by Travis Johnson, Stock Gumshoe | July 28, 2009 9:51 am
This tease comes in an ad for the Motley Fool’s Global Gains newsletter, which has brought some interesting ideas to our attention during its relatively short life so far (though I imagine it probably had a terrible year last year — this is one of the few Motley Fool newsletters that Hulbert doesn’t track, and the Fool no longer has a big chart bragging about their newsletters’ performance vs. the S&P 500 on their site, probably for exactly the reason you’re guessing). It used to be helmed by Bill Mann, whose analysis I always liked, but is now run by a couple of other guys (Nathan Parmelee and Tim Hanson, if you must know).
But anyway, Global Gains picks, you guessed it, international stocks, and they’ve always been heavy teasers of the “China story” — the huge population, the growing infrastructure, the building a new Chicago every day, etc. etc., and most of their teaser picks that we’ve scoped out here have been BRIC picks of one stripe or another (BRIC being Brazil, Russia, India, and China, if you’ve somehow evaded the overuse of that acronym so far).
And the analysts for the Fool just got back from a trip to China, doing what Robert Hsu’s newsletters always call “boots on the ground” research, with the assumption that when you meet with company management and see their products you’ll be wiser and in the know (as opposed to having the wool pulled over your eyes by earnest managers and seeing a stage-dressed factory, which I assume must also happen sometimes). During that trip they continued an exploration of the agriculture sector, a China story that I happen to agree with, and tried to sniff out a stock that might show the same great gains as another one they’ve picked for good gains, China Green Agriculture (CGA).
China Green roughly tripled off of the March bottom (as, to be fair, did many volatile little China stocks), so they’re looking for another delight like that. Though they also say that they still very much like CGA that that it’s still cheap, so there’s a freebie for you.
But the top secret teaser is the one we’re looking for here …
“But right now, I want to tell you about a second, nearly identical opportunity I discovered on this year’s trip.
“I think you’ll see at once why the similarities with last year’s 200%-plus gainer are nothing short of uncanny — and why I’ve made it my No. 1 Global Stock Idea for 2009. “
Now, if you go and call something the number one idea for 2009 (especially now that we’re more than halfway through the year), then you can pretty much count on the Gumshoe doing a little salivating … or at least, a little thinkolating. Let’s see what the clues are …
They tell us that the secret to this company’s success is … marketing. They go through a long spiel about Chairman Mao, and about how he created a brand around himself and focused on the rural peasants, and tell us that this company is doing much the same thing (though the marketing they’re using might have more in common with Coca Cola).
The point is that this company — it’s an organic fertilizer manufacturer and distributor — has put on a full court press to build their brand in rural china, one town at a time, one local supply store at a time. They use existing stores, pay to spruce them up with their own signs and multimedia marketing materials, and build the brand up that way — they have 2,000 stores now carrying their brand now, more than twice as many as last year, and they are trying aggressively to build up trust among the country’s farmers.
“The result is a vast network of specialized outlets with a local feel and longtime recognition in the neighborhood. And mixed right in with the posters and banners — a computer blasting promotional videos touts the benefits of the company’s products!
“In another modern twist, the company runs commercials on CCTV 7, the nation’s agricultural channel, highlighting the success stories of real local farmers who have made more money as a result of using the company’s patented organic fertilizer.
“It’s a long cry, indeed, from the old days when traveling sales reps actually drank the company’s fertilizer to convince skeptical farmers it was organic and safe to use!”
The big picture for increasing demand is the slow consolidation of agribusiness, as the central government starts to allow more property rights, and the transfer of small farms into centralized operations — this seems very early days yet for land policy liberalization in China, with some limited ability to sell your land use rights, but I do keep reading that it’s still going the right direction, at least, however slowly. And, perhaps as important, we hear still more about the Chinese government’s obsession with improving quality of life in rural China — which means bringing more money, which will allow farmers to invest more in better fertilizers and equipment and seeds, which will boost yields, which will help feed a hungry nation. And have the nice side effect of creating opportunity in the hinterlands, which would slow the mass migration to the coastal industrial cities and, perhaps, give the populace one more reason not to rise up against their leaders.
So that’s how the stimulus is supposed to play out in rural China — help the farmers, build roads, get money to trickle down to the peasants. Here’s how the Foolies put it:
“This explains why rural economies have held up better than those in other parts of China and the world. It’s certainly why rural China looks like the safest and most profitable way to play the China growth miracle today.
“Here are just a few other key factors driving China’s Rural Investment Boom…
“1. Insulated from global shocks — Unlike industrialized China which relies heavily on low-cost exports, rural China is immune to changes in global demand… and positioned to benefit from massive domestic stimulus
2. Underleveraged — China’s rural economies are not burdened with debt and don’t have to rely on free global or domestic credit to sustain their awesome growth — currently in excess of 12% per year
3. Billions in govt. subsidies — A top 5 priority in Beijing, China’s rural farmers benefit directly from a wide range of government initiatives, from tax breaks on income to subsidies to buy equipment and supplies — even before the massive stimulus package”
I’m actually mostly on board with that general analysis, so I’m happy to move on to the next step: What’s the company that they call their number one idea for this year? I know it’s not the company I own in this sector (they don’t generally pick light-volume pink sheet stocks from foreign listings, they try to go with ADRs or US-listed firms for investor convenience), so what is it?
Here’s the lead-in to our pile of clues:
“According to Sun Zhengcai, China’s Minister of Agriculture, the nation’s average crop yields must increase by at least 1% per year if China is to feed its 1.3 billion people.
“That’s a monumental challenge. As Sun recently made clear to a group of local officials, “Our strategy must be based on stable farmland and seeking ways to improve yields.”
“Of course, this is what’s driving the revolutionary land reform we discussed earlier. But with roughly half the arable land per person as the U.S., consolidating China’s farmland can only go so far.
“There’s only one way out… If it even hopes to continue feeding the world’s largest population (and you can bet it will), China must squeeze more production out of every square inch of its precious farmland.
“We’ve discussed how a company called China Green Agriculture is helping thousands of China’s farmers do just that, with new capacity coming online everyday — and how we are already profiting from it as U.S. investors.
“We’ve also hinted at how an even smaller agricultural products distributor has brazenly stepped forward to take the baton in the next, most explosive leg of China’s green agricultural revolution.
“In fact, with sales of its patented organic fertilizer growing consistently in excess of 100% per year, the company’s biggest challenge is keeping up with skyrocketing demand.”
“Skyrocketing demand” — that sounds good, right? OK, so what else do we hear by way of clues about this patented organic fertilizer company?
“Last May, the company raised $9 million in a well-placed secondary offering exclusively to fund the working capital needed to break through this distribution bottleneck — and get new products it has waiting in the wings to market.”
Their products are organic.
“Finally, just as with China Green Agriculture last year, the company plans to move to a major U.S. exchange, probably within the year — a huge potential catalyst.
“But don’t worry. You can invest right now through your online broker — and perhaps most remarkably, for just 5 times trailing 12-month earnings.”
OK, and then we have a bit about the specifics of the product that should help with our thinkolating …
“Not only do farmers use less fertilizer and pesticides (the effectiveness of which is boosted by 10% to 50%), they can turn a 42 RMB investment (cost to treat one plot) into hundreds or even thousands in extra profit.
“And because the patent-protected product is extracted from humic acids found in lignite coal, and supplemented by a proprietary mixture of macro and micro nutrients, it is pure green. Farmers simply dilute it and apply it directly to most any crop.
“The nutrient has the added benefits of making treated plants resistant to drought — a serious problem in China — and allowing farmers to grow a wider range of crops. Both play directly to Beijing’s desire for what it calls food security.”
And they go into a bit more teasing about their “21st-century marketing machine” …
“As I mentioned earlier, the company oversees 2,000 officially branded stores across the Chinese countryside (up 158% over a year ago), with another 350 currently in a trial phase.
“Again, picture a neighborhood Ace Hardware — or an early 20th century, dime-store Coca-Cola soda fountain. The proprietor is well-known to the locals, maybe for generations. People trust him.
“And his store is awash with the iconography of one dominant brand, essentially a giant, walk-in billboard! But how does this come to be? All across rural China?
“Here’s the ingenious setup that’s altering the face of China’s countryside…
“In a one-time marketing expense, the company cleans up an old store, plasters the place with posters and banners … and gives the owner the centerpiece computer running its infomercials showing the farmers how to use the product.
“In return, the store gives the company’s products premier placement and promotion — and a profitable, symbiotic relationship is born! No other fees change hands between the company and the store owner.
“Even more so than being stunningly effective and efficient — which it is — the operation has an even more profitable appeal. It’s diabolically scalable!”
Ah, “diabolically scalable” … they really know the way to a Gumshoe’s heart.
So who is this?
The Motley Fool Global Gains gang’s “No. 1 Global Stock Idea for 2009” is, the Thinkolator sez,
China Agritech (US listed, but over the counter on the OTCBB — ticker is CAGC)
[Note — according to a reader, this is wrong — Yongye Biotech, which I hadn’t come across, is traded on the OTCBB at YGII and is a better match, more of a distributor, and also cheap. That’s the problem with being right 99% of the time, the other 1% comes to bite you. Sorry!]
And it does look very cheap based on earnings — according to the one analyst who publicly follows them they should earn 33 cents a share this year, and 37 cents next year, so with a current share price in the neighborhood of $2.15 we get a PE ratio of something like 6. I’m quite sure this is the match, even to the point that the humic acid base and the other details are consistent with China Agritech’s products, but there is one small point to make: the Fool claims that they are consistently getting 100% sales growth on their products, and I don’t see evidence of that in the filings — their revenue has been growing, but fairly slowly (it was $25 million in 2005, and $45 million in 2008 — growth, to be sure, but not consistent triple-digit annual growth). There may be more details that back up their assertion, perhaps some of their core products get that kind of annual growth, or unit growth is at that level and price cuts drop the revenue growth numbers … just wanted to clarify the one point where the clues don’t seem to match.
Their main product is liquid organic fertilizer, but their growth might come from a larger scale product, granular fertilizer (also still organic) — which is easier to transport and more familiar for farmers, and which has a much larger established market.
I can’t tell you whether or not China’s push for organic fertilizers will be long-lived (they claim that the government is pushing for 30% organic in the future), but I can tell you that this looks like it must be the Fool’s new favorite fertilizer stock. I agree that the market for advanced fertilizers of all kind will likely expand in China (that includes compound fertilizers, organic fertilizer, and slow-release fertilizer), though the stock I’ve personally chosen for this theme is different, non-organic, and quite a bit larger (Hanfeng Evergreen). My guess would be that it’s going to be quite difficult to pick the winners, if there are winners, in this business, and that most of the leading private fertilizer companies in China (ie, the non-state-owned ones) should do quite well with the government’s focus on rural China, liberalization of land use rights, higher farming yields, and lower pollution. I won’t argue that the stock I own is better than the one the Fools are teasing, after reading up on China Agritech a bit I’m actually a little tempted to add a second stock in this category, it does seem like an interesting speculation on first glance.
Of course, that doesn’t mean it will go up — it has been extremely volatile, as have most of its peer,s and it did fall from over $4 at the highs in 2008 to about a dollar when the market crashed at the lows, it trades right now for about $2 a share. It looks small, it’s just entering a much larger and more competitive market (granulated versus liquid fertilizer), and much will certainly depend on their ability to drive acceptance of their organic fertilizer formulations and to convince local farmers to pay more for their promised higher yields.
As I noted, this is a very small stock — market cap is just about $60 million, and since they’re trying to expand production for their new granular and next generation products it wouldn’t be surprising if they came back to the market to raise more cash again before too long. The founder continues to hold a massive stake as of the latest filings I’ve seen, something like 40%, so that’s usually encouraging — though it also means he has a free hand to run the company pretty much as he likes. They don’t pay a dividend, and most of their basic valuation metrics are on their website. We should see the next earnings release from China Agritech in mid-August, and the second and third quarters are their big sales quarters (as they generally are for other Northern Hemisphere fertilizer companies), so we might get an idea of the traction in their sales channel during their next earnings call.
Net income has been reasonably steady for the last ten quarters or so, seasonably adjusted, so I expect that some of the reason for the low price for the shares (aside from the low visibility from being traded over the counter) is that earnings growth is not necessarily certain — success of new products is not guaranteed, it costs money to expand capacity, and it seems like they might have maximized their earnings over the last two years from the existing production capacity. So there is some uncertainty afoot, it appears, but I’d agree that it seems likely that the shares would jump a bit if they were to list on a major exchange and get more attention from investors (the Fool says they have that plan, but I don’t know if it will happen in the near future or not) … still, we’re talking about a teeny company, so even the attention from Gumshoe readers today could easily drive the shares higher if a few dozen of you decided to buy shares at the market price, so with little guys like this it’s always wise to be careful.
So … it looks interesting to me, though I’m still reading up on them. What do you think?
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