Category: Investing Analysis

Netflix Inc (NASDAQ: NFLX) is ushering in a new era in its business.

The streaming video giant delighted investors in January when it announced in its 2020 fourth-quarter earnings update that after years of burning cash, it is finally close to being self-sustainable

Subscription video on demand (SVOD) as a business had previously been a highly contested topic among investors. Although there is no denying that there is product-market fit, Netflix has burnt through billions in cash to build original content each year, raising questions about the unit economics of the business model. 

But cash-burn may soon be a thing of the pass for the undisputed king of SVOD. 

For 2021, Netflix said that it anticipates free cash flow to be around break-even. It is so confident in its ability to be self-sustaining that it plans on repaying some of its bonds and even toyed with the idea of returning cash to shareholders through share buybacks.

Unsurprisingly, Netflix’s optimism was met with enthusiasm from stock market participants. On the day after the announcement of its fourth-quarter results, Netflix’s share price spiked by more than 10%. 

So, what’s driving Netflix’s change in fortunes?

The short answer is scale and operating leverage.

Since the start of 2018, Netflix’s paid memberships have risen from 111 million to 204 million. In addition, price hikes have made each member more valuable to Netflix. Its average monthly revenue per member has grown from US$9.88 to US$11.02.

Consequently, Netflix’s revenue has increased by 113.7% from US$11.7 billion in 2017 to US$25 billion in 2020.

At sufficient scale, Netflix can fund its original content production entirely from the cash earned from subscriptions.

In early 2020, I wrote an article titled What Investors Don’t Get About Netflix titled. In it, I explained:

“To improve its free cash flow metric, Netflix needs to spend much less as a percentage of its revenue. And I think its entirely possible that this scenario will play out sooner rather than later. The math is simple. 

There is a fixed cost to producing content but the value of the content scales as the user count grows. 

For instance, the content that Netflix is producing today can reach its 167 million global subscribers. But as the number of subscribers grows, the content it is producing will reach a larger subscriber base. Put another way, the fixed amount spent on each movie or series will be spread out across a much larger revenue base as user count grows.

Over time, the amount of cash spent on content will take up a much lower percentage of revenue and, in turn, free cash flow should eventually be positive.”

This scenario seems to be playing out exactly as I wrote. Netflix, now with its 204 million members paying monthly subscriptions, can start to internally fund its content production each year.

And it likely gets better from here…

With Netflix hitting this breakeven milestone in its business, the company will likely start to exhibit extremely strong unit economics moving forward.

Put another way, from 2022 onwards, we are likely to see a high free cash flow margin generated from each net member addition.

How much can Netflix potentially earn? Well, looking at the market opportunity, I believe the company’s annual free cash flow could be in the tens of billions.

With around 1.6 billion television households worldwide and an estimated 45% of those having broadband internet access, Netflix has an addressable market of roughly 720 million households. If we assume that Netflix manages to penetrate just 50% of that market, it will have 360 million members – or around 155 million more than it reported for the fourth quarter of 2020.

Let’s also assume that Netflix has factored in 20 million new members in 2021, which will bring its free cash flow number to break even.

To be conservative, let’s also say the contribution margin of every subsequent member added is 90%. Using average revenue per user of US$11, we can calculate that by the time Netflix hits 360 million subscribers, it could potentially be generating US$16 billion* in free cash flow annually. That’s a hefty sum – bear in mind too that I did not even factor in any price hikes.

Ending thoughts…

Netflix has long been a highly debated company among investors. Although it is normal for a young technology company to be burning money, Netflix is far from a young tech startup. Its streaming service has been around for more than a decade and yet it has been lighting up cash for years, raising doubts about the sustainability and unit economics of its business.

But the early criticism from outsiders is starting to look misplaced. Netflix, despite the competition from Disney Plus, and other content-giants, is still the top dog when it comes to SVOD. Steady member growth and low churn speak to that. It’s early (and steady) investments in producing original content are starting to reap the rewards, driving new memberships and increasing the value of its service to existing members.

Netflix’s co-CEO and co-founder, Reed Hasting, perhaps knew it all along. In Netflix’s 2017 fourth-quarter letter to shareholders, a time when it was still burning billions of dollars each year, the company wrote:

“We are increasing operating margins and expect that in the future, a combination of rising operating profits and slowing growth in original content spend will turn our business FCF positive.” 

Netflix is one of the modern era’s great examples of how long-term investing pays off. The company was willing to endure years of cash burn and even tapped into the high-interest debt market to fund its growth. But these investments will likely more than pay off in the years to come.

To me, Netflix is a poster child of the benefits of long-term investing, and a shining example for any serious long-term investor to learn from.

* Calculated by using 224 million as the breakeven number of members. The equation is (360 million-224 million)*US$11*12*0.9.

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. I currently have a vested interest in the shares of Netflix Inc. Holdings are subject to change at any time.

You’ve likely heard about the Gamestop Corp (NYSE: GME) saga. I didn’t want to write a post on it but I realised that there is one glaring misconception among Reddit investors that should be addressed.

Many users within the Wallstreet Bets group in Reddit have mentioned that they want to save Gamestop from short sellers.

It’s as if they believe that pumping up the share price of Gamestop will somehow save or help the company.

I appreciate the noble thought, but the concept that driving a company’s share price higher will help it is not how stocks work.

What’s really going on

The stock price is simply the last traded price of the company’s stock. It is the amount that the latest buyer paid to purchase the stock from the previous stock owner.

Buying and selling shares on the stock exchange does not in any way impact the underlying business fundamentals of the company. The money you are paying to buy Gamestop’s stock actually goes to the person who sold you the stock, and not to Gamestop, the company. 

Likewise, there is a misconception that short sellers are destroying a company by trying to drive a company’s stock price down.

This is not the case. Even if a company’s stock price declines, the fundamentals of the company will not change. A fundamentally solid company with a low stock price may, in some cases, even be a good thing for its long-term shareholders: The company can take advantage of the low stock price by buying back its shares to reduce the outstanding share count.

A great example is Restoration Hardware Holdings (NYSE: RH), which was targetted by short-sellers in 2017 and 2018. Seizing the opportunity presented by a low stock price, Restoration Hardware’s management team used the company’s cash to buy back its shares, resulting in a 59.8% decline in its outstanding share count. This created massive fundamental long-term value for its remaining shareholders. Its stock is now up 1,600% since the start of 2017.

How to really save Gamestop?

If you really want to help Gamestop, you can purchase merchandise directly from Gamestop’s retail stores. This hands money over to Gamestop directly.

Similarly, if Gamestop offers a secondary offering or issues a bond, investors who buy into these offerings will be handing money directly to the company. 

These are the real ways that you can help Gamestop’s business.

The unpopular truth is that just buying Gamestop’s stock on the stock market is not really helping Gamestop at all.

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. I do not have a vested interest in any companies mentioned.

Singapore-listed luxury watch retailer The Hour Glass (SGX: AGS) has frustrated shareholders for a few years now. Its share price peaked at S$0.88 in 2015 and has been bouncing sideways since. Today, Hour Glass’s shares trade at just S$0.80 each.

The curious thing is that Hour Glass’s business fundamentals have actually improved since 2015.

While many traditional brick and mortar retailers have struggled due to the introduction of e-commerce, this luxury watch retailer has bucked the trend.  The reason is that the supply of Swiss luxury watches is tightly controlled. Hour Glass has long-standing relationships with brands such as Rolex and Patek Phillipe, giving it near-exclusive rights in Singapore to sell their highly coveted models.

As such, watch collectors who want to buy first-hand watches in Singapore have little choice but to come to Hour Glass. This has been reflected in its financial statements.

Profit has increased from S$53.5 million in FY2016 (fiscal year ended 31 March 2016) to S$77.5 million in FY2020. Because Hour Glass retains much of its earnings, its net asset value per share has similarly increased from S$0.62 as of March 2016 to S$0.90 as of 30 September 2020.

Hour Glass’s business is also very resilient. A good exhibit is its strong performance from April 2020 to September 2020, a period that included Singapore’s COVID-19 lockdown. In these six months, despite having to close its shops for two months during the circuit breaker we have here in Singapore, Hour Glass still managed to be profitable, generating S$38 million in profit, down just 15% from a year ago.

So what is holding back its share price?

Despite all of this, Hour Glass’s share price is still short of its all-time high price reached way back in 2015. Even the most patient shareholders will likely be getting frustrated by the lacklustre performance of the stock. I was one of these investors, buying its shares in 2014 and holding it till early 2020.

In my view, one of the reasons why its share price has fallen is that there is a lack of cash-reward for investors to buy its shares. 

Although the company has grown its profits substantially over the years, it has not used the cash it earned to reward shareholders. In fact, Hour Glass has only been paying out a very small portion of its earnings as dividends to shareholders, opting instead to retain its cash on its own books.

Retaining cash can be a useful thing for a company that has the option of using the cash to generate high returns on capital. Unfortunately, in Hour Glass’s case, this cash has been left in the bank, generating very little returns to shareholders.

With little capital appreciation and a relatively low dividend yield of just 2.5%, there has not been much reason for investors to hold shares of the watch retailer. 

The solution?

I think there is a solution to this problem: Hour Glass can simply start to reward its shareholders by returning some of its excess capital to them. One way to do this is to pay a higher regular dividend or a fat one-time special dividend.

Returning cash to shareholders as dividends give investors confidence that they will be paid while owning the company’s shares, hence giving investors a reason to pay up for those shares.

Another way for Hour Glass to reward shareholders is to use its spare capital to buy back its shares.

Share buybacks result in a lower cash balance, but it also reduces the outstanding share count. Remaining investors will end up with a larger stake in the company after the buybacks. This can be hugely rewarding for shareholders, especially when share buybacks are made at depressed prices.

The power of share buybacks

A great example of the power of share buybacks is the story of one of Warren Buffett’s investments, RH, formerly known as Restoration Hardware.

There are many similarities between RH and Hour Glass. Like Hour Glass, RH is a specialist retailer that has generated consistent free cash flow and profits despite the emergence of e-commerce. RH’s share price was also hammered down back in 2017 and 2018 – market participants shorted the company because they were skeptical about the longevity of such a retailer in the face of the emerging threat from online retailers.

The management team of RH were, however, confident of the company’s brand appeal and the strength of its business. Believing that the market was discounting the value of its business, RH began an aggressive share buyback spree. Within three years, RH had used all of its net cash to buyback shares and even borrowed money to acquire more shares. In all, RH reduced its share count by a staggering 59.8%.

This resulted in RH’s remaining shareholders owning close to 2.5 times the stake that they previously had. As a result of the buybacks, the company’s earnings per share skyrocketed and investors started to sit up and take notice. RH’s share price is today up 15-fold since the start of 2017 when the company initiated its share repurchase program.

So what if Hour Glass repurchases its shares?

Hour Glass could do something very similar to RH. It could potentially use a large chunk of its net cash to buy back some of its shares. As of 30 September 2020, Hour Glass had S$136 million in net cash sitting in its coffers. Using just 70% of its net cash to buy shares, at current prices, will result in a 17% decrease in its outstanding shares. In addition, by keeping 30% of its current net cash as reserves, it will still have plenty of firepower for working capital and expansion needs.

Such a buyback plan will not just increase Hour Glass’s earnings per share, but will also increase its book value per share, as Hour Glass is currently trading at an 11% discount to book value. It is also worth noting that Hour Glass trades at just 7.4 times FY2020 earnings.

Share buybacks will, in turn, give Hour Glass the ability to pay a much higher dividend per share in the future (since the total dollar outlay will be lower with a lower share count).

Final thoughts

The importance of good capital allocation decisions should never be underestimated. Even though its business fundamentals have improved, Hour Glass’s reluctance to return capital to shareholders, and its inability to generate good returns on retained earnings, has resulted in an extremely disappointing share price.

I can’t fault market participants for being reluctant to pay any higher for Hour Glass’s shares given the lack of impetus for sound capital allocation and a dividend yield of just 2.5%.

But I think there is a simple solution to the problem. With a resilient business that generates cash year after year, copious amount of excess cash on its books, and a chronically depressed share price, share buybacks seem like a rather easy problem-solver in my view.

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. I currently do not have any vested interest in the shares of any companies mentioned in this article. Holdings are subject to change at any time.

A few weeks ago, the world rejoiced to the news that two COVID-19 vaccine trials produced extremely encouraging results.

Pharmaceutical giant Pfizer Inc (NYSE: PFE) and BioNtech (NASDAQ: BNTX) announced that their trial COVID-19 vaccine was 95% effective. In its phase III trial, out of the 170 confirmed cases of COVID-19 among the trial participants, 162 were from the placebo group, while only 8 were in the vaccine group. 

Hot on the heels of Pfizer and BioNtech’s announcement, Moderna (NASDAQ: MRNA), a young front-runner in the development of mRNA-based vaccines, announced that its own investigational COVID-19 vaccine had promising interim results. Out of 95 participants of the trial who got COVID-19, only 5 were from the vaccinated group, suggesting a 94.5% efficacy rate.

Stock markets have reacted sharply to the news. Moderna’s current share price is nearly 60% higher from the day before its vaccine announcement on 16 November 2020, while BioNtech’s share price is up by 24% since its joint announcement with Pfizer on 9 November.

Year-to-date, Moderna and BioNtech’s share prices are up by 621% and 237%, respectively.

US$200 billion opportunity

With the hype surrounding these two companies, I wanted to find out if it was too late to get in on their shares. To do so, I came up with a simple calculation to see how much the two companies could potentially earn from their vaccines.

We are currently being told that for best efficacy, two doses of the vaccines are required. There are 7 billion people in the world and to achieve herd immunity, 70% of the population (5 billion people) needs to be vaccinated.

Based on these figures, the world will need about 10 billion doses. 

The US government has placed an initial order of 100 million doses for US$1.95 billion with Pfizer and BioNTech, with the option to purchase 500 million additional doses.  That works out to US$20 per dose. Moderna has said that it will charge between US$25 and US$37 per dose.

Moderna’s market cap vs its potential profits

We can now answer the question of whether the rally in Moderna and BioNTech’s share prices are justified.

Let’s take a base case scenario that the two front runners will manage to corner 50% of the market opportunity.

If Moderna can supply 25% of the global need for COVID-19 vaccines, it will need to supply 2.5 billion doses. We can also assume that these vaccine doses will be sold over a few years. Moderna CEO Stephane Bancel said that they are on track to produce between 500 million to 1 billion doses in 2021.

For the sake of simplicity, let’s assume that Moderna will sell 500 million doses a year for five years. Based on US$25 per dose, that translates to US$12.5 billion in revenue each year.

Pharmaceutical companies can command extremely high margins, especially for a novel product that is first to the market. Given this, Moderna can possibly earn a gross margin as high as 60%, and a net margin of 40%. This will mean that Moderna could earn an annual net profit of US$5 billion based on my projected revenue figure.

Moderna currently sports a market cap of US$56 billion. Given these assumptions, it trades at around 11 times its potential annual earnings.

How About BioNTech?

BioNtech currently has a market cap of US$27.5 billion. Pfizer has agreed to pay BioNTech US$185 million in a mix of cash and Pfizer shares, and an additional US$563 million for future milestone payments.

In addition, BioNTech stands to earn 50% of the profit brought in from the sale of the vaccines.

Pfizer and BioNTech sold their first batch of vaccine doses to the US government at US$20 per dose. If they can sell a similar number of doses as Moderna and achieve similar margins, BioNTech’s share of the profit will be around US$2 billion.

Based on this scenario, BioNTech trades at 14 times this potential annual earnings.

If the above scenarios materialise, BioNTech and Moderna stand to gain a huge windfall. On top of that, their current valuations, at less than 15 times future earnings each, do not seem too demanding.

But…

… there are risks. 

First of all, not every government may be willing to pay for the vaccines to immunise their country. Governments from first world countries such as the US, UK, Malaysia, and Singapore have shown a willingness to pay for the vaccines for their citizens but other countries may not be so willing or even have the means to do so. If fewer governments bite, my estimate of a market opportunity of 10 billion doses over five years may have been overstated.

Another thing to consider is the threat of new vaccines. Competition could erode margins and lead to a lower market share than I modelled for. Pharmaceutical giants AstraZeneca and Johnson and Johnson, have pledged not to make a profit from their vaccines as long as the world is still in a pandemic. This could force companies like Moderna to lower their prices if vaccines from these companies gain approval in the coming months.

We should also not overlook the fact that the vaccines may be effective enough that patients do not need a booster every few years. In this scenario, it could be possible that after the initial demand for vaccines, and once global herd immunity is achieved, subsequent demand for vaccines will subside and earnings will dry up.

This is a legitimate concern as both BioNTech and Moderna have no other product currently in the market.

Potential tailwinds

But there are some potential tailwinds on the cards. Both Moderna and BioNTech have a healthy pipeline of drugs in development besides their COVID-19 vaccines.

The success of their COVID-19 vaccines also validates the potential of mRNA technology in other use-cases. Experts claim that mRNA-based vaccines could potentially be targeted at numerous diseases that we previously had no vaccines for. Both companies specialise in mRNA technology and could stand to benefit from this breakthrough. Moderna, for example, is working on another mRNA vaccine for CMV, which is already in phase II clinical trial.

Besides vaccines, both companies are also researching drugs that use similar mRNA technologies to treat cancer. Moderna currently has a total pipeline of 20 other drugs while BioNTech boasts a pipeline of 28. If another blockbuster drug reaches the market, they could unlock a different source of profits.

So is it too late to buy now?

Investing in young Biotech companies is risky but can be rewarding. The successful commercialisation of a single drug, as in the case of both Moderna and BioNTech, can lead to a multi-year windfall for the company and, as shown, a large appreciation in its share price.

However, there are also risks to pre-product companies.

Many may start off with a promising novel technology only to stumble at the final hurdle.

In Moderna and BioNTech’s case, they seemed to have successfully navigated the final hurdle to commercialisation by posting excellent phase III results for their COVID-19 vaccines. The market opportunity for them is huge and they are set to bring in copious amounts of cash in the not so far future.

But are investors on the sidelines too late now? With the spike in both the share prices of Moderna and BioNTech, and considering the possibility of competition, it seems that the market has already priced in a substantial amount of the future earnings from both companies’ COVID-19 vaccine.

I believe investors who are still considering investing in these two companies should not focus on the COVID-19 vaccine as this has already been priced into the stock. Instead investors should explore the pipeline of drugs and how Moderna and BioNTech plan to invest their windfall. This will be a greater determinant of the long-term returns of the company’s shares.

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. We currently have no vested interest in any companies mentioned. Holdings are subject to change at any time.

Zoom Video Communications Inc (NASDAQ: ZM) has been on a roll this year. The video conferencing software provider has been one of the main benefactors of the COVID-19 pandemic.

In the quarter ended 30 April 2020, Zoom’s revenue increased by a mind-boggling 169% from the corresponding period a year ago. But that wasn’t all. In the very next quarter ended 31 July 2020, Zoom again blew past expectations, reporting a 355% increase in revenue.

Unsurprisingly, investors have reacted sharply to the news, sending Zoom’s stock price up 460% since the turn of the year. As of the time of writing, the company was valued at US$114.8 billion. To put that in perspective, the Singapore stock market’s largest company by market capitalisation, DBS Group Holdings, is only valued at S$61 billion. Zoom was born just nine years ago in 2011 while DBS took 52 years to get to where it is today.

The question now for investors is whether Zoom is overvalued. 

Growth skeptic

In March this year, I preached conservatism when it came to Zoom. The company, then, had a market cap of around US$38 billion. It had just doubled in value and I was concerned that investors were getting too optimistic. 

Looking back, I was way too conservative in my growth projections. Zoom went on to blow past consensus expectations in the two quarters after that, as I had described earlier, far exceeding what some of the biggest bulls had expected.

Zoom has become more than just a company, it has become a verb. Even my non-techy parents use “Zoom” as a synonym for video conferencing.

Since my article, Zoom has more than quintupled in value. After seeing the quick pace of adoption, my blogging partner, Ser Jing, and I decided that Zoom was worthy of a place in our investment fund’s portfolio.

We bought our first tranche of shares at US$254, which was then close to an all-time high and have added more since. Today, Zoom’s shares trade at around US$404.

Believing

I used to be one of the sceptics when it came to Zoom’s valuation but I am now firmly in the opposite camp. In fact, I think that even after the recent run-up in its share price, Zoom can still provide significant value for long-term investors.

Zoom exited the quarter ended 31 July 2020 with an annual revenue run rate of US$2.6 billion. Unlike many high-growth software companies, Zoom boasts not just GAAP profitability, but also a high free cash flow margin. In that quarter, it had a free cash flow margin of 56%. Boosted by record collections during the quarter, Zoom’s cash flow margin is best-in-class for software companies.

Even after accounting for any one-off jump in collections for the quarter, I think Zoom can settle at a free cash flow margin of close to 40% at its steady state.

Given this, and using Zoom’s annual revenue run rate, Zoom currently trades at a normalised price-to-annual free cash flow run rate multiple of 110. By most accounts that seems like a high multiple to pay. But let’s not forget that Zoom has immense business momentum in its favour. The company just grew by a staggering 355% in the last quarter and in its recent Zoomtopia customer and investor day event, the company let slip that usage is up since then.

Can Zoom continue to grow?

Zoom has undoubtedly been one of the benefactors of shelter-in-place measures enacted by governments around the world to combat COVID-19. But even after life returns to normal, I believe Zoom will still be a mainstay for most companies. Video conferencing has become a norm due to the ease and practicality of its use. In fact, many companies have announced that they will permanently adopt work-from-home or hybrid work settings, allowing employees to spend either all or part of their time working from home.

Although Zoom’s growth will understandably slow when the pandemic passes, I believe the company will still see decent growth well into the future as video conferencing becomes even more prevalent for businesses and individuals alike.

Zoom is also barely scratching the surface of its total addressable market. In its IPO prospectus released last year, Zoom stated that it is addressing a US$42 billion communications market, according to independent market researcher International Data Corporation. But I believe the US$42 billion figure understates the increasing number of use cases that video conferencing addresses. The pandemic has demonstrated that video conferencing software can be used for education, telemedicine, fitness classes, and many more purposes than previously imagined. 

Given the momentum in video conferencing, I think it is not beyond Zoom to quadruple its annual revenue and free cash flow run rate in five years to north of US$10 billion and US$4 billion respectively.

Zoom’s current valuation is, hence, just 28 times that projected free cash flow in 2025. More importantly, I don’t see its growth stopping there. Zoom’s CEO, Eric Yuan, and his crew are highly innovative and have already recently released new products such as Zoom Phone and Zoom hardware to expand its addressable market. 

Final words

From a trailing-12-months perspective, Zoom seems immensely overvalued. However, for a company that is growing as fast as Zoom is, the next 12 months will look very different from the last 12, so we certainly shouldn’t be looking backwards to come up with a valuation.

Looking beyond the next 12 months, Zoom’s growth will likely endure as it seeks to win its share of the more than US$42 billion market opportunity ahead of it. Competition remains a threat to Zoom, given that Zoom users can just as easily switch to an alternate software. But I believe that Zoom’s relentless pursuit of customer satisfaction and its superior product gives it a big leg up over its competitors. Zoom boasts a net promoter score of 62, the highest among video conferencing software that I’ve seen. 

Zoom’s branding is also remarkably strong at the moment. Like Google, Zoom has become a verb, which is a fact that shouldn’t be underestimated.

Although there is invariably a chance that Zoom can lose its focus on satisfying customer, and competition can erode growth, the pie is large enough for multiple winners in this space. Given all this, and the momentum behind Zoom, I think that the odds of its success far outweigh the risks. For more on Zoom, you can head here to find an investment thesis for the company that Ser Jing and I have penned for our investment fund.

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. I currently have a vested interest in Zoom Video Communications. Holdings are subject to change at any time.

Tesla recorded another profitable quarter in the second quarter of 2020, marking a fourth consecutive quarter of GAAP (generally accepted accounting principles) profit for the company. It was a welcome change for the previously cash burning and unprofitable electric vehicle pioneer. 

But eagle-eyed investors will have noticed that virtually all of Tesla’s profit and free cash flow generated over the last 12 months was due to the sale of ZEV (Zero Emission Vehicle) credits.

The company booked US$1.05 billion from the sale of regulatory ZEV credits in the 12 months ended 30 June 2020. During the same time period, Tesla recorded US$368 million and US$907 million in net profit and free cash flow, respectively.

So what are regulatory ZEV credits?

To incentivise automobile manufactures to sell ZEVs, some states in the USA have adopted a regulatory credits program, termed the ZEV Program. The ZEV Program is a state law, which currently applies to 12 states in the USA.

This law mandates that a certain percentage of each automobile manufacturer’s annual sales must be made up of zero-emission vehicles, measured by what is termed ZEV credits. ZEV credits can be earned by selling ZEVs such as battery and hydrogen fuel cell electric vehicles or Transitional Zero-Emission Vehicles (TZEV) which include hybrid vehicles.

How Tesla makes money from the ZEV program

In order to avoid penalties, manufacturers who sell in states which impose the ZEV program need to earn a certain number of ZEV credits.

There are two ways to achieve this. Either they sell sufficient ZEVs and TZEVs to chalk up enough credits, or they can buy ZEV credits from manufacturers who have built up excess ZEV credits to sell.

This regulation works beautifully for Tesla. As every vehicle sold by Tesla is a long-range electric vehicle, it generates a lot more ZEV credits than it requires. As such, it can sell excess credits to other automobile companies who need them, earning Tesla extra income at virtually no additional expense.

Can Tesla keep selling ZEV credits?

But how long can this last? Historically, Tesla’s revenue from ZEV sales has increased as more states started imposing the ZEV program.

The ZEV program originated in California in 1990 and has since extended to a total of 12 states in the US. There are a few things to consider here.

First, is the speed of regulatory changes. Tesla can benefit if more states start to impose the ZEV program.

Similarly, Tesla benefits if states that are already imposing the ZEV program increase the credit requirements. For example in California, ZEV targets are expected to rise from 3% of sales to around 8% by 2025.

Another near-term tailwind is that some credits that were bought in the past are due to expire. A recent report by EPA found that some large automakers buy credits in advance to satisfy future requirements. Some of the “banked” credits are set to expire at the end of 2021 if not used. This might result in a rush for ZEV credits in the next few years.

But it won’t last…

However, selling ZEV credits will likely not be a long-term revenue driver for Tesla. Traditional ICE (internal combustion engine) automobile makers are shifting more of their resources towards ZEVs and TZEVs. As their sales mix shifts, they will eventually be able to comply with the ZEV program without having to buy additional ZEV credits.

At Tesla’s analyst briefing for 2020’s second quarter, Chief Financial Officer Zachary Kirkhorn said:

“We don’t manage the business with the assumption that regulatory credits will contribute in a significant way to the future. I do expect regulatory credit revenue to double in 2020 relative to 2019, and it will continue for some period of time. But eventually, the stream of regulatory credits will reduce.”

Tesla can live without this extra income

Tesla is still in the early innings of its grand plan for fully-autonomous vehicles. It also has the ability to keep raising more capital through the sale of its high-flying stock.

Shareholders will also note that Elon Musk said that its autonomous software could be valued as much as US$100,000 per vehicle. With a growing base of Tesla vehicles, which are fitted with autonomous vehicle hardware, Tesla has a ready base of customers to up-sell a much higher margin software product.

In the meantime, the sale of ZEV credits can continue to be a source of cash for the next few years as the company bridges for the next phase of its business. Hopefully for shareholders, by the time the sale of ZEV credits dry up, Tesla’s other businesses will exhibit greater profitability and higher margins to keep the company’s profits and cash flow streaming in.

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 Chinese gaming market is expected to grow 14% per year from 2019 to 2024. One company that is likely to benefit from this is HUYA Inc (NYSE: HUYA).

Instead of competing directly with other gaming companies, HUYA Inc is a gaming streaming platform where gaming fans can watch live video game content. It earns money by selling advertising space, and virtual items to users.

The virtuous loop

HUYA is one of two (the other being DouYu) dominant live-game streaming platforms in China. HUYA also hosts eSports events, which are professional e-gaming tournaments.

As a leading player in the game streaming industry in China, HUYA boasts a large network of streamers and viewers. This has resulted in a network effect.

Streamers create content for viewers, which leads to more viewers. The ability to reach a larger audience attracts more streamers to choose HUYA as their streaming platform. More streamers leads to more content for viewers, and round and round the flywheel goes.

Track record of growth

HUYA has demonstrated that it has been able to use its industry-lead to great effect.

The monthly average users on its platform, HUYA Live, grew 28.8% to 150.2 million in the fourth quarter of 2019 compared to the same period a year ago. The number of paying users increased fairly proportionately by 27.6% to 13.4 million. But most impressively, the average spend per paying user increased by a staggering 40.6% to RMB 595.2 in 2019 compared to RMB 423.1 in 2018. 

Putting everything together, HUYA’s revenue from live streaming (virtual gifts) spiked by 79.5% in 2019. Its advertising revenue also saw an 81% increase. The strong growth is nothing new for HUYA as it merely extends its winning streak of growth since 2016. The table below shows HUYA’s total net revenues from 2016 to 2019.

A profitable business model

HUYA’s amazing growth is one thing but, to me, the most important aspect of any business is whether it has cost structures that enable it to turn a profit. HUYA ticks this box. The Chinese live gaming streaming platform was operationally profitable in 2018 and 2019. Margins have also started to widen as HUYA starts to enjoy economies of scale. 

In the first quarter of 2020, HUYA reported an operating profit margin of 5.8% compared to just 1.8% in the same quarter last year.

As HUYA continues to increase its topline, I expect margins to improve substantially as its operating expenses increase much slower than revenue.

Robust balance sheet and positive free cash flow 

As of 31 March 2020, HUYA had no debt, and RMB 10.3 billion (US$1.45 billion) in cash, cash equivalents, restricted cash, short-term deposits, and short-term investments. 

It also generated around RMB 1.9 billion in free cash flow in 2019. It has been producing positive operating cash flow and free cash flow since 2017.

With its strong cash position and the ability to generate cash from its core business, HUYA has the financial muscle to continue spending on expanding its product offering and to grow its user and streamer base.

Strategic owners

Another thing that HUYA has going for it is that Tencent Holdings is its majority shareholder. In April this year, Tencent exercised its option to acquire an additional 16.5% of shares from HUYA’s previous owner, JOYY. After the transfer of shares, JOYY has 43% total voting power, while Tencent Holdings has 50.9% of the voting rights.

Tencent is the world’s largest video gaming company. It owns some of the biggest game developers in the world such as Riot Games, which owns League of Legends. Tencent also has strategic stakes in game developers such as Supercell (the makers of Clash of Clans) and Epic Games (whose platform was used to develop Fortnite).

I think that HUYA can leverage its relationship with Tencent to further consolidate its position as one of the top video game live streaming platforms in China.

Risks

A discussion about any company will not be complete without talking about the risks. As a Chinese company listed in America, the big risk that everyone is talking about is the possibility that Chinese companies may be forced to delist from the US stock market.

On top of that, Chinese companies listed in America do so via American depository receipts (ADRs), which in turn own an interest in a variable interest entity (VIE). This VIE has contractual rights to participate in the economic interests of the actual operating company in China. The structure is really complex, and there could be potential loopholes where certain parties can use to exploit owners of the ADRs. Although this has not been done before for HUYA, there is that possibility that investors need to be aware of. Moreover, if China’s regulatory authorities should deem the VIE contracts to be invalid in the future, owners of the ADRs could be wiped out.

There is execution risk too. HUYA is still a relatively young company and was only listed in 2018. 

In addition, Chinese companies face regulatory risks that could derail its growth. The Chinese government has been known to implement very strict rules on internet companies – that could potentially disrupt HUYA’s business.

Competition is another factor to keep in mind. For now, HUYA enjoys a strong position as one of two big players in this space in China. But things could change if new entrants emerge that somehow have a better platform and are able to attract streamers.

Final Words

I’m keeping an eye on HUYA. It operates in a fast-growing market and I expect to see double-digit growth for at least a few years. In addition, the company is already profitable, has enough cash on its balance sheet for expansion, and has strategic shareholders that it can leverage.

On HUYA’s valuation, the company currently trades at around 3.3 times 2019’s revenue. Based on its current gross margin of around 18% and the potential economies of scale as it grows, I think HUYA can easily settle at a 10% operating margin.

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.

Cancer is a brutal disease and one of the leading causes of death in the developed world. Worldwide, the disease struck more than 17 million people in 2018 with that figure expected to mushroom. 

One company that is doing its part in the fight against cancer is NovoCure Ltd (NASDAQ: NVCR).

Founded in 2000, NovoCure has developed a cancer therapy called tumour treating fields, which inhibits tumour growth and may causes cancer cells to die.

In this article, I take a look at the medical research behind its technology and whether NovoCure is a potential multi-bagger.

Technology behind Novocure

Novocure was founded 20 years ago by Professor Yoram Palti who believed that he could use electric fields to destroy cancer cells.

I don’t want to go too deep into the technicalities but to appreciate Novocure, it is important to understand the basics behind its technology.

In short, cellular proteins in cancer cells need to position themselves in a particular way during cell division in order for cells to divide. Tumour treating fields use alternating electric fields specifically tuned to target cancer cells, disorientating the position of the cell proteins and disrupting cell division.

It is equally important that tumour treating fields also do not stimulate or heat tissues and has minimal damage to healthy cells, with the only side effect being mild to moderate skin irritation.

From theory to practice

Novocure has done an excellent job of turning Professor Palti’s theory into real-life clinical practice. Today, tumour treating fields is approved in certain countries for the treatment of adults with glioblastoma and in the US for mesothelioma. These are two of the most difficult forms of cancer types to treat.

For instance, life expectancy for newly-diagnosed Glioblastoma, the most common type of brain cancer in adults is typically less than two years. 

Today, there is a growing body of research that shows that tumour treating fields therapy can extend the life expectancy of patients when it is used together with other therapies.

The chart from Novocure’s investor presentation shows the survival rate of patients with and without tumour treating fields (Optune) treatment.

Source: Novocure investor presentation 2020

Out of the cohort of 450 patients, 388 received a survival benefit from the use of tumour treating fields. The 5-year survival rate was 13% in the cohort that used tumour treating fields combined with chemotherapy (TMZ or Temozolomide) compared to just 5% in the cohort that used chemotherapy alone.

In fact, the efficacy and minimal side effect of Tumour treating fields as a therapy has led to the National Comprehensive Cancer Network promoting it to a category 1 recommendation for newly diagnosed Glioblastomas,

Growing the number of indications

Tumour treating fields as a therapy could potentially be used on a wide variety of other cancer types. As mentioned earlier, it is FDA approved for (1) recurrent and (2) newly diagnosed glioblastoma and received FDA-approval for (3) Mesothelioma last year.

On top of that, it is undergoing phase III trials for four other indications, namely (1) brain metastasis, (2) non-small cell lung cancer, (3) pancreatic cancer and (4) ovarian cancer. This could significantly increase the company’s addressable market opportunity.

It is also in Phase II trials for liver cancer and preclinical trials for a host of other cancer types. The charts below summarise where the company is at in terms of commercialising its product for the other indications.

Source: Nocovure Investor relations website

Source; Novocure Investor relations website

In its 2019 annual shareholder letter, CEO Asaf Danziger and executive chairman Bill Doyle, reiterated their commitment to innovation saying, 

“We are increasing investments in engineering efforts intended both to improve time on therapy and to maximize the energy delivered to patients’ tumours. Specifically, our teams are working to design and develop improvements to our transducer arrays and to our transducer array layout mapping software intended to increase Tumor Treating Fields intensity and, as a result, survival.

We believe innovation has the potential to improve patient outcomes and to extend our intellectual property protection into the future as we invent enhancements to our products. Our commitment to innovation resulted in 33 new patent applications in 2019, alone.”

From an investors point of view

From a medical standpoint, Novocure’s Tumour Treating Fields technology looks very promising. 

But as investors, we also want to see that the company has the finances to continue funding its research and can drive adoption to grow its revenue.

There are two things I want to see in a promising company like Novocure- (1) a solid balance sheet so that it does not need to raise too much capital to fund its growth and (2) at least some signs that the company is turning its FDA-approval into meaningful revenue growth.

Novocure has both.

The chart below illustrates its net revenues from 2016 to the first quarter of 2020.

Source: Novocure investor presentation 2020

Novocure has also partnered with a Chinese company, Zai, to launch its Tumour treating fields in China. The partnership is already starting to bear fruit with US$2 million in net revenue recorded in greater China in the first quarter of 2020, a 100% increase in from Q4 of 2019.

It is worth noting that Novocure turned operationally and free cash flow positive in 2019. Novocure also has a robust balance sheet with around US$332 million in cash, cash equivalents, short-term investments and restricted cash and no debt. 

Market opportunity

According to Novocure’s S-1 in 2015, Tumour treating fields is broadly applicable to a variety of solid tumours with an annual incidence of 1.1 million people in the United States alone.

Novocure charges around US$21,000 per month for Optune, its tumour treating fields device that is used to treat glioblastomas. Supposing that Novocure sells its other tumour treating fields products at a similar price range, Novocure will have a market opportunity of US$277 billion ($21,000 x 12 months x 1.1million patients) in the United States alone.

That’s of course assuming that Tumour Treating Fields therapy can be FDA-approved for the whole range of applications. 

Valuation

At the time of writing, Novocure had a market cap of US$6.3 billion. On the surface, that seems expensive if you use traditional metrics to value the company. Novocure only had US$351 million in net revenues and US$262 million in gross profits in 2019. 

Based on current share prices, it trades at 17.9 times 2019’s sales and 24 times gross profit. Those numbers are hard to stomach and would certainly be deemed expensive for most companies.

However, Novocure, to me, is not like most companies. 

In the most recent quarter, revenue grew 39% from a year ago. The growth figure could start to accelerate as its core markets mature and Tumour treating fields gains FDA-approval for other indications.

It is also worth remembering that based on my calculations it has a US$277 billion market opportunity. If it can penetrate just 5% of that, its current US$6.7 billion market cap will be a steal.

Final words

Novocure has all the makings of an excellent company. Its technology can potentially be used in a wide array of different indications and is already generating positive free cash flow.

It has a solid track record of growing revenue. Gaining FDA-approval for other use cases could potentially be a catalyst for much greater things for the company. With all that said, it does look like Novocure has all the ingredients for success.

That said, I do acknowledge that as with any biotech firm, there are risks. The risks that it cannot get FDA-approval for other indications or adoption of its product is slower than expected can hinder growth and can lead to other companies catching up with it.

The technology is also very new and widespread adoption will depend on how quickly Novocure can push clinicians to recommend it as a form of treatment. 

But despite these risks, to me, the probability and magnitude of the upside outweigh the risk. With its market cap still small compared to its total addressable market opportunity, I think if it can execute and fulfil its vast potential, Novocure could easily become a multi-bagger based on today’s price.

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.

As a B2B (business-to-business) cloud software provider, Datadog Inc (NASDAQ: DDOG) may not be a household name to non-developers and IT engineers. However, it definitely caught my attention.

The monitoring and analytics platform for developers, IT operations, and business users is one of the fastest-growing software companies and has some of the best-in-class metrics to boot.

Despite less than a year as a public company, Datadog’s share price is already double from its first trading day in September 2019. In this article, I share my thoughts on Datadog.

A huge market opportunity

Companies that house their data in the cloud can end up with a complex web of data and information that is difficult to monitor. This is where Datadog’s platform can help. It provides monitoring services across public cloud, private cloud, on-premise, and multi-cloud hybrid environments.

Datadog estimates that the IT Operations Management market will represent a US$37 billion market opportunity in 2023, with the company’s services addressing US$35 billion of that.

Compare that to Datadog’s 2020 first-quarter annual revenue run-rate of around US$524 million, and you can see just how much potential lies ahead.

Growing into its own

Datadog is doing a great job in executing its growth strategy. The software-as-a-service (SaaS) company saw its revenue grow by 98% and 83% in 2018 and 2019 respectively.

In the first quarter of 2020, revenue increased by 87% year-over-year as the number of large customers (with an annual run rate of US$100,000 or more) surged to 960 from 508 a year ago.

Moreover, management expects revenue to increase to between US$555 million and US$565 million for the whole of 2020.

Growing customer base

But, to me, the most appealing thing about Datadog’s business is that the company has some of the best-in-class metrics for SaaS companies.

Datadog has recorded gross margins of 75% to 77% over the past three years, and even had positive GAAP (generally accepted accounting principles) operating income in the first quarter of 2020.

Recording a profit is pretty amazing for a company that is growing as fast as Datadog is.

The reason why Datadog can be so operationally efficient even at this high rate of growth is that it has one of the best-in-class customer acquisition cost (CAC) ratios. The CAC payback period measures how long the company takes to earn back the marketing dollars spent to acquire a new customer. It is calculated as the implied annual run rate gross margin from new customers divided by sales and marketing spend of the prior quarter.

Alex Clayton, general partner at venture capital firm Meritech Capital, recently provided a fantastic chart comparing Datadog’s CAC payback period against other listed SaaS companies (note, the lower the number, the better).

From the chart, you can see that Datadog recovered all its marketing cost to acquire a new customer in around 10 months. That’s only behind video-conferencing software provider Zoom, and well below the 30-month median for SaaS companies.

Customers spending more on its platform

Datadog’s existing customers also continually spend more on its platform. In the first quarter of 2020, Datadog’s dollar-based net retention rate (DBNRR) was above 130% for the 11th consecutive quarter. The DBNRR measures the change in spending for all of Datadog’s customers a year ago compared to the same group of customers today; it includes positive effects from upsells and negative effects from downgrades and customers who leave.

Datadog charges customers base on usage, so the more users (the customer’s employees) that use the platform, the more the customer pays Datadog. 

In addition, Datadog has consistently introduced more products on its platform. Datadog uses a land-and-expand growth model. The company first wins customers over to use one product before cross-selling other products to them.

The chart below, taken from Datadog’s IPO prospectus, shows the annual revenue run rate of cohorts (customers that started using the platforms) from 2012 to 2018.

As you can see, each colour on the graph fattens over the years. This means that the cohorts are collectively spending more money on Datadog’s platform.

Robust balance sheet

Datadog raised around US$648 million during its September 2019 IPO. As of March 2020, Datadog had US$794 million in cash, cash equivalents, and marketable securities and no debt. This is a great financial position.

In addition, Datadog announced in late May 2020 that it is raising US$650 million through a convertible notes offering. The conversion price of US$92.30 per share represents a 21% premium to the company’s share price at the time of writing.

The offering should further strengthen Datadog’s balance sheet. The convertible price after 5 years should not dilute shareholder interests by too much as well. As the company is already free cash flow positive (more on this below), I expect management to use the new-found cash to make strategic acquisitions to improve its core offering, or invest in R&D to launch new products.

Free cash flow 

As mentioned above, Datadog is already generating free cash flow. In fact, the company generated positive operating cash flow in 2017, 2018, and 2019; and had positive free cash flow in 2018 and 2019. In the first quarter of 2020, Datadog had US$19.3 million in free cash flow.

That’s equivalent to a free cash flow margin of 14.7%, decent for a company that is seeing such strong growth.

As the company grows, I expect Datadog’s free cash flow margin to widen and easily settle at 30% or more.

History of successful innovation and new products

Much of Datadog’s success has come from its constant innovation and creation of new products. The firm initially offered just infrastructure monitoring but soon expanded its service to monitor the entire technology stack.

This single pane view of the entire technology stack proved extremely popular and is one of the reasons why the company’s DBNRR is so high.

Going forward, innovation and technology upgrades will be key in ensuring that Datadog maintains its market position in this highly competitive space.

Final words

Datadog has the potential to become one of the top dogs in its industry.

But there are also risks such as execution risk and the threat of competition. It also hard to ignore Datadog’s extremely rich share price: The company’s market capitalisation is around 45 times its annual revenue run rate (based on revenue for 2020’s first quarter). This means that a lot of Datadog’s future growth is already being baked into its share price.

However, if Datadog manages to fulfill its potential and captures just 10% of its market opportunity, I think its future market capitalisation will be much higher than it is today.

Moreover, given its recurring income stream, position as a leading player in its space, high margins, operational efficiency and history of innovation, I think Datadog has a good chance of rewarding shareholders five to ten years down the road.

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.

*Editor’s note: The article mistakenly stated that the free cash flow for the first quarter of 2020 was US$23 million and free cash flow margin was 17.3%. However, the correct figures are 19.3% and 14.7%. The article has since been updated to reflect that.

Sembcorp Industries (SGX: U96) dominated the business headlines in Singapore last week. The utilities and marine engineering conglomerate announced on 8 June 2020 that it would be completely spinning off its marine engineering arm – Sembcorp Marine (SGX: S51) – through a complex deal.

As part of the deal, there will be an injection of capital into Sembcorp Marine via a rights issue. Prior to the announcement, Sembcorp Marine was already a listed company in Singapore’s stock market, but it had Sembcorp Industries as a majority shareholder.

I won’t be explaining the deal in detail because others have already done so. My friend Stanley Lim has created a great video describing the transaction for his investor education website Value Invest Asia. Meanwhile, another friend of mine, Sudhan P, has written a great piece on the topic for the personal finance online portal Seedly. 

What I want to do in this article is to share an observation I have about the state of Sembcorp Industries’ business. I think my observation will be useful for current and prospective Sembcorp Industries shareholders.

The market cheers 

On the day after the Sembcorp Marine spin-off was announced, Sembcorp Industries’ share price jumped by 36.6% to S$2.09. So clearly, the market’s happy that Sembcorp Industries can now be a standalone utilities business (the company has other small arms that are in urban development and other activities, but they are inconsequential in the grand scheme of things). It’s no surprise.

Sembcorp Marine’s business performances have been dreadful in recent years. The sharp decline in oil prices that occurred in 2014 – something not within Sembcorp Marine’s control – has been a big culprit. Another key reason – a self-inflicted wound – was Sembcorp Marine’s decision to load up on debt going into 2014. The table below shows Sembcorp Marine’s revenue, profit, cash, and debt from 2012 to 2019:

Getting rid of Sembcorp Marine will allow Sembcorp Industries’ utilities business (the segment is named Energy) to shine on its own. But there’s a problem: The economic quality of the Energy segment has deteriorated significantly over time. This is the observation I want to share. Let me explain.

Low energy

There are two key reasons why I think Sembcorp Industries’ Energy segment has gone downhill. 

First, over the six year period from 2013 to 2019, the Energy segment’s revenue and power production and water treatment capacities all grew – the power production capacity even increased substantially. But the segment’s profit did not manage to grow. In fact, it had declined sharply. Sembcorp Industries does report a separate profit figure for the Energy segment that excludes exceptional items. But the exceptional items are often gains on sale of assets and/or impairment of asset values. To me, these exceptional items are not exceptional; they reflect management’s day-to-day decision-making in allocating capital.

The table below shows the Energy segment’s revenue, profit, power capacity, and water-treatment capacity in each year from 2013 to 2019:

Second, the Energy segment’s return on equity has fallen hard from a respectable 19.3% in 2013 to a paltry 5.3% in 2019. Here’s a table illustrating the segment’s return on equity for this time period:

The sharp fall in the Energy segment’s return on equity, coupled with the decline in profit, suggests that the economic quality of the segment has worsened materially over the past few years. 

Some final words

It’s unclear to me how much of the Energy segment’s power and water capacities were actually in operation as of 2013 and 2019. So it’s highly possible that most of the increase in the capacity-figures seen in the period are mostly for projects that are still under development.

If this is the case, then there may still be a big jump in the Energy segment’s profit and return on equity in the future. But if it isn’t, then the business performance of the Energy segment in the past few years is troubling. If the Energy segment’s numbers can’t improve in the future, the overall picture for Sembcorp Industries still looks overcast to me even if Sembcorp Marine is no longer involved.

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.