UOA – will it continue to create shareholders’ value? (Part 3 of 3)

Case Study 03-3:  Continuation of the analysis and valuation of UOA Group. This post focuses on valuation and risks. 

At AUD 0.63 per share (as at 30 Jul 2020) UOA Ltd is trading below its intrinsic value that I estimated to range from AUD 1.06 per share to AUD 2.20 per share.  At the current price, there is an ample margin of safety.

With most of its activities in Malaysia, is the market saying the there is no future for the Group in the country?

UOA has shareholders in Australia, Singapore and Malaysia.  Are all the 3 markets behaving like lemmings or are there wisdom in the crowd? 

Join me in the 3-parts post as I lay out my case on why this time it is not the wisdom of the crowd.

Part 1, published on 2 Aug, showed how the Group got to where it is today. 

Part 2 published on 16 Aug focused on the future and the performance of top management. 

Part 3 presented here will cover valuation and risk mitigation. 

I will show you that there is definitely mispricing.  Hence an investment opportunity. 

Does it mean that you should go and buy – well read my Disclaimer.



Contents

Is there a great Buying Opportunity?

Will Shareholders’ Value continue to be created?

How to minimize Risk and secure your Investments

How to Gain from the Case Study


UOA Group - will it continue to create shareholders' value?


Case Notes

1) Monetary values are in Australian Dollars (AUD). For cases where the reported figures were in Malaysian Ringgit (RM), I have converted it to AUD. I used the year-end exchange rate as extracted from Investing.com for the conversion. 

2) The UOA Group comprises of 3 listed entities. In the post
  • UOA Group or the Group refers to all the companies within UOA Ltd. These included those under UOA Development Berhad and UOA REIT. 
  • UOA Dev refers to only those companies within UOA Development Berhad
  • UOA REIT refers to only those companies within UOA Real Estate Investment Trust



Is there a great Buying Opportunity?

The UOA Group comprises of 3 listed entities. Accordingly, there are 2 ways to value a group such as UOA
  • Overall - based on the Group level.  This looks at the Group as one with several operating segments. Under this approach, we ignore that it has 2 listed subsidiaries. 
  • Look thru - based on first valuing the individual listed subsidiaries.  Then add them to get the Group value. This takes the perspective of a shareholder in UOA Ltd saying that he owns 70 % of UOA Dev and 46 % of UOA REIT.  The value to him is 76 % value of UOA Dev, 46 % of UOA REIT, and 100 % of the balance.

In theory, the answers will be the same for both the above methods. Because the various Annual Reports present different information, the answers would be different. 

Furthermore, UOA Dev has a shorter listing history as it was only listed in 2010.

The chart below shows the comparative valuation based on the above two approaches. Note the following
  • The Asset Value of AUD 1.06 per share is based on an overall basis and it does not matter which approach is used
  • I have taken the conservative Sum of Parts (SOP) as the key earning based metric.  This ignores growth given the concerns about the Investment Property segment future.  
    • SOP Overall basis = AUD 1.34 per share
    • SOP Look thru basis = AUD 1.32 per share

UOA Group Valuation - Different Basis
Chart 1: UOA Group Valuation with Different Approaches 
Notes

1) The Sum of Parts valuation is based on the Earning Power Value of the property development segment plus the Asset Value of the other segments.   



The chart shows that 
  • The past 5 years market price of UOA Ltd have been below the Asset Value and Earning Power Values
  • The Sum of Parts value (based on Earning Power Value) is greater than the Asset Value.  This implies that the Group has been able to generate returns greater than its cost of capital
  • Given it competitive position, growth would add to the Earning Power Value

The valuation profile indicates that UOA Group is a “compounder”.  It has the following competitive strength and advantages
  • Track record and brand loyalty
  • Projects in strategic locations
  • Experienced team
  • Diversified portfolio
  • In house planning, development and construction

A breakdown of the above valuation is presented in the following sections


Overall basis

Under this basis, I have estimated the value of the Group based on 2 approaches
  • Valuing  the Group as one operation
  • Valuing the different segments of the Group and then summing them up to derive the Sum of Parts value 

One operation - Overall

The valuation as one operation (breaking down the Asset Value and Earning Value into various components), is shown below.

UOA Group Valuation - Overall Approach
Chart 2: UOA Group Valuation - By Components


Chart 3 compares UOA Group values with several other valuation metrics such as the Magic Formula and Acquirer's Multiple.  Together it shows that UOA Group is not overvalued. 



UOA Group Comparative Values
Chart 3: UOA Group Comparative Values


The valuation is based on assuming that the future is equal to what has happened over the past 12 years. I ignored growth given the challenging prospects for Investment Property. Thus I focussed on the Earning Power Value.

Even then, the Earning Power Value at AUD 1.68 per share is 58 % higher than the Asset Value. 

This valuation is not surprising.  Over the past 12 years, the Group generated a free cash flow of about RM 25 million annually.  Free cash flow is operating cash flow after CAPEX and working capital.  

The above valuation is looking at the Group as one operation.

Sum of Parts - Overall 

Another perspective is to decompose the Group into 3 segments.  We first value each segment and then get the Group value by summing them up. 
  • Investment Properties – the book values are already marked to market.  So we took book value as the relevant one rather than try to estimate it from the profits and/or cash flows.
  • Property Development – we took the higher of the Earning Value or Asset Value
  • Others (cash, securities) – we took book value as these are financial assets. As such they would have been “marked to market”

The Sum of Parts value for UOA Group would then be AUD 1.34 per share as follows


UOA Group Sum of Parts Value
Chart 4: UOA Group Sum of Parts Value - Overall
Notes

1) The valuation of individual components is based on value to the firm.  Accordingly, we have to deduct the value of loans and MI to get the value to equity shareholders. 

2) We also estimated the market value of the loan based on the loan tenure as per Damodaran. 


Let's compare the results using the different approaches.  

The Sum of Parts - Overall method gives a more conservative value of AUD 1.34 per share compared to the Earning Power Value - Overall method of AUD 1.68.

But the conclusion is still the same.  
  • The Group return is above its cost of capital (WACC).
  • The Earning Value is greater than the Asset Value.

Look thru basis

The basis of my valuation is as follows
  • UOA REIT.  As a REIT, its properties would have been based on registered valuer assessments. The book value should then reflect the value of the REIT.  The book value of UOA REIT (Net asset value in the Annual Report) as at 31 Dec 2019 is RM 1.67 per unit (AUD 0.58 per unit)
  • UOA Dev.  We adopted the same analytical approach as that for UOA Group.   This is because it has both investment properties and property development.  Chart 5 summarizes the comparative values for UOA Dev. 


UOA Dev Comparative Values
Chart 5: UOA Dev Comparative Values


Now that we have the intrinsic values to the 2 key subsidiaries, we can bring them to the Group level based on the corporate structure below.

UOA Group Structure
Chart 6: UOA Group Corporate Structure


Chart 7 below shows that the sum of parts value of UOA Group based on the Look Thru approach is AUD 1.32 per share. 


UOA Group Sum of Parts Value - Look Thru basis
Chart 7: UOA Group Sum of Parts Value - Look Thru Basis

Notes

1) The valuation of individual components is based on value to the firm.  Accordingly, we have to deduct the value of loans and MI to get the value to equity shareholders.  However, the deduction is negligible as the majority of the loans and MI are at UOA REIT and UOA Dev level. This has been accounted for when the valuation of UOA REIT and UOA Dev was done


Closing thoughts on valuation

The above demonstrated that there are several ways to value a company.  You could use an asset-based approach or an earnings-based one. 

With a group like UOA Group which can be viewed as either comprising several business segments or several listed subsidiaries, there are more options.  You could use the Sum of Parts method based on business segments or based on the listed subsidiaries.

Since there are many unknowns in any valuation exercise, I prefer to consider all of them so as to triangulate an appropriate value. 



Will Shareholders’ Value continue to be created?

Imagine buying UOA Ltd shares on 31 Dec 2008 at AUD 0.135 per share and selling it off at the end of 2019 at AUD 0.87 per share.  

Now add the dividend you have received over the years as well as the capital repayment in 2012.  You would have gained a compounded annual total return of 22 %.

UOA Group : Shareholders gain
Chart 8: UOA Ltd Shareholders Gain


Not bad

But this is looking at the historical perspective.

The challenge is whether you can get a similar return in the future

That is what the Q Rating is trying to assess. 

As a “compounder,” it implies a quality Group i.e one that has a good chance of increasing shareholders’ value. 

The UOA Group has an overall Q rating score of 0.51 placing it in the middle-ranking of companies. (Refer to Note 1)

The rating reflects the strong financial position.  But this is offset by the low growth prospects. 

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.


UOA Group Q Rating
Chart 9: UOA Group Q Rating


UOA Dev accounted for almost all the Group Property Development profits. It also contributed 58 % of the Group Investment Property performance.   Does the Q Rating of UOA Dev reflective of what is happening at the Group level?

The chart below presents this picture.

It is not surprising to have a similar profile.  But the low Growth score is more pronounced at the UOA Dev level.

UOA Dev Q Rating
Chart 10: UOA Dev Q Rating



Growth in Shareholders’ Value

I like to illustrate what drives shareholders value by a simple valuation model. This model assumes that there is no growth as per Damodaran


Valuation formula



Where

V

 

Value of the company

BV

 

Book value

ROE

 

Return on equity

r

Cost of capital



If you slept during maths class while in school, don’t worry. 

What the equation says is the shareholders’ value (represented by V) is equal to Book Value multiplied by a return factor

This return factor is a ratio of the Return on equity over the Cost of capital

The point I want to illustrate is that to grow shareholders value you need 
  • To have the Return on equity greater than the Cost of capital
  • Anything that improves the return eg better margins, would increase shareholders value
  • Anything that reduces the Cost of capital increases shareholders value eg lower risks

This equation is the basic building block for my Q Rating. Of course, it is a more elaborate model in practice as I also incorporate growth. 

It let me link valuation with the various factors that drive shareholders’ value

But you get the idea that I am looking for factors that improves return while reducing the cost of capital. 

How do you reduce the cost of capital? Well, anything that reduces risks will reduce the cost of capital. This can range from business risk to financial risks as well the business model


How to minimize Risk and secure your Investments

How to minimize risk
I like to think of risk as the possibility of a range of negative financial outcome that matters to you. 

In this context, I tend to segregate them into 
  • Investment risks. Your investment value might rise or fall because of market conditions. It will also be affected by how easy or hard it is to cash out of an investment, and how many stocks you hold. 
  • Business risks – These are due to business decisions, such as whether to expand into a new area of business.   Changes in the economic outlook can affect the value of your investments. 

The only investment risk I have covered so far (in the other featured companies) has been the risk of privatization.

I don’t think this would be an issue here given the size of the Group.   Remember that the Group undertook several corporate exercises over the past 15 years.  These were UOA Ltd in SGX, UOA REIT and UOA Dev both on Bursa Malaysia. 

Rather the main risk in investing in UOA Group is the business risk. 

I have already covered the property market supply and demand risks in Part 2.

Also, my approach to using the past 12 years results have an in-built “recession-like” period. 

Remember the US financial crisis of 2007/2008?

Malaysia was not spared from the impact of this crisis.  I would like to think that the current Covid-19 situation would have similar effects.

This does not mean that we don’t’ have to worry about other trends that may further impact the property sector. 

There are two other risks/issues that should be considered.
  • Development model
  • Digital technology

Development model

Most of the property for sales in Malaysia are developed under the “sell then build” model.   Properties are sold while under construction.  

Progress payments are then collected during the construction stage.  This helps to fund a significant part of the development costs. 

The key advantage is that developers can minimize cash flow problems during construction. In return, the selling price during launch might be lower to attract buyers.  

But house buyers are subject to higher risks.  These could be untimely delivery of the house, defect issues and abandoned projects. 

The government has been trying to change to a “build then sell” model like in many developed countries. 

Under the “build then sell” approach, the buyers don't face construction risks. 

But, developers would need to bear higher risk, and this might affect the property selling price. 

The “sell then build” approach has long been used in the Malaysian housing sector.  But the government has been trying to get the industry to adopt the “build then sell” approach. 

Not happening yet!

The industry is still working with the “sell then build” approach.

UOA and digital tech

Digital Technology

I am sure you have heard of the term “Fintech”.  Digital technology companies play in space operated by financial institutions.

A similar trend has emerged in the property sector.

It is more than the digitalization of real estate. It is placing customer experience first at the very heart of all aspects of the property process.  

These could be fintech in real estate and virtual reality.  It could use blockchain and artificial intelligence. 

All these innovations and Proptech at large is seen as a ‘disruption’.  It is intended to change the way industry stakeholders operate.

According to Wikipedia, in the first six months of 2019, $12.9 billion was poured into real-estate tech start-ups. This surpassed the $12.7 billion record for all of 2017.

Think about how Paypal and Alipay are competing with traditional financial services companies.

I would expect that within a decade, some kid in a garage somewhere is developing a “real estate killer model”. This would disrupt the traditional property development and property investment process.

In the Malaysian context
  • Crowdfunding and other digital-tech funding concepts have been set up
  • There is even a Malaysian Proptech association

Secondly, the development of the self-driving car due to advances in digital technology will also impact the property sector.

For most of us who own cars, the majority of the time the car is parked. That is why we have high car parking requirements in Malaysia. 

Now imagine a stage where the self-driving car becomes very cheap. We may then have a “Grab-type” environment where instead of owning cars, we rent cars ie
  • It is self-driven to us
  • After we use it, it is self-driven away

If this really turns out, there will be less need for car parks. Imagine the impact on residential design, high rise design and commercial car parks

What has all these trends to do with investing in UOA? 

If you are a long-term investor, you have to look beyond the coming decade. 
  • Will property companies be disrupted by digital tech like the media and taxi sectors
  • Will UOA Group be able to reinvent itself to face the “build then sell” model

My valuation assumptions are based on a repeat of history.  I assume that there is no impact and/or the Group is able to overcome them.  Is this reasonable?


How to Gain from the Case Study

While the Group comprises 3 listed entities, the case study is focussed on UOA Group. In practical equity investment lingo, you are considering investing in UOA Ltd.

What have we found?
  • The Group has both a recurring income stream as well as a more cyclical project-based one.
  • About the same amount of the Group’s capital has been allocated to both of them
  • Over the past 12 years, the Property Development profits are about 3 times that from Investment Property
  • The Property Development segment seemed to have better prospects than Investment Property. 
  • At the current market price of AUD 0.63 per share, there is an ample margin of safety
  • Our analysis has not suggested that there will be any impairment of the assets.   There is a low risk of reducing its intrinsic value.
  • While growth will be challenging, the Group would be able to sustain its performance.  This means that the Earning Power Value is a reliable indicator of the intrinsic value.  

It will still be able to grow shareholders’ value

Are you more interested in business growth or in the growth of shareholders’ value?

They are not necessarily the same.  I hope the UOA case study has highlighted the difference.  Factor this in when thinking about investing in UOA Ltd

We started off in Part 1 with the question of whether UOA Ltd is a value trap or a bargain.  The analysis has shown that it is not a value trap.  The current market price is trading below its intrinsic value.  The market has mispriced the Group.


End of Part of 3 of 3

Part 1 was published on Sun 2 Aug 2020

Part 2 was published on 16 Aug 2020

Coming Next on Sun 13 Sep 2020: CSC Steel




Notes
1) 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
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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