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Wednesday, March 28, 2007

HEXZA - Introduction and Quarterly Earnings Comments

INTRODUCTION & SUMMARY

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.


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






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).
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.
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.

19 comments:

greenbull said...

Hi Seng,
Thank you for your blog. I've been following your writings regularly thru' investssmart blog. I hope you will post more so that more people can benefit. I know you own more than 70 stocks in your portfolio. Can you tell me what are your 10 best performing stocks todate?

frenzy said...

seng.

I used to own HEXZA at $0.71 back in 2000. This company do posts decent results but the share price really don't move much. I got tired and sold out at $0.55 last year.

If this bull crystalized, I guess HEXZA may trade near to $0.80 level.

I think this is for really long term investors. Good luck ! :)

Seng said...

Hi greenbull,

Thanks for your kind comments.

I don't normally like to mention my Top 10 best performing stocks. This is because what worked best in the past might not necessarily do as well in the future. Especially for a value investor where the past winners might be fully valued by now, whereas tomorrow's winners are yet to be recognized fairly today.

Nevertheless, as you requested, in % terms, my Top 10 best performing stocks to date are
1. Mahsing (*** Buy $1.41)
2. ICP (*** Buy $1.21-$1.50)
3. Eksons (Ave cost $0.583)
4. Maxis-CA (Ave cost $2.05)
5. Maybulk (Ave cost $2.3)
6. Rohas (Ave cost $1.05)
7. Plenitu (Ave cost $1.26)
8. Liondiv (Ave cost $4.6)
9. PPB (Ave cost $4)
10. BKoon (Ave cost $0.69).

Those marked with *** means that I still own them, except I have more than fully recouped my cost. "Ave cost" can be reduced than original cost if I sell at a higher price. Dividends does not reduce Ave cost, so, my actual cost can be lower than above. I expect to continue trading these stocks, so, over time, the ave cost will change.

How about yourself? What stocks do you like best at the moment? (Do let me know, and if I think they are interesting, I might analyze them further).

Cheers,
Seng.

Seng said...

frenzy,

Sorry to hear that. I would love to own HEXZA at $0.55 - unfortunately, the stock only came into my attention end of last year.

My experience with HEXZA is also quite dissappointing. I first owned a small piece of it at around $0.65 and picked up more as the price falls. Normally, I'm not confident in averaging down, unless I am confident that the stock has very sound fundamentals, and is not going to go bankrupt. In HEXZA's case, I believe it is a fundamentally sound stock.

My regret is that I didn't sell more of HEXZA when its price was trading at around $0.78 recently. Then I could have bring the Ave Cost down to something like $0.50. The TA indicators were clearly screaming SELL in the loudest manner. At that time, I just dismissed TA as a quirk. After the correction, I started to realize that stocks have their own price cycles, and even if you love a stock fundamentally, you can enhance your returns by trading the cycles. TA is not 100% accurate, but good TA practitioners can tilt the odds to their favor. Even a 55% chance of success is enough to make quite a lot of money.

In Malaysia, I believe there are very few Buy & Hold stocks. Eg. the likes of PBBANK and PBB are very rare. Even one of my favorite stocks, MAYBULK, is also not a permanent Buy & Hold stock. I believe, there will come a time (hopefully in a few years time, or longer), when BDI will tank, and MAYBULK face a downcycle, when, it's best to sell and move on to other stocks with better potential. But that's another story.

Anyway, all the best in your future investing. Thanks for sharing your experience.

Maxforce said...

Excellent analysis!
I must congratulate you on the effort and the conservative basis being used in your analysis.
Zonal resistance to monitor 0.66-0.69 which may prove a vital breakout if taken successfully.

Sciencegto said...

Thanks a lot. This blog help me to study about the stock and the market. I just newbie, open cds acc last week and still learning about this. Hope you can share all your analysis and I can make it as a guide.

Sciencegto said...

Actually my first stock now is Sanbumi..I just bought it at 0.86 last Monday. But just 1,000 units only. hehe.. Just try and study slowly. I know this stock is speculative but when I see the chart at February its price can go more than rm1.50-rm1.80 and i thinks its is cheap now. I'm still learning how to value the stock because I'm start from zero.
(sorry for my bad english)

Tan said...

Hi Seng,
Why you dispose Liondiv? I though you very bullish about Parkson?

Seng said...

Hi maxforce.

Thanks for your kind and valuable comments.

I took a closer/shorter-term look at HEXZA's price chart, and from TA perspective, I must agree with your comment on the $0.66-0.68 resistance.

I observed that on Dec 1, it failed to break $0.66 on its first attempt. On Jan 12 (during the start of the bull run), it succeeded, and went on to scale greater heights ($0.74-$0.79) relatively easily. On Mar 1 (during the correction), it fell through $0.66-$0.68 support. On Mar 8, that support appeared to have become a resistance again.

Just curious Maxforce. As a more seasoned TA practitioner, would you personally buy, hold or sell HEXZA and why. More importantly, do you think that my article has influenced your buy/hold/sell decision? My personal suspicion is that TA practioners would normally wait until more of the TA indicators confirms a Buy, but I'm just guessing ...

Anyway, thanks for sharing your comment.

Maxforce said...

Seng,
For me, FA tells me why should I buy this particular share. TA will tell me when.
I do not see the value of intrinsic value, frankly, as I find it too subjective, cannot be reliably quantified and is more of a self fulfilling prophecy.
As a matter of fact, I wrote an article about that in my blog.
Ultimately the market is about supply and demand. Therefore, I find TA the better way to do it. Imagine this, you have invented a product. Superb technology breakthrough that the world has never seen. Experts value your product at 1 million a pc. But there is no demand for it. Say demand came later at 500K a pc. Would the valuation be better using the demand or the valuation by experts?
FA centred using intrinsic value is a contrarian approach. Markets are illogical and always wrong.
TA centred approach would be inclined to agree with the market. The market is always right. Imagine a truck coming from the wrong way of the street, it would be suicidal to stand in the way - adaptation from Jesse Livermore.
TA has many approaches to trading/investing. Personally, I prefer to see breakout. Ride on the first wave of the trend and try to get out and the first sign of the end of the trend. Ideally I would buy at higher price (from breakout) and sell at lower price (start of distribution).
Sometimes, I would even anticipate breakouts. Suicidal for beginners as it cost me some tuition fees previously but now, I find I could quite reliably foreesee if a stock is likely to have the breakout. Also TA based.
Your analysis is superb! The way I would use it is diversification. Some of my portfolios are purely trading, some longer term investing. I cannot afford to monitor too many stocks, unfortunately. Therefore, for Hexza, I will buy in weakness and keep it. How I will bargain hunt will depend on the charts.

Seng said...

Hi sciencegto,

Thanks for dropping by. I'm glad you've decided to take a first step towards stock investing. Unfortunately, I can't comment too much about SANBUMI as I don't currently own the stock.

Good luck!

Seng said...

Hi Tan,

During the correction, I did buy more LIONDIV at $5.95, which is more than I needed to hold ... At $7.20/25, that's a nice gain in less than a month, so, I let that one go and swapped into AMANMFB, mainly to protect my downside, and AMANMFB has the potential for a quick upside gain (although with less certainty). I still hold most of my LIONDIV, and intend to add back on weaknesses ... For my larger holdings, my trading tend to be relatively smaller (say 5% to 50% depending on my confidence), and my LIONDIV trading is less than 20%.

I would apply a similar trading principle to other sound fundamental stocks as well ... I wouldn't sell the majority (as I am long-term bullish in those stocks), but when stock prices do something irrational in the short term, I hope to be able to take advantage of it, and so, I hope to beat a Buy & Hold investor. If I turned out to be wrong, I still have the majority of the stock riding the uptrend. I can do this much activity because I'm retired :-)

Tan said...

Hi Seng,
Must be great to be able to retired and play stock all day, right? ^_^

Seng said...

Maxforce,

Wahh ... many interesting comments ... Thanks.

On intrinsic value, there are many interpretations, and so, you're not wrong when you say it looks subjective to you. Personally, my interpretation of Intrinsic Value(and others can be different) is how much would I be willing to pay for HEXZA if I want to own HEXZA's business in its entirity (assets, liabilities, management, staff, brand, etc.) without any fundamental changes to its business (i.e. with existing management running the business as if there is no change)? (This ties in more with Graham and Buffett's way of thinking) Government bonds are currently yielding less than 4% p.a., HEXZA is a business with more volatile returns, my absolute minimum return expectation would be at least 12% p.a., giving myself a safety margin of 8% (=12% - 4%). A return of 12% is equivalent to a P/E of 8. Others might be stricter - they might demand a minimum return of 15% p.a., or a P/E of 6.7. Conversely others might demand less, as HEXZA earnings are growing - e.g. P/E of 10-12, or maybe even more. That's where I derived my intrinsic value range of $1 to $1.50. Given its NTA is already $1.2x, it's probably close enough, even though I know it is precisely wrong (but approximately right, as Buffett would like to say).

You are right - I am hoping with this and other fundamental blogs that when there are more people starting to think more about how undemanding HEXZA business valuation is (3.3 times less cash), they would slowly change the way they look at HEXZA's business. Hopefully, this will change the supply/demand dynamics in the future, and hopefully, it will get reflected in the price charts. But I realize these at the end of the day can be only "hopes", and a safer, more predictable approach would be to wait for confirmation.

I like your TA approach to pay a bit more on breakouts and to sell a bit earlier on approaching peaks - it minimizes the time the funds are tied into stocks, giving higher annualized returns. My only reservation is that I think I am not skillful enough yet to capitalize on trading - e.g. my buy on HEXZA at $0.67 yesterday is probably regarded by TA as less than 50/50, even though on FA terms, it is extremely compelling. That's why I only trade a minority of my holdings.
Hopefully, I will get better at it over time! :-)

Thanks again for your interesting comments.

Maxforce said...

Seng,

Very happy to see your reply. :)
One more reason to use TA for timing of purchase and sale with the fundamentalist idea of markets are crazy.
Markets are crazy - so its best to use something to measure their craziness!!! :)
I think your assumptions are very conservative as it is. Fundamentally very strong buy. TA wise, very soon, we should see the breakout. This bad habit of mine to time the market - say in two weeks time. OK, its never 100% accurate :P.
TA wise, it has its weaknesses, hence the terms like bear/bull trap, false breakouts, etc. Doubt that there is an actual holy grail. But the odds are of course up to the trader/investor.
Actually my aim is normally to:
1) Buy higher as in after breakout
2) Sell lower after start of downtrend.

Of course, being a greedy person, and also a perfectionist :P, I do try to aim to:
1) Buy before breakout
2) Sell before end of the rally.

Very difficult to do. Sometimes, I ended up wasting commission, after I sold, another breakout happens, a valid one. I reentered, lose a couple of points in opportunity cost and commission fees. But this I do, normally would mitigate the risk I am taking.

I also like your liquidation valuation. Perfecto! It gives a peace of mind, knowing that your money invested would likely grow, instead of falling into the abyss.
Being a TA centred person, plus, I do not have the luxury of time to complete a quality analysis, such as yours, I do not have much safety margin. I naturally take more risk. Of course, I am looking towards reducing this risk, and I am glad to find this blog :)
Keep up the good work!

kim said...

sifu seng,

hope you can come up with more research like this,
we the follower and reader will sure benefit from it.
the best we can do is send to you brands essence of chicken to keep the energy full.

thanks

greenbull said...

hi Seng,
thank you for sharing your counters. i am rather green in equity. i don't have the time nor the inclination to learn ta. fa may be just a little. i find stock market is a good place to build character. you learn to be knowledgeable, unimpulsive, courageous, patient, focussed and calm. just that the tuition fee can be expensive. back to your portfolio, if you were to recommend someone like me five counters to go in at this juncture, basing on fa and ta, what would you recommend? just a suggestion, strictly no obligations either way.

Seng said...

Greenbull,

I'm just reading your comment here in more detail, after having answered your later query under "The Intelligent Investor".

I'm sorry to hear that you personally don't have the time nor inclination to learn TA, and FA "maybe just a little". In my experience, one cannot become very good at investing, if one isn't willing to make the effort. I sense you realize this within you. I encourage you to seek advice from a licensed professional, or consider professional investment management, even if you have to pay them a management fee.

You may not like to hear this, but investing in stock market is not just about me giving you a list of 5 stocks. Once you buy them, what do you do next? If the price goes up by 5 sen, do you sell or do you hold? If it then goes down 10 sen, do you buy more or do you hold? If the next quarterly earnings report show decreased earnings, do you sell or do you hold? To me, it's more complicated than just giving someone unique, like yourself, a list of 5 stocks, and then go away. If I do this, I would personally not like myself, because I think that would be irresponsible, to assume responsibility for recommending stocks to a specific unique individual (in this case, yourself who prefer not to do a lot of study), and then, walking away. Therefore, as a matter of personal principle, I have never recommended any stock to any specific individuals circumstances. Also, it wouldn't be practical. If I start giving tailored stock advice for free, then, everybody would be rushing and asking me. Then, I'll be swamped. So, I hope you understand that whilst I'm happy to share what I buy/sell, what I think about my own stocks, I cannot really give tailored advise to specific individual requests.

grahamsmun said...

Hi Seng,
I find hexza a very good buy with Eps of Rm 0.115 per share,nta about Rm 1.20 and cash backing pershare of Rm 0.35 per share.Operating cashflow per share of Rm 0.12 per share
At present at Rm 0.67 it is trading at a low p/e of 6 times very undevalue.
Actually at this price we are actually buying at a lower price than the major shareholder who purchase the company 20 years ago. The only negative part is that there are many disappointed shareholders who want to get out disregarding FA and some esos of Rm 0.53.Over time we will make alot of money need abit of time.
This is a very wonderful investmnt and i will buy more.
I remember Asiatic has the same problem fluctuate betw Rm 0.50 to Rm 1.30 from 1999 to 2003.Look at the price today more than Rm 5.00.Patience is the 2nd most investment criteria other than knowledge.