Description

Executive summary  

Kingboard Chemicals (SEHK:148, market cap: $3bn, EV: $5.5bn) stock faces the prospect of de-rating with a potential catalysts over the next 12-18 months. The company's stock has had a meteoric rise up over 100%+ year to date (see chart below), however this steep rise in our view has outpaced the fundamentals in its core PCB, laminates and chemicals business segments. The property segment has been levered to the red hot Chinese market, however there are several signs this is cooling off, due to government measures, due to potential bubble territory and hence, we would certainly not be chasing the stock at 5 year highs.

A catalyst that may weigh on the stock is the release of an Ernst & Young (E&Y) independent review report (which had been delayed for 5 years!): http://www.kbcopperfoil.com/upfile/2016101208255142195.pdf related to Kingboard Copper Foil, majority owned by the Kingboard Group. Refer to Appendix A of the E&Y report (dated 11 Oct 2016). The background for VIC readers is that Kingboard Copper Foil ("KBCF"), listed in Singapore (SGX:K14) had historically supplied raw material copper foil to its parent, Kingboard Group. However, since 2011, KBCF had essentially ceased its operating business altogether entering into a license agreement with a unknown entity called Harvest Resource (http://www.kbcopperfoil.com/upfile/2013090212115329235.pdf). This was done after minority investors voted against interested party transactions between the parent and KBCF. E&Y was appointed in Nov 2011 to carry out an independent review of the interested party transactions between KBCF and Kingboard Chemical and in respect to the licensing arrangement between KBCF and Harvest.

In addition, the Kingboard Group has been involved in a lengthy litigation by a US investor (http://www.kbcopperfoil.com/upfile/2011081012173264317.pdf) in the Bermuda courts which has dragged on for several years related to issues around transfer pricing, Harvest and corporate governance. The recent hearing summary is: http://www.kbcopperfoil.com/upfile/2016012508305778364.pdf. The next hearing is set for early 2017. Given the Oct 2016 release of the E&Y report, in conjunction with next year's hearing, this may weigh on the stock of the parentCo as Mr. Market and broader investors digest the information independently related to the findings by E&Y, in particular comments related to Harvest. The stock is not as well followed as several sell-side analysts have discontinued coverage on both the parent and the subsidiary. Although not by itself a concern, the balance sheet of Kingboard stands at over 3x debt/EBITDA. In addition, there has been reportedinsider selling at prices lower than current: http://www.scmp.com/business/markets/article/1958521/fresh-insider-buying-star-performers-offers-clues-potential-winning. In sum, the above may suggest the stock has more than priced in the bull case over the next 12-24 months and could de-rate 30% or so and has likely limited upside in the near-term. 

Kingboard Copper Foil - background

Kingboard Copper Foil (KBCF), whose parent is Kingboard Chemical was engaged in the manufacture and trading of copper foil, a raw material for the laminates and PCB industries.  As per the 1999 IPO prospectus "In FY1999, sales to the Kingboard Group accounted for almost 100% of the turnover and profit before taxation of the copper foil business of the KBCF Group". In fact, KBCF had not achieved relevant diversification beyond the parent. KBCF listed on the Singapore stock exchange at $0.53 in 1999, however, unfortunately for IPO investors, this proved to be the "all-time" high on the stock as since the SGX IPO, both margins and the stock declined. At the same time, the parent, Kingboard Chemicals witnessed rising stock price. In 2011, E&Y was appointed to carry out an independent review of the interested party transactions (IPT) between KBCF and Kingboard Chemical and in respect to  Harvest (license agreement initiated by KBCF in 2011 after minority investors vetoed against IPTs)

E&Y independent review - why did this process taken as long as 5 years?

As mentioned above, E&Y was appointed in Nov 2011 to carry out an independent review of the interested party transactions between KBCF and Kingboard Chemical and in respect to the licensing arrangement between KBCF and Harvest. Link: http://www.kbcopperfoil.com/up/Independent%20review.pdf. What is surprising is that this process has taken as long as 5 years. The report has now been released: http://www.kbcopperfoil.com/upfile/2016101208255142195.pdf

Harvest - don't minority investors deserve greater transparency?

VIC readers should refer to the full report above in its entirety and Appendix A by E&Y dated Oct 11 2016. Of interest are comments related to the entity, Harvest of which as we mention little is known to investors. A few comments from the E&Y report, and VIC members should read the entire report :

• Page 29 of Appendix A: Based on the interview with Lin Xiao Yan and Zheng Jia Ping, we are unable to assess whether they have an established reputation and/or track record in the copper foil industry and the extent of their client base (customers other than Kingboard Group) as we noted that the office of Harvest Resource which we visited appeared sparsely furnished with minimal activities and few employees were present at the time of our visit. We did not have the opportunity to speak to any of these employees.

• Page 28 of Appendix A: Based on the above, it would appear that: (i) the Company’s announcements on 3 August 2011 and 18 November 2011; and (ii) the letter from the Board of KCHL and KLHL to the AC members of KBCF on 1 August 2011 in connection with the relationship between the Company’s ultimate holding company (KCHL) and Harvest Resource, are inaccurate. We understand that the SGX Corporate Disclosure Policy Part IX – Content and Preparation of Public Announcement requires each announcement to be factual, clear and succinct.  

• Page 29 of Appendix A: We were informed by Mr. Zheng Jia Ping during the interview that one of the major customers of Fogang Lianwei Trading (Harvest) was Elec & Eltek International Company Limited (“Elec & Eltek”), a subsidiary of KCHL since November 2004. Be that as it may, we were informed by the Management that Elec & Eltek was not a major customer of Harvest Resource 

• Page 6 of Appendix A: Based on our independent checks conducted on 12 January 2012, Fogang Lianwei Trading’s legal representative and shareholder is Mr. Lin Yi Yuan (林亦源) (shareholder and director of Harvest Resource). Our checks revealed that Mr. Lin Yi Yuan was: director and a former shareholder of 深圳吉雅达贸易有限公司 (“Shenzhen Jiyada Trading”), a wholly-owned subsidiary of KCHL; and the legal representative and executive director of 东威 (佛冈) 贸易有限公司 (“Dong Wei (Fogang) Trading”), a partially owned subsidiary of KCHL  

• Page 30 of Appendix A: We also observed that the products at the warehouse were labelled with the Company’s label instead of Harvest Resource. In response to this observation, we were informed by Mr. Jackie Lo that it was not necessary to inform the factory employees of the License Agreement with HRML as long as they stay employed whilst the product labelling was a timing issue as Harvest Resource had yet to obtain the relevant permit and/or license for product labelling at the time of our visit. We were told that the permit/license requirement had been obtained in March 2012. However, we are unable to confirm the same as our requests to visit the Fogang factory (which is in close proximity to the Fogang Lianwei Trading office) in conjunction with our interview with Mdm. Lin Xiao Yan and Mr. Zheng Jia Ping in April 2012 were denied, as the Management told us that HRML has no legal obligations to accede to our requests and was cooperating at the request of the Company. 

• Page 13 of Appendix A: Based on the Summary of RPT, we have selected 201 samples based on identified risk areas (including, but not limited to, sales made to Kingboard Group at a lower unit selling prices as compared to third party customers; and sales made to Kingboard Group with negative gross profit margin) for transaction testing. As at the date of this report, we have yet to receive the complete set of documents which would include, among others, customers’ purchase orders, sales invoices, delivery orders and payment documents. 

• Page 20 of Appendix A: Further, from the minutes of the AC meetings, we noted one other justification for the lower selling price/gross profit margin in relation to sales by the Company to Kingboard Group. The Management justified to the AC that the transportation and overhead costs for sales to third party customers were higher compared to Kingboard Group due to the proximity of the Kingboard Group to the Company’s factories. As such, the savings arising from the mentioned costs could be used as a higher discount for the sales to Kingboard Group. However, we were not provided with any supporting documents or analyses to substantiate the total transportation and overhead costs saved. 

Kingboard Chemical stock has had a meteroic rise which is unlikely sustainable over next 12-18 months

While Kingboard Chemicals stock has risen significantly (a 10-20x bagger) over the last 15 years, KBCF has consistently declined since IPO and lost value for minority shareholders. In the last 12 months, a 100% rise in the stock appears excessive, in light of the recent developments, which we expect may weigh on the stock price and investor sentiment until more clarity emerges on Harvest.

Given the above, we would expect that the stock could correct as much as ~30% and has likely limited upside in the next 12 months. The risks to the thesis could be significant demand for their core business -- PCB, laminates and a stronger than expected Chinese property market.

APPENDIX: SEGMENT BREAKDOWN  

Source: Public filings, CapitalIQ, company website. 

DISCLAIMER

The write up is not investment advice or a recommendation or solicitation for any fund or to buy or sell any securities now or at any time. The author and related persons may hold a position and make no representation that it will continue to hold long or short positions in the securities and disclaims any obligation to notify the market of any changes. The author and related persons may change its views about or its investment positions at any time, for any reason or no reason. This includes buying, selling, covering or otherwise changing the form or substance of its investment. The author disclaims any obligation to notify the market of any change. The information and analysis presented is based on publicly available information through filings, sell-side research, industry analysts and/or company or otherwise sourced. Any forecasts or estimates should not be relied upon (not the least due to the poor disclosure) and could turn out to be incorrect. While the author has tried to present the facts it believes are accurate, the author makes no representation or warranty, express or implied, as to the accuracy or completeness of the write up, and expressly disclaims any liability relating to the write up or such communications (or any inaccuracies or omissions therein). Thus one should conduct their own independent analysis before independently considering a position in securities. Except where otherwise indicated, the write up speaks as of the date, and the author undertakes no obligation to correct, update or revise the write up or to otherwise provide any additional materials.

Catalyst

E&Y report. Slowing Chinese property market.