Description

CHCG is leading and growing "store in store" retailer of electronics in China.  With a current price of $0.90,  it has $0.74 of net cash per share (note: bloomberg has wrong cash figure), trades at 1.8x 2008 P/E, 0.2x 2008 EBIT and 0.7x tangible book (cash and receivables).  Stripping out cash, the company would be trading at 0.3x 2008 EPS.  If this weren't cheap enough, 2008 results were negatively impacted by severe show storms in China during Q1 (pretax profit was down 26% y/y), which is the company's seasonally strongest, so 2009 results should be better for this and other reasons.  Similar to CMFO which I recently posted here, this is a US listed company that follows SEC/GAAP rules.

 The company is a retailer (70%) and wholesaler (30%) of computers, communication products and consumer electronics in Eastern Europe.  The company's retail operations are conducted through 1,014 store-in-stores located in 277 branded retail stores (large-scale supermarket stores, department stores, etc. including Carrefour and Tesco and many of China's leading chains).  The company sells mobile phone, facsimile machines, DVD players, stereo's, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, etc.  Under this store-in-store model, the company leases space/counters where the company's products are displayed for sale.  Approximately 50% of leases are fixed cost while the rest are based on a percent of revenue generated.   The advantages of this model is that the company does not need to invest significant capital to build/buy/stock a store (thus its maintenance capex is basically zero) and it can rapidly turn its inventory (inventory turns were 24x in 2008).  The company operates its stores in four main areas, Shanghai, Zhejiang, Jiangsu and Anhui.  The company has also started a program to roll-out company owned and eventually franchised stores in smaller cities in which it does not currently operate, but it will take sometime before these stores will generate meaningful profitability, so I will not spend any more time on this.

 The company recently delayed filing its 10k (thus the added E to its ticker), although it issued a full earnings release.  We expect the 10k to be filed by the 15^th with no changes to reported financials.  When the company releases its 10k we expect 2 catalysts to occur.  1) the company's results (including its very strong Q4) will be picked up by more databases and the attractive valuation will become more apparent to people and 2) the company may elaborate on Q1 2009 results.  We expect Q1 results to be very strong because the Chinese consumer has not suffered as much as the US consumer and because the Chinese government is stimulating all sorts of spending.  Also, Q1 2009 will seem very strong compared to Q1 2008 which was very weak due to the severe snow storms that not only limited sales in snow impacted areas during Jan and Feb but also disrupted deliveries to stores in areas that were not as impacted by the snow since major distribution points were hit by the snow.  A lack/delay in deliveries is very harmful to CHCG because its stores carry limited inventory, which helps explain the high turns.   

 2007 Segment Breakdown

Cash balance/Acquisition

 Included in the company's balance sheet is $32mm of cash and $7.3 deposit for an announced acquisition.  We have treated the later as cash in our valuation above since the acquisition obviously did not impact 2008 results.  The deposit is for an acquisition of a logistics company, and when the deal closes the company will have to pay another $10mm.  The company expects the deal to be accretive and for target to generate atleast $2mm of net income in 2009 plus reduce the company's logistics expenses of delivering to its existing stores.  This acquisition will also be helpful down the road when the company's franchised operations begin to roll out.  However, there has been a delay in closing this acquisition which was scheduled to close at end of March.  Whether this deal closes or not, the stock is still dirt cheap

Valuation

Let's keep valuation simple.  We believe 2009 EPS will be higher since the company will benefit from increased sales from new product introductions, new store openings, a better Q1 and perhaps the closure of the announced, accretive acquisition.  However, let's be very conservative and just value the company based on 2008 EPS and then add back the cash balance (which didn't add much to 2008 eps).  Below you can see the implied stock price based on various multiples of 2008 EPS and adding back cash on hand.

Q1 is the seasonally strongest quarter.  If EPS in Q1 2009 is only equal to Q4 2008 (it should be higher due to seasonality) the company will report Q1 eps growth of 27% ($0.14 vs $0.11), which should generate some investor interest. 

Other Points

1) MLT Management, which had been one of the largest holders, recently sold virtually all of its stake.  We believe the sale was motivated by factors occurring at MLT as opposed to them thinking the stock was overvalued

2) Insider ownership - The chairman/ceo owns about 18% so he in incentivized to create shareholder value

3) IR - CHCG does i.r. (conferences, roadshows), has a vp or IR (newly appointed and very user friendly) and has an i.r. firm..but anyone who looks at their website (or their valuation) realizes they can do a better job on this front.

4) Auditors - Like many Chinese and micro cap companies, CHCG has changed auditors a few times over the past years.  There have never been any problems with their auditors and we view the changes as the company seeking to upgrade and also spend less on their audit expenses.

5) Other board members - Many of these US listed Chinese companies have inadequate  Boards.  While we have never spoken to him or due diligenced him, we were pleasantly surprised to see someone with Ken Berents background on this board.  Ken's bio is He is a former managing director and senior portfolio manager for Goldman Sachs Asset Management in Tampa, Fla., which manages $30 billion in growth stocks. Before joining Goldman Sachs, he was the managing director and director of equity research for First Union Securities, now Wachovia Securities, from 1993 to 2000. From 1989 to 1993, he was vice president and media analyst for Alex, Brown & Sons. He was a media analyst for Legg Mason and a supervisory analyst for Alex, Brown & Sons.

Catalyst

Filing of 10k

comment on Q1 results

reporting of q1 results

increased investor attention