Good bug, bad bug — it sounds like the title of another Disney movie, but is actually the basic plot of an incredible Chinese growth story. China-Biotics (CHBT) was founded in 1999. It’s the largest domestic supplier of probiotics – ingredients that are added as dietary supplements to foods (yoghurts, for example), baby products and medicines. Probiotics are classed as ‘good bacteria’ because they have been shown to ease digestion, stimulate the immune system and combat allergies.
Unlike many businesses in the West, China-Biotics’ main challenge has been satisfying demand. Turnover is set to soar by “at least 50%” in 2010.
Historically, the local market has been supplied by imports from Europe and America, but the firm has just constructed a state-of-the-art factory in Shanghai, costing $28m. This has raised capacity by 150 tons a year (up from 12 tons), and should add $110m to the top line, delivering gross margins of 70% by 2011. A large slug of the production has already been sold to 31 customers. The firm now plans to double its output at a cost of another $18m over the next two years.
The main concern is that the company may overstretch itself. Running at full throttle with so many balls in the air increases the danger that it will slip up – especially as cash will be sucked up in building working capital to support its nationwide distribution.
China-Biotics (Nasdaq: CHBT)
But the balance sheet is rock solid after last year’s $74.9m share placing at $15, leading to net cash of $115m (or $5 a share) as at the end of March. Assuming the facility becomes fully functional, then China-Biotics should be able to hit turnover and underlying EBITA of $250m and $50m respectively by 2013. Assuming a ten-times multiple, adjusting for the cash pile and discounting back at 15%, gives an intrinsic worth of $19 a share.
So what are the potential pitfalls? There are big risks in owning Chinese stocks – not least from possible changes in corporate governance, tax, regulation and foreign exchange. But the upside is significant. So in light of the recent pullback in the stock, today’s price looks good for adventurous investors.
Recommendation: Speculative BUY at $12.40 (market cap $278m)