China Electric Motor (CELM)

It was quite unfortunate for China Electric Motor Inc. (CELM) that market conditions deteriorated so much since mid-January that the IPO market is in big trouble once again. Just about a month ago the company was hoping to fetch up to $7 a share for their offering, was forced to cut the asking price twice since, replaced one of their underwriters, and finally sold their shares at the low end of the range ($4.50) on January 29th.

However, Nasdaq-listed CELM is the only Chinese IPO this year that is trading above their offering price, gaining about 10% last week and closing in on the $5 mark. Digging deeper into the company's business and financials reveals that it provides a good opportunity for value investors at the current price.

China Electric Motor is a Shenzhen-based manufacturer of micro-motors for consumer electronics, automobiles, power tools, toys and household appliances under the "Sunna" brand. They produce a wide variety of micro-motor products, 1200 to be exact, made for hairdyrers, juicers, paper shredders, air conditioners, heaters, windshield wipers, trimmers, lawn mowers and so on, but they are also used as digital drives and for power transmission in industries such as mining or petroleum. The closest comparable might be Nasdaq-listed Harbin Electric.

CELM is currently selling their products to OEMs and distributors in China, Hong Kong and Korea and their goal is "to become a global leader in the development and manufacture of micro-motor products." For its home market CELM sees good growth ahead: "We feel the Chinese markets are underserved and there exists vast opportunities to expand market presence."

The company's senior management is very young. All of the senior management is age 35 or younger and CEO Yue Wang, a 2005 graduate of University of Leeds in London, is just 26 years old. Having a young, second generation, internationally educated senior management should give CELM an edge in competition, a fact not to be ignored.

Valuation

Shares Outstanding: 19.87 million (627,000 exercisable warrants)
Current Float: about 7.9 million shares
Stock Price: $4.98 (February 5, 2010)
Market Capitalization: $99 million
Cash: $6.5 million plus $21 million IPO proceeds (27.7% of market cap)
Revenue 2009e: $86 million (Revenue Growth: 62%, Price/Rev: 1.15)
Gross Margin 2009 (2008): 28.2% (27.9%)
Net Income 2009e: $14.4 million (Net Income Growth: 46%)
EPS (TTM): $0.73
P/E (TTM): 6.87 (PEG: 0.15)

Accounts receivable are relatively high at $7.83 million (September 30, 2009). But none of those are outstanding in excess of 90 days and the company typically provides payment terms ranging from 30 to 45 days. There were no bad debts written off for the nine months ended September 30, 2009, and the years ended December 31, 2008 and 2007.

If we assume similar growth rates of 40% for FY 2010 - the company didn't give out any guidance yet - CELM's net income should increase to at least $20 million this year. This growth assumption is conservative as the company intends to use the IPO proceeds to increase manufacturing capacity, to purchase more industrial space and to modernize factory equipment.

EPS (2010e): $1.02
P/E (2010e): 4.90 (PEG: 0.12)

Price Target

The originally intended price range for CELM's IPO at $6-7 would have been a perfectly fair offer in a normal IPO market. In the current market environment you can get the stock at a steep discount of more than 30% and I believe investing in CELM at this point will be rewarded well. My price target for CELM is $10, based on roughly 10x expected EPS for 2010, flat gross margins, and conservatively estimated growth of 40% year over year.

The "Quiet Period" after CELM's IPO ends on March 10 and it can be safely assumed that lead underwriter Roth Capital, not known for particularly conservative price targets, will initiate coverage of the stock with a Buy rating and a price target in the double digits.

China Model Portfolio

I am adding 1000 shares of CELM to the model portfolio at Friday's close of $4.98.