Investigating an unknown company is a lot more exciting than reviewing an existing position, but the latter is probably more important since it’s about something you actually own. I have been a shareholder of Allan International Holdings (0684.HK) for a bit more than a year, and the company and it’s intrinsic value haven’t remained static in this time. My own knowledge about valuing companies is also growing and changing. If you checkout my original write-up on the company you’ll see that it’s a bit superficial. So a good time to start fresh and see how I think about Allan International today.
Allan International makes household electric appliances like kettles, mixers and blenders. The company is based in Hong Kong and has it’s manufacturing facilities in China. They are in a competitive business and produce a true commodity product: there is no competitive advantage here, the only thing that matters is efficiency. Let’s take a look at the data first:
As is visible in the table above the historical performance of the company has been excellent on average, but revenue growth has stalled since 2011 while gross margins also show a downward trajectory since 2010. Despite the fact that revenue has been flat the company has invested heavily in new manufacturing capacity: the amount of PP&E on the balance sheet is up roughly 67% since 2011. Another noteworthy development on the balance sheet is the investment property the company bought last year and the bank debt related to this purchase. Despite the use of debt the liquidity position of Allen International remains extremely healthy with a net cash position of HK$207M.
The Allen International valuation puzzle has three pieces: the value of the investment property, the net cash balance and the value of the operating business. The first two pieces are straightforward to value: the cash and the investment property can both be valued at book value. Maybe a haircut for the investment property is appropriate. The value is appraised for every financial report, but you never know what the true value is until it’s sold again, and I’m always a bit distrustful when I see valuations adjusted upwards.
Simply taking the TTM Adjusted EBIT figure from the table above as a normalize pretax earnings figure seems a reasonable shortcut (it’s between the 5 year and 10 year average). The effective corporate tax rate in Hong Kong is a bit below 20% (based on the reported income tax expense), so this would give us an earnings figure of ~HK$100M. Throw a 8.5x no-growth multiple on that and we would get the following valuation:
- Cash: HK$207M
- Investment property: HK$220M
- Operating business: HK$850M
- Total: HK$1277M
The current market cap of Allan International is HK$711M, so it still seems that the company is cheap. If you deduct the value of the cash and the investment property from the market cap the effective P/E ratio is less than 3x.
This was more or less the valuation approach I used in my original write-up, but it does have a flaw. Net book value for the operating business is HK$532M and this is significantly less than the valuation based on the earnings potential. Given the fact that Allen International is active in a competitive commodity business it doesn’t make much sense to value the company above book value, and since a lot of PP&E is fairly new there is probably also not a big difference between accounting value and economic value.
While I don’t think Allan International deserves to trade at a significant premium to book value I also doubt that a large discount is appropriate. The current return on equity is still a respectable 14%, and the company pays out roughly 40 percent of it’s net income as a dividend to shareholders (tax free: there is no dividend withholding tax in Hong Kong).
I still think Allan International is undervalued, but I don’t think it’s such a great deal as I originally thought one year ago. A valuation around book value seems more reasonable to me. Based on current and historical earnings the business is a steal at today’s prices, but don’t think you can justify a big premium above book value. This means that my estimate of intrinsic value is around HK$2.86/share, or 34% above the latest share price.
Combine this with, what looks to me, good corporate governance, high insider ownership and a big dividend and you still have pretty decent investment. But at the same time the company is not as cheap as I would like. If I didn’t already own it today I doubt that I would buy it today, so this means that Allan is moving up on the list of things to sell if I need cash.
For now still long Allan International Holdings