Deer Consumer Products (NASDAQ:DEER)

2010 Fourth quarter earnings review:

Reports fourth quarter EPS of $0.31, beating estimates buy $0.03., but guides 2011 EPS to be around $1.10, which is a little lower than analyst estimate of $1.15. Company announced a couple more shareholder friendly moves: Dividend and management/insider share lock up. The fact that SAIC filings do not match SEC filings and that Ben Wey has a history with this company, leave it open to short attacks.

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 U.S.A? 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?
- Annualized Operating cash flow divided by current liabilities is greater than one. The higher the better. (We will adjust current liabilities for Non-cash items).
- Cash divided by current liabilities is greater than one. This is the most conservative liquidity ratio. The higher the better.
- Is the company buying back stock?

There are also the following issues we must be aware of:

• Ownership structure:

"On April 1, 2008, Deer International acquired 100% of the equity interest in Winder from 50HZ Electric Limited. The transaction was approved by the EcoNomic Development Bureau of Yangjiang High-tech Industry Development Zone (the “Yangjiang Hi-Tech Zone”). Approval from a PRC government agency with higher authority may be required."

"Furthermore, the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors jointly issued on August 8, 2006 (the “New M&A Rule”) by six PRC regulatory agencies, including the Ministry of Commerce (“MOFCOM”), the State Assets Supervision and Administration Commission, the State Administration for Taxation, the State Administration for Industry and Commerce, China Securities Regulatory Commission (“CSRC”) and the State Administration of Foreign Exchange (“SAFE”), has a particular provision which requires that MOFCOM’s approval is required if a PRC domestic Non-foreign-invested enterprise or natural person acquires its/his affiliated Chinese company in the name of an offshore enterprise established or controlled by it or him. At the time of such acquisition, Deer International was an offshore enterprise controlled by some of our shareholders who are PRC residents. These same shareholders at the same time owned or controlled 50HZ Electric Limited, which made Winder an affiliated Chinese company of such shareholders. According to the New M&A Rule, this transaction might require the approval of MOFCOM. As the interpretation and implementation of the New M&A Rule are unclear, if the approval of MOFCOM is required, the approval that 50HZ Electric Limited has obtained from the Yangjiang Hi-Tech Zone may be deemed incomplete and the transferee, namely Deer International, may need to obtain further approval from MOFCOM."

• Currency Risk. An appreciation of the Renminbi(Chinese currency) against other currencies could hurt export sales.

"Historically, the majority of the Company’s sales are made as exports overseas with approximately 52% of our total sales made in North American and European markets in 2008 and 41% of our total sales made in North American and European markets in 2009."

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 brush that is being applied to theses 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 enact shareholder friendly moves. Credibility can also be restored if independent legal/SEC opinions validate accounting practices currently in question.

• Price = $9.31
• Trailing GAAP EPS = $0.62
• Fully-Taxed Trailing EPS^a = $0.56
• EPS Estimates (15% tax rate) = $0.77 (2010) , $0.96 (2011)
• Fully-Taxed EPS Estimates = $0.69 (2010) , $0.86 (2011)
• P/E based on Fully-Taxed Trailing EPS = 16.63

1. DEER meets 8 out of 10 GeoBargain® Requirements
   
   

   	Requirement	Comments
   	Recent 52-week High (generally within 3 months)	Must exceed $19.10
   	30% EPS Growth Rate	1st Qtr. 2010 EPS increased 300% over same quarter 2009 Full year 2010 estimates implies an EPS growth rate of 49.9%
   	10% Revenue Growth	1st Qtr. 2010 revenue increased 248%. Full year 2010 estimates implies a revenue growth rate of 93.6%
   	Strong Balance Sheet	As of 1st Qtr. 2010
   NO	Positive Cash Flow	(1,246,494 )
   YES	Debt to Equity Ratio less than 20%	0.0%
   YES	Current Ratio is at least 2:1	4.8:1
   	Return on Equity is at least 15%	Currently tracking at 12.8% (will likely exceed 15% if guidance is met).
   	Minimum Pre-tax Operating Margins of 8%	20% as of 1st Qtr. 2010
   	Preferably Under 50 Million Shares	33.8 Million shares as of 1st Qtr. 2010
   	High Insider Ownership (generally greater than 15%)	43% as of December 2009
   	Limited Institutional Ownership (generally less than 20%)	15% as of March 2010
   	P/E Divided by Growth Rate (PEG Ratio) is Less Than 1.	0.33

   
   
2. Has been extremely vocal regarding business prospects:
   
   
   • Reinforces that it "sees absolutely no signs of a consumer buying slowdown in the high margin Chinese markets for Deer's products."
     
   • Reassures that currency risk is minimal since DEER uses US dollars as the sole currency for its international sales.
     
   • Stated that it does not foresee any down side risk due to the European crisis.
     
   • Recently raised 2010 full year sales and earnings guidance:
     
     "We are comfortable with raising Deer's 2010 earnings guidance to approximately $26 million in net income on revenues of approximately $160 million, with significant growth anticipated in our seasonally strong second half of 2010. We see little execution risk in achieving and potentially exceeding these new earnings growth targets," concluded Mr. Bill He." (May 17 press)
     
     
3. Commitment to increase shareholder value and understands that EPS growth is the name of the game: DEER has initiated a $20.0 million stock repurchase program and DEER appears in no hurry to dilute.

   "Deer feels strongly about taking proactive actions in enhancing shareholder value. Deer has sufficient cash on hand to fund both the share buyback program and grow our business," commented Mr. Bill He, Chairman & CEO of Deer."
   
   "At March 31, 2010, we had $75.3 million in cash and cash equivalents on hand. Our principal demands for liquidity are to increase sales in China, adding capacity, inventory purchase, sales distribution, and general corporate purposes. We anticipate that the amount of cash we have on hand as of the date of this report as well as the cash that we will generate from operations will satisfy these requirements

4. DEER is set to exceed 2010 Analyst estimates.
   
   
   • Estimates have still not factored DEER's updated guidance.
     
   • Estimates likely do not factor Deer's stock buy back program.
     
     
5. As evidenced by the first quarter, net income is growing faster than sales.
   
   
   • Revenues of $23.9 million, an increase of 248% from Q1/09
     
   • Net income of $4.04 million, an increase of 515% from Q1/09
     

Note: We do require an explanation as to why cash flow from operations is negative. Also, DEER's P/E ratio is higher than many other U.S. Listed Chinese stocks. DEER's commitment to increase shareholder value and strong communication efforts with the street have given us reason to overlooke these two factors.

Potential Valuation Scenarios if the company can achieve its EPS growth goals

Short-Term Potential value based on fully taxed adjusted trailing EPS

P/E 25 * $0.56 = $14.00

^a DEER is not paying a full U.S. tax rate. Therefore, all EPS numbers have been adjusted by the GeoTeam to reflect a Chinese tax rate of 25%.

These scenarios are not intended to be investment advice, but are scenarios based on some commonly used investment guidelines. They are provided to aid investors in making their own investment decisions.