Posted by: donmihaihai | September 2, 2007

Sufficient cashflow is not the worry anymore.

In 2004, when Celestial Nutrifoods announced that they are going to spend RMB1billion to build a Soybean Zone, the main worry back then was how Celestial going to finance the big expansion.

Celestial is a “fortunate and able” company, Fortunate because they are selling soybean products in China. Soybean products are a growth area itself, selling it in China as a local company up it to another few more levels. Best of all, Celestial is selling most of their products to consumers (retail).

The China middle class consumption story is being written everywhere but how many peoples in Singapore really know how true or how strong this story is? The idea is logical, supported by many developed countries growth path but most of all the stock market need some theme to play if not how to explain that everyone is avoiding China stocks(including those in the consumption story) causing most of them to sell at single PE at one time and at a higher valuation in another time. When there is a need for a growth story, consumption story fit well.

How true is that story? By looking into the financial statement of most China listed company in SGX, it says it is very strong and exciting. Most of the companies found in SGX are consider smaller and weaker by many even though I do not agree with in such a general conclusion, indeed, China companies listed here are smaller using all kind of measurement. But as a group, they produce exceptional cashflow which provide some insights that this wave can last very long. I won’t be surprise that in 10 or 20 years time, some of these companies will turn out to be extraordinary investment as they become bigger in size and profitability.

Celestial looks like one of them now and back in 2004. In Q1 and Q2 2004 results, revenues slowed, but the reasons behind it were production plants were running at max capacities and new capacities had not come online yet. The cashflow at that moment was excellent, any experience investor will know instantly that it is real and how well it was being run. In 2004, Celestial generated RMB90million of cashflow. In 2006, Celestial generated RMB274million of cashflow. Celestial cashflow is set to grow further in 2007. It is not just that the amount of cashflow that grow but how it grows and where it is going.

Back in 2004, when Celestial announced that they were going to build a RMB1billion Soybean Zone when their current expansion haven’t come online yet which basically double the production capacity. Despite strong cash flow and balance, RMB1billion is about >10X their cashflow and >2 X their equity. Can they able to pull thru such an expansion? Where can they find the require capital? Issue new shares? Industrial products rather than consumer products? What if the whole project fails? That was 3 years ago, among all worries, the main one was if the whole project fail, does Celestial had sufficient cashflow to repay all debts and regain their health. I was not totally sure but the dropping share price provided the triggering point.

Fast forward to 2007, after a series of issuing shares at an unbelievable low valuation including one to a value fund and convertible bond. Celestial is trading at about half of it peak valuation reached in 2006. It became a favourite story for many investor and securities house then subsequence slowly being forgotten again. At the current price of about $1.10, excluding the new bio-diesel venture which I think it won’t be a good business, Celestial is trading at about 10 X both cashflow or NPAT. Celestial is being fall back to earth in term of valuation, even thought not to hell yet, which was the case 3 yrs back, the current valuation become interesting again.

What lack of in one area(rock bottom valuation) is substitute by another which is there is no need to worry about the required cashflow for Capex. The new investment on facilities for new health food and beverages product range does require Capex but it is not going to take up anything more than ¼ of their cashflow for 2007. Even adding on working capital for both Bio-Diesel and new health and beverages products range, I doubt that Celestial is going to generate negative cashflow for 2007 and 2008 as they are likely to come online in stages.

Paying 10X cashflow for a company like Celestial which a ROE of >20% isn’t excessive but there is a new problem. The problem is how should be how management going to use the cash. It is a problem because cash is flowing in faster than Celestial can invest them. The management clearly knew about the problem as they are mentioning about it during every quarterly report. So far Celestial is sticking to their core as in coming out with soybean products(industry or consumer). Bio Diesel plant is somehow out of their core but still acceptable while the announcement of coming out with new health beverages products is a big welcome. This is the area that makes Celestial such a wonderful company since it incorporated and the current product capacities is going to hit their max utilization soon. The current hope is that management does not start their empire building process.

This hope was greeted by a 2 cents dividend payout during FY2006 results. It is unknown on management views of paying excess free cashflow if attractive investment opportunities are not available. But that is a good start and Celestial has the ability to promise more because they can easily dish out more than 15 to 20% of their cashflow.

The biggest task right now is to understand and weight how Celestial is going to use their cashflow.


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