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Friday, February 1, 2019

(Icon) Why DKSH At Current Level Is Less Risky Than Many People Think

Author: Icon8888 | Publish date: Tue, 22 Jan 2019, 12:21 PM

DKSH traded between RM4 and RM6 most of the time. Based on 158 mil shares, the market essentially ascribed it a valuation ranging from RM632 mil to RM948 mil.

Based on historical earning of RM51 mil, it seemed that the market is comfortable with PER between 12 times and 18 times for the company.

However, due to its recent announcement of intended acquisition of Auric Pacific for RM500 mil (yet to be consummated), share price has collapsed to RM2.35 as at today. This translates into market cap of RM371 mil.

Investors have reason to be worried. As at September 2018, DKSH has RM190 mil borrowings and small amount of cash. Plus the RM500 mil borrowings to fund the acquisition, interest bearing debts will balloon to RM690 mil. This is quite a huge amount, as shareholders' funds is only RM586 mil. Gearing will become 1.17 times.

For most people, the first reaction is to shy away, as there is certain degree of financial risk associated with such high gearing.

What happens if there is an economic downturn and DKSH faces liquidity problem ? Will DKSH go into financial distress ?

Not likely. Because they can always do a cash call (rights issue or placement, depends on the price). Swiss major shareholder holds 74% equity interest in DKSH.

Isn't that bad ? Wouldn't that result in expansion of equity base, potentially diluting earnings and ROE ?

Yes, it will.

But if you take a closer look, even if that happens, worst come to the worst market capitalisation will go back to pre decline level.

Let's put in some numbers for illustration purpose.

Let's say DKSH does a rights issue of RM200 mil. That should be sufficient to address the issue as borrowings will be brought down to a more comfortable level of RM490 mil, while shareholders' funds will become RM786 mil. Gearing will drop from 1.17 times to 0.62 times. A relatively conservative and safe level for an established and well run company such as DKSH. (you can do another simulation with RM300 mil cash call, and the gearing will drop to 0.44 times).

What will happen when market cap balloon from the current RM371 mil to RM571 mil post rights issue ?

Nothing bad or drastic will really happen.

This is because based on DKSH's earning of RM51 mil, market had previously accepted a valuation ranging from RM632 mil to RM948 mil.

I know the message is not really that clear at this point, let me elaborate.

The market has penalised DKSH very severely due to the Auric Pacific deal, causing its market cap to decline from RM632 mil to RM371 mil now.

Due to that overreaction, even if they subsequently undertake a rights issue of RM200 mil to RM300 mil, worst come to the worst, you will face stagnation of share price. Share price is unlikely to go further down from current level.

In other words, if you buy at current level of RM2.35 and you are lucky, there will be no cash call, and you can potentially enjoy upside of 100% as share price goes back to as high as RM6.00 pursuant to earning multiple reflation.

If you are unlucky and there is a cash call, you are likely only to lose the opportunity for capital appreciation. There is unlikely to be huge downside risk. Because historically the market has already been comfortable with such market capitalisation based on earning of RM51 mil.

Limited risk, with substantial upside. That is how I see DKSH at current price level.

(If you find my reasoning above incorrect, kindly let me know. As I would also want to take remedial action to correct my mistake. Thank you)

p/s : Cynics will accuse me of intention to pump and dump. Just wait for them to appear.

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