Is This Cheap Looking Share A Legitimate Bargain?

Midas Holdings Ltd (SGX: 5EN) might be a company that would attract the attention of bargain hunters at the moment.

At its current price of S$0.38, the share’s valued at just 0.7 times its latest book value. In comparison, the SPDR STI ETF (SGX: ES3), an exchange-traded fund which closely mimics the fundamentals of Singapore’s market benchmark the Straits Times Index (SGX: ^STI), has a price-to-book ratio of 1.33.

But, that doesn’t mean that Midas is necessarily a legitimate bargain. After all, like my colleague Chong Ser Jing wrote previously, “cheap shares – even dirt-cheap ones – can still go on to become extremely expensive mistakes if their businesses deteriorate over time.

Let’s take a deeper look at Midas to find out more.

An introduction

Midas is not a very well-known company amongst investors in Singapore, but it does have a sizeable market capitalisation of S$460 million and is a leading manufacturer of aluminum alloy extrusion products for the rail sector in China.

The highly regulated rail industry in China has been facing massive upheavals in recent years following the breakup of the country’s Rail Ministry in 2013. The breakup is part of the central government of China’s plan to fight corruption, an effort which has been ongoing since 2011.

Midas has three main business divisions:

  1. Aluminum alloy extruded products
  2. PE (polyethylene) pipe
  3. Aluminum alloy plates and sheets

Midas’s products are not exclusively used in the rail industry, but it’s worth noting that more than 80% of the firm’s revenue in 2014 comes from rail-related activities. It thus follows that the progress of the rail industry in China will have a big impact on the company.

Hopping on the train to growth

Midas’ top-line has been growing at a brisk pace these past few years; the firm’s revenue growth in 2014 and 2013 came in at 37% and 60% respectively. But, there seems to be a slowdown as Midas was only able to achieve 8% revenue growth in the first quarter of 2015. And as a result of higher operating costs, the company ended the quarter with flat earnings.

Still, Midas believes that there is further room for growth and that the room is big. In the earnings release for the first quarter of 2015, Midas commented that the recent merger of CSR Corporation Ltd and China CNR Corporation Ltd, two of China’s largest train manufacturers, is “likely to increase China’s competitiveness in the global railway market.”

Moreover, the Chinese government has plans to invest heavily – to the tune of RMB2.8 trillion over the next five years – into the rail industry.

But dangers lurk too

That being said, uncertainties still plague the rail industry in China. Just last year, Bai Zhongren, the president of rail industry player China Railway Group, committed suicide; that’s just one out of the many series of deaths and corruption-related investigations that have happened within the rail industry.

In addition, the rail industry in China is also suffering from a debt crisis. With many of its clients in China having to tackle problems related to their debt-laden balance sheets, the impacts on Midas’ business won’t be positive.

In fact, Midas is itself facing some high financial risks. As of 31 March 2015, the firm’s net debt to equity ratio stands at an alarming 95%; in the first quarter of 2015, the firm’s interest coverage ratio (using EBIT over interest expenses) was just 1.6. These figures show that Midas does not much room for error.

Foolish Take

Midas needs to 1) have a firm grip on its operational costs and 2) pare down its borrowings. With the figures we’re seeing, Midas likely can’t afford to have the Chinese rail industry undergo a sharp slowdown.

Bargain hunters would need to be cognizant of the risks involved with the firm despite the presence of some strong tailwinds which might aid its business.

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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 writer Stanley Lim does not own any companies mentioned above.