2010 Summary - Chinese IPO's

2010 saw a total of 41 companies from mainland China going public in the U.S. via a regular Initial Public Offering (IPO). More than half (22) of those IPO's took place in the fourth quarter alone. As a group, those Chinese offerings have been very successful. The average return on the first day of trading was 16%, and year-to-date the average IPO investor is sitting on a 20.9% return from the offering price.



YouTube-clone Youku.com (YOKU) was the most successful Chinese IPO on the first day of trading, with a return of 161.25%. The stock climbed as high as 250% above the IPO price before retreating again, but year-to-date it is still up 170.85%, and higher than the close at its first day. YOKU is a huge bet on the growth of the Chinese internet and consumer markets. As Google's YouTube is blocked in China, its market there is up for grabs. But keep in mind that the race is just at the beginning, and many things could go wrong for Youku from here. The company is not yet profitable, and I wouldn't be surprised to see its stock price cut in half in 2011, even if the company reaches the lofty goals set by investors.



Goldman Sachs (YOKU, CIS, SFUN) and Deutsche Bank (HSFT, SFUN) dominate as underwriters of the year's most successful IPO's. IT outsourcing company HiSoft Technology (HSFT) took the top spot this year, steadily rising since its IPO for a year-to-date return of more than 200%. Even a secondary offering, priced at $25 in December couldn't hurt the stock, as it reclaimed the $30 mark right before Christmas. The company guided for diluted earnings per ADS of $0.83 for FY 2010, which puts its current P/E-ratio at an ambitious 36.5. The market apparently believes that HiSoft's explosive growth supports this valuation.



But not everything has been so bright for Chinese IPO's this year. In fact, 20 out of 41 stocks that went public in 2010 are now trading below their offering price. The list of worst performing stocks is dominated by low-profile underwriters as Broadband Capital for China Hydroelectric (CHC) and Anderson & Strudwick for Dehaier Medical Systems (DHRM). Number three on the list is Credit Suisse IPO Mecox Lane (MCOX), an internet retailer that started out well with a 56% gain on the first day of trading. The stock came under heavy pressure when U.S. shareholders sued the company and its underwriters for not disclosing shrinking margins in the IPO prospectus.

SEC, Congress and Chinese-company Accounting

The big story this week comes from The Wall Street Journal's Dennis Berman, who first wrote about an upcoming SEC probe into Chinese reverse merger and auditing practices.

"The Securities and Exchange Commission has begun a crackdown on the practices of the "reverse takeover" market for Chinese listings, according to people with knowledge of the probe. Specifically, the SEC's enforcement and corporation-finance divisions have begun a wide-scale investigation into how networks of U.S. accountants, lawyers, and bankers have helped bring scores of Chinese companies onto the U.S. stock markets, these people say. The SEC has also begun homing in on individual Chinese companies for accounting violations and lax auditing practices, these people say, beyond a number of previously announced investigations."

A couple hours later, TheStreet.com's Scott Eden followed up with a more detailed look into this issue. Eden said that in early September the U.S. House Financial Services Committee wrote letters to both the SEC Chairwoman Mary Schapiro and the PCAOB (Public Company Accounting Oversight Board), asking how those authorities planned to tackle the problem of sub-par auditing of Chinese companies. The letter demanded that "all market participants can trust the accuracy of the audit work for U.S. publicly-traded companies," including Chinese companies listed in the U.S. and especially also reverse mergers.

This is certainly a valid demand, and the SEC has already launched investigations into three Chinese RTO companies earlier this year: China Sky One Medical (CSKI), Fuqi International (FUQI) and Rino International (RINO). Especially the drama around RINO was a game-changer, and as I wrote here on this blog about one month ago, the fall-out from RINO was expected to be significant. It is very likely that there are more than those three companies with severe accounting "problems," and while the RINO disaster might have sped up an SEC investigation into the whole sector, we all knew that something like this would eventually have to happen. Scott Eden wrote in his article that the SEC "has shown interest in at least six additional companies," but concluded that the probe will not just be focused on individual companies, instead looking into a "systemic problem" that might exist in the Chinese RTO space.

If you are a long investor in China stocks, don't make the mistake to view this new development as a bad thing for the sector. It is entirely positive. The RINO's of the world have to be found, and as long as that doesn't happen the whole sector has to live with negative, often unsubstantiated allegations. It will also put pressure on Chinese management teams who, in many cases, still fail to understand their responsibilities as a public company, fail to take appropriate action to improve corporate governance and strengthen investor confidence. The majority of U.S.-listed Chinese stocks, also reverse mergers, is not deserving of the fraud allegations, but many of them apparently need this kind of pressure to differentiate themselves from RINO and co. - I expect many positive developments in this space next year.

Back to accounting, we have seen many Chinese companies upgrading their auditors this month:

- December 16: China Integrated Energy (CBEH) appoints KPMG
- December 15: Skystar Bio-Pharmaceutical (SKBI) Appoints Crowe Horwath
- December 13: China Automotive Systems (CAAS) appoints PricewaterhouseCoopers
- December 6: Wonder Auto (WATG) appoints PricewaterhouseCoopers

But this can just be a start. There are many Chinese companies still using auditors that don't seem appropriate for their size and level of maturity. All of them will have to upgrade their auditors in 2011, and if they don't then healthy skepticism should be in place. Any company with several hundred of millions in annual revenue can easily afford a top tier accounting firm, and if they don't choose to go that way, we should ask the question: "why not?" Is it that they are afraid of too much scrutiny? Is is that they don't get accepted as clients by one of the Big Four?

The new Trading China Custom Screen Tool makes it easy to identify companies with sub-par auditors. Filtering for Chinese stocks with a senior exchange listing and no Top10-ranked accounting firm, then sorting the results by market capitalization, gives you a good idea of companies that will have to take action. We might even find some of the six additional names, Scott Eden says the SEC has shown interest in, on that list.

Most striking is the large number of Frazer Frost-audited companies on that list. Frazer Frost, the auditor of RINO International, was a business combination of Moore Stephens Wurth Frazer Torbet, LLP (MSWFT) and Frost, PLLC, that broke apart after the RINO scandal. Since December 1st, both MSWFT and Frost resume operations as separate entities again. MSWFT has a history of problems and has been fined this week by the SEC to pay $129,500 in relation to allegations of professional misconduct stemming from the material overstatement of the financial results by a Chinese company back in 2004 and 2005. MSWFT also agreed not to accept any new clients from China, Hong Kong, or Taiwan until an independent evaluation of the firm has satisfied the SEC, and Frazer regains compliance with SEC standards.

In light of these developments all of Frazer Frost's current Chinese clients should feel forced to upgrade auditors as soon as possible, definitely in time for the 2010 annual report, usually due by the end of March. Those companies that don't take appropriate steps should be treated with extreme caution. The list of current Frazer clients is long, including Harbin Electric (HRBN), China Biologic Products (CBPO), China Valves Technology (CVVT), China Fire & Security (CFSG), and SinoCoking Coal (SCOK).

California-based Kabani & Company Inc. is another small firm with a large number of Chinese clients. Most of Kabani's clients are small, OTC-quoted companies, but there are two striking exceptions: L&L Energy (LLEN) and China Green Agriculture (CGA). Kabani has been singled out as a sub-par choice in several articles this year, most notably by Barron's influential "Beware This Chinese Export" piece in August.

With a market capitalization of more than $300 million, and a U.S.-based (Seattle) management team, LLEN must know that Kabani is no longer an appropriate choice for the company, and that the reputation of the auditor is being questioned by U.S. media. Yet the company reappointed Kabani for their 2011 fiscal year in September, continuing to be the (by a wide margin) largest Chinese client of the firm. In an obvious attempt to strengthen management credibility LLEN decided to hire or appoint several retired White House officials. In August, Norman Mineta (former U.S. Secretary of Transportation) was hired for an annual salary of $250,000. This week LLEN hired Edmund Moy, former Director of the U.S. Mint and special advisor to President George W. Bush, for an undisclosed salary.

Kabani's second largest Chinese client is China Green Agriculture (CGA), a company that has already come under pressure by short sellers this year. In late November, China Green retained Ernst & Young to assist the company with strengthening internal controls, and said they were continuing "discussions on the hiring of a new independent auditor." CGA seems to on the right track, however we'll have to wait if words are followed by actions anytime soon.

There are several other small U.S. accounting firms with a bunch of Chinese clients. Child, Van Wagoner & Bradshaw is a Utah-based firm with six partners and an office in Hong Kong. The 2009 PCAOB inspection of Child found several significant deficiencies. Among their clients are Longwei Petroleum (LPH, $265 million market cap) and Yuhe International (YUII, $175 million). Both these companies are growing fast, expanding their business rapidly, and I would expect them to be mature enough already to upgrade their auditors to at least a Top 10 firm.

And the last accounting firm I want to mention here is Sherb & Co., another small U.S. firm with many reverse merger clients. Almost periodically there are issues with Sherb clients, most recently China Education Alliance (CEU) came under severe pressure with fraud allegations that found their way to mainstream financial media and led to the stock being halted twice this month. The largest of Sherb's Chinese clients, China Integrated Energy (CBEH), took immediate action and upgraded to a Big4 auditor. This is what you want to see as a long investor, let's hope many others will follow suit.

Re-Entering CCME

China MediaExpress (CCME) is currently trading at $15.52, up 46.41% for the year and down 30.41% from its November 8 high at $22.30. The Trading China Tracker Score is 12 (Strong Buy).

We are re-adding China MediaExpress to the Trading China Model Portfolio at Friday's close. We have previously sold this stock on November 6th at $19.61 for a 131.25% gain. CCME has a small float of just 11.53 million shares, and as of November 30 the recorded short interest was a staggering 41% of the float.

On December 9th, CCME CFO Jacky Lam bought 100,000 shares at $15. This is significant news that has not yet been digested properly by the market. A major vote of confidence by the one insider that should have the best idea about CCME's future performance. We are setting a price target of $25 (6-12 months).

U.S. China Mining Group Analysis

U.S. China Mining Group (SGZH, formerly known as Songzai International Holding Group) is a Chinese coal mining group that operates three thermal coal mines in Heilongjiang province, close to the Russian border.

Production Numbers:

Tong Gong
---------
March 2008 - Prod: 137,536 - Sales: 137,536
June 2008  - Prod: 168,245 - Sales: 168,245
Sept 2008  - Prod:  66,448 - Sales: 153,517 - Brokerage:  87,069
Dec  2008  - Prod:       0 - Sales: 149,457 - Brokerage: 149,457
March 2009 - Prod:  98,031 - Sales:  98,031
June 2009  - Prod: 184,553 - Sales: 184,553
Sept 2009  - Prod:  67,416 - Sales: 107,645 - Brokerage:  55,000
Dec  2009  - Prod:       0 - Sales:  84,171 - Brokerage:  69,400
March 2010 - Prod:  88,906 - Sales:  88,906 
June 2010  - Prod:  49,310 - Sales:  99,310 - Brokerage:  50,000
Sept 2010  - Prod:  30,810 - Sales: 130,810 - Brokerage: 100,000

Xing An
-------
March 2008 - Prod: 539,737 - Sales: 472,019
June 2008  - Prod: 120,000 - Sales: 225,590
Sept 2008  - Prod:       0 - Sales: 255,909 - Brokerage: 246,000
Dec  2008  - Prod:  83,543 - Sales: 241,944 - Brokerage: 157,700
March 2009 - Prod: 433,806 - Sales: 271,753
June 2009  - Prod:       0 - Sales: 303,002 - Brokerage: 180,000
Sept 2009  - Prod:       0 - Sales: 102,148 - Brokerage: 100,000
Dec  2009  - Prod: 173,252 - Sales: 172,542
March 2010 - Prod: 148,818 - Sales: 175,216 - Brokerage:  30,296
June 2010  - Prod:       0 - Sales: 116,179 - Brokerage: 159,679
Sept 2010  - Prod:       0 - Sales: 242,984 - Brokerage: 223,185

Avg. Selling Price / Cost per ton

March 2008 - $32.12 - $12.17 (37.9%)
June  2008 - $32.69 - $13.59 (41.6%)
Sept  2008 - $37.61 - $16.75 (44.5%)

March 2009 - $56.14 - $15.37 (27.4%)
June  2009 - $49.59 - $14.96 (30.1%)
Sept  2009 - $44.17 - $21.96 (49.7%)

March 2010 - $47.55 - $29.25 (61.5%)
June  2010 - $46.25 - $28.27 (61.1%)
Sept  2010 - $47.84 - $26.97 (56.4%)

Reasons for higher cost per ton:

- outsourcing the mining work to independent contractors (overall price inflation)
- amortization and depreciation

Brokered coal:

In addition to mining coal, we also broker coal from small independent mines operating in the areas surrounding the mines that we operate. Because operators of these small mines often lack the means to transport coal from the mines, they have no market for their coal other than selling it to us at competitive prices. The brokered coal enables our subsidiaries to fulfill their respective sales obligations. Tong Gong currently brokers approximately 124,400 tons of coal annually at approximately 30% mark up of the costs of the coal that it mines. Xing An, on the other hand, brokers approximately 280,000 tons of coal annually at approximately the same costs as the coal that the company mines.

Sales - Gross Profit - Net Income

March 2008 - 15,162,953 -  9,415,179 (62.1%) -  6,799,176 (44.8%)
June  2008 - 12,873,937 -  7,523,624 (58.4%) -  4,659,861 (36.2%)
Sept  2008 - 14,874,732 -  8,496,047 (57.1%) -  6,122,684 (41.2%)
Dec   2008 - 14,218,476 -  7,349,565 (51.7%) -  5,283,234 (37.2%)
March 2009 - 20,758,454 - 15,076,682 (72.6%) - 11,129,749 (53.6%)
June  2009 - 24,179,166 - 16,532,705 (68.4%) - 12,404,475 (51.3%)
Sept  2009 -  9,267,268 -  4,502,711 (48.6%) -  2,757,819 (29.8%)
Dec   2009 - 10,793,568 -  4,104,337 (38.0%) -    947,871 ( 8.8%)
March 2010 - 12,558,119 -  4,832,496 (38.5%) -  2,125,301 (16.9%)
June  2010 -  9,965,946 -  3,874,659 (38.9%) -  1,832,708 (18.4%)
Sept  2010 - 17,854,483 -  7,787,987 (43.6%) -  3,850,140 (21.6%)
Dec   2010 - 26,121,452 -                    -  6,291,851 (24.1%) GUIDANCE

Reasons for higher operating expenses:

- transportation infrastructure construction fee (since May 2010): RMB 10 per ton of sales
- security special purpose fee (since June 2010): RMB 10 per ton of sales
- coal price adjusting fund (since June 2010): RMB 20 per ton of sales
- total local government fees per tons of sales: RMB 40 ($6.00)
- increased payroll and welfare expenses

Reserves:

Tong Gong: 5.9 million tons
Xing An: 19.6 million tons

Energy Content:

Tong Gong: 10.08 btu/pound (5,600 kcal/kg)
Xing An: 6.6 - 9.0 btu/pound (4,330 kcal/kg)

Average: ~4,650 kcal/kg

Thermal coal prices are usually set for a heating content of 5,500 kcal/kg

Fiscal Year 2010 Guidance:

"Management expects the Company to generate revenue of approximately $66.5 million with net income of approximately $14.1 million for the 2010 Fiscal year ending December 31, 2010."

That translates into a record $26.1 million in sales for Q4/10 and net margins of 24.1%, the highest since Q3/09. The December quarter would be the strongest of the year and the most profitable since Q2/09.

Fiscal Year 2011 Projection:

Production: 900,000 tons (Tong Gong: 200,000 + Xing An: 700,000)
Brokerage: 700,000 tons (First 9 months of 2010: brokered 563,000 tons)
Total sales: 1,600,000 tons

Price projection (2011):
- Shanxi ($78/ton) - 10% (Heilongjiang) - $70/ton
- SGZH's coal (lower energy content): $59/ton
- Using another 10% discount here because the company seems to sell their coal at a discount to market in Heilongjiang.
- Projected price per ton: $53 (up from $48 in Q3/2010)

Total 2011 sales: $92.8 million (up 39.5% from $66.5 million in FY 2010)
Gross margin: 50% (up from 43.6% in Q3/2010) - based on more effective resumed Xing An and management comments
Gross profit: $46.4 million
Operating expenses: $14.9 million or 16% of revenue (up from 13.8% in Q3/2010) on higher wages and welfare expenses, overall price inflation. Included are local and provincial government fees of $9.6 million (based on 1.6 million tons coal sold)
Net income before tax: $31.2 million
Net income: $23.1 million (up 63.8% from $14.1 million in FY 2010)

Total FD shares outstanding: 15.35 million
2011 projected EPS: $1.50

Adjustments:

Adding $0.10 EPS as the company has historically mined more coal than its permits allow. Company says this is tolerated in Heilongjiang province. Demand for steam coal should be strong in 2011 and the company has already announced to pursue "short term production opportunities" next year.

Final 2011 EPS projection: $1.60

Upside:

- higher brokerage sales (likely)
- higher coal prices (unlikely)
- acquisitions ("expanding our efforts to pursue other mining properties")

The company has $40.15 million in cash ($2.61 per share), no receivables problem, insignificant debt, and strong cash flow.

Current valuation ($7.25): P/E 4.5 (ex-cash: 2.9)

SGZH is a current position of the Trading China Model Portfolio

Educating China Education Alliance

China Education Alliance (CEU) held a conference call this morning, in response to fraud allegations by Kerrisdale Capital. A transcript of the prepared statements has been filed with the SEC in a Form 8-K.

I want to point out that a large part of CEU's response to question no. 8 "Please explain the discrepancy between the financials filed with the SEC and the SAIC filings," is not the CFO's own statement, instead it has been copied word by word from an article I posted on this blog in early July: On SAIC and SEC Filings. I discovered that by accident. I have not been asked, nor have I authorized the use of my article in this context. Trading China has also not submitted this text for China Education Alliance's defense.

I don't believe that using Google search to find appropriate answers to investors' questions, and then using what has been found - unchanged and uncommented - as the company's response, will be very helpful in a conference call that has been held with the intention to restore management credibility and investor confidence.

Troubled Frazer Frost

As we all know, Frazer Frost LLC, a rather small accounting firm with many U.S.-listed Chinese clients, has come under severe pressure since the RINO fraud story unfolded. I came across the wonderful China Accounting Blog by Paul Gillis from Beijing University - a must read for anyone interested in Chinese accounting - where Mr. Gillis had some more details on how things work at Frazer Frost.

"Frazer Frost audited 15 Chinese companies, 1 on the NYSE, 12 on NASDAQ and 2 OTCBB, earning fees of $6.1 million. According to partner Susan Woo, she is the engagement partner on all of this work, a sizable portfolio for a single partner. According to her firm resume, Woo has more than 13 years of accounting and auditing experience and specializes in providing financial and international tax consulting for multinational businesses. The tax work makes sense, since she has a Master of Science in International Taxation from Golden Gate University. She was licensed as a CPA in California in 1999. International tax practice is a pretty tough field by itself, so it is remarkable that she had the time to also develop the skills to audit public companies." (Source: Audit Scandals in China, Paul Gillis)

Mr. Gillis further explained that Frazer Frost does not have an office in China, though they have staff working there all year round, assigned from FF's California office. Let's have a look at recent developments with two other clients of the firm:

China Biologic Products (CBPO) intends to reaffirm Frazer Frost for the fiscal year ending December 31, 2010 and the interim periods through 2011, later this month on their Annual Meeting of Stockholders. The company has been accused of fraud in January and subsequently formed a special committee to conduct an independent investigation into the allegations.

Last Friday, December 3rd, CBPO filed the findings of this special committee in a Form 8-K with the SEC. The committee "reported that the investigation had been constrained by substantial limitations on access to relevant official records from Chinese military and governmental authorities and the availability of other relevant information in China," but while it found no evidence for some of the allegations, others could be confirmed or the results were inconclusive. It was filed that with respect to the allegation that Mr. Tung Lam, CEO of China Biologic's primary operating subsidiary, was previously known under a different name and imprisoned for smuggling in China, the committee "found evidence supporting Mr. Lam's denial of the allegation, as well as conflicting evidence with respect to this claim." However, in connection with the same smuggling activities, the committee said it found support for the allegation that Mr. Ze Qin Lin, husband of current CBPO director Ms. Lin Ling Li, was indeed sentenced to imprisonment in China.

Harbin Electric (HRBN) has not officially commented on auditor-related issues since the RINO disaster, however the company is actively working on a going private deal and has engaged high-profile names like Goldman Sachs, Morgan Stanley and Baring Private Equity for these matters. Big-4 auditor Deloitte has been retained to perform due diligence, but it seems the market has doubts that the Frazer Frost-audited HRBN will pass this test. The stock has dropped to new lows below $15 after announcement of the buyout proposal and is currently trading at $16.27 or 33% below the proposed $24 buyout price.

Roth Capital has been vigorously defending the company for the past few weeks. They pointed out that Harbin is the first U.S.-listed non-state-owned Chinese company that received loans from China Development Bank, which means they passed the bank's due diligence process which should add credibility (but didn't after all if we are going to judge by the reaction of the market). It certainly didn't help that the buyout proposal was modified soon after the loan was announced.

It will be interesting to see what the next steps of currently Frazer Frost-audited companies will be. Frost PLLC of Arkansas called off the merger with Stephens Wurth Frazer & Torbet LLP immediately after the RINO scandal became public. Of course this could be merely coincidental, but really? That means Frazer Frost will not exist for much longer, and all their current Chinese clients will have to appoint a successor firm or at least file the status of their auditor with the SEC. In my opinion, both CBPO and HRBN have long outgrown such a small firm with no permanent presence in China and they should upgrade their auditor as soon as possible. We'll see what happens. It is always a good idea to judge a company by its management's actions.

Solar Energy: Lessons Learned

History is repeating in the solar energy sector. It's December of 2010 and pretty much all of the U.S.-listed solar companies have just crushed the Street estimates for Q3/2010, posted solid beat and raise quarters, and provided a very positive business outlook. Yet all of the stocks have retreated 30-50% from their October highs, so what's going on there?

The solar bears have taken over, spreading fear about rapidly declining ASP's and collapsing margins. Subsidy cuts and the debt crisis in the European Union would lead to lower demand and a possibly massive oversupply in the industry. We saw a bunch of downgrades for solar stocks which were based on those fears, leading to contracting multiples in the sector. But haven't we heard all of that before?

Back in December of 2008 it was the same group of people spreading fear with exactly the same arguments (pricing, oversupply, subsidy cuts) and the financial crisis let the whole sector overshoot to the downside. All of the solar stocks were trading 90-95% below their 52-week highs and you could grab YGE at $3 and TSL at $4. It was all nonsense back then, none of those fears have materialized and 2010 was the best year in history for Chinese solar leaders.

It is true that current module prices will not be sustainable in 2011. Expect ASP's to drop from $1.70-1.80/watt to $1.40, expect gross margins to come down in 2011 as well. But at the same time cost reductions will lead to several poly-based module manufacturers reaching a cost level of sub-$1/watt for the first time next year. Solar energy will become more and more competitive with many companies reaching the highly anticipated "grid parity."

A common sense approach strongly suggests that today's cost leaders are on a steady (albeit bumpy) ride to much higher valuations: Demand for power/electricity will rise, the price of oil and generally fossil energy sources will rise, costs for solar energy will drop to new lows. Most of the world markets are underdeveloped, especially in those emerging economies (Latin America, Asia, Africa) that will see the highest increase in energy consumption, and in the U.S. where the oil lobby still seems to own the country. And then there is of course the environmental aspect. And the growing need to become more independent from imported energy...

Here are three solar stocks that are very attractive at current levels. I also like Yingli Green Energy (YGE) and JA Solar (JASO) here. Personally I would avoid LDK (balance sheet), CSIQ (restatements), and STP (margins). Small players like China Sunergy (CSUN), or even smaller, should be ignored as this is an industry of scale where you can currently buy the leaders at very low multiples. Solarfun (SOLF) looks attractive, but the company is now 49% owned by Koreans, and had a few too many equity raises lately.

The Cost and Margin Leader

Trina Solar (TSL) is the cost leader in the industry. Despite all the talk about disappointing margins, Trina earned a gross margin of 37.6% (Q3/2010) on modules made from in-house wafers and cells - the highest margin among all polysilicon-based vendors. However, as strong demand by far outpaced Trina's internal capacities, the company had to produce modules from purchased cells, which lowered overall gross margin to 31.4%. TSL reported Third Quarter revenue of $508 million, up 37% sequentially, and beating consensus estimates ($420M) by a wide margin. For Q4/2010 the company expects demand to again outpace internal wafer/cell capacity, and it raised guidance well above consensus with overall gross margins expected to be around 30% (35% for modules from self-produced cells). Looking into 2011, Trina indicated that it is already 80% booked for the First Quarter with fixed pricing, and it sees more than adequate demand for the remaining 20%.

Collins Stewart noted on December 1 that "taking into account TSL's income statement and balance sheet efficiency, the company's ROIC was 24.6% in the quarter, a level exceeded by only JinkoSolar (JKS) and First Solar (FSLR) in 3Q10 among the US-listed solar companies."

Hapoalim Securities believes that TSL may be the only solar manufacturer to report positive free cash flow for a full year in 2010: "In contrast to the rest of its peers, we believe TSL has generated positive free cash flow 2010 YTD with operating cash flow of $204M ahead of ~$145M in capex through 3Q10." And Gilford Securities expects that TSL continues to bring its cost down from the current level of $1.08 per watt due to lower polysilicon and further reduction in manufacturing cost in 2011: "There is a fair possibility that cost of $1.00 per watt and lower could be achieved in 1H2011."

And Auriga addresses solar bears by pointing out that "as fear grips the future of the solar industry -- from the generic sell-side perspective -- one can find solace in TSL's balance sheet as 29days inventory and 68days sales are the lowest on record. This is obviously mute if sales collapse as news flow suggests might occur, but even with a worst case sales decline similar to 4Q08/1Q09 and no proactive measures taken by management, inventory never goes higher than 80days."

Analysts are expecting TSL to earn about $3.80 in EPS for 2011 (Collins Stewart: $4.05; Hapoalim: $3.54; Gilford: $3.70; Auriga: $3.84)

Crushed Estimates on Rapidly Increasing Sales

When Jinko Solar (JKS) reported Q3/2010 numbers on November 1, it vaporized the Street consensus at all levels. The company posted $1.75 EPS for the quarter on $215 million in revenue with ASP of $1.81/watt - versus expected $0.95, $148 million and $1.72/w, respectively. Gross margins came in at an excellent 33.5%. Additionally the company is guiding for rising ASP's in Q4/10 and said that it is ahead of schedule in its capacity expansion and expects to reach 600MW by year end with a goal to reach 1GW by the end of 2011. This expansion is supported by the proceeds of a secondary offering that was completed on November 5 when JKS sold 3.5 million shares at $36.

Auriga notes that increased scale is the biggest driver to JinkoSolar's earnings: "In an industry where price declines must be offset by cost reductions, scale offers the best cost opportunity." Analyst estimates for FY 2011 have all been adjusted upwards after the Q3/2010 report, but the uncertainty about ASP's and achieved capacity expansion is reflected in a wide range. Collins Stewart expects FY 2011 of $6.15 and increased their price target to $43. Auriga raised their EPS estimate to $5.05 with a $40 target, and Roth Capital also has a $40 target on projected $6.10 in EPS.

Low Cost Poly and Wafers

The third Chinese solar stock I want to portray today is ReneSola (SOL). Just like its peers, ReneSola crushed Q3/2010 estimates when they reported profits of $0.70 per ADS on revenue of $358 million, well ahead of the consensus at $0.52 and $319 million. And for the Fourth Quarter the company also raised guidance to $340-360 million in revenue, above the old consensus of $310 million. Immediately after the report, Lazard Capital pointed at the robust operating cash flow of $118 million for the quarter and raised their price target to $21.

Auriga came out with a very bullish note on SOL last week. The firm pointed out that ReneSola will benefit "whether poly spot prices stay high (by focusing on wafering operations) or module prices move lower (by sourcing more modules with its low cost poly supply)," and sees the company as the "low-cost polysilicon solar leader at the heart of industry cost reductions." Auriga has an aggressive EPS estimate of $2.56 for FY 2011, well ahead of the $1.90 consensus. But its view is supported by ReneSola's position in the industry where, even with ASP's declining faster than cost reductions could keep up with it, the company will be able to post Y/Y EPS increases on much higher sales. Auriga has a $20 target on the stock and notes that it is currently trading below their 2011 estimated book value and at less than 4x 2011 earnings.

I am adding all three stocks to the China Model Portfolio.