Asia Enterprise Holdings

[cif5000]

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.

Since IPO, from 2005 to 2009, book value grew 8.1% annually from $0.26 per share to $0.365 per share. Nothing spectacular even after factoring in the consistent 40% dividend payout. I don’t know if that is outperformance but the business did earn money. Reportedly, it has been profitable in every of the past 37 years. I am not saying the business has an earning power and I should rephrase my statement to:
The current price is conservative that it assumes the business to earn nothing going forward.

Given the strong balance sheet with net cash of all liabilities, it is highly improbable for the company to go into a forced liquidation. In voluntary liquidation, there is no need to offer 50% discount on inventory. For discussion sake, let’s assume 50%. Equipment is mostly depreciated and I give the PPE (mostly leasehold properties) a 30% cut from carrying amount.

Inventory: 56,951 x 50% = 28,476 ($0.020 per share)
PPE: 7,704 x 70% = 5,393 ($0.104)
Receivables: 18,578 x 95% = 17,649 ($0.065)
Cash: 33,320 x 100% = 33,320 ($0.112)
Total: 84,837 ($0.310)
Total Liabilities: 6,845 ($0.025)
Forced Liquidation Value = $0.285 per share

It’s actually a close call but it will command a good puff if it is going for a voluntary liquidation.

Guess you have described the “sales network” quite clearly. It’s free at this price anyway. Anyone who wants to join the “network” will have a difficult time.

On gaining mileage, the 2 common approaches are:
1. Pay a good price for a fair business
2. Pay a fair price for a good business (better because you can sit on it for a long time)
The third and uncommon approach is to pay a good price for a good business.

I am not arguing that steel stockists are a good business but the current price, IMHO, is still good enough.

[donmihaihai]

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.

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.

I have thick skin.... so I continue.

If you are referring to inventories, I will be appreciate if you can show me how changes/movement in inventories capture in BV but not P&L.

[d.o.g.]

Given the strong balance sheet with net cash of all liabilities, it is highly improbable for the company to go into a forced liquidation. In voluntary liquidation, there is no need to offer 50% discount on inventory.

Steel stockists cannot simply announce they will shut down and slowly liquidate. It's like a store that is voluntarily going out of business - you go in and buy only if there is a big discount, because if there is an issue you can't go back for help. For small items it's not worth the hassle. For big items you want a big discount.

It is not that different for a steel stockist - a voluntary liquidation will drive away all the customers and soon turn into a forced liquidation. Nor can you just shrink the business 20% each year and hope the customers don't notice. Either you keep going, or you sell the whole thing outright to a competitor at a discount.

It is very difficult to get full value for the business. To sell it for book value (or adjusted book value) is just wishful thinking. I have a friend who owns a steel stockist business. He is willing to sell it, but nobody will pay his asking price. Of course, he wants a premium, but everybody in the business wants to pay a discount. He himself admits that he will buy a competitor only at a discount.

This is not to say that the stock cannot revalue and make an investor money. But it should be understood that a liquidation or trade sale will likely be at a meaningful discount to the adjusted book value.

An investor trying to make some money should demand a huge discount, so that if a liquidation or trade sale does occur, the final proceeds will still suffice to show a profit. Remember that liquidation or trade sale are not even the worst-case scenarios. Worst-cases include heavy losses that erode book value, and rights issues that dilute book value per share. HG Metal experienced both of these events in 2009.

If you are referring to inventories, I will be appreciate if you can show me how changes/movement in inventories capture in BV but not P&L.

Inventory gains and losses should be reflected in both P&L and balance sheet. Gains will be delayed until realized through P&L. Losses are taken immediately and reflected in both P&L and balance sheet.

Perhaps "earning power" was not the best term. "Value creation" is fancier but more accurate. I look at book value per share because it also captures the effect of corporate actions like rights issues, placements and buybacks. HG Metal and Hupsteel do not measure up so well in this regard.

[nextwave]

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.

Since IPO, from 2005 to 2009, book value grew 8.1% annually from $0.26 per share to $0.365 per share. Nothing spectacular even after factoring in the consistent 40% dividend payout. I don’t know if that is outperformance but the business did earn money. Reportedly, it has been profitable in every of the past 37 years. I am not saying the business has an earning power and I should rephrase my statement to:
The current price is conservative that it assumes the business to earn nothing going forward.

Given the strong balance sheet with net cash of all liabilities, it is highly improbable for the company to go into a forced liquidation. In voluntary liquidation, there is no need to offer 50% discount on inventory. For discussion sake, let’s assume 50%. Equipment is mostly depreciated and I give the PPE (mostly leasehold properties) a 30% cut from carrying amount.

Inventory: 56,951 x 50% = 28,476 ($0.020 per share)
PPE: 7,704 x 70% = 5,393 ($0.104)
Receivables: 18,578 x 95% = 17,649 ($0.065)
Cash: 33,320 x 100% = 33,320 ($0.112)
Total: 84,837 ($0.310)
Total Liabilities: 6,845 ($0.025)
Forced Liquidation Value = $0.285 per share

It’s actually a close call but it will command a good puff if it is going for a voluntary liquidation.

Guess you have described the “sales network” quite clearly. It’s free at this price anyway. Anyone who wants to join the “network” will have a difficult time.

On gaining mileage, the 2 common approaches are:
1. Pay a good price for a fair business
2. Pay a fair price for a good business (better because you can sit on it for a long time)
The third and uncommon approach is to pay a good price for a good business.

I am not arguing that steel stockists are a good business but the current price, IMHO, is still good enough.

my friend,

your analysis is fine, but from a liquidation point of view, if you appoint PwC as the liquidator, this is the kind of calculation they will probably go through, they offer they will get though will depend on the market sentiment- btw, there is an excellent example in one of buffett's letters to shareholders that talks about book value of physical assets as opposed to true liquidation value, when i get some time i will post, he actually had to sell his "assets" at scrap value

my point though is this- think of this business like a businessman, i look at it this way- would a business man today put~ 100m$ as equity (~ aeh's book value) to earn ~ 8m$ ( what aeh approx earned in 2008 and 2009) i.e 8% return after taking the following risks:

1. No idea where the price of steel will go especially in today's environment where steel futures have volatility close to agri products like wheat and you cannot effectively hedge through any index
2. does not know what his selling price will be as it is a pure price based game, some desperate competitior may be willing to dump..
3. capital is constantly tied up in inventory

an analogy is refiners, they don't know the price of either oil or the output of oil products, (but can hedge to risk manage so it is a better business than steel) that is why keppel sold SP. small refiners trade at very poor valuations gloablly..

coming back to asia ent, even at its current value of 78m you will make around 10% return (assuming 2008/2009 levels of profitability)- honestly if i had 78m i would not put it here, there are far less nerve wracking ways to make 10% return, on the other hand if you have been doing it for 35 yrs like asia enterprise and are pretty sure you can turn in a reasonable profit under any conditions, you would go on, but i really don't understand why they list such businesses...

[cif5000]

It is not that different for a steel stockist - a voluntary liquidation will drive away all the customers and soon turn into a forced liquidation.

Well, in that case, if the business stopped and the inventory was sold at 50% discount, I am sure there will be willing buyers queuing up, all the way from JB and Batam. The point is, even with a 50% discount on inventory, the liquidation value is still covering $0.28 a share.

It is very difficult to get full value for the business. To sell it for book value (or adjusted book value) is just wishful thinking. I have a friend who owns a steel stockist business. He is willing to sell it, but nobody will pay his asking price. Of course, he wants a premium, but everybody in the business wants to pay a discount. He himself admits that he will buy a competitor only at a discount.

So here we have one that is going at a discount, with management in place for free, who is willing to work and consistent in paying out 40% earnings as dividend. If we want discount on "discounted book value", then I think it's double counting. That happens only when you can get good businesses at good prices, and AEH is out of consideration.

---

my point though is this- think of this business like a businessman, i look at it this way- would a business man today put~ 100m$ as equity (~ aeh's book value) to earn ~ 8m$ ( what aeh approx earned in 2008 and 2009) i.e 8% return after taking the following risks:

1. No idea where the price of steel will go especially in today's environment where steel futures have volatility close to agri products like wheat and you cannot effectively hedge through any index
2. does not know what his selling price will be as it is a pure price based game, some desperate competitior may be willing to dump..
3. capital is constantly tied up in inventory

No.

And AEH doesn't need 100m to earn 8m.

he actually had to sell his "assets" at scrap value

A 50% discount on inventory should be worse than scrap value.

[newyorkcityboy]

Thanks guys for chipping in the last 24 hours. Not much more to add.

To me, AEH does not have a fantastic business model. Which supermarket or middle man commands high margins? Hence, it would far from qualify for a Buffett "moat" pick. But is this a fair business at a low price?

Would this be a multi-bagger? Unlikely but the odds seems tilted in favor of the presence of downside protection with possibility of catalysts as indicated in the first post.

Quick thoughts on liquidation value: I agree that in a firesale, the discount applied to the inventory could be huge. The risk would be present for a poorly managed company. Hupsteel, I believe, had some issues and had to sell inventory to pay down its debt. In that scenario, the buyer would have tremendous bargaining power for a commodity.

At present state, AEH's debt is of no concern. I would give management credit for prudently maintaining a strong balance sheet in an industry which is inherently cyclical. Whilst liquidation value establishes a worst case scenario, it is of, on balance of probabilities, a low possibility event given its quality balance sheet, and long record of profitability.

[d.o.g.]

So here we have one that is going at a discount, with management in place for free, who is willing to work and consistent in paying out 40% earnings as dividend. If we want discount on "discounted book value", then I think it's double counting. That happens only when you can get good businesses at good prices, and AEH is out of consideration.

The management comes for free because it's not worth anything to a buyer. A competitor buying the business will already have their own management in place - they are only after the inventory and the land/warehouse. This particular management is committed, has a dividend policy and is fiscally conservative. These characteristics have value to a long-term minority shareholder. But they are of no value to someone buying the business, for reasons already stated.

Regarding the extent of the discount:

If a business is worth $1 on paper but will only sell for $0.70 in a liquidation or trade sale, then the true realizable value is $0.70. In order to have a good margin of safety, it would be wise to pay $0.50 or less. The "double discount" is required because there is no realistic chance of getting $1. The appropriate reference is $0.70, not $1. The stock market may give you $1 for your shares, but that would be a function of market sentiment rather than fundamental valuation.

A 50% discount on inventory should be worse than scrap value.

I believe the specific case being referred to is Berkshire Hathaway's textile looms. They cost hundreds of thousands of dollars to replace, but were sold for $5,000 when the textile business was shut down. Anecdotes are sprinkled throughout Buffett's writings, and the gory details are in the biography Snowball.

Steel unfortunately has similar characteristics. In the right size, shape and thickness, it can sell for $1,000 a ton or more. In the wrong dimensions, it may fetch only $200 per ton or less as scrap.

[donmihaihai]

If you are referring to inventories, I will be appreciate if you can show me how changes/movement in inventories capture in BV but not P&L.

Inventory gains and losses should be reflected in both P&L and balance sheet. Gains will be delayed until realized through P&L. Losses are taken immediately and reflected in both P&L and balance sheet.

Perhaps "earning power" was not the best term. "Value creation" is fancier but more accurate. I look at book value per share because it also captures the effect of corporate actions like rights issues, placements and buybacks. HG Metal and Hupsteel do not measure up so well in this regard.

Thank you and as noted by you, whatever happened with inventories will reflected in P&L as history has shown. For a company where their main requirement is working capital, operational wise I don't see the need to go fancier like "Value creation" or "asset conversion" even though it is part of the whole equation of looking at a company.

[egghead]

Hi, d.o.g.,

One of your reasoning stems from a competing business buyer point of view and therefore assigning a zero value in the management. Is that the usual way of valuing a business? Or you are using this view in this illustration only because the discussion has led to discussion about liquidation valuation?

[dydx]

Steel unfortunately has similar characteristics. In the right size, shape and thickness, it can sell for $1,000 a ton or more. In the wrong dimensions, it may fetch only $200 per ton or less as scrap.

This I think is a very sharp observation and point!

So, investors in AEH must first satisfy themselves that the management understands very well the key risks of the business, steafastly applies smart and low-risk merchandising policies/strategies, and does not trade or hold on to too much of steel items that are out of the main-stream. I think this could be more important than all the number crunching.