A reader pointed me in the direction of Ming Fai International Holdings. The company is based in Hong Kong and is primarily active in the amenity business. They manufacture and sell products suchs as soaps, toothpastes and towels to hotels and airlines. What makes the company interesting are the solid operating earnings – especially when we look past a loss making subsidiary that has been shut down – in combination with a nice dividend yield, a large cash balance, significant real estate holdings and high insider ownership. As usual first some simple valuation metrics to get an idea of what we are looking at:
Last price (Jul 25, 2014): HK$0.74
Shares outstanding: 697,763,697
Market Cap: HK$516.3M (US$66.6M)
Free float: 55%
P/B (mrq): 0.40x
P/E (ttm): 12.9x
EV/EBIT (ttm): 3.4x
Ming Fai appears to be cheap when we look at book value and at the EV/EBIT ratio, but when we look at the current earnings ratio it’s not an obvious bargain. I have compiled an overview of the historical financials in the table below:
As is visible earnings/share show a downward trajectory and the dividend has been cut as a result. This probably explains why investors aren’t enthusiastic about the company, but when we dive deeper in the various operating segments we will see that things aren’t as bad as they look. And too be honest: things don’t really look that bad to begin with. The company is currently valued at roughly HK$500 million while it has investment property worth a bit more than HK$200 million and a net cash balance of HK$300 million. You get the operating business for free!
Whether or not the investment property is really worth book value is a good question. The company recorded HK$4.8 million in rental revenue and HK$0.6 million in operating expenses for a NOI of HK$4.3 million which implies a cap rate of just 2.1 percent. Apparently this is normal in Hong Kong, but I wouldn’t buy this stock if the investment case would hinge on the valuation of the real estate. It’s certainly not cheap.
What makes Ming Fai interesting is that the true earnings power of the business is a bit obscured. A relative small issue is that the reported earnings are a bit hard to understand due to the consolidation of the partially owned “Everybody Labo Limited” subsidiary. The company owns just 51% and since this subsidiary is generating sizable losses in most years line items such as operating profit underestimate the earnings that are attributable to equity holders of the company. A quick and dirty estimate of the earnings of the retail segment that are attributable to shareholders of the company:
What is more interesting is that the profitability of the various operating segments of the company is very different. The core business – supplying amenity products to hotels and airlines – has been pretty solid. Revenue has grown straight through the recession at a 10% CAGR since 2007 while segment earnings before taxes have been a bit more erratic:
The reason that we don’t see this solid performance back in the earnings statement is the fact that the two other segments: laundry and retail have been a lot worse. The laundry segment is new venture of the company that was started in 2011 in an attempt to expand the range of services they offer to hotels, but it’s fair to say that this has been a failure since it has never been profitable. The retail segment – that includes the 51% stake in “Everybody Labo Limited” – has been profitable in the past, but performed very poorly last year:
Luckily management has realized that the laundry business isn’t a good one, and they have decided to exit the venture before 30 June 2014 and this will obviously improve the performance of the group going forward. Note that other income, primarily revenue generated from the investment properties, is also reported in this segment so the laundry business is even worse than it looks in this table.
How the retail business will develop will be though to tell at this point in time, but I do think this has more potential since it has been profitable in the past. Perhaps it will return to profitability, and if it doesn’t it seems that management is rational enough to pull the plug.
The value of Ming Fai is the sum of the cash, real estate and of course the operating business. The first two pieces of the puzzle are easy to value: book value should be accurate enough, although the conservative investor might want to add a discount because of the high property values in Hong Kong. The value of the operating business is a bit more complex, because the laundry segment has been shut down while the performance of the retail segment has been erratic.
I think simply valuing the retail segment at zero is a decent choice. Either the retail segment will return to (historical?) profitability and it will be worth a decent amount, or it could struggle and lose money for a couple more years before management shuts it down. The weighted average of those two outcomes is probably not too far from zero.
So what really matters is the value of the amenity segment. While it has shown strong revenue growth the growth in earnings has been mediocre so a 10x multiple seems reasonable to me. A good question is what kind of tax rate we need to apply to the pretax earnings. The effective tax rate last year was 44.4% which is more that double the average tax rate of the previous six years. It’s unclear to me what the exact reason is, but I think this is a temporary phenomenon since the corporate tax rate in Hong Kong is just 17.5% and it’s 33% in China. Using the 27% rate that the company paid in 2012 seems like a better guess.
This creates the following picture:
I’m the first to admit that this is not the most conservative valuation possible, but with this kind of upside potential there is a large margin of safety when some of your assumptions are a little bit too optimistic. Maybe taxes will be higher in the future, maybe book value overstates the value of the investment property or maybe the retail segment will continue to generate losses and has in fact a negative value. It could all be true and you would still have a decent amount of upside.
Insiders own 30.33% of the outstanding stock which is in my opinion a great amount. They own more than enough to care more about the success of the business than their salary, but they don’t own enough to be able to ignore outside investors. Unfortunately their ownership stake is making it hard for the company to repurchase shares because insiders would be required to launch an offer for the whole company if they cross the one-third ownership threshold. Sucks, because repurchasing shares would be an great way to spend some cash.
What I do like is that the company has a solid history of paying out a large percentage of income as dividend since their IPO in 2007. The average pay out ratio is above 40% and even though earnings are currently depressed that still translates to a 4.7% dividend yield. I expect that this will go up next year after the exit of the money losing laundry business.
What’s perhaps the biggest risk is that management will spend more cash on unsuccessful ventures like the laundry business, and the retail business doesn’t look that great in hindsight either. But I don’t know if this is really a big deal. They tried to enter businesses that were adjacent to their main business, and not everything you try will be a massive success. But as long as you are willing to exit when it doesn’t work some diversification isn’t a disaster, and their ownership stake is big enough to give them the right incentive. Would probably be better if they would only focus on the core business though.
There is a lot to like about Ming Fai at the current price. The amenity segment could be worth twice the current market cap of the company, and you also get a bunch of cash and real estate thrown in the mix as well. Of course not everything is perfect when you buy a stock this cheap, but I don’t think there is anything seriously wrong with Ming Fai. It seems to me that a lot of investors simply have trouble looking past the headline revenue and profitability numbers, and don’t give the company credit for shutting down the money losing laundry division and the possibility of turning around, or exiting the retail segment.
Author is long Ming Fai International Holdings