Eratat Lifestyle - Forward PE 1.5X

Hi Ethan,
Yes, I agree this is not an academic conference, and I did not attempt to do that. I thought that a perspective that was grounded in strong logic would be something nice to have in a forum where investors gather to gain understanding and facilitate decision making. What I used was logic, plain and simple. We all live by universal rules of physics and psychology. Academic, investor, man, woman, child... we are subjected to the same rules, the same logic, be it reactions to pain and hurt, feelings of hunger and distress, of fear and greed. Laws of physics affect each individual similarly too, unless one comes from a different universe where that might not be so. As such, grounding my analysis has nothing to do with academia. The logic is grounded in philosophy and trust me, it’s very different from what one learns at the university undergraduate level.
 
You might be right in that I might have more time on my hands. In which case, I just have an advantage in thinking through my responses and being able to analyze it in a more rigorous manner. Shouldn’t that be a plus point for my posts then? Why do you make it sound so negative? Saying that, it is NOT the school holidays... sorry to disappoint you by busting another of your claims.
 
On your statement on “why use 2 years prior earnings”. Well, I absolutely agree with you that we can use a longer period, or period from the beginning of when the company got listed. That would just strengthen my example... not weaken it. I had used a more conservative and simple example precisely because “This is not an academic conference”. SO... I do not get your objection to my example. A longer period would just enhance the numbers. I did limit the historical earnings because of my point mentioned in my previous post, about how future earnings, when they come close to the current period of time, is more reliable and can be incorporated into decision making more effectively. Perhaps you should run through my previous posts again... and yes, I agree with your statement that there are other stocks which are undervalued. My previous posts had already handled and addressed that.
 
You talk about discounting the $2 over 2 years. I’m sorry to disappoint you again. If you thought that you had found an error in my logic, you are wrong. Discounting happens because of inflation (which we have to assume happens. This not a given, since deflation can occur. However, historically, inflation has been the more likely phenomenon). As such, you discount FUTURE earnings. The two years were based on PAST earnings. As such, you might actually want to inflate them to NPV because you can earn interest on those earnings. A good thing you wanted to keep it simple, otherwise, your statement would have just added onto the error.
 
Yes, you mention about cash flow and working capital requirements being important. I agree with you with you on that. It’s extremely important, which is why Eratat’s controlled growth is a good thing. Yet, you talk about falling order books, etc. You know. One has to give because these are conflicting goals. How can you reduce working capital requirements, enhance cash flows,  expand orders and move to a higher value-added strategy all in your desired direction? You can use basic math and simple causation (NOT correlation) to show that what you’re asking for is unreasonable. Algrebra teaches us that if A+B-C=D, then we just need to know the outcomes of 3 variables to determine the 4th conclusively. There has to be a balance. That’s their strategy. You understand all the variables, figure out if they make sense and see if you approve their strategy. I have... and I’m comfortable with it. Do I think it’s the best possible strategy? No. But, I think it’s a reasonably good one given all the information I have, including information from the sceptics... some of which are excellent information – like what Green Rookie posted recently. Am I right? I don’t know, but I hope so... after all, I’m hoping to make some cash out of this investment.
The next thing is the causal relationship (NOT correlation, which is a proxy variable only... mostly useful, but can lead to wrongful conclusions if done in a non rigorous manner). Changing strategy takes time and money. There’s a strong causal link there. Increasing sales through increased goods sent to distributors mean an increase in working capital required. Again, a strong causal relationship that is negative. As such, your expectation of wanting Eratat to enhance sales/order books, to conduct a strategy that has long term benefits to its shareholders (moving up the value chain), yet enhance cash flows and reduce capital requirements is well... unreasonable.
 
I agree with your statements on the no 100% thing... which was precisely why I decided to post. I’d been following the forums for a long time but was never actively involved. I’d taken some good information, both good and bad, and I felt that I wanted to contribute to the understanding and discussion... and I thought that there was an under-representation of a fundamental analysis of the company... which was why I tried to ground my arguments as firmly as possible.
 
Actually, Zara, H&M and Gap are not direct competitors of Eratat’s premium line. If you do a strategic group analysis, Gap, Zara and H&M are all mass market – targeting the low to medium segment of the market. They do try to go more upmarket in countries farther away from their home markets, but they’re effectively NOT direct competitors of Eratat’s Premium range.  They are competitors and they compete in the same broad industry, but there are many subtleties that need to be addressed carefully. They are a lot of differences between these companies which have to be considered.
 
Your point on 2 have already been addressed from my previous posts... and from my above points.
 
Cheers
 

Hi Tactician, thanks for the very nice and detailed replies.
I have not had time to read finish all the posts, but I would like to raise some questions on this portion on receivables:
 
"I agree with you. Receivables is a huge portion of NAV. Now, do this. Pretend that their receivables is 0. That every single dollar of receivable is bad debts. Eratat would still have 500 million RMB of assets (less receivables and goodwill) over 120 million RMB of liabilities. Hmmm, pretty good, I think."
1) This calculation was done before the placement.
Pretend receivables is zero. You will see that NAV growth is almost zilch for 8 quarters before placement.
Doesn't seem pretty good don't you think? Receivables, while being recorded as assets on the balance sheet, are still not cash in hand.
*I didn't track after placement.
 
2) Receivables is not just a huge portion. It is in fact greater than 50% of their NAV.
The market would probably have price in a discounted PE because receivables are not of the same calibre as real hard cash. Especially so since it is an S-chip.
But the key is, why has the management allowed receivables to continue growing bigger and bigger for more than 2 years continuously? Is it really that necessary for receivables to grow so huge?
 
3) On 120-150days receivables being collected in full, how would we know it isn't a case of recycling receivables? Afterall, I could pay you a debt taken 120 days ago, then take a new debt (and more) from you and start at 0 days again! And if this process continues, pretty soon, the debts (or receivables to you) will grow to a huge proportion.
The books can be correct, but the actions behind?
 
 
Thanks
*I'm not vested mainly becasuse of i) S-chip and ii) Extreme high amount of receivables.

Hi Tactician,
Indeed we all do wish we have the luxury of time that you seem to have, and in no way am I implying it’s a negative thing. Quite sensitive aren’t you? First of all you thought that my initial posting was meant as a direct rebuttal of your initial posting even though I had not even read your posting, and secondly you took a perfectly neutral statement and construed it as an insinuation.
First of all I agree that past earnings cannot be ignored. But past earnings do not in themselves determine the value of a stock; they are merely a component of value. The value of a stock cannot be determined without taking into consideration the strength, certainty and quantum of future cash-flows as well.
According to your logic, Lehmann Brothers would still be a very valuable company today based on historical earnings alone. The reality is that it is worth virtually nothing because it can no longer attain any future earnings nor are its assets accumulated through past earnings now worth anything.  
Therefore historical earnings alone cannot determine value; they can only form a component of value. They form a component of value in that the earnings accumulated historically are added to the company in terms of various asset forms, adding in other words to its Net Asset Value.  
this juncture, one might therefore be inclined to infer from your argument that a stock is worth at least as much as its book value. There are many stocks in the world today trading at below book value. Are they all undervalued? Some may be; almost certainly not all are undervalued. You cannot determine value without considering future cash-flows.
Future cash-flows is dependent on many factors – market, industry, and company specific. For example, consider market factors. Can we say that a stock trading under book value today would still be undervalued if the world economy went into a depression in the near future?  If the world depression then causes future earnings to decrease or even turn into losses, causing a decrease in forward book value, would you then be able to say that this company is still undervalued today?
If a depression one year  from now causes the value of its hard assets/property and inventory to depreciate significantly, can you still then say the company trading under book value is undervalued today?
If a depression one year from now causes a company’s distributors to all go bankrupt and be unable to return the cash they owe to the company in the form of receivables, and all the receivables are therefore forfeited, could you then say that the company trading under book value is undervalued today? If you have a bearish macroeconomic (or microeconomic) outlook, you would then estimate that future book value may actually decrease significantly. 
Yes of course we cannot be a 100% certain that there will be a depression in the near future, this is just an example. The point I’m trying to make here is that you cannot divorce a company’s value from estimations/predictions of future cash flows. And future cash flows are dependent on many factors – market (macroeconomic), industry and company-specific.
So how can you expand orders and yet reduce receivables and improve cash flows? Simple – if your distributors are making enough profits from selling your products such that they accumulate enough capital not to have to take so much from the company in the form of receivables. If the distributors are making enough profits, you would expect receivables to go down over time and orders to go up since distributors would want to make more money. This has not yet happened now, with receivables increasing significantly over the last 2 years. On top of this they are now offering subsidies to distributors as well. As to who is holding the bargaining chips and who is being forced to take bigger risks, it is difficult to be certain without the precise stats on each individual distributor’s shop’ business but what we do know is that receivables have been growing considerably and now they are introducing subsidies too  to support the distributors.  I’m not saying that this shows with certainty that receivables will never go down and that distributors are doing badly. Once again with the available information we cannot know for sure, but once again there is a cause for ‘doubt’ (as discussed previously) here where the outcome is uncertain.
There are no 2 apparel companies that are exactly alike. This doesn’t mean they don’t compete for the same consumers.  If you look at many of the Eratat Premium products (which incidentally still only form a minority of their overall orderbook), they are comparable to Zara in terms of pricing and ‘smart casual’ style, and it is very unlikely you’ll find many Eratat consumers who wouldn’t consider buying Zara goods instead. There are so many global fashion apparel companies in China now that makes the argument of stiff competition so obvious to most readers that I find it very uninteresting to elaborate on this point. As the Chinese become richer and more westernized, will they start to prefer global brand names like their counterparts in developed Asian countries? Again, another cause for ‘doubt’.
As to the likely amount of subsides to be offered to distributor per store, yes once again we cannot be sure at this point but it’s possible to make a reasonable guess. Eratat has about 1000 stores. $1k per store? If you have a reasonable sense of proportion and the general costs of goods and services in today’s society, even in developing China, 1k would almost certainly be a derisory figure. What’s a reasonable figure? 5k? 10k? That’s 10 million. 20k? That’s 20 million. More than 33% of current market cap. We can’t know for sure, it really depends on your judgment as an investor but once again – doubt and uncertainty. And whatever doubts and uncertainties you have will have an effect on your projection of a company’s future cash flows, which as discussed earlier, is crucial to determining the perceived value of a company.
Are they cooking the books? Again you cannot know for sure. If and when we know for sure, the company would be worth nothing by then. You got to make a judgement based on probabilities with the information you have available. For example, one of the pieces of information we do have that strikes us as strange is why they decided to do a placement and dilute shareholder value by 15% despite apparently having enough cash. Can we infer from this with certainty that there is fraud going on? Certainly not. But again, another cause for doubt.
A the doubts start adding up, and you begin to worry about future cashflows, you got to ask yourself if there are much better opportunities out there to invest in where there are less doubts. Indeed I believe that this is the case, and the opportunity costs of not turning to the alternatives would be too high. 
I’ll stop here for now and continue next time. Will be out of the country for quite a few days so don’t expect any immediate replies, but it has nevertheless been nice having this discussion with you thus far.
Cheers,
Ethan

Hi momo,
I think your statements do focus on one of the touchpoints for Eratat, and I find it very interesting, but for the wrong reason. I agree that receivables are very high, which was why I had discounted it 100% in a very easy and conservative calculation. Given that Eratat had chosen (and supported it with a number of quarters of results and information with regards of their strategy) a growth strategy with focus on moving up the value chain, an increase in receivables is expected. Saying that their other asset base has remained constant is good support that they are carrying out their strategy in a thoughtful and sustainable manner (see my previous posts). Already, their assets to liabilities will be at 500 to 120 million respectively, which is excellent. To still expect growth in their asset base AFTER removing all receivables is very unrealistic (given their strategy and communications). That’s why I find your statements “interesting” – because you expect Eratat to excel in every single matrix available, despite it being a small cap. Your expectations are just unrealistic and unreasonable.
Point 2 is moot given that I had already given a most conservative example of reducing receivables to 0. Even if that was the case, they would still have sufficient cash to run the business. Pretty good, in my opinion. I would like to request that a more realistic approach is used, rather than all this fear mongering which I’ve observed with the so called “issues” of Eratat.
Green Rookie, for example, have brought up some real concerns based on very real data in a very reasonable manner. Kudos to him.
Cheers
 

Hi Ethan,
You mentioned about sensitivity? Nope. I’m just responding with a no nonsense perspective, which might seem harsh because that’s what it’s supposed to be like – a no nonsense approach. Besides, I did sense a stance that was NOT neutral. If you really wanted it to be neutral, it didn’t really come out that way. Oh well.... that’s the way the world works, bro. We all have specific idiosyncracies.
Besides, how can your posts be truely neutral when they clearly are directional and deal with things which I had posted?
You mentioned: “First of all I agree that past earnings cannot be ignored. But past earnings do not in themselves determine the value of a stock; they are merely a component of value. The value of a stock cannot be determined without taking into consideration the strength, certainty and quantum of future cash-flows as well.” – Thank you. That’s my point exactly. It’s meant to set a base. And total value will be that plus future earnings – again, this supports my statements dealing with the undervaluation of Eratat.
Lol... by my logic, Lehman got exactly what they deserved. Unless you’re claiming to fully understand my logic, even better than myself, I’d suggest that you don’t try to confound things by bringing in unrelated statements that have no basis what-so-ever.
With respect to what you’ve mentioned – from “Therefore historical earnings alone cannot determine value;...” to “...can you still then say the company trading under book value is undervalued today?” – I totally agree with you, and that supports everything that I have been saying so far.
You mentioned: “If a depression one year from now causes a company’s distributors to all go bankrupt and be unable to return the cash they owe to the company in the form of receivables, and all the receivables are therefore forfeited, could you then say that the company trading under book value is undervalued today? The book value could theoretically decrease significantly in future if you have a bearish macro-economic (or micro-economic) outlook.” – WOW. Will you listen to yourself??? I might as well just say, if the world ends next year, will anyone even be bothered about how valuable Eratat is? Hahaha. Anyway, I did do the math that treated receivables to 0.... please read through my posts. This point is so incredibly redundant... but quite fun (for me), especially since in my earlier post, I had pre-empted just such ridiculous statements by doing the receivables to 0 assumption, and by saying that i mitigate my arguments to “assuming no endogenous acts, like fraud, occur).
You gave the above paragragh and said “The point I’m trying to make here...” Unfortunately for you, you are not making a point because your statement is 100% speculative and redundant.
With respect to “So how can you expand orders and yet reduce receivables and improve cash flows? Simple – if your distributors are making enough profits from selling your products such that they accumulate enough capital not to have to take so much from the company in the form of receivables. If the distributors are making enough profits, you would expect receivables to go down over time and orders to go up since distributors would want to make more money.” – I agree, except that you’ve missed one key moderating variable. That of time!!!! You expect instant results from strategy. It’s just unrealistic. Enuff said. You also clumped an issue that has spanned over the last 2 quarters and extrapolated it to the last few years without justification again. Please get your facts right.
With respect to “There are no 2 apparel companies that are exactly alike....” – Yes, I agree. But apparently, you don’t quite understand the concept of strategic groups and competitor analysis. Might I refer you to a couple of strategic management texts which can help explain these concepts? Alternatively, you could try googling them.
Yes, I agree we can try to make a realistic guess. “As to the likely amount of subsides to be offered to distributor per store, yes once again we cannot be sure at this point but it’s possible to make a reasonable guess. Eratat has about 1000 stores. $1k per store? If you have a reasonable sense of proportion and the general costs of goods and services in today’s society, even in developing China, 1k would almost certainly be a derisory figure. What’s a reasonable figure? 5k? 10k? That’s 10 million. 20k? That’s 20 million. More than 33% of current market cap. We can’t know for sure, it really depends on your judgment as an investor but once again – doubt and uncertainty. And whatever doubts and uncertainties you have will have an effect on your projection of a company’s future cash flows, which as discussed earlier, is crucial to determining the perceived value of a company.” – instead of fathoming a guess on my part (just because I do not want to guess at this moment), let me just point out some of the issues with yours:
1.       You say that Eratat has 1000 stores. OK, I accept that since I have no idea about the numbers. What I do know is that they are ONLY going to provide the subsidies to their classic stores – and we’re not even sure if it will be for ALL their stores (Eratat said that they are working out the details now – fact). As such, the numbers will be much lower than your 1000 stores. Imagine, just by the lack of consideration of this fact, you could easily be guessing numbers which are multiple times the actual amount spent.
2.       You talk about 1k, 5k, 10k per store. In your last post, it was 50k per store. What’s the point of guessing when your range is well 5000% wide (1k compared to 50k). You’re talking about a margin of error that is INSANELY wide! As such, how can I trust your guessimate?
3.       Next, you have not even guessed at the details of the subsidies? Are you treating it like Eratat will pay 10%, 20%, 50% of the renovation costs? Once again, this will increase the range and totally mess up your guessimate. I’d rather wait for the facts and then decide. You can see why I don’t intend to do any guess work. Simply because unless one is an insider, given the constraints, guessimates are nothing more than speculation, and will likely lead to bad decision making.
You also say “Are they cooking the books? Again you cannot know for sure. If and when we know for sure, the company would be worth nothing by then...” – I’ve addressed this in detail before. Please do your homework again.
I’ve managed to address every single one of your points with facts and logic (once again, I might be wrong with some of the analysis, but that’s because I’m not infallible and I don’t have perfect information). Please don’t fear monger with “A the doubts start adding up, and you begin to worry...”. The only “doubts” that I have has been raised up Green Rookie. They’re not exactly doubts, but a reminder to be vigilant on several areas.
Cheers
   
 
 
 

Hi Tactician,


yep, that is one of the most major touchpoints. I do agree the calculations based on zero collectable receivables is indeed conservative.

However, I do not agree that asset base remaining constant over many quarters is "good support that they are carrying out their strategy in a thoughtful and sustainable manner" at all. Granted, Eratat is a small cap, but I don't see why special concessations should be given to small caps. So I don't think my expectations are unrealistic or unreasonable. But point taken as this is moving on to a subjective manner which I would agree different people would have differing opinions.





Point 2 isn't moot. If they had sufficient cash to run the business, I see no need for doing a placement at all. It isn't fear mongering, for I do not agree with nor buy into the way and reasons the placements was conducted. The timing was impeccable. Why do I say so?

List of events:
1) Declare dividends
2) Give first placements worth S$13.45mil, failed.
3) Give second placement worth S$12.12mil, succeed
4) Give dividends of S$2.74mil worth 20% of placement proceeds

My train of thoughts of the sequence events come in a form of multiple questions. Do pardon me if you think I think too much into it.

Question is, why the need for placements for $13.45m cash on Jan 2011 when the company has $30+m cash in its balance as of end Dec 2010? Ok, so the reason given is they really need the cash for growth.

And if the cash is needed for growth, why bother to give dividends of total S$2+m? Giving dividends not only deplete cash (if needed), but also incurs extra unnecessary expenses. The reason that was given was IMO lame, because they need to give to assure investors the cash is there.

CFO Ken Ho did mention that they had wanted to raise funds to grow faster. Then the question is there a need to dilute investors holdings by giving them dividends after giving placements? There could be much less dilution if dividends had not been given out, and less placements issued. Or the cash pile could grow faster with reinvestments if it had not been given out as dividends. The question in my head is, are they not confident of doing that to boost investors confidence, hence the decision to issue dividends when they really need the cash?

Is issuing dividends the right way to go? To sacrifice even faster growth for the sake of assuring investors? Doesn't seem a very sane decision to me. Or is there something else to meet the eye?