China Energy Recovery - Explosive Growth Ahead

It doesn't happen very often that a pink sheets quoted Chinese microcap catches our attention, but China Energy Recovery (CGYV) is quite special in many aspects. The company designs, manufactures and installs waste heat energy recovery systems for industrial customers, and is set to become a leader in its industry. When the recently initiated second phase of its expansion program is completed in 2012, CGYV's site will stand as the largest single facility for energy recovery systems in China. Phase One of this expansion has already been finished and CGYV's capacity for 2011 increased almost five-fold over 2010.

China Energy Recovery's auditor is Big Four firm PricewaterhouseCoopers (PwC). This alone is extremely unusual for a tiny microcap with a book value of under $8 million (March 2010). Common sense tells us that this is not our typical pink sheets company when they engage a very expensive top tier auditor and especially also when PwC accepts them as a client. Since the engagement, PwC has carried out a complete review of CGYV's financials which resulted in restatements for 2008 and 2009 financials, and a long delay for the 2010 reports. This is how the formerly OTC-quoted stock ended on the pink sheets.

The company is now moving to bring their SEC filings up to date by submitting the remaining quarterly reports for 2010. The first quarter 10-Q has been filed this week and we can expect the others to follow soon. With the 2010 annual report the company would be back in compliance with the reporting requirements and could get rid of its pink sheets status.

The news flow over the past six months has been very positive:

• September 16, 2010: New Production facility announced. Increases manufacturing capacity by 377% from 356,000 square feet to 1.7 million square feet. Another 100% expansion scheduled for 2012.
• November 3, 2010: PricewaterhouseCoopers completes restatements of 2008 and 2009 numbers. Annual report (10-K) for 2009 filed. $22.2 million in total revenue and net loss of $886,480 or $0.03 per share.
• November 5, 2010: $22.7 million contract for two waste heat recovery systems announced. Scheduled for December 2011 and January 2012.
• November 11, 2010: $10.9 million contract for a heat energy recovery system announced. Scheduled for August 2011.
• December 10, 2010: Company initiated phase two of its expansion plan which will triple capacity when completed in 2012. Management notes that when complete CGYV's "site will stand as the largest single facility dedicated to the design and manufacture of energy recovery systems in China."
• December 21, 2010: CGYV secures $4.5 million loan facility with Bank of China.
• January 10, 2011: $74.7 million contract for two major waste heat recovery systems announced. Scheduled for October and December 2011.
• January 19, 2011: $4.2 million contract for a waste heat recovery system announced. Scheduled for November 2011 delivery.
• February 24, 2011: $7.5 million contract for two waste heat recovery units announced. Scheduled for delivery in the third quarter and December 2011. 2011 contract total now exceeds $115 million.
• March 3, 2011: First Quarter 2010 10-Q filed with the SEC. Reported revenue of $4.1 million (+212% YoY) and operating loss of $538,513 (-35% YoY).

The additional capacity from the Phase One expansion came online in December 2010, so we can not expect much growth for the past year. As the company's CEO stated in a recent press release, "production constraints limited growth, a condition that persisted through fiscal 2010 while our new manufacturing facility was under construction." We should see 2010 total revenue come in between $20 million and $25 million, pretty much in line with 2009 results. But from now on the future looks very bright and the company should see explosive revenue growth.

Trading China reached out to the company to clarify some open questions, and Simon Dong, financial controller of China Energy Recovery, was kind enough to respond:

1. Can we expect the remaining 2010 quarterly reports in the near future?

We do expect the remaining 2010 quarterly reports to be filed soon. The delay of Q1 is also due to restatement of 2009 figures took more than expected time.

2. Does the company plan to file their annual report within the deadline and regain fully reporting status this month?

Yes, the Company strongly wish to file annual report within the deadline, we closely cooperate with our auditor, PwC to issue the report on time.

3. In the last update the company announced: "CER's 2011 contract total now exceeds $115 million." Can you give an estimate for how much of this revenue will be recognized in FY 2011?

Most of the 115 million, we estimate about USD 100 million above will be completed in 2011.

Reported revenue of $100 million for 2011 would quadruple the results for 2010 and 2009, explosive growth that won't be ignored by the market as the financial results are backed by a best-in-class auditor. And it won't end there. The Phase Two expansion, scheduled for 2012 completion, "will more than triple the size of the current facility," and with both stages complete, CGYV's "manufacturing capacity will exceed its original Shanghai-based capacity by a factor of 10."

Those numbers suggest that CGYV can grow from $22.2 million in revenue for 2009 to $100 million in 2011 and $200-250 million in 2013. Long-term growth prospects for the energy recovery industry are excellent, as this technology serves two of China's main goals: lowering industrial pollution and reducing carbon emissions. We are adding CGYV to our China Model Portfolio today after the close.

Earnings Previews, Part 1

American Lorain (ALN) reports on March 30 before the open. The stock is doing well so far this year (up 15%) after it beat Q3 estimates nicely. One analyst expects ALN to report Q4 revenues of $58.3 million and EPS of $0.20. This one has further upside with a good earnings report.

Biostar Pharmaceuticals (BSPM.OB) has already pre-announced FY09 numbers with $52-$54 million revenue and $16-$17 million operating income. Watch for confirmation when they report next week. BSPM has already provided guidance for FY10 with $69-$71 million revenue and $16.2-$17 million net income, mind the difference between 'operating' and 'net' here. The stock is expected to move up from the OTC/BB in the very near future, keep your eyes close on this for an announcement.

China Agritech (CAGC) reports on March 31 before the open. The stock is up a whopping 95.7% for the year and now sports a hefty market capitalization of almost half a billion dollars. Whatever they report it will hardly be sufficient to support the current stock price from the fundamental side, but an earnings beat combined with strong forward guidance might reignite the strong momentum CAGC enjoyed for most of its Nasdaq life.

China Green Material (CAGM.OB) is down 12% for the year so far but as the stock reached its all-time-high at the turn of the year it is still performing well. CAGM is currently priced at 10x trailing earnings and 3x sales and I believe for being able to test its highs again the company should report an uptrend in both earnings and net income, both year-over-year and sequentially. CAGM reported $1.11m net income on $4.19m revenues for the Third Quarter of 2009.

China Auto Logistics (CALI) reports on Monday, March 29 before the open. The stock has not participated in the China automotive stocks rally so far and is one of the few in the sector that are down for the year (15%), trading range-bound between $4.20 and $4.70 since late January. Look for revenues of at least $60 million and net income of $2 million for a possible break-out.

China Clean Energy (CCGY.OB) is up 29% for the year already but I see much room for further upside as the company guided back in January for Q1/2010 revenues of $7.3 million or 150% growth from 2009 numbers. Their new chemical plant started operating on a commercial basis in January and for the yet-to-be-reported Fourth Quarter it was still in trial production. We do not know if this trial phase generated significant revenues and I do not expect the company to report outstanding numbers for this period, but that doesn't matter as we should see a reiteration of Q1 guidance which positions the company as a growth play that is trading well below book value.

China Electric Motors (CELM) will be reporting their first quarter as a public company after the market closes on Tuesday, March 30. I would keep a close eye on that one as CELM's industry peers (HRBN) reported strong growth for Q4/2009 and CELM has yet to issue guidance for 2010 and basically introduce itself to the US investing world with their first public conference call. Everything about this company looks very promising to me and we could see big money taking a shot at CELM if those events go well.

China Growth Development (CGDI.OB) is due with their annual report by March 31. We won't see a conference call, probably not even a press release, the company's investor relations are non-existent and it's one of those hidden OTC stocks most people have never heard of. CGDI is profitable, reported $900k net income on $4.5 million revenue in their most recent quarter, and the stock is trading at less than half of its book value. If they report another profitable quarter on top of those numbers then the stock could take off from currently depressed levels. A highly speculative trading idea for a possible 100%+ gain.

China Energy Recovery (CGYV.OB) is another widely unknown China OTC play. But contrary to CGDI all the metrics here say 'avoid'! The stock is down 42% for the year and closed 2 cents off its lows on Friday. Watch for Fourth Quarter numbers more than FY09 ones. The company will likely report a small profit for the year but the trend has been down lately. Last quarter CGYV reported a loss of $0.12 million on revenues of slightly above $6 million.

China 3C Group (CHCG.OB) is trading well below book value and cash on hand, actually it looks like one of the cheapest stocks around based on those numbers alone. Though the stock is down 10% for the year and trading around 45 cents for the past two months. The company posted a big loss for the Third Quarter and Fourth Quarter numbers will likely not look better as CHCG expects their "business performance for the 2009 fourth quarter to be on par with that of the third quarter." The key here is to look for signs that the company can turnaround their business, if there is light on the horizon the stock would be a clear buy at current levels:

"While we expect the remainder of 2009 to be challenging, we remain focused on building a platform for long-term sustainable growth. We have a lot of work to do but believe we have the right plan and managerial team in place to execute on our mission. We look forward to updating you on our developments in the months ahead." (Source: Q3/09 press release)

China Carbon Graphite (CHGI.OB) is in a strong uptrend lately, both for their business with a 50% sequential rise in earnings last quarter, as for their stock price which has appreciated almost 60% this year. Watch out for a confirmation of this trend with Q4 and year end numbers that are due next week. The stock benefited hugely from an internet plug this month but is down about $1 from its mid-month highs and that would be the target for the stock with a trend confirmation.

China Gengsheng Minerals (CHGS) plans to release fourth quarter results on Monday, March 29, after the close. The stock has gained 40% so far this year on several catalysts as the NYSE Amex listing and new contract announcements. Though CHGS is currently trading well below its March 5 high of $4.30. For the stock to resume its uptrend I would be looking for revenues of $15.5-$16 million and net income of about $1.8 million.