Is Agfeed Industries Underfed?

As attractive as valuations for AgFeed industries looked a week ago when the stock was

trading at $2.00, they now look absolutely unreal with a stock price closer to a dollar. After a

completely miserable preliminary quarterly report hit the wires on Tuesday, the question now

becomes 'Is the stock undervalued for a reason?' We'll explore that question a little bit and

look at why the stock got hammered over the last three trading sessions and if it will make a

comeback anytime soon.

The preliminary report was pretty bad if we compare it to the previous quarter, and to analysts
expectations. The company was expected to lose 1 cent per share, and it lost 26 cents per
share. It was expected to record $92 million in revenue, but only recorded $84 million. The
loss includes an expense of $9.2 million related to the collection of outstanding accounts
receivable in the company’s Chinese animal nutrition business and an additional $5 million
of bad debt allowance to increase its bad debt provision. If we take those items out, the
company still lost $2.8 million, or 4 cents a share. Admittedly, this is a preliminary report and
we have no idea what all of the numbers were. It will be interesting to see what the gross
margin was, and if they actually recorded a top line loss due to extremely high commodity
prices during the quarter. The company also noted that it will not be spinning-off its animal
nutrition business due to market conditions.

As bad as all of this looks, it is important to note that revenue growth is still staggering when
we look at the last three and a half years. $144 million in 2008, $173 million in 2009, $243
million in 2010 and $177 million so far in just the first half of 2011. We believe that
potentially, Agfeed's shares may be way undervalued for a reason, but it's not a very good
reason.

At the heart of the problem is skyrocketing commodity prices including the price of hogs.
China consumes more than 50% of the worlds pork, and they produce their hogs on tiny
family owned farms. It's no wonder that they are having trouble making timely payments to
AgFeed. The company over payed on a few Chinese acquisitions and is having a tough time
translating the higher revenues into profits, and the recent quarter was no exception. A new
management team is restructuring the company, and a new American CEO is in the process
of focusing more on the U.S. The first quarter results confirm this, as 60% of the revenues
came from U.S. Hog production units. AgFeed also announced that they are in the process
of buying two large U.S. Hog producers. Furthermore, their new Chinese hog producers
were heavily stocked in the first quarter of this year, and those hogs will not be ready to go to
market until early next year.

Now lets look at why the stock tanked 50% in a few days, busting through our stop loss on
the same day we initiated a buy. The major reason was timing of the report, which could not
have been worse. Not that it was their fault, but the market did tank 500 points later in the
week as traders had no problem selling and shorting stocks like AgFeed, perhaps
irrationally. The other reason the stock was down so much has to do with the last line from
the press release, “In its ongoing effort to rationalize its capital structure, the Company also
noted that it had exchanged a majority of the warrants issued in May 2009 for shares of
common stock.” This large amount of shares were likely sold on the open market.

Looking forward, there are a lot of reasons to believe that the stock will rebound substantially
if you don't mind waiting for a month or two. It is important to wait for the full report before
placing to much stock in the current ultra low balance sheet valuations, and with the one or
two analysts that were covering this stock having turned their tails, we will have to dig a little
deeper to find future projections on which to create the other valuations. There is also
nothing in the report that dismisses the earlier projections of $320-$340 million in revenue
for 2011, and $770 million for 2012. Once we get the hard numbers for the second quarter of
this year, we will be able to get a better feel for how this exceptional revenue growth may
translate into earnings. At close to $1.00 per share, you can bet that the forward P/E will be
in the very low single digits. Keep in mind that the company was expected to earn 43 cents a
share for 2012.