Sysma Holdings Ltd, a niche contractor cum developer, is an undervalued gem currently trading at 0.74 times book and less than 5x historical earnings. With its net cash position currently at 72% of its market capitalisation based on the last traded price of $0.149 per share, it already has a strong balance sheet that might draw interest from value investors.

However, we believe that the strength of its current balance sheet is still severely understated as a surge in sales at one of its completed property projects in the last 6 months should give a further boost to its already large cash pile. After taking into account the 0.5 cts dividend paid in November, we estimate its net cash position and NTA to be at least 17 cts and 20.5 cts per share respectively by the time the company releases its HY2018 results come mid-March (for the period ending 31 Jan 18).

Given that its niche construction business has been consistently delivering healthy pretax profits for the past 5 financial years since listing, we see no reason for its share price to trade at a discount to even its net cash position. Further, with the Executive Chairman cum CEO owning 66% of the total outstanding shares, there is added incentive for management to return a significant chunk of this cash pile to shareholders.

In short, we believe that Sysma is a stock that offers both compelling current value as well as a possible share price catalyst in the form of increased annual or special dividend payouts.

Background
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Listed on the SGX Catalist board in 2012, Sysma is a niche contractor focused on the construction of high-end landed housing projects such as detached houses and Good Glass Bungalows (GCBs). It is helmed by Executive Chairman cum CEO, Sin Soon Teng, a construction veteran with more than 50 years of industry experience under his belt.
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Since its founding in 1986, it has established an impressive track record and built over 150 bungalows in Singapore amongst other high-end projects.

One of Sysma’s impressive bungalow projects (Source: company)

In 2012, shortly after it made its Catalist debut, Sysma made its initial foray into property developments. In less than a year, the company acquired 3 different sites, in Little India, Serangoon and Mountbatten, which were eventually developed into the respective projects: 28 RC Suites, 18 Charlton and 8M Residences.
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Sysma’s property projects

In order to fund its new capital intensive property business, Sysma embarked on a series of equity fund raising exercises, which included a rights issue and two share placements, all less than 2 years after its listing. Inclusive of the IPO, the company generated collective net proceeds of $31.5 million, of which $21.2 million was put to use in property development. On top of it, Sysma borrowed more than $90 million from banks to finance these projects. However, the initial property sales disappointed and even resulted in Sysma taking a hefty write-off in FY2014.

Nonetheless, the company was able to sell the bulk of its remaining units in 28 RC Suites and 8M Residences gradually over the next 3 financial years and pare down most of its bank borrowings. As at 31 July 17, the company is sitting on a much stronger balance sheet including a net cash position of more than $27 million, equivalent to 72% its market capitalisation.

Its construction arm currently has an order book of $50 million after taking into account contracts won in the last 6 months. These orders will be progressively recognised over a period of about 2 years from 1 August 17.

Our Take

Property forays not well-timed but troubles a time of the past

As a relative newcomer to the property development industry, Sysma’s entry couldn’t be more badly timed as it acquired all the land needed for its projects just when property prices were peaking between Q4 2012 and Q3 2013. As a result, it was forced to take a $17.2 million provision for foreseeable losses at its property division in FY2014. That swung its full year profit after tax for that year into the red with a $11.8 million loss from a $6.6 million profit the year before. At the same time, because of the loans it took for the property projects, Sysma’s net gearing also ballooned to more than 2x at its peak in FY2014.

(Source: URA)

Since then, Sysma has recovered to post 3 consecutive years of profits. Gradual monetisation of its property inventory, especially units at 28 RC Suites and 8M Residences also helped it record strong operating cashflows, thereby enabling it to rapidly pare down its debts. As of 31 July 17, it has a net cash position of $27.1 million, a big improvement from its net debt position of almost $90 million just 3 years earlier.

(Source: company filings, stockresearchasia)
 
Surge in Charlton 18 sales should boost already strong balance sheet further; increased dividends possible

As at FY2017, Sysma carried on its balance sheet $44.1 million worth of development properties, reflecting the 4 remaining shop units at 28 RC Suites and 15 unsold terrace houses at Charlton 18. However, we note from caveats lodged at URA that the company has since sold another 13 units at Charlton 18 for a total of $36.8 million.

Although we do not expect the additional property sales to contribute more than $2 to 2.5 million to the bottom line, the cash proceeds should serve to reinforce an already strong balance sheet.  Subject to further working capital movements, we estimate that the company will have a net cash position of at least $43 million and zero debts by 31 January 18, giving it a net cash position of more than 17 cts per share or 14% above its last traded price of $0.149.

With the Executive Chairman owning 66% of the total issued shares, we also think that payment of a much larger annual dividend or even a substantial one time special dividend may be in store.

Dwindling construction order book a concern but stable GCB/landed market offers some comfort
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On the flip side, one area of concern for Sysma shareholders is its gradually dwindling construction order book. Its last reported outstanding orders as at 31 July 17 amounted to $38 million. If we take into account the 2 contracts it won recently for projects at Medway Drive (an IPT subject to shareholders approval as it was awarded by Executive Chairman’s son, Sin Ee Wuen) and Tanglin Hill, this figure would increase to $50 million. Still, this is less than half what it was 3 years ago.

Part of this decline may be explained by the gradual run-down of a $58 million contract Sysma clinched for the Oxley Rise project commencing November 2014. Since that win, its new projects have largely been smaller bread-and-butter GCB and other landed ones. These new orders though have not been sufficient to arrest the order book decline.
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However, we think that there may be a silver lining on the horizon: the GCB and landed detached resale market, which Sysma is highly dependent on, has been growing over the past 3 years. ​

Both resale volume and value of GCBs and landed detached (no-GCBs) houses within the GCB districts have been on the uptrend (Source: URA, stockresearchasia)

Based on URA caveats lodged, total resale volume and value of GCB and other detached houses in designated GCB districts (10, 11, 20, 21 and 23) have been on the rise. And since most reconstruction of GCBs and detached houses typically arise only when they change hands, this spells more opportunities in the market for Sysma. Coupled with the company’s strong track record in this niche segment, this gives rise to hope that the company may soon be able to replenish its order book and provide more earnings visibility going forward.
 
Recommendation

It is likely that Sysma’s missteps in the past 5 years- including a poorly timed entry into property development and a brief “deworsification” attempt into the petroleum products business, which does not offer any natural synergies- may have caused it to fly under investors’ radar.

Nonetheless, a rapidly improving and sterling balance sheet should warrant a closer look from value-oriented investors. At the last traded price of $0.149 and a net cash position estimated to exceed $0.17 per share, the market is effective paying investors $0.021 per share to buy Sysma shares and giving away free-of-charge a consistently profitable niche construction business to boot.
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While a dwindling construction order book could raise some concerns, ongoing strength in the GCB and landed detached resale market may open up more opportunities for the company to reverse the downtrend.

All in all, we believe Sysma currently offers compelling value. Possible near term catalysts include increased or special dividend payouts and contract wins. We are buyers at this price.

Key risks

1. Another “diworsification” attempt by the management- With the top two management staff of the company owning collectively 72% of the company’s shares, we believe the interests between management and minority shareholders are sufficiently aligned in this case to mitigate this risk. Furthermore, we believe that the management would be more cautious in assessing future opportunities after its experience with Sysma Energy’s petroleum products venture.  
2. Company committing its cash hoard to another poorly timed attempt at property development- Again, we believe that the company has learnt its lesson from its initial forays into this sector and will be extra cautious in its approach.
3. Failure to replenish its construction order book- The next 12-18 months could be key. Should the company fail to win significant contracts going forward, its bottom line may swing into the red. Our initial thesis may change in that instance.   

Earlier this month, Lippo China Resources Limited (“LCR”) and funds managed by and including Argyle Street Management Limited (“ASM”) jointly launched a voluntary unconditional offer of 57 cts for each TIH share pursuant to a consortium agreement signed on the same day. The offer is made through Kaiser Union Ltd ("Bidco"), an SPV wholly owned by LCR.

Of the 57 cts per share, 12.5 cts is to be paid in cash with the remaining 44.5 cts to be paid in the form of a 3 year 2.25% unlisted unsecured senior bond issued at par by the Bidco. ASM and its funds have already undertaken to tender a maximum of 110,732,656 TIH shares equivalent to 45.8% of the total issued share capital in acceptance of the offer. The number of shares to be tendered by ASM and its funds will be reduced by the aggregate number of shares tendered by minority shareholders and acquired through open market purchases made by the Bidco.

Based on the responses so far, it seems that the offer has not been received well by the minority shareholders. While it remains to be seen if shareholders have indeed been short-changed, we think one big winner has already emerged regardless of the outcome of the offer: the Lippo group.  

Firstly, due to the undertaking by ASM and its funds, LCR is already assured of acquiring an initial 45.8% controlling stake in TIH based on its 100% ownership of Bidco (although Bidco, LCR and ASM may transfer TIH shares between themselves to achieve their desired shareholding levels within 12 months of offer close). If Lippo’s intention is indeed to expand its securities and fund investment business in Asia through TIH, then this is certainly a cost effective way to do so. Afterall, based on the undertaking shares, LCR need only pay a maximum amount of $13.8 mil upfront for the entire stake with the remainder mostly paid 3 years later.
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Secondly, and perhaps more importantly, the move actually helps Lippo tighten its hold on OUE Ltd. To understand why, we only need to look at the simplified ownership chart  compiled below:

From the chart, we can see that ASM plays an integral role in Lippo’s control over OUE via the holding entities, Lippo ASM Asia Property Ltd (“LAAPL”) and Fortune Code Ltd (“FCL”).

In particular, ASM-controlled TIH currently owns a 7.95% stake in FCL which in turn controls more than 68% of OUE shares. Had ASM sold its stake in TIH to a 3rd party, Lippo would have to deal with a potentially unfriendly minority shareholder in FCL. The Joint Offer by ASM and Lippo’s LCR basically ensures that such a scenario would not happen.

On top of it, Lippo will now gain direct control over the stake in FCL held by TIH. All these for a upfront cash outlay which is unlikely to burn a hole in Lippo’s deep pockets.
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In our opinion, this makes them the biggest winner in this takeover exercise, by far. 

As 2017 came to a close, we find ourselves faced with a vastly different equity market landscape compared to the start of 2016 when we penned our first year review report. At that time, global equity markets were in the doldrums with many Asian market indices plunging to multi year lows. We expressed our optimism then through Herb Stein’s famous quote “If something cannot go on forever, it will stop.” 
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Almost 2 years on, that quote has proven to be more prescient than we originally envisaged as markets bottomed out shortly after with the STI surging 32% from 2577 to end 2017 at 3403. However, even this performance pales in comparison to S&P 500’s 40% gain and HSI’s even more impressive +57% run over the same period. As a result, equity owners should, by and large, be satisfied with the gains recorded over the last 2 years. Indeed, the ongoing bull market appears to be humming in global unison, backed by better than expected growth in top economies like the USA and Japan.

Our picks in the last 2 years have similarly done well and, with the exception of one, outperformed the market significantly. As we did not do a year-end review for 2016, we have included picks for that year in this report. In terms of benchmark, we have elected to use the SPDR STI ETF for the Singapore stocks that we covered instead of just using the STI Index as in the past in order to better quantify the impact of dividends on total returns [1].   
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Performance of our picks
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For the two years combined, our picks have collectively turned in a commendable performance, outgunning the benchmark by an average of 35.8%. However, this is largely skewed by the only recommendation (TSH Corporation) we made in 2016, which generated outsized returns of 129% over 9 months, handily beating the STI ETF over the same period.
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In 2017, our coverage was focused on 5 stocks, the last of which was Hupsteel. However, we will not be reviewing the latter given that our report on it was only issued little more than a month ago, making any comparison of its market performance over such a short period of time less meaningful.  

Among the other four 2017 stock picks, OKP Holdings sticks out like a sore thumb for being the only underperformer, down 8% from the time we made the opportunistic call on 17 July 2017 vs a 5% gain in the benchmark over the same period. On the other hand, Bukit Sembawang Estates, HG Metal and Yongnam performed much better, generating average gains of 29% since the start of their respective coverage till the end of 2017. We should, however, highlight that in Yongnam’s case, the outperformance was somewhat fortuitous as the major contract win that we had originally identified as a potential catalyst did not materialise. Nevertheless, even if Yongnam had been excluded, our 2017 picks would still have outperformed the benchmark on average.   

As usual, a summary of the performance of our stocks is tabulated below accompanied by key updates on selected companies:

Our picks have once again outperformed the market benchmark.

TSH Corporation- impending acquisition could transform it into a property play

Since completing the disposal of its remaining core business at the end of August 2016, TSH has been a cash company as defined under Rule 1017 of the SGX Catalist rules and remains so. As we have mentioned in the past, cash companies typically have up to a year to enter into a new core business or risk being delisted by SGX. In an attempt to preserve its listing status, TSH has entered into a non-binding agreement on 21 August 2017 with entities controlled by its largest shareholder, Teo Kok Woon, to acquire a chain of Australian properties targeted at business owners in the beauty and wellness industry. The preliminary consideration is based on the combined net asset value of these properties of A$8.0 million and is to be satisfied by the issuance of new TSH shares at $0.035 apiece. The terms of the proposed acquisition, though, will only be finalised upon entry into a binding sale and purchase agreement at a date currently expected to be no later than 28 February 2018.

Recall that in our initial report, we had singled out the controlling Teo family as shrewd property investors with a strong track record. In the event that Teo decides to make TSH a de facto holding company for his family’s property business, more acquisitions can be expected in future. We think TSH and minority shareholders as a whole will stand to gain from his expertise in property investment and management. For Teo, having TSH as a ready listed platform for future acquisitions provides him with additional funding options to tap on without having to go through the hassle of a lengthy listing process. Naturally, we see the proposed acquisition as a win-win for both TSH and its largest shareholder.   

For illustration, if the acquisition were to be completed based on the preliminary terms, we expect the NTA backing of TSH shares to increase to more than 2.9 cts per share from the current 2.4 cts.
 
Bukit Sembawang Estates- Market beginning to recognise its potential
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Since our February report on Bukit Sembawang Estates (BSE), the market seems to have suddenly woken up to this deep value play, sending its share price soaring to a multi-year high of $6.90, before closing the year at $6.27. Together with a generous dividend pay-out of $0.33 per share for the third year in a row, BSE clocked total returns of over 33% from 13 February till end-2017, outperforming the benchmark by a wide 21% margin over the same period.   
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We think part of BSE’s rise could be attributed to the sudden pickup in collective sales activities in Singapore as developers bid ever more aggressively for attractive sites such as Amber Park (won by CDL’s subsidiary for $907.7 million) and Normanton Park (sold to Kingsford Huray Development for $830.1 million). In some cases, optimistic winning bids appear to have already built in a minimum increase of 10-15% in property prices. This in turn begs the question: why are developers suddenly throwing caution to the wind?

For one, the gradual improvement in property market sentiments could have boosted developers’ confidence of a sustained recovery in property demand and prices. Two consecutive quarters of increases in URA’s Private Residential Property Price Index following declines in the previous 15 quarters suggests that this confidence may not be misplaced after all:  

(Source: URA, Stockresearchasia) 
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​In addition, the need for listed property companies to replenish their rapidly depleting land banks has also been touted as another possible reason. This seems to be supported by the fact that 6 of the top 10 largest residential collective sales in 2017 involve buyers controlled by listed companies: 

(Source: Stockresearchasia) 
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Regardless of the real reasons that might be fuelling it, it remains to be seen if the collective sales boom will continue in 2018. What is clear though is that, unlike most other listed property developers, BSE is sitting tight on a huge land bank carried on its books at historical costs and is therefore under no pressure to join in the current collective sales fever. This puts it in an enviable position to benefit from any sustained recovery in the property markets without having to pay top dollar for land.  

Going forward, we think that the impending launch of 8 Saint Thomas @ St Thomas Walk and Nim Collection @ Ang Mo Kio would likely provide the impetus for a further rise in BSE’s share price as well as the necessary cash flow to support its best-in-class dividend yield of over 5%. In particular, we estimate that 8 Saint Thomas could easily bump up BSE’s cash holdings by at least $500 million when fully sold, giving its already strong balance sheet a further boost.

As for Paterson Collection, BSE’s completed project near the plush Orchard Road area, there has been little update so far from the company. As we have mentioned previously, the project should already have been liable for QC penalties in October 2017 but BSE has yet to officially launch it. So far, the only sale made was for a single unit to the controlling Lee family in April last year for $3.3 million. Given that QC penalties could be much more substantial in 2018 and 2019 [2], we think the company’s management should do a much better job in communicating its plans for Paterson Collection to shareholders.
 
OKP Holdings- Delay in resumption of Tampines viaduct project an albatross around its neck

When OKP’s share price was punished for a fatal accident at its Tampines viaduct project worksite in July, we deemed it an opportunistic buy at $0.37 per share based on favourable factors such as its established track record, robust order book, strong net cash position, low valuations and an attractive dividend yield. At the same time, we warned that it is likely to face increased scrutiny in its current projects and future tenders and its share price could also be under short term downward pressure from the negative sentiments generated. Since then, OKP has languished mostly around the 33-35 cts range.

Despite previous indication from the authorities that the investigation will conclude by last October [3], results of the inquiry have not been released even as we come to the end of the first week of 2018. When we last paid a visit to the site in December, it was quiet and work did not appear to have resumed since the accident. A quick check with a few workers just outside the worksite confirmed this.

5 months after the accident, work has yet to resume on the Tampines viaduct project.

Needless to say, this puts a dampener into any hopes of OKP shareholders for a quick recovery from the accident as any further delays in the investigation process and pushback of subsequent work resumption would weigh heavily on OKP’s share price and financial performance for FY2018.

On a more positive note, OKP still managed to eke out a profit of $0.7 million for 3Q2017 despite recognising zero revenue and an additional $3.1 million cost for the Tampines viaduct project.
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Its 10%-owned property development project, Amber Skye, has also seen improving sales over the past 3 quarters. According to URA caveats lodged, the project has now sold 73 of its 109 total units, up from a paltry 14 units just nine months ago. The attractiveness of the project has been further enhanced by the recent collective sales of nearby sites at bullish prices- Amber Park, for instance, was sold to a CDL subsidiary at a land cost of $1515 psf ppr whilst Parkway Mansion was sold to a Sustained Land consortium for $1536 psf ppr. Both the latter projects figure to have breakeven costs of above $2000 psf and projected selling prices upwards of $2300 psf. By contrast, the weighed average transacted price for the 73 units of Amber Skye sold so far is a much more affordable $1887 psf.

​Despite being situated closer to the future Tanjong Katong MRT station, Amber Skye is currently selling its units at a discount to even the projected breakeven cost of future developments that might be built on recent collective sales sites of Parkway Mansion and Amber Park. 
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We think this bodes well for future sales at Amber Skye and reiterate our belief that the project should be on track to sell the majority of its units by mid-2018, when the near $20 million loan OKP had extended to the project company is due for repayment. Consequently, subject to any additional cost to be incurred arising from the delay of the Tampines viaduct project, we expect OKP’s net cash position during the year to improve to at least 30 cts per share, representing more than 85% of its last traded price of 35 cts.
 
Closing Note
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So what can investors look forward to for the rest of 2018? The outlook for equities appears to be largely positive, at least according to multiple global banks and investment powerhouses. Our views are somewhat less sanguine. While we do not profess to have the ability to predict where the markets will end up when 2019 comes around, our personal observation is that bargains are harder to come by now than on average in the last 3 years as a result of an across-the-board increase in valuations. Consequently, we anticipate taking on less new positions in 2018 as well as moderate our expectations on returns from these positions.  

NB 1: We have not included any updates on HG Metal and Yongnam as there has not been any notable development at either company since our last report on them in September.
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NB 2: The above views are our own and are not meant to be construed as an offer, or solicitation of an offer to sell or buy securities referred herein. Please refer to the section “Important Notice” at the bottom of our homepage for additional information and disclosures. 

Just two weeks ago, we stated our belief that Hupsteel’s management will increase efforts towards maximising the value of its investment properties going forward. The ball has already started rolling it seems, as after the close of market today, the Company announced it had given a Letter of Award to redevelop its aging freehold property at 38 Genting Lane into a new 8-storey industrial building capable of being strata subdivided for use by multiple users. The new building will have elevated car parks and a gross floor area of 5,259 square metres (sqm).  

While we had previously flagged this redevelopment as less probable in the near future especially with the other recently redeveloped building at 6 Kim Chuan Drive yet to be tenanted out, we are heartened by the fact that:

1. The planned capital expenditure of $9.3 million over 24 months of construction is not as substantial as feared and should be comfortably covered by its cash position of $61.5 million as at 30 Sept after accounting for the dividend payment in November;
2. The new GFA of 5,259 sqm represents an increase of 30% over its existing GFA of 4,040 sqm and will likely lead to an increased valuation for the building; and
3. The move to strata sub-divide the building gives the Company flexibility to sell some or all individual units in it and potentially recoup more than the capital committed thereby unlocking value from the freehold building.

Taken together, we view this move as another step in the right direction for the Company. We remain positive on this deep value stock. 

​Previously in June, we cited the possibility of a renewed interest in steel stockists like Hupsteel and Asia Enterprises following the intriguing developments at HG Metal. While Hupsteel’s share price has returned 12% since then (14% if dividends are included), it is still trading at a substantial 28% discount to just the sum of its net cash, available for sale financial assets and investment properties alone and an even more attractive 48% discount to its revalued NTA of $1.71 per share. Furthermore, recent signs that the Company’s management is turning its attention towards maximising the returns of its investment properties has us increasingly positive that this big discount it is trading at will narrow considerably in the near to mid future. We are buyers at the last traded price of $0.895.
 
Valuable investment properties portfolio- more action in store with new sole CEO at helm?
 
To recap, Hupsteel owns, under its property division, a relatively sizeable portfolio of freehold commercial and industrial investment properties that it had held substantially unchanged from the time of its IPO in 1994. On 29 Jun this year, however, the Company announced that it had sold one of its two long-held Jalan Besar shophouses at a price of S$5.2 million, booking a handsome profit of $4.5 million in the process.
 
This came as a surprise as prior to this sale, the only significant activity Hupsteel undertook with respect to its investment properties in the last 23 years had been the redevelopment of 6 Kim Chuan Drive into a 7-storey industrial building in 2015. 

Hupsteel’s remaining investment properties
 
Although the sale generated little fanfare, we posit that it could mark the beginning of a series of developments signifying the Company’s intentions to maximise returns from its investment properties. Our views are reinforced by telling disclosures in the latest annual report and comments made by the management during last month’s AGM.
 
Besides promising that “more action will be taken on its remaining properties in anticipation of a recovery in market conditions” in its latest annual report when reporting the sale of the said Jalan Besar shophouse, the management also presented some updates at the AGM with respect to the rest of the portfolio, namely:

• The Company is in advanced talks to lease out the majority of 6 Kim Chuan Drive, the largest property in its portfolio, to a single MNC client;
• Rising en bloc activities especially in the nearby Jalan Besar Plaza[1] could stir increased interest in their office units in Hoa Nam Building which is similarly zoned as a mixed development and that may in turn lead to opportunities for the Company to cash in; and
• The Company may consider plans to redevelop its aging 7-storey industrial building at 38 Genting Lane to optimise its potential

 
We think it is no coincidence that the above developments are taking place less than a year after Mr Lim Bor Chuan, the 3rd generation member of the controlling Lim family, took over as sole CEO of the Company, a role previously shared with his uncle Lim Kim Thor. After all, the younger Lim has a degree in Estate Management and has been in charge of managing the Company’s real estate portfolio since IPO. With him at the helm, we are optimistic that Hupsteel will be more proactive in managing the portfolio, which should be music to shareholders’ ears.
 
Given that the remaining investment properties have a total market value of $75.2 million[2], any attempts to maximise the potential of this portfolio could go a long way towards closing the gap between its share price and revalued NTA.

Core business turning a corner
 
The positive developments with respect to Hupsteel’s property division also comes at a time when its core business seems to be finally stabilising after a multi-year decline.
 
Hupsteel’s core business is in the supply of steel products and industrial hardware to industries such as the oil and gas, chemical and petrochemical, energy, infrastructure, marine, etc., with the majority of its revenue derived from Singapore. Perhaps unsurprisingly, it was badly affected by the downturn in the marine and oil and gas sectors in the last few years. In fact, between FY2012 and FY2016, Hupsteel’s revenue collapsed almost 80% while its profit after tax swung from a positive $7.2 million in FY2012 to a loss of $19.1 million in FY2016, mainly due to write-downs in both its inventory and receivables. 

By FY2017, however, its core business appears to have finally stabilised and that momentum continued into 1Q2018 when it announced its fourth consecutive quarter of profits[3]. 
 
A large part of this recovery should be credited to the Company’s efforts to better manage its inventory “by making small regular purchases to avoid being saddled with the burden of holding large quantities of slow moving inventory and making sure that commonly required sizes were readily available to meet customers’ needs”[4].
 
In addition, the Company also revealed that it is actively seeking collaboration opportunities with some of its customers to work together on tendering for projects in a bid to broaden its revenue stream. If successful, we reckon this could lead to an increase in both revenue and profit margins. Nevertheless, regardless of whether it succeeds in its new approach, we think the worst is likely over for its core business. 
 
Strong net cash balance can support increased share buyback and dividends
 
On the back of the welcome stabilization of its core business and a strong balance sheet with net cash balance of $61.5 million[5] as at 30 Sep 17, Hupsteel has also been stepping up both its share buyback and dividend payout. For FY2017, it paid a dividend of 2 cts per share, giving it a dividend yield of 2.2%. This is an increase from the 1 ct and 0.5 ct declared in FY2016 and FY2015 respectively, although it is still a far cry from the 5 cts per share it paid in the years prior to FY2015.
 
Meanwhile, it has resumed its share buyback activities in FY2017, after a break of 2 years. Although the amount of cash it typically spends on buybacks is still insignificant (<$1 million per year), it nonetheless signifies the management’s confidence in the Company’s outlook especially when taken together with the increased dividend payout.

​Going forward, we think there is scope for the Company to increase its dividend payout even further for FY2018, possibly  funded by the proceeds from the disposal of its Jalan Besar shophouse. 
 
Recommendation
 
We expect further actions by Hupsteel in the coming year to drive increased returns from its valuable investment properties. These could include:

• Sale of the smaller properties within its portfolio such as its remaining shophouse at 365/365A Jalan Besar and the office units in Hoa Nam Building
• Entry into a lease agreement for substantially the entire 6 Kim Chuan Drive building. The lease agreement would also likely enhance the attractiveness of the building as an investment and consequently, we also would not rule out its sale if the right offer comes along.

 
That said, we see the redevelopment of 38 Genting Lane as less probable in the near future as the management is likely to be extra cautious in pulling the trigger having already experienced an uncomfortably long 2-year (and counting) wait to rent out or dispose of the redeveloped Kim Chuan Drive property.
 
With the worst of the downturn facing its core steel trading business likely over, any actions taken by the management to enhance returns from its investment properties should have a positive effect on its share price. Consequently, we expect to see the large discount it trades at to its revalued NTA to narrow significantly.
 
As it is, even if we were to value the Company conservatively based on the sum of its net cash, available for sale financial assets (which consists primarily of listed securities) and investment properties alone and discount its core business entirely, we would still arrive at a value of $1.24 per share, implying a 39% upside from its last traded price of $0.895.
 
Following HG Metal’s 30% run-up over the last 5 months, we are also of the opinion that Hupsteel now offers better value as well as more share price catalysts than HG Metal. We are buyers at this price.
 
Key Risks
 
Another prolonged decline in oil price could lead to an extended downturn for its core steel trading business. However, we think the Company has learned its lesson and would continue to exercise caution in managing its inventory to avoid future losses arising from write-offs.

We previously wrote separate reports on HG Metal and Yongnam highlighting recent developments that shareholders of the respective companies should look out for. Coincidentally, last Friday (8 September 17) turned out to be a day of contrasting fortunes for both groups.

HG Metal- value to be unlocked from  proposed BRC Asia stake sale
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In our previous report on HG Metal, we had assumed Sia Ling Sing to be the substantial shareholder whom has been approached with regard to a sale of his stake in BRC Asia. We also posited that if such a transaction leads to a sale of HG Metal’s own BRC Asia shares, it will be a major boost to HG Metal’s balance sheet.

Our assumption was proven correct in last Friday’s announcement by BRC Asia that Esteel Entreprise Pte Ltd (offeror), backed by two individuals in You Zhenhua and Liu Bin, had acquired an aggregate 81.6 million shares from Sia Ling Sin’s Lingco Marine Pte. Ltd. and Lingco Holdings Pte. Ltd., Mr. Seah Kiin Peng, Sin Teck Guan (Pte) Ltd. and Mr. Lim Siak Meng at S$0.925 apiece. As the shares transacted represented 43.77% of the total number of issued BRC Asia shares, this triggered a mandatory takeover offer. The offer is conditional upon the offeror receiving sufficient offer shares as at the close of the offer that will result in it holding at least 50% of BRC Asia’s total outstanding shares.

The offer price is at a slight premium to BRC Asia’s latest reported net asset value of S$0.897 per share and translates into a TTM (Trailing 12-month) high PE of more than 43x. We also note that BRC Asia last traded at the offer price more than 2 years ago. Further, in its latest Q3 results announcements, the company also continued to warn of the bleak industry outlook going forward. All signs, hence, point to the likelihood that BRC Asia shareholders will find the offer an attractive proposition. ​With the offeror needing just 6.23% in acceptances to hit 50%, we think the offer turning unconditional is a matter of when, not if.

Subsequently, HG Metal also announced a day later that it had entered into an agreement with Esteel to accept the mandatory conditional offer with respect to its 22.62% stake, subject to it getting shareholders’ approval within two months. The proposed sale should add $39 million or about $$0.31 per share of cash to HG Metal’s coffers, bringing its net cash to $0.47 per share with an adjusted NTA backing of $0.92. The company also raised shareholders’ expectations by stating its Board’s intention to, among other stated uses, “consider to return any surplus capital in excess of the Group’s needs to Shareholders”.

Consequently, HG Metal’s share price has reacted positively by closing at $0.58, up almost 40% from the date of our last report.

Yongnam- Misses out on Kim Chuan Depot extension project but consolation came in the form of other smaller contract wins

While HG Metal shareholders rejoice last Friday, the opposite could be said for Yongnam shareholders.

When we last wrote about Yongnam, we pointed out that its JV with Korean giant Daewoo E&C had submitted the lowest bid for LTA’s mega contract to construct the Kim Chuan Depot Extension for Circle Line 6 but warned that there is no assurance that the lowest bidder will be the winner with other factors such as quality and safety surely being considered. Unfortunately for its shareholders, Yongnam lost out again, this time to privately held Woh Hup’s slightly higher winning bid of $1.21 billion. This is also the second time one of Yongnam’s JVs had been pipped in a mega LTA contract tender in the last 2 years, having missed out on the $2 billion East Coast Integrated Depot project in 2016. 

The market has since responded negatively with Yongnam shares closing down more than 8% on Monday at $0.265, from the $0.29 it last traded before the results of Kim Chuan Depot extension tender was announced over the last weekend.

However, there was some consolation for shareholders in the form of $70 million of contract wins announced on 30 August 17, which are expected to contribute positively to its FY17 and FY18 results. This follows the $36.2 million total contract wins announced earlier on 15 June 17.

Going forward, shareholders can only hope for more positive new flow from the Yongnam-JGC Corporation-Changi Group ​consortium’s pending US$1.4 billion Hantharwaddy airport project in Myanmar, which has been slow to take-off but seeing some progress of late as well as more project wins especially from the Singapore public infrastructure sector where many projects have yet to be awarded.  Only then can a turnaround in its fortunes be truly realised.

(All currency above in SGD unless otherwise stated)

Not too many things have been going right for Yongnam Holdings Ltd (“Yongnam”) over the past few years with seemingly one bad news after another.

For instance, it announced on 31 May 17 that it had recorded 3 consecutive years of losses and only avoided being placed on SGX’s watchlist by virtue of its larger than $40 million market capitalisation.
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This follows a dismal showing in the last full financial year of 2016 when it recorded a whopping loss of $31.6 million, matching its largest since listing in 1999, and a far cry from its heydays of FY2009 to FY2012 when it was generating more than $40 million in net profits in each of those 4 years. Its future prospects also look challenging as its order book dwindled to $218 million as at 31 March 17, just slightly more than half what it was at the end of 2014. 

Even an attempt to raise funds amounting to $33 million via a rights issue in 2016 was met with poor response. Despite the rights being priced at a significant discount to Yongnam’s closing share price just prior to the rights issue announcement, its own shareholders only took up 36% of their rights entitlement. The fund raising was eventually saved by the 33% excess rights application (including 23% by its CEO Seow Soon Yong as per undertaking) with its underwriter CIMB picking up the rest.
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Not surprisingly, its share price has been battered. At the last close of $0.235, it is trading close to a level last reached in the 2008-2009 global financial crisis and at about a 63% discount to its NTA backing. 

New Substantial Shareholder emerging

Despite the ongoing challenges, Yongnam has curiously managed to attract a new substantial shareholder, Mohamed Abdul Jaleel, in recent months. Mr Jaleel’s initial substantial interest appears to have been a result of CEO Seow’s post-rights issue put and call arrangement with CIMB to acquire the underwriter’s 49.4 million shares at the then rights issue price of $0.21 per share. Of these, 23.5 million share options were still outstanding until early February when Mr Jaleel coincidentally filed with SGX an increase of his holdings by the same number of shares acquired at $0.21 each. He subsequently made 2 other off-market purchases, raising his holdings to 36.5 million shares for a 7.7% stake.  

Mr Jaleel, who has been covered in the past by various newspapers for his philanthropic deeds, runs privately owned MES Group. MES Group reportedly had a turnover of more than $100 million in 2013 and according to its website, is in both the property (accommodation and facilities management) and logistics businesses. On a less glamorous note, the group had also previously been found guilty of tax evasion in 2010.

While we do not want to speculate on what Mr Jaleel sees in Yongnam to invest more than $7.5 million to buy its shares in less than 6 months, his entry and future movement is worth keeping tabs on.

Possible beneficiary of mega-infrastructure projects?

The Singapore government is expected to be awarding several mega public sector infrastructure projects in the coming months as part of the $20 to 24 million public sector construction demand projected by BCA. These include major contracts for Deep Tunnel Sewerage System (DTSS) Phase 2, North South Corridor and MRT Circle Line 6.

It is unclear how many of these tenders Yongnam has participated in although it indicated in its Q1 results announcement that it is currently in pursuit of $1.1 billion worth of projects.
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One major contract of interest is for the Construction of Kim Chuan Depot Extension for Circle Line 6. According to LTA’s tender information webpage, tender for the project has closed and bids from various participants have already been made available. Intriguingly, it appears that a joint venture (JV) between Daewoo E&C and Yongnam has submitted the lowest bid of $1.18 billion, just 2.5% lower than Woh Hup’s next higher bid. Daewoo E&C, a contractor ranked in the top 40 globally according to US based ENR, is no stranger to the Singapore construction scene and has previously won another LTA contract for the construction of Stevens MRT Station on the Thomson Line for $441 million.

(Important note: The above is a screenshot of the actual document that is publicly available on LTA’s tender information page as at date of writing)

We note though that the contract has yet to be awarded and details of the bids are not publicly available. There is also no certainty that the lowest bidder will be the winner with other factors such as quality and safety surely being considered, so it may be too early for Yongnam’s shareholders to pop their champagne. Still, if the Yongnam JV does indeed end up winning the contract and assuming Yongnam’s portion is at least 20-30% of the total contract value, this could represent its single biggest contract win to date and potentially more than double its existing order book.

It would also provide some consolation for the other mega contract -construction of the East Coast Integrated Depot- that it missed out on in 2016. On that occasion, Yongnam’s JV with Penta-Ocean Construction Company was pipped by Korean giant GS Engineering & Construction Corporation who put in a bid of $1.99 billion vs the $2.07 billion put in by the JV. Incidentally, like Daewoo, GS and Penta Ocean are all ranked among the top 100 global contractors, perhaps an indication of the intense level of competition these mega infrastructure projects generate.
 
Conclusion
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It may be too early to say for sure that Yongnam’s fortunes are set for an upturn. Nonetheless, the recent entry of businessman and philanthropist Mohamed Abdul Jaleel as a new substantial shareholder and the results of the tender for mega infrastructure projects such as the aforementioned Kim Chuan Depot construction contract are key events shareholders should closely monitor. In particular, should the Yongnam JV succeed in the Kim Chuan Depot tender, it could lead to a re-rating of Yongnam’s share price, which surely would be a welcome break for long-suffering Yongnam shareholders.   

SGX listed OKP Holdings Ltd (OKP) suffered a major setback last Friday when a worksite accident took the life of a worker and injured 10 others. The project in question was awarded by the Land Transport Authority of Singapore (LTA) in November 2015 for the designing (undertaken by its project partner CPG Consultants) and building of a viaduct from the Pan Island Expressway to Upper Changi Road East. Scheduled to be completed by November 2019, it was also the largest LTA contract the Company has won in recent years. This follows another fatal accident on one of its sites two years earlier when a worker was killed, resulting in the company being fined $250,000.

While the unfortunate accident is bound to trigger thorough investigations by the authorities with the definitive conclusion yet unknown, OKP being the main contractor is unlikely to escape culpability.

The stock market has likewise responded by pushing OKP’s share price down from 43 cts to 39.5 cts before trading was halted early last Friday and further to 37 cts on Monday, after the halt was lifted over the weekend. Over the last two trading sessions, OKP has lost 14% or S$18.5 million of its market capitalisation.

The extent of public backlash is understandable given that a precious life was lost in addition to multiple other casualties suffered. However, is the Company’s safety record really as atrocious as it is currently construed?  And is it all gloom and doom for OKP as its share price plunge suggests or can the company get its act together and emerge from the challenges it faces?   

OKP- A public infrastructure specialist with a proven track record and LTA as its major client

OKP is an established player in the local civil engineering sector, having participated in numerous infrastructure projects over the past 51 years since establishment[i]. While it has undertaken projects awarded by private sector companies such as ExxonMobil and Changi Airport Group, its bread and butter is firmly in public infrastructure works, especially road works. Naturally, LTA is one of its key clients.

According to its annual reports and SGX filings, OKP has won a total of 30 contracts worth $879 million from 2012 to 2017 year to date. Of these, LTA contributed 9, making up slightly more than half of the total value at $444 million. PUB is its next biggest client with 15 contracts worth $323 million.

(Source: Company, Stockresearchasia)

In addition, poring over LTA’s data over the past 5 financial years[ii], we estimate that OKP has won roughly one out of every six major contracts it has tendered for. With an average of 7.8 bidders for each of these tenders that OKP participated in, this translates into a better than average success rate in tendering for LTA projects.

(Classifications as per LTA annual reports. Source: LTA, Stockresearchasia)

Taken together, the above clearly illustrates LTA’s importance as a client to OKP. Hence, any setbacks such as the last which could potentially impede OKP’s ability to tender for future LTA projects is likely to adversely affect the Company’s prospects going forward. That said, we think It is important to look beyond the latest accident and examine OKP's longer term safety track record in order to get a better feel of the potential impact.
 
Safety track record in focus
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According to its website, the Ministry of Manpower (MOM) adopts a demerit points systems for the construction sector as a means of regulating workplace safety. Under the system, contractors will be issued demerit points according to the following categories of safety infringements:

Punishments are meted out in the form of debarments from hiring foreign workers. Since most of the construction firms in Singapore are heavily reliant on foreign workers for their projects, such punishments severely handicap their ability to operate normally and serve as useful deterrents against worksite safety infringements.

(Source: MOM)

​While the individual contractor’s historical demerit point record does not appear to be publicly available, MOM’s record of Stop Work Orders (SWOs) issued over the past 10 years provides a telling clue as apart from major accidents that lead to public prosecution, SWOs contribute the bulk of the demerit points. A careful analysis of OKP and its fellow SGX listed contractors’ SWO records thus provides a good indication of their safety track record.   

(Source: MOM, Stockresearchasia. Full listing of SWO can be found on MOM's webpage)
 
From the table we compiled above, we note that:

• The total number of SWOs issued on a yearly basis ranges from 79 to a surprisingly high 130, perhaps indicating that the construction industry as a whole still have some ways to go when it comes to taking adequate workplace safety measures.
• Within the select group of listed contractors, Tiong Seng appears to be the most frequent offender, chalking up 55 demerit points alone from 9 SWOs received. Three others have 5 or more. Incidentally, Tiong Seng also has the dubious honour of topping the most current list of contractors with demerit points at 55.
• At the other end of the spectrum, two companies have performed relatively well: Hock Lian Seng only had one partial SWO in the period under study and Sim Lian had gone 10 years since its 2 partial SWOs in 2007. Needless to say, other listed contractors that did not have a single SWO in the whole 10 year period performed better still.
• Interestingly, OKP only received 2 partial SWOs in the 10 year period, the second of which was for the aforementioned fatal accident in Sep 2015. Prior to that, it had gone 8 years from Jun 2007 to Aug 2015 without getting an SWO.

Based on the criteria of the demerit points system and OKP’s track record, it is likely that the 25 demerit points it currently has is solely due to the September 2015 accident. Prior to the recent two fatal accidents, OKP’s track record in safety had been relatively good compared to other listed contractors as further evidenced by the multiple safety awards and certificates of recognition it has won since 2006, ironically mostly for its LTA projects. This could partially explain LTA’s willingness to continue awarding it contracts even as recently as 2016.

Nonetheless, we are of the view that worksite safety should be a paramount concern for all and if found culpable, OKP should deservingly be dealt the appropriate punishment. The Company clearly has to step up its efforts in this regard to restore the confidence of its government agency clients. The silver lining is that it has shown itself capable of doing so previously in the period of June 2007 to August 2015. 

Despite latest setback, OKP’s robust order book, stellar balance sheet strength and resilience should see it through

OKP currently has a strong order book of $326.6 million[iii] which translates to a book to bill ratio of close to 3x based on FY2016’s full year revenue of $111.1 million. This should ensure earnings visibility through to 2019 even though its near term margins are likely to be hit with possible delays to the Tampines project and potential associated liquidated damages.

The latest accident may also cast a temporary pall over OKP’s ability to successfully tender for future LTA projects. As each demerit point is valid for 18 months, the latest accident could bump its demerit point total to 50 or 75 depending on the final fatality count[iv] and timing of the point issuance. This could prevent OKP from hiring new foreign workers for up to 1 year but is not expected to keep it from renewing existing workers’ permits. OKP’s capacity to execute its current order book should therefore remain intact.

OKP has also proven in the past its ability to operate in tough environments such as during the 2009 GFC and 2003 SARs outbreak. Its bottom line has consistently been in the black ever since its listing in 2002. This is despite lumpy revenue recognition by nature of its project-based business and the cyclical construction industry.

(Source: Company, Stockresearchasia)

In addition, OKP is sitting on a large net cash position of $83.3 million[v] (or $0.27 per share) representing a hefty 73% of its market capitalisation. It currently trades at an attractive dividend yield of 5.4%. Given its strong cash generating capability (>$20 million in operating cashflow in each of the last 2 financials years), its near to mid-term earnings visibility underpinned by a robust order book and large cash position, we expect the Company to at least maintain the dividend yield going forward.

Current valuations are undemanding compared to peers

At the last closing price of $0.37, OKP trades at an FY16 PE of 8.0x, below its peers’ average of 9.4x. However, on an ex-cash basis, this works out to be just 2.2x FY16 earnings, significantly lower than the next higher 3.9x Hock Lian Seng is trading at. Despite the current negative sentiments, we think OKP should trade at a minimum the same level as Hock Lian Seng, which would translate into a price of at least $0.45 per share, representing an upside of more than 21% from current levels. 

Further upside might be in store as improving sales at Amber Skye could bump cash pile up another $20 million by mid-2018

Besides its core civil engineering business, OKP has in recent years ventured into property development. Its current exposure to this segment is limited to 10% stakes in each of two maiden development projects: Lake Life at Yuan Ching Road and Amber Skye in District 15.  

Lake Life, an executive condominium project, has been fully sold and recognised in OKP’s accounts as at 31 March 17. Amber Skye, though, is a different story. As a 109-unit luxury condominium developed together with 90% majority partner China Sonangol Land, it has performed poorly since launching in September 2014. In the 2.5 years from launch to end of 1Q2017, it sold a paltry 14 units at an average psf of $1802.
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However, on the back of better property sentiments, sales have accelerated in 2Q2017. During the months of April to June this year, the project managed to sell another 32 units at a much higher psf of $1917, according to caveats lodged with URA. Together with the lone sale in early July, the project has now sold 43% of its total available units. It may be early days yet but should the upward momentum be sustained, the project would be on track to sell the majority of its units by early 2018.

(Source: URA, Stockresearchasia) 

With the estimated breakeven cost of the project at around $1550 to $1600 psf, Amber Skye is likely to contribute at most $2-4 million to OKP’s bottom line over the next 12 months. The bigger impact instead, will come from the repayment of $19.7 million in shareholder’s loan that OKP has extended to the project company. The loan is currently repayable in full by 26 June 2018 and had previously been written down by $1.4 million due to poor sales performance. If Amber Skye succeeds in selling the majority of its units by the repayment date, OKP should get back more than $20 million in cash (including its share of profits) giving its already strong cash position a major boost to around $0.335 per share even if we fully discount any additional cash to be generated from its operations.

Recommendation

Amidst the extensive media coverage on its latest mishap, OKP is likely to face increased scrutiny from its public sector clients, particularly LTA, in its current projects and future tenders. At the same time, its share price could also face short term downward pressure from the negative sentiments generated.

However, we think that its solid fundamentals buttressed by a robust order book, strong net cash position (which could potentially get even stronger by mid-2018) representing 73% of its market capitalisation, low valuations and attractive dividend yield should see it through the current challenges.

As for its mid to long term prospects, much will depend on the Company’s success in convincing these public sector clients of its efforts to improve its worksite safety. We believe that LTA and other government agencies will take OKP’s overall track record, including the 8-year run when the Company succeeded in avoiding any MOM-issued SWOs, into account in assessing its future tenders.
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Given the above, we think the selling is overdone and that the current depressed share price offers a good opportunity for value investors to accumulate OKP shares with a potential upside of at least 21%. Further upside over the next 12 months might be in store should its 10% owned Amber Skye project continue its strong sales momentum. We are opportunistic buyers at this price.

Background

Activist fund Quarz Capital Management’s open letter to HG Metal Manufacturing Ltd’s (“HG Metal”) board two weeks ago created quite a buzz, sending the steel stockist’s shares up 21% in just two days. This was preceded by BRC Asia Ltd’s ("BRC Asia") announcement the day before revealing that certain substantial shareholders have received an unsolicited approach in connection with a potential transaction. Details such as the identity(s) of the substantial shareholders or the nature of the transaction were not disclosed and BRC Asia cautioned that discussions are preliminary and may or may not lead to an acquisition of its issued share capital.

HG Metal subsequently clarified on 1 June 2017 that it has not been approached in relation to the potential sale of its stake in BRC Asia. Since BRC Asia only has two substantial shareholders that own more than 10% each: ex-HG Metal controlling shareholder, Sia Ling Sing, who controls 26.8% of BRC Asia shares and HG Metal itself with 22.6%, it is fair to assume that Sia is likely to be one of the substantial shareholders approached in order to necessitate the original BRC Asia announcement.

Regardless of the identity of the mystery substantial shareholder or potential buyer, should the said transaction trigger the sale of HG Metal’s stake in one way or the other, it would provide a major boost to its already strong balance sheet, enhancing its net cash position to at least S$0.46 per share, or a 11% premium over its last closing price of S$0.415.

HG Metal is however not the only stockist trading at a deep discount to intrinsic value: Hupsteel Ltd (“Hupsteel”) and Asia Enterprises Holding Ltd (“Asia Enterprises”) also offer enticing value at current prices but tight shareholding structure may discourage a similar approach by an activist fund.

Our Take

Any divestment of BRC Asia stake would be a major boost to balance sheet although write-off expected

As indicated in Quarz Capital Management’s letter to HG Metal, an intriguing part of HG Metal’s value lies in its 22.6% stake in BRC Asia, one of the leading prefabricated reinforcement steel players in Singapore.

To recap, HG Metal first acquired its original stake of 43.7%[1] in 2008 and 2009 through a combination of share purchase from the then AIM-listed Acertec Engineering Ltd and the subsequent mandatory general offer. The stake was eventually whittled down to the current 22.6% after a couple of placement exercises by HG Metal and issuances of new shares by BRC Asia itself.

Currently, BRC Asia is accounted for as an associate company on the books of HG Metal, with an approximate carrying value of S$49 million largely reflecting HG Metal’s share of BRC Asia’s total net assets plus goodwill. However, the market value of the same stake was only S$29.3 million based on BRC Asia’s last closing price of S$0.695 per share prior to the 30th May announcement. Should HG Metal dispose of its BRC Asia stake at no premium to the 30th May closing price, it will likely have to write off almost S$20 million. Despite this, its net cash would balloon to S$58 million or S$0.46 per share, giving it plenty of flexibility to reward shareholders should it wish to.

Any attempt to maximise shareholders value could find support from within board
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Unlike the other two stockists mentioned here, HG Metal does not have a majority controlling shareholder. Currently, the two biggest shareholders are Foo Sey Liang and private equity fund SEAVI Advent Investments (“Seavi”), holding 22.3% and 10.5% respectively. The other two substantial shareholders with over 6% each are Rise Capital Ventures (Rise Capital”) and Chye Hin Hardware. 

Interestingly, Seavi and Rise Capital acquired their stakes through a placement exercise in October 2014, collectively forking out S$14.7 million to buy new shares at S$0.69 each[2]. Both were then introduced to HG Metal by Foo. Seavi’s Managing Director and private equity veteran, Tan Keng Boon, eventually took over the Chairman’s role from Foo in May 2016. Foo himself, acquired his entire controlling stake (held via Flame Gold International) from Oriental Castle Sdn Bhd at an even higher price of S$0.95 per share[2] earlier in 2014.

The investment has not turn out well for Foo, Seavi or Rise Capital so far as HG Metal’s share price has only gone south since their respective acquisitions in 2014, trading as low as S$0.30 earlier this year before the recent run up.

Seavi, though, could be under more pressure than the other two given its status as a private equity fund.  Private equity investments are typically held for between 3 to 5 years before a planned exit and with Seavi entering into its 4th year of investment this coming October, we think it’s possible that it would soon need to decide on a potential exit or at least seek a partial return on its capital invested. Quarz Capital’s attempt to get the board to maximise shareholder value could therefore very well find support with Seavi and its representative on board, HG Metal Chairman Tan.

Growing Myanmar story a potential bright spark?

Since the entry of both Foo and Seavi, HG Metal has focused its efforts into expanding in Myanmar. There have been some early signs of success, as revenue contribution from the fast growing economy has gone up five times in 2 short years, from S$10.2 million annually to S$61.2 million for FY2016, dwarfing its traditional stronghold of Singapore.

While this has not been sufficient to reverse the falling revenue at the group level, further inroads into a market that is poised to grow 10% a year from 2016 to 2020[3] could have a positive impact and provide shareholders with optimism on HG Metal's future even if management does not grant any immediate gratification by returning existing excess or future cash from a possible BRC Asia shares disposal.

Fellow stockists Hupsteel and Asia Enterprises also offer intriguing value but lacks obvious catalysts

Similar to HG Metal, Hupsteel is sitting on a balance sheet stuffed full of cash and listed securities. As at 31 March 2017, it held S$55.1 million of net cash in addition to S$20.6 million of listed securities (~80% debt, 20% equity), meaning 77% of its current market capitalisation is represented by liquid assets. 

In addition, Hupsteel has also over the years accumulated a healthy portfolio of industrial and commercial property investments. So far it has amassed more than 120,000 sf of industrial properties located in the eastern part of Singapore along with shophouse and office units along Jalan Besar. The investment properties are largely carried at cost less accumulated depreciation and has a net book value of S$34.9 million. However, the company has also disclosed in its annual report that the properties are in fact worth more than double its carrying value, with the latest fair value as at 30 June 2016 pegged at S$79.6 million.

Taken together, this means that Hupsteel’s liquid assets and investment properties are already worth S$155.3 million or more than 58% above its current market capitalisation, potentially making it an attractive investment or target for activist funds.

However, we note that Hupsteel is largely family controlled, with the founding Lim family owning more than 50% of its shares. An approach by an activist fund would thus be less likely and effective. Any efforts to maximise shareholder value would largely have to originate from the controlling shareholders themselves.

Meanwhile, the situation at Asia Enterprises is more straightforward. While it does not own a large chunk of shares in another listed company or have value embedded in some investment properties, it continues to sit on a mountain of net cash of about S$60.5 million, just a shade below its latest market capitalisation S$61.4 million. We note though that the company has been hoarding this cash pile for at least the last 3 years and does not seem to have taken any concrete steps towards either deploying or distributing it. Unless the controlling Lee family (38.7%), who together with fellow long time directors of its key operating subsidiary, Harmaidy (11.7%) and Teo Keng Thwan[4] (5.1%), control just over 50% of the shares, has a change of heart, this might not bode well for shareholders seeking a windfall from the accumulated cash.

Conclusion

While discussions are preliminary, any potential transaction at BRC Asia that leads to an eventual sale of HG Metal’s stake is likely to be positive for HG Metal shareholders. It remains to be seen if HG Metal decides to take adopt some of Quarz Capital Management’s suggestions. Regardless, we believe HG Metal’s two largest shareholders’ interests, private equity outfit Seavi in particular, are pretty much aligned with the public shareholders’ given that both acquired their stakes at significantly higher prices than today.

Hupsteel and Asia Enterprises, in the meanwhile, remain significantly undervalued themselves. However, the tightly controlled shareholding structures in these two companies are likely to dissuade any activist fund from trying a similar approach as that of HG Metal. Any efforts to unlock shareholders’ value would have to be driven by the respective controlling shareholders themselves.

As one of the grand old dames among property developers in Singapore, Bukit Sembawang Estates Ltd’s (“BSE”) origins can be traced as far back as 1911 when it started as a rubber company. Ever since it changed its focus to property development, it has developed and sold more than 4,000 homes comprising largely of landed properties in the northern part of Singapore.

While a recent surge of interest has seen its share price rally 9% in 3 weeks, we think investors still do not fully appreciate how undervalued it truly is. With its legacy land bank carried at a historical cost determined more than 60 years ago, a best in class dividend yield of more than 6.7% and a net cash balance sheet that is the strongest it has been in at least 20 years, BSE is our top pick to ride out the current trough in the property cycle.

Just revaluing the legacy landbank at close to current market prices and without taking into account any future development profits should see the Company add another $2.29 per share to its NTA, giving it a base NTA of at least $7.21 per share, or 46% above its last closing price of $4.94. This is not even taking into account any potential gains from BSE’s recent moves to resolve its long running dispute over its land along Ang Mo Kio Ave 5 (Lot 12949A Mk 18) by surrendering its 999 year lease for a fresh 99-year one in order to convert it fully into residential land without restrictions or the bulk sale of its non-landed projects built on land acquired at attractively low prices.

Background

Long history as one of the largest land owners in Singapore backed by prominent shareholders

BSE, in its current form, started out as a developer to build and sell properties on large tracts of legacy rubber plantations owned by OCBC Bank’s founding Lee family. In the 1950s, BSE owned as much as 172 million sq ft (16 km2) of land. To put this in perspective, this is approximately 2.7% of Singapore’s total land area at that time [i].

Over the years, however, its landholdings have shrunk greatly, largely because of compulsory acquisitions by the Singapore government as well as BSE’s own development projects. By 1998, a year after BSE had another 1.7 million sq ft of land acquired by the government, they were left with just 5 million sq ft of legacy land. While still a massive landbank by all accounts, it was a far cry from their original landholdings. From then on, most of the depletion has been a result of their own development projects. The largely freehold/999-year leasehold legacy landbank today stands at 3.2 million sq ft, which excludes a couple of development phases currently in the works.

Legacy landbank carried at miniscule cost price

Although it is no secret that BSE’s legacy landbank is carried on its balance sheet at historical cost, there is little clarity among the investing public as to what this cost might be. Part of the problem lies in BSE’s lack of disclosure in its own results announcements and annual reports as it had stopped providing an annual breakdown of its development properties from 2004.

To get a better understanding of what this cost might be, we studied BSE’s annual report filings to as far back as 1995. Our findings indicate that:

1. BSE’s legacy land cost stated in its earlier annual reports were in fact based on its historical book value as at 1953. In 1995, its close to 7 million sq ft of land was carried at a mere cost of around $862,000, less than what it would normally cost for a 1,000 sq ft condominium today; and
2. Inclusive of development charges it had paid, we deduce that the carrying cost of the legacy landbank could be as low as $50 psf.
   

For comparison purposes, in 2011, a JV controlled by City Development won a government tender for a 99-year leasehold plot of land meant for landed housing development in Serangoon Garden Way -not too far from BSE’s own Seletar Hills land- for approximately $343 psf. We think the largely freehold/999-year leasehold legacy landbank should be valued conservatively at a minimum of $350 psf.

Excellent track record in land acquisitions

In addition to its legacy landbank, BSE has also proven to be very adept at timing the market in its land acquisitions. For instance, all its major land acquisitions in last 20 years have come in a 2-year period between the 3rd quarter of 2005 and 2nd quarter of 2007, when it shelled out more than $900 million to acquire 9 different non-landed development sites, majority of which are in the prime districts 9 and 10. This acquisition spree came at the tail end of a long property lull which lasted from 2000 to 2006. As a result, it was able to replenish and expand its landbank during a period when property prices were either at or below even the lows of the 2008-2009 global financial crisis. 

Source: URA data, Business Times, Company, Stockresearchasia

Our Take

Strongest balance sheet in at least 20 years supporting a best in class dividend yield of 6.7%

As a result of its well-timed land acquisitions, BSE has been able to generate strong profit numbers and cashflow over the past 5 financial years. This has culminated in a balance sheet that is the strongest it has been in at least 20 years, with a net cash position of $383 million as at 31 Dec 2016 even after deducting the $85 million in dividends paid in the quarter prior. This net cash forms as much as 30% of both its current market capitalisation and NTA, which is unusual for a property developer.   

(Source: Company) 

On the back of its balance sheet strength, BSE has also taken steps to reward its shareholders, paying an annual dividend of 33 cts per share in each of the last 2 years. Based on its last traded price of $4.94 per share, this translates into a dividend yield of 6.7%, the highest by far among SGX listed mid cap developers. 

Going forward, with the last of its major non-landed projects having achieved TOP (Paterson Collection, Skyline Residences) or nearing completion (St Thomas Walk), meaning that most of the construction costs has already been capitalised, we do not expect a significant deterioration in BSE’s balance sheet in the near future. The Company thus has sufficient cash resources to continue its current level of dividend payment should it wish to. In addition, any bulk sale of units in these projects will likely result in a major boost to its already strong balance sheet.

Limited supply for landed properties should augur well for BSE

While BSE has a good track record of developing non-landed properties, its bread and butter is in the landed developments. Its large landbank and long track record in the northern part of Singapore has earned it the nickname “King of Seletar Hills”. According to the Company, it has over the past half a century built more than 2,500 houses in Seletar Hills, 1,000 in Sembawang and 500 elsewhere.

(Source: URA, Stockresearchasia)

Unlike non-landed properties, landed properties can only be bought by Singaporeans and selected foreigners approved by the Singapore government. Despite this, prices of landed properties have outperformed non-landed by a wide margin in recent years according to URA’s Property Price Index (PPI). A large part of this can be explained by the much tighter supply of landed properties in land scarce Singapore.

New landed sites, the main supply of landed properties besides development/redevelopment of existing sites, awarded by URA have shrunk over the years. Only around 403,000 sq ft of land was awarded for landed developments in the last 5 years and a total of 2.4 million sq ft over the last 20 years, comprising entirely of 99-year leasehold land. In contrast, BSE alone has more than 3.2 million sq ft [ii] as at 31 Mar 2016, with close to two-thirds either 999-year leasehold or freehold land.

The decline in supply of new landed properties was confirmed in a report by Knight Frank published on The Business Times in August last year which claimed that over the past decade to Q1 2016, total available stock of landed properties grew by only 5.9 per cent to reach 72,205 units island-wide, while in the same period, non-landed properties expanded by 58.7 per cent to 258,098 units. We expect this trend to continue as Singapore’s population continues to grow towards the government’s projected 6.9 million[i] by 2030. This should augur well for BSE’s future prospects.  

BSE has sufficient options to allay QC concerns for its non-landed projects

In an effort to curb the then runaway property prices, the Singapore government had in recent years introduced a slew of property cooling measures, including requiring all foreign property developers (defined as all developers with shareholders or directors who are not all Singaporeans) to be issued a qualifying certificate (“QC”) whenever they buy land for residential development. Once a QC is issued, a foreign developer will be bound by the QC rules. One of these rules states that the foreign developer has 5 years to complete a project after land purchase with another 2 subsequent years after completion to sell all the units in the project. If it fails to meet this deadline, it may have to forfeit a banker's guarantee worth 10 per cent of the land purchase price. The foreign developer can extend the QC for another 3 years by paying a fee that goes from 8 per cent of the purchase price for the first year to 16 per cent for the second year and 24 per cent for the third. 

As a listed company, BSE falls under the definition of a foreign developer with respect to the QC rule. Hence, it faces pressure to complete the sale of all its units in completed projects as well as soon to be completed projects. The projects likely to be affected include Skyline Residences in Telok Blangah, Paterson Collection in Orchard and St Thomas Walk in River Valley. We examine below how each of these projects could potentially be affected.

BSE projects that are likely to be affected by QC rules

Skyline Residences: According to a report in July on The Edge quoting URA’s Realis database and property agents, BSE has had some success moving the remaining units at Skyline Residences by offering discounts to buyers as well as a “Stay then Pay” scheme and that only 30 units remain as at 5 July 16. This suggests that close to 90% have been sold. Given that BSE had more than a year between 5 July 16 and the August 2017 QC deadline to move the remaining 10% units, we believe BSE’s exposure to potential QC penalties for Skyline Residences should be low.

St Thomas Walk: With the TOP set for the 3rd quarter this year and the QC deadline only in Q3 2019, we believe there is still sufficient time for the Company to market and sell these units even though it has yet to launch the project. There is also the possibility that the government could loosen the QC rules by the time St Thomas Walk’s QC deadline approaches. We estimate that the project has a breakeven price of $1,400 psf vs $1,750 psf [iv] average selling price achieved for nearby comparable projects such as St Thomas Suites.

Paterson Collection: Perhaps the most at risk to QC penalties given that the project’s QC deadline is in October this year and that the project is yet to be launched. However, with low land cost and an estimated breakeven price of $1,600 psf vs an average price of around $2240 psf [v] for Paterson Suites (also by BSE) just across the road, we believe the Company has plenty of flexibility in achieving a positive outcome prior to the QC deadline.

One possibility would be for a bulk sale of the project to a non-related party at a discount to market prices. We believe a conservative discount of 25% would be more than sufficient to attract buyers. Even at this discounted price of approximately $1680 psf, we estimate that BSE would be able to generate a profit of over $10 million and most importantly bring in over $200 million in cash. As the project had already achieved TOP in 2015, meaning all its costs have been capitalised with zero borrowings, all proceeds net of tax from such a sale would accrue to BSE’s already impressive cash pile.

Recent bulk deals were transacted at discounts of between 16% and 23%:

Another option would be for the controlling Lee family to acquire the project, similar to what Hiap Hoe’s controlling shareholder, Hiap Hoe Holdings, did in acquiring Treasure on Balmoral for $185 million from the listed company. However, this would require minority shareholders’ approval as it is deemed an interested person transaction (IPT) exceeding 5% of the Company’s NTA.

A third option would be for the Lee family to privatise the entire company. Despite the Lee family having no shortage of resources to do so, we see this as being a less likely option. For a start, at a market capitalisation of $1.3 billion, privatising the entire company at a premium would cost several times more than the amount needed to just buy all the units in Paterson Collection. In addition, the Lee family is not known for privatising listed companies it controls even when valuations are low, e.g. in 2003 or 2009. Both takeover attempts by the family for Straits Trading and then WBL in 2008 and 2013 respectively were exceptions and came in the form of counter-offers to rival bids by the Tan family. A privatisation offer is probably more likely to come in the form of an attractive external bid, particularly by a land hungry developer.

Recommendation

BSE is a deep value play trading at around 1.0x NTA. However, carrying its legacy land at historical cost pegged to 1953 prices has resulted in a severely understated book. Just valuing the freehold/999-year leasehold legacy landbank at a conservative $350 psf would bring its NTA up to $7.21 per share. 

This does not even include:

• Potential upside from new launches on its low cost legacy land along Ang Mo Kio Ave 5 (Lot 12949A Mk18) for which it has announced that it will pay SLA a differential premium and surrender the 999-year lease in order to be re-issued a fresh 99-year lease without building restrictions; and
  
• Any surplus generated from potential bulk sale of units in Paterson Collection or the soon to be completed St Thomas Walk, keeping in mind that the plots of land on which these projects are sited were acquired at low prices in the period from 2005 to 2007.

It is notoriously difficult to predict exactly when the property market will improve given the current headwinds including the slowing economy, the property cooling measures in place and the spectre of an US-led interest rate hike. Until a more pronounced uptrend happens, BSE’s results in the coming quarters could stay subdued, just as the recently announced 3Q17 results has shown with profit down 78% YOY. That said, its strong balance sheet with a net cash position of $383 million should provide sufficient buffer to see it through the lull period and protect it against any interest rate shocks. In the meantime, investors would still be able to enjoy a best-in-class dividend yield of 6.7%, far higher than any of its mid-cap property developer peers. We thus think BSE’s current share price of $4.94 offers compelling value to value investors and yield seekers alike. We are buyers at this price.

Key Risks

A prolonged downturn in the property market coupled with inaction regarding its non-landed projects at or near TOP could see the Company being hit with hefty QC penalties. However, as we have pointed out, the Company with a financially strong controlling shareholder has enough options to mitigate this risk.

Payment of the yet to be disclosed differential premium for the land at Ang Mo Kio Ave 5 may see a large chunk of cash depleted leaving shareholders with the possibility of a lower dividend payout in immediate years. Having said that, shareholders should eventually be compensated as the Company starts monetizing the site via new project launches.   

(All currency in SGD unless otherwise stated)