SmartHeat: Immediate Beneficiary of China's Stimulus Plan

| About: SmartHeat, Inc. (HEAT)

SmartHeat Inc. (NASDAQ:HEAT) is a market leader in China’s Clean Technology Energy Savings industry. HEAT manufactures standard heat exchangers, custom plate heat exchanger units and heat meters. Through the implementation of its energy‐saving technology, HEAT’s products dramatically improve energy efficiency by 20‐36%. Most importantly, HEAT’s products reduce coal consumption and CO2 emissions by 63% when used in district heating networks connected to co‐generation power plants. With less fuel needed to produce the same amount of heat, SmartHeat’s solutions save energy and dramatically reduce pollution – two important environmental issues for China right now.

The energy‐efficient benefits of SmartHeat products can be seen clearly in the chart below:

Click to enlargeSource: smartheatinc.com

In the short term, SmartHeat is poised to be a major beneficiary of China’s favorable environmental policies. The Chinese government has allocated significant resources within its national economic stimulus plan to increase spending on environmental protection‐related products and technology. As part of the $585 billion stimulus package, $31 billion has been allocated to energy‐savings projects and $59 billion is to be spent on affordable housing projects. These projects are slated to be completed by the end of 2010, allowing HEAT to scale its business dramatically over the next two years.

HEAT’s customer base is also quite impressive. The company has over 300 customers, including global Fortune 500 companies, various Chinese municipalities and industrial/residential users. Earlier this year, SmartHeat entered into a joint venture with Fluor Corporation (NYSE:FLR) and also passed a rigorous product quality assessment by Siemens (SI). Both of these relationships should contribute nicely to HEAT’s sales in this current fiscal year. Additionally, the Chinese government has selected HEAT to be one of two companies in charge of drafting China’s national standards for the heat transfer industry, giving the company brand recognition and an important government seal of approval.

For all of the aforementioned reasons, I believe that HEAT is at a major inflection point in its business, one that should translate into increased sales and earnings momentum in 2009‐2010. In Q109, HEAT reported record revenues of $6.21 million, an increase of 102% from the first quarter of 2008. Net income of $1.02 million increased 117% year‐over‐year. While these numbers were impressive, the company’s incoming orders were even more explosive, with HEAT receiving 5x as many customer orders in Q109 as they did in Q108.

SmartHeat’s revenues are expected to more than double in 2009 to $79 million, up from $32 million in 2008. Earnings are also expected to grow strongly to $15 million this year, up from $6.3 million in FY08. Furthermore, 70% of its sales are closed between June and December, setting up the company for two big quarters in 2H09. Analyst Rodman & Renshaw is looking for Q309 revenues to almost double to $41.4 million year‐over‐year. In Q4, estimates get even better. Rodman sees revenues growing almost 500% to $20 million and earnings ramping up near 400%.

In a market starved for growth stocks, I expect investors to quickly warm up to HEAT’s market opportunities in the second half of this year. For this reason, I have begun buying into a position now. I bought an initial probe this past Friday and plan on adding to my stake on any pullback in the coming weeks. A look at HEAT’s 1‐year weekly chart shows a limited trading history, but one with increased accumulation in the past four weeks:

1 year weekly chart HEAT

Click to enlargeSource: Stockcharts.com

SmartHeat was listed on the NASDAQ in March of this year after languishing on the bulletin board during 2008. Expect institutions to begin working into the stock once the company is able to demonstrate it can deliver on the analysts' expectations. With only one firm following the name right now, expect new analyst coverage to emerge later this year as word on this exciting China‐play spreads. Increased coverage will act as another catalyst to bring new money into HEAT down the road.

HEAT is a longer‐term oriented play for the accounts I oversee. Be advised, however, HEAT is a thinly‐traded stock, so use Limit Orders on the buy side and work into the position slowly.

Disclosure: I am long HEAT in the accounts I oversee.