Are China Banks Undervalued?

 If one observes the valuation metrics of China largest state banks, they are bordering on very cheap valuations- dividend yields of 7.5% to 8.5%, PB ratio <0.5, PE ratio <5.

If they were to be revalued to that of Singapore banks, one is looking at a 100% upside to current prices. 

So why are China Banks Cheap?

Two reasons, one as I have previously alluded here, people are skeptical of the Chinese Bank's financial reports and that they are fake (frauds). After months of observations, I don't see much evidence that their results are fake. In fact, it follows quite closely to the PBOC reported growth and loan levels, so if the China State Banks are indeed fraudulent, it means the country and the Chinese Communist Party are faking the results of an entire industry. This I find it is too far fetched for such a government to be generating fraud results. If this is true, then the communist party reputation will be in ruins.  

Of course, I am open to views from the online community if they can point out China is faking their financial results.

The second reason is the real estate fallout led by China Evergrande. An oversupply of housing units built, a declining population, new regulations to restrict speculative housing and an anti immigration policy, China is struggling to maintain property prices at its high prices. Developers have been relying on new sales generated in order to recycle repaying debts. Now that sales has slowed down, working capital is tight and property developers lack the cash to repay their debts on time. Empty housing units are at double digit highs.

This is resulting in loan provisions. I think the problem is real and the government have to handle this carefully. If real estate prices plunge, individual China property owners will be hit with the need to service their housing loans for a generation or locals will lose their cash savings in financial notes issued by property developers because of asset impairments by companies. China has too many apartment units now for its 1.4 billion population.

In my view, the communist party will speed up the movement of rural people to the cities as there is spare capacity, the PBOC will lower financing rates and property companies will be forced to deleverage at the expense of their own owner's wealth. This is China we are talking about and President Xi will force the chairmen to be 'personal guarantors' to their company's local issued debts even though it is corporately not possible or legal. This will avert a banking crisis.

My View

I think the issue of China State Bank's financial results being fake has been taken out of the equation and I am confident in building up to 10% in portfolio on them. Besides ICBC and CCB, BOC and ABC are entities I am looking at. BOC has a larger segment in the international markets as compared to the other 3.

I am banking that the China Communist Party are not frauds.

Reply by SGX on Best World and my View on the Company Value

As a neutral and unvested individual, I had written to SGX Regco on the unfairness faced by Best World Shareholders.

SGX Regco has replied and updated Best World is evaluating a off market share buyback scheme or complete takeover of minority stake to delist. This is good news.

What is a Fair Price?

Looking at its comparable, these are the P/E Range

To me, Best World should be buying out at a 10 to 15 times P/E range. Assuming an eventual full year EPS of 23 cents, its fair for the majority owners to offer $2.30 to $3.45 per share. Anything less is a signal that they are making use of SGX regulations to make an inequitable offer and is something SGX has to voice out because it is their actions which partly led minority shareholders to be in this predicament.

My Views

At $2.30, this means the company's market cap will be $1.26 billion and the majority shareholders will have to finance a $620 million takeover for stakes they do not own. Best World has cash reserves of $386 million. It is quite easy to seek another $300 million from financial institutions with a business who is generating an average free cash flow of $100 million 

Let's see whether fairness is present in Singapore's market.

Letter to SGX regco for Best World Shareholders

 Understand within the investing community, there has been angst due to unfriendly investor action by Best World international where it had increased remuneration to the CEO and executive directors, stopped dividends to shareholders and yet the company is recording record profits. And sgx action of suspending the company due to its doubtful business model has rendered minority shareholders unable to realise value.

Minority shareholders are currently organising their online petition to regulators

Below is a letter that is sent to the regulator to review their action:

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To SGX Regco,

I would like to flag one company by the name of Best World International. I am not a shareholder but am writing in the interest of investor protection/rights and urge SGX regco to take action.

The company has been suspended by SGX as SGX did not feel comfortable with its business model in China. While the company made efforts to pay its shareholders during its first few years of suspension, Best World has since stopped paying dividends to its shareholders. This despite the company recording record net profits and growing amount of cash generated. On the contrary, over the past 2 years, remuneration to its executive directors has been generous. For example co-chairman, Group Ceo, Dora Hoan has received an increase in remuneration from $4.75million (AR 2018) to $12.25 million.(AR 2020)

Best World audited results shows business is cash flow generative and they do not have an urgent need for cash because the Tuas plant is fully built with minimal CAPEX outlay and a net cash position of $390 Million with no debt as of 1HFY2021.

I understand it was SGX who suspended the company, however, the company has used this opportunity to increase remuneration to executive directors and not pay dividends to shareholders.

Existing shareholders are not able to realise the value of their shares of this profitable company due to no dividends received; while at the same time, the executive directors are increasing their remuneration through increased bonuses.

With the licenses of direct selling in China being unlikely to be granted to Best World International within these 2 years (thus allowing them to be unsuspended), I urge SGX regulators to consider two approaches to help public minority shareholders: (i) Direct the executive directors who are majority shareholders to offer a fair takeover price for the remaining shares or (ii) SGX regco allows the company to be unsuspended this year.

For (i), Best World is highly profitable and it is definitely possible to do a leveraged buyout. Best World net profits are $134 million with cash flow generated of $125 million (accounting for working capital changes and cash outflow due to investing activities/taxes). With the directors holding a majority stake of 50%, it is inconceivable that no banks/funds will lend them s$500 million to buy off the remaining public float stake; unless the audited results are fraudulent. The company can even tap on its cash reserves of s$390 million to buy off the remaining 50% stake in a leveraged buyout situation.

I look forward to SGX Regco actions towards this company. Thank you.

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How Singapore's Reopening to Foreign Workers will Benefit Companies

On Friday, the government made an announcement of re-opening borders to vaccinated foreign workers from most countries.

This is an important moment for many companies here because they are reliant on foreign manpower which in turn reduces their cost. Furthermore with India case counts falling and is being vaccinated with COVIDshield (developed by AstraZeneca), further relaxation of border measures for vaccinated travelers may happen soon.

Key Beneficiary

Construction companies like KSH holdings, Hock lian seng, TTJ holdings are bound to benefit from this. For example KSH holdings has a larger orderbook in the private sector market (which means many of their projects are not considered critical infrastructure which were exempted from border measures); with the lifting of borders, they will be able to tap on more sources of foreign workers for their projects. A lower manpower cost will improve profit margins.

Due to the recent border measures, companies like KSH had impaired for expected cost increases in its current projects and recognised them as losses beforehand. However, the reopening of borders may mean that such impairment will not occur and becomes a gain.

All in all, I am re-evaluating the construction industry. The recent measures is going to result in earnings expansion and with the government needing to prime pump the economy, more projects will come in. The increase in revenue and improvement in profit margins may just be what makes it ripe for construction companies to experience a share price re-rating.

<Not vested in any of the mentioned counters yet>

Selling of Global Invacom and searching for other turnaround companies

<A short post update due to G Invacom recent update on 4 Aug>

Due to the latest profit warning which shows that 1H 2021 is not doing well, I have sold off G Invacom at a price of 11.7 cents.

This is due to my previous investing thesis not being met where I expected a turnaround in earnings which didn't happen and the company is trying to restructure in order to reduce cost.

Searching for other Turnarounds

With the markets now at their highs and COVID situation has started to improve (except for SEA), it is time to source for other companies who have a potential turnaround in earnings.

Wei Yuan Holdings- Potential Turnaround in Profits

While listed in the Hong Kong Exchange (Stock Code:1343), Wei Yuan is a Singapore business who operates in the cable installations for power grid and telecommunication companies in Singapore. They also have a minor business segment in road surfacing. Their geographical business is in Singapore and are in the civil engineering industry.

The company is a mid tier in the civil engineering segment of Singapore holding a 5.7% market share based on its IPO prospectus. 

Observations on Profits

Looking through the company's FY20 profits, it can be seen how Singapore's covid measures have affected its profitability and operations.

During the first half of 2020, Singapore issued a stop work order in a bid to stem the covid spread among foreign workers, as a result, Wei Yuan registered a loss of $4.5million on the back of $23 million revenue. However, as Singapore re-opened in the second half of 2020, they registered a profit of $1.2million on the back of $34 million in revenue.

What do I expect for 2021

First off we have to explain what happened in Singapore for 2021. For the first 4 months, thing went as per normal. However in May 2021, Singapore severely restricted the travel movement of countries which we were relied on for foreign labor. Hence, I expect the company to report the same profit of $1.2 million for the first half

As Wei Yuan projects run roughly 2 years in duration, I expect the company to be hit by labor cost over run for the remaining of FY21 and FY 22. After this, the company should start turning profitable again. 

Track Record of Company Tender

Based on its IPO prospectus, the company has been able to sustain a good profit from its contracts. This shows the tendering team has placed in adequate buffer in case of cost overrun. This is a good sign as there are some civil engineering companies in Singapore (think Yongnam) whose projects have always been loss making over the past years, likely due to poor projections by the tendering team. The companies with good tendering track record, I have encountered thus far is TTJ holdings and perhaps Wei Yuan (if they maintain their record)

Valuation

In my view, the company is likely to register a $1.2million profit for 1HFY2021. This is because it enjoyed 4 months of unrestricted access to labor as well as a good domestic situation of COVID handling. Furthermore, the construction industry grew during the 1Q of 2021. For the remaining half, it is likely to be loss making, but Wei Yuan should still be able to turn in a small profit due to its good track record in tendering. Hence for FY2021, I expect the company to fully turnaround in profits with a $1.0 million profit.

Post 2022, profits should return to pre-COVID levels of $5 - $8 million. The closest comparable to Wei Yuan is TTJ holdings (though they do different civil engineering types). TTJ is trading at 14-18 times P/E on forward earnings. Wei Yuan holdings is of a similar size company to TTJ and has a slightly higher revenue base; hence I have estimated Wei Yuan to be in the value of forward 16 times P/E.

Hence, Wei Yuan will then be priced as a $80-$110 million company on the HK Exchange (TTJ market cap is s$63 million). At current SGD/HKD exchange rate, the market cap of Wei Yuan should be HK$460-HK$632 million.

Will Singapore follow China's method of lowering child-rearing cost?

Over the weekend, the investment community will have heard and felt the impact on China's drastic policy in banning weekend enrichment classes and control over the education industry advertising. 

This brought fear and destroyed the market value of many listed China Education companies. While many have covered on the totalitarian implementation of the policy by the Chinese government, the undercurrent is due to China's aim of increasing the low TFR it faces now. It saw that rising education cost and stress in the education rat race was affecting TFR and hence nipped the root cause in its bud.

Will Singapore do the Same?

Singapore faces a similar issue in which education cost has been rising as parents compete in this education race. This has given rise to a large number of enrichment centers popping out and because of the fees they can command on parents, they are able to afford and moved to centralized locations in transport nexus such as retail malls in recent years.

Since the start of 2016, one will notice shop directories of malls having enrichment centers listed. This particular segment starting to rent retail spaces have helped to mitigate the rise of e commerce and ensure retail/commercial properties maintained their valuation on the balance sheet. Enrichment centers has been filling the void left behind by brick and mortar retail outlets, ensuring that the retail vacancy has been hovering at the 8-9% level.

It will be interesting to see if Singapore decides to follow the footsteps of China's policy direction of reining tight on enrichment centers. Due to the unique structure of Singapore economy where the property sector dominates, such a move will affect the valuation of retail/commercial properties. If the government does indeed move in the direction, I will be less sanguine on the local REITs market.