Dayang - is there a buying opportunity? (Part 2 of 2)

Value Investing Case Study 07-2: This is the second part of the 2-parter series on the fundamental analysis and valuation of Dayang Enterprise Holdings Bhd. This post focuses on management performance, valuation, and risks.

To a value investor, a value trap or a buying opportunity are opposite sides of the value investing coin being tossed up. Which side the coin lands is actually a question of valuation.

Dayang Enterprise Holdings Berhad (DEHB) is currently trading at RM 1.24 per share (as of 1 Dec 2020) compared to its book value of RM 1.42 per share (as of 30 Sep 2020).

You may think that it has enough margin of safety from the book value and hence this would be a buying opportunity.

But this is true only if there is no potential impairment. After all, the DEHC Group recognized some impairment in 2017 due to low vessel utilization.

Given the current Covid-19 situation and the global oil & gas excess capacity, will there be impairment in the immediate future?

But you cannot conclude that this is a buying opportunity or value trap until you have assessed the impact on the intrinsic value from the cash flow perspective.

As shown in Part 1, DEHB Group is actually a topside maintenance company venturing into the marine charter business.

The topside maintenance business is still intact. If this continues to overshadow the marine charter business, it will not be a value trap.

Join me in a 2-part series as I show the circumstances for DEHB not to be a value trap.

Part 2 is presented here while Part 1 was published in early Dec 2020. An update was published on 6 Feb 2022.

Is there an investment opportunity? Well, read my Disclaimer.

This blog is reader-supported. When you buy through links in the post, the blog will earn a small commission. The payment comes from the retailer and not from you. Learn more.

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

Case Notes

DEHB was listed in 2008 following the acquisition of 3 companies.

Its 2008 Annual Report covered 15 months of operations.

Still, the Group 2008 income statement only consolidated the revenue and results for the 10 months. This is from 1 March 2008 to 31 December 2008 using the acquisition method of accounting.

As such, I have ignored the performance of 2008 when it comes to looking at historical financial performance.

DEHB is currently structured as shown below:

As there are two listed entities under DEHB I will use the following definitions in the post

DEHB refers to Dayang Enterprise Holdings Bhd as the listed company

PPB refers to Perdana Petroleum Bhd as the listed company

DEHB Group refers to all the companies within the DEHB Group including those under the PPB Group

PPB Group refers to all the companies within the PPB Group only.

Did Top Management Seize Opportunities?

There are 12 members on the DEHB Board of Directors

5 are Executive Directors that have an average of 10 years of Board tenure

5 are Independent Non-Executive Directors that have an average of 5 years Board tenure

There is one Non-Independent Non-Executive Director. He has been with the Board for 7 years with an Alternative Director who was appointed in Jan 2020.

The Executive Directors controlled at least 58% of the shareholdings of DEHB (Refer to Note 1) making this an owner-managed group. You can assume that the management and shareholders’ interests are aligned.

Note that the Board of DEHB exercise control over PPB by having

The Executive Chairman of DEHB serves as Non-Independent Non-Executive Director of PPB

The Executive Deputy Chairman of DEHB serves as Executive Chairman of PPB

The Alternate Director of DEHB also serves as Alternate Director in PPB

4 senior managers were featured in DEHB 2019 Annual Report. They have an average of 17 years tenure with DEHB Group. 2 of them have also been appointed as Executive Directors of PPB.

Operating performance

Given the breadth and depth of experience, how did top management perform as operators as compared to its peers?

There are about 2 dozen Bursa listed companies under the Energy Infrastructure, Equipment & Services sector.

To have an apple-to-apple comparison, I excluded the following

Those in the drilling business

Those in the floating production and operations (FPO) sector

Rather I focussed on those with significant topside maintenance business. The ideal peers would be those with topside maintenance and marine charter.

I have selected the following as the peer companies to benchmark against.

Carimin Petroleum

Deleum

Petra Energy

T7 Global

The results of the comparisons are shown in the charts below

Chart 1: Peer Revenue Index

Note: The comparative revenue was from 2011 onward as I could not find earlier data for Carimin as it was listed in 2015

Chart 2: Peer Returns

As can be seen from the charts

Revenue-wise, DEHB Group is way ahead of the peers. Note that we are comparing revenue indices with the 2011 revenue as the base. In terms of RM revenue, DEHB Group had the largest revenue from 2013 onwards.

ROE-wise, DEHB Group ranked No 2 for most of the past 9 years. The best performance was by Deleum but I suspect that this was because it did not have any marine charter business.

Note that all the peer companies had turnaround their respective ROE in 2019.

Capital allocation

From 2009 to 2019, DEHB Group generated a total PAT of RM 1,065 million. Over the same period, DEHB Group

Paid out RM 284 million as dividends. This was equal to an average 27 % payout ratio.

Spent RM 565 million (net of proceeds from disposal) for Property, Plant and Equipment

Spent RM 1,056 million as total purchase consideration for PPB. This is the net of cash acquired and realization of post-acquisition reserve of PPB as an associate.

Apart from funding these expenditures from the profits, DEHB Group also increased the net borrowings (debt less cash in the bank) of RM 590 million over the same period.

Expansion into the marine charter segment

DEHB Group had looked at expanding into the marine charter sector as part of its growth plans

In 2009, it has spent RM 135 million to acquire a stake in Syarikat Borcos Shipping Sdn Bhd (Borcos) although the Board did not state why it decided to dispose of Borcos after a year.

In 2011, it subscribed to a private placement of PPB. DEHB then went on to acquire more shares in the open market so that it held 11.53% in PPB by the end of 2011.

By 2015, DEHB had spent RM 1,056 million for 98% of PPB which had shareholders’ funds of RM 744 million as of the end of 2015.

While the shareholders’ funds of PPB had grown to RM 900 million by the end of 2019, DEHB only had 64% of PPB by then. This was due to the distribution of PPB shares to the shareholders of DEHB to meet the shareholding spread.

With hindsight, given the current marine charter excess capacity, the RM 1 billion could have been better spent elsewhere.

DEHB Group attributed its recent contract wins to having in-house vessels. But given the excess offshore supply vessel's capacity, there would be lots of willing strategic allies in its tender bids.

At this juncture, the payback period for its RM 1 billion marine charter investment is likely to stretch beyond 10 years.

Has top management has seized opportunities?

Operational-wise, I would rate management performance as among the better ones in the oil & gas service sector. They have contributed to the right-sizing and other operational improvements in PPB Group

Excluding the diversification into the marine charter business, the capital allocation looks OK.

The venture into the marine charter business has not shown any results. While I am confident that management would be able to turn it around, it does raise questions about the next strategic plans.

Is there an Awesome Buying Opportunity?

Case Notes

Although DEHB comprises 2 listed companies, I have not attempted to value DEHB Group by the "sum-of-parts" valuation of PPB Group and the non-PPB Group part of DEHB Group.

Recall that I undertook such an exercise in the UOA case study.

For DEHB, the operations between the PPB Group and the non-PPB Group part was not only more integrated than those of UOA, but also the information for separate valuation was not readily available.

There were too many assumptions that I have to make for this "sum-of-parts" valuation that the results may not be reliable.

The key point about valuation is that just because you can mathematically get a number, it does not necessarily mean that it shows the correct picture. You still have to exercise some judgment about the appropriate method to use.

This comes from experience. If you are just starting out to analyze and value companies, it may be helpful to supplement it with third-party analyses. There are several financial advisers who provide such analyses. 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 tap into their business analysis, valuation, and risk assessment.

From a value investing perspective, I invest when price < intrinsic value.

I generally use two approaches in assessing the intrinsic value.

Asset-based where the assets are viewed as stores of value. I would assume that the Balance Sheet reflects the fair value of DEHB Group’s assets and liabilities given the impairment history.

Earning-based where the assets are viewed as generators of value. This is generally assessed based on the Free Cash Flow generated by the business over its lifetime.

My base valuation for DEHB Group is assuming that the average past 11 years' performance represents the future. This generally would cover the good and bad years over a business cycle.

For companies like DEHB Group, the business cycle is compounded by the turnaround situation for the marine charter business.

In such instances, the base case Earning Value would not be realistic.

In a turnaround, you would assume that the future should be better than the historical performance.

I have assumed 2 turnaround scenarios:

Scenario 1

I noted that the performance over the past 11 years has been affected by the loss in 2017. This is due to the one-time write-offs as well as the poor performance of PPB Group.

Considering all the above, I guesstimated an optimistic average performance based on:

A time-weighted actual average performance of the past 11 years except for 2017

The 2017 performance is to be equivalent to the average of the 2016 and 2018 performance. The PAT for 2017 would then be RM 99 million instead of a loss of RM 153 million. This is still conservative compared to the 2018 and 2019 PAT of RM 144 and RM 222 million.

Based on these, the Earning Power Value is RM 1.05 per share

Scenario 2

This assumes that future performance is equivalent to the 2019 performance.

This is not unrealistic as the crude oil price is at the bottom part of the cycle and any increase will lead to more CAPEX spending by the E&P companies.

This is turn will drive the demand for marine charter services as well as topside maintenance services.

Based on this scenario, the Earning Power Value is RM 1.64 per share

The chart and table sum up DEHB Group’s valuation with such assumptions.

The Earning Power Value is less than the Asset Value. This is not surprising as DEHB Group has not been operating on all cylinders.

Over the past 5 years, there have been periods when the market price has been greater than both the Earning Power Value and Asser Value.

The Asset Value provides some margin of safety at the current market price.

At the current market price, there is only a margin of safety from the EPV under scenario 2.

From the Acquirer’s Multiple and Magic Formula perspectives, the stock is currently trading at reasonable prices.

Chart 3: Dayang valuation

Table 1: Dayang valuation metrics

The above is of course a simplistic valuation analysis:

If you believe that the future would be better than that projected, then the EPV would be higher than those presented.

If you believe that the future would be worse than the scenarios presented, then the EPV would be lower than the base case. In this event, you should not even be contemplating any investment in DEHB.

Will there be Spectacular Growth in Shareholders’ Value?

Since its listing in 2008, if you assumed that no dividend has been paid and ignoring the new issue of shares, DEHB had grown its shareholder's funds at a CAGR of 14%.

This will create shareholders’ value when you compare it with DEHB's WACC of 11%.

Another way to view growth in shareholders' value is to see the gain that an investor would have achieved since listing.

If you had bought DEHB share at the IPO price in 2008, held on to it till today, and subscribed to all the rights issue, you would have a gain equivalent to 10 % CAGR.

The table shows the transaction details.

Table 2: Shareholders' Gain

Notes

a) Received in 2008 to 2010 as per Annual Reports

b) 1 for 4 bonus issue and 1 for 4 rights issue at RM 1.10

c) Received in 2011 to 2013 as per Annual Reports

d) 1 for 2 bonus issue

e) Received in 2014 to 2017 as per Annual Reports. No dividends were declared from 2016 to 2019

f) 1 for 10 rights issue at RM 0.92

g) Distribution in specie of 0.302 PPB shares for every 1 DEHB share held in Nov 2017

h) Total amount paid over the years.

i) The CAGR was derived by computing the index for each year and then comparing the final index value with that at the start

The gain is estimated conservatively as it is based on market prices of DEHB and PPB shares. These, in turn, are lower than their respective NTAs

As the share price of DEHB went as high as RM 3.00 per share in early 2020, the gain would be higher if the shares are held until the market re-rates DEHB.

Chart 4: Dayang Q Rating

I consider quality from the perspective of creating shareholders’ value.

A high-quality company will have a good likelihood of increasing shareholders’ value.

A low-quality company is one that is likely to destroy shareholders’ value.

The Q Rating assess this dimension

DEHB Group has an overall Q Rating of 0.41 placing it below the median of the panel companies. (Refer to Note 2).

This is due to its financials and profitability scores over-shadowing its low project-based business model score.

DEHB Group's track record and the Q Rating points to its ability to continue to grow shareholders’ value.

How to Secure Your Investment by Minimizing Risk

I look at the investment risks from 2 perspectives

Privatization risk

Business risk

In the case of DEHB, I would rate the privatization risk as low for the following reasons

It undertook a private placement and a rights issue of shares in 2019. The rights issue was offered at RM 0.92 per share which is lower than the current market price of RM 1.24 per share

Apart from the Executive Directors, the other major shareholder is Naim Holdings Bhd (Naim) which holds about 26 % of DEHB. Naim is in the property and construction sector that has been facing a soft market for the past few years. I doubt Naim would want to spend its money on a privatization exercise.

Given DEHB February 2020 price of RM 3.00, there would not be many minority shareholders who would be happy for DEHB to be privatized at the current market price

The main concern is then the business risk. I see the following for DEHB Group.

Immediate to mid-term risk: a prolonged excess global oil & gas capacity scenario. Does DEHB Group have the financial resources to withstand this scenario?

Long-term risk: depletion of Malaysian oil & gas reserves. Historically DEHB Group revenue came from Malaysia. The question then is whether DEHB Group is able to expand to other countries.

Financial resources

In a prolonged excess oil & gas capacity scenario, eg another 5 more years of low oil prices, the challenge would be the marine charter segment, especially the PPB Group.

The table below illustrates the financial position of DEHB Group and PPB Group.

Table 3: Dayang Financial Position

Notes

a) Based on 2017 to 2019

b) Based on contractual cashflow excluding trade payables as per the respective 2019 Annual Reports

c) The PPB debt includes a RM 683 million financial guarantee

The above analysis shows that PPB Group would have to depend on DEHB Group for financial support.

Since its listing, DEHB Group has been able to generate positive cash flow from operations every year.

The analysis assumes that DEHB Group would still be able to secure new orders going forward. This appears reasonable as:

At the end of 2019, DEHB Group order book stood at RM 4.5 billion equivalent to about 5 years of the past 3 years' average annual revenue.

Over the past 7 years where information was provided, the lowest order book was in 2016 with RM 2.8 billion. DEHB Group is lucky to be in the brownfield services sector as this has been less impacted than the greenfield sector.

The financial risk thus seems manageable.

Going beyond Malaysia

There are several Bursa listed oil & gas companies in the Energy Infrastructure, Equipment, and Services sector that have ventured out of Malaysia.

In some cases, the entry has been based on some Petronas international programme.

DEHB Group has also started on this international journey.

In November 2018, DEHB Group together with Gujurly Inzener, its Turkmenistan partner, won a USD 100 million contracts. This was for providing facilities maintenance support for Petronas Carigali (Turkmenistan) Sdn Bhd.

The challenges for DEHB Group are whether

It can compete internationally in securing new contracts

It is able to execute them profitably.

There is no information at this stage to make an informed judgment.

The risk remains.

How to Benefit from the Case Study

DEHB Group is a project-based group in a commoditized cyclical sector.

When the combination of investment and growth is in their favour, cyclical stocks can give large returns in a very short period of time.

What is our investment thesis? You have downside protection while waiting for a re-rating.

After its 2019 corporate exercise, DEHB Group is financially strong with RM 317 million cash as of the end of June 2020 and a debt-equity ratio of 0.46. It would be able to weather a longer downturn if this happens.

Except for 2017, it has a strong track record of being profitable since its listing in 2008. The 2017 performance was a one-off blip resulting from its acquisition of PPB.

PPB has since been restructured, right-sized and the integration with DEHB has improved its vessel utilization.

The Asset value has some margin of safety at the current market price. Buying DEHB at the bottom part of the cycle also provides some margin of safety

Scenario 2 is likely to happen and will provide a 30% margin of safety at the current price.

The risk of a permanent loss of capital looks low if you have a long investment horizon.

Besides, if you invest in DEHB, it has to be part of your portfolio of cyclical and defensive stocks.

That way, you’ll be well-positioned to

Prosper when the global economy recovers and/or the oil price increases,

But will have some downside protection when recovery of the oil & gas industry is prolonged

Is there a buying opportunity? Yes

Would it be an awesome one?

I would define an awesome buying opportunity as one where there is a strong likelihood of more than doubling the current market price or more over the next 3 to 4 years.

For this to happen, I believe that

The oil price has to be at the 2011 to 2014 levels ie north of USD 100 per barrel for Brent crude oil. Global demand has to grow substantially for this to happen.

DEHB Group must be able to achieve and sustain the 2019 performance for a couple of years. Being a brownfield service provider, DEHB Group might be able to pull it off if the global economy recovers quickly after the Covid-19 vaccine is widely distributed.

The stock market may have to be irrationally again as it did in the early part of this year when the price of DEHB went as high as RM 3.00 per share.

Buy DEHB because there is a sufficient margin of safety and if you are lucky, it will give you an awesome return.

End of Part 2 of 2

An Update was published on 6 Feb 2022

Notes

1) I could not tell from the 2019 Annual Report whether there is double counting of indirect shareholding of Datuk Ling and Joe Ling. Conservatively I accounted only for Joe Ling figures)

2) 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.

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Investing For Value

Dayang - is there a buying opportunity? (Part 2 of 2)

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