Let talk about what really drive the share price. In short run, it could be anything. News flow, insider buying or selling, whatever. Whoever can get ahead of the news flow, win as you trade on it. In the long run, it is the earnings power of the company. The company might be sitting on some properties or equities, the common assets one can find on the B/S and they must be generating income and these incomes might flow directly through the P&L, or just partially through. Sometime, these assets might be sold at some point at great price and sometime, it won’t.
Some value investors will say buy at a discount to the BV, ie cheap relative to BV and one will do great. I don’t disagree but I tend to think that beside being lucky, the one that work out well are the ones that have some earning power or generate some decent return. Having a valuable asset sitting just there is not going to generate return by itself. One need to sell it or convert it into sellable product.
A good example is Bukit Sembawang Estate. The same story will keep repeating that it is sitting on some cheap land since its plantation days. I have been hearing about on the day I got to know the name of Bukit Sembawang Estate. After so many years, I bet that a big portion of those land have already been developed. But the story is always, if we look at the revalued net assets of the Bukit Sembawang Estate, the share price is worth XX more.
If I look at their share price, net assets and earnings since 2010, one will be disappointed. Share price still at $4++ range, number of shares outstanding remain unchanged. net asset about double since 2010 to $1.5B and yearly earnings on average maybe below $100M. $100M on equity of $750M is decent, but on $1.5B is just ok but I won’t pay anywhere close to 1.5X book value to get a sub 7% return on equity. After 13 years or so, investor got the dividends and a more and more depressed valuation despite the sexy story of cheap land bank. If you have the cheap land bank, it got to convert and turn into earning. Time is the enemy of return especially when one pay for it. At current valuation of about 2/3 book value, a 7% ROE change the whole calculation. The main point is still not the cheap land bank but what is the earning like in the future. If the future earnings will be like 4 to 5% ROE then I don’t think it is fun to invest in at 2/3 book value. 1/3 book value will make my blood flow faster.
The story of Bukit Sembawang Estate is not unique. It happened to so many local stocks. One start at a higher valuation and slowly roll down toward a lower valuation. I think we are at a point where investors think current valuation fit these companies. This excites me.
When talking about earning power, I can’t help it but talk about UOB and Haw Par together. Everyone know about UOB, but fewer people know that Haw Par is sitting on close to 5% of UOB on its B/S. Those who know about Haw Par will usually come out with the conclusion that, if I want to invest in UOB, I buy UOB straight, why invest in a sleepy conglomerate when there will be no so called unlock of shareholder value and might be even screwed by the Wees. Forget about how shareholder value can be unlocked in the first place, if I go back to year 2000 or 1998 with 1998 one can get to buy at the lowest point in a crisis presumably one is able to do it. Haw Par share price basically matches that of UOB. $3.62 last done in 2000 and $1.02 lowest in 1998 vs $13 last done in 2000 and $2.78 lowest in 1998 for UOB. Number of shares outstanding increased slightly for both but the reason for Haw Par increase is mainly due to bonus shares maybe 10 years back but I can ignore it.
I mean one can just look up to their share price and realised that Haw Par actually not just matches UOB return, its return actually exceeds UOB. Just a quick point out, at $13 at $2.78, UOB was at 2X and 0.5X book value. Haw Par carried UOB at cost and cost was about 1X Book value. Haw Par was trading at 1.3X BV at $3.62 and like 0.4X book value at $1.02. Do the math, It is not hard to tell at $3.62, Haw Par was trading at about 1X book value had UOB being accounted for at market price while UOB traded at 2 X book value.
Both companies’ valuation got depressed over the years. When was the last time Haw Par ever traded at Book value and UOB at 2 X book value. But despite that, share price gone up like 10X from the lowest for both companies and double or more than double at 2000 last done price. What make it so? earnings power if I ignore 1998. In UOB and Haw Par example, with a longer period, we are able to see increase in share price despite the fact that valuation being depressed. Current valuation makes both a better buy than in 2000 and the only question is what the future earnings power look like.
But there is a more important point on Haw Par and UOB. How did the boring Haw Par matches and even outperform UOB? I think valuation play a part. Never really do that math. But when I look at Haw Par, with the changes in businesses over the years, one business stood out, healthcare products. The earnings power of healthcare products made up for those businesses that Haw Par has lost over the years and become a very significant part of Haw Par and at this point, the future of these two businesses will decide the future of Haw Par. UOB is bigger with decent ROE, but ROE of 10 to 15% is in no comparison to healthcare products. The profitability of healthcare products is in another class.
Let continue with bank or DBS and Hong Leong Finance. Hong Leong finance is like Bukit Sembawang Estate. Its share price has gone no since 2010 or dropped like 10 to 20% from just above $3. As for DBS, it is like a little more than double from like $14 to $31. HLF book value was at $3.5 back then and now it is $4.55. So valuation dropped from 0.8 to 0.9X Book value to like 0.6X book value. DBS book value was at $11.25 back then to $21.17 currently. So DBS was valued at 1.3X book value then compared to 1.5X book value. Valuation expanded. Without looking at anything else, the thing that jumped out at me will be DBS increased their book value at a faster rate than HLF. Almost double.
Why so? Did HLF payout a higher portion of their earnings to shareholders? No. Basically DBS has a higher earnings power. DBS ROE used to be lower in the sub 5 to 10% range in the 2000s. But from 2010 to 2022, ROE jumped to about 10% ++. Recent days look like it will go above 15% for the coming years. What about HLF? It remains at about may sub 5% for a long time. FY2022 was a good year or so some called it for HLF and what is the ROE? 6%. Now that is what separates the both. And the story is simple, DBS generate higher ROE, paid out more dividends, retained more earnings over the years and continued to generate higher ROE.
It is no brainer that DBS should value higher than HLF with ROE of about 3X higher. The thing about bank is its need capital to grow, and it look like DBS is doing well with about 50% earnings in the previous years when its ROE is at around 10%. And when ROE improved to 15% for whatever reason, reinvestment need is still the first 5% of the 15%. free cash flow jumped from 5% to 10%. The return after 5% is way more valuable than the return before 5%. Of course, one can always invest in HLF currently at 0.6X book value. Ignoring everything else, one gets a higher return when invested at 0.6X book value with ROE of 6% compared to 1.5X book value with ROE of 15%. But that is to ignore the elephant in the room where ROE of 15% is close to 3 X that of 6%. Compound that over time is the key. Also, is HLF even been keeping up with their competitors in general after dividend out quite big portion of their earnings? Their capital, ie book value hardly grows, like 30 to 40% only, half the rate of DBS.
The most important question to ask is why HLF is ROE is so low. Yes, HLF leverage a lot less than DBS but that doesn’t explain everything. Comparatively, UOB and OCBC leverage more like DBS than HLF and earnings look like DBS as well.
Let end it by saying, while these are the pasts, it is useful to use it to see the future. The 3 local banks used to generate ROE of about 10% and now its look like if the environment remain, they should be generating at around 15%. Are you going to value them like they are in 10% or 15%?
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