Haw Par Corp: Money hiding in plain sight

I got introduced to a value stock recently, Haw Par Corporation (HPC) with ticker code H02. I took a look and liked what I saw. As a result, I decided to collect some of its shares. In this post, I will describe my thinking process behind it.

As usual, please take my words with a pinch of salt. I have vested interest in the company. I am also just a DIY investor and may be totally wrong.

With the disclaimer out of the way, let’s examine what the company does.

Company Background

HPC is perhaps best known as the manufacturer of Tiger Balm, a traditional Chinese medicine brand. However, HPC is primarily an investment company first and foremost. Tiger Balm comes next, then tourist operations third. The following pie charts show where HPC earns income from.

Source: Haw Par Annual Report 2019

First of all, HPC owns a substantial number of UOB and UOL shares. In case you are unfamiliar, UOB is one of the big three local banks in Singapore and UOL is a property developer in Singapore. These 2 companies make up the blue chunk in the pie charts.

For the healthcare segment, the company manufactures products behind the Tiger Balm brand. This includes ointments, mosquito repellents and pain relieving patches.

For my analysis, I ignored the tourist segments and focused only on the larger 2 groups. But before that, let’s take a look at HPC’s figures.

Source: Morningstar, author’s work

(A) Is the Company Profitable?

Yes, based on the past decade’s earnings per share (EPS) data, the company is profitable every year. The profits fluctuated significantly around 2014-2016, but it is generally on an uptrend. You can see it in the top left plot, blue line.

(B) Are the Profits Real?

This part is really interesting. I think that the profits are not real – they are significantly understated. It is not because HPC wants to evade taxes or the managers are rigging the stock price, but because they are bound by an accounting rule to do so.

If you don’t have a background in accounting, this may be confusing. HPC owns less than 20% of all the shares of UOB and UOL, so accounting policies dictate that HPC records only dividends from the 2 subsidiaries as income. HPC is supposed to ignore the retained earnings that the subsidiaries keep. Furthermore, as the subsidiaries stock prices increase (because they retained the earnings over time), HPC doesn’t put that into its income statements.

This way of looking at companies is flawed in my opinion, but it is an accepted convention. Think about it, if company A and company B owned 19.9% and 20.1% of UOB respectively, their declared income statement will look very different! Company B’s earnings will look like it is more than double that of company A’s! If I based my investing decisions purely on raw numbers without digging deeper, I will likely overvalue company B and undervalue company A even though both perform roughly the same.

If you don’t believe me, inspect the financials yourself. From 2011 to 2019, the HPC retained $3.60 of profits yet somehow, the book value per share grew by $5.10 (blue line, top middle plot). Where did the surplus come from? It is because as the subsidiaries retained more earnings, their stock prices will naturally rise (unless they screw up badly). HPC will chuck the capital gains into a not-so-small portion of their balance sheet as reserves.

(C) Are the Profits Sustainable?

In the short run, the declared profits are not sustainable. Just last week, the MAS forced Singapore banks to cut dividends for prudence’s sake. However, I am not concerned about short term performance or declared accounting profits. I am more interested in long term performance and the company’s true underlying performance.

In the long run, this is strongly dependent on UOB, UOL and Tiger Balm’s performances. While I am more pessimistic about a property developer like UOL, I hold the opinion that Singapore banks are sustainable businesses. Tiger Balm is also doing extremely well.

Source: Haw Par Annual Reports 2019 and 2015

I think overall, HPC as a business should not do too poorly in the future.

(D) Is the Stock Cheap?

On paper, HPC looks quite expensive compared to its subsidiaries. I pulled up HPC’s current PE ratio on Yahoo Finance and saw that it was 11.3 on 30th July 2020. As compared to UOB’s PE ratio of 8, one would think that HPC is overvalued with respect to UOB. Is it really true though?

Remember, the accounting earnings understates true earnings. As a result, the declared earnings are irrelevant.

If I recalculated the earnings from UOB and UOL in full in 2019, here’s how much each company contributed to 1 share of HPC
Earnings per share due to UOB: $0.86
Earnings per share due to UOL: $0.19
Earnings per share due to Tiger Balm: $0.33

The total EPS should be $1.42, ignoring the property and leisure segments.

Using the current stock price of $9.28, the trailing PE ratio of HPC’s core is an epicly low 6.5. This means that once the underlying businesses recover to pre-COVID19 levels, I will recover the amount I invested within 6 years.

Using another perspective, let’s say I manage to buy over all HPC shares and sell the UOB/UOL shares. How much would it cost?

HPC has 74.8M shares of UOB and 72.0M of UOL shares. Based on how much the shares are selling for on 30th July 2020 (UOB for $19.39 and UOL for $6.62), I calculated the stakes to be worth a combined $1.93B.

Big numbers tend to be mind boggling, so I’ve divided them down by the number of shares that owns HPC. It is way easier to see things on a per share basis. Since HPC consists of 221M shares, the UOB and UOL shares combined are worth $8.73 for each share you own in HPC.

Effectively, I would spend $9.28 per share today to buy HPC, then recover $8.73 per share through the sale of UOB/UOL. The balance of $0.55 per share is what I paid for the Tiger Balm divison.

Is that a good or bad price? Tiger Balm made $0.33 per share last year and is still growing!

It is an absolute steal. A PE ratio less than 2 for a growing segment!

(E) Is the Manager Track Record Good?

I don’t know enough about the management team, but the board chairman is a certain Wee Cho Yaw. Enough said.

Additional Remarks

I inherently don’t really like to invest in property developers, especially UOL since it derives two-thirds of its earnings from Singapore. However, I take it as a necessary evil for me to get my hands on HPC’s healthcare divison really cheaply. Even if I wrote off the UOL segment in full, the Healthcare division alone would be worth paying for.

If you have access to CFDs and want to buy Tiger Balm cheaply without getting yourself exposed to UOL, you could buy HPC outright, then short UOL proportionately to your interest through HPC. I am not so sophisticated so I will just eat the whole piece.

Conclusion

With each investment, I always learn something new.

If you are interested and want to find out more, look for Warren Buffet’s teachings on a concept called look-through earnings or owner earnings.

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