Fructivore Investments

I suppose that my loyal readers are tired of hearing me going on about cheap Chinese stocks, but value investors have to go where the value is. Some Chinese stocks, small and overlooked, seem to show up on my screens more often than I would expect considering the China cult, and although HQ Sustainable Maritime (HQS) doesn’t have quite the built-in bet on China’s floating its currency, it has some compensating factors. At any rate, recent events have made China floating its currency a little less likely.

I suppose the currency situation merits a digression. The basic thesis of the Chinese currency bet, as I’ve stated, is that China’s currency is being kept artificially weak so that they can boost their export trade, and that international pressure is on them to let their currency float. Unpegging China’s currency to the dollar will mean it takes fewer yuan to produce the same number of dollars, so an American receiver of Chinese cash flows will benefit. However, because of the Europe situation, the dollar, and consequently the yuan, are already stronger, without China having to unpeg a thing. Since China’s economy is so export-based, the internal pressure not to unpeg the yuan, or even to further weaken it, will be fairly intense and therefore the possibility of a floating yuan has been made more remote. Still, I guess we could always run the price of oil up to $140/barrel to shake them off again.

Anyway, HQ Sustainable Maritime Industries raises tilapia and other seafood for export to Europe, Japan, and the US, and they also make health products out of shark cartilage and other marine materials for the domestic Chinese market. Approximately 2/3 of their income is from exporting tilapia, and 1/3 from their health products, which means that they have some exposure to a floating yuan. They also have a P/E ratio of about 9, which considering the higher equity risk premium in China, is reasonable but not screamingly cheap, although they are looking forward to future growth.

But HQ Maritime has the advantage on its balance sheet of being a net-net stock on an unadjusted basis; as of this writing the market cap is $80 million, and the company has $38 million in cash, $57 million in receivables, and $2 million in inventory against $8 million in liabilities, totaling $91 million in current assets. However, those receivables ought to be discounted for the possibility of uncollectability, particularly since receivables have been increasing dramatically over the last year. It is also not clear how the firm has $23 million in quarterly sales from $2 million in inventory; they may be pulling the GM trick in reverse (GM always paid their dealers bonuses the day after the end of the quarter to make their cash balances look bigger, so perhaps HQ makes a huge push to sell their inventory before the end of the quarter to perform a similar form of window dressing). Or it could be the natural effect of last in, first out inventory accounting coupled with a high turnover rate, I suppose Even so, the balance sheet is fairly attractive.

The firm also has 100,000 shares of preferred stock that is largely in the hands of the firm’s management. The preferred stock is convertible into half as many shares of common stock, so from a purely accounting standpoint it knocks about $275 thousand off the price. However, the preferred stock is entitled to 1000 votes per share, giving the holders of the preferreds unassailable control of the company. This arrangement is not unusual outside of the first world, or among certain new companies, and although it sounds less than ideal, Damodaran reminds us that the value of control depends on how well the company is run; if management is generally competent the minority shareholders do not suffer because the management is entrenched because throwing management out and then running the company exactly the same way produces no change in the company’s value. However, it must be admitted that the management seems to be more willing to make convertible debt offerings and other dilutive financing arrangements.

On balance, and assuming that the accounting for receivables and inventory is reliable, it seems to me that HQ Sustainable Maritime is a desirable company, reasonably priced under pessimistic assumptions, and with both growth potential and partial exposure to a floating yuan in its favor.

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Investing by grocca