Qingmei Group Holdings

[AAA]

Qingmei has dropped by 20% from 0.36 to 0.3 last Friday, after the announcement of Q2FY10 results. Net profit dropped by 1.3% compared to Q2FY09. The results are within expectation as it is operating near its full capacity.

The first stage of the installation of equipment and machineries for capacity expansion was completed in December 2010 and production is expected to be ramped up gradually in the next few months. The first stage expansion will increase its production capacity from 45.6m to 65m pairs of sports shoe soles, an increase of about 42.5%. Barring any other unforeseen delays or circumstances, the second stage installation will commence by July 2011. Upon completion of the second stage installation, its production capacity will increase to approximately 84.0 million pairs of sports shoes soles per annum, the total additional capacity form first and second stages of expansions represents about 84.2% increase from the existing capacity of 45.6m pairs. At the price of S$0.3, dividend yield is 8% and rolling PE is 3.7. Cash and cash equivalent is about S$12.66 cents per share. No long-term debt. Total current asset is RMB740.5m versus current liabilities of RMB260.3m. The cash and cash equivalent adjusted PE is 2.15. The valuation looks extremely attractive. The major problem with this company is its short listing history but at the current price of 0.305, I feel there is little downsize potential.

Vested.

[Nick]

I do hope they continue to pay out 30% of their net profit as dividends to shareholders. The yield is certainly attractive.

[D123]

1. Some of the cash on the balance sheet is needed for working capital purposes. Assuming a healthy current ratio of 2, the net cash available is S$0.066 per share. This cash maybe used for capex in future, especially if you assume aggressive expansion in the quarters to come, reserve for dividend distribution etc. There is no reason that this will be used efficiently or above the cost of capital in capital allocation exercises.

2. The net margin of the company is suspiciously high at 22.7%. This is almost certain to come down if the company grows bigger, or with time as competitors come in and undercut selling prices. I think the long-run for commodi-tized industries should be 5-8%. This estimate is purely personal judgement with very little scientific analysis, so your own may vary. But suffice to say, even if margins were reduced only to 15%, that would negate the 43% rise in revenues.

Nevertheless, my calculations yield a P/E of 4, which might be a significant discount for some people.

Side note: there have been a number of posts where people have valued companies net of their net cash positions on the balance sheet. In the first place, cash needs to take into account working capital needs. In most industries, this means a current ratio of 2. Some companies have been conservative and aggressively collecting receivables or demanding cash payments, thus reducing trade receivables and having a large cash position. This does not mean that it is available for distribution or expansion. At least some of it is still used for working capital. You cannot take the cash balance, minus all debts on the balance sheet and say that is net cash available for distribution.

Next, while it might be okay to net out cash when valuing a established company like Apple, I'm not sure it's useful for small companies or companies with little track records of efficient capital allocation. Firstly, these cash may be subsequently used for wasteful expansion, reserved for future dividend distribution, or simply held on balance sheet by overly conservative management (aka inefficient capital allocators). Even when we're optimistic about management's ability to allocate capital, this cash balance will likely be used for the future growth that may already be factored in your target P/E assumptions, so it shouldn't be counted twice.

I guess my point is this: we should look at net cash positions from more angles before simply netting them off in valuations.

[Wee~]

Do note the following from IPO prospectus:

"Upon expiry of the tax holiday on 31 December 2011, a unified income tax rate of 25.0% is applicable
to Qingmei (PRC)"

Current tax rate is ~11.9% for Q1FY11 and ~12.6% for Q2FY111.

[trader2000]

I work at a hedge fund and we're looking at taking a sizable position in Qingmei (similar to Hunter from AUS). Just got done visiting with management a week ago.

Our approach is value based and the new capacity which is online along with new capacity being developed will offset the additional tax rate.

It is hard to find equities paying dividends over 10% in a currency we like (SGD). Management's interest is also aligned with ours. The sell off was driven by buyers at the IPO who wanted to liquidate and were holding onto their shares for an opportunity to break even. With prices where they are it's a steal!

[freedom]

I work at a hedge fund and we're looking at taking a sizable position in Qingmei (similar to Hunter from AUS). Just got done visiting with management a week ago.

Our approach is value based and the new capacity which is online along with new capacity being developed will offset the additional tax rate.

It is hard to find equities paying dividends over 10% in a currency we like (SGD). Management's interest is also aligned with ours. The sell off was driven by buyers at the IPO who wanted to liquidate and were holding onto their shares for an opportunity to break even. With prices where they are it's a steal!

is your act something not right? to announce the intention of a hedge fund to general public no matter it is true or not.

[Nick]

I work at a hedge fund and we're looking at taking a sizable position in Qingmei (similar to Hunter from AUS). Just got done visiting with management a week ago.

Our approach is value based and the new capacity which is online along with new capacity being developed will offset the additional tax rate.

It is hard to find equities paying dividends over 10% in a currency we like (SGD). Management's interest is also aligned with ours. The sell off was driven by buyers at the IPO who wanted to liquidate and were holding onto their shares for an opportunity to break even. With prices where they are it's a steal!

I thought Qingmei revenue and distributions are declared in RMB ? Any ideas why their margins are pretty fat ? At my first glance, the business seems manufacturing based which works on volume rather than margins. May have missed out on something. Thanks for your inputs

[trader2000]

I work at a hedge fund and we're looking at taking a sizable position in Qingmei (similar to Hunter from AUS). Just got done visiting with management a week ago.

Our approach is value based and the new capacity which is online along with new capacity being developed will offset the additional tax rate.

It is hard to find equities paying dividends over 10% in a currency we like (SGD). Management's interest is also aligned with ours. The sell off was driven by buyers at the IPO who wanted to liquidate and were holding onto their shares for an opportunity to break even. With prices where they are it's a steal!

I thought Qingmei revenue and distributions are declared in RMB ? Any ideas why their margins are pretty fat ? At my first glance, the business seems manufacturing based which works on volume rather than margins. May have missed out on something. Thanks for your inputs

Financials were reported in RMB but the company is listed in SGX (S-chip). S-Chips are suited for the more risk averse asian investor because SGX requires a lot more transparency than China mainland listings or Hong Kong listings.

In regards to my earlier comment - I should not have divulged that information. Please disregard my earlier comment.

That being said, we're looking at this investment on a long term basis. If you look at the financials you'll see that the ROIC is about 28.4% and growth is about 7%.

If you follow that Value = [NOPLAT (1- (g/ROIC)] / (WACC - g) then you get [292 * (1-(7%/28.4%)] / (11.4% - 7%) = 5001 RMB. Divide by 640 (number of outstanding shares) and you get 7.81 RMB per share. Divide this by 5.25 to get back to SGD and you get 1.48 SGD.

Now obviously some assumptions were made to the above. First, utilized latest quarter earnings * 4 for annual. This is because the past is less reflective of future earnings given new capacity, but since stage 2 of expansion will occur next year it is safe to say that earnings for 3Q11 will be lower than 3Q12. So by taking latest earnings for quarter times 4 we're making a safe assumption.

Using 7% as the growth rate (based on latest financials). Question here is how long can growth be maintained. We feel confident that we'll see this growth for at least the next 1-2 years based on the additional capacity.

We're using a WACC of 11.4% since this was the most recent figure posted by Deutsche Bank as the WACC for China.

28.4% is the ROIC based on the financial statement. Take out any current liabilities from Assets to see the Investment Capital Base and use that to Calculate the ROIC.

Based on the above the company is significantly undervalued. We feel the valuation is a reflection of the fact that it is a young listing and many people saw investors who cashed out in March 2010 IPO at 31 cents.

People should keep in mind that cashing out at an IPO is sometimes a decision which a fund MUST make because it is in line with their original investment thesis (ie invest pre-IPO at preferential pricing and cash out at IPO). It does not mean that the fundamentals of the company are flawed. In fact, many if not most of the offerings offered pre-IPO are liquidated at the IPO for some level of cash out.

[cyborg]

The number is mouth-watering, but I think it is safer to wait sidelines.

[Drizzt]

is this a pump and dump? how come hedge fund manager will come in and post 2 posts specifically on this?