Wednesday, April 27, 2011

Gulf Resources: sometimes you only need to look at the accounts

Glaucus - a small research firm - has had a dig at Gulf Resources - another Chinese reverse takeover stock.

I hardly felt it was necessary.  At Bronte we have been short Gulf Resources (GFRE:Nasdaq) on behalf of our clients for most of the last year.

Its a bromine and industrial salt producer. Bromine is ugly stuff - highly reactive: in this wikipedia page the bromine is pictured encased in perspex. It will oxidize almost anything.

I knew it was suspect and you could tell off the balance sheet and the P&L. You see in the 2009 annual filing on form 10K Gulf Resources show as having $650,322 in inventories. They had sales of $110,276,908.

In other words they turned their inventory stock over 169.5 times per year. I can't imagine how active a plant would need to be to turn over toxic and dangerous bromine that many times - let alone low value industrial salt.

It didn't seem right to me so we shorted the stock.

But if you are the kind of person that needs a comparable have a look at the last 10K of Great Lakes Chemical. Great Lakes was a super-high quality operator (mostly and originally a bromine producer) with Berkshire Hathaway and Warren Buffett as large shareholders.  This was a mighty fine company as Jeff Matthews relates:

I recall the CEO of a Great Lakes competitor telling me, with awe, about a visit to Great Lakes’ bare-bones corporate office, where the lights in the conference room were operated by an old-fashioned light timer, like the timers that control heating lamps in hotel bathrooms.

These guys you see were hard-driving operators - likely to manage inventory better than almost anyone in the business.

Now we know what arguably the finest bromine maker ever in North America did: we can look at their last 10K.  In their last year (2004) inventories were $324 million. Sales were $1604 million.

The company turned its inventory stock under 5 times.

Gulf Resources claim to turn over their inventory 169.5 times per year looks doubly suspect- and if it is suspect then the accounts are suspect.

I could be wrong of course. Gulf Resources may indeed be able to turn its inventory over 34 times faster than the best American operator. They may. An otherwise obscure Chinese company might be that good and the short might be stupid.

But as a shortseller that is a bet that I was willing to take without any further due diligence.

I admire the effort in the Glaucus report. But for us - we just keep it simple.


PS. There are several high profile asset management firms that hold large positions in this stock led by Fidelity. As stated you only needed to look at two pages of the annual filing to smell a rat: the balance sheet and the P&L. Then the inventory turn jumped out.

Did Fidelity even look at those two pages? Really?



Jeff Matthews said...

Thanks, John. And well done, too.

Nick said...

That's a little harsh on Fido. Don't they have to be long GFRE owing to all their tracker funds?
That's why they are often at the top of any top holders screen.

Sure any actively managed portfolio should have done plenty of DD on the stock but Fido isn't 100% actively managed.

Steve Mazzi said...

Have you ever taken a look at LKQ Corp (LKQX)? It seemed like a natural roll-up (ie, one that made sense), so I gave it a look a while back to see if it might be worth buying a small bit. But they were so aggressive with their purchase price allocations in their transactions, I couldn't get comfortable buying the stock. They're a scrapyard company, yet they were assigning values to acquired inventories that implied that the entity being acquired had been turning over its inventory on the order of 100x per year. I didn't go out and short it, but your example here of GFRE makes me wonder...

I haven't looked at LKQ in a while, so perhaps things have changed.

John Hempton said...

FIDO is so overweight this one it is not tracker. They just figured they liked it in the same way Jesse Glickenhaus liked China Agritech.


Anonymous said...

If you want another company with funny-money inventories, look at ZUN on the TSX (Zungui Haixi - a producer of shoes). They are turning over their inventory every 5 days while competitors do it in 100+ days.


Anonymous said...

ZUN is interesting. Are there these Chinese RTO's elsewhere in the world? Are they defrauding investors other than Americans?

John Hempton said...

Elsewhere: see comments about Singapore.


evangelista777 said...

John - on a somewhat related note, do you have a view on NASDAQ:SCOK?

Anonymous said...

Really interesting post, great insight into how good fund managers work and how bad ones get easily suckered.

While I was looking at the YouTube videos this popped up - a Zacks analyst pushing GFRE. Scary stuff, to think that people make decisions like this with other people's money.

pcarroll said...

Gulf's response re: inventory turnovers has everyone at my small (chemical) engineering firm in stitches.

So, you keep inventories low because bromine is reactive and volatile? You know what's significantly more reactive than bromine, and is a gas (rather than liquid) at room temperature? Chlorine, THE CHEMICAL YOU USE TO MAKE THE BROMINE!

And, on the off chance that someone tries to point out that you're technically storing only one pound of chlorine for every two pounds of bromine you can produce: it doesn't work that way. One pound of chlorine will do exactly the same amount of damage as two pounds of bromine, only it will react with a few things that bromine won't react with (bromine, for example) and it's a gas. No one in their right mind would store a hazardous material as a gas when they could store it as a liquid.

John Hempton said...

Mr Carroll -

Will you send me an email through the blog.

And yes - the turnover stats had me in stitches too.

But hey - some real institutions investing mum-and-pop money own this stock.


Anonymous said...

Excellent post! PS, sometimes it's really interesting and useful to look at the source of these reverse takeovers. One such artist is Laird Cagan who has done a number of these.

The Good Cohen said...

Some of you may have interest in the emergency asset freeze enforcement action last week against issuer China Voice and its principals.

I can't go into details on this blog (for obvious reasons) but it appears some of the promoters involved with that issuer were also involved with GFRE.

The last comment on this blog with respect to Mr. Larid Cagan intrigues me. Would it be possible to elaborate a bit further (specific issuers) or perhaps leave me an e-mail so that I may contact you?

mike said...

Usually really like your stuff but I literally just spit coke on my keyboard when I read that you think Great Lakes was a great "operator". Ironically, Great Lakes (i.e. Chemtura) is the company you should have shorted. They were such great operators that they are no longer operating anymore. Meanwhile, Albemarle and Dead Sea, the comps you should be using, are absolutely killing it. Either way, ALB’s turnover ratio is at 4.5x. So, it is still a huge red flag.

Not sure about GFRE but they sure just gave some good guidance, which isn’t surprising since there has NEVER been a more profitable time to be in the bromine business. Ironically, thanks to Chemtura filing.

Anonymous said...

John, do you still have a dog in this fight? Our analysts are digging in but this one seems to involve a closer look than initially thought.

NYCTraderC said...

I hear that the inventory turns look odd (REALLY odd), but they seem to have spent significant capital outlays that they funded from their own operating cash flows. So it doesn't seem to be have in a fraud manner... Odd.

For some fun, check out BG. Nothing like a $10B company that has negative $5B in FCF over the past decade (and that $5B deficit is spread out over year). Good luck getting a straight answer on their Recoverable Taxes... :)

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