Hupsteel: Glint under Unpolished Steel

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Undervalued stocks are always difficult to uncover. Hupsteel might just be one such stock, waiting to shine.

Hupsteel is a steel trader based and listed in Singapore. Its business model is similar to that of Lee Metal (which has nearly doubled in price since it was highlighted at SingWealth more than 4 years ago). Unlike Lee Metal which sources steel mainly for the construction industry, Hupsteel’s niche is in serving industrial customers such as ship/rig builders and contractors in the oil and gas industry.


Risk Factors

1) Unsexy, cyclical steel business

In line with the softening demand for steel worldwide, Hupsteel’s earnings per share has stedily declined from 2.24 shares to 0.41 cents per share. A quick glance at Hupsteel operating revenue and profit in the past twelve months confirms the observation that Hupsteel’s core business has been lacklustre recently. Indeed, Hupsteel warns in its FY2014 Q3 earning statement that “market demand for structural steel products is not expected to improve in the short term as shipbuilding and construction activities remain sluggish.”

Furthermore, the commodity trading business is one that requires significant working capital. Hupsteel typically has around 6 months worth of sales tied up in the form of trade receivables, which drags down its returns on equity and asset ratios

As a steel trader, Hupsteel’s business is easy to understand, but it is also pretty much a market price taker and has little economic moat to speak of. Faced with this prospect, other steel traders have ventured into related businesses (most notably Lee Metal, which branched into property development), whereas Hupsteel has steadfastly remained almost purely a steel trader (besides collecting a meagre rental income from its investment property portfolio)

Table 1: Hupsteel Quarterly Earnings (Q4 FY2013 to Q3 FY2014)

Source: Bloomberg BusinessWeek

2) Heavily exposed to Singapore market

About 52% of Hupsteel’s revenue is derived in Singapore, with the rest from Malaysia and other South East Asian countries. While marine and offshore activities will continue to contribute a major part in Singapore’s GDP, the growth for such activities is likely to trail the wider economy.

At best, Hupsteel’s steel business is a good proxy to Singapore’s marine and offshore industry. At worst, Hupsteel could be stuck in a low-growth low-margin business for the foreseeable future.

3) Relatively illiquid

Many closely held stocks never fulfill their potential, since they can easily be taken private by controlling shareholders. Hupsteel is largely controlled by a family inner circle. Daily trade volume has languished at about 200,000 shares for the past 1 year. The upside is that Hupsteel has a rather large free float of 45%, which will make it unlikely that privatisation can be done on the cheap.

 

Why Buy?

1) Large cash pile

Hupsteel boasts a cash position of $59.5 million (with borrowings of just $0.5 million) as well as available financial assets of $15.7 million. Net cash equivalents thus total $74.7 million. With 616.8 shares outstanding, the net cash per share is 12.1 cents per share (versus a share price of 21c as of 18 July 2014). Recurring capex in the steel trading business is low, at about $700,000 per year. However, $14 million has been allocated for the development of one its investment properties, of which probably just under $2 million has been drawn down.

Unlike many cash rich companies, Hupsteel has not actually been hoarding cash, but has consistently paid annual dividends of at least 1 cent per share, since 2008. This translates into an attractive yield of just under 5% at a share price of 21c (as of 17 Jul 2014).

2) Property portfolio

Despite the enviable cash position at Hupsteel, the hidden gem in Hupsteel balance sheet is actually its small but valuable portfolio of freehold investment properties with book value of $13.6 million. As stated in its 2013 annual report, these are:

Page 60 of the annual report states: “Investment properties comprising freehold land and buildings of the Group and the Company were revalued … in August 1992 for the purpose of updating the book value of the freehold properties for the initial public offering of shares of the Company…As at 30 June 2013, the fair value of investment properties is $78,500,000 (2012: $47,200,000) as determined by independent professional valuers”.

In other words, there is an unrecognized fair value gain (on the above 4 investment properties) amounting to $64.9 million, over the book value of the properties which were last revalued on its balance sheet in 1992, i.e. 22 years ago! All of of these properties are within walking distance of MRT stations that were completed only in the last 4 to 11 years.

It might be more insightful to break down Hupsteel’s balance sheet on a per-share basis, based on 616.8 million issued shares.

Table 2: Balance sheet summary as of Q3 FY2014 (31 Mar 2014):

 

Total (SGD)

Per share (SGD cents)

Total Assets

$207.9million

33.7

Cash equivalents

$75.2m

12.2

Trade receivables

$41.5m

6.7

Inventories

$45.8m

7.4

Plant property and equipment

$24.9m

4.0

Investment properties

$15.4m

2.5

Goodwill

$4.6m

0.7

 

 

 

Total Liabilities

$8.8m

1.4

Trade payables

$6.7m

1.1

Borrowings

$0.5m

0.1

Other liabilities

$1.6m

0.3

 

 

 

Equity at book value

$199.0m

32.3

Investment property fair value adjustment

$64.9m

10.5

Revalued net asset value (RNAV)

$263.9m

42.8

As summarized in the above table, a purchase of Hupsteel at 21 cents per share buys you about 12 cents of net cash, 7.4 cents of (highly liquid) steel inventories, 13 cents of freehold properties and approximately 10 cents of net working capital/PPE.

 

Other Interesting Facts about Hupsteel:

 

Conclusion: 12-month Target Price 29.5c

Hupsteel is a clearly undervalued stock, with a large cash pile (58% of market cap) and an investment property portfolio whose value by themselves ($155million) already well exceeds the company’s current market capitalization of S$129 million.

At a very conservative 6 times median earnings per share of 1.15 cents for the period 2010 to 2014F, Hupsteel’s core steel business should be worth at least 6.9 cents per share. Adding the cash pile (12.2 cents per share) and investment properties (13 cents less 20% discount conservatively), Hupsteel would have a sum of parts value of a minimum 29.5 cents per share. This represents a 40% upside from the share price of 21c. Yet, even at the target price of 29.5c, Hupsteel’s share value would still be 31% below its RNAV of 42.8c per share.

While it may take time for the market the take notice of the latent value in Hupsteel, the recent move by the company to redevelop its old warehouse site at 6 Kim Chuan Drive is a step in the right direction by the Board of Directors towards unlocking shareholder value. Any cyclical recovery in the steel trading business will just be a bonus.

 

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Last Updated ( Monday, 21 July 2014 04:15 )