HEXZA (Hexza Corporation Bhd) is primarily a manufacturer and seller of formaldehyde based adhesives and resins for timber related industries, ethyl alcohol, natural vinegar, cooler, liquified carbon dioxide and kaoling wine. It is a small-cap stock ($84M market cap at closing price $0.65), listed on the Main Board. The company has a financially strong balance sheet, with a net cash of $0.27, and growing. At $0.65, the business is available for only $0.38, or trading at a very undemanding P/E of 3.3 (net of cash), or 5.7 (inclusive of cash). 2007 (FYE 31 Jan) net earnings grew strongly from $0.081 to $0.115, or an impressive 42% growth. The company paid a small dividend last year. I am speculating that the company may increase dividends this year. On 7 Mar, 2007, the M.D. (Datuk Dr Foong Weng Sum) informed Bursa of its intention to deal in its shares (I am speculating that he intends to buy more, because of its good earnings results and possible increase in dividends). Despite being a fundamentally sound and under-valued small cap, Bursa eResearch does not cover the stock. The company released its quarterly earnings report last night, which was better than I expected. Fundamentally, my intrinsic value would be at least $1 to $1.50. But don't expect the stock to reach this price soon - unless more analysts follow the stock and a single institution/fund starts buying the stock in a signficant manner. In the last 6 months, the stock price has increased nicely from $0.50 to $0.65 (nearly 30% increase approx) Despite this, the stock still looks cheap. Future price catalysts may be upcoming M.D. disclosure of HEXZA transactions if any (possibly late March, or April), upcoming dividend announcement (usually end May/early June, although the pending change in company year end from 31 Jan to 30 June might delay this), and the next quarterly earnings. Downside risk seems limited - my personal liquidation value of this stock is around $0.64, and technically, there seems to be fairly decent support at $0.60.
(Newly completed ethanol plant with enhanced quality and capacity - source 2006 Annual Report).
QUARTERLY EARNINGS RESULTS
Some quick observations are:
1. Nice increase in revenues in last 3 quarters (over $40M per quarter) compared to same period last year. I suspect this is due to both higher prices as well as increased capacity.
2. Decent increase in gross and net of tax margins in 2007, vs 2006. I suspect despite the increase in raw materials this year, the company manages to pass on the higher costs in the form of increased prices, as well as controlling its costs. Tax rates not a significant factor.
3. 2007 bottom-line increased 42%, an impressive growth.
1. Nice increase in revenues in last 3 quarters (over $40M per quarter) compared to same period last year. I suspect this is due to both higher prices as well as increased capacity.
2. Decent increase in gross and net of tax margins in 2007, vs 2006. I suspect despite the increase in raw materials this year, the company manages to pass on the higher costs in the form of increased prices, as well as controlling its costs. Tax rates not a significant factor.
3. 2007 bottom-line increased 42%, an impressive growth.
EARNINGS LAST 8 YEARS
My quick observations are:
1. Always profitable in last 8 years.
2. Still decent profitability in worst year (FYE2004, at 4.3% - i.e. fairly decent still).
3. Personal estimate of liquidation price of $0.64 is close to yesterday's closing of $0.65. The valuation basis assumes 100% cash, 80% receivables, 70% inventories, 50% Plant, Property Equipment as assets (and putting nil value on all the other assets - extremely conservative), and 100% of both current and non-current liabilities. In other words, despite the huge earnings, cashflow, etc. the market is valuing HEXZA close to its liquidation value, which, in my opinion is clearly irrational. To me, this is just one of many examples that Malaysia stock market is still inefficient.
BALANCE SHEET
2. Still decent profitability in worst year (FYE2004, at 4.3% - i.e. fairly decent still).
3. Personal estimate of liquidation price of $0.64 is close to yesterday's closing of $0.65. The valuation basis assumes 100% cash, 80% receivables, 70% inventories, 50% Plant, Property Equipment as assets (and putting nil value on all the other assets - extremely conservative), and 100% of both current and non-current liabilities. In other words, despite the huge earnings, cashflow, etc. the market is valuing HEXZA close to its liquidation value, which, in my opinion is clearly irrational. To me, this is just one of many examples that Malaysia stock market is still inefficient.
BALANCE SHEET
Some quick comments:
1. Strong debt management and control. Nil debt in 2006, small debt in 2007. Company pared down debt in Q4/07 quickly, which I like since this is good for profits.
2. Nice net cash position. Nice growth in cash balance from $24M to $36M (Q4/07).
3. Nice working capital (=Net Current Asset Value). Nice to see it steadily growing.
4. Fairly steady Fixed Assets.
5. Inventories nice. (Q4/07 is lower).
6. Receivables okay (due to increased Revenue).
DIVIDEND HISTORY
Some quick comments:
1. HEXZA is traditionally a small dividend payor. (Net of tax Dividend Yield is only 2.2%).
2. Small dividend increase past 2 years.
3. I am speculating whether HEXZA will declare bigger dividends in 2007, in view of its excellent 2007 earnings results, nice cashflow, increasing cash hoard, and M.D.'s intention to deal in HEXZA securities recently. Current dividend cost is only $1.9M, whereas its cash balance has increased $12M and its PAT increased $15M. Financially, HEXZA can easily afford doubling its dividend this year ...
TOP SHAREHOLDINGS & DISTRIBUTION OF SHAREHOLDERS
Some quick observations:
1. No EPF presence - doesn't appear in the Top 30 list, but the Ministry of Finance does at #18.
2. Absence of major funds ownership - seems mostly individuals. (positive, since first fund move will be beneficial to price).
2. Absence of major funds ownership - seems mostly individuals. (positive, since first fund move will be beneficial to price).
3. Significant insider ownership. Summit Holdings (#1) is owned by the Foong brothers. They own nearly $20M worth of shares in HEXZA. The M.D's pay is nearly $1M, i.e. he should be reasonably motivated by his HEXZA share performance.
4. Predominance of small investors - many holding less than 1,000 shares.
HISTORICAL PRICE CHART
Some quick observations:
1. Share price experienced nice growth over the last 6 months (although end Feb correction can be quite volatile due to small cap).
2. The long-term trend is an increase in prices (as indicated by the lower and increasing 200 day moving average - the correction is clearly irrational).
3. Fairly decent support at $0.60, but expected to grow with more investors knowing its true value. In the last correction (end Feb), the stock fell below $0.60 and quickly rebounded. In the smaller correction following that (early Mar), it rebounded above $0.60. The stock seems to have strong support at $0.60, below its liquidation price, but that may only be temporary. I expect as more investors are aware of its true intrinsic value, the support will rise over time.
1. Share price experienced nice growth over the last 6 months (although end Feb correction can be quite volatile due to small cap).
2. The long-term trend is an increase in prices (as indicated by the lower and increasing 200 day moving average - the correction is clearly irrational).
3. Fairly decent support at $0.60, but expected to grow with more investors knowing its true value. In the last correction (end Feb), the stock fell below $0.60 and quickly rebounded. In the smaller correction following that (early Mar), it rebounded above $0.60. The stock seems to have strong support at $0.60, below its liquidation price, but that may only be temporary. I expect as more investors are aware of its true intrinsic value, the support will rise over time.
INTRINSIC VALUE / TARGET PRICE
To me, HEXZA as a Main Board company should be valued at least 8 times earnings or higher. Trading at only 3.3 times net of cash is ridiculous. (E.g. Bigger companies should consider acquiring HEXZA since it would easily increase their earnings going forward). A P/E of 8 is not unreasonable, given that HEXZA strong earnings growth in the past, consistently profitable history, as well as its increased capacity. As such, I would put a fair value of HEXZA at $0.27 (cash) + 8 x 0.115 (2007 EPS) = $1.20 say, or say around $1 to $1.50. But don't expect the stock price to rise overnight - see Risks.
RISKS OF OWNING THIS STOCK
1. Perceived unexciting/slow/little price appreciation. This perception is actually incorrect, as the stock has appreciated nicely 6 months ago, from around $0.50 to $0.65, or nearly 30% gain. It's still a penny stock at $0.65.
2. Few/no analyst and institutional investors following / owning it, so, share price might not get a similar boost to followed stocks. Still, this is a risk worth taking, since there is little downside, with lots of potential upside should this come to fruition.
3. Continued low dividend yields. Management might continue to be conservative, and not increase dividends. The risk is lower, but should it happen, I would consider liquidating the stock, and put the funds to better uses elsewhere.
CONCLUSION
At $0.65, HEXZA is still very cheap from a fundamental perspective despite its decent price increase in last 6 months. I think it should be valued at at least $1, if not more. The problem clearly lies in the inefficient Malaysian stock market for small caps - the vast majority of ordinary investors probably aren't aware of the company's compelling valuations or its recent excellent earnings growth. Its prudent and conservative management, and low past dividends also contributed to this perception. There are some indications that this could change (e.g. increased dividends last 2 years, possible Director buying in March 2007), but this is far from certain. Investors preferring greater certainty (and possibly lower returns) are better off delaying purchase, e.g. until after the Director has reported his actions more clearly, or waiting for the actual dividend announcement (normally announced in May 2007). On the other hand, those with surplus cash might want to consider parking some of their cash in HEXZA now, as the downside risk seems low compared to the potential upside. If you have surplus cash, BUY some now and the rest on weakness.
Disclaimer: Today, I purchased more of this stock at $0.65-$0.67, just before the CI correction happened later in the morning, to bring my average cost to around $0.61.
