A company operating in China under poor trading conditions may not seem like a great investment opportunity. But when it's valued at less than cash…
Any company valued at less than its cash holdings, with other assets and a tiny historic price-to-earnings ratio (PER) must be worth of consideration. Add to that a degree of excitement over future products, and you have to take it seriously.
But dig down a little under the surface of Taihua (LSE: TAIH), it's easy to see why its valuation has become so depressed. Trading has been difficult and anything operating in China isn't anywhere near as fashionable with investors as it was a couple of years ago. And they don't come much more Chinese than this Chinese traditional medicines and pharmaceuticals company.
The products
But if you're thinking it's all about mixed dried herbs and quack remedies, think again. Taihua manufacturers and supplies some very serious drugs indeed for the treatment of leukaemia and other cancers. Traditional and modern medicines largely rely on plant extracts for their key ingredients, although once identified these can often be replicated in the lab. However, preservation and further planting remains extremely important in order for new cures and drugs to be identified and developed.
Taihua's main specialities are in producing paxlitaxel which is used in used in cancer chemotherapy and homoharringtonine which "could be of potential significant benefit for the treatment of acute myeloid leukaemia because it may act in a different way than the already authorised drugs" according to the European Medicines Agency.
These products are produced to very high levels of purity that meet Western standards. The company has secured continuous access to raw materials as a result of long term supply agreements with Chinese yew tree growers and is also developing its own yew tree nurseries and plantations.
Problems, problems
But things haven't been going so well.
First of all, the Chinese government banned the production of traditional Chinese medicines (TCMs) following a series of fake drug scandals across the country, which meant that Taihua's subsidiary, Taihua Natural Plant Pharmaceutical Co. Ltd was unable to continue with sales into its domestic market. TCM sales accounted for 20% of turnover in 2007.
Then a trading statement in February revealed that sales of its two main specialist drugs, paclitaxel and homoharringtonine were down 16% and 28% respectively. This was mainly due to tighter lending conditions which meant Taihua's customers couldn't secure the credit needed to buy the drugs.
Its customers asked for credit from Taihua and more favourable terms, which increased the company's risk of recovery from some customers, so it turned some orders down from those it considered to be higher risk. Also, the introduction of a semi-synthetic paclitaxel by competitors hit sales of Taihua's all-natural version -- whilst foreign exchange rate fluctuations in Russia and South America impacted on sales there.
What's the attraction?
In short, it's the company's cash position and its potential for a recovery in earnings.
In 2007, Taihua's first full year since the company's admission to AIM in December 2006, it managed to bring in pre-tax profits of Renminbi (RMB) 39.8m (£2.6m) on a turnover of RMB 71.79m (£4.7m). This would put the shares today on a historic PER of just 3.8 at that time, or around 2.2 at today's exchange rates. This clearly isn't going to happen for 2008, but any kind of recovery to this sort of level over time would make the shares look ludicrously cheap.
Cash rich
Then there's the cash. At the interim stage to the end of June, Taihua had a net asset value of over RMB 123m (£11.2m) and cash of over RMB 82m (£7.5m) but at the current mid price of 7.12p, it is valued at less than £6m.
Taihua's final results for 2008 are due out on 26 June and, judging by the trading statement, they aren't going to be pretty. But this news is already in the price and then some. And although we learned that sales revenue and pre-tax profit are expected to be "significantly" below previous expectations, it doesn't sound like the company is expecting to lose money on their "annus horribilis" of 2008.
Meanwhile Taihua is waiting for a result from its application for a certificate of suitability for paclitaxel from the European Directorate for the Quality of Medicines. Approval here could see the shares significantly re-rated, but the cash position offers huge downside protection if not.
More from David Holding:
David owns shares in Taihua.
