FUJIAN ZHENYUN is principally engaged in the research and development, design, manufacture and sale of a broad range of plastic pipes and fittings for four main piping systems, namely water distribution, communications, gas & electrical piping.

 

The stock had its IPO in August 2007 at 62 cts and is listed in the Second Board. The company has a share capital of RMB 115 million comprising 35 million S-shares listed in Singapore and 80 million unlisted shares, the bulk of it in the hands of the management.

 

The Company has an impressive track record with EPS of around 70 cts (RMB) or 14 cts(S) each year for the past 3 years (FY07-09). Although the profit growth had been rather flat, it is one of the few S-chips that have performed well in its business for FY 08 & 09 while many others had suffered a decline in profit or a loss due to economic slowdown. The Company had a healthy cash holdings all along & had declared dividends of 9.96 cts(RMB), 3.83 cts(RMB) & 5.64 cts(RMB) for FY 07, 08 & 09 respectively..

 

The share price of Fujian ZY took a big tumble in early June 2010 after its previous auditor, KPMG failed to pass its FY 2009 financial account in accordance with International Financial Reporting Standards because of some accounting discrepancies in certain business transactions. Since most investors were already fearful of S-chips because of the many cases of insolvency and poor corporate governance among them over the last 2 years, this incident had further dampened Fujian’s stock price to insolvency level. In July 2010, Fujian ZY appointed Deloitte & Touche as Special Auditor to help resolve its accounting problems. The special audit is still in progress.

 

Fujian ZY has now released its 1H 2010 Report that has been held back. The Company stated that figures in the Report could be affected by the outcome of the Special Audit if material discrepancies arise. The 1H 2010 Report shows that the company has been able to maintain its profitability for the first half.. In addition, it has a much improved cash & cash equivalents of RMB 273M and borrowings of RMB 16M. Its EPS for the First Half is 37 cts(RMB) or 7.4 cts(S) [annualized 14.8 cts]; & its NAV is RMB 4.77 or 95 cts(S). Based on its closing price of 24.5 cts, Fujian is selling at a PE of just over 1,5x and a discount to its NAV of over 70%.

 

QUESTION: Is Fujian ZY a grossly undervalued S-chip worth a punt at current price? What is the likelihood of the Special Auditor uncovering some serious misdoings in its FY 2009 Accounts? As most investors have difficulty telling the sound S-chips from the rotten ones, it is always easy to classify everyone that have any problem as rotten and many would just be too eager to “throw out the bath tub water with the baby in it”. Could it be the case with Fujian? If so, the brave ones who pick up the “baby” may be richly rewarded.

 

RISKS vs REWARDS

 

For those who are willing to take calculated risks in taking a position in the stock, they may like to take note that  -

 

1.       Although Fujian’s share price may have factored in much of the worst scenarios and the downside appears limited, any adverse findings by the Special Audit could still have a depressing effect on its share price. The stock is also very illiquid and a fair upside target could be its IPO price level of 62 cts taking into account its reported high EPS of 14 cts & NAV of 95 cts..

 

2.       The company business has benefited from the Chinese government’s RMB 4 billion economic stimulus plans through infrastructure development to supply clean drinking water to the rural areas & to hasten post-disaster reconstruction projects in earthquake stricken areas. Its major customer is government-linked organizations and thus faces less debt collection problems. The company had acquired 5 PE plastic pipe production lines in 2008 to boost PE production capacity by about 11,000 tons. Its acquisition this year of 10 PVC-M production lines for RMB 52 million would increase its production capacity by about 20,00 tons p.a. starting 2H 2010. This should make a significant contribution to its future bottomline.

 

3.       Like all S-chips, which are now out-of-favour with investors, Fujian is likely to continue seeing its share price dampened by the general distrust for S-chips until its management can show that it is among one of the better-managed and trustworthy S-chips.