Brook Crompton

Brook Crompton (AWC.SI) is a Singapore listed distributor of electric motors. These motors are used in various industrial sectors, like mining, oil & gas, marine and HVAC. The company is controlled by Wolong Electric Group (“Wolong”) which is listed on the Shanghai Stock Exchange.

The majority ownership by a Chinese entity, the cash hoarding and the illiquidity of the shares are probably all factors that contribute to a valuation that has become quite extreme today. Ex-cash, the company trades for about 1x earnings and I think that’s a bit too extreme. So I have picked up some shares. I like to pick up small positions in these types of situations and just let them sit in my portfolio. As a group, they tend to do well, but some will not move for years.

The investment case for the company is fairly straight-forward. I don’t see a particular catalyst that makes me believe anything will happen in the short term. It’s just the extremely depressed valuation that makes this situation attractive to me.

Here’s some summary financial data of the company:

Share price: $0.64 SGD
Shares outstanding: 35,458,818
Market cap: $22.7m SGD
Cash: $19.3m (Dec. 31, 2020)
Debt: $0
Total liabilities: $16.1m
Book value: $36.4m
Net income 2020: $2.2m
Avg. net income 2016-2020: $3.5m
Avg. capex (last 5 years): $0.1m
P/NCAV: 0.74x
P/BV: 0.62x
P/E: 10.3x
Price to avg. 5yr. earnings: 6.5x

The graph above was generated with Tikr.com (This is not an affiliate link, so I don’t get paid). I have been using TIKR’s free beta version for a few months and I have been very impressed with their product. It’s a very useful tool if you look at a lot of different stocks.

I have used $0.64 SGD as the share price, even though a small number of shares have traded recently at prices that were a bit lower. There has been some liquidity at $0.64 over the last few months, so that seems like the more reasonable price to use here.

Wolong holds 66.1% of the shares, so excluding their stake the market value of the remaining stock is only about $7.7m, making this a very illiquid stock. Wolong became the controlling shareholder in October 2011 when it purchased a bankrupt Austrian company called ATB Group. ATB was the controlling shareholder of Brooks Crompton before this transaction. The manufacturing operations were sold in 2010 and after the change in control there were other restructurings. The company focused on its core distribution business and that business has been pretty stable since then.

Brook Crompton has required very little capital expenditures, as you can see in the graph above. Depreciation charges (excluding depreciation of right of use assets) have been at similar levels as capex.

The company mainly does business in the UK where they had revenue of $24.4m in 2020 (54.3% of total revenue). The United States is the other large market with $18.1m (40.3%). Asia Pacific makes up for the rest of the revenue.

Their reliance on the UK and the COVID-19 pandemic hurt the company’s performance in 2020:

In 2020, the Group was unsurprisingly dominated by two key factors, the COVID-19 pandemic and “Brexit”, the departure of United Kingdom from the European Union. In Q1 2020, the United Kingdom and Canada markets remain favorable. However, the Group’s revenue was affected by the impact of the COVID-19 pandemic which started in Q2 2020. Group’s revenue decreased significantly as lockdowns were implemented across the globe. Initially, in Asia Pacific region, then in United Kingdom, and lastly in North America.

Source: AR 2020, page 5

Globally, the Group has been impacted by a deferment of project investments across all segments. Particularly, impacted the North American and Asia Pacific business, however the trend is expected to reverse as the COVID-19 pandemic restrictions begin to ease, firstly in the Asia Pacific, then United States, Middle East and lastly in Europe and Africa.

Source: AR 2020, page 5

Another problem is the changing product mix. The more profitable oil & gas segment is now a smaller percentage of sales then before:

Hence, the Group was able to maintain a position of profitability despite the increased costs of business during the pandemic and changing trends in the product mix continuing to move further away from the most profitable oil and gas segments to the more commoditised segments such as ventilation, and materials handling.

Source: AR 2020, page 5 (bold text mine)

Perhaps this dynamic will change if the oil & gas sector recovers. Oil prices are now a lot higher than in 2020, so maybe the company will see an uptick in their oil & gas segment over the next year or two.

Capital allocation

I think the final point that deserves some attention is capital allocation. Over the last five years, the company’s cash balance has continued to grow to $19.3m as of December 31. During this period the company has paid a dividend in most years, usually $0.02 per share, but in 2017 they declared a $0.05 dividend. However, in 2020 they decided not to pay a dividend. This was the Board’s explanation:

No dividends have been declared by the Board for the financial year ended 31 December 2020 as the Board has opted to conserve cash to face the challenge of the global economic crisis caused by the Coronavirus disease 2019 (“COVID-19” or “Pandemic”)

Source: AR 2020, page 31

This is of course ridiculous, given the ~$19m cash balance and continuing profitability of the company. So the management is either overly conservative or completely clueless about capital allocation or perhaps they are creating a depressed valuation to opportunistically take the company private in the future.

Future buyout of minority shareholders?

To clarify this last point: many small caps in Singapore have a large (family) owner and the rest of the shareholders are mostly made up by retail investors. There are just very few funds investing in these micro-caps. Many of the retail shareholders are looking for an attractive dividend yield. By keeping the dividend low, or even cutting it completely, many of those shareholders sell out. This can also be seen at Brook Crompton after they decided not to pay a dividend this year. A relatively large number of shares came on the market as people gave up on the stock. The resulting depressed share price creates an excellent opportunity for the controlling shareholder to take the company private. The company can use the cash it withheld from its investors over the years to now buy them out at a bargain price.

I think this is a reasonably likely scenario over the next few years. A similar situation is unfolding right now in another stock I hold, Dutech Holdings (CZ4.SI), where another Chinese majority owner is trying to buy out minority shareholders at a low price. Even though that offer is too low, people who bought their shares somewhere in the three years before the offer was launched are up about 60%. The same thing could happen at Brook Crompton.

I actually think a buyout is more likely at a Chinese controlled company like this than at, say, one of the extremely depressed family-controlled steel stockists that are listed in Singapore. The latter might just pass the listed business on to a son or daughter. In contrast, it has to be a bit more of a pain for the Chinese to deal with this situation. They need to publish a separate annual report, deal with questions from the Singapore Exchange, hold an annual meeting, travel, deal with the unhappy Singaporean shareholders asking questions about the dividend at the meeting, etc. How many more years do you want to deal with that extra work? Why not make an offer of perhaps $1.10 or so and get rid of this headache? Ex-cash they would still only be paying around ~5.5x the company’s average earnings: a great deal for them.

Disclosure: long Brook Crompton and Dutech Holdings

Edit July 14: a reader pointed out to me that the dividend elimination was already announced at the end of February 2021 when the results were first announced. It is kind of doubtful whether this has really led to a relatively large number of shares coming on the market as late as June. It is possible, because volumes in March and April seem elevated compared to the last few years, but it might be just an individual holder reducing his stake.

I noticed a relatively large shareholder called Liu Wenying reduced his stake by 300k shares between May of 2020 and March of 2021 (check pages 144 & 127 respectively of the annual reports for 2020 and 2019). As of the latest report he owned 930k shares, or 2.6% of the outstanding shares. It could be that this single holder further reducing his stake can account for the higher than average volumes in Brook Crompton, but I don’t know if that is the case. I have also not been able to find any relevant info about this shareholder and have not heard of him before.

Posted in Singapore stocks.

4 Comments

  1. Assuming fair treatment by Wolong, it looks like a nice and stable, asset-light business too.

    As a distributor, their gross margins ultimately rely on the purchasing price they get from Wolong. In 2020, they paid 31.6m (70% of revenue) to Wolong for “Spare parts and goods for resale”. Do you know how this amount is determined? What keeps Wolong from raising the prices (more than the rise in resale price), thereby compressing the margins of their distributor? Isn’t it in Wolong’s interest to keep the whole margin in the parent business rather than a 66% owned subsidiary? Similarly, what stops Wolong from setting up new wholly-owned distributor companies in the same markets Brook Crompton operates in?

    • Thanks for the comment!

      I think they purchased inventories of $25.9m in 2020 from Wolong, if I understand the disclosure about related party transactions correctly (page 113). But I don’t know if these commercial transactions are being done fairly.

      Yes, there are all sorts of ways to screw minority shareholders. Another option is making an interest free loan to Wolong for all the cash on the balance sheet. But formally Brook Crompton is still a separate company and the Board has fiduciary duties towards minorities. And I haven’t seen anything bad yet, other than the cash hoarding in the last few years. They could have done a lot worse.

      I think another important factor here is the size of Wolong Electric (ticker 600580 in Shanghai). It looks like their market cap is around 18bn CNY or about $2.7bn USD. So Brook Crompton is a very small part of their overal business. I’d be surprised if they go out of their way to do some really shady stuff. That would get some attention and could do damage to their reputation. Probably not worth the risk, considering their size.

      I don’t expect a fair price in the event of a buyout, but a pretty unfair price can already lead to a good outcome for minorities at today’s prices. That’s also why I think it is very unlikely that Wolong will set up a new subsidiary to compete with Brook Crompton. It would be a lot more expensive than to buy out the minority shareholders at an unfair price. Plus I don’t think they would then be able to use the Brook Crompton trade name which has been around for a long time and is well known by their customers in the UK.

  2. You are right. Tthey purchased 25.9m worth of inventories from Wolong-related parties. The rest must be from third-party suppliers.

    The lack of care in filings is striking. The reports are full of grammar errors. In 2017 AR, the financial figures are totally out of scale. It must be really tough for them to maintain the listing in SGX. Indeed, privatization may be around the corner.

    But again, this is not a company where an activist investor or a competitor buys some shares to block low-ball offers and order the management around. The business is near worthless without support from Wolong.

    I agree that the reputation of Wolong would be at stake. Therefore, the cost of doing shady stuff is higher than the 10-15m buyout offer for the rest of the shares. I think I will consider buying a small stake in the coming weeks.

    Thanks for the idea and your reply!

    • Yeah, you’re right about the errors. I noticed some pretty bad presentation errors in the graphs on page 2 of the AR 2017, for example. That looks very sloppy indeed. I do see a lot of this sort of stuff in annual reports in Hong Kong and Singapore.

      I don’t know if Wolong will take the company private and whether this is even on their agenda. I think the main danger is that nothing happens at all and the company keeps its listing for many years to come. Minority shareholders are indeed at the mercy of Wolong when it comes to that.

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