What YONG Should Do Now
Simon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you're a Yongye International (NASDAQ: YONG) shareholder, it's been a tough year.
In fact, "tough year" is putting it nicely. Even after it's run-up this past week, the stock is still down 9% in 2012, which is in addition to the 58% crushing it got in 2011. The finger-pointing has already begun, but there are a few reasons that have been largely to blame for the brutality:
- Slowing revenue growth
- Account receivables balance
- Distrust toward Yongye and/or Chinese stocks in general
Perhaps it's a good time to review where Yongye stands on each of these issues.
Shengmingsu's buzz is wearing off
Yongye's prima-donna product has always been Shengmingsu, which is a highly concentrated liquid crop nutrient that enhances the uptake of nutrients and fertilizers into certain crops. Yongye claimed on their last conference call that 1Q'12 sales of Shingmengsu were only $14.1 million. But in 1Q'11 the company sold $49.2 million of Shengmingsu, so it's down 71% year over year. What gives?
The reason is because Yongye has released two new products - Qianggenbao and Zhongbaosheng (imagine pulling one of those in a spelling bee) - that are complementary to Shengmingsu. These products are recommended to be used in the 1Q to focus on strengthening seeds and improving root nutrient uptake. Farmers then follow up in the 2Q with an application of Shengmingsu. Apparently the company's marketing strategy worked. The two new products comprised 77% of 1Q sales, even though they were just launched and are still only mentioned in the FAQ section of the Yongye website.
To assess whether their strategy really worked out, we will have to keep an eye on Shengmingsu sales for the 2nd quarter and see if farmers are actually taking the seasonal recommendations.
Yes, you still have to pay us
Yongye's distribution network makes its accounts receivable collection an agricultural nightmare (right up there with locusts and badgers). They manufacture product and sell it to provincial level distributors, who further sell to county-level distributors. Finally, farmers buy the products from very small, branded retail stores. At the end of 2011, Yongye had a whopper of an A/R balance at $154 million, which was 40% of the company's $390 million of sales that year. The company issued a press release in April that they had successfully collected $140 million of the A/R balance. Proof that they were collecting their bills would reduce the perceived risk of the market and jolt their stock price up, right?
Not exactly. Aside from a quick pop on heavy volume the day of the announcement, YONG has since traded down almost 10%. Yongye is extending favorable terms to its distributors (six months payment terms, among other privileges that include free vehicles for hitting sales targets). However, to get the attention of the heavy wallets, Yongye will have to crack the whip on its customers and prove that they can get paid more efficiently. Culturally, this could be much more difficult than it sounds. Favorable terms are a part of "how business is done" in rural China.
Risk is a four-letter word
Investors have warmed to China recently about as much as Netflix subscribers warmed up to the Qwikster announcement (in case I was too subtle with the sarcasm, they didn't). Confirmed Chinese small-cap fraud cases such as China Media Express alongside short-selling research reports from Muddy Waters and others have scared the Qianggenbao out of potential investors. Allegations about Yongye have ranged from poor transparency and questionable policies, to Absaroka Capital laying out eight accusations claiming fraudulent activity and 'selling an ineffective product to easily duped customers.'
That last one is just a low blow. Having recently visited rural China (en route to the Great Wall), I made it a point to personally speak with farmers in several villages to get their take on Shengmingsu. Though our sample size was small (~5 stops) and was only in the Huairou county, two things were present in each of our interviews. 1) Shingmengsu does exist and the farmers have heard of it; and 2) they all shied away from it because it is much more expensive than other..ahem..*natural* fertilizers. It was clear that Yongye is beginning to build its brand awareness in the country, but there is still a long road ahead of them to convince poor rural farmers to switch to a much more expensive product. And if fellow Fool Tim Hanson's dad can get Shengmingsu to boost the size of his peppers, I'm convinced that farmers who do this for a living can achieve positive results as well.
Yongye is audited by KPMG, who is a Big Four auditor with a pristine reputation. I won't believe in fraudulent book-cooking unless it is them that raises a red flag. Morgan Stanley has also undoubtedly done their own due-diligence in support of their recent $50 million investment in Yongye. But investor sentiment is not changed overnight, and there will no doubt be a watchful eye and an emotional drag that follows Yongye for an extended period.
So what is YONG supposed to do?
There is a pretty clear disconnect between Yongye's company and stock performance. In time, for good companies, these two will converge. That isn't to say that investing in YONG isn't without risk (it is), but the company is growing revenue at 30% a year and net income at 100% a year, while the stock is down 35% over the past twelve months.
I think this is a prime chance to pull a page from Warren Buffett's playbook. Similar to the advice that the Berkshire Hathaway (NYSE: BRK-A) CEO famously gave to Apple's (NASDAQ: AAPL) Steve Jobs in 2010, Yongye should take this opportunity to buy back shares. If YONG ends the year Free-Cash Flow positive, they should take a good look at buying back their stock -- which trades today at a P/E multiple of 1.3 and only 2X the cash they have in the bank. Coupling today's growth rates with fewer shares outstanding could really boost the languishing stock price.
Convincing rural farmers to take a chance by using a new chemical in the fields that they depend on to make a living is not going to be easy. I personally own shares of Yongye, but see this as a long-term investment that will take years, not months, to play out. The company is continuing to build a branded network and is establishing trust with a customer base that could provide recurring revenue for decades. They should take the opportunity to buy back shares while they're still a bargain.
Simon owns shares of Apple, Berkshire Hathaway, and Yongye International. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple and Yongye International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
