Sky People Fruit Juice (SPU) is currently trading at a price below its liquidation value due to poor market sentiment surrounding Chinese reverse-takeovers (CRTOs). In a reverse takeover a private company purchases the shell of an inactive company as a way to get listed on a U.S. exchange. This process is an alternative to the heavily regulated IPO process for raising capital. SPU’s stock price took a beating as fraud scandals surfaced among CRTOs in 2011. There are many CRTOs that are high performers but the market has discounted all of them for the errors of the minority. A recent study titled Shell Games authored by Charles M.C. Lee of Stanford University, Kevin K. Li at the University of Toronto and Ran Zhang of Peking University, proves that these CRTOs actually outperform their U.S. counterparts. This study even includes the impact of CRTOs that committed fraud. SPU has an honest and ambitious management with an achievable growth plan. The company has high margins, positive earnings and cash-flows, and a price that provides investors with a comfortable margin of safety. You could liquidate the company today at fire-sale prices and stockholders would make a minimum of 18% return. I predict a 2-year price appreciation of +200% over the current price of $1.82.
SPU produces fruit juice and concentrate in China for sale domestically and internationally. The company sells its products directly to end-users, as well as to hotels, supermarkets, and through distributors. SPU is vertically integrated, handling everything from harvesting to packaging. It is a small ~$49M market cap company competing against larger ~$1bn+ market cap companies. It has established itself with quality niche products in the small but growing health food/drink space in China.
SPU is clearly undervalued, which I will discuss later, but the main questions investors should want answered now are does management have integrity and will their expansion plan benefit shareholders.
Management has been transparent and acts in the company’s best interest: SPU management has been open with disclosures and in several instances went above and beyond the call of duty to help the company. The company files timely and detailed SEC reports, which is not always the case with CRTOs. The company side stepped the IPO process because of the expenses involved not to avoid regulatory scrutiny. SPU uses a U.S. auditor that has to travel to China to perform the audit. It does not use a Chinese firm or a firm with a satellite office in China, which would make committing fraud easier. These are good signs. The Board of Directors has 5 out of 7 independent members, which provides a good check on management. In 2013, the company separated the duties of CEO and Chairman of the Board, so that no one person has too much oversight or power. The CEO and Chairman are brothers but the separation of duties is a step in the right direction. In my conversations with investor relations, they were always able to quickly and clearly communicate management motivations and goings on at the company. In addition, the CFO can speak English and seems very open and forthcoming about everything. The company even opened up its bank accounts to an audit to verify legitimacy. Every balance was verified at the various banks in person. When accusations of fraud surfaced about SPU the company quickly shot them down with a lawsuit. The website, Absaroka that slandered SPU retracted its comments admitting that they were based on bad information.
After the accusations of fraud in 2011 and after many CRTOs were exposed, SPU stock price tanked. It was at this point that the CEO went above and beyond by buying up the stock, trying to instill stability. He bought more than 3.5x his $200,000 a year salary in stock. This not something an owner committing fraud would do. Later, the new CEO provided a $4M loan to the company at below market rates. I doubt an owner committing fraud would want his cash tied up in the business. Between the two brothers, CEO and Chairman, they own a little more than 50% of the company’s stock. This is major incentive for them to act in the long term interests of the company’s shareholders. It is also notable that it was the less wealthy of the two brothers that spent $742K buying stock when things hit the fan. The other brother owns a ~40% stake in the business while he owns ~10%.
Management has a good track record of investing capital and the future looks bright: Since raising capital with its reverse takeover the company has increased capex and averaged over 22% return on invested capital. The plan for the future is to spend the companies $88M cash balance developing kiwi and orange fields, and building out production. Orange juice would not only diversify the company’s product line with a popular drink but also produce synergies. Oranges have a different harvest season than other fruits, which would increase the company’s production utilization. In addition, current distribution channels could be used to bring new products to market. The health food and juice space in China is small but growing as people in China build wealth. Sales will also be driven by the countries 7% projected GDP growth.
Why it is Cheap
1. CRTO scandals of 2011 hit SPU hard. In addition, false accusations about the company’s activities and legitimacy also hurt investor confidence.
2. It is a micro cap stock with no coverage that is thinly traded. No one knows about SPU and the large funds which control over 70% of U.S. assets cannot buy it because it is too small.
3. Bad weather in 2013 shrunk the company’s fruit supply and hurt sales. This was a random occurrence and as the company develops more fields and different fruits it will be less exposed to this risk.
1. The big risk is that SPU is committing some kind of fraud. I tried to mitigate these concerns with my previous arguments but the risk remains. With a verified cash balance of ~$87M and a market cap of less than ~$50M, no matter what fraud they commit, I do not see much down side. The only suspect activity that I have uncovered is an $8M loan with favorable terms to the company that was failed to be disclosed as a related party transaction in SEC filings.
2. Weather continues to pose a risk to the company’s crops and earnings.
1. The major catalyst will be when the U.S. becomes more comfortable with CRTO stocks. As the academic study that I referenced indicated, CRTO’s are less risky than U.S. equivalent companies. The study included tangible and intangible factors such as profitability and exchange de-listing. Many CRTO’s are mature stage companies with steady cash flows that could give investors positive exposure to the growing Chinese market. Some investors have already caught on and others will begin to follow suit. Morgan Stanley Asset Management bought 1.4M shares of SPU in June of 2011 and added 1M shares in 2012 when market sentiment pushed the price lower.
2. The Chinese economy is growing faster than the rest of the world’s economy. With more wealth, Chinese people can afford to watch their health, driving juice sales.
3. Continued growth from capital expenditures will make SPU’s stock hard to pass up.
Comparable and Historical Valuation Multiples
SPU is undervalued based on comparable company and historical multiples. Since the first full year of trading in the U.S. was in 2010 and the CRTO crisis took place in 2011, I will use trailing twelve month (TTM) and 2010 for historical comparisons. SPU’s TTM P/E ratio is 2.97x while competitors trade at 12x, and in 2010 the company traded at 4.72x. This would imply a value of between $2.88 and $7.32 based on slumping TTM earnings. SPU’s TTM P/Sales ratio is .51x while competitors trade at 2.2x, and in 2010 the company traded at 1.07x. These multiples would imply a value of between $3.79 and $7.79 based on TTM sales. Both P/E and P/Sales ratios would higher if not for the 2013 sales hiccup. SPU’s TTM P/Book ratio is .29x while competitors trade at 2.3x, and in 2010 the company traded at .84x. This would imply a value of between $5.28 and $14.45 based on 2013 third quarter book value. No matter how you cut it the stock is cheap.
|Historical Valuation Ratios||2010||2011||2012||TTM|
|Book to Market||118.4%||290.6%||285.0%||345.2%|
When looking at the downside for this investment it is important to know what would happen in liquidation. To capture the potential upside from continued operations, I used a multi-stage DCF model based on free cash flow. To be especially conservative in my liquidation value I used the Ben Graham approach. I calculated net net working capital (NNWC) per share and net current asset value (NCAV) per share. For those unfamiliar that would be working capital minus all liabilities and current assets minus all liabilities. I also assigned a discount of 20% to A/R and 65% to inventory. The company deals with major distributors so a 20% haircut seemed conservative. It is hard to estimate what the inventory is worth but I assumed 35% would be conservative. I have seen 50% used as the bench mark for inventory in other liquidations. If liquidation did occur an investor would earn either an 18% or 31% return using net working capital per share and net current asset value per share, respectively.
I do not believe that the company will be liquidated, so at a price of only $1.82 you are getting all of the PP&E and future cash flows for free. When using a discount rate of 15% and a growth rate of 7%, expected Chinese GDP growth, I arrived at a value of $7.41. See below for a sensitivity matrix analyzing stock price sensitivity to growth and discount rates.
Net Net Working Capital & Net Current Asset Value Calculations
|Figures in Millions except per share values||BV||BV
|Net Net Value|
|Cash & Equivalents||$87.18||100%||$87.18|
|Inventories: Raw Materials||$2.59|
|Inventories: Work in Progress||$0.82|
|Inventories: Purchased Components||-|
|Inventories: Finished Goods||$4.95|
|Inventories — Total||$8.35||35%||$2.92|
|Current Assets – Total||$115.65||$115.65|
|Total ($m)||Per Share|
|Total Current Assets||$115.65M||$4.34|
|Market Cap & Share Price||$48.5M||$1.82|
|Net Net Working Capital||$59.36M||$2.23|
|Discount to NNWC||18%|
|Net Current Asset Value||$69.85M||$2.62|
|Discount to NCAV||31%|
Discounted Cash Flow Analysis
|DCF – Sensitivity Matrix:|
SPU is a company that could easily triple in value over the next few years. On top of that it has limited downside. As capital expenditures over the next two years begin to produce higher earnings, and investors become more comfortable with CRTO’s, this stock will spike. Academic studies already confirm that CRTO’s are beneficial to the U.S. market, so it is only a matter of time before sentiment changes for the better with investors. In the long run all stocks migrate towards their intrinsic value. The only question I still have is at what price will I sell and claim my profits.