Xinyinhai Tech (PINK:XNYH)

Via a 10Q filing Today, Xinyinhai Tech Ltd reported dismal 2009 third quarter results. Sales declined 38.7% to $1.9 million and EPS fell 66.7% to $0.01.  There was weakness in both of its product lines.

Equipment distribution business

"The current global recession has reduced demand for capital goods in China. Our revenue during the three months ended September 30, 2009 decreased by 39% to $1,921,858 from $3,143,423 achieved during the three months ended September 30, 2008. The decrease was most dramatic in our equipment distribution business, where revenues declined from $857,892 during the third quarter of 2008 to $224,422 during the third quarter of 2009.

The decline in equipment distribution reflected delays in the construction of new manufacturing facilities in China, as potential customers wait to see whether demand for their products is revived. The future of this business segment will depend, in part, on the success of the recent economic stimulus initiated by the Government of China."

Printing business

"During the three months ended September 30, 2009, the revenue from our printing business decreased by 26% to $1,697,436, compared to $2,285,531 during the same period of 2008. The decline occurred, in part, due to the weakening of the Chinese banking industry, as many of our customers are conserving cash pending stabilization of the international credit markets. The decline also occurred because we moved our entire production operation to a larger facility at the end of 2008, which interfered with our printing business."

There are two glimmers of hope

1. Xinyinhai Tech anticipates an improvement in the outlook of its print business which has higher margins than its equipment distribution business:

"Today, however, our new facility is fully operational, and we expect the traditional growth of our printing business to be renewed."

 2. The 10Q also shed light on its expansion plans:

"Our business plan calls for significant investment during the next twelve months. We plan to purchase new equipment for our new production facility. We also plan to invest in the development of additional product lines. To accomplish those goals, during the third quarter of 2009, we obtained a $2.9 million bank loan collateralized by our real property. We will utilize the borrowed funds to implement the capital improvements necessary for our growth."

Due to the stock selling under its book value per share of $0.59 and its receipt of financing, we will still code XNYH as a GeoSpecial, albeit not with the greatest degree of confidence. At these prices it seems worth hanging on to for a quarter or two as the China stimulus plan is still in full force.

Note: We are concerned that the Company has yet to respond to our multiple interview requests.

On October 15, 2009 the GeoTeam® published an article that highlighted U.S. listed China stocks selling at a discount to book value. Xinyinhai Tech Ltd (OTCBB:XNYH) is one of those stocks. A few our readers have also found this stock and suggested we take a look at the story. After some due diligence, we coded XNYH as a GeoSpecial on October 22, 2009 at $0.38.

Xinyinhai Tech Ltd is a leading participant in China’s financial notes printing industry.

Positive points to consider

• In only the past twenty years, China has assumed an important position in the world financial markets. China’s financial services industry has generally lagged behind its international peers.
• China’s government is moving to modernize the industry.
• The movement toward higher quality documentation with advanced technological aspects, such as anti-falsification technology, is creating an increased demand for the level of services that the Company has traditionally offered.
• XNYH was experiencing steady EPS growth before the recent financial crisis.

Points of Concern

• The global recession hit the Company hard as it's customers consist of banks and insurance companies. For the six months ended June 2009, revenues fell 40.0% to $4.5 million while EPS fell 60.0% to $0.04.
• Dilution. The business plan calls for a significant investment in the growth of Xinyinhai Tech during 2009. It plans to purchase new equipment for its new production facility and introduce additional product lines.
• Accounts Receivable Problem. "Our $332,070 in net cash flow from operations during the six months ended June 30, 2009 was less than half of our net income of $734,298 during the same period." The primary reason for the discrepancy was the $576,298 increase in our trade receivables during 2009. Our customers are primarily Chinese banks, and the restriction of international credit lines has adversely affected their liquidity. To assist them in meeting their cash obligations, we have extended the credit terms afforded to the majority of our customers."
• The Company hasn't disclosed the amount of capital it is attempting to raise, making it difficult to estimate potential dilution.

At this juncture, we are more concerned about dilution than with business risk. As business conditions and flow of credit have drastically improved in China, so should the fortunes of the customers targeted by Xinyinhai Tech.

Although it seems that Xinyinhai Tech was another stock priced to fail, it has successfully weathered the storm. Until we actually receive information on fund raising initiatives, the GeoTeam® is willing to devote some capital to XNYH due to the belief that favorable industry trends and an improving banking environment will gradually result in a resumption of EPS growth.

The accounts receivable issue has also garnered our interest. The GeoTeam® contends that this issue could improve, being that Xinyinhai Tech's customers are likely in much better financial health. This is a factor that we are hoping will help the stock at least attain its book value per share of $0.66 ($0.58 excluding minority interest). The stock has already had a nice run from around $0.20, yet still has a trailing tax adjusted P/E of only 7.

We will request an interview management.

Factors that may ultimately effect investor sentiment

• Will EPS improve moving into the second half?
• When and how dilutive will XNYH capital raising efforts be?
• How fast will capital be deployed?
• Will there be an existence of dilutive securities?

Additional thoughts from a reader

"XNYH did 4 cents in the first 6 months which is down from 10 cents last year in the first 6 months, but they had a change into a bigger factory and thus had a bit of a transition time now. My guess is that they will do way better than 4 cents in the second half but even with another 4 cents the stock is cheap at 40 cents."