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.


  1. pardon me, i see you are very passionate about Texhong.
    i briefly heard someone commented about this company before, so i thought maybe i just share with you here...
    Essentially, this is a business with no moat and no competitive advantage. The spinning work is of very low value adding and margins are very thin, and a lot of the Chinese textile companies have all gone bankrupt because labour cost is so expensive they are losing out to other countries, and the business is so easily replicated.
    Texhong managed to earn a decent margin over competitors because it is somewhat playing an arbitrage between overseas prices and onshore prices which are higher due to regulations (I am not very sure about this point). They are also heavily exposed to the FX risk, which is why they just did a profit warning on the FX loss. Considering how its competitors are doing, I am not sure what other stuff Texhong is doing to generate the better margins (might have to use imaginations).
    just my 2 cents worth... Good luck!

  2. Thanks for taking the time comment.

  3. How sure are you that cost plus means all costs plus? And not just cotton costs plus? Because those other costs stay the same if ASP goes down obviously. Although even if they do 'only' a billion HKD in earnings this year, it is still cheap.

    Do you have any estimates on what a TPP signing would mean for their earnings? Do they get a higher price for their goods if they sell it tax free in the EU and US vs China? Is that a big difference? I cannot really find any price quotes on textiles in both areas. But since so much is invested in Vietnam, I'm assuming this would be pretty big if it happens.

    And finally the vertical integration thing, why exactly do those deserve higher margins? Does that mean they also make the clothes and sell them to retailers or brands? If it gets them a higher multiple, doesnt that mean this is probably a more difficult business to get into? Why would Texhong have an edge here vs other textile companies?

    And thanks for taking the time to write this out.

  4. Thanks for writing this out. A few initial thoughts and comments (I'm sure there will be more...)

    - Yarn/Cotton spread is just the difference between lagged 3 month price of cotton and ASP? Or are you keeping a 20% fixed component (since cotton is 80% of COGS if I remember). Just trying to reconcile with the spread numbers you posted here:

    - You use EBIT% as 11% (then 11.3%) as steady-state margins when historical margins averaged 9.2% in normal years, per your data. What justifies the increase?

    - You seem to be ignoring the translation/currency impact on EPS in 2015? It will be significant in 2015, and potentially more so if the RMB depreciates further. I understand that the debt is just a translation impact (although it effects how much RMB cash flows can then be used for dividends/capex)...but there is a NWC impact ("bills payable" are also denominated in USD) plus the margin compression on the gross profit line. But you assume 17% steady state which is 200bps higher than the previous years despite these headwinds....thoughts?

    On the JV:
    - Isn't VAT 13%? See support here:

    - Aren't you double counting the benefit of transport subsidies on the JV? It's a lot longer / more expensive to transport from Xinjiang. Texhong's S&D + G&A costs have averaged ~6% of revenue which is where you start (99 + 46 / 2,524). Presumably though, ex-subsidies, the S&D + G&A % of sales would be higher than normal due to travel distances. So isn't the effect of the subsidy to ensure that same 6%...not lower it to 3% as you have done?

    - Backing into your numbers, you assume a 2.5% subsidized interest rate on the debt for the JV?

    - Any worries on conflicts of interest with the JV arrangement? Seems like such a great deal if subsidies come through, any worries that the owner-managers are taking the other side (and reaping the benefits) instead of finding a way for all shareholders to participate?

    1. AVI -- thx for the questions

      1) The spread I'm using here is simply between Texhong's weighted average yarn ASP as reported on the one hand and (3-month lagged) Cotlook A on the other. I chose not to include wighted average cotton price paid by Texhong (i.e. the CC328/Cotlook A blend) here because I wanted to simplify the narrative.

      2) Gross margin has trended up as Texhong has shifted to producing higher value-add yarns in PRC production bases and lower value-add yarns in VN. Not obvious from the raw data because product because of the recent volatility but should visible in this picture:.

      Obviously the recent volatility was policy induced and the stockpiling experiment having failed and proven itself to be expensive should not recur for some time. If it does not, the trend will manifest itself clearly.

      -- two points on the currency effect:
      (a) I'm interested in run-rate earnings so I use "2015", "2016" etc as capacity/volume (and therefore earnings power) markers rather than as precise estimates for actual 2015, 2016 etc results.

      (b) As I mentioned (or should have mentioned) before a not insignificant share of Texhong's cash, revenues and receivables are denominated in USD. So devaluation doesn't, I think, matter too much above the EBIT line or in the CFO and WC items in the CF statement.

      It does matter somewhat wrt to the interest expense. (I suspect that mr Zhong took out a USD loan with the express purpose of taking advantage of an appreciating RMB -- he is an arbitrageur at heart -- and now that that trade has faltered, he may refiinance in RMB). Either way, to keep things in perspective, the interest impact on EPS is 1 HK cents for every 10% fall in RMB/USD.

      The translation effect for dividends/eps is more material. And if the HKD should become unmoored from its USD peg then that will matter to me since my base currency is USD.


      -- It is and you should probably use that. i used 11% because I think texhong already benefits from one or two VAT rebates at individual facilities elsewhere in PRC and didn't want to overestimate the earnings from Xinjiang.

      -- Maybe my presentation of the transport subsidy was awkward. I'm assuming zero transport cost -- i.e. 100% subsidy -- for the Xingjiang business. Texhong's legacy selling expense is ~700/MT. (Selling and distribution minus transportation). I have used 825/MT for Xingjiang.

      -- I'm using an 8% interest rate on the guaranteed debt -- again, for the sake of conservatism. It doesn't lever up all at once; only as it installs capacity a million spindles at a time. So 320 in 2021 interest expense is on 3200 of debt financing;

      - I like this stock mostly because I like the management and only a little bit because it is is easy to understand. I don't think there was any real way for Texhong to put up all the the money in H1 without impairing its credit rating. Bondholders and the ratings agencies wanted a commitment to delevering. In another year under a different set of commodity & yarn prices I have not much doubt that the project would have been Texhong's alone.

      Thanks for the specific & thoughtful nature of the questions. Holler at me with more if you have any.

  5. Red, could you explain a ltitle bit wherein Texhong's competitive advantage lies? Why is Texhong the lowest cost producer? As they plan to open a new factory with the JV, how does this fit in with an advantage due to economies of scale? Why could'nt a competitor built a new factory with the same economies? Political subsidies are also a risk which I would somehow discount instead taking numbers at face value.

    In order to operate under a cost-plus model there must be prohibitive barriers to entry. For example in another commodity producing industry, oil&gas, companies keep pumping despite negative net margin. They have only 4% market share, which implies no pricing power.

    You obviously believe in management, but to me diversifying into the downstream business looks like a blunder. They would compete with their own customers?

    1. Hi Martin

      Let's start here:

      1) yarn manufacturers are paid cotton x 2

      2) there are ~98,000 yarn manufacturers in the PRC; Texhong's market share according to 3rd parties is 4%

      So, going through the expense items one by one:

      a) cotton (sourcing international cotton from Vietnam and elsewhare rather than sourcing only from more expensive domestic/imported cotton)

      b) other direct costs (purchasing power with respect to consumables; 100% capacity utilization lowers unit cost of depreciation, plant foremen, energy etc)

      c) selling (economies of scale and scope: can afford marketing offices and staff at lower cost/unit)

      d) distribution (on the VN side, especially, proximity to the border and a close distance to fabric and garment manufacturers in the PRC; raipd turnaround of trucks, lower depreciation/MT etc)

      e) admin (important unit cost advantages over small players, less significant in relation to bigger players like Weiqiao)

      f) interest (lower cost of debt b/c of sufficient size to be able to raise funds in the bond market)

      g) taxes (of sufficient size to be offered tax expemptions -- Vietnam yesterday and today, Cambodia tomorrow etc)

      On the revenue side:

      Ability to service 3,000 unique customers requiring 3,000 x Y types of yarn in <2 month turnaround times at (see above) lowest unit cost. Strength brings strength so, over the last ten years, 130,000 domestic yarn manufacturers have shrunk in number to 98,000 today.

      Over that time, both the consumption and production of cotton yarn in the PRC has been flat in inflation-adjusted terms. You can see that Texhong's sales, starting from a low base and therefore enjoying the above scale and scope advantages to a quite modest degree, have by contrast grown exponentially.


      Texhong's customers are midstream businesses producing fabrics not downstream businesses producing garments. in any case, Texhong has been in the fabric business for a long time and has therefore been competing with its customers since inception.

      I tend to apply practical reason here: Texhong could earn $2 for every $1 it invests in producing yarns. They know it, I know it, and anyone giving their business a once over without looking at the share price chart wouldI know it too. So the question is this: would they branch out into garments if the thought their was a reasonable foreseeable risk that their $1 investment would create less value than $2? Are those 2 guys those sorts of guys? Clueless? Unaware of the environment in which they are working? There's quite a bit of material on the internet about Zhong in particular so you can judge for yourself.


      "In order to operate under a cost-plus model there must be prohibitive barriers to entry."

      there are lost of business models that operate cost-plus that require no barriers to entry at all. consulting, law practice, advertising, etc. And that includes all costs, not just raw material cost.


      "They have only 4% market share, which implies no pricing power."

      I'm not understanding the connection. logical or otherwise, between market share and "pricing power".

    2. Red, thank you very much. That is helpful for me.

      Do you know why the analyst uses a 20% discount to the average PER of Texhong's regional peers? If you are right texhong should trade at a premium.

      -re pricing power: If the largest player has just 4% market share, the industry has to be very fragmented. A fragmented industry has lower pricing power than a concentrated industry. You can observe this e.g. for hard drisk drives after market consolidation. One benefit of M&A is lower competition. I don't mean Texhong has lower pricing power than its peers. Just overall their suppliers or customers could squeeze out more profits if they were more concentrated, but I believe they are very fragmented, too. Does the whole industry earn the same ROIC as Texhong? If there is just one company earning nice ROE/ROIC your reasons could apply, but the fraud risk is statistically higher.

      re cost-plus model:For me this means you don't get x plus expenses reimbursed but a guaranteed profit. Utilities sometimes get a guaranteed return regardless of their cost structure.

    3. I hear you, Martin. There are two ways to command a competitive advantage:

      (1) pricing power
      (2) comparative unit cost advantage

      Pricing power is relevant to differentiated products and services; unit cost advantages are relevant to sommodity products and services.

      For example, Wells Fargo, Exxon and GEICO have sustainable unit cost advantages over competitors and sell commodity products. Warren Buffett owns them for that reason.

      .The most commodified commodity of all, for example, is ... money. That's why it is money after all. But Wells Fargo, for example; whose market share is 5% and without any pricing power,
      seems to be at a competitive advantage in selling money -- the ultimate commodity product -- does it not? That's because its deposit-gathering and revenue-generating unit costs are super low, at least in relation to a small neighborhood bank of which there are many in the United States.

      I am suggesting that Texhong has important unit cost advantages in yarns and that it therefore enjoys important competitive advantages notwithstanding the fact that he product that it sells is a commodity.

      You can look at Texhong's annual reports for 2006 and 2014 and contrast the following:

      General & Administrative costs per metric tonne of yarn
      Selling expense per MT of yarn (Selling expense = Selling & Distribution minus Transport)

      The unit cost DECLINE in these two line items between these two years should sum to approximately 1450 yuan per MT. 1450/MT is 6% of the LT average selling price of yarn (24,000 RMB/MT). So a 4.5% operating margin in 2006 becomes, because of scale/scope economies, a 10.5% margin.

      At constant asset turnover of 1.8x, Texhong's ROIC morphs from (1.8 x 4.5%) = 8% to (1.8 x 10.5%) = 19%
      At debt/equity of 50%, ROE improves from 16% to 38%

      Is it sustainable? Well the source is unit cost advantage. Yarn producers and yarn buyers are all price takers so global yarn prices -- and the therefore the prices at which Texhong sells its yarn -- do not go down just because Texhong improved its cost structure.

      What will happen when it is selling a million MT of yarn? How wide will the gap be then between Texhong and the 98,000 other yarn manufacturers in the PRC?

      This is not in my view a complicated story. There are a number of narratives about Texhong that are highly resistant to clearly available evidence to the contrary:

      1) Its competitive advantage rests entirely on the cotton price arbitrage between PRC and VN
      2) yarns are a bad business
      3) Texhong's long term fate depends on passage of the TPP



      Texhong's only publicly listed peer (ex-India) is Weiqiao and no analyst is suggesting that Texhong should trade at anything but a premium to Weiqiao. The others -- Shenzhou etc -- are in the garments and fabrics businesses and are also essentially contract manufacturers for Nike, The Limited etc. The idea is that these should grow at the rate that their customers do and with revenue visibility/stability.


      In the end, there are two ways to approach Texhong:

      A) This company operates in a terrible industry, is mainland Chinese, has an unattractive share price chart, and is trading at >1 x Book Value. Why bother?

      B) This company is a champion, run by capable owner-managers, has compounded value at far above market rates for a long time, and looks to be in a better position to continue to do so now than it was ten years ago. The volatility in yarn and share prices is the red herring that permits an undemanding entry point. Using reasonable assumptions and sensitivities this stock is worth $30 to $40 per share.

      Look at my write up of Mayur Uniquoters. Is there a material difference between it and Texhong?


      HDDs etc.:

      It is a myth that consolidation offers pricing power to suppliers of a commodity product and it is a myth that defies ever-available evidence to the contrary. Find a write-up on RYAM and look up what happened in the aftermath. Consolidation often makes matters worse.

    4. What about Micron? It seems the generally accepted theory is that when the weak players are eaten up, and the industry consolidates, there is no more reason to wage price wars to try and drive out weaker players? Pricing wars would make no sense at that point because it doesn't really result in market share gain and nobody would make a profit. Sort of a prisoners dilemma. And the fewer players there are , the better the odds no one gets out of line and triggers another price war. Not saying this is fool proof, just that with consolidation and no weak players the odds of higher prices are much better in general.

      And it seems like RYAM was more a case of bad management then a proof this theory doesn't hold up? Also total major player count there is around 10. So not that consolidated.

      Otherwise you raise some good points.

    5. Hey guys,

      Nothing intelligent to contribute regarding Texhong, but red mentioned HDDs and how consolidation doesn't offer pricing power for commodity producers. That's true...But in STX/WDC - isn't it true that the they are the only two HD suppliers standing? So not exactly a commoditized producer? This isn't iron ore or oil where you're competing with thousands of independent companies/producers all around the globe with different cost of labor, energy, cost of capital, etc? In case of HDDs, almost all come from Thailand.

      Also I don't think RYAM has anything to do with consolidation per much as it being a high cost producer of a commodity - it was just that Bracell's COGS (Brazilian eucalyptus) was much lower than RYAM's COGS (US South hardwood).

      Am I missing something?


    6. DifferentGuy,

      I suppose tthat that;'s what I was getting at. The thing that matters is how your average cost curve shapes up when compared to the next fellow's. if you can be profitable at prices below the cash breakeven cost of your competitor, then you have a competitive advantage worth the name. That's why it is important to actually count the unit costs rather than assuming that a large player in a consolidated industry has "an economies of scale advantage".

      A "commodity" is any standardized product/service that is bought based on price alone (or where price is the dispositive factor), whether it is rice, oil, yarns or HDDs . By definition "pricing power" and "commodity product" are mutually exclusive concepts. Again, nothing to do with how many suppliers there are.

  6. Fantastic comment. You play in the market like Federer in the court.

    Always learning from you. Thanks a lot.

  7. On currency risk...just one article, but has to be some concern here right?

    1. I'm having a hard time guessing at what risk you're getting at so I'm going to need your help. I need specificity -- what is the mechanism exactly via which texhong will be impacted -- and I need an estimate scale of impact that you expect.

    2. I'm assuming he/ she was referring to this exchange loss of 220 million RMB, which would become larger if the RMB depreciates more against the USD.
      This will coil the spring even more as the full year reported earnings will not just be lower due to the cotton price, but also by the exchange losses.

    3. Gotcha. Thanks for thecomment.

      As I said above in relation to that item: below the EBIT line, it is what it is. Texhong takes the hit but it's a small one in relation to the value of the business.

      Above the EBIT line, we have relative improvement in Yuan-denominated cotton costs, import substitution, and export competitiveness that ought to act in concert to hedge out this and any firther devaluation of the RMB. We've been at 7 and 8 RMB to the USD in the recent past so estimating the operating impact is not ncecessarily a wild guess. (Revaluation losses/gains on the USD loans are also not new).

      What I worry about most is what you are suggesting: that we seem to have a low quality shareholder base holding these shares so that one can't tell whereabouts the bottom is. That makes it harder to know just how to size one's position.

    4. typed this out once but didnt appear to post...trying again

      1) 90% of revenue into China and denominated in RMB, but only 30-35% of cash + NWC in USD while 98% of debt denominated in USD. So there is a mismatch there, with Texhong having to repay with less valuable currency. Also, while I agree the Vietnam arb trade isn't core to the thesis, Texhong does supply a good portion of its cotton supply by buying int'l cotton in USD and at a 20-30% discount to RMB prices - if the RMB devalues by 20%, doesn't this discount disappear and margins get squeezed in Vietnam?

      2) In 2014AR, exchange rate risk is -14m in net profit for every 0.4% currency move. A 20% devalue would wipe out a huge chunk of FY profit. Whule I realize this is mostly just translation in the income statement, the bonds are relatively short-lived and texhong will have to pay those obligations back, but now with less valuable currency so I'm not sure the translation impact should be ignored

      3) Dividends are in HKD. Strong USD = strong HKD = less valuable RMB cash flows. Devaluation means the China operations (and the entire business) is less valuable in HKD/USD terms - potentially 20% less valuable if the RMB devalues

      I'm most worried about a potential cash crunch in paying the bonds and margin compression in the core business due to these exchange effects.

      thinking out loud a bit, so let me know your views

  8. Alright -- thanks for this

    Let's quantify this

    This is a naive, static equilibrium model where yarn ASPs don't adjust up. It also leaves out the Xinjiang JV so that we have an uncluttered look at the legacy business's worst case earnings, cash flow, and leverage profiles.

    Or, of course, we could go back in time -- to 2007, say -- and look at what earnings and cash flows would have looked like at today's capacity level.

  9. I see Dawson Geophysical in your portfolio. I think I recall you (correctly in my view) remarking on Hornbeck Offshore not being a very good business. Do you think Dawson Geophysical is any better business than Hornbeck?

    1. It's not a great business, honestly. But the price is quite low and the risk of a wipeout even lower, esp if you assume that there is some minimal demand for high-grading activity in a low commodity price environment.

      They say the current crude price environment is consistent with 8 to 10 teams. $18M per team, 5% assumed operating cost synergies from the merger, and maintenance capex at 8% of revenue, that gets us to $60 in FCF. (The LT average figures are $23 M per team).

      So a couple of consequential assumptions in there and not a conviction position by any means but I believe the story they're telling about rains having messed up their year. Plus it's a nano-cap and I imagine that the mist of the merger of financials and calendars so I suspect the set up is an attractive one, all things considered -- esp as a companion to my HA position.

      Obvs had I known at the time that the HK small cap world would get roiled I'd not have bought DWSN or Macro. They have nothing to commend them but relative balance sheet sturdiness, low multiples, a suggestion that there is a minimum level of sustenance work that keeps them cash flow positive, and the option that things could go really well if things outside their control improve. At this point they are the weakest links in my book but they're not a coin flip --- Hornbeck is a coin flip.

  10. Looks like they agreed on the terms with the TPP, now politicians world wide will have to vote on it. How do you think this affects Texhong? Is this going to be a 10% earnings boost, or more in the 100% neighborhood? Struggling to see why so many textile manufacturers gets so excited about this. Aren't the gains pretty much passed on to consumers?

  11. To simplify things a bit, textile manufacturers with a footprint in a TPP member country benefit relative to those not under the TPP umbrella. For example, Bangladesh has an ultra low cost apparel advantage but is not in the TPP. Therefore manufacturers in Vietnam benefit.

    There are wrinkles -- "the yarn forward rule" and so on - that in theory may benefit Texhong. In theory Texhong could build more plants to service a VN apparel industry that will grow at a faster rate than previously. But that's really something to worry about at a shares > $20 or $25; it's not essential to the investment case.

  12. Red,

    About Hawaiian: I thought you were a little bit risky with your options (Option call October 24) in Hawaiian but you did it extremely well. For me the market was very volatile, and for that reason the options maybe were a risky thing. And now again you are buying options for November after a rally in the shares of hawaiian of 30/40% in almost a week.

    I just want to learn from your movements. Could yo please explain me a little how could you "predict" the movements of the share in such a short term?


    1. Well,David, as you know one can lose the entire amount when the time frame is so short, especially since I chose to go naked rather than shorting another security in a pairs trade. So it's not something I would recommend to my worst enemy.

      Nevertheless. my reasoning was/is as follows ( I will link to a spreadsheet in due course):

      1) Both the absolute and relative trading range for HA "ought" to be in the $27 to $45 range depending on the EBITDAR multiple one uses (4.5x to 5x)
      2) HA gives out enough information in the 8-Ks that one can predict the EBITDAR number
      3) Zac Hirzel has been selling millions of shares over the past several months, thereby preventing the stock appreciating to where it "ought" to be
      4) The "risk/reward" from $25 to $35 was 10:1; if I repeated that trade 10x over 20 months and lost the stake every time but the last I'd break even;
      5) I thought the company's operational guidance and the consensus EBITDAR/EPS figures wrong (I have followed this stock for some years and I have my own views about how each segment ought to perform in Q3 and Q4)
      6) i thought/think it virtually impossible that HA would stay at $25 or, earlier, at $18 in the absence of a major market meltdown. or a reversal in oil/jet fuel prices (or some in-flight tragedy)

      So that's it, really. I can't emphasize enough that these items don't add up to a hill of beans in the very short term. But there's always a little corner of my portfolio that's not abut making money, exactly, but about being right. It's an itch I sometimes fell like I have to scratch and, as they say, se unha muller che di que te tires pola ventá, o que tes que facer é percurar a que esteña mais baixa

      If I weren't so involved in Macau, I would have just put 10% on HA when it fell to $18, hedged it out with puts on a large cap oil company, and called it a day.

  13. I see from the announcement on the HKEx that the Xinjang project has been scaled down from 3m spindles to 1m spindles, but Texhong's ownership has increased to 90%. I don't think it changes substantially the valuation above, apart from the later years (2020+).

    On the plus side, they've commenced the first 450k spindles so are on target and there's no longer a worry about conflict of interest. Incentivizing key people with the remaining 10% is also a positive - always good to have employees with skin in the game!

  14. Reading through the filing now. Thanks for the heads up :)

  15. Thanks Red,

    It´s always a pleasure to read you. And congrats for your gains in HA.

    "se unha muller che di que te tires pola ventá, o que tes que facer é percurar a que esteña mais baixa" This is my own language, very similar to Portuguese, jajjajaj, where did you get it? I think I will have to invite you to see a match in Riazor, maybe against Barcelona.

    Thanks a lot. I´m also reading the memos from Howard Marks. Intelligent, hard worker and responsible man.

  16. Red, a question for you in connection with Paradise Entertainment. How would you compare it to Emperor Entertainment Hotel Ltd? Both should benefit if Macau turns the corner in the next 3-6 months, both should benefit from a shift towards mass market gaming. Emperor seems very cheap, and (to me) provides more downside protection looking at the 2 hotels they now have, with pretty reliable income streams and a cash cushion, okish dividend. Presumably the Paradise Entertainment story might be a better sell, with possible sales of their gaming machines to US/Australia.

    I hold (small) stakes in both but was wondering how you would compare the two (and what I am missing). The old VIC write up on Emperor Entertainment and the small post on CoBF provided some useful background on Emperor Entertainment.

  17. Emperor is controlled by a man who has spent 30 years denying he's a gangster, set up a sell-side publishing enterprise to pump his own stocks, and once tried to take the comapny private at below the price that the stock was trading at.

    That it's trading at below net cash is interesting only if you have a view about what the cash build is for and what discount (or premium) the market will apply to that purpose. As for the business, one has to have some insight as to the extent of his ties wth unsavoury junket operators, whether the VIP are SOE/Govt or not, etc.

    Generally speaking I find it helpful to differentiate between the price (i.e. the yield) at which one would be happy to own it for oneself, one the one hand, and the price at which one thinks that one could offload it to someone else. So it would be "cheap" if, taking the risks into consideration, you'd be happy with a 7% return on your equity.

    From the trading -- rather that investing -- perspective the truth is there will likely be at least some investors who'll take it off your hands at a higher price:they've run a screen, they too think that there's someone upstream who'll take it off their hands at some higher multiple, etc.

    But it's not, in my view, a particularly interesting stock pick particularly when there are so many other uncontroversial, solid, non-contrarian HK equities trading bar below their IV (properly understood). Even in the Macau space, I can't imagine preferring Emperor above $1 to any of the concessionaires (except maybe Wynn) at their current prices. Which is to say I think Emperor's IV is $1/share or below.

    I think Paradise's IV is $4 - $8. It pays out 80% of owner earnings as dividends (and buys back a trivial # of shares, too) so the only burden on the investor is to figure out the low estimate of earnings power which I think is $0.30/share from casino services alone and another $0.15/share from the already installed base of LMGs in Macau. So $0.40/share in earnings --> $0.32/share in dividends --> 8% div yield if one thinks there may be upside from international sales of LMGs and one's willing to pay to see if it comes about --> $4 share price IV. Buy in now and, by the time the market has gotten its bearings as to the worth of Casino Services, one will have an idea as to whether there is any value in the agreements with Arstocrat & IGT. Or so goes my thinking ..

  18. Using your IV of $1 for Emperor would give zero value to their cash, 2.5 x their trailing earnings, 11% div yield.
    That would give also zero value to the wise decision of the management to hoard cash ( which was the right decision given what happened in Macau in the last contrast with Future Bright management )
    That would give also zero optional value to all the opportunities to buy small distressed casinos which are coming ( a bit like being Berkshire in March 2009 )
    That would give zero value to the fact that Emperor has been profitable for 10y in a row and distributed 30% of its earnings for the 8 years ( $.8 overall )
    No the management is not pumping up its stock ( google Emperor you will find nothing, no PR, annual report very low profile )
    If the owner would be a gangster, wouldn't he be in prison ? It is a big mistrust in HK judicial system and in the SFC ( fyi HK is a much safer city than any European or American city, the law is basically the U.K law and the SFC is stricter in may domains than the SEC - that's why many dodgy Chinese companies decided to be traded on the U.S market rather than in HK )

    The cheap price, plus the 7% dividend, plus the 15% ROE, plus the experienced management, plus the opportunities they have to use the cash are all reasons to be long Macau through this stock.
    Trying to see the downside but I can't : real assets ( 1 casino, 1 hotel ), no leverage, profitable

    Happy to be proven wrong

    1. You like this stock. As I said above, I get it. It's just not my cup of tea.

      Yes, by the way, to the HK/SFC regulatory oversight : I know enough about it to have greater confidence in it than in the SEC or FSA. This is not my first go-around in HK listed equities.

      As for "not pumping up its stock" I think it's worth considering whether it is seemly for this to "provide research coverage" on this which, as you know, is the parentco of your holding. You may think it is seemly and that's okay.

      "Using your IV of $1 for Emperor would give zero value to their cash, 2.5 x their trailing earnings, 11% div yield." That's quite right and that's how I valued it actually. "cash", "real assets", "low multiple", "acquisition option" -- all of these are abstractions. There are circumstances when buying and selling abstractions is an attractive proposition (bottom of the cycle, selling to institutional/professional investors etc) and this may well be such a circumstance. What I'm saying is that you have the choices. Many Macau-related stocks are trading at a low multiple and, within this opportunity set, some of these stocks are cheap-in-fact -- i.e. the return one can expect from the company itself -- after accounting for all reasonable scenarios -- is clearly above one's so-called hurdle.

      These are the things I would consider:
      "His multiple arrest record means nothing because he spent no time in prison": Look at the ex-cash P-to-cash Earnings ratios that this company has perenially traded at . It ranges from 0x to 2.7x. That suggests the market doesn't trust him. I have a variant perception and an edge in assessing his trustworthiness because...

      He will not attempt (and succeed) in taking EEH out at a slight premium to trading price. Because...

      He is not aligned with elements on the wrong side of Xi's anti-corruption initiative. He will win rights to manage additional satellite casinos from one or more of the concessionaires. Suggestive evidence is...

      Or, the cash build is actually purposeful: he is planning a a very large special dividend. The clues to this are ...


      Or I'd treat it as one of so many mechanical picks -- some will pop, some sink, some stand still, and on the whole one'll often end up making money. That's fine, too, but the charm of such approaches is that each compenent of the mechanical basket both doesn't require justification and, looking the facts in the face, can't be justified.

      That's how I should have treated, for example, Enterprise Group, a Canada-listed company that I've written about. It will be a while, at least, before I make a similar mistake.


  19. Red thoughts on Bracell? They trade at half the multiple on competitors. Increased divvy payout, and judging by the quick payout after their disposal that could increase more, real plummeting, likely contract wins for CS and the low cost and low debt position in the industry? Even with some of the stink involved, it looks really cheap. The liquidity is terrible though. I guess this would probably fall more under a mechanical pick.

    seems they can easily do 70m in earnings this year, and more in FCF. and possibly even more if that industry recovers/they win CS business. And m-cap is only about 400 million.

    On the one hand Sukanto Tanoto, but on the other hand real solid demand in a industry that is in it's trhough with the low cost player. And high barriers to entry + surplus capacity is quickly taken out of industry.

    1. Not sure why this is an especially attractive pick but, in any case, it might be easier to buy puts on RYAM if it rises above $9

  20. Im curious how you get 30 cents in casino services for paradise. Do you assume some big recovery in Macau mass market for this? If I take out amortisation too I get 16 cents in total earnings for 2014. And you get 30-40 cents in 2016 or 2017? That is quite the jump. In H1 they did 2 cents in earnings if i take out amortisation. So from 4 cents to 40 cents is quite a jump. Do you assume some big recovery in mass market? What is your edge in predicting that? To me the situation in Macau looks pretty grim right now. How can you be certain Macau won't just muddle a long and grows only a couple % a year from current lows? I struggle to see how they could do more then 20 cents total in earnings next year.

    They would need to add probably at least 50% or more to revenue for that to happen. I guess it boils down to, why do you think there is a high probability of large earnings and also revenue growth for paradise?

    1. Makeit easy and start with casino services before they took on Waldo. Adjust for GGR and you'll see this:
      Revenue ~850,
      Gross Profit = ~65% = 550
      OpEx = -275
      Interest = -9
      Earnings from Kam Pek = 278 = $0.26

      Add Waldo & MJC = $0.30 total at least (though more like $0.35 when all is said and done) = $0.24 dividend = 17% yield at last close

      Then you can add installed base of LMGs and come up with some kind of valuation that you're comfortable with.

    2. You are assuming 20% revenue growth here from today, + better margins then H1 2014 despite wage inflation last half year. Their ebitda margins were close to zero, so you need at least 500m in extra revenue or cost cuts, and revenue is going down actually! With no end in sight so far for any significant Macau recovery. Or am i missing some large one off costs that will be cut?

      Another thing that worries me is all those new casino's and the extra focus on mass market. That seems like extra competition to me. A doubling in casino's + extra focus on mass market by other players vs also doubling number of visitors?

      The stock looks cheap, and will probably do 20-25c in earnings within the next 2 years, but your assumptions look more like the extreme bull thesis then a realistic base case.

    3. "Or am i missing some large one off costs that will be cut?"

      Is it not easier to simply read the filings/presetations/concalls than to shadowbox with me? Especially in view of the fact that I specifically told you that one's edge is in doing so?

    4. I read all of those, and I see their largest 2 casino's in decline so far. My point still stands. Why do you think they will grow so fast when they have been declining so far? I see one vague remark about streamlining some costs. I dont understand how you extrapolate that much earnings out of it. We will see who is right in due time I guess.

      Saw that in some other posts as well, your predictions usually seem to be really on the optimistic side. Otherwise always enjoy reading your blog.

  21. Hi Red, are you expecting a significant profit/surprise at Flybe this 1H? - basically curious to know if you think this is a good short term (in addition to long term) opportunity? Modelling this one is a bit beyond me. If you ever do a writeup on it that would be awesome :)

    Thanks for all the great ideas. You seem to be speeding up in the discovery process recently, so I'm looking forward to many more!

    1. Start with 2013 and cut net 5.20/seat from the cost base, Multiply reasulting profit/seat by 2016 seat capacity and take out E195 rent -- that's underlying profit. (E195 lease liability is instead treated as if it were term debt with 20M/year in principal repayments). Not so hard to get to a P/E of 1x in 2018/9

      H1 #s should look quite different from what has come before and capital markets day should underscore just how much the company has changed for the better, The key from a what multiple does it deserve? persective is going to be tied somehat to its ability to cut yields and increase load factors to the 80% mark. That should prove easier to do when it stops putting $100/barrel fuel in its planes.

  22. off topic: Lanesborough REIT beware of the tax consequences.

  23. Thanks Martin. This was previously announced -- last month, I think.

  24. Hi Red,

    I'm curious if you've ever looked at Piaggio- the maker of Vespa. A Greenwood investors pick that they think is comparable to Flybe risk reward. Basic premise is high incremental margins and pent up demand in Europe. Hope perhaps it interests you.

    1. Hi Ruby

      Piaggio's one of those names that I glance at once a year. If valued at 6.5x forward EBITDA, which I think it should be, one is -- at this price -- being forced guess at both the long and medium term trend in scooter demand. and guessing correctly is not easy for me to do. (Full disclosure: I don't know their thesis so if it involves something other than cyclical recovery then I'd be glad to hear what it is)

      I think Piaggio's future over the very long term is tied to Asian rather than European demand so that an super-long time frame should see an investment in Piaggio work out quite well. But there's an inflection point for that and I don't know that we're there yet.

      Flybe is a v different proposition -- no big guesses necessary.

  25. Texhong profit recovery should be on track:

  26. They hedged the FX! I love these guys. My biggest position by far. I read every annual report since 2004 and am confident Hong will pull the new ventures of.

    Thanks red for handing me the idea.

    1. Best management team I've ever entrusted my money to. Always thinking, always improving the business. Glad you see it the way I do.

  27. There appears to be a glitch in that blogger is not showing some comments. This was a follow up xomment from "theplunger"

    "Red, yes indeed. My 2 cts on the results (all figures as calculated by myself):

    * Much, much better than I expected. EBIT (operating profits ex other gains/losses) and EBITDA actually both hit a new all-time high at RMB 1.166 bn and RMB 1.621 bn.

    * FX: most relevant due to the USD borrowings, but there are natural hedges (lower RMB is good for China textile industry exports). It also matters to investors in the sense you're de facto holding RMB denominated assets. So the fixed HKDUSD is a bit misleading. You can observe this in the book value, which went from RMB 3.7bn to RMB 3.9bn in H2, but book value per share was actually unchanged due to FX (from HK$ 5.23 to HK$ 5.26). I am Europe-based myself, but I don't give this too much thought. It's not that relevant and I have no special insights. Most relevant for now is that RMB tail risk on the USD borrowings is removed. I was actually holding back some investment to be able to buy more stock cheaper in case USDCNY would move above 7 and the share price would drop. No need anymore.

    * Valuation: with flat cotton prices in 2015, trailing numbers provide a good take on average profitability. At HK$ 6, Texhong trades at 6.1x EBIT, 4.4x EBITDA and 7.6x P/E. If you correct for one-offs (book gains, FX losses), it actually trades at 5.8x trailing P/E. This is obviously totally crazy cheap for a serial compounder with a top notch management that's fully aligned with shareholders. I mean, capacity will go up 28% just this year! We're talking a top quality growth stock here at cigar-butt prices. And with the TPP signed, one can just imagine what can happen in the next few years.

    My preferred valuation is actually P/B. It's a capital-intensive business. One can see Texhong historically trades between ~0.5x book up to ~3.5x book, for a large part based on cotton price fluctuations. Again, totally stupid. An oil metaphor would be that Texhong trades like an oil producer, but it's actually a refiner. It's cost plus. At HK$ 6, we're at 1.1x book. I would not think of selling below 2x book. Good thing is, you get the dividend and book is compounding at a high rate, so the price target moves up over time.

    Conclusion: huge margin of safety at this point, and who knows what upside we can expect the coming years. The company is highly leveraged, which I actually like in this case, because management has a multi-decade track record (profits are volatile, but never a loss year). This thing can move to HK$ 10 easily, that would still mean we're at a 9.7x 'clean' trailing P/E, 8.7x EBIT and 1.9x book. That's still cheap.

    Good luck folks. "

  28. Moodys has up graded Texhong's outlook to stable from negative.

  29. Saw your recent partial sale of Texhong. Any change of view, or just see better opportunities elsewhere?

    1. Just trying to reduce the total amount I have invested in the market in the most tax efficient and balanced way possible. (i.e. trying to get back to the scaled $100K that I started the year with). I'm trying to fit Texhong into a 10% slot. There will be a few transactions like that in Q2 also. A lot of mispriced stocks out there so I'm trying to be fair to each of the ones that I like best. I might grab some tax losses, also, depending on how things play out and what new opportunities arise.

      I like Texhong very much.

  30. You mentioned that Texhong usually trades at 9x-13x

    But looking at the past 10 years it seem to trade between 5x-8x almost 90% of the time. I think those are low valuations but it may take time for the market to change sentiment...

    Thank you, and great post¡¡¡

  31. Texhong positive profit alert out yesterday. As expected as cotton prices bounced back in the second quarter. CNY was down a bit versus the dollar but much less than in 2H in 2015.

  32. Great post¡¡¡

    You suggested in your first post about texhong that if the price fixing dissapears in China Gross margins should come down into 14%-15% range. Looking back at 2003 Texhong AR's seem to confirm this thesis. But when I look at Weiquiao their gross margins are 5%-8% ( Weiquiao is 100% China producer ), do you know the reason why they perform so badly? they seem to have the same scale that Texhong has. Maybe this business is more than just scale as some people suggest.

    Thank you

  33. Thx for the question. Weiqiao is not in the same business as Texhong:
    1) half of its gross profit is from the electricity business
    2) half of its textile sales are from grey fabrics
    3) Within yarns it sells only cotton yarns
    3) Within cotton yarns it sells low quality product that wholesales at half the ASP of Texhong's products

  34. More news about Texhong

    What is your opinion?

    It is only 3% new shares... it was 10 years when the issued shares. The are going to use the proceeds to expand in VN.

    1. It doesn't look like particularly significant news to me


    From the release:
    [T]he earnings of the Group for the ten months ended 31 October 2016 exceeded RMB1
    billion. The strong performance was mainly attributable to the strong sales volume and
    increase in gross margin. In particular, due to the recent increase in cotton price, our product
    selling prices have risen accordingly while the inventory utilized in production in prior
    months were procured at a lower cost, leading to a temporary increase in gross margin. It is
    expected that the Group’s gross margin may restore to a normal level in 2017 if cotton price
    is comparatively stable.

  36. Hi Red,

    Texhong presented fantastic results for annual 2016 but the market didn´t react the same way. I can´t understand why. The outlook for this company is fantastic and the price is cheap (growing 15%-20% y/y and P/E 10).

    Have you any explanation for this poor reaction of the market?


  37. Competitive advantage, long runway, probable 15% annualized growth in earnings power available at ~17% forward FCF yield. I don't think there's too much to worry about and there's a strong argument for just allowing your investment in Texhong compound until it exhausts its growth possibilities -- assuming that you don't need the liquity.

  38. Thanks Red,

    I know it´s a fantastic company at fantastic price, but what surprised to me was the poor market reaction on the 2016 annual results. I expect a big raise of the stock.

    1. I don't know what drives short-term stock prices in HK, but someone with a 3- or 6-month time horizon might see falling (really just normalizing) gross margins in the yarn business and increased investment into a more uncertain downstream business (jeans). If you plan to hold this for years, those aren't significant concerns in my view.

      Red: Over the short-term, Texhong's margins should be correlated with FTP's right? For example, strong cotton prices should drive strong yarn prices, with Texhong getting the benefit of the timing mismatch between cotton COGs and yarn selling prices. Likewise, strong cotton prices likely mean strong VSF prices which likely mean strong DP prices, which make Fortress Paper go. So, if you hold both companies, you have a correlated exposure to the reverse -- falling cotton and DP prices. Texhong, however, is a much higher quality business because its gross margins should largely normalize whenever the cotton price stabilizes regardless of what the stabilized cotton price is, but FTP's margins depend on the absolute level of DP prices, rather than just stabilization. Is that roughly right?

    2. KJP: I think that's right. You may have seen the charts in the link that I provided above -- VSF & cotton are substitutes and correlate positively, and DWP is a VSF input and also correlates positively (though more weakly).

      Texhong is a pass-through business so that its yarn normalized gross margin is going to approximate 15% to 19%. In the short term FIFO inventory costing will compress (expand) gross margins as cotton prices fall (rise).

      As you say, Fortress is different in that it does depend on an absolute level of DP pricing in ($USD). So one has to be reasonably comfortable with FTP's position on the global cost curve, replacement cost(and therefore incentive pricing) for new capacity, etc.

      Texhong is more or less USD-neutral now that it has redeemed a substantial portion of USD denominated debt. FTP benefits from a strong dollar.

    3. David: Texhong's results were essentially pre-announced via its 10-month update so it may be that funds bought on that pre-announcement and sold on the publication of the full year results. Maybe. It's hard to anticipate or interpret other people's buy/sell decisions without more information on them.

    4. Another issue I didn't mention in my prior comment that people seem to be worried about is the effect of a US border tax, and similar taxes spreading elsewhere, particularly if Le Pen, Wilders, et al., gain power in Europe. The fear, I take it, is that, depending on currency effects, retail prices for imports may increase, driving down overall retail sales, and U.S. domestic manufacturing might be more competitive and therefore grab a greater share of that decreased volume.

      It's beyond me to try to handicap the chances of border taxes being enacted and, if so, whether the resulting effects on currency would counter-balance the border tax. But I think textiles are very well insulated from at least U.S. domestic manufacturing. Bloomberg just had an article explaining that prices (nominal, not real) for garments in the U.S. are the same as they were 25 years ago, even though the overall price level is 80% higher. That's a remarkable demonstration of the cost efficiencies through scale and lower wages that textile manufacturers (primarily in Asia, but also in Mexico and Central America) have managed to produce. It is hard to see how border taxes would undo that, particularly when it would take years to build up the scale that already exists overseas. But if border taxes do end up increasing retail prices, that likely would drive down overall volume of garment sales, which would effect everyone in the chain of production.

      So, at the end of the day, I think border tax/tariff uncertainty is another issue to think about with Texhong, but it seems to me like a risk worth bearing at current prices. Similarly, Texhong's Vietnam operations likely would have benefited from TPP, but the company would also benefit if China, rather than the US, is at the center of a future Asian-Pacific trade deal.

  39. Ok,you say with the positive profit alert three months ago.
    Congrats for Luis Enrique's quit. I think in 2 weeks barça comes to La Coruña,we are ready for the fight, jajaja

  40. "But if border taxes do end up increasing retail prices, that likely would drive down overall volume of garment sales, which would effect everyone in the chain of production."

    This is, imo, the best case scenario for a LT investor in Texhong.

    1. Do you mean that it would be the best case scenario because lower overall garment volumes will drive out weaker upstream players, leading to larger market share and scale advantages for Texhong?

    2. Right - Domestic shake out means domestic growth potential for Texhong via acquisition of distressed capacity. That's how it got its start. Plus, BAT/DBCFT ==> strong dollar ==> strong cotton price ==> windfall profit that would allow Texhong to buy more capacity than otherwise.

  41. Texhong investing more heavily in jeans manufacturing with this $53 million purchase together with further investments capex coming.
    Interestingly the companies were losing money 4 million and 3 million for 2016 and 2015.

    1. Thanks for the link. A confluence of his favorite themes -- distressed sector/assets, cost arbitrage, & search for new markets.

      When I first looked at Texhong, back in 2013 or so, PRC sector gross profit was 1 RMB per pair of jeans, not enough for small scale manufacturers to thrive. International standard is, I think, $US 0.25/pair = ~70% higher. Cambodian & Vietnamese labor is lower than intl standard so maybe 2x PRC domestic gross margin.

      It also seems to revive his plans to enter the Americas although this seems directed to the US mkt via the bilateral free trade agreement rather than his prior attempt which had been directed to the Brazil mkt.

      Anyway, always interesting to watch this fellow do his work.

  42. Where did you find the stats on jean profitability?

  43. Added more shares of Texhong at 9.50. Fantastic company at fantastic price with fantastic management, what else?