My China play: SDTH

[David Randolph]

As you know China related stocks have been very hot lately, with good and bad stocks moving up quite sharply. The "China" trademark in the stock market went from seen with skepticism to "I can't miss China's growth". This made Chinese stocks earnings multiple expand from below market average to way above market average, because expectations for growth are naturally higher for China than for the US or the World for that matter.

Since the Chinese economy is growing more than others and expected to keep that way for years to come, it is natural for the market to attach an higher multiple to Chinese stocks than others. Chinese stocks also have huge potential because of the size of the market, 1.3 billion people is a lot of people.

I'm like others, I feel I can't miss on China's growth. But I'm not going to chase high flyers without fundamental backup, I need something more solid to have strong hands. I didn't have to go very far to find one of these stocks, it was right here on my side for weeks, the little video analysis for SDTH:

A video Analysis from 3StocksOnFire.org

You can see that I, like others, was a bit skeptical, even though the valuation model said the stock was attractive.

But the thing is the valuation model needs to be updated, because the fundamental outlook improved dramatically when the following press release came out:

• ShengdaTech Begins Construction of New NPCC Factory
PR Newswire (Mon, Sep 17)

«Once the second phase of the Xianyang facility is completed, the Company's total NPCC capacity will be 190,000 metric tons, an increase of 111% from a capacity of 90,000 metric tons at the beginning of 2007.»

I see more than 100% revenue growth here, not the 30% I had in my valuation model. If I change the revenue CAGR estimate to 2 and by the way, if I increase the earnings multiple to 20, I get the following results:



112% share price CAGR would mean SDTH would be the 2nd most attractive stock of the Main Portfolio.

The company already gave a $0.44 EPS guidance for 2007 and analysts see $0.59 EPS for 2008. But I see a lot more than that, say, about $0.9, that is, roughly double of 2007, since production capacity in 2008 will be more than double of 2007 and the demand seems to absorb  everything they can produce.

With $0.9 EPS in 2008 and a 20 times earnings multiple we're looking at an $18 stock in late 2008, maybe earlier. Longer term, if fundamental trends continue (looking at the company's products, I don't see why not), we could expect even more.

The trading plan is:

Buy SDTH, 6.66% of capital as always.

[BigSully1]

David I like your SDTH pick OK and bought some of it, but I would like you to take another look at 3 S Bio - SSRX. It was also in the list of Chinese rockets I asked you about the other day. BTW, I meant to thank you for your response, just hadn't got around to it, till now. I know it's not in your favorite sector (medical/genetics), but the sector has been on fire, and SSRX is again on fire today on even bigger volume +1600%.

I'm not entirely sure about the fundamentals myself, and am always a little leery about these recent Chinese IPO's, but IBD rates SSRX with a score of 98 A+, with best in group (out of 30) both overall and fundamentally, and 3rd in group both technically and attractiveness. It may even now move into best in group on the latter two conditions after todays big move. It seems institutions are buying very heavily into it. So if you would take a deeper look, I'd appreciate.

Thanks again David.

[berloga]

Damn, I blinked at the open and my order filled at $7.20... No more blinking for me!! A good pick, David, thanks. 

[BigSully1]

Damn, I blinked at the open and my order filled at $7.20... No more blinking for me!! A good pick, David, thanks. 

I waited while it ran up, fell back below $6.95 resistance for awhile, and then traded back above $7.00 before I started buying. My average should be about $7.05 or $7.06, a few $'s more than it could have been had for, but better safe than sorry? I believe $6.95 should hopefully provide good support now if I'm not mistaken, whaddaya think?

[BigSully1]

David I like your SDTH pick OK and bought some of it, but I would like you to take another look at 3 S Bio - SSRX. It was also in the list of Chinese rockets I asked you about the other day. BTW, I meant to thank you for your response, just hadn't got around to it, till now. I know it's not in your favorite sector (medical/genetics), but the sector has been on fire, and SSRX is again on fire today on even bigger volume +1600%.

I'm not entirely sure about the fundamentals myself, and am always a little leery about these recent Chinese IPO's, but IBD rates SSRX with a score of 98 A+, with best in group (out of 30) both overall and fundamentally, and 3rd in group both technically and attractiveness. It may even now move into best in group on the latter two conditions after todays big move. It seems institutions are buying very heavily into it. So if you would take a deeper look, I'd appreciate.

Thanks again David.

David you might just want to put SSRX on the back burner for now. I'm growing increasingly wary of these Chinese crotch rockets right now, especially with U.S. markets at a critical technical tipping point and even though I have much more than my fair share of them. People seem to be buying with little DD and regard to the real fundamentals, as long as it's Chinese, up it goes, and numbers shown on Yahoo and elsewhere are often way incorrect. I'm glad you do your DD on them. Some are getting way overheated and probably way overvalued. It's gotten pretty scary and my hair is beginning to stand on end. The last ones in will get burnt, probably severely. I do believe we're fine with SDTH at this point, for now,  but I intend to lighten up on a few others today, maybe even PGJ. This seemingly irrational behavior could continue for some time to come, but I,m going to start reducing my risk anyway. There's probably still some undervalued/reasonably valued ones out there, but getting harder to find, IMO. Maybe you'll find some more though.

Yesterdays moon shot was CHNR - up 75%, but don't own it. JRJC back near a new high. Others were also up consideraby, but who's looking unless it's up more than 30% in a day?

I'm going to make a different request/suggestion to you later today - not Chinese.

[David Randolph]

David you might just want to put SSRX on the back burner for now. I'm growing increasingly wary of these Chinese crotch rockets right now, especially with U.S. markets at a critical technical tipping point and even though I have much more than my fair share of them. People seem to be buying with little DD and regard to the real fundamentals, as long as it's Chinese, up it goes, and numbers shown on Yahoo and elsewhere are often way incorrect. I'm glad you do your DD on them. Some are getting way overheated and probably way overvalued. It's gotten pretty scary and my hair is beginning to stand on end. The last ones in will get burnt, probably severely. I do believe we're fine with SDTH at this point, for now,  but I intend to lighten up on a few others today, maybe even PGJ. This seemingly irrational behavior could continue for some time to come, but I,m going to start reducing my risk anyway. There's probably still some undervalued/reasonably valued ones out there, but getting harder to find, IMO. Maybe you'll find some more though.

Wow, SSRX was up 16% yesterday. I see what you mean, the company is now a $325 M market cap company, with just $16 M in revenues in 2006, which means the Price to Sales Ratio is about 20

Anyway, I'm not all that worried about the US stock market for now ... I believe we'll be at new all time highs in the S&P 500 before 2007 closes. And, if Chinese stocks are going for a bubble, it may last several months (I hope not, I hope it blows right away, before there's the possibility of a potential crash damaging the Chinese and World economy).

As for SDTH, there was a lot of volume yesterday ... one could see the selling pressure, or else the stock would have been up 20% plus.

There was an SEC filing out today saying there are 8,312,603 shares for sale (the total number of shares outstanding is 54,095,103, so, not such a big deal in my opinion). And, you know, these are existing shares, not newly issued shares. There are always people buying and selling shares, I'm not concerned about this issue, even though probably there can be some sellers due to this SEC file today (which would be a buying opportunity).

Management talked abut this issue in a recent press release:

«ShengdaTech also confirms that the recent filing to sell 1,830,000 shares of the Company's common stock is by six investors who invested in ShengdaTech prior to the Company going public. These investors are not members of management or related to the management team. The Company confirms that there have been no sales of common stock by officers and directors of ShengdaTech.»

I'm very confident on the revenue growth and profitability side of SDTH, as I see $0.9 EPS in 2008. However I would like to know more about the company's products, which seem like a true innovation in the chemical space. I love Chinese companies which aren't just copies of Western companies, but which can play a unique role in the global economy. Those are truly special and SDTH seems to be one of those.

More over the following updates, I'll keep holding SDTH for the long term.

[BigSully1]

Wow, SSRX was up 16% yesterday. I see what you mean, the company is now a $325 M market cap company, with just $16 M in revenues in 2006, which means the Price to Sales Ratio is about 20

Anyway, I'm not all that worried about the US stock market for now ... I believe we'll be at new all time highs in the S&P 500 before 2007 closes. And, if Chinese stocks are going for a bubble, it may last several months (I hope not, I hope it blows right away, before there's the possibility of a potential crash damaging the Chinese and World economy).
.
[/quote]

Certainly David. SSRX up another 10% today, JRJC at new highs, CHNR up another 70% on top of the 75% yesterday, etc, etc. and probably all way overvalued. I'm all for finding more undervalued Chinese stocks with excellent potential. Maybe we can still find more like SDTH.

[Se7en]

Maybe CHCG, CHNG, UTVG ...

[kslifka]

DSWL  seems way undervalued.  Hasn't had it's run yet....but it looks ready.

[BigSully1]

GMKT broke out Tues and and followed through yesterday. Korean ADR though.

[stocky]

I am not sure after LDK decline if its safe to play Chinese stocks but tomorrow it will be interesting to see SDTH holds its ground and EFUT continues its parabolic climb.

[David Randolph]

I'm all for finding more undervalued Chinese stocks with excellent potential. Maybe we can still find more like SDTH.

I think I found another with great potential. Will write about it in a moment.

You're giving me too many stocks, I don't have time to cover them all ... some of them are stocks flying a lot, but they don't have fundamental backup in my opinion. I'll try to find one or two stocks which just started rising, not those that already jumped.

Coming back to SDTH, as I was looking at the company's website (English version), I found the following:

«The planned production capacity of Shengda Technology Industry Park (Shaanxi Haize Nano Material Co.,Ltd.), which has been invested and built in Shaanxi, is 1 million tons of NPCC per year. The first phase has gone into production smoothly with an annual production of 60,000 tons of NPCC.»

They'll end 2007 with about 190,000 metric tons of production, but you can see they have plans to run it up to 1 million. If the price is maintained, this would represent a 5 fold revenue jump. If net profit margin is also maintained, EPS would be something like $2.2. Apply a 20 times earnings multiple to this and get a $44 stock, not counting on the other products of the company.

Now, the question is, what really is NPCC and can the market absorb 1 million tons of it per year without getting saturated?

I'll study this question over the next update.

Technically, it is clear there are sellers around this $7 area, because with this kind of volume the stock could be up a lot ... when they stop selling I see the stock possibly doubling very rapidly. Another week of this heavy buying and I believe the way will be cleared for the bullish move that I expect.

I'll keep holding SDTH for the long term.

[Michael]

Now, the question is, what really is NPCC and can the market absorb 1 million tons of it per year without getting saturated?

I'll study this question over the next update.

I don't think demand will be an issue any time soon 

This is from the transcript of Roth Capital Conference February, 2007:

NPCC, what is it? What does it do? Why is it important? Essentially, as we have said it's an additive. It's a powdered additive it's used in a wide variety of products. If you are familiar with functional additives, this is different and that it is reduced down to the nano level. Essentially the key raw material is limestone. It's processed through heat pressure, some proprietary processes to the point where it's a very, very fine powder. Each particle is sub-microscopic. In order to qualify as a nano product, each particle has to be refined to less than one-tenth of a micron in size.

Just to give you some perspective on that. One-tenth of a micron is smaller than the wave length of visible light. So it's very, very fine. And that's gives it some great bonding capabilities and allows it to be used in a wide variety of different products.

It does a couple of different things. It enhances durability, strength, heat resistance, stabilization and also reduces the cost of manufacturing by acting as a substitute for some of the more expensive raw materials, for example rubber in tires. There is a growing range of application. We've got four primary markets that we will tell you about. We are just scratching the surface. There is a ton of new applications out there and as we speak, we are in the lab exploring some new applications that are totally different from what we're doing today.

The important thing too from a customer standpoint, there is no investment on their part in terms of capital equipment in order to embed nano precipitated calcium carbonate in their manufacturing process and get all of the benefits out of it.

Four current applications, our largest one is tire manufacture. We are dealing with all of the major manufacturers in China including Triangle Tire. In that application we are the only one in China that is qualified on tires and we maybe the only one in the entire world. We're not 100% sure of that, but we believe we are.

In tire it increases the durability, reduces abrasion loss, increases tensile strength and also reduces the cost of manufacturing. Our customers tell us about 3% to 5%. When you use NPCC in the manufacturing process their cost comes down about 3% to 5%. Again it increases the tire performance by 10% to 20%.

So it's a two pronged benefit in terms of the customer, lower cost of manufacturing, better quality product. Same thing with PVC building materials, these are PVC plastics that are used in construction, window frames, door frames, PVC pipe that's used in plumbing. And I'm sure you are all aware there is a huge growth in construction materials in China. The infrastructure was booming both commercial and residential construction as well as automobile sales. So these two applications were strategically picked because of the growth opportunities that will come just by the growth that's taking place in China today in terms of the economy.

Two of the other current applications paints and coatings and paper. Taking a look at the addressable markets in our four primary markets as you can see, tires for example, from the research that we've looked at. We believe there are about 325 million tires that are manufactured in China today. That number is going to up dramatically as the economy improves and more people can afford automobiles.

So the market size if you take a look at the amount of NPCC that goes in to an average tire it's about $150 million market, less than 10% penetrated today. We have a 100% of the market, because we are the sole provider. We believe the growth rate, and I think these are conservative numbers 8% to 10% a year on tires.

PVC, again about $120 million market today, 15% or so penetrated and again similar growth rates as with the construction boom in China. And paper and paints you can also see. In our current markets there is plenty of room for growth. They are under penetrated and so there are some huge opportunities in our current market.

Our growth strategy going forward; we are going to continue develop applications and add customers and tires, PVC and paper, plus develop some new applications. We've invested in the new R&D facility in Shanghai, and we are going to be building three other ones through out the country to be close to our potential customers.

We are also just starting to expand internationally. We have an agreement with a Dutch in the paper business. We are talking to companies in Thailand, Singapore, and South Korea. So we do plan to aggressively market internationally, once we satisfy the demand in China.

According to this the tire and building material markets alone is 270 million USD. SDTH's revenue from NPCC is around 36 million USD annually so the revenue can grow 750% based only on the demand from these two segments.

They'll end 2007 with about 190,000 metric tons of production, but you can see they have plans to run it up to 1 million. If the price is maintained, this would represent a 5 fold revenue jump. If net profit margin is also maintained, EPS would be something like $2.2. Apply a 20 times earnings multiple to this and get a $44 stock, not counting on the other products of the company.

NPCC's gross margin is significantly higher than the chemical business gross margin (41% against 25%) so the net profit margin should increase when they increase the share of revenue coming from NPCC 

I like everything about this stock except that I do not own it but that will change today 

[David Randolph]

It's going to be great to have you on SDTH's board Michael

And thanks a lot for answering my question in such a complete way ... it seems that not only the market is there for SDTH's expansion plans, the company also enjoys a position of monopoly.

It seems insiders own 44% of the company, or about 23.8 million shares:



The stock is not advancing as it so clearly should because there are these 8,312,603 Shares for sale:

Form POS AM

But management didn't sell one share:

«ShengdaTech also confirms that the recent filing to sell 1,830,000 shares of the Company's common stock is by six investors who invested in ShengdaTech prior to the Company going public. These investors are not members of management or related to the management team. The Company confirms that there have been no sales of common stock by officers and directors of ShengdaTech.»

(I just wonder about the difference between 8.3 million and 1.83 million - will check it out over the next update)

The one analyst covering the stock is calling for $0.59 EPS in 2008:



But I think he's being conservative, because, for example, in Q4 2006, SDTH made $0.11 EPS, with less than half of the production:

«The additional 60,000 metric tons of NPCC capacity is expected to commence production by the end of 2007.

In the same Xianyang City facility, ShengdaTech brought its latest 40,000 metric tons of NPCC capacity online in July 2007. These lines are operating at 80% utilization and are expected to be operating at full capacity by November. Once the second phase of the Xianyang facility is completed, the Company's total NPCC capacity will be 190,000 metric tons, an increase of 111% from a capacity of 90,000 metric tons at the beginning of 2007.»

With 111% more production I expect no less than double the EPS, that is, about $0.88 EPS in 2008.

SDTH, being in a monopolistic position and growing production capacity by more than 100% a year (and sales?), should be trading at least at 20 times earnings, that is, about $17.6 in late 2008 (excluding potential capacity increases in 2008).

I'll keep holding SDTH for the long term.

[BigSully1]

SSRX made it's debut at #13 and $18.60 on the IBD 100 today.

China Digital TV holding Co., maker of smart cards and TV access control software debuted it's IPO Friday, first day up 75%. Three more Chinese co's plan IPO's this year, look for Fuqi Inernational, - Jewerly,  Noah Education and Longtop Financial technologies.