Fuling Global (FORK): My favorite small-cap stocks in 2017
• Continued double-digit growth in performance.
• Capacity expansion remains a key catalyst for revenue growth.
• Product prices recovered as oil prices stabilized.
• Net income growth is slower than revenue growth, but improving year over year.
• There are potential risks as a small-cap mid-cap stock and its industry.
Boring industries and small-cap stocks are two things that are rarely discovered together. If you search for hot or promising small-cap sectors, you'll find mostly technology and biotech. So, when I stumbled across Fuling Global (NASDAQ: FORK), a Chinese manufacturer specializing in plastic cutlery, plates, cups, straws, and more, the valuation and growth rate made me both skeptical and skeptical at first glance. excited. After more investigation, I really like this company.
As mentioned earlier, Fuling Global is a manufacturer and distributor of plastic products, mainly serving the fast food and fast-moving consumer food segments. The company's business is global, with presence in Europe and China, but the US accounts for 90% of its revenue.
It's an industry that many great investors tell us we should invest in, but many of us still like to chase tech stocks or other overpriced "junk" like SNAP (NYSE: SNAP). The great Peter Lynch, in one of his books "Walking on Wall Street", said that some good businesses are in dull industries that analysts and money managers dislike, such as rock pits, funeral home services, and emptying from restaurants Grease, gas station.
Fuling Global has production facilities in China and the United States. Since it's a small, relatively unknown Chinese company, I took a Google map of his US factory to see if it actually existed. I've never had to do this to see a 3M or GE plant, and of course it didn't take much time at all.
As far as I can tell, everything looks normal. Fuling Plastics, Inc., one of the company's subsidiaries, is listed on its 10-K. It looks like a factory with cars parked and trucks coming and going, but that's all you can see.
In terms of products, it mainly focuses on silver-plated tableware and packaging containers. Its client list is impressive for such a small company. Big fast food companies include Subway, Burger King (NYSE: QSR), and more. Another customer is Walmart (NYSE: WMT). Many of these brands use Fuling's products to meet some of their needs or just for specific certain products, as you can see in the table below, giving the company the opportunity to expand its existing customer relationships to drive more more income.
Apparently, one big customer that's been missed is McDonald's (NYSE: MCD), probably the sixth-largest fast-food chain corporate customer.
Fuling listed in its 2016 10-K annual report that its main competitors in the United States include DART/SOLO, Reynolds Group/Pactiv, and Georgia Pacific. All three of these big competitors are private companies, so it is difficult to get information on them. These companies have a wide range of businesses, unlike Fuling, which only focuses on fast-food chain customers and tableware needs. For example, Georgia-Pacific GP produces paper towels, towels, soap dispensers, and other products for catering customers. In addition to tableware and cups, it also involves many industries that are not related to catering such as construction and paper products.
Fuling may not have the scale and scope to supply McDonald's yet, but the potential exists, such as supplying other very large customers or at least part of their business, such as McDonald's China business.
Fuling may seem like a small company, but it is already one of the world leaders based on the cups and straws it supplies to fast food chain customers. Its competitive advantage is that it has several patented products, including a strong presence in the field of environmentally friendly products.
The company also has a unique U.S. and China production mix that can help it deliver quickly to meet its U.S. market needs and is a low-cost producer.
Fuling's clear focus on technology and innovation could see its increased R&D spending create new environmentally friendly products. The company said it spent $10 million on research and development from 2012 to 2016, equivalent to 21% of its current market value.
Fuling's factors and catalysts are primarily through revenue growth. The company just released fourth-quarter and full-year 2016 earnings today, so we now have some numbers that look better year-over-year. In the fourth quarter, revenue increased 37.1% year over year, from $23.1 million to $31.8 million. Total fourth-quarter sales rose 40.6%. Year-on-year growth was also strong, albeit at 14.9%. When you look closely at the income statement, the story gets a little fuzzy. Fuling's operating income was down slightly from a year earlier, while net income was broadly flat, down 1%. The material I've been looking for and finding this quarter is about improving pricing. It is a common misconception that many producers of petroleum products or crude oil or its derivatives are as successful as they were a few years ago when the feedstock is down. In reality, the drop in oil hurt Fuling's pricing because many of its customers actually demanded lower prices; in fact, new business was brought in at lower pricing rates. These price declines have masked raw materials that have been bought at high levels.
During the quarter, the company commented that gross margins contracted due to higher oil prices, which resulted in higher raw material costs. In addition, Fuling said it may take a quarter or two of prices to make up. If crude oil prices are in stable territory, Fuling will make up for the increase in its raw material costs with some modest price increases, looking for gross margins to continue the recovery. That said, gross profit increased 6.7% year-over-year despite a 1.8% year-over-year decline in gross margin.
Looking further into the income statement, we can see that the EPS decline was primarily due to a foreign exchange shock of $2 million and a $3 million increase in outstanding shares. The increase in the number of shares was only due to Fuling's IPO, which gave the company much-needed funds to expand its U.S. factory, as well as its ongoing construction of a fourth factory in China.
In a recent press release, management stated that the company: "In recent months, it has not been able to produce enough to meet the growing demand for the product. Due to capacity constraints, the construction of our new plant will be completed by the end of this month, and the production of the new plant will be completed by the end of this month. This is a very optimistic statement that gives me confidence as the demand decision allows Fuling to expand rather than build new production and then worry about sales.
Every company has risks, and Fuling is no different. A major short-term risk, oil continues to fall, which could stop Fuling from raising prices could force the company back into a tough environment where it faced oil in the $20s and $30s a few quarters ago. It depends on factors beyond the company's control, such as OPEC compliance and U.S. capacity.
The next risk is related to investing in a company of this size. $48.77 million is the current market capitalization, and Fuling is not small according to its business, but it is tiny in terms of listed companies. No institution owns the stock and no analyst coverage. This could be a good opportunity or a very bad one, depending on your point of view.
The company doesn't hold conference calls, and aside from quarterly reports, there are few avenues for directing company news or events.
Another risk is its structure, and it's a Chinese company. Chinese reverse merger fraud and other outlandish schemes have calmed down, thank goodness, but Chinese companies remain opaque, unreliable, and nearly useless. Compared to the United States, many investors know that China is a very different social, economic, and political landscape. Fuling also has a less direct structure. I mentioned above that it is a Chinese company because it is essentially, but technically, the publicly traded entity is in the Cayman Islands.
I'm not an expert on international business structures and can only assume that companies opt for such a structure because of regulations in some countries or others. I know there are rules about foreign Chinese business ownership and restrictions within it, so that's probably why the company is technically registered in the Cayman Islands. Throughout the filing, you may also find some other companies, some directors, management, or their families outright owning the shares through, these may be a little scary, but if you believe the earnings information, management still owns more than half of the company.
I think that's a very high stake, especially higher than the average company. I see that many large and small companies have insiders under 10%. This can be a risk, again, depending on your perspective, if there is a lack of emphasis on the company, as multiple insiders can simultaneously push the stock down without any retail investor knowing anything.
Due to the combination of all these factors, the liquidity of the stock is also very low.
Fuling Global's stock price at the time of this writing was $3.10. At 50 cents per share, the company trades at a price-to-earnings ratio of 6.2. I don't need to tell the reader that using past returns at this point, the S&P 500 is now up 20, a few points lower if forward returns are used.
When I researched and started buying the stock, it was trading at $2.55. At this level, its market capitalization is less than the current assets on its balance sheet.
Fuling Global has significant liabilities, so it's no less than book value or something like that, but it's still a valuation metric, which I hardly see in the companies I've checked. Given its clear growth trajectory and revenue strength,
The current valuation still seems compelling. This trajectory is due to the completion of a factory expansion in the next fiscal year, which will continue to drive higher sales. The year-over-year decline in net income will scare some investors away, but I can clearly see that in the near future net income will increase and expenses such as tax increases, spending on new equipment and capacity enhancements, etc. will disappear over time . Even if Fuling's product doesn't sell as many customers as it does, as long as its pricing remains firm, keeping profit margins the same, it's easy to see profits rise along with revenue.
Whether you think the stock should be worth three times the S&P 500 because of the company's size, structure, and short history is debatable, but personally, I'm comfortable with the risk of a very cheap valuation. It's hard to say at what level the company should trade. However, I think it's clear that the lack of institutional ownership and coverage makes stock floats potentially inaccurately priced -- a rare thing in today's hyper-efficient market.
Fuling is clearly a risk stock, but growth stocks are rarely priced like those, without growth, established companies that have experienced brilliance. Bottoming in valuation, in a single and low-tech innovative industry, low institutional ownership, 14% revenue growth with a clear growth path and new factories under construction, Fuling made possible
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