On Friday, Hupsteel’s controlling Lim family announced an offer to take the company private after more than 25 years as a public listed company. The $1.20 per share offer is conditional upon the offeror holding at least 90% of the shares as at the close of the offer. (Announcement here)

The Lim family currently controls 54.16% of Hupsteel shares. This means that it needs to receive acceptances or acquire another 35.84% for the offer to go unconditional. Incidentally, Buttermere Capital, which recently emerged as a substantial shareholder with a 6% stake acquired seemingly at an average price of below 80 cts, becomes a key player to watch here.

The offer price exceeds the highest price traded over the past 6 years and implies a discount of 10.7% to Hupsteel’s NAV as at 31 Mar 19. If we take into account the latest valuation of the company’s portfolio of freehold properties, the discount to RNAV would have been a less compelling 29.1%. Taken together, this means that even if the offer does not fairly reflect the true value of the company, it does provide existing shareholders an excellent opportunity to exit their investments at a price last hit when crude oil prices were still at hovering around US$100 per barrel.

We first zoomed in on Hupsteel 2 years ago as a potential beneficiary of increased attention on then undervalued fellow steel stockist, HG Metal. We then followed that up with a strong recommendation report on the stock on 22 Nov 17 as an intriguing deep value play when the share price was at 89.5 cts, arguing that it provided better value at that time than HG Metal. At $1.20 per share and including the 4 cts dividends paid since then, the offer price would represent a total return of 38% over the 19-month period. While that does not exactly qualify as a home run, the returns are nonetheless satisfying especially when a similar investment into the benchmark STI ETF would have produced next to nothing (1%) over the same period.

More importantly, for the 3rd time in the last 4 months, after PCRD and Chuan Hup both announced big one time cash payouts, the value based investing approach that we have religiously honed over past decade and a half has once again been validated. Maybe value investing isn’t dead after all.

Related: http://stockresearchasia.com/latest-recommendations/hupsteel-ltd-discount-to-deep-value-looks-set-to-narrow

Last week’s full year results announcement was a welcome relief for Hupsteel shareholders as it probably confirmed that the worst is over for the Company. The improved performance was driven by increased demand for its steel products induced by a higher and more stable oil price. Some key highlights:

1. FY18 revenue of S$60.8 million represents a topline growth of 22% over FY17, the first upturn since FY2012.
2. Profit after tax of S$4.7 million is also a multi-year high, although it was aided by a net gain on investment property of S$2.3 million as well as certain tax credits.
3. Management’s decision to declare a final + special dividend of 2 cts per share brings total full year dividends to 4 cts, more than any in the past 3 years. Current yield stands at a respectable 4.6% based on a closing price of S$0.865.
4. However, amidst the positive news, the company also cautioned that its recovery could be weakened by the ongoing trade war and a stronger US dollar.

​Our Take
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Interestingly, at last year’s AGM, some shareholders complained that the dividend payout of 2 cts per share pales in comparison to the 5 cts which Hupsteel used to pay up until FY14. The management, in doubling this year’s payout to 4 cts, perhaps gave the clearest indication that it has paid heed to them. We are of the view that the Company would restore its dividend to 5 cts in the near to mid future should the macro environment hold up. 

​As we have stated in our original post, our investment thesis for Hupsteel has always been the deep discount it trades to the value of its cash, available for sale investments and investment properties. That has not changed. We remain optimistic that the current CEO will continue to take a proactive approach towards unlocking the substantial value of its investment properties and narrow the said discount. While waiting for that to happen, it certainly doesn’t hurt if the company decides to at least maintain its dividend payout going forward, as it should. 

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.

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
​
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.