PSB Monthly Issue December 2009
December 2009
ARE THE NEW POTATO CHIPS IN CHINA
The Chinese people’s love affair with seafood goes back a long, long time.
Over 40,000 years in fact.
Studies done on the skeletal remains of a Tianyuan man (a 40,000 year old modern human from eastern Asia) prove it. They show fish was a regular part of his diet.
That love of seafood has grown stronger through the millennia. Today, China is the world’s largest consumer of fish and seafood.
The Chinese people consume about 57.2 pounds of seafood per person every year. That’s more than three times the amount of seafood consumed by the average American.
And, Chinese seafood consumption is expected to increase 40% to nearly 80 pounds per person per year by 2020.
Historically, the Chinese have preferred fresh fish and seafood over frozen processed products. But, the fast paced lifestyles of the rising middle class are causing a major shift in consumer tastes.
Time-constrained consumers are seeking seafood alternatives that can be prepared quickly and easily. But, they don’t want to sacrifice on nutrition, taste, or quality.
This has led to a huge jump in demand for frozen processed seafood and dried processed seafood snack products.
China’s emerging processed seafood industry has quickly grown into a $1.5 billion a year business. And, it’s poised for massive growth. The industry’s target market – the middle class – is huge and growing rapidly.
Although it’s just 19% of China’s total population, the middle class already numbers 300 million people. That’s roughly equal to the entire population of the U.S. And, it’s adding 300,000 more people to its ranks every year.
That’s a lot of mouths to feed.
One company is cashing in on this trend in a big way. Introducing, China Marine Food Group (AMEX: CMFO).
Name: China Marine Food Group Ticker Symbol: CMFO Market Cap: $144 Million Recent Price: $6.24 PSB Rating System 4.9 Stars Raging Revenue: (5.0 stars) Revenue is expected to soar 23% in 2009 and 33% in 2010. The company doubled production capacity this year to meet rising demand. Beautiful Books: (5.0 stars) Earnings are expected to jump 29% in 2009 and 27% in 2010. And, the balance sheet is rock solid with $31 million in cash, no long-term debt, and just $4.1 million in short-term debt. Stellar Structure: (4.7 stars) Insider ownership of 32% is a strong vote of confidence in the company’s future. And, with just 2% institutional ownership, the potential for institutions to drive up the share price is good. Valuation Verification: (4.8 stars) The stock is badly mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $14 a share. That’s upside potential of 124% or more. Meaningful Milestones: (4.8 stars) The company doubled production capacity in 2009 to 20,000 tons per year. |
THE PROCESSED SEAFOOD BUSINESS
CMFO is a fast growing producer of frozen processed seafood and dried seafood snacks in China. The company’s based in Shi Shi City, which is located in Fujian Province on the East China Sea.
In the past five years, the company’s grown from small regional player to medium-sized national seafood enterprise. With advanced processing facilities and over 600 employees, CMFO is now poised to become a leader in its industry.
Nearly all of the company’s revenue comes from selling frozen processed seafood and dried seafood snack products.
Dried seafood snacks are similar to beef jerky or potato chips in the U.S. However, unlike their American counterparts, dried seafood snacks are high in protein and low in fat.
It’s the perfect snack for health-conscious consumers on the go.
CMFO uses a combination of traditional Japanese and modern scientific seafood processing techniques. Every product is made from 100% fresh marine catch… no seafood breeding farm materials here.
And, not one of their products is made with preservatives.
The company sells 25 different dried seafood products under their popular Mingxiang brand. The term Mingxiang has broad marketing appeal as it means “Peace of Mind” in Chinese. These products include roasted squid, roasted file fish, roasted prawns, shredded roast squid, and smoked eel.
CMFO sells its dried seafood snacks through 19 exclusive distributors in China.
These distributors in turn supply the company’s products to over 2,200 retail stores in seven provinces. Convenience stores, supermarket chains, and hypermarkets like Wal-Mart and Carrefour all carry CMFO’s dried seafood snacks.
Needless to say, you can’t go far without finding their products for sale.
The company also sells frozen processed seafood products. These products consist of Japanese butter fish, octopus, and squid rings. They’re sold directly to wholesalers in China as well as Japan, the Philippines, Korea, and Taiwan.
CMFO’s production facilities are located in Shi Shi City.
The company owns and operates six production lines. Five for manufacturing dried processed seafood products. And, one for producing frozen processed seafood products.
To keep up with rising demand, CMFO is rapidly expanding production capacity.
At the end of 2008, CMFO’s total production capacity was 6,500 tons per year. The company increased capacity in January by 50% to 10,000 tons a year. And, after adding more equipment this year, the company’s doubled capacity to 20,000 tons annually.
That’s a lot of seafood!
Although production capacity is expanding quickly, management’s not making any sacrifices on quality or safety. They’re committed to the highest standards of quality control.
As a result, CMFO has a very strong reputation for quality.
So strong in fact the Chinese government designated CMFO as a quality assurance testing base for its region. Essentially, the government’s saying we want you to test your competitor’s products to ensure their quality and safety is up to snuff.
That’s quite an endorsement.
As you can see, CMFO has several competitive advantages.
The company’s strategic location in one of the five largest fishing ports in China enhances profitability. An abundant supply of fresh marine catch makes it easy for CMFO to obtain raw materials at very low cost.
A strong brand name and reputation for quality is boosting sales volumes. Sales of existing products are growing faster in established markets. And, new products are gaining quicker recognition and market acceptance.
The company’s nationwide distribution network is rapidly adding more retail outlets. In March 2009, a major Shanghai-based convenience store chain with over 1,200 stores began carrying CMFO’s products. And, a well-known Hong Kong based chain will begin carrying them soon at their 300 stores in China.
The company’s track record for quality is helping it expand overseas. CMFO has obtained certifications for exporting to the EU and the U.S. The company’s now poised to expand into two of the largest seafood markets in the world.
Finally, the company has a strong management team capable of growing the company into a market leader. Their CEO has more than 30 years experience in the seafood industry. And, he’s already built it up from a small, local seafood business into a nationwide enterprise.
Now, let’s take a look at the company’s financials.
THE NUMBERS
CMFO is growing at a brisk pace.
Just look at their blistering growth from 2004 through 2008. Revenue exploded more than six fold to over $48 million. And, net income soared more than ten times to over $11 million.
This amazing pace is continuing so far in 2009.
Through the first nine months of the year, revenue jumped 26.5% to $44.7 million. The company’s increased production capacity is clearly boosting sales. Net income is up a solid 18.4% to $10.2 million. And, earnings per share of $0.44 are nearly 19% higher.
What’s more, management expects a strong finish to the year.
They’re forecasting revenue of more than $60 million and net income of at least $14.3 million for all of 2009. That’s year over year growth of 23% and 29% respectively.
And, growth is expected to accelerate further in 2010.
Management sees revenue soaring more than 33% to over $80 million. And, they’re projecting net income to jump 26% to at least $18 million.
Here’s why.
Production capacity will be double what it was in 2009. And, management plans on launching several new products, adding new sales territories, and expanding their base of retail outlets.
In addition to strong growth, CMFO has a rock solid balance sheet.
They’re sitting on a cash hoard of more than $31 million. Their only debt is $4.1 million in short-term bank loans. And, working capital is up 25% this year to $46 million.
INVESTMENT RISKS
Of course, an investment in CMFO does involve some risk.
The company’s production of processed seafood products depends on a steady supply of fresh seafood. Any shortage in supply or increase in raw material prices could hurt profits.
Another risk is CMFO’s reliance on its top five customers for about half its sales. If these customers stop buying from CMFO, the company’s growth could slow.
A third risk is the company’s dependence on the popularity of its products. A shift in consumer tastes away from processed seafood products would hurt the company’s business.
POTENTIAL RETURNS OF 124% OR MORE
Despite CMFO’s scorching growth rates, the shares are badly misvalued by the market.
The company’s expected to grow 31% a year over the next five years. But, the shares are trading at just 10 times the 2009 estimate. That yields an extremely low PEG ratio of 0.32.
In other words, the shares are trading at almost a 70% discount to the company’s long term growth rate.
The average P/E ratio for the Processed & Packages Goods industry is 19.9. Since CMFO is growing faster than most companies in its industry, we think it deserves a P/E at least equal to the industry average (if not higher).
Using a P/E of 19.9 times the 2009 estimate of $0.62, CMFO is worth at least $12.34. And, if we use the 2010 estimate of $0.79, the shares are worth $15.72.
That’s potential upside of 98% to 152%!
Based on our analysis, we see the stock trading up to at least $14.00. Buy CMFO now for potential gains of 124% or more.
ACTION RECOMMENDATION
BUY China Marine Food Group (AMEX: CMFO) up to $7.50 per share.
Recent price is $6.24.
Use a stop-loss of $2.90 on this position.
Don’t forget your position sizing and stop-loss rules.
FOR HUGE PENNY STOCK PROFITS
Our second recommendation this month is a turnaround play. Investing in a company going through a turnaround involves high risk… but the potential returns can be very rewarding.
What’s a turnaround play?
Simply stated, we’re looking to buy a stock that’s been beaten down by specific problems. As the problems are fixed, the stock usually rebounds. Sometimes the rebound can provide huge outsized returns.
There are many reasons why a stock may fall.
Right now the most common reason is a drop in sales and earnings due to the global recession. Another typical reason is excessive debt… investors start to question if the company can survive.
Many companies in deep financial difficulty fail to turn it around. But, a few with savvy management are often able to right the ship. And when they do, the returns to patient shareholders can be very significant.
The turnaround play we’re recommending this month is specialty chemical companyOMNOVA Solutions (NYSE: OMN).
Name: OMNOVA Solutions Ticker Symbol: OMN Market Cap: $313 million Recent Price: $7.05 PSB Rating System 4.6 Stars Raging Revenue: (4.0 stars) Revenue is expected to jump more than 11% in 2010. The company’s grabbing up market share and penetrating new markets. Beautiful Books: (5.0 stars) The company’s expected to show a nice profit in 2009 after a small loss last year. And, earnings are forecast to soar 48% in 2010. Stellar Structure: (4.8 stars) Institutional ownership is very high at 81%. As a result, insider ownership stands at just 3%. Institutional investors are clearly bullish about the company’s future. Valuation Verification: (4.8 stars) The stock is badly mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $15.70 a share. That’s upside potential of 123% or more. Meaningful Milestones: (4.5 stars) The company received the 2008 Award for Excellence in Environmental, Health, Safety and Security Performance for the fourth straight year. |
THE SPECIALTY CHEMICAL BUSINESS
OMN is a leading producer of emulsion polymers, specialty chemicals, and decorative surfacing products. Their products provide a variety of important functional and aesthetic benefits to hundreds of products people use every day.
The company operates through two different divisions.
The Performance Chemicals division produces emulsion polymers and specialty chemicals. Customers include major paper, carpet, and specialty chemical manufacturers.
You’ve probably seen the company’s products without even knowing it.
For example, their paper coatings provide that glossy look you find in so many magazines. Their textile chemicals make clothes wrinkle free and home furnishings stain resistant. And, their in-mold coatings improve the look, durability, and performance of plastics used in heavy trucks and recreational water craft.
The company’s other division is Decorative Products.
They produce a number of decorative and functional surfacing products. These include commercial wall coverings, coated and performance fabrics, specialty laminates, and performance films. Major customers include Steelcase, Stingray Boats, and Ashley Furniture to name a few.
The products made by this division have a myriad uses.
They’re applied to walls, ceilings, furnishings, and cabinets to add beauty while enhancing durability. You’ll find them in offices, hospitals, hotels, casinos, retail stores, restaurants, and homes all over the world.
In addition, these products are used in seating and trim found in all manner of vehicles. Many automobiles, heavy trucks, buses, motorcycles, recreational vehicles and boats contain the company’s products.
As the company likes to say, “Everywhere you look… OMNOVA is there!”
OMN’s products permeate through nearly every sector of the economy. As you can imagine, the global economic recession has caused sales to decline sharply across the board.
However, as the economy recovers, OMN will see a huge rebound in sales.
In the meantime, management is deftly steering the company through the recession. Despite the big drop in sales, OMN is showing remarkable profit growth.
Let’s take a closer look at the company’s financials.
THE NUMBERS
Here are the numbers through the first nine months of 2009.
Revenue’s down nearly 22% year over year to $507 million. Lower average selling prices and reduced demand are to blame.
Nevertheless, OMN is raking in the profits.
Net income is up from a loss of $3 million to a profit of $15.7 million. And earnings per share are up from a loss of $0.07 to a profit of $0.35.
Here’s why.
Raw material prices have dropped significantly. The company’s grabbing up a larger share of existing markets and penetrating new markets. And, management has slashed manufacturing expenses by an impressive $23 million.
These are exactly the kinds of moves that produce big turnarounds when a company emerges from recession. And, we could find out sooner rather than later if a big turnaround is in store for OMN.
Management says business is starting to improve.
Demand in the Decorative Products segment has begun to bottom out. Sales volumes in the Performance Chemicals business are expected to increase in the fourth quarter. And, they expect significantly improved fourth quarter earnings.
It sure sounds like revenue is poised to rebound and earnings are accelerating.
The analysts covering OMN seem to think so.
They’ve significantly raised their earnings estimates across the board. They’re now expecting earnings per share of $0.52 for 2009. That’s 24% higher than just two months ago.
Three straight quarterly upside surprises probably have something to do with it.
The outlook for 2010 is even better.
Revenue is forecast to jump 11.2% to $765 million. And, earnings per share are projected to soar 48.1% to $0.77. Just the kind of growth to send a stock price surging higher.
The balance sheet is also much improved this year.
Cash is up 70% to $29.6 million. Current assets are 1.86 times current liabilities. And, long-term debt has been cut by 22.5% to $141.2 million. The company has plenty of liquidity and appropriate leverage is helping grow the business quicker.
INVESTMENT RISKS
Of course, an investment in OMN involves some risk.
Various raw materials are used to manufacture the company’s products. If prices for these raw materials rise too high, it could hurt OMN’s profitability.
Another risk is the Performance Chemicals division’s reliance on a few large customers. The loss of any one of these customers could harm the business.
And, the company’s exposure to credit risk from its customers is another potential problem. If customers fail to pay, OMN could see its financial condition worsen.
POTENTIAL RETURNS OF 123% OR MORE
OMN is at the beginning of a major growth cycle.
Earnings are expected to grow at an amazing 44% annual rate over the next five years. That’s the second highest long term growth projection in the Specialty Chemicals industry.
Despite this terrific outlook, OMN is grossly misvalued by the market.
The shares are trading at 9.2 times the 2010 estimate of $0.77. That’s just half the industry’s average P/E. As a result, the company’s PEG ratio is a paltry 0.32.
In other words, the stock’s trading at nearly a 70% discount to its projected long term growth rate.
We think the shares deserve a P/E at least equal to the industry average (if not significantly higher). At 18.4 times the 2010 earnings estimate of $0.77, the shares are worth at least $14.17. That’s a potential double or more from the stock’s recent price.
A Price to Sales analysis yields an even higher price target.
The industry average P/S ratio is nearly 1.0. But, OMN is trading at just 0.4 times its revenue per share of $17.22. With a P/S of 1.0, the shares are worth $17.22. That’s upside potential of 144% or more.
Based on our analysis, we see the stock trading up to at least $15.70. Buy OMN now for potential gains of 123% or more.
ACTION RECOMMENDATION
BUY OMNOVA Solutions (OMN) up to $8.05 per share.
Recent price is $7.05.
Use a stop-loss of $3.48 on this position.
Don’t forget your position sizing and stop-loss rules.
Category: PSB Monthly Issues
