Sunday, August 17, 2014

Texhong Textile 1st Half Results

Texhong has reported its first half results. Those of us who have been following this stock saw what we had expected to see: 3 months of cotton inventory bought at higher than current market prices were sold at lower cotton yarn ASPs. Gross margins were crimped, and operating leverage ensured that net margins were gutted.






If we add back the 302 million yuan lost due to this temporary mismatch between the historical cost of cotton inventory and its current market cost, we would have something that looked like this:


The higher cost cotton inventory should have already burned off and the second half of the year should see margins return to near normal levels. Plus, added capacity in the second half of 2014 and in 2015 should see earnings resume its upward trend. 



We had also expected to see brokerage downgrades and they have arrived with target prices ranging from ~$5.50 to ~$10. The most significant would have been a downgrade of Texhong's debt by Moody's but that hasn't happened (yet). Consequently, the shares have not sold off as much as I would have liked.

A  29% forward earnings yield is interesting if one believes, as I do, that Texhong is a long term compounder benefiting from major tailwinds.

Disclosure: I own shares in Texhong.

44 comments:

  1. How far will the spread fall you think? It seems there are still import taxes. And about one third of cotton is imported in China. And those taxes are pretty hefty up to 40%. Also I wonder how much more expensive China grown cotton will be 2 years from now.

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  2. Well, I think the precipitous fall, which is what matters for Texhong's margins, is done.

    Ans as long as long as any future decline/increase in Chinese cotton prices is gradual, Texhong can pass along those fluctuations to the customer without defacing their financial statements.

    I also think the spread between international and domestic prices will persist at its long term average of 25% or so. Otherwise the subsidies to Xianyang cotton farmers would become prohibitively expensive to the government.

    Nothing is certain about the future, of course, but I'd be surprised if either of the above assumptions turned out to be unreliable.

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  3. Red - Continue to enjoy seeing your posts. Great to see some real thought going into investing ideas and genuinely appreciate you sharing your thoughts.

    As you see Texhong playing out what are your thoughts with regards to timing of going into the stock. Seems like there may still be some movement downwards as a result of analyst downgrades, potential debt downgrade etc. before we see the upside leg. Not an exponent of market timing (and already have a position) but keen to get your thoughts as to any other catalysts that will make the market move.

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  4. Thanks for reading. I expect a "positive profit alert" from the company in November and the share price to respond soon after. Maybe 2 legs up: post-November and after H1 2015 results. Hard to say how the share price behaves before then.

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  5. Im curious you have about the same cash position as me now. Im having doubts between spreading it between my best idea's now and hold only cash for expenses rent etc, or wait for a better idea to come along.

    Warren buffett says that with small capital today he would always be 100% invested. Opportunnity cost can be a hidden portfolio drain here too. And it seems that you can always sell some inferior idea to put it in something better. Any thoughts on this?

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  6. This is the lowest cash balance I've had in a long time and it makes me uncomfortable.

    I figure that the opportunity cost is 30% per year or so on the cash balance. So, if I hold 20% it costs me 6% pre-tax in drag.

    In exchange, I have the opportunity to take advantage of a market freak-out if there is one or to chance upon a something truly cheap with an near-term catalyst.

    So, at just ~7% cash I'm being greedy and I know it and it doesn't feel right.

    (I'm hoping that Emeco's results on Thursday will let me get to at least 10%. I'm planning to close out the October HA calls, and if I could get out of Epicentre, I would. Together these would get me to 15% which is okay until I can cash out LRM after its next set of results.)

    So, short answer is that I like 20% to 30% as a nice cash balance except in those times when there's a market freak out and the resulting dislocation means that I can find something easy with, say, 3x upside in a year. That kind of find can more than make up for the drag in between.

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  7. Hi Red,

    What would you say is the single biggest risk to Texhong? I guess it would either be rapidly fluctuating cotton prices that continue to mess with margins (or maybe from HKD perspective, depreciation of RMB)?

    Also, how likely do you think we'll see a ratings downgrade, I noticed Moodys affirmed their rating but revise the outlook to negative. You think if this happens, there will be a big move on the stock price? I am looking for an entry point.

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  8. RMB depreciation against the HKD will push gross margins closer and closer to 15%.

    Sudden (and permanent)drops in CC328 will lead to cash burn of the type we saw in this half.

    I think those are the big two risk factors.

    If Moody's downgrades and the debt sells off only the very determined would hold the equity at the same yield as the bonds.

    So, yes, if Moody's downgrades the credit I think it's quite likely that the stock sells off. Smallish float, weak hands, etc.



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  9. I like the catalyst but am concerned about the quality of earnings. Company seems to produce no free cash flow and NI to CFO line is hazy. Their working capital seems to be increasing much faster than sales. If their higher cotton inventory is burning off, why is it increasing so quickly?

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  10. I see CFO before working capital matching EBITDA over the 6 years from 2007. Working capital has grown in line with revenue growth over time.

    Inventory's up at the end of H1 b/c of a substantial step up in capacity/production in H2.

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  11. What broker do you use to buy rain industries? You need to be Indian to buy it at IB.

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  12. You'd have to establish an account in India
    http://www.kotaksecurities.com/whatweoffer/QFI.html

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  13. Would you be willing to buy the bonds if Moody's downgrades?

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  14. I think it would depend on the reasons given for the downgrade. If it's formulaic, I'd prefer the equity. If it says something I hadn't thought of or didn't know, I'd prefer the bonds at >20% YTM.

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  15. Hey red check out RYAM

    http://www.gurufocus.com/news/266867/rayonier-advanced-materials-ryam--will-an-unnatural-shareholder-base-create-an-opportunity

    spin off with a nice sell off currently.

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  16. Thanks. I've done some work on this name & I like it at $27 if it gets there.

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  17. Hi Red,

    How did you see the 2014 annual report published by EMECO?

    It seems that they start to control the situation...

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  18. Hey red thoughts on the Keck seng acquisition? It seems they paid up quite a bit for the NY hotel.

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  19. I'd have preferred it if they'd bought a deeply discounted property elsewhere but at a cap rate of 5% the purchase price is in line with Manhattan hotel valuations.

    There is no tax treaty between the US and Hong Kong and they may have decided that, rather than pay the 30% withholding tax on dividends back to the parent, the company as a whole would be better served if the sub used the free cash flow from San Francisco to buy another quality asset in the United States. And one would imagine that they'll use cheap non-recourse debt to do so.

    That's better than hoarding cash and, in the long term and for most of their stockholders, better than a special dividend.

    That's the appeal of this stock, after all: it is (and it is run as) a long-term compounder with some treats along the way.

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  20. check out Schibsted. Looks to be in your street, looking ugly now, but significant untapped earnings potential.

    And why sell Extendicare?

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  21. What are you seeing, ~1,000 in additional EBITDA when investment expenditure winds down?

    Nothing wrong with Extendicare that I can see -- just trying to reallocate funds to more time-certain opportunities.

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  22. http://www.mondaynote.com/?s=Schibsted

    I have not invested, and these sources could be biased for all I know.

    "For Le Bon Coin’s future, this draws a glowing picture: according to Danske Market Equities, today, the Norwegian Finn.no generates ten times more revenue per page view than LBC, and twenty times more when measured by Average revenue per user (ARPU). The investment firm believes that Le Bon Coin’s revenue can reach €500m in 2015, and retain a 65% margin. (As noted by its CEO, Le Bon Coin has yet to tap into its trove of data accumulated over the last six years, which could generate highly valuable consumer profiling information)."

    They hold three largest craigs list type sites, and many more across the globe like this. I guess the thesis is that besides LBC, this also goes for all the other ones. There are various detailed blog posts describing this business.

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  23. Hi Red,

    Do you think the lastest rises in the stock is due to the rise of the cotton price?

    Here I let you another valuation of Enterprise Group.

    http://seekingalpha.com/article/2422445-enterprise-group-offers-a-compelling-50minus-60-percent-upside

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  24. Red why not buy more enterprise? The more I read about it, the cheaper it looks. I guess I am asking because I accidently bought too much right before it went down and am now trying to rationalize not selling hehe.

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  25. You liked it at 90 but you don't like it at 82? :)

    There are other securities I like as much.

    Awkward time of the year when (1) I'm being hectored by my watch list, (2) I need to hedge, AND (3) I'm reluctant to dip into my cash position.

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  26. No I put in a order too large, so it is now 12% including warrants meant to make it 9%. Bought at 94 cents a while ago.

    How do you hedge? I usually rather stomach the swings with a higher return.

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  27. Swings are okay. I'd instead like to hedge against possible longer-term changes in the environment -- e.g. possible changes in the interest rate regime.

    If you like E it's worth watching MCR.V after earnings this afternoon. It's probably a $10 stock and would be interesting at sub $3.50

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  28. Thanks for the tip. How do you maintain your watch list? You use some kind of service that sends and email when it reaches a certain price?

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  29. A google spreadsheet that I look at every so often and where I can write short notes about what the company does, why it's cheap, what it's worth, when I think it'll play out, what in my portfolio it clashes with.

    200 names at a time so it forces me to cull the so-so and improve the average quality of the ideas

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  30. take a look at village farms. Look really cheap on the surface.

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  31. Your watchlist concept sounds interesting and well thought out.

    Any chance you would share a small snippet as an example of how the google doc is setup? i.e. what fields you track (besides just stock price), and an example of your notes on a given company or two? You can hide the actual company name, would be curious to see your thought process.

    I find that quickly identifying when it's important to "re pay attention to" to a name is difficult.

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  32. Hi Red,

    Notice you look into some HK listcos and was wondering if you knew anything about Tan Chong International (693HK). I think it looks pretty cheap, did a writeup at http://thetaoofvalue.wordpress.com/
    if you're interested.

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  33. Barry - done

    Tao - Nice blog & I'm now following it via RSS. Thanks for linking

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  34. Hi red,

    Thanks a lot for your thoughts Texhong.. I loaded up the boat myself over the past weeks.

    To share some of my own thoughts: profits are very volatile. As Texhong is a compounder, I think it is helpful to look at price to book value history. This is way more steady.

    This is book value per share (with semi-annual book value data):

    [img]http://i61.tinypic.com/2co4cn6.png[/img]

    This is the resulting price to book (p/b) (with linear interpolation of book value in between semi-annual dates):

    [img]http://i61.tinypic.com/11hgbyt.png[/img]

    The p/b points out pretty clearly that the market is way to obsessed with short term semiannual profits.

    So Texhong is now trading pretty cheaply. As you pointed out, if you expect a 20% gross margin going forward, it's no problem to slap a 2+ p/b on this stock. Meanwhile book value has compounded at 23.9% annually from Dec 2004 to Jun 2014, so it's a very comfortable wait getting at those higher multiples.

    For anyone interested, you can find margins over the past 10 years here to link to p/b history: http://financials.morningstar.com/ratios/r.html?t=02678&region=HKG&culture=en-US

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  35. Hey red, one thing worries me here and that is the so called cyclicality of textile industry. They are running at close to 100% capacity. And I don't really see anything resembling a cycle in the last 10 years.

    But aren't you worried they will run below capacity some time in the future? Especially if China would slow down.

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  36. Production temporarily below full capacity at some time in the future in case China's growth rate moderates? I'm not worried about that,no.

    Its the lowest cost producer by far and it will run at full capacity unless it isn't. Higher cost producers will go bust, Texhong will pick them up for a song and we'll go again.

    I'd be more inclined to worry about anything that could impact it relative cost advantage.

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  37. Do you have a good source for excel data for the Daily CC index (Grade 328)? Have only managed to find paid resources and would like to stay updated on cotton prices.

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  38. Subscription I'm afraid but here's the latest:

    http://www.cottoninc.com/corporate/Market-Data/MonthlyEconomicLetter/pdfs/English-pdf-charts-and-tables/Three-Years-Monthly-CC%20Index-Grade%20328.pdf

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  39. Seems to be no end in sight for cotton prices...

    http://www.cottoninc.com/corporate/Market-Data/MonthlyEconomicLetter/pdfs/English-pdf-charts-and-tables/One-Year-of-Daily-CC-Index-Prices.pdf

    But after a 3-6 month period to work-off higher cost inventory, Texhong should still earn a spread on its cotton sales, no? Or is there some lower bound price where things become really bad? Thoughts?

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  40. Right, it's the direction of prices that matters rather than the level of prices. The mark-up is the mark-up. So when CC 328 stops falling (or rises) then margins return to normal after a 6-month or so lag.

    It's been falling for longer than I expected so things have gotten pushed back by 3 or so months.

    On the other hand, the bonds are trading above par so I guess the market expects that we are at or close to the inflection point.

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  41. Agreed.

    Btw, Have a friend who is speaking with Texhong's management team in the coming month...do you have a few key questions you would love to ask management? Will try to report back if I can..

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  42. Thanks Barry. I'll let you know if I think of something.

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