COMFORTDELGRO: A SAFE ENTRY PRICE?


ComfortDelGro has been on my watchlist since early this year, when it was trading at around $2.40. In my earlier post in February, I assigned a target price of $2.17 for CDG, on expectations that taxi earnings would be hit by the intense competition with private hire operators. 

Subsequently, CDG ran up to a high of $2.70 before going on a prolonged decline, and closed at a price of $2.08 yesterday. When CDG hit $2.17 a month ago, I did not initiate a position because I felt that its fundamentals have worsened. I have summarised my thoughts on CDG.


Strengths


Strong Financial Position


With $606.6 million in cash and cash equivalents and $377.1 million of borrowings, CDG is in a net cash position of $229.5 million. Some investors have suggested that CDG invests its cash outside of its core transportation business, similar to what SPH has done by venturing into the property segment.


Consistent Free Cash Flows



CDG consistently generates high free cash flows, as the bus contracting model has reduced capital expenditures. This possibly allows CDG to increase its dividend payout ratio. The management has pledged to payout a minimum of 50% of earnings per share, and the payout ratio has been steadily increasing. For 2016, the total dividends declared of 10.3 cents represented 70.1% of earnings. 


Stable Earnings from Public Transport Segment


Earnings to be supported by the public transport segment. The Downtown Line and North East Line have both reported steady ridership numbers and demand for rail travel would increase alongside population growth.


Challenges


Intensifying Competition with Private Hire Companies


With Grab offering CDG drivers huge incentives to switch over, CDG could potentially lose up to 2,000 drivers, according to this article. Quarterly earnings from the taxi segment has been falling.

http://www.straitstimes.com/singapore/transport/grab-out-to-snatch-comfortdelgro-cabbies-with-huge-discount

A month ago, news that CDG was in talks with Uber sent shares up by 10% in a day. Many expect this ongoing competition among the taxi companies to be a winner-takes-all contest, however, I believe that this outcome is unlikely - I don't expect Uber and Grab to kill off CDG. A more plausible outcome would be that the new entrants to the market permanently cuts the huge profit margins that CDG had enjoyed in the past. 

http://www.straitstimes.com/singapore/transport/comfortdelgro-in-talks-with-uber-on-possible-tie-up

In the past, CDG rented taxis out for around $110/day. Currently, the rental rates for Uber/Grab is around $50/day. Even after factoring in the 20% that U/G takes from drivers, the total cost would still be around $70-80, far less than what CDG used to charge its drivers. 

I believe that the deal would benefit Uber more than CDG, as Uber is still competing for market share, and this allows it to have access to CDG's huge fleet of taxis. For CDG, the outcome would still be the same - lower profit margins from the taxi segment.

Eventually, there would be equilibrium in the market - U/G can't continue to make losses and burn cash forever. Just that ultimately, the profit margins for the taxi segment would be razor thin, and CDG would have lost its 'monopoly' status as well as its dominant position in the market.

Lost Tender for TEL


CDG lost the tender for the Thomson East Coast Line to SMRT, which would have been a substantial growth catalyst. CDG's bid was 30% higher than SMRT's offer of $1.7 billion.


Valuation


I used a sum of the parts valuation to arrive at my fair value for CDG.


Source: ComfortDelGro's Q2 Earnings Report

Since its taxi business is declining, with an uncertain outlook, I have decided to value it separately from the other business segments. Based on the half-year results ending 30 June 2017, operating profits from the taxi segment was $72.3 million, down 15% from $85.1 million in the same period last year. This made up 34% of CDG's operating profit before interest and taxes. The rest of CDG's business segments, including Public Transport, Automotive engineering and inspection made up 66% of operating profit. 

Assuming a constant tax rate across all segments, and that finance costs are split proportionately, the other business segments would contribute $106.8 million (66% x 161.9) to the net profit attributable to shareholders for 2H 2017. 

For 2H 2017, net profit was higher mainly due to net income from investments rising $8.4 million from a year earlier. Therefore, my pro forma earnings for the full year would be lower. I arrive at an earnings per share of (106.8 + 100) / 2,162.8 = $0.0956. Applying an earnings multiple of 14x, which is the long term average P/E for CDG, we arrive at a value of $1.339 per share for CDG's business excluding the taxi segment. I believe that a 14x P/E valuation for the rest of CDG's business segment is rather fair, given that public transport earnings are more resilient. 


ComfortDelGro Annual Report 2016

For the taxi segment, I valued it at 1.2x net asset value. The worst case scenario would be to assign a valuation of 1.0x NAV or even lower to this segment, assuming that the management decides to exit the taxi business and sell off its assets. As CDG is currently valued by the market at 1.72x NAV, I believe that a valuation of 1.2x NAV would be a rather conservative estimate. 

I am unable to find data on the latest assets by segments, so I had to use figures from the Annual Report published earlier this year in April. The assets and liabilities of the taxi segment as of 2Q 2017 may be slightly different, given that the taxi fleet has been shrinking. As of 31 December 2016, the taxi segment had $1,330.7 million of assets and $318.0 million of liabilities. This gives us a net asset value of (1,330.7 - 318.0) / 2,162.8 = $0.468 per share. Applying a premium of 1.2x NAV, I arrive at a valuation of $0.562 per share

Therefore, my fair value estimate for CDG would be $1.339 + $0.562 = $1.90. Investors may decide to apply an appropriate margin of safety to this fair value estimate. Personally, I view any decline in share price to below $1.90 as a good opportunity to accumulate, as the dividend yield would be around 5.5%.


My Thoughts on the Management


I believe that the management was slow to react to the threat posed by private hire operators. They were probably complacent as they had enjoyed a near monopoly status for a long time. Contrast this to how the incumbent telcos reacted to the upcoming entrance of TPG - they have all revised their pricing plans in order to retain customers. I believe that CDG's management had underestimated the threat of private hire operators, otherwise, they would not have took a long time to reduce the rental rates. Here

While operating profits from the taxi segment only makes up slightly more than 30% of the total, how the management makes decisions for this segment is indicative of how responsive the would be to future challenges. CDG is lacking in this aspect.

If you're interested, I have attached an interview with one of Grab's co-founders. Notice how Grab is all about innovation, change and adaptability - qualities that CDG are lacking.

http://www.straitstimes.com/singapore/grab-whiz-happy-to-stay-low-key


Earlier post on CDG: Bumpy Road Ahead For ComfortDelGro


Note: As of writing, I do not have a long or short position in ComfortDelGro.


If you enjoy reading my articles, please 'like' my Facebook page to receive all the latest updates. It would also mean a lot to me if you could share my articles on Facebook. Thanks! :)

https://www.facebook.com/AlpacaInvestments/


Edit: It was earlier incorrectly stated that CDG operates the Circle Line. I have corrected this error. 

JUMBO AT 52-WEEK LOW


I have been monitoring Jumbo's stock for the past few months. After a spectacular run up since its IPO, Jumbo's share price hit an all time high of $0.79 earlier this year. At that point, Jumbo stock was trading at a P/E ratio of 30, which reflected the market's strong optimistic sentiment, along with expectations that Jumbo would continue to report strong growth in its earnings. After two quarters of reporting flat earnings, Jumbo's share price has tumbled to a 52-week low of $0.53. 

This shows us how emotion driven the market can be in the short term - within slightly more than 6 months, the variance in price is close to 50%. Either the market had grossly overvalued Jumbo back in late 2016, or Jumbo is at fair value or undervalued today. Jumbo's underlying fundamentals didn't change much, the only factor that changed was the market's optimism. While Jumbo has increased its earnings year on year, the rise has not been up to market expectations. 



Business Overview


Jumbo operates 16 restaurants in Singapore and 3 in Shanghai under the brands which include JUMBO Seafood, JPOT, Ng Ah Sio Bak Kut Teh, Chui Huay Lim Teochew Cuisine and J CafĂ©. An interesting point to note would be that the Jumbo Seafood Restaurants contribute the largest proportion to revenue, at 77%. Jumbo has also ventured into the Vietnamese market through a franchise agreement in Ho Chi Minh City, and seeks to expand its network in China and other cities in Asia.



Source: Jumbo Corporate Presentation, May 2017


Personally, I have dined Jumbo Seafood, JPOT and Ng Ah Sio Bak Kut Teh. My personal observation is that while Jumbo Seafood and JPOT outlets are usually popular, Ng Ah Sio lacks the differentiating factor compared to other Bak Kut Teh eateries. I am unable to find financial information to compare the profitability of the different brands, but I assume that Jumbo Seafood probably has the highest margins. 

Perhaps Jumbo would be better off closing down some of the non-performing outlets, which would reduce its operational costs. Furthermore, I doubt many customers are actually be aware that Ng Ah Sio is affiliated to Jumbo.


Growth Strategy



Jumbo has successfully ventured into China, with 3 restaurants in Shanghai. Currently, only 17% of its revenue is contributed by its restaurants in China. 



Source: Jumbo Corporate Presentation, May 2017

Leveraging on Jumbo Seafood's strong brand reputation, Jumbo seeks to expand further to other Chinese cities such as Beijing and Shenzhen, either through join ventures or franchising. This positions Jumbo well to ride on the expected increase in purchasing power of the Chinese middle class. As the Chines middle class becomes more affluent, demand for higher end dining options would increase, and the proportion of revenue from China would be larger.

Jumbo has also opened a franchise outlet in Vietnam, and plans to further expand their network there, with three more planned openings of JUMBO Seafood outlets there within the next two years. I believe that this is the right strategy, as licensing a franchise is an asset light model, which reduces start up costs. Based on the local consumers' response to the franchise outlet, the company can then decide on whether it is viable to expand in the country.

These growth plans, if executed smoothly, would materially add to Jumbo's earnings. If successful, we could well see Jumbo transform into a region wide restaurant chain within the next few years.


Financial Performance


For 3Q 2017, Jumbo's net profit fell by 1.1%. The market's reaction to its second quarter results was strong, sending its share price down by 5% after the results were announced. 


Jumbo 3Q Financial Results

Revenue increased by 6.4%, however, this was offset by the rise in operating lease expenses and depreciation 24.5% and 29.8% respectively. I'm not too concerned about the rise in depreciation, as a higher depreciation has to be booked along with new outlets opened. Depreciation is a non-cash expense and does not affect Jumbo's free cash flow. For the higher operating lease expenses, I believe that this is also expected as new outlets generally need some time to breakeven, which would incur higher operating expenses initially. 

As a result, even though revenue increased, Jumbo's net profit was flat. Net profit did not fall much, which indicates that there hasn't been a huge change in fundamentals, yet the share price tumbled. This is probably because Jumbo missed investors' expectations, rather than a deterioration of fundamentals.


Financial Strength


Jumbo's balance sheet remains robust, with $48 million in cash and cash equivalents as at 30 June 17, and no borrowings. Jumbo continues to generate strong operating cash flows, which has been able to cover its capital expenditures for the past two financial years. This gives Jumbo a positive free cash flow. However, if Jumbo continues to execute its ambitious expansion plans, Jumbo may probably have to dip into its cash pile or borrow to fund future capital expenditures. As operations at new outlets ramp up, this would further strengthen Jumbo's cash generating abilities.

Possible Risks

Apart from a sharp slowdown of our local economy or some economic crisis in China, I can't really think of any significant risks to that would severely affect Jumbo's business. There is probably some execution risk involved as Jumbo carries out its expansion plans, as new outlets may take longer to breakeven and incur some operating losses for a longer than expected time period. Another possibility is that when entering new markets, Jumbo may not appeal strongly to the local consumers.

An unlikely but damaging scenario that a friend pointed out would be that consumers avoid eating crabs due to some scientific research or epidemic, which I believe is an extremely low possibility.


Valuations



After the recent correction, Jumbo's price to earnings ratio has dropped to 21. While this is still relatively high compared to many other stocks, I believe that it is decently price for a company with strong growth prospects. Furthermore, companies in the food and beverage industry generally trade at higher price multiples, probably due to the perceived stability of the industry. 


As investors re-evaluate the prospects of Jumbo, I feel that its current share price presents us with an attractive opportunity to purchase a well run company with substantial growth.


Note: I am vested in Jumbo at $0.54 


If you enjoy reading my articles, please 'like' my Facebook page to receive all the latest updates. It would also mean a lot to me if you could share my articles on Facebook. Thanks! :)




AUGUST TRANSACTIONS

1) Divested NetLink Trust at $0.805, because I expected the cessation of the stabilising purchases to have an adverse impact on the share price, similar to HRnetGroup two months ago. However, on hindsight, this was a speculative decision and probably shouldn't have been a strong reason to exit, given that the fundamentals haven't changed and NetLink's dominant position in the fibre broadband market. 

Since my divestment, NetLink's share price has risen by around 4-5%. The strong performance recently can probably be attributed to expectations that the pace of rate hikes will be slowed, which benefits high dividend yielding stocks, as well as recent tensions around the Korean Peninsula encouraging investors to rotate into less 'cyclical' stocks.  

Thankfully, my loss was a rather insignificant, given that I bought the shares during IPO. This was probably a good learning experience to resist the urge to make speculative trades, and focus on the fundamentals of the company.

2) Redeployed some of my available capital by initiating a small position in Far East Orchard at $1.52. FEO's property development segment may be small relative to the more established property developers in Singapore, but I expect the recovery of the local property market, as evident from the increasing number of en bloc sales, to benefit FEO. The en bloc market here is heating up, with the Tampines Court transaction completed and more developments being put up for collective sale. These are signs that developers expect the property market to pick up, and private home sales has rebounded to a 4-year high.

FEO has been a laggard among the developers, with Capitaland and CityDev showing strong performance this year, and more recently GuccoLand and Frasers Centerpoint too. FEO has been consolidating around the $1.50 level for more than a year already, and I expect FEO to follow the property market to emerge from its lengthy slump.

Furthermore, with the hospitality segment picking up and supply tapering off in 2018, these factors will also benefit FEO's hospitality management segment. With the combined recovery of the property and hospitality segments, it should only be a matter of time before FEO retests the $2.00 level.

3) With the recent correction due to North Korean provocations, some stocks on my watchlist include SATS, Raffles Medical, Jumbo, SingTel, QAF, Sheng Siong, ComfortDelGro and Mapletree Commercial Trust. With the exception of MCT, these stocks are trading close to their 52-week lows, which may present some opportunity. I will post more detailed reports of them if I have the time, as I have been quite busy with school work. 

If you enjoy reading my articles, please 'like' my Facebook page to receive all the latest updates. It would also mean a lot to me if you could share my articles on Facebook. Thanks! :)