FEED: Go hog wild or fear the swill?

Wednesday November 18, 2009 11:50 AM PST

By Ken Tudor

AgFeed Industries, Inc. (FEED: NASDAQ) is a Nevada incorporated company that wholly or partially owns and operates 5 hog premix and blended food manufacturing facilities, 1 large hog breeding farm and 29 hog production farms in 5 provinces of southeast China. 65% of its revenues are derived from hogs sold for meat or genetically superior breeding stock for other swine producers. The remaining 35% of revenues comes from the sale of 21 brands of premix and blended feeds for the 7 life stages of swine production. These feeds have a PRC registration as environmentally friendly “green feeds” and swine fed these products are considered “green pork”.

Pork is the primary meat protein consumed in China and recent economic advancements have increased annual per capita consumption of pork from 75lbs to 100lbs., with 2015 projections at 145lbs. China has been described as having a “pork culture” relative to food consumption. In fact, the PRC exempts swine producers and companies involved in swine production from business tax liability and VAT (value added tax) liability. State initiatives regarding swine production include a pork meat reserve, grants and subsidies for pork producers and affiliated businesses, pork price supports and feed price ceilings, and pork futures exchanges to hedge pork and feed prices. Want more reasons to go “hog wild” on this stock?

FEED’s fundamentals are incredible. With a P/E of 10 and P/CF of 7.6, and 5-year DCF of $14-20, this $4 stock is squealing value. Sales and earnings are up 1570% and 950%, respectively, over 2 years. Flush with $36.5 million in cash and only $4 million in short term debt, liquidity is not a problem, so its ROE of 15 is solid. Swine feed and production industry costs are a significant barrier to entry for competition and FEED’s ROIC of 17% is testimony to that reality. A 38% insider ownership shows management confidence in these fundamentals. The limited float of only 28 million shares will result in quick gains with any institutional interest in this stock.

FEED’s investment in 6 new genetically superior farrow-to-finish (birth-to-sale), modern, western modeled hog production farms suggest a corporate change in emphasis to pork production. FEED anticipates producing 2.5 million head of swine annually by 2011, easily eclipsing its present 500,000 head annual production. This change in philosophy may be throwing “swill” on its hog feed market share.

Feed costs represent 65-75% of hog production overhead. 80% of Chinese hog production comes from farms that produce less than 100 head of swine per year. In 2008, FEED’s premix and blended products penetrated 90% of this market. That percentage is now reduced to 65% despite a 17% increase in farm customers and a 25% increase in distributorship. Why FEED is ceding its competitive edge in a market that is growing 13.5% annually, with no dominant producer, is not clear. Net margins for feed production are only 5% less than those for pork production and feed production is much less risky. This company has abundant liquidity for investment to maintain market share in both hog production and hog feed.

Pork production and swine feed production are extremely sensitive to commodity pricing, worldwide disease threats, localized epidemics, and food contamination. This results in potentially violent fluctuations in stock prices for companies involved in these enterprises and a good reason to shun these stocks. However, China's pork consumption excedes its production. Its growing middle class with a hunger for protein and a government generously supporting pork production related enterprises are positive for a quality pork producer and hog feed provider. FEED has tremendous upside potential. Pork consumption in China traditionally increases in the cold winter months. As a result, FEED’s 4th quarter and 1st quarter 2010 earnings should be significantly higher, prompting further upside stock movement. Investors may want to buy on dips before the next earnings report. My limit order is set for entry at $4/share.