At the Fool, we believe that in order to find good shares to invest in, one has to start with figuring out how strong a company’s business is. And to do so, we can turn to the Rule Maker framework outlined by Motley Fool Chief Executive Officer Tom Gardner in his book Rule Breakers, Rule Makers. The Rule-Maker Framework Here’s how the framework looks like: Is the company selling low priced, everyday items? How does the business’s gross margins look like? What about its net margins? Is the company’s sales growing? What about its cash to debt ratio? Is its Foolish…
At the Fool, we believe that in order to find good shares to invest in, one has to start with figuring out how strong a company’s business is.
And to do so, we can turn to the Rule Maker framework outlined by Motley Fool Chief Executive Officer Tom Gardner in his book Rule Breakers, Rule Makers.
The Rule-Maker Framework
Here’s how the framework looks like:
- Is the company selling low priced, everyday items?
- How does the business’s gross margins look like?
- What about its net margins?
- Is the company’s sales growing?
- What about its cash to debt ratio?
- Is its Foolish Flow Ratio (a gauge of how fast the business can bring in cash) strong?
- Lastly, what’s your level of familiarity and interest with the business?
Figuring out SembCorp Industries
With that, let’s run SembCorp Industries Limited (SGX: U96) through the framework today.
For some background, SembCorp Industries has two main business segments: Utilities and Marine. In particular, the latter is represented mostly through Sembcorp Industries’ majority ownership of marine-engineering firm SembCorp Marine Ltd (SGX: S51).
You can read more about SembCorp Industries in here.
Here’s a quick rundown of SembCorp Industries with the Rule Maker framework (numbered in the same order as the seven criteria above):
- As a supplier to the oil and gas sector, the marine segment of SembCorp Industries thrives on large projects ordered by its customers. Those typically wouldn’t be low cost projects that are ordered on a daily basis and this runs contrary to Tom’s criteria. Revenue from the marine segment is important as it made up 53.5% of Sembcorp Industries’ total sales in 2014.
- The gross margin for SembCorp Industries in 2014 came in at 12.9%.
- For 2014’s net margin, SembCorp Industries clocked in at a healthy 10%.
- The nature of SembCorp Industries’ marine business means that its overall top-line can be volatile. This can be seen in how the company’s revenue fell 8.4% to S$8.76 billion in 2010 and then jumping some 12.6% to S$10.2 billion in 2012. Growth wise, Sembcorp Industries’ revenue in 2014 is up a mere 13.8% compared to 2009, representing an annualised growth rate of just 2.6%.
- As of the end of 2014, SembCorp Industries had $1.66 billion in cash and equivalents, and $4.73 billion in borrowings. This gives a cash to debt ratio of 0.35 times, which is well below Tom’s desired ratio of 1.5. Foolish investors will need to keep an eye on the level of borrowings that the company is taking on.
- As of the end of 2014, SembCorp Industries had $1.66 billion in cash, $6.13 billion in current assets, and $5.36 billion in current liabilities. This gives a fairly good Foolish Flow ratio of 0.83. Part of the reason is the proportionally larger payables (money Sembcorp Industries owes) compared to its receivables (money the customer has yet to pay).
- The depth and scale of projects that SembCorp Industries undertakes may require a strong technical background to have full understanding of their competitive advantages. Furthermore, as a company with stakes in the utility and marine sector, SembCorp Industries may require more time to wrap your head around.
Putting a company through the Rule Maker framework can help you size up the type of opportunity at hand.
With SembCorp Industries, the bad news is that the firm has a fairly volatile revenue base (mainly due to the marine segment) and a current cash to debt ratio that is not ideal.
The good news though, is that SembCorp Industries has been able to leverage on its scale to grind out a net margin of 10% – that’s important given the firm’s high level of borrowings. Meanwhile, the company’s also doing a fair job of hanging onto the cash that flows through its coffers and has even been able to generate free cash flow for some years; the ability to generate cash from its business may help Sembcorp Industries pay off those borrowings it has.
As a final note, it is important understand that no one company is perfect.
With the characteristics defined above, the onus remains with the Foolish investor to decide if Sembcorp’s current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.
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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 doesn’t own shares in any companies mentioned.