Farmmi (NASDAQ:FAMI), a Chinese agricultural products company, might look like a bargain stock at its current price around 33 cents. In February, the stock was trading near $1.90, so many investors are wondering if FAMI stock is now cheap.
The answer is that it’s sometimes difficult to determine what qualifies as a cheap stock. At $10, $5 or $1, is a stock automatically cheap? No, as it depends on the fundamentals and the valuation. It is a naive trap to consider penny stocks cheap based only on their stock price.
There’s more to FAMI stock beyond its price that makes even its current 30-cent level not cheap. The main catalyst affecting it is stock dilution, but other factors are impacting its price as well. Contrarians should be wary of Farmmi.
FAMI Stock Was Diluted Twice in 2021
In its 2020 annual report, Farmmi reported that it had 16.2 million shares outstanding. In 2021, the company announced two public offerings. The first one in May brought in gross proceeds of about $48.3 million. In a press release detailing the event, Farmmi stated:
“The Offering included 140 million of the Company’s ordinary shares, and 21 million additional shares from the exercise of the underwriter’s option to purchase such shares to cover over-allotments at the public offering price of $0.30 per share. The Company intends to use the net proceeds from this offering for working capital and general corporate purposes.”
On May 3, the stock closed at 53 cents and by May 10, a selloff sent FAMI stock to a closing price of 37 cents. Notably, the offering price was 44% less than the closing stock price on the date of the announcement.
In September, Farmmi announced another public offering — a larger one with gross proceeds of about $81 million. The offering included 368.3 million of its ordinary shares as well as pre-funded warrants to purchase ordinary shares. Farmmi provided more information in its press release:
“The ordinary shares were offered at a price of $0.22 per share. The pre-funded warrants were offered at the same price per share as the ordinary shares, less the $0.0001 per share exercise price of each pre-funded warrant. The Company intends to use the net proceeds from this Offering for general corporate and working capital needs and capital expenditures.”
What Farmmi’s Stock Offerings Mean
There are some points regarding these events that require further analysis. Most importantly, in the second public offering, the closing price of FAMI stock was 25 cents, meaning the shares were offered at a discount again. The second discount was 12% less than the stock price at the time.
These public offerings have provided Farmmi with plenty of cash to support its business operations. However, they have also severely harmed the intrinsic value of FAMI stock.
Investors who exercised warrants that were in the money came away winners. But why did Farmmi decided to offer shares at a discount?
The choice was both a marketing choice and a business decision. Offering shares at a discount could attract more potential investors, and the price was probably justified by the fundamentals.
Farmmi’s 2020 20-F form shows almost no revenue growth since 2018. The company saw revenue of $30.2 million in 2020, which was a decline from revenue of $30.8 million in 2019. Net income reported in 2020 was $813,455 with earnings per share of 5 cents. This was all before the latest stock dilution.
An Expansion Plan Comes With Three Risks
So far, it looks like Farmmi plans to use the extra cash for acquisitions. In a press release, it announced plans to expand its market by purchasing Jiangxi Xiangbo Agriculture and Forestry Development. Farmmi also plans to grow its health and wellness business.
When you have raised plenty of cash via two public offerings, you can focus on these business plans — even at the expense of the shareholders.
However, there are a few risks that FAMI stock will need to overcome first.
First and foremost, FAMI stock got the attention of social media and has become a meme stock. Beware of the accompanying volatility in the stock price, especially if buyers engage in pump and dump schemes.
Second, Farmmi is a Chinese company. That means its price can move based on any future tensions or political decisions between the U.S. and China.
The third factor may go unnoticed, but it should be noted that there is a foreign exchange risk as Farmmi converts its operations to U.S. Dollars. If the Chinese Yuan is devalued, the reported numbers in U.S. Dollars will be lower. The opposite is true in a revaluation.
What to Monitor in FAMI Stock
The two public offerings in FAMI stock saw its book value per share fall dramatically. This is an important measure of valuation. Farmmi can increase its book value per share either by using profits to buy assets or using earnings to reduce liabilities. Share buybacks are not an option for the company now. Investors should monitor whether this is achieved in the next few quarters.
The bottom line for FAMI stock is that with anemic annual revenue growth and a major stock dilution, the stock is not cheap. The tradeoff between raising cash for business expansion and hurting the intrinsic value of the stock is evident.
When it comes to the dilution, FAMI stock investors have begun to realize there is no such thing as a free lunch. For now, the management has simply hurt the share price, valuation and company too much, too fast.
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On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.