PSB Monthly Issue February 2010
February 2010
A LEADING CHINESE BEVERAGE MAKER
Chinese stocks are off to a rough start in 2010. The Shanghai Composite Index fell 8.8% in January. And, it recently closed at its lowest level in three and a half months.
What’s behind the decline?
The news media says it’s the Chinese government’s decision to raise bank reserve requirements. Investors are supposedly worried this is a first step toward China raising interest rates. (That’s the theory anyway…)
Why would raising interest rates be a problem?
If the Chinese raise interest rates too far too fast, they could choke their fragile economic recovery. You see, higher rates would force many Chinese businesses to stop borrowing and therefore stop growing.
We think investors are overreacting. Or, more likely, they’re just using the situation as an excuse to lock in some big profits.
The Chinese stock market soared 78% in 2009. Many individual stocks doubled, tripled, quadrupled or more. When stocks rise that much, it usually doesn’t take much to spur investors to take profits.
We see the government’s recent tightening policies as a positive for Chinese stocks. By removing excess liquidity, they’re preventing inflation from taking off. And, they’re preventing bubbles from forming in their stock and real estate markets.
The Chinese economy is still going strong.
GDP rose 8.9% in the third quarter of 2009 and 10.7% in the fourth. We’ll probably see it exceed 10% growth again in the first quarter of 2010.
Another sign of strength is December’s export data. After 13 straight months of declines, exports soared nearly 18%. Remember, exports account for the majority of China’s GDP growth.
Given these kinds of growth rates, the government’s moves to reduce liquidity are prudent and appropriate.
Consumer spending was solid last year and should be stronger in 2010. The government has extended several stimulus measures designed to boost domestic consumption.
Strong economic growth, slightly tighter monetary policy, and an emerging consumer class all bode well for Chinese stocks in 2010.
In this context, the stock market correction is a good opportunity.
We have a chance to buy fast growing companies at a discount.
Chinese companies are expected to grow earnings 20% this year on average. But, the market is trading at just 13.5x estimated 2010 earnings. At these levels, the market is not reflecting the companies’ growth potential.
And, I’ve found a terrific Chinese penny stock for this month’s issue.
The company has developed a strong niche market. Revenue and earnings are both expected to grow 40% to 50% this year. And, their stock is badly mispriced by the market.
The company is little known SkyPeople Fruit Juice (AMEX: SPU).
Name: SkyPeople Fruit Juice Ticker Symbol: SPU Market Cap: $96 Million Recent Price: $5.38PSB Rating System 4.8 Stars Raging Revenue: (5.0 stars) Revenue is expected to jump more than 50% in 2010 to over $92 million. Rising demand and increased production capacity should drive huge sales growth. Beautiful Books: (5.0 stars) Earnings are expected to soar more than 40% in 2010 to $1.05. And, the balance sheet is solid with a strong cash position, a current ratio of 2.1, and no long-term debt. Stellar Structure: (4.0 stars) Insiders own nearly 90% of the shares outstanding. And, there is no institutional ownership. We’d like to see some institutional buying to drive the share price higher. Valuation Verification: (5.0 stars) The stock is badly mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $13.65 a share. That’s upside potential of 154% or more. Meaningful Milestones: (5.0 stars) 2009 results should show another year of record revenue and earnings. The company has expanded production capacity to drive significant growth in 2010 and beyond. |
THE FRUIT JUICE BUSINESS
SPU is one of the largest producers of concentrated fruit juice and fresh fruit juice drinks in China. They’re based in Shaanxi Province, one of China’s primary fruit growing regions.
The company operates three lines of business.
The concentrated fruit juice line is the company’s main business. It’s responsible for more than 75% of revenue. And, it has higher gross margins than the other business lines.
Concentrated fruit juices aren’t drinkable. Instead, they’re used as base ingredients for manufacturing fruit juice drinks and as an additive to fruit wine, fruit jam, cosmetics, and medicines.
The company’s primary products are concentrated apple juice, pear juice, and kiwifruit juices. These products are sold mainly in overseas markets such as the U.S., Europe, Russia, and the Middle East.
The company’s second line of business is fresh fruit juice drinks. This part of the business generates about 13% of revenue.
SPU makes a number of different fresh fruit juice drinks. They’re marketed under the “Hedetang” brand name primarily in the Shaanxi retail market. To grow the business they plan on expanding sales of these products to neighboring provinces.
The company’s third line of business is fresh fruit, fructose, fast-frozen and freeze-dried fruits and vegetables, dehydrated fruits and vegetables, fruit vinegar, and other fruit byproducts. It generates less than 10% of revenue. Primary products are fresh kiwifruit, organic kiwifruit, and kiwifruit seeds.
Although the beverage industry is highly competitive, SPU has several advantages over the competition.
The company has developed intellectual property for five special production technologies. They believe they have the most advanced technology for producing concentrated fruit juice from small breed fruits.
By locating factories near fruit supplies, they keep transportation and storage costs low. Lower production costs allow them to be more competitive on price.
And, the company has one of the largest distribution networks in China. A strong sales force is driving huge sales increases for the company.
This business seems pretty simple… now, let’s take a closer look at the financials.
THE NUMBERS
SPU operates a seasonal business.
The period between August and April is their “squeeze season”. That’s when fresh fruits are available to make the company’s products. As a result, the company’s financial results are usually stronger in the third and fourth quarter.
The company’s results tend to be weaker in the first and second quarters. This is due to a shortage of fresh fruits and a lower level of productivity from March through July.
Management knows seasonality doesn’t sit well with investors.
As a result, they’re diversifying their products and trying to prolong the squeeze season. These efforts should eventually help smooth out the company’s financial results.
For years, the company has relied on strong international sales to drive growth. This past year, however, the global economic recession crimped international sales.Fortunately, the company is seeing strong demand from the Chinese market.
SPU’s third quarter 2009 results reflect this new trend.
Revenue jumped 67% to $10.6 million on strong sales of fresh kiwifruit and fruit beverages in the Chinese market. Net income soared nearly 76% to $2.1 million. And, earnings more than doubled to $0.11 per share.
Historically, China’s fruit juice consumption has been very low at just 10% of annual global consumption. But, rising income levels and a shift to healthier lifestyles is starting to generate demand for fruit juice beverages.
Given the country’s massive population, China could one day be the world’s largest fruit juice market. And, that bodes well for SPU.
Thanks to strong demand in China, SPU is on track to post another year of record growth.
Management recently provided preliminary 2009 results.
They expect revenue of $58 to $60 million and net income of $15 to $16 million. If they achieve the low end of these estimates, that’s still huge year over year growth of 39% and 50% respectively.
You won’t find many companies putting up these kinds of numbers.
Management is also excited about the company’s growth prospects for 2010. They project revenue of $92 to $102 million and net income of $19 to $21 million.
What’s going to drive this phenomenal growth in 2010?
Management expects the global economic recovery to drive international and domestic demand higher. And, they expect a recent capacity expansion to push their production levels significantly higher.
If SPU is able to deliver on the low end of their net income estimate, they should generate earnings of $1.05 per share. That would be a 48% increase over the 2009 full year estimate of $0.71 per share.
Topping it off is a strong balance sheet.
SPU is sitting on cash and equivalents of $12.3 million. Current assets are 2.1x greater than current liabilities. And, the company has no long-term debt.
INVESTMENT RISKS
Of course, an investment in SPU does involve some risk.
The seasonality of the business is one important risk factor. It may lead to wider than normal fluctuations in the stock.
Another risk is the company’s reliance on its top five customers for about a third of its sales. If these customers stop buying from SPU, the company’s growth could slow.
A third risk is a potential shortage or increase in the cost of raw materials used to make the company’s products. Either scenario could hurt the company’s sales and profits.
POTENTIAL RETURNS OF 154% OR MORE
SPU is poised for huge gains in 2010.
The company’s expected to grow earnings 30% annually over the next three years. But, the stock is trading at just 5.1 times the 2010 estimate of $1.05 per share. That results in an extremely low PEG ratio of 0.17.
In other words, the shares are trading at an 83% discount to their long-term growth rate.
The average P/E ratio for companies in the industry is 26x estimated 2010 earnings. Since SPU is growing faster than most companies in its industry, we think it deserves a significantly higher P/E.
Using a conservative P/E of 13x (half the industry average), SPU is worth at least $13.65. That’s potential upside of 154%!
Based on our analysis, we see the stock trading up to at least $13.65. Buy SPU now for potential gains of 154% or more.
ACTION RECOMMENDATION
BUY SkyPeople Fruit Juice (AMEX: SPU) up to $6.20 per share.
Recent price is $5.38.
Use a stop-loss of $2.69 on this position.
Don’t forget your position sizing and stop-loss rules.
PEOPLE GET HIGHER QUALITY HEALTHCARE
Is your doctor any good? Do you think he or she is one of the best in your area? If you answered yes, then try this one on for size.
How do you know your doctor is so good?
It’s not an easy question to answer… right?
Most people will tell you their doctor is great. But, when you ask them why, they’ll start to stammer. It’s not their fault. You see it’s difficult to evaluate the quality of medical care.
Before the internet, the best way to find a good doctor was through word of mouth. You’d ask a family member or trusted friend for a referral. But, today more consumers are turning to the web for help.
Check out these results from a 2009 survey by the Deloitte Center for Health Solutions.
30% of people surveyed said they used online resources last year to compare doctors before choosing one. That’s up from just 23% in 2008. Only 15% of people looked for information online to compare hospitals. But, of those that did, 74% were looking for quality or satisfaction ratings.
Before long, everyone’s going to be using the web to find doctors and hospitals. When asked if they would use quality rankings to compare doctors and hospitals in the future, more than half of the people surveyed said they would.
Clearly, consumers want better online resources to help them find quality health care.
And, for good reason.
This information could be the difference between life and death. A recent study showspatients are twice as likely to die at low rated hospitals as at highly rated ones.
So, where can you find reliable ratings on doctors and hospitals online?
One company has emerged as the clear leader in healthcare ratings. They have the number one healthcare ratings website in the U.S. And, they’re turning a nice profit too.
Introducing Golden, Colorado based Health Grades (NASDAQ: HGRD).
Name: Health Grades Ticker Symbol: HGRD Market Cap: $129 million Recent Price: $4.34PSB Rating System 4.7 Stars Raging Revenue: (4.8 stars) Revenue is expected to jump 20% in 2010 to over $62 million. Any recovery in the Professional Services segment should push revenue growth even higher. Beautiful Books: (4.8 stars) Earnings are expected to jump 27% in 2010 to $0.28 per share. And, the balance sheet is solid with $14 million in cash, a current ratio of 1.2x, and no long-term debt. Stellar Structure: (4.6 stars) Insider ownership of 18% shows insiders are confident about the company’s future. Institutional ownership is strong at nearly 54%, but there’s still plenty of room for this to increase. Valuation Verification: (4.2 stars) The stock is mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $7.00 a share. That’s upside potential of 61% or more. Meaningful Milestones: (5.0 stars) The company’s website was recently crowned the number one online resource for healthcare quality ratings. Over seven million people visit the website every month. |
THE HEALTH CARE RATINGS BUSINESS
Health Grades is the leading independent healthcare ratings organization in the U.S. They provide quality ratings on the nation’s 5,900 hospitals, 16,000 nursing homes, and 750,000 doctors. Millions of consumers and hundreds of the nation’s largest employers, health plans, and hospitals rely on the company’s ratings.
Health Grades operates two lines of business.
The Internet Business Group is driving the company’s rapid growth.
They’re responsible for the company’s website, HealthGrades.com. More than seven million people visit the site every month. In fact, more patients are researching and choosing healthcare providers on HealthGrades.com than any other source.
The site offers quality ratings and profiles for every doctor, hospital and nursing home in the U.S.
Each doctor profile offers a ton of information including medical training, board certification, specialty, years of practice, and malpractice issues. They include surveys provided by the doctor’s actual patients. And, HGRD provides its own quality ratings for the doctors as well.
Hospitals are rated on a range of diagnoses, procedures, and patient safety measures. These ratings are based on actual patient outcomes using mortality and complication rates. You can’t fudge these numbers.
Nursing homes receive an overall rating to make comparisons easier. And, each nursing home profile includes results from state investigation reports, a list of recurring complaints, and tips for asking the right questions when looking for a home.
The Internet Business Group generates revenue several different ways.
One way is from the sale of quality reports and subscriptions to consumers. Another is from the sale of premium website profiles to doctors and hospitals. A third way is through the sale of advertising space on the website. And, the last way is from sales of quality information to employers, benefit consultants, and health plans.
This group is knocking the cover off the ball. In the third quarter of 2009, segment revenue soared 134% year over year to $5 million.
The company’s other business line is Professional Services.
This group provides consulting and marketing services to hospitals. They help hospitals improve their clinical processes and quality of care. And, they license Health Grades’ ratings for use in hospital marketing materials.
Provider Services generates about 60% of Health Grades’ annual revenue. Client retention rates are very high at about 80%. And, while new sales have struggled due to the recession, the company began seeing a pickup in activity during September and October.
Management expects it won’t be long before revenue mix is 50% Provider Services and 50% Internet Business Group.
Let’s now take a closer look at the company’s financials.
THE NUMBERS
Health Grades is growing their business very quickly. Over the past five years, the company has increased revenue by an eye popping 35% annually. And, they’ve grown earnings per share by nearly 28% a year.
We’re expecting more strong growth when the company reports 2009 results.
The company is scheduled to report on February 18th. We’re looking for revenue growth of over 30% to $51.9 million. And, we’re expecting earnings soared 47% to $0.22 per share.
These would be fantastic results… especially during a terrible recession.
2010 is shaping up to be another year of solid growth.
CEO Kerry Hicks recently provided guidance for 2010 and said… “We are looking for another strong growth year…”
Revenue is expected to jump 20% to just over $62 million. And, earnings are forecast to increase by 27% to $0.28 per share.
Recent moves by management show they’re committed to growing rapidly.
They’ve expanded the sales team to go after a larger number of money making opportunities. And, they’ve added more staff to increase product development and improve consumer experience.
This is a very good sign. Management wouldn’t add new employees unless they were confident new growth opportunities are close at hand.
In addition to strong growth, the company has a solid balance sheet.
They’re sitting on over $14 million in cash. Current assets are 1.2x current liabilities. And, they have no long term debt.
INVESTMENT RISKS
Of course, an investment in Health Grades does involve some risk.
Slower growth in the Professional Services segment may continue to be a drag on results. Many of the company’s hospital, employer, and other business clients have yet to increase spending levels.
Another risk is the company’s reliance on brand name recognition. They may have to substantially increase their marketing budget to keep growing.
A third risk is rapidly growing competition in the healthcare ratings industry. Some competitors are larger and have greater resources than Health Grades.
POTENTIAL RETURNS OF 61% OR MORE
Health Grades is poised for another year of strong growth in 2010.
More and more consumers are turning to Health Grades for help in finding high quality doctors and hospitals. This trend is driving strong growth in the company’s Internet Business Services segment.
And, strong competition in the healthcare industry should eventually push hospitals to increase spending for Health Grades’ marketing assistance. When business in the Professional Services group picks up, this segment will drive even faster growth.
Despite the company’s excellent past performance and amazing growth potential, the shares are misvalued by the market.
Health Grades is expected to grow 25% a year over the next five years. But, the shares are trading at just 15.5x the 2010 earnings estimate. And, their PEG ratio is a low 0.62.
In other words, the shares are trading at almost a 40% discount to the company’s long term growth rate.
We think the shares deserve a P/E that fully reflects the company’s strong growth potential. Using a P/E of 25x the 2010 estimate of $0.28, HGRD is worth at least $7.00 a share. That’s potential upside of 61%!
Based on our analysis, we see the stock trading up to at least $7.00. Buy HGRD now for potential gains of 61% or more.
ACTION RECOMMENDATION
BUY Health Grades (NASDAQ: HGRD) up to $4.90 per share.
Recent price is $4.34.
Use a stop-loss of $2.17 on this position.
Don’t forget your position sizing and stop-loss rules.
Category: PSB Monthly Issues
