In a previous article I mentioned SkyPeople Fruit Juice (SPU) as a potential value stock in China. At first glance it does looks like a great bargain, but there are too many warning flags to make this a suitable long-term investment and in the discussion below I share my reasoning.
SkyPeople Fruit Juice, Inc., through its subsidiaries, engages in the production and sale of fruit juice concentrates, fruit beverages, and other fruit-related products in the People's Republic of China and internationally. The company sells its products directly to end-users, as well as to hotels, supermarkets, and other outlets; and through distributors, agents, and trade websites. SkyPeople Fruit Juice, Inc. is headquartered in Xian, the People's Republic of China.
2012 Revenues: $102.4 million USD (5yr cagr ~ 20%)
If you were to compare SPU's financial statements, it's strong growth trajectory and capital investment plans to its current market price, you wouldn't be wrong to think this stock is a screaming buy. A net-net stock where the business is growing by leaps and bounds is not easy to find.
In fact, with a negative enterprise value (market cap below net cash), a buyer would be getting paid to buy a profitable, growing franchise in one of the largest consumer markets in the world.
To drive home the point, compare SPU's ratios to China Haisheng (0359.HK) and China Huiyan(1886.HK) two other Chinese juice and concentrate producers and you start to wonder what exactly are investors thinking ?
Ok, so most common shareholders (the little guys like you and me) have decided to stay away from SPU because we think all Chinese RTOs are frauds. However, I would expect strategic buyers/PE firms lining up to get the best run, fastest growing fruit juice company in the country at an incredibly low price. So why aren't they?
Below I try and dig a little deeper to try and find an answer.
Single Owner and Chairman, Y. Xue owns over 50% of the stock, yet other insiders hold little or next to nothing. Hongke Xue, the chairman's brother is the new CEO (since early 2013). They also have changed both a CEO and a CFO since 2011. A lot of senior management changes for a company that is growing by leaps and bounds.
The 2 outside directors in the U.S., Norman Ko (2,300 shares) and John Smagula (0 shares), hold miniscule amounts of SPU stock. Both get paid around $40,000 per year in cash for their services. I'd like to see these payments made in company stock -- it would signal a strong endorsement in SPU's future by 2 independent insiders.
Musical chairs with Auditors
3 auditors in 5 years with the latest one - Paritz in Hackensack, NJ. How well is this new auditor equipped to handle evaluation Chinese operations?
Absoraka vs. SPU
As per an out of court settlement between SPU and Absoraka, Absoraka removed its bearish report on SPU from its website and both parties admitted to no wrongdoing. The now dated Absoraka report does raise some very interesting points (It's not hard to find if you search for it -- I don't wish to link to it here). The report loses some credibility when it tries to extrapolate revenue growth rates and tries to find flaws with SPU's factory locations, yet it does raise some interesting points when comparing SPU against its peers - which I independently analyze below.
SPU versus peers
SPU is the smallest of the lot, less than 1/5th the size of the larger competitor - China Huiyuan. Despite being the smallest, SPU has net margins that are 2x to 5x times higher.
Lots of cash, no debt
SPU has a much higher cash balance and when combined with no debt, it's operations look otherworldly compared to its larger peers.
High A/R percentages
The biggest concern to me is the high percentage of receivables. SPU could easily allay investor concerns by converting some of these A/Rs to cash. They also had zero bad debt expenses in 2012 and 2011, minimal bad debt in the year before, implying very little allowances for bad debts.
SPU has an unsecured loan from the owners for $8mm (6% interest). They also raise small short-term loans in the $5 to $10 million range from banks using their factories as collateral. With its hefty cash pile, I'm left wondering why the need to pay sometimes 10% interest on these loans.
Large Capital Investments
SPU announced a $50 million USD investment plan in Oct. 2012 with Yidu Municipal government for an Orange processing facility. In April 2013, it announced yet another $70 million USD capital investment plan for a kiwi processing plant in a different location.
These investments could potentially wipe out SPU's cash position and if it does not add to the top line quickly enough, it could make SPU look like less of a bargain. On the flip side, these investments also position SPU for even higher growth if you were to take a steady Revenues/PPE ratio.
Who are their customers?
60% of its business is fruit juice concentrate and two of its largest customers "Shaanxi Jiedong Commerce Co." and "Shaanxi Zhongdian Import and Export" don't have much of an online presence.
I did come across "Shaanxi Jiedong Trade Co.", note the very similar sounding name, selling juice concentrate, but the fact this company has turnover of less than $5 million (here and here) - makes me think that can't be the right one.
Morgan Stanley declared in April 2013 that it owns 2.42 million common shares in SPU. Almost a 90% increase from its last declaration back in June 2011. This gives SPU some legitimacy as one would expect Morgan Stanley to have done a fair amount of due diligence before holding a 9% stake in the company (that's 18% of stock not controlled by the owners).
In this discussion, I've attempted to present a balanced view of SPU. On the one hand, SPU's financial statements and Morgan Stanley Capital's almost 10% stake represent a growing, well run business. On the other, given so many Chinese RTOs blowing up, the bar needs to be set higher in terms of due diligence needed and things like very high A/R, short-term borrowings when cash exists, constant shuffling of auditors and senior management do raise some concerns.
Planned capital investments will also see its capital structure (cash vs. debt) change significantly - one of the main reasons SPU looks like such a bargain right now.
Here are some ways management can immediately allay investor concerns
- Buy back some stock or pay dividends -- might be difficult given how much capital spending they have outlined
- Discount Accounts/Receivables and bring them down below 30% before taking out too many short-term loans
- Pay outside directors and key employees with significantly more stock instead of just cash - it has announced 1 million shares to be kept aside for compensation plans, I'd like to see more details on this.
- Get a big 4 auditor or clarify current auditors' capability to evaluate its Chinese operations.
If SPU were to take some of the steps outlined above, it would certainly look a little less risky proposition. Tread carefully before taking a sip of SPU.