Recently Hanergy Thin Film Power Group Ltd (HKG:0566) has been on the news for all the wrong reasons.

 So What’s All The Fuss About?

This may be oversimplifying things but to cut the story short, the share price of Hanergy went on a tear with a 5+ fold increase (Yep you got that right, five fold since September of 2014 from HKD1+ to HKD7+ in less than a year) and just halved in a matter of days!

Anytime a HK$300 billion market capitalization company loses half of its value, you can be sure that the spotlight will be on it!

 

A Short Background On Hanergy

Hanergy is China multinational renewable energy (Solar, wing and hydropower generation) founded in 1994 by Li Hejun. Fun fact: In Feb 2015, Li Hejun was named by the Hurun Report as the richest man in China!

 

Is There More Than Meets The Eye?

Even though we cannot rewrite history, it certainly pays for us to have an eye on our rear view mirror as the saying goes “History doesn’t repeat itself, however it does rhyme”.

 

1. Sharp Gain In Share Price In A Short Period

Anytime a stock increases wildly in a short period of time (Especially in a matter of months – Remember the painful example of Blumont Group Ltd), it would be prudent for us not to be carried away by this ‘hype’ and focus on the fundamentals.

As mentioned in Barron’s Asia:

Hanergy Thin Film Power is a marginal player in China’s solar panel industry with around 800 employees and 2014 revenues of HKD3.27 billion (or roughly US$420 billion). So it’s unsurprising that investors and regulators alike are baffled that such a small company could see its market value balloon to an incredible HKD378 billion in mere weeks and become one of the most rabidly-traded stocks on the Hong Kong Exchange.

Consider the evidence: Shares have nearly quadrupled since mid-November, and are up nearly 480% in six months. Its astronomical valuation means it’s now worth more than all 10 of its biggest solar-power peers combined, making its chairman one of China’s richest men.

To put things into perspective, prior to the drop in share price, Hanergy was priced at over 100x P/E of FY2014 Earnings! Even after the drop, Hanergy was priced at close to 50x P/E!

Some might say that companies with both a good story (Beijing’s clean energy push) and technological breakthroughs justify a premium. However, it still pays for us to be aware of the fundamentals and this was definitely not new news with articles from both Barrons’ Asia and The Wall Street Journal both highlighting this phenomenon early in 2015 way before the crash.

 

2. To-Good-To-Be-True Margins

At first glance, Hanergy seems to be performing very well with:

FY2014 Gross Margin: 57%

FY2014 Profit Before Tax Margin: 47%

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FY2014 Profit Margin (Shareholders): 34%

On a pound for pound basis, I think that we could say that these are exceptional numbers. However once we go to the cash flow statement, we can clearly see that the net operating cash flow is nowhere near the profit attributed to shareholders = most of the gains are non-cash.

FY2014 Net cash flows from operating activities is just HKD316 million, a far cry from FY2014’s total Net Profit of HKD3.3 billion!

Another curious point would be that their competitor First solar achieved GPM and Net margins of only 23% and 9% respectively.

But how is this so? Why is Net Profit 10x higher? How is Hanergy outperforming their peers by so much in such a super competitive industry?

I am glad you asked. To understand this, I would like to highlight my next point…

 

3. Curious Relationship With Parent Company 

Related party transactions are itself not a bad thing if disclosed and exercised appropriately.They could actually be beneficial to all stakeholders if carried out appropriately. There are companies in Asia that operate successfully with their parent company and vice-versa. But the same cannot be said if controls and safeguards are not set in place.

With over 60% of Hanergy’s FY2014 revenue being derived from its parent, it pays for us to take this into consideration. Interestingly, another 35% of FY2014 revenue was derived from an unknown customer (Some say that this is also related to the parent but I am unable to confirm this at the moment).

So how does this link to the difference between the net profit and cash flow figures?

FY2014’s Trade Receivables and Gross Amount due from contract customers totaled HKD 9.3 billion. And guess what FY2014 Revenue was HKD 9.6 billion. Coincidence?

This might indicate a loose cash collection policy in place, meaning an issue of cash collection from their customers. And no prizes as to guessing who that major customer might be.

 

4. Transparency Concerns

The securities regulator in Hong Kong – The Securities and Futures Commission said on Thursday that it is conducting an investigation into Hanergy, just ONE day after the company’s chairman dismissed reports of such a probe as “purely rumors”.

I think that the above statement pretty much summarizes everything you might need to know about transparency issues.

5. Things That CEOs Do

In general, I would think that paying attention to the movement of the CEO’s shareholdings is a decent gauge of the situation. And Hanergy’s CEO Li Hejun increased the size of his short position in the company’s shares just days before the crash, essentially betting that the value of the manufacturer he founded would fall. With an increase of his short position of Hanergy’s shares to 7.71% of Hanergy’s issued share capital on 18 May 2015 just two days prior to 20 May 2015.

And here’s the kicker, Reuters reported that just days before shares in solar power group Hanergy  halved in Hong Kong, its Beijing-based parent offered and sold stock in Hanergy to employees, even as the unit was being investigated by the local securities regulator.

Coincidence again?

 

Value In Asia

At the end of the day, we here at VIA subscribe to the that fundamentals do matter. Even with a good story, we always have to see that the numbers look reasonable to us.

For now, before the verdict is out on Hanergy, we cannot make a definitive statement on them. However, with the number of issues raised, we are certain that there are other investment opportunities out there that we can be more comfortable with!

 

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All views and opinions articulated in the article were expressed in Mun Hong’s personal capacity and do not in any way represent those of his employer and other related entities. Mun Hong does not own any shares in the companies mentioned above.

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