Over the past 1.5 years, we've seen Tianli Agritech (OINK) IPO at $6/share, rise to a high of $8, and then gradually fall to around $1.65, which is the stock price as I write this report. I believe many investors have given up on Tianli in the wake of many Chinese scandals (i.e., Sino-Forest (OTC:SNOFF), RINO International (GM:RINO), Duoyuan (DGW), etc.) and negative reports by motivated short-sellers (Citron Research, Muddy Waters, etc.).
With skepticism at an all-time high, OINK has declined approximately 70% since its IPO. I believe investors have essentially thrown the baby out with the bath water, giving little thought to fundamentals, valuations, and the possibility that OINK might be a Chinese company that is actually legit.
As a value investor, I search for small cap companies with business models that I understand, have good growth prospects, solid cash flow and balance sheet, strong management teams, and of course, great valuations. I believe the current negative sentiment towards US-listed Chinese stocks and the precipitous decline in OINK offers a unique entry point for investors that are able to look beyond surface, focus on the fundamentals, and have the guts to buy when others are fearful.
My main argument for investing in OINK is its valuation, which I will expand upon later in this report. How do you explain OINK trading at a P/E of 1.65x and a liquidation value that is at least double its current stock price? It just doesn't make any sense. But first, I want to share my thoughts on the investment rationale for Tianli Agritech. What makes Tianli a good business? What are the company's competitive advantages?
Tianli Agritech is in the business of breeding, raising, and selling hogs in China. The Company began operations in 2005 and now currently owns and operates 11 commercial farms in Wuhan. The farms, in aggregate, have a total annual production capacity of 170,000 hogs. Based on the 2011 10K, the company is one of the largest (if not the largest) hog farming companies in the Hubei province.
Tianli also began retail operations in which they sell branded pork products in 50 major supermarkets around Wuhan City, including Wal-Mart Stores (WMT), Zon 100, and RT Mart. In 2011, the company also entered into exclusivity agreements with 7 local cooperatives in the Enshi Autonomous Prefecture to breed and sell Black Hogs.
A competitive advantage, or what Warren Buffett calls a "moat," is something that gives a company a clear advantage over others and protects it against incursions from the competition. Now breeding, raising, and selling hogs is a commoditized business in China, so you may wonder if Tianli has a competitive advantage at all. However, I believe there are 3 distinct competitive advantages that Tianli has relative to other hog farmers: the exclusivity agreements to breed and raise Black Hogs, economies of scale, and OINK's vertically integrated platform.
Exclusive Black Hog Program - this competitive advantage is one of Tianli's greatest assets, and one that I believe most investors don't seem to appreciate. Under this program, Tianli has the exclusive right over 10 years to breed and sell Enshi black hogs in the Enshi Autonomous Prefecture in Hubei. Based on Company estimates, black hog meat commands a price premium of about 35% relative to typical lean pork meat. The Company is targeting a black hog production capacity of 100,000 by the end of 2012 and a long run capacity of 1 million. Though I admit that the 1 million capacity may be a stretch, I can easily see Tianli being able to reach a production capacity of 200,000 black hogs by the end of 2013. The beauty of this program is that participating farmers are obligated to purchase feed, vaccines, and other supplies from Tianli and also sell the hogs back to Tianli at production costs. Tianli will be the only provider of black hogs in that region for the next 10 years.
Economies of Scale - At a current production capacity of 170,000 hogs and a potential capacity of 270,000 hogs for 2012 (including the black hog program), Tianli is likely the largest hog producer in Hubei. The benefits of being the largest are obvious: lower cost structure, greater pricing power over raw materials, more economic incentives from the local government, better negotiating power with retail stores, and greater brand recognition, just to name a few.
Vertically Integrated Production System - Tianli not only breeds, raises, and sells hogs, the company also produces its own feed premix. Through R&D and with collaboration with Professor Ming Li of China Central Teachers University, this premix (which contains no antibiotics or other harmful additives) has produced healthier hogs and higher margins. On the "downstream" operations side, Tianli has partnered with An Puluo to sell pork products in major retail chains. This has lead to another source of revenue which has created greater value for shareholders. In the future, the company could have the ability to create its own retail stores (similar to Zhongpin (HOGS).
Valuation: What is OINK worth?
So now that I've made the investment case for OINK, what is the company worth? As of 04/13/12, the market is saying OINK is worth $1.65/share. However, my analysis below suggests that the market is grossly undervaluing OINK - by at least 100%. There are 3 ways investors can value OINK:
- Liquidation Value Analysis - This method involves estimating the remaining value (or "net value") of the company if one were to sell off the assets and pay off the liabilities.
- Comparable Company Analysis - This involves evaluating where comparable companies are trading in the market and applying similar multiples to OINK.
- Discounted Cash Flow (DCF) Analysis - This analysis involves forecasting out the free cash flow of the company and discounting those cash flows at an appropriate risk-adjusted discount rate.
In this report, I will focus on the first 2 valuation methodologies.
Valuation Methodology 1: Liquidation Value Analysis
In general, this type of valuation method is employed when a company is in a distressed scenario (i.e., bankruptcy). However, it can often be a useful analysis for equity holders to calculate a "floor value" - the minimum price at which a stock should trade. The method involves assuming that all the assets will be sold to 3rd parties, all liabilities would be paid off, and the remaining value distributed among the stock holders.
For OINK, I assumed 2 different scenarios in the event of liquidation: 1) The Conservative Case Scenario in which OINK would be able to recover 85% of the fair value of its assets and 2) The Best Case Scenario in which OINK would be able to recover 100% of the fair value of its assets.
Keep in mind that Tianli is not in a distressed or bankruptcy scenario. In fact, Tianli has a very healthy balance sheet with assets that are tangible and easily valued (i.e., pigs, property, feed, etc.). Therefore, it's my opinion that the Company likely will not sell their assets at "fire-sale" prices in the event of liquidation, but at prices at or near their fair market values.
In addition, the fact that there are over 75 hog farms with annual production capacities of at least 10,000 hogs in Wuhan city alone, and 439 within Hubei province, means that Tianli will likely find multiple willing buyers should the Company ever want to sell off assets.
|Conservative Case||Best Case Scenario|
|85% Recoverable(1)||100% Recoverable|
|Total Assets Value||$ 39,738,499||$ 47,067,515|
|Total Liabilities @ 100%(2)||$ 7,029,463||$ 7,029,463|
|Net Value (Assets - Liabilities)||$ 32,709,036||$ 40,038,052|
|# of Shareholders||10,135,000||10,135,000|
|Liquidation Value / Share||$ 3.23||$ 3.95|
|OINK Price (as of 04/13/12)||$1.65|
|Difference||$ 1.58||$ 2.30|
|% Difference (as % of Current Price)||96%||139%|
|Note: Assets and Liabilities as of 12/31/11|
|(1) Assumes cash is recoverable at 100%, short term assets recoverable at 90%, and long term assets recoverable at 80%, and intangible assets recoverable at 50%.|
|(2) Assumes all liabilities will be paid off at 100%.|
|Source: OINK 10K|
Valuation Methodology 2: Comparable Company Analysis
Tianli Agritech can also be valued using valuation multiples of comparable companies. In my opinion, HOGS is the most comparable public company to OINK. There are definitely differences in the business models (i.e., OINK is mainly a hog breeder while HOGS is primarily a pork processor), but they are both mainland China companies that have listed on the Nasdaq. 2 other Hong Kong companies I would consider competitors are China Yurun (1068) and Dachan Foods (3999). 2 US-based comparables are Smithfield Foods (SFD) and Hormel (HRL).
What you'll notice is that out of the entire list, OINK is by far the most profitable:
|Company Comp Set|
|Company Name||LTM Gross Margin %||LTM EBITDA Margin %||LTM EBIT Margin %||LTM Net Income Margin %|
|China Yurun Food Group Ltd. (1068)||8.60%||7.10%||6.00%||5.60%|
|DaChan Food (ASIA) Ltd (3999)||7.60%||3.80%||2.80%||1.70%|
|Hormel Foods Corp.||16.20%||9.90%||8.40%||5.70%|
|Smithfield Foods Inc.||12.80%||8.60%||6.80%||2.90%|
|Tianli Agritech, Inc.||36.20%||33.30%||26.20%||25.80%|
Source: Capital IQ.
In addition, you'll also notice that OINK has the lowest valuation multiple:
|Company Comp Set|
|Company Name||Forward P/E (X)||P/Tangible BV LTM|
|China Yurun Food Group Ltd. (1068)||14.40x||1.5x|
|DaChan Food Ltd (3999)||-||0.7x|
|Hormel Foods Corp.||15.20x||3.7x|
|Smithfield Foods Inc.||7.40x||1.4x|
|Tianli Agritech, Inc.||1.65x||0.4x|
Source: Capital IQ.
If we assume that a reasonable P/E multiple is in the 5-6x range, OINK should be trading at a value of $5.00 to $6.90:
|2012 Estimated EPS||$ 1.00||$ 1.15|
|OINK Value (2012 EPS x Multiple)||$ 5.00||$ 6.90|
Conclusion: I believe now is great opportunity to pick up shares of Tianli Agritech. With the market grossly undervaluing the stock, the potential return over the next few years can be very handsome.