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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$9.07 billion market cap; US$1.18 billion market cap; HK$45 billion average daily value traded] reported marginal revenue growth which was ahead of our expectations. Revenue increased marginally from RMB34.7 billion in 1HFY2019 to RMB35.7 billion in 1HFY2020 despite operations getting impacted due to COVID-19 in the first half of FY2020. Despite the severe impact on the supply chain management industry globally, increasing revenue growth from sale of properties along with sustenance of growth from supply chain management, trading and construction contracts businesses, was commendable. Especially the Group’s Commodities Intelligence Centre Pte. Ltd. (CIC) reported an increase of 20% in the number of customers with total revenues amounting to US$1 billion in the first half of FY2020 which were higher than the total revenues from this business segment as compared to the full year 2019. As a matter of fact, the pandemic situation has brought to focus the importance of digital transformation in the bulk commodity sector paving the way for larger activity on the entire platform. The growth remained subdued for segments such as E-commerce and financial services.
The Group’s gross profit margin slightly decreased from 1.8% in the first half of 2019 to 1.6% in the first half of 2020 mainly due to cancellation of certain commodity transactions with higher gross margins due to the short-term impact of the pandemic. We believe gross profit margins for the Group have bottomed out and it can only improve going forward with further recovery in the supply chain management business. Due to the pandemic, the Group also saw a significant decline of 32% in the selling and distribution expenses to RMB70 million in the first half of 2020 from RMB103 million in the same period last year.&nbsp; We expect continued focus on control and cash generation in the second half of this year, which will help margins and reported net income.
While the stock is cheap on its huge value of investment properties, and underlying revenue growth remains resilient, it now also appears that gross margins have bottomed out. &nbsp;This would be an inflection point for the stock.&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; Importantly, and as detailed below, industrial internet is significantly more than just “ecommerce”. The revenue growth of 30% in the previous year was driven by an increase in the supply chain business and we expect growth momentum to continue once economic growth comes back on track as the global pandemic recedes. In fact growth has started to come back to decent levels as China’s economic activity is returning to normal levels gradually.
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 June 2020 balance sheet lists RMB30.5 billion [HK$35 billion] in investment properties, which equates to HK$2.98 per share.&nbsp;&nbsp;
Everything else, and the main Supply Chain business, which represents 97% of revenues, is thus effectively “free”. Of the HK$2.98 per share in investment properties, 85% are fully developed, and only 15% [predominantly Tianjin] are under development where the construction of the phase II has commenced in the first half of 2020.&nbsp;&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 209% higher than today’s stock price!&nbsp;
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; 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. 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.
Price to Book at Absolute Low Levels 
On a price to book basis, Zall is trading at just 0.46x, and on a price to tangible book basis at 0.55x.&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;&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; In other words, there is strong asset backing for both the company’s balance sheet stated assets and equity values.&nbsp; Trading at just 0.46x 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;&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$2.00 price target would suggest a P/B multiple of 1x on our 2021 estimate.
Attractive Price/Sales 
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 0.09x based on our forward 2021 sales estimate, 0.07x on 2022 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;When looking at other rapidly growing revenue stocks in China and globally, which trade at many [2x – 5x price/sales] times sales, Zall’s multiple of less than 1x is extremely low. Our HK$2.00 price target would still suggest a 0.22x price/sales multiple based on our 2021 estimate.&nbsp;
Drastic Fall in Selling and Distribution Expenses; Increase in Short Term Borrowing
Selling and distribution expenses of the Group decreased by 32% from RMB103 million in the first half of FY2019 to RMB70 million in the first half of FY2020. The decrease was primarily due to decrease in staff costs by RMB8 million, reduction in advertising and promotion expenses by RMB10 million and logistics and handing expenses by RMB6.8 million. We expect the selling and distribution expenses to be in the similar range for the second half of 2020 which is positive for containing the expenses of the company in times of&nbsp; the pandemic.
Finance income of the Group increased by approximately 65.9% from RMB83 million in the first half of FY2019 to RMB137.6 million for the first half of FY2020. The increase was mainly due to the increase in interest income from pledged bank deposits of Shenzhen Sinoagri. Finance costs of the Group increased by 0.2% from RMB466.5 million in the first half of FY2019 to RMB467.6 million in the first half of FY2020. The Group’s total borrowings increased by 29% from RMB18,490.6 million at the end of 2019 to RMB23,792.6 million on 30th June 2020. The Group’s net gearing ratio increased from 65.8% at the end of 2019 to approximately 77.4% on 30th June 2020. The increase in net gearing ratio was mainly due to the increase in total amount of interest-bearing borrowings to strengthen the Group’s operating capacity. We believe that the company is in a comfortable position with the borrowing done in the first half of FY2020 and would not be required to borrow further in the remaining second half.
For further details and financial model, please see our attached Earnings Update Report.

Zall Smart Commerce Group [2098_HK; HK$9.07 billion market cap; US$1.18 billion market cap; HK$45 billion average daily value traded] reported marginal revenue growth which was ahead of our expectations. Revenue increased marginally from RMB34.7 billion in 1HFY2019 to RMB35.7 billion in 1HFY2020 despite operations getting impacted due to COVID-19 in the first half of FY2020. Despite the severe impact on the supply chain management industry globally, increasing revenue growth from sale of properties along with sustenance of growth from supply chain management, trading and construction contracts businesses, was commendable. Especially the Group’s Commodities Intelligence Centre Pte. Ltd. (CIC) reported an increase of 20% in the number of customers with total revenues amounting to US$1 billion in the first half of FY2020 which were higher than the total revenues from this business segment as compared to the full year 2019. As a matter of fact, the pandemic situation has brought to focus the importance of digital transformation in the bulk commodity sector paving the way for larger activity on the entire platform. The growth remained subdued for segments such as E-commerce and financial services.
The Group’s gross profit margin slightly decreased from 1.8% in the first half of 2019 to 1.6% in the first half of 2020 mainly due to cancellation of certain commodity transactions with higher gross margins due to the short-term impact of the pandemic. We believe gross profit margins for the Group have bottomed out and it can only improve going forward with further recovery in the supply chain management business. Due to the pandemic, the Group also saw a significant decline of 32% in the selling and distribution expenses to RMB70 million in the first half of 2020 from RMB103 million in the same period last year.&nbsp; We expect continued focus on control and cash generation in the second half of this year, which will help margins and reported net income.
While the stock is cheap on its huge value of investment properties, and underlying revenue growth remains resilient, it now also appears that gross margins have bottomed out. &nbsp;This would be an inflection point for the stock.&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; Importantly, and as detailed below, industrial internet is significantly more than just “ecommerce”. The revenue growth of 30% in the previous year was driven by an increase in the supply chain business and we expect growth momentum to continue once economic growth comes back on track as the global pandemic recedes. In fact growth has started to come back to decent levels as China’s economic activity is returning to normal levels gradually.
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 June 2020 balance sheet lists RMB30.5 billion [HK$35 billion] in investment properties, which equates to HK$2.98 per share.&nbsp;&nbsp;
Everything else, and the main Supply Chain business, which represents 97% of revenues, is thus effectively “free”. Of the HK$2.98 per share in investment properties, 85% are fully developed, and only 15% [predominantly Tianjin] are under development where the construction of the phase II has commenced in the first half of 2020.&nbsp;&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 209% higher than today’s stock price!&nbsp;
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; 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. 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.
Price to Book at Absolute Low Levels 
On a price to book basis, Zall is trading at just 0.46x, and on a price to tangible book basis at 0.55x.&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;&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; In other words, there is strong asset backing for both the company’s balance sheet stated assets and equity values.&nbsp; Trading at just 0.46x 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;&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$2.00 price target would suggest a P/B multiple of 1x on our 2021 estimate.
Attractive Price/Sales 
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 0.09x based on our forward 2021 sales estimate, 0.07x on 2022 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;When looking at other rapidly growing revenue stocks in China and globally, which trade at many [2x – 5x price/sales] times sales, Zall’s multiple of less than 1x is extremely low. Our HK$2.00 price target would still suggest a 0.22x price/sales multiple based on our 2021 estimate.&nbsp;
Drastic Fall in Selling and Distribution Expenses; Increase in Short Term Borrowing
Selling and distribution expenses of the Group decreased by 32% from RMB103 million in the first half of FY2019 to RMB70 million in the first half of FY2020. The decrease was primarily due to decrease in staff costs by RMB8 million, reduction in advertising and promotion expenses by RMB10 million and logistics and handing expenses by RMB6.8 million. We expect the selling and distribution expenses to be in the similar range for the second half of 2020 which is positive for containing the expenses of the company in times of&nbsp; the pandemic.
Finance income of the Group increased by approximately 65.9% from RMB83 million in the first half of FY2019 to RMB137.6 million for the first half of FY2020. The increase was mainly due to the increase in interest income from pledged bank deposits of Shenzhen Sinoagri. Finance costs of the Group increased by 0.2% from RMB466.5 million in the first half of FY2019 to RMB467.6 million in the first half of FY2020. The Group’s total borrowings increased by 29% from RMB18,490.6 million at the end of 2019 to RMB23,792.6 million on 30th June 2020. The Group’s net gearing ratio increased from 65.8% at the end of 2019 to approximately 77.4% on 30th June 2020. The increase in net gearing ratio was mainly due to the increase in total amount of interest-bearing borrowings to strengthen the Group’s operating capacity. We believe that the company is in a comfortable position with the borrowing done in the first half of FY2020 and would not be required to borrow further in the remaining second half.
For further details and financial model, please see our attached Earnings Update Report.

Zall [2098]: Inflection Point, "Free" Assets at 0.46x P/B, 0.11x P/Sales -Earnings Update Report