Is shares buyback a good thing?

You may have heard of shares buyback but clueless as to what it does. A shares buyback is for all intents and purposes, the purchase of shares of a company, by the said company. To achieve that, a company repurchases its own shares from, in most cases, the open market.

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Photo by Tim Gouw on Pexels.com
What are the effects of a shares buyback?

Every company listed on a stock exchange has a certain number of outstanding shares which are in circulation. When a company repurchases its own shares, it does so with the intent of taking those shares out of circulation. That means, shares are purchased and parked in the treasury of the company. When shares are taken out of circulation, there are lesser numbers of outstanding shares. This makes each outstanding shares more valuable.

Fabled fund manager, Peter Lynch, in his book, One up on Wall Street, approves of shares buyback and has this to say:

“When stock is bought in by the company, it is taken out of circulation, therefore shrinking the number of outstanding shares. This can have a magical effect on earnings per share, which in turn has a magical effect on the stock price. If a company buys back half its shares and its overall earnings stay the same, the earnings per share have just doubled. Few companies could get that kind of result by cutting costs or selling more widgets.”

To illustrate, Company X has 100 outstanding shares and made RM10,000.00 in profits, in a particular year. That equates to an earnings per share (EPS) of RM100.00. However, Company X embarked on its shares buyback programme and repurchased 50 outstanding shares. Hence, there are only 50 outstanding shares left and each share is more valuable because each share has an EPS of RM200.00 (instead of an EPS of RM100.00).

Shares buyback and payment of dividend are perceived as fulfilling the same agenda, i.e. rewarding shareholders. Dividend payment disburses a portion of the profit of the company to shareholders, and is tangible. On the other hand, share buyback is rather an intangible reward to shareholders because its aim is to increase the “value” of your shareholding, making it more “valuable”.

As for me, I’d rather have my dividends, unless I can have both.

What are the criteria for shares buyback?

Firstly, for a company to embark on a shares buyback program, it must first have the means to do so i.e. ample cash lying around. This is because cash is obviously required to purchase shares in the open market. This can be interpreted as a good indication that a company has a good cash reserve to buyback its shares unless that means is supported from borrowings (which is never a good thing). Apple recently took advantage of the preferable taxation cuts to repatriate cash which is stored away, from the USA, to buyback $100 billion worth of stocks. Obviously, it has a stockpile of money to burn.

Secondly, it must satisfy itself that it has no immediate use for the cash which may generate more value than shares buyback. For example, if a company had the resources to expand its production or to diversify into another business, where great wealth can be made, it should utilise those resources, as capital for that venture, instead of buying back shares.

Lastly, shares buyback must be done when share prices are reasonable and that the company should never overpay for the shares repurchased. A company may choose to repurchase shares especially when share prices are low – a plan which is adopted/proposed to be adopted by Malakoff, MYEG and George Kent.

On top of shares buyback, Malakoff is also offering a generous dividends, which for me, is a great bonus.

Conclusion

Shares buyback is also a good indication to gauge the performance of a company’s managerial decisions. If shares buyback is initiated at a wrong time or for a wrong purpose, it is very likely that management decisions are impacted for an ulterior or incompetent reason which may be detrimental.

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Analysis of Oceancash Pacific Berhad

Oceancash Pacific Berhad (“Oceancash“) is a manufacturer of two product lines, being:

  1. Felts.
  2. Nonwoven fabrics.

Oceancash has over 20 years of manufacturing experience and expertise, and is currently listed on the ACE market. It is, however, seeking a transfer to the Main Market in the next quarter of 2018 as it has met the requirements for a transfer. Such transfer will require the approval of shareholders. From the reading of its Q4 FY2017 report, the company had already incurred listing transfer expenses. Hence, it appears that the transfer is in motion.

Oceancash Pacific Bhd

Felts 

Felts are textile materials which are made by interlocking the fibres through the process of compression, heating or chemical bonding (using resins) which causes the fibres to mat together, thus creating a textile. Felts can be made out of natural fibres such as cotton and other synthetic fibres.

felts
Felts

The felts produced by Oceancash have many uses especially for:

  1. heat insulation and sound insulation in automobiles;
  2. noise insulation for compressors of split unit air conditioners;
  3. roof insulation; and
  4. carpet underlay.

Oceancash manufactures and supplies about 60% of felts into the local market, thus making it the biggest supplier of felts in Malaysia. Felts produced are mainly supplied to the automotive and air conditioning industries. This makes Oceancash’s earnings largely dependent on the performance of those industries.

Oceancash’s felts are also exported to overseas markets like Thailand, Taiwan, the Philippines and Australia. In terms of overseas market share, Thailand takes the cake for being the largest importer of felts. This comes as no surprise considering Thailand has Southeast Asia’s biggest automotive assembly industry.

The contribution from the insulation segment has been stagnated since 2012. In FY2016, the insulation segment only contributed to 27% of the company’s top line. And in FY2017, that contribution dropped to 23%. This stagnated pattern is a bleak reflection of a weaken automotive industry in Malaysia, Indonesia and Thailand. Consequently, the company postponed the transfer of one of its production lines from Malaysia to Thailand in 2016.

To soften the bleak outlook in the automotive industry, the company has been stepping up efforts in the air-conditioning industry for some reprieve.

Despite the shrouding negativity, the automotive industry in Southeast Asia is predicted to improve in 2018.

Nonwoven fabric 

Nonwoven fabric is a broad categorisation of fabric where the fabric is manufactured without undergoing the process of weaving or knitting, unlike most textiles with which we traditionally associate. Like felts, nonwoven fabric can be made by bonding the fibers through a mechanical, thermal or chemical process.

nonwoven fabric

Nonwoven fabrics are supplied to manufacturers of diapers, sanitary napkins, wet wipes and surgical caps, masks and gowns. The trend overseas is heading towards a more comfortable and softer fabric for diapers and sanitary napkins which require air-through nonwoven fabrics. Better margins can be obtained from air-through nonwoven fabric too. Oceancash is hopeful that the overseas trend would compel local diapers and sanitary napkin manufacturers to follow suit.

More than 80% of its nonwoven fabrics are being exported overseas to Japan, its biggest export market, followed by Thailand, South Korea, China and Indonesia.

In FY2017, the hygiene segment contributed 67% of the company’s revenue. This is an increase from 63%, in FY2016. Overall, the hygiene segment has enjoyed strong performance since 2012.

The focus of the company lies with its hygiene segment. That segment is expected to be a main driving force behind revenue and earnings in the foreseeable future. Hence, the company, in 2016, acquired spooling machines to increase its capacity to manufacture premium grade nonwoven fabrics, at longer length. This will contribute to better margins.

Financials
DATA FY2016 FY2015 FY2014 FY2013 FY2012
REVENUE (RM’000) 83,686 79,425 72,808 68,581 58,876
OPERATING PROFIT (RM’000) 11,416 10,818 7,005 8,466 5,412
PROFIT TO SHAREHOLDERS (RM’000) 10,188 8,723 4,914 6,503 2,621
SHAREHOLDERS’ EQUITY (RM’000) 75,245 66,007 58,053 59,249 43,876
DEBT (RM’000) 28,141 26,288 21,624 22,783 24,528

RATIO

DEBT TO EQUITY RATIO 0.37 0.39 0.37 0.38 0.60
OCF RATIO 0.48 0.55 0.60 0.56 0.25
OPERATING PROFIT MARGIN (%) 13.64 13.62 9.62 12.34 9.19
PROFIT MARGIN (%) 12.17 10.98 6.75 9.48 4.45
EPS (CENTS) 4.55 4.00 2.20 2.92 1.18
EPS (ADJUSTED) CENTS 4.55 4.00 2.20 2.92 1.18
DPS CENTS 0.7 0.7 0.6 0.4 0.3
DIVIDEND PAY OUT (%) 15.38 17.50 27.27 13.70 25.42
P/E 8.64 11.13 13.18 5.31 9.32
ROE (%) 13.54 13.22 8.47 13.20 5.97

The top line of the company experienced a steady increase from RM58 million, in FY2012, to RM83 million, in FY2016. In FY2017, revenue increased to RM89 million – another milestone for the company.

There is an overall increasing trend, in profitability and profit margin, which is in line with the company’s increasing revenue. Do note that profit fell from RM10.1 million, in FY2016, to RM9.8 million, in FY2017. Further profit margin fell from 12.1%, in FY2016, to 11%, in FY2017. The reasons for the decrease are higher operating costs and transfer listing expenses.

The company does not pay an outstanding dividend because it has its eyes set on growth. I’ve discussed the advantages and disadvantages of dividend stocks [See: Dividend stocks or not? That is the question]

The company’s operating cash flow ratio, within the range of 0.50 to 0.60, is sufficient to manage its debt to equity of about 0.40.

Return on equity is respectable, at about 13%.

Cash balance and retained profits are also on the increasing trend, as per balance sheet.

Potentials

The disposable nature of hygiene products allows for a high turnover and recurring revenue. Products such as adult diapers are fast becoming modern day necessity. They are popular in Japan due to the hectic lifestyle of young carers, and the increasing aging population. The aging population in China and India could also potentially contribute to revenue in the future. However, there may be a certain social stigma attached, in societies outside of Japan, to the idea of using adult diapers. On the other hand, infant disposable diapers are already essential modern day necessity.

In the automotive front, the marriage between Geely and Proton is touted to potentially jump start the production of Proton and other Geely-related brands of cars. This collaboration is positive for Oceancash especially when Geely is planning to utilise Proton’s Tanjung Malim, as its manufacturing hub, for its cars, for exports within the Southeast Asian region. Tanjung Malim has a capacity to manufacture 1 million cars per annum and is greatly underutilised at the moment. Whatever it is, I don’t think that there will be much profit to be made in supplying parts to Proton especially when Proton had specifically requested suppliers to reduce their prices by 20%.

The general outlook in the Southeast Asian automotive industry, at least in 2018, looks bright.

Risk

Being such an export-oriented company, Oceancash’s business is affected by currency exchange fluctuations, especially USD/MYR, albeit minimal.

Further its business, especially the insulation segment, is highly dependent on the business cycle of the automotive industry.

In the Western world, makers of nappies are leaning towards biodegradables which have a smaller environmental impact than regular nappies. As the market caters to more environmentally conscious consumers, biodegradables would, in the future, be a preferred choice over regular nappies. A failure to put emphasis on biodegradable R&D would be detrimental to the company. Currently, the company has no biodegradable properties in their nonwoven fabric, as per their website.

Conclusion

Overall, I think the business-side of the company is intact and viable because of its association with modern day necessities such as cars and hygiene products.

When news broke out that Proton were to be merged or acquired by a foreign car company, the share price of Oceancash rallied in April 2017 and peaked at RM0.78 in November 2017. However, the rally has since fizzled. Share price is steadily declining, currently range-bound between RM0.51 to RM0.54. Further, last quarter’s (Q4 FY2017) lower-than-expected result added salt to injury. Nonetheless, Oceancash’s share price has declined about 35% from its peak, thus presenting an opportunity to take up a position in this company. However, I’m sticking to a wait-and-see approach and would only consider buying when its share price drops lower.

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Disclosure

I do not own shares in this company.

Disclaimer

This analysis is published for your casual and leisurely reading and is not a recommendation to buy, sell or hold shares and must not be relied upon as a financial advice. You are encouraged to seek your own financial advice.

Reference:
  1. http://www.oceancash.com.my/
  2. Q4 FY2017 quarterly report
  3. FY2016 annual report.
  4. FY2015 annual report.
  5. http://www.theedgemarkets.com/article/oceancash-seeks-transfer-listing-main-market
  6. https://www.thestar.com.my/business/business-news/2017/04/04/cimb-research-starts-coverage-of-oceancash-pacific/