Saturday, February 27, 2016

41st AIM Equity Update by Daniel Fernandez. HollySys Automation Technologies Ltd. (HOLI): “HOLI Schneikes - This Firm Faces Some Challenges”

HOLI (HollySys Automation Technologies Ltd.): “When (or If) Chinese Stocks Come Back in Favor, Keep Your Eye on HOLI”
By: Daniel Fernandez Guerra, student at Marquette University

Image result for hollysys logo

Disclosure: The AIM International Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.


HollySys Automation Technologies Ltd. (NASDAQ: HOLI) engages in the provision of automation and control technologies and applications in China (77.3%), United States (5.9%), Japan (1.6%), Brazil (0.8%) and Western Europe (3%).

• Small-cap stocks have become a primary attraction for investors for 2016 as analysts expect low returns from the S&P.

• HollySys Automation Technologies remains highly liquid and has experienced an expansion of its margins recently.

• HOLI has some delayed projects that have caused revenue to slow. However, when these projects are fully implemented, they will become the basis of the company as it would ensure its growth and competitiveness.

• HollySys Automation revenues increased 17.3% in FY2016 Q2 compared to FY2015 Q2

• The company’s stock hit an all-time 52-week low price of $15.00 on January. HollySys has been affected by the underperforming numbers that China presented compared to analysts’ expectations.

Key Points: HollySys has been on a tightrope due to the current uncertainty of the Chinese economy and the weakened currency. The significant slumps in their stock price since December 29, 2015 has been a reflection of the ambiguity in the country. Shares went down from $22.59 to $15.29, 32% decrease in less than a month. This decline can be seen as a clear reflection for investors that are slowly staying away from small to mid-cap Chinese companies.

On February 4, 2016 the company announced its earnings call for Q2 2016 results. Despite the stock price dramatic decline, HOLI reported solid numbers. Total revenues were $152.77M compared to $125 in the previous quarter. Net Earnings reached $32.95M, almost 14M higher than the same quarter of last fiscal year. Earnings per Share (EPS) stayed consistent at 0.54, similar to the past three quarters. An outstanding figure was the widened of the gross margins, going from 37.08% to 39.65% compared to the same period last year. Lastly Operating EBITDA scale almost 6%, being at 20.36% from 14.51%.

The company’s earnings growth was inclined by improvements from one year to another in gross margins from 37.08% to 39.65% as well as better cost controls. Management has shifted its focus to start working on expanding for new Railway Transportation products and technologies such as track circuit which would make potential revenue contribution in the near future. Along with this, management has stated their intentions to gain market share in the High Speed Rail market as it has become the principal contributor for their total revenues.

What has the stock done lately?
HollySys has been investing in several projects and contracts to its different segments in order to increase the market share. The power segment has maintained stable, HOLI has been able to sing large and important contracts that create large number of high-level generator units. In regards to the Railway Transportation segment which accounts for the largest portion of its revenues ($63.8M in Q2), HollySys signed a large contract to provide Automatic Train Protection equipment and system to China Railways Corporation which is expected to make a large revenue impact in short-term. 

Lastly, a key catalyst for the stock price will be the performance of the Industrial Automation segment ($54.2 M) that due to the weak macro environment, the IA business experienced a revenue contraction. Analyst believe that this trend could continue through the rest of the fiscal year given the strong backlog for the rail segment (50% of total excess 2QFY16) and weak IA sales trend.

Past Year Performance: HollySys Automation Technologies was bought at $23.49 on May, 2015. The company is currently trading at $17.74, representing a -25% decrease in value since it was added to the international portfolio. Most analyst have been given a price target to HOLI of ~$30, and they have not make adjustments despite the poor performance of the stock. The reason for the recent unfavorable performance can be attribute to the unexpected slowdown in China as well as in the railway market, and to its slow overseas expansion.

Source: FactSet

My Takeaway

HollySys Automation Technologies' revenues comes primary from China (77.3%) which represents a big risk for the company. China’s economy has entered into a slowdown stage and has been continuously devaluing its currency in order to stay worldwide competitive. The lack of diversification can be one of the biggest areas of improvement for the company. However, despite the tough conditions that the company is facing, management has followed a strategy that consist on developing aftersales and services which has been successful and has continuously helping to take a larger percentage of their revenue.

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