Real Money's Long Shot column is dedicated to trading ideas that are highly risky, but which present an opportunity for significant payoff if they work. Such ideas are sometimes characterized as "lottery tickets" and are for only the most risk-tolerant investors, as the potential for 100% loss is high.
A compelling investment opportunity is afloat in the Arafura Sea of Indonesia. Pingtan Marine Enterprises (PME) operates a fleet of over 120 fishing vessels that mainly work the Arafura Sea and Bay of Bengal off India, bringing back to their home port in Southeastern China a catch of over 30 different species. Due to a complex history, the Nasdaq-traded company is languishing unknown to U.S. investors, but that may change soon, as the stable profitability and low valuation start to attract attention.
"Complex" may not begin to describe its history, but making money is usually accompanied by hard work. PME was a division of a large Chinese conglomerate involved in construction, real estate, and other marine services that went public via an acquisition by a blank-check special purpose acquisition company (SPAC). The SPAC purchased two constituent businesses, the fishing fleet and a dredging service. This was not a marriage made in heaven, as these two businesses are only marginally related (the capital equipment floats). The chairman of the conglomerate decided to buy out the dredging business this summer, and the valuation of the offer was blessed last week by the independent board members, supported by a fairness opinion from Duff and Phelps. When the deal closes, PME will lose the dredging business, but also lose $150 million in debt, resulting in a pure play consumer company with a clean balance sheet and bright prospects.
The business model here is simple and visible. The company has expanded to a fleet of 126 fishing vessels, adding to an existing base by purchasing 46 new vessels this year, and inheriting another 20 as compensation in the dredging deal. The boats generate approximately $3 million in annual revenue, which, of course, can vary somewhat as market prices for fish vary. (Because the boats are not specialized, they can fish for whatever is commanding the highest prices at the moment, so, in practice, the revenue is relatively stable.)
The company estimates that each boat yields approximately $800,000 to $1 million in net income. Historical gross margin is around 43% or $1.2 million per boat, which leaves up to one-third to cover SG&A and taxes to yield that net. The company expects its utilization in 2014 to be 100 boats at full capacity. Factoring in break-in/testing for the new boats, maintenance, and other downtime items, the effective fleet will comprise 100 full-time equivalent boats. Absent any extraordinary circumstances, PME should pull in revenue of $300 million and $80 million to $100 million of earnings in 2014.
Chinese government regulations enhance the profitability of the business. In order to guard against overfishing, each fishing boat has attached to it (figuratively speaking) a license to import fish into China. Like taxi cab medallions, the license is usually worth far more than the vessel itself. The government recently notified the industry that it is issuing no more new import licenses for the regions and type of fish PME specializes in. The stock popped on that news, but even after that move off the bottom, the valuation looks attractive.
With a market cap of $217 million, PME is trading at a 2x to 3x price-to-earnings ratio (P/E) against my 2014 earnings estimate. Those are multiples more often reserved for cash flows, not net income. Fishing and agriculture names are not known for Internet-type multiples, but this business could be fairly valued far higher. Even a discount to market such as 10x would yield attractive returns for shareholders.
Investors may decide they like the growth prospects and spring for an even higher multiple. The company is moving beyond the wholesale business (catch and sell at port) and is in the process of downstream integration. Management is negotiating a deal to sell branded fish through a major Chinese supermarket chain, which will substantially lift the company's revenue and margins. Half of its sales are for ribbonfish, a delicacy in China. The retail price is nearly 6x the wholesale price PME receives now. PME is building a processing plant that should go active in 2014. Downstream retail could double its revenue and more than double income above the estimate I made earlier.
The stock current low multiple overcompensates for the risks involved. Some do exist but are not overly bothersome to me. For instance, the negative sentiment around Chinese stocks traded in the US, especially those without a standard IPO entry, could limit the re-rating. Fair enough, but that negative sentiment is applied indiscriminately, and PME is worthy of more trust. The new CFO (who joined in April) is Western-trained and understands accounting best practices. Management is committed to transparency, and the business is easily tracked. The boats can be counted, and much industry activity can be tracked online. Other risks such as typhoons in the Bay of Bengal or Arafura can disrupt business somewhat, but the fleet is mobile so the risk is not equivalent to stationary assets.
What is the catalyst to unlock value? I think as PME puts up good numbers, investors will discover the name. Deutsche Bank was the lead banker in the SPAC, so while there is no guarantee, certainly a quality investment bank like DB could offer research sponsorship down the road. At a $200 million market cap, the name would also be appropriate for coverage by any number of small-cap specialists.
Pingtan Marine is poised to be a big winner in 2014. With a simple and focused business model, clear visibility to substantial profitability, and a low multiple due to transient causes, I think PME can easily be a double or more next year. I own it in my own account and am adding it to my Real Money Best Ideas list. Get out there while the fish are biting, and catch yourself some Pingtan Marine.
