HG Metal

HG Metal Manufacturing Limited was founded in 1971 as a small retailer of steel products. Today, we are one of the leading steel stockists in Singapore, and arguably the first local steel stockist to provide state-of-the-art manufacturing capabilities. At HG Metal’s extensive "one-stop supermarket" stockyard and manufacturing facility, they carry more than 2,000 types of steel products, of various dimensions and for a wide range of industrial and engineering applications. HG Metal source their steel products from cost efficient producers in Turkey, Russia, Ukraine, and other Eastern European countries. While the primary market is Singapore, they also export to Malaysia, Indonesia and other Southeast Asian countries.

In 2000, the Group diversified into the manufacturing of steel products through their wholly owned subsidiary, Oriental Metals. HG Metal started with the manufacturing of customized flat steel bars and mild steel lip channels, commonly used as roofing support. In mid 2003, we expanded our manufacturing capacity to include pipes and hollow sections through the installation of a new pipe line. HG Metal Manufacturing Limited was listed on SESDAQ on 21 March 2002 and was upgraded to SGX Main Board on 07 May 2004. First look is that HG Metal is a steel manufacturer with its products targeted mainly for the construction sector.

Step #1: Strong consistent sales & earnings growth that looks predictable into the future...

HG Metal’s sales have risen steadily over the past 5 years with most of it attributable to demand from China (rapidly growing economy) and Middle East. Just recently, for FY2006, demand from growing marine sector of Singapore and construction sector, sustained the demand for its steel products.

Taking a closer scrutiny on FY06 results, a one-time investment gain of about $6m on FerroChina shares coupled with a 20% lower operating catapult the PAT to $13.8m, a 122% gain. Stripping out the one-time investment gain, earnings would remain relatively flat from $7.8m, actualizing about 56% gain. The compounded average growth rate over the past 5 years would average about 22.7%.

Overall for the past five years the PAT growth rate is not too consistent and not in line with revenue growth.

Step #2: Conservative Financing with total debt less than a single year's net earnings...
As at Nov 2006, the total long term debt for HG metal stands at $14.7m, only slightly lower than 2005’s $14.9m. The debt is slightly higher than 2006’s profits, and if we strip out one time extraordinary gains, the debt is 2 times a single year’s net earnings.

Step #3: Consistently high ROE, above 15% each year...
HG Metal ROE’s for the past 5 years successively has not been consistently above 15%, often a see saw ride.
FY 2006 ROE of 23.2% (only 11.6% if exclude one time gain)
FY 2005 ROE of 9.9%
FY 2004 ROE of 35.3%
FY 2003 ROE of 12.4%
FY 2002 ROE of 14.2%

Step #4: Intelligent Capital Allocation, where retained earnings are used for growth not maintenance...
HG Metal invested in FerroChina who is principally engaged in the manufacture of heavy gauge galvanized steel coils based in Changsu, China. It is also listed on the Singapore Exchange Main Board. The investment proved to be synergistic too, when a few months later, they were appointed as FerroChina’s sole distributor of galvanized steel coils for the Singapore and Indonesia markets. There are plans to increase this distributorship to other countries in South-east Asia.

In the quest to create a better balance between their trading operations and the more cycle- resistant manufacturing activities, they stepped up value-adding activities by venturing into sandblasting for ship plates. HG Metal’s subsidiary, Oriental Metals, has begun construction of a new factory that will house a sandblasting plant. Expected to cost approximately $3 million to construct and equip, the plant will commence operations in the second half of the next financial year. It is being funded with internal cash reserves and bank loans.

Step #5: The Business is easy to understand, and Management is open, honest and competent...
HG Metal principally manufactures steel products for the construction industry. Margins typically are not high for the construction industry, ranging from 10%-15%. As evident from the profit margin of HG Metal, is typically very low, less than 5%, this implies that any gains can be wiped out by increasing steel prices (supply) or fluctuating demand from the construction sector.

The directors are substantial shareholders of Food Empire holdings with holdings from 3% to 7%.

Step #6: 2x5y= Business/Industry Prospects indicate Earnings could Double in 5 years...
With its primary market being Singapore (approx 50%) and Malaysia (approx 25%), the prospects for the next 5 years would be the upcoming Integrated Resorts, new Financial downtown in Marina and the recently proposed South Johor Economic Region (SJER), all of which are expected to gobble up significant construction resources.

Step #7: Sustainable Competitive Advantages are in place...
HG Metal is almost similar to a commodity supplier (steel plates, bars, beams, etc) where it trades steel products and manufactures primary construction products, high volume, low margin business. There is limited barrier to entry (only initial capital outlay as what the company espouses in their website under strengths) , and the company has little pricing power as there is little product differentiation and branding power to talk about. This is evident from 2005 results where glut of steel products from China and falling steel prices reduced the margins of HG Metal.

Step #8: Attractive Valuation...
Based on a growth rate of 10% (based on tepid growth rates and low margin business) and zero terminal value for 10 years, the estimated discounted cash flow from the business is $0.69. At the current price of $0.49, the value of the business represents a 40% discount from the DCF value of the business.

Decision: Prospects (IR, downtown Marina and SJER) and valuation (at undemanding 8.8PE + 40% discount from DCF), HG Metal is alright. However, the company does not quite meet a few counts of the analysis namely on lack of sustainable competitive advantages, low margin business, relatively high debt to earnings per year and inconsistent growth rates(for profits) and low ROE. Personally I would not be keen to purchase this share.