Pingtan Marine Enterprise Is A Deep Value Turnaround Play That Could Set Sail Soon With 80-200% Upside

| About: Pingtan Marine (PME)

Summary

PME operates in deepsea fishing to meet robust secular demand from the Chinese for high-quality protein in seafood.

PME has a substantial incumbent advantage (0% tax plus government grants) in an industry with high barriers to entry.

Market underestimates the 200%+ upside associated with the potential recovery in production capacity and licensed value not recognized on the books ($2.3 per share).

At about only 20% possible downside based on our bear case PT, the stock offers one of the best risk-reward profiles among US-listed emerging market small cap stocks with near-term catalysts.

Investment Thesis

We are bullish on the long-term prospects of Pingtan Marine Enterprise Ltd. (NASDAQ:PME) for the following four reasons. In short, as PME's stock price has taken a hit since the fishing ban by Indonesia, the current stock price provides an excellent entry point for long-term investors to own a well-managed fishing giant that will benefit from a strong secular headwind as the market looks past the temporary deep-sea fishing halt. Our base and bull case price targets of $7-12 suggest an upside of 85-200%+ versus downside of 20% at the current price of $3.87.

  1. We believe that there is robust demand for oceanic fish supported by secular change in Chinese diet towards consuming more and healthier protein.
  2. The deep-sea industry in China has a high barrier to entry due to regulations, subsidies, limited supply of specialized labor, and high capital spending. This should give PME an enormous incumbency advantage and protects its profitability in the long run.
  3. Although PME's operations took a big hit due to the fishing ban by Indonesia, we believe the market underestimates the company's efforts to diversify its fishing areas and the asymmetric upside potential due to superb unit economics and potential acquisitions.
  4. Large institutional and management ownerships align their interests with shareholders and stabilize the stock price during downturns. Dividend policies are becoming attractive for this small-cap name.

Company Profile and History

Pingtan Marine Enterprise Ltd., through its majority-owned indirect subsidiary, owns and operates 135 vessels (as of 9/30/2016) that fish in the Indian Exclusive Economic Zone at Bay of Bengal, Arafura Sea of Indonesia and the Western and Central Pacific Ocean of the international waters (Exhibit 1). Main aquatic catches include croaker fish, ribbonfish, and shrimp, and are shipped back to China to sell to mainland Chinese consumers. PME is incorporated in the Cayman Islands, but the operating entity in China is Fujian Provincial Pingtan County Fishing Group Co. Ltd. and is based on Pingtan island, the fifth largest island of China. PME has 92% ownership interest in this operating company through a chain of wholly owned subsidiaries detailed in the annual report. The operating company was established in or around 2000, with its predecessor operating as China's oldest state-owned deep-sea fishing fleet since 1970s. The other 8% interest of the operating company was acquired by China Agricultural Industrial Development Fund at CNY 400 million in 2015 (source), which valued PME's operating company at an enterprise value of CNY 5 billion, or $730 million at spot exchange rate currently and $9.30 per share, relative to the current market price of $3.87 per share as of 2/14/2017. This fund is governed by China Ministry of Finance and managed by Cinda Asset Management, one of the four largest asset managers in China. Major shareholders of the fund include China Ministry of Finance, Cinda, CITIC and China Agricultural Development Bank.

Exhibit 1. PME's Fishing Operations Overview

Source: company investor presentation.

As the second largest deep-sea fishing company in China by total tonnage, PME has been receiving government subsidies in the form of shipbuilding grants and low-interest collateralized loans from state-affiliated banks, and extremely favorable tax treatments. The firm pays zero tax rates on custom taxes, VAT, and corporate income taxes, according to management and the policy Q&A website released by Fujian Provincial Bureau of Taxes (Chinese Source, Q&A 55). We believe this is because the Chinese government intends to encourage the development of the deep-sea fishery industry that offers a significant source of protein for Chinese consumers who are upgrading their diets with rising income. PME's largest domestic peer is China National Fishery Corp. (CNFC, China A share ticker: 000798), a state-run fishery firm that has 57 fishing vessels that mainly operates in African waters for historical reasons and do not overlap with PME's operating territories (Chinese source). Another competitor Kaichuang International (China A share ticker: 600097) has about 15 fish vessels that mainly fish in the Southeastern Pacific ocean near Chile, also not overlapping with PME (Chinese source).

PME's fleet in operations took a hit when the Indonesian government banned deepwater fishing of foreign companies by not renewing fishing licenses in December 2014. This incident caused PME to idle the majority of its fishing fleet that operate in Indonesia in 2015 and 2016 and revenue dropped by 73% in 2015, and stock price has since suffered, as shown in Exhibit 2. However, we believe this event creates a great entry point for a turnaround value play, which we will discuss in detail for the rest of the research.

Exhibit 2. PME's Operating Results

Source: company investor presentation.

We believe the motivation behind this ban is to protect Indonesian domestic fishing fleet that are much smaller in vessel size, as industry experts have commented that the fishing ban has led to an increase in productivity of the domestic fleet. During the fish ban period, the Indonesian government reviewed 1,132 foreign vessels and found 769 of them to be committing major violations while the rest of them were committing minor violations.

Recently, Indonesia has lifted its fishing ban in October 2015. Ministry of Maritime Affairs and Fisheries at Indonesia has decided to lift the fishing ban for foreign vessels with gross tonnage (GT) over 30, announced in the Maritime Affairs and Fisheries Regulation No. 10/2015. The Indonesia government has singled out PME, which presumably owns vessels that fall under the category of committing major violations and vowed to pursue legal actions against the firm in court in September 2015. However, PME's filing has not disclosed any recent legal proceedings, implying that the Indonesia government may have paused on this front. Consistent with our view, we believe such persecution is largely motivated for political reasons. In the interview with Xueqiu.com (Chinese source for download), PME has disclosed that the firm is seeking aid from the Chinese government to resolve this dispute via diplomatic relationships, further corroborating our observation that such proceedings are more political.

Thesis Point 1. Solid demand for oceanic fish (CAGR of 14% through 2022) is supported by secular change in Chinese diet towards consuming more and healthier protein

We believe that there is a secular demand for protein consumption per capita over the next decade as income per capita continues to rise and people adjust the compositions of their diet in the form of consuming more protein and healthier protein. Between 2007 and 2010, protein consumption per capita in China has increased by a CAGR of 15% (Exhibit 3). The tilt towards protein in people's diet is fueled by the rapid rate of urbanization in China, which has almost doubled the urbanization population to 820 million in 2015 from 459 million in 2000 (Source 1, Source 2, Exhibit 4, Exhibit 5).

Exhibit 3

Source: morganstanley.com

Exhibit 4

Source: morganstanley.com

Exhibit 5

Source: fao.org

We expect Chinese consumers to turn to ocean fish as a source of protein as near-sea and freshwater fish are becoming increasingly contaminated. Higher income and dining out are both drivers for high sea fish consumption (Source 2); however, numerous new accounts have indicated that freshwater fish contamination problems have been growing. Contaminated water is caused by sewage, industrial waste and agricultural runoff that includes pesticides. Such contamination has raised severe food safety problems that could cause cancer and other diseases (Source 3). Therefore, consumers are making a conscious choice to prefer ocean fish than freshwater fish, when possible.

Consequently, China has become the world's top fish consumer and largest seafood consumer (Source 4). China accounted for 35 percent of the world's seafood consumption in 2015 and will grow its consumption by another 50% by 2019 (Source 5). Data from multiple sources could corroborate the observation above: for instance, the consumption of seafood in China in 2011 is 16.5 million metric tons, compared to 7.56 million metric tons in 2000 (Source 6). Looking ahead, China's total seafood consumption growth is expected to grow at a CAGR of 13.68 percent between 2014 and 2022 (Exhibit 6a), with per capita consumption growing at a CAGR of 40% (Exhibit 6b).

Exhibit 6a

Exhibit 6b

Source: Slide 23, Slide 18 slideshare.net

Thesis Point 2. In the deep-sea fishery industry in China with high barrier to entry, PME has enormous incumbency advantage based on its access to cheap capital and favorable domestic policies, well-trained officers and sailors, domain expertise, and operational efficiency.

There are several barriers to enter the deep-sea fishery industry in China, such as a) limited mandatory industry quotas and licenses, b) high capital spending on deep-sea vessels in absence of government subsidies, c) limited supply of professional labor for deep-sea fisher, and d) experienced management with strong relationships with governments near public sea to mitigate geopolitical risks.

The complex process of obtaining paperwork to enter the deep-sea fishery business starts with obtaining approvals for each fishing vessel from the Bureau of Fisheries of the Ministry of Agriculture of China (BFMAC) to carry out deep-fishing projects in foreign territories, and renewing them every three to twelve months. Equally important, the firm needs to obtain approval from the respective country, if the firm intends to fish in the country's exclusive economic zones (EEZs, see below for definition), such as Indonesia, India and Democratic Republic of Timor-Leste. Alternatively, a firm could opt to fish in international waters outside of the EEZ, where the laws are highly complex and the waters are overseen by regulatory bodies known as the Regional Fisheries Management Organizations (Exhibit 7).

Exhibit 7. Regional Fisheries Management Organizations (RFMOs)

Definition of EEZ: According to the United Nations Convention on the Law of the Sea (UNCLOS), which came into force in 1994, countries have jurisdiction over resources in the waters within 200 miles off their shores, an area known as the exclusive economic zone (EEZ). Source.

Most, if not all, of the regulatory bodies involved in the process have limited the supply of quota or licenses for various reasons ranging from resource preservation, industry protection and geopolitical issues.

Food and Agriculture Organization (FAO) of the United Nations sets the fishing quota for each of the main aquatic specifics by country and monitor them closely in order to preserve aquatic resources. To enforce such quota, the Chinese government monitors all vessels and all aquatic catches are shipped back to China and recorded by China Customs upon arrival for reporting to FAO. In spite so, China is still criticized for unlicensed and excessive fishing over licensed quota (Exhibit 8), accounting to many news reports (source 1, source 2) and industry research (source). For instance, China Tune Corporation had to withdraw its planned IPO on the Hong Kong exchange in December 2014, as its prospectus disclosed its excessive catch of tuna in prior years created a public outcry.

Exhibit 8. Revised Estimates of China's Distant Water Catch That is 12 Times Reported Figure

Source: Wilson center report in 2013.

Facing international pressure, the Chinese government has reined in the explosive growth seen in the industry between 2007 and 2013 that lifted the total number of deepwater fishing vessels from a low of around 1,500 in 2007 to over 2,000 in 2013 (Exhibit 9). Latest news accounts put that figure around 2,500 in 2016 (Source). To position the industry for growth in quality, the Chinese government has adjusted its approach to mainly existing industry players that are well-capitalized and run by experienced management and typically only approves vessels owned by companies that fall into this category, such as CNFC and PME. In 2015, Chinese government paused approving construction permit for new fishing vessels (unless for replacement) (Chinese source) while in 2016, Fujian province, one of the largest fishing provinces and PME's base province, only added 130 vessels, a figure that also includes replacements (Chinese source).

Exhibit 9. Total Catch (Green Line, Left Axis) vs. Number of Deep Sea Fishing Vessels (Blue Bar, Right Axis)

Source: theinitium.com

In addition to construction permits, governments also rely on construction and fuel subsidies to "pick the winners." The cost of deep-sea vessel is also prohibitive for private companies in China to build, as a steel fishing vessel of about 300 tonnage requires at least CNY 10 million ($1.4 million) and several months to build. Governments usually only subsidize the ship-building cost if the new vessel that is over 300 tonnages (Chinese source). PME has a substantial cost advantage here against peers that do not have access to subsidies or state-owned bank loans (Exhibit 10) with net cash outlay being as low as 30% of the overall building price.

At 4.6% a year, PME also enjoys an average interest expense that is far lower than peers. China Development Banks and The Export-Import Bank of China usually issue collateralized loans that are up to 40% of the ship prices and use equity interests, PME's controlling shareholders or affiliated parties' land interests, and the fishing vessels themselves (around 30 vessels, or 25% of the total fleet, according to 2015 10-K) as collateral. We calculate that the firm pays a cash interest rate of 4.6% in the first nine months of 2016, relative to the 3.23% rate of 10-year Chinese government bond as of 1/16/2017. The credit spread of less than 150 basis point is obviously very favorable for PME and gives the firm an edge in financing new ship buildouts or acquisitions of existing ships with fishing licenses in the firm's target fishing areas.

Exhibit 10. PME Enjoys Much Lower Ship-Building Net Cash Expense and Interest Rates

We believe that such cost advantage is durable in the foreseeable future due to the vested interest the Chinese government has in PME's operating company through the China Agricultural Industrial Development Fund. PME also fits well with the government's overall strategy to extract protein resources from international waters that would substitute for aquatic resources in coastal waters. It also creates opportunities for the Chinese navy to undertake deepwater cruising missions. There have been related news accounts on Chinese navy ships patrolling with fishing vessels in waters near Sierra Leone (Chinese source).

Another incumbency advantage that PME has is its deep domain expertise in an industry that faces limited supply of professional labor. Deep-sea fishing could last for 12 months, if not longer, and sailors are not easy to find, especially as the Chinese population gets older on average and adult workers face other alternatives of physical works with rising compensations. Deep-sea sailors also need to be licensed, not to mention the more rigorous licensing and training process for officers, including captains (Chinese source). Per Ministry of Transportation of China, in 2014, there were 6,318 vessels approved for deep-sea sailing, includes over 2,000 ships for deepwater fishing, that needs at least 62,506 officers and sailors to operate. At the same time, we estimate the total number of certified sailors and officers for deepwater fishing is only 170,224, as shown in Exhibit 11, which is only enough to cover labor demand assume a sailor works on a one-year shift every three years. Therefore, we believe deep-sea fishing continues to face limited supply of labor.

Exhibit 11. Estimated # of Seamen for Deep-sea Fishing

Professional labor in this area is important, as deep-sea shipping does have relatively high risks of death associated with natural disasters or manual mistakes. At PME, having sound compensation structure in place, strong leadership at helm, and good working relationship in fact safeguard fishing crew members from dangerous disputes and munities. A rare yet extremely tragic and horrifying incident in 2011 with Lurongyu 2682, where a compensation dispute quickly escalated into a munity that resulted in 22 deaths out of 33 crew members, exemplifies such people risks (Source). PME has operated for over two decades with no major safety accidents on its vessels. All captains have more than fifteen years of sailing experiences, according to management.

Over the past few years, PME also has been improving on its new operating efficiency as management took a couple of measures to better align the compensation incentives of captains and staff with improving fuel efficiency and lowering inventory shrinkage due to defects in captures and storage, and closely monitor vessels' whereabouts, routes and oil consumption. Management also adopted new internal control measures to be fully compliant with COSO standards (Chinese source, see below for definition).

COSO Definition: Committee of Sponsoring Organizations of the Treadway Commission (COSO). COSO is an organization dedicated to providing thought leadership and guidance on internal control, enterprise risk management and fraud deterrence. Source.

Lastly, PME's domain expertise does not stop at operations. As a US-listed company, PME does receive some indirect protection, when it encounters potential disputes at sea with third parties in the form of gaining international media coverage and diplomatic leverage. As alluded above, fishing in EEZs require licensing that is secured with amiable relationship with corresponding countries while fishing in international waters require both prudent planning on the corporate management side and attentive attitude of captains. While the decision of the Indonesia government to stop issuing deepwater fishing licenses caught the firm off guard, as well as all other fishing peers in the area, the firm has been successfully maneuvering to send fleets to other fishing areas, for which we will discuss in the section to follow.

To conclude, PME is uniquely positioned, with its domain expertise, scale, and operational efficiency, in the deepwater fishing industry of China that has high regulatory and capital barriers to entry.

Thesis Point 3. Valuation: Although PME's operations took a big hit due to the fishing ban by Indonesia, we believe the market underappreciates the asymmetric upside potential due to superb unit economics, potential value-accretive acquisitions and license values, which are appropriately captured in our valuation model.

We believe that PME's business projection can be reasonably modeled with realistic assumptions surrounding its operating fishing fleet that demonstrates an asymmetric upside potential (85%-200% upside vs. 20% downside) given the price at current levels. Below is a summary of our price targets in base, bull and bear cases and the rest of the section details our valuation process for PME.

Our DCF-based valuation model is mostly driven by the following four parts, upon which we forecast free cash flow to the firm over the next five years and then assign a terminal value in 2021.

  1. Ship in production projections.
  2. Revenue and income projections, based on discounted management guidance.
  3. Capital spending projections, based on estimated acquisition/construction costs per ship.
  4. License values, based on discounted appraisal values disclosed by management.

In the long run, PME's business model is relatively straightforward to understand and project. Total revenue is based on the number of fishing vessels in production (vs. idle) and the average revenue per vessel, which is a function of average catch and seafood price, and net income contribution per vessel. Since fishing routes are pre-determined and staff count per ship is fixed, the cost structure of each vessel can be assumed with reasonable confidence. Depressed oil price compared to historical levels, on top of oil subsidies, also provide a tailwind for operations over the next few years.

Part A: Ship in Production Projections

The key variable in PME's operational performance is the number of fishing vessels in production. PME has a total of 135 fishing vessels, for which detailed shipping info can be found on the company site, but not all of them are in operations right now.

Following the fishing ban in 2014 through 2016, PME has been acquiring vessels and reallocating existing vessels to other waters (such as 13 vessels in Timor-Leste as shown in Table 1) to put 27 vessels in operations as of December 2016, or about 23% of total production capacity. As seen in Table 1 below, in the base case scenario, we expect that, in 2017, the firm to put a total of 46 ship in operations, including 15 ships in Indonesia, which corresponds to a production capacity of 34%. Our bull case assumes an 100% production capacity, with all vessels in production, while our bear case assumes fishing ban in Indonesia continues through 2017.

The following sections include our detailed projections for each of the three scenarios (Base, Bull, Bear). Base case assumes that PME puts the majority of its shipping fleet in Indonesia back to work in 2018 and 2019, as the dispute with the Indonesian government gets resolved. At the same time, we expect the firm to add 3 fish vessels each year through construction or acquisitions, since over the past two year, PME has acquired six fishing vessels and built two. The Bull case assumes PME returns to 100% production capacity in 2017 with all vessels in Indonesia back in operations, and the firm adds 11 vessels per year in anticipation of greater demand for seafood in China. The Bear case assumes the Indonesia fishing dispute does not get partially resolved until 2021, and PME only operates a total of 31 vessels through most of the forecast period.

Table 2 through 5. Detailed Ship in Production Projections in All Three Cases

Part B: Revenue and Net Income Projections

With the ship production projections in hands, we can then project the revenue and net income based on management's guidance of about $3 million normalized revenue per ship per year and $0.8 to 1 million net income per ship per year (Chinese and English sources in filing, Q6). Just to be conservative, we assign a 75% multiplier to these guided figures in the base case and assume each ship generates $2.3 million revenue and $750,000 in net income. Our confidence is based on management's ability to control the route, fuel costs and staff costs, especially after the CFO modernized the operational management system, and the sustained level of seafood price due to secular demand. Our bull base takes management's guidance at face value, while our bear case assumes each ship only achieves half of the guided amount, on top of low production capacity throughout much of the forecast period.

Table 6 and 7. Detailed Revenue and Net Income Projections in All Three Cases

The revenue and net income trends are detailed in Exhibit 12. In the bull case, we are assuming revenue and earnings to resume to 2014 level by 2018, with modest increase thereafter. Bull case assumes an immediate step-up in revenue in 2017 and robust topline growth through 2021, while bear case assumes revenue and net profits continued to be suppressed in the foreseeable future.

Exhibit 12. Revenue and Net Income Projections for 2017 through 2021

Part C: Capital Spending Projections

For capital spending, we assume maintenance capex is the higher of $10 million or 8% of annual sales. For new capex, we assume $5.9 million per new ship, which increases by a rate of inflation every year. $5.9 million is a simple average of acquisition cost per ship and construction cost per ship, assuming the firm buys half of new ships and builds the other half every year. For acquisition cost, we assume $9.1 million per ship, which is the average of two acquisitions the firm did in 2013 and 2015 detailed in Exhibit 13. We assume it costs the firm the same amount to build new vessels, but 70% of the cash cost is subsidized by governments, as previously discussed.

Exhibit 13. Capex Projection

Part D: Licensed Value Estimations

PME owns fishing licenses that are tied to each fishing vessel and these licenses, per management, possess economic value that is not recognized on the books by accounting standards. We believe this makes sense, as fishing licenses do carry value, which appreciates in value as the opportunity cost of not having a license rises. Lately, unlicensed fishing in international waters has been heavily scrutinized by regulatory bodies. PME's management disclosed the latest appraisal report for the 4 longline fishing vessels (English source), which values each vessel plus its license at CNY 58.3 million ($8.5 million). According to management, half of the value should be attributed to the license, or $4.3 million. We believe this is a reasonable estimate as the construction cost of a fishing vessel in 300 tonnage is about CNY 10 million and more than double in price for bigger vessels around 600 tonnage, which pegs the ship building/replacement cost at around CNY 25 million, or 40% of the CNY 58 million appraisal value.

As shown in Exhibit 14, we use the $4.3 million figure as a base line and value the licenses of the entire fleet, after adjusting for the variability in tonnage (as tonnage corresponds with catch capacity, which relates with the licensed quota of each license). We then apply another 40% discount to the appraisal value to reach a very conservative price that we think the firm could sell these licenses at. This amounts to $179 million of value that is added back to the enterprise value or $2.27 per share.

Exhibit 14. License Value Projections

Part E: DCF Valuation

We combine all the parts discussed above to arrive at the following DCF valuation. Exhibit 15 shows the base case. We assume a 0% tax rate, as PME does not pay any taxes, which we believe will continue. We assume the business will grow at a rate of 2%, pegging inflation, to estimate terminal value in 2021. We then add the license value to the value of the operating entity to achieve at the enterprise value. The price target of $7 per share also corresponds to an exit EV/EBITDA multiple of 7.5x, after factoring in the license value. The rest of the valuation should be more self-explanatory. We will incorporate 2021 data after we roll the model forward, once 2016 full-year results are announced. The bull case PT of $12.2 and the bear case PT of $3.1 are shown in Exhibit 16 and 17, respectively.

Exhibit 15a. Detailed DCF Model Overview - Base Case

Exhibit 15b. Detailed DCF Model Overview - Base Case

Exhibit 16. Detailed DCF Model Overview - Bull Case

Exhibit 17. Detailed DCF Model Overview - Bear Case

Thesis Point 4. Large founder ownerships align their interests with shareholders and stabilize the stock price during downturns. As dividend policies are becoming attractive for this small-cap name, there are a few headline catalysts that could attract institutional investors.

An analysis of PME's shareholder base reveals that the majority of the shares are in strong hands, as opposed to weak hands. Founder and CEO Xinrong Zhuo and his related parties own more than 60% of the firm (proxy source). The firm pays a sizeable dividend that yields 3%, which ensures a steady stream of income for founder's family and reduces the need for them to monetize their holdings through outright sales.

While the stock has stayed under the radar for most institutional investors due to its small market cap size and low share price, several institutional investors have shown interests. Royal Bank of Canada owns about 336,000 shares as of 9/30/2016 (Source). Goldman Sachs and Citadel Advisors also own some shares. We believe that the name will gain substantial interests from sell-side and buy-side for a few reasons.

Firstly, management disclosed in the latest 8-K filing that shareholders approved a share consolidation, or reverse split, of the company's ordinary shares during the annual meeting held on 1/6/2017, as shown in Exhibit 18. While we do not believe reverse split creates value in itself and the filing does not specify the details of the reverse-split ratios, we strongly suspect that the post-reverse-split price would be above $5 using the close price of $3.87 on 2/14/2017. The reduction of shares outstanding, coupled with large ownership of founders, makes it increasingly difficult for short-sellers to sell the stock.

It also clears the mental hurdle many investors would have around this name and results in a greater chance of the stock being captured by stock screens, especially due to the following two factors: pollution and inflationary pressure on fishery prices. These two factors should encourage institutional investors to invest in the name, particularly through private placements with founders. Most importantly, institutional investors who have taken a top-down approach towards long-term secular plays usually take a very strategic approach towards building and profiting from such positions. The firm's generous dividend policy relative to small cap peers also lowers the opportunity cost for institutional investors to allocate capital to this name.

Exhibit 18. Reverse Split Filing

Pollution Factor: The exacerbating pollution in China, as an evidence of latest headlines of smog in Beijing, should encourage top-down thematic research that focuses on names that fit with the storyline of consumers avoiding pollution from contaminated food to contaminated air. A resurgence of such thematic researches should help surface companies like 3M (TICKER: MMM), whose industry-grade air masks generated record-setting sales, and PME, which is supplying safer seafood as a protein source for Chinese consumers than seafood captured in coastal and in-land waters.

Inflationary Factor on Fishery Prices and Fishing Industry: The business model of PME is conceptually similar to mining, with high initial capex, resources fixated, and revenue tied to commodity (here, seafood) prices. PME is arguably a low-cost producer, thanks to governmental subsidies and operating efficiency, where price-to-book ratio acts as a good indicator of value if the commodity price has found its bottom. Although PME's reported P/B ratio is 2.2 with book value at $1.55 per share, we believe that the reported book value understates the value of the licenses attached to vessels it built or acquired ($179 million, or $2.27 per share). We believe the adjusted book value should be $4.0 per share, which gives a P/B ratio of 0.97. Such attractive valuations at a seemingly depressed level should attract interests from institutional investors who are hungry for capitalizing on the revival of agricultural and fishing prices in the anticipation of higher inflation.

As a result, we believe the stock of PME is prone to benefit from headline upside that is associated with reverse split, thematic picks associated with pollution and fishery industry revival, and any announcement of institutional ownership through private placements. We believe downside risk resulted from large block trades of selling order is relatively small.

Investment Risks

There are six key risks to our thesis in the order of importance and some measures we think investors could take to mitigate such risks.

  1. Domestic policy risks. Chinese government may impose taxes on PME or cease grants.
  2. Foreign policy risks. Indonesian and other governments could impose or prolong fishing bans, especially if there are more disputes in southern China sea.
  3. Privatization risk at current stock price. Management is able to take the firm private at a bargain.
  4. Surging oil prices will pressure on PME's margin, although the firm could ask for fuel subsidy and pass on some costs to consumers.
  5. Depressed prices for aquatic catches that continue for years.
  6. Competition intensifies as industry profitability attracts new, well-capitalized entrants.

Additional Disclosure

This report is authored by Timely Long Short Group LLC, an emerging equity research firm.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PME over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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