China Direct: Expecting Stellar Growth

This is meant to be an update to my previous article entitled “China Direct: Star on the Horizon,” posted on February 4, 2008. China Direct, Inc. (Nasdaq: CDS) has been consolidating amidst the recent turmoil of the world’s financial markets and is now poised to challenge its 52-week high of $12.95 within the next few months.

At the time of my last article, China Direct had announced their intent to acquire majority stakes in two magnesium companies located in Inner Mongolia. As of now one of those has been consummated, Baotou Changxin, formerly referred to by the company as Baotou Sanhe. The second, Baotou Xinjin, is scheduled to be consummated on or before June 30, 2008 according to a recent press release.

In a recent conference call and in subsequent press releases, management estimated magnesium production and distribution numbers for 2008. Total production will equal or exceed 40,000 metric tons and distribution will equal or exceed 45,000 metric tons. The company sells a large percentage of magnesium under long-term contracts (6-9 months), therefore, in this strongly rising market the average selling price is well under the average spot price during any period. Magnesium spot prices have been very strong lately, settling at just under $6000/metric ton in the last week.

The current 2008 guidance given by management is for $320 million revenue, $26 million net income, and $1.08 earnings per share, which is based on 24 million shares and excludes certain non-cash items. This estimate represents a whopping 61% increase over earnings per share of $0.67 in 2007, however, even a very conservative analysis of the numbers given above will show these estimates to be too low by a fairly wide margin.

Assuming an average selling price of $3500 per metric ton for magnesium in 2008 and a blended net margin of 10% for the total magnesium division yields $298 million revenue, $29.8 million net income, and $1.24 earnings per share using 24 million shares. Their basic materials, clean technology, and consulting segments did a total of approximately $73 million revenue in 2007 and are expected to remain steady or grow in 2008. Basic materials and clean technology don’t add much to the bottom line, but consulting certainly does. In their 10-K for 2007, China Direct management indicated expected growth for all of these segments. Total operating income for these three segments in 2007 was approximately $8 million. Assuming a similar ratio for net income to operating income for 2008 for these segments, one can estimate total net income for the company to exceed $36 million. Again, using 24 million shares as a weighted average for the year, total earnings per share will be $1.50 excluding non-cash items. Revenue will more than likely exceed $370 million.

The market is currently not placing a strong premium on growth. Although prospects for the company have improved, market conditions force me to reiterate my 12-month price target of $20, which represents a forward PE of just 13 based on my estimated 2008 numbers.

Sentiment: Strong buy

12-month price target: $20

Disclosure: Author has a long position in CDS

Comments

[bluehorses]

We've owned it since $6.82. When is this "breakout" going to materialize?

[bajaroosters]

I think cds will continue a slow climb until Shanghai and Hang Seng markets stabilize ... see interesting article on China and India in today's WSJ ... when will that be? late '08 or early '09 imho ...

[max petrisek]

All your goals are too optimistic since Chinese stocks have taken a beaten for months and CDS is no exception. I would find it difficult to reco a buy at this time. This is a quick look resdponse.

[insatiable]

whats wrong with cds? why the stock is going down? and how much is the magnisum prices please?