China Pharma: Explosive Growth at a Low Multiple

Oct.15.07 | About: China Pharma (CPHI)

One of the reasons that I started my blog was to focus my time and energy toward providing information about companies traded on the often derided OTC Bulletin Board. Despite that focus, I somehow managed to overlook China Pharma Holdings (NYSEMKT:CPHI) until last week, when the stock really broke out on monster volume. However, the stock crossed my radar screen just in time, and I managed to accumulate a nice position in the stock with a basis around $2.80.

Shares of CPHI.OB have been on an absolute tear of late, having more than doubled since the stock first began to move on September 26th. Somewhat incredibly, however, the stock remains very cheap on a PE and PEG basis. Quite simply, we can attribute the incredibly cheap valuation to the “bulletin board discount,” but that discount looks poised to be wiped away as the company appears to finally have been noticed by investors.

China Pharma has been experiencing steady and impressive revenue growth over the last four quarters, with revenues growing by at least 47% year over year in each of the last four quarters. Income has grown even faster, aided by increasing net margins as revenue increases. In its most recent quarter, CPHI.OB reported revenue growth in excess of 100 percent and EPS of $0.09 (80% growth), and management pointed to continued revenue growth in the coming quarters during the company’s first ever conference call. Thus far through the first 6 months of the year CPHI.OB has earned $0.15 cents per share, and the company appears poised to have a substantially better second half of the year on continued revenue growth.

Given the company’s historical revenue growth over the last four quarters, it appears very reasonable to assume that the company will manage to achieve 50 percent revenue growth (year over year) in the next two quarters. That would give the company revenues of about $19.5 million for the second half of 2007, and assuming a net margin of 38% (slightly below Q2), the company would earn about 20 cents per share over the second half of the year. This would bring China Pharma’s full year 2007 EPS at $0.35, which means that even despite the surge in shares, CPHI.OB is still trading at less than 10 times 2007 EPS.

Looking out further, the company expects growth to continue in 2008, and has projected growth of at least 30% year over year. Conservatively assuming no margin expansion, the company can be expected to earn $0.46 in 2008, meaning that the stock is trading at a ridiculous 7.2 times 2008 earnings.

As I remarked in my previous article about China Digital TV (NYSE:STV), profitable companies generally deserve to trade at a multiple of at least 1 times their growth rate. For growth companies that merit premium valuations, 1.3 or 1.5 times the company’s expected growth rate is not uncommon. Therefore, if we ascribe to CPHI.OB a multiple of 1 times its growth rate and assume a growth rate of 30 percent, China Pharma shares ought to trade at 30 times 2008 EPS. In other words, CPHI.OB shares should trade for at least 30 x $0.48 = $14.40.

To be fair, China Pharma is not without issues. Most concerning is the company’s inability to enforce payment of accounts receivable, which have been piling up significantly over the last few quarters. In addition, management showed itself to be rather inexperienced at handling conference calls in their first conference call in August, and transparency during the Q&A needs to improve in order to establish investor confidence. However, to my mind, these negatives are far outweighed by the fact that I can buy a company growing at 50+ percent per year for less than 10 times 2007 earnings. That kind of cheap valuation doesn’t come along every day, and I am willing to grant management the benefit of the doubt in addressing these issues as long as the stock trades at such a cheap valuation.

Overall, the huge move in CPHI.OB shares indicate that investors have finally noticed this company, but the shares hardly look expensive despite doubling in the past two weeks. I look at a lot of stocks every week, and very seldom have I found a stock with such explosive growth trading at such a low multiple. With great operating momentum over the last few quarters and a surge in interest in the stock, I believe that we are likely to see much higher prices in the near term. I have established a sizable position in the stock at a basis of $2.80, and I plan to continue to cover the stock over the next few months.