Is China Green Agriculture's Growth Sustainable?

I'm a believer in growth stocks. As an analyst for our Motley Fool Rule Breakers service, I think you should be a believer, too. But even I have to admit some growth stories are bogus, hence this regular series. We'll be taking a closer look at many of the market's great growth stocks to see which of them show real, numerically relevant signs of sustainability.

Next up in our series is China Green Agriculture (NYSE: CGA  ) , whose fertilizer products are helping the Sino Superpower develop an environmentally friendly farming infrastructure. Few things could be more important for a country with 1 billion people to feed.

Foolish facts

Metric

China Green Agriculture

CAPS stars (5 max)

*****

Total ratings

1,029

Percent bulls

97.4%

Percent bears

2.6%

Bullish pitches

121 out of 127

Highest-rated peers

Yara International, CVR Energy (NYSE: CVI  ) , ShengdaTech (Nasdaq: SDTH  )

Data as of Aug. 30.

Fools like that story to this day, even after the stock has been a four-bagger for our Motley Fool Global Gains service. They see a sustainable growth story.

"This company is about China's internal economy, driven by population pressures, entrepreneurial small farming in rural areas, a hard limit in domestic arable land (and water), and a increasing commercial demand tied to the rising standard of living in population centers, where people increasingly have money in their pockets," wrote CAPS All-Star marc64 recently.

Wall Street agrees. Analysts predict the company will improve earnings by 27% a year for the foreseeable future. Regardless, China Green entered today trading for just seven times next year's estimate of $1.43 in earnings per share. That's just too cheap.

The elements of growth

Metric

Last 12 Months

2009

2008

Normalized net income growth

66.3%

87.1%

24.4%

Revenue growth

45.2%

55.8%

48.9%

Gross margin

60.9%

58.2%

56.7%

Receivables growth

93.9%

127.5%

90.4%

Shares outstanding

24.56 million

18.59 million

18.38 million

Source: Capital IQ, a division of Standard & Poor's.

Most of what's here is good, but there are a couple of areas of concern. Let's review:

  • While revenue growth has been steady, net income growth has varied widely. This isn't so much a bad sign as something to watch. Emerging economy upstarts tend to produce more volatile results.
  • Knowing that makes China Green's track record of expanding gross margins all the more impressive.
  • If there were to be a concern here, it would be with the rising share count. After two years of holding the line on dilution, shares outstanding are up 32% over the past year. What gives? In July, the company completed a $200 million shelf registration that will add heft to its balance sheet.

Competitor checkup

Competitor

Normalized Net Income Growth (3 years)

China Agritech (Nasdaq: CAGC  )

24.8%

China Green Agriculture

N/A

Sino Green Land

N/A

Source: Capital IQ. Data as of Aug. 30.

Interestingly, China Green Agriculture doesn't have the history that China Agritech has. But what the upstart lacks in history it makes up for in growth.

Look at the second table again. When high growth is coupled with increasing gross margins, it usually leads to big earnings gains (check), generous free cash flow (check again), and rising returns on capital (almost; ROC rose in fiscal 2009 but is down over the past 12 months).

Grade = sustainable
China Green isn't the sort of techie we look for at Rule Breakers, but as marc64 points out, it's clearly helping to solve a problem that has value to farmers and the Chinese government. I like that position enough to bet on the stock in my CAPS portfolio.

Now it's your turn to weigh in. Do you like China Green Agriculture at these levels? Would you make it one of our 11 o'clock stocks? Let the debate begin in the comments box below, and when you're done, click here to get today's 11 o'clock portfolio pick.

You can also ask Tim to evaluate a favorite growth story by sending him an email or replying to him on Twitter.

China Green Agriculture is a Motley Fool Global Gains recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. The Motley Fool owns shares of China Green Agriculture and is also on Twitter as @TheMotleyFool. Its disclosure policy thinks Monty Python is sustainably funny.


Read/Post Comments (9) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 31, 2010, at 12:50 PM, erosandras wrote:

    + 1.3B population to feed in China with constatly growing meet demand

    + Plenty of space of technology development in the Chinise agriculture

    + Environmental issues due to currently used fertilizers (poor technology)

    + Good management

    All in all CGA is the right company in the right place, in the right time and in the right business.

  • Report this Comment On August 31, 2010, at 1:10 PM, anopenmind wrote:

    I trust so. Am keeping my shares, looking forward to financials late Wed afternoon, in spite of the other views about CGA that cause current tanking of the stock.

    Wish Tim Beyers had touched on those negative reports.

  • Report this Comment On August 31, 2010, at 1:23 PM, catoismymotor wrote:

    I owned this one until June of this year. I sold it and never looked back.

    http://caps.fool.com/Blogs/bye-bye-cga/406122

  • Report this Comment On August 31, 2010, at 1:35 PM, mweinstat wrote:

    A company that is projected to grow earnings @ 25% per year for at least the next few years selling @ 7 times earnings ? Just insane. I own a bunch of this and will possibly buy more later on in the week. CGA is not for the fain of heart but I think as long as you can handle the volatility, at this level there is some serious money to be made over the next few years, if not sooner.

  • Report this Comment On August 31, 2010, at 5:59 PM, TMFMileHigh wrote:

    @anopenmind,

    Investigating the validity of the claims you're referring to was beyond the purview of this piece. I should also mention that they're at least two months old. Here's where interested readers can find details of the allegations:

    http://www.thefinancialinvestigator.com/?p=104

    I'm betting the present valuation more than accounts for the risk of owning CGA.

    @cato,

    Great post!

    Thanks for reading and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On August 31, 2010, at 10:30 PM, kenwu wrote:

    I bought 2000 shares today. did a lot of studies on my own and believe this one is going to be sustainable. also talked to my buddy in China who specializes in exporting fertilizers to South Korea. He also told me that Yong and CGA are going to do very well especially this year China and Russia had drought and 1.5 billion people need to eat rice! the margin on their product are extremely high and with the huge demand, the revenue and profit will rocket! buy YONG and CGA and hold!

  • Report this Comment On September 10, 2010, at 8:53 PM, easyavenue wrote:

    Tim and all other Fools behind CGA,

    I am tempted to say shame on you, but for the sake of my own ignorance, which sometimes gets me in embarassing trouble, I'll just say: Hey, wait a minute!

    TMF Mile High said he's betting the present valuation accounts for the risk of owning CGA. But if the present valuation is based on fraudulent accounting practices that have not yet been uncovered or proven, then such fraud cannot have been fully priced into the current price, correct? We don't know for sure what they did, yet. Alleged verses proven changes risk, does it not? So the risk is potentially greater, even much greater depending on the facts, than where it sits today. Am I thinking this through right?

    Also, have you read the Barron's article from last week on the subject of CGA's accounting anomalies? Here's a site that summarizes it for you in a cautionary commentary article:

    http://labemp.wordpress.com/2010/08/31/12-signs-and-158-reas...

    If what these authors say about CGA is true, wouldn't you want to stay away from CGA under ANY estimation of risk? It just occured to me that in stock pricing with allegations of fraud such as this, when real money is involved, it's really a case of guilty until proven innocent (or alternatively... what, more guilty?), is it not?

    Also, what about the statement that Chinese reverse mergers lost by 75% to the Halter Index in the first 3 years of trading?

    In fairness, I am biased because I've previously owned CGA and lost money on it. Anyway, best of luck to those of you who hold it now. I hope I am wrong and you make lots of money.

    EA

  • Report this Comment On October 11, 2010, at 1:07 PM, afamiii wrote:

    On paper (with the exception of free cash flow, to which I will come back to) CAGC looks very good.

    However, I sold half my interest in it after reading several allegations (on seekingalpha.com) about pumping and dumping, weak auditors, insider real estate transactions and a potentially fraudulent CFO.

    But the key thing that got me to lighten up was, the fact that it has not generated any cash in the past five years. I could live with the fact that they are investing in new factories and distribution facilities, but all the cash seems to be going into accounts receivables, which beggars the question, are the revenues real?

    I have tight stops on the shares that I still own.

  • Report this Comment On May 26, 2011, at 10:23 AM, catoismymotor wrote:

    *cough-cough*

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