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Saturday, May 12, 2007


I must admit I didn't monitor the stock market yesterday afternoon - I was too occupied writing the article on OSKVI besides other things. So, my eyes nearly popped out when I saw HEXZA price after market closing - HEXZA had made a nice price gain, closing at $0.76, up 7.5 sen or 10.9%. That's decent for a stock that is normally quiet with relatively lowish volume traded ... :-)

Naturally, I was curious as to why. Then today, I happened to visit Moola's blog, and noted his posting on HEXZA this morning. Reading it, there was a Star Article published this morning with Buy Call for HEXZA. Aha ... the light bulb lits ...

So, here's my usual highlighting of the full article (courtesy of biznewsdb.com) with my comments. As usual, use your own judgement, and invest at your own risk.


Hexza at one-month high
Updated : 12-05-2007
Media : The Star
Story By : YVONNE TAN via www.biznewsdb.com

PETALING JAYA: Hexza Corp Bhd shares hit a one-month high of 77 sen yesterday after a local brokerage initiated a "buy" call [1] on the counter, on prospects of the company's profits escalating [2] and a higher dividend [3].

In a report released yesterday, SBB Securities Sdn Bhd senior analyst Ng Jun Sheng said he regarded Hexza as a "hidden gem" [4], given its stable growth and abundant net cash.

The adhesive resins division, which is one of Hexza's two main divisions, is targeted at timber-related industries.

Its ethanol division is the largest ethanol products manufacturer in the country, with more than 60% market share.

For the financial year ended Jan 31, Hexza's turnover jumped 22.7% to RM159.6mil, thanks to expanded production capacity in its ethanol division and rising demand for adhesive resins.

Despite higher raw material prices, the company's bottomline expanded 42.2% to RM14.8mil, spurred by earnings before interest and tax margins of 11.7% on efficiency gains and economies of scale¨ Ng said.

He is targeting a compounded annual growth rate (CAGR) of 21.8% in net earnings from 2006 to 2008 [5] on higher sales from both divisions, buoyed by increased production capacity and recovery in timber-related sectors.

Earnings before interest and tax margins were likely to improve to above 11%, Ng said.

This would be driven mainly by economies of scale and production efficiency, selling price adjustments, stringent cost control and stabilising raw material prices [6], he added.

Ng said Hexza's competitive advantage was its technology and innovativeness.

Its focus on using material science to help customers attain their goals has established Hexza as one of the top leaders in the ethanol and adhesive resins business.

Going forward, Hexza is expected to continue to invest in state-of-the-art equipment to stay ahead of its competitors,¨ he added.

Ng said shareholders could look forward to higher dividends, given Hexza's strong net cash of RM35mil (or 27.2 sen per share), healthy net cashflow of RM10mil to RM13mil every year and low capital expenditure requirements.

Ng does not discount the possibility of Hexza being taken private in future if its share price does not reflect its true potential¨, and its strong intrinsic value.

To this, however, a senior management staff told StarBiz: "Not in the near-term¨,[7] but added that the company's future remained bright.

Hexza shares closed 7.5 sen higher at 76 sen yesterday.

Ng values the company at RM1, ascribing a price-earnings ratio of 8.3 times [8] on earnings per share for the year ending June 30, 2008 of 12 sen.


My quick comments:

[1] Newspaper journalists tend to sensationalize. Technically, SBB did not just "initiated" but has made Buy Calls on HEXZA in the past. It is a shame the Star editors didn't pick this up. Nevertheless, it is comforting to note SBB still thinks it is a Buy, despite the recent price increases.

[2] Just bear in mind that the last 2 month earnings for "Q5/07" is proportionately worse, not better. Something to watch out for for next quarter earnings report.

[3] It is important to mention that the prospect of higher dividends is just that - a prospect. There are no guarantees, and they are probably just odds at this stage. Nevertheless, I take comfort that HEXZA has a nice cash hoard, dividend increase history in last 3 years, good earnings and cashflow well in excess of what's need to pay say a 50% dividend increase (despite the recent 2 month drop in earnings). So, I lean towards SBB here - the odds are good, despite the proportionately worse earnings (unless there is continued drastic drop, which I'm not expecting).

[4] As this will be my 7th posting on HEXZA, I guess it should not be "hidden" to regular visitors here ... :-)

[5] This is a rather strange period, given that HEXZA has already completed 2007 FY (ending 31 Jan, although this is now changed to 30 June). During FY 2006-2007 (which I define as starting from 1 Feb 2005 - 31 Jan 2007), HEXZA earnings already grew nearly 80%, or 21.6% p.a. if compound over 3 year period. If so, then, it implies that HEXZA earnings will not grow in FY 2008, which is possible. However, it is also possible that my reading of the article could be wrong. Suggest better to continue to monitor HEXZA earnings.

[6] Stabilizing raw material prices ... hmmnn ... perhaps more knowledgeable readers on HEXZA's business model may comment more intelligently here. Superficially, it seems to contradict the most recent earnings report, although the earnings report is only up-to-date to 31 March.

[7] I tend to lean towards with HEXZA management, that they are unlikely to privatise in the near term, especially given the recent price increase.

[8] It looks like both SBB and myself agreed that HEXZA is probably still under-valued at $0.765, although the degree (and margin of safety) has clearly lessened when I first made the call at $0.65-$0.67. Technically, yesterday was a bullish signal, with support zones at $0.72-$0.74, and second support at $0.70. Previous 12m high of $0.78-$0.80 might be a resistance, but if it breaks through that, then, $0.85 might be the next resistance.

Disclaimer: As usual, use your own judgement and invest at your own risk. Remember that chart signals can potentially change very quickly (depending on your trading time-frames), so, trade at your own risk too.


grahamsmun said...

Add a few more points;
1)Raw material by right should be coming down instead of up ie if u look into sugar price it has fallen from dec06 to mar07 by right the molasses price should track sugar price.Same apply to resin and glue should track the crude oil price had since stabilise. But based on Hexza results the material price is up is there a lagging effects.
2)Looking at the operating cashflow it generate positive Rm 3m for the quarter but the balance sheet the cash position remain the same.Reason Rm 3m is used to pay other creditor which a big portion used to pay related party transaction ie owner building cash reserve for greater scheme of things!
3)There is about Rm 4m unrealised gain from the cost of quoted investment amounting Rm 14m.If taking into a/c quoted investment the cash position per share should be Rm0.39 per share(exc unrealised profit) instead.

Seng said...

Thanks for your comments.

1) To be honest, I'm not sure if that (using molasses) is the primary way that HEXZA use to produce ethanol. I understand there are many ways to produce ethanol. For example, in the US, the main feedstock is corn, and corn prices have actually gone up this year. Just curious how you know that HEXZA uses molasses and not some other raw material - if you could quote your source, that would be great as it would save me time. Thanks.

3) Yes, HEXZA also holds quoted securities. There is $18.5M at 31/3/07 (in which $14M is recorded as Book Value), which I haven't included in the Net Cash, since I defined Net Cash = Cash (including F.D.) - Total Borrowings. I have also seen definitions which include a % of quoted securities (to reflect volatility), and in HEXZA's case, is probably just as valid. If one were to include the Book Value of quoted securities (which implies 14/18.5=76% of MV - not unreasonable), then, the Net Cash is increased by 14/129 = $0.11 per share. This is a nice additional safety margin which has always been there, but worth pointing out.

Note however that a 30% potential decline in long-term earnings can have a greater impact once capitalized. E.g. if long-term earnings is say $0.12, 30% drop = $0.036, and when capitalized even at a modest P/E of 5, gives a drop of $0.18 to its Intrinsic Value. Personally, I am not 100% convinced yet that FY 2008 will drop by 30% (and as I mentioned to Max earlier, even if it did, HEXZA would still trade at an undemanding P/E), but Q5/07 does indicate signs of earnings flattening/dropping slightly. Notwithstanding this, I believe the P/E traded is still undemanding, especially when one includes a % of quoted securities as "cash" as you mentioned.


grahamsmun said...

The raw material source for ethanol is molasses (sugar cane based)can be extracted from 31-1-2005 annual report chairman statement.

Seng said...

Hi Grahamsmun,

Thanks. You are a real jewel in the investment community! Well done.

Actually, there are 2 main types of raw materials for HEXZA depending on which division.

1. Ethanol Division (Chemical Industries). Here, the main raw material is molasses, and you are right that in 2006, the prices have skyrocketed initially, and then started to come down just as dramatically and in 2007 continues to come down. And there appears to be some time-lag effect on HEXZA's earnings. Going forward, the lower international molasses prices should bode well for HEXZA.

2. Resins (Timber) Division. Here, crude oil prices may be a good proxy for HEXZA raw materials i.e. methonol, urea, phenol and melamine. Historically these prices have followed crude oil and liquified natural gas. Crude Oil Prices has actually risen in 2007, and seems to be stabilizing in April/May compared to the start of 2007, although I must say I am not an expert on the future of crude oil prices. In short, the future outlook seems uncertain to me.

So, in conclusion, it seems that the future outlook on HEXZA's raw materials seems promising. There seems to be some time lag effects, and it's not yet clear to me yet how long exactly we're looking at (3 months? 6 months?) without doing further studies. Notwithstanding this, I take comfort that there is some diversification effects from Sugar prices (which seems to depends on crops, draughts, etc.) and Crude Oil prices. Given HEXZA's large margin of safety at current prices, I'm comfortable to leave it at here so far... But if HEXZA prices started to exceed $1, then, we might have to revisit this again. I know it's better to be prepared, but I'm just a one-man team and I can make mistakes if I push myself too hard. Any voluntary help from visitors here would be greatly appreciated.

Having said this, it should be of interest to note that most of the molasses are imported, and HEXZA should also benefit from the appreciating RM.

In short, despite the recent HEXZA price increase, I am cautiously optimistic of HEXZA's future prospects. I would certainly agree with its quarterly earnings comment on its future prospects. At current prices, it is quite clear to me that HEXZA is still trading at a fairly undemanding valuation, given:
1. the extra buffer provided by quoted securities
2. the recent fall in sugar/molasses prices since start of 2007, and potentially stabilizing crude oil prices.
3. an appreciating RM outlook which should reduce the cost of HEXZA's raw material in the future.