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What Could Happen With China Green Agriculture

|About: China Green Agriculture, Inc. (CGA)

China Green Agriculture (CGA) seems to trade at maximum pessimism. Investors saw repeated drawbacks and unfulfilled promises and expectations. Stocks like this one have on average very high returns. Because it is so extremely cheap I have a position.

I invest based on statistics. I try to find the cheapest stocks in a state of maximum pessimism. On average such stocks have very high returns. I invest using many small positions to decrease overall portfolio risk. See also my free overview article on statistical investing for more information on ranking and net-net investing or take a free trial here.

In the rest of this article I share some basic findings and data. For a start see the table below.

Ticker,

Piotroski

Share Price

Analyst target

Market cap

EV, in millions

EV/EBIT

EV/Revenue

P/Tan B

P/Ret Earn

NCAV / MC

Liq Val / MC

US:CGA

4

1.13 USD

-

43.3 USD

-101 USD

-3.1

-0.31

0.11

0.15

8.3

11

Date

cash flow

EBIT, ttm

until mrq

Cash flow

from ops

Free cash

flow

P/FCF

Yield

%

2018-03-31

32.6 USD

32.7 USD

32.6 USD

1.6

-

I follow the company already for a long time. My notes below give some historic insight.

August 2015: China Green Agriculture’s main business is producing fertilizer products. In October 2014 The GeoTeam published 3 articles on SA suggesting problems with China Green Agriculture’s fertilizer production and that the 26,175 branded retail stores CGA claims to operate don’t exist. See their SA articles here, here and here. A small part of the company is owned via a VIE-construction: another reason to avoid this stock.

In October 2014 the company declared a dividend of 0.1 USD. There has been a class action against the company on behalf of the (former) shareholders in 2010. This class action was settled between March 7, 2013 and August 12, 2014 for 2.5 million USD, which was fully reimbursed by the company’s insurers.

The CEO, Tao Li, owns 29.7% of the shares and the CFO, Ken Ren, owns 1.9% of the shares.

November 2015: down from 1.93 to 1.73 USD. China Green Agriculture published an annual report and a quarterly report. The company issued one million restricted shares (from 35.9 million to 36.9 million) during the quarter as employee compensation. The company also pays certain professional fees in stocks. Also the company owes 20.8 million USD in short term loans to Chinese banks while having a 94.4 million USD cash pile as well. In the conference call there was a question about the dividend. The CFO, Ken Ren, answered the question with generalizations like that they want to reward shareholders but didn’t say when or what China Green Agriculture is waiting for.

March and April 2016: China Green Agriculture went down from 1.56 to 1.35 USD.

The company published a press release with the results and a 10-Q. Cash pile increased to almost 100 million USD. Since last year 3.7 million new shares were issued (10%). Profit decreased on higher sales but the company is still very profitable. The profit decreased because the costs of goods increased and also the selling expenses. The company registered 4.6 million extra shares to give to employees as incentive.

April and May 2017: China Green Agriculture went down from 1.35 to 1.26 USD.

The company is still extremely profitable although less profitable than a year ago. Revenues have increased but gross margin went down even more. The quality of the current assets has improved.

In October 2017 it will be 3 years since GeoTeam published its short thesis. A serious red flag is that the company is increasing the number of subsidiaries owned via VIE’s. See also this earlier filing. The company also combines short-term debt with a large cash pile which is a red flag. However the debt is small and has been reduced.

The company published a quarterly report. See also the press release. Sales increased. The company remains very profitable. The company raised guidance for 2017 for revenue, net income and EPS. For 2017 guidance for EPS is now 0.75 USD.

Large owners: The share count has increased. As a result the stake of the CEO, Mr. Tao Li, went down from 29.7% to 27.5%. His son, President Zhuoyu Richard Li, owns 2.7%. The CFO also owns 2.7%.

June 2018China Green Agriculture went down from 1.26 to 1.24 USD.

The company got a couple of questions from the SEC about internal control and questions resulting in restatements. Cash outflows for acquisitions were booked under cash from operations while they should have been booked as cash from investments. These costs (37 million CNY in 2016 and 8 million CNY in January 2017) were apparently made to end certain VIE agreements. A red flag is when suppliers also act as customers, see here. Furthermore errors had to be corrected for the description of the changes in inventories.

See the recent quarterly report (March 31, 2018). See also the annual report over 2017.

The balance sheet is strong with hardly any leverage and a big cash pile but also a non-current convertible note and a small short-term loan. The short-term loan is a bank loan at 5.22%. The convertible note arises from VIE acquisitions. The conversion price is the highest of 5 USD or 75% of the closing price of China Green Agriculture’s stock. The biggest part (for 51 million CNY) can be converted at June 30, 2019, which is also the maturity date. Assuming the note holders are affiliates of the major shareholder management has a clear incentive for a higher share price. That the company paid for acquisitions with this convertible note is of course a red flag since the company has so much cash.

At the moment the assets of the VIEs have a book value of 88.2 million USD (hardly any cash) and their liabilities have a book value of 68.6 million USD. So this is just a small part of the whole company with 499 million USD of assets and 56 million USD of liabilities. The VIE business is a bit more profitable than the fully owned business but the difference is not so big.

Retained earnings are 294.2 million USD including 30.5 million USD of statutory reserves. Therefore Market cap/Retained Earnings = 43.3/294.2 = 0.15.

The book value of the current assets is 417.0 million USD including for 104.1 million USD of not so valuable assets like inventory. Among the non-current assets there are land use rights with a book value of 10.5 million USD. The book value of the liabilities is 55.9 million USD. Therefore my estimate of Liquidation Value/Market cap = (417 -0.5+104.1 +10.5 -55.9)/43.3 = 11.

Substantial shareholders: the new CEO and chairman Zhuoyu Richard Li (26) owns 30%. Director Lianfu Liu owns 121,000 shares or 0.3%.

The previous major shareholder was Mr. Tao Li, the father of Zhuoyu Richard Li. Mr. Tao Li died and the CEO Richard Li inherited his shares. Just before Mr. Tao Li died in December 2017 the CFO, Mr. Ken Ren, left and was succeeded one month later.

My take on China Green Agriculture

Obviously this is one of the least liked companies on the planet because of fraud allegations, dilutions red (accounting) flags, the VIEs and lack of obvious management actions to remove the undervaluation. And probably for this reason the stock is a good bet. It is so disliked and therefore so cheap that this a highly asymmetric bet with about 10 times more upside than downside. That said this stock is a highly binary bet. Shareholders will get either enormous upside or a zero.

Of course the company might still be a fraud in which case the stock could go to zero. But still, year after year the auditor (not a Big 5 auditor) signs off CGA’s annual report. For a fraud the stock has unusual longevity. Also unusual for a fraud are the high retained earnings.

I like extremely cheap stocks without a catalyst. That means the chances are slim a hedge fund manager will outsmart me. I like this stock also for the complete lack of catalysts. Of course anything can still happen. For example I like that the company got a new CEO, younger and therefore with a new and probably longer horizon.

Become a statistical investor. Investing is mostly a game of luck. Therefore it is dangerous to invest based on conviction with large positions. But investing with many small positions in undervalued stocks with statistically great returns works just as well. So that is what I do.

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Disclosure: I am/we are long cga.

Additional disclosure: positions are small and do not imply conviction