2017 IN REVIEW



Started this blog in February this year, with the aim of encouraging more young adults to begin their investing journey. I've spoken to many young adults who believe that investing is out of their reach, when in reality, even if your capital isn't large, you can still start with a monthly dollar cost averaging strategy. I hope that by penning down my thoughts regarding my investing experience, more young adults would take the initiative to find out more about investing.


As I've gained more investing experience, I have also fine-tuned my process of identifying good companies. Generally, my investment strategy is to identify companies with a track record of stable or growing earnings, reasonable debt to equity levels (<~35%), and with decent dividend yields of at least 3-4%. These companies should also generate healthy levels of free cash flows. If these companies are sold down due to negative sentiment, rather than a deterioration of fundamentals, I would seize the opportunity to purchase them at a lower valuation.

2017 Investment Performance


I have updated my portfolio as of 30/12/2017, and you can find it here: My Portfolio

My holdings didn't change from November. For 2017, DBS is undoubtedly my top performer, with a gain of 43.3%. As the STI index performed strongly this year, my decision to purchase the STI ETF, which is the top holding in my portfolio, contributed to the strong gains as well.

A laggard would be Far East Orchard, which I felt was undervalued. This position is slightly in the red now. I've recently re-looked the financials of FEO, and realised that the way FEO accounts for their property assets probably results in them consistently trading below their net asset value. I'll do a write up if time permits. SingTel has also been weak, but as I had purchased their shares prior to ex-dividend, I'm still able to breakeven.

2018 Investment Goals


I didn't set any investment goals for 2017, so for 2018, I aim to outperform the STI by 5%. I believe that aiming to outperform the index is necessary to justify and validate the time and effort spent on researching individual companies. Otherwise, won't we be better off being a passive investor, and hold a basket of ETFs?

In the process of achieving my target, I hope to be able to identify a two-bagger. This goal is a rather ambitious one. Personally, my biggest miss of 2017 (or late 2016, before I started blogging) would be GLP. A relative of mine constantly reminds me of how we missed the opportunity to purchase GLP, because we had talked extensively about it when it was trading around $1.80. Of course, hindsight is always 20/20, and who knows, even if I had purchased GLP shares back then, I might have exited too early and missed the privatisation too.

I believe that another very crucial aspect to achieve good investment performance is to know when to cut loss. On this aspect, I feel that I'm not proficient enough yet, and is something that I'll have to learn through experience.

Personal Development


Read at least 5 books


On the personal development aspect, I hope to kickstart my reading habit again. During my two years of National Service, I had read a total of 30 books. Due to the nature of my job scope back then, I made use of any spare time I had to read. However, ever since I began my undergraduate studies, my reading momentum had slowed down considerably. Studies, co-curricular activities and school commitments take up most of my time.

My reading list isn't limited to investment related books, it includes books on behavioral psychology, marketing and a variety of biographies as well. If you're also into behavioral psychology, I'll highly recommend Daniel Kahneman's Thinking Fast and Slow.



With regard to building up a habit of reading, there's a blogger, Dan O, who writes book reviews of investment books that he has read. You can check out 'book reviews' on 10percentperannum.blogspot.sg

Learn a programming language


This is something that I've had at the back of my mind for some time, and I'll aim to complete this in 2018. With all the talk about technology replacing jobs, the finance sector is not spared. My personal opinion is that while not everyone has to be an IT expert, having some knowledge and background on programming would be definitely be advantageous.

To end off, I believe that a huge intangible benefit from starting this blog would be the increased opportunities for interactions and discussions with the investment community, from comments, emails and through InvestingNote. It's a privilege to be able to learn from many more experienced investors among us. Please do continue to reach out to me by leaving a comment or through email. A huge thank you to all readers for your support, and wishing everyone a healthy and prosperous 2018 ahead!

Cheers,
AlpacaInvestments




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ANALYSIS OF JAPAN FOODS HOLDING



Japan Foods Holding (JFH) has recently caught my attention, after I have started screening for stocks again. JFH operates a wide range of F&B outlets selling Japanese food. We may be familiar with the Ajisen Ramen brand, which accounts for the bulk of JFH's revenue (39.5%). JFH also operates brands including Menya Musashi and Keika Ramen. JFH has operations in Singapore, Malaysia, Vietnam, Hong Kong and China.


JFH Annual Report 2017


JFH has a four pronged strategy to grow its business - developing new concepts, cost control, overseas expansion and network expansion/consolidation.

1H 2018 Financial Results


For 1H 2018, JFH reported an earnings per share of 1.35 cents, compared to 1.53 cents a year earlier, a 11.8% fall. Revenue fell marginally from $33.5 million to $33.0 million.

As at 30 Sep 2017, JFH had $19.6 million in cash and cash equivalents. This makes up more than a quarter of JFH's market cap of $74 million. Furthermore, JFH has zero borrowings. A healthy balance sheet means that JFH has the financial strength to fund any expansion plans or acquisitions.

Increasing Gross Profit Margins



JFH Annual Report 2017


JFH frequently highlights their high gross profit margins, which have been increasing over the past 5 years, hitting a record high of 85% this year. However, if we were to look at their net profit margin, it would paint a different picture. JFH's net profit margins have been declining over the same period. I'll be looking deeper into the cost structure of JFH to better analyse these differing trends.

Here is the comparison between the expenses JFH incurred in FY 2013 compared to that of FY 2017:





Firstly, while JFH's revenue has increased from $61.3 million to $65.5 million, they still managed to reduce their cost of sales from $12.2 million to $9.9 million. Thus their gross profit margin increased from 80% to 85%. JFH's increasing gross profit margins signals that they have managed their costs of sale well. Cost of sale mainly consists of the cost of raw materials, which were probably kept low because of bulk purchases and economies of scale.


However, JFH's net profit margins fell over the same period, from 10.4% to 7.2%. As we observe from the comparison above, this is mainly due to selling and distribution expenses increasing, from $37.9 million to $46.5 million. Selling and distribution expense is the main component of JFH's expenses, and rose due to higher wage costs and higher depreciation expenses incurred. 


Naturally, the business would incur higher staff cost and depreciation expenses as it expands, as new outlets are set up. However, JFH's expenses have risen at a faster pace than its growth in revenue, which offsets its increasing gross profit margin, resulting in its net profit declining. Going forward, JFH is expected to continue facing such cost pressures due to a tight labour supply. We should pay attention to how JFH manages these cost components in the upcoming quarters.


Dividend Payout



JFH Annual Report 2017


JFH has the highest dividend yield among its peers, at 4.8% as of today's closing price of S$0.42. However, this is mainly due to JFH's dividend payout ratio leaning towards the high side. JFH's 5-year dividend payout history is shown above. Note that JFH used to payout higher dividends from 2013-2014, then cut its dividends after earnings fell. 


JFH 1H 2018 Results Presentation


For FY 2017, JFH paid out 75% of its earnings as dividends to shareholders. For some comparison, Jumbo's payout ratio is around 60%. This is probably because Jumbo still needs to fund its expansions to penetrate new markets, while JFH already has an established network of F&B outlets across the region. For 1H 2018, earnings per share was 1.35 cents, which gives us a full-year pro forma EPS of 2.7 cents, indicating that JFH would probably be abe to maintain a healthy 75% payout ratio. Interim dividend had increased slightly from 0.75 to 0.8 cents.

JFH currently trades at a P/E ratio of 16x, which is reasonably priced compared to its peers. I won't say that JFH is undervalued, but given that F&B companies generally trade at slightly higher valuations, I believe JFH's current share price is still rather attractive.


Discounted Cash Flow Valuation


Personally, I'm not really a fan of using DCF to arrive at a valuation, because of how widely the valuation can fluctuate based on the inputs we decide to use. As they say, garbage in, garbage out. However, since a DCF is still an extremely common valuation metric, I'll still include my DCF-based estimates here.

As JFH is an established F&B chain, and with little expansion plans in the pipeline, the assumptions I used were a discount rate of 9% and a terminal growth rate of 2.5%. I used a 2.5% TGR, which is higher than Singapore's GDP growth rate, because JFH has still has operations in a number of emerging economies such as Vietnam and China. These countries should experience higher GDP growth rates than us. 18 of JFH's outlets are based overseas, while 49 in Singapore.



Starting with JFH's five year average free cash flow of $5.56 million, I arrive at a valuation of $0.51 per share for JFH, which represents a 21.4% upside from today's price of $0.42. Notice that if we were to tweak the parameters slightly, the valuation we would arrive at can differ substantially, as we get a range from $0.34 to $0.95. If we were to be more conservative, and apply a higher discount rate of 10% and assume a lower terminal growth rate of 2%, we would have JFH at fair value now. To me, a DCF is at most rough estimate of the company's value, and we'll have to evaluate both the quantitative and qualitative aspects of the business. 

High Insider Ownership



JFH Annual Report 2017


JFH's CEO, Mr Kenichi, and Non-Executive Vice Chariman Mr Eugene Wong hold a 70% and 5.47% interest respectively. That is a total of more than 75% held by key executives. I prefer companies with high management ownership, because this gives us a much stronger alignment of interest between the management and shareholders. However, a consequence of this high management ownership results a mere 19% of the outstanding shares being held by the public. Thus, JFH's trading volume is extremely low, or may not even be traded on some days. Investors may face liquidity risks if they have to cash out urgently.

Conclusion


While JFH is a small cap stock, I believe that it has a geographically diversified and stable business. If JFH is able to keep its costs in check, increase its operational efficiency and mitigate its declining net profit margins, JFH could see some earnings recovery. However, one aspect of JFH I dislike is that they operate too many brands, which results in JFH's brand equity lagging behind its peers.

Should JFH's share price fall below $0.40, with little change in fundamentals, I believe that it would present a good opportunity to purchase a solid, cash flow generating company. At that price, we would be receiving a dividend yield in excess of 5%. However, as I'm currently a shareholder of Jumbo, should I purchase JFH's shares, my portfolio would become slightly heavy on the F&B sector. 


Read: Jumbo at 52-week low


Note: As of writing, I do not have a position in Japan Foods

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KEEPING AN EYE ON ST ENGINEERING



ST Engineering (STE) has performed poorly for the past few months, and I have added it to my watchlist. STE is an integrated engineering group with 4 main business segments - Aerospace, Electronics, Marine and Land Systems. For FY 2016, the group generated $6.68 billion in revenue and $484.5 million in net profit, representing a net profit margin of 7.2%. The revenue breakdown was 65% from commercial sales and 35% from defence sales. Earnings per share was 15.6 cents, and the group distributed 15.0 cents of dividends to shareholders.

STE Annual Report 2016

This year, 9M 2017 earnings per share stands at 11.03 cents, up from 10.12 cents last year. Profits were higher mainly because of a one-off charge of $61.1 million incurred in 2016, when its specialty vehicle business in China was written off.

STE Annual Report 2016

For an overview, STE's Aerospace segment was the largest in terms of revenue (37%) and net profit (48%), followed by the electronics sector. Its Land Systems segment, while posting a higher revenue than the Marine segment, reported a lower net profit because profit margins for this segment has been extremely low.

I read through STE's Annual Report and I was pleased to see that they had reported detailed breakdowns of the financial statements for each segment. I have included my calculations of the net profit margins for each segment, to give us a more complete picture of the relative performance of each segment.

Aerospace Segment


STE Annual Report 2016

Being STE's largest business segment, and with the highest net profit margins, the Aerospace Segment is facing headwinds from structural changes in the aerospace maintenance and repair industry. Newer aircraft such as the Boeing 787 require less maintenance hours, which affects STE's maintenance, repair and overhaul (MRO) business. Furthermore, there is also increased competition from MRO companies in China and our neighbouring countries, such as Garuda Maintenance Facility AeroAsia, an Indonesian company that recently went public. Consequently, STE's net profit margins have declined over the years, which probably reflects the stiff competition in the MRO industry. STE's passenger to freighter conversion segment provides some support to earnings, as they are one of the leading companies providing P2F services, and receives support from Airbus.

STE has also ventured into the aircraft leasing business, where it aims to build up a fleet of mid-life aircraft to be leased out. When its aircraft leasing business attains sufficient scale, it would complement STE's core MRO segment.

For some comparison, SIA Engineering, a similar company in the aerospace MRO segment, currently trades at a P/E ratio of around 20.

Electronics Segment


STE Annual Report 2016

STE's Electronics Segment is by far their best performing segment during the past few years. Revenue and net profit from this segment has been increasing over the years. For the past year, manufacturers of electronic components have experienced a strong rally, with many companies seeing their share prices rising by more than 100%. I believe this reflects the growing demand for more electronic components required for 'smart' devices.

STE's Electronics Segment includes the Intelligent Rail Transport solutions which has projects in Saudi Arabia, Thailand, Malaysia and Singapore; cyber security and satellite communications. In my opinion, this segment has the greatest potential upside, with the demand for electronics set to rise alongside various 'Smart City' initiatives. For example, in 2016, STE partnered SUTD and invested $44.3 million to set up a Cyber Security Laboratory. As more companies go digital, cyber security would be a top priority for businesses, and STE's cyber security business can benefit from this trend.

Marine Segment


STE Annual Report 2016

The Marine Segment has been a drag on earnings, with the persistent low oil prices affecting the entire offshore and marine sector. The weak earnings from this segment is one of the main reasons for STE's declining net profit. For 9M 2017, net profit from the Marine segment deteriorated again, down by 51.5% from a year earlier. 

STE aims to mitigate the impact of the oil downturn by switching to service more vessels in other sectors such as livestock shipping

Land Systems Segment


STE Annual Report 2016

STE is a leading supplier of equipment and munitions to the Singapore Armed Forces, and most of us would be familiar with products such as the SAR-21 rifle or the Terrex IFV, which are manufactured by STE for the SAF. While this segment provides rather stable earnings, because STE is a major contractor for the SAF, what surprised me was that the profit margins were extremely low. However, we should also note that the unusually low earnings for FY 2016 was because of a one off loss from the closure of its Specialty Vehicle unit in China, resulting in a loss of $61 million.

A potential growth catalyst for this segment would be the development of autonomous vehicles. STE recently acquired Aethon for $50 million, which is a leading supplier of autonomous robots for the healthcare, industrial and logistics sector. With its wide scale of operations, STE would be able to penetrate the Asia Pacific market for autonomous robots. Aethon also aims to expand into the European market.


STE has also partnered LTA to develop autonomous buses. STE has expertise in this area, having developed two autonomous vehicles which are currently operating at Gardens by the Bay. Perhaps sometime in the future, STE might become a leading public transport operator here.


Ideally, STE's investments in the autonomous vehicles industry should put the company in a prime position to match the future demand from this sector, and boost its returns from this segment. 

Potential Risks


STE's dividend payout ratio has been consistently on the high side, as seen from the table above. STE distributed 98% of its earnings to shareholders in FY2016. Personally, I am not in favour of such a high payout ratio, as I believe that STE should retain a higher percentage of its net income to fund its capital expenditures, or to reduce debt. Should earnings continue to decline, I believe that a reduction of dividends is possible. Investors seeking dividend income should watch out for this.

Conclusion


STE's share price is still on a downtrend since its peak of $3.86 in, and is currently at $3.21, near its a 52-week low of $3.16. At this price, STE is trading at a P/E ratio of around 20x and offers a dividend yield of 4.7%. However, although STE's management has stated that it expects full year earnings for FY 2017 to be comparable to that of 2016, there is no certainty that the 15 cent dividend would be maintained.

My investment strategy is to identify companies with a good track record of stable earnings. When these companies are sold down due to negative market sentiment, rather than a deterioration of fundamentals, it would present an opportunity to accumulate their share at a lower valuation. Although STE's Aerospace and Marine sectors continue to face challenges, I believe that STE's current situation seems to fit this criteria. STE's fundamentals haven't worsened much compared to a year before, but its share price has been falling. While STE has seen its earnings decline for the past few years, I hope that with potential growth catalysts in the Electronics and Land Systems segments, we would be able to see their earnings bottoming out soon.

With Temasek Holdings owing a 49% stake in STE, I believe that STE is a rather safe bet and would continue to be one of Singapore's leading companies. I would be looking to accumulate if STE's share price falls further.

Note: As of writing, I do not have a position in ST Engineering

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