2005 Sino-Forest Report

March 30, 2012

Update Sino-Forest entered bankruptcy protection today. As documented below I expressed deep concern about this company way back in 2005. Scroll to the bottom here to see what I  was saying about this company since 2005.

September 3, 2011

This is a re-creation of our November 13, 2005 report on Sino-Forest. Given all the controversy about Sino-Forest we wanted to post again what we were saying about the company in 2005. We said in essence that the company looked like quite good value but that we had some concerns.

In particular, see my comments below this report where I document that I had lost trust in management in late 2005 and even speculated that it might be a fraud. Apparently I was six years ahead of my time on this one.

The report below was re-created from our November 2005 database. All the words in the report are exact, unchanged as they appeared in our November 13, 2005 report. I have however highlighted below the areas where I expressed particular concern. Concerns that now seem highly relevant. The yellow high lighting was not there in the original report.

(TRE, Toronto)
Report Author(s):  InvestorsFriend
Inc. Analyst(s) 
Author(s)’ disclosure of share ownership:  We
hold shares 
Based on financials from: Dec
04 Y.E. +Q3 ’05
Last updated: 13-Nov-05
Share Price At Date of Last Update: $3.90
Currency: $
Current Rating (Company Rating does not consider the
circumstances of any individual investor and is therefore not a
recommendation and is not Investment Advice):
Speculative Buy rated at $3.45
DESCRIPTION OF BUSINESS: Manages, operates and invests in tree plantations in China and produces wood chips which are sold to pulp mills and engineered wood producers. Also produces some lumber products and engages in wood products trading. Also sells standing
trees, which recently has been the fastest growing and most profitable business activity. Purchases trees and arranges for the trees to be made into wood chips and then resold for pulp and paper purposes.
RATING: At the recent price of $3.45 the value ratios are compelling and point to a Speculative (higher) Strong Buy.  Does reasonably well on Buffett’s tenets. It does have
potential for strong growth and provides some exposure to China. Negative factors include the risks of operating in China. Note the recent bond issue has an interest rate of 9.125% and a credit rating of only BB minus which is indicative of higher risk. 
I expect continued price volatility. I generally consider this to be a poor industry but that may not be the case in China. I believe that there could be strong potential upside here of perhaps a 100% gain within one year if the company continues its recent earnings momentum. Some analysts have pointed out that they continue to raise money to grow and there is a risk of not obtaining financing. I don’t view the growth as a bad thing given the earnings. I would think the 2008 Olympics and continued strong growth in China would bode well for the company.  I worry that the story is too good to be true. I worry that the company seems to have changed its business plan several times in the past few years. I am wary to become over-exposed. Note
that Jennings Capital has an unfavourable outlook on the stock.
Note also that management has in the past been less than forthcoming with information. In summary,
the value looks great, but there are many risk factors
investing in this stock will require patience and tolerance of
volatility. I rate this a (highly) Speculative Buy. See
comments under management quality. I feel that I am overexposed and so
will sell most of may shares to take profit and reduce my position
from 4.2% down to under 1%.
The price to earnings ratio of this stock seems almost too good
to be true. Combine that with a lack of detailed disclosure by the
company and the location in China and there is always the potential
that assets and / or earnings are over-stated.
currency risks since costs and sales are in Chinese currency. Risk of
asset seizures by communist Chinese government. I consider there to be
added risks due to location in China. May face risks of write-offs on
certain production facilities. Faces commodity price risks and risks
regarding the quality of its trees. For additional risks see annual
TRADING: checking since January 1, 2005, there is no insider trading
shown (other than “conversions” and “changes in the
nature of ownership”). Three insiders are shown to own
substantial shares (800,000  to
2.8 million shares). It’s comforting that insiders are not selling,
but neither are they buying despite a slide in the share price (since
recovered) . I take no signal from this lack of activity.
WARREN BUFFETT’s TENETS: Seems to pass most of Buffett’s tenets
(see Robert Hagstrom’s book) – not simple to understand due to
location in China and somewhat complex financing (fail), good profit
history (pass), moderately favourable prospects for above average
returns due to cost advantages of fast growing tree climate and
established position in a fast-growing market (pass), probably
ethical management although in the past they have been almost
secretive (marginal pass),
a good ROE (pass), high profits on
sales (pass) ,a reasonably low debt ratio (marginal pass) and probably
selling at a significant discount to a intrinsic value (pass). 
RECENT EARNINGS TREND: Strong earnings growth in latest few
quarters and year. Earnings are made more volatile by sales of
standing timber. Strong
earnings have been made by purchasing and then reselling standing
timber (I am not clear why they are able to make large profits that
way without any apparent value added).
Earnings and
particularly sales on their own planted trees seem disappointingly
very low. Margins on standing timber were lower in Q2 and Q3 but they
explain this by indicating more pine trees were sold versus eucalyptus
VALUE AND GROWTH RATIOS: Price to book value is very attractive
at 0.93 based on diluted number of shares.
P/E is very attractive at 5.2, Return on equity was very strong
at 17.1% in 2004. 16.3% net profit on sales in last 12 months, fair to
good financial liquidity with substantial but not excessive net debt
level. Growth in revenue and earnings per share are uncertain due to
difficulties in calculating the diluted number of shares each year due
to impacts of convertible debt (which no longer exists). Revenue has
grown strongly while earnings per share are more volatile. I calculate
a present value per share of $5.80 using what I believe to be
conservative assumptions and $9.05 using a moderately more optimistic
projection. This implies a good Price to Value Ratio of 60% to 38%.
However the profit growth and therefore the intrinsic value are
uncertain. These ratios point to a Speculative (higher) Strong Buy.
Symbol and Exchange: TRE,
Currency: Canadian
Category: Growth
Contact: info@sinoforest.com
Web-site: www.sinoforest.com
Latest four quarters annual sales $ millions: $539.9
Latest four quarters annual earnings $ millions: $88.4
P/E ratio based on latest four quarters earnings: 5.9
Latest four quarters annual earnings, adjusted, $ millions:  $88.4
Quality of Earnings Measurement and Persistence: Seems fairly
reliable but not necessarily persistent, the net income is largely
realized in cash.  A
possible concern is whether or not cash can be taken out of China. All
cash plus additional borrowings are being re-invested in tree and mill
assets. Recently there was a large expense for stock-based
compensation but this was much-reduced in Q3 2005. The recent amounts
seem arbitrary based on a chosen vesting period, it could have been
much higher, this reduces earnings quality. Income taxes are expensed
and shown as payable but are not paid and may not be legally due, this
increases earnings quality if the income tax will never be payable.
P/E ratio based on latest four quarters earnings, adjusted 5.9
Latest fiscal year annual earnings: $62.8
P/E ratio based on latest fiscal year earnings: 8.3
Fiscal earnings adjusted: $62.8
P/E ratio for fiscal earnings adjusted: 8.3
Latest four quarters profit as percent of sales 16.4%
Dividend Yield: 0.0%
Price / Sales Ratio 0.97
Price to (diluted) book value ratio:
Quality of Net Assets and Book Value Measurement: Apparently good
reliability, assets consist largely of standing trees. The assets are
tangible with very little goodwill, and sales of standing timber
appear to indicate that the standing tree assets are worth at least
50% more than book value. An independent report valued the trees at a
57% premium to book value. However, some investments in wood product
plants may be at risk of further write-offs.
Number of Diluted common shares in millions:
Shareholder:  Fidelity
(mutual funds) owned 10.3% at Mar 31, 2005. Management appears to own
less than 10% of the company.
Market Capitalization $ millions: $537.6
Percentage of assets supported by common equity: (remainder is
debt or other liabilities)
Interest-bearing debt as a percentage of common equity 77%
Current assets / current liabilities: 2.5
and capital structure: reasonable liquidity, with cash on hand.
Although debt has recently increased.
I understand the credit rating is BB minus. This is considered several
notches below investment grade. So it is indicative of higher risk.
Latest four quarters adjusted
(if applicable) net income return on ending equity:
Latest fiscal year adjusted
(if applicable) net income return on average equity:
Adjusted (if applicable) latest four quarters
return on market capitalization:
5 years compounded growth in sales/share 12.1%
Volatility of sales growth per share:  strong
growth with some volatility 
5 years compounded growth in earnings/share 7.3%
5 years compounded growth in adjusted earnings per share n.a.
Volatility of earnings growth:  strong
growth, but some volatility 
Projected current year earnings $millions: not
Projected price to earnings ratio: not
Over the last five years, has this been a truly excellent
company exhibiting strong and steady growth in revenues per share and
in earnings per share?
although volatile
Expected growth in EPS based on adjusted fiscal Return on equity
times percent of earnings retained:
More conservative estimate of compounded growth in earnings per
share over the forecast period:
More optimistic estimate of compounded growth in earnings per
share over the forecast period:
plans to continue its aggressive growth through investments in tree
plantations. In the past results have been volatile and this may
continue. Given recent and pending investments in tree plantations,
the near-term outlook seems quite positive. They may need to issue
additional shares to fund growth and that would dampen the share price
growth somewhat.
Estimated present value per share:
$5.80 if earnings per share grow for 5 years at 8% compounded
each year and the shares can be sold at a higher P/E of 8 after five
years. $9.05 if earnings per share grow at 15% each year and the share
can then be sold at a higher P/E of 10 after five years. Both
estimates use a required rate of return of 8%. This is not a share
price prediction. 
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry
rather than any particular company.)
Michael Porter of Harvard argues that an attractive industry is
one where firms are somewhat protected from competition.
Wood chips, trees and wood products are commodities which tend
to compete strictly on price (although the company indicates
competition is low). The industry is not subject to powerful suppliers
or customers who could usurp the industry profit. The industry has
substitute products (which is a negative). The industry tends to be
cyclical following construction cycles. The industry is subject to
protests from environmentalists. Overall, this is an unattractive
industry. However, the competitive environment for Sino-Forest may be
much better than for the industry generally.
COMPETITIVE ADVANTAGE: Compared to certain other regions of the
world, the trees grow remarkably fast in China. This company has the
long-term use of plantation lands in China. They appear to be a low
cost producer there appear to be barriers to entry due to (perhaps)
limited plantation land available and due to high capital investments
needed. However the more recent business is that of buying existing
plantations and it is less clear what competitive advantage they have
there although it may be their connections and relationships. The
company cites relationships and strategic locations near population as
well as expertise, and research and development.
RECENT EVENTS: Borrowed U.S. $300 million at 9.125% by issuing
bonds (rated BB) to replace existing International Finance Corporation
debt and for capital spending. 
I use diluted number of shares (calculated as earnings divided
by diluted EPS) and this is volatile due to impacts of convertible
debt (since retired). Earnings have been poured into tree plantations
and more recently into mills to process wood. Disclosure
in the past has been opaque. This is improved now but raises questions
as to why they waited so long to become better at disclosure.
SHARE STRUCTURE USED: Recently converted the multiple voting shares to
single voting shares. This was a very positive development.
QUALITY AND ETHICS: Management are of Chinese heritage, are major
shareholders and have a good track record. Previously
I was wary to trust this management given their past lack of
disclosure and high executive compensation. However, disclosure and
governance has now improved substantially.
The company has been
listed on the stock exchange for many years. To
some degree I am placing my confidence in the regulators and
accountants that everything is above board here.
am concerned that most profits now appear to come from buying land
with standing trees and then reselling the trees (not clear why this
would be profitable)
. Also most of the traditional wood chip
business seems to be outsourced. The
hoped for sale of the companies own planted fast-growing trees has
essentially not materialised even after 12 years. Talked about
revenues and profits on wood mills also seems not to have materialised.
This causes me concern about the management quality and
EXECUTIVE COMPENSATION: Recently management were rewarded with
stock-based compensation that of total value of over $10 million
although only $2.7 million was vested and expensed in Q2 2004. There
appears to be a danger here of excessive compensation. In Q3 2004 it
was reported that management was paid $12 million for rights to
acquire shares in a subsidiary of the company. $7.8 million will be
treated as compensation expense over a vesting period. This
seems rather strange and is worrying, however it may be a one-time
BOARD OF DIRECTORS: (2005 annual meeting
info) Six of the eight directors, including the CEO, are
significant shareholders. This tends to align their interests with
those of other shareholders. 5 of the directors are independent after
recently adding two independent directors to improve corporate
Basis and Limitations of Analysis: The following applies to all
the companies rated. Conclusions are based largely on achieved
earnings, balance sheet strength, earnings growth trend and industry
attractiveness. I undertake a relatively detailed
analysis of the published financial statements including growth
per share trends and my general view of the industry attractiveness
and the companies growth prospects. Despite this diligence my analysis
is subject to limitations including the following examples. I have not
met with management or discussed the long term earnings growth
prospects with management. I have not reviewed all press releases. I
typically have no special expertise or knowledge of the industry. 
DISCLAIMER: All stock ratings presented are “generic”
in nature and do not take into account the unique circumstances and
risk tolerance of any individual. The information presented is not a
recommendation for any individual to buy or sell any security. The
author is not a registered investment advisor and the information
presented is not to be considered investment advice. The reader should
consult a registered investment advisor or registered dealer prior to
making any investment decision. For ease of writing style the
newsletter and articles are written in the first person. But, legally
speaking, all information and opinions are provided by InvestorsFriend
Inc. and not by the author as an individual. InvestorsFriend Inc.
itself does not have a position in any of the indicated securities
while the author may have a position.
Copyright:  InvestorsFriend
Inc. 1999 – 2005  All
rights to format and content are reserved.


Our report from August 28, 2000. contained the following:

COMMON SHARE STRUCTURE USED: Poor structure. The shares that trade are subordinate voting common shares, there also exists 6 million multiple-voting common shares with five votes per share. The company founders could thus control the company even though outside investors might have more shares. In our opinion, subordinate voting shares are far less attractive than normal voting shares and are a strong negative indicator. Could prevent future take-overs or replacement of management if they become incompetent.
The company has paid significant amounts to service companies controlled by the founders. 

Our report from November 20, 2003 contained the following:

MANAGEMENT QUALITY AND ETHICS: Management are Chinese, are major shareholders and have a good track record. The company appears to have arranged its affairs so as to pay zero income taxes despite reporting profits. No income taxes appear to be payable in Canada.
One could perhaps question the ethics of this type of tax
. but maybe they are just being smart managers. Some insider trading was reported late and this is not a good sign.


By November 26, 2004 we added a sentence at the end:

MANAGEMENT QUALITY AND ETHICS: Management are Chinese, are major shareholders and have a good track record. The company appears to have arranged its affairs so as to pay zero income taxes despite reporting profits. No income taxes appear to be payable in Canada.
One could perhaps question the ethics of this type of tax avoidance…
but maybe they are just being smart managers. Some insider trading was reported late and this is not a good sign. Executive compensation seems high.
Overall I do not particularly trust this management.




When the November 13, 2005 report reproduced above was issued, we added some comments to our daily
blog provided to our customers. Also I show here some comments made prior to
November 2005. These are as follows, again with some
highlites that were not there in the original:

April 13, 2005


Sino Forest last rated Speculative Strong Buy at $3.50 has seen weakness
and traded down to $3.14 today. I note no insider selling or trading in 2005
(which I am glad to see). They recently announced a transaction to invest in
another Chinese forestry company. See press release http://ca.us.biz.yahoo.com/ccn/050407/2b489d0853d73




This may have been viewed as overly complex. Also
they recently changed auditors also they indicate this was not about
arguments over the accounting
. See pres release. http://ca.us.biz.yahoo.com/bw/050407/75352.html?.v=1
Overall these factors increase the risk, but certainly the value looks quite




November 13, 2005



Sino-Forest is updated and rated (highly) Speculative Buy at $3.45. Based
on the value ratios this would seem to be a very good buy that could easily
soon double. However, I have some
nagging concerns.
The company that has all its assets in China and it
must be difficult for auditors to confirm the existence of the stated amount
of trees.
Recently the earnings have been driven by the purchase and re-sale
of standing trees. It’s hard to understand why that would be a high margin
business. For quite a few years now I have expected to see the company start
to sell from its own planted tree plantations. In Q3 only a tiny 391
hectares were sold from plantations and these were at the low price of
$1,217 per hectare. Several years ago the company built a number of mills to
process wood, there were were start-up delays and then ultimately little
seems to be said about those mills.  It seems like management has
changed the business plan a few times. Overall, this may be a wonderful
investment but I am concerned about the risks
and I plan to reduce my
holdings from 4.2% of my portfolio down to probably less than 1%.



November 14, 2005



I sold 4/5ths of my Sino- Forest today. Again, the numbers would say buy
more, but there is something about
the long-time lack of clear disclosure and the changes in business plans
that makes me uncomfortable.
I also just made a note on the model
portfolio page that I will notionally sell half the position at tomorrow’s
opening price. I have sent an email to them and they have responded
partially and another person from Sino invited me to call to talk further,
so maybe I will change my mind but for now I am comfortable with a smaller
position in Sino-Forest.



Update – I have now spoken with the company by phone, perhaps I am
needlessly nervous. If everything is as they say it is these shares are a
definite Buy.  But the company
was unable to explain to my satisfaction why we do not see much higher
revenues from their own planted lands. I remain skeptical at this time.




14, 2005


As of yesterday, I was at a
definite new peak return for the year.  Gave some back today… Today I
sold the last of my Sino-Forest. See my previous comments on the company.
The numbers still look good on the stock. But
I was just no longer comfortable with the company  in terms of really
understanding what they and what the risks are.


In addition here is an email I sent to one our customers on November 13, 2005

Please don’t share this with others, such as
stockhouse board. But what if Sino
just possibly is some kind of fraud or is hiding something,?
them will not reveal it. I am just saying I am nervous here.
I have
been holding Sino since maybe 1999 and have generally been a big fan…


Page 5 of annual report says Eucalyptus trees mature in 5 years. Yet I
don’t see any indication they sold any of their planted trees in Q3, they
did say 391 hectares from plantation but was that planted trees or just the
older growth? I have been waiting 5 years to see expected big profits when
they started selling these planted trees. I mean I expected some way back
and where are they?
I have now emailed them.














I next mentioned Sino-Forest in my daily comments
to my paid subscribers on September 12, 2006 saying:


I noticed today a stock I used to cover, Sino-forest
is down to $3.70 from highs around $7. Based on earnings it would look quite
cheap. Also there has been some insider buying. So that seems tempting. But
as I said earlier about this company I was just not comfortable with it due
to past changes in strategy and seeming inconsistencies in their story.

Warren Buffett teaches us to not invest unless we are comfortable with
management. For whatever reason I am
just not comfortable.
Therefore I think it is best if I just stay
away from this stock. Maybe I will miss out on something here. But the fact
is that there are thousands of companies to choose from and I prefer to put
money into companies where I don’t have any nagging doubts about whether I
quite trust management. So, I think I will continue to ignore Sino-Forest.


I next mentioned Sino-Forest in the daily comments
on   May 21, 2009 saying:


I notice Sino-Forest is issuing shares at $11.00. I no longer follow it.
It often seemed to be reporting strong profits but I
was uncomfortable with changes in its business plan.
(First the
profit was supposed to be in planted trees that would grow in seven years or
even five, last I checked that profit never materialized but they started
making a lot of money by selling trees on the stump that they had bought but
not grown themselves – curious why there would be big profit in that. At one
time they were supposed to have a bunch of mills to make lumber and that
never worked out. At one time their reports implied that they had mills to
chip wood, later it seemed to be revealed that the chip mills were not
owned, they paid to have logs chipped. For
a variety of such reasons I simply felt I personally was not willing to
trust them. On the other hand they had an S&P debt rating and so one
would think they could be trusted.


I would make the point that they are supposed to be a high profit company
yet they have never paid a dividend and now they need cash. Sure they are
growing but when will cash stream out of the company?


I did not again mention Sino-Forest until this Spring of 2011 when the
allegations of fraud finally arose.



Above I document that I had certain suspicions
in late 2005, even speculating that it might possibly be a fraud
but I had certainly
not concluded it was a fraud. In fact I said it looked like a Buy although a
highly speculative one. As far back as 2004 I indicated I did not
particularly trust this management.

Hit Counter

It appears I did not mention in my notes that Sino had changed
auditors in April 2005 From Ernst and Young and then back to Ernst and Young
in August 2007. I was aware of this both times, I recollect.

both cases the following (probably standard wording) was used:

there have been no reservations contained in the auditors’
reports on the annual financial

of the Corporation for the two most recently completed fiscal years
preceding the date of this notice nor for any period subsequent to the most

recently completed period for which
an audit report was issued


seems odd to me that they don’t just say there were no reservations for the
subsequent period, why use the proviso “for which an audit report was
issued”. The wording seemed a little cute to me at the time but perhaps
it is just the standard wording.