Ming Fai International Holdings: 200% upside?

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

Financials

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:

Ming Fai historical financials

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:

Ming Fai retail segment after minority interests

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:

Ming Fai amenity segment revenue and profitability

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:

Ming Fai revenue and EBT by segment

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.

Valuation

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:

Ming Fai valuation

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

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.

Conclusion

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.

Disclosure

Author is long Ming Fai International Holdings

23 thoughts on “Ming Fai International Holdings: 200% upside?

  1. Martin

    Interesting company and good article.
    For now the share options are no big deal as the strike price is not too low. But if they keep granting them each year their total value will increase. They can be excersised from now until 2019. Quite some option value.
    At least the amount is capped for now:
    “As at the date of this report, the number of Shares available for issue under the Share Option Scheme is 42,560,000 which represents approximately 6.10% of the issued share capital of the Company.”
    They could buy-back some stocks in order to reduce dilution, when options are excercised. If I understand correctly the then fair value of granted options is fully expensed in the year of grant.

    From net cash I would at least partially subtract:
    Loans from non-controlling interests are unsecured, interest free and repayable on demand. The carrying value of these liabilities approximate their fair values (6.5m).

    I also like that PWC is the auditor.

    The in 2010 purchased retail segment also had some cost due to litigation.

    Why do they need debt despite its low interest rate at all? Are there signs the cash is not for real?

    Reply
    1. Alpha Vulture Post author

      I think the debt is used to partly finance the purchase of the real estate since it is also used to secure the debt. Not sure exactly why, but don’t think it’s a red flag. Bit of debt in combination with real estate is pretty standard, and the fact that they were able to buy a building should be a sign that they actually have cash. Being able to get a loan from the bank is another good sign imo.

      About the stock options: yes, I don’t like to be diluted but don’t think it’s a big issue (at this price). Think options are expensed in the same period as they vest. Don’t remember the exact details but remember reading something about a two year vesting period, so it would have been expensed in two years as well.

      I subtracted the loans from non-controlling interests from the net cash balance by the way, although the amount isn’t significant anyway.

      Reply
      1. Martin

        Maybe, I have made an error. My net cash:
        Cash and cash equivalents 343,800
        -Long-term bank borrowings 32,444
        -Current portion of long-term bank borrowings 6,413
        -Loans from non-controlling interests 6,521
        =298,422

        The facility is secured by the office premises with maturity date on 27 November 2019. As at 31 December 2013, the outstanding borrowing of this facility amounted to HK$38.9 million (31 December 2012: HK$45.2 million).
        –> Indeed, all debt seems to be just this real estate related loan. Thanks.

        Interest expense on borrowings for the year ended 31 December 2013 was approximately HK$798,000 and 0.96% interest rate. 798,000/0.096=83,125,000

        Maybe the at the balance sheet date undrawn banking facilities had some cost, too. Otherwise the numbers don’t add up.

        Reply
        1. Alpha Vulture Post author

          You are right, thought I had included that but I haven’t. So cash is indeed HK$298 million. Not really worth spending too much time on, and yes: they are probably paying a bit for undrawn banking facilities. Banks like to make money…

          Reply
  2. Avital

    Hi, great Blog, thanks for sharing!
    While i think it’s an interesting idea, I have a little problem with your valuation method: I don’t think that it’s correct to include the real-estate and the cash in the valuation of this company.
    1. The company is clearly not in a situation of liquidation, so you are not going to get the cash or part of the real-estate.
    2. I think that they are not going to pay the cash to shareholders as dividends (and not as share repurchases) because it seems like they pay dividends only from net income (the pay-out ratio is less than 100% in every year) and not from surplus.
    3. If 2 is right, than they are going to spend the cash on other ventures, and both the retail and the laundry segments can give us a hint about their capital allocation abilities (which are mediocre).
    4. I know you had in the past a position in ASFI (that’s how I get to your blog). You surely remember that they also have a huge amount of cash, which just seat there, eroding. I’m not saying that’s what’s happening in Ming Fai, but employing capital in mediocre ventures isn’t better.

    So, I think that the upside in that company is only if your valuation of the amenity segment is correct. By your method it’s still a 100%, so it’s definitely not bad.

    Reply
    1. Alpha Vulture Post author

      While I get where you are coming from to a certain extent I disagree with your premise that the cash and real estate should be excluded from the valuation. The real estate is generating income, and while I agree that you shouldn’t expect that they will return excess cash to shareholders that doesn’t mean that they will keep it lingering on the balance sheet indefinitely. You might want to apply a discount because of that, but fully discounting the value of those assets seems to be extreme. And by your logic we should also discount the cash that isn’t paid out as a dividend, so with a 50% pay out ratio you could argue that the current market price is the right price…

      Even if they would buy, and overpay for, a new business you still get something in return, and while they might make mistakes they have no actual incentive to do that since they own a large stake in the company. Sure, their history so far with the retail and laundry segment isn’t encouraging, but the real world is unpredictable and complex. Not every new business will be a big success (or a success at all), but that doesn’t mean that it was a bad idea. The retail business actually looked like a pretty decent idea when you check the 2010 and 2011 results, and the amenity business was a great idea. Who knows how many things they tried before they started that?

      Reply
  3. Alexx Buds

    Looks like a great analysis. If I may ask, might you be able to suggest an online broker where US-based investors might be able to buy international stocks like this? I have a Schwab account but they don’t seem to do much with non-US securities.

    Reply
    1. Alpha Vulture Post author

      I’m not based in the US so you probably have a lot more options than me, but I think Interactive Brokers is pretty decent w.r.t. to access to foreign markets (also bought this stock through them). But they don’t provide access to some smaller markets. Because of that I’m using a Dutch broker to get access to for example Portugal, Denmark and the AIM market in London.

      Reply
    1. Alpha Vulture Post author

      I don’t really know. They did enter the retail and laundry segment in 2011 so that could explain why they wanted some cash, and at the end of 2010 their net cash level was pretty low. Not that crazy of an explanation. They also timed the sale pretty well in hindsight, but on the other hand: what I absolutely don’t like is that they were willing to sell the shares at an almost 10% discount.

      Reply
  4. Christopher Spivey

    Interesting discovery. I want to believe, and invest, but… Leadership does not convince me. I don’t get a clear sense that they know what they are doing. Do you have any reason to believe otherwise. E.g. Their costs of distribution and admin are outpacing revenue and operating profit. I’d like to see efficiency in their growth. And investing in and merely giving up on say Laundry, does not convince me that they are serious, but adventurers… Do you see evidence to suggest otherwise? For instance I’d prefer that they fixed Laundry and sold it, rather than just stopping it. Their real estate valuation is overstated by 2x. Where’s the future cash coming from? China, Asia, other?

    Id like to hear management and leadership state that they endeavor to double and triple market value in 3 AND 5 years, by executing, investing, treasury ops (buy backs and return cash to share holders), cost management, new markets, dealmaking, dispositions… Whatever.

    What do you think about the leadership?

    CRS

    Reply
    1. Alpha Vulture Post author

      I’d argue that every mangement team that is able to build a business this big isn’t totally clueless, and at this price you don’t need them to be the next Buffett.

      Reply
  5. John

    I am an investing noob but was trying to do some due diligence on this and had a question. When trying to disentangle the financials of Everybody Labo sub I see the spreadsheet you show has 2013 retail income before taxes of 34,448. How did you get non-controlling interests (after tax) of 4,931 and subsequently retail income attributable to shareholders of 14,231?

    Also if Ming Fai owns 51% of Everybody Labo Limited sub, any idea who owns the other 49%?

    Thanks, I love the blog. Actually stumbled upon it from 2p2 a few years ago. Hope poker is going well if you still play!

    Reply
    1. Alpha Vulture Post author

      Since they have only one partially owned division you can take the non controlling interests reported on the income statement and apply that to the retail segment. This number is after tax though, so I have applied the average tax rate of the company to this number to estimate segment EBT attributable to shareholders.

      Don’t know exactly who owns the other 49%.

      PS. not playing a whole lot of poker anymore…

      Reply
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  7. floris

    David Webb has crossed the 5% threshold. A deep value activist investor based out of Hong Kong. Having just read Deep Value Investing, I think Ming Fai would fit in perfectly. The true earnings power and asset value is completetly obscured by underperforming business units as well as a strong net cash position. Lets see what he can do to close the gap between IV and MV.

    Regards.

    Floris

    Reply
    1. Alpha Vulture Post author

      Nice, good to have him as a fellow shareholder. Guess that also explains the trading action of the past few days. Where did you by the way exactly find this disclosure? Can’t find it on the HKEx website.

      Reply
  8. BlackSheep

    Interesting analysis.
    Did you consider asset tunnelling risk associated with this company? Always a significant risk when investing in cheap asset backed plays in HK.
    Also, the pump and dump engineered post capital raise in 2010 is a red flag.

    Reply

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