China Fishery Group - FY 2007 Annual Report Highlights

Sorry for the lack of updates - life is getting busier and I took the liberty of taking a short vacation to "chill out". Though one is a full-time investor at heart, one cannot practically devote too much time to investing; otherwise other aspects of life will be neglected. Money is, after all, simply a means to an end, and not an end itself.

Since the AGM of CFG is tomorrow (April 28, 2008 4 p.m. at Raffles Hotel), I shall post some of the highlights of the Annual Report after browsing. I will attempt to capture some of what goes on during the AGM proper in another separate post.

1) The Group's blended margins have dropped year-on-year. GP margin has fallen from 38.2% in FY 2006 to 34.8% in FY 2007. Net margins have fallen from 30.7% to 21.8% year-on-year (Page 4). This is due to the debt financing of the Peruvian operations and also the structure of the 4th VOA (which Management is negotiating to change right now). As a result of expansion, net margins have fallen but I feel this is tolerable for now as it is part of CFG's plan to expand their operations significantly. Once everything stabilizes, margins should start to creep up again as Management has a good track record of improving margins.

2) Trawling grounds will be extended to the South Pacific to increase CFG's area of influence and open up new catch areas. This is a promising development as it may open up new species and fish sources for CFG to tap on. Management plans to deploy 3 super-trawlers there in FY 2008, wit the intention to send more in FY 2009. The cost of upgrading was US$40 million which was funded through strong internal operating cash flows, and will increase the fish hold capacity for each vessel (Page 8).

3) Prices for fishmeal are expected to stabilize and trend upward slowly as aqua-culture will be heavily promoted by the Chinese government. Fishmeal is an important component of feedstock and will continue to show strong and sustained demand (unlike certain energy sources which may rise rapidly in popularity and later "fizzle" out due to unsustainable demand or a new alternative source).

4) CFG intends to streamline their new fishmeal plants and vessels to achieve better economies of scale. Management has stated their intention to acquire more fishmeal vessels if possible, and I will clarify what other plans Management has to expand their fishmeal operations during the AGM/EGM.

5) It remains to be seen how CFG is planning to move towards repaying their 9.25% senior notes (which in my opinion, is an obscenely high interest rate to be paying !). But from a glance at their operating cash inflows, I at least have some assurance that they are reaping good cash flows from their trawling and fishmeal operations, and that their investments in equipment, plants and vessels is going to be a one-off thing (at most stretching over 2 financial years). VOA acquisition may still continue, however, and hopefully the Group has thought about how to finance this. This is another point to bring up during AGM - the possibility of a 5th VOA ?

6) Another point I plan to raise is whether expenses/costs will increase in line with business expansion, or will they increase over and above the business growth ? If such is the case, we may witness more margin squeeze. Management should give sufficient assurance of cost control and give examples of how operations are being "stream-lined" and "consolidated" to ensure smooth synergies between trawling and fishmeal. Also, the rapid increase in head count and staff strength will undoubtedly add manpower and overhead costs. If this is a one-off thing related to the expansion into Perucian fishmeal, then it is acceptable. But if costs remain persistently high with no visible increase in productivity or economies of scale, then Management has to rethink their strategy moving forward.

7) Note 4 on Capital Risks Management is a new note (it is also in Swiber's AR) and suffice to say the auditors are getting more and more zealous in quantifying risks. They have detailed tables and explanations about the effects of currency fluctuations on profits as well as interest rate changes. I won't go into too much detail as this Note is very technical, but only wish to mention that CFG is locked into many fixed rate loans (bank loans and notes), thus their exposure to floating interest rates is minimal and is quantified in the Note 4b ii as US$258,000. At the rate things are going, I may soon have to review extensive disclosures just to determine if the Group is exposed to unnecessary risk; hopefully the auditors will decide when TOO much disclosure is deemed onerous to the shareholder and limit their facts to the necessary. I realize this statement may sound controversial but it may be a case of too much information (info overload).

8) Under Note 9 (Page 57), the amount of VAT recoverable is US$13.5 million, up about three times from last year's US$3.5 million. It will be good to ascertain the nature of this receivable.

9) Inventory has almost doubled in terms of fishmeal (US$19.3 million in FY 2007 compared with US$10.5 million in FY 2006). This can be found in Note 11 Page 58. It will be helpful to know if this is merely a temporary backlog of fishmeal, a timing difference or if there is a genuine problem in selling off their inventories.

10) Note 15 Page 62 - Interestingly, under Intangible Assets, fishing permits are treated like land in that they are assumed to be in force in perpetuity (no finite term). Hence, there is no amortization applied to these permits and CFG is permitted to state them at cost in the financial statements (not net book value). Let's hope this continues to be the accounting treatment for fishing permits, otherwise it will be a very unpleasant surprise to suddenly see amortization on fishing permits some time in the future.

11) The part about goodwill on acquisition is rather technical and complex and I will reserve comment until after the AGM as I currently do not see a problem with this. Suffice to say that all these numbers and explanations pertain to CFG's acquisitions during FY 2007.

12) Under Note 36 Page 86, CFG has contingent liabilities amounting to US$3.87 million for various legal claims against them. They have made a provision of US$1.459 million being amounts that they deem to be likely to materialize as liabilities. Shareholders should also raise the question of whether there might be further environmental effects of over-fishing or fishing in certain areas in South America which may precipitate more potential lawsuits. If so, can the company vigorously defend these lawsuits and what will the liability be ?

Comments are welcome on the above points, or if readers think there are other points to be raised for discussion and analysis.