Update on China Sun Group (CSGH)

It's been a rough ride for investors of China Sun Group (CSGH). The stock is down 44% this year and currently fighting with the $1 mark. However, there are new developments which might bring the stock back on the screens of value investors, so it's time for an update.

Let us first look at current valuation. CSGH has a very irregular fiscal year that ends on May 31, so we are already in FY 2011 at the time of writing. For the first nine months of their 2010 fiscal year, the company posted a net income of $6.28 million or $0.12 in EPS, both numbers are flat year-over-year so there is no income growth. Although revenues were up 10% from 2009, a decline in selling prices of cobalt-based products led to lower gross margins.

For the fourth quarter of FY 2010 (March to May 2010) China Sun Group guided for stable revenues and net income so we can expect the company to close FY 2010 with $0.16 in EPS. The stock is currently valued with a trailing P/E of 6.5, based on yesterday's close at $1.04. That is not unreasonable for a stock with no EPS growth, but here are some facts that indicate significant growth for the years to come.

Government Support

On April 15, the company announced that their new Lithium iron phosphate (LIP) power batteries passed all 32 tests required by the Chinese government. The company stated that "this is a strong endorsement of China Sun as a key component vendor for a new energy-saving vehicle."

On April 29, the company announced that their LIP project has been selected by the government of Liaoning province as a "key" industrial project and CSGH will benefit "through the award of subsidies which will help insure a successful and timely ramp up of LIP production."

LIP Growth and Electric Vehicle Batteries

LIP is used in 100Ah's automobile power batteries, which have been certified by the National Automobile New Product Quality Supervision and Test Center. China Sun Group introduced the new product in October 2009 and recently announced that by the end of 2012, it expects to achieve a manufacturing capacity of 2,000 tons. This requires investment in 12 production lines in addition to state of the art equipment.

An excellent interview by Zack Buckley with China Sun Group COO Fu Guosheng (read the full interview at uncoveringalpha.com) sheds some more light into projected LIP growth:

The company has already upgraded 3 production lines to produce LIP and is currently working on upgrading the next 3 lines. According to the interview, CSGH expects to produce 160 tons of LIP in 2010, 700 tons in 2011 and 1,400 tons in 2012. Again, please note that CSGH's fiscal year ends in May so these 1,400 tons for FY 2012 do actually match the 2,000 tons manufacturing capacity by the end of 2012 from the press release. The average price for raw LIP is about $23,000 per ton with a profit margin of 30% - 31%, so we are talking about possible 2012 LIP revenue in the $32 million range with gross profit of about $10 million.

Keep in mind that this is additional to the current cobalt oxide business as "in the future, 6 production lines will focus on LIP and 6 production lines will focus on the old raw material products." (Source: Zack Buckley interview). The company generated about $42 million revenue in FY 2010 with mostly cobalt based raw materials for batteries.

Another driver for growth is coming from the plans to fully vertically integrate the business by producing their own electric vehicle batteries.

We are on pace to create a manufacturing chain which ranges from raw material procurement to final battery production. We expect to produce batteries in August 2010. ... We are planning to build up a unique model to not only supply the raw material for the lithium batteries, but also produce our own lithium batteries, which is one of the major components of battery-powered automobiles. We will be a holistic provider of the raw materials for auto batteries as well as the finished product for automobiles and electronics. (Source: Zack Buckley interview)

Cobalt Mine Project Postponed

CSGH seems to have abandoned the idea of constructing their own cobalt mine in the central African Congo region. That was always a very questionable move in my opinion, due to the unmanageable risks of investing in and operating such a big project in a politically unstable region. China Sun Group, a small company sitting on the other side of the world, shouldn't engage in such risky endeavours. The plans have been postponed as COO Mr. Fu stated:

The transportation from Congo would take too long, as we sometimes need very quick delivery of our raw materials to supply customers’ needs. Also due to the uncertainty in the global economy, we postponed the Congo project and changed our business strategy accordingly. We can get cobalt in China, not only because it is cheaper in China, but also it saves lots of time for us because of the geographic proximity of shipping. Especially when we see the rapidly emerging requirements in the market, it is an advantage that we can get raw materials shipped to us immediately if our suppliers are in China. (Source: Zack Buckley interview)

Bottomline for value investors: even though the company did not achieve EPS growth in their most recent fiscal year, the prospects for the company seem to be much better now. CSGH is trading at a discount to most other players in the lithium-ion batteries group and I wouldn't be surprised if that changes in the next few months. The company also promised that they will "significantly improve their corporate governance and communications with the investment community going forward and look forward to listing their shares on a senior stock exchange soon."