The Long Case for Gushan Environmental Energy

Gushan Environmental Energy Limited (GU) is a Chinese company that produces biodiesel and by-products of biodiesel.

Here is some fundamental information relevant to a potential decision. Current capacity of 290,000 tons is expected to increase to 400,000 tons in Q408 through the construction of two additional production facilities and a ramp up in production capacity at a pre-existing facility. In addition, GU has expectations of adding an additional 200,000 tons of capacity throughout 2009. Using what I expect to be an extremely conservative estimate for the price per ton of biodiesel ($435pt or ~50% of Q208 price), I derive FY09 revenue of $172mm with operating income of $57mm.

GU is currently trading at less than 6x forward estimated operating income. In addition their debt coverage is exceptional and their margins are strong. I suspect that  with China's pollution issues, we should see more of a transition to biofuels such as GU produces.

For Q208 revenues increased 52% YOY and 20% QOQ to $58.3mm while gross profit increased 43.8% YOY and 18.5% QOQ to $24.1mm. Income from operations increased 29.4% YOY and 8.3% QOQ to $19.3mm. On a volume level, both the price and volume of biodiesel being sold rose. Biodiesel sales volume rose 21.8% YOY and 15.8% QOQ to 59,921 tons while the average selling price increased by 33.5% YOY and 7.6% QOQ to $865/ton.

As of the latest filing, GU enjoys a cash ratio of 7.6 with operating margin of 33.2%, which is lower than EOY 2007. Expect this firm to thrive as they increase capacity and China resumes its growth out of the current economic doldrums.

Disclosure: Author has a long position in GU

Comments

[omanmike:]

A good article because it sticks to facts and gives useful information to investors.

2008 Oct 19 06:23 PM

[klemenv:]

I thought that above $12, Gusham is a little pricey. Well, at current levels it is a steal. Good article.

2008 Oct 20 02:30 AM

[Cat's eye:]

The analysis is good, but the buying advice is destructive when it's based on fraudulent information - the information released by Gu is all the most outrageous lies! People in China in the biodiesel industry all know about Gu's lies, but the Western public doesn't know. Don't believe in the big names, such as KPMG, etc. Think about it, why would used cooking oil dealers sell used cooking oil to Gu at half of the market price?? When something is too good to be true, it's usually not true. The fact is Gu has been paying RMB4,200+ per ton when they reported it as RMB2,000+ per ton. It's been disclosed in a recent news report. Too bad the Western public can't read Chinese. So they continue to put their hard-earned money into a blackhole.

2008 Oct 22 11:18 PM

[SchraderTrader:]

Cat's eye

Do you have a link to the article? If you're accurate with what you say then I need to mention that.

2008 Oct 23 08:15 AM

[Cat's eye:]

The link to this article is:

finance.sina.com.cn/g/...

It's in Chinese. You would need it to be translated.

2008 Oct 24 02:38 AM

[Davis:]

Schrader Trader,

Wanted to know if you checked into the GU article mentioned by Cat. I followed the link, then Googled "translate webpage", copied the web address into the translator and the article was translated.

I did this process twice through a Yahoo and a Google translate page. The article reads differently with each one, which is interesting, but the jist of it is the same.

The article is a little hard to read, as the translation is not prefect, but it appears to suggest that the financials reported in GU's financial report are not correct and a front to gain more business. It also indicates that it is impossible for GU to purchase oil for 2390 yuan per ton, as the going rate is 5000 per ton.

Here is the link to the article. finance.sina.com.cn/g/...

I would be interested to know what you think about this. There are a few reliable stock websites that indicate GU is not only a buy, but set to spike, ie. Zacks.com, TheStreet.com and MotleyFool.com. Could it be that GU is not all that it appears to be and the news has not been entirely uncovered yet?

I am hoping not, as it seems like such a great valuation and opportunity!

Davis

2008 Oct 30 04:01 PM

[SchraderTrader:]

Sorry so late on this - didn't know you commented.

I attempted a translation as well and derived the same conclusion... what strikes me as odd (and the reason I initially was bullish on this stock) was how a firm with such great fundamental strength could be trading at such a discount.... then I remembered the saying 'if it sounds too good to be true it probably is'.

In this environment with the global discounts on virtually every company there are plenty of other places to put one's money. Even hearing the possibility of accounting fraud makes this a stock I no longer would spend time in. Too many opportunities out there to take on the potential risk. Just my opinion for what it's worth.



On Oct 30 04:01 PM Davis wrote:

> Schrader Trader,
>
> Wanted to know if you checked into the GU article mentioned by Cat.
> I followed the link, then Googled "translate webpage", copied the
> web address into the translator and the article was translated.

>
>
> I did this process twice through a Yahoo and a Google translate page.
> The article reads differently with each one, which is interesting,
> but the jist of it is the same.
>
> The article is a little hard to read, as the translation is not prefect,
> but it appears to suggest that the financials reported in GU's financial
> report are not correct and a front to gain more business. It also
> indicates that it is impossible for GU to purchase oil for 2390 yuan
> per ton, as the going rate is 5000 per ton.
>
> Here is the link to the article. finance.sina.com.cn/g/...

>
>
> I would be interested to know what you think about this. There are
> a few reliable stock websites that indicate GU is not only a buy,
> but set to spike, ie. Zacks.com, TheStreet.com and MotleyFool.com.
> Could it be that GU is not all that it appears to be and the news
> has not been entirely uncovered yet?
>
> I am hoping not, as it seems like such a great valuation and opportunity!

>
>
> Davis

2008 Nov 03 11:47 AM

[SchraderTrader:]

In this environment with so many assets being discounted so deeply I personally would not want to take on the potential risk of a firm where there's been even a "hinting" at potential fraud such as in the article above. Too many good deals out there. I won't speak for the other firm's ratings.

2008 Nov 03 11:49 AM

[Cat's eye:]

David,

I had this article translated for me. This article is written by a news reporter who went to Gushan's refineries in Fujian and Sichuan provinces. The first thing he discovered was that Gushan hired trucks to come in and out of their factory to put on a show of busy receiving and delivering (in Fujian, he saw 1 truck came into the factory, went on the weigh bridge, which read 2+ tons only, drove around the factory, went out of the factory, stopped at a PetroChina gas station, waited for 15 minutes, and then drove back to the factory for another round. The reporter noticed 3 trucks were doing the show and he recorded their plate numbers. He then found the same thing in Sichuan and the people in the neighborhood said Gushan had been doing this since last year, 4 trips/truck per day and 2 trips/day in raining days). Then he interviewed Gushan's staff and they said that their feedstock purchasing price to their branches was RMB4,200/ton and whatever the Branch managers could source for below that price was their profit, as an incentive). Gushan's factories have severe pollution and local residents were filing complaints to local gov requesting to close the factory down. etc. etc.


On Oct 30 04:01 PM Davis wrote:

> Schrader Trader,
>
> Wanted to know if you checked into the GU article mentioned by Cat.
> I followed the link, then Googled "translate webpage", copied the
> web address into the translator and the article was translated.
>
>
> I did this process twice through a Yahoo and a Google translate page.
> The article reads differently with each one, which is interesting,
> but the jist of it is the same.
>
> The article is a little hard to read, as the translation is not prefect,
> but it appears to suggest that the financials reported in GU's financial
> report are not correct and a front to gain more business. It also
> indicates that it is impossible for GU to purchase oil for 2390 yuan
> per ton, as the going rate is 5000 per ton.
>
> Here is the link to the article. finance.sina.com.cn/g/...
>
>
> I would be interested to know what you think about this. There are
> a few reliable stock websites that indicate GU is not only a buy,
> but set to spike, ie. Zacks.com, TheStreet.com and MotleyFool.com.
> Could it be that GU is not all that it appears to be and the news
> has not been entirely uncovered yet?
>
> I am hoping not, as it seems like such a great valuation and opportunity!
>
>
> Davis

2008 Nov 04 06:28 AM

[igggy:]

That's some interesting article on that chinese site. I do wonder however, what's the point of putting up a show when it's so easy to see that it's just a show. Also, if you check GU's earnings history on Yahoo, it's not that great. When I was first thinking about buying their stock I convinced myself that if they were badly cooking their books, they would be beating estimates every quarter. So I am down 60% on my small stake in GU, but I will hold it at least until the next quarterly earnings.

2008 Nov 08 02:28 AM

[Chillvesting:]

As long as the $2.13 per share in cash reserves and zero debt aren't fraudulent claims, I'm still bullish. If this was trading on the hang seng I would be more nervous, but I have faith in the ADR's and the SEC.

2008 Nov 30 02:56 AM

[pdyount:]

Agree with Chillvesting -

Looking at today's valuation - a lot of this potential fraud seems to be built into the price.

If they have anywhere near the current assets they claim - and if oil bumps up a bit and/or China keeps growing at all - its worth a small risk IMO.

China should come out of this downturn in a better position than many countries.

Any reverse in the global economy could send energy up significantly.

Feedstock for their 'product' isn't going away (Chinese have to eat) - and demand for the product should increase long term.

Only downside seems to be fraud on a VERY massive scale.

I'll take a shot with a small amount of $$$.

Should be fun to watch how this plays out...

Feb 12 01:26 PM

[dermonti:]

Will the author please comment on the fraud alleged on this message board? These are serious allegations that a journalist who issues a public recommendation probably should respond to.

Feb 18 03:17 PM

[David Schrader:]

I apologize for not commenting earlier.... I did not allege any fraud.... others did. I simply stated that if there's even a hint or potential allegation of fraud in the current market environment it's not worth the risk, in my opinion, to become a shareholder in that name. There are too many great deals out there. Again, I apologize as it's been quite a while since I've been on SA.

Apr 07 03:02 PM

[BrentSchn:]

Why would they double production capacity, and how could they pay for it, if they were cooking the books?

Apr 15 07:26 PM

[Chillvesting:]

Who is to say, I don't even have much faith in the ADR's or the SEC anymore. But we kind of have to, or financial markets will be even more broken than in previous history, and less fun! The cash reserves thing made a lot of sense to me, but then came a dividend cut, I believe. I took some nice profits from dubious traders who couldn't stay awake long enough to realize what 2.13 in cash means, regardless of what china says or does. Then I high tailed it out when I saw too much trading.

"Dumb money ceases to dumb when it realizes its limitations. But big money aint always faster than small money..."

-J. Gramer to a good friend of mine

"Tenure is a powerful weapon against reason"

-J. Cramer (the one and only.)

Apr 20 06:21 PM