Union Gas Holdings Limited

Union Gas Holdings Limited ("Union Gas" or the "Company") is offering 60m shares comprising 30m New Shares and 30m Vendor shares at $0.25 each for a listing on Catalist. The IPO will close on 19 July 2017 at 12pm and starts trading on 21 July 2017. 1.28m shares will be available for the public with the rest via the placement tranche. The market cap is around S$50m based on the IPO price. You can find the prospectus here.

History of Union Gas

The founder of Union Gas is a self-made man. His rags to riches story was featured in the Straits Times in Oct 2014, do take some time to read here. He bid for the cab license and started Trans Cab with 50 taxis in 2003 and tried to list Trans Cab in Nov 2014 (my IPO write up is here) but unfortunately for him, the IPO was de-railed by a poison pen letter. With hindsight, the onslaught of Uber and Grabtaxi (one of the risks I mentioned), Trans Cab would be facing extremely challenging times now. Similarly, i can foresee challenging times ahead for Union Gas.

Principal Business and Future Plans

Union Gas is an established provider of fuel products in Singapore with more than 40 years of track record. The Company has 3 main business segments:

• Retail LPG Business

Union Gas is a leading suppliers of bottled LPG cylinders to domestic households and CNG to retail and industrial customers in Singapore. It operates more than 100 delivery vehicles and supply bottled LPG to more than 140,000 households in Singapore. My family used to use Union Gas but we have since switched to Esso LPG cylinders. If you refer to the Financial Highlights section below, you can see that revenue from retail LPG business declined from $24.8m in FY 2014 to $21.2m in FY 2016. As more households switched to piped gas and a highly competitive and fragmented retail market, the revenue is likely to either stagnate (stablise if you really want a more positive word from me 😋) or continue trending downwards.

As part of its business strategy to "stop the downtrend", one of its future plan is to spend $4m of the proceeds to acquire other "dealerships" or competitors. Not sure if this is good for consumers 🤔

• CNG Business

CNG vehicles are unfortunately not catching on due to lack of government incentives to do so. With increased tariffs and the cost of diesel being cheaper than CNG, the number of CNG vehicles have been shrinking over the years. See article here. A series of safety issues resulted in LTA requesting all CNG owners to send the cars for inspection and this is probably the nail in the coffin for CNG vehicles once the existing owners scrap their cars. So this is a business that would cease to exist in the coming years.  This is evidenced by the sharply declining CNG business from $19.7m in FY 2014 to $9.4m in FY 2016 (see Financial Highlights below). I will probably write off this business in 3 years.

The Company recently obtained a gas retailer license from EMA on 17 April 2017 which allows Union Gas to supply and retail pipled natural case to customers in the services and manufacturing industries in Singapore.  The Company intends to expand this to customers in F&B in 2018. The Company intends to use $1m to fund this new business. It is too early to tell if the Company will succeed in this new business line.

• Diesel Business

This is currently not a significant part of the business and generated $5.1m in revenue last year.

Financial Highlights

Despite strong declining revenue, Union Gas is actually able to paint a nice glowing picture of increasing gross margin and profitability. Gross margin grew by 18.4% to 32.5% and net profit increased from $2.4m to 4m from FY2014 to FY2016. How in the world are they able to do this?

Let's take a deeper look.

The Company was able to show an increasing profitability over the last 3 years because it was able to "control" the cost of sales quite effectively given that the supplier is from UEC Group.  This is reflected by the declining cost of sales over the last 3 years.

In April this year, they also formalised the distributorship agreement and the pro-forma was presented. This helped to boost up the gross profits despite the declining revenue and improved the margins quite dramatically. Without seeing the books from UEC group, it is hard to determine whether this related party transaction is sustainable or whether it has been subsidized. However, let's take a look at the key assumption of the pro-forma. You can find the assumptions in Appendix 2.

The pro forma assumed the same fix rate for the last 3 years! We have no idea how this will impact FY2018 and beyond as the fix rate is only for FY2017. I think it is highly misleading to present the pro-forma financial statements here and somewhat painted a even more optimistic picture. 

Based on the historical performance, EPS is 1.98 cents for FY2016 and based on the enlarged share cap of 200m shares, the PE is 12.6x. The NAV per share will be 5.46 cents.

Dividend policy

The Company intends to distribute no less than 50% of its net profit as dividends for FY2017. Assuming a historical EPS of 1.98 cents is used, the dividend yield will be around 4%. This can be potentially higher at 6% if the Company is able to achieve a higher EPS as evidenced by its pro-forma statement.

What I like about the Company

• Experienced management team - The founder has seen the ups and downs of the business and can probably provide sound advice to the management team. Alexis Teo, his daughter and CEO is the heir apparent with 13 years of experience. However, this savvy business man is not going to let go of its business for cheap. A picture of Alexis is below.

Some of my concerns

• The Company is facing strong headwinds. The CNG (vehicles) and LPG business (domestic) are deteriorating as evidenced by the declining revenue over the last 3 years.
• Scalability of business - The Company said in it may expand beyond Singapore and that there is "considerable potential to expand our offerings to household products and health products". I really don't see how this predominantly domestic player is able to scale its business know-how outside of Singapore or expand into healthcare products. Seriously?
• The founder is selling vendor shares at IPO - I wouldn't like to see the founder cashing out in the face of challenging headwinds. The founder still holds 70% of the Company and the CEO (his daughter) holds zero at Union Gas but around 5% of UEC Group. The CEO has no stake in the game and her shareholding at the UEC Group creates potential conflict of interest everywhere! 
• The crown jewel is still with the founder  - To be competitive in this business, you need to control the upstream (that is what the founder said himself in the interview "His earnings hit a plateau when the company exited the market. His margins became lower because of tight controls by the big boys who wanted to close the supply vacuum. I knew we had to bottle our gas," says Mr Teo, who started distributing gas under his own brand Union in 1995.". After this IPO, the founder still own Union Energy while Union Gas is just a distributorship arm that he listed. Ironically, Union Gas will not even own the trademark of Union Gas as that belongs to the UEC Group 😓. The small "saving grace" is that the Company has the right of first refusal if the bottling plant is ever sold. Why is the bottling plant not part of this IPO in the first place?
• Related Party Transactions - It's tough trying to figure out the different related party transactions that affects Union Gas through the prospectus. There are potential conflict of interest everywhere and how they mitigate them will be critical

Fair Value

The company is being listed at a historical PER of 12x which is fair. Assuming the revenue remained the same, the pro-forma EPS of 3.06 cents can potentially be sustained for FY2017. However, i will assume a 20% decline due to the CNG business. The EPS will be 2.45 cents.

Assuming a fair value of 10-12x, the fair value is around 24 to 30 cents.

Given the headwinds, the only way it can continue to maintain the EPS is through buying cheaper gas, which i have no clue as to how to "guess it". (punt intended 😜) given that it is a real black box.

My Chilli Ratings

This is one IPO which i struggle to give a chilli rating. 

My gut feel for the IPO is that it will debut well given the positive IPO sentiments, supposedly low PE and high dividend yield. The small float of shares also made it easy for the gas and taxi tycoon to place out the shares to friends and family. Small punters should be able to get out easily at a profit.

However, for the longer run, I have a few key concerns:

1. Union Gas is just a distributor and don't own the brand
2. The transfer pricing is somewhat of a mystery each year and there are potential conflict of interest between UEC Group and Union Gas everywhere
3. It is hard to buy into a Company whose fate is controlled by a company related to the key shareholder
4. We are buying into a business where the CNG vehicles are depleting dramatically and where the LPG business is slowly being replaced by piped gas

It's probably a 2 chilli rating for the debut and 0 chilli rating for the longer run until we sort out some of the concerns mentioned above. The transfer pricing of the LPG is one area where transparency is needed and by having its own bottling plant, that conflict would have been resolved prior to the IPO.

Union Gas Straw Poll