Migao: A Cautious Buy

May. 2.14 | About: Migao Corp. (MIGGF)

Summary

Migao is growing through new joint ventures.

Migao is losing money but its financial position is sound.

Potash prices are rebounding and the industry is on an upswing.

Migao risks: China is its sole market and remains a small player.

Migao (OTC:MIGGF) is a relatively small player in the potash industry when compared to the other industry giants such as Potash Corp (NYSE:POT), BHP (NYSE:BHP) and Agrium (NYSE:AGU). Migao has eight production facilities and one facility in a joint venture with SQM in Chile. In total, Migao produces 620,000 tons of potash and 440,000 in ammonium chloride and hydrochloric acid.

In the past, Migao had a string of bad luck. In late 2011, National Bank dumped coverage of Migao. Around that time as well, its stock price took a beating as investors lost faith in Chinese companies listed on the TSX and operating out of China - remember Sino Forest? In 2013, Migao suspended its quarterly dividends citing net losses in its operations. It has been over a year since the dividend cancellation and three years since the string of negative press hurting Migao's image.

Despite all this, I'm cautiously optimistic of Migao's growth. For one, the cancellation of dividends was a smart move. Migao is a small time player operating in a Chinese market that is hungry for potash. In early 2014, Canpotex (offshore marketing agent for Saskatchewan's three largest potash producers) signed an agreement to supply 700,000 metric tons of potash to China. This shows that there is still a huge demand for potash. Migao should concentrate on expanding its production capacity to meet supply, and not be depleting its cash reserves to pay dividends.

Recently, Migao has taken to signing more joint venture agreements to mitigate the risks of operating and building new production facilities. The joint venture with SQM is already in play, and there is one with EuroChem to produce 60,000 tons of potash and up to 200,000 tones of chloride-free complex fertilizers in Yunnan. Since Migao is expanding its production, this is a strong signal that the company is not standing still and moving forward. On a global scale, there has been several potash producers whom are also expanding production. Allana Potash Corp (OTCPK:ALLRF) is developing a mine in Ethiopia and believes this will create better access to Indian and Chinese markets. Agrium has a potash mine in Saskatchewan expected to start producing potash by end of 2016 with 2.8 million tons expected. Migao still has its competitive edge because all its facilities are located in China, giving it direct access to the Chinese market. Where the competitors will have to pay freight and shipping costs, Migao shipment costs should be minimal since China is right next door

The potash industry remains predominately dominated by Canpotex and Belarusian Potash Company which control over 50% of global supplies. To understand the state of the potash industry, it is necessary to take a look at how the larger players are performing. In looking at Potash Corp, there is evidence potash prices may be on the rebound. Potash Corp earned a profit and believes the industry is on the mend, as demand is starting to pick up again. Potash Corp also improved its earnings estimate because of higher sales volumes and better pricing. This speaks volumes in how it will positively impact Migao as the market picks up. The external factors are definitely playing in Migao's favor.

Migao's financials however show a more dismal picture. The latest operating figures show the company fared even worse than the previous quarter. Current ratio is stabilized at 0.76 in Q4 2013 similar to the previous quarter of 0.75. The debt to equity ratio is 0.52 in Q4 2013 compared to a quarter ago of 0.43. Net income was -$11,911,000 in Q4 2013 and $4,514,000 in Q4 2012 (I excluded the exchange rate gains and losses). What these numbers reveal is that the company is operating efficiently on a day to day basis but potash prices continue to be weak causing a larger drop in net operating income from a year ago. Migao has taken on more debt which makes sense because of the joint venture with EuroChem. Overall, Migao's finances are still showing a company that is still bleeding red.

In looking at the stock price, the stock has risen by almost 25% since February. The reason for this is simple - investors are starting to see potash prices rebounding. Migao has not been performing well financially. But its balance sheet is still sound, its cash position has stabilized and the most important point is they are growing. I think in the near term Migao stock price will continue to appreciate as potash prices continue to improve.

There are two major risks in Migao. Its main market is the Chinese market. The Chinese economy is growing and demand for resources is expanding but the one caveat is the Chinese economy is showing hints of a slowdown. If China ever becomes a full blown economic downturn, it would deeply affect Migao. The second risk is its small size. Since Migao is a relatively minor player in the potash industry, Migao does not have much leeway in determining what the market price is. When industry giants such as Potash Corp, BHP and Belarusian Potash Company sneeze, it is Migao that catches the cold.

Disclosure: I am long MIGGF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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