Jaycorp Berhad

[RaymondMoay]

Greetings! I'm a 22 year-old student studying in Singapore and I am really interested in value investing and asset management. I've been reading quite a bit and thought it would be a great idea to practice writing cases on companies and investment ideas. I apologise for my amateur analysis and I welcome any suggestions for improvements! Here goes my first on Jaycorp Berhad.

JAYCORP BERHAD

Jaycorp Berhad is an investment holding company primarily engaged in the manufacturing of furnitures. They also engage in other profitable activities which includes packaging, construction and green energy. They have been operating for more than two decades and does business in both North America and Asia. Their customers have (on average) been with them for more than 5 years and have established a rather weak form of competitive advantage with the assurance of long term uninterrupted solid rubber wood supplies at competitive pricing from its access to 88,000 hectares of rubber plantation in Indonesia.

Jaycorp recently loss 50% of its share price due to drop in quarterly earnings primarily due to (1) drop in turnover of furniture segment and its corresponding profits, (2) investment holdings sales drop, (3) loss in kiln-drying segment due to lower demand and higher production costs, (4) renewable energy segment due to temporary closure of a plant for major upgrade. The major cause is due to drop in demand of furniture sales as well as a loss in investment holdings sales. From the reports, it seems as though the loss in profits are temporary and cyclical in nature. 

Other than the drastic drop in share price that peaked my interest, this company also has been paying steady growing dividends for the past 5 years with a recent yield of 11%, coupled with positive operational cash flows and free cash flows for the same period. The company seems to be cash generative; in a 15 year time frame they only had 2 years of negative free cash flow and 3 years in which dividends were reduced. From 1999 to 2017, the company only lost money in one year (1999) and it did not amount to much as compared to its other profitable years. This is a good feat considering the competitive nature of the furniture business with other major players such as Poh Huat and Lii Hen. The company also has a strong balance sheet, holding a negative net debt position for the past 9 years, which shows the management’s distaste for leverage. This is always a good sign when looking for low to zero debt positions. Also, the management has been actively buying back shares.

Since the company is profitable and is likely to be in business for the next few years, a liquidation analysis might be an overkill. Here is my quick liquidation analysis where I discounted assets that matter:

   

The company seems to be trading at 1.48x its liquidation value (adjusted book value). In other words, the most you can lose out of 1 dollar of investment in this company if it is fully liquidated, on a conservative basis, is 48 cents. The company is also trading at 0.86x unadjusted book value. 

Also, the PP&E in the liquidation analysis could possibly be understated. Jaycorp owns over 396 acres of development land in Bongawan Sabah. Recent properties here sell for around 2 million every 10 acres, which makes this land worth MYR79.2 million, or about MYR 0.57 per share. This land is poised for further development by the group, as the company’s newly formed subsidiary Jaycorp Engineering and Construction is bound to develop this land.

Since the company is profitable, a NPV analysis on its profitable business segment makes sense. However, I place a heavier emphasis on its liquidation value and take the NPV analysis with a grain of salt as it comes with heavy assumptions such as the survivability of the business in the long run. The degree of accuracy of the NPV depends on the quality of information fed into the model. To minimise the garbage, I do not take into account growth, as growth is too intangible and subjective.

The company has two main profitable segment. By profitable it means contributing positively to the company’s bottom line for the past few years. Here are the figures I collated from past annual reports:

   

For the furniture and packaging segment combined, I shall conservatively assume the company will be able to sustain a MYR 20 million profit for perpetuity without growth whilst discounting losses from other unprofitable business segments. Discounting it by 15%, which in itself exerts conservatism, we get a NPV of MYR 133 million, or MYR 0.97 per share. The stock is currently trading at $ 0.935 a share. From this two segments alone the stock seems to be undervalued. Again, this is taken with a grain of salt as it implies that the company's life is far from finite. Also, I place a heavier emphasis on cash flows than profits, which leads us to the next activity. 

In terms of cash flows, since the company has been consistently generating cash flows for the past 5 years with the lowest at 3.9 million and its peak at 25 and 25.5 million (most recently), we can conservatively assume an estimate of 11 million in cash generation on average per year. Assuming a conservative discount rate of 15%, the NPV of future cash flows floats at around MYR 0.66 a share, which implies that the company currently trades at 1.4x future cash flows. Again, I stress that this will be taken as a rough gauge and not a proper indicator of undervaluation. In fact, at 1.4x future cash flows, this does not at all seem like a value stock. We're in effect paying 1.4 dollars for 1 dollar in future cash flows that are far from guaranteed.

As for future catalysts, Jaycorp's new construction business could be it. The management has mentioned that they intend for future development of the 396 acres of land in Sabah that they own, spearheaded by their own construction company. I personally think this is too far fetched and would not consider this in my analysis. As of now, the company's construction segment secured contracts with guaranteed cash flows that are insignificant in comparison with the size of the company. Only if the guaranteed cash flows are significant will I perform a NPV analysis. I will keep tabs on this for further development when I return to this stock.

At a price of 1.4x liquidation value, 0.86x unadjusted book value, 5x price to free cash flow, 4x EV/EBITDA, low debt levels and a 15 year return on common equity of 10.6% with a profitable history, the company may seem like a value stock as compared to its competitors. As for now, I chose not to swing. To me, the margin of safety is too small for my risk appetite. I prefer to swing only at stocks that scream, not whisper, value. Do tell me what you guys think!

[Kaimin]

1) What are your figures for the net cash position? In their most recent annual report they gave cash and cash equivalents as MYR $34,515,000 and total liabilities as MYR $56,691,000, which doesn't put it at a net cash position. 

2) Cyclical plays are as much about the market as the company. Furniture business took a huge turn very quickly, can you explain this? And when can recovery be expected? 

I personally can't find anything about the second (and more important) question. There isn't any news about a sudden collapse in wood furniture prices or such. The only useful thing I can add to your analysis is competitor Homeritz would be a better stock if this is a cyclical play. You always want a financially strong company in a cyclical and Homeritz has the least debt.

[RaymondMoay]

1) What are your figures for the net cash position? In their most recent annual report they gave cash and cash equivalents as MYR $34,515,000 and total liabilities as MYR $56,691,000, which doesn't put it at a net cash position. 

2) Cyclical plays are as much about the market as the company. Furniture business took a huge turn very quickly, can you explain this? And when can recovery be expected? 

I personally can't find anything about the second (and more important) question. There isn't any news about a sudden collapse in wood furniture prices or such. The only useful thing I can add to your analysis is competitor Homeritz would be a better stock if this is a cyclical play. You always want a financially strong company in a cyclical and Homeritz has the least debt.

Hi Kaimin, thank you for your comments! Regarding your questions:

(1) My apologies as I used the term Net Cash wrongly. I meant to use a negative net debt position, which should say that the company in the near term is safe from bankruptcy. I apologise for my amateur mistake. Still new!    I have updated accordingly.

(2) The reason I did not research more on the cyclicality of the business is because the company didn't look like a bargain at all when I did a rough quantitative analysis. To factor in cyclicality quickly as a rough gauge, I used a high discount rate (I know it's heavy on assumptions) just to check out the value. If the company was valuable I'd be certain to research on its cyclicality.

Anyhow, Jaycorp's business is very complex. Cyclical factors are numerous and is not only caused by supply side factors (rising wood prices/raw material prices which happened recently, 15% spike in FY16/17, annual report), but are also affected by macroeconomic factors: currency risks (company hedges to protect against this) which is thus tied to business cycles in various countries that the company does business in (North America, Asian countries). A proper research on the cyclical nature of the business will require a proper study into all these economies, which could possibly be useful if the company was in a state of obvious undervaluation, which it isn't.

If the company was undervalued, an example of a cyclical study could be the housing market. As more people move houses, more furniture is needed etc. This activity could be done in the major countries that the company deals with. E.g. Malaysia's housing supply has always lagged housing demand for the past few years. Bank Negara estimated average Malaysians can afford houses priced RM250,000 and below. But 78.7% of new launches in the first half of 2017 were priced beyond RM 250,000. This imbalance creates pent up demand for housing, which is slowly being unleashed with the rise of affordable housing or the possible fall in property prices due to supply and demand factors. Obviously this is not the only factor affecting the demand for furnitures, but it is one that is obvious and probable. More research can be done.

Homeritz is an interesting stock, thanks for the heads up! When I get back to studying furniture stocks I'll look more into it and do more research on the furniture industry.