|Shares Out. (in M):||631||P/E||0||0|
|Market Cap (in $M):||1,122||P/FCF||0||0|
|Net Debt (in $M):||-714||EBIT||0||0|
Chen Hsong Holdings Ltd. ("Chen Hsong") manufactures large-scale plastic injection moulding machines. It is the second-largest manufacturer in the world, although it trails the industry leader (Haitian International, SEHK:1882) by a wide margin. The company was started in the late 1950s by Dr. Chen Chiang who remains the non-executive chairman and through his family trust remains the largest shareholder to this day with a 63% stake. A typical Hong Kong success story, the company tracked the rise of Hong Kong (and later mainland China) as a leading exporter, supplying machines that mass-produce the plastic components that go into a lot of products. The company was listed in 1991 and trades on the Hong Kong Stock Exchange.
In the factory environment, plastic injection moulding machines are large-sized pieces of equipment that inject melted plastic into custom molds to form plastic products or components. These machines are critical in the manufacture of almost any type of plastic product imaginable. Key end markets include packaging (bottles, films), consumer products (household appliances, toys, medical products, crates) as well as the construction and automotive industries. At a high level, these machines do not look that different from two or three decades ago.
This is a classic "net-net" opportunity to buy into a decent business at a fairly large discount to net current asset value. With approximately 630 million shares outstanding, at the current share price of HK$1.78, the company has a market capitalization of HK$1,122 million. This compares with net current assets of HK$1,696 million (HK$2.60/share), or a 34% discount. On top of this, the company has HK$948 million (HK1.50/share) in PP&E, HK$50 million (HK0.08/share) in investment properties (industrial properties in mainland China). Besides the current interest-bearing debt accounted for in the net current assets calculation, the company does not hold any long-term debt.
Chen Hsong's current assets are less liquid than one would prefer for a "net-net" but can still be converted into cash over time. The machines that they build are large and take a long time to build. On top of this, customers normally take a long time to pay their bills, resulting in approximately 8 months of inventory (roughly evenly split between components, work-in-progress and finished goods) and another 6 months of trade receivables. Cash conversion takes over a year and the business needs to be a going-concern to make this happen.
Chen Hsong is in a transition/turnaround period. While not quite a "cigar puff", nobody would mistake Chen Hsong as being a high-quality business. This is no doubt part of the reason why the net-net opportunity exists.
Historically, Chen Hsong's customer base has been weighted towards export-oriented manufacturers, particularly the Hong Kong and Taiwan-headquartered manufacturers that moved their factories to mainland China in the 1990s and 2000s. Chen Hsong grew along with its customers as the export industry boomed, experiencing more or less consistent rapid growth until FY2008 (YE March 31) when it hit HK$2.3 billion or revenue and 15% operating margins.
Then along came the Global Financial Crisis, where demand from the developed world collapsed while at the same time costs and an appreciating RMB put further pressure on exporters, which still have not fully recovered. Driven by these dynamics, Chen Hsong's business has been deteriorating for several years now and is currently struggling to stay at breakeven. It has been forced to start adapting its business model and product design to cater to the needs of mainland Chinese manufacturers which have different needs and requirements. Chen Hsong's Chief Strategy Officer described this dynamic in an interview earlier this year:
“Customers now have different usage habits and different requirements for product features. In the past, customers had experienced factory workers and technicians with decades of experience and could make the finest adjustments to tap the machines’ fullest potential for the specific products. Today, with labor shortage, hiring and training challenges in China, factories need 'fool-proof machines', not complexity ... Customers expect machines that need zero adjustment and zero service. In the past, some customers used 100-ton machines to make products that were supposed to be made on 150-ton machines. They didn’t mind the need for service and maintenance under heavy [and perhaps improper] usage, but things are different now ... They also prefer standard machines, fewer models.” (Plastics News, June 25, 2015)
In other words, Chen Hsong's traditional export-oriented customer base is low-growth so to participate in the faster-growing part of the market, they need to make some adjustments to their products and sales strategy. Mr. Chung thinks that this can be done, remarking in the same interview that "[while] it's been painful ... we have to transform based on market changes ... We need to change our business style, the way we do things, change our product offerings, et cetera".
Downside is limited but so is the upside. The downside is fairly limited because the company has a strong balance sheet, is still generating some cashflow and the industry is not going to go away anytime soon. While it is much smaller than Haitian, Chen Hsong is still considered a large player in the industry and has a good relationship with its core HK/Taiwan export base. Moreover, the company appears to be run by a decent and trustworthy family (the founder and principal owner donated his entire share in the company to charity, his children run the day-to-day business today) that has maintained its majority ownership position through the years and paid themselves through dividends.
That said, the upside is equally boring. There do not appear to be any near-term catalysts to effect a mass liquidation event as Dr. Chen seems content to preside over a relatively sleepy business. I do not expect the business to be bought or sold anytime soon, nor do I expect earnings to bounce back quickly in a successful turnaround situation (more of a long-term play). Even at its peak Chen Hsong's stock only hit HK$6/share -- it is very unlikely this type of business is ever valued by Mr. Market at a premium multiple.
One last interesting factoid is that noted Hong Kong value investor David Webb acquired a 5% share in the company in 2013 (at the time of disclosure, stock price was in the the HK$2.50 range). Because of its concentrated ownership, the stock does not trade much and has zero institutional coverage. As such this investment is really only appropriate for personal accounts and/or very small funds.
On October 20, the company announced a profit warning, reporting that the company would report a loss for the last six month period (partially FX-driven). The company will report its interim 6-month results around the third week of November.
|Subject||Chen Hsong potentially further monetizing its Shenzhen real estate holdings w/GAW Capital|
|Entry||11/29/2018 12:59 AM|
Chen Hsong's operating business has bounced back, although there is potential negative economic impact from the gradually escalating trade war.
However, the more interesting part of the investment thesis here (remember this was a net-net) is the unlocking of value on the balance sheet. This morning, Chen Hsong announced that it had entered into a non-binding agreement with GAW Capital, a HK-based real estate investor with significant experience in China, to develop its land holdings in Shenzhen.
As part of the agreement, GAW Capital would pay RMB 740 million (HKD 833 million) for Chen Hsong to move its factory operations to another location. They would contribute three plots of land in Pingshan District in Shenzhen totalling close to 6 million square feet into a JV where they would retain a 36% interest. GAW Capital would be reponsible for developing residential properties on the land.
To put things in perspective to the balance sheet values, the land/buildings were being carried on the balance sheet at HKD473 million as of 3/31/2018. The relocation fee by itself is at a HKD360 million premium to the carrying balance sheet value. And then there is the upside of the future development project.
I have not yet dived into the potential value of the residential development project, although I am putting in inquiries with my local real estate contacts. Shenzhen has become one of the most expensive cities in the world. Pingshan District is about an hour from the city center but we are probably still talking about some fairly high $/sf figures.
With an increase in share price of 79 HK cents, the market is valuing the potential transaction at HKD500 million. The relocation premium alone comprises over 2/3 of that figure. I have a feeling that the 36% interest in the projects (to be developed over the next 10-15 years) could be worth a lot.