1 Seemingly Dirt-Cheap Stock That Actually Hides Some Huge Risks

Offshore support vessels builder Nam Cheong Ltd (SGX: N4E) could be a stock that would pop up on the screens of deep bargain hunters in Singapore’s stock market.

At yesterday’s market close, Nam Cheong’s shares closed at S$0.093, giving it a market capitalisation of S$195.0 million. Now, Nam Cheong’s market cap alone tells us nothing about how cheap it is.

But if we compare Nam Cheong’s market cap with its net current asset value (total current assets minus total liabilities) of S$200.3 million, that’s when the company can be said to have a really low valuation.

Nam Cheong's NCAV
Source: S&P Global Market Intelligence

A stock with a market cap that’s lower than its net current asset value is known in investing parlance as a net-net stock. A net-net stock is also a great bargain, theoretically. That’s because investors can get a discount on the company’s current assets (assets such as cash and inventory) net of all liabilities. To sweeten the deal, the company’s fixed assets (assets such as properties, factories etc.) are thrown in for free.

But, net-net stocks can come with huge risks. It’s often the case that net-net stocks are companies with businesses that are in deep trouble, which would explain their low valuations.

In Nam Cheong’s case, the fall in the price of oil from over US$100 per barrel in mid-2014 to around US$50 today has hit its business hard. In the first-quarter of 2016, the company had logged negative revenue and suffered a loss in the process. This compares with the profit of RM39.3 million it earned in the first-quarter of 2015.

That’s not the only issue. The company has had trouble generating cash flow from its business; in the five years from 2011 to 2015, Nam Cheong had generated positive operating cash flow in only three years. Moreover, the company’s total operating cash flow in that five year block had been a negative RM503 million.

Investors might also want to pay attention to Nam Cheong’s total current assets. Of the S$988.3 million in total current assets that Nam Cheong currently has (as of 31 March 2016), some 63% of that is in the form of inventory. Thing is, Nam Cheong’s inventory consists largely of the costs incurred for the offshore support vessels that it is building. Given the weak market conditions now in the oil & gas industry, there’s a chance that Nam Cheong may not be able to fully recover from its customers the costs of the vessels it’s constructing.

This puts into question the real market value of Nam Cheong’s inventory and could potentially shrink or completely eliminate the value-gap that currently exists between the company’s market cap and net current asset value.

Investors who are interested in Nam Cheong because of its low valuation might want to pay attention to the risks of (1) the company’s inability to generate operating cash flow, and (2) any potential discrepancy between the accounting and real economic value of the company’s inventory.

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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 companies mentioned.