Via valueblockbusters.blogspot.com/:
A few days ago I wrote about China Yingxia’s (CYXI) tremendous multi-year growth initiative. Let’s now look at some early results and assess its growth in a little more depth.
As mentioned previously the company had 500 franchise stores at the end of last year. Most of these stores were added last year, particularly the second half of the year. Meanwhile, the company introduced 104 new products throughout the year, bringing the total number of products to 186 from 82 in 2005.
The company did not just introduce new products. Despite heavy discount on these new products to gain market awareness, CYXI reported increase of gross margin to 54.35% in 2006 from 51.44% in 2005. The gross margin could have been higher if not for the price discounts. Obviously the company has selectively introduced new products of higher overall gross margin.
Clearly, 2006’s product and store expansion efforts have not been fully reflected in FY 06’s financial results. So it is natural for investors to ask if 2007 is likely to see some of the early results of the projected phenomenal growth. The answer is a square yes.
First quarter is seasonally the weakest quarter for CYXI, due to the extended holidays and vacations associated with the Chinese New Year. However, the company reported an 826% increase in revenue to $1.658M in Q1 2007 from $179K in Q1 2006. The company attributed the remarkable growth to increased number of products and franchise stores (that sell the products).
The gross margin for Q1 07 was 52.34% compared to –4.38% in Q1 06, due to the combined impact of higher-margin new products and lower discount.
We can expect to see more of the same growth picture for the stronger quarters of the year, Q2 through Q4. Besides the new products introduced last year, another significant contributor to this year’s operation performance would be a new high-end rice product introduced this year.
In my previous writing I mentioned about a special breed of rice for renal and diabetic patients. This special rice species originated from a patent transferred from Nanjing Agricultural University. It is called W3660 and lowers the content of soluble albumins to below 4% from about 8% in ordinary rice, such that it is consumable by patients suffering from nephropathy and diabetes. CYXI expects strong market demand for this product and estimated its revenue potential at $10M a year, starting 2007.
Along with increased sales from existing products, W3660 is likely to lift this year’s revenue to above $20M from last year’s $8.4M.
In my previous writing I also mentioned about a simple model I used to peek into CYXI’s financial performance in the next few years. Trying to be conservative, I left out impact from W3660. But that was because I missed the company’s March 5 press release . A $10M annual revenue contribution is clearly not something I meant to ignore for a company that had only $8.4M of revenue last year.
So I went back to update my model. And not too surprisingly, the model now indicates an ROE (and ROC) consistently above 30% through 2011. When I also accounted for the time-lag factor for last year’s expansion initiative (i.e., not all 500 stores were selling CYXI’s products full year and at full capacity), I got an ROE of above 40% for the same 5-year period.
If you are wondering why I’m so obsessed with ROE and ROC, please allow me to tell you that growth creates value only if a company can achieve an ROC that is higher than the cost of capital. When the reverse is true, growth actually destroys value. In that case, the faster a company grows the faster it is heading for extinction.
That is why a company that consistently grows 10% per year at 25% ROC is far better than one that grows 70% a year at a meager ROC of 3%. The former is heading for long-term prosperity; while the latter might well be in for a downward self-destructing spiral.
Another point to note is that CYXI’s growth appears entirely organic, at least for now. No, I have not got to the point where occasional acquisitions would keep me awake at night. But as a value investor, I always like companies that can generate growth from within. This is particularly important for a young company like CYXI. Throughout investment history, there was no lack of examples of “serial acquirers” collapsing out of indigestion and mounting goodwill (and debt) that went bad.
That is not to say that CYXI never will have a need to pursue acquisitions. But the fact that the growth we are seeing now does not involve it just leaves plenty of room for them to pursue additional opportunities should a need arise in the future.
All in all, not all growths are created equal. And in CYXI we are seeing a few key ingredients for a tremendous value-creating growth.
Disclosure: I own CYXI as of this writing. For investment risks refer to my previous writing .
$2.44 (07/21/07)
