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Yongye International: Great Growth Story, but Does It Work?

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One of the most significant challenges associated with investing abroad is actually confirming that a company and its products are as good as they claim to be in their SEC filings. This is particularly true when it comes to China, where investor mistrust of small auditing firms and Chinese internal controls have resulted in significant volatility and an opportunity for short-sellers to exploit an information gap -- something that's become common in the sector, with recent spotlights shined on Orient Paper (NYSE: ONP  ) and China Biotics (Nasdaq: CHBT  ) among others.

While those companies and their investors still struggle to dispute the relevant claims, what's clear is that many investors in Chinese stocks have not performed a level of diligence that makes them comfortable actually holding the stocks regardless of what accusations arise. This is a problem for a variety of reasons, but mostly because you should only buy stocks and at an allocation that you, to paraphrase master investor Warren Buffett, would be comfortable owning even if the stock market shut down for one or more years.

How we try to solve for that
It's in order to get comfortable with our own picks and exploit that information gap for ourselves that our Motley Fool Global Gains research team travels annually to China to meet with companies, tour their facilities, and get our hands on their products. That doesn't mean we'll get every pick right, of course, but our aim is to get a leg up when it comes to analyzing companies.

One of the companies we visited -- and subsequently recommended -- during our 2008 trip was organic fertilizer maker Yongye International (Nasdaq: YONG  ) , based on the thesis that the Chinese government had made increasing agricultural outputs a priority, and that Yongye had a good product and a good marketing plan to benefit from this tailwind. That pick, thus far, has been rewarded, with the stock up some 75% since July 2009. 

The stock, however, continues to trade at a seemingly discounted evaluation of just 6 times EBITDA despite growing sales at a better than 90% clip over the past year. One of the reasons this discount persists is because investors, in addition to being widely skeptical of the entire China sector, are wary of Yongye's hefty accounts receivable. Remember, though, that farming is a seasonal business, and Yongye, as it has in past years, should have no problems being repaid provided its Shengmingsu fertilizer works and farmers realize more significant sales as a result.

And while Yongye makes impressive claims about its product, we wanted to test them for ourselves. So we got our hands on some product and passed it along to our official Global Gains gardener (my dad), who agreed to test it this growing season. Below you can see the result as applied to jalapeno peppers (the larger comes from a plant treated with Shengmingsu):

Now, let me be clear: While this is a promising result (and that big jalapeno is prime for stuffing), this was a very small-scale test. My dad, not unlike Chinese peasant farmers, is skeptical of applying new products to his garden, one reason why Yongye generally chooses to enter a new market by giving free samples of Shengmingsu away to a particularly influential farmer in a given community. But our Global Gains research team was impressed by our own result using Shengmingsu and will expand the test conditions during the next growing year.

Does this make Yongye a screaming buy at current prices? Not on its own; Krispy Kreme Doughnuts (NYSE: KKD  ) is an example of a company with a great product that's proved to be a terrible investment. But with a solid product in addition to a seemingly cheap valuation, impressive numbers audited by KPMG, and looming profit margin improvement thanks to vertical integration, Yongye stock may be worth a look if you're looking to increase your exposure to China.

Tim Hanson is co-advisor of Motley Fool Global Gains. He owns shares of Yongye International.

Yongye International is a Motley Fool Global Gains recommendation. The Fool owns shares of Yongye International. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (30)

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 September 23, 2010, at 5:58 PM, kurtshrout wrote:

    I already know, from reviewing worldwide research on fulvic acid products dating back decades, et cetera, that the company’s products can/do work very well. Please do do additional, broader testing during the next growing season, which will further clarify the strong effectiveness of the company’s plant product(s). In so doing, please keep in mind that the degree of effectiveness of the product(s) (versus a control group) will vary depending upon the type of plant and the environmental conditions under which the plant is grown; so you may see a variation in the degree of effectiveness for different plant types in the same garden or same plant types in different gardens (especially if the gardens are in different parts of the country or the like). (Environmental conditions include things such as the soil type, amount/timing of water, air temperatures, et cetera.) Also, it is important to understand how much product should be applied (and how often) for each different kind of plant. (Yongye can/will inform you of this, unless you are testing the product on a plant type that the company has not completed testing on yet.)

    Also, unarguably, instead of saying “seemingly cheap valuation”, you should have said “ridiculously cheap valuation”. There is, unarguably, no accounts receivable issue of substantial concern, just like there is no inventory level issue of substantial concern. There are simply some people who have not spent the time necessary, or do not have the requisite experience or skill set, to properly evaluate the situation. Those of us who have spent the time and do have the experience and skill set don’t want to spend our time discussing these silly supposed concerns, although sometimes we do. (In total, the reasons behind previously reported accounts receivable and inventory levels are more complex; but it is, largely, just a case of seasonality. [There is far more agriculture in the warmer months in Northern and Central China; and you should build inventory prior to the stronger growing season and build accounts receivable during the stronger growing season.])

  • Report this Comment On October 09, 2010, at 11:26 AM, Duwango wrote:

    Invite 1.3 bbbbillion people to brunch today. Repeat

    tomorrow and everyday. You can see why an "organic" fertilizer company with proven results marketing to their own country is a win.

    YONG is a long-term hold for me. I have spiced it

    up with selling puts on dips and selling covered

    calls on rises. YONG is made for simple option

    plays, profitable and fun, with a sound stock.

  • Report this Comment On February 06, 2011, at 2:37 PM, natsbaseball wrote:

    Tim - please get your dad to respond to the below article - we gardeners need to stick together.

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