A Close Look at Gulf Resources
posted by The Traveller on Sunday, July 24, 2011
Gulf Resources (GURE) is currently trading at $3.80, down 64.46% for the year. The Trading China Tracker Score is 19 (Strong Buy), the Trading China Safety Score is 36% (High Risk).
Let's have a detailed look at Gulf Resources, a producer of bromine, crude salt, and specialty chemicals in China. The company has two operating subsidiaries, one for the chemicals, and another for salt and bromine. The stock has lost two thirds of its value since the beginning of the year, despite record results for FY2010 and positive pricing developments for its core products. Is it worth putting some money at risk here? Let's start with a detailed timeline of the past 18 months to see what exactly has been going on with this stock.
Gulf Resources Timeline
2010, February 10: Gulf Resources dismisses Morison Cogen and engages BDO Limited as its new auditor.
2010, April 14: The company raises guidance for fiscal year 2010 to revenue between $146 million and $150 million and net income between $44 million and $46 million. It says that "in addition to strong demand, a shortage of bromine supply is supporting prices."
2010, May 11: Gulf Resources reiterates revenue and net income guidance for 2010 with the release of First Quarter earnings.
2010, June 8: GURE announces the acquisition of bromine and crude salt manufacturing assets for $13.9 million, paid in cash (95%) and stock.
2010, August 6: The company files a mixed securities shelf for $120 million with the SEC.
2010, August 16: Gulf Resources reiterates revenue and net income guidance for 2010 with the release of Second Quarter earnings.
2010, September 10: Deloitte Touche Tohmatsu is engaged to perform an independent assessment over the Company's internal controls.
2010, September 14: The company defends the shelf registration in a press release, but clarifies that while it plans to use its common stock as currency for acquisitions, it will only happen at levels that are accretive to existing shareholders."
2010, September 15: Due to its depressed stock price, management announces that it has decided not to raise capital during 2010. The shelf registration remains effective.
2010, September 15: The company raises guidance for fiscal year 2010 to revenue between $151 million and $155 million and net income between $48 million and $50 million, as a result of a further increase in bromine prices.
2010, September 27: A $10 million Share Repurchase Program is announced. "We are confident that this is an optimal opportunity to leverage our strong balance sheet and invest in Gulf Resources."
2010, November 6: Independent director Biagio Vignolo resigns without stating a reason. He is replaced with Mr. Nan Li who works as financial controller at Global Pharm Holdings Group (GPHG.OB).
2010, November 16: Gulf Resources reiterates revenue and net income guidance for 2010 with the release of Third Quarter earnings.
2010, December: The company is anonymously accused of falsifying its financial statements filed with the SEC. Allegedly, there are discrepancies between data filed with Chinese authorities (SAT) and the Securities and Exchange Commission.
2010, December 8: Xiaobin Liu, CEO of Gulf Resources, responds to those allegations, says they were completely without merit and that all financial statements are accurate.
2010, December 14: The company follows up with a detailed response, confirms that its 2009 Annual Report is consistent with its 2009 SAT filings, and provides proof in form of an official letter from the local SAT bureau, which is confirming that there are serious discrepancies between GURE's subsidiaries' actual tax filings and the figures provided in the anonymous report. CEO Liu reassures investors that "our financial statements are accurate and we do not expect any adjustments to them. Our business has maintained its momentum and we do not expect any changes in business conditions in the foreseeable future."
2011, January 4: Gulf Resources announces the acquisition of a crude salt field from a state-owned company for $10.6 million in cash.
2011, March 2: Independent director Richard Khaleel resigns from GURE's Board, as the company he recently joined has requested that he resigns as a director of any public company. Khaleel's replacement is Mr. Yang Zou, a senior accountant with a Beijing-based CPA firm.
2011, March 4: Deloitte has issued a final report regarding the internal control assessment performed. Management believes that the Company's internal control is improved after implementing the recommendations made by Deloitte.
2011, March 16: GURE files its Annual Report for 2010. Reported revenue of $158.3 million and net income of $51.3 million both exceed the high end of the company's official financial guidance, which had been raised twice in 2010. Gulf Resources provides a favourable outlook for 2011, without giving specific guidance at this time. Internal control over financial reporting, as audited by BDO Limited in the 10-K filing, is still ineffective due to a "material weakness regarding management's failure to maintain effective controls over the identification of related parties and the disclosure of related party transactions in the company's consolidated financial statements."
2011, March 28: The company provides financial guidance for 2011. It expects revenue to range from $195 million to $198 million and net income to range from $64 million and $66 million. CEO Liu says he expects "the price of bromine to stabilize at a high level and possibly reach a new historical high price during 2011."
2011, April 26: Short-selling outfit Glaucus Research Group releases an extensive 29-page report on Gulf Resources. The group "initiates coverage" with a $0.00 price target, based on its belief that investors "are likely holding worthless paper in a shell company." Glaucus claims that "the two Chinese subsidiaries that own and operate the business are privately owned by a company controlled by the chairman."
2011, April 27: John Hempton of Bronte Capital, who is also short the stock, comes out in support of the Glaucus report. He argues that an inventory turnover of 169.5 times per year is not believable in the bromine industry.
2011, April 28: The company issues a detailed response to the Glaucus Report. Explains that it produces most of its bromine and chemical products on demand, therefore does not accumulate inventory. Provides 2009 SAIC filings for both its subsidiaries and concludes that reported SAIC financials are in line with SEC filings. Provides documents that should prove ownership of subsidiaries. Explains low shipping costs with customers directly picking up their products from facilities. Reiterates that Deloitte's internal control assessment did not find major issues in the Company's corporate governance and internal control system.
2011, May 2: Gulf Resources issues a second press release in response to the allegation in the Glaucus Report.
2011, May 11: Gulf Resources issues a third press release in response to the allegation in the Glaucus Report.
2011, May 16: The company reiterates revenue and net income guidance for 2011 with the release of First Quarter earnings. Says it expects bromine prices to remain at current levels for the remainder of the year.
2011, May 19: Another short-seller, Kerrisdale Capital publishes a hit piece, supporting the April 26 Glaucus report and adding its own claims, particularly that GURE's reported profit margins "are too good to be true." Kerrisdale concludes that Gulf Resources' "business claims are not within the realm of reason."
2011, June 7: GURE announces that it intends to register a subsidiary in Daying county, Sichuan province, in order to research possible resources for bromine and crude salt in Sichuan province.
2011, June 22: BDO Limited is reappointed as the company's auditor for the 2011 fiscal year.
2011, June 23: Gulf Resources announces that the share repurchase program, announced in September 2010, has been initiated, and the company has acquired 100,500 shares of its common stock through open market transactions.
2011, June 29: Independent director Yafei Ji resigns for "personal reasons." He is replaced by Mr. Tengfei Zhang, a CPA and Chairman of the Board of Supervisors of Shenzhen Kaili Industrial Co., a manufacturer of computer cables.
2011, June 30: Gulf Resources' ticker symbol changes from 'GFRE' to 'GURE'.
2011, July 13: Chairman Ming Yang, the company's largest shareholder (38.7%), declares that he will not pledge or sell any of his shares in the next three years. The company reiterates that it maintains 100% ownership in its subsidiaries, that its corporate structure remains linear and unchanged since February 2007, and that Gulf Resources maintains full control over its operating subsidiaries. Documentation for subsidiary ownership is attached to the 8-K Filing.
2011, July 20: The company withdraws its shelf registration that was originally filed on August 6, 2010. "We decided to withdraw our registration statement because we think our share price remains undervalued and do not intend to sell any securities under the registration statement."
Extremely Cheap Valuation - GURE has posted Earnings per Share of $1.48 for the fiscal year ended December 31, 2010. Official 2011 guidance calls for 24.8% to 28.7% net income growth, not taking into account any impact from potential acquisitions. During 2010, the company raised its guidance twice and managed to exceed the high end of its guidance range when it posted final numbers in March. At Friday's close ($3.80) the stock is trading at a forward P/E of 2.05, based on 2011e EPS of $1.85. That is about as cheap as it gets for a Nasdaq-listed growth stock.
No Shareholder Dilution - the company did not sell any stock in the past 18 months. The shelf registration that became effective in August of 2010 has been withdrawn earlier this month. GURE paid for all its recent acquisitions almost entirely in cash. Total dilution for existing shareholders over the past year was just 2.38%, which is among the lowest with U.S.-listed Chinese stocks. If GURE were a fraud then it is certainly not very clever with monetizing its stock.
Management Continuity - Unlike most other Chinese names, Gulf Resources has not been hit with a slew of management resignations. The Chairman of the Board, CFO and CEO are all with the company for a long time. There have been three director resignations in the past 18 months, but I believe it is credible that none of them were in disagreement. I also believe that it is part of good corporate governance if a company changes its independent directors every once in a while.
Strong Responses to Short Seller Attacks - Gulf Resources has been a short seller target for more than a year, the depressed stock price clearly reflects that now. Yet, the company has always been very quick, detailed and elaborate in its response to such attacks, unlike most other names in the China space. GURE does reliably provide documents to support its position and publicly files those with the SEC so all interested parties can review them easily.
Corporate History - This is the strongest negative aspect, and it is one that will never go away. Gulf Resources' public company life began with a China Finance (CHFI.PK) shell, in connection with reverse merger specialists like China US Bridge Capital, a subsidiary of CHFI. China Finance went dark in 2009, stopped filing anything with the SEC, and is now a 2-cent zombie stock. All of the other CHFI RTO's are either complete frauds or extremely questionable at least, including CNOA, JADA, BFAR and CHCG. It is a bit of a stretch to argue that Gulf Resources is the one exception in an otherwise smelly pit of dirt.
However, and here it comes, proclaiming guilt by association has never been a good or wise strategy. Gulf does surely wish - fraud or not - they would have never been associated with China Finance, but we should judge them by their actions after all. Maybe they have cut all the ties with CHFI, as they say they have, a long time ago already? The company's communication with investors in the past 18 months certainly doesn't bear any resemblance with other former CHFI clients.
Prime Short Seller Target - GURE has been attacked several times by multiple individuals and entities. Short interest in the stock sits at about 20% of the float and has been at a very high level for most of 2011. While the company has managed to stabilize the stock price since May, none of the recent announcements led to a meaningful recovery and investors are still sitting on a loss of 64% for the year.
Half-hearted Stock Buyback - There is no better investment for a company like Gulf Resources than investing in its own stock at just 2x forward earnings. But it took the company almost nine months to initiate its buyback program that was announced in September of last year. And the number of shares (~ 100k) that has been repurchased so far is very small for a company that supposedly has more than $80 million cash on the bank.
Ineffective Internal Controls - BDO attested that the company's internal controls are ineffective due to a "material weakness regarding management's failure to maintain effective controls over the identification of related parties and the disclosure of related party transactions." Gulf management hired Deloitte Touche Tohmatsu for an internal control assessment, and announced that DTT did not find major issues in the Company's corporate governance and internal control system. We don't know what issues Deloitte found, but we know that related party issues are one of the short sellers' most prominent claims.
Bottom line is, I don't have any conclusion - you have the choice between a "Yes, but..." and a "No, but..." approach. It is my belief that GURE's stock price will more likely appreciate from here than deteriorate, as the main reason for its low level is the general investing public's reluctance to put money in any name with a strong "but...", especially Chinese reverse mergers. We are now probably beyond the peak of "weeding out China frauds" and there are signs that investor appetite for the remaining Chinese names is slowly but steadily increasing from here.
There are compelling arguments for taking a position in GURE at the current level, however the arguments for staying away completely are also quite convincing. This is the prototype of a "high risk" stock which could easily double or even triple from here if/when market sentiment improves. But those risks are real and they are obvious to most market participants, so cautious investors should act accordingly.