Friday, September 14, 2012

Between making money and needing money

Investing into companies that are able to generate cashflow is important. Otherwise, why would we put our money into these companies for, other than for fun betting. There is no harm injecting more cash into these companies, however the trick is whether they are able to pay us back more in future.

As an investor, I have looked at companies in the following 5 categories:
  1. Needs cash but most probably unable to raise them;
  2. Needs cash and able to raise them, but whether the turnaround is achievable;
  3. Needs cash, able to raise them and has proven to succeed many times before;
  4. Produces enough cash but still needs them for growth and expansion;
  5. Produces more than enough cash hence dividends are very high.
Now, let's look at the companies and see what are the traits of these companies in Malaysia especially. What types of companies come under each category.

Type 1: Needs cash but most probably unable to raise them

Who are they: Quite a number of the ACE market companies and some especially the PN17 companies. Most of the times, we bypass these companies as the financial situations of these companies are so bad that it is wise not to even consider buying. Unless the business itself is viable and there are identified parties who are confident enough to turnaround the companies, do not even touch them. Once a while, you would notice that these companies are able to raise some private placement funds but they have become trading stocks i.e. the shares have turned to the hands of market makers or syndicates.

Type 2: Needs cash and able to raise them, but whether they make more is questionable

These companies need funds for growth. They have some believable stories. That's why they are able to raise funds. However, while the plans and business model are believable, the execution sometimes lags. These companies have the ability to raise more funds but unable to deliver. They will continue to churn out more business reasons and investors somehow continue to plow in more funds for them. In most cases, investors are failed by the attempts by these companies to do too much as the business are no longer viable - as there are little opportunities for these guys to have a strong positioning. More often than not, the industries they are in are still attractive but they are not able to dethrone the incumbents. This sometimes makes investments in these companies very frustrating.

Some examples: MAS, Green Packet, Catcha Media. 

Type 3: Needs cash, able to raise them and has proven to succeed many times before

One good example which I can immediately think of is Airasia. A good growth story. However, as the business that it embarks in is a very high capex venture type of model, the business will need more funds. For now the funds are for expansion. In future, if they are done with expansion, they will need funds for replacement of their fleet. Airline business will continue to be as such. No airline will be a pure cashflow generating business by itself as the successful ones will continue to be needing funds.

Once, they have grown to a sizeable and successful business, they would probably be able to grow by themselves without needing anymore equity cash injections. SIA is one example. From there, these companies would have progressed to Stage 4 or Type 4 companies.


Type 4: Those with enough cash for their own growth but will not be able to provide much dividend returns to investors

To me as an investor, this is the most attractive group. These companies have time and again proven to be successful. They have established brand names and strong capabilities to attract good management or they already have the people to successfully execute. Most of the time, models are already in place for growth.
The problem with this group however is that there are always questions on whether they should continue to look for opportunities or stay more conservative and reap the rewards that their businesses are able to provide for. In Malaysia, these companies most of the time are conglomerates. Names such as Sime Darby, Genting, YTL, IOI comes into mind.

Type 5: Strong dividend generating companies

The darling for investors for now. Names such as BAT, Dutch Lady, Digi, Maxis comes into mind. Sometimes, these companies are paying high dividends for a reason. They need to pay dividends or provide more cash for the parent to expand. Hence, on paper while these companies seem to be good growth generating companies, in actual fact the group is still expanding. Digi (parent Telenor), KFC (parent Johor Corp), Maxis ring the bell?

Investors who invest into the ones that pay high dividends however are enjoying potentially lesser growth opportunities but more predictabilities. These type of companies are more predictable as more often than not they are operating in a more stable environment. However, besides the cashflow from the business that they are operating in, more often than not, they are not able to find opportunities elsewhere. That is the reason why they distribute most of their cash.

Which type of companies are you interested in?

2 comments:

Who are we? said...

Type 3 & 5?

felicity said...

Sure. If the company is right. Company is actually more important.