Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.
Really? Quarterly earnings disappointment, heavy liquidating selling and investor wariness regarding Chinese companies - YES! these factors have converged to now provide investors a compelling buying opportunity in the shares of Global-Tech Advanced Innovations, Inc.(GAI) at yesterday's closing price of $6.49. Why do we think so? Because they have resulted in a very low valuation and low investor expectations despite underlying favorable fundamental change….the three conditions we look for in buying stocks.
At its current price of $6.49 GAI is currently selling at barely half of its $12.16 net cash per share and a quarter of its $24.71 book value. The stock will provide an 87% investment return if it simply trades back up to its net cash per share (giving no value to the underlying business)!
Global-Tech Advanced Innovations, Inc., formerly known as Global-Tech Appliances, was incorporated in the British Virgin Islands in 1991. Its headquarters are in Hong Kong and its manufacturing facilities are in Dongguan in mainland China. In its early years, Global-Tech was an Original Design Manufacturer (ODM). It manufactured and assembled a variety of consumer and household appliances for larger international companies, including kitchen appliances such as "Mr. Coffee" and vacuum cleaners such as "Dirt Devil". A steadily growing business significantly accelerated with an influx of orders from Sunbeam, allowing GAI to complete its initial public offering on April 7, 1998. The stock traded as high as $21.50 per share...equivalent to $60 in today's price after adjusting for dividends and a reverse split.
Shortly thereafter Sunbeam imploded and its stream of business vanished. During the following years, the kitchen appliance business became overly competitive and GAI emphasized higher value-added products such as vacuum cleaners. The company attempted further diversification into more technical products such as Organic Light Emitting Diodes (OLED). While prescient in terms of market trends the bright outlook for that business drew the attention of larger competitors and GAI soon withdrew from it. However, the OLED business allowed GAI to gain expertise in clean room production.
This proved instrumental in GAI's subsequent entry into two higher-technology segments: Electronic Components (EC), where the company supplies compact camera modules for cell phones and Electronic Manufacturing Services (EMS), where the company uses surface mount technology for printed circuit board production and assembles cell phones. These two segments are the company's primary businesses after GAI completely exited the vacuum cleaner business in 2012. A brief description of the company's continuing operations is as follows (note: the company's fiscal year ends on March 31 and all figures are in millions of US dollars ):
The Electronic Components business has grown as GAI has supplied higher pixel count camera modules to Chinese cell phone manufacturers. Future growth will be augmented by the recent installation of three "chip-on-board" production lines. Orders have already been received requiring the use of these "chip-on-board" production lines.
ELECTRONIC MANUFACTURING SERVICES
The Electronic Manufacturing Services business has been pressured by stiff competition, rising labor costs, and a slowing Chinese economy. This business is undergoing management scrutiny and is likely to be de-emphasized. We assume it will achieve break-even or be discontinued.
The Other segment has served as a business incubator. The current new product is a specialty medical device that utilizes GAI's camera module capability.
Corporate expenses are currently burdened by manufacturing facilities made vacant by the closure of the vacuum cleaner business in 2012. Expenses will gradually decline as these facilities are leased out.
Thesis & Catalyst For Global - Tech Advanced Innovations Inc.
GAI stock price languished for years due to a spotty earnings record, no analyst coverage, scant investor relations efforts and investor skepticism regarding Chinese companies. We believe a turning point in investor perception occurred with the cash dividend announcement and subsequent payment in September, 2012.The stock attracted investor interest and began an uptrend in calendar 2013, only to retrace nearly all its upward move when disappointing earnings were announced with the FY 2013 earnings release on July 23, 2013.While the June quarter posted another loss, we believe that should mark the low point and that profitability is possible in FY 2015 (ending March, 2015).
At current prices around $6.49, GAI stock is very undervalued based on its $24.71 book value and $11.76 net cash per share. If the company achieves our rough potential E.P.S. estimate for FY 2015 of $0.52 per share, the stock should easily sell for net cash per share of $11.76 minus assumed losses of $1.00 per share in the remainder of FY 2014 plus 7 times E.P.S., or $11.76 minus $1.00 plus $3.57, resulting in a price target of over $14 a year from now.
While Mr. Sham and family ( see below under "Company Management") have taken no actions to suggest a stock buyback or going-private transaction is in the works, the current valuation must make those actions seem very tempting. Importantly, many Chinese companies are precluded from capitalizing on their abnormally low valuations because most or all of their "cash" is held in Renminbi, which is not freely convertible. Global-Tech, however, holds the majority of its cash in US dollars. Specifically, at March 31, 2013 roughly $22MM, or over $7.00 per share, of cash was held in US dollars. As an example, Mr. Sham could tender for the entire 1.0MM share float at $13 per share (double the current stock price) using only 2/3 of the US dollars in the company's bank accounts and leaving untouched the entire cash portion held in China in Renminbi.
Of the 3.04 million shares outstanding the Chief Executive Officer, John Sham, and related family members own 2.032 million or 66% of the total shares. While this likely precludes a hostile takeover, it also means that the Sham family has an important interest in increasing the value of the company. While the company maintains a very limited investor relations stance, it has acted favorably toward shareholders in the past by paying two special dividends, the most recent one being a $1.00 per share cash dividend paid on September 5, 2012.
Revenue & EPS Outlook
While FY 2014 will likely show a loss for the full year, we believe the company can be profitable in FY 2015. We offer a rough outline of our view of the company's potential for FY 2015, as follows:
FY 2015 Potential
Electronic Mfg. Services
Risks include a worsening Chinese economy, poor management decisions, continued neglect by investors, or the possibility of GAI being a complete fraud. We think it more likely that the Chinese cell phone sales will do well, that management will perform competently (witness the profitable exit from the vacuum cleaner business), that investors are beginning to notice the company, and lastly, that the company is actually real ( I personally met Mr. Sham a few years ago) and is about to embark on a path that will prove to be more profitable for the company and considerably more profitable for investors willing to seize the opportunity at hand.