Aquatic Foods, an Naibu waiting to happen

Tuesday, Oct 18 2016 by
20

Introduction

 

The past decade saw 80 listings originated from China and over this period 45 companies have left the market leaving shareholders empty.

Back then, China was the engine of economic growth for the world economic and was growing four times faster than the UK.

Therefore, it made sense to invest in China because it equates to higher stock returns.

 

The UK investors had learned their lessons and stayed away from Chinese AIM businesses, even if it has a significant cash balance and orbital growth prospects, these financial results can't be trusted any longer!

They have stayed away!

 

You don’t need to talk to the fishes to know Aquatic Foods smell fishy

Despite a lack of interest from the UK investors, the Chinese did not shy away from the UK stock market, especially the AIM market. One of these companies, in particular, is called Aquatic Foods, which is today’s assignment.

So, a twenty minutes skim at Aquatic Foods statements and annual reports tell me several worrying things.

These are:

 

1. Strange asset turnover numbers


Source: Aquatic Foods annual reports (Graph reconstructed by the writer.)

Aquatic Foods monstrous sales growth didn’t stop its asset turnover from declining at an alarming rate since 2012.  

On a separate measurement, Aquatic Foods grew sales by 354%. Therefore, measuring against Property, Plant, and Equipment (PPE) showed the opposite result it jumped by 400%, before declining slightly.

This led me to question how it was possible to triple sales, but not add additional capacity because the value of its PPE has stayed the same.  

Unless fish prices jumped by 300% or Aquatic Foods were operating at a 20% capacity, I can’t see how this could happen!

 

2. Dodgy dividend policies

If a business grew cash in the bank at a compounded rate of 46% per year in the last five years to £50m, but paid under a million pounds in dividends since its IPO, this raise a major red flag.

A bigger alarm is Aquatic Foods paying a much larger dividend three years before its IPO (See it for yourself):


Source: Aquatic Foods annual reports (Graph reconstructed by the writer.)

*2011-2013 dividends total £9m.

A normal growth business pays higher dividends in future years, not in past years!

Another contradiction is calculated using return on retained earnings (%), if the % is high, it should seek more investment to maximise return.

But, when returns are low, Aquatic Foods should return dividends to shareholders.

Item

2011

2012

2013

2014

2015

Return on retained earnings (%)

92.2

97.4

63.7

42.7

31.1


The funny thing is Aquatic Foods paid dividends during periods where they should re-invest, but cut down dividends payout when it can’t get superior returns from new investment.

 

 

3. Deposit rate + Finance income not matching

Aquatic Foods earn 1/10 of what it should make if it invested in a 1-year deposit rate account in China.


Source: Aquatic Foods annual reports (Graph reconstructed by the writer.)

 

Aquatic Foods’s cash balance earns less than 1% in interest in the past five years, while Chinese 1-year deposit rate is four times as large.

 

4. Working capital mismanagement

An assessment of Aquatic Foods working capital management reveals a somewhat surprising revelation.

Back in 2011, its working capital turnover was 6.12 meaning management is highly efficient, as it optimises their operations.

Over the years, its working capital turnover has declined to 1.85 meaning it either has too many receivables or inventories, but loaded with “excess” cash.

They should return the cash to shareholders. Instead, it is earning less than 1% from the bank.

 

5. Market Value

Aquatic raise £9.3m in the AIM Market. The IPO price is 70p/share = £79.3m. Today, its 12.5p/share = £14.15m, a fall of 80%!

This is a company with net earnings growth of 29%/year for 5 years. Its latest annual profit of £15m is greater than the market capitalisation!

On a free cash flow basis, it generated £21m in 2015.

 

Where is the logic

With a valuation this low and its earnings so high, its value should exceed £100m (easy), instead we got a business that is trading for “FREE” to market investors.

This is because liquidating the firm would realise £35m (after debt repaid) earning shareholder 2 and a half times its money back.

 

But, investors wary of other Chinese firms like Naibu and Camkids, both reported large cash positions suddenly went bust!

So, this is a company showing similar symptoms.

 

 

Fun Facts logic

1. Cash grew from 57m RMB to 153m RMB in 2011-13, when it paid out 78m RMB in dividends in the period.

But cash balance increased from 193m RMB to 380m RMB in 2014-15 but manages to pay ONLY 7.6m RMB in dividends.

 

2. Aquatic manages to grow cash balance faster by not collecting from its receivables which have increased by 750% compared to net sales 354%.

Also, it pays its suppliers, as payables grew by 265%.

The only explanation is the 85m RMB raise during its IPO.

3. For a business that relies on processing plants to turn raw fish into frozen products, its CapEx appears non-existent, till it raise money from AIM investors and it decides to invest in capacity.

 

Verdict: Avoid the stock at all costs, because delisting is its next stop.

Disclosure

I wrote this article myself, and it expresses my opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Plus, I do not own the stock of the company mentioned, unless stated.


Disclaimer:  

By reading my articles and newsletters, you agree to use the research of Walbrockresearch.com at your risk. The purpose of this site is to educate and entertain readers. In no way, we are giving investment advice though the information provided is to my knowledge accurate at the time of the report. You should do your research, or seek advice from qualified professional investment advisors.

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Aquatic Foods Group Plc is a marine foods and seafood processor and producer, supplying its products to export and local markets. The Company also processes and trades other aquatic products, agricultural and meat products. It geographical segments include PRC and Outside PRC. Its product categories include Fish, Sea Cucumbers, Cephalopods, Shrimp & Shellfish, and Others. Its products are processed frozen seafood, seaweed-based foods and marine snack foods. It has over 50 regional distributors, covering approximately 16 provinces, municipalities and autonomous regions in China. Its subsidiaries include Yantai Kanwa Food Co., Ltd, which is engaged in processing and trading of aquatic products agricultural and meat products; Yantai Zhenhaitang Foodstuff Co., Ltd, which is engaged in trading and distributing of processed frozen aquatic products and pre-packaged food, and Hong Kong Hanhe Holding Company Limited and Aquatic Foods Group PLC, which are engaged in investment holding. more »

LSE Price
9.5p
Change
 
Mkt Cap (£m)
10.8
P/E (fwd)
n/a
Yield (fwd)
n/a



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47 Posts on this Thread show/hide all

VegPatch 23rd Nov '16 28 of 47
6

In reply to herbie47, post #25

In this case I definitely think Herbie hasnt gone bananas. All v sensible points. Avoid, move on,there are plenty more fish in the sea.

One point i add is that if you really tried I bet you could track down the British non exec directors and arrange a call with them. You could then get a sense of what due diligence they had done, what they really know and get a sense if you think they are puppet directors or actually add something. If they dont want to talk to you then that in itself is a red flag.

I used to work with a really good fund manager called Richard Plackett. He used to avoid Biotechs like the plague because he said the evidence is that most go bust and he couldnt spot the right from the wrong. I think this also applies to Chinese shares listed on AIM. One or two may be right, but the vast majority have turned out to be wrong'uns. Just walk away.

My money is with Herbie47

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Mark Carter 23rd Nov '16 29 of 47
1

This has all the classic signs.

Your figures showing every-dimishing Return on retained earnings is very typical of what we see in Chinese companies.

One thing you didn't mention was debtor days. They crept up from 54 days in 2012 to 116 days in 2015, according to figures on SharelockHolmes. Very very typical for these sorts of shares.

Also, the company is only a relatively recent float, making it riskier on account of not having a proven track record.

Another thing to look out for: the chart is appalling: down 53% over 1 year, and 80% since flotation.

The last thing that caught my eye is that it has a Stockopedia Quality score of 92. That does not mean that the company is a good quality company - quite the opposite. The score is being fooled by accounting chicanery.

All these things that I noticed off the cuff, and are, in my view, make this company a slam-dunk AVOID.

Another little curiousity that I just noticed is that if you look at Stockopedia's cashflow from operating activities, you will notice that every year, there is a significant reduction in working capital. You would think, wouldn't you, that an expanding company would be increasing its working capital, not decreasing it. The implication here is that the company is actually siphoning off cash.

Thanks for bringing this stock to my attention. It's always interesting to hear about these sorts of companies.

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pka 23rd Nov '16 30 of 47

In reply to Mark Carter, post #29

Nigel Somerville of the Shareprophets website seems to think this is yet another Chinese fraud.

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Mark Carter 23rd Nov '16 31 of 47

I thought that the following link was quite interesting: Three Keys to Spotting a Fraudulent Chinese Company
http://www.chinalawblog.com/2016/02/three-keys-to-spotting-a-fraudulent-chinese-company.html

"Interest rates at Chinese banks is very low and legitimate Chinese companies do not usually keeps large amounts of their cash in interest bearing bank accounts."

Another sign are excessively-high profit margins.

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Mark Carter 23rd Nov '16 32 of 47

I can't resist commenting on this company. I was scanning the LSE boards, and came across this little recent gem: "the company actively looking for ways to spend the £51m cash on the balance sheet, either on an acquisition or on a new factory and processing facilities, or perhaps both."

The RNS does not mention the word "factory" specifically, but a "new site". Reading between the lines you could take this to mean the same thing.

This is another huge red flag. It seems standard practice for these Chinese outfits to invest in a new factory, and then disappear off into the sunset.

Chinese companies are not even trying to be original.


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EDWARD FORT 24th Nov '16 33 of 47

I can totally understand the widespread suspicion and cynicism when it comes to Chinese corporate governance. And if you feel the country is systemically corrupt, you definitely shouldn't invest in AFG. Personally I don't think that China is systemically corrupt and I think this company is the real deal. Let's see.

Funnily enough, one of the attractions about this investment, for me, is that IS in China. Given the very difficult situation for the UK at the moment, virtually everything with domestic UK exposure seems too risky to be investable. There also has to be a big risk attached to UK companies trading heavily with the EU, given the high chance of our expulsion from the Single Market in 2019.

The advantage of investing in China is that you have exposure to a society that is getting rapidly richer, not poorer. I like MPO (Macao Property Opportunities Trust) for the same reason.

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loudenr 24th Nov '16 34 of 47

In reply to EDWARD FORT, post #33

Edward

My only question to you is why take the risk? There are many other investments that can be made which are far safer.

Naibu and Camkids benefited from the IC tipping them which pushed the share price up. I used this as an opportunity to escape and I am glad I did. I agree with Mark, this has many similar hallmarks to both of those.

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EDWARD FORT 24th Nov '16 35 of 47

Louden

Because I feel the risk/reward here is good. The risk may be lower than conventional wisdom believes, and the reward may be higher.

I'm expecting this to rise 4 or 5 times within 2 years. The would take it back to the IPO level, which would still be very cheap.

I've met the NEDs and done a lot of work on this share. Of course it's not without risk, but with a PE of 1 what would you expect?

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Graham N 24th Nov '16 36 of 47
1

Edward, believe it or not I owned Naibu and Camkids once upon a time. Thankfully I came to my senses and sold out in good time. But it was a lesson learned.

There is a lack of originality in the AFG story. If it's true that they are looking at a property purchase, this is a well-worn path taken by many similar companies whereby the cash on the balance sheet (presuming that it currently exists) gets off the balance sheet and is replaced by an asset the value or use of which you will be not be able to verify.

The company then only needs to come up with a reason to delist and you will have no recourse besides signing up for an uncertain recovery process.

I know it "looks cheap". I know it has "exposure" to the Chinese economy. This "exposure" attraction is something which stock promoters use to foist their stock onto amateur investors.

You are very likely to lose all the money which you invest in this, if you hold for long enough. The directors are not filling their boots because they are not idiots. I said that these shares should be viewed as lottery tickets because I don't think you should own more of this than you would be willing to invest in lottery tickets. Good luck.

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eiresorpio 24th Nov '16 37 of 47
3

Edward, as I hate to see people lose their money on stocks, I wonder what assurances have the NEDs given you. By that I mean how have they satisfied themselves that this stock is different to that of Camkids or Naibu? This for me would be the starting point.

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EDWARD FORT 25th Nov '16 38 of 47
16

eire

Your concern is touching! Save it for yourself and your lovely, safe shares in UK-focused companies. You may need it, given the way things are going! 

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VegPatch 25th Nov '16 39 of 47
1

I think that was a v fair question - is there an answer Edward ?

"I've met the NEDs and done a lot of work on this share. Of course it's not without risk, but with a PE of 1 what would you expect?"

obviously they couldnt tell you anything that isnt in the public domain, but surely that must have been one of the first questions you asked ?

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loudenr 25th Nov '16 40 of 47
3

In reply to EDWARD FORT, post #38

Edward

I really feel that is an unfair snipe and not something we want to see on these Boards (we want to avoid the sort of personal attacks that appear on ADVFN et al). People are just expressing to you their concerns as they genuinely do not want you to lose money.

My view is that this has many similar characteristics to Naibu and Camkids and I would be extremely nervous if I held. If you are going to continue to hold, I hope it works out but please do not be surprised if you lose your entire investment.

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EDWARD FORT 25th Nov '16 41 of 47

Veg

A NED cannot tell you more than is in the Public Domain, as I'm sure you know.

A NED investing a material amount of their own cash in a business they have recently visited in China is a strong signal of their confidence in the business.

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EDWARD FORT 25th Nov '16 42 of 47
1

Loud

Apologies for any offence caused. But this seems to me a very polite and sensible discussion.

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pka 25th Nov '16 43 of 47
2

"A NED investing a material amount of their own cash in a business they have recently visited in China is a strong signal of their confidence in the business."

Are you sure that the cash wasn't provided by the company?

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Orangetree 25th Nov '16 44 of 47

Personally, I see nothing wrong with putting 10% of my total stock portfolio in the speculative section and Aquatic Foods is that kind of stock because you never know what's going to happen.

I can see one unconventional way that Aquatic Foods can make money for shareholders (however unlikely) and is to facilitate capital flight from China.
What I mean is the rich Chinese looking to move money outside of China via trying to gain quick UK citizenship by making a significant investment towards a UK-listed company.



I know this is unlikely but could make a major impact on the share price.

Blog: Walbrock Research
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EDWARD FORT 25th Nov '16 45 of 47

In reply to pka, post #43

pka

You write "Are you sure that the cash wasn't provided by the company?"

Yes, I'm quite sure it wasn't! This NED has decided to spend £27k of his own money on the shares in the business, having visited the operations in China. That's a positive sign.

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rhomboid1 25th Nov '16 46 of 47

Edward

You seem very determined to see your investment through , good luck as it's a kind of binary , fraud lose all, not fraud make money. FWIW his share purchase as a non exec is pretty much his fee in the AR, are they linked , who knows..

Cheers

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EDWARD FORT 26th Nov '16 47 of 47

rhom

Yes, I think that's right. The NED has decided to invest his NED fees in the company's shares, presumably because he feels they are seriously undervalued. That's a positive sign. There was no obligation for him to do this.

As I've said in other posts, there is no evidence of any fraud at AFG whatsoever.

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