Miami, FL – February 19, 2019 (EmergingGrowth.com NewsWire) — EmergingGrowth.com, a leading independent small cap media portal with an extensive history of providing unparalleled content for the Emerging Growth markets and companies, reports on Natural Shrimp, Inc. (OTCQB: SHMP).
Natural Shrimp Inc.(OTCQB: SHMP) is arguably one of the hottest breakout stocks in 2019, having gained more than 3000% year-to-date. The agro-tech company has patented a new technology for growing Pacific White Shrimp in an indoor recirculation aquaculture system that doesn’t require the use of antibiotics. The new technology is called ‘vibrio suppression technology.’ As the name suggests, this technology suppresses bacteria and viruses that afflict shrimp and lower yields in enclosed aquaculture systems, eliminating the need for costly and increasingly unpopular antibiotics. The company has a facility in Texas and anticipates to harvest its first crop mid this year.
SHMP has had a sharp correction, which presents a buying opportunity for risk-tolerant investors
Although SHMP underwent a sharp correction of around 70% in the week of February 11th, interest in the stock is likely to grow in the mid-to-long-term, for among other reasons, the company’s recent announcement that its patented technology has wider applications beyond shrimp farming. The patent, which was jointly issued to SHMP and F&T Water Solutions, allows SHMP to use its technology to grow all kinds of fish in indoor recirculation systems without using antibiotics.
Broader applications of the patent beyond shrimp farming could result in sustained trading volumes in the market and, more importantly, outsized gains if investors identify the underlying value in the business and buy to hold.
The underlying value in SHMP derives from two factors. First, from the company’s shrimp farming technology, which targets an increasingly health conscious market segment that prefers chemical-free, natural and organic food. Second, from the potential to establish a competitive edge in indoor cultivation of other kinds of seafood, as demand for chemical-free food is also increasing in the broader seafood market.
A staggering 70% of U.S. consumers say they are influenced by the availability of healthy menu items when choosing where to dine out, according to a 2017 industry report by the National Restaurant Association. This strong consumer preference for healthier options—including natural, chemical-free seafood—has direct consequences for all players in the food and beverage value chain, including retailers, wholesalers and growers, like SHMP.
Strong prospects in Shrimp farming
According to the United States Department of Agriculture (USDA), over 1.7 billion pounds of shrimp are consumed annually in the U.S. The price per kilogram, according to commodity price index website Index Mundi, is currently around $11.80. This means that the shrimp market in the U.S. is a $9 billion market (1 pound = 0.45kg; this means the total shrimp market value is $11.50 per kg × 1.7bn pounds × 0.45 = $9 billion). Interestingly, the USDA notes that 1.3 billion pounds of shrimp are imported – that’s about $6.8 billion in terms of market value, leaving domestic producers with just over $2 billion.
SHMP has an opportunity to not only make a play for the $2 billion U.S. market controlled by domestic players, but also for the $6.8 billion market in the hands of foreign players. This is because its technology gives it two key differentiators.
First, and as already highlighted, SHMP’s technology does not require the use of antibiotics in indoor enclosed systems. Most domestic players who produce shrimp in enclosed aquaculture systems rely on a potent cocktail of antibiotics to stave off diseases and ensure bumper yields. The challenge with this approach is that, with consumer preferences shifting more towards chemical-free food, the scope for growth for players that use antibiotics is quickly shrinking. This gives SHMP a distinct advantage. Moreover, the ability to produce shrimp without antibiotics also lowers production costs, giving SHMP a comparatively higher pricing power, which is always beneficial when you are a newer entrant seeking to unseat incumbents in the market. To further press home its advantage, SHMP’s aquaculture systems are computer monitored, lowering labor costs. Systems that use antibiotics generally require more manpower.
Second, by offering a commercially viable way to cultivate shrimp in an indoor recirculation system, SHMP is insulating itself from the multidimensional risks currently facing international players who use ocean trawls to catch shrimp. Ocean trawling is still the most commonly used form of catching not just shrimp, but other forms of seafood. While it is effective, it is not absent risks, which have compounded in recent years.
One key risk of ocean trawling is that oceans have a finite amount of shrimp, which is being depleted faster than it can be replenished against the backdrop of feverish demand. Yields are inevitably declining, which means that most ocean trawlers are facing an existential threat to their business, something that a player like SHMP does have to worry about since it cultivates its shrimp indoors.
Second, environmentalists are increasingly concerned about the physical damage trawling does to the seabed, including destroying coral reefs. Trawlers’ nets also capture other sea creatures besides fish, which are later destroyed and disposed, disrupting the ocean’s natural ecosystem. This is happening at a time when the push to protect our oceans has reached an inflection point, including gaining support at the highest levels of multilateral institutions such as the United Nations, which is looking to establish a legally binding international treaty that protects marine life by 2020. Even here in the U.S., the push to protect marine life and the oceans has gained tremendous momentum over the past decade, negatively affecting some of the largest seafood companies. For example, in 2011, privately-held Trident Seafood– recognized as the largest seafood company in the U.S. by Seafood Business – paid a $2.5 million fine, the largest Clean Water Act penalty ever assessed by the US Environmental Protection Agency for “illegally dumping fish processing waste into the ocean for years.
”In the current market landscape, it is clear that the winning strategy in the shrimp business is an indoor recirculation aquaculture system that doesn’t require the use of antibiotics, which is precisely what SHMP delivers.
SHMP has distinct points of differentiation that give it an edge
From a business strategy point of view, SHMP has distinct points of differentiation that should help it establish a formidable position in the $9 billion U.S. shrimp market. But a strategy is only as good as its implementation, as this is what ultimately unlocks the value of a business and leads to the creation of shareholder value. This is where SHMP gets even more interesting.
With only one operational facility in Texas, and bearing in mind the cost of constructing others, SHMP needs a quicker path to revenues in order to appeal to investors. This is where its ability to cultivate other forms of fish using its patented vibrio suppression technology comes in.
Learning from others’ mistakes
Between 2010 and 2013, there was another agro-tech company that captured the attention of investors in the same manic way SHMP has. The company is Umami Sustainable Seafood Inc. (OTCPK: UMAM). In 2010, the blue tuna producing company that targeted the high-end Japanese market traded at $4.25 per share. It was at some point even covered by leading investment research firm Zacks, which gave it a mindboggling price target of $60.00 a share. Today, however, it is a shell of its former self and is stuck at $0.0028 per share with limited to no trading volume.
UMAM had two facilities, one in Croatia and the other in Mexico, with a combined capacity of 15 million pounds. In Japan, blue tuna usually sells for up to $40 per pound, though the price can fluctuate to more than $200 per pound. UMAM therefore had a market opportunity of between $600 million and $3 billion, assuming it operated at full capacity.
So why did UMAM fail? Concentration risk – that is, relying on a few customers for the bulk of its sales. This is highly risky in a market as complex as seafood, where variables such as storage, shipping, credit terms and other contractual agreements can easily prolong the sales process or thwart it altogether.
SHMP is trying to avoid this mistake – that is, avoiding overreliance on its Texas facility. The facility should produce its first harvest by mid-year, as cultivation began in June 2018 and shrimp has a 24 to 36 week production cycle, according to the company’s SEC filings. It is reassuring that the company recently placed three additional orders for water treatment systems to ensure it meets timelines for harvesting at the Texas facility.
While all this is encouraging, a lot could change in the coming months as the company needs to harvest its shrimp, find a market, secure favourable credit terms that can guarantee sustainable cash flows, and finally secure new orders to grow the business. It doesn’t take a Stanford Business School cum laude to know that all this requires time and carries many unforeseen risks, however bullish SHMP’s management team may appear to be in its press releases.
In the meantime, to reassure investors—and ensure it doesn’t become another UMAM—SHMP needs to establish alternative streams of revenue that can generate sustainable cash flows. Its patent – which allows it to grow other forms of seafood without using antibiotics – could help it achieve this critical goal.
The patent provides scope for it to enter into joint ventures with other seafood players, allowing it to operate a cash-lite scalable business and generate revenues to supplement the shrimp business. The demand for chemical-free seafood (not just shrimp) is on a solid uptrend so SHMP is well positioned in this regard.
The only risk factor is that a clear route-to-market for the cultivation of other seafood besides shrimp is yet to be communicated by the company. However, this isn’t necessarily a deal breaker as SHMP could be modelling itself into an acquisition target. The patent could therefore set the stage for its potential acquirer to position itself in a broader range of market segments within the overall seafood sector.
Potential acquisition target
Looking at SHMP’s management, one of the notable things is the presence of Bill G. Williams, an expert in mergers and acquisitions. As part of his executive experience, which is outlined in several of the company’s SEC filings, Mr. Williams is said to have overseen the acquisition of 37 businesses over a period of five years while at Ameritron Corporation.
Why is this significant? Managers who understand mergers and acquisitions are typically well equipped to run early stage businesses, whose most viable path for creating long-term value for shareholders is often being acquired.
This seems to be the case with SHMP. It has a disruptive technology with strong commercial potential but does not have revenues to speak of and is weighed down by a less-than-stellar balance sheet. Demonstrating the commercial viability of its business model could in the coming months help SHMP court the attention of potential acquirers, meaning that management is likely to prioritize revenue generation and growth in the next 12 to 36 months.
Importantly, SHMP’s capital structure reveals a heavy dependence on short-term debt, some of it being equity-linked debt, which is dilutive. It also relies heavily on sales of securities; recently, for example, it entered into an Equity Financing Agreementwhereby it will have access to up to $7 million through the sale of common stock to an investor.
Besides the obvious risk of massive dilution that comes with sale of securities and equity-linked debt, short-term debt also introduces the separate risk of cash flow constraints. This is because short-term debt is classified under current liabilities in a balance sheet, meaning it is payable within 12 months. The below analysis of its balance sheet helps put the latter point into perspective.
As at September 30, 2018, the company’s notes payable under the current liabilities section of its balance sheet was $1.27 million, representing around 76% of the $1.65 million total liabilities and stockholders’ equity/deficit. On the asset side of the balance sheet, buildings accounted for $1.3 million or 81% of the total assets of $1.65 million. This means that in one year, the business’s aquaculture facilities need to generate cash equal to at least 76% of their market value (short term debt of $1.27 million divided by building valuation of $1.65 million) in order to pay off debt – this is without factoring other operational expenses. This is next to impossible, even for the most lucrative of businesses. This means that to stay in the game, SHMP would need to rack up more debt or sell more equity to pay off its old debt and fund its capital and operational expenditure. This is not sustainable and is sure path to financial ruin.
While SHMP’s unsustainable and perilous capital structure would ordinarily be a glaring red flag, it isn’t necessarily so in this case. When the current capital structure is juxtaposed against the potential of the underlying business, it is clear that SHMP is a prime acquisition candidate. A company struggling with cashflow that has a clear potential to corner a fast-growing market is always a prime acquisition target for a bigger better capitalized player, as the acquirer can buy it at a significantly discounted multiple. The fact that the company’s Chairman, Mr. Williams, has a history in acquisitions further strengthens this thesis.
Recently, some of the bigger players in the food and beverage market have been making forays into the seafood market through acquisitions. For example, in 2018, Tyson Foods Inc. (NYSE: TSN), the Arkansas food processing giant known mostly for chicken, acquired Keystone Foods from Brazil’s Marfrig Global Foodsfor $2.16 billion in cash. Part of the reasons behind the deal was to gain access to the opportunities in the seafood business, as Keystone is the supplier of McDonald’s (NYSE: MCD) Filet-O-Fish. The fact that Tyson was willing to pay 100% cash to get it hands on a business with significant interests in seafood goes to show how attractive an acquisition target in the seafood space can be if it provides access to an attractive market—as is the case with SHMP and its technology.
SHMP has the telltale signs of a potential acquisition target – it is pressed for cash but has a solid underlying business with strong commercial potential that is guaranteed by a patent.
Strong speculative buy
We cannot use conventional valuation metrics such as price to earnings ratio or price to sales ratio since the company is yet to harvest and sell its shrimp. However, it is still possible to work towards a price target by analysing industry research. Research from New York Universityindicates that the average price-to-sales ratio in the food processing industry is 1.39x.
Assuming an acquirer was looking to acquire the company at the food processing industry’s average price to sales multiple of 1.39x, SHMP’s market capitalization at the time of writing of $94.3 million ($0.33 price per share × 285.77 million outstanding shares) would yield sales of $67.84 million or 0.75% of the $9 billion U.S. shrimp market.
Although $67.84 million is a highly unlikely sales projection for SHMP in the short-term, given the liquidity constraints that limit its ability to operate at scale, it is still an indicator of the sales potential a prospective buyer could be seeing at current valuations. The big question is: does SHMP have the potential to generate such sales and attain a 0.75% market share?
In the hands of the right acquirer it has the potential to achieve a market share of 0.75% and much more. Typically, a large company acquiring a smaller company in a niche space would be looking to establish a dominant market position (market share of at least 5% in that niche within five years of acquisition). For the Sh9 billion U.S. shrimp market, a 5% market share works out to sales of around Sh450 million. This works out to a market cap of around $625 million using the food processing industry’s average price-to-sales ratio of 1.39x. Assuming we were to discount this valuation by up to 70% to cater for the acquirers’ own capitalistic urge to make a return (everyone wants to buy low and sell high), we are still talking of a market cap of around $312.75 million (70% ×$625 million). This market cap works out to a price per share of $1.09 assuming outstanding shares remain unchanged at 285.77 million. If SHMP were to be acquired in the imminent future, we would therefore be looking at an acquisition price of at least $1.0 per share.
Conclusion
While it wouldn’t be advisable to base an entire investment decision on the likelihood that a company could be acquired, SHMP could explode in the event that it is – which from all indications is increasingly likely given the fact that it has a disruptive, patent-protected commercially viable technology but no capital to roll out at scale. The fact that the company is saddled with colossal amounts of short-term debt that can’t be repaid using cash from revenue means that management could be looking to close an acquisition by year’s end – or alternatively risk folding the business or raise toxic finance and dilute shareholders even more. A price target of 80% of the potential acquisition price—$1.0 per share—over the next 8-12 months would be a good exit point for a risk tolerant investor. That works out to a price target of $0.80 per share over the next 8-12 months. The recent pullback, which has seen prices go down to $0.33 per share, therefore presents a buying opportunity for a risk-tolerant investor.
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