China Transinfo Tech (NASDAQ:CTFO)

Added to the GeoBargain list on August 12, 2009 @ $5.67

Catalyst: Strong guidance; Low valuation.

Peak performance: Reached a high of $12.90 on Oct. 12, 2009

Current Price: $6.84

Current road block: Issued net income guidance, but no EPS guidance; EPS is forecast to grow less than 30% for the 2010 June quarter; Cash Flow from operation for the 2010 first quarter was negative $10.2 million; Increase in account receivables.

From an EPS point of view, except for the 2010 & 2011 June quarters, CTFO is forecast to meet our 30.0% minimum growth requirement.

• June 2010 quarterly EPS estimate: $0.12 vs. $0.13 in 2009
• June 2011 quarterly EPS estimate: $0.11 vs. $0.12 in 2010 estimate.

The pressing issues are the company’s negative cash flow and increasing accounts receivable positions.

"Net cash used in operating activities was approximately $10.20 million for the three-month period ended March 31, 2010, while for the same period of 2009, we had approximately $3.96 million net cash used in operating activities. The increase of the cash used in operating activities was mainly attributable to the increase of accounts receivable, which was mainly due to the increase in sales and slow seasonal collections during the first quarter of 2010. We also experienced the increase in other receivable, which consists mainly of contract bidding and performance bonds that we put into escrow accounts set up by our customers for contract bidding and performance purposes. Such increases were in correlation to the increase of our sales and also negatively impacted our cash from operations. We also had the decrease in accounts payable and billings in excess of costs and estimated earnings on uncompleted contracts, which also negatively impacted the cash flow from operations for the three months ended March 31, 2010 compared to the same period of 2009."

We are not sure how much of an issue is created by the negative cash flow position. In 2009, the company ended up with positive $8.8 million operating cash flow, after being negative $2.4 million for the first nine months.

The real issue is one of timing: Will the company�s cash flow inconsistencies enable it to sustain growth initiatives during times of cash flow pressure and necessitate a capital raise? (note: as of the 2010 first quarter the company cash stood at $25.8 million, which could help mitigate cashflow concerns.)

According to the company liquidity is sufficient:

"We believe that our current cash and cash equivalents and anticipated cash flow from operations will be sufficient to meet our anticipated cash needs, including our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional cash due to changing business conditions or other future developments, including any investments or acquisitions we may decide to pursue."

The company also recently secured a loan agreement:

"On June 21, 2010, Beijing PKU Chinafront High Technology Co., ("Beijing PKU") a variable interest entity of China TransInfo Technology Corp. entered into a short-term loan agreement with Bank of Beijing, Zhongguancun Branch ("Bank of Beijing"), pursuant to which Bank of Beijing has agreed to loan to the Beijing PKU RMB 30,000,000 (approximately $4,400,000) as working capital."

Still, investors must realize that the cash flow and accounts receivable situation may limit P/E expansion.

Our intent over the short-term is to build a check list to assess the risk position of firms in the ChinaHybrid space. For the time being this will consist of the following: (this list is likely to grow substantially)

-Is the company's auditor ranked in the top 100?
-Is the auditor located in the USA? If located in China the PCAOB (Public Company Oversight Board) may be denied access to investigate the practices of the auditing firm. Short sellers have been using this information as a tool to validate their opinions.
-Are the company's internal controls satisfactory?
-Are their any outstanding legal issues?
-Do the company's top ten customers represent less than 10% of revenues?
- Operating cash flow divided by current liabilities is greater than one. The higher the better.
- Cash divided by current liabilities. This is an the most conservative liquidity ratio. The higher the better
- Is the company buying back stock?
- Chinese filings match respective SEC filings.(In process)

GeoTeam Note:

Short term and risk adverse investors should be aware of the quality issues currently present in the ChinaHybrid Space, questioning the validity of what seem like solid fundamental stories. It is beginning to get ugly so be cautious and understand that more pain may have to be endured, as ChinaHybrids are easy prey for short investors. The broad stereotype that is being applied to these stocks appears unfair, but we can’t ignore the psychological impact this can have on investors’ portfolio decisions. If history is our guide, fear will eventually create an immense opportunity to invest in the companies that prove they can meet quality litmus tests and enact shareholder friendly moves. Credibility can also be restored if independent legal/SEC opinions validate accounting practices currently in question.

We have yet to verify if the Chinese filings for ChinaHybrid stocks we monitor match respective SEC filings. We are in the process of completing this task.  Conservative investors may want to limit exposure or buy put options on stocks that have this availability as insurance against long positions, until we publish our findings.  Odds are we will identify some promising companies that will fail this litmus test.