Is Crest Builder a value trap?

Value Investing Case Study 52-1: A fundamental analysis of Crest Builders to see whether it is a value trap or an investment opportunity.  I also used the analysis to determine what to do with my investment in the company.

Is Crest Builder a value trap?
I first bought Crest Builder Holdings Berhad (Crest Builder or the Group) in 2007 when I started to learn value investing.

I then increased my investment in 2019 substantially as a value stock. My average purchase cost by the end of 2019 was RM 1.03 per share compared to its NTA of RM 1.62 per share. 

I thought that there was sufficient margin of safety. I did not consider it a value trap as it had a concession business and its property development plans for the LRT stations provided a long property development pipeline.

Unfortunately, the market price of Crest Builder has dropped since then so as of 8 April 2024, it was RM 0.47 per share. 


Join me as I update my analysis of Crest Builder and assess the potential for the market price to go above my average purchased cost. 

Based on my analysis Crest Builder is not a value trap. At the same time, I should continue to hold onto Crest Builder. 

Should you go and buy it? Well, read my Disclaimer.

Contents

  • Company background
  • Operating performance
  • Financial position
  • My investment in Crest Builder
  • Valuation
  • Investment thesis
  • Conclusion
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Company background

The Group was founded in 1983 by the late Mr. Yong Soon Chow. Over the past 40 years, the Group carved a strong foothold in the local construction industry. 

The currently listed form of Crest Builder came about in 2003 by taking over the listing status of MGR Corporation Berhad. The Group today reports its performance under 4 business segments:
  • Construction.
  • Concession Arrangement.
  • Property Development.
  • Investment Holding.

Construction

The Group is a registered Class A contractor with the Malaysian Ministry of Entrepreneur Development and Cooperatives. It is also a Category G7 contractor with the Malaysian Construction Industry Development Board.

The segment primarily focuses on infrastructure and building works. In its 2022 Annual Report, the Group reported the following quality achievements:

“…was accorded with a Quality Assessment System in Construction (“QLASSIC”) score of 86% for its construction works for the South Brooks development…and 44-storey Capri Hotel…the Plaza @ Kelana Jaya mixed commercial development achieved a high score of 82%...”

As of the end of 2022, the Group reported an order book of RM 2.27 billion. Of this, 28 % was for the Property Development segment.

Concession Arrangement

This segment has a 23-year agreement with the Malaysian Ministry of Education and Universiti Teknologi MARA (UiTM). It involves the construction and management of the 5,000-student capacity UiTM Tapah 2 campus.

The segment provides a continuous and consistent amount of revenue each year. The revenue comprises a financing component and a maintenance component.

The concession was originally a joint venture. However, in its Q4 2023 announcement, the Group stated that it had bought the 49% equity interest in the joint venture for RM 43.61 million. The Group now owns 100 % of the concession. 

Property Development

Together with the conventional developments, the Group has also secured the privatization and the redevelopment of Dang Wangi LRT station and Kelana Jaya LRT station. 

As of the end of 2022, the Group reported property development projects totaling RM 2.1 billion. Refer to Table 1. 

Crest Builder Table 1: Property Development project status
Table 1: Property Development project status
Note that the Group launched Interpoint in 2023.

Investment Holding

The key earnings are from the rental of two properties:
  • The Crest. This a 16-storey commercial property hosting 1,400 parking bays. It also hosts the address of the Group’s corporate headquarters.
  • Tierra Crest. This is a 17-storey multi-commercial building with two office towers on top of a retail podium in Kelana Jaya.

Operating performance

I looked at 2 groups of metrics to get a sense of where the business is heading. Refer to Chart 1.
  • The left part of Chart 1 tracks the trends of 3 metrics – revenue, PAT, and gross profitability (gross profits/total capital employed).
  • The right part of Chart 1 tracks the trends of 3 return metrics – operating return (NOPAT/total capital employed), ROE, and ROA.

You can see that there was hardly any revenue growth over the past 12 years. PAT was volatile with losses post-2019.
  • The loss in 2020 and 2021 was due to COVID-19. This led to lower revenue and gross profit margins. The lower gross profit margins were due to higher building material costs and labor shortages. The only profitable segment for the 2 years was the Concession Arrangement.
  • The Construction and Property Development segments continued to experience losses in 2022 and 2023. The Property Development performance was impacted by the lack of any new projects launched over the past 5 years.
Crest Builder Chart 1: Performance Index and Returns
Chart 1: Performance Index and Returns

Given the PAT trend, you should not be surprised to see that there were declining trends for all the 3 returns metrics. 
  • The returns mirror the profit drops after peaking in 2018.
  • Over the past 12 years, the Group achieved an average ROE of 1 %. This was because of the poor post-2019 performances.

I would categorize Crest Builder's performance over the past 12 years into 2 – pre-2019 and post-2019. From 2012 to 2018, the Group achieved an average ROE of 8%. From 2020 to 2023, the average ROE had declined to negative 11%.

Segment performance

Referring to Chart 2, from a segment performance perspective:
  • Historically, the Construction segment was the biggest revenue contributor. From 2013 to 2022, it accounted for about 2/3 of the Group’s revenue.
  • The Property Development segment was the next biggest revenue contributor accounting for an average of 21 % of the Group revenue from 2013 to 2022.
  • The Concession Arrangement segment was the biggest EBIT contributor. It accounted for 72% of the consolidated EBIT from 2013 to 2022.
  • Despite being the largest revenue contributor, the Construction segment only accounted for 6% of the consolidated EBIT from 2012 to 2022.

Crest Builder Chart 2: Segment performance
Chart 2: Segment performance
Note: Crest Builder had yet to release its 2023 Annual Report when I carried out the analysis in April 2024. As such there is no comparative Segment EBIT results for 2023. 

Looking at Chart 2, you can see that the performance of the Group is very dependent on the performance of the Construction and Property Development segments. The EBIT of these 2 segments pre-2019 and post-2019 2 illustrates my point. Refer to the right part of Chart 2.

The 4 segments are driven by different economic factors. As such it is more meaningful to look at the returns separately. Table 2 provides such a picture. You can see that the Group had very low returns from all the segments.

Crest Builder Table 2: Segment returns 2013 to 202
Table 2: Segment returns 2013 to 2022
Notes
The revenue and EBIT covered the average values for 2013 to 2022. This was because Crest Builder had yet to release its 2023 Annual Report when I carried out the analysis in April 2024. As such there is no comparative Segment EBIT results for 2023. 
a) 2013 to 2022 average.
b) 2023 TCE = total capital employed = Equity + Debt - Cash.
c) EBIT/TCE.

Prospects

I do not expect much improvement from the Concession Arrangement segment as historically the revenue average is about RM 46 million per annum. About 78 % of the revenue came from financing with the balance from the provision of maintenance services. Refer to Table 3.

Crest Builder Table 3: Breakdown of Concession Arrangement average revenue from 2015 to 2022
Table 3: Breakdown of Concession Arrangement average revenue from 2015 to 2022
Note: The Group only provided data from 2015 onwards. 

At the same time, the bulk of the income from the Investment segment came from rental. Unless the Group acquires new properties, I do not expect a significant increase in revenue from this segment.

It is obvious that to perform better, the Group has to turn around the Construction and Property Development segments.
  • For the Construction segment, it meant re-building back the margins that it enjoyed pre-2019. From 2012 to 2018, it achieved an average EBIT margin of 9%. From 2020 to 2022, this had dropped to an average of negative 14 %.
  • For the Property Development segment, the challenge is building back the property development revenue. From 2012 to 2018, it achieved an average revenue of RM 100 million annually. From 2020 to 2022, this had dropped to an average of RM 6 million per year.

I am positive about Crest Builder’s prospects as the Construction and Property Development sectors are not sunset sectors in Malaysia. For more insights into these sectors refer to:

Both sectors were soft over the past decade. But I expect both sectors to turn around over the next few years. 

To give you a sense of where Crest Builder stood relative to its peers, I compared its performance with the sector. Looking at Table 4, I would conclude that Crest Builder's performance was not too bad compared to the construction sector. 

I am confident in making this assessment as the majority of Crest Builder’s revenue came from the construction sector. 

I am not too sure about the property development comparison. Crest Builder’s property development revenue is very small compared to those of the large property companies covered in my comparison. 

Crest Builder Table 4: Sector comparison
Table 4: Sector comparison
Note: Crest Builder only provided revenue data by segments. As such I was only able to compare its segment revenue growth with those of the construction and property development sectors. For the other metrics, I took Crest Builder’s company performance to compare with the construction and property development sectors. 
a) 2011 to 2021 mean of the Construction sector.
b) 2011 to 2021 mean of large Bursa Property companies.
c) Refer to Table 2 to get a sense of the segment ROE. Note that the data for Table 2 is before tax.

However, the Construction segment's immediate outlook is still not good. In its Q4 2023 announcement, the Group stated:

“…The economic outlook of the construction industry in Malaysia for 2024 is expected to remain challenging… The Group is still facing several challenges, including lack of skilled labor, shortage of materials, rising costs and short-term price fluctuations of building materials…”

However, I am a bit more optimistic about the immediate outlook for the Property Development sector given its RM 2.1 billion GDV projects and the launch of the Interpoint. At the same time, this GDV will provide more than 2 decades of property development revenue based on the past 10 years' average revenue.

Financial position

I would rate Crest Builder as financially ok based on the following: 
  • It has a DE of 1.98 as of Dec 2023. But of its total Debt of RM 570 million, about RM 257 million was for the Concession Arrangement segment. The concession debt is ring-fenced and covered by the concession assets. Ignoring this, the DE would be less than 1. 
  • As of the end of Dec 2023, it had RM 70 million cash and short-term investments. This is about 6 % of its total assets. 
  • During the past 12 years, it generated a cumulative RM 262 million cash flow from operations compared to a cumulative PAT of RM 73 million. This is a very good cash conversion ratio.
  • It had a reasonable capital allocation plan. Refer to Table 5. Its cash flow from operations was sufficient to cover its CAPEX and Acquisitions. If all the balance was distributed as dividends, it would be about RM 0.08 per share.

Crest Builder Table 5: Sources and Uses of Funds 2012 to 2023
Table 5: Sources and Uses of Funds 2012 to 2023

There are of course some negative points:
  • It currently has a negative interest coverage ratio. I defined this as EBIT/interest. This is equal to a D (Fitch) synthetic rating as per the Damodaran approach. You should not be surprised by this due to the negative earnings.
  • Its average ROE over the past 12 years of 1 % meant that it did not create shareholders’ value.

My investment in Crest Builder

When I first started to learn about value investing, I relied quite a lot on Asset-based valuation. 

In 2007, I found that Crest Builder was trading at RM 1.16 per share compared to its NTA of RM 1.64 per share. It looked like a good margin of safety to me. I thus bought some shares in Crest Builder. 

As can be seen from Chart 3, the price declined by about half in the next 2 years. However, I did not sell as I felt that the intrinsic value was greater than my purchased cost. The NTA had risen to RM 1.59 per share in 2009.

I also held onto the shares and did not sell them when the market price went as high as RM 1.57 per share in 2014. This was partly because it was paying annual dividends of about RM 0.04 per share. At the same time, I estimated its intrinsic value based on the Residual Income model to be RM 1.71 per share.

Of course, the market price declined since the 2014 peak. By 2019 it had gone below my original purchase price. I then decided to increase my shareholdings in Crest Builder substantially. 

Crest Builder Chart 3: Crest Builder price trends
Chart 3: Crest Builder price trends

My investment thesis then was that the Group had a long property development runway that would boost its Construction segment earnings. I did not consider it a value trap as:
  • Its 5 years average EPS was RM 0.16 per share.
  • The Debt Equity ratio of 1.5 was due to the Concession loan. Excluding this, the Debt Equity ratio was 0.53.
  • The Concession provided the Group with at least RM 7.6 million PAT annually for the next 16 years. 
  • The investment property provided the Group with some recurring income.

But as can be seen from Chart 3, the market price of Crest Builder has been declining since 2019. At the same time, due to the losses, the last dividend payment was in 2019.

The result is that as of the end of March 2024, I have a compounded loss of 6.8 % per annum. Refer to Table 6.

Luckily my total investment in Crest Builder ranks near the bottom of my stock portfolio (ranked from top to bottom in terms of the total cost of investment).

Crest Builder Table 6: Estimating my returns in Crest Builder
Table 6: Estimating my returns in Crest Builder

Case Notes

An Asset-based valuation may be more suitable for companies with valuable assets but poor current earnings. I have used 2 types of valuation in my blog that relates to assets:
  • Book Value.
  • Residual Income.

The former is based on the Balance Sheet of the company. For the case of companies with substantial properties, I look for any revaluation surplus that is not accounted for in the books.

For construction companies where it is difficult to project future earnings, I use a modified approach. The value is the Book Value plus the present value of the earnings from the current order book.

This would give me a projected Book Value based on its order book. I believe that this is a more appropriate approach than just taking the current Book Value.

The Residual Income approach is also called the “Excess Earnings” method. Here the excess earnings are defined as the earnings in excess of a capital charge. The capital charge is estimated based on the expected returns. The value of the company is then the Book Value plus the present value of the excess earnings.

You will realize that my valuation approach was based on my experience in valuing lots of companies. If you are a newbie, one way to get exposed to lots of valuation is to see how others have done so. Sites such as Seeking Alpha.* can provide such exposure. Click the link for some free stock valuation examples. If you subscribe to their services, you can tap into their business analysis and valuation.




Valuation

Crest Builder is undergoing a turnaround. The value of Crest Builder should take into account the losses during the turnaround phase and the value after the turnaround. In this context, I assumed:
  • The losses during the turnaround phase are to be equal to the average of the 2022 to 2023 losses. There would be another 4 years of losses before the Group becomes profitable.
  • I looked at 2 scenarios to estimate the value after the turnaround – Asset-based and sum-of-parts.

I estimated the intrinsic value of Crest Builder to be RM 1.11 per share based on its Asset Value and RM 1.03 per share based on its sum-of-parts value.

The market price of Crest Builder as of 8 April 2024 was RM 0.47 per share. There is more than a 30 % margin of safety under both bases.

Crest Builder Chart 4: Valuation
Chart 4: Valuation

Valuation model

The key challenge in valuing project-based companies like Crest Builder is forecasting the earnings. The earnings of such companies are dependent on the order book. Unless the company has a strong history of replenishing the order book, I have problems projecting the earnings required for my DCF valuation.

As such I tend to rely on Asset-based valuation as the base method. The alternative is to use the Asset Value plus the profits of the existing order book. These were what I did in valuing Crest Builder.

For the Asset-based scenario, I assumed that the intrinsic value would be based on the 2023 Book Value. Table 7 illustrates the computation.

Crest Builder Table 7: Estimating the intrinsic value based on the asset-based scenario
Table 7: Estimating the intrinsic value based on the asset-based scenario

For the sum-of-parts valuation, I based it on the 2022 financials. This was because, at the time of my valuation, Crest Builder had yet to publish its 2023 Annual Report. 

My sum-of-parts value was based on the following:
  • The values for the Construction and Concession Arrangement segments were based on the capital employed plus the net present value (NPV) of the order book earnings. 
  • The value for the Property Development segment was based on the NPV of the projects. I assumed the earnings to be based on the past 10 years revenue and profitability.
  • The value for the Corp/Investment Property segment was based on the value of cash, securities, and investment properties

Table 8 shows the computation. 

Crest Builder Table 8: Estimating the intrinsic value based on the sum-of-parts scenario
Table 8: Estimating the intrinsic value based on the sum-of-parts scenario
Notes
a) Total capital employed + NPV of losses based on 2022 order book.
b) 2022 financial asset + NPV of earnings from maintenance.
c) NPV of annualized earnings.
d) 2022 Cash, investment, and investment property.

Investment thesis

The Group's performance over the past few years was impacted by the soft construction and property development market. COVID-19 aggravated the situation. To return to profitability, the Group has to turn around the Construction and Property Development segments. This meant rebuilding the Construction margins and launching new property projects.

Before COVID-19 the Group had a track record in replenishing its construction order books as well as achieving good construction margins. At the same time, the Group has RM 2.1 billion GDV in the property development pipeline. These together with its strong financials, will enable the Group to turn around.

Assuming another 4 years of losses before it returns to profitability, there is more than a 30 % margin of safety at the current market price. Crest Builder is not a value trap.

Conclusion

I would categorize Crest Builder's performance over the past 12 years into 2:
  • From 2012 to 2018, the Group achieved an average ROE of 8%. 
  • From 2020 to 2023, the average ROE had declined to negative 11%.

I have shown that the performance of the Group is dependent on the performance of the Construction and Property Development segments. To return to profitability, the Group needs to turn around these 2 segments.
  • For the Construction segment, this meant building back the margins.
  • For the Property Development segment, the focus is on launching new projects.

The positive point is that Crest Builder has a good track record for the Construction segment. At the same time, it has an RM 2.1 billion property development pipeline that can last for more than 2 decades based on the past 10 years' average segment revenue.

The Group is also financially sound to give it time to achieve the turnaround.

My valuation of Crest Builder based on both Asset-based and sum-of-parts approaches showed that there is more than a 30% margin of safety. This is not a value trap.

You can understand why I have decided to hold onto my shares. If I exit now, 
  • I will incur a loss of 40%. This meant that my original RM 1,000 investment would result in cash of RM 600 after I crystallized the loss. To recover the loss as well as make another RM 100, this RM 600 must turn into RM 1,100. In other words, it must generate a return of at least 83 %.  
  • If I hold and the market re-rates to RM 1.00 per share, I would have a 10% gain. In other words, my RM 1,000 investment would be worth RM 1,100.

Looking at the options, I think that it is easier to achieve the latter. I would like to think that my assumption of another 4 years of losses is very pessimistic. The re-rating should not take another 4 years.



End


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