Buying water and selling stationeries

Water problems have long dogged Selangor, with the issue compounded by politics. With the General Election over, there will be less political posturing in Selangor. With that, there will be renewed commitment by both the Federal and State Governments to work towards resolving the issue of treated water in the state.

Between 2011 and 2012, incidence of water shortages in Selangor increased by 79%. Syabas is reportedly running on a reserve margin of just 1% with water consumption growing at 3-4% per year. This will adversely affect future economic activities in the Klang Valley, which accounts for 38% of the country’s GDP.

It is also clear that the governing party in Selangor, which sits as the opposition in the federal parliament, needs to show it is able to run the state effectively, generate new jobs and bring in new investments. A recent public criticism by the leader of the Opposition, of the Chief Minister of Selangor, a senior member of his own political party, is telling.

While the Chief Minister has managed Selangor well in the past term, resolving the water issue is critical for the future of industries and consumers in the state. With this in mind, there may be opportunities for investors in the sector once the restructuring takes place.

Credit Suisse recently issued an excellent report on the Bursa Malaysia-listed companies with exposure to the water sector.  I know the analysts Danny Goh and Rachel Tan well and therefore, the quality of their work. There is no need to reinvent the wheels.

Here is a quick summary table of the financials of three companies in the sector, for those who may not be able to secure a copy:

Company                    Price                P/E (x)                               P/BV (x)

                                    (RM)                2012    2013    2014

Gamuda                      4.89                 20.3     19.8     14.4                2.8

Puncak                        3.25                 5.6       4.9         4.2                 0.8      

KPS                             2.00                16.8      n/a         n/a                 0.9

The Selangor State government has offered RM9.65 billion to buy all the four water concessionaires in February 2013. It was not successful as Puncak Niaga rejected the offer, while the others accepted. To succeed, a better offer will have to be made to Puncak Niaga. Despite the recent rally, Puncak Niaga’s shares are currently still trading on single digit multiples and below book value.  

To be fair, the water restructuring play has made its rounds many times in the past three years, only to peter out as talks ended in a stalemate. However, with the general election over and the danger of dry taps a growing reality, there is palpable sense that a definitive solution will soon be found.

Turning from water to stationery, I feel compelled to return to China Stationery Ltd, which I wrote in this column on 5 Oct 2013. There are troubling facts that are inconsistent and not logical, at least to me.

Below is an extract of the last two years financial information

China Stationery Ltd

Extracts of Financial Statements

                                                               RMB’000                         RMB’000

                                                            31 Dec 2012                 31 Dec 2011

Cash and Bank Balances                   1,889,491                      1,327,077

Borrowings                                               54,400                             49,100

Amount due to a shareholder                        38                              71,746

Revenue                                               1,980,628                     1,774,710

Cost of Sales                                      (1,110,626)                      (979,207)

Gross Profit                                              870,002                        795,503

Gross Margin in %                                      43.9%                             44.8%

Interest Expense                                          8,261                           41,908

Interest Income                                            7,014                             5,200

Imputed:

Interest rate on borrowings                         15.2%                           34.7%

Interest rate on deposits                               0.37%                          0.39%

It raises many questions, such as:

1) What stationeries are sold by China Stationery Ltd that generate an astronomical 44% gross margin? The company makes plastic stationery, plastic tape printer and ink.

2) Why does the company borrow when it has so much cash?

3) In 2012, the company paid back RMB 71.7 million to its shareholder. Is this the controlling shareholder?

4) Why is the total effective cost of borrowing between 15% and 35%?

5) Why was the company paying a hefty 57% interest rate, with RMB 38.9 million interest on a RMB 68.5 million convertible bond in 2011?

6) Why are the bank deposits of some RMB 1.9 billion earning only 0.4% interest when the 1 year deposit rate in China is over 3%?

In our previous report, we also indicated that the major shareholder, Lead Champion, has sold down from 71.85% to 23.43% since the beginning of this year.

China Stationery Ltd is a Bermuda registered company. Its principal place of business is in Fujian Province, China. It is listed in Malaysia. Its independent auditor is in Singapore.

The stock price may look “cheap” now. The cash available per share, accordingly to the financial statements, is four times more than the stock price. But I believe it may get “cheaper” soon. 

This article will be published in The Edge this weekend.