Less than four years ago, Feihe International's stock (ADY) was trading above $40.00 and as this once again booming Chinese company celebrates its 50th anniversary, it finds itself trading under $4.00, but rapidly rising off the $2.22 52-week low set back in January.
About this time last year, institutional and retail shareholders in most Chinese stocks decided to throw in the towel and run for cover as "hit-piece" authors and short-sellers were popping up daily in attempting to further drive nerve-riddled investors to sell their Chinese stocks. It was like throwing darts in cashing in on the downside of most Chinese names, no different than those on the long side of the trade throwing darts in 2009. Both sides experienced a "no lose" trade.
Feihe and many other legitimate Chinese companies became a casualty as a result of many other Chinese companies that turned out to be operating many aspects of their business in a fraudulent manner. Carson Block and his firm Muddy Waters along with Alfred Little and Maj Soueidan's GeoInvesting, all quickly rose to fame as notorious short-sellers that sniffed out fraud, which resulted in many halts and subsequent delistings. Several other copy-cats threw up websites in also attempting to cash in on the fear and while they didn't arrive to the party until after midnight, hefty profits were still able to be stuffed into their pockets. If one of these short-sellers even mentioned a company's stock symbol, it was a mad rush for the exits. That's how shaken shareholders reacted and still do today to some degree.
What most onlookers didn't realize or ever catch due to their state of shock is that Alfred Little actually came out on August 19th of last year and disclosed he was actually "long" Feihe and the stock closed at $6.46 that day, 55% higher than yesterday's $4.16 closing price. Lesson to be learned here regardless of the short term movement that when one of the above named short-sellers with extensive on-the-ground due diligence teams in China tells the market they're going "long" a particular stock in China that's been beaten to a bloody pulp, you'd better pay attention, as enormous future gains are most certainly possible if not probable.
Did Alfred jump in too early?
Well, at the time of Alfred's disclosure last August, the bear camp still believed that Sequoia Capital would be looking to redeem their preferred shares totaling $65 million dollars and most everyone thought there was no way Feihe would be able to repay or roll over this debt, as most doubters thought Feihe would do as most other Chinese companies would do and convert the preferred shares into common shares at $2.00 to $3.00, essentially adding over 100% dilution to existing shareholders. If they tried to pay off the debt from operations it would cause a death spiral to their business resulting in far less money for sales and distribution which would result in far lower sales.
Alfred Little was the only one who thought something different would happen. He opined that Feihe would sell assets and not only pay off Sequoia, but would still retain all seven of their production facilities, all by the way GMP compliant and updated over the last few years.
Let's take a look at the story now and see how it played out .....
As the saying goes, time will tell and Alfred Little appears to be correct. Feihe not only sold their dairy farms for $131 million, they have repaid Sequoia with the final payment only days away. As of the end of March, Feihe is still owed $77 million dollars from the dairy sale and its total debt consisting of short & long term bank notes should be around $60 million dollars, a far cry from the close to $150 million in debt early last year.
In speaking with management, they have clearly stated that capital expenditures will be very low and that most if not all debt should be retired by Q1 of next year. Basically in a year's time, Feihe will transpire from a once BK/Dilution candidate to a debt free company that lowered their share count from 21 million shares to 19 million, all the while increasing their sales as evidenced by their 2nd best quarter ever, quarter ending 12-31-11 with $87 million in revenue.
So why invest in Feihe?
After five confirmed channel checks, all with boots on the ground in China, the one thing that is for certain is that Feihe is a 100% legitimate business operating in China. Two of those checks are by large short sellers, one by an independent research company and two by investor relations personnel, neither working for, nor have they ever, Feihe and one worked for Feihe's competitor. Doris Zhang of Feihe's Public Relations Department has made it crystal clear that the company will not be disappointing investors this year as far as guidance is concerned and will tend to low-ball expectations, opposite of the manner in which they disappointed investors last year.
Feihe's valuation certainly fits the bill here with net tangible assets after debt conservatively over $9.00 a share and then add in some value for a business doing $300 million in revenues a year. Feihe is certainly worth considerably more than $4.16 a share, especially when you factor in the projected EPS of $1.00 in 2012.
Consider their sector peer, Synutra International (SYUT) that currently carries a $330 million market cap. Both Synutra and Feihe are virtually the same size operation, yet Feihe trades with a $70 million market cap and a far better balance sheet. Synutra carries over $200 million in debt and its net tangible assets valuation after debt is $1.54 a share, so either Synutra is vastly overvalued or Feihe is severely undervalued.
Next, I was looking closely at Feihe's business and how they can continue to grow. This was very interesting, as I'm always looking for a catalyst. In my research, I found that Feihe's Super Premium AstroBaby line is gaining real traction with 890% growth in Q4 YOY, not only in their main-stay Tier 2 & 3 cities, but in the Tier 1 cities as well. I also discovered that just after the Chinese New Year ended, Feihe posted 200 new job openings, including sales representatives in multiple regions. This is certainly not the act of a company in dire straits financially and I nearly forgot to mention Feihe's credit facilities.
Feihe has a total credit line as of December 31st of $111 million with $31 million used and $80 million in available credit with their interest rates being Tier 1 rates paying 5.8% to a high of 6.2%. From the 10K, Feihe saw their Super Premium infant formula traction translate into a 33% increase in their selling prices, rising from $7.94 per kilo to $10.57 per kilo. The Super Premium AstroBaby line has also conducted clinical trials performed by governmental agencies which have resulted in successful tests and found to be closest to breast milk in terms of babies' physical growth and digestive systems.
2012 is the year of the dragon in China, which symbolizes power and wealth and estimates are for a 5% increase in babies born this year. An estimated 16 million plus babies will be born this year, coupled with relaxed government restrictions on the one child policy that allows couples who are both only children to have two kids of their own. In addition, rural couples whose first child is a girl over four years old are allowed a second child. With disposable income rising quickly, Chinese parents have more money to spend on children. Estimates call for the baby food market to double by 2015 according to researcher Euromonitor International.
Safety is always a concern in China, especially in the dairy industry and here, Feihe has excelled. Feihe is considered a leader in quality and takes great pride having been in business for 50 years and not being involved in any food scandals. The 2008 melamine debacle gave the milk industry a black eye for sure, but for Feihe, who was one of the only companies not tainted in any way, they saw their share price soar to $42.00 a share. Before the Sequoia redemption when you look at the last 6 years of trading, Feihe never traded under $6.50 a share, with the bulk of that time trading above $10.00.
I also noticed that over 90% of the trading days witnessed volume of less than 100K. While the share price went from $8.50 to the $2s, no high-volume sell-offs took place. Feihe just launched on March 1st, an end to end tracking system designed and put in place by U.S. giant, Cognizant (CTSH), a $22 billion company, so now consumers can track the source of milk powder from beginning to end, ensuring both quality and safety, plus an elimination about worry of counterfeit products.
In March, new licenses were needed to be obtained to sell dairy products in China and all facilities had to be compliant and updated, which Feihe easily demonstrated and thus their new licenses were issued. Over 40% of existing dairies have been shut down due to the new regulations and being a highly regulated business, I'm sure even more of the weak players will fold up as China catches up to western standards.
I have an extremely reliable source that tells me Alfred Little is planning to come out with something very positive on Feihe after the last payment to Sequoia has been made at the end of this month. I can guarantee you that if true, many new eyes will be on the stock for sure. There are still plenty of shorts in the stock that I believe are now trying to make their way out as unscathed as possible.
These are the facts, you decide.
Disclosure: I am long ADY.
Additional disclosure: While I believe ADY heads to much higher prices from here, I'm a trader and my objective is to trade in and out on the way up, although many times in 2009, Chinese stocks ran away from me on the upside and I was left in the dust. That scenario is certainly possible once again as sentiment changes.