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China Agritech, Inc. (OTCPK:CAGC)

Roth Capital Conference

February 20, 2007 4:00 pm ET

Executives

Crocker Coulson - Investor Relations Counsel

Presentation

Crocker Coulson

Great. Thanks a lot. Thanks to all of you for joining us to hear about China Agritech. China Agritech is a company positioned in the organic compound fertilizer industry in China. And over the course of this slideshow I'll be explaining to you why we think that's a very attractive industry to be in and why China Agritech is positioned to create significant value over the next several years.

You're all familiar with the Safe Harbor statements. I'm not going to spend any time on that. We will be making some forward-looking statements potentially in this presentation and potentially in response to your questions.

The Company is traded on the Bulletin Board. A couple of days ago it was trading about $2.50 -- I looked just before I came in -- and it's now at $2.90, giving it a market cap of about $53 million. And as you can see, the Company is quite profitable with $4.7 million in net income on a trailing 12 months basis and trading at about 10 times sales.

China Agritech is -- first of all, the fertilizer market in China is enormous and highly fragmented. China Agritech is a leader in the very specific niche that they focus on, and this is the compound organic fertilizer niche. The Company over the past year, and continuing in the next year, has undergone a very significant -- built a manufacturing capacity, and is also transitioning from what was essentially a regional player in Northern China to now building a true national reach in distribution for its product.

They have a significant competitive advantage in their proprietary formulations and technology, and we'll go into that in a little bit more detail. And they have a two-prong growth strategy primarily focused on the very large market opportunity within the PRC, but they've also made some initial progress in terms of international growth initiatives. And this is an area that enjoys very strong support from the Chinese government. And that's another investment consideration.

So again, China is the largest consumer and manufacturer of fertilizer in the world, representing 35% of total fertilizer consumption. The reason for this is quite obvious. They have 21% of the world's population that they need to feed with only 9% of the world's arable land. This is a $17 billion total market.

But as you can see in the breakdown, the organic fertilizer market constitutes currently only 10% of that market and the majority is still chemical based fertilizers. And those have some -- have had some negative impacts on the environment and on the productivity of China's land that we'll talk about in a little bit more detail.

So what creates the opportunity for China Agritech? We have a population that is growing and also growing more discerning as more people move into the middle class and are focused on the quality of their food and not just on subsistence.

The Ministry of Agriculture has some strong policies in place to support the use of organic fertilizers and there's also shrinking land resources due to pollution and degradation of the land. And the use of organic fertilizers can actually contribute significantly to halting and reversing that destruction of arable land. And there is a government mandate in place that 10% crop reduction should be organic based by 2010.

So if we compare China Agritech's products to other products available in the market, again, we have a general chemical fertilizer. And you can see the significant amount of [natural] fertilizer that is required for each acre. And you can also see a relatively limited increase in yield that is achieved.

Liquid organic fertilizer on the other hand is applied after the crops are already growing. It has a -- requires a much lowered amount to be effective and has a fairly dramatic improvement in terms of the yield and we further will get into how that varies by crops. Some of the benefits is that it eliminates the toxins within plants, mitigate some of the damages done by chemical process and also improves the productivity of the plants, improves the photosynthesis root system and enzyme activities.

So, again, China has essentially been over -- has had overuse of chemical fertilizers for many years. This has had the impact of polluting the environment and contaminating approximately 7% of the urban land.

And on the other hand the use of organic fertilizers increases the nutrients in the soil, improves the long-term use and also allows the farmers to actually command a higher price for their product. And I think as many of you know the farmers and the rural population is a very, very important political segment for the Chinese government.

They have benefited the least thus far from the economic miracle that we’ve seen in China. And now the government is trying to do a number of things to improve their situation and this is one example. As you can see the use of liquid fertilizers projected to grow rather rapidly over the next several years.

So, again, some of the ways that China Agritech benefits from government policies, first of all, there are some farm subsidies in place, the government has eliminated taxes on agricultural products, promotion of organically grown green foods and support for environmental protection.

So the company has been in operation for over 10 years in Northern China. That was their home base, that’s where they developed their products, developed their manufacturing techniques. And now they are in the process of expanding to cover Central China, Southern China and Western China.

Last year they moved their headquarters to Beijing. They have a corp. headquarters outside of Beijing. They have the new concentrated facility and also bottling facility. Their core manufacturing -- legacy manufacturing is up in Harbin. And that was really a distribution based model. They had 46 distributors and 200 sales outlets and as of middle of last year their total production capacity was at 5,000 metric tons. Since then we brought on two new facilities, as I said, in Anhui and then in Beijing.

The company has invested 13 years in developing the technology behind their formulations. They have certified by the Ministry of Agriculture to be effective in every region of agriculture. This is in every province of China. This is a very time consuming and expensive certification to get and many of the competitors do not have it. They have proprietary formulas. They can handle over 30 active ingredients.

So this next slide deals with the components of China Agritech’s products and we're happy to have Mr. Chang speaking in more detail about this afterwards or one-in-one, but humic acid is the base product and then it's further processed and refined. And for each region and each type of crop they have a specific formulation. They modify the components and nutrients to get a formula that’s optimized for that region of the country.

So there are four basic brand products, they go under our, Lulingbao III, Lulingbao IV, Tailong-1 and the Green Vitality, which is a new one they launched just last year. And so these are the four brand names that they go to market with.

So I talked a little bit about the impact for the farmer. Basically, these products have a very strong, a value proposition at the level of the individual farmer who is the person who is making the purchasing decisions.

First of all, they have a dramatic impact on their crop yields. Secondly, it’s a very easy to be applied -- it can be applied either through spare or through a aerial application for larger areas. They have no sedimentation even within 48 hours after its diluted.

And to make it clear, this is a very highly concentrated product. So before application it's actually diluted up to a 1000 times. And again, this is a different from a granular chemical fertilizer, which is a very heavy product. And therefore, it can really only be distributed on a regional basis where the cost of shipping, you know, over a lumsome of value.

This is a very highly concentrated, which makes a little bit more scalable in terms of the markets that they can reach. And they can look on the right side of the screen the impact it has in terms of yield increases, by these different types of crops. So this is applied after the plants are already growing to enhance their productivity and enhance the yield and quality of the products.

So I want to talk a little bit now about their expansion of capacity that’s been going on now, for the last six months and will continue into next year. And that was really the primary use of proceeds for the fund raise that they did in connection with the public issue is to expand these, open up these new manufacturing facilities and then support the working capital that they don't need after the move from regional to a national platform.

So the first new factory that they opened was in Anhui and that had -- that’s a converting factory that has 2,000 metric tons of capacity. They also opened a central concentrate factory in Beijing. So they now have two concentrate factories that has a 5,000 metric tons capacity of concentrate. And they have the Beijing also converting facility with 2,000 metric tons.

And they have two new facilities that are going to come on line over the next two quarters -- Chongqing, which is down in the South will come online in March of this year and in May Xinjiang as I'm probably mispronouncing, which also each of those have 2,000 metric tons.

And so that's, you know, from 5,000 that will be -- at time they have all these in place would be in additional 13,000 metric tons, so a significant increase in their total capacity. And they, also, by moving into the South and the Eastern part of the country, they are able to access now its have a longer growing season multiple high-risk. Obviously, if you're up in the North East of China there's only one draught season and it’s a pretty shortly

So they hope to also smooth out the great pronounced seasonality in their sales, which we're seeing up until now. Like many foreign owned enterprises they're going to enjoy a two year tax holiday on these new facilities and with a 50% tax rate for the following three years. So that will help to optimize the tax rate as well.

In addition, they've started to explore some international expansion opportunities. They signed their first contract supplying Russia and Central Asia. And then, they also have been investing a lot of time over the last couple of months with getting some agreements in place for Malaysia. We feel we have a lot a potential in the next couple of quarters.

And they believe that they can actually generate high margin products already. They believe they are going to enhance those margins in the overseas market.

TRANSCRIPT SPONSOR

Vanguard Equity Research Corp ("VERC") is an independent equity research firm specializing in providing high-quality, objective equity research for micro and small-cap companies. Our analysts are MBA’s and CFA’s with vast experience in the equity research arena. Our continuing year-long program of research coverage allows less visible companies to gain a thorough, independent analysis of their competitive position, along with independently developed earnings and valuation models that otherwise would not be available to interested investors and institutions. Research is prepaid by our clients and distributed free to investors through a massive network of investor contacts and financial data and information providers. For more information about our services or to review reports on current covered companies, please visit www.vanguarderc.com.

Read all investor conference presentation transcripts here.

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So for those of you who are not as familiar with China, here’s a just a map showing you where the production facilities are and again, started off with our Harbin Subsidiary, way up in the north, then they opened [Hevnik], which is in central and eastern China and appears in the very high agricultural provinces in that region. And then Chongqing, which will now allow them to service at Sichuan which is one of the largest agricultural regions in [Saranic] provinces there in the South and then finally Xinjiang.

So it’s really two pieces to it. It’s a fairly simple business model. There is two pieces to it, one is to increase the production capacities, so they can produce additional capacity and build a national production platform. But the next piece is to fill that capacity.

And so the company has also invested a lot of time and resources in the last couple of quarters, building a new sales and distribution structure. And I just feel like they’ve made significant progress there and should have a lot of that trend to come online as we enter the key growing season in the spring.

And so this is at village level sales. So at the end of the day, you have to have a shop in the village and you have to get the information on the products and benefits down to the level of the individual farmer. And you know although some parts of China have a more industrialized large scale agriculture, the majority are really the small farmers and so they need to -- they are very loyal customers, but they also need to be marketed to correctly as this is a not an easy task when that requires a lot of local expertise.

The company will be launching a sales and marketing campaign, again, going into this year to get that word out and you’ll find a “Coca Cola” business model, again where they have the centralized production facility and then following facilities around the country.

So, again, this is the sales model. They have three sales branch offices, each one of those run 10 retail sales offices and each one of those has 20 county level sales agencies. And so in the end, they get down to having a total of 6000 points of sale at the village level. And the company puts out a release on Friday saying that they are approximately 90-95% of the way done in terms of establishing that structure.

In terms of competitive advantages, this is a very crowded marketplace for larger markets in general. However, as I said, they are in the highest value niche which is the liquid organic fertilizer. To get the national level certification is a seven year process with approximately $1 million cost. And as you can see a little over -- I can’t do the math -- may have 12% or 15% of the fertilizer manufacturers have this certification.

Coming out with an experience management team, we have the chairman Mr. Chang here and he will happy to entertain any questions when I'm done and he has a strong and cohesive team working with him on the operational level. The company also is in the process to recruiting an English speaking GAAP conversant chief financial officer and hope to have some news in that regard in the next few months.

The Company has had very strong revenue growth historically, as you can see growing at about 44% from 2003 to 2005. You will see the first nine months of the year that level off quite a bit. The reality is that going into last year, they were at full capacity at the Harbin manufacturing facility.

And so most of the increase in revenues that we saw in the first nine months was actually from optimizing sales mix and price increases rather than increases in production capacity. As I showed you, we now have ample capacity to resume that growth path.

Here, this gives you the breakdown by product of their sales for the first nine months. As you can see, the Company has enjoyed very strong gross margins on its products for the nine-month period this year. It’s actually 52% gross margins. Again, this is a highly concentrated product and one that has a strong value proposition for the end customer.

Operating income growth has also been very strong, growing at about 57% from 2003-2005. And we also saw some strong growth in operating income in the first nine months.

In term of valuation, we are giving you some comps here. There are a few domestic comps and there are also some international comps. You know, this is obviously more your area of expertise to decide what a company like this is worth.

But we feel going into 2007, we have a good solid chance to resume those historical growth rates, and therefore particularly given the strong cash position, the current earnings multiple is very attractive. And you can find all this in the fillings.

Balance sheet, as of September 30th, the Company had $8 million in cash, $25 million in working capital, $25 million in shareholders’ equity and no debt, so a very solid balance sheet.

So investment summary and I am just about out of time, so I may tell you to finish a little bit early. The fertilizer market in China is a very large market. It's extremely fragmented. But there is also a tremendous differential in the types products that are available.

We feel like China Agritech is aligned in the right space with a product that commands a premium pricing, then to a strong government support that has a very strong value proposition returns to the farmers.

We've undergone a very significant expansion in capacity, and we still have more to come over the next two quarters. So going into -- you know, going into this year with more than double the capacity and more of that coming. And most of that will then be in place for the growing season in 2007.

We feel the Company has some very strong competitive advantages as reflected in the strong margins that you can see. And that’s proprietary formulas, the national level certification and very effective sales and marketing network that goes down to the village level.

And so with that, I'll finish my presentation. And you know, Mr. Chang is happy to entertain any questions that you may have.

Question-and-Answer-Session

Unidentified Audience Member

[Question Inaudible]

Crocker Coulson

Sure. I don't have the exact model in front of me, but maybe I'll get more precise numbers by quarter. But clearly, the second and third quarters are by far the strongest sales. And you know, the winter quarters are much weaker. But maybe we can provide some percentage analysis.

Unidentified Company Speaker

Currently -- hello, hi. Currently, the second and third quarters are the best quarters for the Company, particularly when they operate in Northern Area. As the company grow into the Southern China or Southeast Asia, we're going to see less fluctuation because it is hot year around down there. So --

Unidentified Audience Member

[Question Inaudible]

Unidentified Company Speaker

Well, obviously selling fertilizers is not the same as selling Coca-Cola. Therefore, large scale campaigning on television, radio does not do any good. As you know, 900 million farmers are still living in poverty and they have a limited education level. The only thing they believe is to see the crop yielding that is more attractive as compared to chemical fertilizers.

So China Agritech will have some formal advertising. At the same time, they will develop demonstration land around the farming area. So the farmer can see himself that the product they are using, China Agritech liquid organizer -- organic fertilizer are growing better than their old crop. So that's the most effective way of advertisement in this area.

Crocker Coulson

And just to add to that, the Company also has these, kind of, sample packs, similar to if you're going to try out a new brand of a shampoo or something like that. And so it's a small amount but enough that the farmers can dilute it, apply it to a small portion of their crops, and within a fairly short period of time see the result that are achievable. So I think that's also pretty effective.

Unidentified Company Speaker

Yes. I also wanted to add that, as you know, when farmers wanted to convert part of their farming land into organic fertilizer, they don't want to convert 100%. So they're going to convert 10%, and gradually, if they see good results, increase the percentage of organic fertilizers. You are going to see a lot of organic growth in this area.

TRANSCRIPT SPONSOR

Vanguard Equity Research Corp ("VERC") is an independent equity research firm specializing in providing high-quality, objective equity research for micro and small-cap companies. Our analysts are MBA’s and CFA’s with vast experience in the equity research arena. Our continuing year-long program of research coverage allows less visible companies to gain a thorough, independent analysis of their competitive position, along with independently developed earnings and valuation models that otherwise would not be available to interested investors and institutions. Research is prepaid by our clients and distributed free to investors through a massive network of investor contacts and financial data and information providers. For more information about our services or to review reports on current covered companies, please visit www.vanguarderc.com.

Read all investor conference presentation transcripts here.

To sponsor an investor conference presentation transcript please contact us.

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