Stock Review: CWT Limited

During the Singapore budget speech, our finance minister announced that the logistics sector will receive some help and so my attention shifted to look at logistics companies. A friend suggested to check out CWT Limited, which I did, and here I am summarising some of my thoughts about the company.

On the surface, the company has no red flags. Based on SGX data on 23 Feb 2015, share price $1.67, healthy P/E ratio of 8.4, P/B 1.24, yield 4.4%, all other ratios looked average, though the debt is on the high side (>$1 billion).

I read through the website, financial reports, and tried to look for their income driver because their revenue is undoubtedly impressive at $15 billion for a company their size. I was given the impression that they relied a lot on trade income, although they have rental and services income as well. As I still could not really understand how the business model was for trade income, I tried to compare the reports to look for differences in reporting, hoping to find out whether there was anything that the company will try to hide from a press release for example.

Operating Margin

There was something interesting I noticed that was missing in the press release, but present in the presentation slides -- operating margin. Operating margin reduced from 1.2 in 2013 to 0.9 in 2014. That helped me to explain why its profit was a lot lower than its revenue. I really wonder how this is called efficiency if every $100 of sales collected translates to 90 cents of profit.

Revolving short-term debt

The other really strange disclaimer in the presentation slides was two separate line items to report debt -- "revolving short term trade facilities" and "net debt". "net debt" was defined as excludes "revolving short term trade facilities", so the net debt to equity ratio looks smaller. 

Extracted from CWT Presentation slide 9

I spent a few minutes re-reading the table and unaudited statement of accounts to try to figure out what it was trying to show and I realised that the charts were actually showing an increasing debt in a pretty smart way. Debt has increased from $392 million to $1.431 billion which is 3.65 times in the last 4 years. Being able to borrow more is not necessarily a good thing.

Extracted from CWT Presentation slide 9

In lay man terms, the company buys and sells commodities (metals and by products) and earns from the differences. This accounts for majority of its revenue (92%).

Extracted from CWT Presentation slide 5

With such a thin profit margin, this company reminded me of Groupon. Groupon brought in more than US$1 billion yet could not turn in any profit.

The writer does not own shares in any companies mentioned.

Singapore Fixed Deposits - Feb 2015

Seems like every bank is competing for fixed deposits this Feb. All promotions end on 28 Feb 2015. I compile this out of personal interest as I am also doing some shopping.

One Year

POSB 1.88% p.a. 12 months, min 1k (not exactly fixed deposit but have earmark feature)
Standard Chartered 1.4% p.a. 6 months, min 25k
OCBC 1.4% p.a. 12 months, min 20k
Hong Leong Finance 1.3% 12 months, min 25k
UOB 1.3% p.a. 13 months, min 20k
CIMB 1.25% p.a. 12 months, min 25k
Citibank 1.18% p.a. 9 months, min 50k
Maybank 1.1% p.a. 12 months, min 25k

Two Years

Maybank 1.55% p.a. 24 months min 50k
Hong Leong Finance 1.48% 18 months, min 200k

Saving my ILP - Part 2

In Part 1, I showed a high-level strategy of what I intend to evaluate and how my Investment-Linked Policy (ILP) Whole Life Insurance plan could still serve a minimal whole life insurance need while maxising investment returns.

I would like to provide a zoomed-in view of the graph I last showed in Part 1, before proceeding with the cost benefits analysis on the insurance components.

The reason I decided to zoom-in to a section of the graph was because I thought that I should also see where the growth overtakes for the different projected yields. This is just a theory exercise because in reality, yields are never constant. The graph shows that between 48 years old (16 years later) to 55 years old (22 years old), if I decide to surrender the policy, I will be able to regain around the same capital regardless of the yield. However, after 55 years old, when the compounding effect becomes more obvious, there could be a increasingly high opportunity cost to surrender the policy.

Just a recap on the strategy: First, maximise the accumulated benefits of investing "early" (or create a situation to make it behave that way) which is what ILP is good at. Second, move insurance components into a term insurance, and cut down unnecessary insurance items. Now, I will address the second part by first establishing needs of various kinds of insurance products.

In Whole Life Insurance -- What made me buy it?, I prioritised a list of saving and insurance requirements with explanations. I will list the key points here.

Needs (necessity)

1. Medishield
2. Private shield that sits on top of Medishield
3. Piggy bank of 3 months salary
4. Personal development
5. HDB mortgage insurance

Wants (good to have)

1. Term life insurance
2. Emergency fund of 9 to 12 months salary
3. Children's education
4. Opportunity fund to buy in market crashes
5. Retirement fund -- top up SRS and/or CPF
6. Whole life insurance

With my priorities as the premise, I tackle the insurance components one by one.

First, term life insurance is something which I will definitely want to buy because I have dependents. The "industry practice" is 5 to 10 times of your annual salary, but it also depends on the number of dependents you have. As my priority is to spend the bare minimum, I chose $500,000 death benefit. This is because I will just need to probably fund "children's education" expenses. My other savings from CPF, SRS, investments, etc., should be decent by then too. Of course, I will work hard to eat well, exercise, reduce stress, etc, and live a long life, so this is mainly for accidents.

Second, critical illness insurance is something which I will want to buy because I have dependents, but the initial thought was to offset medical bills rather than to pass the benefit to my dependents. I chose $300,000 critical illness benefit for this evaluation exercise. After calculations, I am actually thinking of not buying this because I am already paying for a rider on my private shield that covers 100% private hospital single-bed wards' hospitalisation bills (which covers a much wider scope than critical illnesses so it is more worthwhile). In the event of critical illness, my medical bills will be fully covered, and if I am really that sick, I will want to live more than have a lump sum of cash which cannot save my life. If I am at the end stage of some critical illness, I would probably check out soon and death benefit will kick in. Critical illness premiums are also very expensive, probably because few people buy it. :P

I tabulated the cost of the death (D), terminal illness and permanent disability (TPD) and critical illness (CI) charges based on $1,000 sum assured to normalise the cost between paying the premium through a whole-life plan, 20-year term plan, and 10+10 year term plan. 10+10 means I buy 10 years first, then 10 years later, I buy another 10-year plan. I decided on a 20-year term because I assume that I would have built up my retirement fund and children education fund sufficiently by 55 years old. This will also free up more cash now to channel into investments.

Findings:

1. Paying for D, TPD, CI charges through a whole-life plan is substantially more expensive than a term plan for the age range described -- 34 to 53 years old.

2. Paying for a 20-year term is cheaper than a 10+10-year term. This could be extrapolated to buying 30-year term being cheaper than 10+10+10 or 20+10.

Conclusion:

If the intention of insurance is just to cover yourself for unexpected circumstances during your critical child rearing years, a 20-year term plan might be sufficient, and recommended to be started only after you have your first child, so as too free up as much cash as you can to invest and accumulate returns early.

Getting a rider top-up for your private shield plan is a better option than buying critical illness or early critical illness cover, if you intention is to defray medical bills. If your intention is to get lump sum cash, which the private shield rider would not be able to provide, then you have to weigh the benefit of paying $18,600 for a $300,000 benefit, that will occur with a 1% (based on my memory) probability for this age range. I will dig further for research data to see what the actual probability is.

Saving my ILP - Part 1

This post will document my thoughts and decisions behind how I will proceed with saving my Investment-Linked Policy (ILP) Whole Life Insurance from become "trash" or "useless".

There are two parts of this strategy. First, maximise the accumulated benefits of investing "early" (or create a situation to make it behave that way) which is what ILP is good at. Second, move insurance components into a term insurance, and cut down unnecessary insurance items. This post will address the first part only.

My agent had been very accomodating to my requests to generate many benefit illustration documents and answering all my questions about whether the ILP rules allow me to make the adjustments. Thankfully, the plan is quite flexible.

Step 1: Reduce all insurance coverage to the bare minimum to keep the essential riders alive. I actually just wanted the PruSmart Lady benefit for the free health check up. (Ok, it is quite silly thinking back now that I bought an ILP because I expect health check up prices to go up in the long term, but it may not be all that bad if you read till the end of this post!)

Step 2: Calculate how much sales charges have been paid out. As I had paid three yearly premiums, I had paid majority of the sales charges, so if I can still afford the premium, it does not make sense to reduce the premium because I will be effectively locking in a loss. Separately, when I reduce the premium from $2,699 to $1,200 (the minimum), there was insufficient runway to accumulate the investment returns. As such, I had to create a runway for myself by investing more every year to make up for the "lost" years.

Summary of projected cash values look healthy at the age of 95 years old. As I always think of worst case scenarios, I need to calculate break-even values for everything. A 3% yield will break-even at any age.

For those who prefer graphs, the points plot out the growth for various projected yields and if you count the lines, anything 4% and above is good, i.e. if I surrender before I check out of earth, I will be able to get my capital back, and my death benefit coverage could be deemed as "Free".

All yields and calculations displayed exclude sales charges and admin fees.

When will ILP whole life insurance make sense?

Triggered by a comment to draw a chart of mortality charges within Investment-Linked Policy (ILP) whole life insurance plans, I went back to my table and plotted a pretty chart. This is based on female and non-smoker charges. 

From the chart, the line starts to curve at 30 years old, so I enlarged the scale from 1 to 40 years old to get the following chart.

In general, the first 6 years have a slightly higher mortality charge. Hence, the most optimal point to start if after 6 years old, if the intention is pure investment purposes. Lowest premium is at 10 years old.

Hypothetically, not that I am encouraging you to believe me, ILPs might suit the profile of babies, starting from 1 year old. If you are curious to know how much cash value could potentially be accumulated, theoretically, I had compiled a small chart based on present values. This assumes a benefit sum assured of $100,000 for death, $100,000 for critical illness and $100,000 for early critical illness.

All benefit illustration excludes sales charges and admin fees which are variable across a person's life time. While the cash values are eye popping, this exercise shows that the product could have some potential baby customers.

As a parent of a 4 year old daughter, I will not buy this product for my 4 year old either. My reason is that the margin  (minimum 5% + 5% sales charge = 10% returns over 95 years) is not sufficient for my low-risk appetite. Historically, assets like properties, gold and blue chip shares make a better investment for a 95-year horizon. $100,000 will probably be only worth $100 by then?

Reading into my Investment Linked Policy (ILP) - Part 2

In Part 1, I explained at a very high-level how ILP works and highlighted two important risks that are often overlooked. I also overlooked it when I bought the product. As I am writing this, I am also in touch with my agent to learn more about the product to see how I can "save" my product from becoming trash because I hope to lead a good (and long) life. You will understand why I describe it as trash by the end of this article.

This only applies if you have an insurance component to an ILP. For example, life insurance, terminal illness and disability, crisis cover and early crisis cover.

Risk 1: Vary Premium
Risk 2: Reduction in Yield

Big Idea: Insurance premiums are deducted from the accumulated premium you had paid to the ILP seller. In the initial years, you pay more than what is deducted. In the later years, you pay less than what is deducted, but the balance is covered by the excess that had been accumulated. At some point in time, there will not be enough to pay for the premium. What you pay for is what the insurer calls mortality charges.

Mortality charges is a fixed rate determined by your age, gender, and whether you smoke, for every $1000 insured. This is independent of the premium you pay or the age you start the policy. The age you start the policy and the expected sum insured required will be reverse engineered to a premium such that the break even cost looks good on the benefit illustration.

An extract of how the mortality charges look like is shown below.

I transcribed the numbers into a spreadsheet to do a simple break-even chart. The yearly premium listed is the insurance premium based on a benefit sum assured of $100,000 for each condition (Death, Critical Illness, Early Crisis). My yearly premium is $2,699.

Three rows had been highlighted, which basically showed three potential outcomes of the policy. For ease of explanation and understanding, I had left out sales charge and monthly $5 admin charge, but it will be there.

At 55 years old, the insurance premium of $2,727 will be more than my premium of $2,699. I would be inadvertently forced to stop my early crisis insurance coverage if I do not want to top up the short fall. While the agent's argument is that the accumulated investment returns over the past years could cover the premium, I am skeptical (but more on that later).

Assuming I stop my early crisis coverage at 55 years old, I would be faced with a similar decision point at 65 years old, when the death and critical illness coverage premium will cost $2,938, more than the $2,699 premium. Hmph, so I may be forced to stop my critical illness coverage.

Dividing $100,000 by $2,699, excluding projected returns and charges, a break-even point is at 37 years old, which is 32 + 37 = 69 years old in my example. This is a hide-cash-under-pillow scenario.

Assuming I stop my critical illness coverage at 65 years old, so that my policy can still be active, and if I check out of this world at 69 years old, I would probably just breakeven and have been no worse off with hiding cash under my pillow for 37 years. I potentially could have some cash value remaining in the policy, which I actually do not expect to be much.

At 72 years old, my death coverage (also known as life insurance) will cost $2602, which starts to growth rather exponentially. Anything after 69 theoretically means not "worthwhile" because the guaranteed death benefit is only $100,000 no matter how much you plough in. Earlier arguments had also established that it is impossible to think about critical illness coverage after 65 years old, so there really is no benefit to continue with the policy.

Now I come to the last part about why I am skeptical that the accumulated investment returns (also known as cash value) will not be able to cover a lifetime of premiums. If you have a project return that growths in a linear straight line graph, and an insurance charge that grows in an exponential line graph, we cannot confidently guarantee the projected returns cover the insurance premium charges.

Finally, even the benefit illustration provided in the policy document shows it too, although very (smartly) subtlely.

The last line stops at 40, which does not really tell you the whole truth. At 4% projected returns, the cash value will be $9,000. Based on the mortality charge table, you know that insurance premium will cost $10,570, which cannot be covered by the $9,000. This is where Risk 1: Vary Premium enters the picture. I will need to top up the difference if I want the policy to still be active, else it will be terminated.

Finally, at 8% projected return, Risk 2: Reduction in Yield is acted out. If they had really listed the benefit illustration beyond 40 years, nobody would have bought this product.

Revised image as there was a calculation error earlier that showed break-even at 85 years old.

Indirectly, I am expected to check out at 89 years old, and that is actually based on an extremely optimistic projected return of 8% + average 4% sale charge = 12% return. The early crisis charges also stop at 85 years old in the policy document. Just nice.

I will probably have Part 3 after I have managed to "save" my policy. While many people advocate to terminate the plan, switch to term insurance and cut loss early, I am exploring converting this to a pure ILP product without insurance coverage, or minimal insurance coverage, which appears to be the best option at the moment.

Reading into my Investment Linked Policy (ILP) - Part 1

As an advocate of knowledge sharing, I will use a Prudential ILP which I bought two years ago as an example to share and educate my readers about an ILP. The approach I am taking will be different from the typical "Why you should not buy an ILP" or "Why an ILP is bad for you" format; instead, I will explain the ILP details in lay man terms.

Be it an insurance policy or an investment policy, underlying an ILP is a model. By model, I mean that you could visualise a mathematical model that has a set of rules.

Rule 1: Customer pays the ILP seller a fixed premium, either monthly/quarterly/yearly.

Rule 2: Premium is used to buy units of the selected fund based on the prevailing offer/sell price.

Rule 3: Every fund has a buy (from you) price or sell (to you) price. Alike money changers, the sell price is always higher than the buy price. The difference between the buy and sell price is also what is known as "sales charge" which what the ILP seller earns.

Rule 4: For the first 3 years (thereabout), premiums the customer pays are partially paid to their agent as commission. This is clearly, but indirectly, stated in the policy document that you sign.

Rule 5: If there is an insurance coverage requirement by the customer, units are used to pay for the insurance premium. How this works is your units are sold back to the ILP seller every month at the prevailing buy price, so you will have to indirectly pay for "sales charge" again.

Important RISKS in a typical 50-page policy document which your agent will probably ask you to accept and sign without really explaining to you.

Risk 1: Premium is expected to vary, but they did not explain what it really meant.

Risk 2: Reduction in yield is expected at 65 years old, but they did not explain what it really meant.

I will explain these two risks in Part 2.

Disclaimer: Neither am I encouraging or discouraging you to buy this product. I am trying to explain this underlying mechanisms of an ILP.

Structured Deposit vs Fixed Deposit

Although the names "Structured Deposit" and "Fixed Deposit" differ by just a word, the two are slightly different deposit instruments.

Assessment	Structured Deposit	Fixed Deposit
Protected by Deposit Insurance Scheme up to S$50k, aggregate of all accounts for each person with the bank, if bank becomes bankrupt (insolvent)	No	Yes
Capital Guaranteed (provided capital held till maturity and bank does not become bankrupt)	Yes	Yes
Early Withdrawal	No pro-rated/market interest, fees may apply	Market interest, e.g. 0.05% for savings rate
Interest Income	Guaranteed for the tenure	Guaranteed for the tenure
Tenure	5 years	renewable every 1 or 2 years
Reasonable Interest Rate per annum (as at 9 Feb 2015)	2%	1.3%

The fundamental difference is that structured deposits are not protected by the the Deposit Insurance Scheme if the bank becomes bankrupt, which puts it in the same category as Investment products. While we can have "faith" in the bank, the difference in returns of 0.7% may not warrant taking the risk, especially if you are not filthy rich. By filthy rich, I mean, you have money in different banks and have fully utilised your deposit insurance quota in different banks, and you are fine with taking the risk.

The Deposit Insurance Scheme protects the end consumer by requiring banks to pay the central insurer a sum based on the amount of deposits they hold, such that if the bank becomes bankrupt, the insurer would pay each depositor with the bank, the amount of savings held in the bank, up to S$50,000. Only savings deposits and fixed deposits are protected by this Scheme. The purpose is to avoid a rush of withdrawals if the bank enters a cashflow crisis, which would further worsen the problem. Read more about it from the Singapore Deposit Insurance website.

Personally, being risk-adverse, I prefer to open a few bank accounts and save up to $50k in each bank. At least, when I need some cash to apply for an Initial Public Offering (IPO) or buy some shares on the stock market (when the price is favourable), I will have some cash on hand. As I also like liquidity and flexibility, I dislike deposit tenures that have lock-in periods more than 12 months.

If you expect interest rates to rise year on year, all the more you will like the flexibility to renew Fixed Deposits every year.

Weighing the 3 local banks -- DBS, OCBC and UOB

With the three local banks about to release their full year financial results next week, I decided to read through the 9M14 report to re-look their positions with the new developments in US, mainly in order of priority:

1. Obama's proposed budget to increase corporate tax rates and foreign income tax rates, to reduce debt;
2. Ceasure of Quantitative Easing (QE); and
3. Fed's committment to increase interest rates "realistically", which many people believe to be in the second half of 2015.

I would not have been interested to look through the reports had it not been for Obama's announcement this week, so my focus is on the US currency and loan interest income, which I believe the three local banks share price will react to. Of course, US corporate tax rates hikes may not get the support from the Republicans but generally, I believe the businessmen are smarter than politicians to know who to support and what to believe in. The convergence of the three events will likely guide the USD to appreciate against the SGD.

Data had been extracted from individual bank's 9M14 financial reports. 

The focus is to ascertain the exposure to USD loans and reliance on loans as income, so that we can better infer whether income will increase or decrease when any of the two events occur:

• USD appreciates against the SGD (globally)
• SIBOR interbank lending rates increase (locally)

First, I look for Interest Income, which in lay man terms mean, how much I earn from my customers by lending money to them. This is determined by the interest rates the bank charges its customers for the loan.

DBS has the largest proportion of Interest Income at 82.63%. OCBC and UOB have a much smaller absolute and percentage amount compared with DBS. This potentially could give DBS a windfall if interest rates were to increase. On the whole, DBS' interest rates for income-bearing assets (not shown in this diagram but available in the financial report) were the lowest (2.38%) among the three (2.69% for OCBC and UOB), which gives DBS more leeway to increase rates without hurting their competitive edge. Income-bearing assets include what we understand in lay man terms as loans.

Second, I look for Customer loans by currency, which is the apportionment of loans based on the currency the loan had been given. This is important if we want to infer the income generation ability when one currency appreciates significantly over another.

DBS has the largest proportion and absolute amount of USD loans. UOB has the least exposure, hence will least likely be positively/negatively affected by USD exchange rates. Based on the distribution, OCBC's spread of currency looks more diversified, which implies less interest income fluctuations due to currency. DBS' distribution of a near 50-50 distribution of USD and SGD loans suggests a strategy of hugging both currencies tightly so that the appreciation of one and depreciation of the other will cancel the effects of each other. On the whole, no one bank is superior over another in this aspect mainly because all three banks report their earnings in SGD. For Singapore companies that report their earnings in USD, this could play a bigger role.

Third, I look for cost to income ratio, which is a way of telling the shareholder how much it costs the company to earn every $1. All three banks are close, but OCBC spent the least. At 39.5%, in lay man terms, OCBC spent 39.5 cents to earn $1.

The writer owns units of DBS shares at the time of writing.

References:

1. DBS 9M14
2. UOB 9M14
3. OCBC 9M14