Dongyue (45% Profit in 6 months)

Dongyue Group Limited (‘Group’) is listed in Hong Kong and is a leading operator in the Fluorosilicone industry. It manufactures fluoropolymers (32% of sales), refrigerants (22%), organic silicone (24%), dichloromethane (13%), and other products (4%) – for use in a wide variety of industries such as construction, electrical, electronics, automotive, household appliances, aviation, etc. The polymers segment is the largest contributor to profits – 47% in the last six months.

The group has well-integrated operations. For instance, the key refrigerant R22 is used as raw material for the polymers and organic silicone segments, and ingredients of methane chloride are used as inputs for the refrigerant and organic silicone segments. Such efficiencies are reflected in high returns on tangible assets (see below).

The group recently reduced its interest in the organic silicone subsidiary from 77% to 57.75% and listed it on the Shenzhen stock exchange – raising $820m in equity (and increasing non-controlling interests by $1.4b).

Incongruously, the group is also involved in property development – currently involved in four residential property development projects – tying up $1.6b of net assets. It also has questionable investments of $585m (with another $480m committed) to unlisted equity investments – primarily in a private asset management company.

The group was adversely affected by Covid-19 – experiencing decreases in product demand and selling prices in 2020, though the polymers segment stood up better than the rest.

It reported TTM sales of $12.8b (2019: $14.7b), ebitda of $2.2b (2019: 3.1b), and net profits of $1.1b (2019: $1.7b). Reviewing past results, and averaging out margins, the group is capable of generating $3b of ebitda and $1.8b in net profits under average conditions.

The balance sheet is strong with net cash of $3.2b. The liquidity position was satisfactory.

The stock is selling for $8.8b, which is under 5x normal earning power or 3x after backing out cash.

Recent dividend payouts have averaged over $800m, yielding 9% at market.

The group is highly profitable – generating close to 30% returns on tangible assets - indicating high value in future expansion. It is proceeding with a healthy level of capital expenditures ($790m in the last six months) to boost manufacturing capacity and hasn’t spared research and development expenditures even during the pandemic.

The latest updates from management indicate a continuing deterioration in operating results – therefore, investors may need to be patient for normal conditions to return.

On balance, this stock appears severely undervalued considering the quality of its operations.