SINGAPORE (Apr 23): A strong start to the US corporate earnings reporting season is giving beleaguered stocks a much-needed boost of confidence. Worries over geopolitical tensions, trade and regulations of tech companies remain and are likely to keep volatility at elevated levels, but the rebound is a welcome relief.
Most of the stocks in our Global Portfolio closed higher for the week, mirroring the improved sentiment. Nevertheless, total portfolio value declined 4.1%, dragged down by heavy losses for DIP Corp.
Shares for DIP stumbled, falling some 26.1% in the past one week after it released its latest quarter results for the financial year ended February 2018. The stock has been one of our best-performing, until this latest setback. Its price has now fallen below our initial acquisition cost. We have parsed through the numbers and do not believe the steep selloff is warranted.
A main metric that the market is unhappy about was the drop in sales revenue per job advertisement, which fell 14% y-o-y. The rationale is that giving excessive discounts to generate sales is bad strategy. This is true to a point, but not necessarily. The other reason behind the sharp drop in prices could be DIP’s own lowball profit growth forecast of just 6% for FY2019.
First, whether the decline in pricing is due to increased competition or by design, it is not necessarily a bad thing from a business point of view. The key is whether the additional sales generated outpaces the price decline — that is, what is the price elasticity of demand?
Chart 4 clearly shows that, for DIP, the demand elasticity is likely >1. Even though the price declined 14%, the number of job postings grew 33%, resulting in sales growth of 15% for the latest financial year (see Charts 1 to 3).
The beauty of a digital business model is that sales and earnings can grow proportionately faster than capex, it has low marginal costs and builds network effect at the same time. Case in point: DIP’s cost of sales actually fell in absolute terms in FY2018 despite generating higher sales volume.
Digital platforms tend to have far fewer supply constraints. This is evidenced by the company’s sales growth relative to total assets base (excluding cash) over the years. Net cash has risen consistently on the back of robust cash flow from operations, from ¥188 million in FY2012 to the current ¥14.7 billion ($179.3 million).
Operating expenses — principally, personnel, marketing and promotion as well as rental costs — did rise in FY2018 as the company seeks to expand its customer reach, from hiring more staff to increased promotions via TV commercials and web ads, and opening new offices in Sapporo and Sendai.
Even then, Ebitda (earnings before interest,taxes, depreciation and amortisation) margin extended its long-term uptrend, expanding from 11.1% in FY2012 to 30.4% in FY2017 and 31.5% in the latest FY2018. Net profit margin showed a similar trend, expanding from 3.3% in FY2012 to 18.6% in FY2017 and 19.8% in FY2018 (see Chart 5).
In other words, DIP is not sacrificing margins simply to generate sales growth.
Remember, DIP is a market leader. It operates one of the largest web portals and mobile applications for part-time and temporary jobs in Japan. Given the benefits from network effect and near-zero marginal cost, reducing prices can actually gain market share and improve profits.
We are still upbeat on the outlook for DIP. There remain numerous factors in its favour.
Japan’s economy is in the midst of its longest stretch of growth since the asset bubble burst in the 1980s. A gradually recovering economy, ageing population and shrinking workforce have led to rising job vacancies. Furthermore, the country is seeing a shift away from permanent positions — demand for temporary and part-time jobs are typically high for an ageing society. Unemployment has fallen to the lowest level in decades — there are currently 1.58 jobs for every job seeker.
In addition, the trend is clearly biased towards usage of online job postings, which carry more information. A digital platform — such as that of DIP’s — is the fastest and most efficient way to match job seekers with prospective employers.
Job postings online have exceeded those in print media (including free papers) since April 2015 and now account for 69.8% of all postings (see Chart 6).
Valuations are reasonable, with a trailing price-to-earnings ratio of 18 times and enterprise value/Ebitda at only 10 times — relative to net profit and Ebitda growth of 22% and 19% respectively.
The company has guided for sales growth of 11% but net profit growth of just 6% in FY2019. This suggests operating expenses will rise at a faster pace — DIP plans to keep increasing sales capacity (hiring more staff), expanding existing offices as well as opening new ones to grow its footprint. This reflects a sound longer-term strategy instead of maximising short-term profits, as equity markets prefer.
We are fairly confident DIP can achieve its top-line target and we believe it can exceed its own profit growth forecast if margins can continue to improve, which has been the trend in the past years. The company also pays dividends, which totalled ¥43 a share last year and are expected to increase to ¥45 a share in FY2019.
We bought 33,000 shares in Hong Kong-listed Nine Dragons Paper Holdings for US$49,909.90. After this purchase, cash holding in the Global Portfolio was reduced to 16%.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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