The 2001 Christmas Pick
3rd December 2001
Webb-site.com has been running three years now - in the internet space, it helps to be not-for-profit from the outset! At Christmas 1999 we began a tradition of giving one positive recommendation from our portfolio each year, something to brighten your festive season and a day off from bringing you horror stories from Hong Kong's corporate governance crypt.
Before we tell you who we've picked this year, first we'll do something you seldom see the professional analysts do - look back at how our previous recommendations performed.
2000's Pick
Last year's pick on 4-Dec-00 was Kingmaker Footwear Holdings Ltd (1170), which closed at $1.16 before our recommendation. Well, a big round of applause for the boys in boots! The shares closed at $1.52 today, and during the year they made a 1:10 bonus issue, which means for every 10 shares purchased then, you now hold 11. You also got $0.105 of dividends during the year, for a total return of 53.2%. Lovely jubbly. If you reinvested your dividends in the stock, you did even better, but let's not be picky. All our calculations exclude dealing costs, by the way.
At roughly the same time, the Hang Seng Index, including reinvestment of dividends, has lost 17.1% during the 12 months to 30-Nov-01 (we only have monthly data). So if you put $1,000 in the HSI on 30-Nov-00, then a year later you had $829. Put $1,000 in Kingmaker, and you'd have $1,532. So Kingmaker has out-performed the HSI by 84.8%.
We still like Kingmaker. They grew turnover by 7.4% and earnings per share by 15.6% in the year to 31-Mar-01, and were sitting on net cash of around $376m or around $0.59 per share, more than enough to finance their expansion which calls for a $250m factory in Zhongshan, PRC opening next year, taking production up by 12 lines from the current 17, as well as continued expansion from 5 to 8 lines in Vietnam.
1999's pick
On 5-Dec-99 we recommended Christmas tree maker Boto International Holdings (0585), which showed a healthy first-year return of 23.3% compared with a 7% negative return in the HSI from 30-Nov-99 to 30-Nov-00 (dividends reinvested).
Last year we said we still liked the stock, despite reservations about their internet strategy on www.drfestive.com. If you held on to it (as we did), then you are a happy soul because since then they have risen from $0.226 to $0.315 (as of tonight) and paid out $0.018 interim dividend (the stock is still trading cum the final dividend of $0.007). That means they've returned 47.3% this year, and compounded with the previous year they've returned 81.6% in two years. Meanwhile the HSI, in the two years to 30-Nov-01, has returned negative 22.9%. So Boto has out-performed the HSI by 135.5%.
They've had a good run. The garden furniture business is developing nicely - the latest interim report says that orders in hand are $157m at 30-Sep-01, which compares with $65m at 15-Nov-00. However, they've also diversified by investing in computer animated cartoons with Imagi Production Ltd (now 82.5% owned) which makes Zentrix (formerly Robotica). That's an unproven business and not within their core expertise of manufacturing.
The stock still only trades on about 6.8x historic earnings and we estimate 20% earnings growth to Mar-02 making the prospective p/e around 5.7x, but we've probably seen the best of the returns for now, and the fiddling with technology investments necessitates a continuing discount for the risk of "accidents".
This year's Pick
Can we make it three in a row? Who knows? But let's give it a try...
This year, our silky stocking-filler is Tungtex (Holdings) Co Ltd (0518). This company makes garments, traditionally in silk, but has been diversifying into non-silk garments too as the quota restrictions begin to drop away. They have factories in China, Malaysia, Thailand and the Philippines.
The shares closed today at $1.43 with a market capitalisation of $504m (US$64.6m). The directors hold 42.59% of the company, of which Chairman and founder Benson Tung Wah Wing (Mr Tung) owns 36.93%.
Here's the track record:
Fair warning: 91% of last year's sales were to North America. Therefore, we can expect some drop in earnings in the current year to Mar-02, perhaps as much as 25%. The Chairman warned as much, in the annual report dated 12-Jul-01 he said "The Group... foresees a fall in the sales turnover and operating results for the first half of the coming year."
We regard this as a temporary setback which the market has probably discounted. The long-run outlook for Asian textile manufacturing as positive, because of the vast supply of low-cost labour and the difficulty that robots have handling anything soft. Trade globalisation under WTO means a gradual dismantling of protective practices in developed countries such as the quota system, which will tend to support the export flow from China and other low-cost countries.
On the upside, Tungtex has been cautiously growing a retail business in the PRC, with 25 stores opened by 31-Mar-00, 40 stores by 31-Mar-01, 44 at 12-Jul-01 and a target of 50 by 31-Mar-02.
The group pays out most of its earnings in dividends and for good reason - take a look at this summary balance sheet:
As you can see, over half the net assets, or $0.727 per share, are in cash. In the past, management has shown a willingness to pay out some of the surplus cash as special dividends, the last time being 1999. With interest rates now at record lows, we hope that they will consider distributing surplus cash this year rather than leave it sloshing around in the bank. Unless they have some expansion plans to consume it, investors can make better use of it.
The operating properties are probably worth more than book value because they are held at depreciated cost, including a 110,000 sq ft head office building in Wai Yip Street, Kwun Tong, which was acquired many years ago.
Corporate Governance
The company was founded in 1977, has been listed since 1988 and has kept its nose largely clean. It hasn't speculated in the property market, stock market or technology sector. They seem dedicated to their core skills in the textiles sector. In a stock market where fraudsters abound, it's nice to find a solid track record where public shareholders have not been abused.
There are five executive directors: Mr Tung (aged 50), who was the principal founder of the group, his brother Tung Siu Wing (52), a co-founder, Cheung Kee Yuen (Mr Cheung, 54), who joined the company in 1982, Alan Lam Yiu On (39), who joined in 1988 and is now the deputy managing director, and Raymond Tung Wai Man (36) who joined in 1988 and became a director in 2000. The annual report does not mention any relationship to Mr Tung.
There are four non-executive directors. Two of the NEDs, Johnny Chang Tak Cheung (appointed at listing in 1988) and Tony Chang Chung Kay (1994), are each described as "director of a famous shirt making company" and hold 1.54% and 1.36% of Tungtex respectively. We don't know whether that's the same shirt making company or whether the two are related. Tony Chang is described as independent, and although his shareholding exceeds the 1% guideline in the listing rules, we see no problem with putting your money where your mouth is.
The other declared independent NED is James Kwok Ho Kon, appointed on 15-Jun-99 and who has no shareholding. He is the MD of a "European trading company" with over 32 years in the garment industry. The other NED is Kevin Lee Kwok Bun, a chartered accountant who has been on board since 1987 and owns 2.56% of Tungtex, having been an executive director until 1-Oct-95.
One piece of history; six years ago, in Apr-95 a BVI shell company called Charter View proposed to buy a controlling shareholding in Tungtex at $1.50 per share and make a general offer, but the deal was eventually aborted. We don't know why the Tungs wanted to sell, but history shows that the business has performed well since then.
The bidder's financial adviser, Goldwyn Capital Ltd, and its directors John Kao Ying Lun, and Joseph Wan Chuen Chung came in for some stick from the SFC for not taking adequate steps to confirm that Charter View had the money for the bid. In Mar-98 Mr Wan's registration was suspended for 12 months by the SFC after he withdrew his appeal against a Sep-96 decision of the SFC. In Nov-98 Mr Kao's registration was suspended for 4 months in 1998 by the SFC Appeals Tribunal. A few weeks later, the SFC also suspended Goldwyn Capital's registration for the same length of time. Mr Kao is now a director of HK-listed Yanion International Holdings Ltd, but that's another story!
Mr Tung increased his holding
Until a restructuring in Oct-00, a company called Corona Investments Ltd (Corona) held 146.35m shares (41.56%) of Tungtex. Corona was owned by Mr Tung, his brothers Tung Gut Wing (a co-founder and former Chairman) and Tung Siu Wing, and Mr Cheung.
The earlier percentage holdings in Corona are not known, but just before the restructuring, Mr Tung had 56% of Corona, which held 146.35m shares (41.56%). So his economic interest was 81.96m shares (23.27%). The other three shareholders appear to have been bought out, with some of them taking shares, because on Friday 27-Oct-00 Corona reduced its stake to 130.05m shares (36.93%) and then the next Monday Mr Tung increased his stake in Corona from 56% to 100%. So in effect, he increased his holding by 48.09m shares, and the disclosure says he paid $1.03 per share, which was the closing market price on 27-Oct-00.
The full details of this transaction are private, but it is likely that he was keen to remain above the voting takeover threshold (then 35%, now 30%) under the arrangement. Assuming those details are correct, then he has a strong incentive to increase the dividend payout in order to refinance the roughly $50m he spent increasing his stake.
Conclusion
The earnings of Tungtex before interest, tax, depreciation and amortisation (EBITDA) were about $120m in the year to Mar-00 and $166m last year. The market cap of $504m, less net cash of $256m, leaves an enterprise value (EV) of $248m. Assuming EBITDA falls back to the 2000 level in this year to Mar-02, then that gives you EV/EBITDA ratio of just 2.1x.
Look at it another way. The historic p/e is about 4.2x, the current-year p/e (assuming a 25% drop) is about 5.4x, but strip out the cash (and deduct interest on that cash from the earnings) and you have a historic p/e of around 2.1x and a prospective p/e of around 2.9x. That's so cheap that anyone would think clothes are going out of fashion!
The dividend yield based on last year's payout is 14.3%. If they keep that up, without any growth at all, you would get your money back in 7 years and still own the stock.
So there you go. We own the stock - in fact we've held it several years. We are tipping a company which is almost certain to record a drop in earnings this year, but has been a consistent earner with a favourable WTO textiles regime ahead of it. But don't all rush in at once, because it is not liquid. Always consult your broker or investment adviser.
© Webb-site.com, 2001
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