Duoyuan Global Water Inc. (DGW)
Per share values on 02-25-2011 -
Market value: $9.15
Equity value: $2.86
Shares: 24.61 million
Duoyuan Global Water Inc. is a leading China-based water treatment equipment supplier. They have been continuously developing advanced water treatment technologies for multiple end users including municipal, industrial and residential clients. Currently, they offer more than 100 water treatment solutions.
We selected Duoyuan Global Water Inc. because it is one of the select few that fit our model. Our goal is to select, purchase and continually monitor companies in an effort to obtain outstanding performing investments while minimizing risk by finding low values for our clients. We will cover part of our review and selection process as well as explain why Duoyuan Global Water made the cut and is the latest addition to our High Cash Stock Review.
Duoyuan Global Water is seen as an innovator in low cost Chinese clean water services. They are focusing efforts on developing advanced technologies, increasing production capacity, exploring potential markets and expanding their market opportunities. They provide customers with SO9001 Quality Certification, ISO 14001 Environmental Certification, and Six Sigma methodology. Duoyuan is focusing on both its internal efficiencies and further enhancing customer satisfaction. Products regarding technology, quality, service and innovation have become a focus as they aspire to become China’s leading supplier in the water industry.
Duoyuan Global Water is extremely well positioned in a desirable and infinitely growing industry. Demand from both society and industry for water in China is expected to develop exponentially. According to the Joint Monitoring Program for Water and Sanitation from WHO and UNICEF, about 100 million Chinese still do not have access to an improved water source as of 2008 and about 460 million did not have access to improved sanitation services. Progress in rural areas appears to lag behind what has been achieved in urban areas. Some parties have claimed that water in China may be even more valuable than petroleum.
Also, 60% of China's 661 cities face seasonal water shortage. Over 100 cities have severe water constraints, such as contamination of drinking water from upstream sewer flow. This is a critical health problem that could and does causes serious illnesses. A study by UNICEF in 11 provinces found that over half of all drinking water samples contained unacceptably high levels of bacteria.
Shanghai, like many other Chinese cities, depends on surface water that is heavily polluted, such as the Huagpu River, where water comes through Suzhou Creek from the heavily polluted Tai Lake.
Step 1 – We first search for companies with pristine balance sheets.
Duoyuan Global Water has $6.29 million in cash with no debt on the balance sheet. It had sales of $51.5 million last quarter meaning an annual run rate of about $200 million or $8.13 per share annually. The stock price minus the cash on hand gives the company an enterprise value of about $2.86 per share. This is a strong balance sheet and $2.86 per share is a very low enterprise value especially when the company earned $0.55 per share in the last quarter alone. This is an amazingly low level considering the growth potential and required infrastructure that Duoyuan Global Water caters to as China may be one of the unhealthiest and largest population center in the world. The enterprise value trades at only 5.5x last quarter’s profit. Annualized, the last quarter’s earnings illustrate a 1.3x to enterprise value which is one of the lower we have seen. The enterprise is earning about an 18% rate of return after tax, again based only on the last quarter. The enterprise value is very low considering they have an average earnings forecast for 2011 of $1.67 per share. Based on the average analyst forecast, Duoyuan Global Water has an enterprise value after tax return of over 50%.
As a secondary note: Having a mountain of cash and no debt is considered a very conserve business model, especially when one considers this has been a very high growth company in a rapidly expanding industry.
Step 2 – We like extremely low values.
After reviewing hundreds of companies for the rare strategic position of growth and value, if not thousands, Duoyuan Global Water is one of the lower valued companies that we could identify. The enterprise value per share is a near $2.86. Sales last quarter were $51.5 million, up 35% year over year. Profits were $0.55 per share which were up an amazing 121% year over year. During the last nine months of 2010, sales were $119 million. The company's $51.5 million single quarter sales were close to the entire enterprise value of $70.3 million. These are very low valuations for a high margin sector.
Step 3 – Is the operation or enterprise driving value to their shareholders?
Duoyuan Global Water has been executing at high levels over the last year. On virtually every valuation metric, they have generated strong growth and profitability. They are trading below some benchmarks that turned out to be very strong, and is realizing higher returns on their enterprise. But Duoyuan Global Water is in a far more exciting industry, growing substantially faster in sales while making the top tier of profit growth for companies we review. Understanding that they have close to $2 of earnings potential per year per share, we find it difficult to identify firms in the current climate that have the ability to generate a 66% return after tax relative to the enterprise. In the last reported quarter, they generated $0.55 in profits with the average analyst estimating a profit of $0.48. The 14% earnings surprise was attained in part by solid growth, believing short term orders might have peaked and also permanent cost reductions due to decreased advertising. After analyzing Duoyuan, their structure and industry position reminded us of another Chinese firm we reviewed, China Yuchai International (NYSE:CYD), which has performed very well since inclusion into the High Cash Stock Review.
Management believes the reduction in marketing cost will not affect their on going business as they still are forecasting 29% growth rate, which is quite strong. Mr. Wenhua Guo, Chairman and Chief Executive Officer, stated,
"This quarter's revenue increased due to strong demand from all three product segments, which was partially due to a change in the timing of sales as some customers shifted fourth quarter purchases to the third quarter in order to meet the completion deadlines of China's 11th Five Year Plan."
Step 4 – Is this a good business?
This is an extremely well positioned business in an intriguing industry. There are numerous competitors in the water and sewer pollution control business. As China’s demand increases, we believe that being an organically developed Chinese company selling to the Chinese municipal and federal governments may be a competitive advantage. Most of the competitors are global firms with few being based in China. We believe this may allow the company to have a true advantage in the semi closed socialist economy.
Step 5 – Is the Train Wreck and then the fog from the Wreck clearing?
With this case a very low enterprise value, often a “Train Wreck,” is needed to drive value close to cash. We’ve identified six major issues that in part have driven the value so low:
1. Accounting irregularities
2. Lawsuit on accounting
3. Business built on a distribution model
4. China is the only market place
5. World class competition try to gain access
6. Additional risk and issues
We will be going into the accounting Irregularities in length on Part II.
To find updates, current news, financial ratios, and graph on Duoyuan Global Water click here.
Disclosure: I am long DGW.
Additional disclosure: Durig Capital owns Duoyuan Global Water (DGW) for itself, clients and related client accounts.