This post is for sharing of knowledge and discussion purpose. It is by no means a buy or a sell call for any stock.
First I would like to qualify myself that I am no financial analyst as someone said, lack alone a “famous” financial analyst. I am also an engineer by profession which I have spent 22 years in. But I hope that shouldn’t stop me from expressing whatever views I have on OTB’s comments posted in this thread.
I also hope he views it as in a constructive manner, something maybe useful for his considerations as an alternative point of view as he said he is an investor in V.S. Why not? If someone tells me about his view on a stock which I am so confident of and hold a lot in my portfolio, I will be extremely happy if he alerts me of something which I need to consider. Won’t he too?
Yes, I emphasize on cash when investing in my articles in i3investor as you can read, and that is very true. But the cash if anyone who understands the language of business, he will know that the cash I mean all the time is cash flow; cash flow from operations (CFFO) and free cash flows (FCF) in particular, it is not the cash in the balance sheet.
I never recommend to buy shares of companies which have loan, although I have written so many articles about companies in i3investor. That is true too, not only company with loans but any company, good or bad, cheap or expensive, because my knowledge about the market is limited and I know very well that I could be wrong in my call, and then cursed by others who lose money following my call. What for? I earn nothing from that.
The financial market is full of unknowable and uncertainties. This is what Howard Marks says:
“The future does not exist. It’s only a range of possibilities. We have to understand that most outcomes will be determined by luck.”
Some people may make a lot of money when they make a right call. Listen to what Nassim Taleb said:
“Clearly my way of judging matters is probabilistic in nature; it relies on the notion of what could have probably happened… If we have heard of [history’s great generals and investors], it is simply because they took considerable risks, along with thousands of others, and happened to win. They were intelligent, courageous, noble (at times), had the highest possible obtainable culture in their day – but do did thousands of others who live in the musty footnotes of history:”
Having acquired some academic knowledge in corporate finance through my postgraduate study, in stuff like merger and acquisition, management and leveraged buyout, etc., I do not dislike to invest in companies with debt as alleged, not at all, knowing very well that public companies mostly use other people’s money (OPM) to do business. Company loans when properly used, can amplify returns.
Scientex is one company which I have invested in and has substantial debts as shown in my article below. It leverages up by having a leverage of 2 times total assets to its total equity, yield a nice amplified return on equity of 20.8% in 2014.
Scientex borrowed a total of RM340m, in comparison with the RM410m of V.S. Its debt is about 50% of its equity, in comparison to 64% of V.S. Not much difference and it is alright for both companies, no problem at all if the companies have enough cash flow to service their debt. Here are the differences.
In 2014, Scientex produces a net profit of RM151m and CFFO of RM153m compared to V.S net profit of RM46.6m and CFFO of RM46.4m. Scientex CFFO is 27 times and earnings 21 times its interest payment, whereas V.S CFFO is only 6 times and earnings 4 times its interest payment, taking interest for V.S as the average of the last three years. This has not taken into consideration that in the last three years, V.S has to spend 85% of their net operating profit after tax for capital expenses compared to 53% of Scientex.
The cash return, CROIC, (FCF/IC), or FCF over its invested capital of Scientex which I view as very important, is average of 21% a year for the last three years. But my computation of cash return for V.S is “Not Applicable” as there is no FCF for the last three years. It has some now for the last one year, and even if I take that into considerations, its average three years cash return is less than 1%.
Do not underestimate the problem of cash flow. In this article below, I used Enron as an example:
This was what I have written:
“Look at Enron’s four years financial performance and cash flow from 1997 to 2000 below with its net income galloped by 832% from $105m to $979m before it went belly up. This was one of the most talked about corporate scandals in the US in 2000s. Focussed on PE ratio, Wall Street sent Enron’s stock price soaring from about $30 to $100 from 1997 to 2000. However, from 1997 to 1999, the company burned all its revenues and required an additional $3b of capital expenses just to open its doors.”
Here is another well-known example. Lucent Technologies was one of the most widely held stocks in the late 1990s. It burned through all its cash flows in the late 1990s, except in 1997. In that single successful year, Lucent’s CROIC was merely 3.2%. It requires $31 just to generate $1 of cash. Just two and a half years before the share price tanked, it reported record “earnings” almost every quarters. It business eventually crumbled with its share price tumbled by a whopping 99%. Investors, many of them are savvy institutional investors were left crying without tears. No, I am not saying V.S will be the same, it most probably won’t.
And what about the return of invested capital from shareholders and borrowings?
In 2014, Scientex requires to spend just RM5 to earn RM1 whereas V.S need to spend RM15 just to earn RM1. Return of equity (ROE) of 7.3% for V.S in 2014 is certainly not good as it is way below the cost of equity. Even in its best twelve months which is the last twelve months at 10.8% is not great too as it is still below my required return investing in V.S.
A company which continues to earn high return on capital add shareholder value by keep on growing with internally generated fund, making more cash flows in the future and the company can distribute increasing dividends to shareholder. A company earning return below cost of capital will have to keep on borrowing money or asking more money from shareholders just to keep its doors opened. It can also grow itself to bankruptcy. No I don’t mean V.S is in this category.
So it is not whether a company uses OPM, but how effective the management utilizes OPM, and how risky it is. Think about if there is a severe economic downturn, or simply because Keurig finds the Chinese, or a South East Asian country produces cheaper and better coffee makers than V.S. Impossible?
Nevertheless, I do discourage individual from using margin financing to speculate in the stock market, in fact fervently. I have written a number of articles about it with a lot of examples, numbers as I find this is a very important knowledge for retail investors who have been bombarded by investment bankers, fund managers enticing them to use OPM in the hope of enhancing return. One of the articles is here:
“Leverage magnifies outcomes, but doesn’t add value.” As a reminder, please read what Nassim Taleb said above.
I personally would rank this as my most useful article written in i3investor for those wannabe newbie investors who think they can produce a baby in one month by making nine women pregnant at one time, best in the sense of a philosophy, not how good it was written, not some stock picking ability.
You want to compare P/E ratio with Globtronics and MPI? P/E ratio is a favourite ratio pitted by investment bankers. I have written about the pitfalls of using this metric for comparison as shown in the link here. You can dispute it if you wish with your reasoning:
And here is a very good comment from a commentator here:
Posted by soojinhou > May 24, 2015 08:25 PM | Report Abuse 
OTB, with all due respect to Mr Koon, I think it's a folly to compare VS with Gtronic and MPI. VS is not an electronics components manufacturer, its is more of a PCB and plastic injection EMS player. In my opinion, it doesn't require the technological expertise that the latter 2 demands. Also, Keurig is not doing well, and I don't think a cold drink machine will not be as popular as a coffee machine, simply because your soda do not have the coffee connoisseur factor. In other words, would anyone pay a couple hundred dollars for a machine to make coke? Still, VS has a wonderful run and it is wonderful profit. But in my opinion its core competency and prospect is a bit over inflated.
And bear in mind that in investing, past performance is not an indication of future success. And what Nassim Taleb said about alternate history in his quote above should serve as a guide.
No, I am not saying V.S will not improve its performance. I have no crystal ball in front of me to tell me its future. No, I never dispute V.S share price can go up to RM10, RM20, I don’t know. No, I never visit their factories, talk to their engineers, management etc. I know they won’t entertain me, but I don’t think I have to, even if they would entertain me.
I hope you take my comments in a positive manner.
K C Chong (25th May 2015)
Posted by Ooi Teik Bee > May 24, 2015 02:38 PM | Report Abuse
After reading KC Chongnz’s recent 2 articles on VS Industry as posted on i3investor.com which are not encouraging readers to buy VS, I am wondering why Mr Koon Yew Yin bought so much within the last few months to become a substantial shareholder. Is he really so stupid?
The VS price chart shows that it has gone up from Rm 2.50 to Rm 4.30 within the last 6 months.
Is he not aware that the company has increased borrowing, increased interest payment, increased receivable, poorer cash flow etc as shown in its financial report?
So, I asked him to explain to me his reason for being so bullish.
He said that although he is not an accountant, he looks at VS business operation as a business man. As long as it is selling cheaper than MPI or Globtronics in terms of P/E ratio, he is not afraid to buy it. As an experienced business man, he can imagine that if the company has tremendous increase in sale revenue, the company surely requires more borrowing to do more business. VS needs more money to pay for more raw materials.
Regarding the increase of receivables and poorer cash flow, he said that the company requires longer time to make and deliver its products to customers spread over 30 countries.
The most important consideration is how sustainable is VS’s new business in manufacturing coffee machines for Kuerig, the famous US coffee brand?
He said that during his recent site visit of VS’s 5 factories in Johore, the American Engineers from Keurig were working with their own Engineers to develop a new type of coffee machines and a new machine for cold drinks. Cold drink business is about 5 times larger than hot drinks.
Moreover, VS is only supplying about 25% of the total machines required by Keurig and the rest of Keurig’s requirement is from manufacturers from China. As labour and other cost are rising in China, VS has a better competitive advantage to gain more orders.
Mr Koon told me to look at the summary of his investment talk on 9th May 2015 when I assisted him. The talk was organized by Dali of Malaysia Finance blogspot in KL. The following is part of his speech:
My largest holding is VS Industry:
I selected this electronics manufacturing company because it is so cheap in terms of P/E ratio, ROE and other criteria in comparison with the 2 famous leading electronics manufacturers in Malaysia as shown below:
Name Half Year EPS Half Year Revenue Share price P/E ratio
Globtronics 13 sen Rm 180 million Rm 6.10 23
MPI 23 sen Rm 670 million Rm 7.00 15
VS Industry 27 sen Rm 1,010 million Rm 3.96 8
VS has a total of 9 factories in Johore, China, Vietnam and Indonesia. VS employs 15,000 workers which is more than the total number employed by MPI and Globtronics.
Their largest customers are Keurig. Dyson, Sony, Sumsung, Panasonic etc. They have been in this business for 30 years.
Mr Koon said that his VS and Latitude investment reminds him of his past performance in buying Supermax and make a kill about 5 years ago when Supermax price shot up from Rm 1.00 to above Rm 6.00 within a period of 15 months. It is similar to Latitude which shot up from Rm 1.00 to above Rm 6.00 in the last 24 months.
I will study his past performance in buying Supermax and post another article which should be useful knowledge to all investors.
Note :
It is not a recommendation to buy ... I repeat ... not a recommendation to buy, I just post Mr Koon's view why he is so bullish about VS. There are some information is useful to VS investors since he visited VS Industry during AGM.
FYI, I hold VS stocks which I bought at very low price at the beginning of 2015, you can check my posting in the below link :
Final decision is yours.
Thank you.
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