Sinofert is a BUY because it is a "broken stock" trading at 0.5x P/B, but it is NOT a broken company.  It has endured several problems over the past several years - none of which constitute a terminal illness.  The cumulative effect of these dissapointments has been to create a sense that the company is broken and not entirely in control of its own destiny.  The stock has been a serial dissapointment, missing earnings estimates several times and falling from a high of HK$8.50 in early 2008 to its current price of HK$1.28.  But Sinofert's problems are temporary, it has a new CEO, it has highly valuable assets, and it is the beneficiary of positive long term trends.  I believe that Sinofert can grow earnings at a 20% clip for the next several years and restore a sense that it is on the right track.  Investing in Chinese companies is tricky, however Sinofert is compelling at its current price.  

 

Sinofert is the largest distributor of fertilizer in China with >50% market share.  They have over 2,000 retail locations and an 18% stake in Qinghai Salt Lake Potash Company (a local producer).  The company purchases fertilizer (and makes some itself) and sells it to farmers.  Like any distributer, Sinofert takes inventory risk and makes a small margin on huge volumes; however the company's margins and ROE are less than half that of global peers.  

 

It is also important to note that Sinofert is 53% owned by Sinochem and 22% owned by Potash Corp.

 

As background, China seeks food independance and has a rapidly declining supply of arable land (because of competition for land use).  As such it really is important for them to get more out of each acre.  There are not many ways to do this, better fertilization practices are an obvious one.  China's demand for fertilizer is expected to double over the next decade and its domestic production growth (esp. in potash) cannot keep up.  Of the three key fertilizer nutrients (Nitrogen, Phosphate, and Potash), potash has the best industry structure.  The only huge deposits are in Russia and Canada and production is essentially controlled by two cartels.  I won't go into the entire history and structure of the potash industry - many readers probably are familiar with it given how much attention POT has received in recent years.  Suffice it to say that potash prices have been rising and extremely volitile.  They went from from $120/ton in 2003 to $1000/ton in 2008  

 

 

After reaching a high of $1,000/ton, potash prices dropped back down to $300 in 2009.  This volatility was unusual.  Potash was in chronic oversupply for decades and finally became tight when the cartels got most of the world's spare capacity, Russia became sold out, and other producers reached full utilization.  After decades without it, producers got drunk on pricing power (and ethanol sent corn prices to new records).  Producers took things too far, too fast and ultimately had to retrench.

 

Distributors got whipsawed.  From Bunge (in Brazil) to Sinofert, distributors around the world were left holding the bag with high priced potash inventories purchased in 2007 and 2008.  In 2009 and 2010 they had to mark inventories to market and sell them through at much lower prices.  Sinofert generated big losses because of this.  

 

Also, as potash prices rose the Chinese government began to intervene to spare farmers from the pain of this commodity price appreciation by placing limits on Sinofert's pricing.  Two years ago, the government backed off and eliminated price controls.  

 

In 2010 Sinofert got a new CEO (Mr. Feng Zhi Bin), who cleaned house and took some write downs and charges to clear the decks.  

 

Long-story short: Sinofert has survived a very unusual period of volatility and change.  It's financial results from 2009 - 2011 were unusual.  And its results in 2007 and 2008 were higher than normal.  But what remains is a company with strategically significant assets and massive demand tailwinds. 

 

 

	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	CAGR / AVG
Sales	$  1,519	$  2,474	$  2,719	$  3,732	$  6,533	$  3,943	$  4,325	$  5,676	$  6,176	$  6,643
y/y		63%	10%	37%	75%	-40%	10%	31%	9%	8%	19%
Net income	$      66	$     100	$     115	$      84	$     275	$    (211)	$      79	$     105	$     131	$     154
nmgn	4.3%	4.0%	4.2%	2.3%	4.2%	-5.4%	1.8%	1.8%	2.1%	2.3%	2.2%

 

For simplicity I put this table in USD.  Potash prices have now settled to the $500 - $600 range and by all accounts from POT we will be in a much more stable pricing range.  POT is more focused on growing volumes steadily as it brings new capacity on line.  I think they, and everyone else in the industry, realize now that $1,000/ton potash is not sustainable.  If we look through the past decade at Sinofert, we see a company with average net margins of 2.2%, growing the topline at a 19% CAGR.  The company thinks that normal net margins are closer to 4%.

 

This is a good distribution business - razor thin margins, but volumes that are set to grow as Chinese consumption of fertilizer grows.  The market thinks of Sinofert as unpredictable and volatile, however I think it is more of a "growth cyclical" that has just come through a very unusual period of volatility.  

 

I think Sinofert's normal earnings power is $200m of EBIT, growing at 15-20%

 

The world produces 850mt of corn per year; 315 of that is produced in the United States, 190 by China, 60 by Brazil.  Those are the big guns.  The United States exports 40m, Argentina 12m, Brazil 8m... China consumes a little bit more than it produces.  But this year China imported 5mt (up from 1mt last year) and is forecasted to import 7mt next year. 

 

With ethanol mandates firmly in place and gobbling up 35-40% of the U.S. corn crop, U.S. corn inventories are at the lowest levels in 30 years.  In 2012, drought in the Corn Belt is anihilating produciton.  The USDA is forecasting the lowest yields since 1988, which will mean there are significantly less tons availble for export. 

 

The writing is on the wall - China has to be more self sufficient in corn.  Yields in China are half of what they are in the United States.  This means that the demand tailwind for fertilizer application growth in China should remain strong.