Gulf Resources (GFRE) recently reported record quarterly revenue and net income in the 2nd quarter. Revenue was $46.8 million for the three months ended June 30, 2010, a year-over-year increase of 58.0%. Revenue was 25% higher than the consensus analyst estimate of $37.47 million and 1.5% higher than my estimate for Q2 revenues as highlighted in my July 29th article (Gulf Resources Q2 Revenue Preview: An Opportunity to Beat Consensus). Net income was $16.4 million, or $0.47 per basic and diluted share for the three months ended June 30, 2010, an increase of 83.1% from $9.0 million, or $0.29 per basic and diluted share, a year ago. EPS beat the consensus estimate by $0.13, which is a 38% beat. The company beat my Q2 EPS estimate by $0.05, a 12% EPS beat.
With only two quarters left in 2010, Gulf Resources reiterated their existing guidance of $146 to $150 million in revenue and $44 to $46 million in net income. It is almost impossible for 2010 revenues and net income to be this low. The following would have to happen for the rest of 2010:
- Bromine production would have to be flat in the second half of 2010 over the second half of 2009, which would drop 2010 utilization to 75.1%. In the first half of the 2010, utilization was 83.9%. In 2008 and 2009, utilization was 80.3% and 80.7%, respectively.
- The company sold bromine in the 2nd quarter for an average price of $2,801 per metric ton. Prices would have to drop to $2,200 per metric ton in the second half of the year, a decrease of 21%.
- Gross margin was 49.3% in the 2nd quarter. Gross margin going forward would have to drop to 45.3%, the same level as in the first quarter.
- For simplicity, I assume the tax rate, G&A expense and R&D expense stay flat for the rest of 2010 at the same levels as the 2nd quarter.
After all of these draconian assumptions, I still can't get net income to be less than $47 million on $148 million of revenues. This is what the rest of the year would look like if you believe management's guidance (assumptions in blue text):
click to enlarge images
Ok, let's get back to reality. Mr. Liu, CEO of Gulf Resources, said
Following the rapid increase in the first half of the year, we have seen market prices of bromine begin to stabilize. However, we have successfully renegotiated contract prices with all of our major customers near current levels. We believe the new contract prices will allow us to benefit from the strong pricing environment and maintain our profitability.
Given this comment, bromine prices can't decline 21%, especially if the company already has contract prices.
If prices drop to $2,750 per metric ton in the 2nd half of 2010 with the same gross margin realized in Q2, revenues would be $157.3 million and net income would be $52.6 million. If capacity utilization stayed flat in 2010 at 80.7%, revenues would be $164.5 million and net income would be $55.2 million for $1.59 in EPS.
In summary, management has set themselves up for huge revenue and net income beats over the next two quarters on the same magnitude of what we just witnessed in Q2. We can also expect to have repeat huge beats of consensus revenue and EPS if our two research analysts decide to keep following management's lead instead of building their own bottoms-up revenue models. However, I think it is more than likely management increases guidance in short order to close the obvious gap after today's call. The math is just too simple to ignore.
Here is a normal case for the rest of the year. The only changes are the assumptions highlighted in orange.
After I have a chance to listen to the analyst conference call and speak with management, I will provide my own realistic estimates for 2010 and 2011 that are not sandbagged like the consensus estimates for 2010.
Disclosure: Author is long GFRE at the time of this writing