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Would Yongnam Holdings Limited’s Shares Rebound In The Future after a Poor 2014?

Yongnam Holdings Limited (SGX: Y02), which provides construction services in addition to the fabrication and erection of steel structures, might catch the eye of bargain-hunters hoping for a share price rebound.

The company has had a horrible 2014, with its shares down 22% for the year from S$0.245 to S$0.189. 2015 hasn’t been kind to Yongnam either, as its shares now sit at S$0.156, some 17% lower than where it was at the end of 2014.

With these as a backdrop, would Yongnam’s shares prove to be a rewarding play for bottom-fishers from this point on? For some hints to the question, we could assess the quality of Yongnam’s business, keeping in mind that it’s a share’s business performance which drives its price over the long-term.

A quick way to gauge the quality of a business could come from a checklist developed by investor Pat Dorsey in his book Five Rules for Successful Stock Investing. Here’re the criteria for the nine-point checklist:

  1. The firm provides regular financial updates, has a long track record as a publicly-listed entity, and has a market capitalisation that isn’t too small.
  2. It has consistently earned an operating profit.
  3. It has generated consistent operating cashflow.
  4. The firm earns a good return on equity.
  5. It has been able to grow its earnings consistently.
  6. It possess a clean balance sheet.
  7. The firm can generate lots of free cash flow.
  8. There are infrequent appearances of one-time charges.
  9. There has not been major dilution of shareholders’ stakes in the firm.

Dorsey had designed the checklist to be completed in 10 minutes so that investors can quickly narrow the field to a list of companies which are worthy of a deeper look. If you’d like some in-depth elaboration as to why these criteria make sense, you can check out my colleague Chin Hui Leong’s work. It’s a three-part series so here they are: Part 1, Part 2, and Part 3.

A company which scores a “no” response to most or all of the criteria is a hint that said-company may be a risky investment and that you’d have to step in with your eyes wide open and be cognizant of all the potential risks involved.

With that, let’s take a closer look at Yongnam’s business.

As mentioned earlier, the firm provides construction services as well as the fabrication and installation of steel structures. Given its market cap of S$201 million, the fact that it has quarterly earnings releases, and that it has been listed since October 1999, Yongnam would check off with a “yes” for Dorsey’s first criteria.

Moving on, this is where cracks start to appear. The chart immediately below plots out a 10-year long history (from 2004 to 2014) of Yongnam’s operating income, net income, operating cash flow, and free cash flow.

And as you can observe, there hasn’t been any real consistency nor real-growth in those four financial figures for Yongnam over the past decade. As such, criteria 2, 3, 5, and 7 would deserve a tick in the “no” box.

Yongnam's operating income, operating cashflow, free cashflow, and net income

Source: S&P Capital IQ

The next chart below shows Yongnam’s returns on equity and key balance sheet figures over the same 10-year period as above.

Although Yongnam has managed to generate really high returns on equity at times – the firm’s return on equity had been above 20% from 2005 to 2011 – this financial metric has shrunk to near-zero levels for the construction outfit in recent years.

In addition, the chart also makes clear that Yongnam’s balance sheet has been weak over the past decade with its debt coming in way higher than cash. From 2013 to 2014, the firm had also seen its balance sheet weaken yet further with its cash position declining and its debt-levels climbing to new highs.

It thus follows that criteria 4 and 6 would also deserve “no” responses.

Yongnam's return on equity (ROE), total cash, and total borrowings

Source: S&P Capital IQ

The pen-ultimate criterion in Dorsey’s checklist is where Yongnam does well as the firm has not really had any one-time “other” charges.

Yongnam's share count

Source: S&P Capital IQ

We’re down to the last point on Dorsey’s checklist and Yongnam does not fare well here either. As you can see in the chart above, the firm had a big jump in its share count from 747 million at end-2006 to 1,217 million at end-2007.

The increase had partly been due to share placements Yongnam had made in 2007 which totaled 243 million shares; the placements were made to raise capital to help shore up the firm’s balance sheet as its gearing was at an appallingly high level of 10.6 at end-2006.

With Yongnam having diluted shareholders significantly in the recent past, criterion 9 in Dorsey’s checklist would be a clear “no” as well.

A Fool’s take

Rounding up the scores, Yongnam has not been up to mark with seven of Dorsey’s nine criteria.

Of course, like I mentioned earlier, Dorsey’s checklist is certainly not the final word on whether a share will be a good or bad investment as other factors, like valuation, would have to come into play as well.

There’s a chance that Yongnam might yet turn out well for its investors in the future. For instance, the firm’s currently in discussions with authorities in Myanmar after a consortium it’s in was selected to build and run the Hanthawady International Airport in the fast-growing country. In Yongnam’s latest earnings release last week, the firm also stated that it’s “currently in active pursuit of S$1.1 billion worth of new infrastructural and commercial projects in Singapore, Hong Kong, Malaysia, and the Middle East.” These projects, if won, can provide a significant boost to the firm’s business.

But that said, given what we’ve seen with Yongnam’s history, investors might want to take a cautious approach. I’d also want to highlight a particular risk with Yongnam’s balance sheet.

Based on its latest finances as of 31 December 2014, the construction outfit had just S$6 million in cash on hand with total borrowings of S$167 million, of which, S$81 million would be due by 31 December 2015.

With such low-levels of cash on its balance sheet and a significant amount of debt coming due by the end of the year, there’s a possibility that the firm may run into financial difficulties in the near future if it can’t refinance its borrowings.

Yongnam does have S$101 million worth of receivables which are supposed to be convertible into cash by end-2015 and that could help with the repayment of the firm’s debt which is due within the year. But the point is, Yongnam’s margin of error is very thin. If there are any problems with the collection of payments from its customers just as it has to repay its borrowings, Yongnam might find itself having to have unpleasant chats with its lenders.

In cases like these, I’m often reminded of the following snippet: “Have you heard of the 6-foot tall man who drowned in a river that’s 5-feet deep on average?

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.