NEW YORK (
) -- The only thing fishy about
HQ Sustainable Maritime
( HQS) is the high-quality tilapiaand marine bio products that the company produces from its low-cost, vertically integrated operationsin China.
Established in 1999, HQS' aquatic farming and processing operations in Hainan Province are in southern China's designated green province, where only environmentally friendly, agri-food related industry and tourism are permitted.
In August 2004, the company acquired Jiahua Marine, which develops, producesand sells marine bio and health care products such as shark cartilage capsules and liver oil products.
Packaged tilapia products are marketed at the retail and wholesale level in the U.S. and Europe underthe name Tiloveya and "Lillian's Healthy Gourmet" from the company's headquarters in Seattle.
With world ocean catch of fresh fish on the decline, aquaculture (farm-raised fish) is set to take anincreasing share of world fish production. According to the USDA, by 2020, 50% of the U.S. seafoodsupply will come from aquaculture. In addition to being a healthy and flavorful white fish, tilapia hasmany favorable characteristics that will insure its continued aquaculture production growth.
Tilapia is disease-resistant, reproduces easily, eats a wide variety of feeds and tolerates a variety of water qualityconditions. To illustrate tilapia's growing consumption, from 2000 to 2007, per-capita consumption inthe U.S. grew from 0.4 pounds to 1.2 pounds, according to the American Tilapia Association. This places the fishfifth in per capita consumption behind only shrimp, tuna, salmon and pollock.
HQS' financial performance reflects both the growing demand for its products and successfulimplementation of the company's growth strategy by the management team. From 2005 through thelast 12 months ended Sept. 30, 2009, sales grew from $27.6 million to $70.5 million and are expected to grow to approximately $100 million by 2010.
Meanwhile, profitability and margin expansion have been equallyimpressive over the same time period, with earnings per share growing from 6 cents to 97 centsrshare and EBITDA margins expanding from 20% to 25%.
The company has a variety of growth plans in place to further expand revenue and margins, andrecently raised $10.8 million through a secondary offering at $8.50 a share share in June 2009. For starters, the company just completed a new feed mill that improves efficiency, reduces operational costs and ensures better quality control over products.
A second tilapia processing plant in China is planned for2010 that would add a run-rate capacity of 30,000 metric tons with a $15 million investment. Furthermore,HQS envisions a fry-breeding facility to be completed in 2011, which will install the latest technologies toimprove feed, fry and mechanical selection to increase harvests rates at a total investment of $8.9 million.
For all the exciting developments at HQS, the share price has been slowly sinking like a stone, but may have ultimately hit the bottom. With a rock-solid balance sheet composed of $5.81 a share in cash and working capital vs. a $7 stock price, there's a large margin of safety at the current price.
On a valuation basis, HQS is clearly the most undervalued public company among monoline food producers. A group of publicly traded poultry, nut, egg, fruit and pasta producers trade at an average forward EBITDA and EPS multiple of six times and 10 times, respectively. This compares with HQS' forward EBITDA and EPS multiple of 2.3 times and 7.5 times.
It is important to note, that HQS is also debt-free, fast-growing and boasts thehighest EBITDA margins at 25% vs. an average of 7.5% among food producing peers.
So why do HQS' shares and its delicious products suffer such investor distaste? One issue this year has been lower tilapia prices, due in part to softer demand from the general economy. Prices arebelieved to be stabilizing and not indicative of longer-term structural problems of oversupply, or lack ofdemand.
Another issue is that the three founders are family members and control 91% of the votingpower of the stock, primarily through their super-voting preferred share holdings. However, the risk ofmanagers engaging in value-destructive behavior is mitigated by the fact that they also currentlyowns 27% of the common stock and have been with the company for 10 years.
Another concern is thatmanagement has been slow in implementing its growth objectives and at times has fallen behindschedule. While a valid concern, the delays amount to months, not years, and do not affect the company's long-term earnings potential.
Another issue may be a lack of directly comparable fish companies on which to base an accurate valuation.However
, China Marine Food Group
recently began trading on theAmex in October and sports a trailing sales, EBITDA and EPS multiple of 2.2 times, nine times and 11.4 times respectively, vs. 0.7 times, 2.7 times and 7.2 times for HQS. Both companies are nearly identical in size and havecomparable margins and growth profiles, indicating yet again that HQS appears to be severely undervalued.
So where's the catalyst to feed the growth of this fish stock? One area that management is focused on isgetting HQS listed on the
, which would add liquidity to the shares and enhance the profile of thecompany.
Another could be an acquisition by a global food producer such as Cargill, or a private equityinvestor. The
announced acquisition last week of frozen foodsproducer Birds Eye Foods for $1.3 billion implied a sales and EBITDA multiple of 1.4 times and nine times,respectively, and underscores the interest level among investors for high quality "HQ" consumer staples.
In the mean time, investors should feel comfortable giving the company time to execute on its businessplan, and take comfort in the safety net of a strong balance sheet at the current share price.
-- Written by Ben Axler in New York
At the time of publication, Axler was long HQ Sustainable Maritime. Ben Axler is managing partner and founder of Spruce Point Capital Management, a New York-based hedge fund. Prior to founding the company, Axler spent eight years as an investment banker advising, structuring and executing billions of dollars of financing, risk management and M&A transactions for leading Fortune 500 companies. Axler started his career with Credit Suisse in 2000, and from 2006 to 2008, was an associate director at Barclays Capital in the Diversified Industrials Group. Axler graduated from Yale University with a master's degree in statistics and received both a bachelor of arts degree in statistics and a bachelor of science in marketing and business administration from Rutgers College, where he graduated with summa cum laude and Phi Beta Kappa honors.