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Tug of Fools: VICOM Limited – The Bear Argument

Charles Darwin regularly tried to disprove his own theories, and the scientist was especially skeptical of his ideas that seemed most compelling. The same logic should apply to investment ideas.

Morgan Housel,

I am Chin Hui Leong and welcome to my bear article for VICOM Limited (SGX: V01).

Before we start, I have a confession to make: I own Vicom shares. So, what am I doing writing a bear thesis? Well, I am also a believer of listening to all sides of an investment story – the good, the bad and what’s in-between.

In my opinion, Foolish investors are better served when they are able to go into an investment with awareness of potential risks and rewards.

With that in mind, let’s lay down our rose-tinted glasses for a moment, and put on our bearish hats, shall we?

Slower growth

According to an AM Fraser report, about one-third of Vicom’s revenue comes from its vehicle inspection segment, which relies on the number of vehicles flowing through the company’s vehicle inspection centres.

Realistically, there will be a finite limit on the number of cars on Singapore’s roads. From the graph below, we can see that the rate of growth in the number of motor vehicles in Singapore is slowing over time – that may eventually affect the revenue growth of Vicom’s vehicle inspection business segment.

Sure, there is the possibility of charging higher inspection prices but still, one tailwind (more vehicles) for Vicom may be more subdued in the future.

vicom bear 1

Source: Land Transport Authority of Singapore

Lower margins

The non-vehicle inspection segment at Vicom makes up the other two-thirds of the company’s revenue, according to AM Fraser. Although sales for this segment may continue to grow, it may come at the expense of lower profitability.

Unlike its vehicle inspection segment’s market-leading position, the non-vehicle inspection segment faces more competition. This could translate to lower operating profits.

We can see this from the last-known official business segment breakdown provided by Vicom in 2011.

vicom bear 2

Source: Vicom’s Earnings Report

As such, it is possible that the overall net income margin for Vicom may decrease in the future if the non-vehicle inspection segment makes up a larger piece of the overall revenue pie.

High dividend payout, slower dividend growth in the future

Shareholders of Vicom have enjoyed years of increasing dividends. However, we should note that the dividend pay-out ratio (ratio of dividend against net income) has been creeping up over time. This is seen in the chart below.

vicom bear 3

Source: Vicom’s Earnings Report

What this means is that the growth in dividends may be less steep than before.

Historically high PE

Despite revenue growth slowing over the past few years (from 8% in 2011 to just 3% in 2014), shares of Vicom have been trading at an elevated trailing price-to-earnings (PE) ratio. As of 22 March 2015, the trailing PE ratio for Vicom was 19.2. As you can see in the chart below, that’s substantially higher compared to the firm’s historical trading range.

vicom bear 4

Source: S&P Capital IQ

This presents a valuation risk in the sense that Vicom’s shares could fall if its underlying business growth was to stall.

So, the question is, can Vicom continue to grow at a reasonable rate over time to justify its current share price? Only time will tell.

I hope you enjoyed following this bear-focused article. Click here for the bullish take on Vicom by my duelling partner.

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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 contributor Chin Hui Leong owns shares in Vicom.