Drink the low hanging fruit (Skypeople Fruit Juice).

April 28, 2010
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I have recommended cheap Chinese stocks as desirable as a way to bet on the possibility that China will be forced to let the yuan float against the dollar, and of course, a cheap stock anywhere is a cheap stock, although markets outside of the first world should be given a higher equity risk premium. The ideal company would do all of its business in China but be listed on an American exchange and therefore subject to American accounting rules, which, AIG aside, are reasonably accurate. And I think I’ve just about found a good company, and a thematically appropriate one, with Skypeople Fruit Juice (SPU).

Skypeople is a company that prepares fruit juice concentrates and fruit drinks from specialty crops like kiwi, as well as pears and apples. They operate out of the fruit-growing regions of China, and last year 78% of their sales were to Chinese purchasers either for consumption in China or for export. This figure is up from 65% the year before, although they attribute some of that to the slowing global economy. The firm states that according to market research, consumption of fruit drinks is on the rise the world over, but China has historically lagged. The company views China as somewhat of an untapped market to develop. The firm also owns or has applied for several patents for fruit processing technology, and has made research and development expenditures to improve its operations.

The firm’s financial history has been a little murky; like American Lorain it started off as a US holding company that had bought and sold a couple of other companies beforehand, starting in the 90s. They acquired the firm that owns Skypeople in 2008 and changed the name. Their capital structure betrays some sign of their chaotic history; according to the latest SEC filings they have outstanding 3.21 million warrants at $2.55 a share, plus 1.32 million shares of preferred stock that is convertible into 880 thousand shares of common stock on top of 19.77 million shares of common stock. The firm is also considering making an additional offering of $40 million, or 6.5 million shares based on today’s closing price, in order to expand their sales range and product offerings in China.

At any rate, without taking into account the conversion privilege and the warrants, the firm has a market cap of $121 million, which works out to a P/E ratio of 8. The firm has a price/book ratio of about 1.8, so the share offering, if it proceeds at approximately the current price, will technically not be dilutive, and the firm’s historical return on assets of over 15% is promising as well so the equity offering might not be a negative for existing shareholders.

The major variable in their operations is the cost of fruit, which cannot easily be hedged, and because the firm focuses on specialty crops like kiwi and mulberry. But the firm claims to have excellent gross margins on its products, perhaps owing to their patents–Skypeople is apparently very proud of its ability to clarify juices–and so there is room to absorb some price volatility. And although a P/E ratio of 8 is adequate, not definitely cheap, because of China’s higher risk premium, the growth potential and the built in bet on the yuan makes this company highly desirable.

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