Market Strategy - RHB Invest 2016-02-03: Finding Diamonds In The Rough (Part 2)

ISOTEAM LTD 5WF.SI SHENG SIONG GROUP LTD OV8.SI SINGAPORE SHIPPING CORP LTD S19.SI

Finding Diamonds In The Rough (Part 2)

ISOTeam is a market leader in the repairs & redecoration (R&R) and addition & alteration (A&A) segments in Singapore’s public sector projects industry.
The R&R business boasts defensive, recurrent qualities while the A&A division complements the former, with both riding on government initiatives.

Since 2014, ISOTeam has managed to deliver strong net PAT growth of 187% and 33.5% for FY14 and FY15 respectively.
Coupled with its net cash position and highly maintainable gross margins of above 20% – this was due to good cost controls over the past 10-15 years since its founding – this has enabled the ROEs to be at attractive levels of more than 15%.
Going forward, with a steady orderbook of about SGD80-85m, we expect ISOTeam to deliver another 24.7% net PAT growth in FY16 as well.

The company has no direct peers in Singapore. ISOTeam – which is in a net cash position and has over 80% of revenue from the Government and its related bodies – is just trading at 7x FY16F P/E.
In addition, its cash flow has also been very healthy since listing, generating SGD9m of free cash in FY14 and SGD19m in FY15.
Our DCF valuation derives a TP of SGD 0.82.

ISOTeam has three independent directors in a 6- person board with a simple corporate structure. It has not changed auditors over the past 10 years and was listed in 2013.
Since its listing, management has displayed transparency and proactiveness in dealing with investors and analysts.
ISOTeam has also engaged an investor relations firm to help liaise with the investment committee.

Sheng Siong is a supermarket operator. The company employs an asset-light business model, renting most of its retail store space on long-term leases. It also does not require substantial capital investments. This is further enhanced by the cash-generative nature of its business and the positive working capital cycle.
Management has a strong track record of being operationally efficient, and Sheng Siong enjoys one of the highest gross margins for a supermarket operator in this region.
Considering the company has no financial leverage, its ROEs are even more impressive.

Sheng Siong has been experiencing higher operating margins since 2013. This was on the back of both higher gross margins as well as more efficient operating costs.
We believe operating margins are most relevant for this industry because they measure the profitability of a business without being distorted by non-cash gains/losses and financial leverages.
Going forward, we expect its operating margins to improve further through:
1. more direct buying,
2. a higher proportion of fresh food sales that provides better gross margins, and
3. incremental improvements of backend operations and distribution.

We use grocery retailers operating in ASEAN as its peer comparison. Using this, Sheng Siong is trading at a lower multiple than average. We believe this is mainly because the company operates in a single mature market, Singapore, which is perceived to have limited opportunities for growth.
While market potential is lower, we believe Sheng Siong’s business is much more resilient and medium- to longer-term growth may still surprise on the upside. This is due to the structural shift to supermarkets from wet markets previously.
Amongst peers, Sheng Siong also has one of the highest dividend yields.

We believe the company has strong corporate governance despite being a family-dominated business.
Since its listing in 2011, management has displayed transparency and proactiveness in dealing with investors and analysts.
Chairman Mr Lim Hock Eng has been in his role for more than five years since the listing. Together, the Lim family owns more than 70% of the company.
Out of the eight board members, four are non-executive directors that are external – and this includes three independent directors.
With a simple operating structure consisting of a single-market/single-business, there is also less room to confuse auditors and investors.

SSC is the only listed “pure play” car truck carrier (PCTC) company in the world, and is a rare gem that offers both safety and growth in the highly-cyclical shipping sector.
Operating in the extremely oligopolistic PCTC sector, the company has carved a profitable niche by:
1. securing a decades-long profit visibility through its long-term charters to blue chip clients, and
2. enjoys quality growth with its fleet expansion plans.
Minimum earnings risk justifies high gearing in order for good ROEs.
SSC’s ultrasafe ship-owning business model – with its decades-long charter contracts with century-old blue chips at fixed contract terms – ensures minimum earnings variability going forward.
As such, Japanese banks allow the company to gear up (net gearing of around 150% as at FY15) at favourable fixed interest rates (around 2%) in order to expand and get better return for investors (FY16F ROEs of around 21%).

If we were to compare SSC to its SGX-listed shipping peers – who are largely unprofitable at the moment – the company operates in a more favourable niche space with higher barriers of entry, ie PCTC vs container ship/dry bulk/etc. PCTC is a niche industrial shipping sector that requires a high degree of specialisation and where oversupply is a far less serious issue.
Going forward, demand and supply is expected to grow at the same rate.
Currently, SSC trades at a significantly higher ROE to its peers.

SSC is known by the market to have one of the best management teams in Singapore market for keeping minority shareholders close to its heart.
Since the company was first listed in 2000, SSC has dished out more than SGD200m worth of dividends and has never raised equity.
Executive chairman, Mr CK Ow – who owns an around 37% stake in the company – showed uncanny timing in the disposal of SSC’s vessels before the downturn.
Subsequently, the company distributed capital back to shareholders as special dividends back in 2008.

Ong Kian Lin RHB Invest | http://www.rhbinvest.com.sg/ 2016-02-03

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