Friday, 6 May 2016

JHM Consolidation (2) - Growth, Growth, Growth

Publish date: Fri, 15 Jan 2016, 02:13 PM 





1. Introduction

I first wrote about JHM not too long ago. Subsequently, a forum member furnished me with further information, which I think warrants another write up to discuss. 

According to this article dated 27 May 2014 below ("Sun Article"), JHM intends to spend RM25 mil to establish a production facility in Sungai Petani, Kedah. My objective for this article is very simple - I want to do a quick analysis of where JHM is now with regard to the abovementioned expansion plan. 

This will allow me to have a feel of whether JHM's growth has peaked, or there is more to come (with the rest of the expansion, if any, coming onstream).


Following the publish of the Sun Article (which was made after released of March 2014 quarter), JHM has altogether released 6 quarterly results : June, September, December 2014 and March, June, September 2015. 

Clear signs of revenue and profit growth was witnessed from March 2015 quarter onwards (I have discussed this in my previous article) :-

Quarter Result:
F.Y.QuarterRevenue ('000)Profit before Tax ('000)Profit Attb. to SH ('000)EPS (Cent)
2015-12-312015-09-3034,6968451,3241.08
2015-12-312015-06-3031,9622,1021,4611.19
2015-12-312015-03-3125,0491,8481,7861.45
2014-12-312014-12-3120,118811630.13
2014-12-312014-09-3016,268-1,325-968-0.79
2014-12-312014-06-3018,842-611-433-0.35
2014-12-312014-03-3116,5981171180.10

Will there be any more growth ? Has the company reached a plateau ?
2. Keeping Track of The Capex Programme
The table below sets out the relevant items of the Group's balance sheets, cahflow and P&L which should allow us to have a feel of the status of the Capex programme :-
Key observations :-
(a) My earlier impression was that the turnaround seen since March 2015 was a result of capex (resulting in additional capacity, etc). However, the spreadsheet told a slightly different story.
It seemed that the improvement in profitability was achieved with minimal capex spending - total capex from June 2014 until March 2015 was only RM3.29 mil, lower than total depreciation charges of RM4.17 mil during that period.
This means that the money spent was most likely for wear and tear replacement, instead of new capacity.
In other words, the group achieved turnaround by becoming more efficient, without the need to inject capital to buy growth.
I give that a BIG LIKE. 
(b) Despite making known to the public as early as May 2014 about the intention to spend RM25 mil for growth, it seemed that the group did not really embark on the massive capex until June 2015 quarter. 
During the June and September 2015 quarters, serious money was committed to increase capacity. Closed to RM8 mil was spent in that two quarters, resulting in PPE growing by 23% from RM26.2 mil to RM32.3 mil.
(c) The capex spending needs to be funded. This showed up in the balance sheets, with net loans increasing from RM2.9 mil in June 2014 Q to RM11.3 mil in September 2015 Q.
I am not alarmed by the increase in borrowings as the group has been doing it in an incremental manner, increasing capacity when demand justifies it.
Nevertheless, it is still good for us to try to have a feel of how the capex will affect balance sheets, which is what I will discuss in the next section. 
3. Funding The Capex
Before we proceed with the analysis, let's first take stock of the Group's financial position.  As at 30 September 2015, the group has net assets of RM34.4 mil, cash of RM3.2 mil and loans of RM14.5 mil. As such, net gearing is 0.33 times. 
The gearing is not considered high, but if they proceed to spend further, balance sheets might be stressed. 
Probably because of that, the company announced that it will be undertaking a Special Issue of up to 21 mil new shares to Bumiputra Investors. For illustration purpose, based on latest closing price of 46 sen, the Special Issue could raise up to RM9.66 mil.
On 8 January 2016, the company announced that it has submitted draft circular to shareholders to Bursa. Once cleared, an EGM will be convened and the Special Issue will be implemented after shareholders vote in favor of it. 
The Special Issue will allow the company to meet the bulk of its funding requirement. Just to have a feel of the figures, I have done up a financial model to facilitate discussion.   
As shown in table above, there will be a minimum and maximum scenario. This is because we don't know the exact amount the group has spent on the RM25 mil capex so far. As discussed in Section 2 above, the group has purchase PPE amounted to RM11.3 mil. However, some might be for replacement of existing equipment (wear and tear), so we can't really say for sure that the RM11.3 mil was entirely for the RM25 mil capex.
Under the minimum scenario, the Special Issue, existing cash and internal cashflow (future) will be sufficient to meet the funding requirement, without the need to draw down additional bank loans.  
(Note : A quick analysis of the group's cashflow showed that the assumption of up to RM2 mil from internally generated cash is reasonable. Please refer to Appendix below)
  
Under the maximum scenario, the group needs to draw down loans of RM3.8 mil.
Pro forma effects on balance sheets will be as follows :-
As shown above, even under the maximum scenario, net gearing will increase to 0.42 times only. Of course, this is just our guesses. Actual figures should be some where in between. But the overall concept is that with the Special Issue in place, the group will be able to grow without unduly stressing its balance sheets.
4. Concluding Remarks
(a) One thing that has so far held this stock back was that it is not an export play. However, this is exactly what I like about it. I have many export stocks in my portfolio, this stock allows me to diversify.
(b) The group has an ambitious plan to grow its business. The various sections above had discussed the possible ways they can fund it. That takes care of the Supply side.
The question now is the Demand side - will they be able to get new customers / orders to soak up the additional production capacity ?
Unfortunately, I don't have access to insider information to provide you with a definitive answer. However, I have chances to speak to CEOs of PLCs before. Based on my observation, PLCs (or in general, established businesses) usually have very good understanding of their operating environment.
When they said that they plan to spend certain amount to expand production capacity, they should have more or less sorted out the specifics. Instead of vague concepts like "getting new customers", they usually would have already initiated discussions with potential customers and have a good feel of potential demand.
(c) It is common for PLCs to tell investors about their plans and ambitions. Sometime, those plans never materialise, they forever remain as concepts.
For example : I find one of the most silly things that a PLC can say is "We intend to secure RM1 billion contract this year". In my opinion, the PLC should only say something after securing the contracts. Saying what you intend to achieve is meaningless.
However, in JHM's case, the Special Issue is a strong signal that the Capex programme is on track. The Special Issue will dilute the company's EPS, but the additional production capacity should (hopefully) be able to boost profit and bring down PER at a later stage.
A nice growth story. 
Appendix - Group Historical Cashflow


Key observations :-
(a) Except for FY2014, the group usually relied on net operating cashflow to finance capex. In FY2014, the group drew down RM5.9 mil borrowings as net operating cash flow in that year was not strong.
(b) For the 9 months ended September 2015, net operating cashflow was RM7.3 mil, which allowed the group finance the bulk of its RM8.3 mil capex.
(c) In Section 3 above, it was assumed that RM2 mil of the RM25 mil capex will be funded by internally generated cash. This assumption appeared to be reasonable as the cashflow table above showed that during reasonablly profitable period, it is not difficult for the group to generate net operating cash flow of more than RM5 mil. 

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