by Travis Johnson, Stock Gumshoe | August 6, 2008 10:58 am
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No big news in the earnings or conference call to speak of — which is good news. The earnings were slightly short of the consensus estimate that I saw (13 cents versus 15 cents), largely due to a decrease in profit margins that has been predicted for six months for Hanfeng but had yet to really materialize.
Hanfeng’s strategy remains unchanged, and their business performance and sales growth are exceptional — as is execution, particularly of partnerships and construction projects, including the early completion of a key rail spur that is now expected to come this quarter (had been predicted for the fourth quarter). I’m quite impressed by their consistent ability to manage construction projects for new plants and get them completed on time and on or under budget.
And on the margin issue, there is no huge surprise: they are able to raise prices and pass along the higher material costs, as I have been confident they would do. The decrease in margin is because they are raising prices to keep their DOLLAR profit margin intact, not their PERCENT profit margin.
To explain, with made up numbers for clarity — these numbers have no relation to Hanfeng at all:
If the fertilizer costs $100 a ton to make, and they sell it for $200, then there’ s a very nice margin of $100, or 50%.
Then the raw costs climb by 50% and it now costs $150 a ton to make their fertilizer. That $50 increase in their raw costs will get pushed along to their customers, so they sell it for $250.
They still make the same profit per ton — $100. But the profit margin has gone down and is now only 40%.
That’s essentially what’s happening to Hanfeng (though not as clearly or obviously) — they’re keeping the same profit per ton, but not the same profit per dollar of sales.
This is how they explain it in the release: “Along with the sales volume increase in every quarter since the beginning of 2006, Hanfeng has been increasing its selling price to at least track the dollar value increases in our raw material costs. Consequently, the gross profit as a percentage of sales has decreased while total gross margin dollars are also increasing. In addition, the international sales (typically higher margin with lower volume) decreased in this quarter from the last quarter (17,000 tonnes versus 4,500 tonnes), as a result of the introduction of 100 percent additional export tax on all types of fertilizers by the Chinese government for the period between April 20 and September 30, 2008.”
With tonnage and sales increasing rapidly, and the likelihood that they will be able to continue to do fine along similar lines whether future raw costs increase or decrease, assuming no calamitous move either direction, I’m still very happy to own these shares — the shares are trading right around where they were when I added to my position yesterday, and I’m still planning on adding to my position over the coming weeks, hopefully for a slightly lower price as the lack of blowout earnings should hopefully make investors lose interest for a while.
Hanfeng, like many China stocks, falling this morning due to inflation numbers. Seems like a good time to buy HF. I placed an $8.50 USD limit order that was filled at $8.28 USD. May buy more.