Is UOA Ltd one of the better SGX stocks?

Value Investing Case Study 03-4: My last analysis and valuation of UOA Ltd were published about a year ago based on the financials till FYE 2019.  This is an update incorporating the FYE 2020 results.

Is UOA Ltd one of the better SGX stocks?
There are two questions when it comes to considering a company to invest in:
  • Is it a good company?
  • Is it a good investment?

A good company can be a bad investment if the price is such that you are not likely to see further price increases.

A bad company can be a good investment if the price is such that even based on a liquidation basis, there is a sufficient margin of safety.

I would classify a stock as one of the better ones for investment if it is both a good company and a good investment.

I generally assess a stock first to determine whether it is a good company based on its fundamentals. Only then do I proceed with valuing it. This is because all valuations are based on assumptions. The company analysis will ensure that the assumptions are realistic.

United Overseas Australia Ltd (UOA or the Group) comprise 3 listed entities:
  • United Overseas Australia Ltd is dual-listed on ASX and SGX.
  • UOA Development Berhad is listed on Bursa Malaysia.
  • UOA REIT is listed on Bursa Malaysia.

The steps to be taken to determine whether UOA Ltd is an investment opportunity then follow the above steps. Join me as I present my Investment Thesis on why UOA Ltd is one of the better stocks to invest in.

If you are not familiar with the Group, I suggest that you read the previous articles as I would not be repeating the company profile, history, and risk profile in this article. Refer to the following:


Should you go and buy it? Read my Disclaimer. 

Contents

  • Summary
  • Investment Thesis
  • Rationale
  • Supporting details
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UOA summary

Summary

  • The Group comprises 3 listed entities. Although UOA Ltd is dual-listed in Australia and Singapore, the bulk of the operations and earnings are from Malaysia.
  • The Malaysian property market has been soft over the past few years. This has resulted in a decline in revenue and earnings for the industry. UOA performance followed similar trends. 
  • UOA is one of the bigger players in the Malaysian property sector in terms of shareholders' funds, revenue, and earnings. It has been able to maintain its performance relative to the industry.
  • UOA is fundamentally strong. This was based on a number of metrics such as returns, gross profitability, and financial health. 
  • At the same time, the current market price does not reflect its Asset Value or its Earning Power Value. It is an investment opportunity.

Investment Thesis

The Malaysian property market has been soft over the past few years. Covid-19 has prolonged the downturn. But UOA is a fundamentally strong Group with the financial resources to outlast a soft property market. 

It is trading at a price that is well below its Asset Value. There is also a significant margin of safety based on the Earning Power Value (EPV). This is even if you view that it would take 3 to 4 years for the market to re-rate UOA based on its EPV.


Case Notes

According to Investopedia an investment thesis is a written document that recommends a new investment, based on research and analysis of its potential for profit.

It can help individual investors evaluate investment ideas and select the ones that can best help them meet their investment goals.

As with any thesis, an idea may surface but it is methodical research that takes it from an abstract concept to a recommendation for action.

More importantly, the thesis can be used to look back and analyze why a particular decision was made in the first place and help you improve your investment performance.

I have presented several case studies in this blog to serve as a template for how to analyze and value companies. 

I will now focus on the investment thesis and hope that it can be used as a template for you to document your own investment thesis.

There is no standard way to document an investment thesis. Below are 2 examples from The Motley Fool
  • Apple. Even though Apple's customers are as loyal as ever and its most important segments are still growing, Apple is priced for low single-digit growth. And healthy cash flow combined with a diligent plan to return cash to shareholders mitigates downside risk.
  • Tesla. As the sole player in long-range fully electric vehicles with a significant head start over its potential competitors, Tesla is poised to be a major benefactor in the adoption of electric vehicles over the coming years. If demand for its luxury Model S sedan is indicative of the zeal the mass market may have for an affordable fully electric Tesla vehicle, Tesla will soon become a major player in the automotive market.

How do investors use investment theses? This is what the Motley Fool had to say.

“Simply re-evaluate your investment thesis every time there is any new meaningful information related to your stock. I've found having an investment thesis keeps me calm even in the midst of irrational volatility; it keeps me focused on the underlying business. As long as my thesis is still intact, everything else is simply noise.”

As you can see, fundamental analysis is more than just using some formula. There are choices to be made in terms of which approach to use and what to assume. 

So, if you are just starting out to analyze and value companies, it may be helpful to supplement it with third-party analyses and valuation.  

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 and valuation.



Rationale

  • UOA business fundamentals in the context of earnings, growth, and financial health are still good. Note that these are the metrics that have a direct impact on its intrinsic value. This is assessment is based on UOA absolute numbers as well as in comparison with its peers. 
  • The returns achieved by the Group exceeded its cost of funds. This meant that it had created shareholders’ value.
  • The Group is financially strong with zero net debt as of the end of 2020. Its cash holding was about 25 % of the Total Capital Employed (TCE) while its debt only amounted to 10% of the TCE. It had also been generating positive cash flow from operations.
  • About 40 % of the Total Assets are in investment properties. These do not look at if they are going to be impaired. However, the demand for office space is going to be challenging.
  • UOA Ltd has reduced its shareholdings in UOA REIT from 46 % in 2019 to 34 % currently. This is probably a positive step in light of the challenge in leasing office space in the greater KL area. 
  • About ¾ of the Group's revenue came from property development. The building blocks for this activity are land held for development, inventory, and land under development. These are currently still higher compared to those in 2009, the year just after the US Sub-prime Crisis.
  • The valuation of UOA showed that there is a sufficient margin of safety both from both an Asset Value and EPV basis.
  • Based on the above, I would consider UOA Ltd as one of the better stocks to invest in. 

UOA valuation
Chart 1: UOA Valuation


Supporting Details

The Group operates mainly in Malaysia. 

UOA Ltd has 2 listed subsidiaries. While the shareholding in UOA Development has not changed substantially, UOA Ltd has reduced its shareholding in UOA REIT from 46 % in 2019 to 34 % in 2020.

UOA corporate structure
Chart 2: UOA Group

However, the results of UOA REIT were still consolidated in 2020 as UOA has control over the REIT's  Board and management. 

From a Look Thru basis, the reduction in the shareholding in UOA REIT is positive as it reduces the Group exposure to the office sector. This is considering that there is an excess supply of office space in the Greater KL area and the increasing level of office vacancies. 

This Look Thus basis is inspired by Warren Buffet.

Warren Buffett created a metric for the average investor known as look-through earnings to account for both the money paid out to investors and the money retained by the business.

The theory behind his look-through earnings concept is that all corporate profits benefit shareholders, whether they are paid out as cash dividends or ploughed back into the company. 

Look-through earnings can be calculated by taking an investor's pro-rated share of a company's profits and deducting the taxes that would be due if all profits were received as cash dividends.

Accordingly, my Look Thru basis is to include the pro-rated share of the associate/joint venture company’s revenue and profits as part of the Group revenue and profits. 

Overall performance

Over the past few years, the Malaysian property sector had been experiencing some slowdown. 

UOA performance reflects this as can be seen from the Performance Index chart below.

UOA performance index
Chart 3: UOA Performance Index

Given the slowdown in the Malaysian property sector, one way to gauge UOA performance is to compare them with the industry.

In my article “Will the Malaysian property industry turn around by 2024” I had shown that:
  • The industry has been experiencing a decline in revenue and earnings over the past few years.
  • The pre-pandemic slowdown as well as the measures taken to address Covid-19 will continue to be felt over the next few years.

In the article, I had grouped those companies into 3 based on the 2020 shareholder funds.
  • Large with shareholders funds > RM 1 billion.
  • Medium with shareholders funds between RM 300 million and RM 1 billion.
  • Small with shareholders funds less than RM 300 million.

The UOA Group with about RM 4 billion shareholders funds falls within the Large Group. As such, I compared its performance with those in this category. For the purpose of this article, I will refer to them as UOA peers.

As can be seen from the chart below, UOA Total Assets rank above the upper quartile of the peers.

UOA vs Peers Total Assets
Chart 4: Total Asset comparison

UOA financials are reported in AUD. For the peer comparisons, I have converted them to RM based on the respective year-end exchange rate extracted from Investing.com.

Revenue

In terms of revenue, UOA ranked among the top over the past decade. While the revenue has declined over the past 2 years, I would still consider UOA performance as good.

UOA vs Peer Revenue
Chart 5: Revenue comparison

Profits

In terms of PAT, UOA far outranked its peers. This was driven by better gross margins and profit margins.

UOA vs Peer PAT
Chart 6: PAT comparison

However, the larger revenue and earnings were due to UOA having a large asset base. The result is that its gross profitability was only about the peer median. In fact, this has declined over the past few years to rank within the lower quartile. 

UOA vs Peer Gross profitability
Chart 7: Gross Profitability comparison

Returns

I considered 2 return metrics - ROE and ROA.  In both of the cases, UOA ranked among the upper quartile.

As can be seen from the chart below, although the peer performance has declined since 2014/15, UOA has managed to maintain its relative ranking.

On an overall basis, I would rate UOA performance in terms of generating earnings as good.

UOA  vs Peer ROE
Chart 8: ROE comparison

UOA vs Peer ROA
Chart 9: ROA comparison

Over the past 12 years, UOA achieved a return that exceeded its cost of funds. I used several metrics to come to this conclusion.
  • UOA had a time-weighted average EBIT(1-t)/TCE of 11.5 %. The cost of funds estimated as the WACC in 2020 was 5.7 %.
  • The time-weighted ROE was 10.2 % compared to the cost of equity of 6.0 %.
  • Assuming that no dividend was paid, the shareholder's funds would have grown at a CAGR of 16.3 % from 2007 to 2020. Compare this with the 6.0 % cost of equity.

Note that time-weighted here refers to placing greater weights on recent values compared to those a decade ago. 

Funding and cash flow

UOA has a very conservative borrowing scheme so that it ranked below the lower quartile in terms of the Debt-Equity ratio.

Furthermore, in terms of generating cash flow from operations as % of the revenue, it ranked well. 

On a relative basis, I would rate UOA as financially healthy.

UOA vs Peer Debt Equity
Chart 10: Debt Equity ratio comparison

UOA Cash flow from Ops / Revenue
Chart 11: Cash flow from Ops/Revenue comparison

In terms of capital structure, debt accounted for 10 % of the TCE at the end of 2020.  But effectively UOA is debt-free as its cash is about 25 % of the TCE.

About 75 % of the TCE is deployed for its operations.

UOA Sources and Used of funds
Chart 12: Sources and Uses of Funds

Investment Properties

As of the end of 2020, Investment Properties accounted for about 40% of the Group's Total Assets. In 2020, fair value adjustment (an additional value) amounted to about 3 % of the value of the Investment Properties. 

The fair value method was applied to all its Investment Properties.  In other words, the current Book Value reflects the fair value of the properties.

The biggest threat to the Investment Properties segment is the excess supply of office space in the Greater Kuala Lumpur area.  The worst would be an impairment of the assets if this leads to low occupancy and low rental.

At this stage, there is no indication of this happening as can be seen from the chart below of the Group leasing situation. 

UOA Leasing Index
Chart 13: Leasing Index

However, the future for office space in the Greater KL area is challenging. I quote the following from Savills report that was attached to the IGB Commercial REIT prospectus:
  • Average occupancy in the Greater KL has been on a falling trend since 2014 to 74.4 % in 2020. This falling occupancy is attributable to lower-than-average office demand and high supply growth.
  • Notably, the weakness in demand is led by the KL City region.
  • In 2020, the average office rent in Greater KL has remained stagnant. 
  • The price index of prime office buildings in KL had declined from 1043 in 2019 to 885 in 2020.

Development pipeline

Property development is still the bigger component of UOA revenue accounting for about 76 % of the revenue in 2020.

The Group land bank only accounted for about 7 % of the Total Assets in 2020. There is thus no large tract of vacant land waiting for development. In fact, the land held for development is only 27 acres and the bulk of it relates to the Bangsar South development.

This means low landholding cost in the event there is a prolonged downturn in development activities. 

As can be seen from the chart below, the basic building blocks for the property development activities still remain good.

UOA Development Pipeline building blocks
Chart 14: Property Development Building Blocks

Board and Management

There was no change to the Board comparing 2020 with 2019. Two of the members are executive directors who are also substantial shareholders. Together they still control about 73% of the company (as of 19 Mac 2021). As founder directors, they have been associated with the Group since the start.

As for the senior management, the Group did not provide any profile of the members in 2019 and 2020. However, 5 of them were listed in both years as having service agreements. The base salary for 4 of them in 2020 was about 5 % lower than in 2019.  But for one, it had been reduced by about half in 2020.

Note that the base salaries for the 3 Executive Directors had also been reduced by about 23 % in 2020.

There were no details about the service agreements but I was surprised by the reduction in the base salary. But this is a good sign.

Valuation

I used 2 valuation methods to derive the intrinsic value:
  • The discounted Free Cash Flow method as per Damodaran.
  • The discounted Residual Income method as per Penman.

I then took the average from both methods as the final computed intrinsic value. This applied to both the EPV and the Earning value with growth. When it came to growth:
  • I used the fundamental growth equation to derive growth for the Discounted Free Cash Flow method. This is Return X Reinvestment rate = growth.
  • For the Residual Income method, I computed the growth trendline based on the historical residual income. 
  • In both cases, I capped the growth at 5%.
UOA valuation
Chart 15: Valuation

You can see that the current market price of UOA is below its Asset Value and significantly below its Earning Power Value.

UOA Valuation table
Table 1: Valuation metrics

In deriving the Earnings value, I had assumed that the past 12 years’ average performance represented the future.  This meant that:
  • If you believe that the future is better, then its Earnings Power value would be higher than AUD 1.65 per share.
  • However, if you think that it will be worst, then the AUD 1.65 per share is over-estimated.

The Earning Power value assumed zero growth and provided a 117 % margin of safety.  This margin of safety is supported by the Magic Formula and the Acquirer’s Multiple.

Given the concerns about the office space, I would not look at the Earning Value with growth.


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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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