GEO Investing

ChinaHybridâ„¢ companies have begun to report financial results over the past three weeks. We believe it is important to provide investors with year end updates on these companies so investors can begin to sift through the volumes of information in order to identify stocks that may offer the best chance of success during 2011, as well as the challenges that exist.

Over the course of the year-end results schedule coming out of China, we will be making all of our data available, real time, on the GeoBlog. Please check back daily, as the spreadsheet will be constantly updated.

We are compiling our wish list of stocks to watch in 2011. Once narrowed down, we will pull SAIC filings to verify if they match SEC filings. Ideally, we are searching for companies that:

  • reported superb EPS growth,
  • and/or expect superior growth for 2011;
  • offer minimal dilution risk;
  • possess effective internal controls;
  • do not retain controversial auditors;
  • and/or are in the midst of upgrading auditors

We have eliminated CDII, SGTI, CJJD, SCOK, and CPSL. All of these companies have retained auditors that have come under fire in recent months.  All but CPSL have ineffective internal controls; however, near term growth outlook will be uncertain due to industry dynamics. Furthermore, a capital raise appears to be a high priority.. SCOK’s business has been negatively affected by government legislation resulting in a temporary shutdown of mining operations in their locale. We will revisit story at the end of March, when restrictions are expected to be lifted. CJJD has been a laggard since its entry into the public markets and is now looking at a challenging competitive environment leading to subpar EPS growth estimates, that call for under 15% for fiscal 2012. CDII gave impressive net income guidance but without EPS guidance. Additionally, taking into account their propensity to raise money, we believe another capital raise is certainly in the cards. For investors who choose to ignore auditor/internal control risk but have faith in analyst estimates, SGTI and SCOK may be stories worth tracking. The EPS growth outlook for SGTI’s next two quarters should be well above average; however, unless estimates are revised upwards, 2012 EPS growth will be anemic at less than 10%

ANNO is a newcomer to the scene. We have done no due diligence on this company. Demand seems strong, though internal controls are ineffective and we see a high probability of a capital raise in the near future.

We have also eliminated YYIN, CGPI, CHPN, CSWG, GDHI, SINO, and CNGL. YYIN faces a challenging market environment due to the recent infant formula issues. The company commented:

“We have chosen to adjust our guidance due to the recent turbulence of China’s infant formula market, which has created a challenging environment for implementing our transformation strategy.”

We see this stock possibly headed lower to its book value per share of $0.45. CGPI is in the midst of responding to our inquiries.  We hope to have more clarity on the issue within the next seven days. CHPN Revenue growth has been anemic, catching up to its EPS growth that has turned decidedly negative. CSWG has offered no outlook. GDHI is way too early to consider and has a ton of shares outstanding. We listened to the conference call that offered lots of “aspirations and intentions”. SINO is losing money and will continue to be negatively impacted by the revaluation of the $ to the RMB. We want to like CNGL, but EPS inconsistency and a penchant to raise money will currently keep us at bay for now. Overall, CHPN, CSWG, and CNGL seem likely to tap the equity markets.

Its important to note that although we have removed these companies from our consideration for the portfolio, they are still trading at absurdly low p/e multiples. If the RTO space is to recover and/or these companies improve their corporate governance quality, investors may be able to bid up the p/e multiples from current levels. Investors should pay close attention to companies with effective internal controls  whose audits are signed off by top ranked auditors. Of course, we will continue to revisit these stories for updates and developments, willing to pounce on opportunities as they occur.

Who has peaked our curiosity on the RTO front? We will closely follow newcomers OPEI, EGHA, and BFTI.

OPEI is engaged in two energy-related business segments in China, the wholesale distribution of finished oil products and the operation of retail gas stations. OPEI completed its RTO in early September 2010 and we have seen shares quietly rise from $5.75 to its current price of $8.45. The stock trades with relatively low volume.

EGHA is a manufacturer of footwear and came on the scene in October of 2010. The stock is also trades low volume; however, this could change as communication flow with investors has slowly begun.

BFTI has had six quarters of year-over-year EPS growth in a row. EPS for the last three quarters has been sequentially stagnant which could imply that the company may have to tap financial markets. However, the company seems akin to exploring options other than equity financing.

Even though all three companies do not retain top auditors (though they have not been specifically targeted by the media, yet), each seems averse to using equity to finance near-term growth, claiming that debt and internal cash will be the primary sources of capital. We also like the fact that they are new kids on the block, with light volume, which will hopefully subdue short attacks for some time.  Additionally, all three have effective internal controls and have exhibited strong EPS growth. OPEI sports a P/E of 8.4. Could this imply that investors see quality here? Of the two, EGHA’s prospects for near-term EPS growth seems more certain, based on company commentary:

“The Company plans to purchase more manufacturing equipment to increase its production capacity during the second half of fiscal year 2011, in order to meet increasing demands of our shoe sole products.”

OPEI earnings comparisons appear more challenging in the near term. More due diligence will be required to determine short-term growth prospects.

EGHA is an FIE which means it will be easier to verify SEC numbers, as opposed to OPEI and BFTI, which are both VIE’s. However, OPEI is audited by BDO–a supposed ‘top auditor.’ Other companies with unranked auditors but effective internal controls include CHHE and TPI.  We will continue to actively track both of these FIE’s that were once GeoSpecials.  TPI has still not addressed issues of mismatched SAIC filings.

YTEC, LPH and ONP are RTO’s that retain what some consider to be top auditors. Since ONP has been through the ringer we may consider long term call options once its audit is completed. YTEC quarterly EPS growth is expected to be inconsistent despite showing annual growth.  LPH shares outstanding are well over our threshold for an RTO. We generally like to buy companies with outstanding shares of 25 million or less, but we will consider up to 50 million shares.

Some investors may be somewhat intrigued by CMDI, but they will require capital– possibly why the chart is dismal despite some impressive EPS gains. Internal controls are also not in check.

We plan to pull SAIC filings on OPEI, EHGA, BFTI, and CHHE– maybe giving us the green light to take speculative positions If trading volume eventually improves. All four of these stocks trade on the OTCQB.

None of the companies in this list will be considered Tier 1 companies, as they do not have a top 6 auditors and came public via reverse mergers. The companies mentioned should only be considered by risk-seeking investors.

We did not see any IPO’s with compelling value in the last week. We will be watching YGE, CMED, and HOLI for analyst estimate revisions. An interesting comparison between just these three IPO’s and the slew or RTO’s is the difference in quality of auditors–YGE is audited by KPMG; CMED by PWC; and HOLI by BDO. If these young companies can retain top auditors, the young RTO’s should theoretically have the same ability.

Please see this spreadsheet for more details.

Stay tuned as we continue to offer more insight into upcoming earnings releases. If you have companies you would like us, including our attorney Bob and our analyst Dan France, to take a look at, please send us a note

Disclosure: None