By MARILYN ALVA, INVESTOR'S BUSINESS DAILY 

The potent white liquor known as baijiu is as popular in China as sake in Japan or vodka in Russia.

And as disposable incomes rise, demand for the grain-based national drink keeps growing, more than 16% a year, higher than supply growth.

The supply-demand imbalance gives China New Borun Corp. (BORN) reason to cheer.

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It's the third largest producer and distributor of corn-based edible alcohol, used by distillers to make baijiu.

As it expands plant capacity while many older and smaller producers are being shut down by the government, Borun aims to be the No. 1 supplier.

The company, which went public in June, is the only pure-play edible alcohol supplier in China that's publicly listed. Though it priced under guidance at $7 a share, the stock has nearly doubled since.

A Leisure Play

"It's a way to play leisure entertainment spending in China," said Jeff Papp, senior analyst with Oberweis Asset Management, which owns 360,000 shares in the company. "Think about it: Its product is used in the production of baijiu, which is super popular and has the same kind of growth trajectory beer had here ."

The company raised $35 million in its initial public offering, after expenses. A lot of it is earmarked for expansion of its plant in Daqing, a big corn-producing region in the northeast. The region is also home to many baijiu distillers, Borun's customers.

At the Daqing plant, 120,000 tons of additional capacity is expected to be added by the end of December to the current 100,000-ton maximum.

Borun also operates facilities in the east-central coastal province of Shandong, another fertile corn belt.

The region is home to the company's headquarters in Shouguang.

The two regions bring total production capacity to 260,000 tons of corn-based edible alcohol per year, not counting upcoming capacity.

In both regions, Borun has secured favorable corn-supply contracts with local growers.

The recent global wheat shortage won't have much effect on the company's corn supply due to the abundance of local suppliers, the company's chief financial officer said in an August conference call. And any hikes in corn prices can be passed on, the CFO said.

"As alcohol spot prices are trending up in China, we believe this would create room for cost pass-on, even if corn cost rises higher than expected," wrote Piper Jaffray analyst Anson Chan in a Sept. 21 client note.

Pricing trends bode well for Borun now, says analyst Katherine Lu of Oppenheimer & Co. Prices of edible alcohol have risen 40% year to date while the price of corn, the main raw ingredient, has gone up 20% during the same time, she said Wednesday.

Facilities in both regions have already completed expansion begun earlier, driving much of the company's recent revenue and net income growth.

In the second quarter, revenue rose 154.5% from the year-ago period to $63.7 million, the company reported. Net income rose around the same percentage amount to $9.9 million. In its first quarter as a public company, Borun earned 46 cents a share.

Papp says the government has granted Borun "one of the last licenses to increase production of edible alcohol," which gives it a leg up on the competition.

 

"Most of the factories for this stuff are somewhat polluting, and the government is trying to limit polluting industries," he said. "This is one (industry) being targeted by the government."

Borun says its proprietary wet-process production method consumes less energy and water than the typical dry-milling process used by other edible alcohol producers in China. It also results in higher yields and generates added revenue streams from byproducts.

If Borun wants to expand volume by an additional 110,000 metric tons next year under its last remaining government license, it will likely need to raise more funds through a follow-on offering, Lu says.

"They are putting everything into expanding their capacity now," she said.

About 70% of revenue comes from edible alcohol. The rest comes from byproducts, such as dried grains with solubles used as feed for livestock, poultry and fish, and corn germ used to make corn oil.

At its Shouguang facility, Borun recently began converting waste carbon dioxide to liquid form for sale to third parties. The operation started generating output in July.

After Borun expands to the fullest extent allowed by the government, future expansion would likely come through acquisitions, management has said. Lu doesn't see that happening before 2012.

Meanwhile, the company is expanding its customer base in other provinces, including brand-new regions such as Sichuan Province, where demand for edible alcohol is strong.

Higher Margins

Borun is shifting production away from grade C edible alcohol to higher-margin, higher-quality grade B product.

Analysts surveyed by Thomson Reuters estimate Borun's per-share earnings next year will grow 23% over this year to $2 a share and go up 17% in 2012.

Piper Jaffray's Chan sees more.

"We expect Borun to stay on a fast growth track" of 31% compounded annual EPS growth from fiscal 2010 through 2012, he wrote in his recent note. Piper Jaffray was an underwriter in Borun's IPO, as was Oppenheimer.

Despite stock volatility, Chan said plant utilization was over 95% in August, corn costs in July and August were stable due to long-term procurement agreements, and expansion in Daqing "is well on track." New commercial production there, he notes, will start in early 2011.

The company itself forecasts that 2010 revenue should range from $243 million to $245.9 million for a gain of 55.7% to 57.5% over 2009. It didn't give guidance beyond that