Posted by: donmihaihai | July 29, 2007

SP Chemicals, Micro Mech and Full Apex relatively cheaper to the general market.

Relative cheaper doesn’t mean it will deliver positive returns for investor in short to middle term.

It is about one year since I made my 1st purchased of Full Apex shares which were below 30 cents. With lack of coverage by security firms, it may seem to be a difficult task trying to understand the economics realities of their businesses. But surprising, the picture of Full Apex is much easy to understand due to the fact that there are just 3 players in their main market and it is servicing beverage giants like Coca-Cola and Pepsi. But as the company is fighting a losing battle with the raw materials, the profitability drop along so does Full Apex share price. At one point, Full Apex was trading at one time book value, with help of hindsight that was the bottom of the share price.

Somehow there is an article in BT today by Teh Hooi Ling in her “Show me the money” column trying to exploit that Full Apex is decent investment candidate. Putting some ratio, brokerage report and exchanges with the management, she seems to be favour that the odds are favourable for Full Apex to deliver decent return in short to medium term. The main reason? Full Apex is trading at relative cheaper in term of valuation compare to its peers.

Comparing companies in the same industry which listed in different stock exchanges always seem to be a good idea but it may not work. Even trying to do a year-on-year comparison of financial number of the same company can be  a difficult task as what we see is the front presentation by the company but there are thing that happened behind the screen, which mean digging is required. Taking Full Apex for example, changes in IFRSs make Full Apex NPAT much higher by about RMB 20 million. Which mean if IFRSs does not change, NPAT would dropped from RMB145 million to RMB117 million compare to what was reported of RMB137 million. That was a drop of about 20% compare to about – 5%. The reason? IFRSs change the requirement that borrowing costs to be capitalise rather than expenses it recently.  

Borrowing costs directly attributable to the acquisition, construction or production of qualifying assets, i.e., assets that necessarily take a substantial period of time to get ready for their intended use of sale, are capitalised as part of the cost of those assets. The capitalisation of such borrowing costs ceases when the assets are substantially ready for their intended use or sale. Investment income earned on the temporary investment of specific borrowings pending their expenditure on qualifying assets is deducted from the borrowing costs capitalised. Other borrowing costs are recognised as an expense when incurred

The end result is the same, i.e. cash flow does not change but Full Apex will get better NPAT upfront before depreciation kick in which can last 10 to 20 years depend on the company policy. Beside that Book Value goes up too, if this is not a isolate case, 5 to 10 years down the road, Full Apex will has a much higher Book Value compare to its peers if different reporting standards are being used.

Someone may say Zijiang enterprises and Zhuhai Zhongfu may not be a good comparison as they may have other businesses beside PET bottle. Full Apex has other business segment as well which is paper packaging. Many people may think companies in the same kind of business should trade at around the same valuation. So since the other two competitors are currently trading at around 10 X more expensive in term of PE where their other profitability is much lower, the changes for Full Apex to catch up somehow is pretty high. Who know, after being pointed out by BT, it may just happen, Short to middle term? Maybe that is the magic.

No relative cheaper in investing.

The value of an investment or stock, depend on the discount future cashflow. When relatively cheaper is being use, one will get disappointed one point or another sometime in the future. Who know what if Full Apex is decently value while Zijiang enterprises and Zhuhai Zhongfu are being over valued? Anyway it doesn’t matter which market the company listed on or which industry the company belong to, the one with the highest discount future free cashflow is the most valuable.

Take SP Chemicals, Micro Mech and Full Apex as examples; they are trading at a valuation relatively cheaper than the market.

SP Chems at $1.22, PE : 8.5X, P/B : 2.5 X. and ROE of 29%. That was FY2006 number, FY2007 number should be better. While ROE is going to be pretty constant, using $1.22, P/B is likely to below 2X and PE is going to below 8.5 X as well. SP Chems is a super growing company.

Micro Mech at $0.66, PE : 11.3X, P/B : 2.6X and ROE of 22%. Since Semiconductor is facing hard time now, FY2006 and FY2007 should not be of much different. Overall, Micro Mech has a decent future with decent growth.

Full Apex at $0.325, PE : 9.5 X, P/B : 1.2 X and ROE of 13%. Raw material is still causing problems for Full Apex in which the number should stay pretty constant as well. Full Apex future is pretty bright in term of revenues growth.

So all three are a decent buy compare to the current market? Maybe it is true but if only one security can be pick right now, then which one is it? The cheaper one of course. But cheaper in term of ratio? Relatively cheaper or DCF? When all these are being brought up, DCF is usually the ans but again there are two problems. 1st of all is the guesstimate of future cashflow, it is easy to put some number into the model but getting the correct cashflow is not easy and it can be so hard that not worth trying. But the most important of all is free cash flow. All future cashflow that can be pay out as dividends after taking care of all future capex.

So should we look into the past dividends payment to gauge future free cashflow? Of course not. In SP Chems case, it had been paying yearly dividends to shareholders, despite a small amount compare to their cash flow, SP Chem will be better off if they never paid those cash out as they will be a much better financial position right now. For Full Apex, their dividend payout is dropping yearly because of 2 reasons, 1st is that of decreasing profitability due to increasing raw material price. 2nd is the need to expand into upstream and current production capacities. So will the current huge capex continue? That will depend on where the management set their eyes on, PET bottle or PET Chip or both. The conclusion that I come with is that for the immediate future, Capex will decrease. Increasing free cash flow can be use to reduce debts or payout as dividends. For Micro Mech, they are having surplus cash at the moment or all the while as compare to the other 2 companies. The reason? Micro Mech is generating free cashflow yearly which amount to about half of their cashflow and these free cashflow are being distribute to shareholders as dividends at the same time while they are investing for future.

Looking at the number alone and what the future of their industries and businesses alone is not enough. Management and employees are of main concern as they drive the train forward. At this regard, Full Apex score pretty low in here after reading their annual reports and seeing them in persons during AGM. Micro Mech is one that I regard highly and SP Chems follow not too far behind. I have not see the management teams of these two companies but action speaks more than words and their results clearly can only be achieved with good management.

So despite Micro Mech being relatively more expensive at this moment when standard ratio are being apply, I think it present the best investing candidate among the 3. SP Chems come close behind despite having the best outlook for increasing profit in the biggest amount in 3 to 5 years time, if the share price is cheaper by 25% or more, I might pick it over Micro Mech. Still the main worry is SP Chem is unable to show that it can produce free cash flow. Every increase in profit is cause by increase production capacities which require all cashflow that it generated and more. As long as this continue, it is always safer to demand a cheaper valuation of entry. Full Apex does not present a much bargain despite that the ratio apply and with increasing utilitisation of their bottle plants and the coming profit from PET Chip plant. Production of PET bottle is a decent business but not extraordinary one, the only positive part is that their competitors are weak and slow. PET Chip is even worst in the long run in my view despite the current favourable situation due to demand > supply. Another worry is of course raw material which comes from the derivative of oil. As far as my reading of oil production, high oil price is to stay and perhaps going upward for many years to come. This mean Full Apex is working extra hard to overcome it. If the price is going downward in the future, then Full Apex is worth much more.

I do not hold the thesis that return of equity > bond > cash or property and commodities are being added to the picture. Which ever can produce more future cashflow get my vote of the investment choice. And of the future cashflow, only free cashflow is real regardless where or how it comes from.

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