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A China Smallcap for LT returns

|Includes: China Industrial Waste Management, Inc. (CIWT)
China Industrial Waste Management is a provider of comprehensive environmental services and solutions in northeastern China. The company currently has two primary areas of business. In their Industrial Solid Waste Treatment and Recycling business, the company collects, stores, treats, disposes and recycles industrial solid waste. In its Sludge and Sewage Treatment business, the company is licensed to treat municipal sewage generated from a designated portion of Dalian, China, as well as treat the sludge resulting from the processing of sewage routed to them from sewage treatment facilities. In addition, they recently began to offer sludge processing equipment supply and engineering services.
The company generates revenue from two business areas: 1. The collection of fees and 2. Sales of recycled commodities such as cupric sulfate and methane.

Not only has CIWT proven to be more than a simple landfill company by offering more advanced technologies, the company has as well proven to be a leading recognised service provider in their region.
Its facilities have been awarded different prices such as the award for "Best Sewage Sludge Process Application of China" for their sludge-to-energy plant that generates methane which is then sold to the Dalian Gas Company (trough a 20 year BOT-project).
Some CCTV coverage on the sludge treatment facility can be found here
Its in this expertise that the company has also formed a joint venture with a company called German Lipp; Dalian Lipp, the sole appointed partner by German Lipp in the arena of anaerobic fermentation in China
Morover, the companys CEO has been named one of theTop Tenin Dalians economy and is also the chairman of the Dalian Environmental Protection Association
In july 2010, CIWT was approached to lead the oil waste management operation following Chinas largest recorded oil spill off the coast of Dalian City, and one year later the CEO was being authorized to represent all waste treatment service providers in Liaoning province at the Environmental Safety Conference in Shenyang.

Because of the rapid waste management & sludge treatment industry growth fueled by industrialization and urbanization in China, the company has been investing heavily over the last two years in projects to expand their capacity and several projects will come online from the end of 2011. For example they will double (!) their industrial solid waste disposal and treatment capacity by the end of 2011. (Last year the service fees related to the solid waste came in at 11,6m which equals to around 50% of total revenues. )

Due to Chinas high growth I want to make sure my investment pick has some degree of sustainability, even when growth might temporary slow down or when competitors would try to kick in and create a downward pressure on profit margins. Enough companies have shown to be a labor-shop only, or have had a business model that would only turn out last a couple of years to make a quick profit.
Waste management firms usually offer a certain earnings predictability because of a steady recurring revenue flow due to the nature of their contracts, which often are long term contracts with municipalities such as BOT projects. These BOT projects are designed to generate a steady and recurring source of income (from the PRC gov) over a sustained period of time - typically between 20 and 25 years. This ensures that another hard recession cannot simply weep out this company.
In contrast, the resale of commodities (cupric sulfate, metals, methane...) typically makes up around 30% of their revenue. Therefore any rise or drop in commodity prices will as well affect CIWTs profit. The management however seems to be fairly competent in pursuing an active commodity inventory management and has succeeded to increase commodity inventory in 2009 when prices were low and is now reaping benefits of it (for example the price of cupric sulfate has gone up almost 50% by the time they were holding it.)

Another advantage of the waste management industry is that its a very capital intensive industry.
So far the company hasnt been in need for extra funds and is able to borrow more money from banks, which leaves the company some room to not immediately address the capital markets.
Some bigger multinational companies, take Veolia for example, have been active in China for hazardous waste management operations as well. However, the initial resuls were below expectations. These prominent giants do have competitive advantages in sufficiency of capital and advanced technology over many local participants (that’s why it’s such a big plus for CIWT to be one of the more advanced technological players in their industry). The local players however also have their advantages, according to management. First of all CIWT is listed as one of the 31 hazardous waste treatment center for Liaoning Province and possess utmost treatment facilities to serve the surrounding areas, and the only company out of two to have been given certain landfill rights in the whole Liaoning Province. According to management, the relevant authority is not likely to grant Redundant construction of such facilities when existing ones can satisfy local demand. A second competitive advantage over the multinational players trying to access the Chinese market might be the comprehensive utilization rate. This improved comprehensive utilization rate is of utmost importance to enhance high profitability. To realize this goal, not only technology is required but also a decent market exploration, which is non-realizable without long term accumulation of knowledge on the local market. Therefore, the overseas giants will have to rely on relatively high cost measures, namely incinerator or landfill, to handle waste. They might be doomed to lose economic feasibility from the very beginning by doing waste management business in that way.
So it’s fair to conclude that entry barriers seem to be very high for newcomers who would try to take home their share of the profits and the very promising future growth prospects in this sector.

Basically to me CIWT seems to be in the perfect business, it’s profiting from China’s environmental issues and active in sectors such as the (grey)water and alternative energy sector. And if you believe in rising commodity prices, you will get your share of it by buying CIWT as well. Buffet and Gates who both love the waste industry nowadays, have been said new opportunities can be found in emerging markets investing heavily in waste management infrastructure, which does not seem to be incorrect at all if you take a look at the stimuli CIWT is receiving from the PRC for its expansion plans.
Finally, the greater part (66,7%) of the company is held by insiders (especially by the CEO who owns 62.8% of the company), and I like to put my money where his is. Besides, it makes me comfortable knowing that in 2008 the company raised funds by selling 1,32 million shares to a group of institutional investors for a price of 2 dollar/share, issuing 660k + 660k warrants which expire this year in September at 3.5 and 4.5 respectively. The top management has a compensation plan with options involved (about 30% of there compensation is in options) thus they can’t just neglect the share price and keep investors waiting for another couple of years.

The company has already made many efforts in improving investor relations and is very willing to help and listen to shareholders opinions.
In a mid 09 press release the company stated that it “is currently evaluating the establishment of one or more committees in connection with a possible application for listing [...] on a national stock exchange in the US”. They seem to have kept their promises as they have since engaged a legal counsel (Pryor Cashman) to “help them take the company to the next level” in the US capital markets, appointed independent directors and formed an Audit Committee and Compensation Committee. Management stated that they will submit an application for an up-listing to a major stock exchange when they believe the company has reached the minimum criteria.
Moreover, only less than two weeks ago, they have engaged the firm of UHY LLP ( ranked by Accounting Today as a Top 20 professional services firm) as its new independent registered public accountant to fight the excessive pessimism in the Chinese RTO markets.

The share price in contrast seem to be hitting 3y-lows and currently fluctuates around 1.0 on a very low volume and can easily shoot up or down 20% or more in one single day without any obvious reason. Buying shares of the company does not seem to be ideal for short term profits and you’ll need a strong stomach once you get in, but it could be very lucrative on the long-term. The company is trading at a P/E of only 2.85 and their book value stands at around 2.2 last quarter, which is about 250% higher. Not at all expensively priced for a company that’s growing net income double digits yoy and seems to still have it’s best years to come/ahead?

As the company seems to be legitimate, a fair and conservative P/E of only 12 would be easy to justify. That would translate into a share price of 3.85, more than 4 times the current stock price.

This stock is definitely a long play and can’t be missed in my basket of beaten down quality Chinese RTO companies with a more than promising future.