Description
OVERVIEW
Renhuang Pharmaceutical (RHGP) is a growing, undiscovered and undervalued Chinese pharmaceutical manufacturer. It trades at 4.6x 2010 FYE Oct. net income (3.6x if you exclude cash), generates significant free cash flow and is growing rapidly (25%+ this year) due to increasing demand for its major product, a traditional Chinese medicine which treats depression (over 200 million people in China suffer from depression, but few receive treatment..although that is changing). The company has a very healthy balance sheet (net cash = 20%+ of its market cap), so investors do not have to worry about a dilutive equity raise. Furthermore, the company is operating at only ~50% of capacity, so it can continue growing without incurring meaningful capex. Importantly, management is rapidly addressing the major reason why its stock trades at such a low valuation (it is listed on the pink sheets, had been delinquent in its SEC filings and had done very little investor relations). Specifically, RHGP is now current on its SEC filings, is in the process of uplisting to the Amex (RHGP meets all the criteria and hopes to successfully uplist within the next month) and has significantly increased and improved its investor relations efforts (including hiring a highly qualified and bilingual CFO). Near term catalysts for the stock include the uplisting, the reporting of improved financial results, and increased investor awareness.
BUSINESS DESCRPTION
The company's 10k and its presentation filed march 4th as an 8k are very descriptive. RHGP 3 product categories are: botanical anti-depression & nerve-regulation products (80% of revenue) , biopharmaceutical products (10%), and botanical antibiotics and traditional OTC Chinese medicines (10%). RHGP's largest product is Siberian Ginseng (Acanthopana). Acanthopanax, which is known in the United States as Siberian Ginseng, has been used for centuries in China. It is used to treat depression and other ailments and has numerous medical efficacies including, improving kidney and spleen function; relaxing the mind, improving appetite; decreasing pain; and improving sleep quality. The raw material for this product is the Siberian Ginseng (Acanthopanax) plant. In China, about 94% of the wild Siberian Ginseng (Acanthopanax) resources grow in the Heilongjiang Province. The company has an arrangement with the Dongfanghong Forrestry Bureau, which provides RHGP exclusive rights to the wild Siberian Ginseng (Acanthopanax) in Dongfanghong, which represents approximately 70% of the wild Siberian Ginseng (Acanthopanax) resources in China. The company believes this arrangement provides it with a meaningful competitive advantage. RHGP has a distribution network of over 3,000 distributors and over 70 sales centers across 24 provinces in China.
The market for depression treating drugs is very attractive. In China, over 200 million people are suffering from depression, and most of these people are not receiving any treatment. As part of its new healthcare plan, the Chinese government will be providing coverage for more people. Since RHGP's depression drugs are cheaper and have fewer side effects than traditional western medicines, RHGP believes it is well positioned to capitalize on the growing demand for its products.
CAPITALIZATION
Stock Price $2.23
Shares 37.2
Warrants 1.1 @$0.88
Total 38.3
Market Cap 85.4
Cash 17.7 (excluding $15mm Deposits discussed below)
Warrant Proceeds 1.0
Debt 0.0
Ent. Value 66.7
VALUATION
- 2010 estimates represent the midpoint of management's guidance for the year ending Oct 2010. We would not be surprised if the actual results exceeded the high end of guidance.
- As you can see from the financials section, the company generates significant cash flow as well as net income.
Equity Cap/LTM Net Income 5.3x
Enterprise Value/ LTM Net Income 4.2x
Equity Cap/Proj. 2010FYE Oct. Net Income 4.6x
Enter. Value/ Proj. 2010FY E Oct. Net Income 3.6x
FINANCIALS
- - FY ends Oct. 31
- - Q1 and Q4 are seasonally strongest
- - 2010 projections represent the midpoint of the company's guidance. Based on conversations with management and considering management's new found i.r. efforts (and desire to underpromise and overdeliver), we would not be surprised to see the company beat guidance.
- - Guidance is based largely on organic growth and does really heavily on new product introductions, which the company is making. Guidance does not assume any acquisitions.
FYE Quarter Quarter LTM Proj. FYE
Oct 2009 Jan 2009 Jan 2010 Jan 2010 Oct 2010
Revenue $43.4 $13.8 $17.1 $43.4 $55.2
Growth NA NA 24.3% NA 26.9%
Net Income $14.9 $6.3 $7.4 $16.0 $18.8
Margin 34.3% 45.5% 43.3% 34.3% 34.0%
CFO $13.1 $1.2 $9.6 $21.5 na
OTHER CONSIDERATIONS
1) RHGP's chairman/CEO owns ~50% of the company, so he clearly has the incentive to create shareholder value;
2) For sometime the company had not been very shareholder friendly. It was delinquent in its SEC filings and did not communicate with investors. Much has changed lately as the company has:
- a) become compliant with SEC filing requirements as of February;
- b) hired a new cfo (anna@renhuang.com) who is bilingual, very accessible and knowledgeable and has a strong accounting background (including being an auditor at Pricewaterhouse);
- c) significantly increased its investor relations efforts including issuing guidance and updates on other business and SEC matters, and hiring a well know i.r. firm;
- d) began the process of uplisting its stock from the pink sheets to the AMEX. The company meets all of the criteria for the uplisting.
3) The company is operating at only 50% of capacity so it can easily grow without incurring significant additional capex.
4) Net cash ($18mm) represents over 20% of RHGP's market cap. This year, cash flow from operations should exceed net income since the company is continuing to reduce its DSO so w/c should be a source of cash. The company will use its cash, opportunistically, for acquisitions or new r&d efforts, but all of these would be growth initiatives and thus not included in guidance. Any acquisitions would be financed in with cash on hand, and thus would be highly accretive.
5) RHGP is relatively unknown among the US investment community. There is no sell-side coverage and there very little institutional ownership.
6) The company is in the process of buying its major manufacturing plant that it currently rents. RHGP must make a final payment of $9.9 million for this plant by December 2011. The company has already made $16 million of payments towards this acquisition and these payments are listed as Deposits on the balance sheet. Our valuation gives no credit to the company for the payments made to date (although we probably should) nor did we treat the remaining payment due as an obligation since the company will generate far more than $9.9mm in free cash flow by December 2011. The company is buying the plant from its Chairman/CEO/founder who also owns ~50% of the company or about $45mm of stock. While we dislike all related parties, we have gotten comfortable with this since we ascribe no value to the plant anyway, the CEO is a large shareholder, he does not take a big salary and such related party transactions are not uncommon in entrepreneurial Chinese companies. We have not attempted to value the facility but remind you that we have ascribed no value to it.
7) For the past few years, the company has been granted a tax rate reduction since it is considered a high tech enterprise and has thus paid a tax rate of zero percent. Every year the company must apply for such a reduction and the company has already been granted the reduction for FY2010. Management expects to continue receiving annual reduction for the next few years. If it does not get the reduction, its tax rate would be 25%.
Catalyst
- 1) Uplist from pink sheets to Amex
- 2) Increased I.R., including visit to USA sometime after uplisting
- 3) Improved financial results - next eps report in June.