Friday, October 30, 2015

Perusahaan Sadur Timah Malaysia Berhad

Dr Neoh Soon Kean

Dear KC,
I have just retired from 40 years of working as an engineer. At the same time, the youngest of my three children has just graduated from England. Well at least I have provided them with good education.
I have really worked very hard through my whole career. Fortunately I still have some money left for me and my wife to live for another 20 years. This saving we have could easily do this job. However we wish to leave all of this as charity to a charity organisation named by you.
We are thinking of if we can survive with the regular income from this money we have. We figure that by placing this money in bank with this low interest environment may not be able to fulfil our wish as I am afraid inflation and the foreign exchange risk may derail our plan, as we are thinking of doing quite some travelling overseas.
You know we also do not like too much risk. Please help.”

In an article in i3investor written by me on dividend yield investing here,

I have articulated the importance of dividends for an investor. I would like to summarize here:

  1. It is real, money into pocket.
  2. It provides a floor to share price when bear stampedes
  3. It keeps us in touch with reality when there is irrational exuberance in the market.
  4. It prevents you from being side-tracked by events which have little of or no real benefits to you as a shareholder of a company.

In addition, dividend payment and especially increasing dividend payments provides a positive signal from the management that the company is doing well and can afford to pay, and that they are willing to share the fruits of success of the company with shareholders.

I now have a specific reason why I like to invest in dividend stock; I am more confident in carrying out a discount cash flows analysis using dividends to find the intrinsic value of a stock, compare with its price, and be confident with the margin of safety estimated from the model.

I will use this company, Perusahaan Sadur Timah Malaysia Berhad, Perstima, as an example. This company was brought to my attention a couple of months ago by a forumer in i3investor which I first dismissed the industry it is in as a sunset industry. I have since changed my perception after enlightened by him, and read further about the company’s business.

Perstima business background and historical share price movement
Perstima is the country’s sole manufacturer of tinplate. Its products are used for the packaging of processed food, including liquid milk, fruits, vegetables, fish and meat; dry food, including milk powder, tonic food and biscuit, and aerosol, including insecticide, spray and perfume. The Company's products are also used for packaging of edible oil, beverage and beer, and industrial products.

Figure 1 below shows its share price performance for the last 5 years.
It shows there was an excellent buying opportunity for Perstima at about RM3.00 just before the the last General Election when many investors were fearful. Its share price went straight up after that. At the close yesterday on 28th October 2015, its share price shot up by 19 sen to RM5.00. That was due to the announcement of a great quarterly result with earnings spike of 78% from the corresponding quarter the previous year.
The company also declared an interim dividend of 18 sen, up by 20% from last year.

Historical financial performance

Table 1 in the Appendix shows the 10-year financial performance of Perstima from March 31 2006 to March 2015.

The business has been declining after the US financial crisis in 2009 with revenue falling from close to a RM1 billion to the present RM657m due to the challenging operating environment from stiff competition from tinplate imports from China and South Korea.

However, there is a sign that the declining trend has stopped, and a recovery of its revenue and particular in margin since three years ago. Best of all, you can see an increasing trend in dividend payment, with no sign of reduction even during the financial crisis in 2009.

It is this steady dividend payments which provides the certainties on the estimation of future cash flows, and hence the estimation of its intrinsic value using the Dividend Discount Model (DDM). Having a good estimation of the intrinsic value, then compare with its share price, investor has a good feel of the margin of safety in investing in Perstima.

“A stock dividend is something tangible-it is not earnings projection; it is something solid, in hand. A stock dividend is a true return on the investment. Everything else is hope and speculation.”
Richard Russell

Dividend Discount Model (DDM)
Financial theory postulated by John Burr Williams in his “The theory of investment value” postulates that the value of a stock is worth all of the future dividends expected to be generated by the firm, discounted by an appropriate risk-adjusted rate.

In this article below in i3investor, I have set up some theoretical background for DDM, and used it to value a construction company, Pintaras Jaya.

Most investors, for example, like to follow the crowd when investing, listening to the peddling and buying of stocks which have gone up many times in prices, hoping that someone else will buy from them at higher price; a greater fool theory. This is how insiders and manipulators can make big kills in the stock market, at the expenses of the retail investors.

Valuation such as discount cash flows analysis (DCFA) provides a feel what the value of the stock is in order to provide us with an informed judgment, if the stock is worth buying by comparing its price and value. Of course there is much art in valuation, especially in the projection of future cash flows, which is highly unpredictable and uncertain.

Does it mean DCFA is useless? For me, it isn’t. DCFA is not infallible, of course, far from it. But it provides me with something to fight the lemmings in me, and not to be side-tracked from the noises in the market. Anyway, it is just me, not necessary you.

DDM, used for a company like Perstima, with steady earnings, cash flows, and plenty of cash in its balance sheet, is a very good model for estimating the intrinsic value of its stock.

DDM for Perstima
As shown in Table 1 in the Appendix, Perstima’s dividend payment has been growing from 15 sen in 2006 to 35 sen for the fiscal year ending 31 March 2015, for compounded annual growth rate (CAGR) of 10%. What is the intrinsic value of Perstima using DDM?

Here, we will use the expected dividend payment for the next 10 years, and then a dividend growth rate according to the rate of inflation after that as the company becomes a more matured company. The future dividend payments are discounted to the present value. This is essentially a two-stage dividend growth model; one at supernormal growth and the other, a terminal growth.

Perstima has good earnings and cash flows although somewhat gyrating all these years. The earnings and cash flows on average is substantially higher than its dividend payout as shown in Table 1 in the appendix.  Free cash flows averages 43 sen per share over the last 10 years. It has a FCF of 56 sen last year. It is from this FCF that dividend is paid out, without having to borrow any money from the bank. Perstima also has a very healthy balance sheet with RM127 cash, or RM1.28 per share, very low short-term debt of RM12m, and no long-term debts.

With these good numbers, we will use a discount rate of 8.0%, twice the bank fixed deposit rate, for discounting future expected dividends to the present to obtain its intrinsic value. Buffett would use the risk free rate, in this case 4%, as the discount rate because he is normally very sure of the future cash flows of the company he invests in. He relies solely on the margin of safety at the end to make his investing decision. But I am no Buffett. I use a risk premium of 4%.

To be conservative, in investing, it always pays to be conservative, we assume that its dividend will grow by 5%, half of its past 10 year’s growth, and then at the long-term growth in GDP rate of 3% subsequently. I would say these are reasonable assumptions.

Value of a growing dividend
The first part of the computation of the present value of the dividend is the growing dividend from year 1 to year 10, or during the period of supernormal growth. Using the present value of a growing annuity formula

PVGA = C1 / (r-g) * [1- {(1+g) / (1+r)}n]

First payment in year 1, C1= C0*(1+g) = 35 sen*(1+5%) = 36.8 sen
Where C0 is this year’s dividend, C1 is next year’s dividend
Required return, r = 8.0%,
Supernormal growth rate, g = 5%
Number of supernormal growth, n = 10 years

We get present value of the growing dividend up to 10 years using the above formula
PVGA= 300 sen, or RM3.00

Terminal Value
The terminal value after 10 years C11 / (r-g1). This is essentially the Gordon Constant Growth Model

Where C11 is the dividend in year 11, g1 = 3% is the terminal growth rate forever after year 10.

C11 = C10*(1+3%) = 35*(1+5%)^10 * (1+3%) = 58.7sen

Terminal value at year 10 = 58.7 / (8%-3%) = 1175 sen

Present value of terminal value = 1175 / (1+8.0%)^10 = 545 sen, or RM5.45

Total present value
Total present value of expected future dividends = PV of growing annuity + PV terminal Value

= RM3.00 + RM5.45 = RM8.45

Computation using spreadsheet
Table 2 in the appendix show the data and assumptions and the two-stage DDM computed using a spreadsheet. The present value of all future dividends using this method is shown to be RM8.45 per share, representing a margin of safety of 40% investing in Perstima at today’s price of RM4.93 on 30th October 2015. Perstima is undervalued according to this DDM with the assumptions which in my opinion, are pretty reasonable.

Figure 2 below shows the estimated future and present value of dividend payments over the next fifty years. As value investors investing to build long-term wealth, we can wait for five years at least but not 50 years as we will not be around anymore then. The time duration is just used to estimate all future cash flows as required for the model to give the intrinsic value of a stock, but you don’t need to wait for 50 years to reap your results.

The blue values are the actual dividends you expect to be paid if the dividend grows by 5% per year for the next 10 years and 3% subsequently. The red values are the discounted versions of those dividends at a discount rate of 8.0%; the dividends translated into today’s value. As can be seen, if this chart continues forever, the sum of all dividends would be infinite, but the sum of all discounted dividends is finite, because the discount rate is larger than the dividend growth rate, with the discounted value shrinking smaller and becoming insignificant to its present value as the years go by.

Is the dividend payment sustainable? Is this DDM plausible?
Let us carry out the following check and answer the questions to see if the strategy is a viable one and if dividend payment for Perstima is sustainable according to what I have proposed here:

  1. Dividend yields at least two thirds the bank fixed interest rate, currently about 4.0%.
At RM4.93 and a dividend of 35 sen, DY is 0.35/4.93 = 7.1%, twice the FD rate. A big tick.
  1. Dividend payout ratio should be less than a cut-off rate, say 65-80% so that there is money left for the business to grow with the reinvestment for potential increase in future dividend.
Average payout ratio is 63% over the last 10 years, and last year was 82%.
It is hence okay as after payout out a big chunk in dividend, it still has substantial retained earnings for future growth. A tick.

  1. A business model that doesn’t require massive amounts of capital outlays relative to its earnings power.

For the last 10 years, its capital expenses amount to only 40% and 31% of its net income and cash flows from operations (CFFO) respectively. It is not too capital intensive. Unlike say V.S which spent 95% and 110% of its net income and CFFO for capital expenses for the last 7 years, leaving no free cash flow for dividend payment without borrowing more from the banks.

A big tick for Perstima.
  1. Reasonable expected growth rate in earnings at least matches the overall economy, say >4%, also for the potential growth in dividends in the future.
Earnings per share EPS has dropped from 78 sen in 2010 to 27 sen in 2013 due to the stiff competitions from imports of tinplate. But since then there is a sign of earnings reversal as shown in Table 1 in the Appendix. EPS has improved from 27 sen to 43 sen last year. As I have mentioned, there is a substantial jump in EPS the latest two quarters not considered in this valuation. Another tick.
  1. Strong balance sheet for sustainability of dividend payment.
Perstima has RM127m, or RM1.28 per share in its balance sheet, and no long-term debt. There is hence no evidence that dividend payment is unsustainable, in my opinion.
  1. High return of equity and capitals > 12% such that the dividend payment is not only sustainable, but grows from internally generated funds.
For the financial performance as at 31st March 2015, the return on equity and invested capital for Perstima is 12.1% and 16.9% respectively. Another big tick.
  1. Shareholder-friendly management dedicated to treating shareholders as owners
Looking at the dividend payment over the years, there is the sign that the management must have been doing something right for the shareholders. Another tick.

Perstima is a boring stock. There is little or none coverage of this stock by analysts and investment bankers. One hardly hears anyone talks about it in investment forums. It is because it has little liquidity, and the management doesn’t think about those useless corporate exercises to boast up share price. But to me it is precisely a good reason for a long-term investor who can still find bargain in this stock.

Value portfolio managers buy and sell judiciously, choosing today’s ugly duckling that shows the promise of becoming tomorrow’s beautiful swan.”

The steadily increasing dividend payment by Perstima, with its good cash flows and healthy balance sheet, provides investors a good potential investment based on this dividend investing strategy with a wide margin of safety of 43% at its present price of RM4.93.

For those who are interested in a dividend machine, a portfolio of stocks which provides regular income as well as good potential for capital appreciation, or simply want to learn the art and science of investing to build long-term wealth for yourself, please contact me at