Ok guys, I've completed an initial analysis of two construction counters that seem to have rock solid fundamentals. I'll post the first one here for you guys to take a look. I have a few important decisions to make for the new year (this being one of them) and this was an important step.
Just sharing whatever I managed to unearth, but I hope someone finds this slightly useful. Caveat emptor.
CHIP ENG SENG
Business
Construction company with some interest in property development. Specializes in building residences (condominiums). A significant number were developed for HDB, the rest were private developments. 90% of its revenues are contributed by construction and 10% of its revenues are contributed by property development.
There is a large amount of competition in the residential construction space with several companies like Koon and KSH also active. The industry itself has incredible barriers to entry from the number of certifications required and the need for a solid tracking record so at least there is little risk of new entrants anytime soon.
Fundamentals
I’ve looked up the numbers over the past 10 years and taken a harder look at the past 5. I do like what I see. I have compared it with LKH. Both companies are in the residential construction business with side interests in property development and both have a comparable market cap.
I've attached a picture of the numbers I've pulled out. Please take this with a gain of salt. Numbers are a combination of mine as well as some stock sites I use. These are quite rough. Caveat Emptor. Once again, this is just for my benefit, really, don't use these numbers as the sole basis (or any basis at all, really) for any of your investing decisions.
[Image: chipn.jpg]
1) PE
PE of CES is now quite good thanks to a drop in the share price over the years and a significant increase in EPS. With PE currently at 4, this stock is now quite cheap. The PE for LKH is comparable, which is good for comparison since both are valued at about the same price.
2) ROE
ROE is now excellent at about 30% and has remained so in the since 2006 (which includes a recession).
ROE for LKH is a less impressive but still very very good 24%. However, LKH’s ROE over the years before hasn’t even gone above 15% for many years which makes the CES ROE that much more impressive.
3) ROA
ROA is good as well, but has taken a hit due to the amount of debt that the company carries. With it hovering at about 10% over the past since 2007, the ROE is still very respectable.
ROA for LKH is just slightly less due to the fact that LKH has next to no long term debt (unlike CES).
4) Debt to Equity
Going by the Financial reports, the company takes up some debt to prepare for a large new development. IIt has taken a slug of 100m extra long term debt in the 3Q 2010 to bring debt up to 220m. With only about 100m of cash, this bears some watching. However, judging by past performance, management should be prudent enough to manage this well. I don’t mind some debt, especially with ROE at 20%, but this bears watching since this increases debt to equity to uncomfortable margins.
LKH has negligible long term debt, which is excellent as always.
5) Dividend Yield
Yield in 2009 was a ridiculous 6.5%. This is significant in comparison to past few years where dividend next breached 5% since 2006. This is due to 2 large factors. The first is the spike in EPS and the second is due to the lower share price. Dividend is very nice and makes the stock look much better. In the past few years, the company seems to distribute a good portion of the profit after tax (it even managed to distribute about 10% in the recession of 2008). This looks good.
LKH on the other hand distributes at a 8% yield which equates to a significant 35% of their EPS. LKH seems to be very dividend happy in the past few years. There was even a past distribution of a 90cents based on some savings from a tax credit, but that was a one off.
6) EPS Growth
EPS has been growing well along with revenue as the company bulks up and takes on multiple projects.
7) Project uptake
Without a better breakdown of how ‘good’ each project is, I’ve decided to track how many projects the company is currently developing and how many it finishes in a given FY. As seen in the chart the company has taken on an increasing number of projects over the past few years which shows the growth of the company.
Since CES (and LKH for that matter) don't show how much each project is worth this is an incredibly rough number at best. I didn't really like this and I do know that other construction companies do list the worth of each project.
8) NAV
The company is trading at NAV so I don’t believe that it is not too expensive. It’s a bit difficult to find a good construction counter trading below NAV.
9) Valulation
Using my normal conservative DCF method with a 11% Discount rate, the stock should be at 0.80 in 5 years.
Points of concern
1) There are a large number of players in the residential construction space in Singapore. With the property boom and the large number of housing projects planned by the government and private sectors, I believe that there should be enough for everyone for now but we need to watch out when the market heads south.
2) Minimal overseas exposure. CHIP ENG SENG has dabbled in Australia for the past few years and it seems that it has developed a couple of properties in Australia. However, Australian exposure has remained insignificant over the years (<5% of revenue). It dropped to 1% in 2008 and reached 2% in 2009. While the Singapore market is no where near saturation, I think overseas exposure should be monitored.
3) Increase in debt in 3Q 2010 bears taking a look at. I’m not too concerned with this, but I wonder why did the company need to double its debt. We’ll see what the 2010 financial reports and dividend look like.
4) Construction Segment is loss making. I’ve gone through their financial reports and it seems that their construction segment is loss making, whereas their property development segment makes the bulk of the profits. This puzzles me a lot. 85% of the company’s revenue is in construction but that segment is loss making. 15% of the company’s revenue is in property development but it makes so much money that it covers the bulk of the construction segment’s loss and allows the company to have a record profit year.
This confuses me quite a bit. I can only assume the following:
1) Normal construction activity is marginally profitable
2) For projects under property development, the construction segment handles it at cost (or a loss) which allows the property development to generate large profits
3) Therefore, the construction segment runs at a small loss
Otherwise
1) If only property development is profitable, why bother with normal construction?
2) If all construction is not profitable, why even bother with that at all?
3) If property development is so ridiculously profitable, why not just ditch construction?
Incredibly, LKH’s construction segment was also loss making for most years, but it managed to turn a profit in 2009. I wonder whether this is normal and just some accounting thing which they used to split the segments.
Summary
The company has fantastic numbers and has managed to maintain those numbers in a recovery (2009) a crash (2008) and a bull run (2007/2006). The numbers are generally better than LKH’s. This shows that management is solid and the company seems to be able to weather most economic cycles.
However, the lack of overseas exposure worries me. Throughout the years, 2005 onwards, the company repeatedly goes on about how it intends to develop land overseas, but the exposure is still very low for something that seems to be one of the company’s objectives. Does this mean that management decided to wait it out? Or are they half hearted in their pursuit of overseas expansion?
The large shot of gearing in 3Q 2010 and the strangely loss making construction arm worries me as well (the loss making more so). With all their profit being derived from property development, will this construction counter suffer in a property downturn?
All in all, the numbers are very tempting and there seems to be a lot of upside especially in the next few years with the property and construction sectors improving, but there are enough red flags to warrant caution.
As a side note, I didn't really like LKH's financial reports. The 2007 report put an incredible weight on the 90cents special dividend and how this was fantastic for yield and one of the best dividend yields ever, when it was obviously just a one off. But maybe that's just me.