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  • ZhongPin: No Fraud at All, Target Price $40 16 comments
    Oct 11, 2011 10:49 AM | about stocks: HOGS
    ZhongPin: No Fraud at All, Target Price $40
     
    Zhongpin was close at $6.74 with a trailing PE of 3.6, a forward PE of 2.76, PEG ratio of 0.23 (Source: Yahoo Finance http://finance.yahoo.com/q/ks?s=HOGS+Key+Statistics), as a fast-growing Chinese Food company, this such a low price tells us only one thing, like CER, GEO ,Jefferies and some individulals stated, it is a fraud.
    Is that a fraud for Zhongpin? Absolutely Not and it will deserve the 20X PE at a target price of $40.
    There are 2 focus articals to elaborate how Zhongpin ‘could’ be fraudulent, let me summarize them and try to dig into those allegations to see how poor those ‘researches’ are.
    1)      CER: Zhongpin: Where Are the Pigs?
    ·         Zhongpin claims it purchases 1.1mil hogs from large breeding farms in Henan annually, but the farms say only 81,000, 93% less than Zhongpin’s reported figures.
    ·         The company claims more than 1,200 retail stores in major cities in Henan, but detailed checks in all five cities failed to find more than 83.
    ·         Zhongpin claims to sell through more than 2,000 supermarkets nationwide. But in Henan, Zhongpin’s most important market, only 51 supermarkets were found to carry Zhongpin brand products.
    ·         Evidence collected indicates slaughterhouse output is insufficient to sustain reported totals, and based on anecdotal evidence could well be only 50% of reported output.
     
    2)      GEO: Overstated Income, Excessive Capex and Deceptive SAIC Filings
    ·         Overstatement of SEC net income vs. SAIC filings by nearly 500% in 2009.
    ·         GEO estimates 2010 net income of $10-20 million vs. $58 million reported to the SEC.
    ·         Deliberate manipulation of SAIC filings.
    ·         Likely diversion of almost $150 million of reported capex.
    ·         Inconsistent trends between inventories and sales.
    ·         Repeated capital raisings, despite assurances to investors that none were needed.
    ·         Capex concerns already noted by Roth Capital resulting in downgrade.
    I do not want to spend more time on the CER article, it doubts on the no. of stores and pigs based on things like ‘but in Henan,51 supermarkets were found to carry Zhongpin brand products’, how many days has the author been in Henan Province and did he/she know how big it is? Since the CER’s allegations are full of shit, just ignoring it by now.
    Let us focus on the GEO’s big findings, it used some data, graph, looked relative professionally; as you really looked into those findings, they are wildly guess only and all the conclusions are wrong. The GEO’s findings covered 3 items:
    1)Capex is much higher than peers’, noted by Roth Capital, Jefferies as well;
    2) Overstated net income compared with SAIC filings all the time;
    3)Repeated capital raisings
    WHAT IS THE AVERAGE CAPEX PER TON IN PORK INDUSTRY?
    We take a look at the Capex from GEO in a glance first:
    Table 3 - Capex per Ton - HOGS vs. Peers
    Company - Year
    Capex per Ton
    People's Food - 2005 (Source: 2005 People's Food Annual Report)*
    $262
    China Yurun - 2008/2009 (Source: Dec. 2010 Jefferies Report, pg. 8)**
    $338
    Shuanghui - 2008/2009 (Source: Dec. 2010 Jefferies Report, pg. 8)**
    $328
    HOGS 2006 - 2010 (Source: HOGS Annual Reports)
    $682
    HOGS 2011 - 2012 Est.
    $515 (based on Table 4 Total)
    Source: GEO
    Table 4 - Zhongpin Planned Capacity Increases - 2011/2012 cost per ton**
     
    Incremental Capacity (000s Tons)
    Capex
    (millions)
    Capex per Ton
    Taizhou, Jiangsu Province
    130
    $63
    $484
    Changchun, Jilin Province
    125
    $61.5
    $492
    Tangshan
    102
    $49
    $480
    Tianjin
    36
    $21
    $583
    Changge, Henan Province
    100
    $58.5
    $585
    Totals
    493
    $254
    $515
    **Source: June 30, 2011 Annual Report by GEO
    The first thing here is the capital expense per tons is widely different by segments in meat industry. There are 4 major products: chilled meat, frozen meat, low temperature meat product (LTMP) and high temperature meat product (HLMP), the first 2 products are mostly produced by the slaughtering line then go with being chilled or frozen; and the last 2 are produced on different lines. As the company claims it has a capacity in upsteam business like to slaughter 100M heads (75,000 tons), the cost could be widely different due to the proportion of its product being chilled or frozen. Jefferies report quoted by GEO does not distinguish all the differences.
    The 2nd thing, most important point here, the data from Jefferies and GEO are widely wrong. Here is Peers’ Capex / Tons:
    THE CAPEX/TONS FOR PREPARED PORK
    SHUANGHUI: n Shuanghui 2010 Annual report Page 34:
    Invest 172 Million RMB (26 MM) on a prepared pork project of the 120 tons per day (43.8 K tons) which means $595 per tons.
    This is almost the same with Zhongpin’s Tianjin’s project of 36,000 tons with cap of 21MM,
    LTMP/HTMP Project
    Incremental Capacity (000s Tons)
    Capex
    (millions)
    Capex per Ton
    Shuanghui:
    44
    $26
    $595
    Zhongpin
    36
    $21
    $583
    Source: annual reports
    That is average cost / ton for prepared pork is around $590; Zhongpin has 308,000 tons capacity built and in progress, which needs the cap of around 182 MM.
    THE CAPEX/TONS FOR CHILLED/FROZEN PORK
    The No.5 brand ‘DELISI’ was IPOed in earlier 2010 for one project of capacity of 200M heads (approximately 150,000 TONS) annually with cap of 189 MM RMB (USD30MM ), $200/ton, half with chilled and half with frozen pork.
    The average cost of 100M heads slaughter line with all chilled and frozen products is around 130 MM RMB currently in China (this is most popular average industry cost per tons for chilled and frozen pork), which means the average cost is $275/tons; this amount will be different among different cities due to the different land right use cost.
    Zhongpin has the capacity of 838780 tons both built and in process, which needs Caps between 167MM to 230 MM. Zhongpin states they invest the most efficient plant (their plants has the highest utilization rate at 77%, so assume the total cpaex for upstream business is 230MM.
    The total invest Capex is $ 412 MM; compared with total funds from the raising activities $432, there is no obvious difference.
    Table 5 - Zhongpin Capital Raising Activity - 2006 to 2011
    Raise Type
    2006
    2007
    2008
    2009
    2010
    2011
    Cumulative
    Combined
    Equity (net long term debt, millions $)
    23
    63
    0
    57
    0
    66
    209
    $432*
    Debt (net long term debt, millions $)
    0
    12
    43
    32
    49
    87
    223
    Source: GEO
    The 3rd point with Jefferies data is that the Shuanghui and People`s food are focusing on the downstream businees, also Shuanghui buys most of products from its parent company so that the products in tons were not produced by itself. THEY ARE NOT COMPARABLE AT ALL AS A WHOLE COMPANY.
    The CapEx in Zhongpin is reasonable and in line with peers, the doubt from GEO is because they are lack of the common sense in pork industry.
    IS THE NET INCOME OVERSTATED?
    GEO states: revenues between PRC and SEC filings are in line that is good; no need to prove how the revenue makes sense by comparing with peers. So how about the gross margin or net income?
    Let us take a look what UBS was saying on Aug 15, 2011:
    The margin gross for Shuanghui is based on the consolidation between Shuanghui and its parent company; the gross margin for Zhongpin is in the middle of the first 5 brands, which corresponds to its sales ranking.
    As we breakdown all the sales into chilled, frozen, LTMP (low temperature meat product) and HTMP (high temperature meat product), we will find all the gross margin by segment among each company are all in the line as well.
    Provided the revenue and gross margin are reasonable, for a simply business like pork,
    it is pretty straight forward to get the net income, which was easiest part for audit firm.
     
    Source: UBS Investment Research date: 20110815
    DRINK BLOOD by Repeated capital raisings?
    Somehow! The capital raise for one company which has PEG of 0.26 is supposed to be repeated. The only thing is that the management should be shy to state that and also need to consider raising the funds from other market, like China or Hong Kong.
    Valuation:
    Now we take a breath to recall what the logic for `if fraud`: the revenue is OK, the capital expense is OK, the gross margin is OK by compared with peers; the net income is OK derived from above OKs.
    What else for lower valuation? Excuse of shorters. Can you image the floats of one stock was shorted by 1/3 based on analysis like GEO and others’?
    I do not either want to spend too much time on the valuation, the EPS estimation from most analysts are pretty close, like range $1.84-$2.01; I am pretty optimistic with the EPS of 2011, the brand 1 and 2 company, Shuanghui and Yurun are experiencing the food safty issue now, Shuanghui reported a loss in 2nd quarter and Yurun will have this negative impact since the 3rd quarter; Zhongpin will beat the analyst’s esitmaiton in the 2nd half of 2011, I will say it like at least $2.1.
    How much PE ratio will you give it if there is no any fraud concern for one Chinese food company? I will give it 20, so the target price for me is $40, I dare not say it will be reached in 6 months or 36 months, because the price is not based on ‘valuation’, is based on ‘supply/demand’, the shorters absolutely can dump it to $5 or even lower if they ‘create’ the ‘demand’ in such a circumstance of shorting China.


    Disclosure: I am long HOGS.
    Stocks: HOGS
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Comments (16)
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  • akhait
    , contributor
    Comments (273) | Send Message
     
    Thank you for thoughtful consideration of a key metric. GEO is more interested in painting the whole RTO field with the same negative brush. It's unfortunate this was not published by SA as an article.
    12 Oct 2011, 03:22 PM Reply Like
  • johnz
    , contributor
    Comments (270) | Send Message
     
    SA is biased towards shorts. What was the reason they won't let you publish this as a focus article?
    21 Oct 2011, 08:31 PM Reply Like
  • Ian Bezek
    , contributor
    Comments (6061) | Send Message
     
    SA doesn't publish articles that require heavy copy-editing, as would be needed with this one.
    25 Oct 2011, 06:06 PM Reply Like
  • Business Economics Analyst
    , contributor
    Comments (2532) | Send Message
     
    Did you learn your English at EDU? You should definitely get a refund and use the money to figure how to do due diligence on a company.
    22 Oct 2011, 09:40 PM Reply Like
  • Laoding
    , contributor
    Comments (17) | Send Message
     
    Author’s reply » Shorting China almost ends as the Sino Forest investigation is completing with no fraud. The evaluation on China Stocks will be back to normal soon.
    15 Nov 2011, 05:17 PM Reply Like
  • nostores
    , contributor
    Comments (94) | Send Message
     
    Laoding, ah.. what about CCME, CHBT, LFT, JGBO, CAGC, PUDA, CBEH, SBAY, CELM... etc.

     

    fyi - that audit hardly means there is no chance that Sino isn't a fraud.
    15 Nov 2011, 05:43 PM Reply Like
  • Business Economics Analyst
    , contributor
    Comments (2532) | Send Message
     
    Is there any Chinese expression similar to, "The fox guarding the henhouse"?
    16 Nov 2011, 10:09 AM Reply Like
  • nostores
    , contributor
    Comments (94) | Send Message
     
    And how did it cost 35m to do the investigation?
    16 Nov 2011, 10:27 AM Reply Like
  • Business Economics Analyst
    , contributor
    Comments (2532) | Send Message
     
    sometimes bribes can be expensive, especially if you take a piece of it for yourself.
    16 Nov 2011, 07:55 PM Reply Like
  • Laoding
    , contributor
    Comments (17) | Send Message
     
    Author’s reply » I do agree the percentage of Chinese fraudulent company is much higher than the one for US companies; that is a fact I never deny.

     

    Shorting Sino Forest is a milestone in this shorting storm to push almost all Chinese stocks to the hell; so if the allegation on Sino Forest is negative to shorts, it means it is a turnpoint for non-fraud Chinese companies.

     

    This 'crisis' for Chinese stock means an opportunity somehow now if they are wrongly painted by fraud brush.

     

    Zhongpin will be the one wrongly judged, it needs fund to expand its capacity to get more shares in pork feild, so I keep contacting the management team to convince them to delist here, it is pretty hard to get a fair valuation which negatively affects another round secondary like in 2013; also the Shanghai Exchange welcome some good companies listed in US back to China, it is a good chance for both company and invetors.

     

    The best way for Hogs is to buy back more shares from market, they have already bot around 3MM shares and keep buying from the CC; they have a open purpose credit line with amount over 10 bilions; then offer a higher price to make sure the buyout is successful. Good for all.
    18 Nov 2011, 04:19 PM Reply Like
  • Laoding
    , contributor
    Comments (17) | Send Message
     
    Author’s reply » I do not know who will be blamed on this, but the company was hardly hurt; Can put the Muddy into prison if they are wrong? No idea, not clear with the law in US regarding this.
    18 Nov 2011, 06:36 PM Reply Like
  • Laoding
    , contributor
    Comments (17) | Send Message
     
    Author’s reply » Zhongpin did not have any safty scandal so far, it is the only one among the big 6 pork producers.

     

    I am really impressed by it, it is really hard to have no food safty issue as your run the pork business in China, I believe the managements extremely care about it, they put their minds in it.

     

    Only from this point, I believe it will be outstanding brand in coming future, acutally customeres vote it as No. 1 trustable brand already.
    18 Nov 2011, 06:36 PM Reply Like
  • Business Economics Analyst
    , contributor
    Comments (2532) | Send Message
     
    Laoding:

     

    Why would anyone put Muddy in prison? The real question is whether they can put you and your ilk in prison.
    19 Nov 2011, 08:32 AM Reply Like
  • Laoding
    , contributor
    Comments (17) | Send Message
     
    Author’s reply » Hogs can get more growth this year, there is around 30% capacity released also the outstanding share is down 10%, the EPS of 2012 will be USD2.7+
    11 Jan 2012, 05:01 PM Reply Like
  • Laoding
    , contributor
    Comments (17) | Send Message
     
    Author’s reply » The SI was covered during Dec 1 2011 to Dec 15 by 1.446 M shares; the whole volumns (excluding the pre and after market volumn) in the same period is only 1.508 M shares, there was not much volumn in pre and afer market; in this period, the price was down from 9.7 to 8.3 slowly one way.
    How did that happen, shorters?
    11 Jan 2012, 11:56 PM Reply Like
  • Laoding
    , contributor
    Comments (17) | Send Message
     
    Author’s reply » I got 80% RoR on Hogs but I lost the chance to be $40 due to the buyout which was forced by shorters!
    3 Jan 2013, 12:15 PM Reply Like
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