Sunday, January 29, 2012

Young Investor Series - Why Should you invest in the stockmarket (Part 3)

One likely pitfall that many thinking of starting young will face will be their limited capital. With a minimum charges of around $30 ($25 for commission and another $5 for GST and clearing fee) per trade, a trade of $3000 will cost $60 of brokerage fees to buy and sell, equating to a 2% loss. However, a smaller capital outlay at the start can prove to be a better investment in the long run.

First of all, let's face the fact that it is highly unlikely for one to be generating high returns continuously in the long run when one just started out even if one may have read tons of investment books. Knowledge is just a tiny portion of investing as compared to experience, emotional stability and patience.

Personally, I have make all kinds of mistakes right at the start which has allowed me to learn in a much less painful way. Think about those who started in a hot bull market, where everything they buy just rises spectacularly and they can double their capital in weeks as they believed they have the "Midas touch". They will continue pouring all their savings into their so called investment, trade with margin and when the bull cycle ended, many faced a near total wipe-out of their capital.

My point is not whether one should start in a bull or bear market, but the younger one is, the lesser capital one will have and thus the lesser the mistakes will cost. Be it a 10% or a 90% loss, one will lose lesser in the absolute term and it will be likely that one can earn those money back by saving and working harder. And of course, unlikely that one will have to support his family. Imagine a 40 years old who losses his lifelong savings and has about 20 years more before he retires.

Another way to look at this will be that the earlier one learned from his mistakes, the longer a period that he has to compound his win. Assuming a super bull cycle of 10 years, a 20 years old will only be 30 years old when he learned his lessons, gained experiences and maintain emotional stability.

Last but not least, investing in stocks will be beneficial to students studying economics, accounting and business, or exploring career path in these area. While I have the habits of reading The Straits Times before I started investing, I will always skip the Money section as I think that it is just too complicated. Now, I read Bloomberg and CNBC even before I have my breakfast. Understanding what's happening in the financial sector will definitely put one at an advantage over his peers when it comes to finding a job.

Thus, starting young is beneficial in many ways and there's not much reason why not to other than maybe the younger one is the more rash and impatient one will be. Even if one is afraid of capital loss, there is no harm in playing around with paper trading though one need to be careful when one decided to switch to real stock investing.

Wednesday, January 25, 2012

Young Investor Series - Why Should you invest in the stockmarket (Part 2)

Earlier in part 1, we have discussed about how inflation has been eroding our wealth, while the stockmarket has proven to generate a much higher return in the long run. Some may say that with the current macroeconomic environment, inflation is not that high and it might be safer to put in fixed deposit with the bank. They will want to wait till they got much older and with more capital before they start investing. While there's nothing wrong with that, the younger one starts, the better one can enjoy the effect of compounding interest. Warren Buffet who started an age of 11 in fact thought that he should have started even earlier.

Using a 6% rate of return (considering historical 9% return for stock index) and 55 years old as the end year with an initial starting capital of $10,000, here are the differences in return:

At 55 years old,

Start at 20 -> 76,860
Start at 25 -> 57,435
Start at 30 -> 42,918
Start at 35 -> 32,071
Start at 40 -> 23,966
Start at 45 -> 17,908

For every 5 years younger that one start, it can equate to a lesser return of $10,000, which is your initial starting capital.

Here's another scenario: Assuming the same condition previously but that one add an additional sum of $1000 every year (Saving up $3 per day).

At 55 years old,

Start at 20 -> Total Sum Invested = $45000 Total Return= $194,981
Return Earned= $149,981

Start at 25 -> Total Sum Invested = $40000 Total Return= $141,237
Return Earned= $101,237

Start at 30 -> Total Sum Invested = $35000 Total Return= $101,075
Return Earned= $66,075

Start at 35 -> Total Sum Invested = $30000 Total Return= $71,064
Return Earned= $41,064

Start at 40 -> Total Sum Invested = $25000 Total Return= $48,638
Return Earned= $23,638

Start at 45 -> Total Sum Invested = $20000 Total Return= $31,880
Return Earned= $11,880

Therefore, the earlier that one starts, the higher the absolute return that one can get.

Saturday, January 21, 2012

My definition of Margin of Safety

Margin of Safety is a very important concept in the field of value investing and of course comes from no other than our dear Benjamin Graham. In the Intelligent Investor, he mentioned that "margin of safety is always dependent on the price paid". Basically, if the intrinsic value is $1, you should purchase the stock at as much a discount as possible. Do note that intrinsic value and book value are not the same. The reason why margin of safety is needed is because that we are always susceptible to a huge downturn or error in judgement. Should anything happen, losses will be limited as we have bought it at a discount. However, the crucial part in the calculation of margin of safety lies in the estimation of intrinsic value, which makes it very very dangerous for those untrained or inexperienced, like me. Valuation methods differ from comparable, DCF, PE, PB and more than often using of different methods give you different intrinsic value. This is one reason why I never try to do valuation (I will try to learn though) for my stock. So how should the layman ensures his margin of safety? Here is how I do it:

Never Overpay
I will be very careful whenever the PE is more than 15 and will very likely not consider it at all if the PE is more than 20. This only works for company that has regular products and services being sold, else I will have bought into OUE whose PE is 2. For companies in the property sector or whose income is highly dependent on their assets, P/B will be more useful. P/B can also be used for banks and financial company as they essentially depend on borrowed money and lending it out. Discount to P/B differ for different sector, thus it will be better if one will to compare it with the sector and their historical P/B value.

Research and Understand the Company
Knowing as much as possible about the company that you buy into is very important. Be it whether it is in your circle of competence, one should at least understand the type of products and services that the company provides, its market share, competitors and the industry at large. In such a case, one will be able to react well should anything unexpected happen like maybe a lawsuit, new competitor, recession and e.t.c. If sufficient research is done, one will be able to sleep well at night without fearing the unknowns. This is also a criteria for you to be able to take advantage of Mr Market, by understanding about the company more than your fellow shareholder.

Good Business Model confirmed with Financial Statement Analysis
With a good business model, a company will be able to maintain its profit in almost all circumstances. So long as a company is able to grow its bottom line, its intrinsic value will be achieved sooner or later. As Warren Buffett says "You should invest in a business that even a fool can run, because someday a fool will". Thus, after you have identified a good business model, you should start to examine its past annual report and financial statement. If the business model is indeed sound, it will usually be confirmed by the financial statements like consistent profit growth, high profit margin, net cash, high ROE and e.t.c. If the analysis proves otherwise, it only means two things: 1) A fool is indeed running the business or 2) The business model is not as sound as you think it is.

Intention to hold it for a significant period of time
Having a long term view is important since more than often we are never that fortunate to pick a stock when it reaches its lowest point. If you have abide by the above three principles, the last thing that you need to do is to hold it out so long as the initial reason for the purchased is unchanged or wrong. Just like an antique collector that knows the worth of his collection, he will never sell it at a discount even if you may try to convince him that it is overvalued. What he will do will be to wait until he is being offered a price that he deemed fit. Similarly, the market might offer you a deserving price only in the long run, perhaps years.

These I believed will be much more meaningful than trying to calculate the intrinsic value and hence the price that you should buy a stock.

Thursday, January 19, 2012

Young Investor Series - Why Should you invest in the stockmarket (Part 1)

I have decided to start the Young Investor Series to encourage and educate more young students and adults to invest in stock because I have believed in the merits of starting young. While I am obviously way too inexperienced, it has been a very meaningful journey for me thus far especially since I started my journey at this time of uncertainty and turbulence. In fact, I believed that I have learned much more than I will have from having started in this current mild bear market. From getting very excited at how the price tick when I first began, I will only get as excited now when I discover a company of great fundamental.

The first reason why you should invest in the stockmarket is that while cash is king, it is never wise to have 100% of your wealth in cash (other than possibly waiting for the next huge financial crisis) because cash has proven to be a depreciating asset due to inflation. Inflation results in the erosion of wealth as the price of goods increases but your cash remain the same. Your 50 dollars note will only provide you with $50 of value next year even if your chicken rice costs you an additional 50 cents. Average inflation has been around 3.5% for the last 100 years, this may seemed little but in fact it is very scary if you will to compound the 3.5%. Using the rule of 72, your wealth will be depleted by 10% every 3 years and half every 20 years. The total amount of inflation from 1913 to 2006 is at a staggering 1929%. Neither should you expect the inflation trend to discontinue as it was only during the Great Depression of the 1930s that you have a long period of deflation.

On the other hand, stockmarket has generated an average of 9% return over 100 years. The key is 100 years, which means such a return is likely only if one invest with a long term outlook. Thus, it is wise to have some of your wealth invested in stockmarket be it directly or indirectly through some form of stock mutual fund or ETF. The stockmarket has over the long term be able to deliver a return that way exceed the inflation rate. One need not put all its wealth into it in order to combat inflation as putting 30% of it in stockmarket will be sufficient to avoid erosion of wealth. This is especially true in Singapore where our bank pays a meagre amount of 0.125% interest on deposits. For every $1000 that you have, the bank will pay you $1.25 yearly.

While many might have heard stories of people going bankrupt from PLAYING with the stockmarket, one can choose to be a passive and defensive investor which does not requires much of your time and effort to be.

In conclusion, one's wealth will be drop by an average of 3.5% yearly if one does not take any action to protect it. Part 2 will be on the magic of compounding interest and why the younger you are the better a magician you are.

Monday, January 16, 2012

Scuttlebutt in the 21st Century

In Common Stocks and Uncommon Profits, Philip Fisher devoted a chapter to write about scuttlebutt and how it can reveal precious information about the company. Scuttlebutt involved talking to the customers, competitors, suppliers, employees and key management of the company. Through the technique, it can tell us about the competition, popularity and quality of the products and how strong is its brand name.

However, for some of these people, it might be really inaccessible to us, the retail investor. Some companies might have also expanded overseas of which it will be rather expensive and time-consuming to have a look at them. Or a company might just have more than 50 branches all over Singapore. Supplier of which you have no business interest in might not be bother about you as certain information revealed might sensitive or simply confidential.

These applies more to the Fisher era where the internet is not as developed yet. In this era today, the potential of internet in the scuttlebutt research process is tremendous. This development has narrowed the knowledge gap between the retail investor and the professional fund managers. Now I shall elaborate on how can we make use of this tool to access information that Fisher might have to spend weeks to gather in the past.

Forum and Review site
Nowadays, whenever we wish to find out about which brand of laptop has the highest quality, which mobile phone has the longest battery life or utility, we can just Google it or find the answer on the forum. These site allows customer to badmouth about their bad experiences or to compliment a company for its excellent product. Without the need to fly overseas, we can easily find out about how popular a product is elsewhere. More than often, there will be two sides of argument like though product A's design is not as nice, it is still the most reliable and durable.

IR, PR and customer service
While not all IRs are willing to answer your questions faithfully, there are some that will be ready to help out with most of your enquiries and try their best to provide you with the necessary information. For PR, it is more of how well they can handle the media and how well they are being received by the general public. The reputation and brand name of a company can be maimed when you notice how people started scolding or even threatening to boycott it. Or try sending an email as a customer that has just met with some problem after a purchase to check the quality of service.

What's a better avenue for a disgruntled employee to scold its boss or lament about the organisational inefficiency other than the web where one can comment anonymously. Or simply to share the benefits and perks they enjoyed with potential future colleague.

Industry Data
Other than having your annual report online, industry statistics can also be found through government website, university research or some other research project. News archive may also be available online for free and provides a history of problems the company has faced before.

While this has nothing got to do with your internet, it is much easier nowadays to find a book commenting on maybe how Google becomes the search engine giant or how GSK manipulated the pharmaceutical scene. Of course, this mostly applies to big corporations with extensive operations.

While the above that I have listed are all that I can think of, the potential of it depends on how creative you are in sourcing for your information. One word of caution though, because of the anonymity you need to exercise your discretion in processing the information. And no matter how positive your Scuttlebutt is, never forget to analyse the financial statements of the company for you might never know what you will come to know about the company.

Saturday, January 14, 2012

VICOM - Part 4 (Conclusion)

The following table is the summary of all that have been discusses thus far:

Financial Statement Analysis

Positive Signs

Negative Signs

Average of 15% profit growth for the past 6 years

Profit Margin and Net Profit Margin not expected to increase further.

Net Profit Margin of 26.6%

Average ROE of more than 20% for the past 6 years

Net Cash, No Debt

FCF/Net Profit of at least 75%


Health Dividend Payout of 60%

Vehicle Inspection

Positive Signs

Negative Signs

Further tightening of COE supply will jack up prices and thus people are likely to hold on to their car longer

Vehicle growth to be stunted until 2014 before a review of the policy though the vehicle population growth will still remain positive

Such an impact has not been fully realized as monthly trend still points towards further aging of car population

Such impact is likely to be fully realized by the end of 2013

Closure of an important inspection centre in Ayer Rajah on Aug 2011 by STAI

While the Ayer Rajah centre will not be reopened again, no one knows if STAI will open another elsewhere. However, it will take $10 million and at least a year to open a new centre

The only one in the region to have a Vehicle Emission Testing Laboratory. VETL costs $4.7 million and VICOM was lucky to have been granted $2.3 million in fund. High cost might limit number of VETL being set up

Parallel import is at its lowest point currently

Adoption of Euro V std by 2014 will lead to further regulation of vehicle emission

A long term trend of more diesel cars on the road with the government doing a test trial on the impact of DPF on diesel vehicle

For each increase in diesel car, it will take another 2 years before the increase in revenue will be realized


Now, what is a fair value and target price of VICOM that i should be looking at. Valuation is something that is extremely tricky and I believe it to be much more of an art than a science. I will not be using DCF as I think that I am inadequately trained to do such a calculation yet. For valuation I will use expected earnings for 2011 given that 2011 FY has passed and the annual report is just 1 month away.

At $3.61 where I initiated my coverage, VICOM is trading at a P/E of 13 which is pretty high. However, if we take into account VICOM's net cash position, EV/EBIDTA is in fact only 7.87.
Even if we count in ITDA, EV/Earning will be 10.5.

Here's a question for everybody, will you choose a stock trading at PE of 10.5 but a EV/Earning of 13 or will you choose a stock trading at PE of 13 but a EV/Earning of 10.5?

No matter what your answer is, I still believe that VICOM is a fair buy given its high profit margin, ROE, high FCF, low CAPEX and a sound business model. While the current value might be on the high side, it is definitely undemanding. What's more a final dividend will be declared in a month time and distributed in May.

While I initiated the coverage at $3.61, I got it at an average price of $3.40. The reason why I choose to initiate it at $3.61 is because it was the price of VICOM on that day. Initiating a coverage at $3.40 will in fact be giving me a 3 months hind side, but this is not to say that $3.61 is not a fair value to buy in.

Thursday, January 12, 2012

VICOM - Part 3B (SETSCO's history and competitors)

Talk about SETSCO and i am sure that not even 5% of the population will know what it is and what it does. SETSCO started in 1981 from Singapore Institute of Standards and Industrial Research (Currently called SPRING after merging with PSB) to provide commercial testing services to the industry. It was also the first testing lab to be accredited by Singapore Accreditation Council for Civil Engineering. It is then privatised in 1987 and sold to Keppel Corp before becoming a part of VICOM in 2003.

Earlier in part 3A, we talked about the two largest firms in the ITC industry - SGS and Bureau Veritas, so now we shall compare SETSCO with them. It is of course unfair to compare SETSCO with the largest ITC companies which operate more than 1000 offices worldwide. However, we can at least compare their operating margins to see how lean SETSCO is as earlier we have already conclude that staff cost is the biggest expense of VICOM's business.
Fig 1 - SETSCO

Fig 2 SGS from Deutsche Bank report

Fig 3 Bureau Veritas

SETSCO's EBIT margin was a mere 7.3% in 2003 when VICOM acquired it from Keppel Corp but has steadily increased to 12% in 2008 before shooting up to 19% after that (same goes for 2011). While I have no idea what happened during 2009, it can be seen that SETSCO produced much more synergies with VICOM as compared to Keppel Corp. VICOM's management has also done a good job in doubling SETSCO's revenue and profit margin through expanding its range of accredited services. SETSCO's EBIT margin is better than that of Bureau Veritas and SGS from 2009 onwards. Will the move of VICOM's HQ further improves efficiency as mentioned by the chairman, this i will not be able to answer.

Competition is indeed fierce in this industry but how do the companies compete with each other? Price competition should be out as in the field of ITC, brand name is the most important. Aside from the brand, I believe that the next most important factor will be the number of accreditations that one have. Why is this important? The amount of products that a company has that require testing are often varied and numerous. For e.g. for a construction - concrete, steelwork, paint and tiles. For a can food producer - meat, preservative and tin can. The point that I am trying to make is if I need to hire only one company to test the whole range of products, why will I want to hire two companies for it. Therefore, the bigger the ITC company the more likely that it is going to get the larger contracts. Now, we shall review SETSCO's accreditations by sectors to understand the competitions. All information comes from Singapore Accreditation Council (under SPRING).

Fig 4 Products Certification

SETSCO is accredited to certified concrete and fire safety products(fire extinguisher, fire alarms, testing of fire resistance of all materials). In the area of concrete certification, SETSCO has only managed to garner a 5% market share because SETSCO was only accredited in October 2010 to do product certification. However, this signifies its push into the certification area to offer a full range of ITC services. TUV SUD is the current market leader in the certification business, accredited to certify electrical appliances safety and a lot more products than any other companies.

Fig 5 Inspection

It is the sole provider of inspection services in the Pressure Vessels and Lifting Equipment category for air receiver, tank and chain block. Air receiver is a pressure tank commonly used in the marine, oil and gas industry. For building construction and maintenance category, competition is slightly lesser with around 2-3 competitors in each of its accredited inspection area. And one last thing inspection service is a recurring income as inspection needs to be carried out regularly. Under the Building Control Act, a building that is not solely for residential purposes will need to be inspected every 5 years from the date of TOP and 10 years for residential building. The following tables will all be on Testing accreditation, where the left side will be on services SETSCO has been accredited with in that category while the right side will be its main competitors and their number of accreditation in that category.

Fig 6 Civil Engineering

Civil engineering is the construction of all types of buildings, bridges, MRT tunnels and roads. For civil engineering, a lot of different products are required as seen above. SETSCO is the sole tester for structural fixing and has the most number of accreditations in this category. Closest competitors will be Al Tech.

Fig 7 Calibration and Measurement

Calibration and Measurement is to ensure that measurement devices like thermometers and weighing scale are accurate. In this area, competition is slightly stronger with Singapore Test Services and Ming Deng Metrology Services, but SETSCO still has the most number of accreditation. In order to maintain the ISO 9001 standard, all devices need to undergo a recalibration every 3 years.

Fig 8 Non-Destructive Testing

Non-destructive Testing is a wide group of scientific techniques to evaluate properties of material, component and system without causing damage thus making it a highly valued technique that can save both time and money. Its applications range from Aviation, Power Plants, Construction, Marine, Oil and Gas and Submarine. SETSCO is once again the market leader here which got every accreditation possible in this category. NDT is often used in "Risk-based Inspection" and it is a requirement for refineries, oil platform and chemical installation to undergo the inspection regularly.

Fig 9 Mechanical

Mechanical Engineering is the testing of materials and mechanical system and overlaps with aerospace, civil engineering and petroleum engineering. Competition is less intense here but SETSCO is also not the market leader here though it is the sole tester for 4 of the products.

Fig 10 Chemical Products

This is the testing of chemical properties and products. TUV SUD is especially strong in this area though competition is relatively sparse here.

Fig 11 Biological Products

This is more of the food safety standard. Nestle is not counted as a competitor as it is used to test their own products. Competition is very sparse here with only HSA, AVA and SETSCO testing most of the products and in fact these 3 bodies work in partnership. To be eligible for Food Export Health Certificate, an application need to be made to AVA for each consignment top be exported. After that

"On the appointed date, AVA officer will carry out an inspection of the food consignment intended for export. He will then draw samples from the consignment for laboratory analysis. Applicant should ensure that the consignment is ready on the day of inspection. The inspection date is scheduled according to the applicant’s request and 3 working days advance notice is required.

The samples will be sent to M/s Setsco Services Pte Ltd for microbiological analysis and/or Health Sciences Authority (Food Safety Laboratory) for chemical and radiation analysis, depending on the type of product and analysis required."

Normally, the ratio will be one-third of the products to SETSCO and two-third to HSA.

Thus, we can conclude that SETSCO has a very stronghold in the local ITC industry with the closest competitor being TUV SUD which is one of the 8 largest ITC corporations. It has the most number of accreditations in the whole range of services and this is its competitive advantage over all other companies. Notice how many of the services are in fact interlinked. A marine company will require certification on Air Receiver, Mechanical Testing and NDT. A construction project will require a testing of concrete, followed by civil engineering testing and maybe even NDT. After that, an inspection of the building might then be required to be carried out. A huge portion of the inspection services are required regularly due to regulations, like building inspection, recalibration of devices, NDT, food export and fire safety products. SETSCO's expansion into product certification is its bid to offer a full range of ITC services downstream and upstream, which is what SGS and Intetek are doing.

With such strength, it is no wonder why SETSCO is able to attract huge projects over the years.

2005-Moog Aerospace (undergo NADCAP), reclamation material for Tuas and Jurong Island, Water quality at Marina Barrage, Jurong Shipyard, SP Power, Hyflux, ExxonMobil and Seraya Chemicals Singapore

2006- Jurong Chemical Hub

2007- Fusionopolis, Orchard Turn, Singapore Art School, Horizontal Bulk Liquid Storage Terminal (Emirate National Oil Company), Henderson Bridge and Dubai Metro Rail

2008- Resort World, MBS, Pinnacle at Duxton, Keppel Bay and Exxon Mobile

Tuesday, January 10, 2012

VICOM - Part 3A (Understanding the ITC industry)

In 2003, VICOM purchased SETSCO (Scientific Engineering and Technical Services Company) for a sum of $15.7m. Currently, SETSCO accounts for 45% of VICOM's net profit, but information about it has not been very forthcoming, leaving many in doubt about what SETSCO really does. While some might feel that SETSCO is a completely different type of business from vehicle inspection, in fact the whole of VICOM business can be classified as being in the ITC industry.
Vehicle inspection is actually a niche area under the ITC (Inspection, Testing and Certification) industry which offers its services to a very wide variety of products ranging from food to buildings, from marine to aerospace.

The main purpose of this post is to let readers understand the functionality and fundamental of the ITC industry. This will be more of an informative post and most of the information is gathered from the following sources:

Deutsche Bank's Investor Day report of SGS
NZB's FY10 report of SGS
Bureau Veritas Investor Relation Presentation
TUV SUD Annual Report 2010
AL Tech

Before I start, I will like to warn reader to exercise some discretion in discerning between facts and opinions as 2 of the sources are analyst's report while 2 of them are company's annual report. Stuffs like market structure and past information counts as fact while things like valuation are more of an opinion. I have also highlighted important points in bold.

About the business

From Deutsche Bank Report

Inspection Services: SGS inspects and verifies the quantity, weight and quality of traded goods. Inspection takes place prior to shipment at the manufacturer’s or supplier’s premises.
Testing Services: These services test product quality and performance against various health, safety and regulatory standards. It is done by SGS in state-of-the-art laboratories close to the customer’s premises.
Certification Services: SGS certifies whether products, systems or services meet the requirements of standards set by governments, standardization bodies (e.g. ISO 9000) or by SGS customers. SGS also develops and certifies its own standards.”

Market Structure

Fig 1 Market Structure from Bureau Veritas

From NZB Report

Competitive landscape
“The global testing, inspection and certification remains a highly fragmented market, with less than 20% of market value estimated to be outsourced to independent companies such as SGS. SGS, Bureau Veritas, Dekra, TUV, DNV and Intertek account as the six largest players in the industry though their combined share do not exceed 15%. SGS share does not exceed 5%.”

From Deutsche Bank Report

“We estimate the global testing, inspection, and certification (TIC) industry serves a c.EUR60bn market. Out of this market c.30-35% is served by specialized and independent agencies such as SGS, Bureau Veritas and Intertek while the rest is not yet outsourced.

The industry covers all sectors (primary, secondary and tertiary), companies of various scales of operation (from small to large), and all regions. A large portfolio of services is offered, ranging from very basic (commodities quantity control) to tailored and sophisticated services(tests in laboratories, critical products / building conformity assessment). The market is still highly fragmented with only a few global players operating in multiple sectors (SGS, BV and Intertek) while the rest of the market (DNV, Dekra, TüV Süd and others) comprises mid-size organizations that often focus only on one region or on a limited number of sectors and areas of expertise. However, the industry is in a consolidation phase with large players like SGS focused on adding to their capabilities and increasing their local presence.”

Business’s Fundamental and Barrier to Entry

From TUV SUD Annual Report

“The key growth driver – not only in the CERTIFICATION strategic business segment, but also within the entire TÜV SÜD Group – is our service offering relating to the market readiness of manufacturers’ products, from development to marketing through to recycling. Here, we expect above-average growth rates in photovoltaic and in the inspection of textiles and leather goods. Overall, double-digit revenue growth is expected in ASIA PACIFIC.”

“In the ASIA PACIFIC region, revenue growth is primarily generated in the CERTIFICATION strategic business segment. However, the INDUSTRY and MOBILITY strategic business segments will increase their contribution to revenue in this region in the medium term. We see high potential for growth in the ASIA PACIFIC region, particularly in the area of environmental and energy technology.”

“In the CERTIFICATION strategic business segment, our business development in the ASIA PACIFIC region continued to be impacted by risks arising in Singapore due to higher administrative burdens, new certifications, and competition from the public sector. Furthermore, we are facing new risks in the region due to falling student numbers at the PSB Academy, tougher legislation in the field of education, and the new EduTrust certification scheme.”

From NZB Report

VTIC industry has experienced CAGR of between 5-6% over the past 20 years, nearly 10% on average in the past 10. The industry has tended to decouple from traditional macro indicators such as GDP or World Trade volume growth, though a minor cyclical dimension is still conserved (some 35% of sector growth). Resilience of VTIC activities is on the account of the structural drivers behind sector growth combined with the upstream expansion of testing services in the product value chain, resulting in a lower dependence from final demand.”

“The industry is characterized by high barriers to entry, due to the need of an international network, extensive know-how and expertise as well as the need of accreditation from government bodies.”

From Deutsche Bank Report

“General overview
SGS’s customer base is relatively fragmented, i.e. the group’s top 100 clients together account for less than 15% of group sales. The contract scope is wide, ranging from basic quantity checks to very sophisticated tailor-made services involving laboratory testing.

Revenue patterns are quite predictable since a big portion is generated from recurring contracts. Customer loyalty is high as it can be expensive and time consuming to change from one provider to another. Furthermore, many services are specialized and only delivered by certain certification companies. Acquiring and processing the first certification cycle is costlier than subsequent recurring testing and certification processes.”

“Growth drivers
We believe globalization results in increased global trade flows, which are a major driver of growth for SGS, generating among other things the desire to trace the origin of goods.
Furthermore, we believe that protectionism, rather than freight forwarding companies, should be a growth driver for the sector. We believe that standards and testing are “great weapons” to be utilized by countries to avoid imports.”

Fig 2 Resilience to downturn from Bureau Veritas


Fig 3 Deutsche Bank report on SGS's valuation

Fig 4 NZB Bank's report on VTIC peer group valuation

Cash Flow Generation

Fig 5 Cash Flow from Net Income from Bureau Veritas's Report

Fig 6 Deutsche Bank's FCF analysis of SGS

Here's for a better understanding of 2 of the many segments in ITC industry

Civil Engineering

Fig 7 AL Tech's brochure

Industry Service


“TÜV SÜD Industry Services provides services for the safe, reliable operation and optimization of industrial plant, buildings and infrastructure facilities. The division supports its customers with tasks including the planning, construction, operation, dismantling and disposal not only of plant and facilities, but also of refineries and power plants. The division focuses, in particular, on developing solutions in the fields of energy efficiency and renewable energy.”

From Deutsche Bank

“SGS’s services in this segment increase safety and quality and reduce technical and commercial risks faced by various industries. SGS assures asset integrity (asset needs to fit purpose) from design to decommissioning, across all industries, globally. SGS has a large portfolio of service offerings addressing safety, quality, compliance, reliability, and maintainability issues for the overall production cycle in any industry including design, procurement fabrication, construction commissioning, operation, maintenance and modification.

SGS’s Industrial Services business primarily serves the oil & gas, power, construction and transportation industries. The different client segments that SGS caters to are plant operators/owners, EPC contractors, consulting companies, construction companies, suppliers of technical components, government authorities, investors, insurers, and trading companies.”

My Summary

While all these reports are mostly about the largest company in ITC industry with global operations, it does shed light on the industry itself. Competition inside the ITC industry is pretty strong as even the leader (SGS) can only garner a 5% share and the trend poinst toward more consolidation and acquisition. Companies compete through having more accreditions and services available as well as having a brand recognition. Such intense competition has also been recognised in VICOM's annual report and chairman's statement.

Despite the competition, high barrier of entry exists as one has to meet the high accredition standard of the country as well as brand name recognition. However, once one is able to secure a steady base of customer, recurring income is expected as these services may need to be performed on a regular basis (for e.g. safety inspection of plant). Cost of switching inspector is also not cheap as labels and certificates need to be changed while the whole range of products need to undergo a re-inspection.

Growth in the industry is not exactly dependent on economical growth as policies and regulations will still need to be obeyed. Despite the fact that most of the largest companies core operation are centered in Europe, the 2 largest SGS and Bureau Veritas has proven to be rather resilient. But, a portion, possibly one-third of its growths, might still depend on economic growth as services like inspection of oil rig and new construction are part of the revenue. The industry being one that offer its inspection and testing services to a whole range of products help to diversify its income source and reduces the risk from a global downturn. In fact SGS even has a 2014 plan in which they seek to double their income with a compounded annual growth rate of 13.7% and to achieve an operating margin of 20%.

The main source of growth in this industry will still be a tighter regulation, public and consumer's demand for better quality control and adoption of health and environmental standard. Events like Japan's Nuclear Plant incident and Avian Flu can have a positive effect on the industry.

FCF is also pretty high as capex will be spent only on acquiring of new technology and accredition. A huge proportion of costs come from employee which requires the company's management to be able to understand staffing requirement in relation to potential growth in revenue.

With high barrier of entry, a proven resilient business model and recurring income, these companies are often valued at a PE of 20. Despite being situated in Europe, currently SGS (Swiss) has a PE of 21, Bureau Veritas (France) PE of 21.2, Intertek Group (London) PE of 26.5. This does not mean that VICOM deserves a PE of 20 but that such valuation shows the confidence of investors in these stocks even though the Euro debt crisis is still developing.

Part 3B will be on SETSCO's standing in the Singapore's ITC industry and the competition that it faces.


Saturday, January 7, 2012

VICOM - Part 2B (Market Share of Vehicle Inspection Business)

For all of its annual report since 2005, VICOM has always claimed that it has a market share of 70%. However, is this market share derived from some form of monopolistic advantage or is it simply a result of VICOM being a market leader? Now, we shall examine the truth behind its 70% market share.

Fig 1 VICOM's Market Share

By taking the number of vehicles that VICOM inspected with LTA's figure, we can see that VICOM has managed to garner a market share of 70% from 2005 to 2010. While we see a dip in market share from 2005 to 2009, I am sad to say that I am unable to find any data or reason to support such an occurence. From the LTA's list of APPROVED vehicle inspection centre, we can see that VICOM's main and only competitor is STA Inspection (Under Singapore Test Services which is under ST Engineering).

Let's now assume that you are one of those that have just received a letter from LTA stating that you have to send your vehicle for inspection. Between VICOM and STAI, who will you choose? Price competition is out as both are similarly priced other than STAI offering a 50 cents discount for repeat inspection of motorcycles. The answer is either as it depends on where you live. Simply put, both inspection centres compete on its strategic location, the one that is the nearest to the most number of people. VICOM currently have 7, while STAI used to have 3 but it just closed down the one at Ayer Rajah while the Jurong West's was opened late 2009. Through a very simple scuttlebutt, I got to know that the Ayer Rajah one was closed on 13 August 2011 and will not be reopened again. However, a further probe as to why did it close down and I never get any more reply. Now, I will like your to look at the maps below where I have labelled the location of the inspection centre. (The map belongs to
Fig 2 Location of Inspection Centres before August 2011

Fig 3 Current Location of Inspection Centres

The red star stands for VICOM, Black Circle stands for STAI and Purple Square stands for JIC. For those that still does not know, VICOM has a 78% stake in JIC. The red lines that I have drawn symbolised the supposed market share of VICOM, taken by splitting into half the distance with the nearest STAI centre. As it can be seen, even before Ayer Rajah branch was closed, VICOM has some sort of a regional monopoly of the East, the North and Tuas. JIC is strategically position such that the one at Tuas is to captured heavy vehicle inspection, while the one at Ang Mo Kio is right beside SBS depot.

What is more important to us now is its market share in the future. What STAI did was more of maybe choosing Jurong West as a better location than Ayer Rajah. However, I have serious doubt about their decision. (all thanks to Lizardo, the reason for closure of Ayer Rajah centre is due to relocation for a media hub) From fig 3, we can see that VICOM now has a monopoly of the Southern part of Singapore, while the Jurong West's STAI centre can only capured a market share of Jurong West. The light green part above Jurong West is the super ulu place known as Lim Chu Kang, which houses mainly military camps. I supposed this is a reason why VICOM's market share did not get affected in 2010 and well, I expect its market share to rise by at least 4-5% now that the crucial Ayer Rajah STAI centre is gone.

One peculiarity about the map is the cluster of vehicle inspection centre at Bishan- Ang Mo Kio. The explanation is simply that the vehicle and transit licensing division of LTA is located there. VICOM used to be a government body until it got privatised by Comfort.

With such monopolistic power, is VICOM able to utilise them through increasing the price of inspection as a result of inflation or reduced demand? Currenlyt, cost of vehicle inspection for a car is $58, while the initial cost of inspection when it started out in 1980 was at $40. Here's the timeline regarding increase in fee:


1997-$50 (VICOM was allowed this limit earlier in 1980 when it was formed but it chooses not to charge at that price)


2005-$55 (due to a drop in demand)

2006-$58 (due to the same reason. However, this is not the confirmed year of increase in price but a speculation that I have calculated through dividing revenue by number of vehicle inspected through fig 4 below).

This is an increase of 45% in 26 years, which is a compounded increase of 1.5% per year. This might not be very impressive but the fact that it can do so during years when demand for inspection service has fallen is worth noting.


Here's something interesting that have been overlooked by a lot of people and that is the combination of CDST and Vehicle Emission Testing Laboratory.

Look at fig 4 where there is a significant increase of $8 per inspection from 2007 onwards. This is due to LTA's regulation that all diesel-powered vehicles need to undergo CDST during their routine vehicle inspection and this cost an additional fee of $17-$26. For now we shall put this aside first to look at the Vehicle Emission Testing Laboratory

Fig 4 Revenue Per inspection

In 2009, a $4.7 million Vehicle Emission Testing Laboratory (VETL) was being set up of which $2.3m is being forked out by LTA. This VETL is the first of its kind being set up in the region and is compliant with Euro V standard. FYI, Singapore has adopted the Euro IV standard and will be adopting Euro V standard by 2014. This VETL is currently serving two purposes :

1)Mandatory Fuel Economy Labelling Scheme

2)Supporting a test trial of diesel particulate filter

The Mandatory Fuel Economy Labelling Scheme is an initiative under the Environmental Protection and Management Act and as the word mandatory implies, every vehicle supplied to Singapore must be affixed with this label (the yellow label thats pasted on nearly every new electrical appliances). As it is the only one of its kind here, it has a monopolistic market here. However, this is a rather small market currently as it mainly affect parallel importer whose imported car does not possess this label. A check with NEA and they say that one of every vehicle model need to be inspected. "Ie 5 honda Fit bearing model code abc1, you will only need to test 1. But if there is a Honda fit bearing model code abc12 subsequently, you will need to register for that particular model." And the price of each inspection is around 2-4k per model.

Fig 5 LTA's plan

Fig 6 LTA's Plan

One of the reason why LTA is willing to fork out half of the building cost is that it intends to use it for a trial. The trial is basically to test out the emission level of diesel vehicle after installing the diesel particulate filter. The significance of this trial is that it implies that the government is looking at the alternative of diesel car instead of petrol car (This is purely my speculation as the LTA guy refuses to give me any direct answer as he says that this will be at a higher level of policy-making and that the trial is still on-going).

In the past, diesel vehicle used to be very environmental-damaging as all the black smokes rises from the exhaust. However, modern diesel technology has make it such that it is more environmental friendly than petrol car. Moreover, diesel is a cheaper option and is much more efficient than petrol. In 2008, the government decided to reduce special taxation on diesel car by 30-50% as current Euro IV vehicle has proven to be better. In some part of Europe, diesel car now accounts for half of the total car population. For the past decade, number of diesel cars (not taking into account taxi) has remain less than 20 due to government intervention. In 2009, this was 43 and in 2010 it rises to 138. This signifies a longer-term trend of having more diesel car on the road and the result is that they will have to undergo the CDST which will boost the profit margin of the inspection business. Please refer to the below links for more information on diesel cars.

Building for a trial is just part of the reason in the sharing the cost in building VETL. The other reason lies in Singapore's planned adoption of Euro V standard by 2014. The difference between Euro IV and Euro V is that Euro V requires emission of particulate matter to be controlled at less than 0.005 for all vehicles including petrol vehicle, which is what VETL is capable of.

With the VETL at a high cost of $4.7 million (STAI Jurong West took only $10m to build), it may not be likely that all inspection centres will have it. Thus in 2014, only VICOM might have VETL, and it will likely undergo an inspection of all vehicle imported into Singapore. (This is again pure speculation on my part) With such an high cost built, even if VICOM does not have the monopoly in this area, LTA will allow it to "cover cost" for PM inspection like how VICOM justify the $17 CDST inspection fee with the CDST facility built ($5m spent in total for all 7 inspection centres).

Part 3 will be on VICOM's non-vehicle testing and inspection business SETSCO. But it might not be ready so soon as I will be a bit more busy the next few days.

Thursday, January 5, 2012

VICOM - Part 2A (Impact of LTA's Vehicle Growth Policy)

Fig 1 Vehicle Inspection Revenue and Profit

From fig 1, we know that the vehicle inspection business is an extremely profitable business, with a 2010 profit margin of 37%. And vehicle inspection business is a hgue proportion of VICOM's overall profit.

In this part 2A, I will examine how LTA's recently announced vehicle growth policy is going to affect VICOM's inspection business. In 1990, Vehicle Quota System was introduced where the government will be able to control the vehicle population.Since then, LTA has set the vehicle population growth at 3% until May 2009 where it was cut to 1.5%. On October 2011, LTA announced that it is going to reduce the vehicle population growth rate from current 1.5% to 0.5% until the end of 2014. For this year rate of 1.5% will be maintained until August before it is reduce to 0.5% to achieve a 1% increase in vehicle growth this year. With such a policy, many feared that VICOM's most profitable segment is going to take a hit from it. However, one thing to be noted is that with a 0.5% growth rate, the number of vehicle will still be growing albeit at a slower rate. Now I am going to take you through the statistics to examine the impact on VICOM's profit. The following sources are all derived from LTA's statistics.

Fig 2 Singapore Vehicle Population Statistics from 2000 to 2011

Private Car has always occupy around 50-55% of the total vehicle population and is increasing its proportion steadily. From 2003 onwards, total car population has been increasing reaching a peak in 2007 before the growth slowed down. Many might have wondered wasn't LTA controlling the growth rate at 3%? Have a look at this article to understand why :
So in fact we do understand that LTA has not been very successful in controlling vehicle population growth as their prediction for number of vehicles deregistered are flawed.

Another point to note is that number of private cars owned per 1000 population has been increasing. This does not means a saturation of demand for cars as such increase is much slower than the real GDP Growth. Even at the previously set 3% growth rate, the demand still outstrips the supply of COE. The previous data is just a primer for everyone to understand the vehicle population situation. Now we shall look at how vehicle inspection business will be affected by the change.

Fig 3 Vehicle Inspection Frequency

The above table shows that the impact to revenue for every 6 additional car is the same as 2 additional Goods Vehicles and 1 additional Taxi or Omnibuses(SMRT and SBS buses). With this data, we shall first look at the impact on Car inspection.
Fig 4 Age Distribution Data

As we know private car get inspected every 3rd, 5th, 7th and 9th year, and from the 10th year onward it will be annually. The above is the age distribution data that I have compiled showing the % of vehicle from each age group. Those highlighted in red is the proportion of cars that has to undergo inspection. From 1998 onwards, percentage of vehicle undergoing inspection has drop from 51.4% all the way to a 2006 low of 34.6% where cars that are less than 2 years old occupy 47.8% of the total population. After 2006, lesser people start to buy a new car as a result of reduced amount of COE and higher COE cost and proportion undergoing inspection increase to a high of 47.3% by the end of 2011. This is a clear example that lowering of vehicle growth rate will in fact cause a spike in the percentage of vehicle undergoing inspection. However, some might still prefer a higher vehicle growth rate as they argue that increase in population of vehicle will result in a net increase in number of cars going for inspection. On the table above, the blue bolded shows the total population of the car, while the green is number of vehicles going for inspection at a given year calculated through multiplying percentage of cars undergoing inspection with the total population. And I charted these 3 pieces of data in fig 5 below:

Fig 5 Chart

Total number of cars inspected has been stagnant from 2000 to 2006 despite a 20% increase in total car population. Instead there is a 8.6% drop in total number of cars undergoing inspection as a result of a 24% drop in percentage of cars inspected from 45.4% to 34.6%. Thus it can be concluded that for the vehicle inspection business to grow, there must be an increase in population of cars as well as an increased in percentage of cars undergoing inspection which is that people do not change their car as frequent.

Fig 6 Number of Vehicles inspected (excluding private cars)
Fig 7 Distribution of Vehicle's inspection

Over at Fig 6, I add up the total number of all other vehicles (number of taxi and omnibuses was doubled to reflect their twice a year inspection) to arrive at total number of inspections. As can be seen, this portion is much more steady compared to private cars and has been consistently rising around 1% to 3% year-to-year. In total, private car's inspections occupy 40% of total vehicle inspected. Thus, for VICOM's Vehicle Inspection, 60% has a very steady, yet slow growth while 40% of it is determined by the government's regulation and the market price for COE.

To conclude, the restriction in supply of COE (which pushes price of COE up) will cause age distribution of car to tweak in the favor of VICOM. This coupled with a continual slow growth in vehicle population will therefore result in an increase in revenue for this particular segment over the next few years.

Part 2B will be a discussion on VICOM's monopoly power and market share.