Tuesday, January 18, 2011

Liquid Diamonds

Last week we updated coverage of Sino Clean Energy, Inc. (SCEI: Nasdaq), a China-based producer of Coal Water Slurry Fuel (CWSF). CWSF is a highly viscous liquid fuel made from pulverized coal particles suspended in water. Suspension additives prevent settling of the coal particles during transport to customer premises.

Expansion in production capacity and the addition of new customers have helped drive sales growth for Sino Clean Energy. The Company reported $46.0 million in total sales in the year 2009, compared to $14.3 million in the previous year. The pace accelerated in the first nine months of 2010, with sales reaching $73.6 million, more than 2.5 times over the year-ago period.

Profits have followed sales. Profit margins have increased, largely on better coverage of fixed costs at the higher sales levels even as raw materials costs have risen. The gross profit margin in the nine months ending September 2010 was 39.5% compared to 34.4% the same period in the previous year and 34.9% in the year 2008.

Cash flow from operations provides a good view on Sino Clean Energy’s financial performance. In 2009, the Company was successful in converting 21.1% of sales to cash from operations. The conversion rate increased to 28.9% in the first nine months of 2010.

Generating cash at that pace it looks like Sino Clean Energy has found liquid diamonds in China’s coal deposits.

The Company sold 456,000 metric tons of CWSF in the year 2009. Total production for the year 2010 has not been reported yet. However, with expansion of production capacity to 850,000 metric tons and the Company’s claims it has retained all its customers, we expect a sizable increase in sales by volume for the year. Of course, volumes are highest in China’s winter months, making the current period Sino Clean Energy’s big season.

So just how far can Sino Clean Energy go with its CWSF? The smaller the coal particle size in the mixture the more versatile the CWSF is for application for heating and industrial production processes. For example, in the largest particle form CWSF is a viable substitute for heavy grade fuel oils used to produce steam in heating boilers. When the particle size is 80 microns or less the CWSF can be used as a co-fuel or substitute fuel in diesel engines.

China’s Central Government has bought into its potential. CWSF technology has received the support of China’s Central Government for its environmental advantages and has been included in each Five-Year Plan since 1981. In response to rising demand for energy and the pressing need to better utilize valuable natural resources while reducing environmental harm, China is encouraging all forms of alternative renewable fuels and improved fossil fuels. The abundance of coal resources in the Asian continent and a dearth of oil reserves has made coal China’s fuel source of choice. Even with advances in renewable energy sources, coal is likely to remain China’s primary electrical power and industrial fuel source.

Provincial government policies are key facilitators of demand for CWSF. At least four cities in China have mandated conversion of aggregate coal-fired boilers to clean energy alternatives. In Tongchuan, the Company’s homebase, all coal heating boilers are to be converted to clean coal energy sources by 2012. The city also plans to develop twenty central heating stations using CWSF. In Shenyang, where Sino Clean Energy operates two production lines, there are plans to build fifty-six CWSF boilers. The community of Dongguan in Guangdong Province is offering a one-time subsidy of 20% for upgrades to CWSF equipment. Sino Clean Energy is currently establishing two production lines in Dongguan.

What has sparked the enthusiasm of China’s government officials is the relatively environmentally friendly combustion of CWSF. When burned, coal aggregate emits sulfur oxides (SOx), nitrogen oxides (NOx), mercury, and particulate matter (PM). Coal also produces more carbon dioxide per unit of energy produced than oil or natural gas. However, higher combustion efficiencies using CWSF leads to lower emissions relative to burning coal aggregate, making CWSF a comparatively cost effective and environmentally friendly fuel for heat and power generation. (See more data comparing the cost, thermal efficiency and emissions of coal aggregated, CWSF, oil and natural gas in our most recent report on SCEI dated January 14, 2011.)

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research publishes research on SCEI in its Focus Report Series for issuer sponsored research coverage.

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