Description

(Notes: figures above in USD equivalent except per share figures.  Texhong reports in RMB but trades in HKD, so if you forget to do the conversion your valuation multiples will be too high.)

Yarn manufacturing might sound boring as hell, but this stock is up 11.4x since its Dec ‘04 IPO.  With dividends, shareholders have made ~21% annualized over the past ~14 years. There’s also plenty of runway left: Texhong has just a tiny fraction of the yarn biz in China (despite being much larger than its competitors), and the oldest guy in senior mgmt is just 51 years old.  The top 2 guys own ~⅔ of the shares, and Texhong routinely dividends out ~30% of earnings, so their dividend income is vastly larger than their comp. Interests are pretty well aligned, and takeunder risk is very low.

Texhong is predominantly a yarn manufacturer - the most capital intensive part of the textile value chain - whose product winds up primarily in clothing and other textiles sold in the PRC (roughly 80% of revenues).  But its smaller presence in fabrics and garments has recently begun to grow rapidly and the goal is to become a much more vertically integrated manufacturer.

VIC member gemintherough wrote this up in 2013 and the story remains largely the same: single digit P/E (currently ~6.5x forward) with EPS growth >20% and ROEs >20%.  Only difference is that Texhong is now roughly twice the size and it’s low-cost advantages are more entrenched.

Brief history:

After working as a manager for another textile company, founder Hong Tianzhu (Textile + Hong = Texhong) sees opportunity in the financial distress of many state-owned textile firms.  He founds Texhong in August 1997 and buys the assets of six such companies in liquidation. In doing so he managed to preserve a lot of jobs, has continued this sort of vulture investing many times over the years, thereby putting him on good terms with the government (always a plus in the PRC).

Hong realized well in advance that the heydays of the Chinese textile industry would come to an end due to the inevitable rise of wages.  Thus, in 2006 he was the first PRC-based company to build a plant in Vietnam, and built another in 2012. For the same reason, he automated Texhong’s fabric and garment plants in the PRC.  (Fabric and garment production have been a small % of revenue until just recently, but I mention this as it tells you something about mgmt quality.)

The Moat:

As a result, the company sits comfortably at the low-end of the cost-curve today.  For example, in spandex yarn (it’s specialty at about half of total revenue), Texhong has more than tripled its PRC market share since 2005.  That share is now ~30% - multiples larger than any competitor. Scale really matters here. In an industry where most firms get by with razor thin margins, just getting good operating leverage on something simple like G&A gives you a real advantage.  (Texhong’s G&A as a % of sales on each tonne of yarn sold was 10% in 2005 and is well under 4% today.)

Further, the replacement costs of its South and North Vietnam plants are around USD 200M and USD 325M respectively.  These are huge sums in this highly-fragmented industry where most (as in, almost all) competitors lack access to the public markets.  As a result, Texhong is the only company making spandex yarn in Vietnam. Although shipping costs are higher, labor and overhead costs are lower by ~20% and ~10% respectively.  More importantly, Vietnam places no tariff on cotton imported from the U.S., whereas the PRC has historically added a 13% VAT and 1% customs duty. Thus, the Vietnam plants have historically saved 10-20% on cotton and today save even more as China recently upped the VAT to 25% due to the trade war.  Finally, the Vietnamese gov’t sees the textile industry as a key to growth and has granted Texhong some long-term tax incentives.

The yarn industry is consolidating and Texhong is a prime consolidator.  From 2005 through 2015, the number of yarn producers in the PRC went from 130k to 98k (sorry I don’t have more recent data).  In Hong’s words, “the superior will survive, and the inferior will be squeezed out. The lack of big companies in the industry is an opportunity.”

Doing right by shareholders:

As mentioned, Hong’s dividend income from this company is multiples of his comp - specifically, in 2017 that multiple was >62x.  For the CEO, that multiple was >8x. Option grants are tiny and comp is reasonable overall. Interestingly, Hong’s comp is typically much lower than that of the CEO or COO despite him owning 52.8% of the company.  Just in case you’re worrying about a takeunder, keep in mind that for HK-listed companies, acquisitions must be approved by 90% of the minority shares.

The one potential negative I see is that Hong is involved in substantial ongoing related party transactions - basically renting land and providing services (e.g. electricity) to the Vietnam plants.  I’m not yet sure if there’s any legit business rationale here (I’ll update this soon as I get an answer), but the numbers don’t seem large enough for me to change my recommendation (but to each his own).  Let’s say he’s charging Texhong an egregious 10% markup on arms-length prices. I then divide that by half since he owns about half the company. In this hypothetical, Hong would have “cheated” shareholders out something like RMB 19M in the LTM.  In 2017 he made 2.8M in comp and received 178M in dividends. LTM profits were 1,110M.

Why is it cheap?

Texhong has typically traded single digit P/Es, getting above a 20 P/E only on a couple occasions.  With estimated EPS growth of 20% or better, you don’t really need multiple expansion to do well here.  

Catalyst

20% EPS growth