China Organic Agriculture: Tapping Into Growing Chinese Affluence

Nov.23.07 | About: China Organic (CNOA)

Company Description

China Organic Agriculture (CNOA.OB) is one of the largest producers of green and organic rice in China, with approximately 7% of the green rice market and 4% of the organic rice market. Unlike its competitors, the company is vertically integrated and controls all aspects of the process from R&D to seeding, planting, processing and distribution.

The Company has an extensive sales network, located in the major cities in China. CNOA currently has in excess of 6260 acres dedicated to green and organic rice, and its flagship brand, ErMaPao, has won several quality awards and is the most popular rice brand in the country.

Current Price: $1.90

52-Week Range: $0.51-$4.00

Evaluation

This is one of the best ways to tap into the growing affluence of the Chinese consumer. Rice is an essential staple, and with increasing spending power, the average shopper is seeking out healthier food options. The company has experienced continuous growth since its inception in 2002 and its quality products, coupled with branding, easily command a premium over competitors' offerings. CNOA obtains approx. a 15% price differential for its organic rice, and a 10% premium for its green rice. This year's growth (so far) has been solid, with revenues and earnings exploding in Q3:

Q3 2007: Revenues grew 1,357% yoy; Net income grew 1,156% yoy
Q2 2007: Revenues grew 60.4% yoy; Net income grew 58.1% yoy
Q1 2007: Revenues grew 29.6% yoy; Net income grew 35.1% yoy

One reason is that CNOA has been very successful in expanding its distribution channels. In July 2007, it reached an agreement with Nanjing Suguo Supermarket to carry its ErMaPao rice products. Suguo is considered the fourth largest supermarket chain in China with annual sales exceeding $3 billion. Suguo currently operates stores at more than 1,600 locations, with a leading position in the populous Jiangsu province.

Also in July, CNOA entered into an agreement with Beijing-based Hualian Hypermarket to sell ErMaPao products. Hualian operates more than 50 retail mega-stores located across major cities in China. Further, the Chinese authorities' intervention in the price of rice has mostly stopped and it is now determined predominantly by market forces. For the last five years, demand has outstripped supply, especially for organic rice.

It has to be noted that the company recently (in November) appointed a new CEO and a new CFO. This was done by the board on behest of the company's major shareholders. This appears to be a move designed to position the company for its next stage of development. CNOA's new CEO is Zhidong Li, who, apart from having run large corporations in China, graduated from University of Newcastle in Australia and holds an MBA as well as a Ph.D in Business Administration.

Valuation

I do not think the market has fully digested the company's explosive growth for Q3 2007. One reason is that CNOA has yet to file its 10Q, resulting in a recent lack of transparency, mainly due to the management changes mentioned above. I have full confidence that once we have the whole picture, CNOA's share price will soar.

EPS: (FY06) -0.01 (FY07) 0.27
*P/E: (FY07) 7.0x
*PEG: 0.20*
*Based on COP estimates.

Contrast this with the LTM P/Es of several comparables: (i) American Dairy (ADY) (dairy products) - 17.3x; (ii) Synutra (NASDAQ:SYUT) (dairy products) - 86.0x; (iii) ZHONGPIN INC (ZHNP.OB) (pork products) - 27.2x; and it is clear that CNOA is significantly undervalued and currently presents a compelling buying opportunity.

Investment Risk: Moderate to Moderate-High.

Bottom Line: Accumulate.

My Position: None, but looking to buy.