As value investors, we have always preferred Grahamite stocks, whereby the Market Capitalisation of the company is trading below its NCAV. However, while such companies are ideal investments, there are many caveats we have to take note of. One such criteria is sticking to the core business operations as will be explained in today’s article using Lerado Group Holding as a case study.
Founded in 1988, Lerado Group designs, manufactures and distributes a wide range of infant and pre-school products including baby strollers, beds and playards, soft goods, high chairs, bouncers, infant car seats, battery-operated ride-on cars, as well as other accessories. Furthermore, the Group has also extended its business scope to the manufacturing and selling of infant and preschool products under its own brand of “Angel”.
– Extracted from Lerado AR 2012
As seen from the above-mentioned extract, Lerado is a company that is principally engaged in infant products where the manufacture and distribution of juvenile and infant products contributes 84.4% of the revenue in 2012 and retail sale of juvenile and infant products contributes 2.6% of the revenue in 2012.
However, in the years of 2013 and 2014, due to the change in business climate, management have sold off these two core business divisions, retail sales in 2013 and manufacturing and distribution in 2014.
In 2013, with respect to the PRC market, the Group faced significant challenges and for the sake of focusing on the sales of its own brand in the PRC market, the operation of retail shops of maternity and infant products has closed down completely. While in 2014, the Group entered into a sale and purchase agreement to dispose of its manufacture and distribution of juvenile and infant products business at a consideration of HK$930 million. With the slower than expected economic recovery in the two major markets of the Group's juvenile and infant products, US and Europe, coupled with the declining birth rates experienced by developed countries, the export markets continued to be weak. The Group has experienced a decline in profit margin in recent years under this difficult operating environment and therefore decided to exit the Disposed Business.
What is left in the Group?
Having exited the previously mentioned business segments, within the Group only 2 business operations remains – medical products and plastic toys. During the FY2014, the medical products segment contributed HKD130 million while the plastic toys segment contributed HKD23 million. Asides from these two small business operations, Lerado is pretty much a cash shell.
Having disposed of these two core infant businesses, a snapshot of the company is as such.
After disposal and special dividends, Lerado has a market capitalisation of HKD489 million and a NCAV of HKD518 million. This translates to a discount of approximately 4% to NCAV. Given how Lerado is similar to a cash shell, this has resulted in the share price to be trading at such levels and is a common occurrence.
Management has insisted on keeping a majority of the cash from the disposal of the business for the plans of potential acquisitions. They have spelt out their plans for the cash in the circular (LINK) for the Special General Meeting.
- HK$200.0 million as expansion capital for the Medical Business
- HK$280.0 million for potential investment or acquisition opportunities in connection with the Medical Business
- HK$120.0 million for investment opportunities in other business sectors that would benefit from the growing aging population and health consciousness in the PRC
- HK$68.3 million as general working capital for the Remaining Group
In our opinion, having a cash allocation of HKD200 million as expansion capital for the medical products segment that only generates HKD130 million seems a tad too much. Furthermore, with respect to the other allocations, not only does management have no concrete plans as of now but they are venturing into a whole new industry – from infant products to elderly products. The big question would be, does management have the relevant expertise to be successful in the elderly industry?
From our past experience and history, there is statistical evidence that management that deviated from their core businesses have always ended up with a loss making division and ultimately having to cut it off. While Lerado does present itself as a classic net net investment, however, investing is not some formula. There are many caveats that investors have to be aware of and not just follow any one strategy blindly.