China-Biotics announced its annual earnings for the 2010 fiscal year (which ends on 31 March 2010) on Friday, 6/11/2010. The company missed quarterly revenue and earnings targets and saw its shares drop by more than 9% on the day. Does the miss in estimates justify the drop in share value?
The company did increase net sales by 50.1%, to $81,363,973 with a gross profit of 70.42%. Other operating expenses are pretty much in line with 2009 numbers (27% of revenue). Income from operations went from $21,783,094 in 2009 to $35,280,665 in 2010. Pretty good news so far, you would think.
The EPS in Q4 of 2009 fiscal year were $.39 and EPS estimates for Q4 2010 were $.36. However, net income per share for the quarter was a mere $.13, a huge deviation from expectations. There are two main reasons for the decline in EPS, a good one and a bad one.
First, a minimal research will enrich you with the fact that $12.1 million was deduced from the operating income because of a “deficit arising from the revaluation of the conversion feature embedded in the convertible note issued in December 2007.” It’s a one time charge and does not affect China-Biotics future ability to generate earnings.
The second aspect is the issuance of 4.6 million additional common shares (plus 690,000 in over-allotment options), that raised $74.91 million in cash. As a result, the company had $155.58 million in cash at the end of the fiscal year, almost $7 per share. Why did the company issue all those shares?
China-Biotics is in the middle of a very extensive expansion process as it has built a new plant designed for the bulk additives business. The construction is done in two phases. Phase 1 of the project involved constructing a facility capable of producing 150 tons of probiotics per annum (previous capacity was 12 tons p.a.). Construction costs for phase 1 are $28 million and were funded by cash received from the sale of a convertible promissory note. The plant commenced production in February 2010.
Phase 2 will enhance the plant’s production capacity to 300 tons per annum. The construction cost of Phase 2 is funded by cash received from the public offering of common stock in October 2009 and is estimated to be $18 million. In addition, leasing fees of approximately $1.89 million were paid in December 2007. There are no future lease payments for the land lease.
So, with an expected future cash outflow of $18 million, the company still has about $138 million in available cash. Why did the company raise all this cash in the first place? It does not seem to benefit the initial shareholders. They will have to employ it somehow, but management has not stated how it intends to do that. The management has not announced any acquisition plans. If they would, my concern is that in a rapidly expanding market such as this one there is the risk of prices being inflated.
Although the adjusted per-share earnings (less one time expenses) of $1.28 per share are an improvement from $.88 in 2009, return ratios are significantly lower. But a long-term DCF valuation, even with a very conservative growth expectation, shows China-Biotics stocks to be considerably undervalued.
My main concerns are:
- the ability of the management to find feasible ways to allocate the big amount of cash it has available.
- an indication that clients are clearing their invoices later (accounts receivable are up 67.5%).
But the bottom line is that there is nothing in the annual filing that rationalizes the recent drop in share value as the fundamentals of the company are still just as strong.