Market Gems
China HongXin
China HongXin Ltd is one of the many cash rich S-shares, which im very interested to look at and possiblily include in my portfolio...the share price as of this writing is $0.13. Their Net cash value per share (using only cash less off all liabilities then dividing the dearrived figure by the total amount of issued shares) is $0.10 and Net current asset per share is $0.23. What these data means is..if i buy into China Hx at a share price of $0.13, i should get back at least$0.10 in cash, another $0.06 in value and get their business for free! In addition (according to them) their business is doing well with strategic plans and contracts being established, opening 100 new sport stall, having a consistent history of earnings, strong cash flow (barring this FY 2008) expected to bring in higher profits and revenue. Wow, sounds very attaractive hor.. but whatever sounds too good, it usually is!
Soo i took the liberty to research on a few thing, with regards to the company.
I believe the following factors are the reasons why China Hx is trading at such an attractive or (disgusting) share price to some investors.
Reasons are as follows :
· Fear of fraud, inflated cash and accounts related beacuse we are dealing with an S-share!
· Fear of poor internal control and governace
· Is the cash really there?
· What have they been doing with the cash if its really there? Huge jump in recievables.
· Business of selling Sports apparels not that attractive or resilent in a sense, plus their industry is very competitive as well.
So to address the following concerns and risks, this is what i found out.
To answer the first question ->Does China HX have proper Governance in place?
I looked at their Cooperate Governance report which indicates
· No signs of directors or independent ones leaving the company soo far
· Board Composition and Balance.
The Board consists of five (5) directors of whom, three (3) are independent.
The list of directors are as follows:
Executive Directors Wu Rongguang (Appointed 28 April 2005/ Chairman of the Board)
Wu Rongzhao (Appointed 6 May 2005/ Chief Executive Officer)
Non-Executive DirectorsBernard Tay Ah Kong (appointed 20 September 2005/Independent)Chan Wai Meng (appointed 20 September 2005/Independent)
Alfred Cheong Keng Chuan (appointed 20 September 2005/Independent)
· A bit about the independent directors
-Mr Bernard Tay Ah Kong is currently the Non-Executive Chairman of Horwath First Trust, which is a Certified Public Accountants firm. Mr Tay is also an Independent Director of several public companies listed on the SGX Mainboard and Catalist. He is the Senior Advisor to the Government of Huzhou City, Zhejiang Province of the People’s Republic of China. The President of the Automobile Association of Singapore and Vice-President of the Singapore Productivity Association
Then i look at who chairs the committee's of the company.
· People in the Nomittee/Audit/Remuneration committee
Mr Chan Wai Meng (Nominating Committee Chairman)
Mr Alfred Cheong Keng Chuan
Mr Bernard Tay Ah Kong
All three committee’s are chaired by independent Directors
· Foo Kon Tan Grant Thornton have expressed their willingness to accept re-appointment.
· Update: RSM Nelson Wheeler and Tan Grant Thornton have expressed their willingness to accept reappointment their verdict for FY 2008 accounts "A true and fair view will established".
In addition China Hx was listed 166th position on the governance and transparency index (march 2009) which is quite high relative to 679 positions in the index.
Next question: Is cash really there? Did they inflate their cash holdings?
Research shows that in FY 2006 , their cash balances were 545,442k rmb
in 2007, this figure jumped to 2.6billion rmb, the reason...
There was an Issue of shares on placement 2,376,959 on FY 2007
Latest FY in 2008
Share premium: 2,645,397
Retained profits: 997,480 increase from FY 2007 of 598,192
· Basically the fear of created cash figures should have subsided due to the glaring fact that 2.3billion RMB were raised from SGX IPO listing on 2007.
However.. the worry that net profit for FY 2008 was inflated 448,515k increase 7.7% from FY 2007 or through out the years cannot be deal with , just by simply looking at their annual reports. The reason why i think China Hx Net profit of 2008 should be lower then in 2007 is due to terrible economic conditions and stiff competition in the industry, yet one can argue that it could be that the Olympics last year helped with it’s increased sales?
The next Question to ask is, having received 2.3billion, what exactly did the company do with it after 2 years?
Their accounts stated on their Balance Sheet's assets are as follows
-1.98billion in Cash
-1.159billion in Receivables
Equity
-Share premiums of 2.6billion
-Retained profits of 900million
As mentioned by some analysts, they were not comfortable with the high recieveables and they indicated that the risks here is that the amount stated in Cash is not actually there, but in other accounts like inventories or receivables (account manipulation) etc.
The cash amount is place in
China Construction Bank
Zhanlan Branch
1st floor, Mingfa Hotel
Nanhuan Road
My take is that, they indeed have cash , whether or not there was manipulation in the accounts i also cannot tell.. that's why the FY 2008 auditors opinions are vital in my deduction of whether China Hx is honest in their accounts. Having a "true and fair view" should more or less prove that China Hx is honest? Some more got two auditors appointed, should be enough.. i think..i don;t expect them to issue any more shares to gain capital or establish any more loans in the future though.
Proceeding to the next question:
Why a huge jump in prepayments/receivables?
------SGX questions to China Hx management--------
Prepayments, deposits and other receivables increased from RMB278.7 million as at 31 December 2007 to RMB1,159.2 million as at 31 December 2008. Approximately RMB1,155.5 million (2007: RMB277.5) was advanced to distributors to facilitate the setting up of approximately 358 (2007: 100) new stores in 21 (2007: 20) provinces/cities during the year ended 31 December 2008. The RMB277.5 million advanced to distributors in 2007 was fully collected in 2008.
Please disclose the terms of the advances to distributors (ie. repayment period, penalties).
The advances to distributors are unsecured, interest-free and repayable within one year. In the
event of a default in repayment by a distributor, the Group will take over the distributor’s operating rights to the store and its assets in accordance with the advance agreement made with the distributor.
Please provide an indication if there are any difficulties in recovering the advances
particularly given the current market conditions.
As at to date, the Group has recovered up to an aggregate amount of RMB50.3 million from the distributors. The distributors have kept up with the repayment schedule and we have not encountered any collection problems from the distributors.
As at 1 January 2009, the Company has ceased to provide such advances to the distributors. The Company will continue to pursue collection of the outstanding advances from distributors and will provide updates of the repayment of advances from distributors in its quarterly results.
Why keep soo much cash?
The cash will be used to support the Group’s operations in the current financial year.
Why don’t declare dividends for final part of the year?
In addition, the Board would like to clarify that in view of the uncertain economic environment, it
was deemed prudent to maintain its cash position and not declare a final dividend for the year.
Quickly, i ran thru my "spotting the red flags" screening test for China Hx
Checking Red Flags in balance sheet of China HX.
1) Is there a growing gap between cash flow from operation activities* and earnings (total cash flow has to be higher then net earnings for refinancing purposes ), the important thing is cash flow from operation have to increase as much as NPAT
2008 (‘000) and 2007 (‘000)
Operational Cash flow: (357,503) and 79,991
Net income: 448,515 and 416,453
Problem here, failed test.
2) Net Earnings grown faster then sales? No
3) Disproportionate increase in account receivable vs Sales increase
Sales: 2,889,000 and 2,046,000
Accounts receivable: 1,159,152 and 278,665
Problem here as well.
4) Unusual increase in inventories vs. sales increase
Not a problem here
5) Any Large assets write off? (No)
6) Quality of the earnings
-Did they include profits from the past periods? (No)
-Under provide for future expenses with current sales, bad debts? (Possible)
-Increase in reliance of earnings sources apart from main business? (No)
-Cutting pay in workers, employees, R&D etc? (No)
Important point to take note, because company has already bleached two of my screens, I must take note that every quarter I must see that receivables top drop and operational cash flow to increase.
Insider data reviews that
Overlook Partners fund bought 25million shares on March 4th @9.5cents
Chairman bought 1million at 19cents in November 2008
Wasatch fund sold at 6cents @ 28.9million 12th March 2009
Summary of good and bad points
+ Governance is alright, no directors have quit
+ Nomittee/Audit/Remuneration committee all chaired by independent director
+ Cash is there, in FY 2007 IPO was established, 2.3billion RMB was collected
+ Net Cash is 0.17cents, still give a decent margin when comparing to a share price 0.10-12
+Don’t foresee any borrowing, as the IPO issues are more then enough, high liabilities incurred by the company is not visible as of now.
+With respects to the questions asked by SGX, I don’t see how the Chairman could have answered any of them better, the company just IPO in 2007,of course Capital cash is need to kept with them, to expand and to support operations!
+ Share price advantage at 0.09-0.11 give significant margin to target price of 0.25cents NCAV. 66%!
+Positive new and forecast by the company
The bad
-Question about it’s net profit sustainability, fact or inflated?
- Question as to whether what exactly they did with the cash, are the components reflected correctly in the accounts?
-Their receivables are super high which gives raise to bad debts, but $0.17 is the Net cash per share so it still worth it to invest at $0.13 do take note.
- Questions asked by SGX and replies from Chairman not those satisfactory, sounds fishy especially the part about not declaring dividends.
-Business model might not be resilient in this crisis, despite optimistic forecast for the company, possibility is high for the company to bleed cash this year and the next.
Scenarios
Scenario 1: Pure and out alright fraud
China HX Management really did inflate accounts, possible higher amounts in receivables and lesser of cash. Share price cannot sustain 0.13cents (buying level), however if liquidation of company is activated, confident to get back more then 0.17cents per share.
Scenario 2: Running away
This is the worse possible outcome. CEO runs away with cash, lawsuits plus investigation, might result in the loss all invested capital.
Scenario 3: Deterioration of share price
As time goes by, receivables are denied or written off as bad debts, company yield in huge net loss because of huge expanding. But confident that share price would’t vary much at 0.09 cents.
Scenario 4: Honest accounting
Share price will raise drastically, back to 0.23 or more, yielding a 200-300% return.
Comments:
"Well, you are a vested shareholder in this company thus you will know more about the workings of this company.I am referring to the loans given to distributors from a standalone point of view. What you said is true since such a good loan given to distributors can indeed build goodwill between the company and them. From the standalone point of view, I find it to be strange that the company lends money to distributors and the guarantors are the significant shareholders and the executives of the company. The guarantor of any loan is not supposed to be the lender itself. Now let us think of the risk. In the event that the company is unable to recover the loan from the distributors, it will recover the loan from the guarantors of the loan instead. However, the guarantors of the loan are the significant shareholders of the company. So what can they do to prevent themselves from paying this loan ? Since they are the significant shareholders and the executives of the company, can they write off this loan ? In short, there is a potential for the abuse of power for this scenario.The scenario that I am suggesting may seems to be far-fetched and I'm trying to evaluate the risk of this arrangement of loan with the distributors. There is no right or wrong actually as I'm trying to raise this point up for discussion. I hope this helps". -Moneytalk.sg
Soo i took the liberty to research on a few thing, with regards to the company.
I believe the following factors are the reasons why China Hx is trading at such an attractive or (disgusting) share price to some investors.
Reasons are as follows :
· Fear of fraud, inflated cash and accounts related beacuse we are dealing with an S-share!
· Fear of poor internal control and governace
· Is the cash really there?
· What have they been doing with the cash if its really there? Huge jump in recievables.
· Business of selling Sports apparels not that attractive or resilent in a sense, plus their industry is very competitive as well.
So to address the following concerns and risks, this is what i found out.
To answer the first question ->Does China HX have proper Governance in place?
I looked at their Cooperate Governance report which indicates
· No signs of directors or independent ones leaving the company soo far
· Board Composition and Balance.
The Board consists of five (5) directors of whom, three (3) are independent.
The list of directors are as follows:
Executive Directors Wu Rongguang (Appointed 28 April 2005/ Chairman of the Board)
Wu Rongzhao (Appointed 6 May 2005/ Chief Executive Officer)
Non-Executive DirectorsBernard Tay Ah Kong (appointed 20 September 2005/Independent)Chan Wai Meng (appointed 20 September 2005/Independent)
Alfred Cheong Keng Chuan (appointed 20 September 2005/Independent)
· A bit about the independent directors
-Mr Bernard Tay Ah Kong is currently the Non-Executive Chairman of Horwath First Trust, which is a Certified Public Accountants firm. Mr Tay is also an Independent Director of several public companies listed on the SGX Mainboard and Catalist. He is the Senior Advisor to the Government of Huzhou City, Zhejiang Province of the People’s Republic of China. The President of the Automobile Association of Singapore and Vice-President of the Singapore Productivity Association
Then i look at who chairs the committee's of the company.
· People in the Nomittee/Audit/Remuneration committee
Mr Chan Wai Meng (Nominating Committee Chairman)
Mr Alfred Cheong Keng Chuan
Mr Bernard Tay Ah Kong
All three committee’s are chaired by independent Directors
· Foo Kon Tan Grant Thornton have expressed their willingness to accept re-appointment.
· Update: RSM Nelson Wheeler and Tan Grant Thornton have expressed their willingness to accept reappointment their verdict for FY 2008 accounts "A true and fair view will established".
In addition China Hx was listed 166th position on the governance and transparency index (march 2009) which is quite high relative to 679 positions in the index.
Next question: Is cash really there? Did they inflate their cash holdings?
Research shows that in FY 2006 , their cash balances were 545,442k rmb
in 2007, this figure jumped to 2.6billion rmb, the reason...
There was an Issue of shares on placement 2,376,959 on FY 2007
Latest FY in 2008
Share premium: 2,645,397
Retained profits: 997,480 increase from FY 2007 of 598,192
· Basically the fear of created cash figures should have subsided due to the glaring fact that 2.3billion RMB were raised from SGX IPO listing on 2007.
However.. the worry that net profit for FY 2008 was inflated 448,515k increase 7.7% from FY 2007 or through out the years cannot be deal with , just by simply looking at their annual reports. The reason why i think China Hx Net profit of 2008 should be lower then in 2007 is due to terrible economic conditions and stiff competition in the industry, yet one can argue that it could be that the Olympics last year helped with it’s increased sales?
The next Question to ask is, having received 2.3billion, what exactly did the company do with it after 2 years?
Their accounts stated on their Balance Sheet's assets are as follows
-1.98billion in Cash
-1.159billion in Receivables
Equity
-Share premiums of 2.6billion
-Retained profits of 900million
As mentioned by some analysts, they were not comfortable with the high recieveables and they indicated that the risks here is that the amount stated in Cash is not actually there, but in other accounts like inventories or receivables (account manipulation) etc.
The cash amount is place in
China Construction Bank
Zhanlan Branch
1st floor, Mingfa Hotel
Nanhuan Road
My take is that, they indeed have cash , whether or not there was manipulation in the accounts i also cannot tell.. that's why the FY 2008 auditors opinions are vital in my deduction of whether China Hx is honest in their accounts. Having a "true and fair view" should more or less prove that China Hx is honest? Some more got two auditors appointed, should be enough.. i think..i don;t expect them to issue any more shares to gain capital or establish any more loans in the future though.
Proceeding to the next question:
Why a huge jump in prepayments/receivables?
------SGX questions to China Hx management--------
Prepayments, deposits and other receivables increased from RMB278.7 million as at 31 December 2007 to RMB1,159.2 million as at 31 December 2008. Approximately RMB1,155.5 million (2007: RMB277.5) was advanced to distributors to facilitate the setting up of approximately 358 (2007: 100) new stores in 21 (2007: 20) provinces/cities during the year ended 31 December 2008. The RMB277.5 million advanced to distributors in 2007 was fully collected in 2008.
Please disclose the terms of the advances to distributors (ie. repayment period, penalties).
The advances to distributors are unsecured, interest-free and repayable within one year. In the
event of a default in repayment by a distributor, the Group will take over the distributor’s operating rights to the store and its assets in accordance with the advance agreement made with the distributor.
Please provide an indication if there are any difficulties in recovering the advances
particularly given the current market conditions.
As at to date, the Group has recovered up to an aggregate amount of RMB50.3 million from the distributors. The distributors have kept up with the repayment schedule and we have not encountered any collection problems from the distributors.
As at 1 January 2009, the Company has ceased to provide such advances to the distributors. The Company will continue to pursue collection of the outstanding advances from distributors and will provide updates of the repayment of advances from distributors in its quarterly results.
Why keep soo much cash?
The cash will be used to support the Group’s operations in the current financial year.
Why don’t declare dividends for final part of the year?
In addition, the Board would like to clarify that in view of the uncertain economic environment, it
was deemed prudent to maintain its cash position and not declare a final dividend for the year.
Quickly, i ran thru my "spotting the red flags" screening test for China Hx
Checking Red Flags in balance sheet of China HX.
1) Is there a growing gap between cash flow from operation activities* and earnings (total cash flow has to be higher then net earnings for refinancing purposes ), the important thing is cash flow from operation have to increase as much as NPAT
2008 (‘000) and 2007 (‘000)
Operational Cash flow: (357,503) and 79,991
Net income: 448,515 and 416,453
Problem here, failed test.
2) Net Earnings grown faster then sales? No
3) Disproportionate increase in account receivable vs Sales increase
Sales: 2,889,000 and 2,046,000
Accounts receivable: 1,159,152 and 278,665
Problem here as well.
4) Unusual increase in inventories vs. sales increase
Not a problem here
5) Any Large assets write off? (No)
6) Quality of the earnings
-Did they include profits from the past periods? (No)
-Under provide for future expenses with current sales, bad debts? (Possible)
-Increase in reliance of earnings sources apart from main business? (No)
-Cutting pay in workers, employees, R&D etc? (No)
Important point to take note, because company has already bleached two of my screens, I must take note that every quarter I must see that receivables top drop and operational cash flow to increase.
Insider data reviews that
Overlook Partners fund bought 25million shares on March 4th @9.5cents
Chairman bought 1million at 19cents in November 2008
Wasatch fund sold at 6cents @ 28.9million 12th March 2009
Summary of good and bad points
+ Governance is alright, no directors have quit
+ Nomittee/Audit/Remuneration committee all chaired by independent director
+ Cash is there, in FY 2007 IPO was established, 2.3billion RMB was collected
+ Net Cash is 0.17cents, still give a decent margin when comparing to a share price 0.10-12
+Don’t foresee any borrowing, as the IPO issues are more then enough, high liabilities incurred by the company is not visible as of now.
+With respects to the questions asked by SGX, I don’t see how the Chairman could have answered any of them better, the company just IPO in 2007,of course Capital cash is need to kept with them, to expand and to support operations!
+ Share price advantage at 0.09-0.11 give significant margin to target price of 0.25cents NCAV. 66%!
+Positive new and forecast by the company
The bad
-Question about it’s net profit sustainability, fact or inflated?
- Question as to whether what exactly they did with the cash, are the components reflected correctly in the accounts?
-Their receivables are super high which gives raise to bad debts, but $0.17 is the Net cash per share so it still worth it to invest at $0.13 do take note.
- Questions asked by SGX and replies from Chairman not those satisfactory, sounds fishy especially the part about not declaring dividends.
-Business model might not be resilient in this crisis, despite optimistic forecast for the company, possibility is high for the company to bleed cash this year and the next.
Scenarios
Scenario 1: Pure and out alright fraud
China HX Management really did inflate accounts, possible higher amounts in receivables and lesser of cash. Share price cannot sustain 0.13cents (buying level), however if liquidation of company is activated, confident to get back more then 0.17cents per share.
Scenario 2: Running away
This is the worse possible outcome. CEO runs away with cash, lawsuits plus investigation, might result in the loss all invested capital.
Scenario 3: Deterioration of share price
As time goes by, receivables are denied or written off as bad debts, company yield in huge net loss because of huge expanding. But confident that share price would’t vary much at 0.09 cents.
Scenario 4: Honest accounting
Share price will raise drastically, back to 0.23 or more, yielding a 200-300% return.
Comments:
"Well, you are a vested shareholder in this company thus you will know more about the workings of this company.I am referring to the loans given to distributors from a standalone point of view. What you said is true since such a good loan given to distributors can indeed build goodwill between the company and them. From the standalone point of view, I find it to be strange that the company lends money to distributors and the guarantors are the significant shareholders and the executives of the company. The guarantor of any loan is not supposed to be the lender itself. Now let us think of the risk. In the event that the company is unable to recover the loan from the distributors, it will recover the loan from the guarantors of the loan instead. However, the guarantors of the loan are the significant shareholders of the company. So what can they do to prevent themselves from paying this loan ? Since they are the significant shareholders and the executives of the company, can they write off this loan ? In short, there is a potential for the abuse of power for this scenario.The scenario that I am suggesting may seems to be far-fetched and I'm trying to evaluate the risk of this arrangement of loan with the distributors. There is no right or wrong actually as I'm trying to raise this point up for discussion. I hope this helps". -Moneytalk.sg
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