SI RESEARCH: IS TAT HONG HOLDINGS AN UNDERVALUED GEM?

Cranes have been instrumental in the world of construction and the development of human civilisations. It has been about 2500 years ago since the first known crane was invented. On the stone blocks of ancient Greek Temples, archaeologists discovered distinctive cuttings for lifting tongs and lewis irons. These cuttings, dated as far back as 515 BC, became the first blueprints for the modern cranes.

Today, the modern cranes that we use to build our skyscrapers have evolved and we now power them with internal combustion engines or electricity compared to manual labour in the past. But despite the technological advancements, these modern cranes still utilize the same mechanical principles that were developed thousands of years ago.

Shining a spotlight on the crane industry over the last fortnight, Standard Chartered Private Equity (SCPE) Singapore, made a non-binding offer for shares of crane supplier,  Tat Hong Holdings (Tat Hong). It was reported that SCPE might be looking to acquire a 29-percent stake in Tat Hong, at a proposed offer price of $0.50 per share. At the proposed offer price, SCPE is ready to pay a premium of $0.05 per share over the current trading price of $0.45 per share.

The potential transaction proposed by SCPE could spell that the private equity investment arm of Standard Chartered Bank values Tat Hong at more than $0.50 per share (to leave itself some upside right?).  Is Tat Hong really an undervalued gem?

Literally An 800 (Thousand) Pound Gorilla

Established in 1957, Tat Hong gradually grew to become one of the largest crane rental companies in the world. Today, Tat Hong&rsquo s fleet comprises more than 1,500 crawler, mobile and tower cranes, ranging in size from under 50 tonnes to 1,600 tonnes.

According to a survey by International Cranes Magazine 2016, Tat Hong is a true heavyweight, in terms of aggregate tonnage, weighing in as the eighth largest crane rental company in the world and the largest in the Asia Pacific region. Its fleet of tower cranes is also the second largest in China.

Naturally, since land-scarce Singapore does not call for a crane battalion of such size, Tat Hong&lsquo s footprint extends internationally to Australia, China, Malaysia, Thailand, Hong Kong and Indonesia. Notable projects that Tat Hong has participated include: Hong Kong &ndash Zhuhai &ndash Macau Bridge, Fujian Ningde Nuclear Power Station the National Centre for Exhibition and Convention in Shanghai.

Lackluster Financial Performance

Despite Tat Hong&rsquo s impressive backstory, the company&rsquo s recent financial performances have been somewhat lackluster and hence leading to persistent low valuations of its share price. From the start of 2013 to November 2017, Tat Hong&rsquo s shares have fallen from the high of about $1.6 per share to just $0.45 per share.

For Tat Hong, the group&rsquo s financial performance also peaked in FY13, when it reported revenue of $836.9 million and net profit of $70.4 million. Since then, its top line and bottom tumbled downhill, even incurring significant losses in the past two financial years.

In the latest FY17, Tat Hong&rsquo s revenue was roughly half of what it used to be at just $458.3 million while net loss amounted to $38 million. In the preceding FY16, revenue was $528.2 million while net loss was slightly higher at $39.3 million. Unsurprisingly, the group&rsquo s deteriorating financial performance coincided with a period of contraction for construction activities in its key markets such as Australia and China &ndash caused by a collapse in commodity prices. In FY17, utilisation rates of crawler/mobile cranes were as low as 56 percent while tower cranes only clocked in 76 percent.

In the current 1H18, we see continuing weakness in the financial results: revenue was 7.1 percent higher at $242.6 million but gross profit sank 4.5 percent to $66.1 million compared to 1H17. The lower gross margin of 27.2 percent, as compared to 30.5 percent, was attributed to pricing pressures in tower crane rental and its distribution divisions.

What is worrying is that the tower crane rental division pertains to the Tat Hong&rsquo s business in China. In 1H18, although the tower crane rental division saw contributions rise by 9.5 percent to $54.7 million, the supposedly fast growing segment might actually be supported by depressed rental rates. The problem thus could be magnified should construction activities start to slow due to high borrowings and heated housing market in China.



The Positives

Not everything about Tat Hong&rsquo s latest 1H18 results is bad. For one, the group has been undergoing de-fleeting and fleet rationalisation for the past two years.  We saw impairment charges decreasing sequentially and we do not expect full-year impairment charges to be as significant as FY17 (although we cannot completely rule that out).

Meanwhile, the group&rsquo s business is also cash-generating, even during loss-making years. In fact, since Tat Hong was listed in 2000, the group&rsquo s operating activities have consistently generated cash. The group has also been gradually paring down debt since FY14 from $645 million to $420.7 million by 1H18, all while building up its cash reserve which doubled from $58.6 million to $107.2 million during the same period.

As a result, Tat Hong&rsquo s total debt-to-equity has fallen to more manageable level, from 88.6 percent in FY14 to just 68.4 percent in 1H18. Correspondingly, interest expenses also started to fall and hence should ease some burden off its bottom line going forward.

Opportunities are also abound for Tat Hong. For instance, the group can leverage on its established footprints to participate in ambitious mega infrastructure projects such as China&rsquo s One Belt, One Road initiative. Growth prospects are also huge amongst many developing countries in the Southeast Asia region which will also bode well for Tat Hong.

At $0.45 per share, Tat Hong is trading at a price-to-book value (P/B) of 0.58 times or at a deep discount of slightly more than 40 percent to its books. Comparatively, SCPE offer of $0.50, represents a P/B of 0.65 times or a discount of 35 percent to book value. Intuitively, the current share price suggests that the market is not taking into account of the opportunities that Tat Hong could capture.

That said, the rationalisation of the fleet size and the deployment of assets may be paramount in determining if Tat Hong can return to profitability as well as capturing opportunities. But with the group&rsquo s extensive experience in handling cranes, it is not hard to fathom that the business will eventually turnaround. At current valuations, patient investors might just find that Tat Hong is indeed a gem.