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Sunday 11 May 2014

The Humble Cassava And A Very Fishy Deal

The humble cassava or tapioca as is commonly known in these parts of the world is the third largest source of food carbohydrates in the tropics after rice and maize.  It is a highly productive crop in terms of food calories produced per unit land area per unit of time, significantly higher than other staple crops.  Cassava can produce food calories at rates exceeding 250,000 cal/hectare/day compared with 176,000 for rice, 110,000 for wheat and 200,000 for maize.

For the poor masses, cassava is a rich source of carbohydrates but a poor source of protein, surviving on a diet of predominantly cassava can cause protein-energy malnutrition deficiency.  Apart from keeping the poor perpetually malnourished, cassava has other uses as well, namely as an ethanol biofuel feedstock (mainly in China), animal feed, laundry starch and some say, a treatment for bladder and prostrate cancer.  But there is no convincing scientific evidence that it is effective in preventing or treating cancer.

Care has to be followed processing cassava as they contain cyanide and eating unprocessed or poorly processed cassava can cause acute cyanide intoxication.

Cassava is mainly sold in large quantities in dried chips form.

Asia Cassava Resources

While the dangers and impact on human health from eating cassava is well documented, investing in Asia's largest cassava trading firm on investors' pockets is poorly understood. 

Asia Cassava Resources Holdings Ltd (ACR), a Chinese company listed on the HKEX in March 2009 is the largest importer of dried cassava chips into China.  It sources its supplies mainly from Thailand which is the largest exporter of dried cassava chips.

ACR is majority owned (50.15%) by the Chairman Mr Chu Ming Chuan who is a Chinese national.

According to ACR, revenues have increased significantly due to an "agreement" reached with a "third party" to procure dried cassava chips from Thai government warehouses.  There has been no disclosure who this third party is.  And whilst volumes have certainly doubled, bargaining power remains firmly in the hands of the suppliers.

Profitability remains chronic, decreasing substantially in the past two years with the share price similarly falling precipitously.  Whether the recent increase in net income margin for the six months ended 30 September 2013 can be sustained is anybody's guess.

Being Asia's largest trader of dried cassava chips is nothing to brag about.

Cheap stock or a value trap?

Early investors who bought into the story and backed management are still licking their wounds.  A short lived ramp in the stock price from increased revenues at the expense of further erosion in margins have successfully pulled in a bunch of new punters.  Unfortunately these second batch of punters will eventually lose money as well.

On all value metrics, the stock is cheap.  ACR PE is 9x and it is trading at a discount to NAV of nearly HK50cents to the dollar and HK70cents to the dollar on Net-Net basis.  I will not be surprised if it has caught the radar of value investors' screens.

Value investors' ought to be careful with this value trap: ACR is nothing more than a middleman in a very low value and cyclical commoditized business masquerading as good story. 

It also does not bode well that dividends are poor with overall stagnant gross margins and declining net income margins.

Creaming off ACR's cash holdings sold as a Benefit to Minority Shareholders

Understandably, the business operates in harsh environment and minority shareholders have been long suffering but recent action by management will mean shareholders are about to experience an even rougher ride.  You see, ACR Board had just approved the purchase of a hotel in Rizhao, China owned by Mr Chu.

According to management disclosure; extracted verbatim: "The Group has always been in search of appropriate business opportunities to diversify its’ business portfolio and asset base."  Now where have we heard this before?  It's a standard text intended to lure unsuspecting small investors and a whitewash for activities that ultimately decimate shareholder value. 

One of the tenets of good corporate governance is to ensure the efficient and careful use of the company's resources.  And this means that the Board has a fiduciary duty to act in the best interest of its shareholders.

Does this transaction pass the good governance smell test? 

One of the ways to assess whether management is acting in the best interest of shareholders is to check to see if management have considered all options when it comes to using capital.

These options are:

  1. Pay down debt
  2. Increase dividends
  3. Share Buybacks
  4. Acquisitions - related or not related to core activity 
Lets look at these options one at a time:
  1. As at the latest interim, the company is carrying HK$430m of short term debt mainly denominated in USD which bears effective interest rate of between 1.80% and 2.80%.  Interest rates are considered low for a company of this nature.  Therefore it seems sensible that the debt need not be paid down.
  2. The company declared dividends similar to previous year despite overall distributable profits increased 20%.  By right dividends should have trended up, however a massive HK$100m increase in the Prepayment had effectively wiped out cash flows from operating activities.  No explanation given apart from some related party balances amounting to HK$2.5m was explained.  Potential warning sign - say no more.
  3. Share buybacks.  The stock as mentioned about is trading at nearly 50% discount to NAV and management should have taken initiated a share buyback program.  But this was not implemented. 
Which leaves option (4).  Buying businesses are risky affairs, usually it is the shareholders that are left holding a grenade.  There is a danger of overpaying and particularly in Asia it is a way for insiders to take minority shareholders to the cleaners.

This one is shaping up to be one of the cleaning variety.

Mr Chu is reportedly to have purchased the hotel for a princely sum of RMB47m (RMB15,400/sqm; RMB3,800/GFA).  He is now exiting at a profit of HK$165m a 180% return on his original investment.  What is such an astute property investor messing around with dried cassava chips you might add?  Good question indeed.  Mr Chu is shaping up to be more than a peddler of cassava, he is shaping up to be a charlatan.

Minority shareholders are now asked to pony up for a hotel more than 12 years old at a shockingly high valuation in a tourist area rather than a commercial hub.  I wonder what sort of valuer they will be using to justify this outrageous valuation.  A valuer that has been paid handsomely to come up with meaningless fudge.

The truth of the matter is, Mr Chu saw it fit to raid almost the entire unpledged cash balance of HK123.4m for himself.  This hotel is worth no more than what Mr Chu originally paid for it, if indeed he did even spent HK$59.2m in the first place.

If Mr Chu was really acting in the interest of shareholders, he would have initiated a share buyback program to buy back cheap stocks instead of pontificating how cheap the hotel is being acquired for - which isn't the case as there are many more listed hotel groups in HK trading at much lower multiples.

The other half of the of the purchase consideration paid in stock is nothing more than a smokescreen in a weak attempt to prove to minority shareholders that he still has a lot of skin in the game.  Mr Chu will cash out completely many times over this hotel deal.  Incidentally this devious transaction will mean Mr Chu now ends up holding 66.66% of ACR up 16.51%.  He can now treat minority shareholders with complete disregard.

Punters looking to profit from this misery should look at buying this stock when it goes down to HK20cents.  Because at that level, Mr Chu your friendly Chairman will have another transaction up his sleaves which will boost share price.

I will not be exchanging my tapioca cake for some ACR shares.

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