Hongguo offer closing soon

The major shareholder of Hongguo has received more than 90% of the company share. It looks like the delisting will become a reality soon. The offer is a generous one, considering the premium they are willing to pay.

However, looking at it in the long term perspective, it is cheap for them to take the company private. Who knows? Once the business turn around in 1-2 years time, they can float it in hong kong and fetch higher price.

Through these years of holding the stock, I have learned

1. Being third doesn't mean you are going to be first soon. There is a big gap between the first and second/third place shoe brand. It takes a lot more effort for the company to catch up. In another word, it is better to buy the market leader, which can outgrow the smaller player.

2. Being a good company is not enough. Hongguo steadily grows through the years. However, most of the time, market is not appreciating the company by giving it a better valuation. If the company can grow at 20% annually, having the single digit PE, is too cheap. Of course, this is before the sub prime crisis occurred.

Hopefully my next venture will be more profitable.

Hongguo delisting offer

I did some quick sum on the hongguo de-listing offer.

The cash per share is roughly 0.13. For the past 9 months, the EPS is 13.1 RMB cts. So, this year, the company might be able to earn 16 RMB cts which is 3.29 SGD cts. With the offer price of 0.439, the offer PE will be 13.3 which is a good offer. Good in the sense that for past two years, the company has been trading at lower PE.

In the Q3 result, profit margin was down to 35.2% reflecting the tough business environment. This might be a good offer depends on your entry price. Most likely they will seek some professional advise for the shareholder.

Major shareholder of Hongguo announce delisting offer

After trading halt for a few days, Hongguo major shareholder has announced the voluntary delisting offer at 0.439. At the first glance, this is a bad offer for me. I will review and update my comment later on. Offer at 0.439 is good for those hold the company since IPO. In a way, it also says the company is worth more than the current price.

Hongguo FY09 half year result

Revenue +19.31%
Cost of sales +29.31%
Gross profit +6.2%

Selling and distribution expenses +42.5%
Profit after tax 38,022 (-38.69%)

Cash and equivalent 208,097
Current liabilities 182,456
Amount repayable in one year 14,426 + 41,008

Cash generated from operation 95,753
EPS 9.58 RMB cts (from 15.63 last year same period)

Revenue continue to increase, the company still on the growth track. Gross margin decreased to 38.5% from 43.3%. The retail competition is fierce. Expenses increased because of continue store expansion. But the cost escalation is at alarming level.

This shows the consumer spending is slowing in China because of the financial crisis. But as the China economy picking up and the existing brand building effort already spent. The group could back on the growth track in coming years. The cashflow is strong, more than enough to cover the loan.

I remained confident in the China consumers. But, like planting fruit trees, it takes a while for it to bear fruit. If we estimate the second half they are able to make the same amount of money. Forecast EPS is 19 RMB cts or 4 SGD cts. The stock closed at 0.28 last Friday. It is about PE of 7. It is definitely not very expensive. But I won't buy at the current market level, as market has priced in lots of optimism. Hopefully when the China economy turn up, the company would be able to made up the growth.

Celestial, no more in heaven

The eventual has happened. The bond holder is calling for redemption and the group issued the statement that they are unlikely to be able to meet the obligation.

It is quite unfortunate that a company with a well known and growing brand, ended up in this kind of situation. The problem started when a small company is trying to expand rapidly and borrow aggressively. The convertible bond was issued with early redemption option, when people don't expect the bond holder would ever call for early redemption. You never know, when crisis strike.

This highlight the risk with small cap stock. The company is small, so you can afford to grow quickly. But, at the same time, the more leverage you have, it is increase the risk. Compare a company with little borrow, you know which one is more stable. Therefore, never bet big on one single small cap. You never know what would happen next.

There could be three outcomes

i) a white knight is willing to acquire shares in the company and the proceed can be used to pay the bond holder
ii) the bond holder is willing to receive the share in the company
iii) the company has to wind up

i & ii should be more likely. But that would dilute the existing shareholder's stake. iii is the unthinkable, you can kiss goodbye to your share.

Hongguo FY08 financial result review

Hongguo just release the FY08 financial result. Let's look at whether the consumer spending is slowing down and what are the challenges ahead.

All amount in RMB ,000

Revenue + 19.6%
Cost of sales +21.9%
Selling and distribution expense +35.6%
Loss in joint venture +595% (6,247)
Profit of the year -3.39%

Cash and equivalent 115,376
FD 24,793
Inventories 343,805 (quite a lot)
Amount repayable in a year 65,801 (cash on hand should be able to service this)

Profit before income tax 126,099 (Cashflow quite flat)
Operating cashflow before working capital 156,575
Net cash from operating activities 33,589 (less than last FY)
Cash after adjust investing and financing 115,376

EPS 26.82 RMB cts (a drop compare to last year 27.76)

The revenue continue to grow, as the group open more store. However, the cost is running ahead of the sales. Gross profit margin drop from 40.6% to 39.4%, reverse the past year trend. The reality bites now, as consumer cut back spending, and more promotion activities is being carried out. If not the JV loss, the group might post slight profit growth. Quarter 4 figure got hit after more tax provision is provided. Cashflow wise, the group is generating enough cash for the debt repayment, this should not be a cause of concern.

As highlighted in the financial statement, China retail sector suffered as a result of financial crisis. The group would continue the outlet expansion to drive growth. No dividend is being declared. This seems to be a common practice now among small cap, since they want to conserve the cash for uncertainties ahead.

The result has broken the previous multi year growth trend. The group is not doing too bad, consider the current economy climate, they only suffered a small reduction in profit. I think the retail segment is still quite resilient. But prepare for another year of negative growth. If the EPS decline by 10% for FY09, it would be 24 RMB cts (5.4 SGD cts). At last done price of 0.16, the stock is selling at PE 2.96 which is really amazing.

However, don't forget, the earning now is uncertain. So, the conventional valuation technique like PE is not really working in this kind of environment. It also shows sign of time, when in bear market, cheap would go cheaper. Keep a close watch on it, whether earning would deteriorate more?

The China stimuli package should drive up the demand in coming year. Let's wait and see.

MIDAS in focus again

The market took a turn quickly after RBS announced the big loss. Like I say before, market might have more bad news awaiting us. The reason being that we are still in the process of deleveraging. The untangling of all the complex leverage would take sometime to clear. Loss get snowballed because of lack of credit, sellers forced to sell at fire sales price.

Today, Philips release a report recommending a buy on MIDAS. If I remember correctly, recently other broker also have the same recommendation. The past issue of The Edge also feature the company again.

Since I took notice of the company and concluded it is a worthy investment, the fundamental seems to keep getting better. Only the macro environment keep getting worse. The stock is up for prime time in coming 5 years. Although in stock market, people seems to have short term view only on recent earning.

Macro environment getting better as China keep the infrastructure investment. The company position is improving, but increase production and do more. Bear in mind the company is one of the suppliers to major european train vendor. Have a close watch on it.

China Hongxing store in JB Bukit Indah

I have been to AEON Bukit Indah JB yesterday. To my big surprise, I saw the following store:



Hongxing Erke store in JB! This is truly amazing. I wonder some malaysian business man has actually set up the store there?

MIDAS secured Euro contract

The stock market is in endless turmoil now. Market is really sentiment driven now, rather than fundamental driven. We keep hearing contradicting comment from different analyst, fund manager and experts. So, do be clear of your investment objective and game plan, before dive into any purchase or sale.

MIDAS share price has fallen a lot. From the chairman incident to current credit crisis, it just keep falling. However, I do believe the fundamental is still improving. The new contract might come slower now, but as long as the company show distinct competency, investor should be still alright.

In recent announcement,

Contract awarded by Alstom Transport (“Alstom”) to supply 140 Tram Sets for the RS-Citadis Project

The company has tie up with Siemens and this new contract further show the quality of its product. Base in low cost location like China and with the European quality, I really see a great future for the company.

Within China, the various tie up and joint venture should enable the group to get more government contract. China is planing for big spending on railway, the future is going to be brighter. Outside China, the group is slowly penetrating into Euro market. This should serve as diversification.

I don't have figure and figure at the current climate seems mean nothing. New contract might be slowing, loan might be harder to get. The only comforting part for investor is the company is still making progress of supplying product for more and more companies.

China Sports International 2008 Q2 result

It is interesting to evaluate other sports player result also. Following is the China Sports International result for Q2.

Revenue +50%
Cost of sales +49.9% (in sync with revenue)
Selling and distribution expense +281.5%
Administrative expense +387.3%
Profit before tax increased only 25.7% as a result of high expenses incurred. The group is probably trying to put resource to grow faster.
Group has no debt

Look at cashflow statement, profit before tax +25.7%
Net cash generated from operation 123,932k RMB.
Minimum cash used in investing and financing activities
Cash at end of period 535,293k RMB. Strong cash position would allow them to grow aggresively.
Q2 EPS number fall from 9.92cts to 8.7cts. But this should not be a cause of concern, since company is newly listed and this is calculated using pre-invitation shares.

Revenue increase is evident. The cash raised during IPO was put into work and allow faster growth. The widen distribution network also contribute to the significant increase of operating expenses. This is normal. The rise of average selling price is a good sign the brand is gaining traction. OEM business seems to be getting the margin squeeze. Building own brand is the way to go.

The group believe that the Beijing Olympic would raise the sports awareness and contribute to long term growth of sports sector. This might be true, but we are not sure whether there is olympics overhang. Since the group was doing OEM for Kappa, they are into the fashion sports segment currently. I once read few reports about the fashion sports niche which Kappa is doing really well. People treat sports shoe as part of the fashion. The group is focusing on this niche but is really a small player in this aspect, although story looks promising. The tie up with sohu and CCTV might further raise the brand awareness. In overall, the prospect looks bright, but bear in mind of their size.

Looking at current market condition, everything is cheap. Investor can afford to cherry pick good deal. Let's assume this quarter of EPS 8.7cts is consistent across all quarters – 34.8cts RMB. This translate to 7.15cts SGD. At today closing of 0.32, it selling at PE of 4.47 only! What a steal. However, keep in mind the current market sentiment, china share situation and the inflation environment, one might choose to go in or wait for a while.

Celestial Nutrifood 2008 Q2 result

Soy bean price has risen a lot together with other commodity price. Let's look at how Celestial is doing.

Sales +37.1%
Cost of sales +46.5%
Gross profit +22.2% (cost increase faster than sales)
Distribution and Administrative expenses +53.8% and +44.3% respectively
Income tax +50%
Net profit +11.7% (clearly the high cost and tax weight the profit down)
Cashflow before working capital change +14.7% (the business is generating strong cash)
EPS increase slightly to 0.17 RMB

When we look at the sales mix, the industrial product sales grow faster. Gross profit margin dropped because of the higher raw material price and change of sales mix. Group has put in measure to mitigate the cost pressure. Selling price of most health food and beverage increased more than 20%, yet it still achieve growth, this might signal better pricing power.

There is increased plant utilisation of industrial protein business. Biochemical feedstuff and lecithin business also achieved strong growth. The component of cost increase include advertising and promotion, transportation and other distribution expense. The intense competition could be another reason. The administrative expense include donation to Sichuan earthquake, otherwise it would be lower. Increase in income tax also erode the earning.

The directors believed high raw material cost continue be a concern. The group is to launch four new health food and beverage in 2008.

The group continue to grow despite rising raw material cost. They also managed to increase price without affect the sales severely. Overall, it is a good result. Since the price of commodity is on down trend now, there is high change Celestial would do even better in the coming quarter. It does look interesting at this level.

China Hongxing 2008 Q2 result

The quarterly reporting season is back. It is number crunching time.

Revenue +53.1%
Gross profit +53.8
Selling and distribution expense +83% (so high)
Income tax +108%
Profit for shareholder +31% (obviously the cost and tax weight the profit down)

Bank balance 2,201,588k RMB vs current liabilities 227,954k RMB (more than enough to cover the liabilities)
There is an increasing cashflow to 150,676k RMB. But after adjusting receivables, there is net cash outflow from operating activities. Not a big problem, since company has so much cash.
EPS increased to 4.37 RMB cent, growth of 8.7%

Apparel and accessories sales is catching up. There is a decrease of gross margin. Expenses increased in line with outlet expansion and promotion activities. The environment is still favourable for sporting goods, but the group is mindful of the inflation situation which could affect the raw material price.

The growth is still on track, strong growth is still expected. I am assuming they would continue to growth at the 30% rate per year. However, inflation has indeed caught up with many China companies now. I still prefer company with strong brand like hongxing. There is the only way to mitigate the cost pressure. They are having some Olympic advertising, hopefully it would raise further awareness on the group's product. The sporting good bull seems to still going strong.

Consider the quarterly earning of 4.37 cents. Full year EPS should be 17.48 cents, which is 3.51 SGD cents. At today's closing of 0.49, it is selling at forecast PE of 13.9. If the earning accelerated, we are looking at even lower PE. I think it is quite reasonable for a company with high growth. If we compare the expected growth rate of 30% against this PE, it is really cheap. Of course, the market is going through the PE compression. To invest or not, depends on whether you are taking long term view of the business.

Hongguo 2008 Q2 result

Hongguo just released the Q2 result of the year.

Revenue +13% to 188,128k RMB
Cost of sales only increased 6%
Gross profit +23%
But the selling and distribution cost +34% and administrative expense +18%
As the result, profit for quarter only +4%
Cashflow remain healthy but after consider the working capital, cashflow is negative
EPS only increased 4% to 7.03 RMB cents

Gross margin improved from 41.6% to 45.2% implying stronger brand value. Due to the expansion and hiring of staff, the cost escalated. The result is quite a disappointment from me, since the EPS growth is only 4%. Although this looks like one off expense resultant from the expansion strategy. But the high inflation in China might have already caught many companies in surprise.

Company is to continue with the retail expansion and might introduce a new brand. Assuming the cost would stable in the second half of the year. Assume quarterly earning does not grow much, full year EPS is 4 x 7.03 cents = RMB 28 cents = SGD 5.6 cents. Currently, it is selling at 0.36, which means PE of 6. Still a buy. When the market recover, the stock you bought at this kind of depressed level should give a good return.

Oceanus, first glance

Oceanus released the 1st half result of 2008.

Sales surged 349% to RMB 181.4m
Profit before tax and goodwill up 303% to RMB180.4m
Plan to triple production capacity to 40,000 tanks in next 18 months

The group is specialised in producing premium Japanse Abalone in China. Accordingly, the cost is under control and group has cost advantage against the competitors. The group recorded a goodwill write off due to the RTO it has undertaken. This is an accounting item and does not affect cashflow.

The outlook remain robust and due to the shortage of wild abalone, the group is ramping up the production capacity quickly. The plan is to grow the capacity quickly and move into downstream processing to improve the margin.

The group looks interesting to me right from the beginning. These are the interesting points:
Chinese consumption of abalone is set to grow strongly
The group is one of the top producer and plan to grow capacity rapidly
Plan to move to downstream to capture even higher market share

Things look rosy for the group in the coming years. But the risk with agri stock remained. Comparing the current valuation against the projected growth, it does look attractive. More research needs to be done to uncover the competitive advantage and more facts.

China New Town unappreciated

Last Friday, Dow closed at the positive region, the coming week should see some rebound. After that, the bad news might get investor nervous again.

The only transaction I did last month was to buy China New Town share. After watching it plunging from 80 cents to near 20 cents, I think it is a good buy. My buying time also coincide with major shareholder purchase.

As highlighted in the listing prospectus before, one of the risk is investor don't understand the business and don't know how to value it. It looks like that is the case right now. Surprisingly no analyst has started coverage on the stock.

When the company decided to list in Singapore, obviously it did not aim to fail. It has an ambitious plan and unique business model. The institution demand was huge and they count the major fund manager as investor. But it was a bad timing, the subprime crisis erupted and the lumpy earning disappoint the investor. Maybe those are just excuses, since if you really understand what they are doing, then you should be aware that they have funding risk and have to wait for land sales for revenue.

I bought at 0.21 which I think is relatively cheap. However, I didn't really go and calculate how much the company worth. The usual way for property stock valuation is to take the RNAV. But, since they get the money after land sales, is there a proper valuation of the current land? I have no answer, but buying a small stake for the future. Key reasons:

- After fallen more than 75%, I think the downside is limited. If the fortune turns, it should perform strongly
- Major shareholder purchase.
- Once the town they developed maturing in years to come, the land they hold would rise in value

It is a long term play. I think patience would pay off, we have to watch out for future development.

Hongguo FY08 Q1 result

Figures are provided for Q1

Revenue +27.32%
Gross profit +34.38%
Selling and distribution cost +66.09%
Net profit +16.06% at 34m RMB

If not the substantial higher selling and distribution cost, this would be another good quarter. Compare to last full year result, it is showing sign of escalation. It is not discussed in the result announcement that what is the significant contributor to this cost increase. Are they promoting the brand more aggressively or the rising inflation in China significantly lift the cost?

Cashflow remain strong, but trade receivable increased. Gross margin increased to 41.61% which generally signal the brand position. The group expansion strategies have remained the same
1)Retail store expansion
2)Multi brand strategy

It is yet to see whether the cost would go out of control. Looking at the Q1 growth percentage of 16%, let's assume full year would be at the same rate. The forecast EPS would be 0.32 RMB. Today it closed at 0.52, which means trading at forward PE of 8. Still consider cheap, but I would rather wait to see the cost trend. However, if the general market improves, it might still fly.

My china friend said he saw mainly Daphne stores in the cities he visited. Hongguo still has a lot of catch up to do.

***Updated 30 Apr 2008

Some comments from analyst.

DBS:

Maintain BUY, TP S$0.94 based on 12x FY09 PER.

DMG:

The Group’s strategy for growth is to continue expanding its sales network. Hongguo plans to set up 200 new outlets for C.Banner and E.Blan, and 40 new outlets for Naturalizer by 4Q08. Coupled with a stronger design capability and greater production capacity, revenue is expected to continue to grow. We maintain our BUY recommendation for a target price of S$0.60.

Westcomb:

Maintain BUY with target price of S$0.82 – HGUO is currently trading at S$0.52, a historical FY07 P/E of 9.6x. We consider HGUO to be relatively undervalued as compared to peers China Hongxing Sports Ltd (CHHS:SP; P/E of 16.7x) and Li Ning Co. Ltd (2331:HK; P/E of 45.3x).

Bio-Treat bond default

Bio-Treat appeared in the headline again today, but for the wrong reason.

0200 GMT [Dow Jones] Bio-Treat Technology (B22.SG) down 6.5% at S$0.36 after company says it has received a notification of default on convertible bonds due 2013 from Merrill Lynch; adds Merrill has notified company that bonds that Merrill holds, which had an original face value of S$27.6 million, now immediately due and payable.

As explained in the company announcement, the bond comes with a put option. For most of us, it is sort of confusing, but I think it just simply means the bond holder has the right to request for bond termination and return of the borrowed money. The company also explained, it has no problem in servicing the bond, except the issue of remit the money out of China to repay the bond.

It depends on which angle you look at it. Technically, there may be nothing wrong with the operation and company strategy. But, at this poor sentiment market, any uncertainty could cause severe market reaction. From my observation around the forum, many still likes the counter. Be it for short term trading or for its long term fundamental.

I have long sold my position after found out that, most of the time, it has appeared in the headline for wrong reason. The key attribute to successful stock investing is certainty. It might be prudent to avoid at all cause.

China shoe maker sale

Today DBS Vicker issued the following report.

Attractive Value Emerging For SChip Shoe Brands

S-Chip Sports Shoes plays have slipped more than their HK counterparts. China Hongxing and China Sports International have lost 59% and 55% of their share value respectively from their respective peaks over the last 12 months. This is in contrast to HK peers such as Li Ning, Anta Sports and Dongxiang, which have seen their share price decline by between 29% and 50% from their peaks. In terms of valuations, China Hongxing and China Sports International are trading at 15x and 7x FY08 earnings respectively compared to HK peers that are trading at 18x – 30x FY08 PER.

Hongguo has performed relatively in-line with HK peers. Hongguo’s share price has fallen by about 64% from its peak, compared to 62% for Prime Success and 47% for Belle. In terms of valuations, Hongguo is trading at c. 8x FY08 PER, versus 13x FY08 for Prime Success and 23x for Belle.

Growth remains intact whilst valuations are now much more attractive for S-Chip Shoe Brands. We continue to be positive on the consumer goods sector in China, especially for companies with strong branding power, such as China Hongxing and Hongguo, which are able to raise their prices to pass on higher material and labour costs. Latest figures also show that retail sales in China in the month of February grew by 20.2% yoy, continuing the strong double-digit growth momentum over the last few years. In the meantime, valuations for the S-Chip shoe brands have become very attractive, trading at single digit to low teens current PERs, compared to more than double of that 6 months ago and relative to EPS CAGR of 20% or more for the sector

Target prices adjusted and BUY calls re-iterated. We maintain our BUY call for China Hongxing, with target price adjusted to S$0.90 based on 18x FY09 earnings. We have also included our Nanjing store visit notes in our update piece for China Hongxing. For China Sports, we have adjusted our target price to S$1.77, based on 10x FY09 PER and also maintain our BUY recommendation for this stock. For Hongguo, our target price is adjusted to S$0.94, based on 12x FY09 earnings and our update note also talks about a recent visit to their stores in
Nanjing.

>> For the past few years, the shoe makers have been growing pretty well. China Hongxing is expanding at a fast pace, Hongguo is slow and steady and China Sport is the new kid on the block. I am still very confident in the China consumer sector, especially the shoes. Unlikely the food sector, they seems to enjoy better pricing power and growth. I always like the lady shoe market, if you look at how many pairs of shoe a woman would buy a year. Surprisingly, sport shoe is even hotter.

It is yet to be seen the recent inflation would hit the consumer on shoe buying. But, consider long term, I would think they might be the best bet.

The sweet tooth - China Lifestyle FY07 result

Sales +23.5%
Cost of sales +24.9%
Gross profit +21.2%
Profit before tax +10.5% (Significant increase of administrative and finance expense)
Profit after tax +3.5% (Income tax +32%)
Borrowing at 20,000K
ROE at 18.9% (86,741/458,589)

From cashflow statement (figure in '000),
Profit increased from 83,839 to 86,741, but operating cashflow increased from 125,314 to 145,217. This is due to a few adjustments. But the core profit cashflow didn't increase significantly. Where does the cash from adjustment came from?
Net cash go from 200,578 to 48,088 due to purchase of property, plant and equipment. Still able to cover the borrowing.

EPS decreased to 0.17 RMB from 0.19 RMB. Profit increased slightly but there is dilutive impact from the share option.

Although the sales increased significant, but the cost increase is even greater. Big increase at advertising and promotion expense and there are significant items like exchange loss and disposal on property, plant and equipment(quoted as one off item). Constraint on jelly dessert sales, and significant jump on candy sales. Gross profit margin 39.2% and the raw material price increase remain challenging.

FY07 probably is a consolidation year where they build the brand name, expand production capability and lay the foundation for future growth. Management expect new production facility to ease constraint and more product choice to drive more earning growth. I thought this is a disappointing result where cost increased faster than sales and I don't understand why the core profit cashflow only increased marginally. Given the continue rising of raw material price and uncertain advertising effect, best is to avoid for now.

Strong cotton - Hongwei Technologies FY07 result

Revenue +41.1%
Cost of sales +39.6%
Profit after tax +30.2% (+163.8% of income tax)
Bank loan 45,000K
Cash generated +21.3%
Cash at end of year 130,840K (should be enough to cover loan)
EPS RMB 0.2889 +14% (dilutive effect of share placement)

For FY07, they issued new share to fund the expansion. As the factory is still under construction, there is a dilutive impact to the EPS. Synthetic cotton was the star performer. Gross profit margin increased to 30% from 29%. This is remarkable since the oil price has increased substantially. The new factory for synthetic cotton would be ready in second quarter of 2008, they expect the gross margin to improve.

This is generally a good result as revenue rise strongly and they manage to keep the cost down. Since the new production capability is going to come online soon, it would enhance the profitability. What I afraid is the margin erosion as oil price keep charging ahead. I think this is the major reason for the share price to under perform for so long. All the fiber related stock is trading at great discount. Assume they are able to increase EPS by 10% next year, which in my opinion should be achievable, the EPS would be 0.3178 RMB. At current price of 0.28, it is only trading at forward PE of 4.4 which I think is cheap in any measure. However, consider on the company size and uncertain oil price, it is not clear where it would go. If you are a deep value investor, this is a buy, otherwise a hold.