Lian Beng @ 61.5 cts ( Construction / Singapore ) 1 comments

Final Poll Results: 63:27

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Main issues

1. Cyclicality of industry might be overlooked

2. High current valuation for construction segment

3. Limited upside for current property developments

Lian Beng is one of Singapore's largest home-grown builders and is poised to benefit from the multi-year construction boom seen to last for the next 2-3 years at least. The market has recognised this and run up its price from ~15 cents at the start of 2007 to >60 cents today. This will be another hotstocknot call on valuation grounds.

Firstly, it is important to recognise that construction, as a downstream service provider to property development, is subject to cycles like the latter (though less because demand from government is often counter-cyclical). This must be factored into valuation as a risk.

Lian Beng, besides being a construction player, has also recently taken equity stakes in property developments which it is building. There are hence two parts to its valuation: construction and property development. Let's consider the former first.

The company by its recent disclosure has a construction order book of about S$575M. I would expect it to be spread over the next three years. These include mainly private housing projects and a contract to build the substructure for the Marina Bay IR, seen as a plum project. By most brokerage estimates, the group's annual revenue is expected to be in the region of $300-400M over 2008-10, which I shall not dispute. As for margin, there is an abundance of construction projects which might lead to a shortage of building capacity, which means the bigger builders can cherry-pick projects offering good margins. Margin expansion is certain; however note that although many small builders (and a few big ones like Econ and Chew Eu Hock) have failed during the doldrum years, there are the foreign builders such as Ssangyong, Sato Kogyo, Penta-Ocean and China State Construction which have been undertaking mega-projects with plum margins (eg. Vivocity, Esplanade, also the Marina Bay IR hotel recently) over the years; the building capacity constraint should not be overstated. Let's use pre-tax profit margin of 5%, a reference from the last construction boom of 1999-2000. That brings an after-tax profit of $16M on $400M in annual revenue, or 3 cts earnings per share. (Furthermore, it should be noted that according to Lian Beng's latest FY07 results, it would have been close to net loss if not for other income that is non-recurring, in a period when construction was already on the recovery trail).

In order to derive what P/E the construction arm is trading at, let's look at the income that could be derived from Lian Beng's current property development stakes. It has equity stakes in three condominium projects: a 20% share of a Simon Road development (land cost $290M), a 10% share of an Upper Bukit Timah development (estimate land cost to be $70M by scaling up construction costs), and a 25% share of Lincoln Lodge en-bloc (land cost $240M). It also has full control of a development at Mountbatten Road at land cost $40M. Note that all these deals were done from June 2007 onwards, which means Lian Beng is not an early bird to the game and can hardly expect windfall gains given the government controls recently. Applying a 30% profit margin to land cost, I would calculate the overall undiscounted gains from Lian Beng's current developments (accounting for its equity stakes) to be ~$50M, or 10 cts per share.

Subtract this from current price of 61.5 cts and we get market valuation of Lian Beng's construction business to be 51.5 cts/share or forward PE of 17X. It is rather high, remembering my earlier note of construction being a cyclical business and all my assumptions being quite liberal so far. There is limited upside from this point.

The construction industry outlook is good but this is not one of the better stocks in terms of valuation. Caveat emptor.

Afternote (on 13 Nov):
I just read that Kim Eng had set a target price of $1.22 for Lian Beng in a report that says "Ah Beng is back!". My comment that "Kim Eng is mad". They are assuming a pre-tax profit margin of 15% which explains why their target price is so high while I call it a hotstocknot (I assume margin of 5%). Let's see who is right. For reference, peer KSH reported interim profit with pre-tax margin calculated at ~4.8%.

Poll
I agree that Lian Beng is a hot-stock-not: Agree/Disagree