China Marine Food (NYSE AMEX:CMFO)

Global Hunter on CMFO (Update October 20, 2010)

Summary:

China Marine Food Group (CMFO) announced that it generated $2MM in sales of Hi-Power beverage for the month of September and raised its FY10 guidance for the drink to $23MM-$25MM from the prior $20MM, which we view as achievable. We attended the company’s Investor Day on 9/30 and came away with a positive impression of its operations and marketing campaigns. Following our visit and the company's announcement today, we are adjusting our estimates to reflect higher sales of Hi-Power beverage, higher marine catch trade expected in Q4, as well as increased marketing expenses. We continue to expect the company to deliver strong growth in the next two years given the consumer demand and distribution network expansion. Shares are trading at 7.6x and 6.0x our FY10 and FY11 EPS, respectively. We reiterate our Buy rating and $10 price target.

Highlights

Hi-Power beverage FY10 guidance raised. CMFO announced Wednesday morning that it expected the sales of its algae-based health drink, "Hi-Power", to be in the range of $23MM-$25MM for FY10, up from the prior guidance of $20MM. In the meantime, the company reported sales of $2.0MM from Hi-Power beverage during the month of September, which brought total Hi-Power sales to $6.7MM in Q3 and $17.3MM for the first nine months. As Q4 is typically a strong season for CMFO when consumers start their holiday shopping, we view the raised guidance as achievable. Hi-Power retail locations now total 12,000 retail points in Fujian. As a result of an aggressive campaign to promote its beverage products, we believe CMFO has incurred increased sales and marketing expense in Q3 versus the previous quarter.

Our recent visit to the company. We attended CMFO's Investor Day held in Xiamen and Shishi on 9/30. We visited several large retail stores such as Wal-mart and Tesco and several convenience stores in Xiamen, where Hi-Power products are displayed together with well known brands such as Redbull and Wanglaoji. We also visited a Hi-Power bottling factory and the company’s seafood snack facility. We were impressed with the company's production operation and its comprehensive marketing campaign.

Updating our FY10 outlook. Following our visit to CMFO, we are further convinced that there is sustainable growth in the company's seafood snack and Hi-power drink business. For FY10, we expect seafood snack to grow at a 30% rate and Hi-Power beverage to continue its strong momentum into Q4. We believe the company has used extra cash on hand to purchase a large amount of marine catch in Q3 and we expect a significant increase in marine catch revenue in Q4. We note that marine catch has a ~10% gross margin, versus 32-35% for seafood snack and ~40% for Hi-power drink products.

Adjusting estimates. We now anticipate higher revenues for FY10 due to a better outlook for Hi-Power beverage and significantly higher revenue expected for marine catch. We are increasing our FY10 revenue to $118MM from the prior estimate of $104MM. However, considering the company's aggressive marketing campaign for Hi-power drink, we are also substantially increasing our estimates for sales and marketing expenses. We now expect a total of $5MM in sales & market expenses in '10, versus $2.9MM we estimated previously. As a result, we are lowering our FY10 non-GAAP EPS to $0.83 from $0.90 previously. For FY11, we are raising our revenue projection from the prior $140MM to $150MM, reflecting assumptions of 25% growth for seafood snacks, 60% growth for Hi-Power drink, and roughly $25MM contribution from marine catch. Our FY11 non-GAAP EPS estimate is lowered to $1.06, from $1.08 previously, since we are also increasing sales & marketing expenses for '11 as we expect the company to expand its Hi-Power distribution to other provinces.

Reiterate Buy. We are encouraged by the execution and growth momentum of CMFO's business. We continue to expect strong growth this year and the coming year, driven by domestic demand and distribution channel expansion. Shares are trading at 7.6x our updated FY10 non-GAAP EPS and 6.0x our FY11 EPS, which we believe are undervalued. We reiterate our Buy rating and $10 price target, which is 9.4x our FY11 non-GAAP EPS estimate of $1.06.

Rodman & Renshaw on CMFO

We are assuming coverage of China Marine Food (AMEX: CMFO, $156.1MM mkt cap) with a Market Outperform / Speculative Risk Rating and 12-month Price Target of $9. 

Investment Thesis 

We view the risk/reward as hugely attractive at the current level and see little long-term downside risk. Both Mingxiang seafood snacks and Hi-Power are, by now, proven brands capable of developing a consumer following in some of the most competitive regions such as Fujian and Zhejiang. We believe that the expansion of CMFO’s footprint into other provinces for both products is a matter of time and bandwidth rather than capability. We also favor the company’s focused approach of signing up distributors on a region-by-region basis as opposed to a less focused sprawl into multiple localities. This approach enables management to focus on strengthening local distributor bonds, incorporating feedback one region at a time, and also more efficiently leverages marketing expenditures. 

With the announcement of BDO China as its independent auditor, China Marine Food has largely put to rest investors’ concerns over its financial integrity. Furthermore, CMFO has vaccinated itself from additional scrutiny by demonstrating the ability to quickly and effectively respond to such allegations. On the business front, CMFO is simultaneously executing upon topline and margin opportunities across its seafood processing and Hi-Power (海宝) beverage line, leading to our estimate of 27.1% and 20.7% EPS growth, respectively, in 2010 and 2011. CMFO has very conservatively guided towards 43.7% revenue growth to $100MM in 2010, driven by a 23-$25MM contribution from the Hi-Power beverage line, with the remainder attributed to sales increase in dried and frozen processed seafood, and significantly higher marine catch trading revenues. Our estimate and the Street consensus reflect significant upside from the company’s guidance.

Much investor attention had centered on CMFO’s entry into the beverage market with the acquisition of Xianghe and its product Hi-Power. Monitoring reorders, channel inventory, and distributor feedback on end-consumer reception has been key in achieving success for this brand, in our view. 4Q10 should be an important checkpoint for Hi-Power, from which the effectiveness of its recent mass marketing program can be gauged. The introduction of follow-up formulations (such as a low-calorie version) and obtainment of the “Green Food” certification (which garners the product a ~5%-10% premium in ASP) present further growth and margin opportunities for the Hi-Power brand.

Market Outperform Rating and 12-Month Price Target of $9. CMFO shares are trading at 6.0x its 12-month rolling forward consensus P/E and 5.9x our 2011 EPS estimate of $0.92. This compares with the historically traded range of 5.4x – 7.9x its 12-month rolling forward P/E, averaging 6.6x. In addition, before the company’s accounting integrity was called into question in June 2010, CMFO shares, on average, traded at 7.4x its 12-month rolling forward P/E.

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