United Envirotech @ 51 cts ( Water / China ) 8 comments
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2.Limited scale, access to capital, intellectual property
I have to admit that sometimes I look at a stock and my gut instinct on looking at key valuation metrics is that the stock is overvalued or at best fully-valued. It is only subsequent to getting this instinctive feeling that I back it up with some research. But ultimately the call (not to buy) emanates from this initial instinct.
A screen of United Envirotech's key valuation and financial figures suggests in my mind that there is little margin of safety ie. more downside risk than upside potential in its share price. For 20 times trailing PE and probably 15 times forward PE (based on estimated S$8M FY05 profit, projecting from its 9M05 results) and 4 times NTA it is rather expensive for an engineering stock, albeit one in the highly rated water sector. And I'm still waiting to see what's its dividend policy; the stock IPOed in April 2004 but did not pay a dividend that year. My view is that for China-based companies it is better to see the cash change hands to your account through dividends than for the company to keep in its balance sheet; the shareholders should get a piece of the profits.
My view of engineering stocks is that it is all about scale, scale, scale. It is very rare that the company owns intellectual property via patents to some proprietary technology; rather, their value-add lies in their ability to integrate the technologies available on the market to provide solutions for the customer. That's why I don't think much of United Envirotech's claims that they have competitive strengths in membrane bioreactor, microfiltration, PVDF membranes; they just have the know-how to install and integrate them, but these technologies are available on the market, not proprietary to the firm. Under such a business model, company capital (to provide working capital for undertaking larger and more projects) and significant revenue, order book and customer base (strong reputation) becomes important. A long history also suggests a strong installed base and access to recurring revenue through maintenance. United Envirotech probably does not have much protectable intellectual property, else its margins wouldn't have dropped so drastically from 50% to 30% from FY04 to FY05. In terms of scale of operations, it hardly belongs to the big league, with about S$20M revenue expected this year; my idea of significant revenue base would be at least S$50M or above, in the scale of Sinomem, for example.
I can understand why United Envirotech has risen from a stagnant 35 cents (with no liquidity) to over 50 cents today (with strong liquidity). It has recently secured a TOT municipal wasterwater treatment project in China, along with contracts with new blue chip customers CNPC and Sembcorp. But the contracts with CNPC were only worth S$5M, while that with Sembcorp Utilities was presumably too small to mention. The municipal TOT projects in China typically work on a private-sector-builds-municipal-government-offtakes concept. This effectively means the company that builds the plant assumes all the risk of construction, ownership and operation. It is all too well to package it as being a source of recurring income, but it is a less preferable situation to building a plant for a client which is the eventual owner. See the difference? United Envirotech will need access to capital to undertake a few more of this, and capital is not a resource that it has a lot of.
Consider a peer. Asia Water ran up from below 30 cents to 48 cents on a spate of contracts, including an impressive one for a nuclear power station, that brought its order book up to nearly RMB$900M, enough on its plate for the next 3-4 years. It has since corrected to below 40 cents, possibly on market realisation that order book does not necessarily mean profit growth of the same magnitude. Extrapolate that thinking to United Envirotech.