Description

Sitoy is a collection of cash, a HK property, and a structurally challenged but profitable operating business which manufactures leather handbags for Coach and other international brands.  The operating business is seeing revenues decline, possibly terminally, but it remains profitable and will likely generate significantly more cash than the current market-implied price.  How management will dispose of this cash is unknown - some will be invested the firm's nascent own-brand leather goods business, and the remainder will probably be invested into other new projects with uncertain prospects.  A return of cash is unlikely.  Despite this risk, the assets are sufficiently cheap that the stock is attractive.

Assets

The firm currently owns three assets of value:

Firstly, the firm has a net cash balance of $79m.  Approximately a third of this balance is classified as 'IPO proceeds' and the firm has disclosed plans to invest this portion into the retail business (discussed subsequently).  No plans have been disclosed for the remainder of the cash.

Secondly, the firm owns an investment property - a 20-storey building in Kowloon (see image).  The building was valued at $80m at the time of acquisition (2016), although only $67m is listed as 'investment property) on the balance sheet (the remainder was transferred to PP&E, for space occupied by Sitoy).

Finally, the firm's listed operating assets (PP&E and NWC) are carried on the balance sheet at $100m (PP&E is ~60%).  Valuing the cash & property (net of the occupied part) at face value, the operating business is valued at $81m at today's market price.

Operating business

The operating business generated $360m in sales in FY2016 (ending June) and operating profits of $49m.  These results have been deteriorating fairly rapidly over the years (2014 operating profit: $79m; 2015: $65m), driven by declining revenues (down ~14% annually) and moderately declining margins (down ~9% annually).  Clearly, the insane returns being generated by this business attracted competition and led to both pricing compression and market-share losses for Sitoy.

In 1H17 (i.e. July-Dec 2016), the deterioration accelerated as Sitoy's main customer, Coach, withdrew a significant portion of its order.  Sales to Coach represented approximately 40% of revenues in FY2016, and sales to Coach declined by approximately 80% in 1H2017 (Coach now represents ~20% of revenues).  Despite this set-back, the firm generated $15m in operating profit in 1H17.  Operating profit understates cash flow, as the firm is winding down working capital and no longer investing meaningfully in capex.  1H17 saw D&A of ~$3m and capex of ~$0.6m.

Sales will continue to decline.  However, there's some reason to believe that with the loss of Coach almost complete, the declines should moderate in the coming years.  Backing out declines at Coach, although somewhat approximate due to incomplete disclosure, does not suggest a secular decline is happening in the non-Coach revenues over recent years.  However, even if the decline in the business is terminal, it appears that Sitoy is able to wind-down this business profitably, maintaining positive margins and realising the value of the balance sheet assets.  

As this manufacturing business declines, management have begun to invest in a retail business, selling their own branded leather goods through a retail distribution network.  The investment has been measured, and the segment is only minimally loss-making ($0.5m operating loss in 1H17), although still at very early stages.  As noted, management plans to invest another ~$25m into this business.  There's fairly limited visibility into the prospects for this business - although management clearly have demonstrated some skill in the wholesale leather business, it's unclear they will have similar skill in managing a consumer-facing business.

Management are entrenched.  The CEO has been with the firm for decades.  The Chairman happens to be the CEO's brother, and the Chairman's son is also an executive and director at the firm.  These two brothers collectively own ~70% of the firm.  These three family members are paid ~$600k each.

Conclusion

The existing assets of the Sitoy business appear materially undervalued at the current market price.  However, there is very limited visibility into what management will do with the cash from the declining manufacturing business, particularly if the retail venture were to prove incapable of absorbing the capital.  I haven't been able to speak with management and the amount of information on the company publically available is quite limited, so there's significant risk with this investment.  The recent purchase of the investment property suggests that a return of cash to shareholders is unlikely.  However, the stunning success to date of the manufacturing business at least suggests that management are competent and know the leather-goods market market well, which offers some hope for the retail business.  Management own most of the company and seem to be siphoning only moderate amounts of value, but given this misalignment, Sitoy is probably best suited for investment as part of a basket of low P/B stocks.

Catalyst

Wash-out of the loss of Coach.

Any traction with the retail business.