Keyuan completed their reverse merger to become listed on US exchanges in April of 2010 and has since moved their listing to the NASDAQ. Many individuals have a negative perception of reverse mergers because of recent negative press, greater potential for fraud, and lack of transparency with management. As a result, the majority of reverse merger listed companies are selling for low multiples in regards to several valuation metrics. This can create an opportunity for individuals who are able to seek out good companies within this particular sub-set of stocks. I believe Keyuan may be one of those companies.
Keyuan is a manufacturer and supplier of petrochemical products in China. According to management, Keyuan maintains a competitive advantage through its ability to innovate and develop new ways of produce their products. A good example of this is Keyuan’s ability to use heavy oil in the production process as opposed to naphtha. Heavy oil is a cheaper input in the production process allowing Keyuan to achieve higher margins on similar products than its competitors. Keyuan’s production mix is as follows:
- BTX aromatics: widely used in paint, ink, construction coating, pesticides, and other gasoline and solvent materials.
- Propylene: A building block for an array of chemicals and plastics including paint, household detergents, automotive brake fluid, carpeting, insulation, textiles, and electrical appliances.
- Styrene: A precursor to polystyrene that is used in packaging materials, construction materials, sporting goods, and etc.
- LPG: A mixture of gases used as a fuel in heating appliances and vehicles and a replacement for chlorofluorocarbons.
- MTBE: A chemical with applications in fuel, fertilizers, fungicides, insecticides, and refrigeration systems.
According to the company’s filings with the SEC, current Chinese demand has outstripped China’s available supply for many of these items. There are current plans in place to expand Keyuan’s product offering to include asphalt and Styrene-Butadience-Styrene (SBS) to continue to take advantage of supply/demand imbalances.
Construction on the SBS facility is expected to be completed somewhere between July and September of 2011. The asphalt facility is expected to be complete in 2012 and the completion of their pre-treatment facility is expected to occur in March 2012. The effect on revenues and net income is discussed later.
Given the negative sentiment towards reverse mergers, I will begin by addressing the company’s qualifications first.
The company has what appears to be an excellent management line-up (management details from the company's recent Form S-1/A).
Mr. Chunfeng Tao: Chief Executive Officer
Mr. Tao has over 20 years of extensive experience within the petrochemical industry. He has served as President of Ningbo Plastics and Ningbo Hebang Chemical Co. which had annual revenue of RMB 10 billion. Mr. Tao served as Executive Vice President of Ningbo Daxie Liwan Petrochemicals Co which had annual revenue of RMB 6 billion. Mr. Tao has also received over 30 technological innovation, management awards, and distinction awards during his career.
Ms. Aichun Li, CPA: Chief Financial Officer
Ms. Li has a decade of experience in Corporate Finance. For the years 2006-2010, Ms. Li was a member of the CFO Group with Bank of American (ticker: BAC) where she managed reporting, forecasting, and planning for several multi-million P&L accounts. Ms. Li also served as senior accountant with Nucor Corp. (NYSE:NUE) and was a consultant with Deloitte & Touche LLP in the analysis of financial reports and complex tax planning.
The company also has many other experienced and noteworthy directors that are worth your review. More details can be found about those individuals here on page 105.
Keyuan has done other things to boost investor confidence with the hope that individuals will look past the reverse merger stigma that has become attached to it. KPMG has recently been retained as the company’s auditor going forward. An annual cash dividend has been declared, but senior management and the company’s largest shareholder have forfeited the right to receive their dividend showing potential shareholders they are not just here to transfer wealth from US shareholders to themselves. Lastly, the company has been really transparent in all of their dealings. This is represented by the amount and quality of the disclosures in their SEC filings as well the willingness of the Ms. Li, Keyuan’s CFO, to answer several of my questions for the production of this article.
Individuals will have a hard time locating other reverse mergers that can parallel the amount of effort that Keyuan has put into informing potential investors of the exact nature and condition of its business.
Now, with all of that out of the way, we can move onto the financials of the company.
Keyuan began production in 2009 in Q4 of 2009 and had a net operating loss. Projected sales for the year 2010 are expected to be $550 million. As of September 30, 2010, Keyuan reports revenues of $400.7 million with net income totaling $20.7 million after currency adjustments.
This represents a net margin of just over 5%. If the company was able to maintain this margin while achieving their goal of $550 million, we can expect net income for the year to be around $27.5 million.
In the later part of 2011, the company is expected to finish construction on the new SBS facility. It is expected that this new facility will generate $107 million in sales and an additional $10 million in profit once it is operating at full capacity.
In 2012 the company is expected to finish construction on a pre-treatment facility and their new asphalt facility. The asphalt facility is projected to add $300 million in revenues and contribute $30 million to net income once it is operating at full capacity.
Assuming that management’s forecasts are accurate and that there are no unforeseen expenses, it can be seen that revenues in 2013 should be close to $1 billion with profits near $70 million. This assumes very little growth outside of the additional capacity in the new facilities, no change in foreign exchange rates, and similar margins.
How does this translate in terms of EPS? Currently, Keyuan has 71, 515, 618 shares outstanding assuming that all warrants, options, Preferred A, and Preferred B shares are converted. When not considering the immediate conversion of all outstanding options, warrants, and preferred stock, the number comes to 57,577,840.
It is possible that there may be even more shares than this in 2013 considering the employee stock rewards program that has adopted. Keyuan reserves the right to issue 6,000,000 shares plus 5% of shares outstanding (up to 4,000,000) every year for the years 2011-2013. It is possible that the share count may be closer to the 100,000,000 maximum allowed if this employee rewards plan is maxed out every year.
On top of this potential appreciation, Keyuan’s current dividend to shareholders represents a 7% annualized yield. Currently, a large number of shares owned by management and the largest shareholder will not be receiving the dividend. This places increased confidence on current and near-future shareholders as to the ability of the company to pay.
I questioned Ms. Li in my interview with her if it was management’s intent to declare a regular dividend going forward. She confirmed that it was but metioned that future dividends, as always, will be subject to availability from future cash flows. Shareholders will want to regularly follow the company’s reported cash flows to determine the sustainability of such a dividend going forward as more shares are issued and outstanding. Consideration should also be given to the inclusion of the shares currently forfeiting the dividend.
In writing this article I asked Ms. Li if there was anything that Keyuan wishes to express to potential investors and current shareholders. She reiterated Keyuan’s innovative ability, the experienced nature of the Mr. Tao, the Chief Executive Officer, and his aligned interests with current shareholders by maintaining a large ownership stake (21.7 million shares).
With all of this in mind, I can say that Keyuan is giving investors more than just a dividend: Keyuan is doing its best to give US investors confidence in an area that has been stigmatized by fraudulent companies whose only operations were those undertaken to defraud US investors.
Any investors who have been watching Chinese reverse mergers with interest should consider Keyuan Petrochemicals as a prime target for a deeper look. The company is expected to release year end results in March. As always, investors are encouraged to do their own due diligence starting with the company’s financial statements and SEC filings which can be found here. Another place to begin is by viewing the transcript of my interview with Ms. Li which can be found here.
Disclosure: I am long BAC. I have no current positions in Nucor Corp. or Keyuan and no plans to initiate any positions within the next 72 hours.