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Disclaimer: Based on recent reports (Oct-Dec 2010), both OTC:RINO and its auditors are now under investigation for possible fraud and misstatement of financial numbers. All investors are urged to perform their own due diligence and read the comments below.

RINO International is a fast growing environmental protection and remediation company. Unlike some of my other investments in low P/B and out-of-favor stocks, RINO has been growing like crazy over the past several years.

I can’t say for certain whether this torrid growth will continue, but sometimes a typical ‘growth’ company can be selling at a cheap price, even if the growth is largely ignored.

Technology Overview

RINO has been around since 2007 and has three primary product lines:

Lamella Inclined Tube Settler Waste Water Treatment System – An advanced waste water treatment system for the iron and steel industry.

Rapid growth and government spending on infrastructure has placed a huge demand on raw materials from these mills – as they ramp up production, this waste water is a byproduct and must be dealt with in some fashion, driving demand for RINO’s products.

Circulating, Fluidized Bed, Flue Gas Desulphurization System – Removes sulphur from flute gas emissions by the sintering process in the production of iron and steel.

Just like the waste water, the iron and steel industry generate a toxic gas that must be handled properly. In 2009, the China’s Ministry of the Interior implemented a formal process for requiring sintering desulpurization equipment.

According to RINO’s CEO,

We believe that the addressable market for sinter FGD systems specific to RINO is over 200, which includes sinters at least 90m2 in size, and creates a billion dollar plus opportunity for our Company.

High Temperature Anti-Oxidation System for Hot Rolled Steel – 90% of China’s steel production uses this particular method. Oxidized steel results in lost production output, wasted water & energy, and generates pollution. RINO’s system reduces this loss by over 60%.

Other Products:

Sludge Treatment System

We estimate that there is a market of approximately $28.8 billion for the treatment of sludge generated by various municipal wastewater and industrial processing systems in the PRC market.

DXT System

Our new DXT operating system utilizes coking waste ammonia in the flue gas to effectively remove the sulphur dioxide from the sinter flue gas and produces ammonia sulfate as a by-product, which can be used as fertilizer.

Growth Potential

There is no doubt that the company owns some very exciting technology, with huge ramifications and an extremely large potential market. According to RINO’s press release,

Pollution problems in China are estimated to cost the country more than $200B annually. The China State Environmental Protection Agency (SEPA) states that over $190B will be spent by industrial companies for cleanup.

As the country grows, especially from an industrial standpoint, RINO benefits from the cleanup required. The company’s SEC filings put it best:

Our business is driven more by policy, environmental regulations which are mandating steel manufacturers to install these systems – THEY DON’T HAVE A CHOICE AND THE FINES FOR NOT COMPLYING ARE INCREASING.

Financial Highlights

RINO has grown extremely rapidly over the past 3 years, and benefits from outstanding margin numbers with median gross, operating, & net margins of 43.6%, 24.8%, and 16% respectively. Topline growth in 2009 was 38%, following a crazy 119% growth rate in 2008.

The company has a total debt to equity ratio of .07, and a quick and current ratio of 4 and 7.1 respectively. P/E is only 5.83.

Risks

CFO Turnover: The company hired a new CFO in July 2009 who resigned promptly on May 3, 2010, a potential warning sign. Using the Beneish M Score Formula to test for earnings manipulation, RINO scores -2.48 on the 5 variable test (anything less than -2.2 might signal earnings manipulation).

However, turnover among the executive ranks, especially at the CFO level, is always a cause for concern.

Q1 Earnings: Although the company reported a nice QoQ EPS growth rate for the latest quarter, there were definite warning signs. The EPS increase was largely driven by a change in the valuation of stock warrants, a variable number that is not tied directly to business operations.

Gross margins declined from 45.5% to 35.3%, as RINO was forced to rely on outsourcing for a good portion of their contracts.

Initially, we had to try to fully utilize our own manpower on the contracted projects. However, when we reached our maximum production capacity, we have to outsource some of our products to outside constructors.

Many companies do not effectively take advantage of such hyper-growth periods, and RINO is no exception. If the outsourcing trend continues, the financial situation will look much different in 2010.

New Sales Model: RINO has been experimenting with a new sales model (maybe pushed by the government?) that opens them up to greater financial risk.

Rather than accepting payment from the iron/steel companies for each project, under the new “Build-Operate-Transfer” or BOT plan, RINO will construct – and pay for – the entire project and then transfer the finished project in the final state.

Read more about in this SeekingAlpha article entitled “Rino International Morphing into a Financier.”

Valuation

click to enlarge

RINO Stock Valuation

Conclusion

RINO has a very attractive product line that is addressing huge potential markets in China. Long-term, China’s infrastructure needs will continue to grow rapidly and RINO is positioned to capitalize on the environmental cleanup that must go along with this growth.

At its current price, I don’t think the company offers enough margin of safety but I’ll be watching closely, especially if it drops back below $10.

Disclosure: No position in RINO at the time of this writing.

Source: RINO International: Undervalued Chinese Company on the Surface