Maynard Paton forewarned of problems at two Chinese AIM shares. and one has just collapsed 47%. Which one could be next?
Last month I evaluated two AIM-quoted Chinese companies for members of the Motley Fool's Champion Shares service. I concluded the duo were "good examples of growth shares I'd avoid", adding "both companies have demonstrated rapid expansion of late, but a complete absence of cash generation does not suggest these businesses are built on firm foundations."
One of the shares I looked at was Bodisen Biotech
(LSE: BODI)
, which has since collapsed 47%.*
Bodisen claims to be a "leading Chinese manufacturer of environmentally friendly organic bio-fertiliser". With Chinese farmers apparently attracted to the fertiliser's "natural nutritional elements", Bodisen has witnessed its sales triple to about $31m (£16m) and earnings quadruple to $8m between 2003 and 2005. The rapid growth has continued into the first half of 2006, with sales and profits more than doubling.
So on the surface Bodisen seemed a great growth business. but further investigation showed terrible cash generation.
For instance, I discovered about $7m from a $9m operating profit was absorbed into working capital rather than translated into free cash during 2005. Then in the first six months of 2006, working capital gobbled up $12m -- exceeding the interim $9m operating profit!
I therefore warned the Champion Shares community that "far too much of Bodisen's cash is advanced to suppliers and owed by customers and thus I'd question the quality of reported sales and earnings." (If you want to know why I feel working capital is so important, read up on these five cash-flow nightmares.)
Fast forward to last week and an announcement from the American Stock Exchange (where Bodisen has a second listing). AMEX claimed Bodisen has made "insufficient or inaccurate disclosure" and "expressed concern [about]internal control issues related to. accounting and financial reporting obligations".
Given the state of the accounts, I'm not surprised Bodisen could have "internal control issues." (Certainly somebody needs to be managing the group's cash flow!) The news from AMEX has caused Bodisen's AIM-traded shares to slump 47% since then.
What now?
Businesses should always generate 'cash profits' as opposed to just 'accounting profits'. So with every share tip I publish for Champion Shares, I always ensure reported earnings are supported by cash. Needless to say, I'm glad I told members of the Champion Shares service to avoid Bodisen.
But what of that second Chinese AIM share? This company seems very much like Bodisen to me. Great sales and profit growth, but appalling working capital in my view. Though the share price is doing very well and the bulletin boards are positive, I reckon a cash crunch is likely and the company could well be the next Chinese AIM disaster.
The identity of this second Chinese AIM share can be obtained through this FREE 30-day trial of Champion Shares (please note: there is no obligation to pay and the trial can be cancelled at anytime). Once you're part of the Champion Shares community, this article will reveal all!
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As at 17 November 2006, the Champion Shares portfolio had delivered an average return of 14.8% versus a comparable 12.6% return for the FTSE All-Share index. Performance figures are based on mid-prices at the time of recommendation, include due dividends and exclude costs.
*Maynard wrote about Bodisen Biotech in a Champion Shares update on October 25, 2006. The share price closed at 502.5p on October 24, 2006. On November 17, 2005, it closed at 265p.
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