PSB Monthly Issue January 2010
January 2010
THIS SUPPLIER TO THE SOLAR POWER INDUSTRY
Happy New Year!
We hope you enjoyed the holiday season and rang in the New Year with style. The holidays always provide a nice break from our regular, busy routines. And, spending quality time with family and loved ones is a real blessing.
Now that the New Year has officially begun, it’s time to get back to business.
We’re thrilled to tell you we’ve found a fantastic Chinese penny stock to get 2010 off to a great start. This amazing little company has a wonderful legacy business generating significant revenue and earnings. (More on that in a moment…)
But, that’s not why we’re excited about it.
The exciting part is the company’s launching a new high-growth business this year… the production of precision abrasives. They aim to supply precision abrasives to the booming solar power industries in China and Taiwan.
Precision abrasives are ultra-fine, high-strength pellets made of silicon carbide. Solar power companies use them to cut and polish the silicon used in solar panels.
The markets for these products are huge and growing very fast. Taiwan-based companies spend over $500 million a year on abrasive products. And, China’s market is even bigger with sales of more than $2 billion annually.
What’s more, demand for precision abrasives in China is about to explode.
The Chinese government is currently drafting a plan to increase the country’s solar power capacity 14-fold by 2011. If the plan is approved, solar panel production will shift into overdrive. And, solar companies will need to purchase much bigger quantities of precision abrasives.
Our company plans on taking a chunk of the market by undercutting foreign competitors.
Right now, most precision abrasives sold in China are imported from Japan. But, thanks to lower production costs in China, our company will be able to sell precision abrasives at significantly lower prices.
In fact, the company has already signed its first customer.
A Taiwan-based company recently signed a five-year contract for the supply of precision abrasives. The deal will add anywhere from $16 million to $53 million a year to our company’s top line.
And, seven potential customers who were testing the product recently provided positive feedback. We wouldn’t be surprised to see several new precision abrasives orders in the weeks ahead.
With their new production line, our company is poised to become one of the largest producers of precision abrasives in China.
They’re capable of producing 20,000 metric tons of precision abrasives annually. Only two other Chinese companies have production capacities greater than 15,000 metric tons a year.
When operating at full capacity, the precision abrasives line should add $88 million a year to revenue. That’s a huge number considering total revenue for 2008 was a shade under $50 million.
And, this is only the beginning.
Management believes they’ll grab 20% of the Chinese market within three years. At recent prices, that translates into $400 million a year in revenue… nearly 10 times the revenue generated in 2008.
As you can see, this company is poised for major growth in 2010 and beyond. And, we haven’t even told you about their existing lines of business.
Without further ado, we’re excited to introduce China Gengsheng Minerals (OTCBB: CHGS).
Name: China Gengsheng Minerals Ticker Symbol: CHGS Market Cap: $54 Million Recent Price: $2.25PSB Rating System 4.8 Stars Raging Revenue: (5.0 stars) Revenue is expected to soar 42% in 2010 to over $83 million. The new precision abrasives line could boost revenue to several hundred million annually in just a few years. Beautiful Books: (5.0 stars) Earnings are expected to jump 39% in 2010. And, the balance sheet is rock solid with $9.8 million in cash, a current ratio of 1.6x, and no long-term debt. Stellar Structure: (4.0 stars) The CEO owns 70% of outstanding shares and effectively controls the company. We’d prefer to see ownership by other directors and some institutions. Valuation Verification: (5.0 stars) The stock is badly mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $6.72 a share. That’s upside potential of 205% or more. Meaningful Milestones: (5.0 stars) The company is launching its new precision abrasives business this year. This business could add over $50 million a year in revenue. |
THE HIGH-TECH INDUSTRIAL MATERIALS BUSINESS
CHGS develops and manufactures monolithic refractories, fracture proppants, and industrial ceramics. The company sells its products to over 200 customers in China, Asia, Europe, and North America. Most of them operate in the iron, steel, and oil industries.
The company’s core business is making refractory products for many top steel companies in China.
Refractory materials maintain chemical and physical stability at extremely high temperatures. These qualities make them ideal linings for steel-making furnaces, ladles, industrial kilns, and other high temperature processing machines.
This business is poised for higher growth in 2010.
According to the World Steel Association,global steel demand should grow 9.2% this year. As steel makers boost production, CHGS should see greater demand for its refractory products.
The company’s next largest business segment is manufacturing fracture proppants for China’s largest state-owned oil companies.
Proppants are very fine, ball bearing-like pellets. They’re used to release oil and gas deposits trapped in underground fractures. In other words, proppants help increase yields from oil and gas fields.
Management estimates the Chinese market is $400 million annually. With the second largest production capacity in China, CHGS is well-positioned to grab a larger share of this market in 2010.
The company’s third line of business is industrial ceramics.
CHGS makes industrial ceramics used in steel production, electronics, metallurgy, and electric power. This business accounted for just 3% of revenue in 2008.
Now, let’s take a peek at the company’s numbers.
THE NUMBERS
CHGS had a difficult first quarter of 2009. Big production cuts by Chinese steel and oil companies significantly hurt demand for the company’s products.
However, as the year progressed, the Chinese stimulus plan helped get the economy growing again. Chinese steel and oil companies gradually increased production levels.
With other economies around the world now recovering, we’re seeing even larger increases in steel and oil production. This is helping CHGS end the year on a much stronger note than it started.
Just take a look at the company’s third quarter results.
Revenue jumped 16% to $14.9 million. Net income and earnings per share both surged 40% to $1.7 million and $0.07 respectively. And, earnings beat estimates by 40% (a third consecutive quarterly upside surprise)!
Driving top line growth was strong sales of fracture proppants. Sales of these products soared 174% year over year to a record $2.6 million. Strong demand from domestic oil and gas producers was behind the surge.
We expect this trend continued in the fourth quarter. We’ll know for sure when the company reports fourth quarter and full year 2009 results in late January or early February.
We think sales of refractory products were also stronger in the fourth quarter. Recent data from the World Steel Association shows global steel production rose for the third straight month in November.
A strong fourth quarter should offset weak first quarter results and produce strong growth for all of 2009.
Revenue is expected to rise more than 18% to $58.5 million. Net income is projected to surge 34% to $5.5 million. And, earnings per share are estimated to rocket 35% higher to $0.24. We’ll let you know what happens in a future portfolio update.
The outlook for 2010 is for more of the same.
Revenue is expected to climb 42% to $83.1 million. Net income is projected to jump 33% to $7.7 million. And, earnings per share are expected to move higher by 39% to $0.32.
Remember, the company’s refractory and fracture proppants businesses should see greater demand due to the global economic recovery. And, the new precision abrasives business should add significant revenue in its first year of operation.
In addition to high growth, the company has a strong balance sheet.
They’re sitting on $9.8 million in cash. Current assets are 1.6x current liabilities (anything over 1.5x is good). And, they have no long-term debt.
INVESTMENT RISKS
Of course, an investment in CHGS does involve some risk.
Control of the company is in the hands of just one person… the CEO. He owns more than 70% of outstanding shares and has the power to elect and remove all directors.
Another risk is the company’s reliance on its top ten customers for about 60% of its sales. If these customers stop buying from CHGS, the company’s growth could slow.
A third risk is a potential shortage or increase in the cost of raw materials used to make the company’s products. Either scenario could hurt the company’s sales and profits.
POTENTIAL RETURNS OF 205% OR MORE
CHGS is poised for terrific growth in 2010 and beyond.
The refractory and fracture proppants businesses are perfectly positioned to benefit from the recoveries in the steel and oil industries. And, the new precision abrasives business is launching just as a new boom in solar power is about to begin.
Despite the company’s excellent past performance and amazing growth potential, the shares are badly misvalued by the market.
CHGS is expected to grow 32% a year over the next five years. But, the shares are trading at just 7 times the 2010 estimate. That produces an extremely low PEG ratio of 0.22.
In other words, the shares are trading at almost an 80% discount to the company’s long term growth rate.
The average P/E ratio for companies in the industry is 21x estimated 2010 earnings. Since CHGS is growing faster than most companies in its industry, we think it deserves a P/E at least equal to the industry average (if not higher).
Using a P/E of 21x the 2010 estimate of $0.32, CHGS is worth at least $6.72. That’s potential upside of 205%!
Based on our analysis, we see the stock trading up to at least $6.72. Buy CHGS now for potential gains of 205% or more.
ACTION RECOMMENDATION
BUY China Gengsheng Minerals (OTCBB: CHGS) up to $2.60 per share.
Recent price is $2.25.
Use a stop-loss of $1.12 on this position.
Don’t forget your position sizing and stop-loss rules.
Earlier this year, the commodity markets started moving higher. Oil and gas prices moved up, and it wasn’t long before the threat of inflation pushed up precious metals.
As world economies started stabilizing, the “light at the end of the tunnel” for the recession was finally visible. No longer were investors fearful of a global credit crisis or economic collapse… They started thinking about growth.
Economic growth is an amazing thing.
It drives markets higher… it helps companies grow… and most importantly, it can make investors wealthy! Economic growth in emerging market countries like China and India create huge demand for commodities.
The tie in is simple… millions of Indians and Chinese are entering the middle class. It means they have money to spend on things like new modern homes, private cars, better food, even vacations.
As middle income populations rise, consumer spending trends higher.
As more people look to buy new homes and autos, it puts pressure on the commodity markets. Just think of all the commodities needed to build a modern home or car.
One industrial metal tops the list… Copper!
Copper’s use is widespread. It’s found in everything from electrical systems and plumbing to household appliances and electronics. It’s even used as a decorative product and a roofing material.
New home construction has a big influence on demand for copper (especially in the US). As the economy starts to rebound… home building activity will jump, and so will copper demand.
Also, don’t forget about emerging markets in China and India. China alone accounts for 23% of world copper demand. And with an 8% plus economic growth rate, I only see that demand heading higher.
Take a look at copper prices.
This is the chart of an ETF tracking the price of copper… as you can see, it’s done nothing but go straight up! Copper prices have more than doubled since the beginning of 2009.
The companies most likely to benefit from higher copper prices are none other than the copper mines.
Most of the world’s copper supply comes from Chile. The United States and Peru follow in a distant second and third place. Major copper producers include Freeport McMoRan (FCX) and BHP Billiton (BHP).
While those companies are interesting, you’re never going to hit a home run buying a multi-billion dollar company.
That’s when I found Taseko Mines Limited (AMEX: TGB).
Name: Taseko Mines Ticker Symbol: TGB Market Cap: $770 million Recent Price: $4.22PSB Rating System 4.5 Stars Raging Revenue: (5.0 stars) With commodity prices climbing and mine production growing by 45% in 2010, we could see revenue jump considerably. Beautiful Books: (4.2 stars) Despite a rough 2009, the company will show a profit… and they’re sitting on more than $50 million in cash. The recent sale of 25% of their Gibraltar mine site brings another $171 million to the bank. Stellar Structure: (4.0 stars) Institutional ownership is very high and insiders own several million shares. A number of funds have multi-million share positions. Valuation Verification: (4.8 stars) The stock is badly mispriced by the market. Based on our valuation analysis, we think the stock is worth at least $11 a share. That’s upside potential of 159% or more. Meaningful Milestones: (4.5 stars) They’re working to ramp up mine production by 45% in the next year… as production grows, so will revenue and profits! |
THE MINING BUSINESS
Taseko is a small mining company based in Vancouver, Canada. Their mines are located in the central and northern parts of British Columbia. What amazes me most is how Taseko is incredibly mis-valued by the market… I’ll explain more in a moment.
Taseko owns four large mining sites. One mine is fully operational and the other three are in varying stages of development.
The company makes money simply by pulling ore bearing copper and gold out of the ground. The ore is processed and refined. The resulting commodities are then sold in the market.
It’s not a very complicated business… Let’s look at the mines…
The Gibraltar Mine
The Gibraltar mine is currently operating and has an estimated life greater than 25 years. The primary focus of the mine is on two metals… copper and molybdenum.
Molybdenum is able to withstand extreme temperatures. It is often used to form extremely stable metal alloys. These alloys are used in the manufacturing of aircraft parts, electrical contacts, and industrial motors.
Recent engineering studies of the Gibraltar mine estimate proven and probable reserves at 2.7 billion pounds of recoverable copper. With copper prices over $3.30 a pound right now, the value of the copper in the ground is just over $8.9 billion.
And that doesn’t include the other metals like molybdenum… which is currently selling for around $10.75 a pound.
The Prosperity Mine
I can’t think of a more aptly named mine site. Prosperity was acquired by the company back in 1969. By the 1990s, the property had been studied and mining plans were in the works… however, commodity prices were so low that opening the mine didn’t make economic sense.
Now with commodity prices rising, Taseko has put in motion plans to develop the site. Initial estimates from drilling and surveys indicate the site might hold as much as 3.6 billion pounds of copper and another 7.7 million ounces of gold.
A little back of the envelope calculation tells us the site might hold as much as $11.8 billion of copper and $8.4 billion of gold.
Technical and feasibility studies are complete. They estimate the mine will be profitable as long as gold stays above US$575 an oz and copper is higher than US$1.50 a pound. Given today’s prices, that shouldn’t be a problem!
Construction of the mine could start by late 2010 with commissioning in 2012.
The Harmony Mine
In 2001, Taseko acquired the Harmony mine. This site is located on Graham Island just off British Columbia’s west coast.
The site holds significant potential for gold production. Very early studies indicate initial gold in the ground might be as much as 1.6 million ounces. That’s roughly a value of $1.8 billion at today’s prices.
Right now the site is part of the company’s longer term growth plans… They don’t have a concrete date to start feasibility studies.
The Aley Mine
This is the last of Taseko’s mines. The site was acquired in 2007 and is located in northern British Columbia. The site is believed to contain the mineral Niobium. It’s a metal used in making high strength steels for use in jet turbines, super conductors, and other high technology applications.
This site is still under review and nobody has any idea what the ground might hold… further study by the company is needed.
THE NUMBERS
One thing caught my eye about Taseko…
Not only is the company developing new projects, they already have one mine up and running. Unlike most exploration and discovery companies, Taseko is generating revenue and profits…
Before we jump in, remember, Taseko is a Canadian company. That means all of their financial numbers are in Canadian Dollars. Don’t let that scare you away… right now the exchange rate is 0.95 to 1… in other words, for every $95 US Dollars you get $100 Canadian Dollars… the 5% difference is small… besides, what we’re looking for are trends.
Obviously as a copper mining company, Taseko’s fortunes rest heavily on the change in copper prices. In 2007 and early 2008, copper prices were high (at one point more than US$4.00 a pound). In the middle of 2008, commodity prices started falling and didn’t hit bottom until the beginning of 2009.
Since the lows at the start of 2009, prices have climbed steadily… but we’re still a long way away from the highs set 18 months ago.
In the first nine months of 2009, the company generated C$132 million in revenue and C$12 million in earnings. EPS for the same period was just C$0.07.
The numbers aren’t bad. But if you compare them to the same period in 2008, it looks a little rough.
In the first nine months of 2008, the company generated C$176 million in revenue and C$26 million in earnings. EPS for the period was C$0.18.
Here’s the key… commodity prices are rebounding and mine production is expected to jump by 45%. So while past comparisons don’t look so hot, what’s got me excited is the potential growth.
The company’s balance sheet looks good. As of the third quarter, the company is sitting on C$52 million in cash. And that doesn’t include the C$180 million they recently received for selling part of the Gibraltar mine.
INVESTMENT RISKS
Like any investment, Taseko does involve some risk.
The company is highly exposed to copper prices. If they collapse, revenue and profits would fall.
Also, the proven and probable reserves of a mine are at best an estimate. Taseko could find much more or much less copper or gold than they estimate. This could impact any or all of their mining properties.
Finally, the cost of developing new mine sites can fluctuate widely. Costs for equipment, fuel, and labor can change… and that could make the company less profitable.
POTENTIAL RETURNS OF 159% OR MORE
When we started discussing Taseko, I mentioned the company was mis-valued. Now let me explain what I mean.
Taseko recently sold 25% of their Gibraltar mine for US$171 million… The money will help develop the Prosperity mine.
Here’s the important part… if 25% of the mine is worth US$171 million, that means the entire mine is worth US$684 million. It works out to a value of about US$3.75 per share! You can buy the company’s shares for around US$4.20 a share… or the whole company for $760 million.
That values the other three mine sites at less than $80 million dollars… It’s like buying one mine and getting the other three for free!
But that’s not all…
Take a look at the Prosperity and Harmony mine sites. They’re estimated to hold deposits worth about US$22 billion in copper and gold.
Remember these are rough estimates based on current prices… if commodities continue to move higher, these numbers move up significantly.
US $22 billion is a big number. It takes time and money to extract the ore deposits from the earth. So the present value of the mines is something less.
Let’ look at the Gibraltar mine. The present value of the mine is about 7.6% of the estimated value of the ore in the ground.
If the Harmony and Prosperity mines hold $22 billion of ore in the ground… and the mines are presently worth 7.6% of the total ore… then those mines add another $1.7 billion to the value of the company.
That’s an additional $9.34 a share!
So if Gibraltar is worth $3.75 and Harmony and Prosperity are worth another $9.34…the company could easily be worth $13.09. And that doesn’t include the value of the Aley mine site!
As you can see, Taseko is horribly mis-valued by the market. The potential upside on this stock is easily 120% to 209%.
Based on our analysis, we see the stock trading up to at least $11.00. Buy TGB now for potential gains of 159% or more.
ACTION RECOMMENDATION
BUY Taseko Mines (AMEX: TGB) up to $4.65 per share.
Recent price is $4.22.
Use a stop-loss of $2.10 on this position.
Don’t forget your position sizing and stop-loss rules.
Category: PSB Monthly Issues
