Fountain Set (Holdings) Limited

Fountain Set (‘Group’) is majority owned by Cofco corporation, a Chinese state-controlled entity, and listed in Hong Kong. It is engaged in the manufacture of fabrics for apparel retailers and brands.

It sells dyed fabrics and yarns (88% of sales) and garments (12%). Its sales are generated primarily in China, Sri Lanka, Hong Kong, Korea, and Taiwan – all profitable geographical segments. It has eight production facilities in China, Sri Lanka, and Indonesia.

Covid-19 has significantly impacted production and sales of retail apparel. Sales volumes were down 33% and cotton prices were down 16% over the last year – resulting in losses in the first half of 2020.

The group’s performance track record has been satisfactory generating average revenues of $6-7b and ebitda of $350-400m. Working capital management appears to be excellent and the earnings are fully backed by operating cash flows.

Capital expenditures, as expected for this industry, is fairly high, and deducting recent depreciation (annualized) of $200m results in pre-tax earnings of $200m or $150m after tax.

The financial position is very strong with net cash of $529m. The net current asset value is $1.5b, and net tangible asset value (including fair value of investment properties) is $3.4b. 

Customer credit terms range between 30 and 60 days but there were receivables of $250m older than 60 days due to severe operating difficulties caused by the pandemic. (Management recorded a $12m impairment loss in receivables.) However, this seems to be a temporary difficulty, and doesn’t affect our conclusions below.

The equity is selling at $1.2b, which is under net current asset value (even after deducting aged receivables), and 35% of net tangible asset value. It trades at 8x normal earnings or 4.5x earnings net of cash.

A major plus with this group is the shareholder-oriented management reflected in its outstanding dividend payouts. The group has paid out $125m+ (net of share issuance) to shareholders in the last two years yielding over 10%. Management paid this even when performance was temporarily affected by the pandemic. We commend such generous dividend payouts of normal earning power. Too often, managements are quick to scrap an already stingy dividend policy when facing temporary headwinds.

This seems to us a bargain priced stock with the bonus of a generous dividend payout.