While MS Holdings may seem to be turning the corner, investors need to be wary of its declining net asset value, high debt levels and cyclical business.
In Singapore, I always tell my wife that construction activity seems to be never-ending. Wherever we go, we see huge cranes dotting the landscape, tall hoardings and workers in coveralls buzzing around like busy bees.
There always seems to be something being constructed, from spanking new condominiums to new MRT stations around the island.
This constant hive of activity and the sight of tall crawler and tower cranes made me wonder: just how many companies are in the crane industry in order to supply these huge machines to the property and construction companies?
It turns out that there is a booming industry for crane rentals, and there are many players in the industry vying for a slice of this lucrative pie.
MS Holdings Limited (SGX: 40U), or MSH, is one of these companies. The group’s business was established in the 1960s by Mr Yap Lian Loke and it was listed back in November 2014. MSH is one of the leading crane companies in Singapore and provides mobile and lorry cranes that can be deployed in a wide range of lifting operations.
These cranes are rented out to customers in various industries such as oil & gas, construction and logistics on a daily or short-term basis. MSH has a diverse customer base in order to buffer against a downturn in any one particular industry.
Patchy 5-year financial record
MSH has had a patchy financial track record, with revenue declining over FY 2017 & 2018 and then rebounding again in FY 2019. Note that the group had acquired new cranes since FY 2015, such as a 750-tonne mobile crane as well as rough terrain cranes, in order to extend the range of cranes offered to customers. In FY 2017, MSH also introduced project management services for customers, but this portion of revenue quickly dwindled in subsequent years to form an insignificant part of the business
The key reasons for the losses incurred for FY 2017 and 2018 were the fall in crane rental rates as well as the drop in utilisation for MSH’s cranes. This acted as a double whammy for the business as both revenue and gross margins have fallen, the former due to lower overall utilisation for cranes and the latter due to the group’s inability to price its services to garner a higher margin.
It should also be noted that the group’s fleet has shrunk considerably since FY 2015 despite the addition of new crane types and “fleet renewal” (i.e. the replacement of older cranes with newer ones) taking place. Fleet size fell from 32 cranes to a low of 24 cranes in FY 2018 and then rebounded slightly to 29 cranes as construction activity in Singapore picked up steam in FY 2019. The shrinkage in fleet size is correlated with the fall in crane rental rates and demand for cranes, as the group had stated in FY 2017 and 2018 that conditions remained challenging due to lower demand for cranes. This fact, coupled with strong competition in the market from other crane rental companies, led to lower overall utilisation and the group having to dispose of cranes from its fleet.
Investors should also note that the group’s net asset value (NAV) has been on a steady decline since FY 2015. From a high of S$0.27 in FY 2015, the NAV has fallen by around 41% to S$0.16 in FY 2019. This was due to losses over the last five years that eroded the equity base and led to a steady NAV decline. In addition, the group also announced a 4-for-5 rights issue at 6.2 cents/rights share back in October 2018 to bolster its balance sheet. Every four rights share also came with a free detachable warrant at an exercise price of 13 cents each.
This rights issue expanded the number of issued shares from 102 million as of FY 2018 to 165.8 million as of FY 2019 and was dilutive to NAV. The last traded price of the group was S$0.06, but we will revisit the issue of whether MSH is really undervalued as its NAV is still at S$0.16 at the end of this article.
Burdened by debt
MSH’s balance sheet has always held significant amounts of debt relative to its cash position, as can be seen in the five-year cash and debt compilation above. The business has always needed to operate with fairly high levels of leverage, and the balance sheet has stayed in a net debt position all these years. Worryingly, the level of net debt has increased over the years, moving from S$9.1 million back in FY 2015 to S$19.7 million in FY 2019.
In terms of the finance costs the group is paying, it has remained fairly stable over the years but exceeded S$1 million in FY 2019, taking up 7% of revenue. Finance costs as a % of revenue have hovered at the 7% to 8% level in recent years and should act as a red flag for investors.
Free cash flow
The group generated free cash flow (FCF) in four out of the last five years, and this is a fairly decent track record for MSH. However, the latest fiscal year saw operating cash flow at a low of just S$237,000, resulting in negative FCF of around S$182,000. This fact, coupled with the recently-concluded rights issue, seems to ring alarm bells as it implies the group may not be able to generate enough operating cash flow moving forward and therefore has to rely on a mix of borrowings and equity in order to raise cash.
The company has not paid dividends in the last five fiscal years, and it is envisioned that unless business conditions improve materially, it would be unable to pay out a dividend for the foreseeable future.
Business segment highlights
From the business segment analysis over the last five years, MSH only started to diversify into the trading of cranes and project management in FY 2017. These contributed decent levels of profits for the group even as the core leasing division floundered, but were insufficient in quantum to provide the required boost to prevent the group from sinking into losses.
For FY 2019, even though the group reported overall profitability, investors should note that the leasing segment still reported losses of S$372,000, signalling that the core business is still unprofitable. The trading business is volatile and cannot be expected to continue to contribute to overall group profits, while project management revenue has shrunk to just S$29,000. Unless MSH is able to increase margins for the leasing business, it looks like the division will continue to be mired in losses. Though the gross margin was nearly 30% on a group level, MSH continues to report “challenging conditions” and crane rental rates continue to remain depressed.
Catalysts for the business
As the business is mired in an inherently cyclical industry that relies heavily on the fortunes of construction and oil and gas companies, it’s difficult to think of clear catalysts for the business. The good news is that management is aware of the challenges the business faces and is taking active steps to improve utilisation. However, the business continues to be a victim of low crane rental rates that it has no control over, and this lack of pricing power, coupled with strong competitive pressure, make it tough for the business to regain its footing.
One catalyst I can think of is the continued investments in infrastructure within Singapore, such as the building of new roads, highways and MRT stations. This should prop up the demand for crane rentals and provide a consistent source of income for MSH. As the group’s financials have recovered somewhat, the hope is that this momentum can continue and further lift the group’s profits over time.
The crane industry: challenging and cyclical
If we look at the crane rental industry in general, it has always been rather challenging and cyclical. We can break this analysis down into clear components and explain why the industry has always been struggling, and why even larger players fail to consistently maintain a high margin and return on invested capital.
First off, the fact that cranes are fairly homogenous and “commoditised” means that a developer or construction company will be indifferent as to which rental company it engages with. Unless there is a need for specialised equipment for lifting extremely heavyweights, most cranes in the market will suffice. It then boils down to a matter of pricing, and crane rental companies often jostle for a piece of the pie by undercutting one another, in a classic “lose-lose” situation.
Secondly, it’s not difficult for new entrants to enter the market, as one simply needs to incorporate a company and purchase a few cranes. This makes the industry fragmented and ultra-competitive, implying that only the larger players can survive due to economies of scale.
Finally, cranes are usually rented by construction companies and contractors, who traditionally suffer from a toxic mix of high working capital requirements and negative cash conversion cycles. Such customers may run into cash flow problems and be unable or unwilling to pay the crane rental companies. This aspect exacerbates the problems faced by crane rental companies and further dents their prospects for growth.
For the competitor analysis, I have selected three other companies on SGX that also offer crane and heavy machinery rentals. They are Sin Heng Heavy Machinery Ltd (SGX: BKA), Tiong Woon Corporation Holdings Ltd (SGX: BQM) and Yongmao Holdings Limited (SGX: BKX).
It’s probably clear from the competitor analysis table above that most of the companies in the industry are not performing well, with low net margins and losses. The dividend yield is either non-existent or very low (Tiong Woon at 0.4%). Yongmao fares better than the other players purely because its operations are mostly in China, where there is a larger market for cranes. It boasts a net margin of close to 9% and pays a dividend of 3.5%. However, investors should note that all the companies are richly-valued due to a low earnings base, and that caution is advised due to the cyclical nature of the industry. Investors should note that one of the largest crane rental companies in Asia, Tat Hong Holdings Limited, also reported heavy losses in both FY 2018 and FY 2017 despite having large scale and size. It was reported in an article last month that the group owned more than 1,550 tower, crawler and mobile cranes. The company’s share price traded as high as S$2 during the commodity boom years, but it was taken private at just S$0.55 in July 2018. This is a rather scary example of how even a giant in the crane rental industry fell on tough times and saw its share price collapsing, let alone the smaller, struggling players.
Risks to the business
The risks to the business have been mentioned above and I shall reiterate them once more – the business is challenging as it is essentially commoditized, with very little to differentiate one crane rental company from another. There is also no pricing power for all players coupled with low barriers to entry. MSH is reliant on customers in the construction and oil and gas industry, who themselves are subject to cyclical forces. This makes it tough for MSH to manage its receivables as some customers may go belly up or request for longer credit terms.
Valuation and conclusion
At a share price of S$0.06, MSH is trading at just a fraction of its book value per share of S$0.16. However, I need to caution that this may not imply that the shares are severely undervalued. First off, the share price may be factoring in a continued decline in earnings or further dilution of the NAV as the business struggles to generate a consistent profit.
Also, note that the book value per share represents the liquidation value of the company, but the company still remains a valid going concern. This means that investors will not be able to extract the NAV of the company unless it is liquidated, and even then, the value of certain assets such as inventories or receivables may receive a further haircut.
MSH is also facing challenging and tough conditions that may further impair the value of its NAV. Hence, I conclude that even though the group’s shares may seem to offer a great bargain, this may end up being a value trap. Coupled with the non-payment of dividends, investors in MSH may remain stuck for a long time in a struggling business without any returns whatsoever.
It’s always good to have someone else write up your potential investing ideas, how they think, view, and investigate the company reveals more often than not what you miss. Information on companies you are looking at needs to be placed into context and this context is best seen when you pit opposing stances against one another. For example; bear vs bull scenarios.
MS Holdings is a stock that passed the piortroski f score and had a price to book ratio of less than one. When I was scouting for companies such as this, I had few requirements other than that they were turning around and that they were cheap. Their cheapness is the relative protection offered to investors.
As of right now, I think the valuation is indeed dirt cheap, though the high levels of debt poses significant risk. The company is now trending with negative values if you include its high debt ceiling. This isn’t a good thing. An uptick in interest rates or continued lack of profitability can easily sink the company.
The important question here to ask, similar to shipping, is whether rental rates for cranes are turning. There is quaint saying in commodity sectors that the fix for a low price is a low price.
EG-> “The fix for low shipping rates, are low shipping rates”.
What this means is low earnings translates into losses, and extended periods of low rates/prices/earnings translates into periods of time where the entire industry experiences severe contraction – companies go bankrupt, slash jobs, cut production, cut spending, issue more shares that are net dilutive to current shareholders, or get bought out by stronger competitors who can buy up their debt and do a hostile take over.
What happens? As producers of a commodity stop producing because of low rates/earnings/prices, scarcity for this commodities abounds. Oil still needs to be shipped. Buildings still need cranes. Commodities are by the very nature of their business, a product necessary for life, whether fuel, electricity, transport or otherwise.
This is when things get interesting. Low rates/earnings/prices have led to destruction and industry shakeups and now the strongest of the companies are left to pick up all of the floating demand. This means higher rates, higher earnings and higher prices. Often, these companies which have been losing money for years will see a big pickup in share prices once they start posting profitable earnings and increasing cash flows.
So how does that translate into an investing thesis for MS Holdings? It doesn’t. I don’t buy companies with big amounts of debt. Period. I don’t care how undervalued they are, buying companies burdened by severe debt is stupid in the extreme. Sure. they might go on to be 3-5 bagger and some smart aleck might go out and rub it in my face later on, but my job is to protect my downside risk. And you might get lucky once or twice, but eventually, the markets will punish bad decisions.
How many good decisions can you get in a row for 20 years? 5? 10? 15? It’s a fool’s errand and I’m not going to step foot on that path.
Instead, here’s how I intend to play any cyclical industry.
- Spend 90% of my time and energy understanding the cyclical industry dynamics at a deep level to decipher if the upturn is indeed coming
- Look for commodity industries where share prices have been relatively beaten down for the past decade. (shipping, oil, uranium)
- Look for companies with the best ability to survive the protracted downturn and are best poised to benefit from the upturn
- Buy the companies at dirt cheap roadkill prices to give myself a margin of safety
- Look for significant insider owning and insider buying as clues and as confirmation signals for if the company can be invested
- Look for low debt, low cash burn, shareholder-focused management teams that are open with their communications.
- Avoid companies burdened with heavy debt burdens unable to service their debt for the next three years.
In particular, 1&2 are very important. Companies are typically cheap for good reason. The industry may be yucky (funeral business anyone? China seems decent), underfollowed (microcap companies can’t be bought easily for big players, leaving it to smaller retail folks like us to benefit), or just plain troubled. Shipping, uranium and oil are all in these bandwagon, where the industry have suffered chronic oversupply which destroyed large amounts of shareholder capital.
Being contrarian means you have to develop an insight or an edge that allows you to decide when these companies are too undervalued, further understand if the upturn is indeed coming (because if you’re wrong for 3-5 years, you’ve wasted time and capital and the company might still go under anyway, case in point, shipping) and staying disciplined.
To sum up, when you’re buying deeply undervalued companies;
- understand why they are cheap
- try to determine the catalyst for their share prices going up (this is normally tied to earnings which is easier when you’re looking at cyclical commodity industries),
- study the industries deeply to understand the dynamics behind it since there’s real value understanding how the industry fluctuates to create upturns, this deep knowledge is also intensely rewarding because deep level thinking gives YOU an edge versus the rest of the investors who don’t understand the industry
- apply very large margins of safety or discounts to share prices and only buy when the prices are so dirt cheap it hits you over the head with a baseball bat
- DO NOT buy companies with lots of debt
- stay very disciplined with buying cheap companies
- look for strong insider buying, these guys know more than you most of the time and understand the industry better than you so there’s value in following their movements to decipher if there is an opportunity for strong upsides
I hope this piece has been informative for you in understanding how to better buy undervalued companies. If you’d like to find out more about how we invest, we give regular free seminars on factor-based investing. You can register for a seat here.