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China Growth Development: A Compelling Value Play

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mall(Sept. 21, 2009 - Zou Soueidan) On September 18, 2009 ($0.38) we coded China Growth Development (OTC:CGDI) as a GeoSpecial due to the stock selling below its book value per share.  It's price ended Sept. 18, 2009 was $0.40.

As of its the 2009 second quarter China Growth's book value per share is $1.28.  The Company develops real estate that generates revenues from rental income. Recall that China Housing & Land Development (NASDAQ:CHLN) is another Chinese real estate development company. Unlike China Growth, China Housing develops and sells its real estate holdings and is trading above its book value per share of $3.43.

Why is CGDI selling below book?

One reason could have to do with the negative GAAP earnings per share growth The Company reported in 2008.

 

Full Year 2008 Full Year 2007 Period Change
GAAP Revenue $16.23 million $12.78 million 27.00%
GAAP EPS $0.05 $0.14 -64.29%
Non-GAAP Adjustments $0.07 $0.00 n/a
Tax Rate 26.6% 1.2%

2116.47%

GeoCalculated Tax-Adjusted Non-GAAP EPS (at 26.6%) $0.12 $0.10 20.00%

However, upon further inspection a few non-cash items exist in the cash flow statement that, when added back to net income, tell a different story. Furthermore, in 2007 CGDI paid no taxes, while in 2008 it paid a tax rate of 26%.  So, on an apples to apples comparison, if we add back the non-cash charges and adjust 2007 for a 26% tax rate, we arrive at a different non-GAAP EPS picture.  CGDI also finished 2008 with operating cash flow of $7,962,614.

If investors are valuing CGDI on GAAP EPS, they may reevaluate the situation once they make the necessary adjustments.

Another reason could be the lack luster non-GAAP EPS growth so far in 2009.

 

First Quarter 2009 First Quarter 2008 Period Change
GAAP Revenue $3.74 million $3.67 million 1.9%
GAAP EPS $0.01 $0.04 -64.3%
Non-GAAP Adjustments $0.00 $0.00 n/a
Tax Rate 24.5% 0.0%

n/a

GeoCalculated Tax-Adjusted Non-GAAP EPS (at 24.5%) $0.01 $0.03 -66.7%

 

Second Quarter 2009 Second Quarter 2008 Period Change
GAAP Revenue $4.18 million $3.74 million 11.76%
GAAP EPS $0.03 $0.02 50.00%
Non-GAAP Adjustments $0.00 $0.03 n/a
Tax Rate 24.5% 0.0%

n/a

GeoCalculated Tax-Adjusted Non-GAAP EPS (at 24.5%) $0.03 $0.04 -25.00%

We also have some questions concerning receivables and the ownership structure of the Company's properties. (For example, direct ownership or ownership rights).  China Growth's second quarter press release also seems to have a few "number" typos that don't match up with the SEC filing.  While not a big deal, this lack of attention to detail is not what we desire with a small company.  This situation could be easily resolved with the proper investor relations representation.

Putting a value on real estate development companies can pose a dilemma

Important factors that can influence valuation:

1. Dividends- The attraction of a real estate estate development company is often the eventual receipt of dividends through the generation of consistent cash flows.

2. Price appreciation of land holdings- Ideally we would also want to forecast the expected rate of growth of real estate which would ultimately affect book value and potential cash flows.

3. Consistent Earnings Per share- Whopping EPS growth is not necessarily a staple of  this type of investment, but if EPS growth can be attained we feel there is a better chance of the stock selling at or a premium to book.

While China Growth does not have any current plans to pay a regular dividend, it seems bullish on its regional real estate outlook and cash flow position.

“Our expansion projects have lead the way to increased revenue, and that is a perfect example of our growth strategy succeeding. We are focused on continuing that strategy of growth via expansion, development, and acquisition throughout the third and fourth quarters of 2009.” (Business Wire August 20, 2009)

"Over the course of the next few years, we intend to grow and expand our commercial real estate business. We currently generate positive cash flow and we expect to acquire an additional 2 shopping centers within the next three years.' (Business Wire August 20, 2009)

"Chinese government policy is in favor of the growth of retail shops in Shanxi Province because it will greatly stimulate the economic growth of the region." (2008 10K, Page 2)

If CGDI delivers on these goals and barring dilutive events, investors may be able to justify a price closer to book.

The more sophisticated investor may want to utilize a discounted cash flow model.

Please read what the GeoCommunity has to say to shed further light on the risk/reward factors surrounding the CGDI story.



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