BEIJING (TheStreet) -- The past 12 months have been very volatile for China battery makers including Advanced Battery Technologies (ABAT) , Hong Kong High Power (HPJ) - Get Report, New Energy Systems (NEWN.OB) , China Ritar( CRTP) and China Bak Battery (CBAK) . After six months of sitting on the sidelines and doing plenty of analysis, I recently bought back into New Energy Systems and view it as a stock with the potential to double.
I have owned shares of New Energy Systems off and on for about a year. I have a very favorable view of management, the company and the industry. I have also met with members of management, including the new chairman, on several occasions and toured its Shenzhen manufacturing facility.
The only reason I sold the stock last year was because I didn't fully understand the math behind its two recent acquisitions. The company issued around 7 million shares in order to complete two significant acquisitions that could generate significant revenue. However, I didn't know if the additional revenue and earnings generated by the acquisitions would be more than offset by the additional shares outstanding.
NEWN presented at the
conference in Beijing and gave a detailed breakdown of incremental income vs. share dilution as well as guidance on its expected performance for 2009 and 2010.
Before taking a closer look at New Energy Systems, it is important to note that every online financial site still has outdated information on the company. I have checked Bloomberg, Reuters,
and all show approximately 5 million-6 million shares outstanding when the real number is now 12.6 million. Obviously this has very important implications for valuing the company.
NEWN is set to release annual results within days and has already given "guidance" of earnings of $5.3 milion-$6.0 million, excluding non-cash charges. Normally I don't place too much weight on guidance, but this "guidance" was released in March, two and a half months after the fiscal year end and the company have re-affirmed it three times, so I am reasonably confident that it will be accurate.
It is important to note that when earnings are releases, the bottom-line EPS number will be lower than forecast due to non-cash charges related to the acquisitions and issuance of shares. There are two reasons why I will ignore those charges completely.
First, they are simply an accounting entry that does not reflect economic reality. The reality is that shares were issued in order to acquire incremental profits. If we use the proper share count of 12.6 million, then the additional non-cash charges are superfluous.
Second, because the company did not issue convertibles or warrants, the charges are one-time charges only and will not affect the business going forward. How much will the non-cash charges be? I don't know because the company did not disclose it. But frankly, I don't care how much they are because they are irrelevant to the business in 2010.
On the day that earnings are released, some investors may simply look at the bottom line EPS, including non-cash charges, and conclude that profitability was lower than expected. As a result, there may be some selling pressure that day, which I will view as a good opportunity to pick up more shares.
On the other hand, given that the company has been so proactive about communicating guidance, there may be no negative reaction at all. In any event, I always try to be careful to not get fooled by non-cash earnings charges related to acquisitions and share issuances.
The company released detailed guidance for 2010 projecting EPS of $1.23, which implies a forward PE of only 6.1 times, despite a projected tripling of net income. For a pre-
stock, this valuation looks somewhat cheap. But the real upside here is that the company has already publicly announced its intentions to uplist and has said it will do so in 2010.
Once this happens, NEWN should trade on a multiple closer to that of its other Nasdaq-listed peers. That's where the current valuation becomes compelling.
Advanced Battery, Hong Kong High Power and China Ritar all trade in a consistent range of 13-19 times earnings. So what is the "right price" for New Energy Systems?
I use the following assumptions: 2010 earnings as guided of $15.6 million, shares outstanding as indicated of 12.6 million, for an EPS of $1.23. Once NEWN uplists, I would expect it to trade at a P/E in line with China Ritar and ABAT at around 13x, implying a share price of $16.12.
If NEWN can start making the rounds and generate research coverage and better institutional penetration, there could be more upside placing it more in line with HPJ at 19 times earnings. This would imply a share price of $23.56.
Given that the company has already begun attending investor conferences, such as the Rodman conference in Beijing, and has already hired an investor relations firm, I think eventual research coverage is likely.
The key catalyst that will cause the stock to pop will be when the company puts out a press release stating that it has appointed its independent directors, which is necessary for the uplisting. Based on my discussions with management and its IR firm, the process of appointing these directors is already under way.
Currently NEWN shares trade for less than $8.00 and seem to show a significant amount of support at prices above $7.00, so the potential upside vs. downside profile of the stock currently looks very attractive. Last year the stock hit a 52-week high of $10.00, but I now view that high as largely irrelevant because it was based on a different share count and it took place prior to the two new acquisitions, which significantly enhance the company's earnings potential.
Recent comments by CEO Fushun Li also provide further comfort, "we have a clean capital structure, our balance sheet is very healthy, and we do not anticipate issuing additional equity in the near future. Finally, we have significant excess production capacity and can achieve our 2010 growth targets without incurring meaningful additional capital expenditures."
At the time of publication, Pearson was long NEWN.OB. The author can be reached at email@example.com.
Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.