So today we are looking at a company called China Linen Textile Industry LTD (CTXIF). China Linen Textile Industry, Ltd. China Linen Textile Industry LTD is principally engaged in the production and sale of linen yarn and various types of linen fabric. The Company is also involved in consultation and R&D related to linen technology and linen products. The Company carries on all of its business activities through its subsidiary, Heilongjiang (try saying that 10 times fast) Lanxi Sunrise Linen Textile Industry Co., Ltd. ("Lanxi Sunrise"), near Harbin City in China. So this basically means that China Linen Textile Industry LTD is a holding company.
This company is doing a lot of great things, and here are a few reasons why you should buy into this company (and hopefully make an excellent return). Oh and brace yourself, this is going to be a long one but a good one.
Reasons to Buy
1. It Is Undervalued:
Using an intrinsic value formula we find that the company should be trading at approximately 20.33ish (for those of you who do not know the intrinsic value formula you are more than welcome to look it up, just search Benjamin Graham). Its book value is approximately 5.02, which is also more than double what the stock is trading at (right now about 2.25), and is also about double what the industry average is for book value. Furthermore, when looking at their latest financials it can be seen that their current EPS (diluted of course) is approximately 0.44 (the value I have shown here is slightly different than their stated value of 0.46, as I do not believe government subsidies should be included as actual earnings). This is also only for 1 quarter! If we multiply this by 4 quarters we would have earnings of about 1.76! It is fairly safe to assume this as their revenue streams are not cyclical in nature (read financial statements) so each quarterâ€™s earnings should be roughly the same. However it should be pointed out that this may not necessarily be true as it is possible that unforeseen circumstances may arise (earthquake, politics, regulations etc.).
This means that the company is only trading at about 1.3X earnings. When we look at the textile industry as a whole the average P/E ratio is about 25.5X. If we use that number as an average CTXIF should be trading at just under $45. Now that is a little overpriced in my opinion, but itâ€™s good to know. A more appropriate valuation of where it should be trading at would be 10X earnings ($17.6). We can also look at CTXIFs net profit margin (2010) which is well above the industry average of 3.2% at approximately 17.6%, which is huge for the industry. Iâ€™ll explain why I think this is so further down.
On a side note, it should also be noted that during their 2010 year they were operating at full capacity and couldnâ€™t actually take on any more orders (even when operating 24 hours a day). They also did not utilize their fabric subcontracting revenue stream to generate revenue. Once the company expands (as it has due to the purchase of a yarn spinning operation) and if it were to utilize the additional subcontracting revenue stream, their EPS would be much higher. Weâ€™ll keep it conservative for now though.
2. Key Relationships:
CTXIF has a few relationships that give it some particularly great advantages over its competitors. One is that some of the companies that it imports raw materials from and exports itâ€™s finished goods (Harbin Zhongyi and Harbin Sunshine) have special licenses granted to them by the PRC (Peoples Republic of China) which allow them to take advantage of special waivers on import/export taxes in areas of northeast China (where CTXIF does some of its business). Now this may not seem that big of a deal except that the company's CEO, Gao Ren, owns these companies. Hmmmm how convenient lol! So CTXIF pays almost no mark-up for any imports and exports. This is one reason why CTXIFs costs are minimized and it has a high profit margin.
The company is also considered to be a leading manufacture enterprise by the local government, Lanxi Government ("Lanxi Government"), which has a long-term desire to encourage Lanxi Sunrise to expand its production capacity and to create more job opportunities for local residents. For that purpose, the local government has granted various subsidies to Lanxi Sunrise. These subsidies offset over 40% of its income taxes and also cover some of its land, building, and sewage facilities improvement costs. This is another reason why their costs are low, as they are reimbursed for a number of them.
The company has also partnered with Tianjin Institute of Technology and Donghua University in order to research more cost effective ways to produce linen and yarn. Furthermore, the companyâ€™s subsidiary Lanxi Sunrise is building the first and only linen research and development center in China. Should this be completed AND the research pays off in the form of decreased costs (or some other discovery) the company should be more profitable.
On the customer side of things, the company has diversified its customer group over the past year to not have such a high threat from buyers. 2 years ago 90% of the companyâ€™s revenue was generated by its 5 largest customers. Its five largest customers now only account for about 47%, which means a decreased threat from buyers. The risks of not having buyers are greatly minimized as the company has entered into many long term contracts with them. This was outlined as a concern that management was looking at, and they are obviously trying to fix it.
3. Excellent Management:
The companies CEO is doing great things and is delivering on all of his promises. He has said that the company is looking to expand, which they did by purchasing a company that produces yarn, and is continually looking for more acquisitions to increase its percentage of the market. The company is also looking to expand into India and Turkey as well as produce more high quality yarns and linens. I guess weâ€™ll see how they perform! The CEO has also been recognised as the â€œNational Entrepreneur with Honesty in Businessâ€, â€œChina Enterprise New Man of the Yearâ€, â€œEntrepreneur with Honesty in China Textile Industry Businessâ€ and â€œModel Worker of National Textile Industry.â€ Management is also very good at using their invested capital, as in 2010 they achieved an ROIC (return on invested capital) of about 6%. This is a decent return (this is not an ROI, but somewhat similar).
The only downside to management is that they currently have poor internal controls and have limited accounting personnel. This is minor though, as any changes that needed to be made to their financial reports are dealt with swiftly, which leads back to how honest management is.
4. Other Advantages:
While CTXIF has a lot of competition, many of them only produce thread and currently do not have the capability to produce fabric. Due to this the company is one of the largest manufacturers of linen cloth in China. In addition the companyâ€™s operating facility operates 24 hours a day, in which workers work for three eight hour shifts! That is pretty insane considering they were operating at full capacity in 2010. If only there were 25 hoursâ€¦
The risks that potentially face the company are minor and many of which are not expected to happen. Some of these are a change in customer demand, a change in government policy, and the risks associated with managing rapid growth. The one major concern that I think would be the most likely to become apparent is the managing of rapid growth. The company is growing very quickly, with EPS growing over 12% over the past few years, as well as very large increases in assets and acquisitions of companies. I do believe that Gao Ren and the rest of the management team will prevail in this area though.
There are also a few risks to the shareholders in regards to the company. It may difficult to file any lawsuits against them as their main operations are in China. Currently I donâ€™t see any reason to file a lawsuit, and I think this risk is greatly minimized by the CEO, as he seems like an honest and trustworthy man. Gao Ren does own about 40% of the company though, which can either be a curse, if he messes around, or a blessing, as his stocks are worthless if the company doesnâ€™t perform. The company is also incorporated in the Cayman Islands, which means that it may be difficult for shareholders to protect their interests if the actions of management cause concern.
The company is a great buy at its current price of 2.20ish (and in my own personal opinion it is still a great buy anywhere under $15). It has growing EPS, it is undervalued by a substantial amount, it utilizes key relationships very well and it has excellent and honest management. I believe that this company is worth about $18 based on a combined look at its EPS, its intrinsic value, its book value and the strength of its management. I also believe this is a little conservative because if we look at its growth potential and how it stands relative to the industry as a whole it could be worth closer to $45 maximum (as of right now), and it is far out-performing the industry average. The company is also looking to grow and expand its business, which could lead to higher earnings in the future, and thus a higher share price.
Now I know that these numbers are much larger than what it is trading at, so if you donâ€™t believe me then check out CTXIF for yourself.http://www.chinalinentextile.com/
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