Introduction
In this report we tried to evaluate the financial performance as well as financial position of two companies of KNM Group Berhad (7164) and Wah Seong Corporation Berhad (5142) which are both operate in oil and gas industry. To reach objective of this report we undergone the process of financial statement analysis which is consists of Accounting analysis, Financial analysis and Prospective analysis. On fortunately we do not cover the first step even though it is very important and prerequisite to next two steps, as accounting analysis determines the reliability of financial statements. However this task requires access to detail information related to company¶s financial and operational activities which is not available to us. In terms of financial analysis, the report initially presents the time series analysis for each of companies past 5 years (2004 to 2008) and then progress into intercompany comparison of financial ratios. In both parts the report evaluates the liquidity, capital structure and solvency, operating performance and asset utilization ratios to assess the risk and profitability of each company. Profitability analysis is the process of analysis of the company¶s return on investment by referring to two major sources of profitability, the margin which refers to percentage of sales not offset by cost and turnover which also refers to asset utilization. Risk analysis is the process of Evaluation Company¶s ability to fulfill their commitments which involves short term (liquidity analysis) and long-term (solvency) to assess the whole company risk. This is also referred to credit analysis as well. As the last step of financial statement analysis, this paper conducts prospective analysis of these companies in order to determine the intrinsic (fair) value of their shares. This is done through estimation of each company¶s income statement for next 5 years (2009-20013) and discounting back the future earnings. It is important to notice that getting the intrinsic value of these companies in order to facilitate the decision making (buy, hold, sell) is the ultimate objective of this research. The background and market strategy of the two companies is discussed on the first part of this report to give the reader a better comprehension on each company.
Risk analysis analysi s
profitability
Liquidity
solvency
Return on asset (ROA)
Current ratio
Total debt to equity
Return on equity (ROE)
Quick ratio
Long term debt to equity
Net profit margin
Collection period
Time¶s interest earned
Asset utilization
Days to sell inventory
Inventory turnover Account receivable turnover
Strategy Analysis KNM st
KNM is a world class process equipment manufacturer and is ranked 1 in Malaysia, top 2 producer in the world for air-fin coolers and top 3 in heat exchangers products. It has 13 plants in 8 countries and strategically located at the oil and gas hotspot. KNM has exposure to both upstream and downstream segments. The company¶s strategy is simple, which is to be among the top 10 players in the O&G and energy industry. But the matter of how lies on the management of the company and their vision on making it reality. Over the years we see that the expansion plans that the company have made the company more efficiently competing with other players in the market. It proves that the strategy of vastly expanding the company to gain market percentage works. The company sees that the growth of the O&G and energy industry will increase tremendously, thus the management take steps further on expanding the company to cater with the demand.
Wah Seong Wah Seong is currently one of three leading oil and gas pipe coaters in the world. Its line of work specialization consists of oil and gas pipe coating, gas compressor and manufacturing of steel pipes. Given that the pipe coating business is in effect an oligopoly in Asia, Wah Seong stands a good chance of securing new pipeline projects in Malaysia and Asia. In the perspective of the growth of the Group, Wah Seong actively look for and invest in the development and growth of its human capital as well as the strengthening of its values and performance driven culture.
Since undertaking various major acquisitions in 2005 and 2006, the Group continued to consolidate and balance its operations, focusing on cost and efficiency improvements, and strengthening its financial position. Wah Seong Group has been able to steadily enhance their shareholders' value mainly through internal growth. Over the last two years through 2008, the Group has invested significant financial resources in increasing and developing its productive and engineering capabilities and facilities, primarily in deepwater corrosion protection and compressors rental fleets, which are now generating income streams. Currently, the Group is anticipating minimal capital expenditure to be incurred for the year 2009 and 2010, which will translate into improved cash flows and further reinforcing of the Group's balance sheet in 2009 and 2010. It is worth noted that there was a huge increase in Wah Seong¶s short term debt during the year 2008. This is due to the initial funding for the Turkmenistan Block 1 Gas Development Project. Time
Series Analysis
*please note that we used http://www.securities.com/ch.html?pc=MY as source to check our ratios.
KNM Ratio Analysis KNM Financial Ratios 2004
2005
2006
2007
2008
Average
3.18 3.04 215.86 17.90
1.52 1.47 141.10 7.93
1.16 1.10 173.64 7.46
1.29 1.17 144.34 17.16
1.01 0.95 128.06 15.74
1.63 1.55 160.60 13.24
1.35 1.23 8.45
0.69 0.63 10.85
0.51 0.32 15.73
0.48 0.24 22.78
0.79 0.42 7.91
0.76 0.57 13.14
4.47 12.65
11.41 26.15
13.05 33.95
15.05 33.87
7.56 18.54
10.31 25.03
21.91 8.51 8.41
23.16 28.50 11.97
21.58 13.20 14.58
25.88 18.29 15.29
27.93 20.23 13.30
24.09 17.75 12.71
11.03 1.67 20.11 10.13 1.83 0.56
15.71 2.64 45.40 4.22 2.93 0.95
16.72 3.17 48.28 14.23 2.73 0.89
12.52 2.49 20.97 10.54 2.85 0.98
8.14 2.81 22.87 29.65 4.20 0.57
12.82 2.55 31.53 13.75 2.91 0.79
Liquidity
Current Ratio Acid-Test Collection Period Days to sell inventory Capital Structure and Solvency
Total debt to equity Long-term debt to equity Times interest earned Return on Investment
ROA(%) ROE(%) Operating Performances Gross
profit margin(%) Operating profit margin(%) Net profit margin(%) Assets Utilization
Cash turnover Account receivable turnover Inventory turnover Working capital turnover PPE turnover Total assets turnover
Growth of KNM Financial Ratios 2005
2006
2007
2008
Average
-52.26% -51.65% -34.63% -55.70%
-23.80% -25.12% 23.06% -5.93%
11.26% 6.36% -16.87% 130.03%
-21.71% -18.80% -11.28% -8.28%
-21.63% -22.30% -9.93% 15.03%
-48.89% -48.41% 28.42%
-26.09% -49.45% 44.98%
-5.88% -25.00% 44.82%
64.58% 75.00% -65.28%
-4.07% -11.96% 13.24%
155.26% 106.72%
14.37% 29.83%
15.33% -0.24%
-49.77% -45.26%
33.80% 22.76%
5.71% 234.90% 42.33%
-6.82% -53.68% 21.80%
19.93% 38.56% 4.87%
7. 92% 10.61% -13.02%
6.68% 57.60% 14.00%
42.48% 58.00% 125.72% -58.36% 60.22% 69.64%
6.43% 20.30% 6.34% 237.20% -6.83% -6.32%
-25.12% -21.45% -56.57% -25.93% 4.40% 10.11%
-34.98% 12.85% 9.06% 181.31% 47.37% -41.84%
-2.80% 17.43% 21.14% 83.56% 26.29% 7.90%
Liquidity
Current Ratio Acid-Test Collection Period Days to sell inventory Capital Structure and Solvency
Total debt to equity Long-term debt to equity Times interest earned Return on Investment
ROA ROE Operating Performances Gross
profit margin Operating profit margin Net profit margin Assets Utilization
Cash turnover Account receivable turnover Inventory turnover Working capital turnover PPE turnover Total assets turnover
Liquidity Analysis
Current Ratio
Current Ratio Growth
4.00
50.00%
2.00
0.00%
0.00
-50.00% 2004
2005
2006
2007
2008
2005
2006
2007
2008
-100.00%
Based on the computed current ratios, we can see that the liquidity of the company is being affected throughout the years. The current ratios of KNM of year 2004-2008 are 3.18, 1.52, 1.16, 1.29 and 1.01 respectively. The decrease pattern is due to the undergoing expansion of the company towards being the top 10 biggest player in the O&G industry. The liquidity ratios show that how the company could pay its short-term obligation. The company has undergoes a vast expansion throughout the year 2004-2008. Due to the competitive industry of O&G, the company is committed to pursue the company¶s objective. Due to this, the current ratios drops 52.26
%(2005), 23.80 %(2006),
11.26 %(2007) and 21.71 %(2008). From the investor¶s point of view, they
prefer higher ratios as it show the solvency of the company. The collection periods of the company are decrease due to the huge projects in hands. The early collections of payments are highly needed and the management did a good job on running the business as the days decrease. This is to make sure that the payment due did not exceed its time; thus jeopardize the cash flows of the projects. The company¶s inventory is selling like hot cakes as the demand for the O&G equipment are high. The average days in inventory during 2004-08 are 17.90, 7.93, 7.46, 17.16 and 15.74 respectively. This could be the reason why KNM bought a lot of stakes in other company as there are in need of increasing supply of equipment. The technological advancement transferred from the buyouts benefited the company which shows in the increase of demand as KNM are being trusted buy Oil companies such as Petronas, Petbras, Exxonmobil, shell and ect. In the short-term, we see that the company¶s performance have been affected by the heavy bought of expansion. It could jeopardize the solvency of the company to run in the short period. However the expansion of the company will see the results in 2009-2010 as the economy are slowly booming after the sub-prime crisis. In the long-run the company is solvent enough to run and with the well manage by the management, the company¶s objective could be achieved.
Capital Structure and Solvency Analysis Total debt to equity Growth
Total debt to equity
1.50
100.00%
1.00
50.00%
0.50
0.00%
0.00
-50.00% 2004
2005
2006
2007
2005
2006
2007
2008
2008 -100.00%
Total debt to equity ratios for the analysis years shows that the ratios are decrease over the years of 04-07 before increase in the following year. The reason behind the ratio lies on the massive expansion of the company throughout the respective years;
y
During 2004, KNM acquired a stake in FBM-Hudson Italiana SpA¶s plant in Dubai and secured the exclusive marketing and manufacturing rights for FBM¶s products in South-East Asia and China.
y
In 2004-05 KNM increase the production of O&G equipment in Kuantan, Gebeng, China and Jaber Ali Dubai. Plan to invest 135mil in building new plant and plant expansion.
y
In 2006, having 1.6bln in hand it increase the production to 115000 metric tons. It acquired VPSB (virgo Pulse Snd Bhd) for RM28mil. It is the leading manufacturer of industrial boilers and heat recovery steam generators (HRSG). It acquired the whole stake in FBM for another RM7.9mil
y
In 2007, it increase the production to 146000MT and fully utilized all the plant. It made a PPE investment worth 258mil in year 07, KNM¶s latest partnership is with Prosernat SA of France.
y
In 2008, KNM acquire Borsig GmbH for 1.7bil and In January and KNM proposed to buy a 100% stake in mid-sized Belgium-based process equipment maker Ellimetal NV for another 20 million euros (RM97mil) while having RM4.7bil worth of order book value.
The increase in the ratio in 2008 is because of KNM lower down the debts in hand as it received payments from the previous projects in hand. The company paid cash on acquiring Borsig GmbH which worth Rm1.7bil. Long-term debt to equity is in the decreasing manner as it made a vast expansion throughout the 5 years. Investors are being skeptic on how the company will pay it long term debts and it undergoes a selling craze of shares in 2008. The times interest earned ratio shows that the company¶s performance are increase through 2004-07. But due to the crisis that falls on 2008, it affects the earnings of the company. In the long run the company is doing well in the long run and might achieve its goal. However the company needs to remain competitive to gain new projects in the future as to remain solvent in the long run and the ability to pay its long term obligations.
Return on Investment Analysis 200.00%
40.00
150.00%
30.00
100.00% 20.00
50.00% 0.00%
10.00
-50.00% 0.00
2005
2006
2007
2008
-100.00% 2004 2005 2006 2007 2008 ROA % ROE %
ROA(%)
ROE(%)
From the graph, it shows that both ROA and ROE are in the increase manner from 2004-07. The heavy expansion and increase in production of O&G equipment have showed and increment of more than 150 %
in ROA and more than 100% in ROE in 2005. However the ROE of the company is below the industrial average of 25.4x*. The CAPEX that are being use to expand the production really shows its results. But during the 2008 the amount of return on both ratios are drops significantly due to the sudden bird flu outbreak. It scared off the investors and potential buyers as the economy are badly affected. Due to the high in ROE, the company achieved the corporate goal which is to maximize the shareholder¶s wealth. But the company should consider investing more into the profitable projects and expand its scope of works to increase its ROA. *refer to appendix
Operating Performance Analysis 30.00
250.00%
25.00
200.00%
20.00
150.00%
15.00
100.00%
10.00
50.00%
5.00
0.00%
0.00
-50.00%
2004 2005 2006 2007 2008 Gross profit margin(%) Operating profit margin(%)
2005 2006 -100.00% Gross profit margin(%)
2007
2008
Operating profit margin(%)
Gross profit margin and operating profit margin of KNM is somehow quite stable, this is due to the continuously projects that are being awarded to the company. The projects are drives by the heavy CAPEX by the oil companies as the industry is booming. KNM most projects come from the oil sand development in Canada, several LNG pipeline projects in Australia, Brazil, middle east countries such as Egypt and many others. The profitability of the company is assured as by the end on 2008, it has Rm4.7 bill worth of projects in hand. Incomes of the company are approved throughout 2004-07 as it can be seen from the net profit margin ratio. The company¶s expansion and acquired stake have improved the profitability of the company as it capture the market percentage. KNM which accounts for 1.2 percent of the world demand in O&G equipment and services, have shown its ability to achieve to be among top 10 main players in the industry.
Assets Utilization Analysis Cash turnover
Cash turnover growth 60.00%
20.00
40.00%
15.00
20.00%
10.00
0.00%
5.00
-20.00%
0.00
2005
2006
2007
2008
-40.00%
2004 2005 2006 2007 2008
The cash turnover ratio shows the ability of the company efficiently use the cash resources to generate income. The company is efficiently handling its cash and it reflects on the computed ratio. The company which used up the cash for expansion really profits the company and it shows in the growing net income of the company. Even though the buyouts of other companies and expansions did affect its long and short term liquidity, it shows that the buying the act of doing so benefited and maximized the efficiency of the company in generating profits. Inventory turnover which shows that the company needs to improve the production as it will leads to loss of opportunity. The company which have expand and increase the capacity of the production might still loose as the high demand in O&G equipment. Overall the performance of the company is good even though the vast expansion and increasing capacity made by KNM affects the short-term solvency. But in the long-term run, t he profitability and the solvency of the company will enhance as the energy industry has the most percentage of growth. The company still have the growth opportunity as It has variety of business portfolio and strategies, in the long-run investors should invest on the equity as it will expand further in the future.
Wah Seong Ratio Analysis
*Please note that we used http://www.securities.com/ch.html?pc=MY as source to check our ratios.
You can refer to the graph for all the calculated ratios in the appe ndix.
Wah Seong Financial Ratios 2004
2005
2006
2007
2008
Average
1.80 1.16 101.82 63.58
1.20 0.89 119.56 53.31
1.35 0.93 100.62 55.96
1.39 1.01 101.82 46.85
1.48 1.09 104.69 46.85
1.44 1.02 105.70 53.31
1.35 0.66 6.12
1.36 0.47 5.93
1.25 0.58 3.74
1.00 0.39 5.50
0.86 0.31 6.04
1.16 0.48 5.47
3.38 11.55
4.07 16.34
2.70 10.06
5.51 18.31
5.43 14.61
4.22 14.17
15.23 8.72 3.40
18.65 8.07 4.27
17.87 5.76 2.30
16.72 7.32 4.41
16.62 7.41 4.93
17.02 7.46 3.86
11.40 3.01 5.53 4.64 3.26 0.99
13.63 3.54 6.66 8.10 4.03 0.95
15.14 3.58 6.55 9.66 4.48 1. 17
18.93 3.59 7.68 7.93 6.05 1.25
15.42 3.31 7.68 6.73 5.30 1.10
14.90 3.41 6.82 7.41 4.62 1.09
Liquidity
Current Ratio Acid-Test Collection Period Days to sell inventory Capital Structure and Solvency
Total debt to equity Long-term debt to equity Times interest earned Return on Investment
ROA(%) ROE(%) Operating Performances Gross
profit margin(%) Operating profit margin(%) Net profit margin(%) Assets Utilization
Cash turnover Account receivable turnover Inventory turnover Working capital turnover PPE turnover Total assets turnover
Growth of Wah Seong Financial Ratios 2005
2006
2007
2008
Average
-33.33% -23.28% 17.42% -16.15%
12.50% 4.49% -15.84% 4.97%
2.96% 8.60% 1.19% -16.28%
6.47% 7.92% 2.82% 0.00%
-2.85% -0.56% 1.40% -6.87%
0.74% -29.18% -3.02%
-8.09% 24.68% -36.95%
-20.00% -33.05% 47.06%
-14.00% -20.31% 9.80%
-10.34% -14.46% 4.22%
20.41% 41.47%
-33.66% -38.43%
104.07% 82.01%
-1.45% -20.21%
22.34% 16.21%
22.46% -7.45% 25.59%
-4.18% -28.62% -46.14%
-6.44% 27.08% 91.74%
-0.60% 1.23% 11.79%
2.81% -1.94% 20.75%
19.54% 17.51% 20.43% 74.57% 23.54% -4.04%
11.12% 1.20% -1.65% 19.31% 11.23% 23.16%
25.03% 0.45% 17.25% -17.98% 35.05% 6.84%
-18.54% -7.90% 0.00% -15.09% -12.42% -12.00%
9.29% 2.81% 9.01% 15.20% 14.35% 3.49%
Liquidity
Current Ratio Acid-Test Collection Period Days to sell inventory Capital Structure and Solvency
Total debt to equity Long-term debt to equity Times interest earned Return on Investment
ROA ROE Operating Performances Gross
profit margin Operating profit margin Net profit margin Assets Utilization
Cash turnover Account receivable turnover Inventory turnover Working capital turnover PPE turnover Total assets turnover
Liquidity Analysis
curre nt Ratio
2.00 1.80 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 1
2
3 y
4
5
e a r
As it is known that the liquidity ratios shows the ability in handing the short term financial obligations by the information provided from the financial statement and the balance sheet. As the calculations for the liquidity ratios for Wah Seong company shows, the company current ratio was at the highest level in 2004 where it was 1.8:1 which means that the company¶s current assets is 1.8 to the 1 of the company¶s current liability, where with the movement of the years we can see that this current ratio is decreasing from year to year when as we can see that in 2005 it dropped by 0.6 to become 1.2:1 which was the worst year among the last 5 years and that was because of the increasing in the current liability in that year and then it started to grow by the years after to 1.35:1 in 2006 until it reaches to 1.48:1 in 2008 where the current assets did increase. Moving to the other ratio we have here we will find the quick ratio for the company where this ratio shows us the relation between the company¶s most liquid assets to its liabilities where the higher is the better where in this ratio we exclude the inventory from current assets because it takes tims for the company to turn the inventory into cash (inventory to A/C receivables to cash), and by looking at the last 5 years for the company we will find out that the best year was in 2004 as well where it was 1.16:1 comparing it with the last year which is 2008 which the ratio was 1.09 where that happened in the current ratio as well where it was because of the decrease in the current assets and increase in the current liabilities. So by looking at the graph and the dates (in the appendix) we will find that the worst was in 2005 where it was 0.89:1 where the current liabilities was higher than the current assets after excluding the inventories from the current assets which shows some differences. The main reason for decrease in current and quick ratio of Wah Seong is increase in short-term borrowings for fast expansion of business. Collection period shows the period from point of sales to the point that the company will collect their money, so if look at our company we will see that the best year was in 2006 where the company was able
to collect the money in 100.62 days. And before thinking about when to get the money back the company should know in how many days they are going to sell all their inventories so by looking at the day to sell inventory ratios we will find that the fasts year that the company could sell its inventory was in 2007 and 2008 where the company could sell its inventory in 46.85 days and that was the best in the last 5 years. In conclusion we can say in terms of liquidity analysis ratios the company had lots of fluctuation up and down where it was at the best in 2004, and then it started to grow up again in 2007 and 2008. The company could decrease the number of the days to sell its inventory in the last 5 years, and there was increase in the number of the days to collect the money back. The
Capital Structure and Solvency Analysis long tearm debt to equit 0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00 1
2
3
4
5
y e a r
Going a step forward to the capital structure and solvency by doing the total debt to equity ratio which show as what proportion the equity and debt the company is using to finance its assets, so if the ratio is greater than one means assets are mostly financed with debt, and if it was less than one it means that the equity provides a majority of the financing, so by looking at the result for the last 5 year we will find that since 2004 until 2007 it was either one or more than one until the last year 2008 we will find that it dropped to 0.86 where it was 1 in the year before (2007) and that drop was because of the increase in the equity which means that the assets are financed by equity. Considering long term debt to equity ratio which is showing or judging the company dept over the equity, by looking at the years of 2004 until 2008 we will find that it¶s all below 1 where in 2004 it was 0.66 and in 2005 it was 0.47, and it shows that shareholder equity is higher than the long term debt and that decrease could be because of selling some assets and that would be the reason of decreasing the debt. Return on Investment Analysis
Going after the capital structure and solvency we find the return on investment where we have the return on assets and the return on equity, taking it one by one the return on assets where it indicates what return a company is generating on the firm¶s investment assets, ROA of our company in the last 5 years it shows us that the highest rate was in 2007 and the rate was 5.51 and the lowest rate was in 2006 which was 2.70. After that we move to the retune on equity (ROE) which indicates what return a company is generating on the owner¶s investment, (ROE) is also referred to as stockholder¶s return on investment, it tells as that the rate that shareholders are earning on their shares, and by looking at our company we will find that the highest rat was 18.31 in 2007 which was also the highest rate on the (ROA) as well and looking at the lowest rate will find that is accurse in 2006 at a rate of 10.06. So we can say that the company return on assets was moving up and down in the last 5 years and the return on equity was high in rat in the year 2004 and 2008 as well. Operating Performance Analysis oper ation profit m argin 10.0 0 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.0 0 0.00 1
2
3
4
5
ea r
Gross profit margin which it used to assess the company financial performance by revealing the proportion of the money left over from revenues after accounting for cost of goods sold over the total revenue. By looking at our company we will find that the highest rate was in 2005 which was 18.65
%
and
the lowest was in 2004 which was 15.23 % and that was because of the small amount of differences between the sales and the cost of the good sold in that year which was (Rm757773K & RM643139K) where you can see that the differences about (RM 114634K). Operating profit margin which is measuring the company pricing strategy and operating efficiency, and shows how much the company is making on each Ringgit of sales, so by looking at the performance of our company in the last 5 years we can see that the highest rat was 8.72 % in 2004 where the sales for that year was (RM757773K) and the lowest was 5.76 % in 2006. The last one is the net profit margin which shows how much of each Ringgit earned by the company is translated into net profit, so by looking at our company we will f ind that our company performance in the
last 5 years, and the highest was in 2008 which was 4.93 with a great net income and the lowest was in 2006 which was 2.30 because of the low net income. Assets Utilization Analysis
w ork ing capital turnover 12.00
10.00
8.00
6.00
4.00
2.00
0.00 1
2
3
y
4
5
e a r
Assets utilization, we have done a 6 ratios to judge on the assets utilizations, first is inventory turnover which shows how many times a company¶s inventory is sold and replaced over a period, the highest was 7.68 in 2008 in the last 5 years and the lowest was in 2004 which was 5.53 and the cost of good sold was (RM643139k). Total assets turnover, this ratio is useful to determine the amount of sales that are generated from each dollar of assets, so by looking at the last 5 years we can find that the highest was 1.25
%
in 2007 and the
lowest was in 2005 which was 0.95 % where the total assets was (RM762952k) for that year. The cash turnover ratio where it shows how efficiently a company using the cash to get the income, so by looking at our company we will see that the rate was increasing from 2004 until 2007 and that was because of the increase in the sales for those years. Working capital turnover ratio for our company was increasing in the since 2004 until 2006 and it reached to 9.66. In 2007 and 2008 there was a decrease that was due to the increase in the average working capital. In conclusion we can see that the assets utilization and the performance for the company is good compare with the market and it sales is increase by the years which will help them a lot to move on in the future.
Intercompany Evaluation In intercompany evaluation the total risk and profitability are compared considering both, the average of ratio percentage and growth along with ratios of last year of operation (2008) to see what has been the performance of each company within these years.
Liquidity
In terms of current (2008) liquidity ratios, Wah Seong has higher current and quick ratio of 1.48 and 1.09 compare to KNM¶s 1.01 and 0.95 as well as better collection period of 104 day in contrast to KNM¶s 128 days. But KNM much in better than Wah Seong considering days to sell inventory ratio of 15 days compare to 46 day¶s of Wah Seong. In view of average figures, we will see that the situation is different and KNM has a better average current, quick and days to sell inventory ratios and Wah Seong is better in terms of collection period. This in consistency between average and 2008 figures of current and quick ratios happened as result of better (or less worse as they both have negative growth) average growth of Wah Seong over the past 5 years. Therefore in general we can conclude that Wah Seong has more capacity to meet its short-term obligations as result of better liquidity ratios. But it is also considerable that KNM has a very short days to sell inventory ratio. Un fortunately both of the companies have a negative average growth rate of main liquidity ratios which indicates that their ability to pay their short term debt reduced over time as result of increase in their short term borrowings and debt. *please refer to Appendix for the graphs related to liquidity ratios comparison.
Capital structure and Solvency
Considering the current (2008) as well as overall (average) position (measured by ratios) of both companies relative to their ability to pay pack their long-term debt, KNM is slightly in better position compare to Wah Seong. KNM has somewhat safer total debt to equity of ratio (0.79) compare to Wah Seong (0.86) in 2008. This slighty safer position us also supported by KNM¶s higher times interest earned ratio of 7.91 against Wah Seongs¶s 6.04. But in terms long-term debt to equity ratio this relationship is opposite and Wah Seong maintain a slightly better figure 0.31 verses KNM¶s 0.42.
It is also important to notice that KNM maintained a much better average rate of growth in times interest earned of 13.24% against Wah Seong¶s 4.22 % during the past 5 years. Please notice that all of the above arguments are also supported by average ratio figures of 2004 to 2008. In general we can conclude that KNM is slightly less levered compare to Wah Seong and it is somewhat safer (more able) in terms of ability to meet its long-term obligations (solvency) considering both last year of rations and the average of past 5 years. This makes KNM more attractive to long-term creditors and lenders. Return on Investment ROA Graphs
20.00
200.00% 150.00%
15.00
100.00%
10.00
50.00%
5.00
0.00% -50.00%
0.00 2004
2005
KNM
2006
2007
2008
2005
2006
2007
2008
-100.00% KNM
Wah Seong
Wah Seong
The ROA shows how companies efficiently handling money to generate profit. From the graft we see that KNM performs better than Wah Seong as it shows tremendous increment throughout the years. The expansion plan really did increase the profitability of the company. While Wah Seong¶s earnings ROA shows some fluctuation, this shows that the ability of the company to efficiently generating profits could be question. The industry is booming while Wah Seong¶s ROA does not reflect the actual situation as KNM did. The management needs to come up with a plan to expand to the company as it needs to remain competitive even though it is the largest pipe coating company in Asia. The company needs to venture into new projects or other products. The needs to diversify their portfolios are crucially needed and the company might lose the opportunity in the booming industry. ROE Graphs
40.00
150.00%
30.00
100.00%
20.00
50.00% 0.00%
10.00
-50.00%
2005
2006
0.00 2004
KNM
2005
2006
2007
Wah Seong
2008
-100.00%
KNM
2007
2008
Apart from the ROA, ROE show how management uses the source of shareholder¶s equity to generate profit. Based from the ROE above, we can see that the return that KNM is generating more than what Wah Seong did. During 2005 we see that the expansion plan made by KNM have made the ROE growth more than 100%. The momentum of the growth, grow steadily until 2007 before falls on 2008 due to the acquiring of Borsig GmbH and the bird flu outbreak. However, with the total of RM4.6bil worth of projects in hand, KNM expected to grow in 2009. Wah Seong on the other side sees the fluctuation in the ROE. In investors view, Wah Seong is less likely to be affected to the global downturn whereas KNM survived through all cycles of economy. Wah Seong again, in needs to explore new opportunity into new business portfolio as to expand like other player in the market and embark into new products and technological advancement.
Operating performance
Gross Profit Margin for KNM and Wah Seong is 27.93% and 16.62% respectively. Meaning that RM1 of KNM sales generates RM0.2793 of gross profit, whereas Wah Seong is less competitive at this point, generating RM0.1131 less than its major rival. But for more reliable comparison we consider the average of 5 years, 2004 throughout 2008. In that case 24.09 % vs 17.02%, which proves stable comparative advantage of KNM Sdn Bhd, which is obviously sustained by minimizing cost of sales.
In terms of operating profit margin KNM has 20.23 % vs. Wah Seong¶s 7.41 %. And again Wah Seong didn¶t manage to reduce its operating expenses in order to boost its operating gains, leaving its indicators 2.73 times less behind KNM. Average of 5 years of operating profit margin shows 17.75 % vs. 7.46%, corresponding to RM0.1775 operating gain from RM1 of sales of KNM and RM0.0746 operating profit from RM1 of sales of Wah Seong.
And finally, arriving to Net profit margin evaluation, the gap between KNM and Wah Seong indicators is drastic: 13.30% vs. 4.93%. This shows that KNM is 2.7 times more effective in generating profits when it comes to net gains. Well, as we can see the financing gain and cost is almost at the same percentage level of sales, as the 2.7 proportion difference in net profit margin after 2.73 difference when calculating operating profit margin. Thus, we can conclude that financing activities are almost equally efficient. Net profit margin outlook for last 5 years shows is as follows: KNM performing at 12.71 % vs. 3.86% of Wah Seong.
In General, we can say that KNM shows better overall operating performance compared to Wah Seong Sdn Bhd, whether analyzed based solely on financial indicators or on average indicators for last 5 financial years (2004-2008).
Asset Utilization 2008 Assets Utilization
KNM
Waseong
Growth
Average Difference
KNM
Waseong
Difference
KNM
Waseong
Difference
Cash turnover
8.14
15.42
-7.28
12.82
14.90
-2.08
-2.80%
9.29%
-12.09%
Account receivable turnover
2.81
3.31
-0.50
2.55
3.41
-0.86
17.43%
2.81%
14.62%
Inventory turnover
22.87
7.68
15.19
31.53
6.82
24.71
21.14%
9.01%
12.13%
Working capital turnover
29.65
6.73
22.92
13.75
7.41
6.34
83.56%
15.20%
68.36%
PPE turnover
4.20
5.30
-1.10
2.91
4.62
-1.71
26.29%
14.35%
11.94%
Total assets turnover
0.57
1.10
-0.53
0.79
1.09
-0.30
7.90%
3.49%
4.41%
Considering historical and current (2008) efficiency in use of assets, Wah Seong is more successful than KNM as it has a higher current and average cash turnover, account receivable turnover, PPE turnover and total asset turnover ratios. But KNM maintain a higher working capital and inventory turnover ratio which means that the company generate sales with lower rate of working capital compare to Wah Seong. This difference is substantial, especially in 2008 whereby KNM has Ratio of 29.69 versus Waseong 6.73. In terms of growth in asset utilization ratios though, KNM shows strong progress. KNM poses higher average rate of growth in all asset utilization ratios except cash turnover. In general we believe that in terms of asset utilization, Wah Seong is currently in better position as indicated by its higher recent and average ratios. But considering the future of these companies considering their efficiency in use of their assets in producing revenue, KNM has a better chance assuming that it maintains its high rate of growth over time.
Prospective Analysis In our prospective analysis, we are following the ultimate objective of estimating the company¶s intrinsic value. Therefore the only forecasted financial statement that we need is the income statement. To prepare the forecasted income statements we based our estimation on historical data and ratios of the income statement for the year ended 31 st December 2008 for both KNM and WahSeong. Please note that we generated the estimated income statement for period of 5 years (2009-2013).
KNM Group Berhad (7164) KNM Forecasted Income Statement in RM'000 Estimated
Revenue (-)Cost of sales Gross profit (-)Other expenses & earnings Operating Profit (-)Interest cost/income Profit before tax (-)Tax expenses Net income Selected Ratios Sales Growth Gross profit margin Other expenses & earnings / Sales Interest / Prior-year Total debt*
1 3 2 4 5 6 7 8 9
2008
2009
2010
2011
2528750 1810588 706390 194858 511532 57811 453721 117489 336232
5198352 3746226 1452126 400570 1051557 310974 740583 191771 548812
10686255 7701119 2985137 823451 2161685 373168 1788517 463128 1325389
21967740 15831194 6136546 1692769 4443777 447802 3995975 1034740 2961236
2012
45159093 92833567 32544192 66901109 12614901 25932458 3479826 7153480 9135075 18778978 537362 644835 8597713 18134143 2226339 4695754 6371374 13438389
105.57% 27.93% 7.71% 21.74%
Income tax / Pretax income 25.89% Note: All of the calculation is done in Excel; the file is in the cd attached to the report as appendix.
1- Forecasted Sales: Previous year sales x (1 + sales growth rate) 2-Gross profit: F sales x Gross profit margin ratio 3-Cost of sales: Forecasted sales ± Gross profit 4-Other expenses & earnings: F sales x (Other expenses & earnings /sales) ratio 5-Operating profit: Gross profit ± Other expenses & earnings 6-Interest cost/income**: Beginning year interest bearing debt x (interest/prior- year total debt *) 7-Profit before tax: Operating profit ± (Interest cost/income) 8-Tax expenses: Profit before tax x (Income tax/ pretax income)
2013
9-Net income: Profit before tax ± Tax expenses *
We used (interest/Prior-year Total debt) ratio instead of (interest/Prior-year Long-term debt)ratio
because we realized that most of the financing cost and interest paid by company which is reflected in Income statement as interest expenses is related to short-term borrowings and not the long-term. Therefore we believe that using the Interest to total debt ratio is more relevant and realistic to forecast the company¶s future interest payments. **
As you may noticed KNM has an unusual rate of growth in sales (more than 100 %) for the past years.
Looking at the details of the financial statement you will see that this high rate of growth is backed up by relatively high cash inflow in to the company which is either raised by share issue or more borrowing. Therefore we assumed that the amount of interest-bearing debt of the company will rise at the average rate of 20% per year. We believe that this modification will make the future forecast of the company¶s income more realistic. Intrinsic Value ± In case of KNM we canµt simply discount back future net income assuming that the net
income will grow at the same rate as 2013. This company had a tremendous rate of growth which is way above industry (any industry) average. If you look at the details of the past financial statements, you will see that this growth is highly supported by increase in equity (especially issue of new shares). Therefore if we simply discount back forecasted net income we will get and intrinsic value illogically above the current price of the share and the result won¶t be realistic. The correct method of calculating the Intrinsic value of KNM in to discount back the future return above the required rate of return of the future common equity (also called residual income) for each future period and then add cumulative present value of residual incomes to beginning book value of equity to get the current fair value of the company¶s equity. Unfortunately this process requires lots of calculation and can¶t be done under scope of this report. Therefore we will try the qualitative method instead of quantitative. One thing that is obvious about the KNM is that the company¶s share price is (probably highly) undervalued as the companies major share holders insist on delisting the firm as they believe that the market price of the company¶s share should by way above the current price of RM0.73( as at 5/4/2010) . But how much is the fare value of the shares, we need to undergo the complicated calculation explained in above paragraph. In terms of decision making (buy, sell, hold), we suggest that investors have to BUY this share as it is highly undervalued.
Wah Seong Corporation Berhad (5142) Wah Seong Forecasted Income Statement in RM'000
Estimated
Revenue (-)Cost of sales Gross profit (-)Other expenses & earnings Operating Profit (+)Earning in equity* (-)Interest cost/income Profit before tax (-)Tax expenses Net income
1 3 2 4 5 6 7 8 9
2008
2009
2010
2343194 1953667 389527 211992 177535 5723 30345 152913 19864 133049
2815509 2347466 468044 254723 213321 Nil 40763 172558 22416 150142
3383028 2820642 562387 306067 256319 Nil 46062 210257 27313 182944
2011
4064942 3389195 675746 367761 307985 Nil 52050 255935 33247 222688
2012
4884308 4072352 811956 441890 370066 Nil 58817 311249 40432 270816
2013
5868832 4893212 975621 530961 444659 Nil 66463 378196 49129 329067
Selected Ratios Sales Growth Gross profit margin Other expenses & earnings / Sales Interest / Pre-year long-term debt Income tax / Pretax income
20.16% 16.62% 9.05% 12.97% 12.99% Note: All of the calculation is done in Excel; the file is in the cd attached to the report as appendix.
Please notice that Item 1, 2, 3, 4, 5, 8 and 9 are calculated based on the same formula as KNM company.(please refer to above notes to see the details of calculations) 6-Interest cost/income**: Beginning year interest bearing debt x (interest/pre- year Long-term debt) 7-Profit before tax: Operating profit + Earning in equity* ± (Interest cost/income) *As earning in equity is not a recurring item (and there is no benchmark to forecast), we assumed that this item will be zero for forecasted periods. **the amount of long-term debt of company had an average growth of 13 % during the past 5 years. Therefore we assumed that Wah Seong continue to have the same amount of growth in long-term debt for future periods. Interest calculation is based on this assumption. Intrinsic Value ± For calculating the intrinsic value of Wah Seong we assume that the company¶s future
earnings after 2013 will grow at the rate of 10.52 % (expected growth in earnings= g = Retention Ratio x ROE = 0.72 x 14.61 = 10.52%). Considering the discount rate for these calculations, we believe that the s imple interest rate announced by Bank Negara Malaysia is not a proper benchmark because investing in stock market is much more risky
than fixed deposits and interbank loans. Therefore we use the Oil and Gas industry average ROE equal to 25.9% as discount rate (please refer to the article ³Sector focus Malaysia Oil and Gas´ in the appendix). Value of equity
Fair value of equity
Intrinsic (Fair) value of each share
As indicated by our calculation the approximate fair price of Wah Seong Company should be around RM2.66. Compare to current market price of RM2.69 (as at 2/4/2010) the share may slightly be undervalued. But in general, considering the probable error in our calculation we can conclude that the market price of this share represents its fair price and in terms of decision making (buy, sell, hold) we believe that the investors have to HOLD their shares hoping for increase in prices.
Conclusion KNM Group Berhad and Wah Seong Corporation Berhad are both one of the major competitors of oil and gas industry. Considering the past 5 years they have both a substantial increase in their short term borrowings in order to expand their activities which resulted in decrease of their liquidity. Considering creditors point of view and risk analysis, Wah Seong is in better position to meet its short term obligations but KNM is less levered compare to Wah seong which makes it more attractive for longterm creditors (like bond holders) as it has more capacity to pay its long-term liabilities. In terms of profitability and from the investor¶s point of view, we can conclude that in general KNM is in better position as it has better return on investment and operating performance ratios along with much better growth in Asset utilization ratios over time. As it comes to the ultimate objective of this report which is estimating the intrinsic value of each company¶s share, our finding somehow supports the statement regarding the profitability of the companies.
In Case of KNM we know that currently it is highly undervalued as the major share holders arguing about delisting the company. We didn¶t calculate the intrinsic value of the shares as the company¶s constant unusual growth in earning is highly supported with increase in common equity and it won¶t be realistic if we simply discount back the future earnings of the company. On the other hand our calculations regarding the Wah Seong intrinsic value shows that the current market price of the company is very close to the company¶s fair value. Hence perhaps it would be best for investors to HOLD their shares. Therefore in general, we conclude that KNM is in better position compare to Wah Seong. Although the company¶s share price been controversial, but KNM would be profitable BUY decision specially for passive (buy and hold) investors. As we believe that sooner or later the market share price of KNM will reflect its fair value resulting from company¶s strong performance.
Appendix KNM Graphs Liquidity
Acid-Test
4.00
Acid-Test
20.00%
3.00
0.00% 2005
2.00
2006
2007
2008
-20.00%
1.00 -40.00%
0.00 2004
2005 2006 2007 Acid-Test
Collection
250.00
2008
-60.00% Acid-Test
Period
Collection
40.00%
Period
200.00 20.00%
150.00
0.00%
100.00
2005
50.00
2006
2007
2008
-20.00%
0.00 2004 2005 2006 2007 2008 Collection
-40.00% Collection Period
20.00
150.00%
15.00
100.00%
10.00
50.00% 0.00%
5.00
-50.00%
0.00 2004
2005 2006 2007 Days to sell inventory
Capital Structure Solvency
2008
2005
2006
2007
-100.00% Days to sell inventory
2008
Times
Times
interest earned
interest earned Growth
25.00
100.00%
20.00
50.00%
15.00 10.00
0.00%
5.00 -50.00%
0.00 2004 2005 2006 2007 2008
2005 2006 2007 2008
-100.00%
Operating Performance
Net profit margin
Net profit margin
20.00
50.00% 40.00%
15.00
30.00% 20.00%
10.00
10.00% 5.00
0.00% -10.00%
0.00 2004 2005 2006 2007 2008 Net profit margin
2005
2006
2007
2008
-20.00% Net profit margin
Assets Utilization
3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 2004
2005
2006
2007
Account receivable turnover
2008
70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% -10.00% -20.00% -30.00%
2005 2006 2007 2008
Account receivable turnover
Inventory turnover 60.00
150.00%
50.00
Inventory turnover
100.00%
40.00 50.00%
30.00 20.00
0.00%
10.00
-50.00%
2005
2006
2007
2008
0.00 2004 2005 2006 2007 Inventory turnover
2008
Working
Inventory turnover
Working
capital turnover
40.00
-100.00%
300.00%
30.00
capital turnover
200.00%
20.00
100.00%
10.00 0.00% 2005
0.00 2004 2005 2006 2007 2008 Working capital turnover
2006
2007
2008
-100.00% Working capital turnover
PPE turnover
PPE turnover
4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00
70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% -10.00% 2004
2005 2006 2007 PPE turnover
2008
2005
2006
2007
-20.00% PPE turnover
2008
Total
assets turnover
Total
assets turnover
1.20
80.00%
1.00
60.00%
0.80
40.00%
0.60
20.00%
0.40
0.00%
0.20
-20.00%
0.00
-40.00% 2004
2005
2006
2007
2005
2007
2008
-60.00%
2008
Total assets turnover
Wah
2006
Total assets turnover
Seong Graphs
collection period
days to sell invetory
125.00
70.00
120.00
60.00
115.00
50.00
110.00
40.00
105.00
30.00
100.00
20.00
95.00
10.00
0.00
90.00 1
2
3
4
5
1
2
3
4
5
year
year
acid-Test
total debt to equity 1.40
1.60 1.40
1.20
1.20
1.00
1.00
0.80
0.80 0.60 0.60 0.40
0.40
0.20
0.20 0.00
0.00 1
2
3
year
4
5
1
2
3
year
4
5
times interst earned
cash turnover
7.00
20.00 18.00
6.00
16.00 5.00
14.00 12.00
4.00
10.00 3.00
8.00 6.00
2.00
4.00 1.00 2.00 0.00
0.00 1
2
3
4
year
5
1
2
3
4
year
5
inventory turnover
Gross profit margin 20.00
9.00
18.00
8.00
16.00
7.00
14.00
6.00
12.00
5.00
10.00
4.00 8.00
3.00
6.00
2.00
4.00
1.00
2.00
0.00
0.00 1
2
3
year
4
1
5
account receivable turnover
2
3
year
4
5
Net profit margin 6.00
3.70 3.60
5.00
3.50 3.40
4.00
3.30
3.00
3.20 3.10
2.00
3.00 2.90
1.00 2.80 2.70
0.00 1
2
3
year
4
5
1
2
3
year
4
5
Total assets turnover
PPE turnover
1.40
7.00
1.20
6.00
1.00
5.00
0.80
4.00
0.60
3.00
0.40
2.00
0.20
1.00
0.00
0.00 1
2
Liquidity Comparison
3
year
4
1
5
2
3
4
year
5
of KNM and Wah Seong:
Current ratio
Acid-TEST ratio
3.50
3.50 3.00
3.00
2.50
2.50
2.00
KNM
WOHSeong
1.50
2.00
KNM
1.50
WOHSeong
1.00
1.00
0.50
0.50 0.00
0.00 1
2
3
4
1
5
2
3
4
5
year
year
Collection period
Days to sell inventory
250.00
70.00
60.00 200.00
50.00 150.00
40.00
KNM
KNM
WOHSeong 100.00
WOHSeong
30.00
20.00 50.00
10.00
0.00
0.00 1
2
3
year
4
5
1
2
3
year
4
5
