Hengxin Technology Limited ($Hengxin Tech(I85.SI)) is an investment holding company principally engaged in the production of radio frequency coaxial cables for mobile communications.
The Company is also engaged in the research, design, development and manufacture of telecommunications and technological products, mobile communications systems exchange equipment, as well as antennas and high temperature resistant cables.Given that the focus is on net-net strategy, in this article I will approach the valuation of Hengxin Technology on the basis of its assets e.g. should the stock be trading at a discount to its asset value? Should the company be selling for less than its liquidation value? Hence, note that in this instance the conventional method of cash flow generation; analysing the company’s operations and business value is not as important.
This column is written by @j_chou.
–@J_chou has an interest in global macro trends, financial markets and equity research and enjoys applying a combination of the three in his investments. His eventual investing goal is to manage a risk parity portfolio and achieve true financial freedom.
First, Hengxin has an astonishingly low P/B ratio of 0.44 and P/S ratio of 0.617!
A quick look at Hengxin’s balance sheets:
Table from Hengxin Technology FY2016 Annual Report
Firstly, assessing the actual liquidation value of the current assets is vital. This is to see how much of the stated value of the current assets can realistically be salvageable for shareholders in the event of a fire sale.
Table source: Security Analysis, Chapter 43: Significance of the Current Asset Value
Ideally you would want most of the current assets to be parked in cash, as it has the highest liquidity.
For Hengxin, around 40% current assets is in cash. Interesting thing to note is given current exchange rate of CNY/SGD of 0.20, net cash holdings stands at 112M, shares outstanding at 388M, net cash per share arrives at S$0.289, which is 77% of current share price of S$0.375. This implies that shareholders are paying only a premium of S$0.086 for the rest of Hengxin’s business! Also important to note that Hengxin do not have an issue of high cash burn rate, which are not uncommon in net-net stocks.
However, take note of Hengxin’s high proportion of trade receivables, which makes up 45% of current assets.
Table from Hengxin Technology FY2016 Annual Report
Looking at Hengxin’s annual report, payments have typically been made on time hence liquidity concerns should not be a major issue.
Table from Hengxin Technology FY2016 Annual Report
The annual report has also indicated increasing effectiveness in managing inventory and receivables.
Another important metric to evaluate is the company’s debt levels. As liquidated value of a company will be attributed to creditors first, hence if the company’s debt levels are high then shareholders will be at the losing end. For instance, in the case of Noble Group, though it is a net-net stock, breaking down its current assets of 9901M, where over 80% is attributed to receivables and inventory, and total liabilities is at 8235M, it is highly possible shareholders will not be able to realize any value from this stock in the event of liquidation.
As clearly seen in the table above, Hengxin has hardly any debt with a very low gearing ratio of 0.019. For a net-net stock this is highly attractive.
Four Possible Scenarios
There are typically four scenarios that will play out to allow net-net stocks to realise their potential value. To evaluate whether Hengxin is truly an undervalued gem or a value trap, I assess the likelihood of each scenario occurring:
Company undergoes liquidation
In theory, liquidation would be the best possible scenario, as it allows shareholders to immediately realise a positive return. Given that non-current assets such as property, plant and equipment are not factored in, there is even more possible upside from liquidation. However, this scenario is least likely as management will be out of a job if the company liquidates. Especially in the case of Hengxin, management has reiterated at several points that despite business in a sunset industry they are striving to find ways to restructure the business (expanded further upon below).
However, I like to consider this scenario first as the liquidation value provides a review of the absolute downside of the stock, given that very few businesses can be liquidated at less than its working capital. Hence, it gives a good assessment of the margin of safety of this investment.
A very conservative valuation of the stock will be looking at the net net working capital, where we assume only 75% of receivables and 50% of turnovers could be liquidated.
In this instance, net-net working capital of Hengxin will be around 177M, which on a per share basis is still worth $1.375, more than 400% upside than its current share price of $0.350. Hence, we can conclude that Hengxin’s liquidation value is very high.
Delisting and Share Buybacks
As opined by Warren Buffet:
“When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.”
For Hengxin, this may not be feasible given their dual listings on HKEX and SGX. Nevertheless, note that Hengxin has attempted to delist from SGX in Aug 2013, offering S$0.17 per stock but shareholders vetoed the decision likely due to the unattractive pricing. Hence, in my opinion a share buyback is not likely, unless share price falls back to 2013 levels.
Merger and Acquisitions
Hengxin has stated in its annual report that it recognises its main business segment of RF coaxial cables is in a state of “irreversible decline” hence are “commencing measures for its business transformation”. One easy remedy to undergo transformation for companies rich with cash is to acquire other businesses. Hengxin’s cash and low debt position gives them the flexibility to consider growth through inorganic means. This possibility is highly likely, given that Hengxin has not shown any indications of developing other business segments organically considering they have not spent a single dollar on R&D. Also, Hengxin bought a 24% equity stake in Mianyang City Siemax Industrial Co, a company that is involved in the manufacture and sale of communications equipment and related components. A series of strategic investments could be positive for its share price. Nevertheless, investors should note that acquisitions are a double edged sword: it could signal a positive turnaround in company fortunes but if the acquisitions made were poor it will saddle the company with debt and eat into its margins.
Reversal of company fortunes
Roughly two thirds of Hengxin’s revenue comes from RF coaxial cables. It is a dying industry, given the dominance of optic fibre over copper cables and intensified price competition due to lack of demand. Hence the group began in 2016 to focus on its other products of leaky cables and temperature resistant cables, which has seen positive growth in revenue. If successful, could signal turnaround in share price growth. However, the process may take a few years for it to come to fruition. Another opportunity for Hengxin is the commercial adoption of 5G, which will translate to greater spending by telecom operators on communications infrastructure, hence more demand for RF coaxial cables and antennas. However, the 5G infrastructure requires technological requirements that the company do not have, hence Hengxin will not have a competitive edge if they are unable to develop the cables in time.
Net-net stocks are no strangers to various risks, given that they are usually in an industry with significant headwinds. However, as a S-chip there is an element of corporate governance risk when investing in Hengxin. Especially when the balance sheet appears too good to be true. Investors may remember Eratat Lifestyle Limited, where the company defaulted on its debt payments and was subsequently revealed to have falsified one of its subsidiaries’ bank accounts to show 577million in cash when in actuality it only had 73 thousand.
Though it should also be noted in Hengxin’s case its cash holdings seem to be backed up by a steady income stream over multiple years and it has hardly any debt. Hence the risk of default should be low.
Overall, in my opinion as a net net play Hengxin is a stock worth vesting, as downside seems limited due to its relatively strong balance sheet, high liquidation value and multiple catalysts.
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