Description

Michang makes lubricants for transport and industrial uses. The business’ economics are decent and it generates reliable (albeit lumpy) cash flows. I think shares sell for something like ~30% of its private market value.

Michang buys commodity raw materials and processes them into products ranging from slightly-less-commoditized “by-the-barrel” stuff to branded consumer “by-the-quart” packaged goods. Profits jump around and have ranged from ~₩10-40b (pretax) over the past ~5 years (₩40b-ish trailing). Ballpark best guess, average normalized operating profit is around ~₩25b (or ~₩17k/share). The business grows a bit (using gross profit – otherwise you’re tracking oil…) and I’d guess it’ll have a stable future. Maybe that’s “worth” ~7x operating profit, or roundabouts ~₩115k/share.

Michang also has value on its balance sheet – approximating perhaps ~₩90k/share in (theoretically) separable assets (cash, fin assets, etc.). Then they’ve got ~30% of a car-dealership group that’s maybe “worth” another ~₩20k/share (pretax).

So perhaps a private buyer could get comfortable buying this whole enchilada at ~₩90/share (B/S) + ~₩20/share (Dealer) + ~₩17/share pretax*7x (Biz) = ₩225k/share? As a sanity check, that’s close to tangible book value. Shares “trade” around ₩71k/share so there is some margin of safety and potential upside (225/73 = ~3.1).

Now you and I can’t buy the whole thing at the existing market price, so what’s a share worth to a passive minority shareholder? Hard to say - but recent capital allocation isn’t that dreadful. You’ve got a ~3.5% yield (seemingly paid dividends since listing in ‘89), and they’ve repurchased stock (shares out down ~12% in the past ~10 years, with the float down more). Buybacks would be mind-blowingly accretive – but, like this idea, are severely limited by liquidity. I haven’t heard anything bad about the people from local market participants.  

OK – so Korean small cap at a small fraction of an approx. private market value – is that interesting? Maybe… It could easily be a dead money for a while, but I don’t reckon there’s huge downside (famous last words…) and there could be a few ways for things to turn out well, including:

• Could trade at a less ludicrous discount to a higher fair value
  • Best guess, this is like bottom ~2 percentile obvious cheap for a non-distressed decent businesses in stable countries. I think there’s good upside to being “only” bottom decile cheap! I would not hold this all the way to 100c on the dollar…
  • For example, the ROE isn’t too bad and the P/B is ~35%. If they do an 8% ROE and trade at ~50% of book in ~3 years – that’s about a double (with dividends)
• Could become thematically popular for some arbitrary reason for some short period. This seems to happen sometimes. You might logically argue this is just double counting the first bullet…
• Could appreciate in line with increased value. In the next ~10 years this thing maybe generates ~₩150-250b+ of FCF from the core business, plus the car dealership earnings, plus some interest on their other assets. That seems like a lot relative to a market cap of ~₩110b.

Obviously if you’re “turning over rocks” you’d really like to find the Hope Diamond, and this ain’t that… but what should you do when you stumble upon the proverbial ~30c dollar with nothing particularly wrong with it? Is that a consolation prize and is there something to that old-school, keep-it-simple-stupid, Moody’s manual approach after all? Anyhow, I think this thing has a decent risk-reward for a small position.

Risks: The wild-west components of investing in old-economy, small-cap Korea

Disclosure

Have ownership interest in Michang Oil at the time of this write-up that can change at any time without notice. There are no plans to provide future updates on the authors buying or selling activities for this or other stocks. The author may buy or sell shares of Michang Oil without notice for any reason at any time.

Catalyst

TBD