Valuing Straco Corp

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

1. 10 years period
2. Growth rate
3. No substitutes to theme facilities / aquarium
4. North Korea do not nuke Shanghai
5. 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.

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