Disclosure: I do not hold position in mentioned stock. Also, the price has increased slightly since I initially wrote it up (from HK$5.11 to HK$5.30), however all points in this write up are still valid with a price level of HK$5.30.

Company Overview and Recent History

Texwinca is a Hong Kong-listed textile & apparel company, with two main business segments: 1) Textile business, which produces, dyes & sells knitted fabric and yarn, & 2) Retail and distribution business, which sells casual apparel and accessories. Each segment contributes about the half of the revenue to the firm. The vertically integrated cost-efficient model used to work well, however both segments have been hit hard by some adversity recently.

Texwinca’s textile business is one of the largest fabric producers in the world, serving many global fashion brands like A&F, Ralph Loren and Gap. However, it is facing cyclical headwind driven by the soft global (especially US, which is the main textile revenue source) economy and the increasing production cost in mainland China.

The retail business sells its apparel majorly through brand Baleno. However, Baleno (along with many other local mainstreet fashion brands like Esprit, Giordano & Meters/bonwe) has been squeezed very hard in its mainland China market (its main retail revenue source) by new-entering international fast fashion brands like Zara, H&M and Uniqlo. Baleno, once a high end fashion brand, lost its value significantly in the past few years, and is now considered merely as an “immigration worker (lowest income city worker from rural area) brand”. To cope with the competition, the business tried to streamline by disposing all the non-core brands and focus solely on Baleno.

Driven by weak performance on both sides, the stock has lost more than 40% of its value since the recent peak at HKD 9.38 in July 2015. At the current stock price (5.11), the stock looks attractive from first glance with following traits:

• Trailing P/E ratio under 7;
• P/B ratio close to 1;
• Dividend yield over 9%;
• Clean balance sheet (Marginal debt, HK$2.4 billion net cash on a HK$7 billion market cap business);

 

Valuation – Book value

As a textile and apparel business, Texwinca has quite straight forward underlying assets, mostly in working capital (about HK$4.4 billion) and PP&E (HK$1.4 billion). There are limited intangible assets (only HK$33 million in Trademarks) and limited long term debt (about HK$377 million). A quick and dirty book value for equity, according to the 2016 half year report (as of 9/30/2016), is about HK$5.88 billion (HK$4.26/share), leading to a P/B ratio about 1.2.

One thing worth mentioning is that the inventory looks a bit worrisome to me, as it kept growing since 2015 (about 10% yearly). The annual report didn’t disclose the breakdown of the inventory between business segments, but it’s safe to assume the swollen part is mostly from the retail side as they were not able to move the products effectively. For book value purpose, some discount might be needed to imbed some margin of safety. According to the 2016 annual report, the finished good was about 64% of the total inventory. Using the same percentage, as of 9/30/2016, one can estimate the finished goods would be about HK$1.38 billion. Taking a 25% discount on that, it can wipe out HK$ 345 million book value.

Give or take, this “provisions” will take the “real” book value of equity to HK$ 5.52 billion (HK$4/share), leading to a P/B ratio of 1.28, which is still in the attractive zone.

Valuation – P/E ratio

P/E using comparable is probably not the best way to value a business, nonetheless it’s a dirty and quick estimate for me just to see how cheap the business may be. Below I will try to value each segment separately, disregarding the vertically integration synergy. The goal is to get a value for business as going concern using assumptions as conservative as possible.

Textile side, net income attributed to common shareholders for 2017 is expected to be about HK$480 million (HK$0.35/share). Based on the P/E distribution of 4 textile pure-play competitors (1382 HK, 2111 HK, 2678 HK & 2698 HK), I think a P/E of 7-10 would be reasonable, so without any expectation of sector revival, you get HK$2.45 to HK$3.5 per share.

Retail side, at this point it is very hard to predict the earning power since it depends heavily on the outcome of the turnaround execution, thus my estimate below should only be viewed as speculation (hopefully, conservative speculation). 2017 might see it break even after the cost cutting. I think even as a low end brand targeting low income consumers, it is still possible for Texwinca to turn Baleno into a profitable operation, albeit probably with a lower margin. An example for similar recent low end brand turnaround is Semir (SZ 002563). Assuming a net profit margin of 5% (the low end of 7 HK listed garment pure-play competitors, including 2313 HK, 311 HK, 1982 HK, 551 HK, 709 HK, 3322 HK & 2199 HK), Baleno can be expected to generate normalized earning attributed to common shareholders about HK$ 140 million (HK$0.1/share). Giving it an average forward P/E from the same competitor group of 17 (which some might argue a bit high, but the profit margin of 5% to start with is very conservative already), you get about HK$1.7 for the Baleno business. Bottom line, it’s certainly worth more than nothing because if the retail business turn out to be not turnaround-able, we could plug a discounted book value assuming private market disposition.

With all the pessimistic assumptions, I estimate the business as a whole would worth HK$4.15 on low end and HK$5.2 on high end.

This estimate range, based on very conservative assumptions, provides good downside protection as the price currently stands at HK$5.11. It possibly won’t be the case that all things go against you, so any positive development (retail net margin turns out to be larger than 5%, US retailing warms up, etc.) could make the stock worth a lot more than the current level.

Lastly, it should be noted that the CEO Poon Bun Chak purchased 520,000 shares in June/July 2016 with an average price of HK$5.58. The quantity is not significant compared to his existing holding of 664+ million shares, but the price gave some indication of what insider thinks of the market valuation.

Risk

– Increasing price of energy and labor in mainland China poses real threat to the textile business, driving the margin down.

– Environment concerns in mainland China in long run will push the textile industry out of the country to less developed countries (e.g. Vietnam), like what happened in developed countries in 60s & 70s. If Texwinca cannot adapt to this trend (i.e. shifting production overseas), the mainland China based textile business will go under eventually.

– Failure in turnaround executing on the retail side.

Summary

In short, this opportunity exists because cyclical headwind impacted both Texwinca’s businesses and the stock price seemed to be depressed to an unreasonably cheap level. If you believe the cycle will reverse, Texwinca will survive to see the light form the other end of the tunnel with its strong financial position. There might be further disappointing performance, but the already cheap price should warrant some down side protection. Plus, you will get paid (can expect 8%, based on traditional generous dividend payout policy) for waiting. It’s a typical Graham opportunity and may not suit every investor.

Milestones To Look Out For

– Retail side turnaround performance

– Textile side expansion to lower production cost regions (Vietnam, Xijiang, etc.)