Following the past two years of market uncertainty, Inverness continues to hold the view that markets are incredibly inefficient. In this environment, if homework is neglected, inferior results will result. We find it valuable to invest in our US circle of competence, and within that, find the center of the bull’s eye to be evaluation of the geographic exposure and reporting of a company. Don’t venture too far outside the light of the fire, as it were, lest you encounter the beast in the night. One does need to venture out to keep the tribe fed however…
Highway Holdings (HIHO) is a lesson in building out that circle of competence. Inverness found the Company in a high-level screen based on price to book value and dividend yield. At first blush, it was a pass: as the company is shown in Barchart (our stock screener of choice), it is Hong Kong-based. This is usually a non-starter: from a risk control perspective, Inverness likes its assets to be close to home and familiar to analyze. This is intended to limit analytical mistakes. But the 0.97x price to book value ratio was too tantalizing to pass up.
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crossorigin="anonymous"></script>Picking through its website and 20-F (international filing annual report), one finds HIHO incorporated in the British Virgin Islands in 1990[1]. The company began as a metal stamping business, and utilized that stability and BVI shelter to begin a spree of capital markets activity from 1992-2006, including purchasing Nissin Precision Metal Manufacturing Limited (metal stamping); listing as HIHO on the NASDAQ in 1996; onboarding Roland Kohl, current Chairman and CEO, in 1997; purchasing Kienzle Uhrenfabriken GMBH (German watchmaker) out of bankruptcy; and acquiring Golden Bright Plastic Manufacturing Company Limited, a Hong-Kong based plastic injection molding and mold making operation, in 2006. Its strategy included transferring all metal stamping, clock manufacturing, and molding operations to China.
Primary risk characteristics include reporting (given the ex-US nature of the stock) and geopolitical:
- Deloitte & Touche audited the company from 2011-19, and Centurion ZD has been the auditor since 2020. Financial statements are assembled according to US GAAP and are reported in USD. The Company is traded on the NASDAQ. This reporting history gives our analysis some familiar measurement of the Company’s financial characteristics. HIHO reported a material weakness in securing its cash balance in Myanmar in 2021, but it does report it holds deposits at various banking institutions.
- Myanmar as a country has about 55 million people. It traded hands between the empires of Britain and Japan before its independence in the 1960s. It then saw decades of civil war, before civilian elections were established in 2010 and the country began improving its human rights record in 2015. Unfortunately 2021 saw a military coup, driving the country into a state of uncertainty, and is ranked 147 of 189 countries by the UN in its human development index.
Today, the company employs approximately 200 people. It manufactures and sells metal, plastic, and electronic parts and components through its five subsidiaries in the Hong Kong Special Administrative Region; Shenzhen (comprising Long Hua), China; and Yangon, Myanmar. The Group’s manufacturing activities are principally conducted in Shenzhen of China and Yangon of Myanmar, while its selling activities are out of Hong Kong. It maintains five primary customers, accounting for 90% of revenue. While the company may have a history in watches and cameras, management has seen fit to expand its horizons to limit its concentration risk, with precision manufacturing for video game consoles and electric motors as its latest attempts to diversify the business. This innovation and growth will be good, but results have yet to be seen.
Financially, the past three years have been tumultuous to say the least. Revenue has fallen from approximately $20mm in 2018 to $9.2mm in 2021, and EBITDA in turn from $2.3mm (12% margin) to roughly break even over the past three years, averaging an EBITDA margin of -1.3% and total cash flow of -$59k. The company began seeing deterioration in its revenue in 2019, as one of its customers reduced its order size by 30% due to decreased demand from its Chinese customers, citing inflation. Additionally, according to management, the costs of operating in China have increased significantly owing to increased inspections and government intrusion in operations. Management has shifted strategically to cope, with design and administrative operations conducted out of China and more labor-intensive work completed in Myanmar. Finally, 2021 saw shutdowns for multiple weeks due to COVID 19 and a military coup in Myanmar. The factory did not operate for at least two weeks in each instance, with employees abandoning their posts for fear of safety and government shutdowns.
Fortunately for investors, HIHO has built and tested a fortress balance sheet. Its cash balance of $7.8mm as of 3/31/2021, approximately 40% of total capitalization, is compared against operating leases of $2-3mm and capital expenditures less than $100k annually. HIHO has no debt. On a liquidation value basis, the company has approximately $0.99 per share, or 44% of total shares, as residual value of saleable assets, and only lost 7% of that value in 2021. These characteristics were immensely important to operations in 2021, as its high-quality liquidity has allowed HIHO to weather production shutdowns.
It may not be love-at-first-sight, but we nevertheless have valuable insight into HIHO’s operations thanks to the BVI incorporation, NASDAQ listing, and US GAAP financial reporting. Management gives us insights into the Myanmar military coup, the business practices and people in the East Asia markets, how the company made strategic moves to maximize profit, and what management is doing to create profitable solutions for customers. And for the Cundill or Buffett investors, the fortress balance sheet demonstrates the importance of cash-on-hand for a business.
If you like a manufacturing asset with Hong Kong and Myanmar business exposure, US reporting, and an 8% dividend trading for cheap, this is the one for you. If you don’t like exposure to the Myanmar military and impacts of geopolitical proxy wars, well . . . happy hunting!
Disclosure: Inverness has no financial interest in HIHO. This article has been peer-reviewed.
[1] At the time of writing, the reason for BVI incorporation is a mystery, but Inverness has seen reports that company predecessors date as far back as 1930 under German watchmaking auspices.