Description

Why is Tan Chong International (TCI) Worth Your Attention?

• Tan Chong International is a HK$5.44bn (~US$736mm) market cap company whose primary business is distribution of automobiles in ASEAN, China, Hong Kong and Taiwan. The company is off the radar of many investors with no analyst coverage partly due to low liquidity, making it ideal for smaller mid cap value funds
• The stock is very cheap, as the company has a 1.4% stake in Subaru Corp (TSE: 7270) and 53.2% of ZERO Co., Ltd. (TSE:9028) (which is worth 46% and 15% of TCI’s market cap respectively) and both investments intrinsic value over the last few years has increased, while TCI stock has not. Moreover, if we adjusted the reported 0.5x P/B  by revaluing its properties, we conservatively estimate it to be 0.3x P/B, giving us a cheap stock with a margin of safety. On a earnings multiple, it is also cheap at just 11x earnings in FY18 considering the overseas operations (China, Thailand) are witnessing top-line growth and recovery.
• Discount to NAV is near all-time highs at nearly 60% although book value has grown nearly every year - The company has compounded book value by 9% CAGR for the past 13 years, with a positive growth in 12 years, while share price has lagged, leading to a widening gap in valuation
• Capital allocation / disclosure: Management has made multiples on their investment in Subaru and Zero (2-4x), which indicates good capital allocation. Disclosure is not the greatest, but incrementally has improved. 
• Chairman’s son, Glenn Tan, has taken the helm since late 2017, and he seems more open to unlocking shareholder value through increased dividends or disposal of asset

What does the company do?

• Vehicle Distribution & Dealership (60% of FY17 Revenue and 42% of EBITDA): TCI distributes automobiles, both passenger and commercial, across 10 countries in Asia – Singapore, China, Hong Kong, Thailand, Taiwan, Malaysia, Vietnam, Philippines, Indonesia and Cambodia
• Their main brands are Nissan (only in Singapore) and Subaru in all their markets
• Transportation (35% of FY17 Revenue and 36% of EBITDA): Through its 53% stake in Zero (TSE: 9028), the company offers vehicle transportation and logistics in Japan
• Property (1% of FY17 Revenue and 15% of EBITDA): TCI owns 7 investment properties which it leases out for rental income
• Others (4% of FY17 Revenue and 7% of EBITDA): Manufacture and sale of vehicle seats, provision of workshop services and other JVs

Why is it ignored by the market?

• Family owned – The Tan family collectively owns ~70% of the shares and they are seen as “sleepy” and extremely conservative
• No sell-side coverage – With such a low trading liquidity, there is no incentive for analysts to spend time understanding this multi-faceted company
• Poor disclosure of financial assets – Up until FY16’s annual report in 2017, the company did not breakdown its financial asset holdings, masking the management’s investing acumen
• Drastic improvement of domestic operations was masked by collapse of overseas operations, particularly China and Thailand – We believe TCI is at an inflection point, especially once its CKD plant in Thailand starts production in 2019

Hidden assets

• TCI has been acquiring land for decades, currently sitting on 39 properties excluding 15 properties owned through its stake in Zero. This gives us a significant margin of safety, even if we do not revalue its non-investment properties
• Investment Properties: 7 properties held at market value of HK$3.4bn
• Other Properties: 32 properties held at cost less accumulated depreciation of HK$3.9bn. Based on our primary research, these properties could be worth between HK$6.1bn to HK$8.3bn
• Key properties: The company has two properties in Singapore that are not crucial and are worth HK$1.7 based on extremely conservative estimates or HK$4.2bn if we use more realistic figures

911 & 913 Bukit Timah Road (198,606 sq ft):

• Showroom and head office in Singapore  
• We visited the site on multiple occasions and found it mostly empty. According to one of their salesmen, closing this showroom would barely impact the company’s overall sales in Singapore. 

• Currently, TCI has 5 showrooms throughout Singapore, a figure which we think is excessive based on the country’s size, especially for anyone who resides in Singapore (it takes ~45 mins to go end to end)
• Property in Bukit Timah can range from SGD$1,200 to SGD$2,200 per sqft which would put the market value of this building between HK$1.4bn to HK$2.6bn

• For comparison, TCI also owns a 200,991 sq ft condominium (Wilby Residence) that is a stone’s throw away (3 mins by walking or 1 min by car according to Google Maps) from this showroom. The company has 3 freehold properties outside HK that is classified as investment – Wilby Residence and 2 others which are much smaller (combined for 30,045sq ft). These 3 properties have a market valuation of HK$2.5bn and their Bukit Timah condominium is by far the most prestigious area out of the 3 locations. We can infer that the Wilby Residence is worth at least HK$2bn

700 Woodlands Road (233,188 sq ft):

• Classified as workshop and office
• One of nine workshops throughout Singapore
• While not as valuable on a psf basis as Bukit Timah, we feel this huge property is extremely under monetized as well

• On a standalone basis, TCI could probably fetch S$200 per sqft. However, as seen from the picture above, the land is surrounded by residential property that could sell for S$800-1,200 at current valuations. It would be safe to assume the property’s value would fall in the range of HK$273mm to HK$1.6bn (if fully developed)

Domestic Vehicle Distribution – Singapore

• In its largest market, Singapore, the group is the sole distributor for Nissan and Subaru

• Since its peak of HK$5.3bn in 2005, TCI’s Singapore sales declined steadily and bottomed out in 2013 due to a conscientious decision by the government.
• For a brief background, the government utilises Certificates of Entitlements (COEs) to control the number of vehicles in Singapore. This COE gives the holder the right to own a car for 10 years

• In 2009, the government decided to start reducing the COE quota (blue bar in the chart above). For the next 5 years, the growth of COE quota was negative before picking up in from 2014 to 2016
• Finally, growth has been tapering off since 2016, and the government actually announced 0% growth in COEs since 2018. From our primary research, the market views this as a big negative but actually it is not as bad as the street thinks because the government is guaranteeing that COE growth will not be negative

• Bringing it back to TCI, Nissan and Subaru have seen car sales pick up drastically from the trough in 2013. Over the same period, sales from Singapore have tripled, going from HK$1.41bn in FY13 to HK$4.33bn in FY17 (representing 42% of core operations)
• Subaru – Good reputation for safety and handling, quite affordable considering its quality. From speaking to the company, they have a good portfolio lined up and we believe Subaru’s market will only continue to grow
• Nissan – Value brand, comparable to Toyota, has been losing market share but TCI has been actively working with Nissan to make their cars more appealing to Singaporean tastes
• Based on the information available to us (flat COE growth and strong portfolio of Subaru cars), we believe that TCI should be able to grow Singapore’s sales at low single digits on average. As long-term value investors, we prefer lumpy 15% growth over a steady 10% growth

Overseas Operations – Recovery finally in sight

• As shown in the evolution of geographical exposure, TCI created their international businesses from scratch over the past 15 years – definitely a sign that management knows how to create value in our eyes
• China (11% of core operations) – TCI has dealership rights for Subaru in certain provinces and owns a car seat manufacturing business. In FY14, the company had a one-off change from distributor to direct retailer, causing a 43% yoy decline in sales. The next problem that TCI faced in China was tighter emission regulations which led to a 29% decline in FY17 sales. In response, the company launched some restructuring initiatives which are starting to bear fruit and will launch more eco-friendly models. Additionally, the group has started to expand its client base for the seat manufacturing business which also gives them the added benefit of reducing customer concentration. Finally, China has announced a cut to imported car tariffs from 25% to 15%, allowing TCI to price their cars more competitively
• Thailand (5% of core operations) – 51% yoy revenue drop in FY17 from HK$1.14bn to HK$0.56bn because i) Subaru sales were impacted by regulatory changes and added competition, ii) Scaling down of loss-making truck distribution operations and reduced headcount by 25% (good to see that management is rational and willing to cut loss-making businesses). In addition, TCI established a JV with Subaru (TCI owns 74.9%) in February 2017 to build a CKD factory in Thailand which will distribute Subaru vehicles across ASEAN. Production is on track to commence in 2019, which could be a hugely beneficial
• Others (41% of core operations) – Grouped in this segment are operations in Philippines, Taiwan, Hong Kong and Malaysia. Others have been steadily growing under the radar from HK$1.16bn in FY12 to HK$4.26bn in FY17 with strongest growth in Taiwan and Philippines where they were able to both grow volumes and expand profit margins. We believe that once these countries reach a significant size, the company will split and report each country individually, giving investors greater clarity on the success in these regions

A word on Japan – Zero Co., Ltd (TSE: 9028)

• Although TCI doesn’t have any motor distribution business in Japan, it derives 35% of its revenues from Japan through its 53% stake in Zero (worth ~HK$680mm)
• Zero is the largest automobile transporter (both new and second-hand) in Japan. Its main client is Nissan has started customer development activities to expand its customer base. This segment is 73% of revenue and 79% of EBIT in FY17
• Besides automobiles, it also has a human resource business and a general cargo business (mainly coal handling and loading)
• Not a “sexy” business but very stable throughout the economic cycle – New cars are popular in a booming cycle and second-hand car sales will do well in a recession
• We think Zero won’t be a multi-bagger, but it should continue compounding and outperform the general Japanese market.
• After TCI got control of the company, they told the management to run it like their own business, leading to share price doubling in 3 years. Once again, this demonstrated TCI’s investing acumen and managerial style – delegating responsibility to capable people

Value of Continuing Operations including Zero

• Our conservative DCF estimates were:
  • Revenue growth of 0% growth in Singapore, 1% in Japan, 3% growth in China, Thailand and 5% in Others
  • Constant EBIT margin ex-Subaru dividends of 5.2% (even though results of restructuring have been bearing fruit in FY17)
  • WACC of 7% and Terminal Growth of 1%
  • Cash of HK$3.44bn
• Estimated EV of HK$9.98bn or HK$4.96 per share which implies 73% upside versus current share price of HK$2.87

Value of assets give us downside protection

• Listed securities portfolio of 1.4% of Subaru worth HK$2.4bn as of July 2018
  • 53% of Zero worth HK$681mm is not included because management has indicated that position to be strategic, hence we included it in our DCF
• Debt: HK$4.35bn (including financial leases and obligations)
• Investment properties: HK$3.4bn
• Other properties: HK$3.9bn (base) or HK$6.1bn (conservatively revalued)
• Total value of assets:
  • Bear case – HK$5.44bn or HK$2.70 per share (property is not revalued)
  • Base case – HK$7.57bn or HK$3.76 per share (property is conservatively valued)
  • Bull case – HK$9.56bn or HK$4.76 per share (property is realistically valued)

Putting it all together

• Even if we leave TCI’s property as reported, we estimate the company’s intrinsic value to be HK$7.28 = 154% upside
• In our bull case, the intrinsic value of each share could be worth HK$9.34 = 225% upside
• What we like about this company is the huge margin of safety afforded by their tangible assets – Heads you win, tails you don’t lose much type of investment is our ideal situation

Risks to our thesis

• In our mind, the main risk is that the controlling family decides to privatise the company and buyout minority shareholders. Even if they offer a 50% premium to minorities, the value they would get would be a daylight robbery!
• China and Thailand operations do not recover – We do not attribute a high probability of this happening because of the positive macro factors (cut in automobile tariffs in China) and company-specific events (new CKD plant in Thailand will benefit sales in ASEAN region + restructuring initiatives in China and Thailand)
• Losing exclusive distribution rights in key markets – Based on our primary research and conversations with the company, we feel that TCI has established an extremely robust working relationships with Subaru and Nissan that have persisted over decades. In the case of Subaru, they even have an equity stake in the parent company, which leads nicely into the final risk…
• Decline in value of listed securities – The only security we are concerned about is Subaru as we think TCI will never sell Zero, and any decline could be an opportunity for them to accumulate more. In the case of Subaru, there is nothing much we can do to alleviate this risk especially because it is a global automobile company. With all the trade wars going on, we would be lying if we were to say it isn’t a concern. However, Subaru’s multiples are largely reasonable (4x EBIT and 9x P/E) and we are essentially getting this stake for free.
  • Even if we assume Subaru decreases by 50% (highly unlikely) TCI’s stock is still grossly undervalued  

Catalyst

Catalysts

• New CEO, Glen Tan, seems to be more open to listening to shareholders and unlocking value
• Continued ramp up of sales in Philippines, Taiwan and Hong Kong
• Commencement of production from CKD factory in Thailand which will benefit the entire ASEAN region
• Turnaround of China operations
• Disposal of non-core assets, either property or part of Subaru stake