China Clean Energy, Gushan: Very Different Animals in China's Biodiesel Space

China Clean Energy's (CCGY.OB) fundamentals seem to be deteriorating quick. The company released its Q1 results on Monday and they disappoint. Here are some highlights:

- Revenues of $4.5 million, up a mere 8% yoy
- Gross profit DOWN 9% yoy
- The company almost went into the red with net income of just ~$164,000
- EPS of $0.01

By any measure this is quite a reversal of fortune. We have already been warned: commodity prices are rising fast, and with flat growth in diesel prices in China, margins are getting squeezed. The fact is, the landscape for the company's core business has changed, which is why CCGY recently announced that it will be shifting its focus away from biodiesel to concentrate on specialty chemicals. How it will do so still remains a mystery to me. It appears that the new biodiesel plant the company is building can be quickly refitted to be used for producing other chemicals. I hope CCGY can come forth with more specific information as to how this is to be accomplished.

But there is another mystery to this story. When CCGY announced that it is moving away from biodiesel, NYSE-listed Gushan Environmental Energy (GU), the largest producer of biodiesel in China, had this to say (press release dated 4/28):

"Although we are aware of another operator in the PRC biodiesel sector recently reporting material adverse changes in its operating conditions, we have not experienced similar changes in our operating conditions. The underlying trends in both our raw materials costs and selling prices for our products remain the same as we have previously reported in our public filings ..."

In fact, Gushan is forging ahead to begin construction of its biodiesel plants in Chongqing and Hunan, while increasing the capacity at its Beijing plant. It has another plant in Shanghai which is coming on line in June this year. So what is the difference between GU and CCGY? Gushan's Q1 earnings statement released Tuesday provides a clue:

"The increase in the average selling price of biodiesel was attributed to an increase in the retail selling price of diesel, resulting from an increase in the guidance price of diesel set by the PRC government in November 2007 coupled with continuing shortage of diesel supply in China, and the commencement of sales in March 2008 of some of Gushan's biodiesel to chemical companies at higher selling prices than those prevailing in the diesel market."

The fact is, there is a shortage of diesel in China. Biodiesel can alleviate that shortage. The question then is: what impact does this have on the wholesale price of biodiesel? I suspect the answer may be different for different companies. Gushan is able to sell its biodiesel at a premium to market, thus counteracting some of the margin squeeze. Given that GU is a major supplier, this is not out of the realm of possibility. It is the 800 pound gorilla in this space.

But Gushan is also saying that it is not experiencing any rise in commodity prices, at least in the earlier press release. This is difficult to swallow. But Tuesday's statement clarifies (my emphasis in bold):

"That increased capacity, together with significant increases in diesel selling prices reflecting strong local demand, rising global prices and the company's success at expanding sales of its biodiesel products to the chemical industry, allowed us to achieve strong growth in both sales and income despite increases in raw material prices in line with rising transportation and labor costs in China."

So the scenario is actually very simple. Gushan, taking advantage of local market situations and buyers from the chemical industry, is able to sell its biodiesel at a premium, allowing the company to adjust for increases in commodity prices. CCGY, a smaller company, is subject to wholesale diesel prices set by the government and is devastated by rising raw material costs. Is it any wonder then that CCGY is currently trading at below $1 while GU is up almost 10% Tuesday?

My Position: None.

Comments

[User 152213]

Great article! Thanks for helping us to flesh out GU.

[gadflea]

As I was saying...................


On May 14 09:29 AM User 152213 wrote:

> Great article! Thanks for helping us to flesh out GU.

[BeijingBased]

Gushan is in flaud. If you talk with any provider of used cooking oil, they would quote you more than 4000 RMB per ton. But GU claimed their cost is less than 2300 RMB per ton. Their Beijing factory started partial production since middle of April. But they claimed to start production in January.

[sagemama]

if you listened to the conference call, you would have heard that they have proprietary technology that allows them to use a lower grade of grease, thereby cheaper.
also they state that they have scale, which gives them leverage in negotiating prices.