Posted by: donmihaihai | October 5, 2007

Inter-Roller strives to be a living company.

Inter-Roller vision is to be a living company. It captured my attention as it is being printed right in the annual report from 2004 to 2006. A living company? What is that? I am not too sure except that I encountered this book “The living company” as it is being mentioned by an author of another book “The Dhandho Investor”. Because of that, “The living company” is one of the book in my “to read list”. All I know is that this is a very interesting and good book about business, just like “Built to last” and “Good to great”.

Having a vision is nothing to shout about and most of the time, the company vision mean nothing much about the company as it is just for show. But at least for Inter Roller, it is a people company. The simplest fact is that the staff costs is almost 20X over the cost for depreciation for hard assets. For a company like Inter Roller, their staffs must be compensated well as they depend on their people rather than machines. People can and will move around easily so if they don’t find any satisification working in Inter-Roller, they will leave.

Inter-Roller is profitable too, very profitable and producing lot of free cash flow from 2002 to 2006. Just looking at the free cash flow over equity for the past five year, the return is 15%. This is very high considering that many companies are not able to produce any meaningful free cash flow. Their business focuses mainly on Airport Baggage Handling Systems, In flight Catering Systems, Air Cargo Handling Systems and Parcel Handling Systems. With good fortune and a past reputation due to their past projects in Changi Airport, Inter-Roller go on to become a global company despite their small size focusing in all part of the world especially, Middle East, China and Asia, their current focus is in Europe and North American.

With high ROE, free cash flow and a strong position in their industry, Inter-Roller is creating lot of shareholder value by returning most all their unused cash back to shareholder. This become a double plus as no matter how good the company is, if they do not return surplus cash back to shareholder and engaged in all kind of value destroying activities, shareholder just can and unable to benefit from it.

But there is one problem, Inter-Roller is a project base company, getting one project at a time with no recurring profit after the project is completed. This mean that the past may not be the future, especially the straight surge of revenues and NPAT from $19 million to $147.5 million and ($0.2 million) to $25.7 million respectively. It is not going to happen again, even a growth of 15% p.a for the next 5 to 10 yrs is highly questionable. The only certainty is to expect revenues and NPAT to be lumpy as securing the project itself is lumpy too. This is the reason that Inter-Roller share price dropped from over $1 to around $0.80 when their profit from main business and net margins dropped in 1H2007. This drop provided the incentive for me to really take a good look at Inter-Roller.

Reading thru annual reports and research reports, it is hard not to notice that there is a very strong tail wind blowing at Inter-Roller which may not repeat again.

1) 1st of all is the security issue in Airport post 9-11 and many airports are upgrading their system after years of under investment in this area. This wave will slow down somehow in the future.

2) Upgrading of handling system due to the launch of new A380 by Airbus. This huge flying ship requires better and faster bag handling system. Not sure how long and how many major Airports will require upgrading their systems but such event does not happen often. Not every new aircraft type require rework of the current system, it may be decades before another such event will happen.

3) The recovery of Asia, emerging of China and India post the last recession.

4) The emerging of Middle East due to petrodollar. This is the second time they experience such richness due to high oil price and many are not going back to the same old route by wasting away such wealth which lead to a boom in building infrastructure.

These are the contributing factors, and many are still in force. The biggest among all is actually the emerging of Middle East and China as they build world class Airport in their major Cities with bag handling system project may worth $40 to 80 million. Beside Airport projects, Inter-Roller also deal with industrial projects but that is just a very small part of their total revenues. Even as they seem to trying to diversify into different industry, it is not working right now. Another interesting point is that Inter-Roller has their own investing arm, buying and selling equities and property. Their latest transaction in commercial offices yields a return nothing short of extraordinary. Not sure who and how they are doing it, tracking their buying and selling can possible avoid knowing that they are potentially destroying shareholder money.

This is a company that generates very high ROE, 37.5% for 2006 and 20% for last 5 years(base on cashflow). At $0.84, it is trading at 3.4 X book value, historical PE of about 11X. It does not look expensive using if I will to extrapolate last 5 years growth into the future. Even if a lower growth of 15% per year, Inter-Roller still look cheap enough as the company double in size in 5 yrs and 4X in 10 yrs. Now if the future is not a straight reflection of the past, then the valuation is going to be off the mark. There are actually many concerns when the future of Inter-Roller is being look into.

1) The growth in air travel both by human and cargo are being projected sanguinely which also lead to believe that Inter-Roller is being closely associated with it. It is true that that both passenger and cargo will grow from now moving forward but this is also the truth since the turn of last century. So in short, there is nothing special here, this is a growing industry.

2) Power law is in work here. ( A powerlaw implies that small occurrences are extremely common, whereas large instances are extremely rare. ). The number of major airports is closely related to the number of major cities. One doesn’t get to see big modern airport in small town. Taking example of American, it is claimed that there are 14,800 airports around, does it mean that most of them are going to be a place for potential project of at least $40 million to Inter-Roller? A good guesstimation is that maybe half or more than half is not even going to be big enough to be potential customer for Inter-Roller in short term. For airports to be potential $40 million for Inter-Roller, one can start counting all major states in American.

3) If Inter-Roller is to maintain FY2006 revenues of around $140 million, it seem that they must win one to two major contact each year. If Inter-Roller is to double it earnings with margins staying the same, Inter-Roller required 2 to 4 major projects and 4 to 8 major projects each year if revenues grow by 4 X. It does not sound like a big problem but power law suggests that everytime the scale increase by one, the chances decreases by half. It is still back to the same question, how many major airports out there which require total rebuild rather than upgrade. Not to say that Inter-Roller requires many more times more smaller contracts to support their growth too.

4) Going by revenues and contract value, to maintain FY2006 revenues, Inter-Roller needs to win $140million of contracts yearly. To double in revenues, $280million yearly and $560million yearly if double again. Value of contracts won in 2006 was less than half of $140million in 2006 and the contract won ytd have not surplus $140 million yet. In another word, before looking at growth, revenues are going to extremely lumpy not just for these few years but as long as Inter-Roller wish to remain in their niche.

5) Inter-Roller also has a higher “fixed cost” to cross as this is a people company with little fixed assets. So most part of the salary of their staffs is fixed and in bad time, it layoff is not going to be common(if it is common, then there is no point investing buying their shares). With all the increase in staffs for last few years, Inter-Roller must has revenues of around $60 million at any single year in order to have any bottom line. The bar is much higher compare to 2002.

6) Does anyone know what the total value out there is yearly for companies like Inter-Roller to bid? I don’t know. One thing I am certain is that these handling system is not a life and dead matter to Airport, so if recession or down turn come, it can and is usually be delayed. Which also mean suddenly all players are bidding at a smaller pool at a time when time is bad, what the margin is going to be like? Next, once the system is in use, how long can it last? 10, 20 or 30 yrs? Sure there are upgrades along the way but… I am very interested to see when is the next upgrade of Singapore budget terminal bag handling system or better still a new system replacing the current system just built by Inter-Roller.

At the current price, Inter-Roller is cheap if there are lots of growths going forward. Other than that it gets very difficult. And if $140 million at the maximum range of its revenues, current price is quite expensive. Looking at it, I won’t like to bet on something where the outcome that requires all tail winds, lot of growth and no downside surprise on contract wins. Give me a much cheaper price and perhaps with very little contract wins due to recession or slowdown, I will bite.

Before that happen, I can spend my time watching the new management.

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Responses

  1. Hi DNHH, long time no see. Lost your blog for a while.

    Your sentiments about interroller is the same as mine. Being in an industry where most projects are turnkey, there is a certain risk in this. I will look at the size of the pie and going forward whether that pie will expand. Apparently im not really very familiar with it, but based on my layman knowledge i think it is limited.

  2. Hi Drizzt,

    Long time no see.

    My is layman knowledge as well. but it is not that difficult to map over by using available information and power law.

    Available information like “High margin and high free cashflow” : Questions to ask can be Why there are not much competitors? Due to too high Tech and design? If “yes” then try to ascertain it if “no” then more questions to ask,

    like : Does Inter-Roller Europe acquisition provide some clues? It is a small but reputation company.

    Like : Who are taking those deals which Inter-Roller missed out?

    The use of power law.

    And never rule out the possibility that Inter-Roller reach a critical point where they are able to clinch most deals out in the market. It is like explosion where the input of one plus one is not 2 but 4 or 6. The input can be reputation, cost, management, or structure chances in the industry.


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