China Botanic Pharmaceutical Deserves A Closer Look

| About: China Botanic (CBP)
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One of my first articles on Seeking Alpha was A Closer Look at Renhuang Pharmaceuticals, and back then the stock was around $1.86. China Botanic Pharmaceutical (NYSEMKT:CBP), as the company is now known, currently trades around $0.80, about a dollar less than in October 2010. Revenues and profit have risen, but the stock price has been hard hit by the turmoil in the China space.

Background: Investment thesis

Although modern medicine is now established in Asia, traditional medicine also plays a big role in people's healthcare. Traditional medicine - a system of ancient medical practice that differs in substance, methodology and philosophy to modern medicine - plays an important role in health maintenance for the peoples of Asia, and is becoming more frequently used in countries in the West.

Within Asia, traditional Chinese medicine (TCM) is the medicinal system with the longest history. TCM was developed through thousands of years of empirical testing and refinement. It was the only medical practice in China before the early nineteenth century, when English missionaries arrived, bringing with them the drugs, devices and practices of modern medicine. TCM encompasses a wide range of practices, including some that are familiar to the West, such as herbal medicine and acupuncture.

Millions of patients around the world use TCM or a related practice. In Hong Kong and Mainland China, approximately 60% of the population has consulted traditional medicine practitioners at least once. Pharmaceutical companies are also taking an active interest in TCM research.

For instance, GlaxoSmithKline (OTCPK:GLAXF) has established a research and development base in Shanghai, China, and is actively seeking to expand its operations in traditional medicine. Most of these companies are hoping to find the next 'miracle' drug like Artemisinin, an anti-malarial drug extracted from the medicinal plant sweet wormwood, which has saved millions of lives.

Background: China Botanic Pharmaceutical

One company that can profit from this huge market is China Botanic Pharmaceutical. China Botanic is a leading producer of all-natural plant-based botanical, biopharmaceutical and traditional over-the-counter (OTC) drugs. The company, formerly known as Renhuang Pharmaceuticals, Inc., was founded in 1996 in Harbin, Heilongjiang province in Northeast China.

In September 2006, the company became a US-listed public company through a reverse merger and began trading on the Over the Counter Bulletin Board under the ticker symbol "RHGP". On July 2, 2010, the company began trading on NYSE Amex under the ticker symbol "CBP". The company offers three major product lines including Siberian Ginseng (Acanthopanax) based natural medicinal products, biopharmaceutical products, and OTC Traditional Chinese Medicines , representing roughly 70.1%, 13.1%, and 16.8%,respectively of total revenues 2011.

China Botanic 's key product line is the Siberian Ginseng (Acanthopanax) based product series, a natural medicine effective in treating depression, melancholy, and other nerve regulating products. With control over an estimated 70% of China's natural raw materials of Siberian Ginseng (Acanthopanax), the company possesses a sustainable competitive edge and, therefore, commands a dominant market position in Siberian Ginseng (Acanthopanax) based products.

The company distributes its products through a multi-layered sales network of over 3,000 sales agents organized under 70 sales centers across 24 provinces China Botanic has established a multi-channel research and development infrastructure composed of in-house researchers and a government approved post-doctoral work station. The company also collaborates with well-known institutions and scientists to advance the scope of its research and development.

The company has achieved significant progress in the research and development of standard extraction and separation of effective components China Botanic has three manufacturing facilities producing over 200 types of nutritional and medicinal products in various forms. The company strictly follows the international Good Manufacturing Practices (GMP) and all of the manufacturing facilities are GMP certified quality processes and systems by utilizing cutting-edge technologies, state-of-the-art equipment, and proprietary innovative and award winning processes.

First quarter 2012 highlights

  • Net sales increased 24.4% year over year to $28.1 million
  • Gross profit increased 25.4% to $17.3 million, from $13.8 million in the first quarter of fiscal 2011
  • Gross margin increased to 61.6%, from 61.1% in the year-ago period
  • Net income rose 12.4% to $12.3 million, or $0.33 per diluted share, from $10.9 million, or $0.29 per diluted share, in the first quarter of fiscal 2011

Financial Snapshot In Past Three Years (In USD)
2009 2010 2011
Revenues 43,411,562 55,183,941 72,714,000
Net Income 14,846,857 17,868,942 25,919,085
Gross Margin 53% 53% 59%
EPS 0.41 0.47 0.69
P/E Dec. 31 2.39 4.19 1.15
Book Value 1.35 1.87 2.67

Final note

In my view, the company is way undervalued and investors are still to cautious regarding Chinese companies. EPS will be around $0.88 this year, which leaves us with a P/E-ratio below 1.

Many Chinese frauds have been disclosed since auditors began to upgrade cash confirmation processes last year. In January, auditor Windes & McClaughry signed off China Botanic's annual report, saying:

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of China Botanic Pharmaceutical Inc. as of October 31, 2011 and 2010, and the results of their operations and their cash flows for the years in the two-year period ended October 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

In February, however, I had some questions for the company, and got some answers:

Q1: TCM is a growing market in Asia, but also in Australia, the U.S. and Europe. What role could China Botanic play internationally? Are there plans for international sales or expansion?

The Company considers that opportunities in the domestic China market will be more than sufficient to drive growth this year

Q2: Are you planning to distribute dividends in the (nearby) future?

Please refer to our disclosures on Form 10-K including the following:

Our holding company structure may hinder the payment of dividends.

China Botanic Pharmaceutical Inc. has no direct business operations, other than its ownership of our subsidiaries. We intend reinvest all undistributed earnings to expand our PRC operations, which the management would be most benefit our shareholder. Should we decide in the future to payout dividends, as a holding company, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries, from time to time, may be subject to restrictions on their ability to make distributions to us due to restrictive covenants in agreements, restrictions on the conversion of local currency into U.S. dollars or other hard currency and other regulatory restrictions applicable to our subsidiaries. If future dividends are paid in Renminbi, fluctuations in the exchange rate for the conversion of Renminbi into U.S. dollars may reduce the amount received by U.S. stockholders upon conversion of the dividend payment into U.S. dollars.

A provision has not been made at October 31, 2011 for U.S. or additional foreign withholding taxes on approximately $79,375,132 of undistributed earnings of foreign subsidiaries because it is the present intention of management to reinvest the undistributed earnings indefinitely in foreign operations.

We do not expect to pay dividends.

We expect to apply our future earnings, if any, toward the further expansion and development of our business. The likelihood of us paying dividends is further reduced by the fact that, in order to pay dividends, we would need to repatriate profits earned outside of the U.S., and in doing so those profits generally would become subject to U.S. taxation. Thus, the liquidity of your investment is dependent upon your ability to sell your shares at an acceptable price, rather than receiving an income stream from your investment. The price of our stock may decline and fluctuations in market price coupled with limited trading volume in our shares may limit your ability to realize any value from your investment, including recovering the initial purchase price.

Q3: What do you want to achieve with CBP five years from now?

We have not disclosed our long-term plans to the public, however we have provided an outlook for the year ahead which was given in our earnings press release on January 30. This outlook was the company's view as of that date. We are under no obligation to update that view as circumstances change:

Business Outlook

"Looking into the fiscal year 2012, we believe the market demand for botanical and pharmaceutical products will continue to grow as a result of growing awareness of conditions like depression and melancholy and the government's mandate to enhance healthcare coverage by the public insurance system. In addition, consumers are increasingly making a conscious decision to live a healthy lifestyle and avoid western medicines which pose other side effects. Driven by such market dynamics and our aggressive sales and marketing efforts, we believe our all natural plant based products will achieve greater market acceptance in fiscal year 2012, in particular our Siberian Ginseng (Acanthopanax) Series. We also expect our recently launched product, Ginseng and Venison Extract to make meaningful revenue contribution in fiscal year 2012."

"We expect to be listed as one of China's essential medicine suppliers as the PRC government moves forward with its Health Reforms in 2012. We have also established a Medical Reform Sales Department as a dedicated resource focused on capturing this tremendous growth opportunity," added Mr. Li. "In the longer term, we expect Ah City phase two plant and new products which are currently in our R&D pipeline to provide sizeable contribution to our future revenue and net income growth."

For fiscal year 2012, the Company expects revenues of between $91.6 million and $93.1 million, representing an increase of 26% to 28% over fiscal year 2011 revenue of $72.7 million. Revenue growth is expected to be driven largely by sales volume increases from the existing product portfolio. The Company expects net income to be in the range of $32.7 million to $33.2 million, representing an increase of between 26% and 28% over fiscal year 2011 net income of $25.9 million.

Q4: If someone would make an offer to buy your company for a big premium, you would consider it?

Our Board of Directors is open to considering any credible offer that represents a material increase in value for the current shareholders.

However, please consider our concentration of share ownership as disclosed in our recent 10-K:

Our chairman, chief executive officer and president currently owns approximately 48% of our common stock and has the ability to prevent certain types of corporate actions, to the detriment of other stockholders.

As of October 31, 2011, Mr. Shaoming Li, our chairman, chief executive officer and president, owns 17,850,000 shares of our common stock, which represents approximately 48% of our outstanding shares of common stock. Mr. Li is able to exercise significant influence over all matters requiring stockholder approval, including the election of a majority of the directors and determination of significant corporate actions. This concentration of ownership could also have the effect of delaying or preventing a change in control that could otherwise be beneficial to our stockholders.

Q5: What are the biggest challenges for the company right now?

We refer you to Item 1A. Risk Factors. In our most recent 10-K.

Q6: It seems that excellent results do not convince investors. What are you planning to do to get more attention to your stock?

We believe that all micro-cap China based stocks that went public via reverse merger have suffered over the past year from lack of credibility rather than lack of attention. Although once credibility suffered, lack of attention followed in a number of cases.

We plan to do as much as is possible to restore our credibility. Our most recent annual report on form 10-K was filed on time. Our most recent earnings press release and conference call were praised for their levels of disclosure, and we plan to do more during the current year to enhance disclosure still further. We plan to improve the content of our website so that investors can see more clearly the ways in which we are creating shareholder value.

Once we see sentiment towards micro-cap China based reverse merger stocks improving, management will reach out to investors more aggressively through telephonic and in-person meetings and through attendance at investor conferences.

This is a "going private" candidate. The chairman Mr. Li holds almost the half of the outstanding shares and could become desperate of the ongoing distressed stock price.

Disclosure: I am long CBP.

Additional disclosure: For emerging markets such as China, it is better to have a diversified portfolio. Don't put more than 10-20% of your investments in Chinese stocks and try to diversify to at least 10 companies.