China Sky Chemical Fibre - Disproportional receivables, a point of concern?

First glance

A friend came upon a buy call on China Sky by CIMB in TODAYonline and ask me to take a look. The target price is SGD $2.25, a three-fold increase from today's close price of 74 cents. Thus, there's enough margin safety? Another undervalue counter, a product of current market tumoil?

Closer look

The bad- disproportional receivables

Comparing 2Q 2008 and 2Q 2007, revenue rose 11.5% from RMB 569.4m to 634.8m. Comparing 2Q 2008 with last quarter, 1Q 2008, revenue rose a meagre 4%. However, receivables (uncollected cash from sales) shot up 69% (YOY) year-on-year from 231.2m to 390.7m. Comparing with last quarter, receivables was also up 68% from 232.7m.

A closer look at the cash flow statement shows that from the reported earnings (accounting earnings), receivables was up 157.9m from 23.3m last year. This made up 71% of reported earnings and are all clocked in 2Q 2008 alone. i.e. For each dollar of reported earnings, 70 cents are not collected ... yet.

The quarter announcement offer a few clues (quoted directly):

...
The volatility in oil prices will have a ripple effect on our raw material prices. The PRC government’s counter inflationary measures and the general tightening of credit in the PRC will have an impact on our customers. Their capacities to react to these measures could affect the extent of our ability to pass on dramatic increases in our raw materials costs to them and our need to extend longer credit periods to them.
...

The (significantly) longer credit periods could account for the 677.7% increase in receivables compared to the 11.5% increase in sales. Thus there could be a great risk for bad debt.

The good- gross margin maintained

Across the pass few quarters, gross margin had maintained at around 34%. This meant that China Sky is able to pass on the rising raw material price to consumers. However, as noted above, their profitability in the near future depends on whether they can continue to sustain their gross margin.

Share options expenses contributes significantly to administrative expenses up to 4Q 2007. Going forward, bearing any substantial slow down in sales, net profit should enjoy a double digit growth if and only if the current gross margin can be maintained.

However, management already warned of a possible bad quarter in 3Q 2008 due to the closure of certain industries in China for the duration of the Olympics, hurting demand in the process. If 3Q 2008 is the only bad quarter ahead as predicted, there should be no adverse effect on general prospects of the company in the long run.

Conclusion

I could not find the actual report on issued by CIMB on China Sky and hence have no idea how they arrived at $2.25. I have also not done a thorough, detail analysis on China Sky to arrive at any valuation but using rough estimation on the information at hand, $2.25 seems high.