My Investing Journey: United Food Circa 2003 2 comments

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Over the years I must have been involved in dozens of stocks. I had talked about one that was obviously speculated to the heavens (Allied Technologies: Part 1 and Part 2) earlier. Let's look at another one that looked like it had solid fundamentals ..... even up till today, there are die-hard supporters of this stock.

If one looked at the financials and valuation of United Food in 2003, he would understand why it was highly regarded by so many fundamental investors. That included Curtis Montgomery, otherwise known as the Wallstraits Sage, who recommended it strongly on his Wallstraits forum. Listed in 2001, the China-based pork processor had enjoyed compounded annual profit growth rate of >40% the previous three years pre-listing, and had continued to grow profits post-listing by annual rates of 20-40% up till FY02. Its balance sheet looked fabulous, with zero gearing and lots of cash. The cashflow statement showed attractive free cashflow. The prospects looked great; you can't go wrong with a potential market one billion strong, and growing. Warren Buffett would have liked this stock.

In mid-2003, in the wake of the SARS crisis, United Food was trading in the mid-30s. This meant its trailing PE, based on FY02 results, was 4X. 4X! Price to NTA was 1.1X. 1.1X! Frankly, if you ask me today again, I would have done the same thing and bought it in a rush. The contextual background behind the stock market valuation in mid-2003 was that there were lingering concerns of SARS afflicting the pig business in China structurally, as well as that three-year bear market that had worn down even the sturdiest of bulls. Nobody knew that the tide was about to turn. Of course, that sealed the fate of the bear.

I bought United Food at 35 cents. Over the next three months it shot up ~60-70% to above 60 cents. But of course, I guess everything else did. In August, feeling encouraged, I doubled up at 61 cents. The purpose of this article is not to illustrate what a great buy United Food was for me, but rather, what a great sell it was.

I sold out everything in mid-September 2003, reversing my recent buy just two weeks earlier. And it was on a very simple premise. It was because the main shareholder inexplicably sold out in early September 2003. There are shareholder sales and there are shareholder sales. Chairman and CEO David Yip, just shortly after my second purchase of United Food, placed out 100 million shares of United Food, amounting to 9% of total shares outstanding, to an unnamed buyer which later turned out to be Value Partners, a relatively well-known Hong Kong investment fund.

When a main shareholder sells out a key stake, one can read the move from a half-full glass perspective or the half-empty glass viewpoint. The common explanation employed is that it will "increase the market liquidity of the stock", a sometimes acceptable explanation if the stock is thinly traded and the company hopes to "spread the ownership" to some strong hands, say institutional funds which can increase market awareness of the stock. One wonders, however, whether this was necessary for United Food when it was relatively liquid, had good retail participation, its share price was apparently on the upward trajectory and was still relatively undervalued from all appearances under standard stock valuation parametrics. Another common explanation is why would the buyer buy in unless the outlook was good? Well, it depends how one chooses to see it, I guess. From the half-empty glass viewpoint, such a large sales tranche by a key company insider indicates possible urgency to exit, especially when again, the stock still looked relatively undervalued.

There is often a thin line separating the two contrasting perspectives; those in the market long enough will know what I mean. The market is all about dichotomies. I wouldn't say that my judgment had been sharpened at that stage and prompted me to exit; rather I think the episode of Global Tech earlier in the year had sharpened my focus on monitoring managerial moves and if necessary, emphasing such qualitative developments over quantitative measures. Under other circumstances I could have been wrong; for example recently Cosco directors have been selling aggressively and yet the company has continued to secure new contracts and the stock has been on the up (a mitigating explanation is that these guys got their options really cheap). However, events proved eventually that I had sold well. United Food announced a benign set of results for FY03, but in FY04 it reported a shocking 50% collapse in profits and the bottomline continued to decline ever since. Rumours have plagued the company, which I shall not repeat here.

Today, the stock trades at below 20 cents, 50% below its NTA and fundamental investors point out that its cash holdings alone could support its current market cap. Yet nobody dares to buy. It has probably been among the top market underperformers since 2003 given its collapse amidst the rising market tide. Nobody has really come out to explain David Yip's equity sales in late 2003. But the benefit of financial hindsight makes it abundantly clear. The business was on a decline, and the scale of its impending decline must have been very clear to insiders before it manifested itself in the shocker 2004 results. The potential market was one billion strong, but not many have been able to tap this one billion customers. United Food was spreading itself too thin, trying to diversify in too many fields (chondroitin sulphate, animal feeds) and expanding up and down the supply chain (it was even into pig-farming, an activity which bigger processors like People's Food chose to outsource); it was losing market share in a tightening market that was even affecting market leader People's Food. Scale of operations was important; as a regional operator United Food might not have had the necessary scale. All these are explanations offered after the event by analysts. It was not easy to make this out in 2003, which is why I must thank David Yip. He was my early warning system for United Food.