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Gene Chan
Gene Chan
Articles (4)  | Author's Website |

Singapore-Listed Sunright Ltd. Undervalued by Almost 100%

The small semiconductor company is undervalued even based on conservative assumptions

February 19, 2019 | About:

A recent article from Bloomberg first piqued my interest in the Singapore stock market. In essence, the Singapore market is shrinking in terms of market capitalization and number of companies. The number of initial public offerings also trails Hong Kong badly, and many listed companies are avoiding Singapore due to the poor valuation assigned to them by its stock market.

This all sounds negative, but the last point actually makes Singapore a haven for value investors.

As a result, I scoured the market for these supposedly poorly valued companies, starting with Benjamin Graham's “cigar butt” net-net criteria, and I came across a very interesting business.

Someone left us the whole cigar

Sunright Ltd. (SGX:S71) is a deeply undervalued Singapore-listed semiconductor company. It is a rare company trading near net current asset value that also has a viable and potentially growing business.

It is the world's largest provider for “burn-in and test” services for integrated circuits. The company also sells equipment to customers who want to do their own testing in-house.

Sunright's subsidiary structure may be hiding its true worth. First, the company has a 48% stake in a listed company in Malaysia called KESM Industries Bhd (XKLS:9334). KESM primarily focuses on burn-in and test services for electronic components used in vehicles. On the advent of autonomous cars, this is expected to be a high growth area. Sunright exercises de facto control over KESM given that most of its executives hold offices or board seats for both companies, including its chairman and CEO.

The market value of KESM is about 391 million Malaysian ringgits, or 130 million Singapore dollars ($96.1 million), of which Sunright owns 48%. This translates to about 51 cents per share of Sunright. Meanwhile, as of the time of writing, Sunright stock is trading at 46 cents, which means it is undervalued based on its holding of KESM alone, before accounting for any net cash position in Sunright, let alone the profitable business itself!

Now before we get ahead of ourselves, we should consider the KESM is potentially overvalued - which is entirely possible given its visibility and placement in an area that's considered high growth. By buying Sunright, we can't necessarily realize the full value of KESM's stock unless Sunright sells its controlling stake and distributes the proceeds to us in the near term – a very unlikely event.

Let's take a more conservative approach by treating KESM as a look-through subsidiary of Sunright, where we value the assets and liabilities of the company as part of Sunright rather than taking its stock price at face value.

Sunright holds a large amount of investable securities and cash, part of them through KESM, which is already consolidated into the company's balance sheet as a de facto subsidiary. For our analysis of NCAV, we need to exclude the 52% of KESM that Sunright does not own.

(All figures from here on in 1000 Singapore dollars except unit data or otherwise stated)

Sunright

KESM

Sunright minus non-controlling interests

Current Assets

133,264

93,227

84,786

Total Liabilities

60,892

45,969

36,988

NCAV

72,372

47,258

47,798

NCAV/Share

0.59

0.39

So excluding the the part of KESM that Sunright doesn't own, we get a NCAV per share of 0.39. This forms the baseline of my valuation.

Next, let's look at how the actual business is doing.

Sunright reported earnings of S$6,794, or 5.5 cents per share, for fiscal 2018. These figures already exclude non-controlling interests in KESM.

For any capital-intensive business, where capital expenditures form a material part of cash outlay, it is prudent to check and see if the reported depreciation is an accurate proxy of the “maintenance capex” required to continue normal operations (before any consideration for growth capex). For this exercise, I applied Bruce Greenward's methodology, where we look at historic property, plant and equipment levels versus sales to estimate the required capex for maintaining a certain level of sales.

Sales PPE PPE as % of Sales Sales Increase CapEx Growth CapEx Maintenance CapEx D&A
2014 138,913 63,777 45.91% 27,118 21,766
2015 138,396 68,285 49.34% -517 27,307 -250 27,557 23,050
2016 130,594 59,145 45.29% -7,802 9,957 -3,772 13,729 19,777
2017 149,334 79,717 53.38% 18,740 33,603 9,060 24,543 22,573
2018 155,282 74,226 47.80% 5,948 14,386 2,876 11,510 25,965
48.34% 77,339 91,365

We can see the reported depreciation and amortization of Sunright seems to overestimate expenditure required to maintain operations. This means if I adjust Sunright's earnings by replacing depreciation and amortization with the estimated maintenance capex, I would increase Sunright's earnings and, thus, its valuation. But erring on the side of caution (and laziness), I'll make no adjustment to the amount for the purpose of valuation.

There is one line item that I do want to adjust - taxes. Per Sunright's annual report, there were various adjustments and deferred tax assets that caused the company to pay less than the statutory tax rate of 17%. To be conservative, I've assumed these adjustments are transitory and the long run tax rate will revert to 17%. Based on these assumptions, I've updated Sunright's owner earnings:

Pretax Earnings Tax Recurring Earnings Non-controlling Interests Owner Earnings EPS
2018 15,145 2,575 12,570 6,306 6,264 0.051

Looking forward, there may be some short-term noise to the company's earnings due to the U.S.-China trade war. Regardless, I agree with management's assertion this will be a temporary effect given the expected growth from semiconductor usage, and I assume the above represents the business's long-term earnings power.

Assuming no growth in perpetuity and a discount rate of 10% (I assign discount rates based on the current risk-free rate, historic equity premium and geographical premium to compensate for any location-specific risks; 10% is my required rate-of-return for a Singapore equity), I come to a net present value of 51 cents per share based on Sunright's earnings.

Adding the previously calculated NCAV of 39 cents per share to the net present value, the total valuation comes to 90 cents, which represents a 95% gain from current share price of Sunright.

Potential catalysts

Warren Buffett (Trades, Portfolio) once said, don't buy a single share of stock unless you are willing to buy the entire business and own it forever. Under that lens, the only consideration one should have is the future cash flow of the business.

That said, there are a few catalysts that could cause the value to be realized quicker, such as a take-private offer from Chairman and CEO Samuel Soo, who already owns 55% of Sunright shares.

A third party could also present a takeover offer for Sunright's undervalued assets or operating synergies.

Last but not least, management can opt to return some cash to shareholders or perform some kind of share-swap or arbitrage operation to realize the value of its KESM holding.

The chronic undervaluation of the Singapore stock market allows us to purchase a public business for significantly less than the cost of its private valuation. If this opportunity is truly a symptom of the market structure, then by no means it is the the last one.

Disclosure: I am long SGX:S71.

Read more here.

About the author:

Gene Chan
Value investor. Poker player. FinOps exec. Writer.

Follow me on Twitter for my latest musings: https://twitter.com/genejchan

Visit Gene Chan's Website


Rating: 5.0/5 (1 vote)

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Comments

bruce.gang.jin
Bruce.gang.jin - 1 year ago    Report SPAM

i'm not sure the method used here:

- using NCAV, ie the intention is to consider if 'so liquidated';

- then 2nd method of discounting, treat it as an on-going concern.

either way is already, but add them together? i did just quick browse, might not fully understand the rational behind.

however another concern is that its revenue topline increased by only 10% over last 5yrs, but its investment cash outflow is consistent(didn't read detailed explanation yet) annually.

Gene Chan, CFA
Gene Chan, CFA - 1 year ago    Report SPAM

Thanks for the comment Bruce. I tend to look at NCAV as cash that a company can distribute out to shareholders without hurting the day-to-day business, even after paying for ALL liabilities. Sunright holds a large hoard of cash and securities that could be distributed if they choose to, while keeping the business running, so it makes sense to add NCAV and NPV of future cashflows together for valuation. (Technically you could say the receivables & inventory are required to keep business running, however in that method you should take out the payables also and come to similar result.)

But in any case, NCAV still underestimates the amount of cash that can be returned to shareholders, because the business can sustain with a certain level of debt above 0 without hurting operations/furture cashflow. It's very conservative to assume they need to pay off all their debt before returning any cash to shareholders.

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