China Agri-Business Inc. (CHBU) has been holding in my Value Uncovered model portfolio since June, when the company was selling at a discount to its NNWC.

The company reported outstanding second quarter earnings 10 days ago, with the stock jumping over 20% on the news, before falling back over the last week.

CHBU remains in solid financial shape and is growing like crazy, and yet is trading for less than NNWC.

Financial Highlights

CHBU reported a huge increase in sales for the first half of the year on strength of the company’s “New Agriculture-Generator” initiative. Net revenues jumped an outstanding 325% to $4.99M compared to revenues of $1.17M in the prior year period.

For the second quarter, net income increased 206%, increasing quarterly earnings per share to $0.06.

Gross margin has dropped significantly compared to last year, from 73% to 35%, as the company undergoes a transformation to the new direct store sales model.

Despite the change in gross margin, both operating and net margin levels remain extremely high at 23% and 21.8% respectively (the company pays no taxes).

The company’s balance sheet is extremely solid, with a current ratio of 13.9 – with most of these assets being liquid.

Despite significant investments in equipment this year, CHBU continues to throw off cash, generating 757k in FCF for the year so far, more than doubling the amount from a year ago.

New Sales Model

Based on these results, the company is moving to an entirely new sales model going forward. Direct store sales now make up over 80% of the CHBU’s total revenues, as the traditional sales network becomes less of a focus.

Growth was largely driven by an expansion in the number of total stores, increasing from 250 to 346 in a single quarter. The company expects 500 stores by October 2010, several months earlier than previously forecasted.

Although the new model has much lower margins than the traditional network, the rapid growth like this is hard to ignore. Despite the impressive steps China has taken as a country overall, there remains a huge rural population that could benefit from the company’s products.

According to the press release,

“At the Company’s direct sales stores, farmers can purchase fertilizer products, including organic fertilizers made by China Agri, have access to the Company’s sales staff who are knowledgeable about the products offered, and receive services that include technical support. This will help farmers to increase their crop yields and productivity and, in turn, should encourage them to be loyal long-term customers for China Agri.”

Valuation

My original investment thesis was based on the fact that the stock was a Net/Net trading at less than net cash. Here are updated numbers for the past few quarters:

Based on the most recent closing price, the stock is currently selling at a 22% discount to NNWC.

Conclusion

It is not often that the market provides a growing, cash flow positive stock with a market cap less than the cash on the balance sheet. CHBU is a capital-light business with little debt and obvious growth potential.

As with many Chinese stocks, management and disclosure is always a concern. The company has limited experience running a retail operation and will assuredly run into growing pains as the torrid expansion eventually slows.

The company is also in line to purchase a large parcel of land to expand capacity, a transaction that will cut into the margin of safety on a NNWC basis.

However, if CHBU continues to report operating results like this quarter, the stock might be worth holding on to as an earnings/growth play, rather than just a value investment based on assets.

Disclosure

Long CHBU

Servotronics Inc. (SVT) recently reported 2010 second quarter earnings and the market reacted favorably as the company turned in another solid quarter. The stock price jumped to $10, after trading around $9 for the prior month or two.

Second Quarter Results

Revenues for the 2nd quarter were $8.2M compared to $9.1M in the same period last year, a drop of approx. 10%.

The Consumer Products Group was the source of the decline, with sales dropping 23%, partially offset by a slight increase in revenues for the Advanced Technology Group.

Despite the top-line drop, quarterly net income was up significantly, increasing 10% to $778k compared to $710k in the prior year quarter. For the 6 month period ending June 30, 2010, net income was 68% higher, as the company continues to benefit from an outstanding first quarter.

FCF is $1.6M so far this year, more than doubling the cash flow generated in the same period last year.

Segment Analysis

The ATG division continues to chug along, as operating profit increased for the second consecutive quarter.

The company has also worked to improve the CPG’s product line, allowing margins to increase slightly despite the drop in sales.

Conclusion

With conservative estimates, the business is on track to generate over $3M in owner earnings for the year, close to the record set in 2008.

Management has performed well through the economic downturn – after a small hiccup at the end of 2009 – and the stock should benefit as the aerospace markets turn around (see my post on SIFCO as well).

I’m revising my conservative valuation downward slightly, to $12.50-$13.50, with an upward estimate closer to $15.

Disclosure

Long SVT

Access Plans Inc (APNC) continues to chug along with solid results after reporting fiscal third quarter earnings this week. The stock remains substantially undervalued based on company financials despite worries about broader healthcare reform.

Sales Highlights

Company-wide revenue for the fiscal third quarter climbed 3% to $14.4m compared to the same quarter last year. Both the Wholesale Plans and Retail Plans divisions reported organic growth in revenue, increasing 15% and 9% respectively.

At the bottom line, net income in the period increased 10% to $0.95m compared to $0.86m a year earlier.

The company’s balance sheet has steadily improved as well. Current Ratio has increased from 0.9 to 1.4 over the past year. The company paid down all of its long-term debt and FCF for the year is the highest on record.

APNC also bought back approx. 8% of shares outstanding under the stock repurchase program, bringing the total number of shares down to 19.8m.

Business Segment Analysis

The revenue increase in Wholesale Plans was especially solid as margins also improved significantly, building upon the 14.5% revenue increase in APNC’s previous quarter.

Although profits declined in the other two divisions, the company has several new initiatives underway for achieving growth targets.

The Retail Plans segment is rolling out a new offering while phasing out legacy programs. Meanwhile, Insurance Marketing is focusing its strategy on combining supplemental and life products with major medical sales:

“We believe this new approach, which was prompted by certain aspects of the Healthcare Reform Act, should maintain commission income for agents, while improving the division’s operating margins. We are in the final stages of designing this new supplemental offering, and rollout is scheduled for the first quarter of Fiscal 2011.”

Uncertainly Around Health Care Reform

In the broader market, healthcare stocks are suffering after the passing of the ‘Health Care and Education Affordability Reconciliation Act of 2010’. According to Standard & Poors, Health Care is the second worst-performing sector YTD with a loss of 6.24%.

Although many of the new rules are yet to be implemented or even agreed upon, the market has shied away from companies whose business could be affected by the new reforms.

APNC – Health Insurance Company in Appearance Only?

Looking through the financials, company revenues are almost evenly split between Wholesale Plans, Retail Plans, and Insurance Marketing.

The Wholesale Plans division contributed 40% of total sales through the first nine months of 2010 and 51% of total operating profits – it is the most important division and wouldn’t be affected by the new law.

The Retail Plans segment offers ‘insurance-like’ services outside the scope of traditional healthcare insurance regulation. While there is some risk in this area – i.e. potential customers moving to a government-sponsored health insurance program instead of APNC’s products – I think there will always remain a market for alternative offerings.

On the other hand, the Insurance Marketing segment is the one area that will immediately be affected by the new law. According to the company’s filings,

“As a result of the minimum loss ratio requirement in the Health Care Reform Law, it is likely that commissions on the sale of individual major medical insurance policies will be reduced in January 2011 and, if that happens, it could result in a significant reduction in our revenue.”

However, it is important to note that the changes will only affect the commissions ultimately paid to agents – the company’s real risk is that fewer policies will be sold under the lower commission structure:

“Most of our commission revenue is ultimately paid to our agents so the potential reduction in revenue will not necessarily cause a reduction in our profitability in the same proportion. “

Conclusion

APNC continues to report solid performance, and has solid potential for growth in each division.

Although risk certainly remains (it is often hard to predict the outcome of governmental decisions on such a testy subject as healthcare), a good portion of the business seems to be insulated by its niche focus on wholesale plans and supplementary ‘insurance-like’ products.

As the debate rages on, there doesn’t appear to be any reason why APNC should be trading so low based on the financial numbers – substantial upside to the stock remains.

Disclosure

Long APNC