The hunt for yields

Business Times - 20 Feb 2010

Here's a selection of regional stocks that appear promising in terms of dividend payouts
By TEH HOOI LING SENIOR CORRESPONDENT

ONE of the questions I'm asked most often is: which good stocks provide decent dividend yields? Today, I've decided to do a stock screening to see which names I come up with. I ranked stocks based on their dividend yields. And then, to make sure these yields have more certainty of being sustained, I weeded out those with a market capitalisation of less than $100 million and those deemed by StarMine (the provider of the data) to have low earnings quality - whose earnings can swing wildly. I carried out the screening process in four markets - Singapore, Hong Kong, Japan and Taiwan. Here's what I found:

Taiwan has the most companies with a market cap of at least $100 million that pay dividends of 6 per cent or more. Many are technology-related companies. There are also some from the marine sector, in machinery manufacturing and real estate development. The median market cap of these companies is $218 million.

I came up with the same number of companies from Singapore and Hong Kong - 16 from each market. Among Singapore stocks, Datapulse appears to be the highest dividend-paying stock that has been able to sustain its payout, at least in the past few years. Its yield this year, should it be able to sustain last year's magnitude of distribution, is 10.9 per cent. Meanwhile, its operating margin is healthy at 21.8 per cent and its pre-tax return on assets is 14.9 per cent.

Big-cap stocks - with market cap of $1 billion and above - that made our list include StarHub, M1, SingPost, Venture Corp and Thai Beverage. StarHub's yield, based on last year's payout, is 8.7 per cent. M1's yield would work out to 6.4 per cent, and SingPost's at 6 per cent. Venture Corp and Thai Beverage would each have a yield of 5.6 per cent. The median market cap of these 16 stocks is $181 million.

As for Hong Kong, the companies represented are more mixed. There are construction and engineering firms, textile and apparel producers, a commercial bank and a specialty retailer. The yields range from 5.6 to 10.9 per cent. The median market cap is $331 million.

In Japan, the Tokyo Stock Exchange had the lowest number of stocks that met our criteria. The median market cap of these companies is $224 million.

So there you have it - a shortlist of some stocks which potentially can sustain their dividend payouts, based on data from StarMine. You, of course, have to study them yourself and decide if any of them are good buys. Good luck!

Think before picking up that bargain

Business Times - 11 Jul 2009

SHOW ME THE MONEY

When it comes to large acquisitions and huge outlays, the odds of such acquisitions succeeding are not great

By TEH HOOI LING
SENIOR CORRESPONDENT

ASSETS are still relatively cheap compared with their pre-crisis levels. And companies with fat cash hoards are no doubt tempted to deploy some of this money in the hope of picking up a bargain. But before embarking on any major acquisition, these companies would do well to read the book Billion Dollar Lessons - What You Can Learn from the Most Inexcusable Business Failures of the Last 25 Years by Paul Carroll and Chunka Mui.

Investors, too, will benefit from this book. It will help them work out whether what their investee company is about to do makes strategic sense. They will also have a better understanding of the likelihood of success of the strategy.

In the words of the authors, for executives, 'why spend $500 million and a decade of your life repeating someone else's mistake when you could learn to avoid it by spending a few hours with a $26 book'?

Here is the extent of corporate failures. Between 1981 and 2006, 423 US companies with individual assets of more than US$500 million filed for bankruptcy. Their combined assets at the time of their bankruptcy filings were more than US$1.5 trillion. And their combined annual revenue was almost US$830 billion.

Over those 25 years, the write-offs of 258 publicly traded US companies came to US$380 billion. Sixty-seven companies had combined losses from discontinued operations that totalled almost US$30 billion.

The authors found that the number one cause of failure was misguided strategy - not sloppy execution, poor leadership or bad luck. After eliminating failures that stemmed from poor execution and factors beyond the control of management - such as the 9/11 terrorist attacks - from the remaining cases, the authors identified repeating patterns where failures across multiple industries were variations on a theme. They found the failures tended to be associated with one of seven types of strategy.

One, pursuing non-existent synergy. Companies tend to over-estimate the benefits from a merger. A Bain study found that two-thirds or more of takeovers reduce the value of the acquiring company. And two-thirds of companies routinely fail to achieve all the synergies identified before a takeover. One reason why synergy goals aren't met is that companies don't do detailed work to make sure that the synergies that seem possible can, in fact, be produced.

In 1981, after IBM introduced personal computers to the market, it thought that it would be synergistic to offer software programmes with its hardware. So it started buying small independent software companies. It also hoped that the entrepreneurial spirit of these software companies would rub off on IBM itself. Instead, IBM smothered the software companies. The Big Blue eventually took US$2 billion of losses on software before giving up on the business.

Quaker bought Snapple for US$1.7 billion in 1994. It sold it for $300 million just three years later. In 1996, Union Pacific bought Southern Pacific Rail Corporation because the combined railroads would be the biggest network in the US. But the two railroads' information systems didn't work together. There were so many delays that the federal government declared an emergency and intervened.

Two, aggressive use of financial engineering when structuring deals. Green Tree Financial Corporation, through financial engineering, made trailer-home ownership more accessible to low and middle-income Americans. In 1992, it lent US$1.2 billion. In 1996, it lent four times that amount. The market rewarded Green Tree generously. Its stock jumped 30-fold and its 'profits' surged six-fold between 1991 and 1997. Green Tree's chairman and chief executive took home pay of US$200 million during the boom.

Green Tree's 'financial innovation' was to offer 30-year mortgages instead of the 15-year terms that were standard for trailer homes. The fatal flaw? Trailer homes depreciate and have a life-span of only 10-15 years. On a typical US$50,000 mortgage, after five years the borrower would still owe US$49,000 in principal based on an interest rate of 12-13 per cent. But by then, a trailer home is worth much less than the sum owed. Borrowers are better off defaulting. And many did just that.

But in the intervening years, Green Tree securitised the mortgages, held on to the mortgage-backed securities and booked profits based on its own forecast of defaults and pre-payments. In those earlier years, the more borrowers it found, the higher the profits it recorded. The long-term performance of the loans was of no importance to Green Tree's management. Investment bankers, said the authors, have an acronym for this: IBG YBG, which stands for 'I'll be gone, you'll be gone.' It means that even though there may be long-term problems with a deal, the folks who put it together will have reaped their profits and be long gone.

In 1997, Green Tree's intricate design began to unravel. Defaults and pre-payments started to escalate. In November that year it took a US$190 million pre-tax write-off. Its credit rating was downgraded and it couldn't roll over its short-term debt. Then came a white knight - life and health insurer Conseco. It was attracted by Green Tree's 30 per cent growth rate, and perceived that both companies served and shared the same market and culture.

So Conseco bought Green Tree for US$7.6 billion in 1998 - at US$53 a share, despite the latter's market price of only US$29 a share. To lift sales, Conseco continued to use the Green Tree model, and actually increased the number of loans made after the acquisition. It financed US$6.3 billion in new trailer homes in 1999. The quality of loans was even worse than before the acquisition. Conseco's founding CEO resigned in April 2000. He received a US$72 million severance package. In total, his pay from 1993 to 2000 was US$530 million. Conseco declared bankruptcy in 2002.

Three, buying a string of small companies in a fragmented industry - referred to as roll-ups - to form a behemoth. A Booz Allen study followed 81 roll-ups between 1993 and 2000. Only 11 outperformed the S&P500. 20 were in or near bankruptcy. Many of these failed roll-ups ended in fraud. Part of the problem for roll-ups is that they are searching for efficiencies in the most inhospitable environment imaginable. In the initial years, however, investors do get excited by the perceived rapid growth. Tyco spent US$63 billion acquiring more than 1,000 companies between 1994 and 2001. It tried multiple roll-ups in home-security alarms, special electronic connectors, fire-protection equipment and specialised manufacturing. There was little emphasis on integration. The strategy came apart in 2002. Tyco's market cap sank by $90 billion that year.

Four, stay on a misguided course. This would involve a former dominant player in a declining industry gobbling up its competitors in a bid to increase market share. Paging company Arch Communications bought dozens of paging companies as it tried to achieve scale, even though the writing was on the wall that mobile phones would make pagers obsolete. In mid-1998, Arch paid US$649 million for Mobile Media. From 1999 to 2003, more than two-thirds of people who used pagers gave them up. Arch filed for bankruptcy in December 2001. In another example, Kodak noted the threat of digital cameras but tried hard to protect its fat profit margins in the photo printing business for as long as possible. In the past decade, as digital cameras gained dominance, Kodak lost 75 per cent of its stock market value.

Five, misguided adjacencies. Avon decided its 'culture of caring' qualified it to operate retirement homes. It also bought into a medical equipment rental company. Avon simply did not have the expertise to manage the new acquisitions. In 1988, it took a charge of US$545 million to dismantle its health care business.

Six, investing in a technology without keeping an eye on the alternatives. Motorola's US$5 billion satellite telephone venture Iridium went bankrupt less than a year after it began. Its assets were auctioned for just US$25 million. Motorola had not anticipated the progress that cellular phones would make.

Seven, consolidation in a declining industry. The example of the paging company above would apply here too.

A lot of the cases above involved large acquisitions and huge outlays. The odds of such acquisitions succeeding are not great. Perhaps a viable strategy is the 'string of pearls' approach, as adopted by Olam. With this strategy, acquisition outlay should not exceed 10 per cent of a company's current value. And preferably, acquisitions should be spaced - perhaps one every three years. Yes, growth would be slower. But it is definitely a better alternative than the massive destruction of shareholder value which inevitably will happen when a company tries to acquire many others in a hurry.

How to avoid the dash to trash

Business Times - 20 Jun 2009

SHOW ME THE MONEY

In the current fickle market, here's a way to find stocks that are potentially good long or buying candidates

By TEH HOOI LING SENIOR CORRESPONDENT

BACK in May 2008 - it seems so long ago - James Montier of Societe Generale wrote a global strategy report titled Joining the Dark Side: Pirates, Spies and Short Sellers. He screened stocks for three characteristics: a high price-to-sales ratio; deteriorating fundamentals (as measured by a low Piotroski F-score - I'll elaborate later); and poor capital discipline (as measured by high total asset growth).

'Each of these characteristics is a telling sign - but when combined, they become even more potent,' Mr Montier wrote.

According to him, over the period 1985-2007, a portfolio of such European stocks rebalanced annually would have declined more than 6 per cent per annum in absolute terms; in comparison, the general market was rising 13 per cent per annum. The basket of stocks suffered absolute negative returns in 10 out of 22 years. It underperformed the index in 18 of the 22 years. Similar findings hold for the US, Mr Montier said.

However, in the few years leading up to 2008, this strategy totally backfired. The basket of stocks that one was supposed to short, based on the above criteria, actually outperformed the general market. 'This attests to the extreme nature of the dash to trash that we had witnessed,' said Mr Montier.

In any case, in May last year he ran the screen and saw a record number of stocks passing the criteria for the short basket. Generally, such a screen would yield 20 stocks in European markets. But when he looked, the number of stocks totalled 100. In the US, the typical average number would be 30 stocks; last year, however, it was 174. 'The opportunities are on the short, not the long side, currently,' concluded Mr Montier. 'Perhaps it is time to join the dark side.'

Events have indeed proved him right. Now that prices have corrected significantly - despite the sharp rebound in the last three months, equity prices are still some 30 per cent below the levels in May 2008 - and the economy is supposed to be on the mend, perhaps we could try to do the reverse of what he has done to see what names we come up with as potentially good long or buying candidates.

First, let's go through the criteria. The first one for Mr Montier is valuation. From a short-seller's perspective, the most useful valuation measure is price-to-sales. According to Mr Montier, high price-to-sales stocks allow investors to hone in on counters that have lost touch with reality.

Here's what Scott McNealy, then CEO of Sun Microsystems, apparently said in 2002: 'Two years ago, we were selling at 10 times revenue when we were at US$64. At 10 times revenue, to give you a 10-year payback, I have to pay you 100 per cent of revenue for 10 straight years in dividends. That assumes I can get that by my shareholders.

'That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes.

'And that assumes that with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at US$64?'

With that first criterion, I went to the Bloomberg terminal and downloaded all Singapore-listed stocks and their price-to-sales ratios. SingTel is trading at just over three times its revenue, Wilmar at 0.78 , DBS Group at 2.1 and CapitaLand at 4.6.

Singapore Airlines and Keppel Corp are both trading at less than their revenue - 0.93 and 0.84 times respectively.

The company that stands out from the rest of the big-cap stocks is Singapore Exchange (SGX). Its market capitalisation is a whopping 12.5 times its revenue. But the thing is, SGX raked in a net earnings margin of 62 per cent. So its price-to-earnings multiple is a more palatable 15 times. So for 'buy' candidates, the better measure would be price-to-earnings ratio, or my favourite, price-to-book (P/B) ratio - the lower the better. For the record, Mr Montier's short screen is for companies with price-to-sales ratios of more than one.

The second characteristic Mr Montier uses to sieve stocks to short is deteriorating fundamentals.

Here, he uses Joseph Piotroski's F-score. There are nine measures that relate to a company's profitability, the health of its balance sheet and its operating efficiency that one looks at to arrive at the F-score. The checklist is:

• positive net earnings;
• positive cash flow from operations;
• increasing return on assets (ROA);
• higher operating cash flow relative to net income;
• decreasing long-term debt as a proportion of total assets;
• increasing current ratio;
• stable or decreasing number of shares outstanding;
• increasing asset turnover; and
• increasing gross margins.

If the answer is yes for each item on the checklist, the score is one; no, and the score is zero. Companies with improving fundamentals will have higher F-scores (seven to nine), and those with deteriorating fundamentals will have low F-scores (below three).

Piotroski's strategy calls for buying a company with the requisite low P/B ratio and an F-score of eight or nine. Piotroski's research shows that low P/B stocks with high rankings are less likely to go bankrupt or to fall drastically in price than those with low rankings. This provides a greater safety margin.

Mr Montier's final criterion is capital discipline. Companies that have grown their total assets by more than a double-digit percentage will pass through his short screen.
So let's say our 'buy' criteria should be companies with price-to-sales of below 1.2 times, Piotroski F-score of more than seven and total asset growth of less than 20 per cent from a year ago.

The lone stock the screening process spits out is Singapore Petroleum Corp. Its market cap is less than half of its sales, and its Piotroski F-score is seven. And it didn't have a big asset growth in the year just ended; in fact, its asset base shrank 22 per cent. But arguably, investing in a depressed market may yield long-term rewards.

According to the Bloomberg screen, other stocks that come close to meeting the criteria (although not quite all of them) include SembCorp Marine, Keppel Corp, Cosco, Venture, SembCorp Industries, Yangzijiang, Noble Group and Thail Beverage. Readers, of course, are advised to verify for themselves if these stocks do indeed meet the criteria - and to decide if they deem the criteria sound enough, to begin with.