Why you should take a look at Wellcall?

In this article, I am going to talk about hose, not pantyhose, but the largest rubber hose supplier in Malaysia. Established in 1996, Wellcall is able to manufacture a wide range of high-quality rubber hoses through the mandrel or extruded process (like wow but no idea what is it but it's okay just keep reading).

The company has a global presence and can count customers from the Middle East, Europe, USA, Canada, Australia, New Zealand, Asia, Russia, Africa and South America (which is a good thing as to reduce customer concentration risk). Geographically, the U.S. and Canada are the top revenue contributors at 25% of total revenue.

Extracted from annual report 2018

Before deciding whether to invest in this stock, let's take a quick look on the past financial performance as well as the future growth of this company.

1. Increasing and consistent EPS

I always emphasize that I would prefer to invest in a stock that has a consistent and increasing earnings per share (EPS) over the past 10 years. If you take a closer look on this company, its EPS growth rate is slow but consistent. Further, the consistent PBT growth (13%) is supported by the increasing revenue (6%) and increasing operating cash flow (12%).

However, the rising production costs which mainly pertains to raw material has resulted the operating profit to decline in FY2018, which is one of the key risks that we should be considering before investing. Nevertheless, despite this former concern, we noticed management was still able to retain a healthy profit margin of 29% in FY2019.

2. ROE (>12%) and ROTA (>7%)

All investors like a company with high Return on Equity (ROE) and Return on Total Asset (ROTA). Over the last 10 years, Wellcall has recorded an average ROE of 30%. Its high ROE indicates the business is of high quality, but the fact that this was achieved without leverage (see point 3) is truly impressive.

3. Low D/E ratio

The ideal debt over equity (D/E) ratio is preferably below 0.5. Wellcall has zero borrowings and its liabilities are mainly related to trade and other payables.

4. Does the company have long-range outlook in regards to profits?

(i) Diversification/new products

In April 2019, Wellcall set up a JV company, Trelleborg Wellcall Sdn. Bhd. (“TWSB”) with Sweden's Trelleborg Holdings AB. This enabled Wellcall to diversify into a new market segment where Trelleborg will contribute the technology know-how in manufacturing of composite hose.

Composite hose is lighter with flexible structure and it is mainly used to transfer petroleum and chemicals (I will explain further below). The market segment for the composite hose would expect to target the ASEAN region. The operation is expected to commence in 2Q2020, though I do not expect any significant earnings during the year.

(ii) Future outlook

Rubber Hose is widely used by many industries and hence remained strong especially Wellcall has the ability to streamline their process flow for products customization. Coupled with the strong Research & Development (R&D) capability in Wellcall, they are able to meet customers’ various technical specification and requirements and hence allows ample room for expansion.

Next, the new segment - composite hose represents a niche but extremely high-opportunities in years to come. Based on Stratview research, the market for composite hoses is forecasted to grow at an impressive rate over the next five years to reach an estimated value of US$ 354.0 million in 2024.

These hoses are more suitable for applications situated in highly vibrating regions and for conveying the highly corrosive chemicals. The oil & gas and chemical industry increasing preference of composite hoses over their counterparts are the major factors spurring the growth of the market, though we have to admit the coronavirus pandemic has disrupted maintenance and growth of oil & gas projects and refineries.

Nevertheless despite the current trade war between China and US, as a homegrown Malaysia company, Wellcall could be able to touch base the potential market in both nations since China being one of the largest producers of chemicals and petrochemicals, whereas US is one of the largest producers of oil & gas in the world.

5. Low CAPEX for maintenance of current operation?

For a manufacturing company, there will definitely be high initial CAPEX cost during the company set up. Since Wellcall has been a seasoned market player in the industry across the years, it has already established a strong infrastructure and manufacturing capacity.

In FY2019, RM 3 million was spent to purchase a single storey factory for expansion, which concur with our desired business model where profit retained will be reinvested for expansion or R&D.

We further drilled down the annual report and noted only RM 2.5 million out of its net profit (RM 37 million) was used for maintenance and upgrading of older production lines to improve productivity. Hence the maintenance costs constitute approximately 6.8% of profit, which we deem reasonable.

6. Share price trend

Share price is slowly growing despite several share split across last 10 years. Currently share price has entered an uptrend recovery stage, which could be an excellent opportunity to stock up this share.

7. Conclusion: To buy or not to buy?

The future of Wellcall is promising with its new product launching soon. Sometimes it is not the profit margin of the past but those of the future that are more important to the investors.

As a value investor, I would prefer to enter when the stock falls below its intrinsic value:

a) Fair value (include 33% margin of safety) = RM0.79

b) Discounted cash flow = RM1.00

c) Based on Earning method = RM0.75

*Intrinsic value is calculated based on my personal valuation

Feel free to share with me your opinion below :)

Disclaimer: I am neither an expert nor certified trader, and the views contained in this post should not be taken as an indication to buy or sell. I will not be held liable for any gains or losses incurred as a result of one's individual investing decisions after reading this post.

#financial #investing #analysis #wellcall