Monday, March 14, 2011

Is Chaoda Modern Dropping Because of an Unfounded Rumor that it Changed Auditors?

Chaoda Modern, the 3rd largest agicultural firm in China has dropped from a price of near HK$10 in the past year to somewhere near $HK4 currently. I suspect the current drop is due to an inaccurate rumor that Choada changed auditors -- but the last auditor Grant Thornton was acquired by the current auditor, BDO Seidman, which is the 5th largest auditor in the worldwide.

An article stating that Chaoda changed auditors appeared on Dec 31, 2010 on a blog -- Since that time the stock has dropped from $HK6 to $HK4ish, with the only other news a moderately positive 6 months ended Dec 31, 2010 earnings release (more on this earnings release below).

Chaoda is audited by BDO Seidman,which is the largest US based accounting firm outside the Big 4. The previous auditor Grant Thornton merged with BDO (reference: but no change in auditors. BDO actually is probably a stronger accounting firm than Grant Thornton, but Grant had a good reputation as well.

Grant Thornton gave an unqualified opinion in the last Annual Report:
source: p. 41-42

It should also be noted that Chaoda is ranked by Forbes as the 3rd largest agricultural co in China. It is very difficult to fake being one of the largest agricultural firms in the world's largest country in terms of agricultural production.

The results announcement was moderately strong. Chaoda reported good top line for the six month period ended Dec 31, 2010 (+18%) but flat in net profit, the main item was an increase in general and admin expenses to 6% of revenues from 2% the previous period, plus they issued shares to pay for mainly an acquisition of more land.

Shares increased as they issued equity instead of dipping into cash to fund expansion (don't really know why they won't utilize their very large cash and investment position). Chaoda has RMB3.8Bn of cash and no debt -- all assets are in RMB and look solid, buildings (RMB8Bn), vegetables in inventory (RMB2Bn) and they have very low liabilities RMB218M total. They also have RMB1.3Bn of equity assets - mainly I believe their share of HK listed Asian Critus. One asset is "prepaid premium for land leases" at RMB5.8Bn -- I believe this is tangible (prepaid leases, so expenses won't appear in future periods, as long as the firm is a going concern). With prepaid land leases, net tangible book value is RMB 24.9Bn while market cap is HK15Bn (RMB12.5Bn) so market cap is around 50% of book. PE is below 4 (interim 6 mo net profit is RMB1.54Bn).

Operating cash flow looks strong, equal to EBITDA of RMB1.8Bn for the interim period, but the co raised RMB2.3BN of financing (mainly equity) to fund expansion. Almost RMB1Bn from new shares issued over the past half year (this seems to me, not a huge dilution).

Note, the major reason for the increase in SG&A was an increase in options exercised, from only RMB6M in 2010 to 160M in 2011 - also note salaries were up about RMB100M (this is likely due to wage inflation in China, surprisingly workers are somewhat in short supply for farming). So this hopefully won't be repeated. -- they are approx 192M share options outstanding but the majority have excercise prices between $HK6.75 and HK$8.10 per share. The exception is the ceo who has 66M options with an excercise price of HK1.50 (but at least he'll be motivated to get the stock price up).

They are paying a dividend this year of RMB84M -- didn't pay a dividend last year. So at least will get some income, also shows they care about the stock price a bit.

Overall to me the company looks strong I don't know why it's dropping for sure -- the first drop, issuance of equity at HK$7.50 when the stock was trading at HK$9 -this made sense to drop, but the second drop, if it has anything to do with the rumor that they've changed auditors, is just plain wrong (the news of the previous auditor, Grant Thornton, being acquired by BDO maybe is not well known, and it may be thought that Chaoda really did want to change auditors, but BDO is a well respected accounting firm). So this one really has me scratching my head. It looks very strong, with the exception of the issuance of equity to fund expansion, that has made net profit growth relatively flat.

1 comment:

Robert said...

Thanks for the post. I had heard the rumors as well, and was starting to get worried. Thanks for clearing it up. Until your post I couldn't find any other information, as it was all in Chinese. I thought I was going to have to hire some translators! But, thanks to you, now I don't.