Opportunistic Play on C&O Pharmaceutical

Opportunistic Play on C&O Pharmaceutical                                                                                 28 Jan 11

Before I start, I will like to emphasis that this short write up is to highlight a possible opportunistic (technical) play on C&O Pharmaceutical (“C&O”) with a horizon of 1-2 weeks (max) and not an in depth analysis on its fundamentals. In addition, I reiterate that this write-up is a general one and does not take into account of the reader’s risk profile. It may or may not be suitable to you.

7.2% YTD drop, 2^nd worst performer

Among the companies listed in Table 1 below, C&O is the 2^nd worst performer, just below Si Huan Pharmaceutical. In addition, it has also underperformed the FTSE Strait Times China index year to date (“YTD”) by about 6%.

Table 1: C&O Pharmaceutical's statistics vis-à-vis its peers

Short Name	Cur	Last Price	Analyst Consensus Px	Adj Mkt Cap (S$m)	Cur FY PE	Nx FY PE	Est Div Yield	YTD Returns
C & O Pharm	SGD	0.450	0.63	298.5	13.4	12.3	4.8%	-7.2%
Luye Pharma	SGD	1.30	NA	639.7	NA	NA	NA	0.0%
Sihuan Pharma	HKD	5.10	7.13	4,349.6	38.9	26.3	0.6%	-10.2%
Biosensors Intl	SGD	1.14	1.35	1,258.9	24.1	18.2	0.0%	0.9%
Techcomp Holding	SGD	0.415	NA	96.5	8.3	6.4	2.8%	-1.2%
Lma Internationa	SGD	0.300	NA	176.3	NA	NA	NA	-6.3%
Average excluding C&O Pharmaceutical					23.8	17.0	1.1%	-3.4%

Source: Bloomberg (as of 28 Jan 11).

Technical aspect – very oversold but should likely to retrace in the next 1-2 weeks

Based on historical records, C&O has seldom hit an RSI of 21.3988 which was the RSI seen on 28 Jan. To be more specific, according to Bloomberg, there were only two days (out of 1,169 trading sessions) whereby the RSI are lower than 21.3988. Both sessions occurred on 14 & 15 Nov 06, after the release of its dismal 1QFY06 results. Nevertheless, there were open market purchases announced on 14 Nov where the share price subsequently recovered.

In addition, it is noteworthy that the lowest RSI level for C&O was 21.3761. Thus, at this level, it may be a good time for aggressive traders to initiate long trades starting at current levels via tranches on C&O.

However, I wish to caution readers that RSI should not the sole indicator to indicate that a company is ripe for retracement. In addition, RSI can remain depressed for some time. Nevertheless, it is a good indicator (sensitive but not too sensitive) to highlight companies which are oversold. Furthermore, I have used a large sample size (1,169 trading sessions) to increase the probability of the veracity of this signal. In addition, other indicators such as MACD or MFI also corroborated to the oversold condition.

What analysts think on C&O Pharmaceutical – fundamentally?

As mentioned above, I have not researched into C&O’s fundamentals. However, there are four salient points on the fundamentals which readers should take note.

Firstly, C&O announced on 1 Dec 2010 that Sumitomo Corp bought a 29% stake in C&O at $0.50 / share, resulting in Sumitomo being the 2^nd largest shareholder. C&O is likely to be able to benefit with Sumitomo as a 2^nd largest shareholder. In addition, Sumitomo has indicated that it would want a majority stake in C&O eventually, i.e. a general takeover. (Do refer to the poems research report on 3 Dec 10)

Secondly, C&O is going to release its 2QFY11 results on 10 Feb 2011 during lunch break.

Thirdly, in the recent results release, C&O cautioned that revenue may be affected in the short run in view of the uncertainty in the government’s pricing policy. However, company is cautiously optimistic that the increase in sales quantity and demand for pharmaceutical products caused by the increase in government funding on medical care, will be more than enough to offset possible losses caused by lower prices in the long run.

Fourthly, with reference to Table 2 below, analysts’ consensus target price is around $0.63, representing a potential capital upside of 40%.

Table 2: Analyst calls on C&O Pharmaceutical

Source: Bloomberg (as of 28 Jan 11)

Conclusion – an opportunistic play

The risk to reward ratio seems favourable to initiate long trades (i.e. buy) starting at current levels via tranches on C&O with a horizon of 1-2 weeks (max). As this is an opportunistic trade with a short term horizon, readers should set their return expectations realistically and may have to settle for a small profit (if any) or even cut loss if necessary. Lastly, it is extremely important that this opportunistic trade involves risks which may or may not be suitable for all readers. Thus, I urge readers to evaluate this trade against their risk profile before initiating long trades.

C&O’s supports and resistances which are subject to change, are provided for reference only.

Price on 28 Jan 11: $0.450

Supports: $0.445 / $0.440 / $0.435

Resistances: $0.455 / $0.460 / $0.465

This is an amended version which I sent out to my clients over the weekend.

Disclaimer
The information contained herein is the writer's personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied.  In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials.

Techcomp - A consistent performer

Techcomp was covered or at least mentioned in a number of research reports after it posted sterling FY09 results in end Feb 2010. This coincided with an approximate 50% surge in share price from end Feb to early May with volume expansion (Refer to Chart 1). However, investor interest gradually dies down since May with dwindling volume and the reduction in analyst coverage.

Chart 1: Techcomp 1 year chart

Source: Shareinvestor (25 Jan 11)

For investors who are not familiar with Techcomp, it is a manufacturer and distributor of highly advanced scientific instruments, analytical instruments, life science equipment and laboratory instruments. These are used in laboratories for a multitude of industries such as pharmaceuticals, biotechnology, medicine, food and beverage etc. Manufacturing which commands higher margins, comprises of 19% of its FY09 revenue, with the balance coming from distribution segment.

Investment merits

Consistent track record

Techcomp is one of the most consistent companies which I have researched on. It has posted a 20% compound annual growth rate (“CAGR”) in net profit and revenue since FY02. This means that Techcomp can double its net profit and revenue every four years. Nevertheless, it will be increasingly more difficult to sustain such growth when its revenue and net profit base grow bigger.

Manufacturing arm to grow in the coming years

According to 1HFY10 results briefing, management indicated that the growth of their manufacturing business segment should outstrip that of distribution segment. This view is corroborated by the announcement on 30 Sep 10, where management has inaugurated a new facility to ramp up its production capacity for biological safety cabinets in October 2010. The rapid growth of the manufacturing segment bodes well for Techcomp as manufacturing segment commands higher margins than the distribution segment.

Acquisitions to contribute to bottom line in FY11 and beyond

In 2009, Techcomp acquired a 75% stake in HCC group and subsequently acquired the remaining 25% stake in 2011. It has also bought an 80% stake in Swiss based company, Precisa Gravimetrics AG (“Precisa”) for CHF3.5m in Feb 2010. As of 1HFY10, these acquisitions were still loss-making as there were some one off expenses related to the acquisition. Furthermore, Techcomp also allowed the subsidiaries to invest in R&D and sales networking in Europe to strengthen their presence which resulted in additional expenses (than if Techcomp did not acquire the companies).

According to 1HFY10 results briefing, management believes that these acquisitions should contribute positively in 2011.

Other growth initiatives

Techcomp has lined up a number of new products such as healthcare laboratory micro-plate reader and washer, Virto Diagnostic which will obtain the CE certification and obtain the medical license for the PRC market in the coming months. Secondly, Techcomp is also developing a proprietary Automatic Immunoassay System. This is also used for the clinical diagnostic market as well.

Thirdly, Techcomp’s French subsidiary is also finalizing the prototype for a healthcare product for the blood banking preparation market. Management has made plans to launch the new product by early 2011. Last but not least, Techcomp announced in Apr 2010 that it has entered into a joint venture with Shanghai Precision & Scientific Instrument Co., Ltd. for the manufacturing and distribution of analytical balance products in China. This joint venture has begun operations in 4Q and is expected to turn profitable in 2011.

Recent increase in stake

Kabouter Management which has first emerged as a substantial shareholder since 9 Apr 2008 has recently increased their stake in Techcomp to 9.02%. This was announced on 30 Dec 2010. For a fund to stay (increasingly) invested in a company for so long, there are likely to be some merits in this company worth looking into.

Cheap valuations vis-à-vis its peers

With reference to Table 1, according to Bloomberg, Techcomp trades at 6.2x 2011F PE. This is at a discount relative to Techno Medical, the next smallest player with a forward 2011F PE of 8.6x. It is noteworthy that the average 2011F PE (excluding Techcomp) for the larger and smaller peers are at 23.5x and 25.6x respectively. Techcomp seems to be trading at a substantial discount for a company with 20% CAGR in both revenue and earnings since FY2002.

Table 1: Techcomp’s valuations vis-à-vis its peers

Larger Diagnostic and medical equipment players by adjusted market capitalization
Short Name	Cur	Last Px	Analyst TP	Change in TP	1 Yr high	1 Yr low	Adj Mkt Cap S$m	FY10F PE	FY11F PE
Techcomp Holding	SGD	0.41	0.55	35.8	0.49	0.25	94.2	8.1	6.2
Shandong Weig-H	HKD	17.4	20.8	19.9	24.5	12.6	6,150.4	36.2	29.0
Hitachi High Tec	JPY	2,082.0	2,350.6	12.9	2,222.0	1,342.0	4,462.7	NA	NA
Biosensors Intl	SGD	1.13	1.35	19.5	1.26	0.69	1,246.7	23.8	18.0
Horiba Ltd	JPY	2,290.0	2,534.0	10.7	2,933.0	1,905.0	1,515.7	NA	NA
Average ex Techcomp								30.0	23.5
Smaller Diagnostic and medical equipment players by adjusted market capitalization
Guangdong Shir-A	CNY	7.7	NA	NA	12.4	7.1	695.6	31.0	25.8
Da An Gene Co -A	CNY	12.3	NA	NA	17.5	9.5	692.6	59.2	44.8
Shinva Medical-A	CNY	23.3	21.0	-9.7	30.7	13.1	608.5	50.9	34.2
Japan Lifeline	JPY	580.0	NA	NA	609.0	478.0	102.0	NA	NA
Techno Medica	JPY	290,000	NA	NA	300,000	255,000	131.8	9.7	8.6
Pacific Hospital	TWD	115.5	142.7	23.5	140.0	74.7	275.5	17.3	14.8
Average ex Techcomp								33.6	25.6

Source: Bloomberg as of 25 Jan 11

Investment risks

Illiquidity is the big drawback

According to Bloomberg, the average 30D and 100D volume for Techcomp are about 129,000 shares and 113,000 shares respectively. This is rather illiquid and investors have to take this into consideration when they are evaluating this company.

Insufficient analyst coverage

As mentioned before, Techcomp was covered or at least mentioned in a number of research reports after it posted sterling FY09 results in end Feb 2010. Nevertheless, this interest seems to fade over time. This is apparent after its release of 1HFY10 results where only a couple of research firms wrote a short note on it.

Conclusion

With reference to Table 1, Techcomp is trading at a substantial discount to its peers. If Techcomp can consistently deliver on its results and net profits, it is likely that it will capture the attention of the investment community over time.

This is an amended version of the write-up which I have sent to my clients recently.

Disclaimer
The information contained herein is the writer's personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied.  In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials.