Along with the three companies to sell, pointed out yesterday, I’ve dug up three new companies worthy of a place in the Toshuo Portfolio: Henan Zhongpin, Famous Dave’s and Exelixis.
It’s not a pleasant thought, but humans eat a lot of meat. Being as cheap as it is, pork is one of the major dietary meat sources around the world, for those who don’t have religious or other objections to eating it. Amazingly, half of all that pork is consumed by China. While those in America are familiar with the idea of having a strategic oil reserve, the Chinese have a strategic pork reserve. You just can’t make stuff like this up.
At this point, over 75% of pork in China is sold through wet markets. That means pork is butchered and sold right on the premises without refrigeration or any modern sanitary precautions. This process has been slow to change, but with the panic associated with SARS, the Asian Bird Flu, and more recently Blue Ear Pig disease, both the public and the government will exists to improve livestock sanitation.
That’s where Zhongpin (NASDAQ:HOGS) comes in. They’re a modern pork processor, not so different from many found in the west. They have three main lines of business: chilled pork, frozen pork, and processed pork. Their packaged meat cuts are are stored in refrigerated, hygienic conditions and distributed to to supermarkets and smaller refrigerated counters where they can be sold. As other developing countries have, China is just about certain to move more and more towards this sort of modern distribution.
Over the past year, facilities have opened in Zhumadian, Deyang, Anyang and Tianjin, and they’ve already started working on construction that will bring another 150k tons of annual capacity, starting in late 2008. Also scheduled for late 2008 is 30k tons/year of fresh fruit & vegetable processing capability. Since vegetables are a higher margin business than pork, after tax, this yields even more expansion possibilities.
Does the CCP like it?
One of the most frustrating things about investing in this sort of business is that the communist party sometimes helps rapidly expanding companies and other times, buries them in a mountain of red tape. From what I’ve read, it appears that Zhongpin is on very good terms with the government. They actually received government financing for the vegetable processing they’re working on and they were the recipient of a “China Top Brand” award for it’s pork products. The award was based upon the criteria of quality, market share, development capability, and social responsibility.
In any heavily-regulated industry, though, there is always a risk of government interference.
This is the part where I nearly spewed my drink all over the keyboard. This company is ridiculously cheap. It’s cheaper than anything I’ve written about on this blog before. Ever. Even cheaper than Silicon Motion was.
|Revenue and profit for 12 months ending in December|
All data are from Google Finance, figures are in millions
And what kind of P/E do we have to pay for this first mover in a huge market displaying rocket-growth? Just under 12. We’re talking a PEG of about .25?!! This is nuts. There are risks of increases in global commodity costs, among others, but this stock meets all my criteria for a perfect small-cap. It’s relatively unknown, I can’t find a single major analyst covering it, it has good growth prospects, it’s in an unglamorous industry, and it’s grossly undervalued. These kinds of opportunities don’t come often, so I plan to leap on this one. If necessary, I’ll sell some BWLD to cover a larger purchase.
Famous Dave’s (NASDAQ:DAVE) is a branded BBQ and grill restaurant. It’s been getting rave reviews from it’s customers, it’s profitable, growing at a good clip (est. 23%), and it’s taken an absolute beating over the last several months. In many ways, Dave’s is like what Buffalo Wild Wings was a few years ago. It has a good atmosphere, and it’s catching on, but it’s still very small and very volatile. The entire chain only has 164, and 120 are franchisee-owned. I see a very volatile path, but it has a lot more potential growth ahead of it than any other Toshuo restaurant pick.
While it may not be so far off the beaten path as Zhongpin is, Famous Dave’s is almost completely under the radar of institutional investors at this point. With a market capitalization of under 100M, no decent sized fund could invest much of anything in it without buying the entire company. Individuals can make some real money out of a tiny-cap, though… as long as the company survives. One thing it has going for it, though, is that it’s margins are very good (gross margin over 50%). Dave’s has a bit more breathing room than other companies, such as Panera, if commodities continue to get more expensive. This is a riskier than average investment, even for a small-cap enthusiast, but the rewards are sufficient to justify the risk.
In many ways, Exelixis (NASDAQ:EXEL) is similar to past Toshuo Portfolio biotech picks, Flamel and Panacos. It’s a small company, it has no earnings, and its future lies in the hands of its talented leadership… and the results of its drugs’ FDA clinical trials. Unfortunately, even with the best of researchers, the drugs just don’t work, or they aren’t safe. If a drug is successful, then a gigantic company is born virtually overnight. If not, then they keep burning their cash reserves away in the hopes of creating a drug that is successful. Investing in this industry is akin to being a home-run hitter in baseball– there will be many strike outs, but just occasional grand slams can win the entire contest.
The biggest edge Exelixis has over Flamel and Panacos, my previous two biotech investments, is that it has a very full pipeline of drugs on the way. To this point, big pharma partners such as Bristol-Myers Squibb (NYSE: BMY) and Genentech (NYSE: DNA) have chosen to advance six of Exelixis’s drug candidates. It hardly needs to be mentioned how much getting FDA marketing approval improves a small biotech company’s outlook.
Traditional valuation metrics really don’t work with this sort of company. Revenues can jump from nothing at all to hundreds of millions per year with a single successful drug. Though there hasn’t really been any bad news out of Exelixis to speak of, its stock has been hammered down with all the rest of the biotechs this past year, and now sits at a market capitalization of under 700m. In order to get a return of about 30% over three years, it would take a market capitalization of just over 1500m. Assuming a P/E of about 30 for a growing biotech, it would only take 50m per year in earnings to do it. With the quality of its team and the breadth of its pipeline, I think this is very doable. In fact, I estimate the odds of a bigger success to be more than enough to compensate for the risk of the company going under.
Silicon Motion and Loop.net are both still very cheap. As a whole the market hasn’t seemed so full of bargains since the end of 2001. One other company on my radar is Brasil Telecom. They’re stable, growing, selling at a P/E of 12, and they have a 4% dividend!
05/19/2008 Bought 500 HOGS @ 11.53 -5,774.99
05/19/2008 Bought 300 EXEL @ 6.2399 -1,881.96
05/19/2008 Bought 300 DAVE @ 9.7299 -2,928.96
Disclosure: I already own shares of Exelixis in my IRA.
Remember, you are responsible for your own investment decisions! In addition to the companies in my Toshuo Portfolio, I own shares in Exelixis at the time of this writing. See the disclaimer.