Seeking Alpha • Aug 08
Update On Origin Agritech: Selling Feed Corn, Not Just Seeds - Increases Upside Potential
In early 2021, investors were waiting on a key catalyst: Chinese regulators approving GMO seeds to be grown and sold in China. The stock has drifted down during the wait.
Origin Agritech then focused efforts on a burgeoning business unit: growing feed corn from its own seed bank with unique properties to specific customers.
A recent announcement of a large multiyear purchase order proves their feed corn business has a huge potential and reinvigorates the upside potential of the Company.
This little Chinese seed company could once again be worth a small speculative investment, with two potential catalysts to drive substantial growth.
Introduction
Origin Agritech (SEED) was founded in 1998 to focus on developing genetically modified seeds for China's market. The Company established relationships with multiple Chinese agriculture institutes to have early access to technology that it could license and commercialize. It was understood that China would eventually need to allow genetically modified organisms ("GMO") products into the country. Origin made the early investments to capitalize on that eventuality.
China has been a net importer of food for a long time, and there are no signs of that changing. China has 22% of the world's population and only 10% of the world's arable land. As the middle class grows, so does the demand for meat and dairy. The domestic Chinese meat industry has dramatically increased over the last few years, which has resulted in a dramatic increase in the importation of feed corn. In the first quarter of 2021, China imported 6.7 million tons of corn - a 438% increase over the first quarter of 2020.
The Chinese government has made the policy shifts necessary to allow GMO seeds to be grown in China. The government currently allows GMO corn to be imported for animal feed because of the outsized demand that is not able to be locally supplied. At present, the regulatory agencies are in the final stages of allowing GMO seeds to be planted on Chinese soil. When that final hurdle is cleared, Origin stands to be one of three companies to capture the Chinese GMO seed market, expected to be approximately 15.6 billion yuan (US$2.4 billion).
Chinese Regulatory Framework for Seeds
In July 2000, China enacted a Seed Law to cover the development, approval, production and distribution of crop seeds. The law became effective December 1, 2000, and has been amended a number of times. In addition to the Seed Law, China regulates the seed and plants through a series of other laws, including the Plant Quarantine Law, Administrative License Law, Administrative Penalties Law, Plant Varieties Law and Genetically Modified Organisms Safety Law. Local provincial laws may also apply but these vary from province to province. The system is complex and requires local knowledge.
A Seed Production and Operation License is given either at the Provincial level, or the National level, and sets some minimum operating requirements on license holders. Origin is one of a few companies in China that are able to use the Corn Seed Green Pass Test System, which reduces the timeline to market for new hybrid varieties and allows the company to use a government protocol on their own fields to conduct the testing.
The Chinese government published Regulations on Administration of Agricultural Genetically Modified Organisms Safety in 2011, which were updated 2017 ("GMO Regulations"). The GMO Regulations govern the research, experiment, production, processing, marketing, import and export of agricultural GMO in China. The GMO Regulations classified agricultural genetically modified organisms, or GMO, into Classes I, II, III and IV according to the extent of their risks to human beings, animals, plants, microorganisms and the ecological environment. The principal difference among the classes is the reporting obligation to the relevant agricultural administration. The testing of agricultural GMO will normally go through three stages: restricted field testing, enlarged field testing and production testing. Depending on the classification of the GMO, the GMO research entity will differing levels of reporting obligation to the Ministry of Agriculture and Rural Affairs ("MARA") prior to the commencement of the testing and when the GMO advances from one testing stage to the next testing stage. After the completion of productive testing, the GMO research entity may make an application to the MARA for a safety certificate of the tested GMO.
Origin's GMO products are classified as Class I. As of September 30, 2019, the Company has received safety certificate for its phytase corn products. Two other products are in the Biosafety certification application stage.
A production license from MARA is required for the production of GMO seeds. A business must obtain a bio-safety certificate of agricultural GMO and pass other standards and conditions provided for by MARA. Origin is in the process of applying for GMO Biosafety certificate and in active discussions with related regulatory authorities to meet the requirements to obtain a biosafety certificate.
As with many industries in China, foreign companies are relatively blocked from entering the market, and entities can only have a limited amount of foreign investment. The Chinese GMO seed market, even when opened up, will be limited to Chinese owned and operating businesses.
Origin Corporate Structure
Origin Agritech Ltd. is a British Virgin Island's company. Origin owns 100% of State Harvest Holdings Ltd., based in China. State Harvest subsequently owns 100% of Beijing Origin Stage Harvest Biotechnology Ltd., which owns a majority state in a number of regional distribution companies, and Beijing Origin Seed Ltd., which owns a majority state in one other regional distribution company.
SEED 20-F
For the regional distribution companies for which Origin does not have full ownership, the company has Consignment Agreements to hold rights over the portion of the companies that Origin does not have full ownership. These agreements are standard practice in China to help navigate the foreign entity ownership laws.
Origin's Germoplasm Advantage
Origin has developed, or licensed, over 100 hybrid seeds, and multiple GMO trait seeds.
One example that Origin has developed is GMO Phytase Corn. Phytase is added to the diets of livestock to help them absorb nutrients. Over US$1 billion is spent on the additive for chickens and pigs. By modifying corn to produce phytase, the livestock producers no longer need to purchase or administer that supplement to their livestock.
SEED Corporate Presentation - July 2020
Some other key traits that Origin has disclosed are drought resistance, herbicide resistance and pest resistance. Drought resistance is probably the biggest potential product given the effects of climate change. GMO corn seeds have been shown to produce about 25% more corn than standard corn seeds. (Source: Genetic Literacy Project) . Having the ability to resist herbicides like glyphosate allows farmers decrease the invasion of other plants.
The Company has not disclosed additional traits, but have stated that they are actively working on additional GMO traits internally and with collaborators.
Total Addressable Market
China imported 6.7 million tons of corn in the first quarter of 2021. Much of that corn was for animal feed, a large percentage of which was GMO. Annualized, that represents 26.8 million tons of corn per year.
Hypothetically, the initial market for GMO seed corn in China could initially focus on replacing the imported feed corn. Assuming at least 75% of the imported corn was for animal feed, and a cost of seed per pound is between US$1.25 and US$2, then the value of the market for could be between US$900 million and US$1.4 billion. That market math assumes 26.8 million tons of corn converts to 950 million bushels. Production of corn using GMO traits caps at around 28,000 plants per acre and delivers between 180 and 220 bushels per acre - suggesting approximately 140 seeds required per bushel. (Source: Iowa State) Each bushel yields 56 lbs of shelled corn grain. There are approximately 140 seeds per pound. (Source: USDA) These US-farming assumptions would suggest that 950 million bushels requires approximately 950 million pound of seeds be planted over 4.7 million acres.
The actual potential market is likely much, much larger. It will take time for Chinese farms to figure out which seed traits are best for production on their land. It will take time for the Chinese regulatory agencies to trust an expanding portfolio of GMO seed products. Given the higher yields and China's growing demand, GMO seeds have been recognized as part of the future.
Origin's corporate presentation points to the GMO corn market in China to be around 15.6 billion Yuan, or US$2.3 billion. At the end of the day, for the purposes of valuing Origin, it does not matter if the market is US$900 million, US$2.3 billion or US$10 billion. Compared to highly competitive hybrid seed market, the GMO market, once open, is a huge opportunity.
Press Releases Announced the Progress of New Feed Corn Business Unit
On February 7th, 2022, the Company announced that it expected its fiscal year 2022 to be 300% of its fiscal year 2021. In the press release, Origin declared that it had sold out of its hybrid seeds for the year, and that it was going to expand its feed corn partnership with BaoDao Feed Ltd.
On March 7th, 2022, Origin announced the creation of a new subsidiary to focus on seed and feed corn production on land on Hainan Island, which has multiple growing seasons. The corn grown would be nutritionally enhanced to reduce to overall cost of feed for stock animals.
On April 7th, 2022, the Company announced that it had signed contracts to sell 50,000 metric tons of corn at market prices, plus a premium for the nutritional additives. The value of the contracts were stated to be approximately 150 million RMB.
On May 23rd, 2022, Origin announced that Yunan Feeding Company agreed to purchase 20,000 metric tons of nutritionally enhance corn for approximately 62 million RMB (~$9.2 million).
On July 27th, 2022, the Company announced an order for 240 million RMB ($35 million) from Muyuan Foodstuff, Co., Ltd., a $50 billion company with large hog farming operations. At current corn prices in China of 2.9 RMB/kg minus some estimated cost for logistics, the 240 million RMB transaction reflects approximately 100,000 metric tons. In the release, they also mentioned that the initial order was part of a 1 million metric ton 5 year order (in the corrected version of the release). At current prices, that could represent a total contract value of approximately 2.2 billion RMB (~$320 million).
At first read, the Muyuan deal sounds good. When I learned that Muyuan is the largest hog producer in China and is twice the size of Smithfield Foods, the largest hog producer in the US, the press release sounds amazing. Doing the math, based on an assumption of the average daily consumption being ~3 kg/day/hog, Muyuan could be using more than 3 million metric tons of feed per year for their hogs. The contract with Origin represents a tiny fraction of Muyuan's overall feed corn needs. If Origin's feed corn does indeed reduce the need and cost of additives, it would be hard to imagine that the demand from Muyuan would not grow exponentially.
The addition of the nutritionally enhanced feed corn business unit to the Company is potentially massive. The Company has telegraphed that it has sales of over 600 million RMB (~$90 million) per year in feed corn for the next five years lined up through current relationships, which would be on top of any hybrid seed sales or, if it ever gets approved, GMO seed sales.
Valuation
Based on the six months ended March 31, 2022 6-K, and the recent announcement of 240 million RMB order, Origin is probably going to have an annual run rate of north of 100 million RMB, with a gross margin of 30%. Even though the Company issued guidance of 150 million RMB, there is a fiscal year caveat. The caveat is that the Company's 2022 calendar end is on September 31, which is in the back part of the growing season. Therefore, some part of the revenue from the most recently announced 240 million RNB initial purchase may come in the next fiscal year in October 2022.
With the addition and rapid growth of the feed corn business unit, and the growth in the hybrid seen business, the Company has projected 2022 to be a 300% increase over 2021. For a valuation model, I used 100% growth from 2022-2024, 50% from 2025-2027 and 10% in the terminal value.
Internal Analysis
With the shift in business model, and the rapid growth of their feed corn business, one could imagine that the company could actually grow faster. If Origin grows 200% over the next 3 years, dropping to 100% for 2025-2027, then the NPV would be 5.2 billion RMB ($132 share price).
If the Company only grows at 50% for the next 3 years, with a drop to 25% growth for 2025-2027, then the NPV would be 275 million RMB ($7 share price).
As with most revenue companies, the valuation is highly dependent on the revenue growth rate. If Origin is actually able to grow at 100% of more, and maintain its current gross margin, then it is possible for the valuation of the Company to easily exceed a 1 billion RMB.
Comparable Companies
For the GMO side of the business, there are two other major companies in China, Beijing Dabeinong Biotechnology Co., Ltd and Longping Biotechnology (Hainan) Co., Ltd.
Beijing Dabeinong Biotechnology Co., Ltd is a 70% controlled subsidiary of by the Beijing Dabeinong Group. It is Dabeinong Group's GMO technology research and development subsidiary. Modern Seed Industry Development Fund Co., Ltd. and Central SOEs Investment fund For Poor Area Co., Ltd. together invested RMB 400m in Beijing Dabeinong Biotechnology Col., Ltd. The deal was announced on April 26th. The pre-money valuation is RMB 3.92 billion (US$ 580 million). Modern Seed Industry Development Fund Co., Ltd was set up by Ministry of Finance, Ministry of Agriculture and Rural Affairs and Sinochem Group in 2013. Central SOEs Investment Fund for Poor Area Co., Ltd. is managed by China's State Development & Investment Corporation. (Source: Baidu link to Chinese newspaper Securities Times)
Interestingly, Dabeinong entered a deal last year with Origin to collaborate on GMO corn seed production. Origin has one of the largest germoplasm databases in China. Currently It has three GMO corn biosafety certificates and one GMO soybean biosafety certificate. (Source: Bloomberg)