China Growth Development, A New GeoSpecial

On September 18, 2009 ($0.38) we coded China Growth Development (OTCBB:CGDI) as a GeoSpecial due to the stock selling below its book value per share.  As of its the 2009 second quarter China Growth's book value per share is $1.28.  The Company develops real estate that generates revenues from rental income. Recall that China Housing & Land Development (NASDAQ:CHLN) is another Chinese real estate development company. Unlike China Growth, China Housing develops and sells its real estate holdings and is trading above its book value per share of $3.43.

Why is CGDI selling below book?

One reason could have to do with the negative GAAP earnings per share growth The Company reported in 2008. 

However, upon further inspection a few non-cash items exist in the cash flow statement that, when added back to net income, tell a different story. Furthermore, in 2007 CGDI paid no taxes, while in 2008 it paid a tax rate of 26%.  So, on an apples to apples comparison, if we add back the non-cash charges and adjust 2007 for a 26% tax rate, we arrive at a different non-GAAP EPS picture.  CGDI also finished 2008 with operating cash flow of $7,962,614.

If investors are valuing CGDI on GAAP EPS, they may reevaluate the situation once they make the necessary adjustments.

Another reason could be the lack luster non-GAAP EPS growth so far in 2009.  

We also have some questions concerning receivables and the ownership structure of the Company's properties. (For example, direct ownership or ownership rights).  China Growth's second quarter press release also seems to have a few "number" typos that don't match up with the SEC filing.  While not a big deal, this lack of attention to detail is not what we desire with a small company.  This situation could be easily resolved with the proper investor relations representation.

Putting a value on real estate development companies can pose a dilemma

Important factors that can influence valuation:

1. Dividends- The attraction of a real estate estate development company is often the eventual receipt of dividends through the generation of consistent cash flows. 

2. Price appreciation of land holdings- Ideally we would also want to forecast the expected rate of growth of real estate which would ultimately affect book value and potential cash flows. 

3. Consistent Earnings Per share- Whopping EPS growth is not necessarily a staple of  this type of investment, but if EPS growth can be attained we feel there is a better chance of the stock selling at or a premium to book. 

While China Growth does not have any current plans to pay a regular dividend, it seems bullish on its regional real estate outlook and cash flow position.

“Our expansion projects have lead the way to increased revenue, and that is a perfect example of our growth strategy succeeding. We are focused on continuing that strategy of growth via expansion, development, and acquisition throughout the third and fourth quarters of 2009.” (Business Wire August 20, 2009)

"Over the course of the next few years, we intend to grow and expand our commercial real estate business. We currently generate positive cash flow and we expect to acquire an additional 2 shopping centers within the next three years.' (Business Wire August 20, 2009)

"Chinese government policy is in favor of the growth of retail shops in Shanxi Province because it will greatly stimulate the economic growth of the region." (2008 10K, Page 2)

If CGDI delivers on these goals and barring dilutive events, investors may be able to justify a price closer to book.

The more sophisticated investor may want to utilize a discounted cash flow model.

What follows are some comments from the GeoCommunity that shed further light on the risk reward factors surrounding the CGDI story.

Drexion:

Yeah I've had CGDI on my watch-list for a while now... I'd be a buyer below $0.20, maybe sub $0.25. Insanely cheap compared to book value, profitable and has growth. My problem is with the amount of growth. I only expect 10-13% growth(Going off memory here, been awhile since I looked at the details on the company) there since they are a real estate company with ZERO leverage. Not sure I want to be involved in zero-leverage real estate... If they decided to lever themselves to increase their growth, i'd be jumping all over that stock.

On the bright side, land/building value in China will continue to go up...So their property values will improve. They also do 'pay all upfront' on their leases, so they can expand and pay off that expansion immediately once leasing starts. They also have quite a bit of 'guaranteed income' coming every quarter right now...Provides a nice 'base revenues' for coming quarters.

What I need to know about CGDI is when their OLD leases start to expire. Since they are paid up-front, when expirations begin they will get new cash...and I bet the rates on new leases will be much better.

ChinaStockPicker: CGDI is a GeoBargain in my book- this is why

This is why I believe the share price will triple to > $1/share by eoy....

28% Revenue Growth yoy

2007 revenue 12.7M
2008 revenue 16.2M

2007 eps: .14/share
2008 eps: .05/share (The lower eps for 2008 due mostly to SG&A expenses that nearly doubled from $6.7M in 2007 to $10.9M in 2008. Most of this extra $5M in expenses were ONE TIME CHARGES.)

"The higher expenses were mainly due to one-time charges incurred in the closing of the reverse acquisition."

See Income Statement 2007 vs. 2008 for more clarity.

Shareholders Equity: $44.6M
BV Per Share: $1.22

New Revenue Source Going Forward:
CGDI announced 100% capacity and nearly $2M in new revenue from a mall expansion project in August:

Dilution Unlikely- even with aquisition plans

"The Company currently generates its cash flow through operations which it believes will be sufficient to sustain current level operations for at least the next twelve months. In 2009, we intend to continue to work to expand our presence in the commercial real estate market, including the potential acquisition of another shopping mall.

To the extent we are successful in growing our business, identifying potential acquisition targets and negotiating the terms of such acquisition, and the purchase price includes a cash component, we plan to use our working capital and the proceeds of any financing to finance such acquisition costs."

BUT HERE'S THE REAL BEAUTY OF CHINA GROWTH DEVELOPMENT

CGDI gets it's rent paid in advance for their longer term leases so they don't have an accounts receivable issue. In fact they have the exact opposite- as of the most recent quarter, they have "non-current deferred revenue" of $32,242,257.

That's about $1/share just waiting to hit the books in future quarters. Apple Computer gets non current deferred revenue from their I-phones- and it's a beautiful thing. I've never seen it in a penny stock though.

Non-Current Deferred Revs. = Conservative Money Management

"CGDI management will continue our financially prudent practice of requiring prepaid rents from our commercial tenants, for the entire term of the leases (typically 5 to 8 years). This method allows for an expeditious return of capital to CGDI, while greatly reducing debt service carried on the properties."

Over the course of the next few years, we intend to grow and expand our commercial real estate business. We expect to acquire an additional 2 shopping centers within the next three years. These acquisitions will be financed either through revenues of the Company or by financings and sales of the Company’s stock or other securities.

Our board of directors currently intends to retain all earnings for use in the business for the foreseeable future. See “Risk Factors.”

On November 12, 2007 we entered into a Stock for Stock Equivalent Exchange Agreement and Plan with Taiyuan Rongan and all of its current capital contributors (the "Taiyuan Rongan Shareholders") pursuant to which at closing the Taiyuan Rongan Shareholders will assign 80% of the 100% of capital contributions in Taiyuan Rongan to our company in exchange for an aggregate of 31,500,000 shares of our common stock and common stock purchase warrants to purchase an aggregate of 1,400,000 shares of our common stock at an exercise price of $0.50 per share, both giving effect to the reverse stock split described below.

We expect that our company will grow over the next few years. Currently, we own and operate six (6) shopping malls in the City of Taiyuan, in Shanxi Province of China. Taiyuan West City (Xicheng) Shopping Mall – Phase II has completed from construction and commenced its operation in 2008 managed by Xicheng Shopping Mall, one of the five subsidiaries of TRBT. Taiyuan West City Shopping Mall – Phase II is a 30,000 square meter, five story shopping center which includes 21,000 square meters of commercial space for retail stores. Although TRBT has not announced any new shopping malls, we do expect to acquire at least two more shopping centers within the next three (3) years. Specifically, in the near future, we expect to break ground on the following projects: Taiyuan Royal City Shopping Mall, Phase II. Taiyuan Royal City Shopping Mall, Phase II will be a 40,000 square meter, six story shopping center which will include 28,000 square meters of commercial space for retail stores. Chinese government policy is in favor of the growth of retail shops in Shanxi Province because it will greatly stimulate the economic growth of the region. TRBT intends to fund the new project by internal cash flow and, depending on management’s assessment of available financing, a combination of bank financing, government policy subsidies, outside private investors or additional equity raised through public offerings