Do You Think You'll Make Money Investing in a Company Solely Because It Makes Money?
Don't be naive
Disclaimer: this is not an equity research report and it is not a buy, sell or hold recommendation on any mentioned stock. This article also contains the view of the author, which may not necessarily reflect the view of the company. The purpose of this article is strictly for educational reasons only.
Remember, there is no free lunch in the stock market. If you find information floating around that promises you to be rich with no cost, be sure to be extremely skeptical. With that, let’s kickstart this article.
Philosophy When Evaluating a Stock
At Recompound, when we are performing due diligence of a stock, it is imperative for us to understand:
How do they make money and what is their future prospect like (businesswise)?
Capital allocation: After money is made, where does the money go? Does it get reinvested to generate more money? Do we as minority shareholders enjoy their earnings?
Using the Indonesian stock INKP as an example, we explain why a good business may not necessarily mean a good investment, if the controlling shareholders intentionally do not want to benefit the minority shareholders.
What is INKP?
INKP / PT Indah Kiat Pulp & Paper Tbk. is a major Indonesian producer of pulp, paper and tissue products and is a part of APP (Asia Pulp & Paper) group owned by Sinarmas. APP group itself is the world’s 4th largest Paper & Paperboard Producer.
Is it a Good Business?
From the 2 figures above, I hope we all agree that INKP is a good business and it should make its minority shareholders like us richer overtime, right? Well, not really.
We won’t discuss INKP’s business model here because it is not the focus of this article.
What we are interested in is how the money made (net profit) is being allocated inside the company.
INKP’s Net Profits + Dividends
Over the years 2012 - 2022, INKP accumulated a total net profit of 53,445 billion IDR
Phew, that’s a lot of money made! But do we as minority investors who buy the stock in IDX get to enjoy their success?
Total dividends paid from 2012 - 2022:
Note: Dividends payout ratio means how much percentage of the net profits are paid to the shareholders as dividends.
The answer is: only a fraction of their profits go to their shareholders (including us as minority investors).
So, Where Does the Money Go ?
To answer this question, it is easiest to read its balance sheet because a balance sheet is basically the cumulative accumulation of a company’s wealth throughout its history.
Let’s compare INKP’s balance sheet between 2013 vs 2022. Sorry we could not find 2012 financial statement. You could download and view all things INKP at IDX Public Expose.
2013 (amounts in the table are expressed in thousands of USD):
2022 (amounts in the table are expressed in thousands of USD):
At a glance, company’s overall asset grew from 6.7 billion USD to 9.6 billion USD: nice! It’s a testament of a business which is profitable and growing. But how does INKP allocate its hard-earned cash? What we know for sure from the previous section: it distributes little to no dividends to its shareholders.
Let’s focus on the following accounts which experienced significant increases from 2013 - 2022:
Cash:
67 million USD to 1.2 billion USD —> An 18x increase
This is normal, as the company grows, a company must have a strong cash buffer for unexpected crisis and future expansions
Trade receivables:
Means how much money is owed to INKP by its customers
198 million USD to 1.8 billion USD —> A ~9x increase
Why such a huge increase?
What is INKP’s ability to collect payments from its customers over the years?
We shall check this account further
Advances and prepaid expenses:
Means an advance payment made to the supplier of INKP
149 million USD to 810 million USD —> A ~5x increase
Why such a huge increase to its raw materials supplier?
We shall check this account further
Current Assets
Means easily-liquidated assets that INKP owns
373 million USD to 1 billion USD —> A ~3x increase
Cash already experienced a 18x increase, why do they need to significantly increase this account?
We shall check this account further
Money Hole 1: Trade Receivables
From 2013 - 2022: This account experienced an astounding ~18x increase from 198 million USD to 1.8 billion USD
If we dig further on the details of this account:
Majority of this receivables went to PT Cakrawala Mega Indah (around 65%), which is an affiliated entity (not under INKP), which has the same ultimate beneficiary owner: Sinarmas.
If an increase of trade receivables is not followed by the same rate of increase in sales, this is an indicator that INKP takes longer to collect payments after making sales to PT Cakrawala Mega Indah.
Let’s compare the growth of sales vs trade receivables to PT Cakrawala Mega Indah from 2014 - 2022.
Needless to say, the difference in growth is astounding.
This indicates that a lot of INKP’s cash is being “held captive” by PT Cakrawala Mega Indah, which is owned by the same owner: Sinarmas.
Money Hole 2: Advances and prepaid expenses to suppliers
From 2013 - 2022: This account experienced a ~5x increase from 149 million USD to 810 million USD
If we dig further on the details of this account:
Almost 100% of this account went to an affiliated supplier PT Arara Abadi (not under INKP), which has the same Ultimate Beneficiary Owner: Sinarmas Group.
Let’s dive into the futher detail of this agreeement:
It basically says that PT Arara Abadi has the liberty of setting the advance payments to INKP without any consequence whatsoever.
This is very scary for us minority investors! Because PT Arara Abadi is free to suck INKP’s cash whenever it wants to. Furthermore, PT Arara Abadi is not included when we buy INKP, albeit having the same owner.
Money Hole 3: Other Current Assets
From 2013 - 2022: this account experienced a ~3x increase from 373 million USD to 1 billion USD
If we dig further on the details of this account:
Majority of this account are contained within short term investments in “Global Income Fund” & “World Resources Investment Fund”.
We tried to Google the details of these 2 funds, we strongly suspect these 2 funds are operated by Singaporean Asset Management companies:
The fact that:
This account increased by ~3x for the last 10 years
INKP utilizes a substantial amount of interest bearing debt (~3.2 billion USD) to fund their operations and expansions…
…suggests that INKP has no intention to enrich its minority shareholders through its business returns.
Summarizing the Corporate Structure
From the structure below, it can be clearly seen that most of INKP’s wealth are siphoned off by Sinarmas through their privately-owned entities, in which we as minority shareholders do not have access to.
Is INKP a Bad Investment? Not Necessarily!
When we invest in INKP as minority shareholders, it is not wise hoping to enjoy its business returns for the following reasons explained above:
Little to no dividends for its minority shareholders
Business earnings are transferred into 3 accounts with no benefit to the minority shareholders:
Trade Receivables (~65% of them to an entity owned by the same parent entity)
Advances and prepaid expenses (100% of them to an entity owned by the same parent entity)
Current Assets
However, can it potentially be a rewarding investment? Yes!
INKP’s share price rose by 885% within 1 year from 2017 - 2018 before plunging by 50%, and never recovers until now.
However, when we looked deeper, the rapid share price rise was not because of INKP’s business returns, but instead because of inclusion within a foreign index MSCI (Morgan Stanley Capital Index) in 2018.
Final Remarks
By now, we hope you understand that not all IDX stocks’ share price would increase simply because of its business performance.
Certain stocks (i.e. INKP) can only go up if there is an incentive by the owner (i.e. Sinarmas) to jack up their stock price, and this can be due to a wide variety of reasons:
Foreign index inclusion like MSCI / FTSE
Tender offer
Share buybacks
Other corporate actions..
We hope this article is helpful for your investment journey. Until next time, ciao!