How My Deep Value Stocks Fared From 12 March 2019

Summary

• For subscribers of my Marketplace newsletter I discuss about 10 deep value stocks based on quantitative rankings twice a month.
• In this article I share information on stocks discussed in my newsletter from 2 years ago. While some information is outdated most information can still be useful.
• I will also do a quick follow up on each stock. In particular I compare them with recent quantitative stock rankings. Several stocks are still very cheap.

A 2-week free trial to my newsletter is available here.

Let's start with the stocks I looked into but I did not recommend based on what I found. Then I will give the average return of the 8 stocks I discussed in more detail and did not warn against, followed by a list of stocks that are still good picks and/or interesting. Finally you will find the detailed descriptions of 10 stocks. At the end of each of these descriptions you will find a short update.

The share prices mentioned in the short company descriptions are from the day I wrote these notes. That is before 11 March 2019, which is the date of publication of my research. I use 12 March 2019 as the start date for computing returns.

Silk Road Energy Services Group (HKG:8250) provides coal mining services and heating supply services and is also a money lender providing high interest unsecured short term loans and invests in listed stocks in Hong Kong. The company is a net-net and 5-year low at 0.026 HKD.

According to David Webb the company had shady shareholders. The company scores 2 out of 4 points when using the method of GMT Research for assessing the probability of fake cash and fraud.

I skip the detailed analysis for this net-net because it has been extremely dilutive in the last 10 years. Such a track record is typical for stocks of companies with this kind of business description. With this kind of diluting it takes several years before confidence is restored, if ever.

For those still interested see the interim report over the first second of 2018 and the annual report over the year ending 30 June 2018. There are no really large shareholders: the biggest stake is 8.61%. Directors do not own any shares or options.

Update 22 February 2021: I use 19 March 2021 as the end date for computing returns of this stock I did not recommend. The dividend and split adjusted stock price decreased from 0.027 HKD to 0.020 HKD. In USD the return is -25.0% and the annualized return is -13.76%. I was right with this stock.

I now continue with 10 stocks I discussed in more detail 2 years ago. This was the first newsletter of March 2019. After publishing this newsletter I added 2 of these 10 stocks to the Selected Stocks list I had started at the end of January. Initially I was very careful and added only the stocks I had a strong preference for. At the moment it is the other way around: I add every stock to the Selected Stocks list unless there are very strong signs governance is terrible or if there is much financial distress.

Nearly 2 years ago I added the following 2 stocks to the Selected Stocks list: Hoshi Iryo-Sanki Co and Pharma Bio Serv. After one year, on 11 March 2020, I moved these 2 stocks to the Played Out list.

I compute an average return of -7.46% for these 2 stocks. The average annualized return was the same within 2 significant digits. The average return of the 8 stocks I investigated in detail and I did not explicitly warn against was 17.54% and the average annualized return was 7.15%. I tried too hard to limit downside. That does not work well with deep value stocks and net-nets. I changed that later by recommending more stocks.

BTW, if I had held on to these 2 stocks for another year returns would have been much better because of a recent surge of Pharma Bio Serv. So I had a look again why I put this stock on the Played Out list a year ago. My conclusion was EV/EBIT was not low anymore and therefore I could not find it in any of my lists anymore. Looking it over again I would have expected to see this stock in the nanocap list. But it turns out trading volume was way too low for inclusion in this list. Normally I always check if a stock is very illiquid before I move it to the Played Out list. If trading is indeed too illiquid for inclusion in my lists I do not move it to the Played Out list.

So the low returns of my picks could have been avoided if I had followed the procedures of my own investment process more carefully. If I had done that, so held on to Pharma Bio Serv for another year, average return would have been 33.59% and average annualized return would have been 14.48%.

I should say I might have added this rule of not selling illiquid stocks in April or May 2020, so after I moved these 2 stocks to the Played Out list. I just don't know anymore. But I cannot emphasize enough how important this rule is. Here is another example.

Recently I sold United Power Technology AG (ticker UP7 in Germany) for about 1.5 EUR. About 5 years ago I had bought this stock as a promising net-net based on shareholder structure, profitabilitiy and payouts. Unfortunately the stock price decreased to a few eurocents. It did not make sense to sell my shares because trading liquidity was almost zero. But in this bubble time it must have gotten some big pumps. The fundamental value right now is almost certainly zero.

The 3 stocks I warned against performed very poorly: -35% price decrease when holding one year and similar annualized returns when holding two years. So though my 2 picks did not perform great my research was useful.

The following stocks are still cheap:

1. KCI SA (ticker KCI in Warsaw): among the best 19% in my nanocaps list
2. Kensoh Co (ticker 7939 in Tokyo): among the best 14% in my nanocaps list
3. Inter RAO Lietuva (ticker IRL in Warsaw): I find the stock cheap based on EV/EBIT, EV/Revenue, P/FCF and dividend yield.

Detailed Stock research (March 2019) with updates

1. Universal Health International Group Holdings: net-net, nanocap, 5-year low

Ticker, Fin Strength	Share Price 5-year low	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
HKG:2211 4	0.069 HKD 0.062 HKD	179 CNY -729 CNY	- -0.28	0.09 0.9	6.8 5.7
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-06-30	-1966 CNY	-184 CNY	-295 CNY	-	-

Notes from before March 2019: Universal Health International Group Holding is a pharma retailer and distributor in Northeast China. The company has changed its name from Jintian Pharmaceutical Group in 2015.

The company owns almost 1000 pharmacies. About half of the revenue comes from the retail segment and the other half comes from the distribution activities. The company also owns 16 supermarkets. The quality of the current assets is high. The distribution segment is not as profitable as the retail segment. I think profitability of the retail segment can be boosted simply by closing some pharmacies. The company issued a profit warning over the first half of 2016.

In May 2016 the company announced it would acquire a “high-tech” manufacturer of hollow capsules and gelatin for 27 million RMB cash and 243.3 million RMB in shares. The company will issue 400 million new shares for 0.725 HKD per share. The current, pre-acquisition share count is 2.4 billion shares. The capsules are meant to be used for medicines. This is an extremely expensive acquisition since this manufacturer only booked 5.3 million HKD profit over 2015 and only has a book value of 26.2 million RMB. No wonder that the stock cratered after this announcement.

Large shareholders: the new shareholder Mr. Di Hongying owns 16.67% or 400 million shares. The family Jin owns 40%. I think a stake of about 25% is held in a margin account so that stake can be sold short. Mr. Jin Dongtao is the Chairman of the company. Zhongrong International Trust Company (or Wu Qiaofeng) owns 10.11%. Lerado Group owns 6.19%.

Zongrong bought this stake from Mr. Jin Dongtao in January 2016. See also here. The company introduced this asset management company as a “strategic investor”. Existing mangement might have thought such an investor could have built more trust in the company. However a selling insider is never a good sign. Almost certainly this caused the fall in the stock price from 2.5 to 1 HKD in January 2016.

March 2019: The company still runs a pharmaceutical retail chain network in the Northeast of China with 917 stores. The company is also a pharmaceutical distributor in Northeast China with 6200 distributors and 5 large-scale logistics storage centers. The company also sells online.

Searches on the company names and keyword “fraud” did not reveal any relevant links. However David Webb mentions the controlling shareholder taking 2 loans from companies in the Enigma Network from 2016. These loans were secured by a 14.86% stake in Universal Health International Group. Otherwise I have not found any ties between this company and the Enigma Network.

The company scores 3 out of 4 points when using the method of GMT Research for assessing the probability of fake cash and fraud. So fraud risk is really high.

According to the cash flow statements in my screener the company paid out a dividend in 2014 and 2015 and did a small dilution in 2014, after the IPO in 2013.

The company tried to dilute much through options but because of a declining stock price this scheme failed.

In August 2018 the big five auditor, PwC, resigned and was replaced by a cheaper auditor.

There are 2 other reasons this company is so cheap: ongoing losses and value destroying acquisitions paid in undervalued shares.

See the annual report (over the 18 months (!) ending on June 30, 2018) and the recent interim results announcement (6 months ending December 31, 2018).

Key audit matters were several non-current assets: goodwill impairment, an impairment loss on an investment in an associate, and a small fair value gain on biological assets (ginseng plants).

These impairments are worrisome: Often controlling shareholders get extra returns via related-party transactions, at the expense of minority shareholders. The investment in the associate was only made in 2016, for much more than book value. Also in April 2018 there was a new transaction.

Retained earnings are approximately 200 million CNY including statutory reserves and certain other reserves. Therefore Market cap/Retained Earnings = 179/200 = 0.895. For details see here and here.

The balance sheet is strong with hardly any leverage, lots of cash and no debts.

The book value of the current assets is 1.45 billion CNY including for 0.29 billion of inventory. Total liabilities are 0.29 billion CNY. Therefore my estimate of liquidation value is 1.45 -0.5*0.29 -0.29 = 1.015 billion CNY. Liquidation Value/Market cap = 1015/179 = 5.67.

Substantial shareholders: CEO and chairman Jin Dongtao 18.69%, outsiders Mr. Lu Baocai 15.07%, Mr. Wu Qiaofeng 7.98%, Mr. Xie Wei 9.77%. The annual report displays a much higher stake for the CEO/chairman but this is misleading, see the footnote in the annual report.

Related-party transactions: the company rents office space in Beijing for 3 million CNY per year. Also the deputy chairman is the brother of the controlling shareholder. The chairman and his brother have the highest salaries of about 700 and 512 CNY, which is not excessive.

The outsiders got their stakes from selling overvalued companies to Universal Health International Group. There is some trust in the company: the outsiders could vote for another chairman. Despite that there is some trust I do not recommend this stock because of the value destroying transactions paid in shares trading below NCAV. Effectively the controlling shareholder is reducing his stake (so selling) via these transactions. Although the company denies it it is still possible the substantial outsider shareholders are affiliates of the controlling shareholder.

Update 22 February 2021: I was right to warn against this stock because of the value destroying transactions. The stock price decreased from 1.04 to 0.405 HKD. In USD the return was -60.57% and the annualized return was -38.05%. The stock has still a good ranking in my net-net list. However based on my previous research I still think it will take more years before investor trust in this company is restored, if ever. Moreover according to the cash flow statements in my screener the company did a smaller but still very substantial dilution in the second half of 2019. I guess that won't help.

2. KCI: net-net, nanocap

Ticker, Fin Strength	Share Price 5-year low	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
WAR:KCI 6	0.55 PLN 0.42 PLN	37.7 PLN -18.2 PLN	- -0.16	0.46 -	1.58 >3?
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-09-30	-124 PLN	9.9 PLN	9.8 PLN	3.8	-

March 2019: KCI SA trades real estate and manages owned and leased real estate. The company also owns 84.22% (voting, 80% economic ownership) of Gremi Media with stock code GME in Warsaw. Gremi Media provides financial news through its own newspapers, a TV channel and an online video channel.

A search on the company name and keyword fraud revealed a relevant link. The company was accused of being a “fraud-based financial pyramid”, lacking "elementary corporate governance". In its recent quarterly report the company also writes it was a victim of crime in 2008. The damage was 64.8 million PLN.

The source of these allegations was Piotr Szczęsny. He also started a lawsuit to get other management at KCI but that failed. The company started a defamation lawsuit against him in June 2017.

The company is involved in many lawsuits. Among others the company wants to downlist from the main market to the Newconnect market in Warsaw. That management decision was blocked by a group of minority shareholders in July 2018. Among these shareholders is also the person the company filed the defamation lawsuit against. The company also accuses him of stock price manipulation. See also here.

According to the cash flow statements in my screener the company did not dilute, did not buy back shares and did not pay a dividend during the last 8 years. The company paid a dividend 9 and 10 years ago and raised about 5% of book value 10 years ago.

The interesting thing with KCI SA is the valuation of its subsidiary Gremi Media. Gremi Media went up with a factor 7.8 since its latest quarterly report (September 30, 2018). Therefore KCI’s stake is now worth almost 1.7 billion PLN!

Based on book value the stake is worth only 56 million PLN because Gremia Media has a P/B of 30 at the current stock price of 1160 PLN. This P/B is based on mostly goodwill and other intangible assets and net tangible assets are negative. A conservative estimate of the EBIT is 4-8 million PLN per year. Average EBIT over the last 4 years was 4 million PLN but recently EBIT was higher as a result of costs savings.

So that corresponds to a value of 40-80 million PLN. After subtracting the debt my estimate for the value of Gremi Media is 20-60 million PLN. However in its short life since November 2017 the market cap was never less than 177 million PLN.

Also KCI SA initially owned 100% but sold about 20% as part of the IPO of Gremi Media. It sold these shares for 147 PLN. In December 2017 it bought a tiny sliver back for 138 PLN per share.

BTW, Gremi Media is largely financed by KCI SA with about 20 million PLN of (mostly current) loans.

In the filings I could not find any reasons for the massive share price increase of Gremi Media. I have to assume its unrealistically high market value has somehow been achieved by manipulation, also taking the low float into consideration. I do not think the real value is higher than 60 million PLN, so 50 million for KCI’s stake. The share price will go down if KCI reduces its stake, but maybe it could convert 20% into 200 million PLN of cash, so effectively adding 150 million PLN to the value of KCI.

Disclosure is in Polish. I was able to machine translate the relevant documents. See the recent quarterly report (September 30, 2018) and the annual report over 2017. See also the quarterly report of Gremi Media.

There are 68.58 million shares including 3.62 million treasury shares, or 5.27%. My screener (spreadsheet and table above) does not display the correct market cap because of the treasury shares. At a share price of 0.55 PLN the correct market cap is 35.7 instead of 37.7 million PLN.

The big loss entirely consists of a big write-down of intangible assets of Gremi Media 4 quarters ago.

I am not sure about retained earnings, since this is not clear from the machine translated quarterly report. Accumulated retained earnings were negative in the last 8 reporting years.

The balance sheet is quite leveraged with Tangible Assets/Tangible Book = (388 -256)/(295 -256) = 3.4. The company has hardly any cash but owns 115 million of debt instruments (short-term investments) offset by 37 million PLN of non-current loans. So there should be no financial distress at KCI.

The book value of the current assets is 174 million PLN, including almost no assets that I normally discount. The current assets include for 33 million PLN of assets for sale which I have not discounted. See here. Total liabilities are 115 million PLN including 24.5 million PLN of non-controlling interest. My naive estimate of liquidation value is 174 -115 = 59 million PLN, so Liquidation Value/Market cap = 1.6. However the debt instruments might still be loans to a related-party: see here. In that case these debt instruments need to be discounted. That means the liquidation value might be below the market cap.

But when including the valuation of Gremi Media the picture is different. In that case the liquidation value could be computed as shown below:

Description	Value (million PLN)
Discounted related-party debt securities and cash presumably at parent	115*0.5
Accounts receivable at KCI	25
Assets held for sale (not discounted)	33
Subtract total liabilities excluding non-controlling interest	-90
Subtract cash of Gremi Media	0
Subtract accounts receivable of Gremi Media	-22
Add back accounts payable of Gremi Media	20
Add back external debt of Gremi Media	0
Add proceeeds when liquidating stake in Gremi Media at huge discount to market value	200
Subtract value of non-controlling interest after liquidating stake in Gremi Media	-50
Liquidation Value	153.5

Substantial shareholders: CEO Grzegorz Hajdarowicz 62.76%. Almost a third of this stake has been pledged.

In the supervisory board there are also 3 people with the same surname, including the chairwoman.

Related-party transactions: according to the annual report over 2017 the company lent over 100 million PLN to the controlling shareholder.

My take: complex situation, especially if you cannot read Polish (like me), with many reasons for not liking. Therefore it might be a great although risky bet.

Update 22 February 2021: I was right that this stock could have great returns but unfortunately I was too much focused on the downside to recommend it. The stock price increased from 0.554 to 1.01 PLN. In USD the return was 87.60% and the annualized return was 38.22%. According to the table above there might still be upside (do your own research). Also KCI SA is still cheap in my nanocap list: among the 19% cheapest nanocaps.

3. Heng Tai Consumables Group: update, net-net, 5-year low, high fraud risk

Ticker, Fin Strength	Share Price 5-year low	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
HKG:197 4	0.255 HKD 0.243 HKD	478 HKD -323 HKD	- -0.33	0.23 -	2.9 2.7
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-06-30	-164 HKD	-32.6 HKD	-69.8 HKD	-	-

March 2019: Heng Tai Consumables Group operates along 3 business segments. It trades "fast moving consumer goods including packaged foods, beverages, household consumable products and cold chain products" (“FMCG Trading Business”, 40% of assets). It grows and trades fresh and processed fruits and vegetables (“Agri-Products Business”, 40% of assets). The company owns citrus trees in this division but also imports from Australia. It provides logistics services (10% of assets). Only the FMCG business and the logistics services are profitable, but only marginally.

See also my previous notes from January 2017.

Recently and last reporting year (ending of June 30, 2018) the company also diversified in investing in Hong Kong listed equities, investing in shady convertible bonds and investing in the Gulf brand. These investments are worrisome but so far they are relatively small at slightly more than 10% of total assets.

A search on the company name and keyword "fraud" did not reveal any relevant links.

David Webb reports 2 things about the company. First, in 2009 the company misrepresented the value of an available-for-sale asset. The auditor got a fine because of this. Second, there might have been an undisclosed sale of a major stake on December 21, 2017.

Staggered election of directors in the board (not good).

The company scores 3 out of 4 points when using the method of GMT Research for assessing the probability of fake cash and fraud. So fraud risk is really high. Interest on the cash balance is about 1%.

According to the cash flow statements in my screener the company has been diluting in 8 of the last 10 years. Last year it raised only 1% of equity, but at the current P/B that must have been about 5% new shares. Especially more than 6 years ago the dilutions were big, but also in the year ending on June 30, 2017 the company raised 10% of its book value. The last dividend was 10 years ago.

I was holding the stock at that time. I subscribed into the rights issue even subscribing for excess rights at the end of 2016. A couple of months after the rights issue a pop enabled me to sell for a nice gain. I have seen this a couple of times before: after a rights issue there is a pop. I suppose such pops are orchestrated to allow the underwriter and his affiliates to get out.

See the annual report for the year ending on June 30, 2018 and the interim results announcement for the 6 months ending on December 31, 2018. An important key audit matter was an assessment of impairment of assets of the agricultural business segment with about 800 million of assets before impairment.

There are no retained earnings, just accumulated losses.

The balance sheet is strong with hardly any leverage, lots of cash, and hardly any debts.

The book value of the current assets is 1.31 billion HKD including for 350 million HKD of less valuable assets like inventory. Among the non-current assets there is for 200 million of non-current listed equities and for 95 million of land. The book value of the liabilities is 164 million HKD including 17 million HKD of non-controlling interest. Therefore my estimate of liquidation value is 1.31 -0.5*0.35 +0.2 +0.1 -0.16 = 1.275 billion HKD. So Liquidation Value/Market cap = 1.275/0.478 = 2.67.

Substantial shareholders: the executive chairman Mr. Hing Lam Kwok owns 14.69% together with his wife who is also an executive director. Another executive director, Mr. Stephen Chan Cheuk Yu used to own 27.87%. He got most of his stake in the beginning of 2017 after subscribing for excess rights of a rights issue. Then he became an executive director. But he sold all his shares on July 19, 2018 for slightly more than 0.6 HKD per share. He is still an executive director.

Executive directors are well paid but not excessive, see here. Share options are way out of the money. Otherwise there have been no related-party transactions.

My take: do not touch it. High fraud risk and high business risk also because of insider selling and recent diversification.

Update 22 February 2021: I was right that I warned against this stock because of insider selling and diversification. The stock price decreased from 0.238 to 0.076 HKD. In USD the return was -67.67% and the annualized return was -44.06%. Currently the stock is in my net-net list and in my nanocaps list but not with a good ranking in either of these lists.

4. Kensoh Co: nanocap, low EV/EBIT

Ticker, Fin Strength	Share Price 5-year low	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
TYO:7939 8	422 JPY	1698 JPY 2435 JPY	6.9 0.42	0.81 1.22	- -
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-09-30	312 JPY	336 JPY	284 JPY	-	2.4

March 2019: Kensoh Co manufactures name plates (“signature products”) and sells these products in Japan. The company also rents out real estate, but this is a negligible contribution to revenue and profit.

The stock can be found within Edinet by searching on E01428. In the search results Google translates the company name as “R & D Center”.

A search on the company name and keyword “fraud” did not reveal any relevant links.

The mix of multi-year metrics for measuring earnings quality does not suggest any durable competitive advantages. Over the last 8 years free cash flow generation was quite good though.

According to the cash flow statements in my screener the company is paying virtually the same dividend already 10 years. The company has also bought back shares. In particular the company bought small but meaningful numbers of shares back in the last 2 reporting years.

There are 4,022,774 shares including 298,100 treasury shares (7.41%). So the market cap = 0.422*(4.0228 -0.2981) = 1.572 billion JPY. So my screener (spreadsheet and table above) overestimates the market cap.

The balance sheet is somewhat leveraged with Tangible Assets/Tangible Equity at 2.7. There is about twice as much current debt as cash and the current ratio is also slightly below 1. However I think the company generates enough profit and cash to either pay off current and non-current debt or refinance it.

The recent three quarters (until December 31, 2018) were not so good because of higher overhead expenses partly offset by higher revenue and gross profit. I think it does not matter much because business seems to be seasonal. By far the best quarter is probably the quarter ending on March 31. So only when we have numbers for the current quarter we will know whether the business really declined.

Retained earnings are 1.29 billion JPY. Therefore Market cap/Retained Earnings = 0.422*(4.0228 -0.2981)/1.29 = 1.22.

The book value of the current assets is 2.4 billion JPY including for 0.3 billion JPY of not so valuable assets. Among the non-current assets there is for 1.4 billion JPY of land and for 0.4 billion JPY of real estate for investment purposes. The company hardly owns any non-current investment securities. The book value of the liabilities is 3.4 billion JPY. Therefore my estimate of liquidation value = 2.4 -0.5*0.3 +1.4 +0.4 -3.4 = 0.65. So the company trades much above liquidation value.

Substantial shareholders: R & D Enterprise Co 21%, “Recruitment employee stock holding meeting” 5.5%, Watari Hida 4.0%, “Creative welfare association” 3.6%. Two executive directors (not the CEO) own 60,000 and 70,000 shares. The CEO, Mr. Ryoichi Hayashi, is the elder brother and father of these directors/shareholders. Though he does not own shares directly he controls the 21% of “R & D Enterprise” together with other close relatives. Several other individuals own small stakes. Percentages are based on the total number of shares minus the treasury shares.

Related-party transactions: the CEO got a short-term loan of 6 million JPY and a long-term loan of 58.2 million JPY from the company. The company does not give any information on how much the executive directors earn in their role as employees.

Update 22 February 2021: The dividend adjusted close increased from 401.31 JPY to 405 JPY. In USD the return was 6.59% and the annualized return was 3.34%. The stock is still cheap as a nanocap: among the best 14%.

5. INTER RAO Lietuva: low EV/EBIT

Ticker, Fin Strength	Share Price Analyst target	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
WAR:IRL 9	12.8 PLN -	59.5 EUR 48.6 EUR	3.5 0.2	3.8 4.0	- -
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-09-30	14.0 EUR	31.0 EUR	31.0 EUR	1.9	11.9

March 2019: INTER RAO Lietuva supplies electricity in the Baltic and provides regulating and balancing services to other electricity suppliers. The company supplies electricity mainly in Lithuania (85% of revenue) but the company says it is expanding rapidly to Latvia and Estonia. See also the wikipedia page. Though the company owns a wind park (30 MW, onshore) the company is mainly an intermediary between other electricity producers and end customers. Its electricity is almost entirely bought from operators of power plants.

The company went public in 2012.

A search on the company name and keyword “fraud” did not reveal any relevant links.

According to the cash flow statements in my screener the company paid a dividend in each of the last 10 years. The company has not bought back shares but it has not diluted either.

The company is not in the low EV/EBIT + quality list but I think it belongs there. It is not in the list because computing the 8-year geometric mean of returns on capital and assets require taking a square root. In this case the 8-year geometric mean of return on capital cannot be computed because it requires taking the square root of a negative number. Gross margins are not stable and have decreased much but the 8-year geometric mean of return on assets is very high and the company is a phenomenal cash flow generator as well.

Disclosure is in English. The latest numbers in my screener are from September 30, 2018 but the company has published the annual report over 2018. There are no noteworthy key audit matters. The difference in EV/EBIT and cash flows between the data from my screener (table above, based on 12 months ending on September 30) and the annual report over 2018 is small.

The balance sheet is much leveraged with Tangible Assets/Tangible Book about 4. The current ratio is about 0.9. I do not think the company is financially distressed because of its strong cash flow and because it has much more cash than debts. Typically this kind of businesses collect payments for their products/services in advance so these businesses should be ok with some operating leverage. Though I think the leverage is no big deal right now the company is reducing debts.

Retained earnings are 14.7 million EUR. Therefore Market cap/Retained Earnings = 59.5/14.7 = 4.0. There must have been heavy losses more than 8 years ago since Market cap/Retained Earnings over the last 8 years = 1.25. This inconsistency suggests book value underestimates economic value.

Substantial shareholders: Finnish company Rao Nordic OY 51.0%, Lithuanian company UAB Scaent Baltic 29.0%. Since apparently Russian PLSC Inter RAO owns Rao Nordic we could call this a Russian company as well. One of the members of the supervisory board, Mr. Jonas Garbaravičius, owns 0.57% directly. He purchased many shares in 2018 for prices between 5.5 and 7.5 EUR.

Related-party transactions: in 2017 the company borrowed money from the 2 main shareholders at 1.3%. These loans were paid back on March 31, 2018. The company purchases electricity from PJSC Inter RAO: for 180.4 million EUR in 2018.

Management is mixed Russian and Lithuanian with the leading roles given to Russians, except for the CEO.

In total I think the company paid about 750k to the CEO, CFO and board members. At least that is what you get when you add the parts. The company says the total is only 600k EUR so I may have double counted. Salaries for the directors and executives seem to be modest.

Update 22 February 2021: The stock price increased from 12.55 to 21.20 PLN. In USD the return was 73.83% or 32.90% annualized. The stock is still be cheap and the cash flow statements in: among the best 6% in my low EV/EBIT list but that list is still based on 19.1 PLN per share. Looking a bit deeper I find the stock still cheap based on EV/EBIT, EV/Revenue, P/FCF and dividend yield.

6. Ternium: low EV/EBIT

Ticker, Fin Strength	Share Price 5-year low	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
US:TX 8	29.03 USD 39.19 USD (14x)	5820 USD 8653 USD	4.1 0.76	1.08 0.83	- -
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-12-31	2108 USD	1739 USD	1219 USD	4.8	3.8

March 2019: Ternium (TX) manufactures steel in Mexico, Brazil, Argentine and Colombia. See the wikipedia page for the company, also here in Spanish. See also the annual investor presentation from September 2018 and the transcript of the last earnings call.

The company hopes to benefit from increasing steel consumption in Latin America and the rest of the world. Furthermore the company tries to increase production efficiency in Brasil and to expand its product range with more advanced products in Mexico. It will expand its research with a new lab in Mexico, close to a big car factory. The company tries to put pressure on politicians against unfair steel dumping, among others from China.

A search on the company name and keyword “fraud” revealed relevant links. The chairman and majority shareholder, the Italian/Argentina Mr. Paolo Rocca, was indicted for bribery in November 2018 by the Argentina justice authorities. See also here (in Spanish). They have also requested preventive detention in December 2018. Also there are several issues with unions, among others allegations of violations of workers rights, wage disputes and anti-union practices. See here and here.

Before the financial crisis in 2008/2009 a mine in Venezuela got nationalized. After allegedly paying a lot of money to high ranked individuals working for other governments Ternium got about $1.5 billion USD as compensation plus a 10% stake in the mine. I think Ternium shareholders profited as much from it as Mr. Paolo Rocca. This article states it is unlikely Rocca will end up in prison.

According to the cash flow data in my screener the company paid a dividend during each of the last 9 years. Also in 2019 the directors propose a dividend of 1.2 USD per ADS. The company bought some shares back 8 years ago and did not dilute during the last 10 years.

Multi-year metrics for measuring earnings quality do not suggest much competitive advantages or great capital allocation but are not bad either. It’s overall quality ranking is better than 52% of the stocks in the low EV/EBIT + quality list. This is even better considering the high market cap of almost 6 billion USD.

1 ADS is equivalent to 10 commons. There are 2,004,743,442 common shares including 41,666,666 treasury shares (2.08%). My screener (spreadsheet and table above) and investing.com overestimate the market cap because of the treasury shares.

See the recent annual results announcement over 2018 and the accompanying company presentation. See also the annual report over 2017.

The balance sheet is strong with low leverage and a current ratio of over 2. The company has more short-term borrowings than cash though. But from the cash flow the company should be able to repay its entire debt in less than 2 years. So no financial distress at Ternium.

Retained earnings are 6.86 billion USD. Therefore Market cap/Retained Earnings = (2.00474 -0.04167)*2.903/6.86 = 0.831. Based on retained earnings over the last 8 reporting years the ratio is 2.26.

Substantial shareholders: Techint Holdings 62.02%, Tenaris 11.46%. Both companies are controlled by a company San Faustin. The chairman, Paolo Rocca, and his family control San Faustin via a controlling stake in the Dutch “brievenbusfirma” (letter box firm) Rocca & Partners Stichting Administratiekantoor Aandelen San Faustin. I suppose the shares of the 2 main shareholders are not listed since all remaining shares are with the US depository of ADSs.

Director Martín Berardi owns 76,000 shares and director Rodrigo Piña owns 40,000 shares.

Related-party transactions: the company bought steam from Tenaris for 11.4 million USD. The contract will expire or be terminated in 2018. The company sold for 0.8 million USD of metal building components to Techint. The company bought scrap steel from Tenaris for 26.3 million USD. The company sold for over 300 million USD of steel products to Tenaris in 2017. Steel sales to Tenaris will probably increase much because of an acquisition in September 2017.

The company also bought mainly engineering and labor services for 108 million USD in 2017 from San Faustin.

Ternium sells natural gas and electricity to other companies in which it holds a minority stake. It also gave a loan for capex spending to a 48% owned company.

See also note 25 and 26 or better item 7B of the annual report.

Together the board and managers earned about 23 million USD in 2017.

Update 22 February 2021: The dividend adjusted stock price increased from 24.73 to 30.28 USD. The return in USD was 22.43% and 10.97% annualized. EV/EBIT is now about 15 so the stock is not cheap anymore.

7. Hoshi Iryo-Sanki Co: low EV/EBIT + quality

Ticker, Fin Strength	Share Price 5-year low	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
TYO:7634 7	4030 JPY	13783 JPY 6049 JPY	4.7 0.56	1.13 1.17	- -
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-09-30	1296 JPY	1404 JPY	831 JPY	-	1.0

March 2019: Hoshi Iryo-Sanki Co supplies medical gas (34% of revenue) and sells and rents oxygen generators related equipment for home care (43% of revenue). Other revenue is mainly “construction and maintenance of medical gas piping facility and construction of fire extinguishing facility” and rental and selling equipment for nursing care. Also in terms of Profit/Assets the 2 main business segments are approximately equally profitable. The company also operates a home nursing care business.

These business segments seems to be roughly equally profitable in terms of gross margins except for the home nursing care business which generates a small loss.

The company benefits from a secular tailwind: aging in Japan.

The company can be found in Edinet by searching on Edinet id E03330.

A search on the company name and keyword “fraud” did not reveal any relevant links.

All multi-year metrics for measuring earnings quality are excellent except for gross margin growth.

According to the cash flow statements in my screener the company has paid the current small dividend during the last 10 years. The company spent small amounts on buybacks 6, 9 and 10 years ago and did not dilute during the last 10 years.

There are 3.4200 million shares including 117,100 treasury shares (3.4%). Because of the treasury shares my screener (spreadsheet and table above) overestimates the market cap.

Retained earnings are 11.4 billion JPY. Therefore Market cap/Retained Earnings = 4.03*(3.42 -0.1171)/11.4 = 1.17.

The balance sheet is very strong with hardly any leverage, a big cash pile and no debts.

My estimate for the liquidation value is 10 billion JPY. So the stock trades above liquidation value.

Substantial shareholders: Hoshi Iryo-Sanki Co Business Partners Shareholding Association 14.8%, Fidelity 10.9%, Ms. Earl Co Ltd 11.9%, 4 Hoshi’s own together 18.3%, including the stake of the executive chairman, Hoshi Hoshi, with 5.2% and 2 other directors. They are family members. Yet another director, Makoto Enomoto, owns 1.9%.

Because of block ownership I do not think it is easy to acquire this company.

Related-party transactions: the company bought land from the Hoshi’s for 68.2 million JPY in the year ending on March 31, 2017. There were no related-party transactions in the year ending on March 31, 2018.

As with other Japanese companies the annual report provides very limited and incomplete information on remuneration of key executives.

Update 22 February 2021: In March 2020 I moved this stock to the "Played Out" list. In the mean time the dividend adjusted stock price had decreased from 3913.12 to 3598.13 JPY. In USD the return was -2.23% and the annualized return was -2.24%. The stock is still in my low EV/EBIT list, among the 50% best stocks. So cheap but not cheap enough.

8. The Mission Marketing Group: microcap + momentum + high retained earnings + low EV/EBIT

Ticker, Fin Strength	Share Price Analyst target	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
LON:TMMG 8	0.635 GBP 0.69 GBP (1x)	53.6 GBP 62.2 GBP	7.6 0.4	- 1.7	- -
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-06-30	7.5 GBP	7.9 GBP	6.5 GBP	10.2	2.9

March 2019: The Mission Marketing Group provides marketing services. The company covers the UK, Asia and the US. The company is organized as a collection of specialized agencies. The company owns these little, seemingly independent businesses but also makes sure they work together. When an agency cannot fulfill a recruitment or expertise need it asks for the required skills from the pool of agencies.

For example a client may need an search engine optimization engineer and a media marketing professional. An agency then places the SEO engineer and then asks within the TMMG network for a media marketing professional.

My impression is most if not all agencies have been acquired, hence the large amount of goodwill on the balance sheet and the negative tangible assets.

Strong and reasonably smooth momentum combined with low valuation based on market cap/retained earnings and EV/EBIT predicts high statistical returns. See the stock chart in GBX (pennies):

A search on the company name and keyword “fraud” did not reveal any relevant links.

According to the cash flow statements in my screener the company paid out increasing dividends during the last 5 years. The company did small but significant dilutions recently and 4, 6, 8 and 9 years ago. The company also repurchased shares from time to time but spent much less money on repurchases than it raised via dilutions.

The multi-year metrics do not suggest above average earnings and asset allocation quality.

See the interim report over the first half of 2018 and the annual report over 2017. Key audit matters were revenue recognition and goodwill, See also these video comments on the results over the first half of 2018.

Retained earnings are 31.7 million GBP. Therefore Market cap/Retained Earnings = 53.6/31.7 = 1.69.

Tangible book value is negative but if goodwill is worth book value then leverage is low. On the balance sheet there is 6.1 million GBP of cash but 13.9 million GBP of current bank loans. The current ratio is 0.85.

The company’s priority is to reduce debt. From the cash flow the company should be able to pay off its debt within 2 years. In the video comments the chairman is confident about the near future. Also the company declared an interim dividend of 0.007 GBP. Moreover the company sold a subsidiary for 4.4 million GBP on November 12, 2018, so after the last financial report. The proceeds will be used to reduce debt. I do not see any financial distress at this company.

Substantial shareholders: executive chairman David Morgan 7.3%, deputy chairman Robert Day 6.1%, Herald Investment Trust 6.9%, BGF Investment Management 5.6%, Polar Capital Forager Fund 5.3%, Objectif Investissement Microcaps FCP 5.0%.

On November 14, 2018 executive director Fiona Shepherd sold 270,000 shares for 0.565 GBP. She still owns 1.00 million shares or 1.19%.

The board consists of 11 people. A large board predicts lower returns. In this case managers and possibly also the previous owners of the connected agencies are board members. They own shares as well.

Salaries for the executive directors are modest. The company grants share options but the amounts are limited.

Related-party transactions: the company rents property from the chairman and close family members for 158k GBP per year. The company also rents property from the deputy chairman for 215k GBP per year and purchases solar electricity from him “at a discounted commercial rate” for 18.5k GBP in 2017. Directors received loans to pay the tax on their options for a total of 81.9k GBP in 2017. The company also pays rent to 4 individuals including 2 other directors: in total 74k GBP per year. I suppose these different lease contracts were inherited from the time all these agencies were still independent.

Update 22 February 2021: For momentum stocks short holding periods, a year or less, are best. So this stock was meant to be held until 11 March 2020. In that year the stock price increased from 0.615 to 0.751 GBP. In USD the return was about 19.75%.

Note the ticker changed from TNMG to TMG between 27 and 30 September 2019. The company name also changed, to The Mission Group. This is not a momentum stock anymore. The stock is not cheap anymore based on EV/EBIT but still cheap based on EV/Revenue and P/FCF, but not very cheap. So not a great stock for a quant portfolio.

9. Mobile Internet China Holdings: falling knife, low EV/EBIT, close to 5-year low

Ticker, Fin Strength	Share Price 5-year low	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
HKG:1439 7	0.192 HKD 0.161 HKD	226 CNY 48.4 CNY	0.41 0.05	0.53 1.0	1.27 0.99
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2018-06-30	119 CNY	64.5 CNY	56.0 CNY	4.0	-

March 2019: Mobile Internet China Holdings operates along 2 business segments: developing mobile games and a packaging business manufacturing printed cartons. The company is looking to diversify into other businesses (bad sign).

The online gaming business is structured as a VIE subsidiary. The subsidiary is controlled by Mr. Huang Jianqiang.

The company was formerly known as China Packaging Holdings Development (until 2017) and China Environmental Packaging New Energy (until 2013).

A search on the present and former company name and keyword “fraud” did not reveal any relevant links. David Webb does not report anything worrisome on the company either. Furthermore insiders do not overlap with any shady Chinese companies (according to David Webb).

The stock crashed on June 19, 2018. Then a memorandum of understanding for acquiring a company providing medical data services lapsed. Furthermore the company recently issued a grim profit warning, for both business segments.

According to the cash flow statements in my screener the company did not pay any dividends during the last 10 years. The company diluted twice: in 2014 and during the 12 months ending on June 30, 2018, hence the unfavorable total yield in the spreadsheet. Each time the company raised roughly 10% of book value and an even higher percentage of net tangible assets.

I think the recent dilutions were caused by exercising share options and converting convertible bonds. There are still some convertible bonds left but because of exercise prices much above the current price (0.75 and 0.85 HKD) these bonds are not dilutive.

See the interim report over the first half of 2018 and the annual report over 2017. Key audit matters were goodwill and revenue recognition of the online gaming business.

During the first half of 2018 38% of the revenue came from mobile games, increased from a year ago. In the gaming business segment almost all revenue comes from self-developed games.

Retained earnings are 227 million CNY. Therefore market cap/Retained Earnings = 226/227 = 0.996.

The balance sheet is strong with Tangible Assets/Tangible Book slightly above 2. The company has plenty of debts and other liabilities. At 475 CNY the cash is equal to all liabilities. Part of the debt has a high interest rate of 8.5% and the few remaining convertible bonds have even higher interest rates. So the combination of the big cash pile and the debt does not make sense. The company paid back some of these debts though.

The book value of the current assets is 768 million CNY including 138 million CNY of not so valuable assets like inventory and prepayments. The book value of the liabilities is 475 million CNY. Therefore my estimate of liquidation value = 768 -475 -0.5*138 = 224. Therefore Liquidation Value/Market cap = 224/226 = 0.99.

Substantial shareholders: Ms. Zheng Xue Xia 30.16%, Mr. Peng Dongmiao 25.62%. Ms. Zheng Xue Xia is the wife of Mr. Sun Shao Hua, who is a founder and one of the executive directors. He is not the executive chairman.

Looking at his function description I suppose Mr. Sun Shao Hua is the highest manager though the executive chairman is someone else and the annual report mentions there is no separate CEO. The executive chairman is responsible for the packaging business while Mr. Sun Shao Hua is responsible for the group as a whole. Another executive director, Ms. Zheng Li Fang is responsible for the mobile gaming business. Also because she earns much more than the executive chairman I suppose she is related to Ms. Zheng Xue Xia. I could not find any confirmation of family relations in the annual report.

The compensation packages for Ms. Zheng Li Fang and Mr. Sun Shao Hua are the equivalent of about 460k USD and 580k USD. In reporting the company does not distinguish between basic salary and performance related pay.

Related-party transactions: In 2015 the company paid Mr. Peng Dongmiao for his online gaming company Cable King Group by assuming a loan with him as beneficiary and by paying the rest in cash and shares. The interest on this loan of 160 million CNY is a related-party transaction. At that time the share price was also much higher.

There were 40 million options outstanding with exercise price 0.65 HKD and 40 million options with exercise price 1.09 HKD. In 2018 these options expired.

Update 22 February 2021: The company suffered from huge losses. As a result book value is now negative. The losses were financed with current debt. I think the company is financially distressed. The stock price decreased from 0.195 to 0.081 HKD. In USD the return was -57.94% and the annualized return was -35.95%. The stock is not cheap anymore.

10. Pharma-Bio Serv: US listed low EV/EBIT + quality, nanocap

Ticker, Fin Strength	Share Price Analyst target	Market cap EV, in millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
US:PBSV 9	1.1 USD -	25.3 USD 9.3 USD	8.5 0.52	1.25 1.32	- -
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2010-10-31	1.1 USD	4.4 USD	4.3 USD	5.9	-

March 2019: Pharma-Bio Serv (OTCQB:PBSV) provides “compliance and technology transfer services” to “pharmaceutical, chemical, biotechnology, medical devices, cosmetic and food industries” mostly in Puerto Rico, the United States, Europe and Brazil. Headquarters are in Puerto Rico.

When producing medicines manufacturers should follow all kinds of procedures. Manufacturers should produce using a “validated process”. Creating and describing such a process is the work of a validation consultant. In other words, the consultant does the paperwork such that manufacturing processes comply with certain standards of regulators. Such validation services can be provided by consultants of Pharma-Bio Serv.

A search on the company name and keyword “fraud” did not reveal any relevant links.

Multi-year metrics suggest strong durable competitive advantages and/or good asset allocation. In particular gross margin increased a little bit over the last 8 years, 8-year geometric returns on capital and assets are high and the company has been an excellent free cash flow generator during the last 8 years.

Though the company is listed at the OTCQB, so an unofficial exchange, the company still reports with the SEC. The company may also be obscure because I could not find it in investing.com and my screener does not display interim financials.

According to the cash flow statements in my screener the company paid its first dividend in 10 years in last reporting year (ending on October 31, 2018). The dividend was 0.075 USD per share. During the last 10 years the company did a tiny dilution 6 years ago followed by also tiny buy backs.

See the annual report for the year ending on October 31, 2018.

There are about 23.0 million shares. There are also 1 million warrants with exercise price 1.8 USD expiring on December 1, 2019. Furthermore there are 160k options with average exercise price of 1.48 USD that are about to expire. Finally there are 330k options with about 2.5 years remaining before expiration with an average exercise price of 0.82 USD.

Retained earnings are 19.1 million USD. Therefore Market cap/Retained Earnings = 25.3/19.2 = 1.32.

The balance sheet is very strong with hardly any leverage, a big cash pile and no debts.

Substantial shareholders: non-executive chairman and founder Elizabeth Plaza 17.8% (39.8% voting through voting proxy), director Mr. Dov Perlysky 8.8% (many shares are owned via his wife who is a family fund manager and these votes go to Ms. Plaza), Mr. David Selengut 13.6% (votes go to Ms. Plaza), Ramon Luis Dominguez Thomas 8.9%, Addison McKinley Levi III 8.9%.

Related-party transactions: the company leases the laboratory from Elizabeth Plaza for 30.3k USD per month. Since the company sold the laboratory business for 5 million USD I suppose this continuing transaction has ended. Her sister works as a contractor for the company earning between 90 and 125 USD per hour. In 2017 and 2018 the totals for this contracting work were 181k and 183k USD.

The CEO and CFO earned both 249k USD in 2018, including everything. The difference was the bonus: 75k USD for the CFO and zero for the CEO. They routinely exercise their options, maybe to cover the tax, even far before the expiration date. They do not seem to sell more shares than needed to get shares without investing their own capital.

The chairman, Elizabeth Plaza, earned 681.5k USD including 245k USD related to performance. Given the size of the company I consider her package excessive.

Update 22 February 2021: See also my remarks at the beginning of this article. About a year after publishing the newsletter I move the stock to the Played Out list. That was too early because I had overlooked lower trading liquidity. When I moved the stock to the Played Out list the stock price had decreased from 0.89 to 0.80 USD. So the return was about -9.8%.

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