Saturday, 12 December 2015

Thong Guan (4)

Balance Sheet Improvement Pleases Me Tremendously

Author: Icon8888   |   Publish date: Fri, 21 Aug 2015, 03:46 PM

1. Earnings Finally Normalised

Two days ago, Thong Guan released its June 2015 quarterly results. 

Net profit came in at about RM7 mil. To be honest, nothing to shout about.

Having studied Thong Guan so extensively before, I consider myself quite familiar with the group. Thong Guan in the past few years has been reporting net profit of about RM28 mil per annum. So RM7 mil per quarter is just the norm. Close my eyes also I can figure that out.

Having said so, I am not disappointed either. In the past, net profit of RM7 mil per quarter was driven by strong Japanese demand. However, recently, the Japanese market has softened quite a bit. Also, their operation in China is facing increasing cost pressure. Against this backdrop, ability to sustain profit is an indication that their turnaround plan is working. 

2. Good News At Balance Sheets

What pleases me most is the improvement in balance sheets. The group's US Dollar loans had been reduced from RM65 mil to RM33 mil, a reduction of RM32 mil.

The paring down of this particular loan is very important. Over the past two quarters, Thong Guan had been reporting dismal profit exactly because of the forex losses associated with this loan.

To be honest, the amount is not really that huge. Losses of a few million Ringgit here and there didn't really pose an existential threat to the group. But it dragged down overall earnings and dampened sentiment for the stock. As a result, despite being an export counter, Thong Guan is one of the worst performing stock in my portfolio.

Now that the US Dollar loan has been reduced by almost half, earnings visibility going forward improves substantially. Due to continue strengthening of US Dollar, the remaining RM33 mil US Dollar loan will still result in losses in coming quarters. However, the group also has cash and trade receivables denominated in US Dollars. The amount of those items are much larger. The gain recognized will more than offset any US Dollar loan losses.

3. Positive Outlook Going Forward

For those not so familiar with the group, Thong Guan is in the midst of a 2 year RM100 mil capex programme targeted to be completed by 2016.

Please refer to the article below for further details.

The capex prgramme aims to increase the group's capacity as well as to enhance competitiveness by differentiating from other industry players. 

It seemed that the capex progamme has started yielding results. In Q3 and Q4 of FY2014, the group's net profit declined to approximately RM5 mil per quarter. In Q1 and Q2 of FY2015, net profit has returned to the range of RM7 to 8 mil.

The group's prospect is further boosted by the recent depreciation of Ringgit. With closed to 70% of its products exported, the group should be able to gain market share at the expense of other manufacturers. Some of the group's production lines are operating at 60 to 70% capacity. They can be readily ramped up to meet additional demand from new customers.

Who don't want to pay less for a garbage bag ? The world is their oyster.

4. The Night Is Still Young

With Thong Guan underperforming other export counters over past few months, I used to have this grudging feeling that the company's share price might have missed the opportunity to benefit from the currency play before it is over.

However, following a recent study, I am of the view that strong US dollars could potentially last for few more years.

In other words, there is still plenty of opportunity for Thong Guan to realise its full potential and shine. With all the new machines installed and super-competitiveness driven by cheap currency, it is not inconceivable that in the next one to two years, Thong Guan's net profit can grow by as much as 50% (as per analysts' original projection before they changed their mind after the group was affected by forex losses).

5. Turning Into A High Dividend Stock ?

As I flipped through Kenanga's recent analyst report, one thing that caught my attention is the analyst's projection of Thong Guan's cash build up going forward.

To be honest, I found the RM174.6 mil cash by 2015 / 2016 a bit far-fetched. I just cannot imagine how that can be achieved.

However, this piece of information does lead me to start thinking about Thong Guan's future dividend payment capacity.

As at to-date, Thong Guan has approximately RM91 mil cash. However, I think easily half of it is earmarked for the RM100 mil capex (which is half way being implemented).

Assuming that the remaining RM40 mil is used to fully repay the existing loans. The group is closed to zero gearing. 

Thong Guan incurs depreciation charges of closed to RM20 mil per annum. With net profit of let's say RM30 mil, zero capex requirement (RM100 mil has already been spent), and minimal debt servicing obligations, the group could potentially generate free cash flow of RM40 mil to RM50 mil per annum.

Theoretically, all these free cash are available for distribution to shareholders as regular dividend. Based on existing market cap of RM300 mil, can the company reward shareholders with more than 10% dividend yield ?

The potential is there. But as the saying goes, "I will believe it when I see it". 

Let's see whether this will happen in the future.

Have a nice day.

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