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Sunday, March 05, 2006

JEL @ 25.5 cts (Trading / Africa & Asia) 9 comments

Final Poll Results: 10:2

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Main issues

1.Execution risks tremendous as it is in midst of business model transition

2.Financial figures suggest problems with margins, working capital management

3.One-time gains to boost profits

4.Potential resources over-spread

This is a "hot stock" because of three reasons: (1)it has risen substantially, by >50%, from its bottom of 16 cents just 2 months back; (2)trading volumes have recovered substantially; (3)a prominent website, Wallstraits, has been pushing it as it top WS8 stock pick for 2006. And surely, it qualifies as a "not-to-buy" when one looks at its recent business performance.

This is a company that is in the midst of a transition. It IPOed on the back of a trading and distribution business in photographic products and FMCGs (fast-moving consumer goods) in emerging markets such as Central Asia, Africa and Indo-China. Profits seemed to be on a steady growth path and it was touted by some as the next growth stock in 2003. Today. the geographical distribution of revenue has not changed (primarily Africa and Asia) but the nature of distributed products has, with the demise of the photographic film as digital photography is increasingly taking over (and the better for it, too).

The company has secured agency rights to distribution of new product classes in the regions that it claims to have an incumbent advantage: stationary products, IT products, consumer electronics, telecommunications. My impression is that such a spreading of its resources over a wide range of products with no obvious synergy seems to be a hedging strategy, an over-reaction to its original over-dependence on photographic products which backfired. But then it is not my business to comment on corporate strategy, since my view has always been that the insider knows best, so I'll just focus on the results.

And they aren't good. Topline is easy to generate for a trading firm, in the same way that a stock trader can keep churning volume all day. The acid test must be the bottomline and the cash flow. In 1H05 topline grew 30% year-on-year but profit fell >60% as margins on photo-related products were eroded. Those hoping for contributions from its new distribution segments to weigh in in 2H05 would be disappointed as well: if we take out the S$4.3 gain on disposal of its building (to a REIT) the full-year FY05 profit would be S$2.5M ie. 2H05 net profit was ~S$1.5M. The ex-extraordinary FY05 net profit works out to an EPS of 1.1 cents, or a P/E of 23X based on the current price of 25.5 cents.

The figures indicate the typical problems associated with a business model transition. Revenue has increased by 50%, but operating overhead (under which I classify distribution expenses, administration expenses) have increased more than proportionately, by ~60%. Direct costs of goods sold have also increased by 55%. Combine such disproportionate cost increase with its already low profit margins and it will be clear that the revenue growth is nothing to rave about. Are these expenses recurring? Very likely so, otherwise the company would have capitalised them.

Since this is a trading company, it may also be useful to look at its working capital management. Inventory days (number of days to clear inventory) has increased from 59 to 73 days, while days receivables (number of days to collect receivables) has increased from 47 to 59 days. What it means is that the company's working capital position has deteriorated, or another way of saying it is that its cash conversion cycle is lengthened. It is analogous to the stock trader taking a longer duration before he can dispose of his holdings, and also a longer duration for him to receive the cash from the brokerage. Obviously liquidity is tightened, with the effect being that short-term credit has to be drawn on. That is why bank bills payable has increased from S$38M to S$59M, leading to finance expenses (interest) ballooning 3 times, from S$0.7M to S$2M. Stripping away the extraordinary income, interest coverage (EBITDA/interest payments) is only 2.5X, a precarious position.

Now, what do market veterans say about falling knives? Of course, that is talking about stock prices, but clearly it can be extrapolated to company earnings as well. A company in transition might yield great returns when it does so successfully (eg. Boustead, Cosco) but one must have evidence that the turnaround is yielding good results to the bottomline before plunging in.

And what about Wallstraits' recommendation for JEL to be the stock of 2006 (target price 52 cents)? That's pushing the envelope a bit; a position no doubt distorted by Sage's top-10 holding in JEL. Two comments: their predicted cash flow for FY2005 --4.5 cents, is way off the actual cash flow of about 3 cents; secondly it is amazing that they are assuming the same number for FY06, when >50% of FY05 profit was one-off.... are they assuming >100% operating bottomline growth for FY06? Quite surprising that such a pick was made.

(1) Wallstraits Top WS8 Stock Pick for 2006




Anonymous Anonymous said...

agreed, never like stocks in distribution business as margins tend to be low and they tend to trade at suppressed P/Es


3/06/2006 6:57 PM  
Blogger Gallen said...

later morning greetings :)

3/08/2006 11:32 AM  
Anonymous Anonymous said...

I had a closer look at the company's financial reports when wallstraits recommended it. Found some inconsistency in their reports.

On the cash flow statement for the latest full year result, i saw the entry "Bills payable to banks" under the cash flow from operating activities.
I did not see a similar entry in the cash flow statement in the audited annual report for FY2004.

I am inclined to agree that the share price of this company is on the high side.

3/08/2006 11:45 AM  
Blogger DanielXX said...

For their trading business I think it is reasonable that the bills payable to banks is classified under the operating cash flow (as working capital flow), instead of under the financing section. Banks do finance the working capital of trading companies.

3/08/2006 8:10 PM  
Blogger Gallen said...

hi daniel, thu greetings :)

3/09/2006 6:32 PM  
Blogger Gallen said...

hi daniel, friday evening greetings :)

3/10/2006 11:13 PM  
Anonymous Anonymous said...

JEL is now trading at 0.375. What gives? The market seems to be disagreeing with your analysis?

4/10/2006 10:39 PM  
Blogger DanielXX said...

Oh it's natural this happens sometimes. I am not a clairvoyant. But there are some additiona points which make the current optimism seem misplaced:

1) The distribution rights do not appear to be exclusive .... somebody correct me if I'm wrong here. The OEM can always hedge by awarding multiple distributorships

2) The expansion of distribution takes money and investment to develop. I don't believe they can just go from distributing photographic products to distributing IT products using the same methods and downlines. Price points are different, target market is different, products are different (IT products are not FMCGs are they?)

3) Investors are buying on the hope of future promise.... just look at its last dismal set of results and wonder who was willing to ramp it up to 40 cents.

Basically, one has to be real careful around this stock, espeically at its price now.

4/10/2006 11:01 PM  
Anonymous Anonymous said...

Good working capital management will reduce the risk for needing working capital loans in the future, which is always a good thing.

6/04/2008 12:29 PM  

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