Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

My Study Notes On China Armco Metals: Part One - Business Overview

While Chinese ADRs has always been interesting case studies for institutional and retail investors with an appetite for participating in China's robust growth through equity investment over the past 20 years, it is more true recently with a slew of U.S.-listed Chinese companies going private or dark in light of countless short attacks and fraud accusations. Lack of institutional participation and support has driven prices of many small/macro- cap Chinese ADRs to historical (in some cases, ridiculous) low levels. While it appears that the U.S. capital market will likely remain "unfriendly" for a while for many small/micro- cap Chinese ADRs, we believe current environment also provides unique opportunities for investors who do their "homework". China Armco Metals (CNAM) is one of those Chinese ADRs that caught our attention with its deeply discount valuation - the stock is trading at a mere 0.16x tangible book value per share of $1.80.

Business Overview:

Incorporated in 2001 and went public through a reverse takeover in June 2008, China Armco Metals, Inc. started as an importer of metal ore and non-ferrous metals in PRC. Its imports iron, chrome, nickel, copper, and manganese ores, as well as non-ferrous metals, coal, and steel billets from various countries including Brazil, India, South Africa, Oman, Turkey, Nigeria, Indonesia and Philippines. Over the five period between 2008 and 2012, the Company has generated approximately $300 million in metal ore trading revenue with gross margins for the trading business ranging from the low of 4.9% in 2011 and 2012 to the high of 10.3% in 2009.

Since 2009, the Company has been trying to diversify away from a pure metal ore trading company by building a scrap metal recycling facility in Lianyungang City, Jiangsu Province. According to its SEC filings, the Company has spent approximately $50 million in acquiring the land use right of a 32-acre land parcel and building a state-of-the-art scrap metal recycling facility which has design capacity of one million metric tons ("MT") per year and current capacity of 600,000 MT. Since Q3 of 2010, the scrap metal recycling business has over $124 million in sales revenue. Notably in 2012, the scrap metal recycling business surpassed its trading business and contributed 58% of total revenue and 74% of gross profit, making it the "bread and butter" of the Company's businesses.

Our Takes:

While any business having anything to do with iron or steel processing these days in China tends to keep most investors away as the entire steel value chain battles looming supply gluts and weakening demand on the back of an economic slowdown in the world's largest economy, we believe that a cooling housing market and slowing infrastructure build out, combined with overcapacity and unprofitability among majority of steel makers, will likely continue to put pressure on iron ore and steel prices in the near term and thus affect China Armco Metal's businesses, particularly its trading business. That said, we think current environment makes it very difficult for investors to gauge the earnings prospect of the Company's trading business.

In summary, an overview of CNAM's business lines clears the way for us to truly understand the Company's recent financial results which we will discuss in detail in our next article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.