BEIJING ( TheStreet) -- Every so often I see individual stocks whose valuations simply do not make sense. Most recently I came across China Digital Communications ( CMTP), which is based in Shenzhen, China.

To gain some perspective on a target valuation, I compared CMTP to China Bak Battery ( CBAK), Advanced Battery Technologies ( ABAT) and to Hong Kong Highpower Technology ( HPJ).

And to make sure I wasn't missing anything important on CMTP, I went to Shenzhen to meet with company management and tour their factory.

Battery shells and caps production line

My conclusion from all of this is that China Digital's valuation should fall roughly in the middle between CBAK and ABAT, which would place it on a P/E multiple similar to that of HPJ. These are three very solid data points that all point in the same direction. The fact that it is still trading at a significant discount creates a very strong buying opportunity.

For a valuation comparison, CBAK, also based in Shenzen, is currently trading at around $3 per share, has a $170 million market cap, and currently has gross margins of around 11% despite the fact it is unprofitable. On the balance sheet, CBAK has over $150 million of debt due within 12 months and only $30 million of cash. CBAK has $40 million of long-term debt. On the expansion side, CBAK has recently announced it is building a factory in India.

ABAT is currently trading at about $4 with a market cap of $240 million. ABAT is profitable and has high gross margins of 40% to 50%. On the balance sheet, ABAT is very strong, having raised significant equity financing over the past year at stock prices in the $4-$5 range.

As a result ABAT has cash of $45 million and no debt. In terms of expansion on the battery side, ABAT has just announced that it in the process of acquiring "a leading battery production company in Shenzhen, China." ABAT put down a deposit of RMB10 million ($1.5 million), meaning that its target is likely a smaller battery producer. I find this to be an encouraging data point for my valuation of CMTP.

HPJ is a great comp for CMTP because it is also a Shenzhen-based battery manufacturer, which happens to be located just five minutes away from CMTP's headquarters and factory. HPJ is currently trading at less than two times cash, but is trading on a cash adjusted P/E of about seven times. This is more than triple the multiple of CMTP's current price.
Battery production line

It is worth noting that HPJ has enjoyed a jump in its stock price of nearly 30% following the company's attendance at the Rodman and Renshaw conference in New York where it presented its story and gave one-on-one meetings with institutional investors. I expect CMTP may enjoy an even greater boost in stock price once it gains any meaningful institutional following.

I like CMTP because it is very profitable, expanding, debt-free and cash rich. At the current price of $4, the company trades at a cash-adjusted P/E ratio of only two times TTM earnings (compared to 10 times for ABAT, and losses for CBAK).

HPJ trades at a P/E of 13 times, or roughly seven times once its substantial cash balance is backed out. According to its recent 10-Q, China Digital had nearly $10 million of cash on its books at quarter-end. The company has completely changed from its low-margin business of manufacturing battery shells and caps for lithium ion batteries.

Over the past one to two years, the company has been expanding its production of finished, high-margin lithium ion batteries for phones, computers and other electronic devices. CMTP now derives the majority of its revenue from this line of products, which provides gross margins in excess of 30% and account for over two-thirds of revenues. The company has had positive cash flow from operations every quarter in the past and previous years.

CMTP is clearly an ignored, underfollowed stock. In March, CMTP briefly traded at a 20% discount to cash on its books. Six months later, the stock has tripled. Although I am kicking myself for not finding CMTP back then, I don't want to make the mistake of ignoring it now just because it has gone up so quickly, particularly since it is still trading at a very significant to its direct comparables.

Below are segments of interviews with CFO Junfeng Chen in Shenzhen, and Investors Relations Vice President Ken Lin (via phone from New York).
CFO Junfeng Chen explains battery products to Rick Pearson.

Mr. Chen, can you please give me some overview and background information on China Digital?

Since 2001 we have been in the business of supplying battery caps and shells to the battery industry, particularly lithium ion batteries. Since 2008 we began expanding into the high margin business of producing finished batteries. Our operating subsidiary in Shenzhen is E'Jenie. We are U.S. listed and trade under the symbol CMTP.OB. Later this month, we will be changing our name to New Energy Systems Group to reflect our primary focus on producing lithium ion batteries.

In terms of product mix, as of the second quarter, we had total revenues of $5.4 million, which were comprised of 68% finished battery revenues and 32% battery shell and cap revenues. Margins in the shell and cap products are quite low at about 6%, however, margins in the finished battery business are quite high at about 30%.

How significant is customer concentration in your finished battery business?

The finished battery business is a relatively new business for us, which we have been building step by step. Last year, when we first entered the business, our first and only customer accounted for 100% of the finished battery revenues. Since that time we have added two new major customers such that total battery revenues will be divided very approximately as 50%, 30% and 20%. As time goes on we expect to continue adding new customers. With our customers, we have 90-day payment terms and have had no problems with accounts receivable.

The company currently has a sizable cash balance. Do you have plans for it?

We continue to look for attractive local battery producers to acquire to expand our battery business. Being located in Shenzen is ideal because there are many small, profitable private battery companies with up and running production facilities and sales channels.

Please tell me more about the battery production lines.

We are currently running three battery production lines staffed by 70 factory workers. We currently produce 600,000 to 700,000 batteries per month, but we have the capacity to increase that by a significant multiple to meet customer demands.

We produce batteries as specified in the orders by our customers in four categories: mobile phone batteries, MP3/MP4 batteries, laptop batteries, digital camera. The majority of the business is in mobile phones and MP3/MP4 batteries. Some of the well known products that we manufacture for include aftermarket battery products for use in Sony, Samsung, Canon and Apple Ipod products.

Mr. Lin, please tell me more about the plans for uplisting and other recent corporate events.

We recently conducted a reverse split and are in the process of effecting a ticker change. Our name will change to "New Energy Systems Group" in upcoming weeks, to accurately reflect the primary focus of our business. Junfeng Chen is CFO of our operating company in Shenzhen and has been with the company for almost five years. He is currently acting as interim CFO for China Digital while we search for a candidate to assume to CFO role of our U.S.-listed entity. That search is under way and is focused on individuals with an international skill set and a focus on accretive acquisitions.
China Digital's products

On a more qualitative note, one of the other things I like about CMTP is its attention to investor relations. To set up a meeting in China, I called the company's internal New York-based investor relations vice president who answers on the first ring and speaks English.

CMTP has also retained China America Financial Communications as an investor relations service. CAFG recently coordinated CMTP's quarterly earnings call. While these may seem like logical steps, they are often not followed by U.S.-listed China companies. Simple things such as these give me confidence that CMTP will be able to quickly attract and retain the interest of investors.

-- Written by Rick Pearson in Beijing.
At the time of publication, Pearson was long China Digital Communications. 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.