Market Strategy - RHB Invest 2016-02-03: Finding Diamonds In The Rough (Part 1)

IPS SECUREX HOLDINGS LIMITED 42N.SI FIRST RESOURCES LIMITED EB5.SI

Finding Diamonds In The Rough

In the wake of the global markets' meltdown, we find it an opportune time to dig for gems.
The tools we used to find the “Diamonds In The Rough” among the companies under coverage in our footprint in ASEAN + Hong Kong, were a bottom-up fundamental analysis and also screening for companies that meet four criteria:
1. ROEs of 15% or above,
2. widening margins,
3. trading below the average market multiples, and
4. reasonable corporate governance.

we did not employ an automatic screening of parameters. Instead, our methodology made use of RHB’s unique “on-the-ground” analytical insight of our analysts who provided their assessments of the outlook for the companies they cover.
Thus, we performed an initial bottom-up fundamental analysis; after a first cut, our sector analysts provided their assessments of the average market multiples for the respective sectors that the companies operated in.
In parallel, the list was further refined based on our assessments of each company’s corporate governance.

we believe investors should stay selective in ASEAN + Hong Kong, with a focus more on defensive companies as well as those with earnings growth.

First Resources is an almost pure upstream plantations owner and operator.
With CPO prices at current levels of USD570-580 per tonne and cash costs at USD200-220 per tonne, GPMs continue to be in excess of 50-60%.
Management has a strong track record of being operationally efficient, as its cash cost is one of the lowest in the region.
In addition, it has a low net gearing of just 20-25%.

We compare the EBIT margins for the planters as there is a need to take out the depreciation factor, given that some companies (particularly those in Malaysia) may suddenly record a spike in depreciation charges upon the maturity of their estates.
In terms of EBIT margins, First Resources has been regularly recording high margins 40-55% over the past five years due to the prime age of its oil palm trees (averaging nine years currently) and its efficient costs structure.
Going forward, we expect the company’s EBIT margins to increase further on the back of a rising CPO price environment and an improving age profile, which ought to improve cost efficiencies further.

We use plantation players in Malaysia, Singapore and Indonesia as its peer comparison. Using this, First Resources is trading at a lower multiple than average.
Even if we exclude the Malaysian planters, given that such planters generally trade at a premium to Singapore- and Indonesia-listed peers due to regulatory structure differences, First Resources is also trading at a discount. We believe this could be due to liquidity concerns over the stock, which, has improved over the last few years.
The company’s free float has increased to 30% from 17% during its IPO in 2007.

We believe First Resources has strong corporate governance, despite being a family-run business. Management has displayed transparency and proactiveness in dealing with investors and analysts.
Chairman Mr Lim Ming Seong has been with the board since the company’s listing in 2007.
First Resources is 63.2%-owned by Eight Capital Inc, an investment vehicle of the Fangiono family.

IPS is one of Singapore’s leading providers of integrated security solutions.
As political instability grows around the region, ongoing disputes in certain countries and increasing national security concerns have led the governments in the region to boost their defence budgets. This puts IPS in an advantageous position of being able to benefit from this scenario.

According to IPS’ business model, it orders supplies only when it receives confirmed orders from clients.
In most circumstances, the company requires a 50% initial down-payment to be made before it orders the products from suppliers. As such, there is hardly any inventory risk.
In addition, most of IPS’ clients are government agencies or the middle-men parties that represent such agencies. This implies that the risk of clients defaulting would be minimal.
This business model also enables the company to generate healthy positive cash flow and does not require much bank financing or capital. This results in positive ROEs of above 50% once net PAT exceeds a certain level.

There are no direct peers that do both general and homeland security products, especially in Singapore. However, if IPS were to be compared with partially similar businesses listed overseas, these peers would be trading at an average FY15P/E of 25.1x.
One thing to note is that such peers are also much larger in size. However, with large contracts already secured for delivery in the next 2-3 years, IPS’ earnings are set for a boost of approximately 300% in FY16 and by another of approximately 69% in FY17. This is according to our forecasts.
As 90% of the company’s revenue comes from government-related agencies – coupled with its net cash position – we think that IPS is in a prime position.

IPS is a distributor of homeland and general security products. Like all other distributorship models, it has an operating leverage.
The company’s operating costs are likely to increase much less than its revenue. If IPS is able to sell more products at a profitable margin, its operating margins would likely increase, which would result in higher net PAT.
The triggers are mainly:
1. USD55m worth of PepperBall contracts in FY16/FY17 with a gross profit of 30%
2. USD64m worth of Hyperspike contracts from FY16-21 with a gross profit of 50%.
As at FY15, IPS revenue was SGD15.7m with a net PAT of SGD1.3m.
With these new orders, the company’s topline is likely to balloon to SGD39m in FY16 with a net PAT of SGD10.9m.

IPS has three independent directors in a 5-person board with a simple corporate structure. The company has not changed auditors over the past 10 years, as was only recently listed in 2014.
Since IPS’ listing, management has displayed transparency and proactiveness in dealing with investors and analysts. It has also engaged an investor relations firm to help liaise with the investment committee.

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

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