Van Shung Chong has transformed itself from a Hong Kong trader into a China industrial play, winning investor notice Investors could be forgiven for not knowing the business of Van Shung Chong Holdings. Its small profits have put the company far below the radar screens of many players, even small-cap enthusiasts. But a pair of fund managers - reportedly Value Partners and Barings, according to sources - have taken notice. The two fund managers have apparently bought shares in Van Shung Chong (which is a steel products distributor and processor, by the way) from majority shareholder Huge Top Industrial. The interest in Van Shung Chong from the fund managers comes amid increasing bullishness toward industrial stocks, which are tipped to become the star performers in the second half. In a filing to Hong Kong Exchanges and Clearing dated July 4, Van Shung Chong said Huge Top, controlled by chairman Andrew Yao Cho-fai, placed 31.2 million existing shares at $1.25 each. This represented an 18.3 per cent discount to Friday's closing price of $1.53. The counter fell 2.61 per cent to $1.49 yesterday as the overall market rose. But yesterday's fall did not upset bullish analysts, who believed the counter would rebound given its successful turnaround story and 'undemanding' valuation at five to six times forward earnings - even after Van Shung Chong more than doubled over the past year. Van Shung Chong posted an operating loss of $4 million for the year to March 31, 2001. But it surprised the market by posting a fivefold, year-on-year increase in net earnings to $60.41 million for the year to March, proving it had successfully transformed from a pure Hong Kong-based steel trader to a mainland-focused steel distributor and processor. Herbert Lau Chung-kwan, head of research at Celestial Asia Securities, said that while the steel trading business in Hong Kong - the main revenue contributor for Van Shung Chong - would remain stable in the medium term, future earnings growth would come from its construction, steel trading and steel coil processing operations in China. Mr Lau has a 'buy' recommendation on the stock with a price target of $1.60. Given increasing infrastructure demand in eastern China, primarily driven by preparations for the 2008 Beijing Olympic Games, Mr Lau forecast that profits from Van Shung Chong's mainland construction steel trading division would increase by about 25 per cent to $75 million next year, accounting for about 25 to 30 per cent of total profit. The steel trading business aside, the company has spotted another area of growth potential: increasing demand for steel processing services from mainland manufacturers of cars, computers, home appliances and mobile phones. 'The metal value-added processing business will be the growth engine of the company,' said Johnson Ho Sai-hou, executive director and chief financial officer at Van Shung Chong. 'These high-growth industries have steel consumption of about 20 per cent.' What is more, steel processing has a gross profit margin of 20 to 30 per cent, compared with just 8 to 10 per cent for steel trading. To catch the high-growth opportunities, Van Shung Chong has been busy lobbying Japanese carmakers, successfully securing a contract with Isuzu. There is also market speculation the company is in talks with Toyota and Honda on supply contracts. On the production front, Van Shung Chong plans to increase capacity by setting up new coil centres in Shanghai and Guangzhou next year. 'By the end of this year, we will decide [on either Shanghai or Guangzhou] to set up the first plant,' Mr Ho said. But Van Shung Chong is not the only industry player eyeing the growth potential. Japan's Sumitomo has announced plans to set up a joint venture with mainland steelmaker Baosteel and carmaker First Automotive Works. The $165 million project would process and distribute steel for China's roaring car industry. But Van Shung Chong is undeterred, and company officials say they plan to serve a niche market in China. 'We will not spend too much on capital expenditure ... compared with other Japanese plants,' Mr Ho said. He said the start-up cost for its planned plant would come to just $20 million to $30 million. While many analysts and fund managers are upbeat on the company's prospects, others are unconvinced. 'First of all, there is the property oversupply problem in China, which would have an impact on [its] China steel trading business,' one analyst said. 'Also, the majority of [its] revenue and profit is still from the ailing construction sector in Hong Kong.' The analyst also raised concerns about Van Shung Chong's cash flow, saying it had 'lots of cash commitments but small contributions' from its new China business. For the year to March, net operating cash inflow was $29.4 million, compared with $118.6 million last year. Mr Ho said: 'Cash flow is never a problem to us. We are well backed up financially.'