Three Bombed Out Chinese AIM Stocks - Ben Graham Bargains Or Value Traps?

14th Apr '11 by Edward Croft

14 comments 17142 reads

Back in 2006-2007, many private investors had it easy. The markets were on a tear and UK investors were benefiting from a boom in new flotations on AIM. Amongst them were a ream of Chinese listings which were attracted to AIM in order to raise growth capital. These included the glamour stock Renesola (LON:SOLA) , a solar wafer company which proceeded to sextuple over about 18 months amongst much decadent howling from private investors on the bulletin boards. Of course it couldn't last, and Renesola, as well as most of the other Chinese stocks, crashed during the credit crunch.

Picking up the pieces today, there are a few Chinese AIM stocks that have recovered somewhat, with some such as Asian Citrus (LON:ACHL) posting very strong gains and moving to new highs, but there are also many that have remained bombed out predominantly on size, accounting and cashflow concerns. The worry that many investors have is that they just don't trust these companies, and don't trust the companies' accounting practices. As a result these companies now trade on completely derisory ratings - to such an extent that they are now appearing on our screens as selling for less than their liquidation value.

Ben Graham, the famous value investor and tutor of Warren Buffett, was the ultimate contrarian investor and loved derisory ratings. He was the investment world's first ever 'quant', running his investment fund for many years almost purely based on a statistical strategy that looked to buy bombed out stocks for less than their liquidation value. Graham wasn't shy of investing where others feared to tread as he believed that in a well spread portfolio any individual bankruptcy risks could be diversified away. Holding anywhere from 30 to 100 stocks, he found the investment returns that resulted to be 'more than satisfactory', with his Graham-Newman partnership returning 17% per year.

If you take a Graham approach to the market, you look for companies that are selling for less than what investors would receive in the worst possible scenario; a liquidation. In this scenario, there's really little point the companies remaining on the market as investors could just liquidate and make a profit. Knowing that in a firesale companies might not get full value for their assets he used an extremely cautious calculation to value them. In his 'Net Net…

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Mark Carter

14th Apr '11

Buffett's first rule of investing: don't lose money. Buffett's second rule of investing: remember rule one.

Anything dual-listed on a Hong-Kong exchange, or anything like that, that's an immediate pass in my books. Run, don't walk. I've been reading a few posts by American investors on the Magic Formula Yahoo Group earlier today. A lot of the stocks thrown up were Chinese, listed on the American exchanges. They proved to be horrendous investments.

Look at Asian Citrus (LON:ACHL) on MSN: http://bit.ly/e421Mo Notice that the shares in issue went from 608m in 2002 to 853m in 2010. During the last year alone, share issues outstanding increased by 10.7%. RCG (LON:RCG) has more than tripled the shares in issue in the last decade. I see huge huge danger in these companies. These companies might not go to 0 (although they might!), but you could end up being diluted into oblivion. Read some of the posts on the RCG (LON:RCG) board over at Interactive Investor for some stomach-churning comments.

Having said that, I really missed a trick with China Soto, which I noticed was mentioned recently. Some time ago it appeared on my screen as a "net-net". I didn't invest, because I thought the thing far too risky. As it turned out, I was probably wrong, because it recently de-listed at a substantial premium.

Still, I think you really do have to adopt a "safety first" attitude. If you're in doubt about the basic integrity of the directors, then you really are taking a huge gamble.

Edward Croft

Very True Mark - and I think that's one of the points that many screeners pick up on. If you add a Piotroski and ZScore filter to Graham net nets you should be able to filter out companies with the worst financial health.

The point that Graham made by insisting on wide diversification with Net Nets is to attempt to gain the general value without the stock specific risk. Buffet has always been more associated with concentrated portfolios, which certainly nobody should attempt here!

As regards dilution, that's something that so many investors ignore. In our upcoming updates we'll be highlighting the most dilutive companies on the stock pages. Big red flag imo.

zangdook

15th Apr '11

Not sure I follow your argument, Mark. You seem to be saying that because some Chinese companies listed in America have performed poorly, it's best to avoid companies with dual listings in Hong Kong. Do you include, say, HSBC (LON:HSBA) and Standard Chartered (LON:STAN) ?

Asian Citrus (LON:ACHL) did issue some new shares, but the dilution was modest and the purpose was expansion of the company. I really don't have a problem with that. Over the same period you cite, EPS has increased nearly 5 times.

HSBC (LON:HSBA) and Standard Chartered (LON:STAN) are of course perfectly fine.

hieronymous1

The elephant in the room is that RCG is in exploratory discussions to delist from AIM and PLUS.

I believe this week that the motion to delist from AIM wasn't passed. It does appear though that RCG wants to delist from AIM. Due to the ongoing Nina Wang / Tony Chan saga in HK where it is dual listed, they don't exactly have the best reputation there either. Presumably if they did delist from AIM, remaining UK shareholders would have their ownership transferred to the HK securities.

Gray Woods

16th Apr '11

Yes, Asian Citrus (LON:ACHL) recent rights issue and purchases were in no way counter productive, take a look at there half yearly report to see why:

http://miranda.hemscott.com/servlet/HsPublic?context=ir.access&ir_option=RNS_NEWS&item=612047872072224&ir_client_id=5185

Also see there site for more in depth details on the placings and purchases:

http://www.asian-citrus.com/investors_rn.html

17th Apr '11

I don't know Asian Citrus in more than passing detail , but I've been aware of its stellar SP return since float. They issued stock last year to make an acquisition. Dilution is of course a critical factor to assess in any stock - but all dilution isn't created equally. If shares are issued for a reason, and that reason ends up increasing shareholder value and earnings per share - then surely shareholders should be happy?

Not every stock can be in the position of, say, Domino's Pizza, and fund all growth from internally generated cash. Sometimes companies have to make an acquisitive move, or seize market share with investment which requires a fundraising.

The red flags should be raised on the companies that consistently issue stock while creating zero shareholder value. There are a lot of oil exploration and mining stocks tarred with that brush.

Edward, I also don't know Asian Citrus (LON:ACHL), so I apologise for any ignorance I have shown. What is interesting is that it has net cash of £289m against a market cap of £881m. Analyst forecasts strong growth for 2012. On 1 March, two directors bought shares with a combined value of approx £370k. On 8 March, it announced in a trading statement: "Asian Citrus achieves 10% increase in average selling price and increases orders by 1% of 2011 Summer Orange crop".

On 25 Feb 2011, I see that the interims mention "with increase in average selling price of oranges of approximately 9% year on year.", so it doesn't look like there's a problem with the timing of purchases and the trading statement.

"Asian Citrus Holdings sells its oranges to supermarket chains, corporate customers, wholesalers, and sole proprietors." One interesting thought that occurred to me is this. Unfortunately, it doesn't state "which" supermarkets - whether in China, or abroad to places like Europe. The reason I bring this up is that if it is the former, then things are quite interesting. China has a high inflation rate, and yet it tries to peg its currency. This is great news if you're from the UK, as ever-higher Chinese prices are translated to you at constant rates.

That's just a speculative idea I made up in my head, though. Anyone care to comment as to whether the idea actually makes sense?

Just to note, you are correct, it is the former, Asian Citrus only sell their proceeds to Chinese buyers. In terms of your idea, it is a very interesting one, and you are correct, as long as their currency is kept low with such high inflation we will benefit. But of course as their currency is kept artifically low, if it were let off the hook then it would rise in value and we would benefit as the pound weakened against the yen.

Just a few extra thoughts ...

TAX RATES
the tax rate seems suspiciously low. For 2010 it is 0.32%

INVENTORY TURNOVER
Is the inventory turnover credible? I'm looking at figures from Money Central here: http://bit.ly/fzBu4K
According to MSN, the average inventory for 2009 was 0.74 (= (0.84+0.64)/2); cost of sales 210.
That gives the number of days to sell inventory as 1.3 (= 365*0.74/210)
I don't know how - isn't that too rapid?

RETURNS ON EQUITY
I'm trying to get it straight in my head why ROE was 22.9% in 2005, and then declined monotonically in subsequent periods. It now stands at 4%. What's going on here? Surely, in a general inflationary environment, ROEs should skyrocket? I haven't wrapped my head around it yet, but it looks like the company is retaining quite a lot of capital whilst getting a lot of paid-in capital. I'm not sure what's going on here.

I took a look at the four companies as a group. Two common patterns were observed:
1. they have been listed only a relatively short while
2. their ROEs steadily decline year-upon-year
3. I don't know how their tax system works, but in a number of cases tax rates are miniscule, a possible warning sign that the profits aren't real

I don't know what's going on, but I smell a rat.

19th Apr '11

The tax rate is low because that is the way China works, simple as that really, they like businesses like Asian Citrus (LON:ACHL) to be able to use all their money to grow, and because of the way China is run they are able to do this. Of course in the future this will likely change, but I do not see it happening for quite a while yet (Just my opinion).

In terms of the inventory figures, they are an orange citrus company, if they had large inventories at the end of the year, it would be terrible for them, because as you would imagine, if they hold large amounts of fruit, it will not last that long, and therefore would be worthless, and not inventory. Basically the year end and half year end inventory figures are useless as they only hold fruit at the points of harvest, with the fruit needing to be sold swiftly for it to have any value, as though fruit can be stored for short periods, there is no way they could keep it from the harvest to when they report their results. So basically the reason for the figures you have got is simply just because of the type of business they are.

In terms of the return on equity, I havent looked at those figures, and havent got time a the minute, but I would imagine the issue will have been the recent placings and purchases which will have effected the figures, giving a lower ROE, I would imagine if you took the recent placing cash etc out, and the effects it had on capital etc, the figures would look more normal.

Giga71

25th May '11

Mark: I am 100% with you around the risk ... it is all about capital allocation and what managers are doing with capital raised through constant increase/issues of new shares. RCG has grown inorganically thru acquisitions: much of the price paid has gone to intangible assets or goodwill ... in other word the premium paid to the sellers. In the last 2 years RCG had significant impairment of both Intangibles or goodwill.

That might trigger to some question-mark/doubts abouth the decision making process around these acquisitions ... either paying to much (with lack of business judgement) or even worse transferring wealth/funds from individual investors of RCG to owners of acquired companies.

Three Bombed out Chinese AIM Stocks - Ben Graham Bargains or Value Traps?

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Edward Croft

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