IPE Group
IPE is a Hong Kong listed company engaged in the manufacture of high-precision metal components used in automotive parts, hydraulic equipment, hard disk drives, and electronics. Its customers are top-tier multi-national companies in information technology, fluid power, automotive, and electronic sectors where optimal precision is vital.
Its major sales by country are split as follows: China (44% of sales),
Europe (20%), US (19%), Malaysia (12%)
The business is highly capital intensive and has high operating
leverage. Such a cost structure reduces profits substantially during downturns.
The company has been hit by Covid-19 with mandated disruptions in its production
and shutdowns of its customers operations. Prior to that, it was hit by US tariffs
on its products.
The business generated peak sales and ebitda in 2017 of $940m and $281m
respectively – falling to $747m and $130m in the last twelve months. High depreciation
charges reduced the net profits to $27m (ttm). Net profits averaged $77m in the
last five years.
The financial position is very strong with a high net cash balance (net
of borrowings) of $623m. Net working capital (net of all obligations) was $957m,
and the net tangible assets were $1.66b.
The equity was selling for $747m or 78% of net working capital and
45% of net tangible assets. Net of cash, the operating business trades at about
2x average earnings; Including cash, the company trades at about 10x average earnings.
Management have paid out about half of net profits as dividends, but
this isn’t commensurate with the substantial cash balance – yielding just over
3%.
Management have, however, awarded themselves 54m share options this year
at an exercise price of $0.90/share (current price: $0.71/share). This is in
addition to 40m options awarded in 2017 at an exercise price of $2.02/share.
The justifications provided in the proxy statement make for embarrassing
reading.
With such substantial cash balances, why couldn’t this be paid as “incentive”
instead of diluting shareholders? If the ultimate motivation is to reward
shareholders, why can’t the cash be used to repurchase shares at the apparently
sub-normal price?
The options constitute <10% of issued shares, and the shares are
selling below the debt that could be safely issued against the company. The
current average earnings yield of about 10% is sufficient to warrant purchase
of the shares. This may not be the most attractive bargain on the block, but it
meets our quantitative investment criteria.
TTM: Trailing twelve months
$ represents Hong Kong $