XPD Soccer Gear Group Ltd (ASX: XPD) listed on the ASX last week and immediately saw its shares double from 20 cents at IPO to 40 cents.
Interestingly, shares opened trading at 30 cents, rose as high as 40 cents, before closing at 38 cents. Today, shares are trading at 37 cents, having dropped 5.1%, although shares are highly illiquid with key executives holding around 80% of all shares on issue.
XPD says it is involved in the manufacture, distribution and sale of sportswear products, particularly XPD-branded football/soccer boots, clothing and apparel. The company also says it manufactures sportswear products for international brands Joma, Kinetix and Yonex, although that only represents about 5% of sales.
The company says it is one of the leading retailers in China, with distribution to more than 1,900 retail outlets throughout China and a 14.6% market share behind Adidas and Nike in 2013. But with sales of around A$58.6 million last financial year into a market valued in the billions, that appears hard to swallow. As part of its strategy, XPD says it intends to build its own retail network and continues to sell its products through a range of online stores.
As some readers might know by now, I remain sceptical of Chinese businesses listing on the ASX and not providing shareholders with more insight into their operations, given the difficulty of verifying the reports. The recent failure of huge solar company Hanergy Thin Film, which was listed on the Hong Kong Stock Exchange, and the recent history of Chinese companies listing on overseas exchanges suggests it may be better to avoid these companies at all costs.
You can read an in-depth article here on Hanergy and its spectacular fall from grace, and alleged proof from Australian fund manager John Hempton here that the company is a huge fraud. This was a multi-billion dollar company too, not some tiny Chinese retailer, and one has to question why the company's auditors never suspected anything. Maybe it's because Western auditors aren't granted full access to Chinese companies' financial information.
The curious investment
I'm especially cautious when I see things that are out of the ordinary. In the case of XPD, I'm curious why the company has invested $14.9 million to receive a 26% interest in Henan Yuanlong Industrial Co., Ltd, which includes an additional investment of $7.2 million between September and December 2014.
Henan Yuanlong is apparently constructing a production facility and footwear raw material wholesale centre, which XPD plans to lease 25,000 sqm at a cost of $1.5 million per year according to my calculations.
However, searching the web for Henan Yuanlong Industrial Co appears to uncover one company – an aluminium producer. Now that may mean nothing in and of itself of course.
But add in controlling shareholdings of CEO and chairman, transactions with related parties, particularly in regard to Jinjiang XPD Import and Export Co. Ltd – which is 20% owned by XPD's managing director Jiameng Zhang, and the number of red flags start rising. Growth has been nothing short of spectacular, with net profit rising from $1.7 million in 2011 to $11.9 million in 2013 and around $15 million in 2014, while profit margins are large at 20% or above. Bank loans secured by guarantees from key executives, including the chairman's brother and wife, and other unrelated third parties also raise concerns. That might be common practice in China, but most definitely is not in Australia.
Summary
XPD may well be on the level and a small Chinese company trying to compete against the likes of giants Adidas and Nike.
The problem for Australian retail investors is that there's no real way to verify anything the company says in its reports without visiting China themselves, and we have to rely on audit reports.
But if multi-billion dollar companies like Hanergy can fall over despite being audited by a top 4 accounting firm, it's clear that audit statements and auditor reports on Chinese-listed companies aren't worth the paper they are printed on – as we warned last year.
Being successful at investing doesn't just mean finding great companies at cheap prices, it also means avoiding those that could do serious damage to your portfolio.
Buyer beware.
