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Stock research on global mid-cap companies, Evaluate Research

Equity Bottom-Up

Zall Smart Commerce Group / Equity Bottom-Up

Zall Smart Commerce Group [2098_HK; HK$9.43 billion market cap; US$1.2 billion market cap; HK$45 billion average daily value traded] reported stellar revenue growth supported by acquisitions as well as increase in sales from its existing business. &nbsp;Revenue increased a significant 30% from RMB56.1 billion in FY2018 to&nbsp;&nbsp; RMB72.9 billion in FY2019. &nbsp;The increase was a result of the significant rise in revenue from supply chain management, trading and construction contracts businesses, offset by a decrease in the revenue from segments such as E-commerce, financial services, sale of properties and related services. &nbsp;While the stock is cheap on its huge value of investment properties, and underlying revenue growth is strong, gross margins have continued to be weak. &nbsp;We expect the gross and net profit margins to gradually pick up going forward as the company would want to focus on growing its business profitably.
Zall Smart Commerce Group represents a rapidly growing company with a unique industrial internet B2B model that combines both an online and physical infrastructure for its customers.&nbsp; &nbsp;Importantly, and as detailed below, industrial internet is significantly more than just “ecommerce”. &nbsp;The revenue growth of 30% in 2019 was driven by increase in the supply chain business and we expect growth momentum to continue once economic growth comes back on track after the global pandemic recedes.&nbsp; In fact things have started to come back to normal levels as China’s economic activity is returning to normal levels gradually. &nbsp;Importantly, 65% of the participants at Zall’s main North Hankou Trade Center, which is located in Wuhan, are now reported to be back at work, an encouraging sign for the whole world.&nbsp;
Zall’s revenue from supply chain management and trading business has contributed 98.4% of the Group’s total revenue in FY2019. &nbsp;The significant increase in revenue from supply chain management and trading business was primarily attributable to the increase in revenue from Zall Steel and CIC. Zall Steel was established in March 2018 and CIC in May 2018. &nbsp;Zall’s intelligent trading ecosphere, named “Zall Smart Commerce” encompasses latest technologies such as Blockchain, Artificial Intelligence, big data, etc.&nbsp; This online platform has been merged with physical capabilities, including the company’s ambitious North Hankou International Trade Center, developed over 10 years and counting, which all serve to provide customers integrated solutions including logistics, inventory management, warehousing, credit, etc.&nbsp; Zall’s business model has few peers, which although may make it challenging for investors to reference “comps” for valuation and analytical purposes, also gives the company a huge edge in gaining revenues and market share, and providing valuable services for customers. &nbsp;Zall is also therefore a misunderstood and underfollowed company, with Evaluate Research now the only firm covering the stock.&nbsp; &nbsp;As detailed below, Zall’s below-the-radar stock, down -5% YTD and -92% from all-time highs 24 months ago, looks compelling on multiple valuation metrics, and we see 275% upside within investors’ immediate one year time horizon to our target price of HK$3.00, and more upside intermediate-term. &nbsp;See details of our triangulation of our price target using 3 separate valuation methodologies:&nbsp; P/E, Price/Book and Price/Sales.&nbsp;
Zall has grown revenues rapidly, both organically and via acquisitions, which clearly indicates it has large growth plans going forward for its hugely scalable business model. &nbsp;But importantly, as we detail below and based on our numerous meetings and discussions with management, the key building block pieces of the platform are now largely in place, and the company is thus at an “inflection point” in its life cycle.&nbsp; They don’t plan large acquisitions going forward, and any future M&amp;A will likely be small and incremental.&nbsp; &nbsp;While management sees rapid organic growth going forward, driven by Supply Chain Management and Trading business, the company should also exhibit strong growth in net income.&nbsp; We believe that strong growth, as well as positive net income [with and without property revaluation gains] are the key metrics that investors will focus on.
Effect of pandemic Reducing, Recovery Seen in Offline Markets
The coronavirus outbreak since early 2020 has brought about additional uncertainties in the Group’s operating environment and has impacted the Group’s operations and financial position. &nbsp;The pandemic had led to the decrease in the volume of transactions on various online commodity trading platforms operated by the Group and slowed down the recovery of receivables which impacted the working capital. The Pandemic also had led to a temporary closure of offline commodity trading markets operated by the Group (such as the North Hankou International Trade Centre in Wuhan, Hubei province) and possible delay in construction progress of property development projects in Tianjin and Jingzhou. &nbsp;The company has therefore offered certain concessionary measures to the tenants in the North Hankou International Trade Centre in order to assist and facilitate them. &nbsp;With the gradual lifting of restrictions by the local government in Wuhan in April, the North Hankou International Trade Centre has resumed operations recently. &nbsp;The offline commodity trading market is recovering and the impact of the Pandemic on commercial properties in Wuhan is also reducing which is encouraging.
Operational Results Robust Despite Economic Slowdown in China
The contribution from the supply chain management and trading business segment is 98.4% of the total revenue of the company, which has grown by 31% in 2019 as compared to 2018. &nbsp;Since the contribution from other segments accounts for only 1.6% of the total revenue the overall growth indicates robust operational results. &nbsp;Overall supply chain management business segment has not yet turned profitable for the company.&nbsp; The business segment of commodities such as Sugar (Shenzen Sinoagri) has already started to generate profitability for the company and it expects other businesses to start generating profits gradually when each of them achieves economies of scale.
The group’s revenue from e-commerce and financial services business decreased by 91% from RMB106 million in FY2018 to RMB10 million in FY2019 mainly due to the disposal of Zalljinfu Information Technology (Wuhan) Co., Ltd (“Zalljinfu Information Technology”) during 2019, the revenue from which was no longer consolidated into the financial statements of the Group. The company sold the subsidiary as it did not align to be a strategic fit in the aspirations of the Zall Smart Commerce Group.
The rental income increased by 4% from RMB740 million in FY2018 to RMB769 million in FY2019 due to decrease in rental areas in the North Hankou Project. &nbsp;The net valuation gain on investment properties decreased&nbsp; by 33.7% from RMB3,865 million in FY2018 to RMB2,533 million in FY2019. The decrease was primarily due to the decreased number of completed properties transferred to investment properties for rental purposes. The Group’s revenue from construction contract to build certain properties on behalf of a third party increased by 89.7% from RMB5.0 million for FY2018 to RMB9.5 million for FY2019. The increase was primarily due to the increase of the cost incurred for property development projects during the year. &nbsp;Revenue from sales of properties and related services decreased by 81.8% from RMB682.8 million for FY2018 to&nbsp; RMB124.3 million for FY2019. The Group’s revenue from sales of properties was generated from the sales of auxiliary facilities units, office and retails units and residences. The decrease in revenue from sales of properties was mainly attributed to the decrease in the gross floor area delivered in 2019.
The financing income decreased by 49% from RMB317.2 million for FY2018 to RMB161 million for FY2019. The decrease was mainly due to that Shenzhen Sinoagri compressed its partial supply chain financial business to its upstream customers, based on the industrial research and analysis.
Gross profit decreased by 23% from RMB1,560 million in FY2018 to RMB1,198 million in FY2019. &nbsp;The gross profit margin decreased from 2.8% in the FY2018 to 1.6% in FY2019 mainly due to changes of the revenue portfolio of the Group since the completion of acquisition of a majority equity interest in Shenzhen Sinoagri and HSH in June 2017 and March 2018 respectively, and the establishment of Zall Steel and CIC in March and May 2018, respectively. &nbsp;Given the characteristics of initial development of the supply chain management and trading business, it has contributed higher revenue but lower gross profit margin. &nbsp;Due to initial development of the supply chain management and trading business gross profit margin was drastically lower albeit with 30% growth in revenues. &nbsp;The gross profit margin of the company is expected to recover gradually as the company would strategize to grow its business profitably.
The finance costs rose by 59.6% from RMB697 million in FY2018 to RMB1,113 million in FY2019 due to increase in interest expenses, increase of bank charges from expansion of supply chain finance business of Shenzhen Sinoagri, and due to decrease in amounts capitalised into properties under development and investment properties under development. &nbsp;Excluding the listed equity securities and contingent losses the company reported a net profit of RMB1338 million in 2019. &nbsp;The finance costs are expected to stabilize around current levels which augurs well for the net profit margin from a long-term perspective. &nbsp;Also the listed security losses are one time in nature which would not dent profitability going forward for the company.
Property &gt; Market Cap; Supply Chain for “Free”
Zall’s stock is in “deep value” territory, as the stock price does not even fully reflect the current value of hard property assets, so investors are effectively getting the company’s RMB73 billion [US$10.3 billion] in revenues for “free”. &nbsp;The December 2019 balance sheet lists RMB29.1 billion [HK$32 billion] in investment properties, which equates to HK$2.73 per share.&nbsp; Even if we discount the per share price by 15% the value of HK$2.32 per share also turns out to be much higher than the current stock price.
Everything else, and the main Supply Chain business, which represents 97% of revenues, is thus effectively “free”. Of the HK$2.73 per share in investment properties, 85% are fully developed, and only 15% [predominantly Tianjin] are under development.&nbsp;
The fact that vast majority of investment properties are already developed gives investors more confidence in the value and going-concern nature of these assets, as CAPX and development risk no longer exists.&nbsp;
For further clarification and details, and factoring in all property related debt, total property development segment assets as of December 2019 of RMB38.2 billion [HK$42 billion] minus all liabilities/debt of RMB12.8 billion [HK$14 billion] equated to RMB25.4 billion [HK$28 billion, US$3.6 billion], or HK$2.38 per share.&nbsp;This figure is 198% higher than today’s stock price!
Huge “Free” Call Option on Supply Chain&nbsp;
Put in another way, hard investment property assets, which contributes negligibly to the overall revenues of Zall but all of 2019 net income [but less of a percentage of going forward net income], fully explains the current stock price.&nbsp; &nbsp;This implies that small changes in the gross margin and net income contribution from the US$11 billion in Supply Chain revenues can have a huge impact on the stock price going forward.&nbsp; Importantly, investors are not paying anything for this future “call option” on the likely success of the Supply Chain segment in generating positive net income and FCF. &nbsp;The optionality implied in Zall’s stock price is huge, and it is effectively a “free option” given the stock price declines to the current levels.
Metric #1:&nbsp; Price to Book at Absolute Low Levels 
On a price to book basis, Zall is trading at just 0.48x, and on a price to tangible book basis at 0.54x.&nbsp; Given that 95% of Zall’s total assets are comprised of current assets plus investment properties, there is clearly a high percentage of hard property assets plus liquid current assets backing the book value of the company.&nbsp;
In addition, goodwill and intangibles, which is obviously excluded/deducted from the aforementioned tangible book value calculation mentioned, is relatively small for Zall, and comprises only 3% of total assets.&nbsp; &nbsp;In other words, there is strong asset backing for both the company’s balance sheet stated assets and equity values.&nbsp; Trading at just 0.48x price/book, investors are valuing the company at less than liquidation value.&nbsp; The reality is that Zall generates US$11 billion in technology driven Supply Chain revenues [which represents 98% of entire revenues] but only utilizes 10% of the firm’s assets.&nbsp;
The price/book valuation further highlights that the Supply Chain business continues to be effectively ignored by investors, and is hardly reflected in the stock price.&nbsp; Our HK$3.00 price target would suggest a P/B multiple of 1.7x on our 2021 estimate.
Metric #2 and #3 Attractive P/E and P/S&nbsp; 
For rapidly growing revenue companies [read:&nbsp; Tencent, Alibaba, Amazon, Uber, etc] that are still early in its lifecycle in terms of earnings/FCF, investors are focused on revenue growth and price/sales as the principal valuation metric which really determines stock price. The company is currently trading at a price/sales ratio of 0.10x based on our forward 2020 sales estimate, 0.09x on 2021 expected, and 0.11x on actual/trailing 2019 reported. The average 5 year actual price/sales for Zall, excluding the large spike in late 2016, has been 3.0x times.&nbsp; Zall’s multiple of 0.10x is also extremely low in comparison to even 1x. Our HK$ 3.00 price target would still suggest a 0.33x price/sales multiple based on our 2021 estimate. Also the stock is attractively valued today trading at 10.19x our 2021 and 6.12x on our 2022 EPS estimates.&nbsp; This level of price/earnings represent a huge discount to the Hang Seng and Mainland Chinese indices, as well as Zall’s own history.
For further details and financial model, please see our attached Earnings Update Report.

Zall Smart Commerce Group [2098_HK; HK$9.43 billion market cap; US$1.2 billion market cap; HK$45 billion average daily value traded] reported stellar revenue growth supported by acquisitions as well as increase in sales from its existing business. &nbsp;Revenue increased a significant 30% from RMB56.1 billion in FY2018 to&nbsp;&nbsp; RMB72.9 billion in FY2019. &nbsp;The increase was a result of the significant rise in revenue from supply chain management, trading and construction contracts businesses, offset by a decrease in the revenue from segments such as E-commerce, financial services, sale of properties and related services. &nbsp;While the stock is cheap on its huge value of investment properties, and underlying revenue growth is strong, gross margins have continued to be weak. &nbsp;We expect the gross and net profit margins to gradually pick up going forward as the company would want to focus on growing its business profitably.
Zall Smart Commerce Group represents a rapidly growing company with a unique industrial internet B2B model that combines both an online and physical infrastructure for its customers.&nbsp; &nbsp;Importantly, and as detailed below, industrial internet is significantly more than just “ecommerce”. &nbsp;The revenue growth of 30% in 2019 was driven by increase in the supply chain business and we expect growth momentum to continue once economic growth comes back on track after the global pandemic recedes.&nbsp; In fact things have started to come back to normal levels as China’s economic activity is returning to normal levels gradually. &nbsp;Importantly, 65% of the participants at Zall’s main North Hankou Trade Center, which is located in Wuhan, are now reported to be back at work, an encouraging sign for the whole world.&nbsp;
Zall’s revenue from supply chain management and trading business has contributed 98.4% of the Group’s total revenue in FY2019. &nbsp;The significant increase in revenue from supply chain management and trading business was primarily attributable to the increase in revenue from Zall Steel and CIC. Zall Steel was established in March 2018 and CIC in May 2018. &nbsp;Zall’s intelligent trading ecosphere, named “Zall Smart Commerce” encompasses latest technologies such as Blockchain, Artificial Intelligence, big data, etc.&nbsp; This online platform has been merged with physical capabilities, including the company’s ambitious North Hankou International Trade Center, developed over 10 years and counting, which all serve to provide customers integrated solutions including logistics, inventory management, warehousing, credit, etc.&nbsp; Zall’s business model has few peers, which although may make it challenging for investors to reference “comps” for valuation and analytical purposes, also gives the company a huge edge in gaining revenues and market share, and providing valuable services for customers. &nbsp;Zall is also therefore a misunderstood and underfollowed company, with Evaluate Research now the only firm covering the stock.&nbsp; &nbsp;As detailed below, Zall’s below-the-radar stock, down -5% YTD and -92% from all-time highs 24 months ago, looks compelling on multiple valuation metrics, and we see 275% upside within investors’ immediate one year time horizon to our target price of HK$3.00, and more upside intermediate-term. &nbsp;See details of our triangulation of our price target using 3 separate valuation methodologies:&nbsp; P/E, Price/Book and Price/Sales.&nbsp;
Zall has grown revenues rapidly, both organically and via acquisitions, which clearly indicates it has large growth plans going forward for its hugely scalable business model. &nbsp;But importantly, as we detail below and based on our numerous meetings and discussions with management, the key building block pieces of the platform are now largely in place, and the company is thus at an “inflection point” in its life cycle.&nbsp; They don’t plan large acquisitions going forward, and any future M&amp;A will likely be small and incremental.&nbsp; &nbsp;While management sees rapid organic growth going forward, driven by Supply Chain Management and Trading business, the company should also exhibit strong growth in net income.&nbsp; We believe that strong growth, as well as positive net income [with and without property revaluation gains] are the key metrics that investors will focus on.
Effect of pandemic Reducing, Recovery Seen in Offline Markets
The coronavirus outbreak since early 2020 has brought about additional uncertainties in the Group’s operating environment and has impacted the Group’s operations and financial position. &nbsp;The pandemic had led to the decrease in the volume of transactions on various online commodity trading platforms operated by the Group and slowed down the recovery of receivables which impacted the working capital. The Pandemic also had led to a temporary closure of offline commodity trading markets operated by the Group (such as the North Hankou International Trade Centre in Wuhan, Hubei province) and possible delay in construction progress of property development projects in Tianjin and Jingzhou. &nbsp;The company has therefore offered certain concessionary measures to the tenants in the North Hankou International Trade Centre in order to assist and facilitate them. &nbsp;With the gradual lifting of restrictions by the local government in Wuhan in April, the North Hankou International Trade Centre has resumed operations recently. &nbsp;The offline commodity trading market is recovering and the impact of the Pandemic on commercial properties in Wuhan is also reducing which is encouraging.
Operational Results Robust Despite Economic Slowdown in China
The contribution from the supply chain management and trading business segment is 98.4% of the total revenue of the company, which has grown by 31% in 2019 as compared to 2018. &nbsp;Since the contribution from other segments accounts for only 1.6% of the total revenue the overall growth indicates robust operational results. &nbsp;Overall supply chain management business segment has not yet turned profitable for the company.&nbsp; The business segment of commodities such as Sugar (Shenzen Sinoagri) has already started to generate profitability for the company and it expects other businesses to start generating profits gradually when each of them achieves economies of scale.
The group’s revenue from e-commerce and financial services business decreased by 91% from RMB106 million in FY2018 to RMB10 million in FY2019 mainly due to the disposal of Zalljinfu Information Technology (Wuhan) Co., Ltd (“Zalljinfu Information Technology”) during 2019, the revenue from which was no longer consolidated into the financial statements of the Group. The company sold the subsidiary as it did not align to be a strategic fit in the aspirations of the Zall Smart Commerce Group.
The rental income increased by 4% from RMB740 million in FY2018 to RMB769 million in FY2019 due to decrease in rental areas in the North Hankou Project. &nbsp;The net valuation gain on investment properties decreased&nbsp; by 33.7% from RMB3,865 million in FY2018 to RMB2,533 million in FY2019. The decrease was primarily due to the decreased number of completed properties transferred to investment properties for rental purposes. The Group’s revenue from construction contract to build certain properties on behalf of a third party increased by 89.7% from RMB5.0 million for FY2018 to RMB9.5 million for FY2019. The increase was primarily due to the increase of the cost incurred for property development projects during the year. &nbsp;Revenue from sales of properties and related services decreased by 81.8% from RMB682.8 million for FY2018 to&nbsp; RMB124.3 million for FY2019. The Group’s revenue from sales of properties was generated from the sales of auxiliary facilities units, office and retails units and residences. The decrease in revenue from sales of properties was mainly attributed to the decrease in the gross floor area delivered in 2019.
The financing income decreased by 49% from RMB317.2 million for FY2018 to RMB161 million for FY2019. The decrease was mainly due to that Shenzhen Sinoagri compressed its partial supply chain financial business to its upstream customers, based on the industrial research and analysis.
Gross profit decreased by 23% from RMB1,560 million in FY2018 to RMB1,198 million in FY2019. &nbsp;The gross profit margin decreased from 2.8% in the FY2018 to 1.6% in FY2019 mainly due to changes of the revenue portfolio of the Group since the completion of acquisition of a majority equity interest in Shenzhen Sinoagri and HSH in June 2017 and March 2018 respectively, and the establishment of Zall Steel and CIC in March and May 2018, respectively. &nbsp;Given the characteristics of initial development of the supply chain management and trading business, it has contributed higher revenue but lower gross profit margin. &nbsp;Due to initial development of the supply chain management and trading business gross profit margin was drastically lower albeit with 30% growth in revenues. &nbsp;The gross profit margin of the company is expected to recover gradually as the company would strategize to grow its business profitably.
The finance costs rose by 59.6% from RMB697 million in FY2018 to RMB1,113 million in FY2019 due to increase in interest expenses, increase of bank charges from expansion of supply chain finance business of Shenzhen Sinoagri, and due to decrease in amounts capitalised into properties under development and investment properties under development. &nbsp;Excluding the listed equity securities and contingent losses the company reported a net profit of RMB1338 million in 2019. &nbsp;The finance costs are expected to stabilize around current levels which augurs well for the net profit margin from a long-term perspective. &nbsp;Also the listed security losses are one time in nature which would not dent profitability going forward for the company.
Property &gt; Market Cap; Supply Chain for “Free”
Zall’s stock is in “deep value” territory, as the stock price does not even fully reflect the current value of hard property assets, so investors are effectively getting the company’s RMB73 billion [US$10.3 billion] in revenues for “free”. &nbsp;The December 2019 balance sheet lists RMB29.1 billion [HK$32 billion] in investment properties, which equates to HK$2.73 per share.&nbsp; Even if we discount the per share price by 15% the value of HK$2.32 per share also turns out to be much higher than the current stock price.
Everything else, and the main Supply Chain business, which represents 97% of revenues, is thus effectively “free”. Of the HK$2.73 per share in investment properties, 85% are fully developed, and only 15% [predominantly Tianjin] are under development.&nbsp;
The fact that vast majority of investment properties are already developed gives investors more confidence in the value and going-concern nature of these assets, as CAPX and development risk no longer exists.&nbsp;
For further clarification and details, and factoring in all property related debt, total property development segment assets as of December 2019 of RMB38.2 billion [HK$42 billion] minus all liabilities/debt of RMB12.8 billion [HK$14 billion] equated to RMB25.4 billion [HK$28 billion, US$3.6 billion], or HK$2.38 per share.&nbsp;This figure is 198% higher than today’s stock price!
Huge “Free” Call Option on Supply Chain&nbsp;
Put in another way, hard investment property assets, which contributes negligibly to the overall revenues of Zall but all of 2019 net income [but less of a percentage of going forward net income], fully explains the current stock price.&nbsp; &nbsp;This implies that small changes in the gross margin and net income contribution from the US$11 billion in Supply Chain revenues can have a huge impact on the stock price going forward.&nbsp; Importantly, investors are not paying anything for this future “call option” on the likely success of the Supply Chain segment in generating positive net income and FCF. &nbsp;The optionality implied in Zall’s stock price is huge, and it is effectively a “free option” given the stock price declines to the current levels.
Metric #1:&nbsp; Price to Book at Absolute Low Levels 
On a price to book basis, Zall is trading at just 0.48x, and on a price to tangible book basis at 0.54x.&nbsp; Given that 95% of Zall’s total assets are comprised of current assets plus investment properties, there is clearly a high percentage of hard property assets plus liquid current assets backing the book value of the company.&nbsp;
In addition, goodwill and intangibles, which is obviously excluded/deducted from the aforementioned tangible book value calculation mentioned, is relatively small for Zall, and comprises only 3% of total assets.&nbsp; &nbsp;In other words, there is strong asset backing for both the company’s balance sheet stated assets and equity values.&nbsp; Trading at just 0.48x price/book, investors are valuing the company at less than liquidation value.&nbsp; The reality is that Zall generates US$11 billion in technology driven Supply Chain revenues [which represents 98% of entire revenues] but only utilizes 10% of the firm’s assets.&nbsp;
The price/book valuation further highlights that the Supply Chain business continues to be effectively ignored by investors, and is hardly reflected in the stock price.&nbsp; Our HK$3.00 price target would suggest a P/B multiple of 1.7x on our 2021 estimate.
Metric #2 and #3 Attractive P/E and P/S&nbsp; 
For rapidly growing revenue companies [read:&nbsp; Tencent, Alibaba, Amazon, Uber, etc] that are still early in its lifecycle in terms of earnings/FCF, investors are focused on revenue growth and price/sales as the principal valuation metric which really determines stock price. The company is currently trading at a price/sales ratio of 0.10x based on our forward 2020 sales estimate, 0.09x on 2021 expected, and 0.11x on actual/trailing 2019 reported. The average 5 year actual price/sales for Zall, excluding the large spike in late 2016, has been 3.0x times.&nbsp; Zall’s multiple of 0.10x is also extremely low in comparison to even 1x. Our HK$ 3.00 price target would still suggest a 0.33x price/sales multiple based on our 2021 estimate. Also the stock is attractively valued today trading at 10.19x our 2021 and 6.12x on our 2022 EPS estimates.&nbsp; This level of price/earnings represent a huge discount to the Hang Seng and Mainland Chinese indices, as well as Zall’s own history.
For further details and financial model, please see our attached Earnings Update Report.

Zall [2098]: +30% 2019 Sales, Unique Biz - Earnings Update Report