Meanwhile, the Chinese market has corrected sharply from the highs of last year and now looks more reasonably priced. After hitting lows in mid-March, Chinese equities have regained some upward momentum and have begun to recover, though they remain significantly lower than the levels achieved in mid-October. At these prices, there are more attractive opportunities in that market than was the case last fall.
WSP Holdings (WH), which is headquartered in Wuxi and went public in December 2007, offers an inexpensive play on both markets. As I have described in my earlier posts, WSP Holdings is a leading Chinese manufacturer of API (American Petroleum Institute) and non-API seamless casings, tubing, and drill pipes used for oil and natural gas exploration, drilling, and extraction, known as "Oil Country Tubular Goods" [OCTG]. It has a market cap of $787 million. At a price of $7.67 per share at last Friday's close, it has a trailing P/E of 8.43 (based on its last quarterly earnings report) and forward P/E ratios of 8.72 for 2008 and 6.79 for 2009.
The quarterly earnings conference call on May 15, which received little notice, was quite promising. Net revenues for 1Q 2008 increased 31.6% from 1Q 2007 to $131.2 million. Gross profit for 1Q 2008 increased 25.3% year-on-year to $32.0 million, though the gross profit margin declined to 24.4% from 25.6%. Income from operations grew 10.6% to $25.1 million; net income was $15.8 million, down 1.1% from $16.0 million. A net foreign exchange loss in the quarter, due to the depreciation of the US dollar against the Chinese renminbi, subtracted $1.6 million from income. Overall, revenues came in above earlier company forecasts of $110-$130 million, while net income was within the forecast of $14-$17 million. For the year, management remained comfortable with its forecast of net income in the $80-95 million range ($0.78-$0.92 per share); currently, the consensus estimate (two analysts!) is for $0.88.
Non-API product sales in 1Q 2008, a higher margin item and the fastest growing segment, increased 90.2% on the same period last year, accounting for 42.9% of the company's net revenues. In March of this year, WSP received an order from SINOPEC for 5,300 metric tonnes of non-API products.
The major cause of the decrease in profit margins was increased raw materials costs, which in turn raised production costs. Going forward, WSP's management expects to be able to pass on these increased costs to their customers. The increase in non-API products, both as a percentage of sales and in absolute terms, will also help. In line with overall oil demand, management expects demand for their products to continue to grow at a rapid pace.
In order to support this growth in demand, WSP Holdings is expanding its production capacity with major investments. It invested $28 million to acquire a 70% stake in Liaoyang Seamless Oil Pipes Company, which will construct a manufacturing facility for hot-rolling, finishing, and heat treating OCTG pipes. This facility is expected to be complete between August and October of 2009. Also, WSP invested another $6 million to establish a wholly-owned subsidiary, Songyuan Seamless Oil Pipes Company, and start construction on a facility for pipe threading, which should be complete by the end of this year and start production in the first quarter of 2009.
Though there are no long-term growth forecasts for WSP Holdings, analysts forecast a 28% growth in earnings from 2008 to 2009, following on an 8% decline predicted for this year. Given a 2009 forward P/E of 6.79, this produces an attractive PEG (P/E divided by growth) of 0.24. Price to cash flow for the trailing twelve months is 8.40, also attractive. Further, the company has been conservative in its financing, maintaining a low debt/equity ratio of 0.173 -- much lower than the average for the industry.
WSP is not followed by many analysts and has consequently remained below the radar. Compared to similar firms in the oil services industry, WSP Holdings is inexpensive. Though not in precisely the same business line, Baker Hughes (BHI) is valued at a P/E of 17.6 and Allis-Chalmers Energy (ALY) is valued at a P/E of 14.0. At their highs, the P/E ratios of both of those companies have been in the 20's. In this context, WSP Holdings could easily justify a P/E of at least 15. With earnings estimates for 2009 ranging between $1.10 and $1.16 per share, for an average estimate of $1.13, WSP could thus conservatively be priced at $17. If we estimate a long-term growth rate in the region of 20%, one could easily make a case for a P/E of 20 and a target price of $22 or better.
Of course, WSP is not without risk -- it is, after all, a Chinese small cap company and transparency is always a concern. Additionally, with a small company, any shift in demand from one major customer (such as SINOPEC) can produce a significant impact on results.
However, with these results and the prospects for WSP Holdings, I will continue to be a buyer.