Wednesday, September 9, 2015

Texhong Textile - Update

Texhong reported results last month and provided an update on its outlook. I'll attempt to summarize the state of play here.

I'll start with what I'll call its legacy business. What I wrote out in long  form here can be summarized via a wide angle view thus (apologies for the formatting):

There is a central tendency to margins and ROE despite the volatility in cotton prices because, put simply, Texhong operates under a cost-plus business model:

So it is not, I think, unfair to characterize the legacy business as follows:

Big picture: occasional volatility but the central tendency is 25% EPS growth (25% annualzed growth in book value at 20% ROE) with either a 30% or a 50% payout ratio, depending on what one thinks normal.  Texhong is the largest spandex yarn manufacturer but its market share is 4%; the runway is a long one. The company's stated ambition is 10 million spindles by 2020.

Xinjiang Joint Venture

Prior to the earnings release the company announced a joint venture agreement between the company and its owner-managers for a 3 million spindle capacity plant in Xinjiang. The original release was free of detail but the post-earnings debrief with brokers revealed the following:

A $200 million investment by Texhong matched by an equal investment by Messrs Hong and Zhu;
  • The JV will be leveraged 10x in order to take advantage of a debt guarantee provided by the government of Xinjiang; 

  • The government of Xinjiang has committed to (1) providing a full VAT rebate, (2) paying a 100% subsidy for the JV's transportation costs, and (3) waiving income taxes. 
Xinjiang is the PRC's major cotton producing region and is majority Uighur. The desire to develop the hinterlands and to dampen ethnic unrest appears to have motivated this subsidy program.
We can model out the outcome of that arrangement as follows:

There are no capital expenditure liabilities attributable to Texhong -- capital expenditure will be debt financed -- and earnings are therefore equivalent to free cash flows.

If this is approximately right, then we can sum the the earnings power of the legacy and Xinjiang businesses thus:

The company has estimated a payback period of 4 years on this project but did not specify whether to enterprise value or to Texhong's equity stake. If it is to the enterprise then the numbers above are in the ballpark as one would expect.


The company's other update on its plans concern its intent to enter into the downstream business -- organically or via JVs or acquisitions. This is a fuzzier ambition to model, obviously, but we can maybe arrive at rough guesstimates by 
  • estimating Texhong's net cash flows after de-levering; and

  • "comping" ROICs at 15% and, at 1:1 debt-to-equity, ROEs at 30%

At a 14x earning multiple for the typical downstream textile business it could add value.

Pulling it all together

Lowish and base-caseish trajectories may look something like this:

This is not altogether out of line with Texhong's trailing ten year record. We'll know more as things play out but, for the moment, it looks to me as though the market is offering a >25% normalized earnings yield and therefore an >8% normalized dividend yield from the no-growth legacy business to keep one fed and watered in the waiting room.

edit: I have uploaded broker notes re: Xinjiang here

Disclosure: I own shares in this company.

Tuesday, August 25, 2015

Future Bright - H1 2015 (1 of 2)

The company has upgraded the detail with which it reports results so that we can now substitute management provided information for some of the informed guesstimates that I attempted in a prior post.

For the moment, I am particularly interested in the question: How much did the company earn before its investments in the Huafa mall and in the food souvenir business?

This is what the answer appears to be:



One or two seemingly reasonable assumptions (50% gross margin for the food court; pro rata share of mall operating expenses by floor area) and we can surmise further that the Huafa restaurants are operating at or above breakeven:

The food court will be closed at the end of August.

Disclosure: I own shares in this company

Friday, May 8, 2015

Enterprise Group, Inc - Exit

The Board of Enterprise would like to re-price management's option grants at a lower strike price. 
A reasonable person could link this development with last quarter's earnings miss. 

Investing in this company's stock was my mistake, not theirs. They are who they are and I should have known better

In any case, I no longer have any confidence that the earning power of the business will overwhelm the risk of entrusting my capital to these people.

Thursday, April 2, 2015

Future Bright - 2014 Results and Outlook


(i) Other than Food & Catering
Let me first attempt to contextualize the discussion about the food and catering business by removing it altogether:

(ii) Food & Catering

A refresher: the food and catering business consists of a number of parts that, for the sake of clarity, I will categorize as follows
  • Restaurants, coffee shops, and food court counters located in casinos;
  • Restaurants, coffee shops and cafeterias in Macau but located outside casinos;
  • Restaurants and a food court outside Macau;
  • A food wholesale operation that imports and distributes Japanese ingredients throughout the Pearl River delta; and
  • A nascent food souvenir business that is oriented toward selling moon cakes, chocolate products and so on to Macau visitors.
In the casino-located footprint are a number of high margin restaurants -- five "Edo" branded outlets serving Japanese food and one "Shiki Hot Pot" branded outlet serving Chinese food -- that cater to the VIP trade and make Future Bright as profitable as any publicly traded restaurant business as you and I are likely to ever come across.

The cost of food, rent and labor -- 90% of its restaurant operating costs, in other words -- are variable. Punters who would pay 800 MOP for a meal at a high-end casino restaurant can tolerate high mark-ups on alcohol. There are no marketing expenses associated with the VIP (and most of its other) restaurants because they cater to captive traffic -- at the airport, the university, the hospital, the mall, and the casino. These factors, in my view, sum to high and stable margins.

I suppose that the notional bear case must be (and, as far as I can tell, is) that Future Bright is heavily dependent on the VIP trade, that VIP attendance in Macau is in terminal decline because of the anti-corruption and anti-money laundering crackdown in the PRC, and that the company's earnings power is therefore permanently impaired. And, in there somewhere must also be a theory about tremendous margin compression as VIP sales decline. 


I'm now going to try to unpack the results reported for 2014.

The second half of the year, the period in which Macau gross Gaming Revenue (GGR) collapsed, also saw the company open new food and catering outlets at the Macau International Airport, the J Plus Hotel in Hong Kong, the One Oasis Residential complex in Macau, and the University of Macau's New Campus.

The fourth quarter (mid October) also saw the launch of the company's operations in Huafa Mall on the PRC side of the border with Macau. 

I have knitted together the company's same store sales (SSS) and other information to derive an estimate of Huafa's sales for the period between Mid-October and the end of December:

If I assume that Huafa Mall rents are in line with retail rents in Zhuhai more generally, this follows:

So an approximately right representation of Future Bright's  2014 results looks, I think, something like this:

Coming back to the margin compression idea implicit in the notional bear case, if it is there I don't see it as clearly as I should:


Macau GGR and VIP GGR are headed toward 2011 levels from which they are expected to grow at a rate that matches the PRC's reported GDP. That's the plan that Macau and PRC seem to have agreed on. Most publicly listed Macau-related stock are priced for that scenario. The fourth quarter of 2014 was more or less comparable to 2011 and while YoY GGRs are still falling MoM comparables have stabilized. 

As I have said before this is a stock I think highly likely to double at least three times within the next four years. The best thing, I think now, is to make the case for each doubling separately and at the appropriate time. 

Here is a signpost justifying the first doubling: 

This assumes, obviously, that the food souvenir business, and the 126,000 sq ft of restaurant and food court space at Huafa Mall breaks even -- but no more than that. 

It assumes that the Hengqin real estate is worth no more than the price paid for it. And it assumes that the 70 additional restaurants that are contracted to come on line between 2015 and 2018 have no value. 

The immediate pathway to closing the gap to ~$3.50 seems to me to consist of three steps:

1) the cessation of dramatic YoY declines in GGR will likely turn Macau sentiment around. We appear to be three or so months away from that eventuality;

2)  the interim results in July/August ought to show a dramatically reduced bleed from the food souvenir business and Huafa operations; and

3) a sale of a part interest in the Hengqin property seems to me to be a course of action that is both sensible and one signaled in the Annual Report. 

It would make sense to me if such a sale occured before November. 
The risks at this stage are principally the company's exposure to any future sustained tension between Japan and China, on the one hand, and its reliance on Chan Chak Mo on the other.

Disclosure: I own some shares in Future Bright.

Wednesday, April 1, 2015

Texhong Textile - 2014 Results & Outlook

When I first wrote about Texhong I suggested that the low-end run rate gross margin would approximate 15.7%. The full year 2014 results seem to bear this out.

Remember that the company holds 30 days of inventory so that as prices fall last month's more expensive cotton is sold on at today's lower prices. It is the direction -- and not the level -- of cotton prices that matter.

This is what happened:

and this is the impact that it had on Texhong's gross margin:

One can also see its imprint in the balance sheet:

Now that cotton prices appear to have stopped falling, adding that back get us to this:

The next issue is that of the appropriate multiple to apply to these estimated forward earnings (or dividends).

First, Texhong will de-lever despite continued substantial growth capital expenditure:

Its bonds are publicly traded and rated by, inter alia, Moody's. An upgrade of the bonds ought also to improve the market ratings of the equity.

Second, this is a company with a history of domination, ambition, and profitable growth, and whose long-term outlook is no worse now than it has been in the past.

Third, I have excluded a number of free options: cyclical recovery in the PRC end markets, the Trans Pacific Partnership, lower operating costs (labor, utilities, taxes, distribution) in Vietnam, etc.

If 10x earnings is conservative then $15 is at the low end of fair value. 

Disclosure: I own some of these shares

Thursday, February 19, 2015

A UK Portfolio 2014 - 2016

This is the third in a series [2012 to 2014 is here and 2013 to 2015 is here].

The UK market is now an uncomfortable place to be and what follows will I suspect be of interest only to a few.

I have said my piece about about Lombard Risk and Lamprell and I don't have anything new to add. I am allocating 20% to cash. The opportunities and risks attached to Dolphin Capital and Goodwin are as you see them so I'll only sketch Hogg Robinson, Hargreaves Services, Findel, and Cambria.

Hogg Robinson

I own shares in Hogg Robinson, a travel management company catering to multinational organizations with large traveling populations (Volkswagen, for example), confederations with special travel needs (the NBA, Cricket Australia), as well as governments and inter-governmental bodies (UK, Canada; NATO).

Its financial statements look fairly placid but belie both the structural transformations playing out in the managed travel industry and the neurosis that periodically grips the market about HRG's ability to align its strategy and cost structure accordingly. (There is, of course, a whole subculture dedicated to forecasting what "Managed Travel 2.0" will look like. I recommend the white papers at the website of Carlson Wagonlit).

We get a better view of what's going on if we adjust for a few items.

First, it appears that HRG lost 8 million in revenue in H1 2015 due to the strength of sterling and, second, it lost 6 million as a result of reduced European travel for cyclical reasons.

I think it reasonable to add those back to get normalized figures and to account for cyclicality instead via the modesty of the 10x multiple applied to the resulting FCF (10x unlevered FCF is equivalent to 8x EBIT). 

The company has also begun the process of rationalizing its cost base -- it has incurred the special charges but the annualized benefits have obviously not yet shown up. I add those back too.

There has been a rise and an acceleration in self booking of travel tickets among the traveling populations in its client roster. Each 5% increase in self-booking appears to reduce revenue by 1 million. The share of tickets that are self-booked will continue to increase and might hit a wall at ~80%. That would reduce run rate revenue by 25 million. It is low quality revenue since the margins are necessarily thin -- but no matter.

HRG has indicated that it will cut another 20 million out of its cost structure by rationalizing offices and reducing headcount. I add that back in the 2018 figures.

So we are left with a slightly smaller but more profitable revenue base and a forward FCF yield that cannot be sustained.

SpendVision would, in other hands, be more valuable than HRG itself. It is a wild exaggeration to say that it is a mini Concur but there are similarities in its potential. The combined value of SpendVision's potential and Travel Management's cash generative properties would, I think, make this HRG attractive to private equity. It has, in fact, been taken private in the past. 

Things to pay special attention to:

Think about who you'd target if you ran a travel management company with six thousand staff and a presence in 120 countries.

First on your list, surely, would be large multinational corporations with complex travel needs -- that is, with employees who frequently travel to and from places with higher than average security risk; higher than average flight cancellation risk; and higher than average need for local knowledge about where to stay, how to get around in country, and what to do in case this or that happens. The oil majors and the ecosystem that supports them maybe would be the place to start.

This is what it says in the H1 2015 report:

    "Our focus of targeting the provision of specialised travel services to companies operating in the marine, offshore and energy sectors is paying off.  HRG's track record over many years of successfully managing complex travel has resulted in new business wins during the period with Baker Hughes, Orica and Subsea 7, adding to a roster that includes, amongst others, ConocoPhillips, DOF Marine, Statoil and Tullow Oil."

It is awfully perplexing that this should be a new idea in 2015. At the same time, one does feel mollified that there is something that approximates a strategy in the works.

Second, the pension deficit is more substantial than the company's market capitalization. If corporate bond yield fall further, the deficit will widen. If corporate bond yields rise by 2% or so, the deficit will disappear. That would add 60p in value to the shares and therefore renders them an okay way to hedge against the possibility of a rising interest rate environment.

Hargreaves Services

HSP is a mix of good and bad businesses. The bad businesses -- surface mining of coal in the UK and bulk trading of thermal coal throughout Europe -- are not always bad and in any case enable HSP to profit from the trading of specialty coals.

Pulling together the contents of HSP's latest filing lets us draw this picture:

and therefore

and finally


The thing to do with Findel is, I think, to temporarily set aside everything but the Express Gifts segment. Its closest publicly traded comparable is  N Brown.

The other segments may not, in the end net out to zero. Kitbag is under "strategic review" and has received multiple expressions of interest. The education business is probably more cyclical than structurally challenged. Nevertheless, if Findel's share price rises -- and stays -- above 479p 8.34 million convertible shares come into play and negate the benefits of an improvement in these businesses.

Something to pay attention to: Management has an economic interest reporting ever improving EPS figures. This can be good and it can also be bad. It can, in a business quite reliant on securitized receivables and in one targeted at (or is it targeted to? or, perhaps, "serving") the working poor, become quite tempting to engage in risky operating and accounting practices.

Cambria Automobiles

The business model of a car dealership is to sell cars in order earn a profit on the sale of aftersales products and services. It can be done well and it can be done badly. The people who run Cambria do it well. They buy underperforming dealerships and make them profitable. 2.5% to 3% EBIT margin  represents very good performance in the dealership business. Cambria's margins, at 2% on average, reflect a mix of dealerships under its buy and improve strategy. 

As is, Cambria could (should) be valued as follows: 

so that

although, of course, the latest IMS suggests that the performance of the very latest acquisitions is such that there will be a substantial advance in the group's revenue base so there may be upside beyond what I've suggested here.

If the pace of acquisitions slows and we see 2.5% margins the shares would be worth 130p. That is also what it would be worth to a private buyer.


Of course this exercise is fun only if y'all dig in for yourselves, use your own judgment, and push back where appropriate so I look forward to that. 

Disclosure: I own shares in Hogg Robinson