Merchant House International a Stock for the Bargain Hunter

Merchant House International Limited is a designer, manufacturer and marketer of leather boots and shoes, home and seasonal decorative items, and home textile. The Company operates in three segments: Home textile, Footwear manufacturing and Footwear trading.

Company is engaged in sourcing, producing and selling consumer products in USA, Australia, Canada, UK and Europe.

Merchant House International Limited is incorporated in Bermuda. The company is listed in Australia, but has its headquarters in Hong Kong and their factories are mainly located in China.

The company was founded by Ms Loretta Lee in 1978 and the footwear division has been active since 1980. Loretta Lee owns 53.4% of the outstanding shares and she is Executive Chairperson of the Board of Merchant House International, since July 15, 1994. Ms Lee began her career in market research, working for an international advertising agency as research director. In 1972 she founded TransMarket Research Limited, in partnership with ASI of Los Angeles. In 1978 she decided to capitalize on her international experience and explore those business opportunities. Ms Lee is already over 80 years old so investors should be prepared for the time after her. It is difficult to say is it more of a threat or an opportunity in this case.

Merchant House International (ASX:MHI)

Market Cap: 16.97 M AUD

Price: AUD 0.19 (Net Cash 0.12, Net-Net Working Capital 0.22, Net Current Asset 0.27)

Price/NCAV: 70%

F-Score: 7

Z-Score: 3.84

Debt to Equity: 0.02

Dividend Yield: 2.6%

EV/EBIT: 3.95

Merchant House International’s customers are primarily located in the United States. The main export market is US (97% of revenue), although merchandise is also sold to buyers in Australia, Canada, the United Kingdom and Europe. Customers in US include major importers as well as many of the leading retailers. It is also worth mentioning a strong customer concentration.

Over recent years the company has faced secular headwinds as competitors have moved their production out of China to lower cost areas.  To meet this changing competitive situation the company has organized a new subsidiary and opened a footwear manufacturing facility in Tennessee.

Ms Lee chose to open a plant in the US, because closer to the market, you know what consumers want. Her investment at the plant in Jefferson City was in the order of $5 million, but she intends to double production over the next two years. So far the plant has underperformed. Merchant House’s low labor costs in China cannot be matched in the US. Though it is true that in recent years the trend of moving production to China seems to be reversing to some extent. As minimum wages have been increased in many Chinese regions the gap between the US and China in production costs has narrowed.

Merchant House has supplied work shoes to the United States of America for almost 30 years. Although they are well established suppliers to major discount retail chains on a direct basis the footwear trading segment suffered a decline in sales due to loss of a major customer. And this is coupled with a decreased in orders due to changing customer preferences.

Sales of home textiles remained stable and has increased in recent years. Seasonal fluctuations have a significant impact on this segment. Home textile segment brings already 56% of revenue and footwear trading and manufacturing the remaining 44%. A few years ago the situation was reversed.

Management seems to be shareholder friendly as the company has paid regular and occasional special dividends. Of course dividends are always under the pressure if the company’s business will not be profitable.

Merchant House’s cash and cash equivalents make up 64% of its current assets. Anyway company’s balance sheet is very strong. There’s a good downside protection and the company is safe. Could this be a classic “buy a dollar for 50 cents” play? Why not.

I’m pretty sure that Merchant House will still produce most of its products in China for the foreseeable future. They have a long history of profitable operations, positive free cash flow and the large discount to book value, despite of recent headwind, I think Merchant House International has a good chance of a good future. I dare recommend this stock as an addition of a broader diversified net-net portfolio.

I think one reason for low valuation is that Merchant House is being listed in Australia and because of it a little bit forgotten.

Maybe the biggest risk is that nothing will happen in the near future and the stock will trade at the same low level for longer time. It is normal story with most of the net-nets and that is why the believers of Benjamin Graham’s old strategy need patience.

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