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Monday, October 20, 2008

HUAAN: Some rumblings

Firstly, this is NOT an automatic BUY call for HUAAN.

The background is that today, we were chatting about steel stocks in my chatbox, someone mentioned HIAPTEK (a steel stock), I took a quick look at the Balance Sheet and noticed that it has significant borrowings that is larger than its inventory, I am then reminded of HUAAN and wondered if this could be something to watch out for LATER when the market has found "the bottom". Just to be clear, I am still long term bearish on the KLSE, so, let me talk first about my own bearish outlook on the KLCI.

Bearish KLCI Outlook

From the above chart, the important things to note are:
* KLCI is still making new lows as late as this morning (888.28).
* Obvious trend is DOWN since the peak at the start of this year.
* Both 20 day EMA and 200 day EMA are still pointing DOWNWARDS as of today.
* Today's price is well below both EMAs, which is BEARISH.
* Generally speaking, we have yet to see THE BOTTOM, even if this week turns out to be "a bottom".
* The odds are still against long-term investors "buying and holding", and they are better served to wait until they have clearly seen THE bottom.

So, why am I writing about HUAAN?

In two words - Preparation and Discussion.

The attractive part is that the share price has clearly taken a huge whack, since listing in March 2007. Take a look at HUAAN's price chart below.

HUAAN Price Chart

WEEKLY chart since HUAAN's listing in March 2007.

* Opening price on listing day at $1.48 in Mar 2007.

* Found peak price 5 weeks later at $1.79.

* Since then, fallen steadily to close to $0.26 as of today (also new closing low). This is a huge fall, since 26 sen is only 17.5% of Opening Price of $1.48, and only 14.5% of Peak Price of $1.79. However, be careful about picking up stocks like this where the price just made a new low, since it is easy to cut one's fingers whilst trying to catch a falling knife, even if there appears to be a deceleration in the price fall.

* It is clearly OVERSOLD by any oscillators. For example, the weekly RSI shown above is oversold. It is important to note that oversold does NOT mean BUY, as evidenced by past oversold readings when the stock price continues to fall 4 times in the past in Aug 2007 (quick rebound), Nov 2007 (quick rebound), Jan-Mar 2008 (continued price fall), and June-July 2008 (continued price fall).

The key question is has it found bottom yet?

The prudent answer is "we still don't know". Superficially, support is seen at 25.5 sen, but if global markets makes a new low, it is obvious to me that this 25.5 sen is not going to hold. The odds are when a stock price makes a new low, expect more new lows to be made, until we've seen reversal signals, such as a new higher low subsequently.

So, even though price starts to look interesting, the bargain hunter might still want to wait a little bit longer.

Balance Sheet

This is the original reason as I recalled:

* No debts. No short term borrowings. No long term borrowings. Net cash position on 30 June 2008 of $76 Million, although the dividend paid on 13 Aug 2008 will have reduced this cash amount today by approximately $25 Million, leaving a Net Cash Position of say $51 Million, ignoring new cash flows since 30 June 2008.

* Current Assets of $275 Million compares favorably against Market Capitalization at 26 sen of $292 Million. If we adjust Current Assets down by $25 Million, this leaves $292 - ($275 - $25) = $46 Million, to own (Fixed Assets - Goodwill - Total Liabilities) = $571 - $107 - $44 = $420 Million. In other words, at 26 sen, HUAAN is fundamentally cheap by traditional Net Tangible Asset valuation.

* I personally don't like NTA because it can be overstated sometimes. For example, in the current global recession environment, and in the current soft global steel prices since mid this year, inventories are unlikely to be worth the stated values. For conservatism, better to mark these down by 50%. Similarly, receivables are unlikely to be worth the stated values - in times like these, even though we don't know exactly who HUAAN clients are, we should mark these down by 50% for conservatism. Only cash is worth its stated value. Goodwill is worth nothing in the event of liquidation. Total liabilities worth full value. So, what would be a realistic worth of HUAAN in the event of liquidation? My quick calculations showed that Revised Fixed Assets = $464M, Revised Current Assets = $150M, Total Net Tangible Assets = $464 + $150 - $44 = $570M, or say 51 sen per share.

* At 26 sen, from a valuation perspective, HUAAN appears cheap. At this price, it is *almost* giving away its entire fixed assets for very little amount. The concern of course is that what appears cheap can get cheaper in a declining stock market. In serious bear markets, I have seen stocks selling at cheaper than its Operating Capital.

Income Statement

* Net Earnings is around 6.5 sen in the last 6 months, roughly evenly distributed between Q1 and Q2.

* The major concern is of course huge increase in Revenue (Q2/08 vs Q2/07), and yet, Net Earnings only increase by a tiny %. The margin erosion is indeed serious.

* The earnings outlook is equally serious. As the coy has stated, "the metallurgical coke industry is largely dependent on the direction and growth prospects of the steel industry as
metallurgical coke is one of the critical raw material for the manufacturing of steel in China.". Since the steel industry is soft, we can expect serious deterioration to the metallurgical coke industry. The question is how serious?

* Q2/07 margins was 15.7%, it has deteriorated to 8.5% in Q2/08. Given the huge fall in global commodity prices, huge fall in Baltic Dry Index, huge fall everywhere, it is difficult to make a prediction on how low margins can get. The truth is I don't know if half of 8.5% is adequate or inadequate. I did remember that HUAAN - when compared to its competitors in China - is not exactly an "average coy", but more like a "below average" company, from Moolah's blog. How would a "below average" coy perform - from an earnings perspective - in a prolonged global recession?

* In 2007 Annual Report, the coy mentioned its expansion plans - "In mid 2007, we have also commenced the construction of our additional metallurgical coke ovens to increase our annual production capacity from 1.2 million tonnes to 1.8 million tonnes. The construction of the said new metallurgical coke ovens have been completed and are expected to be fully commissioned in June 2008." So, it seems we can expect greater output, but the question of course is what will be the profitability of these expanded businesses? Whilst the Directors are optimistic (in latest quarterly report) on continued profitability for the rest of this year, this doesn't speak anything at all for the next year.

* There is a high degree of uncertainty in calculating P/E, but some people like to take current price (26 sen) and divide that with an annualized earnings of 13 sen (6.5 sen for H1/08 x 2) , giving a superficially low P/E of 2 times. One is tempted to think that even if H2/08 earnings is nil, the P/E for 2008 is still 4 times. The question is - is this meaningful? For example, if Q3/08 earnings are zero, do we seriously think that HUAAN Price will not take another hit downwards? Yes, there are some cushion because it is trading below its realistic liquidation price, but in a credit crunch environment, will potential buyers be able to finance this acquisition, if liquidation occurs?

* It begs the question - has the huge price fall "priced in" zero earnings for H2/08, and half of 2008 earnings in 2009?

* HUAAN is in a Net Cash position. It has no borrowings. Probably, in a prolonged global financial crisis where credit is hard to find, it will probably survive better than its leveraged competitors, if it doesn't expand beyond where it is already, or do something else silly that consumes precious cash/capital. It is comforting to see no new capital commitment planned from the latest quarterly report, and the past capital spending just a tiny fraction of prior year. However, it needs to watch its inventories tightly, it needs to chase its clients for its receivables to make sure that they finally receive cash, because in this sort of environment, cash is King. But from above, it is concerning that both inventories and receivables have increased, suggesting that HUAAN management doesn't appear to be on top of this problem, as least judging by the past. One would want to watch closely these figures in the next Quarterly Report that is due next month. If there is further deterioration in these numbers, then, the price is unlikely to rally.

Major Shareholders

To date, there are no selling reported to Bursa this year by the major shareholders. Top 5 shareholders responsible for over 60% shares outstanding. The history of the listing is somewhat puzzling, since this is over 1.5 years ago, and at the time, China stockmarket was red hot. I will forever remained puzzled as to why the owners did not list the company in China where it would have obtained not only easy credit but also command huge share valuations in the red hot Chinese stockmarket then. I guess this will forever remain a mystery to me. Still, as time passes, I suppose it loses some significance over time, as long as the major shareholders don't sell, and to date, it is becoming less discomforting that no selling is announced so far. My guess is that since the stock price has taken a huge beating (fallen more than 80%-85%) of listing price and peak price, the major shareholders are unlikely to sell now at 26 sen. (But if they did, this would then become an extremely bad sign indeed). But what is equally glaring is that the major shareholders have not been adding their stake despite the low "bargain discount" price. Perhaps this may be one of the the catalyst needed to send the share price up again, when major shareholders buys more. What is interesting though is that we haven't seen the company using up its cash holding to buy back its shares, which to me is a good thing. However, if it did buy back its own shares, then, I would view it as generally bad, because in the current global credit crunch, cash is King until the global credit/business environment recovers.


So, what can we make out of this?

I have deliberately pointed out the pros and the cons.

I think my own conclusion so far is still unchanged.

If you are an investor who buys and hold, then, it doesn't seem like it's clear yet that we've found THE BOTTOM, and even if we've seen "a bottom", the Buy and Hold investor is unlikely to sell at a local peak, and it would be terrible if the price then dived to make another new bottom which is lower than 26 sen. So, Buy and Hold investors are advised to still stay aside and just monitor.

And of course, if one is a trader, then, you don't need me to tell you when to enter, when to exit, and when to cut your losses.

Anyway, this is my honest view so far on HUAAN. If you would like to add anything, please do not hesitate to drop me a comment here in this article.

And if you are considering other steel stocks, do give consideration to its balance sheet too, besides its future earnings prospects. My feeling is that in times like this, as the global economy deteriorates, a strong positive cash flow and a strong balance sheet will increasingly find a premium relative to the highly geared competitors with negative cash flow. Relative to its steel peers, Huaan balance sheet with its net cash and nil debt position appears to be above average, if not one of the best amongst the steel companies listed in Bursa. But steel future prospects at the present moment doesn't appear exciting yet.

In short: Investors - KIV. Traders - do your own thing, don't wait for me to call.


Wedding Gifts, Favours, Bells... said...

onasteel / cscsteel is net cash too...

huaan high inventories (in $$) maybe due to high selling price of coke (during the quarterly reporting)... giving ppl a preception tat their products are piling up back of their warehouse... hohoho

Seng said...

Just some quick comments:

1. It is worthwhile to check the size of the Net Cash too, as a % of market capitalization.

Some coys have Net Cash = 1% of Market Cap, others have Net Cash = 50% of Market Cap. Obviously, the one with bigger Net Cash as % of Market Cap would be "safer", other things equal.

2. Also, even if 2 companies have the same Net Cash, but one of them has no borrowings, and the other have large borrowings, then, it's also not equal, because typically, the one with borrowings attract higher finance cost than interest earned on cash deposits. But we're getting into details here.

3. With 1 and 2. in mind, you will need to evaluate your other "net cash" stocks yourself.

4. It is worthwhile to compare revenue, receivables and inventory growth together quarter by quarter, over the past few years. This will clearly show to you whether the inventory growth has outpaced revenue and receivables growth or not. They tell completely different pictures over the longer term. For this article, I'm too lazy to do this, but if one is interested in the stock and have plenty of time, one can consider this.

Wedding Gifts, Favours, Bells... said...

now now... HUAAN major shareholder just started to dispose some % at current low price... tho not very substantial...

wat does it indicate? bad news?

Seng said...

After my article, HUAAN share price fell from 26.5 sen down to 20 sen, before recovering slightly at 21.5 sen. So, investors who waited are vindicated at least temporarily.

The insider selling at such low prices is indeed sad. Either desperate, or deliberate. Either way, not a good sign for investors.

My position remains the same. Investors should still hold out and wait until market sentiments improves. Extremely short term traders do not need to wait for anyone's call to do their own thing.