ISOTEAM: The next Vicom? Our target valuations are ....

ISOTeam's stock has jumped 18% in the past week (from 30.5 cents to 36 cents) on strongly rising volume. We republish, with permission, excerpts from an article on ISOTeam by Kenny Chia of The Little Snowball website.

The Valuation

At first glance, it might seem that ISOTeam is overvalued relatively to its SGX-listed peers. However, an article from NextInsight provides an invaluable insight as to how ISOTeam should and should not be valued.

The article states that ISOTeam should not be compared with construction companies since it has none of the characteristics: highly cyclical with poor returns on capital. ISOTeam’s business is defensive and recurring in nature, and provides good returns on capital (ISOTeam’s projects have very short cycles, and are almost service in nature).

This is further supported by a Business Times article (ISOTeam to add more to its toolkit) on 8 Sept 2014, where Mr. Koh said: “We are almost 100% immune to the softening in the property market. Although we are construction related, we focus on maintenance and upgrading, not newbuilds”.

Given the lack of comparative peers and the nature of ISOTeam’s business, the discounted cashflow model would mostly accurately reflect the intrinsic value of the company. Given that FY2015 EPS is S$0.0333, using a discount rate of 10% and terminal growth rate of 2.5% (pegged to long-term inflation):

♦ Intrinsic value 45.5 c (conservative) -- 62 c (aggressive)

“I see an uncanny resemblance between ISOTeam and Vicom (which went from S$0.50 in 2000 to S$6 in 2014). They both have a defensive and recurring business with strong cashflows. Furthermore, they both have the same kind of price action. "I am of the view that ISOTeam has the potential to be the next Vicom. It will be interesting to see how ISOTeam turns from being a fast grower to a dividend-play stalwart like Vicom in the coming years.” -- Kenny Chia (photo) Aggressive: Local and overseas growth plans play out smoothly Earnings growth of 10% over the next 5 years Terminal growth rate of 2.5% thereafter Intrinsic Value: S$0.62 Moderate: Local growth plans play out smoothly, excluding overseas growth plans Earnings growth of 5% over the next 5 years Terminal growth rate of 2.5% thereafter Intrinsic Value: S$0.505 Conservative: Excluding local and overseas growth plans Terminal growth rate of 2.5% Intrinsic Value: S$0.455

Back in Nov 2014, I acquired ISOTeam at approximately 10x P/E. Now, ISOTeam trades at around the same valuation as before. It seems to me that the market has not priced in the overseas expansion plans (Myanmar and Indonesia) at all, and that may very well be the share price catalyst ISOTeam needs.

The Bottomline

• 20% Market Share in  R&R and A&A ($400-$450m market)
• Recurring and Defensive Business with Low Credit Risk
• Government Initiatives bodes well for the company
• Exclusive paint applicator for Nippon and SKK Paint in HDB and town council sector
• Successful expansion into Myanmar and Indonesia as a price catalyst
• Management is candid, competent, prudent allocators of capital, and pro-growth
• Net cash position, increasing dividends, consistently buy back shares
• Increasing revenues, profits, cashflow from operations, and free cash flow
• ROE consistently above 15% with little debt
• Virtually immune to the softening property market.
• Potentially worth S$0.455-0.62 currently

The Risks

• Contract-based business: Revenues and earnings will inevitably be sporadic.
• Concentration risk: 90% of ISOTeam’s revenues are from HDB Town Councils.
• Sub-contracting risk: ISOTeam subcontracts 75-80% of its R&R jobs. This leads to execution risks and makes it hard for ISOTeam to control quality of its services.
• Failure to expand into overseas markets.
• Liquidity risk: ISOTeam’s shares are thinly traded. But it shouldn’t be much of a concern to long-term investors.