China Minzhong Food Corporation

[sgd]

all investing is a risk, as a contarian when I see general news publish in straits times tar all S-CHIP with the same brush wah hoh-sey liao lah waiting for massive sell off buy a cheaper lah. Sure I've seen the news the coy that you mentioned but I think not all are bad but how to tell?

Firstly the books you mentioned, if you see billions & billions on the balance sheet that is so unbelievable and yet still have debts or they still need to raise money that's a no-no.

Or another way to invest is to look at the management must at least have a Singaporean director besides independant directors. So at least if the company commit fraud these people are the tripwire and the first to give an account or go to prison so they better make sure it's clean. If they resigns suddenly that's the signal to sell all.

Another way I see is s-companies with dual listing, especially in hongkong where I hear requirements very strict.

[Jared Seah]

sgd,

Shhh.... Don't spoil our lobang in S-chips.

LOL!

I've got burnt more by Singapore listed companies run by true blue Singapore born and bred Singaporeans

Upon reflection, it's my greed and pride that's to blame. I smart (or that's what I thought!); others not stupid too.

You need to be smart to run scams you know!?

[freedom]

if GIC can't determine whether the book is cooked with a board director, it had better not invest any further of the reserve.

[dzwm87]

It is often the stereotyping that allows the good opportunity to be missed. What contrarian is he if almost a majority of the crowd believes likewise as him? Yet, it is also not wise to be the contrarian just for the sake of it. In fact, the word 'contrarian' seemed to be overplayed. Buying when a stock price is plunging may well fit the title 'contrarian' but I am not so sure if it is a wise and profit-making contrarian...

More importantly, when a price falls, it is important to determine what causes it to fall. Throughout my experience, I have come to realise that the market can indeed, on a majority of time, be efficient. There must always be a reason behind every hike or plunge in a stock price.

If it's purely S-chips risk, then why did CMZ's stock price hiked even before the recent selldown? Does it mean that the public markets finally realised, "Oh! CMZ is a potential fraud??" I won't argue that there is an element of fraud-ness within each S-chip but I doubt that is the sole reason behind CMZ's recent plunge. The fraud fear perhaps was an amplifying effect. There are other effects that warrant the price fall and it is important to analyse each of these factors and determine the sustainability of the under-performance. Of course, you can never be 100% sure or 100% correct of every aspect. There will bound to be a certain extent of uncertainty and discomfort - hence, the essence of being a contrarian. More importantly, the job is to cover as many perspectives as possible regarding the "uncertainty/discomfort" so that the likelihood of it being true is minimal.

As for S-chip fraud, one of the best way I have learned is simply to put yourself into the shoes of the management and see what are the possible ways to 'cash out' on the business. If there are too many possible ways, avoid it, otherwise, there is potential for it to be a genuine business.

*not vested*

[dzwm87]

Some key takeaways from a conference call I had with CMZ IR manager:

http://thevaluethought.wordpress.com/201...ence-call/

*vested*

[karlmarx]

Without an intimate understanding of the industry, there is no way that you can tell if the books are cooked. Because mainly, you wouldn't know what to look at, and you wouldn't have a clue that whatever you're looking at is sensible. You cant tell if it's a fake just by looking at the Income statement, balance sheet, and cash flow statements. You have to look at all the footnotes. And see if they do add up, in a sensible manner. Using institutional investors as reasons for investing is only acceptable if the institutional investor has an excellent track record. I will be confident of buying cmz only if WB is buying.

A few months back I was looking at conscience food's ipo prospectus. I thought it could be one of my possible targets if the price became cheaper. It was many many hours of work, trying to make sense of their growth story and all that. Most of the number stuff just flew over my head. After all, I have no idea of the cost structure for noodle manufacturing, or how much labour or rent cost in Indonesia. They reported revenue growing rapidly for the three years leading to ipo. But for one of the years, 2009-2010 I think, unit sales actually dropped drastically. So much so that per unit selling price had to be almost doubled (or raised by a lot, can't rem the details) to achieve the reported revenue. I couldn't make tails of it. And conscience food is no longer on my watch list.

S chip investing is not for the brave; it is for the industrious. There is probably at least one real deal out there selling at a steep discount. But which is it? You'll have to spend lots and lots of time and effort (that even a full time investor may find not worthwhile) to find out.

[morten]

Some key takeaways from a conference call I had with CMZ IR manager:

http://thevaluethought.wordpress.com/201...ence-call/

*vested*

I ve met enough S chips management to realise something. Never speak with any of them, be it CEO or Chairman etc. To me, they are salesmen.

They come to us to recite a nice beautiful story. Any issues are always brushed off skillfully and stealthily. Whether its the case in truth? Well, I prefer to stand inside the cautious camp.

[dzwm87]

No doubt, I will agree that one has to do much analysis work to ensure a minimum probability of a possible fraud. However, I do believe that one cannot reach 100% certainty of a fraud-less business.

Personally, I don't think the past sell-down was due to a fraud risk primarily. It won't make sense that CMZ be realised as a fraud only until recently.

However, the main concerns were as such:
1. Late winter issue brings a risk of lower sales
2. Rising receivables of RMB860m - almost 4 times from FY11 RMB230m!
3. Rising inventories of RMB210m - almost 4 times from FY11 RMB53m as well!
4. Rising bank loan debts of RMB582m - more than 50% increase from FY11
5. And lastly, perhaps the major concern, CMZ won't be expanding its farm leaseland for FY12 - a potential strong hit to CMZ business since agriculture biz can only grow strongly through expansion

But, I don't think the concerns are long-term justification because:
1. Late winter effect brings only a shift in earnings. If you notice, Champignon mushroom has a seasonality trend growing to its peak from 2Q to 3Q. The late winter, as an effect, lag the seasonality trend to one quarter later - from 3Q to 4Q. There has already been a contract RMB200m of sales roll-ed over to 4Q. Even if 4Q does not earn anything by itself, the RMB200m + 9M's RM1700m will have matched FY11's total sales of RMB1900m
2. Rising receivables are indeed a concern as it can potentially mean some fraud risk. However, the rise had been due to the late winter effect. RMB180m has already been collected since April - such early collection probably warrant the lagged winter issue. Also, looking at quarterly receivable trends, there is a seasonality peak in 2Q and 3Q. Accounting away the RMB180m of winter effect, you realised a majority of the increase in the seasonality peak is probably due to business expansion. (2Q FY12 increased 150% qoq compared to 2Q FY11 qoq increase of 140%; 3Q FY12 increased 30% qoq compared to 3Q FY11 qoq increase of 20%) - Nothing too alarming yet if you ask me.
3. Inventories issue, if remain high, can be an issue since CMZ business is mainly demand-oriented and makes no sense for them to stock up on such high inventories. Indeed, it prove to be otherwise. Mgmt stated that a majority of the inventories account for the late season sales. A bulk of it comes from the RMB200m sales rollover. Hence, inventories hold a significant amount in finished goods.
4. Increasing bank loan is also another concern. This is, however, a paradigm shift in CMZ business model. I don't think they can revert back to their net cash position as most of their IPO has been utilised for expansion plans. An increase in bank loan was partly due to the need for working capital maintenance while CMZ was unable to draw cash on time from their delayed sales. Secondly, an observation in their cash flow statement does show that they have been paying off their previous debts. Bank loans could have been much higher! I reckon this is really based on CMZ's rolling debt business model - a risk which I am concern with (explained later). Looking at net gearing ratio, it is at only 14%, which is still safe if you ask me.
5. No expansion plan is only a short term phenomenon. CMZ will proceed with their expansion in 2013 and it will be focusing on indoor industrialised agriculture which will see year-round harvesting. This means they are shifting away from agricultural risks like the winter effect. the question now is how are they going to finance this expansion? It will most likely to debt financing as recent share prices will prove to be too expensive. This should see net gearing increase but anywhere till 30% should still be fine.

What I am more concerned about:
My concerns are two-fold:
1. Inherent business model where they are working at a very tight cash conversion cycle. In other words, they receive cash just in time to pay off debts. Any unexpected effect like the late winter will mean in a delay of payment of debts.
2. Negative FCF trend - CMZ has been booking in negative FCF, which means they are burning cash. It is in the nature of the business. Though CAPEX tends to be super cyclical, I probably waiting for the time when theyreap the harvest from their CAPEX investment.

Why I am not too concern about CMZ being a fraud:
1. http://thevaluethought.wordpress.com/201...structure/ - they have cashed out too little to warrant any fraud possibility - strong distinction against other S-chips
2. CEO Lin Guo Rong had purchased S$350K worth of CMZ shares during the sell-down - almost close to half of its annual remuneration. Absolute figure is small but will we put 50% of our annual income if we are in the same shoes?
3. Last reason which shouldn't have too much weight. The business operation is open to fraud, as mentioned by Anonymous. Chaoda had been victimised by short-sellers. China Green had its fair moments as well. Yet, CMZ has yet to be picked by short-sellers despite the recent short selling trend. They might have yet to find anything substantial or CMZ is indeed genuine. One thing for sure, I am certain CMZ did come under their analysis work and somehow, did not prove to be significant enough as a short-sell candidate.

==

Overall, I can say there are still loopholes within my analysis above but like I said, there is only so much we can analysed. We can never be 100% certain. Indeed if WB purchased CMZ, it can mean 100% fraud-free but aren't we jumping to the extreme? If that happens, what contrarian are we? CMZ will have been fair-valued even before we have the chance to get in. Of course, it is also important to not expose a significant % of your portfolio into S-chips - that I will agree wholeheartedly.

I feel at 0.5x P/B, there is sufficient (IMO) margin of safety. CMZ used to trade above 1x P/B even in the midst of S-chip frauds. Like I said, I don't think the market 'suddenly' realise CMZ is a fraud.

Apologies for the lengthy post
*vested*

---

I ve met enough S chips management to realise something. Never speak with any of them, be it CEO or Chairman etc. To me, they are salesmen.

They come to us to recite a nice beautiful story. Any issues are always brushed off skillfully and stealthily. Whether its the case in truth? Well, I prefer to stand inside the cautious camp.

Same goes to every company - not just S-chip specifics.

[freedom]

balance sheet is just a snapshot. a lot of current items can be distorted to quite extreme. e.g. if you just harvested your vegetables or bought from locals on 31st Mar, you would record significant higher inventory. the same goes to receivable/cash/payable/short term debt. one day does make a difference sometimes. But, persistently higher inventory, declining receivable collect-ability, higher debt, would mean totally different thing. Anyway, next quarterly report would say a lot about its business performance.

The expansion of CMZ is not sustainable to me. I don't know what the CFO is thinking. How could a negative FCF company expand too much? It would make more sense to slow down and strengthen the balance sheet then expand.

[D123]

However, the main concerns were as such:
1. Late winter issue brings a risk of lower sales
2. Rising receivables of RMB860m - almost 4 times from FY11 RMB230m!
3. Rising inventories of RMB210m - almost 4 times from FY11 RMB53m as well!
4. Rising bank loan debts of RMB582m - more than 50% increase from FY11
5. And lastly, perhaps the major concern, CMZ won't be expanding its farm leaseland for FY12 - a potential strong hit to CMZ business since agriculture biz can only grow strongly through expansion

As mentioned earlier in another post, my main concern about CMZ is not these, but the fact that it seems to be pursuing growth at all costs. And in fact, growth in a strange area as they are prioritizing the sale of fresh vegetables in China where prices are controlled, rather than processed vegetables for export, which can have higher margins and are more price-competitive.

Increasing bank loan is also another concern. This is, however, a paradigm shift in CMZ business model.

Erm, China Minzhong was operating with debt-equity ratios of 40% - 50% in the years before they IPO-ed. They merely cleaned up the books for the IPO. No surprise about needing to draw on debt, it is a capital-intensive business.

No expansion plan is only a short term phenomenon. CMZ will proceed with their expansion in 2013 and it will be focusing on indoor industrialised agriculture which will see year-round harvesting. This means they are shifting away from agricultural risks like the winter effect. the question now is how are they going to finance this expansion? It will most likely to debt financing as recent share prices will prove to be too expensive. This should see net gearing increase but anywhere till 30% should still be fine.

A lack of expansion is not a problem. An over-aggressive push for expansion might be the problem instead, with the realization of returns for equity investors being pushed out further and further into the future. Nothing really wrong with delayed satisfaction but increased duration means lower NPV and higher chance of something wrong happening along the way.

Each mu of land requires RMB 24,000 of capex, RMB 10,000 for land and RMB 14,000 for PPE and infrastructure. Let's say they can comfortably generate RMB 600M worth of cash flow from operations each year. Taking a 20-year depreciation rate, they will need about RMB 123M for replacement capex based on historical cost and another RMB 13M for replacement land, also based on historical cost. This leaves them with RMB 464M for expansion, which equates to about 19,333 mu at present estimates of cost.

This is significantly short of the company's target of 30,000 mu per year. So they will definitely need external financing. Note that these estimates are based on generous assumptions, using peak historical cash flows, historical replacement costs, company's estimates of future capex costs (which seem to be increasing every year), and a generous 20-year depreciation rate. In other words, everything has to go smoothly just for the company to be able to expand by 19,333 mu. So why is the company so aggressive in wanting to target an expansion rate of 30,000 mu per year? I remember the management saying that they will not need any more equity finance for at least three years after they completed their IPO. After one year, all the IPO money and more is gone. They will need debt financing, but one wonders if this was already part of their plans, or the result of being wrong on their initial estimates of costs.

Given the many variables involved, I think it is very hard to get clarity on the prospects of the company unless you have knowledge of how costs are going to be managed and the yield you are going to get from your farmland (how much they can be increased in percentage terms to justify the land grab). Anyway, for perishable goods like fresh vegetables, how much economies of scale can there be beyond a certain point? Does your cost basis improve that much with more land when you are already operating 85,000 mu of land?

I don't know the answer to many of the questions I have posed. Just sharing my thoughts on the analysis of CMZ. I'm not taking any view on the prospects of the company as an investment.