Value Investing

Pico Far East Holdings: A Look Back At Our Valuation Analysis

Pico Far East Holdings:

Pico Far East Holdings Limited designs exhibition stands as well as fabricates museum interior fit outs, and advertising signs. The Company also organizes exhibitions and conferences. It is listed on the Hong Kong Stock Exchange. The analysis on Pico was done for a presentation in November last year, so there won’t be an extensive write up. It was also the first time I was required to forecast earnings for a company. Since then, the company has released its full-year earnings and I thought it would be an interesting opportunity to do a little reflection. Below, I present the 3 key points which I originally had, along with my thoughts and updates for the full year results (represented by strikeouts and italics). These should be viewed in conjunction with the presentation deck.

Revenue boost in 2015 from World Expo and ITMA. We expect 2015 to be a bright year for Pico due to both events which are held once every 5 and 4 years respectively. While 2015 World Expo is about half the size of the 2011 World Expo, the contribution is still expected to be significant. We estimate revenue contribution of 2015 World Expo and ITMA to be HKD181.4m and HKD200m respectively. Overall, we estimate FY15 net income to increase by c.16.2% from FY14.

I originally expected FY2014 results to be weak, therefore the jump in net income from FY14-15 would now be less than the 16.2% given that FY2014 turned out to be a strong year (see second point).

Weak near term outlook, excess capacity drag on margins. In the long run, Pico faces headwinds in the MICE industry in China which is its key markets. MICE business arrivals have fallen about 42% from 2011 to 2013, as evident by its impact on Exhibitions revenue. Considerable time will be required for it to return near its peak levels. Furthermore, Pico recently completed 2 new facilities in Beijing and Shanghai in 2H13. In the absence of strong growth, the increase in SG&A expenses will be a drag on margins. We estimate net margins to decline from 6% to 5% in FY14-16.

Net income actually increased from FY13-14 when I expected a decline. However, net margins did decline by about 0.4% from FY13-14 likely because of the new facilities. I think the key takeaway here would be the hit-and-miss nature of forecasting/financial modeling. Unfortunately, this seems to be the bread and butter of the sell-side research industry where expectations are built upon layers and layers of assumptions. You can build a model with very detailed drivers; for example, estimating the revenue of Apple by the number of phones sold. However, even then, such numbers will be inevitably be based on macro-economic drivers and the problem with that is that we are almost always only able to use macro indicators in predicting micro-level performances. I have written on the advantages and the disadvantages on financial modeling, and I maintain that the mentality and process is more important than the outcome. If I could add another point, it would be to err on the side of caution.

Solid company under industrial headwinds. We note that company fundamentals remain strong, with weakness in performance solely due to industry slowdown. Revenue for exhibitions for its competitors has been similarly sluggish as well. However, Pico is still the largest player in the Exhibition Services space with the highest revenue and highest segment net margins among its competitors. We believe this efficiency will allow Pico to compete successfully against competitors for projects. For example, looking at Kingsmen, (one of Pico’s main competitors) while contribution from China has increased from 22.9% in 2010 to 33.8% in 2013 of total revenue, revenue for its exhibition segment remain relatively fixed, implying that Pico’s position as an end-to-end provider of exhibition services remain largely unchallenged in China. Inexpensive financial ratios (EV/EBITDA and P/E) with low debt and decent FCF yield.

The full presentationon Pico Far East Holdings: can be found below and free to be downloaded via Scribd.

Pico Far East Holdings:
Pico Far East Holdings:

Pico Far East Holdings Limited

A word of caution – I concede that valuation might be a little over-optimistic given that its based off a WACC of 5%, even if this figure was arrived at objectively. Nevertheless, I believe that margin of safety still persists, even if it’s no longer as bullish as the target price in the slides might suggest; at a WACC of 10%, we will still have an intrinsic value of 2.32.