There has recently been a clarification on the consumption tax issue, and Gushan Environmental Energy (GU) has issued a statement saying that it will resume production in 2011 at all plants at various times during Q2, except for two plants that are already operational. This clears most of the concerns I have had in the past.
Jamz and other authors on Seeking Alpha have done a good job discussing GU's developments and valuation, especially relative to book value, so I will not spend more time on that. Instead, my objective is to make an estimation of GU's profitability in 2011 and 2012. The years will be very different, as 2011 will be one of restarting production, while 2012 will be its first "normal" reporting year.
Before we jump to the numbers, here are my thoughts that form the basis of my estimation:
- GU has in past years demonstrated that it only produces when it is cash flow-positive. Since it states it will restart production, it is reasonable to thus assume that it will at least be CF-positive.
- The Chinese government has made it rather clear that it wishes to encourage alternative energy production.
- It has also made it clear that it doesn't want waste cooking oil to be used for food for humans. This is where the feedstock is currently going.
- The input variable with by far the most uncertainty is at what price GU can secure feedstock, and in what quantities.
- GU states in its annual accounts that it procures the majority of its feedstock from a limited number of suppliers that engage in waste collection.
My thesis from above is that these collection companies are state-owned/controlled, and that the government will put pressure on them to sell feedstock to companies producing bio-diesel rather than food and at a price that makes bio-diesel profitable. After all, why else bother with all this regulation and grand statements?
Below are three estimates: My best estimate for 2012, my best estimate for 2011, and an operationally cash flow break-even scenario for 2011.
I put available capacity at 318,000 tons for 2011, as some of the plants will only be available later in the year.
For 2011, I am assuming that the sales price will be 15% higher than Q3 2010, as crude prices and traditional crude oil refining spreads have risen significantly since then. For 2012: +5%. In the best estimate I use, the feedstock price of Q1 2010 and for the CF break-even is a price that will result in gross profit plus depreciation to cover increases in administration and selling expense due to volume increase. For 2012: +5% to Q1 2010 prices. For 2011, for utilization of operational capacity I use 75% as a best estimate, which is 5% lower than the 2008 capacity utilization, and for the CF break-even 50%. For 2012: 80%.
The result looks as follows:
|Profit and loss||2012 Est.||2011 Est.||2011 OPS CF break even|
|Total cost of revenue||1,979||1,166||909|
|- Other costs of feedstock||157||94||63|
|- Cost of feedstock||1,734||984||759|
|Provision for cons. tax||-||-||-|
|R&D S, G and A||140||130||120|
|Income from ops||232||39||(140)|
|Net income before tax||232||39||(140)|
|Net income after tax/CNY||156||26||(94)|
|Volume and price assumptions|
|Bio diesel volume||400||239||159|
|Average bio diesel price||5,641||5,373||5,373|
|Average bi-product price||2,347||2,236||2,236|
|Total sales volume||440||262||175|
|Total average price||5,342||5,088||5,088|
|Average feedstock price||3,360||3,200||3,700|
|Jin Xin Net Income/CNY||30||15||15|
From this data, 2011 will be moderately profitable but 2012 is set to unveil how undervalued Gushan is at current valuations.
Having tried to adjust the utilization and feedstock prices, it is very clear that this has an enormous impact on the net result. This will be the key point to follow in the coming quarters.
Gushan is a risky investment, but it also holds large potential upside. If the "spread" was ever to return to the average of 2006-08 of 3100, then the net income/USD would be $78 million -- which is close to a PE of 1.
I especially welcome comments that relate to the price of feedstock and volumes.
Disclosure: I am long GU.