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Hock Lian Seng – Undervalued or Value Trap?

Before I proceed with the analysis of the aforementioned company, I would like to further expand on my thoughts that I had briefly touched on in the last post. As I had mentioned, I believe USD interest rates might stay at around the current level for longer, and so would impact rates on various global currencies. As is widely known, asset prices are the aggregation of future cash flows discounted back to present value. Have asset prices reset accordingly? I leave it for readers to decide for themselves. You would see that the next few names are all geared towards limiting downside while still allowing for room for capital gains.


Over the past decade, many companies on SGX are labelled as “Value Traps”. These companies tend to boast strong balance sheets, stable business prospects and small to middle sized market capitalisations. What I am focusing on, are companies that have strong cash and near cash equivalents. So much so that if one were to buy their shares, their business might come nearly free. I believe that in the past decade of low interest rates, these cash balances have been overlooked. These cash balances had not had much impact due to the low interest returns and all that has changed in the past year. The interest earned by these cash balances have started to benefit the profitability of the companies holding them. And in some of these cases, would prompt the companies to return unused cash to shareholders rather than holding them in the companies’ coffers. Why pay corporate tax on the cash when individuals can get the full interest by holding the cash outright?


Valuation of equity is similar to what was mentioned above, aggregation of discounted cash flows discounted back to present value. What needs to be taken note of, is what one deems to be cash flows coming back to equity holders. A $130 million cash balance deriving nearly zero interest hardly brings any value to minority shareholders if management does not intend to share it and thus in my opinion, highly discounted (contradictory to valuation methods that treats cash as just cash, which is to be netted against interest bearing loans for deriving equity value from enterprise value). However, a $130 million cash balance earning interest might trickle through in terms of higher dividend yield or one-time special dividends.


Now onto the main lead of the article.





Introduction

Hock Lian Seng is a civil engineering group listed on the Mainboard of Singapore Exchange Securities, which carries out civil engineering works for bridges, expressways, tunnels, Mass Rapid Transit, port facilities, water and sewage facilities and other infrastructure works. Recent contract wins include two new contracts for the Cross Island MRT Line. The Group is currently working on execution of the design and construction for Aviation Park, Serangoon North projects and Changi Airport joint venture project. The Group is also involved in property development and property investment businesses. Recent projects includes Ark@Gambas, Ark@kb, Shine@TuasSouth, Skywoods (TOP 2016) and The Antares (TOP 2022, fully sold). Hock Lian Seng appears to be cautious in this market environment and has not undertook new development projects since The Antares.


This listed group has been profitable every single year since it was listed on the Mainboard of the SGX. It consistently pays out dividends every year as well, including during the pandemic, ranging from 0.25 cents to 12.5 cents per share. We will cover this in more details later.


Investment Thesis

The main premise is straightforward. At its current pricing, Hock Lian Seng offers an attractive prospect as an investment. And that conclusion stems from 3 main considerations being the outlook on construction sector, the likelihood of a special dividend payout due to its burgeoning cash pile and the consistency of the group in achieving profitability and handing out dividends over the past 15 years.


Outlook

The pandemic has unfairly caused a correction in the share price while the group stayed profitable and has strengthened its balance sheet year over year. The outlook on the sector seems rosy, with the public and private sectors playing catchup on the backlog of housing and infrastructure projects that were held back by the pandemic. BCA has projected total construction demand in 2024 to be between S$32 billion and S$38 billion with the public sector contributing 55 percent of the total demand, reaching between S$18 billion and S$21 billion. Preliminary construction demand for 2023 reached S$33.8 billion, exceeding BCA’s forecast of S$27 billion to S$32 billion in January 2023.


BCA expects a steady improvement in construction demand over the medium term and project demand to be between S$31 billion and S$38 billion per year from 2025 to 2028.



Hock Lian Seng has already demonstrated a recovering revenue for FY2023 with a 22% increase in Civil Engineering revenue year on year. As of FY2023, the civil engineering order book stands at S$708 million, which gives a visible revenue stream for the years ahead. Additionally, 63% of the units at Shine@TuasSouth has been leased out, and rental of development properties netted the group S$7.0m in revenue in FY2023.


Special Dividend

As mentioned, Hock Lian Seng has been a very consistent dividend payer over the years as you can see from the record over the past 10 years. The Group has just announced a 1.5 cents dividend yesterday which racks up to a 5.6% dividend yield for FY2023.



Source: Hock Lian Seng FY2022 Annual Report


What stands out in the figure above is that huge special dividend that took place in FY2016. From my point of view, I think there is a significant likelihood that this would happen again for FY2024. I would like to quote what Howard Marks like to quote in his memos.


“History doesn’t repeat itself, but it often rhymes” – Mark Twain


In this case, I will draw up the similarities and we can see how much it rhymes. Let’s take a quick look at the comparison between what’s in the balance sheet in FY2016 and FY2023 based on the released financial statements.

 


Source: Hock Lian Seng FY2022 Annual Report




Source: Hock Lian Seng 2H 2023 Financial Statement

 

$’000,000

FY2016

FY2023

Equity attributable to Shareholders

243.3

259.1

Current Assets

305.1

290.0

Cash and Short Term Deposits

206.0

132.5

Contract Assets

7.7

49.8

Order Book

950

708

 

The direct comparisons above in my opinion shows that the group is primed for a special dividend in FY2024. Cash balances would increase with additional sales from Shines@TuasSouth and Ark@Gambas. Contract assets are higher than usual and would contribute to the cash pile on delivering to the clients. The remaining $14m in joint ventures from The Antares would be distributed as cash to the Group since TOP was achieved. The order book looks strong, with the ability to sustain business for the next few years. The group is flushed with cash from a recent TOP of a residential development, namely Skywoods in May 2015 versus The Antares in Dec 2022.


Consistently Profitable


Source: Hock Lian Seng FY2022 Annual Report


In case the special dividend in FY2024 does not pan out, I would still be comfortable holding onto the shares as I believe the special dividend would come sooner or later. Even if it doesn’t materialise, what are we looking at in terms of dividend yield? Average dividend per share over the past 11 years (excluding the bumper year of 12.5 cents in dividend) would be 1.71 cents. That translates to 6.3% dividend yield at the S$0.27 closing as of 22nd Feb 2024. If you are looking for a SA shielding replacement, look no further! Here is a worthy contender that is within reach just by setting up a CPF Investment account! The group is trading so cheaply that I do believe there is protection to the downside with the current market cap at only S$138.27 million as of 22nd Feb 2024. For this company, we are literally getting the business for free. This is not including the P&L that would be realised from the remaining S$71 million development properties to be sold. In FY2023, the company (Page 17) garnered S$32.4 million in revenue in the property development segment while reaping S$11.7 million in gains. That indicates the developed properties on the books could potentially be realising 56% in gains on being sold.


Conclusion

So is this a value trap or value to be uncovered? Is the increased interest rate not going to change how cash is valued? In FY2023 itself, the amount of interest received by the group from cash and investment securities has increased from S$2 million to S$5 million. With historical precedence, I do believe that a special dividend will be tabled to reward the shareholders. And in the meantime, I am paid to wait.

 

Disclaimer: All posts on The Squirrel's Drey are for informational and discussion purposes only. This is not a recommendation to buy or sell securities discussed. Please do your own due diligence before investing.

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