PPS, post surge -the important company update.

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Company Visit

PPS (1.77) extensive company visit last week.  Here is my take through this re-visit and update.

Ever so often but actually not very often, you discover a company (stock) which has most -but just about never all- the attributes you treasure on your vast wish list to quality as a very strong investor idea.  Here I jot down my own inclines:

First, the stock price is not sky-high, meaning it did not just soar to a new highest price.  As we all have a psychological problem with that -no matter how compelling the story.  I much favor to buy low and sell high or to invest on a stock price correction. 

Second, the stock price even if it price corrected some, is not at a valuation which is over demanding.  Presently to me this means a 2017 p/e of not over 25 and a 2018 of say not over 22 besides, not a p/e over its industry average.   As I have written here extensively in the past, p/e’s are inversely related to the prevailing level of domestic interest rates. These remaining very low -and for some time -and in Thailand at least, likely to stay so through year 2018.  I don’t think interest rates will raise next year here because if they did, the Baht currency would likely strengthen even further which is not good for tourism and exports. Both are key GDP contributors in Thailand. Hence Baht stability, not strength, is what the country needs, wants and is aiming for.

Third, the company is visibly growing faster than its industry (besides the SET) and yet is p/e valued at less than its average industry peers.  Call this a double whammy positive.

Forth, the company has a solid balance sheet. Meaning mostly not much or no debt and nothing unusual beaming up…like for example ballooning accounts payable or a large holdings of treasury shares coming to the end on its legal holding period -and so in need to be sold out.  We call this an “overhang of shares” which will hit/depress the stock in the foreseeable future.  Along this forth point I would include insider buy/sell transactions where we detect & monitor some meaningful share selling by the insiders in the recent past, say over the past year.

Fifth, the company’s insiders/owners/managers should own a substantial amount of shares themselves so that the shareholders’ interest are aligned with senior management whom run the company.  If they further increased their ownership in the recent past (say 1-3 years) this is even better.  Increase in ownership can often take place through an early conversion of warrants issued -or by any other means.

Six, the management must be credible, capable, forward looking (i.e. not old fashion) and last but not least: smart & connected with good GC (corporate governance).  If it’s a family related run business, like so often in Thailand, the next generation owners/managers running the business must have broad decision power.  Not a “lame duck” operation where the near or retired seniors make all the key and critical final decisions and the heirs are but puppets.

Seven, be in a foreseeable future favorable industry and one which we can identify with in having strength, growth and is in a current and future up-cycle.  Not a leader in a sun-set industry. An industry in which in which Thailand itself is competitive in besides not subject to a sudden mega foreign entity competition prone to enter the market.

Eight, its principal major customers (say top 5 or half dozen) should not make up more then 50% of its total revenues for obvious reasons. It goes beyond saying that a highly profitable company where most of its profits come from say 1-3 clients, is far more risky then a diversified client base.  Here it would also be favorable in some instances to have revenues from both the private and government sector.  As we currently know the Thai govt. is in a huge infrastructure spending mode, vs. the private sector is still muddling along (albeit picking up speed of late).

Nine, the company revenues should be expected to grow double digit…not the just often quoted stale “+10%”.  Further, net profit margins should be improving, not slipping.  This indicates the company is turbo charged in that revenues are increasing with a higher expected net profit margins, hence profits increasing even faster.

Ten, the company should not just be astute in the business they are operating in, but also in financial engineering as I would call it.  In other words, understand the value for example in issuing warrants while grasping those should be at a conversion price slightly out-of-the money, as I here have often explained.  The company should be open to other shareholder sweeteners, like issuing stock dividends. As these are a near equivalent to cash dividends, due to any shareholder’s ability to sell them out in the open market.  Stock dividends increases’ total shares outstanding of the company -all the while preserving cash.  This creates some new dilution but often also better share liquidity. More shares outstanding and the issuing of warrants almost always increases the liquidity of the common shares which in time will increase the p/e rating.  Such financial tools/engineering creates real new shareholder value and so in time a higher p/e rating, besides enriching all shareholders. It also reduces the firm’s “cost of capital”, as we can prove in finance.

Eleven, the company should be a sort or clear leader in its industry along with a good reputation and have been around for many years. Yet not be stale or overly conservative nor a green behind the ears newcomer.

Twelve, the company should have a solid reputation in its industry, with its clients, competitors and not least, in corporate governance (CG).  The company should have future growth plans beyond just sitting on its laurels of its present business.  Example, new business ventures, newly created subsidiaries, exciting joint ventures. But these should be related in what it does best and so knows best! The company should ideally not have huge newly expected (CapEx)* investment plans as this will mandate capital increases and so share dilution…also some risk as say building a new factory with new machinery can endure delays or start up problems.  *Capital expenditure, or CapEx, are funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. It is o ften used to undertake new projects or investments by the firm.

A company which is growing twice as fast as say the SET average, yet does not have the requirement investing in new expensive machinery or plants etc.. or new headquarters, is obviously advantaged.    In finance we can demonstrate how a business which grows twice as fast as compared to an averaged SET listed company is worth 3 times more.

The average SET company is expected to have 7-8% core earnings growth for the foreseeable future -with the SET average p/e at currently 18.3. The average current dividend rate is 2.3% for the SET.  Hence a company which can visibly deliver 15% earnings growth into the future, should be worth well more than double of the p/e (36). This assuming the company also yields some dividends which are near or equal the SET average.  Here we assume earnings growth from normal operations, not from unusual or so called “one off” items.

 

After a lengthy visit with PPS (1.77) last week besides attending their 30th year anniversary grand celebration,  I here can state with conviction: to me this company meets all of the above -and then some.  (Picture is with the Chairman and Founder Khun  PRASONG THARACHAI).

Here is the valuation case which prompts me to keep rating PPS with a strong buy view, despite its already large price rise this year.  But post a 12% downward price correction from early September, when the shares peaked at 2.04.

My expected revenues estimate for PPS for all of 2017 is 410 mill.  At an 16% net profit margin this year, this comes to say an estimated 65.6 mill. in net profit for 2017.  Divided by 610 mill. shares outstanding comes to 0.108 Baht in earnings per share (EPS).  At the current price of 1.77 PPS’ p/e for year 2017 is around 16.4  (I have taken the current number of shares outstanding from their published end of 2Q. financial statement). Realize some of the key insiders have already converted their warrants 1).

Above I assume a 16% net profit margin (npm) for this year, as we realize the 2 & 3 Q. benefited from some former but now recognized incomes which the auditor had previously excluded, hence full year 2017 will be above the company’s long-term stated goal of 12% npm.  This vs 10% and lower for previous years.  PPS 2 Q. had 94.87 revenues with net profit at 19.5 mill, or a npm of 20.5%!  But my understanding is that PPS is benefiting from economies of scale presently and into the future, as the npm appears in expanding mode.

PPS net profit margin for the first six months shows 17.55%, but again this is slightly overstated due to some unusual items which were included in 2Q., that were previously excluded by the auditor.

PPS has a very well diversified income stream from these four sectors Infrastructure, Residential, Retail Areas, Office buildings, Other. Retail Areas features the second largest which is traditionally the strongest in the current 4th Q. (Residential is second largest).

My expected revenues forecast for year 2018 is 510 million Baht as the company recently announced 20% expected revenue growth for next year and I take it has a number of large projects in the making. PPS has also just recently stated it aims for 1 Bill. in yearly revenues “within 5 years” which represents a (double compared to the SET) +15% long term average yearly growth rate.  By next year its mega contract will be in full bloom with the Airport new extension. With an expected net profit margin (npm) for next year estimated at 13% (probably higher), this comes to estimated 66.3 mill. Baht net profit, or 0.09 Baht per share. Realize we must next year prudently use 741 mill. total shares outstanding, due to the increase number of shares from conversion of the PPS-W1 (warrants). Last conversion is by year end 2018.  At this, the tabulation comes to a forward year 2018 p/e of 19.6.

To summarize:  PPS’ p/e in year 2017 is estimated at 16.4 -and for next year 2018 its estimated at 19.6 -as 2017 was unusual high npm, besides the increase in number of shares due to the complete warrant 1 conversion. Very undemanding I would say, when the 2017 construction industry p/e is right around 40! Here I must add something I am not clear on: Pre-August 2017 this sector traded around 25-30 p/e and then for some odd reason I don’t understand, this sector got re-rated to p/e 40. Either way PPS trades well below the sector p/e and is a higher faster growing company with a better balance sheet then most (if not all) in that sector.  IF PPS traded at the 2018 p/e of 25 its stock price would be 2.25 and so this is my price objective. But I see further upside potential beyond this as next year progresses.

However 2 important positive caveats must be added. PPS is sitting on nearly 100 mill Baht in cash with no long term debt and when all the remaining warrants are converted an estimated additional 55-75 mill. of new cash will flow into the company. Hence all other things being equal and assuming no acquisition, PPS will be sitting on some 0.25-0.30 Baht per share in cash within a year. This means the company is in excellent financial shape with plenty of options to expand (via acquisitions of a competitor?) if they want.

I can see a further 20% stock dividend along with a 0.15 cash dividend next year. Hence combined, the current dividend yield to shareholders will continue to be rather attractive as stock dividends can always be sold out for cash, as each shareholder sees fit.

Since PPS is trading at less than half its industry average, has excellent GC, plenty of cash on hand able/energetic management and IT systems, besides a leader in its sector, the investor conclusion is obvious -while I always stand humble in front of Mr. Market.

I tried very hard to see any negatives’ and/or explore/find what I may be missing?  Perhaps members can contribute and find some more by playing devils advocate so feel free to challenge me by posting below this article.  Here I attempt hard to come up with some:  

1) This stock is listed on the MAI and the company has a relative low market cap of (1 Bill Baht) or 33 mill. US$ and so will not be on many institutions’ radar screens (not yet), only and solely due to these very large liquidity obsession/handicap.  Yet the share liquidity (average daily trading volume) has dramatically increased this year, well more than double as compared to a year ago.  

2) The Thai SET construction sector has underperformed the SET of late and hence its high p/e of 40 may be scaring off investors despite its promising future due to mega infrastructure spending next year. PPS 3Q earnings will likely be a touch less than the very impressive 2Q, but only due to some unusual items which were included in the 2Q.

3) The company has not given any “SET opportunity day” presentations yet, hence most investors don’t know PPS’s success story and only 2-3 brokers follow this company.  Not as of yet, so as this changes so will its stock valuation be rated upwards. Most of these points are in fact not negatives, but an opportunity.

At the beginning of this year for members I here posted my strong positive views on PPS with an extensive review/company visit *at PPS's headquarters. As this year comes to an end I re-affirm the same enthuse despite PPS' stock price moving up an impressive 55% since (doubling since I fist mentioned it in our member-lounge on December 23 '16).  Yet to me PPS as an investment looks just as attractive today as earnings moved-up more then its stock price and the outlooks for 2018 looks rater very promising for this 30 year old established company. Again: its balance sheet is strong, its market positioning is superb and I like the younger more energetic/smart/highly educated and progressive management. 

As always diversify your portfolio. These are my views only and never specific recommendations to you -as I don't know your financial situation and here only express viewpoints.

Best Regards,

Paul A. Renaud.
www.thaistocks.com
 
* You can see my first company visit here from early last February:

https://thaistocks.com/content/ppsgroup-superb-and-leading-engineering-consulting-company