Haier has gone from a basket case in the 1980s to become a global competitor and source of national pride for Chinese business today – and it continues to increase its revenues without having to sacrifice its margin growth.
The Chinese New Year holiday – one of the periods each year when consumer spending within China soars, as millions of migrants return home toting costly gifts for their friends and families – has just wrapped up. One of the biggest beneficiaries of this great wave of spending is Haier (600690.SS), the Qingdao-based manufacturer of household electronics, the most coveted of such goods not just among the country’s hordes of migrant workers but also its burgeoning middle class.
Back in the 1980s, Haier was teetering on the verge of collapse, struggling with a large debt load and operating woes that ranged from poor quality control to an unmotivated workforce. Under the leadership of Zhang Ruimin, the company has not only improved its operations but also expanded, making some smart acquisitions, putting it in a position to become a brand of choice for Chinese consumers proud of their country’s economic renaissance.
Haier’s revenues have soared from 15.3 billion Chinese renminbi in 2004 to 73.7 billion renminbi in 2011, the latest annual period for which results are available. Not only are the company’s earnings robust, however, they also are of high quality: Haier scores 91 out of a possible 100 on the StarMine Earnings Quality (EQ) model, suggesting that the its profits are coming from sustainable sources.
The gains in revenue depicted in the chart above have been matched with positive cash flow from operations. As shown in the chart below, this has exceed Haier’s net income on a very consistent basis in the last five years, with operating cash flow exceeding 1.5 billion renminbi in each of the last three quarters. The greater the extent to which a company’s earnings are backed by strong cash flows, the more sustainable those profits tend to be. Indeed, Haier scores 93 on the cash flow component of the EQ model, its highest rank on any of the components of the model.
The rise in revenues also has been accompanied by a gradual increase in Haier’s margins. This is a good sign, telling investors that Haier’s quest for ever-higher revenues hasn’t forced it to compromise and trade away margin growth for growing sales, a not uncommon trend among companies trying to market their products in a tough economic environment. In fact, as you can see in the chart below, while the trailing four-quarter gross margin dipped in 2009 and 2010, it has been improving slowly but steadily for the last seven quarters. Even more impressive is the fact that the company’s operating margins and its net margins (represented by the green and the blue lines, respectively) have been gradually increasing over the last five years, reaching their highest level in that five-year period in the fiscal quarter ended September 2012, at 5.7% and 4.1%, respectively. As long as the company can continue to increase revenue while maintaining these margins, the company’s earnings are likely to remain of high quality.
Haier’s stock price has been rallying in recent months, climbing almost 20% from 10.80 renminbi to 12.60 renminbi in the last six months, the StarMine Relative Value (RV) Model suggests that it may still be inexpensive relative to its potential earnings growth. The company currently trades at only 8.9 times its forward 12-month estimated earnings, well below its 10-year median P/E of 15.2. That contraction in Haier’s valuation has occurred in spite of the forecast 20% jump in the company’s earnings from its 2011 fiscal year to 2012. (Analysts expect Haier to report its 2012 earnings later this week.)
The outlook for 2013 is for a more modest growth rate of 10%, according to analysts, but it is still early in the fiscal year and it is still possible that a pickup in the Chinese economy will drive consumer spending and Haier’s earnings higher as the coming months unfold. Indeed, if we back out the expected growth rate over the next 10 years and calculate what is required to justify the current stock price, the market-implied growth rate turns out to be a mere 2.6%. In other words, the market has priced in a fairly significant contraction in the rate of earnings growth, to a figure that seems conservative when set beside its annualized 37% growth in earnings over the last five years. Drawing on analysts’ estimates rather than the market price, and after accounting for analyst biases in long-term growth estimates, StarMine calculates that the actual CAGR earnings growth rate over the next decade should be a healthier 9.9%. (It is worth noting that that figure still appears conservative when set beside Haier’s historical earnings growth.)
As the ranks of the Chinese middle class continue to expand and as Haier continues to gain popularity – and sales — in other rapidly growing emerging markets (such as India), it seems likely to deliver continued growth. Better still, Haier’s strong earnings appear sustainable, thanks to its increased operational efficiency. That is a factor that many may well view as attractive in the context of the Chinese economy, which remains volatile and may offer as much risk as it does potential for reward.
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