Action Asia Ltd. (Singapore SGX A59)

Action Asia Ltd. (“ActionAsia” or the “Company”) is a Singapore listed company involved primarily in the assembly of video and DVD players for vehicles (mostly cars, also buses) as well as portable DVD players and other similar gadgets. The Company is an OEM supplier primarily to three companies: Audiovox, Zenith and Thomson. Action Asia is principally owned and managed by a Malaysian family, with manufacturing facilities in Malaysia and Guangdong. Over 50% of the shares are held by a related Taiwan listed company, Action Electronics.

While the ratios presented below may appear attractive, the company in 2009 was deeply cash-flow negative on an operating (pre-investments) basis primarily due to end-of-year accounts receivables that were nearly 4x higher than in 2008, dividend payout dropped from 35% to 15% (and dropped by 20% in dollar terms), and to fund investments and remain cash positive the company had to obtain S$69 m in short-term financing, quite likely from a related entity as no terms were disclosed in the accounts other than that the loan is unsecured. Note that the days receivable and days payable figures below take the average of the last two FYE accounting periods. Taking only the last FYE figures, days receivable and days payable would be 130 and 56 days, respectively.

There are three serious corporate governance issues (discussed in addition detail below) that investors should be aware of: 1) Company has made a request to change auditors; 2) Company requests grossly excessive discretion on non pre-emptive and pre-emptive share issuances (20% and 50%, respectively) with no limitation on discount; 3) Some years FYE company accounts as well as the Company M&A document are not available online at Company website or at SGX.

Evaluation of the Sector, Overall Business Model and Company’s Position within the Sector

The macro characteristics of in-automobile and portable DVD and video players are not compelling. Although demand is likely to grow (in line with growth of vehicle sales), DVD and video players are regarded as low-margin, generic products. Also, these single-use players may over time be threatened by touch-screen computers able to perform many more functions.

The Company’s sales are over 80% attributable to the US, where it supplies units (primarily in-automobile video and DVD players) to 3 clients that constitute approximately 80% of sales. The company’s largest customer is Audiovox, a US-listed company with a very poor profitability record. In two of the last 6 years, including in 2009, Audiovox was loss-making. The Company’s two other key clients, Thomson and Zenith, are also regarded as low-end electronics suppliers. These three key clients in turn rely heavily on sales to US hypermarkets, particularly Wal-Mart. Wal-Mart is infamous for its ability to squeeze margin out of its suppliers.

Action Asia is probably a “price taker” rather than a “price maker” on all of the products it manufactures as it is likely to compete with dozens of factories (particularly in China) manufacturing similar (if not identical) products. The company strategy described in its 2004 IPO prospectus has only partially been fulfilled, as the company has not succeeded in diversifying its customer base or geographic distribution of sales. However, this is a volume business and the company has been successful in increasing volumes and improving operating margins.

The Company’s heavy reliance on the North American auto sector is a potential area of concern. The Company’s strong sales in 2009 may have been largely attributable to US Federal stimulus packages to facilitate the sale of new vehicles. In the next several years most growth in new vehicles is likely to take place outside of North America, where the Company does not currently have established sales channels.

The Company is geographically dispersed. Its listing entity is in Singapore, manufacturing facilities are in Malaysia and China, the principal (related) shareholder is listed in Taiwan and significant sales seem to be managed out of Hong Kong.

Labor costs in Southern China (where the Company has a key factory) have recently been increasing. China and Malaysia are both likely to see appreciation of their currencies relative to the US dollar. However these issues may have a neutral impact on the Company as they will similarly affect its competitors.

Internal Evaluation of the Business and its Constituents

The Company is principally managed and owned by family members. From reading company accounts, it is difficult to determine to what degree the company has genuine management depth versus being a one-man show. Overall strategic management and the relationship with three key customers may remain the responsibility of the Non-Executive Chairman, Mr. Peng Chiun Ping.

The company’s shares remain significantly controlled by the family, principally through a Taiwan listed company, Action Electronics.

Since listing, the company has not succeeded in product or geographic diversification and it appears that the Company’s allocation for “R&D” has principally focused on the design and manufacturing of essentially similar products. Going forward, it is unclear where value creation is going to come from.

The Company is a 51% shareholder of ASD Electronics Limited, a Hong Kong company involved in sales and marketing of the Company’s products and incorporated in 2005. On the basis of disclosed payments to minority shareholders, in FYE 2009, 29% of net profit appears to be attributable to ASD (versus 52% in 2007). In the Company’s FYE 2005 accounts, the Company did not disclose why it is not a 100% shareholder of ASD and whether the 49% minority shareholders are connected parties.

Viability of the Business Model

The Company seems to have what it takes to survive in the narrow sense of producing a very limited range of commodity products at a volume and being able to retain key buyers. However, management has not demonstrated their ability to reduce the concentration risk of buyers by diversifying into other geographies and other products. No information is provided by management to indicate whether they have significant advantages in cost or scale vis-à-vis what are likely to be many existing and potential low-cost competitors.

The Company’s overall debt position is low and P&L margins appear to be healthy, although the negative operating cash flow, largely the result of working capital issues, raises concerns on the sustainability of margins. Management’s decision to reduce the dividend payout ratio may also reflect this concern.

Company’s Desire to Improve Value and Governance

There’s nothing in the published information by the company to indicate a strong desire for improvement in operations, ramp-up in valuation or improvements in governance. The latest accounts (dated March 1, 2010 and obtained from SGX website) have no discussion on strategy. The inter-related company holding structure is a potential risk for value-stripping.

The quality of disclosed management reports is poor, suggesting the possibility that management has lost interest in the listed company. There are 3 corporate governance “red flags” that investors should take note of:

• “Resolution 6”(due for vote at 21 April 2010 AGM) to change Auditors from Deloitte & Touche to PriceWaterhouseCoopers. Changes of auditors should always be viewed with suspicion

• "Resolution 7” (due for vote at 21 April 2010 AGM) empowering Directors excessive discretion in issuing new shares with no limitations on the discount. Both the amount of share issuance discretion (up to 50% with pre-emption) and the lack of limitations on the discount of shares are unacceptable. To add insult to this potential injury, management also seeks permission to issue up to 20% of shares (at any price) without pre-emption rights. Totally unacceptable. In the UK, pre-emption rights are only waived in respect of issues for cash which are a maximum of 5% of the company in any one year, with a 5% maximum discount to market price.

• Previous years’ annual reports are missing at both the Company website and at the SGX website. It’s pathetic that SGX would not have all annual reports available for download since the 2004 IPO. Likewise, the company’s Memorandum and Articles of Association are not available online for download (although a summary does appear in the prospectus).

The FYE 2009 accounts show a marked deterioration in the Company’s working capital situation with insufficient explanation as to the reasons.

The Company has not adequately disclosed the strategic rationale in only being a 51% shareholder of ASD Electronics Ltd., the Hong Kong based sales and marketing company, and whether the 49% shareholders are related parties.

Note: for more information on proper corporate governance regarding pre-emption rights, readers are encouraged to visit webb-site.com and in particular the following articles: Project Vampire and Status of Shareholder Rights in Hong Kong, both written by David Webb.

Ajinomoto Malaysia Berhad

Ajinomoto Malaysia Berhad (the “Company”) is primarily involved in the production and sale of monosodium glutamate salt (“MSG”) and a variety of snack foods. The Company primarily serves the Malaysian market with some exports to the region and the Middle East. The Company was founded in 1961 and remains 50% directly owned by parent company Ajinomoto Co. Inc of Japan and most of its raw materials are sourced from the parent and other affiliated companies. 

Evaluation of the Sector and Business Model

Ajinomoto seasoning was invented in Japan in 1907 and patented by the company in 1908. The combination of loss of patent around 1930 followed by WW II disrupted growth, but following WW II the company continued to grow in spite of gradually losing its market share. Currently the Ajinomoto group companies supply an estimated 25% of the world’s MSG and Ajinomoto remains the price leader, although it is not able to set the price. MSG prices have dropped significantly over the last 15 years as China has become the world’s largest producer and consumer (over 50% of global production and consumption comes from China and recently global consumption has dropped to 69% of production). Aside from Ajinomoto and a Taiwan based producer, the global MSG market has become highly fragmented.

Due to aggressive production increases of MSG by competing factories in China, the margin of supply over demand has increased significantly in spite of continued price cutting. In Malaysia the Company has diversified into condimented snack foods, soups and flavored food enhancers, however company accounts do not indicate the breakdown.

China leads the world in per-capita annual consumption of MSG (1.2 KG) and Malaysia’s consumption is probably far lower and continuing to grow (in 1987 Malaysia’s consumption was estimated at 137 grams).

MSG is often suggested to be unhealthy; however numerous independent studies have been conducted with none concluding that it is dangerous to health. Although high consumption of sodium is generally unhealthy, it is not likely that per capita consumption of MSG, at least in emerging markets, will stop growing in the medium term.

Although MSG was originally produced from seaweed, today it is primarily produced by fermentation of starch, sugar beets, sugar cane or molasses. Significant price fluctuations in these raw materials have been a challenge to all MSG manufacturers over the past several years.

Internal Evaluation of the Business and its Constituents

Ajinomoto Malaysia Bhd is a subsidiary of Ajinomoto Co. Inc. of Japan, with 50% of the Company’s shares held directly by the Japanese parent, active senior managers seconded by the parent company and most of the cost of goods being attributed to purchases from the parent company.

The financial and operating performance of Ajinomoto Malaysia has been superior to its parent. This is probably because the Malaysian market continues to have more growth potential than Japan and also because the parent company has diversified into a wider range of areas (such as pharmaceuticals) with mixed success.

The company appears to be well run in terms of operations, employee relations and its understanding of the market; however its capital structure is too conservative (it operates on zero debt in spite of reasonably predictable sales and costs) and senior management does not display ambition to aggressively grow the business organically or through acquisitions. Much of the retained earnings seem to be sitting in cash and increasing inventories.

However, management has succeeded in a 9% 5 year CAGR of net income in spite of strong price competition from China-made MSG, raw materials price volatility and a challenging local economy. However, this rate of growth was probably slightly under the growth rate of the market. In FY 2009, gross profit and EBIT were below the previous year’s results, although much of the industry also saw declines.

Although competitive pressure will probably continue, particularly as the perceived and actual quality of China-made MSG improves, pressure on the Company may alleviate due to rising labor costs in China and the possibility of a strengthening RMB.

However, it’s difficult to envision the company doing anything to significantly grow above the overall rate of growth in the market. The last 5 years of annual reports read like carbon copies describing the “difficult market environment” but there are otherwise not many signs of urgency coming from management as to how the company will tackle market challenges to seek greater market share and profitability.

Viability of the Business Model

The Company has demonstrated its ability to survive and adapt, although it remains to be seen whether management has what it takes to make the company prosper. The company should focus on seeking growth as opposed to merely maintaining market share. Profit margins, averaging under 9% over the last 5 years, could probably be better.

Fundamentally one has to ask what the rationale is for this subsidiary company to continue to exist as a listed entity, given the limited growth prospects and how small the company remains. In South East Asia the parent Japanese company retains no less than 14 large subsidiary companies. One could perhaps see strong rationale for consolidating these companies under a listed holding company headquartered in Singapore (consolidate expenses, attract regional professional managers, develop region-specific products, etc.), however the strategic rationale for retaining this listed company is difficult to see, particularly given the very limited mandate that seems to have been given to management.

This will probably remain a “muddle-through” stock in the years ahead. The defensive qualities of the product and the management could merit consideration at the right price, but probably not at a P/E approaching 10x, given the apparent lack of urgency by management to pursue growth and improve profit margins.

sources: company accounts, company websites, ft.com, sriconsulting.com, food-info.net, wikipedia.com