Straco Corp is a theme facilities and aquarium operator in China that we talked about a fair bit in the past.
Many still cannot fathom the edge this Singapore outfit is able to garner their results consistently, when we kept seeing similar ventures crumble.
Today, we won’t focus on the business case of Straco nor the fact that its generating good cash flow and 11 cents of the current 31 cents are in cash.
Lets see if there are any value to add at this price.
Straco’s PE
At the current EPS of $0.023, the price earnings ratio is 13 times. The earnings yield is 7.4%. That looks rather fairly valued.
There are folks who would think that 13 times is fair there are those that will think its expensive.
Certainly, for a small company, it should trade at a much lower multiple. In that case 13 times is expensive.
A low PE indicates certain risk, such as the earnings growth of the company will not likely to be very consistent. Or that there will be up years and down years.
13 times probably indicate that the market expects earnings to be consistent so much so to command that high of a price earnings.
Earnings Yield
An earnings yield of 7.4% looks reasonable. Versus a 15 year SGS government bonds currently yielding 2.25%.
A look at my dividend stock tracker, only Sabana, Rickmers and MIIF yield more than that.
Note the difference there. Most of the stocks on the dividend stock tracker are paying out 100% if not more.
REITs pay out from free cash flow, same for Venture, SPH etc.
Rickmers and Cityspring pays out more, yet they are heavily leverage unlike Straco which is net cash.
Further growth illustration
Here is a table summarizing Straco’s profit, equity, NAV, dividend and net cash status (Enlarge to read more).
Our objective here is to garner a reasonable growth rate for Straco. In this tumultuous period, we have gone through one bull, one bear and another bull.
Profit growth is haphazard due to some acquisitions at the start of the period and a great showing due to the China Olympics.
An annualized growth of 23% is very very good.
Equity grew 14%, and the gripe we will have is that this will eat into ROE. why is the equity and NAV growing so fast? A look at the net cash status tells you why the equity is growing.
The cash net of debt is growing at 22.7% per annum. That is how it accumulate such a treasure trove.
It pays out less than 50% of its earnings as dividend and annualized, its roughly 25.8% growth.
Discounted Cash Flow
Discounted Cash Flow (DCF) is one way of valuing a company. The difficulty in carrying out based on DCF is the subjective nature of the variables.
Growth rate needs to be set, and you will need to estimate that based on historical. The safest thing you can do is to be conservative with your estimate, hence we look at the historical growth.
This is unless future cash flow changes, such as business dynamics impaired or that there is a tremendous growth opportunity, therefore you need to change your growth projections.
How many years should we DCF? For REITs, bonds or concession based businesses its straight forward because you can use the average land lease left.
And here you need to be conservative as well. Would you use 20 years? Probably not. So much can change in 20 years.
Hell I don’t even know if people will still see aquarium then! For all you know Waterworld happens and all of us will be submerged into the sea!
A safe period will be 10 years.
How much would the cost of equity / discount rate? That is usually subjective and tells us what is the market demanding such an investment.
Here, we will do it differently. We will calculate based on the growth rate set and adjust the present value to the current share price which is $0.31.
Since we know that out of $0.31 cents, $0.11 cents are in cash, we will force the present value to be $0.21 to see what is the discount rate.
I input 3 years of 15% growth, 3 years of 10% growth and 4 years of 3% growth. Annualized the growth is 8.7%. This is a conservative estimate versus the 23% annualized growth for the past 10 years.
We get a discount rate of 13%. This means that with this kind of growth, the market is pricing that if you buy Straco now, you are looking at a 13% yield.
This gets more attractive when you know that Straco capex is very low, and that the free cash flow growth is likely to be much higher than this.
Suppose we be more conservative and assume Straco grows at 3% or the long term growth rate.
The discount rate is 5%, which is rather close to abit less than what most yielding stocks are yielding.
The market seem to be assuming no above average growth for the next 10 years for Straco. Will this be the case?
This is where you need to figure out the business case going forward.
Conclusion
One thing you will realize is that there are many assumptions presented here
- 10 years period
- Growth rate
- No substitutes to theme facilities / aquarium
- North Korea do not nuke Shanghai
- Straco is not a shell company
Valuation is not a static exercise and if the assumptions change, the valuation will change. It is up to you to be conservative with estimates to provide you with a margin of safety.
I hope this little exercise helps readers in some way to understand that it is understanding the meaning of PE, earnings yield and the processing of DCF that is important in identifying whether a particular asset is really undervalue or not rather than going through the motion.
Hi Drizzt,
Thank you very much for you detailed analysis on Straco. I’d like to just add a few twists on the valuation using some of your estimations.
Using Reuters’ data, I’ve found that on average Straco earned 19.43 mil of FCF since 2008. Assuming that they can maintain this average FCF to infinity (no-growth model), add back the company’s Cash minus it’s Total Liabilities give me an intrinsic value of 0.27$ per share. In another scenario, we can be more optimistic and take the company’s lastest FCF at 27.516 mil to calculate, the intrinsic value now is 0.34$. In the third scenario,I also consider is that it may grow it’s FCF at a stable rate of 5%, this hence will lead to a company’s value of 321.17 mil and a per share value of 0.38$.
With this calculation, I also agree with you that the company is fairly value with the most optimistic upside of 20%. However, the strong point of this cash-rich company is that with their Dividend Pay Out at only 24.5% of FCF, they can surely maintain or even increase their dividend and at current price, the yield is about 2.52%. Furthermore, they have 30% of their share price in Net Cash position hence will probably sail through any financial difficulties in near terms.
In conclusion, a very good defensive, reasonably priced stock.
P/S: By the way, it is great to see someone who is using Reverse DCF like you did with the stock price. I thought this method has rare user. Great to learn from you more.
Jack Nguyen
Hi Jack,
you hit many points on target, but perhaps one you missed is that Reverse DCF is actually taught to me by another friend so kudos to him.
at the end of the day the i would rather take the growth conservatively.
the 34 cents 38 cents and 27 cent you estimate contains the 11 cents cash?
I also know about Reverse DCF via reading blog and book on investing. It is true that for value investors we focus on value of asset and earning power rather than growth. I also try to do multi-year growth rate and take median to be conservative. And the value I estimated also include all the Cash minus all Liabilities.
Hi jack,
Perhaps you cannot educate me why we factor in cash minus all liabilities
Well..if you think about DCF as a calculation based on the company earnings power, adding back it’s cash or very liquid asset and minus away total Debt (not necessary all liabilities) is a way to assess it’s balance sheet NAV value.
In a less conservative way, you can try to adjust it’s book value and assign value on the intangible assets and long term asset like buildings or lands. For me, I tend to assume that these asset is almost worthless in liquidation, so at most I’ll add back the cash, short term investment, a portion of Account receivable and minus total debt.
Ah I see. Thanks for explaining it to me
It’s my pleasure Kyith.
just from the numbers i gather so far from this article, this stock seems like a reasonably defensive stock. surely a stock to take note off should the entire market dropped in near term and fundamentals stay the same. good analysis from drizzt and jack!
Don’t mentioned it kaii xiang, we often need this exercises to ensure we roughly know if companies in the market is overpriced or underpriced
How does Mr marks usually value his companies?
for that i do not know specifically haha. His memos only list out his investment philosophy and mentality. You can tell that he is probably a more margin of safety guy like klarman/graham instead of good companies at reasonable price to buffett (today) and fisher.
Klarman once mentioned investing to be four different stages/kinds, e.g. cigar butts – try to extract the last puff, cheap price for reasonably decent businesses, reasonable price for wonderful businesses, and seth klarman described himself to be the distressed investments/cigar butts kind. I see Mr. Marks as a similar type of investor like Klarman.
Ah I see. Going too read his book soon