Yuhe Intl (PINK:YUII)

The GeoTeam® is suspecting that Yuhe Intl (NASDAQ:YUII) may be contemplating a capital raise:

At the last minute, management cancelled its participation in the Rodman conference last week. We were scheduled for a one on one with the company. Early last week, we emailed the investor relations firm to inquire why YUII canceled, but never received a response.  Although not for certain, we may be able to assume that YUII is in a quiet period or saw no reason to attend the conference, as they may have already secured a capital raise deal. Shares have also been weak, despite the company reporting solid 2010 second quarter financial results and publicized claims that its SAIC files match SEC files. Most of the price decline has happened since September 7, 2010.

This reminds of us a similar situation when Skypeople Fruit Juice (NASDAQ:SPU) did not host a question and answer during its 2010 second quarter conference call. Just days after the call, SPU announced a private placement, contradicting its related 10Q which eluded it would not do so at the time.

YUII does have some debt, which could limit financing options. Still, we would consider it a slap in the face to investors if YUII completes a raise anywhere near its current price, which is about 30.0% off its recent highs.  2011 EPS is expected to grow 58.6% to $1.76.  It would be more prudent to allow this growth to play out before joining the ranks of other ChinaHybrid companies that have showed a lack of consideration to shareholder value. On the bright side, YUII had mentioned that it would only use its stock as currency for accretive acquisitions. Issuing EPS guidance would be beneficial if our speculation is validated.  Hopefully, we are overreacting, but the Chinese RTO sector is becoming increasingly difficult to read.

As we approach 2011, EPS growth should improve for the ChinaHybrid universe. Now is the time to identify qulaity companies that will benefit from this trend.  Some stocks have already been moving up from recent lows, perhaps a clue from the market on who it believes the quality companies are. 

On July 30, 2010, we placed Yuhe International on the GeoBargain list. YUII is the first ChinaHybrid company we have added to this list since we recoded the Chinese GeoBargains/GeoSpecials to their respective radar lists with intentions to perform further due diligence on the sector.  Previously, YUII was a GeoSpecial.  We hope to have more stocks join YUII as we head towards 2011.

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Yuhe Intl (NASDAQ:YUII)

Company Description: Founded in 1996, Yuhe is one of the largest day-old broiler poultry breeders in China. The Company's main operations involve breeding, as all broilers are sold within a day of hatching.

Data Ended 7/30/10

• Price = $9.40
• Trailing EPS = $0.80
• Fully-Taxed Trailing EPS^a = $0.60
• 2010 EPS Estimate= $1.06
• 2010 Fully-Taxed EPS Estimate= $0.80
• 2010 EPS Estimate= $1.68
• 2011 Fully-Taxed EPS Estimates= $1.26
• P/E based on Fully-Taxed Trailing EPS = 15.66
• P/E based on Fully-Taxed 2010 EPS = 11.75
• P/E based on Fully-Taxed 2011 EPS = 7.46
• Fiscal Year ends in December

Reasons for Optimism

1. YUII meets 7 out of 10 GeoBargain® Requirements
   
   

   	Requirement	Comments
   	Recent 52-week High(generally within 3 months)	Must Reach $12.43
   	30% EPS Growth Rate	The June 2010 Qtr. through the 2011 December Qtr.are all expected to achieve EPS growth in excess of 30%.
   	10% Revenue Growth	The June 2010 Qtr. through the 2011 December Qtr.are all expected to achieve revenue growth in excess of 30%.
   	Strong Balance Sheet/Operating Cash Flow	As of 1st Qtr 2010
   Yes	Positive Cash Flow	$2.0 Million
   Yes	Debt to Equity Ratio less than 20%	18.50%
   No	Current Ratio is at least 2:1	1.84:1
   	Return on Equity is at least 15%	15.00% on an annualized basis
   	Minimum Pre-tax Operating Margins of 8%	24.91% as of 1st Qtr. 2010
   	Preferably Under 50 Million Shares	16.06 Million shares as of 1st Qtr. 2010.
   	High Insider Ownership (generally greater than 15%)	50.0% (Still need to verify)
   	Limited Institutional Ownership (generally less than 20%)	>20.0% (Still need to verify)
   	P/E Divided by Growth Rate (PEG Ratio) is Less Than 1. (Ideally less than 0.50).	0.35, Using the average EPS growth rate for 2010 and 2011

   
   
2. We are continually seeking leading companies to add to our portfolio. YUII fits this bill, as it is one of top three day-old broiler poultry breeders in China. Soon, upon completion of a recently announced asset purchase agreement of five breeder farms, YUII will hold the number one spot in terms of production capacity. There is a big distinction between being the leader and to being a leader.
   
   
3. The company is expected to experience over 30% EPS growth for the next 7 quarters.
   

   	2011 EPS	% Change	2010 EPS	% Change	2009 EPS
   1st Qtr.	$0.33 Est.	83.3%	$0.18	-5.3%	$0.19
   2nd Qtr.	$0.30 Est.	66.7%	$0.18 Est.	38.5%	$0.13
   3rd Qtr	$0.54 Est.	45.9%	$0.37 Est.	42.3%	$0.26
   4th Qtr.	$0.52 Est.	57.6%	$0.33 Est.	43.5%	$0.23
   Full Year	$1.68 Est.	58.5%	$1.06 Est.	30.9%	$0.81

   Investors should note that estimates likely do not include the impact of the breeder farm asset purchase agreement which is expected to add $3.0 million to 2011 net income.
   
   
4. YUII has expressed a commitment to the maximization of shareholder value, with a particular emphasis on EPS growth. Such a commitment is especially important during a time when the ChinaHybrid sector has lost some credibility.
   
   * Comments detailing aspects of the breeder asset purchase agreement reinforces our assumption:
   

   "This deal represents the first time we are using our stock as a currency for making acquisitions.

   Where appropriate, we plan to use our stock as an acquisition currency, but only if we have a high level of confidence that any future acquisitions match the return profile of this deal, which we expect to be highly accretive and have a positive impact on our revenues, net income and diluted per share earnings. Our ultimate objective, above and beyond achieving revenue and net income growth, is to grow our earnings per share."

   * 300,000 restricted shares of Yuhe common stock were issued in the deal at a price of $10 per share (or 42.9% above the stock's price at the time of the announcement). The restricted shares are subject to a six-month lock-up period.
   
   * At $3.1 million, YUII paid only about one times the 2011 projected net income contribution.
   

   Hopefully, YUII can help lead the charge to help rebuild investor confidence in the ChinaHybrid space, a plea that we have already directed towards the CEO's of these companies.
   

5. Credibility established:
   
   * As indicated in a Seeking Alpha article, YUII's SAIC files parallel SEC filings. (Wherever you may stand on your belief on the validity of SAIC filings, one can not deny that at the current moment mismatching information can cause perception problems. Until this issue is laid to rest, knowing that filings match will give investors a sense of comfort and a willingness to bid P/E's higher. Long-term investors who do not subscribe to the SAIC filing debate will find the current ChinaHybrid sector ripe for success)
   
   * The company's substandard payment procedures have been reviewed by Ernst & Young, and subsequently rectified.

Investors may feel that the above factors will help YUII experience an above average P/E when compared to the rest of ChinaHybrid space. In fact, YUII sports a tax adjusted trailing P/E of 15.66, which many investors may consider lofty when compared to the ChinaHybrid sector. We, on the other hand, believe the market is telling us that it perceives YUII shares may offer a favorable growth/risk profile, giving us some confidence that a trailing P/E of 25 and a P/E of 15 on future estimates may be in the cards.

Points to Ponder:

• YUII auditor is not in the top 100. This is common for small firms. We believe that YUII will eventually retain a top 100 auditor.
  
• On On June 2, 2010 the company filed a S-1, allowing it to raise capital in the future, which will weigh on the minds of investors. We feel that management will only tap equity for accretive purposes which lightens our dilution concerns.
  
• Debt to equity is knocking on the door of our maximum threshold of 20%. We would also like to see a higher current ratio. As the company's growth gains steam, we are hopeful that these statistics will improve.

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 * $0.60 = $15.00

Short-term Potential value based on 2010 & 2011 fully taxed adjusted EPS estimates:

P/E 15 * $0.80 = $12.00
P/E 15 * $1.26 = $18.90

^a YUII is not paying a full 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.