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Tug-Of-Fools: Vibrant Group – The Bear Argument
Corporate Digest | 03 October 2014
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By: Shane Goh
Articles (99) Profile

Following the bullish case of Vibrant Group by Motley Fool Singapore, this is my bear case for Vibrant Group.

From an income statement standpoint, Vibrant looks like every growth investor’s dream while its rising dividends every year for the past five years would look attractive to income investors.

However, behind every darling, we have to be wary of any cracks that may pull down the firm like a house of cards.

In Vibrant’s case, I propose four areas of caution:

  1. Shrinking Profitability
  2. Potential Interest Rate Rise
  3. Negative Operating Cash Flow
  4. Questionable Diversification

Rising Margins, Falling Returns

Over the past five years, Vibrant’s gross margin went through a roller coaster ride from 31.3 percent in FY10, to a low of 24.5 percent in FY12, before returning to 31 percent in FY14.

At the bottom line, the company’s net margin has climbed steadily from 11 percent to 22.3 percent during the same period.

Helped further by a surging turnover from $125.8 million in FY10 to $191.4 million in FY14, the firm’s net income has flourished and grown at 32.5 percent compounded annual growth rate to reach $42.7 million.

However, Vibrant’s profitability, as measured by return on equity (ROE), has peaked at 17.6 percent in FY12 before sliding to 11.9 percent in FY14. Since we know that net income has been expanding, it means that equity must be increasing at a faster rate.

A glance at the company’s balance sheet will show an improvement in share capital and retained earning every year for the past five annum. Additionally, in FY14, Vibrant issued a 7.35 percent per annum $100 million perpetual securities.

This has led to a more than doubling effect on equity from $145.3 million in FY10 to $358.4 million in FY14. Alarmingly, debt has tripled in that period, pushing its total debt to equity percentage from 39.6 percent to 60.7 percent.

Source: Capital IQ

Usually when debt expands, a company’s ROE tends to improve as it’s using ‘other people’s money’ to fund its business.

However, Vibrant’s narrowing ROE means that despite the increased leverage position, it’s not achieving higher profitability.

Potential Interest Rate Hike

To compound the situation, in its latest quarter ended 31 July, total debt has grown by a further $120 million to $337.5 million as the firm sought financing for its part-acquisition of Equity Plaza and purchase of Cecil House. The move has lifted its total debt to equity percentage to 92.3 percent.

Interest coverage ratio, which divides operating profit by interest expense, is a measurement of a company’s ability to meet its debt obligations. Vibrant’s interest coverage ratio (excluding accretion of deferred revenue and gains on sales of investments and assets) has tumbled to 0.2 in FY14, from 2.3 a year earlier. In the last-twelve-month period, the ratio rose slightly to 0.4. As a rule of thumb, companies should have a ratio above 1.5 to be comfortable.

As the company borrows from local banks, we should understand where domestic interest rates are headed. Singapore’s interest rates take guidance from its US counterpart. With the end of quantitative easing in the US, the US Federal Reserve has hinted at a potential interest rate hike six months after completion of the unwinding (i.e. 2H15).

Based on Vibrant’s total debt as of 31 July, a 25 basis points upward shift in interest rate would result in an additional interest expense of $0.8 million. For comparison, its interest expense for the last 12 months was $7.5 million. If the $0.8 million was included, the firm’s interest coverage ratio would thread closer to 0.3 instead.

Negative CFO

Apart from the interest rate, another financial health check is a company’s cash balance. Vibrant’s cash and cash equivalent has risen from $38.5 million in FY10 to $83 million in FY14. However, how much of it was generated from its business?

Cash flow from operations (CFO), the money a company brings in from regular business activities, has posted two deficit years in the past five years. If we sum up the CFO over that period, we’ll end up with a net amount of $18.5 million.

But we know that cash grew by $44.5 million instead. This means the remainder had to be raised by debt, as seen from the substantial growth in cash flow from financing activities in the past three fiscal years.

In most cases, we would prefer a company to build its cash balance with its business, as opposed to taking on more debt as the latter represents an artificial growth of cash.

Diversification; For Better Or Worse?

Since inception in 1981, Vibrant has been focused on providing integrated logistics solutions. It also has a real estate arm that provides build-to-suit lease properties and building management.

Atop, Vibrant is the sponsor of Sabana REIT. The trust’s portfolio includes high-tech industrial and chemical warehouse and logistics properties.

All its services are complimentary to the mainstay logistics division.

However, in June, the firm invested in commercial properties via the purchases of Cecil House and Equity Plaza.

This can work two ways. Either the management has spot opportunities to spread its risk and add a revenue stream into its turnover mix, or it faces limited options in the logistics space to continue its growth.

While its freight and logistics division has shown steady top line and operating profit growth over the past five years, it remains to be seen if the investments in commercial properties will pay off. The risk here is the lack of experience in this field.

SI Research Takeaway

Legendary investor Peter Lynch spoke about ‘diworsification’ where a company diversifies too widely and risk destroying its original business as management time, energy and resources are diverted away. This will be the key concern for Vibrant’s commercial properties foray.

On the income statement front, Vibrant paints a rosy picture. However, we need to look further into its other financial statements to pick up potential thorns.

Disclaimer: The author owns a stake in Vibrant. 

Currently pursuing his Chartered Financial Analyst qualification, Shane provides coverage on the property, consumer and environmental sectors at Shares Investment.

Please click here for more information about this author.

Sabana Shari'ah Compliant REIT  0.450 -- --   
Business: Trust established principally to invest in income-producing real estate used for industrial purposes in Asia, as well as real estate-related assets, in line with Shari'ah invs principles.

Insight: Jan-19, FY18 gross revenue fell 5% to $81m due to ... Read More

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