Thursday, September 19, 2013

Zuoan Fashion Ltd (ZA): A No-Brainer For Big Returns

Just took a long position in Zuoan Fashion, Ltd. (NYSE: ZA), opportunities like this come few and far between. Not far from its IPO back 2011, Zuoan Fashion is a design-driven fashion menswear company in China that has taken a beating for no apparent reason.

The No-Brainer Aspect

The reason to me this is a no-brainer investment is because while the company is currently priced at $2.17/share, a quick look at their balance sheet in 2012 shows they have $5.96/share in net cash alone (cash minus debt). Furthermore, if we take all the current assets and pay off all outstanding debt, we're left with $11.79/share. What this means is that if the company liquidated everything tomorrow, that's how much shareholders would receive per share, which makes this a textbook Buffet/Graham/Klarman value play with a 82% margin of safety. Wow...

And the story gets better. The company has no long-term debt and no short interest whatsoever. Below is my analysis of the fundamentals versus the stock price over a 5-year period:

Zuoan Fashion Quality of Earnings Vs. Stock Price (2008-2013)
(click to enlarge)

So what we have is a company who's fundamentals are clearly growing stronger over time while the stock price is diverging to reflect the opposite. No financial shenanigans here either, their financial reports were signed off by Crowe Horwathe, one of the top 10 auditing firms in the United States. Zuoan is essentially like a straight-A student in a bad high school, the top institutions are overlooking her just because she's small and didn't go to Harvard Academy. Their loss...

Not only has their fundamentals improved, but their ability to self fund with cash is getting stronger too (defensive), which means they can weather any storm that may lie ahead because their industry is so competitive.

Industry Recognition

So what about the company? Well, the fashion industry is highly fragmented. While the company has no defensible competitive advantage against competition and its success is dependent upon its ability to recognize and create appealing fashion styles in the years to come, the company has received the #1 spot of fashion designers in China by Apparel Magazine two years in a row now, beating out major competitors such as True Religion, Ralph Lauren, Nike, Urban Outfitters, & lululemon, two times over. From the July 2013 issue of Apparel:

(click to enlarge)

And as apparel magazine mentions, they sponsor and are regularly featured on the Chinese equivalent of Project Runway, "Hello Gorgeous." What better marketing avenue could a fashion company ask for? As China's middle class grows, Zuoan's affordable fashion line stands to benefit which makes this not only a value opportunity, but a growth one as well.


Baseline valuation is $9.08/share (assuming a 50% write-off of Accounts Receivable in a liquidation event), but if the trend continues I may hold on until $12-14, making this one a potential 6 or 7-bagger. Estimated time to value realization, 2 years, maybe even sooner.

Tuesday, September 17, 2013

A Great Value Play: Lihua International, Inc. (LIWA)

Just took a position in Lihua International (NASDAQ: LIWA) and I usually like to do some sort of writeup so I can remember in the future why I took particular positions. Lihua International is a Chinese reverse-merger company that is in the copper wiring/electrical arena. They're currently trading at about $5.07 per share ($158M market capitalization).

Asset Valuation

First thing that jumped out to me about this company is that while the market is valuing them at $158M, they have $144M in cash equivalents alone in the bank. Ignoring the $854M in revenue in 2012, this at first glance seemed to be a complete misvaluation by the market because if you divided up the cash alone, each share outstanding would receive about $4.80. In fact if you look back to 2011, if all assets were liquidated and debt paid off, net current assets per share alone are worth $11.69, and that was over two years ago:

Lihua's Net Current Asset Value/Share (2011)
(click to enlarge)

Attractive Margins

Another thing worth noting is Lihua's supply chain management. Unlike its competitors, Lihua isn't making its wiring from virgin copper, but instead scrap copper. The benefit of this is that its margins are not compressed like it's competition's because its costs are not as high, so its management of scrap copper suppliers has given it a competitive advantage:

Chinese Copper Suppliers
(click to enlarge)

Product Mix

Besides it's supply chain management, Lihua also has the benefit of focusing on one of its core product innovations, copper-clad aluminum wiring (CCA). Their high-quality pure copper wiring alternative is priced much cheaper than pure copper wiring (almost 1/3) which provides significant cost advantages in larger projects from the lower commodity price of aluminum.

Copper-Clad Aluminum (CCA) Wiring Structure

Why is this important? Because the PRC government just approved $240B to be invested in the development of China's Smart Grid infrastructure over the next five years so all of its citizens are able to receive affordable power. Along with this comes miles and miles of necessary wiring and cable running, and what better use of CCA wiring/cables than for large projects over thousands of miles. Why is Lihua set up best to benefit from this? Because they currently are the only company that has the proper license in place to import scrap copper to China from places like the United States, which makes them the only company currently able to even approach filling such large orders. Besides CCA wiring, its product mix does still include pure copper wiring, in addition to copper anodes, rods, and magnetic wiring.

In addition to China's investment in its infrastructure, China is the number one consumer and importer of copper:

Copper Demand By Region
(click to enlarge)

The trend is in no way slowing down either, current predictions are that given the trend, China's consumption and utilization of copper could soon exceed world supply, which means scrap copper suppliers are going to become vital, and Lihua is already in position to benefit from this. As far as copper commodity fluctuations go, even though copper pricing is expected to remain stable with the growing demand, Lihua's products are all priced on a cost-plus basis, which means any movement of commodity prices would not erode its profit margins.


So why does this price of $5.07/share seem too good to be true? Well, its China, which means shady business practices, and its a Chinese reverse-merger, which means potentially even shadier accounting practices. However, due to the fate of its fellow reverse-merger companies such as China MediaExpress Holdings (CCME), all Chinese reverse-mergers are being painted with the same brush by institutional investors.

In 2011, Absaroka Capital, who had taken a short position on Lihua, released a study it commissioned on Lihua trashing the company's practices and accounting methods. Among things claimed in the study included doubt regarding Lihua's financial statements, its executives' backgrounds, supplier relations, and its auditor's track record. In response to this allegations, Lihua's CFO directly addressed all claims (seen here) made by Absaroka, which in my opinion rendered them moot. In addition to that, Lihua has made strides over the past year to be as transparent as possible to the market regarding its accounting methods, even going so far as to having forensic accounting firms such as John Lees Associates do a full investigative confirmation of its cash balances. Besides this, its auditor is Crowe Horwath. While technically using Crowe Horwath's Hong Kong division, Crowe Horwath has a reputation here as one of the top ten auditing firms in the US.

Also, since these allegations were made two years ago in 2011, I'd presume Absaroka has already left its short position by now after the stock tumbled 22% from its study. In other words, they made their money, and now with Lihua's transparency of accounting practices, there's little more to gain for Absaroka or any other institution with a short interest.


Taking a long position in LIWA, committed half my capital allocated to this position for now in case of a dip in the price, this will allow me to average down a bit for a bigger return later. My estimated fair value of the stock is about $15, with a hedge of at least $11.69 from a net asset valuation. Expected time for value manifestation is about 2-3 years, with a option for future review of fundamentals at the $12/share mark.