china 3c CHCG
April 13, 2009 - 11:39am EST by
oliver1216
2009 2010
Price: 0.90 EPS $0.51 tbd
Shares Out. (in M): 53 P/E 1.8x tbd
Market Cap (in M): 48 P/FCF tbd tbd
Net Debt (in M): -39 EBIT 35 0
TEV: 8 TEV/EBIT 0.2x tbd

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Description

 

CHCG is leading and growing "store in store" retailer of electronics in China.  With a current price of $0.90,  it has $0.74 of net cash per share (note: bloomberg has wrong cash figure), trades at 1.8x 2008 P/E, 0.2x 2008 EBIT and 0.7x tangible book (cash and receivables).  Stripping out cash, the company would be trading at 0.3x 2008 EPS.  If this weren't cheap enough, 2008 results were negatively impacted by severe show storms in China during Q1 (pretax profit was down 26% y/y), which is the company's seasonally strongest, so 2009 results should be better for this and other reasons.  Similar to CMFO which I recently posted here, this is a US listed company that follows SEC/GAAP rules.

 The company is a retailer (70%) and wholesaler (30%) of computers, communication products and consumer electronics in Eastern Europe.  The company's retail operations are conducted through 1,014 store-in-stores located in 277 branded retail stores (large-scale supermarket stores, department stores, etc. including Carrefour and Tesco and many of China's leading chains).  The company sells mobile phone, facsimile machines, DVD players, stereo's, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, etc.  Under this store-in-store model, the company leases space/counters where the company's products are displayed for sale.  Approximately 50% of leases are fixed cost while the rest are based on a percent of revenue generated.   The advantages of this model is that the company does not need to invest significant capital to build/buy/stock a store (thus its maintenance capex is basically zero) and it can rapidly turn its inventory (inventory turns were 24x in 2008).  The company operates its stores in four main areas, Shanghai, Zhejiang, Jiangsu and Anhui.  The company has also started a program to roll-out company owned and eventually franchised stores in smaller cities in which it does not currently operate, but it will take sometime before these stores will generate meaningful profitability, so I will not spend any more time on this.

 The company recently delayed filing its 10k (thus the added E to its ticker), although it issued a full earnings release.  We expect the 10k to be filed by the 15th with no changes to reported financials.  When the company releases its 10k we expect 2 catalysts to occur.  1) the company's results (including its very strong Q4) will be picked up by more databases and the attractive valuation will become more apparent to people and 2) the company may elaborate on Q1 2009 results.  We expect Q1 results to be very strong because the Chinese consumer has not suffered as much as the US consumer and because the Chinese government is stimulating all sorts of spending.  Also, Q1 2009 will seem very strong compared to Q1 2008 which was very weak due to the severe snow storms that not only limited sales in snow impacted areas during Jan and Feb but also disrupted deliveries to stores in areas that were not as impacted by the snow since major distribution points were hit by the snow.  A lack/delay in deliveries is very harmful to CHCG because its stores carry limited inventory, which helps explain the high turns.   

 2007 Segment Breakdown

 

 

 

 

 

 

 

 

mobile

home

office

consumer

total

%total rev

30%

24%

22%

23%

100%

%total gp

28%

33%

19%

21%

100%

 

 

 

 

 

 

 

 

 

Cash balance/Acquisition

 Included in the company's balance sheet is $32mm of cash and $7.3 deposit for an announced acquisition.  We have treated the later as cash in our valuation above since the acquisition obviously did not impact 2008 results.  The deposit is for an acquisition of a logistics company, and when the deal closes the company will have to pay another $10mm.  The company expects the deal to be accretive and for target to generate atleast $2mm of net income in 2009 plus reduce the company's logistics expenses of delivering to its existing stores.  This acquisition will also be helpful down the road when the company's franchised operations begin to roll out.  However, there has been a delay in closing this acquisition which was scheduled to close at end of March.  Whether this deal closes or not, the stock is still dirt cheap

 

 

Valuation

 

Let's keep valuation simple.  We believe 2009 EPS will be higher since the company will benefit from increased sales from new product introductions, new store openings, a better Q1 and perhaps the closure of the announced, accretive acquisition.  However, let's be very conservative and just value the company based on 2008 EPS and then add back the cash balance (which didn't add much to 2008 eps).  Below you can see the implied stock price based on various multiples of 2008 EPS and adding back cash on hand.

 

2008 p/e

3.0x

4.0x

5.0x

6.0x

7.0x

8.0x

9.0x

Price

1.53

2.04

2.55

3.06

3.57

4.08

4.59

Cash

 $   0.74

 $   0.74

 $    0.74

 $   0.74

 $   0.74

 $     0.74

 $    0.74

Implied Price

 $   2.27

 $   2.78

 $     3.29

 $   3.80

 $   4.31

 $     4.82

 $    5.33

implied upside

153%

209%

266%

323%

379%

436%

493%

  

Q1 is the seasonally strongest quarter.  If EPS in Q1 2009 is only equal to Q4 2008 (it should be higher due to seasonality) the company will report Q1 eps growth of 27% ($0.14 vs $0.11), which should generate some investor interest. 

 

Other Points

1) MLT Management, which had been one of the largest holders, recently sold virtually all of its stake.  We believe the sale was motivated by factors occurring at MLT as opposed to them thinking the stock was overvalued

2) Insider ownership - The chairman/ceo owns about 18% so he in incentivized to create shareholder value

3) IR - CHCG does i.r. (conferences, roadshows), has a vp or IR (newly appointed and very user friendly) and has an i.r. firm..but anyone who looks at their website (or their valuation) realizes they can do a better job on this front.

4) Auditors - Like many Chinese and micro cap companies, CHCG has changed auditors a few times over the past years.  There have never been any problems with their auditors and we view the changes as the company seeking to upgrade and also spend less on their audit expenses.

5) Other board members - Many of these US listed Chinese companies have inadequate  Boards.  While we have never spoken to him or due diligenced him, we were pleasantly surprised to see someone with Ken Berents background on this board.  Ken's bio is He is a former managing director and senior portfolio manager for Goldman Sachs Asset Management in Tampa, Fla., which manages $30 billion in growth stocks. Before joining Goldman Sachs, he was the managing director and director of equity research for First Union Securities, now Wachovia Securities, from 1993 to 2000. From 1989 to 1993, he was vice president and media analyst for Alex, Brown & Sons. He was a media analyst for Legg Mason and a supervisory analyst for Alex, Brown & Sons.

Catalyst

Filing of 10k

comment on Q1 results

reporting of q1 results

increased investor attention

    sort by   Expand   New

    Description

     

    CHCG is leading and growing "store in store" retailer of electronics in China.  With a current price of $0.90,  it has $0.74 of net cash per share (note: bloomberg has wrong cash figure), trades at 1.8x 2008 P/E, 0.2x 2008 EBIT and 0.7x tangible book (cash and receivables).  Stripping out cash, the company would be trading at 0.3x 2008 EPS.  If this weren't cheap enough, 2008 results were negatively impacted by severe show storms in China during Q1 (pretax profit was down 26% y/y), which is the company's seasonally strongest, so 2009 results should be better for this and other reasons.  Similar to CMFO which I recently posted here, this is a US listed company that follows SEC/GAAP rules.

     The company is a retailer (70%) and wholesaler (30%) of computers, communication products and consumer electronics in Eastern Europe.  The company's retail operations are conducted through 1,014 store-in-stores located in 277 branded retail stores (large-scale supermarket stores, department stores, etc. including Carrefour and Tesco and many of China's leading chains).  The company sells mobile phone, facsimile machines, DVD players, stereo's, speakers, MP3 and MP4 players, iPod, electronic dictionaries, CD players, etc.  Under this store-in-store model, the company leases space/counters where the company's products are displayed for sale.  Approximately 50% of leases are fixed cost while the rest are based on a percent of revenue generated.   The advantages of this model is that the company does not need to invest significant capital to build/buy/stock a store (thus its maintenance capex is basically zero) and it can rapidly turn its inventory (inventory turns were 24x in 2008).  The company operates its stores in four main areas, Shanghai, Zhejiang, Jiangsu and Anhui.  The company has also started a program to roll-out company owned and eventually franchised stores in smaller cities in which it does not currently operate, but it will take sometime before these stores will generate meaningful profitability, so I will not spend any more time on this.

     The company recently delayed filing its 10k (thus the added E to its ticker), although it issued a full earnings release.  We expect the 10k to be filed by the 15th with no changes to reported financials.  When the company releases its 10k we expect 2 catalysts to occur.  1) the company's results (including its very strong Q4) will be picked up by more databases and the attractive valuation will become more apparent to people and 2) the company may elaborate on Q1 2009 results.  We expect Q1 results to be very strong because the Chinese consumer has not suffered as much as the US consumer and because the Chinese government is stimulating all sorts of spending.  Also, Q1 2009 will seem very strong compared to Q1 2008 which was very weak due to the severe snow storms that not only limited sales in snow impacted areas during Jan and Feb but also disrupted deliveries to stores in areas that were not as impacted by the snow since major distribution points were hit by the snow.  A lack/delay in deliveries is very harmful to CHCG because its stores carry limited inventory, which helps explain the high turns.   

     2007 Segment Breakdown

     

     

     

     

     

     

     

     

    mobile

    home

    office

    consumer

    total

    %total rev

    30%

    24%

    22%

    23%

    100%

    %total gp

    28%

    33%

    19%

    21%

    100%

     

     

     

     

     

     

     

     

     

    Cash balance/Acquisition

     Included in the company's balance sheet is $32mm of cash and $7.3 deposit for an announced acquisition.  We have treated the later as cash in our valuation above since the acquisition obviously did not impact 2008 results.  The deposit is for an acquisition of a logistics company, and when the deal closes the company will have to pay another $10mm.  The company expects the deal to be accretive and for target to generate atleast $2mm of net income in 2009 plus reduce the company's logistics expenses of delivering to its existing stores.  This acquisition will also be helpful down the road when the company's franchised operations begin to roll out.  However, there has been a delay in closing this acquisition which was scheduled to close at end of March.  Whether this deal closes or not, the stock is still dirt cheap

     

     

    Valuation

     

    Let's keep valuation simple.  We believe 2009 EPS will be higher since the company will benefit from increased sales from new product introductions, new store openings, a better Q1 and perhaps the closure of the announced, accretive acquisition.  However, let's be very conservative and just value the company based on 2008 EPS and then add back the cash balance (which didn't add much to 2008 eps).  Below you can see the implied stock price based on various multiples of 2008 EPS and adding back cash on hand.

     

    2008 p/e

    3.0x

    4.0x

    5.0x

    6.0x

    7.0x

    8.0x

    9.0x

    Price

    1.53

    2.04

    2.55

    3.06

    3.57

    4.08

    4.59

    Cash

     $   0.74

     $   0.74

     $    0.74

     $   0.74

     $   0.74

     $     0.74

     $    0.74

    Implied Price

     $   2.27

     $   2.78

     $     3.29

     $   3.80

     $   4.31

     $     4.82

     $    5.33

    implied upside

    153%

    209%

    266%

    323%

    379%

    436%

    493%

      

    Q1 is the seasonally strongest quarter.  If EPS in Q1 2009 is only equal to Q4 2008 (it should be higher due to seasonality) the company will report Q1 eps growth of 27% ($0.14 vs $0.11), which should generate some investor interest. 

     

    Other Points

    1) MLT Management, which had been one of the largest holders, recently sold virtually all of its stake.  We believe the sale was motivated by factors occurring at MLT as opposed to them thinking the stock was overvalued

    2) Insider ownership - The chairman/ceo owns about 18% so he in incentivized to create shareholder value

    3) IR - CHCG does i.r. (conferences, roadshows), has a vp or IR (newly appointed and very user friendly) and has an i.r. firm..but anyone who looks at their website (or their valuation) realizes they can do a better job on this front.

    4) Auditors - Like many Chinese and micro cap companies, CHCG has changed auditors a few times over the past years.  There have never been any problems with their auditors and we view the changes as the company seeking to upgrade and also spend less on their audit expenses.

    5) Other board members - Many of these US listed Chinese companies have inadequate  Boards.  While we have never spoken to him or due diligenced him, we were pleasantly surprised to see someone with Ken Berents background on this board.  Ken's bio is He is a former managing director and senior portfolio manager for Goldman Sachs Asset Management in Tampa, Fla., which manages $30 billion in growth stocks. Before joining Goldman Sachs, he was the managing director and director of equity research for First Union Securities, now Wachovia Securities, from 1993 to 2000. From 1989 to 1993, he was vice president and media analyst for Alex, Brown & Sons. He was a media analyst for Legg Mason and a supervisory analyst for Alex, Brown & Sons.

    Catalyst

    Filing of 10k

    comment on Q1 results

    reporting of q1 results

    increased investor attention

    Messages


    SubjectRE: Dates
    Entry04/13/2009 11:14 PM
    Memberoliver1216

    They publicly said it would be filed by 4/15...im not sure where you are seeing the 5/15.  Thanks.


    SubjectQuestions
    Entry04/14/2009 11:03 AM
    Memberthoreau941

    Thanks for the writeup.  A couple of questions:

    Have you been to visit the distribution facilities?

    How did the management get the right to distribute in the area they do...in China these rights are tightly guarded and commonly subject to nepotism or other means.  How does the CEO/key man have an in?

    Do they have a CFO (that's actually there)?  Not really clear. 

    There is massive competition in what they do, how do you get comfortable with margins?

    The 10K (old) is a little shady as to the ownership structure of the assets.  For your cash value to be worth anythign to holders there has to be a way to get the $.  Are assets merely pledged to the offshore entity that holds them and then there is US traded company interest in that sub?  Almost seems like there should be a discount to cash as shareholders are so far from the actual value.

     


    SubjectRE: Questions
    Entry04/14/2009 11:54 AM
    Memberoliver1216

     

    Thanks for your good questions.  Im hoping on a plane so hopefully my brief answers will help..also, feel free to contact chcg's i.r. guy, jason yuan.

    We have been to facilities and to stores to due dili...we have a team based in china

    I don't know the history re: how company got its "in" but i know the co (and its acquired businesses) have been doing biz for a while.  But whatever in/relationships mang might have , dont most/many companies (CHinese or usa) have some kind of "in"

    Sorry if write up was unclear, they have a cfo...mr huang

    At this valuation, even at a downside margin case, i think its still dirt cheap.  Margins will benefit from increased top line as they open more "stores", increased consumer spending per unit (beter economy means more spending and less promotional expenses)(so total rev will benefit from price and volume improvements).  However, i believe you are right that absent growth, overtime margins will be challenged

    You point re: discount to cash is valid....but , i believe even if u discount cash, i believe th3e valuation is still compelling.  Ironically, the big challenge that many chinese co's face is getting money out of china due to capital restraints imposed by the gov.  If these restraints were loser, many of these us listed cos would be sending $ to the usa (alleviating your concern) for their personal benefit, to fund acquisitions, or buying back their stock or implementing dividnendds (look at what happened to ticker tpi when they announced div).  There are some interesting developments/structures that i think you will see over next few months that will let these cos get $ outta china. 

    Sorry if this was a long ramble but hope it was helpful


    Subjectcorrection
    Entry04/14/2009 01:42 PM
    Memberoliver1216

    My write up mistakenly says the company operates in eastern europe.  It should have said eastern china.


    SubjectRE: RE: Questions
    Entry04/14/2009 02:58 PM
    Memberthoreau941

    I have seen the stores in China (Hangzhou), and found that the competitive landiscape might not lend itself to the expansion your analysis anticipates.  Saturation seemed high.  It seems to me that they will always have to overpromote to maintian their market share.  It would make more sense to me that they would try to expand their store-within-a-store operations, but my data is not recent enough to know if the larger landlords/operators are still willing to provide the same margins. 

    I'm still not certain on the ownership structure with this story.  Forget repatriating the earnigns (buyback, dividend etc.) what is the equity holders ownership/rights to the assets.  Not really clear.  Any light you could shed would help.


    SubjectRE: 10k and website...
    Entry04/15/2009 09:40 PM
    Memberoliver1216

    10k was filed late today and will be available on sec website tomorrow morning.  The best i.r. contact is their "in house" guy, jason at irchina3c@gmail.com  Many companies i know have recently fired their outside i.r. firms as they are relatively expensive and obviously not being effective enough if your stock is trading at such an undervalued price.  The website is pathetic i would agree.

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