Asian Citrus ACHL
May 29, 2014 - 2:01am EST by
Den1200
2014 2015
Price: 0.13 EPS $0.00 $0.00
Shares Out. (in M): 1,250 P/E 0.0x 0.0x
Market Cap (in M): 158 P/FCF 0.0x 0.0x
Net Debt (in M): 202 EBIT 0 0
TEV: -44 TEV/EBIT 0.0x 0.0x

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  • Discount to Liquidation Value
  • excess cash
  • Agriculture
  • Insider Ownership
  • Management Change
 

Description

Asian Citrus is a Chinese company that trades in London and Hong Kong. The code in Hong Kong is 73 and the ticker in London is ACHL. Their accounting year ends on June 30. Both the London and Hong Kong shares have the same rights.

The company has 1,249,637,884 shares outstanding. The price on the London exchange is 12.625 Pence at this time. In Hong Kong the price at this time is 1.680 HKD.

GBP to RMB

10.53

 

Current Price Asian Citrus in London

0.12625

GBP

Market Cap Asian Citrus GBP

             157,766,783

GBP

Market Cap Asian Citrus RMB

         1,661,284,223

RMB

     

HKD to RMB

0.8

 

Current Price Asian Citrus in Hong Kong

1.68

 

Market Cap Asian Citrus HKD

         2,099,391,645

HKD

Market Cap Asian Citrus RMB

         1,679,513,316

RMB

 

The company reports in RMB, but trades both in HKD and GBP.

Asian Citrus has 3 assets. A. Net Cash in excess of its market cap. B. Tree plantations in China where they grow mostly winter and summer oranges, but also grapefruit and bananas. C. Beihai Perfuming Garden (BPG), a producer of fruit concentrates and purees.

The company trades at about a 20% discount to its net cash on the books while it own a number of different assets, namely three fruit plantations and three juice and puree concentrate factories. The company had pretty much everything go wrong for it in the last year from excessive rain that negatively impact yields and cost to a decrease in price for the products it sells. In addition one of its orange tree plantations was hit with a disease. Still if the economics normalize to the performance of the last few years the company would trade at less than 3 times earnings not including its net cash balance. And this 3 times earnings number does not include the upside potential from better operations because of new management, the increased earnings from bringing its new concentrate plant up to normalized operating capacity and the increased quantity of fruit that will be generated when its immature trees mature and start producing fruit.

I believe the shares are worth between 4.54 HKD and 7.41 HKD (or 0.366 GBP and 0.572 GBP). The current share price in HKD is 1.68 and in GBP it is 0.12625.

Net Cash

Let us start with the net cash of 2,108,021,000 RMB. (Dec 31, 2013 cash) All this while the market cap in RMB is 1,679,513,316. So Asian Citrus trades at 80% of its net cash.

Tree Plantations

The tree plantations are Hepu, Xinfeng and Hunan.

On those plantations they grow winter oranges, summer oranges, grapefruit and bananas. (Actually Asian Citrus also sells tree saplings, but since that represents only 0.1% of revenue I am ignoring this business.)

The difference between winter and summer oranges is the time of harvest. Winter oranges are harvested from October through November, while summer oranges are harvested March through June. The growing cycle for oranges and grapefruit is that they do not yield any fruit in the first 3. In year 4 the average orange tree yields about 8 Kg. Growth is slow to about 50 Kg in year 7 after which it tends to make big nominal jumps to an expected quantity of 140 Kg by year 10. It is then expected that the tree will continue to produce at this level for 13 to 15 years after which production starts falling until year 35. This growth profile makes that the upfront cash expenses are high as true positive cash flow generation only starts about after year 8 or 9. And it isn’t just that one can plant those trees and go away for 8 years. No, the trees still needs fertilizer, pesticides and other maintenance work from the time of planting. Over the last 4 years fertilizer has represented between 50.7% and 52.2% of cost of sales for Asian Citrus’ plantation business. Pesticides represent between 8.4% and 13.1%. This is a sizeable expense that make that a new plantation will run cash flow negative for a long time after startup.

Here is a layout of COGS over the last few years:

 

2010

2011

2012

2013

Cost Of Sales Agriculture

% of COGS

% of COGS

% of COGS

% of COGS

Fertilizer

51.2%

50.7%

51.8%

52.2%

Packaging

12.4%

11.2%

8.3%

6.1%

Pesticides

8.4%

8.4%

11.2%

13.1%

Direct Labor

9.6%

9.7%

9.2%

9.8%

Depreciation

15.4%

13.2%

12.6%

11.9%

Others

2.9%

6.7%

6.8%

7.0%

Total

100.0%

100.0%

100.0%

100.0%

 

Pricing for winter oranges is lower than that of summer oranges and that of grapefruit. Grapefruit sells for about double the price of winter oranges and summer oranges also sell for a significant premium versus winter oranges. Here is the price evolution for oranges sold by Asian Citrus over the years.

 

Dec

Dec

Dec

Dec

Dec

Dec

June

Prices Oranges RMB

2008

2009

2010

2011

2012

2013

2014

Hepu Winter Oranges

                          3,089

                      3,470

                 3,567

                      3,922

                               4,085

                    4,013

                     3,863

Hepu Summer Oranges

                          4,868

                      5,057

                 5,516

                      6,061

                               5,856

                    5,694

 NA*

Xinfeng Winter Oranges

                          2,900

                      3,260

                 3,330

                      3,660

                               3,770

                    3,776

                     3,137

* NA as summer orange harvest was not yet final.

Grapefruit has a similar growth profile as oranges do. FYI. The reason I have no pricing data for grapefruit and bananas for Asian Citrus is that both crops were recently planted and there has not yet been a harvesting cycle for either fruit.

Bananas have a different growing profile as they need significantly less space and start producing after year 1. Bananas represent only a small part of Asian Citrus’ yield. They planted their first batch of banana trees recently and are expecting the first production in 2014/2015. This is a test to see if it makes sense revenue wise and as a way to diversify.

Oranges is the largest part of Asian Citrus’ agricultural business. Neither grapefruit nor bananas have had a harvesting cycle up to now.

Below is a layout of the number of trees by kind at each of the plantations by age:

Age

Summer Oranges Hepu

Winter Oranges Hepu

Banana Trees Hepu

 

Winter Oranges Xinfeng

 

Summer Oranges Hunan

Grapefruit Hunan

Total By Age

0

   

   221,769

       

      451,360

      673,129

1

             

      301,200

      301,200

2

     66,449

         

      622,475

 

      688,924

3

     63,584

         

      427,400

 

      490,984

4

     64,194

             

         64,194

5

     81,261

             

         81,261

6

     76,135

             

         76,135

7

     55,185

     

      400,000

     

      455,185

8

       

      400,000

     

      400,000

9

 

     46,077

   

      400,000

     

      446,077

10

               

                  -  

11

 

   180,180

   

      400,000

     

      580,180

12

 

     42,300

           

         42,300

13

               

                  -  

14

               

                  -  

15

               

                  -  

16

               

                  -  

17

     29,996

             

         29,996

18

   128,966

             

      128,966

19

   186,003

             

      186,003

20

   223,741

             

      223,741

Total Trees

   975,514

   268,557

   221,769

 

   1,600,000

 

   1,049,875

      752,560

 

 

Important is to look at the tree age profile of the plantations. As you can see, Xinfeng’s age profile is 7, 8, 9, 11 years. Meaning the plantation crop tonnage should continue to grow for the next 4 years at Xinfeng until the whole plantation reaches the age of 10. The Hunan plantation’s age is even younger with its eldest trees at this time being 4 years old. (FYI. In the following calculations you will see that I treat grapefruit equal to that of oranges. Why? Well it makes the picture easier to understand and since grapefruit trees are expected to have a superior revenue profile this is a conservative choice anyway.) Basically this means that we are destined to see a material increase in volume of product even in case we have no expansion in the total acreage. This way normalized tonnage should increase by 67% in 5 years from today and increase by 104% in 10 years time. (This assumes that trees get cut down at the age of 25 which is conservative.) No new capex is going to be required to achieve this increase in producing trees.

The below graph shows us the aggregate percentage of citrus trees by year planted. As you can see 42% of all trees are 3 years old or less and never had a harvest. And 74% of all trees are 9 years old or less. All these trees will have higher volumes annually until they reach the age of 10.

Age

Sum Citrus Trees

Aggregate %

0

              451,360

10%

1

              752,560

16%

2

          1,441,484

31%

3

          1,932,468

42%

4

          1,996,662

43%

5

          2,077,923

45%

6

          2,154,058

46%

7

          2,609,243

56%

8

          3,009,243

65%

9

          3,455,320

74%

10

          3,455,320

74%

11

          4,035,500

87%

12

          4,077,800

88%

13

          4,077,800

88%

14

          4,077,800

88%

15

          4,077,800

88%

16

          4,077,800

88%

17

          4,107,796

88%

18

          4,236,762

91%

19

          4,422,765

95%

20

          4,646,506

100%

 

 

 

Additionally as mentioned above, the immature trees still require a fair amount of expenses after planting. The immature trees require fertilizer, pesticides and other maintenance expenses. Fertilizer tends to represent about 50% of COGS and pesticides about 9% to 13%. So when the immature trees become mature and start producing there will be significant operating leverage.

This all does not include 221,769 banana trees which will start producing soon.

Asian Citrus orange business can also be split between graded and ungraded oranges. Graded oranges are selected based on quality, packaged and delivered to the customer. Ungraded oranges are not selected, but just packaged and the customer is required to pick up the oranges. The graded oranges are sold at a premium price to ungraded oranges through supermarkets under the brand name Royal Star which is owned by Asian Citrus. Royal Star can be compared to the Sunkist brand in quality, but sells for a significant discount to Sunkist. Graded was about 18% of volume sold in 2013. In the future there will be the ability to grow Royal Star as the PRC market matures and the middle class grows in size. There is also the ability to grow the brand across Asia.

The agricultural business has struggled over the last two year though. The problems were multiple going from Citrus Canker, excessive rainfall causing lower yields and higher expenses, and lower prices. This combination of lower prices and lower volume resulted in a hit to revenue and earnings over the last 12 months.

  • Excessive rain: In both 2012 and 2013 Asian Citrus plantations had to deal with excessive rain fall. In 2012 there was 1,938 mm of rainfall and in 2013 they had 1,975 mm of rainfall. This compared to an average rainfall between 1981 and 2010 of 1,521 mm. Excessive rainfall results in leaching of nutrients which results in lower yields which requires use of fertilizer and pesticides. Excessive rainfall also damages the plantations requiring increased maintenance expenses.
  • Citrus Canker: Hepu plantation had an issue with Citrus Canker. Citrus Canker results in leaves and fruit dropping prematurely. Also it makes the fruit unappetizing to eat. Citrus Canker is a disease that is pretty persistent and requires significant attention. Asian Citrus handled this issue in a cautious manner and hired a US based expert/agronomist to assist them. A friend investor was at the plantation when the agronomist was available and the agronomist confirmed the problem was handled correctly. It is important to find out about Citrus Canker as early as possible and therefore Asian Citrus has changed it routine of twice monthly inspections to weekly inspections.
  • Pricing: Pricing suffered too, especially the last year. The price decline at Hepu was between 3% and 4%, but Xinfeng took a significant hit in pricing of about 17%. Two issues drove this. First there was a dyeing scandal, where unsavory operators from Gannan would inject oranges with red dye in order to make them look more appealing. This naturally dented the reputation of oranges coming from this region and made many consumers buy other oranges thus driving down pricing. Second we saw an increase in supply of oranges. Other areas like Sichuan, Guangxi and Chongqing had great harvests while the Jiangxi region had excess rainfall which brought down yields (and increased costs). This year the expectation is about a 10% industry wide increase in oranges due to improved yields and maturing of trees. There is no growth in acreage going on right now.

The company has had lower yields (rainfall and Citrus Canker), lower prices and higher costs. Basically on every metric things went against the company last year.

I do feel fairly confident that the amount of rainfall will revert to its mean over the next few years. A reversion to the mean is most important as the biggest impact on results was caused by the lower yields and higher expenses caused by the excess rain.

On the Citrus Canker issue, that is a low to moderate worry. From what I learned, a diligent monitoring program cannot prevent outbreaks, but it allows for the damage to be limited.

An additional worry is the pricing of oranges. In the same way that Asian Citrus has a lot of young trees it could be that many other plantations have done the same. Something I was not able to confirm. On the other hand while it is possible to develop new large plantations, it isn’t that easy either. A. Building a new plantation requires a large upfront investment that will not generate any meaningful revenue for the first 7 years. Actually because of the need for fertilizer, pesticides and other maintenance, the plantation will run cash flow negative until about year 8 to 10. And B. In addition it is hard to find new large pieces of land that provide for the necessary economies of scale.

 

Opposite that increase in supply sits the demand equation for citrus products in the PRC. For example, in the US in 2011 total demand for citrus products was 76 lbs. Of that 23 lbs. was for direct consumption, the other 53 lbs. was for use in concentrate/juice. Of that 76 lbs., 53 lbs. was the consumption of oranges with 10 lbs. being personal consumption and the other 43 lbs. for the use in concentrate/juice. If I overlay that 53 lbs. (24kg) per person on China they would need to produce 32 million ton of oranges a year. Currently China produces around 7 million ton of oranges. The aggregate supply from the top 10 producers in the world is only 51.7 million ton of oranges.

 

If we take a look at orange juice consumption then the potential growth in China versus the rest of the world then we see a lot of potential.

Per capita juice consumption in

  • USA – 100 Liters
  • Japan – 98 Liters
  • Germany – 90 Liters
  • UK – 70 Liters
  • France – 65 Liters
  • Australia – 47 Liters
  • China – 9.5 Liters

If one looks are orange juice, it seems that there is some correlation between wealth and per capita quantity consumed.

 

And there is a lot of potential when it comes to fresh orange consumption too. With its 10 lbs. of per capita fresh orange consumption the US is actually far down the ranking. In countries like Brazil, Mexico, even the European Union per capita orange production is more than 4 times that of the per capita consumption of the US. Chinese per capita consumption of fresh oranges is about 11 lbs. at this time. Important to know is that in China fresh oranges play an important part in its food culture. I assume most of us have been to a Chinese restaurant where it is the habit to finish the meal with a piece of fresh orange.

 

As one can see, we’d need a lot of oranges even if Chinese per capita consumption increases by just 50% from about 12 Lbs. per person to 18 Lbs. per person.

Here are some of the relevant numbers related to the agriculture business.

Quantity Asian Citrus Winter Vs Summer Oranges (Ton)

2010

2011

2012

2013

Winter Oranges

                     114,530

             143,698

                           171,607

                 161,233

Summer Oranges

                        72,408

               73,194

                             71,814

                   57,367

Total

                     186,938

             216,892

                           243,421

                 218,600

Here is the revenue for the plantation business:

Revenue Breakdown RMB (000)

2010

2011

2012

2013

 

Hepu Plantation

                     583,649

             631,139

                           593,454

                 449,230

 

Xinfeng Plantation

                     194,016

             330,988

                           463,873

                 470,753

 

Total Agriculture

                     777,665

             962,127

                       1,057,327

                 919,983

 

 

 

 

 

 

 

Revenue Per Ton RMB (000)

                          2,010

                             2,011

                 2,012

                      2,013

Plantations

                          4,160

                             4,436

                 4,344

                      4,209

                   

 

Segment Information Revenue and Earnings RMB (000)

 

Agriculture 2010

Agriculture 2011

Agriculture 2012

 Agriculture 2013

 Agriculture June 2014

Revenue

 

                   784,721

                  969,030

                1,060,671

                  921,823

             468,907

Earnings

 

                   625,115

              1,042,192

                    621,600

                    31,912

          (576,032)

Biological Assets*

 

                   306,000

                  507,712

                    166,900

               (260,468)

          (583,000)

Adjusted Earnings**

 

                   319,115

                  534,480

                    454,700

                  292,380

                 6,968

 

* Biological assets are an IFRS invention. Annually the NAV of the Asian Citrus plantations is calculated using an NPV calculation with an 18% discount rate. From that number the tangible asset value related to these assets on the balance sheet is deducted. If there is a change in this year’s biological asset value versus last year’s then the delta is run through the income statement and the change is then reflected on the balance sheet. For Asian Citrus this creates sizeable volatility in the income statement. All this is non cash.

** FYI In the PRC certain agricultural activities have a tax rate of 0%. Asian Citrus falls under these regulations.

 

Beihai Perfuming Garden

 

Beihai Perfuming Garden (“BPG”) is the 3rd asset owned by Asian Citrus. Asian Citrus owns 92.94% of BPG which it bought for 2.04 billion RMB in 2010. BPG currently owns tree concentrate plants. The Hepu, Beihai and Baise production plants.

 

Hepu has a capacity of 46,200 ton and Beihai has a capacity of 14,850 ton. The capacity utilization of these plants tends to be between 90% and 95%. At this capacity utilization the gross margin tends to be between 20% and 30%. It all depends on the spread between world prices and the cost to input.

 

Baise is a new plant that is just coming online. Its capacity is 40,000 ton. In case Baise gets up to 90% capacity in a few years it should contribute nicely to the bottom line rather than be a drain. The new Baise plant represents a 65% increase in capacity for BPG.

 

I have an investor friend that has visited all 3 plants and says they all look ultra modern, clean and well managed.

 

The story here is somewhat the same as with the plantations. We have this production capacity in Baise that was just built and already paid for. The plant was just started up and is running far below its planned capacity utilization. In general it is expected that it takes a few years for this kind of plant to be up and running at full capacity.

 

There should be enough demand for this new plant. Below is the growth profile of BPG’s juice market globally and in the PRC.

 

Global Demand (Ton)

2007

2008

2009

2010

2011

2012

2013

Pineapple

451,089

380,000

452,300

467,900

530,600

588,500

645,280

Lychee

6,320

4,970

8,295

9,210

10,310

11,450

12,620

Passion Fruit

130,000

110,000

150,000

163,800

184,500

206,800

232,500

Total

587,409

494,970

610,595

640,910

725,410

806,750

890,400

 

 

PRC Demand (Ton)

2007

2008

2009

2010

2011

2012

2013

Pineapple

14,380

16,380

19,650

25,650

33,150

42,850

55,370

Lychee

307

397

553

740

987

1,325

1,325

Passion Fruit

850

1,075

1,630

2,350

3,390

4,890

6,990

Total

15,537

17,852

21,833

28,740

37,527

49,065

64,143

 

Beihai BPG processes over 22 different types of tropical fruits, including pineapples, passion fruit, lychees, mangoes and papayas into juices or purees. The main groups of products sold by BPG are Pineapple Juice Concentrate, Lychee Juice Concentrate, Other Fruit Concentrates, Mango Purees, Other Fruit Purees and Frozen and Dried Fruit and Vegetable.

 

BPG also has the necessary export licenses and represents about 60% of exports out of the PRC in its category.

 

BPG’s business has been under pressure too. Basically just as with the plantations it suffered from lower volumes at lower prices. The issue is that BPG sells its products on the world market, but sources locally. For example the excessive rains shrunk the capacity of pineapple available for BPG at the same time global market prices were declining. Especially pineapple juice concentrate pricing has been under pressure due to increased volumes coming out of the Philippines and Thailand.

 

 

2011

2012

2013

Sale of processed fruit BPG

Volume (Ton)

Volume (Ton)

Volume (Ton)

Pineapple juice concentrates

                     16,636

                      24,348

               18,295

Other fruit juice concentrates

                       4,017

                      10,017

               11,230

Fruit purees

                       3,616

                      17,472

               13,354

Frozen and dried fruits and vegetables

                       9,634

                      18,170

               14,051

Total

                     33,903

                      70,007

               56,930

 

 

Revenue Breakdown RMB (000)

2011

2012

2013

Processed Fruit

                    417,393

             715,473

                 564,089

 

 

Revenue Per Ton (RMB)

2011

2012

2013

Processed Fruit

                    12,311

               10,220

                      9,908

 

Segment Information Revenue and Earnings

Processed Fruit 2011

Processed Fruit 2013

Processed Fruit June 2014

Revenue

                 417,393

              715,473

              279,426

Earnings

                 131,845

              138,711

                47,771

Biological Assets

                            -  

                         -  

                         -  

Adjusted Earnings

                 131,845

              138,711

                47,771

 

 

New Management, Corporate Governance and Ownership

 

Tony Tong, the founder and patriarch, controls 19.2% owned by him and his family through an entity called Market Ahead Investments. Sunshine Hero, the original owner of BPG, owns 9.34% of Asian Citrus and Chaoda Modern Agriculture* owns 5.9%. Lastly the public owns 65.74% of the company.

*Choada used to be a much larger shareholder of Asian Citrus, but Chaoda turned out to be a fraud. Asian Citrus used to buy organic fertilizer from Chaoda which combined with the large ownership naturally tainted Asian Citrus too. So in October 2011 Asian Citrus stopped buying organic fertilizer from Chaoda, its representatives left the board and its ownership stake was mostly sold. I feel confident that Asian Citrus was not involved in the fraud.

 

Options

           

Exercise Date

26-Jul-14

08-Feb-15

08-Feb-15

08-Feb-15

26-Jun-18

27-Feb-19

 

GBP

GBP

GBP

GBP

HKD

HKD

Exercise Price

0.2045

0.139

0.112

0.2425

5.68

9.00

Current Price Stock

0.1263

0.1263

0.1263

0.1263

1.68

1.68

Tong Wang Chow

               1,500,000

              1,500,000

   

             850,000

 

Tong Hung Wai "Tommy"

                   550,000

                  600,000

   

             750,000

 

Mer Cheung Wai Sun

                     90,000

                  360,000

   

             750,000

 

Pang Yi

                   480,000

                  960,000

                    900,000

 

         3,400,000

 

Lui Ming Wah

       

             500,000

 

Yang Zhen Han

       

             500,000

 

Employees and Other

               1,270,000

                  300,000

                2,010,000

                  890,000

       22,884,000

         20,000,000

 

Options are about 3.8% of the current number of shares outstanding. Most of these options are far out of the money. New management has already made clear that they will propose new option grants fairly soon.

 

Now that we got ownership and options out of the way I’d like to address the old and new management.

Tony Tong and his son, “Tommy” Tong are the founders of Asian Citrus. They had a board that was not independent and somehow felt this was mostly their company rather than the shareholder’s. This made the overall corporate governance poor. That naturally all worked fine as long as the company was doing well. But when the business got hit with Citrus Canker and the trifecta of lower yields, lower prices and higher costs, things went wrong. It all came to a head during the last AGM. A number board proposals were voted down. Current shareholders also directed a lot of criticism towards Tony Tong, his son and the board. In short, shareholders made clear they were tired of the below average management of the company. It seemed that it was quite the shock to Tony Tong and his son. They did not expect this to happen ... and then they did the right thing. Tony Tong resigned as CEO and Chairman of the board. His son relinquished his executive role and maintained his role on the board as the representative of the family and then new independent board members were elected, making the majority of board members independent including the new Chairman.

The new non-executive Chairman is Mr. Ng Hoi Yue, the new CEO is Mr. Ng Ong Nee. There is also a new CFO, Mr. Ng Cheuk Lun. Both the Chairman and new CEO have extensive experience in developed countries and understand capital markets. The new CEO spent a lot of time in Australia as well as China, while the new Chairman spent time in the UK and has been a CPA for many years in Hong Kong. Both have been on the boards of many companies, not just in China.

Both have a good understanding of what needs to be done, being:

  • Improve shareholder communication and reestablish the trust of shareholders.
  • First focus on the current core business before expanding for more scale. More size means more economies of scale in production as well as distribution which is to happen in the future.
  • Improve operational efficiencies. For example there seems to be dysfunctional communication between different plantations and concentrate plants within the company. The Hong Kong headquarters is often not in line with the plantations and BPG plants. Often it takes a long time to get approvals. There are also cost opportunities like applying fertilizer when there is a dry period predicted rather than just apply at regular intervals even when it is raining. One can also work on creating infrastructure that will prevent less damage being done to the plantations in case of adverse weather. Better monitoring for disease and its remediation will also be important.
  • Improve revenue generation. For example there are many markets, like Indonesia, that have significantly higher prices for oranges. In addition there are lot of middle men involved in the export side of the business. The CEO believes that by investing in cold storage in different markets Asian Citrus will be able to cut out middlemen and sell directly. The CEO also believes there is an opportunity to enter different higher margin business for BPG, like sugar cane concentrate and red bean puree. He also believes he can work with his customers, being ingredient mixers, and provide more value added services like pre-mixing ingredients.

 

The CEO has stated that by August he will present his plan for the company which will include new incentives for employees as well as strategic initiatives.

 

Now let’s not get too exited either. The most important factors will still be disease management, yield recovery and price recovery. If those factors go our way earnings will balloon independent of all the efforts implemented by the new CEO.

 

Valuation.

 

Before I get going on my own valuation exercise, in 2013 there was a bid for the company at 4.4 HKD per share, which was rejected by the board as too low. The current price is 1.68 HKD.

 

When valuing the company I adjusted the income statement and balance sheet.

 

Here are the adjusted income statement numbers for the last few years

 

Year June

Year June

Year June

Year June

6 Months Dec

Adjustments

2010

2011

2012

2013

2013

 

Net Profit Attributable To Shareholders

              585,467

         1,038,953

             750,200

             114,395

          (547,971)

Net Gain Biological Assets

              306,000

             507,712

             166,900

          (260,468)

          (583,000)

Interest Income

                  1,845

                 7,308

               21,559

               50,509

              20,416

Adjusted Net Profit*

              277,622

             523,933

             561,741

             324,354

              14,613

 

* Adjusted Net Profit = Net Profit Attributable To Shareholders – Net Gain Biological Assets – Interest Income. Why exclude Interest Income? Later I exclude cash from my calculation of Adjusted Equity. So … no cash, no interest income. I also exclude the impact of Biological Assets as it is purely a non cash item.

 

On the balance sheet I made the following adjustments in order to get to adjusted equity.

 

 

12 Months June

12 Months June

12 Months June

12 Months June

6 Months Dec

Adjusted Equity

2010

2011

2012

2013

2013

Equity Shareholders

             3,921,692

             7,566,993

             8,150,119

             8,091,047

         7,524,599

Biological Assets

             1,642,024

             2,232,058

             2,463,860

             2,380,599

         1,728,685

Intangible Assets

                   36,800

                   53,287

                   58,506

                   64,463

               59,089

Goodwill**

                            -  

             1,157,261

             1,157,261

             1,157,261

         1,157,261

80% times Cash and Cash Equivalents

                780,059

             1,785,762

             1,910,491

             1,712,979

         1,686,417

Adjusted Equity*

             1,462,809

             2,338,625

             2,560,001

             2,775,745

         2,893,147

 

 

* Adjusted Equity = Equity Shareholders – Biological Assets – Intangible Assets – Goodwill – 80% times Cash and Cash Equivalents. Why deduct 80% of cash? I assumed that Asian Citrus would need about 20% of its cash balance to operate.

** Why exclude the Goodwill? After all didn’t the company invest the cash to acquire the asset that put the Goodwill on the balance sheet? Yes, agreed. But I just don’t like to count on Goodwill as an asset and put a multiple on that in this case.

 

12 Months June

12 Months June

12 Months June

12 Months June

6 Months Dec Annualized Adjusted Net Profit

Return on Adjusted Equity

2010

2011

2012

2013

2013

Adjusted Net Profit

                277,622

                523,933

                561,741

                324,354

                 29,226

Adjusted Equity

             1,462,809

             2,338,625

             2,560,001

             2,775,745

           2,893,147

Return on Adjusted Equity

19%

22%

22%

12%

1%

 

To me it seems that this might be a better business than people think. We have had pretty much everything go wrong for Asian Citrus, starting with two years of horrible weather which drove down yields and forced up expenses, the red dye scandal in the Gannan region where Xinfeng is located, a super harvest in the other growing regions which drove down prices, Citrus Canker hitting Hepu, delays in opening the Baise plant, lower prices on the world market for concentrate and purees all the while the increased rain limited the availability of local fruit at attractive prices. As I said, a lot of stuff went wrong. What are the odds that that will continue? It seems to me that the more likely outcome is that we will see a reverse of fortunes and go back to how it was in years prior over the next few years.

 

So I decided to create a valuation matrix assuming that given the historical performance Asian Citrus was worth between 1 and 2 times the Adjusted Equity + the 80% of the Cash and Cash Equivalents we excluded earlier. With this return profile I believe that a 1 times multiple is conservative and, a 2 times multiple to be the upper limit. Although in case things turn around and go back to the economic returns from 2011 and 2012 the stock will likely trade at a 2 times multiple. After all, the adjusted net profit in 2011 and 2012 was already more than 500 million RMB and then there is still the added volume related to the Baise plant and the aging of mature trees which will increase volume of fruit every year for the next 10 years. In my mind there is little doubt that in case the economics return to what they used to be this is a multi bagger and if they don’t then, we still have a margin of safety due to the negative enterprise value.

FYI. One should expect that when June 2014 numbers come out that they will be bad. We had a bad year and it is likely that the new management might do a kitchen sink operation to get rid of legacy issues.

 

Valuation

 

Per Share

Per Share

Per Share

Adjusted Equity Dec 31, 2013 (RMB)

             2,893,147

RMB

HKD

GBP

1 times Adj. Equity + 80% of cash*

             4,579,564

                       3.66

                       4.54

                     0.366

1.5 times Adj. Equity + 80% of cash

             6,026,138

                       4.82

                       5.98

                     0.461

2 times Adj. Equity + 80% of cash

             7,472,711

                       5.98

                       7.41

                     0.572

* 80% times cash December 31, 2013.

Dividend

 

New management states that it was a mistake to cancel the dividend, especially since the company has so much cash on hand. There is an issue though with paying out the cash. For the dividend to be paid, cash needs to be transferred from China to Hong Kong and there seem to be some issue related to that transfer. Personally I don’t care about the payout of a dividend. I’d much rather have a tender offer for a large chunk of the company and/or other forms of buybacks at this stock price. This is a unique time to retire a lot of stock. Still I believe that creates the same cash transfer problem from China to Hong Kong than the dividend payment does.

 

Risks

 

The impact of disease, not just Citrus Canker, but also Citrus Greening. Either disease can wreak a lot of havoc and it is pertinent that the plantations are closely monitored at all times. The sooner you catch it the less the damage.

 

A continuation of the abnormal weather patterns of the last 2 years. I am a firm believer in return to the mean, but it is not guaranteed that we will not have excessive rain next year too. I have a 3 year window for my investments to work out so I can wait it out if need be.

 

A continuation of low prices. The good news is that there does not seem to be an expansion of acreage in the PRC going on. On the other hand I have no idea how much of the planted acreage in the PRC is already mature (above 7 years) and how much is immature (below 7 years). And it will naturally also depend on the growth in demand and imports/exports. Demand for oranges and other fruits continues to increase every year in the PRC at a nice clip and it should be able to absorb the additional quantity but one never know what kind of event might impact demand.

 

More food scare scandals like the red dye scandal in Gannan.

 

Increasing costs. The biggest risk here is the cost of fertilizer at about 50% of COGS. An increase in that cost can have a big impact.

 

The Chinese economy crashing is a worry too. We all know about the debt, real estate bubble, infrastructure bubble, etc. I understand the risk and also realize that such an event will have a big impact on Asian Citrus. It is very reasonable to expect that pricing of its products would take a big hit for some time. On the other hand I know Asian Citrus has no debt and a lot of cash. Cash it can use to survive and even buy distressed assets. Basically I think the thesis that the Chinese economy needs to go through an adjustment at some time in the future is correct, but I do not believe it is possible to put a timeframe on it. After all I have been hearing for four years now that China is about to fall apart any day now. I guess I am making a bet on a company with a descent business trading at a large discount to IV in a risky macro environment. Also if China crashes in the way many of the pundits have been saying US based stocks won’t be safe either.

 

Fraud is always an issue, especially given the recent past with Chinese companies. There have been multiple efforts made to ensure investors, like having an outside company count all the trees. Also annually there is the calculation of the value of the biological assets. Asian Citrus’ auditor is Baker Tilly, ranked 8th in the world. My main worry was the status of the cash and how was it invested. In note 22 of the Dec 31, 2013 interim report it states that most of the cash is in bank deposits and cash on hand. None of the cash is invested in time deposits longer than 3 months, nor have they played shadow bank with the cash. Given that information I feel comfortable that Baker Tilly can assess the right cash balances. Lastly my investor friend has visited each of the concentrate plants and a number of the plantations and his feedback is positive. He hasn’t noticed any discrepancies. I have know him for a while now and highly respect his opinion. If it was not for him having visited the company in China I would likely have passed.

 

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 
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    Description

    Asian Citrus is a Chinese company that trades in London and Hong Kong. The code in Hong Kong is 73 and the ticker in London is ACHL. Their accounting year ends on June 30. Both the London and Hong Kong shares have the same rights.

    The company has 1,249,637,884 shares outstanding. The price on the London exchange is 12.625 Pence at this time. In Hong Kong the price at this time is 1.680 HKD.

    GBP to RMB

    10.53

     

    Current Price Asian Citrus in London

    0.12625

    GBP

    Market Cap Asian Citrus GBP

                 157,766,783

    GBP

    Market Cap Asian Citrus RMB

             1,661,284,223

    RMB

         

    HKD to RMB

    0.8

     

    Current Price Asian Citrus in Hong Kong

    1.68

     

    Market Cap Asian Citrus HKD

             2,099,391,645

    HKD

    Market Cap Asian Citrus RMB

             1,679,513,316

    RMB

     

    The company reports in RMB, but trades both in HKD and GBP.

    Asian Citrus has 3 assets. A. Net Cash in excess of its market cap. B. Tree plantations in China where they grow mostly winter and summer oranges, but also grapefruit and bananas. C. Beihai Perfuming Garden (BPG), a producer of fruit concentrates and purees.

    The company trades at about a 20% discount to its net cash on the books while it own a number of different assets, namely three fruit plantations and three juice and puree concentrate factories. The company had pretty much everything go wrong for it in the last year from excessive rain that negatively impact yields and cost to a decrease in price for the products it sells. In addition one of its orange tree plantations was hit with a disease. Still if the economics normalize to the performance of the last few years the company would trade at less than 3 times earnings not including its net cash balance. And this 3 times earnings number does not include the upside potential from better operations because of new management, the increased earnings from bringing its new concentrate plant up to normalized operating capacity and the increased quantity of fruit that will be generated when its immature trees mature and start producing fruit.

    I believe the shares are worth between 4.54 HKD and 7.41 HKD (or 0.366 GBP and 0.572 GBP). The current share price in HKD is 1.68 and in GBP it is 0.12625.

    Net Cash

    Let us start with the net cash of 2,108,021,000 RMB. (Dec 31, 2013 cash) All this while the market cap in RMB is 1,679,513,316. So Asian Citrus trades at 80% of its net cash.

    Tree Plantations

    The tree plantations are Hepu, Xinfeng and Hunan.

    On those plantations they grow winter oranges, summer oranges, grapefruit and bananas. (Actually Asian Citrus also sells tree saplings, but since that represents only 0.1% of revenue I am ignoring this business.)

    The difference between winter and summer oranges is the time of harvest. Winter oranges are harvested from October through November, while summer oranges are harvested March through June. The growing cycle for oranges and grapefruit is that they do not yield any fruit in the first 3. In year 4 the average orange tree yields about 8 Kg. Growth is slow to about 50 Kg in year 7 after which it tends to make big nominal jumps to an expected quantity of 140 Kg by year 10. It is then expected that the tree will continue to produce at this level for 13 to 15 years after which production starts falling until year 35. This growth profile makes that the upfront cash expenses are high as true positive cash flow generation only starts about after year 8 or 9. And it isn’t just that one can plant those trees and go away for 8 years. No, the trees still needs fertilizer, pesticides and other maintenance work from the time of planting. Over the last 4 years fertilizer has represented between 50.7% and 52.2% of cost of sales for Asian Citrus’ plantation business. Pesticides represent between 8.4% and 13.1%. This is a sizeable expense that make that a new plantation will run cash flow negative for a long time after startup.

    Here is a layout of COGS over the last few years:

     

    2010

    2011

    2012

    2013

    Cost Of Sales Agriculture

    % of COGS

    % of COGS

    % of COGS

    % of COGS

    Fertilizer

    51.2%

    50.7%

    51.8%

    52.2%

    Packaging

    12.4%

    11.2%

    8.3%

    6.1%

    Pesticides

    8.4%

    8.4%

    11.2%

    13.1%

    Direct Labor

    9.6%

    9.7%

    9.2%

    9.8%

    Depreciation

    15.4%

    13.2%

    12.6%

    11.9%

    Others

    2.9%

    6.7%

    6.8%

    7.0%

    Total

    100.0%

    100.0%

    100.0%

    100.0%

     

    Pricing for winter oranges is lower than that of summer oranges and that of grapefruit. Grapefruit sells for about double the price of winter oranges and summer oranges also sell for a significant premium versus winter oranges. Here is the price evolution for oranges sold by Asian Citrus over the years.

     

    Dec

    Dec

    Dec

    Dec

    Dec

    Dec

    June

    Prices Oranges RMB

    2008

    2009

    2010

    2011

    2012

    2013

    2014

    Hepu Winter Oranges

                              3,089

                          3,470

                     3,567

                          3,922

                                   4,085

                        4,013

                         3,863

    Hepu Summer Oranges

                              4,868

                          5,057

                     5,516

                          6,061

                                   5,856

                        5,694

     NA*

    Xinfeng Winter Oranges

                              2,900

                          3,260

                     3,330

                          3,660

                                   3,770

                        3,776

                         3,137

    * NA as summer orange harvest was not yet final.

    Grapefruit has a similar growth profile as oranges do. FYI. The reason I have no pricing data for grapefruit and bananas for Asian Citrus is that both crops were recently planted and there has not yet been a harvesting cycle for either fruit.

    Bananas have a different growing profile as they need significantly less space and start producing after year 1. Bananas represent only a small part of Asian Citrus’ yield. They planted their first batch of banana trees recently and are expecting the first production in 2014/2015. This is a test to see if it makes sense revenue wise and as a way to diversify.

    Oranges is the largest part of Asian Citrus’ agricultural business. Neither grapefruit nor bananas have had a harvesting cycle up to now.

    Below is a layout of the number of trees by kind at each of the plantations by age:

    Age

    Summer Oranges Hepu

    Winter Oranges Hepu

    Banana Trees Hepu

     

    Winter Oranges Xinfeng

     

    Summer Oranges Hunan

    Grapefruit Hunan

    Total By Age

    0

       

       221,769

           

          451,360

          673,129

    1

                 

          301,200

          301,200

    2

         66,449

             

          622,475

     

          688,924

    3

         63,584

             

          427,400

     

          490,984

    4

         64,194

                 

             64,194

    5

         81,261

                 

             81,261

    6

         76,135

                 

             76,135

    7

         55,185

         

          400,000

         

          455,185

    8

           

          400,000

         

          400,000

    9

     

         46,077

       

          400,000

         

          446,077

    10

                   

                      -  

    11

     

       180,180

       

          400,000

         

          580,180

    12

     

         42,300

               

             42,300

    13

                   

                      -  

    14

                   

                      -  

    15

                   

                      -  

    16

                   

                      -  

    17

         29,996

                 

             29,996

    18

       128,966

                 

          128,966

    19

       186,003

                 

          186,003

    20

       223,741

                 

          223,741

    Total Trees

       975,514

       268,557

       221,769

     

       1,600,000

     

       1,049,875

          752,560

     

     

    Important is to look at the tree age profile of the plantations. As you can see, Xinfeng’s age profile is 7, 8, 9, 11 years. Meaning the plantation crop tonnage should continue to grow for the next 4 years at Xinfeng until the whole plantation reaches the age of 10. The Hunan plantation’s age is even younger with its eldest trees at this time being 4 years old. (FYI. In the following calculations you will see that I treat grapefruit equal to that of oranges. Why? Well it makes the picture easier to understand and since grapefruit trees are expected to have a superior revenue profile this is a conservative choice anyway.) Basically this means that we are destined to see a material increase in volume of product even in case we have no expansion in the total acreage. This way normalized tonnage should increase by 67% in 5 years from today and increase by 104% in 10 years time. (This assumes that trees get cut down at the age of 25 which is conservative.) No new capex is going to be required to achieve this increase in producing trees.

    The below graph shows us the aggregate percentage of citrus trees by year planted. As you can see 42% of all trees are 3 years old or less and never had a harvest. And 74% of all trees are 9 years old or less. All these trees will have higher volumes annually until they reach the age of 10.

    Age

    Sum Citrus Trees

    Aggregate %

    0

                  451,360

    10%

    1

                  752,560

    16%

    2

              1,441,484

    31%

    3

              1,932,468

    42%

    4

              1,996,662

    43%

    5

              2,077,923

    45%

    6

              2,154,058

    46%

    7

              2,609,243

    56%

    8

              3,009,243

    65%

    9

              3,455,320

    74%

    10

              3,455,320

    74%

    11

              4,035,500

    87%

    12

              4,077,800

    88%

    13

              4,077,800

    88%

    14

              4,077,800

    88%

    15

              4,077,800

    88%

    16

              4,077,800

    88%

    17

              4,107,796

    88%

    18

              4,236,762

    91%

    19

              4,422,765

    95%

    20

              4,646,506

    100%

     

     

     

    Additionally as mentioned above, the immature trees still require a fair amount of expenses after planting. The immature trees require fertilizer, pesticides and other maintenance expenses. Fertilizer tends to represent about 50% of COGS and pesticides about 9% to 13%. So when the immature trees become mature and start producing there will be significant operating leverage.

    This all does not include 221,769 banana trees which will start producing soon.

    Asian Citrus orange business can also be split between graded and ungraded oranges. Graded oranges are selected based on quality, packaged and delivered to the customer. Ungraded oranges are not selected, but just packaged and the customer is required to pick up the oranges. The graded oranges are sold at a premium price to ungraded oranges through supermarkets under the brand name Royal Star which is owned by Asian Citrus. Royal Star can be compared to the Sunkist brand in quality, but sells for a significant discount to Sunkist. Graded was about 18% of volume sold in 2013. In the future there will be the ability to grow Royal Star as the PRC market matures and the middle class grows in size. There is also the ability to grow the brand across Asia.

    The agricultural business has struggled over the last two year though. The problems were multiple going from Citrus Canker, excessive rainfall causing lower yields and higher expenses, and lower prices. This combination of lower prices and lower volume resulted in a hit to revenue and earnings over the last 12 months.

    • Excessive rain: In both 2012 and 2013 Asian Citrus plantations had to deal with excessive rain fall. In 2012 there was 1,938 mm of rainfall and in 2013 they had 1,975 mm of rainfall. This compared to an average rainfall between 1981 and 2010 of 1,521 mm. Excessive rainfall results in leaching of nutrients which results in lower yields which requires use of fertilizer and pesticides. Excessive rainfall also damages the plantations requiring increased maintenance expenses.
    • Citrus Canker: Hepu plantation had an issue with Citrus Canker. Citrus Canker results in leaves and fruit dropping prematurely. Also it makes the fruit unappetizing to eat. Citrus Canker is a disease that is pretty persistent and requires significant attention. Asian Citrus handled this issue in a cautious manner and hired a US based expert/agronomist to assist them. A friend investor was at the plantation when the agronomist was available and the agronomist confirmed the problem was handled correctly. It is important to find out about Citrus Canker as early as possible and therefore Asian Citrus has changed it routine of twice monthly inspections to weekly inspections.
    • Pricing: Pricing suffered too, especially the last year. The price decline at Hepu was between 3% and 4%, but Xinfeng took a significant hit in pricing of about 17%. Two issues drove this. First there was a dyeing scandal, where unsavory operators from Gannan would inject oranges with red dye in order to make them look more appealing. This naturally dented the reputation of oranges coming from this region and made many consumers buy other oranges thus driving down pricing. Second we saw an increase in supply of oranges. Other areas like Sichuan, Guangxi and Chongqing had great harvests while the Jiangxi region had excess rainfall which brought down yields (and increased costs). This year the expectation is about a 10% industry wide increase in oranges due to improved yields and maturing of trees. There is no growth in acreage going on right now.

    The company has had lower yields (rainfall and Citrus Canker), lower prices and higher costs. Basically on every metric things went against the company last year.

    I do feel fairly confident that the amount of rainfall will revert to its mean over the next few years. A reversion to the mean is most important as the biggest impact on results was caused by the lower yields and higher expenses caused by the excess rain.

    On the Citrus Canker issue, that is a low to moderate worry. From what I learned, a diligent monitoring program cannot prevent outbreaks, but it allows for the damage to be limited.

    An additional worry is the pricing of oranges. In the same way that Asian Citrus has a lot of young trees it could be that many other plantations have done the same. Something I was not able to confirm. On the other hand while it is possible to develop new large plantations, it isn’t that easy either. A. Building a new plantation requires a large upfront investment that will not generate any meaningful revenue for the first 7 years. Actually because of the need for fertilizer, pesticides and other maintenance, the plantation will run cash flow negative until about year 8 to 10. And B. In addition it is hard to find new large pieces of land that provide for the necessary economies of scale.

     

    Opposite that increase in supply sits the demand equation for citrus products in the PRC. For example, in the US in 2011 total demand for citrus products was 76 lbs. Of that 23 lbs. was for direct consumption, the other 53 lbs. was for use in concentrate/juice. Of that 76 lbs., 53 lbs. was the consumption of oranges with 10 lbs. being personal consumption and the other 43 lbs. for the use in concentrate/juice. If I overlay that 53 lbs. (24kg) per person on China they would need to produce 32 million ton of oranges a year. Currently China produces around 7 million ton of oranges. The aggregate supply from the top 10 producers in the world is only 51.7 million ton of oranges.

     

    If we take a look at orange juice consumption then the potential growth in China versus the rest of the world then we see a lot of potential.

    Per capita juice consumption in

    • USA – 100 Liters
    • Japan – 98 Liters
    • Germany – 90 Liters
    • UK – 70 Liters
    • France – 65 Liters
    • Australia – 47 Liters
    • China – 9.5 Liters

    If one looks are orange juice, it seems that there is some correlation between wealth and per capita quantity consumed.

     

    And there is a lot of potential when it comes to fresh orange consumption too. With its 10 lbs. of per capita fresh orange consumption the US is actually far down the ranking. In countries like Brazil, Mexico, even the European Union per capita orange production is more than 4 times that of the per capita consumption of the US. Chinese per capita consumption of fresh oranges is about 11 lbs. at this time. Important to know is that in China fresh oranges play an important part in its food culture. I assume most of us have been to a Chinese restaurant where it is the habit to finish the meal with a piece of fresh orange.

     

    As one can see, we’d need a lot of oranges even if Chinese per capita consumption increases by just 50% from about 12 Lbs. per person to 18 Lbs. per person.

    Here are some of the relevant numbers related to the agriculture business.

    Quantity Asian Citrus Winter Vs Summer Oranges (Ton)

    2010

    2011

    2012

    2013

    Winter Oranges

                         114,530

                 143,698

                               171,607

                     161,233

    Summer Oranges

                            72,408

                   73,194

                                 71,814

                       57,367

    Total

                         186,938

                 216,892

                               243,421

                     218,600

    Here is the revenue for the plantation business:

    Revenue Breakdown RMB (000)

    2010

    2011

    2012

    2013

     

    Hepu Plantation

                         583,649

                 631,139

                               593,454

                     449,230

     

    Xinfeng Plantation

                         194,016

                 330,988

                               463,873

                     470,753

     

    Total Agriculture

                         777,665

                 962,127

                           1,057,327

                     919,983

     

     

     

     

     

     

     

    Revenue Per Ton RMB (000)

                              2,010

                                 2,011

                     2,012

                          2,013

    Plantations

                              4,160

                                 4,436

                     4,344

                          4,209

                       

     

    Segment Information Revenue and Earnings RMB (000)

     

    Agriculture 2010

    Agriculture 2011

    Agriculture 2012

     Agriculture 2013

     Agriculture June 2014

    Revenue

     

                       784,721

                      969,030

                    1,060,671

                      921,823

                 468,907

    Earnings

     

                       625,115

                  1,042,192

                        621,600

                        31,912

              (576,032)

    Biological Assets*

     

                       306,000

                      507,712

                        166,900

                   (260,468)

              (583,000)

    Adjusted Earnings**

     

                       319,115

                      534,480

                        454,700

                      292,380

                     6,968

     

    * Biological assets are an IFRS invention. Annually the NAV of the Asian Citrus plantations is calculated using an NPV calculation with an 18% discount rate. From that number the tangible asset value related to these assets on the balance sheet is deducted. If there is a change in this year’s biological asset value versus last year’s then the delta is run through the income statement and the change is then reflected on the balance sheet. For Asian Citrus this creates sizeable volatility in the income statement. All this is non cash.

    ** FYI In the PRC certain agricultural activities have a tax rate of 0%. Asian Citrus falls under these regulations.

     

    Beihai Perfuming Garden

     

    Beihai Perfuming Garden (“BPG”) is the 3rd asset owned by Asian Citrus. Asian Citrus owns 92.94% of BPG which it bought for 2.04 billion RMB in 2010. BPG currently owns tree concentrate plants. The Hepu, Beihai and Baise production plants.

     

    Hepu has a capacity of 46,200 ton and Beihai has a capacity of 14,850 ton. The capacity utilization of these plants tends to be between 90% and 95%. At this capacity utilization the gross margin tends to be between 20% and 30%. It all depends on the spread between world prices and the cost to input.

     

    Baise is a new plant that is just coming online. Its capacity is 40,000 ton. In case Baise gets up to 90% capacity in a few years it should contribute nicely to the bottom line rather than be a drain. The new Baise plant represents a 65% increase in capacity for BPG.

     

    I have an investor friend that has visited all 3 plants and says they all look ultra modern, clean and well managed.

     

    The story here is somewhat the same as with the plantations. We have this production capacity in Baise that was just built and already paid for. The plant was just started up and is running far below its planned capacity utilization. In general it is expected that it takes a few years for this kind of plant to be up and running at full capacity.

     

    There should be enough demand for this new plant. Below is the growth profile of BPG’s juice market globally and in the PRC.

     

    Global Demand (Ton)

    2007

    2008

    2009

    2010

    2011

    2012

    2013

    Pineapple

    451,089

    380,000

    452,300

    467,900

    530,600

    588,500

    645,280

    Lychee

    6,320

    4,970

    8,295

    9,210

    10,310

    11,450

    12,620

    Passion Fruit

    130,000

    110,000

    150,000

    163,800

    184,500

    206,800

    232,500

    Total

    587,409

    494,970

    610,595

    640,910

    725,410

    806,750

    890,400

     

     

    PRC Demand (Ton)

    2007

    2008

    2009

    2010

    2011

    2012

    2013

    Pineapple

    14,380

    16,380

    19,650

    25,650

    33,150

    42,850

    55,370

    Lychee

    307

    397

    553

    740

    987

    1,325

    1,325

    Passion Fruit

    850

    1,075

    1,630

    2,350

    3,390

    4,890

    6,990

    Total

    15,537

    17,852

    21,833

    28,740

    37,527

    49,065

    64,143

     

    Beihai BPG processes over 22 different types of tropical fruits, including pineapples, passion fruit, lychees, mangoes and papayas into juices or purees. The main groups of products sold by BPG are Pineapple Juice Concentrate, Lychee Juice Concentrate, Other Fruit Concentrates, Mango Purees, Other Fruit Purees and Frozen and Dried Fruit and Vegetable.

     

    BPG also has the necessary export licenses and represents about 60% of exports out of the PRC in its category.

     

    BPG’s business has been under pressure too. Basically just as with the plantations it suffered from lower volumes at lower prices. The issue is that BPG sells its products on the world market, but sources locally. For example the excessive rains shrunk the capacity of pineapple available for BPG at the same time global market prices were declining. Especially pineapple juice concentrate pricing has been under pressure due to increased volumes coming out of the Philippines and Thailand.

     

     

    2011

    2012

    2013

    Sale of processed fruit BPG

    Volume (Ton)

    Volume (Ton)

    Volume (Ton)

    Pineapple juice concentrates

                         16,636

                          24,348

                   18,295

    Other fruit juice concentrates

                           4,017

                          10,017

                   11,230

    Fruit purees

                           3,616

                          17,472

                   13,354

    Frozen and dried fruits and vegetables

                           9,634

                          18,170

                   14,051

    Total

                         33,903

                          70,007

                   56,930

     

     

    Revenue Breakdown RMB (000)

    2011

    2012

    2013

    Processed Fruit

                        417,393

                 715,473

                     564,089

     

     

    Revenue Per Ton (RMB)

    2011

    2012

    2013

    Processed Fruit

                        12,311

                   10,220

                          9,908

     

    Segment Information Revenue and Earnings

    Processed Fruit 2011

    Processed Fruit 2013

    Processed Fruit June 2014

    Revenue

                     417,393

                  715,473

                  279,426

    Earnings

                     131,845

                  138,711

                    47,771

    Biological Assets

                                -  

                             -  

                             -  

    Adjusted Earnings

                     131,845

                  138,711

                    47,771

     

     

    New Management, Corporate Governance and Ownership

     

    Tony Tong, the founder and patriarch, controls 19.2% owned by him and his family through an entity called Market Ahead Investments. Sunshine Hero, the original owner of BPG, owns 9.34% of Asian Citrus and Chaoda Modern Agriculture* owns 5.9%. Lastly the public owns 65.74% of the company.

    *Choada used to be a much larger shareholder of Asian Citrus, but Chaoda turned out to be a fraud. Asian Citrus used to buy organic fertilizer from Chaoda which combined with the large ownership naturally tainted Asian Citrus too. So in October 2011 Asian Citrus stopped buying organic fertilizer from Chaoda, its representatives left the board and its ownership stake was mostly sold. I feel confident that Asian Citrus was not involved in the fraud.

     

    Options

               

    Exercise Date

    26-Jul-14

    08-Feb-15

    08-Feb-15

    08-Feb-15

    26-Jun-18

    27-Feb-19

     

    GBP

    GBP

    GBP

    GBP

    HKD

    HKD

    Exercise Price

    0.2045

    0.139

    0.112

    0.2425

    5.68

    9.00

    Current Price Stock

    0.1263

    0.1263

    0.1263

    0.1263

    1.68

    1.68

    Tong Wang Chow

                   1,500,000

                  1,500,000

       

                 850,000

     

    Tong Hung Wai "Tommy"

                       550,000

                      600,000

       

                 750,000

     

    Mer Cheung Wai Sun

                         90,000

                      360,000

       

                 750,000

     

    Pang Yi

                       480,000

                      960,000

                        900,000

     

             3,400,000

     

    Lui Ming Wah

           

                 500,000

     

    Yang Zhen Han

           

                 500,000

     

    Employees and Other

                   1,270,000

                      300,000

                    2,010,000

                      890,000

           22,884,000

             20,000,000

     

    Options are about 3.8% of the current number of shares outstanding. Most of these options are far out of the money. New management has already made clear that they will propose new option grants fairly soon.

     

    Now that we got ownership and options out of the way I’d like to address the old and new management.

    Tony Tong and his son, “Tommy” Tong are the founders of Asian Citrus. They had a board that was not independent and somehow felt this was mostly their company rather than the shareholder’s. This made the overall corporate governance poor. That naturally all worked fine as long as the company was doing well. But when the business got hit with Citrus Canker and the trifecta of lower yields, lower prices and higher costs, things went wrong. It all came to a head during the last AGM. A number board proposals were voted down. Current shareholders also directed a lot of criticism towards Tony Tong, his son and the board. In short, shareholders made clear they were tired of the below average management of the company. It seemed that it was quite the shock to Tony Tong and his son. They did not expect this to happen ... and then they did the right thing. Tony Tong resigned as CEO and Chairman of the board. His son relinquished his executive role and maintained his role on the board as the representative of the family and then new independent board members were elected, making the majority of board members independent including the new Chairman.

    The new non-executive Chairman is Mr. Ng Hoi Yue, the new CEO is Mr. Ng Ong Nee. There is also a new CFO, Mr. Ng Cheuk Lun. Both the Chairman and new CEO have extensive experience in developed countries and understand capital markets. The new CEO spent a lot of time in Australia as well as China, while the new Chairman spent time in the UK and has been a CPA for many years in Hong Kong. Both have been on the boards of many companies, not just in China.

    Both have a good understanding of what needs to be done, being:

    • Improve shareholder communication and reestablish the trust of shareholders.
    • First focus on the current core business before expanding for more scale. More size means more economies of scale in production as well as distribution which is to happen in the future.
    • Improve operational efficiencies. For example there seems to be dysfunctional communication between different plantations and concentrate plants within the company. The Hong Kong headquarters is often not in line with the plantations and BPG plants. Often it takes a long time to get approvals. There are also cost opportunities like applying fertilizer when there is a dry period predicted rather than just apply at regular intervals even when it is raining. One can also work on creating infrastructure that will prevent less damage being done to the plantations in case of adverse weather. Better monitoring for disease and its remediation will also be important.
    • Improve revenue generation. For example there are many markets, like Indonesia, that have significantly higher prices for oranges. In addition there are lot of middle men involved in the export side of the business. The CEO believes that by investing in cold storage in different markets Asian Citrus will be able to cut out middlemen and sell directly. The CEO also believes there is an opportunity to enter different higher margin business for BPG, like sugar cane concentrate and red bean puree. He also believes he can work with his customers, being ingredient mixers, and provide more value added services like pre-mixing ingredients.

     

    The CEO has stated that by August he will present his plan for the company which will include new incentives for employees as well as strategic initiatives.

     

    Now let’s not get too exited either. The most important factors will still be disease management, yield recovery and price recovery. If those factors go our way earnings will balloon independent of all the efforts implemented by the new CEO.

     

    Valuation.

     

    Before I get going on my own valuation exercise, in 2013 there was a bid for the company at 4.4 HKD per share, which was rejected by the board as too low. The current price is 1.68 HKD.

     

    When valuing the company I adjusted the income statement and balance sheet.

     

    Here are the adjusted income statement numbers for the last few years

     

    Year June

    Year June

    Year June

    Year June

    6 Months Dec

    Adjustments

    2010

    2011

    2012

    2013

    2013

     

    Net Profit Attributable To Shareholders

                  585,467

             1,038,953

                 750,200

                 114,395

              (547,971)

    Net Gain Biological Assets

                  306,000

                 507,712

                 166,900

              (260,468)

              (583,000)

    Interest Income

                      1,845

                     7,308

                   21,559

                   50,509

                  20,416

    Adjusted Net Profit*

                  277,622

                 523,933

                 561,741

                 324,354

                  14,613

     

    * Adjusted Net Profit = Net Profit Attributable To Shareholders – Net Gain Biological Assets – Interest Income. Why exclude Interest Income? Later I exclude cash from my calculation of Adjusted Equity. So … no cash, no interest income. I also exclude the impact of Biological Assets as it is purely a non cash item.

     

    On the balance sheet I made the following adjustments in order to get to adjusted equity.

     

     

    12 Months June

    12 Months June

    12 Months June

    12 Months June

    6 Months Dec

    Adjusted Equity

    2010

    2011

    2012

    2013

    2013

    Equity Shareholders

                 3,921,692

                 7,566,993

                 8,150,119

                 8,091,047

             7,524,599

    Biological Assets

                 1,642,024

                 2,232,058

                 2,463,860

                 2,380,599

             1,728,685

    Intangible Assets

                       36,800

                       53,287

                       58,506

                       64,463

                   59,089

    Goodwill**

                                -  

                 1,157,261

                 1,157,261

                 1,157,261

             1,157,261

    80% times Cash and Cash Equivalents

                    780,059

                 1,785,762

                 1,910,491

                 1,712,979

             1,686,417

    Adjusted Equity*

                 1,462,809

                 2,338,625

                 2,560,001

                 2,775,745

             2,893,147

     

     

    * Adjusted Equity = Equity Shareholders – Biological Assets – Intangible Assets – Goodwill – 80% times Cash and Cash Equivalents. Why deduct 80% of cash? I assumed that Asian Citrus would need about 20% of its cash balance to operate.

    ** Why exclude the Goodwill? After all didn’t the company invest the cash to acquire the asset that put the Goodwill on the balance sheet? Yes, agreed. But I just don’t like to count on Goodwill as an asset and put a multiple on that in this case.

     

    12 Months June

    12 Months June

    12 Months June

    12 Months June

    6 Months Dec Annualized Adjusted Net Profit

    Return on Adjusted Equity

    2010

    2011

    2012

    2013

    2013

    Adjusted Net Profit

                    277,622

                    523,933

                    561,741

                    324,354

                     29,226

    Adjusted Equity

                 1,462,809

                 2,338,625

                 2,560,001

                 2,775,745

               2,893,147

    Return on Adjusted Equity

    19%

    22%

    22%

    12%

    1%

     

    To me it seems that this might be a better business than people think. We have had pretty much everything go wrong for Asian Citrus, starting with two years of horrible weather which drove down yields and forced up expenses, the red dye scandal in the Gannan region where Xinfeng is located, a super harvest in the other growing regions which drove down prices, Citrus Canker hitting Hepu, delays in opening the Baise plant, lower prices on the world market for concentrate and purees all the while the increased rain limited the availability of local fruit at attractive prices. As I said, a lot of stuff went wrong. What are the odds that that will continue? It seems to me that the more likely outcome is that we will see a reverse of fortunes and go back to how it was in years prior over the next few years.

     

    So I decided to create a valuation matrix assuming that given the historical performance Asian Citrus was worth between 1 and 2 times the Adjusted Equity + the 80% of the Cash and Cash Equivalents we excluded earlier. With this return profile I believe that a 1 times multiple is conservative and, a 2 times multiple to be the upper limit. Although in case things turn around and go back to the economic returns from 2011 and 2012 the stock will likely trade at a 2 times multiple. After all, the adjusted net profit in 2011 and 2012 was already more than 500 million RMB and then there is still the added volume related to the Baise plant and the aging of mature trees which will increase volume of fruit every year for the next 10 years. In my mind there is little doubt that in case the economics return to what they used to be this is a multi bagger and if they don’t then, we still have a margin of safety due to the negative enterprise value.

    FYI. One should expect that when June 2014 numbers come out that they will be bad. We had a bad year and it is likely that the new management might do a kitchen sink operation to get rid of legacy issues.

     

    Valuation

     

    Per Share

    Per Share

    Per Share

    Adjusted Equity Dec 31, 2013 (RMB)

                 2,893,147

    RMB

    HKD

    GBP

    1 times Adj. Equity + 80% of cash*

                 4,579,564

                           3.66

                           4.54

                         0.366

    1.5 times Adj. Equity + 80% of cash

                 6,026,138

                           4.82

                           5.98

                         0.461

    2 times Adj. Equity + 80% of cash

                 7,472,711

                           5.98

                           7.41

                         0.572

    * 80% times cash December 31, 2013.

    Dividend

     

    New management states that it was a mistake to cancel the dividend, especially since the company has so much cash on hand. There is an issue though with paying out the cash. For the dividend to be paid, cash needs to be transferred from China to Hong Kong and there seem to be some issue related to that transfer. Personally I don’t care about the payout of a dividend. I’d much rather have a tender offer for a large chunk of the company and/or other forms of buybacks at this stock price. This is a unique time to retire a lot of stock. Still I believe that creates the same cash transfer problem from China to Hong Kong than the dividend payment does.

     

    Risks

     

    The impact of disease, not just Citrus Canker, but also Citrus Greening. Either disease can wreak a lot of havoc and it is pertinent that the plantations are closely monitored at all times. The sooner you catch it the less the damage.

     

    A continuation of the abnormal weather patterns of the last 2 years. I am a firm believer in return to the mean, but it is not guaranteed that we will not have excessive rain next year too. I have a 3 year window for my investments to work out so I can wait it out if need be.

     

    A continuation of low prices. The good news is that there does not seem to be an expansion of acreage in the PRC going on. On the other hand I have no idea how much of the planted acreage in the PRC is already mature (above 7 years) and how much is immature (below 7 years). And it will naturally also depend on the growth in demand and imports/exports. Demand for oranges and other fruits continues to increase every year in the PRC at a nice clip and it should be able to absorb the additional quantity but one never know what kind of event might impact demand.

     

    More food scare scandals like the red dye scandal in Gannan.

     

    Increasing costs. The biggest risk here is the cost of fertilizer at about 50% of COGS. An increase in that cost can have a big impact.

     

    The Chinese economy crashing is a worry too. We all know about the debt, real estate bubble, infrastructure bubble, etc. I understand the risk and also realize that such an event will have a big impact on Asian Citrus. It is very reasonable to expect that pricing of its products would take a big hit for some time. On the other hand I know Asian Citrus has no debt and a lot of cash. Cash it can use to survive and even buy distressed assets. Basically I think the thesis that the Chinese economy needs to go through an adjustment at some time in the future is correct, but I do not believe it is possible to put a timeframe on it. After all I have been hearing for four years now that China is about to fall apart any day now. I guess I am making a bet on a company with a descent business trading at a large discount to IV in a risky macro environment. Also if China crashes in the way many of the pundits have been saying US based stocks won’t be safe either.

     

    Fraud is always an issue, especially given the recent past with Chinese companies. There have been multiple efforts made to ensure investors, like having an outside company count all the trees. Also annually there is the calculation of the value of the biological assets. Asian Citrus’ auditor is Baker Tilly, ranked 8th in the world. My main worry was the status of the cash and how was it invested. In note 22 of the Dec 31, 2013 interim report it states that most of the cash is in bank deposits and cash on hand. None of the cash is invested in time deposits longer than 3 months, nor have they played shadow bank with the cash. Given that information I feel comfortable that Baker Tilly can assess the right cash balances. Lastly my investor friend has visited each of the concentrate plants and a number of the plantations and his feedback is positive. He hasn’t noticed any discrepancies. I have know him for a while now and highly respect his opinion. If it was not for him having visited the company in China I would likely have passed.

     

     

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

     

    Messages


    SubjectBPG acquisition
    Entry05/29/2014 02:26 PM
    MemberWeighingMachine
    They spent roughly their current market cap on this business?  Who did they buy it from and why?  On the surface oesn't look to be earning much (in 2011, 2012, or 2013) relative to purchase price.  
     
     

    SubjectRE: Fraud
    Entry05/29/2014 10:42 PM
    MemberWeighingMachine
    That's a fair point. Embezzlers never take time off work and it seems reasonable that fraud perpetrators wouldn't bring in new mgmt. if there is no fraud, this is a screaming buy (3-4 bagger). So if there is <50% chance this is a fraud, on a probability weighted basis it would still be a buy. 

    Subjectcash
    Entry06/04/2014 08:14 AM
    MemberGriffin
    In the past management has refused to transfer the cash to HK for tax reasons and because AC was considering an acquisition in China. Assuming that new management is motivated to provide proof to the market that the cash held by the Chinese subs is real, how do you see their other options?
     
    Can you also comment on how much control the company has over the cash? We heard that the manager of the Chinese sub, who did not trust the Tong family, refused to transfer the cash to HK. 
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