(Editors' Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.)
- Sino-Global Shipping America (SINO) is mispriced, as concerns over slowing Chinese growth mask the recent transition from a lower-margin shipping agency services provider to a diversified provider of higher-margin logistics services.
- Moreover, there is plenty of growth runway due to a continued expansion of its international network and potential to steal market share in the increasingly balkanized industry.
- Furthermore, a new cornerstone investor provided much-needed shareholder stability and played an instrumental role in the recent transition.
SINO delivers shipping agency, shipping/chartering and inland transportation management services, primarily in China.
The danger in relying on superficial analysis
Investors focused on the steep revenue decline due to the well-known story of slowing Chinese growth are missing the bigger picture of a company at a key inflection point. In the YTD period (six months ended 12/31/13), revenue fell 60% to $5.8 million due to lower iron ore imports, as loading/discharging services (which account for virtually all shipping agency revenue) were provided to only 40 ships compared to 132 in the year-ago period.
However, in 2H13, SINO began providing shipping/chartering and inland transportation management services.
This transition from a lower-margin shipping agency services provider to a diversified provider of higher-margin logistics services is the single greatest growth catalyst. SINO made even more progress after it signed a three-year agreement last month with a subsidiary of Chinese state-owned China United Tally to jointly develop third-party verification services at key ports across China. In December 2013, it signed a one-year agreement with Lianyungang Port Logistics to jointly develop and promote each other's shipping agency and logistic service businesses.
This transition resulted in the gross margin more than tripling from 8.3% to 28.7%, as the gross margin for shipping agency services is only 18.5% compared to 33.4% for shipping/chartering services and 85.8% for inland transportation management services.
The chart below is a textbook example of "shrinking to grow", as the gross profit (on a YTD annualized basis) is 23% higher than the 2012 peak level, even though revenue is 66% lower.
An aggressive focus on cost control, lower overheads and a streamlined shipping agency business (along with the previously mentioned diversification) resulted in operating income going from a loss of $1 million to a profit of ~$37,000, while total operating costs fell by ~$9.6 million. Moreover, operating cash flow improved from ~-$3.5 million to only ~-$343,000. This improvement in profitability and cash flow reduces the need for any additional capital raises (see below).
How David can win against four Goliaths
Since the 1980s, the shipping agency industry in China has gone from being dominated by a single state-owned agency (Penavico) to more of an oligopoly, as two more state-owned agencies (Sinoagent and China Shipping Agency, or CSA) entered, followed by COSCO Container Shipping Agency (Cosa). The relaxation of foreign ownership restrictions and allowing of joint ventures between Chinese and foreign entities further altered the competitive landscape. While these four agencies account for a vast majority of industry revenue (85%), this ongoing industry balkanization provides plenty of growth runway.
For example, SINO can steal market share from the >1,900 smaller agencies due to its larger infrastructure and wider range of services offered. By being a general agent (compared to a local agent), it can offer many more value-added services, such as providing information about ports for shipping arrangement, appointing and coordinating local agents as well as reducing parking time and loading/discharging costs.
While stealing market share from the larger agencies may be more difficult, this is a realistic long-term goal, as a smaller, private and more responsive player such as SINO can provide a higher level of service. Moreover, all of its managers or chief operators previously worked for Penavico or Sinoagent.
Furthermore, SINO used its customer relationships with Chinese steel manufacturers and traders to build a large international network (e.g. Australia, Hong Kong, India, Canada, South Africa, Brazil) of offices, agents and local service providers. Management said in the 2013 10-K that the overseas loading services business is the "fastest area contributing to our business growth".
Cornerstone investor to the rescue
In November 2012, SINO received a letter from NASDAQ regarding its noncompliance with the listing rule requiring a minimum of $2.5 million in shareholders' equity. While this may seem like an unhedged negative, it turned out to be a blessing in disguise. SINO regained compliance in May 2013 by selling 1.8 million new shares at only a 5% discount to Zhang Zhong, who now owns ~38% of the stock.
This capital raise brings two key benefits. First, there is increased shareholder stability during this transition period, as insiders and Zhang Zhong collectively own ~69% of the stock. This reduces the effect of any selling by short-term focused "weak hands". Second, and most importantly, he played an instrumental role in the previously mentioned diversification, which resulted in the first profitable quarter since the IPO.
For example, in June 2013, SINO signed a five-year global logistic service agreement with TEWOO Chemical & Light Industry Zhiyuan Trade and TianJin Zhi Yuan Investment Group (together referred to as Zhiyuan). Zhang Zhong is the largest shareholder in TianJin Zhi Yuan Investment Group. In September 2013, SINO executed an inland transportation management service contract with Zhiyuan. Management said that it expects to generate "major revenues" from Zhiyuan going forward.
While microcaps in general suffer from the same two "valuation limiting" factors of small size and lack of analyst coverage, SINO has three additional boulders to push up the hill. First, the slowing growth in China continues to receive significant coverage in the financial and general media. However, investors focusing only on the headlines (e.g. negative macro outlook) by definition miss the rest of the story (e.g. positive company-specific fundamentals).
Second, the lingering assumption that all Chinese companies are frauds may be affecting SINO, despite the fact that this is an unwarranted and outdated stereotype. In general, problems are solved much sooner than investor perceptions change, which creates these opportunities in the first place.
Third, while the microcap market is highly inefficient in general, it is even more so for companies such as SINO undergoing a transition, especially during a period of greater economic uncertainty. In virtually every instance, the company does not receive the benefit of the doubt.
The previously mentioned larger competitors would not provide a relevant peer comp given their much more diversified operations. However, on an absolute basis, SINO is attractive given that it trades at an 8x P/E using YTD annualized EPS of $0.32.
The following are the primary risks to the investment thesis, in order of importance:
- SINO is highly dependent on global economic growth (with particular exposure to commodity demand from large producers, such as Australia and South America) as it provides shipping agencies services for vessels carrying bulk cargo, raw materials, consumer goods and vehicles.
- There is intense competition from the previously mentioned four larger agencies.
- SINO has a history of losses and only recently became profitable.
- Due to the restructuring of the Chinese steel industry, the agency contract with Beijing Shourong Forwarding Service (an affiliate of Chinese steel company Capital Steel) has been under review. As a result, SINO has not provided agency services for its vessels discharging in a Chinese port since 7/1/13. SINO is working with Shourong to sign a new agency agreement.
The target price of $3.20 is based on a 10x P/E multiple, which SINO should grow into over the next 12-24 months. The 50-DMA right below the current price provides a natural place for a stop loss.