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For Chinese Pharmacy Chain, Sky's the Limit

NEW YORK (TheStreet) -- China Jo-Jo Drugstores (CJJD) runs 45 retail pharmacies in the Chinese city of Hangzhou.

All have on-site, licensed doctors specializing in Western and traditional Chinese medicine, or TCM. A few even have adjacent urgent care clinics. The average store size is about 2,800 square feet (roughly a standard mall location), and carries between 2,500 and 7,500 products. Pharmaceuticals account for about 38.5% of sales, over-the-counter 34.5%, TCM 11.5%, and nutritional supplements 9.3%.

China Jo-Jo is yet another "reverse merger" Chinese small-cap. It uses a defunct, renamed U.S. corporation, in this case Kerrisdale Mining, to access foreign capital via a web of holding and management entities. This is done because Chinese regulations disallow foreign ownership exceeding 49% of any pharmacy chain operating over 30 stores.

The actual operating subsidiaries in China are the "HJ Group" companies, primarily Hangzhou Jiuzhou Grand Pharmacy. The HJ Group companies are not owned by China Jo-Jo but maintain contractual agreements that, in effect, control them. Three founders -- Lei Liu, Li Qi, and Chong'an Jin -- own 47% of China Jo-Jo, and essentially 100% of the operating subsidiaries, so this setup seems feasible in order to finance through U.S. investors. The stock started trading on the Nasdaq in April of this year at $5 a share.

The sexy part of this company is growth potential. With only 45 stores, the sky is the limit, even in Hangzhou, with a population exceeding 8 million. The company aims to double store count this year, from 31 to about 60. The next step would be Zhejiang Province, with a population of more than 50 million.

Chinese gross domestic product continues to expand at an 8% to 10% rate, and health-care spending even faster than that. China's health spending as a percent of GDP is just 6.4%, compared with the U.S.'s 15%. Furthermore, the population of the country is aging, universal health-care coverage is being targeted by 2020, and China continues to see increasing urbanization, creating higher wages and better access to pharmacies. China Jo-Jo should be able to grow revenues at rates exceeding 20% annually for many years, assuming solid execution.

After the public offering, China Jo-Jo's balance sheet is in good shape, with close to $16 million in cash and about $3 million in short-term loans and notes. Operating margins are in the low 20% vicinity, which is well above large Chinese chain Nepstar (NPD) and, for that matter, U.S. firms like CVS (CVS) and Walgreen's (WAG), both under 10%. There are some concerns about free cash flow, as China Jo-Jo is cash flow negative over the past 12 months and reported under $1 million in cash flow last year (vs. over $9 million in net income reported). Large cash advance requirements to suppliers, over $10 million currently, seems to be the main culprit, as many firms in China do not do business on credit. (In fact, Jo-Jo's sales are paid over 80% in cash.)

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