Posted by pcslegal > 2018-04-09 14:42 | Report Abuse

Business valuation is an art more than a science. It may be tempted to look at the historical balance sheets, P/Ls and cash flow statements for clues on the current valuation of a company. If you are accounting savvy, analysis of balance sheets, P/L and cash flow statements will likely help to you uncover some hidden value that may not be obvious to a lot of investors based on technical analysis or inferior analysts' reports to buy shares. But the limitations of accounting information is its historical in nature, some valuable assets not meeting accounting recognition criteria will not be reflected in accounts, good business model and management cannot be discovered through analysis of financial statements. Nevertheless, financial statements analysis is the first starting point to check how healthy a company's financial position and performance currently and in the past. As a value investor, I always start with objective analysis by checking the latest balance sheet for clue on company's cash and short term investment, liquidity, long-term debts position and any valuable assets e.g. real estates in prominent location not fully reflected in the balance sheets. Then, I look at the P/L position in the past to discern the normalized earnings of the company whether that normalized earnings consistent with the cash flow statements presented to ensure accounting earnings were actually translated into actual cash flow to the company concerned. Lastly, I will examine the subjective side of the business by evaluation the company's earning sources and business model to check whether the company can compete successfully within its industry. The subjective side of the business part is difficult to perform due to future uncertainties beyond our human ability to predict. That's why Warren Buffett always buy companies with simple business model within his circle of competence to understand so that he is more likely to know the future cash flow of a company to actually put a value on it. Having said that, how to use the above value investing approach to value Hengyuan? First, the company latest quarterly report 31 Dec 2017, balance sheet showed cash in bank and FD holding about RM510 mil, current ratio is about 4, total current assets is RM2.8 bil more than cover its entire liabilities (both short and long term) of RM2 bil. Latest quarterly EPS was 61.18 cents (profit after taxation is about RM180 mil) with cash flow from operating activities after depreciation was about 311 mil. It does has a very healthy financial position and performance recently. We can see its operating results started to improve in year 2015 till today with oil price hovers around USD60-70 today thanks to the OPEC production curb, the world commodities price is picking up with the growth in world economy but the likelihood of large fluctuation either move up or down substantially in oil price in the near future is dim as concerns over the volume of US shale oils supply, Federal Reserve tightening policy and US-China trade wars will cap its upward trends in future. Hengyuan is a cyclical company which cash flows and earnings will be moving up during the times when commodities cycle is picking up, so one should expect its market price to go wild when the cycle is peak like the year 2008 and the recent year 2014. So it is hard to find normalized earnings and cash flow of Hengyuan in the past, it is about timing of buying the shares during commodities picking up time. Like what I said in the beginning, valuation is an art more than a science. I prefer to put a range of value on a company and see how much margin of safety I have if I were to buy a company's shares at market value today. Usually I require at least 30% margin of safety before I will invest in the shares. If one is to review the balance sheet of the company, its NTA is RM5.9 per share, if using earnings base to value I will conservatively use the latest quarterly EPS 61.18 cents (EPS RM2.4 per year) as a guide for the year 2018 and using PE ratio 6 (due to small capital company), one can come to a value of RM14.40. IF one would to put a weighting of 20% on book value and 80% on earnings based value, then one can come to a valuation of Hengyuan at about RM12.70. Market price today is about RM9.2, margin of safety is about 40%. So it does provide a good margin of safety for the value investor to buy at the current market price. The above is my personal impartial opinion, please check with your financial advisers before you invest in the shares.