Is Eksons a value trap? (Part 1 of 2)

Case Study 01-1: A fundamental analysis of the Group

What is a value trap?
 
It is an investment that is trading at a low price relative to its value that while appearing to be cheap, is misleading. 

With a market price of RM 0.57 per share on 1st June 2020 and with cash and marketable securities of RM 1.27 per share (based on the Balance Sheet on 31st Dec 2019), Eksons looks like a bargain. 

But is there a catalyst for the price to go up? Or will there be some impending impairment that will wipe out a significant portion of its value? In other words, is Ekson a value trap? 

In this 2-parter I will lay out my case why Eksons is not a value trap.  

Now as to whether you should go and buy Eksons - see my Disclaimer.

I present Part 1 here while  Part 2 was published on 21 June 2020. 


Contents
  • Is there Anything Special about the Group's Expertise?
  • Is there Concern about how it Uses its Funds? 
  • Is the Current Performance Outstanding?
  • Tracing the Group's Rich and Unique History
  • Will the Timber segment have a Great Future?
  • Will the Property Development segment have a Great Future?

Eksons - Value Trap or Bargain?



Valuation Date

1st June 2020

Company name

Eksons Corporation Berhad

Stock name in Bursa Malaysia

EKSONS

Company Bursa Malaysia code

9016

Bursa Malaysia sector

Industrial Products and Services

Listing date on Bursa Malaysia

February 2001

Financial Year End

March

Latest Quarterly results

3rd Quarter, 31 Dec 2019

Shareholders’ Equity

RM 427 million (31 Dec 2019)

Market capitalization

RM 91 million   (31 Dec 2019)

Total Enterprise Value (TEV)

RM 74 million  (31 Dec 2019)

Corporate website

https://www.eksons.com.my/

Table 1: Company Info


Is there Anything Special about the Group's Expertise?

According to its corporate web site, the Eksons Group specializes in the manufacturing of tropical thin plywood that is sold under the “Panda” brand name.  Eksons also produces veneer and sawn timber.

The Group has 2 factories with a combined installed capacity of 285,000 m3 per annum located in Sibu, Sarawak and Tawau, Sabah. Over 90% of its products are exported, mainly to the US, Middle East, North Africa, Taiwan & Korea.

The Eksons Group is also described as having investments in property development and property holding.

My first impression then is that this is a group with interests in the secondary wood processing sector, property development as well as owning properties for rental income.  

Well, it is not exactly like what its corporate profile said. 

I found out that while it has a long history in the wood processing sector, it really does not own properties like those of a REIT.  Furthermore, its property development arm has two current projects:
  • The Atmosphere, a 55 acres commercial development in Sri Kembangan, south of Kuala Lumpur without further development pipeline for the Group
  • Affinity Residences, a 6.5 acres residential project in Taman Bukit Serdang, Selangor is still in its early stages of construction.
If I am a speculator, then all these do not matter.  However, as a long-term investor, I wanted to understand how the Group is going to continue to generate profits. 

Is there Concern about how it Uses its Funds? 

I am not an accountant so when I look at a company’s accounts, I want to get a sense of where its funds have been deployed and how effectively it has been used.  

From this perspective, the Group has a total capital employed (TCE) of RM 468 million as at the end of December 2019, with SHF accounting for about 90% of it.  But only about 57% of the TCE is deployed for its operations.  The main reason for this is due to the scaling down of the Timber business. 

You can look for yourself from the table and chart. 

Items

Ref

RM million

Shareholders’ Equity

SHF

427

Minority Interests

MI

28

Total Debt      

Debt

13

TCE

 

468


Items

Ref

RM million

Net Operating Assets

Net OA

267

Net Financial Assets

Net FA

201

Non-Operating Assets

Non-OA

0

Total

 

468

Table 2: Sources and Uses of Funds (Revised 16 June)


Eksons Sources and Uses of Funds
Chart 1: Sources and Uses of Funds (Revised 16 Jun)


Is the Current Performance Outstanding?

While the Group has two main business segments, they are not of the same size. 
  • Timber – about 57 % of its SHF and MI (based on Mac 2019) are deployed here
  • Property development – about 14 % of its SHF and MI (based on Mac 2019) are deployed here
While the Group reported a YTD PAT of RM 3.6 million for the 3rd quarter of FY 2020, it was from its investments and interest income and not from operations,

Sad to say, the Group has not been profitable for the past 3 years due to a decline in both businesses.

As a long-term investor, you want to get a sense of the business direction and I tend to look at comparative performance rather than specific ringgit value. 

So I plotted indices of the key metrics – revenue and profitability over a 12 years’ period as per the Performance Index chart. 

Eksons Performance Index
Chart 2: Performance Index

Compare the table and the chart. You can see that the past 3 years’ performance is reflective of the past 12 years trend i.e. a downtrend in the Group revenue and gross profitability.

Item

 

2017

2018

2019

Revenue

RM m

121.3

149.3

67.3

PAT

RM m

(12.2)

(20.2)

(13.2)

Gross Profitability   (Note 1)

%

2

1

(2)

ROE

%

(2)

(4)

(3)

Debt to SHF & MI ratio

 

0.0

0.0

0.0

Table 3: Past 3 years’ Performance


More bad news! The long-term returns (based on the 12 years weighted average segment profits and capital deployed) have not been good. 
  • The Timber segment generated almost zero returns on the capital employed. Thus, even with a long-term horizon, I would be concerned about the Timber business.  
  • The Property development segment achieved about 16 % after-tax return on capital. Hah! Don't be misled.  This is due to a one-off sale of land in 2015 and excluding this, the return would be reduced by about 2/3 (Refer to Note 2)
You want a good overview of how well the funds have been deployed?  Then look at the picture below.

Eksons segment performance
Chart 3: Segment Performance

Note: a) SHF & MI were based on the 2019 Annual Report as the quarterly results do not provide a breakdown of the segment assets and liabilities. b)The Corp/Others is a balancing figure and represents the leasing and investment part of the Group. c) The averages are12 years time-weighted values (Refer to Note 3)


Look at the low contribution from the RM 135 million under the "Corp/Other" segment.  It is so small that it will pull down the performance of the Group. 

More important! The Group does not own major investment properties. I inferred that the “investment properties” and rental income are from the unsold units in The Atmosphere.

While good that management is extracting some revenue from inventory, you can see that its property holding business is a by-product of sales challenges rather than a business that is pursued separately. 

Tracing the Group's Rich and Unique History

In the mid-2000, the Timber segment was the core business. At its peak in 2007 and 2008, this segment had an average annual revenue of RM 345 million with about 15 % return on the SHF + MI utilized by the segment.

You would think that its future was bright. 

But then the Timber segment business started to decline by about 6 to 7 years ago and for FYE 2019 the revenue is about 1/5 of the 2008 revenue. 

Double whammy. The gross profit margin from the Timber segment has also declined so that in 2019 it was minus 11% compared to 28 % in 2008. 

This was due to both a decline in the international price for plywood as well as increased costs. 

For example, the current plywood price is about 25 % lower than the 2008 price while escalating production costs have been reported in almost all its Annual Reports for the past 12 years. 

This is not the end of its problems. There was a log supply problem such that it had to operate below optimal levels over the past few years. This not only affected production costs but even led to the suspension of some of its production.

Eksons Group Revenue
Chart 4: Group Revenue


Luckily Eksons diversified into property development in 2006? 

Property development started with The Atmosphere via separate joint ventures with the project manager and the landowner to overcome the issue of expertise and to minimize start-up costs.  

Then 2008/10 the Group acquired the Atmosphere land to cap the land cost.  

In 2009, the Group successfully launched the shop offices and boulevard shops component of The Atmosphere with 90% of the units sold. 

Unfortunately, the Malaysia property market started to turn soft in 2014 affecting its property development plans.  This affected not only the sales of units in The Atmosphere but also led to the re-timing of the Affinity Residences that were originally planned for the 2016 launch.  

Be careful when you look at the results.  The jump in the revenue for the Property Development segment in 2015 was due to a one-off sale of 14.64 acres of land which was part of The Atmosphere project. 

While technically correct to count the land sale as revenue for the property business, you want revenue from development.  Afterall Eksons is not a land trader.    

There was no significant revenue from the Property segment for the past 3 years as the residential project is still in its early stages of construction and The Atmosphere had soft years. 

In reality, the Property Development segment is a relatively small revenue contributor compared to the Timber segment.  If you ignore the sale of land, the property sales over the past 10 years are only equivalent to around RM 30 million a year, only about 1/10 the size of that from the Timber segment in its good years. 

Will the Timber segment have a Great Future?

Poor future for Eksons Timber segment
Surely, this cannot be the end of the plywood business. Given its track record, you would think that management should be able to turn it around. 

The Timber segment has to address 3 issues in order to return to profitability – log supply, production costs and new markets

Conceptually you can think of the wood-based industry as comprising
  • The upstream logging
  • The mid-stream primary processed wood products such as sawmilling, veneering, plywood and panel production
  • The down-stream secondary processed wood products such as moulding, builders’ carpentry, and joinery production as well as the furniture and it's component manufacturing.
Eksons is a stand-alone mid-stream player unlike some other Malaysian groups with an integrated upstream and midstream operations.  It thus has to purchase logs.  

Log supply has been a major challenge to Eksons over the past few years partly due to bad weather for some years and partly due to the reduction in logging activities.  

You can argue that Eksons had faced similar log supply problems before as in 2005/06. But this time may be different. 

This time the supply problem is also due to the national policy of reducing the natural forest logging areas.  While this is supposed to be offset by the increase in forest plantation areas, the planted forest areas have not met this goal.  

Implication? There will be a continuing reduction in the supply of the log from within the country so that log supply will be a mid to long term issue for Eksons. 

Sadly, there are other bad implications.   The log supply problem has resulted in an increase in its raw material costs.  

At the same time, Eksons experienced other cost increases.  All these could mean that a standalone mid-stream timber processing sector may no longer be viable.   

Finally, to make a comeback, Eksons has to win back the confidence of all its customers it lost over the past few years.  

It is a long road ahead. 

Will the Property Development segment have a Great Future?

Neutral future for Eksons Prop dev
In the short to mid-term, the Property Development segment performance is dependent on 2 projects - The Atmosphere and the Affinity Residences


The Atmosphere approved master layout plan comprised: 
  • 9 acres hypermarket zone
  • 12.5 acres stratified community with shops and a medium-size entertainment centre
  • 14.5 acres commercial component with a retail complex, hotel, serviced apartments and office towers. 
In terms of Eskons's own property development activities, the Group only developed the 12.5 acres plot as
  • The 9 acres of land hypermarket zone was sold in 2009 (on which a Giant Hypermarket was set up) contributing to the maiden segment revenue of RM 23.5 million.  
  • The 14.5 acres of land were sold in 2015 for RM 140.3 million.  
Wah! With 55 acres of land, the Group only developed less than a 1/4.  It sold most of it.  Well, selling of land is a good opportunistic move.  But this is not a long-term plan for a property developer. 

With most of the 12.5 acres plot of The Atmosphere developed, any future contribution from this development will be from the unsold properties currently held as inventory.  

As at financial year ended March 2019, the Group has RM 67.7 million of unsold properties, with most of them likely to be from The Atmosphere.  The sad part is that any contribution from these sales will probably be after 2022 when the MRT2 line is completed as the on-going construction has affected businesses in that place.  

The other contributor in the immediate to mid-term is the Affinity Residences. 

This is a RM 155 million gross development value (GDV) project comprising 23 Grand Villas and 70 Duplex Villas that was officially launched in Jun 2018.  As of the end of FY 2019, about RM 43 million out of the RM 155 million GDV has been sold.  

To be fair, this was launched when the property market was soft.

I estimated that with both these developments, the Property Development segment would have about RM 250 million of revenue in the pipeline.  This should be compared with the RM 255 million revenue generated from the sale of properties in The Atmosphere (excluding those from the sale of land) since venturing into property development.

OK, not so bad if the game plan is to be a supportive business. 

At the stage, there does not seem to be any other property development venture and/or land acquisition plans by the Group.  

End of Part 1 of 2   

Part 2 was published on 21 June 2020


Reading guide
If you are a first-time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation.  I suggest that you check up the Foundations series - Fundamentals 01,  Fundamentals 02, and Fundamentals 03.   I also have a Definitions page in case you are not familiar with the terms I have used.



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Disclaimer
I am not an investment adviser, security analyst or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned in this website may not be suitable to you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.

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