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China Gaoxian – Cream Of The Crop
Corporate Digest | 10 March 2010
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By: Ernest Lim
Articles (134) Profile

China Gaoxian (Gaoxian) reported an excellent set of results on 22 Feb after trading hours which exceeded my expectations. However, what is disappointing is that Mr Market responded with lackluster trading of Gaoxian shares on 23 Feb, with less than 2m shares changing hands. Another disappointing factor is that it did not announce a final dividend as management believes that the cash can be better deployed for capital expenditure (capex) and shareholders will likely reap the benefits in the near to medium term.

Against the backdrop of the illiquidity of shares and no “immediate term” incentive (i.e. dividend) to entice investors, should investors continue to hold, sell, or to accumulate further? Let’s take a look at the company.

Results analysis

Sparkling set of results

With reference to Table 1 below, China Gaoxian reported a strong set of results. FY09 revenue dipped slightly due to Gaoxian’s competitive pricing strategy which saw sales volume rise 10.6% y-o-y. Net margin rose from 21.3% in FY08 to 22.6% in FY09 due to a more favourable product mix, as Gaoxian sold more higher margin triangular fibre yarn (TFY) and warp knit fabric (WKF). In fact, sales for these two products amounted to 28.1% of FY09 sales, up from 14.5% in FY08.

Key information at a glance
Table 1: Key information at a glance
*No of shares refer to the actual number of shares as at that period under review and
do not refer to weighted average of shares for that period
**SGD / RMB fixed at 4.86.
Source: Bloomberg

Aggressive CAPEX signifies confidence

Gaoxian announced that it had acquired 60 new production stations for the production of TFY products. Once fully operational, this will add 18,500 metric tonnes to Gaoxian’s existing production capacity. In addition, Gaoxian intended to acquire another 72 new production stations in 1H2010 for the production of DTY and TFY products which will add another 43,000 metric tonnes to Gaoxian’s existing production capacity. Furthermore, Gaoxian intended to ramp up the production of higher margin WKF by acquiring 100 sets of warp knitting machines by end of 1H2010, which will increase annual production capacity to 81,000 tonnes by FY2010. These aggressive expansions, if successfully executed, would have an impact to earnings in FY10 and would be more significant in FY11 and beyond.

Production Capacity in FY10F (Source: Company)
Table 2: Production Capacity in FY10F (Source: Company)

Demand for Gaoxian’s products remains unabated

According to Gaoxian management, China is still dependent on imports to satisfy approximately 50% of its overall demand for highly differential polyester yarn needs. This represents a huge market for growth for local suppliers. In addition, according to China Textile Industry Association, China’s large textile businesses recorded a 25.4% y-o-y jump in net profit to RMB133.2b in 11M2009 on broad base growth in all product segments.

Furthermore, companies in the same sector such as Li Heng is also modestly upbeat on its prospects in FY10 as it continues its capacity expansion and expects to complete by 1QFY10. In addition, Li Heng management also expressed orders visibility up to 1H10, instead of only one month in 1H09. This also corroborated the overall improvement in the sector.

Arguably best among SGX listed textile firms but …

With reference to Table 3 below, Gaoxian leads the pack by having the best financials in terms of net profits and earnings per share. However, it is still inadequately covered by analysts, due in part to the poor market sentiment on the overall sector and a lack of familiarity to Gaoxian business. Gaoxian’s average 3 month liquidity is only at 6.5m shares. A good reflection of its poor liquidity can be seen on 23 Feb, where less than 2m shares exchanged hands, after its result release the day before.

However, management is making inroads to engage the investment public. It just participated in the Financial PR Conference on 9 Mar where it had a lively discussion with analysts and fund managers. This should bode well for Gaoxian in the medium to long term as fund managers and analysts get more familiar with Gaoxian.

Financial comparison among Gaoxian’s peers (Source: Company & Ernest’s calculations)
Table 3: Financial comparison among Gaoxian’s peers (Source: Company & Ernest’s calculations)

No final dividend but…

Gaoxian is conserving cash in view of its RMB300m aggressive capex in FY2010. Although I am initially disappointed (as I am a shareholder too), I am heartened by management’s aggressive capex which bears testament to the improving sector outlook and their own optimistic outlook. The capex, if successfully executed, should bear fruits in the short to medium term.

Valuation – Target price remains at S$0.335, 91% potential upside

Table 4 lists Gaoxian’s valuations against its peers. It is apparent that Gaoxian trades at a significant and unwarranted discount to its SGX listed closest peer Li Heng. According to Bloomberg, Gaoxian trades at FY10F PE of 1.9x, vis-à-vis that of Li Heng of 6.4x and the sector average of 5.1x. With its strong earnings growth, low valuations of less than 2x and sanguine industry prospects, Gaoxian is likely to outperform relative to its peers. Pegging Gaoxian to 5.8x FY10F earnings, target price for Gaoxian remains unchanged at S$0.335 in a year’s time, representing an upside potential of 91%.

Gaoxian’s valuations vis-à-vis its peers (Source: Bloomberg)
Table 4: Gaoxian’s valuations vis-à-vis its peers (Source: Bloomberg)

*Note: I have taken out Foreland Fabrictech, Qian Feng Fabric and China Fibretech as they do not have any FY10F PE.

Disclosure: Writer is vested

Ernest Lim is a CFA, CA and has worked at GIC Special Investment. He has a solid feel of the markets and financial world and is now a remisier.

Please click here for more information about this author.

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