This article was recently published at www.sharesinv.com, and is reproduced here with permission. The writer, Ernest Lim, works as an investment manager. He is also a shareholder of China Gaoxian.
AT THE TIME of its listing, China Gaoxian Fibre Fabric Holdings (Gaoxian) was the largest IPO in 2009, raising net proceeds of S$78.3m and sporting a market capitalization of S$350m.
However, with only one analyst covering it, China Gaoxian soon faded into obscurity. It closed at S$0.175 recently, 33% below its IPO price.
Should investors invest in China Gaoxian? Let’s take a look at this premium high-end yarn and fabric manufacturer.
Up till 2007, Gaoxian only produced full drawn yarn. It introduced three new products, namely drawn textured yarn, blended polyester yarn and triangular fibre yarn in 2008 and warp knit fibre in 2009. It sells its products under “华港” (HuaGang) and “大华威” (DaHuaWei) brands.
Its clientele includes more than 1,500 garment and textile manufacturers in the PRC, who use the products to manufacture apparels, sports shoes and upholstery for automobiles and airplanes, etc.
Examples of domestic brands in Gaoxian’s clientele are Metersbonwe, Septwolves, Tebu and Xtep.
Investment Merits
a) Improving industry prospects:
Gaoxian operates in the highly differentiated yarn niche, where demand outstrips supply. According to management, China is a net importer of such yarn, importing about 50% of its total demand.
Demand is increasing steadily due to the rising affluence of the people. Furthermore, the government supports the textile and garment industry as it employs a lot of workers.
b) Expansion drives growth:
In view of the improving industry outlook, Gaoxian is planning to increase yarn production capacity by 37% from 176,200 tonnes in 2009 to 241,300 tonnes in 2010. Moreover, it is targeting to increase its fabric production capacity by 382% from 17,000 tonnes in 2009 to 81,900 tonnes in phases.
c) High net margins – a testament to demand
Net margins have remained around 20% since its records in 2006. 9MFY09 net margin is at an enviable 22.0%. One of Warren Buffett’s tenets is to buy companies with a high profit margin as it is important for the company management to convert sales into profits and to control their expenses. Gaoxian satisfies this tenet.
d) Cheap valuations
Gaoxian trades at a substantial discount against its peers. According to Bloomberg, at the close of trade on 10 Feb, Gaoxian traded at 2.6x FY09F earnings vis-à-vis the peers average of 8.6x.
(The FY09F average PE is calculated by taking the average of Li Heng and China Taisan FY09F PE. I have ignored the companies with “NA” FY09F PE, as well as, China Sky’s astronomical FY09F PE in the calculation.)
This colossal discount is unwarranted for Gaoxian which is the most profitable fibre company listed on SGX and has great potential in the next few years.
e) Play on domestic theme
Gaoxian services domestic brands such as Xtep and Metersbonwe. Recently, Xtep announced that its 2010 3Q sales fair in Hefei City saw strong order book growth of 23% year-on-year (y-o-y) in sales value. Orders for apparel products soared 25% y-o-y, while footwear orders jumped 22%.
The macro economiy is set to brighten. I believe the 12th Five-year Plan (2011-2015) would likely include more policies which are conducive to domestic consumption, as China seeks to shift gradually from an export-driven economy to a consumption-based economy.Overall, this bodes well for companies which serve the domestic sector.
f) Possibility of another dividend payout
Based on my estimates, it is likely that Gaoxian will maintain its dividend payout of 25% as per its payout in 1H09. Thus, there is a high chance that Gaoxian will announce a final dividend of S$0.0050 to S$0.0066 which will bring its dividend payout to about 25% for FY09F earnings.
Assuming that Gaoxian pays out S$0.005, together with 1H09 dividend of S$0.0066, this translates to a high yield of around 6.6% as per the closing price of S$0.175 on 10 Feb.
Investment Risks
a) Lack of analyst coverage
Currently, there is only one brokerage house which covers Gaoxian with a target price of S$0.40. Lack of analyst coverage reflects the market’s unfamiliarity with Gaoxian, thus it may take some time before institutions, fund managers and retail investors understand Gaoxian and appreciate its great potential. However, I wish to reiterate that investors who understand and believe Gaoxian’s potential now can purchase it with a huge margin of safety.
b) Poor sentiment on this sector
With reference to the table above, readers may have noticed most fibre companies have “NA” in the “Analyst TP” column. This is because they do not have any analyst coverage due to lack of institutional interest. This lack of interest was due mainly to the slump in the fibre industry since 3Q08 onwards which bottomed at around 1Q09. Recovery has started slowly in 2Q09 and should increase its pace in 2010 onwards. Sentiment on this sector should improve in tandem with its recovery.
c) Lack of track record
Although Gaoxian was established in 1997, investors would only have financial records dating from FY06 onwards in the prospectus. Thus, there is a “lack” of financial records and some investors may be reluctant to invest in companies with limited financial track record.
Valuation
In my opinion, Gaoxian is deeply undervalued based on cheap valuations, respectable return on equity and dividend yield, strong operating cash flows, and a play on the domestic theme in China. I believe the investment merits more than outweigh the risks of poor sentiment and limited financial track record.
Applying a conservative PE of 6.2x to FY10F earnings (PE and FY10 earnings are my estimates), it could trade to about S$0.335 in a year’s time. This represents an approximate 91% upside since its close of S$0.175 on 10 Feb.
Disclosure: Writer is vested
Ernest Lim works as an assistant treasury and investment manager. Prior to this role, he was with Legacy Capital Group Pte Ltd, a boutique asset management and private equity firm, as an investment manager since 2006. He received a Bachelor of Accountancy (Honours) from Nanyang Technological University in 2005. He is a Chartered Financial Analyst, as well as, a Certified Public Accountant Singapore.
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