CHINA CERAMICS CO LTD 3CCLTF
May 27, 2010 - 9:17am EST by
Coyote05
2010 2011
Price: 6.00 EPS $3.60 $3.00
Shares Out. (in M): 10 P/E 1.7x 2.0x
Market Cap (in $M): 61 P/FCF nm nm
Net Debt (in $M): -4 EBIT 35 44
TEV ($): 57 TEV/EBIT 1.6x 1.3x

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Description

I believe it is time to revisit China Ceramics ("the Company").  An extremely attractive valuation seems to compensate investors very well for the risk taken.

 

Summary description

The Company is the leading ceramic tile manufacturer in China.

+ very strong ROIC (~80%)

+ robust balance sheet (net cash after adjusting for recently concluded acquisition)

+ five largest customers (distributors) account for ~25% of revenue

- offers 90-day trade credit to its customers (all current as of 12/31/09 per SEC filings)

- thinly traded (on BB)

+ unlike many Chinese companies traded in the US, Op co is 100% owned by publicly traded Hold co

+ original owner who sold stake to SPAC was paid solely in stock

+ modest management compensation (extremely modest by western standards)

+ large insider ownership (both original owner and SPAC sponsors)

+ potential Yuan appreciation provides additional upside (or downside protection) not reflected on valuation numbers presented

 

Financials (Rmb million, IFRS)

 

2007

2008

2009

2010(p)

Note

Sales

618

737

836

1100

 

Gross profit

176

204

253

 

 

Ebit

166

190

240

 

x m&a exp

Ebitda

181

206

256

330

x m&a exp

Net income

146

165

153

 

 

Capex

4

7

8

140

 

 

 

 

 

 

 

Net debt, adj

 

 

24

 

Adj fror acq of Gaoan facility

 

2010(p) = financial projections from the Company's prospectus

 

Key risks

The biggest risk in my opinion is potential overcapacity.  The acquisition of the Gaoan facility increased the Company's installed capacity from 28 to 38 million m2/yr.  Further, it plans to invest an additional US$40 million to bring capacity to 70 million m2 by the end of 2011.  It is certainly possible that demand could suffer a contraction just as the company has committed significant resources to its expansion.

 

For those who are convinced that there is a real estate bubble in China that is about to burst, risk could be mitigated by hedging.  To this end, there does not seem to be a shortage of richly valued companies in the Chinese real estate sector.  In my opinion, a hedged position has a very attractive risk profile.

 

The company has a cost structure that would seem to allow it to withstand severe demand contraction without losing money.  First, SG&A accounts for about 2% of sales (currently Rmb 17 million/yr).  Second, variable costs in the form of raw materials account for ~60% of COGS (with clay 22%).  Lastly, D&A adds to about 2% or sales (currently Rmb 16 million/yr).

 

To illustrate, assume a draconian sales contraction of 50%, and to make it more severe, also assume that the non-variable cost base can not be rationalized (a very unrealistic assumption):

Sales                 450

Fixed cogs        200

Variable cogs   175

Gross profit        75

SG&A                20

Ebit                    55

Ebitda               75

Maint capex         8

Ebitda-m capex  67

 

One should also consider that the Company's capacity (28 million m2) was not enough to meet demand in 2009.  It had to outsource 4.5 million m2.  It is logical to assume that its true fixed cost base is lower than that implied by the 2009 numbers, which serve as the basis for the analysis above.

 

To conclude on the sensitivity analysis, even under quite pessimistic assumptions, the valuation is very undemanding.

 

Share count and valuation

The share count deserves some attention.  As of 12/31/09 there are 8.95m shares outstanding.  There are 15.55m warrants (CCLWF) expiring on 11/16/12 with a $7.50 strike price.  The Company can redeem these warrants at $0.01 each once the stock reaches $14.25.  In addition, there is an earn-out escrow that would increase the share count as follows:

A) Provided certain earnings targets are met the following number of shares will be released once audited financials are issued:

FY09   1.2 million

FY10   1.8 million

FY11   2.2 million

 

B) Once the stock trades for twenty days (within a thirty-day period prior to 4/30/12) at or above the following levels:

$20/share then 2 million shares will be released, and

$25/share then 1 million shares will be released

 

Thus, as of today the share count is approximately 10.2m (12/31/09 o/s + FY09 earn-out).  Adjusting for the acquisition of the Gaoan facility, China Ceramics is trading at less than 1x (tangible) book, 1.2x fy10 ebitda, and 2.0x fy10 ebitda-total capex (which are far in excess of maintenance).

 

Given the various moving parts, I find it helpful to look at the share count (and valuation) under different scenarios (with P being the stock price at the completion of the FY10 audit):

 

Scenario

Share count

FY10 Ebitda

EV/Ebitda

FY10 target met, P≤$7.5

12

48

2x (P=$7.5)

FY10 target met, P>$7.5

27.5

48

3x (P=$10)

FY10 target not met, P≤$7.5

10.2

16

5x (P=$7.5)

FY10 target not met, P>$7.5

25.7

16

8x (P=$10)

Catalyst

Earnings release on June 1st.  While I do not necessarily think the release will propel the stock price upward to a large extent, I see it more as a soft catalyst.
    sort by    

    Description

    I believe it is time to revisit China Ceramics ("the Company").  An extremely attractive valuation seems to compensate investors very well for the risk taken.

     

    Summary description

    The Company is the leading ceramic tile manufacturer in China.

    + very strong ROIC (~80%)

    + robust balance sheet (net cash after adjusting for recently concluded acquisition)

    + five largest customers (distributors) account for ~25% of revenue

    - offers 90-day trade credit to its customers (all current as of 12/31/09 per SEC filings)

    - thinly traded (on BB)

    + unlike many Chinese companies traded in the US, Op co is 100% owned by publicly traded Hold co

    + original owner who sold stake to SPAC was paid solely in stock

    + modest management compensation (extremely modest by western standards)

    + large insider ownership (both original owner and SPAC sponsors)

    + potential Yuan appreciation provides additional upside (or downside protection) not reflected on valuation numbers presented

     

    Financials (Rmb million, IFRS)

     

    2007

    2008

    2009

    2010(p)

    Note

    Sales

    618

    737

    836

    1100

     

    Gross profit

    176

    204

    253

     

     

    Ebit

    166

    190

    240

     

    x m&a exp

    Ebitda

    181

    206

    256

    330

    x m&a exp

    Net income

    146

    165

    153

     

     

    Capex

    4

    7

    8

    140

     

     

     

     

     

     

     

    Net debt, adj

     

     

    24

     

    Adj fror acq of Gaoan facility

     

    2010(p) = financial projections from the Company's prospectus

     

    Key risks

    The biggest risk in my opinion is potential overcapacity.  The acquisition of the Gaoan facility increased the Company's installed capacity from 28 to 38 million m2/yr.  Further, it plans to invest an additional US$40 million to bring capacity to 70 million m2 by the end of 2011.  It is certainly possible that demand could suffer a contraction just as the company has committed significant resources to its expansion.

     

    For those who are convinced that there is a real estate bubble in China that is about to burst, risk could be mitigated by hedging.  To this end, there does not seem to be a shortage of richly valued companies in the Chinese real estate sector.  In my opinion, a hedged position has a very attractive risk profile.

     

    The company has a cost structure that would seem to allow it to withstand severe demand contraction without losing money.  First, SG&A accounts for about 2% of sales (currently Rmb 17 million/yr).  Second, variable costs in the form of raw materials account for ~60% of COGS (with clay 22%).  Lastly, D&A adds to about 2% or sales (currently Rmb 16 million/yr).

     

    To illustrate, assume a draconian sales contraction of 50%, and to make it more severe, also assume that the non-variable cost base can not be rationalized (a very unrealistic assumption):

    Sales                 450

    Fixed cogs        200

    Variable cogs   175

    Gross profit        75

    SG&A                20

    Ebit                    55

    Ebitda               75

    Maint capex         8

    Ebitda-m capex  67

     

    One should also consider that the Company's capacity (28 million m2) was not enough to meet demand in 2009.  It had to outsource 4.5 million m2.  It is logical to assume that its true fixed cost base is lower than that implied by the 2009 numbers, which serve as the basis for the analysis above.

     

    To conclude on the sensitivity analysis, even under quite pessimistic assumptions, the valuation is very undemanding.

     

    Share count and valuation

    The share count deserves some attention.  As of 12/31/09 there are 8.95m shares outstanding.  There are 15.55m warrants (CCLWF) expiring on 11/16/12 with a $7.50 strike price.  The Company can redeem these warrants at $0.01 each once the stock reaches $14.25.  In addition, there is an earn-out escrow that would increase the share count as follows:

    A) Provided certain earnings targets are met the following number of shares will be released once audited financials are issued:

    FY09   1.2 million

    FY10   1.8 million

    FY11   2.2 million

     

    B) Once the stock trades for twenty days (within a thirty-day period prior to 4/30/12) at or above the following levels:

    $20/share then 2 million shares will be released, and

    $25/share then 1 million shares will be released

     

    Thus, as of today the share count is approximately 10.2m (12/31/09 o/s + FY09 earn-out).  Adjusting for the acquisition of the Gaoan facility, China Ceramics is trading at less than 1x (tangible) book, 1.2x fy10 ebitda, and 2.0x fy10 ebitda-total capex (which are far in excess of maintenance).

     

    Given the various moving parts, I find it helpful to look at the share count (and valuation) under different scenarios (with P being the stock price at the completion of the FY10 audit):

     

    Scenario

    Share count

    FY10 Ebitda

    EV/Ebitda

    FY10 target met, P≤$7.5

    12

    48

    2x (P=$7.5)

    FY10 target met, P>$7.5

    27.5

    48

    3x (P=$10)

    FY10 target not met, P≤$7.5

    10.2

    16

    5x (P=$7.5)

    FY10 target not met, P>$7.5

    25.7

    16

    8x (P=$10)

    Catalyst

    Earnings release on June 1st.  While I do not necessarily think the release will propel the stock price upward to a large extent, I see it more as a soft catalyst.

    Messages


    Subjectwarrants
    Entry09/10/2010 12:29 AM
    Memberrasputin998
    Any new thoughts here?  What is your view on the recent warrant exchange?  Valuation seems interesting yet illiquidity makes the investment leap difficult...

    SubjectAny new insights?
    Entry09/28/2010 03:10 PM
    Memberrasputin998
    Warrant overhang seems to have been mostly mitigated.  Any new thoughts at current price?
    No response to my prior message...perhaps anyone else involved could weigh in?

    SubjectRE: RE: Any new insights?
    Entry09/28/2010 05:03 PM
    Memberrasputin998
    Thanks.
    Curious what your takeaways were on the companies you visited if you don't mind sharing?  We are considering allocating a portion of our fund to a basket of these Chinese names that may have been indiscriminately tarred with the "Fraud Brush" if we can confirm their legitimacy.

    SubjectRE: RE: RE: Any new insights?
    Entry09/28/2010 06:51 PM
    Memberrjm59
    I added updates to my CCME and TXIC posts and just wrote up EDS here...
    TXIC is my favorite based on valuation, though CCME (if real) is the best business by far and has the strongest competitive position of all 4 by a long way.  I still don't think CCME is a fraud and if it is it's still the most sophisticated fraud I've ever seen - fooling Deloitte on cash balance, etc.  The story is just so self consistent to me but it's also difficult to verify since they are spread all over the country vs TXIC where the factory is on a big campus you can walk around and approximately verify the production.

    I am still positive on all 4.  They all went public via SPACs as opposed to company initiated reverse mergers where I've seen a lot more fraud.  The only SPAC confirmed fraud I've seen lately was IDI though they may still pull through, the fraud was in some of their subs not at the top.  In the more distant past Heckmann/China Water had issues of a similar nature to IDI...

    SubjectRE: RE: RE: RE: Any new insights?
    Entry09/29/2010 05:13 PM
    Memberrasputin998
    RJM -
    Thanks very much for your response.  Looks like you're getting some company on CCME...
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