Description

Hong-Wei Electrical: the cheapest listed elevator manufacturer in Taiwan (and maybe the world?)

Note: this idea is only suitable for personal accounts or small funds

Founded in 1979 and publicly listed in 2016, Hong-Wei Electrical (ticker: 4565, 宏偉電機 www.elevator.com.tw), is the leading freight elevator manufacturer in Taiwan (its products are marketed under the “Volbin” brand name).   

Why did we consider an investment in Hong-Wei?  Of the three publicly traded elevator manufacturers in Taiwan, Hong-Wei has the lowest P/E ratio (~10x), highest dividend yield (~6%), highest ROE (~20%), and is tied for the highest EBITDA margin (~19%).[1]  Hong-Wei is also the only publicly traded Taiwanese elevator manufacturer that achieved profits in mainland China from 2015-2018.  Hong-Wei was also the only publicly traded Taiwanese elevator manufacturer with the least foreign shareholding or analyst attention.[2]  We also knew from experience that passenger elevator companies, especially those in developed markets like Taiwan, often enjoy steadily growing streams of recurring revenue thanks to lucrative maintenance contracts.  Though Hong-Wei’s elevators are focused on carrying freight instead of passengers, their high profit margins also come from recurring maintenance contracts.  

What are “freight” elevators exactly?  Unlike passenger elevators used in high-rise buildings, freight elevators are designed to different specifications, the most important of which is the ability to bear a lot of weight (up to 25 tons or more).[3]  Freight elevators are critical to the functioning of factories, warehouses, and other commercial facilities where moving things is more important than moving people.

Another difference between passenger and freight elevators is that passenger elevator demand is ultimately driven by urbanization.  According to the Swiss elevator giant Schindler Holding, “every second, two people move to a city,” a trend that leads to more high-rises and elevators.[4]  New freight elevator sales, however, are not necessarily driven by urbanization.  Hong-Wei’s customers, for example, span a variety of industries like semi-conductors, chemicals, automobiles, and logistics. 

Where passenger and freight elevators are alike, however, is the need to be maintained and, eventually, replaced or “modernized.”  In developed countries, maintenance and modernization are not optional activities for elevator owners thanks to ever-stricter safety regulations.  As a result, maintenance and modernization are sticky businesses that generate most of the profit for leading elevator manufacturers, and that is also the case at Hong-Wei. 

Hong-Wei seems to have a clearly defined niche business that does not attract much competition in Taiwan, the company’s most profitable market.  Hong-Wei has the capability to manufacture, maintain, and replace freight elevators that can carry loads of 25-plus tons, but most of the company’s orders today are for 2-5 ton elevators.[5]  Because freight elevators don’t lend themselves to cookie-cutter mass-production (i.e. customers only order a few highly customized elevators at a time), Hong-Wei does not sell many freight elevators annually.  Even in Taiwan, where Hong-Wei is the market leader, sales volume was only 197 units in 2017.[6]  This pales in comparison to the 2,150 units sold in 2017 by Golden Friends Corporation, one of the top three dominant Taiwanese passenger elevator manufacturers.[7]

The silver lining in Hong-Wei’s low unit sales is that their customers in Taiwan – large companies like Taiwan Semiconductor Manufacturing Company – seem to care more about product quality than price.  In fact, Taiwanese freight elevators command much higher selling prices and maintenance values than passenger elevators.  For example, Hong-Wei’s new elevators in 2017 sold for an average price of NT$2.6 million per unit, and each of the cumulative 3,000 freight elevators under their maintenance contracts generated average maintenance revenues of NT$122,000 per unit.  By comparison, in 2017 Golden Friends Corporation only achieved average selling prices per unit of NT$1.1 million and each of their 33,000 elevators under maintenance contract generated average maintenance revenues of only NT$48,000 per unit. 

Hong-Wei also operates in China, where there’s a more painful story to tell.  Globally, China accounts for two-thirds of all new passenger elevators sold each year.  Not surprisingly, the largest elevator manufacturers in the world all want a piece of this goldrush, so competition is cut-throat.  In recent years, the prices of both new elevators and their maintenance contracts have been pressured downward, so it has been tough to find any publicly traded elevator manufacturer with good news to report about China.  Hong-Wei has also been challenged in China: each of their elevators sold generates far less revenue than in Taiwan.  Still, Hong-Wei has impressively eked out profits in mainland China every year since 2015.[8]  We think Hong-Wei’s relative success in China owes in part to the fact that they sell less to local mainland Chinese companies and more to large Taiwanese companies (i.e. Foxconn) and multi-national companies (i.e. Corning).  The Foxconns and Cornigns of the world also buy elevators from Hong-Wei in Taiwan, so there’s a deeper level of trust for Hong-Wei to take advantage of as those customers expand in China.[9]  Proof of that trust can be found in the fact that Hong-Wei has secured steady maintenance contracts on an installed base of about 2,000 elevators in China.  We view this as a huge accomplishment in itself even if Hong-Wei’s China maintenance contracts are at discounts to what they would earn in Taiwan. 

Continued success in China would be great news, but our investment thesis in Hong-Wei does not hinge on that.  Hong-Wei’s current market capitalization of only represents about ~10x the annual cash profits from Taiwan alone, where a) competition is less intense, b) there is growth potential from new maintenance contracts and replacement-elevator sales, and c) the company can afford to pay 70% of profit as dividends.  If we are proven wrong about Hong-Wei in both China and Taiwan, then the NT$870 million appraisal value of the company’s properties – some of which generate rental income – might provide a backstop as they’re worth about half of the market capitalization today.[10]

http://mops.twse.com.tw/nas/STR/456520160929E001.pdf

See above link (page 10): a breakdown of the installed base of roughly 3,000 elevators maintained by Hong-Wei in Taiwan.  Of the 3,000 elevators maintained by Hong-Wei in Taiwan, 71% and 38% of them are older than 6 years and 15 years, respectively.  Freight elevators that old are ripe for replacement, so age vintages of Hong-Wei’s existing installed base in Taiwan indicates there is potentially at least another 5-10 years’ worth of elevator unit sales in the pipeline from existing customers alone.

The surest way for Hong-Wei to improve their stock price from here would be to keep growing their profits and dividends.  But even if Hong-Wei is unable to expand, we suspect an upgrading of their stock’s listing status from the lowly, illiquid “emerging board” it trades on today might trigger a re-rating to a more “normal” P/E multiple.[11] 

Since January 2018, we have visited Hong-Wei’s headquarters twice, conducted two conference calls, and exchanged several emails.  We also conducted brief conference calls with peers Golden Friends and Yungtay Elevator to ask about Hong-Wei and freight elevators generally.  Everything we have learned suggests we should consider ourselves very lucky to have found a company like Hong-Wei selling for double-digit free cashflow yield and high single digit dividend yield. 

Some additional context:

1)    - Hong-Wei’s insiders and major shareholders have increased their shareholding on the open market, most recently in September 2018 when Chairman Huang Tan-Cheng bought 140,000 shares (this increased his entire personal shareholding by 4%).

2)    - Yungtay, the largest passenger elevator company in Taiwan, received a take-private offer by its top shareholder Hitachi at NT$60 per share for a trailing P/E of 33x.  United Technologies (Otis) is also a major shareholder and could be in the mix for a control fight as they have aggressively increased their shareholdings on the open market.

3)    - Hong-Wei’s monthly consolidated sales growth rate has accelerated recently.  October 2018 sales were up 78.94% YoY, November 2018 sales were up 25.98% YoY, December 2018 sales were up 122.50% YoY, and January 2019 sales were up 62.07% YoY.  This may or may not mean much profit-wise, because in the first half of 2018 consolidated revenue was down YoY (thanks to lower recognized sales of new equipment) but consolidated operating profit still grew 16% YoY thanks to growth in maintenance revenue.  By our estimates, at least 89% of consolidated gross profit in the first half of 2018 came from maintenance.

Catalyst

Delisting from the emerging board and relisting on the main board of the Taipei Exchange (TPEX)

Increased profits and dividends as the number of elevators under maintenance continues to grow