Those of you who know a little bit about China are probably aware of the country's gigantic infrastructure projects.
Today's stock, Hollysys Automation, is one of the companies best positioned to benefit from these. In addition to government projects, Chinese companies are spending more and more money on building huge factories, which further increases the addressable market for Hollysys. The idea for this analysis came from one of my viewers.
In addition, there are not many analysts in the English-speaking world who cover the stock. But before I will tell you more about how Hollysys could profit from this megatrend.
Hollysys Automation company is one of the leading manufacturers of automation and control system solutions in China. The company generates the majority of its sales in three segments: industrial automation, rail transport as well as mechanics and electrics.
In industrial automation, Hollysys offers a wide range of automation hardware and software, as well as cloud-based applications. In their rail segment, Hollysys offers advanced signal control and so-called SCADA systems, which are used for data acquisition and monitoring on high-speed trains and urban rails.
While China is by far the most important market for Hollysys, they also operate in other East Asian countries and the Middle East. So far, Hollysys has completed a total of more than 25,000 projects for approximately 15,000 customers in a variety of sectors, including energy, petrochemical, high-speed
and light rail, in which Hollysys has built leading market positions.
The company's stock performance has been quite weak so far this year due to the negative ramifications of the CV crisis, which hit the company fairly hard. However, one could argue that the 19.5% the stock lost since the beginning of the year is not much, considering that the company's first-quarter revenues were down 35% year over year.
Unfortunately, Hollysys investors are used to a weak share price performance. If we look at the 5-year chart, we see that the stock has dropped 45% during this period. The reason for this is the weak growth of the company.
From 2015 to 2019, Hollysys revenue only increased by 7%. While net income grew a little better at 29%, this growth rate is certainly not one that will delight investors. In addition, as you can see, there were also some very weak years in between for the company. With a price-to-earnings ratio of 7.8, this lack of growth is already priced into the stock.
Apart from that, the stock has a decent dividend yield of 1.59%. But unfortunately, the company has not increased its dividend in recent years. While Hollysys spends part of its profit on its dividend, they have also significantly increased their cash position over the years.
As of March 2020, the company total amount of cash was $ 366.4 million. Given that Hollysys' market cap is only $ 797 million and the company has very little debt, they definitely have a fantastic balance sheet.
Having said that, it is important to note that the vast majority of the company’s cash is located in China and there are significant restrictions on the use of this cash to finance expansion and dividends overseas.
Hollysys is currently facing stiff competition from foreign companies. However, this could change in the coming years as the Chinese government takes more and more measures to reduce dependence on foreign companies.
For this reason, they support Chinese companies in the development of important areas such as automation and control and prefer domestic companies in the awarding of government contracts.
Given the trade war between the United States and China, this advantage gets even greater, as the Chinese government imposed a 25% tariff on imported automation components. Considering that a lot of Hollysys' services and products were already around 10 to 20% cheaper than those of its foreign competitors, it will be even more difficult for non-Chinese companies to compete.
The company should also benefit from the general growth of infrastructure projects in China as well as from some government initiatives. For example, in recent years the Chinese government has committed to helping many Asian and African countries with their infrastructure projects.
Hollysys has already received several orders here. Apart from that, a large number of interesting projects for transport, electricity, and other infrastructures will be awarded in China in the coming years.
While it is by no means certain that Hollysys will benefit massively from this, it is definitely a great opportunity for the company. In addition, Hollysys could also profit from the planned construction of some high-speed intercity rails in China.
Here the company recently received an order for the Beijing-Zhangjiakou line, which will transport athletes for the 2022 Olympic Games. This should be an important flagship project for Hollysys. One of the biggest weaknesses of Hollysys is that they have not been able to diversify their business meaningfully in recent years.
Because of their excellent position in the Chinese automation market, many expected the
company to take advantage of this and expand into a variety of new markets. Expansion into markets such as food, beverages, life sciences, pharmaceuticals and electronics should have led to massive growth.
But so far, Hollysys has not had any notable success in these areas. In addition, the company has also failed to generate more of its sales outside of China. Hollysy’s inability to enter new markets definitely casts a bad light on the company. However, there is one thing that worries me, even more.
Investing in smaller Chinese companies has always been quite risky due to China's lax financial regulations. But after the Luckin-Coffee scandal at the latest, investors have become even more sceptical about Chinese companies.
It is therefore all the more important that these companies are now as transparent and trustworthy as possible. Unfortunately, Hollysys management has not done a good job in this regard. A good example of this happened over a year ago when the company made a secondary share proposal.
Although Hollysys had more than $ 400 million in cash at the time, the proposed stock offer would have diluted the stock by more than 10%. Management wanted to use this money to increase spending on research and development.
As a result, some investors wondered if the company might have spent too little on research and development to improve the appearance of short-term results. Fortunately, the proposal was then withdrawn due to strong criticism from investors and a sharp drop in the stock price.
Another thing I don't like about Hollysys in terms of transparency is that the company's investor relations page isn't very informative. Hollysys gives investors little information about things like the profitability of different segments and its dividend policy.
As an investor, I find that pretty disappointing. I have to say, when I first read Hollysy's company overview and saw what areas the company is operating in, I was pretty excited and thought that I might be dealing with a strong growth company here.
However, when I then looked at the fundamentals and read a few articles about the company, my excitement was unfortunately gone. Now, this may sound like I think the company is terrible. However, this is not the case either, as I think Hollysys definitely has a lot of potential. They are one of the leading Chinese companies in an enormous growth area.
The problem, however, is that the company doesn't seem to be able to take advantage of this huge potential. And when I look at their unsuccessful attempts in recent years to open up new markets, I don't think anything will change so quickly. If we look at their current price-to-earnings ratio of only 8, I conclude that the market shares this opinion.
Now with such a low pe-ratio and a great balance sheet, one could argue that the stock is pretty cheaply valued even if they don't grow anymore. The problem with this is that there is always a certain discount for Chinese stocks because of the lack of trust in the country's equities.
And this lack of trust is especially warranted in the case of Hollysys because of their weak communication with shareholders. So all in all, I have to say that while I don't think that Hollysys is a bad company and I wouldn't be surprised at all if shareholders make some good money with the stock over the coming years, for me the risk-reward ratio does not justify investing in the stock.
So this was my analysis of Hollysys. If you have any questions about the stock, please feel free to ask them in the comments below. I would also be very interested to hear your own opinion about the company.
But before I'm done, it's important to remember that I'm not a professional investor. Therefore, everything I said in this video represents my own views and should not be considered financial advice. That being said, I hope you enjoyed the video and I wish you all a nice day.