China Wind Systems Has Long-Term Buoyancy

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ESR stands for Electro Slag Remelting. It is an industrial process - common in Europe, but less so in the US - for remelting and refining steel and some special alloys, in order to make them stronger and more durable.

In October 2009, Chinese components company China Wind Systems (NASDAQ: CWS) installed its initial ESR production line, and from July 2010, to December 2010, it generated $7.6 million in sales of high-quality components using ESR technology. As I shall explain, I believe the company is set to profit greatly from ESR, and the shares can be acquired as a long-term buy.

China Wind Systems is an interesting company. It was founded in 1995, and its original role was the manufacture of dyeing and finishing machinery for China's booming textiles industry. It was known then as Huayang Dye Machine Company. It later branched into the manufacture of power equipment for coking plants and coal-fired power stations.

However, it was in 2007 that founder and CEO Jianhua Wu, becoming aware of the enormous potential in China for wind power infrastructure, decided to change the focus of the company's activities. He also changed the name, to China Wind Systems, and in December 2009, in order to tap new sources of finance, listed on NASDAQ.

The company's initial products for the wind industry were forged roll rings, up to nine feet in diameter, for use in wind turbines. It also now manufactures wind turbine shafts, weighing up to 18 tons.

Business has grown strongly. In its December 2010, annual accounts the company revealed that its precision components business saw revenues up 61 percent to $58.3 million. Of this amount, $40.6 million was derived from the wind power industry, more than double the figure of 2009.

Its traditional dyeing and finishing machinery business also did well, with sales up 23 percent to $21.2 million.

However, not only did the components business achieve strong growth in sales, but the gross margin rose from 25.5 percent to 28.2 percent, as increased demand led to significant economies of scale.

By contrast, the gross margin for dyeing and finishing machinery edged down from 21.4 percent to 20.9 percent, hit by rising raw material costs and intensified competition.

The company's exposure to China's booming wind power industry should be sufficient to attract investors. However, its moves into ESR, I believe, give it even greater appeal.

It is specifically targeting the next generation of wind turbines - up to 5 MW capacity - along with turbines for offshore generation. Demand is just beginning for these.

They are going to need high-performance, super-strength components that are more durable than those generally used in existing turbines. And in contrast to the company's existing wind components business, which carries gross margins of 28 percent to 30 percent, ESR products are expected to deliver margins of 32 percent to 35 percent.

It is noteworthy that China Wind Systems is one of only three large-scale ESR producers of wind components in China.

In March 2011, the company hired a US sales director, and it is now working to sell its components to US manufacturers.

Meanwhile, the company's textile machinery business continues to expand, with new high-tech machinery that is seeing growing demand.

In addition, the company is using its technological base to branch into new areas, notably solar power. It has developed a prototype solar chamber sub-assembly, and is starting to receive orders from the buoyant Chinese solar industry.

It is difficult to make short-term profit forecasts for China Wind Systems. But with an historical price-earnings ratio of around six, fully diluted, it is equally difficult to see much downside to the shares.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.