SINGAPORE (Jan 14): The Global Portfolio did not fare well in 2018, with total portfolio value falling about 20%. Our stocks are chosen based on value investing, after assessing the underlying fundamentals of the companies and their future business and cash-flow prospects.
Unfortunately, many of the stocks have underperformed despite reporting good earnings. Perhaps this is due to an environment of excessive liquidity and the resulting prevalence of beta or momentum-driven investing strategies.
Recently, we talked about how the share price performance of DIP Corp appears disconnected from continued improvements in its business and earnings. Shares in Sunpower Group, too, have performed poorly; they are now down 29.3% from my acquisition cost.
We recently spoke with one of the company’s co-founders, Frank Ma, to assess Sunpower’s business and outlook in view of its sudden share price drop late last year. The stock suffered a precipitous dive, falling from 53 cents on Oct 19 to a low of 28 cents on Nov 1.
In reply to a query by the Singapore Exchange, the company explained that executive chairman Guo Hongxin and executive director Ma Ming had each pledged 14 million shares to America 2030 Capital (on or around Oct 17) as collateral in exchange for loans that were never disbursed. For reasons unknown, some of the pledged shares were subsequently dumped on the market, causing the share price to collapse.
Both founders have since commenced legal proceedings against America 2030. On Nov 8, the Supreme Court of Singapore granted an ex parte interim injunction to restrain America 2030 and its depository brokers from selling or transferring the collateral shares, or any proceeds from the collateral shares. The case is now pending.
Management has given assurances to investors that the case has no impact on Sunpower’s underlying fundamentals and growth trajectory. Indeed, it is business as usual for the company.
Sunpower will release its 4Q2018 quarterly earnings results in late February. We expect good earnings, as 4Q and 1Q are seasonally stronger quarters — the winter months in China mean higher demand for heating and electricity. In addition, we should see a full-quarter contribution from Yongxin Plant, whose acquisition was completed in August 2018. Market consensus is for net profit to hit roughly RMB248 million ($49.38 million), compared with RMB145.8 million in 2017.
The company is well positioned to benefit from China’s efforts to clean up its air and curb pollution. Chart 1 shows its quarterly revenue and earnings in the past four years.
Management believes the current share price does not reflect its intrinsic value and has initiated a share buyback plan, starting Jan 2. Shareholders approved a buyback programme for up to 73.9 million shares, about 10% of its share capital. So far, the company has bought back just over one million shares.
For readers who are new to the company, Sunpower was formed in 1997 and listed on the Singapore Exchange in 2005. It has two businesses — manufacturing and services (M&S), and green investments (GI). Management believes the new GI arm will provide steady recurring income and power the company’s growth.
In 2015, China faced very serious smog problems caused by coal combustion from a huge number of small industrial boilers used to provide steam to small and medium- sized enterprises (SMEs). The government is now clamping down on those small, inefficient industrial boilers, which do not have pollution protection systems.
Sunpower is positioned to capitalise on China’s new stringent environmental policies. It aims to be the country’s leading centralised steam supplier in the next three years. The sector is currently highly fragmented.
Steam boilers are not new. However, Sunpower’s boilers are versatile — they can use coal, biomass, natural gas or waste as feedstock. Electricity, a by-product, is also supplied for use within industrial parks. At present, coal is the cheapest fuel.
Sunpower owns and operates centralised steam boilers in industrial parks under long-term contracts with the government, typically for 25 to 30 years. Steam is supplied to SMEs located within the parks under concession agreements, thereby replacing the use of individual old steam boilers.
Barriers to entry are not high, but few companies would find this business profitable without the suite of environmental protection technologies that Sunpower owns. The company is able to transport steam over long distances efficiently, using its manufacturing capabilities for insulated pipes.
Temperature loss during heat transfer in its pipeline is three times lower than that for competitors while the coverage radius of its centralised heating plants is five times longer/larger (see Chart 2).
The insulated pipes could transport heat and chemicals at sub-zero temperatures over long distances with minimal loss of government in Shantou closed down 183 printing and dyeing companies that were polluting a nearby river and ordered them to move into an industrial park (where Sunpower is constructing a GI project) or cease operations.
At present, seven GI projects are in operation, three are at the construction stage and the company is evaluating a further 10 projects.
Aside from insulated pipes, Sunpower also produces heat pipe exchangers, heat exchangers, pressure vessels, reactors and GGH-Gas gas heaters, all of which are used for the GI projects as well as sold to third parties, under the M&S segment. The M&S arm has an order book of about RMB2.26 billion.
As the company’s focus on GI increased, so did its capital expenditure and investment commitments. Total GI equity investment is targeted at RMB2.5 billion by 2021. Currently, Sunpower has invested RMB922.9 million of the RMB1.3 billion in committed projects.
To fund these investments, Sunpower issued two tranches of convertible bonds (totalling US$180 million) and 41 million warrants to funds managed by DCP Capital Partners and CDH Investments Management, two large Chinese institutional private- equity investors.
Tranches 1 and 2 of the bonds have conversion prices of 50 and 60 cents, respectively, and five-year maturity (March 2022). The bonds have a prevailing yield to maturity of 8%. The warrants were issued to CDH and DCP at an exercise price of 70 cents.
If all the bonds and warrants are converted, Sunpower’s enlarged share capital will rise to about 1,324.74 million shares. To counter the earnings dilution effect, management is committed to a profit target of RMB460 million in 2021 — underpinned by the progressive ramp-up of existing and new GI projects.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Current price is as at Jan 10, 2019 or last close
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