Monday, January 08, 2007
Every Dog has its Day? My Industrial Picks for 2007
Industrials have taken up so much beating over the past two/three years. Some say rightfully so but I say 2007 may be a year of turnaround for the underdog, mainly because of the huge liquidity in the market. When most have their hands full of Chinese financials and H-shares, sooner or later people will move on to something else. Just a tiny drop of this liquidity will give a huge boast to the industrials as they have been ignored for so long which pretty much exhausted all selling. Also I'm seeing some positive trends developing.
(1) Prices of oil and other resources have come down and seem stabilised.
(2) Industrials have adapted to become more efficient.
(3) RMB has depreciated against most currencies in 2006 thanks to weakening USD, so export has become more competitive especially for those serving non-US markets.
(4) Valuation has come down to a level unseen since 2001 with most now trading at low single digit p/e.
Some negative factors remain though.
(1) Government's stance to fade out most small-size, low tech, labor intensive type manufacturing.
(2) Coming profit tax reform which will hurt most industrials which are foreign enterprises.
(3) Rising labor cost, environmental standard, and competition from uprising local factories.
One needs to be selective as not all will rise like in the last small cap boom. Following Peter Lynch's rule of 5, that out of 5 small caps one will become a star, one will become a dog, and 3 will be average, I'm listing out 5 of my choices for 2007. All five have a prospective p/e of 4-8x, are financially strong, pay dividends, and won't give you many sleepless nights.
Man Yue (894)
It produces capacitors of all kinds and sizes used inside every electronics. A capacitor works like an internal battery storing and supplying power, save that it discharges itself completely when powered off. Man Yue is ranked 7th in the world in sales and its products are found in all major brands of electronics. As a capacity is used in the power supply section where safety (as opposed to cost) is most important, customers are less likely to switch suppliers often. Product liability lawsuit is the last thing they want. Just imagine those China made applicances in the past which tend to lit up themselves after a while and you'll get the picture. So entry barrier is high for new comers and MY enjoys lesser competition. Profit has been up for 5 straight years and I expect 2006 results will continue the trend.
Arts Optical (1120)
It's a ODM of eyeglasses frames and has been a steady performer earning more or less HK$100m for the past 5 years, quite remarkable already considering the worsening operating environment. Latest interim result showed a 30% increase in profit as a result of capacity expansion. Management was cautious in their tone in the interim report but I expect it will do well in the second half, since most of its customers are in Europe and its competitors Sun Hing and Elegance also reported excellent result last month. Fashion never dies and the strong Euro should bring in more business.
Fujikon (927)
It is a ODM for headphones used for mobile phones (Nokia and the like), game consoles (X-box), and mp3 players (ipod and the like). It's a direct beneficary of the mobile phone and digital gadget boom which is still going strong. As more and more mobile phones are turned into personal entertainment center, demand for higher audio grade and wireless headphones will grow stronger. It recently completed its expansion programme and the latest interim result already showed 50% increase in profit. I expect the momentum to remain strong in the second half.
Yip's (408)
It's a downstream petrochemicals player which produces solvents, coatings, and lubricants, serving the PRC market under multiple brands. Solvents and coatings have all kinds of applications, e.g. in tannery, medicine, adhesives, toy, electronics, printing, furniture, paint, ink, varnishes, and you name it. I figure it's a supporting player for the construction and manufacturing industry, which both will grow over time. Despite of the rise in oil price, its profit has been up for 3 straight years and the latest interim showed another 36% increase in profit. Petrochemicals are more complex than other businesses but I'm buying Yip's management. It's also comforting that Forbes Magazine voted Yip's as one of the 200 best small enterprises in Asia.
VSC (1001)
It's a long time construction steel supplier in HK and the PRC. Under the 2nd generation leadership of Andrew Yao, VSC expanded into steel coil processing in the PRC supporting the industrial sector. VSC suffered last two years as its contruction supply contracts were for muti-year but at fixed price, a deadly combination in a boom market. Now variable costing is built into new contracts and we saw much improved figures in the latest interim report with doubling of profit and resumption of dividend payment. Recent joint venture in steel coil processing with Ryerson, a large Amercian steel player, should help VSC move up the value chain and access to bigger customers over time. It's also a vote of confidence on VSC and its management. 2006 should be a turnaround year for VSC.
p.s. financial performance of a small cap is by definition less predictable and reliable, so one should always diversify and vary his bet accordingly.
DISCLOSURE: I hold all 5 stocks at time of writing.
(1) Prices of oil and other resources have come down and seem stabilised.
(2) Industrials have adapted to become more efficient.
(3) RMB has depreciated against most currencies in 2006 thanks to weakening USD, so export has become more competitive especially for those serving non-US markets.
(4) Valuation has come down to a level unseen since 2001 with most now trading at low single digit p/e.
Some negative factors remain though.
(1) Government's stance to fade out most small-size, low tech, labor intensive type manufacturing.
(2) Coming profit tax reform which will hurt most industrials which are foreign enterprises.
(3) Rising labor cost, environmental standard, and competition from uprising local factories.
One needs to be selective as not all will rise like in the last small cap boom. Following Peter Lynch's rule of 5, that out of 5 small caps one will become a star, one will become a dog, and 3 will be average, I'm listing out 5 of my choices for 2007. All five have a prospective p/e of 4-8x, are financially strong, pay dividends, and won't give you many sleepless nights.
Man Yue (894)
It produces capacitors of all kinds and sizes used inside every electronics. A capacitor works like an internal battery storing and supplying power, save that it discharges itself completely when powered off. Man Yue is ranked 7th in the world in sales and its products are found in all major brands of electronics. As a capacity is used in the power supply section where safety (as opposed to cost) is most important, customers are less likely to switch suppliers often. Product liability lawsuit is the last thing they want. Just imagine those China made applicances in the past which tend to lit up themselves after a while and you'll get the picture. So entry barrier is high for new comers and MY enjoys lesser competition. Profit has been up for 5 straight years and I expect 2006 results will continue the trend.
Arts Optical (1120)
It's a ODM of eyeglasses frames and has been a steady performer earning more or less HK$100m for the past 5 years, quite remarkable already considering the worsening operating environment. Latest interim result showed a 30% increase in profit as a result of capacity expansion. Management was cautious in their tone in the interim report but I expect it will do well in the second half, since most of its customers are in Europe and its competitors Sun Hing and Elegance also reported excellent result last month. Fashion never dies and the strong Euro should bring in more business.
Fujikon (927)
It is a ODM for headphones used for mobile phones (Nokia and the like), game consoles (X-box), and mp3 players (ipod and the like). It's a direct beneficary of the mobile phone and digital gadget boom which is still going strong. As more and more mobile phones are turned into personal entertainment center, demand for higher audio grade and wireless headphones will grow stronger. It recently completed its expansion programme and the latest interim result already showed 50% increase in profit. I expect the momentum to remain strong in the second half.
Yip's (408)
It's a downstream petrochemicals player which produces solvents, coatings, and lubricants, serving the PRC market under multiple brands. Solvents and coatings have all kinds of applications, e.g. in tannery, medicine, adhesives, toy, electronics, printing, furniture, paint, ink, varnishes, and you name it. I figure it's a supporting player for the construction and manufacturing industry, which both will grow over time. Despite of the rise in oil price, its profit has been up for 3 straight years and the latest interim showed another 36% increase in profit. Petrochemicals are more complex than other businesses but I'm buying Yip's management. It's also comforting that Forbes Magazine voted Yip's as one of the 200 best small enterprises in Asia.
VSC (1001)
It's a long time construction steel supplier in HK and the PRC. Under the 2nd generation leadership of Andrew Yao, VSC expanded into steel coil processing in the PRC supporting the industrial sector. VSC suffered last two years as its contruction supply contracts were for muti-year but at fixed price, a deadly combination in a boom market. Now variable costing is built into new contracts and we saw much improved figures in the latest interim report with doubling of profit and resumption of dividend payment. Recent joint venture in steel coil processing with Ryerson, a large Amercian steel player, should help VSC move up the value chain and access to bigger customers over time. It's also a vote of confidence on VSC and its management. 2006 should be a turnaround year for VSC.
p.s. financial performance of a small cap is by definition less predictable and reliable, so one should always diversify and vary his bet accordingly.
DISCLOSURE: I hold all 5 stocks at time of writing.
Comments:
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other than the 5 picks highlighted by you, i recommend Weiqiao (2698). here is a short list of pros and cons of investing in Weiqiao:
Pros:
- a leader in the China cotton textile industry
- i like the management though on average they are relatively young
- strong track record in the past; turnover keeps increasing from rmb2.4b in 2001 to rmb13.6b in 2005, net profit from rmb0.15b to 1.24b over the same period (note there was no drop in all the past few years). 2006 1H posted a 34% top line increase and 27% bottom line increase
- 2006 1H profit is rmb0.6b. due to seasonality, 1H profit is around 40% of the annual figure, a very rough estimate of the annual profit would be rmb1.5b which equates to a 8.3x p/e. buying an industry leader at single digit p/e!
- not many institutions following this company now though it was a usual pick of fund managers in the past. I guess it is mainly because of the sector and many investors prefer to invest in other sectors that allow more room to have an upside dream. What the company needs is a revaluation by investors which may naturally occur after other sectors have gone up too much (now or near future?)
- if you look at my primitive technical analysis, Weiqiao is now trading below the mid-price of the 52-week high-low. I think it is kind of difficult to find a solid company that is under-performed in the stock market given the general rise we experienced last year.
- NAV per share is about rmb9.16 while it is now trading at around hk$10.3. you are just paying a 12% premium over its assets for its industry leader position, brand, management, track record etc.
- dividend yield of 2-3% expected which is quite protective
Cons:
- highly competitive china cotton textile market. But the company demonstrated its ability to re-balancing its product mix (cotton yarn, grey fabrics and denim) to stabilize its GP
- low GP which is about 15%, low NP which is just high single digit
- high D/E of about 0.84. I am not quite concern about its liquidity but it may lead to share placement and earnings dilution. From another angle, if you are anticipating an interest drop in 2007 (to be triggered by the USA), the company can save interest cost
- the company is not quite clear about its local sales vs export strategy but tends to place more emphasis on local sales in the recent past. In the light of increasing china demand, it may not be a real bad thing.
Disclosure: I hold 2698 at the time of writing
Pros:
- a leader in the China cotton textile industry
- i like the management though on average they are relatively young
- strong track record in the past; turnover keeps increasing from rmb2.4b in 2001 to rmb13.6b in 2005, net profit from rmb0.15b to 1.24b over the same period (note there was no drop in all the past few years). 2006 1H posted a 34% top line increase and 27% bottom line increase
- 2006 1H profit is rmb0.6b. due to seasonality, 1H profit is around 40% of the annual figure, a very rough estimate of the annual profit would be rmb1.5b which equates to a 8.3x p/e. buying an industry leader at single digit p/e!
- not many institutions following this company now though it was a usual pick of fund managers in the past. I guess it is mainly because of the sector and many investors prefer to invest in other sectors that allow more room to have an upside dream. What the company needs is a revaluation by investors which may naturally occur after other sectors have gone up too much (now or near future?)
- if you look at my primitive technical analysis, Weiqiao is now trading below the mid-price of the 52-week high-low. I think it is kind of difficult to find a solid company that is under-performed in the stock market given the general rise we experienced last year.
- NAV per share is about rmb9.16 while it is now trading at around hk$10.3. you are just paying a 12% premium over its assets for its industry leader position, brand, management, track record etc.
- dividend yield of 2-3% expected which is quite protective
Cons:
- highly competitive china cotton textile market. But the company demonstrated its ability to re-balancing its product mix (cotton yarn, grey fabrics and denim) to stabilize its GP
- low GP which is about 15%, low NP which is just high single digit
- high D/E of about 0.84. I am not quite concern about its liquidity but it may lead to share placement and earnings dilution. From another angle, if you are anticipating an interest drop in 2007 (to be triggered by the USA), the company can save interest cost
- the company is not quite clear about its local sales vs export strategy but tends to place more emphasis on local sales in the recent past. In the light of increasing china demand, it may not be a real bad thing.
Disclosure: I hold 2698 at the time of writing
# posted by 
: 5:06 PM, January 10, 2007
: 5:06 PM, January 10, 2007
dearfatb hing,
i have no problem with your reasoning, except perhaps i'm not so sure if some of the rapid expansions we saw was a result of M&A as opposed to organic growth, which will not be recurring. i definitely like the idea of buying an industry leader at 8x p/e only.
on the other hand, i have reservations about recommending it over and above the 'small cap' category because in addition to being in the neglected industrial sector, weiquao is also in the middle of textile trade dispute between China and the US/EU (which will affect its customers and limit industry growth) and at odds with the government's goal for a greener economy (expect more regulations to come).
i think it'll take the management an ironman will and effort to win this 'trilathon' race.
on the bright side, yuen yuen, a global leader in manufacturing sport shoes also in china, consistently demands a much higher p/e of 15+, which suggests potential for weiqiao, but yuen yuen doesn't face as much headwind.
i have no problem with your reasoning, except perhaps i'm not so sure if some of the rapid expansions we saw was a result of M&A as opposed to organic growth, which will not be recurring. i definitely like the idea of buying an industry leader at 8x p/e only.
on the other hand, i have reservations about recommending it over and above the 'small cap' category because in addition to being in the neglected industrial sector, weiquao is also in the middle of textile trade dispute between China and the US/EU (which will affect its customers and limit industry growth) and at odds with the government's goal for a greener economy (expect more regulations to come).
i think it'll take the management an ironman will and effort to win this 'trilathon' race.
on the bright side, yuen yuen, a global leader in manufacturing sport shoes also in china, consistently demands a much higher p/e of 15+, which suggests potential for weiqiao, but yuen yuen doesn't face as much headwind.
I just have no idea about 1120 because I did not analyze it before. Except it, I am sure that they are very good industrial companies.
VSC (1001)
==> in fact, start collecting it 1 yr ago due to the reasons as stated + good management + HKMA award for the annual report + ....
==> in fact, start collecting it 1 yr ago due to the reasons as stated + good management + HKMA award for the annual report + ....
share monster hing,
i started buying around the same time too as i thought it's rare that a stocker with a commodity as inventory could be traded at such a large discount to NAV (i think it was like 70% discount at the time).
i started buying around the same time too as i thought it's rare that a stocker with a commodity as inventory could be traded at such a large discount to NAV (i think it was like 70% discount at the time).
yes, u are right !
around 60% discount to book value last yr !
also, > 90% of book value is current asset (seldom happen in an industry stock )
more information upon # 1001 is kept under my blog ==> p/s share !
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around 60% discount to book value last yr !
also, > 90% of book value is current asset (seldom happen in an industry stock )
more information upon # 1001 is kept under my blog ==> p/s share !
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