China Essence

Just find it very strange that Sanlam sold off at 6.3 cents when their average cost at 58.8cents!!! (90% loss in value)

They will rather take a 90% loss, than trying their luck with the remaining 10% value…??
What logic is this?

They are so desperate that the share price will fall to zero?

(18-08-2012, 12:08 AM)cif5000 Wrote:

(17-08-2012, 09:53 PM)Musicwhiz Wrote: it turned out to be a value trap.

A value trap is when there is indeed value but the value is trapped i.e. share price not reflecting the true value even over the long run or the management is benefiting at the expense of the shareholders. I classify the local property developers in general as value traps because their stocks are trading at discounts to NTA and yet they have the desire to retain cash (and more cash) to grow their business. That's understandable because their business can deploy "unlimited" amount of cash. Since their stocks always trade at a discount (except during euphoria), every dollar of cash retained creates less than a dollar in market value.

S-chips are not value traps. They are just ass-chips.

(18-08-2012, 12:08 AM)cif5000 Wrote: A value trap is when there is indeed value but the value is trapped i.e. share price not reflecting the true value even over the long run or the management is benefiting at the expense of the shareholders. I classify the local property developers in general as value traps because their stocks are trading at discounts to NTA and yet they have the desire to retain cash (and more cash) to grow their business. That's understandable because their business can deploy "unlimited" amount of cash. Since their stocks always trade at a discount (except during euphoria), every dollar of cash retained creates less than a dollar in market value.

S-chips are not value traps. They are just ass-chips.

I am afraid I have to politely disagree with you on this point. A value trap to me constitutes a difference in perception in what is considered value and what is, in reality, not. To define a value trap literally, meaning value which is "trapped" as in the property example you gave, is a little too narrow.

Value can be perceived and measured in the form of low P/B, low PER and other measures. The fact that some companies display these metrics makes them value traps as they are perceived to have value, yet there is something inherently wrong about them which destroys or invalidates that proposition. It could be corporate governance, a slowing declining market position/loss of market share or other issues.

Hence, value traps should have a broader defnition - which is that of a company which is perceived to have value (using objective metrics for defining value), but which turns out to be not so.

(18-08-2012, 12:48 AM)Underdogger Wrote: Just find it very strange that Sanlam sold off at 6.3 cents when their average cost at 58.8cents!!! (90% loss in value)

They will rather take a 90% loss, than trying their luck with the remaining 10% value…??
What logic is this?

They are so desperate that the share price will fall to zero?

There is a particular human heuristic, where we have a higher tendency to take more risks, under the certainty of losses - I reckon, if they had held on, they are just falling into this heuristic category.

I do not have much background understanding on Sanlam and China Essence. But by cutting their losses (although many of us would argue that they shouldnt have averaged down, but should cut losses earlier), it pretty much sounds very logical to me!

(19-08-2012, 09:34 AM)Musicwhiz Wrote:

(18-08-2012, 12:08 AM)cif5000 Wrote: A value trap is when there is indeed value but the value is trapped i.e. share price not reflecting the true value even over the long run or the management is benefiting at the expense of the shareholders. I classify the local property developers in general as value traps because their stocks are trading at discounts to NTA and yet they have the desire to retain cash (and more cash) to grow their business. That's understandable because their business can deploy "unlimited" amount of cash. Since their stocks always trade at a discount (except during euphoria), every dollar of cash retained creates less than a dollar in market value.

S-chips are not value traps. They are just ass-chips.

I am afraid I have to politely disagree with you on this point. A value trap to me constitutes a difference in perception in what is considered value and what is, in reality, not. To define a value trap literally, meaning value which is "trapped" as in the property example you gave, is a little too narrow.

Value can be perceived and measured in the form of low P/B, low PER and other measures. The fact that some companies display these metrics makes them value traps as they are perceived to have value, yet there is something inherently wrong about them which destroys or invalidates that proposition. It could be corporate governance, a slowing declining market position/loss of market share or other issues.

Hence, value traps should have a broader defnition - which is that of a company which is perceived to have value (using objective metrics for defining value), but which turns out to be not so.

I tend to agree more with cif5000 than MW definition of Value traps.If your analysis of perceived value turns out not to be so then it is a case of wrong analysis. Value traps exist and agreed by everyone and even the owners but the owners have no incentive or different motives to want to see the value been realised. eg wanting to accumulate it on the cheap or simply to exploit it over the years by paying themselves fat salaries/bonuses(ala metro)

From investopedia,

Definition of 'Value Trap'
A stock that appears to be cheap because the stock has been trading at low multiples of earnings, cash flow or book value for an extended time period. Stock traps attract investors who are looking for a bargain because these stocks are inexpensive. The trap springs when investors buy into the company at low prices and the stock never improves. Trading that occurs at low multiples of earnings, cash flow or book value for long periods of time might indicate that the company or the entire sector is in trouble, and that stock prices may not move higher.

Investopedia explains 'Value Trap'
Companies, and even sectors, can be doomed, because of situations such as the inability to survive competition, the inability to generate substantial and consistent profits, the lack of new products or earnings growth, or ineffective management. Often, a value trap appears to be such a good deal that investors become confused when the stock fails to perform. As with any investment decision, thorough research and evaluation is recommended before investing in any company that appears cheap when reviewing its relevant performance metrics.

Does China Essence has pricing power?

How do u define pricing power?


In economics, market power is the ability of a firm to profitably raise the market price of a good or service over marginal cost. In perfectly competitive markets, market participants have no market power. A firm with market power can raise prices without losing its customers to competitors. Market participants that have market power are therefore sometimes referred to as "price makers," while those without are sometimes called "price takers." Significant market power is when prices exceed marginal cost and long run average cost, so the firm makes economic profits.

In the last harvesting which was subsequently described by the company as an “exceptional market condition”, almost every other starch producer was so desperate to dump all their starch to distributors to generate cashflow. No one was able to stem the drop in starch price by withholding supply or tacit collusion with other producers.


What does this say about the nature of potato starch market in China?

Let's think this a bit further. Excluding the chance that China Essence is legitimately lead company with honest management, what scenarios do we have left?

1) Outright fraud. Either the sales have never existed, or they have seriously understated expenses through years. By this the owners would have tried to pump up the company value, though getting money out only by selling shares. Massive stock sales have never occurred, rather the very opposite. Considering the massive legal risk and very limited economic benefit, I don't think this scenario is very likely.

2) Solid business, dis-honest ownership. In this scenario the profit statements have been reliable, but the owners have pumped out the cash by over-investing in overpriced or imaginary PPE. This is not as far-fetched idea as the first one, although one must consider the potential benefits and risks of this sort of conduct. If the business is as good as it looks like (or looked like until 2012...), why bother breaking the law?

3) The company over-invests under current economic and political environment. There are a number of nudges towards this, including tax status, finance availability, production licences etc etc. As consequence EBIT margins will erode substantially, but this doesn't necessarily ruin the investment case. With strong revenue growth they will achieve good EBITDA and maybe even decent EBIT. Consequently they end up with lower profit margins, significantly lower return on capital expenditure, but at the same time sigificantly larger business. It is certainly not as astonishing achievement to reap 150M aft-tax profit out of a revenue of a billion as it was out of 500M, but I am not that interested in artistic impression.

Scenarios 1-2 are not too appealing, but the third one doesn't mean the end of the world.

Let's use real current actual numbers.

Raw potato price 750 RMB per ton.
Current starch price = 6000 RMB.

Cost = 6.5 X 750 =4550 RMB per tonne.
Add 10% overheads = 5000 RMB per tonne.

Selling price = 6000/ 1.17 = 5128 RMB per tonne.

Gross profit per tonne = 128 RMB.
This is before Depreciation, financing costs.

Net profit is likely to be negative.

*******
More optimistic case - starch price goes to 7000 RMB.

Selling Price = 5982 RMB per ton.
Gross Profit = 850 RMB per ton.

************
Which is the more likely case?

(21-08-2012, 03:13 PM)jzk Wrote: Let's think this a bit further. Excluding the chance that China Essence is legitimately lead company with honest management, what scenarios do we have left?

1) Outright fraud. Either the sales have never existed, or they have seriously understated expenses through years. By this the owners would have tried to pump up the company value, though getting money out only by selling shares. Massive stock sales have never occurred, rather the very opposite. Considering the massive legal risk and very limited economic benefit, I don't think this scenario is very likely.

2) Solid business, dis-honest ownership. In this scenario the profit statements have been reliable, but the owners have pumped out the cash by over-investing in overpriced or imaginary PPE. This is not as far-fetched idea as the first one, although one must consider the potential benefits and risks of this sort of conduct. If the business is as good as it looks like (or looked like until 2012...), why bother breaking the law?

3) The company over-invests under current economic and political environment. There are a number of nudges towards this, including tax status, finance availability, production licences etc etc. As consequence EBIT margins will erode substantially, but this doesn't necessarily ruin the investment case. With strong revenue growth they will achieve good EBITDA and maybe even decent EBIT. Consequently they end up with lower profit margins, significantly lower return on capital expenditure, but at the same time sigificantly larger business. It is certainly not as astonishing achievement to reap 150M aft-tax profit out of a revenue of a billion as it was out of 500M, but I am not that interested in artistic impression.

Scenarios 1-2 are not too appealing, but the third one doesn't mean the end of the world.

(21-08-2012, 08:54 PM)Underdogger Wrote: ...
Raw potato price 750 RMB per ton.
Current starch price = 6000 RMB.
...
Cost = 6.5 X 750 =4550 RMB per tonne.
Add 10% overheads = 5000 RMB per tonne.
Selling price = 6000/ 1.17 = 5128 RMB per tonne.
...
More optimistic case - starch price goes to 7000 RMB.
...
Gross Profit = 850 RMB per ton.
...
Which is the more likely case?

Not being a potato professional I don't have anything to add to your analysis. To my eye it seems partly a bit oversimplified, partly jibberish. But most certainly your analysis is sensitive to input numbers. Two factors are hardly enough to give too exact result forecasts, especially under extremely distressed liquidity situation.

Not having any insight to potato business I stick with good old mean reversion.... Refining margin from potato to starch was good for a long time, and last year was the first meaningful exception to that. If the margin stays at 2012 levels, China Essence will be out of business sooner rather than later. I can live with that, but it doesn't mean I regard it as a likely outcome.

If an investor wants to perform detailed target price analysis based on results of one arbitrary fiscal year, one is free to do so.

Key assumptions:-
a. Essence in its 1st Q results said that it would procure 50% of the potato at 700RMb to 750RMB.
b. Inventory + A/R = approx 700 RMB. 50% will be used to pay potato. hence around 80k ton starch can be produced.
c. Even if plants are mothballed, deprecation expenditure will still be incurred. Last yr, depreciation and land use rights amounted to $90mil RMB. Interest expenses = $55mil RMB

Depre and interest = 1812 RMB per tonne.
Overheads and Distribution = 400 RMB per tonne.
Cost of Potato = 700 /1.13 * 6.5 = 4025 per tonne.
Full cost per tonne of starch = 6237 RMB.
Breakeven Selling price = 1.17 x 6237 = 7300 RMB. (Net Zero profit level)
Current starch price (with VAT) = 6000 RMB

Net loss per tonne of starch = 1300 RMB

Projected full-yr loss (if starch price stays at this level) = 104 mil RMB

i just cannot rationalize how Essence can break even, let alone make any tiny profit if starch price stays at current level..

Can someone help me out?