SIA’s latest earnings saw the airline record one of its worst quarterly losses: Key points from its earnings update and what should investors do now.
Last week, Singapore Airlines (SGX: C6L) announced a sobering set of results for the quarter ended 31 March 2020. SIA’s latest earnings showed an operating loss of S$803 million on the back of a 21.9% fall in revenue.
I’ve got to say, though, that these figures were not unexpected. Earlier this year, SIA announced that it had grounded more than 90% of its passenger fleet as the COVID-19 pandemic effectively halted most passenger air travel around the world.
To prepare for the sudden drop in revenue, the airline also announced that it was raising up to S$15 billion from existing shareholders. The timely injection of cash will save the company from insolvency but shareholders will still have to endure a tough few quarters ahead.
Government support cushioned the blow
Things could have been much worse had the Singapore government not stepped in to support the aviation industry. Under the jobs support scheme, the government co-funds 75% of the first S$4,600 of wages paid to each local employee for 9 months. SIA was one of the beneficiaries of this scheme.
Through the scheme, its employee expenses for the quarter were lower by 62% to S$273 million. However, this was not enough to save the company from reporting a loss for the quarter.
Part of the reason was that SIA reported a large mark-to-market loss from surplus hedges that arose due to the recent sharp fall in oil prices. This reversed most of the cost savings that SIA got from government support, capacity cuts, and other cost-savings measures. In addition, despite a fall in activity, SIA still has a lot of fixed costs, and recorded high depreciation and aircraft maintenance expenses of S$798 million.
How does the loss impact shareholders
The huge bottom-line deficit resulted in a sharp decline in the company’s book value per share. The book value per share fell from S$10.25 on 31 December 2019 to S$7.86 as of 31 March 2020.
That’s a 24% drop in just three months. In addition, the 3-for-2 rights issue at S$3 per rights share will further dilute the company’s book value per share.
Based on my calculation, and excluding further losses in coming quarters, the dilution will cause SIA’s book value per share to drop to around S$5.
A difficult path ahead
Unfortunately for SIA shareholders, the path ahead is uncertain. In its press release, management said:
“There is no visibility on the timing or trajectory of the recovery at this point, however, as there are a few signs of an abatement in the Covid-19 pandemic. The group will maintain minimum flight connectivity within its network during this period while ensuring the flexibility to scale up capacity if there is an uptick in demand.”
In addition, management highlighted that there could be more fuel hedging losses due to weak near term demand. With half of the second quarter of 2020 over, and SIA still grounding most of its planes, I think that the next reporting quarter could be even worse than the last.
More worryingly, with no end in sight, SIA could see poor results up to the end of 2020 and beyond.
The worse is not over for the airline and I expect revenue to be much lower in the second quarter of 202,0 and losses to exceed the S$803 million recorded in the first quarter. Given this, diluted book value per share could even fall to the mid-S$4 range (or worse) after the losses are accounted for next quarter.
Final thoughts
The aviation industry is one of the most badly-hit sectors from the COVID-19 pandemic. Warren Buffett announced earlier this month that he sold all his airlines stock after admitting he did not factor in the risk that airlines faced. Their low-profit margins and capital intensive nature made them highly susceptible to cash flow problems should disaster strike.
SIA has certainly not been spared.
The only comfort that shareholders can take is that, with Temasek promising to buy up all of the company’s non-exercised rights, SIA will have sufficient capital to see it through this difficult period. But even so, the airline looks likely to suffer more losses and book value per share declines. Given all this, shareholders are unlikely to see its share price return to its former glory any time soon.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
Pushpay Holdings has seen its share price rise dramatically since listing in Australia in 2016. Here’s why I’m paying attention to it.
Pushpay Holdings (ASX:PPH) may not be a company that rings a bell with many investors but it certainly warrants some attention.
The little-known software-as-a-service (SaaS) company, which is dual-listed in Australia and New Zealand’s stock markets, has seen its share price rise by around 300% since 2016. That’s a really strong performance.
In this article, I use my blogging partner Ser Jing’s six-point investment framework to assess if Pushpay has the makings of a good investment.
1. Is Pushpay’s revenue small in relation to a large and/or growing market, or is its revenue large in a fast-growing market?
Pushpay operates in an extremely niche market.
It provides churches and non-profit organisations with the tools to create an app to engage their communities. Customers use Pushpay to customise the design and feel of their app-interface. Customers can also communicate with their community members through the app by posting videos, audios and notifications.
Through the app, community members can make donations too. In addition, customers can access donor data, allowing church leaders to take effective next steps for better engagement with donors.
The growing popularity of Pushpay’s app service has been evident with customer numbers increasing steadily since its iOS launch in 2012. As of 31 March 2020, Pushpay boasts 10,896 customers.
Pushpay has two revenue streams: (1) Subscription revenue for its services; and (2) processing revenue, which consists of volume fees based on a percentage of the total dollar value of payments processed.
Despite operating in a niche market, Pushpay actually has quite a large addressable market opportunity. Chris Heaslip is the co-founder and ex-CEO of Pushpay; he stepped down from the CEO role in May 2019. In an interview with Craigs Investment Partners in late 2018, Heaslip said:
“Giving to churches alone is about $130 billion a year, which represents a TAM (total addressable market) of just under a couple of billion dollars. And as we continue to make good inroads in that market and expand our product functionality, we’ll look to expand into other verticals as well, such as the education or non-profit verticals which are about one and two billion dollars respectively of TAM opportunity, for about $5 billion in total.”
Pushpay’s latest annual report – for the year ended 31 March 2020 (FY2020) – mentioned that “Pushpay is targeting over 50% of the medium and large church segments [in the long term], an opportunity representing over US$1 billion in annual revenue.”
For FY2020, Pushpay processed just US$5 billion and earned a total operating revenue of US$130 million, which is still small compared to its total addressable market size.
2. Does Pushpay have a strong balance sheet with minimal or a reasonable amount of debt?
Pushpay does not have the strongest balance sheet with a net debt position of US$48 million as of 31 March 2020. This is largely due to it spending US$87.5 million in FY2020 to acquire Church Community Builder, a church management system software provider.
That said, Pushpay has recently become cash flow positive and should be generating a good amount of cash in the future. In FY2020, Pushpay produced US$23.2 million in free cash flow, a marked improvement from the negative US$3.1 million seem in the prior year.
As the company continues to grow in scale, I foresee free cash flow growth in the years ahead (more on this later).
3. Does Pushpay’s management team have integrity, capability, and an innovative mindset?
I think Pushpay’s executive team have so far demonstrated all of the above. The team has been extremely transparent about their goals and targets for years, and have set revenue and earnings guidance that they have been able to consistently meet or beat.
I appreciate management teams that set realistic guidance and can deliver on their targets, and so far Pushpay has done exactly that.
I believe Pushpay’s rapid growth is also a testament to management’s capability to expand the company, reach new customers, and increase the average revenue per customer.
Management has also been actively seeking to improve the company’s product. In 2019 alone, Pushpay launched numerous new functions on its app, including Donor Development, which delivers donor insights and streamlines reporting to organisation leaders.
Pushpay also launched Pushpay University in May 2019, It is an education website for Pushpay’s customers to “learn from leading experts in leadership, communication and technology, while also deepening their Pushpay product knowledge.”
4. Are Pushpay’s revenue streams recurring in nature?
Recurring revenue is a beautiful thing. It enables a company to focus its energy on expanding the business, knowing that it can rely on a stable source of revenue. It also means that the company can spend a bit more to acquire new customers due to the long lifetime value of its customers.
In FY2020, recurring subscription revenue made up 27.7% of Pushpay’s overall revenue. The rest was derived from commissions that the company earns for processing money that is donated through its app.
I see both sources of revenue as recurring in nature. Subscription revenue recurs as long as customers continue using Pushpay’s platform. Meanwhile, payment processing revenue recurs as long as donors keep making donations via the company’s platform; many donors tend to make repeat donations so payment processing revenue tends to recur. In FY2020, Pushpay’s total processing volume increased by 39% to US$5 billion, as the company likely increased its market share in the donor payment market.
Another metric that demonstrates the recurring nature of Pushpay’s revenue is the annual revenue retention rate. This measure the amount collected per customer compared to the previous year. This figure has consistently been north of 100%, suggesting that existing customers are paying Pushpay more each year as the amount of money they raise through the platform grows.
5. Does Pushpay have a proven ability to grow?
The SaaS company is growing quickly. The chart below illustrates its revenue growth from FY2015 to FY2020.
The growth has been driven both by an increase in the number of customers using the company’s platform, as well as the average revenue per customer.
Equally important, as Pushpay scales, more of that revenue can be filtered down to the bottom line and converted to cash flow.
The company reported its first net profit before tax in FY2020 as costs rose much slower than revenue. The relatively long customer lifespan that Pushpay has enables the company to spend more on customer acquisition, as it can reap the returns over a few years.
6. Does Pushpay have a high likelihood of generating a strong and growing stream of free cash flow in the future?
In FY2020, Pushpay demonstrated that with sufficient scale, it can turn a profit and generate free cash flow.
Previously, the company was in a high growth phase and spent a significant proportion of revenue on marketing. However, as the recurring revenue base grows, the amount spent on marketing decreases as a percentage of revenue and the young SaaS company can turn a profit and generate free cash flow.
In FY2020, Pushpay had a free cash flow margin of 17.8%, a very decent return for a company that is still growing strongly.
Pushpay expects to earn between US$48 million and US$52 million in EBITDAF (earnings before interest, tax, depreciation, amortisation, and foreign exchange fluctuations) in FY2021. This represents 90% growth in EBITDAF from FY2020. As revenue and EBITDAF grows, we will naturally see free cash flow follow suit.
Given the large addressable market to grow into, I believe Pushpay’s free cash flow is likely to grow even faster than revenue as margins improve.
Risks
As a young SaaS company, Pushpay has a lot of potential. However, actually fulfiling that potential depends on the company’s execution. Therefore, execution risk is a major factor in its growth. The company’s ability to scale, attract and retain customers, and fend off competition, will be put to the test in the coming years.
Pushpay also spent a large chunk of cash to acquire Church Community Builder. The acquisition brought with it a ready set of new customers. However, it also stretched Pushpay’s balance sheet.
With growth a priority, management’s ability to put capital to use wisely will be crucial. Given that Pushpay has a very short history, I will monitor how management allocates its capital in the future. Poor allocation of capital could derail the company’s growth.
In addition, competition can be a major threat to Pushpay’s business. For now, Pushpay boasts a loyal set of customers who likely will find it tedious to switch apps. However, there is still a risk that other players may encroach into Pushpay’s territory.
Valuation
Valuation is perhaps the most tricky part of assessing a company. Pushpay is currently valued at around US$1.1 billion. That translates to around 70 times trailing earnings and 8.5 times sales.
On the surface that seems quite expensive. However, the company is growing its sales and profits fast. It also has a large opportunity to grow into. As mentioned by co-founder, Chris Heaslip, donors give around $130 billion to churches alone.
The currency for the $130 billion is unclear – it could be US dollars or New Zealand dollars. But either way, Pushpay’s revenue of US$130 million (NZ$216 million) is much lower than its addressable market size. Given its dominant position in its space, Pushpay can easily grow its market share.
The recent COVID-19 pandemic is also likely to accelerate the migration of donations from being made offline to online, with Pushpay the beneficiary of this trend. Indeed, Pushpay shared the following in its FY2020 annual report:
“Pushpay expects the increase in digital giving as a proportion of total giving resulting from COVID-19, to outweigh any potential fall in total giving to the US faith sector.”
The bottom line
Pushpay may not be the most recognisable SaaS company in the world, but it has got my attention. The company is revolutionalising the way churches interact with their communities.
Not only is it a great business financially, but it is also doing its part to help donors and campaigners raise funds for causes they believe in.
Despite some risks, I still think Pushpay’s risk-return profile looks really attractive right now.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
a2 Milk Company (ASX:A2M) has been a top-performing Australia stock over the past few years. Does it have the legs to continue growing?
a2 Milk Company Ltd (ASX: A2M) is one of Australia’s best-performing stocks. If you had bought shares in 2015 after its listing in Australia’s market, you would be sitting on a gain of over 3,000%.
In this article, I’ll take a look at how the company got to where it is and what’s in store for the future.
A checkered past
a2 Milk Company may be one of Australia and NewZealand’s most successful business stories, but its journey has been anything but smooth.
a2 Milk Company is actually the successor of the much-maligned A2 Corporation, which was co-founded by scientist Dr Corran McLachlan. In 1994, McLachlan began his research on the effects of milk consumption and heart disease and concluded that there was a correlation between A1 beta-casein protein (found in milk) and ischaemic heart disease, childhood type 1 diabetes, and other ailments.
Inspired by his research, McLachlan co-founded A2 Corporation in 2000. He used genetic testing to identify cows that produced milk that contained only A2 beta-casein protein.
However, Dr McLachlan’s research on the harmful effects of A1 beta-casein protein in milk was not widely accepted by scientists. They felt the findings were correlative, rather than causative. Even today, a lot of the research done on milk with A2 beta-casein protein is funded by a2 Milk Company and there is insufficient data to prove that A1 beta-casein protein predisposes consumers to these ailments.
Moreover, A2 Corporation ran into more significant problems along the way. In 2003, both Dr McLachlan and co-founder Howard Peterson passed away. The company was also facing financial difficulties. Just five months after it went public in May 2003, A2 Corporation had to go into administration in October and was liquidated in November.
A2 Corporation set up a new subsidiary to license and sell A2 milk in Australia. It sold a stake of that to Fraser and Neave and focused on expanding its international business. By 2006, A2 Corporation was able to buy back most of the stake it sold to Fraser and Neave and by 2011, A2 Corporation finally made a profit for the first time in its history.
It raised another $20 million through a secondary listing in New Zealand and used the funds to expand its business.
A2 Corporation changed its name to a2 Milk Company in April 2014 and has since seen remarkable growth (more on this later).
Catalysts that propelled its business
Although data about the harmful effects of A1 beta-casein protein in milk is still inconclusive, a2 Milk company enjoyed two key catalysts that saw a spike in demand for A2 beta-casein milk.
First, the publication of a book titled Devil in the Milk by Keith Woodford in 2007 caused a spike in A2 milk sales in New Zealand and Australia. Woodford discussed A1 beta-casein protein and the perceived health risks.
Next, the Chinese milk scandal in 2008, which resulted in six baby deaths and 54,000 hospitalisations, led to a spike in demand for infant milk formula from trusted Australian milk companies. a2 Milk Company was one of the beneficiaries from that scandal as its milk formula sales in China exploded.
Steady growth
FY2011 (financial year ended 30 June 2011) was the turning point for the company. After turning a profit 11 years after its founding, a2 Milk Company was able to grow its revenue and profit steadily, leading to a significant jump in its share price.
Revenue has jumped 30-fold from NZ$42 million in FY2011 to NZ$1.3 billion in FY2019. Earnings per share increased by almost 100-fold from NZ$0.004 in FY2011 to NZ$0.39. Crucially, that growth has been fairly consistent and has continued in recent times.
The charts below show a2 Milk Company’s revenue, EBITDA (earnings before interest, taxes, depreciation, and amortisation), and basic earnings per share over the last four financial years.
Source: a2 Milk Company FY2019 earnings presentation
Strong sales momentum
Today, a2 Milk Company is more than just a liquid milk company. As mentioned earlier, the company has its own infant milk formula and other nutritional products, such as pregnancy and Manuka products.
All its three product segments saw significant growth in FY2019. Liquid milk sales increased 23% from NZ$142.4 million in FY2018 to NZ$174.9 million. Infant nutrition has grown to become the most important product segment; in FY2019, infant nutrition revenue was up 47% to NZ$1,063 million.
a2 Milk’s three key geographic markets- (a) Australia & New Zealand; (b) China & other Asian markets; and (c) the US – saw sales growth of 28.3%, 73.6%, and 160.7%, respectively, in FY2019.
Huge potential in China & Asia and the US
a2 Milk Company already has a strong presence in Australia and New Zealand with its a2 Milk brand of fresh milk achieving an 11.2% market share in its segment. Meanwhile, its infant formula brand, a2 Platinum, is the leading brand in its category.
So the main driver of the company’s growth should come from its less developed markets in the US, China, and other parts of Asia.
a2 Milk Company’s main product in China is infant milk formula (IMF). In FY2019, infant nutrition revenue from China and Asia was NZ$393.1 million. This is still a fraction of the NZ$652.9 million in revenue that the same business-line generated in the Australian and New Zealand market. Considering that Australia and New Zealand have a combined population that is about 2% the size of China’s, you can just imagine the huge addressable market in China that a2 Milk Company could grow into.
Investing in growth
To management’s credit, a2 Milk Company is investing prudently to unlock this vast potential in China. The company has increased its physical footprint. As of 31 December 2019 its products are now sold in 18,300 stores in China, up from 16,400 in June 2019.
There’s been a steady increase in the company’s distribution store count in China, which is partly fueling the increase in brand awareness and sales in the country.
The chart below shows the store count numbers from 2017:
Source: a2 Milk Company interim FY2020 earnings presentation
a2 Milk Company’s China label IMF products has also grown from a mere 2% of the product-category’s total sales in FY2016 to 22% in the first half of FY2020. This suggests that the company’s investments in marketing in China is paying dividends in terms of brand recognition.
a2 Milk Company’s infant nutrition consumption share in China has also increased from 4.8% in June 2018 to 6.6% in December 2019. That’s still a small number, and there’s potential for the company to increase wallet share in China considerably in the future.
Growth in the US has also been steady, as revenue in the first half of FY2020 jumped 116% to NZ$28 million. Although the US still represents a small fragment of a2 Milk Company’s total sales, the size of the US market could result in it becoming a more important revenue contributor in the future.
Lots of cash…
Since 2011, a2 Milk Company has completely turned its business around. From a company that had to be liquidated back in 2004, a2 Milk Company now stands on solid ground, financially.
It boasts NZ$618 million in cash and no debt (as of 31 December 2019). It also milked NZ$286 million in free cash flow in FY2019. Its capital-light business model, decent margins, and strong free cash flow should enable it to reward shareholders with buybacks and dividends in the future.
Final words
a2 Milk Company has certainly come a long way since its bumpy start in the early 2000s. Since 2011, the company has seen tremendous growth and is in a great position to capitalise on its strong brand in China. On top of that, the company boasts lots of cash on its balance sheet that can be reinvested into growing internationally.
Although it is currently not paying a dividend, I believe it is in a great position to start rewarding shareholders in the near future.
a2 Milk Company does come with risks though. Its stock trades at a high valuation of around 46 times trailing earnings. There are also concerns about regulatory changes in China. International expansion also has an element of risk, and a2 Milk Company has had its own share of failures, including its inability to expand meaningfully in the UK. It ultimately ended up announcing the closure of its UK business in 2019.
Nevertheless, despite the risks and high valuation, I think a2 Milk Company still has a favourable risk-reward profile. Its huge market opportunity in China alone could provide a significant tailwind for the company and I think shares at these rich valuations still have a decent risk-return profile.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
Domino’s Pizza Inc shareholders have been massively rewarded over the past decade or so. Can the company continue to deliver?
Many of us would have heard of Domino’s Pizza before but did you know that Domino’s has also been a great stock to own? As the leading global quick-service restaurant in the pizza category, the share price of Domino’s Pizza Inc (NYSE: DPZ) has increased a phenomenal 2600% from 2004, easily outpacing the S&P 500 in the US.
Here are some of my thoughts on this amazing company.
A capital-light business model
Just to make sure we are on the same page, the Domino’s I am referring to is the brand owner that is listed on the New York Stock Exchange. There are other Domino’s Pizza franchisees that are the master franchisees in different countries. These companies are also listed on their respective exchanges.
Domino’s the brand owner derives its revenue from (1) royalties and fees it charges its franchisees, (2) providing the supply chain to its restaurants, and (3) franchise advertising.
Most of Domino’s restaurants are franchised outlets so the company has very little capital outlay requirements. The company spent only US$85 million in capital expenditures in 2019, while raking in US$496.9 million in operating cash flow.
This capital-light business means that most of the company’s cash flow from operations can be returned to shareholders either through share buybacks or dividends.
Strong track record of growth
Domino’s has a steady track record of growing its business. Same-store sales in the US has increased in 35 consecutive quarters, since 2010, at an average pace of 6.9%. More impressively, same-store sales in its international stores have increased for 104 consecutive quarters.
The charts below show same-store sales growth since 1997:
On top of that, the number of Domino’s stores has grown considerably over the years. Today there are over 17,000 stores in more than 90 markets worldwide. Net store numbers increased by more than 1000 each year from 2016 to 2019.
Increase in net store numbers and same-store sales growth have ultimately translated into healthy revenue growth for Domino’s. The chart below shows the global retail sales growth from 2012 to 2019.
Source: Domino’s investor presentation
A resilient business model
The COVID-19 pandemic has demonstrated the resilience of Domino’s business. Domino’s United States business has actually improved during the current lockdown in many parts of the US. Same-store sales in the US were up 7.1% in the first four weeks of the second quarter of 2020, and US retail sales were up 10.7% over that same period.
Internationally, Domino’s business has also done better than most. Despite many of its International stores being temporarily closed or having some operating restrictions, international retail sales were still down only 13.2% during the first 3 weeks of the second quarter.
These are impressive figures and highlights that Domino’s has the ability to keep raking in the money even in a difficult operating climate.
Potential for more growth
Although Domino’s 17,000+ store count may seem like a lot, there’s still a large market opportunity for more growth.
Domino’s currently has 6,126 stores in the US and 10,894 stores internationally. The company believes that the US market can accommodate 8,000 stores, which means Domino’s can open another 1,800+ stores in the US alone.
On top of that, its 15 largest international markets have the potential for another 5,500+ stores. The chart below shows Domino’s estimates of where their expansion opportunities lie internationally.
Source: Domino’s investor presentation
Domino’s is targeting to have 25,000 stores worldwide and US$25 billion in annual global retail sales by 2025. That’s a 47% increase in store count and a 71% growth from 2019’s revenue.
The risks
Domino’s is not perfect though. The company has the unwanted distinction of having negative shareholder equity.
That’s because the company has been returning more cash to shareholders than what it rakes in each year. It is tapping aggressively into the debt market to finance its share buybacks and dividends.
Management believes that its resilient business model, steady cash flows and capital-light business enables it to function well with leverage.
While I agree, I still think that the company could be a little bit more conservative to prepare itself against unforeseen circumstances.
As of 22 March 2020, Domino’s had US$389 million in cash and restricted cash, and a staggering US$4 billion in debt. It had negative shareholder equity of US$3.4 billion.
If Domino’s has an extended period of disruption to its business, it may end up running into liquidity issues.
Final words
There is much to admire about Domino’s Pizza Inc. It has an admirable track record of growth and still has room to grow into. On top of that, its capital-light and resilient business model enables the company to continually reward shareholders with dividends and share buybacks.
However, the company is not perfect and its highly-leveraged balance sheet poses some risk. Even though I think Domino Pizza Inc can provide shareholders with good returns, investors should still proceed with caution.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
MSCI Inc is an index provider that has grown over time as more money flows into index-tracking ETFs. Is it worth investing in?
Recently, I found out that MSCI Inc (NYSE: MSCI) is a listed company. That got me really excited.
MSCI is one of the major index providers in the world. It formulates and provides indexes – such as the MSCI World index and the MSCI US equity – to financial institutions. In total there are more than 1,200 ETFs (exchange-traded funds) that track MSCI indexes. As of 31 December 2019, there was a mind-boggling US$934 billionin assets under management that are benchmarked to MSCI indexes.
With the rise of passive investing, I believe that index providers stand to benefit the most. Index providers such as MSCI collect a small cut of every dollar invested in an ETF that tracks its index. That’s a great business model and one that will likely continue to grow as more money flows into index-tracking ETFs. In addition, MSCI also offers other subscription services that recur each year.
Steady track record of growth
Passive investing has been on the rise for years now. So its no surprise to see that MSCI has been growing steadily along with the broader industry.
From 2015 to 2019, operating revenue increased at a decent clip of 7.7% per year. Operating income ticked up by 13% annually, while the company’s dividend increased by 25% a year.
The chart below illustrates the company’s sales growth over the last five years.
Source: Msci 2019 annual report
Fat margins
But what makes MSCI a truly solid business is its fat profit margin. In 2019, the index provider earned net income after taxes of US$563 million from revenue of US$1.56 billion. That translates to a healthy net profit margin after tax of 36%.
It achieved this partly because of its low cost-of-revenue, as its gross margin was around 81% for the year. This is a margin that investors usually associate with software-as-a-service companies.
MSCI’s high profit margin means that the company can afford to spend more money expanding its business, as more of that top-line growth filters down to the bottom line.
Recurring business
If you’ve read this blog before, you would know that one of the six main factors that Ser Jing and I look out for in companies is recurring revenue. Businesses that have recurring revenue can focus their efforts on winning new clients and developing other areas of the business.
MSCI is an example of a business that ticks this box. The index provider offers recurring subscriptions to clients under renewable contracts. Recurring subscription revenue made up 75% of MSCI’s total revenue in 2019.
In addition, asset-based fees, which includes the fees it charges ETFs for tracking any of its MSCI indexes, made up 23% of revenue.
Both these sources of revenue will likely recur year after year.
Another important metric to note is the retention rate. The retention rate is the percentage of clients that renew existing contracts with MSCI. MSCI boasted a retention rate of 94.7% as of the end of 2019. Impressively, the company’s retention rate has been above 90% in recent history, highlighting the crucial role that MSCI plays for its clients.
Steady cash flow
MSCI’s cash flow has also grown along with its profits. The company generated US$709.5 million in cash from operations in 2019. Its business requires very little capital expenditures, which was only around US$33 million.
That means most of the cash generated from the business is in the form of free cash flow that can be returned to shareholders or used to buy back shares.
A black mark?
There are many things I like about MSCI as a business. However, one negative is that the company has been, in my opinion, too aggressive in rewarding shareholders. This is causing its balance sheet to weaken.
MSCI spent US$949.9 million and US$292 million buying back its own shares in 2018 and 2019, respectively. In addition, it paid US$170.9 million and US$222.9 million as dividends in those years. Together, this is more than the cash the company generated from operations.
It’s great that MSCI is returning money to shareholders, but I think it is a little too aggressive.
MSCI took on an additional US$1 billion in debt last year, partly because it spent so much on repurchasing shares. It now has US$1.5 billion in cash and US$3 billion in debt. While its net debt position is still manageable, I prefer management to be more cautious and not take on so much debt.
Closing thoughts
MSCI is a company that has many merits. It boasts recurring revenue and is one of the leaders in a growing market. On top of that, MSCI generates copious amounts of cash flow, has a fat profit margin, and is a very capital-light business, meaning it can grow without burning a hole in its pocket.
However, there are some risks to note such as its heavily leveraged balance sheet. From a potential investor’s standpoint, I can forgive management for taking an aggressive approach to maximising shareholder value, given its recurring revenues. However, if management is not careful and continues to be overly aggressive by taking on too much debt in the future, I may have to change my view on the company.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
During times of uncertainty, it may be tempting to sell your stocks to cut your losses. But I’ve not done anything to my portfolio. Here’s why.
Markets are volatile, parts of the world are in lockdown, and oil prices have plunged. This is indeed an uncertain time for investors. So what should we do now?
I can’t answer for everyone but I thought it would be useful to discuss the changes to my portfolio I’ve made since the crisis started.
Absolutely nothing
This may be anti-climatic but I’ve done absolutely nothing to my portfolio. I’ve not added any stocks nor sold any positions.
The reason is quite simple. I’ve not added any stocks to my portfolio because I am saving the cash I have now to invest in my own business.
And I’ve not sold any stocks because my portfolio of stocks is resilient.
Most of the stocks in my portfolio have more cash than debt. This means that these companies can pay off any fixed expenses while business is down and can still borrow more due to their strong financial position. As such, they are in a great position to survive this crisis.
In addition, most of the stocks in my portfolio also have resilient businesses that either are less impacted by Black Swan events or are likely to thrive when business resumes to normal.
But stocks may fall further so why don’t I sell now and buy back later?
I’ve read multiple reports suggesting that we are in a “dead cat bounce” and that the current uptrend of stocks will not last.
I don’t like to speculate on how stock prices will gyrate in the short-term but I believe that what we are seeing in the stock market is quite reflective of the expectation of the real economic impact on companies.
Financial experts point to the fact that the S&P 500 has rebounded strongly in the last couple of weeks but the truth is that the S&P 500 is not reflective of the entire economy. Financial blogger and investor Michael Batnick wrote in a recent article:
“The S&P 500 is doing well, but many stocks are not.
The pain that retail companies are experiencing is being reflected in their stocks. Nordstrom and The Gap are both down 60%, Macy’s and Bed & Bath are both down 70%. That’s year-to-date, and to remind you it’s only the second quarter.
The pain that hotels are experiencing is being reflected in their stocks. Marriott and Hyatt are both down more than 40%.
The pain that casinos are experiencing is being reflected in their stocks. MGM and Wynn are both down more than 50%.
The pain that energy companies are experiencing is being reflected in their stocks. Halliburton and Apache are both down more than 60%.
The pain that home builders are experiencing is being reflected in their stocks. PulteGroup is down 47% and Toll Brothers is down 57%.”
There are stocks that are still down a lot despite the recent rally in the S&P 500. This suggests that the market is pricing in the economic impact for the companies that will be hurt the most.
The S&P 500 is heavily weighted towards mega-cap stocks such as Apple, Facebook, Amazon, and Alphabet. They have lots of cash and will likely survive and even thrive in this crisis. For perspective, these four companies collectively hold US$353 billion in cash and short-term investments, according to data from Ycharts (based on their last-reported financials as of 29 April 2020). As such, the S&P 500’s performance is positively skewed by their performance.
Focusing on what I do know
That said, we never know. Even fundamentally sound stocks may yet fall in the coming weeks and months. But I can’t be certain and I don’t want to bet on it. I prefer focusing on the outcomes that I know will happen.
We don’t know how long it will take for the world to return to normal, but what we know is things will return to normal, eventually.
The economy will reopen, the COVID-19 curve will flatten, and consumer sentiment will improve. It may take months or years but eventually, it will happen.
When that occurs, consumer confidence will return, businesses will expand, and the economy will grow. Investor confidence will make a comeback and stocks will rebound.
Knowing this, I much rather hold on to the stocks I own, and let them ride out the current volatility. When economic growth returns, I want my portfolio to be well-positioned to succeed.
Final words
“In investing, what is comfortable is rarely profitable.”
Robert Arnott
Seeing your stocks fall is painful. No one likes to see their hard-earned money vanish into thin air. Unfortunately, volatility is part of investing. Recessions are normal. Bear markets are normal and investors have to live with it.
In times of massive volatility, it is often tempting to take action to reduce your losses or to try to time the market to make a quick gain. However, timing the market is extremely difficult. It’s simpler to wait out the volatility and give your investments time to grow.
Charlie Munger perhaps summed it up best when he said:
“If you’re not willing to react with equanimity to a market price decline of 50 percent two or three times a century, you’re not fit to be a common shareholder.”
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
Bank stocks in Singapore have been massively sold down. However, I think they are well-positioned to ride out the recession. Here’s why.
With a recession looming, it is no surprise that bank stocks in Singapore have been massively sold down. Besides the COVID-19 pandemic halting businesses around the globe, lower interest rates and the plunge in oil prices could also hurt banks.
Despite this, I think the three major banks in Singapore are more than able to weather the storm. Here’s why.
Well capitalised
First of all, DBS Group Holdings (SGX: D05), Oversea-Chinese Banking Corp (SGX: O39) and United Overseas Bank (SGX: U11) are each very well capitalised.
A good metric to gauge this is the Common Equity Tier-1 ratio (CET-1 ratio). This measures a bank’s Tier-1 capital – which consists of common equity, disclosed reserves, and non-redeemable preferred stock – against its risk-weighted assets (i.e. its loan book). The higher the CET-1 ratio, the better the financial position the bank is in. In Singapore, banks are required to maintain a CET-1 ratio of at least 6.5%.
As of 31 December 2019, DBS, OCBC, and UOB had CET-1 ratios of 14.1%, 14.9%, and 14.3% respectively. All three banks had CET-1 ratios that were more than double the regulatory requirement in Singapore.
This suggests that each bank has the financial strength to ride out the ongoing stresses in Singapore and the global economy. In a recent interview with Euromoney, DBS CEO Piyush Gupta “noted that years of Basel reforms have left banks with ‘enormous capital reserves’ and a clear protocol: to dip first into buffers, then counter-cyclical buffers and finally into capital reserves.”
Diversified loan book
The trio of banks also have well-diversified loan portfolios.
For instance, the chart below shows DBS’s gross loans and advances to customers based on MAS industry code.
Source: DBS 2019 annual report
From the chart, we can see that building and construction and housing loans make up the bulk of the loan book. While the 22% exposure to building and construction could be seen as risky, I think it is still manageable considering that the loan portfolio is well-spread across the other industries.
Similarly, UOB’s and OCBC’s largest exposure was to the building and construction sector at around 25% and 24% of their total loan portfolio respectively. Though there is an element of risk, the loan portfolios at the three banks are sufficiently diversified in my opinion.
Will Singapore banks cut their dividend?
I think the big question on investors’ minds is whether the trio of banks will cut their dividend. We’ve seen some banks around the globe slash their dividends amid the crisis to shore up their balance sheet. Regulatory bodies in some other countries have even stepped in to prevent some banks from paying a dividend in order to ensure that the banks have sufficient capital to ride out the current slump.
However, based on what DBS’s CEO said in the interview with Euromoney, it seems unlikely that DBS will cut its dividend in the coming quarters. The bank is sufficiently capitalised and can continue to pay its regular dividend without stretching its balance sheet. Gupta elaborated:
“If there is a multi-year problem… banks will likely get to the point where they can’t pay dividends. But promising now to not pay them is, to me, illogical.”
I think besides DBS, both UOB and OCBC also have sufficient capital to keep dishing out their dividends too. Both have high CET-1 ratios, as I mentioned earlier, and similar dividend payout ratios to DBS.
Final thoughts
Banks in Singapore are going to be hit hard by COVID-19. There’s no sugarcoating that.
We have seen banks in the US increase their allowances for non-performing loans in the first quarter of 2020 and they expect to do so again in the coming quarters. If the US banks are anything to go by, we can expect a similar situation in Singapore, with bank earnings being slashed.
However, all three major local banks still have strong balance sheets and diversified loan portfolios. So, despite the near-term headwinds, I think that the three banks will ultimately be able to ride out the recession.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
The annual shareholder letters from Seth Klarman provides us with insight to his thought process and invaluable wisdom to approaching investing.
Seth Klarman is a legendary investor. The Baupost Group, led by Klarman, has a reputation as one of the top-performing hedge funds in the world. In 2012, Bloomberg ranked it as the fourth best hedge fund in terms of net gains since inception (Baupost was established in 1982). Baupost is also reported to have earned an annual return of around 19% since inception as of 2010.
I recently got my hands on Baupost’s shareholder letters from 1995 to 2001 that are written by the low-profile Klarman. In it are insightful quotes that I think are worth sharing.
On the relationships between the past and the future
“Any contrarian knows that just as a grim present is usually a precursor to a better future, a rosy present may be a precursor to a bleaker tomorrow. Without me listing all the things that could go wrong, simply consider that none of these virtuous factors are cast in stone. Just as seeds are sown during the seven lean years that allow the seven fat years to ensue, so does the reverse hold true.”
In his 1995 letter, Seth Klarman rightly pointed out that the past is the past. A couple of good years in the past does not always indicate good years in the future and vice versa. We are now living at a time when these words ring louder than ever.
As investors, we should be aware that things can change rapidly when we least expect it.
Predicting the Dotcom bubble
“Even the slightest association with the Internet is cause for an upward thrust in a company’s share price. This is reminiscent of so many similar episodes over the last few decades, where everything from technology stocks to gambling shares to gold mines had their moment in the sun. We know the current mania will end badly; we do not know when.”
In a letter to shareholders in June 1996, Seth Klarman warned of the bubble emerging in internet stocks. Looking back, it seems obvious to us that Internet stocks were vastly overpriced and the bubble would soon burst. But hindsight is 20-20 and Klarman was one of the few investors who could see it at that time.
We all know by now what happened. In 1999, the dotcom bubble finally burst with the tech-heavy Nasdaq Composite Index subsequently falling by 78% from its peak.
On being adaptable
“Investors who find an overly narrow niche to inhabit prosper for a time but then usually stagnate. Those who move on when the world changes at least have the chance to adapt successfully.”
The investing environment has changed significantly over the past three decades.
For instance, investing in loss-making companies used to be frowned upon. But today, some of the best-performing stocks have been loss-making for numerous year. Netflix and Amazon are two prime examples of stocks whose values have skyrocketed despite them incurring losses in the last few years (Netflix is still making losses). But both these companies are increasingly worth more because of their sizeable market opportunity and their ability to easily turn a profit after reaching enough scale.
Investors who are able to adapt and use different investment approaches can maximise the opportunities afforded to them in the market.
On investing
“We regard investing as an arrogant act; an investor who buys is effectively saying that he or she knows more than the seller and the same or more than other prospective buyers. We counter this necessary arrogance with an offsetting dose of humility, always asking for whether we have an apparent advantage over other market participants in any potential investment. If the answer is negative, we do not invest.”
In his shareholder letter in December 1996, Klarman describes how he and the fund makes investment decisions. I believe this is a great analogy and applies to all investors.
On how value investing works
“Value investors should buy assets at a discount, not because a business trading below its obvious liquidation value will actually be liquidated, but because if you have limited downside risk from your purchase price, you have what is effectively a free option on the recovery of that business and/or the restoration of that stock to investor favour.”
As a proponent of value investing, Seth Klarman describes brilliantly how value investing works. If investors are able to purchase a stock that is trading well below its liquidation value, the stock is unlikely to fall much further. The investor, hence, can get the upside potential without the downside risk.
On the challenges of investing in a bear market
“In investing, nothing is certain. The best investments we have ever made, that in retrospect seem like free money, seemed not at all that way when we made them. When the markets are dropping hard and investment you believe is attractive, even compelling, keeps falling in price, you aren’t human if you aren’t scared that you have made a gigantic mistake.”
In his 1997 shareholder letter, Seth Klarman remarked how challenging it is to buy stocks in a falling market.
I believe many investors may have felt the same way when many REITs in Singapore fell by more than 50% in March this year. Even if we knew that REITs looked like attractive bargains after the fall, how many of us managed to pull the trigger to buy them at those discounted prices? Today, REITs have climbed steadily and investors who bought in just a few weeks ago would be sitting on some meaty gains.
Final words
Seth Klarman’s words in his shareholder letters contain an arsenal of insights and advice. If you want to read more of his letters you can head here.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
The MAS has increased the gearing limit for REITs in Singapore and extended the deadline for REITs to pay out at least 90% of their distributable income.
In light of the challenges that real estate investment trusts (REITs) in Singapore are facing, the Monetary Authority of Singapore (MAS) has stepped in to relax the regulatory constraints for REITs. This is extremely timely and is welcome news for worried REIT investors.
In this article, I’ll summarise some of the key changes and what it means for REITs.
Extension of permissible time for REIT to distribute its taxable income.
REITs in Singapore are required to distribute at least 90% of their taxable income to unitholders to qualify for tax transparency treatment. Under the tax transparency treatment, a REIT is not taxed on its income that is distributed to unitholders.
Previously, REITs had to distribute this amount within 3 months of the end of its financial year. But MAS has now extended the deadline to 12 months for this financial year.
What does this mean for REITs?
This will give REITs a larger cash buffer for this difficult period, especially for REITs that intend to approve later collection of rents or provide rental rebates for their tenants. Such REITs will now have the cash buffer to pay off their expenses and interest payments first, while still supporting their tenants.
This is great news for REIT investors who may have been concerned that REITs who have cash flow issues will not be able to enjoy the tax benefits that REITs usually enjoy.
SPH REIT (SGX: SK6U) was the first REIT in Singapore to announce that it will retain a large chunk of its distributable income in its latest reporting quarter in anticipation that it will need the cash in the near future.
Higher leverage limit and deferral of interest coverage requirement
MAS has raised the leverage limit for REITs in Singapore from 45% to 50%. This gives REITs greater financial flexibility to manage their capital. Lenders will also be more willing to lend to REITs who were already close to the previous 45% regulatory ceiling.
MAS also announced that it will defer the implementation of a new minimum interest coverage ratio of 2.5 times to 2022.
What does this mean for REITs?
I believe that the pandemic could result in tenancy defaults. This, in turn, could result in lower net property income for some REITs in the near term, putting pressure on their interest coverage ratios.
The deferment of the minimum interest coverage ratio and the higher gearing limit will allow REITs to take on more debt to see them through this challenging period.
Investors who were concerned about REITs undertaking rights issues, in the process potentially diluting existing unitholders, can also breathe a sigh of relief. The increase in the gearing limit to 50% will enable REITs to raise capital through the debt markets rather than issuing new units at current depressed prices.
My take
The lightening of regulatory restrictions by MAS is good news for REITs. This is especially welcoming for REITs with gearing ratios that were already dangerously close to the 45% regulatory ceiling, such as ESR-REIT (SGX: J91U). It now can take on a bit more debt to see it through this tough period, without breaking MAS regulations.
At the same time, I would like to see REITs not abuse MAS’s new rules. They should still be prudent in the way they take on debt to expand their portfolio. Ideally, REITs that have expensive interest costs should be more careful about their debt load and not increase their debt beyond what they can handle.
I think this COVID-19 crisis is a great reminder for all REITs that they cannot take anything for granted and need to have safety measures in place to ride out similar challenges in the future.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
Markets are volatile and earnings are likely to sink. Nobody knows when the economy will return to normal. How can we approach investing during COVID-19?
“Fear incites human action far more urgently than does the impressive weight of historical evidence.”
Jeremy Siegel, Stocks for the Long Run
The COVID-19 pandemic has thrown markets into a frenzy. The month of March was likely the most volatile period in stock market history. Traders were zig-zagging in and out of the markets, causing daily swings of up to 10% in the S&P 500.
COVID-19 is indeed a black swan event. No one really knows what will happen and how the market will pan out in the short-term. With so much uncertainty, what should long-term investors do now?
Focus on things that you can predict
There are many things we can’t predict in the stock market. But investing is not about accurately predicting everything that will affect stock prices. Instead, it’s about focusing on stuff that you can predict. It’s about investing in companies that are likely to succeed in the long-term.
Terry Smith is the founder of Fundsmith, the manager of the UK’s largest fund, Fundsmith Equity Fund. Here’s what Smith wrote in a recent letter to his investors:
“What will emerge from the current apocalyptic state? How many of us will become sick or worse? When will we be allowed out again? Will we travel as much as we have in the past? Will the extreme measures taken by governments to maintain the economy lead to inflation? I haven’t a clue. Rather like some of the companies we most admire, I try to spend very little time considering matters which I can neither predict nor control and focus instead on those which I can affect.”
Don’t forget that the stock market is the best place to invest for the long term
In times such as this, it is easy to forget that the stock market is actually the best place to invest your money for long-term returns.
According to data from NYU finance professor Aswath Damodaran, US stocks have outperformed bonds and cash by a wide margin over the long run. From 1928 to 2019, US stocks produced an annual return of 9.7%, while bonds (10-year treasuries) had a 4.9% return per year.
In a recent video, Motley Fool co-founder David Gardner shared:
“From day one, when we started the Motley Fool 27 years ago, we said three things. Number one, the stock market is the best place to be for your long-term money. Number two, the stock market tends to rise 9 to 10% a year. That includes every bad week, quarter, month, year, bear market… and number three, make sure that you are invested in a way that you can sleep well at night.”
Don’t try to time the bottom
One of the most-asked questions among investors today is “Have we reached the bottom?”
I think that nobody really knows the answer to that. But it should not stop us from investing.
If you insist on only buying at the trough, you might miss a few good opportunities. In fact, I’ve heard of stories of investors who planned to enter the market at the bottom but missed out when their preferred-bottom never came. As stocks rose and got more expensive, they couldn’t bring themselves to buy and missed out on years of gains.
Billionaire investor Howard Marks mentioned in his latest memo:
“The old saying goes, “The perfect is the enemy of the good.” Likewise, waiting for the bottom can keep investors from making good purchases. The investor’s goal should be to make a large number of good buys, not just a few perfect ones.”
But remember to pick the right stocks
If you intend to invest in individual companies rather than an index-tracking fund, then it is important to remember that not all companies are created equal.
The well-followed S&P 500 index in the US has risen steadily over the long-term but a lot of its return can be attributed to only a handful of outperforming companies.
In fact, my blogging partner Ser Jing reported an interesting statistic in an earlier article. He wrote:
“ A 2014 study by JP Morgan showed that 40% of all stocks that were part of the Russell 3000 index in the US since 1980 produced negative returns across their entire lifetime.”
That’s an astounding statistic and goes to show that simply investing in any random stock will not guarantee you positive returns, even if you hold for the long run.
Picking the right companies is as important as choosing the right asset class to invest in. It is perhaps even more important for times such as today, where poorly-managed companies with weak balance sheets are fighting for their survival. As Warren Buffett once said, “Only when the tide goes out do you discover who’s been swimming naked.”
Stay calm and keep investing…
It is an understatement that markets are volatile. We are also likely going to see sharp drops in earnings from many companies in the next few quarters. Already Starbucks has guided for a 46% fall in earnings for the first quarter of 2020 and I expect to see many more companies reporting similar if not worse figures than this.
However, over the long-term, I expect earnings for well-run companies to return and for life to eventually return to normal.
Instead of focusing on the next few quarter results, I am keeping my eye on long-term results and which companies can survive the current economic standstill.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
