2678.HK - Texhong Textile

[yadayada]

Well I think people are scared off by textile, and by hong kong. But this one pays dividends, seems to have a v smart CEO, and except for the crazy Cotton bubble in 2010-2011, produced steady profits and v nice return on capital. It is trading at a PE of like 5 now. It pays out steady dividends, 30% of net income (so low because they are growing rapidly).

 

But what is nice is that this year, their production will increase about 70%, because they built new plants in Vietnam.

 

and then there is also this:

http://www.voanews.com/content/with-an-eye-on-tpp-garment-companies-flock-to-vietnam/1894275.html

 

So basicly this thing is trading at 2.5-3x 2015 earnings. They will pay out dividends that are 20-30% of earnings probably. That would be a 13% dividend yield! And if they don't grow, that dividend yield will becom larger. If they do grow, it will become larger as well.

 

The sell offs have to do with the cotton bubble in 2011 (look up cotton prices). This stock seems pretty misunderstood.

 

write up on VIC:

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/100583

 

And blogger red has a 20% position in it (that is what got me curious)

[yadayada]

Ok so everyone is drooling over apple and sears lol, with over 500 pages in the sears thread. Meanwhile you can buy a business here for 2-3x earnings that pays out steady dividends, and zero comments. Someday I will understand this.

 

Anyway, Buffett doesn't like textile for a good reason. But this is different. China wants to protect cotton farmers (you can guess why), and does'nt like the textile industry too much. Sucks up energy, and doesn't add much value. So they forced textile mills to buy up cotton at high prices to protect the cotton farmers. But they set the price too high, so cotton stockpiles where too big last year, while textile mills had a cotton shortage. Spread between US cotton and china cotton was 30%. Historically it has been lower. 20-25%.

 

Ofcourse Tex hong exploited this by setting up shop in vietnam, buying up cotton from the US, and selling the yarn to China.

 

China now lowered the price to get rid of stockpiles, and it seems the market completly overreacted, thinking this will kill texhong's margins. But even with this spread being lower, they had about 9-10% profit margins historically (in 2013 it was like 12-13%). And their capacity will basicly double in july 2014.

 

So even with a 9% net profit margins because of the lower spread, 15 billion RMB in revenue is still about 1.4-1.5 billion in net profit. And that is lowballing it probably. They are also opening facilities in Uruguay I think, similar principle vs Brazil. And there are some scale advantages as well.

 

Anyway that is a PE of between 2-3. Historically they paid out 30% of dividends, which is v nice. SO no cash hoarding that you typically see with these hong kong traded company's. That would imply a 10-15% dividend rate. And price will probably adjust 100%+ once the market sees that margins are not destroyed by china lowering their cotton price a bit.

 

Also another reason why market is panicky on this stock is this:

http://www.indexmundi.com/commodities/?commodity=cotton&months=360

 

You see this huge cotton spike in 2011. Seems rare that will happen on a regular basis (given that it was the only spike in 30 years). But that made the profits kinda swingy in the past few years.

 

Even if you think this will end in like 5 or 10 years, the margin of safety here is huge. And cash is returned to shareholders. And debt is pretty low. I think upside could be several 100% with near term catalysts. Downside is v limited.

[cameronfen]

Seems really interesting.  I will look into it. 

[paperwerks]

I really like this idea and also like how volatile the stock has been over the last few years.

 

It seems the company makes its profit on the arbitrage of world cotton prices and cotton prices in China which are priced above market by Chinese regulation.

 

I looked into it a bit yesterday and found this which was initially worrisome: ""There are also rumours that China could impose import duty on cheap cotton yarn."" which came from this recent article on the current cotton market:

 

http://www.business-standard.com/article/markets/cotton-outlook-prices-to-be-guided-by-factors-other-than-cotton-114042700773_1.html

 

Now, initially I said aha!, that's why the price of the stock is down because China is going to close that arbitrage spread by imposing a tarriff on cheap imported cotton yarn.

 

But after a while I realized that if China imposed that tarriff then countries like India would be hurt but that Vietnam exports of cheap cotton yarn would not be affected due to the ASEAN China free trade agreement.  Does this free trade agreement protect against the imposition of tarriffs?

 

Also, I realize that Texhong makes other yarns like specialty polyester etc. that would be unaffected and that they also have cotton yarn operations in China that could actually benefit from tarriffs on imports.

 

So, maybe this tariff rumor that I saw is nothing that could hurt the company and is basically a non issue to Texhong. Does that seem correct?

[yadayada]

yeah i think so. Also their operations in China are more specialized, so they do better then most textile mills there. But most of the profit is made from the smaller operation in Vietnam. I think like 600 spindles in china or something and 400 in vietnam. But that will become 1 million in july.

 

I think if china increases tarriffs, they do have some competitive advantage in china, and they will have higher margins there for a short while. So your somewhat hedged there.

 

Also if this was likely, I don't think they would increase their capacity there so much.

 

One thing i dont get is that they are excited about Vietnamese exports not having to pay tax in the US and EUrope? Since cotton prices make up most of the difference, it doesn't seem they profit from a cotton price spread there?

[yadayada]

so it dropped from 5.75 to 5 in the past few days. Not sure why it is in free fall? a 4.5 billlion market cap on potentially 2 billion hkd in earnings in 2015. It is cheaper then those chinese scam stocks that never pay out any dividends.

 

One thing that might scare off investors:

 

Mr. Hong is a director and

the 100% beneficial owner of Texhong Group Holdings

Limited, and the sole director of New Green Group

Limited, which is 100% owned by Texhong Group

Holdings Limited. Mr. Hong is also a director of Trade

Partner Investments Limited, which is owned as to

56.44% by him. Each of New Green Group Limited and

Trade Partner Investments Limited was the beneficial

owner of 377,342,400 and 154,600,000 shares of

HK$0.1 each in the Company as at 31 December 2013

respectively.

and

 

Mr. Zhu Yongxiang, aged 47, is an executive Director

and co-chief executive officer of the Group. He is

responsible for the daily operations of the Group. Mr.

Zhu graduated from the 南通紡織工學院 (Nantong

Textile Industry College) in 1987. Prior to joining the

Group in 1997, Mr. Zhu was an assistant to the general

manager of 南通第二棉紡織廠 (Nantong No. 2 Cotton

Textile Factory). Mr. Zhu is the sole director and the

100% beneficial owner of Wisdom Grace Investments

Limited. Mr. Zhu is also a director of Trade Partner

Investments Limited, which is owned as to 41.81% by

him. Each of Trade Partner Investments Limited and

Wisdom Grace Investments Limited was the beneficial

owner of 154,600,000 and 68,000,000 shares of HK$0.1

each in the Company as at 31 December 2013

respectively.

 

So it seems insiders own a v large stake. But this has been the case for years. They could have hussled out the minority holders a long time ago? Especially since the stock has been v cheap at times.

 

Kinda worried im buying from worried insiders here.

[ni-co]

Thanks, yadayada. Seems to be a very nice idea. Unfortunately, I can't bring myself to investing into countries where I'm not completely confident in the rule of law and shareholder rights.

 

And blogger red has a 20% position in it (that is what got me curious)

 

Who is "blogger red"?

[cr6196]

Thanks, yadayada. Seems to be a very nice idea. Unfortunately, I can't bring myself to investing into countries where I'm not completely confident in the rule of law and shareholder rights.

 

And blogger red has a 20% position in it (that is what got me curious)

 

Who is "blogger red"?

 

He means http://quinzedix.blogspot.co.uk/

 

And law in HK isn't the same as law in China...An intro to this point, http://en.wikipedia.org/wiki/Law_of_Hong_Kong

[yadayada]

yeah I think I prefer company's on the HK stock exchange vs chinese company's on the western stock exchanges by a wide margin.

 

A lot of company's with pretty stellar management that pays out on a regular basis are trading so so cheap on the HK stock exchange right now. And it seems people are equating them with those western reverse merger stocks, which is not fair at all.

 

I think take over laws are even more minority shareholder friendly then in the US. And shareholders actually own the company's assets, they can legally go after them much more easily then those US traded chinese stocks.

 

So pretty much the only risks are government related, and I dont think they want to hurt hong kong traded company's, as a lot of powerfull chinese people own these stocks. Unlike the US traded Chinese stocks.

 

I do think you need to do more due dilligence on the people running and owning it tho, often you have v large family's who own like 50%+ of the stock.

[paperwerks]

I don't have a problem with governance here. This is not some pink sheet shell company reverse merger deal.  It is a real company.

 

The problem has been that the price of cotton has been going up on the world market and down in China lately. This is the exact opposite of the desired business model of texhong. In my opinion that is why the stock is down from 16 to 5 recently. The chart says it goes lower.

 

I have a starter position at $5.42 and hope I can add more in the 4's.  Right now it feels like as falling knife until those price patterns for cotton reverse. Then look out; it will run back up. I can not see any other way to play this other than adding slowly as it goes lower because we do not know when the cotton price trend will reverse if it has not already.

 

 

[yadayada]

yeah it seems like this stock is one where knowing some technical analysis could help increase your returns. Any news catalysts coming up in the near future that could drive the price higher then it is now? Otherwhise i wait a bit before buying :D .

[ni-co]

Thanks, yadayada. Seems to be a very nice idea. Unfortunately, I can't bring myself to investing into countries where I'm not completely confident in the rule of law and shareholder rights.

 

And blogger red has a 20% position in it (that is what got me curious)

 

Who is "blogger red"?

 

He means http://quinzedix.blogspot.co.uk/

 

And law in HK isn't the same as law in China...An intro to this point, http://en.wikipedia.org/wiki/Law_of_Hong_Kong

 

Thanks! Certainly seems to be worth to give it a second look.

[xxx1313]

yadayada, many thanks for sharing this idea. Texhong textile seems to be a decent company (no scam) and the stock is too cheap to ignore. Despite of being first mover to Vietnam, Texhong still has 60 % of its spindles in China (1.2 million out of about 2 million) and has grown in China by taking over weak rivals. Even though rising international cotton prices are bad for Texhong and hurt profitability of its operations in Vietnam, I feel its stock is oversold and too cheap. So I had to buy a small piece of this.

[cameronfen]

This definitely looks like a cheap company but there is a good chance earnings this year will be really bad.  I did a lot of regressions and it turns out the  the spread (or Margin) between China Cotton Prices and World Prices isn't actually a good predictor of Gross Margins (or Gross Profit or net Profit or Net Margins).  The R^2 is only .15.  The coefficient fails the t test on the 10% level of significance and I think it even fails on the 20% level (granted only 12 data points were used so if there is a weak correlation between the two it could still fail the ttest). 

 

A better predictor of Gross Margins is actually last year's inventory as a percentage of revenue (still not very good though).  This year the number was .28 which is higher that it has ever been (and higher than in 2010 which was .25 and the company earned only 61 million RMB the next year).  Combining the two predictors we have a better regression.  The R^2 is about .31 which is still really low.  The two coefficients won't pass a t test separately or an f test (basically a t test for more than 1 variable) jointly on the 10% level. 

 

This regression predicts next year's gross margins will be centered around 10%.  You should take this with a grain of salt though because the confidence interval on this answer probably varies from negative gross margins to gross margins in the 20s (I have forgotten how to calculate confidence intervals on a predicted value though so you will have to live with that approximation).  This means net margins will be centered around 2% and revenues (which are really well estimated by total asset size (which seems to make a lot of sense)) will be around 10 billion yuan.  This means the company could potentially make only 200 million yuan this year and so the company will be trading at like 28 times earnings and will probably sink in the short term. 

 

That being said 200 million is nowhere close to the normalized earnings power of this company and additionally the company is not actually all that dependent on the spread between China's cotton prices and World Cotton prices.  Average Gross margins and Net Margins were actually higher before the company went into Vietnam than after it did (even after taking out 2011 when cotton prices sky rocketed).  The company's China division actually earned something like 400 million yuan last year (before the bargain purchase write up) , which is 40% of Texhong's earnings (again before the bargain purchase write up).  The company has more spindles in China than in Vietnam, so perhaps it is true that the Vietnam's spindles are more profitable but they are only marginally more profitable and Texhong will still make ridiculous profits (for it's market cap) even if the cotton arbitrage goes away. 

 

This company's competitive advantage probably comes from its scale (or something else) and not from its Vietnam operations (or only marginally) and so even if earnings go to 200 million, that won't be where they will stay as China manufacturers will at some point resume purchasing textiles when they get more visibility on cotton prices.  Not in the stock yet.  Will probably be in it if some capital frees up.  I've attached my excel spreadsheets and my regression outputs. 

Regressions_Cotton_Prices_and_TexHong.docx

Texhong_cotton_data.xlsx

[yadayada]

hey thanks for analyzing it. I was thinking the same thing haha. I think the spread became big after 2008 right?

 

Also according to this, price per ton is around 16500 rmb right? which is like 2600$ per ton or so?

 

http://www.investing.com/commodities/us-cotton-no.2

This says 90 cents per pound? Is that right?

 

One tonne is 2204 pounds. So if i do 2600/2204 I get 1.18$ per pound. Which is still a 31% spread? And 16500 seems the already lowered price of cotton.

 

http://www.cottoninc.com/corporate/Market-Data/SupplyChainInsights/China-Cotton-Market-01-11/china_center_of_cotton_market.pdf

 

If you scroll all the way down you see that the spread between A index and C index was pretty steady.

 

But it seems:

http://www.agprofessional.com/news/Chinas-new-cotton-policy-255183231.html

 

So the cotton spread no longer exists now as mills can buy at normal prices now? If you look at the stock price, it started to crater right after this news.

[yadayada]

Ok I did some research.

http://www.cottoninc.com/corporate/Market-Data/SupplyChainInsights/Chinese-Cotton-Policy/item14783.cfm

 

The cotton market in china worked like this. The government would give farmers the option to sell to government reserves for a premium or sell to mills. Because prices of reserves are higher most end up selling to government ofcourse. And because of the lack of cheap alternatives they also sell to mills.

 

domestic  production is not enough to feed all the mills so they also import. And on imports they seem to tax a 30-40% tariff. This also keeps the price  highers for farmers if they sell directly to mills. But that is probably lower some of the time then the price mills pay to government (if for example price spread is more like 80%).

 

Now because of the 2011 bubble (increased domestic cotton production due to higher prices) and because they just bought too much cotton in general their reserves are too high, and the price they charge is too high. So they lowered the price. There will also be a temporary cut in tarriffs to incentivize mills to buy government cotton which seems often to be of lower quality.

http://www.reuters.com/article/2014/03/27/china-cotton-idUSL4N0MO23F20140327

 

It seems because of the cotton bubble farmers increased production. And they just sold it into the higher bidding government reserves, which is why they are too bloated now.

 

But i still feel I am missing something here. They started buying cotton from farmers only in 2008. Before there were tariffs too. And Texhong had 7-15% net profit margins before 2008. So I wonder, at what prices did farmers sell cotton before 2008? They are much less advanced then US farmers, so they need to sell at a higher price right?

 

Also the wide spread will still exist for at least one or two years because they have to sell their huge reserves of cotton. They can't just sell them at US market prices because that would be bad for their balance sheet and their farmers.

 

Check page 10, and you see they didnt buy at higher prices from farmers before 2008

http://www.usda.gov/oce/forum/2014_Speeches/MacDonald_ppt.pdf

 

[yadayada]

srry for the spam of posts. @cameron, you put in your spreadsheet the price Bejing pays for cotton. But that is different then the average price mills pay for cotton  in China. For example the spread was 80% in 2012. But was that the average price?

 

Also there seems to be a limit on how much cotton the government buys. So cotton is either bought at lower prices directly from farmers, from the government for those really high prices or imported with a max of 40% increase of US prices due to tariffs.

 

Now it seems the government will stop buying cotton for increased prices and just pay the farmers subsidy instead to sell it for lower prices. But it seems the tariff will mostly keep existing. So the price spread will not go away. It will only become smaller over time. But if they already make 400 million with their chinese mills, then you can at least expect that with the same capacity in Vietnam, and with added (but decreased) price spread, they can at least make close to a billion RMB in the future? Also due to lower cotton prices, the Chinese mills will make a bit more as well. But not much probably because other mills can also charge lower prices.

 

If you think 8-900 million RMB is on average the bottom. And there is potential for closer to 1.5 billion RMB of net income while the Chinese government is trying to get rid of their cotton stash. This is because mills can either buy from government, from US for (temporarily) reduced tariffs or from farmers directly. So the price they pay on average will be somewhere in between of those 3 prices. But as long as government keeps selling cotton for lower prices, that also means cotton in the US is cheaper due to decreased demand. So that shouldn't affect the spread on the short term  that much.

 

And with a 9x multiple on 800 million RMB, that is still like 56% upside in the bear case. and several 100% upside in the bull case.

 

Does this sound right?

[xxx1313]

I would expect margins in China for Texhong to expand, because they purchase cotton in China at lower prices now. Even though margins in Vietnam will contract much more, I do not expect Texhong's earnings to go to zero (nearly). I do not know how they model this, but for example Standard Chartered now expects Texhong to earn 30 - 40 % less in 2014 compared to 2013. This would still result in a low P/E of about 6.5 (and P/E of 4.5 in 2015). They have a price target of 8,90 HKD.

[yadayada]

yeah but i dont get how they will make so much less on the short term? 40% lower profit margins is about 600 million in net income in 2014 correct? Because China's government still needs to offload stockpiles which is more then half of china's annual cotton consumption (and currently that premium is still more then 30%). And because of reduced imports, the price of US cotton will also go down. And this is still sold at premiums. So why would their margins in Vietnam collapse? They are essentially going back to pre 2008 price levels.

 

They made 400 million RMB in China right? This is with 1 million spindles.

 

Also in last 2 months of 2013 due to increase of prodcution facilities, they produced 32k tons of yarn/month vs 20k tons in the rest of 2013. Total production was 284k tonnes of yarn in 2013. But if you assume the 32k monthly production of last 2 months that is already 384k tonnes (not counting the added capacity in 2014.) Or a 35% increase.  And 250k will come online in july. And about 600k came online in Q4 in 2013, most of those in vietnam. Vietnam production is about 750k spindles now.

 

So now they have about 730k spindles in vietnam and 1.1 million in China. So add 258k spindles in july 2014, that is another 14% increase. So 36k tonnes per month? Or about 430k a year. Which is a 54% increase I guess. So about 13 billion RMB in revenue for Texhong in 2015 (allthough another 120k spindles will be added in turkey then). So how will they have only 4.6% net profit margins? This would assume that Vietnam operations will not make any money? There is still a pretty large spread, so that doesn't seem right.

 

If you assume a 7% net profit margin that is still 900 million RMB. And almost 100% upside.

 

BUT this is historically before China government started buying from their farmers and before demand for textile was as high in China. Revenue mix was mostly China with those 7% profit margins and not Vietnam. So I fail to see how net income will be 40% lower :/ . Because the spread will still exist and China business will make more money with decreasing spread, but not more per spindle then Vietnam (because spread will not go away). They also have more scale advantages now.

 

For example in 2007 there was 17% production in Vietnam. And net profit margins were 7.2%. They had smaller scale and China gov didn't buy cotton from the farmers at higher prices. There were just the import tariffs.

 

Anyone has a take on this?

[xxx1313]

Earnings in 2013 were 1.126 million RMB and artificially high because of "badwill" amounting to over 200 million RMB from company takeovers below book value. If earnings in 2014 would come in at 820 million RMB (analyst consensus estimate according to Bloomberg), that would be 27 % below 2014 numbers (not 40 %, but still). This apparent earnings collapse is mostly attributable to one-time items in 2013.

 

Right, before 2008 they had a 7 % net profit margin (fluctuating between 5 and 10 %). With 7 % net profit margin in 2015, P/E would be somewhere between 4 and 5. Very cheap!

[yadayada]

Earnings in 2013 were 1.126 million RMB and artificially high because of "badwill" amounting to over 200 million RMB from company takeovers below book value. If earnings in 2014 would come in at 820 million RMB (analyst consensus estimate according to Bloomberg), that would be 27 % below 2014 numbers (not 40 %, but still). This apparent earnings collapse is mostly attributable to one-time items in 2013.

 

Right, before 2008 they had a 7 % net profit margin (fluctuating between 5 and 10 %). With 7 % net profit margin in 2015, P/E would be somewhere between 4 and 5. Very cheap!

yeah and given that they made 400 million in China, they now have bigger capacity in China and lower costs, they will probably make 600 million in China in 2014? This would mean only 200 million in Vietnam. So it seems 820 million RMB is really a bear case with much more capacity..

 

Also this article is interesting:

http://www.cottoninc.com/corporate/Market-Data/SupplyChainInsights/Chinese-Cotton-Policy/Chinese-Cotton-Policy-PDF.pdf

 

Apparantly their scale is a nice edge when it comes to purchasing cotton.. They have the right to buy cotton cheaper then the smaller mills in China.

 

hmmm. Anyone else making this a large position too?

[cameronfen]

@yadayada I used Beijing Spot Prices #2 cotton.  This is what bloomberg suggested when I searched for Beijing Spot cotton Prices which seemed to me to be the main market for cotton in my research.  I don't think Bloomberg had information on average mill price.  I didn't know mills paid so much less for cotton (I have a hard time believing it is 80% less).  I would guess the cotton that mills buy is very correlated with the spot price.  It may be cheaper because they buy in bulk but goes up and down with the spot.  (Also note: If you look at tab 2 on the spreadsheet you will notice that the Beijing Spot prices that I put into my regression are the 12 month average price over the year.) 

 

The reason why I think earnings may collapse this year is not because of the spread between cotton prices, but mainly because inventory levels are higher than they have ever been.  Inventory usually tends to predict next years earnings (and has for Texhong) because high inventory levels suggests that their textiles aren't selling well and they probably have to cut prices.  The thing to look for, in my opinion, is to try and figure out why apparel manufacturers aren't buying textiles from Texhong right now.  My guess is this is only cyclical/ based on uncertainty over textile prices and not secular, but I will do my best to find out (I will ask my friend in China who speaks better Chinese than me). 

 

I wouldn't just slap a 7% net profit margin on this years revenue as this years projection of earnings.  There is probably a 75% chance that margins will be worse than that this year. 

[yadayada]

If you look at the ratio of finished goods to revenue is higher because they added so much capacity later in 2013. Like 600k spindles, which was like a 50% added capacity on previous 1.2 million spindles or so. They produced a lot more finished goods in the last 2 months of 2013 then in the rest of the year. I think that is why it looks so high compared to revenue.

 

Production was 32k tonnes in last two monnths, instead of 20k tonnes. So if you do 32k/20k that is 60%. Finished good stockpiles were 73% higher then previous year. But they also added some capacity in early 2013. So it seems to match up?

 

This is also why raw materials is higher. It was higher in 2010 due to higher prices. But that isnt the case now. Because of inreased capacity they need higher stockpiles of raw material.

 

Oh and thanks for posting that spreadsheet btw, very helpfull :) .

 

I dont think all mills get their cotton from bejing. There is a 40% cap on import taxes. So if the spread was 80%, that would mean the spread they charged mills from their stockpiles was even higher then that (which seems unlikely).

[cameronfen]

What worried me is in the MD&A management did mention that inventory was unusually high because they were having difficultly selling textiles at the end of the year.  The high levels of inventory seems to agree with this.  I didn't really check the composition of inventory though...

[xxx1313]

Trading halt today, pending the release of an announcement "in relation to inside information of the Company".