“Strong 3Q, Sell Off Unjustified – Reiterate Buy”. That’s what Wisco Research said on November 10, and we have the full report here…

Here is the report in pdf:

Fuqi-by-Wisco Research-10nov09

Some highlights:

• After the market close last night, we had a conversation with CFO Frederick Wong. We came away from that call feeling that the quarter was misunderstood by investors. We reiterate our Buy recommendation, but have lowered our target price to $32 based on our conservative DCF model. We continue to favor the stock because it trades at a discount to companies with a similar growth profile. Please refer to our relative valuation metrics.
• Management has reiterated 2009 full year revenue guidance of $519.4-$528.4 million, and raised 2009 diluted EPS of $2.21-$2.27. We are increasing our 2009 EPS estimate from $1.90 to $2.21 and our 2010 EPS estimate from $2.20 to $2.30.
• Management expects 2010 wholesale revenue to grow at least 25%, while retail revenue is expected to increase at least 50%. Please refer to our financial model for our estimates.[p.1]
• FUQI reported 3Q09 (Sep) EPS of $0.72 versus $0.31 a year ago, up 138%, beating consensus estimate of $ 0.44 EPS and our estimate of $ 0.43. However, revenue of $127 million fell below our $131 million estimate because of a political issue that hindered sales at the end of September. 2009 was the 60th year anniversary of China’s National Holiday and the government didn’t allow jewelry sales for several days before the Oct. 1st holiday on the security concerns, which means FUQI was not able to deliver products and record revenues during that period.
• Original design manufacturing (ODM) work accounted for $19.1 million of wholesale business segment’s sales, compared to $3.3 million in 2008. Profit margins increased to 23.5% during 3Q, primarily due to the sizable ODM orders. We believe the market feels these sales were a one-time event, which is not true. ODM sales occur when some of FUQI’s clients decide that they only want FUQI’s design without FUQI’s raw materials. In the industry, if a buyer selects only a wholesaler’s design business, it has to pay a much higher price premium for the design itself. The trade-off is that if a buyer obtains its own raw materials in a cheaper channel, or they consider the price of FUQI’s raw material too high due to price volatility, it will purchase only FUQI’s design, resulting in higher margins for FUQI. [p.2]

We (shareholdersunite) conclude that:

1. The ODM business is likely not to be a one-off, and it’s substantially higher margins should be seen as a positive, not a negative. If the next couple of quarters confirm this picture the shares could (perhaps even should) rise substantially.
2. There is a perfectly logical explanation for the small dip in revenue (compared to consensus expectations), the several days at the end of September when jewlery sales were not allowed
3. The negative cash flow from operations (the only other possible negative item we could find in all of the four research reports we published recently) is not a problem in a fast growing company with hardly any debt.
4. The company is very cheap, both according to it’s track record (it has been growing substantially faster than the industry average), it’s peers (see the WS report in the link above p.3) and it’s growth potential.

In short, we see a particularly favourable risk-reward situation.