Friday, March 4, 2011

My views on China Eratat

Recently, I noticed quite a bit of interest in this S-Chip counter called China Eratat. Upon doing some really basic research (note: just basic one), I came upon the conclusion that it isn't worth a punt. While it may eventually turn out to be a multi-bagger, I wouldn't place my bets on it.

I posted some of these in http://www.sgforums.com/forums/2092/topics/423944. I rather not share this over at CNA forum because I know, once people gets extremely bullish about a stock, some would snare, insult, or exhibit some form of mentally incapacitated animalistic behaviour. Might as well share it at places where people are more willing to take note or share with. As CW88 puts it, analysts like to give bullish views because that is what most people like to hear.

My initial views
China Eratat is a sportswear company operating in China. To me, China Textile companies aren't a good fundamental buy at all.

1) Low barrier to entry.
2) Highly competitive.
3) Traditionally low margins. It would be very suspicious if the margins are high.

And the weird thing is, why the need for placements for $13.45m cash on Jan 2011 when the company has $30+m cash in its balance as of end Dec 2010?
==> This is suspicious.

And if the cash is needed for growth, why bother to give dividends of total $2+m? Giving dividends not only deplete cash (if needed), but also incurs extra unnecessary expenses.
==> Suspicious too.

Views from a forumer
Regarding Placement:

Have a look at this. http://www.nextinsight.net/index.php/story-archive-mainmenu-60/912-2011/3549-eratat-97-surge-in-latest-quarterly-net-profit-and-why-it-wants-to-place-out-shares

CFO Ken Ho was specifically asked during the briefing how the placement would affect expansion plans - the simple answer is that with the placement would allow them to grow even faster, but that even if the placement does not through, their expansion plans including the launching of the new Eratat Premium Product Line will continue to go through.

They feel that the placement with CMIA will also add credibility and raise the profile of the company, as CMIA is a well-recognized fund known for long-term investments in China's growth, in particular its rapidly growing consumer market, as China transforms from a manufacturing-export dominated economy into one that is consumption--focused.

With all the blanket-stereotypically negative sentiment towards and distrust of Chinese companies going on in the Singapore market, the establishment of a major fund such as CMIA as a major shareholder, which according to Ken Ho spent 2 months doing its due diligence on Eratat's balance sheets prior to the attempted placement, also serves to increase investor confidence in the reliability of its numbers.

Despite doubling profit over the last 2 quarters on a year-on-year basis, Eratat has actually decreased its dividend payout ratio, presumably because it wishes to retain more cash for expansion. However, to eliminate the periodical dividend payouts altogether would be rather drastic and may induce negative investor sentiment over its cash position, since it has a policy of regular dividend-payouts, as long as this constitutes only a small percentage of its cash position, as is the case with this 2 million, I wouldn't be too worried and am in fact pleased as an investor that they are sharing profits with us.

My comments add on

Btw, all CEOs have to make their plans sound nice. If CMIA wants a share of Eratat, they can jolly well buy direct from SGX market. The two points remain that why the need for a placement of 13m when they have 36m cash and can still give out 2m worth of dividends.

One more thing, big funds entering doesn't mean they are right. Tradewinds Global Investor entered China Hongxing in Jan2011, and Hongxing is now suspended for accounting irregularities. Hongxing has been giving dividends too. Think about it.

Additional Views from the forumer
No one is denying that it's still an s-chip, I like certain s-chips like Eratat because they are sorely undervalued due to the blanket judgements done by most local investors on Chinese companies listed here as unreliable, they fear these companies, I like to purchase when people fear, especially irrationally - because it cannot be the case that all of the few hundred Chinese companies listed in Singapore are lying about their balance sheets, that is statistically extremely unlikely. It also helps that Eratat is rated second by the Business Times among all Chinese companies in terms of corporate transperency. Yes I'm not saying that you can be 100% sure about anything, but then again there are risks with every investment.

CMIA can buy from the open market, but we're talking about 65 million lots here. Eratat's daily volume is barely a few million. If they were to buy from the open market, it may well cause Eratat's share price to skyrocket before they can complete the bulk of their purchase - hence the desire to negotiate for a placement. Also, they're going to become a major shareholder that participates in management, their experience and networks in the Chinese market may well also open doors for Eratat. Coupled with the fact that their addition raises the profile and credibility of the company, CMIA may well feel that they also have a feel bargaining chips to bring to the table. Eratat has shown so far that it is able to turn its excess cash into profits and I therefore see no reason not to be confident that the increased cashed position from the placement can be translated into increased profitability.

2 million is much smaller than 13 million. The 13 million will serve only to bolster its expansion plans but as CFO Ken Ho has said, is not critical to its expansion plans, which is why they would not simply settle for any deal.

As for why they are still giving out divdends, as already explained in my previous point, to eliminate dividends altogether decreases investors' confidence - they have compromised and are in fact paying less dividends, both on a prorated absolute basis and in terms of payout ratio compared to last year, despite doubling net profit over the last 2 quarters, retaining a higher proportion of cash to facilitate expansion plans.

My comments add on
To me, not eliminating dividends so as not to decrease investors confidence isn't a good reason at all. A growth company that is well managed should never distribute its dividends if it has much better use for the money.

Next, companies seeking for growth and are confident about it will give shareholders a better deal by growing via debts instead of growing on net cash. Getting a huge placement with no concrete plans other than to increase the cash level will severely dilute existing shareholders. Any EPS or any dividends to be received will be severely diluted in the future as well, unless profits can grow just as fast.

Disregarding the above and the fact of being S-chip, the first 3 points I raised in the first post are sufficient to make me not touch this for a long term play. A world famous investor mentioned in his most recent shareholders letter that it was his mistake to have moved into the textile industry. I guess you should know who he is.

It's your money. You decide.

Reply by isaac

one more point to add on:

look at eratat’s cash balance: RMB 159,319,000

Interest earned on that amount: RMB 154,000

Interest rate: 0.01%.  [Pointed by comments below, it's actually 0.1% for 3 months]

I believe PRC’s interest rate is 1.5% thereabouts.

Further views from the forumer

A growth company should never distribute dividends? Can we categorically say that it is statistically proven that growth companies that pay dividends, even if only amounting to a tiny fraction of their cash position grow less than growth companies that pay absolutely no dividends at all? I highly doubt that any statistical analysis would show this, and even in the unlikely scenario that it does, it also does not imply that every growth company that pays dividends would tend not to grow. Common sense would tell you that with a bit of research, it would not be difficult to find a growth company in any market out there that has had a policy of paying dividends throughout the years but still managed significant growth through the years, especially if the dividends amount only to a small fraction of net profits, hardly detrimental to the growth plans of any company.

Conceivably, not paying dividends at all, especially in the case of s-chips given the unfortunately negative perception that every Chinese company listed in Singapore is tarnished by at the moment due to a few bad eggs would actually signifcantly decrease the stock price of the company, because it could be the case that local investors perceive dividend payouts by Chinese companies to be a validation of its profits and cash position. Whether this is the case is difficult to verify but this is conceivably how the management perceives the situation to be and that therefore not paying dividends would actually result in negative perceptions due to factors out of its control, and that therefore eliminating dividends would not be in the interest of its shareholders.

Furthermore, with working capital amounting to the region of 480 million RMB, it does not seem that paying dividends amounting to 10 million RMB would signficantly affect expansion plans, the benefits of protecting investor sentiment quite possibly outweigh the the opportunity cost of not using that 10 million RMB for growth. It's hardly as if it's 65 million RMB, if it was paying 65 million RMB in dividends and then getting a placement amounting to that I would certainly be concerned - but that is hardly the case at all.

It is also surely an oversimplifcation to say that every company in the textile industry will fail. The growth stories of the likes of the many famous apparel/fashion accessories companies around the world tell the story - Nike, Kappa, Esprit, Polo or even Chinese equivalents like Li Ning, Anta and 361 Degrees tell the story - compare their prices from as far back as 8 years ago to what they are now - we're talking about multi-multi-baggers here. I'm not saying Eratat will definitely be another one of them but I'm optimistic and bullish based on what I've seen so far - not only is it a potentially great growth story, it is also potentially highly undervalued at a forward PE of between 3 to 4 due to the blanket negative sentiment that s-chips are currently suffering from, resulting them in many of them being in prices and valuations that you would only normally only see during a recession for other companies.

As for [isaac] and your point about loans, please read up on the loan situation in China, it is not as simple as you think, and I would trust that the CFO of a listed Chinese company would understand the situation better than someone like you who has probably never applied for a loan in China before.


I think I've made my points clear and will make no further comments for now, to each his own.

My add on here on the loans in the forum post yet:
Why would one believe blindly in a CFO without question? He might know better, but still, 0.01% interest is still weird. Even a basic savings account here gives at least 0.1% interest. 0.01% is 10 times lesser!!

A quick look at the Bank of China for local context shows an interest of 0.475% for SGD100k and above.
Compare with 0.01% again???

Comparing with SGD is fair because Eratat is listed in Singapore, and IPO and placement funds are in SGD. 

Admittedly, I didn't check up the books to see if it was really 0.01%, but isaac is a personal friend.

Thanks to Joshua's comments,  the interest rate is 0.04% instead of 0.01% as the interest is for 3 months. However, I do think that 0.04% is still too low. 

UPDATED: The effective interest rate is 0.4%, so it does look more normal now. Sorry for the calculation error. My bad for not verifying it completely.

My comments add on
To me, dividends of 2m out of 36m cash (5.5% of cash pile) is hardly a tiny fraction of the cash; utlised properly, it could be used grow even faster. While it is true that s-chips are suffering from negativities, the question remains on whether the cash is indeed there. Dividends are not the way to judge if the cash pile is valid. Anyone who used that as the meter for judging and had bought into CHX would have been in for a rude shock.

I fail to see how any of my posts meant every company in the textile industry will fail. I mentioned that the textile industry is one of highly competitive and low barriers to entry. There's no point comparing with just the established brands as you have. We have a moderately new entrant CHX in the same industry as Eratat, and CHX advertising in the NBA, yet what happens?

The growth story could be nice, your reasons extremely valid, but the uncertainty is not about the growth or your reasons. The uncertainty and risks lie in the integrity of the reported statements. Again, with the established brands like Nike as you mentioned, the uncertainty of the integrity of their reports is much lesser.

It is already tough enough to judge and take the risks of whether a business will take off; what's the point of taking on additional risks of the integrity? Unless I personally make a trip to China, see their shops and sales, etc, I find it hard to put my money on a company that I have little idea how their products are like, and how their customers feel about their products compared to others.

Upon further research of the mentioned investor CMIA and its credibility, I digged out some additional information on it:
Additional Information about CMIA and its track record:

CMIA invested in FerroChina, which is now suspended


Admittedly, they invested in ChinaMinZhong as well, although they have been selling while the price has been continuously rising. ==> Hardly a long term investor.

From the website:

CMIA Capital Partners ("CMIA") is a private equity firm focused on investment opportunities in China and Southeast Asia. To date, CMIA has led over US$600 million in private equity investments. CMIA is primarily focused on Growth Capital opportunities, and has also financed Greenfield, Buyouts and Privatizations selectively. Established in 2003 and headquartered in Singapore, CMIA also operates out of offices in Shanghai and Hong Kong.

US$600m is hardly a big enough fund with muscle power.

But now, there are lawsuits against CMIA for negligence:
"Directors of Fund II are suing Mr Lee and CMIA in Singapore for alleged breach of fiduciary duties. CMIA and Mr Lee are counter-suing the directors for defamation and breach of investment management agreement, among other things."

In conclusion, the following paragraph does not hold:
They feel that the placement with CMIA will also add credibility and raise the profile of the company, as CMIA is a well-recognized fund known for long-term investments in China's growth, in particular its rapidly growing consumer market, as China transforms from a manufacturing-export dominated economy into one that is consumption--focused.
To me, CMIA does not add credibility at all. It was only established in 2003, hardly long enough to be considered a long-term investor nor sufficiently well-recognized.

Remember that if funds lose money, it is their clients and investors that lose, and not the managers themselves.


  1. first of all, there is an error in your calculation of the interest rate because 154k is for 3 mths of interest and not full year. so it is incorrect for you to calculate it like that which demonstrate your inability to read the financial report correctly.

    secondly, the cash balance in the balance sheet is as at 31 December 2010 and does not mean that the company has that full amount of cash for the whole 12 mths period and this is why the interest rate is much lower than what u have expected.

    thirdly, the company has to raise funds because their business are growing and they are granting higher and longer trade credits to their clients. overall the AR is increasing, but they do not have any bad debts and most of the AR is receive within 6mths which is still very much inline with the change in season.

    lastly, regarding giving of dividend, i believe that shareholders should be rewarded for the year and giving a small dividend is always better than not giving any if u understand the bird in the hand theory. of coz there is always a trade off between growth and dividend but i believe that having a good balance between both is better than just focusing on growth.

  2. Hi Joshua,

    thanks for your views. First of all, I have mentioned I didn't look at the report for the interest amount, which demonstrate your inability to read with a detailed eye. On the other hand, I truly appreciate that you have pointed out my mistake, which demonstrates your ability to read with a critical mind. :) I, however, do believe that my ability to read financial is extremely low and usually incorrect. Hence, I won't contradict the last sentence of your first paragraph. I did take a look after you mentioned, and yup, 154k is for 3 quarters. Still, 0.04% still sounds low.

    You have an extremely valid point for your 2nd paragraph. It is an extremely good explanation. They might have took out some 60% of the cash, and leave 40% in the savings acount to earn a 0.1% annual interest for that 3 months, resulting in that 0.01% over 3 months???

    For your third paragraph, I do not deny that what you mentioned was what the numbers have shown. As I have mentioned, the question remains at the integrity of the reported statements.
    As for the AR, CIMB does have a report that the trade receivables have been increasing (granting longer trade credits as you said), which is something that needs to be monitored. While Eratat did give an explanation for that, again, to me, the integrity of it is still questionable.

    I do agree that a giving a small dividend is always better than nothing. But giving a dividend on the back of needing to put a placement at a discount when there's already 36m cash on the table? My words aren't good in explaining, but I've a nagging feeling that this isn't anything good.

    Again, I might be totally wrong, extremely incorrect in my analysis.

  3. Joshua,

    regarding the interest rate thing, 154k for 3/12 is my error. the "inability to read the financial report" is solely mine. I apologise.

    However, even if you times 154k by 4, the interest rate is still at 0.04%.

    Even if 90% of that money was not in the bank, it still gives an interest earned of 0.4%.

    Regarding your point on raising funds. If Eratat is swimming in liquidity, why bother spending administrative costs, diluting shareholder value to add S$13million? Why not use the S$30 million rotting in the bank?


  4. Hi JW,

    Once I saw the word "S-Chip" and "China", I stopped reading.


    Just kidding, I still read the whole post just to gain some knowledge.

    Thanks for the review! ^^

    Dividends Warrior

  5. a pig with lipstick is still a pig. don't fall in love with a pig with lipstick. substitute pig with s-chip and you get my point.

    In my opinion, dividends are a good signal that the cash is there. if you want to be more accurate, you should use the dividend payout ratio. For FY10 DPR was 20 percent. A growth company like OSIM gave 28 percent last year.

    The question becomes, why propose placement at a steep discount and then declare dividends? One theory goes, if you area major shareholder (but not controlling stake), won't you want to declare a dividend and take the money first? After which, the company issues more shares causing dilution, which is supposedly bad.

    Let's be skeptical here to understand the mechanics. Assume company pays out 10m of dividends from 50m earnings, 20% DPR. If a shareholder owns 30% shares, that is 3m cash. Rest of the money goes to CAPEX, retire debt or becomes retained earnings. The latter adds to shareholders' equity and cash pile (i'm not too sure about this).

    What if the cash is not there but kept in secret accounts? Maybe to buy a house or something? The real cash is much lower, and less liquid, and it is not possible to fund expansion as if there was a stash of cash sitting there. Hence the placement.

    The discount is very unnerving. Maybe CMIA knows something we do not. Maybe a 30% discount gives the fund a margin-of-safety. This also translate to a 0.55 price-to-book for the deal. Would you cheap sell your company unless you are hard up for cash? Don't fall in love with a stock.

  6. Traditional finance says that companies should always reinvest all their earnings if their ROE > required return on equity. Intuitively, this is as the company as a cash flow generating entity is able to compound the money more effectively than the investor.

    I assume that this is the thinking that you are alluding to in your post. It is a very valid point and is along the "proper" lines of finance theory.

    But do consider the situation in Singapore, especially in view that they are an S-chip. If Eratat had stopped dividends, what would the market say? Conversely, excessive dividend yield would of course, sap funds away from their growth.

    I think they kind of chose the middle line after weighing the cost/benefits of their dividend policy.

  7. Hi DW,

    There are definitely some gems around undiscovered, but I do think this isn't one. Just my opinions :)

    Hi SgStockPicker,

    the share price is at their original proposed placement price. If CMIA is really very interested, they could swoop in slowly everyday and scoop at 0.21, cheaper than the 0.2135 proposed. Perhaps that is what's happening now.

    The question still remains if they really do need the cash? And why a discount? There have been examples of placements at a premium. Appears that Eratat does not have the financial muscle and reputation to push that through?

  8. Hi Anonymous (5th March 2011),

    yes, you are right. If Eratat continued to give dividends without placements, that would probably not trigger me to look through. Sure, they could give dividends and still grow.

    But giving dividends and placements after that? Poor financial management? Or were the dividends to falsely allay investors' fear that the money isn't there?

    And if a company needs to choose a middle line just to ensure credibility with the shareholders, it isn't really one that is worth investing.

    And if I do turn out to be wrong 10 years from now, it's no problem. Better to put money in a company that is well proven and tested at a higher price, than into one that is relatively unknown, its integrity questionable due to being an S-chip, and needing to placate shareholders with dividends to ensure the cash is indeed there, at a lower price.

  9. JW,

    i would not bet on 10 years. some one might be holding on to physical certificates when that time comes.

  10. Hi SgStockPicker,

    I meant if I'm wrong and Eratat actually did turn out well, it's never too late :)

    I will not touch it right now; rather go with the more defensive Singtel.

  11. Eratat’s cash balance: RMB 159,319,000

    Interest earned for that quarter: RMB 154,000

    Interest rate: 0.01%.

    Is the interest rate calculated correctly?

  12. Hi Anonymous,

    you are right. The interest is 0.1%, not 0.01%. Now it does look more normal.

    I will get it changed again. Thanks for pointing out.


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