Yesterday I noticed that the stock of one of my holdings in Singapore, AP Oil International (SGX:5AU), suddenly jumped 20%. There was no press release or other corporate event that I could find. After asking on Twitter I was pointed (thanks Writser!) to a report by broker KGI Fraser Securities (PDF). KGI initiated coverage on AP Oil with a target price of $0.37.
I have sold my position in AP Oil after this run-up of the share price.
The title of the report is “The type of company Mr. Buffet looks out for”. Spelling the name wrong of the most famous value investor in the world in the very first line of the report didn’t inspire a whole lot of confidence in me for the quality of the rest of the document. After reading it I felt better about the report and agreed with some of the analyst’s points, but there are some things in there that I disagree with.
The main thing I disagree with is the notion that AP Oil is likely to make substantial acquisitions in the near future. I don’t think there are strong indications that AP Oil is going to make acquisitions that really move the needle for their business. The acquisitions they have done in the past have been fairly small. The deal value of their most recent acquisition of Heptalink Chemicals in January of this year was just $0.8 million. Meanwhile the cash balance of AP Oil at the end of 2014 was $31 million.
Management seems content to make small “bolt-on” acquisitions from time to time. I don’t think there is anything wrong with that. There are a lot of businesses that would be better off just focusing on their core business and staying relatively small. The excess cash generated by that business can simply be returned to their shareholders. Unfortunately it is exactly this last element that is missing at the company. AP Oil’s management has let the excess cash pile up on the balance sheet. AP Oil could easily support a much larger regular dividend or pay a large special dividend to return excess cash. But dividends have not been increased in the last few years. This was probably the main reason for AP Oil’s long languishing stock price.
This large cash balance in my view provided some nice downside protection and optionality for investors during the last couple of years. With the company now trading at a market cap of $46.9 million, just above book value of $46.3 million, the question of what management will do with the money becomes more important. My best guess, based on management’s past behavior, is probably nothing in the near future. The KGI report could be right and management might make a substantial acquisition or increase dividends after all. I think I should be more conservative in my expectations and let management’s past actions be my best guess of their future intentions. In 2008-2009 the oil price crashed as well and AP Oil had a solid financial position then, but no acquisitions were made. Why should today be any different? And while it is true that dividends could be increased if management does not find attractive acquisitions the same narrative could have been told 2-3 years ago.
There are certain managers that are just extremely reluctant to return cash to shareholders. I think it has at least partially to do with psychological factors of the managers involved. A great example that might be unfamiliar, especially to readers from Singapore, is the US-based company Solitron Devices (ticker: OTCMKTS:SODI). There is a very interesting proxy battle unfolding at that company right now that you can follow by reading the company’s SEC-filings: http://www.otcmarkets.com/stock/SODI/filings.
That whole drama could have been prevented if the CEO, a man named Shevach Saraf, had been more rational about capital allocation and had been a little more forthcoming with his shareholders. The company would probably never have had to deal with activist investors. Now they are likely (at least in my view) to lose two board seats and will ultimately be forced to do the things that should have been done long ago. Why do people behave like that? You see the same thing at numerous companies in Japan that are sitting on enormous amounts of cash. The lesson from Japan is that a severe economic crisis can lead managements to extremely conservative policies. Perhaps personal hardships endured during one’s life can also lead to extreme conservatism and frugality.
I don’t want to imply that AP Oil’s management is like Solitron’s, but they could be. One should also keep in mind that the Ho family is firmly in control at AP Oil. It’s very unlikely that activist investors will get involved.
I don’t think AP Oil is expensive at its current price. I also think the re-rating of the stock has more to do with momentum investors buying shares after a favorable report than a sudden increased interest among long term, fundamental investors in the company. As such I think AP Oil’s stock is more likely to decline when these investors sell their shares when favorable developments like acquisitions or dividend increases do not materialize in the months to come. At that point I’m likely to become a buyer again.
If you’d like to read more about AP Oil, I can recommend the write-up on The Secret Investors from Dec. 2014.
Disclosure: no position in AP Oil, long Solitron Devices