CHINA CERAMICS CO LTD 3CCLTF
May 27, 2010 - 9:17am EST by
Coyote05
2010 2011
Price: 6.00 EPS $3.60 $3.00
Shares Out. (in M): 10 P/E 1.7x 2.0x
Market Cap (in $M): 61 P/FCF nm nm
Net Debt (in $M): -4 EBIT 35 44
TEV ($): 57 TEV/EBIT 1.6x 1.3x

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Description

I believe it is time to revisit China Ceramics ("the Company").  An extremely attractive valuation seems to compensate investors very well for the risk taken.

 

Summary description

The Company is the leading ceramic tile manufacturer in China.

+ very strong ROIC (~80%)

+ robust balance sheet (net cash after adjusting for recently concluded acquisition)

+ five largest customers (distributors) account for ~25% of revenue

- offers 90-day trade credit to its customers (all current as of 12/31/09 per SEC filings)

- thinly traded (on BB)

+ unlike many Chinese companies traded in the US, Op co is 100% owned by publicly traded Hold co

+ original owner who sold stake to SPAC was paid solely in stock

+ modest management compensation (extremely modest by western standards)

+ large insider ownership (both original owner and SPAC sponsors)

+ potential Yuan appreciation provides additional upside (or downside protection) not reflected on valuation numbers presented

 

Financials (Rmb million, IFRS)

 

2007

2008

2009

2010(p)

Note

Sales

618

737

836

1100

 

Gross profit

176

204

253

 

 

Ebit

166

190

240

 

x m&a exp

Ebitda

181

206

256

330

x m&a exp

Net income

146

165

153

 

 

Capex

4

7

8

140

 

 

 

 

 

 

 

Net debt, adj

 

 

24

 

Adj fror acq of Gaoan facility

 

2010(p) = financial projections from the Company's prospectus

 

Key risks

The biggest risk in my opinion is potential overcapacity.  The acquisition of the Gaoan facility increased the Company's installed capacity from 28 to 38 million m2/yr.  Further, it plans to invest an additional US$40 million to bring capacity to 70 million m2 by the end of 2011.  It is certainly possible that demand could suffer a contraction just as the company has committed significant resources to its expansion.

 

For those who are convinced that there is a real estate bubble in China that is about to burst, risk could be mitigated by hedging.  To this end, there does not seem to be a shortage of richly valued companies in the Chinese real estate sector.  In my opinion, a hedged position has a very attractive risk profile.

 

The company has a cost structure that would seem to allow it to withstand severe demand contraction without losing money.  First, SG&A accounts for about 2% of sales (currently Rmb 17 million/yr).  Second, variable costs in the form of raw materials account for ~60% of COGS (with clay 22%).  Lastly, D&A adds to about 2% or sales (currently Rmb 16 million/yr).

 

To illustrate, assume a draconian sales contraction of 50%, and to make it more severe, also assume that the non-variable cost base can not be rationalized (a very unrealistic assumption):

Sales                 450

Fixed cogs        200

Variable cogs   175

Gross profit        75

SG&A                20

Ebit                    55

Ebitda               75

Maint capex         8

Ebitda-m capex  67

 

One should also consider that the Company's capacity (28 million m2) was not enough to meet demand in 2009.  It had to outsource 4.5 million m2.  It is logical to assume that its true fixed cost base is lower than that implied by the 2009 numbers, which serve as the basis for the analysis above.

 

To conclude on the sensitivity analysis, even under quite pessimistic assumptions, the valuation is very undemanding.

 

Share count and valuation

The share count deserves some attention.  As of 12/31/09 there are 8.95m shares outstanding.  There are 15.55m warrants (CCLWF) expiring on 11/16/12 with a $7.50 strike price.  The Company can redeem these warrants at $0.01 each once the stock reaches $14.25.  In addition, there is an earn-out escrow that would increase the share count as follows:

A) Provided certain earnings targets are met the following number of shares will be released once audited financials are issued:

FY09   1.2 million

FY10   1.8 million

FY11   2.2 million

 

B) Once the stock trades for twenty days (within a thirty-day period prior to 4/30/12) at or above the following levels:

$20/share then 2 million shares will be released, and

$25/share then 1 million shares will be released

 

Thus, as of today the share count is approximately 10.2m (12/31/09 o/s + FY09 earn-out).  Adjusting for the acquisition of the Gaoan facility, China Ceramics is trading at less than 1x (tangible) book, 1.2x fy10 ebitda, and 2.0x fy10 ebitda-total capex (which are far in excess of maintenance).

 

Given the various moving parts, I find it helpful to look at the share count (and valuation) under different scenarios (with P being the stock price at the completion of the FY10 audit):

 

Scenario

Share count

FY10 Ebitda

EV/Ebitda

FY10 target met, P≤$7.5

12

48

2x (P=$7.5)

FY10 target met, P>$7.5

27.5

48

3x (P=$10)

FY10 target not met, P≤$7.5

10.2

16

5x (P=$7.5)

FY10 target not met, P>$7.5

25.7

16

8x (P=$10)

Catalyst

Earnings release on June 1st.  While I do not necessarily think the release will propel the stock price upward to a large extent, I see it more as a soft catalyst.
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