Description

China Marine Food Group, (CMFO) is leading and growing producer of dried fish snack food in China.  With a stock price of $1.60, the company has $1.40 per share of adjusted net cash, trades at 3.3x 2008 EPS ($0.48) and 2.6x 2009E EPS ($0.62, up 29% y/y).   Stripping out adj cash (which is not needed to hit the company's 2009E EPS guidance, but not adjusting for the minimal interest income received on the cash), the stock would be trading at 0.4x 2008 EPS and 0.3x 2009E EPS.  As shown below, if the company does not do anything with its excess cash, it will have net cash of over  $1.74 (more than its current stock price) by the end of 2009.  Management owns 50+% of the company (so it is highly motivated to create shareholder value), intends to soon utilize a $3mm  stock buyback, is evaluating highly accretive acquisitions/expansion opportunities, and is planning to meet with US investors (for the first time in ages) in May on a non-deal roadshow.  Note: this is not an ADR.   It is a Chinese company listed in the US that files SEC docs and follows US GAAP.

 CMFO's business is very simple and its recently filed 10k and u.s. based i.r. firm are  very helpful so I will not make business description the focus of this write up.  CMFO buys fish from fisherman, dry it, process it and then sell it.  They have been doing this, thru predecessor companies, for 15+ years. The major products are dried roasted quid, file fish and prawns, and are sold under the popular Mingxian brand name.  The company has 21 products and virtually all products are sold in China.  The company's products are sold thru 18 distributors in six provinces, Fujian, Guangdong, Jiangsu, Shandong, Zhejiang and Liaoning.  These distributors in turn sub-distribute the products to over 1,400 retail points (including major supermarkets and retailers such as Wal-Mart and Carrefour) throughout these provinces.  This business accounts for over 90% of the company's revenue and will represent even more as the company expands this business significantly.  This business has 30%+ gross margins.  The company also has a smaller business (Marine Catch) which is 10% gross margin business. The company is located in Fujian which is in southeast China on the coast of the East China sea. 

 Growth Opportunities

The company expects to continue organic growth by expanding its high margin snack business distribution thru existing and new distributors and in existing and new markets.  This growth can be achieved relatively inexpensively because they don't need to make big investments in pp&e or staff.  They sell a well known product and are using distributors to increase their penetration.   In July 2008, the Company signed agreements with two new master distributors based in Shanghai (China's largest city) and Guangdong. Combined, the new distributors and their respective customer bases contributed $3.5 million or 7.2% of the Company's overall revenues in 2008. The Company expects this growth trend to continue as new sales opportunities are developed in these highly-populated areas. On March 3, 2009, the Company subsequently announced a sales contract with a leading convenient store chain in Shanghai (China's most populated city) which over time can add over 1,000 new points of sale to the Company's existing retail network of 1,400 locations (This alone would equate to a 70% increase in the number outlets where CMFO products are sold). Similar sales opportunities are developing in Guangdong and other provinces where the Company actively markets and sells its goods.

Growth thru acquisitions, which are not part of the 2009 guidance but that are likely and highly accretive, are discussed further below.

Capacity expansion

To prepare for future growth, the company has been aggressively expanding and modernizing capacity, mainly for the snack food business.  This enables the company to increase its gross margins (larger more efficient facilities, more attractive product mix).  During 2008, the Company added more than 3,000 tons of additional capacity to its production lines, which came online at the end of the fourth quarter, so it had no real impact on 2008 results. This additional capacity boosted total annual output by 50% to 10,000 tons per year. The Company has also announced plans to double annual capacity up to 20,000 tons by Q3 of 2009, at a cost of $5mm. On its recent earnings call, management indicated that the expansion will be completed earlier than anticipated. To put this in perspective, in 2008 the company generated $49mm in revenue with 7,000 tons of capacity.  It now has 10,000 tons of capacity ($70mm implied revenue) and by Q3 2009 will have 20,000 tons of capacity ($140mm implied revenue).  Note that the company was not operating at full capacity in 2008 so these figures are likely a bit deceiving, but directionally correct. 

Year end and current cash balance

At the end of 2008, the company had $31.6mm of cash and $4.3mm of debt for net debt of $1.19 per share.  As discussed below, the company has subsequently monetized a $5mm one time inventory position, which brings adj net cash to $32.3mm or $1.40 per share.  There are no unfunded pension plans, big earnouts, big tax payables, etc..this is pure cash.

Projected Cash at end of 2009

Free cash flow is pretty close to net income.  In 2008, it was less, primarily because the company opportunistically purchased $5mm in Q4 of some fish (related to the marine catch business) and as of last week had sold all $5mm of that inventory.  So, the current cash balance is really $5mm higher than the year end figures.

If the company does not do anything with its excess cash and only meets  its earnings guidance (although they say they will "exceed 14.3mm"), as shown below, it will have net cash of $1.74 per share (more than its current stock price) by the end of 2009.

12/31/08 cash                                      $31.6

12/31/08 debt                                       -4.3

2009 cfo/net income                             14.3

2009 inventory liquidation                       5.0

2009 expansion capex                          -5.0

2009 other capex                                 -1.5

Cash at end of 2009                             $40.1

Shares outstanding                                23.0

Net Cash per share at end of 2009       $1.74  

Other Valuation

Above I've illustrated p/e valuations based on 2008 and 2009 figures.  Let's also look at what this stock will look like at the end of 2009 based on 2010 EPS.  We know at end of 2009, the company should have $1.74 per share of cash.  For 2010 eps, I will assume eps of $0.74 or growth of 20% in 2010.  I think this is ridiculously low growth rate considering all the company's low cost growth opportunities in its higher margin business and the company's historic growth rates.   However, in addition to wanting to be conservative, the big issue in valuing the stock isn't necessarily what the eps will be, but rather what multiple the market will assign to that EPS.   I will let the reader decide what type of multiple a leading, growing, unlevered, microcap snack food company based in China should get.

Below is the implied valuation of the stock at end of 2009 based on several 2010 p/es.  

I believe the eps estimate is too low and even the high end multiple is too low..in other words, I personally think this stock is worth more than $9.18.

So why is the company trading at such ridiculous levels?

• 1) This is an undiscovered company. The company came public through a reverse merger into a shell company, which is a popular technique for Chinese companies to quickly become public and raise growth capital. They chose this option because it can take years to go public in China. The disadvantage to this route is that the company does not do a traditional roadshow and does not have sell-side analyst coverage. As a reminder, the company is coming to the USA in May and both management and their i.r. firm are readily accessible.
• 2) This is a Chinese company. Although it is files with the SEC and uses US GAAP people are still weary of Chinese investments in general for political and "practical" reasons (its hard to due dili a foreign company). We have visited the company several times and have a team in China to monitor the company so we have gotten comfortable with these issues.
• 3) It's a microcap whose stock has limited liquidity. However, there is stock available for sale. We understand that in addition to some small sellers, a large U.S. institutional holder may be selling down some of its position as a result of a reduction in its AUM. Also, as we have seen many times, liquidity often increases as the stock price goes up. Finally, there are warrants for 2.1 million shares (held by institutional investors, not management, purchased in a Nov 2007 PIPE to raise growth capital) exercisable at $4.17/share. While ordinarily this may be a ceiling on a stock, the reality is that even at $4.17, the stock is still dirt as illustrated above. Also, Halter, one of the largest shareholders, we believe paid approximately $0.40 per share, so they have a nice paper profit.
• 4) Questions regarding use of excess cash. The company has $32mm of net cash (including $5mm from inventory liquidation) and is free cash flow positive. The company plans to spend $5mm of cash to complete a major plant expansion by Q3 2009. I have not subtracted this from the above p/e analysis because this expansion did not impact 2008 EPS and is not included in management's 2009 guidance. The company also plans to begin using its $3mm stock buyback. However, even pro forma for all these uses, the company will continue to have significant cash. While not widely discussed, we believe the company may attempt to purchase one of its two largest competitors, which happen to be State Owned Enterprises (SOEs). For those of you unfamiliar with China, there is massive consolidation occurring, in part because the government in selling off its SOEs. Buying a SOE is often a very attractive and accretive deal because (i) the government doesn't always sell to the highest bidder and (ii) the acquirer can often significantly improve the target's profitability since the previous owner (the government) was not focused on maximizing profitability. Buying an SOE can be very similar to the profits people made in the USA buying real estate from the RTC years ago. As I mentioned, the Chinese government does not always seek to maximize its selling price and always takes other factors in consideration when selecting the winning bidder. In this case, CMFO is well positioned to win such an auction (and not have to pay top dollar) because as industry experts they can continue to operate the SOEs without the risk of business interruption. The last thing the government wants is to sell an SOE and then have the company run into problems (i.e. products not being manufactured/available, people getting laid off, etc). I have no idea regarding the timing or price of any acquisition. Finally, if the company wants to create shareholder value, it could consider a dividend as ticker TPI, another Chinese based US listed company, recently did. Again, insiders own 50% of CMFO so they are incentivized to create value.
• 5) Most investors can not relate to the product. CMFO's products are foreign to most of us , but very well know to the Chinese
• 6) The sector lacks sponsorship. Many of the funds that had invested in these types of companies (U.S. listed Chinese stocks) are either out of business or had big redemptions last year

 Make-whole Provision

As part of a November 2007 capital raise, CMFO's CEO agreed to give a portion of his personal shares to these investors if the company did not reach certain net income targets for 2008 and 2009.  This is a common feature for those members not familiar with PIPEs.  The company surpassed the 2008 target of $10.5mm and the company's 2009 net income guidance is "in excess of" $14.3mm (which is the 2009 target).   The CEO obviously believes the company can achieve this target or he would not have agreed to the deal in the first place.  More importantly, if one wants to be somewhat cynical one could assume that (after realizing he would surpass the 2008 target) the CEO might have he slowed down business a bit to make sure he would hit the 2009 target.  I do not suspect this occurred but wanted to mention this to give people further confidence that 2009 guidance will be achieved.   

Catalyst

Increased investor awareness

Management non-deal roadshow  

Stock buyback

Accretive acquisitions

LBO - Mang already owns alot..if public market not attractive, why not take it private.