by gumshoe | September 9, 2011 2:42 pm
Happy Friday! Here’s the pitch from Yiannis Mostrous that got me interested today:
“… the population of children aged zero to 14 has decreased steadily year after year…
“… yet sales of children’s products have exploded—from USD 11 billion in 2005 to USD 30 billion in 2009.
“This apparent disconnect is the direct result of the one-child policy.
“Conclusion: Children have become precious possessions, cherished above all else by Chinese families, especially in urban areas where they are the single focus of six adults—two parents and two sets of grandparents—who are willing to dote, and spend lavishly, on them.
“It is now commonplace for upwardly mobile middle-class families to spend half their income on the child—and the most recent figures indicate that Chinese household spending on children’s products has doubled over the past five years.”
Sounds good, right? This is a story we’ve seen told many times over the years, most often by China stock enthusiast Robert Hsu, and the basic pitch makes perfect sense and is backed up by lots of impressive numbers and demographics: The Chinese are getting older, and the one child policy has created a generation of spoiled brats. OK, not as spoiled as many Western kids, but for middle-class Chinese in particular the focus on family and the small numbers of children relative to adults means that huge spending and attention is lavished on this generation of kids — after all, their parents were the result of the one-child policy, too, so now it’s often six employed (maybe) adults who have but one child to spend on. That has meant big investments in private education stocks, with well-known names like New Oriental Education (EDU) being long-term beneficiaries of the willingness of the Chinese to invest heavily in their kids, who’ve been given the nickname “little emperors.” But this idea is a little different, and gets to more of the western idea of consumerism — buy ’em toys and cute clothes, not fancy educations!
Mostrous is trying to get us to buy his Global Investment Strategist, which often touts stocks that I find interesting — though I thought it sounded more fun when he called his letter Silk Road Investor. He’ll charge you $495 for a year’s subscription, which is more than I’d want to spend to satisfy my curiousity, so I thought we ought to try to pick out this stock for you for free.
So … some more clues?
“Take a look at these numbers posted just since 2007…
“Revenue up 88%…
“Gross profit up 107.4%…
“Store locations up 85.1%…
“Shareholder profit up 160.5%…
“The company operates an integrated business model, participating in key stages of the product lifecycle—product design and development, brand promotion and management, sales network and operation, and sales and marketing.
“With a huge retail network comprised of 1,477 department store concessions, 13 flagship stores, 29 street shops and 36 unique “365 stores” (independent stores in large shopping malls in premium locations), their inventively creative promotions attract some of the largest customer volumes ever recorded in China.”
So … kids clothing stores, enough to give me flashbacks to our “back to school” trips to the outlet mall, which brings on fits of nausea. But Mostrous makes it sound a bit sexier than that.
“The secret of their staggering success story is the remarkable ability to leapfrog the competition in just about every way—especially marketing and branding.
“In 2008, they pulled off a restructuring coup by divesting all manufacturing facilities—a difficult decision, but the right one for shareholders.
“The strategic masterstroke enabled them to morph into a developer and retailer of branded children’s products. All manufacturing is now outsourced.
“The operative word here is… branded.”
OK, so brands. That I can understand. And apparently some recognizable ones, too.
“In plain English, the company has successfully introduced product brands based on children’s cultural icons, including the globally adored Harry Potter, Thomas and Friends, Bob the Builder and the widely followed Japanese comic book The Prince of Tennis.
“The company also has licensing agreements to introduce products under the names of three of the most renowned and popular soccer teams in the world—Manchester United, Barcelona and Juventus.
“If that wasn’t enough, they’ve also worked out a merchandise deal with the National Basketball Association, enabling them to capitalize on the skyrocketing popularity of basketball in China….
“Yet another clever move was finalized this year when the company joined hands with a legendary Japanese toymaker known for creating many of the most successful games and toys ever marketed….
“I fully expect this cooperation with yet another famous brand will gain higher popularity and strengthen my recommendation’s global influence in China.”
And just to get you drooling a little more:
“My top pick also has an ambitious vision. A spokesman recently said, “Our future goal is that the parents will get whatever their kids need with just a click. Speaking in the comics language, we aim to become ‘the lamp of Aladdin.’”
“Considering the insatiable material appetites of China’s little emperor generation, the anxious desire on the part of parents to please their precious progenies at any price and the demonstrated skill of this remarkable company, I have little doubt this goal will be achieved.
“The future looks very bright—add this stock now and I predict returns that will have you feeling like a kid set loose in a toy store very soon!
“Bottom line: This is one of the best emerging-market profit-makers I’ve encountered in my global travels.”
Well, dangit — after all that leadup, this is one of those stocks that Mostrous occasionally pitches that you can’t easily buy on any US exchange, at least not as far as I can tell. The company is Boshiwa, and though most brokers could buy it for you in Hong Kong it’s certainly not as easy and probably not as inexpensive as a pink sheets trade … the ticker is 1698 in Hong Kong, where they just IPO’d last fall.
And from a quick glance, the company has been in a freefall over the past month … and indeed, has declined pretty consistently since the IPO. That oughtta make you nervous, even if it does now look pretty cheap based on the numbers.
The tease is a perfect match, just to be clear — Boshiwa has been around for about 15 years, and is a brand sort of similar to Gymboree in China, and more recently they’ve added a baby brand (Baby2) and what looks like a toy and accessories line (Dr. Frog), and started licensing in a lot of famous brands (that’s the NBA, Harry Potter, Thomas, etc. stuff, some of the deals are non-exclusive and a few run out soon, but they do have them). The most recent deal was with the Japanese toy giant Takara Tomy, in case you’re wondering. There’s also a laudatory article from a state newspaper about their jump from being a manufacturer to a brand creator and marketer, in case you’d like more background.
I don’t know anything about the power of these particular brands in China, nor do I know if they’re able to maintain brand identity and pricing in the face of what I presume must be rampant piracy of all of those licensed brands — given how cheap and easy it is to buy “unapproved” Harry Potter t-shirts here, all of which are undoubtedly made in China, I can only imagine the brand piracy situation is even worse there given China’s tendency to overlook intellectual property rights. I might be too cautious on this, since I assume that — in practice — domestic companies in China probably get better copyright protection than do international ones, but I’d be cautious about companies whose assets are licenses for other brands … ie, it’s not even their brands they have to protect, it’s Thomas the Tank Engine and Harry Potter.
Still, that’s not all they say they own — the numbers of outlets are real, though the vast majority of their outlets are what I would call boutiques within department stores, so they don’t carry much in the way of real estate value or anything like that, and they mean the company is probably in some ways beholden to the parent store.
Why did the shares fall? Well, it may have been telegraphed a little bit by the controlling shareholder, who reportedly pledged shares as collateral for a big loan at a steep discount back in December — though they did recently pay back that loan.
More importantly, expectations were high following the IPO and the shares were looking pretty expensive before the drop — they are now, after falling about 75% from their highs, priced at a trailing PE of about 10, which apparently is fairly average for their sector and country. Sounds appealing, though, given Mostrous’ pitch about the huge growth potential in their niche … after all, even if the economy sours in China there will be a fairly substantial middle class, and the ratio of children to adults in that class is going to stay pretty constantly low for decades, so the logic of buying a low-end luxury like branded kids’ clothes does ring true.
But of course, logic doesn’t always come up well in its fight against reality, particularly with the overall concern about Chinese companies, particularly young companies with controlling shareholders … so hopefully Mostrous has done some good homework about their finances and is comfortable with their auditors. This is not one of the “Chinese reverse merger” stocks that have been painted black with a broad brush of late, but it is a recent Hong Kong IPO, and if Yiannis is right about their growth prospects then the stock price is telling us one of two things: There’s something very wrong with management; or investors are too scared to see a bargain when it bites them in the nose. With the third possibility, of course, being that Yiannis is wrong about their growth potential.
They reported a decrease in earnings per share for the most recent 6-month period, though revenues did climb pretty nicely (almost 50% year over year) and they’ve been investing fairly heavily in expansion — the decrease is mostly because of the issuance of half a billion new shares (now at about two billion shares, so a market cap of almost HK$4 billion, which is around US$500 million … smallish still, but not tiny), but perhaps more notably they also saw a big jump in distribution and selling expenses — they report that cost of sales is actually going down and the gross profit margin is staying steady in the 40%+ range, but the inventory value almost doubled so they must also be pre-buying inventory, which makes sense if they’re going to keep growing so quickly.
Receivables ballooned and seem to be getting older, which could mean they’re having trouble collecting cash from their partners or it could just mean that they have different credit terms with their new customers — we’re only looking at a snapshot of one year and it’s a young company, so I can’t really tell. That doesn’t seem like enough to inspire this collapse in the share price, and the company announced that the shares their large shareholder had pledged as collateral for his loan have been returned and the loan repaid, so it seems like it’s probably just disappointment over revenue growth not hitting the bottom line as profit or earnings per share growth in this last report — from a quick glance at their six-month report (PR is here, full report on their website), if I didn’t know the company or have any expectations I would probably think the operating results looked reasonably impressive given their stated goal of investing in growth.
The investment folks at The Standard were certainly disappointed with the results, and noted that Deutsche Bank reduced the price target to HK$2.68 on what must have been a surprising earnings miss, though of course the stock is far below that now (it closed at HK$1.85, just a whisker above their all-time low).
So … interesting little stock, I’ll leave it at that since we’re dealing with a stock that most of us would find it challenging to trade. I’m not planning to buy shares personally, though never say “never” … and I am often (sometimes foolishly) tempted by stocks that have viable businesses but have seen their share price collapse. In this case, I’d want to do a lot more digging to find out where the fire is underneath all this smoke — if it’s just an earnings disappointment, you could probably do worse … but stocks that are profitable and growing revenues at a rapid rate, even if profit margins disappoint, don’t usually drop 50-75% on an earnings miss even if the earnings miss is dramatic.
And since that one’s tough to trade even if you’re interested, I’ll keep blathering for a moment:
To get you a little bit more to chew on for a lovely late-Summer Friday, I thought I’d also mention that we’ve again seen our old friends the National Inflation Association on the teaser podium, banging their gavel for the same agriculture stock as last time. And in keeping with our theme for the day here, it’s a Chinese stock — though it’s a play not on the “little emperors” but on food — it looks like this group, who are so entwined with stock promoters that it’s always hard for me to tell if they have an opinion or if they just pump, dump or promote shares, is again pushing Agria (GRO). I mentioned back in July in the Daily Update that I hate to call attention to the stock because it always seems to be a promotional target and I don’t want to encourage them, but I figure it’s safe to say a few words to my favorite folks in this smaller group here.
Agria is a perfect company for stock promoters not just because it’s so tiny, but because the story legitimately sounds so good and the finances look so compelling on the surface — and it’s not just a shell, the stock has also been a target of legitimate China stock pickers and newsletters over the years. I first wrote about it not long after its IPO when I thought it was being teased by the Money Map folks, and despite the fact that the stock has gone almost straight down since the late-2007 IPO near the top of the last China bubble it’s still a great story, at least on the surface: a company who sells corn seeds in a country with a growing appetite for processed foods, and lately it even comes up in all the screens for stocks trading below net asset value or below the value of their cash on the books (it may or may not belong on those screens, but with the data available to folks like Yahoo Finance, it looks like a no-brainer).
As I noted back in 2008, though, it’s a story that still — even with the stock price well below $2 — comes with a bit of hair on it. Now, a bit of hair doesn’t always mean you can’t have a taste — as anyone familiar with toddlers and lollipops will tell you — but it does mean it shouldn’t be the centerpiece on your table. What’s the hair? Well, that’s a good question.
Agria has been threatened with delisting by the NYSE, but that’s just because the share price has fallen so dramatically and was under the $1 threshold (in part thanks to the previous promo campaign from NIA, which started when it was just under $1, it jumped up on their promo then fell back again, and jumped again after that — it’s no longer quite that low). More importantly, it doesn’t make any money and hasn’t ever made any money as a public company, with consistenly huge expenses, particularly SG&A (selling, general and administrative) expenses that dwarf their revenues. If SG&A costs you $14 million and you had revenues of only $4 million, then you don’t have to read much further to note that this is a special situation, and not a company you can evaluate as a profit-making enterprise … or even, perhaps, as a potential profit making enterprise, since they booked profits just fine before their IPO but have not been profitable since. Which should tell you that investors have reason to be suspicious — companies that peak in the year before their IPO tend to give off at least a whiff of scandal.
But still, despite the fact that they spend dramatically more on their administrative expenses and sales efforts than they take in in revenue, at least over the last few years, folks salivate when they look at the balance sheet. Why? It’s because Agria’s recent move was to expand out of China — they took over controlling interest in the New Zealand “rural services” company PGG Wrightson (largely a distributor of supplies and grain and processor of livestock), which just reported decent numbers in their “transition” year. PGG Wrightson has been selling off divisions, including their finance division, and reorganizing in conjunction with the partial takeover by GRO, and they still carry a pretty big debt load and a challenging growth outlook (their home is New Zealand, where growth is limited, and growing in South America will require more investment) … but they are at least fairly close to becoming profitable, which seems like more than GRO can say.
And more importantly for the purposes of teaser-mania, the fact that GRO can now report PGG Wrightson on its books or as an asset means that the “enterprise value” of GRO is now firmly negative — Agria is valued in the stock market at just about $90 million, but their 50% stake in PGG Wrightson (50.1%, I think) is worth right around $120 million according to the New Zealand trading in PGG shares (ticker is PGW in NZ, FYI). That means you can buy the shares for far less than their book value, which always sounds impressive (and sometimes is impressive), and much of that book value is made up of easily accounted for shares in a publicly traded company.
It’s a good story, but still, something stinks a bit — it could just be that you’ve got a money-sucking parent company that will continue to spend far more than they make for years, which would mean that the book value of the company is almost meaningless — it’s not like they’re going to sell their assets and give you the cash, because then what will they do without their golden goose? Or it could be that there’s something of genuine concern in their numbers, or, given past scandals, just a general fear of a Chinese company whose books make it appear that there must be something more there than meets the eye.
And yes, Jonathan Lebed, who is somehow affiliated with the National Inflation Association folks, has recommended and/or promoted Agria several times over the past few years — well before the PGG Wrightson stuff made an exciting story look even cooler, in part becasue for years GRO has always looked cheap if you go by book value, and, of course, they’ve always been in the important-sounding Chinese agriculture space. All of this promotion makes me nervous — the fact that stock promoters like a stock because it’s small, has a good story, and can easily be manipulated doesn’t always mean that the company underneath the promotions is a dud, but in my experience it almost always means that … and with so many interesting stocks in the world, I hate to touch picks like these that would probably keep me awake at night. If you’ve been involved with Agria over the years, or have an opinion to share on the NIA folks or this recurring pick of theirs, feel free to let us know.
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