Waiting on Yongye
Board: Value Hounds
Yongye continues to see high revenue growth. Unfortunately, in 2011, much of the growth has rested on extending longer and longer credit terms to distributors. The credit shows up as higher dollar amounts in receivables and long days sales outstanding.
The company has not been as far behind in receivables in its history as it was in Q4 2011. In Q2 2011, management was confident of collecting in a timely manner by the end of the year.
From the CEO in Q2 2011:
We expect to collect significant A/R in Q3 and Q4. We only need to collect from our 25 provincial-level distributors most of whom we have been dealing for a long time. We review the credit of every one of them individually and determine whether bad debt allowance is needed. For the past three years, we never have any bad debt. We feel very confident that we will collect all of our A/R.
However, at the end of Q4, Yongye found it necessary to create a reserve for doubtful accounts of $15 million and accounts were further in arrears. Days sales outstanding (DSO) and the ratio of receivables to sales (A/R) continued to increase. Cash flow from operations (CFFO) ran into the red at ($31) million for the year. The company took on an additional $28 million in debt in Q4 presumably to cover upcoming expenses. Yongye often issues shares to raise cash, but seldom incurs significant amounts of debt. In 2011 they needed to use debt and equity to maintain cash levels. In May, $50 million in convertible preferreds were sold to Morgan Stanley Private Equity Asia.
There were no unusual expenses and capital expenditures were minimal. There was no indication that the cash was needed for growth. Developing the coal mine was not mentioned. We can assume they need the cash to run the company. With the debt and the sale of shares, Yongye managed to end 2011 with $81 million in cash. Without it, there would have been a lot less to spend in 2012.
The following table is a new addition to Yongye’s 10K showing the aging of receivables. Two notable trends are the flipping of the percentages due 0-3 months and 3-6 months 2010 and 2011. There is 70% of receivables outstanding in the 3 to 6 months time frame. One year ago, 65% of receivables were collected in 3 months or less.
[See Post for Tables]
Because receivables are now up to and beyond 6 months out, Yongye added this as a risk to business in the 10K—also a new addition to the recent filing.
We may experience difficulty in collecting our accounts receivables, which could have a material and adverse effect on our liquidity, financial condition and results of operations.
And in fact it did create havoc in working capital and showed up as a ($31) million in cash flow from operations—the worst CFFO in their history. Record revenues do not necessarily translate to enough cash to run the company. Yongye took an additional loan in Q4 for $28 million—presumably to keep the lights on since capex spending has been almost non-existent this year and there are no stated plans for expansion or development of a coal mining operation in 2012.
The three-month collection has now moved to six months and beyond. Rather than collect for spring and summer planting by December, Yongye says they are shooting for Q1 of the following year. While they claim to be in line with industry norms, CGA still collects in 3 months.
The credit period we grant and our credit policies are generally in line with market practice.
In 2011, Yongye’s continuing amazing revenue growth was made possible by keeping distributors well supplied with product and recognizing the revenue as soon as it shipped. Now that collectability is in doubt and the company may be forced to delay revenue recognition if receivables continue to deteriorate. They cannot recognize revenue if there is reasonable doubt the account cannot be collected. At present that is $15 million. Going forward, that has the potential to slow Yongye’s superlative growth.
From the 10K:
[The]deteriorating payment ability of our distributors will result in delay revenue recognition, until collectability can be reasonably assured which is generally upon cash receipt and, thus, have a material and adverse effect on our financial condition and results of operations.
[See Post for Tables]
AR/revenue is a ratio of accounts receivable to revenue. In 2011, it took an ever-increasing amount in receivables to create revenue growth. It suggests the demand is trailing the amount of plant nutrient Yongye has in its channels.
Increase in AR year-over-year is at all time highs.
Increase in revenue has slowed
DSO is at historic highs for Q4. The company did not collect all they had anticipated incurring establishment of a doubtful accounts reserve. The AR represents around 10 months of sales outstanding in Q4 and far exceeds the six-month credit term the company has extended to distributors. CGA collects in 90 days.
Yongye buys cars for some of its distributors. It appears to offer an incentive to distributors to take enough product in order to keep the car whether or not there is adequate demand for them to then sell through these high levels of Shengmingsu.
Because of the restrictions on reducing the price ie discounting, distributors may be finding it difficult to move the product in a very competitive space. Shengmingsu has always sold at a premium to the companies I have been able to track through flings. Those companies are China Green Agriculture and China Agritech.
China Agritech was suspended and recently trades on the pink sheets and no financial information is available. For CGA, sales figures for their humic acid product have slowly declined over the past 18 months and in December 2011, a ton of humic acid product sold for $1300. Contrast that with Yongye’s average per ton sales price of $11,800. It may be a difficult sell such expensive nutrient against a cheaper competitor. There are by Yongye’s estimates over 800 manufacturers of plant nutrient products.
The car account has been a steadily rising asset that I have been tracking.
To qualify to keep the free car, distributors must:
1) Meet annual sales figures
2) Sell product at company mandated pricing
3) Sell only in approved territory
[See Post for Tables]
The amount the company is investing in vehicles for distributors is increasing significantly along with revenue and DSO. There are 810 county level distributors under the supervision of 25 provincial distributors. There is no information given on how many qualify for the cars. If the cars average around $15,000, almost all of the distributors would have a car.
Vehicle loans-distributors represented loans that were initially obtained by the distributors from banks and financial institutions. The Company and the distributors entered into agreements, pursuant to which the Company would assume the full repayment of the loans on behalf of these distributors in exchange for the distributors agreeing to comply with certain sales conditions (See Note 11). The loans have two or three years terms and are payable in monthly installments. Interest rates on the loans range from 5.40% to 17.24% annually, subject to the change of the base interest rate prescribed by People’s Bank of China.
In Q3 2011 car loans were $5.6 million and by the end of Q4 2011 in December it had more than doubled. It is not difficult to believe that owning and keeping a car provides a powerful incentive to distributors to fill quotas. The sales quotas set by the company are intended to keep revenue growth high, but the demand may be lagging. Distributors are quite likely to take what the company mandates in quotas to keep the cars, but they appear to be have difficulty moving that much product into stores. It’s a method of growing revenue that can turn on a company once saturation is reached.
In 2010, Yongye was finally CFFO positive for the first time and investors were expecting a similar result this year after fast growing revenue and earnings increases.
Growth in revenue and EPS
Even with the high growth of revenue for 2011, the company could not produce positive cash flow and had to use debt and equity to raise cash levels. The negative EPS for Q4 was largely due to the increase in SG&A from the $15 million bad debt reserve.
This is an abbreviated version of the cash flow statement that compares 2010(their only CFFO positive year) to 2011. Notice how out of line the change in accounts receivables is.
[See Post for Tables]
The conference call did little to clarify what is going on in the company and what has happened in the distribution network. Management claims they were too focused on revenue growth and expansion and need to spend time managing the distribution network. If I had a suspicious nature, I might suspect Yongye has created its own distribution problems and has taken advantage of revenue recognition accounting that allows legal recognition of sales on shipment. Selling it is another matter and it appears that product is backed up in the distribution channel.
Distributors are not going to be inclined to pay until the get it off their shelves into stores. Revenue grew less fast in Q4 2011 than in 2010. The product channel is full.
The company claims to have collected over $70 million in receivables in the first quarter of 2012. However, this is the time of year that sales are expected to escalate and in order to meet their 2012 guidance they are going to have to aggressively re-supply distributors who may not be able to sell through completely to stores after having just caught up. If distributors don’t meet the quota set by Yongye that supports the $500 million revenue guidance for 2012, they lose the wheels. It seems more likely than not, Shengmingsu plant nutrient will get shipped in big quantities. The receivables may continue to be Yongye’s Achille’s heel.