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China Industrial Waste (OTCPK:CIWT) is the first industrial waste treatment company based in Dalian, a beautiful coastal city in northeast China.

Macro Background

1. China has enacted stricter regulation to enhance ecological and environmental protection.

2. Environmental protection industry is growing 25% per year according official media.

3. High barriers to entry. Companies need to demonstrate their technologies and go through lenghthy license approval process.

4. No more than two direct competitors within a specific region.

Due to the requirements of waste consolidation and mass treatment, as well as possible disastrous results if companies perform industrial waste collection and processing, the government usually only allow no more than two direct competitors to serve a particular region.

5. The region where CIWT serves is the heavy industry center and thus the largest waste producers.

Business Overview

The company mainly engages in three business segments:

1. Industrial waste management

CIWT provides “one-stop” comprehensive solution of industrial and commercial waste treatment. CIWT charges service fees and also makes money from selling scrap materials and recycled products.

This segment contributes around 90% of total revenue and has about 20-30% growth rate.

The expansion plan is in schedule and the management expects the new project to make profit in the second half of 2010. The company expects to double its processing capacity within 1-2 years. Currently, CIWT operates four facilities with a combined 35,300 tons of capacity. After the expansion project, the capacity will increase to 77,000 tons. The company hopes that this expansion will help drive revenues and profitability going forward.

The service fee charged by CIWT is renegotiated annually. As the regulation is stricter and stricter, large clients don’t want to risk their business with the government, so they usually don’t have bargaining power. Usually, service fee makes around 70-75% of total revenue of this segment, and sales of recycled and scrap materials are 25-30%.

Accounts receivable collection is stable, usually at around one month. CIWT collects cash at the end of every month.

2. Municipal BOT projects

This segment contributes about 5% of total revenue. Competition in this field is fierce and profit margin is also low compared to industrial waste management. The company does not plan to invest more in this field. However, this is a stable business with stable cash flow. So CIWT still operates this segment to make some stable profits.

3. Environmental protection engineering.

CIWT has a joint venture with a German company to provide waste water and sludge treatment service. CIWT is not a pure equipment but a comprehensive solution provider.

This segment will be future CIWT’s revenue driver.

Financials

Over the past four years, CIWT has grown its revenues more than 300% from $4.87 million in 2005 to $13.4 million in 2008. Net income grew more than 300% from $1.49 million in 2005 to $4.75 million in 2008. The profit margins were 69% and operating margins were 42.5%. Although the company is involved in big capacity expansion project, it still can generate $4.9 million in cash flow from operations during 2008. 1Q09 was difficult due to economic slowdown but business has since improved.

The company also has enough cash for its debt and construction project payable, which suggests that they don’t need immediate outside financing to finance its projects.

Future Growth

1. China’s environment protection industry is still in its infancy. But with strong government support, the growth will be much faster in the following years.

2. China is moving its manufacturing plants from coastal provinces to inland provinces due to economic development. CIWT has strategically chosen a few sites across the country to meet this change.

3. The central government has enacted favorable tax policies on those environment related industries. There is no value added tax. 70% of corporate tax will be returned and no operations tax. Government also provides favorable interest rate if CIWT wants to borrow loans from national banks.

Conclusion

I believe CIWT is a hidden gem. The value has not been discovered by many investors. I recommend to buy this stock now. If you are patient and can hold this one for one or two years, you may see a very nice return.

Disclosure: I am long CIWT

Source: China Industrial Waste: A Hidden Gem