Litu Holdings, formerly known as Brilliant Circle Holdings International Limited (‘group’), is engaged in the printing of cigarette packages (87% of sales), manufacture of paper packaging materials (6%), laminated papers (3%), and RFID products (4%). It generates 98% of revenues in China and exports to Brazil, Indonesia, USA, and Korea.
The group halted production in February due to lockdowns arising from the pandemic. However, subsequent sales picked up so vigorously as to eliminate any adverse impact from Covid-19.
The key risk facing the business apart from public pressure to restrict smoking are the tendering rules set by China Tobacco, the monopolistic government-owned cigarette company and tobacco regulator.
The current mandatory tendering system has kept the group’s selling price under pressure.
It reported TTM sales of $1.5b (2019: $1.5b), ebitda of $336m (2019: 335m), and net earnings of $183m (2019: $176m).
The balance sheet was healthy with net cash of $61m though gross borrowings had gone up to $672m – apparently to pay a $300m final dividend and to finance capital commitments of $94m to upgrade machinery.
Another indication for the presence of value is the relative lack of impairment for goodwill allocated to the cigarette package printing unit – despite the application of a 13.25% discount rate over the next five years (and 3% growth thereafter).
The most recent announcement after the close of market last Friday indicated the failure in tendering for contracts in 2021 and 2022 from a major customer in Sichuan province. Management haven’t indicated the extent of the revenue loss - just that it may have an adverse impact “for the coming years”.
Dividend payouts have been fairly generous i.e. the 2019 final dividend of $300m amounts to over 50% of the market cap. The 2018 final dividend, however, was skipped.
The secular decline in cigarette consumption must be offset by consideration of the importance of tobacco revenues to the Chinese government, especially when the rest of the economy isn’t contributing as much tax revenues.
In the case of Amvig, we declined participating in the company at a control price of 7x earnings – but the valuation of 3x earnings for this stock appears too cheap to ignore on an investment basis.