China Integrated Energy (OTCPK:CBEH) has recently been flirting with all time lows. My research leads me to believe the shares are worth much higher than recent prices would indicate. I have a new found interest in the company. Since mid 2010, I have published articles on a select number of Chinese companies that I believed were due for significant price appreciation. In an investing climate of punitive stock price performance for U.S. listed Chinese companies; my performance has been eerily positive; and can be found here.
In this article I will share my belief that CBEH is largely undervalued based on the company's net assets, consistent profitability, vertical integration across the wholesale and retail oil and biodiesel segments, and future growth prospects. I believe the shares today to be worth $12, and I will delve into my reasoning below.
I’ll start the basis for my investment thesis with the fact that, at a $200MN market cap, CBEH very recently traded at its book value. To me, this represents the theoretical liquidation value, where management could liquidate the company’s assets and liabilities such as cash (about half its book value), plant assets and any outstanding liabilities. The market is erroneously giving CBEH zero value for future income and business growth by pricing it roughly equal to its liquidation value. I believe there is significant value in the future earnings of CBEH, to the tune of $12 per share for the net assets and future earnings combined.
CBEH operates in three segments, Oil Distribution, Biodiesel Production and Retail Gas Stations. Conveniently, CBEH breaks down each segment in its financial filings. My interest in this investment story is in the growth in both the Biodiesel Production and Retail Gas businesses. Having said that, there is still a solid base of relatively safe earnings in the oil distribution segment; again, seemingly getting no value by the market recently.
Oil Distribution seems to be the company’s lowest risk unit, as it essentially buys and sells oil from and to its well developed distribution networks. Through the first nine months in 2010, this unit netted CBEH $21MN in profit. In 2009, this segment netted CBEH $13.5MN. So, for 2010, it is likely that CBEH will close to double its profits in this business unit.
The biodiesel production unit also grew profitably and rapidly in 2010. In 2009, biodiesel netted the company $11MN in profits (through the first nine months), and for that period in 2010, it netted the company $16MN in profits. So, the biodiesel segment may also close to double its profits for full year 2010.
First 9 Mo. 2010
Retail Gas Stations
The biodiesel business excites me because of the prospects for enhanced profitability through the Chinese government’s support of alternative energy, the growth prospects of the industry in general, and CBEH’s ability to remain profitable in this segment through an enormously tough diesel production environment. My belief if that with the economic recovery in place, and the days of cheap oil, gas and diesel seemingly behind us, financial conditions can improve even more for oil, gas and diesel producers and distributors.
It is my belief that CBEH has a competitive edge against competition due its production process that allows it to source different forms of raw materials. Due to its plants using patented technology allowing for different feed sources, CBEH switches to cheaper forms of raw materials depending on market prices for those inputs. This has, and I believe will, continue to lead to higher margins relative to its competition. Additionally, CBEH holds several patents for these production facilities. Its newest plants will take this idea a few steps further to include the ability to source and diversify into even more raw materials. Management estimates 20% cost savings for their newest plants.
A recent press release from CBEH's main competitor, Gushan Environmental Energy (GU), explains that the Chinese government has recently made a decision to support the industry. I believe the Chinese government in general is making it a priority to help its alternative energy producers develop profitably. In addition to the current profitability CBEH is able to achieve on its own, further financial incentives from the government could provide even more value for shareholders.
On this note, China may impose a biofuel mandate to mix biofuels into all fuel production. In a recent Q & A with GU’s management, president Wai Son Kwong speculates that this mandate will take place at some point. And when it does, both GU and CBEH’s plant assets become significantly more valuable.
Through the first nine months of 2010, CBEH pumped more capex into its biodiesel unit than any of its other two segments (see table above). Biodiesel represents only 16% of all three segments combined in terms of assets deployed as of Q3 2010. Though, Biodiesel represented 36% of all three segments profits during this time frame. Management’s decision to grow the biodiesel unit seems very financially smart, as its ROI, ROE and ROA are much higher than the other segments.
Finally, the retail gas station segment seems to be the culprit for CBEH’s recent price performance. CBEH recently executed on a shelf filing to raise $24MN in equity. I believe some investors find this excessive.
While I understand the negative sentiments surrounding dilution, I have a much different take on these corporate actions. CBEH has proven that it is financially sound. The company's sales and profits are growing rapidly. Each business segment has grown profits significantly between the first nine months of 2009 and 2010. The retail gas stations actually more than doubled during this time frame, from $3.5MN to $7.7MN, which is where I believe this new capital will be deployed if there is excess.
CBEH is firing on all cylinders. My view on this is that management has proven its ability to deliver return on equity. I believe if there is additional capital to be deployed it will be used to purchase gas stations, which we can see is a high growth business for CBEH. Gas stations also represent the retail outlet for its wholesale and biodiesel segments. So, this also strengthens its vertical integration business model, which I believe to be a core financial driver that has led to valuable operating efficiencies.
The fact that they took in seemingly more money than they immediately communicated they require seems to puzzle some people. I wouldn't disagree that it's a red flag of sorts, but in this case, given CBEH's rapid growth and strong financial performance, I am taking it as sign that the company is expecting to grow even more than currently communicated.
In summary, CBEH currently trades within a few hundred basis points of its book value. To me, this indicates the market is giving value only to its assets that it could liquidate, and no value to its future earnings and growth. CBEH is highly profitable, and I don’t think this is going to change much for the worse, especially since we are in the recovery portion of a global economic cycle.
CBEH has reported $321MN in sales for the first nine months of 2010. In all likelihood, CBEH will report well over $400MN for the full year 2010, with management's recent guidance at $435MN. At a current market cap of $200MN, you can buy CBEH today for less than half of its 2010 sales. And as we can see clearly, the company is profitable and growing rapidly within a very high potential Chinese alternative energy sector.
An additional positive catalyst is the recent announcement to retain KPMG as its auditor. We are all familiar with the small cap Chinese sector woes regarding financial integrity, and so this move in my opinion is the best thing CBEH could have done.
With the exception of the dilution, the operating performance of the company is strong and getting better. Sales and profits have never been higher and management's outlook for the future is bright, according to an excerpt from the most recent earnings release.
"We experienced strong demand in each of our three business segments," stated Mr. Gao Xincheng, Chief Executive Officer of China Integrated Energy, Inc. "Sales growth was driven by a combination of increase in sales volume and an increase in average selling prices. Wholesale distribution sales increased 35.5% year-over-year due to increased penetration within existing regions, growth in new distributors and higher oil prices. The Company's biodiesel sales increased 35.8% for the third quarter of 2010, compared to the third quarter of 2009, driven by growth in both volume and pricing. Retail gas station sales increased 120.0% due to strong consumer demand, the addition of five stations and higher retail gasoline and diesel prices."
My intrinsic valuation for the shares would be a conservative 8x 2010 P/E ($53.5MN Net Income Guidance from management), or roughly $12 per share.
I may write follow up articles on CBEH as I explore this story further, reach out to management, and report on significant changes to the business.