“WE STRIVE to be a living company” - this vision of Inter-Roller Engineering captured my attention when I flipped throught its annual report 2006.
I wondered: What in the world is a living company? It’s not entirely alien to me as I had encountered this phrase in a book “The Dhandho Investor: The Low-Risk Value Method to High Returns.”I had also heard of the highly-rated book, “The Living Company”, and I decided to surf to eBay to buy it.It’s on how companies could be run for long-term success, and this would be my bed-time reading for the next few weeks.I suspect that for many companies having a vision
Book focuses on habits for suvival in a turbulent business environment. is not much of a deal. I wasn’t so sure about Inter-Roller, though.Its people are its key assets, as reflected by the staff costs (at S$29.6m for FY2006) being almost 20X more than the cost for depreciation for its tangible assets (S$1.5m for FY2006).Inter-Roller has a very profitable business and it has produced lots of free cash flow from 2002 to 2006.Based on the free cash flow over equity for the past five years, the return was approximately 15%. I thought that this was good considering that many companies are not able to produce any meaningful free cash flow in the first place.
Inter-Roller’s core business is mainly in developing airport logistics systems such as:* Airport Baggage Handling Systems;* In-flight Catering Systems;* Air Cargo Handling Systems; and* Express Courier Handling Systems.Inter-Roller has had a good track record arising from its success in Changi Airport, the latest being its installation of its baggage-handling systems in Terminal 3 and Budget Terminal. The company has expanded out of Singapore to become a global company.Over 89% of its revenue was generated outside of Singapore in FY2006 compared to 76% in the previous year. China contributed 46% of the Group’s turnover while Middle East, 27%. This seems like a truly internationalising SME.Creating lots of shareholder value
Revenue growth of Inter-RollerWith high ROE, free cash flow and a strong position in the industry, Inter-Roller has created lots of shareholder value by returning most of its unused cash back to shareholders.
Rare among Singapore-listed companies, it has been paying dividends every quarter from the start of FY 2006.This is fantastic as we have seen so many cases of companies destorying shareholders’ value by buying non-core businesses and eventually having to write the investments off. Inter-Roller, however, is a project-based company, getting one project at a time with no recurring income after the project is completed.This means that past success may not be repeated, especially the massive increase
Net profit growthin revenue from $52.9 million in FY2003 to $147.5 million in FY2006.Will this tripling of revenue within 4 years occur again? The only certainty is that revenue and profit could be lumpy as project awards are irregular.I surmised that this was the reason Inter-Roller’s share price plunged from over $1 to around $0.60 after it announced that its profit from its main business and net margins dropped in 1H2007.
Net profit was $19.8 million (+48%) but it included a a hefty $10.6 million net gain from the sale of investment properties.When I checked through its annual reports and research reports, I learnt how wonderful the business environment had favoured Inter-Roller over the past years.My observations:
Market capitalisation has also boomed
1) The key catalyst was the upgrading of security in airports post 9-11. Many airports began upgrading their systems after years of under-investment in this area. The Aviation and Transportation Security Act was established to ensure that all US airports screen baggage for explosives. New baggage systems would require 100% baggage screening (Explosive Detection System or EDS), which was unheard of in the 80s.
2) The impending launch of the Airbus A380 required upgrading of baggage handling systems. I was told by a fund manager that this type of massive flying machine requires a faster bag handling system to cope with the higher number of passengers and freight per flight.Inter-Roller’s system was chosen for the new Changi Airport Terminal 3, where there are 135 check-in positions, and over 6 km of belt conveyors. It can handle over 20 million passengers a year.
3) The recovery of Asian economies after the 1997 currency crisis, and the emergence of the Chinese and Indian economies have all resulted in higher passenger and cargo traffics in this part of the region.
4) The number of budget airlines is growing and this has led to second-tier airports being constructed to cater to them. The Singapore Budget Terminal and KL Sepang Low Cost Carrier terminal are examples.
5) Crude oil price has increased five-fold over the last five years, leading to a boom in the economy in the Middle East. With a gush of new wealth, countries there are investing in infrastructure.About US$30 billion is expected to be invested in airport infrastructure over the next 15 years as passenger traffic is set to grow from 29 million in 2004 to 78 million by 2010.
These are many of the factors that are in Inter-Roller’s favour. Amongst them, I would consider the emergence of Middle East and China as the key factor.Just look at the numerous world-class airports that they are building in each and every city. Inter-Roller has had a slice of the expanding cake: It did part of the design and construction of the baggage handling system for the new terminal in Beijing Capital International Airport.The system consists of more than 300 check-in counters, 13 km of transport conveyors and can support 60 million passengers a year.Before I knew it, they got another contract to support FKI Logistex in the Shanghai Pudong International Airport. That system has 392 check-in counters!Boom in airports in China
Demand for baggage systems is high in China where the number of airports will grow to 230 by 2020, compared to 142 now.The outlook is rosy: The civil aviation authority in China is forecasting the number of airports to grow to 230 by 2020, compared to 142 airports currently. It looks like there is going to be quite a bit of work for Inter-Roller. Most recently, Inter-Roller announced a S$58-million contract to support FKI again in Doha International Airport in Qatar. The system will handle 24 million passengers annually.
Aside from its core business, Inter-Roller has an investment division that buys and sells equities and properties. Its latest transaction in commercial offices has yielded a fabulous return.
But this is not its core business – and certainly not what investors are looking for.So what is going to be the next catalyst for this company?It is obvious that it has made little progress in the Europe and North America markets, even though there are over 18,000 airports (including commercial and military airports) in the United States alone.Not every airport is big enough to be a client of Inter-Roller. A good estimate would be around 400 (using the major cities as a guide) which can potentially offer work worth more than S$50 million.If a breakthrough in the US market materialises, it will enable the company to elevate its status to that of the main contractor and allow it to stand tall with industry leaders like Siemens, Vanderlande and FKI Logistex.Such a contract could bring recurring income as the US aviation industry tends to outsource maintaince works due to the higher labour costs. This would provide a strong potential recurring income stream for the company.
In an announcement in November, Inter-Roller said it has bid for a number of projects in different parts of the world and it was still busy preparing for new bids. "Some of these projects are promising and the Group is confident that it would secure more jobs in the coming months."
Now that Inter-Roller has established a track record and successfully put itself on the radar screens of major airport operators, the next step would be to beef up its financial muscles so that it can take on bigger projects.The company recorded revenue of $147.6 million in FY2006 and $105 million in the first nine months of 2007.Shareholders’ equity was $93 million as at 30 Sept 2007. Imagine a $50 million contract would account for 50% of Inter-Roller’s nine months’ sales. This would probably deter big airports from awarding the main contractor’s job to Inter-Roller.
Inter-Roller stock's 52-week range: $0.56-$1.36Inter-Roller is a company that generates very high ROE: 37.5% for 2006 and 20% for the previous 5 years (based on cashflow).At $0.60, it is currently trading at slightly over 2x book value, historical PE of about 7.7x (based on FY2006 EPS of 7.81 cents).Over the past 2 years, it has a payout ratio of 67% (FY2006) and 66% (FY2005), which gives a jolly decent dividend yield of over 8% at this price.Total shareholders’ return over a 5-year period is 93%, which ranks among the highest on the Singapore Exchange.
Inter-Roller was founded 38 years ago in 1979 and has established itself in its industry and won investors. Can it continue to grow and fulfil its vision of becoming a “living company” – one that will create a long-lasting business legacy?
I think it has more than an even chance of doing so.
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