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Friday 7 June 2013

HuaBao International (0336.HK) a fool's gold? Part 1

Yesterday, wondering through my spreadsheet of all listed companies on the Hong Kong Stock Exchange, I came across this amazing company called Hua Bao Holdings International Limited 华宝 or so I thought.

As the Chinese saying goes - "on a full stomach and nothing to do" (吃饱饭没什做) I loaded up my spreadsheet of over 1,300 companies listed on the Main Board of the HK stock exchange and started to review the list.  Boring but a necessary process.  You might wonder with modern technology that can slice and dice making stock screening easier why this laborious process?

The grind goes like this...

Company number 300, Kunming Machine.  'eh' PE n/a? 'ai ya' loss making industrial goods manufacturer.  Market cap only HKD$300m (H shares).  My head starts to roll; you have to ask why these small companies come on to the main board when you have Hutchison (courtesy of Mr Li Ka Shing) with a market cap of HKD$352bn at a reasonable PE of 13x and dividend yield of 2.6%.  Yes, we are in the age of zero interest rate policy and real inflation very much higher than that.

Never mind only 30 seconds wasted so far - plough on.  Ticker number 336 HuaBao Intl.  'wa' interesting, PE 6.22. Let's check out the stock chart, 'wa' even better when QE have floated all dead carcasses like Kunming Machine this stock had barely budged in the last 12 months.  Alright, I am curious, lets look at what it does.  Hmmm flavor, fragrances and reconstituted tobacco leaves (RTL) sounds interesting.  Market cap of HKD$ 10.7bn which is decent size. 

Scrolling further down, one cannot not be impressed with HuaBao - DIVIDENDS!  RISING DIVIDENDS! 6.35% Yield! 

Usually Chinese business owners have multiple businesses, some listed some not, they do not depend on dividends, they depend on rising stock prices, transfer pricing mechanisms, using their listed vehicle's cash to acquire companies that they own (but cannot directly traced to them) at unjustifiable earnings multiples etc. i.e. they treat it as though it was their own personal candy jar.

 This Company really takes care of its shareholders - Jackpot!

5 minutes gone 

Never mind, must look further - next stop - Recent Announcements.  'WA!'  look at the share buybacks.  Charlie Munger says buy cannibals.  Companies do buybacks because they think their stocks are too low.  Another tick in the box

10th minute

Back to the profile.  Net assets only HKD$6.3bn.  Not bad, but no Ben Graham. 'Ah' but look at how much Warren Buffet paid for General Re?  Maybe it has strong market position, brand, customer base etc.?  Better encapsulate within the term 'Franchise Value'.

15th minute

By now memory wandered back to UK about speciality chemicals companies in the flavours and fragrances industry being a good safe bet.  Nothing exciting but safe and pay good dividends.  (Treatt PLC: PE 17, Dividend Yield 0.9%)

60 minutes later

Feverishly downloading annual reports, interim reports and share price data going back to 2006.  Now, I have all the data in front of me, its time to look at the latest interim report - six months to 31 March 2013.  So far so good.  Margins are amazing at nearly 70% but report says margins may reduce in the future as RTL carries lower margins.  At that kind of margins why concern yourself?  Cash is being churn out faster than used for buying plant and machinery.  I have not come across a company operating in China with that sort of margins, even the operating margins are double digits at over 60%. 

Talk of China exporting deflation, over capacity, squeezed manufacturing margins and wages getting higher simply does not apply to this company. 

I must be missing something...

120 minutes later

I am now analyzing insider and substantial shareholders. 

  • Ms Chu Lam Yiu, Chairwoman (age 42) 38% shareholder.  Spectacled, skinny and I guess petite.   
Showed Rachel (the wife) a mug shot of Ms Chu.  She was dismissive and went back to her poker.  She said, she don't look the part - i.e. an entrepreneur who started a company now worth HK$10bn+.  Well at least she has an honest looking face I protested.  All the other guys look like charlatans and snake oil salesmen.  No disrespect to women, but how many CEOs or business women in China are that young or indeed exist?  We agreed perhaps someone must be behind her.
  • Mr Lau Chi Tak, CEO (age 55) -
Well he looks sly.  We both agreed and laughed.  But he does not have any shares in the company.  No vested interested.  Just a professional operator?  Anyone that good in China would have started their own business already.  Another strange feeling.

Got to be careful - management cannot be trusted 100%.

Substantial Shareholders
  • Wow! Blue blood names - JPM, Lazard, UBS, BNY Mellon, Credit Suisse, Morgan Stanley, Prudential and Wellington.  together through various capacities has just over 51.2%.
They cannot all be wrong.  These guys are smart and well paid!  Smartest guys in town will control the behavior of management and take care of us little guys.

But, something still bothered me...too good to be true...have to start reading the MD&A sections.  Yawn.

180 minutes later

All these fanciful words mean very little to me, must be the translation.

"The Zhejiang Xiangyuan is principally engaged in research of certain production technique in a specialized RTL in China and has gained laboratorial achievements." HUH?
"The new headquarter has referenced to international enterprises’ concepts, to improve the facilities of the existing office building and to group key departments and major management teams into one place, and with the implementation of an advance cloud terminal system, which will help further elevate management efficiencies." HUH?

All right time for be bed.
Saturday, 8th June, 10am
Continue with MD&A...

FY 2012. Excerpt from Chairman's Letter to Shareholders:
"Responded to crisis solemnly, protecting shareholders’ interests
Ever since last year, the Company had suffered from a series of groundless accusations and condemnations, resulting in wild fluctuation in the share price and both the Company and its Shareholders suffered severe loss. The management was in unity to rebut the relevant criticism in a prudent and detailed manner. In addition, I have notified the Company in writing, my intention to increase my shareholding as soon as practicable and in full accordance with the relevant regulatory requirements. The management and I are confident that we are able to overcome this crisis, and we strongly believe that, as long as the Company keeps on bringing returns for its Shareholders, the true value of the Company will ultimately be reflected in the market."
Better check the Company's response.
Better still let's Google - Anonymous Analytics
As of today (13+ months after the report) Ms. Chu's shareholding has not changed.  It has neither increased not decreased.  It remains at 38%. 

While I was lucky to have kept a healthy level of skepticism which kept me digging deeper and deeper.  It would have been difficult, if not impossible with little resources to uncover such fraud in the business. 

Nevertheless there are clues that one should watch out for and if you have doubts and there are no concrete explanations to those doubts, then it is best to keep a wide berth to avoid permanent loss of capital.

In the next blog I will explain some of the things to watch out for and the pitfalls to avoid particularly when it comes to Asian stock markets. 

I might have wasted 10 hours but I have avoided a permanent loss of capital if this unfolds further.  However it might turn out that there is nothing wrong with the Company and I'd have missed the opportunity of a lifetime, but those points raised in the Anonymous Analytics report have not been addressed satisfactorily.  Their report went to 44 pages.  The Company's response 11 pages.  There are still questions left unanswered - the little things that HKEX regulators do not concern themselves with. 

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