Straco Corporation: Initiation Report

Business Model of Straco

Straco Corporation Limited (‘Straco’) is a developer, owner and operator of tourist attractions in Singapore and China. It started operations in 1990s and successfully listed on the SGX Mainboard in February 2004. Its current portfolio includes Shanghai Ocean Aquarium, Underwater World Xiamen, Lintong Lixing Cable Car and Singapore Flyer.

Straco employs a business model that is simple enough for the man on the street to understand. As the owner and operator of tourist assets, Straco generates the bulk of its revenue from the sale of admission tickets. Part of its revenue comes from rent paid by third parties that lease some of the ancillary spaces at its assets. It also has a relatively stable operating expenditure (labour, utilities etc) while capital expenditure is also minimal.

Investment Merits of Straco

1. Solid track record

Straco’s track record is enviable. As shown in Diagram 2, its revenue, profit and net operating cashflow have increased annually since 2012, although there was a minor blip in 2016. The compounded annual growth rates for these observed metrics are all above 20%, very impressive indeed. In particular, Straco Corp is noted for its ability to generate high free cash flow since the capital expenditure required is small.

Its performance from 2012 to 2014 were boosted by increasing visitor-ship to its aquariums in Shanghai and Xiamen. Meanwhile, its financial performance in 2015 and 2016 were boosted by the acquisition of the Singapore Flyer. The reputation of Straco was further burnished when the management managed to turn around a loss-making Flyer into a profit- making asset after acquiring it. Needless to say, Heartland Boy is very impressed at its stellar track record after analysing its annual reports.

2. Superior Operating and Net Profit Margins

Straco enjoys high operating and net profit margins as a result of its ability to increase visitors and ticket prices without a proportionate increase in cost. However, these superior margins started coming down after the addition of Singapore Flyer into its portfolio. Singapore Flyer does not enjoy the same high margins as the rest of the assets. With net profit margins in the high thirties, it will naturally attract more competitors to compete in this segment. Therefore, some form of sustainable competitive advantage ought to be present in Straco since it is able to sustain its fat margins.

3. High and Growing Return on Equity

Straco’s ROE is in the low 20%, easily exceeding the 12% ROE benchmark that Heartland Boy sets for all his stocks. As Straco continues to be profitable, the challenge is for it to find more earnings accretive acquisitions in order to make good use of shareholder’s equity.

4. Net Cash Situation

Despite taking on debt to finance the acquisition of Singapore Flyer, Straco’s cash generative business means that its cash stockpile has already outgrown its debt. As at 9 months ended 2017, it is currently sitting on $137 million of net cash. This translates into 16 cents per share. With Straco’s stock price at 85 cents, net cash currently forms 19% of the market capitalization.

5. Growing Dividend Yield

In the most recent financial year, Straco paid out 2.5 cents as dividends or about 46% of its earnings. At a share price of $0.85, this translates into a dividend yield of approximately 2.9%. Based on Straco’s financial reports over the years, it has been able to increase its dividends gradually, keeping it close to the 3% mark as per Management’s guidance. Other shareholder-friendly actions including buying back shares from the open market, the last of which took place in August 2017 at 86 cents per share.

6. Sustainable Competitive Advantage

As aforementioned, Straco’s tourism assets possess some form of sustainable competitive advantage. For instance, by virtue of its superior location in the new city center, Shanghai Ocean Aquarium is able to benefit from the positive externality of Shanghai Disneyland. Hordes of domestic tourists are visiting the Shanghai Disneyland since it opened its doors in June 2016. Straco benefits from this positive spillover as some families inevitably include the Shanghai Ocean Aquarium as part of their itinerary in Shanghai. This is evident as the Aquarium has only been recording year on year growth in revenue ever since Shanghai Disneyland welcomed its first visitor. If the Aquarium continues to stay relevant, it will welcome more visitors and increase utilisation rates.

Likewise, the iconic Singapore Flyer enjoys some form of competitive advantage by being a family-friendly tourist attraction that allows visitors to enjoy the Singapore skyline.

Underwater World Xiamen used to enjoy such status until the government decided to control the flow of visitors to Gulangyu island in a bid to achieve UNESCO status. Ironically, the island obtaining UNESCO status has turned out to be a short-term blow to Straco as visitorshop to Underwater World Xiamen has been declining for almost 2 years.

7. Good Growth Story

China’s burgeoning domestic tourism

The Chinese government has been very serious in its attempt to shift the economy’s reliance away from exports and foreign trade to domestic consumption. As a result, massive resources have been poured into the Chinese tourism industry. Furthermore, decades of economic growth have led to a burgeoning middle class. Here are some statistics to illustrate this phenomenon.

Based on the information provided by China National Tourism Administration, domestic tourism trips have been growing at a minimum of 10% p.a. over the last 8 years. The compounded annual growth rate during this period is 12.9%. 2017 is turning out to be even better as there were already 13.5% more domestic trips recorded for the first half of the year compared to 2016. The Chinese appetite for new travel experiences is clearly insatiable and Straco is well placed to ride on this macro trend. In this way, buying into Straco can be seen as a proxy to buying into China’s consumption story.

Singapore’s tourism outlook

Singapore has also done quite well in the tourism industry this year. A media release by the Singapore Tourism Board stated that international visitor arrivals and tourism receipts have increased 4% and 10% respectively in the first half of 2017. STB is also stepping up efforts to grow the pie. It recently released a new slogan that seeks to tap onto new travel trends. Ultimately, an increase in tourist arrivals bode well for the Singapore Flyer and this is an easy backward indicator to track to forecast the performance of the Flyer.

New Product

In all honesty, most investors are watching how the management will mobilise the growing cash stockpile. Most suspect that an acquisition is on the cards. If Straco manages to replicate what it has done with Singapore Flyer, shareholders will be in for a treat. Well, the CEO revealed his company’s philosophy when it comes to new investments in an interview with Business Times in April 2017.

“Every year, we assess many potential projects but we usually have to walk away because of key factors such as location and infrastructure. Being careful stood us in good stead because we are able to build a strong cash reserve that we can use when a good opportunity comes our way,” he said.

This philosophy is heartening as it aligns with Heartland Boy’s conservative risk profile.

Investment Risks of Straco

1. Economic growth of China

The greatest risk to Straco’s future earnings would be the economic performance of China. Tourism is a form of discretionary consumption; the higher the income growth, the higher the spending on consumption goods. Therefore, this is a very important indicator to track as well. IMF estimates China’s growth to reach 6.8% in 2017 and 6.5% in 2018. These are pretty healthy numbers despite decades of continued growth.

2. Expiring Leases

Here are the lease expiry profiles of its various assets. If the leases of these assets are not renewed, the challenge remains for the Management to find new products to replace the lost income. Closer to home, we have a very recent example of an aquarium ceasing its operations after its lease has expired.

3. Regulatory Risk

Straco had planned to increase the price of its admission tickets for Shanghai Ocean Aquarium and Underwater World Xiamen in late 2015. However, this was postponed as the Chinese government commented that admission fees in China’s tourist spots had risen too fast. Heartland Boy believes that Straco has free reign when it comes to determining the ticket price for Singapore Flyer.

Another example of regulatory risk would be the control of daily visitors to Gulangyu island. It had a direct impact on the revenue of Underworld World Xiamen.

Conclusion of Straco

Heartland Boy has personally kept Straco under his watch list since December 2014. It was a stock that ticked all the right boxes but Heartland Boy was extremely apprehensive about its purchase of the Flyer. Ultimately, he was glad that he was proven wrong. Investors have to stay patient as growth in other assets are being frustrated by government controls over the island of Gulangyu. Therefore, new catalysts probably have to come from new acquisitions or increasing ticket prices, if that does not step on the authorities’ feet.

Heartland Boy has a personal price target of $1.22 on Straco.

Vested at 85 cents since Oct 2017

This article is published on 15 December 2017. CIMB last published an analyst report in December 2014 with a target price of 78 cents.