Sinoenergy: Two Parts Elation, One Part Fear

Right now, with the market crashing and burning, I feel two things on a daily basis: fear and elation. Fear at the idea that maybe this isn’t the bottom, maybe there is more blood to come, and maybe in a couple of months I will be on a street corner begging for change. Elation at the thought of all of the stocks out there that are trading at dirt cheap valuations that we can be loading up on, in the hopes that in three years we look like heroes.

The only problem is that when you combine elation with the fear that there is more blood to come, we transform into irrational lunatics (or maybe I should just speak for myself) on a daily basis. Anyways, at this point if you had a gun to my head (which I feel like there already is) and asked me to make one pick that I am certain is a winner, I would no doubt say Sinoenergy (SNEN).

This Chinese natural gas play, after having trouble getting kickstarted in 2007 and early in 2008, is now thrusting ahead with rampant growth. It is only flying way under the radar because most people are either knee deep in it all right now or are waiting on the side for the storm to pass. If you follow China and the move towards natural gas there, you have most likely come across SNEN and CHNG (CHNG.OB). Both an article on Seeking Alpha and Cramer have recently given the go ahead on CHNG, but SNEN has not even started to get the praise it deserves, especially when this company is going balls to the wall in China.

Even with the obvious growth of SNEN, China and the Chinese natural gas industry, this stock has gone from a 52 week high of $10.50 to a low of $2.02 during the chaos of the last month and closed yesterday at $2.51, a price which I feel is a raging strong buy.

There are several things to consider here:

1. Competition? - While it may seem that CHNG and SNEN are competitors because they are both growing natural gas players in China, they operate in different regions of China and the growth of one does not overlap with the growth of the other. From my perspective, they are both good investments, but SNEN is significantly more undervalued than CHNG at this point and it is listed on Nasdaq, while CHNG is still OTC.

2. Location - In terms of geographical location, SNEN has been opening the majority of its new stations in Wuhan.

Wuhan is the largest city in Central China with over 9 million population. Because of rising gasoline prices, Wuhan's demand for alternative energy is quickly growing. The use of CNG is particularly well suited to the local public transportation system, which consists of more than 6,000 public buses and 20,000 taxis. According to Wuhan city development plan, all of the mobile vehicles in city's public transportation system will be converted to be fueled with CNG by the end of 2010, reflecting a daily CNG demand of about 1,200,000 cubic meters, or the daily CNG filling capacity of 120 standard CNG filling stations. Till the end of July 2008, there were merely about 25 standard CNG filling stations in Wuhan, indicating huge potential for its CNG market development.

3. Guidance - The Company affirmed its previously announced guidance for fiscal years 2008 and 2009. For its fiscal year 2008 ending September 30, 2008, Sinoenergy expects its diluted earnings per share to be from $0.60 to $0.65. For its fiscal year 2009 ending September 30, 2009, Sinoenergy expects its diluted earning per share to be from $0.90 to $1.00. Using the high end of these estimates, the compound annual growth rate (CAGR) of its diluted earnings per share for fiscal years 2007 to 2009 is about 79.6%.

Based on the 2009 guidance, as of the closing price on Wednesday ($2.51), the company is trading with a forward P/E under 3 and a PEG ratio of .056 (4.45/79.6).

For Q3 2008, Sinoenergy's net income surged 106.4% to US$4.01 million from US$1.94 million in the prior year quarter.

4. Government mandate towards cleaner fuels - On October 7 Beijing raised the retail price of gasoline and diesel today to offset the higher cost of providing the capital city with cleaner fuels - Chinese government is mandating that at least 25% of vehicles in China be CNG powered. - With the projected population and economic growth in China for years to come, along with the shifting trend from rural to urban areas, SNEN is well positioned to take advantage of increased demands for natural gas.

We have all seen the pictures of the polluted Chinese air and rivers, and have read about the international pressure on China to make a transition towards cleaner forms of energy, only now it seems like the government is being proactive in cleaning up its country.

According to a Fuel Tax Regulation proposed by the Chinese government, natural gas vehicles are expected to be treated under a half-tax bracket compared to vehicles powered by gasoline or diesel.

5) SNEN’s diversification within their natural gas business - Unlike CHNG, which has the vast majority of its revenue from stations, SNEN has several main revenue streams. The company is engaged in the manufacturing of pressure containers and compressed natural gas (CNG) facilities and equipment. The CNG vehicle and gas station construction business consists of two divisions: the manufacture of CNG vehicle and gas station equipment, and the design of construction plans for CNG stations, the construction of the CNG stations, and the installation of CNG station equipment and related systems at the CNG station.

Because of the manufacturing component of SNEN, and the shift towards natural gas in China, the company experiences revenue growth from other expanding natural gas players demanding natural gas equipment in addition to the increasing demand that SNEN caters to by operating natural gas stations of its own.

Stations: Since the beginning of 2008 they have went from having 3 operating stations to 16 today (most of these opened in the last 4 months) and they plan to have 28 operating by the end of the year (20 in Wuhan and 8 in other provinces). SNEN also has plans to have 70 operational stations by the end of 2010. New stations operate at 70% capacity for the first several months of operation, meaning that there will be significant revenue growth in 2009 from the stations already opened in 2008 in addition to new stations being constructed and planned at this time. (While this does mean moving forward the majority of the revenue will be from the stations, it is important to note the revenue SNEN receives from its manufacturing business.)

6. Recent developments -

July 28th 2008: Listing on Nasdaq.

October: Opens two new stations and affirms guidance.

SNEN conducted a non-deal road show that took place from October 10, 2008 to October 16, 2008. SNEN visited fund managers and securities analysts in Los Angeles, Chicago, Milwaukee, Boston, New York and several other Mid-Atlantic cities.

Ringing the closing bell on the Nasdaq on October 17th to celebrate the company’s listing.

Analyst coverage is light at this point, but on August 6th Westminster Securities updated coverage with a “Strong Buy” and a price target of $9.12 (I believe they increased it to $10.50).

In August, Sinoenergy Corporation signed a share exchange agreement with China New Energy Development Investment Co., Ltd (China New Energy) to exchange part of the ownership between the two party's jointly established companies, Hubei Gather Energy Co., Ltd (Hubei Gather) located in Wuhan City and Anhui Gather Energy Co., Ltd (Anhui Gather) located in Wuhu City. Both Hubei Gather and Anhui Gather are joint venture companies between Sinoenergy and China New Energy that engage in the construction and operation of CNG mother stations.

In July, SNEN announced that its majority owned subsidiary, Qingdao Sinogas General Machinery Company Limited ("Sinogas"),has received two significant orders from two domestic natural gas transportation companies for a total of 80 CNG transport trailers. Sinoenergy will manufacture 30 CNG trailers for Wuhan Green Energy Transport Co., Ltd. and 50 CNG trailers for Xuancheng Anjie Natural Gas Transport Co., Ltd. Both orders are scheduled to be completed before the end of calendar year 2008.

7. Risks - The only main issue I see moving forward is for SNEN to have trouble getting the local government approval to open more stations, but it seems the governmental issues are what slowed them down throughout 2007 and now with government mandates towards cleaner fuels and the recent cooperation between SNEN and local governments, there shouldn’t be any significant problems moving forward. But this is China and there is always a political risk.

Also, the average daily volume of the stock is still only 60,000 so the intraday movements are erratic, so use caution in establishing a position, but at anything under $3 (or even $5) is money under the mattress.

The last risk I see is the possibility of an earthquake or Mother Nature related ailment that does significant damage to Wuhan (with the way 2008 has unraveled, nothing is out of the question).

I originally built up my position when SNEN was still trading OTC before its listing on Nasdaq. I watched it go up to 7 after being listed and crash down to 5 before I sold it out of fear. I turned my eye for a couple of days and lo and behold it burned straight under 3 and spiraled towards 2.

When I saw it trading at 2.20 that was where the elation kicked back in. In order to find the gems, you have to be willing and able to clear all the blood out of your vision so you can see clearly again. As my former colleague once said, “the second you lose that fear and no longer obsessively look over your own shoulder is the moment they bury the dagger deep in your back.”

So, when Sinoenergy management is up there ringing that bell Friday afternoon, I will be watching with elation, awe (and fear), and I will be on my knees thanking them for giving me the only gift I will be getting this holiday season

Disclosure: Author holds a long position in SNEN

Comments

[YY:]

Thanks! Very insightful analysis.

2008 Oct 17 10:57 AM

[Mochi:]

CNG stations need CNG-powered vehicles. Wuhan may have 6000 public buses and 20,000 taxis that are potentials for conversion to CNG, but what is the conversion potential for private passenger cars and the cost of conversion.

2008 Oct 18 08:58 AM