Posted by: donmihaihai | March 1, 2009

Soybean, pork and a letter

Celestial

About 5 years ago, Celestial shocked everyone with a big project — Soybean Zone which cost up to RMB1billion, included working capital to be spend in a few years. How can Celestial fund the project with NPAT not more than RMB0.1billion per year without issuing new shares? Indeed, through issuing of new shares and exercising of share options at cheap prices, total shares outstanding increased by 1/3, bring in RMB288million for Capex.

That was then, in FY2008, Celestial spent RMB1.2billion in Capex alone with no addition share issued, entered FY2009 with net debt of RMB676million, net gearing and gearing at 0.31 and 0.56 respectively. That was after generating cashflow of RMB543million in FY2008 where NPAT was RMB499million.

More number.

With share price at $0.19, Celestial was valued by market at $121million, RMB535million with exchange rate of 4.42. What can RMB535million do? It is not enough to pay for Soybean Zone project and can’t even pay for half of Celestial Capex in FY2008. If Celestial is to issue new shares at $0.19 to pay for convertible bond, outstanding shares will increased by 2.3X. If all CB ever convert, total share will increased by <15%. Lastly, Celestial is selling at less than FY2008 cashflow, 1.1X NPAT for FY2008.

This kind of valuation is so unreal, even triple nets — net book value, net current assets and cash net all liabilities is of no comparison as triple nets is selling at less than money sitting in bank without saying how the money was there in the 1st place. 1X cashflow is the earning Celestial cans potential earning in a year. I have read and heard about it but never in all my stock buying years, now I am seeing such unreal stuff with my own eyes and as a shareholder. There may be stocks selling at such price due to one-time gain, peaked earning for cyclical companies. But that RMB543million was earned in FY2008 as Celestial faced all kind of cost problems and unwanted situations. It may get worse in FY2009 but FY2008 was not a free ride for Celestial.

FY2008 was a good year, high ROE, superb cashflow as NPAT edged up by 19%. How much will Celestial earns in 2009 is a big question mark, it can be up or down by big amount as China economy continue to drag and the potential or destruction cause by new projects coming online. But their basic products should be doing well even if consumer buying lesser and more pricing pressure for their industry products. Consumer and industry(as a group) will still earn a good ROE, likely >15% in 2009.

But there are worries

1) Biodiesel commences soon – How Celestial going to make a profit with Crude oil at USD$40? Let say if it is going to be profitable, what about working capital requirement? This “pet project” is not “a walk in the park”, it look more like “a walk in a mine field”. But with Celestial so confident about it, I wish and hope that my logic and understanding is wrong as their confident and track record is right.

2) Convertible bond, cashflow and Capex – I don’t know how much more Capex is required for their new “pet projects” but let says Celestial going to spend a lot more(not less than RMB750million) in the next few quarters, then we may get — chaos in cashflow. By saying this, it is not what can be seen in the cashflow statement but rather in operation. Add in redeem of CB, gearing can suddenly shoot up by a lot. With a history of issuing shares at low price, Celestial will be destroying shareholder value by doing it anywhere much lower than the conversion price of CB. If there is a need, borrow money, Celestial has the capacity to do so.

Pfood

Pfood has completed a 888. 8 years of generating profits, 8 years of positive cashflow(7 years with free cashflow) and paying 8 years of dividends. Last 8 years was no easy ride, competitors listed in SGX have disappeared. Ok, only 2 which is China Food Industry in pig farming gone due fraud and United Food totally ceased operating for their pork segment in 2008 blaming every external factors. In this kind of unfavourable environment, Pfood NPAT roared back by almost double that of 2007. This was no easy achievement. Maybe that is the reason that Pfood is trading at 5X earnings rather than 1X earnings.

To say Pfood roared by is an overstatement, as despite almost double of NPAT, ROE was at 15%. Respectable but not something to shout about. But there is something about the beauty of well-run F&B companies in China — strong cashflow that come with little working capital risk and Pfood is certainly on top of it. Pfood listed in 2001 with inventories stood at 42 days and trade receivables at 35 days. That was an improvement from 2000 where inventories at 59 days and receivables at 35 days. In FY2008, Pfood inventories stood at 37 days and receivables at less than 1 day — which is RMB3million. This is no easy feast as revenues increased 1.6X from RMB4.2billion in 2001 to RMB10.8Billion in 2008.

That was the past glories, I can almost hear someone saying that. But I would certainty bet on a past winner than bet on a past loser. Anytime, I would bet with a past winner in a difficult period than a past loser in a favourable period if the landscape has not changed much. For Pfood, landscape is changing. They are going to be in pig farming soon, which will increase and stabilise the supply of fresh pork at the same time increase the risk involved. Glory of the past – working capital, might change. Going upstream to ensure confidence in their downstream products is in one word — expensive. And results will be unknown. But it seem like this is one of the choice and who is better to decide than the management with past glories in difficult period.

Someone has to complain. Yes Pfood is not going to raise capital, they are not going to please anyone including shareholders. But their annual report and quarterly financial statement is getting shorter and shorter. This is not a good sign. But for them to change, shareholder must show concern, asking good questions in coming AGM so rather than complaining, complain can be put forward in another way.

Pine Agritech

Pfood listed associate Pine Agritech had a bad year in 2008 with NPAT down by 58%. 4Q2008 was especially bad but since there is no way to know that the worse results of 4Q2008 was due to what factors, the only way is to wait. But this result is just a reflection of the business they are in. Industry product is not going to generate excess profit over a long period and Pine Agritech is going forward with one main product which is SPI. Pine Agritech must increase their products.

But Pine Agritech is healthy with good cashflow and excess cash of RMB608million. In 2008, if excess cash is taken away, Pine Agritech ROE was still at mid teen. In short run, ROE might goes down but in long run, there is a good chance that Pine Agritech can earn ROE of 8 to 10% if industry product is what they want to do.

Saturday

Yesterday was a Saturday that don’t sound and feel like one. Being last day of Feb 09, listed companies are pushing their results out fast and thick. At the end of the day, I spend another 2 hours reading WB chairman letter. He seems to be changing and steering the letter back to the company but it is still amasing especially when he put down examples. The thought process and pulling out the right information — easily say then be done as the reverse can be seemed everywhere.

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