If you look at my portfolio, you may conclude that I am very conservative and will not and is not looking at investing into small high growth stock which pay little or no dividend. This is not exactly true though I am not terribly optimistic that I will find such opportunities frequently in the local market. They are by far too few and if they happen to be there, I may not be able to spot it early on and get invested.
But that does not stop me not continuously scouting and looking around for such potential. If I think I find one, I will be mostly willing to put some money in it.
Today, I will talk about one such potential that I have been looking at for a while but I must conclude that I am not convinced by it as yet. - Oceanus. This is an interesting case as all the standard valuation techniques cannot be used.
There is not FCF and actual sales is not exciting. Why Oceanus?
Yes, Oceanus - a land-based abalone farming company operating in Southern China whose Chairman is a Singaporean. It offer an enticing notion - more than a billion consumers in a rapidly affluence country where abalone is considered a "luxury" food item.
However, when I Iook into it a bit more, I am not comfortable with it. There is a possibility that it will take off but there is also a high chance that this will blow-up or just shrivel down and die away quietly. Or even sold off to some bigger acquaculture company at an unexciting price eventually.
First, the actual sales it not really there, RMB 106M in Q12010, RMB103M in Q22010. It made a net margin in both quarters by having a fair value gain in it biological asset (BA) of RM 177M in Q12010 and also RM 177M in Q22010. What is fair value gain in BA? It basically means that the abalones in the farm have gotten bigger and worth more in the market and new young abalone additions that did not exist last quarter. Now, this is counted as revenue which in reality the sales did not actually happen and the risk is still with Oceanus. Also, there is no guarantee that the market price will remain the same or go higher.
The bulk of Oceanus assets is in the BA, currently at RM 987M. Although, the company have taken some preventive steps to prevent large scale infection (by separating them into tanks) and insuring part of the BA assets, this is no guarantee that nothing bad will happen.
Most of Oceanus land-based farms are near the coast, a torrent of heavy floods or typhoons could possibly wreck havoc with the crop. There is also the possibility of poaching when the abalones have grown bigger and hence more valuable. I have not seen any comments by the management how they can prevent this from happening.
I also, read that abalone need 5-7 years to reach length and weight maturity. Small abalones are worth very much less than bigger ones. This means that Oceanus is currently "burning" cash very fast to feed the young abalones. Real profits are still a few years away.
Evidence from this is from the cash holding which drop from RM 561M in Q42009 to RM 185M in Q22010. Oceanus has recently completed two rounds of TDR in Taiwan to raise cash, I believe. They took a loan of $74M in 2009 at a interest rate of 9%. In exchange, they issue 490M warrants to the lenders which can be exercised at any time before 2012 at a price of 0.15ct/shr. There is definitely heavy dilution going on but I think this may not be suffice. I think they will need additional cash later on but I doubt they can get them on good terms. As at June 2010,one-third of the warrants have been converted. I guess they have been converted in exchange of TDR which is currently trading at a premium to the SGX shares. This may allow the investors a window to take risk off the table and profit.
I read from some sources that the ratio you can keep young abalones (< 1 year) to mature ones (> 5 years) in tank is about 12:1. Now, I think most of the abalones in Oceanus farms are young, if they grow bigger, they might have an issue with tank sufficiency. I read that there are going to put the bigger ones into into sea for conditioning and fattening, but I think the issues behind could be tanks sufficiency. Trying to acquire more tanks means acquiring more farms but the cost may be prohibitive. The group intend to implement sea-farming once the trial is successful to enhance weight and selling price, but we know sea farming is riskier than land-farming due to difficult to migitate natural disasters.
I also note that they tried unsuccessfully to established a cafe-style restaurant chain serving abalone-meals in China due to poor net margins. I wonder if demand for live abalone at the right price is so good in China, why the management need to bother about setting up a restaurant channel to consume the produce from the farms at this stage in the company growth cycle. Lately, they are turning to processing farm produce into canned abalones instead. With this, I am getting the impression that may not have sufficient confidence and market know-how in selling the live produce in the china market as yet when volume ramp-up.
Yes, despite all my analysis, I might turn out to be wrong and this will turn out to be an excellent opportunity. But as value investor, I look at it and decided that it is not worth taking the risk at 0.315cts/shr as I inclined to believe that there may be more dilution to go on to raise capital assuming no serious aquacultural disasters.
I hope to revisit Oceanus at some future date for a reassessment.