Hollysys Finds Its Future In Its Past, But Investability Is A Real Question

 

I should have known better than to think anything with Hollysys Automation Technologies (HOLI) would be simple or straightforward.

When I last wrote about this Chinese manufacturer of process automation and rail control systems, I said that with a solid $23/share offer in hand from an investor group on good terms with the board, a buyout at an attractive price for shareholders looked far more likely.

I couldn’t have been more wrong. In a series of events that included bringing back the original CEO (and a member of that $23/share bidding group), the company has instead decided to stay independent and eschew further evaluation or consideration of go-private bids. They also, finally, posted results for the quarter ended on June 30, 2021 … in mid-February.

As for me, I’m done with this stock for the time being. Maybe things will settle down and return to a more acceptable level of communication and reporting with the management changes, but between an auditor change, generally poor communication with investors, and a lot of operational uncertainties, I don’t see the need to bother with this one. Yes, the shares could perhaps be substantially undervalued, but I’d rather earn less money with a lot less hassle elsewhere.

 

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Hollysys Finds Its Future In Its Past, But Investability Is A Real Question

Inconsistency Continues To Offset HollySys's Potential

China’s HollySys Automation (HOLI) remains a frustrating stock, as the company’s inconsistent operating performance makes it a difficult name for investors to trust. Now take explicit guidance for the next year out of the mix and it becomes an even murkier situation, particularly as there is not a lot of visibility as to rail order/contract win timelines.

HollySys still has attractive opportunities. The company is gaining share in China’s process automation market and is starting to make a bigger push into factory/discrete automation. Rail orders remain consistently inconsistent, but opportunities in subways/metro should offer upside, and the M&E business could still benefit from China’s long-term One Belt One Road initiatives. Valuation really doesn’t look very demanding, but consistent execution has never been a strong point to this story, and I can understand why investors would stay clear.

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Inconsistency Continues To Offset HollySys's Potential

Seeking Alpha: HollySys Hanging On, But The Rope Is Slippery

HollySys (NASDAQ:HOLI) has been doing better than I thought it would. Companies in the automation space have recovered pretty well from the doldrums of late 2015/early 2016. While HollySys has lagged the likes of ABB Ltd. (NYSE:ABB), Rockwell (NYSE:ROK), Honeywell (NYSE:HON), and Emerson (NYSE:EMR), the 10% rise in the stock price since my last update is better than I would have expected given the ongoing pressures and challenges in China.

To be sure, the path ahead for the company is not smooth. China, HollySys's largest automation market, has put the brakes on new coal-fired power gen in many parts of the country, and it doesn't seem as though high-speed rail orders are going to come roaring in at a strong pace. Expansion into new process automation, discrete automation, and rail markets should keep HollySys growing, but the stock's apparent undervaluation does come with above-average risk.

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HollySys Hanging On, But The Rope Is Slippery

Seeking Alpha: HollySys Executing Well, But Process Automation Is A Rough Neighborhood

I still believe that there will be substantial adoption of discrete and process automation in the coming years, and that key markets like China will increasingly look to substitute products sold by ABB (NYSE:ABB), Fanuc (OTCPK:FANUY), and Honeywell (NYSE:HON) with "home-grown" solutions. The problem for companies like HollySys (NASDAQ:HOLI) (also sometimes spelled "Hollysys") is that by no means precludes some pretty scary stretches of end-market weakness along the way.

Process automation is a pretty rough place to operate right now; Honeywell did fine in the fourth quarter, but ABB and Emerson (NYSE:EMR) were both in the range of double-digit revenue declines due to ongoing weakness in markets like oil/gas, chemicals, and metals. That doesn't help HollySys right now, particularly as the company is trying to diversify into chemicals, but the company does at least have a growing rail business to help it along.

I continue to believe that HollySys is an interesting, albeit risky, play on the growth of domestic automation companies in China. I'm still looking for long-term growth in the high single-digits, with a fair value of around $23 stemming from that. Given the surplus of cheap, relatively safer plays right now, though, I can understand that HollySys likely won't feature very high on most investors' buy lists.


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HollySys Executing Well, But Process Automation Is A Rough Neighborhood

Seeking Alpha: China's Economic Challenges Making Life More Difficult For HollySys

As a company that generates the lion's share of its revenue and profits from capital spending in China, the last year has not been an easy one for HollySys (NASDAQ:HOLI) (also sometimes written as "Hollysys"). Like Siemens (SI) (OTCPK:SIEGY), Rockwell (NYSE:ROK), ABB (NYSE:ABB), and the rest of the factory and process automation sector, HollySys has seen a sharp correction in demand for automation systems. While the rail system business has offset this to some extent, here too orders have been inconsistent.

It's difficult to strongly recommend a stock that is so heavily exposed to capital spending in China at a time when China's economic outlook is still murky at best. Patient value investors will argue that that's the time you want to go shopping, and while I agree with that sentiment, the reality is that investors considering HollySys's shares need to brace themselves for the possibility that the business hasn't yet bottomed and that there could be downside risk ahead of a recovery. I still believe that this company can be a high-single-digit grower over time, though, and the stock should trade closer to the mid-$20s.

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China's Economic Challenges Making Life More Difficult For HollySys

Seeking Alpha: Wabtec Looking To Leverage Mandates And Grab Foreign Share

Value investors have nightmares about stocks like Westinghouse Air Brake Technologies (NYSE:WAB) (or Wabtec). The shares are expensive by most conventional metrics, but the company has roughly doubled its margins over the past decade and only scratched the surface of its market share opportunities outside of North America. Skilled at both product development and M&A, Wabtec has tied itself to the ongoing growth and use of both freight and transit rail - arguably as close as you can get to a sure thing in the industrial world.

Valuation remains a challenge when it comes to this stock. On one hand, projecting double-digit annualized revenue growth for a company that is already generating more than $3 billion a year in revenue and has more than 50% share in its core market is aggressive. On the other hand, while replicating such impressive share outside of North America is by no means guaranteed, getting only half that would still be more than enough to support 10%-plus revenue growth.

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Wabtec Looking To Leverage Mandates And Grab Foreign Share

Seeking Alpha: HollySys Needs To Ease Concerns Over Slowing Automation And Rail Orders

While I thought that the shares of HollySys Automation Technologies (NASDAQ:HOLI) might have been getting ahead of themselves back in August of 2014, the shares managed to go up another 10% or so before disappointing fiscal second quarter results and concerns about the outlook chopped off about one-third of the company's market valuation.

HollySys shares have rebounded about 20% from the recent low, but there are still some real questions about the near-term outlook. Investment in the company's largest automation sectors has slowed significantly and management's efforts to address higher-growth sectors and new markets will take time to bear fruit. Elsewhere, the potential of new rail products is matched against worries of substantially lower rail investment spending in the next couple of years.

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HollySys Needs To Ease Concerns Over Slowing Automation And Rail Orders

Seeking Alpha: Wabtec Is High-Priced And High-Quality In Equal Measure

Westinghouse Air Brake Technologies (NYSE:WAB), or Wabtec, is the sort of company that chronically only looks cheap in the rear view mirror. Wabtec has strong share in the relatively concentrated U.S. market for technologies and components that go into rail cars, locomotives, and transit cars/locomotives, and is moving to replicate that share overseas. Add in a willingness to acquire its way into new markets and an increasing mix of electronic components, and the basic market opportunity looks appealing.

Now, what do you want to pay for it? Wabtec already trades at more than 13x forward EBITDA and appears to price in mid-to-high teens annual FCF growth for the next decade. There's little argument that Wabtec is a leader in large markets and produces strong returns on capital, despite an aggressive ongoing M&A policy. For investors who can take a "don't worry, be happy" view on valuation and/or make a credible argument that Wabtec's growth rate will exceed that which is already implied in the valuation, Wabtec could still be a name to consider but value-focused investors may find it a harder case to make.

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Wabtec Is High-Priced And High-Quality In Equal Measure

Seeking Alpha: Hollysys Offsetting Weak IA With Strong Rail

Chinese automation and control systems developer HollySys Automation Technologies (NASDAQ:HOLI) continues to come along nicely. The shares are up more than 100% from when I first mentioned them on Seeking Alpha, and up more than 20% since my last write-up, as the company continues to gain share in the Chinese industrial automation sector and leverage growth in train infrastructure. Although the shares are not extremely cheap (at least not on the basis of my current assumptions), the opportunity to leverage double-digit underlying growth in rail infrastructure and take more share in the industrial automation market, all while growing its ex-China business, is still pretty significant and I wouldn't be in a hurry to exit or dismiss this story.

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Hollysys Offsetting Weak IA With Strong Rail

Seeking Alpha: Wabtec Remains A Frustrating Mix Of Quality, Opportunity, And Expectations

Locomotive and train car components manufacturer Wabtec (WAB) has missed revenue expectations for four straight quarters, but it hasn't done any harm to the sentiment on the stock. These shares are up more than 60% for the past year and over 100% over the past two years, as investors continue to play their enthusiasm for a rail infrastructure build-out in the U.S. and the potential for Wabtec to replicate its "components on almost every car" market share in North America, in Europe and Asia.

Wabtec also remains a frustrating company to evaluate from a valuation perspective. If Wabtec could hold 20% overseas market share by 2023 in those areas, where it has roughly 50% share in North America, a fair value above $100 is definitely reasonable. On the other hand, these shares already trade with significant near-term expectations, and it could take more than a decade to build significant share in markets like Russia or China.

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Wabtec Remains A Frustrating Mix Of Quality, Opportunity, And Expectations

Seeking Alpha: Strong Orders And Large Markets Keep Hollysys Moving Forward

The combination industrial automation and train signaling/control story that is Hollysys (HOLI) continues to improve. Building on solid share in its existing businesses, Hollysys is adding products and targeting end markets that should billions to its long-term addressable opportunity. Although the stock has doubled the return of the S&P 500 over the past year, the company is still largely unknown and the prospects of many years of strong revenue and FCF growth still argue for owning these shares.

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Strong Orders And Large Markets Keep Hollysys Moving Forward

Seeking Alpha: Hollysys Automation Still Good, Just Not As Cheap

I last wrote about HollySys Automation (HOLI) on December 18, 2012 ("HollySys Looks Like A Name To Watch..."), saying at the time that I thought it was a very interesting (and undervalued) company in the Chinese industrial automation and trail/subway control markets. Since then, the shares have risen about 34% - doubling the return of the S&P 500, and doing considerably better than other players in automation and mass transit like Siemens (SI) (up 5%), ABB (ABB) (up 10%), Emerson (EMR) (up 20%), Invensys (up 22%), Rockwell (ROK) (up about 23%), and even Honeywell (HON) (up about 32%).

Certainly plenty has happened over the past nine months, including ongoing struggles in the Chinese industrial automation market and delays in rail and subway projects. Along the way, HollySys also spent about $73 million on an acquisition in Singapore/Malaysia, and continued to make progress with its automation portfolio. I no longer see HollySys as a table-pounding buy, but I'd suggest current owners hang on and non-owners keep this one on their watch list.

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Hollysys Automation Still Good, Just Not As Cheap

Seeking Alpha: Hollysys Looks Like A Name To Watch In Emerging Market Automation

Investors do well to hold on to a thorough skepticism when it comes to small Chinese companies, but Hollysys Automation Technologies (HOLI) looks like a name that aggressive investors should get to know better. While it is a lofty goal indeed to say that Hollysys could become the next ABB (ABB), Siemens (SI), Emerson (EMR), or Rockwell (ROK), Hollysys has already shown that it can carve out a meaningful niche against these large foreign competitors in China's fast-growing automation market.

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Hollysys Looks Like A Name To Watch In Emerging Market Automation