Qian Hu analysis - Business overview

Shall do an analysis on Qian Hu, a company which is not widely covered nor actively traded. My whole analysis shall revolve around one word: sustainability.



What does Qian Hu do? Qian Hu is an ornamental fish service provider, breeding, selling, importing and exporting ornamental fish from around the world. Physical presence in 4 countries, namely Singapore, Malaysia, Thailand and China. Accounts for >10% of Singapore's ornamental fish exports.



Its business generally revolves around 4 areas:



i) export of ornamental fish and accessories

Qian Hu imports, exports, breeds, quarantines, conditions, farms and distributes ornamental fish. When I went down for a visit however, a quick enquiry revealed that Qian Hu acts more of a "holding" area for fishes as opposed to a breeding area, because the costs of breeding are high and not worthwhile. Its ornamental fish are imported from countries in South-East Asia, South America and Africa. It has > 500 species and varieties of ornamental fish, exporting directly to >70 countries and also distributes to local retailers and exporters, including the "Qian Hu" dragon fish(one of which Chow Yun Fatt owns haha)



ii) distribution of ornamental fish and accessories; &

iii) manufacturing of aquarium and pet accessories


The distribution of accessories complements its ornamental fish business, meeting customers' aquarium needs. Qian Hu distributes > 5,000 types of aquarium and pet accessories from more than 20 major manufacturers and principals to local retailers and wholesalers in Asia, including supermarkets operated by NTUC FairPrice, Cold Storage and Carrefour.



Qian Hu has also developed its own brands of aquarium and pet accessories, namely
"Ocean Free", "Delikate", "BARK", "Nature's Gift" and "ARISTO-CATS YI HU", and they are sold through Qian Hu's subsidiaries. Rather silly-sounding names if u ask me.



Qian Hui also manufactures plastic bags(not the NTUC kind, its for packaging fishes) as an ancillary business. Qian Hu manufactures plastic bags for its own use to package ornamental fish for sale in a separate factory located in Woodlands. The plastic bags are also supplied to third parties in the ornamental fish, food and electronics industries. The investment in this area is treated as a sunk cost, and a quick enquiry revealed that the CEO Kenny Yap treats this business as a cash cow for its other segments.



iv) breeding of dragon fish



A licence is required to breed and distribute Dragon Fish, and there are 6 farms in Singapore registered with AVA for the breeding of Dragon Fish. The barriers of entry to the breeding of Dragon Fish are high in view of the knowledge and experience required and the high capital investment involved in the breeding of Dragon Fish, for example, Qianhu has been breeding Dragon Fish (through Wan Hu) since 1995 and capitalised 350 pieces of Brooder Stock amounting to $1.5 million as fixed assets in 1999. This is not exactly something that ordinary fish sellers/farmers would want to go into.



Having gone through the business overview, shall now do an analysis on the sustainability of Qian Hu's business, through a simple SWOT analysis.



Strengths



i) Market leader (shall talk about this slowly in more detail since everyone claims to be a market leader):



a) accounts for >10% of Singapore's fish exports



b) Only fish company in the world to be able to export fish from 4 countries in Asia



ii) competitive positioning

carves a niche by not only rearing Arowana(dragon fish), because most other competitiors like Xian Leng(Malaysia) also do that; Qianhu also sells pet and fish accessories. The reason lies in that the accessories industry is a much larger market than that of the fish itself. Let's do a simple logical explanation: would u keep buying fish or keep buying fish food? That's assuming that you have the skill not to kill your $3000 Arowana once every few weeks. The total customer equity of fish food customers would be the present value of the future consumption(or rather purchases) of fish food. This thus does not come as a surprise that for every $1 spent on fishes, >$2 is spent on accessories($4.5 billion dollar industry for fishes but $10 billion industry for accessories).



The clever part about this is that the accessories industry helps to improve sustainability of Qianhu. Now, let's think again, if Qian Hu sells Arowana solely, will it be sustainable? Perhaps. But think in this way, customers do not keep buying Arowana, this is perhaps a one-off purchase in say, once every few years? It's akin to us not buying wardrobes every few months; similarly, customers do not keep buying Arowana every few months. It does not mean of course that its other competitors do not sell fish accessories, but from management statement(for Xian Leng's, choosing it because it's the largest competitor), there is a noted emphasis on Arowana. However sadly, for some reason, the segment and geographical breakdown is not reported in the financials, so I am unable to conclude whether Xian Leng does in fact emphasise on Arowana and less on accessories. But if Qianhu continues its emphasis on the accessories and Arowana portion, it will bode well for the company, and its actions thus far have proven so.



iii) High barriers to entry



Bredding of Arowana requires R&D(yes, even for fishes). Qian Hu's collaborated with Temasek Life Sciences Laboratory, and the research team has completed the genotyping of all the brooders owned by Qian Hu and has set up an efficient method to identify breeding pairs. For the first time in the history of Arowana breeding, offspring collected from the mouth of
brooders can be assigned to both their parents, opening the way to pedigrees based
on pair-wise breeding. The team is now searching for sex-linked DNA markers that
can be used on juveniles and even larvae.



Qianhu has also invested about S$3m on a new farm in Singapore, next to its current fish farm. This new farm will be 2-3x bigger than the existing one and is under construction(it's the big piece of land beside it which is currently undergoing construction, for those who have gone to the fish farm before.)



Now, how does this help in sustainability? Qianhu's R&D efforts are largely to keep up with competitors(it does not state this in the website of course, you need to look at its competitors'). Its competitor, Xian Leng, is the first Asian company to secure CITES registration, permitting the trading of the Asian Arowana. Although Qianhu has first-mover advantage here in Singapore, however, it has its work cut out to achieve its aim of being one of the top breeders and exporters of Arowana to China(where the market is still damned big despite the one-child policy) and also the top ornamental fish exporter in the world. This expertise has however enabled Qianhu to ensure customers of a loss rate <3%.>60%, which is indeed very high, considering the current gross margins and net margins of 35% and 8% respectively.



v) Vertically integrated



Qian Hu is dependent on the importing of ornamental fish for its supply. However, other than that, everything else can be done in-house because they have the expertise and facilities, i.e. breeding ground, employees, packaging of fishes to be exported(plastic bags). So what does this mean? It means that Qianhu has most production factors are under its control. The control of such factors reduces the lead time required for the entire chain of importing the fish to exporting the fish, or selling it locally, and this high turnover results in a higher potential to convert this into profits.



Now, what's the competitive advantage again? Again, Xian Leng's 4 main subsidiaries revolve around breeding of its Malaysian Golden Arowana; trading of ornamental fish and property holding(#%@!); supplying and trding of aquarium accessories; and trding of aquaculture products. The vertical integration of the supply chain is lacking here where the accessories of Xian Leng in the exporting of fish is actually purchased.



There are other "strengths" which include a management which has been in the business for decades(Kenny Yap and family), employee satisfaction rates of 97.5%(2007), ISO 9001 and 14001 etc, but these are signs and symptoms of strengths rather than actual strenghts itself. Furthermore, there are no significant others to compare with, so I shall not spend more time talking about these little aspects.

vi) Cash convertion

Qianhu's fishes are sold through the conventional pay-at-counter method. There are little problems with receivables as people don't normally pay for fish using cheques, do they? This allows for quick conversion to cash, and Qianhu can now use the cash for investments in breeder stock, instead of having "profits" locked in account receivables. Shall talk about the financial ratios with regards to this in later analyses.

Weaknesses



i) Largely dependent on family management.



Qianhu is largely run by the Yap family, having inherited their pig-rearing business from their fathers 2 decades ago. It is largely controlled by the Yap family, i.e Kenny Yap, Alvin Yap, Andy Yap etc.



Now, why is this a weakness? The Yap family has been running Qianhu's business well for many years, without showing much signs of complacency. However, as it is pretty much a family-run business, it might not augur well for shareholders as the board might not have much say in the running of the business, and the Yap family MIGHT make business decisions which might not be in the best interests of shareholders, although I might be tempted to dismiss this. Kenny Yap has largely been ascribed to the success of the business, and has been largely accountable to shareholders, as shown by its winning of the Most Transparent Company 2 years running(SIAS) and also by Business Times(since 2002). In 1997, Kenny took on a project to automate its fish-packing processes by designing a proprietary auto-packing machine. These are evidences of competent management and help to dispel the abovementioned worries. Furthermore, on a more personal note, Kenny Yap can actually be found chatting online in forums and discussing about fish rearing. This is a clear indication that he is devoted to his job and loves his business, something that long-term investors would like to see. This is a "weakness" that might be seen as a strength too.



ii) Dependent on suppliers for supply of ornamental fish



As mentioned earlier, Qianhu has a integrated supply chain, with the only part of the chain not within control being the supply of the fish itself. When I went down for a visit, the workers revealed that fish breeding(except for Arowana) is generally not practiced in Qianhu(and also other oramental fish companies) because of the large amount of space required and also resources. However, this dependence on suppliers in Malaysia and Indonesia could meet difficulties like export problems( as they are obtained from overseas). This is one major factor that Qianhu cannot control, and I do not foresee that happening in the short run due to their recent $3 million investment in the new Arowana farm. Even if there's capability to purchase a new farm for breeding of ornamental fish, this would not make business sense as it is akin to "inventory pile-up".



iii) Dependence on Asian markets

The revenue contribution from Asian markets is 70% as opposed to European markets which makes up the remaining 30%. This is a modest 2% increase from its previous 28%. Nonetheless, the point here is that the Asian markets are more receptive towards the Arowana (dragon fish), especially so for the Chinese which believe in the superstitions related to the Arowana. This trend is not likely to change in the near future because this is a cultural habit, and consumption patterns take very long to change. Nonetheless, the Chinese market is still large enough for Qianhu at the moment, and geographical diversification is not an absolute necessity.

Opportunities:

1) Growing market

As aforementioned, the ornamental fish industry is currently about $14 billion, not big as compared to other industries, but what is most important is the sustainability. This has been proven so far, with the market growing at a CAGR of 15% p.a since 1985, very impressive indeed. To appreciate this figure, try imagining if your current equity holdings right now are being compounded at 15% p.a. for 23 years ala Buffett-style.

Nonetheless, what does it bode for Qianhu? A growing industry is likely to bring in new competitors. But bring in the point about the industry having high barriers to entry. This likely means that the current leaders in the industry will enjoy the bulk of the growth. Furthermore, Singapore has the nickname "ornamental fish capital of the world", having been the top exporter in the world in 2005 with a current global market share of approximately 20%, and is already the world's largest farm breeder of ornamental fish. Qianhu, being the biggest player here, seems poised to capture a large market share.

Now, why is this important for Qianhu still? Do take note that, as earlier mentioned, ornamental fishes are not bought at the frequency you buy toothbrushes or chocolate bars, perhaps only fish accessories. People are likely to buy 1-2 Arowanas or slightly more, but probably not much more than this figure, nor will they repeatedly buy ornamental fishes. Thus, it is increasingly important for Qianhu to outsource and increase its customer base instead of solely focusing on customer retention, at least more important than other companies not in this industry. The increasing market share will increase the amount of fish sold to new customers, and since this is a somewhat personalised service, customer retention will take care of itself through post-purchase service and fish accessories.

ii) Arowana popularity in China

Like earlier mentioned, the dragon fish has a position in the hearts of the wealthy Chinese due to their aesthetic beauty and its purported luck, something that us Chinese can personally relate to.

iii) Accessories business

Some of these are repeated points. As earlier mentioned, there is a potentially much larger market for accessories rather than fishes. The financials indicate $2 spent for every $1 spent on fishes, but an enquiry with Kenny Yap revealed that the figure is around $5 for every $1. Agreed, this might be a lower margin business. But using logic again, does Qianhu need to actively market its accessories? The customer base comes from the people who buy fishes, and people will purchase accessories after purchasing their fishes, thus it is a complementary business, and there is no need for Qianhu to spend more resources in marketing this segment of the business. In fact, it doesn't make sense at all for Qianhu to market its accessories solely. Thus, this means that not much extra effort is needed to sell the accessories, and this can be seen as a potential cash cow for Qianhu, or rather a cash multiplier. There's no such term, but I feel that it suits the nature of this business because it reaps in more revenue for Qianhu than without this segment.


Threats

i) Disease outbreaks

Qianhu lost its entire brood of 4000 loach fins about a decade ago, and this had threatened to send the family into bankruptcy. Not to say that such events will not happen, as there is still a likelihood that disease outbreaks or other unforseen scenarios can wipe out portions of Qianhu's breeder stock. However, this is likely to have a smaller material impact as Qianhu's farms are now geographically diversified, and the experience gathered these years in rearing fish would minimise the impact of disease outbreaks. Furthermore, do again take note that these fishes are not totally in-bred as mentioned earlier due to space constraints, and the majority of the fishes are imported, then immediately exported within a short period of time.

ii) Forex risks

Qianhu has exposure to certain currencies like the baht, USD, yen and ringgit. This is likely to have an impact on earnings, with forex losses at around 7.7% at present. There are currently no measures to hedge against these positions, and might have a more significant impact on Qianhu during times of crises. However, I believe that holding such forex swap contracts or their equivalents will chalk up increases in expenses that are totally not related to the business, and this amount of money may actually be better off invested in breeder stock. Thus, I do not see this as a problem for now. Even if forex risks are to increase substantially in the short run, I do not see this causing a huge problem for Qianhu's sustainability, as it is highly unlikely that forex risks will cripple Qianhu's earnings at the current level.

iii) Government legislation or regulation

This is the biggest weakness of Qianhu in my opinion, as this is something that will materially impact Qianhu's business and at the same time, not something that Qianhu's management can control as this is the nature of the business. There are certain species of fishes that are restricted due to them being endangered. In fact, the Arowana is an endangered species, and under CITES, the fishes actually have to be tagged and the sales monitored to ensure that wild stocks are not being traded.

One important weakness of a business is its restricted markets, and this is one good example. This indicates that the business might not have the potential to continue to grow at the rate it has seen previously due to restrictions not within its control.

Is the ornamental fish industry any different? Somewhat. Firstly, Qianhu has already obtained its licence to breed Arowana. 2ndly, the beauty of ornamental fish is that fishes are not all identical, as in-breeding can occur. This means that the supply of ornamental fish can be said to be unrestricted save for the ones that are endangered. This again, bodes well for the sustainability of Qianhu.

That was one long analysis. Shall talk about the financial portion in my next analysis.

Blue Chips or not?

For some investors, blue chips are the only companies which are worth picking up. They have had proven cash-generating ability, sustainable dividend yields, and also gone through some crises, and are a must in some portfolios. Whilst these may be true, however, the markets are largely efficient to the extent whereby blue chips are mostly fairly valued. There are hundreds of brokerages out there covering blue chips, and a million other investors out there which have their eyes on the companies, waiting to swoop in once some idea of inefficiency rears its head. As such, blue chips are likely to "market perform".

With these being largely true, value investors will tend to stray away from them. However, with the recent turmoil in the markets, some value seems to be emerging amidst the sell-down. Now, why should value investors stay away from them if their valuations have been beaten down? Only because of the notion that there are many other brokerage firms which are covering them, and thus a low likelihood that one would catch it when it is undervalued? I believe 2 main points actually disprove this idea for now.

1) fund redemption

There had been an increase in capital outflow from Singapore from mutual funds. This has led to a massive sell-down in equities. One can argue that the mutual funds are selling to the extent whereby the prices reflect the current financial turmoil, and that prices are reflecting the newsflows.

However, over 90% of trades a day are accountable by mutual funds (quoted from Pulses), so it is likely that massive sell-downs can be attributed to the large funds. So, if all the funds start to sell collectively, will there be any fund manager which would want to pick up stocks even though they are aware that value is compelling? It is highly unlikely that a fund manager would want to be caught catching a falling knife, especially so since their performances are tracked on a quarterly basis. Now, if all fund managers were to hold on to their holdings, would the markets be faring as badly? Probably not. But this is only likely to happen in an utopian world. This can be likened to the prisoner's dilemma, where few fund managers would want to dip their toes into the markets knowing well that other fund managers are still selling.

2) Other unforseen circumstances

One such example is margin calls. Let's all recall the performance of Keppel T&T over the past few months. It dropped from $4++ to <$1 at penny stock status in a matter of a few weeks, dropping 30+% compounded for 2 straight days. Reason? Fundamental change? Not really. A large shareholder (though not substantial enough to hit the 5% mark) was caught in a margin call and was forced to sell his holdings, resulting in the dramatic drop. It is currently trading at around 73 cents. Now, what on earth could have made a company lose 60% of its value over 2 days? Was the market valuing Keppel too highly before the drop? Or is the market valuing it too lowly after the drop? Mind you, Keppel T&T isn't exactly the kind of obscure stock where market inefficiencies might lie. It was a spin off from the Keppel conglomerate years back. Even though it has a low float, however, this is no reason for a huge discrepancy in the valuation in the space of 2 days. However, I have not seen its financials to be able to make a more informed stance on whether it is undervalued or not. Nonetheless, this is another prime example of how companies, even the better-known ones, can suffer from certain market inefficiencies.

Now, how can we know if a blue chip has been priced out of its fundamentals or not? One essential way is to look at how much of a fall that the markets have priced in. E.g. for property companies, this means taking a look at how much the markets are pricing in for a devaluation in the revalued net asset value. Now, if the markets have priced in too large of a fall (in your opinion), you might consider picking up the stock.

More importantly, blue chips are largely proven to have been consistent earners, and there is a high chance that earnings will go back on track after some hiccups here and there. Back to the definition of an undervalued stock again, which is to purchase stocks of a company when they are trading way below its intrinsic value. This intrinsic value is derived from its ability to generate earnings beyond the current 1-2 years, quite possibly even 5-10 years down the road. Now, blue chips have seldom fallen into this undervalued category, at least in my opinion. Was trying to bargain hunt for some blue chips but realised that the majority of them had been priced expensively, only until recently did it change. It does not mean that the small-to-mid cap stocks are the ones which are more likely to be priced inefficiently; the same can also happen to blue chip stocks, but only rarely, and possibly in bear markets like these.

The bottom line? No matter blue chip nor S-chip nor red chips, do your homework. True, blue chips can be covered by hundreds of brokerage firms around. But due to several reasons where value is emerging but nobody dares to purchase (factors as mentioned earlier), blue chips can still be hunting ground for value investors. Although the markets are efficient, there can still be opportunities abound. Information takes seconds to disseminate, but insight takes much longer.

Short-term view coupled with Long-term view

Got me thinking in this bear market about a short-term and long-term view. Value investors have the mantra: take a long-term view and purchase the stock when it is trading at a significant discount to the intrinsic value.

Not that there are any flaws with regards to this idea. But problem lies in that, for e.g., u apply a 10-yr DCF for a certain company and u arrive at say, $5. So, if you apply a significant MOS, say 50%, you should purchase it at $2.50. But as everyone might have been aware, this might have left you smarting with some losses at this moment of time. Simply because the markets are viewing it more bearishly say at $1.50, largely because of the fall in their short-term earnings.

The natural response might be to average down your cost, some might say. If the MOS was applied, the losses might not have been huge at this moment of time, and all you need to do is to dollar-cost average your way down. But, let's be a little realistic here. We're retail investors. How deep are your pockets? you've got $200,000 more? $1 million more? There's going to be an extent to which you can average your way down.

How now? Do we still stick to this principle? Of course! But, we need to understand that the fundamentals do change with the macroenvironment. Do we apply a larger MOS? You could. But what I think could work better is to find out how much of earnings downgrade the market is factoring in. The ways to do this will not be covered for now, but a simply suggestion(but highly inaccurate) could be to predict the earnings next year and apply a suitable PER. Most importantly, the concept lies in that one should know what this short-term price, that the market values the security currently, means. This will help to limit your downside, probably, and after you've factored in some earnings downgrades, back to the principle, do apply a MOS as well.

Now, the difficulty in this lies in that earnings cannot be predicted so easily. If it could, we would have all been rich. There are probably 2 ways to do so:

1) refer to analyst estimates and consensus estimates

2) look at how the company has been performing previously in crises, and predict the earnings from there.

I try not to use 1), not because of overconfidence that I'll predict better than the analysts, but only because they tend to try to be accurate, but value investing is all about being roughly accurate, because it is indeed very tough to be highly accurate. When you try to do that, chances are that you might make mistakes somewhere by failing to account for itsy-bitsy pieces of information. For now, I've been trying to apply the 2nd methodology. Of course, companies change with time. The $5 stock I mentioned could be much more robust now than in previous crises, possibly because of a regional franchise, or larger sources of revenue. But the macroenvironment could be different based on the previous crises (i.e. Sars and Asian Financial Crises). That's where the MOS comes in handy.

Now, how much of earnings downgrade to factor in will alter your pick-up price. Then, the question comes. What if you've factored in too much an earnings downgrade, or too high a MOS? You could miss picking up the stock because of that. I can't answer this question, but for myself, what I do is to make a reasonable earnings downgrade, and apply a smaller than usual MOS only because you have subconsciously applied an MOS when you did your earnings downgrade. Will this method work? I'm not sure. Try calling me in a few years time to see if I've moved to a larger bungalow or mansion. But worth trying? Maybe.

Cash

Recently, found myself looking for companies where valuations were distressed enough for me to take a second look. However, in the midst of looking at them, I realised that I might have been straying away from good businesses and looking at valuations only. However compelling, one should always make it a point to buy only when the companies are looking at, and selling for a song. Shall treat this as a reminder, keeping true to my resolve.

Thinking about the nature of some businesses recently since the start of the week, and how they can bring in the cash for the company. Realised that it might be wise to steer clear of companies which generally depend on contracts for their businesses. Firstly, contract bidding is something which might result in inconsistent margins. Secondly, and probably the most important point, is that cash doesn't come in until after stages. Talked about KingsmenC some time back, but realised that they lie in this 2nd category. After awarding of contracts, they start their work. But payment is received only after certain stages of the project are completed. Now, this only means that the cash has to be invested first, i.e. u can be working for the entire year and only see ur money coming in at the end of the year. How's that for cash? High profits with low cash received, mostly in accounts receivables, Enron-style. During times when contracts keep coming in, the cash might keep coming in too. But when contracts dry up, u're faced with a dearth of cash. Profitable? Might be, but this lack of cash visibility might keep some investors like myself away. It's unlike the kind of business where you immediately see your cash coming in(e.g. I don't think you buy your shirts on contract, but that's just only one example). So, these companies might have high leverage so as to continue on their projects first. When contracts dry up, debts still have to be repaid.

Let's take this simple analogy. Today, I just made some "money" on the markets, because the prices have risen(akin to winning of contracts). Now, if one does not sell away the shares, the "money" is still in the markets(akin to profits in accounts receivables), although the reason and whether you should sell or not is another issue for another day. So, if you "earn profits" in the markets in this way, your profits are techinically not yours, you can't take the money out to invest in other shares to earn more money(akin to lack of cash visibility to reinvest), or repay your housing loan(akin to the business not having the profits in cash to repay debt). What's more, your profits might not remain profits anymore as the price might drop below cost anytime(akin to customers defaulting on payment). Hope this helps.

Now then, what's the way to avoid this happening? Sadly, most of the time, that happens to be the nature of the business, there isn't much that you can do about it. If you can understand and handle it, stay vested. If not, you might want to steer clear.

Anyhow, shall only update more frequently and writing up more in one week's time after everything at hand now is over. Shall look at some property companies if possible and talk about them. Seems like property companies do fall in the abovementioned category, but there are some exceptions. Would really love to hear comments regarding this;)