Evaluating a growth company is always a tricky proposition - growth and risk tend to come hand in gloves. In this 2-part analysis, I will attempt an in-depth investigation of Hollysys (NASDAQ:HOLI), with the first part focused on qualitative discussions and the second part on quantitative measures.
Hollysys is the No. 1 domestic provider of industrial automation and control technology, and one of the top 2 providers of high-speed rail signaling systems in China.
When I evaluate a company, one of the first few things I look at is the people running the company. Hollysys is run by engineers whose dedication to the business can be seen from the very personal tones of their press releases (including more than once personal apologies from the then-CEO for under-performances during the financial crisis). Founded in 1993, the company has also established a strong corporate culture that emphasizes integrity, professionalism, and cooperation, which cannot always be taken for granted for companies operated in PRC. My scuttlebutt investigations have all come out complimentary on the company. For example, Huawei, the most famous Chinese industrial heavyweight, likes to hire people from Hollysys, but not from Supcon, Hollysys' nearest domestic competitor in the industrial automation market (Supcon's founder, by the way, was arrested by Chinese authority for Supcon-related embezzlement charges). Current and former employees of Hollysys also commented that the corporate culture within Hollysys is very collaborative and supportive. New and prospect HOLI employees asking for advices on forums were encouraged that HOLI makes people work very hard but they would become sought-after talents with a stint at HOLI.
There is another thing that can make investors suspicious of Chinese companies feel better: unlike most Chinese dotcoms traded on the US markets, HOLI does NOT use the Variable-Interest-Entity (VIE) structure. HOLI is not in an industry regulated by Chinese government, so your right as a HOLI shareholder is protected by direct ownership, not by contracts that may or may not be honored by Chinese courts.
Chinese government is more a friend of HOLI investors here. In FY2013, HOLI received USD$4.9 million government subsidies. Better yet, HOLI is also getting rewarded approximately $5 for every $100 sales it makes today from the government in the form of VAT refund.
The government is also helping in other ways. HOLI's main competitors in industrial automation are mostly Western multinationals such as ABB, Honeywell, Siemens, etc.. Investors following news headlines should know by now that the Chinese government is making life harder for multinationals every day. In fact, the "mini-stimulus" Premier Keqiang Li announced in April called for accelerating the development of nuclear power, and prioritizing procurement from domestic suppliers. HOLI is currently the leading provider of nuclear automation technology in China, so is expected to benefit from these policies.
The possibility of an imploding Chinese economy has kept many investors away from Chinese market for some time. This concern, however, is playing out in HOLI's favor. HOLI is in industries where the government likes to stimulate, such as high speed rail, and industrial automation that enhances efficiency and reduces pollution.
China is world's manufacturing powerhouse, and it will remain so despite rising labor cost because of its leading infrastructure, the depth and breadth of its talent pool and supply chain, and its geographic adjacency to the largest Euroasian market by land. China is already the largest buyer of industrial robots in the world, and its industrial automation market will be the biggest too. The bigger pie will benefit most participants in the market, domestic or foreign. It is possible some domestic players will gain more market share, and HOLI is a good candidate for that.
In addition to the acceleration of high-speed rail investment in China, international railroad construction is also providing a vast market for HOLI to grow. African countries such as Egypt and Kenya are already building high-speed railroads with China's help. Modi's new government in India also has its focus squarely on infrastructure including railroads. HOLI has also recently won a contract to provide its Integrated Supervisory Control System for Singapore's subway systems. Although I do not expect overseas railroad market to grow as fast as that of China due to lengthier decision-making and land acquisition processes, the overall demand for the faster and more efficient transportation infrastructure undoubtedly exist.
On the risk side, HOLI is clearly not as risky as dotcoms. It is in a business that requires patient investment in hardware and R&D. Its customers have mission-critical tasks that favor established suppliers over newcomers. Experiences and expertise in executing projects are also "soft" skills that take newcomers years to learn and build. The biggest risk with HOLI still lies with the macroeconomy development in China. If China's economy has a hard-landing and if the government refuses to act or act inadequately to stimulate the economy, there will be hardships facing all companies operating in China. However, this is an unlikely scenario from the author's perspective.
All in all, secular trends are very favorable for HOLI to grow in its core segments, but even for the best company there will be a price that is too high to buy. The next installment of this analysis will dissect HOLI's financials and try to assess whether current price ranges still provide good values for long-term investors.
Disclosure: The author is long HOLI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.