
6.5
8
2%
5.9
KNM
0.88
1272
1.7
20.5
6%
0.0
WAHSEONG
2.06
1596
1.7
69.2
3%
1.9
PANTECH
1.02
582
14
8.6
5%
3.4
TURBO
1.29
141
28.1
8.5
15% (5 year avg)
3.8
By using the EV/EBIT and ROIC method, a better comparison can be made between companies with different capital and debt structure compared to P/E and ROE. For more information on the benefits of using these 2 metrics, I use these links as a reference:-
 
Based on a peer to peer comparison the valuation of Turbo Mech does not appear expensive when looking at the high ROIC it is able to achieve. It also has the highest free cashflow among all although it loses out in terms of dividend yield to APB Resources.
 
 

SOP valuation using DCFM for core operations and P/E for associate value

DCFM valuation for core operations
Discounted cashflow method was used to value the core operations since Turbo Mech is profitable and generates a good amount of free cashflow.
 
 
*Starting value FCF was taken as average of past 4 years due to exceptionally high FCF for this year.
** Exclude interest in associate from DCFM valuation
Assumptions
  
Current stock price
$1.29
Share outstanding (Mil)
108000
*This year FCF
$6,151
Next year's FCF (mil)
$6,458
Growth for the next 5 and 10 years
5.0%
Teminal growth rate, g
3.00%
Discount rate, R
10.0%
 
PV of FCFF of core operations
$105,000
Non-operating cash
$42,273
Investment properties
$0
**Interest in associates
$0
Debts
$0
PV of FCFE
$147,273
Less minority interest
$542
FCFE
$147,815
Number of shares
108000
FCF per share
$1.37
 
Valuation for associate operations using P/E
 
2013
2012
2011
2010
Investment in associate
19786
18122
14616
13330
Net profit
4615
4097
3991
3179
ROI
24
25
29
24
EPS
0.04
0.04
0.04
0.03
 
The earnings from associates and ROI is quite healthy and consistent with the parent reaping >20% ROI annually since being listed. Even by assigning a conservative P/E of 10, the associate stake is valued at RM0.43 per share.
 
Therefore:-
SOP valuation for Turbo = RM1.37 + RM 0.43 = RM 1.81 which represents a MOS of 30% or an upside of 40%
TURBO (5167)
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Created by NOBY | Apr 20, 2015

Discussions
2 people like this. Showing 18 of 18 comments

Icon8888

Well done Noby. Hopefully more and more people will start writing useful articles to benefit everybody.

At least today I learn that Turbo Mech is a potential Pengerang play. Will keep it in my watch list

Looking forward to seeing more articles

2014-05-07 14:57

sephiroth

noby, yr analysis on fcf,roic,roe are superb, all write up shd include these to provide a much better picture of the company

2014-05-07 15:30

Barbarian

getting ready to buy more Turbo when Minho ripe

2014-05-07 15:34

sephiroth

not exactly undervalue as PE = 14.2X

2014-05-07 15:38

NOBY

sephiroth, dont forget the excess cash is RM0.39 per share. The adjusted P/E after taking away excess cash is 9.8x, still undervalued in my view based on its return of capitals.

Also, reason I use EV/EBIT instead of P/E when comparing the different companies is because of different debt structure.

2014-05-07 15:46

sephiroth

noted noby, hexza/homeritz have good cash flow as well

2014-05-07 15:47

sephiroth

noby, yr masterpiece are as good as kcchongnz, well done

2014-05-07 15:49

Barbarian

Yes agree. Sui Sui

2014-05-07 15:49

Icon8888

Recently more and more forum members started to write. SJSoon recently wrote about Gadang. Now Noby wrote also.

A very encouraging trend

2014-05-07 15:52

sense maker

Good margin, cash-rich, clean balance sheet (AR is a bit high though) and its share price has already gone up a lot in the past 3 months to reflect the value.

But revenue has been flat in the past 4 years. Reliance on distributorship may explain why it did not venture out too far beyond Sg successfully.

At a glance, it may be the mechanical equivalent of super-strong Pestech which sells cheaper electrical than dominant overseas players. But it is just a pump and compressor distributor.

5% growth every year for the next 10 years is too optimistic, unless one is convinced of its growth story and catalysts.

Not a buy for me at this price level.

2014-05-07 15:55

Icon8888

This is one stock that I had missed out, due to my ignorance

In stock market, knowledge is wealth

I came to know about this stock too late

2014-05-07 15:57

NOBY

Glad that my write up has invited a lot of useful comments. Thanks everyone.

2014-05-07 16:14

sense maker

Thanks for sharing, Noby.

Sepiroth asked me quite long ago about fair value of Homeritz. To me, it is not undervalued. That is why I did not comment on it. Furniture shares to hold for me are just Liihen and Latitude.

2014-05-07 16:54

keithchan

Sense maker likes Liihen so much, because he is Chan Keng Chung, the major shareholder of Liihen. That is naturally but biased

2014-05-08 00:00

cheongcy

Now only I realized there is such a good write up here. With current closing price of RM1.23, seems market is ignoring its excess cash of RM0.39 per share.

2014-08-07 23:49

newklear

Hi Noby, I agree with your analysis but I also believe other companies have been unduly ignored in this study.

You have to understand that Energy will always to be the most precious commodity, as what you are talking now O&G. In Thermodynamics, it is clear that O&G is absolutely related to power generation...high grade energy 'Electricity' !!

Talking about underpriced counters related to turbo-machineries & power generation, one can easily identify one below RM0.20...

Rgds,
NK

2014-08-08 04:05

NOBY

NK, name me a few counters. I am open to further analysis definetely

2014-08-16 15:54

RolandPerez

Hmm. A good value stock. However, in my opinion, it is better to purchase a well known and strong base company. It will be less risk unlike this one. A turn of event could happen and I don't do gambling.


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2015-10-13 12:36

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