If someone asked me what would be the perfect investment opportunity I would say it would be a company that had a very stable, predictable business, more specifically a non-cyclical business that would deliver consistent profits in good or bad times and has a product that is not at risk of being obsolete - the types of companies Warren Buffet likes to own. I would require that there be significant upside potential for earnings growth and a clean balance sheet with plenty of cash to fund such growth. I would also want the company to be operating in a politically stable and business friendly country like Canada or the US. Finally and most critical, I want to be able to buy at a steep discount to fair value. Such a list is wishful thinking. It's like searching for a girlfriend who looks like Angelina Jolie, has a perfect personality, is single and is willing to go out with you. But I may have just found the perfect investment specimen in my top holding Greenstar (GRE) for it meets all the aforementioned criteria with the exception on one item.
GRE sells fresh produce, canned fruits and canned tomato paste which are always in demand rain or shine and will never go obsolete and while there may be fluctuations in pricing, their margins are so wide that they have delivered profits every single quarter for at least the past 4 years. The company has shown solid growth during recent years and has positioned itself for further growth going forward. It has an immaculate balance sheet flush with cash and it trades at only trades at 2.5 times 2013 earnings and 70% of net assets - a ridiculous discount. The only ""flaw""you can point out is that it's based in China and in addition to political risks, the stock may be trading at such a huge discount because of some frauds in recent years such as Sino Forrest. If GRE operated in Canada or the US then it would indeed be the perfect investment but here's the thing - the company would not be able to get the type of margins and growth they have been getting if they were in North America. Being in China is what allows them to be the cashflow machine that they are and so the operational advantage of being in China should offset a large portion, if not all, of the political risk of being in China. As far as the "fraud discount" goes, it is completely unwarranted for GRE to be painted with this brush and that's where rational investors can take advantage. GRE is legitimate. Their assets have been extensively verified by Canadian auditors who have visited their facilities and their bank branch in China. The business is also very simple and straightforward and therefore easy to verify. The main assets GRE has is leased farmland which has been additionally verified by an independent surveyor.
As a result of their operational success, GRE recently announced a 50% hike in their dividend starting next year (which gives the stock about a 6% yield ) and intends to acquire a tomato pulp producer (tomato pulp is the raw material they use to manufacture tomato paste). The company also rejected the proposed acquisition of another tomato pulp producer in which they signed a letter of intent back in May due to concerns discovered while conducting their DD. This rejected acquisition would have added significantly to GRE's q4 results. With this new acquisition, GRE won't see a significant impact to earnings until late next year which will probably result in about 25% growth. The advantage of this new acquisition over the other one is that it has 45% more capacity and so GRE will have the potential to double its tomato paste production and do so with better margins. Since tomato paste production accounts for 50% of revenue, GRE therefore has the potential to increase total revenues by 50% from current levels with this acquisition. This probably won't happen until 2015 as GRE's processing facilities are running at full capacity and so they will need to expand them but as mentioned, the acquisition will still result in about 25% growth in 2014 although it will be back end loaded.
Despite all of this good news, the stock has not made any progress. This situation reminds me of hwo back in the summer when they announced a dividend hike and share buy buyback and the stock did nothing and languished near $2 because there was a supply overhang pressuring the stock. There are a couple of large sellers in GRE who are eager to sell large quantities at current prices and this is suppressing the price. I have a hunch as to where this supply is coming from and I think a good portion of the overhang has been gobbled up but these sellers still lurk. Overhangs like this can be frustrating and cause you to second guess yourself but there is no way I will be because the fundamentals are too strong and the valuation too cheap for me to be unhinged by any declines caused by this.
I have never come across a situation like this where the market gives you an opportunity to make what is as close as you can get to a sure profit if you can just have some patience and let time work in your favor. Imagine if this was a private company and you had the opportunity to buy it knowing that in just 2 years time you will have earned in profits an amount that will cover your cost of investment, not to mention you will be entitled to a pile of cash the company already has in the bank which can finance 40% of your investment cost. It would be the no brainier of century and the person who is selling you the business at this price is beyond an idiot. When it comes to making an "investment" you have to look at it this way. You have to be willing to buy shares without the need to sell to some greater fool in order to make money.
The main risk I see with GRE is if China has some sort of collapse which causes the value of the yaun to plummet vs the loonie. I see the odds of that happening quite low in the next few years although I'm sure guys like Jim Chanos feel otherwise. As far at the Sino Forrest effect goes, that will fade if the company continues to produce the types of results it has been producing and keeps increasing the dividend. Given the performance in the stock this year so far, people are indeed starting to slowly warm up to GRE but I think this is only just the beginning.
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ReplyDeleteI'm a novice who stumbled across this company, and I'm wondering if you have any more thoughts about it. My biggest concern so far: I know earnings per diluted share is great, but what happens to the stock price if that dilution actually happens and the share count is doubled by the exercise of the ~15 million outstanding warrants?
ReplyDeleteHalf of the special warrants are owned by the CEO and he will almost certaintly never sell any of this shares unless the company gets acquired. The rest are held by LT holders who already own a significant number of shares. If you're gonna buy this stock you need to be committed LT and believe that in time the fundamentals will assert themselves. If you use stop losses, ect you will most likely get burned because there's a lot of noise volatility and the stock can be illiquid. You have to be willing to buy it and hold it no matter what the price does in the ST. If you can't do that you shouldn't buy.
ReplyDeleteThe fundamentals are pretty amazing, if they're true. $14 million in cash, $15 million in receivables with a 95%+ payment rate, only $6 million in debt, great margins, market cap only $14 million. I want to find out what they're doing to get revenue over 2.5 times the cost of sales for the locally sold oranges and bamboo.
ReplyDeleteAnother stupid novice question: Why would they be borrowing and paying back $500,000-$700,000 each year at 13% interest rates if they've got so much cash? Since the end of 2011, they've never reported less than $7 million in cash, but they keep going back to the local bank for that little bit extra.
Let me first say that I've done a lot of DD to ensure that their numbers are real and I'm quite confident they are. I've questioned every asset and liability and I'm satisfied that there's no hidden "surprises".
ReplyDeleteYour question regarding the loan is a very good one and not novice at all. Fist off, they have about $3M in borrowings and are paying 12 % interest on the bulk of it. I too have wondered why they have this debt if they got so much cash and can pay it all off it they wished. The answer I got from the company is that mgmt wants to preserve as much of its cash as possible for expansion plans and it's difficult for a company their size to obtain favorable debt financing. For those reasons, they don't want to retire debts earlier than they have do. They are going to buy a pulp producer for $5 M soon and they will also have to expand their production facilities as they are now running at fully capacity. I'm sure they have other growth plans in the works as well.
I should also point out that the correct way to view the market cap is to include the special warrants in the share count and so the true market cap is about $30M which still means it's trading at 2.5 times trailing earnings
ReplyDeleteGood point about the market cap.
ReplyDeleteI saw something about a pulp producer in Inner Mongolia, and that the previous deal to buy a pulp producer fell through because of problems that came up during due diligence. I guess the problem with the stock always comes back to the difficulty of on-the-ground due diligence for any Chinese stock, e.g.:
http://labemp.files.wordpress.com/2012/08/jon-carnes-china-economic-review-august-2012.pdf
"Consider how easy it is for management to falsify financial reports. Chinese bank employees can quickly prepare false statements to hide the existence of debt from foreign invested entities’ auditors. Liens, mortgages, security interests and guarantees are often impossible to discover. Fake asset, equity ownership, invoice and tax records are all easily filed at local tax and State Administration for Industry & Commerce (SAIC) offices. Larger companies can even file fake tax records at national tax bureaus. Recent restrictions on public access to SAIC records only make the transparency problems worse."
...etc, etc.
How do you deal with that, other than crossing your fingers and hoping that the Canadian investors and auditors who've traveled over there haven't been taken for a ride?
While the potential for corruption/fraud is higher in China than say North America I don't think it's as bad as people make it out to be. If it was, Muddy Waters would be coming out with new targets to attack weekly. btw, since Sino Forrest their track record has not been good. When it comes to GRE, their business is very simple to analyse and verify. With the cash for example auditors have visited both branch and head office to verify. Last yrs aquisition for $9M and the pmt of dividends provides some hard proof that the cash is there. While I suppose there could always been hidden liabilities that the auditors didn't catch you have to ask yourself what are the odds of that. I would say its quite low. To think otherwise without any reasonable doubt is paranoia. And again, if such things were commonplace Muddy Waters would be shooting fish in a barrel.
ReplyDeleteThe most important thing you have to take into account in the risk/reward situation. GRE trades at such huge discount thanks to to likes of Sino Forrest, and so the "fraud risk" is largely priced in, Therefore if GRE is indeed kosher, as the market eventually realizes this the reward will be quite large given the fundamentals and forthcomming growth. Ask yourself given everything you know about the company what are the odds of it being a fraud? Is there anything you see that gives you reason to doubt (aside from general fears people have about Chinese companies)? I've assigned the odds of this company being anything less than kosher as quite low which means the risk/reward set up is very attractive....in my eyes. It's up to you to decide for yourself if it is too.
The fraud risk already being priced in is a nice way of putting it.
ReplyDeleteBut then until yesterday, Asia Packaging Group looked like it had the fraud risk priced in, too. :-) (Not that I've looked through that company's past few years of financials closely yet, mind you.) I'm extremely tempted by the numbers from Greenstar, but what incentive does Mr. Guan have to keep trying to please Canadian shareholders? Money available from earnings is so much larger than anything the company could raise with stock issues right now (no carrot for management), and the ability for shareholders to get their hands on the cash if things go bad is so weak (no stick for management), that it's hard to see what incentive any Chinese manager of such a small company would have to keep slogging through the paperwork and timely reporting required for a North American listing. The impression I get (so far) from what happened with Asia Packaging isn't so much an intent to defraud so much as reporting requirements being too damn much work with too little benefit, and management not seeing any real value in outside advice/scrutiny.
That said, all the due diligence work that Greenstar appears to be putting into its tomato pulp acquisition plan is somewhat reassuring.
Thanks for letting me think this through out loud on your blog, BTW, and thanks for your insightful feedback.
Yeah, I saw what happened with apx. The company itself appears kosher. The principle shareholders (who are brothers) had a major falling out with the board for whatever reason. The timing is quite bizzare given that they just closed a major acquisition. I've never seen something like this happen. It will be interesting to see how this plays out. I know with GRE, Guan has a very good relationship with the board and wants to keep the listing. This is confirmed both by my discussions with mgmt and more importantly actions that have been taking place. Over the past year there has been an influx of CDN directors in addition to a dividend policy (very rare for a Chinese listed company in Canada) and just recently the 50% hike in the divy . All of this strongly indicates that Guan is very co-operative with the board by allowing them to call the shots. If GRE can continue to deliver the results it has, keep raising the dividend and perhaps do even more shareholder friendly things like a buyback, the hope is that the stock price will eventually rise significantly and at that point, the company will be in the position to do an equity raise at a more reasonable price. For now, as you said, they don't need to as they have plenty of cash to grow organically.
ReplyDeleteThe thing that separates GRE from the rest of the Chinese pack is not only the dividend but how clean and simple the balance sheet is with their number 1 asset being cash. I came across a similar situation with hwo.to about 2 years ago and like GRE, the valuation seemed almost too good to be true....well it wasn't! It turned out that people were simply not giving them the proper respect at the time for various reasons. GRE will have an uphill battle to win investor confidence as many people are skeptical when they first come across it as are you...and don't get me wrong, given what has happened in the sector skepticism is warranted but over time skepticism towards GRE will dissipate if GRE keeps growing and keeps delivering solid results while doing more shareholder friendly things like dividend hikes and buybacks.The stock has had a good performance this year despite the recent slide and so I think it's starting to gain some respect. But if after say 2 years the company is not attaining a decent valuation then I suspect the company will be taken private in an amicable way like what appears will happen with cho.v. That's obviously my somewhat biased opinion I guess.
btw, I'm curious as to how you discovered my blog...mind telling me?
I found your blog while searching for more information on Greenstar. There are only a few discussions of Greenstar out there, and yours is one of the only in-depth discussions. Much better than the hairpulling and boosterism that passes for analysis on stockhouse.com. :-)
ReplyDeleteThanks for the discussion. It was helpful for me as well. You don't strike me as a novice and if you are, you seem to be on the ball. Feel free to chime in anytime about GRE or anything else. One last thing regarding GRE. I've been in regular contact with the lead director and CFO for a year now and I'd say I'm pretty tight with them. I have often mentioned the concerns that investors have when they discover GRE and so I can safely say mgmt is well aware of the "China factor". From day one I've urged them to do whatever they can to prove to investors they are the real deal and to separate themselves from the Chinese herd (like issuing a dividend). So far I'm happy with how they have responded. I think they can do even more i.e. a buyback. Also, they have the potential to hike the dividend significantly in the future (on top of thee 50% hike) given that they are only paying out 10% of cashflow. However, given thier ambitious growth plans they need to find the right balance between div pmts and retaining cash for growth.
ReplyDeleteFriends might describe me as an excessively cautious novice - I'm the sort who'll read ten books before doing one thing. :-)
ReplyDeleteIt's good to know you've had such positive experiences with North American management. They have good feelings about Chinese management, I assume?
Would it help investor impressions at all to do a slow-and-steady buyback of the outstanding warrants, rather than a buyback of shares already on the market? I don't know how more experienced investors feel about them, but I know that my first reaction was to fear that they might be exercised all at once and cause the share price to dive. Even if they aren't sold by the CEO, could they push share prices down the way I fear if they're exercised, or would an announcement of a doubling of shares have no such effect?
Thanks again.
Also... mind if I ask (privately, if you'd like) what your hunch is about who's selling and causing the supply overhang? Something to do with the Bliss Time/Lucy Xia or Ding Xiusun stuff, or an early Sino Elite holder?
ReplyDeleteI put my thoughts together into a half-baked investment thesis, if you're interested:
ReplyDeletehttp://www.stockhouse.com/companies/bullboard/v.gre/greenstar-agricultural-corporation?postid=21909673
I'd be glad to hear any thoughts or criticisms you might have.
Thanks again.
I'll post a response on stockhouse tonight or tomorrow but I'd appreciate it if you don't make mention of me or my blog there....I prefer to keep these 2 virtual worlds separate from each other!
ReplyDeleteWill do. But now you've got me worried... :-) ...is there something about stockhouse that I should know that'll make me want to keep it away from the rest of my Internet presence?
ReplyDeleteNothing to worry about just personal preference. Sometimes there might be things I say here that I would rather not share on the boards. Just beware what you read on SH....lot's of misinformation. By the way that was me who responded to you this morning. Looks like you bought some shares. Welcome to the wild, wild west of microcap investing! If you want to continue talking about GRE it's probably best you email me. nosuchdice@gmail.com
ReplyDelete