Due to ongoing investigations by regulatory authorities and declining profits, share prices of China Fishery has suffered a heavy beating. As at today’s price of $0.051, China Fishery's market valuation is s$187.8 million (US$134 million).
Given that China Fishery holds one of the largest proportion of Peru's anchovy permits (approximately 17% of the country's quota) and that Peru is one of the largest exporter of such fish, the question is asked if Mr. market is pricing China Fishery correctly?
China Fishery business
In recent times, China Fishery has shifted from its contract supply business in the North Atlantic to that of processing Peruvian Fish meal. China Fishery’s main segment is now involved in the catching of anchovy in Peru, processing it and subsequently selling it off as fish meal to fishing farms worldwide. There it is commonly used as fish feed to rear other fishes which are farmed (e.g. Salmon).
China Fishery’s transformation has been achieved through its aggressive acquisition of fish meal processing plants and companies in Peru. The largest and of highest profile was the acquisition of Copeinca in 2013. Copeinca was one of the largest holders of fishing permits in Peru. As a result of these acquisitions, China Fishery‘s Peruvian fish meal business became its largest contributor to revenue. However, these acquisitions resulted in China Fishery being geared to a net debt to equity ratio of 57.8%.
The company now holds a large proportion of permit rights. And with Peru highlighting it is unlikely to issue more permits, one can safely assume China Fishery’s Peruvian fish meal business will not be eroded.
Balance sheet analysis
Given the low valuation awarded by Mr. Market, the signal seems to be that China Fishery’s business is in trouble and the ongoing investigations will destroy the company. However given that Copenica, now a subsidiary of China Fishery, holds an amount of Peru's fishing rights, it got me wondering what is the value of Copeinca’s business?
Valuation of Copenica
Before being acquired by China Fishery, Copeinca reported the book value for its fish meal business. This can be found in China Fishery’s FY 13 annual report:
From Copeinca’s own account books, its reported net book value of its business stood at USD $363,559,000. If we were to strip off the reported goodwill ($139,095,000) and property, plant and equipment adjustments of $29,140,000 which China Fishery wrote off, the carrying amount value of its business is USD $195,324,000. Furthermore, we have to account that China Fishery recently redeemed Copeinca's senior notes and hence this should be removed from our calculations. With that, the value of Copeinca is estimated to be in the region of USD $455,000,000 or s$638 million.
Consolidating this into the bigger picture, assuming the rest of China Fishery’s business has a zero book value and only Copeinca is of value, the group is worth about s$600 million or 16.22 Singapore cents per share (based on 3.684 Billion shares).
China Fishery’s Earnings
Besides analyzing China Fishery through the balance sheet, another aspect is via the company's earnings prospect.
From its recently released third quarter report, China Fishery’s 9 months' earnings have declined 64.4% to USD $18 Million. This was mainly due to Peru’s decision not to allow Fishing activity during 2014 Season B (Oct 14- Jan 15). Furthermore, its profitability was weighed down by its ballooning debt interest, a result of high debts. Lastly, its earnings per share have been declining over the past 5 years.
A turnaround next year?
In a bid to reduce its debts, China Fishery recently did a right offering at $0.173 cents per share. The proceeds was used to redeem Copeinca’s US$250 million 9% notes. With the redemption of these notes, China Fishery will save an annual interest expense of US $22.5 million. In addition, assuming China Fishery is able to conduct its usual fishing activities for both Fishing Season A and B, one can reasonably expect it to deliver a USD $60 million profit for FY 2016, similar to profit levels in FY 2014.
A profit of USD $60 million will translate to 1.6 USD cents earnings per share or 2.2 Singapore cents. China Fishery will then be priced at a prospective P/E of 2.3 times. Do note I made the assumption Peru opens both of its fishing seasons; 2014’s Fishing Season B was closed due to weather effects on fishing stocks.
So is Mr. Market right?
Benjamin Graham describes the stock market as a business partner who appears daily to either sell his interest or buy ours. This is how Mr. Graham describes “Mr Market”:
“Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.”
In short, the market is characterized by mood swings where prices quoted can be way depressed or over exuberant. As investors, it is important to us to discern that the prices quoted on the stock market are separate from the value of the underlying business behind each stock counter. This underlying value has to be appraised by us and not through the mood swings of Mr. Market.
Hence as individuals in the stock market, it is up to us to assess if a mis-pricing of China Fishery has occurred. This assessment can be based on the future prospects of its business and potential effects of ongoing regulatory investigations.
<Vested China Fishery at 0.048>