Kluang Rubber Company (Malaya) Berhad (KLSE:KLUANG): An Illiquid Net-Net Controlled by A Very Conservative Family of Value Investors

Kluang is a very small (~MYR 200 MM so approx. USD 50 MM market cap), closely held Malaysian company.  On the surface it looks like a very small plantation owner which trades for 32 times 2018 earnings and isn;t growing.  But if you dig below the surface Kluang is a conservatively positioned investment portfolio managed by a family with a long history of value investing.  To appraise Kluang there’s not much point in digging into the economics of the underlying businesses – most of them would be worth more if sold to another buyer.  A better way to look at Kluang is to value it like a listed investment company or closed-end fund. The most important questions when looking at Kluang are – what does the company really own, what evidence is there of management’s investment strategy and how can we get a payout?

Maligned, Illiquid and Obscure

Kluang is very illiquid – there are often days when it does not trade.  The company doesn’t have any analyst coverage. However along with its sister companies, Kuchai Development Bhd (KLSE:KUCHAI) and Sungei Bagan Rubber Company (Malaya) Bhd (KLSE:SBAGAN, SB for abbreviation’s sake), Kluang has had a few articles written about it in the past.  The most recent articles tend to describe the group of companies as ‘lacking drive and ambition’ or as potential privatisation targets. This isn’t a recent development. There are newspaper articles from the 1980s with headlines like, “Dull Returns at Kluang Rubber”. There are also a few blog and newspaper articles from the last time the group did anything newsworthy, between 2004 to 2008.  At that time, Kluang had one of the highest share prices on the KLSE and was forced to do a 29 for 1 bonus share issue to raise liquidity. Since then, not much has happened and there appears to be little investor interest in Kluang.

Complicated Group Structure

Kluang, Kuchai and SB are very old companies.  Kluang and SB were originally rubber plantations which have long since been replanted with palm oil.  The plantations they own have been around since at least the 1920s and the companies have survived through a world war and a terrorist insurgency with little change in their activities.  Kuchai is an old tin mining company whose assets currently consist of a shop-house in Singapore and an unused block of mining land on the eastern outskirts of Kuala Lumpur. Historically, the companies have been robust but not particularly profitable.  

There are cross-shareholdings between the three companies.  Kluang is the top of the pyramid with 32% ownership of SB and 42% of Kuchai.  SB owns 9.4% of Kuchai and Kuchai owns 26.5% of SB. Until recently, Kuchai and SB owned small amounts of Kluang but these holdings were distributed to shareholders in 2018 as a dividend-in-specie.

It’s not clear why the cross-holdings exist and online records don’t go back far enough to establish when they were first set up.  The earliest mention of their association is in the late 1970s. The only place I’ve seen similar cross-holdings is in ASX-listed companies which set up such holdings to protect against corporate raiders in the 1980s.  Given that Kluang is controlled by the Lee family (45.6% ownership via a holding company, The Nyalas Rubber Estates Ltd), it’s possible the cross-holdings were put in place to discourage hostile takeover attempts. Or perhaps the directors of each company decided to invest in the other purely on the merits of the stock.  I don’t know for sure.

Assets

Kluang reports SB and Kuchai as consolidated entities.  For simplicity’s sake I have collapsed the holding company structure and calculated the percentage of the assets which correspond to Kluang’s share of the group’s equity.

Plantation Assets

Kluang directly owns Kluang Estate in southern peninsula Malaysia and indirectly (through SB) owns part of Sungei Bagan and Kuala Pergau (KP) estates in the northern part of the Malay peninsula.  Kluang and Sungei Bagan estates were last revalued in 2015 for a total of MYR 197 MM (MYR 123,000 and MYR 38,000 per hectare, respectively). By comparison, United Plantations (KLSE:UTDPLT) recently purchased Pinehill Estate for MYR 45,000/Ha and United Malacca Bhd (KLSE:UMCCA) recently sold plantation land for MYR 172,000/Ha. That’s a wide spread in values but it makes sense when you look at the locations.  The higher valuations (Kluang and UMCCA) are for land close to urban areas with recent development nearby. My understanding is that Pinehill is high-quality estate land but its rural location makes it useless for property development and so prevents a higher price. The same applies to Sungei Bagan Estate – it looks like reasonable quality plantation land but it’s in the middle of nowhere. I’m happy with the carrying values for Kluang and Sungei Bagan estates but in comparison to these figures, KP’s holding value just cannot be correct.

KP is an unlisted UK public company (Kuala Pergau Rubber Plantations plc) which SB owns a 25% share of.  SB’s books use the equity method to account for KP. The carrying value of the land is ridiculously low, MYR 0.86 MM.  It hasn’t been revalued since at least the 1990s – the reason given is that state land transfer restrictions make revaluation impractical.  This is fair enough when considered in isolation – Kelantan, the state where KP and SB have their estates, makes it very difficult for non-Kelantanese to buy land.  However, SB also owns land in Kelantan which was revalued in recent years. KP’s plantation land produces obvious value for the group so to put a value on it I have used the same per hectare valuation given to SB’s land.  That produces a book value of MYR 38 MM for Kluang’s share of KP.  

The fruit yields from the estates have been in line with local averages but nowhere near those of UTDPLT (which I wrote up previously for Focused Compounding).  Kluang also has no mills or refineries. Consequently, income is much more sensitive to fluctuations in the commodity price. Net income from the plantations is in the order of a few million MYR.  KP has been in the process of replanting for the last few years and replanting costs are expensed (not capitalised and amortised like UTDPLT). This makes recent returns very lumpy. Because of this, trying to value the plantations based on income not only produces a wide range of values, it also undervalues the assets compared to their private market value.  The way I look at the plantation income is that it adds a small amount to the income of the company whilst preserving the land value for an eventual sale.

When considering a private market sale Kluang’s land is worth more to one of the integrated plantation/downstream companies than it is to Kluang.  An integrated miller could better hedge the commodity sale price and process the fruit through their own mill. There may also be some margin going to a middleman that could be cut out – fruit agents are often used by smaller plantations.  All considered, the fairest appraisal value I have for the plantation assets is based on the land values as reported plus the above uplift of KP’s land value – MYR 297 MM inclusive of working capital but exclusive of cash.

Investment Properties

Kluang has four investment properties.  Two are held through Kuchai (Emerald Hill and Hulu Semenyih) and two are held through SB (Down St. and Balland).  

Emerald Hill is a shop house adjacent to Orchard Road in Singapore.  It’s a very attractive looking building in an expensive area. Kluang’s share of the property is worth MYR 11.1 MM, last revalued in 2017.  It’s currently leased to a related party for MYR 429,000 (Kluang’s share) which equates to a rental of about SGD 9.34 per square foot per month.  That’s not a fantastic cap rate (~4%) but it’s slightly higher than comparable Orchard Rd office rentals so I’m happy that the directors are doing the right thing here.  This asset seems fairly valued, especially given that it is a pre-war building and probably under a conservation order. It is unlikely to be developed further in future. 

Down Street (Flat 5, 22 Down St London W1) is a flat in the west end of London.  Like Emerald Hill, it’s an attractive old building in a very nice area – close to Buckingham Palace and Hyde Park.  Last valued in 2018 at MYR 35.98 MM (MYR 15.6MM being Kluang’s share) it generated a rental income of MYR 0.69 MM in 2018.  This seems low. However the lease has since been renewed for two years so I expect it will increase in line with the London average yield of around 4%. The valuation seems to be at the high end for the area – no reason to make any changes to the carrying value for our purposes.

Kuchai’s Hulu Semenyih land is a vacant lot next to an abandoned tin mining pond.  The land is carried at a value of MYR 4.5 MM (Kluang’s share is MYR 2 MM) which equates to a valuation of around MYR 1.3 MM per hectare.  This is a much higher valuation than the Group’s plantation land but is towards the bottom of the range of prices I can find for similar land advertised nearby. The land is on the far eastern edge of Kuala Lumpur’s ever-growing sprawl and has residential developments surrounding it.  The company recently cleared the land so it seems like there is some chance of the land being developed in the future. However I don’t expect it to happen soon enough to tempt me to adjust the valuation. This property is also probably better off owned by a company focussed solely on property development.

Finally, Kluang holds (via SB) 43.4% of the equity of Balland Properties Limited, which is registered in Ireland.  I haven’t been able to find any info on where this asset is physically located. Balland’s latest reporting shows that the company owns freehold property assets worth USD 1.4 MM (based on historical cost less depreciation and impairment) which originally cost USD 3.09 MM.   The depreciation schedule suggests the building is up to 40 years old (assuming no impairment charges) but strangely the depreciation bill for the equipment and fixtures is tiny in comparison to what the depreciation rate (10%) and carrying value suggest they should be. The reporting doesn’t suggest that the property earns any rental income.  Possibly this is just a vacant building. Kluang’s share of the asset is worth MYR 4.47 MM.  

Investment Holdings

The group holds MYR 9.2 MM of gold (at June 2018 prices) and MYR 120 MM of cash.  That’s the simple part.  

There is a share portfolio (most of which is listed) worth MYR 215.3 MM.  The largest part of this is MYR 169 MM worth of shares in Great Eastern Holdings Ltd (SGX:G07), a large life and general insurance company which in the last five years has had a combined ratio less than 94% and a ROE between 9% and 16%.  Great Eastern shares were priced at SGD 22 at the time of writing which equates to a P/E of 12 and a P/B of 1.2. That doesn’t look like an unreasonable valuation. There are no clues as to what the balance of the portfolio consists of so I have left the share valuations as reported.  

The other large investment holding is in Raffles-Asia Investment Company (RAIC), held via SB.  Kluang’s share of RAIC is carried at MYR 98.3 MM. RAIC makes up less than 5% of Kluang’s assets but it’s worth paying attention to because it provides some insight into management’s capability and patterns of behaviour.  RAIC is a closed-end fund managed by Chartered Asset Management Pte Ltd (CAM). CAM’s main personnel are Lee Yun Shih (one of the Lee family of controlling shareholders mentioned above) and his wife, Low Siew Kheng. Mr Lee previously was an asset manager at Credit Lyonnais and Mdm Low was head of research at Baring Securities and UBS Securities.  

CAM has been in business since 1994.  Assets under management at inception were SGD 12 MM and reached at least SGD 680 MM by 2014.  I would describe their strategy as long-only, growth at a very reasonable price with a focus on Asian stocks.  In a rare interview, Mr Lee talks about compounding by buying and holding undervalued consumer stocks with a demographic tailwind for long periods.  The few reports from around 2008 that I can find are also a good read – the content is the sort of thing you would read in a typical value fund shareholder letter.  By comparison, the commentary in Kluang’s reporting seems factually complete but lacking in insight. I wish the Lees wrote their management commentary for Kluang with the same degree of candidness. 

From inception to 2004 CAM (not necessarily RAIC) compounded NAV at 17%.  By June 2008, RAIC had compounded at 9.5% since inception. Not bad. Clearly the Lees are happy to deploy capital when the conditions are favourable.

Since 2008 RAIC has had a harder time.  NAV has decreased from USD 2.21 per share in 2008 to USD 1.35 at the time of writing.  Most of that decline tracks the decline in value of the local currencies (MYR, SGD etc) vs the USD up until 2016.  After 2016 RAIC’s NAV declined faster than the change in forex rates. RAIC pays distributions so this doesn’t necessarily mean the fund has lost money – in MYR terms SB’s portion made around 4% CAGR over that period.  But in 2017 SB stopped reinvesting the dividends it received from RAIC. This coincided with a jump in SB’s share of RAIC from 35% to 43%.  

Putting all of this together, it looks like RAIC has been returning money to its other shareholders and either RAIC/SB’s management has decided the dividends generated by RAIC can better be deployed outside of RAIC.  If you use archive.org to look at CAM’s shareholder letters pre-2008 they explicitly say that they massively reduce their equity exposure when they think the market is overvalued. Combine this with the appearance of gold investments on Kluang’s balance sheet in around 2011 and you could argue that the Lees have been positioning their investments for some sort of financial crisis for most of the past decade.

So, why has the performance of RAIC’s remaining holdings been so poor since 2008?  I don’t know for sure and management haven’t responded to any of my emails requesting information on this.  Perhaps RAIC has held a high cash balance over this period – they held about 14% cash in 2008. Some of RAIC’s 2008 holdings may have contributed, assuming they still hold them.  Here is a brief summary of how their largest positions in 2008 have fared through to July 2019:

  • CSE Global Ltd (SGX:544).  15% of RAIC’s 2008 NAV. Share price SGD 0.92 in 2008.  Sold in 2018 for SGD 0.45 per share. Produced around SGD 0.66 per share in dividends.  Equivalent to around 2% CAGR.  
  • Boustead Singapore Ltd (SGX:F9D) 10% of NAV.  Share price SGD 0.99 per share in 2008, SGD 0.80 currently. 5%  CAGR if you include the dividends and spin-off of Boustead Projects Ltd. It’s not clear if this is still held by RAIC.
  • Unisteel Technology Ltd (9% of NAV).  Acquired by KKR for SGD 1.95 in 2008.
  • China Shineway Pharmaceutical Group Ltd. (HK:2877) 8% of NAV.  Share price has increased from HKD 6 to HKD 6.79 whilst paying HKD 2.93 in dividends over the period.  Equivalent to about 5% CAGR. RAIC’s holding wasn’t large enough to show up on the list of largest shareholders so this may have been sold.
  •  Eng Kah Bhd (KLSE:ENGKAH),  6% of NAV or about 4.1 MM in 2008.  RAIC still holds a stake in Eng Kah but appears to have traded out and in since 2008.  Eng Kah’s share price has gone from MYR 2.62 to MYR 1.08 whilst paying MYR 1.425 in dividends plus an 11/10 stock split. CAGR a little more than zero.  
  • 0.68% of OCBC NISP (6% of NAV). RAIC still owns this holding.  Share price has gone from IDR 420 to IDR 890 whilst paying out 11 IDR in dividends plus a 1-for-2 stock split in 2018.  CAGR approx 15% in IDR terms. Unfortunately the IDR has depreciated versus the USD by around a third over the same period.

The performance of these holdings may account for part of RAIC’s performance or they may not.  Apart from the ones which are clearly still held, the portfolio may look completely different now.  The ones that they still hold trade at modest multiples but aren’t ridiculously cheap. For valuation purposes I think it’s conservative to assume that RAIC will compound at 4% under current conditions.

Unknown Holdings

There are also a few entities within the group that I can’t find much information on – Devon Worldwide Limited (100% owned by Kluang), Lanstar Assets Limited (100% owned by SB) and Springvale International Limited (100% owned by SB).  Springvale appears to hold SB’s interest in RAIC and Balland. Devon owes 39% of Kluang’s receivables. I have no idea what Lanstar owns or does. As these three are all British Virgin Island companies they may exist solely to hold some of the assets I mention above.  They may also hold some assets that aren’t accounted for in the above figures. For the purposes of valuation I have left them at their nominal carrying values.

Putting all of the above together, each share of Kluang consists of:

Plantation assets MYR 4.70 

Investment properties MYR 0.49

Share portfolio MYR 3.41

RAIC MYR 0.55

Gold MYR 0.14

Cash MYR 1.90

Management fee drag (see below, 2.5 MM per year capitalised at 10%) MYR -0.40

Net Asset Value: MYR 10.80 per share

Safety

Financially and in terms of business risk, Kluang is a very safe company.  The biggest risk and probably the main reason that it trades at a large discount to NAV is the risk of being taken private by the controlling shareholders.  There are two ways to evaluate this risk – quantifying the downside and looking at the past behaviour of the Lee family.

Going-private transactions for companies with <90% control holdings are usually done in Malaysia via a Selective Capital Reduction (SCR).  Either the company’s funds or external funds are used to buy out the minority shareholders. Minority shareholder approval of more than 75% by number of shares and 50% by number of shareholders is required and a blocking vote of 10% or more of the total shares on issue is enough to stop a SCR.  There’s currently one shareholder with 11.41% of Kluang’s shares that could do this alone (although their identity isn’t given). SCR’s are usually priced at a 20% to 30% premium to the various volume-weighted average prices that the company has traded at within the previous year. Given that Kluang’s share price hasn’t fallen below MYR 3 in that last few years I think the likely worst-case scenario is being taken out by an SCR priced at around MYR 3.20.

If we look at the Lees, we can see that the earliest mention of them being on the board of Kluang is 1981.  I wouldn’t be surprised if they have owned shares in Kluang since long before that. They have had control of the company since at least 1999 and sufficient cash on the balance sheet to fund an SCR at a minimum 20% premium since at least 2013.  Despite this, they haven’t pulled the trigger on an SCR and in recent times have laddered their cash term deposits which suggests a buyout isn’t imminent. Dividends have been paid each year since at least 1999 and special dividends have been paid in years when Kluang has grown tangible book significantly. The companies I’ve seen previously which were setting up to go private haven’t paid dividends as they were trying to hoard cash.  The only negative I can see is that the dividend in specie of Kluang shares by SB and Kuchai in 2018 will act like a buyback of Kluang shares and increase the Lee’s share of Kluang by a few percent.

Another example.  In 2017 the Lees gained control of Singapore-listed British & Malayan Trustees Ltd by buying the holdings of the main shareholder at a discount to the market price.  They were then obliged to make a compulsory buyout offer to the minority shareholders at the same price (which failed) and they have since done a pretty good job of restructuring the company and leaving the minority holders in peace.  I think an SCR for Kluang is possible but pretty unlikely.

Management 

Apart from what I’ve written above, the Lees are an interesting family.  They keep a very low media profile so there’s not a lot of information about the current generation. It looks like Kluang’s current main shareholders are the grandsons of the brother of Lee Kong Chian, a Singaporean conglomerate owner from the early 20th century.  In the 1990’s the Lee Rubber Company Pte Ltd (founded by Lee Kong Chian) appeared on Kluang’s shareholder register so the direct descendents may have been involved in Kluang also. Mr Lee finished life as a wealthy philanthropist with a number of Singaporean institutions set up using funds he donated.  There have even been leadership books written about him. The Lee family was also involved in founding Singapore’s second-largest bank, OCBC. I believe they still own around 4% of OCBC.

For me the most interesting thing about Mr Lee is that his biggest jump in fortune occurred during the 1930s depression.  Lee entered the depression period owning a conservatively financed rubber business and was able to accumulate a number of other plantations at bargain prices as other owners were forced to exit.  Perhaps the Lee’s are currently following the same strategy – both Kluang and RAIC have been sitting on a lot of dry powder since around 2008.

Management and director’s fees charged by related parties total around MYR 2.5 MM.  That seems reasonable when compared to Australian listed investment companies and considering that the plantation and property assets are managed directly.  Management doesn’t receive any share options – there is no dilution drag.

I’ve tried to write as much detail as possible about management so you can draw your own conclusions.  My conclusion is that the Lees are less likely to lose money than the vast majority of asset managers. And they are highly likely to increase Kluang’s running return when stock valuations decline significantly and they roll out the dry powder.  

Running Return

In total, tangible book plus dividends have compounded at a little over 10% CAGR over the last 20 years.  A lot of those gains came from revaluation of the plantation properties in the last 10 years (CAGR > 30%).  Some of those revaluations were on properties that hadn’t been revalued in decades so that rate is not real.  When I wrote about UTDPLT I mentioned that their tangible book value tended to compound as the wages and fertiliser invested in replanting increased with inflation.  That’s not going to happen as predictably with Kluang.

With UTDPLT, the economic returns from the plantation were predictable, to an extent.  It was easy to say that in the most likely worst-case scenario for the palm oil price, UP would still make money.  Kluang doesn’t have the production and customer advantages that UTDPLT does so the plantations will have years when they don’t make money or make a small loss.  Kluang’s accounting practices (expensing replanting costs) combined with the mix of income streams also tends to obscure the plantation earnings somewhat. Listed pure-play plantation companies similar to Kluang tend to have returns on assets in the mid to high single digits.  Assuming 5% ROA for Kluang’s plantation operations would be a conservative figure.

There is also the potential for plantation land value appreciation.  Demand for palm oil is not going away and the amount of land available to grow it is finite, particularly in Malaysia.  Long-term, Malaysian residential properties have grown at 6% CAGR. I don’t have agricultural land price data but I imagine it would be less than that.  For valuation purposes I’m going to assume land appreciation is zero.  

As far as the investment properties go, the long-term property price growth rate for Singapore is 4.6% and for London is 10.2%.  I think properties in developed capital cities are probably overvalued at the moment so returns in the next ten years will likely be less.  For the purposes of valuation I’m going to use 5% CAGR for the investment properties.

The financial assets should do better than the properties.  The insurance holdings should return around 7% based on the ROE and P/B figures above.  If market conditions remain overvalued I expect RAIC to stay battened-down but it shouldn’t do any worse than the 4% CAGR it has managed recently.  Under normal market conditions it should perform similarly to the base case for closed-end funds (around 10%).    

Cash and gold won’t add anything and might even detract from returns in the current market but should return something like what I mention above for RAIC if deployed into a normal market.

Putting this together I end up with two compounding rates for Kluang.  Under current market conditions Kluang compounds tangible book worse than the market index but better than a high-grade corporate bond, around 5%.  It’s also safer than most corporate bonds but the payouts are nowhere near as predictable. Under these conditions Kluang should be worth about 70% of tangible book.  

That’s something worth thinking about.  If Kluang was a corporate bond and was more hazardous (higher leverage and lower diversification of income) but paid a taxable 5% coupon then it should sell for more than par (tangible book) in today’s market.  Instead, Kluang is safer, more tax efficient (for many investors) and has upside potential compared to a bond. But it sells at a large discount to tangible book because the payouts are totally unpredictable and it could be taken private.  So the explicit hazards with Kluang are a delay in receiving a return or possibly losing a little in a going-private transaction. I don’t believe going to zero is a realistic possibility here.

Under normal market conditions Kluang should produce a return at least as high as the market.  History backs this up – from 1999 to 2008 (the last “normal” market) Kluang compounded tangible book at >10% without any revaluation of the plantation or investment properties.  Under those conditions Kluang should sell for at least tangible book.  

That sounds like I’m about to make a macro call on whether or not to buy Kluang.  There’s no need to do that. At the time of writing (July 2019) you can buy Kluang for about ⅓ of tangible book.  That would produce around a 15% return on the purchase price under current equity market conditions if the discount remains the same.  

If Kluang’s management continue to believe that there are no worthwhile investment opportunities in the world and the comparison index of your choice continues to grow at say, 10% then you could hold Kluang for 15+ years, sell at the same discount to NAV and still beat the market.  If the market changes then obviously Kluang is much more attractive but you would need to be aware that management could go “risk off” again at any time if they view assets as generally overpriced.

Footnote

Kuala Pergau’s shares could be interesting for a small UK-based investor with the time and patience to find and buy small holdings directly.  The latest shareholder list (2013) is full of deceased estates. For example there is one name that I recognise that isn’t shown as a deceased estate who would be a world’s oldest person record holder if still alive so I wonder how up-to-date the register actually is. It’s unlikely that many of the people that control the shares are interested in or even aware of the company. As mentioned above, the book value of the company is also far below the economic value of the land.  The company earns MYR 250,000 in rental from SB each year so the company must be worth at least MYR 2.5MM (using a 10% cap rate) but really should be earning a much higher income based on the comparative land value above. If anyone looks into KP I’d love to know how it works out.

Disclosure: The author holds KLSE:KLUANG at the time of writing.  This is not a recommendation to buy or sell any securities, nor is it financial advice.  All information presented is believed to be reliable and is for information purposes only.  Do heaps of your own research before purchasing any security.