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SkyPeople Fruit Juice: A healthy investment option

2010-09-06: SkyPeople Fruit Juice (SPU.NASDAQ) will provide juicy returns for patient investors SkyPeople Fruit Juice (SPU.NASDAQ) is sitting pretty. Not only is the company part of a fast-growing consumer market, but it has also carved out a niche platform which should withstand growing competition in the industry as a whole.

Various large companies – Pepsi (PEP.NYSE), Huiyuan (1886.HK), Coca Cola (KO.NYSE), Nongfushanquan and COFCO Tunhe (600737.SH) – are looking to establish or build on sizeable footprints in China’s fruit juice market.

China consumed 12.5 billion kiloliters of fruit and vegetable juice in 2009, according to Euromonitor International, and this figure is likely to reach 18.1 billion kiloliters within three years. Double-digit growth will therefore remain a feature of the market for some time.

Shaanxi-based SkyPeople, which was established in 2001, produces kiwi, apple, pear, mulberry and jujube fruit juice concentrate and fruit juice beverage as well as fresh fruit. It owns the largest kiwifruit plantation in Asia. The company reported gross profit of US$ 7.16 million for the first quarter of 2010, up 144.9% year-on-year. Growth in the sale of kiwifruit, pear and apple products came in at 32.6%, 18.7% and 18.1% respectively.

Fruit juice concentrate is the most profitable product in SkyPeople’s portfolio, accounting for 58% of total revenue in the first half of 2010. As the base ingredients for the production of fruit beverages and other related products, such as ice cream and fruit wine, fruit concentrates are sold to manufacturers.

This means demand is very sensitive to fluctuations in the international market, but SkyPeople rode out the financial crisis and has managed to maintain annual revenue growth in excess of 40% for the past four years.

The company’s strength lies in its diversity. China currently is the world’s largest producer of apple concentrate around the world, with 95% of its annual output exported overseas. SkyPeople, however, specializes in small-breed fruits, such as kiwi. This gives it a great competitive advantage over apple concentrate specialists.

In 2009, the fruit concentrate export contribution to SkyPeople’s total revenue fell to 35% from 44% the previous year, yet the company still managed to post its fourth consecutive annual increase in revenue. By contrast, Yantai North Andre Juice (8259.HK), the largest producer and exporter of apple-related products in China, saw its revenues decline by nearly 55%.

The other major players in this segment –Sdic Zhounglu Fruit Juice (600962.SH), Shaanxi Hengxing Fruit Juice and Shaanxi Haisheng Juice Holdings (0359.HK) – also struggled.

SkyPeople has also been trying to expand its presence in the downstream market, introducing a bottled kiwifruit and mulberry juice under the Hedetang in Beijing earlier this year. Again, small-breed fruit juice helps the company avoid direct competition with Huiyuan (1886.HK) and other major players, whose main products are orange and apple juice.

Although Chinese people so far have not taken to kiwi or other small-breed juices en masse – which means market capacity is very limited – the profit margins are much wider than for apple and orange-related products. Huiyuan, the largest domestic fruit juice producer, posted an average profit margin of 36% on its juice products in 2009. SkyPeople enjoyed a margin of 47.3% for its kiwifruit products in the same period.

As of the second quarter of 2010, sales of Hedetang bottled juice in Beijing have generated approximately US$1.5 million, or 4.8% of total revenue, which points to strong growth potential.

To stay competitive, SkyPeople has been investing dramatically in R&D, with expenditure increasing from US$31,000 in 2007 to US$1.1 million in 2009.

In addition to Hedetang, the company has introduced a fruit cider beverage, which delivered a gross margin of 52.5% for the first half year compared to the 37.1% gross profit margin of its pure fruit beverage. In the second quarter of this year, SkyPeople commenced production of jujube juice for use in medicine production. Revenue for the quarter came to US$1.8 million, or 13.6% of total revenue, and the gross profit margin was 45.9%.

On August 24, the company announced a secondary public offering of nearly 5.2 million shares with a view to raising US$24 million. The net proceeds will be used to improve facilities in its Huludao Wonder and Qiyiwangguo subsidiaries.

Even with US$24 million in the bank, though, SkyPeople is still well short of the projected US$62 million required to expand its current production capacity in 2010-2011 financial year. Expansion plans include the construction of beverage production lines for concentrated apple, pear and pomegranate juice as well as refrigeration storage.

As of June 30, the company had US$26.6 million in cash and equivalents, which means it needs to raise at least another US$11.4 million through existing operations and bank loans.

The announcement of the secondary offering saw SkyPeople’s stock decline 18% in a single day. Given the spike in trading volume a few days earlier, it looks suspiciously like insider trading by short sellers.

Nevertheless, SinoSage believes the price drop is the typical result of an impending dilution of share value as some investors look to sell up. Don’t be deterred. A combination of the huge growth potential of China’s fruit industry, recovering overseas demand and increased fruit beverage consumption in the summer months should mean a good third quarter for most players. To this, SkyPeople can add a strong past performance and a cleverly diversified business model.

SkyPeople’s price-to-book ratio is currently around 1.31, which is relatively low for a company with great growth potential. This represents a great opportunity for investors to go long on the stock.