The Company
Sinoenergy is a Chinese company with three main segments, pressure containers, CNG storage and transportation and CNG retail filling stations. Pressure container business is low margin construction of metal tanks to hold and transport pressurized materials such as compressed natural gas. CNG storage and transportation includes vehicle conversion kits, CNG transport trailers, and turnkey design and construction of CNG retail filling stations. Finally, the CNG retail filling stations leverage the other two segments to build and operate company-held compressed natural gas filling stations.
Based in Shandong province, China, SNEN has a little less than 400 employees. Their current fully diluted share base is about 35MM. The company first began operating in Shangdong in 1956 as Qingdao General Machinery Factory.
The Business
In the recent past, SNEN has maintained a healthy business as a provider of pressurized containers and turnkey CNG station solutions. In the 4th quarter of 2006 the company reported revenue of 2.6MM and net income of 1.1MM based only on these two segments. Full year 2006 net income amounted to $3.4MM.
The company changed strategy in 2007 and secured financing to build out a network of 30 company owned retail CNG filling stations. At the same time the company restructured their pressure container business to focus on higher margin products associated with CNG, biodiesel, and LPG. This resulted in lower revenue and net income in the first quarter of 2007 as CNG station design and construction were all but suspended in order to support company-owned station construction.
Retail CNG Stations
Although SNEN's other business lines can probably support 16MM revenue and eight to ten cents per share in net income annually on an on-going basis, the real future of this company is in the retail sale of compressed natural gas. The economics are compelling. Consider the case of Wuhan, the target city for SNEN's first retail CNG filling stations.
There are 5000 buses and 20000 taxis in the city of Wuhan. Although only several hundred currently run on CNG, the local government has signed a JV with a company to convert vehicles. According to SNEN management up to 300 buses per day can be converted under this joint venture agreement, meaning the entire fleet of buses could be converted in about a quarter.
Each bus travels about 200 km in a typical day, consuming about $40.66 in gasoline. The same bus would consume only $23.75 per day in CNG to do the same work. That's a 41.5% cost savings. A typical taxi might travel twice as far and consume $20.65 in gasoline daily. Switched to CNG, that fuel cost drops to $12. So it's not hard to imagine why people would want to convert as soon as possible.
How much CNG retail business would Wuhan's bus/taxi fleet support? Consider that at typical bus would consume 65 to 80 m3 of CNG daily and a typical taxi would consume 25 to 30 m3 per day. If there are 5k buses and 20k taxis that amounts to 825k m3 per day. Each of SNEN's stations will dispense about 10k m3 per day under typical operating conditions so the existing fleet in Wuhan could support more than 80 stations. That's just one city...and that doesn't even consider what demand there might from non-commercial passenger vehicles.
From the retailer's perspective, the economics are also very attractive. According to SNEN, a given station will produce 300k in annual net income and 1.3MM in annual revenues. That's over 20% net margin which is good by any standard. More importantly, SNEN have 30 stations financed and under development that are scheduled to be operational by the beginning of 2008. If they perform per company guidance that will amount to 9MM in annual net income or 25.7 cent per fully diluted share (based on May 07 fully diluted share base of 35MM per Laby Wu, CFO).
Long Term Prospects
Long term, SNEN plan to open 70 stations over the next 3 years. 30 are already funded and will be complete by the end of 2007. 40 more need to be financed to the tune of 800k per station.
The company also signed a gas supply contract recently to supply up to 200MM m3 of gas daily. The supply agreement commences in 2009 upon completion of a gas pipeline to that location. SNEN plans to build a compression 'mother station' at a cost of $5MM that will generate $60MM in annual revenue and net income in the range of $10MM to SNEN's 60% owned subsidiary Hubei Gather.
So, long term, the company is looking at another 40*300k + 60%*10MM = 18MM in annual net income. This for a total capital expenditure of about 37MM which will probably be financed through equity. That probably amounts to 11MM shares of dilution, conservatively.
Boone Times
T. Boone Pickens recently made headlines by making the rounds through CNBC and the Wall Street Journal after visiting China to investigate compressed natural gas as a fuel for transportation. It seems he is going to make an investment in the CNG retail business through one of his funds.
From The Wall Street Journal: "Natural gas is cheaper and better for transportation," he told reporters in Beijing.
Mr. Pickens's group says the world has six million autos that run on natural gas, but such vehicles remain a tiny share in most markets, including China, where they are limited to a small number of buses and taxis. Beijing has pledged to put several thousand buses powered by natural gas on the road ahead of the 2008 Olympics in an effort to cut air pollution. Other cities in China are converting their taxi and bus fleets to run on natural gas."
Say what you want about Pickens, but he knows a thing or two about making money in the energy markets. And he represents a source of well-financed capital. The article never mentions what company he talked with, but it serves notice that CNG in China is an industry that has government support and has piqued the interest of some big time finance.
Valuation
The company has guided to 9MM-10MM operating income in 2007. The share purchase agreement they signed in february placed half a million shares in escrow that are subject to pro-rated forfeiture if the company doesn't achieve 2007 net income per fully diluted share of at least 35.3 cents. Depending on how FDEPS is calculated, I doubt they'll make that number. They certainly won't make it if 10MM operating income is achieved and they use the true fully-converted, fully-exercised diluted share base of 35MM.
Using an average fully diluted share count of 30MM, FDEPS are likely to be 30 to 33 cents per share. At that point, 30 stations will be built, a third of them that have contributed no revenue will be poised to contribute a full quarter's revenue. A 12x multiple is ridiculously low for a company with SNEN's fundamentals, but that would mean a share price of $3.60 to $3.96. That works out to a total return of >40%.
Medium Term Model
Date Cashflow
7/21/2007 2.45
28-Apr-08 -3.6
IRR 64.56%
Total 46.94%
Long term, the company will generate 21MM in annual net income from 70 CNG stations, 6MM from Hubei Gather, and ~4MM from their other business segments. On a share base of 46MM, that works out to 67 cents a share.
Long Term Model
Date Cashflow
7/21/2007 2.45
31-Mar-10 -8.04
IRR 55.39%
Total 228.16%
Disclosure: Author is long SNEN
