Kingsmen Creatives Ltd (My Take)

The recent slump in our local market has resulted in a number of stocks reaching new 52 weeks low. One of them being Kingsmen Creative (KC). A reader has asked me about my views on this company.

A brief introduction on the company: Kingsmen Creatives Ltd. engages in retail and corporate interiors, exhibitions and museums, research and design, and alternative marketing businesses.

A few facts about it:

• Over 1,600 creative professionals and project managers
• 19 offices worldwide
• Over 870,000 sqft of manufacturing facilities in Asia Pacific and Middle East
• Business Segments
  • Research and Design
  • Retail and Corporate Interiors
  • Exhibition and Events
  • Thematic and Museums
  • Alternative Marketing

It is not common to read about Kingsmen Creative among the local investing community given its strong financial fundamentals and past strong stock performance.

• Recent Action – Kingsmen Creative (read here)
• Kingsmen Creatives – New Stock Added! (read here)
• Three Shares That Are Built To Last – Fool Singapore (read here)

In fact, not too long back I have written a post on the performance of the “Rock Solid Shares” as stated by Motley Fools at the beginning of 2015 – read here.

There are many way to approach an analysis of a company (many ways to skin a cat), and given the many shares available it is near impossible to compare Kingsmen Creative to each of them. In my case, given that Motley Fools article, stated the 4 below mentioned companies as the Great Ones, I tend to make the comparison among them:

1. Raffles Medical Group Ltd (SGX: R01),
2. Silverlake Axis Ltd (SGX: 5CP),
3. Kingsmen Creatives Ltd (SGX: 5MZ),
4. Vicom Limited (SGX: V01)

Initially, I have an incorrect view of Kingsmen:

• I judged it mainly as a Design-centric / consultancy company. I vividly recalled Warren Buffett’s saga with Solomon Inc in 1987 – when he moved in as a Director (read here), and his difficulty in managing a company whose performance is dependent on star traders (who tend to vote with their feet if they don’t like how they are treated and taking their clients along with them). Among the four companies up there, I would label Raffles Medical and Kingsmen Creative as more dependent on the capabilities, knowledge and the quality of services delivered by their staffs. Other similar companies in SGX (in this aspect) which I can think of are Q&M (Dental), Zico Holdings (Legal), to a smaller extend Rowsley (via back-door listing of RSP Architects), UOB Kay Hian (Stock-broking) etc. What makes Raffles Medical & Q&M stands out is the fact that they are in a very defensible (non-cyclical) industry eg. Medical and Dentistry. In good times or bad times, people need to see doctors and dentists. Nevertheless, Kingsmen is more than just a design firm – read below.

• I initially compare Kingsmen Creative to developers, contractors, design firms dealing with big contracts (large scale housing, commercial or industrial projects). Being from the construction industry, I know how cyclical the business is. However, Kingsmen’s operation is vertically integrated (and geographically they are a major player in the Pan Asia sector). In simple layman term, if I am an event organizer, I just approach Kingsmen to be totally in charge of the exhibits or retail interior – Kingsmen as the Designer, comes up with the design, as the project manager ensure project is on time & within budget, and as the manufacturer, ensure good workmanship and low cost (3 in 1). They are able to do so because they operate in the niche sector of retail and corporate interiors, exhibitions and museums, MICE (read here). The other advantage of operating in this sector is that retail interiors (and to a certain extend corporate interiors) require constant update. Some may argue, that when economy is bad, retailers & companies may even feel a stronger urge to update their interiors or have more exhibits to entice more customers. The other major player in this sector / area is Pico Far East Holdings Ltd (Enterprise Value is HKD 1.19B or SGD 220M). The enterprise value of Kingsmen is SGD 95.54M.

Manufacturing is conducted under Kingsmen’s direction by contract labour, keeping fixed costs relatively low. This is important. A June 2012 article states that of the 1,200 employees (now 1,600), 400 are designers (read here). As an Employer if I am able to ‘marry’ the variable side of the business which is more dependent on the creative performance of designers with a more stable base of low manufacturing, I am more likely to obtain contracts on the merit of design, speed and cost (or either of them).

The above reminds me of Tiffany (was watching a Pat Dorsey video recently)- Tiffany gives the allure of a very prestigious / pricey brand, but 40% of its revenue actually comes from products below $400 (if I remember correctly) – they place the really pricey products (beautiful & priceless according to my wife) at the shopfronts but the low price items at the rear of the shops.

Subsequently, when you combine all this with the drive and determination of the founders (who have vested interests in the company) with aligned interest as the shareholders, the moat becomes stronger.

Accordingly to the 2014 Annual Report, base on the number of shares, Mr Soh Siak Poh Benedict has a deemed interest of 19.53% while Mr Simon Ong Chin Sim has a deemed interest of 19.53% – combined they hold 39.06% and if I am not wrong, this has dropped somewhat over the years (Some may argue that the high deemed interest of the founders is double edged sword as a successor with the same aligned interest may be difficult to find). Just for info, Mr Soh Siak Poh Benedict is  66 years old this year while Mr Simon Ong Chin Sim is 62 years old this year.

Extract from 2014 Annual Report (See below):

Extract from 2004 Annual Report (See below):

Incidentally, the remuneration packages of the Directors and Key Executives have a very high percentage of Bonus / Incentives (less fixed Salary proportion). Hence a large part of their pay is determined by the performance of the company as a whole (again this is aligned with the shareholders’ interests). Extract from 2014 Annual Report (See below):

Normally people do not consider management as an Economic Moat. (Click here)

Nevertheless, the article by blogger Investment Moat mentioned the following:

Companies like Kingsmen Creatives need to put that in place, identifying where are their core competency, building a management culture focus on design and bringing up people through that culture. Focus on customers externally and enriching staff internally would go a long way in creating a bulwark around a business that traditionally is very competitive.

Let’s take a look at KIngsmen Creative Financials. Just for comparison, I have placed PICO’s information beside it.

The good points:

1. Valuation wise, it appears that Kingsmen Creative (KC) is undervalued. A search in POEMS, shows that the P/E is 8.66, and the EV/EBITDA (as shown above) is only 5.81 (As a rule of thumb, any EV/EBITDA below 10 is the sign of a good value).
2. Balance sheet of KC is very good, with a high total cash level of SGD 66.99M and total debt level of only 11.68M. After deducting debt, the cash value is a high SGD 55.31M.
3. Current Ratio is only 1.62 (Acceptable current ratios vary from industry to industry and are generally between 1.5 and 3 for healthy businesses).
4. It has quite a good dividend yield at 4.58. (read here)

The bad points:

1. In terms of profitability, I find the Profit Margin at 4.42% & Operating Margin at 3.92% too low (for my liking). Incidentally PICO’s Profit Margin, Operating Margin and ROA are not stellar as well.
2. Return on Assets is a low 3.81%, while Return on Equity is acceptable (not stellar) at 15.85%. Similarly for PICO’s ROE which is at 16.47%.
3. A search in POEMS show that the 5 years EPS growth rate is only 2.35%.

In addition, the ROA, ROE and ROIC all exhibit a downward trend over the years. (See below)

Free Cash Flow is not consistent – not sure if there is an upward trend. (See below)

In gist, good balance sheet, but growth is an issue. Maybe bordering on the stable, good dividend yield stock type. Motley Fools did a good study of the company – read here and here.

On another note, the article by Motley Fools suggests that Kingsmen Creative has a low cash conversion cycle of -44 days in 2014 , which is good as Kingsmen Creatives would require less cash to be tied up in the daily operations of its business.

 

Let’s do a quick study on the trailing PEG and intrinsic value of Kingsmen Creatives Ltd.

1) Trailing PEG

• P/E: 8.66
• Dividend Yield (%): 4.58
• EPS compound growth rate: 2.35%

The trailing PEG will be 8.66/(4.58+2.35) = 1.25. Which is not good (> 1).

2) Intrinsic Value

First let’s look at the estimated 5 years earning growth. We are going to use a time-frame of 5 years from now for this purpose. Given EPS and a PE ratio, stock price can easily be calculated for any company. Using the below formula.

F = P(1+R)^N where:

• F = the future EPS
• P = the starting (present) EPS (0.08)
• R = compound growth rate (2.35%. However let’s take a 20% discount, and use 1.88% as I am not really sure if growth can be maintained. As mentioned in my previous blog post, the second quarter results are not good and the outlook is gloomy.)
• N = number of years in the future (5)

Estimated future EPS: 0.0878

I will be estimating the future PE of Kingsmen Creatives Ltd to be 8.88 (See below data from Morningstar) – average of the PEs from 2009, 2010, 2012 to 2014.

Future Stock Price

P=EPSxPE

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

Hence future stock price of Kingsmen Creatives Ltd is 8.88 x 0.0878 = 0.779664

 

Intrinsic Value

P=F/(1+R)N

• P = present (intrinsic) value
• F = future stock price (0.779664)
• R = MARR (15% or 0.15)
• N = Number of years (5)

Hence, the intrinsic value of Kingsmen Creatives Ltd is SGD 0.39.

Stock price of Kingsmen Creatives Ltd on 1 Oct 2015 is SGD 0.765.  Hence, there is no margin of safety.

In summary:

I think in the case of Kingsmen Creative, it is the narrative that is stronger than the numbers. However, I always feels that both the narratives and numbers need to complement each other.

Although, the balance sheet and previous strong performance makes it one of the value investing community favourite, it appears that growth may not be as strong.

In addition, the calculated trailing PEG and intrinsic values suggest that the stock is not undervalued. May consider buying if there is a big margin of safety.

“We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). 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

In this article (too bad about what happened to Silverlake Axis recently), it states that the three things Pat Dorsey looks for in a stock is a moat, strong management, and compounding potential. In this case, the compounding potential seems to be lacking.