I first noticed Minth Group when I was doing stock screening in May 2014. The Company stood out in the screening because of its high margin, good ROE, good track record with steady revenue and net profit growth over the past 10 years. I thought I found another Graco (see earlier post).
Minth designs and manufactures automobile body parts. It supplies to many world-renowned international automakers. These automakers represent 80% of the total global auto market share.
This is the revenue breakdown by products categories and by geography. (Source: DBS research report)
Competitive Advantage: Low Cost
Minth’s product prices are 20-25% lower than overseas compeitors. It has lower overhead and depreciation cost from its cheaper land and enjoy low-cost advantages by in-house made core tooling. It sources 75% of its raw materials from local sources on good terms due to its economies of scale. By locating its production facilities in close proximity to customers, Minth is able to provide customer with just-in-time service.
Minth has a diversified customer base and growing overseas business. Overseas sales grew from 9% of revenue in 2005 to 41% in 2015. It benefits from the global outsourcing trend in the auto parts industry and global expansion strategy of major customers who have strong brands.
Its revenue in FY14 was RMB 6.7bn, but it has achieved accumulated order backlogs of RMB 26bn. This should keep them busy and grow its revenue in coming 3-4 years.
Price war in China’s passenger vehicle sector is forcing OEMs to cut their purchase price of auto parts. Minth’s gross margin has steadily shrunk from 40% in 2005 to 30% in 2015. Net margin fell from 28% in 2005 to 17% now. See the chart below for the margins in the past 5 years.
Auto industry is a cyclical sector. Therefore, any weaker than expected passenger vehicle sales will affect its book order.
Source: DBS Research Report
When I first noticed Minth, it was facing a corporate governance issue. SFC was investigating the Company for potential breach of fiduciary duty in a connected-party transaction between the Chairman and his family members. Basically, Minth acquired assets from two companies owned by niece and nephew of the Chairman in 2008, and the paid amount was higher than the reported transaction amount. When the announcement of investigation was made in April 2014, the share price fell 20%.
I studied the Company and found that it has a solid business with high margin, good ROE, consistent operating history and solid balance sheet with net cash. In the worst case scenario of the SFC investigation, the senior management could be removed from the positions, the Chairman could be ordered to pay USD 12.7m to the Company. I thought the probability of removing the management was low. The transaction happened in 2008 but was only investigated in 2014 and the amount involved was relatively small.
A 20% fall in share price created a good entry point to buy. I suggested this Company to my fund manager. As he was focusing more on commodity-related companies at that time and didn’t have much experience in this auto sector, he kept this in the watchlist and asked me to check out the development on the SFC investigation. In 2 months time, the share price recovered from the slump.
After I left the hedge fund, I continued to follow Minth and thought the story remained good. In Aug 2015, I bought it at 15.19/share after it came down from its peak of 19s in April. After I bought it, it hardly rose above my buying price. But that didn’t bother me. I wish the price fell further so that I could buy more. Recently, it rose to 19s again. At 19.54/share today, the gross return on my investment is 28.6% in 8 months. I have no intention to sell at the moment as it continues to be a good company with low cost advantage. It operates in a cyclical auto sector, but its revenue is not really that cyclical given that it has order backlogs several times its revenue for next few years.
The main risk is when the price war gets worse. In any business, when the tough competition gets into price war, all the players stand to lose. Minth’s margin may continue to decline slowly. However, its growth rate of 15-20% more than offset the declining margin for now. Will follow this story every 6 months to assess whether I should keep my position, add more to it, reduce it or get out of it.
Look at the growth and margins for the past 10 years. This is more than satisfactory. Over the past 5 years, revenue grew at CAGR 21.3%, operating income at CAGR 15.5% and net profit at CAGR 12.4%. However, ROE has dropped from 29% in 2005 to mid teens now, which is not great, but ok. When following the story of Minth, this ROE is another thing to watch. Value is created when the return from the invested capital is above the cost of capital. If the ROE continues to fall and drops to 10% or below, we know the market has gotten very competitive and Minth’s excess return has largely diminished.
See how the company become so cheap in 2011-2012 when the market panicked over Europe collapse and global economic risks (this global economic risks never went away since GFC in 2008 until now). When market turns bearish, they will first leave the cyclical sector and move to cash or defensive stocks. This creates an opportunity to pick good quality companies in cyclical sector at low price. Remember to be greedy when others are fearful in the next market sell off (but you better have a collection of good quality companies in mind now)