GEO Investing

Tianli Agritech (NASDAQ:OINK): Sluggish Trading in OINK’s Shares and Subdued PE Multiple May Persist for a While.

Patient OINK investors turn focus to 2012 when more substantial revenue and EPS growth should resume.

OINK’s shares have drifted lower recently after a sharp spike up and reversal in heavy trading on January 7, 2011, when management released 2010 and 2011 guidance and rang the opening bell on NASDAQ.  The EPS guidance was $.90-$.92 for 2010 and $1.04-$1.14 for 2011.  This was very much in line with my own financial modeling that indicates $.92 and $1.09 for 2010 and 2011, respectively.

Recent trading in OINK has been sluggish.  OINK’s PE multiples are subdued at around 6X likely 2010 EPS and 5X 2011 guidance.  So what ails OINK’s shares?

Upside Surprises Unlikely to Impact 2011 Operating Results but Negative Factors Might

Now that guidance is out investors apparently don’t have that much to look forward to in 2011 other than additional acquisitions which would impact 2012 and beyond.  Barring unforeseen developments, 2011 operating results should be in line with guidance.  While possible upside surprises for 2011 may not be apparent there are negative factors that could manifest themselves during the current year including:

  • Increasing Hog Production Takes Time: There are no quick fixes to speed up the process for increasing the production of hogs.  OINK has completed construction of its 9th farm but production from that facility will not materially impact operating results until QIV.  The recently acquired 10th farm won’t begin contributing to operating results until QI 2012.  That’s because breeding and raising hogs takes time.  The gestation period for hogs is 15 weeks.  It then takes four months to raise breeder hogs to their target market weight of 110 lbs. and another four months to reach breeding age.   It takes ten months to grow meat hogs to their target market weight of 220 lbs.  You can’t fool or speed up Mother Nature!  The process simply takes time.
  • Rising Corn, Labor and Overhead Costs Could Impact Profits: Corn is the primary ingredient in OINK’s feed for its hogs.  Corn prices have been on the rise worldwide and that trend is likely to continue during 2011.  Increased feed costs could impact margins at some point unless they can be passed along to customers.  In addition, direct labor and overhead costs will inevitably increase over time impacting profits going forward.
  • Central Government’s Attempts to Control Inflation Might Affect OINK: Rising food costs are causing political unrest worldwide.  Government authorities in China could impose price controls that adversely impact OINK’s revenues.  Price controls imposed last fall did not impact OINK but future actions might.
  • Market Prices for Hogs Can be Volatile: OINK sells its breeder and meat hogs at spot market prices.  Hog prices have shown seasonal patterns and volatility in the past.  Such price trends could either benefit OINK or not in the future.
  • Difficult Quarterly EPS Comps During 2011: Although management does not give quarterly guidance my own forecasting models do.  My estimates call for around $.25 EPS in QI and QII 2011 vs. $.21 and $.26 in QI and QII 2010.  Nobody’s estimates are infallible but mine have been close to the mark so far.  There is a possibility that quarterly comparisons will not be well received by investors especially during the first half of the year.
  • Action or Inaction Regarding Auditor Will Impact Multiples: The tainted reputation of OINK’s auditor has dampened enthusiasm for many investors.  OINK’s auditor has been linked to some US listed Chinese small cap companies that are alleged to have financial reporting irregularities.  Whether the allegations prove true or not the market is punishing the shares of companies that use certain auditing firms that have had their reputations damaged by associations with questionable clients.  One could question whether such auditing firms are truly independent auditors that investors can rely on or simply facilitators and enablers for management.  For this reason the auditing firm used has been put at the top of the due diligence checklist for sophisticated investors.  Unfortunately for OINK and its shareholders the Company’s auditor is on the list of auditors to avoid.  Management has signaled they understand this issue and will upgrade auditors for the 2011 audit.  That means the red flag concerning the auditor will continue to fly over OINK until the change is made.

More Substantial Revenue and EPS Growth Should Resume in 2012

Increased capacity will boost 2012 operating results as the 9th and 10th farms add 20,000 hogs capacity each bringing total capacity to around 150,000 hogs.  OINK’s management has not given 2012 guidance and probably won’t until later in the year.  My own estimate is 2012 EPS of around $1.35 but a lot can happen to revenues and costs between now and then.

I believe patient investors will be rewarded holding OINK’s shares longer term if the auditor is upgraded and the company passes on the ground DD, but caution is advised. Based on what we know the risks of something going wrong seem to outweigh the prospects for favorable surprises.

GeoTeam Conducting On the Ground Due Diligence:  Investors should take note that the GeoTeam is conducting an on the ground investigation of OINK in China.  I am not aware of any material issues that have been uncovered so far but conservative investors may wish to hold off making commitments to OINK until Geo has completed its work.

At the time of this article Dan had no position in OINK.

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