Haier Electronics

Haier Electronics Group Company Limited (Haier) is the leading manufacturer of washing machines and water heaters in China. Its market share in terms of sales value for both products continues to rank first in China. It holds a market share of 26.9% in washing machines and 18.2% in water heaters. Since 2009, Haier has been transforming from being a home-appliance manufacturer to being an Integrated Channel Services (ICS) business. ICS encompasses distribution, logistics, after-sales services and e-commerce and other businesses.

Haier - Business Structure.PNG

Source: Haier’s Annual Report FY15

To date, ICS contributes nearly 75% of the total revenue, but due to its low margin, it contributes only 39% of the profit.

Haier - Segment revenue and result FY15.PNG

Source: Haier’s Annual Report FY15

To avoid confusion, Haier Electronics (listed in HK with stock code 1169) is a subsidiary of Qingdao Haier (listed in Shanghai with stock code SHA: 600690), which is the leading manufacturer of many other home appliances: air conditioners, washing machines, dishwashers, water heaters, TV, vacuum cleaners, rice cookers, etc. Qingdao Haier owns 56.17% of Haier Electronics. This post is focusing on Haier Electronics only.

Drop in Market Expectation

In 2014, several banks initiated coverage of Haier. Credit Suisse issued a 37-page report with target price of 30. UBS issued a 28-page report with target price of 25. Haier’s share price at that time as around 19-22. The target price indicates lots of upside to the share price. A report with 28 to 37 pages takes some time to read and digest. This post will not study Haier in such detail. It will mainly focus on a few important items.

Haier - Share Price - 2016-10-21.PNG

From the start of 2014 until now, the company was doing ok. Revenue peaked at 67bn in 2014 and fell to 62.8bn in 2015, which was same level as 2013. Net profit actually grew from 2bn in 2013 to 2.7bn in 2015. But its share price fell from the range of 18-24 at the start of 2014 to 11-14 now. That’s a huge 40% drop!

Again, like many other stocks that I studied, there wasn’t anything wrong with the company. It’s the market expectation that is the real problem. In 2013 when Haier was growing well (net profit grew 20%), the market expectation was equally high (or even higher). Haier was priced at 25 P/E in 2013. As Haier maintained net profit growth of 20% in 2014, its share price fell from 22 to around 19 and the P/E was 17.9x. In 2015, when the market realized that Haier couldn’t grow its revenue and net profit as fast as previously expected, the share price dived down 20% to 15, and P/E dropped to 14.1x. In 2016 first half, the falling momentum continued and the price dropped to 11-14 range with latest P/E at 11.6x.

Haier - Valuation 10Y - 2016-10-21.PNG

Source: Morningstar.com

In 2 years 10 months, the market expectation changed from P/E of 25x to 12x.  That largely explains why the share price fell 40% during the period.

Business Segment

To understand and value Haier, we have to understand each business segment.

1. Washing Machine

Haier’s washing machines continues to rank 1st in terms of sales value and sales volume in China. Its market share is relatively stable at around 26%. From 2010 to 2015, revenue grew at CAGR of 5.4% while profit before tax at 9.1%. The growth driver comes increasing penetration rate of washing machines in both rural and urban areas. The penetration rate is close to 100% in urban areas, but as urbanization is still taking place, more people are moving to cities, and that increases the demand for washing machines.

2. Water Heaters

Like its washing machines, Haier’s water heaters remains number one in terms of sales value in China with market share of around 18%. From 2010 to 2015, revenue grew at CAGR of 8.1% while profit before tax at 12%. The growth driver is similar to Washing Machine’s, mainly from rising penetration rate and urbanization.

3. Integrated Channel Services (ICS)

This business segment can be further divided into 4 sub-segment:

  1. Distribution and Services: distribute Haier branded products (washing machines, water heaters, air con, refrigerators, brown goods, etc) and other third-party (non-Haier branded) products.
  2. E-commerce: sell the products through e-commerce: e-Haier, Taobao, Tmall and JD.com.
  3. Logistics: delivery the products from merchants, factories, franchise stores to customers. The products include home appliances and furniture. The logistics company is called Goodaymart, which can deliver big items on the same day or next day.
  4. After-sales services

All these sub-segments are integrated as one business segment. Basically, they work together as a supply chain to sell the products to customers through online or offline, with or without middleman.

Just for ICS itself, you can write several pages of report on the details. You can find banks’ research report online for that or read up the Company’s annual report for clearer understanding. We will not go into the details.

Financial Performance

ICS business grew rapidly since its start in 2009, coincide with the rapid rise of e-commerce (Alibaba’s TMall). Haier started its ICS business in 2009. That’s why we see exploding revenue growth from 2009 to now. But ICS is a very low margin business, hence the blended gross margin fell from 28% before ICS to around 14-16%  now. Past performances became less relevant as the Company is transforming from a white-goods player to an ICS player (distribution + e-commerce + logistics).

Haier - Financial 10Y - 2016-10-21.PNG

Source: Morningstar.com

Looking at its profitability over the past 3 years, Haier managed to grow increase its operating margin from low 4% to 5+%. ROE declines from 30+% to 20%. One thing that you can note is that gross margin is around 15% only now and operating margin is 4-5%. This is a low margin business, but quiet decent return on capital ROE of 20%). With such low margin, a small percentage point change can shift the profit substantially. For example, if margin of 4% increases to 5%, that’s 20% rise in profit, everything else equal. On the reverse, if the margin of 5% drops to 4%, that’s 25% fall in profit, everything else equal.

Haier - Profitability 10Y - 2016-10-21.PNG

Source: Morningstar.com

We can’t just take the blended financial data to do valuation as it has different businesses. We can combine washing machines and water heaters, but certainly can’t combine any of them with ICS.

Segment Performance

Let’s breakdown the revenue and profits into segment:

Haier - Segment Revenue FY15.PNG

Haier - Segment Profits FY15.PNG

Haier - Segment Profit Margin FY15.PNG

Profit margins in aggregate rose in the past 5 years. Profit margin for washing machines rose from 7.3% in FY10 to 8.4% in FY15. Water heater also saw its margin rising from 10.0% to 11.6%. ICS margin rose was flat. The return on capital for each segment is high.

Haier - ROA ROE - 2016-10-21.PNG

The ROA and ROE per segment look very high. I’m not sure how Haier segregate the assets and liabilities per segment. If we compare the aggregate ROA of 12.1% in FY15 with the blended average ROA ex-cash of 13.7% from reported numbers, it’s not too far off. ROA of 13% is very good for home appliance business. This is higher than the cost of business and should create value in long run.

Investing for Growth

haier-segment-capex-and-depreciation-fy15

Haier is investing aggressively in the past few years, especially in ICS business. The capex is for construction of additional logistics warehouses, purchase of plant and equipment for capacity expansion. We will study whether the capex has created value for the Company by increasing the profit. This will be done by comparing the capex and the incremental profit increase from the prior year. For example, Haier spent capex of 252m in FY12 for washing machine, and its FY12 profit (before tax) increased by 209m from FY11.

For Washing Machines, capex increased multi-folds after FY11. Total capex from FY12 to FY15 was 1bn. From FY11 to FY15, revenue increased by 22.4%, while profit increased by 52%. Total incremental profit generated (before tax) from FY12 to FY15 was 1.45bn (or 1.09bn after tax of 25%). This incremental profit is calculated by taking the profit in each year from FY12 to FY15 and deducting the profit in FY11.

For Water Heaters, capex rose sharply after FY10. Total capex from FY11 to FY15 was 495m. From FY10 to FY15, revenue increased by 47%, while profit increased by 76%. Total incremental profit generated (before tax) from FY11 to FY15 was 809m (or 607m after tax of 25%). This incremental profit is calculated by taking the profit in each year from FY11 to FY15 and deducting the profit in FY10.

ICS was started in FY09. Total capex from FY10 to FY15 was 2.1bn. During this period, revenue doubled and profit nearly doubled. Total profit before tax generated (including elimination of intersegment sales) was 4.58bn (or 3.43bn after tax of 25%).

In each of the three businesses, total capex in the past 6 years have generated total incremental profit that is higher than the capex itself. The benefits from construction of logistics warehouse or increased capacity can last longer than just 3-4 years. Therefore, we know that the capex is creating value to the shareholders.

Capex in FY15 was the record highest due to 975m capex for ICS. Much of this is spent on constructing new logistics warehouses. Currently, Goodaymart Logistics’ average daily delivery volume is 0.25 million, and maximum daily delivery volume reach to 0.90 million, representing the leading capacity in the large item transportation industry. The aggressive investment is to anticipate the continued robust growth of e-commerce sector. Goodaymart Logistics aims to become No. 1 large-scale goods logistics service provider in terms of domestic market share and customer satisfaction.

Haier is investing in Internet of Things (IoT) for its home appliances business. The potential of IoT is huge and it’s still at an infant stage at the moment. These “smart” home appliances may trigger a higher replacement rate for the appliances, thus increasing the demand. But, I can’t quantify the impact of IoT. For now, I assume neutrality to IoT.

Valuation

1. Washing Machine

In FY15, it generated revenue of 15bn and profit before tax of 1.25bn. It has maintained its number 1 market share position for many years and increased the profit margin slightly over the years. However, as the penetration rate of washing machines has reached a high level, the growth rate is also slowing. To be conservative, I assume growth rate of only 2.5%.

I estimate that the Free Cash Flow to Firm (FCFF) for washing machine business is around CNY 864m. With 10% WACC and 2.5% terminal growth, washing machine business can be worth 11.5bn. That’s P/E of 12.3x.

2. Water Heaters

In FY15, it generated revenue of 4.6bn and profit before tax of 536m. Like Washing machine, Water Heaters has maintained its number 1 market share position for many years with rising profit margin. But, due to the already high penetration rate of water heaters, to be conservative, I assume growth rate of only 2.5%.

I estimate the FCFF for water heaters business to be around 341m. With 10% WACC and 2.5% terminal growth, water heater business can be worth 4.5bn. That’s P/E of 11.3x.

3. ICS

In FY15, it generated revenue of 57.9bn (or 43.2bn if we eliminate intersegment sales) and profit before tax of 843bn. Haier exited from third-party home appliance distribution business as it was making losses overall. This caused the revenue to decline, but profit to rise as margin improved.

This is the tougher business to value as it contains many moving parts. Haier is investing very aggressively in its logistics. Its offline distribution business is currently suffering from soft market demand and price war. Its e-commerce business, partnering with Alibaba’s Tmall, is growing rapidly. Current revenue and profit figures can change quite drastically in the next few years, and I can’t predict it.

To be conservative (I hope), I estimate the FCFF for ICS to be around 478m (vs PBT of 843m in FY15). With 12% WACC and 3% terminal growth, ICS business can be worth 5.3bn. That’s P/E of only 8.4x.

Others

There’s average 70m of corporate and unallocated expenses in the past 6 years. There are also other incomes from government subsidies, compensation from suppliers and others that are harder to predict but can be meaningful and recurring. These other incomes range from 120m to 240m in the past 3 years.  We assume these other income to average 120m. After deducting the corporate and unallocated expenses of 70m, the balance is 50m additional income. We apply current P/E of 12x and value this additional income at 600m (or 0.6bn)

Sum of the Parts

Estimated Total Enterprise Value (EV) for Haier is 11.5 + 4.5 + 5.3 + 0.6 = 21.9bn (CNY).

Adding net cash of 11.5bn (as at June 2016), the estimated Equity Value is 33.4bn (CNY).

At current CNYHKD exchange rate of 1.15, the estimated equity value in HKD is HKD 38.4bn or HKD 13.5 per share. Based on FY15 reported diluted EPS of 0.951, the P/E is 14x.

At today’s share price of HKD 12.92, my estimated valuation price of 13.5 has just 4.5% upside. In other words, current share price is quite fair.

I think the key in my valuation is on the ICS. I don’t really understand the strength and weakness of this business and how competitive this business is. E-commerce is booming now, but as happen to many things related to tech, things can change very quickly. Haier is growing its logistics aggressively and could make mistake in the expansion. For example, over-building the logistics warehouse, which leads to over-capacity and under-utilization.

Growth not factored in (yet)

In my valuation, I have assumed a slow growth rate of just 2.5 – 3.0% going forward. From FY10 to FY15m, Haier’s total revenue actually grew at CAGR of 11.3% and operating profit at CAGR of 13.7%. Therefore, I could be too conservative in my assumption of growth rate.

The aggressive capital spending in washing machines and water heaters in recent years could generate substantial profit growth for next few years. The large capex in ICS coupled with strong growth in e-commerce should see rising revenue and profits in medium term. If executed well, Haier could increase the capacity utilization of its logistics warehouses, thus improving the margins.

If we factor in a stronger growth potential from all recent large capex and assume Haier executes its plan well, then my estimated value would increase to around 15, which has 16% upside from the current share price of 12.92.

Conclusion: HOLD. Current share price of 12.92 is quite fair.

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6 thoughts on “Haier Electronics

  1. I really like your clear analysis of a company, unlike most brokerage reports out there 🙂

    I am aspiring to become an analyst and fund manager and your website really helps me a lot in thinking clearly about investing.

    I am curious about a few things:
    1) How did you bump into Haier? Do you have a specific screening criteria on finding companies to dig deeper? Sector-specific? Metric-specific?

    2) Do you construct your own earnings model? It seems that you put up a lot of screenshots of existing materials rather than your own compiled data (in excel, although I’ve seen some in this post, I hope they are from your Excel)

    3) Have you ever made a loss from your investment? The one where you have to cut your loss because you missed something about the company.

    4) Could you do a post on trading costs and how they impact net gain?

    5) How long do you take to do a detailed write-up like Haier?

    6) How did you get your data on data like “No.1 washing machine in China”?

    7) If you could estimate, how much of % of your research/analysis actually get expressed in your post?

    8) You said you are running a business now. Does it have something to do with investment/finance? Or totally a different thing altogether, and you’re doing this (investment) out of pure interest. If it’s different, what made you exit from the stock-picking game?

    Well, not really a few things, but I really enjoy reading your blog. Thanks for spending your time on writing all these.

    Like

    1. Thanks for reading my posts!

      I got to know Haier through speaking with a friend. This is the same friend who told me about Qualcomm, which I invested. For other companies, I get to know them through various sources: newspaper, magazine, online articles, friends, broker reports, etc. Occasionally, I do stock screening based on metrics, and it still takes time to go through one by one in the list.

      Yes, I do construct my own financial models for many cases, but not all cases. For Haier, I did. These are the companies that provide good free cash flow, so I can build a DCF model. I probably spent 4-5 full days to study Haier, read the annual reports, build the financial model and write the post. You can find its market share in washing machine and water heater in its annual reports. The management did a good discussion on the business and industry, unlike many other management who simply said they faced challenging environment and would continue to operate efficiently, all in one page.

      I didn’t study Haier until “very detail”, such as analyzing new property demand, statistics of white goods penetration goods in urban vs rural area, the strength of its distribution and logistics, its network coverage in T1/T2/T3 cities, competition, etc. Broker reports covering Haier can reach 30+ pages and take much longer time and resources. Also, I usually studied companies only during evening (after 9.30pm) when I had time.

      Those screenshots from annual reports, company presentation, Morningstar.com, etc, are nicely presented, so I just re-use them in the blog. Those numbers from Morningstar often need adjustment, so, I don’t rely on their numbers. When I build my own models, I take the numbers directly from companies’ annual reports of past several years and adjust them. As I’m writing a casual blog post, not an internal report for the fund, I choose the quicker way of presenting and take existing resources. Those numbers in Excel format are from my own models.

      Every investors surely made losses in investing. I have lost money in more than 10 stocks, and the list will continue expanding in future: NRG Energy, AllianceBernstein, Sohu, Bank of America, Blackrock, Sinomedia, Life Partners, etc. Some are due to flawed analysis, some due to folly, naivety, speculation, etc. The worst loss is 70% on Sinomedia. In some cases, I had 30% paper loss, held on until recovery and made profit. In other cases, I had 3% loss and sold out. As you trade more stocks over the years, you will encounter all different combination of experiences: you buy and it rises immediately, you buy and it falls immediately, you sell and it continues rising, you sell and it falls further.

      I did write a post on trading cost (see here). The overall trading costs depend on the cost per trade and how actively the portfolio is traded. If each trade costs 25bps and the portfolio has 1x turnover in a year, then full year trading cost is around 0.25% of AUM (there are other costs, such as clearing fee, trading access fee, GST, but they are very small). Fund management can negotiate for a lower cost per trade (e.g. 7bps) with brokers, while retail investors generally pay a higher cost per trade (e.g. 18-28bps, subject to minimum commission). If you short, then you’ll cost will increase substantially, depending on your borrow rate.

      My business is not related to investment/finance at all, and it’s failing! I didn’t quit stock-picking game, I am just not doing it full time for now. I’m still active in my personal stock investing. I’ll probably get back to full time soon. It’s a mistake to do the business, but I have learned some lessons.

      As to how much % of my research/analysis get expressed in my post, I don’t really have a figure. It varies per post too. Some can be 50%, some can be 80%. The main points are there, but some details may be too much to write. I don’t share every single trading activity either. In some cases, I post that I bought the stocks, but I did not post that I had sold out several months afterwards. In other cases, I post that I did not buy the stocks, but I changed mind few days later when the price fell. There are also several Buy and Sell activities that I did not share at all. I’m writing blog posts out of interest to share my knowledge and opinion, and hope they can be useful to some people out there. The posts can also serve to remind me why I bought certain stocks and what was in my mind at that time.

      Hope I have answered your questions. Cheers!

      Like

  2. Thanks for your prompt and informative reply.

    1) Do you mind writing posts on your losses? It’s a bit difficult to dwell in losses and recall details around them, but I am really curious in your line of thoughts when you made the decision, and how you miscalculated your steps (because I can make sense of your line of thoughts for your many of calls in your posts, and can’t find any strong way to counter argue).

    2) I forgot to include this, but why did you leave your hedge fund?

    3) Do you keep track the performance of your investment portfolio? How does it compare against your benchmark e.g. IDX composite, bond yield etc. (hihi)

    Also, can’t wait for your next post, that’s for sure!

    Like

  3. For my losses, where should I start? There are more than 10. It can be a long post.

    Let’s do a quick one, starting with the worst one, Sinomedia. I retrieved my notes on Sinomedia, written in April 2014, which will save me time from re-writing.

    What Sinomedia do: TV business in China – buy advertising minutes from CCTV China and sell them.
    That’s nearly 90% of their revenue.

    It has a track record of increasing its utilisation rate (number of minutes sold divided by number of minutes bought) and its margin (gross, EBITDA and net) from 2010 to 2013. For 2014, they bought similar number of minutes from CCTV.

    Good net profit margin of 21% in 2013 (rose from 11.5% in 2010). ROE of 25-30% in past 3 years. Stable dividend payout ratio of 40%, with dividend yield of 5% and more over past 3 years.

    Earnings growth for 2011, 2012, 2013: 51%, 27%, 20%.
    Strong net cash, which is about 40% of market cap at that time.
    Currently trading at only 7.9x P/E.

    Risk:
    – luxury brands may reduce their advertisements in future. e.g. two luxury brands were impacted by the govt anti-graft policies and held back their advertisement spending. Sinomedia was also impacted by the trend.
    – china slow down is real and the growth is getting slower and slower every year.
    – lower utilisation rate of ads minutes

    …. (other notes omitted)

    What went wrong?? The risks that I stated above, all turned out to occur, badly. The number of minutes sold and the average sales rate fell. Double whammy. Advertising spending shifted from traditional media to the internet.

    I thought I bought it cheap at below 8x P/E, and with 40% of market cap in cash, I had cushion. It’s a value trap.
    Net profit fell 17% yoy in 2014 and 60% yoy in 2015. First half of 2016 reported losses. Net cash still represents more than half of market cap for now, but the market won’t care that much.

    My worst mistake is that I didn’t follow up the story. I just held on. That’s a painful lesson, even though it’s a small position and the lost was just a few thousand dollars. The company did pay some decent dividends in 2014-2015, so my overall net loss is ~60%.

    So, this is a classic value trap. It’s cheap for a reason based on normal valuation metric.

    For other stocks that I lost money, e.g. AllianceBernstein, Blackrock, BoA, etc, I didn’t study them well. The purchase was a mistake. Who would have thought of losing money on these big names when the market was recovering? That is naivety. Part of the reason to lose money on them was also because I sold them during 2011, which was a bad year for stock market. If you check their prices, all have recovered from 2011 level.

    I left my previous hedge fund because I wanted to learn to start and run a business. It’s a valuable experience. My fund manager suggested that I continued working for the fund on part time basis while working on my own business. But I thought that I needed focus to run one thing well, and it’s not appropriate/fair to the investors of the fund that I worked half heartedly.

    Yes, I keep track of my portfolio performance. The benchmark I use is SP500. I started in late 2008 and went all-in in 2009 (all US stocks + 1 SG stock), which was a great year for market return. Therefore, my return for 2009-2010 was high double digit, better than SP500. That great start skew my average to higher number. That’s why when investing in a fund, it’s important to know the inception date. For anyone who started in early 2009, they would have fantastic first two years.

    I made small loss in 2011. From 2012, I had to sell most of my positions because the fund I joined banned most of the trading. At one point, no BUY activity was allowed. I held to only few stocks (5 or fewer) with small position and had very few trades for next 3 years (need compliance approval for each trade) until I left the fund. That’s actually costly to me because US stock markets had great years from 2012 to 2015. My small portfolio was also doing well during this period, but it’s small (just a quarter or a third of the size of the portfolio in year 2009).

    When you start your personal investing, you will realize that it’s not easy to calculate your overall performance and keep track. It is a topic in itself.

    If you start with a fix capital at the start of the year, and just invest based on that capital, you can calculate your return easily, which is profit/loss at the end of the year divided by the capital at the start of year.

    But, you may not start with a fix capital. You are likely add more and withdraw some along the way. For example, you may start with 100k and add 50k more several months later or withdraw 30k in mid year. In this case, in order to calculate portfolio return, you will use money-weighted rate of return, while fund managers will use time-weighted rate of return. The two methods will yield different result when there is addition to or withdrawals from the portfolio. Keeping track of the performance will take some effort.

    Like

    1. Wow. Thanks so much for the writing.

      It really is different from reading theories from book from experiencing and doing it yourself.

      For example, the money-weighted vs. time-weighted return, I never actually appreciate the distinction between the two.

      Main things I learn from your write-ups are the importance of clear stories and line of thought and the importance of keeping tab on risks.

      You are right – writing your thoughts on investment on paper/blog will make it clear whether an investment has a good story or a flaw.

      Like

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