Vicom

Vicom provides vehicle and non-vehicle inspection and testing services in sectors including mechanical, biochemical and civil engineering. Vicom is also a subsidiary of ComfortDelgro, a substantial shareholder of Vicom at 67%.

Vehicle inspection and testing services revenue accounts for 30% of Vicom’s total revenue while non-vehicle accounts for 60%. However, both vehicle and non-vehicle inspection and testing services account for 35% of operating profit which implies a higher margin from the vehicle segment, an impressive 37.6%. The operating margin of non-vehicle segment is 19.1%. Do note that the above figures are from 2011 as Vicom stopped reporting segmental results from 2012 onwards. It is however safe to assume that these % should not deviate much in recent years. This means that vehicle inspection is equally strong in contributing to the bottom line even though its revenue share is smaller relative to non-vehicle segments. 

Vicom’s strong margins in the vehicle segment can be attributed to:

1. 74% market share of Singapore vehicle testing and inspection (520,000 inspections out of 702,000 total vehicles inspected.
   
   
2. Most vehicles on the road will have to be inspected at least once every 2 years.
3. Strong growth rate of vehicle population at 2.4% CAGR over the past 10 years, from 754,992 in 2005 to 957,246 in 2015.

At the existing price of $5.85 on 12 Feb 2016, the PE ratio is at 16.26 and PBV ratio is at 3.54. The payout ratio as of the latest dividend is about 75%. It might seem expensive at first glance but it is expensive for reasons. Vicom’s ROE is at 23% and ROIC is at 60%. ROIC has been increasing since 2006 at 20%. This is due to the minimal capital expenditure required once the basic machineries have been in place. Vicom’s net capital expenditure in recent years is mainly to cover its depreciation. Due to its business model, Vicom does not really need to acquire new technology to attract business. Cars will also have to be inspected due to safety regulations. Free Cash Flow to the Firm has also been positive after payment for dividends, averaging $10 million each year over the past 4 years. It also has no debt therefore it is less susceptible to rising interest rates and it has built up a decent sum of cash in recent years standing at $100 million. What are the risks and what price should I buy Vicom at then?

Risk

Vicom’s share price has been down beaten from its high of $6.78 on Apr 2015 to current levels. This could be mainly attributed to the aging profile of Singapore’s car population (accounting for 40% of vehicle inspections in 2015).

As seen in the table above, we can see that Singapore’s car population shot up during 2005-2010 period due to the government stance to encourage car ownership. Growth rate is set at 3% + de-registrations for at least a decade till 2009. From then on it staggered downwards and from Feb 2015 onwards, it is set at 0.25% growth rate + de-registrations. The age profile of 8-10 years is also the bulk, accounting for 51% of car population. By 2018, about half of the car population will most likely be renewed into new cars. Fortunately, with a lower growth rate of COE supply, some people might be considering holding onto their cars longer than 10 years as it is unlikely that COE prices will reach to previous lows. This is evident as you can see that there is a huge jump of cars older than 10 years of age in 2014 and 2015.

For the gloomy years ahead, Vicom has built up cash to prepare for the storm in the vehicle segment over the next 3-5 years as vehicles less than 3 years of age need not be inspected. Although we do not have colour to non-vehicle segment sales in recent years, what I see from recent annual report is that they have started to expand their range of services in Setsco. Hopefully this will mitigate the fall in revenue from vehicle segments even though the management is expecting slowdown in non-vehicle testing services. 

Valuation

I will assume that Vicom will have -5% growth in revenue over the next 3 years and 0% growth from 4th to 5th year. From year 6 to year 10, I will allow it to grow at a decreasing rate from 5% to 2% and the terminal growth rate set at 0.5%. There have to be a cap on growth of vehicles in land-scarce Singapore therefore a 0.5% growth rate is considered appropriate. Operating margins will also be decreased from the current 34.7% to 28% in the terminal year. I have adjusted the regression beta of Vicom’s from 0.5 to 0.72 due to the nature of its higher operating leverage business which has higher fixed cost. After accounting for reinvestment needs, the free cash flow over the next 10 years and the terminal value is discounted at the weighted average cost of capital of 6.93% and 7.8% in the terminal year respectively. Adding back cash and accounting for operating lease as debt, the estimated value per share is $4.83. I have to admit that this is a rather conservative estimate. By assuming 0% growth over the next few years instead, the estimated value per share is $5.35.

Conclusion

Based on current price, the market is over-valuing Vicom 21% above its intrinsic value. The current yield is at 4.87% (FY 2015 dividend of 28.5 cents) and at the intrinsic value, 5.9%. With the current market sentiment, Vicom will be a conservative play in one’s portfolio with stable dividends and strong economic moat in the long term. The vehicle population is a 10 year cycle and I do not foresee vehicles being displaced from Singaporeans’ life over the next 30 years. Right now, Vicom is nearing the end of the 10-year cycle which many cars will be deregistered. The share price has been affected and the downward pressure will continue to persist in the near term. But be sure to catch it when Vicom offers itself at a discount and you will be in for a ride of decent dividend yield if your investment horizon is at least 10 years.