Computime Group Ltd (0320.HK): a net-net in Hong Kong

The market turbulence in the last quarter of 2018 created a few attractive prices in some of the companies on my watchlist. Many of the companies I loosely track in Hong Kong also became a lot more appealing during this sell-off. I have bought a couple. The subject of this post is one of these companies: Computime Group Ltd (0320.HK).

The company is currently in net-net territory and trading at a large discount to book value:

Share price: $0.81 HKD
Shares outstanding: 839.74m
Market cap: $680.2m HKD (~$87m USD)
NCAV Sept. 30, 2018: $818m
Book value: $1.24bn
Price/NCAV: 0.83x
Price/BV: 0.55x

Computime has historically been a company that offered contract manufacturing services to large multinational companies. Computime offered OEM and ODM services for appliance controls, HVAC solutions and commercial, industrial and medical applications. In recent years they’ve been focusing on introducing their own products. They’ve seen some success with their SALUS branded products. These are products for the “smart home” – think thermostats that offer more control over the temperature in your home and that can communicate with your mobile phone. The SALUS brand was introduced in 2008 and showed operating losses in the early years, but their products are now established and revenues have been growing nicely.

The SALUS products belong to the Smart Solutions (SS) segment. The other segment for Computime is Contract Manufacturing Services (CMS). These two segments were introduced in the H1 fisc. 2019 report. In earlier reports there were three segments: Building and Home Controls (BHC), Appliance Controls (AC) and Commercial and Industrial Controls (CIC). I believe the BHC segment has been renamed Smart Solutions and that the former AC and CIC segments have been combined and renamed to Contract Manufacturing Services (CMS). The most important thing is that the SS segment is the better business, with higher margins and better growth prospects. Although SALUS seems to be doing well, I’ve not been able to find out what percentage of the overall revenue SALUS currently represents.

A more attractive net-net?

The Internet-of-Things market is expected to grow quickly in the coming years and Computime is in a good position to capitalize on this growth with their SALUS products. I think this makes the company more attractive than most of the other Hong Kong listed companies on my watchlist. There are probably many companies that are, for example, trading at larger discounts to NCAV or book value than Computime. But often their businesses are struggling: revenues are stalling or declining and labor costs are steadily going up, driven by minimum wage increases at their Chinese factories.

Computime is certainly not immune to all this, but I do think that they are in a better position than most small manufacturers, thanks to their exposure to a sector which looks to have the wind at its back over the coming years.

Capitalized R&D

The company is spending relatively large amounts (for its size at least) on R&D. Computime is very clear about their expenses. Even though they do capitalize R&D expenditures (they are called “deferred expenditure” in their reports), they do not try to hide this fact. The deferred expenditures are included when they talk about capital expenditures (for example on page 28 of their H1 2019 report). Their deferred expenditures have been somewhat higher than their amortisation charges, but no dramatically so.

I think it is a good sign that they are talking about their R&D in this way. In general I found Computime’s reports to be quite informative and detailed. I’ve seen a number of seemingly cheap companies in Hong Kong that provide you with very short and very general reports about their business and performance. Their reports don’t really tell you anything. I think companies like that should be avoided, no matter how cheap they seem.

A long history of profitability & dividends

Computime’s IPO was in October 2006. I’ve looked back at old annual reports and the company has not had a single money losing year since their listing. Profits did drop in the years after the financial crisis, but in the last couple of years earnings have rebounded. In fiscal 2018 net income was $126m, which was the same amount as in fiscal 2017.

The company is a consistent dividend payer as well. For fiscal 2018 and 2017 Computime paid a 7.5 cent dividend, which would give it a very high yield (9.3%) on the current share price. Unfortunately, profits are currently under pressure and the company will almost certainly pay a far more modest dividend for fiscal 2019. More about this below.

One thing I noticed about their dividends is that they are listed under operating cash flows in their cash flow statement, instead of under the financing section where most companies report dividends paid to their shareholders. I’m not sure why they choose to do this, but it is something to keep in mind when you’re looking at cash generation for this company.

This consistent stream of dividends are a positive sign. Many investors are (rightly) worried about fraud when they think about investing in Hong Kong. I think you can increase your odds for success by focusing on companies that have returned large amounts of cash to their investors since their IPO while not significantly diluting their shareholders or taking on a large amount of debt. Computime checks all these boxes: it pays consistent dividends, it has a stable share count and a low amount of debt. It is also not a recent IPO.

I also always do a search on Webb-Site.com for any Hong Kong listed company I’m interested in. Nothing came up that looked fishy. Of course this is no guarantee that there is nothing going on, but David Webb has exposed a lot of dubious activity among Hong Kong listed companies and published about it on his site. It pays to do a check on this site as part of your research. I have found a couple of red flags this way when I was looking into other companies.

Why is it cheap?

The company’s share price was already under pressure in 2018, due to the sell-off in emerging markets, but declined to its current levels in October 2018 when it issued a profit warning, citing a “slow down in customers demand due to deteriorated market conditions”.

Their subsequently released interim report for H1 fiscal 2019 offers some more details. Profits have declined by ~54%. Uncertainties about US tariffs among the company’s customers were leading to a slowdown in sales and a key customer also revised its inventory build in response to a business slowdown. Escalating component costs were another problem.

A bright note was that SALUS revenue grew 36% during the period. The company was also very positive about its near-term prospects:

SALUS recently launched an industry-leading thermostat with advanced energy-saving features, and it has received an overwhelming market response. More innovative products are being developed and scheduled for timely launches in the pipeline to ride on the brand’s rising market recognition. Coupled with business strategies to expand sales channels, the strong growth momentum of SALUS is expected to continue into the second half of FY18/19.

The trade war between China and the US is obviously scary and the possibility of future tariffs is already hurting the business. “The America’s” made up 28% of fiscal 2018 revenues. I have not been able to find out if this is all US based revenue or if this includes some amounts from Canada and/or South America.

I think that even if Computime does get hit by tariffs, the company will probably be able to manage. Europe and Asia are very important markets as well with 47% and 25% of fisc. 2018 respectively, and it is unlikely that all revenue from the US would disappear. The fact that component scarcity was a problem for Computime recently is probably a positive in this regard, because the US would probably be less likely to impose tariffs on products that contain components that are already hard and expensive to get. Also, the company’s SALUS line of products are part of the strongly growing Internet of Things (IoT) category. Perhaps that category of products is also less likely to be hit by tariffs than a more mature category.

Either way, I think the US and China will eventually work out a deal, because it is in both their interests to do so. The company has certainly been caught in all this trade war turbulence, but I think you also need to take a longer term view. A couple of years from now the trade situation will probably have improved, or the company might have found ways to mitigate the impact. The company has operated profitably for more than a decade and this doesn’t look like an insurmountable problem that will lead to a string of losses.

Another risk is customer concentration. For fiscal 2018, their largest customer represented 24% of revenues. The top five customers represented 57% of revenues. Losing a large customer could lead to another (big) hit to profits. I’ve invested in a number of companies that have relatively large customer concentration and at some point one will end up losing a large customer. So far I’ve been lucky on this front, but this is a reason why I will not take a large individual position in a company with customer concentration.

Another reason why the company could be cheap is that it is a micro-cap with a low float, due to large insider ownership.

Insider ownership

The Chairman, Mr. Auyang, has an interest in 353.5m shares or 42.1% of the outstanding shares. Another shareholder, Ms. Leung Yee Li, has an interest in 215.2m shares or 25.6% of the shares. Most of these holdings are held through holding companies, which is very common in Hong Kong. It can make the ownership situation very murky though, as you often don’t know who else is holding an interest in those holding companies and what the relationship is between those people.

I don’t know what the role of Ms. Leung is in the company. She doesn’t hold a seat on the Board. Perhaps she is a co-founder. I do know that she has held a large stake in Computime since before the IPO.

These large stakes reduce the float of the company. Computime’s market cap of around $680m HKD ($87m USD) is already quite small for Hong Kong. The float is probably smaller than $200m HKD ($25m USD), which makes the company unsuitable for any investor who is looking to invest many millions of dollars in a single position. I think that can create some inefficiencies in stocks like this, because retail shareholders play a more important role in the trading.

One thing that did stand out when I reviewed the insider transactions was that Mr. Auyang made a gift of ~8m shares (about 1% of shares outstanding) in September 2018. There was no further disclosure about this gift or its beneficiary. This is not an immediate concern to me, but it is something to keep an eye on.

Conclusion

Computime looks like a fairly high quality net-net. There is a long history of profitability and substantial dividend payments to shareholders. Their exposure to a strongly growing category of products (IoT) should insulate them somewhat from cost pressures.

Illiquid stocks like this can get overlooked for long periods of time, especially when sentiment is poor, as it is now. If profits do ultimately recover to levels reached in fisc. 2018 and 2017, the company will probably increase its dividend again to somewhere around the level they paid in those years. If this scenario does play out, I’d be surprised if the stock price continues to sit at current levels, as the dividend yield would be around 9% at that point.

Disclosure: long Computime Group Limited (0320.HK)

Posted in Hong Kong stocks and tagged .

11 Comments

  1. If you like Hong Kong net nets, take a look at 184 HK – Keck Seng Investments. Cash per share 6 HKD, stock price is 4.80. Also has 30 HKD worth of real estate per share, with roughly 4.50 HKD in non-recourse debt. Generates 1 HKD in free cash flow per share per year.

    • Thanks! I’ve heard the name before, but have not really looked at it yet. I should probably spend some time on it.

    • 184 HK sounds intriguing, Mike. How do you arrive at your estimate of the value of the real estate? The company reports are not very forthcoming on this, so any pointers would be much appreciated!

  2. I think it’s good to emphasize here that I don’t think Computime is a wonderful company. They are active in very competitive and fairly low margin industries.

    I noticed that because I said in my post “Computime looks like a fairly high quality net-net”, some readers seem to believe that I’m making the case that this is a wonderful Buffett-type business with high margins and a moat. It is not.

    I was just saying that compared to many of the other net-nets that are out there in Hong Kong and other places, Computime looks attractive to me. So “high quality net-net” is very much a relative term.

  3. I tend to agree that this is not such a clear value proposition as it might seem at first glance.

    While is it indeed a somewhat quality net-net, the co. earnings power is somewhat disappointing and very volatile. Looking at normalised historical earnings, the co. seems to be able to do $95m yearly (average since 2015) and its LTM stands actually quite lower that that, at $69m when adjusting by (non-recurrent) FX gains.

    This is my simplistic way of value Computime:
    10 x adjusted average earnings since 2015 => + $947m
    add excess net cash (at 1HSep18) => + $41m (I would not use excess cash at YE March since the co clearly needs most of this cash to invest in working capital during the year)
    subtract Operating leases => – $95m (as of Mar18)
    subtract Dividend paid after Sep18 => – $63m
    Total target value: $ 830m
    Divided by fully diluted share-count => $0,98, which still yields an OK but limited 14% upside… The IoT might drive industry growth, but I imagine there are several players well positioned to capture it and returns for them should not be spectacular.

    • Thanks. Yeah, it’s a bit of a “cigar-butt” investment.

      I think Computime offers a cheap option on the growth of their most attractive segment. If their SALUS brand can continue to grow nicely over the next few years, I think I should do fairly well. If not, I don’t think I’ll lose much at these prices. The IoT industry is very competitive, but I think their other business lines are as well and those have had lower margins than the Smart Solutions segment.

      Cash & working capital: the last period was a bit unusual, I think. It started off weak and recovered a bit towards the end of the period. Both inventory and receivables were over $100m higher than in the same period last year. I’ve not looked back further though to see what a typical level is for the company at that time of their fiscal year.

  4. Hi this is definitely a net net stock , however upon further inspecting the net net working capital, it don’t look that attractive do you have any insight to it?

    Best regards
    James

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