Monday, June 28, 2021

Portfolio Updates (June) - 2022 goal of $583k achieved!

2021 is probably one of those years that you would regret if you had followed the advice to sell in May and go away. Despite the U.S. Consumer price index jumped 5.0% in May, the NASDAQ Composite Index brushed off inflation fears and resumed its bull rally. Hence, many of the tech stocks that I have been averaging down the past few months paid off well, and I have achieved my 2023 goal of $583k!

(1) Growth Portfolio

Recently, the value of my Growth portfolio has surpassed my Dividend portfolio due to the recent stock price appreciation and buying the dips. It will probably be my fastest growing asset which will help me achieve Financial Independence, Retire Early (FIRE) by the age of forty. Although it has been a great month for me so far, I am not resting on my laurels. I will continue to hunt for potential multibagger stocks by spending time to do research as well as divesting the ones with limited growth potential. Other than happily cutting my losses on Serba Dinamik shares, I have sold Salesforce at USD 240 for a 11.21% gain due to opportunity costs. Don’t get me wrong-  I still believe in the future of this company and its management. It is just that Salesforce might not be able to meet my revenue growth expectations. If the history is any guide, the company has been relying on acquisition to fuel its growth.  The CRM leader is projecting growth rate of low to mid 20s (even after acquisition of Slack), which I believe has passed its inflection point in its growth trajectory. With that being said, I may revisit this counter if it drops below USD 200.

I have bought shares of Roblox, Upstart, and Unity this month. Right after my Roblox stock order was filled, came the bad news. The daily active users were down 1% month on month, which some investors believe is a sign of an impending slowdown. The year-on-year growth is still impressive, but given that the stock is trading at a high price to sales ratio, any slight miss in investors’ expectation can send the share price tumbling. Roblox is indeed a beneficiary of Covid 19, as many kids were probably stuck at home during the pandemic and ‘hanging-out’ on Roblox. Hence, last year’s revenue surge was an exceptional one which will likely not be repeated this year, since classes have resumed, and kids may spend more time travelling during the summer break.

However, not all hope is lost. Looking at the quarterly Daily Active Users (DAU) chart, one could easily infer that the quarterly DAU did not increase in a linear fashion. The DAU in 1Q to 4Q 2019 looked somewhat flattish, and only saw a jump in Q1 2020.  Likewise, the DAU 3Q to 4Q are languishing in the range of  36-37 mil , and unexpectedly jumped in Q1 2021. The stock may repeat a similar pattern and the next surge could be in the cards or could be in the horizon. We can also see a similar pattern in the total Bookings as well.

If Roblox reports a decline in DAU in Q2 2021 compared to the prior quarter, I won’t be too concerned either. In a grand scheme of things, one quarter of lacklustre performance does not carry much weight. I learned this when I invested in Arista Networks in 2019. I first bought five shares at USD 310 and USD 268 in March and May of 2019, respectively. In November that same year, the share slid 24.2% after the CEO of Arista, Jayshree Ulal, gave a disappointing outlook for its fourth quarter, due to slowdown in orders from a cloud tech titan, which some believed to be Facebook or Microsoft. I adopted an averaging down strategy by adding another 5 shares at USD 195.47 and another 6 shares at USD 210.16 as I am optimistic about the company's future. After the 24.2% drop, share price continued its decline before it found its bottom at USD 157.04. However, those who had held on tightly to their shares and looked past one quarter of earnings disappointment are handsomely rewarded, as its shares had recently closed near all-time high of US 362 last Friday. I believe that one of the important traits of a successful CEOs is the ability to envision the company’s future, where his/her planning horizon is five to ten years ahead, and not choosing to optimize quarterly results at the expense of long-term disadvantage. I did a write-up on Arista Networks. You can check it out here.

Roblox is similar to the YouTube platform, but the content is games rather than videos. Anyone with limited coding knowledge can develop games and monetize it on its platform. Despite a potential slowdown in its activity as pandemic subsides, I believe there's a long runway for Roblox. Beyond growing its gaming content, Baszucki hinted that ‘metaverse is coming’, where people will meet virtually like the movie ‘Ready Player One’. Currently we can only experience it on a PC or mobile device, but when AR glasses and 5G become more mainstream, we can experience it in real life.

Similarly, Unity Technologies is another software development company that will benefit greatly when metaverse becomes the new normal. What started as a development platform for online gaming has become a software for companies to design and showcase their product in 3D format. I have added only 10 shares and will buy on the dips.

(2) Dividend Portfolio

Initially, I had thoughts of selling all my REITs for growth stocks. However, after much deliberation, I have decided to keep the REITs in my portfolio, because it will be an asset to generate passive income and provide inflation hedge for my future retirement. The nature of it being low risk and providing recurring dividend can act as a cushion during periods of volatility.

Last month, Mapletree Industrial Trust (MIT) proposed to acquire 29 data centres in the US. To fund the purchase, the REIT announced a $800 mil fundraising exercise which consisted of preferential offering and private placement. The Preferential Offering was 176% subscribed and I was pleasantly surprised to be allotted 1,267 excess rights. Currently, my total shares of MIT stands at 9,700, and has overtaken Ascendas REITs in terms of stock weightage.

For now, I will not be diversifying my dividend portfolio by adding new REITs. However, I may be adding to my existing shares when their valuation gets attractive.

(3) Serba Dinamik

As mentioned in my previous blog post here, I have fully divested Serba Dinamik. It was the right move given that there were more warning signs in the days that followed.

Just last Monday, the company conducted a press conference on Youtube, with Chairman Datuk Mohamed Ilyas Pakeer Mohamed threatening to take legal action against KPMG, and calling the audit firm, 'Gangsters'. He also claimed that he had spoken with the Securities Commission and Bursa Malaysia. The next day, SC and Bursa came out to deny that they had spoken with him. Personally, I felt that the press conference did more to tarnish Serba Dinamik’s image than to clear the air, as the management did not address any of the concerns raised by KPMG but putting the blame on KPMG and reiterating their stance that the company has strong fundamentals. The press conference did nothing to soothe investor’s fears. If all that was not bad enough, four independent non-executive directors resigned in protest over the company's decision to sue KPMG. It is indeed a company that is rotten inside out, and we might see further weakness in share price in the upcoming days.

(4) Total Portfolio Value  (2022 Goal achieved! :))

Stock Portfolio: $503,097

Total Cash at Hand: $89,922

Total Portfolio Value: $593,019

Portfolio 1 Net Worth: $503,097

Portfolio 2 Net Worth: $192,098

Net Worth (Cash+Equity): $785,177

Finally I can cross something off my list this year!

Just another update before wrapping up: I will be changing my domain name and shifting my blog from Blogspot to Wordpress. You will hear from me soon once my new website in up!

Thank you so much for spending time to read my blog and I really appreciate you. If you enjoyed reading my blog, hope you can support me by liking my Facebook page here or share my post. Currently, I do not earn any fees through any affiliate programme or sponsor. If you have any queries, feel free to post them and I am happy to take questions! :)

Sunday, June 20, 2021

Serba Dinamik - Inconsistencies in Financial Reporting

I have a confession to make: despite advocating for the importance of doing due diligence on a stock before clicking the buy button, I went against my advice and bought a listed company in Malaysia without doing any research. The stock turned sour. The company is Serba Dinamik, ticker symbol: SERBADK.

I invested into this company with the ang pow money from Malaysian relatives. Not to blame myself for having roots in Malaysia, but if I had not had Malaysian currency in the first place, I would not have invested in this company. How have I decided to buy into this company? I quickly skimmed through some analyst reports and suggestions from the broker and went ahead because it was only a small sum of money.

Just less than a month ago, when the company announced that KPMG refused to sign off its accounts, the news made headlines in The Edge Magazine, and was also reported in Singapore’s Straits Times and ChannelNewsAsia. That was when it caught my interest to delve into its financial statements. As the devil is in the details, I dug into the past years’ financial numbers and identified many potential warning signs. In hindsight, I could have avoided this stock if I had done my homework. 

Here’s my findings. However, hindsight is 20/20 – here’s what I would have seen with perfect vision. 

1. Unable to ascertain the legitimacy of certain trade receivables balances 

In accrual accounting, once a service or product is delivered, the transaction will be realized as revenue, even if the cash is not received. Having a ballooning accounts receivable signals that the company is having trouble getting paid for its products or services. Look at Days Sales Outstanding (DSO).

 DSO shows how many days it takes for a customer to convert account receivables to cash. This alone does not signal accounting fraud, but coupled with the fact that KPMG had difficulty verifying its clients and sales transactions did cause me to raise my eyebrow. The bulk of its account receivables originated from its customers in the Middle East, and KPMG had discovered that certain customers do not bear registration numbers - an ominous prelude to what could later become financial shenanigans.

There were many users in online forums who lambasted KPMG’s delay in sounding alarm bells after auditing Serba Dinamik’s accounts for many years. However, the situation is far more nuanced than it seems. If KPMG had discovered only one or two minor errors from past audits, I believe the auditor could let it pass. But, recognizing the growing trend of a poor earnings quality coupled with the difficulty in verifying sales transactions definitely raises some eyebrows, leading the auditors to scrutinize the accounts more closely this time round.

When it comes to trade payables, one of the findings by KPMG was that the fax contact number of its supplier (per the official website) belongs to one of the group’s employees using a ‘Truecaller’ Application. When a company’s supplier shares the same phone number as its employee, that gets me wondering: is there something behind the numbers? As an outside investor, I can’t be sure if the transaction is really at arm’s length between local suppliers and Serba Dinamik. 

2. Consistent Gross Profit Margin (GPM), Operating Profit Margin (OPM) and Net Profit Margin (NPM)

The above is the GPM, OPM and NPM of the companies operating in the same sector as Seba Dinamik: Bumi Armada Berhad, Yinson Holdings Berhad and Wah Seong. Notice what they have in common: from the charts above, one should easily infer that the profit margins are quite lumpy but genuine due to the timing of contracts delivered. 

However, the same cannot be said for Serba Dinamik, where its GPM and NPM have been very stable over the past five years. In my view, it seems too good to be true.

Moreover, 2020 was a challenging year for the Oil and Gas (O&G) industry due to declining oil prices, thanks to Covid-19. One does not need to look too far: Singapore blue chip companies like Keppel Corp and Sembawang Marine Corporation were struggling last year and their numbers are still in the red. Yet, Serba Dinamik miraculously defied all odds and managed to achieve an all-time high revenue and profit through inflating receivables.

3. Proposed to replace KPMG when audit issues were raised.

To add fuel to fire, just a few days after the financial report, the director proposed to replace its auditor from big four KPMG to BDO PLT. As the saying goes: Quis custodiet Ipsos custodes - who watches the watchmen? The watchmen are auditors and CFOs. To fire the auditor after some potentially damaging accounting issue surfaced is a major red flag to look out for; hence, I choose to err on the side of caution and cut my losses.

The board’s decision to persuade KPMG to resign suggested that management may have cooked the books and have something to hide. The market reacted to the news by sending the stock price tumbling. Even the reputable Employees Provident Fund (EPF) and Permodalan Nasional Berhad (PNB), who have been known for delivering promising returns, expressed their concerns. When the market opened on the June first, I tried to place a sell order below the last traded price to get my order filled immediately. I was dealt a shocking blow when I found out that I could only sell at a fixed price of RM 0.795. In the end I got my 1,200 shares filled at RM0.795 and another half at RM0.90.

Although the management gave in to shareholders’ pressure and shelved his plans on changing auditors, the damage had already been done and stocks showed no signs of recovery. Although the stock price reversed its course and shot up to RM0.75 (intraday gain of 24.8%) due to the news that Ernst & Young was appointed as an independent reviewer, it was short-lived and the stock gave up most of its gains in a short span of time.

4. Consistently Negative Change in Working Capital

This is not accounting fraud, but it is a tell-tale sign of a company with poor fundamentals. When you have a negative change in working capital, it means that the company is investing heavily in its current assets and reducing its current liabilities. In Serba Dinamik’s case, its current working capital is made up of inventories, receivables, payables, and net contract assets. Hence, this suggests that Serba Dinamik is investing in most of its operating cash flow to ramp up on receivables and inventories. By doing a ratio between change in working capital and cash generated from operations before working capital, we get a ratio hovering close to one. That explains why there has been no free cash flow over the years. Most of their current cash, past dividends and capital expenditure were financed through issuance of term loans, private placements and proceeds from Sukkuk.

Negative Free Cashflow for the past 5 years (RM '000)

In a healthy financial statement, an increase in company cash flow from operations should track its increases in net income, and this divergence in number suggests that the company is generating sales without collecting the cash - in this case, on receivables and inventory. That probably explains why the auditor was concerned about its suppliers. 

Once bitten, twice shy. It is indeed a sobering reminder for me to do my research on any stocks that I plan to buy, no matter how small the investment may be. But retrospectively, it is a blessing in disguise as the ‘school fee’ from my losses in this share is worth paying, since I have gained much insight on what’s 'really' behind the numbers.

Thank you so much for spending time to read my blog and I really appreciate you. If you enjoyed reading my blog, hope you can support me by liking my Facebook page here or share my post. Currently, I do not earn any fees through any affiliate programme or sponsor. If you have any queries, feel free to post them and I am happy to take questions! :)