There are some signs, however, that all is not well with its business. Year-over-year sales were down 35% in the most recent quarter, and the company expects this quarter's sales to drop by over 40%. In addition to the economic malaise plaguing the industry, the company is having trouble with new competition: 3C has had to lower prices to remain competitive. Furthermore, the company has also had to extend its credit terms to customers. As a result, even though sequential quarterly sales were down 30+%, accounts receivable are actually higher now than they were last quarter - this is usually a bad sign!
Recognizing that the business is facing some problems, 3C management has started taking the firm in a new direction: rather than grow its existing store-in-store retail model, the company plans to shrink those locations in favour of opening up its own retail stores as well as franchised stores. This transformation is not free, of course. To finance the investment, 3C will have to draw down on what value investors would consider to be the company's margin of safety! The company summarizes it best:
"[T]here are no plans for paying dividends in the foreseeable future. We intend to retain earnings, if any, to provide funds for the implementation of our new business plan."
And because this is a new direction for the company, investors don't have a great indication of what the financials will look like for this company's new format. Value investors, on the other hand, prefer companies that have been operating in the same line of business for years, since their cash flows can be predicted with more confidence. Indeed, there is a risk that the new business plan will not work out well.
So in summary, what we have is a company trading at a discount to its liquidation value that will be spending some (but we don't know how much) of that discount on a relatively new business segment for which previous financials don't neccessarily apply. While it may be more likely than not that the investor has downside protection, there is nevertheless a fair amount of risk associated with this stock. Investors may still find value in this stock at its depressed level, but they should ensure they understand and recognize these risks.
Disclosure: None
1 comment:
Thanks for your comments Barel. At least we now know than Chinese small caps look like fertile ground if you are willing to take some risks.
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