Saturday, August 25, 2007

GMG Global - A Play on the Weather

I know that certain investors are extremely enthusiastic about a stock called GMG Global:

As can be GMG Global's stock price has fallen in half since its highs earlier this year. Some investors are seeing this as an opportunity to pick up a "bargain" and have been snapping up the stock at its current perceived low price.


As a rubber seller, GMG Global operates in a commoditised market. It has no pricing power and the only way for GMG to increase its profitability is by lowering its cost structure. However, cost structures are only flexible to a certain extent. The primary factor affecting the business is thus the revenues that GMG Global derives from selling its rubber.

A glance at GMG's financial statements will reveal that in the first half of 2007, there was a sharp decline in revenue year-on-year while the company's cost structure remained the same. This resulted in a sharp drop in profits from $18m to $8.5m in the corresponding financial periods.

The company claims that this was primarily the result of poor weather conditions:

"Lower yield, and field production caused by extremely bad weather conditions prevailing in the first half ended 30 June 2007 which had adversely affected sales and revenue;"

Taking this statement at face value, a bet on GMG Global is essentially a bet on the weather conditions in Cameroon and Ivory Coast. Now, we all know that nobody knows where the weather is going to go in the next one month, let alone the next half year. Hence, no investor can possibly be certain that the weather in Cameroon and Ivory Coast will much better than the conditions that prevailed 1H07. The weather might improve, however we have no idea how much it will improve. This is the first element of uncertainty regarding GMG.

The second issue regarding GMG is its current valuation. The stock is currently trading below book value of $0.126 per share at about $0.105. However, the EPS of 1H07 is 0.31 cents. Even if we give an optimistic full year EPS of 1 cent per share, this is a sub-par 8% return on equity - this is a business that is generating very low returns on capital employed.

The third issue regarding GMG is that it seems to be a company operating with a high operating leverage. Any significant fluctuation in revenues will result in a significant impact on the bottom line. This acts as a double-edged sword, but in the event that the weather moves adversely against the company, this could effectively wipe out most of GMG Global's profits.


At the price of $0.105, this puts GMG into the net-net category for Benjamin Graham. However, I feel that there is a possibility for more value in this stock. The high operating leverage and the magnitude of an impact of a further adverse move in the weather may push GMG into deeper value territory, in the region of 8.5-9.5c per share.

I am putting this stock on my watchlist with buy signal at 9c per share.

Update: Just some information about GMG I found on the net

Cameroon Rubber

Rubber is produced primarily in the forested region of Niete, north of Yaoundé, by 3 agro-industrial companies, CDC, Hevecam and Safacam. The rubber yield plummeted from 58,000 metric tons in 1998-1999 to 32,000 metric tons in 1999-2000. The main producer, Hevecam, was purchased in 1996 by the GMG Group based in Singapore. Most of Cameroon's rubber is exported to the European Union. With average annual rubber exports valued at CFA20 billion (US$30 million), this industry provides 2 percent of Cameroon's export revenue.

From here

More on Hevecam Rubber

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