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An article posted Wednesday by Cameron Fous entitled “ShengdaTech: Undervalued Chinese Chemical Manufacturer” lays out the background on what I think is an undiscovered small cap gem.

In addition to what Cameron wrote, I have been researching ShengdaTech (OTC:SDTH) for the last week and find the future to be very exciting. Here are the reasons why:

They company had $39 million in cash and no debt as of March 31, 2007.

The nano precipitated calcium carbonate [NPCC] side of the business is growing like a weed and demand is huge. To try to satisfy the demand, the company more than doubled capacity (to 90,000 metric tons) last year and is running at 100% utilization and will add another 45% in capacity at then end of this month (so total capacity will be 130,000 metric tons) and then plans to add another 46% capacity to that later this year (up to 190,000 metric tons). That is potential for huge earnings growth as the NPCC side of the business has 40% gross margins. And the thing is, the company did 10 cents in EPS in Q1 of 2007 without the capacity and subsequent profits from a 111% increase in capacity slated for this year.

One application of many for NPCC is the tire market. The company is the only company approved to sell its NPCC into the Chinese tire market. That’s right, they have 100% share of the market and only have penetrated 10% of the $150 million market for NPCC in China. Plus, using NPCC in tire manufacturing is a win for the customer too, because it increases the durability, reduces abrasion loss, increases tensile strength and also reduces the cost of manufacturing. SDTH customers tell them it reduces manufacturing costs about 3% to 5%.

The non-NPCC chemicals side of the business is a consistent cash cow which generates between $10-$13 million a year.

Last year they developed a patent pending process for manufacturing NPCC that will reduce manufacturing costs 3% to 5% and improve the quality.

Current PE around 15 and forward PE at around 10 (with very conservative estimates).

The company said they would make between .43 and .45 a share this year. I think they will beat that easily as they made 10 cents in Q1 without all the new capacity. Next year’s estimate is at .57 a share but I think they will do closer to .70 with a full year of the doubled capacity on the high margin NPCC side of the business. If they do .57 cents in EPS in 2008 over the .43 in EPS from 2007 that would be growth of 33% for a PEG (current PE / Growth) ratio of .48x. If they do .70 cents in EPS in 2008 over the .43 in EPS from 2007 that would be growth of 63% for a ridiculously low PEG ratio of .25x. And those ratios are without subtracting the 39 million in cash out of the PE.

I think this company is vastly undervalued due to the fact that it just moved of the OTCBB and is undiscovered.

I would highly recommend reading the transcript from a Roth Capital conference they recently spoke at.

I would also encourage anyone who is not sold on SDTH or wants more information on this one to read the Q1 2007 conference call transcript.

Disclosure: Author has a long position in SDTH

SDTH 1-yr chart

SDTH

Source: Shengda Tech: A Cheap Chinese Smallcap