Asian Citrus Interims show further good progress

AIM and Hong Kong listed, Asian Citrus Hldgs (LON:ACHL, 0073.HK), the China-based orange plantation owner, released their interims this week [ref] http://www.stockopedia.com/news/announcement/ACHL/100316achl000573.htm?title=asian-citrus-hldgs-half-yearly-report&date=1268697600 [/ref] providing some more compelling results and further cementing their position as the largest orange plantation owner and operator in China.

Asian Citrus is the largest orange plantation owner and operator in the PRC. It currently owns and operates two orange plantations: the Hepu Plantation in Hepu County in the Guangxi Zhuang Autonomous Region, occupying approximately 30.9 sq.km, and the Xinfeng Plantation in Xinfeng County in Jiangxi province, occupying approximately 37.1 sq.km. The plantations are located in similar latitudes to that of Florida of the US, which is well known for growing oranges. The Group cultivates and sells two types of oranges: winter (the varieties grown being Navel, Hamlin, Pineapple and Hong Jiang) and summer (principally Valencia).

Investors in Asian Citrus will be used to results like this, as they have been releasing similarly stellar results year after year since listing on AIM. For this reason, I am not going to talk about the growth they have achieved in the accounts or how they achieved them. Rather, I am going to focus on i) their balance sheet which has been further strengthened, and ii) the future prospects, focusing on whether these results can be sustained. 

Balance sheet

Asian Citrus’s balance sheet, like other parts of their business, seems to go from strength to strength. They have continually increased the current and non-current assets side while keeping the liability side to a negligible amount. In fact, the only real liability of note (they only have three) is trade payables. By the year end, this will likely be lower than the level when they listed (historically payables are high in the interim period than at the year-end). This is a quite a feat when compared to other companies. But it is over the last few years where their balance sheet has started to take off. Below are their non-current assets, current assets and liabilities totals: 

 

As you can see from the above, they have a very strong balance sheet. Unlike most businesses, you can actually count non-current assets at book value due to the fact that it is made up mostly of land and their highly acclaimed biological assets. The figures that stand out the most are the increase that they have achieved in current assets over current liabilities since they listed, and of course the removal of all non-current liabilities. To explain how they have achieved this, first the removal of non-current liabilities reflects the fact that they were made up of mostly convertible bonds which have now all been converted. In terms of how they have increased current assets so much, it is simply because as their cash flow continues to increase at such a rate, retained profit, and thus the cash pile, has been able to increase substantially.

 Can they sustain growth like this?

Clearly, the future is certain but a number of facts suggest that they can. To explain this, let's examine where the revenue growth underlying for the current results came from:

•  Hepu has 1.3m trees planted of which 1.1m are fruit bearing, the plantation produced 55,000 tonnes of oranges for the period, slightly up on last year earning RMB191m for the period with an average price earned per tonne produced being RMB3,500.

•  Xinfeng has 1.6m trees planted of which 1.2m are fruit bearing, with the plantation producing 60,000 tonnes of oranges, double last year thanks to the fact that 400,000 more trees became fruit bearing and the already fruit bearing trees continued to mature. Xinfeng earned them RMB194m with an average price per tonne produced being RMB3,200.

•  The nursery division sold 400,000 saplings earning RMB4,000. 

Just to make a note, a mature tree produces on average approximately 0.1 tonnes of oranges a year (the deviation around this figure can make quite a difference to total tonnage produced).

So what growth do they have to look forward to? Below I will list each part of their business highlighting the growth prospects for each:

• Hepu is currently a near fully mature plantation thus there is not much room for growth, but they are currently undergoing a replanting to try to improve the tonnage produced from Hepu, the following shows what they have to say about it in the interims:

‘The Group's replanting programme in the Hepu Plantation continues. During January and February 2010, 64,194 winter orange trees have been removed and the corresponding land area will be replanted with the same number of the new species of summer orange trees. The ongoing replanting strategy is expected to equate to 5% of Hepu's trees every year and it will be principally focused around replacing the existing winter orange trees with a new species of summer orange tree. It is expected that this ongoing replanting will take another four years to complete and the first batch of 55,185 trees replanted during 2007 will commence production in 2010. At the beginning of this year, 242,000 winter orange trees remained to be replanted in the next four years. We believe the improved species of trees will deliver long-term economic benefits by increasing average yields and achievable revenue per tonne.’ 

The above shows that they should see growth from Hepu over the next few years. Once the replanting is complete, Hepu will have 200,000 more fruit bearing trees than the current 1.1m (ie once it returns to fully operational status at 1.3m trees), and hopefully they will provide more high quality oranges then at present.

• Xinfeng will see a further 400,000 trees become fruit bearing over the next year making the plantation fully operational, it should then continue, albeit at a slower rate, to increase the tonnage produced every year for the next six years after until the field reaches full maturity.

• The nursery division will likely see continued growth due to the high quality of their tree saplings. It is not actually the sale of saplings that is the key for Asian Citrus (it only contributed RMB4,000 to turnover). It is the fact that for all the saplings that they sell, they earn the right to have the first refusal on all of the oranges produced from the saplings. This is the business that they talk about being a big contributor to turnover and profits in the future. The way that is works is that if Asian Citrus think the oranges are a good quality, they can then buy them at a cheap price then quickly sell them onto their buyers via their marketing division yielding a quick, hopefully high margin profit. But with the nursery division only coming online in early 2009, it means that the saplings sold will not become fruit bearing until 2013 at the earliest hence it is unlikely that they will contribute much to turnover until then. 

• Hunan is their biggest plantation project yet with a fully planted target of 2.4m trees which they expect to achieve by 2012. In this same year, the first 0.6m trees should become fruit bearing allowing for a first harvest, with 0.6m becoming fruit bearing each year until the field is fully operational. At this point, output should continue to grow each year over the next six years until the trees reach full maturity. 

• There has also been hints that, once Hunan achieves its first harvest, they will look to begin work on a new plantation (something that only has been speculated in the press so I would not count on it). With their history of purchasing a new plantation once beginning first harvest (they purchased and began planting Xinfang once Hepu became fully planted and achieved first harvest, they then purchased Hunan once Xinfeng became fully planted and achieved first harvest), I would not be surprised if they did this again. 

Below is a table that shows the roughly estimated EBIT profits that each plantation could give over the next five years (The new nursery business will be excluded from this as there is no way to know what the earnings from this division will be, also any net gains from their R & D division and from their land and property will be ignored as any estimate would be impossible to make). The cost per tonne sold will be the median of this years to date at RMB3,350, and the cost to produce will be the median for this year to date also at RMB2,000 per tonne.

£1 = HK$11.91

The above is obviously a very simplistic forecast as it ignores many factors, for example the fact that the cost of production as well as the sale price of the oranges are very unlikely to stay the same. Also, in terms of converting the RMB to Pounds, it is also highly unlikely that the exchange rate will remain the same (though it is more likely than not that the Pound will fall against the RMB which would be a benefit). Nevertheless, what the above suggests is that there could be a lot of room for growth from Asian Citrus’s plantation business.

Conclusion

Of course, there are many risks involved when investing in a company like Asian Citrus without even considering the normal risks involved with investing in a Chinese company. These include poor harvest, disease, falling demand, increasing costs etc (I discuss in more depth the risks involved in investing in Asian Citrus in my previous article on Asian Citrus).

Nevertheless, by 2015, Asian Citrus will have more than double the current 2.3m fruit bearing trees in full operation if all goes well. Add to that the fact it will take a further six years for the plantations to fully mature and then the fact that their new nursery business should start making decent contributions to turnover from approximately 2013, the future looks relatively rosy for Asian Citrus, especially as the demand (and therefore hopefully prices) for orange citrus fruit are expected to increase.

They are dividend paying and have a strong balance sheet. At 55p, they are only valued on a 2008 finals P/E ratio of 11 ( a number which should fall this year due to the sharp increase in profits). This does seem low, although please note that they earned a large portion of earnings via a upward net change in fair value of their biological assets and, without this, they are on a 2008 final P/E ratio of 22 (this is something that occurs each year due to their R & D department so you need to take note of this). Thus, even though as mentioned this company is not without its risks, the company seems to have considerable attractions and still warrants a place in the growth section of ‘Grays Stocks to Watch’. 

Disclosure of Interest: Gray has an interest in Asian Citrus