Asia Enterprise Holdings

Keppel Corp and Sembcorp Industries both have embarked on a strong run up on expectation of winning contract(s) from Petrobras. Instead of picking either of the rig builder to bet on, why not place money on Asia Enterprise Holdings.

Its business model can easily be described as a steel supermarket. Despite being a middle man, it has maintained healthy profitability and margins through the cycles. The company entered the steel distribution business in 1973 and was listed in 2005 so it already has a considerable history.

It supplies primarily to the marine industry in Singapore and is expected to be a primary beneficiary if Keppel or Sembcorp bags a major contract.

There could also be scope for the company to increase prices for its inventory for steel. Devastating flood waters across the Australian state of Queensland has halted 75% (figure quoted by Queensland Premier) of operations in state's coal fields which in turn supply half of the world's coking coal needed in steel manufacturing.

Company also has a strong balance sheet and a steady dividend policy so investors can expect a payout mounting to 40% of its net profit. We expect a 4 - 5% yield. Given its hefty net cash balance sheet, its P/E on ex cash basis is only 4.4x on historical earnings. We expect 2010 earnings to be higher than 2009 and hence compress the multiple further.

Given the two catalysts above, the company is a steal at 0.74x NAV (price of S$0.28). We recognise that market capitalisation is small, so a discount may be warranted. A fair value price could be closer to S$0.35, representing a 10% discount to forward NAV, representing appx 6x PER ex cash basis.

Value of steel inventory fluctuates too much with steel prices. It is hard to see whether the inventory is being priced at a time when steel prices are high or low. It is even harder to know if steel prices will go up or down in the future. A larger discount is warranted.

I love these charts.

[Image: z?s=A55.SI&t=1y&q=l&l=on&z=l&c=BN4.SI,S5...&region=SG]

[Image: z?s=A55.SI&t=5y&q=l&l=on&z=l&c=BN4.SI,S5...&region=SG]

newyorkcityboy Wrote:the company is a steal at 0.74x NAV (price of S$0.28).

NAV is basically inventory. Since the price of steel fluctuates, the inventory needs to be adjusted for the price of steel, to RNAV. If steel price is flat for at least the inventory turnover period (usually about 3 months) the NAV approximates RNAV.

Should a stockist sell above RNAV? No. Because other stockists can replicate that inventory at RNAV by buying from the steel mills and fabricators. Would other stockists buy an existing stockist? Only at a discount to RNAV. This is the same problem as the watch retailers - there is no way a sensible competitor will buy you out at RNAV or higher. Only a meaningful discount will induce a serious bid.

Unlike the watch retailers, the steel stockist business is a commodity business. Prices are volatile and there is no pricing power. Customers are bigger than the stockists, so inventory gains are reduced by customer demands, while inventory losses have to be absorbed.

Given such economics, what discount to RNAV is appropriate?

(04-01-2011, 11:16 AM)d.o.g. Wrote: NAV is basically inventory. Since the price of steel fluctuates, the inventory needs to be adjusted for the price of steel, to RNAV. If steel price is flat for at least the inventory turnover period (usually about 3 months) the NAV approximates RNAV.

Should a stockist sell above RNAV? No. Because other stockists can replicate that inventory at RNAV by buying from the steel mills and fabricators. Would other stockists buy an existing stockist? Only at a discount to RNAV. This is the same problem as the watch retailers - there is no way a sensible competitor will buy you out at RNAV or higher. Only a meaningful discount will induce a serious bid.

Unlike the watch retailers, the steel stockist business is a commodity business. Prices are volatile and there is no pricing power. Customers are bigger than the stockists, so inventory gains are reduced by customer demands, while inventory losses have to be absorbed.

Given such economics, what discount to RNAV is appropriate?

Hi d.o.g,

could you elaborate more on the concept of RNAV? From what I understand, it means revalued net asset value right? My first concern is how would one achieve revaluation using the figures from the B/S? Is there a formula that one can use to calculate? So for e.g. for the steel inventory in the AR, would the notes provide some clue on the actual market prices of the steel inventory? And what values do you revalue to? To the current market price or replacement cost or other prices?

(04-01-2011, 11:16 AM)d.o.g. Wrote:

newyorkcityboy Wrote:the company is a steal at 0.74x NAV (price of S$0.28).

NAV is basically inventory.
... what discount to RNAV is appropriate?

For AEH case, NAV is about half-inventory. The rest are cash and receivables. Since collection has not been an issue, a 5-10% discount may be appropriate.

At 0.74x NAV, we are essentially marking a ~50% discount on inventory. A bit over-done I think. And we are not talking about selling inventory at a discount. The going concern is selling inventory at a healthy gross margin (~10%). So there is some gap to close between 10% and 50%.

IMHO, the current price is conservative that
- it does not factor in the "earning power"
- it is a discount to the liquidation value
- it ascribes no value to the management and "sales network"

Hi cif5000, can you help put down what the blue green and red lines stand for? What's BN4.51, A55.S1, S51.S1? Thank you for that.

Haha, i first learnt about AEH from Wallstraits and it was quite a fav. Good to see that it has well lasted the last financial debacle.

The gap to close should be between +10% and -50%.

(04-01-2011, 11:16 AM)d.o.g. Wrote:

newyorkcityboy Wrote:the company is a steal at 0.74x NAV (price of S$0.28).

NAV is basically inventory. Since the price of steel fluctuates, the inventory needs to be adjusted for the price of steel, to RNAV. If steel price is flat for at least the inventory turnover period (usually about 3 months) the NAV approximates RNAV.

Should a stockist sell above RNAV? No. Because other stockists can replicate that inventory at RNAV by buying from the steel mills and fabricators. Would other stockists buy an existing stockist? Only at a discount to RNAV. This is the same problem as the watch retailers - there is no way a sensible competitor will buy you out at RNAV or higher. Only a meaningful discount will induce a serious bid.

Unlike the watch retailers, the steel stockist business is a commodity business. Prices are volatile and there is no pricing power. Customers are bigger than the stockists, so inventory gains are reduced by customer demands, while inventory losses have to be absorbed.

Given such economics, what discount to RNAV is appropriate?

Basically steel stockist business is a commodity business and on paper it look right that if one hold stock at high price, not just other can move in buy new stock at lower price, current high price stockist has to reduce price to complete as customer pay market price. Flip it over for M&A.

When that happened as it will usually will due to movement in commodity price then other than up cycle, the reduction is price will always shown up in P&L, i.e. making losses.

But when the whole industry is doing the same thing and being a location base business with little new competitor, whole equation is going to change. And that start to make business sense for stockist. But at the end of the day, stockist is hardly a good business to be in but not that lousy in the sense if there are some control.

That say I think looking at steel stockist need to see more than one layer.

mrEngineer Wrote:My first concern is how would one achieve revaluation using the figures from the B/S?

For most stockists the carrying value of inventory is cost or net realizable value, whichever is lower.

However there is a time lag since the balance sheet may be 3 months old. So you need to look at steel prices from the last 3 months to see whether prices have changed. If they have then you need to adjust the inventory value up/down by the appropriate percentage. In the past, steel prices were fairly stable. But in recent years the volatility has led to extraordinary inventory gains (and losses) for all the stockists.

cif5000 Wrote:IMHO, the current price is conservative that
- it does not factor in the "earning power"
- it is a discount to the liquidation value
- it ascribes no value to the management and "sales network"

Earning power is best tracked over a full market cycle to even out the boom/bust earnings. Look at the change in book value per share, as not everything is captured in P&L. AEH compounded book value per share faster than most of the other stockists - why? Is this outperformance likely to persist?

Liquidation value of the inventory is likely to be 30%-50% discount to the adjusted carrying value. No competitor will buy the inventory except at a big discount since they can replicate it themselves. Money is not free - buying inventory locks up working capital. So any extra inventory has to be cheaper to compensate.

The sales network is nothing special, especially in Singapore where it is a fairly friendly neighbourhood. Everybody knows who the customers are. Everybody knows who the suppliers are. Everybody knows what everybody's costs are. They even buy from each other. And you can't (officially) bribe the customers' employees. It is a question of what products you choose to carry, and how low you are willing to go on price.

As usual, YMMV.