OKP Holdings Limited - MANAGEMENT REPLY: What is the actual state of its order book?

Q1 FY13 came in below expectations but DBS Vickers and OCBC are remaining sanguine because of the order book. But can this be relied upon? Also, management clarifies its loan to China Sonangol.

2/6/2013–OKP Holdings Limited fears continued pressure on its margins due to highly competitive bids for new projects.

The company recently announced earnings for Q1 FY13:

Revenue: +28.4% to S$32.04 mln
Profit: -22.2% to S$2.38 mln
Cash flow from operations: S$0.39 mln vs (S$1.06 mln)
Dividend: Nil
Order book: S$393.5 mln up to 2015

Analysts Sarah Ong and Eli Lee at OCBC find the results to be way below expectations.

OKP Holdings' gross margin fell sharply to 15.1% compared to 21% a year ago.

Based on interaction with the management, OCBC says the fall was largely due to increased subcontracting and labour costs.

The company's Q1 profit after tax and minority interest (PATMI) makes up just 18% of OCBC's FY13 estimate and 15% of consensus estimate.

So, OCBC maintained its HOLD rating on the stock but reduced its target price to S$0.46 compared to S$0.48 previously.

Analysts Alfie Yeo and Suvro Sarkar at DBS Vickers find Q1 revenue to be slightly below estimates and profit is disappointing due to lower margins.

Consequently, the broker has reduced its earnings estimate for FY13 by 44% and for FY14 by 51%, factoring a lower gross margin on 17.5% compared to 23% earlier.

DBS Vickers has downgraded the stock to FULLY VALUED with a significantly lower target price of S$0.405 from S$0.49 previously.

Investor Central. Asian insights for global investors. We ask the tough questions of Asian companies which global investors need answers to.

Question

1.What is the actual state of its order book?

We just don't get it.

As at April 30, 2013, OKP Holdings' order book was S$393.5 mln (refer page 33 of the earnings report).

Both, OCBC and DBS Vickers feel the company's order book is "healthy".

OCBC justifies the comment saying the order book of S$393.5 mln is 12.3 times OKP's Q1 revenue.

The problem is that this doesn't gel with how the company assesses its order book.

In November last year, replying to Investor Central's query about its order book calculation, OKP Holdings said 'A project will only be removed from the order book upon 100% completion'.

In other words, it recognises revenue from the project progressively, depending on how much of it has been completed.

But the project is removed from the order book only after it is 100% completed.

It follows, that OKP Holdings' S$393.5 mln order book on April 30, 2013 also includes those portions of projects which have already been completed and the revenue has been booked.

The problem for investors is that they have no way of knowing how much of that S$393.5 mln order book has already been booked as revenue, and how much of it is actual orders outstanding.

Then, what is the basis for OCBC's comparison of order book and Q1 revenue?

This draws into question how the brokers can claim the order book is "healthy" when nobody knows the actual outstanding order book of the company.

It therefore also renders the broker's recommendations and price target unreliable.

That makes it all the more important to know the real order book of the company.

Management ReplyOur order book stands at S$393.5 million and the projects are expected to last till 2015.

Question

2. Why is OKP keeping projects in the order book until 100% completion, but booking revenue progressively?

This is bound to lead to confusion, and it's difficult to understand why such a policy would be adopted in the first place.

Management Reply This is in line with our company policy. However, we are open to exploring other ways of updating our order book, to best reflect the progress we have made.

Question

3. How worried should shareholders be about loan to China Sonangol?

Let's do a quick recap: China Sonangol, via its subsidiary CS Amber Development Pte Ltd, bought Amber Towers in Singapore for S$161.6 mln in April 2011.

According to China Sonangol's website, Amber Towers will be redeveloped into a 109-unit condominium called 'Amber Skye'.

A year later, in June 2012, OKP Holdings bought a 10% stake in CS Amber Development Pte Ltd.

But it was a curious deal, because it involved both shares and a loan.

On the face of it, OKP Holdings should have paid S$16.2 mln (10% of S$161.6 mln China Sonangol paid for Amber Towers) for its 10% stake in CS Amber Development Pte Ltd.

Instead, OKP bought 111,111 new shares, representing 10% of the enlarged equity of CS Amber Development, for just S$111,111.

That's even though CS Amber Development had total assets of S$188.7 mln as on December 31, 2012 (refer page 13 of Q4 earnings report).

So, first, it's odd that it received a 10% stake at such a low price.

Second, OKP extended another S$20 mln 'unsecured' loan facility to CS Amber Development.

The loan facility carries an interest rate of SIBOR+2% (ie 2.44% - refer page 15 of Q4 earnings report), and is to be repaid in full on June 26, 2018.

This is a very, very low interest rate, given the circumstances.

So, what's going on?

First of all, CS Amber Development Pte Ltd has a very low equity of S$1.11 mln, compared to the Amber Towers property it bought for S$161.6 mln.

This shows that CS Amber raised significant debt to acquire Amber Towers in 2011.

And maybe this is why OKP Holdings agreed to give an 'unsecured' loan facility of S$20 mln.

Perhaps all the assets of CS Amber are already pledged to other lenders.

Being an 'unsecured' loan, one would expect the risk premium to make the loan costlier.

But, surprisingly, OKP Holdings gave an 'unsecured' loan at SIBOR+2% (ie about 2.44%) even though prime lending rate in Singapore is about 5.4% p.a. (check PLR on MAS' website)

The interest rate on an 'unsecured' loan pinches even more when one compares it with interest rates of 4.30%, 5.125%, and 7.875% on OKP Holdings' investments in financial assets.

Certainly, if the aim was to make the best use of idle funds, OKP Holdings' should have invested the S$18.4 mln funds, loaned to CS Amber, in financial assets.

Therefore this makes us believe that OKP Holdings is doing a favour to China Sonangol by lending money at such cheap rates.

One must not forget that OKP and China Sonangol have been doing business for the last couple of years.

In December 2010, OKP was 50% partner in a JV which was awarded an S$83.5 mln contract to develop Anguilla Park, a project owned by China Sonangol.

Subsequently, China Sonangol bought a 14% stake in OKP Holdings in August 2011 for S$9.9 mln from its executive directors and other shareholders.

And now, 'Amber Skye' is being jointly developed by China Sonangol and OKP.

The scheme of arrangement between China Sonangol and OKP Holdings makes us believe that either OKP Holdings has found a true business partner in China Sonangol or it is offering very favourable terms.

Undoubtedly, the reasonable investor would like to know OKP Holdings' rationale.

Going ahead, if CS Amber Development defaults on the loan, OKP Holdings can't really do much as it is an 'unsecured' loan.

And if OKP Holdings and China Sonangol ever decided to part ways, OKP might be at the losing end.

While China Sonangol can sell its 14% stake in OKP Holdings on the open market, OKP Holdings would be stuck with its 10% stake in CS Amber Development Pte Ltd.

All this makes us wonder how worried OKP Holdings shareholders should be if things don't turn out as planned with China Sonangol.

Management ReplyIt all depends on how you look at it. One must understand: Is the company making money by giving out loans, or property development?
Clearly, in our case, it's property development. So there's no reason for us to charge a high rate of interest on loan to CS Amber Development. If we were to do that, we would have to book it as interest income. It doesn't align with what we are trying to do. We are not a bank. SIBOR +2% is a rate we have asked for from the banks. We don't want to be seen to be throwing in money at zero. So, SIBOR +2% is a balance between charging enough but not so much to then have to book it as interest income.
It eats into your margin if your interest income is too high. You have a higher income from interest but lower earnings on the 10% stake. It might be seen as unsecured, but the only asset is Amber Towers. OKP already owns 10% of CS Amber Development. So it is secured against the assets of CS Amber Development.
China Sonangol bought Amber Towers for S$167 mln, including taxes. As Net Asset Value is a moving number, we felt that instead of paying 10% of the NAV (because we still had to tear it down, rebuild, etc) it was simpler to buy 10% of the company that owns Amber Tower i.e. CS Amber Development. This is the norm, common market practice among developers and JV partners. The loan is then used to fund the tear-down and rebuilding.
Investor Central's follow-up question: How were OKP's margins at risk with the above transaction because in any case OKP cannot consolidate results of Amber Development because it has a minor stake of 10%? Also, what is the NAV and market value of OKP's 10% stake in CS Amber Development?
OKP's reply: OKP's margin will be impacted only if a sale is made below cost or if there is no sale.

Question

4. What is the purpose of S$20 mln loan facility extended to CS Amber Development Pte Ltd?

We have not heard from the management on the purpose of S$20 mln loan facility given to CS Amber Development Pte Ltd.

Management ReplyThe money will be used for the purchase of land and working capital.

Question

5. What is next for Forte Builder Pte Ltd?

Forte Builder Pte Ltd is a 50:50 JV of OKP Holdings and Soilbuild Group Holdings Ltd.

It was formed in 2010 to build the luxury Angullia Park condominium in Orchard Road for S$83.5 mln for China Sonangol.

The JV was mandated to complete the construction by April 22, 2013.

Therefore we would like to know if the project is on track for completion by April 22.

Also, how much did the JV profit from the S$83.5 mln contract from China Sonangol?

And finally, what is the future of the JV after Angullia Park project is completed in the next couple of months?

Management ReplyThe JV will be completed by April 2013.

Check out the following Handshakes map to gain better understanding of the relationship between China Sonangol, OKP Holdings and Soilbuild Group.

Question

6. What forced it to sell S$2.5 mln non-current assets soon after acquiring them?

OKP Holdings bought 'financial assets, available-for-sale (non-current) for S$4.5 mln during Q1 FY12.

These assets were bonds with fixed interest of 5.125% p.a. without fixed maturity.

Being non-current assets, it is expected that the company intends to hold them for more than a year, at least.

But all of a sudden, OKP Holdings sold S$2.5 mln of these bonds during Q4.

Therefore that makes us wonder what forced it to sell these 'non-current' assets all of sudden and that too within months after acquiring them.

Management ReplyWe have high cash-on-hand. We get questions from investors on how do we plan to use our money.
We have already bought 10% stake in CS Amber Development and extended an unsecured loan.
5.125% Genting bonds were bought for S$4.5 mln. These bonds have a very low risk of defaulting because of strong and consistent earnings of Genting group.
The reason we have booked these bonds as a non-current asset because they are perpetual bonds. From the outset, we wanted to hold it for the long-term.
US interest rates were very low when we bought these bonds. Along the way, the sentiment has improved so Treasury yields are going up.
So we felt we should sell before the bond prices fall. When we sold these instruments it's still a net positive gain than if the cash had stayed in the bank. We just pared down. We didn't sell all. We don't have a need for the cash.

Investor Central's follow-up question: If such is the risk, why not sell all the bonds?

OKP's reply: The yields that we're getting from the bonds are higher than the fixed deposit rates.

Question

7. Can we have the schedule for changes in 'property, plant and equipment', please?

We are scratching our heads to figure out the changes in company's 'property, plant and equipment' during FY12.

It began the year with an S$18.7 mln balance.

It bought S$4.5 mln and sold S$0.2 mln, and reclassified S$3.1 mln worth of properties as 'investment properties' during the year.

Therefore that should leave us with S$19.9 mln in 'property, plant and equipment' as on December 31, 2012, before adjusting for depreciation.

After deducting S$3.3 mln for depreciation, the net value at the end of year should work out to be S$16.6 mln.

But the company's balance sheet carries it at S$19.2 mln as on December 31, 2012.

This is a difference of S$2.6 mln.

Did they make an error, or did we miss something?

Sorry, but unlike schedules for other items in the Balance Sheet, the company did not share a schedule for 'property, plant and equipment'.

Also, the cash flow statement (page 23) shows that the company had a cash inflow of S$185,000 from additions to 'property, plant and equipment' during Q4.

We couldn't get our heads around this item because the cash inflow is not from a disposal - that is recorded separately in the cash flow statement.

Management ReplyWe will provide when available.
We have reclassified some PPE to intangible assets in 4Q2012. Therefore, "additions to PPE" and "additions to intangible assets" should be read in conjunction with one another (net cash outflow = S$185,000 - S$353,000 = -S$168,000).

Question

8. Why didn't it payback 'trade creditors'?

OKP Holdings has written off S$0.8 mln 'trade creditors' during Q4 and S$1.3 mln during FY12.

Did it suddenly score discounts?

Or negotiate lower fees after having received their suppliers' invoices?

Management ReplyThe sub-contractor had not requested for payment since 2002.

Question

9. Why is it not writing off 'goodwill' on its books?

OKP Holdings continues to carry S$1.7 mln 'goodwill' on December 31, 2012, unchanged from previous year.

It elaborates (on page 17) that the 'goodwill' represents excess of price paid over net asset value of subsidiaries acquired during IPO.

Therefore that makes us wonder why the company is not writing off the goodwill even after 10 years since its IPO in 2002.

Management ReplyLiquidation of two subsidiaries - job completed, but took a long time to close that. Now starting to write off the goodwill. But not likely in 2013.

We have adopted FRS103 in FY2004. Under FRS103, goodwill shall no longer be amortised. Instead, an impairment test is carried out annually or more frequently if events or changes in circumstances indicate that there may be impairment.

Investor Central's follow-up question: Sorry, but can you please clarify - was goodwill related to two subsidiaries acquired at the time of IPO? And both these subsidiaries were liquidated later (after many years)? If the liquidation is now complete, why won't the company write off complete goodwill (instead of 'starting to write off goodwill' after 2013) as those subsidiaries no longer exist? Also, how much gain/loss did it suffer on this liquidation?

OKP's reply: In our case, the subsidiaries in question satisfied the annual impairment test and as such, the goodwill continues to remain on our books.

Question

10. Why did it pay income-tax twice what it provided for?

OKP Holdings Ltd made an income-tax provision of S$0.3 mln for Q4 and S$2.2 mln for 2012.

But it actually paid income-tax of S$1 mln in Q4 and S$5.4 mln in FY12 (refer cash flow statement on page 23).

Management ReplyProvisions were made based on profit in FY12 but the actual payment was based on income in FY11.

We thank the management for their response.


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