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[Editors' Note: This article covers a stock trading with less than a $100 million market cap. Please be aware of the risks associated with this stock.]

Background

Nutrastar International (OTCQB:NUIN) is a leading China based producer and supplier of premium branded Traditional Chinese Medicine consumer products including commercially cultivated Cordyceps Militaris, organic and specialty food products and functional health beverages.

Cordyceps Militaris, their primary product, also known as Chinese Golden Grass, is a species of parasitic fungus that is typically found in north-eastern China. It is a precious ingredient in traditional Chinese medicine and widely believed in China to offer high medical and health benefits by nourishing the yin, boosting the yang, and invigorating the meridians of the lungs and kidneys. According to Georges Halpern's Healing Mushrooms, research has shown that Cordyceps Militaris may boost the immune system, and can be used as a supplement for combating effects of fatigue and aging, the occurrences of tumors, and combating arteriosclerosis and gastrointestinal disorders, as well as reducing blood pressure. In addition, Cordyceps Militaris has significantly high economic values. According to Halpern, wild Cordyceps Militaris can cost as much as $10,000 per kilogram.

Due to the extremely sensitive growing conditions of Cordyceps Militaris, it is very difficult to grow the plant in a man-made environment. After several years of laboratory tests, NUIN developed a technology to commercially grow and produce Cordyceps Militaris in 2006.

NUIN generated 75.5% and 74.1% of their revenues from Cordyceps Militaris for fiscal years 2012 and 2011, respectively and believe that they own approximately 16% of the worldwide market share in the cultivated Cordyceps Militaris industry. They plan to continue to focus on Cordyceps Militaris based consumer products in the near future, which is their fastest growing product line with the greatest market demand and a high profit margin. (Source: Summarized from NUIN 10K filed 3-29-2013)

Financials

For the first three quarters of 2013 NUIN had revenues of $30.2 million generating a net profit of $17.3 million or 57%. This compares to $24.5 million and $11.1 million or 45% in the comparable 9 months of 2012. It is clearly a growing and highly profitable business.

In 2012 NUIN generated cash from operations of $19.9 million. In the first 9 months of 2013 they have generated $15.8 million.

At September 30, 2013 NUIN had cash on the balance sheet of $93.2 million or $5.80/ share. (Source NUIN 10Q and Yahoo finance)

What is depressing the stock price and what negatives can be discounted

There appear to be four things that are depressing the stock price:

  1. NUIN is based in China and therefore has the China Discount. The China Discount is discussed in this excellent Seeking Alpha research paper. However, there is not much that NUIN can do about this other than wait for time to heal investors' wounds.
  2. Large percentages of NUIN's cash is in Chinese Renminbi (RMB) in Chinese bank accounts subject to government restrictions on conversion to US$. Again there is little that NUIN can do to change this in the short term. Longer term they share the hope of many China based companies that the RMB becomes a fully convertible reserve currency and NUIN's cash can be used outside of China.
  3. NUIN's businesses and cash are in companies that are defined as Variable Interest Entities (VIEs) not directly owned by NUIN. It appears that until late 2010 NUIN operated with a traditional subsidiary structure but converted to their VIE structure in conjunction with a PIPE financing. I can only assume it was at the request of these investors so it does not appear to be something NUIN is using to be opaque in their financials. Also, VIE structures are more common in Chinese public companies (e.g. Baidu and Alibaba). Lastly, to be categorized as a VIE and consolidated into NUIN's consolidated financial statements the VIEs need to meet criteria that demonstrate that they are really controlled by NUIN and not by their stockholders. While the details of NUIN's control are not clear to me from a review of SEC filings, I have to assume that the auditors have been all over this and are comfortable that the VIEs cannot be shaken loose from NUIN.
  4. NUIN is quoted on the OTC Bulletin Board with the associated BB discount. NUIN appears to meet most of the more difficult criteria for listing on NASDAQ such as SEC filing currency, profitability history etc. The one they do not meet is the one that is most easy to achieve: a stock price of $4.

Potential catalysts

As stated above the near term catalyst for NUIN is moving from the NASD Bulletin Board and being listed on NASDAQ. They can request this listing when their stock price has remained over $4 for 90 days.

Longer term the catalyst is the same as for many Chinese companies which is the RMB becoming a fully convertible currency.

The analysis below assesses only the impact of promotion to a NASDAQ listing on NUIN's stock price, and not the potential impact on changes in the currency role of the RMB.

Professional Money

Accretive Capital recently accumulated a holding in NUIN of 10%+ from transactions with public and management investors. Accretive Capital targets undervalued small and micro-cap public companies which represent attractive take-private candidates.

Share Valuations

NUIN's financials are what I would expect those of a drug cartel to look like so I don't have access to very good comparables. Following therefore is a sizing of the opportunity using general P/E and Enterprise Value/Revenue ratios we are all familiar with to assess the impact of the short term catalyst of NASDAQ listing.

Highly profitable, high growth companies conservatively typically have:

  • A P/E of at least 20. Applying a China Discount of 50% leaves a P/E of 10. Adjusting NUIN's ttm P/E of 1.8 to 10 implies a share price of around $12.
  • An Enterprise Value/Revenue ratio of at least 4. Applying this ratio to NUIN's ttm revenue derives an Enterprise value of $170 million. Adding in cash of $93 million gives an implied market capitalization of $263 million. Applying a China Discount of 50% and dividing by 16 million shares leaves a share price of $8.

Averaging these prices leaves a reasonable share price of $10, almost a 5X increase over the closing share price.

Source: Nutrastar: $5.80 Cash Per Share And A Highly Profitable Business For Less Than $2 Per Share