ZKL.V TARGET PRICE: $0.50
UPSIDE POTENTIAL: 400%
SHARES OUTSTANDING: 90,415,223
CURRENT MARKET CAP: 9,041,522
January 1, 2014 - China Keli Electric Company Ltd. (TSXV:ZKL), rose an outstanding 400% yesterday on 665K shares traded, the highest ever daily volume for the company, thanks to the release of their Q2 financial results ended October 31 which included a 33% increase to revenues and 50% increase to net profit. This financial release appears to have been a tipping point for the company as it has always traded at an extreme discount to its revenue and net income.
Through its subsidiary Zhuhai Keli, ZKL develops, designs, manufactures and markets high-voltage switches, breakers, auto-control equipment, high voltage complete electric sets and high-power resistors for China's power industry. The record setting revenue growth and strong increase in profits is assisted by China Keli's Product Manufacturing/Sales License Agreement with Siemens signed in April 2013. The agreement not only stimulates revenue growth today, but should shore up future revenue growth as the contract calls for substantial increases to the sales targets over the next four years. From the NR:
"The agreement, which will be renewed annually provided Keli complies with the terms, recognizes that Keli has appropriate high quality manufacturing facilities and quality control procedures to comply with the stringent requirements for the manufacture of Siemens-designed electrical equipment. Siemens and Keli have agreed to some production and sales targets, which increase substantially over the first four years of the agreement, and will bring increased revenues to both companies."
A summary of ZKL's income statement can be seen below:
|ZKL||FY 2011||Q1 2012||Q2 2012||Q3 2012||Q4 2012||FY 2012||Q1 2013||Q2 2013||Q3 2013||Q4 2013||FY 2013||Q1 2014||Q2 2014|
|Cost of Goods Sold||9,020,376||2,409,549||2,377,265||1,788,347||2,773,266||9,348,382||3,096,234||2,995,604||1,891,348||3,356,785||11,339,971||3,682,301||4,116,633|
|Gross Margin %||41.0%||40.6%||41.4%||31.9%||36.0%||38.0%||35.2%||33.8%||36.3%||33.1%||34.4%||31.1%||31.8%|
|Operating Margin %||-0.7%||11.7%||12.4%||-24.1%||5.8%||3.9%||10.2%||5.8%||-12.5%||8.3%||4.6%||9.0%||6.9%|
|Profit Margin %||-5.0%||9.4%||8.5%||-23.0%||5.2%||2.3%||6.1%||3.2%||-13.0%||7.9%||2.5%||4.8%||3.6%|
|YoY Revenue Growth %||-1.4%||17.8%||11.6%||13.0%||15.8%||14.7%||11.9%||33.3%|
|YoY Operating Profit Improvement||634.7%||2.3%||-48.0%||41.4%||65.1%||33.2%||-0.8%||59.0%|
|Income Attributed to Common Shareholders||-1,088,801||604,568||1,059,510||-357,438||-16,021||1,290,619||355,615||421,432||-354,364||652,070||1,074,753||675,841||541,225|
The company recently split out product and service revenue within their reporting. While product revenue has remained relatively flat, it is the installation service revenue that has seen strong growth from less than $277K for the full fiscal year of 2012 to nearly $3.2M for fiscal year 2013. But Q2 2014 saw a 44% jump in product revenue from $3.2M to $4.6M, shortly after the Siemens agreement was signed. Gross margins have been trending downwards but overall profit margins have been about flat as operating expenses have remained steady even as revenue grows.
The last four quarters saw $19.4M in revenue, $942K of operating profit, $479K of net profit and $1.5M of comprehensive income used to calculate an EPS of 1.7 cents per share. Comprehensive income is greatly assisted by the rising RMB versus the Canadian dollar since 2012. Excluding currency effects the EPS is 0.5 cents per share. All of these numbers compare very favourably versus the company's market cap of $9M at 10 cents per share. The price to earnings ratio is reasonably low, ranging from 6 to 20 while the price to sales ratio is very low at 0.47 despite the stock price quintupling overnight.
For the four quarters from Q3 2012 to Q2 2013, revenue was $16.2M so the trailing 12-month revenue saw an increase of 19% to $19.4M. Operating profit grew from $365K to $942K while net profit grew from $53K to $479K. The largest driver of the earnings growth is the vastly improved Q3 which is seasonally the worst quarter for the company and is the only one in which the company still loses money. Given the strong increase in net income, the steadily growing increase in revenue in the last quarter and the Siemens deal, ZKL should be valued at much higher metrics than a 20 P/E or 0.47 P/S. Click here to see the Reuters comparison of ZKL to its industry and sector as summarized in the charts below.
Although these numbers are not yet updated for the Q2 release (for instance the P/S metric of 0.51 includes Q2 2013 instead of Q2 2014), they tell a very clear story of the company being undervalued by multiple times when compared to its industry and sector of electrical components/equipment in Asia. ZKL's price to sales ratio is 7 times lower than the industry and 62 times lower than the sector. The P/E ratio of 22.27 is more than three times lower than the industry of 72.87 and over 100 times lower than the sector. Even when looking at balance sheet results, ZKL's tangible price to book value is 0.55, more than 6 times lower than the industry and 4 times lower than the sector. Price to cash flow is the only metric in which ZKL appears to be appropriately priced versus the market as the accounts receivable for the company is high relative to its size.
The company's growth rates (Most Recent Quarter and Trailing Twelve Month) from Reuters shows that it is in line with the industry for top line sales and superior its sector by 3-4x. However, the Reuters' most recent quarter shows the weaker Q1 results of 11.9% growth in revenue and not the 33% seen in Q2. As calculated above the latest TTM revenue growth rate is 19% while the net profit growth rate of $479K from $53K implies a far superior 803% earnings growth, but that number is assisted by having a very small denominator.
Consider that all of the previous analysis has taken place after the company already improved from 2 cents to 10 cents. The sector analysis includes all Asian companies so while stronger Japanese and Korean companies offset some of the impact, other Chinese companies which are supposedly susceptible to fraud are also included in the group and yet ZKL was very cheaply priced even relative to them.
Why has ZKL been priced so low for so long? Similar Chinese companies trading in the US like China Electric Motor, Inc. (CELM) were found out to be frauds in 2010 and 2011 and trade at very low multiples compared to their reported numbers which in all likelihood are inaccurate. Canadian investors are particularly sensitive thanks to the financial shenanigans uncovered at Sino Forest which eventually led the company to becoming delisted. ZKL has been discounted to an extreme amount due to the misdeeds of others despite the fact that no one has ever accused them of wrongdoing more than two years after the allegations against CELM, TRE and others came to light. With continued reporting and the contract with Siemens it looks more likely that ZKL is a legitimate company with strong current earnings potential and great growth prospects. There is no reason to discount it to such an extent where its price practically assumes it is a fraud. Each individual investor should evaluate their own risk tolerance for Chinese companies, however there is no evidence to suggest that ZKL is involved in any wrongdoing.
Given the superior growth metrics and far superior value metrics, it is reasonable to assume a target where ZKL should be 10 times its current price. Nonetheless, TSX Tech News and Analysis will discount this target by 50% to account for the higher risk of this tainted sector to come to a 50 cent price target for ZKL. Even at 5 times the price, the P/S of around 2.5 and the P/E ratio of around 100 show a company that is conservatively valued versus its peers.