Revenge of the RTO’s

  • Posted by
  • on August 16th, 2011

“When one dances with dragon, one gets burned by dragon” – old Chinese proverb I just made up

Playing with Fire

 

It’s never easy discussing your worst investment moves, but a few months ago we blogged about three RTO companies we owned (and still own): China Sky One Medical ($CSKI), Gulf Resources ($GURE) and Telestone Technologies ($TSTC). All three are small cap Chinese names that make up the more speculative corner of our portfolio, and each have come under fire over the last year amidst allegations of fraud and/or accounting irregularities. We don’t recommend dabbling in these names, or any Chinese stocks for that matter, unless you’ve got the risk appetite.

Over the last couple weeks each of them reported Q2 earnings. CSKI and GURE’s reports didn’t turn out so hot, while TSTC’s seemed quite impressive. Going into earnings, all three appeared to be sporting strong fundamentals in the BeanScreen.

Let’s start with the worst report – CSKI‘s numbers:

  • Revenues -7.6% YoY
  • Operating income -39.6% YoY
  • GAAP net income -50.2% YoY
  • Cash and equiv. of $44.3 mil

From the CEO:

“Our second quarter revenue declined 7.6% year-over-year, primarily reflecting the loss of two distribution relationships in the third quarter of 2010. We continue to aggressively pursue new customers to distribute our broad portfolio of pharmaceutical products…Despite the challenges of the past year, we are optimistic that we can reestablish robust revenue and earnings growth at China Sky One Medical by continuing to invest in R&D, securing new distributor relationships and identifying uses for our strong balance sheet and cash flow.”

2 year chart (Y! Finance)

We’ve gotten our ass handed to us on CSKI over the last year. It was our biggest RTO position. While we did make money on them at the end of 2009 after buying in the low teens and selling in the low $20’s, the sell-off ever since has been brutal. We hold our remaining shares at a cost basis of about $12.78, and are feelin’ the burn! Might be time to dump them as growth rates have tanked across the board for two quarters in a row now.

 

Ok, on to GURE‘s Q2:

  • Revenues +10% YoY
  • Operating income -41% YoY
  • Net income -39%
  • Cash of $59.7 mil

From the horse’s mouth:

“Our performance in the second quarter was mixed. Bromine and crude salt prices were higher compared with a year ago levels, which helped us combat increased raw material costs. However, despite a favorable pricing environment and an increase in the number of our bromine production factories, we have experienced a decrease in sales volume mainly due to less bromine being extracted from brine water during the production process due to the decrease in bromine concentration of brine water, government restrictions related to the supply of electricity to industrial users during periods of peak usage and limited supply in May 2011 and continued enhancement of our production facilities.”

1 year chart (Y! Finance)

No way around it, this was a crappy report. Sure, revenues were up a bit, but the huge drop in net income worries us. Having your success hinge on the unreliable concentration of bromine in brine water and government-managed power supply seems kinda sketchy. We currently hold GURE at a cost basis of $7.10 per share, but may cut it loose soon.

 

Last but not least, TSTC‘s nice looking Q2 report:

  • Revenues +46.4% YoY
  • Operating income +154% YoY
  • Net income +163% YoY
  • Signed letter of intent to acquire Sichuan Ruideng Telecom Corp
  • SG&A expenses -13.6% YoY
  • Cash and equiv. of $19.9 mil

From the Chairman:

“We continued to see solid sales of our Wireless Fiber-Optic Distribution System (“WFDS”) products and we increased our sales to non-telecom-carrier customers in the second quarter. In addition, we reached a preliminary acquisition agreement with Sichuan Ruideng, which is an important strategic move in our business expansion strategy in the southwestern China market. We remain optimistic about our business growth for the remainder of 2011, while remaining committed to improving operational efficiency and collections.”

1 year chart (Y! Finance)

Ranked just behind GURE at #24 in the BeanScreen, we initiated a position in TSTC at $8 this past March, and haven’t added since. Unlike CKSI and GURE though, we feel good about TSTC’s prospects going forward, but we’d like to see them string together a few more strong quarters.

Again, rumors still abound about whether these companies’ financials are up to snuff. Coming to the market via a reverse merger carries quite a stigma these days, and being a small cap Chinese stock just adds fuel to the fire. We’ve given our three RTO’s the benefit of the doubt for some time now, but price action has ultimately laid down the law. We should have been more cautious and heeded the warning signs sooner.

While not our finest moments in investing, it has been a fine lesson learned.

 

sources: China Sky One Medical Announces Second Quarter 2011 ResultsYahoo! Finance

Gulf Resources Reports Second Quarter 2011 Financial Results – Yahoo! Finance

Telestone Technologies Corporation Announces Second Quarter 2011 Results – Yahoo! Finance

disclosure:  we currently own shares in CSKI, GURE and TSTC

 


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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