The Microcap Speculator

A few news items worth mentioning:

• Advocat, Inc. [[AVCA]] received a letter from activist shareholder Paul Kessler of Bristol Investment Fund pressuring it, among other things, to let shareholders vote on whether to de-stagger the board of directors and to hire an advisor to weigh strategic alternatives.  Similar demands from Kessler, who controls about 5% of shares, have been disregarded by the company.  I expect no action here even though Kessler’s demands would probably increase shareholder value.
• China OTC Player has an interesting post on three companies that could benefit from China’s devastating snowstorms [via Seeking Alpha].  He names China Solar (CSOL.OB) (formerly Deli Solar), China Pharma Holdings (CPHI.OB), and Sino Gas (SGAS.OB)
• Air Industries (AIRI.OB) announced that its Welding Metallurgy subsidiary has won $1.07 million of new contracts during the month of January 2008. The company says that this is the largest aggregate amount of new contract awards in a single month for Welding Metallurgy since its inception in 1979.
• Bagel-maker BAB Holdings (BABB.OB) announced $.10 earnings for 2007, virtually identical to 2006 results.  That’s fine with me as long as they keep paying $.08 or more in annual dividends.

DISCLOSURE:  Long AVCA, AIRI.OB, BABB.OB.  No position in other stocks mentioned.

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China Pharma Holdings (CPHI.OB) has come a long way since I purchased the stock and profiled it in early August. In less than three months, shares rose from around $1.40 to over $3.75, although they gave up almost 10% by the close today.  Curiously, only a part of the runup appears to be related to fundamental news.  While China Pharma reported good earnings in mid-August, most of the rally occured in September and October in the absence of any substantial news.

I took profits on my remaining shares today, cognizant that: (1) a period of consolidation was likely after a 150%+ rally; (2) a good part of the rally was probably due to frenzied trading of Chinese stocks rather than company-specific events; (3) Chinese stocks are typically vulnerable after the Chinese National Party Congress adjourns; and (4)  though last earnings report was solid, cash flow remained negative and collections of receivables may continue to be a problem.

To be clear, I do not believe that the fundamental situation has deteriorated at all for CPHI.  But after a two-month 150%+ rise, massive short-term expectations have been baked into the stock price and anything but a blowout quarter may disappoint new investors.  I’m interested to see how shares react to any weakness, and will not hesitate to reenter if the price action warrants it.

Finally, I’d like to thank reader J.Z. again for pointing out the stock.  It has been my best performer for the latter half of 2007, and he deserves all the credit.

DISCLOSURE:  No position.

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After the bell, China Pharma Holdings: CPHI.OB filed impressive quarterly results with the SEC. The company, which I profiled in greater detail a few weeks ago, announced quarterly earnings of approximately $3.33M, or $.09 per fully-diluted share, on revenues of $8.57M. All metrics improved over the same quarter in 2006, when the company earned $1.83M, or $.05 per fully-diluted share, on revenues of $3.98M. Cash flow remains slightly negative as the company has a long collection cycle; however, even this metric improved sequentially over the first quarter. While the company will certainly be asked about receivables in the conference call tomorrow, there was no indication in the 10-Q that any of the receivables need to be written off.

$216,000 of income is attributable to favorable currency translations. Many analysts deduct this and other charges to arrive at core earnings. However, with Chinese companies I think currency translation should not be disregarded. The dollar is in a long-term decline versus the yuan. Chinese companies selling mainly in China should enjoy an earnings boost as long as the trend persists, and there is no reason for investors to deny the existence of this phenomenon.

Technically, CPHI shares seem to have put in a bottom just under $1.40. I’m looking for a solid boost tomorrow in reaction to the earnings report, and a sustained move off of these lows.

DISCLOSURE: Long CPHI.OB

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Microcap traders have hit homeruns in a number of Chinese pharmaceutical and biotech companies, such as American Oriental Bioengineering (AOB) and Tiens Biotech (TBV). Reader J.Z. has alerted me to another intriguing Chinese pharmaceutical play — China Pharma Holdings: CPHI.OB. China Pharma develops, manufactures, and markets Chinese and Western bio-pharmaceutical products for treating infections, hepatitis, vascular disease, CNS, and other conditions.

With roughly 40.9M shares outstanding (37.23M at the end of last quarter plus 3.76M registered for issuance upon exercise of warrants), CPHI has a market cap of approximately $55.2M at today’s closing price of $1.35. The balance sheet is clean, with $2.95M in cash and equivalents, no long-term debt, and short-term notes amounting to less than half of its receivables. Last quarter, China Pharma earned $2.4 million (up 46.6% year-over-year) on revenues of $7.2 million (up 52.8% year-over-year). A substantial part of the growth came from two newly-introduced products: hepatocyte growth promoting factor and ozagrel sodium (representing 8.5% and 10.7% of revenue, respectively). In the earnings release, China Pharma also reaffirmed its full year guidance for 2007 of 30% increase over 2006 net income of $8,587,086. By my calculations, that amounts to $11.16M, or just over 27 cents per share.

Now for the caveats:  First, despite progress in most operational metrics, CPHI was operating cash-flow negative last quarter due to ballooning receivables and inventories.  While this is not abnormal for a growing business, it needs to be watched very closely.  If the receivables need to be written off, CPHI will be adversely affected.   Second, J.Z. indicates that $600k of the first quarter revenues were attributable to one-time gains on technology sales, although I can’t seem to find that information.  Third, the technical picture is not good.  After a breakout and spike upwards last fall, CPHI has retreated steadily even after what appeared to be a solid first quarter report.  I am concerned that perhaps the sellers know something I don’t.

Bottom line:  Despite a good first quarter report and reaffirming 2007 guidance, China Pharma shares have been pummeled mercilessly.  If the company reports even a decent second quarter, I expect shares to bounce up to $1.80 or  higher.

DISCLOSURE:  Long CPHI.OB.

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