SITRA HOLDINGS: "My Bull Case For Stock & Bumper 1H2017 Revenue"

Article republished with permission from The Little Snowball.

The Business

Highly-lasting outdoor furniture is a key selling product of Sitra. The products can withstand temperatures ranging from sub-zero to 30-40 degrees Celcius.
Photo: CompanySitra is an international distributor of high quality wood-based products and premium lifestyle outdoor furniture. Sitra markets its products under its proprietary Comcia, decKING and Pacific brand ranges. The group’s products can be categorised into two main groups, namely (i) high-value wood-based products; and (ii) premium lifestyle furniture.

Approximately 90% of Sitra’s revenue is denominated in USD.

The European, New Zealand and Australian, ands Asian/Others Markets accounted for 72%, 17%, and 11% of Sitra’s revenues respectively.

Sawmill Factory in Surabaya, Indonesia  – worth S$13.8m ($0.018 per share)

In 2008, Sitra expanded upstream by having its own manufacturing base in Surabaya, Indonesia. The company also managed to obtain a licence to run a sawmill in Indonesia. Effective since 2008, under Indonesian laws, raw timber can no longer be exported from the country; certain degree of value-add have to be done locally first before exporting. Furthermore, Indonesia has ceased to issue such licences since 2008. Hence, the sawmill license that Sitra hold has significant value that is not reflected on its balance sheet.

Refer to annual report 2016, page 77-78: The Indonesian Factory’s book value of S$3.95m is derived from sales prices of comparable properties in close proximity and does not reflect the value of the sawmill license. 

Unfortunately, Sitra’s manufacturing became a major cash drain and ran at a loss over the subsequent years due to the high level of CAPEX and fixed operating costs, while its distribution business was profitable.

In 2015, Sitra attempted to get rid of its distressed sawmill factory and received an offer of US$10m (S$13.8m).  However, Sitra chose to hold on to the factory as it was beginning to show signs of turning around. Sure enough, the factory eventually turned around. Sitra’s losses reduced from S$1.56m in 1HY15 to S$776k in 2HY15 to S$245k in 1HY16. In 2HY16, the factory started to generate profit. Management expects this to continue in 2017.

Management turned the factory around by leasing its excess capacity to outsiders and providing sawmill and molding services. The factory only started its leasing in July 2016, hence, rental income can be expected to double in FY2017 from $96k to $192k. The utilization rate of the factory is currently around 80%.

In the 2016 Annual Report, Executive Chairman George Chew mentioned that the “Group will…explore options that will enhance the value of our Indonesian assets“. A likely scenario would be a Joint Venture to further increase the utilization rate of the factory. Sitra can sell a minority stake in the Indonesian Factory to its Joint Venture partner to unlock the value of the asset. It is also likely that the factory will be able to obtain a higher valuation than previously offered now that it is profitable.

10% Stake in WFH – worth S$9.5m (S$0.013 per share)

Sitra holds a put-and-call option with no expiry on a 10% stake in WFH which it owns. This means that Sitra can exercise its rights to sell it’s stake to its partners or the partners can exercise their rights to buy Sitra’s stake at an agreed fair valuation. WFH is an industrial property located in Sungei Kadut, currently valued at S$95m. Hence, the 10% stake held by Sitra is worth S$9.5m.

Management views this stake as non-core and will explore the option.

There is also potential upside in the valuation of WFH. Although there are no concrete plans yet, there is a real possibility that as the Sungei Kadut area develops, the government may look to build NS6 Sungei Kadut Station. It would be an infill station like EW22 Dover Station.

Generally, property prices increase when they are in close proximity to MRT stations. Furthermore, when you look at the satellite mapping of the NS line between NS5 Yew Tee and NS 7 Kranji, you would find that the most suitable place (equidistant between the two stations and the rail path is straight) to build the station would be around the area circled in yellow. Turns out, the WFH is situated right next to it (yellow star icon). Therefore, if the Sungei Kadut Station becomes a reality, the valuation of WFH is bound to increase considerably.

The Management

Based on Annual Report 2016:

Father and son: George and Steven Chew. NextInsight file photo
• George Chew Ah Ba – Co-Founder, Executive Chairman & CEO holds 16.10%

• Steven Chew (son of George Chew) – Executive Director, and Deputy CEO holds 3.11%

• Teresa Tan (wife of George Chew) – Senior Vice President holds 11.45%

• Chin Sek Peng – Lead Independent Director holds 0.64%

• Daniels Ng Boon Huan – Independent Non Executive Director holds 0.55%

In aggregate, the management owns 31.85% of the company.

In FY16, there was a voluntary reduction in salaries of the Executive Directors and the Senior Vice President which I view as a firm commitment to shareholders in reigning in costs and turning the company around.

The most recent insider purchase was by Steven Chew on 21 June 2017. He bought 1m shares @ S$0.013 per share. This provides investors with a good price/support level which the management will be buying the company shares at. At S$0.013 per share (also the per share value of the 10% stake in WFH), an investor would be getting the entire core business and Indonesian factory for free.

The Financials

Note: FY2014 had a one-off gain of S$10m from the sale of property. Excluding the one-off gain, Sitra would have reported a net loss.

Gross margins, net margins, net income, and cash flow from operations have been improving due to the sale of higher margin products and better utilization of the Indonesian Factory.

After many years of running losses; in FY2016, Sitra became profitable, with positive operating cash flow and free cash flow. Since the Indonesian Factory only became profitable in 2HY16, FY2017 is likely to witness further improvements in Sitra’s profitability. Sitra has a high operating leverage, so small improvements in the top-line will result in a significant increase in operating income.

Sitra is currently in a net cash position with S$111k in net cash.

The Valuation

Sitra is an undervalued asset play that has begun to turnaround. Since there is more robust information on the non-core assets that Sitra owns, I will be using SOTP valuation to value Sitra:

1. Wholly-owned Sawmill Factory in Surabaya, Indonesia  – worth S$13.8m ($0.018 per share)
2. 10% Stake in World Furnishing Hub (WFH) – worth S$9.5m (S$0.013 per share)
3. Net Cash amount – S$111k

Total value = S$23.41m or S$0.031 per share. At current share price of S$0.016, there is approximately 94% upside to the non-core breakup value of Sitra. No value has been accorded to Sitra’s core trading business.

Both assets are non-core in nature and do not affect Sitra’s core trading business which is profitable. Hence, management can fully divest them without winding up. Furthermore, both assets could potentially fetch higher valuations due to the reasons mentioned in the beginning of this article.

Management can reward shareholders by giving out special dividends or conducting capital reduction with the sale proceeds from the complete or partial divestment of Sitra’s non-core assets.

Since management has already hinted on many occasions as to unlocking the value of Sitra’s non-core assets, investors should not have to wait long for the good news.

The Bottomline 

• Company at the cusp of a turnaround
• Improved  profitability expected
• Management looking to monetize non-core assets
• Potentially worth S$0.031 per share (94% upside)
• Limited downside from insider purchases

The Risks

• Further improvements in profitability may not materialize
• Management may chose not to full or partially divest the non-core assets
• Management may not give a special dividend or conduct capital reduction upon sale of the non-core assets