My Bull Case for Straco Corporation (S85)

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Introduction

Straco was my second value-growth stock and has been a large part of my portfolio since then. I remember making my first purchase at $0.60 on 22 April 2014, using my phone app, after having lunch at Food Court 6 at SP’s Business School. Back then, it was near the all-time high of $0.615. Fast forwards to today, Straco has appreciated 50% excluding dividends in the span of roughly 1.6 years. Below are the following reasons why I am still vested in this company and think that there’s still room for growth.

 

The Business

Straco is in the business of development and operation of tourist attractions. Its portfolio includes the Shanghai Ocean Aquarium (SOA), Underwater World Xiamen (UWX), Lintong Lixing Cable Car (LLC), and the recently acquired Singapore Flyer (SF).  Since its listing in 2004, Straco has been  consistently profitable, even during the recession of 2008/09, its earnings grew 14%!

 

The tourism attraction business is simple and understandable. The bulk of the revenues is derived from ticket sales while the bulk of the expenses consist of maintenance, marketing, and labor related expenses. The tourism attraction business requires significant start-up costs which results in large barriers to entry. Furthermore, the tourism attraction business has a large proportion of fixed costs, with minuscule variable costs. Approximately 80% of Strabo’s operating expenses comprises of fixed costs. This means that the company can enjoy economies of scale, higher margins, and ROEs through higher sales volume. 
Due to the strategic location of its attractions and lack of similar attractions nearby, Straco is able to reap benefits of being a pseudo monopoly. For example, Straco is able to raise prices of its ticket by an average of 15% every 2-3 years without dampening demand. This superb pricing power gives Straco a deep and wide economic moat. A great candidate for a long-term investment.

 

Besides the impressive economic moat that Straco possesses, there are also positive growth catalysts for Straco:

  1. Singapore Flyer 2.0 – When Straco announced that they had acquired the Singapore Flyer in August 2014, its shares fell 14% on fears that the supposedly loss-making asset would drag the company down. There was a cover story in the Edge Magazine titled “Wheel of Fortune?” on the SF in 29 September 2014. In summary, the manager of the SF while it was on receivership said that the SF was actually ‘a very good business’ that was poorly ran. Tourism agencies were given steep discounts and too generous credit terms. Tour operators were also found touting and selling their tickets which they obtained at steep discounts to walk-in visitors at the Flyer for profit. Existing rentals were less than 50% of the market rate. Some tenants had not paid their rents for months. There were plenty of unused commercial space and idle function halls. So it was already clear then that the SF was profitable if ran ‘passionately’ but it took 4 more months before the market realised it and bid its share price to an all time high of $1.09. After taking over the SF, Straco has been actively rectifying the above issues and improving profitability. For example, Straco secured insurance coverage at a lower premium, slashed validity period of bulk tickets from 6 to 1 month and the discount to the travel agents.The management has also guided that there will be a major revamp to the SF, expected to commence in 2016, that would cost about $30m over a period of 2 years, with lesser space for retail, more space for F&B, and a new mid-sized attraction added to the Flyer. The new and improved SF will be able to attract more traffic, lease out more space, increase rents and ticket prices. This combined effects would greatly boost the profitability, margins, and ROEs of the SF. SF’s asset size is approximately 2x the size of the rest of Strabo’s tourism assets combined.
  2. Opening of Shanghai Disneyland in 2nd Half of 2016 – Situated in the Pudong New District, which is in the vicinity of the SOA. My belief is that, net-net, the opening of the Shanghai Disneyland will benefit SOA in terms of higher visitor arrivals.
  3. Opening of Chao Yuan Ge in in 1st Half of 2016 – Located at the upper station of the LLC. Straco owns the development rights to build replicas of major buildings from the Hua Qing Palace. Straco also owns the exclusive rights from the State Administration of Cultural Heritage to display relics unearthed from the site. Once completed, Straco can revise its LLC ticket prices by 2x (RMB60-RMB120) since the fare will also include the entrance fee to Chao Yuan Ge.
  4. Completion of renovation works on UWX in  2016 – After completion, Straco can revise ticket prices beyond the current price of RMB90 in 2016.
  5. China’s tourism to maintain rapid growth – China National Tourism Administration reported that China’s tourism expenditure grew 14.5% year-on-year to RMB1.65 trillion in the first half of 2015, while investment in the national tourism industry grew 28% to RMB301.8 billion. It is expected that the industry will continue to enjoy high growth as China enters a new economic phase through reforms and consumers shift towards service consumption.
  6. Singapore to promote inbound travel to Singapore – Singapore Tourism Board will be collaborating with Singapore Airlines and Changi Airport Group on a 2-year partnership to promote inbound  travel to Singapore. The 3 parties will jointly invest $20m to promote the Singapore experience to leisure, business, and MICE audiences in more than 15 markets worldwide.

 

The Management

Straco is currently led by its Founder, Executive Chairman, and Chief Executive Officer Wu Hsioh Kwang. He has a deemed interest of 55.43% of Straco. His spouse, Non-Executive Director Chua Soh Har has a deemed interest of 54.77%. Such significant stakes bodes well for investors as long-term interests of the company are more aligned.

 

Straco’s management has also proved to be efficient allocators of capital. Due to the nature of its business, Straco is able to generate a lot of cash flows. Over the years, the management has showed its rationality in the allocation of its capital in the form of increasing dividends and stock buybacks. Furthermore, prior to the SF acquisition, Straco was without debt. A company without debt cannot go bankrupt. It is only a matter of time before the cash generated from Straco’s operations is able to completely pay off the debt.

 

Strabo’s management has also proved to be shrewd acquirers.For example, Straco bought UWX for $12.5m in 2007, considering its current valuation and the cashflows generated by the business, Straco has reaped a  1,000% return to date. This precedent gives me the confidence that the management knows what they are doing and can turn the SF around well.

 

Year 2010 2011 2012 2013 2014
Revenue (S$’000) 51,571 46,122 55,198 72,840 92,322
Net Profit (S$’000) 18,667 16,526 19,731 34,097 37,688
Net Profit Margin 36.2% 35.8% 35.7% 46.8% 40.8%
ROE 26.02% 20.70% 23.49% 23.35% 21.69%
Cashflow from Operations (S$’000) 26,252 21,584 27,517 35,667 36,994
CAPEX (S$’000) 832 1,299 1,135 1,436 117,665
Free Cash Flow (FCF) (S$’000) 25,420 20,285 26,382 34,231 -80,671
Debt (S$’000) 73900
Dividend Per Share 0.0075 0.0075 0.0125 0.02 0.02

 

The Financials

Straco’s financials are solid, which validates the strength and sustainability of its business and the management’s competence in allocating capital, managing costs, while pursuing growth. Since 2010, Strabo’s revenues, profits, net profit margins, cashflow from operations, free cashflow, and dividends  has been steadily increasing. The cost structure of Straco enabled it to produce high quality ROEs in excess of 20% from 2010-2014 with little to no debt. Due to the little maintenance CAPEX Straco requires, most of its cashflow from operations translates to free cashflow. This is how Straco has been able to consistently pay out more dividends and buyback its stock. Using 2013 FCF figures, Straco can once again become debt free by 2018 assuming no major  CAPEX is incurred.

 

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The Valuation

I first got Straco at a valuation of roughly 14.8x P/E. Now, it is valued at 16.3x P/E. Which means that the share price has slightly outpaced the growth in the company’s earnings. Straco’s earnings grew around 30% after my initial investment. Hence, the source of Straco share price surge had more to do with its earnings growth compared to valuation growth. In my opinion, Straco is still undervalued due to the fact that it has better growth prospects, lower valuations, a stronger balance sheet, and higher ROEs compared to its industry peers. The tourism attraction industry has historically averaged around 20x P/E and I believe Straco should at the very least be trading around that level if not higher. Assuming the growth plans materialises through 2018 (increases in ticket prices, increases in visitor arrivals, and a successful turnaround of the SF), earnings should be able to grow by 15% p.a. for the next 3-4 years. Hence, Straco could potentially be worth $1.68 by 2018-2019.

 

The Bottomline

  • Simple and Understandable Business
  • Clear Growth Plans – Up till 2018
  • Founder-led business with significant stake in business
  • Increasing dividends
  • Consistently buying back shares
  • High Returns on Equity
  • Potentially worth $1.68 by 2018-2019 (Industry Average 20x P/E , EPS CAGR 15%)

 

The Risks

  • Cyclical business
  • Disease outbreak
  • China’s economy slumps further
  • Unsuccessful turnaround of the Singapore Flyer
  • Shanghai Disneyland competes instead of complement

Kenny Chia

Value-Growth Investor

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