Just like the word Investment, Speculation has different meaning to different persons. The funny thing is, almost everyone involved in financial market like to pride themselves as Investors (or Traders), and none of them would regard themselves as Speculators. Cambridge dictionary define Speculation as "the activity of guessing possible answers to a question without having enough information to be certain."  So, like it or not, the element of speculation is unavoidable in almost every investment decision we make. 

In his famous book The Intelligent Investor, Benjamin Graham actually suggested the readers to set aside a portion (the smaller the better) of their capital in a separate fund to speculate. However, we don't think the most conservative valued investing guru was suggesting the readers to jump into the most active stocks using the speculation fund. Benjamin Graham got his own definition when it comes to the term Speculation. He too, agreed that element of speculation is unavoidable in making investment decision. If we may, we speculate that, Benjamin Graham was actually suggesting the readers to minimize the element of speculation when making investment decision, but use it freely (predicting future profit, future trend etc) in the Speculation Fund.

In our previous post, 

https://www.stockifyblog.com/single-post/Q1FY17,

we invited readers to vote on the poll to decide which stock to cover. At time of writing, AJIYA is leading the rest of the stocks by getting 25% of the votes. As promised, we are going to present AJIYA, with the topic of Speculation.

Business Analysis

The history of AJIYA goes back to 1990 where it started as a metal rollforming manufacturer under the brand name of AJIYA. From a company with only 3 employees to produce metal roofing, AJIYA has been working relentlessly to expand geographically and its products range to be where she is today.

Product

The products of AJIYA can be largely classified as Metal Base and Glass Base.

For its Metal Base products, AJIYA has diversified into manufacturing of various prefabricated steel products in particular metal roofing system, metal frame products, structural products, architectural products and light-weight channel products. Its metal products division contributes 60% of the total revenue of AJIYA.

For its Glass Base products, AJIYA ventured into safety glass business in 1996, the same year it was listed on 2nd Board of Bursa Malaysia for expansion. In retrospect, The Group made a right move. It started as tempered and laminated glass producer, and later broadened its product to include insulating glass, decorative coat glass, security, safety and storm protection glass. Today, the Glass Division is contributing roughly 40% of AJIYA revenue.

With years of experience in the industry, AJIYA is one of the leading building suppliers in the country. AJIYA places great emphasis on quality control on its products. Over the years, we have seen continuous update in quality of AJIYA Metal and Glass products, with the accreditation of ISO 9001:2015 for its Metal products and MS 1498:2011 for its Glass products (find out more about Malaysia Standards Collections at https://www.msonline.gov.my/default.php)

Today, AJIYA's Metal Base and Glass Base products make up 8 series of housing components, which is illustrated as below.

 

 Taken from Pg 4, AJIYA FY16 Annual Report

 

 Taken from Pg 5, AJIYA FY16 Annual Report

However, one should not be easily carried away by fancy phrases like "Leading building material supplier". As far as we know, it is a tough business, which can be mathematically proved in our financial analysis later. AJIYA serves as a downstream player in the metal products segment. The raw materials for production are usually imported from upstream player, therefore its profit margin is heavily affected by foreign exchange and raw material costs. In our previous post on HOMERIZ, we opined that HOMERIZ has the ability to pass the cost to customers, although as much as 40% of its raw material is imported. However, we don't see the same in AJIYA metal segment. Worse, without much product differentiation, especially in Malaysia construction sector where quality of building materials always being overlooked, the Group products are facing price pressure from sub-standard products from China. In the financial year of 2016, the Glass Division is badly affected by the supply glut from China, causing its safety glass processing plants only running at a capacity of 40%.

In recent years, AJIYA has developed another source of revenue, known as Ajiya Green Integrated Building Solutions (AGIBS). Leveraging on its know how in manufacturing the 8 series of housing components, AJIYA invested RM 20 million in the past four years to develop the new business. Strictly speaking, AGIBS is a solution and system provider for IBS (Industrialized Building Solution). In view of the unavoidable transformation in Malaysia construction sector, the management targets to be the very first one-stop manufacturer that can provide affordable, fast and an efficient integrated building system solution for Malaysia and South-East Asia. As pointed in previous paragraph, AJIYA current Metal Products Division & Safety Glass Division do not have any moat, but AGIBS could be a game changer to AJIYA.

Before we go further to explain more on AGIBS and IBS, let's look at the geographical analysis on AGIBS.

Geographical Analysis

The Group derived 93% of its total revenue from local business activities. We can see that this juncture, or in near future, the revenue of the Group is still highly dependent on local construction sector outlook. The Group established its first overseas presence in Thailand back in 2007, which contributes to the overseas revenue. AJIYA possesses 12 factories currently as shown below:

 

 Taken from Pg 33 , AJIYA FY16 Annual Report

Based on the allocation of the factories, we believe the main market of AJIYA is Peninsular Malaysia. In May 2016, AJIYA signed a MOU with PT. BAJA BAHANA UTAMA to explore potential buinsess opportunities in Indonesian market. In December 2016, AJIA has entered into another MOU with YKGI Holdings Berhad with the intention of establishing a long-term strategic business partnership between both companies in East Malaysia. These are the recent update in AJIYA in expanding geographically.

Management 

Apart from the financial reports that do not specify revenue and profit segment (if you are with the management and reading this please improve this), we are basically quite happy with the management. From its venture into safety glass business, expansion to Thailand market, and promotion from second board to main board, we see the management ability to transform the company. The management has also been able to keep the business profitable with a strong balance sheet over years.

Another point worth noting is the reputation of AJIYA in the building material industry. As pointed out earlier, AJIYA metal base and glass base products are all updated and accredited with Malaysia ISO standards. For its new business, AGIBS, the subsidiary is also certified by CIDB as an IBS Status Company. Besides that, AJIYA is also one of the founders of Malaysia Green Building Confederation (MGBC), which allows it to spearhead the development of greenbuilding components in Malaysia. Its subsidiary ARI was also recognised by CIDB as "Pusat Bertauliah Installer IBS" for IBS Metal Structure Framing System.

Based on the Annual Report FY16, the Managing Director and Founder of AJIYA Dato' Chan Wah Kiang has a substantial shareholding close to 30% in AJIYA. The directors in AJIYA are also getting fair pay of an average of 10.8% of the company earnings over the 5 years.

 

 Illustration 1: AJIYA Directors' Remuneration over 5 Financial Years

Financial Analysis

When we talk about Financial Analysis, there are basically 3 main components to it, ie, Earnings, Balance Sheet and Cash Flow. 

Let's compliment before criticize. AJIYA has been maintaining a very strong balance sheet over the years as shown in Illustration 2 and 3. It turned net cash since FY15. AJIYA also presents a set of very strong liquidity ratio that allows it to meet any short term obligations.

 

 Illustration 2: AJIYA Balance Sheet over 5 Financial Years

 

Illustration 3: AJIYA Liquidity Ratio over 5 Financial Years

Cash Flow of AJIYA is equally good. It has been maintaining positive Free Cash Flow (FCF) in 3 out of 5 Financial Years as illustrated below. The two years (FY 13 & FY14) that failed to achieve positive FCF was probably due to the Group initial heavy investment in developing AGIBS.

 

Illustration 4: AJIYA Cash Flow over 5 Financial Years

However, we cannot give the same compliment on AJIYA's earning ability. In business analysis above, we mentioned that it is a tough business in building material sector. As shown in Illustration 5, we can hardly see any improvement in its revenue, gross profit and net profit. In Illustration 6, when we strip out the non-other income, AJIYA can hardly achieve a net profit margin of above 5%.

 

Illustration 5: AJIYA Profitability over 5 Financial Years

 

Illustration 6: AJIYA Profit Margin over 5 Financial Years

The Speculation 

Now you get the picture. AJIYA is a company with strong balance sheet, good management, and decent cash flow. What is stopping it to gain attention from investors? It is the razor thin margin of the business. 

If you want to know how important is profit margin to a company, check our previous post

https://www.stockifyblog.com/single-post/profit-margin

Now, what if, AJIYA is holding one wild card that could change the only thing we don't like about the company? Yes. It is AGIBS, the Industrialized Building System (IBS) solution provider developed by the Group in recent years.

For those who don't know, IBS is a pre-fabricated construction method where building components are made in the factories under controlled environments and sent to the construction site to be assembled like LEGO. While it might sound unfamiliar to some people, IBS has actually been introduced to Malaysia Construction Industry for more than 40 years, and today it is already widely and commonly used in Europe, United States, Japan, Singapore etc. Although in the <IBS Roadmap 2003-2010> endorsed by the Cabinet of Ministers required 50% of government project to completed with IBS in 2003, and later raised to 70% in 2008, the overall adoption in IBS is still very low in Malaysia. 

However, with recent boom in the construction sector, increasing competition from foreign contractors, and continued undersupply of affordable houses in local property market, we started to see government re-initiates the efforts in pushing IBS, and also increasing interests from local contractors and developers in adopting IBS. From 2012 to 2015,  MIDA has approved a total of 96 IBS manufacturing companies with investments worth RM1.1 billion. MIDA targets 100 additional IBS manufacturing companies by 2020. The CITP has set important strategic goals and milestones to bring Malaysia's construction industry to the next level.  To support the growth, MIDA provides both fiscal and non-fiscal facilitation to entice companies to adopt IBS method. Companies that manufacture IBS components are eligible to apply for tax incentives from MIDA in the form of either Pioneer Status (PS) or Investment Tax Allowance (ITA). Any importation of machinery, equipment and raw materials which are used directly in the manufacturing of IBS components and not available locally are also entitled for import duty exemptions. In March 2017, Prime Minister Najib and Work Minister Fadillah Yusof have announced that it is mandatory to achieve IBS score of 70 in construction industry.

It is obvious that Malaysian government wants to push the revolution in construction industry with IBS. The benefits of IBS include:

1) Shorten construction period significantly

    The construction period could be 3 times shorter, therefore achieving cost savings. According to Dato Chan, MD and Founder of AJIYA commented that With AGIBS, the conventional 24-month construction period is significantly reduced to only eight months.

2) Reduce dependency on foreign workers

    IBS can reduce dependency on foreign workers. As we are writing this, Malaysia Immigration officials is swooping down on thousands of illegal foreign workers in the country after a deadline for registering them on 30.06.2017. This will worsen the insufficiency of foreign labour which has already been a concern to the several industries in Malaysia.

3) Environmental friendly

     IBS solves the problem of noise pollution and garbage disposal at the sites.

4) Reduce site accidents

      IBS can reduce site accidents and save on safety costs.

5) Cost efficient

     While the initial capital investment for IBS is deem to be high, it will eventually achieve cost saving purpose over the long term, especially with economies of scale.

In an interview with Dr. Suraya Ismail, the Director of Research of Khazanah Research, she opined that local construction firms must modernize their construction method in order to be able to build more affordable houses. She also warned that local construction firms will be losing more jobs to foreign construction firms, if they continue to adopt conventional construction method. Therefore, it is obvious that any project involving affordable housing will likely require an unconventional way of building homes.

Therefore, current undersupply of affordable houses in local property market would likely further promote the implementation of IBS.  In Budget 2017, the Government reaffirmed its focus on initiatives such as PR1MA, People’s Housing Programme (PPR) as well as People’s Friendly Homes (PMR), among others. We came across an article published on <The Edge Financial Daily 22.06.2017>, stated that PR1MA has inked an agreement to raise RM 5 billion as working capital for 89 of its housing projects (comprise at least 89,499 unit of homes) with gross development value of RM 23 billion. The article pointed out that PR1MA aims to build 500,000 homes, of which 267,902 homes has been approved, of which 139,393 are under construction. The agency has only completed 8,475 affordable housing units so far, half of its target 17,000 completed units by end-2017. While it is controversial whether building affordable houses by government using taxpayers money a good move, the schemes are definitely going to give a rise in IBS. In addition to government efforts, there are also more private property developers jump into the bandwagon of providing affordable houses. 

Now, we might have convinced you about the IBS Trend in Malaysia. The next question you should ask is: "How do we know AJIYA is going to benefit from this trend for sure?". We ought to remind our readers again, we don't. We are only speculating.

To clarify, AGIBS is not a contractor who is involved directly in building houses with IBS, but the supplier of IBS solution to contractors and developers. From an interview by BFM, Ubull Din Om, Managing Director of Gamuda Engineering Sdn Bhd, we understand that IBS manufacturing requires high initial capital, therefore only the big boys in the industry can manage to manufacture their own IBS components. This is the reason why there is an undersupply of IBS manufacturers in Malaysia. In a report from MIDA, we can see that there are only 210 IBS manufacturers (AJIYA being one of them) registered with CIDB as at Dec 2015, and CIDM aims to increase the number 300 by 2020. From here, we can see the undersupply situation in IBS, and the barrier of entry. Therefore, due to the high capital requirement, small & mid sized developers and contractors would not be able to manufacture their own pre-fabricated building components and have to turn to IBS solution providers like AJIYA. 

 

 Taken from MIDA Report in 2016

We are also impressed with the roles AJIYA currently play in the IBS system. Currently, AJIYA is working on two PR1MA projects in Simpang Pulai and Tapah, Perak, which comprise 1,000 units of single-storey and double-storey houses. AGIBS will also be used in the construction of affordable 746 PR1MA housing units in Sarawak. AJIYA managing director commented that any stakeholder which is related to the affordable housing segment, be it Perbadanan PR1MA Malaysia, Syarikat Perumahan Negara Bhd, the urban wellbeing housing and local government ministry, or the Public Works Department, has all visited their site. He also said AJIYA is among 15 companies shortlisted by the Public Works Department  (JKR) to supply the AGIBS to contractors to build about 100 schools in Peninsular Malaysia. Besides that, AJIYA is also the first in the country to be recognised by CIDB as the accredited IBS trading centre to offer skills training to individuals to use IBS Metal Frame System. This will effectively pave a way in the future for more parties to relate to AGIBS while adopting IBS.

Judging from the current undersupply of IBS manufacturer and the barrier of entry, we speculate that AGIBS is going to contribute significantly to AJIYA bottom line. Unlike AJIYA existing core businesses, AGIBS is expected to provide a better margin as there is much more value added in such solution. For example, the AJIYA Green IBS Wet Wall System developed by the Group in 2015 is internationally patent protected. According to Dato Chan, on average, the per-unit price of the AGIBS is about RM20,000 to RM25,000, which will provide AJIYA a reasonable double-digit profit margin. He also expects AGIBS to make up at least one-third of the group’s earnings in FY17, while its metal roofing and safety glass businesses are expected to make up the remaining two-thirds. 

In Stockify checklist, AJIYA fails as an ideal investment due to its business with no moat (resulting in razor thin margin). We believe in efficient market hypothesis (on some level), a better business always deserves a higher valuation, in terms of PE, EV/EBIT, EV/EBITDA etc. If what we speculate turns out to be true, AJIYA can easily pass the Stockify checklist, and investors are very likely to see a re-rating in the share price of AJIYA.

Summary

"The only indisputable truth that the past teaches us is that the future will always surprise us - always! And the corollary to that law of financial history is that the markets will most brutally surprise the very people who are most certain that their views about the future are right. Stay humble about your forecasting powers, as Graham did, will keep you from risking too much on a view of the future that may well turn out to be wrong."

Yes we are quoting from The Intelligent Investor again. Even though we sound very excited and optimistic to AJIYA new business division AGIBS, we are well aware that things can always turn out wrong. We are speculating on AJIYA based on the three factors:

1) The good management track record in managing and transforming the company,

2) The strong balance sheet and cash flow that allows the company to weather a storm, 

3) The new division (AGIBS) that allow the company to ride on the trend of IBS.

We wish to redefine the term Speculation , and challenging our readers to re-examine their previous investment decision: "Have you been speculating all this while?" And since we are speculating in the case of AJIYA, we are ready to pay the price if things go wrong, with our heads held high. 

Source: https://www.stockifyblog.com/single-post/ajiya