China Green Agriculture - Deep Value Or Value Trap?

| About: China Green (CGA)

Summary

CGA is selling below its net current asset value which is a proxy for liquidating value.

CGA market capitalization is below the net cash it has on balance sheet.

CGA is debt free and is selling for less than the debt it can completely service.

Suppose you went to a local neighborhood shop with the intention to buy it. Try telling the shop owner that you will buy it for less than the cash in the cash register, in effect valuing the inventory, the brand value of the shop, and the real estate all at zero. Sounds like an offer everyone will refuse. However stock market which is typically obsessed with earnings per share often throws up such a buying opportunity. One such buying opportunity is China Green Agriculture Inc (NYSE:CGA).

The company currently has $116 million of cash on its balance sheets. If you deduct from this number, all current and long term liabilities of $36 million you will be left with a value of $80 million which is substantially more than the current market capitalization of approximately $54 million.

The company also has other current assets (apart from cash and cash equivalents) of $220 million. The net current asset value (which is current assets - current liabilities - non current liabilities) is a proxy for liquidating value of the company. This means that $300 million (116+220-36) can be generated by liquidating the company if we assume that non current assets of $67 million, are worth nothing.

The company's stable operating cash flow and lack of long term debt, prompts us to run a thought experiment. Suppose the company approaches creditors asking for long term debt. It can comfortably service a debt of approximately $80.8 million dollars if we assume an interest coverage ratio of 4 and long term interest rate on debt in the market of 10% ($32.33/4=8.08 and 8.08/10=80.08). This number is much larger than the current market capitalization of approximately $54 million. Logically, the market value of a company cannot be less than the debt it can comfortably service. To understand this run another thought experiment. What if the company borrowed $80.8 million and paid a dividend immediately of $80 million. It can comfortably service the debt from its cash flow from operations. Would the market capitalization of such a company be less than zero. It will be less than zero if the current valuation figure was correct. Logically it follows that market capitalization should be a lot more than $80 million.

The natural question that follows from the above facts, is why is the company selling so cheap. The answer lies in an unsatisfactory trend of earnings and earnings per share which has declined from $1.56 to $0.69 over the last five year period. However the market seems to be ignoring the stable cash flow from operations over the last five years, which has averaged $32.33 in the last five years and has stayed within the range of $6 million to $68 million over the same period.

The company through its subsidiaries is engaged in production, development and distribution of agricultural products. The fertilizer business conducted by Jinong and Gufeng (two of its subsidiaries) accounts for approximately 80% of the revenues. The net sales have increased in the last six months, but that can be attributed to inclusion of a Variable interest entity. For the three months ended December 31, 2016, Jinong's net sales decreased by $4,476,887, or 14.3%, to $26,825,674 from $31,302,561 for the three months ended December 31, 2015. For the three months ended December 31, 2016, Gufeng's net sales were $21,066,559, a decrease of $2,513,115 or 10.7% from $23,579,674 for the three months ended December 31, 2015. These numbers indicate why the company is selling at a discount. Suspicions about small Chinese companies, have also coloured the opinion about this stock. Those familiar with market lore will remember RINO International Corporation, a Chinese water-treatment equipment company, which also was trading at a deep discount from its liquidating value, but whose value declined all the way to zero cents, when the books were found to be fraudulent. A dividend payout would have helped to remove some of the negativity, and could have given a boost to the P/E ratio.

The company is trading at a forward price to earnings ratio of 2 and price to sales ratio of 0.2. Slightly more than 30% of the company is owned by insiders. The deep discount from liquidating value, net cash value and debt capacity makes China Green Agriculture Inc. an undervalued stock. However one should be prepared to hold the stock for a period of 3 to 5 years in his or her portfolio, which should be adequately diversified (a basket of similar value stocks would do). At the current price of close to $1.39 the downside seems limited. In June 2016, company announced a string of acquisitions which mark a first step in establishing a sales channel for the company. Such acquisitions can be a potential catalyst for unlocking value.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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