China 3C has Q2 Setback, Remains Undervalued
China 3C Group (CHCG) may have experienced a drop in the sales in its consumer electronics, but a robust turnaround plan could help this value-priced stock turn around.
China 3C Group [[CHCG.OB]], which resells and distributes consumer electronics in China, has seen its stock drop precipitously as lower gross margins and higher operating expenses ate into net income during the first quarter. Meanwhile, the good news – a jump in sales – can be largely attributed to a snow storm during the comparable year.
However, China 3C did manage to earn $0.07 per share and management remains committed to improving results going forward. With a price-earnings multiple of just 2x trailing and 3.2x projected earnings (assuming $0.28 for the year), this stock could quickly turn into a bargain if sales turn themselves around during the later part of the year.
The Store-in-Store Model
Currently, China 3C operates primarily via a store-in-store model, where it negotiates for space in a larger retail chain like Best Buy or Trust-Mart. The low overhead costs associated with this strategy has allowed the company to quickly expand its operations, while realizing a higher return on assets and return on investment.
Unfortunately, increased competition has led to lackluster sales and pressure on its profit margins. The company spent the last few months playing catch-up, by increasing employee salaries and marketing expenses to try and increase their competitive edge within the stores, but the strategy wasn’t effective during the first quarter.
Retail Franchise Operations
In March 2009, China 3C announced that it would establish a retail franchise operation in order to shift expenses onto franchisees and increase its margins. The company’s existing retail operations would be kept as models, but more than 100 franchise locations in more remote parts of Eastern China would be setup to drive growth in 2010.
China 3C expects these franchise stores to pay 20% to 30% of their monthly net income as a royalty to the company, while it will also generate 1% to 2% net profit from products sold to the franchisees. Additional revenue opportunities will also be available in the form of rebates from product manufactures after 100 stores are opened.
The franchise operations will be supported by China 3C’s acquisition of Jinhua Boafa Logistic to transport the goods. Based on these projections and assumptions, the company believes that the franchise operations can generate 7% net margins on an annualized basis and will contribute to healthier inventory management and operating cash flows.
Show Me the Money!
China 3C also has a lot of hidden value in its balance sheet in the form of a massive cash stockpile. Last quarter, the company reported cash and cash equivalents of $28.6 million or $0.54 per share. Given that the current share price stands at just $0.92 a piece, this represents a substantial piece of value that has been overlooked by investors.
Subtracting out the cash from China 3C yields a share price of just $0.38, which equates to a trailing price-earnings ratio of less than 1x and a projected price earnings ratio of less than 2x. As a result, even if the company’s growth has temporarily reversed, the stock could still be sharply undervalued upon any recovery.
In the end, China 3C expects its store-in-store locations to continue generating the majority of its income for the foreseeable future. However, the retail franchise operations could help diversify its revenues and increase its profitability down the road. Meanwhile, the company’s cash stockpile makes it a compelling bargain if management can pull off an effective turnaround.
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