Allan International Holdings

Current Price: 3.74 HKD
Current Book Value: 757M HKD
Current Market Cap: 1,250M HKD
Exchange Rate: 7.77 HKD to 1 USD (fixed)

Allan International Holdings is a holding company based in Hong Kong that specializes in constructing household electrical appliances. It drew my eye with its low P/E (6.35), relatively high yield (6.15%), and rock-solid financial position.

AIH has virtually no debt and a cash balance of 332M HKD as of the interim report (Sep 2010). The company also has a recent record of positive free cash flow, so it has been able to fund its growth internally without needing to go to the capital markets. Both are good signs about the company’s ability to withstand another severe downturn, as is its strong performance during the last crisis.

Management has a significant stake in the company (44%) and seems to avoid any equity dilution. The family’s been running it for decades and it feels unlikely that they would suddenly put that at risk to grab a quick profit. Given the size of their stake and the length of their involvement it’s fair to say that their interests are aligned with outside shareholders.

So, why’s it so cheap? I see a few issues that might be putting off investors. There’s a lot of exposure to Europe, currency and commodity movements are squeezing margins, and receivables are way up as of the interim report.

I think that exposure to Europe is the least of AIH’s problems. Sales in Europe accounted for about 50% of FY2010 sales volume, so it is definitely the primary geographic region, but sales there held reasonably steady even during the financial crisis. Sales are invoiced in dollars, so the weak dollar ought to help sales, and national debt crises probably won’t prevent European consumers from replacing their blenders. It’s probably a short-term concern at most.

Margins will probably be a bigger issue. Gross margin is currently at a five-year high (possibly longer since I only went back five years) but is already creeping down towards the historical average. I’m not going to try to predict the direction/magnitude of commodity price changes over the next year or two, but to be on the safe side it would make sense to assume that gross margin would be at or below the level of 2008 (lowest of the past five years). Applying that assumption to TTM earnings basically cuts them in half and results in an adjusted P/E of 13.4.

The real issue comes from the growth of receivables. Receivables were way up at the interim mark and let to the company burning a lot of cash. A look at previous interim reports shows that mid-year receivable growth is something of a pattern for AIH, but this year’s growth was larger than in previous years and significantly outpaced revenue growth.

AIH has very substantial customer concentration (another issue I’m not thrilled about), which makes the receivables issue more serious. Their largest customer accounts for 49% of sales and the top five collectively provide 92% of sales. Since the biggest three customers account for 80% of receivables on average, I’d wait to see the receivables balance decline a bit before jumping in. AIH doesn’t seem to have had any problems with bad receivables during the recession and despite the pile-up receivables also don’t seem to be aging – only a small fraction more are more than 90 days old – but a problem with any of their major customers would result in a a substantial write-down as well as a major decline in future revenue. With that in mind I’ll take a lesson from SKX and steer clear of even potential working capital issues.

Their fiscal year ended March 31, so the annual report ought to be due out soon. That ought to clarify where the receivables issue stands. There is also a growing percentage of finished goods in the inventory. Inventory growth didn’t exceed revenue growth, but I’d like to see that play out a little more as well. Overall it seems like an interesting opportunity and the annual report ought to give a good sense of how serious these issues actually are.

Financial statements and vertical/horizontal comparisons:

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