Is Asia File a Value Trap? (Part 2 of 2)
Value Investing Case Study 02-2: Valuation and risk assessment of Asia File to show why it is not a value trap. This article was first published in Jul 2020. There is now an update that incorporated the 2020 results. Revision date: 20 June 2021
The value of a company is more than just its NTA. It has customer relationships, a brand name (ABBA in the case of Asia File), and manufacturing secrets.
With a market price below its NTA, does it mean then that Asia File is grossly mispriced?
If it is just the market over-reacting to the current economic climate, there could be an investment opportunity.
However, if the Group is facing some secular headwind that is going to disrupt its business like what happened to the newspaper and taxi sectors in Malaysia, then it is not an investment opportunity.
Which is it?
In Part 1, I have shared Asia File's track record and showed that there is no imminent disruption due to digital technology.
But digital disruption is coming and the question is whether Asia File is using the time to reinvent itself.
In Part 2, I will argue that the Group has the financial resources and track record to meet such challenges. The value is still intact.
This means that it is not a value trap. You can interpret it as being undervalued.
There is now a Jun 2021 update that shows that Asia File is still a value trap/
Now as to whether you should go and buy - see my Disclaimer.
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Contents
- Did Top Management Seize Opportunities?
- Is there an Awesome Buying Opportunity?
- Will there be Spectacular Growth in Shareholders’ Value?
- How to Secure Your Investment by Minimizing Risk
- How to Benefit from the Case Study
Did Top Management Seize Opportunities?
Remember what we are trying to do?
- See whether Senior Management is honest and have shareholders interest at heart;
- See how well they have done both as an operator as well as a capital allocator.
Asia File has 5 directors on its Board of which 2 are executive directors. There is also an alternate director to one of the executive directors.
Together the 6 of them have been Board members for an average of 17 years. The 2 executive directors have been on the board since 1996.
The long tenure meant that they have gone through the international expansion phase of the Group.
Asia File is a family-controlled group where the 2 executive directors and the alternate director are children of a substantial shareholder of the company. The 2019 Annual Report showed that the Executive Chairman has about 47 % interest in the company while his brother (the other executive director) has about another 2 %.
At the same time, two of the Senior Managers are daughters of the Executive Chairman.
No doubt the interests of the Group are tied to the interests of the substantial shareholder.
6 Senior managers were profiled in the 2019 Annual Report.
- 2 of these are non-Malaysians and were part of the original management team of the respective international companies acquired by Asia File. They have more than 20 years’ industry experience in their respective markets.
- The remaining 4 are Malaysians with an average of 15 years of service with the Group working either in finance, operations, or business development.
Given the breadth and depth of experience, did they make a difference?
The Group strategy of being an integrated international filing company has been achieved and we should credit the team for delivering on the numbers.
- From 2007, I estimated that the value of the Group has grown by a compounded annual growth rate of 9 %. (Refer to Note 1). This is about doubled the Malaysia GDP growth rate over the same period.
- The Group spent about RM 100 million on its UK and European acquisitions. I estimated that the cumulative profits from these acquisitions are almost 4 times what was spent (Refer to Note 2). These acquisitions added value.
- In Part 1 I mentioned that the Group’s investment in Muda Holdings gained 273 % since 2007.
- Asia File outperformed its Bursa listed peers over the past 5 years. The chart showed that Asia File had the No 1 position in all the years except for 2017 when CWG led.
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| Chart 1: Bursa Malaysia Stationery Companies Performance |
They have shown themselves to be good operators. Were they also good capital allocators?
The Group made about RM 670 million from 2008 to 2019 that was allocated as follows
- RM 337 million paid out as dividends
- RM 100 million in the European expansion/acquisition
- RM 45 million as an investment in Muda Holdings
- RM 116 million increase in cash
- Presumable the balance went into working capital
But there is one weak area. As of the end of FY 2020, the Group had RM 230 million cash, equivalent to about 37% of its SHF. Considering the low returns from holding cash, I would hold this against them.
Concerns
- It ventured into food ware in 2017, but there has not been much reporting on the total amount invested to-date. The Group just mentioned in its 2019 Annual Report that the contribution is still insignificant.
- The Board has yet to articulate its vision for the future but it does appear that it is unlikely to be seeking a bigger stake in the global stationery market
- The Board has also been silent about Brexit. A transparent senior management team should not avoid this.
Is there an Awesome Buying Opportunity?
Mispricing can happen in 2 ways - the market price is significantly below the intrinsic value (good) or significantly higher (worrisome if you are going to buy).
For Asia File, it is good mispricing.
Look at Chart 2 and Table 1 comparing the Asset value and Earnings value.
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| Chart 2: Asia File's Valuation |
The Earning value is higher than the Asset value by about 41 %. This is significant as I normally consider these two values as similar if the differences are within plus or minus 10 %. It means that the Group is using its operating assets effectively.
The Earning value is based on a conservative model assuming that the future is similar to what happened over the past 12 years.
- If you believe that the future is better, then Asia File’s Earnings value will be higher than RM 4.53
- However, if you think that it will be worst, then the RM 4.53 is over-estimated
I believe that the Group will be able to sustain the earnings given its integrated business model and track record in tackling operational issues.
Our analysis showed that there is no immediate threat of disruption due to digital technology. Note that the bulk of the Earning value is based on the zero-growth assumption (ie EPV).
Even if we just look at the Asset Value, it has cash, investments in securities, and the 20 % share of Muda Holding totaling RM 2.05 per share.
With the current price of RM 1.85, there is an ample margin of safety.
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Valuation metrics |
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Value |
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Valuation date |
1 Jul 2020 |
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Price at valuation date: |
RM per share |
1.85 |
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Conservative Earning Power Value (EPV) |
RM per share |
4.52 |
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Conservative Earning Value (EV) |
RM per share |
4.53 |
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Asset Value (AV) (based on Mac 2020) |
RM per share |
3.21 |
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WACC |
Number |
0.09 |
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Table 1: Comparative Values |
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Comparing the Asset value and Earning value with the 5 years high and low prices, you will note that at its peak, the market price is 48 % above its Asset Value and close to the Earnings Value. It suggests that any re-rating will be focused on earnings.
As pointed out in Part 1, the current filing business is a cash generator. Even after accounting for capital expenditure, it generated about RM 39 million free cash flow annually over the past 12 years.
Case Notes Valuation is not an exact science. As such I prefer to try to triangulate a value based on several different valuation approaches.
I then compared them with approaches used by other renowned investors. I tend to favor comparing with the Magic Formula and Acquisition multiple. Because it is not an exact science, I prefer to illustrate the valuation graphically rather than tabulate the results. People tend to look at numbers as if they represent some exact value. I think there is less chance of looking for "exact values" with a graphical representation. However, since this is a learning case study, I have provided both. I hope that what I have done can be used as a template for your analysis of other companies. What would you do if you are not interested in doing your own valuation but still want to be a value investor? One way is to rely on other experts to assess and value companies for you. Those who do this well include people like Seeking Alpha.* Click the link for some free stock advice. If you subscribe to their services, you can then just read their analysis and assessment. |
Will there be Spectacular Growth in Shareholders’ Value?
I consider a high-quality company as one that has a good chance of increasing shareholders’ value.
There is a link between quality and valuation.
With Asia File’s Earnings value > Asset Value, you must ask whether this is triangulated by Asia File's ability to create shareholders’ value.
Asia Group has an overall Q rating score of 0.50 placing it in the middle of the ranking of the panel companies. (Refer to Note 3)
The rating reflects the strong profitability and financial position. However, the rating highlights its poor growth. I will interpret the rating to mean that the Group would be able to sustain its earnings but do not expect to see significant earnings growth.
Reading this Q rating with the valuation comparing chart, I would conclude
- There are substantial non-operating assets
- If these non-operating assets can be redeployed to more productive assets, the Group earnings could grow substantially
- These non-operating assets are masking the real returns from the current filing segment. If the filing segment was to be split into a separate entity, it would have an ROE of 16 %.
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| Chart 3: Q Rating ranging from 0.00 to 1.00 with 1.00 as the best |
How has the Group actually performed in terms of growing shareholders’ value?
- From 2007 to 2020 if you assumed that no dividend was paid, the shareholders’ funds would have grown at a compounded annual growth rate of 14 %
- Over the same period, the NTA has grown at a compounded annual rate of 9 % (You would expect the NTA growth rate to be lower as dividends are paid out)
These are decent growth rates.
How to Secure Your Investment by Minimizing Risk
Your personal risk covers the risk of the Group being privatized while the major business risk relates to the Group’s business direction.
a) Privatization
In Asia File's case, with the major shareholder collectively controlling about 46 % of the company, any privatization plan to acquire the remaining 54 % at the current market price of RM 1.85 per share would require about RM 195 million.
The company has cash of about RM 230 million (as at Mac 2020). So, it is possible to take it private via a capital reduction route.
While I cannot read the mind of the shareholders, note that Amanah Raya is an institutional investor of Asia File with about 19 % as of the end of June 2019.
I would think that any privatization offer by the controlling shareholders would need to be at an attractive price for Amanah Raya to vote for it. I doubt the current market price is attractive.
This would minimize privatization risk.
b) Strategic Direction
As shown in Part 1, over the past 2 decades Asia File had to meet
- Challenges brought about by changes to the supply chain as well as
- The threat of the stationery sector being disrupted by digital technology.
The performance of Asia File and a number of its Bursa listed peers over the past 12 years as shown in Chart 4 reflects the challenging industry.
This is not a growth business.
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| Chart 4: Bursa Malaysia Stationery Companies Revenue Note: China Stationery was suspended in 2017 and subsequently delisted |
When Asia File share price was at the 5 years peak, (about 5 years ago) the Group had an ROE of 15%. In 2020 this had come down to 6 % which is below its cost of funds.
One of the key requirements for shareholders’ value creation is for the ROE to be greater than its cost of funds.
To be above its cost of funds, given its RM 657 million TCE and a WACC of 9%, the threshold is RM 59 million PAT annually.
With the substantial non-operating assets, the Group would not be able to achieve this with just the current filing business.
It has to deploy its cash into higher return ventures. This is where the biggest risk will come from.
About 2 decades ago, the Group set on a path to be an international integrated filing company. I believe that the Group is now at a similar crossroad that will shape its future
- Should it seek opportunities in the current stationery industry OR diversify into new sectors?
- Should it seek organic growth OR focus on M&A given its UK and European track record?
I think that in the 2019 Annual Report, the Group has given a glimpse of its strategic direction
- Enhance existing operations
- Diversify beyond the filing business
In its first diversification plan, Asia File has opted to build on its manufacturing expertise to venture into food ware with a RM 30 million budget
Given its resources, this is probably too small to make an impact on the Group. Rather the Group needs to think of an investment that within a decade could be as large as the current filing business.
I am not sure whether the Group has thought in such quantum leap terms. If not, there will be limited growth.
But a quantum leap will have to be from new ventures where Asia File is unlikely to have the expertise. It has no track record of such ventures.
It is between the devil and the deep blue sea!
How to Benefit from the Case Study
What is our investment thesis?
- The stationery business is a cash cow for Asia File
- We are unlikely to see the historical growth rates in the future as it was achieved via M&A-type expansion into Europe. The Group has already announced that its focus is not expanding into the stationery sector
- The potential disruption by digital technology is still unclear giving the existing filing business some runway to continue to be profitable.
- The Group is financially strong giving it time to seek a diversification path
- The market price does not reflect its Asset value let alone the Earnings value. There is thus downside protection
- For any re-rating, it has to improve its ROE. This will not come from the existing business. I would go so far as to say that if it wants to be re-rated so as to match the 5 years high price, the ROE should go back to the 15 % level.
- But any new venture has to be sizeable, and the Group has yet to show that it is ready for such an investment.
If you invest in Asia File, it must be because you have a long-term horizon. There is downside protection and you are betting that either the market will eventually re-rate it based on its existing earning power.
Or better still the Group finds an opportunity to redeploy its cash and the market re-rate on this basis.
So is it a value trap? When the intrinsic value is intact, the conclusion is that it is undervalued rather than a value trap.
Note that whenever a company is trading below its intrinsic value, there is always the question of whether it is a value trap or it is undervalued.
You have to look at its business prospects to get a definitive answer.
End of Part 2 of 2
There is now a 20 Jun 2021 update
Notes
1) This was derived by comparing the 2020 SHF including the total dividend paid out with the 2007 SHF.
2) The Group does not provide a breakdown of profits by geographical regions. However, based on the sales info, we estimated that over the 12 years period from 2008 to 2019 Europe contributed about RM 2.72 b in sales equivalent to about RM 226.7 million annually c/w with the prior 5 years average annual European sales of RM 35.3 million.
Thus, the additional sales from the acquisitions/expansion are about RM 2.29 billion. Assuming the same average operating profit margin of 17%, this is equivalent to RM 390 million PAT.
3) I would consider quality as being related to the creation of shareholders’ value. A high-quality company would then be one with a good likelihood of increasing shareholders’ value. A low- quality company is one that is likely to destroy shareholders’ value. The Q Rating assesses this dimension of quality. About 80 companies across a number of non-financial sectors are covered annually. For further details, refer to the posting "Q Rating"
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 & Disclosure
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 on this website may not be suitable for 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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