Carpenter Tan Holdings: 6.1% Dividend Yield, 6.3x EV/EBITDA by Sui Chuan Yeo, ValueEdge

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Carpenter Tan designs, manufactures and distributes wooden accessories made of natural wood. Its main product is wooden combs which are marketed as premium gift sets and works of art. In FY2014, combs and box sets accounted for 27.1% and 67.6% of total revenue respectively. The Company sells its products through a franchise network primarily in China. We highlight 4 key points about Carpenter Tan for potential investors.

Stable and Highly Profitable Company

Carpenter Tan

Carpenter Tan has demonstrated consistently high profitability in the last 5 years with net profit margins and return on equity averaging 41.5% and 24.7% respectively. This can be partially attributed to interest income, VAT refunds (as the Company qualifies as a social welfare industrial enterprise) and rental income which accounted for 9.8%, 6.6% and 3.1% of FY14 Profit before Tax respectively. Excluding these effects, net profit from operations averages at 32.9%.

Carpenter Tan

More importantly, it also indicates that the decline in net margins and return on equity is largely due to these increased non-core contributions as net operational profit margin has remained relatively stable.

Increased Gearing Not a Concern

Carpenter Tan

The business has been highly cash generative with the Company being FCF positive in the last 5 years. This has supported its increase in dividend per share from RMB0.182 in 2010 to RMB0.258 in 2014. It may therefore seem peculiar that gearing has increased from 0 in 2012 to 0.23x in 2014. Besides the fact that it is still at a conservative level, we believe that this merely the result of interest rate arbitrage.

Carpenter Tan

Based on its 2014 Annual Report disclosure, the loans have effective interest rates between 1.22% and 2.39%. In contrast, if were to compare interest income to total cash and cash equivalent, we get an implied interest rate of 3.02%.

Therefore, we do not believe that the increased gearing amidst high FCF is any cause for concern or suspicion.

Valuations Support Earnings Play Potential

Carpenter Tan

At 14.2x price to book, Carpenter Tan is fundamentally an earnings play. Despite its 20% run up in share price in the last month, valuations, calculated based on a share price of HKD5.28, are still attractive enough for serious consideration.

Key Risks

It’s not all castles in the sky; we have some reservations about the company as well. Some food for thought:

Are margins sustainable? For a business with relatively low barriers to entry, Carpenter Tan seems to be making supernormal profits for an extended period of time. Are their designs, technology and branding that revolutionary? Will this be a case of ‘If it’s too good to be true, it probably is’?

On that note, while many retailers in China have reported declines in turnover, Carpenter Tan has managed to eke out a 12.4% CAGR in revenue which, while ideal, is abnormal. One argument is that it positions itself as a high-end product to upper income consumers which can be argued to be more resilient. However, it is no secret that luxury retailers like Prada, Hermes have all experienced declines in sales. Without fully understanding the secret to Carpenter Tan’s success, we cannot be confident of its future performance.