I just returned from China were I visited one of my portfolio investments, QKL Stores ( QKLS), a thriving grocery store chain. It had been two years since I first visited QKL's headquarters in Daqing, a city in northern China near the Mongolian border. At that time, QKL was operating 19 stores and had at a run rate of $7 million in sales a month. The company founder and CEO, Zhuangyi Wang (or Johnny as he is called in English) had impressed me beyond belief. You want to meet a CEO that lives and breathes every crack and crevice of his business. Well, "here's Johnny!" When describing him to others, the simple term I like to use is he is a "killer," a take-no prisoner CEO -- the kind of man that you know would have made a hell of a field general if he wasn't running a grocery business. What a difference two years can make. What I found this trip back to visit QKL Stores was a totally different company. QKL is no longer the small boutique grocer with a hand full of stores. The company has evolved and is now operating almost 40 stores, having transformed itself from an autonomous group of stores under the QKL umbrella to a true western style chain of supermarkets, hypermarkets and department stores. This transformation can be linked to one man, Alan Stewart, the company's new chief operating officer. Tall, well dressed, with his grey hair slicked back, Stewart is easy to spot at QKL's headquarters. At 67, he moves with the energy of someone 20 years his junior. His resume is legendary, most notably as president of American Stores when it had 175,000 employees and $22 billion in sales. He has also run various international chains, including a period in the mid 1990s when he worked directly for HRH Prince Alwaled, helping him expand his Riyadh-based grocer Al Azizza-Panda United into the largest retail supermarket chain in the Middle East. I sat in on a presentation he gave to some visitors and there is no question that he knows every aspect of the business. He should; he's been doing this for over 40 years.
"I love to build things," Stewart said. "I have one more journey left at my age, and QKL Stores is it." When I asked how, in his opinion, QKL stacked up versus the other business building opportunities he had tackled over his career, his answer was direct and powerful, it's the "biggest opportunity I have ever been involved with." At a run rate of over $21 million a month, sales are up 300% in two years. A recent $35 million financing in the fourth quarter of 2009 added needed expansion capital. Although investors (myself included) got a lump in our throats when, in January, it announced it had spent $10 million on a new headquarters building, I will tell you that although it may have paid top dollar for the property, the rationale was sound. The current headquarters simply doesn't have the space. In fact, the overcrowding at the headquarters is direct result of the past two years' growth. As we walked through the current headquarters with Stewart on our way to visit the new headquarters building, he showed me the purchasing department, which was so crowded it had three employees to a desk, in three shifts, around the clock. QKL's goal is to hit 200 stores by the end of 2014. In order to do this, it expects to expand its workforce from 4,200 employees to over 22,000 employees. QKL believes in a bottoms-up approach to its workforce. Each person hired is put through a rigorous education and training program. After our brief stop to look at the new headquarters (the expected move-in date is in the middle of the second quarter, we drove two hours south to the city of Harbin. Strategically located, Harbin has been in the cross-roads of trade throughout this region for centuries. In fact, the famous Trans-Siberian railroad, which winds 5,200 miles from Moscow to Vladivostok , branches off through Harbin as it makes its way to Beijing. Here at this most important point, QKL is putting the finishing touches on its massive distribution center. With over 200,000 square feet of storage space, this facility is more than capable of taking care of the 200 stores it expects to have in place within the next four years. According to Stewart, everything is in place for the QKL to mushroom into the dominant player in this region of 150 million people (almost one-half the population size of the U.S.) The only thing that keeps him up at night is "execution, and I think we are 80% there," he said. I believe him.
What does this mean for the stock? First of all, I'm biased. I was there from the very beginning and I am proud to say I was one of the original shareholders when it listed its stock on the Nasdaq. I own it and continue to add to my position. My reasoning for predicting success is gut instinct, buttressed by the numbers. At 38 stores (end of 2009), it generated $250 million in sales and a gross profit of about 5% or $12.5 million. There are 35 million shares outstanding, plus 11.4 million warrants, which have an average exercise price of $3.82 (when exercised, it will bring in another $43 million in cash). Using the fully diluted number of 46.4 million shares, QKL should earn approximately $.27 cents per share for 2009. According to a research report from Roth Capital, QKL should garner a 20 PE on forward projections. I figure based on the growth rate, it should generate over $375 million in sales in 2010 and gross profit somewhere in the neighborhood of $17.5 million or about $.38 cents a share, fully diluted. At a 20 PE, that puts the stock in the $7.50 range. Currently it trades below $6.50, so in my opinion, there is definite value now. I believe the real action is going to be in two to three years. At 200 stores, it should generate over $1.25 billion in sales and bring $60 to 65 million to the bottom line. While it's a given that it will probably need to raise more capital to fuel this growth, remember it should get $43 million when the warrants are exercised (they expire within the next three years.) And they have no debt, so they could theoretically leverage up without any further dilution. Using these assumptions, it is not inconceivable that in a couple of years, QKL could command a price north of $20 a share. My partner likes to say, "Always bet on the jockey and not the horse." If you think like that, you can only come to one conclusion. Add QKLS to your portfolio. At the time of publication, Sumicrast owned QKL Stores.