Capitalizing on China's Stimulus Plan, Part I

 |  Includes: CSGJ, GSI, RINO, TOR
by: The GeoTeam

On July 16, 2009 China released figures stating that GDP growth for the 2009 second quarter came in at 7.9%, easily surpassing expectations and giving some indication that the government's quick and aggressive response to the global recession is taking hold. However, it remains to be seen whether or not China's stimulus affect will remain intact. As more information on the efforts to revive the economy becomes available, we will continue to gain insight on the appropriation of the funds.

The GDP report stated that steel, cement and retail companies are seeing positive benefits from the stimulus plan. For this reason, the GeoTeam has perused through its database of U.S. listed China stocks to compile a list of small and microcap stocks involved with these industries. We also included stocks involved with the construction, real estate, housing and auto sectors.

Please note that investors should perform their own due diligence as we have not yet analyzed all of the companies highlighted in this article.

We downloaded price and fundamental data using the in-house data feeds that present earnings per share data in a GAAP format. In the final analysis, non-GAAP calculations and a diagnosis of filings should also be performed to better understand the finer details of company operations. Also, be aware many of these firms are illiquid penny stocks that may require significant capital.

In the coming days we will break down this list with emphasis on the following:

  1. Calculations of fully taxed GAAP or, if applicable, non-GAAP earnings per share figures. Adjusted Non-GAAP EPS figures exclude certain non-operating gains and losses as well as certain non-cash items.
  2. Commentary from the companies regarding business outlook.
  3. Financing needs that may lead to dilution.
  4. Healthy cash balances, positive cash flows and debt to equity ratios of less than 20%.
  5. Exposure to exports. The preference is to find companies with limited exposure outside China where the effects of the global recession are much more prevalent.
  6. Analyst estimates, when available.
  7. Investor relation efforts.
  8. Investment potential.

The GeoTeam's Focus

We initially took a look at stocks in the steel and cement industry: RINO International Corp (OTC:RINO), Sutor Technology Group (SUTR), China Runji Cement International (CRJI.OB), China Shaungji Cement (OTC:CSGJ), General Steel Holdings Inc. (NYSE:GSI).

We calculated fully taxed earnings per share figures. As you can see for some firms like RINO and CSGJ, non-GAAP adjustments are vital in the valuation process.

With respect to GAAP EPS, RINO understated its earnings and in the case of CSGJ, one-time gains resulted in grossly overstated earnings. For CRJI, after deducting large amounts of government subsidy income, the non-GAAP calculation wiped out virtually all of the Company's profit.

RINO and CSGJ had the most bullish commentary implying that growth should occur in subsequent quarters.

RINO Commentary

We are very confident that we will continue to provide incremental and robust top-line and bottom line growth for our Company. We foresee positive business sales in the fiscal second quarter and beyond due to a Chinese government decision to shut down a collection of small cement plants by the end of 2010 and from the recently announced 4 trillion RMB stimulus program by the PRC government. We expect that this program will result in increased demand for cement and may increase commodity price for cement.

SUTR and GSI bullish commentaries were not overly specific, simply stating expectations to benefit from the stimulus plan.

SUTR Commentary

We anticipate that we will continue to grow by taking advantage of a long-awaited resurgence in manufacturing and industrial development and activity and favorable economic results from the implementation of PRC government's active stimulus policies during the coming quarters.

GSI Commentary

As we look at the remainder of 2009, I'm confident that spending on earthquake rebuilding and stimulus projects will continue to drive demand for our products. While the economic slowdown has made for challenging times for many steel companies, it is also creating numerous opportunities to acquire quality assets with excellent growth potential at attractive valuations. We were founded on an M&A platform, and will continue to play a significant role in the industry's consolidation as catalysts strengthen.

CRJI Commentary

We could not locate a press release for CRJI's most recent quarter, but commentary in its third quarter filing implies that despite rising sales, profit margins are under pressure.

Furthermore, intense market pricing competition forced us to decrease prices to maintain existing clients and market share.

With regards to dilution CSGJ is the most obvious candidate to raise capital via the equity market.

We anticipate raising funds through an equity or debt offering or with a strategic partner in the coming year.

SUTR commentary suggests that tapping the financial markets for capital will be part of their business plan.

Short-term bank and private loans are likely to continue to be our key sources of liquidity for the foreseeable future, although in the future we may decide to raise additional capital by issuing shares of our capital stock in an equity financing. We believe that our currently available working capital after receiving the aggregate proceeds of Sutor Group's capital raising activities, the credit facilities referred to above and the expected additional credit facility should be adequate to sustain our operations at our current levels through at least the next twelve months.

Commentaries from RINO, CSGJ and GSI filings infer, but do not guarantee, that cash flow from operations and existing credit lines will be sufficient to meet short-term business needs.

RINO Commentary on Cash Flow

Without the redemption provision ($24.5 million) arising from the capital structure of RINO, we believe that we have sufficient cash, along with projected cash to be generated by our business to support operations for at least the next 12 months. We believe that the possibility of such redemption is remote.

CSGJ Commentary on Cash Flow

We believe that our liquidity will be adequate to satisfy our obligations for the foreseeable future.

GSI Commentary on Cash Flow

The Company believes that existing cash, cash flow from operations and available borrowings under the Credit Facility will be sufficient to support its working capital, capital expenditures and debt service requirements for the foreseeable future.

Investment Decisions Breakdown

CRJI Investment Decision. Due to the low quality of earnings (government refund), outstanding shares count, not profitable on a non-GAAP basis and dilution possibilities, we are not inclined to currently consider CRJI as an investment candidate.

GSI Investment Decision. On a short-term basis we are also holding off GSI due to its trailing loss. However, it should be noted that the company was able to return to profitability in its 2009 first quarter. The stock may have some long-term appeal as 2009 earnings estimates are positive and in 2010 analysts are forecasting the company to achieve 2010 earnings per share of $0.57.

SUTR Investment Decision. This was as a stock we used to own and before the economic crisis took hold was posting consistent and respectable growth. It is important to note that through all the chaos SUTR has been able to maintain profits.

Still, at first glance, the story could be passed over. SUTR has posted two consecutive quarters of negative sales and earnings per share growth and 2010 full year analyst earnings per share estimates ending in June show the company only growing 9% for their 2010 year.

However, upon closer inspection, most of this decline will occur in its first quarter. Analyst estimates have the company growing at an average of 55.5% for the last three quarters. Obviously, a big reason for this growth is due to easy quarterly comparisons, but SUTR will have yet to meet their peak earnings performance accomplished in 2008.

Once the 2011 estimates become available, SUTR longer-term growth outlook should offer more clarity. The question to consider is, when will investors start to pay up for the growth that is expected to occur at the tail end of this year? At $3.54 and a trailing tax adjusted P/E of 7, it seems at the very least to offer a reasonable risk/value proposition. However, the stock does have a larger amount of short-term debt ($108 million), which could limit P/E expansion.

  • Current ratio 1.6 to 1. We prefer to see a 2 to 1 minimum current ratio.
  • Cash and marketable securities: 25.7million or 12% of current assets.
  • Cash flow from Operations as of most recent quarter: $54.3 million
  • Long-Term debt to Equity ratio: 1.9%
  • Short-Term Debt to Equity ratio: 71.8%
  • Domestic business accounts for the majority of revenues.
  • The company has had no United States Investor relation representation for some time, but has analyst coverage and is still communicative with investors.

RINO Investment Decision. We currently have owned RINO since we coded the stock as special situation on June 4, 2009 ($6.70). The company exceeded first quarter analyst estimates by a significant t margin. The company also has issued revenue guidance ($176 million) which is above consensus analyst estimates. This fact combined with the fact that that RINO has given some pretty bullish commentary leads us to believe that it may be able to top analyst predictions once again. However, there are some concerns regarding fluctuating margins, pricing challenges and timing of orders. Also, the stock has risen 77% since being coded as a special situation and has substantially eclipsed analyst price targets. See potential valuation scenarios.

  • Current ratio 3.53 to 1.
  • Cash and marketable securities: 48.0 million or 41.3% of current assets.
  • Cash Flow from Operations as of most recent quarter: $27.6 million
  • Long-Term debt to Equity ratio: 0%
  • Short-Term Debt to Equity ratio: 11.3%
  • Domestic business accounts for all of the company's revenues.
  • RINO has reputable investor relations representation.

Note regarding RINO analyst estimates. It may be difficult for analysts to get a grasp on estimates due to the surprise factor of China's stimulus plan. It seems safe to assume that many analysts may be conservative and haven't yet priced in the stimulus plan into their forecasts, giving rise to the possibility of upside earnings surprise among Chinese firms.

CSGJ Investment Decision. This company has quietly piqued our curiosity. While its growth hasn't been spectacular (tax-adjusted earnings per share growth was 12.5% in 2008 and relatively flat for the first quarter of 2009), the company has been able maintain profitability in these turbulent times. Inspection of the company's 2009 first quarter SEC filing, we uncovered some interesting commentary that points to some favorable industry trends that could benefit CSGJ.

We plan to upgrade that capacity to 500,000 metric tons by July 2009. Due to the closure of the old Zhaoyuan plant we have experienced a 7.14% decrease in tonnage production during the first three months of 2009 from the prior period.

We foresee positive business sales in the fiscal second quarter and beyond due to a Chinese government decision to shut down a collection of small cement plants by the end of 2010 and from the recently announced 4 trillion RMB stimulus program by the PRC government. We expect that this program will result in increased demand for cement and may increase commodity price for cement.

China's cement output is forecast to grow 10% per annum between 2008 and 2010. Due to the regulatory guidance of "eliminating old capacity before establishing capacity", growth of new cement production capacity may somehow slow down in the next few years, and it may even result in supply shortage in some regional markets at some stage. Overall cement prices are expected to climb steadily upwards, due to factors such as supply-demand structure, and higher costs of coal and electricity. Organic growth of the cement industry in PRC should be able to deliver satisfactory operating results in the coming years.

The Chinese government has mandated the elimination of 250 million tons of outdated cement production capacity by 2010, so it is expected that industry consolidation will accelerate and market shares and industry profits will be further concentrated to strong companies. There are close to 300 cement plants to be closed in Shandong Province. Therefore, we expect that additional value will be created by acquisition opportunities due to this industry consolidation.

Without any specifics, the GeoTeam is not sure how to gauge this commentary as it directly relates to earnings. However, we can not ignore the overall positive tones that the company conveyed.

With a tax-adjusted EPS of $0.61, the stock is selling at a P/E of 2. Furthermore, its current book value per share stands at $4.72. The GeoTeam is delving more completely into this story and is coding CSGJ as GeoSpecial based on re-pricing of risk premium. We are a little concerned that cash only represents 2% of current assets.

  • Current ratio 3.5 to 1.
  • Cash and marketable securities: $517 thousand or 2% of current assets.
  • Cash Flow from Operations as of most recent quarter: $2.2 million
  • Long-Term debt to Equity ratio: 0%
  • Short-Term Debt to Equity ratio: 5.7%
  • We are still attempting to gather information on the CSGJ international exposure.
  • As far as we can tell the company has had no United States Investor relation representation, but is still communicative with investors via press releases. We have attempted to make contact with the company via email.

Thanks for reading. We will be continuing this discussion in subsequent parts of our interpretation of how China's stimulus plan will help various industry sectors. In the meantime, please see a partial list of companies that may benefit from the Chinese government's answer to the recession.