New Lease Accounting Rule Impact On Companies and Investors- Making Something Out of Nothing

The new accounting standard FRS116 on leases came into effect on 1^st Jan 2019. The “right of use” asset model basically attempt to plug the loophole of off-balance sheet liabilities. Basically, for operating lease assets, companies are now required to capitalize the present value of future lease payments of such arrangement as a direct fixed asset and also to recognize a theoretical liability. This gives rise to a strange phenomenon whereby an arbitrary financing cost is also created monthly for the right of use of the asset during the unwinding of the interest component in the lease liability. From the cash flow statement perspective, companies now have to account for the monthly lease payments into (i) repayment of principal portion and (ii) the cost of financing the “right of use” asset. From a retail investor perspective, it does lead to massive confusion over the understanding of the traditional Statement of Comprehensive Income (Profit and Loss statement) as well as cashflow statement.

Majority or only a minority of companies affected?

Majority of companies are being impacted by this change in accounting. For example, most business would definitely have an office lease or industrial premises lease. Since the lease of premises is one of the huge cost components of business, this impact can be very significant on the financials.

To illustrate this, a company may have signed for a 5 year industrial lease for S$120K per month. Total contractual obligation thus amounted to S$7.20Mil over 5 years. Under the new accounting rule, the present value (assuming the benchmark incremental borrowing rate is 3.5% and the landlord requires prepayment on 1^st day of month) of future lease payment will be S$6.62Mil. The differences of S$584K is deemed as the financing cost over the 5 year period.

Key parameters to work out the present value of lease payments

What are the differences between the new profit and loss impact relative to previous method on lease accounting?

Instead of recognizing rental expense in a straight line over 60mths under the old method, the new accounting rules does not have any rental expense for operating lease with the exception of low value or items less than 1 year. The new accounting rules recognizes (i) depreciation and the theoretical (ii) finance cost of liabilities unwinding into the profit and loss consideration.

The mind blogging aspect is that the new rule loads up expenses upfront at the onset of the first few periods of the lease period whereas the previous method has a simpler approach of constant and equal lease expense every month. This is illustrated in the screenshot from period 1 to period 60. The fluctuating figures make it hard to do an accurate forecast of the future business performance with the declining profit and loss impact especially towards the end of the lease whereby the liabilities have been significantly lowered hence very little finance cost at this juncture.

 

Screenshot of monthly profit and loss impact of new recognition method vs previous method

The experts who implemented this new rule rationalize the fluctuation by justifying that this is the realistic application of the time value of money concept.

Further confusing aspects of new accounting rule

1.   As mentioned above, the new accounting rule stipulates the recognition of operating lease has exceptions for low carrying value lease contracts or contracts for less than 1 year. What this meant is that the rules still allow one to use back the old method for such “immaterial” lease contracts to cater to complaints from commercial practitioners on the practicality of implementation for every operating lease in their business which will be too onerous.

2.   If the operating lease contract comes with an option to renew upon the end of the contracted lease (which is actually very common), the new rule requires one to use a judgmental estimation of the probability to decide whether the contract period should take this additional option into consideration to derive the total value of future payments for lease liabilities. Once you leave things to judgment, hell breaks loose eventually and leads to big fluctuation in future financial results.

Summary

I do not like the new accounting rule as it makes an assessment of current potential businesses identified for investment more complex due to the monthly fluctuation and the additional mental acrobatics during analysis. It also makes the overall profit and loss weird with front-loading of expenses and then a favorable impact towards the mid to end point of the lease. But it does have added transparency to potential investment company statement of financial position by bringing in contractual lease obligations into the gearing ratio.

Sing Medical Group Déjà Vu- Undervalued Stock Price Increased 20% But Price Collapsed Again Recently

Since my last posting on the “The Enigmatic Case of Sing MedicalGroup- More Money Earned Lead to Lower Share Price” on 8 January 2019, the price of Sing Medical Group has shot up by 20% from S$0.400 to S$0.485 within 2 months. However, its share price has since plunged by 22% to a low of S$0.380 on 7 June 2019. If one had the ability to see the future using a magical crystal ball, then one would have sold off in Feb’19 at S$0.485 and then buy again when it hit S$0.380 recently and locked into the profit. If it can recover to S$0.480 level, one would have made a staggering 40% profits. Of course, I am saying this with the benefit of hindsight. I know of a retail investor who subscribed to value investing sinking in up to S$100K over the past few months into Sing Medical Group (“SMG”) and the recent plunge in stock price would have been disastrous. So, what exactly happened here for the price to have plunged so dramatically again and most importantly, the key question is whether the share price of SMG is severely undervalued again?

The very peculiar nature of Sing Medical Group share price

The strange thing is that whenever the financial results showed improvement or if it issued rights to raise funds for M&A opportunities, the share price will go the other way. The recent sharp drop in share prices maybe also due to existing shareholders punishing the management team for selling off part of their shares at SGD 0.605 to CHA, the Korean Medical Group and existing investor.

1. Excellent Q1 2019 financial results but share price tanked

The recently announced results of Sing Medical Group is excellent. Revenue increased to SGD21.6Mil  relative to SGD19.2Mil (+12.3%) on a year to year basis due mainly to growth in its Diagnostic & Aesthetics segment while Net Profit After Tax dropped <3%> in view of lower tax exemptions and lesser carried forward tax benefits. Since we cannot control statutory taxation, a better gauge would be to look at the Net Profit Before Tax which increased by 0.9% (the increased revenue is being offset by increase in marketing expenses). Despite the wonderful Q1 2019 results, the share price of Sing Medical Group tanked.

Many shareholders have been extremely disappointed with the lack of dividends being declared. Last year, the management did raise the possibility of a formal dividend policy in the new financial year but have since remained silent on this issue. Despite the high profits made, SMG has been aggressively reinvesting the proceeds into opening new clinics. A new pediatric clinic in Punggol has just been opened recently this year. A new Breast clinic and its specialist has also just come on board SMG. There are other plans to increase the number of specialists by another 7 to 8 which means revenue topline is going to continue to expand rapidly but profitability may be hit in the short term while ramping up patient loading.

2. Punishment by investors in retribution against the management for selling their shares at S$0.605 to CHA Medical Group without a general offer to other shareholders and proposed S$10Mil convertible loan to shares at a low conversion price of only S$0.423 per share.

Many existing shareholders in investment forum have been upset by the existing management selling off part of their shareholdings in SMG. CHA Medical Group has valued the shares at S$0.605. This exercise was just recently concluded. Compare S$0.605 independent valuation against the current price of S$0.380. This represented a 59% discount of the independent share valuation should the price hits S$0.605 in future.

Even for the S$10Mil convertible loan by shareholder CHA, the price of S$0.423 against the current market price of S$0.380 represented close to 10% discount for new investors entering at the current market price. This means that your investment automatically gain a 10% discount premium of S$1Mil out of S$10Mil cash injection by CHA medical group- free hard cash put in by the other shareholder to increase your margin of safety.  

3.Jinxed Fund Raising Exercises

Whenever there are rights issues or offer of convertible loans to shares, this always spell bad news for existing retail shareholders albeit improving revenue and future profits. This is because the share price will most likely plunge after this exercise. This has a lot to do with the lack of tangible returns to shareholders as alluded to point 1 above. There is thus currently an unhealthy downward spiraling cycle in its share price whenever SMG raised funds for expansion as the market seems overly risk-averse to the business of SMG. This is clearly a stark contrast to the industry PE average based on S$0.380 per share being traded.

Parting Thoughts

SMG management needs to seriously look into immediate actions to revive the share price. This is paramount as SMG will always need to give an increasingly huge discount of its intrinsic value to fund its aggressive growth initiatives which resulted in a perpetual downward cycle. I maintain my view that the share price will grow 20% by end of this year and with a potential for 50% growth in share price over the next 2-3 years if the management continued with SMG expansion. The increase in share price by 20% and then a decline of more than 20% represents good buying opportunity. I have accumulated extra SMG shares as I think that the management has been delivering and executing well on its expansion plan. The strategic partnership with CHA Korean Medical Group will also strengthen SMG.

Last but not least, at the current low share price of S$0.380, there is a probability that some existing corporate shareholders or perhaps Dr Beng himself may buy out the other shareholders and delist the undervalued SMG. After building up the medical group over the next few years, the controlling shareholders can easily go for IPO again at a better valuation to realise their investments. This is also the strategy employed by our local billionaire and business tycoon Peter Lim on Thomson Medical Group.

Pls also see my previous postings:
(i) Hidden Gem with Explosive Growth- Potential Further Upside of 25% to 50% (Part 1);

(ii) Hidden Gem with Explosive Growth- Singapore Medical Group S$10Mil Shareholder's Loan for M&A (Part 2)

Frasers Centrepoint Trust Acquistion of Punggol Waterway Point and Death of Shopping Malls in Singapore?

On 16 May 2019, Frasers Centrepoint Trust ("FCT") announced that it is acquiring a 33.33% stake (S$440.6Mil) in Punggol Waterway Point from its sponsor Frasers Property. The suburban mall is conveniently located next to Punggol MRT/LRT/Bus Interchange and integrated with Watertown residential component on top of the mall. It serves as the main shopping mall for residents of Punggol new town and the footfall catchment area is huge as evident from the large crowd of shoppers even during the weekday.

1. FCT is a great defensive retail REIT with excellent DPU growth track record and many assets in the pipeline from its Sponser.

The acquisition of Waterway Point has a distinct advantage of further diversifying its earnings base from suburban shopping malls. This is the first large scale shopping mall being developed by Frasers, Far East Organisation & Sekisui House and managed by Frasers Property. The layout of Punggol Waterway Point shopping mall is very different from many traditional mall layouts. It is separated into an East Wing and a West Wing which are connected by a 24-hour walkway. Interestingly, this can get a little confusing for new shoppers trying to locate certain shops that they are intending to visit. Nevertheless, the shopping mall contains lots of F&B outlets, retail shops, a huge NTUC Finest supermarket and also many movie theatres including iMax by Shaw which draws excellent footfall into the mall.

I was a little surprised by the latest acquisition of Waterway Point by FCT in as they seemed to be on an aggressive warpath to grow their existing portfolio in 2019.  Just less than 3 months ago, FCT had announced on 28 Feb 2019 that they were acquiring a 17.1% stake (S$342.5Mil) in one of the largest Singapore private retail mall fund. The fund, PGIM Real Estate Asia Retail Fund (PGIM Real Estate), owns and manages six retail malls in Singapore - namely Tiong Bahru Plaza, White Sands, Liang Court, Hougang Mall, Century Square and Tampines 1 - as well as office property Central Plaza.

In conjunction with the latest acquisition news, FCT will be launching an equity fundraising exercise via private placement and also preferential placement from existing shareholders. Funds raised will be used for the Waterpoint acquisition and also pare down debt for the previous PGIM Real Estate acquisition. Their underwriter DBS, will be announcing the details of the pricing of the non-renounceable rights issue for the preferential tranche on 27 May 2019. 

2. Death of retail shopping malls in Singapore?

I do not agree with the many doomsayers over the upcoming decline of retail malls in Singapore due to the emergence of e-commerce. This is similar to the retail scene in China. A suburban shopping mall is currently part of a typical Singaporean family lifestyle with educational centers for kids, F&B options as well as various other entertainment options being made available. It is not just a pure retail shopping experience.

Also, for retail, a brick and mortar shop actually complements their e-commerce arm in terms of building up the brand's presence. The "future world" being envisioned by doomsayer whereby everyone stays at home after work hours waiting for all items to be delivered by Ninja van or Redmart is absurd. E-commerce will never be able to fully replace the family experience offered by suburban shopping malls. Shopping malls, in turn, are re-inventing themselves as a lifestyle mall with their own unique identity.

3. Parting thoughts

FCT is a very fascinating REIT as its manager has a growth mindset as well as an excellent track record in gradually growing its DPU for shareholders. Besides further piecemeal acquisition opportunities of additional stakes in Punggol Waterway point or PGIM Real Estate Asia Retail Fund, I am looking forward to their future acquisition of another star jewel in Yishun, that is, the south wing of Northpoint City.

Thai Beverage First Half Profits Increased Relative to Last Year But Share Price Plummet by 10%- Oversold?

Thai Beverage share price plummeted by almost 10% the following day after the release of their 2nd quarter financial performance (ending 31 March 2019) to as low as S$0.735 per share from S$0.825 per share. This seems to be a knee jerk reaction to the unfavourable results for 2nd quarter relative to the previous financial period. However, the fact of the matter is that if I recall correctly, Thai Beverage is coming off from an abnormally highly skewed profit base for Q2 2018 which was mainly before the additional excise tax came in for alcholic drinks hence agents and retail outlets were stocking up as much as possible before the new measurement and price increase in April 2018 by Thai Beverage.

A better gauge of their financial performance should be for at least 6mths. Thai Beverage 1st half results were still 11.3% better overall than prior financial period albeit the decline for the 2nd quarter. I think that it is too soon to write off the good performance and to decide that Thai Beverage will underperform for the 2nd half of its financial year. Revenue for Beer is still on a rising trend. 

2nd quarter results-Revenue still improving.

Normalised net profit due shareholders is still up by 11.3% for first 6 months (excluding non-recurring M&A expenses)

Even before the release of the results, I saw an increase in short selling activities. Looks like magically, some shareholders already glanced into their crystal ball and knew that the 2nd quarter results will show a decline relative to the prior year financial period and the market will react very negatively. Sometimes, I just can't help but wonder whether there are any leakages of key financial data before the announcement to the market despite SGX stringent rules governing such disclosure. As of the recent 2nd quarter results announcement, I  was still holding on to 41,000 shares at an average cost of S$0.630 per share. Since the beginning of this year, I have gradually sold off part of my original 81,000 shares in order to take profit after the recovery from the bearish market sentiment in Q4 2018.

During the 1 day plunge in the share price of Thai Beverage following the release of the results, I had taken profits off 10,000 units of Starhill Global REIT and used the proceeds to accumulate 10,000 shares of Thai Beverage at S$0.740 a piece. My view is that it is still too early to conclude that Thai Beverage results will deteriorate and a better benchmark would be to wait 1 more quarter. Based on the 1st half excellent financial performance, I think that the shares of Thai Beverage were oversold. In addition, due to the global economic uncertainty, Thai Beverage remains a good diversification of one's portfolio with exposure to the South East Asia wine/beer market as well as the F&B (KFC) fast food segment in Thailand.

Organisations Must Treat Employees As The Soul Of The Company

This week, I came across an interesting article on Channel News Asia by Sara-Ann Lee on “Always tired and worried about under-performing-when extreme meritocracy drives burnout.”  Sara-Ann Lee also mentioned that “Organizations must treat employees as the soul of their company, rather than as resources to be expended at their disposal.” While this is indeed true, it is always a two way street in terms of employer and employee relationship. Employees should also stop treating their organizations as a resource to exploit and be expended while pursuing their career and wealth accumulation. I list down some of the paradoxes in employer and employee relationship.

1. Time waits for no one. Every man for himself then?

Firstly, I find it strange that many young employees these days like to job hop. I have seen resumes of job candidates who change job every 1 or 2 years. I also have colleagues who jump ship every 1 or 2 years so that they can have a huge jump in salary increment. Their motto is “Every man for himself”. Show me the money first and fast. No use telling me to wait for year-end promotion and grow with the organization.

2. Strawberry generation

One of my colleagues remarked that the strawberry generation are easily bruised. I can remember during my first few years in the auditing profession, there were a number of “meanie” senior managers who like to scold their staff for not fulfilling their required standard. There were even files being thrown out of the office and into the rubbish bins right in front of the junior employee by the senior managers. Nowadays, the situation is entirely different. If a manager tells off a staff, chances are the employee would tender resignation the next day. If a manager throws a file into the dustbin, the employee may complain directly to MOM or raise a lawsuit for abuse and psychological harm.

3. Singaporeans are victims of our own success

It probably does not help that Singaporean parents are better to do relative to their parents or grandparents’ generation who in their earlier days were struggling to put food on the table. I had a colleague who told me that her parents asked her to quit the auditing profession as the hours were too long and the work too stressful. The parents even told my colleague that they would give her a monthly allowance/pocket money if she decided to quit the job while looking for an “easier” job.  Not sure whether this is the right way to educating young adults which is not exactly molding them into a value-adding employee in the workforce.

4. My way or the highway modern employees

Some employees cannot be criticized. If you bring up that their reports can be further improved on for presentation, they immediately felt very defensive and offended. These particular employees think that they are the best of the best after graduation. They will then decide to quit as they feel that their “professionalism” is being insulted.

Parting thoughts

My personal thought is that there is no doubt that some organisations- in its pursuit of business excellence via uncompromising effectiveness and adopting a paradigm of no-nonsense- appears devoid of heart, soul and spirit in its interaction and dealing with employees. But at the same time, there are also heartless employees who treated their employers as nothing but a mere stepping stone to cater to their own individual whims that are clearly not in the interest as well as out of sync with that of their organization’s businesses as well as the greater good of our whole society.

Developer SPH and Kajima Slashed Woodleigh Residences Price by 10%-13% from $2000psf to starting from $1733psf For Relaunch in May 2019.

Interestingly today, my property agent messaged me that Singapore Press Holdings ("SPH") and its partner Kajima had slashed the price of Woodleigh Residences by 10% to 13% from S$2,000psf to as low as S$1,733psf. This was despite their initial assertion that the VVIP launch in October 2018 was a resounding success with over 60% of the launched units sold at an average price of 2,000psf. However, for the re-launch of Woodleigh Residences in May 2019, the developer SPH and Kajima must have decided that the risk of the market downturn may not be worth it and started slashing prices drastically in order to move more units. After all, the developer was only able to sell 30 units on the first weekend of its initial launch albeit declaring that 60% were sold by proclaiming that they only launched 50 units.  

For a 958sqft 3 bedder unit, prices would have dropped from S$1.92Mil to S$1.66Mil which translates to substantial savings of +S$256K for potential buyers relative to the first batch of VVIP. This does not seem fair to those first batch of buyers who had supported this integrated mixed commercial and residential project of SPH and Kajima during launch. I hope that SPH and Kajima would have given some goodwill renovation packages to compensate these initial buyers. 

On the property market front, I am not sure whether other developers will also take the lead in slashing prices but I hope so for the benefit of consumers. Once the music stops, property developers holding on to the most unsold inventories would need a very strong balance sheet to wait out the economic downturn. 

From the stock investing perspective, I have previously highlighted the lingering impairment risk of the Bidadari project, that is, Woodleigh Residences, due to the potential property market downturn and uncleared inventories.  I am glad that SPH has decided to slash the price in order to move their inventory of unsold units. Coupled with the bad news from the US/China trade war today, SPH price has dropped to S$2.40 per share and it may be worthwhile to re-look into their newly transformed property business from the previous media giant model. The new UK student accommodation segment acquisition should prove invaluable in the event of an economic downturn due to earnings resiliency.  

Note: Please refer to my previous SPH post "Singapore Press Holdings Transformation Into Property Giant Almost Completed".

Undervalued Stock- Global Investment Limited and Recent Share Buy-Back Activities

The share price of Global Investment Limited ("GIL") has risen over 30% to S$0.136 per share since its lowest point on 7th December 2018 of S$0.103 per share. The main reason was due to the January 2019 market rally against the bear market sentiment that plagued the market during the last quarter of 2018. The other reason for the strong showing was due to the management of GIL exercising the share buy-back mandate. Ever since 8th January 2019, GIL has been pretty busy buying back shares almost daily. The last share buyback announcement was just as recent as 26 April 2019. 

Nevertheless, I am not entirely convinced by the effectiveness of the share buyback initiative given the significant difference to its fair value. GIL is still severely undervalued by the market. In the longer term, the share buyback is no use as a tool to prop up share price as the mandate for purchase has a limit imposed on it. Using a quick and dirty method to derive the valuation, we can use the NAV to approximate the fair value given that most of its assets are repriced to the market during the book closing. The fair value per share thus worked out to be around S$0.187 per share (S$322Mil of Net Assets over S$1,723 Mil number of ordinary shares). The current share price of S$0.136 per share is still at a very steep discount of 37.4% discount to the estimated fair value. 

The management of GIL should seriously conduct a strategic review as soon as possible and assess options such as selling off the entire company to other industry players such as banks, fund management companies or even government institutions (Temasek Holdings). This would then unlock the huge discount in its current languid share price. The market is apparently demanding a substantial risk premium for GIL over the meltdown of GIL during the previous Global Financial Crisis in 2008 that has scarred too many souls and did not re-price in the current restructured investment assets adequately.  

For now, the good thing is that GIL is paying out dividends and not hoarding excessive cash, unlike other companies. The Company's mission statement is to invest in a socially responsible way to generate steady income and capital appreciation so as to deliver regular dividends and achieve capital growth for shareholders.

Note: Please refer to my other postings with regard to the assets held by GIL. 
1. Global Investment Limited- Financial review. Is it really a "Hidden Gem"?
2. Global Investment Limited- Excess cash from FY2017 deployed into China Domestic Bonds
3.Global Investment Limited (Attempt To Unlock Intrinsic Discounted Value)- Wiping off Accumulated Losses from the Global Financial Crisis