A-Power and AgFeed: The Importance of a Strong Balance Sheet

Includes: APWR, FEED
by: China Stock Guru

Scrooge visits Chinese equity holders

Happy New Year indeed! Holders of AgFeed (OTC:FEED) and A-Power (NASDAQ:APWR) were greeted with belated Christmas presents this year and quite expensive ones at that. To recap, on Monday FEED greeted investors, at least those who stuck around post the lowered earnings guidance of last month, with even more painful news; dilution at levels below the market. Tuesday brought the - not completely unexpected - news that APWR would be coming in light of its recently endorsed guidance. Both stocks suffered dramatic declines on the news, yet the damage to APWR is temporary while FEED’s is irreparable.

When guidance is misguiding: Why real cash trumps projected earnings.

Companies missing earnings targets and lowering forecasts is commonplace. In the current economic crisis, guidance given over three months ago is borderline irrelevant. Don’t expect it to be achieved. I would expect most every company that has given guidance for 2009 to fail to achieve its targets. I am advising companies not to give guidance at this time. The benefits of doing so are small, while the downside from missing is large.

There is one shred of relevance to company guidance that one can glean, however. Guidance shows how the company thinks it will do if the economic situation stabilizes or returns to normal. While earnings probably won’t achieve their stated targets, the targets represent earnings potential and this is why one purchases stock in growth companies. I like to buy companies with strong earnings potential, but more importantly, I like to buy companies that have the balance sheets to allow them to achieve their potential.

Dilution Permanently Diminishes Upside Potential

This brings us back to A-Power and AgFeed. Lowered guidance is unfortunate, yet in the current environment not completely unexpected and somewhat priced into the share prices. However, the dilution to common shareholders of FEED at these depressed valuations is irreparable. FEED, with a weak balance sheet, was not prepared for the current business climate. In the case of APWR, however, it has a very strong balance sheet. Book value is over $4 per share and cash is over $1 per share with no debt. The company is rock solid and well positioned to recoup lost business and lost market cap once the tightness in the credit markets eases up.

FEED, on the other hand, has a much weaker balance sheet. This is exemplified by its recent offering of common stock. By issuing 5 million shares and 4.2 million warrants, FEED has strengthened its balance sheet but at a significant cost to current holders. It has guaranteed that, even if it achieves its guidance for 2009 on net income, Earnings Per Share will not achieve the levels indicated just last month when it issued guidance. As an investor I can tolerate owning great value with earnings growth pushed out, however I can’t tolerate being diluted out of my earnings growth.

Staying Power Equals Long Term Winners

When looking for investments during difficult economic times, earnings guidance and potential is important. It will drive your upside when times improve, which they will. More important, however, is the corporate balance sheet. It allows a company to position itself properly to catch the next economic cycle. When credit loosens and economic uncertainty diminishes, both APWR and FEED will see their business improve. But, of the two, only APWR will be able to achieve the EPS potential represented in previous guidance and its share price will be the better performer as a result. Right now guidance is irrelevant, balance sheet is king.

Disclosure: Long APWR.