We think that there are numerous reasons for a rather large upgrade in 2010 earnings estimates once the Q4 figures are out. The shares are a steal.
China's retail sales were up by 15.5% in 2009. Real (inflation-adjusted) retail sales growth was even higher, at 16.9%. And it seems to be accelerating as December sales were up by 17.5% over December 2008. Auto sales were up a staggering 46.15% on the year, showing Chinese interest and ability to pay for high ticket price items.
This is not surprising. The Chinese economy has weathered the storm pretty well. Even exports are returning to former glory. After rising a remarkable 21% in January 2010 (over Jan 2009), they rose a whopping 45.7% in February 2010 (over Feb 2009).
Despite this impressive performance, the trade surplus actually narrowed, giving some indication of the health of domestic demand in China.
This is the backdrop at which we're looking at the upcoming figures from Fuqi International (OTCPK:FUQI) at the end of the month.
Is all this growth actually reflected in analysts earnings estimates? The simple answer is no. The seven analysts covering Fuqi expect $2.24 per share for 2009, and the five analysts covering 2010 expect exactly the same number, $2.24 per share.
This would still make the shares remarkably cheap (p/e less than 10). The company has very low debt ($48M), way more cash ($173M) and boasts an impressive growth record. Revenue growth in the last three years has been 74.2%. Both earnings and revenues grew at 30-60% in the lasts four quarters, even during the more challenging economic climate.
So will that growth grind to a halt now that the Chinese economy is firing out of all cylinders again? That doesn't seem likely. Fuqi itelf expects wholesale revenue to grow at least 25%, while retail revenue is expected to rise at least 50% in 2010.
So already cheap shares are likely to get a lot cheaper still.
And more importantly, earnings are likely to be substantially upgraded when the figures are out. But there is more.
- That expected 50% retail sales growth in 2010 is likely to boost margins and profitability (retail carries higher margins and few competitors can benefit from the integration with a wholesale and design business like Fuqi). There is ample room for that, wholesale is still over 90% of their business. Retail business has already grown from 3% of revenue in 2008 to 9.9% in the first half of 2009.
- Market took the higher margin original design manufacturing (ODM) sales as a one-off and wholesale sales ex ODM sales (slightly disappointing in Q3) fall as permanent while we argued it's much more likely to be the other way around.
- Retail sales in Q3 were also somewhat disappointing due to delays in new store/counter openings, but these problems are likely to be temporary as management maintained full-year guidance of 95-1000 new store openings.
So, barring some disaster, it's difficult to see how Fuqi will not be able to surpass 2009 earnings, most likely by a substantial margin.
One also has to realize that analyst earnings revision the single biggest drivers of stock prices (according to Zacks). A further near inevitable force is a Chinese currency appreciation. This is a matter of if, not when, and Fuqi will profit from that, given that it buys in dollars and sells in renminbi.
Isn't there anything negative then?
- Small negative cash-flow not a problem, it's the price for fast expansion into higher margin business, and the balance sheet is very healthy.
- There is a rather large short-count (6.19M per 26 Feb.). We believe, for lack of other viable reasons, that Fuqi is one of the proxy's used to short the Chinese markets (access to the Chinese markets themselves is highly restricted for foreigners and shorting is only now becoming possible). Given what we have argued above, we cannot imagine that the shorters will wait with any kind of confidence to the earnings (most likely March 30, although Fuqi has a bit of a history of announcing with just a few days notice)
- The short count produces a sort of fear factor into the share price which, in our view, provides probably the best reason why these shares are so remarkably cheap. But we have kicked the tyres rather thoroughly using the latest analyst reports, we really can't see much wrong with the company.
As we argued last week, the shares have broken out from its downward trend channel, despite Friday's drop.
Disclosure: Long FUQI shares