Skypeople Fruit Juice (NASDAQ:SPU)

On December 16, 2009 we coded Skypeople Fruit Juice (NYSE AMEX:SPU) as a GeoSpecial. We subsequently conducted an interview with Spring Liu, CFO of Skypeople, to gain an understanding of the company’s growth path. The SPU growth formula is similar to many China firms we have followed; gain a leading market position, increase manufacturing capacity to meet demand, expand product offering, obtain better province coverage. Skypeople is hopeful that these factors will lead to an increase in earnings per share and the maximization of shareholder value.

The simplicity of company’s business plan of marketing and manufacturing juice products was the trigger for us to look further into its story.

The impetus for its branded line arose from a crafty management decision in 2008 which was made in response to declining concentrate sales during the global crisis. Normally, Skypeople would sell the majority of its raw material supply to its customers, but the global recession softened this demand. In an effort to maximize its concentrate production capacity, the company embarked on a strategic move to process excess supply into its own branded products. The move has paid off, paving the way for product diversification, new customer channels and fresh market opportunity.

There is an aspect to the company that we are not particularly enthused about. Historically, the company experience seasonality in its first and fourth quarters which tend to be dramatically stronger than the others. This stems from the limited ability of the company to build its supply inventory only during the months of July through April, referred to as the squeezing season. Due to capacity constraints and strong demand for its concentrate line during this period, Skypeople has less inventory to carry over into non-peak periods, essentially limiting its ability to generate additional concentrate or branded product sales.

We addressed this topic with Ms. Lui by expressing our opinion that smoothing out seasonality may result in increased stock valuation multiples. She understood our sentiment and briefly outlined several points to the company’s growth strategy.

“The main thrust of our growth strategy is to increase our concentrate capacity, enabling us to accomplish several things. First, increasing our raw material supply will enable us to more fully satisfy current customers’ demands as well as solicit new customers.”

Secondly, we can increase branded beverage production, where we experience higher margins, especially in our new cider beverages lines, which was introduced to Chinese market in the first quarter of 2009. Our goal is to expand this line domestically, which is currently only available in one province and consists of two categories (kiwi & mulberry). The opportunity to achieve substantial gains exists if the company can penetrate more provinces.

Third, Increasing capacity will help smooth out seasonality by allowing us to build up inventory to sell past the squeezing season (concentrate has a two year shelf life). ”

We also asked Ms. Liu if Skypeople would emphasize any particular product line. She indicated that the company will increase the production of kiwi products domestically and internationally, due to a competitive advantage it has with respect to its production technique, access to the largest kiwi plantation in Asia and its high profit margins. Skypeople holds two patents in the kiwi processing technique. Lui continued,

“In conjunction with this goal we recently doubled our apple juice capacity to 20,000 tons. Globally, apple juice is the second largest demanded juice product. We are planning to attract more customers, through our apple juice offerings, who we can eventually introduce to our KIWI product line. Additionally, as the Chinese standard of living rises we will increase our focus on higher quality branded juice products.”

Overall, we are intrigued by the SPU story especially since the stock has a trailing P/E of just 9.37 and book value of $2.30. The reason we have not coded the stock as GeoBargain is largely due the seasonality issue. We would like Skypeople to address seasonality as well as grow earnings 30% consistently. In order to increase capacity we anticipate that the company may have to tap the capital markets before the next 2010 squeezing season, which the company hopes will be accretive to EPS.

Below is a brief Q&A conducted by the GeoTeam with Skypeople.

Q: As demand for pear juice is lower than many other juices why did you also choose to recently expand your pear juice capacity?

A: Pear juice is a one kind of specialty fruit juice. Specialty fruit juices are squeezed from fruits that are grown in a relatively low quantity.

Pear is easy to get oxidized. To keep the nutrition value of the pear juice, special manufacturing techniques are employed to keep the nutrition value of the pear juice and prevent it from oxidizing. We are one of the few companies which can produce high quality pear juice. Our special manufacturing techniques not only keep the clear color of the pear juice, but also keep the nutrition value of it. As the competition in pear juice is mild, we enjoy a higher margin on pear juice. That is the main reason for the expansion of pear juice capacity.

Q: Please give us some history on your Mulberry product line?

A: We are one of the first companies to initiate large-scale production of concentrated mulberry juice in China. As the concentrated mulberry juice are processed from dried mulberry, it does not meet the requirement from the international customers, who require it be processed from fresh mulberry. All the concentrated mulberry juice made by us is further processed to our own branded beverages.

Mulberries are widely regarded as one of the most nutritionally substantive fruits available to consumers. They possess rich active proteins, vitamins, amino acids, carotenes, and a variety of essential minerals. Compared with other fruits, the concentration of nutrients in mulberries is six times greater than that of apples and over four times greater than that of grapes.

As the harvest season for mulberries is only between April and May, and the quantity of mulberry produced in Shaanxi Province is not sufficient for our production needs, we produce mulberry juice from dried mulberries. Skypeople is capable of storing mulberries for at least 12 months, allowing for year round manufacturing.

Mulberries are mainly produced in the south part of Shaanxi Province and Sichuan Province. We are planning to transport our processing machines to these areas during its squeezing season and increase our production of concentrated mulberry juice and also meet the requirement of international customers.