Friday, January 04, 2008

French Fries in the Gas Tank

Last month the leading producer of biodiesel in China, Gushan Environmental Energy Limited (GU: NYSE), braved the rough, frigid waters of the U.S. capital markets to stage an initial public offering. Although priced well below initial expectations for a price near $13.00, the offering raised $173 million (18 million shares at $9.60). Even in the wake of a series of dismal economic reports that have come across the U.S. news wires over the last three weeks, GU shares are holding up, closing at $11.50 on January 3, 2007.

Whether the stock’s early success comes more from the underwriters’ pragmatic pricing effort or the appeal of Gushan’s business model is not certain. One thing for certain, Gushan is not the usual corn-for-gas story. Gushan produced 190,000 tons of biodiesel in the last twelve months using vegetable oil offal, animal fat and recycled cooking oil!

Waste-to-energy is an appealing investment target from a social and political standpoint. Intuitively there should be a strong economic value proposition in it as well. Indeed, Gushan management says their low-cost sourcing of feedstock is giving them a competitive advantage over other biodiesel producers that rely on higher-cost food quality oils.

Darling International (DAR: NYSE) is a U.S.-based play on the upstream end of the waste-to-energy industry. Darling is a leading rendering and recycling solutions provider with a nation-wide collection network of meat processors and food service establishments. Sales have grown steadily, reaching $598.0 million in the trailing twelve months ending September 2007, compared to $407 million in calendar year 2006 and $308.9 million in calendar year 2005.

Like many commodity businesses, the Company has experienced periods of net losses. However, recent efforts to bring new efficiencies to operations through the strategic acquisition of National By-Products, LLC in May 2006, have set the Company up for continued growth and increased profitability.

Crystal Equity Research estimates for $0.15 EPS on $170.0 million in sales for the final quarter of 2007 falls at the lower end of the range of contributions to Thomson’s First Call consensus estimate - $0.17 EPS on $175.4 million in sales. However, we have a more aggressive view on Darling’s top-line potential in 2008, but appear to think more conservatively in terms of profit margins. The consensus estimate reflects higher profits on lower sales - $0.67 EPS on $696.1 million in sales - compared to our 2008 figures. The range of contributions to the 2008 consensus is $0.56 to $0.76 EPS and $656.3 million to $716.1 million in sales.

There are no published estimates for Gushan, but historic results are impressive and suggest management is doing more than just “whistling Dixie.” In the first nine months of 2007, Gushan posted $33.4 million in net income on $98.3 million in sales. The gross profit margin appears solidly in the low- to mid-40s. Gushan proposes to more than double production in the next year and we expect to see some improvement in efficiencies from better utilization of existing plants. However, that may not show up in reported margins given plans to spend the IPO proceeds on new production facilities and R&D.

Gushan and Darling illustrate that waste-to-energy is good business as well as good politics. With over five dozen biodiesel producers in the U.S. - mostly private - it is likely there will be a few more IPOs in sector.


Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research has a Buy rating on DAR shares.

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