Is now the time to buy Clover Corporation?

This company may help you profit from China’s growing middle class.

Clover Corporation (ASX: CLV) owns technology that turns fish oil into a powder. Fish oil is a well-known source of omega-3, which plays a crucial role in brain function. It is normally contained in breast milk. Therefore, omega-3 is included in baby formula, and that’s where Clover comes in.

In FY 2013, Clover continued to expand sales of encapsulated fish oil into the Oceania region, which now makes up 67% of revenue. One driver of this growth is the Chinese middle class, who are increasingly interested in buying infant formula to feed their babies. The Chinese are keen to buy formula manufactured in the developed world, including in Australia.

In 2004, 13 Chinese babies died from malnutrition and 200 were hospitalized because they were fed infant milk formula with little or no nutritional value. In 2008, at least six children died and 54 were hospitalized because 22 companies, including the state-owned Mengniu Dairy Group, were selling baby formula that contained melamine (a highly toxic substance added to conceal the fact that the milk was of low nutritional value).

Clover’s share price is down because another company, Fonterra (ASX: FSF), had a contamination scare. Fonterra supplies one Clover’s major customers with milk powder, and sales will be impacted by the product recall. As it turns out, the contamination scare was a false alarm. Fonterra was careful to make sure no one would be harmed by a potential contamination. I believe that the Chinese will continue to buy imported infant formula.

Clover is also attempting to expand its product offering. It is in the process of clinical trials to assess the utility of a new delivery system of nutritional supplements to preterm infants. It also provided products for evaluation to potential clients in 2011, and hopes to achieve initial sales in FY2014.

R&D spending is likely to be higher in FY2014, and the company faces ongoing margin pressures. Sales will need to continue to grow over the next few years to maintain profits. However, management have been instrumental in drawing attention to this risk, and have kept operating costs in check. Gross margins remain well above 30%.

CEO Dr Ian Brown has announced that he will retire in FY2014, and the company is searching for a replacement. Major shareholder Washington H Soul Pattinson (ASX: SOL) does have two seats on the board and is a major shareholder. However, the board has treated its minority shareholders well.

Clover Corporation lost money in a failed joint venture that it wound up in 2012. Nonetheless, the company has achieved a ROE of above 15% for the last three years. There is no debt on the balance sheet, the company has over $7 million in cash and pays a dividend of about 3.8%, fully franked.

Foolish takeaway

At 52 cents per share, Clover is trading at a reasonable price. The business has good economics and honest and competent management. In the long term, shareholders are likely to see capital gains as well as a regular dividend. However, Clover faces challenges in the short term, and investors may yet have another opportunity to buy shares under 50 cents.

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Motley Fool contributor Claude Walker does not own shares in any of the companies mentioned in this article. Find him on Twitter @claudedwalker.

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