The future of a Chinese steel company teeters atop a pile of porcelain artwork.
Those fragile pieces are the latest elements straining to prop up China Gerui Advanced Materials Group (CHOP).
The company says it intends to eventually sell porcelain pieces in hopes of saving the steel business.
But the hammers are raised and threaten to shatter CHOP’s last-ditch efforts.
TheStreetSweeper highlights the cash burn, business shift, lawsuit allegations, and other issues that we believe make CHOP shares worth a couple of quarters or maybe even, as one analyst said, “zero.”
Meanwhile, investors may find other viewpoints here about the Chinese cold-rolled steel manufacturer. The company’s thin steel product – sometimes only as wide as a human hair – is sold to the Chinese food packaging, electrical appliances and construction materials industries.
CHOP has not yet responded to TheStreetSweeper’s request for an interview.
*Virtually no cash left
CHOP has been burning through a mountain of cash – about $240 million in three quarters or $80 million per quarter - the company now reports just $2.3 million of unrestricted cash and $50 million in restricted cash remaining. At the current unbelievable burn rate, CHOP must find more operating money soon.
*History of massive revenue decline, debt problems and recent cash-poor position
CHOP shares suddenly rocketed from 70 cents apiece to about $4, in opposition to the direction of the company’s cash and revenue.
The company’s revenue has been spiraling downward for some time, as shown in the company’s Securities and Exchange Commission filings:
Filed Jan. 6, 2015:
Third Quarter 2014 Results Revenue decreased 90.0% to $3.1 million in the third quarter of 2014 from $30.9 million in the third quarter of 2013. Nine Months 2014 Results Revenue was $62.2 million in the first nine months of 2014 compared with $119.6 million in the first nine months of 2013…As of June 30, 2014, the Company had $3.0 million in unrestricted cash…
The company also posted a loss of $6 million in the third quarter. Noting its one-for-ten reverse stock split, the company blamed poor results on low steel prices, declining sales, credit problems, downtime of production lines, bank loan defaults and working capital shortages.
Filed Sept. 4, 2014:
Second Quarter Results Revenue decreased 24.1% to $32.7 million in the second quarter of 2014 from $43.1 million in the second quarter of 2013. Gross profit decreased 51.8% to $1.7 million in the second quarter of 2014 from $3.5 million in the same quarter of 2013.
Gross margin was 5.2% … Operating loss was $0.6 million…Net loss was $1.4 million.
Filed May 20, 2014:
First Quarter Results Revenue decreased 42.0% to $26.4 million in the first quarter of 2014 from $45.6 million in the first quarter of 2013. Gross profit decreased 123.9% to ($1.2 million) in the first quarter of 2014 from $5.2 million in the same quarter of 2013.
The chart from Bloomberg below, presents a vivid image of CHOP’s perilous cash position, plummeting from about $200 million or more in the second quarter of 2012 through the first quarter last year, down to a few million in the second and third quarters of 2014:
The cash wasn’t used to pay down debt, since short-term debt declined only a tiny bit, according to this Bloomberg chart:
And it wasn’t a share buyback because common shares outstanding remained relatively unchanged:
*So show us the money!
What happened to all that money?
Well, the company CEO complained during its earnings report Sept. 4, 2014:
“Despite various corporate actions to sustain our stock price, including share repurchases, our stock performance has been tied to our operational performance.”
The fix for this annoying issue?
“At this time, management views the entry into the China antiquities market as a viable alternative to maximize the long-term cash appreciation of its cash assets.”
Yes, the steel company suddenly became a Chinese porcelain trader.
Here’s what the company stated under the “Business Update” heading in its latest financial filing:
"We continue to believe that our investment in the Chinese antiquities market will yield mid-term cash flow which will in turn drive and expand our metals processing business. We are vigorously pursuing opportunities with established domestic and international auction houses to liquidate the antique collection in part or in its entirety. As we navigate these lengthy negotiations, our research and development team continues to create innovative, wide-ranging products to attract new business from existing clients and penetrate into additional markets to expand our customer base. These advanced products will specifically target applications possessing higher gross margins. With our advanced manufacturing capabilities and new products, we are positioned to gain from the eventual recovery of the steel industry."
So that’s apparently what happened to the money. The company says it forked over about $234 million to someone – no word on who or when or where it might be store - for delicate Chinese porcelain dating back as far as the Song Dynasty.
“It is our intention to sell all 206 pieces over time to reinforce our cash position and earn a substantial return,” said CEO Mingwang Lu.
The porcelain was a steal – a 74 percent discount according to the “$905 million” value as appraised by some undisclosed entity, said Mr. Lu.
It’s interesting that Mr. Lu’s letter to shareholders three weeks late didn’t even mention the huge porcelain acquisition but did discuss the company’s “comprehensive product mix.”
*Class-action lawsuit hits CHOP
This steel-porcelain business turned into a class-action lawsuit filed Nov. 26, 2014 by shareholder Aram Pehlivanian, alleging securities laws violations. The complaint revolves around the company’s use of most of its unrestricted cash to buy the Chinese porcelain.
“This supposed purchase of antiquities was all the more shocking because, in the years and months leading up to the announcement, CHOP had consistently and unambiguously communicated to the investing public that its goals for growth included an expansion and diversification of its product lines, identification of overseas markets, and business combinations with competitors,” states the lawsuit.
Shares dropped from 61 cents on Sept. 3, 2014 to 49 cents the day of the announcement on Sept. 4, 2014, according to the complaint.
A reverse stock split managed to raise the share price above the NASDAQ’s $1 listing requirement, but “the utter failure of CHOP’s directors and officers to make any clarifying disclosures since September 4, 2014 regarding CHOP’s purported antiquities purchase has caused the investing public’s total loss of confidence in CHOP’s corporate governance …”
We could find no response to the lawsuit from CHOP but recent court filings say more time has been allowed because company managers in China have not yet been served the legal papers.
*Steel surplus exists in China and if CHOP returns to the steel business, margins will likely continue to be razor thin.
Investors can see that CHOP’s porcelain affection is related to sales that have been decimated by a 9 percent drop in steel prices and a 97 percent drop in sales volume.
The chief executive describes the perilous situation this way:
“Given the continuing unfavorable sentiment towards China’s steel industry and uncertain outlook, our operations continue to be streamlined to mitigate operational risks generated by industry-wide excess capacity, weak demand in prices and restricted access to credit.”
Researchers who wrote “China’s Steel Industry,” say that the decentralized and dispersed steel industry is concerning Chinese policy-makers about the ability to exploit economies of scale. It says most large steel producers are state-owned. Additionally, more than 660 companies produce crude steel and thousands of other firms produce finished steel and steel-related products.
CHOP’s CEO quoted experts who said, “The steel industry will need at least three additional years to realize actual recovery in the balance of supply and demand.”
The glut of steel has been even more debilitating to CHOP because the margins are razor thin - about 5 percent.
But maybe steel margins don’t really matter, anyway, if CHOP is now in the Chinese porcelain business.
*Competitors outdistance CHOP
Investors can see that China-based steel companies China Precision Steel (CPSL) and Sutor Technology Group (SUTR) are unimpressive anyway, but recent troubles have made CHOP look even worse.
(Sources: SEC filings, Yahoo Finance)
*Institutional interest? No….
We always feel some comfort when big names hold a significant portion of a stock. That’s not case with CHOP.
A major shareholder and director, Harry Edelson – who has received $10,000 monthly since 2010 for “helping to promote awareness of the company” - used Warren Buffett’s name in an interesting headline for a piece boldly promoting CHOP, here. Mr. Edelson said the “down side for CHOP appears minimal while the upside is high.”
But it’s obvious that there are no Berkshire Hathaways or other big names and very little institutional interest overall, as institutional shareholders hold only a sliver of the stock – about 3 percent. See below:
(Source: Yahoo Finance)
Meanwhile, CHOP has no analyst coverage other than allchinastocks.com, which rates it a “sell.”
CHOP’s recently screaming stock price is not justified, particularly in light of the sudden switch from steel to 1,000-year-old ornaments. There’s no guarantee CHOP’s porcelain is authentic or valuable (concerns about fraud have damaged the Chinese art market previously) or, as the company noted here, that it will profit if it can even manage to auction off the porcelain in a timely fashion.
With the low cash position and excessive cash burn, the company is likely preparing for a potentially dilutive stock offering in hopes it can hold out until the steel business returns – years in the future by its own admission. Of course, if it were to somehow pull out of this mess, what’s to keep CHOP from becoming another state-owned business?
We believe CHOP is on the chopping block and investors should prepare for the stock to get whacked down to size - nickels and dimes per share.
* Important Disclosure: The owners of TheStreetSweeper hold a short position in CHOP and stand to profit on any future declines in the stock price.
Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to [email protected] or [email protected].