Question on DCF

[HyperionTree]

5) is a simple steel trading business, easy to understand, they pretty much do the same thing every yr. Buy and resell steel. nothing fancy, not expanding into anything new etc.
Even then you can see their long term cashflow can vary from 1.3mil to 14.5mil. So which FCF figures would you use if averaging would not help?

Thanks

Hi GFG,

Hyperion and Tree here. We took a quick look at Asia Enterprises Holdings cash flow statement.

1. Adjustments
Tree said there is a line item call Bills Payable that has to be removed from the Trade and Other Payables item from year 2011 to 2005 and it significantly affects the analysis of the business. Tree noted that before 2011, Asia Enterprises Holdings classify Bills Payable as working capital when in fact it is a short-term loan(guaranteed by directors and some are secured by assets) which should be classified under the Cash Flow from Financing Activities Section. If you look at 2012 Annual Report, you'll notice that in 2012 Bills Payable was correctly classified under Cash Flow from Financing Activities in 2012 Annual Report.

As for the Inventory and Trade and Other Receivables which are part of working capital, Tree did not find anything to adjust.

The effect on the Net Operating Cash Flow From Operating Activities is as follows(all figures in thousands):
Year, Net Operating $, Adjustments, Adjusted Net Operating $
2013, 10783, 0, 10783
2012, 2499, 0, 2499
2011, 4444, 0, 4444
2010, 12063, -587, 11476
2009, 14660, 26116, 40776
2008, 12747, -11813, 934
2007, 1565, -4992, -3427
2006, 8168, 11772, 19940

2. About Averaging
As observe from above, the Adjusted Net Operating Cash Flow is not stable and averaging would be very risky.

Hyperion noted that in the early years from 2005 to 2008, Asia Enterprises Holdings probably benefited from strong steel demand worldwide due to China's development and thus there might be shortages in supply in the short term which allow Asia Enterprises to earn a net profit margin of 10% which is highly uncommon for a middle man type of business. For example, another middle man business call DKSH which trades on Bursa Malaysia and distributes consumer goods, only earns 2% net profit margin on good years. In bad years, they'll earn -2 to -5% and shareholders will cry. From 2009, the net profit margin of Asia Enterprise Holdings has been on a down trend towards 2% in the recent quarter which is actually more normal. In 2012 especially, the oversupply of steel in China cause the Chinese producers to export overseas and thus affecting the worldwide steel market. This is likely to persist given the situation in the current quarter had worsen due to Chinese exporters.

Further, given Asia Enterprises' main customers are in the Marine and Offshore Busines, oil prices would be a main driver of their business. Hyperion observes that the Cash Flow from Operations before Changes in Working Capital does seem to correlate well with Crude Oil Prices.

Given the past cash flow trend of Asia Enterprises Holdings seem to relate to a period of abnormal margins and is related to crude oil prices, averaging might be risky since the structure of the market has changed from shortage to one of oversupply and crude oil prices have also changed.

3. Build up and Liquidation of Inventory and Receivables
During early periods of the oil price boom, Asia Enterprises build up inventory and receivables causing a drag in operating cash flow. When oil prices drop in 2008, Asia Enterprises liquidated the inventory and account receivables because they lack liquidity. This results in a jump in Adjusted Net Operating Cash Flow in 2009 and 2010 as inventory and account receivables are liquidated. Thus given this situation, averaging does not make sense. One solution is to separately model the liquidation of inventory and account receivables from the Cash From Operating Activities before Changes in Working Capital.

4. FCF Modeling
Hyperion suggests you wait one more quarter to see the real effect of oil prices on Asia Enterprises Holdings because oil prices have drop significantly in 4Q 2014. This means you can take the quarter 4Q 2014 operating cash flow before changes in working capital as a better and conservative estimate for future cash flows.Thus, Multiply this quarterly number by 4, minus CapEx of 200k a year to get the Free Cash Flow from the business assuming no changes in level of inventory and receivables for next 5 years. Alternatively, you can model a SGD10mil liquidation of inventory and account receivables for next 3 years. These two methods should give you a conservative estimate of the value of Asia Enterprises Holdings.