It is an easy to understand business with fortress balance sheet and high cash generation capacity. Haier Electronics (OTCPK:HRELF) is a homegrown brand success from China that has successfully migrated to premium consumer durable products. The privatization proposal from the parent could help bridge the gap for valuing cash.
I am positive on the company, considering its leadership position in the washing machine segment, and the growth potential of the water purifier and water heater markets. I see the potential privatization, announced in December 2019 by its parent, Haier Smart Home (600690) as a near-term catalyst with a 20%-30% upside potential for acquisition premium.
Stock doubled in last 4 years; even if privatization fails the same performance is not out of reach on fundamental basis alone.
Haier Electronics Group (Haier) consists of the following divisions:
- Washing Machines – leading washing machine brand in China.
- Water Heaters – leading water heater brand in China.
- Integrated Channel Services – leading provider of distribution, logistics and after-sale services to the home appliances and electronics market in China.
Source: Company Presentation
Haier is one of the two leaders in China’s washing machine segment with market share of approximately 37% over the past decade. In particular, its high-end brand, Casarte, had a market share of 77% in the high-end washing machine segment (units with retail prices above RMB10,000) in terms of retail volume in 1Q-3Q19, according to China Market Monitor. Its pricing power underpinned by its premiumization strategy will drive top line growth with modest volume increase over the next few years.
Haier Electronics has stepped up to become a leading second-tier player in the water heater and water purifier segments over the past few years, and it has made substantial share gains from prominent foreign brands. I expect the rising replacement demand, increasing possession rate and continuous ASP hikes amid an expanding market would support the two business segments.
News of privatization could further boost share price. I expect Haier SmartHome may pay an attractive premium (20% -30%) to acquire Haier Electronics to help alleviate its current cash flow pressures. Privatization should increase Haier Smart Home’s net profit attributable to the parent company, as it gains control of Haier Electronics’ quality assets, despite slight dilution of Haier Smart Home’s EPS. However, I believe the investment thesis on Haier is a compelling one on its own even without the privatization.
Haier’s competitive advantage is its scale efficiency and its pricing power. The company also benefits from its entrenched market position in oligopolistic stable sector. Haier is the leader in premium segment and #2/3 in the rest of its segments.
Haier demonstrate that it could grow ahead of the industry, which allows the company to gain market share even during weak period of growth.
Source: Company Presentation; China Market Monitor
Haier’s strengthening industry position supports ASP hikes as Haier enjoys strong pricing power in the mid-end washing machine market. In Water heaters division, Haier has stepped up to become a second-tier player in the gas water heater segment. As for electric water heaters, the company ranked second with a market share of 22.6% by volume share. I see no disruption to the premiumization trend as Haier’s ASPs continue to increase. I believe management’s strategy to not participate in price wars is clear, even though its peers have been aggressively tapping into cost savings for promotions, particularly for online channel.
Source: Bloomberg; *consensus forecast
Haier steadily increased its profit margin and generated strong cash flow driven by stringent cost controls, scale efficiencies and steady premiumization of product portfolio. Above results demonstrate that the company could grow modestly even in recessionary environment.
Key Takeaways from Conference Call:
Impact from the COVID-19 outbreak: The management stated that all of its sales channels had been heavily hit by the outbreak of COVID-19 in 1Q2020. However, Haier continued to gain market in China during the period. The management expects market recovery in the rest of year. Currently, operations have almost been resumed to normal but sales are still below 50% of normal level.
The industry has been changed by the pandemic: The operating environment has been resuming but offline traffic is still scarce. Demand for online sales is accelerating and live streaming business is growing rapidly. The company also launched its own mobile app and provides solutions through live streaming. In addition, the company unified the management of warehousing and distribution systems to alleviate inventory pressure and improve competitiveness of its franchisees. The company adopts strategies to increase operating efficiency inside the company and improve customers’ experience through both online and offline channels.
Expect intensified competition: The management expects intensified price competition in April as many enterprises try to lower their inventory level and gain market share. However, Haier does not intend to compete with a lower price but will adjust its products structure and launch more value for money products to maintain their market share and gross margin.
Update on privatization: The management mentioned that they have not received a formal offer from parent and they are still waiting for the details. The company will set up an independent committee to evaluate the potential valuation offered.
Haier is trading at a reasonable multiple of 12x (forward P/E). However, if I count its cash then the valuation (8.2x ex cash P/E) looks very cheap compare to the market multiple of 14.x (P/E). Privatization is under consideration by the parent.
Haier Electronic demonstrated a long history of sector leading profitability, control on working capital, and costs that has helped grow even through industry slowdowns, driven by astute management team.
The company is trading at a reasonable valuation given the company’s very long runway of growth available in China with share of exports only 4% of revenue and expanding competitive advantages (brand and scale).
I believe the company would deliver a dependable 2x return in 3-4 years (18%-24% IRR) with a near term catalyst of privatization which could deliver 20%+ return over the short-term if the transaction goes ahead.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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