Oct 16, 2009 @ 12:44 PM PDT
When the recession hit, Audiovox was already in the process of cutting its fat, whereas other companies were only just beginning.
Last week I recommended AgFeed Industries (FEED), a hog and hog feed producer, as a play on the escalating appetite for meat protein by a growing Chinese middle class. Presently that pick is up over 20%, but Wall Street’s focus is on another Chinese “pork play”, Zhongpin, Inc. (HOGS).
HOGS is a Delaware holding company that operates as a vertically integrated processor, distributor, and retailer of pork, fruit, and vegetable products in the People’s Republic of China. HOGS owns 6 abattoirs (leases 3 additional) for the slaughter of locally purchased swine and 11 meat, fruit, and vegetable processing plants. Customers include 47 meat processors, 1,683 school, factory, and military cafeterias, and 3,178 grocery and restaurant retail outlets. 27 domestic and international fast food companies also purchase HOGS’ products. HOGS offers 314 fresh, chilled, and frozen pork and meat products and 20 fruit and vegetable products. 136 products are in the developmental pipeline. No wonder this stock is a Wall Street darling. Want the full story?
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HOGS is a compelling growth story. Revenues, net income, and earnings have increased 1162%, 1034%, and 708%, respectively, since 2004. These same parameters have increased 28%, 30%, and 27% for the first 9 months of 2009.
Due to the lack of adequate transportation infrastructure in the PRC, HOGS, like other pork producers in China, operates a regional and local business model. Live hogs, fruits and vegetables are purchased from sources close to slaughter and processing facilities. A network of 66 warehouses and 85 sales offices provide products for retail outlets in 24 of China’s 30 provinces. Despite this fragmented model, the Zhongpin brand enjoys national and international recognition. 42% of revenues are derived from independent proprietary “showcase” stores and supermarket counters that allow for consistency of presentation and quality of product. Although primarily marketed in Tier 1 cities, HOGS has initiated penetration into Tier 2 and 3 markets (populations less than 3 million). International sales presently account for less than 1% of sales. 88% of sales are fresh, chilled, processed and frozen pork products. Fruits and vegetables bring in 5% and other meat products round out the menu. Selling at only 48% of its total pork processing capacity and a PRC mandate to limit open-air marketing of meat products, HOGS is in a good position to capitalize on the growing demand for pork, the primary meat preference in China. 46% of world pork production and consumption occurs in China.
So where is the downside? HOGS has expanded by taking on significant debt. Here is a company at the mercy of swine disease, particularly the recent H1N1 swine flu, local pig supply, economic downturns, or food contamination scares that is wallowing in $96.8 million of short term and $33.6 million of long term debt with just $26.8 million in cash flow. It has eaten through 58% of its credit line. HOGS' options are limited in the event of calamity.
Recently the PRC opened 6 state owned abattoirs in Beijing that are considered “safe practice” hog slaughter facilities, suggesting that present meat slaughtering practices in China are inferior to the needs of a developing society. Although HOGS pre-slaughter and slaughter meat inspection procedures are exemplary, this state initiative casts doubt on all pork processors in the PRC and could affect sales.
Although HOGS sells products in 24 of China’s provinces, the bulk of its business is concentrated in the 4 provinces and 3 Autonomous Regions (Beijing, Tianjin, and Shanghai) with large supplies of swine. The lack of road and rail infrastructure in China limits any major national competition but it is also an impediment in HOGS’ attempt to establish a significant national footprint (think Chinese Smithfield) to ward off serious regional or foreign competition. Presently, China must import pork products to meet domestic demand.
Fundamentals for HOGS are mixed. ROIC, ROE, P/CF, Current and Cash Ratios all suggest a limited business moat and debt inflated return to investors. However a P/E of 11, low D/E, increasing sales & earnings growth, with 28% insider ownership and limited float, support Wall Street’s infatuation with this stock.
My personal investment portfolio is betting heavily on Chinese consumer growth, but I must agree with Jim Cramer that HOGS is too risky for even the most intrepid of investors. China is in the midst of peak pork consumption (winter) so earnings reports for the next two quarters may be tempting to momentum investors. I would only give this stock a second look when I could limit my downside risk and it was selling at $6-7/share or a P/E around 5.
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