The Truth About Yongye International (Part 1)

| About: Yongye International (YONG)

If you could buy stock in a company growing revenues at approximately 100% per year, with a net income margin that figures to improve, no longer needing to sell additional shares to support organic growth, and trading at a trailing price/earnings ratio of 7, would you do it? Of course you would. Well, now you can. And, no, the company isn’t a fraud. And, yes, the company’s products work. In fact, they work very well.

From Yongye International’s (NASDAQ:YONG) 2009 10-K, page 4:

On December 6, 2008, the Inner Mongolia Autonomous Region Scientific and Technology Bureau (IMARSTB) thoroughly reviewed scientific and economic data provided by the Company and reached the opinion that our liquid plant product effectively increases agricultural output, improves the utilization rate of fertilizer, enhances a plant’s resistance to disease and has a lighter weight and higher bio-activity than the other products it tested. In addition, the IMARSTB concluded that large scale experimentation has proven that our product can increase overall yields of staple crops, such as wheat and rice, and vegetables by 10-20% and 15-30%, respectively, while also improving product quality. In a separate study, the IMARSTB concluded that our extraction process is more efficient and produces purer fulvic acid as compared to traditional extraction methods.”

As time progresses, the company has made and is making its products more effective.

There are some things in China that are more certain than they are in the United States. You do not want to cross the Chinese national government regarding anything of major public interest - that is, if you want to still be alive and roaming freely several months in the future. If you strongly doubt whether the above statement from Yonge International’s 2009 10K is factual, you aren’t thinking clearly. You can’t lawyer your way out of falsifying something like this in China.

Also, here is a tiny sampling of research from around the world over the course of decades that proves the efficacy of fulvic acid products for plant growth.

Yes, there have been many well researched trials using fulvic acid as a growth stimulant on many different types of crops. We have carried out trials in New Zealand using fulvic acid as a component of an organic liquid fertilizer mix, which had promising results. To summarize some of the research findings: (1) In cucumber plants grown in hydroponic nutrient solutions, the addition of 100-300 ppm of fulvic acid produced highly significant increases in the growth and development of the above and below ground plant parts, in the uptake of nutrient elements (N, P, K, Ca, Mg, Cu, Fe, and Zn), and in the formation of numbers of flowers per plant. This was found in a study carried out by the Chemistry and Biology Research Institute, Ottawa, Canada, and published in Plant and Soil, Volume 63. (2) In tobacco plants, concentrations of fulvic acid in the 50-100 ppm range promoted root length by 25 percent while high concentrations did not have an effect. This study was carried out by the Department of Agronomy, Tobacco Institute, Drama, Greece, and the Department of Soil Science, North Carolina State University and was published in Plant and Soil, Volume 54. (3) …daily drenching of a sand-based growing medium with 300 ppm of fulvic acid solution was found to stimulate length of top growth as well as fresh mass of top and root growth of four tomato cultivars and four cabbage cultivars grown under greenhouse conditions. This study was published in the Journal of the Southern African Society for Horticultural Sciences, Volume 7, Number 1. (Source)

Worldwide, many fulvic acid products are of poor quality. (One of many sources.) Yongye doesn’t have this issue. Yongye is experiencing extremely strong plant product sales growth in areas where their plant product is already widely sold, demonstrating that the word-of-mouth among farmers regarding the products is very good.

“Sales from Hebei increased…96% year-over-year during the first nine months of this year.” (3rd quarter 2010 results press release)

“Hebei Province…is Yongye's largest regional market in China, representing approximately 30%...of the Company's revenues in 2009…” (2010 Q3 10-Q, page 18)

Sometimes, a Chinese government entity buys the product and provides it to farmers for free or large farming enterprises, versus small-scale farmers, buy the product. Yongye has a strategic partnership with Farmer’s Daily, the largest national newspaper in China targeted at rural residents, and one which is administered by the PRC Ministry of Agriculture, making Yongye the envy of like companies. Yongye’s products, technology, and Chief Scientist have all won prestigious awards. (See Yongye International Forms Strategic Partnership With Farmer's Daily, Yongye International Receives Awards Recognizing Products, Technology, and R&D Initiatives, and China Central Television Honors Yongye International's Chief Scientist.)

After learning all of this, and related information, if you doubt at all whether Yongye’s plant product works particularly well, you aren’t thinking clearly. If you doubt at all whether the company exists, given knowledge of the above, the other prestigious awards the company has won from Harvard Business Review and China Marketing Forum, the company’s Big 4 auditor (i.e., KPMG), the many times that the company has been on Chinese TV or in Chinese or United States publications, et cetera, please check yourself into a mental ward. (Example of Yongye on Chinese TV. See from prior to the 10 minute mark to approximately the 15 minute mark.)

At its current price, the stock of Yongye International is truly one of the best investments in the world. Presented here are some basic information, fundamentals, strengths, and weaknesses related to this investment. Also presented here are some of the many bogus criticisms that have been made regarding the investment. It is these criticisms, and the many bogus or overblown criticisms regarding the companies in the U.S.-listed Chinese stock space in general, that have served to suppress Yongye’s stock price so severely. (Please see here and here for an explanation of the many unfair criticisms that have been made, ad nauseam, against the companies in the U.S.-listed Chinese stocks space in general.)

This is just one specific case wherein a U.S.-listed Chinese stock’s price is severely suppressed for no valid reason. There are many other cases. This is one of the most severe cases, if not the most severe. Some of the bogus criticisms used against Yongye are also used, either verbatim or in a tweaked form, against many of the other companies in the stock segment. Largely, what is suppressing the stock prices of these companies has nothing to do with the companies being riskier investments than similar U.S. companies. It has a great amount to do with very strong false impressions that have been created via extensive misinformation.

Business: Yongye is the leader in its business niche and famous in China. Almost all sales, until now, have been for its fulvic-acid-based plant-fertilizer-supplement product that can increase yields by 10-35%, et cetera. The company also has a dairy cow nutrition product that helps cure and prevent mastitis, et cetera, for which they recently built enough additional manufacturing capacity for large-scale production. Enhanced, more-specialized, or additional products are newly launched or under development and testing. All sales are in China. Sales outside of China are a definite possibility, but are unlikely to occur in the near future.

Stock Price: $7.15 (as of 2/18/11)

Estimated 2010 EPS: $1.08 (3 analysts)

Estimated 2011 EPS: $1.56 (3 analysts) (As you will see in reading the remainder of this article, this estimate is probably well short.)

All Possible Shares Count: 49,518,883

Outstanding – 48,187,044 (end of 2010 Q3)

Stock Grants – 1,183,667 (vesting in April 2011)

Warrants – 148,172 (strike price $1.54, expire 2013)


2006: $3.72 million

2007: $13.14 million

2008: $48.09 million

2009: $98.09 million

2010: $213.20 million (projected)

Strength Highlights:

1. Current share price. This creates an overwhelming reason to buy YONG.

2. Extremely strong past and current revenue growth and strong net income margin. (Non-GAAP net income margin less non-controlling interest was 25% for the first 9 months of 2010.)

3. Recently reached the point where no additional stock sales are necessary to support the company’s tremendous growth. (Despite more than doubling revenues in 2010, the company recently became operating cash flow positive. Also, about six months ago, they obtained 400 million RMB [i.e., approx. $60 million] in revolving credit facilities from Agricultural Bank of China and China CITIC Bank. [See Yongye International Announces Positive Operating Cash Flow for Fourth Quarter and Full Year 2010 and Improvement in Accounts Receivable and Yongye International Announces RMB 400 Million Revolving Credit Facilities])

4. New manufacturing capacity is relatively inexpensive for the company to build. (The recently opened new manufacturing facility which expands the company’s manufacturing capacity from 16,000 tons to 46,000 tons and gives it the ability to produce its own humic acid—as a precursor to producing fulvic acid—only cost $15-20 million. (Source: Recent quarterly conference calls.)

5. Margins are projected to improve significantly as the company can now produce its own humic acid and the company is acquiring its own coal—a precursor to producing humic acid. (Source)

6. Mid-year 2010, Yongye acquired the distribution rights from its largest regional distributor—the distributor for Hebei Province—and now sells directly to the local distributors in the region. This had/has a positive effect on margins. It cost $3 million in cash and 3.6 million shares though, so it was dilutive to shareholders. (Source)

This acquisition may or may not be accretive to earnings per share long-term, but it was positive from an intangibles perspective. A single customer no longer accounts for 30% of sales, greater vertical integration was achieved, and Yongye is now closer to the end customers in Hebei.

7. Previously, the company said that it would increase revenues by at least 50% in 2010, 2011, and 2012. (Source. [Note: As of this point in time, Yongye is executing this 2010-2012 strategic plan perfectly.]) As you can see by the projected 2010 revenue number so far, the company is far under-promising-and-over-delivering.

8. Despite its tremendous growth so far, Yongye has still only captured less than 5% of the available market share within China for its plant product. (Source)

9. When the company’s domestic sales growth eventually slows substantially, they can begin to sell internationally.

10. Award-winning business strategy, execution thereof, and marketing. (See Yongye International Receives ‘Best Practice Award of Harvard Business Review’ and ‘Blue Ocean’ Strategies Assist Yongye in Winning 2009 Chinese Enterprise Marketing Innovation Award)

11. Yongye has a company partnership, the first-ever, with Farmer’s Daily.

12. Being able to get more productivity out of China’s relatively limited arable (i.e., farmable) land is very important to China’s future. (One of many sources.)

13. Yongye has a dairy cow nutrition product that it can now, potentially, sell far more of. Previously, Yongye did not have the manufacturing capacity available to do this.

14. Yongye has been developing, testing, and launching enhanced, more-specialized, and additional products.

15. Products that are the future of agriculture, as they are scientifically advanced, part of the organic movement, and help to address serious issues with crop and food animal nutrition depletion caused by many years of chemical fertilizer use and crop removal (i.e., crops not being left to decompose).

Until the 1940's, farmers returned essential nutrients to the soil by mulching, manuring and crop rotation...By the 60's, in order to compete in the food market, almost all American farms had become totally dependent on NPK products in order to make a living. Mixtures of NPK…grow fine-looking crops with abundant yields. But your body is not a vegetable. Humans need more than nitrogen, phosphorus and potassium....NPK fertilizers…do not contain the minerals essential for human health, because they were never designed for human nutrition. As each succeeding crop grown on NPK products has depleted the soil of other essential minerals…most produce and food animals now grown in America have become mineral deficient.

(Dr. Michael Colgan, The New Nutrition, pages 10-11)

16. A green and socially-conscious investment.

17. KPMG (one of the Big 4) as auditor for the last 1 ¾ years.

Neutral Highlights:

Internal controls have been judged as effective by management, but the auditor has not expressed an opinion on internal controls effectiveness yet. (Source: 2009 10-K, pages 41, F-1, and F-2) Such an opinion was not required by the Sarbanes-Oxley Act (SOX) yet. The auditor should have to express an opinion for the 2010 10-K.

Weakness Highlights:

  • Operating expenses and cost control were poor the last quarter or two.
  • Upper management and independent directors were granted shares of stock (in October 2010) versus stock options. (Source: 2010 Q3 10-Q, page 16)
  • The Chairman and Chief Executive Officer has 91.7% ownership of a company that has a 5% non-controlling interest. (This is the only non-controlling interest in the company.) This is less ideal for shareholders than stock ownership would be, in that any shareholder dilution has no affect upon the non-controlling interest. (Source: 2009 10-K, pages 10-11)
  • Although in the food industry, it has no product liability insurance. (2009 10-K, page 21)

>>> Click here for Part 2

Disclosure: I am long YONG.

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