Monday, April 23, 2012

American Lorain Corporation (NYSE: ALN), a Global Exporter

In our quest to find undervalued companies, the Chinese reverse merger sector currently offers a lot of opportunities that can be hardly overlooked. We recently covered Skystar Bio-pharmaceutical Company (SKBI) and it seems that at least another company offers the kind of value that we are looking for.

According to Reuters, American Lorain Corporation (ALN), incorporated on February 4, 1986, is an integrated food manufacturing company. It develops, manufactures and sells food products, which include chestnut products, convenience foods, including ready-to-cook (RTC), foods, ready-to-eat (RTE), foods and meals ready-to-eat (MRE). ALN conducts its production activities in China. ALN operates under three segments: chestnut products, convenience food products, and frozen food products. During the year ended December 31, 2009, it produced 230 products, including 19 new products in its convenience foods segment. Its products are sold in 26 provinces and administrative regions in China and 42 foreign countries. Its subsidiaries include International Lorain Holding, Inc. (ILH), Luotian Green Foodstuff Co., Ltd. and Junan Hongrun Foodstuff Co., Ltd. The company operates in the following categories:

Chestnut Products
ALN developed brand equity for its chestnut products in China, Japan and South Korea. The chestnuts produced include aerated open-bottom chestnuts, which are chestnuts packaged with nitrogen; sweetheart chestnuts, which are sweet preserved chestnuts; chestnuts in syrup, and golden chestnut kernels. They are natural and do not contain chemical additives. The chestnut contains small quantities of oil and complex carbohydrates. Chestnuts are commonly steamed, boiled, sugar stir-fried, roasted or added into dishes or desserts as an ingredient. ALN differentiates its chestnut products based on flavor, size and method of packaging. The chestnut products that are sold in Japan are packaged in plastic bags or tin cans, each considered a different product. Some of its chestnut products are processed with hot water or cold water. The Company competes with Hebei Liyun and Foodwell Corporation.

Convenience Foods
ALN’s convenience food products are characterized as Ready-to-cook, or RTC, food products, Ready-to-eat, or RTE, food products, and Meals ready-to-eat, or MRE, food products. RTCs can be served after a few easy cooking procedures. When preparing a RTC, customers need only to heat the food in a microwave or boil it for several minutes before eating. RTEs can be served without any cooking. It includes various pickle products. Other RTEs include spiced belt fish, cherry tomato, spicy pork fillet, pork and egg roll, pears and pineapples. MREs are meal kits with self-heating devices. These are used in both military and civilian uses, such as camping, traveling and other situations, in which a person does not have access to traditional cooking supplies and equipment, such as a stove or microwave. During 2009, ALN also introduced MRE products that are microwaveable. MREs are based on various styles of food, such as Italian cuisine and Chinese cuisine. During 2009, ALN produced 117 convenience food products, including 16 new products, such as candied bean products and MRE microwaveable rice products.

Frozen Food Products
ALN produces a variety of frozen foods, including frozen vegetables, frozen fruits, frozen fish, and frozen meats. During 2009, it produced 61 frozen food products. The frozen foods sold during 2009 were frozen asparagus and frozen corn. During 2009, this segment contributed 15.7% of its total revenues. The Company competes with Weitang Langdong, Yuyao Hongji Food Co. Ltd. and Yantai Pengshun Food Co. Ltd.

Let's take a loot at the fundamentals for the company. Assuming the current P/E ratio of 2.3, the current price assumes that the earnings of American Lorain will remain flat over the next 5 years, giving us a 2017 price of 1.33$. However, public information tells us that earnings have been growing at about 25% a year over the past 7 years. Let's make another assumption and let's say that the current inflationary environment puts some breaks on the growth of Lorain's earnings and that the company is only able to grow EPS at 10% per annum. We find ourselves with a 2017 price of 2.35$ per share with the current P/E ratio. The industry's average P/E stands at 39, but even with a ratio of 10 in 2017, American Lorain would be worth around 21$ per share. The past performance of the company can be seen here:

Also, American Lorain has managed to grow it's book value per share over the past 6 years at an average rate of 35% per year. Assuming the pace slows down to 24% as the company gets bigger, we end up with a book value of nearly 16$ per share in 2017. If we use the current incredibly depressed Price/Book ratio of 0.29, we end up with a price per share of 4.76$. If we compare once again to the industry, we see that the average Price/Book ratio is close to 8. Using an alarmingly conservative Price/Book ratio for the year 2017, we obtain a value of 32$

The following table shows the relatively conservative 2017 price targets using different methods, even some that were not explored in details here:

Taking into account that the previously raised assumptions are not too optimistic, it seems to therefore that the market has a biased bearish view on the long term prospects of American Lorain Corporation, mostly compared to companies doing business in the same industry. The buying opportunity screams very loudly in this case and cannot be ignored. Investors getting in right now have a pretty wide margin of safety in case the company's operations would come to disappoint in the inflationary context currently prevailing in China. 

Disclosure: The author has a long position in ALN.

Monday, April 2, 2012

Skystar Bio-Pharmaceutical Company (SKBI), the Hidden Chinese Pharmaceutical

Not too long ago, roughly at the end of 2011, there was a breakout of a huge controversy surrounding dozens of chinese companies that accessed the US capital markets with reverse mergers, effectively getting an IPO through the backdoor. These companies we being critisized for misrepresenting their financial information, some cases falling into the downright fraud category.

According to the company's website, Skystar Bio-pharmaceutical Company ("Skystar") is one of China's leading manufacturers and distributors of vaccines and medicines for poultry, livestock and domestic pets. Skystar has over 173 products in its current product line and has over 50 more products in development. Skystar employs over 200 people in Production Facilities located in Hu Xian, Xi'an City, Shaanxi, Province, PRC.

Skystar has opened its GMP Certified Facility that increased production capabilities by 200%. The demand for veterinary medicines and vaccines in China far exceeds the supply and Skystar's plan is to capitalize on its new GMP Certified Facility to increase margins while increasing production to help meet the growing and overwhelming demand for its products.

Skystar has an experienced management team, a solid and diverse customer base, proven products, key R & D relationships to develop new products that are in high demand.

Skystar was incorporated on July 3, 1997 in the PRC as a limited liability company without shares. On December 31, 2003, Skystar was restructured from a limited liability company without shares to a joint stock company limited by shares. Skystar is a high-tech enterprise, which has grown to become one of China's leading manufacturers and distributors of bio-pharmaceutical and veterinary products. Skystar Bio-Pharmaceutical (Cayman) Holdings Co., Ltd. was incorporated under the laws of the Cayman Islands on January 24, 2005. The Company is engaged in the research, development, production, marketing and sale of bio-pharmaceutical and veterinary products. All current operations of the Company are in the People's Republic of China ("China" or the "PRC"). Skystar does not conduct any substantive operations of its own and conducts its primary business operations through its variable interest entity ("VIE"), Xian Tianxing Bio-Pharmaceutical Co., Ltd. ("Xian Tianxin"). In 2005, Skystar executed a Share Exchange Agreement with the Cyber Group Network Corporation ("CGPN"), which is listed on the NASDAQ, and then Skystar was restructured into Skystar Bio-pharmaceutical Company ("Skystar" or the "Company") (Nasdaq: SKBI)
Time will tell if the company has really cooked it's books, but in the meantime, I adhere to a contrarian camp who thinks that Skystar has room for tremendous growth. Assuming a the current P/E ratio of 1.5, the current price assumes a decrease of Skystar's earnings of 1.02% annually over the next 5 years, giving us a 2017 price of 2.70$!! However, we know that the chinese firm has been growing earnings at about 38% a year over the past 6 years. Let's make another assumption and let's say that the highly puts some breaks on the growth of Skystar's earnings and that the company is only able to grow EPS at 10% per annum. We find ourselves with a 2017 price of 5.07$ per share.

For the long term investor who is knowledgeable of the pharmaceutical industry in regards to farm animals, this must be a great entry price, from a fundamental sandpoint, into a company that is operating in an growing industry as china industrializes further. With my limited knowledge of this particular industry, I used four different measurements and I came to the conclusion that the current price of Skystar's stock is overly pessimistic. The P/E method, which would be set at 7, gave me a 31.36$ price tag on shares of SKBI.

From another point of view, Skystar has managed to grow it's book value per share over the past 6 years at an incredible 70% per year. Assuming they can manage to keep that pace, we end up with a book value of nearly 23$ per share in 2017. At the current depressed Price/Book ratio of 1.6, we end up with a price per share of 38$.
We can also look at free cash flow per share, which I calculated to have grown about 7% per year over the same period, even if it has been swigging wildly as it can be seen on the above chart. Keeping Skystar's stock for 5 years and using a 10% discount rate, I ended up with a present value of 23.40$ per share for SKBI. Free cash flow per share would end up being about 2.40$ per share in 2017, If we use a reasonable Price/Free cash flow ratio of 7, justified by the fact that the market will gradually realize the value of chinese companies, we end up with a 2017 price per share of 31.36$ per share.

Assuming that my assumptions are not too flawed, it seems to me therefore that the market is being overly bearish on the long term prospects of Skystar. Investors with a long term view will be rewarded with above average returns by holding their positions in the company.

Disclosure: The author has a long position in SKBI.