KHD Humboldt Wedag Has Powerful Growth Potential at a Low Price

On Friday, I added a starter position in this very interesting Hong Kong based infrastructure name: KHD Humbolt Wedag (KHD). Yes that's a mouthful.

I actually found this name in my ever constant search for new and better ideas through an article on Seeking Alpha.

• KHD Humboldt Wedag International, Ltd. (KHD) has spent two years transforming itself from a financial services company into a global infrastructure company. Prior to November 1, 2005 the company was known as MFC Bancorp.
• The transition was completed in the 3rd quarter and now the company is focused on their core business of (from their website): supplying proprietary technologies, equipment and engineering/design services for cement, coal and minerals processing. KHD through its subsidiaries offers their clients all over the world engineering services, machinery, plant and processes as well as process automation, installation and commissioning. The services include staff training as well as pre- and after-sales services through to feasibility studies and financing concepts. This array of supplies and services includes, in particular, the modernization of existing facilities for capacity increases and, for reducing the specific energy demand and the burden on the environment.
• First, KHD’s primary markets are Asia, Russia and eastern Europe. It also does business in the Middle East and Africa. All are strong growth areas for infrastructure.
• Second, revenues are earnings are growing at 50% to 100% rates over 2006 quarters and year to date. The company’s backlog of signed orders is also growing: on Sept. 30 the backlog was $762 million, by Nov. 14 it was up to $925 million. The company has done $420 million in revenue for the first 9 months of 2007.
• Third, the company has a PE of 21 on trailing earnings and over $9 a share in cash. The stock is very fairly valued for this type of growth. I believe the transition from financial services has not yet been noticed by the general market.
• Finally, the company is followed by very few analysts. Yahoo finance shows one, TradeKing has no earning estimates available, there is very little info out on the Internet about the company. So you have a $1 billion market cap, international stock doing infrastructure business in emerging markets, that hasn’t been discovered. Sounds to me like a recipe for some outstanding stock price appreciation.

Well I couldn't have dreamed up a better scenario myself. For those who have been following along you know I love the infrastructure group for: little exposure to domestic US economy, exposure to energy markets, exposure to petrodollars, growing backlogs, etc etc. I also love any companies with exposure to truly emerging markets such as Africa, Eastern Europe, and the Middle East. (For example my investment in Millicom Cellular International (MICC)). So here is a name that appears to be a home run.

Now I will say normally I have a lot of suspicion concerning companies that are completely changing their line of business, but it appears over time this seems to be a legitimate and in fact very successful transformation. The numbers in the latest earnings report are truly impressive.

• Revenue for first 9 months of 2007 +75% over 2006
• Net income for first 9 months of 2007 +102% over 2006
• Revenue for Q3 2007 +54% over Q3 2006
• Net income for Q3 2007 +63% over Q3 2006
• Backlog was $762M on Sept 30, 2007 - as of Nov 14, 2007 it increased to $925M

So obviously these are heady numbers, and while I don't expect this pace to continue as the company grows larger, it looks headed for a nice 30% growth rate for the near term. Analysts are not on board with that, claiming despite 40% revenue growth rate projections for 2008, EPS will only grow by 18% (this could be due in part to higher tax rates, I am not sure yet). Despite this impressive growth background, KHD Humbolt Wedag is valued at only 18x 2007 estimates and 15.5x 2008 estimates (which appear on the surface to be too low). So we get quality growth at a low price - the best of both worlds.

Motley Fool also weighed in on KHD Humbolt Wedag in an August article:

• With all of the troubles in residential real estate, and the worries over weakness in commercial real estate, it might be a bit surprising to see a company that helps build cement plants continue to post amazing growth.
• The strength behind KHD's growth is that it has a truly international business. The difference being that KHD receives an even smaller percentage of its sales from the U.S., which has helped to shelter it from some of the worries recently plaguing our markets.
• 70% of the company's order intake during the second quarter came from Asia, Russia, and Eastern Europe. The company's partnership with CITIC Heavy Machinery will likely provide another stream of earnings starting next year.
• Some might quibble that the 13% gross margins are far below last quarter's results, but the company advised last quarter that those results weren't sustainable. Through the first six months of the year, the company's 16% gross margin is right on par with historical results.
• Overall, the coal and minerals sales only represent about 15% of the current backlog.
• KHD would like to do an acquisition in this sector, and it has the cash and overall balance sheet strength to make one, but it can't find an attractively priced target. It's willing to wait, and in the meantime, the company is pursuing partnerships here and in waste treatment. That should help diversify its revenue stream away from cement engineering, projects where growth will inevitably level off.

So as we've seen with some smaller cap stocks of late in the international arena, when the US market weakens people start tossing the smaller fare out the window the quickest. Stocks like WuXi PharmaTecth (WX) from China, Gafisa (GFA) from Brazil, and Mechel (MTL) were treated like Rosie O'Donnel at a Republican caucus. So buying a stock like this carries the risk of the "baby getting thrown out with bathwater" when the market turns south, plus it carries the inevitable fear of global slowdown risk.

While I think that will be a misguided assumption, it does not mean these type of stocks cannot lose a third of their value very quickly while panicky investors flee. It won't mean a change in fundamentals, simply a change in perception. In fact, KHD Humbolt Wedag has already taken quite a hit - the stock peaked near $46 on Halloween and has lost a third of its value simply due to 'fear'.

On a technical basis, the stock's 200 day moving average has been in the mid $28s, which is where the stock fell to in the worst of the selling. It has since recovered a bit, and made a nice 4-5% type of move Friday. What I would like to see now is a move back above the 50 day moving average ($34 and falling by the day) to establish a clear new uptrend. However, I am willing to start a stake here, with the understanding the stock could be relatively range bound until it breaks over this $34 level. So a break above $34 would be bullish, a break below $29 would be bearish and everything in between those 2 levels is sort of 'white noise' from a technical standpoint. I began my KHD Humbolt Wedag position with a 250 share stake in the mid $31s, or roughly $7.7K (0.7% stake). On either a breakout above $34 or a pullback to $29 I will add a larger stake in this position.

Disclosure: Long all names mentioned in story in fund; long none in personal account