Year of the Dragon – HK stock picking

We are quickly approaching the year of the dragon, a special year for Chinese people. In the past birth rates would go up as its extra lucky to be born during a dragon year. Given how extreme the Hong Kong market underperformed the rest of the world in the past 3 years, I just have to talk about the opportunities it presents. In this post I will present 8 stock pitches of what I believe are excellent companies selling at rock bottom valuations – take your pick!

There are probably a number of investors that are, contrarian in nature and know that opportunities like these is when you are supposed to pounce, but haven’t spent enough time on HK listed stocks. This is your introductory guide to do further work in the pockets of the market that speak to you. Let’s dive straight into it.

Risks with investing in Hong Kong

The Hong Kong stock market is broad with many different types of companies, depending on what risks one wants to avoid one can look at different pockets of the market. One should clearly stay very skeptical before investing in Hong Kong but there is also a limit to how cheap something can be. In my view at these valuations it makes sense to have some HK risk in your portfolio. One can dream up very bad tail events, for example given what happened with investments in Russia. But even with such a negative scenarios I believe in some HK listed stocks you won’t be more hurt than investing in for example Apple. Be skeptical but not paranoid is my view on this. This categorization I myself use to understand what risks am I exposing myself to with a HK investment.

First categorization – Who owns it

Chinese state owned enterprises (SOE)

The main benefit of these companies would be that you are aligned with the CCP. These companies enjoy preferential treatment by the banks and the government. They can for example get deals other companies do not have access to. Quite often the valuations are very low and the stocks are more a dividend play than a play on revenue growth and some type of payout far far in the future. It’s almost like a long duration corporate bond position betting on that China won’t withdraw fully from the world financial markets.

Chinese family owned

This is a very common category among HK listed companies, you find that many companies are lead by one family and nobody else will ever make the decisions on how the company is run. Investing with the family then to a large degree becomes about looking at that families track record and how have they in the past rewarded minority shareholders? Obviously you here also run geopolitical risks if you are based outside of China.

Non-Chinese family owned

That a non-Chinese family would decide to list their company on the HK exchange is much more rare, but there are still quite a few examples and some of them are very interesting. This category is also what potentially could be closest to babies that have been thrown out with the bearish bath water. As even if worst case scenarios happened, since the family owner is not Chinese, the company would most likely just re-list elsewhere (if it’s not feasible to be listed in HK anymore). Probably a painful process depending on what has happened in the world but at least not impossible.

No majority owner

This is also a decently common category, quite often there is still some family involved but for whatever reason they did not manage to maintain total control over the company. There are of course companies with just funds etc as largest owners, but this is not nearly as common as it is in the western developed markets, at least not among better run companies.

Second categorization – Where do they sell

Companies mainly selling into China and/or Hong Kong

Many HK listed stocks is a Chinese business, selling products mainly in China. With these companies one has to have both some understanding of the market, but also some belief in that the Chinese economy won’t totally crash. This is hard for many investors to get a grip on, me included although I lived in Hong Kong for over 10 years.

Companies selling globally

This category is much more comfortable to many, me included. Here the products can perhaps even be found in your home market and you can perhaps even have an edge over Asian investors if you can inspect the products at your local Home depot, Walmart or whatever the product may be selling.

Third categorization – Dividend Payout / Buybacks

This is tackling the risk from another perspective. Something can stay cheap for a long time, but if you get paid a high dividend to wait, it is much less painful to wait for the revaluation.

Here I will divide it into three categories. Companies with:

  • Low dividends and/or buybacks (0-3%)
  • Medium dividends and/or buybacks (3-6%)
  • High dividends and/or buybacks. (6-10%+)

Drawing the line what is investable

So some people will draw the line and say I don’t invest in SOEs. Others actually go the other way around as say, well at SOEs I at least will get my dividend, they won’t go bust no matter what. Others won’t trust Chinese family owned companies in fear of never seeing any of the cash flow generated making it back to their pocket. In the same way some people feel comfortable over the whole spectrum of where the sales happen in China or outside. The good thing is that no matter how skeptical you are, there are still some pockets that should not seem un-investable to you. With all that out of the way, let’s look at companies in these different categories, how cheap they now are. Press Read more to see all specific stock ideas..

I will start with what I see as the lowest risk category and work my way downwards with brief stock pitches on each:

Non-Chinese family business + Global sales

L’occitane (973 HK)

This is a top cosmetics luxury group with three large brands, L’Occitane en Provence, ELEMIS and Sol de Janeiro. Majority owned by Austrian Reinold Geiger who nowadays resides in Switzerland. Dividend in the low category 1%.

Investment pitch: Undemanding valuation (Forward looking P/E 15 and PEG ratio under 1) for a company with quality assets where especially the Sol de Janeiro brand is growing at an incredible pace. The main L’occitane brand had great growth up until 2015. With that cash flow the company tried to diversify by acquiring up-and-coming brands. A number of acquisitions was made over the years, many of them unfortunately with limited success. Brands like Melvita, Erborian never managed to scale and have to this day rather deteriorated the bottom line. Sales plateaued for the main brand and the stock drifted downwards for years. Even worse than that, the company sat with a fairly large net cash position, further deteriorating shareholder returns. The companies transformation started with the purchase of ELEMIS in 2019 for US$900m and later Sol de Janiero in 2021 for US$450m (83% stake). This brought in growing quality companies with added to the bottom line and at the same time a more reasonable capital structure with a small net debt position. So now with three strong brands, where especially Sol de Janeiro has been growing into a top popular brand recently. This is easily confirmed by looking at google trends data and other sources, just look at that YoY growth of Sol de Janeiro below:

Euroeyes (1846 HK)

In 1993 Dr. Jørn S. Jørgensen founded the Hamburg Eye Laser Center, one of the first LASIK clinics in Germany. Over the years the company has grown and opened more centers and also specialized in the new Evo ICL technology as an alternative to Laser. Today they have 15 centers in Germany, 5 clinics in Denmark, 8 centers in China and one in Hong Kong. The company is still majority owned by Jørn. Dividend in the low category 2.5%.

Stock pitch: High quality business with strong track record of growth (double in 6 years). The stock is now -50% since it’s IPO 2019 with revenue up 50% and Op Income doubled. The business is neither run by Chinese and does not have a overly heavy reliance on China (although the strategy has been to grow in China).  With a small net cash position which will most likely be deployed for growth this 150m USD MCAP with Forward P/E 10 has a long runway to grow if they play their cards right (largest Chinese competitor Aier is 18bn USD MCAP fwd P/E 30). See my post on how myopia is growing, that is the background to why this company is working in a market with a huge tailwind: Myopia. 

Chinese family business + Global sales

Modern Dental Group (3600 HK)

Well covered by me in the past, see these two posts: Previous posts on MDG. The company is a low cost producer of different types of teeth replacements, mainly crowns and dentures. Dividend + Buyback in the middle category, roughly 5%.

Investment pitch: Solid track record of growth with 14% Revenue CAGR over the past 10 years with undemanding forward P/E of 9x and EV/EBITDA 5x. But the main reason to invested is not the revenue growth, but rather that margins have been depressed and are now returning to pre-ipo levels. This is driven by the digitalization of the dentist office, where the impression for the tooth replacement is made with a digital camera instead of a mold. The picture below shows the percentage of cases that are received in China through digital channels and how the Net Income margin also increases.

A fairly free call option at the moment is their inroad into the clear aligner segment with the product Trio Clear. Modern Dental Group paid away a lot of it’s cashflow and high margins from buying it’s own distribution network over the past 10 years. The benefit of this is of course a stronger market position but also the possibility to in its own channels push a product like their Trio Clear aligner. A market where the market leaders MCAP is 45x Modern Dental’s.

Health and Happiness (1112 HK)

Another under the radar global player in nutrition for both humans and pets. H&H’s background is as a seller of baby milk formula under the name Biostime. This business is shrinking but in its stead some acquisitions made in the past have started to shine instead (story somewhat similar to L’Occitane although owners in this case are Chinese). The acquired businesses doing well are Swisse (nutrition supplements), Zesty Paws (pet supplements) and Solid gold (pet food). Dividend yield in the high category at 8%.

Investment pitch: Although 70% of global sales is still in Mainland China, the global sales is significantly outgrowing the Chinese at 26% vs 7%. I’m especially impressed with how Zesty Paws seems to be winning the USA market (available at Costco, Walmart etc) and also ranking high on google trends, reviews etc. The company has spent 10.5bn HKD to purchase Swisse and Zesty Paws and the companies EV is 15bn HKD. Allegedly H&H overpaid especially for Swisse but the stock looks very compelling here with quickly growing businesses (baby formula is declining and masking some of the growth). Some hesitation comes from previous insider dealings by majority owners, so quality of management is a question mark. The 8% dividend helps to easy some of the worries. The company also has issued bonds which can be looked at for reference if anything really bad would be happening.

Chinese family business – Chinese Sales

JNBY (3306 HK)

JNBY (Just Naturally Be Yourself) is a niche fashion brand focusing mainly on China, although even if its niche there are so few big Chinese domestic fashion brands that it’s one of the very largest (and oldest). This is still only a 670m USD MCAP company. Founded in 1994 by Li Lin and later supported by her husband Wu Jian. The journey started with 2 stores in 1996, company listed in 2016 and has now expanded to 2000 stores. The company belongs in the high dividend category with a 9.5% yield.

Investment pitch: Just like many other luxury companies this one seems immune to Covid restriction, recession, the fundamentals speaks for themselves that this is a well liked brand among their fans.

A brand like this also plays into the geopolitical situation where more patriotic winds are blowing, a certain portion of Chinese I’m sure are looking for a more Chinese fashion identity, JNBY is one of few established options to go for. Although the company has almost a 10% dividend yield only around half of the cash generated is paid out in dividends. This is a growing cash machine which is priced like it is a dying business at P/E of 7x and EV/EBITDA of 3.7x. ROE and similar metrics are also excellent at stable levels above 30% historically. Just because this is a Chinese company selling to Chinese, an excellent business is priced like its the plague. I think this is the clearest example of how low the valuations have become. This could double and still be cheap.

No majority owner – Chinese Sales

Vitasoy (345 HK)

Vitasoy was founded by Dr. Lo Kwee-seong in 1940 in Hong Kong with door-to-door delivery of soy milk, selected as a product because many Chinese people are lactose intolerant. Today the brand sells many types of soya based products and other beverages products like lemon tea, water etc. The brand is really one of few real Hong Kong brands and was unfortunately in that regard also negatively linked in the protest movement when a staff endorsed the stabbing of a police officer. The company was of course not behind this but a single staff managed to damage the reputation built over 80 years with one press release. The company is still trying to recover from this incident. This used to also be a Fundsmith holding and seen as one of few Hong Kong listed compounders. Dividend yield is only 0.5% and puts it in the low category.

Investment pitch: Just looking at today’s fundamentals won’t do it with these stock, as you can see the Operating Income has been pulverized when the revenue started declining. This is a slightly more complex investment in the sense that one has to know the brand and have faith in that those 80 years of building the brand among Chinese will long term matter. My base case is that the company will be able to stop the bleeding within the next few years, return to growth and stabilize margins. My target is that the company will return to 2016 profitability levels, generating some 530m HKD of Net Income, that would mean that Vitasoy was trading at a forward P/E of roughly 13x. This is probably more of a 2025 story than 2024 though. The stock in 2016 (after a pretty strong China stock market crash) was at the time a 14-15 HKD stock, it’s now 6 HKD. So if they pull that off, there is plenty off upside. This is in some senses one of the highest quality stocks but also the scariest one as there is little to hold on to in terms of profits or dividends.

Chinese State Owned Enterprise

As a general note for these two stock pitches, the problem with SOEs is of course that the companies are not mainly run for international investors, the cash the company generates could end up in projects which see no return but this would still be fully aligned with the countries agenda. Still I think these two companies are exceptional businesses that are still avoided by most.

China National Offshore Oil Corp CNOOC (883 HK)

Asian oil & gas, focused on upstream operations. Has a monopoly on oil exploration under production sharing contracts. High dividend yield category at 8%.

Investment pitch: Put in the ticker in Bloomberg and the terminal will tell you the stock is under sanctions, meaning some investors are not able to access the stock. Which could partly explain the low valuation. Obviously the stock will be dependent on oil price, but the production costs are among the lowest globally. Rather the upside is capped by the Chinese gov taking a larger percentage over a certain oil price. Lately there have been rumors that Chinese SOEs will introduce a share price metrics to the statesmen that run these companies. That would further solidify the high payout ratio, I recently saw Goldman predicting the dividend for 2024 to again be in the 10% yield range. Upside is perhaps not massive from here but 8-10% dividend with a 10% tax on the dividend is not bad.

TravelSky Technology (696 HK)

An almost monopoly provider of information technology services to the Chinese air travel and tourism industries. Their systems are similar to the European Amadeus system and for flights in China and in and out of China their system is always involved. Low dividend category 1%.

Investment pitch: Previous owner of this company was Fundsmith and Polen Capital. What has surprised most Chinese investors have been how unwilling the Chinese have been to travel across the border to other countries. Early after Covid restrictions were lifted it was explained through delays in issuing passports or VISAs. I think there is some small part of the explanation still related to that but generally it’s just that preferences changed during Covid as well as the economic recession the Chinese population are experiencing. Well this is not much of a pitch so far but the idea is that this high quality company has been sold down way too far and Chinese travelers will return with time. Perhaps not to their peak levels but even some recovery would easily defend Travelsky’s current valuation.  The company also has a major net cash position (half of current MCAP), which further de-risks the case.


7 thoughts to “Year of the Dragon – HK stock picking”

  1. Great post, thank you for sharing!
    A question on Vitasoy – do you attribute the entire decline in revenue to brand impact from the aftermath of the HK police incident? This incident aside, how well has management executed on the business in recent years?

    1. No definitely not all of the decline is due to this. I actually expected a stronger rebound by now and was very disappointed with the latest financials released, seems the management is still trying to figure this out. Like I wrote, this is the trickiest case of the bunch..

  2. Great post!

    Samsonite may be worth a look too. It’s a global company (no dividend currently) listed in HK. Its sales has recovered from Covid and may benefit further if travel trend persist. Its operating expenses are probably leaner, compared to pre-Covid.

  3. Are you still in Essex Bio-tec? Its crazy cheap now, especially since earnings are forecasted to increase (not sure though how credible this is).

    1. Yes its crazy cheap, but capital allocation has been bad and I think its too complicated case for most people

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