In 2023, during an AI frenzy that might soon change our lives, at a time when global internet oligopolists grow in perpetuity with limited additional capital expenditures needed, one of my favorite companies is a 46 year old producer of women’s garments and clothing which posted operating losses for eleven straight years, until this year. Try to hold back your excitement. I’ll do my best to explain my reasoning for owning this out of every public company available in the world.
Twenty years ago, Tungtex Holdings (HKG:518) was seen as a stable, highly profitable company providing apparel to Western labels and retailers. Written up in David Webb’s Christmas picks, and Marc Faber’s 2001 Gloom & Doom report, it was a classic value investor set-up, trading at a low price relative to ongoing earnings with an ROE around 15-20% and appreciable revenue growth, generating average operating income around HK$100m per year versus a market cap of anywhere from HK$400-1b depending on when you found it.
Since early 2004, the stock has been pure death, and has fallen nearly in a straight line for 19 years for a compounded annual average return of around -11%. There’s been no real recovery from any prior price drop and it’s been Down and To the Right Capital Management for any buyer in that time. Investors have been told almost every year for two decades that the stock is a loser and the company’s operating performance has politely obliged the narrative.
This has never been a popular stock, but there are the usual suspects of past owners such as DFA, Fidelity, and a few others which tend to dump shares whenever a value-stock’s price dwindles away and operating losses appear (as possibly the smallest active investor in North America, I’m allowed to punch up on $600b asset managers, and quite frankly, most of us investors will admit to having sold in similar fashion at least once). David Webb sold off in 2007 and has been buying back since 2017, and the only other outside owner I see is Wykeham Capital, which has been trimming since 2020 (not sure if that’s a result of redemptions and forced selling or an allocation choice). Among Comus and clientele, we’re nearing 1% ownership in total (if you did the math it’s a tiny $ amount for a public company), which should be acceptable/forthcoming for me to publicly share. I imagine there are a few other 1-4% owners, but we can’t see them.
Since the global financial crisis, it’s been a string of bad news for Tungtex and other small Asian apparel producers just like it. An historic US recession which impacted retail demand followed by years of lost customers, later a trade war and tariffs, followed by a pandemic forcing the temporary shutdown of both Chinese and Vietnamese operations numerous times- 1, 2; and now comes another possible US retail slowdown. From 2012-22, they posted annual operating losses around HK$70m per year, with revenue down about 80% since 2007. No wonder the stock is down 90% and trading at an all-time low! If they couldn’t generate a profit in that decade of economic growth, how are they supposed to now?
But things started changing recently. In 2020 they sold one of their Chinese facilities resulting in a HK$300m extraordinary profit, amounting to nearly the entire consideration for the building as it was written down to nothing over the years, along with a few small subsidiaries, soon after which they paid a sizeable special dividend of HK$100m. Directly from that announcement, their reasoning for this move:
“SYO owns Shenzhen Building, which was built in 1992 and was one of the principal production and auxiliary facilities of the Group for the manufacturing of garments. After over almost 30 years in operation, the equipment in Shenzhen Building has not been able to operate up to the Group’s required productivity, efficiency or cost-effectiveness, and has therefore become obsolescent. In view of the aforesaid, the Group issued an announcement regarding its intention to sell Shenzhen Building on 31 July 2018, and the Group has completed the relocation of the manufacturing operation at Shenzhen Building to the Group’s other production plants in China during the fiscal year ended 31 March 2019. Since the whole fashion and apparel industry has been operating with increasing uncertainties during the current fiscal year ending 31 March 2020, the Group has further strengthened the consolidation of production capacities in China to target for better cost savings and effectiveness in the longer term. As one of the Group’s main strategic initiatives, the Group commenced to merge production facilities and workforces into the Group’s Zhongshan production plant from July to September 2019. Thereafter, the manufacturing operation at Shenzhen Building has been ultimately and completely consolidated into the Group’s Zhongshan production plant. In Vietnam, the Group has been strategically expanding its manufacturing capacity and operation effectively to serve quality customers with higher profit margin by improving productivity and expansion of production lines. The Group will continue to commit further resources to its Vietnam production plant. Upon completion of the Disposal, the remaining production bases of the Group’s garment manufacturing activities will be situated in Vietnam and Zhongshan of China.”
To summarize, they’re trying to reduce costs and generate a profit in a severe environment by consolidating production facilities. Adding HK$200m to the bank account and paying off debt helps the cause. At least the balance sheet is improving.
Soon after, more good news started rolling in. Year-end march 2022 revenue growth of 27%, and excluding 2020’s extraordinary profit, operating loss decreased from around HK$60m to $HK30m. Nobody cares, the company is still generating losses and depreciation add-backs aren’t enough to attain positive cash flow (and nobody is following the stock anyways).
Now come the positive profit alerts. First one, followed by a mid-November 2022 update reporting 80% revenue growth year-over-year mostly coming from a rebound in North American sales and rising demand for products sourced from Vietnam. Gross profit and margins spiking, they just generated their first operating profit in years. Economies of scale are at work. Working capital levels stable, still paying down debts and cash flow is now positive.
A month ago in late June, another positive profit alert, followed by the year-end results showing the year’s improvement in sales and a HK$19m net profit for the year, versus its current HK$115m market cap. Sales in the past six months didn’t move year-over-year, but profit margins spiked, partly due to currency depreciation, and so the company ends the past year with its highest operating profit since 2009, but still trading around the lowest price in its history. Priced at around a third of its net working capital balance and under net cash (HK$110m is encumbered by a banking facility, but they’re paying it down rapidly so I really don’t mind).
Now, I have no certainty as to what happens from here and people looking at this company will view it with severe skepticism- they finally posted a profit, but how can we know they moved on from the last 11 years beforehand? How can we know they won’t go right back to that after what could be a fluke year? And the answer is we really can’t, but I have recently come to strongly believe in the phenomena of mean-reversion and momentum in corporate profitability. It’s within the power of most companies to achieve average-levels of industry returns on capital and when things start improving or deteriorating, it often continues. That’s how we get long fluctuations in performance and pricing- like a big ship changing course, once profits start moving in one direction, they’re often hard to stop.
While I can’t know for sure if this is a new era of profitability for Tungtex, or if I’m just overreacting to one good year and we’re soon back to the money burning, at this valuation I’m happy to find out if we bottom ticked the stock or not at a HK$0.26 average price the past 9 months. I’m sure other Tungtex investors since 2004 hoped for the same. In HK, any valuation is possible so I’d never rule out further stock losses, or a HK$0.13 price in a year, but right now all measures of corporate improvement are firing at full-cylinder. I see no reason the company can’t get back to the 6% net margins it once had in a distant era, and at 1/7th of revenue, good things can happen- I’m not buying it for this year’s profits, or its past performance, I’m buying it for the potential it has. The most unexpected outcome for observers would be for Tungtex to keep posting profits, and for the stock to actually rise; nobody will believe it until it happens, and this uncertainty is the reason the stock is dirt cheap.
To pull the 8 Mile routine again, if that outline of the company’s past decade wasn’t enough for you, there are always weird negatives and risks. I don’t know why they have any debt left and haven’t paid it all off yet. Good chance it’s gone soon, but we can’t know for sure. The dividend is still low, and they aren’t buying back shares which they should be doing if at all possible. Poor capital allocation is a continuing risk. Insiders have good positions, but aren’t adding to them, and the float is high-ish for this type of stock. They posted a weird director notice, although the company and stock named in that announcement have done fine since. They also have a very old outstanding case in litigation- 1, 2, I’m no lawyer and don’t know why it’s been held up for so long, but the outcome is expected to be immaterial to the firm whatever happens.
The US retail market has also been sluggish, with retailers cancelling inventory purchases in the first half of 2023, affecting various manufacturers globally, although most retail data has looked okay recently with the good old resilient consumer (what a euphemism that is) powering through all kinds of adversity from spiking costs to corporate price gouging, but that could change. US retail inventory levels have remained high, so everyone (myself included) expects continued destocking for a while. It’s not impossible the recent order blast came from the remnants of the pandemic shopper, and they struggle in the future, throwing out my dreams of mean reversion. Unlike in the case of Sitoy (HKG:1023), where this risk becomes a bit harder to bear after the price doubles, we’re still getting the dumpster-fire discount here.
Trading volume in the stock was extremely low from February til June’s report, and recently shot up post-earnings, but for whatever reason, there are skeptics willing to sell at HK$0.26 in good quantity. I assume they’re glad they finally have the opportunity to dump a loser off on someone else now that buyers are coming back, but who knows for sure, it’s possible they know something I don’t. In my opinion, this is when the money is made in deep-value; when the zombies come back to life, and I accept risk at this price.
This isn’t a recommendation, suggestion, solicitation, or advertisement, and doesn’t constitute investment advice. The opinions offered above aren’t recommendations to transact in any securities, and I could be missing something, or entirely incorrect on any potential fact, assumption, opinion, or claim provided. There are numerous risks associated with holding thinly-traded, micro-cap contrarian stocks such as this that most investors are unwilling to accept, including significant or total loss, and this stock isn’t excluded from that risk. Other than our position, I have had no communications/dealings with the company mentioned, and receive no compensation for discussing it.