My Earnings has been Shrunk!

The following post is dedicated to Anon who asked about the dilutions effects caused by placement shares, esos etc.

One of the best example I could really think of is a past discussion I had on this one stock called Integrax.

On 28th feb 2003, Integrax announced its fy2002 Q4 quarterly earnings.

It made a total net earnings of 16.159 million from a sales revenue of 25.244 million for its fiscal year.

I got a message in July 2003 asking about this stock:

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I have made some studies on this counter and noted some good points:

1. stable assure income from TNB power plant (future earning will double)
2. closely link to state goverment
3. potential aluminiam plant project (will add on the coal transportbusiness)
4. low PE (really fantastically low)
5. proposed to transfer to main board.

here was my reply then.

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my comment on integrax ...

1. those listed port stocks, their fundamentals are ok, meaning they are companies that operates on a very high profit margins. in which you have also choices like Bintulu Port. So far, from its only earnings (Integrax was a newly listed stock, which was listed via a reverse takeover of a stock called Ganz) , in its 02 Q4 earnings report, Integrax had figures like this...



2. now as you would see the numbers were fantastic. (the eps is based upon 115.656 million shares, which was stated in that quarterly earnings report). And if you annualise such performance for fy 2003, then the potential is there.. cos one is looking at a potential eps of 38-40 sen for fy 2003. And yes, I did note that folks like Ah Goh (GK Goh) was projecting 03 earnings to be lower, at around 30 million, or an eps of 26 sen based on 115.656 million shares.

( Back then Integrax trading around 1.15-1.30 and based on the projected 03 earnings, Integrax at 1.15 was trading at a super duper low PE of 4.4x based on Ah Goh's estimates.. and at such a low PE multiple, surely this would have been an ideal hidden gem right? In fact, Surf 88 back then, had a super positive research calling it a Lumut Gem!)

3. But after researching more, i found out that there were lots of ICP shares being converted into ordinary shares. This was part of the agreement under Integrax's takeover of Ganz. Now I do NOT know know the exact restriction (if any) on how these ICPs were converted but judging from KLSE announcements, they were converted on quite a regular basis. So what's important is, if you wanna invest in this stock, you need to figure out how many total ICP's were issued. (here is where the DILUTION of shares has such an impact on the share price.)

Now these ICPs, they have this dilution effect. As I had checked out the other day (back in July 2003), the number of shares in Integrax stands at 196,762 million shares!!

Now based on the projected earnings of 30 million, Integrax projected DILUTED eps is now 15 sen. Which now means, at 1.15 Integrax is trading at a forward PE of 7.6! (compared to a pe between 4.4).

See how greatly the eps has been diluted by these ICP's?

So... if you are not carefull.... you might have actually invested in Integrax had a much higher PE multiple than you have immagined...

4. Is Integrax an average company or an excellent company? I dunno.

Too early for me to determine, plus there is really too limited info i can dig up on Integrax itself.... so i cannot comment on it.

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That was in July 2003. Now Integrax was in a nice rally mood.

And soon in Oct 2003, it was trading around 1.90++ (which turned out to be its peak today)

And here is another extremely interesting point.

Integrax Loan Stocks and its Irredeemable Convertible Preference (ICP) shares were still constantly being converted into ordinary shares. (here is one announcement indicating the conversion of ICP shares )

Which meant that the earnings per share were constanly being diluted at a very rapid pace.

But the share price was rocketing.

How?

Would an investor cash out back in Oct 2003? (remember, they had an opportunity to buy just in July 2003 at around 1.15)

A year later, on 27th Feb 2004, Integrax announced its fy 2003 quarterly earnings.

It made a total net earnings of 28.819 million from a sales revenue of 93.434 million for its fiscal year.

Integrax's results is pretty impressive really. And in fact it does look like a decent and very profitable company... but i guess the main question is why the share price is performing so poorly was explained clearly by the company.

• PATMI changes are reflective of the above while EPS changes reflect the impact of a larger share capital base this quarter.

Ahh... the EPS shranked.

Diluted!

The dilution effects from the conversion of Integrax's ICP shares and loan stocks. And the more conversion are made, the large the share base becomes, hence Integrax share base is growing each quarter, which meant that unless Integrax earnings grow at a much faster than how its share base expands, the eps would become smaller each quarter and when the E in PE becomes smaller, the price 'usually' goes down to reflect the lower E.

To fully illustrate how diluted the earnings become:

Integrax number of shares now is 263.882 million shares!! (back in Feb 2004)

Which meant Integrax eps is only 10.9 sen for its fy 2003! (a huge cry from Ah Goh's estimate of 26 sen eps!.. and most important see how the net profit increased a lot BUT yet the EPS 'dropped drastically?)

Which meant that the traded shares of Integrax is now much more expensive despite a pretty impressive fiscal year earnings? (In Feb 2004, at 1.50, Integrax was trading at a PE of 13.7x!!)

Perhaps it is better to take note of all those ICP shares, right?

Example (done on 28th Feb 2004)

Integra has 263.882 million shares
Integra LA has 31.890 million shares
Integra PA has 10.570 million shares.
Full dilution = 263.882 + 31.890 + 10.570 = 306.342 million shares.
Fully diluted eps = 28.819 / 306.342 = 9.4 sen.

So do remember.. this bugger just got soooooo many shares out there.... that you dun really know what is going.... plus since this is a RTO listed company.... so you never know the true cost of those ICP shares, etc, etc..... and do take one step back ... dig deeper back into history.... look at Ganz last reported earnings report. Ganz had only got 19.8 million shares. Compare it to now. 263.882 million shares. A lot of new shares has been issued.

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So in July 2003.. Integrax was trading around 1.15-1.30.

It peaked in Oct 2003 around 1.90++

On Feb 2004 it traded in the 1.50 region.

now on May 2006? Less than 0.70!

The below pix says it all... (long term buy and hold? if your initial reasoning is wrong.. holding it longer is holding in hope!)



So if one purchases a share in a company and discounts the effect of the dilution of earnings, see the drastic end result?

Of course not all companies are like that. And as mentioned in the case of IOI, the conversion of warrants did not have a negative impact on the share price. Why? IOI Corps earnings grew at a much faster pace.

It's pretty simple actually.. take the blog posting ROI on Uchi: Part III - the ESOS issue

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Now if you add both figures up, you will get 82,820,992 new shares, assuming full exercise of ESOS.

Currently Uchi has 372,392,800 shares. Which means there is a possible dilution in earnings per share of 22% assuming full exercise of all these ESOS.

Now let's be realistic and ask ourselves this... is 22% dilution in earnings per share a lot or not?

Simple way to look at this dilution.

Say U** has a current eps of 100 sen.
Say U** has a possibility to trade at a price earnings multiple of 18x.

Which means U** could be worth some 18.00 in market price.

Now a 22% dilution means... the eps would be 78 sen.
And using the same pe multiple assumption of 18x, U** should be trading at a market price of 14.00.

See how disadvantage it is to the minority shareholder?

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