Tuesday, April 05, 2011

Cleaning up China's Skies

In response to pressing demand for energy and the need to better utilize valuable natural resources while reducing environmental harm, China is encouraging all forms of alternative renewable fuels and environment-friendly 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. 

With its Coal Water Slurry Fuel (CWSF) product, we believe Sino Clean Energy, Inc. (SCEI:  Nasdaq) is well positioned to capitalize on China’s Central Government policies.  Based in Shaanxi Province, the Company sells its CWSF product to a growing base of industrial, commercial and residential customers.  In 2007, the Company installed its first 100,000 metric ton production line in Tongchuan, Shaanxi Province.  It has since increased capacity to 1.2 million tons from six production lines and serves customers in markets around Xi’an, Shaanxi Province, Shenyang, Liaoning Province and Dongguan in Guangdong.  The Company is planning expansion into the Guangxi area in southern China and additional lines in Liaoning that could bring total capacity to 2.6 million metric tons per year by 2013.

While Sino Clean Energy has a limited operating history in its present business model, early on the Company achieved profitability and positive cash flow.  In fiscal year 2008, the first full year of operation as a producer of CWSF, the Company recorded revenue of $13.8 million, providing $4.0 million in operating income or 29.0% of sales.  Capacity expansion and strong execution in penetrating its markets helped Sino Clean Energy grow sales in 2010 to $106.2 million, 131.1% over the previous year.  The operating profit margin also increased to 32.6% on efficiencies of scale and operating leverage.  The Company expects to reach the $170 million sales level in 2011 and to produce over 1.4 million metric tons of CWSF. 

We believe good working capital reserves and a debt-free balance sheet provide a foundation for the Company’s ambitious expansion schedule and aggressive market penetration strategy.  In December 2010, the Company raised $32.7 million in capital through the sale of 6.3 million shares of common stock at $5.25 per share.  Cash and equivalents at the end of 2010 totaled $52.1 million.  We believe cash resources and current cash flow from operations could be sufficient to support the Company’s capital spending budget of $42.4 million over the next two years.

We expanded our coverage of SCEI with a Speculative Buy rating.  In our view, Sino Clean Energy is undervalued relative to its growth and earnings potential.  We set a new price target of $13.00, representing a multiple of 7.1 times our 2011 earnings estimate of $1.82.  We view SCEI as speculative and appropriate for investors with a tolerance for risk and long-term investment horizons.

Additional information is available in our most recent report on SCEI dated April 4, 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 Sino Clean Energy through its CER Report series for sponsored research and has a Speculative Buy rating on SCEI.

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