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  • Emerald Dairy: Uncomplicated and Undervalued 3 comments
    Jul 20, 2011 10:04 AM | about stocks: EMDY, RDBO, SYUT, ADY
    By the numbers, Emerald Dairy is one of the biggest value and growth opportunities of the beat-up-broken-down Chinese microcaps.  Not only is it profitable, but it is growing rapidly in a sector that itself is growing at a brisk 14% per year (from EMDY’s FY2010 Annual Report).  It is currently highly undervalued compared to its peers in every respect.  It also has been untarnished by the scandals that have surrounded others, and is free of the many questionable practices that call other Chinese companies’ conduct into question.  Let’s get into it.

    The Chinese dairy sector has been in the news a lot over the past three years - and not to its benefit.  Many companies large and small were involved in the melamine scandal, which has added a lot of fear and uncertainty to the sector.  Large dairy companies are outsourcing milk from New Zealand, and many Chinese are only buying imported brands.  It doesn’t help that brands are indicators of social status, and high-end brands retain customers and pricing through more than their inherent quality.  

    Emerald Dairy has a very different story to tell.  They are a small producer that operates only in the “smaller” cities in China, choosing not to compete in the biggest markets with the international brands.  They have a unique business plan where they sell directly to retail outlets, cutting out a wholesaler middleman and increasing their margins.  They have a multi-tiered product line that undercuts the price of imported or other high-end brands while maintaining a high-end image.  Finally, they have been completely untarnished by the melamine scandals and have been fully tested and certified by the state.

    Earlier this year, the Chinese AQSIQ (General Administration of Quality Supervision, Inspection and Quarantine) board published a list of dairies that achieved proper certification.  Both of Emerald Dairy’s production facilities were on that list, but many of their smaller competitors were not.  As in many other industries, the Chinese government is trying to crack down on unsafe or unlicensed producers, forcing consolidation or the extinction of producers that don’t shape up or can’t afford new equipment.  They hope to increase the safety and quality of products, which makes perfect sense seeing how many people were sickened by melamine.  Only producers with a clean bill of health will succeed in the future, and they will benefit from their competitors’ closures.

    While Emerald Dairy’s growth had been stagnant for a few years, they recently underwent some huge changes.  Last fall they completed their second production facility, doubling their capacity and expanding their ability to grow.  They are already planning on adding another line to that facility that will grow capacity by another 50%.  This all adds up to a tripling of production capacity in a very short period of time.  While growth like this is by no means sure, they are confident that they will be able to replicate the successes of companies like Synutra and Feihe who grew at similar speeds.

    Their advantage, however, is that they plan to grow organically and not overextend themselves by acquiring too many other dairies.  Synutra and Feihi did a great deal of buying and now have a lot of debt and convoluted corporate structures to show for it.  Emerald Dairy has said that they would look to grow by acquisition, but only if they can sell their own shares at a 10 P/E and buy companies with P/Es of 3-4.  That’s not going to happen in the short term, but we’ll see how their strategy changes over time.

    This brings me to their current valuation.  At $.64 a share, they are trading at a backwards P/E of 2.26.  They expect to earn $.36 a share this year, giving them a forward P/E of only 1.79.  Their PEG ratios, which values companies according to their earnings growth, are so minuscule that they aren’t even worth typing.  Their quick ratio is 2.83, so their liabilities are well covered in the short-term, and they have little long-term debt.  Their debt to equity ratio is only .32, so they are not even particularly leveraged.   Compared to other Chinese dairies these numbers are a joke.  I have put together some comparisons in a Google spreadsheet (let me know if you find any errors!), which you can view here.  It’s not complete, but it shows the discrepancy clearly.  For example, SYUT has an expected forward P/E of 37 and has a debt to equity ratio of 4.25, while ADY has a forward P/E of 7.44 and a debt to equity ratio of 1.72.  SYUT has had a net loss the last three years, ADY lost money last year, and while RDBO had a profit last year their profit will be lumpy this year (though perhaps that’s not their fault, as the AQSIQ board left their name off an approved producer list causing months of lost sales).  Finally, EMDY’s Price/Book is .48, while ADY’s is 1.01, SYUT’s is 7.24, and RDBO’s is 1.02.

    So why the discrepancy?  There are perhaps a few good reasons.  They went public via reverse merger in 2007.  They only have a Top 100 auditor, Windes & McClaughry.  Their internal controls are not effective nor audited.  They are a very small company with little institutional ownership, which won’t improve as the stock price is below the $5 mark.  They have no analyst coverage.  At the same time, they are fully SEC reporting, are improving their internal controls and corporate governance, host conference calls, and are relatively responsive to email inquiry.  They have a decent English website.  They have not changed auditors or CFOs in three-and-a-half years, nor have raised equity at questionable times or prices.  They haven’t engaged in related-party transactions and the CEO and chairman owns 42% of the company.  They have a very simple corporate structure, have no FIEs, and each leg controls 100% ownership.  Their CFO has an MBA from Georgetown, worked at Ernst & Young for 6 years, and speaks English fluently.  Though he can still be a bit hard to understand on the conference calls, this is a major step up from a translator.  Their quarterly and annual reports are well-written, and while they regularly file for extensions, they always make the deadline.

    To me, these are very positive signs for a small company with limited resources.  They have ambitions to uplist their auditor and their listing, but that will only occur as their value is recognized (and may drive further value recognition as well).  I believe they are the only Chinese dairy company to own, as Feihe has debt and share overhang problems, Synutra is expensive at 37 times next year’s earnings, and Rodobo isn’t going to be profitable in the near-term.  They have yet to prove they can perform in growth mode, but they have set a solid path to it.

    Some helpful links:

    Disclosure: I am long OTC:EMDY.
    Themes: Dairy, Chinese, Small caps Stocks: EMDY, RDBO, SYUT, ADY
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Comments (3)
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  • abrandt101
    , contributor
    Comments (12) | Send Message
    what do you think about this company now?
    5 Dec 2012, 11:39 PM Reply Like
  • benjers
    , contributor
    Comments (22) | Send Message
    Author’s reply » This article was written with a belief that I could build a solid trust in a company based on its financial records and other evidence, and then assign an appropriate value to the company based on standard metrics. I no longer believe that I can figure out whether or not a company is a fraud, and since the corruption has been so rampant and the stock market hasn't cared just how cheap things can get, I cannot invest in a company like this. Certainly they can be amazing trading vehicles if you get the jump on some news or see momentum building, but I wouldn't hold any of them for more than a few days.


    I have no idea if this company is legit or not, or to what extent their financials relate to reality. Best of luck in making a judgement call yourself!
    6 Dec 2012, 08:52 AM Reply Like
  • abrandt101
    , contributor
    Comments (12) | Send Message
    I know, I am disappointed in this company (there website wont work) and I would love to know what happened
    22 Jan 2013, 11:53 PM Reply Like
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