Saturday, May 10, 2008

Hongguo - Profitability part 2


Looking at the graph below, we can see that for the trio, earnings are pretty good and is consistently getting higher. I do find it strange that even though Hongguo’s portfolio is behind both Belle’s and Prime’s, its EPS is actually the highest among the three.

If this trend is sustainable, it doesn’t even matter to me if Hongguo is ranked 3rd or ranked 1st, since it’s the earnings that ultimately drive the company, not the market share of their brands, though both are usually correlated.

Hongguo’s EPS historical growth is around 25%. I did some calculations based on different periods of years to derive the CAGR and found that it’s pretty consistent, always hovering around 21 to 29% since inception. The CAGR shown below is actually for 5 year period since 2002 to 2007.

As for Prime’s, EPS historical growth rate is much higher and also less consistent compared to Hongguo. It grows at a 5-year CAGR of 62%, but the fluctuations of the CAGR for different periods vary from 22% to 41%. In other words, Prime’s EPS growth rate is high but less consistent than Hongguo.

Based on my previous post on Hongguo’s valuation, I projected the EPS in 2020 to be $2.04 and I know that the EPS for FY07 is $0.28. That gives us a projected CAGR of 16.5% over 13 years into the future. Comparing my projection with the historical EPS growth rate of 25%, I think it’s quite reasonable, considering that the historical EPS of Belle and Prime is well in excess of 60%. Even Prime’s more recent earnings growth rate of 33% (from 2006 to 2007) is way higher than my projected CAGR of 16.5% for Hongguo.

PE of Prime Success vs Hongguo

Prime’s historical PE ratio is shown below. It goes from a low PE of 1.1 times to a high PE of 42 times. But let’s just look at the more recent PE, it’ll be around 16.2 to 42 times. Last close of Prime Success is HKD 4.55, which gives it a PE (based on FY07 earnings) of 19.2 times. Prime’s FY06 to FY07 earnings is 32%.

On the other hand, Hongguo current PE is 10 times, with FY06 to FY07 earnings growing at 22%. According to Peter Lynch, PE of a fairly valued stock should be the same as the earnings growth rate. Dividing earnings growth rate by PE, a stock having 1.5 is considered good but having above 2 is a possible bargain. Following his line of thought, Hongguo will be quite undervalued at the current price, having a PE of 10x but an earnings growth rate of 22%. It should be more fairly valued around PE of 22 times. (22/10 = 2.2)

Similarly we can do the same for Prime. It is trading at PE of 19 times, but with earnings growth rate of 32%. (32/19 = 1.7).