Although Muda Holding Berhad had an impressive dividend paying record, the annual capital expenditure required just to keep the revenue growing/remain the same every year resulted in a negative Return on Investment Capital (ROIC) , which is a strong sell signal.
Before the analysis
1. The myth of earning after tax number.
The earning after tax number reflect the earning on the capital employed by a company in a particular year. It takes into account the historical cost of asset deploy to generate the revenue (registered under depreciation/amortization) but do not consider the cost of maintaining the production capacity (ie, the replacement cost). As a result, a company that adopt aggressive recognition of depreciation/amortization accounting practice will have inflated earning at the end of useful life of property, plant and equipment. But that earning (often retained ) will not be transformed into real cash disposable by the owner as long as the company need to reinvest in order to stay in the business.
As always, i will try to illustrate it with following examples.
Case 1,
Company A start with a fixed asset which cost = RM 10 million. The fixed asset has useful life of 10 years. Each year, after charging 1 million as depreciation cost, company A registered profit after tax of 1 million.
Question: How much is the company worth now?
Answer : Less than RM 10 million. Since the company will only generate return for 10 years ( assuming no reinvestment of property). The total return receive in nominal value by the owner of the company is RM10 million. Discounting the cost of capital ( the income forego by investing the same amount into Fixed Deposit ), the Present Value of the company will be less than RM 10 million.
Case 2,
Now , supposed that instead of distributing the RM 1 million into shareholders fund, the company opted to retain the earning by reinvest it to maintain the production capacity of the company after 10 year. How much would the company worth now?
Answer : The company worth only the aggregate fair value of the property, plant and equipment and nothing more. Fair value is not equal to historical cost. Most often, manufacturing plant and equipment will sell at value far below their historical cost, while only land and building might registered an appreciation.
Now, it can be shown clearly that in both case, the company net worth is less than the stated net asset value. The inflation, will raise the cost of replacement of property, plant and equipment, while imposing a tax on "manufactured" appreciation of land and building. A retain earning is not an earning unless it can produce market value more than that.
2. The concept of ROIC,
Taking into the cost consideration for the company to remain in business, Warren E.Buffet proposed a concept in reviewing the actual earning power of a company.
Return on Investment Capital (ROIC) which is Owner Earning/Invested capital.
owner earnings = (a) reported earnings
+ (b) depreciation, depletion, amortization,
- ( c) the average annual amount of capitalized expenditures for plant and equipment
It should be noted that, in the financial statement, the direct cost of acquisition of property, plant and equipment will not reflect the total capitalized expenditures. In fact, most of the capital expenditure will be recorded as asset under capital work in progress item.
The concept of ROIC will put company under rapid expansion program in disadvantage, but it nonetheless serve its purpose in indicating the real cost of expansion.
The Key Parts.
| 1 year | 3 year | 7 year | |
| Price | 0.785 | ||
| NAV | 2.069 | ||
| ROE | 0.029 | 0.065 | 0.054 |
| EPS | 0.056 | 0.116 | 0.087 |
| PER | 14.071 | 6.796 | 9.022 |
| Dividend | 0.025 | 0.025 | 0.024 |
| ROIC | 0.029 | -0.048 | -0.020 |
| OEPS | 0.056 | -0.079 | -0.033 |
| POER | 14.071 | -9.988 | -23.890 |
At initial glance, the ROE look unsatisfied but still in positive, the PER ratio and Price to book ratio shows that the share might be undervalued. However, after adjusting for owner earning item, the ROIC, OEPS all show negative number.
Not to mention, when the company is showing accounting profit after tax of RM26 million (including the effect of tax benefit ), the board of director take home a package of average RM 4.5 million.
One would wonder, whether the expansion of the company serve the interest of the management more, or the shareholder's interest more.
Disclaimer
The data above was taken and calculated according to information supply from the company's quartery report and annual report available at the Bursa Saham website.
The author bear no responsibilities of any buying/selling action of the investor, and any profit/loss incur by the investor.
Muda Bursa Saham Website
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