“K C, what is your view on Robert’s adverse posting on Hevea in i3investor”

A course participant asked me on August 30 2016 when Hevea’s share price was wacked down by more than 10% to RM1.05 from RM1.20+ in just a couple of days.

“Avoid following rumours and baseless accusation and just focus on the fundamentals”, I said.

Yes, what we read from bloggers we have to take it with a pinch of salt, in fact, it should be a handful of salt as there are all kinds of rumours, half-truths, lies and more lies in the internet. You are fortunate that you have learned the language of business and you should be able to evaluate if the second 2016 quarterly results were bad as claimed by Robert, without any justification. You can also evaluate the value of the company, using the various valuation techniques that you have learned and come out with a range of values, and also take a peep in the future of the business of Hevea. I am pretty sure you can come out with better judgement on your own.

“K C, what you say Tan Teng Boo has a target price for hevea at 60 sen, half its share price now?”

That was another question asked by another course participant a couple of months ago when we had a drink at Sunway Pyramid. I didn’t pay much attention to it then but this issue was raised again by a few more participants in our WhatsApp group just a couple of days ago. This time, I think I must look at how TTB has come out with his target price of 60 sen as this is a huge deviation of my estimated value. TTB is a pioneer in value investing in Bursa, I thought we should pay heed to what he says. In investing, it pays to look at other people’s point of view too. I got a copy of icap’s report from one of my participants.

My previous analysis

Five months ago I have written about Hevea as a stock pick in this service when it was trading at RM1.17. I have done detail analysis and given you a comprehensive report about my investment thesis. Its share price has risen a little, not much, but with the dividends, the total return is about 10% now, which is satisfactory in this short term, in my opinion, although the long-term return is what we are looking for. Appended below was my conclusions in my report.

[Conclusions

Hevea, in the past few years, has transformed itself from a very risky company with huge debts facing a financial crisis in 2008 to a highly profitable and safe company with net cash now. It exhibits high growth in recent years and earns high return on capital with excellent cash flows and free cash flows. In another words, Hevea has transformed itself into a great company.

The investment thesis of Hevea lies in its low market valuation with earnings yield of 19.3% and its high cash yield of more than 10%, more than twice that an investor can get from putting his money in bank fixed deposit.

The conservative GCGM with growth assumption just matching the rate of inflation shows that Hevea is worth RM2.18 per share, or a margin of safety of 46% investing in it at RM1.18.

I see little risk in investing in a good company at a cheap price, but potential in extra-ordinary gain.]

The intrinsic value of Hevea of RM2.18 has taken into the dilution effect of the warrants using the Black-Scholes OPM in my analysis. There won’t be significant difference if you consider the warrants are fully all converted as the warrants are deep in-the-money now. But how come there is such a huge discrepancy between my valuation and that of TTB, bearing in mind that we both follow fundamental value investing.

Let us have a look at what TTB’s analysis and report is on Hevea as shown in his report. It is either I was overly optimistic or he is too pessimistic. It is the two ends of extreme.

Icap’s evaluation on Hevea

For sure icap has very good qualitative analysis about Hevea, and for most companies they analyze. This is understandable as they are the professionals and this is their rice bowl. We can’t get near to them.

Reading through the report, I see many positive points mentioned by icap on Hevea. These are:

• In house R&D capability
• Products mainly export to Japan, China, Korea etc. of 80%-90%
• Huge improvement in efficiency in RTA especially
• Huge improvement in asset turnover the last couple of years. It means sell more.
• huge increase in revenue and profit
• Huge improvement in balance sheet and in net cash

These were basically what I had seen. Why not, as we both follow fundamental analysis.

But why the target price of 60 sen?

Dear course participants, I am afraid you have interpreted wrongly what icap is saying. It never says the target price of Hevea is 60 sen if you read the report thoroughly. it merely mentioned that,

"Based on these, icap rates Hevea as a Buy at below RM0.60 for long term"

Anything wrong with the above statement by icap? I don’t think so.

You were taught as value investors. We should only buy a stock when it is selling at a wide margin of safety, weren’t you? TTB has always been very consistent with his opinion, that the market is heading for a crash since some years ago, and hence his low recommended buying price, in any stock he analyzes now. He, however, didn’t come out with any valuation of Hevea and we don’t know what intrinsic value he has for Hevea, 20 sen, 30 sen? We don’t know. But we do see a glimpse of its opinion on Hevea in its conclusions as shown in points form below.

1. “At RM1.21 and with warrants outstanding, Heveaboard is capitalized at RM662.2m. for this what do investors get in return?”
2. “With the majority of sales coming from exports, currency fluctuation has a significant influence on revenue”
3. “While lowering cost through higher automation, the company is currently focusing on margin growth through the sale of low formaldehyde emission products and equipment upgrading.
4. Although this is a good strategy, without an adequate expansion of PPE, the company’s growth will eventually be hindered.

I will try to give my opinions on icap’s concern as below:

1. With a market cap of RM662.2m, it is only selling at a price of 7 times net earnings, enterprise value of just 4.8 times its Ebit, and a high cash yield befitting a No-brainer Investment of close to 10%. After taking the full dilution of its warrants into consideration, Hevea is still selling at 45% below my estimate of its intrinsic value from a conservative Gordon Constant Growth Model using an average FCF for the last 5 years to be conservative. Its FCF last year was two and a half three times more than this average.
2. I have no predictive power about the future direction of Ringgit versus say USD. However, I think it is not easy for Ringgit to rise up to RM2.50 to one USD like 30 years ago, and hence hamper the export companies like Hevea. What do you think is the likely the direction of Ringgit against USD?
3. Isn’t this equipment upgrading a form of capital expenses which have had shown good outcomes?
4. I think we will leave them to the management which should know better than anyone else.

Second quarter 2016 results

Hevea reported its second quarter 2016 results at the end of August. Revenue for the half year increased by 18% to RM268m and net profit by 15% to RM35.4m compared to the corresponding period last year. Free cash flows remained strong at RM30m for the 6 months. Needless to say, the balance sheet continues to improve with net cash now at RM100m, up from RM67m at end of last year. As a result of this good FCF, a first interim dividend of 1.3 sen was paid. There is no negative surprise in the results so far.

Conclusions

I always propagating on focusing on the fundamentals of investing. Good to read analysts’ reports, listen to market talks, including forecasting of macro-economic events, but do not let them dictate too much on your investment decisions. You are well equipped to analyze and make independent judgment on your investment with all the knowledge in fundamental investing that you have already acquired. Make full use of all this knowledge in your investing decision. You should be doing satisfactory in the long run.

I do not see any significant event which will adversely affect the business of Hevea. To me, at RM1.25 now, it is still a steal. Of course it will be fantastic if you can buy at 60 sen. However, sometimes one has to be realistic in our investment, as well as life in general. Don’t you think so?

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.”
― Winston S. Churchill

In case you have any further question or comments, you may contact me at

ckc15training2@gmail.com

KC Chong