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Is This Cheap-Looking Company A Trap For Investors?

There are many companies that appear cheap based on valuation ratios. However, it can be difficult at times to know which shares are really cheap and which are in actual fact, value traps.

We recently did an interview with value investing legend Professor Bruce Greenwald and part of our discussions were on value traps. According to Greenwald, a value trap is a company which has assets, but the management team might not be utilising the assets in shareholders’ best interests. Management can misuse assets in two main ways: 1) Making unwise acquisitions; and/or 2) holding large piles of cash instead of distributing it to shareholders

From a quick scan done on Singapore Exchange’s website, I found that China Yuanbang Property Holdings Ltd. (SGX: B2X) is trading at an extremely “cheap” valuation. The company is valued at a price to earnings (PE) ratio of only 2.3 and has a price to book (PB) ratio of 0.46. In comparison, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks Singapore’s market barometer the Straits Times Index (SGX: ^STI), has a PE ratio of 13 and a PB ratio of 1.3.

Let’s see if the company passes the value trap test.

China Yuanbang is a property developer based in Guangzhou, China and focuses on providing residential and commercial properties to the middle- and high-income market segments. According to China Yuanbang’s latest annual report for the financial year ended 30 June 2014 (FY2014), it was able to grow its revenue from RMB287 million in FY2010 to more than RMB1.3 billion in FY2014. Its bottom-line also improved tremendously as a loss of RMB98 million in FY2010 had turned into a profit of RMB144 billion by FY2014.

Management has managed to turn China Yuanbang’s business around and in FY2014, the company even managed to generate a return on equity of 20%. The company has also started to distribute some cash back to investors as it paid a dividend of RMB1 cent per share in FY2014.

Despite its strong growth thus far, investors might want to watch the company’s high net debt (total cash minus total borrowings) to equity ratio of 105.7%. Management has warned about a possible slowdown in China’s property market; that coupled with a  high debt load might not be an ideal situation for China Yuanbang to be in.

But all that said, there’s nothing about the company’s actions which suggests that it might be a value trap. So, am I missing something or is the market being overly harsh on the company due to the fact that it is an S-chip (China-based companies which are listed in Singapore)?

Foolish Summary

Although the company seems to pass the value trap test, one has to be mindful of the reputation of S-Chips in our local market. In Singapore, it seems that S-Chips have received a label of “guilty until proven innocent” – in other words, the market often thinks that a company’s fundamentally broken in some way or another unless proven otherwise. It might be a long time before S-chips will regain the trust of investors again.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.