A Quick Screen: Ley Choon(Q0X.SI)

A Quick Screen: Ley Choon(Q0X.SI)

This column is written by @calvinwee
-Calvin is a fundamental analyst at heart and an ardent disciple of value investing. He relishes the process of searching for undervalued stocks and enjoys collecting dividends from his stocks.

Brief Background
Ley Choon Group Holdings Limited (Ley Choon) is an established one-stop underground utilities infrastructure construction and road works service provider. It business segments includes
1) Underground utilities infrastructure construction and maintenance services,
2) Road and airfield pavement construction and maintenance services,
3) Construction materials supply services

Performance Summary
FY16 was a challenging year for Ley Choon as it reported a gross loss of $22.4 million due to provision for liquidated damages and foreseeable losses for additional work to be performed for certain ongoing projects.In the absence of the above factors, the Group would have reported a revenue and gross profit of approximately S$151 million and S$22 million respectively, and a corresponding gross profit margin of 14.6%.
In view of its financial difficulties, Ley Choon have engaged Professional Advisors to restructure its debe obligations and divest its non-core assets to reduce borrowings and strengthen the balance sheet The divestment of non-core assets and businesses is envisaged to reduce overall borrowings by approximately S$30 million. In addition, the Group has also embarked on an optimization program for its operational asset base, where under-utilized assets are identified and disposed to recycle capital.

Macro outlook

1. Natural Monopoly
Ley Choon main edge lies with its technical expertise in underground utilities infrastructure and the in-house supply of asphalt premix and recycled aggregates as raw material. Also, Ley Choon is one of the few asphalt plant operators in Singapore and it is currently the largest in term of production capacity.

2. Consistent stream of orders from the government
Some of the Ley Choon’s largest customers are government agencies such as PUB, LTA, HDB, URA, BCA, JTC as well as large corporations such as Changi Airport Group. Moving forward, Ley Choon expects to continue the strong partnership with the government. As a L6-registered contractor with the BCA, Ley Choon can tender for Singapore’s public sector contracts of unlimited value in the categories of cable/pipe-laying and road reinstatement, pipes and other basic construction materials. In the press release dated 15 January 2016, the Building and Construction Authority (“BCA”) projected construction demand to be between S$27 billion and S$34 billion, with 65% driven by public sector demand. Construction demand from public sector remains high in year 2016 with key projects such as PUB’s water reclamation and sewerage projects, Changi Airport’s 3-runway system (package 2), improvement works to the Kranji Expressway and Pan-Island Expressway, associated infrastructure works for Changi Airport Terminal 5 and phase 2 of the Deep Tunnel Sewerage System.

3. Overseas expansion plans
Ley Choon expects to leverage on its expertise and capitalise on the opportunities oversea, especially in developing and emerging markets. For instance, it has set up its first plant in China, engaging in the construction waste recycling and the development, production and sale of eco-green construction materials. With the strong push for infrastructure in developing countries, Ley Choon is well positioned to ride on the wave.

Micro outlook

1. Debt woes

Even though Ley Choon net debt is decreasing, it should be noted that this is the result of its debt restructuring. One can get a clearer picture of its debt situation when comparing to its net profits, equity and cash flows. In particular, its net debt to cash flow is a bigger cause of concern as the sudden jump from 3.57 in 2016 to 13.564 in 2017 is a combination of a falling free cash flow and rising debt level.

2. Fluctuating profits

Ley Choon net profit margins delved into negative territories from 2014 to 2016. While it may have recorded positive net profit margins in 2017, this is partially to the credit of projects that they completed recently and its internal cost cutting. It waits to see if they can sustain this profit margin moving forward amidst the competitive market.

3. Cash flows

Ley Choon’s free cash flows has been rather unstable, posting negative free cash flows from 2014-2016. A large part of it comes from the operation cash flow, which saw another drop in 2017. Going back to its debt issue, it is a concern whether Ley Choon will have sufficient free cash flow to cover its debt repayment given its highly unstable cash flows.

Ley Choon is a dominant player in its field with a steady stream of projects from the government, coupled with its expansion plans into China and Sri Lanka, it will help to diversify away the competition that it is facing in Singapore. However, the elephant in the room is whether Ley Choon can restructure its debt profile and sell off its non-profitable assets successfully to reduce its relatively high debt. Ley Choon still has the potential to grow, but its potential is limited by the effectiveness of the management in managing its debt.

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