Aug 19th, 2010 Posted in Intelligent Investing
XingQuan is one of the 4 China shoe companies listed in Malaysia. I am more familiar with MSports, XDL and XingQuan and is not familiar with KStar (too new for me to be interested).
While XinQuan has been the most favorable stock among the shoe companies to most people, it is not to me when compared to MSports and XDL. Why I like MSports has been written in my long Multi Sports Holdings review.
Unfortunately I didn’t have the time to write about XDL so I will try to tell you briefly about them.
Three of these companies are shoe companies but they have very different business model. While their market price move in tandem with each other because they share the same theme, i.e. China and Shoe, they are actually very different to each other.
MSports is a very simple business, they manufacture shoe soles and sell them to other shoe makers. Yes, plain vanilla with no added chocolate chips, just shoe soles. Their customers are other shoe makers.
Introduction to XDL (XiDeLang)
XDL on the other hand doesn’t even manufacture shoe soles! They might consider buying it from MSports or probably have been buying from MSports. Shoe soles are the most important component of a sport shoe and there are only 100+ among the 3,000 shoe companies in JinJiang that manufacture them.
XDL buy shoe soles from other shoe soles maker and use them to make complete shoes. They are not OEM shoe maker which means they are not making shoes for other branded shoe companies such as Nike or Adidas. They are manufacturing their own branded shoes XiDeLang and sell them in their own XiDeLang stores.
So, XDL is more a retail shoe companies with their own manufacturing capability and brand. MSports on the other hand manufacture and sell shoe soles. So they are very very different.
XDL also sell sports apparels for XiDeLang brand but they don’t manufacture apparels themselves. They source them from other makers. They are planning to manufacture the sports apparels themselves in the future using operating cashflow and the IPO proceeds.
They do not own the retail outlets themselves. It is more like “franchise” but not exactly that. There are 3 parties involved.
1. XDL which owns the brand and supply the shoes. They are in charged of the branding and marketing effort. They get around 38% of the final retail price.
2. Distributor – they mark up the price not more than 10% and sell to the retailers.
3. Retailers – Operate the stores and try to make money after paying for the shoes, rental and sales staff.
XDL customer in “accounting” terms is the distributor. But their ultimate customers that affect their sales is the end user who shop at the retail shops. If retailers can’t sell the shoes, they won’t buy from the distributor and distributor won’t buy from XDL. So XDL is a consumer retail business.
XinQuan = MSports + XDL
What about XinQuan? XinQuan is a mixed of both. XinQuan manufacture shoe soles and also manufacture own branded shoes AddNice and sell them in their own AddNice stores [also through distributors]. They even manufacture their own AddNice apparels.
So we shouldn’t generalize all these shoe companies and think that they are the same. They are not. They have different business model and they make their money in different ways.
Does That Mean XinQuan is Better?
For many people, yes because it has multi different income sources and is more diversified. For me, no.
Don’t get me wrong, XinQuan is a good business selling at a very very cheap valuation out now. What I am trying to do is to compare it to MSports and XDL. I am trying to explain why I like MSports and XDL more than XinQuan, not trying to say XinQuan is bad. XinQuan on its own is good enough, but not as interesting when compared to MSports and XDL.
Reason #1 – Too Much Cash
While most people assume a lot of cash is a good thing but it is not for me. I am trying to make an investment, investment that is suppose to give me good returns. But cash are – CASH! Cash are not investment because it can’t generate good return on it’s own unless it is invested.
Cash in a business is like the sugar in the coffee. We don’t want too much or too little. We are not drinking “sugar”, we want it to be just enough.
With quick approximation for better illustration, XinQuan is worth around RM500 million today (at RM1.64), but it has RM250 million net cash after paying back all borrowings! When you buy their stock, you are like making 2 investments. The first half in XinQuan business that manufacture shoe soles and sell AddNice products. The second half in something like a fixed deposit or a savings account.
I want to make money investing in “stocks” and “businesses”! If I need to put money in fixed deposit or savings account, I can do it myself and have full control instead of going through a company!
More discussions on the “cash debate” later in this article.
Reason #2 – Harder to Value
While it is cool to have a diversify business but I can get the same diversification through XDL and MSports and even better, I have 2 stocks and 2 market price instead of just 1 stock with 1 market price.
It is also slightly harder to value the business due to the business mix. Since both business (shoe soles and retailing) are very different in nature, the metrics that we are trying to get from the consolidated statements such as margin, days sales outstanding (DSO), inventory sales outstanding (DSI) will be a mixed making us harder to figure out which segment is doing better and which is not.
And as reason #1 has stated, you are technically investing in 2 investments when you buy Xing Quan – the business and the cash. You have to value the cash too and most of the time, RM1 is RM1. [No matter how hard I try, the most I can sell you my RM50 note is RM50, it can be less but not more]
The whole company is selling for RM500 million today and it has around RM250 million net cash.
So how much is the “fixed deposit” part worth? RM250 million max.
So how much is the business worth? RM250 million too. [RM500 million minus RM250 million cash]
The company makes RM100 million in the last 4 quarters, so what is the PE? PE is only 2.5 for the business! Yes it is very cheap, similar to MSports. But wait, when you buy MSports, you don’t need to make another investment in an ‘FD’. But if you buy XinQuan at PE 2.5, you need to put an equal amount in an ‘FD’ (that is out of your control) that give you maybe 2% return max.
So if you mix that “two” investment together, it no longer looks that sweet. 2% is nothing at all. It is like the cash under your mattress. Actually under somebody else mattress because you don’t have full control on it although technically it is yours.
Might as well use 50% of your money to buy XDL or MSports and put the remaining 50% in FD at a local bank? You have a real FD with full control and it doesn’t affect the valuation of your XDL or MSports.
But again, don’t get me wrong, all of these are coming from a comparison point of view with MSports and XDL. Without the 2 of them, XinQuan will look marvelous on its own. Why? Because even if you assume the cash never exist and you are buying XinQuan at RM500 million where is makes RM100 million a year, you are buying a PE5 stock, a very very very cheap valuation. What does PE5 means? If this is a private business, it means you are making a 20% return investment. Because you pay RM5 for a business that can make you RM1 per year, thus 20% return (We call this earning yield). Not bad at all.
Petronas Dagangan is selling for above PE10, Public Bank is selling above PE10 too. Both are considered fairly valued because you still get a good 10% earning yield. There are stocks like SP Setia that is selling for nearly PE20, a 5% earning yield which is expensive [at least for me].
Reason #3 – More People Are Interested
Surprisingly, more people prefer to invest in XingQuan then the other shoe companies. This can be seen by its current price as comparison with its IPO price and how much it has gone up from the bottom, which outpaced the other shoe companies. It is also owns by more funds then the others.
Why? Because they assume it is safer with that cash and the diversification mixed of their business. I have mentioned that for me it is a different story. If I need an FD, I can put it myself, no need to go through a company. And if you hold too much cash for me, I will need to worry that you are not taking good care of it! These money are not “free”, we pay for it when valuing the company as a whole. Remember we add RM250 million valuation to the company because of the cash?
And for the business mixed, I can have that by owning XiDeLang and Multi Sports. I then have 2 stocks price, 2 managements and 2 AGMs (means more door gifts, aha)…
What is a better investment? An investment that everybody interested in? Or an investment that no body interested in?
Not both, sorry I tricked you. A good investment is an investment that no body interest in RIGHT NOW but will make everybody interested in it IN THE FUTURE. There are more people interested in XinQuan right now compare to the other shoe companies, making it less favorable to serious investors.
On the other hand, MSports and XDL are better candidates as investments that not many people interested in NOW but ‘might be’ in the FUTURE.
REASON #4 – KIAMSIAP MANAGEMENT WHO DOESN’T KNOW HOW TO PLEASE INVESTORS
When they announced the Q4 earnings and dividend 3 days ago after market close, my first respond (and the second and third for the entire night and until today) is “WHAT THE DUCK!!!” [replace D with F]
These management certainly doesn’t seems to understand the importance of minority shareholders. They announced another 2.5 cents dividend making it total 5 cents for the year. [Their financial year end is June 2010]
The entire year earning is 34 cents. But management certainly failed their math in primary and secondary school. They have been promising shareholders that they will make 20% payout for 2010 and 2011 but hey, 5 cents is only 15%!!! It should be 6.8 cents or 7 cents rounded up.
7 cents over 5 cents is 40% more dividend for the shareholder.
Now they will explain to you that they didn’t promise you 20% payout, they are promising “up to” 20% payout, which is very different in meaning. They are playing with words! They think they are very smart and funny.
But this is not the whole point as we are not Karpar Sigh trying to fight in court. We as shareholders are using the 20% as reference point. If management pay 20%, we assume they are honoring their promise, keeping their words. If it is above, we will believe that we have found a great management that love us as much as our father and mother! But if it is below, we may think that we have been cheated by a bunch of duckers (you know what to replace the d with).
The management is correct in interpreting the phase “up to”. But what is the point for management to be “right” in that sense but totally “wrong” when come to fulfilling their responsibility to the shareholders? It is like the law that say it is “wrong” to beat the traffic light. So you are “right” when you try to block the ambulance from sending a man who has been badly hit by a meteor to the hospital. You can argue and “win” but what is the point? Do you feel proud with your winning and will everyone else like you?
What is more upsetting is that they have RM250 million of net cash! They make RM100 million for the year and the refuse to pay RM20 million to the shareholders as promised but choose to pay only RM15 million. They want to save RM5 million for what?!
What the duck! [yes, replace the d]
So what happened to XinQuan stock price? It dropped 13.7% in 3 days after the announcement. Padan Muka!
I hope they have learned a lesson here and do not repeat it in the future.
And for MSports (promised 20% payout) and XDL (30%), I hope they learn a lesson too from XinQuan mistake.
But the bad news is, it is very likely that they won’t learn it! We will see when they make the announcement in the next few days. Why? Because when I attended the XDL AGM a few months ago and even when the shareholders are shouting to them (I am one of them), the management still keep on debating the word “up to” and keep reminding us that they need a lot of capital.
I can forgive them on less dividend payout if they are buying back shares in the market. But they are not doing that!
Reason #5 – Slowing Down?
Ending June 2009
|EPS (RM) *||0.07||0.07||0.08||0.07|
Ending June 2010
|EPS (RM) *||0.06||0.09||0.11||0.07|
* EPS has been adjusted by assuming company has 307.33 million shares all the time
Again as I said in my MSports article, you don’t compare the results with previous quarter, you don’t compare Q4 with Q3 because of seasonality. You need to compare Q4 with Q4 of previous year.
Quick judgment cannot be done because it didn’t say anything very clearly. There is no dead body found, maybe only some fingerprints. We just got a few hints. These hints are:-
Revenue increased a lot. It increased 39% from last year. But Q3 increase even more at 59%. 39% increase is very very good, but is not better than 59% achieved in Q3.
But the key is that profit is almost flat! Why? There are a few reasons but the most alarming is the drop of gross profit margin. Gross profit margin drop to 31.7% which means they are trying to push for more sales (revenue) by giving a lot of discounts. They are trying to make more sales by making less money per shoe sold.
The other 2 reasons you got to be aware of is the tax rate, they no longer have much tax incentive left and is nearing the 25% tax bracket. You will have to pay this tax rate onwards.
The S&D (Sales and Distribution) expenses is quite high this quarter but I will “assume” that it is used for network expansion and other good purposes.
The only alarming factor out of these 3 reasons is the gross margin. We want to monitor this in the future quarters closely. It can means 2 things in the future, revenue remain high while profit margin improve – good news. Revenue drops while profit margin remain low – bad news.
But Q4 and Q1 are usual slow quarter for XinQuan. Q2 (year end) and Q3 (new year) are important quarters for them. So we need to pay more attention to Q2 and Q3.
XinQuan ROA and ROE still remain very strong, especially if you strip the cash from the assets/equity. They are just amazing.
Based on DSO and DSI, they also don’t have any problem collecting bills and they don’t have inventory problem.
More Cash Debate
The cash XingQuan is holding now is like armies. They can serve their purpose well when we need them. But did Angkatan Tentera Malaysia need to go to war? We invest a lot on them buying them M16 and submarines but all we need of them is when there is flood in Kelantan and when there are buildings falling down in Bukit Antarabangsa.
Cash in a company can be invested to make great returns for the shareholders. If you have a lot of cash, you can make a lot of investments. But the problem is you don’t have good investment hanging around all the time. So the cash will just sleep and do nothing when you are waiting for it. And this is a risk to the investor.
On the other hand, assume opportunity arise and Xing Quan is able to acquire a good business at a good valuation, for a good example the entire MSports which is worth exactly the cash they have right now (RM250 million)! Then that would means a very good use of the cash.
But the problem is, what is the chance of them being able to do that? It is difficult. So as a retail investor, I will prefer to keep that cash to myself so I can buy MSports or other stocks, instead of letting them sleeping in XinQuan bank account and hoping that one day they can find a good investment. I am sure I have more investment ideas and opportunities then them (because I am small and nimble, I only have that much cash).
Even if they start building factories and expanding their retail networks with those cash, it will take a long time before those cash are invested. With the strong cashflow from operation and their kiamsiap dividend policy, there will be a lot of cash sleeping all the time. They are suppose to raise cash from the IPO to invest but end up that they are now having more cash today then after the IPO.
Because XDL and MSports don’t have that ‘much’ cash [They do have a lot of cash, but a lot less when compared with XinQuan], they might not be able to make big acquisition even if opportunity arise. Management might be very upset for that but it is totally OK for shareholders like us!
We as retail investors are not trying to make money from their “once in a millennium” opportunity to acquire another company or their big aggressive growth plan to dominate the earth. We don’t need it to grow to the moon. Our strategy is to buy 1 dollar for 50 cents. We invest on them at very cheap valuation (such as PE 2.5 for MSports) and ‘wait’ for the valuation to increase to PE 5 or PE 8 or even PE 10. You see, we don’t really need them to grow to the moon or make big acquisitions. Because we are already buying them very very cheap, i.e. buying 1 dollar for 50 cents (maybe 25 cents for the shoe companies). We just need them to maintain the business as usual.
Since the cash factor plays an interesting role in XinQuan valuation, if XinQuan stock price drops 50% tomorrow, that would means it is trading at net cash value. You pay RM10 and you get RM10 in their bank account (assume they didn’t steal the money and fake the book) plus all the future cash flow which is 40 cents per year!
XinQuan on its own is still a very good investment even with all the reasons I “hate” about them because the valuation is too cheap. But due to the existence of better alternatives, I didn’t “weight” it so heavily when allocating my capital.
Disclosure: Long XinQuan, MSports & XDL. I might buy and sell anytime without SMSing you!
Disclaimer: This is not a recommendation to buy or sell. Information can be wrong. Invest at your own risk.