Wednesday, October 17, 2007

Shengda Tech Inc. Analysis

I have done some more DD and did get in on a small dip.

Here is my full Bull/Bear investigative notes on SDTH:

Potential Drawbacks/Areas to watch:
1. China.
Though SDTH in my opinion is undervalued as of right now there are many Chinese companies that are trading at PEG ratios over 2. If this continues a true bubble might form and collapse. In such a case the good companies will, at least for a period of time, go down with the bad. Some investors, Such as Warren B, are pulling $ out of companies that have had huge runs such as PTR. Perhaps he is being prescient. Additionally, China is always dicey because who knows how good the regulation is over there. Are they producing what they say they are? We have to hope so.

Just as importantly what happens if (really when) the Chinese economy slows. At the pace it is growing even the PRC may not be able to prevent a large, enduring correction. In such a case companies that cater directly to Chinese industry, such as SDTH, will likely see large downturns in demand. Thus the company bears close watching at all times. That being said, I think that the Chinese economy still has more than enough room to grow at this point to make this investment worthile (but with caution).

2. Competition
NPCC is produced throughout the world. In China SDTH is by no means the largest producer. (According to their website at least that honor goes to Shanghai Yaohua Nano-tech Inc. (http://www.caco3-yhnano.com/html/products-application.html). Right now SDTH has a proprietary method for producing NPCC at a very low cost. Additionally, it is the only company that sells NPCC to the Chinese tire industry. Still, the barrier to entry here is not as enormous as I would like. The huge potential growth of the industry overall may overshadow this. However, again something to watch closely.

3. The chemical business, while billed as a stable source of cash generation, is not growing fast enough to support a PE (ttm) and P/OCF (ttm) of around 18. The growth primarily depends, as of now at least, one one product. Should demand dry up for whatever reason this company immediately goes from being cheap to being overvalued.

4. Some of the bad press from other Chinese companies, such as lead in paints and melamine in pet food, may spook some investors. Hopefully SDTH has nothing to do with this. Even if they don't, though, there may be stock selling by association.

5. The company is a fairly new public company. Seasonality is thus hard to gauge. Long term progress and success bears watching. Some new stocks have a bit of a wild ride before settling down. Also, the stock has appreciated 100% since March... though still cheap this may cause short-term price drops and stagnate price appreciation for some time.

Positives that SDTH offers...
In addition to what I listed in my original post which is...

PEG around .41 as of today

Solid cash business with NPCC growth potential

Proprietary methods of forming NPCC

Demand so high that they have to build more facilities.

Close to Quarry

Very large inside ownership

Scare tactic column actually Bullish if read between the lines.

it also...

1. Has a management team that has been in the chemical industry for a long time (10 years + for some).

2. Is listed on the Naz and recently hired a US trained accountant to help ensure compliance with GAAP principles (they are making every effort, at least it seems, to be honest and accurate in presenting their figures).

3. Has associations with major Chinese universities. In order to stay ahead of the game in any scientific exploit it really helps to have research tied to universities and university culture. (I have a background in biochemistry myself... I see the relevance firsthand).

4. Has a ammonia/ammonium carbonate, etc. fertilizer business that will be needed to feed people regardless of business conditions. This does not justify the current price by itself but at least the company is not completely out of business if NPCC demand slows.

5. Has a current ratio over 3, $27M in cash with no debt, profit and operating margins around 25%. As the higher margin NPCC business becomes a larger percentage of the business their margins may increase. All numbers are derived from yahoo finance.

6. Valuation: according to grahaminvestor.com the forward (next year) intrinsic value is 29. This is based on a DCF model which, for unestablished companies, tends to overestimate price because of risk... however it still helps demonstrate that a price in the 7's is very cheap. A P/E of 25 would put the price at 25*.45 = 11.25 by Dec 07 and at 25*.59 = 14.75 by Dec 08. Even if the projected growth for the next 5 years is substantially below the estimated 42% a P/E of 25 may well be justified.

7. Analyst estimates may be low. There is only one analyst and he has missed slightly in each of the past three quarters. A bump from .34 last year to .59 for 08 may be low given all of the new NPCC capacity that is scheduled to come on line. It will be interesting to see how SDTH does in comparison to the estimates given the new capacity just put in place.


Questions I have:
1. The new capacity is expected to add 40,000 tons NPCC production for the first facility and 60,000 tons for the second. What is their current capacity? How much as a percent will this increase production capacity?

Answered:
"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."
http://biz.yahoo.com/prnews/070917/cnm024.html?.v=11

BTW: this figure will equal or surpass the current capacity at Yaohua Nano-Tech unless they are also expanding largely

Closing remarks:
To me the company looks good enough for some opening positions. Still, it is young and there are a lot of questions left unanswered so I hope to buy during dips and hold off on buying too much until the next CC. That's just my opinion. Others may have different ones. I would love to hear them!

BTW: Company website: http://www.shengdatechinc.com
This is not listed on yahoo's web page for some reason.

Some other good links:
The links are too long but google search NPCC China

1 comment:

John Jeffrey said...

Very well written and outlined..we need this kind of analysis for other stocks such as "snen"