Saturday, January 19, 2013

Value Traps & NTA Plays

Following Inch Kenneth meteoric surge, some readers have been so kind to send me emails about other great value stocks, e.g. Landmarks, Selangor Dredging, etc ... Dear all, stocks that trade at massive discounts are aplenty. You cannot just point to any one and say that's a good investment. It has a lot to do with proper usage of capital by investors. Why lock up your capital in a non performing great asset? The key is there must be a CATALYST to unlock value, something must be happening to unlock that value.

Those who have been in the markets long enough will understand the term "value trap". It is when you buy and hold something for the longest time because there is great inherent value. However the investor does not know when will the hidden values be unlock by management and/or owners. 

Hence investors who are wiser will always bear in mind the "value trap", being locked into something for the longest time, sometimes years. Let's look at: 

Kuchai Development 

Its basically a holding company. Its got a substantial stake of 26% in palm oil Sg Bagan and a highly attractive 3m shares of Great Eastern (traded now btw S$15-16). All in the total net asset value for Kuchai Development is around RM260m. It has 120.7m shares (50 sen), which makes for a NAV of RM2.47. Guess what's the share price??? Its just 1.20. How to go wrong?

Technically you have to outlive the owners or wait till they finally decide to do something with their shares. When looking at a value company, the first thing to check is the shareholdings level. For Kuchai: 

Kluang Rubber 41.9% 
Sg Bagan 9.38% 
Lee Foundation 4.18% 
Kota Trading 1.77% 

The top 3 are basically the same group of people and they made doubly sure they have more than 50% as that will stop anyone thinking of raiding the company. So if someone comes along and collect shares and then make a G.O. at RM1.60, he/she will not succeed as long as the controlling shareholders do not sell. They will probably sell if someone comes along and offer a substantive premium to NAV, say RM2.60-2.80 or thereabouts. The value is in the NAV and then the listing vehicle as a value add. 

Once the owner controls more than 50%, there's very little you can do. If you can locate a value company and there is ample free float, plus the controlling shareholder holds less than 35%, then I bet you that many vultures will be circling to take over the company, thus narrowing the gap between NAV and the share price.

It might be OK to hold on forever if the company pays a decent dividend, but in Kuchai's case it paid 0.8 sen in 2008 and 0.45 sen in 2009. If you take the share price of 80 sen  then, that works out to be a paltry dividend yield of 1% and 0.56%. Really no incentive to own this stock.

Stock               Share Price / NAV
Minho                 0.54 / 2.67
Mitrajaya            0.44 / 0.79
Pasdec                0.32 / 1.81
Advance Synergy  0.15 / 0.89
Majuperak           0.28 / 1.23
Eupe                   0.57 / 1.99
Focal Aims           0.37 / 1.17
Xian Leng            0.31 / 0.91
PW Cons             0.45 / 2.10
BCB                   0.40 / 1.69
Ekowood             0.18 / 0.73
Kia Lim               0.34 / 1.08
Prinsiptek            0.22 / 1.00
Rex Industry        0.62 / 1.92
KPSC                  0.39 / 1.26
Mycron Steel        0.34 / 1.43
Jerasia Capital     0.56 / 1.44
Cymao                0.31 / 1.47

I can go on and on ... for another 100 more at least ...


These are not recommendations at all, just to highlight those with massive discounts to NTA. Besides the discount, one must look at a few things:
a) the quality of assets under its NTA, whether they are readily realisable or industry specific sunk cost (e.g. steel mills)
b) the real burn rate of an imploding company, many companies with discounts are because investors are dumping stocks of a deteriorating company which will be making significant amount of losses over the next few years just by hanging around, an imploding business model (let's not mention names la) .... then the discount is actually JUSTIFIED
c) there are material litigation which may cause future losses and liabilities

Dear SC & Bursa: I really think that there is a strong case for the SC and Bursa to come down hard on Kuchai because it does not resemble a normal company with on-going businesses. Its strictly a holding company. It does NOT allow shareholders to participate in the growth of the company, it just holds the stakes forever. It does NOTHING to extract value from their inherent value. 

To me, its like a company which has sold all businesses and sits on cash. In this case, the cash is the assets. Yes, we are treading on uncharted waters here when I advocate that SC & Bursa put in a proactive move to reinvigorate stocks like Kuchai ... but we can certainly draw up some stringent parameters, and if they are long drawn out inactive management presiding over deep value assets ... then issue a GOOD no-UMA, further inaction give them a delisting notice. We already have rules that forces companies to have a decent free float, we have rules that prohibits a company from sitting on cash forever, rules that warn companies if they are too inactive in volume traded ... all wanting a properly regularised market place to safeguard investors. Companies like Kuchai makes a mockery of being a listed company.

For companies like Kuchai, I would suggest that they need to sell down their company from above 50% effective stake to below 40% within 2 years, and then to below 35% within 4 years. One, it makes for better liquidity, two... it puts the company in play, three ... the owners will finally do something to extract value instead of doing nothing. Sounds like a great idea but will never get passed for being too radical. Still, worth thinking about it than doing nothing.

Some may say so is Berkshire Hathaway - in Buffett's case, he actively manages his positions, positions will be sold once they reach above fair value and vice versa. Kuchai's position makes a mockery of being a listed counter - anyone in their right mind would be 100x better off to invest directly into Great Eastern or Sg Bagan - there is absolutely no value to its existence.