Asia Enterprise Holdings (AEH) is a steel stockist listed on Singapore Stock Exchange. I first got to know it during its IPO, but I classified it with Telechoice as those Singapore smallcaps that earns 5-7% dividend yield.
The thing about these smallcaps is that you do not know whether they would stand up to the test of time.
There are many smallcaps that have been in operation for a long time despite its size. Some names are Boardroom, CEI, SinGheeHuat, Telechoice and GRP. You guys might want to take a look at them.
Steel Stockist like Asia Enterprise Holdings are simply the small middleman between large companies like Keppel, Sembcorp Marine and their demand for different types of steel products. Whatever size of steel products the users look for they deliver.
It is not a very glamorous business and it is a very competitive business. Every body in the industry likely knows everybody. So do the users.
AEH serves a wide range of industry. Even their own competitors. When someone needs to make up for sudden surge in demand they are likely to cross sell to each other. But mainly they serve the marine and offshore industry.
Their client based is pretty diversified, which is a good thing. Here you see that Singapore and Malaysia sales have been tapering off. Wonder how significant that is.
After taking a look at this company, I came to this conclusions:
- AEH will keep humming along if the regional economy hums along.
- A lot of how profitable or not depends on the skills and management of the manager. These guys have been in this business for 35+ years and they never had a unprofitable year. The red flag is when they have one really.
- There is nothing special about what they do. They are just more conservative with the way they manage compare to others.
- You are likely to see your profits and free cash flows fluctuate. They might not be cyclical but their clients demands are. Add to the fact that due to competition, they sell more in some years they sell less in others.
- How much their business is worth at liquidation and whether they are way overvalue can be computed because like commodities business such as Noble, their NAV is made up of 2 components- Cash and Inventories.
Profit, Cash Flow and Margins
AEH is listed in 2005, but its operating history goes further back then that. They doe state that they have been profitable every year for the last 37 years. Now I am not in this industry so I am not sure how hard that is. But a look at the past 7 years of operation do tell us that they may be telling the truth.
It is worth noting that SinGheeHuat and Lee Metal, which are also in this industry was profitable through this period as well.
The steel stockist enjoyed a great 2004 to 2007 before the recession. Profit was high due to the shipping boom as well. Since 2008, profit have halved and they have struggled to get back to that level.
Depreciation in this industry is low as do capital expenditure. So what it means that profits get paid out as dividends, pay down debts and keep as retain earnings for operations.
You will see that free cash flow differs from profit quite a lot, yet they have little capex. This is because when times are good inventories gets cleared, but when times are not good inventories build up. This affects free cash flow.
You need good working capital management and for AEH their working capital is funded by their cash, so they need to retain a fair bit of it for this purpose.
I would suggest since fluctuation in free cash flow is due to working capital, using net profit to measure the ability to pay dividends is more appropriate. It will take out inflated FCF due to working capital.
AEH’s dividend policy is to pay out 40% of profit to share holders. Payouts have been more than 3 million since the lowest profit hit was around 7.4 million. On a market cap of 82 million that works out to a yield of 3.6%. Not something that would appeal to a lot of income investors.
To earn a 5% yield, they would have to payout 4 million which means a profit of 10 million. That’s not been hit for some time.
The margins have dropped since the 2007 highs, but are steadily climbing back. I n such a competitive business, the growth in margins is probably where we should measure the management on.
Balance Sheet and Valuation
Since IPO, AEH’s balance sheet is characterize by these few traits:
- No debts
- Plenty of cash as working capital
- Inventory as other main assets.
The conservative approach have created a very clean balance sheet.
The Market Cap is around 82 million with 29 million in cash.Total equity is about 115 million. it is made up of 59 mil in inventories, which are steel inventories in various categories. So essentially you are paying 53 million in inventories and receivables.
Since market cap is below book value does that mean this is undervalued?
We do have to remember that the book value is as valuable when their underlying assets.
Receivables will eventually be collected as cash. But what about inventories, which makes up roughly the other half?
Assuming the steel inventories are liquidated at 75% of their current price,
RNAV = (115-59) + 59 x 0.75 = 100 mil.
Assuming the steel inventories are liquidated at 50% of their current price,
RNAV = (115-59) + 59 x 0.50 = 85 mil.
Essentially this means that if AEH were to liquidate tomorrow, they are priced as if their inventory can only fetch 50% of their current value.
Where is the margin of safety? is it a 75% liquidating factor or 50%? I would think 50% is good enough margin of safety.
We did a simulation using discounted cash flow with a discount factor of 6% (that is, the opportunity cost of investing in AEH is a 6% REIT investment)
Assuming that net profit earned varies from 5 mil, 7mil, 10 mil and the occasional 12mil, 14 mil, our net present value comes to 86 mil.
There is hardly any safety if we value this way. Now of course we know that out of the 82 million paid almost 35-40 mil is cash and receivables. We could essentially be paying 40-50 million for AEH, in that scenario, the XIRR becomes 13%.
I believe this business is not very sexy, but it is somewhat necessary to the regional economy. The problem is that it is a very commodity based business and the one with the best contacts and lowest cost wins.
I will keep watch on this. If it gets cheaper, I wouldn’t hesitate to get it. Do let me know what you think of this