Hong Leong Asia
On the 27th of November 2016, I noted an entry into my investing journal. My modus operandi is to create a master folder of companies that I am interested in. And within these folders contain the information with which I do my research. The folder may also contains annual reports, links to news articles in the media and any filings related to the company. Within 1 of these master folders contained a company called Hong Leong Asia Ltd, a holding company of various subsidiaries operating in diverse industries. It has a total of 5 core business segments. They are:
- Diesel Engines
- Consumer products
- Building materials
- Industrial packaging
- Air conditioning
Diesel engines, air conditioning and building materials are very cyclical products. And of course, since one of its largest markets is China, the fall in economic growth has somewhat affected Hong Leong Asia’s subsidiaries, which in turn affects Hong Leong Asia itself. In the 2015 annual report, the chairman, Kwek Leng Beng issued a statement:
” The slowdown in the growth of the China economy to 6.9% in 2015 had a critical impact on our China operations, namely, the diesel engines unit and the consumer products unit.”
The biggest business unit within Hong Leong is that of diesel engines. In 2015, it did close to 3 billion in sales. This is followed by the building materials unit with 580 million in sales. And thirdly, consumer products came in with 425 million in sales.
Enfolded within Hong Leong Asia Ltd lies these business units and its more significant subsidiaries are China Yuchai International Ltd, Henan Xinfei Electric Co Ltd and numerous other smaller subsidiaries. China Yuchai is a listed entity in the NYSE.
I would have to say that holding companies are really not a favourite place for me to start my research process. You could say that I do have a bias towards holding companies. And this bias stems from my market experience and a lot of things I have read about. My humble opinion is that holding companies sometimes trade at a wide discount to net assets because there is very little visibility into some of their subsidiaries. The “gold” so to speak is in these subsidiaries.
That lack of visibility can cause a period of undervaluation and worse still, a prolonged period of undervaluation. And as investors there is little we can do to realize that value unless the gap between the net asset value and the market capitalization narrows. And in order for the net asset value and the market capitalization to converge, the proceeds from the subsidiaries must flow to the investors of the company.
With numerous subsidiaries coupled with a lack of reporting into the subsidiaries, these holding companies are punished big time by the markets. Many of these holding companies stay undervalued for very long periods of time and justifiably so. So unless we have the kind of investing clout that can buy a large chunk of the company in concern and force upon management certain policies, these holding companies can stay apparently undervalued for long periods of time.
I have a lot more to say about holding companies and I could probably write a lengthy essay about it . But for now, I will leave it at that.
Now that we know that Hong Leong Asia is a holding company of various business units which are cyclical in nature, it is natural to see a fluctuation in the past earnings of the company. Have a look at the earnings history below.
And with a fluctuating earnings comes fluctuating stock prices. The markets will react accordingly to the reported after tax per share earnings. Also, analysts would have to do revisions to their models to find a renewed target price and publish them for their clients. When earnings ebb and flow, so do market prices.
And pretty much, this was what happened to Hong Leong Asia. Therein lies the opportunity as well. These ebbs and flows, expansions and contractions, follow a certain rhythm found in nature. At a good price, on a cyclically adjusted price to earnings basis, an investor could decide if the company is right for him or her. Learn more about the cyclically adjusted price to earnings ratio by reading Countering The Simple PE ratio.
If today you are thinking of investing in Hong Leong Asia Ltd, be sure to understand the business and also, look into the future and see if you could see a probable earnings growth from 2014 and 2015 earnings. In 2015 alone, the earnings per share is reported to be a negative 16.4 cents.And at a good price, the investment thesis becomes very simple. The question is how likely is it, how probable is it that the company in question will enjoy earnings growth. So you don’t even have to do a valuation of the company here. It is not necessary to run a discounted cash flow analysis and a dividend discount model analysis here for we are simply talking about probabilistic thinking here. But if you’d like, you could run your own valuation models here. But be sure of one thing, you are most likely going to be wrong. And so is any equity analyst out there.
Debt And Liquidity
With regards to the debt and liquidity, I do not have much concerns regarding it. I think that liquidity levels and debt levels are not at its best levels, but it is acceptable. At the time when I was reading its annual reports, its cash exceeded its long term debt and short term debt combined.
Inventory turnover ratios also improved from 6.3 to 7.8 over the last 5 years. Inherently, that is a good sign.
The current assets are quite liquid in my opinion. We are talking about cement, building materials, air conditioning systems, diesel engines, consumer products and industrial packaging.
The last thing I would like to talk about is China Yuchai. As mentioned earlier, it is a listed entity in NYSE. When we looked at this company, it was trading at $12. We believe that the company deserves to trade at closer to $20. Now, China Yuchai is trading at $14. This will have a positive impact on Hong Leong Asia as Hong Leong has a stake in this company. This could be the catalyst that we are looking out for.
We initiated a long position of Hong Leong Asia at 68 cents per share. Since then, it has gone up to around $1.30 per share.