NeraTelecommunications Ltd (Time to buy?)

The Singapore Market is some way off its previous peak of 3539, and the Shanghai market is in correction mode (read here). One must note that corrections and bears markets are necessary for future growth. Perhaps this is an opportunity for long-term investors to get back in.

Nobody knows if the China market is in a short term correction or long term crash. Whatever the scenario, it is good to dip slowly into the market (and sell off over-valued shares).

Consequently, I have noticed that a number of stocks have dropped in price. Some reaching new lows (read here). I have done some blog posts on these companies:

1. Osim International Ltd (Time to buy?) – Read here.
2. Genting Singapore PLC (Time to buy?) – Read here.
3. Japan Foods Holding Ltd (Time to buy?) – Read here.
4. Don’t worry about indexes. Worry about your stocks. Super Group – Read here and here.
5. Sarine Technologies Ltd – Monday Surprise – Read  here and here.

Some of these stocks are (or were) respectable value-growth or dividend stocks. Many are familiar names eg. OSIM, Genting and Starhub. Most have high cash levels (even after deducting debts). While others were in the news due to the huge or numerous share buy backs by the companies themselves – notably OSIM and Genting. Of these, I have purchased some shares in Sarine Technologies Ltd and Super Group Ltd.

“The best stock to buy may be the one you already own.” Peter Lynch

However, there are reasons why these companies stocks’ prices have dropped so drastically (usually due to poor earnings, quarterly results) – so it requires more effort to study the reasons behind the poor performance, and to decide for yourself if these are indeed long term fundamental issues or temporary setbacks. It seems like even rock solid value growth companies are susceptible to poor quarterly results (but not as bad and not much drop in share prices):

• Kingsmen Creative (read here). From peak share price of $1.055 to share price of $0.99 on 26 June 2015, there is a decline of 6.2%.
• Raffles Medical (read here). From peak share price of $4.65 to share price of $4.56 on 26 June 2015, there is a slight decline of 1.9%.

While individual stocks may be pulled along momentarily by a strong bull market, ultimately it is the individual stocks that determine the market, not vice versa. All too many investors focus on the market trend or economic outlook. But individual stocks can rise in a bear market and fall in a bull market.  Sir John Templeton

Even though I like the idea of share buy backs, but ultimately financial ‘engineering’ (which includes reducing debt, outstanding shares etc) by the company to raise share prices has less of an effect as compared to operational changes (eg. making workforce more efficient, reducing wages / rents, strengthening the business moat etc). The latter is harder to find out.

Among the many stocks making new low, one stock darling that many value investor is aware of is NeraTelecommunications Ltd (read here). I was aware of NeraTel some time back (read here and here). The stock price of NeraTel on 26 June 2015 is $0.6350, which is just a hairline above its 52 weeks low of $0.63.

One of the main reason why NeraTel is popular with many investor (as compared to other high growth stocks) is because it can also be considered as a high dividend yield stock (Dividend yield is currently at 6.299%. Not bad at all). (read here)

Nera Telecommunications Ltd designs, engineers, distributes, sells, services, installs, and maintains telecommunication systems and products in transmission, satellite communications, and information technology networks. It has four business segments, namely, Telecommunications, Infocommunications, Network Infrastructure, and Payment Solutions.

Before I go any further, I would like to clarify that the initial reasons why I did not invest in NeraTel is because I felt that its business model is beyond my circle of competence. Beyond the fact that I see their company logo in the signature tablet whenever I pay via Visa for my groceries or other purchases (NeraTel provides network solutions to point of sales terminals used in retail outlets), I have fairly little knowledge of their business. I am just not in this business, neither am I tech savvy. If anyone is to quiz me about what NeraTel actually do, I will be hard-pressed in finding a concise answer.

My next question would be what is the impact of Paypass and mobile POS be on NeraTel? There is an article (read here) stating that NeraTel is participating in the IDA‟s Contactless POS Terminals Call-for-Collaboration (CFC) with the aim of strengthening their business in cashless payment and make headway into e-payment for small ticket items or micro-payments. However, am not sure the extend of NeraTel’s involvement in Paypass.

On 19 June 2015, M1 Limited (M1), in collaboration with CIMB, MasterCard and Wirecard, launched the new mobile Point of Sale (mPOS) solution (read here).

There are now so many ways to pay beside the signing on tablet for Visa & Master card holders. So will this erode NeraTel’s competitive advantage?

“If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored.” Peter Lynch

“Never invest in any idea you can’t illustrate with a crayon.” Peter Lynch

“You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital”. Warren Buffett

Prior to 2014, it exhibits all the attributes of a high growth, strong value stock.

Indeed, prior to 2014, on a yearly basis, profit (before and after tax), net income, and earning per share have been progressively increasing year after year.

There were many positive attributes with NeraTel’s business (read here), namely:

• Paying out consistent dividends over the past eight years at least. However, its dividend payout ratio (dividends per share dividend by profit) has been close to 100%;
• Generated positive free cash flow in each year since 2007;
• Parts of its business are highly recurring in nature (eg. Telecommunications’ payment solutions segment);
• Nera Telecommunications’ strong balance sheet (high cash level);
• Nera is highly efficient in the use of its assets to generate sales;
• Its payment solutions business is growing (1st quarter results: Payment solution revenue increased by 57.1 per cent to S$10.7 million, but margins are shrinking.);
• Nera’s payment solutions are easy to scale;
• Neratel operates in quite a few countries and their business is the same in all of these countries. This means that they do have economies of scale when it comes to purchasing equipment.

Indeed, Nera Telecommunications Ltd with a market capitalisation of around S$229.8 million accounts for over half the market in the SE Asia. Nera links its clients up with satellite, microwave and radio frequency communications. Its customers span the length and breadth of Asia and South East Asia. They include countries such as Myanmar, Vietnam, Thailand and Malaysia.

However, a quick glance at NeraTel financial statistics (see below) show mixed results:

• It does not have extremely high PE.
• Has a EV/EBITDA of 8.68. (As a rule of thumb, any EV/EBITDA below 10 is the sign of a good value)
• Has a respectable return on equity of 21.76% (> 20%).
• Total cash is still more than total debt (by approx. 19.48 mil).
• Total Debt / Equity is not that high, only 8.53.
• Current ratio is 1.74. (Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses.)

However,

• Price / Book ratio is 3.61 (definitely more than 1).
• Quarterly earning growth is a disappointing -33.80% (hence the fall from grace, no longer enjoy a growth stock status).

Base on the above mentioned 2 items (Price / Book & Earning Growth): Not quite a value stock and definitely not a growth stock. The most striking perhaps is the lack of earning growth.

“In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.” Warren Buffett

The recent quarters’ results have been disappointing. Its first quarter 2015 net profit fell by about a third to $3 million from $4.6 million previously.  (read here)

The recent quarter poor result is mainly attributed to the telecom segment, with some revenue from the Middle East and Africa region not being recognised (read here). This is caused by a delay in the shipment of point-to-point equipment to Nigeria as well as a late contract win from Pakistan. All these point to temporary issues.

However, I noticed that the previous quarters results are also not consistently improving. (See below). It is hard to predict future growth base on these lumpy results.

A study of the free cash flow, shows disappointing results. It is lumpy with a downward trend.

“Never bet on comeback while they’re playing “Taps”.” Peter Lynch

Let’s do a quick study on NeraTel’s share price of SGD$0.6350 (as of 26 June 2015) – via Trailing PEG and Intrinsic Value.

1) Trailing PEG

• P/E: 14.16 (from POEMS)
• Dividend Yield (%): 6.299 (from POEMS)
• 5 years EPS compound growth rate: 8.75 (from ft.com – see below)

The trailing PEG will be 14.16/(8.75+6.299) = 0.94. Which is good (< 1).

2) Intrinsic Value

If we calculate the intrinsic value using a growth rate of 7% (20% less than 5 years CAGR of 8.75%).

F = P(1+R)^N

• F = the future EPS
• P = the starting (present) EPS (SGD 0.04)
• R = compound growth rate, 7%
• N = number of years in the future (5)

Estimated future EPS: 0.0561

I will be estimating the future PE of NeraTelecommunications Ltd to be 10.56. (See below, data from Morningstar) Average of P/Es from 2005 to 2014.

Future Stock Price

P=EPSxPE

• P = future stock price
• EPS = future EPS
• PE = future PE

Hence future stock price of NeraTelecommunications Ltd is 0.0561 x 10.56 = SGD 0.592416

Intrinsic Value

P=F/(1+R)N

• P = present (intrinsic) value
• F = future stock price (0.592416) 
• R = MARR (15% or 0.15)
• N = Number of years (5)

Hence intrinsic value of NeraTelecommunications Ltd is SGD 0.29.

Given the stock price of NeraTelecommunications Ltd on 26 June 2015 is at SGD 0.6350, thus there is no margin of safety base on the estimated intrinsic value.

In summary:

On the future outlook, the CEO in the annual report mentioned that “with public cloud computing gaining greater adoption, customer spending on cloud infrastructure is projected to increase in the coming years. The Group is also seeing an increased adoption of Software Defined Networking (SDN), which delivers automated, on-demand application delivery and mobility at scale across cloud architectures.”

Nevertheless the recent quarters are a disappointment. I am doubtful (or not knowledgeable enough) if the above mentioned will be successful.

Even though the trailing PEG shows that the stock could be undervalued, the calculated intrinsic value shows otherwise. In addition, given that NeraTel’s Free Cash Flow has not been growing and that its dividend payout ratio (dividends per share dividend by profit) has been close to 100% (read here) leaving little left for future increase in dividend payout, it is doubtful that NeraTel can maintain its current high dividend yield.

Finally I know little of its business model, the future for satellite communications and transmission products & systems for a layman like me would be difficult to foresee.

Therefore I would be hesitant in buying the shares of NeraTelecommunications Ltd.

“You have to know what you own, and why you own it. “This baby is a cinch to go up!” doesn’t count.” Peter Lynch