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Saturday, May 5, 2007

HEXZA - Financial Results Update

HEXZA posted its "quarterly" financial results last night. It might be surprising since it has just posted its previous earnings results just over a month ago (27 Mar). The reason is due to the change in the company's financial year-end (from 31 January to 30 June) - the company has therefore announced the results for 31 March 07 (14 months), and there should be another one for 30 June 2007 to complete its new financial year end. For convenience, I have labelled the 2 month period from 1 Feb-31Mar as "Q5/07", but note that this is only 2/3rd of a traditional quarter.

QUARTERLY EARNINGS

Quick comments:
1. Q1/07 relates to the 3 month period from 1 Feb 06-30 Apr 06. We can compare Q5/07 with 2/3rds of Q1/07.
2. Revenue for Q5/07 is proportionately better than Q1/07, despite Q1/07 being a traditionally slower quarter.
3. PBT and PAT however is proportionately worse.
4. In the notes, the company attributed the reduced earnings to a rise in raw material costs. Whilst the company does not try to hide and instead draws shareholder's attention to the proportionately worse earnings results, they have also not elaborated further. My feeling is that two months may be too short a period to judge, as final product price rises & fall tend to lag costs rise & fall.

BALANCE SHEET

Quick Comments:
1. Total borrowings continue to inch downwards - ok.
2. Long term debt continues to inch downwards - ok, since long term debts typically carries higher finance costs, and I take comfort that the traditional company strength and culture is still intact.
3. Inventory and Receivables - ok.
4. Cash inch upwards - good.
5. Net Assets continue to grow albeit slowly, from $1.26 to $1.27.
6. Liquidation price (same basis as before) continues to grow, from $0.63 to $0.65. (Note that number of shares outstanding has grown slightly due to ESOS).
7. Balance sheet is still strong overall and improving slightly.

REVISED P/E AND MARGIN OF SAFETY
If we assume Q1/07 revenue and earnings are uniformly distributed over the 3 month period (even though we know they are not), then, the TTM PAT = $14.2M, representing a slight reduction from $14.8M previously. At yesterday's closing price of $0.69, the company is capitalized at $89.2M. Net cash is $34.9M. The business is effectively capitalized at $89.2 - $34.9 = $54.3M. This gives a net of cash P/E of 3.7, which is still undemanding. With NTA/share at $1.27, and liquidation price of $0.65, current price of $0.69 still affords quite a significant amount of margin of safety.

TECHNICAL


(courtesy of tradesignum.com)
Since my first posting on HEXZA (Mar 28), the stock price has generally advanced up to Apr 10 with a "doji". Note the long upper shadow and the relatively high volume (which is slightly different from past false dojis). The next day (coincided with the irrationally bearish 10 April news article on Pioneer, Nipah Palm and Ethanol - see my 30 April posting) provided confirmation that the bulls have lost and the price starts its downward trend up to Apr 19. On Apr 20, the green candle provided confirmation that the bears has lost. Apr 27 - red candle, lower volume - potential reversal. Apr 30 - undecided, but May 3 confirmed downtrend. May 4 - slowing down, increased volume. Downtrend is still possible next week. I will be looking to accumulate on further weakness, after trading some of my HEXZA holdings earlier this week. However, I don't expect to make significant gains from trading since it's quite clear that there are more exciting "trading stocks" around that affords much higher potential gains. For me, it is largely to gain more trading experience, as well as earning extra interest whilst waiting for the catalyst to emerge (if any), not to mention always having a position in a fundamentally sound stock.

DIRECTOR UPDATES
In addition to his earlier filing on 7 March, the M.D. has filed his intention to deal in shares during the closed period again on 6 April. So far no activity has been reported to Bursa. It pays to continue to watch the M.D.'s movements closely.

CONCLUSION
Whilst the proportionately lower Q5/07 earnings and the rise in raw material costs is something to watch out for, it is too early to make a definitive conclusion that future earnings will be permanently impaired. Balance sheet is still strong and solid, the company still continue to manage its business well, so, at this stage, I would say the results are still well within reasonable parameters. At $0.69, I believe it is still trading at a rather undemanding valuation.

2 comments:

Maxforce said...

Thanks for the update.
The results I find a little disappointing - while revenue is proportionately higher, the profit is proportionately lower.
This you've highlighted as in comparison to Q1.

Rise in raw material was cited as the reasoning. So unless there is some measures being taken to reduce this - either by bigger lot size or perhaps some radical changes to the delivery or supply of raw materials, the effect would be "permanent".

Basically, personally I dislike it when declining profit is due to decline in gross profit (GP). This is because it is more difficult to make countermeasure if the problem is in GP and just PBT/PAT.
(Cost of Sales vs Operating Expenses)

Look forward to your opinion. Thank you.

Seng said...

Max,

You're welcome. Yes, the result can be a little dissappointing, but I think it is also to be expected since businesses cannot fully escape from operating within economic cycles and volatility.

Usually, if raw material cost rises AND becomes permanent, it is usually just a matter of time before the entire industry (including HEXZA) is forced to raise prices. In times like this, adversity favors the cash-rich, low debt, efficiently managed companies, like HEXZA.

In the worst case scenario (assuming raw material cost increases permanently, AND prices remained unchanged), then, HEXZA earnings would drop 30% (based on last 2 months experience, extrapolated to infinite future). This raises the P/E from 3.7 to 5.3. If that's the worst case scenario, and the liquidation price is $0.65, then, I can live with it.

I believe it's important to invest in accordance to one's own beliefs. If you dislike it, it's better to sell down to your own "sleeping point". There's no point owning something if we cannot sleep. For HEXZA, when its price suddenly moved upwards so quickly, I took the opportunity to sell some of my holdings, to reduce my average cost down to $0.56. (See my earlier posting on Rule No 1, point 10).

I still own HEXZA and am now looking to increase my HEXZA holdings using TA. It's possible the price might continue to fall further next week, due to the lower earnings, and might fall below $0.65 even. To me, Mr market would be irrational then, but I'm not going to argue with him, and will try to profit from his folly ... :-)

As usual, use your own judgement and invests at your own risk.

Cheers,