Alibaba’s Increased Investment in Haier
Last week, on the First working day of 2017, Haier released an announcement on the exercise of Convertible and Exchangeable bond and call option. Basically, there is an increased investment from Alibaba in Haier’s logistics subsidiary, Goodaymart Logistics, and they are strengthening their logistics collaboration. This is the upside in Haier that I didn’t value well in my previous post, due to my lack of understanding and the lack of visibility in Integrated Channel Services (ICS) business. The whole logistics, distribution, e-commerce and after-sales service business are grouped together as one reporting division called ICS at Haier, and we can’t tell how large the size of each business is.
E-commerce and logistics business in China are growing by leaps and bound. Just imagine, Alibaba, the largest e-commerce company in China and worth USD 233bn, is still growing its latest quarterly revenue by 50% yoy. Haier is also investing in its logistics business aggressively with huge capex, so, I think I might have undervalued its logistics business and its growth potential.
But it’s not all upside without downside. The growth of e-commerce business is cannibalizing its own retail distribution business. Therefore, the upside in ICS is partially offside by its downside. We just don’t know how big is each.
Shortly after my first post on Haier, I bought the shares at 12.68 on the reason that I bought it at fair price (my valuation estimate was 13.5) with the upside potential from logistics business. If Alibaba is still growing its revenue at double-digit growth rate, Haier, being Alibaba’s partner in white goods’ logistics, will stand to benefit.
As I highlighted in several other posts, growth is nothing without good return on capital. When growth is achieved at the return below cost, it’s destroying value. When growth is accompanied with return above cost, it’s creating value.
For Haier’s case, the rapid growth in ICS business from FY11 to FY15 was accompanied with increasing FCF, except FY15 which had negative FCF due to unusually large capex. But ICS business has ROA of 4.6% and ROE of 24% in FY15. Over the past 6 years, ROA was in the range 4.5% to 10%, which is quite low, while ROE turned from negative in FY10-FY12 to positive 24% in FY15. So, it seems that the investment in ICS has taken turn to pay off. But the picture is not clear yet, and that’s why I’m more reserved in valuing this business.
Today, the share price rose to 13.80 and I sold out. The reasons:
1. The share price has reached my base case valuation estimate of 13.5. At selling price of 13.80 and buying price of 12.68, I got 8.8% before trading costs in 2.5 months.
There is still an upside in its logistics business that I have not priced in yet. This upside is like a Call Option to me. If the heavy investment pays off, the earnings and share price will rise to give me additional return. If the investment does not create value, then I have my base case valuation estimate of 13.5 as the guide for me to invest.
2. CNY depreciation, which reduces the value of Haier to non-Chinese investors like me
Haier is listed in Hong Kong Exchange, so I convert the earnings to HKD. Since the start of 2014, CNY started depreciating against USD and it continues to depreciate till now. As HKD is pegged to USD, CNY depreciates against HKD. I thought after 3.5% depreciation for first 9 months of 2016, it won’t depreciate further, but I was wrong. From late October (the day I bought Haier) until now, CNY depreciated by another 2.5% against HKD. So, if I’m to do my valuation today, I will reach my value estimate of HKD 13.5 x 97.5% = 13.1625. My selling price of 13.80 is 4.8% higher than my newly updated value estimate.
3. USD/HKD appreciation, which benefits investors like me with SGD capital
The Trump rally saw strengthening USD. At the same time, SGD weakened. Since late Oct until now, HKD strengthened by 2.9% against SGD. I didn’t expect this, so this additional return is like a luck to me.
In total, we see #2 CNY depreciation, which reduces the value of Haier to me, but the rising share price did not reflect it. Plus #3 HKD appreciation gives me additional unexpected return. So, I took advantage of both and sold out. My net return is slightly more than 11% in 2.5 months, which is satisfactory.
4. Haier’s FY16 result is not likely to impress the market after flat EPS growth of 1.1% yoy for first half.
Haier’s 9M16 result saw revenue falling by 3.5% yoy and profit increasing by 1%. I don’t think last quarter result will improve materially given the soft market demand. So, fundamentally, this shouldn’t trigger the share price to rise substantially. This does not mean the share price will not increase further. In short term, the price can go up or down by 10-20% for no apparent reason.
My friend told me about the trading strategy for Haier: Buy at 11-12 and sell at 13-14. Haier’s share price has been trading in this range since the start of 2016. This strategy will work on the *assumption* that the pattern repeats again. I don’t usually follow such range-bound trading strategy. I usually need some fundamental value estimates to guide my investing activities.
Few weeks ago, I also saw an article discussing similar strategy for Hang Seng Index. From 2010 until now, if someone bought at 20,000-21,000 and sells at 23,000-24,000, they would have earned much better return in HSI than a buy and hold strategy. It’s true, but it’s easy to look at past chart pattern and find a strategy that fits in the past. Investing through rear-view mirror is always clear, but it’s the windshield that we need to focus at.
Now that I have sold Haier at the upper end of the 11-14 range, I do hope the pattern repeats again. If it falls to 11-12, I’m likely to buy back provided that Haier’s fundamental has not changed materially. My activity may look like following the range-bound trading strategy, but it’s not. I’m using my valuation estimate of around 13.5 as my guide to invest. I missed the chance to buy more shares at 12.00 two weeks ago. I hope I have a second chance.