In this report, Absaroka will present compelling evidence that SkyPeople Fruit Juice, Inc. (NASDAQ: SPU) has materially misrepresented its production volume, revenue, and profitability. SkyPeople’s management has been focused on stock promotion and SPU appears overvalued by the market at this time.
- SkyPeople’s Chinese SAIC financials indicate the Company is less than 10% the size claimed in the United Sates SEC financials
- Visits to all four of SkyPeople’s production factories found idle facilities with limited and antiquated production equipment; the facilities only operate in production mode for less than two months per year due to limited demand and inefficient production
- SkyPeople does not own the largest kiwifruit plantation in Asia and is forced to source input fruits for its factories from local farmers at high costs due to its relatively small size
- Retail channel checks and discussions with SkyPeople’s distributors and customers make the company’s claims regarding product distribution and sales volume unbelievable. Many of the Company’s “customers” claim to have done little or no business with the Company and Absaroka’s researchers struggled to find the Company’s beverage products on store shelves
- EBITDA margins, inventory turnover, accounts receivables, and selling/marketing costs seem particularly dubious relative to peers and indicate potential accounting shenanigans
- A history of low-quality auditors raises significant concerns about validity of published financials and future business prospects
Any of these serious issues on a stand-alone basis should be enough to convince public shareholders to question the current $2.55/share valuation. A complete copy of Absaroka’s report is available here.
1. SkyPeople's SAIC vs. SEC Financials - Significant delta indicates SPU has massively overstated its financials and size of its business
SkyPeople’s financial statements filed in China are not in any way similar to its SEC financial statements and indicate the actual business is substantially smaller than claimed. These local financial statements, which SPU must file with the Xi’an branch of the State Administration for Industry and Commerce (“SAIC”), show that the Company generated revenue of less than $5.3mm in FY09. Below are hyperlinks to the 2009 SAIC filings of SPU’s main operational subsidiaries, as well as English translations:
SAIC Reports:
- Skypeople 2009 SAIC Filings in Original Chinese
- Skypeople 2009 SAIC Filings in English Translation
- SkyPeople's Simplified Organization Structure as per 12/31/10 10-K
click to enlarge images
Chinese GAAP does not consolidate subsidiaries, and thus Absaroka has developed the following reconciliation of SkyPeople’s 2009 SAIC financials in comparison to the SEC financials from the same time period.
Please note that Yingkou Trusty Fruits Co., Ltd. did not commence operations until 4Q10, when the construction of the processing facility was supposedly completed. Thus, Absaroka has assumed the Yingkou segment contribution for FY09 was zero. Absaroka’s in-country investigators were unable to locate any FY09 SAIC financials for this segment. In summary, the significant delta between the Company’s SAIC and SEC financial statements are one of the many reasons Absaroka considers SkyPeople to be over-valued.
2. SkyPeople's Limited Actual Operations - Significantly smaller than claimed in SEC filings
Main Facilities as per SPU Management
Seasonal Production Volume
After completing site visits to all four plants belonging to SkyPeople, Absaroka learned that the maximum length of production season is August through December, but most of the plants generally operate only approximately two months per year. When Absaroka’s in-country investigators visited the various production facilities in March, each plant was closed and dormant except for minor maintenance work.
Jingyang Production Facility
Located in Jingyang County north of Xi’an, the SkyPeople Jingyan production facility was acquired by SPU’s predecessor company in 2004 from the local PRC state-owned enterprise. Originally named Shaanxi Fruit Products Processing Plant, the World Bank provided $2.18mm in funding for the land, equipment, and construction of the facility. According to a former manager of the Jingyang plant, the 1992 World Bank funding was utilized to import Bertuzzi equipment (an Italian vendor of fruit-processing equipment), and enabled Shaanxi Fruit to produce 5,000 tons of pear concentrate per year at full capacity. While the exterior of the facility appeared to have been recently renovated when Absaroka’s in-country investigator visited in March 2011, the production equipment was mostly the original Bertuzzi machinery acquired in 1992.
Although production at Jingyang had ended in December, three months prior to the site visit, the facility was filthy and unkempt. Absaroka’s in-country investigator noted that the smell of decomposing pears permeated the entire plant and the equipment was dusty, overflowing with partially processed peels, and pear pulp was piled on the floor to rot. Based on the unsanitary condition of the plant, it is difficult to believe any foreign juice companies or distributors would be interested in sourcing concentrate from SkyPeople.
The factory manager confirmed during Absaroka’s site visit that the Jingyang facility only produces pear concentrate. Also, according to the factory manager, in calendar year 2010 Jingyang production volume was only 2,000 tons, as the price of pears had risen without an increase in the price for pear concentrate. Also, there was no inventory on-site at the time of the visit. Finally, Jingyang staff confirmed that the plant intends to install new production equipment this year with an annual capacity of 20,000 tons, which should be ready for use in August.
Interestingly, photos on the Jingyang offices wall showed a March 9, 2011 plant tour for investors led by Rodman & Renshaw. However, Jingyang staff told Absaroka’s in-country investigator that the plant was not actually in production during the investor tour. Instead, the seasonal production workers were called into work to appear as if they were busily involved in production and had to wear special outfits for the day.
In summary, below are SkyPeople’s inconsistent production statistics for the Jingyang facility:
- Plant capacity as per SkyPeople SEC filings: 10,000 tons per year
- Plant capacity as per Bertuzzi equipment design: 5,000 tons per year
- Actual 2010 production as per factory manager: Approximately 2,000 tons per year
Qiyiwangguo Production Facility
According to SkyPeople’s SEC filings, Qiyiwangguo is the kiwifruit concentrate and kiwifruit puree production facility. However, according to Qiyiwangguo’s sales manager, no kiwifruit concentrate production currently occurs at the facility. The Qiyiwangguo facility was originally called Xi’an Qinmei Food Company and incorporated in 2002 by Xi’an Jiaotong University and Surea, the local flour company. Qiyiwangguo was sold in 2006 to SkyPeople.
Also, the Company does not currently have a title deed for the purportedly $2.2mm Qiyiwangguo building, but supposedly plans to apply to the regional PRC authority for this important legal requirement in 2012. Absaroka is puzzled about SkyPeople’s rationale in making a significant investment without even completing this basic legal requirement; this exposure means the Company could potentially lose the factory and the entire investment following any dispute over the land. Finally, since SkyPeople is listed in the United States and must comply with the Foreign Corrupt Practices Act of 1977, the Company cannot provide “facilitation payments” or other bribes that are common and necessary in China to obtain a favorable regulatory outcome.
- Plant capacity as per SkyPeople SEC filings: 7,368 tons of kiwifruit puree and approximately 10,000+ of concentrated kiwifruit puree
- Maximum plant capacity as per Qiyiwangguo’s sales manager: 5,000 tons per year
- Actual FY10 Production as per Qiyiwangguo’s sales manager: Approximately 1,000 tons of kiwi puree per year
Huludao Production Facility
SkyPeople acquired the Huludao production facility in June 2008 from the Shaanxi Hede Investment Management Co., for a total purchase price of $6.3mm via the offset of a related party receivable. Shaanxi Hede Investment Management Co. was 80% owned by Mr. Yongke Xue, SPU’s Chief Executive Officer and 20% owned by Ms. Xiaoqin Yan, a Director of SPU. Because of the significant related parties involved in this transaction, Absaroka finds it difficult to believe the transaction was in the best interests of public shareholders.
The Huludao facility is SkyPeople’s largest production facility, yet there was little activity visible when Absaroka’s in-country investigator visited in late March of this year. Absaroka’s in-country investigator was not allowed on premises and only saw two employees on-site, a forklift driver and a guard at the gate, during a weekday, business hours observation of the facility
Absaroka’s in-country investigator spoke with several shopkeepers, neighbors, and fruit farmers that historically sold fruit to the Huludao plant. In addition, one migrant worker who operates concentrate machinery at the plant, for example, stated that she is employed by Huludao during the production season, which lasts four months a year, starting in late August or early September. Also, according to this plant employee, SkyPeople has to pay approximately 1,500 RMB per month, which is slightly above the average blue-collar wage for the area, in order to attract workers during the short seasonal production period.
A shopkeeper near the plant stated that the plant goes into production for a little more than three months a year to produce bottled apple juice. This shopkeeper said that Huludao buys apples locally for about 800 RMB/ton for cultivated apples and around 360 RMB/ton for wild apples that have been gathered from the ground.
No production activity at Huludao plant when Absaroka's in-country investigator visted the facility in late March:
- Plant capacity as per SkyPeople SEC filings: 7,000+ tons of apple juice concentrate
- Maximum plant capacity: 10,000 tons per year
- Estimated 2010 production: Approximately 2,000 tons of apple juice concentrate
Yingkou Production Facility
The Yingkou plant was actually located in the mountains in Gai County, Liaoning and was idle in March 2011; there is no plant at the Yingkou addess listed in SkyPeople's SEC filings
SkyPeoples’ newest production facility, Yingkou Trusty Fruits, was acquired by SPU for $3.3mm in November 2009 from Shaanxi Boai, a firm with overlapping directors with the Company prior to the acquisition and was also partially owned by SPU’s CEO prior to the acquisition. Despite the fact this transaction closed in FY09, the complete scope of this significant related party transaction was not fully disclosed until 03/25/11 in the footnotes of the FY10 10-K.
Absaroka’s in-country investigator attempted to locate the plant at the address published in SPU’s SEC filings, but found nothing at this location. Instead, after investigation, Absaroka’s in-country investigator was directed to a remote, mountainous area in Gai County where SkyPeople owns a previously county-owned concentrate plant. Although the physical buildings were relatively new, it was difficult to assess the production equipment inside because of the complete lack of production activity. Two former managerial employees of SkyPeople, however, told Absaroka that the plant has 10,000 tons per year of concentrate capacity.
Like the Qiyiwangguo facility, SkyPeople currently lacks a title deed for the $7.1mm Yingkou factory; the company supposedly is in the process of applying for the deed with the relevant PRC authority. Absaroka is puzzled about SkyPeople’s rational for making a significant investment without even completing the basic legal requirement of title acquisition; this significant risk exposure means the Company could potentially lose the factory and the entire investment in any dispute over the land. Finally, since SkyPeople is listed in the United States and must comply with the Foreign Corrupt Practices Act of 1977, the Company cannot provide “facilitation payments” or the other bribes that are common and necessary in China to obtain a favorable regulatory outcome.
- Plant capacity as per SkyPeople SEC filings: 7,000+ tons of apple juice concentrate
- Maximum plant capacity: 10,000 tons per year
- Actual 2010 production as per plant managers: Approximately 2,000 tons of apple juice concentrate
3. SkyPeople Does Not Own the Largest Kiwifruit Plantation in Asia – Forced to purchase input fruits at high prices from local farmers
Contrary to SkyPeople’s prior statements in SEC filings that it “owns the largest kiwifruit plantation in Asia,” Absaroka can find no record of any fruit plantation owned by SkyPeople. SkyPeople’s financial statements do not include any indication the Company owns such an asset or finances the carrying costs associated with a large kiwifruit plantation.
In addition, local farmers in Shaanxi and Liaoning stated SkyPeople is forced to buy fruit from local distributors at prices higher than larger competitors because of the Company’s small production volume. Finally, farmers in Liaoning claimed that SkyPeople often delays payment to local farmers, making them reluctant to do business with SkyPeople.
4. SkyPeople Beverage Business - Limited distribution and slow sales
SkyPeople’s claims regarding the profitability and scope of its beverage business are completely preposterous. The Company has two beverage brands:
- Hedetang: kiwi, mulberry, kiwi vinegar and mulberry vinegar flavors sold in 280mL and 500mL glass bottles. From 2007 through 2010, Hedetang beverages were the only beverage product sold by SPU. These beverages are bottled at SPU’s Qiyiwangguo facility
- Qian Mei Duo: kiwi and mulberry juices in “Tetra Pak” packaging, blended and filled by Sanmenxia Prima, LLC, an OEM manufacturer in Henan
Hedetang:
In FY10, SkyPeople claims their Beijing-focused distributor generated $10.7 million in revenue from sales of Hedetang in the Beijing area. Assuming retail prices consistent with the product Absaroka’s in-country investigator found for sale in Beijing, SPU claims to be selling approximately 10mm units of beverages in the Beijing area. Therefore, Absaroka assumed that retail distribution penetration in Beijing would be relatively strong. If actual sales volume corresponds with SPU management’s claims, it should have been far easier for Absaroka’s in-country investigators to find Hedetang beverages on the shelves of the retailers and distribution channels that SPU claims as customers. Finally, even at the locations that do carry Hedetong, the product does not sell well according to store and procurement managers.
Absaroka’s in-country investigators were only able to identify three Wal-Mart stores that carry the Hedetang beverages, SkyPeople’s original beverage product. For instance, the store manager at the Wal-Mart in Zhichun Lu (Haidian District, Beijing) told Absaroka’s in-country investigators that at best, the store sells ten bottles of the Hedetang beverage per week.
SkyPeople's mulberry and kiwi Hedetang brand drinks at Wal-Mart in Beijing - please note the sub-optimal bottom row shelf placement, which is usually reserved for slow-moving merchandise.
Qian Mei Duo Juice:
SkyPeople doesn’t produce mulberry juice concentrate, but instead purchases it for mixing from its contractor, Sanmenxia Prima in Henan. Based on discussions with Sanmenxia Prima, producers of mulberry concentrate, and retail channels, Absaroka estimates that SkyPeople is actually losing money on each beverage sale. In FY10, the Company claimed a 40% gross margin from its fruit beverages in its SEC filings.
Interviews with both Sanmenxia Prima managers and SkyPeople sales and production staff revealed that SkyPeople supplied 30 tons of concentrate to Sanmenxia Prima between December 2010 and March 2011 to produce approximately 60 tons of beverages, or 240,000 cartons, at a 50% concentrate level. Absaroka’s in-country investigators were told that, initially, the order size was expected to be for 100 tons of beverages, but was scaled back by SPU Management at the last moment. Sanmenxia Prima informed Absaroka that after the initial production run of 60 tons in February 2011, there now are no plans for further production because the current inventory has yet to be sold.
Retail Availability of Beverages
According to SkyPeople’s recent 10-K filing, the Company has established relationships with major supermarkets in China’s most populated cities and with beverage wholesalers to ensure broad distribution of its branded fruit juices. In April and May 2011, Absaroka’s in-country investigators visited several large retailers in Xi’an, the company’s hometown, and did not find any SkyPeople beverages.
SkyPeople Retail Channel Checks
Absaroka’s in-country investigators did not find any Qian Mei Duo drinks at all the retailers checked in Beijing. In addition, Absaroka’s in-country investigators were only able to find Hedetang brand drinks in three Wal-Mart locations in Beijing: the Zhichun Lu, Wangjing, and Sunshine Plaza stores. At these three Wal-Mart locations, both individual bottles of mulberry and kiwi juice were displayed as well as six-packs. However, a Store Manager at the Wal-Mart in Zhichun Lu (Haidian District, Beijing) told Absaroka’s in-country investigator that sales are very weak since the product is unknown in the Beijing market and the manufacturer does not provide any promotional support. The Store Manager estimated that ten bottles of Hedetang are sold each week at the Zhichun Lu Wal-Mart. The Zhichun Lu Wal-Mart Store Manager stated the store began stocking Hedetang beverages in December 2010 and believed Wal-Mart would likely stop carrying the beverages shortly due to poor sales.
In summary, Absaroka believes it is highly unlikely that SkyPeople sells its beverages to “…84 distributors in approximately 17 cities…” Diligent attempts by Absaroka’s in-country investigators prove that it is quite difficult to find SkyPeople’s products at retailers and other consumer outlets.
5. Margin Analysis and Financial Metrics - Dubious relative to peers and indicative of potential accounting shenanigans
After site visits to SkyPeople’ plants and discussions with industry experts, it is clear the Company’s primary business is the production of apple and pear juice concentrate, which are commodity products and even the largest and most efficient firms do not achieve margins as high as those reported by SkyPeople. The chart below compares SPU’s EBITDA margins to its Chinese juice concentrate-manufacturing peers.
SkyPeople’s gross margins significantly exceed those of other public Chinese juice concentrate-manufacturing peers and SPU’s EBITDA margins are double the median of their Chinese peers. Absaroka strongly believes this significant and inexplicable disparity is yet another indicator of accounting malfeasance.
Unusually High Inventory Turnover
For a seasonal producer of juice beverages, SkyPeople has an unusually high inventory turnover rate relative to its peers. This further calls into question SPU’s reported SEC financials
The primary juice pressing season for juice concentrate production occurs in the last three months and first three months of most fiscal years, which corresponds to the completion of the fall fruit harvests. For SPU’s Chinese juice peers, inventory only turns over once to twice per year because of the seasonality of the business. Even compared to primary beverage producing peers, such as China Huiyuan Juice, SPU’s inventory turnover still appears too high.
Unusually Low Marketing Expenditures
The selling and marketing costs incurred by SkyPeople’s competition in the juice concentrate business are significantly higher than SPU’s annual expenses as a percentage of revenue. Despite the fact SkyPeople claims to be rapidly growing a new beverage business, SPU spends a shockingly low amount on marketing than its competition in the beverage business. As would be expected for a beverage manufacturer, China Huiyuan spends a greater portion of its revenue on marketing than concentrate manufacturers.
Accounts Receivable Appear Inflated
In trying to determine how SkyPeople’s average days sales outstanding could be so much higher than its peers, the first place to review is the Company’s credit sales policy. Unfortunately, disclosure is poor and conflicting. The percentage of sales taking place on credit is not disclosed. On one page of the 2010 annual report, credit terms are described as ranging from 30 to 90 days. On a different page, credit terms are described as ranging from 30 to 120 days. No explanation for this difference is provided.
Accounts receivable, as a percentage of revenue, have been rising, from 28% in 2008, to 46% in 2009 and 49% in 2010. Management provides no explanation. Apple juice concentrate manufacturers are faced with high working capital needs. The large apple juice producers pay the supplying farmers in cash, while the credit terms for their export customers range from two to six months.
6. SkyPeople's Low-Quality Auditors - Raises significant concerns about validity of published financials and future business prospects
BDO Limited (Hong Kong) has an abysmal track record of providing audit opinion letters for the financial statements of companies that were committing accounting improprieties or have been credibly accused of committing accounting improprieties, such as CHBT, CXTI, ONP, GFRE.
Disclosure: I am short SPU.
