Company Analysis of ComfortDelgro – Hit or Miss?

Famous for their blue & yellow Hyundai Taxis, ComfortDelGro (C52) is a household name to most Singaporeans. However, many will be surprised to learn that it is in fact one of the largest transport companies in the world. It has operations all around the globe – most notably in the United Kingdom, China & Australia.

2005 2006 2007 2008 2009
Revenue (S$’ Mil) 2497 2786 3013 3120 3052
Operating Expenses (S$’ Mil) 2192 2479 2676 2842 2702
Profit attributable to Shareholders               (S$’ Mil) 202 245 223 200 220
Return on Equity (ROE) 15.4% 17.6% 15.3% 13.2% 13.5%

 

The company has done reasonably well in the past five years considering the financial crisis (2007 -2010). Even though its core customer base in located in Singapore, it also does extensive business overseas.  It has for the past five years, delivered a solid ROE of at least greater than 13%, a definite plus point in my book.

2002 2003 2004 2005 2006 2007 2008 2009
Net Cash From Operating Activities              (S$’ Mil) 546 442 619 515 548 643 574 728
Capital Expenditures        (S$’ Mil) -380 -245 -363 -402 -386 -328 -351 -447
Average Captial Expenditures               (S$’ Mil) -348 -348 -348 -348 -378 -378 -378 -378
Free Cash Flow            (S$’ Mil) 198 94 271 167 170 265 196 350

 

Cash Flow Analysis of ComfortDelGro (2002 – 2009)

Net Cash from Operating Activities has been steadily increasing since 2002. Being a fairly capital intensive company, it ploughs back a significant portion of their cash back into capital expenditures. Free Cash Flow (Net Cash from Operating Activities – Captial Expenditures) is extremely healthy. Armed with a substantial war chest and healthy cash flows, the company has been making a string of acquisitions – the most recent being its attempted takeover of Swan Taxis Ltd in Perth.

Debt Analysis

2005 2006 2007 2008 2009
Shareholder Equity 1345 1441 1483 1557 1690
Total Assets 3,058 3,085 3,316 3,352 4,052
Financial Leverage (Total Assets/S.Equity) 2.27 2.14 2.24 2.15 2.40

 

As of 2009, ComfortDelGro has a financial leverage ratio of 2.4 – healthy by my standards. I do not foresee debt repayment to be a significant problem as the industry is relatively stable. Furthermore, strong cash flows help to facilitate interest and debt repayment for the foreseeable future.

Economic Moat Analysis

Despite the deregulation of the taxi industry in Singapore, ComfortDelGro continues to maintain its leadership status in the industry (63% as of 2009). Its subsidiaries, VICOM & SBS Transit also maintain similar market shares – a plus point. One of the biggest strength of ComfortDelGro is its sheer size and strong financial health. It enjoys significant economies of scales compared to its local competitors.

It must be noted however, that the transport industry (in my opinion) is highly competitive in nature. Consumers taking taxis tend not to have distinct preferences in the company of the cab they are flagging down.  Their competitive edge is further eroded overseas, where they have a much smaller foothold.

The Bear Case

Geographical Segment %
Singapore 56.7
UK/Ireland 24.5
China 9.3
Australia 9.1
Vietnam 0.3
Malaysia 0.1
Group 100.0

 

With local growth stagnating, ComfortDelGro has looked outwards to expand.  Despite the healthy growth of its businesses in China & Australia, the outlook is much more lackluster in the UK, Vietnam & Malaysia. As these are not main income contributors, I do not foresee a significant impact on its core business.  Rising fuel costs and currency translation effects will also continue to hamper their growth both locally and overseas.

Conclusion:

Despite the challenges ahead, I feel that ComfortDelGro will be able to leverage on its strong financial health and continue to expand overseas.  Potential investors should look forward to capital appreciation in the long run. Coupled with its dividend yield (about 3%), I feel that it remains an attractive investment at this point of time.

 

Economic Moats of Locally Listed Companies

Here are some locally-listed companies that possess economic moats.

Singpost

Singpost possesses a great economic moat – namely it’s the virtually the only provider of mail services in Singapore. No other close competitor exists to rival it due to regulatory constraints. In other words, as long as regulations do not change, Singpost has pretty much been given a license to print money.

 

Do note however that Singpost has also branched into other businesses whereby it possesses little or no economic moat whatsoever.

SMRT

SMRT is pretty much the dominant MRT operator in Singapore. It also runs certain bus routes in Singapore.

Like Singpost, SMRT also posts extremely healthy numbers and growth despite the down turn. The nature of the service – being a necessity more than a luxury good guarantees this. Capital expenditures are much higher in SMRT than in other companies mainly due to the nature of the industry.

SPH

SPH is the dominant provider of printed newspaper and magazines in Singapore. It has done extremely well over the years. However, its economic moat has weakened somewhat in recent years with the rising popularity of the Internet.

As you can see, companies with economic moats tend to do extremely well over the years. Some of the hallmarks of economic moats (by no means exhaustive) are good ROE (>12%) and ROA (5 – 7%) with moderate leverage. Do note that economic moats are not always impenetrable and can be eroded over time.

Economic Moats – Consumers Worst Enemy, Investors Best Friend?

“In business, I look for economic castles protected by unbreachable ‘moats’.” – Warren Buffett

The best kinds of businesses that I love are the ones with strong economic moats. They are often characterized by supernormal profits and high returns on capital. In this post, I characterize the different economic moats that exist.

Companies with profitable margins are often eroded over time. The bubble tea craze a few year back is a textbook case. Initial start-ups were immensely profitable and its novelty soon became a craze. Competitors soon entered the market and before long, the once profitable industry became over-saturated and profits plummeted.The bubble tea industry is one in which firms possess virtually no economic moat at all. Coupled with the fact that entering the industry was relatively low, pioneers of bubble tea were soon unable to maintain past profit margins.

Industry Without an Economic Moat

You will often find firms with economic moats to be extremely profitable in the long run – provided that their competitive advantage is maintained.

Type of Moat Examples
Intangible Assets Tiffanys & Company, Nike, Coke
Customer Switching Costs Adobe. Microsoft
Network Effect Microsoft, Visa, eBay
Cost Advantages Dell

 

Intangible Assets – Brands, patent and regulatory licences. Patents of drugs drives profits from pharmaceutical companies – one reason why they are so highly guarded. Strong brand names such as Nike or Tiffanys & Co. allow companies to charge much higher premiums as compared to their competitors. If consumers are willing to pay a premium for a brand name – you have evidence of a moat.

Customer Switching Costs – Adobe has come to become the gold standard for image editing software.  Most designing firms run using its propriety software not because it’ cheap but because were trained using Adobe Photoshop. Switching to cheaper software doesn’t make sense as any savings made will most likely be offset by the loss of productivity (not to mention the risk involved).

Network Effect- Credit card companies are a prime example of this economic moat. You’ll find that shops readily accept cards like AMEX or VISA. Competitors who try to enter the market will be hard pressed to competing against well established networks.

Cost Advantages – Dell, famous for their optimizing and reducing cost in the process flow has done exceedingly well compared to its competitors. By cutting out the middle-man and selling directly to consumers, they have a comparative advantage against well established players like HP.

This list is by no means exhaustive but merely acts as a good reference point.

I recommend reading “The Five Rules for Successful Stock Investing” as a great primer for learning more about economic moats in different industries.  I also recommend “The Little Book That Builds Wealth” as a secondary reading.

I will be covering economic moats of locally listed companies in my next post. Look out for it!

Starhub – Irrational Debt Levels; Irrational Management?

There has been much speculation & confusion regarding the significant amounts of debt that Starhub now carries on its balance sheets. As of September 2010, Starhub possessed an astounding financial leverage ratio of 33.8. This means that for every dollar in equity, the firm had $33.8 in assets (anything above 4 or 5 is a potential red flag.)

So what’s going on here?

Bank loans made up 0.9 billion dollars in 2009! Let us take a closer look at the footnotes.

Even in a world awash with cheap money, I found the interest rate that Starhub was borrowing at to be extremely low. In 2009, their floating rate loans bore i/r of only 1.24% to 2.13%. This already low interest rate was reduced further in 2009 to only 0.92% to 1.39%. In opinion, it makes perfect sense for Management to leverage on the historically low rates to fund their capital expenditures.

Healthy Cash Flow Levels in Starhub:

Starhub is one of the few companies that use Free Cash Flow figures in their annual reports (a plus point for me) and for good reason. Even in the wake of the financial recession, they have posted impressive results.  I do not foresee a problem with loan repayments at this current point of time.

The Bear Case:

Starhub paid $20 Million in interest from bank loans last year (taken from the Cash Flow Statement of 2009’s Annual Report). Assuming that interest rates suddenly quadruple (highly unlikely in the near future but let’s take the worst case scenario here) to 5.6%, Starhub would have to fork out $80 Million in interest payments. A sizeable increase of $60 Million – but still within tolerable limits. I envision that as long as interest rates remain at their current levels, Starhub will have no qualms about maintaining the status quo.

 

Cash Flow Statement from Starhub Third Quarter 2010.

I want to bring your attention to another point – Refinancing. Judging from their cash flow statements, I suspect that Starhub is refinancing significant portions of their debt as the maturity date loans. This is akin to what REITs do when their debt is about to expire. In other words, they will be able to extend their loan maturity dates as long as they remain credit worthy.

I came across a post in another blog stating that Starhub was not making enough in FCF to cover their monthly 5.0cents dividend payment. The more risk adverse among you (it could be just me though..) might be wondering why Starhub doesn’t reduce its dividend payment in order to give itself a greater buffer or margin of safety. The argument is that once a company has started paying a regular dividend (in this case Starhub has committed itself to 5.0cents a quarter), the market will expect it continue the cycle at regular intervals forever. Any disruption to this cycle will be perceived as a potential sign of financial difficulties and a loss of confidence.

Conclusion:

In my opinion, debt levels while significant, should not pose much problem for Starhub. Close monitoring of their financial performance in their years to come is in order however. I feel that management has delivered solid returns up till this point of time and I see no reason why they wont in the years to come.

Tell-Tale Signs That Investors Should Look Out For in Reconsidering Their Investment in Starhub:

  1. Significant drops in Free Cash Flow over a sustained period (i.e. 1 – 3 years)
  2. Starhub being forced to raise additional amounts of money (i.e. through bond issues) AND refusing to cut its dividend yield
  3. Starhub taking on even more debt despite a significant rise in interest rates.

When faced with special situations such as these, its always good to dig deeper into the financial statements. Always make sure you understand the debt structure of the company. If its too complex, skip it. There are plenty of other companies that are much easier to understand.

Disclaimer: The author is vested in Starhub.

Value Investing Philosophy

As part of a series of introductory posts, I decided that making clear my investment philosophy would best serve my readers (or lack of).  Drawing inspiration of Benjamin Graham and David Dodd, I follow a value based approach to investing. I have summarized the key tenets of my philosophy as:

Safety of Capital

“Rule No.1: Never Lose Money

Rule No.2: Never Forget Rule No. 1”

- Warren Buffett

Preservation of capital is of paramount importance to me. I am extremely rise adverse, and choose to invest only after making a substantial time and effort to run through my investment thoroughly.

Margin of Safety

Suppose you were an engineer building a bridge. You estimated that 150 tons of vehicles passed through its roads at any given time. How much weight would you design the bridge to withstand? 150 tons? I doubt it. 200 tons? Now we are getting somewhere. How about 400 tons just to be safe.  That’s more like it.

The additional weight is the margin of safety (MOS) that engineers give themselves in case their calculations turn out to be wrong. Similarly, the same applies to investments. Suppose you calculated that the intrinsic value of a company was $0.30 a share. How much would you pay for it? The buffer that exists between the Intrinsic Value and the actual price paid is the Margin of Safety. I will provide a more in-depth discussion on this in subsequent posts.

Take Time To Mark Out Your Circle of Competence

Circle of Competence

Understanding what you know and what you don’t is essential in getting your investments right.  Never buy into anything that you can’t understand, no matter how appealing or attractive it looks.  Despite my extensive effort, I have yet to figure out how to analyze financial companies like UOB or DBS; hence I have never considered investing in them. We all have our specific areas of expertise. Getting our circle of competence right will play great dividends in future investments.

Mr. Market

Mr. Market suffers from wild mood swings; he might be on a manic high one day and depressed the next. The most important thing to realize is that you are free to ignore him if you chose to do so. Treat him as your friend if need be, but always realize that he’s serving you and not the other way round.

In short, exploit the tendencies of the market to swing from extreme high to record low. The market is just like a pendulum swing from one side to the other. Accepting it as part of the business cycle will give you conviction when others forecast only doom and gloom.

PE Ratio of the S & P 500. Don't be a slave to the market - Exploit it to your advantage.

Do note that this list is not exhaustive. I do hope that it’s a useful guide to get you started.