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I was reading up on Yongye (NASDAQ:YONG) this weekend while preparing this article. I came across a comment in one of the short hits that basically said, “If a story is too good to be true… then it must be false.” This is a sad brand of logic and one that I have seen refuted many times in my life.

One example is the story a coworker told me of a man who was hell bent on creating the perfect dog treat. He envisioned a tasty treat that was healthy, cured bad breath and cleaned teeth. He failed, and failed, and failed again. He mixed chemicals and leveraged every bit of himself to buy supplies and meet with veterinary nutritionists. The result was the same; no edible bones wrought of his labors, no tasty treats for all those puppies. Then, one day, he hit a home run. One of his compounds worked splendidly and that was the beginning of a Cinderella story. You can see the story of Greenies at its website (greenies.com), and I should mention that dogs don’t just like these treats, they love them like nothing I’ve ever seen.
This doesn’t mean everyone who tries to make a groundbreaking product succeeds, but it does mean that some of them do. This is my problem with the main thesis against Yongye, if you can even call it a thesis. The brand of attack against YONG doesn’t seem to be consistent or believable. Here are the main short attacks:
(Click to expand)
Now, you’ll notice that these short attacks do not support one another. If it doesn’t work, then how could it be a commodity? If the company doesn’t exist, then what are the 24,000 stores that had Yongye on their signs at the end of 2010? It is all hogwash to me. The fact is, sometimes these stories make the best investments. I guarantee you that the creator of Greenies is no longer having to scrape for a living. This is especially true when the price is right for investing, as is the case with Yongye. So, I am going to focus on the positives for this stock moving forward. If you have reservations about the legitimacy of this stock, Kurt Shrout gives a passionate defense in two parts starting here. I won’t address the short concerns any more here, but I will look at this stock from an investing perspective.
Overview
Yongye International is a leading agriculture and fertilizer company headquartered in Beijing. It serves only Chinese customers using a proprietary blend of organic nutrients marketed under the brand Shengmingsu. These two lines of products are made in either spray form for plants or powdered form as an additive to feed. The products are designed to increase plant yield up to 30% and increase the health and livestock. Growth has been explosive for Yongye, as they have seen revenues increase at a 100% pace and store channels multiply from 9,000 at the end of 2009 to over 24,000 at year end 2010.

Shengmingsu means “life essential” in Chinese, and is a combination of fulvic acid with other plant nutrients in a patented formula. At times, the effectiveness of this compound has been refuted by shorts who cite Western research in their claims. Recently, Yongye responded to these claims of ineffectiveness in a press release, stating:

Shengmingsu plant nutrient product combines fulvic acid with a variety of other plant nutrients in a patented formula (patent number: ZL200610131953.7) that has been demonstrated to have a significant impact on the yield and quality of a wide variety of agricultural products in China. An important fact is that compared to its North American counterpart, Chinese soil has been over farmed for many years, with much depleted soil quality.

Another advocate of fulvic acids in combination with other nutrients is Dr. Robert Petit, formerly of Texas A&M. He states in a research paper (pdf) that the acids are in fact effective at improving growth and yield of plants when he says:

Humic acids (HAs) and fulvic acids (FAs) are excellent foliar fertilizer carriers and activators. Application of humic acids (HAs) or fulvic acids (FAs) in combination with trace elements and other plant nutrients, as foliar sprays, can improve the growth of plant foliage, roots, and fruits.

Some authors have attacked Dr. Petit’s personal beliefs as a cause to negate the findings of this scientific paper. I expect that such an attempted debasement of a person is only done in desperation. Furthermore, Chinese governments Inner Mongolia Autonomous Region Scientific and Technology Bureau (IMARSTB) had reviewed the results of the Yongye product and had similar findings. IMARSTB states that the:

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 product increases yields. IMARSTB says the studies have:

Proven that our product can increase overall yields of staple crops, such as wheat and rice, by 10-20%, and of vegetables by 15-30%, respectively, while also improving product quality.

The research can be found on the Yongye website. So, if the product works and the stores exist, what else is left to attack? I’ve seen some people asking why they can’t speak to any of YONG’s customers, without understanding the true nature of their distribution channels. This is not worth addressing, as the company certainly has customers and even sells to the government at times. Let me get to the meat of the argument; Yongye is a pure fundamental play that has incredible upside even given the risks associated with short bait.
Fundamental Value

Yongye International is a straight value play. Its trailing PE ratio of 7 is absolutely crazy for a Chinese small cap that has such sound financials and footprint in the country. Its position with the Chinese government and distribution network both provide huge advantages, regardless of the long term effectiveness of the product. Even if competitors came out with a similar product, Shengmingsu could be build a RoundUp like name brand in the next ten years in China. As a result, I am confident to give a price floor of $9 and ceiling of $28 to YONG. This incorporates the huge growth potential in this stock and also takes into account the myriad of risks associated with China small caps. Despite how legitimate these risks may or may not be, if investors believe them then they may reflect reality in the marketplace.
Conclusions
Yongye is yet another example of a stock beaten down mercilessly by shorts. Even more so than in the cases of China Media Express (OTCPK:CCME) and China Biotics (OTCQB:CHBT), there are no plausible reasons for the attacks on this stock. The short attacks are disjointed, contradictory and some of them are plain silly. In the case of Yongye, even if it sold something that was close to a commodity, its distribution channel and the fact that it has only penetrated 4% of the growable land in China should be enough to invest. Despite all this, the company sits at a PE of 7 and growth of 100% a year. This is simply absurd.
As I always say with my China articles, please maintain a diverse portfolio of these stocks. I am a firm believer in having many eggs in many baskets. The short hit by Ian Bezek shaved $40 million off of this stock… in one day. That article provided nothing new that I could glean, but did have several negative things to say about the stock itself, presented in a neat, concise article format. Never invest in these stocks if you cannot stomach the rollercoaster ups and downs. However, if you can, there is a lot of money to be made in this crazy Chinese market.
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.
Source: Yongye: Another Chinese Investment Opportunity Beaten Down by Shorts