Wednesday, 10 January 2018

Priceworth (2) - Juicy Details From Insider

Publish date: 

1. Teh Tarik With Deep Throat

Last week, I spoke to somebody ("Deep Throat") who is familiar with Priceworth. He generously answered all of the questions I posed to him. Some of the information I will disclose in this article while some I prefer to keep it confidential as those information has yet to be announced officially. I want to make sure Deep Throat does not get into trouble, even though he has never told me what to write, what not to write.

Please refer to details below.

2. Completion of Acquisition of Forest Concession

Deep Throat concurred with my analysis in earlier article that the ONLY condition for the proposed acquisition yet to be fulfilled is Shareholders' Approval. They are in the process of finalising the circular and will be calling for EGM soon. Target to implement the rights issue by March 2018.

The rights issue is confirmed to be two call rights with first call at 5 sen while the second call of 5 sen to be capitalised from retained profit, share premium, etc.

Post rights issue, the number of shares outstanding is estimated to be 3.6 billion. 

3.  Timber Extraction Volume

As mentioned in my previous article, in the month of November 2017, the group extracted 18,000 cubic meter from the concession (Compartment 57 and 58). The extraction volume (from the entire concession) will gradually go up until it reaches approximately 50,000 cubic meter per month (and stabilise there). This is targeted to be achieved within next 6 to 12 months.

4. Timber Market Condition

The timber market is relatively healthy. Demand is stable (not really growing in a big way), but supply is hard to come by. As such, timber price is stable and on steady upward trend. This is expected to continue over the long term. 

Japan's 2020 Olympic should have material positive impact on demand.

5. The Concession

After I published Part 1, certain reader commented that the deal sounds fishy. He was of the opinion that if the concession is indeed so good, why would the owner wants to sell it ? There must be a trap.

I sought clarification with Deep Throat. Deep Throat explained that the concession was originally held by few Chambers of Commerce. They couldn't work together, so they sold it to the existing owners (West Malaysians) in 1997. The West Malaysians are not familiar with the industry, so they hired a contractor to do the extraction and replanting for them. The contractor also did not perform well (they were originally from palm oil industry). Until now, they have only logged a few thousand hectares. 

This of course is met with dissatisfaction from the Sabah Forestry Department. If the concession is not logged properly, the State will not get tax revenue. Replanting also cannot be implemented effectively. As a result, the owners have to do something about it. Under this kind of circumstances, disposal to Priceworth is apparently a good option.   

6. Timber Volume Determines Value of Concession

As mentioned in Part 1, Priceworth is acquiring the 80,000 hectares forest concession (FMU 5) for RM260 mil (discount of RM30 mil if payment is settled quickly). This translates into RM3,250 per hectare. However, in 2013, Priceworth acquired 20,000 hectares of forest concession (FMU 16) for consideration of RM25 mil. This translates into RM1,250 per hectare. 

I asked Deep Throat why there is such huge discrepancy. Is Priceworth overpaying for FMU 5 ? Deep Throat explained that FMU 16 does not have much timber left. It only has salvageable value. FMU 5 on the other hand, is still full of timber as it has hardly been logged since 1997. As per announcement, the valuation is closed to RM500 mil (which they are getting at a discount at RM260 mil).

This also explained why the group still cannot turn around after acquiring FMU 16 in 2013. There is simply not much timber there. FMU 5 will be a different story, it will provide a steady supply of logs for Priceworth over many years to come.

7. A Volume Game

Deep Throat explained that what Priceworth needs most is not so much good price for its wood products, it needs volume. In FY2017, Priceworth only broke even. However, if you take a closer look, you will notice the huge Depreciation charges of RM25 mil. This means that the group has huge fixed cost. Due to lack of supply of logs, its plywood factory is now operating at low capacity (40% ? if I remember correctly). The acquisition of FMU 5 will address this structural issue. As volume comes in, profitability can be scaled up dramatically.    

8. Operating Cost

One of the readers commented in Part 1 that profitability could be affected by hike in diesel and labour cost. According to him, diesel constitutes 30% of logging cost. Deep Throat commented that there might be some truth to that figure. However, Priceworth is not solely reliant on sale of logs. It also has a huge plywood operation. From entire group's perspective, diesel only constitutes 10% of operating cost. As such, recent rise in oil price will not have huge adverse impact on profitability.

As for labour cost, Priceworth has always faced this issue before. There might be some adverse impact, but not disastrous.

9. No Sarawak Style Black Swan Event

In July 2017, Sarawak State Government announced huge increase in timber logging premium (from 80 sen to RM50 per cu m). This shock therapy caused many timber stocks price to tumble. I asked Deep Throat whether we should worry about something similar happening to Sabah.

Deep Throat asked me to relax. He said that unlike Sarawak which kept rate unchanged for 30 years, Sabah has been increasing the rate gradually over the years. As such, there is no need for Sabah to undertake such drastic measure in the future.

(Note : I am not able to verify what Deep Throat said above. I don't have any figures to cross check. If you are familiar with Sabah timber industry and have the relevant info, please kindly share it with us).

10. Earning Forecast

Net profit unlikely to be RM100 mil in FY2018 as publicised by one of the company's director in May 2017. However, it is possible for FY2019.

Q4 of FY2018 (April to June 2018) should see full potential being unlocked.

11. Concluding Remarks

I initiated coverage on Priceworth on 30 December 2017. It was then trading at 25 sen. It is now trading at more than 30 sen. I don't recommend chasing the stock now. HOLD

Launching of Subscription Service

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Happy new year everybody.

I am pleased to announce that I will be starting a subscription service soon. The subscription fee is RM600 per annum. I will email you 30 research reports per annum (at least)

Some time when there is nothing exciting, I will not send out any report during the week. But during busy period (such as reporting season), I might send out more. 

No matter what happens, it is 30 reports per annum (at least). 

The intention of the subscription service is not for me to make lots of money. It is more to motivate myself to carry out investment research on a regular basis. The bulk of the subscription fee will be used to set up office, hire assistants, subscribe for useful data, attend AGMs and EGMs to gather first hand information, etc.

However, there is one thing I would like to seek your forgiveness and undertsanding - I will NOT be able to response to any query from my subscribers (regarding the reports I send out). It will be a one way information flow. This is simply because I don't have the time, energy and resources to reponse to questions, debates, discussions, etc.

Having said so, I will try to figure out at a later stage how to set up a forum (a website) for my subscribers to interact among themselves so as to facilitate exchange of information.

Whoever that is interested please email me at :

No need to pay me immediately. I will send out a few reports for you to trial. If you are happy with my reports, please make payment to me latest by 8 February 2018 (details will be provided through separare email notification) and you will officially become a subscriber and receive the 30 reports from me over the next 12 months.  

If somehow I decide to cancel the subscription in the future (for example : if I fall off a horse and break my arm and cannot type), I will make full refund to every subscriber irregardless of how many reports I had already sent out during the subscription year. 

p/s : the articles I send to my subscribers might be posted on i3 after let's say, a ten days period. The purpose of course is NOT for my subscribers to dump the shares on i3 members (It just doesn't make sense for somebody to expose himself for ten days just for the hope of selling to someone else at higher price later). The purpose is more for them to tap into greater pool of wisdom and feedback. Of course, this will also benefit i3 members.

Priceworth (1) - Approaching Inflection Point. 2018 Will Be A Very Good Year

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1. How I Came Upon This Company

I have been studying Jayatiasa and WTK recently. Their timber division has been badly hit by regulatory changes by the Sarawak State Government which took effect on 1 July 2017 :-

(a) logging premium increased from 80 sen to RM50 per cu m; and
(b) logs export quota reduced from 30% to 20%, so as to provide more supply to local wood industry.

This should have benefited Sabah timber companies. Furthermore, log prices had been strong since early 2017 (one of the factors is Japan 2020 Olympic). So I decided to find out which listed timber companies are based in Sabah. 

That is how I ended up with Priceworth. After a brief study, I realised that I have stumbled upon a potential gold mine. Priceworth could be the dark horse for 2018.

2. Transformation Into Timber Concessionaire

Priceworth has been in the timber industry for a long time (logging as well as plywood manufacturing). Due to lack of forest concession, it has not done well in the past. Most of the time, it only managed to break even.

However, the breakthrough came in October 2016. The company announced that its wholly owned subsdiary GSR had entered into conditional sale and purchase agreement to acquire 100% equity interest in RCSB for cash consideration of RM230 mil (originally RM260 mil, but discount subsequently granted to expedite payment). RCSB holds an 80 year (remaining) logging concession of an area of 80,000 hectares (it is a lot, folks) called Forest Management Unit 5 ("FMU5") located at Trus Madi, Sabah (the red pin in the map below).

(I did the map check to ensure that it is far from the Pinoy pirates)

The cash consideration of RM230 mil is proposed to be funded by a combination of the following :-

(a) private placement and special issue, which since the October 2016 announcement, has been implemented few times to place out to various investors. 

Tan Sri Rashid Hussein (8% equity interest) and an independent Bumiputra investor Mahagaya Bina Sdn Bhd (15%) had been the subscribers. Together with Priceworth director Lim Nyuk Foh (9%), these three parties collectively hold 32% equity interest in Priceworth.       

(Implication : in my opinion, the 32% block will provide check and balance to ensure management handle their job properly, especially when the CEO does not hold much shares)

(b) a massive rights issue of 1.7 billion shares (I know you hate cash call, but don't panic, read the details first) at 5 sen per share (first call 5 sen, second call of 5 sen via capitalisation of share premium). Every 2 rights shares subsequently entitled to 1 bonus share (850 mil bonus shares). 

How should you view the rights issue ? Well, it is pretty harmless. Due to the deep discount and limited amount raised (RM85 mil), it is more like a massive bonus issue.

A back of envelope calculation produces the following theroetical ex all price :-

RM mil (850 x 0.25 + 1700 x 0.05 + 850 x 0) / (850 + 1700 + 850) mil shares = 
RM298 mil / 3,400 mil shares = RM0.088. 

Discount = RM0.05 / 0.088 = 57% (equivalent to 43% discount).

The calculation above is based on the October 2016 announcement (apart from the prevailing market price). After the rights and bonus, market cap will balloon to RM298 mil. 

However, subsequently, the company announced finetuning of the funding proposals. More special issues and private placement had been introduced. They also mentioned that the rights issue will be adjusted accordingly (no details provided). 

It is too complicated for me to simulate the various potential scenarios. For discusssion sake, let's assume market cap will balloon further to RM400 mil post proposals. I am not simply plucking from the air. Their cash call is not meant to be limitless, it is determined by their proposed utilisation. The ultimate market cap of RM400 mil should be sufficient to address their financial need (in my opinion), and hence is a reasonable assumption.

So now what ? Well, it tells us a lot whether the stock is worth buying now. Even though market cap now is only RM250 mil, it will eventually balloon to RM400 mil (based on my estimate above). The question to be asked is whether Priceworth post proposals will be able to deliver at least RM40 mil net profit. If the answer is "yes", then the stock now is trading at prospective PER of about 10 times : a reasonable valuation considering the size and length of the concession as well as the increasingly valuable status of timber due to scarcity. If the company delivers more than RM40 mil net profit (or market likes it so much, there is expansion of PE multiple a.k.a "Goreng"), there is upside to this stock. Please refer to below.

(c) Listing of the concession holding company GSR in SGX. The company has appointed UOB Kayhian to undertake the corporate exercise. According to news report, GSR will be listed based on market cap of RM600 mil (based on CEO's statement that Priceworth will raise RM180 mil from the listing and yet retain 70% equity interest). The listing application was targeted to be submitted to SGX by second half of 2017 (no update on this) and completed in first quarter of 2018.

(Source : same article as per (b) above)

3. Deal Progress

The story sounds pretty compelling. But the deal has yet to be completed. What is its status now ? What is the chance of it falling through ? 

According to the October 2016 announcement, the proposed acquisition is subject to certain conditions, the details of which are as set out below :-

As shown above, out of 4 major conditions, 2 had been fulfilled while 1 had been made irrelevant. The only condition remained is shareholders' approval, which carries almost zero risk as the major shareholders (and minorities) are likely to vote in favor of such a value creating corporate exercise.

In other words, there is almost 100% certainty that the transaction will be completed (very soon).

4. First Taste of Success

Following the issuance of coupe permit for Compartment 57 and 58 in May 2017, Priceworth (through subsidiary Sinora Sdn Bhd) has started extracting timber from the concession area. November 2017 saw all time high production of 18,475 cu m. More should come in 2018 as the group ramps up extraction.

5. Concluding Remarks

2018 should be an exciting year for Priceworth. Backed by the huge forest concession, prospect is interesting going forward. The stock is likely to attract more interest and attention as we go into first quarter of 2018. But just like any other investments, there are also potential risks. It is difficult to tell when is the best time to buy. I will leave it to you to decide.

Gadang - Likely To Report Super Profit In 2018

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1. Share Price Retracement

Gadang reported a weak set of result on 25 October 2017. Since then, share price has retraced from RM1.28 to RM1.07. 

Despite the set back, analysts are still positive about the stock. JF Apex and RHB Investment Bank expect earning to normalise in subsequent quarters, with EPS around 15 sen for FY2018.

(Source : JF Apex Securities)

(Source : RHB Investment Bank)

Based on existing price of RM1.07, Gadang looked undervalued, trading at prospective PER of merely 7.1 times.

Curious about the stock, I decided to take a closer look. What I found was interesting : there might be further upside to the analysts' earning forecast for 2018. The company still has huge earning coming in from its Capital 21 project in Johor.

2. Update On Capital 21

According to forum member Ricky Kiat who attended Gadang's AGM on 8 November 2017, there is still RM260 mil revenue to be booked in from Capital 21. The Capital 21 land cost is only RM31 mil. Based on assumption of 25% tax, the project will contribute RM171 mil to net profit going forward. 

Unknown to many people, the Capital 21 Project has been listed on Singapore's Catalist (equivalent to malaysia's ACE Market) in May 2017 :

(Source :

Please click on the following link for Capital World's latest quarterly report and corporate presentation :-

Capital World has been reporting decent profit since FY2015 :-

(Source : Capital World's corporate presentation for September 2017 quarterly report)

Actually, I am not so interested in how well Capital World is doing. What interests me is that the Capital 21 project is progressing well. This is because if the Capital 21 project is doing well, Gadang will get paid. 

Perhaps the most interesting information from the September 2017 quarterly report is that Capital 21 is currently in Interior Design stage and targets to open in 2018

(Source : Capital World's corporate presentation for September 2017 quarterly report)
Just to recap, Capital World's project in Johor comprises two components :
(a) the mall with GDV of RM1.3 billion; and
(b) office, service apartments, hotel, etc with GDV of RM500 mil.
(Source : Gadang's 2014 circular to shareholders)
As mentioned above, the mall is targeted to be completed and open in 2018. The remaining components (service apartments, etc) will likely complete in 2020 (as per Gadang management's guidance during AGM). However, payment to Gadang is substantially based on the mall (RM300 mil out of the RM320 mil). Please refer to below :-
(Source : Gadang's 2014 circular to shareholders)
In this regard, with the opening of the mall, Gadang can expect to receive as much as RM240 mil (being RM300 mil less RM60 mil already received) from Capital World in 2018.
I have to point out that things might not be as simple as I describe above. It seemed that the RM300 mil is further split into RM217 mil and RM83.5 mil (as per table above), depending on Capital World's cash collection. Having said so, I think it is reasonably safe to assume that at least RM217 mil is payable to Gadang upon completion of the mall. Less out the RM60 mil already received, we can expect revenue of lets' say, RM157 mil in 2018 (the rest spills over to 2019 or perhaps 2020). After deducting RM31 mil land cost and 25% tax, 2018 net profit contribution from Capital 21 works out to be RM95 mil. Still a fantastic figure.
3. Concluding Remarks
My guess is that Gadang should do well in 2018. Due to rise in operating cost (steel, labour, etc), the group is likely to experience certain degree of margin compression going forward. However, this will be largely compensated by expansion in construction revenue as the group ramps up execution of its RM1.98 billion construction order book. Cushioned by huge incoming contribution from Capital 21 project, earning visibility for 2018 (and 2019, if Capital 21 spills over) is very good. At current level, risk vs reward seemed favorable. 
Gadang will be one of my top picks for 2018.

Supermax (4) - Heading towards RM3.36 ?

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Few days ago, Top gloves announced a strong set of results. EPS grew by 44% y-o-y. 

Yesterday, it was Comfort's turn. EPS also grew by 44% y-o-y. 

As mentioned in my earlier article dated 24 November 2017, China's closing down of glove manufacturing factories has swung many glove users to source from Malaysia. This is a structural change that is likely to benefit Malaysian glove manufacturers for many years to come.

Due to Malaysia's unique position as the dominant gloves manufacturing country, our glove industry seemed to have strong international pricing power. This is evidenced by the fact that whenever cost goes up (either due to hike in latex price or the recent increase in natural gas, etc), Malaysian manufactures have always been able to pass the cost to users. This makes the industry very closed to the type liked by Warren Buffett - a moat that protect the producers from competition and unfavourable factors such that they can consistently make money over an extended period of time ? 

Apart from pricing power, the glove industry also has plenty of room to grow. Even though Malaysian glove manufacturers had been growing for many many years (easily 10 years or more), only about 17% of world population use gloves extensively (mostly developed nations). Meaning that there are still 83% of the world market remained untapped. In this regard, we can expect the industry to continue growing almost indefinitely. It is a proxy to world economic growth. 

Backed by the above favourable factors, I believe the market is rational to ascribe high valuation multiples to gloves stocks. Top Gloves, Hartalega, Kossan has PE multiples of 27 times, 52 times and 29 times respectively. For whatever reason, let's assume Supermax deserves a discount and as such, PE multiple of only 20 times. Based on EPS of 16.8 Sen (being latest Q EPS of 4.2 Sen annualised), the stock is potentially worth RM3.36.

A screaming buy at current level.

As for Stanley Thai and his little adventure, I believe he will eventually emerge unscathed (pay the fine but no jail).

Having said so, it is your money - your risk, your return. So don't blame me if things don't work out well. 

Have a a nice day.

Supermax (3) - Turning Around

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1. Recent Quarter Result

Two days ago, Supermax released its September 2017 quarterly report. EPS rebounced to 4.2 sen. I am quite pleased with the result so I added more at RM2.04.

2. Information From AGM

I attended the company's AGM on 20 November. The following is some of the relevant information provided by management :-

(a) Water issue for Plant 10 and 11 has been fully resolved. These two plants are gradually scaling up production and expects to reach full capacity by January 2018.

(b) In previous quarters, plant 10 and 11's depreciation charges were booked in even though unable to generate revenue due to water issues. In this regard, full production will have positive impact on profit margin. 

(c) China is cleaning up its environment. Many people is aware of the PRC government's effort to curb green house gas emission (both to fight global warming and to clean up its air). Less known is its effort to clean up its water under a system called 河长制. 

Basically, every stream, river and lake in China will have a caretaker (河长). It is usually the top leader in the area. This person is responsible for keeping the health and cleanliness of the river under his supervision. If the river is polluted, he / she will be directly held responsible. To ensure compliance, many polluting factories had been closed down. According to Supermax, this has caused users of Vinyl Gloves to switch to Rubber Gloves, benefiting Malaysian manufacturers. This is expected to be a permanent feature.

(Stanley Thai, CEO of Supermax during 2017 AGM)

(d) The company targets to invest RM100 mil in contact lenses. So far, it has invested RM70 mil. It has started selling online in US and is now trying to enter Japan. The Japanese market is huge but has very stringent requirement. One way to go around it is to acquire a Japanese manufacturer (in negotiation). China is also a big market, but apparently very protectionist. Stanley Thai said unlikely to be able to sell there unless the Malaysian government provides assistance.  

(Will the Malaysian government step in to give Stanley Thai a helping hand ? Laughdieme....)

Anyway, it won't bear fruits so soon. Supermax expects contact lense positive contribution only by second half of 2019.

Portfolio Management

Publish date: 

1. Angler, Drift Wood and Surf Rider

On 1 December 2015, I wrote the article "Three Ways You Can Punt The Market".

In that article, I explained that there are three ways you can pick stocks :-

(a) Angler

2. Drift Wood

(c) Surf Rider

2. How I Manage My Portfolio In Real Life

The above information is more than just theory, I actually manage my portfolio based on a combination of the 3 methods.

My portfolio comprises of stocks with 3 different investment horizon :-

(a) Immediate Term

For immediate term play, I am basically a Surf Rider. I go through newspapers, forums, analysts reports, etc regularly to identify stocks that can perform in the near future. 

Some examples of Immediate Term Play are Hengyuan, Careplus (wrong pick), Crest Builder, Lion Industries, etc.

Some of the stocks perform, some don't. I am afterall just an armchair analyst and do not have insider information. Only God is perfect. I am not God.

Despite the imperfection, the performance of my Immediate Term Portfolio is usally quite good. I give credit to my participation in investing forums such as The forum has so much useful information (blog articles, comments, analysis, etc) that I am able to have abundant good candidate stocks to pick from. 

Having said so, one must have strong stomach. No matter how good a company is, its profitability might go up and down over different quarters. Sometime it takes as much as 6 months to 1 year for the stock to start performing. Downside potential can also be sizeable. This is natural because so many investors are chasing these hot stocks. Once the earning disappoints, there is tendency to rush for the exit.       

(b) Medium Term

For medium term play, I see myself as an Angler.

There are many stocks that have good potential over the next 12 to 18 months. However, as Malaysian investors are short term focused, these stocks are usually ignored. 

For example : WCE Holdings (highway under construction and will only be completed by end of 2018), HSL (RM2.8 billion order book expected to start contributing strong profit only by second half 2018), Supermax (contact lense business will drag down earning until probably second half 2018).  

If you are lucky, the price of these stocks will stagnate until closed to the catalytic event (and then go up). If you are not lucky, negative events or negative sentiment might occur during the holding period and cause price to trend downwards. Due to absence of strong earning, the latter is very likely to happen. Most of the stocks in my Medium Term Portfolio is now experiencing losses (price has come down).

For these stocks, you probably need to adopt a different book keeping method : Stop reflecting the latest market price when computing portfolio return. Instead, freeze the stocks' value at your cost of investment. Only make provision for permanent impairment when a negative event happens and adversely impact fundamentals.

For illustration purpose : I bought WCE at RM1.50 few months ago. It has now declined to RM1.28. If I reflect this in my portfolio, my portfolio gain this year will decline by 7% from 30% to 23% (lets' say). That will make me nervous. However, if I ignore the price change (as I know WCE fundamental has not deteriorated), then my portfolio return will not be affected. Then I feel better and continue to hold on.

Am I manipulating figures to make myself feel better ? Not really. This is actually how accountants do things in real life. If PLC A holds stake in PLC B, daily fluctuation of share price of B does not have impact on the P&L of A. Only if something bad happens to B only then the accontants will step in to review and see whether there is a need to provide for impairment. We should practise the same. By eliminating the noises from daily share price fluctuation, it makes our task of managing portfolio less stressful. And because of that, it gives us the courage and confidence to make longer term investment, instead of purely involved in short term plays (short term is not necessarly a bad thing, but comes with pros and cons as explained above).

(c) Long Term

Long Term Portfolio is bascially stocks that I hold for let's say 3, 4 or 5 years. Unlike Surf Rider and Angler, I don't have insights of catalytic events that might happen in the future to re rate those stocks. Basically, it is a Drift Wood strategy of dumb dumb hold.  

One of the myths in the market is that "if you hold long term, you can make money". Is that true ? Yes or no. If you hold Public Bank long term, you are cool. But if you hold BJ Corp for long term, you are fool.

If that is the case, how do I pick long term plays ? I actually get them from my short term and medium term portfolios. As mentioned in (a) and (b) above, I behave as Surf Rider and Angler to identify stocks that can do well in the not too distant future. These stocks usually will deliver result in 6 to 12 months time. Once it reaches my target price, I will sell lets's say 70% of my holdings and keep the remaining 30% for long term exposure. These stocks are usually good quality stocks (as proven by their ability to go up and reached target price). This is better than picking stocks blindly and hold them for long term without good reasons and hoping that one day miracles will happen. 

In other words, be a smart Drift Wood. Don't dumb dumb hold for the sake of dumb dumb hold. Only long term hold those stocks that have proven themselves. 

3. Concluding Remarks

In this article, I propose that we should have a combination of stocks that spread out over different investment horizons. It will allow us to reduce our risk as well as stress level.

Short term plays yield faster return, but is usually crowded space and is more volatile. It can also be stressful. 

Channeling some money to buy stocks that nobody pays attention (Medium Term Play) is one good way to mitigate the abovementioned negative points. But be careful not to buy stocks that need very long gestation period (the longer the holding period the more chance of black swan events). Preferably the stocks should have potential to be re-rated within 12 months. Once you bought them, ignore the short term price fluctuation so as not to give you unnecessary stress. 

When a company is doing well, it can potentially last for multiple years (such as Air Asia). Long term plays hence allows us to capture maximum benefit from good quality stocks. By selling 70% (lets' say) of the initial holding at target price, original cost of investment will be reduced to very low level. This creates a conducive environment to hold long term and potentially benefit from multibaggers.    

Making money in stock market is easy. The difficult part is how to do it year after year. A good portfolio management strategy not only reduces your risk but also helps you to manage your emotion, making investing less stressful and also sustainable over the longer term.

Have a nice day.

Hengyuan Refining (4) - Upgrade To "Sailang"

Publish date: 

When I first wrote about Hengyuan on 12 July 2017, I was also not so sure. But subsequent to that article, many positive development have unfolded. 

From a slightly positive attitude, I have now turned very bullish on this stock.

(a) Crack Spread In Very Bullish Territory, Touching USD10.22 Yesterday

Please refer to diagram below, which is self explanatory.

(b) Royal Dutch Shell Unveiled Fantastic Earning YesterdayMOSTLY Due To Strong Refining Profitability

(c) Crack Spread Is Expectd To Remain Strong Going Into Second Half of 2017

Crest Builder (5) - Director Selling Down : Bad News Or Good News ?

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On 19 July 2017, an independent director of Crest Builder disposed of 5 mil shares. The disposal was effected through crossing of two blocks at RM1.03. Please refer to The Edge's report below : 

"KUALA LUMPUR: Crest Builder Holdings Bhd non-executive chairman Tengku Datuk Sulaiman Shah Tengku Abdul Jalil Shah has disposed of five million shares, representing a 2.93% equity stake in the company, over the past two days.
According to a filing with Bursa Malaysia, the shares were sold by his privately-held vehicle Pertiwi Positif Sdn Bhd via two blocks of three million and two million shares at RM1.03 per share, totalling RM5.15 million.
Following the sale, Tengku Sulaiman Shah’s indirect interest in the company stood at 1.8 million shares or 1.059%.
According to Bloomberg data, Pertiwi Positif was previously the third-largest shareholder of Crest Builder, after SC Yong Holdings Sdn Bhd (39.03%) and Koperasi Permodalan Felda (4.37%).
Crest Builder’s share price closed unchanged at 1.08 yesterday, with a market capitalisation of RM182.64 million."

Disposal of shares by Directors is usually not a good thing. I was expecting share price to come down the next day. However, that was not the case. On 20 July 2017 (the day after the announcement), a huge buyer surfaced to provide buy queue below RM1.09 (the price before announcement of director disposal). This is sign that somebody does not want the price to weaken. The buy queue worked and price stabilised with no material retail sell down. 

When a director pares stake in a company, there are two possibilities :
(a) something bad has happened to the company (for example : coming quarter result is bad); or
(b) the company is working with funds (or syndicates ?) to push up the stock. This can be done by placing out certain amount of shares to funds at cheap price (in this particular case, RM1.03 ?). The funds will then make a commitment to average up by acquiring more shares from open market, thereby pushing up the price to a desired level. 

I believe that (a) above is unlikely. The MD has recently mentioned that 2017 earning will be strong (please refer to my previous article). 

As for (b), the company does have the incentive to do it. The founder of the company, SC Yong, passed away two years ago. His wife and son are now helming the company. The son is still young at age of mid thirties. He is quite a capable young man. However, putting myself in the shoes of the widow Mrs Yong, as a defensive measure, I would like the company to have more financial resources. Crest Builder has wanted to do a placement back in 2014, but called it off in 2015 after stock price declined due to bad market sentiment. Now that fundamentals has improved, maybe it is time to revisit the placement proposal by first of all, ramping up share price to coincide with good results ahead ? 

Before I end this article, I would like to qualify that I do not have access to insider information. My conspiracy theory of funds / syndicates pushing up share price is purely a speculation. Only time can tell whether I am right or plainly wishful thinking. Please do not blame me if things do not work out well in the future. Your money, your risk your reward. 

Have fun !!!

Hengyuan Refining (3) - The Economics of Petroleum Refining

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1. Products Mix

Refineries process crude oils into a broad range of refined products. Transportation fuel such as gasoline, diesel and aviation fuel account for 75 percent of output. The remaining 25 percent comprise heating oil, lubricants, asphalt for roads and feedstocks for petrochemical industry, etc.

2. Crack Spread
In the oil refining business, the cost of inputs (crude oil) and the price of outputs (refined products) are both highly volatile. To do well, refineries must constantly find the sweet spots to operate. Crack spread is the difference between crude oil prices and wholesale petroleum product prices (mostly distillate fuels (diesel and fuel oil) and gasoline). Crack spread is positive most of the time. However, it went negative in 2008 temporarily.

A major determinant of a crack spread is the ratio of how much crude oil is processed into different refined products. Each type of crude more easily yields a different product, and each product has a different value. Some crude inherently produces more diesel or gasoline due to its composition. The most common ratio in the US is three barrels of crude to produce two barrels of gasoline and one barrel of middle distillates (or 3:2:1). In Europe, a 6:3:2:1 ratio is the most common (six barrels of crude produce three barrels of gasoline, two of distillates (diesel) and one of residual fuel). 

(The composition of outputs is called "Product Slate").

3. How Crack Spread Is Calculated In Real Life

As mentioned above, a refinery does not really have FULL flexibility to decide which product to produce. It is governed by the ratio it chooses. For example : if Refinery A chooses the 3:2:1 ratio, it will produce 2 barrels of gasonline and 1 barrel of diesel. Refinery A gets these products IRREGARDLESS of how good or bad their price is during that period. And that will have impact on its crack spread, which is calculated as follows :-

Refinery A's Crack Spread = (66.66% x Gasoline Crack Spread) + (33.33%  x Diesel Crack Spread)

The interesting thing is that even though gasoline and diesel are both petroleum products, their fortune can be hugely different during a particular period. For example, in June 2017, China imposed fishing ban on its fishermen (an annual event). This has caused demand for diesel to drop dramatically, causing diesel crack spread to shrink. In the meantime, demand for gasoil remains high and supports a strong crack spread. 

4. Product Slate and International Trade 

Local refineries often cannot economically meet demand in a given region for a certain refined product: they must import from other regions or countries. For example, European demand has gradually shifted due to the large-scale conversion of domestic vehicles from gasoline to diesel. As a result, European refineries have a surplus of gasoline and a shortage of diesel. They have responded by exporting gasoline to North America (primarily the US) and importing diesel from the US. Transportation costs will help determine whether matching production to demand in this way can be profitable in the long term.

The growth of international trade in refined petroleum products is partly due to the trend to build large, complex refineries that provides felxibility to accomodate various types of crude inputs and refined outputs. These ‘merchant refineries’, like those in Singapore and South Korea, are designed for producing and competing in global markets, not for supplying local markets. 

5. Conclusion

The economics of the refining business are complex. It is a capital intensive manufacturing industry operating between the two related but independent markets for crude oil and finished petroleum products. Profitable operations that deliver adequate returns on investment are a function of a complex set of variables underpinned by basic supply and demand dynamics, and shaped by competition that is increasingly global in nature. 

Refiners must strive to maximize their margins by optimizing a number of variables including: the type of crude feedstocks and products; energy requirements; plant complexity and efficiency; and logistics and transportation. They operate in a business environment that is dynamic, and that comes with varying levels of commercial, technical, regulatory and economic risks.

Hengyuan Refining (2) - The Story Behind Shandong Hengyuan's Entry Into Shell Refining

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1. The Teapots

Shandong Hengyuan is an enterprise backed by Shandong's local government (some said it is privately owned. Whatever it is, I don't think the nature of ownership is important). 

It is a Teapot Refinery, a term used to describe refinery with capacity as small as 20,000 to 100,000 barrels per day (bpd). Shandong Hengyuan's capacity is 70,000 bpd while the capacity of its newly acquired 51% owned subsidiary Hengyuan Refining at Port Dickson (previously Shell Refining) is 156,000 bpd, twice its size. 

There are about 20 Teapots in China, 80% of which are in Shandong province. Their presence is quite significant. Collectively, they accounted for 15% of China's crude import and 20% of its refining capacity. 

Teapots are more efficient and profitable than state owned big boys such as CNPC, Petrochina and Sinopec. One of the reasons is because the SOEs incurred high assets acquisition cost during the oil boom years. 

The SOEs are hostile towards the Teapots and constantly lobby against them. As a result, the Central Government imposed all kind of conditions on the Teapots. Teapots were not allowed to import crude directly from overseas and have to buy from SOEs, thereby allowing SOEs to make a cut (this restriction was uplifted in 2016). The Central Government also imposed export quotas on Teapots. In short, life for Teapots is not easy.        

If that is the case, why did the government allow the Teapots to mushroom in the first place ? That was actually caused by the unique dynamics between the Local and Central Government in China.

Teapots came into existence because of the policy pursued by the existing provincial governor Guo Shuqing. It was a way to generate economic growth, create employment and increase tax revenue. All these are good things, so the Central Government has no issue with it. However, when the Teapots became too successful and threatened the SOEs, the Central Government stepped in to intervene. That is how they ended up with the current mess. Welcome to China !!!

As a result of the unfriendly policies, Teapots started looking for ways to diversify. Some moved up the value chain to produce chemicals, one ventured into lumber business, one ventured into Lithium battery business, etc. And of course, diversification overseas is always an option, provided the opportunity is there. 

And that opportunity came knocking on the door one day.

2. The Deal

In February 2016, Shell International announced that it was disposing 51% equity stake in Shell Refining to Shandong Hengyuan. Shell has been in Malaysia for a long time (at least since the 1960s). It has three major divisions : upstream, refinery as well as petrol stations. It is not difficult to guess why Shell wanted to exit the refining business. Oil price has collapsed since 2014. The disposal was likely part of its streamlining exercise to strengthen its financial position.  

What was intriguing about the deal was the pricing. Shell disposed of its 51% stake in Shell Refining to Hengyuan at RM1.92 per share. This represented a huge 60% discount to Shell Refining's market price before announcement of the deal. The official reason given by Shell International was that Shandong Hengyuan has demonstrated ability to refinance Shell Refining's borrowings. This is actually a very credible explanation : banks lent money to Shell Refining in the past because they trusted the Shell name. But now a Teapot has emerged as the new controlling shareholder, the risk profile has changed beyond recognition. The banks wanted their money back. Whoever that can pull off a refinancing deal will be the most qualified candidate.

Still, one can't stop wondering whether Shell International has tried hard enough to find a better buyer. Shell Refining is a very valuable asset, it is really a big waste to sell at such a depressed price. Afterall, it is not like Shell is facing bankruptcy during that time. Why in a hurry ? Until today, many investors, analysts and fund managers are still scratching their head.

Maybe they can stop scratching their head now. I think I might be able to provide an explanation.  

3. The Partnership

It seemed that Shell International's disposal of 51% stake is not the end of the story. Pursuant to the transaction, Shandong Hengyuan has entered into a 10 year agreement with Shell to supply it with 4 million tonnes of fuel annually. 

This explains a lot of things. First of all, it explains why Shell International was willing to part with its 51% stake at such depressed price. The Shell Group can claw back some of its lost value (probably through attractive pricing of products) through the subsequent long term supply agreement. 

Secondly, it explained why an ex Shell empoyee was appointed as the Managing Director of Hengyuan Refining. The objective is not to protect Shell's interest (there is nothing to protect anyway. Shell International does not own any more stake in Hengyuan Refining). I believe it is more to make sure that Hengyuan Refining can continue to meet the high standard required by Shell International for its products. 

It seemed that Shandong Hengyuan's relationship with Shell is not limited to Malaysia. The Chairman elaborated on how they intend to work with Shell on various other business oppurtunities.

4. Concluding Remarks

I have fed you with a lot of information. But this is not a business school, we are here to discuss how to make money from punting Hengyuan. So, what are the conclusions ?

The conclusions are as follows :-

(a) Once again, I would like to argue that the Hengyuan Group is not the same as the other dodgy Red Chips that faked accounts and information. It has an established track record in the industry. The details that I got from various news sources allow us to have a good feel of what it does, what problems it faced, what drove its recent acquisition of Shell Refiing and what its aspiration is.

(b) The long term partnership with Shell Group is a very positive point. Even though Shell has exited the refining industry in Malaysia, it is keeping its petrol stations operation. 
The petrol stations are sourcing the refined products from Hengyuan Refining. Hengyuan will need to operate professionally to ensure no disruption of supply.
The government is actually a party to this arrangement (albeit invisible). Any disruption of supply to Shell petrol stations will create turmoil and adversely affect the economy. In other words, many pairs of eyes are watching the Hengyuan Group. Do you really think they will do stupid things like cooking their books ?

For more detals, please refer to the following articles :-