1 Dirt-Cheap Value Stock That May Not Be A Bargain After All

With the people of UK voting to leave the European Union, stock markets around the world, including Singapore’s, have fallen in response. If any declines continue due to fears of negative impacts from Brexit, that could mean more bargains appearing.

But, it’s worth noting that not every stock with a low valuation is a bargain. Here’s one potentially dangerous dirt-cheap value stock: Dukang Distillers Holdings Ltd (SGX: BKV).

Why it’s cheap

There’s a good reason why I used ‘dirt-cheap value stock’ to describe the aptly-named spirits distiller, Dukang Distillers. That’s because the company is a net-net stock at its current stock price of S$0.775.

In the investing world, a net-net stock is one with a market capitalisation that’s lower than its net current asset value. The net current asset value in turn, is found by subtracting a company’s total liabilities from its total current assets. The following’s a table showing just why Dukang Distillers is a net-net stock.

Dukang Distillers' net current asset value
Source: S&P Global Market Intelligence

Theoretically, a net-net stock is a great bargain because investors can get a discount on its current assets (assets such as cash and inventory, among others) net of all liabilities. Meanwhile, the stock’s fixed assets (assets such as properties, factories, etc.) are thrown in for free.

The risks involved

But, that’s not to say that all net-net stocks are a sure-fire way to riches. Net-net stocks have their risks too – they’re often deeply-troubled companies. This makes sense. Companies with a healthy, thriving business, would rarely be available at such a low valuation.

In the case of Dukang Distillers, its business has been in really bad shape. In its fiscal year ended 30 June 2013 (fiscal 2013), the company raked in RMB2.41 billion in revenue and RMB390 million in profit. But by fiscal 2015, its revenue had plunged by nearly two-thirds to RMB863 million. The bottom-line was worse, as the company had suffered a loss of RMB561 million.

The first three-quarters of fiscal 2016 saw Dukang Distillers log a loss of RMB2.5 million, although there were some improvements seen; revenue for the period had climbed by 1.8% year-on-year and the company’s loss had narrowed dramatically from the RMB23.9 million seen in the previous year.

But that’s not the only problematic issue with Dukang Distillers. The company was listed on September 2008. From fiscal 2009 (as a reminder, this is the fiscal year ended 30 June 2009) to fiscal 2015, the company has produced negative free cash flow in totality, as the table below shows:

Dukang Distillers' free cash flow
Source: S&P Global Market Intelligence

In other words, the company has failed to generate positive free cash flow for most of its life span as a listed entity.

A Fool’s take

Dukang Distillers’ dramatic decline in revenue and profits as well as its inability to generate positive free cash flow over a period of six years should not be seen as signs that the company will definitely be a poor investment going forward.

But, they are still important risks to note for investors who are interested in Dukang Distillers by virtue of its low valuation.

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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 Chong Ser Jing doesn't own shares in any companies mentioned.