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Merchant House International a Stock for the Bargain Hunter

- By Tuomo Saarnio

Merchant House International Ltd. (MHI.AX) is a designer, manufacturer and marketer of leather boots and shoes, home and seasonal decorative items and home textiles. The company operates in three segments: home textile, footwear manufacturing and footwear trading.

It is engaged in sourcing, producing and selling consumer products in the U.S., Australia, Canada, the U.K. and Europe.

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

The company was founded by Loretta Lee in 1978, and the footwear division has been active since 1980. Lee owns 53.4% of the outstanding shares, and she has been executive chairwoman of the board of Merchant House International since July 15, 1994.

Lee began her career in market research, working for an international advertising agency as research director. In 1972 she founded TransMarket Research Ltd., in partnership with ASI of Los Angeles. In 1978 she decided to capitalize on her international experience and explore those business opportunities.

Merchant House International

  • Market Cap: 16.97 million Australian dollars ($12.879 million).
  • Price: 0.19 Australian dollars (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 U.S. The main export market is the U.S. (97% of revenue), although merchandise is also sold to buyers in Australia, Canada, the United Kingdom and Europe. Customers in the U.S. include major importers as well as many of the leading retailers. It is also worth mentioning a strong customer concentration.

In 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.

Lee chose to open a plant in the U.S. because closer to the market, you know what consumers want. Her investment at the plant in Jefferson City, Tennessee, 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 U.S. 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 U.S. and China in production costs has narrowed.

Merchant House has supplied work shoes to the U.S. 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 the loss of a major customer. This is coupled with a decrease 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. The home textile segment brings 56% of revenue, and footwear trading and manufacturing account for 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 pressure if the company's business is not profitable.

Merchant House's cash and cash equivalents make up 64% of its current assets. Anyway, the 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?

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

One reason for low valuation is that Merchant House is being listed in Australia and because of that it is 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 a normal story with most of the net-nets, and that is why the believers of Benjamin Graham's old strategy need patience.

Disclosure: No position.

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This article first appeared on GuruFocus.