Wednesday, November 1, 2017

Recent Action - Straco Corporation

I initiated a position in Straco Corporation recently at a share price of $0.855 for 50,000 shares.

I don't think I have to introduce this company much more. We all know they've been returning incredible shareholder's value since its inception in 2004 and it was only after around 2014 that the share price remains rather flat until today.

For me, I am treating this more of a momentum play given that organic growth is back on track and debts remain lowest since they acquire the Flyer back in 2014. I still want to see the company generating double digit growth either through organic or M&A and the latter remains to be questionable given the past 3 years have been a lackluster performance in terms of share price since they bought the flyer.







In the 2nd quarter of 2017, we see visitors to the attractions up by 8.3%, which highly impacted the better performance of the SOA, LCC and Flyer through increase in revenue by 8.4%. UWX was the only exception as it reported lower sales.

Assuming growth is back on track, we should see similar growth in the Q3 and Q4 and EPS for the year should comes in at about 4.70 cents. Assuming share price is at 85.5 cents, this translates to about 18x earnings. It's just about fair given industry average for tourism sector is at 20x. I don't think there's much to shout at.

The company generally generates around $40m to $60m cashflow on average depending on working capital situation.

They have been consistently reducing their debts from the purchase of the flyer by repaying around $12m to $20m every year on average through their operating cashflow, while using the other $20m to pay dividends. Any retained earnings will go back to their cash in the balance sheet.

The company currently has about $56m worth of debts in their book (net cash: $104m) and cash of $160m. So they can essentially be debt free in the next 3 years or faster if they are more aggressive in repaying the debts.

The company generates tons of free cash flow through their model.

Asset Lease Concession

The asset concession is one to watch out for.

The flyer, for example, is a 30 years asset on lease concession that commences on July 2005. The initial cost to build the flyer is $240m and Straco bought it in 2014 for $140m with 19 years lease left (90% stake).

Today, they are generating a revenue of about $40m and an operating profit of about $10m a year.

The asset is capitalized throughout the useful life of the asset (35 years and 7 months) based on about $8m a year. Adding this back and deducting capex assuming at $1.5m (based on AR) every year, the company would generate a cashflow of about $16.5m a year from this asset. If we multiple back the $16.5m throughout the 19 years, this would sum up to about $313m. This would translate to about 9.1% IRR ($313m - $140m) / 19 years which I thought was pretty decent. This though, only takes up 1/3 of the overall assets they own (~$40m/$120m revenue)

The other 2/3 makes up of mainly SOA and UWX, both of which are flagship assets of the company.

For SOA, the agreement for the incumbent land use right is a period of 40 years concession from 1997 to 2037. That means we essentially have about 20 years left as of today. For UWX, the agreement for the incumbent is also a period of 40 years concession from 1994 to 2034, translating to about 17 years left.

The company generates a sales of about $82m with a handsome gross profit margin of about 70% at $58m operating profit.

This makes up almost 80% of the overall operating profit segment, so clearly this is one that we should watch out for. Too bad they didn't provide the detailed segmental breakdown any further between SOA and UWX. With tourism gaining traction back in China and the assets have about 17 to 20 years left, Straco can enjoy a lot more years on this. Capex is also in the range of only around $2m a year so if they can keep the overhead down, it's pouring cashflow for them for the next 17 to 20 years. I don't even have to mention the crazy IRR they have on these two investment over the years.

This reminds me of China Merchant Pacific.

Summary

I don't think the valuation we are looking today represents crazy compelling value if we look at it from an earnings point of view but if we try to use a discounted cashflow, it does look a bargain. Though, with the model, it depends on what we put in the assumptions. We need to make sure the growth in future years is higher than the WACC that we assign.

Clearly, organic growth can only help that much at this point, that pile of cash will surely be required to boost the company into the next stage of phase. That will be important to the g function in our dcf model.

Straco will report its Q3 on the 14th Nov.


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16 comments:

  1. From my calculations, I was valuing in at $1+. Maybe I should really consider building a larger allocation

    ReplyDelete
    Replies
    1. Hi SPR

      I guess you must have used the dcf method? It's hard to say when this will move even though year on year the cashflow keepa piling up.

      Delete
    2. It's based on an average of dcf, ddm and peer multiple comparison. Using solely dcf comparison gave me crazy high tp actually..

      Delete
  2. Hi B,

    Wah. Straco is on my watchlist as well, just that I didn't execute :/

    ReplyDelete
    Replies
    1. Hi UN

      I guess you are still studying the company yah. Do let me know when you are onboard.

      Delete
  3. Hi B,

    Another great article. I always enjoy reading your investment articles.
    Although I have written about Straco Corp in my blog, you have covered many interesting angles that I did not touch on.
    Thank you and keep up the great job.

    Regards,
    Gerald
    www.sgwealthbuilder.com

    ReplyDelete
    Replies
    1. Hi Gerald

      Thanks for your kind words.

      I've also always loved your piece and have read your analysis previously on straco vicom and rmg as well.

      Delete
  4. Hi B,

    This is a strong fundamental stock that is overlooked by market this year.It is excellent on all fronts (ROE, growth, balance sheet, profit margin, cashflow etc.)

    2016 EPS was 5.41 cents, and based on growth we seen in Q1 and Q2 this year,I suspect 2017 ESP will be ~6 cents.(Q3 is typically a strong quarter) That makes PE of ~14 at current price level.Excluding cash of 0.13 cents per share, the PE is ~12 which is really cheap in my view.

    There are several catalyst on the table serving as positive surprises:
    1. Increase of dividend (which Straco is more than capable of doing)
    2. Increase of ticket price
    3. New acquisition to boost earning and ROE with 110M cash
    4. This is a low free float stock which generates tremendous amount of cash. This "cash machine" can be privatised easily and there is really no need to raise cash through equity.


    Regards,

    TengFei

    ReplyDelete
    Replies
    1. Hi Ling Yang

      Thanks for your valuable inputs.

      You are right there, I was suppose to take in the seasonality where they would perform a stronger q3 so I cannot just annualized it like that.

      The increase in ticket price is something Straco has considered in the past for their soa but delayed subsequently so it can be a near term catalyst. The m&a is another one that will surely be the next phase of growth. I do wish sometimes they could pay out a bit more in terms of dividends while waiting but no complaints for now I guess :)

      Delete
    2. Hi B,

      Haha, I have stolen and benefited a few great ideas from you in the past like CDL reit, Hong Kong land (which I am still holding on today) etc.

      I am quite vested in 3 local small caps: Riverstone, Micro-Mechanics and Straco. That is the reason I try to know as much about these companies as possible.

      1. Straco typically wants to get government consent before raising the price, and this actually shows its business has certain pricing power.
      2. Whether Straco uses the cash for M&A, or simply return the huge cash pile to shareholder, both will greatly enhance the value of the business in terms of rising ROE and earning yield.
      3. Straco seems to have a pattern of increasing dividend every two years. And with its huge cash pile and typical 50% payout ratio, I think we will likely receive 3 cents of dividend next year.
      4. Actually as long as Straco can grow and make additional smart acquisition, I dont mind the company retaining more of its earning.With its high ROE of 20-30%, retained earning will generate greater shareholder value in long term.

      Time will tell if we made a good buy on this. Haha


      Delete
    3. Hi Lingyang

      Wow you are really good!

      I had divested HK Land, CDLHT and Micro Mech much earlier. Looking back it does seem a pity and should have hold on longer to it.

      I agree with your analysis on the ROE. I hope the company can either find a suitable m&a or return the cash to the shareholder to maintain the high roe. The last thing I want is for them to hoard the cash like what Vicom did for years, and drag their roe down for a long time. Hahaha

      Delete
  5. Hi B,

    I divested CDLHT as well at lower price than your disposed price~ But I still keep HK land and Micro Mech. HK land is still a compelling buy at current price in my view. (prime quality property portfolio, low debt, growing book value and ~0.5 P/B) With your idea, I am still adding to this position recently.

    Regarding Straco, its management actually have good inside ownership of this stock, therefore we can rest assured that our interest is well aligned and whether do M&A or return cash, it will be in the interest of shareholder like us. I believe the management is prudent and will only make a buy when it is a really good deal in terms of quality and scale.

    Their Singapore flyer actually has an option to further extend the lease by ~30 years. I believe they are trying to negotiate a better terms before putting down investment to renovate the area.

    The key risk I see is that its aquariums get obsoleted like one in sentosa before churning out enough cash.(we need about 8-9 years to get back our invested capital~)


    ReplyDelete
    Replies
    1. Hi Ling Yang

      Thanks for your views.

      Indeed, the key is the aquariums which is generating lots of cashflow at this point and we have to make sure they are able to replicate what they buy on the assets that they are generating through the aquarium, and its not easy.

      Delete
  6. Hi B,

    I'm surprised you're still investing large sums 40k at this time. Aren't you afraid of market downturn in the near future when global markets are at all near-time highs?

    How're you preparing for a potential correction?

    ReplyDelete
    Replies
    1. Hi Alucard

      I have one eye on the potential correction to come but I would definitely not go for a strategy to wait until that big moment comes.

      I'd still look for opportunities meanwhile while trying to keep my capital intact by buying companies that have either growth catalyst or margin of safety.

      Delete
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