Tuesday, December 04, 2007

Fundamental analysis on Popular

Introduction

Popular has this big vision of being the Edu-Channel of East Asia. With this vision in sight, they are making inroads into China, notably Beijing, Shenzhen and Guangzhou. This is besides their usual operating position in Singapore, Malaysia, Hong Kong, Macau, Taiwan and Canada.

Popular had been around for a long time, and they celebrated their 80th anniversary in 2004, having been listed in SGX since 1997. They have 3 branches of growth – retail and distribution, publishing/e-learning and their new business segment - property. Publishing is their key contributor to their bottom line. Very recently, they are also going into property, a whole new business segment through their new subsidiary, Popular Land Pte Ltd.

Popular to me is quite a recognized brand name at least in Singapore. I’m quite in tune with the education scene in Singapore so I’m in a good position to know. A lot of students have this popular card membership that entitles them to have discounts of 10%. It’s a paid subscription and offers discounts to other places like restaurants, optic shops etc. And boy do they shop – pens, correction tapes, exercise books and the most essential – assessment books and ten-year series (affectionately called TYS for short). The TYS are so popular that towards the end of the year around Sept/Oct, the shelves are snapped clean of them. Whether this can translate into profits in their coffers is another thing altogether, of course.

I’m going to break up my analysis on Popular into different segments – economic moat, growth, profitability, financial health, risks/bear case and their management. If I’m still up to it, I might want to do a DCF or DDM to arrive at some numerical valuation of the company.

Economic moat

It is important to think about whether Popular has a economic moat around it that prevents other competitors from snatching away its earnings and growth. It appears that Popular does have a certain moat around it, being one of the major publishers in its homeground – Singapore and Malaysia. It is fast gaining a foothold in the textbook market in Hong Kong and Taiwan, but more of that later. To look for evidence of economic moat, let’s take a look at how profitable Popular had been in the past by analyzing free cash flow, margins, ROE and ROA.


From 2003 to 2007, Popular managed to turn 12.7% (5 year average) of its turnover into free cash flow – that is cash flow that is not used for capital expenditures. This means that every $100 of goods sold, Popular managed to generate $12.70 of cash. I do not know what is the figure for its competitors, but I think this is pretty okay to me. Take note this free cash flow mean the cash can be used for anything - paying dividends, retained earnings - and all those capital expenditures needed for business had been accounted for already.

It’s quite something that Popular had never had a negative year, even though STI did had a rough patch around 1999 and 2003, but that’s not good enough for investors. Net margin shows a decreasing trend from 1999 till 2007; with a 9 year average of 4.3% - hmm, not a good sign of a strong economic moat. Net margins at 4.3% average means out of $100, Popular will get $4.30 as their net profit. Is that a little low? I need to find out about the margins in the publishing and retail sector to know if this is comfortable. ROE and ROA also shows a similar downtrend through the years. This is a little disturbing to me as it seems that market forces is gnawing at the profit margin of Popular.

(In case you're wondering why there's a spike in 2006 and 2004 - it's due to a one-off capital gain. That will make the graph more in line with the trend)

I wonder what is the competitive advantage of Popular over other publishers. I mean there are so many smaller publishers so why go to Popular? The answer could be the sheer size of the group, spanning over Singapore, Malaysia, Macau, Taiwan, Canada and China and their enormous distribution network. Popular have this interesting concept called the central book clearing house strategy – big name for something simple. It is a distribution network that aims to consolidate and move books in and out of all the Popular outlets in different regions. Popular aims to achieve this by acquiring and having joint ventures with local distribution giants in their respective countries. In 2004, Popular set up a joint venture with China National Publishing industry trading corporation (CNPITC) to move books in and out of China. It’s a huge step to enter China market, knowing that CNPITC is one of 3 fully licensed book importer/exporter in China. Beginning of wal-mart, anyone?

Is there evidence that this central book clearing concept works? The gross profit margins increased steadily over the years, so it could be this cost-effective way of distribution that contributed to this.


Another possible source of economic moat could lie in the strong brand name. From my humble field experience, I can tell you the first thing people want to purchase ANYTHING to do with school, the first name that comes in mind is popular. They sell packets of cheap stationery, files, TYS, assessments and all the basic necessity of school life. Scores of parents will throw to the admin staff their school book list for the new academic year. So go to any outlet during December and January, you’ll see what I mean.


While there’s no doubt that Popular has a certain level of protection that keeps competitors away, I hesitant to think that Popular has a strong economic moat, given the decreasing margins and returns. Are the profit margins sustainable? Maybe not… yet. If I want to get into this company, I’ll have a bigger margin of safety because of this perceived lack of a strong competitive edge.

Growth


Turnover is increasing year by year, with the % increase yoy falling, which is totally acceptable. I don’t expect the turnover to keep increasing at the same rate as that 10 years ago – pretty unreasonable. It worries me a little if over the next few years, I do not see any increase in turnover growth %- could be a sign of stale sales growth. Nevertheless, a 8-year average for revenue growth of 10% is still pretty good. However, looking at earnings growth, it’s a different story. EPS is a little more volatile, fluctuating between 2 to 3 cts, with 8-year average EPS growth of 3%.

-------------
Something wrong with the chart. I realised on 7th sept, 2008, from Decarn that the 3-year average is actually my 2-year average. My apologies...
------------

A 3% earnings growth averaged over 8 years, isn’t that mediocre? I find it hard to fathom why the earnings is only growing at 3% while turnover is growing at 10%. This is exactly the same story when we look at net margins, ROA and ROE – it shows a decreasing trend, so despite the higher and higher turnover, it doesn’t translate into higher earnings.

Now that's something we have to worry about.



Breaking up the business into segments, we see a growth in the retail and distribution segment over the years while a decrease in the publishing/e-learning segment. Profit before tax clearly shows the trend in the two business segment. The drop in publishing/e-learning segment is most likely due to the high development cost and publication cost associated with new syllabus changes in Hong Kong. With the entry in new markets, development cost in course content would erode away publishing earnings. Really hope to see their publishing/e-learning sector up, as I believe this is the recession proof contributor. Even if times are bad, textbooks and educational materials still have to be used – that is my humble beliefs. As such, Popular entry into textbook market (esp pre-school and primary school) in other countries is a very wise decision. They had penetrated close to 70% of pre-school and 50% of primary textbook market in Hong Kong, very commendable. Not resting on their laurels, Popular also set up 15 tutorial centres in Taiwan where Popular’s own publications are adopted. They believed in 3 years time (by 2009), rewards would be reaped. I shall wait for them to prove it.

Popular growth story should be something like this: It managed to sell a lot of goods and services over the years, and this is a good thing. To make better use of the considerable development cost in developing good content for their publications, they are trying to introduce the books to other countries - and they did find out that it can be done. From my own point of view, Popular is trying to spread their pre-school materials over as many places as possible since the development charges are the same - this will spread out their cost and hopefully increase their earnings. It's wise not to do the same for secondary and above because there are different standards to adhere for secondary school materials and so the cost to develop so many contents over so many countries will be too prohibitive to even start it.

Pre-school syllabus are free and open-ended. Secondary school and above syllabus are regulated and subject to changes every few years (meaning development cost in content every few years). A smart management will enter pre-school market, capitalise on our strong primary school education materials (our primary school materials are the best in the world) and keep secondary and above materials in local context. That is exactly what they are doing. Nobody in the right mind will focus on higher levels of education, because there simply isn't a market - while everyone have to go pre-school and primary schoool, the education system will filter out people as we get higher and higher.

Possible growth story in pre-school textbook. Other than that, it's not my idea of a sustainable growth, unless their central house clearing concept makes it so cost-effective that it weeds out other publishers. Remains to be seen, of course.

Popular is going into property too. They purchased 2 residential properties, namely 1 Robin and 18 Shelford Road for development of up-market residential units. They are looking into commercial property and for future potential self-use. This is something totally new to diversify their business. Do what you do best, in my opinion.

Profitability

Take a look at these two table. The first one on top shows the ROA, ROE and net margins over the years. The second one below shows each item on the income statement as a % of revenue.



As I said before, it's good that popular did not have a year where it does not have positive earnings, despite being around for so long in good and bad times. Asset turnover increases very slightly, nothing to worry about over there.

One thing that shocks me is the high COGS of the Popular. Isn't it a bit high at 80% over? If they can find some way to reduce this cost, their margins will be improved tremendously. From this, I can say that either the industry have very high cost of goods sold, or Popular need to control the costs of their production. Could it be that Popular have no pricing power over their goods and services rendered?


Though COGS is high relative to turnover, it had been steadily decreasing over the years. I think there is one main reason for this - their central book clearing strategy. It serves two purposes - firstly is to distribute books that they had spend development cost on to other countries, to 'recycle' their materials sold, and secondly, to make it more cost effective to distribute their goods to different countries.

Gross margin seems to be increasing from 2003 to 2007 as a result of this cost cutting. I do not have data for the gross margins before 2003. But net margins since 1999 is dropping. Conflicting information. But to me, the bottom line wins - if net margins isn't good (4.3% averaged over 9 yrs) and shows trend of decreasing, that is all that matters. The profitability record of Popular, while in the black and shows no real signs of concern of being in the red anytime, isn't bad but it stops short of being fantastic.

Financial health

Below shows Popular's financial bill of health.


The figures for Debt to equities is slightly different from the official figures because I used shareholder's equities as opposed to total equities in my calculation. Debt to equity is pretty low and is dropping over the years, so it's a good sign. EBIT is more than sufficient to cover interest payments an average of 30 times (5 yr average), so it's very okay. Current ratio and quick ratio is also very steady over the years, absolutely no cause of concern at all. Financial leverage of roughly 2 times is considered reasonable, meaning that for every $1 worth of assets, another $1 is borrowed - not excessively leveraged.

Cash to total assets (my own ratio, haha) is quite strong at around 20 plus %, indicating that Popular is far from insolvency. Their free cash flow to turnover % is high also, so it isn't a cause for concern yet again. We can see that Popular is past the growth phase, considering that it has such a high percentage of assets as cash. This is cash sitting around, so I guess the management do not have a better use of it right now. Dividend is pretty consistent, around 40% of net profit given off as dividend, amounting to around 1.2 cts per share for most years.

A clean bill of health for Popular.

Risks/bear case

With appreciating SGD to HKD, their revenues earned in HKD might not contribute as much as they would have like. However, Popular does not deal with derivative foreign exchange contracts to hedge its foreign currency risk, so no big fx losses like those of Sembmarine happening. Popular is exposed to fx risk from HKD, M'sia Ringgit, Chinese renminbi, New taiwanese dollar and canadian dollars.

There is also project risk involved in their developing of course content for the textbook markets. The risk is that they might not recoup their development cost in time if the changes in the syllabus takes place faster than anticipated. But as long as they stay close to the pre-school market, should be pretty okay (so far no or not much regulation).

Their venture into property market - hmm, I don't know why they are doing this. Do they have the expertise to do that? They bought in when the market is high, so it remains to be seen if their investment into property development turns out to be a wise choice or not. Maybe they are sourcing out another way to increase their growth.

Management

I admit honestly that I'm lacking in analyzing the management. But let's give it a try.

Firstly, I'm not sure if this is common - the CEO and the chairman of the board of directors is the same person - the son of the founder of Popular - Mr Chou Cheng Ngok. They stated on their code of corporate governance that this is to "ensure that the decision-making process of the Group would not be unnecessarily hindered". Hindered by what, may I ask? Their board is made up of 2 executive directors and 3 non-executive directors, 2 of whom are independent. The other non-executive director is the son of the CEO/chairman, Mr Wayne Chou, who also sits on the renumeration committee. It's important in this kind of situation to sit in the AGM to have a feel of the power sharing between the directors in the board, as there might exists a possible conflict of interest. The independent directors must be vocal and steadfast enough to voice out their views as the usual checking mechanism of the board of directors on the CEO is missing here.

The directors' fee is not stated explicitly (nothing wrong with that), but the CEO/chairman has 2% of his pay as director's fees, 25% as salary, 57% as bonus/profit share and 16% benefits-in-kind. I thought it's quite good to have most of the pay as bonus/profit sharing, instead of salary. This would push the CEO harder to work towards the benefit of the company. However, since Popular's chairman of the board and CEO is the same person, nothing much to say on this already. I wonder what's the benefits-in-kind that of the the directors have. It's not stated anywhere. I want to find out how much the CEO and other directors are getting in terms of bonus and profit share.

It is stated that the Group does not have any share scheme in place. I take it that Popular do not give share options to employees.

Valuation

This really kills me. Trying to juggle around and find fault in my excel spreadsheet because I was getting ridiculous values like $560 per share (I made a mistake in turnover - per $million instead of $thousands). I even have to look at fishman's blog for some clues as to the process of valuation. I gave up trying to use free cash flow because the value I get is too crazy ($200 per share if you want to know). This is totally a GIGO effort - garbage in garbage out.

Since this is essentially a GIGO effort, I made some creative solutions to the model. Instead of using a one off % to determine the growth in operating income, I used a couple of ratios to help me. This is what I did:

1. I noticed that the turnover per year is growing pretty consistently, so I did a linear regression and I end up with a correlation coefficient of 0.9966 (the closer it is to 1, the more linear the data is), which confirms my observation. So, I found the equation of the turnover to years and spread it out over 10 years.

2. From previous crunching, the free cashflow (FCF) to turnover had an average of 12.7%, so I changed turnover to FCF by multiplying 0.127 by turnover.

3. Next I found out that the operating income over the years is about 35% of free cash flow, so I converted FCF to operating income by multiplying it 0.35 by FCF.

4. After that, it's the same old stuff for discounted model and I end up with a per share value of Popular as 0.830. Since this model is GIBO, I used a high margin of 40% and arrive at an safety value of 0.330.


At today's close of 0.305, it is undervalued according to my GIGO model by around 8%.

Technical Analysis



Long term chart (2000 till 2007) of Popular doesn't good at all. There is a very important and strong dynamic resistance line (red line) that always prevent upside movement of Popular. This resistance line, together with 2 support lines at 0.385 and 0.300 forms a descending triangle - a pattern with bearish tendency. The first descending triangle, developed from 2004 to end 2006 had already been validated after breaking support at 0.385. There is a downside target of 0.270 for this.

Another medium term triangle, formed from the start of this year, is materializing now. Support is around 0.295, so once broken, a downside target of 0.215 is there. Short term, popular seems to have rebound but will definitely test 0.300/0.295 support level again. By extrapolating the resistance line, the two lines of the triangle will converge - pointing to a time period somewhere in the middle of next year 2008. By then, we will see if Popular will pierce through the support level or not.

Conclusion

With a healthy cash flow, good debts to equity ratio, Popular has a clean bill of financial health. It is not excessively geared too, so it should be able to withstand bad economic seasons. The growth isn't exciting, neither is it stagnant, and this can be seen as Popular finds new ways to expand its old business and go into newer ones. However, while turnover is increasing steadily, the earnings, ROE and net margins isn't. This is the thing that I worry most - what's wrong? I would say that Popular is a slow and steady stock to invest in, but don't expect too much out of it. If it pays a good dividend, it might even be a rather defensive stock. There's no coverage for this company by analyst - probably Popular isn't that popular anymore.

-----------------------------------------
This is a pivotal moment in my education in being a value investor. A whole new way of looking at business is now opened to me. I spend a tough one week digesting the annual reports and thinking about the business of popular, instead of the price. This is my thesis on Popular - my hardwork and learning all condensed into one.

Feel free to criticise it, I'll try my best to answer :)

8 comments :

musicwhiz said...

Hi la papillion,

Very detailed analysis, I salute you for that ! The reason why I don't wanna start on a company is because of the sheer volume of numbers to crunch, as you can tell from analyzing Popular. And Popular is considered small by Singapore standards; imagine analyzing Keppel Corp or DBS or even KS Energy and you end up with a larger headache ! Haha..

Anyway, jokes aside, I think your method is essentially very Graham, and less Fisher and Buffett. Graham stresses a lot on quantitative factors such as margins, ratios and FCF. Nothing wrong with that, but sometimes it pays to see if the business has a viable long-term growth in the future. In my view, Popular is in a business which can be easily replicated, as they serve the mass market, and even though they have good branding; a textbook or TYS is still the same no matter who supplies it. That said, I would conclude that there is no economic moat because of the industry it is in. Unless you can justify that its branding is so strong (e.g. Hour Glass, Cortina, OSIM) that people can instantly identify it, I do not think this constitutes a sustainable competitive advantage. Thus, usually I will not bother to analyze the company unless the industry is attractive, it has brand equity and it commands a niche market or a sustainable competitive edge. Just of note: the companies I own possess either one of these traits, which is why I started researching them in the first place.

I feel that the work you did is certainly of value for your experience in value investing; however, a company like Popular may not be the right type of company for a long-term investment, as I see it as a cash cow rather than a star (using BCG growth share matrix). Even using Porter's 5-forces (which I prefer over a quantitative analysis), barriers to entry are very low and customer loyalty is not really there. The threat of substitutes is high and as mentioned by yourself, COGS is way too high at 80+%, giving a GP margin of less than 20%.

I would say this is more of a dividend company which produces steady FCF, rather than a growth company. For consistent yield, you may wish to invest, but for long-term growth, it's not a good idea.

Note: All opinions are strictly my own. I think you have done a splendidly detailed analysis and kudas to you for that !

la papillion said...

Hi MW,

Tks for the encouragement, I needed it! You're right, it's just sheer hardwork sloughing through those data.

I haven't finished reading past chapter 4 of Graham's intelligent investor, so it's strange why I'm influenced more by him than others. I haven't read the works of Buffett and Fisher, but since you mentioned it, I'll go and read up on both of them. I'll interested in Fisher, actually, haha :)

Actually, I think you're right about the branding. The branding for popular is good for retail only, but anybody can replicate it. I never thought about that before, hmm.. You mean to say that certain industry will never have economic moat? Can you pls give me some examples?

I guess I'll work on smaller companies first, to acquire the feel of doing FA. More of such analysis to come, this I promise. Hope that one day I can do those big ones like banks, or even complicated ones like pac andes. Haha, but for now, no more analysis for me, I need a long break to avoid burnout :)

Thks again for your comments, I value it!

Derek said...

Hi la papillion,

Great effort, I will probably need more time to digest your analysis.

On industries without economic moat, F&B is one very good example. In fact, any industries with a very low start up cost will have very little barriers of entry. Regulations also play an important part.

I would agree with you that Popular has a certain economic moat. Talk about buying text books and Popular will spring out. However, I agree with MW that Popular is more of a dividend yielding stock than a growth stock not because of its economic moat but rather because the market is too saturated for competitors. Imagine that I want to open a bookstore to sell textbooks, I will probably be selling the same books Popular has and given a choice, would you prefer to go to a new unheard XYZ bookstore or Popular which can easily be found anywhere in the heartlands.

The above analogy applies only to Singapore. I'm a common sense investor hence my views are pretty simplistic. I don't really go into details of a company such as it's ROI, EPS etc unless I want to.

la papillion said...

Hi derek,

Thks for your encouragement :)

Haha, I'm learning to do FA so no choice, have to do a lot until I'm confident of my own analysis. I guess for their industry, price is the main thing here. I don't see how much value-add u can do to the products. I'm starting to rethink my idea of popular economic moat.

But thks for your comments, I value it greatly!

fishman said...

Hi Lp,

Didn't think you do finish your analysis so quickly! =P

I read your analysis after finishing mine. Think it's interesting that we both arrive at quite similar results. (But you perhaps gave a bit more detailed discussion at the end)

As you mentioned, I thought its quite weird why margins is so low. I have one conclusion actually, that Popular does have an economice moat in the sense of the a reasonable brand name at home and significant market leadership in the heartlands. But the items the sell are of low margins and very hard to keep customers, who are mainly price sensitive mothers. So combining the two, Popular does not have a economic moat.

Just my reflections!

fishman

fishman said...
This comment has been removed by the author.
Anonymous said...

Hi La Papillion,
Thanks for the HARD WORK. Salute.
Just my little sharing:
Over years, this company just as all mentioned, it's not an "Exciting" company as compare with others listed company. But it is a slow and steady - doing the biz. (That's why the management now enter into others higher margin area for a better prospect, i think) But is it a wise idea enter into property market during that period? I am not sure, because last year is a peak year for property, higher cost right?

I do not know much about property market, so not sure is it a good entry point IF one need to start the property biz. But the Management would like to increase the "Other Operation Income", i think. Anyway, we shall just wait and see, because biz need times to shows the result.

As for the COGS, i think is due to the high discount given to the customer / members. As far as i concern, "book's margin" is approx. 25% - 45% for retailler. So a 16%/17% net profit is normal. So far i see the company is doing good. Since that, my view is that, this biz is not easy to replicate. It is not as easy as you just open a book shop, then buy some book and sell. As we see the "low % of margin", not many people / biz man really wanted to enter the market, and fight for surviver. But once you survive in the biz, you are hard to be kicked out as mentioned by all people, this biz are able to sustain during bad time too.

As for the ROE, well, depand which comapny you compare with; Right? Thay's why i say it is not an "Exciting" company, but it is slow and steady. Just that, at what price is our entry point, make the different. Today, 8 May 2008, (about $0.290) i think it is ok. Ofcause we don't know the coming performance as the company just enter into the property market, but that is so call "Investment" (correct me if i am wrong); If sure win, like "Singapore pool".... Then there is no chance for the ordinary people like me. hahahah.

Just my comman sense. Please feel free me to comment. Your post and sharing helps. Thanks again.
by,
ec


One thing i like this company is that they don't practice Share Options Scheme. Ofcause there is good and bad for this. I think i no need to state it as most people know already. Just that i see this as an advantage to the shareholders.

la papillion said...

Hi ec,

Thks for reading it!

Popular already had the property built on April 07 on Robin road, named "One Robin". Besides, this property business isn't their core business, it's just something that they do with their cash which is sitting there. I suppose the management realised that their business can't give the sort of returns in the past anymore. They did mentioned, however, that they are going to focus on it. One wonders why the unrelated diversification by the management.

Their low ROE (around 10% in recent years) is possibly the reason why management wanted to venture out to property. I personally will not invest in a business with ROE < 15% consistently, but that's me.

Take a look at their EPS over the years:

EPS(cts)----year
2.5---------1999
2.6---------2000
2.7---------2001
2.8---------2002
3.0---------2003
3.5---------2004
2.4---------2005
3.6---------2006
2.6---------2007
4.1---------3Q08

Their 08 earnings is bound to exceed 07 earnings. It's not growing as much as their turnover, which averages around 10% CAGR over 8 years, neither is it particularly bad.

Their net margins is not as high as 16/17% that you mentioned. It's more like 4% (see my attached pics) and there's a trend of getting lower and lower net margins, which testify their rising cost. Books are ultimately a commodity products where prices are the main concern. As such, popular can only compete on pricing, otherwise they will lose market share. It's also why books dun differ much in prices anyway you look.

I also did a valuation for popular using the discounted earnings method, assuming a 4.1 cts EPS for 2008 (i'm conservative) and thereafter an EPS growth rate of 5% (which isn't terribly fantastic and is closing to popular's historical earnings growth rate). The time frame for my analysis is 10 years. Discount rate I used is 3% (based on very low risk, 10 years SG bond rate).

I got a value of $0.434. If you buy at 0.29, you'll get a compounded CAGR of 4.6%, slightly better than CPF rates. If I use 4% discount rate, then the value drops to 0.411, giving a CAGR of 4%.

You still like it? :)