This article is written for knowledge sharing and discussion purpose. It is not a recommendation of buy or sell a stock.
“A value investor buy and sell judiciously, choosing today’s ugly duckling that shows the promise of becoming tomorrow’s beautiful swan.”
In Bursa, most retail market players are following the next big thing, chasing rumours, hot stocks, hypes, and fads. They start to buy only after syndicates, insiders, manipulators have bought and start peddling the stocks; buy high and hoping to sell higher and make huge return in shortest time, 50% in half a year, 100% in a year, and 200% in two years. Some intelligent, courageous, confident and skilful players did make it, so did thousands of others who fell from grace and sank to oblivion.
There is this statement that in investing, “This time is different”, only TA matters and FA is not important anymore. Looking at the performance of the company has no value. Looking at the chart is more important as charts tells you correctly the price in the future, so they said. Well, I just can’t understand the rationale of this statement. I can only see the intuition that FA should work. Why not? Buying good companies at reasonable price, or better still when they are cheap, and buy a basket of them. Sure, we could be wrong in a few of them, buy not most of them, and the wrong is generally “small wrongs”, but there would be some “big rights”. At least this is my experience as shown here.
Actually my experience is not that convincing as the holding period of my portfolios above are short, although it still works. In a paper titled “The Super Investors of Graham and Doddsville”, Warren Buffet showed the track records of each of nine disciples of Benjamin Graham showing that they all generated annual compounded returns of between 18% and 29% over track records lasting between 14 to 30 years. There are numerous super investors in the US and in the world who have successfully used FA; Joel Greenblatt, Seth Klarman, Howard Marks, Water Schloss, Irving Kahn, Jean-Marie Eveillard, Mark Mobius, Teng Ngiek Lian, Shuhei Abe, V-Nee Yeh, Cheah Cheng Hye, Fong S L (Len Yan), etc. The list is endless and their records are for everyone to see. All of them use FA. Some of them are just simple FA strategies like just looking at the balance sheet like Walter Schloss, or just basing on two financial ratios in return on capitals and earnings yield like that of the Magic Formula of Joel Greenblatt. They don’t talk to the management, their engineers. What for as most information can be obtained from the annual reports, the management discussions etc.? They don’t try to predict how the sector is going to do in the next few years, or how the interest rate will go up or go down.
Having said that, many of them do make other qualitative analysis besides all the numbers. They do “look behind the numbers”, many more relevant numbers, rather than relying some simplistic revenue or profit growth in the next two quarters, or the ultra-simplistic and problematic PE ratio.
But why are people still keep on saying that FA won’t work? That it will only work if combine with TA, or whatever entrepreneurship. Where are the proven records of other investing strategies? Are their return as high and consistent as those super investors mentioned above? Proof please!
There is another group of fundamental value investors who follow the principles of the Dhandho Investors. They make investment choices that exposes them to situations where loss on downside is minimal while potential upside is multi-fold.
The Dhandho Investor
The Dhandho Investor (DI) was popularized by a US super investor named Mohnish Pabrai, a low risk value method with the potential of high returns with the motto of:
“Heads I win, Tails I Don't Lose Much”
Mohnish Pabrai’s long-only equity fund has returned a cumulative 517% net to investors vs. 43% for the S&P 500 Index for 13 years since inception in 2000. The compounded annual return was 15% compared to the S&P 500 index of just 2.8% during the same period. $100000 invested in Mohnish Pabrai’s fund during the 13 years became $617,000, compared to $143000 in the broad index.
The DI prefer to invest in existing businesses with long history of operations that has established business model. This allows them to analyse the past performance of the business, its profitability and cyclical nature of business. Mohnish does analyse financial statements and does valuations, including discount cash flow valuation as mentioned in his book, The Dhandho Investors.
One business listed in Bursa which has the characteristics of a stock of the DI is Kumpulan Fima. But why talk about such a dull stock which nobody cares about it in an investing forum such as i3investor? This is because it meets many of the characteristics of a perfect stock of Peter Lynch that:
- It sounds dull,
- It does something dull
- It is an easy to understand business
- The institutions don’t own it, and the analysts don’t follow it.
- It’s a no-growth industry
- It’s got a niche
- People have to keep buying it, or need its service
- It is an owner-orientated management
- Its chart doesn’t look good (added by me)
I have been holding this stock since 6 years ago. In the last two and a half year, its return of 14.3% just managed to marginally out-perform the broad market of 11.9%.
Kumpulan Fima Berhad operates in five segments: Manufacturing, which include production and trading of security and confidential documents; Bulking provide bulk handling and storage of liquid products and cargoes, warehousing and transportation and customs forwarding services; Plantation include oil palm and pineapple estate operations; Food include manufacturing and packaging of food products, and Others include investment holding, rental and management of commercial properties and local and international trading.
Kfima’s main business is divided into the following segments in terms of revenue, all of which I can consider as durable businesses, which will last for some time to come, won’t they?
Business Segment Revenue Profit before tax
Security manufacturing and printing 47.7% 40.9%
Plantation 20.7% 23%
Bulking and logistics 12% 30.8%
Food 16.3% 6.3%
Others 3.3% -1%
The bulk of the revenue and profit is contributed by its security manufacturing and printing which provides stable earnings to the company of more than 40%. Plantation which have been the next biggest contributor has its contributions slipped somewhat to 20% from more than 30% previously due to the poor palm oil price, and now overtaken by Bulking and logistics in term of profitability. The performance of the Food division was dampened by the devaluation of the currency of Papua New Guinea, its major export market. It appears that this division is recovering from huge losses a year ago to profitability in the latest quarters.
For the past 10 years, Kfima’s revenue has been increasing steadily from RM247m in 2005 to RM545m in 2015, or a good compounded annual growth rate (CAGR) of 8.2% as shown in Table 1 in the appendix. The growth was contributed by the successful diversification from its security printing business and the loss making broking business before that to the profitable palm oil plantation, bulking and food business. Net profit increased by a higher CAGR of 10.9% from RM32m in 2005 to RM90m for the year ended 31 March 2015. Net profit has dropped somewhat from the peak of RM116.5m in 2012, mainly due to the drop in palm oil price and the food business to a lesser extent. Despite of that, the gross margin of Kfima is still remain high at 38%. However, plantation business is highly cyclic in nature and it will revert to its mean in the future. The food business also show signs of improvement.
For the last 13 years, Kfima has stable earnings and has had not a single year of losses. It even has free cash flow every year since then even after spending huge amount of sum for its increase in plantation acreage for its future growth. Some will say, it has no profit growth from last year to this year, and continuous profit growth in the last two quarters. Yes, it is true, but can they name me some companies which have continuous and unabated profit growth every quarter?
The return on capitals (ROC) of Kfima has deteriorated from 26% in 2012 to 10.8% in 2015. This appears to be quite bad. This is due to the deterioration of net profit from the poor palm oil price and the food division. The number is still good though. It is hopeful that this will improve with the price recovery in these cyclical businesses in the future.
Kumpulan Fima’s Balance Sheet
The safety in investing in Kfima is reinforced by its balance sheet. Kfima has a very healthy balance sheet. It has a total cash and cash equivalent of RM233.3 m and a negligible debt of just RM8m. The quality of its other assets is good with a good distribution in palm oil plantation, plant and equipment, investment properties, interest in associates, receivables and inventories. Its net tangible asset backing is RM2.60 per share, way above its present price of RM2.01.
A good company is not necessary a good investment. It all depend on what the offer price is, in relation to its value. That is why FA practitioners always carry out some valuations to have a feel of the value of the company, and hence to compare with its price.
“The success of investing is not from buying something good, but from buying something right.”
Some Simple Valuation of Kumpulan Fima
Table 2 below shows some simple valuation metrics for Kumpulan Fima with its closing price of RM2.01 today on 17th June 2015.
Table 2: Some simple valuation metrics for Kumpulan Fima
The attractiveness of investing in Kfima is its cheap market valuation as shown in Table 2 above. Despite its reasonably good return on capitals, stable earnings and cash flows, its market valuations are all below some relatively stringent benchmarks. The enterprise value of just 5.1 times its earnings before interest and tax, or an earnings yield of about 20%, is particularly attractive. Another low risk feature of Kfima is with 8.5 sen dividend, its high dividend yield of 4.2% provides regular good income to investors.
Earnings Power Valuation of Kfima
Earnings Power Value (EPV) was postulated by a Columbia University Professor and proven successful investor Bruce Greenwald. It is an estimate of the value of a company from its ongoing operations only. First we would assume that current revenue is sustainable. We then normalize the earnings to the business cycle. This eliminates the effects on profitability of valuing the firm at different points in the business cycle. This means that we are considering the average % operating profit over 5-8 years. This average would then be applied to current sales. The beauty of EPV, for value investors, is that the numbers used to calculate it are no growth free cash flows. By using no growth free cash flows we eliminate the predictions of future growth and as such arrive at a number which we can be fairly certain of. This isn't to say that some companies can't expect significant growth, but as value investors we refuse to pay for it.
In this method, we still need to have a cost of capital to be used as a capitalized rate. As almost all the capital in the company is that of the equity shareholders, a rate of 10% is used. But why 10%, and not 5%, or 15%? My rationale is tabulated in Table 4 in the Appendix, and it needs not to be precise.
Table 3 in the Appendix shows the step-by-step EPV for Kumpulan Fima. Disregarding any future growth, not even growth according to inflation, or the growth of GDP, Kfima is worth RM2.79 a share, 33% above its closing price on 17th June 2015 of RM2.01.
Kfima appears to be a good quality company with resilient and easy-to-understand businesses. It has long history of stable earnings and cash flows. Revenue and earnings have been growing steadily for the last 10 years. It has an excellent set of balance sheet with abundant cash and little debt. The investment thesis of Kfima lies in its low market valuation and its intrinsic value obtained from EPV. But why is it accorded such a low valuation? The main reason could be it is not covered at all by any analyst from investment banks. However, this is exactly the reason why one should get excited about it. The major shareholders have been buying the shares continuously which gives positive signals.
“Heads we win; Tails we don’t lose much” The Dhandho Principle of Investing
For those who want to learn the fundamental value investing, please email me at
K C Chong (17th June 2015)
Table 1: Financial performance of Kfima
Table 4: Required return for Kumpulan Fima
|Market risk premium||KLSE||6.0%|
|Stability of earnings and cash flows||Good||-0.5%|
|Required return, Re||10.0%|
Table 3: EPV for Kfima