Hexza a Definite Undervalued Stock

If you don’t see us posting many research reports these days it’s because most stocks in our target had liftoff such as TOPGLOV, MIKROMB or JOHOTIN. We look at HEXZA this time around and we felt that this stock is undervalued.

Industry

A niche market formaldehyde producer or likely the only large size listed producer of formaldehyde in Malaysia. For HEXZA, formaldehyde is used to produce adhesive resin meant for the use of furniture manufacturing which is a complement to the furniture industry. There are around 10 furniture companies listed in Bursa which meant that the market for adhesive resin is much bigger than the supply itself.

Formaldehyde had always been associated to high toxicity towards human and animals, evidently the use of formaldehyde had declined with building materials not adopting formaldehyde as the base material. Formaldehyde was part of the base used for roofing materials.

HEXZA is moving towards ethylene based manufacturing with its newly acquired such as the production of ethanol. This segment is gaining momentum and thanks to lower raw material prices, it couldn’t be a better time to have ethylene based manufacturing since we believe that oil will stay low for quite a while before it peaks once again.

Outlook Ahead

The company stated that it plans to acquire more businesses related to their core manufacturing segment and no doubt that they could go on a shopping spree with so much cash in hand. Although the company has zero bank borrowings, we felt that the management style of this company is less aggressive towards debt financing making it less likely to take up huge loans to finance a new acquisition.

In last year’s annual report, it stated that they are moving towards automation which is also a key factor in lowering cost in the future. Rising labor cost factors such as foreign worker levy and higher minimum wage increases labor prices directly affecting production cost. That is why, it is the right decision for the company to slowly move and invest in automation for the future. Expect to see stronger margins in the upcoming quarters.

With oil prices down again, raw material prices used as manufacturing feed would decline in tandem as well. Another good reason that this company could be reporting higher margins in the near future.

Financials

One thing that we really like with this company is how rich its financials are. The latest quarterly report showed RM 72 million in cash and equivalents with zero borrowings. This meant that if you are paying RM 1.12 per share, RM 0.3584 of it is worth cash.

Uniquely, a huge portion of HEXZA’s assets are classified as ‘Other Investments’ which represents investment in shares by the company. Again, this could be considered liquidity for the company which if it would to liquidate all its shares. The final number comes in at around RM 140 million worth of cash which is double the cash and equivalents amount.

This again pushes up the cash per share to 63% which is really high!

Other Investments are quoted at RM 71 million in 31 December 2016. We all know that the markets gone on a crazy rally since the first day of trading for 2017. This again proves that the quoted number should be even higher than the RM 71 million listed in the balance sheet.

Performance wise, its YTD performance for HEXZA had achieved 20% and we can assume that the market had already factored the rally into the stock price but the amount of cash per share is higher than the 63% that we’ve calculated earlier.

The Idea

This time around, we are not looking at growth as we used to because most growth stock had already rallied with the market. HEXZA on the other hand comes with deep value in which the true value has yet to be priced in at RM 1.12

In a bull market like what it is now, growth stock had started to rally and it is not wise to chase high flying ones because one minor correction in KLCI would have the ability to wipe-out all the gains that were made if one is overvalued.

It’s stocks like HEXZA that’s filled with value suggest that it worth to put money in. If it doesn’t move, were only miss the bull run. If it drops, we continue to hold knowing that there’s value. During times like this, additional money available could be allocated to stock like this hoping for a revaluation by the market when the quarterly report comes out. In fact, HEXZA is likely to report its Q3 2017 report this week or so…

We recommend buying if you believe in value and doubt that we see a huge rise in capital gains in the near future except when the market goes on revaluation.

Technical Analysis

According to Fibonacci levels, it suggested that RM1.08 is a major support. We determine RM1.05 as the cut loss point for the near term before we revisit this stock again after it has stabilized. We usually set lower tolerance towards stock that just got a big jump from last quarter’s results.