PSB Monthly Issue May 2009
May 2009
CHINA’S $586 BILLION STIMULUS PLAN
For the past 20 years, the Chinese government has pursued a program of “informatization”.
The term refers to the development and use of new technologies in government, industry, education, and culture. This policy is the linchpin of China’s economic development strategies.
I’ve found a unique way to make a lot of money off China’s informatization program.
But, before I share it with you, I need to provide a little more background. Please bear with me… you won’t regret it!
A major component of the informatization policy is the creation of China’s e-government platform. It’s an electronic system for sharing information between government agencies.
One important government agency involved in this program is the Ministry of Public Security (MPS). In 2003, MPS launched a program to improve the information technology infrastructure of China’s public security bureaus and customs. They call the project “Golden Shield”.
Golden Shield requires implementation of the National Police-Use Geographic Information System (PGIS) Application Project. PGIS is the platform used by police, fire, and medical rescue to coordinate emergency response services.
The goal of the PGIS Project is to connect all variations of PGIS used throughout China into an integrated system. By allowing all public safety departments to share information, PGIS promotes efficient quick-response capabilities for public emergencies.
MPS plans to connect 100 major cities to a standardized PGIS over the next three years. Once that’s accomplished, they’ll roll the system out nationwide.
But, that’s not all…
Another major initiative is the Golden Health program. It’s designed to create digital hospitals and a nationwide electronic medical records system. This will help improve medical care, reduce medical errors, and minimize medical claims fraud.
One company is a major player in both of these initiatives…
It’s a dominant national competitor with strong brand recognition…
Introducing China Information Security Technology Co. (CPBY).
Name: China Info Security Tech Ticker Symbol: CPBY Market Cap: $149 million Recent Price: $3.05 PSB Rating System 4.9 Stars Raging Revenue: (5.0 stars) Revenue rocketed 127% to $85.3 million in 2008. Look for revenue to jump 26% to $107 million this year. Beautiful Books: (5.0 stars) Net income popped 88% to almost $27 million or $0.57 a share in 2008. Look for it to rise 23% to $33 million or $0.70 per share in 2009. Stellar Structure: (4.5 stars) Insider ownership is very high at 52%. Institutions own just 32%. Look for the stock to move when institutions start buying up shares. Valuation Verification: (5.0 stars) With a PEG ratio of just 0.13, CPBY trades at an 87% discount to its growth rate. The shares offer upside of 179% or more. Meaningful Milestones: (5.0 stars) The company’s PGIS core technology was selected by China’s Ministry of Public Security for inclusion in the national PGIS system now under construction. The company also won a huge contract for installation of its Medical Case Statistics software in 1,000 hospitals in Guangdong Province. |
THE DIGITAL INFORMATION BUSINESS
CPBY provides software, systems integration, and geographic information systems to public security and civil-use markets in China. The company also provides digital hospital information systems to the Chinese healthcare market.
Their customers are some of the most important government departments in China. They have authority over areas like public security, traffic control, fire control, medical rescue, border control, surveying and mapping, and hospitals.
CPBY operates three business segments.
The Public Security Information Technologysegment targets three key areas of the Golden Shield project.
CPBY’s First Responder Coordination Platform is the Chinese equivalent of our 911 system.
It’s already been installed in nine major Chinese cities and Macao. Approximately 660 cities are required to deploy a coordinated emergency response platform. This is a major opportunity for CPBY. And, the market’s growing 30% a year.
The company’s Intelligent Border Control System is used by MPS to protect China’s borders.
The system stores passengers’ biometric information like fingerprints and facial features. It allows for faster and more accurate processing at border checkpoints. This is another huge opportunity for CPBY. The market is about $300 million and growing 30% a year.
Another system created by CPBY is the Residence Card Information Management System.
It was adopted by the city of Shenzhen to more efficiently provide social services like welfare, education, and rental housing. If successful, the system could be extended to 660 cities across China. Yet another key opportunity in a market with 20% annual growth.
The GIS Software Services segment markets the company’s PGIS and civil-use GIS (CGIS) systems.
CPBY’s core PGIS technology has been selected by MPS for use in the “PGIS Project”. This means it could be rolled out nationally as part of the standardized national service. The market for PGIS in China is about $346 million. And, it’s growing 23% per year.
CGIS is also a blockbuster opportunity.
CGIS is widely used in national defense, surveying and mapping, land resource, city planning, and electricity. This market is growing by a whopping 50% per year. And, CPBY is one of just a handful of companies with the highest level CGIS certification.
The company’s reputation for CGIS got a big boost last year. During the Sichuan earthquake, CPBY’s CGIS services helped locate many victims. Nothing like saving lives with your product to impress potential customers.
Finally, the Digital Hospital Information Systems segment markets the company’s Medical Case Statistics software to hospitals.
With best in class software, CPBY won an exclusive contract from the Health Department of Guangdong Province. The system is now being rolled out to 1,000 hospitals in the province. It could serve as the model system in a market with 20% annual growth potential.
I know this all sounds too good to be true. But, don’t just take my word for it. Take a look at the company’s financial results. They don’t lie.
THE NUMBERS BEHIND INFORMATION SECURITY TECHNOLOGY
CPBY’s growing faster than a bodybuilder on steroids.
The company has posted higher revenue and earnings in each of the last four years. Revenue is rising at a mind boggling compound annual growth rate of 115%. And, profits are growing at a no less impressive 106% per year.
2008 was another record year for CPBY.
Revenue rocketed 127% to $85.3 million. The company enjoyed strong sales of its products and services across all lines of business. This trend should continue in 2009 and beyond.
But, more on that in a moment…
Profit margins declined slightly due to recent acquisitions and cost overruns on several projects. Nevertheless, the company boasts strong gross profit margin of 45% and an enviable operating margin of 31%.
Net income catapulted 88% higher to almost $27 million or $0.57 per share. That’s more than five times 2006 profits and about 15 times 2005’s.
We’re expecting CPBY to grow at a red hot pace of 34% annually over the next five years.
The outlook for 2009 is for more amazing growth despite the economic slowdown.
Management expects revenue to jump 26% to $107 million. And, they believe net income will pop 23% to just under $33 million or $0.70 per share.
A strong balance sheet completes this pretty picture.
The company had $15 million in cash at the end of 2008. And, total debt of $6.3 million is insignificant given shareholder equity of $109 million. Most important, CPBY’s cash flows adequately support the company’s working capital needs.
The huge growth opportunity and sound financial practices at CPBY are exactly what we’re looking for in a penny stock. Look for confirmation of these trends when the company reports first quarter earnings on May 13th.
INVESTMENT RISKS
Despite the company’s terrific performance and outlook, an investment in CPBY does carry some risk.
CPBY depends on a small number of customers for most of its revenue. If they lose one or more of these customers, their business could suffer.
Another risk is an unexpected change in the Chinese government’s spending for public security and healthcare information technology. A substantial decrease in spending could lead to fewer projects for CPBY.
A third risk is management’s ability to find and make suitable acquisitions. The company’s long-term growth depends on expanding products and services and increasing economies of scale.
POTENTIAL RETURNS OF 179% OR MORE
A number of factors are driving CPBY’s business in 2009 and beyond (most businesses would be happy with one or two of them):
- China’s $586 billion infrastructure spending program
- $17 billion in spending for new Golden Shield projects
- Standardization of the National PGIS system
- Construction for the 2011 World University Olympic Games in Shenzhen
- Expansion of digital hospitals under the Golden Health Project
Given the unique nature of CPBY’s business, good comparisons are hard to come by. So instead, we’re going to compare it against the Application Software Industry.
CPBY offers huge upside potential from its recent price. A comparison with the Application Software Industry averages shows the stock is really misvalued.
On a price to sales basis, CPBY is trading more than fifty percent below the industry average. The company’s revenue per share is $1.84. Using the industry P/S ratio of 3.9x, the shares are worth $7.18. (Upside potential of 135%).
The company’s P/E ratio of 6.0x is incredibly low. With projected earnings growth of 34% annually, CPBY deserves a P/E at least equal to the industry average. At 12.7x last year’s earnings of $0.58 per share, the stock would be worth $7.36 (141% higher than its recent price).
A price to book analysis yields an even higher price. The industry average P/B ratio is 3.4x. CPBY’s book value per share is $2.29. Applying a P/B of 3.9x, CPBY’s shares are worth $8.93 (a potential gain of nearly 193%).
Finally, on a PEG ratio basis, CPBY offers phenomenal potential returns. CPBY’s PEG ratio is a meager 0.13. At this level, CPBY is trading at a discount of 87% from its projected earnings growth rate of 34%. A conservative PEG ratio of 0.5 implies a price of $9.86. (Upside potential of 223%).
Based on my analysis, the stock is worth at least $8.52 a share. Buy it now for potential gains of 179% or more.
ACTION RECOMMENDATION
BUY China Information Security Technology (CPBY) up to $5.00.
Recent price is $3.05.
Use a stop-loss of $1.47 on this position.
Don’t forget your position sizing and stop-loss rules.
AND PAD YOUR INVESTMENT ACCOUNT
WITH THIS PENNY STOCK
Did you know the amount of toxic pollutants released into the air each year numbers in the millions of tons? I know air pollution is a problem. But, when I read this statistic, I almost started coughing (and, I was indoors at the time).
Here in the Phoenix area, we’re all too familiar with air pollution. The infamous “Brown Cloud” hovers over the city almost all year round. I can see it right now from my office window.
How do these toxic pollutants get into the air in the first place?
Some come from natural sources like forest fires. We have our fair share of these in Arizona too. But, most are released from manmade sources like factories, vehicles, power plants, and refineries.
Toxic pollutants are very dangerous to our health. They can cause cancer, reproductive problems, and even birth defects. Pretty scary stuff.
That’s why people the world over are pressuring their governments to improve air quality. In response to the political outcry, governments are placing ever greater restrictions on toxic emissions.
As you might have guessed, I’ve found a way to profit from this trend… but more on that in a moment.
First, let me briefly explain how U.S. environmental law works to reduce toxic air pollution.
The Environmental Protection Agency (EPA) has set stringent emission standards for each industry group. These standards are known as “maximum achievable control technology” (MACT) standards.
As the name suggests, these standards are very high.
They’re based on emissions levels from the better-controlled, lower emitting sources in an industry. Each major source of toxic pollutants must reduce their emissions to levels within the MACT standards.
The EPA estimates the MACT standards will reduce emissions of toxic air pollutants by 1.5 million tons per year. (I’m breathing a little easier now.)
How are companies supposed to comply with the MACT standards?
It seems simple enough… they must employ clean processes, pollution control devices, work practices and other methods. The EPA doesn’t mandate the use of any specific control technologies. Companies are allowed to create their own cost-effective solutions.
Another major weapon in the fight against air pollution is the Occupational Safety and Health Administration (OSHA).
OSHA has established threshold limit values for more than 1,000 industrial contaminants in interior air. Employers are required to protect their employees from the harmful effects of these pollutants.
Ok, enough with the lesson in environmental law. Let’s talk about how you can make money with this information.
Air pollution regulations spawned a whole new industry to help companies reduce emissions. It’s called the air pollution control and industrial ventilation industry. This multi-billion dollar industry is expected to grow to more than $250 billion by 2015, a four-fold increase from 2004 levels.
Right now the industry is highly fragmented.
Hundreds of small firms separately supply engineering services, fabrication, installation, testing and monitoring, products, and spare parts. In the past, customers with air pollution control projects have had to work with multiple vendors. As you can imagine, this isn’t cost-effective and makes project management difficult.
Now customers have another option.
One air pollution control company offers a complete end-to-end solution. This company offers everything from engineering and project management, to procurement and fabrication, to construction and installation, to aftermarket support and sales. And, it’s been doing business for over 100 years.
Allow me to introduce CECO Environmental (CECE).
Name: CECO Environmental Ticker Symbol: CECE Market Cap: $52 million Recent Price: $3.60 PSB Rating System 4.6 Stars Raging Revenue: (4.0 stars) Revenue growth averaged 26% annually over the past five years. Look for a return to high revenue growth as the economy recovers. Beautiful Books: (4.5 stars) Expanding gross profit margins signal strong earnings growth as the economy recovers. The company is expected to grow earnings by 36% in 2010. Stellar Structure: (4.8 stars) Insider ownership is very strong at 40% of shares outstanding. Insiders increased their stake by 8% in the last six months. Institutional ownership of 29% has plenty of room to grow. Valuation Verification: (4.8 stars) CECO offers huge upside potential. Using the industry average P/E of 20x its 2010 earnings estimate of $0.45, the shares are worth $10. That’s a potential gain of 177% from the recent price. Meaningful Milestones: (4.8 stars) CECO sold products in 46 countries and expanded operations in China, India, Japan, Korea, Mexico, Saudi Arabia, Taiwan, and Canada. 15% of their backlog is for projects outside the U.S. |
THE BUSINESS OF AIR POLLUTION CONTROL
CECO is the leading provider of complete turnkey air pollution control and industrial ventilation solutions. They help customers solve both indoor and outdoor air quality problems.
Here’s how.
The company’s industrial ventilations systems remove airborne contaminants from indoor work spaces. And, their air pollution control systems capture or eliminate those contaminants before the air is exhausted into the atmosphere.
CECO operates through four product groups.
The Contracting Group produces air pollution control and industrial ventilation systems. The Equipment Group produces various types of air pollution control equipment.
The Parts Group manufactures products used by CECO and other air pollution control companies. And, the Engineering Group provides industrial ventilation engineering and source emission testing services.
I know it’s a lot to get your head around. But, trust me, each group plays an important role in the company’s turnkey solution.
CECO has a huge customer base.
They’ve got more than 3,000 customers worldwide including some of the largest aerospace, automotive, foundry, ethanol, power, and metals companies in the world. Companies like General Electric, Proctor & Gamble, Boeing, Honda, Toyota, and Alcoa all work with CECO.
But, their business isn’t limited to just the U.S.
CECO is expanding its presence in key international markets like China, India, Japan, Korea, Mexico, Saudi Arabia, Taiwan, and Canada. At the end of 2008, more than 15% of the company’s order backlog was for projects outside the U.S. I expect CECO’s international operations will grow significantly in years to come.
The company’s management team is tops in the industry.
Senior management has an average of 20 years experience in the air pollution control industry. And, they’re supported by an operating management team that also averages 20 years experience – most of it gained at CECO.
Management’s two-pronged growth strategy should solidify CECO’s position as the industry leader.
First, they’re horizontally expanding the scope of CECO’s products and services through selective acquisitions. And, second, they’re forming new business units which are vertically integrated into CECO’s growing family of turnkey system providers.
You don’t have to look any further than CECO’s financial results to see the growth strategy is already a huge success.
THE NUMBERS BEHIND AIR POLLUTION CONTROL
CECO posted profits in each of the last three years. Even more impressive are back to back record years for revenue and earnings in 2006 and 2007.
While the global economic downturn depressed 2008’s numbers, CECO still managed to post solid results.
Revenue slipped 7.6% to a still respectable $217.9 million. Decreased demand from weakened industrial sectors was to blame.
Nevertheless, revenue was still two and a half times greater than 2005’s number of $81.5 million. And, 60% higher than the $135.4 million posted in 2006.
Despite the slight fall in revenue, CECO managed to post record gross profits in 2008 of $43.4 million. A 10.7% increase over the prior year’s figure. (These guys know how to make money!)
And, gross profit margins increased 3.3 percentage points to 19.9%. Expanding margins show the company is squeezing more profit out of every dollar of revenue.
Net income fell to $5.0 million from $6.3 million. And, earnings per share fell to $0.30 from $0.45. These smaller net profits were caused by two things. The decline in revenue and higher expenses related to recent acquisitions.
It’s really no surprise CECO’s results suffered in 2008. Its customers are in the sectors of the economy hit hardest by the recession.
The key is CECO will return to high revenue and earnings growth when the economy recovers. (Looks like that may happen a lot sooner than everyone thought.)
For 2009, earnings are expected to rise 10% to $0.33 per share on revenue of $216 million. Then, it’s off to the races in 2010. Earnings are expected to jump 36% to $0.45 per share on revenue of $231 million.
The company’s balance sheet looks pretty solid.
Long-term debt increased last year due to acquisitions. I’m not concerned because it amounts to just 60% of shareholder equity. And, the acquisitions immediately added revenue and profits.
INVESTMENT RISKS
Every investment carries some risk and CECO is no exception.
One risk is the impact from the ongoing global recession. We need the recession to bottom out before we’re likely to see higher growth at CECO.
Another risk is the company’s debt level. If cash flows were to decline significantly, CECO could have difficulty making its principal and interest payments.
A third risk is the company’s strategy to grow through acquisitions. The company’s growth could suffer if management fails to continue making sound acquisitions.
POTENTIAL RETURNS OF 177% OR MORE
I like CECO for several reasons.
First, it’s a market leader in an industry with strong growth potential. Every year more stringent standards are issued for air quality. Industrial companies have no choice but to continue investing in air pollution control and industrial ventilation systems.
Second, CECO has the broadest portfolio of clean-air technologies in the U.S. This means they have business opportunities in virtually every sector of the economy. The sheer breadth of their clean-air technologies drives growth.
Third, CECO is the leading provider of complete air pollution control solutions. They have experienced engineers to design the systems. They have the large scale fabrication capability to build the systems. And, they have the field personnel to install and service them. (Now, that’s what I call a true end to end solution.)
Last, they generate recurring revenue from consulting and aftermarket parts, rebuilds, and upgrades. This is virtually guaranteed revenue year in and year out. Over 25% of CECO’s 2008 revenue came from these sources.
CECO offers huge upside potential from its recent price. A comparison with two larger competitors shows how misvalued the stock really is.
A forward P/E ratio of 8x is incredibly low. Given revenue and earnings growth potential, CECO deserves a multiple closer to the industry average of 20x. At that level, the stock would be worth $9.00 (150% higher than its recent price).
A price to book analysis yields an even higher price. The average P/B ratio for Fuel-Tech (FTEK) and Donaldson Co. (DCI) is about 4x. CECO’s book value per share is $3.10. Applying a P/B of 4x, CECO’s shares are worth $12.40 (a potential gain of nearly 244%).
On a price to sales basis, CECO is really misvalued. The company’s revenue per share is $14.89. Using the industry P/S ratio of 1x, the shares are worth $14.89 (upside potential of 314%).
Based on my analysis, the stock is worth at least $10 per share. Buy it now for potential gains of 177% or more.
ACTION RECOMMENDATION
BUY CECO Environmental (CECE) up to $5.00.
Recent price is $3.60.
Use a stop loss of $1.80 on this position.
Don’t forget your position sizing and stop-loss rules.
Category: PSB Monthly Issues
