Aqua-Terra @ 66 cts ( Hardware distribution / Singapore ) 3 comments
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1.Questionable valuation compared to Sinwa
2.Overvalued compared to parent KS Tech
3.Growth through acquisitions funded by placements is a dodgy strategy
Aqua-Terra is in the business of distribution and supply of consumables for the oil and gas, marine and mining industries. Its share price has surged upwards from below 20 cents to a high of 80 cents recently due to the strength of the sectors it serves, and in particular it has become an alternative play to the rising fortunes of its parent KS Energy which has become the oil-and-gas blue-eyed boy of Temasek Holdings to whom KS Energy placed out a stake. The assumption that Aqua-Terra would gain from its association with KS Tech through new supply contracts in the booming Asia-Pacific rig building/refurbishment market is quite reasonable, which is why the company managed to place out new shares to 4 unnamed institutions recently at 62 cents per share.
I will make my case through a series of comparisons of Aqua-Terra's valuations with several companies.
Firstly, an apple-apple comparison with an industry peer, Sinwa. The latter is also in the business of providing consumables and hardware supplies to the marine industry (known as ship chandling), with less focus on the offshore sector. Sinwa is trading at 7 times PE and 2 times NTA, and has exhibited steady 15-20% growth in topline/bottomline since its IPO. Aqua-Terra is trading at ~15 times forward PE (reasonably conservative to annualise 1H05 earnings since margins are on upward, not downward, trend) and at 5 times NTA. The latter has hardly demonstrated credible organic growth both in topline and bottomline (revenue stagnated at <$30M in FY03 & FY04, profit actually more than halved in FY04) and has only grown prodigiously due to its several acquisitions in FY05.
Secondly, a comparison with KS Energy. One might argue that Sinwa is less well-placed in the "correct" sectors of offshore oil and gas compared to Aqua-Terra and consequently commands lower valuations. Surely one cannot argue so for a comparison between KS Energy and Aqua-Terra. KS Energy is trading at about 13 times forward PE (again I annualise PE for the same reason as for Aqua-Terra earlier), and at a similar 5 times NTA. Surely it's better to buy KS Tech over Aqua-Terra? The former would clearly provide more value-add and have more intangible know-how inherent in its operating business compared to the latter. Additionally, my belief is that subsidiary listings should have "subsidiary discount" valuations to account for "parental risk" (see my blog on Buying Spinoff Companies); in bad times when the parent is troubled the subsidiary will not be spared; such is the nature of Asian business. Just look at Radiance and its troubled Goldtron parentage. Of course, KS Tech is not in any financial hardship now, but the way Aqua-Terra is valued, it seems to have priced in all the benefits of linkages to its parent but none of the risks.
My third comparison might be a bit strange. It strikes me that the company has jazzed up topline growth through its FY05 acquisitions of MarineHub (mooring equipment and rigging systems), Orient Marine (marine consumables and engine components), and Runva (winches); these were financed by several share placements earlier at 23.5 cents and then at 62 cents recently. I am reminded of another company adopting the same strategy, SNF (an electronics components distributor), which obtained new funds from its 2004 IPO and subsequent placements (at $0.27) to make a series of acquisitions to stimulate growth, surged to over $0.50 (5 times NTA) on the back of good short-term results and then collapsed to 11 cents as of recently due to the dramatic downturn of the electronic components distribution industry. The price action of SNF (its upward surge) is reminiscent of Aqua-Terra's rise from 20 cents to 80 cents. It appears that this growth-by-acquisition-funded-by-placements strategy is popular among smaller companies eager to build critical mass (both Aqua-Terra and SNF are SESDAQ companies), but such strategies often have higher risk due to integration problems and unsustainable earnings growth (unless they continue acquiring and integrating successfully, aka the Cisco strategy). The oil and gas industry is not likely to experience a downturn anytime soon, but my point is: it is always prudent to build in a margin of safety in one's share purchases, which in Aqua-Terra's case is thin; any industry downturn is going to hit it REALLY badly.