When I wrote an article on V.S recently in the thread below, there were quite some interesting debates about it. Thanks for the valuable feedback.
http://klse.i3investor.com/blogs/kcchongnz/76875.jsp
That is good as we all can learn from them. Although the argument can be a little heated up and blunt at times, I hope participants do not get offended and angry with each other. After all it is a sharing of knowledge, and it is not about personal attack.
My argument was “cash is king”. If there is no cash an investor can extract from the business, it is not a No-Brainer Investment, or NBI, purely in my context. A couple of forumers argued fervently that V.S is a good investment because of its fantastic growth prospect, and that we must be forward looking, and it is no use looking at past financial statements. They claimed that V.S is cheap at RM4+, as compared to MPI and Globtronics. Some argued about the qualitative aspect, that the management is very good, their integrity and willingness to share, and they are the experts in the industry.
The above arguments somewhat have their validity, after all, who can argue about the steep rise of its share price recently? And yes, my knowledge about V.S is also limited; I don’t know about its future, its management. I don’t have enough insights, insider information as some possess, and that is why I only rely on the past performance to make an educated guess. So please bear with me.
As an individual investor, we have our limitations, no doubt. But that shouldn’t stop us from making a judgement based on publicly available information such as its past financial statements, should it? Somehow it is strange for me, I always base on financial statement to make judgement, but it has served me very well to avoid investing in some lemons, though I missed some multi-baggers. The link below shows some of my experience. And you know what, it was 100% spot on; that the past performance of a poorly managed company tends to continue its streak.
http://klse.i3investor.com/blogs/kcchongnz/45373.jsp
Let us get started. First and foremost this is what I learned from a former here regarding the business model of V.S and Globtronics. Are they doing the same thing and are comparables?
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.”
The above is just a statement. We can actually look at the financial performance, or get back to business. Is V.S a quality growth company? Should it deserve the same market valuation as say Globtronics as suggested by a number of forumers?
I did write an article on how to identify a high quality growth company as shown in the link below:
http://klse.i3investor.com/blogs/kcchongnz/70874.jsp
Marker valuation
The price of Globtronics and V.S closed at RM5.95 and RM4.15 respectively at the end of May 2015. At these prices, Globtronics is trading at a PE ratio of 26. V.S’s trailing twelvemonth EPS is 45.6 sen. Why there is nobody offering RM11.85 for V.S share with the same PE ratio of 26 as Globtronics? Is the high PE ratio of Globtronis due to its much higher growth than V.S?
Growth
Table 1 in the Appendix shows the revenue and net profit of V.S grows by a compounded annual rate (CAR) of 19% and 60% respectively since 5 years ago, compared to 10.3% and 32% respectively for Globtronics. V.S is certainly growing much faster than Globtronics.
Figure 1 below shows the share price performance of the two stocks. One can see the share price of Globtronics has been outperforming V.S by a wide margin. Why don’t investors pay a higher price for a higher growth stock such as V.S as compared to Globtronics?
The quality of growth
A high quality growth is accompanied by high return on capitals, higher than its cost. That is the very basis of corporate finance. I have said many times, a company can borrow RM1b and still grow the profit of the company by RM10m, if it just earn a return of 1% from the borrowed money. But that is certainly not a quality growth and a very clear shareholder value destroyer.
Let us first look at the return on equity by using the famous DuPont Analysis to dissect where does the return comes from. For those who are interested to know more about DuPont analysis, you can refer to the link below:
http://klse.i3investor.com/blogs/kcchongnz/49969.jsp
Table 3 below shows the DuPont analysis on the return on equity (ROE) of Globtronics.
Table 3: DuPont analysis of Globtronics
ROE of Globtronics improved year after year from 7% to 22.6% in 2014, twice above its cost of equity. The uptrend of the return on capital is also shown in the return on invested capital, ROIC. Globtronics ROIC is a whopping 47% in 2014. More importantly, the ROE was achieved with the increasing profit margin from 7.3% six years ago to 18.1%, and somewhat from a slightly higher asset turnover of 1.0 time in 2014. The leverage is maintained moderately low at 1.2.
In contrast, V.S has not shown its ability to improve its ROE for the last few years, despite its increasing high leverage of 2.4 in 2014, up from 1.9 in 2009. ROE has been in single digits every year, way below its cost of equity. It has extremely thin margin of 0.6% to 3.5%, hardly shows it is technology intensive kind of business, rather a low cost contract manufacturer without much moat. A further squeeze of its margin can easily result from profit to loss in its operations.
Table 4: Return on capitals of V.S
ROIC is also very low at 6.7% in 2014, hardly matching its weighted average cost of capital. A good company must have a ROIC of double digits figure.
ROIC is one of the two components of the Magic Formula described in the thread below:
http://klse.i3investor.com/blogs/kcchongnz/51631.jsp
Figure 2 below shows the comparison and trends of return on equity for Globtronics and V.S. A picture paints a thousand words.
Cash flow
My ultimate benchmark for a good company is, on average over a number of years, it must be able to produce cash, or free cash flow, after allowing for capital expenses to maintain its business. This I have deliberated in the thread below:
http://klse.i3investor.com/blogs/kcchongnz/76588.jsp
Comparing the cash flow of Globtronics and V.S as shown in Table 5 and 6 in the Appendix, it is easy to see which company is a cash cow, and which is sucking cash.
Table 6 shows that Globtronics produces an average positive FCF of RM26.8m last 6 years, with RM43.6 m last year. Its FCF on average amount to 9.3% of revenue (>5%), and its cash return is 16.4% (>10%) of its capitals invested in the business. It is indeed a cash cow.
In contrast as shown in Table 5, V.S has been spending huge amount on capital expenses. Average FCF is only 0.4% of revenue, and less than one percent of invested capital. It has shown some good improvement over the last two quarters though.
Conclusion
Looking at the business model, peeking through its past financial performance, V.S is far away in its performance when compared to V.S. It is like what the Chinese says “a small witch seeing a big witch”, 小巫见大巫. How can V.S command a PE ratio the same as Globtronics? I wonder.
But then what is the appropriate valuation of V.S? In my opinion, using enterprise value is the right metric to value V.S as it has a lot of debts and substantial minority interest as I have commented in my first post on V.S. In this valuation, growth is not taken into consideration, but then what good is growth if it doesn’t come with increased margins and return on capitals?
What I can see V.S is not that great a company. But then not-so-good company can still be a good investment if it is selling cheap. Is V.S at the present price of RM4.15 cheap?
For those who wish to learn about how to identify quality growth company selling at reasonable or cheap price for a small fee, please contact me at
ckc14invest@gmail.com
K C Chong (31st May 2015)
Appendix
Table 1: Growth of V.S
Table 2: Growth of Globtronics
Table 5: Cash flow of V.S
Table 6: Cash flow of Globtronics
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