Weikang Bio-Tech (PINK:WKBT)

One stock on our list that may fit this bill is Weikang Bio-Tech Group.

1. Liquidity standing has improved. We have followed Weikang since April 26, 2009 when it had a negative working capital of $8.0 million. Over the past year the company has consistently improved its working capital position, which now stands at positive $1.15 million.
   
2. Need for expansion capital may not be a number one priority. Combined with its $18.1 million cash position and ample production capacity, the company should be able to grow EPS without having to dilute it shares. During a brief conversation with company management, it indicated that tapping the equity markets would mainly occur to take advantage of an accretive acquisition. (As we will discuss later, we would not be in total agreement with such a move at current prices).
   
3. Acquisition opportunities are abound. China's health and nutritional supplements industry is fragmented and characterized by many small players. Weikang believes that it can gobble up a few companies with complimentary product lines that need access to capital, technology and distribution channels that WKBT possesses.
   
4. Impressive growth track record. With healthy pre-tax margins of over 50%, the company has been able to grow EPS for five straight quarters in which only one quarter was below 30%.  Still, at its current price of $3.05 WKBT sports a meager P/E of 4.6
   
   

   Mar Rev (t) EPS	2010 13,959 0.20	Chg 38.1% 33.3%	2009 10,111 0.15	Chg 782% 650%	2008 1,146 0.02
   Jun Rev (t) EPS	- -	- -	13,196 0.13	543% 225%	2,051 0.04
   Sep Rev (t) EPS	- -	- -	11,227 0.16	225% 129%	3,452 0.07
   Dec Rev (t) EPS	- -	-  -	12,950 0.17	109% 6.30%	6,204 0.16
   Totals Rev (t) EPS	- -	- -	47,484 0.62	269% 114%	12,853 0.29

   
   
5. Healthy Product Pipeline. WKBT has a more robust line than usual. Typically the company would like to introduce about 2 to 4 products a year. Currently, WKBT has nine more products that could see preliminary launches during the 2010 third and fourth quarters.

Lack of investor awareness and a small float could make for a limited trading market in WKBT shares. However, the company has recently hired an IR firm and other than price qualifies for NASDAQ listing; two factors that should eventually help increase awareness. Also, the company has aggressively communicated its goal to maximize shareholder value. The validity of this goal is reinforced by the fact that insiders own 88.0% of the stock.

Another potential "psychological" road block is the existence of a 2010 Make good net income target of $17.0 million, associated with a recent private placement, that implies growth of just 12.2%. This creates a dilemma for us, as we normally seek EPS growth rates of at least 30%.

The positive news is that the first quarter's adjusted net income of $5.5 million translates into an annual run rate of $22.0 million which would imply a growth rate of 41.1%. Adjusted EPS for the 2010 first quarter rose 33.3% to $0.20. Combine these observations with the fact that the first quarter has historically been WKBT's low quarter in terms of sales and earnings, gives us added reason to postulate that the company can handily exceed its target. If we apply the first quarter outstanding share count of 27.4 million and $22.0 million in net income, 2010 EPS would come in at $0.80 implying a growth of 29.0%.

Still, investors need to be aware that WKBT may have to deal with some less desirable EPS growth rates in the third and fourth quarters, when comparisons become more challenging, depending on how net income falls.

Dilution:

Investors need to be aware of three issues with respect to dilution.

First, 772,000 in the money warrants exist which translates into only about 3% dilution.

Second, we cannot rule out a capital raise as the company has yet to complete a major raise as a public company. Regardless, with the low capital requirement needs of WKBT's model, we are speculating that a raise would only be required to make an accretive acquisition and hopefully at higher valuations. With $18 million in cash and an extremely low valuation, we believe a raise at current price levels would not be a great show of faith to WKBT shareholders. Then again, we must be mindful that the ChinaHybrid space has been known to blind side us with irrational equity raises.

Third and most importantly, there are minimal funding requirements that have to be met to satisfy the original conditions of the reverse merger. As part of the original reverse merger agreement on July 22, 2008 Sinary, the public shell that Weikang merged into and 98% owner of WKBT, was obligated to pay Weikang $7.6 million (RMB 57 million). So far no money has been applied to this liability.

The following passages from the most recent 10Q sums up where WKBT currently stands on this issue:

"Sinary was incorporated under the laws of the State of Nevada on August 31, 2007. On October 25, 2007, Sinary entered into an equity interests transfer agreement with the stockholders of Heilongjiang Weikang, a limited liability company in the PRC, to acquire 100% of the equity interests of Heilongjiang Weikang for 57 million Renminbi (“RMB”), or approximately $7.6 million."

"Under applicable PRC regulations, the acquisition is deemed completed as of November 9, 2007. Pursuant to the terms of the equity interest transfer agreement and the requirements of applicable PRC laws and regulations, Sinary had a grace period to remit the Acquisition Price of RMB 57 million by August 6, 2009, which was extended to June 30, 2010 pursuant to an approval letter issued by PRC government on August 7, 2009. In the event that we are unable to timely remit the Acquisition Price by June 30, 2010, the Heilongjiang Provincial Government and Heilongjiang Office of the State Administration for Industry and Commerce may revoke the approval and license of Weikang as a foreign invested enterprise, and Sinary as the 100% owner of Weikang, thereby unwinding the acquisition. In the event that the acquisition is unwound, we will not be the owner of any equity interest in Weikang, and as a result, Weikang will no longer be our operating business. Should this occur, it would have an absolutely detrimental effect on our business; the Company would most likely fail and YOUR INVESTMENT IN OUR STOCK WOULD BECOME WORTHLESS. If we are unable to timely remit the purchase price for the acquisition of Weikang, the approval and designation of Weikang as a foreign investment enterprise and Sinary as the 100% owner of Weikang may be revoked, and the acquisition of Weikang may be deemed void. Although we may seek to acquire the equity interest of Weikang through other means , we cannot guarantee that we will do so, nor can we guarantee that we will be successful if we do."

The issue that exists here is that, unfortunately, this liability cannot be legally funded via operations.. To rectify this situation, we would suggest that the company utilize debt or a combination of debt and stock, as well as urge management to buy back stock if it completes a raise. This would show a strong commitment to its shareholders.

We have asked the company to respond to this matter as it leads to the perception of a threat to the company's survival.

Overall we are impressed with WKBT's accomplishments. If the company can put to rest its capital formation issues, which we believe it will, and confirm that the 2010 net income target is conservative, which is often the case with make good targets, we are speculating that its shares can achieve P/E expansion.

Important Note: The financial table and verbiage included in the 2010 first quarter press release seems to contain errors.

The following statement appears incorrect:

Operating income for the first quarter was $6.4 million, up 27.1% from $5.0 million in the first quarter of 2009. Operating margin was 45.6% compared to 49.6% in the same period a year ago. Adjusting for the previously mentioned non-cash, stock-based compensation charge of $912 thousand, non-GAAP operating income was $5.5 million in the first quarter of 2010. Obviously non-GAAP should be higher than GAAP.

The 2010 Non-GAAP pre-tax number should be $7.3 million. Instead of adding back the compensation charge WKBT subtracted it. This is likely no big deal, but right now Chinese firms have to make sure they are impeccable with respect to financial reporting.

The non-GAAP adjusted net income figure of $5.5 million is correct.