Pine Agritech @ 73.5 cts ( Food / China ) 8 comments
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1.High PE valuation of 16X despite being recent IPO
2.Uncomfortable about large related-party transactions in soy-protein isolate with main shareholder People's Food
3.Limited exposure to more optimistic consumer segment through soy oligosaccharide syrup
Pine Agritech was listed in May 05 at 57.5 cents and has since ratcheted up to 70-80 cents on the back of strong interim results (1H05) which saw growth of 80% and 100% on topline and bottomline respectively.
The company is in the business of processing and selling soybean-based products to the China market, which on initial purview looks like quite a similar business to Celestial Nutrifoods. In fact, their main customer base is quite different: Celestial's main business is selling soy-bean based health beverages under its Sun Moon Star brand, while for Pine Agritech according to its latest FY04 results the main revenue source is from sales of soy protein isolates to meat processing companies (such as People's Food) and animal feed manufacturers who use these as raw material for their production purposes; this forms ~70% of their sales and profits.
Which means that in fact, what is being trumpeted as an underlying trend that will anchor growth in coming years, that of China consumers' growing preference for healthy soy products as they grow more affluent, is not really a sector that Pine Agritech is well positioned in. The only product that it sells directly to China consumers is soy oligosaccharide syrup, a healthcare product registered under their Tiansong brand that only forms ~10% of the group's sales (although its higher margins means that it occupies ~20% of group profits). To grow this lucrative segment, I would think that the group would have to spend a substantial amount in advertising and expanding their distribution channels every year; the Tiansong trademark was only registered in mid-2003.
As for their soy protein isolate segment, one should note that Pine Agritech's main customer is People's Food, who accounts for over a fifth of the group's total sales. This means about a third of Pine Agritech's protein isolates are sold to one customer alone. And People's Food owns ~40% of Pine Agritech post-IPO! Such a large volume of interested party transaction is unhealthy. Firstly, bargaining power for Pine Agritech is likely to be compromised for such a main customer, and more so when this customer is their main shareholder; that's why I don't like to buy listed subsidiaries of a listed parent group eg. Nera Electronics, Radiance, Alantac etc. Secondly, the parent can give the listing subsidiary more business during its IPO year so that revenue and profit growth appear stupendous but it is a question whether this is sustainable; when the parent falters it will make sure to transfer some burden to its listed subsidiary (and hence the minority shareholders). And I do have some doubts about People's Food: the recent share price collapses and volatility are rather unsettling together with its change of auditors, persistent negative rumours, majority shareholder (Ming KS) stake disposal, Fidelity buying a huge stake and then selling off within a year etc.
The valuation for Pine Agritech is also rather rich. It is trading at 16 times trailing PE while the China food companies are generally at single PEs, with Celestial, probably the closest comparison, trading at 11 times. Of course, if Pine Agritech continues its earnings momentum for FY05 then its forward PE could well be between 8-10; however it looks like the price has factored in strong earnings for FY05 (based on its runup in response to the strong 1H) while risks (such as those mentioned above) are not. One word of caution: proforma revenue and earnings, which are those reported for Pine Agritech so far, can often be very different from actual earnings. Proforma, of course, is that used for IPO companies which have just been restructured in preparation for the public listing; it is sometimes a shock to investors that the actual financial statement, released the year after the IPO, can be so different from (usually lower than) the proforma.