NEW YORK ( TheStreet) -- The only thing fishy about HQ Sustainable Maritime ( HQS) is the high-quality tilapia and marine bio products that the company produces from its low-cost, vertically integrated operations in 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, produces and 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 under the 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 an increasing share of world fish production. According to the USDA, by 2020, 50% of the U.S. seafood supply will come from aquaculture. In addition to being a healthy and flavorful white fish, tilapia has many 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 quality conditions. To illustrate tilapia's growing consumption, from 2000 to 2007, per-capita consumption in the U.S. grew from 0.4 pounds to 1.2 pounds, according to the American Tilapia Association. This places the fish fifth in per capita consumption behind only shrimp, tuna, salmon and pollock. HQS' financial performance reflects both the growing demand for its products and successful implementation of the company's growth strategy by the management team. From 2005 through the last 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 equally impressive over the same time period, with earnings per share growing from 6 cents to 97 centsr share and EBITDA margins expanding from 20% to 25%. The company has a variety of growth plans in place to further expand revenue and margins, and recently 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 for 2010 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 to improve 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 the highest 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 are believed to be stabilizing and not indicative of longer-term structural problems of oversupply, or lack of demand. Another issue is that the three founders are family members and control 91% of the voting power of the stock, primarily through their super-voting preferred share holdings. However, the risk of managers engaging in value-destructive behavior is mitigated by the fact that they also currently owns 27% of the common stock and have been with the company for 10 years. Another concern is that management has been slow in implementing its growth objectives and at times has fallen behind schedule. 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 ( CMFO) recently began trading on the Amex 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 have comparable 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 is getting HQS listed on the NYSE, which would add liquidity to the shares and enhance the profile of the company. Another could be an acquisition by a global food producer such as Cargill, or a private equity investor. The Blackstone Group's ( BX) announced acquisition last week of frozen foods producer 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 business plan, and take comfort in the safety net of a strong balance sheet at the current share price. -- Written by Ben Axler in New York