China Gerui Advanced (NASDAQ:CHOP)

Third Quarter 2011 Results

• Revenue increased 63.4% to $101.1 million in the third quarter of 2011 from $61.9 million in the third quarter of 2010.
• Net income increased 76.2% to $21.4 million in the third quarter of 2011 from $12.1 million in the same period of 2010. Net income per diluted share in the third quarter of 2011 increased to $0.37 from $0.25 per diluted share in the same period of 2010, which factors in the significant increase of number of shares outstanding from the warrants exercised by March 21, 2011.

"We achieved a record increase in revenues in the third quarter and a substantial increase in operating profits resulting from our ability to meet further customer demand from the utilization of our new production capacities," said Mr. Mingwang Lu, Chairman and Chief Executive Officer. "Our third quarter saw a ramp-up in the utilization of our 400,000 tons of annual specialized steel production capacity, which included a substantial revenue contribution from our much-anticipated new wide-strip production line capable of annual volume of 150,000 tons. We are experiencing continued robust demand for both narrow and wide-strip cold-rolled steel products in China across a variety of industries. We believe that our new large-scale chromium-plating capacity and precision wide-strip cold-rolled steel products will enable an expansion in our operating margins in the quarters ahead."

"The final phase of our expansion plan will result in an additional 100,000 tons of cold-rolled steel per year by the fourth quarter of 2011," Mr. Lu continued. "The addition of wide-strip production lines and chromium plating capacity better diversifies our capabilities which will enable us to optimize our production mix. We plan to continue to capitalize upon our competitive advantage to meet the strong demand of the high growth domestic China market place."

Outlook

For fiscal year 2011, China Gerui will maintain guidance of revenue between $330 million and $345 million, gross profit of between $115 million and $120 million, adjusted net income* of between $70 million and $75 million, and adjusted diluted earnings per share* of between $1.20 and $1.25.

Second Quarter 2011 Results

"We achieved a strong rise in revenues in the second quarter and a solid rise in operating profits resulting from continued strong customer demand and the addition and utilization of our new production capacity," said Mr. Mingwang Lu, Chairman and Chief Executive Officer. "Our second quarter saw the addition of 200,000 tons of new chromium plating capacity which began normal operations in late March 2011, bringing our total chromium plating capacity up to 250,000 tons. This is already being used to complement our existing 250,000 tons of cold-rolled, narrow-strip steel capacity as well as our newly added 150,000 tons of cold-rolled, wide-strip steel. Due to our positioning in this specialized niche, we expect that strong customer demand will drive the utilization of our new wide-strip capacity to at least 75% of capacity by the end of the 2011."

"The final phase of our expansion plan will result in an additional 100,000 tons of cold-rolled steel per year by the end of 2011," Mr. Lu continued. "With the addition of added wide strip lines and chromium plating capacity, we have become a one-stop shopping source for many of our existing customers while new customers might also seek to capitalize upon the advantages attributable to the distinct customized nature of our business."

Revenue increased 34.4% to $86.1 million in the second quarter of 2011 from $64.0 million in the second quarter of 2010. The increase in revenue was primarily due to both a 23.3% increase in the Company's average selling price to $1,004 per ton for the second quarter of 2011 compared to $814 per ton for the same period of 2010, and an 8.9% increase in sales volume to approximately 85,600 tons for the second quarter of 2011 as compared to approximately 78,600 tons for the same period of 2010.

Net income increased 16.3% to $14.0 million in the second quarter of 2011 from $12.1 million in the same period of 2010. Net income per diluted share in the second quarter of 2011 decreased to $0.24 from $0.26 per diluted share in the same period of 2010, which is primarily due to the significant increase of number of shares outstanding from the warrants exercised by March 21, 2011.

Business Outlook

As previously disclosed, the Company's expansion plan is being implemented in two phases. Phase I involved the construction of two new cold-rolled, wide-strip steel production lines with 150,000 tons of total annual capacity and a chromium plating line capable of processing 200,000 tons of cold-rolled steel per year. These lines began normal operations as of June 2011. The Company expects an estimated 50% capacity utilization for the new wide-strip steel production lines in the third quarter, which is expected to rise to approximately 75% by the end of 2011. Phase II of the expansion plan involves the addition of 100,000 tons of cold-rolled steel production capacity per year by first quarter of 2012. This will bring the Company's total production capacity up to 500,000 tons of specialized steel.

Mr. Lu concluded, "Our value-added capabilities enable us to customize according to precise customer requirements in a variety of industry sectors. The completion of our new facility during the second quarter is a major milestone in our strategic growth plan as it heightens our product platform and enables us to be the steady source of supply to our customers, produce higher margin products as well as develop new, high-end technology products. We expect to see our production costs stabilize and experience margin improvements from our additional capacity in the second half of 2011 so as to reach sustainable gross margins in the 30% range."

For fiscal year 2011, China Gerui expects revenue of between $330 million and $345 million, gross profit of between $115 million and $120 million, adjusted net income* of between $65 million and $70 million, and adjusted diluted earnings per share* of between $1.10 and $1.15.

ZHENGZHOU, China, June 21, 2011 /PRNewswire-Asia/ -- China Gerui Advanced Materials Group Limited (NASDAQ: CHOP) (the "Company" or "China Gerui") today provided an update on its previously announced $10 million share repurchase program.

As of June 20, 2011, the Company has repurchased 780,273 ordinary shares at an average price of $3.82 per share for a total share repurchase to date of approximately $2.98 million.

Mr. Mingwang Lu, Chairman and Chief Executive Officer, stated, "We believe the repurchase of our shares represents a sound investment decision for our Company given recent trading prices. Our Board of Directors approved a share repurchase program that has been designed to comply with applicable securities laws and we commenced open market purchases of our shares in mid-May of 2011. If the price of our shares remains at or around the current market price level, we plan to continue to buy back our shares in accordance with the economic parameters of the repurchase program and subject to the legal limitations of the program, as approved by our Board."

We believe that our future capital expenditures will be incurred primarily in connection with (i) purchases of property, plant and equipment and construction of our facilities, (ii) leasehold improvements, (iii) investment in equipment, technology and operating systems, and (iv) capitalized interest. Our planned capital expenditures for 2011 and 2012 are for (i) the second phase of our capacity expansion program, in which 100,000 metric tons of processing capacity will be added by the first quarter of 2012, resulting in total capacity of 500,000 metric tons of cold-rolled steel processing, out of which 50% can be further plated with chromium, zinc or tin; (ii) upgrade our existing narrow strip acid pickling line for acid regeneration and environment control; and (iii) potential acquisitions or strategic partnership initiatives. We expect to finance these capital expenditures from cash on hand, future internal cash flows, short-term bank borrowings, and funds raised from capital markets.

Rodman and Renshaw on CHOP                          5/11/2011

Maintain Outperform Rating Despite a Slightly Below-Expectation 1Q11 Performance

1Q11 Results Slightly Below Expectations

China Gerui Advanced Materials Group (“Gerui”, Ticker: CHOP, Market Outperform) reported 1Q11 results that slightly missed our expectations. Revenue for the quarter increased 1.4% YoY to $62.7 million, a touch shy of our $63.5 million estimate. Average selling price increased 4.5% YoY to $909 per ton in 1Q11; however this was partially offset by a 3.0% YoY decrease in sales volume to approximately 69,000 tons in the quarter. Gross profit decreased 3.8% YoY to $18.0 million, representing a gross margin of 28.7%, below our respective estimates of $19.4 million and 30.5%. It should be noted that the pressure on gross profit and margin was partially attributable to costs incurred from the testing process for the company’s new chromium plating facility. This should be a one-time expense item and we expect Gerui’s gross margin will bounce back next quarter. SG&A as a percentage of revenue was 3.5%, below our estimate of 3.8%. Adding back the one-time $5.7 million expense item related to the warrant exercise, non-GAAP net income in 1Q11 was $9.7 million, or $0.20 per diluted share, below our respective estimates of $11.4 million and $0.22 EPS.

As of March 31, the company had $210.1 million in unrestricted cash and $83.1 million in restricted cash with no long-term debt. Working capital stood at $133.1 million and shareholder’s equity was $239.7 million. Accounts receivable was $3.8 million.

Updated 2011 Guidance

Gerui provided an updated 2011 guidance. Management continued to expect $330-$345 million of revenue and $115-$120 million of gross profit for the year. However the updated $65-$70 million net income and $1.10-$1.15 diluted EPS expectations were down $5 million and $0.10 from their respective figures provided by management a month ago.

Maintaining Market Outperform Rating and $11 Price Target

We have tweaked our model to reflect the updated 1Q11 financials and revised outlook. For 2Q11, we now estimate revenue, gross profit, and non-GAAP net income will reach $84.9 million, $28.0 million, and $17.0 million, respectively. The respective figures for full year 2011 are: $339.4 million, $114.1 million, and $69.1. We are reiterating our Market Outperforming rating on the shares of Gerui as well as our $11 price target. Our price target of $11 is based on Gerui shares trading at 9x our 2011 EPS estimate of $1.22, representing a PEG ratio of 0.4.

Risks

Major Risks include macroeconomic risk, steel price volatility, competition, customer concentration, and execution risks, as well as country and political risks related to operating in China.

Notice Regarding Privacy and Confidentiality:


This material has been prepared for informational purposes only. While it is based on information generally available to the public from sources we believe to be reliable, no representation is made that the subject information is accurate or complete. Past performance is not a guarantee nor does it necessarily serve as an indicator of future results. Price and availability are subject to change without notice. Additional information is available upon request.

Since Rodman & Renshaw, LLC is not a tax advisor, transactions requiring tax consideration should be reviewed carefully with your tax advisor. Similarly, Rodman & Renshaw, LLC is not a law firm and provides no legal opinions or legal advice.

Rodman & Renshaw, LLC may make a market in the securities being discussed.

Rodman & Renshaw, LLC and/or its officers or employees may have positions in any of the securities of this (these) issuer(s).

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Member SIPC.

First Quarter Results:

"We achieved a strong increase in operating cash flow in the first quarter of 2011 as a result of improved working capital management, while our sales growth increased slightly, constrained by our production capacity limitations as we continued to run our production facilities at near full capacity," said Mr. Mingwang Lu, Chairman and Chief Executive Officer. "Our first quarter profitability was negatively impacted by three expenses that we believe are of a non-recurring nature.  Firstly, our chromium-plating line was in test runs in the first half of the first quarter and raw materials used for testing purposes were included in the cost, thereby impacting our gross margin.  In addition, we incurred one-time interest expenses as we took out additional bank facilities during the quarter because we did not have certainty on the amount of cash proceeds that we would receive from the warrant exercise.  Finally, we incurred one-time expenses related to recent warrant exercises of $5.7 million.  As such, we are reporting certain non-GAAP numbers with this quarter's earnings release that we believe more appropriately reflect the fundamental health and profitability of our business."  

• Revenue increased 1.4% to $62.7 million in the first quarter of 2011 from $61.8 million in the first quarter of 2010
• Adjusted net income, which excludes the aforementioned one-time warrant exercise expenses, was $9.7 million, or $0.20 per diluted share.*
• For fiscal year 2011, China Gerui expects revenue of between $330 million and $345 million, gross profit of between $115 million and $120 million, adjusted net income of between $65 million and $70 million, adjusted diluted earnings per share of between $1.10 and $1.15. Adjusted net income and adjusted diluted earnings per share exclude one-time warrant exercise expenses incurred in the first quarter of 2011.  

Rodman and Renshaw on CHOP                            4/8/2011

4Q10 Review; Share Buyback and Removal of Warrant Overhang Positive; Increasing PT to $11

Q4 Results mostly in-line with our expectations

China Gerui Advanced Materials Group (“Gerui”, Ticker: CHOP, Market Outperform) reported 4Q10 results that were by and large in-line with our expectations. Total revenue increased 15.6% YoY to $66.1 million, above our estimate of $64.3 million. During the quarter, the company sold 75,551 tons of products at an average selling price of $875 per ton. Gross profit increased 15.4% YoY to $19.6 million, slightly higher than our estimate of $19.3 million; however actual gross margin of 29.7% was a touch shy of our expectation of 30.0%. Operating expenses continued to be weighed by new hires and training in anticipation of the expanded capacity. As a result, net income for the quarter was $11.3 million, missing our expectation by $1 million. And diluted EPS for 4Q10 was $0.23, one penny shy of our $0.24 estimate.

At the end of 2010, Gerui had $119.5 million of unrestricted cash and an additional $66.5 million of restricted cash, against zero long-term debt.

New 2011 guidance

For 2011, Gerui now expects to realize $330-$345 million of revenue, $115-$120 million of gross profit, and $70-$75 million of net income, translating to diluted EPS between $1.20 and $1.25. We believe this guidance is achievable, as we expect the company will start normal production of its two new cold-rolled, wide-strip steel lines with 150,000 tons of annual capacity in 2Q11, after the successful production launch of its chromium plate line last month. We also anticipate some margin expansion as the new wide-strip and chromium plated products could bring in higher gross margins (somewhere between 35-40%) than the existing thin-strip products that typically offer gross margins of around 30%.

$10 million share buyback plan announced

In conjunction with the earnings release, the company announced a share repurchase plan to buy back up to $10 million of its common stock. While no details were provided regarding the specific timing and amount, we believe the announcement should serve as a positive signal indicating management’s confidence in the company as well as expressing their view on the current share price. In addition, with the ample cash on hand (especially after the recent warrant conversion) and strong capability to generate operating cash, we believe the company has sufficient ammunition to announce further buybacks in the future if needed.


Notice Regarding Privacy and Confidentiality:

This material has been prepared for informational purposes only. While it is based on information generally available to the public from sources we believe to be reliable, no representation is made that the subject information is accurate or complete. Past performance is not a guarantee nor does it necessarily serve as an indicator of future results. Price and availability are subject to change without notice. Additional information is available upon request.

Since Rodman & Renshaw, LLC is not a tax advisor, transactions requiring tax consideration should be reviewed carefully with your tax advisor. Similarly, Rodman & Renshaw, LLC is not a law firm and provides no legal opinions or legal advice.

Rodman & Renshaw, LLC may make a market in the securities being discussed.

Rodman & Renshaw, LLC and/or its officers or employees may have positions in any of the securities of this (these) issuer(s).

Member FINRA.
Member SIPC.

ZHENGZHOU, China, April 7, 2011 /PRNewswire-Asia-FirstCall/ -- China Gerui Advanced Materials Group Limited today announced that its Board of Directors has approved the repurchase of up to an aggregate of $10 million of its Ordinary Shares.  

"Based on current market prices, we believe that the repurchase program is in the best interests of our shareholders," said Mr. Mingwang Lu, Chairman and Chief Executive Officer. "The board's decision to implement this buyback reflects our firm belief that our shares are presently undervalued in the marketplace and represent a sound investment decision at recent trading prices.  Our board of directors believes that the repurchase program is an effective use of cash to enhance value for our shareholders and demonstrate our confidence in the long-term health and future financial performance of our business."

Third Quarter 2010 Highlights (From November 15,2010)

• Revenue increased 4.4% to $61.9 million compared to the same period last year
• Gross profit increased 2.3% to $18.6 million
• Operating income increased 1.8% to $16.5 million
• Net income increased 5.6% to $12.1 million, or $0.25 per diluted share vs.

"There continues to be robust demand for high precision steel in China supported by the country's fast growing economy," said Mr. Mingwang Lu, Chairman and Chief Executive Officer.  "There is a limited domestic supply of this type of product in China because Chinese manufacturers lack the equipment and expertise to produce high end specialty cold rolled steel.  As a result, even though China is a net exporter of crude steel, the country is actually a net importer of cold rolled narrow strip steel. Our business has benefited from an increasing movement toward import replacement in China.  Domestic Chinese customers are turning to our high-end precision steel products because our products are more competitively priced and, equally important, are also of the same quality as the premium priced imported products that domestic Chinese customers have historically relied on.

"As a result of this robust demand, our current production facility continues to operate at near-full capacity and we very much look forward to having our additional capacity come online.  Despite existing capacity constraint, we were able to increase our production volume slightly year-over-year which was the main driver of our revenue growth.  Our average selling price during the third quarter was lower than last year but higher than in the second quarter of 2010, mirroring the pricing trends in the raw steel market.  Rising steel prices mean higher revenues for our company due to the fact that we have adopted a cost-plus pricing strategy and we can pass on the raw material increase to our customers while maintaining a gross margin equivalent to our current 30% level, if not higher.  The decline in our operating margin was the result of our additional staffing and training costs as we prepare for the opening of our new production facility.  With our new capacity coming online, we will be able to offer our customers new, higher value-added products, such as chromium and zinc coated products and wide strip products.  Our customers are asking us to produce these products so we are confident the demand will be there once our new production capacity comes online.  These products will increase our sales and our profitability as they are higher margin than the products we make now."

Outlook from December 9, 2010

For fiscal year 2010, China Gerui expects

• revenues of $252 million
• net income of $48 million.

For fiscal year 2011, China Gerui expects

• revenues of between $330 million and $345 million
• gross profit of between $115 million and $120 million
• net income of between $70 million and $75 million
• capital expenditures to complete its previously announced expansion plan of between $12 million and $15 million.

Mr. Mingwang Lu, Chariman and Chief Executive Officer, commented, "Our current production facility continues to operate at near-full capacity and we very much look forward to having our additional capacity come online. By December 2011, we plan to double our existing production capacity to 500,000 tons per annum, and increase our chromium plating capability to 250,000 tons per annum, covering 50% of our total annual steel production capacity.

Phase I of the expansion plan involves the construction of two new cold-rolled, wide-strip steel production lines with 150,000 tons of total annual capacity and a chromium plating line capable of processing 200,000 tons of cold-rolled steel per annum. We expect that the two new cold-rolled production lines will be completed by January 2011, to be followed by test production runs and a full launch of production operations by March 2011. We expect a relatively quick ramp-up after the full launch of production operations begin with an initial capacity utilization of the two new cold-rolled wide-strip steel production lines of approximately 50% rising to approximately 75% by September of 2011. Phase II of the expansion plan involves the construction of a third cold-rolled wide strip steel production line with 100,000 tons of capacity by the end of the third quarter of 2011.

"We expect demand in China for the type of high precision steel that we produce to continue to grow at a healthy pace due to the continuing improvement of the standard of living in the country and the growth of the Chinese middle class, who are the ultimate end-users of our products. In addition the Chinese government is continuing to encourage domestic consumption throughout the economy. With our new capacity coming online, we will be able to offer our customers new, higher value-added products, such as chromium and zinc coated products and wide strip products. Our customers are asking us to produce these products so we are confident the demand will be there once our new production capacity comes online. These products will increase our sales and our profitability as they are higher margin than the products we make now."

Rodman & Renshaw on CHOP

3Q10 Results Slightly Below Expectations 

China Gerui Advanced Materials Group (“Gerui”, Ticker: CHOP, Market Outperform) reported 3Q10 results that slightly missed our top and bottom line projections. Total revenue increased 4.4% YoY to $61.9 million, but below our estimate of $64.8 million and Street consensus of $64.0 million. Gross profit grew 2.3% YoY to $18.6 million, representing a gross margin of 30.0%, slightly below our respective estimates of $19.6 million and 30.2%. SG&A as a percentage of revenue was 3.4%, above our estimate of 2.9%, largely due to increases in additional salary and training expenses from hiring new employees in anticipation of the opening of the new production facility. Net income increased 5.6% YoY to $12.1 million, a touch shy of our estimate of $12.4 million, but higher than Street consensus of $11.9 million. Diluted EPS for the quarter was $0.25, in-line with our estimate, higher than Street consensus of $0.24. At the end of the quarter, the company had $110.7 million in cash and $73.1 million in restricted cash with no long-term debt. Accounts receivable was $4.2 million, down $0.6 million from the end of last year. 

Our Take 

We believe Gerui’s 3Q10 results as a whole were more or less within the range of our expectations. Demand for the company’s high-precision cold-rolled steel remained robust, however the company’s revenue and profit growth continued to be constrained by its capacity bottleneck, as it has been operating near full capacity for over a year. Average selling price during the quarter was slightly higher than 2Q10, but noticeably lower than 3Q09, mirroring that of the general raw steel pricing trend. There was an important development regarding the company’s capacity expansion, however. Due to severe flood in Henan earlier this summer, construction for the company’s two new cold-rolled wide strip lines were delayed. The company now expects completion date in 1Q11 instead of 4Q10. On the bright side, Gerui’s chromium-coating line will come online in Q4 as previously scheduled. 

Adjusting Estimates 

We are adjusting our model in light of the quarterly results and revised outlook. Since the two wide strip lines will not be completed until next year, for 4Q10, we now expect the company will realize $64.3 million of revenue, $19.3 million of gross profit, and $12.3 million of net income. We expect sales volume for the quarter will be more or less in line with the past quarter. Due to the launch of the new chromium plating line, we estimate ASP will increase slightly from the Q3 level. Looking forward to 2011, we expect the wide strip line will start to contribute the company’s top and bottom lines as early as in Q1, and by Q4, we expect Gerui’s phase II expansion will start to generate revenue. For the whole year, we now estimate revenue, gross profit, and net income will reach $324.3 million, $98.7 million, and $63.3 million, respectively.

Notice Regarding Privacy and Confidentiality:

This material has been prepared for informational purposes only. While it is based on information generally available to the public from sources we believe to be reliable, no representation is made that the subject information is accurate or complete. Past performance is not a guarantee nor does it necessarily serve as an indicator of future results. Price and availability are subject to change without notice. Additional information is available upon request.

Since Rodman & Renshaw, LLC is not a tax advisor, transactions requiring tax consideration should be reviewed carefully with your tax advisor. Similarly, Rodman & Renshaw, LLC is not a law firm and provides no legal opinions or legal advice.

Rodman & Renshaw, LLC may make a market in the securities being discussed.

Rodman & Renshaw, LLC and/or its officers or employees may have positions in any of the securities of this (these) issuer(s).

Member FINRA.

We may offer, issue and sell from time to time our ordinary shares, preferred shares, debt securities, warrants, or units up to $100,000,000 or its equivalent in any other currency, currency units, or composite currency or currencies in one or more issuances.

Second Quarter 2010 Summary:

• Revenue increased 15.5% to $64.0 million compared to the same period last year.
  
• Gross profit increased 13.0% to $19.1 million.
  
• Gross margin decreased 60 basis points to 29.9%.
  
• Net income increased 5.8% to $12.1 million, or $0.26 per diluted share vs. $0.33 per diluted share in the prior year comparable quarter.
  
   "Our second quarter results were driven by increased sales volume as compared to the same period last year," said Mr. Mingwang Lu, Chairman and Chief Executive Officer.  "During the quarter, we fulfilled large orders for some of our lower margin products.  This enabled us to post a double-digit increase in sales as well as higher net income, but also resulted in a decrease in our margins.  We continue to see strong demand for our products and as our new production lines focused on higher priced, higher margin products commence production later this year, we expect to achieve sustained increases in sales, margins, and earnings performance."

Business Outlook:

 As previously announced, by December 2011, the Company plans to double its existing production capacity to 500,000 tons per annum, and increase its chromium plating capability to 250,000 tons per annum, covering 50% of its total annual steel production capacity. Phase I of the expansion plan involves the construction of two new cold-rolled, wide-strip steel production lines with 150,000 tons of total annual capacity and a chromium plating line capable of processing 200,000 tons of cold-rolled steel per annum. The Company expects total capital expenditures for Phase I to be $42 million, of which approximately 65% has been spent to date. The foundation for the building housing the two new cold-rolled steel production lines was completed in August 2010 and the building will be completed by mid-September 2010. 

The two cold-rolling machines are expected to be completed by October 2010. The acid pickling, annealing, and temper rolling facilities relating to the Company's new steel production lines are expected to be completed by the end of September 2010. As for the chromium plating line, the building to house this line was completed in August 2010; installation is currently underway; testing is scheduled for mid-September 2010; and the line is expected to be ready to begin production in mid-October 2010. The chromium plating line can handle both narrow and wide-strip cold-rolled steel. 

For Phase II of the project, the Company expects to construct a third cold-rolled wide strip steel production line with 100,000 tons of capacity by the end of the third quarter of 2011. The Company expects the capital expenditures for Phase II to total $12 million.  
 
Mr. Lu commented, "Our expansion project remains on track and we look forward to bringing this new capacity online later this year.  Our business outlook remains strong as the sale of our products are driven by domestic purchasing power in China, which continues to rise, and the import replacement trend in our industry.  With our new facility we will be able to produce both narrow and wide-strip cold-rolled steel for a wider range of high-end applications than we do currently.  We see the demand in the market and are confident in our ability to ramp up production once our expansion is complete."   

Rodman & Renshaw initiating coverage of China Gerui Advanced Materials Group Ltd. (“Gerui”, Ticker: CHOP) with a Market Outperform/Speculative Risk rating and a price target of $10. Based in Zhengzhou, China, the company is the largest manufacturer of high-precision and high-strength cold-rolled narrow strip steel products in China, with customers in diverse industries ranging from food packaging to construction materials, telecommunication equipment, and electrical appliances.

We believe Gerui enjoys a favorable market position, in spite of the overall sluggish Chinese steel market. The company operates in the high-end precision strip segment, in which the Chinese demand, driven by large addressable and fast growing end-markets, still far exceeds supply. With limited domestic competition due to high entry barriers, Gerui’s business enjoys significant competitive advantages over foreign imports as the company can offer lower prices coupled with comparable product quality and faster local services. Gerui is also very much of a steel processor and not a steel maker. With a “cost plus” pricing strategy, it effectively passes through most of the steel price fluctuations to its customers, allowing the company to maintain margins during periods of market volatility. 

 With a solid track record and an experienced management, the company is poised to achieve significant growth in the near future. Gerui has been operating near full capacity since the beginning of last year and has one of the most efficient operations in the Chinese steel industry. After the recent two rounds of capital financing, the company is in the process of doubling its strip steel production capacity within one and half years and expanding its margin-improving chromium-plating capability. With such capacity increases, we expect the company will realize $357.5 million of revenue and $70.5 million of net income in 2011, up 37% and 42% from 2010, respectively. 

 Compelling valuation The shares of Gerui are currently trading at 5.5x and 4.6x our respective 2010 and 2011 EPS estimates, below its respective peer averages of 11.9x and 9.1x. This in our view represents an attractive valuation for this company. We believe Gerui, as the national leader in its market segment and with a favorable market environment, should command a forward P/E multiple that is at least in-line with its steel company comparables. Our 12-month price target of $10 is thus based on Gerui shares trading at 9x our 2011 EPS estimate of $1.15, representing a PEG ratio of 0.5. 

 Risks Major risks include macroeconomic risk, steel price volatility, competition, customer concentration, and execution risks, as well as country and political risks related to operating in China.

Last week, GeoInvesting Contributor Zack Buckley had the chance to interview Mr. Edward Meng, CFO of China Gerui Advanced Materials Group (CHOP). Here is the full transcript, the abbreviated transcripts can also be found on thestreet.com and seekingalpha.com.

Zack: Can you give me some background on your company?

Edward: China Gerui is the largest producer of high precision cold-rolled narrow strip steel products in China, with a market share of 12.5%. We started back in 2000 and over the last 10 years we have continuously been adding to our capacity to meet the increasing demand from the China market for the high-end cold rolled steel products that we produce. We are in the sweet spot where there is limited supply of the high-end products that we produce, which puts us in a great position. The company came from a SPAC background. The SPAC merger was completed in March 2009. In November 2009, we completed a follow-on offering and were upgraded to NASDAQ. Our current production is 250,000 tons of cold rolled narrow strip steel. In view of the long-term cold-rolled steel market growth in China, which is primarily driven by rising domestic consumption, we are currently in the process of expanding capacity because we have reached close to full utilization on the existing capacity, which admittedly is a good problem to have. We cannot churn out our product fast enough to meet the high demand. By the end of 2010 we will add about 150,000 tons of cold rolled wide strip capacity. By end of 2011 we will be adding another 100,000 tons, achieving a total production capacity of 500,000 tons, which is two times the capacity we have now. This is one of the major reasons we did the latest capital raise of $18.8 million.

Zack: What is the price per ton for your product?

Edward: The average selling price of our products ranged between $870 to $890 per ton over the last 12 months, depending on the then prevailing price of commodity hot-rolled steel. Due to our cost-plus pricing strategy, we have been able to pass on any increase in raw material prices to our customers.

Zack: Where do you see the company in 5 years? 10 years?

Edward: From 2004-2008, we added capacity year on year and funded this all through our own internally generated cash flow. Going forward, we will be adding capacity to meet market demand. We have always been able to stay one step ahead of our competitors. When everyone got into hot rolled coil, we got into cold rolled steel. When cold rolled steel got competitive, we went to high-end steel. Now we are focusing on adding to and optimizing our overall product mix. Our high-end products are of the same quality as products that are currently being imported into China except our products are sold at a much more competitive price, so we have had great success in enhancing our growth by replacing products that were until now imported into the country. In the next 5-10 years, we will continue to strengthen our market leadership while optimizing our product mix with high end products.

Zack: What are the various segment lines of the company?

Edward: Our core business is cold-rolled steel production and we have no other businesses. High precision cold rolled narrow strip steel is the primary business of the company for now. With the additional expanded capacity of 250,000 tons before the end of 2011, we will start serving the cold-rolled wide strip steel market with high-end, higher margin products.

Zack: Can you explain the different steel products?

Edward: Cold rolled steel – Cold rolled sheet products are used in a wide variety of end applications such as food & beverage packaging, construction and decoration materials, electrical and home appliances and fiber optic cable. Cold rolled sheet products are used in these and many other areas of manufacturing. To meet the various end user requirements, cold-rolled sheet products are metallurgically designed to provide specific attributes such as high formability, deep drawability, high strength, high dent resistance, good magnetic properties, enamel ability, and paintable. These are the types of products that we make. They are specialized, high-end, high-margin, non-commodity products.

Hot rolled steel – Hot-rolled steel is the commodity raw material that goes into our production process of cold-rolled steel. Hot-rolled steel cost is impacted primarily by the cost of iron ore. China Gerui purchases hot-rolled steel from the open, commodity market, and then turns this steel into high-end cold-rolled steel products by leveraging our proprietary production process and advanced high-precision machines. We do not make hot rolled steel. We are not a commodity steel producer.

Zack: Who are your main competitors?

Edward: The cold-rolled steel market in China is highly segmented. Our competitors are both state-owned and private sector companies. We are the largest player in the cold-rolled narrow steel strip market with about 12.5% market share. The top five players in this segment of the market accounted for about 36% of the market, with the rest of the market consisting of over 200 smaller and private players.

Zack: Why do your customers choose you over the competition?

Edward: Customers will choose us over our competitors for a number of reasons

1. We have a strong brand name and reputation in China in our industry. Our products are known for their high quality and precision. We have strong technical capabilities.
2. We have proven that we are able to customize contracts for our customers based on the specific attributes they required for the intended end-use application. As such, they have seen us do it successfully before, so they keep coming back since they know we are reliable and can meet their specifications.
3. We have strong R&D capabilities and we continue to offer new product offerings that our clients are interested in.
4. We are able to adjust our operations to meet different size orders. Our contract sizes range from over 2,000 metric tons for some companies to as little as 500 tons.

Zack: Will the margins stay the same on the new facilities?

Edward: Historically we have been able to continuously improve on our profit margins. Our gross margins are approximately 30%. With the new 250,000 ton capacity that will be released from the expansion program by 2011, we expect to improve on this profitability level going forward. Our ability to enhance our margin performance is primarily due to our cost-plus method of pricing, our ability to optimize our product mix (with higher margin chromium-plating accounting for an increasing percentage of total capacity going forward), and our ability to continuously offer new products to the market.

Zack: How is the growth in the overall industry? In China?

Edward: We serve over 200 customers and they primarily come from 4 industries. Food and beverage packaging, construction and decoration materials, electrical and home appliances as well as telecom. The first three industries are all driven by the increase in the consumption power of the Chinese economy, which we expect to continue to rise. Over the next three years, we expect to see double digit annual growth in our industry. The telecom industry in particular should continue to benefit from the Chinese government's policy on expanding broadband and 3G networks in both rural and urban areas, which in return, provides for increased demand for China Gerui's product in the manufacturing of fiber optic cables.

Zack: Who are your main customers? May I speak with them?

Edward: Our main customers come from those industries mentioned above. For example, one customer is a producer for telecom operators in China. Other customers are food and beverage packaging and home appliance producers in China.

Zack: Do you expect your revenue by industry to stay stable in the next few years? Where will your additional capacity go to?

Edward: The food and beverage packaging industry contributes almost 50% of the revenue for our company. Going forward, we see increasing revenue contribution from the telecom industry and construction decoration materials, along with growth in revenue from food & beverage packing.

Edward: Our additional capacity will go toward more coated products and wide strip products.

Zack: What will be the return on capital? What is the output?

Edward: We estimate the payback period for this capacity expansion program to be about 2.5 years. This is for both phases combined. The total additional output will be 250,000 tons, 150,000 for phase 1 and 100,000 for phase 2. The expected capex for phase 1 will be 42 million, while the capex for phase 2 is expected to be 12 million.

Zack: How will you finance both phases?

Edward: The capacity expansion program has been financed with internally generated cash, proceeds from the conversion of warrants, and accessing the capital markets. We are confident the expansion program will be executed successfully and production will start as per the original schedule. Our business generates strong free cash flow. We currently have approximately 16 million warrants outstanding and the majority of the warrants get converted by March of next year. We anticipate this warrant conversion can yield an additional $75 million plus to finance our expansion and future business and capacity expansion All of these resources together will help finance Phase 2 of our expansion, serve us well in terms of our overall working capital needs and put us in a competitive position for future business development.

Zack: What will the private placement be used for?

Edward: We plan to use the net proceeds from the private placement to finance the previously announced expansion of the Company's high-precision cold-rolled steel production capacity, accelerate the build-out of a chromium-plating production line of 200,000 metric tons that was originally scheduled for 2011, as well as for general working capital purposes related to the expanded production capacity.

Zack: If you had to invest in a small cap US listed publicly traded Chinese company other than your own, what would it be?

Edward: Looking at the overall spectrum of Chinese companies that trade in the U.S., I would encourage investors to look at companies that will benefit, the way China Gerui has and expects to continue to benefit, from the growing purchasing power of the Chinese consumer and middle class.

Zack: If you had a golden bullet, where you could eliminate one competitor, who would it be?

Edward: We don't think we need a golden bullet to compete in our market. We believe we will continue succeed in penetrating China's cold-rolled steel market as well as replacing high-end imports. We are focused on maximizing our operating efficiency and optimizing our product mix. We expect to continue to increase our market share in China. Overall we are optimistic about our business prospects. We expect continued growth in both our top and bottom line for the rest of the year.

Disclosure: No Position

Profile

GeoTeam Contributor Zack Buckley is CEO of Uncoveringalpha.com and a research analyst at Geoinvesting.com. He developed his investing methodology by synthesizing the ideas from the best investors of all time, based on their track record. This led him to closely follow Warren Buffett, Peter Lynch, Seth Klarman and Benjamin Graham. Using a value approach, he pursued the most undervalued companies he could find, which led primarily to companies in China. Buckley will be spending three months this year in China visiting companies that are exciting investment opportunities.

****Follow him on his blog, Uncoveringalpha.com, , as he travels across China touring factories and interviewing management.**

Added to the GeoSpecial list on 11/11/2009 @ $5.25

    Catalyst: High margin leader in its industry; repricing of risk premium.
    Peak performance: Reached a high of on $8.20 on 3/10/2010
    Current Price: $5.58

    Current road block: Dilution, 2010 eps growth is expected to be negative before growing 20% in 2011. Operating at full capacity, leading us to believe they will need to tap the equity markets again.

    Removing from  GeoSpecial list.

"We are pleased with our fourth quarter and full year results," said Mr. Mingwang Lu, Chairman and Chief Executive Officer. "Our top line growth was driven by our ability to increase the volume of our sales to meet continued robust customer demand and rising average selling prices for our products. The majority of our revenues come from the domestic consumer market in China, which we believe will continue to exhibit growth. Additionally, our continued focus on operational efficiency and cost controls helped us increase our gross and operating margins and achieve strong bottom line performance. We continue to improve the overall utilization rate of our production capacity and better mobilize existing resources towards higher-margin product offerings to further increase our profitability."

Mr. Lu added, "Our immediate focus for 2010 is increasing our production capacity and expanding our product portfolio into higher margin coated steel and wide strip products. We also expect to continue to benefit from the sustained rise in the purchasing power of the Chinese consumer, who is the ultimate buyer of the products our customers produce. Another market trend that we expect to benefit from is the continuing movement toward import replacement in our industry. Our customers are increasingly turning to our high-end precision steel products, which are more competitively priced but of the same quality as the premium priced imported products that they have historically relied upon."

 For the first quarter of 2010, the Company expects to achieve revenues of between $54 million and $56 million and net income of between $10.5 million and $11 million. The Company expects to file its Annual Report on Form 20-F for the fiscal year ended December 31, 2009 on or before April 30, 2010.

Source: PR Newswire (March 10, 2010)