Better Days Ahead for China Yingxia

Note: Due to questions I have on China Yingxia CEO Ms. Jiao's business practices and personal integrity, I have stopped following and analyzing CYXI. I hereby withdraw any positive views I had on CYXI, as expressed in my previous posts. Cabeza 1/13/2009

Bear markets always end up to be Santa Claus for intelligent investors. This one will be no exception. In Santa’s huge warehouse of gifts, it looks like there is a place for China Yingxia (CYXI).

Currently trading ($0.48) at 1.85x company’s 2008 EPS projection ($0.26), and 0.49x book value ($0.97), CYXI might turn out to be quite a generous giving from Santa. Although it is difficult to predict short-term stock performance, a few key indicators are pointing to better days ahead for the company.

Improving Inventories

Investors have been concerned about CYXI's growing inventory in the past three quarters. But this inventory growth should be placed in the context of revenue growth going forward. For this company, second half of the year usually performs much better than the first. Revenue ($17.4M projected) for the second half of 2008 is set to more than double that of the first half ($8.5M). This dramatic revenue growth in the next two quarters will sure consume much of the inventory buildup so far.

In fact if we assume similar cost margin to the first half, simple calculation will prove that sales (as projected) in the second half will consume 90.1% of the $8.3M inventory (as of end of Q2). In other words, all but $0.82M of the existing inventory buildup ($8.3M) will be gone by the end of the year.

Some might be keen to point out that the $3.56M accounts receivable (A/R) increase (in first half) might one day become inventory. This is because much of that A/R was due to cactus seedlings loaned to farmers who would grow cacti and sell them back to the company. But given the close to complete exhaustion of the existing inventories by year end, new inventories are actually essential for future operation and growth.

According to Chief Accountant Mr. Chen, the company took advantage of a favorable government policy (exemption of VAT) on agricultural plantation to expand its cactus growing areas in Q2. By doing this, it has secured future cactus supply on the cheap. That was why the bulk of cactus sales in the first half was from the cactus seedlings sales mentioned above. For Q3 and Q4, the cactus sales should be mostly from the "outside" market as the cactus-growing initiative winds down.

Improving Cash Flows

Negative cash flows in 2007 and past two quarters might have been another factor that has spooked investors. But there is strong evidence things are getting better in the second half of 2008.

CYXI’s business nature determines that it normally does not incur substantial A/R. Q2 was an exception due to the expansion of cactus growing areas. But the A/R incurred in Q2 is expected to be collected starting Q3 and lasting into Q2 next year.

On company's Q2 conference call, CFO Mr. Hu predicted that both accounts receivables and other receivables will likely come down in the second half. This along with depletion of inventory as explained above removes all the devils that have caused operating cash flows to be negative.

Meanwhile, loans (to other parties) will continue to be collected. No more acquisitions are on the horizon. Capital expenditures will be moderate to minimal. Investing cash flows will thus remain positive (already were in first half).

Altogether a robust cash flow picture is taking form for the year.

Discover the Phenomenal EPS Growth

Some investors have failed to look through the currently negative EPS growth to understand that earnings are actually growing by leaps and bounds. EPS for the first half of 2008 decreased 11% year over year; but that was due to the diluting effect of last year’s massive PIPE offerings. Diluted shares increased 48% YoY for this period.

Yes, that massive dilution has cost past investors dearly (and was a key reason I bailed more than one year ago). But the dilution is now history and has no impact on any new investment made. Actually if you just compare the company’s 2008 EPS (diluted) projection ($0.26) with 2007’s actual EPS ($0.15, diluted), you get an EPS growth of 72.9% even when the diluted share count has still increased 23.8% YoY. Furthermore, this EPS growth is achieved even when more income taxes (nil for 2007) will be paid this year.

Significantly Increased Growth Projection

I bet many investors have also neglected the fact that the company has recently increased its full year guidance significantly. Back in Q1, full year revenue was projected to be $21.1-21.9M (32.6-37.6% YoY growth) and net income $9.0-9.3M (47.1-52.0% growth). The most recent projection was for revenue to reach $25.9M (62.8% YoY growth), net income $12.9M (110.8% growth), and EPS $0.26 (fully diluted, 72.9% growth).

Interestingly this fabulous growth stock (62.8% top line, 110.8% bottom line growth) is trading at a P/E of 1.85 and P/B of 0.49 thanks to a bear market, investor fear and ignorance. When the market gets more rational, no one would be surprised to see it trading at a P/E of 10 and up. Then we are talking about more than 5 times the current stock price of $0.48!

Of course, how the stock actually fares in the future depends on if they can keep the growth going. Regarding this, I see huge growth potential from company's recently acquired Shanghai Jin Ao subsidiary for the next few years. Here are three key reasons.

(1) Shanghai Jin Ao recorded a revenue CAGR of 26% from 2005 to 2007. 2008 is on track to be another good year. Projected revenue contribution in the second half of 2008 is $1.6M (or RMB 11.04M), which is about 22% higher than the whole-year revenue in 2007 (RMB 9.07M).

(2) The subsidiary is now only producing 2,000 tons out of the total 14,960 tons of capacity (in soybean-based products).

(3) Shanghai and Shenzhen account for 80% of current revenue. This indicates a lot of room for nationwide expansion.

Looking to the longer term, India market and company's collaboration with Sanitarium promise to be additional growth drivers.

Feel the Business

Any microcap story is flawed or incomplete at best, until one can be reasonably assured about the credibility of its underlying business. In the case of China Yingxia, CEO Ms Jiao has won quite a few provincial and national awards and recognitions over the years. China Yingxia’s operating company Harbin Yingxia is among the government-endorsed top 10 agricultural firms in Heilongjiang Province.

To get comfortable with China Yingxia’s business, I have spoken with a few people within or related to the company. A business consultant spoke quite highly of China Yingxia’s Shanghai Jin Ao acquisition as well as its long-term collaboration with Australia’s Sanitarium.

My most recent conversation occurred this past Saturday with company’s new subsidiary (China Xianhe) in New Delhi, India. Although the team is still small (6 people selling 6 cactus-based products) at this stage, it is quite upbeat about the Indian market. China Xianhe’s Mr. Zhang compares the current Indian market to that of China in the 1980s. He then points to the huge Indian population of 1.1 billion. According to him, China Yingxia has also contracted another office in a central Indian city (which he didn’t disclose).

All told, stars look aligning for China Yingxia…

Disclosure: Author is long CYXI as of this writing.