Ivory Properties (2)

From Model Student to Problem Child

Publish date: Thu, 24 Apr 2014, 11:26 AM 

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Of all the stocks that I have written about, Ivory provokes the most intense and hostile reactions.

The company used to be viewed favorably. During the period from 2007 to 2011, it reported consistent earnings and has reasonably strong balance sheets.

However, starting from 2012, the group's earnings started to decline and borrowings started to rise. Investors are upset.

There are allegations of mismanagement. However, nobody is able to provide concrete evidence.

Usually, a company like this doesn't warrant our attention. After all there are so many other fishes in the sea.

However, Ivory has something very unique and valuable, which keeps drawing me back to relook at it despite quarter after quarter of poor financials - its 45% stake in Penang World City, a RM10 billion GDV development project located at Bayan Baru, Penang Island. The land is facing the sea, a very attractive feature for property investors.

I wrote Part 1 of Ivory in early March 2014. My original intention was to write Part 2 when the company reports it's result by end May 2014. However, recently the market seemed to begin to realize the potential of Penang based property developers. Ivory is also a beneficiary of this trend. It's share price has risen from 62 sen when I first written about it, to 70 sen recently.

In view of the above, I decide to bring forward Part 2.

In this article, emphasis will be given to analyse Ivory's past performance in order to have a better grasp of its fundamentals. Hopefully this would help us to arrive at a reasonable expectaion for its future direction.

1. Background Info on Ivory

Ivory has 445 mil shares outstanding. Based on share price of 68 sen, market cap is RM302 mil.

Based on net assets of RM379 mil and borrowings of RM307 mil, gearing is approximately 0.81 times.

The group reported RM14 mil net profit in FY2013. This translates into historical PE multiple of 22 times. 

However, i am of the view that FY2013 figure might not be reflective of its real potential.

Even without Penang World City, Ivory's natural earnings capacity should be RM25 mil (please refer to section below). Based on that, historical PE multiple should be approximately 12 times.

If the company is not able to grow its earnings, it is considered overvalued at this price.

2. Historical Profitability

Please refer to table below for Ivory group's P&L from 2007 until 2013 :-

					Note *
FYE 31 Dec	2007	2008	2009	2010	2011	2012	2013
(RM mil)
Revenue	109.6	154.3	121.0	164.7	97.4	211.8	304.5
Cost of sales	(57.9)	(99.4)	(71.7)	(88.5)	(41.9)	(161.8)	(212.5)
Gross profit	51.7	54.9	49.3	76.1	55.6	49.9	92.0
Gross margin (%)	47.2	35.6	40.8	46.2	57.0	23.6	30.2
other expenses	(14.9)	(17.5)	(25.2)	(34.2)	(42.8)	(58.4)	(63.5)
expenses/revenue (%)	13.6	11.3	20.8	20.8	44.0	27.6	20.9
other income	1.6	1.7	4.4	6.0	11.1	16.3	10.6
Operating profit	38.4	39.2	28.5	47.9	23.8	7.8	39.1
margin (%)	35.0	25.4	23.6	29.1	24.4	3.7	12.9
exceptional item	0.0	0.0	0.0	0.0	0.0	36.6	0.0
Interest expenses	(1.5)	(1.6)	(4.5)	(4.3)	(6.6)	(11.1)	(9.7)
Associates	0.4	(0.3)	0.9	6.1	13.9	3.2	(2.8)
Jointly controlled entities	0.0	0.0	0.0	0.0	0.0	(0.8)	(4.1)
PBT	37.3	37.3	24.9	48.8	31.1	35.4	22.5
Tax	(10.8)	(10.4)	(7.8)	(12.8)	(6.6)	(2.9)	(8.6)
Net profit	26.5	26.9	17.1	36.0	24.5	32.5	14.0

Note* The group reported negative revanue of RM18.5 mil in Q4 2011 due to reversal of en bloc sales in Penang Time Square amounting to RM37.6 mil due to buyer's inability to secure financing from financial institution. As a result of that, for FY2011, the group's revenue declined from previous year's RM164.7 mil to RM97.4 mil, representing a decline of RM67.3 mil or 40%.

3. Key Observations

(a) Natural Earnings Capacity

When investing in a company, one of the first thing I would like to check is whether the company has  an established track record ?

We should not invest in a company that delivers profit in one year and goes into the red in subsequent years. It shows that the business model is not yet matured, the requisite infrastructure and critical mass might not be in place, and the company might not have found a mechanism to deliver economic value sustainably.

If not careful, investing in a company of this nature would trap your capital for many years as the problem it faces is structural, not cyclical, and hence does not heal natutrally over time even when economic conditions have improved. 

It is with this in mind that I scrutinised Ivory's past records. 

I would say that the finding is clearcut and conclusive.

From 2007 and 2011, the group reported average net profit of RM26 mil per annum, without major fluctuations. Things deteriorated in 2012. If not because of an exceptional gain of RM36.6 mil, the group would have reported a small loss. The group has not done that well in FY2013 either. It reported net profit of RM14 mil only. 

(Further analysis will be carried out to provide more insights into the group's poor financial performance in FY2013)

Not withstanding the recent two years' poor performance, the overall big picture is that the group is an established developer.

It might not have done well over past two years. However, it does seem to have natural capacity to deliver net profit of approximately RM25 mil per annum.  

(b) Gross Profit Margin

Ivory has high gross profit margin from 2007 to 2011 (average of 45%). However, this dropped to about 23% and 30% in FY2012 and FY2013 respectively. 

There is insufficient information in the financial accounts to explain the drop. It could be due to depletion of low cost land bank, change in product mix, rise in construction cost, or any other reasons.

There is also the possibility that it was due to start up cost incurred for construction work related to Penang World City, as Ivory is the contractor for the project. The construction work is undertaken separately and should not be reflected in accounts of "Jointly Controlled Entities".

At this stage, we simply don't have sufficient information to ascertain the actual causes.

However, I don't view this lower margin as something alarming (after all, it seemed to have stabilized). Pending further information, I would like to view it as reflecting new economic reality on the groud, something the company has to learn to live with pursuant to changes in macro environment.

After all, despite the drop in margin, the group still managed to grow its operating profit from approximately RM50 mil in the past years to RM92 mil in FY2013, in line with increase in revenue from RM200 mil range to RM300 mil.      

(c) Other Expenses

It is not clear what constitutes Other Expenses. Very likely is marketing and admin expenses for the various projects.

At first look, this item looked alarming as it is on increasing trend. However, upon closer examination, the ratio of expenses / revenue in FY2013 seemed to revert to its norm at 20.9% (2011 and 2012 ratio is bad, at 44% and 27.6% respectively).

In my opinion, it is natural for expenses to increase together with revenue, as long as the group kept the ratio in check and consistent with historical level. 

(d) Borrowings and Interest Expenses

Ivory's interest expenses increased notably from RM4.3 mil in FY2010 to RM9.7 mil in FY2013, in line with its increase in borrowings from RM105 mil in FY2010 to RM307 mil in FY2013 (please refer to table below). 

Based on preliminary analysis, the rise in borrowings could to a certain degree be attributable to acquisition of new land banks. 

In 2011, borrowings increased by RM75 mil while the group acquired RM50 mil land bank. 

In FY2012, borrowings increased by RM108 mil while the group acquired RM65 mil land bank. The rest of RM43 mil proceeds from the loans could possibly have been used to defray expenses associated with kick starting Penang World City (just my guess).

     

(RM mil)		2010	2011	2012	2013
Loans		105	180	288	307
S Funds		192	216	364	379
gearing (times)		0.55	0.83	0.79	0.81
changes in loans		n/a	75	108	19
land acquisition		n/a	50	65	0
for other purposes		n/a	25	43	19

In short, over the past three years, the group's borrowings and land bank increased by RM192 mil and RM115 mil respectively. There is a possibility that 60% of the group's new borrowings have been used to build up its land banks. 

4. Taking a Closer Look at FY2013 Figures

The analysis above is useful for us to understand the group. However, it is a bit too macro and might not be useful to guide us on our investment decision.

As such, we need to look at the group's recent performance in more details. This will allow us to have a better feel on whether it is actually turning around and worthy of immediate attention.

FYE 31 Dec 2013	March	June	Sept	Dec	Full year
(RM mil)	2013	2013	2013	2013	2013
Revenue	51.9	95.8	66.8	81.7	304.5
Cost of sales	(32.1)	(75.6)	(49.0)	(55.8)	(212.5)
Gross profit	19.8	20.2	17.8	25.9	92.0
Gross margin (%)	38.1	21.0	26.6	31.7	30.2
other expenses	(15.8)	(14.3)	(14.0)	(19.5)	(63.5)
expense/revenue (%)	30.4	14.9	21.0	23.8	20.9
other income	2.8	1.7	9.7	4.8	10.6
Operating profit	6.8	7.6	13.5	11.3	39.1
margin (%)	13.1	7.9	20.2	13.8	12.9
exceptional item	0.0	0.0	0.0	0.0	0.0
Int expenses	(3.2)	(3.0)	(3.4)	(0.2)	(9.7)
Associates	(0.3)	0.0	(3.2)	0.7	(2.8)
Jointly controlled entities	(0.1)	(0.7)	(3.9)	0.7	(4.1)
PBT	3.2	3.9	3.0	12.5	22.5
Tax	(1.2)	(1.7)	(1.4)	(4.3)	(8.6)
Net profit	2.0	2.2	1.5	8.2	14.0

Q1 of FY2013    The group's gross profit margin is decent at 38%, significantly higher than the average of 30.2%. This means the group's product mix is priced at attractive level.

However, the strong performance was dragged down by high Other Expenses of RM15.8 mil (expenses / revenue ratio of 30.4% is high vs norm of let's say, 20%). Reason for the high expenses are unknown.

Q2 of FY2013    Gross profit margin is at depressing 21% (vs average of 30.2%). That was why despite low expense ratio of 14.9%, net profit was lackluster at RM2.2 mil only.

Q3 of FY2013    In my opinion, the group showed tentative signs of turning around in this quarter.  Gross margin at 26.6% is reasonable. Expense ratio at 21% is in line with historical level. If not because of losses at associates and joint venture entity totaling RM7.1 mil, the group would have reported net profit of RM8.6 mil, a level that meets market expectation.

Q4 of FY2013   In this quarter, it seemed that almost all key operational parameters are at healthy level. Gross margin and expense ratio at 31.7% and 23.8% respectively is in line with historical norm and average level.

There is no losses at associate level. 

Penang World City, as reflected in Jointly Controlled Entities, also has stopped bleeding. This is a very significant development as it is a high impact project. Turning around will propel Ivory's earnings upwards decisively to a level never seen before.

5. Concluding Remarks

(a) Ivory is not an untested entity. Based on past record, it is capable of effortlessly delivering RM20 mil plus earnings year after year. There is no reason to doubt whether they have the requisite skills and resources to operate and function just like any other developers.

(b) However, this pattern of predictable performance was broken in 2012 and 2013, due to reasons not well known or understood by the market. As a result, the company has fallen out of favor with investors.

(c) As mentioned above, the group's 45% stake in Penang World City has huge potential. This warrants further attention.

(d) Phase 1 of Penang World City was launched in early 2013. It was priced at expensive RM700 per sq ft and yet received favorable responses. If not mistaken, the project is easily 97% sold. 

We are now in April 2014, more than 12 moths from the above mentioned launches. It is time to watch for early signs of bearing fruits.

(e) Having said so, the group's fundamentals is not really top notched. Gearing is relatively high, and there is no certainty that the recent profitability can be repeated in the coming quarters. However, the market seemed to be re rating the stock due to positive sentiment associated with Penang based developers. 

It is time to take a closer look.

Have a nice day.