Is Eksons still a value trap? (May 2021)

Value Investing Case Study 01-3: An updated fundamental analysis of Eksons based on the financial results till FYE Mac 2020.

Is Eksons still a value trap
The fundamental analysis of Eksons Corporation Bhd (Eksons or the Group) was first published in the blog in Jun 2020.
  • At that juncture, Eksons was trading at RM 0.57 per share compared to its cash and marketable securities of RM 1.27 per share.
  • That fundamental analysis was based on the results of the financial year ended (FYE) 2008 till FYE Mac 2019.

The Group has since released its FYE 2020 Annual Report. The question of whether Eksons is a value trap still remains. Eksons market price of RM 0.835 per share (as of 28 April 2021) is still below the latest cash and marketable securities of RM 1.32 per share (as of the end of Dec 2020).

In this article, I will focus on the issues that will have a major impact on the prospects of the Group.  If you are not familiar with the Group’s history, business profile, and track record, you should read the 2 previous articles first.  Otherwise, you may not be able to follow this article. 

This article which incorporated the 2020 financial results has two goals:
  • To assess whether the previous investment thesis is still valid. In other words, if you have bought Eksons then, do you still hold onto the shares?
  • To assess whether there is still a margin of safety based on the updated valuation. In other words, is there still an awesome buying opportunity?

I would say yes to both these questions. Should you go and buy Eksons? See my Disclaimer.

Contents

  • Recap
  • Is the current performance outstanding?
  • Is there any change in the business direction?
  • Was shareholders’ value created?
  • Is there still an awesome buying opportunity?
  • How to secure your Investments by minimizing risks
  • Conclusion

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Recap

In Jun 2020, I had concluded that Eksons was not a value trap.  The investment thesis was that Eksons was a classic Graham Net Net.  You had downside protection while betting on the upside.

Eksons had two business segments - Timber and Property. Both business segments were facing headwinds.  

Being the larger contributor, the Timber segment has to turn around for the Group to have a return greater than the cost of funds. But the Timber segment's long-term prospects will depend on a different log supply strategy. 

The Group is financially strong and not burning cash giving it time to put its recovery plan into action. But note that with the turnaround, a significant part of the financial assets would be deployed for working capital. 

A turnaround of the Timber segment would be a catalyst for a re-rating.  But it will take 2 to 3 years for both business segments to get back to where it was before.   

There was an expectation that the Property Development segment could provide some breathing space for the Group as it tackled the Timber segment issues.

But, the Property Development segment contribution had come from the sale of land and some properties. The Group's first property development project - The Atmosphere - did not sell as anticipated.  The Group still has about RM 60 million of it recognized as inventory. Its other project - Affinity Residences - was started at a time when the property market was soft.


Is the current performance outstanding?

For the YTD ended Dec 2020 (Q3 FYE 2021), the Group had a YTD revenue of 30.6 million and a YTD PAT of RM 10.5 million. These were better than the revenue and PAT of RM 14.8 million and 3.6 million respectively for the same YTD period of the last financial year.

The better YTD revenue was due to the sales from the Property Development segment.  However, the better profit performance is the result of lower taxes and miscellaneous income of RM 5.4 million.

I could not trace the reasons for the low tax rate nor the source of the miscellaneous income.  I do not believe that they are sustainable.

While the property business will show improvements in 2021, there are no new projects in the pipeline to sustain this segment.  The Group has a vacant plot in Seremban for development that was acquired in 2007. But, there is no news about developing this.

At the same time, the Timber segment is still facing log supply problems as well as soft demand for plywood.

From a long-term perspective, the 3 performance metrics do not point to a turnaround yet as illustrated in the chart below.

Eksons Performance Index 2020
Chart 1: Performance Index

Is there any change in the business direction?

The Group has a total capital employed (TCE) comprising shareholders’ funds, minority interest, and loan of RM 431 million as of 31 Mac 2020.  These were deployed as shown in the chart below.
  • You can see that the bulk of the funds are focused on the Timber segment.
  • The Corp/Others comprises securities, cash, and investment properties (unsold properties). Securities and cash of course accounted for the bulk of these.
Eksons Total Capital Employed 2020
Chart 2: Total Capital Employed

You can conclude that the fortune of the Group is still tied to the Timber segment. Unfortunately, there is no sign of any turnaround yet for this segment.

For the smaller Property Development segment, the Group in the immediate term is relying on the Affinity Residences.  This is a RM 155 GDV project.  

As of the end of FYE 2019, RM 43 million of the RM 155 million of GDV has been sold. The Group did not report the new sale for FYE 2020 or YTD FYE 2021. I took it to mean that new sales were not significant.  I hope I am wrong.

Property development revenue for the past few years was from the recognition of construction progress.  In other words, it was from units sold previously. 

The construction of Affinity Residences is expected to be completed by the end of the calendar year 2021. Given the best-case scenario, I would expect Affinity Residences to contribute another RM 80 million of revenue in total.  This should translate to a RM 20 million to RM 30 million profit in total over the next 1 to 2 years. It is good returns for the segment. But it is not exactly something to shout about for a group with a TCE of RM 431 million. 

The above analysis demonstrates that the Group still needs to address the Timber segment for any market re-rating.

Senior management

Comparing the 2020 Annual Report with that of 2019, I noticed the following changes to the Board of Directors.
  • Mr. Tay Hua Sin, who was the Group MD in 2019 is now the Deputy Executive Chairman.
  • Dato’ Philip Chan, who was previously a Non-Executive Independent Director is now the Group MD.
  • There are two new Non-Executive Independent Directors in 2020. One of them was to replace the Non-Executive Independent Director who has left the Board. The other was a new appointment. 
  • Altogether there are now 6 Board Directors compared to 5 the year before.

There was no change to the 2 senior managers that featured last year.

The Chairman and The Deputy Executive Chairman still controlled about the same number of shares in 2020 as in 2019.  They controlled about 59 % of Eksons (direct and indirect).

Given the above, I do not think that there is any significant change in the way the Group is being managed.  The new Group MD has not articulated any new vision or business direction.   I suspect this will continue to be influenced very strongly by the Chairman and Deputy Executive Chairman.


Was shareholders’ value created?

I had previously used the Q Rating to assess whether shareholders’ value was created. Given the poor performance for FYE 2020, the latest Q Rating would not show better results.

As such, I looked at other metrics to answer this question. I used the following 3 metrics:
  • Comparing the after-tax return on Total Capital Employed (TCE) with the WACC.
  • Comparing the return assuming no dividend or share buyback ie CAGR in SHF with the cost of equity.
  • Looking at total shareholders' gain from investing in the shares of Eksons.

As can be seen from the analyses below, the returns were less than the respective cost of funds.  In other words, there was no shareholder value created during this period. We should not be surprised by the results as the Group was not profitable for 5 years out of the 12 years analysis period.

Was Shareholders' value created?
Table 1: Shareholders' value creation metrics
Notes
a) Based on average EBIT/TCE from FYE 2009 to FYE 2020 and assuming a 24 % tax rate.
b) From FYE 2009 to FYE 2020. This looked at how the SHF would have grown over this period assuming that no dividends were paid. I also ignored treasury and capital injection/reduction transactions.
c) Refer to Table 2 for the detailed computation.


Total gain for shareholder

This is the return that a shareholder would have obtained if he had bought RM 1,000 of Eksons shares at the start of 2009 as shown below.

Total gains for a shareholder
Table 2: Computing the total gain by a shareholder

Is there still an awesome buying opportunity?

In my previous post, I valued Eksons based on the financials from 2008 to 2019. Here I will look at the valuation based on the financials from 2009 to 2020.

The chart and table sum up Eksons’ updated values. 

Eksons valuation 2020
Chart 3: Eksons Valuation 2021
Notes
a) The Book value = NTA since there were no goodwill or intangibles.
b) The cash and marketable securities would potentially be converted into working capital in turning around the operations. As such I have not attempted to classify them as Non-Operating Assets when analyzing the Earnings Value. 

  • The value of Eskons derived from a conservative Earning-based valuation is below the Asset value.  This is not surprising as the Group is not utilizing its resources well. 
  • Over the past 5 years and even currently, the market price of Eksons’ share has been below the Asset value.  Note that I have also updated the past 5 years' market prices compared to the previous ones.
  • The company is currently still trading below its updated Graham Net-Net (a proxy for liquidation value) of RM 2.18 per share.

In deriving the Earnings value, I have assumed that in the past 12 years' average performance represents the future.  This means that:
  • If you believe that the future is better, then Eksons’ Earnings value will be higher than RM 1.08 per share.
  • But, if you think that it will be worst, then the RM 1.08 per share is over-estimated.

Eksons valuation table 2020
Table 3: Eksons valuation table 2020
Note
(a) The cash and marketable securities would potentially be converted into working capital in turning around the operations. As such, I have not attempted to classify them as Non-Operating Assets when analyzing the Earnings Value.


You will note that the Earning-based values are lower than those computed before.  The main reason for this is that the valuation is based on 12 years rolling period. As the latest year is a loss, the current rolling period average values were worse than the previous rolling period values.

If you are a firm believer in the Graham cigar-butt approach, Eksons is worth a bet as the market price is very much below the liquidation value.

But I doubt that Eksons is going to be liquidated. So do not look at this as a catalyst for re-rating. 

Secondly, a significant part of the asset value is in cash and marketable securities.  This is because the Timber segment operations have been scaled down.  Most of it would be converted to working capital if the Timber operations get back to the levels they achieved in the mid-2000s.

Case Notes

Slightly more than half of the Group’s Current Assets are in the form of cash and cash equivalents (marketable securities).

Unfortunately, you should not consider these as potentially distributable to shareholders. This because a significant portion of these is the result of the slowdown in the Timber segment. Much of it would be redeployed as working capital when the Timber segment operations pick up.

I have an article on the implication of this in Focus Malaysia magazine titled “Eksons: Don’t be mesmerised by the cash hoard”.

However, even when the cash is redeployed, it should not affect the Graham Net Net value. This is because the cash would be translated to stocks and receivables. These are still components of working capital

In other words, the current computed Graham Net Net value would still be unchanged.

It is obvious that the margin of safety comes from the Graham Net Net rather than the Earning-based value. This is the main reason why I do not provide details on the assumptions used to derive the Earning-based value.




How to secure your investments by minimizing risks

We considered two main risks previously.
  • Investment risk - would Eksons be privatized?
  • Business risk - can the Timber segment be turned around?

The privatization risks look less likely now since this was not pursued last year when the market price was much lower. 

The current main investment risk is whether you have the holding power while waiting for a turnaround and/or the market to re-rate it.

No double if you buy Eksons at the current price, the Graham Net Net will provide ample margin of safety. But this will only crystalize if the company is liquidated. I don’t expect this to happen.

The most likely scenario is for the Group to exit the Timber business if it cannot turn it around. But I would expect that this would be on the back of using the funds for other ventures. In other words, do not expect the cash to be distributed to shareholders even if the Group exit the plywood business.

Expanding the property development business is one likely scenario. But I would not rule out venturing into a completely different sector.  But both will take time to return the Group to the RM 0.25 earnings per share levels it achieved in the mid-2000s.

If you buy Esksons today as a value stock, you have to consider your holding power.

Timber segment turnaround

Plywood is a commodity and as the charts below indicate, over the past 2 decades there has been a few cycles of price swings of more than 40 %.

The US market (one of Eksons export markets in the past) is currently experiencing a huge price spike compared to the price in early 2020.  However, on a global basis, the price swing in Africa and South East Asia is less severe.

US Plywood Producer Price Index
Chart 4: US Plywood Producer Price Index   Source: FRED

I would expect that there would be future price cycles.

At this stage, it would appear that the industry is experiencing some upswing.  As such there are opportunities for Eksons to turn the Timber segment around provided it can resolve the logs supply issue.

Timber is not a depleting resource like tin or crude oil.  Sustainable logging and the trend towards timber forests will ensure this.  

Unfortunately, Eksons has still to resolve its long-term timber supply problem. There is no report by the Group that it has finally addressed this issue. The risk of being squeezed out of the industry still exists.

Plywood prices
Chart 5: Plywood Prices (Africa and South East Asia).  Source: Index Mundi

Conclusion

A value trap is a stock that while appearing to be a bargain turns out to be a dud. This is because the company actually has insurmountable problems that would affect its profitability.

From a liquidation perspective, Eksons is not a value trap. If liquidated, all shareholders will be able to get more than the current share price.

Liquidation of the Timber segment is not something that Eksons is considering. The question then is whether the shareholders’ funds are going to be wasted away.

From the time Eksons reported its first loss-making year (FYE 2016), the NTA of the Group has declined from RM 2.88 per share to RM 2.43 per share for FYE 2020.  This is about RM 0.09 per share per year decline.
  • At this rate, it will take 27 years for the current shareholders' funds to go to zero.
  • At this rate, it will take about 19 years for the current shareholder's funds to reach the level of the current market price.
 
You would think that this would give the Group enough time to either turn around the Timber segment or to divest out of the plywood business. 

Management has shown that they are prudent in spending money and I am confident that they are cost-conscious.  There is ample margin of safety provided you have the holding power.

I would conclude that last year's investment thesis is still valid and if you have bought Eksons share then, there is no reason to exit. This is still a Graham Net Net.

If you had not bought it last year, there is still a margin of safety between the current market price and the intrinsic value.  Even today, Eksons is not a value trap. 

But, as an investor, it is not only about holding power.  Are there better investment alternatives?  If there are, then Eksons may not be so attractive.

The other consideration for investing in Eksons today is dependent on how you assess the intrinsic value.
  • Do you look at a stock from a liquidation perspective or a going concern basis? 
  • The margin of safety from a liquidation perspective is much greater than from an EPV basis. 

It would appear that assessing whether a stock is a value trap is not so straightforward after all. If you are new to fundamental analysis, all this may prove very challenging.  

One way to overcome this is to complement your analysis with those of other experienced advisers. Those who do this well include people like The Motley Fool. Click the link for some free stock advice. If you subscribe to their services, you can tap into their business analysis and valuation.


END



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. 




Investment books that I have read.

Books


Comments




Till today, I still read value investing books to see whether I can get new insights to incorporate into my value investing process. 

 

 

 

When Warren Buffett and Greenblatt started out, they also invest in special situations in addition to conventional stock investments. 



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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.

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.







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